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INFO RUEHOO/CHINA POSTS COLLECTIVE

UNCLAS SECTION 01 OF 13 BEIJING 000303 
 
SIPDIS 
 
DEPT FOR EEB/IFD/OIA 
STATE PASS USTR 
 
E.O. 12958: N/A 
TAGS: EINV EFIN ETRD ELAB KTDB PGOV USTR OPIC CH
SUBJECT:  2010 INVESTMENT CLIMATE STATEMENT - CHINA 
 
REF:  09 STATE 124006 
 
¶1.  The following is Post's submission for the 2010 Investment 
Climate Statement for China, keyed to the categories listed in 
reftel. 
 
¶2.  2010 Investment Climate Statement - China 
 
-------------------------------------- 
Overview of China's Investment Climate 
-------------------------------------- 
 
Amid a 39 percent decrease in global foreign direct investment (FDI) 
flows, FDI into China fell only 2.6 percent in 2009, according to 
the United Nations Conference on Trade and Development (UNCTAD). 
UNCTAD's preliminary estimates show 2009 FDI flows into China (not 
including finance) totaled $90 billion, making China the second 
largest recipient of FDI after the United States.  UNCTAD estimates 
that FDI stopped declining in China in the latter half of 2009. 
 
China's sustained high economic growth rate explains its relative 
attractiveness as an FDI destination.  However, foreign investors 
face a range of potential problems that affect China's investment 
climate. These problems include a lack of transparency, weak 
intellectual property rights (IPR) protection, corruption, 
industrial policies that protect and promote local firms, and an 
unreliable legal system. 
 
China has a legal and regulatory framework granting it the authority 
to restrict foreign investment that it deems not to be in China's 
national interest.  Key terms and standards in many regulations are 
undefined.  China has told the United States that it wants to 
preserve flexibility for its regulators to approve or block foreign 
investment projects in response to changing circumstances.  The 
potential restrictions that China may impose are much broader than 
those of most developed countries, including the national security 
review conducted by the Committee on Foreign Investment in the 
United States (CFIUS). 
 
At the moment, China appears to discourage foreign investments: 
 
- intended to profit from currency, real estate, or asset 
speculation; 
 
- in sectors where China is seeking to cultivate national 
champions; 
 
- in sectors that have benefited historically from state-authorized 
monopolies or from a legacy of state investment; 
 
- in sectors deemed key to social stability; and 
 
- that are nominally foreign but are actually Chinese capital that 
has been exported offshore and then re-imported to take advantage of 
preferential treatment accorded to foreigners, i.e., "roundtrip" 
investment. 
 
China's laws and regulations give regulators significant discretion 
to shield inefficient or monopolistic enterprises from foreign 
competition.  They are also often applied in a manner that is not 
transparent.  In addition, overall predictability for foreign 
investors has suffered because investors are less certain that China 
will approve proposed investment projects. 
 
Investment Guidelines 
--------------------- 
 
While insisting it remains open to inward investment, China's 
leadership has also stated that China is actively seeking to promote 
investment in higher value-added sectors, including high technology 
research and development, advanced manufacturing, energy efficiency, 
and modern agriculture and services, rather than basic 
manufacturing.  China also seeks to spread the benefits of foreign 
investment beyond China's more wealthy coastal areas by encouraging 
foreign companies to establish regional headquarters and operations 
in Central, Western, and Northeastern China. 
 
Five Year Plan 
-------------- 
 
China defines its broad economic goals through five-year 
macro-economic plans.  The most significant of these for foreign 
investors is China's Five-Year Plan on Foreign Capital Utilization. 
The most recent version was released in November 2006 and promised 
greater scrutiny of foreign capital utilization.  The plan calls for 
the realization of a "fundamental shift" from quantity to quality in 
foreign investment from 2006 to 2010. 
 
BEIJING 00000303  002 OF 013 
 
 
 
According to the document, the focus of China's investment policy 
should change from shoring up domestic capital and foreign exchange 
shortfalls to introducing advanced technology, management expertise, 
and talent.  Government regulators should pay more attention to the 
environment and energy efficiency when evaluating investments for 
government approval.  The document also demands tighter tax 
supervision of foreign enterprises and seeks to restrict foreigners' 
acquisition of "dragon head" enterprises (i.e., premier Chinese 
firms), prevent the "emergence or expansion of foreign capital 
monopolies," protect "national economic security," particularly 
"industrial security," and prevent the "excessive use of 
intellectual property rights protection that is unfavorable to 
Chinese indigenous innovation." 
 
Foreign Investment Catalogue 
---------------------------- 
 
China outlines its specific foreign investment objectives primarily 
through its Catalogue for the Guidance of Foreign Investment 
Industries.  The most recent version of this Foreign Investment 
Catalogue entered into effect in 2007.  The catalogue is revised 
every few years and is supplemented by directives from various 
government agencies.  According to Chinese officials, it is a static 
document, intended as a snapshot of policies in place at a given 
time, subject to revision at the government's discretion, and thus 
may not fully reflect China's foreign investment policy after it is 
published.  In December 2008, China also released an updated version 
of its Catalogue of Priority Industries for Foreign Investment in 
the Central-Western Regions, which outlines additional incentives to 
attract investment in targeted sectors to those parts of China. 
 
The Foreign Investment Catalogue serves two functions.  First, China 
intends for it to help foreign investors understand China's complex 
industrial policy by delineating sectors of the economy where 
foreign investment is "encouraged," "restricted," and "prohibited." 
In addition, the catalogue spells out some more specific 
restrictions in various sectors, like caps on foreign ownership and 
permissible types of investment.  In many restricted sectors, 
foreign firms wishing to invest must form a joint venture with a 
Chinese company, restricting their equity to a minority share.  In 
addition, the release of an updated catalogue, with State Council 
blessing, sends a signal to other relevant agencies that they should 
adopt measures to implement the new guidelines. 
 
Investment in sectors not listed in the catalogue is considered 
permitted.  China "encourages" investment in sectors where it 
believes it benefits from foreign assistance or technology. 
Investment is "restricted" in sectors that China deems do not meet 
the needs of its national economic development.  China "prohibits" 
foreign investment in a number of sectors, including certain 
farming, mining, manufacturing, power, transportation, scientific 
research, education, and publishing and broadcast industries. 
 
Problems with the Foreign Investment Catalogue 
--------------------------------------------- - 
 
Foreign investors have expressed frustration that China does not 
publicly seek input before updating the Catalogue and offers no 
rationale for changes.  In addition, Chinese regulators are not 
bound to follow the catalogue and instead maintain the flexibility 
to ignore its guidance and restrict or approve foreign investment 
for other reasons.  Part of the problem is that the catalogue is 
intended only as a general guideline, not an exhaustive list of 
formal restrictions.  Even in "encouraged" and permitted sectors, 
regulations apart from the Catalogue often specify additional 
restrictions on the specific forms of investment that are allowed. 
China may also adopt new regulations or make unannounced policy 
decisions that supersede the most recently published edition of the 
catalogue.  Chinese officials have told the United States Government 
that China is not able to exhaustively catalogue all existing 
investment restrictions and requirements. 
 
Contradictions between the Catalogue and other measures have also 
confused investors and added to the perception that investment 
guidelines do not provide a secure basis for business planning. 
Uncertainty as to which industries are being promoted and how long 
such designations will be valid undermines confidence in the 
stability and predictability of the investment climate.  As a 
consequence, the practical implications of listing a sector in a 
given category are uncertain. 
 
China's Foreign Investment Review and Approval Process 
--------------------------------------------- --------- 
 
According to the Interim Measures for the Administration of 
Examining and Approving Foreign Investment Projects, issued in 
 
BEIJING 00000303  003 OF 013 
 
 
October 2004 and still in effect, all proposed foreign investments 
in China must be submitted for "project verification" to NDRC or to 
provincial or local Development and Reform Commissions, depending on 
the sector and value of the investment.  Project verification 
includes assessing the project's compliance with China's laws and 
regulations, its national security implications, and its economic 
development ramifications.  In some cases, NDRC also solicits the 
opinions of relevant Chinese industrial regulators and "consulting 
agencies," which may include industry associations that represent 
domestic firms.  The State Council also weighs in during the 
verification stage for high-value projects in "restricted" sectors. 
 
Once project verification is complete, the Ministry of Commerce 
(MOFCOM) conducts an "enterprise establishment verification," which 
certifies that the contract establishing the foreign investment 
conforms to China's laws and regulations.  Foreign investors next 
apply for a business license from the State Administration of 
Industry and Commerce (SAIC), which allows the firm to operate. 
Once a license is obtained, the investor registers with China's tax 
and foreign exchange agencies.  Greenfield investment projects must 
also seek approval from China's Environmental Protection Ministry 
and its Ministry of Land Resources.  These ministries review 
projects for compliance with environmental and land use regulations, 
respectively. 
 
Mergers and Acquisitions and the Anti-Monopoly Law 
--------------------------------------------- ----- 
 
MOFCOM (or, depending on the sector and value of the investment, 
provincial or local Departments of Commerce) also reviews all 
proposed mergers and acquisitions (M&A) by a foreign investor.  The 
Regulations Concerning Foreign Investors Acquiring Domestic 
Enterprises instruct regulators to consider an M&A's potential 
impact on "national economic security" when evaluating a 
transaction.  The regulations also authorize MOFCOM to ensure that 
proposed sale price of a "prominent Chinese old brand" to a foreign 
investor has been accurately valued.  Projects that result in 
"actual control" of a domestic enterprise in a "key industry" are 
also examined more closely. 
 
China's Anti-Monopoly Law (AML) took effect in August 2008, and 
China is in the midst of drafting implementing regulations.  The 
text of the law notes China will protect the "lawful activities" of 
state-regulated monopolies and does not clearly resolve whether 
state-owned enterprises (SOE) are otherwise subject to the law's 
competitive provisions.  The law allows regulators to make decisions 
based on macroeconomic factors (e.g., social and employment goals) 
other than consumer welfare.  The AML states that China will set up 
a national security review process for proposed inward investments, 
but this process has not yet been established. 
 
China's courts have been reluctant to take AML cases involving 
China's largest SOEs.  More than 70 percent of the mergers reviewed 
by MOFCOM since the AML went into effect have involved multinational 
firms.  MOFCOM has reviewed 49 M&A transactions, approving 43 
unconditionally and five with conditions.  Only one case, 
Coca-Cola's bid to buy Chinese juice-maker Huiyuan, has been 
rejected by MOFCOM.  All five M&A cases approved with conditions 
involved offshore transactions between foreign parties rather than 
transactions between Chinese companies. 
 
AML implementation also suffers from a lack of decision-making 
transparency.  MOFCOM decisions to block or conditionally clear 
proposed M&As are the only administrative decisions required to be 
publicized, so the majority of MOFCOM reviews have left no public 
record.  MOFCOM's published decisions are brief and offer little 
substantive analysis. 
 
Problems with China's Foreign Investment Review and Approval Process 
and the Anti-Monopoly Law 
--------------------------------------------- ------ 
 
All proposed foreign investments in China are evaluated on a 
case-by-case basis. This allows significant discretion on the part 
of Chinese regulators to impose unexplained restrictions on new 
investment projects, regardless of a given sector's designation in 
the Foreign Investment Catalogue and taking into account the 
interests of domestic competitors.  This ad hoc system diminishes 
the transparency of China's investment regulations and contributes 
to anxiety among foreign investors by limiting their ability to 
predict whether proposed investments will be approved. 
 
Investment Restrictions in "Vital Industries and Key Fields" 
--------------------------------------------- ------- 
 
China limits private investment in "vital industries and key 
fields," defined by China's State Council as "industries concerning 
 
BEIJING 00000303  004 OF 013 
 
 
national security, major infrastructure and important mineral 
resources, industries that provide essential public goods and 
services, and key enterprises in pillar industries and high-tech 
industries."  The December 2006 Guiding Opinion Concerning the 
Advancement of Adjustments of State Capital and the Restructuring of 
State-Owned Enterprises calls on China to consolidate and develop 
its state-owned economy, including enhancing its control and 
influence in "vital industries and key fields relating to national 
security and national economic lifelines." 
 
The Chairman of the State-Owned Assets Supervision and 
Administration Commission (SASAC) has since clarified that "vital 
industries and key fields" include, but are not limited to: 
aviation, coal, defense, electric power and the state grid, oil and 
petrochemicals, shipping, and telecommunications.  "Pillar 
industries" include automotive, chemical, construction, electronic 
information, equipment manufacturing, iron and steel, nonferrous 
metal, science and technology, and exploration and design. 
 
China's State Assets Law is intended to safeguard China's economic 
system, promote the "socialist market economy," fortify and develop 
the state-owned economy, and enable SOEs to play a leading role in 
China's economy, especially in "vital industries and key fields." 
The law requires China to adopt policies to encourage SOE 
concentration and dominance in industries vital to national security 
and "national economic security." 
 
Additional Regulations that Could Restrict Foreign Investment 
--------------------------------------------- ----- 
 
In addition to the measures outlined above, China has also adopted 
policies in specific sectors that appear designed to restrict 
foreign participation.  For example, the State Council's 2006 
Opinions on the Revitalization of the Industrial Machinery 
Manufacturing Industries call for China to expand the market share 
of domestic companies in 16 equipment manufacturing fields. Policy 
supports include preferential import duties on parts needed for 
research and development, encouraging domestic procurement of major 
technical equipment, a dedicated capital market financing fund for 
domestic firms, and a strict review of imports.  The measure 
suggests China will implement controls on foreign investments in the 
sector, including requiring approval when foreign entities seek 
majority ownership or control of leading domestic firms. 
 
In November 2009, China formalized policies in place since 2006 
promoting indigenous innovation by establishing a national 
accreditation system for national indigenous innovation products. 
This accreditations system will be used to award preferences for 
qualified companies in government procurement.  Many international 
firms fear this system will further restrict their access to Chinese 
government procurement contracts.  Similar discriminatory practices 
occur at the provincial level.  For example, Hubei Province 
officials have said they will exclude all foreign brand products 
from government procurement, regardless of their manufactured 
location. 
 
Laws Governing Business Operations 
---------------------------------- 
 
China's Corporate Income Tax Law fixes corporate tax rates for both 
foreign and domestic firms at 25 percent.  The law establishes two 
exceptions to the flat rate: one for qualified small-scale and thin 
profit companies, which pay 20 percent, and another to encourage 
investment by high-tech companies, which pay 15 percent. 
Preferential tax treatment applies to investments in agriculture, 
forestry, animal husbandry, fisheries, and infrastructure. 
 
China's Contract Law encourages contractual compliance by providing 
legal recourse, although enforcement of judgments continues to be a 
problem.  Most contracts must be registered with the government. 
Contracts establishing a foreign-invested enterprise require 
government approval. 
 
The Securities Law, which was amended in 2005, codifies and 
strengthens administrative regulations governing the underwriting 
and trading of corporate shares, as well as the activities of 
China's stock exchanges in Shanghai and Shenzhen.  No wholly 
foreign-owned enterprise has yet issued shares on a Chinese 
exchange, though China's regulator has voiced support for this in 
the future. 
 
Additional investment-related laws include:  the Insurance Law, the 
Foreign Trade Law, the Law on Import and Export of Goods, the 
Arbitration Law, the Government Procurement Law, and the Labor 
Contract Law. 
 
Rankings 
 
BEIJING 00000303  005 OF 013 
 
 
-------- 
 
The following table lists China's most recent rankings by 
organizations that monitor economies' economic freedom, business 
regulations, and perceived level of corruption. 
 
Index                    Year   Score      Rank 
 
Transparency 
International 
Corruption Perceptions   2009   3.6/10     79/180 
 
Heritage Foundation and 
Wall Street Journal 
Economic Freedom         2009   53.2/100   132/179 
 
World Bank 
Ease of Doing Business   2010   N/A        89/183 
 
-------------------------------- 
Conversion and Transfer Policies 
-------------------------------- 
 
To open and maintain foreign exchange accounts, foreign-invested 
enterprises must apply to China's State Administration of Foreign 
Exchange (SAFE).  SAFE determines the amount of foreign exchange the 
firm needs.  Enterprises authorized to conduct current account 
transactions can retain foreign exchange equal to 50 percent of 
export earnings.  Deposits above the limit SAFE sets must be 
converted to local currency. 
 
Foreign exchange transactions on China's capital account require a 
case-by-case review, and approvals are tightly regulated.  During 
the first part of 2009, SAFE reportedly refused to allow some 
American companies to repatriate their earnings.  These restrictions 
eased in the second half of the year.  Several foreign firms have 
noted difficulties in receiving government approval to bring in 
foreign capital to expand their businesses. 
 
The Chinese government registers all commercial foreign debt and 
limits foreign firms' accumulated medium and long term debt from 
abroad to the difference between total investment and registered 
capital.  Foreign firms must report their foreign exchange balance 
twice per year. 
 
------------------------------ 
Expropriation and Compensation 
------------------------------ 
 
Chinese law prohibits nationalization of foreign-invested 
enterprises except under "special" circumstances.  Officials claim 
these circumstances include national security and obstacles to large 
civil engineering projects, but the law does not define the term. 
Chinese law requires compensation of expropriated foreign 
investments but does not describe the formula to be used in 
calculating the amount.  Foreign investors have reported 
disappointment with compensation offers.  China has not expropriated 
any U.S. investments since 1979, though the Department of State has 
notified Congress of several cases of concern. 
 
Many sectors listed as "restricted" in the Foreign Investment 
Catalogue require local ownership.  Furthermore, investors face the 
risk that the sector in which they have invested may be 
recategorized to prohibit foreign investment, leaving investors 
little legal recourse. 
 
------------------ 
Dispute Settlement 
------------------ 
 
Investor-state disputes leading to arbitration are rare in China, 
and China has never lost an arbitration case resulting from an 
investment dispute.  China is a member of the International Center 
for the Settlement of Investment Disputes (ICSID) and has ratified 
the United Nations Convention on the Recognition and Enforcement of 
Foreign Arbitral Awards, the New York Convention. 
 
Formal commercial disputes between investors are heard in economic 
courts that fall under China's Supreme People's Court and at three 
levels in the provincial court system.  These economic courts have 
jurisdiction over:  contract and commercial disputes involving 
foreign parties; trade, maritime, intellectual property and 
insurance; and economic crimes, like theft and tax evasion.  Foreign 
lawyers cannot act as attorneys in Chinese courts, but may observe 
proceedings.  China also has an extensive administrative legal 
system, which adjudicates minor criminal offenses.  China uses this 
system extensively to address intellectual property infringements, 
 
BEIJING 00000303  006 OF 013 
 
 
with limited results. 
 
China's court system is not independent of the government, and the 
government often intervenes in disputes. Corruption may also 
influence local court decisions and local officials may disregard 
the judgments of domestic courts.  Well-connected local business 
people are often in a better position to win court cases than 
foreign investors and reportedly use their connections to avoid 
prosecution for taking illegal actions against their former foreign 
partners.  China's legal system rarely enforces foreign court 
judgments. 
 
Chinese officials typically urge firms to resolve disputes through 
informal conciliation.  If formal mediation is necessary, Chinese 
parties and the authorities typically promote arbitration over 
litigation.  Many contracts prescribe arbitration by the China 
International Economic and Trade Arbitration Commission (CIETAC). 
Some foreign parties have obtained favorable rulings from CIETAC, 
but difficulties in other cases have led other participants and 
panelists to question CIETAC's procedures and effectiveness.  For 
contracts involving at least one foreign party, offshore arbitration 
may be adopted.  Provinces and municipalities also have their own 
arbitration institutions. 
 
Business disputes in China, whether between partners or competitors, 
are not always handled through the courts or arbitration.  The 
Embassy has received reports of foreign partners being held hostage, 
threatened with violence, or arrested. 
 
China's Enterprise Bankruptcy Law extends bankruptcy protection to 
both SOEs and private companies, including financial firms.  The law 
stipulates that all insolvent enterprises will pay creditors first 
and use only assets not earmarked as credit guarantees to pay 
laid-off workers. 
 
--------------------------------------- 
Performance Requirements and Incentives 
--------------------------------------- 
 
China has committed to eliminate export performance, trade and 
foreign exchange balancing, and local content requirements in most 
sectors.  China has also committed to enforce only technology 
transfer rules that do not violate World Trade Organization (WTO) 
standards on intellectual property and trade-related investment 
measures. 
 
In practice, however, local officials and some regulators prefer 
investments that develop favored industries and support the local 
job market.  Local authorities also operate with great autonomy from 
the central government.  In addition, foreigners seeking to invest 
in "key sectors" that the government views as important to its 
economic development or national security face an array of often 
opaque regulations that limit their operations and may have the 
effect of imposing performance requirements.  For example, Chinese 
regulators have pressured foreign firms in these sectors to disclose 
intellectual property content or license it to competitors, 
sometimes at below market rates.  In many sectors where foreign 
investment is restricted, Chinese nationals must own a majority of 
the enterprise. 
 
China offers investors a complex system of incentives at the 
national, regional, and local levels.  In particular, it offers 
preferences for certain investments in sectors and regions it seeks 
to develop. 
 
The Special Economic Zones (SEZ) of Shenzhen, Shantou, Zhuhai, 
Xiamen and Hainan, 14 coastal cities, hundreds of development zones 
and designated inland cities all court foreign investors with 
packages of reduced income taxes, resource and land use fees, and 
import/export duties, as well as priority treatment in obtaining 
basic infrastructure services.  Many locales offer high-level 
support and services to businesses, including streamlined government 
approvals. Chinese authorities have also established a number of 
free ports and bonded zones. 
 
China boasts numerous national science parks, many focused on 
commercializing research developed in Chinese universities.  The 
parks provide infrastructure, management and funding support for 
start-ups across a variety of industries and welcome foreign firms. 
Foreign investors often must negotiate directly with authorities as 
benefits may not be conferred automatically.  These packages also 
often stipulate export, local content, technology transfer, and 
other requirements.  To achieve a unified national trade regime, as 
required by its WTO accession, China has indicated that it will 
decrease SEZ investment incentives over time. 
 
Chinese visas, legal residency, and work permits are tightly 
 
BEIJING 00000303  007 OF 013 
 
 
regulated, and may inhibit investors' mobility.  Foreign investors 
working through established law firms typically are able to meet the 
requirements. 
 
-------------------------------------------- 
Right to Private Ownership and Establishment 
-------------------------------------------- 
 
In China, all commercial enterprises require a license from the 
government. There is no broad right to establish a business. 
Disposition of an enterprise is also tightly regulated. 
 
The principle law governing establishment of an enterprise is 
China's Administrative Permissions Law, which requires China to 
review proposed investments for conformity with Chinese laws and 
regulations, and is the legal basis for China's complex approval 
system for foreign investment.  Apart from its legal regime, China 
makes liberal use of administrative regulations that restrict 
foreigners' ability to establish investments in some sectors. 
 
----------------------------- 
Protection of Property Rights 
----------------------------- 
 
The Chinese legal system mediates acquisition and disposition of 
property. Chinese courts have an inconsistent record in protecting 
the legal rights of foreigners. 
 
All land in China is owned by the state, state-controlled entities, 
or rural collectives.  Individuals and firms, including foreigners, 
can own and transfer long-term leases for land, structures, and 
personal property, subject to many restrictions.  To obtain land-use 
rights, the land user must sign a land-grant contract with the local 
land authority and pay a land-grant fee up front.  The grantee will 
enjoy a fixed land-grant term and must use the land for the purpose 
specified in the land-grant contract.  The maximum term of a land 
grant ranges from 40 years for commercial usage, 50 years for 
industrial purposes, and 70 years for residential use.  China's 
Property Law stipulates that residential property rights will be 
automatically renewed while commercial and industrial grants shall 
be renewed absent a conflicting public interest.  A number of 
foreign investors have seen their land-use rights revoked as 
neighborhoods are slated by the government for development. 
Investors report compensation in these cases has been nominal. 
 
China's Securities Law defines debtor and guarantor rights and 
allows mortgages of certain types of property and other tangible 
assets, including long-term leases as described above.  Important 
areas of the law remain unclear, such as how to effect transfer of 
property under foreclosure. Chinese commercial banks have 
successfully repossessed vehicles from delinquent borrowers, and 
banks are allowed to foreclose on owner-occupied residences. 
Foreigners can buy non-performing debt through state-owned asset 
management firms, but bureaucratic hurdles limit their ability to 
liquidate assets. 
 
China acceded to the World Intellectual Property Organization (WIPO) 
Copyright Treaty and the WIPO Performances and Phonograms Treaty in 
¶2007.  China is also a member of the Paris Convention for the 
Protection of Industrial Property, Berne Convention for the 
Protection of Literary and Artistic Works, Madrid Trademark 
Convention, Universal Copyright Convention, and Geneva Phonograms 
Convention, among other conventions. 
 
China has updated laws and regulations to comply with the Agreement 
on Trade-Related Aspects of Intellectual Property (TRIPS), as 
required by its WTO membership.  The United States in 2007 requested 
WTO dispute settlement consultations with China on IPR protection 
and enforcement issues.  The WTO panel found in favor of the United 
States in January 2009 on two of three U.S. claims that China's IPR 
regime is inconsistent with China's obligations under the 
Trade-Related Aspects of Intellectual Property Rights (TRIPS 
Agreement). 
 
A recent amendment to China's Patent Law came into effect on October 
1, 2009.  The law now provides for the compulsory licensing of 
patents if, after three years from the grant of a patent or four 
years from the filing of a patent application, the patent holder, 
"without proper justification," is found not to have exploited the 
patent "sufficiently," or if the patent use is found to restrict 
competition. 
 
Industry associations representing software, entertainment, and 
consumer goods continue to report high levels of piracy in China. 
The Business Software Alliance (BSA) estimated that 82 percent of 
the business software that was used in China in 2007 was pirated, 
the same levels found in a 2006 study.  At the same time, because 
 
BEIJING 00000303  008 OF 013 
 
 
business software use grew, the value of the pirated software used 
in China grew from $5.4 billion to $6.6 billion over the same 
period, according to BSA statistics.  Consumer goods companies 
report that as much as 20 percent of their products in Chinese 
markets are counterfeits.  Online copyright violations are 
pervasive. 
 
In general, criminal penalties for infringement are seldom applied, 
while administrative sanctions are typically non-transparent and so 
weak as to lack a deterrent effect.  Civil sanctions also tend to be 
of limited effect.  Trademark and copyright violations are blatant 
and widespread.  There are widespread technology transfer practices 
that are often predatory in nature.  Chinese companies are 
increasingly found squatting on the trademarks, company names, and 
design patents of well-established companies, even companies with 
household names.  Such squatting practices are often legal in China, 
particularly when they occur where a company has declined to obtain 
registration of its rights in China in a timely fashion. 
 
Significant regional differences exist in infringement and 
enforcement, with some areas showing higher levels of protection of 
IPR and others apparently offering safe harbors to local 
counterfeiters and pirates.  While many Chinese officials are 
increasing enforcement efforts, violations also generally continue 
to outpace enforcement.  Lack of coordination among various 
government agencies also continues to hamper many enforcement 
efforts. 
 
There has been some limited progress in terms of cooperation between 
industry and enforcement agencies.  In August 2009, a Chinese court 
jailed four individuals for their role in spreading a bootleg 
version of Microsoft's Windows XP software.  China has stepped up 
coordination with foreign enforcement agencies in cases involving 
international organized crime, and in 2008 Chinese courts 
successfully prosecuted several major counterfeiters caught as a 
result of joint international enforcement efforts.  China 
established IPR law centers at Beijing University, Tsinghua 
University, and People's University, among other institutions, and 
dispatched Chinese IPR policymakers, enforcement officials, and 
legal professionals to study other countries' intellectual property 
enforcement techniques.  China has also announced it will begin a 
pilot program that will unify the trials of civil, administrative 
and criminal intellectual property (IP) cases under a dedicated IP 
court and will study the feasibility and necessity of setting up an 
IP appeals court.  China began establishing specialized IPR 
complaint centers in provincial capitals and other large cities in 
the spring of 2006, and now operates a national network of 50 such 
centers. 
 
------------------------------------- 
Transparency of the Regulatory System 
------------------------------------- 
 
China's legal and regulatory system is complex and contradictory, 
and generally lacks consistent enforcement.  Foreign investors rank 
inconsistent and arbitrary regulatory enforcement and lack of 
transparency among the major problems in China's market, 
particularly outside of coastal regions. 
 
The State Council's Legislative Affairs Office (SCLAO) has issued 
instructions to Chinese agencies to publish all foreign trade and 
investment related laws, regulations, rules, and policy measures in 
the MOFCOM Gazette, in accordance with China's WTO accession 
commitment.   China said it would also help WTO members and 
enterprises understand its rules. However, foreign investors report 
that Chinese regulators at times rely on unpublished internal 
guidelines that impact their businesses. 
 
SCLAO also posts an increasing number of draft administrative 
regulations (which are issued by the State Council and have nearly 
the legal force of laws passed by the National People's Congress) on 
its website, as well as some draft departmental rules from various 
ministries and agencies with economic responsibilities, but the 
posting of such draft rules is not comprehensive.  Central 
government ministries agencies have increased the number of draft 
trade and economic-related departmental rules made available on 
their own ministry websites for public comment, including from 
foreign parties, but comment periods can be extremely brief and the 
impact of public comments on final regulations is not clear, as some 
rules are published for comment in final form.  Some agencies 
release draft regulations only to certain favored enterprises, 
usually domestic enterprises, or have allowed enterprises to read 
but not retain drafts. Comments do not become part of a public 
record. 
 
--------------------------------------------- ----- 
Efficient Capital Markets and Portfolio Investment 
 
BEIJING 00000303  009 OF 013 
 
 
--------------------------------------------- ----- 
 
Bank loans continue to provide the vast majority of credit in China, 
accounting for roughly 75 percent of formal financial sector 
financing.  Nevertheless, with the development of capital markets, 
venture capital and private equity, and stock exchanges, that 
percentage has fallen from 85 percent in 2007. The People's Bank of 
China (PBOC), China's central bank, continues to maintain a floor on 
lending rates that is 2-3 percentage points above the ceiling on 
deposit rates, thereby maintaining a healthy profit margin on bank 
loans.  This raises borrowing costs for the most creditworthy 
borrowers, which are usually large firms, both state and 
foreign-owned.  Commercial banks are increasingly being urged by 
regulators to limit financing to projects that are not in compliance 
with environmental regulations.  The lack of adequate credit 
information on borrowers also contributes to inefficient credit 
allocation.  Small- and medium-sized firms experience the most 
difficulty obtaining bank financing, instead financing investments 
through retained earnings or informal channels. 
 
The ratio of non-performing loans (NPL) in China has dropped 
steadily in recent years.  NPLs system-wide dropped to about 1.7 
percent by the third quarter of 2009 from 8 percent in 2006, 
according to PBOC statistics, although many analysts warn of 
possible future increases in the NPL rate stemming from 2009's large 
flow of new bank lending. 
 
Non-bank financing has expanded over the last few years.  Regulators 
increasingly support the listing on domestic exchanges of shares in 
both state-owned and private Chinese firms.  However, stock market 
declines led regulators to limit the number of new issuances on 
China's stock markets in 2008-09.  Although new issuances resumed in 
July 2009, in total only 250 billion renminbi (RMB) of capital was 
raised in the first eleven months of 2009, with just RMB 95 billion 
of this coming from initial public offerings, compared to almost RMB 
438 billion in 2007.  In comparison, corporate bond issuance stood 
at over RMB 793 billion in 2009.  Beginning January 2009, listed 
Chinese banks were again allowed to trade exchange-listed bonds in 
an open-ended pilot program, whereas since 1997, they had been 
limited to trading in the interbank market. 
 
Most foreign portfolio investment in Chinese companies occurs on 
foreign exchanges, where investors buy and sell shares in Chinese 
firms, primarily in New York (N-shares) and Hong Kong (H-shares). 
In addition, China permits limited access to renminbi-denominated 
A-share markets for portfolio investment by foreign institutional 
investors.  Through its Qualified Foreign Institutional Investor 
(QFII) program, China had granted QFII status to 87 foreign firms 
through August 2009. 
 
---------------------------------------- 
Competition from State-Owned Enterprises 
---------------------------------------- 
 
China's leading SOEs benefit from preferential government policies 
and practices aimed at developing bigger and stronger national 
champions.  SOEs enjoy administrative monopolies over the most 
essential economic inputs (hydrocarbons, finance, telecoms, 
electricity) and considerable power in the markets for others 
(steel, minerals).  SOEs have long enjoyed preferential access to 
credit.  Provincial governments have reportedly used their power to 
deny operating licenses to persuade reluctant owners to sell out to 
bigger state-owned suitors. 
 
China has two sovereign wealth funds:  China Investment Corporation 
(CIC) and SAFE.  CIC generally is more open and transparent than 
SAFE, and is overseen by a board of directors and a board of 
supervisors.  SAFE is a government agency that reports directly to 
the PBOC.  The SAFE Administrator serves concurrently as a PBOC Vice 
Governor. 
 
The portion of SAFE funds invested domestically is very small. 
CIC's only domestic investments are as a financial holding company 
for the state-owned portions of commercialized national-level bank 
and securities companies.  They also have some investments in 
Chinese companies' non-mainland listings (for example through the 
Hong Kong H-share market).  CIC and SAFE otherwise play little role 
in the local economy. 
 
Sovereign wealth funds are not required to submit their books to 
independent audit, nor are they required by law to publish annual 
reports.  CIC published its first annual report, for the year 2008, 
in July 2009. 
 
------------------------------- 
Corporate Social Responsibility 
------------------------------- 
 
BEIJING 00000303  010 OF 013 
 
 
 
Corporate social responsibility (CSR) is a new and still relatively 
unknown concept for most Chinese, though CSR awareness appears to be 
rising among younger and more-affluent consumers.  However, it is 
difficult to pinpoint any change in consumption behavior due to CSR 
considerations.  The 2008 Sichuan earthquake led many Chinese to 
recognize the contributions of enterprises to earthquake relief 
efforts, and there are an increasingly large number of press reports 
about the importance of labor and environmental CSR commitments by 
enterprises.  Large Chinese SOEs and large foreign-invested 
enterprises tend to follow generally accepted CSR principles, and 
most report annually on their CSR policies and achievements. 
 
------------------ 
Political Violence 
------------------ 
 
The risk of political violence directed at foreign companies 
operating in China remains small.  Some violent but unconnected 
protests have occurred in areas throughout China, but such mass 
incidents generally involved local residents protesting corrupt 
officials, environmental and food safety concerns, and confiscated 
property.  Large-scale ethnic riots in the province of Xinjiang 
erupted in July 2009, leaving nearly 200 dead and 1600 injured, and 
leading the Chinese government to cut off Internet connections in 
the province.  Tibet has also witnessed ethnic violence in recent 
years, but political violence in China's other regions remains low. 
 
---------- 
Corruption 
---------- 
 
Corruption remains endemic in China.  Surveys show that concerns 
about corruption limit U.S. firms' investment in China.  Sectors 
requiring extensive government approval are most affected, including 
banking, finance, government procurement, and construction.  The 
lack of an independent press as well as the fact that all bodies 
responsible for conducting corruption investigations are all 
controlled by the Communist Party hamper anti-corruption efforts. 
Senior officials and family members are suspected of using 
connections to avoid investigation or prosecution for alleged 
misdeeds. 
 
According to Chinese law, giving or accepting a bribe is a serious 
crime.  Accepting a bribe of greater than RMB100,000 is punishable 
by 10 years to life in prison, or death in "especially serious" 
circumstances; accepting a RMB 50,000 to 100,000 bribe is punishable 
by five years to life; RMB 5,000 to 50,000 gets one to seven years; 
less than RMB 5,000 is punishable by up to two years. 
 
Offering a bribe merits five years' punishment. For serious 
circumstances or "heavy losses" to state interests, the punishment 
can range up to 10 years. "Especially serious" circumstances lead to 
imprisonment from 10 years to life. 
 
It is not, however, a crime under Chinese law to bribe a foreign 
official.  While a bribe denoted as such could not be deducted from 
taxes as a business expenses, practically speaking, a Chinese firm 
could mis-categorize a bribe and deduct it from revenues. 
 
Three government bodies and one Communist Party organ are 
responsible for combating corruption.  The Supreme People's 
Procuratorate and the Ministry of Public Security investigate 
criminal violations of anti-corruption laws, while the Ministry of 
Supervision and the Communist Party Discipline Inspection Committee 
enforce ethics guidelines and party discipline.  Corrupt officials 
are first investigated by the Discipline Inspection Committee, which 
gathers evidence outside of the judicial process and strips the 
official of Party membership before deciding whether to hand the 
case over to the judicial system.  China's National Audit Office 
also inspects accounts of state-owned enterprises and government 
entities. 
 
China ratified the United Nations Convention against Corruption in 
2005 and participates in Asia-Pacific Economic Cooperation (APEC) 
and Organization for Economic Cooperation and Development (OECD) 
anti-corruption initiatives, but has not signed the OECD Convention 
on Combating Bribery. 
 
------------------------------- 
Bilateral Investment Agreements 
------------------------------- 
 
China has bilateral investment agreements with 124 countries.  As of 
June 1, 2009, 92 of these agreements had entered into force. 
China's treaty partners include Japan, the United Kingdom, Germany, 
France, Italy, Spain, the Belgium-Luxembourg Economic Union, South 
 
BEIJING 00000303  011 OF 013 
 
 
Korea, Austria, and Thailand, among others.  China's bilateral 
investment agreements cover expropriation, arbitration, 
most-favored-nation treatment, and repatriation of investment 
proceeds, and are generally regarded as weaker than the investment 
treaties the United States seeks to negotiate.  In 2008, the United 
States and China began negotiation of a bilateral investment treaty. 
 China has a bilateral taxation treaty with the United States. 
 
--------------------------------------------- ---- 
Overseas Private Investment Corporation and Other 
Insurance Programs 
--------------------------------------------- ---- 
 
The United States suspended Overseas Private Investment Corporation 
(OPIC) programs in the aftermath of China's violent crackdown on 
Tiananmen Square demonstrators in June 1989.  OPIC honors 
outstanding political risk insurance contracts.  The Multilateral 
Investment Guarantee Agency, an organization affiliated with the 
World Bank, provides political risk insurance for investors in 
China.  Some foreign commercial insurance companies also offer 
political risk insurance, as does the People's Insurance Company of 
China. 
 
----- 
Labor 
----- 
 
Human resource issues remain a major concern for American companies 
operating in China.  Difficulties in hiring appropriately skilled 
labor, navigating new and comprehensive labor and social safety net 
laws, the restriction on the mobility of workers, and the lack of 
independent trade unions combine to create a challenging environment 
for foreign-invested enterprises. 
 
The cost and availability of labor has varied since the onset of the 
2008 global financial crisis.  The large surplus of rural workers 
laid off or furloughed during the crisis appears essentially to have 
been reabsorbed.  Some of south China's manufacturing centers 
currently experience a localized labor shortage.  This is likely due 
to many workers having left to seek employment in other cities or 
other parts of China.  The remaining workers have shown greater 
selectivity than in the past, with their demands for higher wages 
and willingness to turn down undesirable job offers also 
contributing to a perceived labor shortage.  Skilled workers remain 
in short supply. 
 
Independent trade unions are illegal in China.  Officially 
sanctioned trade unions must affiliate with the All-China Federation 
of Trade Unions (ACFTU), which is an arm of the Communist Party.  It 
is illegal for employers to oppose efforts to establish ACFTU 
unions.  While worker protests and work stoppages occur regularly, 
the right to strike is not protected in law. 
 
China has not ratified core International Labor Organization 
conventions on freedom of association and collective bargaining, but 
has ratified conventions prohibiting child labor and employment 
discrimination.  Apart from a lack of freedom of association and the 
right to strike, Chinese labor laws generally meet international 
labor standards.  However, enforcement of existing labor regulations 
is poor. 
 
------------------------------ 
Foreign-Trade Zones/Free Ports 
------------------------------ 
 
China's principal duty-free import/export zones are in Dalian, 
Guangzhou, Shanghai, Tianjin, and Hainan.  Besides these official 
duty-free zones, numerous free trade and economic development zones 
and open cities offer similar privileges and benefits to foreign 
investors. 
 
------------------------------------ 
Foreign Direct Investment Statistics 
------------------------------------ 
 
Data Limitations 
---------------- 
 
Some mainland companies utilize "roundtrip" investment via 
subsidiaries in the Special Administrative Regions of Hong Kong and 
Macau in order to obtain incentives available only to foreign 
investors.  Analysts have estimated that mainland Chinese funds 
flowing through Hong Kong may account for 10-30 percent of Hong 
Kong's total realized direct investment in China.  Hong Kong and 
Macau statistics are further skewed because many Taiwan firms invest 
through them to avoid scrutiny from Taiwan authorities.  Indeed, 
some observers estimate accumulated stock of FDI inflows from Taiwan 
 
BEIJING 00000303  012 OF 013 
 
 
is actually two to three times the amount formally recorded.  The 
data listing investments originating in the Virgin Islands is 
similarly problematic. 
Chinese FDI data do not include much of the high dollar value 
minority equity stakes that American financial services firms have 
taken in major Chinese lenders.  In addition, China does not 
classify reinvested locally-generated profits as new investment. 
 
Foreign Direct Investment Flows for 2008 
(Top 10 Sources of Origin) 
---------------------------------------- 
 
Country/Economy     Millions of 
of Origin           U.S. Dollars 
 
Hong Kong           41,036 
British 
Virgin Islands      15,954 
Singapore            4,435 
Japan                3,652 
Cayman Islands       3,145 
South Korea          3,135 
United States        2,944 
Samoa                2,549 
Taiwan               1,898 
Mauritius            1,494 
 
Source: China Commerce Yearbook 2009 
 
Cumulative* Foreign Direct Investment for 2008 
by Selected Source of Origin 
--------------------------------------------- - 
 
Country/Economy     Millions of 
of Origin           U.S. Dollars 
 
Hong Kong           349,569 
British 
Virgin Islands       90,100 
Japan                65,376 
United States        59,651 
Taiwan               47,660 
South Korea          41,911 
Singapore            37,826 
Cayman Islands       16,507 
United Kingdom       15,695 
 
Source: China Commerce Yearbook 2009 
 
*Cumulative values are totals of the data collected each year, are 
not adjusted for inflation, and do not account for divestment. 
 
Flow of Outbound Direct Investment for 2008 
(Top 10 Destinations) 
------------------------------------------- 
 
Destination        Millions of U.S. Dollars 
 
Hong Kong          38,640 
South Africa        4,808 
British 
Virgin Islands      2,104 
Australia           1,892 
Singapore           1,551 
Cayman Islands      1,524 
Macau                 643 
Kazakhstan            496 
United States         462 
Russia                395 
 
Source: China Commerce Yearbook 2009 
 
Stock of Outbound Direct Investment for 2008 
(Top 10 Destinations) 
-------------------------------------------- 
 
Destination        Millions of U.S. Dollars 
 
Hong Kong          115,845 
Cayman Islands      20,327 
British 
Virgin Islands      10,477 
Australia            3,355 
South Africa         3,049 
United States        2,390 
Macau                1,561 
Kazakhstan           1,402 
 
BEIJING 00000303  013 OF 013 
 
 
Pakistan             1,328 
Canada               1,268 
 
FDI as a Percentage of Gross Domestic Product 
--------------------------------------------- 
 
According to UNCTAD, China's FDI stocks equaled 8.7 percent of its 
gross domestic product (GDP) in 2008; China's FDI inflows equaled 
2.5 percent of GDP. 
 
Selected Major Foreign Direct Investments 
by U.S. and Other Nations' Companies 
----------------------------------------- 
 
Company            Estimated Current Value 
                   in Billions of U.S. Dollars 
 
Intel              4.0 
Motorola           3.6 
Coca-Cola          3.3 
General Motors     2.0 
Wal-Mart           2.0 
Anheuser-Busch     1.8 
General Electric   1.5 
Kodak              1.5 
DaimlerChrysler    1.5 
Alcoa              1.0 
ExxonMobil         1.0 
Ford               1.0 
United 
Technologies (UTC) 1.0 (including Hong Kong) 
DuPont             0.7 
IBM                0.4 
Cummins            0.2 
Microsoft          0.1-0.5 
 
HUNTSMAN