While the rest of the world grapples with recession, China is poised to move into economic overdrive. But will WTO accession really change the face of the mainland? Lauren Scott reports.

Much has been written of late about the People's Republic of China. The world's fastest growing economy, the mainland's place on the global stage was put under the spotlight following its membership of the World Trade Organisation's the predecessor to GATT's in December last year. Admission to the WTO - which as the global body dealing with the rules of trade between nations aims to promote and foster the free movement of goods and services - means China is committed to liberalising almost every sector of its economy, giving unprecedented access to 'the West'.

Tariff barriers on foreign goods have been slashed, and doors to industries including telecommunications, wholesale/resale, gas, financial services, public water supply and banking are being opened up to foreign investors for the first time.

On April 1, new guidelines on foreign investment came into force, the first definitive statement on where the mainland wants such investment to go. China has even gone beyond its WTO commitments to ‘encourage’ investment in areas including mining, real property, social services, health, sports and social welfare and higher education.

And in what some regard as a mark of its acceptance to the world’s biggest club, China will play host to the Beijing Olympics in 2008. In preparation, a $22bn building and clean-up operation began this year, and foreign players are waiting in the wings for their chance to take part.

But will entry to the global economy truly transform China’s landscape? Authoritarian attitudes and corruption have been the hallmarks of the country’s political and judicial system for years, which, coupled with an opaque decision-making and regulatory environment, provides little comfort to new entrants, despite the WTO dispute settlement system.

The government is also facing up to the potential ramifications of foreign competition, encouraging homegrown businesses to take stock and consolidate in an effort to maintain market position.

Already, China’s 1.3 billion people are feeling the effects of the changing environment. Unemployment is a new reality, with about 5 million expected to be without jobs for the first time. This is particularly so in the rural sector, with farmers and agricultural workers accounting for around 70% of the population.

Views are mixed as to whether trade and foreign investment, the bedrocks of the country’s GDP in recent years, will remain so. China’s trade surplus is expected to shrink, and a predicted surge in foreign direct investment on the back of liberalisation may not occur for a few years. The country is burdened by a large public debt relative to GDP, and economists predict the government will need to spend up big if it is to keep growth above desired levels.

There are also political changes afoot. The popular career politician, Hu Jintao, will replace Jiang Zemin as leader of the ruling Communist Party in October this year, a mantle he assumes at a significant time in China’s history.

Protecting the innocent

China may be opening up in many respects, but its legal sector remains largely protected. The Ministry of Justice has stood firm in relation to allowing foreign firms to enter the domestic market, although it has announced its intention to remove the ‘one firm, one office’ restriction.

This restriction has not proved a problem for some firms, who have, through associations with other offices, been able to maintain a presence in two Chinese cities – mainly Shanghai and Beijing. US firm Bryan Cave LLP has a Shanghai office, and through associated firm Jewkes Chan & Partners, one in Beijing.

Similarly, firms such as CMS Cameron McKenna, Coudert Brothers, Freshfields, Herbert Smith, Linklaters and Rouse & Co have all been able to capitalise on links with other firms to keep a foot in both cities.

But when it comes to practising local law, it’s a different matter. The MOJ raised eyebrows earlier this year with the announcement that it would uphold its existing ban on foreign firms practising local law – but that firms from Hong Kong, Macau and Taiwan would be subject to ‘special rules’.

This led to intense speculation as to exactly what constituted a ‘Hong Kong’ firm – and it is still not clear, despite the ‘special rules’ finally being promulgated.

“We are one, whatever it is,” says Hong Kong managing partner of Deacons, Keith Cole. Coles says the new regulations are “pretty much identical” to those governing foreign law firms.

“There has been some discussion as to whether because those areas are within the PRC, particular Hong Kong and Macau as Special Administrative Regions, should be differentiated from other foreign law firms.” As a Hong Kong firm, says Cole, Deacons is hopeful there will be a differentiation.

“There’s been a discussion as to how Hong Kong lawyers can qualify as PRC lawyers in order to practise in China – that’s in the formative stages. Clearly, the MOJ is looking down the road and working out ways that they can liberalise the legal market while obviously protecting the local domestic market.”

If there is to be a differentiation, it seems the ability of Hong Kong lawyers to practise local law to the exclusion of lawyers from other jurisdictions is most likely.

In July 2000, after months of extensive lobbying, former Hong Kong Law Society president, Anthony Chow, led a delegation of lawyers to Beijing to meet with the MOJ, State Council and Hong Kong & Macao Affairs Office.

The delegation comprised current Law Society president Herbert Tsoi, and the presidents of the Hong Kong Federation of Women Lawyers, the Association of China-Appointed Attesting Officers, and the Young Legal Professionals Association.

At that meeting, the MOJ vice-minister Duan Zhengkun, announced the MOJ’s intention to lift the restrictions on the number and location of foreign law offices in China, as well as the ‘one firm, one office’ rule. It was also announced that mainland firms would be permitted to employ Hong Kong lawyers to practise Hong Kong law, and that Hong Kong ‘residents’ would be eligible to sit for PRC lawyer qualification examinations with a view to practising mainland law.

Let the issuing begin
The MOJ first began issuing licences to foreign firms in 1992, and allowed them to open offices in 15 Chinese cities only. UK firms Allen & Overy and Lovells, US firms Baker & McKenzie and Shearman & Sterling, and Hong Kong firms Vivien Chan & Co and Siao, Wen & Leung were among the first to benefit from China’s first tentative steps towards market liberalisation.

Some firms that have come later to the market have established large operations within a short period of time. US firm Jones Day Reavis and Pogue, which advises US, European and Asian companies on their China activities, is one of these, currently with 33 legal professionals on the ground in Shanghai, and plans to increase this to more than 40 by the end of the year.

As at December 2001, the number of foreign and Hong Kong-based firms holding a licence to operate in the PRC stood at 131. In April 2001, 11 foreign licences were issued to firms from countries as diverse as UAE, Brazil, France, Holland, Singapore, Belgium and the US.

There are more to follow, the MOJ apparently having indicated to certain firms that they will be in the ‘first batch’ to receive a second office licence. Which firms is not entirely clear, some firms announcing the ‘grant’ of a licence, and others saying they have only been given an indication they will get the nod.

The basis on which licences are allocated is, like many of China’s administrative processes, shrouded in a veil of secrecy. In February this year, the senior partner of Johnson Stokes & Master, Simon Ip, told ALB: “ We’ve just now been granted permission to open our Beijing office. There were four other Hong Kong law firms. I don’t believe any of the non-Hong Kong law firms or non-domestic Hong Kong firms were in the first batch.”

Ip could not name the other four law firms, but Vivien Chan of Vivien Chan and Co. could. Apart from her firm, they are, she says, Deacons, Johnson Stokes & Master, Khoo & Partners and commercial/property firm Tony Kan & Co.

Keith Cole, Deacons Hong Kong managing partner, is also in the dark as to the identity of the other firms. “We’ve been notified that we will be given a licence (to open an office in Beijing. The indications we’ve had is that the first batch will include five firms.”

Andrew Godwin, Shanghai partner of UK firm Linklaters which has use of the Beijing office of alliance member De Brauw Blackstone Westbroek, says the firm has applied for a licence to open its own office in the Chinese capital. “Hopefully it’s just a matter of time before the government formalises the intention to remove the one office restriction….There’s a general air of optimism it will happen this year.”

But Peter Neumann, the Shanghai resident partner of US firm Faegre & Benson, which opened an office in Shanghai in August last year, says the MOJ’s process of allocating licences is “contrary to the whole spirit of the rule of law”.

“Frankly,” he says, “they need to clean up the whole process and make it more transparent.” He says firms that have tried to operate in more than one city through associations have been frowned upon. Hotel offices “these people try to stay off the radar screen”.

Ties to the mainland
China is an important market for Hong Kong law firms, in line with the SAR’s focus on developing a new role as the mainland’s chief services provider. They offer a pool of highly-trained, highly-qualified professionals who are perceived to have a better understanding of Chinese law than lawyers from other countries.

But China’s domestic market, with its 110,000 or so lawyers, is catching up. Local lawyers are training overseas and returning better qualified. And they are getting more experience. Says Keith Cole: “The quality of the local law practices – the better ones – are immeasurably superior than what they were five or ten years ago. They’re dealing much more with Western law firms. They’ve got more Western and PRC educated people within the firm – and they’re learning.”

The Hong Kong Law Society has in place what president Herbert Tsoi calls a “programme of exchange” through which Chinese lawyers spend a month in a Hong Kong law firm. In his speech to open the Hong Kong legal year, Tsoi pointed to the “overwhelming demand” for places in the programme and “increasing pressure” on the Society to extend it. Tsoi also commented on the “enormous amount of interest from mainland lawyers in establishing some form of association with Hong Kong law firms”.

Godwin says there’s no doubting the quality of local lawyers. But they aren’t the only ones on the move. “You’re starting to see movement both ways…movement by local lawyers to foreign firms, and in some cases movement from foreign law firms to local firms by those young lawyers who feel that they perhaps can achieve their potential better by setting up their own firm or joining one of the local firms.”

Cole says Chinese lawyers are highly sought after. “It’s an immature market and there are a limited number of real China lawyers who’ve got the depth of experience…There tends to be much more lateral hiring going on,” says Cole. “The quality of PRC lawyers has improved immeasurably. We’re definitely looking.”

Chinese lawyers also stand to benefit from moves by the State Economic and Trade Commission (SETC) to require mainland-listed companies and other large firms to hire chief legal advisers. SETC is responsible for overseeing the mainland’s state-owned enterprises.

Says Don Hess, newly appointed partner of Allens Arthur Robinson: “I believe there are some fabulous PRC law firms. I think we’d be a very good partner.”

Godwin says China is no different to other countries in the restrictions it has had in place regarding its legal market. “We can’t really be critical of China because they applied in many other jurisdictions. For example, they applied in Singapore for many years – foreign law firms were not allowed to practise local law. Now they can through joint ventures. In Japan, similar restrictions applied.”

The State Council permits foreign law firms to strike up contractual arrangements with Chinese firms to advise on local law. But it has stated that bans prohibiting jointly invested law firms will not be lifted post-WTO accession, and representative offices of foreign law firms are still not permitted to recruit Chinese lawyers.

Despite this, Godwin thinks the PRC government is committed to liberalising the domestic legal market. “The impetus for that would obviously be foreign lawyers who feel that by either having the ability to enter into partnerships with registered PRC lawyers and thereby gaining the capacity to practise PRC law in their own right, or by entering into some sort of joint venture as you have in jurisdictions like Singapore, they would be able to offer a much better service to their clients.”

“On the other hand,” says Godwin, “the concern on the side of local lawyers that by giving foreign law firms too much of a free hand that might squeeze them out of the market. China’s position as an emerging market might lend weight to the argument that perhaps it should liberalise the profession. It would be good for everyone concerned.”

But is there room for every-one? Says Cole: “You’ll have to ask us again in 18 months or so. There’s an element of flavour of the month, which tends to mean that there may be some people who won’t stay the course. The people who are committed – there is enough work for them.”

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Foreign Investment

Foreign investment has to date been a major component of China’s GDP, and the mainstay of firms’ China practices. China introduced its open-door economic policy in 1979, creating Special Economic Zones and export-driven sectors within them in which foreigners could invest. Companies in which foreigners invested experienced significant growth.

A new Guidance Catalogue for Foreign Investment Industries and accompanying Provisions on Directing Foreign Investment came into effect on April 1 2002. Under the Catalogue, and pursuant to its WTO commitments, China has opened up a number of industry sectors to foreign investment for the first time, and taken others out of the “restricted” investment category to place them in the “encouraged”. It has also relaxed restrictions on the foreigner stakeholdings in mainland enterprises.

Sectors opened up include insurance, foreign trade, telecoms, transportation, accounting, tourism and banking. China is also encouraging investors to set up FIEs in its western regions, which remain largely undeveloped. These FIEs can take different forms - equity joint ventures (EJVs), co-operative joint ventures (CJVs) and wholly foreign-owned enterprises (WFOEs).

Deacons China practice head, Franki Cheung, says the firm has seen a “definite surge” in the last few months in foreign investment, in areas such as telecommunications and projects. The firm has a core team of around 20 lawyers focused on FDI and regulatory type work with the China practice group, which has been operating since the open-door policy.

Says Cheung: “There will be increasing FDI in China in the areas that have been conditionally opened up – manufacturing, telecommunications, financial services, insurance, distribution, logistics.”

Don Hess, former PCCW general counsel who has joined Allens Arthur Robinson to help develop its Shanghai practice, says while foreign investment will pick up, not all who go into China will succeed. “China’s a tough market,” he says. “As an investor there, you need to take a longer term view. A lot of companies have gone there and not made much money. There’ll probably be a gold rush – and some will lose their shirts.”

Godwin agrees that foreign investment will flow in gradually as sectors open up, and points to the government’s lifting of restrictions in areas such as shareholdings in domestic fund management companies and joint venture investment banks. But it won’t happen overnight.

“All of these things require procedures, rules, a mechanism for regulating these activities. There really is a lot of preliminary groundwork that needs to take place before investment flows in. But I would expect that by the end of this year, there should be quite a bit of movement,” says Godwin.

“Although the caps on the level of foreign investment over a period of time will be phased out, there are obviously issues that foreign investors need to consider in terms of what they can do with a minority shareholding.”

Godwin has been in Shanghai for around six years and joined Linklaters in 2000 from Simmons & Simmons. He handles principally banking and finance work within the Shanghai practice, which also focuses on corporate M&A, including inward investment, the establishment of Foreign Investment Enterprises (FIE), and acquisitions of existing businesses in China, and financial/capital markets work.

M&A and corporate restructuring have come into their own in the last few years, with a shift in the restrictive attitudes that saw foreign investors hamstrung when attempting to sort out their operations.

There are signs restructuring and rationalisation activity has overtaken foreign investment as a major source of work as China steps up efforts to put its house in order. This is particularly the case in relation to the country’s State Owned Enterprises, which for years have sustained losses that the banks have had to bear. SOEs traditional reliance on state bank loans to subsidise their operations has hindered financial sector reform, although some inroads began to be made in the early 80s when the banking system was decentralised and competition between banks promoted. The financial sector’s main regulatory authority, the People’s Bank of China, transferred its commercial banking operations to the Industrial and Commercial Bank, and became a truly ‘central’ bank. It controls supply of money, determines interest and deposit rates, oversees banks’ operations, supervises the People’s Insurance Company of China, handles foreign exchange reserves.

Says Godwin: “The government has taken steps to tidy up the balance sheets of the large state and commercial banks by setting up asset management companies to purchase the non-performing loans.” But China has yet to see the level of debt restructuring work that has occurred in countries such as Thailand and Indonesia. Godwin believes there are two reasons for this. “The State has a very strong involvement in the economy still….And China still doesn’t have a well-developed system of insolvency law. The rights of creditors are therefore still quite limited.”

Deacons’ Cole says the reason for increased restructuring activity is clear. “SOEs and local companies have got to know that there is going to be serious competition coming – and they’re cleaning up their act in preparation for it.”

China is also reforming its capital markets sector, after a year in which allegations of insider trading and over-stated profits were bandied about. The China Securities Regulatory Commission has been forced to adopt a more hard-line approach to corporate governance, and as a result, a number of mainland companies reporting sustained losses have been de-listed. Listed companies are now required to report quarterly to the market in an effort to introduce a degree of transparency and accountability. There are other reforms in the pipeline. In early 2001, China opened up the B-share foreign currency market, previously the domain of foreigners, to PRC nationals, signalling a step towards integrating A and B-share markets.

Godwin says China is also looking at a scheme similar to that in place in South Korea and Taiwan through which qualified foreign institutional investors (QFII) can acquire securities on the domestic stock market. He says there have been few ‘B’ share issues for some time, but a number of ‘A’ share issues by PRC companies have been well-received in the market.

Cheung says there are also plans to permit JVs and FIEs to be listed on the PRC Stock Exchange, as part of the government’s foreign investment drive. A number of multinationals are favouring a different structure to the traditional FIE – converting to companies limited by shares with foreign investment (CLSFIs), which have the advantage of being able to raise capital via IPOs and placements, and an unlimited term of operation.

What sectors? Petrochemical, electronics, acquisition transactions in distribution sector. Lot in the consumer goods sector with acquisition of local companies.

Project finance work has been slow since the 1997 Asian financial crisis, and the work available is being given to local firms. Banking and structured finance steady.Preference for renminbi over foreign currency financing for cost saving and eliminating FX risk.

The path of reform

The slow pace at which China has gone about reforming its laws is set to pick up significantly as the country rises to meet the challenge of international competition. The general consensus seems to be that it is committed to doing so.

Says Hess: “Chinese law….is a vast improvement on what it was 15-20 years ago. There’s more clarity. They’re working extremely hard to ensure China has the right legal framework [and] what they’ve done is remarkable.”

But will China be able to cast off the pall of corruption and authoritarian attitudes that dominate high-level thinking?

Godwin says China’s problems with corruption are not as serious as those in other countries, where it is “institutionalised”. “In China, a lot of the problems have arisen out of the transition period between essentially the planned economy and market economy. During that process, funds have been misapplied and misappropriated.”

“Obviously, as the market opens up, it becomes more critical to stamp out corrupt practices and ensure that there’s a transparent legal system. It’s going to be a challenge, but I think the positive thing is that there’s an understanding on the part of the leadership that there’s no alternative.”