How to find your way through China's business labyrinth

One of the mostly highly-regulated economies in the world, China presents firms of any size aspiring to do business in the country with dauntingly complex political and legislative systems.

But despite legislative vagueness and administrative discretion, China is very open to foreign investment: Like any other jurisdiction around the world, there are frameworks business people should be aware of, Clifford Borg-Marks and Brad Herrold of Beijing-based international law firm Hogan Lovells International LLP, admit.

Dr Borg-Marks, an intellectual property law specialist originally from Birkirkara, moved to China 33 years ago to study the language and later pursued his law training in the region.

"Business people need to keep in mind that some things work differently here and they need to be aware of the complex regulatory environment," he told The Times Business.

"The Chinese government is involved in approvals and issues licences - there are many layers of bureaucracy to deal with. It is not impossible to deal with. Business people just have to know how to work through the maze of approvals that are required."

Dr Borg-Marks says there are many entrepreneurial people in China who are willing to help businesses through the maze as it is to their advantage to seek partners who might help them with overseas markets.

"It is really a question of whether you want to do it or not," Dr Borg-Marks added. "The opportunities are here. At times I feel Maltese businesses expect government representatives to do all the work for them. The government representatives work with limited budgets and resources, so it is up to business people to carry out their research. There are many service providers who can direct them to potential partners."

Dr Borg-Marks warns against establishing online relations with Chinese firms as there have been cases when people contracted with non-existent companies. It is imperative to establish a presence in China, visit the trade fairs, and meet people in person.

Asked whether China entirely deserved its copycat reputation, Dr Borg-Marks said the government had promulgated a modern system for the protection of property rights.

"When China joined the World Trade Organisation in the 1990s, it had to upgrade the laws to become compliant with the Agreement on Trade-Related Aspects of Intellectual Property Rights," he pointed out.

"It has world class laws related to the protection of copyright, trademark, and patents. Despite the enforcement of all these structures and its good efforts, China is a huge country. There is an old Chinese saying: the mountains are high and the emperor is very far. Lots of entrepreneurs do not necessarily abide by these laws and regulations. There is a lot of copying that goes on but the government is taking steps to crack down on it. Much innovation and research and development take place in China now. The systems to protect that are definitely in place."

Dr Borg-Marks' colleague Brad Herrold, an American who also travelled to China to study the language over 20 years ago, gave a group of Maltese business people an overview of Chinese legislation on Monday afternoon.

He said local laws were designed to be vague, allowing government agencies ample discretion and for flexible policy changes. Almost all aspects relating to foreign direct investment require approval by authorities across the multi-tiered hierarchy.

The approval process and capitalisation requires interested investors to consult a state-issued foreign investment catalogue which lists prohibited, restricted and encouraged investment. Anything not listed, should be permitted. In terms of business scope, there is no such thing as company registration procedures that are common across industries.

Every inward and outward foreign exchange move also requires approval from the authorities. On the granting of a licence, businesses must then proceed to obtain ancillary registration.

Dr Herrold explained how to deal with Chinese counterparts: "China is not a monolith - beware of over-reliance on a single figure or partners. This is one of the most individualist places on earth. Find a third party and 'investigate'. Carry out thorough due diligence and confirm status and statements. Consider the three Cs - corruption, conflict of interest and confidentiality. Kickbacks here are a reality and you need pro-active measures to make sure you are protected. Also be careful what you disclose. The concept of confidentiality is not as well understood as in the West.

"State-owned businesses still make up 40 per cent of GDP. China's basic policy is to create a couple of hundred major entities which are internationally competitive. If you are going to come to China to do business, do your homework and establish a team of people around you - a successful "troika" of government relations, business development and legal expertise - and you should get it right."

Dr Herrold listed various ways to establish a presence in China. One is setting up a representative office, which, however is not permitted to actually do business but rather to provide a contact point - any contracts entered into by the firm seeking to venture to China must be signed by the head office.

The representative office, he pointed out, is a viable option for businesses that do not directly generate revenue in China.

Taxes are mostly based on the cost-plus method and have recently been increased to a minimum 15 per cent from 10. Recent restrictions include annual renewal requirements. Firms are prohibited from using special purpose vehicles unless they have been established for over two years. There are also restrictions on the number of expatriates involved and the office should expect government officials to visit.

Another option is the wholly foreign owned enterprise featuring essential elements including equity interests as opposed to shares; a fixed term of operation which can be short in some sectors but up to 50 years in manufacturing; and a four-tier management and supervision structure. The wholly owned foreign enterprise model is especially suited to trading and distribution companies.

Among the more complicated models are the Sino-foreign equity and co-operative joint ventures. The equity option would involve limited liability and profit distribution ratios or co-operatives where liability may not be limited and there is a more flexible capital structure. A three-tier management and supervision structure would be necessary in these particular cases.

Dr Herrold cited other models worth looking into like foreign invested companies limited by shares, admittedly a rarity in China; holding companies or branch companies of wholly owned foreign enterprises; or joint ventures. Foreign invested partnerships are a recent development in local legislation but authorities in Beijing are still unfamiliar with the concept.

Other means could include acquisitions - Dr Herrold explained the concept of mergers and acquisitions in China largely stops at acquisitions as merger rules are complex. Legally, buyers are required to pay a price that is not less than 90 per cent of the appraised value of a company - within 90 days. There are capital markets investments, nominee shareholding arrangements, and contract manufacturing or processing and assembly operations; the latter two are less common nowadays although Dr Herrold said they were popular models in China in the 1980s.

Technology licensing has not been spared complexity either. Dr Borg-Marks emphasised the country welcomed IT in particular. All technology introduced to the country is heavily regulated and subject to approval under another catalogue listing prohibited and restricted technology.

Any firm seeking to do business in China is also advised to protect its assets like copyright, software, trade secrets, patents and domain names which are now available in Chinese. The country is the largest trademark register in the world but registration could take at least two years.

Dr Herrold advised prospective investors to familiarise themselves with dispute resolutions options in case things go wrong. Negotiation and private settlement are preferred; alternatively the parties could go to arbitration in China or overseas and there is a penchant for Hong Kong as it considered a "home port". It is also imperative for business people to be aware of the judicial system's structure, which Dr Herrold pointed out, had made significant strides in the past 20 years.

Beijing, he added, has made great strides in just over two decades. Rolling up the blinds in the law firm's meeting room on the 31st floor of China Central Place's Tower 3, a panorama of tall buildings - not quite skyscrapers mostly, but tall nonetheless - appeared beneath.

The closest bore bright signage of the world's luxury brands and hotel chains.

"In the mid-1980s, there were fields here," Dr Herrold, who originally studied law in San Francisco, said. "Beijing was a one-storey city and people got around by bicycle. If someone told me 25 years ago when I first came here that Beijing would turn into this, I would never have believed them."