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Startups and Shanghai FTZ - Negative List

Shanghai Free Trade Pilot Free Trade Zone

In my previous article Best Location for Startups in China - Shanghai FTZ I talked about Startups and Shanghai FTZ. When I wrote that article my view were too optimistic about the openness of the FTZ. But next day right before the golden week, Shanghai government released the negative list [1]. It turned out to be more restrictive than anticipated. In this article I will talk briefly about the negative list and its impact on Startups in Shanghai FTZ.

Since this is the first pilot FTZ in China and various ministery and state council are still fine tuning and debating its policy, hopefully it will be less restrictive in subsequent revisions. Currently Shanghai FTZ has miles to go before it can be at par with Hong Kong and Singapore. So if you are planning your Startups’ target market to be Asia besides China, I will still suggest to do Startups in Hong Kong, Singapore, South Korea or Japan. Since these are the only places in Asia with best policy framework and infrastructure for Startups. But if your target market happens to be China, then definitely I feel Shanghai FTZ is still the best place. I hope the future FTZ like QianHai and others might specifically target Startups and provide an open platform for innovation with a mix of right policy framework, infrastrcuture and cultural environment. So obviously I will take back my earlier assertion Shanghai FTZ will be at par or better than Hong Kong and Singapore.

If you look closely at the negative list, except for minor revision, is similar to the list restricting access to various sectors in China for foreign investments. Also its rather long list running into 10 pages for a FTZ which is only 29 square kilometers in size. This might be due to different internal priorities and unclarity on the impact of FTZ between state council and various ministry. Still the good news is, for the non-restricted sectors, it becomes much easier. It only needs registration and budding enterpreneur can get rid of complicated WOFE, FICE, Representative office, VIE (Variable Interest Entity) route for foreign investments, saving valuable time, money and efforts. The negative list [1] covers 1,069 sectors across 18 broad categories of industry and contains 190 special regulatory measures. Some of the sectors are highlighted below:

  1. Agriculture, Forestry, Animal Husbandry and Fishery Industries
  2. Mining Industry
  3. Manufacturing Industry
  4. Production and Supply Industries for Power, Gas and Water
  5. Construction Industry
  6. Wholesale and Retail Industries
  7. Transportation, Warehousing and Postal Service Industries
  8. Information Transmission, Computer Service and Software Industries
  9. Finance Industry
  10. Real Estate Industry
  11. Leasing and Commercial Service Industries
  12. Scientific Research and Technical Service Industries
  13. Water Conservancy,
  14. Environmental, and Public Facilities Management Industries
  15. Education Industry Health and Social Industries
  16. Cultural, Sports and Entertainment Industries

The service sectors which impacts Startups most is related to restrictions on internet and information technology which is the core of modern industries. Startups cannot be competitive unless restrictions on investment and innovation in this sector are completely removed. Following are the measures within that specific category of negative list impacting Startups:

Restriction on Information Transmission, Computer Service and Software Industries

  1. Foreign Investment in eCommerce shall not exceed 55%

    This is a very good news indeed compared to current regulation outside the Shanghai FTZ. Since outside FTZ its almost impossible for foreign firms to get ICP License (category 2) and start a legal eCommerce business in China, unless they go through a join venture or via VIE route or manufacturer of products for which they hold a retail license. Its also a very good news for local enterpreneurs since they can start eCommerce business from Shaghai FTZ without lengthy approval process and company formations. Also they can tap angel, private and venture capital investments.

  2. Foreign Investment in Data Processing and Online Transaction processing shall not exceed 50%.

    This is also a very good news since currently online transaction processing is completely off-limits to foriegn investment outside FTZ. Also this means for local enterpreneurs it has similar benefits as above.

  3. Foreign Investment in IP-VPN services shall not exceed 50%

    This is a good news for StartUps who target China for launching innovative IP-VPN services based on TCP/IP protocol. Since outside Shanghai FTZ its off-limits for foreign investment.

  4. Foreign Investment in Mobile App Store shall not exceed 50%

    This is a good news as well for StartUps who wants to build a service similar to google play in China for Mobile and Table software applications. Outside FTZ its prohibited for foreign investment.

  5. Investment is prohibited in Internet Data Center Services Industry.

    This is really bad news for Startups. This effectively means companies and startups who work in areas which requires large Internet Data Centers still needs to seek approval from the government. This is similar to existing regulation outside the FTZ. This includes web hosting, server rentals, telecommunication, ip network and other basic computing services necessary to build the basic foundation for innovative software and technology Startups. This is off-limits for foreign investment and for local requires a very lengthy approval process, which requires significant energy, upfront capital; unless you bypass or use guanxi or some clever arrangement. This effectively means Startups are at the mercy of the large telecom companies and need to find creative ways for a work around and waste energy rather then spending it on building something innovative helping society. Unless the target market is China, it doesn’t make any sense to build a StartUps in this area unless you are local enterpreneur.

  6. Prohibited Online Game Services

    This is a bad news for StartUps who wants to build next Zygna or PopCap in China. So if you plan on doing anything with gaming there is no incentive in Shanghai FTZ, you are better off building it in Software Technology Parks which might offer you better incentives.

Conclusion

Although the negative list is rather long, its a mixed bag of good and bad news for Startups to setup in Shanghai FTZ. But definitely Shanghai FTZ is still the best location for StartUps in China, if the target market is China. Also it will take time for the state council and various ministry to clarify and fine tune the policies for FTZ. As it is said “Well begun is half done”, I still believe State Council under Li KeQiang took the right steps for the transition of China’s economy by launching a pilot free trade zone in Shanghai. So the work is already half done and we need to wait for few more years to see the next half. If some of the readers who stumble across this article have some opinion to share, make suggestions or improvement please let me know. Hope someone find this information useful.

Footnotes:

[1](1, 2) Shanghai Free Trade Zone - The Negative List