Chinese banks will soon emerge as powerful competitors in the world financial services market, a senior advisor to the Chinese government on financial services reform told a European Chamber seminar recently.

"There will be huge new competitors with eventually global ambitions which have been constrained by lack of capital rations," said Howard Davies, director of the London School of Economics (LSE) and former Chairman of UK's Financial Services Authority at the July 3 seminar, titled "China's Financial System: The View from London".

China's main banks have become adequately financed through IPOs and improved their management through knowledge transfer from strategic foreign stakeholders. "The worry is we have focused on reform but now what? They are ambitious and won't sit on their hands," Davies said.

As China's banks emerge - only Japan's Mizuho is bigger in Asia than China's largest banks - there is concern that they will seek market share by cutting prices. "Chinese banks are not as margin-sensitive as other banks with more demanding shareholders," said Davies. "In Europe, if you are not getting 17 to 18 percent return on equity, you will be attacked … but that won't happen in China."

Davies pointed to the lesson of Japanese banks which in the 1980s and 1990s entered the UK and took 18 percent market share by undercutting competitors: "They found themselves exposed by a collapse in Japan and had to retreat." China's largest banks will prosper if the Chinese economy continues to grow at 10 percent a year, and the banks "expand rationally," said Davies.

China's financial services system is growing at 14 percent per annum - whereas China accounted for 4.5 percent of the world financial system in 2004, its share now stands at 6 percent, similar to that of the UK, explained Davies. China's figure is three times that of India.

Yet China's financial services sector remains too heavily concentrated in banking, which accounts for 60 percent of the country's financial sector, compared to 20 percent in the USA. "Private equities by comparison account for only two percent of China's financial system," said Davies.

Government control and the centralised setting of interest rates makes it harder to cultivate a badly needed sense of competition among Chinese banks. China's banks must also undergo a cultural shift to encourage "creative tensions" within banks and between banks and regulators, and "institutional loyalties" within banks.

While post-WTO liberalisation has technically put foreign banks on an equal footing with domestic counterparts, they will grow slowly in China, predicted Davies. "There are still restrictions for foreign banks - you still have to go branch by branch." Foreign access will benefit China's banking sector, Davies said, "but competition has to be real for it to have effect." Domestic banks, meanwhile, are becoming more sophisticated in their product offerings.

Chinese lenders still face plenty of hurdles to reform. The natural steps for Agricultural Bank of China take - cutting staff and branches and focusing on high-end business - would have a drastic impact on credit in rural areas, Davis said. "China has to look at rural financial cooperatives, and is studying the Japanese model in this regard."

An underexploited market for private pensions could be key to increasing foreign financial service companies' market share while also driving domestic consumption, but currently lags and is "one of the main reasons why China is not consuming more," according to Davies.

Reform of China's capital markets has progressed well through sales of government holdings and an investor compensation scheme. "The problem now is the stock market is too highly valued," said Davies. More investment products are needed.

China remains reform-minded, says Davies. Now, in line with Western systems, it is considering establishing an umbrella organisation to improve coordination and speed up approval processes between the various bodies.

To ease frictions with its trade partners, China needs to be integrated into the world financial management systems. Though the country accounts for 10 percent of the world's banking system, it is not a member of the policy-setting Basel Committee on Banking Supervision, though smaller European nations, most recently Spain, have been included. "Europe needs to make room for China," said Davies.

Customs in China

Navigating customs is one important aspect of having an efficient supply chain, both in to and out of China. With the boom in trade putting more and more pressure on the entire customs structure, it is important that the system develops and improves. To that effect, the Trade and Distribution Working Group of the European Chamber in Shanghai held a seminar on June 28 to discuss the progress customs authorities have made and issues that still remain. The event was moderated by the Working Group's chairman, Titus von dem Bongart, who introduced two expert speakers.

Speaking first, Wu Huading, director of Shanghai Customs' Legal Affairs Division, provided an outline of the legal system of China Customs, from current regulations to detailed legislation procedures. He also commented on the clean-up of regulations that has been underway for several years, aimed at reforming and improving the transparency of the customs process.

Reacting to Director Wu's words, Bob Fletcher of the Customs and International Trade Group at Deloitte Touche Tohmatsu spoke about the practical issues that companies currently face, even in light of the new developments. While there have been significant improvements in customs over the last few years, issues clearly remain in areas such as valuations and providing written replies to enquiries.

He said that although there may be national legislation, there is a lack of consistency in the way it is implemented throughout the country. The key approach, he stressed, is communication with authorities to bridge the gap between industry and officials. This way, law makers can better understand the needs of industry. While accepting that many problems still exist in China, Fletcher was fast to point out the improvements and frank in admitting that the EU itself was not immune to arbitrary customs decisions.

The Chamber was particularly happy to welcome Director Wu, as his participation showed a clear effort of local authorities to be accessible to industry and to listen to their opinions.

Setting the standards

Even with the WTO accession process now complete, disputes on standards for products remain a contentious issue between China and its trading partners. "In a world without barriers to trade, standards have become a tool to market access," said Klaus Ziegler, European Standardisation Expert attached to the European Union Delegation in Beijing. He was speaking at a recent EU Chamber seminar titled "Standardisation: Threat or Opportunity for European SMEs?"

China has been vigorous in supporting local standardisation efforts, most noticeably in its bid to come up with a local DVD standard and hence avoid paying royalties to foreign companies on the DVD machines manufactured in China. Apart from exerting an ever-greater influence through global standards bodies such as the International Organisation for Standardisation (ISO) and the International Electrotechnical Commission (IEC), China "will also affect the standards process indirectly through IPR [intellectual property rights] and competition policy," said Ziegler.

Experiments with mandatory patent pools, forcing companies to contribute their patents to Chinese standards bodies (while agreeing to ex ante price caps on royalties), have drawn protest from European electronics firms like Philips. "The ex ante price cap for patent pools seem to run contrary to EU law and practice," said Ziegler.

Foreign companies importing products or producing locally must adhere to China's system. Foreign SMEs who did get involved in the local standards process, however, have had difficulties protecting their intellectual property rights (IPR), said Hong Ming, giving a presentation on behalf of Enrico Perlo, general manager at Beijing Guala Closures. Guala, an Italian-owned firm which produces bottle closures to prevent counterfeiting in the drinks industry, has registered 18 patents in China since entering the market to supply leading spirits maker Maotai in 1995.

Since then over 100 Chinese competitors entered the market with products "inspired" by Guala's products, he explained. In 2006 Beijing Guala Closures was approached by the China Packaging Association (CPA), asking if it would lead a group of companies in formulating a National Standard for bottle closures, said Hong. "We were positive and had several preliminary meetings with the CPA, nothing more.

"Then, in early 2006, we were told that the CPA was formulating three standards, one for plastic, one for aluminium and a standard for ‘plastic plus aluminium' closures. We opposed the concept of a plastic-plus-aluminium closure on the grounds that there was no international equivalent."

The CPA set up the Safety Closures Group, appointing another Chinese-owned company to lead it. "They said it would be better to have a Chinese company leading the group," Hong said, "but we said, ‘We are a Chinese company, too, and pay taxes.'"

Familiar designs

When Beijing Guala Closures got a draft of the proposed standards a few months later, three of the six specified types of closures included detailed and photographed aspects which Guala had patented. After protesting at the CPA office the company was told it could attend a CPA meeting attended by other cap producers, "at very short notice." The company succeeded having photos of its patented technology removed, but feels that standards are created to protect local producers are unable to match international standards. "Be involved in the organisations related to your product," Hong suggested. "And be careful."

Even with the inherent IPR dangers, investment in standards remains essential to the marketing strategy of any foreign company selling goods in China. "If you are involved in a specific market in China that has a standard, you better be involved," said Ziegler. "It can determine the survival of your business." EU firms should get involved in the Chinese standards process, advised Ziegler. "Identify the industrial association or organisation developing standards, as well as testing labs. Understand the key players in voluntary and compulsory testing schemes. Participate in the process by offering technical expertise."

Foreign SMEs, said Ziegler, are welcome to contribute to the Chinese standards process, "particularly if you have specialist knowledge which you are willing to share. … If you are not in sensitive sectors such as auto-making or IT you won't have problem getting access and influencing the process." The EU, he added, is encouraging European businesses to exchange ideas and concepts with China, and is seeking to establish a joint experts panel as well as a voluntary certification and monitoring scheme with China.

A Chinese system of compulsory testing compares with an EU approach of self declaration by producers, who must comply with an EU-wide CE quality standard mark. Whereas the China Compulsory Certification system obliges companies to use Chinese standards and appointed testing centres, the EU testing market is deregulated. Designated testers certify hazardous products such as medical devices.

Heilongjiang-EU Partnership Day

On June 14, European Chamber Secretary General Ian Kay and a delegation from European businesses, embassies and the European Chamber attended the Heilongjiang-EU Partnership Day in Harbin, part of the 18th Harbin Fair. The event marked the expanding commercial ties between Heilongjiang and the European Union.

Before the inauguration of the event, visitors were received by the Deputy Governor of Heilongjiang, Wang Limin. Deputy Governor Wang gave a warm welcome to the delegation and provided a brief introduction on the recent development of Heilongjiang and Harbin's economy, external cooperation, foreign investment and environment.

During the ceremony, speeches were given by Wang, Kay, Ilpo Sarikka, Vice-President of Finpro at the Finnish Embassy and the President of the German International Entrepreneurs Association (GIEA), as well as other European officials, business representatives and local government officials including Tan Wen, Deputy Director General of Heilongjiang Province Development and Reform Commission and Ge Lulin, Deputy Director General of SOA Supervision and Administration Commission of Heilongjiang.

After the opening ceremony, the visitors participated in a number of activities organised by Heilongjiang's department of commerce, including match-making, a visit to Harbin-Daqing-Qiqihar Industrial Corridor and the fair's opening banquet, where delegates were able to talk informally with Chinese government officials including State Councillor Tang Jiaxuan, Deputy Minister of Commerce Ma Xiuhong and Heilongjiang Party Secretary Qian Yunlu. It was impressive for delegation members to see the significant development of Heilongjiang province and have such an interesting, informative and fruitful trip.

In his speech at the opening ceremony, Kay said, "The EU is the largest trading partner of China and I hope this fair and the Heilongjiang-EU cooperation business day will help to develop trade for both parties." The Chamber will continue to support communication between its members and the central and local government, with the goal of improving the business environment in China.

The new VAT rebate rate

On June 19, the far-reaching new regulation on the value-added tax (VAT) rebate rate was issued by the Ministry of Finance and the State Administration of Taxation, sending ripples through the manufacturing industry in China, so much so that Chamber President Joerg Wuttke appeared on CCTV 9's "Dialogue" programme on July 9 to discuss the issue. Reacting immediately to the release of the new rules, the Finance and Taxation Working Group of the European Chamber in Shanghai organised a seminar on June 26, moderated by Working Group Vice-Chair Simon Tan, to address members' concerns.

The new rules will affect over 2,300 tariff headings, chiefly those involving high-polluting and high-energy materials, as well as products that consume scarce natural resources. It is anticipated that it will have a widespread impact on European industry in China.

VAT in China is not simply a consumer tax; it is a significant part of macroeconomic policy. By having this rebate system through the production process, authorities are able to use VAT to leverage more than tax revenue. Many commentators believe that the Chinese government - in this case five bodies: the Ministry of Finance, customs, the State Administration of Taxation, the National Development and Reform Commission and the State Environment Protection Administration - is using the new rules to address the swelling trade surplus and control the types of products made in China, in hopes of forcing manufacturers to move further up the value chain.

Desmond Yeung of Deloitte Touche Tohmatsu introduced the background of the changes in terms of trade surplus and also in discouraging the development of energy-intensive, polluting and resource-consuming industries. The new rule was promulgated on June 19 and became effective on July 1. Yeung said that the time between the regulation's promulgation and implementation was intentionally quite short, and showed the most affected industries as well as a simple equation for calculating the irrecoverable VAT.

Bob Fletcher, also from Deloitte Touche Tohmatsu, introduced two practical methods of reducing the rules' impact: "passive" and "dynamic" planning. Although China has adopted the harmonised coding system, there is still room for interpretation. Different rates apply to different codes and therefore it is important to make sure the correct codes are selected for documentation. This is what Fletcher called passive planning. Dynamic planning refers to the adding or removing of a process done in China that may alter the product's classification and rating in China, resulting in a different export VAT refund rate.

The next important issue is to look at the business model that a company is using, be it buy/sell, contractual manufacturing or toll manufacturing. Each of these incurs a different rate, particularly if materials are imported under bond. It may also be possible to have local companies use bonded logistics parks to receive benefits associated with "indirect imports".

These changes were anticipated, following on from similar amendments in September and April, and more may follow. Still, their scale and scope means that companies will have to seriously consider the profitability of their China operations; few will have the luxury to absorb such a dramatic change without serious consequences.

However, taking the time to look at the business model of your company and the tariff classifications is, for now, the best place to start when trying to limit the impact.

Growth via proper M&A T he impact of WTO admission, the rapid consolidation of globally competitive domestic industry, clarification of legislation and high annual economic growth rates have made China a genuine world player in global mergers and acquisitions markets. In the first quarter of 2007, global M&A activity amounted to US$1.13 trillion (€828 billion), 14 percent higher than the same period in 2006. How is it possible to take advantage of the many opportunities and achieve fast growth and expansion via proper M&A in China? Danish Chamber invited three experienced experts on M&A in China to share their insights and best practices, which will hopefully provide a better perspective of the M&A market in China. This will include the following: Mr Tue Tyge Moller, Vice-President of Danisco (www.danisco.com) and specialist in strategic ventures in China. He has been working with Danisco in his current position in China for almost two and a half years with a special focus on joint ventures, cooperations, alliances and acquisitions. Prior to coming to China he worked in Denmark for Amcor Flexibles, an Australia-based global packaging company. He has extensive experience with Danisco in many different management positions. He has been involved in many acquisitions primarily as the acquirer, but has also experienced working with a company being acquired. His background is law in which he holds masters degrees from NYU and Denmark. Mr Moller advised on how to prepare for a proper acquisition and integration of a Chinese company. He mentioned good preparation is the key to success, and elaborated on integration from different perspectives: management, HR, sales, and health and safety.

Mrs Camilla Ojansivu, Lawyer at Roedl & Partner Consulting, has been working in China as a lawyer since 2001. Her focus is on foreign investment-related legal issues, M&A and related pre-operational work such as due diligence and pre-transaction negotiations. She gave an update on the latest legal issues in M&A, legal frameworks applicable to transactions involving SOEs and FIEs, legal procedures to follow and legal problems that are most likely to crop up in the M&A process.

Dr Stephane Grand, CEO of SJ Grand International Business Solutions, has 11 years of experience of the Chinese market. A graduate of the HEC MBA programme, La Sorbonne and the Fletcher School, he has first-hand experience of the development of the legal system of the PRC as an associate at the Beijing office of Gide Loyrette Nouel, in the early 1990s and with the World Bank's legal reform and private sector development department. Dr Grand was then a consultant in New York and Beijing for US and British management consulting firms, advising clients on acquisitions and strategic market positioning moves. He later went on to head the Chinese practice of RSM. He created both the tax and management consulting practices of RSM in China. His firm, SJ Grand IBS, was founded in 2003 and has been advising large and small clients on their development and profitability strategies in the PRC. The firm has advised clients on over 20 acquisition and sales deals. Dr Grand discussed how to financially optimise an acquisition, covering due diligence and valuation of target companies; how to finance a purchase; and post-acquisition restructuring.