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By Jackson Slipek
Anyone paying attention to the news lately can't help but notice that relations between the US and China are becoming more confrontational. Google is threatening to pull out of China over increased censorship, and President Obama is under pressure from Congress and trade groups to address unfair Chinese trade practices and currency manipulation.
Less obviously, Chinese import-export regulations are becoming more complicated and restrictive, especially on the technology front, as a large number of high-tech foreign firms have either flocked to China or are in the process of beefing up their existing local presence.
Until recently, high-tech industry that use encryption technology within their products had little to worry about, as commercial encryption product license management in China has had a relatively low profile in the compliance environment for Chinese customs officials.
Flash forward to 2010 and industry is experiencing increased authority and oversight. While some restrictions were placed on encryption technology in 2008, more have followed.
The tightening of encryption policies isn't all bad for importers. Official announcement No. 18, related to commercial encryption products, contains two updates; the first one is favorable to the international trade community while the second is more restrictive.
The first update states that an encryption license is no longer required in the case of bonded production purely for overseas sales. In the case of processing trade or bonded production, all the licenses relating to raw materials containing encryption technology can be waived under the condition that upon completion of bonded manufacturing, all the finished goods are physically exported for overseas sales. This is good news, as in the past all commercial encryption products were subject to the license requirement, regardless of trading modes.
The second update states that the Chinese government has plans to regulate encryption products based on the Harmonized Tariff Schedule (HTS) number. As of January 1, 2010, these new controls went into effect on commercial encryption products and products containing encryption technology in a number of HTS categories.
All products falling into one of these categories need to have an import license for entry into China. In addition, any commercial encryption product whose key length is 56 bits and above is also subject to this license requirement. There is also an expectation that more encryption-controlled categories will be established in the coming months and years. In the meantime, the above two-pronged system is most likely to be the guiding force overseeing commercial encryption technology. It is a future possibility that HTS-based regulation will eventually completely replace the other product description-based regulation.
China Customs can more easily identify products subject to encryption license requirements due to the HTS classification and a better working relationship with the State Encryption Management Commission. The previous description-based regulation was difficult to enforce as it required deep product and regulatory knowledge. It was rare to find a Customs official who could appropriately judge if a declared product contained encryption technology and was therefore subject to the license requirement.
Now, an encrypted-like product that does not have an encryption license at the time of import will be held by Customs. Considering it takes at least 25 working days for China to process a license application and additional time to actually prepare the application documents, materials could be held up for a month.
Delays will reverberate through the supply chain cycle. As a warning to businesses, do not expect Chinese authorities to expedite the application process. Attempts to skirt the law may subject the importer to goods confiscation and/or fines up to three times the expected revenue to be generated from the product sale according to regulations issued in October 1999.
The high-tech industry is far from alone in facing new Chinese restrictions.
During 2009, the Chinese government launched a series of anti-dumping probes or investigations against the US, EU, Italy, Saudi Arabia, France, Taiwan and various other countries. Specifically, the Chinese anti-dumping cases against the US involve multiple products such as chicken products, Adipic acid, Polyamide-6, and sedan and cross-passenger automobiles. Some of these investigations are ongoing. Regardless, during the anti-dumping investigation process, a firm will face challenges importing into China. These may result in detained shipments or demands for more information, thereby adding time and cost to supply chain cycles.
To confront these challenges, businesses should consider purchasing domestic products or evaluate the possibility of purchasing foreign products from a different country of origin. With spare parts, a firm could avoid anti-dumping duties as long as the parts are imported along with complete equipment or systems. In any case, the importer must provide and maintain complete and clear financial and cross-border trade information for the inevitable anti-dumping inspection.
China has also imposed additional compliance responsibilities on "Processing Trade" or bonded firms. The term "Processing Trade" refers to business activities in which a business imports for manufacturing all or part of the raw or ancillary materials, spare parts, components, and packaging materials, with the intention to re-export the finished product after processing or assembling. In the past, this process was encouraged by the Chinese authorities. These imported materials were exempted from the requirements of so-called China Compulsory Certificates (CCC).
Processing trade or bonded businesses provided the processing log book as the evidence of exemption, a simple straightforward procedure. The rules changed in September 2009 when Chinese authorities required a formal CCC exemption certificate be issued by China's General Administration for Quality Supervision, Inspection and Quarantine office during the import customs clearance. This new process adds one to two additional working days and additional fees to the process. Complicating matters, the Chinese import broker will charge an additional fee to coordinate the exemption certification. It is safe to assume that with this impediment to smooth supply chain operations, the Chinese government is no longer encouraging sole assembly operations as they did 5 to 10 years ago.
The China-US trade relationship will evolve over time. Eventually, tempers will cool. Today, however, companies must deal with the consequences of rising temperatures.
Jackson Slipek is a senior consultant at JP Morgan.
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