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Shanghai Free Trade Zone: Model for China’s Future Economic System

The Shanghai Free Trade Zone (FTZ) has made considerable progress in investment management, trade facilitation and other areas of institutional innovation since it was established more than a year ago. Chinese President Xi Jinping recently said that the successful experience gained from the Shanghai FTZ should be copied to other locations as soon as possible. In line with this, it is now expected that investment and trade systems that comply will international practices will be put in place across China within the next two years.

The present administration has put forward a call to deepen reforms and increase economic efficiency, with the market playing a leading role. The Decision of the CPC Central Committee on Several Major Issues Concerning the Comprehensive Deepening of Reforms, issued after the 3rd Plenary Session of the 18th CPC Central Committee, clearly stated that reform of the economic system is the focus of all such efforts to deepen these comprehensive reforms. The core issue is the proper handling of relations between the government and the market, with the functions of government needing to be changed accordingly.

The Shanghai FTZ is the pilot zone for institutional innovations in China and forms part of the country’s efforts to promote economic restructuring. The experiment will include the following aspects: (1) an investment management system with the negative list at its core; (2) a trade regulatory system with an emphasis on trade facilitation; (3) financial innovation with the aim of capital account convertibility and the liberalisation of financial services; and (4) a system of ongoing and ex post supervision in tandem with the transformation of government functions.

The Shanghai FTZ has made considerable headway in these four major areas of institutional innovation since its establishment on 29 September 2013. In particular, it has put an end to the dominant role of prior approvals under the old management model by streamlining administration procedures and through the delegation of powers. A system of ongoing and ex post supervision has now been established in accordance with the revised legal requirements. A number of the successful experiences gained from the FTZ have already been copied and promoted in other parts of the country.

At the October meeting of the Central Leading Group for the Comprehensive Deepening of Reforms, President Xi Jinping said that the replicable and scalable experience gained from the FTZ should be copied to more locations as soon as practicable, and extended to the whole country if possible. It can be foreseen that China will establish investment and trade systems in line with international practice over the next two years, as more reform experiments reach maturity and are promoted nationwide.

Investment Management Systems

China’s policy for bringing in foreign investment has long been to let the present requirements of industrial development guide the direction of capital inflow. The Provisions on Guiding the Orientation of Foreign Investment and the Catalogue for the Guidance of Foreign Investment Industries divided foreign investment projects into the encouraged, permitted, restricted and prohibited categories, whereby examination and approval of project proposals, contracts and articles of association are required. The Shanghai FTZ has adopted the negative list approach, in line with international practices, and accordingly reformed foreign investment management. Other practices adopted include the principle of treating domestic and foreign investment in the same way, and the implementation of a record filing system instead of an examination and approvals system. Record filing formalities generally take five working days at present. Following further liberalisation of the service industries, the FTZ issued a revised negative list in June 2014. This cut the number of restricted sectors to 139 and gave companies greater assurances and flexibility when making investment decisions based on market development needs.

After completing record-filing formalities, companies may proceed directly to the State Administration for Industry and Commerce (SAIC) to apply for a business licence. They may then complete tax, customs, financial and other registration procedures, as long as they do not need to apply for a qualifications permit from the relevant departments. Vice Minister Liu Yuting of the SAIC said that to further simplify and speed up investment and the operational flow of companies, his department has prepared a Catalogue of Items of Reform on Licence First, Permit Later in the China (Shanghai) Pilot FTZ for trial implementation in the FTZ. This will be introduced when the conditions are right.

To ensure the effective implementation of the negative list, the Shanghai FTZ has launched a series of institutional reforms on enterprise access and registration, including implementing a subscribed registered capital system and a “single window” access system for enterprises under the SAIC. It is also now subject to an “all-in-one taxation net” and other facilitation measures introduced by the taxation department.

Photo: The “single window” service hall in Waigaoqiao, Shanghai FTZ.
The “single window” service hall in Waigaoqiao, Shanghai FTZ.
Photo: The “single window” service hall in Waigaoqiao, Shanghai FTZ.
The “single window” service hall in Waigaoqiao, Shanghai FTZ.

Trade Supervision System

The Shanghai FTZ has implemented a policy of “full opening of the first line and safe and efficient control of the second line, with free movement of goods within the zone”. In addition, more than 60 facilitation measures for trade supervision, covering customs, inspection and quarantine, have been introduced. The new facility for “enter first, declare later”, “centralised declaration of incoming and outgoing batches”, “paperless customs clearance” and “intelligent checkpost release management” has significantly improved the efficiency of customs clearance at the FTZ and reduced the logistics costs the of companies concerned.

The Shanghai Origin Supply Chain Management Co Ltd[1], for instance, was incorporated in Shanghai’s Yangshan bonded port in 2009 for customs and inspection declaration services, warehousing and other value-added services. Its business covers cosmetics, food, garments and parts and accessories. These products have numerous and complicated nomenclature, with every batch of incoming cargo involving hundreds of product names. Previously, the company would have to conduct classification by HS code, data compilation and record filing after receiving pre-arrival declarations from clients. In cases of uncertainty, the firm had to wait for the cargo to arrive at the warehouse in order to make verifications and corrections. The entire process – from data compilation, record filing and declaration of incoming cargo through to the issuance of release permits, container release and collection at the port area – took more than half a month.

This process was dramatically shortened after the “enter first, declare later” approach was introduced. Now, entry declarations may be filed with the Customs Office within 14 days of the declared date of entry. Origin Supply Chain can start the process of document exchange and declaration formalities once a client’s pre-arrival declaration has been received. It will obtain details on the release of goods, based on the information shown on the manifest, within five minutes. With the delivery notice and delivery order, cargo can then be collected at the port area. Thus the entry process has been cut to only two working days.

Since the implementation of the “centralised declaration of incoming and outgoing batches”, cargo in the FTZ may be delivered to clients in batches and then declared in a centralised manner, as required. The introduction of “paperless customs clearance” also enables Origin Supply Chain to electronically send documents to clients. This makes time management easier, ensures the smooth execution of transportation, and prevents increases in transport costs due to changes in transportation plans. Submission of a single customs declaration form after the arrival of all batches of cargo also helps reduce customs declaration costs.

Photo: Shanghai FTZ adopts an innovative customs management system featuring full opening up
Shanghai FTZ adopts an innovative customs management system featuring full opening up of the first line and safe and efficient control of the second line, with free movement of goods within the zone.
Photo: Shanghai FTZ adopts an innovative customs management system featuring full opening up
Shanghai FTZ adopts an innovative customs management system featuring full opening up of the first line and safe and efficient control of the second line, with free movement of goods within the zone.

The trade supervision and facilitation measures of the FTZ will also contribute to the development of international transit and consolidation business. Taiping Mingwei Logistics Co Ltd, a company that has been operating in the Waigaoqiao bonded zone for 10 years, for example, is making use of the new FTZ policies to launch an international transit and consolidation business in line with international practices. Currently, only the first 4-6 digits of the HS codes are needed to file for import declaration (all 10 numbers were required in the past) and complete the transit consolidation. This also facilitates the secondary packaging and consolidation of international transit goods with goods originating from inland river ports or coastal ports or with locally produced goods.

Financial Innovation System

The FTZ has explored and experimented with a number of innovative measures over the past year. These include establishing a system of accounts that facilitates risk management, promoting investment, allowing for financing and foreign exchange facilitation, authorising the cross-border use of the Renminbi, allowing the building of a liberalised interest rate system, and establishing a foreign exchange management system that meets the development needs of the FTZ.

The free trade account system, which came into force in May 2014, allows financial institutions to open separate accounts for companies, individuals, other banks and offshore institutions. These accounts, which are distinguished from ordinary accounts by their “FT” prefix, provide innovative financial services for trade, investment and other services relating to the real economy. The domestic departments concerned may make use of these accounts as a platform for the promotion of personal cross-border investment, capital market liberalisation, cross-border financing facilitation and other pilot reforms. They can also achieve capital and current account convertibility under the free trade account.

Shanghai Capacity Exchange Co Ltd, a company that provides forward container booking services in the FTZ, previously had to contend with a number of cross-border settlements and payments as part of its international shipping and trade activities. Prior to the free trade account system, it had no way of arranging cross-border collection and the payment of freight charges for its clients. As it was unable to give full scope to its advantage as a container booking platform, this affected its business development.

Overseas investment formalities have also been simplified in the FTZ. Shanghai Ruiken Investment Co Ltd has already benefitted from that companies in the FTZ may adopt the record-filing system for their overseas investments. Under the “delegation of foreign exchange registration procedures for direct investment”, companies need only to submit the necessary documents to their bank to simultaneously complete formalities for foreign exchange registration, account opening and funds remittance. Previously, companies had to obtain approval from several government departments for outbound investment. They also needed to complete direct investment foreign exchange registration with the departments concerned for fund remittances. Now companies may also make use of their FT account to remit funds out of the country at exchange rates closer to international market rates within the period specified in the contracts for the purposes of investment and merger and acquisition.

After February 2014, when the Shanghai headquarters of the People’s Bank of China issued its notice on expanding the cross-border use of the Renminbi, banks within the FTZ were able to co-operate with their offshore branches in conducting cross-border lending business, and making use of the lower offshore lending rates in order to reduce the financing costs to their clients and optimise the liability structure of companies.

On-going and Ex Post Supervision System

The negative list approach changes the old mode of management under which prior approvals played a dominant role. Based on the principle of preventing risk and maintaining a market order of fairness, the FTZ has established six systems for ongoing and ex post supervision - security review, anti-monopoly review, social credit, publication of corporate annual reports and listing of non-compliant companies, information sharing and joint law enforcement, and participation of social forces in market supervision.

The security review system mainly involves the establishment of a working mechanism at the foreign investment access phase to assist the government departments concerned in conducting security reviews. Although no details have yet been announced, the National Development and Reform Commission has indicated that security review measures for the Shanghai FTZ have already been drawn up.

The anti-monopoly review system explores institutional arrangements for anti-monopoly reviews. This considers such aspects as concentration of business operators, cartels, and the abuse of a dominant market position. At a joint conference in October 2014, the FTZ announced its measures for law enforcement against cartels, the abuse of dominant market positions and administrative monopoly, as well as highlighting its plans for the anti-monopoly review system.

The social credit system makes use of the Shanghai public credit information service platform to promote the building of the FTZ sub-platform, and to improve systems relating to credit information and the use of credit products. At present, the FTZ sub-platform has already rolled out a number of related features, including data compilation and enquiry, objection handling and information catalogue management. Explorations are also being made into a model of credit management with an ex ante integrity pledge, on-going assessment and classification, as well as an ex post reward-punishment linkage.

Following the replacement of annual inspections with the publication of annual reports, companies must now use the online enterprise credit information disclosure system to submit their annual reports to the SAIC. Specific companies must submit annual audit reports issued by accounting firms. In October this year, the Shanghai FTZ announced a list of 1,467 companies with irregularities in their operations. These included “blacklisted” companies that had either failed to make public their annual reports or had allegedly made false claims or omissions in their annual reports.

As regards information sharing, the focus is on building an information sharing and services platform for the FTZ. The platform has initially achieved the compilation, utilisation and sharing of information among the relevant administrative departments to promote inter-departmental joint supervision. The purpose of joint law enforcement is to establish a corroborative enforcement mechanism and co-ordinated co-operation between different departments, including the exercise of enforcement powers in a relatively centralised manner, the building of an online enforcement system, and a joint command platform.

The system of participation of social forces in market supervision is focussed on supporting the participation of industry associations and professional services institutions in market supervision through support and guidance policies, purchase of services, formulation of standards and other institutional arrangements. The Opinions on Promoting the Participation of Social Forces in Market Supervision of the FTZ is at the stage of seeking comments.

As a next step, the Shanghai FTZ will establish a “government powers list”, which will clearly delineate out the competent departments, approval criteria, fee schedules and other factors for different items requiring approval in order to limit the powers of government. At the same time, greater efforts will be made to increase the transparency of the changes to government functions and to ensure that government departments “do what is statutorily required and refrain from doing what is not expressly authorised by the law”.

Experience to be Copied Nationwide

After a year of experiment, 21 systems of the Shanghai FTZ have been adopted in other parts of the country. The Central Leading Group for the Comprehensive Deepening of Reforms also reviewed and adopted the Progress of the Work of the China (Shanghai) Pilot Free Trade Zone and Opinions on the Promotion of the Replicable Experience of the Pilot Reform at its meeting in October. Speaking at the meeting, President Xi Jinping said that the replicable and scalable experience gained from the FTZ should be copied to more places as soon as practicable and should be promoted nationwide if possible.

Among the first batch of systems to be adopted nationwide are nine measures for trade supervision relating to Customs. These include the enter first, declare later approach for goods entering the first line; FTZ-registered companies making their own transport arrangements for circulation of goods within the zone; centralised declaration of incoming and outgoing batches; a simplified consolidated list of entry and exit records; work-order verification for processing trade; customs supervision for financing and leasing; online supervision of warehousing companies; bonded display and transaction; and intelligent checkpost release. Other measures to be adopted and promoted across the whole country include six measures for investment and six relating to financial innovation. These include: reform of the business registration system; reform of the registered capital registration system; the publication of corporate annual reports; the use of the cross-border Renminbi-fund pool; personal Renminbi cross-border trade settlement; Renminbi settlement of payment agencies for cross-border e-commerce; and the centralised operation and management of foreign exchange funds for headquarters of multinational companies.

In the latest development, the General Administration of Quality Supervision, Inspection and Quarantine has submitted to the State Council the first batch of eight FTZ inspection and quarantine measures that can be copied and promoted. These include the adoption of third-party test results; global repairs industry supervision; risk management for incoming and outgoing biological products; management of certificate of origin for goods in transit; reform of paperless inspection, quarantine and customs clearance; pre-inspection of import goods; separate supervision and management of inspection and quarantine; and a negative list for the examination and approval of quarantine of animals and plants and their products. The first five will be adopted and promoted nationwide, while the remaining three will be adopted in special customs supervision areas.

With respect to market access for foreign companies, following the issuance of the Administrative Measures for the Approval and Record Filing of Foreign Investment Projects by the National Development and Reform Commission in June this year, the management model of requiring approval for all foreign investment projects has been replaced by one that combines approval for a limited range of projects with record filing in general. Specific plans are being drawn up for the implementation of the negative list approach for the whole country. If the amendment of relevant rules and regulations regarding foreign-invested enterprises goes smoothly, the negative list approach can be expected to be in full force throughout the country before 2016.

Meanwhile, another report has indicated, that if the FTZ experiment is to “blossom and its fruits are to be harvested as quickly as possible”, Shanghai alone cannot give full play to the role of the FTZ in paving the way to the deepening of reforms across the country. Thus, pilot FTZs in Tianjin, Guangdong, Fujian and other coastal areas are expected to be given the green light from the State Council in order to expand the scope of market opening and institutional innovation and accelerate the establishment of investment and trade systems that are in line with international practices.

[1]  For further information on Shanghai Origin Supply Chain Management Co Ltd and other companies operating in the Shanghai FTZ, please refer to the Collection of Cases of Innovation at the Pilot FTZ published in Chinese by the China (Shanghai) Pilot Free Trade Zone Administration.

Content provided by Picture: Pansy Yau
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