ISE04/15-16

• China has achieved impressive economic and trade growth after years of economic reform and opening-up. Its accession to the World Trade Organization ("WTO") in December 2001 has set itself on the course of pursuing all-round opening-up to the world and preparing itself for full involvement in economic globalization. The WTO membership also set the stage for the Central Government to establish the pilot free trade zones ("FTZs") in the 2010s, in a move to (a) expeditiously honour its WTO accession commitment to open up the service sector, and (b) provide the testing grounds for further deepening the economic reform. The Central Government aims to first realize the goals of financial internationalization, administrative streamlining and trade and investment liberalization in FTZs, and then replicate the successful experience of FTZs to other parts of the country.
• This issue of Essentials highlights the development roadmap and targets of FTZs recently set up in the Mainland, and the opportunities and challenges that FTZs will bring to Hong Kong. The historical development and features of other free economic and trade zones established earlier in the Mainland^{1Legend symbol denoting Free economic and trade zones in the Mainland may comprise various types of economic zones including special economic zones, bonded zones, bonded logistics parks, export processing zones and free trade zones.}, as well as the process and significance of China's accession to WTO, are discussed in the Essentials entitled "Free economic and trade zones in the Mainland (Part 1)".

Establishment of pilot free trade zones in the 2010s

• FTZs are managed under the regime of "opening the first line and controlling the second line". The "first line" refers to the direct passage between a FTZ and overseas markets that should be opened-up gradually and fully. For the "second line", it refers to the passage between a FTZ and the domestic market that must be controlled safely and highly efficiently. Under the "opening the first line" arrangement, goods entering a FTZ from abroad are exempted from payment of customs tariffs. This is to realize the spirit of being "within the territory but beyond the customs", meaning that a FTZ can be regarded as being outside the customs territory although it is physically located within the territory of China. As to "controlling the second line", it means the levy of relevant customs tariffs on goods that need to enter the domestic market from FTZs.
• At present, the Qianhai Shenzhen/Hong Kong Modern Service Industries Co-operation Zone ("Qianhai"), and the four FTZs located respectively in Shanghai, Guangdong, Tianjin and Fujian all serve as the testing grounds for further deepening the economic reform in the Mainland. If analyzed by their functions, these FTZs serve different purposes as highlighted below:
  
  

  (a)	Qianhai: strengthening co-operation between Hong Kong and Shenzhen and providing impetus for continuous innovation;
  (b)	China (Shanghai) Pilot Free Trade Zone ("Shanghai FTZ"): exploring the transformation of governmental functions, introducing innovations in management models, promoting trade and investment facilitation, exploring new paths to comprehensively deepening reform and expanding the opening-up, as well as promoting Shanghai as an international economic centre while focusing on the development of finance and shipping businesses;
  (c)	China (Guangdong) Pilot Free Trade Zone ("Guangdong FTZ"): focusing on promoting integrated economic and trade relationship between Guangdong, Hong Kong and Macao;
  (d)	China (Tianjin) Pilot Free Trade Zone ("Tianjin FTZ"): placing emphasis on the co-ordinated development of the Beijing-Tianjin-Hebei region, and promoting the transformation and upgrading of manufacturing and service industries in Beijing, Tianjian and Hebei; and
  (e)	China (Fujian) Pilot Free Trade Zone ("Fujian FTZ"): seeking to strengthen closer economic partnership with Taiwan.

Qianhai Shenzhen/Hong Kong Modern Service Industries Co-operation Zone

• In August 2010, the State Council approved the Overall Development Plan on Qianhai Shenzhen/Hong Kong Modern Service Industries Co-operation Zone. The plan elevates the future development of Qianhai to a national strategic level and by 2020, Qianhai will be built into an international modern service industry zone with a gross domestic product ("GDP") of Renminbi ("RMB") 150 billion. In addition, Qianhai is positioned as a future modern service industry centre in the whole Pearl River Delta ("PRD") region and a demonstration zone for Guangdong-Hong Kong co-operation and innovation in modern service industry. This arrangement reflects Qianhai's strategic location in western Shenzhen and on the eastern side of Pearl River Estuary, as well as its proximity to Hong Kong and Macao. In March 2011, the Central Government went further to incorporate Qianhai into the "Outline of the Twelfth Five-Year Plan for National Economic and Social Development of the People's Republic of China".
• The early and pilot implementation policies adopted for Qianhai cover areas such as financial services, legal services, human resources and professional services, medical services and education, and telecommunications services. Area-specific facilitation measures include the following policy initiatives:
  
  

  (a)	finance services: (i) encouraging Hong Kong financial institutions to extend RMB lending to enterprises or projects in Qianhai; (ii) supporting enterprises and financial institutions in Qianhai to issue RMB bonds in Hong Kong for funding development projects in Qianhai; and (iii) lowering the entry requirements for Hong Kong financial institutions to enter the Mainland, so as to strengthen the cross-border development in the future;
  (b)	legal services: (i) allowing Hong Kong arbitration institutes to establish branch institutes in Qianhai; and (ii) improving the mode of associations of law firms of the Mainland and Hong Kong;
  (c)	human resources: (i) allowing Hong Kong professionals to practice in Qianhai; and (ii) allowing Hong Kong professionals who are qualified Chinese Certified Public Accountants to become partners of Mainland accounting firms;
  (d)	education and medical services: allowing Hong Kong service suppliers to set up wholly-owned international schools and hospitals in Qianhai; and
  (e)	telecommunications services: supporting telecommunications operators in Hong Kong and Macao to establish joint ventures in Qianhai with Mainland counterparts to operate telecommunications businesses.

• In order to promote the development of modern service industries, tax concessions and land supporting policies are introduced in Qianhai. Relevant tax concessions include (a) exemption of business income tax for offshore services enterprises registered in Qianhai; (b) levy of concessionary business income tax rate, at 15%, on high-technology companies registered in Qianhai; and (c) exemption of business income tax on income derived from the provision of international maritime insurance services by insurance companies registered in Shenzhen. On land supporting policy, the Qianhai Authority offers office rental concessions to Hong Kong's small and medium enterprises to reduce their operational costs in Qianhai.
• As at the end of August 2015, of the enterprises operating in Qianhai, more than 1 770 were Hong Kong-invested enterprises registered in Qianhai with a total registered capital of RMB 258.4 billion. Finance is one of the major fields of co-operation between Qianhai and Hong Kong. Reflecting this, many Hong Kong financial institutions have established branches in Qianhai to develop cross-border RMB loan business.^{2Legend symbol denoting See Qianhai's portal site.}

China (Shanghai) Pilot Free Trade Zone

• Against the background of appreciating RMB, rising labour costs in the Mainland, as well as the worsening industrial pollution problem, it is increasingly difficult for China to rely solely on commodity exports to support its long-term economic growth, as had been the case in the past years. It is, therefore, necessary for China to establish FTZs as a platform for transforming its economic structure and further opening-up the service sectors. Meanwhile, China's earlier WTO commitment to gradually opening-up its service market, and the recent conclusion of talks on the United States-led Trans-Pacific Partnership ("TPP") Agreement, have heightened the importance of utilizing FTZs as the testing grounds for economic liberalization in China.
• TPP creates the largest free trade zone in the world, encompassing 12 member countries^{3Legend symbol denoting The 12 current TPP member countries include the US, which has dominance under the TPP, Japan, Australia and Singapore, while China is not a TPP member country.} that represent 40% of the global GDP. The TPP Agreement, comprising 30 chapters, aims to achieve a higher level of liberalization of goods and service trade. For instance, in the context of goods trade, the TPP Agreement aims to achieve the goal of zero tariffs; whereas in the context of the service trade, it aims at full liberalization of the service sectors such as finance, telecommunications, e-business, etc. In addition, TPP member countries are required to make clear commitments on various areas covering investment, intellectual property rights, government procurement and environmental protection. China has market entry requirements for service trade and foreign investment, and it has not joined TPP. Nevertheless, the achievements and experience gained in the Shanghai FTZ will serve as a guiding reference for China in considering whether to join the TPP Agreement in the future. This is particularly the case as the Shanghai FTZ is the testing ground for all-round opening-up and faces the challenge from its commitment for a higher level liberalization of goods and service trade.
• The Shanghai FTZ, established upon the approval of the State Council in August 2013, has officially commenced operation since September 2013. The Shanghai FTZ occupies a total area of 28.8 sq km which covers four special customs supervision areas: the Shanghai Waigaoqiao Free Trade Zone, the Waigaoqiao Bonded Logistics Park, the Yangshan Bonded Port Area, and the Shanghai Pudong Airport Comprehensive Bonded Zone. In December 2014, the State Council decided to incorporate the Lujiazui Financial Area, the Jinqiao Development Zone and the Zhangjiang Hi-Tech Park into the Shanghai FTZ. The expanded Shanghai FTZ has a total land area of 120.8 sq km.
• The State Council has set out the requirement for implementing a negative list management system^{4Legend symbol denoting The current negative list published by the State Council applies to the four FTZs in Shanghai, Guangdong, Tianjin and Fujian. The negative list, the contents of which are complicated, covers various economic sectors and industries such as finance, culture and entertainment, and sets out more than 120 special management measures. However, with the Central Government pressing ahead with successive reforms, the negative list is expected to be further streamlined to increase the level of opening-up.} in the Shanghai FTZ in accordance with the policy of "full access to non-prohibited sectors". Under the negative list management system, the State Council complies a list clearly setting out the sectors in which foreign investment is prohibited or restricted in the Shanghai FTZ. Those sectors falling outside the scope of the list are opened-up sectors in which foreign investment is permitted. The implementation of the negative list management system by the State Council seeks not only to streamline foreign investment management, but also to bring it in line with the international practice. For instance, the TPP member countries have adopted a negative list regime for service trade and foreign investment.
• In addition to the negative list management system, an all-round reform and opening-up is another highlight of the Shanghai FTZ. A total of 18 service sectors covering six major areas of financial services, maritime services, commerce and trade services, professional services, cultural services, and social services have been selected by the State Council for further opening-up. Area-specific opening-up measures include the following policy initiatives:
  
  

  (a)	financial services: (i) provided that risks are properly controlled, early and pilot implementation policies will be carried out in the Shanghai FTZ to create the conditions for making Renminbi convertible under the capital account, establishing a market interest rate system, and using Renminbi in cross-border transactions; (ii) within the Shanghai FTZ, assets of financial institutions are priced based on market forces; (iii) enterprises are encouraged to optimize the use of domestic and foreign resources and markets to achieve cross-border financing liberalization; (iv) the reform of the management model of foreign debts is deepened to boost cross-border financing activities; (v) support is provided for foreign-owned and Sino-foreign joint venture banks to set up branches in the zone; and (vi) cross-border RMB-denominated reinsurance business is launched to foster and develop reinsurance market;
  (b)	maritime services: (i) foreign enterprises are allowed to engage in international maritime cargo handling and container business on a wholly-owned basis; and (ii) foreign enterprises are allowed to engage in international shipping agency business on an joint venture or co-operative venture basis, with their shareholding limit relaxed to 51%, so to enable them to become a major shareholder;
  (c)	trade services: foreign-invested enterprises are allowed to engage in the production and sale of gaming equipment, and such equipment may be sold in the Mainland market subject to examination of its content and approval by the cultural authorities;
  (d)	professional services: conditions imposed on foreign-invested engineering design and architectural service providers in relation to business turnover, shareholding limit in a project, etc. are removed;
  (e)	cultural services: (i) the shareholding limit of foreign-invested performing arts agencies is removed, and foreign enterprises are allowed to set up wholly-owned performing arts agencies to provide services in Shanghai; and (ii) the establishment of wholly foreign-owned entertainment premises is allowed to provide services in Shanghai FTZ; and
  (f)	social services: (i) the establishment of wholly foreign-owned medical institutions is allowed; and (ii) training bodies in the form of Sino-foreign co-operative ventures are allowed to organize education programmes and vocational training.

China (Guangdong) Pilot Free Trade Zone

• The Guangdong FTZ, endorsed by the State Council at its meeting in December 2014, has officially commenced operation in April 2015. The Guangdong FTZ covers three districts totalling approximately 116.2 sq km: Nanshu area of Guangzhou, Qianhai/Shekou area of Shenzhen, and Hengqin area of Zhuhai. According to the Framework Plan for the China (Guangdong) Pilot Free Trade Zone approved by the State Council, the Guangdong FTZ is to embrace Hong Kong and Macao to serve the Mainland and open up to the world. Efforts will be made to develop the Guangdong FTZ into a Guangdong-Hong Kong-Macao in-depth co-operation demonstration zone, and an important hub for the 21st Century Maritime Silk Road. The development goals of FTZ are to create an international, market-oriented and regulated business environment based on pilot reforms implemented over a period of three to five years.
• The different positioning of the three sub-districts of the Guangdong FTZ is highlighted as follows:
  
  

  (a)	Nansha area of Guangzhou: located at the heart of the Pearl River Delta ("PRD"), and positioned to develop into the world's leading integrated service hub;
  (b)	Qianhai/Shekou area of Shenzhen: located across the sea from Hong Kong with close proximity to two major airports (namely the Hong Kong International Airport and the Shenzhen Airport), and positioned to serve as a testing ground for opening-up the financial sector to market forces and an important hub port for international service trade; and
  (c)	Hengqin of Zhuhai: connected to Macao via the Lianhua Bridge, and positioned to serve as a pilot zone for the opening-up of cultural and education services and an international commercial services and leisure tourism base, as well as create a new carrier for the diversified development of Macao's economy.

• Under the preferential policy measures set out in the Mainland and Hong Kong Closer Economic Partnership Arrangement ("CEPA")^{5Legend symbol denoting CEPA is a free trade agreement signed between the Mainland and Hong Kong in June 2003, followed by 10 Supplements thereto which expand market liberalization and further facilitate trade and investment. At present, the Mainland has applied zero tariff to 1 700 kinds of imported goods of Hong Kong origin, and opened-up 50 service sectors to Hong Kong, including construction and real estate, accounting, health care and logistics, etc.}, Hong Kong enterprises can enter the Mainland market ahead of foreign investors in sectors such as manufacturing-related services, telecommunications services, financial services and legal services. Meanwhile, the Guangdong FTZ allows in-depth co-operation among Guangdong, Hong Kong and Macao and hence less restrictions on foreign investment. As a result, Hong Kong companies are entitled to both easy market access to the Guangdong FTZ and preferential measures under CEPA, resulting in more options for developing the Mainland market. Take goods trade as an example. Hong Kong companies may choose between either the Guangdong FTZ's facilitation measures and bonded arrangements that are available to cross-boundary e-commerce operators, or the zero tariff preferential treatment granted to Hong Kong products under CEPA, and choose the appropriate sales channel for their circumstances.
• In addition, the deepened co-operation among financial services providers in Guangdong, Hong Kong and Macao and the promotion of cross-boundary RMB business development in the Guangdong FTZ should strengthen Hong Kong's position as an offshore RMB trading centre. Moreover, given Hong Kong's status as the major gateway for Mainland enterprises to "go out" and the Guangdong FTZ's role as the vanguard of leading the PRD region to "go out" and undertake transformation/upgrade, the establishment of the Guangdong FTZ will definitely provide more opportunities for the service industry in Hong Kong.

China (Tianjin) Pilot Free Trade Zone

• The Tianjin FTZ, also endorsed by the State Council at its meeting in December 2014, has officially commenced operation in April 2015. The Tianjin FTZ has three areas totalling approximately 119.9 sq km: the Tianjin Port Area, the Tianjin Airport Area and the Central Business District of Binhai New Area.
• According to the Framework Plan for the China (Tianjin) Pilot Free Trade Zone approved by the State Council, the goal of the Tianjin FTZ is to develop into a platform for opening-up the Beijing-Tianjin-Hebei co-ordinated development. Its main missions include: (a) developing service sectors such as maritime and logistics, international trade, and finance lease; (b) developing industries such as finance, cross-boundary trade and e-commerce, and culture, media and creative industries; (c) integrating the customs arrangements of Beijing, Tianjin and Hebei; and (d) promoting the development of "One Belt One Road"^{6Legend symbol denoting "One Road One Belt" is the combination of "Silk Road Economic Belt" and "the 21st Century Maritime Silk Road". "One Belt" refers to three land routes in the north, comprising (a) the main route connecting China and Europe through Central Asia and Russia; (b) a sideway linking Central Asia to Mediterranean Sea via the Persian Gulf; and (c) a land route linking China to the Indian Ocean via Southeast Asia. For "One Road", it refers to the maritime route in the south, linking coastal China to Europe through South China Sea, Indian Ocean, Persian Gulf, Suez Canal and Mediterranean Sea.} by capitalizing on Tianjin's location as a major node along the China-Mongolia-Russia Economic Corridor.
• To enhance the Beijing-Tianjin-Hebei economic and trade developments, the Tianjin FTZ has put in place a series of measures including (a) refining relevant supporting systems and measures, such as customs supervision, tax refund, cross-border payment and logistics, to facilitate cross-boundary e-commerce development; (b) strengthening international maritime services by allowing the setting up of wholly foreign-owned international ship management enterprises and promoting maritime container and mail courier business; and (c) supporting the leasing industry to raise funds outside the Mainland, and encouraging all kinds of leasing companies to expand the scope of cross-boundary use of RMB funds.

China (Fujian) Pilot Free Trade Zone

• The Fujian FTZ, endorsed by the State Council at its meeting in December 2014, has officially commenced operation in April 2015. The Fujian FTZ occupies approximately 118.1 sq km covering Pingtan, Xiamen and Fuzhou. The most notable feature of the Fujian FTZ is to leverage on its close relationship with Taiwan to implement investment and trade facilitation measures, which include: (a) a speedy customs clearance pilot scheme for imported goods of Taiwanese origin; (b) a lower access threshold for Taiwanese-invested financial institutions and an increase in their shareholding limits; and (c) a lower investment threshold for Taiwanese enterprises in sectors like communications and transportation. Meanwhile, the Fujian FTZ will make significant efforts to grow the tourism industry, particularly the development of tourism products such as seaside resorts, leisure and wellness tourism, and recreational and shopping activities.

Observations

• After some 30 years of reform and opening-up, China has emerged as a major economic power. It is the second largest economy and the largest trading nation in the world. In recent years, China has been facing the problems of appreciating RMB, escalating labour costs, and worsening pollution problems caused by industrial and manufacturing activities. This makes it difficult for China to rely solely on the export-oriented development strategy. To this end, China has sought to deepen economic reforms and enhance the industry structure in order to improve its competitiveness. Of particular importance is the recent establishment of FTZs to serve as a means for China to deepen reforms and open-up further. Indeed, FTZs features predominantly the implementation of all-round reform and opening-up of the service industry which includes financial, maritime, trading and professional sectors.
• In recent years, China has established a number of FTZs. The establishment and development of the Shanghai FTZ might affect Hong Kong, particularly its financial and maritime services. According to a recent study,^{7Legend symbol denoting See致富證券有限公司：《專題報告：上海自貿區帶來的變革及其對香港的影響》.} the Shanghai FTZ is unlikely to challenge Hong Kong's status as an international business centre in the near future. Hong Kong is cushioned by its comparative advantages such as thriving service trade, a low tax regime, free flow of capital and information, and a sound business environment. The establishment of the Shanghai FTZ should, instead, provide the financial services sector in Hong Kong with a new access to the Yangtze River Delta. Nevertheless, there are views that Hong Kong should uphold the spirit of self-strengthening and seek to strengthen its status as a financial hub and a maritime centre through measures such as stepping up manpower training and efforts on introducing new financial products.^{8Legend symbol denoting See中國評論月刊網絡版.}
• Among the FTZs established in the Mainland, Qianhai and Guangdong FTZs embody more Hong Kong elements as evidenced by their focus on deepening the liberalization of service trade in Guangdong, Hong Kong and Macao. As such, there will be more room for future co-operation among Hong Kong, Qianhai and Guangdong FTZs on goods and service trade. This includes the co-operation on finance, maritime and transportation, trading, professional and technology services. According to the Chief Executive, Hong Kong can also play the role of "super-connector" by providing the platform for helping Qianhai and Guangdong FTZs to "go out" and "bring in the advantages of their business partners". In so doing, this should generate more opportunities for the service industry practitioners in Hong Kong.^{9Legend symbol denoting See大公報：《梁振英：香港"超級聯繫人"角色重要》.}

Prepared by Jackie WU
Research Office
Information Services Division
Legislative Council Secretariat
19 November 2015