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China allows foreign investors expanded access to the Internet market

China allows foreign investors expanded access to the Internet market

The 2024 China policy mandate, Pilot Program for Foreign Business Access to the Telecommunications Industry, provides that foreign companies will be granted market access to provide Internet data center, ISP, and CDN services, starting in four FTZs in Beijing, Shanghai, Hainan, and Shenzhen.

The Pilot Program rules provide expansive access for foreign businesses to operate internet services that fall under Chinese telecommunication law governance. The new rules, however, provide only a framework, which will require implementing regulations to specify the exact means by which market access is provided. Rules on variable interest entities (VIEs) are currently of major interest to telecom and Internet lawyers in China.

Contents

New rules

Pilot Program Sites

Future Ordinances

Several internet industries are covered by the new rules

China’s pilot program eliminates numerous foreign investor access exceptions. China’s foreign investment laws include an Exceptions List that prohibits foreign investment in businesses deemed critical to national security. If you’re not familiar with these rules, take a look at the PRC government’s official guidance, How Foreign Investment is Regulated.

The China Telecommunications Administrative Regulations provide the framework for the industry rules, which divide telecom between infrastructure and value-added services. These divisions are defined differently from the more common network service provider and internet service provider distinction. As you might expect, infrastructure providers are traditionally state-owned, and telecommunications infrastructure is defined to include network, data transmission, and voice telephony services. For example, Huawei produces base station, femtocell, and digital twin network equipment used on China Unicom’s network. Value-added telecommunication services are those provided utilizing the infrastructure provider’s network. These are all specifically defined in the 2015 Telecommunications Operations Classification List.

Under the Foreign Investor Telecommunications Investment Rules, foreign investment in a telecommunications infrastructure services business entity is limited to 49% of the equity holdings. In a value-added service provider entity, the foreign investor equity holding is limited to 50%.

The Pilot Program mandates eliminating foreign investment restrictions on value-added services, particularly for IDCs, CDNs, ISPs, and their related data processing services, meaning that foreign companies will be able to own the full 100% of the equity in such an entity. In the larger regulatory picture, the Pilot Program marks a milestone in China’s foreign investment liberalization reform, as mandated in the Premier’s previous executive order. (see article here)

Internet Data Centers (IDCs)

International business has been vigorously lobbying Chinese policymakers for IDC market access for several years. In China, IDCs fall under item B11 of the Telecommunications Operations Classification List, which defines them as servers, databases, communication lines, and similar equipment of services housed in server rooms leased to customers with appropriate security measures. Mainly, typical IDC services are those provided using databases, servers, telecommunication lines, bandwidth, and IP addresses.

A B11 classified company may lease server rooms, servers, virtual storage, or cloud hosting. The List also includes online collaboration tools (e.g., AWS or a service running on AWS, like Adobe) under the B11 IDC definition. Online collaboration tools under a B11 license utilize typical data centers, IP addresses, and bandwidth to provide on-demand software, hardware, and data storage services. Internationally, these are often marketed as Infrastructure/Platform as a Service (IaaS/PaaS).

Both IaaS and PaaS providers in China need an IDC License, which may be surprising because PaaS is not even an Internet Data Center operation. Nonetheless, a PaaS provider must get an IDC license covering online collaboration tools. This raises the question as to whether Software as a Service (SaaS) would be regulated as a telecommunication service, and the answer requires analyzing whether it falls under the List. Generally, if the company’s services are limited to software products and it does not offer B11-type services, such as hosting, then it only requires the appropriate software license. Some SaaS services do constitute telecommunication services under B11, and a good example of this is app builders or automation platforms that have backend functionality.

Therefore, the Pilot Program allows foreign investors to hold 100% of the equity in the kind of IaaS and PaaS entities described above. Prior to this, foreign investment within the B11 classification was impossible, under a policy dating back to when China joined the WTO with an agreement that IDC access need not be provided to foreign companies.

Content Delivery Networks (CDNs)

CDNs fall under item B12 of the Telecommunications Operations Classification List, which defines CDN operations as those that distribute traffic through geographically distributed server clusters to provide storage and caching facilities closer to users and reduce loading times.

In other words, CDNs are characterized by geographically spreading out telecommunication equipment throughout China. CDNs are important for supporting fast webpage load times, low latency in gaming, and high-resolution video streaming.

Internet Service Providers (ISPs)

ISPs fall under item B14 of the Telecommunications Operations Classification List, where they are defined as operations that use telecommunication infrastructure and network service providers to provide customers with internet access. ISPs generally need servers, software, broadband, and IP addresses to function.

The definition includes corporate customers and ordinary consumers and includes both legacy dial-up and contemporary broadband services. The Pilot Program mandate for broadband access is limited to providing broadband services; therefore, network service provider (NSP) operations are excluded.

Data and Transaction Processing

Data and Transaction Processing is classified as a value-added service under Item B21 in the List. Item B21 defines data and transaction processing operations as those that use the telecommunications infrastructure for eCommerce, backend data processing, and data transfer. These services require telecommunication resources such as network lines, domains, and IP addresses.

Transaction processors in China are typically e-commerce platforms, which interact with customers through websites or mobile apps to make sales to customers. Electronic device data processing platforms are generally used to provide IoT services. A cell phone app can be used to control IoT-connected devices remotely. The regulations also classify Electronic Data Interchange as a specialized service.

Content Management Systems (CMS)

CMS platforms are a subsection of item B25 of the Telecommunications Operations Classification List, excludes news, publishing, and culture.

B25 defines these as platforms that use the telecommunications infrastructure to provide users with posting, sending, feed, and query (i.e. jQuery) features. In China, a CMS platform will be one where organizations and individuals can send text, images, and videos that are displayed in a feed; they allow uploading and streaming of content to be shared with other users.

CMS platforms need hardware such as servers, software, and IP addresses and domains. As China has a highly independent information technology ecosystem characterized by a mobile-first approach with oligopolistic app dominance (e.g. WeChat, TikTok, etc.), Chinese CMS design concepts differ significantly from international practice. However, there is a major national interest in ending the privileges enjoyed by the country’s tech titans. B25 has five subcategories, but the Pilot Program does not provide access to all five subcategories, however, and only two are available: posting & delivery and data protection & processing.

Content posting & delivery is characterized under Chinese definitions as anything providing one-way posting and delivery for individuals and organizations; the posted or sent information can include documents, images, videos, and app content, but not services like VOIP. Representative services include content distribution platforms, cloud drives, document libraries, and app stores.

Data protection and processing is characterized as the provision of data protection and processing to individuals and organizations, including online anti-virus scanning for user devices, and spam message blocking and interception. Representative business models include antivirus and cell phone management software.

Information technology services operations fall under the regulatory jurisdiction of several different administrative agencies, and authorization may be required from both the IT and foreign investment regulators. The Pilot Program excludes four types of services from CMS: news, publishing, audiovisual, and culture. The basic reason for the exclusion is that Chinese foreign investment law has strict national security requirements; you must report your foreign investment plans so that it can be reviewed for national security concerns. To make sure you know how to comply with these requirements, read the PRC government’s guidance, Investment Information Reports for National Security

Pilot Program Sites Will Be Located in Several Major Cities

The Pilot Program identified existing FTZs located within several major cities in which to begin trialing the program. They are the Beijing Service Liberalization Zone, Shanghai Lingang FTZ, Hainan Free Trade Port, and the Shenzhen FTZ. Compliance with local law will require understanding current expectations from local regulators; foreign companies compliance problems are usually due to misunderstandings driven by unprofessional translations.

Shanghai’s Lingang FTZ: The Shanghai Lingang FTZ is located to the south of the Pudong Airport in Shanghai and is a master-planned business community that is already home to several semiconductor companies. The FTZ is mandated by a 2021 central government policy seeking high-end industry development in the Pudong area. Geographically, Pudong is one of the several administrative districts of Shanghai with a population of 5.6 million; the Lingang FTZ is located in Pudong and has its own set of comprehensive superseding regulations that provide a higher degree of regulatory flexibility than typical national law, attracting leading international companies like Tesla, who’s China facility is located in Lingang.

Beijing: Beijing’s service sector FTZ was formed in 2015 by order of the State Council to trial a wide spectrum of trade liberalization policies. Beijing’s service liberalization zone is intended to coordinate with Beijing’s more traditional free trade zone and covers 16,400 square kilometers, an area substantially larger than the 120 square kilometers covered by the FTZ. The official website indicates that Beijing’s service industry liberalization zone actually covers the entire city, not just a district within the city, as was done with earlier FTZs.

Hainan Free Trade Port: The 2020 central government policy defined the Hainan Free Trade Port as encompassing the entirety of Hainan Island. This was further defined in the Hainan Free Trade Port Act and, throughout 2021 and 2022, the Hainan Provincial Legislature issued a set of comprehensive legislation that implements the trade liberalization policy in accordance with the Act.

Shenzhen: A 2019 central government policy mandates the establishment of a Shenzhen Advanced Demonstration Zone. The mandate defines the zone as covering the entirety of Shenzhen city.

Based on the definitions contained in the Pilot Program, the covered areas include all of Beijing, Hainan, Shenzhen, and Shanghai’s Pudong district.

The Pilot Program provides that the operating entity must be registered within one of these areas and that all of their equipment be located within a single Zone; moreover, operating entities are prohibited from purchasing or leasing CDN capabilities outside their Zone. ISP services may only be provided within the pilot program region and services must be provided through the infrastructure network using local operator equipment, but other services can be offered nationwide.

Specific Ordinances Will be Issued by Local Governments in the Future

The Pilot Program provides local governments with the flexibility to define the specific rules and timeline for implementing the mandate to best suit the needs of their local technical environment, existing industries, and economic growth model. Again, those localities are Beijing, Shanghai, Hainan, and Shenzhen. The central government information technology ministry will then hold meetings with industry experts to verify the security and efficacy of the local government proposals and then decide on whether to approve the local rules.

To put it another way, tech companies will be able to offer the kinds of cloud and ISP services described above after three steps have been taken:

The Ministry of Industry and Information Technology holds meetings with industry experts to evaluate the rules;
The Ministry verifies the effectiveness of the security regulation policy;
The Ministry approves the local government’s rules.

The rulemaking process outlined above can be somewhat time-consuming. Policymakers expect the pilot program to be implemented late 2024 or early 2025. Implementation rules are likely to be approved as each locality completes its work, which is unlikely to have a simultaneous nationwide launch date.

Legal requirements for a pilot program permit will be determined based on existing telecommunications law. Foreign companies and foreign investors that want to offer these cloud, Internet, and SaaS services will be required to obtain a permit from the information technology ministry, in compliance with the rules adopted by the local government. However, Chinese telecommunications law already has established general principles for providing these services. In general, the law requires:

The operator must be organized as a company, with financial and staff capability to provide the service.
The entity must have adequate credibility or capability, and at the very minimum have 1 million CNY registered capital if operating locally or 10 million CNY if offering services nationwide. In either case, operators must have adequate facilities, equipment, and technical protocols.
Finally, the company, its key investors, and executives must not be on a governmental list of untrustworthy individuals.

Around these general principles, there is some room for each locality to develop somewhat varying rules. The Pilot Program implies that approvals will be made case-by-case, as the Pilot Program explicitly states that, in addition to applicable law, approved business entities must comply with pilot approval rules. Foreign-owned entities that have obtained permits under these special rules will also be subject to regulations issued by telecommunications regulators and other government agencies.

The Pilot Program also provides a process for limiting or terminating a local pilot program due to uncontrollable security or safety risks.

Market access is also provided for cloud computing service providers. The Pilot Program makes clear that the participating regions will provide market access to foreign investors without any shareholding ratio restrictions. Foreign companies that want to provide IaaS and PaaS services in China will be allowed to apply for an Internet Data Center License within the participating locality, which includes collaboration tools. Except for ISPs, a cloud service provider that obtains an IDC License can base a data center within one of the four localities and offer its services nationwide from that location.

Conclusion

Over 2024-2025, China will be issuing new regulations that permit foreign investors access to cloud computing, ISP, and data processing services. Whether a particular kind of service will be permitted depends firstly on whether it falls into the B11, B12, or B14 classifications above. Secondly, the investment must comply with China’s foreign investment laws, including the Exceptions List to market access.