• 29 liberalisation measures spanning 17 service sectors
• 17 Guangdong pilot measures adopted under CEPA service sectors
• 4 new business areas opened under individually-owned stores scheme
• Number of products with CEPA origin rules expanded by 8 to 1,510

Signing Supplement V to the Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA) in Hong Kong on 29 July 2008, the Central and Hong Kong governments agreed on the latest liberalisation measures which are to take effect from January 2009.¹

Supplement V to CEPA introduces 29 measures spanning 17 services sectors, building on the liberalisation of 15 existing services sectors and opening two more mining-related services sectors to Hong Kong businesses. Compared to Supplement IV to CEPA, which is recognised for considerably broadening the scope of services sectors with its introduction of 11 new services sectors (raising the total to 38),² Supplement V contains measures to enrich and deepen the content of liberalisations, especially in relation to Hong Kong-Guangdong economic and trade cooperation. Against the backdrop of CEPA, the Chinese mainland has approved some liberalisation and facilitation measures for early and pilot implementation in Guangdong (¥ý¦æ¥ý¸Õ).

A total of 25 Guangdong pilot measures will be implemented, 17 of which are included under CEPA's services liberalisation package. Some pilot measures accord treatments to Hong Kong services suppliers (HKSS) in respect of minimum capital requirements to be in line with Guangdong province, while others delegate the authority to approve applications in respect of establishing business units in Guangdong at the provincial level. The CEPA package and Guangdong pilot measures will offer new business opportunities on the mainland for HKSS and residents, while making the city even more attractive to overseas investors. For instance, HKSS can benefit from the WTO-plus treatment to set up wholly-owned environmental pollution control enterprises on the mainland, and approval of their qualification will be delegated to Guangdong under the new pilot implementation measures.

Another feature of Supplement V to CEPA is the addition of two new, mining-related services sectors, which have been offered by China to Chile under their free trade agreement (FTA) but not covered by prior CEPA measures. This inclusion is consistent with the extension to Hong Kong under Supplement IV to CEPA the preferential access that China offered to ASEAN, indicating that Hong Kong will also gain access to the mainland market in areas offered by the mainland to other FTA signatories, as the mainland works on more FTAs.

CEPA is conducive to removing the remaining hurdles for HKSS in the mainland's distribution sector, which is now very open. For a single foreign enterprise that opens more than 30 stores accumulatively in China for sales of certain commodities, foreign ownership is limited to 49%. With Supplement V provisions, HKSS can expect the controlling stake to rise from 65% currently to 100% in 2009, and this should provide greater flexibility for HKSS to embark on more aggressive retail expansion in the mainland market. Besides, Hong Kong permanent residents with Chinese citizenship are allowed under CEPA to set up individually owned stores throughout the country, and the allowable business scope will be expanded under Supplement V to CEPA to include four more kinds of services, namely: building cleaning, advertising production, trade brokerage and commission agencies, as well as renting and leasing services (the latter two services are for Guangdong). These new measures will further stimulate the entrepreneurship of Hong Kong residents.

From January 2006, all Hong Kong-made products are eligible for zero-duty access to the Chinese mainland if they comply with the agreed CEPA rules of origin by virtue of Supplement II to CEPA. Through the implementation of CEPA from January 2004 to June 2008, the number of goods eligible for tariff-free treatment rose from 273 to 1,502. From July 2008, CEPA added 8 new products to the list to 1,510. For these items, the applicable tariff rates which would otherwise apply range from 2% to 15%.

Trade in Services

Recent Developments

A total of 29 liberalisation measures covering 17 services sectors (15 existing sectors and 2 new sectors) are provided under Supplement V to CEPA. Consequently, the total number of service sectors covered by CEPA has been expanded from 38 to 40, with the new CEPA provisions to become effective from 1 January 2009. Since the implementation in 2004, more than 200 service liberalisation measures have been introduced under CEPA.

As a result of the service liberalisation measures under Supplement V, the Chinese mainland has specifically agreed to relax market access conditions in the following services sectors, namely: accounting, construction, medical, convention and exhibition, banking, tourism, transport (including air, road and sea), distribution, individually owned stores, job placement (referral agency and intermediary), printing, environment, social services for the disabled, mining, and scientific and technical consulting.

Owing to the geographic proximity between Guangdong Province and Hong Kong as well as their strong economic ties, the Chinese mainland has also approved 17 service liberalisation measures under CEPA for early and pilot implementation in Guangdong (¥ý¦æ¥ý¸Õ). If these Guangdong pilot measures were to prove effective, they might be extended to other mainland provinces.³

Accounting Services

Generally, CEPA does not include significant market liberalisation measures for Hong Kong's accounting firms and professionals. For smaller Hong Kong accounting firms, the main option for them to serve the mainland market is via the "Provisional Licence to Perform Audit-Related Services" (i.e. Temporary Audit Permit). The validity period of the Temporary Audit Permit has been extended to two years since 2006. Further extension allowed under Supplement V from January 2009 will further reduce the administrative burden for Hong Kong accounting firms compared with the requirements which otherwise apply to other foreign companies, which are non-CEPA beneficiaries (see table below).

In addition to the three liberalisation measures under Supplement V to CEPA, Hong Kong and the mainland signed two supplementary agreements on 29 July 2008, with effect from that day, to:

• Extend the mutual exemption of two examination subjects between members of the Chinese Institute of Certified Public Accountants (CICPA) and the Hong Kong Institute of Certified Public Accountants (HKICPA) Qualification Programme graduates to cover exemption of a third subject ("financial reporting" in Hong Kong and "accounting" on the mainland); and
• Extend the scope of beneficiaries to all HKICPA members who were not qualified solely through the Qualification Programme.

Thanks to the two supplementary agreements, a far greater number of HKICPA members will be eligible for the mutual exemption arrangement. Further, with the exemption of the third subject, HKICPA members will have to take examinations in two more mainland subjects (taxation and economic law) to become qualified. The new arrangements to set up examination centres in Shenzhen, Dongguan and Hong Kong will also facilitate Hong Kong people in their endeavour to obtain mainland accounting qualifications.

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Construction Professional Services

Currently, foreign-owned construction and engineering design enterprises can set up wholly-owned or joint venture entities on the Chinese mainland. As stipulated under Article 15 of Decree No. 114 of the Ministry of Construction (MoC), i.e., Regulations on Administration of Foreign-Invested Construction and Engineering Design Enterprises, however, there are strict requirements on the number or proportion of Chinese-qualified architects, engineers and technical staff with relevant design experience on the staff of these enterprises. CEPA offers more relaxed access conditions for Hong Kong service suppliers (HKSS) by allowing them to employ mainland registered professionals to fulfill the requirements.

For joint-venture construction and engineering design enterprises, there is currently a requirement that the proportion of the total capital contributed by the mainland partners to the registered capital should be no less than one-quarter. Thanks to Supplement V to CEPA, this restriction will be removed from January 2009, thus offering HKSS greater flexibility in partnering with their mainland counterparts.

Additionally, Supplement V to CEPA also enhances the participation of Hong Kong professionals who have obtained the mainland's supervision engineer or urban planner qualification in the concerned services sectors in Guangdong Province, as they will be allowed to register and practise there, regardless of whether they are registered practitioners in Hong Kong or not.

Medical Services

In view of the unfulfilled demand for quality medical services on the mainland, provision of Hong Kong's quality medical services via Hong Kong-run hospitals and clinics and Hong Kong-trained doctors would help improve services by enhancing competition in the mainland's medical services market.

On the heels of the liberalisation measures under Supplement IV to CEPA, which lower the investment amount for establishing equity or contractual joint venture medical institutions (including hospitals and clinics) by 50% from RMB 20 million to RMB 10 million, Supplement V further opens up business opportunities for Hong Kong's medical sector in Guangdong Province. From January 2009, there will neither be any minimum investment amount nor restriction on the ratio of capital investment for setting up outpatient clinics in the form of wholly-owned, equity joint venture or contractual joint ventures in Guangdong Province. Project establishment and approval procedures will also be handled by Guangdong's health administrative department.

Outpatient clinics are divided into several categories on the Chinese mainland, such as "Integrated outpatient clinics" and "Specialist outpatient clinics", each with specific establishment requirements. The Ministry of Health will later provide more details on types of medical services that can be provided in outpatient clinics set up by Hong Kong service providers.

In addition to previous measures to allow eligible Hong Kong permanent residents to sit the mainland's qualification examination, qualified Hong Kong permanent residents with Chinese citizenship will be allowed to apply for and obtain the mainland's "medical practitioner's qualification certificate" through accreditation from January 2009. This, along with the prior measure on a short-term practising licence, should be conducive to attracting Hong Kong-trained doctors to work on the mainland.

Convention and Exhibition Services

Although China began granting foreign companies access to its convention and exhibition services sector in March 2004, foreign-invested companies on the mainland are not allowed to organise exhibitions in overseas markets. In contrast, Hong Kong-invested exhibition companies set up on the Chinese mainland are allowed under CEPA to organise exhibitions in Hong Kong and Macau from January 2007 on a wholly-owned or joint venture basis. In addition, Hong Kong-invested exhibition companies set up on a wholly-owned or joint venture basis in Guangdong or Shanghai are allowed to organise overseas exhibitions on a pilot basis.

Under the provisions of Supplement V to CEPA, Hong Kong-invested exhibition companies registered in Beijing, Tianjin, Chongqing and Zhejiang as a wholly-owned or joint venture enterprise in that municipality or province will be allowed to organise overseas exhibitions on a pilot basis from January 2009.

The extension from Guangdong and Shanghai to other municipalities and province will further open up the mainland market for Hong Kong services suppliers (HKSS), as the four other places included are also important manufacturing bases and have robust demand for overseas exhibitions to showcase their products.

While such pilot measures will also assist enterprises in these municipalities and provinces eyeing the international market to venture out and attend overseas exhibitions organised by HKSS, Hong Kong's position as a leading trade fair and convention centre in the region will be further strengthened. Moreover, more international players will likely be attracted to establish their presence in Hong Kong given CEPA's advantages.

Banking Services

Hong Kong's banking sector has benefited significantly under CEPA. Among other things, the thresholds of market entry have been lowered considerably so that the mainland market is now more widely open for smaller Hong Kong banks.

Under Supplement V to CEPA, the mainland-incorporated banking institution established by a Hong Kong bank can locate its data centre in Hong Kong, provided that the banking institution was incorporated on the mainland on or before 30 June 2008 and a data centre was already established in its parent bank in Hong Kong at the time of incorporation, subject to the approval and prudential requirements of the relevant mainland authorities.⁴

This new CEPA provision is beneficial to Hong Kong services suppliers, as the establishment of a separate data centre on the mainland incurs additional cost and risk and difficulty in maintenance, especially if a data centre has already been established in Hong Kong. On the other hand, this arrangement also signifies the confidence of mainland authorities in Hong Kong's legal, regulatory and technical infrastructures for banks' data centre operations. Hong Kong banks that would reportedly benefit from this CEPA provision include the Bank of China (Hong Kong), Bank of East Asia, Citic KaWah Bank, Hang Seng Bank, HSBC and ICBA Asia and Wing Hang.

Tourism and Travel-Related Services

Under CEPA, the mainland agrees to open up its outbound tourism market to Hong Kong travel agencies, which is a significant endeavour in itself. Currently, Hong Kong travel agencies can set up a wholly-owned or joint venture entity in Guangdong to apply to conduct group tours to Hong Kong and Macau for Guangdong's permanent residents on a pilot basis. This pilot scheme of outbound group-tours is also extended under CEPA to places like Guangxi, Hunan, Hainan, Fujian, Jiangxi, Yunnan, Guizhou and Sichuan.

Supplement V to CEPA stipulates that Guangdong Province will be delegated the authority to approve applications submitted by Hong Kong services suppliers (HKSS) to set up travel agents on a wholly owned, equity joint venture or contractual joint venture basis in Guangdong, starting from January 2009. Besides, Hong Kong permanent residents with Chinese citizenship will be allowed to take an examination to qualify as a mainland tour guide.

The two new measures well complement each other. Under the new measures, a Hong Kong travel agent or tour operator, meeting the appropriate requirements, can establish a network in Guangdong Province, and at the same time, use its own Hong Kong tour guides with mainland qualifications to perform tour guide functions on the mainland. These measures will help contribute to the modernisation of the tourism sector in Guangdong through the introduction of quality HKSS into the province.

Besides the new measures under CEPA, there are three other measures that dovetail with deepening the cooperation with Guangdong Province in the tourism sector, including the extension of the "simplified entry arrangement" from the Pearl River Delta to the entire province of Guangdong, and allowing mainland-authorised Hong Kong travel enterprises to organise group tours to Hong Kong Disneyland for certain non-residents in Guangdong.*

Transport Services

Air Transport Sales Agency Services

CEPA provides enhanced access to HKSS in the provision of air transport sales agency services. Currently, Hong Kong companies can set up wholly-owned, equity joint venture or contractual joint venture units to provide air transport sales agency services on the mainland to cover both domestic routes as well as international routes (including Hong Kong, Macau and Taiwan), that is, Type I and Type II air passenger and freight sales agency services. The registered capital requirement is the same as that for mainland enterprises.

As stipulated in Qualification Procedures for China Civil Aviation Transportation Agency Services issued by the China Air Transport Association (CATA), however, the applications for Type I and Type II air transport sales agencies on the mainland, whether in the form of wholly-owned enterprises, equity joint ventures or contractual joint ventures, are required to go through the substantive initial vetting by CATA's local representative offices. Contrastingly, HKSS can submit their application materials directly to CATA for examination.

In applying to set up air transport sales agencies on the mainland, HKSS are currently required to submit an economic guarantee provided by China-capital banks on the mainland or guarantee companies recommended by CATA (provided that the registered capital of the China-capital enterprise is not lower than that of the Hong Kong enterprise being guaranteed). With Supplement V to CEPA, the economic guarantee can be provided by mainland-incorporated banks, including both domestic and foreign banks. Conceivably, the new CEPA measure provides a clear scope of parties eligible for providing an economic guarantee, which would help HKSS in their applications to operate air transport sales agencies on the mainland.

Air Transport Services

Sea Transport Services

Compared with the conditions applying to other foreign companies, CEPA allows Hong Kong service providers to have greater flexibility in providing many types of maritime services, as they are allowed to form wholly-owned units.

China's Regulations on the Administration of Foreign Investment in International Marine Transportation stipulate that only minority-owned foreign joint ventures are allowed to provide services that include the following: international shipping agency; international ship management; international shipping; maritime cargo-handling services; customs clearance services for maritime transport; container station and depot services; international marine shipping, freight loading and unloading, and international marine shipping container terminal and yard business.

Under CEPA, Hong Kong service providers can form wholly-owned units in providing maritime services such as international ship management services, container station and depot services, non-vessel operating common carrying services, port cargo loading and unloading services, tug services between Hong Kong and mainland ports, ship maintenance and repair services, international ocean container leasing, buying and selling as well as trading of container parts, and ship survey services for ships registered in Hong Kong.

Because of Supplement V provisions, the business scope is further expanded for Hong Kong service providers, as they will be allowed from January 2009 to set up wholly-owned enterprises and branches in Guangdong on a pilot basis to provide shipping agency services to vessel operators for routes between Guangdong Province and Hong Kong and Macau.

Road Transport Services

CEPA currently allows Hong Kong service suppliers to establish wholly-owned enterprises in the provision of road freight transport and related services like road freight transportation station and motor vehicle repair services. The approval is currently vested in the Ministry of Transport.

The latest CEPA agreement on road transport services states that Guangdong will be delegated the authority to approve the provision of road freight transport services by Hong Kong-invested production enterprises in Guangdong from January 2009. Applications for providing transport-related services in Guangdong, such as road freight transport stations, repair and driver training enterprises, will also be handled by the Guangdong authorities. These new arrangements are expected to hasten the approval process and facilitate HKSS in their business expansion into Guangdong.

Distribution Services

CEPA is conducive to the removal of the remaining hurdles for Hong Kong companies to participate in the mainland's distribution business, which is already very open. In compliance with WTO commitments, China removed all restrictions on foreign participation in distribution services in December 2006, except one. For a single foreign enterprise that opens more than 30 stores cumulatively in China, and if the commodities for sale include pharmaceutical products, pesticides, mulching films, chemical fertilizers, vegetable oil, edible sugar and cotton, the proportion of capital contribution by its foreign shareholders cannot exceed 49%.

In comparison, CEPA currently allows Hong Kong companies to become controlling shareholders (capped at 65% of capital contribution) in the distribution of the above commodities. By virtue of the further liberalisation measures under Supplement V to CEPA, Hong Kong companies can operate on a wholly-owned basis to supply these products on a wholly-owned basis, if these commodities are of different brands and come from different suppliers. This new measure is expected to provide greater flexibility and incentives for Hong Kong's large retailers to embark on more aggressive expansion in the mainland market.

Individually Owned Stores

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

Under Supplement V to CEPA, the allowable scope for Hong Kong permanent residents' individually owned stores on the mainland will be expanded from January 2009 to include building-cleaning services and advertising production services (excluding franchising operations). Thanks also to the Guangdong pilot measures unveiled in July 2008, the business scope for individually owned stores set up in Guangdong will cover trade brokerage and commission agency services (excluding auctions),⁵ as well as renting and leasing services (excluding the renting and leasing of housing premises).

Job Referral Agencies and Job Intermediaries Services

Compared to other foreign job placement agencies on the Chinese mainland, Hong Kong companies have gained enhanced flexibility in tapping the huge mainland market as a result of CEPA provisions. They can now form wholly-owned job referral and intermediary agencies on the mainland. From January 2009, Hong Kong companies will benefit additionally from the liberalisation measures as per Supplement V to CEPA, with the required minimum registered capital for setting up job placement agencies in Guangdong changed from US$125,000 to RMB 100,000, which will be a significant reduction, as Hong Kong companies will be subject to the same requirements applicable to Guangdong enterprises.

Printing Services

CEPA is instrumental in lowering the thresholds of Hong Kong service suppliers in entering the mainland market. Compared to a minimum registered capital requirement of RMB 10 million in respect of setting up of printing enterprises to provide printing services for packaging materials by other foreign companies, national treatment will be accorded to Hong Kong companies in respect of the minimum capital requirement for setting up printing enterprises to provide packaging material printing services, as it will be lowered substantially from RMB 10 million to RMB 1.5 million which is applicable to mainland enterprises.

Environmental Services

With rapid urbanisation and industralisation on the Chinese mainland, there is also growing attention about the effects on the environment. Under CEPA, HKSS are given WTO-plus treatment to set up wholly-owned enterprises on the mainland to provide environmental protection services compared to the majority-owned joint ventures allowed for other foreign companies.

The business scope of services allowed for HKSS under CEPA is similar to that under WTO, including sewage, refuse disposal, cleaning of exhaust gases, noise abatement, sanitation, nature and landscape protection, and other environmental protection services, but excluding environmental quality monitoring and pollution source investigation.

As one of the Guangdong pilot measures agreed in the latest CEPA package, Guangdong will be delegated the power to approve the qualification of HKSS in setting up enterprises to operate environmental pollution control facilities in the province.

Social Service for the Disabled

Presently, CEPA allows HKSS to operate social service agencies in the form of wholly-owned private non-government enterprises to provide elderly services in Guangdong on a pilot basis. With Supplement V provisions, the scope of the pilot scheme will be extended to include services provided to persons with disabilities in Guangdong.

Private non-government enterprises, as defined under the Provisional Regulation Concerning the Registration and Administration of Private Non-enterprise Units promulgated by China's State Council, are those community units set up by enterprises, public services units, social organisations and other community parties and individual citizens with non-governmental assets that are engaged in the provision of non-profit services.

HKSS registered as private non-government enterprises to provide the aforementioned social services will be entitled to the prevailing preferential treatments granted by Guangdong authorities to other social agencies in the province.

New Services Sectors under Supplement V to CEPA and Other Guangdong Cooperation Measures

In addition to the liberalisation measures spanning 15 existing service sectors, Supplement V to CEPA adds two new sectors to the services liberalisation package. These new services are incidental to mining (confined to exploration of oil and natural gas only, through contractual joint ventures), and related scientific and technical consulting services (prospecting and surveying services for iron, copper and manganese, where HKSS can provide such services in the form of equity joint ventures, contractual joint ventures or wholly-owned enterprises).

Access to the two new sectors has been offered by China to Chile under their bilateral free trade agreement (FTA) and is yet to be covered by prior CEPA liberalisation measures. Their inclusion into Supplement V to CEPA is consistent with the liberalisation measures adopted in Supplement IV, under which the Chinese mainland agreed to offer preferential access to HKSS in the 9 sectors that it had opened up for ASEAN countries (as a result of the China-ASEAN Free Trade Agreement, or CAFTA). Conceivably, in light of CEPA's building block approach and the mainland's preparation to enter into more FTAs, it can be expected that access to the mainland market to FTA signatories could in part be extended to Hong Kong through CEPA.

Other Cooperation Measures with Guangdong

In addition to the 16 service liberalisation measures between Hong Kong and Guangdong covered under CEPA, there are 8 other service liberalisation measures outside CEPA approved to deepen economic and trade co-operation between Hong Kong and Guangdong.

Furthermore, of the three initiatives agreed between the Chinese mainland and Hong Kong under CEPA's trade and investment facilitation, one is connected with Guangdong - a working group will be set up to take forward the pilot run of applications of the mutual recognition of electronic signature certificates issued by Guangdong and Hong Kong. The other two facilitating measures are related to trademark and branding cooperation between the Chinese mainland and Hong Kong.

Mutual Recognition of Professional Qualification and Professional Examinations

CEPA broadens not only the mainland's services sectors for Hong Kong companies, but also enhances the latitude of Hong Kong professionals and residents participating in the mainland's services market, by way of encouraging mutual recognition of professional qualifications and allowing them to sit the mainland's professional qualification examinations. For example, eligible Hong Kong residents are allowed to sit a wide range of qualification examinations for professionals and technicians on the mainland (e.g. medical, legal, insurance, engineering and accounting sectors).⁶

Under Supplement V to CEPA, the Chinese mainland and Hong Kong have agreed that competent authorities or professional bodies from both sides will continue to promote work on the mutual exemption of some of the papers under the Accounting Professional Technician Qualification Examination, and to carry on the mutual recognition of qualifications for construction and engineering professionals in disciplines which have signed mutual recognition agreements and meet well-tested conditions.

Trade in Goods

Recent Developments

The Chinese mainland has granted all products of Hong Kong origin tariff-free treatment under Supplement II to CEPA, which took 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 request by local manufacturers.

From the implementation of CEPA in 2004 until the first half of 2008, the mainland and Hong Kong had reached agreement on the rules of origin for a total of 1,502 products. Effective from 1 July 2008, 8 new products have been included in the list of goods eligible for tariff-free treatment under CEPA. As a result, the number of products with agreed CEPA rules of origin, and hence which are eligible for zero-duty access to the mainland market, has increased from 1,502 to 1,510.

These newly-added products cover lubricating oils, fluorosilicates, preparations containing petroleum oils, polybutylene terephthalate, monofilament, grinding machine-tools, rubber or plastic machines, and audio-frequency electric amplifiers. In 2007, Hong Kong's domestic exports of these 8 products to the mainland only amounted to around HK$13 million. But now with zero-duty access, Hong Kong's domestic exports of these products to the Chinese mainland are expected to go from strength to strength in the way ahead. Without tariff-free treatment, the applicable tariff rates for these 8 products range from 2% to 15%.

Cost Savings for Hong Kong Products

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 2008, a total of 35,230 Certificates of Hong Kong-origin (CEPA) were approved under different phases of CEPA, incurring a total value of HK$13,634 million. Textiles and clothing products were the largest beneficiary, followed by food and beverages, plastics and plastic articles, pharmaceutical products, chemical products, base metal products, colour matters, and paper and printed articles.

Indeed, spurred by the growing number of products eligible for tariff-free treatment, which has surged from 374 in 2004 to 1,510 at present, the share of Hong Kong exports benefiting from CEPA in Hong Kong's domestic exports to the mainland has increased from 3% to almost 14%.

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 1,510 products, 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. 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 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 could 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. With zero-tariff arrangements, CEPA in part encourages some Hong Kong companies to keep their manufacturing facilities here, especially for high-end items. In essence, the share of Hong Kong's garment exports to the Chinese mainland as a share of total domestic garment exports has increased from about 25% to 30% of the total over the past two years.

Given widespread food safety concerns on the mainland, food processed in Hong Kong may also instil greater 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.

Effect on Manufacturing Investment

While increased opportunities in exporting Hong Kong-origin 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 into setting up new production lines in Hong Kong. Under CEPA, the rules of origin have now been agreed for 1,510 products. But all Hong Kong-origin products will subsequently be eligible for tariff-free access amid applications by Hong Kong manufacturers, with the rules of origin being agreed and met, including those without existing production in Hong Kong. This demonstrates 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 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 can be of 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 an important factor of consideration in purchases. 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. 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 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 2008 Liberalisation Measures - Implications and Prospects

As an open and developing platform, CEPA allows Hong Kong to continue to engage the mainland authorities in further liberalisation of trade in goods and services with the mainland, and other areas of cooperation in the future. It is also instrumental in permitting enhanced market access for Hong Kong services suppliers and residents to the mainland market, realising its huge investment and business potential.

Compared to the 2007 CEPA package, which provided as many as 40 liberalisation measures in 28 service sectors with 11 new sectors added, the 2008 CEPA package under Supplement V offers only 29 liberalisation measures in 17 services sectors, with only two new services sectors added. However, if one were to signify the 2007 CEPA package as a strong attempt to broaden the scope of services liberalisation for Hong Kong suppliers, then the current CEPA package is significant in that it deepens the liberalisation of the existing services sectors, while concomitantly incorporating a strong dimension of services sector cooperation with Guangdong.

In light of the geographical and cultural proximity to Guangdong, it is clear that these cooperation measures will offer greater and broader investment opportunities to Hong Kong companies and residents by further deepening the economic and trade ties between Hong Kong and Guangdong. For example, according provincial treatments to Hong Kong companies in respect of minimum capital requirement will lower the entry thresholds for the Guangdong market, while delegating the approval authority to the Guangdong provincial level will facilitate and speed up applications of Hong Kong companies. As these cooperation measures will be on a basis of early and pilot implementation in Guangdong (¥ý¦æ¥ý¸Õ), they might also be extended in future to other mainland provinces if they were to be proven effective in Guangdong. A case in point is that HKSS can benefit from the WTO-plus treatment to set up wholly-owned environmental pollution control enterprises on the mainland, and approval of their qualification will be delegated to Guangdong under the new pilot implementation measures.

Of the 29 services liberalisation measures under CEPA, 16, or 55%, are related to Guangdong, covering accounting, construction and related engineering, medical, placement and supply services of personnel, environment, social service, tourism, maritime transport, road transport, and individually-owned stores. In addition, Guangdong will implement 8 other services liberalisation measures in the area of tourism, education, environment, advertising and distribution services, which are outside CEPA but included as measures for deepening economic and trade cooperation between Guangdong and Hong Kong.

Another feature of Supplement V to CEPA is the addition of two new, mining-related services sectors, which have been offered by China to Chile under their free trade agreement (FTA) but not covered by prior CEPA measures. This inclusion is consistent with the extension to Hong Kong under Supplement IV to CEPA the preferential access that China offered to ASEAN, indicating that Hong Kong will also gain access to the mainland market in areas offered by the mainland to other FTA signatories, as the mainland works on more FTAs.

CEPA is conducive to removing the remaining hurdles for HKSS in the mainland's distribution sector, which is now very open. For a single foreign enterprise that opens more than 30 stores accumulatively in China for sales of certain commodities, foreign ownership is limited to 49%. With Supplement V provisions, HKSS can expect the controlling stake to rise from 65% currently to 100% in 2009, and this should provide greater flexibility for HKSS to embark on more aggressive retail expansion in the mainland market.

Besides, Hong Kong permanent residents with Chinese citizenship are allowed under CEPA to set up individually owned stores throughout the country, and the allowable business scope will be expanded under Supplement V to CEPA to include four more kinds of services, namely: building cleaning, advertising production, trade brokerage and commission agencies, as well as renting and leasing services (the latter two services are for Guangdong). These new measures will further stimulate the entrepreneurship of Hong Kong residents.

On trade in goods, the zero import tariff preference has the potential to attract to Hong Kong more investment and production targeting goods with higher-value added content, in terms of brand, design, quality, technology, etc., or substantial intellectual property input. The bi-yearly discussions between Hong Kong and the mainland on origin rules will provide further flexibility to potential investors planning to manufacture products that are not currently produced in Hong Kong.

Under Supplement V to CEPA, the mainland and Hong Kong have also agreed to adopt trade and investment facilitation measures in the area of branding, trademark and e-commerce, building on the many other trade and investment facilitation measures already in place.

This new report is available at HKTDC's Retail Outlets. It can also be purchased through the HKTDC Bookshop section in the HKTDC's trade portal: www.hktdc.com.