S&ED Shows Potential Breakthrough on Bilateral Investment Treaty, Modest Progress in Other Areas

Stephanie Henry and John Lenhart

China committed this week to begin substantive negotiations for a Bilateral Investment Treaty (BIT) based on two key concepts included in the US model BIT and tagged by USCBC as essential – a “negative list” approach and “pre-establishment” treatment. This commitment marked the most important outcome of this week’s round of the annual US-China Strategic and Economic Dialogue (S&ED) held July 10 and 11 in Washington, DC. This year’s dialogue represented the first S&ED for the four principals on both sides, and was held amidst ongoing Chinese reform discussions that appeared to promote agreements in some areas – such as the BIT – while delaying it in many other areas – such as issues related to state-owned enterprises (SOEs). While the two sides also negotiated agreements in a range of other issues important to US companies doing business in China, including government procurement, foreign investment approvals, cybersecurity, intellectual property rights protection, and market access, progress in these other areas was modest, as the outcomes are less specific or repeat previously agreed language in many areas.

S&ED Agenda and Schedule
US Vice President Biden opened the dialogue on Wednesday morning with a brief speech welcoming the leaders of the Chinese delegation, Vice Premier Wang Yang and State Councilor Yang Jiechi. Biden’s speech raised issues of concern, such as intellectual property rights protection, cybersecurity, and economic reforms, but also included many lighter moments of humor. Following Biden’s speech, Wang and Yang, and the leaders of the US delegation, Secretary of State John Kerry and Secretary of Treasury Jacob Lew, all gave remarks. Vice Premier Wang’s remarks also included a few humorous references, which were touted by Chinese media as a sign of confidence and an attempt to connect with his fellow interlocutors.

The S&ED marked the conclusion of a series of bilateral meetings this week. CMI reported on the US-China Strategic Security Dialogue and the new US-China Climate Change Working Group earlier this week.

Economic track focuses on investment negotiations and economic reforms

New commitments by the Chinese government on its bilateral investment treaty (BIT) negotiations with the US headlined discussions in the economic track, which was led by Lew and Wang.

Investment Environment
Negotiators made potentially important progress that could affect the long-term investment environment in China. For the first time, Chinese officials agreed to use the US approach to a bilateral investment treaty (BIT), covering investments in all sectors except those specifically excluded by China during the negotiations (“negative list” approach). MOFCOM spokesman Shen Danyang was reported as saying this approach aligned with China’s efforts to reform administrative approvals and create a level playing field for investors in China. In a joint government release, China affirmed that it would move from technical discussions – which have seen nine rounds of negotiation during the Obama Administration – to substantive BIT negotiations. 

If realized, this represents an important breakthrough for US companies. USCBC’s board of directors, in its 2013 and 2012 Statements of Priorities for the US-China Commercial Relationship, specified that both “pre-establishment” – which allows both new and existing foreign companies to enjoy the same ownership rules as domestic companies – and a “negative list” approach that would give US companies the opportunity to invest in all sectors in China except those it specifically excludes. USCBC has also consistently raised these two requirements in meetings with senior Chinese officials.

While China’s commitment on these two requirements represents an important development, turning the commitment into reality will take time. Once the BIT is successfully negotiated, it will – like all treaties – require Senate approval. In the meantime, USCBC will press for China to move ahead with reducing foreign investment ownership barriers while BIT negotiations are underway – in line with other commitments at the S&ED – and not delay all such openings until the finalization and implementation of the BIT. Additionally, USCBC will advocate that China not simply take the prohibited and restricted sections of its most recent Catalogue Guiding Foreign Investment and convert that into its “negative list” of carve outs not subject to the BIT.

As a continuation of China’s administrative reform efforts, PRC negotiators also committed to gradually loosen and decentralize review and approval processes for foreign investment. This commitment may reflect several recent announcements from the State Council to eliminate or streamline more than 100 central-level approval processes, though those policies were not specifically aimed at restrictions on foreign firms.

Chinese officials also stated that a soon-to-be established free trade zone in Shanghai will be completely open to foreign services investments. Chinese media had previously reported the Shanghai Free Trade Zone would be a pilot entity open to both domestic and foreign investment. However, USCBC sources indicate that there remain considerable questions about the specific rules for the zone and how it may differ from other trade zones such as Shanghai’s Waigaoqiao Free Trade Zone.

Government Procurement
The US made some progress getting China to agree to submit a revised offer for the World Trade Organization's (WTO) Agreement on Government Procurement (GPA) by the end of this year, reversing previous statements by China at the WTO that it would not table a new offer in 2013. Despite this progress, the S&ED did not result in any meaningful progress on China’s domestic regulations for defining domestic products, such as the Government Procurement Law Implementing Regulations and the Administrative Measures for the Government Procurement of Domestic Products – another key USCBC priority. USCBC has long called for – and raised again in its 2013 Board of Priorities statement – on China to finalize these regulations quickly, as a clear definition of domestic products to include products made in China regardless of company nationality would provide a legal underpinning to level the playing field for US companies that seek to provide products and services in China’s government procurement market. Discussions with senior US government officials suggest this deliverable needs to move up higher on the list of US priorities.

In addition, China agreed to engage US officials in technical talks this summer to facilitate the process of making a bid that is up to the standards of other GPA members. US officials have emphasized China’s next offer would need to lower thresholds above which GPA commitments would apply and include more sub-central entities. The next offer would be China’s fourth, as previous offers fell below the standards of GPA members. The US and EU had been encouraging China to submit an offer before July, though Chinese officials reportedly pushed back on that time frame.

Accounting and Auditing
The S&ED also announced some progress on the ongoing US-China accounting dispute, under which Chinese government guidance to China-based branches of US accounting firms that they could not submit audit papers to US regulators had put at risk audits required for US-listed Chinese firms as well as potentially for multinational companies. In late May, the Public Company Accounting Oversight Board (PCAOB) announced a new deal with the China Securities Regulatory Commission (CSRC) to exchange regulatory documents for us in PCAOB investigations, and CSRC on July 10 announced it was willing to share audit papers with the Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) for one Chinese company listed on the US stock exchange – presumably Longtop Financial Technologies Ltd.

Following S&ED negotiations, PRC negotiators affirmed that China would begin providing audit papers to US regulators, though reports did not indicate when that sharing would begin, or for how long it would continue – and notably, the language included in final outcomes made no mention of the US Securities and Exchange Commission (SEC). USCBC has advocated on behalf of member companies to for China to permit the sharing of audit papers. While the S&ED outcome represents a step in the right direction, USCBC continues to advocate that the two sides need to develop a more formal agreement to regularize such sharing between US and Chinese agencies and provide a long-term solution to this issue.

Financial Services and Financial Market Development
Some progress was made towards improving the environment for financial services firms operating in China. PRC negotiators committed that locally incorporated foreign banks and securities firms may trade government bond futures. Negotiators also said China would assist in the underwriting evaluation process for foreign participation in the corporate bond market.

Officials also committed that China would expand its consumer finance company pilot program to additional cities and allow both foreign and domestic firms the ability to participate. China also welcomed foreign firms’ participation in its pilot tax-deferred pensions program, and may indicate it will take steps toward increasing the range of financial services available to Chinese households. Lastly, official outcomes indicate China would provide foreign banks the ability to participate in RMB settlement of cross-border trade and investment, which is expected to facilitate the opening of China’s capital accounts and internationalization of the RMB. While PRC negotiators committed to increase flexibility for pricing, move forward with interest rate reform, and facilitate credit allocation based on market forces, official outcomes do not mention concrete steps for these key components of banking sector reform.

State-Owned Enterprises
The two sides held discussions focused on SOEs, but the ongoing nature of Chinese internal debate about the role of SOEs in the Chinese economy likely hindered the ability to make much progress or break new ground. This was reflected in the final language which made only small progress on previous commitments.  For the first time, PRC negotiators pledged China will provide all enterprises equal access to production inputs such as energy, land, and water, and affirmed that China would develop a mechanism to derive market-based pricing for those inputs – one of the near-term reforms that China identified last year. Moreover, in order to speed up SOE reform, negotiators committed to spin-off social programs, such as the management of retired SOE workers’ benefits, and increasing the dividend payout ratio of central state-owned enterprises – another reform announced previously and included in last year’s S&ED outcomes. In addition, negotiators also committed that China would increase the size of SOE dividend revenue to be spent on social security and general welfare, rather than being recycled to fund other SOEs.

Intellectual Property
PRC negotiators promised to boost enforcement of trade secrets, and committed to strengthen legal procedures and remedies for handling trade secrets. The two sides also agreed to exchange data – including enforcement data – through the Joint Commission on Commerce and Trade (JCCT), presumably the JCCT’s Intellectual Property Rights (IPR) Working Group. Though previous JCCT IPR Working Groups have raised trade secrets, this could provide a stronger hook for the US side to push for clearer, stronger means to protect of trade secrets – a top issue for US companies. Companies should monitor upcoming bilateral discussions on IPR issues – including the vice minister-level meetings of the IPR Working Group this fall – for further progress on these issues.

Additionally, Chinese officials pledged steps to promote software legalization among state-owned enterprises. While the commitment included few details or timelines for these efforts, and mirrors commitments made in previous dialogues, stronger language in the final commitment may indicate a greater willingness to take concrete action in ways that will aid foreign companies seeking to tackle illegal use of software.  Finally, China confirmed the work of its national leading group tackling IP infringement and increased enforcement on counterfeiting, with a particular emphasis on Internet piracy.

PRC officials committed China would restart a bilateral vice minister-level transparency dialogue by mid-December. This dialogue would likely be headed on the Chinese side at the SCLAO Deputy Director level – as it was the last time such dialogue was held several years ago. China’s record on the transparency-related process of releasing draft laws and regulations for public comment has been poor, as shown in USCBC’s recent Transparency Scorecard.

US and Chinese negotiating teams also agreed to develop a mechanism to allow the US to share with MOFCOM its concerns about national and sub-national policies that are perceived to conflict with China’s multi- and bi-lateral commitments. MOFCOM agreed it seek to remedy any conflicts with the appropriate Chinese agencies, USCBC has actively engaged with the US government to provide information about policies and provisions that would appear to violate bilateral trade commitments. However, the S&ED commitment included few details on how such a mechanism would work, when it might be initiated, or whether MOFCOM might realistically be able to compel other government agencies to revise policies.

Subject to specifics and follow-through, progress was also made in a number of other areas, including:

  • Energy and the Environment: Chinese officials made a commitment to increase exports of American shale gas, and committed to improve fuel efficiency standards, reduce coal-related pollution, and use technology to strengthen emission controls. The US and China also announced six new EcoPartnership programs linking US and Chinese companies, universities, and organizations.
  • Liberalization of exchange rates: Chinese officials committed to continuing exchange rate reform, and said China would consider following the International Monetary Fund’s standard for data dissemination to help boost transparency. Jointly, both the US and China agreed to avoid competitive devaluation, while Chinese negotiators committed to make “significant changes” to its exchange rate system, though such changes were not specified.
  • Tax: As China moves forward with its VAT reform, negotiators committed to extend VAT to railway, postal, and telecommunications sectors by 2014. These areas had been discussed as possible sectors for extending VAT, but had not been confirmed.
  • Economic Reform: On China’s reform efforts, PRC officials reaffirmed it would take efforts to reform interest rates and reduce China’s wealth gap.
  • Other Issues: In a joint statement, the US and China committed to discussing issues emanating from recent US legislation that bars certain federal US agencies from buying IT systems “owned, directed or subsidized” by the Chinese government, except in limited circumstances.

Strategic track focuses on cyber debate, regional security

Discussions in the strategic track centered on cybersecurity, regional issues, and North Korea denuclearization. State Councilor Yang Jiechi and Secretary of State John Kerry led discussions on the first day of the two-day talks. Deputy Secretary of State William Burns took over for Kerry on day two after Kerry departed to care for his wife, who remains hospitalized.

Amidst an ongoing debate about the handling over the release of Edward Snowden from Hong Kong, the US and Chinese negotiators focused on coming to consensus on potential norms of behavior in the cyber realm, and cyber espionage in the commercial sector. Though no new breakthroughs seemed to emerge from discussions, both sides offered what one administration official referred to as “practical proposals” to strengthen cooperation and transparency on cyber issues. China’s negotiators committed to improve trade secret protection and enforcement, and acknowledged cyber hacking of commercial sector remains an issue. One senior Chinese official informed USCBC that the next meeting to discuss cyber issues would take place this autumn.

North Korea
North Korea’s nuclear ambitions remain an ongoing focus of both the US and China. At the S&ED, the US and China recommitted and urged all parties involved in the Six Party Talks to move toward restarting the dialogue. Officials agreed on the importance of North Korea’s denuclearization, and said they would work toward implementing the UN Security Council Resolution that imposes additional sanctions on North Korea.

Regional Security
The two sides also discussed a number of regional issues, including in-depth consultations on joint foreign policy issues in Iran, Syria and Sudan. Joint steps announced included a joint commitment to call on Iran to fulfill its international obligations and to participate in P5+1 talks with Iran, discussion on the military and humanitarian situation in Syria, and other regional security issues in Asia and Africa.

Two business events held on sidelines of S&ED

On the margins of the S&ED meetings, two events with US companies were held in Washington, DC. On Thursday the US and PRC governments hosted a small roundtable with senior executives of American companies, and Chinese private and state-owned entities. Each participant was provided an opportunity to make remarks and hear from the lead negotiators for the two governments. CEOs of US companies E.I. du Pont de Nemours & Co., Archer Daniels Midland Co., Corning Inc., Blackrock Inc., and Western Digital Corp. were joined by counterparts from Baidu, Bank of China, CITIC, China State Construction and Engineering Corporation, ENN Group, and Lenovo.

At the conclusion of S&ED talks, USCBC and the National Committee on US-China Relations co-hosted a large dinner event on Thursday evening in honor of the S&ED. Vice Premier Wang and State Councilor Yang Jiechi made keynote remarks. New Commerce Secretary Penny Pritzker also spoke, as did Agriculture Secretary Tom Vilsack.

Export Controls and Sanctions Tracker

Export controls and sanctions continue to be an important economic tool in each US administration’s China strategy. The export controls and sanctions tracker lists all active Commerce, Treasury, and State Department export controls aimed at China.