20 May 2020

China’s Digital Opportunity

This article was written by Mark Schaub, Shawn Hu and Tom Shi


How many video calls have you attended this past month? Like many people around the world, you probably joined more video calls in the past two months than in the rest of your life put together. 

The shift to a digital lifestyle has gone beyond surfing the internet. Across all metrics (age, location, social class, income level, etc.), digital is changing how we work, consume entertainment, learn, shop and communicate. Soon most companies will need to transform into digital companies at least in part. 

Overview of Digital Opportunities

For some, the shift to digital may be a temporary answer to a temporary problem of COVID 19. But this is probably wrong. Many businesses will rather see how they can harness the lessons learnt to be ready for a more digital world. 

In China’s digital is transforming business (in both the State and private sector):

  • Traditional brick & mortar retailers driving their online promotions and ecommerce sales;

  • Education companies, schools and universities establishing eLearning curriculums, utilizing edtech and offering accreditation programs digitally;

  • Creative industries (gaming, museums, film/TV, marketing, etc.) adapting how their products are consumed digitally;

  • Robotics (healthcare, autonomous vehicles, drones, supply chain, etc.) as China shifts from the world’s factory to a technology driven economy;

  • Data centers storing, handling and transmitting electronic information for all the above examples domestically and internationally; and

  • Communication – this is not limited to video conferencing but exhibitions, PR events … indeed all forms of communication 

In addition there is huge scope for technology companies to build the infrastructure, cloud services, digital storage, managing membership accounts and personal information, developing office collaboration systems and offering a wide array of digital services and products at an unseen scale and speed.

This trend towards digital existed well before COVID-19 appeared on the scene. National initiatives such as “Made in China 2025” also had a focus on digital as part of a strategy to modernize China’s global competitiveness in high-tech industries. China’s role in these fields have not been limited to strategy papers and discussions, China is a leader in future technologies such as 5G, AI and big data just to name a few.

While China may be promoting a surge of indigenous innovation and R&D, there is no doubt that foreign technology will play a critical part of China’s digital aspirations. Joint ventures, M&A, license agreements and other forms of cooperation will undoubtedly rise to meet demand.

Overview of Challenges 

“If you open a window for fresh air, you have to expect some flies to blow in.” – Deng Xiaoping

Digital in China is a great opportunity for international and Chinese companies alike. 

However, digital’s ability to touch consumers, share information instantaneously, allow remote access, control crucial infrastructure all means that regulation and oversight by the authorities is required. 

Like most countries, China’s regulations on digital products, services and applications are not covered by a single, all-encompassing law. The degree that your business will be regulated or how strictly you are subject to oversight will, logically enough, depend upon what you are doing.

At one end of the scale a brand wishing to establish its own direct ecommerce storefront (i.e. for its own products) in mainland China will face light regulation such as:

  • Operating a website in China (subject to ICP Filing regulations)

  • Operating an App in China and listing on the various Chinese App Stores (a variety of App regulations and policies exist)

  • Dealing with the collection, storage and transmission of consumer information (this will entail privacy protection, issues in respect of the offshore transmission of personal data)

Although this looks somewhat concerning in practice the requirements are easy to fulfill and tend to be less onerous than Western jurisdictions.

For more technology focused businesses, additional challenges may arise:

  • Is the business scope limited or restricted in China (e.g. banking, education, businesses requiring ICP Licenses, “critical network operators”, critical information infrastructure etc.)

  • What licenses are required for the intended operation? Can such licenses be legally obtained by a foreign invested enterprise? Can they practically be obtained? If difficulties exist in obtaining licenses is a Variable Interest Entity (VIE) a possible workaround?

  • What are the potential liabilities/risks for non-compliance in respect of licenses or operations?

For many companies the main issues are not specific legal points but rather structural issues. Much is bespoke to the specific business. There is much nuance in how each business will approach and structure their solution for China. 

Main structural issues to be considered when need addressing how to do business digitally with China include:

  • Offshore Model – Is it possible to provide the services to China remotely – that is an offshore model? What limitations does an offshore model entail for the business; what onshore structure should be utilized; what licenses am I eligible for and are required?

  • Onshore Model – Almost any ambitious company will at some stage need to be able to offer its services onshore. When going onshore the main issue is to consider what specific  licenses are required to operate.

  • Data – Data is understandably a highly sensitive issue globally. It will be important for companies to consider whether their business complies with China’s cybersecurity law; What are the potential issues when collecting data in China? Privacy concerns? Who owns the data? Can the data be transferred offshore?

  • Intellectual Property – first-to-use versus first-to-file; what about any existing patents?; trademark filing is relatively inexpensive; is my trademark registered in China? Do I have a Chinese version? Do I need to reveal my source code to protect my IP in China?

Common-sense approach to PRC Digital Laws

The above list of questions may be unsettling to most international companies. However, with limited exceptions these issues are relatively easy to deal with. 

Although there is no shortage of journalists in the West screaming that the sky is falling every time a new regulation is passed in China, especially so if the regulation is related to digital or data. As a result many international companies have a preconceived (and often incorrect) view that PRC regulations are onerous to comply with, intrusive and unreasonable in scope. In most cases much of the regulation which is of primary concern does not apply to their business. Ironically, while worrying about irrelevant bogeyman the international companies end up being unprepared for the regulations that actually do apply to them.

So how can international companies separate hype from fact and identify the legitimate legal and commercial obstacles? The answer to this crucial question is unfortunately … it depends. An international bank will be impacted in a very different way from a cross-border technology company bringing a tech product to China or a brand setting up an ecommerce sales channel. 

For technology and digital-centric businesses we suggest issues to consider include:

  • How to deal with large Chinese SOEs or businesses in sensitive sectors (such as financial sector; infrastructure; telecoms; medical etc.) can impact how data can be dealt with and the role of the PRC government and restrictions international companies will face;

  • Understanding business contingency risks and potential impact to your revenue (i.e. authority prohibits further use of your companies’ services/product; if you are blocked from procurement; security checks);

  • Data localization requirements means utilizing new data services in China or renting from local server providers (e.g. more likely Huawei, Tencent or Alibaba than Amazon).

  • Bringing data under Chinese jurisdiction does elevate risk of prosecution if you violate China’s digital laws; and

  • PRC policy of promoting indigenous innovation is a concern for those that do not wish to divulge IP (like source code) to the PRC government due to concerns what may happen to that data once released.

For most businesses generally, the most commonly encountered issues are:

  • How is user data collected?

  • What are the primary techniques or channels used to acquire data?

  • Are there explicit prompts for the user?

  • Are we authorized to collect data? What is the scope of authorization?

  • What internal control systems are in place?

  • Should we report to authorities? Do we require licenses?

  • Who owns the data?

  • Are our procedures standard or similar to other companies in the industry?

  • What backup measures are in place?

Summary

The digital economy is booming in China. However, digital is not just an opportunity in many ways it is an evolutionary test – embrace digital and succeed or … do not and wither.

This change in attitude will impact both companies that are digital by nature (i.e. SaaS companies) as well as those that are digital in part or as a complement to their main business (i.e. education or health apps). 

Although digital companies are varied the challenges they will face are remarkably similar. Will they provide their services via an Offshore Model or an Onshore Model? How to deal with data? What licenses do I need? Do I need a partner? How can I connect to the PRC’s wider digital eco-system?

The good news is that for most companies the legal challenges are actually less onerous that expected. The main issue is to work out how best to enter the market,.  














A Guide to Doing Business in China

We explore the key issues being considered by clients looking to unlock investment opportunities in the People’s Republic of China.

Doing Business in China
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