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Responsible Value Creation

Import Substitution Measures and “Green Channels” at Both Local Customs and Stock Exchanges

Posted by on August 26, 2020

Highlights below reflects pro-business measures fused with import substitution policies and measures at local government level and at stock exchanges. These business/financing-boosting measures are available to both domestic and international businesses legislatively. Prudence for ramifications to businesses either gaining from these local measures or disadvantaged, remain crucial for international businesses to navigate through these regulatory complexities, with your legal departments and experienced trade counsels. It remains to be seen how these new local measures would unfold, in light of the broader context of pending enforcement of US-China trade agreement as well as China’s top-down WTO compliance efforts committed by the State Council back in 2014.

Shanghai Customs Speeding Up Import Substitution in Semiconductor Sector

Import substitution has increasingly reemerged as policy orientation at local level in China. On August 25, 2020, Shanghai Customs officially announces that it is “speeding up the process of import substitution” with “domestic equipments,” from “taxation, customs clearance, public services and other multi-dimensional facilitation efforts to promote the rapid development of integrated circuit (IC) industry.

上海正加快国产化设备替代进程，从税收、通关、服务等多维度加大扶持力度，推动集成电路产业蓬勃发展。

Two years ago, the Chinese Ministry of Commerce (MOFCOM) reiterates prohibition of either import substitution subsidies or export subsidies, despite in the context of steel sector rather than semiconductor sector. Elimination export performance, import substitution and other trade-distorting polices have been key principles of the State Council to ensure “WTO compliance” within the WTO rules, at all level of governments, according to the Circular of State Council on Further Strengthening the Regulatory Compliance of Trade Policies issued on June 9, 2014, and China’s WTO commitments.

落实《国务院办公厅关于进一步加强贸易政策合规工作的通知》（国办发〔2014〕29号）各项要求，认真做好贸易政策合规工作，不得提供世界贸易组织规则禁止的出口补贴和进口替代补贴，确保贸易政策符合世界贸易组织规则。

According to Shanghai Customs, IC imports at Shanghai-level in the first seven months of this year reaches RMB163.87 billion ($23.7 billion), with IC exports at Shanghai-level reaching RMB81.7 billion ($11.8billion) with y-o-y increase respectively at 23.2% and 22.7%. The Shanghai Integrated Circuit Research and Development Center, located in Zhangjiang, Pudong, is one of the key R&D platforms in Shanghai, which aims to build a “National Integrated Circuit Manufacturing Innovation Center” for new devices and processes at 5 nanometers and below technology nodes.

As such, prosperity of local semiconductor constituencies has been pivotal to Shanghai’s developmental priorities. Targeted companies under these incentives include SMIC and its supply chain. Interestingly, Shanghai Customs highlights SMIC’s listing at the Science and Technology Innovation Board, also known as the STAR Market, in Shanghai in July, which achieved US$7.6 billion listing and was China’s biggest IPO in a decade. Specific measures include:

  • “Single window” for paperless, “zero-touch” and “zero inventory” process for tax exemption and reduction applied by SMIC to maximize smooth import of components and equipment.
  • Facilitation for “exclusion application” under punitive tariffs imposed by US;
  • “Tailor-made customs clearance program,” which mandates Pudong Airport to green light imports of R&D items with same-day-entry-to-clearance.

Shanghai Stock Exchange Lowers STAR-Listing Thresholds for Startups Achieving “Import Substitution” or With Strategic Importance for State

Shanghai Stock Exchange issued rules earlier this year, which also echoes with Shanghai Customs’s above announcement with “import substitution” policy direction. We briefed yesterday on the landmark IPO reform in China that transforms from a licensing regime into market-based registration-based IPO system, which has started at the inception of Shanghai’s STAR Market last year.

On March 27, 2020, Shanghai Stock Exchange released Notice by the Shanghai Stock Exchange of Issuing the Interim Provisions of the Shanghai Stock Exchange on Application and Recommendation for Issuance and Listing of Enterprises on the STAR Market (上海证券交易所关于发布《上海证券交易所科创板企业发行上市申报及推荐暂行规定》的通知) (“Tentative STAR Listing Recommendation Rules“). The Tentative STAR Listing Recommendation Rules further repealed its earlier version, and overrides the existing listing rules with very specific thresholds for listing, which are sector-specific, R&D-intensity, and policy orientation, in addition to regular earning/performance requirements, along with important exceptions. For example, an enterprise must have accumulated R&D investment in the past consecutive three years at the level of 5% or more of its accumulated revenue, or at least RMB60 million ($8.7million), among other criteria, in addition to the minimum revenue thresholds for listing.

Nevertheless, exceptions allow lowering the bar for listing as follows:

“An issuer falling under one of the following circumstances and with prominent science and technology innovation capability shall not be restricted by the indicators of science and technology innovation attributes set forth in the preceding article, and shall be supported and encouraged to apply for issuance and listing on the STAR Market according to these Guidelines: 

(1) Strategic Significance for State: The core technology possessed is identified by the competent state department to play an international leading and guiding role or be ofstrategic significance for the state. 

(2) Instrumental to National Scientific Achievements: The issuer serving as the major participating entity or the core technician serving as the major participant has won a National Natural Science Award, a National Award for Science and Technology Progress, and a National Award for Technological Invention, and applies the relevant technologies in the main business. 

(3) Critical Role in National Scientific Projects: It independently undertakes or takes the lead in undertaking a “significant national thematic scientific and technological” project concerning main business and core technology. 

(4) Import Substitution: The major products (services) formed with the core technology are key equipment, products, components and parts, and materials, among others, and are encouraged, supported and promoted by the state, and have realized import substitution. 

  • (5) 50+ Core Patents: It has formed over 50 patents for invention (including national defense patents) forming core technologies and main business income in total.

Take-away and Outlook

On August 25, 2020, USTR announced that the parties addressed steps that China has taken to effectuate structural changes on intellectual property rights, removing impediments to American companies in the areas of financial services and agriculture, and eliminating forced technology transfer.  Chinese Vice Premier Liu He, stressed in these dialogues to “strengthen the coordination of the macroeconomic policies of the two countries and the implementation of the phase one trade deal.”

China, at WTO and multilateral level, has room to argue these import substitution and associated policies at local level, are “counter measures” (subject to WTO dispute resolution) against trade-restrictive measures imposed by the US against high-tech exports, which might frustrate effective enforcement of phase one trade agreement.

With respect to Shanghai Customs’ explicit import substitution policy, it remains to be seen how to ensure these pro-business facilitation measures as administered locally are consistent with the long-time WTO compliance policies committed at State Council level.

With respect to non-market exceptions lowering the listing bars, given better access to capital market financing directly benefits the eligible emerging enterprise based in China (foreign or domestic), the exceptions to listing thresholds that aims at boosting import substitution have trade implications. It remains to be seen how to ensure these nuances in listing requirements in a more “market-based” IPO regime and financial reform are in line with China’s WTO commitments and State Council’s overall mandate for WTO compliance.

As such, we cannot exclude the likelihood of “later on” disruptions and negative outcomes in terms of the overall regulatory implications of these import substitution measures/policies, especially in light of current US-China trade tension.

For MNCs with trade compliance & advocacy capabilities, it remains to be seen to what extent they (or their portfolio or targets) would benefit from the “green channels” provided at STAR market, as well as concerns of their competitors from non-US WTO Members.