China’s WTO Record: A Two-Year Assessment

Testimony before the U.S. — China

Economic and Security Review Commission

Thursday, September 25, 2003

Willard A. Workman

Senior Vice President, International

Policy & Economic Reform

U.S. Chamber of Commerce

This testimony focuses strictly on how China is carrying out its World Trade Organization (WTO) commitments and does not attempt to encompass the many other aspects of the U.S. commercial relationship with China. We recognize that such issues as the U.S.-China trade deficit, the impact of an undervalued Chinese currency, and the challenges created by Chinese import competition are currently getting increased political attention, but these subjects, though important, are not the focus of my remarks. That said, the current focus on such broader issues is driving an examination of China as a global economic player and its ability to follow through with its obligations. Absent more progress toward fulfilling its WTO commitments, concerns about China will only rise.

The undertakings in China’s WTO accession were massive, the most ambitious any country ever made to accede to the WTO or its predecessor, the General Agreement on Tariffs and Trade (GATT). The international business community judged these wide-ranging, comprehensive commitments necessary because of China’s growing role in the international economy. Implementation of obligations as broad as China’s was always understood to be difficult, and American businesses have never assumed that it would be a short or smooth ride. In some respects, China’s implementation efforts have been impressive, and the rapid growth in two-way trade and investment into China reflects this. But partial implementation is not what China promised nor what the international community and American business can accept.

China’s WTO compliance has been uneven and incomplete. Unless this picture improves, there will be an increasing crescendo of complaints about China’s record. A number of companies are already publicly expressing the view that China is dismissive of global trade rules and commitments. Since the country’s WTO entry on December 11, 2001, we have not seen enough new contracts, new access, and new customers to stem this tide. Faithful implementation of China’s WTO obligations will have positive commercial ramifications and demonstrate that its membership in the WTO is leading to new opportunities for exporters and investors.

It is important to also place these issues in their larger context. On political and security issues, China and the United States enjoy the most cooperative relationship that they have had in recent times. There has been close coordination on efforts to combat terrorism and with respect to developments on the Korean peninsula. Moreover, China and the United States share certain multilateral priorities connected to the new Doha Round of trade talks and are both involved in a series of regional and bilateral free trade agreement discussions. While these high-priority political and economic agenda items require continued attention, China’s WTO record also merits the focus of the two governments at the highest levels.

Throughout my testimony, there are examples of U.S. companies interested in providing input and engaging in dialogue and consultations on how to develop laws and regulations that comply with both the letter and spirit of China’s WTO commitments. China has demonstrated a willingness to work with us, but we need to see more progress in the months ahead. If progress is not made, there will be political and commercial ramifications and the full potential of this critical partnership will not be realized.

In this environment, we make the following observations:

• Additional implementation progress is critical. China’s entry into the WTO brought

• China must stay focused on having a positive WTO record as it works through

• If China does not adequately address compliance deficiencies, it is likely to face an

• U.S. businesses are ready and willing to work with China to develop constructive

• China’s General Administration of Quality Supervision, Inspection, and Quarantine (AQSIQ) should restrict its activities to import quarantine procedures that are science based and compliant with WTO and international conventions and should not impose delays, uncertainties, or commercially discriminatory or commercially unrealistic requirements that inhibit free trade.

• AQSIQ should approach the approval of import permit requests in a timely and commercially realistic manner.

• AQSIQ should ensure that all formalities are transparent, with clear timelines openly promulgated.

• China should honor its TRQ obligations and not engage in such practices as delaying announcements; granting insignificant, uneconomic quotas; applying restrictions that are not required of domestic producers or merchants; or designing nontariff trade barriers that circumvent TRQ obligations.

• China should ensure that there is greater transparency in the TRQ process and comply with the requirement to publish a list of importers that have been granted TRQ allocations.

Issue Assessment: While there has been progress in some areas, the agriculture industry continues to face a range of Chinese government actions that have held back the potential growth in U.S.-China agricultural trade.

• China should put in place a regulatory structure that reflects global norms and not institute capitalization requirements and net asset ratios for auto loan institutions that act as market access barriers. In light of the nearly two-year delay in implementing its auto finance commitments, China should expedite the approval of applicants.

• Draft regulations covering distribution services should be made available for prior public comment, and final regulations must allow foreign-invested auto enterprises to engage in distribution activities as soon as possible, with no requirement of a separate distribution system for domestic and imported autos.

• The allocation of the remainder of the 2002 and 2003 auto quotas and the reallocation of unused 2002 and 2003 quotas should take place promptly. China should also provide assurances that there will be a fair, transparent, and open process for the 2004 quota application and allocation.

• China should actively enforce compliance with the WTO’s Trade-Related Intellectual Property Rights (TRIPs) agreement as it applies to the automotive industry.

• China’s draft auto industrial policy should be modified to bring it fully in line with the letter and spirit of its WTO commitments.

Issue Assessment: Auto finance reform is nearly two years behind schedule, and delays in the release of the relevant regulations have hindered the ability of U.S. automakers to realize some of the expected benefits of China’s WTO accession. Greater transparency in regulatory processes and in procedures for quota application and allocation is necessary to fully and fairly implement the WTO automotive quota

• New postal legislation must reflect China’s WTO commitments and not allow China Post to extend its existing monopoly to new areas.

• The new legislation should define the scope of the postal monopoly as packages and documents weighing less than 350 grams where the price is less than three times that of the lightest ordinary mail over the shortest domestic distance. In two years, this should be reduced to 250 grams and two times the price of ordinary mail; two years later, it should be reduced to 150 grams and the price of ordinary mail.

• Although not technically a WTO mandate if certain requirements are met, China should ensure competition and efficiency by separating the postal regulatory function and the postal business function into different and independent entities. The postal regulator should focus on the quality of postal service, pricing related to cost, and related accounting systems to prevent abuse of the exclusive rights granted to the universal service provider.

• China should regulate businesses that operate outside the scope of the defined postal monopoly by using a nonpostal regulator, such as the Ministry of Commerce, for international freight forwarders

Issue Assessment: The lack of an independent regulator creates challenges in the express delivery services sector, where China Post is trying to use its regulatory authority to expand its postal monopoly into a market already well served by existing commercial operators. U.S. industry representatives are encouraged at the dialogue with Chinese officials on draft postal legislation, but China will ultimately be judged by the extent to which the new law complies with its WTO commitments.

• China should bring registered capital requirements in line with global best practices and regulatory standards.

• China should improve the clarity and specificity of financial services regulations and administrative measures and consistently provide advance notice and reasonable comment periods on proposed measures.

• China should allow foreign insurance companies to expand geographically according to the terms of its WTO commitments and permit the use of a single branch/sub-branch structure throughout the country without any additional capitalization requirements or lengthy application processes.

• China should allow foreign insurance companies to establish more than one branch at a time– that is, on a concurrent, not consecutive basis–commensurate with domestic counterparts.

• China should adopt prudential criteria for the banking sector based on international norms and should avoid the use of borrowing restrictions that limit the efficient functioning of the market.

• China should avoid proposals that would limit the maturity of interbank transactions and create difficulties for banks to match the maturity structure of their assets.

• China should make the qualified foreign institutional investors system more workable by eliminating some of the requirements under the current system.

Issue Assessment: China has begun to implement its WTO obligations in the financial services sector by revising its laws, regulations, and administrative practices, but excessive capitalization requirements are limiting the healthy development of the market.

• China should undertake a coordinated nationwide intellectual property rights (IPR) enforcement campaign against traditional (e.g., book, cassette) and recent or emerging (e.g., CD, VCD, DVD, Internet-related) piracy, end-user piracy of software and other copyrighted materials, and counterfeiting. China should also immediately eliminate the high criminal thresholds and procedural obstacles that prevent the effective use of criminal prosecutions in addressing IPR violations. At the same time, China should make revisions to the Penal Code such that it fully applies to all rights under copyright as well as all other piracy-related crimes.

• China should take similar effective enforcement actions in other manufacturing sectors to stem the tide and culture of piracy, including in areas such as pharmaceuticals that pose grave public health risks.

• China should take more effective customs and border measures to curtail the massive importation of pirated materials into the country.

• China should continue with its efforts to train judges in IPR laws; provide adequate resources to relevant police, prosecutors, and administrative agencies; and ensure that penalties for intellectual property violations are sufficiently strong to serve as a deterrent.

• China should ratify the World Intellectual Property Organization Copyright Treaty and the Performances and Phonograms Treaty.

Issue Assessment: Improvements in China’s IPR legal framework must be matched by greatly enhanced enforcement efforts at the local level.

• China should not reduce the scope of its commitments in the category of value-added services by reclassifying them as "basic" services, a category that is far more restrictive for foreign investors. The capitalization requirements that China has established for providers of basic telecommunications services are unrealistic, bear no reasonable relationship to commercial or public interest requirements, and constitute a barrier to entry. This high capitalization requirement should be eliminated.

• China should promote greater transparency in legal and regulatory proceedings, including the consistent use of required advance notice and comment periods.

• China should take steps to increase the independence of the regulator, the Ministry of Information Industries, from the major state-owned telecommunications operators.

• China should cease to restrict the ownership and operation of international gateways to wholly owned telecom service providers.

Issue Assessment: China’s classification of value-added services has become more restrictive in the period since WTO accession. The reduction in the scope of value-added services and the increase in the scope of basic services are especially problematic given the unreasonably burdensome registered capital requirement for foreign-invested basic service joint ventures.

• China should put forward transparent and WTO-consistent regulations that spell out precisely how U.S. enterprises can begin to realize the benefits of China’s commitments in the area of trading rights and distribution services.

• These regulations should eliminate the artificial restrictions imposed on companies that made investments in China before its accession to the WTO and should make clear that all companies may conduct operations in China as they would anywhere in the world.

• China should make draft rules relating to trading rights and distribution services available for prior public comment.

Issue Assessment: China’s trading rights and distribution services commitments are now the subject of serious discussion between Chinese officials and U.S. negotiators regarding China’s interpretations of their commitments in this area.

The September 2002 report of the U.S. Chamber’s China WTO Implementation Working Group represented the group’s views on how China’s WTO implementation efforts were proceeding nine months into its membership in the global trading body. That report highlighted a number of positive areas where China had faithfully complied with its obligations and where its efforts–in such areas as WTO education and training–were indicative of a high-level commitment. That report also highlighted areas where compliance had certain shortfalls.

Many of our initial assessments are still valid today. China seems committed to the WTO process, but there remains a continued need for progress, including in such areas as regulatory transparency and the establishment of fully independent regulatory bodies–that is, regulators that are not also competing in the market. With respect to individual industries, excessive capitalization requirements in the financial sector, delays in permitting nonbank institutions to provide auto financing, the lack of a functioning agricultural TRQ system, and continued delays in granting permanent approvals for genetically modified crops are among the year-one issues that carry over as concerns.

On the positive side, tariff cuts continue to be made in a transparent fashion and according to the agreed upon timetable. This past year also saw progress with respect to China’s participation in the Information Technology Agreement (ITA) as the country removed certificate requirements on 15 tariff items that previously had to meet conditions before qualifying for the ITA tariff rates. In addition, as just one example of consultations with foreign companies to develop WTO-consistent regulations, the direct-selling sector has been pleased by the willingness of the new Ministry of Commerce to consult with companies about the form and substance of new regulations being drafted to govern that industry.

While the 2002 report did not mince words about our expectation of full compliance, it reflected our members’ understanding about the scope and likely challenges of the effort ahead. It recognized the time that would be needed to develop or amend literally thousands of regulations to ensure their compliance with China’s WTO commitments and to put in place the physical and human capacity to implement those regulations in a transparent and predictable manner.

One year later, expectations are rising, and the degree of progress in implementing WTO commitments in year two and beyond will impact how quickly China’s own economic modernization efforts proceed, how foreign investors view opportunities in that important marketplace, and how political leaders in the United States, particularly in the U.S. Congress, approach the bilateral relationship.

China’s commitments in the second year of its WTO membership range from the continuation of tariff cuts that began upon its accession to the second phase of gradual market openings being implemented over a period of years. Some of the most significant commitments in the second year include those related to financial services, telecom services, and trading rights and distribution services. Many of these are highlighted below.

This testimony makes constructive recommendations regarding some of the high-priority trade differences with China in the hope of avoiding more serious trade disputes. Let’s take a closer look at some key areas.

China’s WTO commitments to reduce both tariff and nontariff barriers in the agricultural sector have met with mixed results. There has been welcome progress in some key areas such as tariff reductions. Unfortunately, however, many nontariff barriers continue to limit the progress anticipated from China’s WTO membership.

Some of the key issues that need to be addressed include

• a range of problems with the implementation of China’s promised TRQ system, including a lack of transparency, delay in the announcement of quotas, granting of insignificant and uneconomic quotas, imposition of restrictions that are not required of domestic producers or merchants, and other unnecessary restrictions;

• uncertainty regarding biotech regulations and the issuance of permanent safety certificates for biotech products;

• labeling and information requirements on meat and poultry products that raise export costs without enhancing food safety;

• administrative interference with import trade by China’s quarantine authorities and Ministry of Commerce, including requirements that importers get import permits before signing purchase contracts and making shipments;

• significant export subsidies for agricultural products, particularly corn; and

• Chinese adherence to the WTO’s Agreement on the Application of Sanitary and Phytosanitary Measures. There is particular concern regarding the failure to utilize the International Plant Protection Convention, "zero tolerance" pathogen standards that are neither science based nor practical, and undue quantitative restrictions on meat and poultry imports.

The agricultural TRQ issue has the potential to be the first case against China under the WTO dispute resolution system.

The U.S. Chamber’s September 2002 report called for science-based, permanent rules for genetically modified organism (GMO) imports, a transparent TRQ system, and an end to agricultural export subsidies.

While China has eliminated or reduced some tariff barriers, the benefits from these actions can be quickly offset by continued nontariff barriers that restrict trade into China, create significant marketplace uncertainty, and discourage further foreign investment.

We urge the governments of China and the United States to work collaboratively to reduce these unjustified barriers to agricultural imports and the modernization of Chinese food production.

For 2003, the U.S. Chamber has chosen to highlight two specific areas where reform is urgently required for China to comply with the spirit of its WTO commitments: (i) regulatory practices of AQSIQ and (ii) agriculture TRQ systems.

U.S. soybean, cotton, and meat traders have reported significant restrictions on exports of products to China stemming from AQSIQ’s posture on the issuance of Import of Animal and Plant Quarantine permits and its inspection procedures. Chinese quarantine regulations require importers to obtain import permits before entering into purchase contracts and effecting shipments. With import permits valid for only 90 days, buyers are locked into a very narrow period to purchase, transport, and discharge their cargoes before expiration of the permits.

While the technical requirement imposed on importers is to obtain an import permit in advance of contracting for commodity shipments, the current AQSIQ requirement is essentially unworkable as importers buy products when prices are low–sometimes months ahead of actual shipment. Contracting parties cannot wait to obtain an import permit first before making a contract for shipment of commodities.

Although China removed soybean import quota control in 1999, the Chinese government now appears to control import volume through WTO-inconsistent methods such as the use of quarantine import permits. Many of the administrative requirements of the import permit system–such as factory inspections, the requirement that buyers not import more than they did in previous years, rules that restrict buyers from using premium/basis or other forward delivery contracts, and rules that restrict the issuance of permits only to processing plants and not to traders supplying multiple plants–have no relevance to the enforcement of animal and plant health regulations. The requirement for a surface inspection of imported grain and feed ingredients prior to discharge has no scientific validity.

AQSIQ has recently slowed the issuance of permits, which has resulted in significant commercial uncertainty and, in some cases, has placed U.S. foreign investment in the Chinese agricultural sector at risk. Because of the commercial necessity to contract for commodity shipments when prices are low, combined with inherent delays in having import permits issued, many cargoes of soybeans end up arriving in Chinese ports without import permits. This has created delays in vessel discharge and resulted in demurrage bills for Chinese buyers.

AQSIQ has committed to notify importers about the result of their permit applications within 30 days of receipt. However, some importers are waiting well beyond 30 days without obtaining any feedback from AQSIQ, as it appears that provincial inspection and quarantine offices that act as intake centers for import permit applications are asked to delay submitting these applications to AQSIQ in Beijing. This effectively extends the 30-day notice period AQSIQ has to respond to the party requesting an import permit.

Most recently, AQSIQ has suggested to foreign diplomats that it will take action to restrict specific firms from exporting or importing soybeans based on allegations that the firms have failed to meet certain quarantine regulation and mandatory quality requirements.

Recommendations:

• China’s General Administration of Quality Supervision, Inspection, and Quarantine (AQSIQ) should restrict its activities to import quarantine procedures that are science based and compliant with WTO and international conventions and should not impose delays, uncertainties, or commercially discriminatory or commercially unrealistic requirements that inhibit free trade.

• AQSIQ should approach the approval of import permit requests in a timely and commercially realistic manner.

• AQSIQ should ensure that all formalities are transparent, with clear timelines openly promulgated.

China has not made sufficient progress in implementing tariff-rate quotas for bulk agricultural commodities such as wheat, corn, cotton, and vegetable oil in a manner that opens the market to trade as anticipated under China’s WTO accession agreement. Regulations designed to establish TRQ systems were late in being released, lacked sufficient transparency, and introduced unreasonable licensing procedures for importers. In some cases, China contravened its accession agreement by allowing TRQs reserved for "nonstate trading companies" to be issued to state-owned enterprises.

The TRQs for corn and wheat in many cases were distributed in such small quantities as to render them uneconomic to fulfill. When TRQs were issued, it has been very difficult, if not impossible, to ascertain which companies were granted quotas, and the authorities responsible have refused to publish full lists of quota recipients, in violation of the WTO agreement.

We are encouraged by China’s recent proposed elimination of current State Development and Reform Commission requirements that a significant portion of each TRQ be used only for processing and mandatory reexport of finished products. This restriction is most important for cotton, where well over one half of the TRQ has been restricted to reexports, and represents a violation of China’s accession agreement.

Recommendations:

• China should honor its TRQ obligations and not engage in such practices as delaying announcements; granting insignificant, uneconomic quotas; applying restrictions that are not required of domestic producers or merchants; or designing nontariff trade barriers that circumvent TRQ obligations.

• China should ensure that there is greater transparency in the TRQ process and comply with requirements to publish a list of importers that have been granted TRQ allocations.

China’s WTO commitments in the automotive sector were designed to address a range of policies and practices that limited the ability of automakers to fully engage in the Chinese automotive market. These commitments include a significant reduction in automotive tariffs, phaseout of auto tariff quotas and licensing requirements, easing of restrictions on investment, permission of nonbank automotive financing, phasein of trading rights and distribution services, full adherence with the WTO agreement on technical barriers to trade for auto standards and certification, and active enforcement of the WTO agreement’s commitments on intellectual property. Overall, compliance with these commitments has been uneven. The commitment China made to lower tariff rates has largely been met. In many other areas, however, China has fallen short of fully meeting its obligations.

A case in point is in the area of auto financing. China agreed that upon accession it would allow nonbank financial institutions to provide auto financing without limitations on market access or national treatment. Almost two years later, final implementing regulations have not been issued, and the most recent draft regulations contain excessive capitalization requirements and net asset ratios that are significantly higher than are found in other markets around the world. These requirements will make it difficult for U.S. and other foreign firms to provide these services to consumers in China, which will, in turn, dampen the demand for automobiles in China and reduce the economic contribution that the auto sector can make to the Chinese economy.

With regard to its auto quota and import licensing commitments, China agreed to a three-year global auto quota for the importation of finished motor vehicles and select components. The quota was US$6 billion for the first year (2002) and is scheduled to grow 15% annually until all quota restrictions are eliminated by January 2005. While the 2003 import quota on motor vehicles (US$9.125 billion) exceeded minimum WTO commitments to expand the quota levels, the delay in issuing the regulations and quota allocations has resulted in uncertainty and significant disruption of distribution and retail businesses for imported vehicles.

China also committed to phase in trading and distribution rights for joint ventures and foreign-owned enterprises within three years of accession. The ability of automakers to fully utilize trading rights to freely bring in motor vehicles and distribute them to complement the vehicle models manufactured in China is critically important. This will enable automakers to market a wide range of vehicle options and provide consumers with more choices. Although draft implementing regulations granting and governing trading rights and distribution services have not yet been released, there is a growing concern that automakers will be required to establish separate distribution systems for domestic and imported vehicles, which would clearly be inconsistent with the intent of the WTO commitments on trading rights and distribution services.

Protection and enforcement of IPR, as defined in the WTO TRIPs agreement, is increasing in importance to automakers operating in China. Since China’s accession to the WTO, there has been an increase in IPR violations of automotive products, such as automotive braking, steering, and emissions systems. The violations have an adverse commercial impact on those automakers that hold the patents and trademarks for these products, but more importantly, they pose a serious safety and health risk to Chinese citizens.

In early May 2003, China released for comment a draft update of the industrial policy governing China’s automotive industry. In general, the policy appears to promote a return to top- down, government-directed management of the fundamental structure and scope of the industry. For example, the policy contains guidance on the close management of automotive production, investment, distribution, trade, and technology, which is inconsistent with the great strides China has taken toward a more market-oriented economy. We are encouraged that China is seeking input on the draft auto industrial policy and support modification of the policy to ensure that it is fully consistent with the letter and spirit of China’s WTO commitments.

Recommendations:

• China should put in place a regulatory structure that reflects global norms and not institute capitalization requirements and net asset ratios for auto loan institutions that act as market access barriers. In light of the nearly two-year delay in implementing its auto finance commitments, China should expedite the approval of applicants.

• Draft regulations covering distribution services should be made available for prior public comment, and final regulations must allow foreign-invested auto enterprises to engage in distribution activities as soon as possible, with no requirement of a separate distribution system for domestic and imported autos.

• The allocation of the remainder of the 2002 and 2003 auto quotas and the reallocation of unused 2002 and 2003 quotas should take place promptly. China should also provide assurances that there will be a fair, transparent, and open process for the 2004 quota application and allocation.

• China should actively enforce compliance with the WTO’s TRIPs agreement as it applies to the automotive industry.

• China’s draft auto industrial policy should be modified to bring it fully in line with the letter and spirit of its WTO commitments.

In the U.S. Chamber’s 2002 report, it called on China to prohibit the State Postal Bureau, which is both a regulator and a competitor in the market, from acting inconsistently with its WTO obligations by adopting measures that either expand the traditional postal monopoly to new areas, such as express delivery, or accord more favorable treatment to China Post when supplying express delivery services in direct competition with private operators. In 2003, express delivery service providers continue to call for WTO-consistent regulations and laws that encourage, not hinder, competition.

China needs to separate China Post’s regulatory functions from its business operations, define the postal monopoly as narrowly as possible, and promote fair competition in sectors, such as express delivery, where China Post competes with private-sector operators. Express delivery companies can then operate outside the scope of the defined postal monopoly without obtaining any entrustment or approval from China Post.

U.S. industry representatives are concerned that the current draft revisions to China’s postal law, which the National People’s Congress (NPC) has announced that it will pass this year, violate China’s WTO market access and national treatment commitments. The draft law would expand China Post’s monopoly to all shipments under 500 grams, which would greatly impair the ability of express delivery carriers to provide services in China.

Express delivery companies are encouraged that the NPC and the State Council’s Legislative Affairs Office have met with them to discuss this draft and appear to be making a serious effort to listen to the views of foreign participants in the market. But China will be judged by its actions. The draft must be revised to reflect China’s WTO commitments and to promote beneficial competition in the market. Specifically, China must remove the existing 500-gram threshold for shipments in the draft postal legislation. These restrictions would allow China Post, the dominant carrier, to extend its monopoly from private letters to other shipments.

Recommendations:

• New postal legislation must reflect China’s WTO commitments and not allow China Post to extend its existing monopoly to new areas.

• The new legislation should define the scope of the postal monopoly as packages and documents weighing less than 350 grams where the price is less than three times that of the lightest ordinary mail over the shortest domestic distance. In two years, this should be reduced to 250 grams and two times the price of ordinary mail; two years later, it should be reduced to 150 grams and the price of ordinary mail.

• Although not technically a WTO mandate if certain requirements are met, China should ensure competition and efficiency by separating the postal regulatory function and the postal business function into different and independent entities. The postal regulator should focus on the quality of postal service, pricing related to cost, and related accounting systems to prevent abuse of the exclusive rights granted to the universal service provider.

• China should regulate businesses that operate outside the scope of the defined postal monopoly by using a nonpostal regulator, such as the Ministry of Commerce, for international freight forwarders.

Since joining the global trading body, China has made considerable progress toward openness and the acceptance of international norms, and much of this progress has come in the financial services sector where China made substantial liberalization commitments. In insurance, foreign nonlife carriers will be able to provide insurance to indigenous Chinese companies by the end of 2003. In addition, China will eliminate geographic limitations on foreign insurance company expansion by the end of 2004. Foreign companies may already provide master policies (if the headquarters of the insured is located within the insurer’s licensed city) and large-scale commercial risks without geographic restrictions. Moreover, under China’s WTO obligations, foreign insurance brokers may now form joint ventures and may gradually transition to wholly owned foreign enterprises by December 2006.

Some of China's reforms go beyond its WTO commitments.  Allowing nonlife insurance companies to provide accident and health products, under the terms of the recently amended Insurance Law, is an encouraging development.  China has not, however, succeeded in meeting all of its commitments, and significant challenges remain.  The U.S. Chamber is pleased with recent actions by CIRC offering public comment periods on the "Trial Implementing Rules on the Regulations of the People's Republic of China for the Administration of Foreign-Invested Insurance Companies" and "The Administrative Regulations on Insurance Companies" and applauds this move to realize China's transparency commitments. 

However, certain draft regulations are inconsistent with China’s WTO obligations, including the requirement for insurers to convert existing branch operations to local subsidiaries. China should also allow insurers to conduct business on a branch/sub-branch operating structure, as is widely permitted under established international norms. Foreign insurers await CIRC’s reply to their request for confirmation of their understanding on a series of issues that they have identified as vague regarding the treatment of domestic and foreign companies, including from the national treatment standpoint. Generally, foreign insurers believe China’s drafts are a move in the right direction and expect CIRC to provide further clarification during its next meeting with industry representatives and officials from the Office of the U.S. Trade Representative. Such a meeting will represent the next stage in an ongoing dialogue and collaborative process initiated in December 2002. Given the number of outstanding questions that exist on a range of significant issues, foreign insurers consider it important that the next meeting be held during the fall of 2003.

The current approach of specific regulations for domestic insurers and separate regulations for foreign insurers may be necessary in the early stage of opening the insurance sector. However, as China implements national treatment for all insurers, we look forward to the day when China will have a single, unified set of regulations, based on international best practices, for all insurance companies operating in China.

At this time, of greatest concern are the following three issue areas:

The U.S. Chamber’s 2002 China WTO compliance report called for policies that would allow foreign insurance companies to establish a branch with a reasonable initial capitalization backed up by the strength of the parent organization. It also called on China to permit geographic expansion in compliance with scheduled phaseouts of geographic restrictions and without having to separately capitalize each location. Unfortunately, in 2003, excessive capitalization requirements to enter or expand in the insurance market remain a major concern for many U.S. Chamber members.

China’s imposition of extremely high registered capitalization requirements–substantially higher than similar requirements in the vast majority of insurance markets throughout the world–has negative implications for both foreign and domestic insurers. Such high capitalization requirements severely limit the WTO benefits of greater market access for foreign firms seeking to enter the market and the removal of geographic restrictions on firms already in the market. These requirements also represent a poor utilization of capital for all insurers, preventing them from using capital efficiently and thus hindering the sound development of an important component of China’s integration into the world economy.

China’s current regulations were put in place when the Chinese insurance market was relatively closed and when regulations sought to govern a primarily domestic insurance industry. Those regulations may have made good sense at that time and in that context. But China’s growing role in the global economy requires the acceptance of global practices and regulatory standards as the Chinese are now regulating global insurers with global assets, not just domestic insurers with domestic assets. The modernization of these requirements will help China achieve its goal of a more developed, open, and competitive market for the benefit of insurance consumers throughout the country.

Capital requirements that emphasize overall insurer solvency over registered capital would free up resources that would allow both domestic and foreign insurers to introduce new products and technologies and help build a thriving insurance market. In place of excessive capitalization requirements, levels could be calibrated according to the scale of a company’s business and levels of risk being covered, which would address any present or future concerns about the viability of smaller market players.

China should provide more clarity and specificity with respect to insurance regulations and administrative measures. A number of China’s insurance regulations are vague and permit a wide degree of bureaucratic discretion, which has led to confusion, misinterpretation, and inefficient operating practices. In line with its WTO commitments, as well as internationally accepted standards and good business practices, China should make consistent use of advance notice and comment periods. Both local and foreign insurance professionals should be given a reasonable period of time to review and comment on proposed new measures.

In the past, the Chinese Insurance Regulatory Commission (CIRC) rarely allowed insurance companies and/or other interested parties to comment on draft measures before they became effective. CIRC should take advantage of the international experience that many foreign insurance professionals bring to China and work more closely with the private sector to ensure the development and acceptance of timely, market-oriented, and economically sound policies. CIRC should also establish and maintain a regular dialogue with industry experts and consumers to address the needs of the industry and consumers of insurance services.

U.S. insurance companies are pleased by the dialogue CIRC has undertaken with a

U.S. government-industry group and hope to contribute to solutions that will both promote solvency and build an internationally competitive Chinese insurance market.

China’s WTO commitments on branching clearly state that China will permit branching consistent with the phaseout of geographic restrictions. But China’s current regulations do not allow insurers to sub-branch off a branch operation except within the immediate, licensed territory (e.g., Shanghai). While foreign and domestic companies may apply for more than one branch at a time, the Chinese government has not approved more than one branch at a time for foreign insurers. In addition, China has not permitted geographic expansion of existing foreign life insurance companies with the same corporate structure they had established before China’s WTO membership.

Without a change in current practice, foreign insurers will be unable to achieve the economies of scale necessary to build a truly national business like their domestic counterparts. This means that both commercial and individual consumers will remain underserved in many parts of China and will not benefit from the competition that market opening was intended to stimulate.

Foreign insurance companies should be allowed to expand geographically in China in line with established international norms and operating practices (i.e., through the use of the internationally accepted branch/sub-branch structure). Specifically, foreign insurance companies should be able to establish a branch with a reasonable initial capitalization backed up by the strength of the parent organization. They should be allowed to expand throughout the country–in accordance with China’s timetable for the phaseout of geographical restrictions–through the establishment of sub-branches that are not limited to the immediate, licensed territory. Additionally, the company should not have to separately capitalize each new location.

In most countries, when insurance companies enter foreign markets, they are allowed to establish an initial branch and then expand to new locations throughout the country through a network of sub-branches that report to the original branch. This branch/sub-branch structure is supported by, and legally tied back to, its corporate parent. Thus, branch operations should not be treated as if they were separate, stand-alone entities. Likewise, because a branch/sub-branch structure is supported by its parent corporation’s assets, the company should not have to recapitalize when expanding to a new location. This branch/sub-branch operating structure is an established international norm and a widely accepted principle of operation.

Recommendations:

• China should bring registered capital requirements in line with global best practices and regulatory standards.

• China should improve the clarity and specificity of insurance regulations and administrative measures and should consistently provide advance notice and reasonable comment periods on proposed measures.

• China should allow foreign insurance companies to expand geographically according to the terms of its WTO commitments, and should permit the use of a single branch/sub-branch structure throughout the country without any additional capitalization requirements or lengthy application processes.

• China should allow foreign insurance companies to establish more than one branch at a time– that is, on a concurrent, not consecutive basis–commensurate with domestic counterparts.

In the banking sector, concerns revolve around recent Bank of China proposals to limit the renminbi (RMB) interbank loan market and high dotational or endowment capital requirements for branches of foreign banks–which rise many times over for also conducting business in Chinese currency.

The proposed regulation to cap borrowing at 40% of total liabilities and to limit borrowing tenors would lead to an inefficient use of capital, and would contravene national treatment principles by discriminating against foreign-funded financial institutions. The U.S. Chamber’s 2002 report also spoke out against such a cap, which would negatively impact the foreign-funded institutions that depend on this financing to serve their clients, mainly foreign-invested enterprises that are making positive contributions to the Chinese economy.

Foreign banks depend on interbank RMB loan agreements as they are still not allowed to accept RMB deposits from Chinese enterprises or individuals, except in very limited cases. Moreover, foreign-invested enterprises deposits in RMB do not usually exceed what they borrow. Chinese banks are much less dependent on interbank refinancing as they do not face the same legal restrictions as do foreign banks regarding drawing on deposits and, unlike foreign banks, have access to the savings pool of Chinese citizens.

China’s WTO commitments in the banking sector do not encompass such a borrowing restriction. Article XVI of the General Agreement on Trade in Services (GATS) says that, among other things, limitations on the total value of service transactions in the form of numerical quotas shall not be maintained or adopted in sectors where market access commitments are undertaken. Therefore, the cap is a violation of this article. And as a prudential measure, quota restrictions on certain refinancing sources are inferior to liquidity supervision approaches that relate the maturity structure of a bank’s liabilities to the maturity structure of its asset portfolio.

Also a violation of the GATS article is the proposal that would restrict the maturity of interbank transactions to three years, in addition to the possible rollover of not more than half of the original maturity. Such a step could prevent banks from matching the maturity structure of their assets when they are already placed at a competitive disadvantage with respect to Chinese banks due to Bank of China minimum interest regulations on loans, a refinancing cartel of the Chinese banks, and a tax on foreign bank branches based on their interbank refinancing interest rate.

As China finalizes implementing regulations for financial services, the U.S. Chamber encourages the Chinese authorities to bring financial services capitalization levels and refinancing conditions in line with common global practices and regulatory standards. New regulations must not be allowed to undermine the benefits that the WTO accession agreement was designed to bring or to hinder China’s ability to develop a thriving financial sector.

Recommendations:

• China should bring banking sector capitalization levels and refinancing conditions in line with common global practices and regulatory standards.

• China should adopt prudential criteria for the banking sector based on international norms and should avoid the use of borrowing restrictions that limit the efficient functioning of the market.

• China should avoid proposals that would limit the maturity of interbank transactions and create difficulties for banks to match the maturity structure of their assets.

China’s entry into the WTO was a significant step in opening up the asset management market in China. Under the country’s accession agreement, foreign firms are permitted to own up to 33% of a Chinese asset management firm as of December 11, 2001, and up to 49% of an asset manager by December 11, 2004. For the asset management sector, the concerns regarding WTO implementation are similar to the challenges that exist within other segments of the financial services sector, including a lack of transparency and high capitalization requirements.

When the China Securities Regulatory Commission (CSRC) published the draft joint venture rules under which foreign firms could participate in the asset management market, there was concern that the draft rules did not provide a complete list of objective criteria for approving foreign institutions. Unfortunately, when the CSRC adopted its final rules, it did not clarify the criteria that it intended to use in its approval process. Instead, it replaced the unclear text with language providing the CSRC with broad discretion to impose additional requirements for qualification of a foreign firm. Regulations that lack transparency or provide broad discretion to officials in approving applications create uncertainty for foreign firms that wish to enter foreign markets. Moreover, when the CSRC published the draft joint ventures rules for comment, interested persons had only 10 days to respond.

Under the final joint venture rules, a foreign institution seeking to enter a Chinese joint venture must have no less than RMB 300 million [US$36 million] in capital. This high level of mandated capital for asset management firms is excessive and represents a barrier to entry. The business of asset management is not capital intensive, and client assets typically are not in the custody of the asset manager and are not at risk if the asset manager experiences financial reversals. Moreover, a high capital requirement disproportionately affects foreign asset managers because their operations in each country will typically not be as significant as their operations in their home country.

China has taken steps to open the A-share market to foreign investors by adopting rules governing qualified foreign institutional investors (QFIIs). A number of aspects of the new QFII rules, however, limit their practicality by (1) restricting the percentage of an issuer’s securities that may be held by any one QFII and by all QFIIs in the aggregate, (2) requiring each QFII to commit total investments of at least US$50 million to a dedicated QFII account, (3) requiring the amount invested to remain in the QFII account for at least one year for open-end funds and three years for closed-end funds, and any remittances from the account to be approved in advance by the State Administration of Foreign Exchange, and (4) lacking specific criteria to be applied for certain aspects of the licensing process.

Recommendations:

• China should put in place transparent regulations and administrative practices to ensure that foreign firms will not be treated in an arbitrary manner and that approvals of applications will be based on objective and fair criteria and rules that protect investors.

• China should provide a meaningful period of time for comment in promulgating financial services regulatory requirements.

• China should reconsider the high capital requirements it has imposed on fund management companies.

• China should make the QFII system more workable by eliminating some of the requirements under the current system as described above.

China was required to fully meet its WTO obligations in the area of IPR protection before its accession on December 11, 2001. But after nearly two years of membership in the global trading body, it is clear that the country’s IPR enforcement system still has significant weaknesses and is far from effective. Upon accession, China’s laws and regulations and enforcement systems had to comply with the substantive and enforcement provisions of the TRIPs Agreement. Although the country’s statutory legal regime was largely in place prior to its accession, IPR enforcement continues to be a major concern, as it was in the Chamber’s 2002 analysis.

The International Intellectual Property Alliance estimate of losses due to copyright piracy was US$1.85 billion in 2002, with piracy rates above 90%. Trademark and patent enforcement has fallen short as well.

Enforcement of IPR, a key obligation under TRIPs, cannot be considered effective until civil and criminal penalties are routinely applied to infringers of IPR. While China’s government at the central and provincial levels carries out raids and other enforcement actions, there is limited coordination of these efforts and no commitment to pursue criminal prosecutions with deterrent penalties. Pirated music, books, (especially higher-education textbooks, pirated translations, and increasing counterfeiting using well-known publisher trademarks, authors’ names, and trade dress), business software, movies, and video games are readily available throughout the market, hindering the ability of both indigenous and U.S. creators and rights holders to build successful businesses. Newly emerging problems include Internet piracy, such as the illegal and unauthorized download of online journals and other materials. Without a strong criminal remedy, rights holders have turned to more expensive and less effective civil actions, which are not providing the necessary deterrent effect.

Also worrisome are increasing reports of counterfeiting in industrial areas beyond the copyright industry. Manufacturing sectors, such as the automobile industry, report an increasing prevalence of theft of industrial designs.

Ultimately, China will not continue to attract foreign investment in research and development if the resulting intellectual property will not be protected long enough for creators to see a return on that investment. And as more trade is stimulated through China’s continued implementation of its WTO commitments, IPR-related frictions are likely to grow with trading partners with resulting damage to China’s international reputation as an investment destination for knowledge-based industries.

China is a large and increasingly significant market for U.S. pharmaceutical companies. In 2002, the country made positive strides in promulgating laws that will improve intellectual property protection for pharmaceutical products in China, including a regulation extending all patents to 20 years, as required by TRIPs. Other improvements include adopting provisions on data protection and patent linkage.

But counterfeit pharmaceuticals continue to be a significant problem in China, especially

over-the-counter products sold outside hospitals, of which 10%—15% are by some estimates counterfeit. Although Chinese authorities, including the State Food and Drug Administration (SFDA), are devoting time and resources to addressing this problem, success will be limited without laws on the books that strengthen criminal penalties for counterfeiters.

Currently, only if a substandard pharmaceutical seriously injures someone is the infringer subject to incarceration. Affixing someone else’s intellectual property onto one’s own packaging or labeling only subjects the infringer to incarceration if the infringement is "serious." Without criminal sanctions, including mandatory minimum incarceration at a relatively low threshold for all counterfeiting, it will be difficult to significantly curtail the counterfeiting of pharmaceuticals in China. And in the wake of the recent SARS epidemic, it is more important than ever that the Chinese authorities take effective actions to ensure the integrity of the drug supply. Action includes not only promulgating laws strong enough to take action against this criminal activity but also strong and consistent enforcement activities by law enforcement and judicial officials.

In the area of data exclusivity, China committed to encourage clinical trial development by adopting provisions that would provide a six-year period of exclusivity. Data exclusivity encourages the investment into clinical trials by not allowing a second registrant to rely on the pioneer’s data package for the period of exclusivity. While the industry welcomed the promulgation of new regulations in 2002, it has still received relatively little feedback on how these provisions are to be implemented.

On the issue of patent linkage, it is critical that the regulatory authorities at SFDA do not grant marketing approval to infringing generic producers of products receiving patent protection. Provisions to provide for such linkage between drug regulators and IPR agencies are found in Articles 11 and 12 of the Drug Registration Regulation.

However, there is concern that the SFDA does not publish drug registration application information with a sufficient degree of transparency to enable the patent holder to identify a registration application of an infringing product. U.S. pharmaceutical companies look forward to working with Chinese drug registration authorities to increase transparency, both at the national and provincial levels.

Recommendations:

• China should undertake a coordinated nationwide IPR enforcement campaign against traditional (e.g., book, cassette) and recent or emerging (e.g., CD, VCD, DVD, Internet-related) piracy, end-user piracy of software and other copyrighted materials, and counterfeiting. China should also immediately eliminate the high criminal thresholds and procedural obstacles that prevent the effective use of criminal prosecutions in addressing IPR violations. At the same time, China should make revisions to the Penal Code such that it fully applies to all rights under copyright as well as all other piracy-related crimes.

• China should take similar effective enforcement actions in other manufacturing sectors to stem the tide and culture of piracy, including in areas such as pharmaceuticals that pose grave public health risks.

• China should take more effective customs and border measures to curtail the massive importation of pirated materials into the country.
• China should continue with its efforts to train judges in IPR laws; provide adequate resources to relevant police, prosecutors, and administrative agencies; and ensure that penalties for intellectual property violations are sufficiently strong to serve as a deterrent.

• China should ratify the World Intellectual Property Organization Copyright Treaty and the Performances and Phonograms Treaty.

China’s Ministry of Information Industries (MII)’s classification of value-added services has become more restrictive and rigid in the period since WTO accession. The 2003 Telecommunication Services Classification Catalog moves several services from the value-added service category to the basic service category. Equally troubling, MII’s most recent catalog eliminates the value-added service of "code and protocol conversion" that China specifically listed in its WTO commitment. The current framework establishes a ceiling rather than a floor as to what qualifies as a value-added service, providing no transparent opportunity for an applicant to demonstrate that a new and innovative unlisted service should qualify as a value-added service. This post-accession increase in barriers on value-added service providers runs contrary to China’s market-opening commitments.

China’s reduction in the scope of value-added services and increase in the scope of basic services is especially problematic given the unreasonably burdensome registered capital requirement for foreign-invested basic service joint ventures. The Foreign-Invested Telecommunications Enterprises regulation specifies that basic service joint ventures must meet a 2 billion RMB (US$240 million) registered capital requirement to be eligible for application. This requirement "could not reasonably have been expected" when China’s commitments were made, as required by Article VI 5 (a)(ii), because it was effected by an administrative regulation dated December 11, 2001, after WTO members approved China’s accession on November 10, 2001. The unjustified and unrealistic amount of this capital requirement bears no reasonable relationship to commercial or public interest requirements and represents a barrier to entry that China must eliminate.

China should do more to improve the degree of transparency in it its regulatory processes, including providing required advance notice and comment periods. For example, the 2003 Telecommunications Service Classification Catalog was released in Chinese on the MII website without any prior notice or opportunity for public consultation. The effective date was two weeks following release, limiting any meaningful opportunity for public comment.

Additional measures are necessary to increase the independence of the regulator–MII–from the major state-owned operators in the telecommunications industry. Currently, by designation, MII occupies dual roles as a protector of state enterprise operators and as the industry regulator. The first role should be removed without delay.

Recommendations:

• China should not reduce the scope of its commitments in the category of value-added services by reclassifying them as "basic" services, a category that is far more restrictive for foreign investors. The capitalization requirements that China has established for providers of basic telecommunications services are unrealistic, bear no reasonable relationship to commercial or public interest requirements, and constitute a barrier to entry. This high capitalization requirement should be eliminated.
• China should promote greater transparency in legal and regulatory proceedings, including the consistent use of required advance notice and comment periods.

• China should take steps to increase the independence of the regulator–MII–from the major state-owned telecommunications operators.

• China should cease to restrict the ownership and operation of international gateways to wholly owned telecom service providers.

A key year-two priority is ensuring that China will allow foreign firms to take full advantage of the trading rights (i.e., the right to import and the right to export) and distribution services commitments set forth in its WTO accession agreement. This area is one of the most critical to a wide range of industries and will be a key measure of how China’s implementation is evaluated. China's trading rights and distribution services commitments are now the subject of serious discussion between Chinese officials and U.S. negotiators regarding China’s interpretations of their commitments in this area.

Full compliance in the area of trading rights and distribution services is particularly important in China, as many of the companies that invested there in the years prior to its WTO accession were forced to agree to restrictions to normal business practices in order to enter the market. In granting full trading rights, China should remove all artificial restrictions on company operations, such as those placed on companies whose investment licenses specified that they could not sell imported products or products purchased from third parties.

China committed to allow foreign-invested enterprises to receive full trading rights for virtually all products over a three-year period. Minority-share joint ventures should have received these rights–without having to satisfy export performance, prior experience, and other similar commitments–by December 11, 2002. In fact, regulations were vague about how this would happen and, in some cases, they made new requirements contrary to the stated commitment to provide full rights.

With respect to distribution services (wholesaling, commission agents, retailing, and franchising), a similar three-year phasein is to take place. Foreign minority joint ventures providing direct retailing services (and subordinate and related services) were to have been permitted upon China’s WTO accession, subject to certain geographic and numerical limitations. Minority-share foreign joint ventures in wholesale business and commission agents’ business operations were to have been permitted by December 11, 2002.

Currently, foreign-invested manufacturing enterprises may only engage in wholesale and commission agents’ services and may provide after-sales services for those products that they manufacture in China and, in some cases, for imported parent company products. Other enterprises with minority foreign ownership that obtain specific distribution licenses can provide these services, as well as direct retailing services, for others’ products, subject to stringent requirements not authorized by China’s accession agreement. And there is ongoing concern in the auto industry because China is reportedly considering requiring automakers to establish separate distribution systems for domestic and imported vehicles, which would be a clear violation of the national treatment principle.

China has also issued vague, problematic measures covering subordinate and related services. A July 2002 Notice regarding foreign-invested logistics companies technically met China’s obligation to permit foreign minority joint ventures by December 11, 2002, but the text did not define precisely how enterprises could expand their business scope to include distribution. In addition, a November 2002 Notice opened up goods transport, loading and unloading, and warehousing to foreign majority ownership but capped foreign investment levels at 75%, contrary to China’s commitment not to impose such caps on foreign participation.

Members of the China WTO Implementation Working Group are monitoring closely how distribution services commitments, one of the key benefits of China’s WTO accession, are implemented.

Recommendations:

• China should put forward transparent and WTO-consistent regulations that spell out precisely how U.S. enterprises can begin to realize the benefits of China’s commitments in the area of trading rights and distribution services.

• These regulations should eliminate the artificial restrictions imposed on companies that made investments in China before its accession to the WTO and should make clear that all companies may conduct operations in China as they would anywhere in the world.

• China should make draft rules relating to trading rights and distribution services available for prior public comment.

Conclusion

The U.S. Chamber’s China WTO Implementation Working Group believes that the Chinese government remains committed to implementing its WTO obligations as a crucial underpinning of its own economic development and modernization goals and has seen many examples of a willingness to work with the American business community as it seeks to fulfill its WTO obligations.

We knew at the outset that this would be a complex undertaking. China would be amending or writing literally thousands of new laws and regulations as part of a fundamental transformation of its system, and this would not be a process without challenges. But in advocating for China’s WTO membership, our expectation has always been that this process would lead to a more open and transparent Chinese market based on the rule of law. In addition, we expect that China’s compliance with its commitments will create tangible examples of new business opportunities for exporters and investors. Unfortunately, evidence of new commercial opportunities is not yet as strong as it should be.

At the end of the day, China will ultimately be judged on the extent to which it opens its markets, puts in place a more transparent system based on the rule of law, and creates a business environment in which foreign companies and Chinese companies alike can thrive. When China achieves this goal, we will see the kind of commercial results that American business and political leaders anticipated when they gave their strong support for China’s membership in the WTO.

The U.S. Chamber will continue to represent the interests of its member companies doing business in China or seeking to do business there. By providing forums and other opportunities for dialogue and the fostering of new business relationships, we hope to contribute to the strengthening of U.S.-China relations. The U.S. Chamber urges the two governments and business communities to find ways to resolve WTO-related challenges through ongoing dialogue and consultations and stands ready and willing to assist in these efforts.

Appendix 1 - Investing in China or India

Appendix 2 - WHAT GOES INTO A COMPANY'S FOREIGN
MARKET INVESTMENT DECISIONS?