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China is opening its telecommunications sector to limited foreign investment. Nevertheless, there are fundamental legal issues to be decided before investment can effectively take place. Among the questions to be resolved are: the rules for minimum registered capital; the starting dates for Foreign Investments by type and location of business; clarification of geographic restrictions; treatment of Chinese owned foreign entities; conversion of existing Chinese entities into joint ventures with foreign participation; and the treatment of businesses administered as "Value-Added Businesses."

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The long-awaited Provisions on the Administration of Foreign-Invested Telecommunications Enterprises (the "FITE Provisions") were promulgated by the State Council of the People's Republic of China (the "PRC" or "China") on December 11, 2001 and came into effect on January 1, 2002. The FITE Provisions contain much good news and some bad news for potential foreign investors in telecommunications businesses in China. In addition, they are disappointing in that they fail to address a number of significant issues that are fundamental to structuring foreign investments in telecommunications companies. Issues Addressed - The Good News and the Bad News Form of Investment The FITE Provisions provide that foreign investment in the telecoms sector in the PRC is permitted only in the form of Chinese-foreign equity joint ventures. This restriction, which also appeared in the draft FITE Provisions, which were widely circulated a year and a half ago, was expected. Permitting Chinese-foreign cooperative joint ventures in the telecoms sector would have meant allowing foreign investors to obtain a share of the profits of such joint ventures that exceeded the caps on foreign investment. Given the intensity with which the PRC negotiated on the issue in its bilateral WTO negotiations with the United States and the European Union, it is no surprise that the FITE Provisions limit the form of foreign investment to Chinese-foreign equity joint ventures in which the percentage of profits obtained by foreign investors will correspond exactly to their percentage ownership. However, by limiting the form of foreign investment in the telecoms sector to equity joint ventures, the PRC government has also effectively limited the pool of Chinese investors in such enterprises. The Chinese investors in equity joint ventures must contribute cash, tangible assets (the value of which must be duly assessed) and/or limited types of intangible assets (not including good will or licenses held by the Chinese party) that have a total assessed value equal to the amount of such investor's equity in the registered capital of the joint venture. Chinese investors in a cooperative joint venture, however, need not contribute anything of assessable value to the joint venture and can still hold any percentage of the joint venture to which the parties to the joint venture contractually agree. Thus, limiting foreign invested telecoms enterprises to equity joint ventures limits the Chinese investors in those enterprises to those that have cash and/or tangible assets to contribute to the joint venture. Minimum Registered Capital The FITE Provisions provide that for a basic telecoms business with a nationwide or interprovincial scope of operations, the minimum registered capital permitted is RMB 2 billion. This is reasonable for a nationwide fixed line company, but is considerably in excess of the commercial operating requirements of other businesses categorized as interprovincial basic telecoms businesses, such as resale and VSAT businesses. If this requirement is applied to all foreign-invested interprovincial basic telecoms businesses, it may be that foreign investments in certain basic businesses will not be commercially feasible. We do not think that this was the intent of this requirement and hope that the Ministry of Information Industry will issue regulations stating this requirement is not applicable to certain basic businesses. The following chart sets forth the minimum registered capital requirements for all types of telecoms businesses pursuant to the FITE Provisions: 1.Note that the total percentage of the registered capital of a company that can be contributed in the form of intangible assets is limited. 2.Note that the pool of potential Chinese investors is narrowed further by the PRC Company Law restriction on a company investing more than 50% of its net assets other companies. Effectively the Chinese investor must be at least twice as large as the amount of its investment in the telecoms joint venture (plus any other investments in other companies that it has already made). Qualifications of Investors - The Primary Investor Concept The good news for funds considering investments in telecoms businesses in China is that the FITE Provisions only require that investor qualifications be met by the primary foreign investor. The primary foreign investor is defined as the largest among the foreign investors. The Primary investor must hold more than 30% of the total foreign investment. Thus, a fund that does not meet the primary foreign investor requirements would be permitted to invest in a PRC telecoms company jointly with a foreign operator that does meet the requirements. This is a significant improvement over the draft FITE Provisions, which applied the qualifications to all investors. The specific qualifications for the primary foreign investor in a basic telecoms business are also considerably more flexible than those originally set forth in the draft FITE Provisions. The primary foreign investor in a basic telecoms business must satisfy the following requirements: 1. be a legal entity; 2. have been granted a basic service operating permit in its country/territory of incorporation; 3. have funds and professional personnel appropriate to the business activities to be engaged in; 4. meet the industry specific requirements set forth by the MII. These qualifications mean that the primary foreign investor must be an telecoms operator. However, the elimination of provisions set forth in the draft FITE (the extremely high financial requirements, and the requirement that the investor have an established representative office in China at least three years prior to the application to invest in a telecoms joint venture) will result in a significant widening of the pool of potential investors in foreign-invested basic telecoms businesses. With respect to the principal foreign investor in value-added telecoms businesses, the FITE Provisions only require that the investor have a good record and experience operating a value-added telecoms business. No Restrictions on Appointment of Management The good news for foreign investors in general is that the FITE Provisions do not dictate that certain management positions must be filled by individuals nominated by the Chinese party. The draft FITE Provisions provided that the Chinese party to a foreign-invested telecoms joint venture must have the right to nominate the chairman of the board and the general manager of the joint venture. MII officials now indicate that decisions about management are an issue for contractual agreement between the parties and that MII does not intend to impose any restriction on appointment of management. Approval Procedures The good news for foreign investors is that, unlike domestic telecoms companies which must first be established and then obtain an operating permit, a foreign investor will not have to contribute any of the registered capital of a telecoms joint venture prior to having MII's assurance that the joint venture will receive a license. The bad news is that the application approval process is such that it could easily take a year to establish a basic telecoms business and half a year to establish an interprovincial value-added telecoms business. Issues Not Addressed - The Unclear Schedule for Foreign Investment The most startling omission in the FITE Provisions is the specific schedule for foreign investment in telecoms companies. The FITE Provisions merely state that the schedule will be determined by MII in accordance with the relevant provisions. It is assumed that the schedule will reflect China's WTO commitments, which are as follows: However, it would give investors additional comfort to see this schedule specifically incorporated into the regulations to be issued by MII. Geographic Restrictions The FITE Provisions do not specifically set forth the geographic restrictions to which foreign invested telecoms companies will be subject in the initial few years of their operation. Instead, the FITE Provisions state that the geographic scope of such companies will be determined by regulations yet to be issued by the MII. The issue of geographic restrictions is complex, especially for certain telecoms businesses. Will a company that is established in Beijing be counted as a Beijing company for the purpose of the geographic restrictions regardless of where it operates? Will opening a branch office of such Beijing company in Tianjin, for example, make the Beijing company into a Beijing and Tianjin company for the purpose of geographic restrictions (and foreign investment in it, then, not permitted in the initial years of liberalization)? There are a long series of such complex questions. MII officials answer many of these questions informally, but the FITE Provisions address none of these issues so many foreign investors are unable to finalize or even initiate investment plans. Treatment of Red Chips The FITE Provisions do not address the issue of how PRC state-owned or majority state-owned companies incorporated outside the PRC will be treated for the purpose of the cap on foreign investment. This issue must be addressed in order to align the existing treatment of Unicom, China Mobile and China Netcom, all established pursuant to State Council waivers, with the treatment of other companies. Conversion The FITE Provisions address the approval process for new telecoms joint ventures, but do not address the conversion of existing PRC telecoms companies into Chinese-foreign telecoms joint ventures. FITE Provisions fail to take into account the many existing telecoms companies in which foreigners would like to invest. This furthers the lack of clarity in this area. Treatment of Basic Businesses that are Administered as Value-Added Businesses The PRC Telecommunications Regulations state that certain telecoms businesses categorized as basic telecoms businesses will be administered as value-added businesses. These businesses include large region wireless mobile, analog trunk, VSAT, paging and resale of basic telecoms services. Unfortunately, the FITE Provisions do not make clear whether these businesses will be treated as basic telecoms businesses for the purpose of the application of the various requirements set forth in the FITE Provisions. The application of some of the requirements for basic telecoms businesses to these businesses, such as the registered capital requirement for interprovincial basic businesses, would seem to be excessive. Conclusion Although foreign investors interested in investing in telecoms companies in China should be happy finally to have the FITE Provisions and should be happy with many provisions of these regulations, much clarification is still needed.