Converting China Trade Processing Agreements into WFOEs

November 25, 2010 Posted by China Briefing Reading Time: 4 minutes

Op-Ed Commentary: Alberto Vettoretti

Nov. 25 – As was noted by Professor Thomas Chan of the Hong Kong Polytechnic University’s China Business Center yesterday, the trade processing industry in China is dying out as it faces regional competition over lower wages and land, and it is becoming increasingly costly to operate such businesses in the China market.

Processing and Assembly Operations have accounted for a significant part of China’s exports and have been particularly popular amongst Hong Kong and Taiwanese investors since the early 1980s. Under this arrangement, the Chinese party (either a local Chinese company or a FIE) processed materials or assembled parts supplied from abroad by the foreign party, and then shipped the completed products back to the foreign party. No local sales were allowed and the whole production was required to be exported.

Due the fact that the cost of manufacturing has increased and will increase in the years ahead (it was recently announced that minimum wages are likely to double in the next five years), many investors are now looking at moving out of the main cities to 2TCs and, in some cases and industries, to other countries (both in Asia or even back in the old continent!). A large portion of these entrepreneurs has also converted trade processing businesses into WFOEs (wholly foreign-owned enterprises) or JVs (joint ventures), with the rest about to restructure within the time-frame given by local governments. This is actually desirable in most cases as it allows the restructuring of the aged and limited processing Lai Liao Jia Gong set up which did not cater for domestic sales into a legal entity that has the right to sell onto the Chinese market. The restructuring of LLJG to WFOE is also becoming a pressing issue. As noted by Professor Chan, trade processing is a dying industry in China as cost issues dictate such business will relocate elsewhere in Asia where there are lower wages, welfare, land, and less stringent operational regulations. But at the same time, China’s own domestic consumer market is developing, and the capability to sell to the Chinese domestic market is now the focus of attention.

It must be pointed out that certain industries, for example, electronics, semiconductors, manufacturing large orders with lean operations and just in time deliveries will still be around China for some time as the supply chain and the logistic infrastructure simply can not be replaced so easily or cannot be established so quickly elsewhere outside China. However for operations previously focused purely on China based manufacturing and export, the options now are: relocate to a cheaper location in other provinces in China or other countries, restructure the China ops by adding automation and innovation, sell to the Chinese market or do a combination of these. Increasingly, our practice is seeing businesses in South China both expand operations to other internal regions in the country, India and Vietnam to continue their export trade processing work or heavily investing into the upgrading of the existing manufacturing lines in the country. Most of them are also repositioning the China entity to sell to the China market.

Over time, foreign investors have increasingly found themselves in the position of having, on the one hand, still to cater for the overseas markets but also, on the other hand, to tap into the growing domestic market. In fact, both local Chinese companies as well as FIEs were increasingly demanding locally manufactured goods of high standards for which they could easily pay for in local currency. This has triggered a flow of first and second tier manufacturers who in the past focused only on processing trade turning their attention to the domestic market. At the present moment, some of them are not only able to still manufacture for export but can also provide local supplies to their Chinese clients. Legal and market changes have also made it easier for WFOEs to sell locally without having to export the majority of their production or even without adding value to the final products.

Alberto Vettoretti is the managing partner for Dezan Shira & Associates in China and is based in the firm’s Shenzhen office. Dezan Shira & Associates have been advising foreign investors in China since 1992 and have 10 offices throughout the country. For advise and assistance over converting trade processing agreements into WFOEs please contact the firm at info@dezshira.com.

The practice also maintains offices in India and Vietnam. For professional assistance with the establishment of manufacturing entities in these locations, please email info@dezshira.com. The firm’s brochure, outlining all services provided, may be downloaded here.

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