The Economist & Baker-McKenzie on China

Friday 17 June, 2011

The good folks @ Baker & McKenzie were kind enough to extend an invitation to an update on China: China Update Roadshow 2011-Structuring for Growth in a Changing China.  Mike Morkin, Managing Partner of BM’s Chicago office, Jia Zhao, the 1st Chinese woman to earn a western law degree & pass the bar, & Tom Doyle, Chair of the North America-China Initiative, provided opening remarks.  We then jumped into new legal developments:

  • Bing Ho said 85% of BM clients are making money in China, & 20% said China is their most profitable market globally.  Foreign Direct Investment reached $90B in China during the financial crisis, & is now @ $105B.  The government continues to roll out the red carpet & is downsizing it’s approval domain by raising the level which it uses to approve investments from $30M to $300M.  Investing in China still requires skillful due diligence & lots of work post-acquisition.
  • Michelle Gon spoke to compliance & corruption in admitting China is not yet “civilized.”  There is less bribery of public officials, & now no one is exempt from prosecution.  China does have an equivalent to America’s Foreign Corrupt Practices Act including it’s extraterritoriality, but state secret issues are still vaguely defined.
  • Brandon Kelly expounded on taxes.  Shares transfers require a 10% withholding tax on capital gains, which were rarely paid before 2007.  Now transactions are more difficult with more reporting obligations because there are fewer shells in which companies can shelter income.  The withholding tax was reduced to 5% in Hong Kong & Shanghai, but you must have real substance to justify the lower rate, which changes how you structure deals.
  • Joseph Deng talked to employment.  As Chinese demographics change, the is no more endless labor pool.  The dependency ratio is changing from 10:1 to 3:1.  Companies that came to China for labor savings are staying to serve local consumers.  Unions in China are passive & work with the government on development.  Regardless, unrest is now further, deeper, & more dangerous.  The government should not be paranoid about the Jasmine Revolution, but should be afraid of dissatisfaction.  Employee demands for individual rights have increased the last 3 years & we are starting to see some overtime actions.
  • Clement Ngai informed us about intellectual  property (IP).  Because China sees it’s future in innovation, technology, R&D, invention, & patents, rather than as the world’s factory, filings are up the last 5-6 years.  HuaWei was sued by Cisco & they settled, & HuaWei now is a joint venture partner of 3Com.  There is new legislation on patent law:  inventors are required to file in China 1st with creations created in China.  Inventor compensation is now mandatory, but the issue is ownership.  The presumption is the creation belongs to the employee, who receives ongoing remuneration of 2-10%.
  • Howard Wu espoused on  supply chains.  There is a shift from broad assembly for export to turnkey manufacturing for local consumer consumption to add more value & pay more taxes.

I attended the break-out sessions on investments/acquisitions & R&D/IP.   Mergers & acquisitions have increased from $41B in 2001 to $105B in 2011.  The number of projects has dropped from 45 at it’s peak to 28 now.  87% of respondents said their investments are profitable, & 68% are better than overall.  74% make China a top 5 priority & 66% are accelerating their commitment, while 61% are producing locally for the Chinese market.  31% say bureaucracy & 30% say finding capable management are the most pressing challenges.  The Chinese are tightening up on the approval process, having adopted a European model which requires lots of information.  The specifics of a new National Security review are unclear.  If for some reason your deal is rejected, it’s better to negotiate further rather than going to court to overturn a decision.  Pre-acquisition due diligence & post-acquisition integration are key.  The questions respectively are “What will you tolerate & not tolerate?” & given 3 typical sets of books, how do you set a price?  1 result is pushing Chinese multi-national companies out to better compete globally.

To R&D/IP, R&D has increased .45% to 2.2% of Chinese GDP.  High New Technology Enterprises (HNTE) & Technologically Advanced Service Enterprises (TASE)  seek to create National Indigenous Innovation Products (NIIP).  HNTE’s get 10% tax breaks from 25% to 15%.  TASE is created to confront India in services.  Chinese companies compensate inventors with either a 1-off payment when a patent is filed &/or 2-10% when a patent is granted 2-5 years later.  NIIP product certification is done @ the local level, but may transition to federal, & impacts upon government procurement opportunities.

Ran Xu of the Economist Intelligence Unit offered insights from their research.  Although American living standards are still higher than those of the Chinese, China wields more clout around the world today.  Chinese household income is $15K/year, & will equal that of the US in 2014.  The Chinese market is the #2 market in many global sectors after the US.  Chinese growth will fall from 7.5%/annum 2011-2020 to 5.5% 2021-2030.  Rebalancing investment, consumption, & exports is tricky.  The financial crisis exasperated imbalances.  China has 100K infrastructure projects where corruption & quality are problems.  What could go wrong in the next 5 years?

  • a volatile stock market with lots of insider trading & the end of cheap Chinese labor could lead to inflation
  • changing demographics lead to 1 worker feeding 4 mouths as the young decline & the aged rise
  • the centers of wealth are changing 2009-2015 with new consumer markets:  Carrefour moves fast & makes decisions after opening a store whether to stay open or close in 1 year; Burberry is buying back it’s franchises.  Income disparity is leading to social stability issues as local governments are beholden to the rich, & there is lots of hidden wealth.  Shanghai residents have 1.3 computers while the national average is .6-.8
  • In 2012, the majority of the Chinese population will live in urban areas, which is increasing property values, & potentially leading to another bubble.  The majority of the Chinese can’t afford to buy a home, (men have lost wives due to lack of a house) but there is little incentive to build low-cost housing.  Property value has been divorced from rent.  The population was angered when, during China’s most recent earthquake, the government buildings withstood the melee while schools did not.
  • China is the world’s biggest consumer & emitter of CO2, so they are desperately seeking new energy sources, but China doesn’t develop it’s own technologies:  it imports or “shares” them.


  • Whether inflation will kick in depends on whether or not you include food & housing in the definition
  • GDP/per capita will plateau in 2015 & then show 5% growth
  • China will not crash in the next 1-2 years

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