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• The Chinese government has made progress in bringing its laws and regulations into compliance with its World Trade Organization (WTO) commitments. Although significant flaws remain, the new body of commercial laws has improved the business climate for foreign companies in China. With new, more transparent rules, the Chinese trade bureaucracy has reduced regulatory and licensing delays in many sectors.

• The Chinese commercial regulatory regime remains, however, largely opaque to both domestic and foreign businesses. When China joined the WTO in December 2001, the government committed to establishing an official journal that would publish drafts of trade-related measures for notice and comment, and to publishing trade-related measures no later than 90 days after they become effective. Although the government has acted to improve transparency, some central government agencies and many local governments are not consistent in publishing trade-related measures in the official journal.

• The Chinese government tolerates intellectual property rights (IPR) infringement rates that are among the highest in the world. The Chinese government has not introduced criminal penalties sufficient to deter IPR infringement, and steps taken by Chinese government agencies to improve the protection of foreign intellectual property have not produced any significant decrease in infringement activity. The Chinese government's failure to provide effective criminal enforcement of IPR has led foreign companies to turn to civil litigation to obtain monetary damages or injunctive relief. Civil litigants continue to find, however, that most judges lack the necessary training and experience to handle IPR cases, and damage awards are too low to be an effective deterrent.

• Since acceding to the WTO, the Chinese government has used technical, regulatory, and industrial policies, some of which appear to conflict with its WTO commitments, to discriminate against foreign producers and investors and limit their access to the domestic market. U.S. rights holders and industry groups have complained that the government's censorship regime serves as a barrier to entry and encourages IPR violations. In 2005, the American Chamber of Commerce in China wrote that censorship clearance procedures severely restrict the ability to distribute CD, VCD, and DVD products in China and provide an "unfair and unnecessary advantage to pirate producers who bring their products to market long before legitimate copies are available for sale."

Introduction

On December 11, 2001, China formally became a member of the World Trade Organization (WTO). In doing so, the Chinese government agreed to abide by the rules governing trade relations among most of the nations in the world, and voiced its willingness to make fundamental changes to its trade regime to conform with the WTO's rules-based system, affecting China's system of governance at all levels. The WTO agreements and China's accession documents contain many core elements of the rule of law. When China joined the WTO, the Chinese government committed to ensuring that all trade-related measures be administered in a non-discriminatory manner. The WTO also imposes transparency on its members by requiring that all laws, regulations, judicial decisions, and administrative rulings relating to trade be published promptly.

The government's implementation of its WTO non-discrimination and transparency obligations is a useful measure of the overall development of the rule of law in China, including the extent to which the government treats individuals equally under the law and makes laws and administrative regulations accessible to the public. The Chinese government has made progress in bringing its laws and regulations into compliance with its WTO commitments. The new body of commercial laws has improved the business climate for foreign companies in China. With new, more transparent rules, the Chinese trade bureaucracy has reduced regulatory and licensing delays in many sectors. Nevertheless, serious problems remain in such areas as regulatory transparency, the enforcement of intellectual property rights (IPR), and discrimination against goods and services of foreign origin. Most of China's WTO commitments were to have been phased in by December 2004, and the past year therefore provides an indication of what Chinese citizens and foreign investors can expect of China as a WTO member with its full range of WTO commitments in place.

The U.S. and Chinese governments established the U.S.-China Joint Commission on Commerce and Trade (JCCT) in 1983 as a government-to-government mechanism to develop and facilitate the bilateral commercial relationship. The two governments held the 17th plenary session of the JCCT on April 11, 2006, in Washington, D.C. The Chinese delegation made a number of commitments on trade issues of priority concern to the United States, such as fighting piracy of U.S. intellectual property; increasing transparency in China's domestic regulatory process; ending duplicative testing of U.S. medical products entering the Chinese market; resuming sales of U.S. beef; and making progress toward accession to the WTO Agreement on Government Procurement. The U.S. Department of Commerce is the lead U.S. government agency in the JCCT process, and engages the Chinese government to ensure compliance with commitments made at JCCT meetings.

Transparency

The Chinese commercial regulatory regime continues to exhibit what the United States Trade Representative (USTR) describes as "systemic opacity."¹ China's Protocol of Accession to the WTO requires that the Chinese government translate all trade-related laws, regulations or other measures into one or more of the WTO's official languages.² In addition, to the maximum extent possible, it must make these laws, regulations and other measures available before they are implemented or enforced, but in no case later than 90 days after the date of implementation or enforcement.³ Moreover, the government committed to designating an official journal to regularly publish trade-related laws, regulations, and other measures, and to provide additional relevant information, such as the effective date for a particular measure and the identity of the governmental and non-governmental authorities responsible for authorizing, approving, or regulating services activities.⁴ Before implementing or enforcing trade-related laws, regulations, and other measures, the Chinese government has committed to publishing them in an official journal and to providing a reasonable period for public comment to the appropriate government authorities, except in extraordinary circumstances.⁵

The government, in particular the Ministry of Commerce (MOFCOM), has taken steps toward improving transparency, but still does not consistently publish trade-related measures⁶ and does not always translate those measures that it publishes.⁷ Some government agencies do not circulate drafts of trade-related measures to outside groups or individuals, domestic or foreign, or do so only on the condition that the outside party promises not to share the draft more widely.⁸

In March 2006, the State Council issued a circular providing that the "Chinese Foreign Economic Trade Gazette" would be the government's official journal for the publication and registration of "all laws, regulations, or other measures pertaining to or affecting trade in goods, services, trade-related aspects of intellectual property rights (TRIPs), or the control of foreign exchange."⁹ The circular reiterated that all local governments and government agencies are required to forward to MOFCOM any trade-related regulations that they promulgate or make available in draft form for public comment. MOFCOM is then responsible for publishing the regulations. MOFCOM began making the Gazette available on its Web site in 2003.¹⁰ A Commission review of the Gazette indicates, however, that few trade-related measures below the central government level have been published there.

Poor transparency has made it difficult for the U.S. government to obtain accurate information on the Chinese government's subsidy programs.¹¹ The WTO Agreement on Subsidies and Countervailing Measures requires each WTO member to submit an annual notification of all the subsidies that it maintains, and provides that members shall respond to requests for information regarding practices that appear to constitute subsidies "as quickly as possible and in a comprehensive manner."¹² To date, however, the Chinese government has not met its annual notification commitment. The United States submitted a request to the Chinese government in October 2004 regarding a number of subsidy programs.¹³ The Chinese government did not respond until April 2006,¹⁴ and that response was limited to subsidies that existed between 2001 and 2004.

Chinese officials credit China's accession to the WTO as having increased the government's attention to transparency. Zhou Hanhua, the head of the State Council-designated drafting team on open government measures [see Section VII(b)--Institutions of Democratic Governance and Legislative Reform], said WTO accession has raised awareness about citizen rights and the importance of openness and transparency.¹⁵ Some local governments also have cited the WTO transparency principle as support for their own reforms. For example, officials in Changzhou city, Jiangsu province, announced in November 2005 that the city government would no longer enforce regulatory documents that have not been published first in the local newspaper, the government's gazette, or other publications specified by the city government. In the circular announcing this requirement, the Changzhou government said that, "[A]ccording to the WTO 'principle of openness and transparency,' there is generally one month between the time that regulatory documents and other policies and proceedings are promulgated and the time that they are implemented."¹⁶ The new procedures provided that the public could "inspect and review" any such draft measure before the government makes it effective if it has been published in one of the three approved media.

Intellectual Property Rights Protection and Enforcement

Intellectual property counterfeiting and piracy in China are rampant, according to Chinese¹⁷ and U.S. government sources.¹⁸ Industry reports indicate that infringement levels in China range from 85 to 95 percent for all copyrighted works.¹⁹ In 2005, the value of copyrighted works that were pirated exceeded US$2.3 billion.²⁰ China is now the second-largest legal music market in Asia, with sales worth US$212 million in 2004. Sales of pirated discs were, however, worth approximately US$400 million.²¹ Ninety percent of the software used in China is pirated,²² and business software losses were estimated at US$1.27 billion in 2005.²³ A study commissioned by the Motion Picture Association of America found that 93 percent of the Chinese film market is lost to piracy,²⁴ costing U.S. rights holders nearly US$300 million per year, according to industry estimates.²⁵ According to U.S. customs statistics, 69 percent of all counterfeit products seized at the U.S. border in 2005 were of Chinese origin,²⁶ and the volume of seized Chinese goods continues to rise.²⁷ U.S. industry reports of piracy levels in China ranged from an assessment that "no significant reduction in IPR infringement levels" had taken place in 2005,²⁸ to a more positive assessment that there had been sharp improvement in some regions.²⁹

Some Chinese officials have characterized their government's IPR enforcement efforts as effective, or downplayed the seriousness of IPR issues.³⁰ In November 2005, the head of China's WTO delegation responded to simultaneous requests under Article 63 of the WTO Agreement on Trade Related Aspects of Intellectual Property Rights from the United States, Japan, and Switzerland for information on the Chinese government's IPR enforcement, by saying that the blame laid on China for being one of the top producers and exporters of counterfeit and infringing automotive parts was groundless.³¹ One report in the state-run Chinese news media cited the United States and other developed countries as being the source of intellectual property piracy.³² A Ministry of Commerce (MOFCOM) analyst said that the U.S. government exaggerates IPR issues because it fears China's surging exports.³³ According to one senior Chinese customs official, IPR infringement in China is "not that serious" when compared with international standards and when viewed in proportion to China's total exports to the United States.³⁴

Chinese officials cite enforcement statistics and legislative activities to demonstrate a strong respect for IPR.³⁵ In the weeks before the April 2006 meeting of the bilateral Joint Commission on Commerce and Trade (JCCT), Chinese officials made several announcements regarding administrative IPR enforcement measures that the government had recently undertaken.³⁶ The State Council and its agencies continue to issue new regulations regarding intellectual property rights.³⁷ In March 2006, the MOFCOM National IPR Protection Working Group Office issued an "Action Plan on IPR Protection 2006" outlining how 11 government ministries and agencies will coordinate in nine areas to work on the protection of trademarks, copyrights, and patents, and formulate and revise IPR-related laws and regulations.³⁸ In July 2006, a new regulation on Internet copyright protection went into effect.³⁹ Chinese officials said this regulation would form the basis of China's ratification of the World Intellectual Property Organization Internet treaties in the second half of 2006.⁴⁰ In November 2005, the Supreme People's Court published four draft interpretations for comment regarding unfair competition, plant patents, civil IPR disputes, and civil disputes regarding music television broadcasting rights.⁴¹

Ongoing enforcement and legislative activity, however, has not translated into decreased IPR infringement. At the conclusion of a review conducted under Special 301 provisions of U.S. trade law in April 2005, the United States elevated China to the "Priority Watch" list. In its report, the USTR noted that "[i]nadequate IPR enforcement is one of China's greatest shortcomings as a trading partner," and that "China suffers from chronic over reliance on toothless administrative enforcement and underutilization of criminal remedies."⁴²

At the 2005 JCCT Plenary, the Chinese government committed to completing its legalization program to ensure that all central, provincial, and local governments offices would use only licensed software, and would extend that program to enterprises in 2006.⁴³ In March 2006, the National Copyright Administration, Ministry of Information Industry, Ministry of Finance, and State Council jointly reiterated requirements set forth in previous regulations that ordered Chinese government agencies to use legitimate copies of software. According to Chinese officials, all government departments had complied with this mandate.⁴⁴ The software industry reports, however, that the level of new government purchases does not support this claim.⁴⁵

Current provisions in the Criminal Law are inadequate to deter infringement.⁴⁶ While China has said that the absolute number of criminal IPR infringement cases rose from 2004 to 2005,⁴⁷ the number remains small in comparison to the volume and value of IPR violations that occur in China each year. The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) requires WTO members to maintain criminal IPR infringement penalties, including monetary fines "sufficient to provide a deterrent."⁴⁸ China's state-run media, however, cites "experts" to support the position that, because intellectual property is a private right, the government should prosecute IPR violations only in those cases that "negatively influence the public interest," and that if the government were to focus on assisting foreign companies in protecting their IPR, "it would be an infringement on the rights of Chinese individuals and companies."⁴⁹

High thresholds for criminal liability make it difficult for the Chinese government to prosecute illegal commercial operations.⁵⁰ Although some high-profile prosecutions have been undertaken,⁵¹ because the government calculates criminal thresholds using the retail value of the illegal goods rather than the value of genuine products, the current procedure creates a "safe harbor" for commercial infringers. In addition, because a government agency that successfully prosecutes an IPR case is eligible to receive a portion of any fines assessed, current rules create a disincentive to transfer cases to law enforcement officials.⁵² The Supreme People's Court and Supreme People's Procuratorate issued an interpretation in 2004 on transferring IPR infringement cases from administrative to criminal enforcement,⁵³ but the U.S. government subsequently determined that the revisions did not go far enough,⁵⁴ and less than 25 percent of respondents in one survey of U.S. businesses believed the interpretation would aid IPR protection to a moderate or great extent.⁵⁵ In response to expressions of concern from the United States regarding the availability of remedies to address commercial-scale counterfeiting and piracy, as well as reliance on non-deterrent administrative penalties rather than transferring cases for criminal prosecution,⁵⁶ China's WTO delegation said that the National People's Congress had no plans to amend China's Criminal Law or other intellectual property laws.⁵⁷

A lack of interagency cooperation is at least partly to blame for the government's continued failure to impose criminal sanctions on IPR infringers, according to Zhu Xiaoqing, Deputy Procurator General of the Supreme People's Procuratorate.⁵⁸ The government has begun, however, to address this problem. In January and March 2006, the Ministry of Public Security and several other government agencies enacted rules intended to improve interagency coordination in handling criminal trademark and copyright infringement cases.⁵⁹

The Chinese government's failure to provide effective administrative and criminal enforcement of IPR has led foreign companies to turn to civil litigation to obtain monetary damages or injunctive relief.⁶⁰ Civil litigants continue to find, however, that most judges lack the necessary training and experience to handle IPR cases. In addition, the evidentiary and other rules governing civil lawsuits are generally vague or ineffective, and damage awards are too low to be an effective deterrent.⁶¹ Despite these challenges, some high-profile lawsuits have been filed in which foreign IPR holders have succeeded in suing infringers as well as the Chinese government. For example, in December 2005, the Shanghai No. 2 Intermediate People's Court ordered a Chinese coffee retailer to pay Starbucks Corporation 500,000 yuan (US$62,000), saying the Chinese retailer had engaged in unfair competition by using Starbucks's Chinese name and imitating the design of its cafes.⁶² In June 2006, the Beijing No. 1 Intermediate People's Court ordered the State Intellectual Property Office to withdraw its decision to invalidate Pfizer, Inc.'s patent on the active ingredient in the drug Viagra.⁶³

The central government has begun to make policy statements emphasizing the importance of IPR protection, specifically about how this protection will benefit domestic Chinese IPR holders. At its October 2005 plenum, the Communist Party included "innovation" in the 11th Five-Year Plan (2006-2010), and since then Chinese officials⁶⁴ and the state-run media⁶⁵ have called for increasing IPR protection to further the innovation of Chinese companies and increase China's international trade. In 2004, China overtook the United States to become the world's largest exporter of information and communication technology goods.⁶⁶ Although the majority of these goods are made by foreign-invested enterprises,⁶⁷ some high-technology Chinese manufacturers, such as Huawei and Lenovo, are garnering global name recognition and market share. In 2005, the first Chinese company with independently developed intellectual property was listed on the NASDAQ.⁶⁸

The Chinese government possesses the resources necessary to enforce IPR, but appears to lack the resolve to do so with respect to foreign rights holders. The government's position is that its failure to enforce IPR is a result of China's current stage of economic development.⁶⁹ According to Chinese and U.S. experts, however, the problem is that local police generally resist efforts to shut down commercial infringers because large-scale pirating efforts support local economies and have the financial support of key local officials.⁷⁰ In 2002, the State Council enacted regulations specifically addressing protection of the 2008 Beijing Olympic Games' trademark symbol from counterfeiting.⁷¹ Western news media reports indicate that vendors who otherwise sell counterfeit goods are avoiding the new Olympic symbol out of fear of government reprisals.⁷²

Financial Services

In 2004, the United States recorded a US$145 million financial services surplus with China, according to the U.S. International Trade Commission.⁷³ Exports of U.S. banking and securities services to China were down, however, from 2003.⁷⁴ Although the Chinese government has acknowledged the value that foreign investment and exchanges can bring to its financial services sector,⁷⁵ it continues to impose strict limits and high barriers to entry on foreign investment in its banking, insurance, and securities sectors.

Banking

The Chinese government has committed to eliminating all non-prudential measures that restrict ownership, operation, and juridical form of foreign financial institutions, including measures on internal branching and licenses, before 2007.⁷⁶ The government currently imposes tighter limitations and higher barriers to entry on foreign banks than on Chinese banks.

In its WTO accession agreement, the government also set different restrictions and schedules on foreign banks based on whether they conduct business in domestic or foreign currency. With respect to business in domestic currency, the government has met its WTO commitment regarding lifting geographic restrictions. The Chinese WTO accession agreement provides that, immediately upon joining the WTO, the government would allow foreign banks to conduct domestic currency business with foreign-invested enterprises and foreign individuals, subject to certain geographic restrictions. Within two years after accession, foreign banks were also to be able to conduct domestic currency business with Chinese enterprises, subject to certain geographic restrictions, which were to be lifted gradually over the following three years.⁷⁷ The Chinese government met these commitments, and opened several cities ahead of schedule.⁷⁸ In addition, in December 2005, the China Banking Regulatory Commission (CBRC) announced that it was lowering the minimum operating capital requirement to conduct domestic currency businesses from 500 million yuan to 400 million yuan for a foreign bank branch, and from 300 million yuan to 200 million yuan for a wholly foreign-owned or a joint venture bank.⁷⁹

With respect to foreign currency business, the Chinese government agreed as part of its WTO accession agreement that, immediately upon joining the WTO, it would allow foreign banks to conduct foreign currency business without any geographic or client restrictions. According to the U.S. Trade Representative, although the Chinese government has permitted licensed foreign banks to freely engage in foreign currency business with any customer, only a limited number of banks are allowed to enter into forward foreign exchange contracts.⁸⁰ In addition, according to one industry group, measures issued in May 2004 limit the foreign currency financing of foreign banks in China and, although identical restrictions are applicable to domestic banks, their effects on foreign banks are disproportionately negative.⁸¹

Market entry requirements for foreign banks are higher than those for domestic banks. For example, domestic banks need only 100 million yuan in registered capital to establish an urban commercial bank.⁸² Foreign banks seeking to establish a market presence through a wholly foreign-owned or joint venture bank must have at least 300 million yuan in registered capital.⁸³ In addition, Chinese regulations, consistent with China's WTO services schedule, provide that these banks must have total assets of at least US$10 billion.⁸⁴ Finally, a wholly foreign-owned bank must have had a representative office in China for at least two years.⁸⁵ Even if a foreign bank meets these requirements, it is restricted to conducting foreign currency business with a limited category of clients, unless it meets higher registered capital requirements.⁸⁶

The prudential thresholds to establish a branch are much higher for wholly foreign-funded banks or joint venture banks than for domestic commercial banks.⁸⁷ A wholly foreign-funded bank or joint venture applying to establish a branch must have three years of business operation experience in China, and have been profitable for two consecutive years before applying.⁸⁸ In addition, Chinese law, consistent with its WTO services schedule, provides that a foreign bank applying to establish a branch in China must have at least US$20 billion in total assets.⁸⁹ In its accession agreement, the Chinese government agreed that qualified foreign financial institutions could establish joint venture banks immediately after accession. The government currently caps total foreign investment in any single Chinese bank at 25 percent, however, with no single foreign investor allowed to hold more than 20 percent.⁹⁰

In December 2005, it was reported that a group of investors led by Citigroup had successfully bid for the right to negotiate to purchase an 85 percent stake in the Guangdong Development Bank, with Citigroup taking a 40 percent stake.⁹¹ This led to speculation and conflicting reports that Chinese authorities might be considering raising limits on foreign investment in Chinese banks.⁹² In April 2006, however, China's state-run media reported that, "It is certain that the banking regulatory agency will not let the ceiling be broken in this case."⁹³ The same month, the CBRC sent a letter to the Guangdong provincial government saying: "The case of Guangdong Development Bank has been looked into many times by the CBRC and other related administrations, and it is hard to break the present restrictions on foreign strategic investor issues."⁹⁴ In July, Chinese-language news media in Hong Kong reported that Citigroup would lower its offer to below 20 percent.⁹⁵

Insurance

According to the USTR's 2005 report on China's WTO compliance, opaque regulatory processes and overly burdensome licensing and operating requirements continue to hinder U.S. insurance companies' access to China's insurance market.⁹⁶ In its accession agreement, the Chinese government agreed that it would phase out geographic restrictions on all types of insurance operations by 2004.⁹⁷ The China Insurance Regulatory Commission (CIRC) approved life insurance operations for U.S. insurers in Beijing municipality, Suzhou city, and Tianjin municipality two years ahead of schedule, in Chongqing municipality one year ahead of schedule,⁹⁸ and removed all geographic restrictions in 2004.⁹⁹

Foreign insurance companies may enter the Chinese market as wholly foreign-owned subsidiaries selling insurance policies other than life insurance, but foreign investment in domestic life insurance providers is capped at 51 percent,¹⁰⁰ and the Chinese government does not plan to lift this restriction.¹⁰¹ To obtain a license, foreign insurance companies must have at least 30 years of experience in the insurance business, have had a representative office in China for no less than two years, and have no less than US$5 billion in total assets.¹⁰²

According to the USTR, every U.S. insurer that has applied to enter the China market has received a license.¹⁰³ At the end of 2005, the CIRC had approved 40 overseas insurers, which operated 99 offices and held a combined market share of almost 7 percent.¹⁰⁴ In May 2006, the CIRC authorized subsidiaries of American International Group, Inc. to expand their businesses in Guangdong and Jiangsu provinces and to issue group contracts throughout China covering life insurance, personal accident and health insurance, and other products.¹⁰⁵

U.S. companies have complained, however, that while domestic insurers can obtain multiple branch licenses at once, the government requires foreign companies to apply for them one at a time.¹⁰⁶ According to a report from the U.S. Embassy in Beijing, while the CIRC claims it does not have any restrictions on opening multiple branch offices, it has denied several U.S. insurance companies' applications to open multiple branch offices, and instead granted approval to open only one branch office.¹⁰⁷

Securities

The Chinese government currently limits foreign participation to minority stakes in securities joint ventures (49 percent for fund management and 33 percent for securities trading).¹⁰⁸ Joint ventures are permitted to underwrite and trade B-shares and H-shares, as well as government and corporate debt.¹⁰⁹ The Chinese government has allowed foreign institutions to trade in A-shares since December 2002, but only those that have met strict criteria, and then only to a limited extent.¹¹⁰ "A-shares" refers to shares of companies incorporated in mainland China that are traded in Chinese stock markets and are denominated in local currency. "B-shares" refers to shares of companies incorporated in China that are traded in Chinese stock markets and are denominated in foreign currencies. "H-shares" refers to shares of companies incorporated in China that are listed on the Hong Kong Stock Exchange and foreign stock exchanges.

In its accession agreement, the government agreed that immediately upon WTO accession it would allow foreign securities institutions to engage directly (without a Chinese intermediary) in B-share business. In addition, representative offices in China of foreign securities institutions could become special members of all Chinese stock exchanges. Finally, foreign service providers were permitted to establish joint ventures with foreign investment up to 33 percent to conduct domestic securities investment fund management business, increasing to 49 percent in 2004. Also by 2004, foreign securities institutions were to be permitted to establish joint ventures with up to one-third foreign ownership. These institutions were to be allowed to engage (without a Chinese intermediary) in underwriting A-shares, underwriting and trading of B- and H- shares, government and corporate debts, and launching funds.¹¹¹

The U.S. Securities and Exchange Commission (SEC) and the China Securities Regulatory Commission (CSRC) announced they had established a framework for a dialogue between the two agencies.¹¹² The objectives of the dialogue included improving cooperation and the exchange of information in cross-border securities enforcement matters, and expanding upon the existing program of training and technical assistance that the SEC provides to the CSRC.

China's Financial Services Environment

Money laundering, embezzlement, bribery, and financial fraud are major problems in China. The International Monetary Fund has estimated that money laundering in China may total as much as US$24 billion annually, while the Asian Development Bank estimates that more than 2 percent of China's gross domestic product is laundered in mainland China each year. Transparency International, an anti-corruption NGO based in Germany, ranked China 78 out of 158 in its 2005 Corruption Perceptions Index,¹¹³ and reports in Chinese state-run news media indicate that government corruption in China is widespread.¹¹⁴

The Chinese government is taking steps to address these issues. In January 2005, China became an observer to the Financial Action Task Force.¹¹⁵ In October 2005, the National People's Congress ratified the UN Anti-Corruption Convention.¹¹⁶ In April 2006, the People's Bank of China issued a series of draft regulations for public comment aimed at "beefing up efforts to rein in money laundering across its banking, securities, and insurance sectors."¹¹⁷ In addition, in February 2006, the China Banking Regulatory Commission issued rules requiring newly established joint stock commercial banks, which have equity owners and are typically smaller institutions, to have at least one foreign shareholder.¹¹⁸

Information and Entertainment

The Chinese government made limited commitments in its WTO accession agreements regarding foreign participation in the domestic information and entertainment sectors.¹¹⁹ The government agreed to permit foreign investors to enter the retail market for books, newspapers, and magazines within one year after accession, and to permit them to import and engage in wholesale distribution of these products within three years of accession. The government also committed to implementing a system in which the relevant regulatory authority for the provision and transfer of financial information would be separate from, and not accountable to, any service suppliers that it regulated.¹²⁰

Although the government initially allowed foreign enterprises to obtain the right to distribute books, newspapers, and magazines,¹²¹ it has recently enacted regulations that appear to restrict this right.¹²² In January 2005, the State Council issued a revised Sectoral Guidelines Catalogue for Foreign Investment that, like the version issued in March 2002, placed the importation of books, magazines, and newspapers in the "prohibited" category.¹²³ The Chinese government maintains that it may impose this restriction based on the general exception for the protection of the public morals in Article XX of the General Agreement on Tariffs and Trade 1994.¹²⁴

The government has not established an independent regulator for financial information service providers, despite its WTO commitment to do so. In 2004, the State Council issued a decision designating the Xinhua News Agency, a government agency directly under the control ofthe State Council, as the regulator of foreign financial information service providers in China.¹²⁵ Foreign companies have complained that Xinhua has been using its regulatory authority to increase control over the distribution of content, and has been expanding the definition of a wire service so as to establish a monopoly on the dissemination of sports and financial news.¹²⁶ In September 2006, Xinhua issued new measures prohibiting international financial information companies from providing news and information directly to Chinese customers.¹²⁷ Instead, under the new measures, foreign media outlets such as Reuters and Bloomberg may only sell their products through an agency appointed by Xinhua.¹²⁸

U.S. rights holders and industry groups have complained that the government's censorship regime serves as a barrier to entry and encourages IPR violations. In 2005, the American Chamber of Commerce in China wrote that censorship clearance procedures severely restricted the ability to distribute CD, VCD, and DVD products in China and provide an "unfair and unnecessary advantage to pirate producers who bring their products to market long before legitimate copies are available for sale."¹²⁹ In its 2006 Special 301 Report, the USTR cited delays created by the Chinese censorship process as a market access restriction. This restriction adversely affects U.S. IPR holders by artificially limiting the availability of foreign content and thereby leading consumers to resort to pirated goods. In addition, U.S. officials noted that rights holders have complained that the government's censorship standards and procedures for video and television broadcasting products are unclear. The U.S. delegation to the WTO's TRIPs Council asked Chinese officials to explain their government's standards and procedures, how WTO members can obtain copies of them, and the inquiry process when a delay in approval occurs. U.S. delegates made similar inquiries about how Chinese authorities screen and censor entertainment software.¹³⁰ The Chinese government told the U.S. delegation to "convey these TRIPs non-relevant concerns to the competent committees or councils in the WTO, for example the Committee on Market Access."¹³¹

Chinese government censorship also makes it difficult for foreign Internet and media companies to operate in China. In February 2006, in testimony before the Subcommittee on Asia and the Pacific and the Subcommittee on Africa, Global Human Rights, and International Operations of the Committee on International Relations of the U.S. House of Representatives, a Google representative said that Chinese government censorship was one of the factors that forced the company to launch a new, self-censoring service.¹³² Microsoft has said that Chinese government regulations allow authorities to restrict content on "the kinds of Internet-based services provided by Microsoft's MSN division."¹³³ Yahoo! no longer owns the Yahoo! China business.¹³⁴ In September 2005, the chief executive of Time Warner, Inc., said that his company had withdrawn from a US$50 million Internet venture in January 2004 because the Chinese government insisted that it had the right to monitor all traffic on the service.¹³⁵ [See Section V(b)--Special Focus for 2006: Freedom of Expression.]

The government's restrictions on foreign participation in China's media industry reflect growing Party concern that its monopoly is weakening over what Chinese citizens view, read, and listen to. The government has effectively banned all foreign news media from distributing their products in China.¹³⁶ When the State Administration of Radio, Film, and Television increased restrictions on foreign participation in China's domestic television and film production in March 2005, it issued a circular saying that regulators must "control the contents of all products of joint ventures in a practical manner, understand the political inclinations and background of foreign joint venture parties, and in this way prevent harmful foreign ideology and culture from entering the domain of television program production through joint ventures."¹³⁷ In August 2005, Chinese government regulators blocked News Corp.'s plan to operate a television channel in China.¹³⁸ In June 2006, when News Corp. announced it would sell part of its stake in Phoenix Satellite Television, a channel that the Chinese government permitted to have limited broadcast rights in China, Western news media cited analysts as saying that the deal "underscored Beijing's apparent attempt to limit foreign firms' operations in the sensitive media industry and News Corp.'s efforts to circumvent that."¹³⁹ The action coincided with the government's promulgation of several regulations that limit foreign access to China's media industry.¹⁴⁰

Government Procurement

When China acceded to the WTO, the government made several commitments related to non-discrimination in government procurement. These commitments include providing all foreign suppliers an equal opportunity to participate in procurements that are opened to any foreign suppliers, conducting procurement in a transparent manner, and ensuring procurements would be subject only to regulations of general application and procedures that had been published and made available to the public.¹⁴¹ In addition, the Chinese government committed to beginning negotiations for membership in the Government Procurement Agreement (GPA) "as soon as possible."¹⁴² China became an observer to the WTO Committee on Government Procurement in February 2002, but has yet to join the GPA. At the April 2006 Joint Commission on Commerce and Trade (JCCT), Chinese officials committed to starting formal negotiations to join the GPA, and to submitting a list of government entities to be subject to GPA coverage no later than December 2007.¹⁴³ The government has acknowledged the potential benefits to the domestic commercial environment that joining the GPA represents.¹⁴⁴ Nevertheless, at least one Chinese expert has said that China's government procurement market may remain closed to foreign companies for another four years.¹⁴⁵

Little government procurement in China is currently open to competitive bidding, and decentralized and individual agency procurement expenditures are growing much more rapidly than centralized government procurement expenditures.¹⁴⁶ According to the state-run media, the current government procurement system suffers from several problems, including officials making procurements without prior authorization and government agencies charged with oversight of procurement not imposing sanctions for violations of existing regulations.¹⁴⁷ These practices in turn hinder the government's ability to make appropriate budget forecasts for procurement.¹⁴⁸ Corruption also continues to be a problem. In April 2006, the Ministry of Finance launched a four-stage program, scheduled to be completed by the end of 2006, to address bribery in government procurement.¹⁴⁹ In April 2006, the Ministry of Finance also established a task force on commercial bribery and launched a hotline for reporting bribery in government procurement.¹⁵⁰

Agriculture

Agricultural trade with China is "among the least transparent and predictable of the world's major markets," according to Deputy U.S. Trade Representative Karan K. Bhatia.¹⁵¹ The government's inspection and quarantine system continues to implement discriminatory sanitary and phytosanitary (SPS) measures with questionable scientific bases. The WTO, the United States, and other WTO members have expressed concerns over how the Chinese government handles restrictions on foreign agricultural imports. According to the WTO, the Chinese government's SPS regime and inspection procedures for imports are complex and unclear.¹⁵² The Chinese government maintained bans on Florida citrus and U.S. cherries entering the Chinese market through late 2004, despite the lack of a scientific basis for the decisions.¹⁵³ The General Administration of Quality Supervision, Inspection and Quarantine (AQSIQ) has also set a limit for selenium in U.S. wheat that is lower than the international standard. The requirement, if enforced, could result in a significant decrease in exports of U.S. wheat to China.¹⁵⁴ WTO members have also raised concerns that the Chinese government is apparently using SPS measures to ban imports of affected products from countries rather than just the affected regions within countries.¹⁵⁵ The Chinese government has said however, that its SPS standards are fully compliant with international standards and were based on risk assessment.¹⁵⁶

According to the USTR, "capricious practices by Chinese customs and quarantine officials can delay or halt shipments of agricultural products into China."¹⁵⁷ In August 2005, the United States expressed concern to the WTO Committee on Import Licensing about requirements that importers must obtain an import inspection permit¹⁵⁸ and quarantine inspection permit¹⁵⁹ prior to signing an import contract.¹⁶⁰ These regulations allow port quarantine authorities to return or destroy any cargoes without a prior import inspection permit. In addition, according to the USTR, AQSIQ uses its discretion to slow down and suspend issuance of quarantine inspection permits, and uses unofficial quantity requirements to reject shipments that are too large, and to limit imports during peak harvest periods.¹⁶¹ Furthermore, exporters are forced to ship commodities to Chinese ports without quarantine inspection permits because of delays in the issuance of the permits and the limited time purchasers have under the permits to purchase, transport, and discharge cargoes.¹⁶² The inefficiencies lead to demurrage bills for Chinese purchasers.

The Chinese government employs food safety standards for imported commodities in a manner that lacks transparency,¹⁶³ and in some cases appears intended as a way to limit imports. With respect to genetically modified agricultural products, international practice is that, once a trait is approved for a product it need not be approved for use in other products, whether singly or combined with other approved traits.¹⁶⁴ The Chinese government, however, not only requires that a trait be reviewed each time it is used in a new product, but also requires combinations of approved traits to be separately approved.¹⁶⁵

The end result of the Chinese government's implementation of its SPS, import inspection permit, quarantine inspection permit, and food safety systems has been, according to the U.S. government and the American Chamber of Commerce in China, a source of both significant commercial uncertainty for U.S. exporters as well as higher prices for Chinese importers and consumers.¹⁶⁶ The U.S. government has asked the Chinese government to explain why import inspection permits do not constitute import licenses, but instead fall under the umbrella of SPS measures, as the Chinese government has claimed.¹⁶⁷

While the soybean industry has not experienced significant problems in these areas in the past two years,¹⁶⁸ U.S. beef exporters continue to be hard hit. At the April 2006 Joint Commission on Commerce and Trade (JCCT), the Chinese government agreed to reopen the Chinese market to U.S. beef, subject to the completion of a technical protocol.¹⁶⁹ China had joined several countries in banning U.S. beef following the discovery of bovine spongiform encephalopathy (BSE) in a cow imported into the United States from Canada in December 2003. Even though the United States repeatedly provided China with extensive technical information on all aspects of its BSE-related surveillance and mitigation measures, China maintained its ban for over two years without providing any scientific justification for the decision or identifying the regulatory steps that the U.S. government needed to pursue to have the ban lifted.¹⁷⁰

The Chinese government announced in June 2006 that it was lifting the ban on U.S. beef.¹⁷¹ U.S. government officials and industry sources have said that this will not lead to a resumption of beef exports, because the Chinese government has yet to agree to a technical protocol.¹⁷² Moreover, China's June announcement, even if implemented, would only open the Chinese market to a narrow segment of imports (boneless beef under 30 months of age) rather than all beef, consistent with Organization for Animal Health (OIE) standards. The Chinese government made similar commitments in 2004 and 2005 with respect to bovine semen and embryos, but the U.S. government and industry analysts have noted little or no progress in getting the relevant Chinese agencies to allow imports of those items to resume, as regulatory authorities impose information requirements that are not consistent with OIE standards.¹⁷³

When it acceded to the WTO, the Chinese government committed to establish a transparent tariff-rate quota (TRQ) system that included large and increasing TRQs for imports of wheat, corn, rice, cotton, wool, sugar, vegetable oils, and fertilizer, a portion of which was to be reserved for importation through non-state trading entities.¹⁷⁴ After China joined the WTO, complaints arose that its TRQ system lacked transparency and included burdensome licensing procedures.¹⁷⁵ While the Chinese government eliminated certain unnecessary licensing requirements in 2004,¹⁷⁶ problems with a lack of transparency continue, and there is no publicly available list of quota holders.¹⁷⁷

Certain aspects of China's value-added tax (VAT) system continue to generate concerns about a lack of national treatment as they relate to agriculture. In October 2005, the United States and China notified the WTO that they had resolved a longstanding dispute over the Chinese government's preferential rebate of a substantial portion of VAT for domestically designed and produced integrated circuits. Problems remain, however, with respect to fertilizers and agricultural products, as U.S. industry reports state that Chinese producers are able to avoid payment of the VAT on their products, either as a result of poor collection procedures, special deals or even fraud, while the full VAT must be paid on competing imports.¹⁷⁸

In April 2006, AQSIQ Minister Li Changjiang signed a memorandum of understanding with U.S. Agriculture Secretary Mike Johanns. The signatories agreed to exchange information on food regulations and standards, inspection and quarantine procedures, and other issues such as pests and diseases, harmful residues, and food certification.¹⁷⁹ The same month, the American Soybean Association signed a three-year agreement with China's Chamber of Commerce for Import and Export of Foodstuffs, Native Produce and Animal By-products that included measures on information exchange and training programs.¹⁸⁰

Automobiles

In March 2006, the United States filed a WTO request for consultations with China, saying that the Chinese government's industrial policy for automobiles discriminates against foreign auto parts in a manner which appears inconsistent with China's WTO commitments.¹⁸¹ Canada and the European Union also filed similar requests.¹⁸² The U.S. request expressed the understanding that, if imported parts in a vehicle exceed a specified threshold, the Chinese government would assess a charge on the imported auto parts equal to the tariff on complete vehicles, rather than the lower charge otherwise applied to auto parts. The U.S. request says that these measures appear to constitute a charge in excess of rates that the Chinese government committed to in its accession agreement, as well as a subsidy contingent upon the use of domestic rather than imported goods.¹⁸³

Even as it agreed to consultations with the United States, Canada, and the European Union,¹⁸⁴ the Chinese government, speaking through state-run media, said that China should "promulgate a regulation on imports of auto parts in an attempt to prompt foreign partners to produce core auto parts in China, thus reducing the country's dependence on imported components."¹⁸⁵ Consultations were held in May, which were joined by Japan, Mexico, and Australia, but no resolution was reached.¹⁸⁶ In June, the European Union said it would seek another round of consultations. In September, several countries, including the United States, requested the WTO establish a dispute resolution panel to address this issue.¹⁸⁷

Steel

The National Development and Reform Commission (NDRC) issued a new steel industrial policy in July 2005¹⁸⁸ that, according to the USTR, provides for state management of "nearly every major aspect of China's steel industry."¹⁸⁹ The USTR reports that the policy includes provisions that appear to raise barriers to foreign participation, discriminate against foreign equipment and technology imports, and encourage the use of domestically produced equipment.¹⁹⁰ The USTR has said that the policy imposes a high degree of government direction and decisionmaking about the allocation of resources into and out of China's steel industry. The USTR reports that this policy is inconsistent with the spirit of China's general WTO obligations, and raises concerns regarding China's WTO commitment not to influence, directly or indirectly, commercial decisions on the part of state-owned or state-invested enterprises.¹⁹¹ The U.S. and Chinese governments held the first Steel Dialogue meeting in March 2006. During this meeting, U.S. officials stressed U.S. steel industry concerns that government direction, not market mechanisms, is driving much of the capacity expansion in China's steel industry.¹⁹²

The policy's requirement that foreign investors possess proprietary technology or intellectual property in the processing of steel also raises concerns. The USTR has said that, because foreign investors are not allowed to have a controlling share in Chinese steel and iron enterprises, this requirement would seem to constitute a de facto technology transfer requirement, in conflict with China's WTO commitments not to condition investment on the transfer of technology.¹⁹³

In May 2005, without prior notification to the WTO, the Chinese government imposed new import licensing procedures for iron ore.¹⁹⁴ In August 2005, the United States submitted questions to the WTO Committee on Import Licensing noting that qualification rules reportedly restrict licenses to 48 traders and 70 steel producers, but that no list of criteria or list of qualified companies had been published.¹⁹⁵ The United States raised the issue of the operation of the import licensing procedures applicable to iron ore during the transitional reviews before the Committee on Import Licensing in September 2005,¹⁹⁶ and before the Committee on Trade-Related Investment Measures in October 2005.¹⁹⁷ The Chinese delegates maintained that the government did not impose any qualifying criteria, but it also acknowledged that two organizations affiliated with the Chinese government had been discussing whether it was necessary to impose industry rules regarding the qualification criteria for enterprises applying for automatic import licenses.¹⁹⁸

Distribution Services and Trading Rights

When it acceded to the WTO, the Chinese government committed to phase out restrictions on the right of foreign investors to import and export products in and out of China ("trading rights") and to sell products within China ("distribution services") for most sectors by December 2004.¹⁹⁹ While it implemented its trading rights commitments nearly six months ahead of schedule,²⁰⁰ the government's efforts to implement the distribution services commitments were characterized by "delay and confusion."²⁰¹ Although the Ministry of Commerce (MOFCOM) issued regulations on foreign distribution services in April 2004,²⁰² the Ministry subsequently found it necessary to issue several circulars to clarify issues relating to sales away from a fixed location ("direct sales"),²⁰³ the ability of foreign-invested enterprises in bonded zones to apply for distribution rights,²⁰⁴ and the procedures for foreign-invested enterprises to expand their business scope to include distribution.²⁰⁵ The government did not issue formal regulations on direct sales until August 2005.²⁰⁶ According to U.S. government and industry sources, however, these regulations contained several problematic provisions.²⁰⁷ In February 2006, however, MOFCOM issued the first direct selling license to Avon Products, Inc.,²⁰⁸ and in April 2006, the government agreed to establish a public-private dialogue designed to facilitate direct sales.²⁰⁹

Standards

As part of its WTO accession commitments, the Chinese government became obligated under the WTO Technical Barriers to Trade Agreement to use international standards as the basis for domestic standards except when ineffective or inappropriate, and to refrain from adopting more trade-restrictive standards than necessary.²¹⁰ In November 2005, a Chinese representative told the WTO Committee on Technical Barriers to Trade that as the result of an "overhaul" of national standards to ensure their consistency with WTO commitments, the General Administration of Quality Supervision, Inspection and Quarantine and the Standards Administration of China reported that a total of 1,416 national standards had been nullified, among which 114 were mandatory.²¹¹ Nevertheless, according to the WTO, the percentage of China's national standards that are equivalent to international standards has remained unchanged since 2000, at around 32 percent.²¹² In May 2006, the U.S. Trade and Development Agency awarded the American Chamber of Commerce in China a US$500,000 technical assistance grant to promote increased cooperation between the United States and China in the development of commercial and industrial standards and regulatory policy.²¹³

Despite these positive steps, according to the USTR, the Chinese government continues to pursue "unique national standards in many areas of high technology that could lead to the extraction of technology or intellectual property from foreign rights holders."²¹⁴ For example, in May 2003, the Chinese government issued two standards that incorporated the WLAN Authentication and Privacy Infrastructure (WAPI) encryption.²¹⁵ WAPI differs from, and cannot function with, the 802.11 standard approved by the International Standards Organization (ISO). In addition, the government was prepared to enforce the standard by providing the algorithms only to a limited number of Chinese companies, requiring foreign competitors to provide specifications of their products if they wished to produce WLAN equipment for the Chinese market.²¹⁶ At the April 2004 Joint Commission on Commerce and Trade (JCCT) meeting, Chinese officials agreed to delay WAPI implementation, and submitted a voluntary WAPI standard to the ISO.²¹⁷

In March 2006, the ISO rejected China's proposed WAPI standard.²¹⁸ The Chinese government said that the decision had been influenced by "the diplomatic relationship between the United States and other nations," and that "nothing would affect WAPI's domestic application."²¹⁹ The Chinese government filed appeals with the ISO in April and May asking it to overturn the vote and accusing the Institute of Electrical and Electronics Engineers (IEEE) of "organizing a conspiracy against the China-developed WAPI, insulting China and other national bodies, and intimidation and threats."²²⁰ In June, the Chinese delegation walked out of an ISO-organized meeting, saying that only 7 of the 17 countries opposing the WAPI standard had attended the meeting, and that the "monopoly force from the American standard maker IEEE poisoned the voting process and created an unfair atmosphere at the Prague meeting."²²¹

Bilateral Cooperation on Commercial Issues

The U.S. Department of Commerce (DOC) promotes bilateral cooperation with relevant Chinese government departments and agencies on market access issues and ensuring compliance with trade agreements. Past DOC programs have offered training to Chinese officials on protection of intellectual property rights, adoption standards, promotion of the rule of law, and improving domestic health care. To improve transparency in the Chinese commercial legal regime, DOC officials, in cooperation with the National People's Congress, held roundtables in three major Chinese cities during 2005 that focused on legislative and regulatory transparency. As the Chinese government works to adopt its first anti-monopoly law, DOC also hosted a Chinese delegation to the United States in November 2005 to discuss the principles of U.S. antitrust law. In July 2006, DOC officials organized a program focusing on the U.S. Federal Register system and regulatory transparency for a delegation from the China Foreign Economic and Trade Gazette. In August 2006, DOC and the Legislative Affairs Commission of China's National People's Congress Standing Committee (NPCSC) jointly organized a seminar on the revision of China's Partnership Enterprise Law. The revisions adopted by the NPCSC later in the month incorporated a number of suggestions made by the U.S. side, thus bringing the Chinese regulatory regime, important to professional services and venture capital firms, closer to international practices. A bilateral Standards and Intellectual Property program held in September 2006 focused on the relationship between standards and intellectual property as well as their impact on innovation and competitiveness.