http://online.wsj.com/public/article/SB115402455406219387-HJnoEtl0vW_M8o6FdvES8guBdeU_20060804.html?mod=regionallinks
BEIJING -- New rules issued by China's telecommunications regulator could
create significant complications for foreign Internet companies operating in
China as well as for Chinese Internet companies listed overseas, lawyers and
analysts said.
Just how much the measures, unveiled this week by the Ministry of Information
Industry, will affect Internet companies in China could depend largely on the
level of enforcement, experts said. The rules appear to target a complicated
legal structure that has been widely used for years to enable foreign investment
in the Chinese Internet industry.
The new requirements come amid ballooning interest in the Internet in China,
which boasts more than 120 million users, the second largest such population
after that of the U.S. Google Inc. and Microsoft Corp.'s MSN service each
launched operations in China last year, joining other big foreign Internet
companies like Yahoo Inc. and eBay Inc. Numerous Chinese Internet companies,
such as portal Web site operators Netease.com Inc. and Baidu.com Inc., have
attracted foreign investors through listings on the Nasdaq Stock Market.
The measures are aimed at strengthening control over foreign investment in
"value added telecom services," a category that includes search engines and
other Web sites. The rules require that local providers of such services own the
domain names and trademarks that they use in China -- key pieces of intellectual
property that are often controlled by foreign affiliates or investors.
A Google spokeswoman said in an email: "We have been working closely with the
government agencies for some time and are following their direction to ensure
that the legal structure of our activities in China satisfy all government laws
and regulations."
Spokesmen for Netease and Baidu said they weren't aware of the new
regulations and couldn't comment.
It isn't clear exactly what prompted the new regulations, which were
contained in a notice posted Wednesday on the Ministry of Information Industry
Web site, titled "Notice on strengthening management of foreign investment in
operating value-added telecom services." A spokesman for the ministry declined
to comment.
But the growing foreign role in China's Internet sector in the past several
years has come at a time when the government is trying to tighten its controls
over the Web, and some analysts say the level of foreign involvement has
unnerved regulators.
The new measures are "a starting step" for the ministry, said a senior
researcher at a think tank affiliated with the ministry. The regulator is
concerned about the increase in foreign investors buying control of Chinese
Internet companies, a trend it expects to accelerate, he said. "The MII is eager
to bring things under control now," the researcher said.
Even so, the government has in the past issued tough-sounding new rules that
it then followed with relatively lax enforcement.
"The significance will depend on how the MII enforces this regulation," said
Chen Jihong, a partner at ZhongLun W&D Law Firm in Beijing who represents
Internet company clients and who has examined the new measures. "If they enforce
it strictly I do think this will lead to a significant change." He said affected
companies might need to substantially restructure their operations to continue
operating.
Because China's laws limit direct foreign ownership of domestic companies
that provide Internet content and related services, Chinese Web-site operators
that want to sell shares overseas first establish a legal entity offshore, such
as in the Cayman Islands. That entity owns the trademark, domain name, and other
key intellectual property for the site.
The Chinese Internet-content provider license and related licenses,
meanwhile, are owned by one or more separate Chinese legal entities, which
themselves are often controlled by top executives of the offshore companies but
not by the companies themselves. The relationships between these offshore
companies and their local operating affiliates are governed by contracts.
Generally, the local operator collects revenue in China from sales of online ads
or other sources, which it passes on to the offshore company in exchange for the
license to use the trademarks, domain names, and other intellectual property.
Lawyers say most or all foreign companies that operate in China or have
bought into local companies use similar legal structures, but their arrangements
generally aren't made public. Chinese Internet companies that list overseas,
however, must describe their structures in detail in their regulatory filings.
Nasdaq-listed Baidu.com, a major Chinese search-engine operator, for example,
stated in the prospectus for its initial public offering last year that it
licenses its domain names, trademarks, and certain software to a Chinese
affiliate that is owned by two top Baidu executives. The prospectus noted that
there are "substantial uncertainties regarding the interpretation and
application" of China's laws, including those "governing our business, or the
enforcement and performance of our contractual arrangements with our affiliated
Chinese entity" and its shareholders. Other Nasdaq-listed Chinese Internet
companies like Netease, Sohu.com Inc., and Sina Corp., describe similar
arrangements in their regulatory filings. Spokesmen for Sohu and Sina said they
didn't know about the new regulations and couldn't comment.
The MII notice said that "most" foreign investors have "strictly observed"
China's laws governing value-added services. "But," it said, "recently, there
have also been some foreign investors, using domain-name licensing, trademark
licensing and other means," in cooperation with domestic companies, to "evade
the demands" of the existing regulations and "illegally operate value-added
telecom business."
The new measures say that the trademarks and domain names for local Web sites
should be owned by the domestic operators themselves. The notice also indicates
that local operators should own the servers and other infrastructure used to
operate sites. It says value-added-service companies already operating in China
have until Nov. 1 to evaluate their compliance with the new rules and report to
the MII. Companies that fail to comply with the rules can lose their license to
operate.
Google ran into questions about its structure in China this year. In February
the MII said it was investigating the licensing of the U.S. search-engine giant,
which had recently launched a Chinese Web site. MII didn't elaborate on the
nature of the investigation, but local news reports said it centered on whether
Google had obtained proper licenses.
A Google spokeswoman said at the time that Google's partnership with
Ganji.com, a local Internet content provider, provided Google with the required
licenses.
New rules issued by China's telecom regulator may require
foreign and domestic companies operating in China's Internet industry to revise
their structures.
* Domain names used by Internet companies and other
value added telecom (VAT) providers must be owned by the local operators.
* Trademarks used by VAT providers must be owned by the local operator or
its shareholders.
* Applications for new VAT licenses that fail to meet the specified
requirements can be rejected.
* Existing VAT license holders whose structures don't comply with rules
could have their licenses withdrawn.
Sources: Ministry of Information Industry, China; ZhongLun W&D Law
Firm
