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Mainland/Hong Kong CEPA

A 75-page Chamber paper was submitted to Financial Secretary Antony Leung on March 12, giving him the Chamber's views on the Mainland/Hong Kong Closer Economic Partnership Arrangement (CEPA). These views were gathered from our members and from extensive interviews and research of documents. Mr Leung met Vice Minister An Min of the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) on March 27. (Note: The CEPA discussion is being held between two jurisdictions under the same sovereignty. Therefore, instead of "negotiation," it is referred to as the "consultation.")

1   The relevant WTO rules and the "One country, Two systems"   
     principle should be observed.

2   The CEPA should be mutually beneficial, and take into account
     the trends of economic development in the two places.

3   The consultations should be progressive, starting with the less
     difficult areas.

4   The political, business and academic communities of the two
     places would be widely consulted in the process.

5   Both sides will work actively together to take forward the
     proposal with a view to achieving continuous progress.

These principles largely coincided with the ones espoused in our paper entitled "Towards a Regional Trade Agreement between China and HKSAR", which we submitted to the Financial Secretary on January 21. The Chamber's principles were:

AN ECONOMIC INTEGRATION AGREEMENT: We have proposed that the aim of the RTA should be closer economic integration between China and Hong Kong, a "Closer Economic Relationship" (CER) or "Closer Economic Partnership" (CEP) agreement covering trade and investment in both goods and services.

LIBERAL AND PRO-FREE TRADE: The China/Hong Kong CEPA should be viewed as strongly pro-WTO and pro-multilateralism.

BUILDING ON EXISTING COMMITMENTS: The China/Hong Kong CEPA should be built upon existing WTO commitments, but with both parties being able to enjoy the benefits earlier.

FURTHER LIBERALISATION: In addition, China and Hong Kong can both use the CEPA to discuss further, new liberalisation over and above that already committed to the WTO. China can offer further liberalisation through pilot schemes for Hong Kong traders, which can become test cases for possible offers in the new Doha Round of multilateral trade negotiations.

WIDER COVERAGE THAN WTO: CEPA should have wider coverage than the WTO and should cover investment, competition and government procurement.

BALANCE OF RIGHTS AND OBLIGATIONS: The benefits of the China/Hong Kong RTA should be mutual.

PROGRESSIVITY: The CEPA should not be a one-time arrangement, but should provide the framework for ongoing, progressive liberalisation, especially for the many service industries.

• The talks could be arranged in two phases, using a "first easy, then difficult" approach. Phase I of the talks should be completed before the end of 2002. The CEPA can then enter into force on 1 January 2003. Phase II can take two to three years to complete at a more leisurely pace.

• The business sector should be closely involved.

TARIFF REDUCTION   Hong Kong should seek to achieve a free trade area with zero-tariff in both directions immediately, under Phase I of the talks. This will give Hong Kong manufacturers an advantage in exporting to the Mainland. It may even attract some high value-added manufacturing/assembly operations back to Hong Kong.

EARLY LIBERALISATION OF EXISTING COMMITMENTS   We should seek to establish the principle of "early liberalisation" for Hong Kong companies, by fast-tracking the application to Hong Kong of the benefits of market opening which China has committed for foreign enterprises in the service industries in its WTO accession. This will give Hong Kong companies a time-advantage of between 1 to 6 years.

FURTHER LIBERALISATION OF NOT-YET-COMMITTED MARKET OPENING MEASURES   Through the CEPA a framework should be established for continual negotiations on further liberalisation over and above the commitments in China's Protocol of Accession. If necessary, the concept of "piloting" can be used. For example, as a transition for certain sensitive sectors, the new liberalisation can be limited to "pilot schemes" in some localities in the Mainland, e.g. Guangdong Province or the Pearl River Delta region. At this stage we see no need for a comprehensive and immediate coverage of commitments under this "further liberalisation" category. But we suggest that we strive for a limited number of further liberalisation to be agreed to in Phase I.

REGULATORY CLARIFICATION AND REFORM   Many service industries are highly regulated, hence the CEPA between Hong Kong and China should also address pertinent regulatory issues. Since the regulatory environment in China is emerging, there are many potential pitfalls. Many areas may need to be clarified, while others need to be reformed. The CEPA will be a valuable vehicle for this purpose. A highly regulated market in the Mainland is that of government procurement. Through the CEPA Hong Kong can seek greater access to this very large market.

FACILITATION AND PROMOTION   Even with de-regulation, trade and investment can, and indeed should, be further enhanced through facilitation and promotion. A number of issues can be considered, including greater transparency of rules and regulations, rationalisation of existing regulatory procedures to make them more business-friendly, streamlining of customs procedure for goods and formalising of regulatory dialogue for services.

DISPUTE SETTLEMENT   The over-riding principle should be dispute avoidance, and settlement through arbitration and goodwill.

MISCELLANEOUS CO-OPERATIONS   Other miscellaneous Hong Kong SAR-China co-operative effort, for example, some financial initiatives or agreement on logistics co-ordination in the Pearl River Delta, can be also a part of the CEPA content.

Consultation Model

Based on the principles and objectives described, we have developed a two-phased, "first easy, then difficult" model for the CEPA Consultation between HKSAR and the Central Government, as follows.

Phase I

Tariff reduction

If early liberalisation can be achieved, Hong Kong service providers will gain a time advantage of between one to six years, if the CEPA can be concluded by the end of 2002. This will benefit the full range of business and professional services sectors, financial services, distribution and transport services, tourism services, and telecommunications services. Hong Kong should aim for an across-the-board application of the concept of early liberalisation. However, if China feels strongly about excluding certain sectors from early liberalisation, some of the more "difficult" sectors may be excluded if necessary. For some other sectors, it may be easier to reach agreement if Hong Kong's request for liberalisation is limited to a geographical region of China only, on a pilot basis. In that case, Guangdong Province would appear to be the most natural. Finally, exceptions can be made both for "difficult sectors", and for geographical restrictions if needed.

A small number of further liberalisation can be included in the Phase I talks, in areas where substantial progress can be made within the short time frame for Phase I, for example, in some of the professional services sectors, on bank asset requirements, or quota for distribution of films.

Nearly all service industries are subject to regulations of one form or another. In practice, therefore, many regulatory hurdles may become market access barriers. The aim of the CEPA Consultation should thus be to seek regulatory clarification, to improve transparency in China's domestic regulatory regimes. In addition, in many sectors where the regulatory systems are still emerging, Hong Kong could ask for appropriate regulatory reform which would facilitate market access and equal treatment for Hong Kong companies. Some of the easier issues can be agreed upon in Phase I.

On trade and investment facilitation, the issue in question is not the negotiating of better rules, but the design of business-friendly procedures to help implement the rules. Some statements of principle on investment facilitation can be agreed in Phase I. For investment the time-honoured principles of transparency, MFN and national treatment should be established as the guiding principle governing regulation of foreign direct investment in the two jurisdictions. For trade and investment facilitation, a general enabling statement can be agreed upon, which the governments of both sides can use to institute trade-facilitating and promotional projects to assist traders and investors.

Phase II

Manufacturing investors would seek various concessions in tax, distribution rights, and generally national treatment.

In the Phase II Consultation, the service sector coverage could be much broader. The talks will coincide with the broader multilateral negotiations on services trade liberalisation under WTO's Doha Round, so more interaction with the WTO will be expected. Some results should be achieved within two years (i.e. by the end of 2004), so that the Mainland/Hong Kong CEPA will become a more substantial RTA ahead of the WTO milestone of early 2005 for the Doha Round. For the Phase II Consultation to be fruitful, the liberalisation requests should be realistic.

For investment and services, even if full national treatment is achieved, foreign enterprises may still be subject to a lot of regulatory barriers, even though the latter may not be discriminatory against them. A substantial part of the CEPA Consultation should therefore cover regulatory reform. This could include Government procurement, investment regulations, as well as regulatory reform in various service sectors.

Definition of a Hong Kong Company

The WTO recognises that the determination of "origin" of service is difficult. GATS Article V provides for non-RTA member companies to be given the same treatment if they have "substantive business", but that only shifts the difficulty to determining what "substantive business" is.

In our consultation with our members, we have identified a number of factors that have been raised as possible criteria for what constitutes a "Hong Kong company."

We stress that there is no consensus at all in the Chamber on which criteria or combination of criteria should be used, except that the Chamber wishes any definition to be in accordance with WTO and Hong Kong's international character.

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An important consideration must be the likelihood of reaching a meaningful CEPA agreement with China, keeping the international character of Hong Kong in mind. The more specific the definition, the likelier it is to get more concessions from China, but that could be divisive in Hong Kong. On the other hand, an all-encompassing definition is not likely to generate many concessions from China, thus diluting the benefits of CEPA. However, the Chamber certainly hopes that foreign companies which have a substantive business in Hong Kong, and have been contributing to the economy will be included. The consultation goal should be to strive for the broadest definition for a "Hong Kong Company" that China would accept for a meaningful Phase I CEPA, in the shortest time possible-no longer than one year from now.

Whatever definition is adopted, it is important that the WTO provisions are complied with. To be consistent with GATS Article V, any criteria used to define Hong Kong companies should be so applied for the purpose of CEPA only, in a non-discriminatory manner, and not as a "nationality test". In other words, we would not be setting a new legal definition of what a Hong Kong company is, but merely determining a company's eligibility to be qualified as a "Hong Kong company for the purpose of CEPA". What this means is that all companies, irrespective of claimed nationality, will be subject to the same eligibility criteria for "Hong Kong company" adopted in CEPA.

The practical solution may turn out to be a combination of a few criteria. There are many ways of combining the 12 criteria listed above, and the four options which the Chamber forwarded to the government are either: based on legality; based on substantiality; based on a combination of criteria ("points"); or based on a sector-by-sector eligibility approach. We made no specific endorsement, other than stressing that the determination should be WTO consistent and be as broad as possible in keeping with Hong Kong's international character, while at the same time being realistic and take into account considerations on the Chinese side.

Benefits for China

Much of the benefits to China of this CEPA would be of a general and macro nature, but there are considerable benefits for China of a tangible kind as well.

China's entry into the WTO signifies the integration of its trading regime into the international rule of law. But a smooth and orderly process of implementation is by no means automatic. We do not under-estimate the difficulties for China in adjusting to the globalized market. A CEPA with Hong Kong will help China in its adjustment in several ways, namely, capacity building, integration with neighbouring economies, pilot-testing market openings, and gaining regulatory experience.

The CEPA would present an opportunity for the Mainland to obtain some tangible benefits as well, in increasing foreign direct investment from Hong Kong, boosting China's export to third countries, expanding the Mainland's export of services in which it has comparative advantage (such as some business and professional services sectors, education, culture and entertainment industries, etc.,) or enhancing growth of its aviation industry, etc.

Finally, if CEPA benefits Hong Kong, that in itself would be a benefit for China.