Chinese spice

The press, both international and local, has given much coverage to the new Closer Economic Partnership Arrangement (Cepa) signed last year between China’s central government and Hong Kong. Cepa has been heralded as a great boost for Hong Kong’s economy, and was certainly designed as a confidence-boosting measure in a year which saw Hong Kong battered by Sars, the international economic fallout from the Iraq war and the wrangling over Hong Kong’s new security legislation. But beneath the media hype, what is the position three months into 2004?

Cepa’s benefits relate to trade in goods and trade in services. In relation to trade in goods, from 1 January 2004 China has applied zero import tariffs to exported goods from Hong Kong in some 374 designated product codes, subject to these products meeting certain “rules of origin” and Certificate of Hong Kong Origin requirements. The arrangement offers attractive opportunities for overseas businesses, which can use the zero-tariff status of Hong Kong origin goods to compete favourably in China’s enormous and
fast-growing market, by expanding existing investments or acquiring eligible enterprises in Hong Kong.

As for trade in services, Cepa provides for the liberalisation of market access in a way which, as of 1 January 2004, enables qualifying Hong Kong service suppliers in 18 services sectors (including banking, securities, insurance, law and accounting) to enjoy earlier and a greater degree of market access, higher foreign stakeholding percentage, relaxed business scope and lower qualification requirements than would otherwise be the case under World Trade Organisation requirements.

Hong Kong and international businesses with a Hong Kong base will only be able to pursue such lucrative opportunities under Cepa if certain basic criteria are met. Accordingly, such businesses must meet the ‘Hong Kong service supplier’ requirements by being legal entities duly incorporated under Hong Kong law, having valid business registration certificates and also by having records of substantive business operations in Hong Kong for a designated number of years, which varies according to the service sector. Indeed, the specific exclusion of overseas companies registered in Hong Kong, their offices, liaison offices and mailbox companies from the remit of Cepa bars many international businesses with a base in Hong Kong – or even local businesses incorporated overseas – from enjoying the benefits under Cepa.

Another factor limiting the opportunities for foreign businesses is that, on or after the day Cepa came into effect, where a qualifying Hong Kong service supplier has been acquired by, or merged with, an overseas service supplier, and the latter has acquired more than 50 per cent of the equity interests in the acquired or merged enterprise, the enterprise will be regarded as a qualifying Hong Kong service supplier only one year after the acquisition or merger. It is not yet clear whether this restriction can be circumvented, for example by the overseas service supplier acquiring the shares of the holding company of the qualifying Hong Kong service supplier and thus exercising indirect control. Hong Kong’s trade and industry department may well lift the corporate veil in these circumstances and identify the ultimate shareholders of the applicant when considering the application of a Hong Kong service supplier.

In addition, qualifying Hong Kong service suppliers must satisfy entry qualification and experience requirements imposed by People’s Republic of China (PRC) law in relation to each service sector. A host of new regulations has already been (or will soon be) promulgated, implementing the arrangements in relation to each service sector, and resulting thresholds set by the central government will often be difficult to meet. It is therefore clear that, although there are great potential benefits for foreign investors under Cepa, careful and thorough planning will be essential before they can be safely captured.

The part of Cepa that has evoked most interest within the legal fraternity is Annex 4, which deals with the legal service sector. The bones of liberalisation in this sector have been fleshed out by a series of measures promulgated by the mainland. These, for example, permit certain Hong Kong permanent residents to sit the examinations to qualify as mainland lawyers, and set out the provisions under which they can then practise. They also determine the extent to which mainland law firms are henceforth able to employ Hong Kong solicitors and barristers to practise Hong Kong law. But of more interest to the international firms, which have offices in Hong Kong and/or the mainland, are the measures which deal with associations between Hong Kong firms and mainland firms, and the relaxation of residence requirements for representatives of Hong Kong firms based in the mainland.

The prospects of an easier route to associations with mainland firms at first blush looked to be a major attraction of Cepa for the international firms. The inability of those firms to practise mainland law out of their offices in Beijing or Shanghai has been a critically limiting factor in the expansion of their China practices. So was Cepa going to be the lever with which they could start to prise open the lucrative mainland market?

The short answer is no – at least, not yet. There are real attractions to the relatively broad ambit of Cepa associations; for example, associations can use a unified name and logo, share office accommodation and facilities (including support staff), charge clients jointly and share fees – the latter also expressly permitted by the Hong Kong law society via a waiver of the practice rule, which would otherwise prohibit Hong Kong solicitors from sharing profit costs.

Unsurprisingly, there are also a number of detailed conditions and restrictions that apply, at least for the time being. Of note is that the Hong Kong firm can form only one association in the location of the firm’s representative office; the association cannot operate in the form of a partnership or of a separate legal entity; and each firm in the association is not permitted to advise on the other’s law of origin, ie the Hong Kong firm cannot handle mainland legal matters.

Have the international firms with offices in Hong Kong and China been quick to take advantage of these new measures? It would seem not.

So far no international firm has announced that it is forming a Cepa association. Why is this? At least one reason is that, although many of these firms have offices in Hong Kong as well as on the mainland, most opened their offices in Beijing and Shanghai as representative offices of the firms in their home jurisdictions (largely the UK or US), rather than of their Hong Kong branch. Accordingly, the Cepa provisions do not apply and will not do so, unless those firms first reregister their mainland offices as representative offices of their Hong Kong operations. It is not yet entirely clear how straightforward that change will be, so far as the mainland authorities are concerned. Another factor may well be the expressed reluctance of the top mainland firms to jeopardise their independence by falling in with any one of the big international players. The arguments against are familiar and have been well rehearsed in other jurisdictions, where the international firms have been granted association and/or practice rights. Concerns on the part of local bars and the governments’ lingering wishes to protect the development of their own legal professions have generally made change in this area painfully slow. So why should China be any different?

Despite the uncertainties and stringent entry requirements described above, Cepa presents significant opportunities to both local and international businesses. So far as international law firms are concerned, Cepa as it currently stands will provide real benefits only for those who wish to enter into associations with appropriate mainland firms and which ensure that their mainland representative offices are appropriately registered with the mainland authorities.

But two possibilities beckon for the future: first that the terms of Cepa itself will be developed, which is a real possibility over the next year or so; and second, that China, as it continues to open up to the world, will decide to extend the advantages which at present Cepa gives only to Hong Kong firms. Hype? There has been some, but there is plenty to hope for too.

Tim Parkes and Jack Young are partners in Herbert Smith’s Hong Kong office