China’s telecommunications regulator, the Ministry of Industry and Information Technology (MIIT), has announced a pilot scheme that would allow foreign investors to establish wholly owned subsidiaries in Beijing, Shanghai, Shenzhen, and Hainan that will be eligible to offer data center services, content distribution network services, and a range of other value-added telecommunications services (VATS) that require regulatory licenses that have historically not been available to foreign-invested telecom enterprises (FITEs) or have been subject to a 50% cap on foreign investment. As a result, while certain sensitive services continue to be limited to domestic providers, the pilot scheme aims to initiate a material opening up of the previously restricted market for online services.

Details of the pilot scheme include:

• Contemplated by the Circular on the Pilot Opening of the Value-Added Telecommunications Sector (关于开展增值电信业务扩大对外开放试点工作的通告, MIIT Circular No. [2024] 107 (“Circular 107”)) issued by MIIT on April 10, 2024;
• Would allow FITEs with full foreign ownership to operate data center services, content distribution network services, Internet access services, online data processing and transaction processing services, as well as information release platform and transmission services and information protection and processing services (two subcategories of Internet information services) in Beijing, Shanghai, Shenzhen, and Hainan;
• Excludes online news, online publishing, online audiovisual services, and Internet cultural services, which remain off limits to foreign investors seeking full ownership under the pilot scheme;
• Is not self-implementing; requires provincial governments in the pilot areas to draft implementation rules at the local level, which are subject to the MIIT’s approval; and
• Requires participating FITEs to be set up within a pilot area and operate service infrastructure and facilities within that same area, although their services (other than Internet access services) may be offered on a national basis.

In this update, we provide a brief overview of China’s VATS licensing regime and discuss the terms of the scheme and its potential implications for foreign investors.

China’s VATS licensing regime

VATS categories

The Telecommunications Services Classification Catalogue (the “Telecoms Catalogue”) classifies VATS in several different categories. An entity wishing to offer locally hosted VATS to the public in China will require a VATS license issued by the MIIT for the relevant category. We frequently advise foreign investors on the following VATS categories in relation to their proposed online services in China:

• Internet data center services (categorized as “B11” under the Telecoms Catalogue);
• Online data processing and transaction processing services (“B21”); and
• Internet information services (“B25”), which are broadly described under the Telecoms Catalogue as the “provision of information to users via Internet or other public networks, by means of collection, development and processing of information and the construction of information platforms.” B25 is essentially a catch-all category covering many types of online services that are not otherwise classified into other VATS categories.

Current restrictions on foreign investment in VATS

The different categories of VATS licenses are subject to different eligibility requirements under the current regulatory regime, including, in many cases, limitations on foreign investment. Taking B11, B21, and B25 VATS services for example:

B11 VATS license for data center services

The B11 license is generally not available to a company with any degree of foreign investment – with only two exceptions:

• A FITE set up with a Hong Kong or Macau investor qualified under the Closer Economic Partnership Arrangement with Mainland China (CEPA), with the level of Hong Kong/Macau investment capped at 50%; and
• A FITE established, and with service infrastructure located in, Hainan Province that provides data center services to users within Hainan (but not in other areas of China) and outside China, with no limit on foreign investment.

B21 VATS license for data processing and transaction processing services

FITEs with 100% foreign investment are currently eligible to obtain B21 VATS licenses that cover e-commerce marketplace platforms (i.e., the subcategory of “transaction processing services” under B21), but foreign investment in the conduct of other subcategories under B21 VATS (namely “electronic data exchange services” and “network/electronic equipment data processing services”) remains capped at 50%.

B25 VATS license for information services

For this most commonly required B25 VATS license, foreign ownership is capped at 50% in most cases. The only limited exception is app store services, where full foreign ownership is permitted for businesses qualified under CEPA (see above) or operating in one of China’s free trade zones (FTZs) or the Beijing municipality.

Highlights of Circular 107

Pilot areas

• Beijing: All of the Beijing municipality;
• Shanghai: The Lin-Gang Special Area of the Shanghai FTZ, and Pudong New District;
• Hainan: All of the Hainan Province; and
• Shenzhen: All of the Shenzhen municipality.

The issuance of Circular 107 does not by itself effect the related market opening. Rather, the Circular requires provincial governments in the pilot areas to draft their own implementation plans, subject to MIIT’s assessment and approval. FITEs may then seek MIIT approval to participate in the pilot scheme in accordance with the local implementing rules.

VATS services to be opened up:

• Internet data center services (“B11”): all service types;
• Content distribution network services (“B12”): all service types;
• Internet access services (“B14”): all service types;
• Online data processing and transaction processing services (“B21”): all service types; and
• Internet information services (“B25”): the subcategories of “information release platform and transmission services” (but excluding online news, online publishing, online audiovisual, and online cultural operation), and “information protection and processing services.”

The following chart summarizes the scope of the market opening contemplated by Circular 107:

Practical requirements

• FITEs participating in the pilot scheme must be registered within a pilot area, and their service infrastructure and facilities (either owned or leased) must be deployed in the same area.
• Other than B14 Internet access services, participating FITEs can offer other services covered under Circular 107 to customers on a national basis. For B14 services, participating FITEs are only permitted to provide services within the registered pilot area and must rely on infrastructure provided by one of China’s basic telecom service providers (mainly China Mobile, China Telecom, and China Unicom).

Assessment of implementation of pilot scheme

Circular 107 calls for cross-sectoral collaboration to oversee the implementation of the pilot scheme and requires participating FITEs to comply with telecom, cybersecurity, and data protection rules. It also contemplates that MIIT and the relevant provincial governments will work together to undertake an annual assessment and summarize best practices for a potential wider roll-out if the pilot scheme proves to be successful.

It is noteworthy that Circular 107 specifically provides for the suspension or early termination of the pilot scheme if the implementation generates concerns in any pilot area – including in particular if “frequent violations of law”, “increased risk factors”, or the “inability to ensure cybersecurity supervision” occur. Express language of this kind is novel and has not been seen in previous market opening schemes. It may reflect MIIT’s reservations regarding the pilot scheme. In any event, its inclusion in Circular 107 adds uncertainty to the long-term sustainability of the pilot scheme.

Practical implications

The telecom industry is one of the most heavily regulated sectors in China. A wide range of technology companies in China (including foreign companies and those Chinese companies with cross-border corporate structures) have long grappled with the stringent VATS licensing restrictions relevant to the provision of online services in China. Pre-Circular 107 statutory restrictions largely precluded foreign investment in some cases, and in others imposed a 50% cap on foreign investment.

The pilot scheme is potentially a game changer for these companies. The removal of foreign ownership limits on the provision of B11 data center services, B12 content distribution network services, and B14 data processing services within the pilot areas has the potential to open up the China market to foreign cloud services and data-processing companies. Moreover, the pilot scheme may pave the way for a market opening beyond the pilot areas at a later stage.

Nonetheless, caution is warranted. Foreign-invested participation in B14 Internet access services and B25 internal information services remains subject to material limitations. Moreover, it will take time for local governments to adopt implementing rules and formulate local practices to implement Circular 107, and those rules and practices may include requirements that will make it difficult for foreign investors to participate in the pilot scheme. In addition, MIIT’s inclusion in Circular 107 of an express exit ramp from the pilot scheme may dissuade more risk-averse investors from making significant investments in new structures and infrastructures that are required to participate.

Foreign investors are advised to closely monitor the implementation of Circular 107 and consult with local governments to better understand the possible regulatory positions in the relevant pilot areas. Those currently using variable interest entities (VIEs), technical services arrangements, or other indirect structures to participate in the provision of VATS services, or currently operating via a joint venture, may have the opportunity to move away from those structures and set up wholly owned FITEs to provide those services, where they are within the scope of Circular 107.

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