CEPA - 2006 Update on Expanded Liberalisation Measures (hktdc.com)

On the heels of the implementation of CEPA III measures from January 2006,¹ the Central and Hong Kong governments agreed in late June of 2006 on another spate of liberalisation measures under CEPA that are to be effective from January 2007.

These further liberalisation measures cover trade in goods, trade in services as well as trade and investment facilitation. From 1 January 2006, all Hong Kong-made products meeting CEPA origin requirement can be exported free of tariff to the Chinese mainland. On top of a list of origin requirements for 1,370 products as agreed in 2005, the Chinese mainland and Hong Kong have worked out the CEPA origin rules of another 37 products, the applicable tariff rates of which would otherwise range from 4% to 21%.

On the heels of 23 liberalisation measures spreading across 10 service sectors as agreed under CEPA III, the new CEPA agreement adds another 15 liberalisation measures spanning across 10 service sectors. The WTO-plus liberalisation measures are expected to give Hong Kong firms, especially SMEs, a head start over their competitors from other economies. For example, Hong Kong lawyers and barristers will find enhanced access to the mainland market - Hong Kong barristers can become agents in civil litigation cases on the mainland; and Hong Kong residents qualified for legal practice on the mainland can act in the capacity of mainland lawyers in matrimonial and succession cases relating to Hong Kong.

Further, the mainland will allow Hong Kong permanent residents with Chinese citizenship to set up individually owned stores throughout the country to provide five more kinds of services, namely crop cultivation, animal husbandry, aquaculture, computer repair, and technology exchange and promotion services. Consistent with the overall thrust of individually owned stores for Hong Kong residents, the new measures will further stimulate the entrepreneurship of Hong Kong residents, while fostering a stronger economic integration between Hong Kong and the mainland.

In addition to three phases of CEPA liberalisation measures implemented since 2004, the Chinese mainland and Hong Kong agreed in late June of 2006 on another package of liberalisation measures under CEPA covering trade in goods and services, as well as trade and investment facilitation.

Regarding trade in goods, the Chinese mainland and Hong Kong have agreed to extend the list of CEPA-origin products by 37 to 1,407. These newly-added products will be eligible for zero tariff from 1 July 2006.

As for trade in services, there will be 15 liberalisation measures spreading across 10 areas, namely legal, construction, information technology, convention and exhibition, audiovisual, distribution, tourism, air transport, road transport, and individually owned stores. Like CEPA III, there is no new service sector open under the latest liberalisation package, after CEPA I and CEPA II have combined to provide enhanced access in 27 sectors for Hong Kong's service suppliers and residents. All the service sector liberalisation measures will take effect from 1 January 2007, and the Chinese mainland will devise and implement the necessary rules and regulations as appropriate.

A new initiative under trade and investment facilitation of the latest CEPA package is to enhance the co-operation and exchanges between the two sides on intellectual property issues. In addition, the Central government is studying the scope for further expansion of Renminbi (RMB) business in Hong Kong, which includes allowing Hong Kong importers to settle direct import trade from the mainland in RMB, and allowing mainland financial institutions to issue RMB financial bonds in Hong Kong on a pilot basis.

The Chinese mainland has granted all products of Hong Kong origin tariff-free treatment under CEPA III, which has taken effect from 1 January 2006, except for prohibited items such as used electrical machinery and medical products, chemical residual, municipal waste, tiger bone and rhinoceros horn. However, eligible products must fulfill the CEPA rules of origin to enjoy tariff-free treatment. For products which have no agreed CEPA rules of origin, Hong Kong will initiate discussions with the mainland twice a year upon requests by local manufacturers.

Of the products in which Hong Kong manufacturers have shown interest in the first round of discussions undertaken in the first half of 2006, the CEPA rules of origin on 37 products have been worked out. As a result, the number of products with agreed CEPA rules of origin, and hence eligible for zero-duty access to the mainland market, has now expanded from 1,370 to 1,407.

These newly-added products, which have become eligible for zero tariff starting from 1 July 2006, include aquatic products, food and seasonings, chemical products, plastic and rubber products, as well as electrical and mechanical products. In 2005, Hong Kong's domestic exports of these 37 products to the mainland surged by 62% to almost HK$ 23 million. Now with zero-duty access, facilitated by the liberal CEPA origin rules, Hong Kong's domestic exports of these products to the Chinese mainland are expected to go strength from strength in the way ahead. Without tariff-free treatment, the applicable tariff rates for these 37 products range from 4% to 21%.

The immediate benefit of tariff-free access is cost savings for Hong Kong's domestic export items being sold to the Chinese mainland. From January 2004 to June 2006, a total of 13,874 Certificates of Hong Kong-origin (CEPA) were approved under the first three phases of CEPA, incurring a total value of HK$4,872 million. Textiles and clothing products were the largest beneficiary, followed by pharmaceutical products, food and beverages, plastics and plastic articles, paper and printed articles, and chemical products.

Note: The total figure is smaller than the sum of all product types as one Certificate of Origin can cover products of more than one type.

With the origin rules of an increasing number of items to be worked out over time, it is expected that zero-tariff access to the mainland market will stimulate some manufacturing activities in Hong Kong, and provide an impetus for Hong Kong's domestic exports to the mainland. While the CEPA rules of origin have now been agreed for 1,407 products only, all other products will subsequently be eligible for tariff-free access, amid applications by Hong Kong manufacturers and the rules of origin being agreed and met. Besides, existing production can also be expanded to take advantage of the zero-tariff benefits.

Apparently, most manufacturers in Hong Kong will continue to use the mainland as their main production base. Yet, some of them may consider revitalising their existing facilities or setting up new production lines in Hong Kong to take advantage of CEPA. Meanwhile, given the zero-tariff advantage of Hong Kong's domestic exports to the mainland, it is hoped that some foreign manufacturers that plan to set up production lines in the region will be attracted instead to Hong Kong.

Given that the ultimate or target market of these companies is the Chinese mainland, tariff savings in Hong Kong must be substantial enough to offset the higher Hong Kong production costs. Alternatively, for products with high value-added content (in terms of brand, design, quality, technology, etc.) or intellectual property (IP) input being the major component in their total cost structure, production in Hong Kong would be more feasible if Hong Kong can generate a higher IP value, or provide better IP protection.

In these circumstances, it is expected that some high value-added or IP input industries that do not require a mass scale of production would probably be set up in Hong Kong. These industries are likely to be high-end lifestyle products that have a strong design element. A case in point is clothing, of which Hong Kong still maintains quite substantial production locally. Prior to 2005, existence of clothing quota encouraged Hong Kong companies to retain domestic manufacturing in light of the quota availability in Hong Kong. Currently, they still continue their local production to go around the quota re-imposed by the US and EU on mainland-origin clothing products.

Given widespread food safety concerns on the mainland, food processed in Hong Kong may also instil better confidence in product quality among mainland consumers. A "Made in Hong Kong" label for these products is expected to be a sought-after item by mainland consumers, and their production in Hong Kong seems feasible. In the meantime, production that requires strong protection of the investor's proprietary technology or R&D results, such as medicines, may further find Hong Kong a better investment location, although sales across the border are subject to a set of rules governing drug importation into the mainland.

While increased opportunities in exporting Hong Kong originated products to the mainland market may encourage existing local industries to expand their output and production capacity, it is also expected that some Hong Kong and foreign companies may be attracted by CEPA to set up new production lines in Hong Kong. Under CEPA, the rules of origin have now been agreed for 1,407 products only. But all Hong Kong origin products will subsequently be eligible for tariff-free access amid applications by Hong Kong manufacturers and the rules of origin being agreed and met, including those without existing production in Hong Kong. This demonstrates well the positive effect of CEPA in attracting new industrial investment and new manufacturing activities to be located in Hong Kong.

At present, most Hong Kong factories on the mainland are producing under original equipment manufacturing (OEM) arrangements for overseas markets. Even though some companies have developed their own brands and started selling to the mainland domestic market, most of them are positioned at the middle- or upper-middle end of the market. In light of the zero-tariff arrangement, Hong Kong companies might be interested in starting a new product line of premium products or new brands in Hong Kong to target the higher end of the mainland market.

It is agreed that although a "Made in Hong Kong" label is able to charge a higher price for certain lifestyle and fashion products in the mainland market, it must be complemented by a strong or premium brand image. This is because, for most mass-market products on the mainland, price is a dominating factor of consideration in purchase. Even for branded products, once the brand is accepted, its place of origin is of less importance. Hence, setting up a mass-market product line in Hong Kong might not be feasible or profitable.

Industries that are likely to benefit from CEPA's zero-tariff arrangement and justify production in Hong Kong for selling to the mainland market would need to fulfil one or more of the following criteria.

Admittedly, only niche and high-end products of traditional industries will benefit from CEPA. Lifestyle products, such as high fashion and accessories, stylish watches and spectacles, are likely to be able to capitalise on the strength and reputation of Hong Kong in design and quality control, and to develop upmarket brands or products for the mainland's emerging middle class. Lifestyle products aside, a "Made in Hong Kong" label may be crucial for certain processed food products, which have the upper hand over mainland brands in terms of quality and safety of consumption.

Apart from traditional industries, Hong Kong may also be able to attract some new local and foreign investment in industries that require strong protection of their proprietary technologies, formulae or inventions. This is particularly true for some industries that are still restricted from forming wholly-owned foreign companies on the mainland. For example, foreign investors must form joint ventures if they invest in the "restricted industries"² , such as production of certain medicine materials, small crawler dozers and small truck cranes, on the mainland. Since the IP value of the proprietary technologies or inventions of these industries is high, foreign investors may prefer investing in a wholly-owned venture in Hong Kong to forming a joint venture on the mainland.

Even for some industries that do not have any restrictions in the shareholding by foreign investors in manufacturing projects on the mainland, foreign investors may still be attracted to set up R&D facilities or production of proprietary products in Hong Kong if they are targeting the mainland market, or making use of the advantage derived from the economic synergy of Hong Kong and the mainland. This is particularly true for medium-sized foreign companies which are not familiar with the mainland's business environment, and cannot afford to invest in their own independent R&D facilities on the mainland. Hong Kong's high standards of IPR protection, its status as a free port and the added advantage of CEPA that allows tariff-free and more efficient trade with the mainland, would be an edge in attracting foreign companies to invest in Hong Kong.

CEPA effectively lowers the entry threshold for Hong Kong service suppliers, giving them enhanced access to the mainland market compared with other foreign companies (whose access conditions are subject to the mainland regulations as depicted in the left hand column of respective tables below, under Current Scope of Access). For example, foreign law firms on the mainland are not allowed to practise Chinese law or operate in association with mainland law firms. Besides, foreigners are disallowed to sit the mainland's legal qualifying examinations and to undergo internship.

The latest CEPA package not only offers greater flexibility for Hong Kong law firms to operate on the mainland, but also significant steps for Hong Kong lawyers and barristers to render services to their clients.

From 1 January 2007, Hong Kong lawyers qualified to practice on the mainland can represent clients (with a Hong Kong connection) in marriage and succession-related lawsuits. Hong Kong barristers can act as agents in mainland civil cases.

The latest CEPA measures waive the requirement on the number of full-time lawyers employed by mainland law firms that operate in association with Hong Kong law firms. On the other hand, there will be no residency requirement for representatives of Hong Kong law firms in their mainland offices from 1 January 2007.

In addition, Hong Kong residents who have acquired mainland legal professional qualifications can undergo internship in the branch office of a mainland law firm set up in Hong Kong.

Current Scope of Access	Access for Hong Kong under CEPA
Foreign law firm's representative office: residency period of 6 months each year	Hong Kong law firm's representatives in their mainland representative offices are generally subject to a residency period of 2 months each year, though this residency requirement is waived for offices in Guangzhou and Shenzhen are waived. From January 2007, there will be no residency requirement for Hong Kong law firm's representatives in their mainland representative offices.
Foreign law firms: cannot operate in association with mainland law firms	In order to operate in association with mainland law firms, Hong Kong law firms must meet the following four conditions: have its own name, premises and its articles of association; have asset of RMB100,000 or more; have 3 or more partners [to be eligible as a partner of a law firm on the mainland, a person must possess lawyer qualification and have been in practice for 3 years]; and have a partnership agreement in writing. For mainland law firms to operate in association with Hong Kong law firms, current CEPA provisions require that (1) they have set up for 3 years; and (2) have at least 20 qualified lawyers. From January 2007, however, the second condition will be lifted (i.e. there is no required number of full-time lawyers employed by mainland law firms to operate in association with Hong Kong law firms).
Foreign lawyers cannot practise Chinese law.	Hong Kong residents who have acquired mainland lawyer qualifications or legal professional qualification are allowed to intern and engage in non-litigation legal work on the mainland. They can expand their service scope from January 2007, acting in the capacity of mainland lawyers to engage in matrimonial and succession cases that are connected to Hong Kong.
	From January 2007, Hong Kong barristers can act as agents in civil litigation cases on the mainland in the capacity of citizens
	Hong Kong residents with Chinese citizenship can sit the legal qualifying examination on the mainland. Hong Kong residents who have acquired mainland legal professional qualifications to undergo one-year internship in a mainland law firm may apply to practice as lawyers. From January 2007, internship can be carried out in the branch office of a mainland law firm set up in Hong Kong.

Under CEPA, construction professional services include construction design services, engineering services, integrated engineering services, urban planning and landscape design services (except overall urban planning services).

Existing mainland laws and regulations allow the formation of wholly foreign-owned engineering design enterprises and urban planning service enterprises, though most Hong Kong firms are small enough in size to find it hard to comply with all of the current grading qualifications and professional requirements. While CEPA III touches on relaxation of qualification requirements, details of the necessary implementation rules and regulations are still being awaited. As an aside, it is reported that a total of 23 Hong Kong companies have obtained Grade A or B qualification certificates in the mainland's construction engineering design services sector.

The new CEPA measures announced in late June of 2006 stipulate that Hong Kong companies can set up wholly-owned construction engineering cost consulting service companies on the mainland. Hong Kong companies' individual performance, be it in Hong Kong or on the mainland, will be taken into account in qualification assessment by mainland authorities (as in the case of engineering design enterprises and urban planning service enterprises).

Thanks to the liberalisation measures introduced under the CEPA II package, Hong Kong companies are allowed to apply for Computer Information System Integration Qualification (CISIQ) Certification in accordance with the provisions of relevant mainland laws, regulations and rules. Under the mainland system, only companies registered on the mainland are eligible for CISIQ Certification.

Owing to the further liberalisation measures under CEPA in 2006, the assessment criteria in respect of professional job titles, business turnover and number of personnel will be relaxed from 1 January 2007 for Hong Kong service companies.

In addition to facilitating Hong Kong's IT industry to gain enhanced access to the mainland market, CEPA also allows third-party accreditation in Hong Kong of system integration capability of Hong Kong service suppliers.

Foreign companies were allowed access to the sector in March 2004, even though the Chinese mainland had made no related commitment under its WTO accession protocol. Nevertheless, foreign invested companies on the mainland are not allowed to organise exhibitions in the overseas market.

Thanks to further liberalisation measures of CEPA unveiled in June 2006, Hong Kong-invested convention and exhibition companies on the mainland can organise exhibitions in Hong Kong and Macau from 1 January 2007. This arrangement would not only help companies on the mainland, which are increasingly aiming for 'going out' to the international market, to make better use of Hong Kong's premier platform and world-class facilities in exhibition to international buyers, but also further enhance Hong Kong's position as a leading trade fair centre in the region.

While the existing CEPA provisions include significant market liberalisation measures for Hong Kong's audio-visual services industry, the new CEPA measures further simplify the approval procedures to facilitate mainland-Hong Kong cooperation in TV programme production. The exact implementation details are being worked out by the concerned mainland and Hong Kong authorities.

CEPA is instrumental in removing the remaining hurdles for Hong Kong companies to participate in the mainland's distribution business, which is already very open.

By virtue of the further liberalisation measures under CEPA unveiled in June 2006, the maximum shareholding of Hong Kong investors in retail businesses with over 30 stores on the mainland will be raised -- from currently not exceeding 51%, to 65% from January 2007. This is expected to provide higher flexibility and incentives for Hong Kong's large retailers to embark on more aggressive expansion in the mainland market.

The individually owned stores provision under CEPA is a significant measure to promote relocation and entrepreneurship for Hong Kong people. Given the widened scope of business that individually owned stores can participate in, the opportunities and choices opened to Hong Kong individuals are immense.

CEPA has always been a boon to Hong Kong. Aside from the liberalisation measures in trade in goods and services, CEPA has also instituted other measures to benefit Hong Kong economically. For example, Hong Kong has drawn substantial economic benefits from the Individual Visitor Scheme (IVS) implemented since July 2003. On a cumulative basis, more than 13 million of mainland tourists have come to Hong Kong under IVS. In May 2006 alone, more than 470,000 mainland tourists arrived in Hong Kong under IVS, rising year-on-year by 13% and accounting for 45% of the total mainland visitors.

The influx of mainland visitors has helped Hong Kong's tourism and hotel sectors, as well as related sectors like retail, catering and entertainment. Further, the shopping spree has prompted some foreign brands and retailers to open outlets in Hong Kong. Currently, more than 200 million residents from over forty mainland cities can apply to come to Hong Kong as IVS travelers, and the scope of mainland cities participating in IVS looks set to further expand in the future.

In addition, CEPA liberalisation measures allow Hong Kong's travel agencies to set up wholly-owned operations on the mainland ahead of competitors from other nations, also with lower turnover requirements.

Thanks to the further liberalisation measures announced in late June of 2006, Hong Kong travel agencies set up on a wholly-owned or joint venture basis in Guangdong can apply for running group tours to Hong Kong/Macau for Guangdong's permanent residents on a pilot basis. Significantly, this pilot scheme marks the first endeavour of the Chinese mainland to open up its outbound tourism market. Accordingly, this CEPA measure is expected to generate more business opportunities for Hong Kong's travel industry and lead to higher mainland tourist arrivals to Hong Kong.

Access for Hong Kong under CEPA