Category Archives: Technolgy

China Systematically Cracks Down On The Internet

IT IS EASY to assume that the Cyberspace Administration of China (CAC)’s investigations into three of the country’s leading social media platforms are just a tightening of censorship typically to be expected ahead of the forthcoming Party congress.

Tencent Holdings’ messaging app WeChat, Sina’s Twitter-like service Weibo, and Baidu’s communication forum Tieba face complaints that they have allowed their users to spread terror-related material, rumours and obscenities, breaches of the law that “endangered national security, public security and social order”.

But there is a more systematic effort to control information in play.

The new cybersecurity law that took effect on June 1 and of which the social media platforms have fallen foul as it makes online platforms responsible for the content they carry, is the third piece of recent legislation codifying China’s doctrine of cyber-sovereignty.  The National Security Law and the Anti-Terrorism Law, both passed in 2015, are the other two.

Collectively they form the basis of Beijing’s intended state control of the internet, which, in turn, is part of the greater crackdown on incipient dissent.

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Another Tightening Of The Cyberscrew

CHINA’S NEW CYBERSECURITY law, which takes effect from June 1, purportedly makes the country more secure from cyberattack and gives citizens greater protection from misuse of their personal information.

But, like so much Chinese legislation, the new law is so broadly and vaguely defined that it potentially affects virtually any person or business that conducts business using a computer network.

The new law also stipulates that data collected in China must be stored in China and only China. The corollary is that data cannot be transferred abroad unless specifically authorised by authorities. Does accessing it from abroad fall foul of this?

If data proposed to be moved out of China contains the personal information of more than half a million users or is “likely to affect national security or social public interests”, then a security review is mandatory.

Although the law applies to domestic and foreign firms alike, it is this ‘sovereignty of information’ that is so troubling to foreign firms: multinationals, especially those now using global cloud services, will struggle to operate efficiently without breaching the law, while the requirement to cooperate with state security services and other government authorities to investigate crimes and cybersecurity issues raises potentially difficult questions about trade secrets and intellectual property rights. Beijing will have the right to request proprietary source code as part of security reviews.

Separate draft legislation announced in April also proposes that the government can demand what is called decryption support, in effect forcing companies to decode encrypted data, “in the interests of national security”.

Authorities have denied that the new law is protectionist, although Alibaba’s cloud services seem a likely commercial winner. Foreign businesses’ lobbying to delay implementation of the new cybersecurity law has been brushed aside. Getting involved to the extent they can in the writing of the implementation of the law is the best they can now hope for.

What is likely, however, is that the new law — like most laws, written to be vague and sweeeping to give authorities the greatest freedom of action in their implementation — will be selectively applied to foreign firms, if nothing else, to be a warning to others.

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China’s R&D Gets Ever Bigger Bucks

TARIFF CUTS ON imports of some 200 IT products ranging from touch screens to semiconductors took effect on Thursday. The goal is to eliminate them within seven years.

China is one of 50 countries that signed up to a World Trade Organisation Information Technology Agreement last year to promote trade liberalisation of technology goods. China imports an estimated $325 billion worth a year of the components covered by the agreement. Reducing the duty on them will cost an estimated $2.25 billion a year, rising to a potential $8 billion a year with complete elimination.

However, the benefits of cheaper imports for the IT sector are seeing as outweighing these costs. Beijing is undertaking a drive to promote the development of technology-based industries. To this end, it is also raising research and development spending to 2.5% of GDP by 2020 from 2015’s 2.1%, a change that eventually will fatten China’s R&D pot by $50 billion a year.

Intensification of investment into R&D facilities outside China parallels this. So far this year, Chinese companies have announced nine new overseas R&D centres for a total capital expenditure estimated at $224m, according to fDi Markets, a Financial Times division, with pharma and biotech investments particularly prominent. Only Germany and the United States have spent more.

That will support the transformation of the manufacturing economy from low-end exports to self-sustaining indigenous technological innovation, an essential prop for the rebalancing of the economy overall towards being consumption-led.

Winning domestic market share is the aim for now of Chinese firms’ R&D efforts.  The success some are having is creating an indigenous innovation culture built around rapid, incremental product development that can take advantage of the economies of scale of the domestic market.

However, Chinese firms are closer than ever to competing with developed-economy companies in R&D. Products they are now selling in Africa and Asia, as well as at home, are starting to show the results of that, a harbinger of what will eventually come to developed markets, too.

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Will Unravelling China’s VIEs Pull The Rug Out From Under Alibaba?

IS THE LAW of unintended consequences — or intended ones — in play with the new draft revisions to China’s foreign investment law? And if the later, whose intentions need to be examined?

What may be at stake is control of three of the fastest growing sectors of the Chinese economy — the internet, e-commerce, and cloud computing. Privately owned companies, not state-owned enterprises dominate all three. More to the point, these are about the only sectors of the economy to create large privately owned Chinese companies and from which state-owned behemoths are absent.

As Steve Dickinson of the China Law Blog points out, Baidu, Sina, and Alibaba are at risk of getting their wings clipped. To be fair, that is not the wording he uses. However, this Bystander sees it as a consequence of the significant implication he does note will result from the draft foreign investment law newly published by the commerce ministry: it will end a corporate governance structure known as the Variable Interest Entity (VIE).

All three companies and hundreds of others, particularly technology and telecoms firms, use VIEs to get round the investment regulatory rigidities of sectors of the economy the government deems strategically important and so proscribes or limits foreign investors.

The new draft revisions specifically set out to end VIEs. The revisions’ other main goals are:

  • to lessen the red tape for foreign direct investors wanting to own businesses in China;
  • to switch to a system of monitoring foreign investors via annual reports from pre-approvals for new foreign investments, save for in sectors of national significance; and
  • to put Chinese companies with foreign investors under the same legal regime as domestic companies.

China’s foreign investment law is outdated, so modernisation is to be welcomed — even if the draft law runs to a weighty 179 articles across eleven chapters.

VIEs are a loophole that has let foreigners operate businesses in the country through Chinese front companies. They are a corporate sleight of hand by which an investor controls a company through contractual legal agreements rather than through share ownership.

In short, VIEs say to authorities in country A ownership resides in country A while at the same time telling investors in country B that ownership resides in country B. This Bystander doesn’t need to be a lawyer to see that doesn’t pass many smell tests for good corporate governance.

There have been a number of VIE-related scandals, including involving Alibaba, Sina.com, and New Oriental Education, as VIEs open too many creases along which any or all of regulatory, ownership and operational risk can spread.

Nevertheless, VIEs have become widely used. At first, they were a way for inward foreign investors to enter parts of the Chinese market otherwise closed to them. Increasingly they have been used by privately-owned Chinese companies that list overseas, especially those from industries in which having any foreign shareholders is forbidden or restricted, such as tech and telecoms.

They circumnavigate regulatory rigidities: the constraints on Chinese firms raising capital domestically and the need for private firms to get permission to invest overseas, and restrictions on foreign investors and firms having ownership of Chinese enterprises in certain sectors of the Chinese economy. But given those restrictions on foreign investment exist, VIEs aid and abet in breaking the spirit of the law, if not its letter.

The straightforward solution would be to remove the regulatory rigidities. However, Beijing is not going to abandon keeping sectors of the economy ‘off-limits’ to foreign investors. Its new draft foreign investment regulations use where ‘effective control’ of a company resides to determine ownership.

At a stroke of the legal drafting pen, VIEs becomes irrelevant. Any business that authorities determine to be effectively foreign controlled will be breaking the law if it operates in a restricted or prohibited industry.

All of which would leave the likes of Baidu, Sina and Alibaba and all the other internet businesses that operate as VIEs in China, in a pickle. So, too, foreign investors who bought into the initial public offerings with such gusto and who could end up holding the paper of a company that is illegal.

Now, we don’t doubt that between drafting and final promulgation of a new foreign investment law, accommodations will be made to resolve any such discomforts. While the regulators appear to have rejected lobbing from the companies to, in effect, grandfather them into legality, the draft regulations would let a VIE that is controlled by Chinese to be considered a Chinese company. That determination would be made by authorities on a case by case basis. It would be incumbent on the VIE to show it should be exempted from being put out of business like every other VIE.

Beijing has to walk a fine line if it is not to discourage the development of those industries in which Baidu, Sina and Alibaba operate. All of them could play critical roles in encouraging domestic consumption and thus help meet the government’s goal of rebalancing the economy away from infrastructure investment- and export-led growth. On the other hand, it can’t be too blatant in showing that there is one rule for the powerful and well connected and another for all the rest.

Such companies could also switch their governance to a two-share-class model, and keep the relationship between investors and owners as effectively separated as they are with a VIE. (We don’t approve of companies having A and B shares as a matter of good governance, but that is a topic for another day.)

However, the cost of that will be greater government regulation over them and possibly the promotion of state-owned enterprises to rival them, though perversely it may also give the big, established players some protection from new entrants who won’t be allowed to go the VIE route or anything that looks like it (though opening the capital account would mitigate the need to).

There are several parts of the political establishment, from the security and propaganda arms to the state-owned enterprises themselves, who would welcome reining in the big private Internet groups. Abolishing VIE’s might be intended primarily to kill a lot of flies, but, intentionally or not, there are some endangered tigers, too.

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