The China-Australia Free Trade Agreement

In brief

After almost 10 years of negotiations between the nations, on 17 November 2014, Prime Minister Abbott and President Xi announced the conclusion of negotiations on the China Australia Free Trade Agreement (ChAFTA). Once implemented, the ChAFTA is expected to significantly reduce import barriers for Australian food and dairy, resources and services sectors and create a more favourable environment for Chinese direct foreign investment in Australia. Partner Kate Axup, Managing Associate Emin Altiparmak, and Associates Tess Fitzgerald and Tracy Lu report.

How does it affect you?

• Australian exporters in the agricultural, resources, pharmaceutical and manufacturing sectors will benefit from significant and wide-ranging tariff reductions.
• In the services sector, wholly Australian-owned companies will benefit from improved access to the Chinese services market, with new opportunities presented in sectors such as banking, insurance, telecommunications, hospitality, health and aged care and legal services.
• The ChAFTA is also expected to encourage Chinese foreign direct investment into Australia. Broadly, FIRB approval thresholds for Chinese private investments in Australia in non-sensitive sectors will be significantly increased, from A$248 million to A$1.078 billion, in line with the thresholds applicable to private investors from the United States, New Zealand, Japan, Korea and Chile. Investments by Chinese state-owned enterprises (SOEs) will remain subject to FIRB approval regardless of the value of the investment.

Background

On 17 November 2014, Australia and China signed a Declaration of Intent to enter the ChAFTA, marking the conclusion of negotiations on a landmark bilateral trade agreement. The announcement of the ChAFTA has been warmly received in China with commentators highlighting the domestic demand for Australian agricultural products and welcoming the improved opportunities for direct investment in both nations¹. Australian businesses also look set to benefit from the deal, which is particularly significant in light of the substantial market access issues that foreign companies face when selling to China or doing business in China.

According to the Department of Foreign Affairs and Trade (DFAT), official translations of the ChAFTA will now be prepared and the draft treaty will undergo final legal review before being executed. Formal treaty-adoption processes must then be followed in both Australia and China, and diplomatic notes exchanged, before the ChAFTA will become effective (we anticipate at some stage in 2015).

Entry into the ChAFTA, which is reported to cover projects potentially worth more than A$20 billion², is expected to further strengthen Australia's trade position in East Asia, following the conclusion earlier this year of the Japan-Australia Economic Partnership Agreement (the JAEPA) (see our previous Focus: The Japan-Australia Economic Partnership Agreement) and the Korea-Australia Free Trade Agreement (the KAFTA) (see our previous Focus: Korea-Australia Free Trade Agreement: strengthening cross-border investment).

Key outcomes

At the date of publication, the text of the ChAFTA has not been made public. However, DFAT has released various Fact Sheets as well as a summary of the key outcomes to assist interested parties in understanding the deal.³

Encouraging Chinese Foreign Direct Investment

DFAT reports that the ChAFTA will substantially increase the FIRB approval threshold for private (ie non-state owned) entities investing in non-sensitive sectors. Under the ChAFTA, the FIRB approval threshold for investments by these investors will be increased to A$1.078 billion (up from A$248 million). The approval threshold for investments in a limited number of prescribed sensitive sectors, such as media, telecommunications, transport and defence, will remain A$248 million. Similar to its approach under the JAEPA and the KAFTA, we expect that Australia will reserve its right under the ChAFTA to impose lower limits for investments in agricultural land (A$15 million) and agribusiness (A$53 million) in line with the Australian Government's stated intention to introduce those limits generally.

While the increased thresholds will be welcome news, the ability to rely on them is likely to continue to depend heavily on the acquisition structure to be adopted in a particular case. For example, the increased thresholds for investors from the United States, New Zealand, Japan, Korea and Chile operate such that if a private investor from one of those countries proposes an investment in Australia through a subsidiary that is not from its home country (including, bizarrely, an Australian subsidiary), then the increased threshold does not apply. There has been no suggestion that the ChAFTA will be any different in this respect. As tax and other considerations will often favour foreign investment via an Australian or third-country subsidiary, the higher thresholds are often unavailable.

Also, the proposed changes will not apply to investments by Chinese SOEs, who will remain subject to FIRB approval regardless of the value of their investment (as is the case with investment by SOEs from all other nations). These are investments where the interest acquired equals 10 per cent or more, or less than 10 per cent if it provides potential influence or control (including by way of preferential voting, director appointment or contractual rights). Between 2007 and 2013, Chinese SOE investors accounted for 89 per cent of the total value of Chinese outbound direct investment in Australia.⁴ For this reason, it remains to be seen whether the increased thresholds will result in any material benefit for the largest class of Chinese investors in Australia.

We are yet to see confirmation of whether the ChAFTA will include a 'Most-Favoured Nation' clause enabling China to receive the benefit of any market access arrangements granted by Australia pursuant to free trade agreements with other nations. We will monitor this issue when the text of the ChAFTA becomes publicly available.

Australia has also agreed to create new avenues for Chinese companies to engage Chinese nationals in aspects of their Australian operations, as part of a mutual agreement to allow for greater workforce mobility. Australia's concessions in this regard are expected to facilitate Chinese investment into Australia, as workforce mobility is often a key policy driver for Chinese entities looking to invest abroad.

Specifically, it is reported that Australia will grant certain categories of Chinese citizens with rights to enter and work in Australia for a limited time period, including:

• intra-corporate transferees, independent executives and contractual service suppliers, for up to four years; and
• business visitors for up to 90 days (or six months in the case of service providers).

China and Australia have also entered a Memorandum of Understanding allowing for Investment Facilitation Arrangement, which will permit Chinese-owned companies which are registered in Australia and undertaking large infrastructure development projects above A$150 million to negotiate for increased labour flexibility, on a specific, case-by-case basis, as is the case for Australian businesses.

Like the KAFTA (and in contrast to the JAEPA), the ChAFTA contains an Investor-State Dispute Settlement mechanism, pursuant to which obligations within the Investment Chapter can be enforced directly by investors from the two countries. We report on this issue in more detail in our Focus: Investor State Dispute Settlement and the China-Australia Free Trade Agreement.

Reducing barriers to trade in goods

Agricultural and Processed Food

According to DFAT guidance, major concessions have been agreed in the agriculture, food and beverages sectors with the removal of all import tariffs on Australian dairy, meat, wine, seafood and horticultural products (ie fresh vegetables, fruits and nuts). The removal of import tariffs addresses a substantial barrier to trade faced by Australian exporters, with tariffs as high as 20 per cent (dairy and wine), 25 per cent (beef) and 23 per cent (sheepmeat) currently imposed on imports into China. The ChAFTA is also reported to provide a quota of Australian wool that may be exported to China on a duty-free basis, which is in addition to China's existing commitments on wool under the General Agreement on Tariffs and Trade.

No additional concessions have been made in relation to rice, wheat, cotton and sugar, which are considered by China to be 'significantly sensitive staples' and will remain subject to import protections. This is similar to the position in respect of rice under JAEPA, where no additional concessions were provided. According to DFAT, China has agreed to a review the position on these staples in three years.

Australia has also agreed that all remaining tariffs on agricultural and processed foods imported from China will be eliminated.

Resources and Energy

Under the ChAFTA, China will remove all tariffs currently applicable to a wide range of Australian energy and resources products, manufactured goods and pharmaceuticals. China's current trade and investment laws impose tariffs of 3 per cent and 6 per cent to coking coal and non-coking coal (respectively), while transformed resources and energy products such as alumina, unwrought aluminium and titanium dioxide are subject to tariffs in the range of 5-10 percent. The deal also guarantees no tariffs will in future be imposed on the import of Australian iron ore, gold, crude petroleum oils or liquefied natural gas.

Under the ChAFTA, all Australian tariffs on Chinese resources, energy and manufactured goods will also be eliminated.

Pharmaceuticals and Manufacturing

The deal is also expected to improve market access for Australia's pharmaceuticals and manufacturing sectors. Notably, all tariffs on pharmaceuticals, health products and vitamins will be removed, providing new opportunities for Australian companies in these sectors, which currently attract tariffs of up to 10 per cent.

Tariffs will also be removed on products within the automotive, steel, aluminium and plastics sectors, which are currently subject to a 5 per cent tariff. We understand that the position under the ChAFTA in this sector is likely to be similar to that under the JAEPA and the KAFTA (other than the retention of a specific tariff in relation to Japanese used cars under the JAEPA).

Reducing barriers to trade in services

China's concessions in the services sector are reported to be significant and, according to DFAT, represent China's 'best ever' services commitments in a free trade agreement (excluding China's agreements with Macao and Hong Kong).⁵ They include:

• Financial services – improving Australia financial services providers' access to the banking, insurance, funds management, securities, securitisation and futures sectors in China. In particular, the deal is reported to remove the minimum working capital requirement for Australia bank branches (RMB100 million per branch), and allow Australian insurance companies to access the third-party motor vehicle insurance market. The ChAFTA is also reported to permit increased foreign equity participation in securities firms, allowing Australian ownership of up to 49 per cent.
• Telecommunications – improving access to the telecommunications sector for wholly Australian-owned companies, including by allowing Australian service providers to supply Chinese domestic multi-party communication services, application store services, store and forward services and call centre services.
• Technical services – improving access in a range of specific technical service areas. The ChAFTA is reported to permit certain categories of services, including the provision of technical consulting and field services in coal bed methane and shale gas extraction, contract manufacturing services and maritime and air transport services, by Australian service providers.

The ChAFTA is also reported to improve market access for Australian tourism and hospitality businesses by permitting wholly Australian-owned hotels, restaurants and travel agencies in China. Similarly, in the healthcare sector, Australian health service providers will be permitted to establish wholly Australian-owned hospitals and aged care institutions in China.

Additional opportunities will also be provided for Australian service providers in the Shanghai Free Trade Zone (SFTZ). In particular:

• Australian law firms will be allowed to establish associations with Chinese law firms in the SFTZ;
• Australian companies established in the SFTZ will be allowed to undertake joint construction projects with Chinese companies in Shanghai; and
• wholly Australian-owned companies will be allowed to participate in joint ventures in the SFTZ to supply online data and transaction processing services, with an increased equity participation limit of 55 per cent.

The SFTZ is a tax-free trading zone established in 2013 by the Chinese Government to attract foreign investment and to trial economic and currency reforms. The permitted activities in the SFTZ under the ChAFTA are significant in part as they signal possible areas of future reform on a wider scale. 

Australia will also provide specific assurances to China under the ChAFTA in relation to protecting the interests of Chinese international students, Chinese financial institutions' participation in the Reserve Bank Information and Transfer System and the research and development of traditional Chinese medicines in Australia.

Comment

The ChAFTA marks a significant milestone for bilateral trade between China and Australia. We will closely monitor further developments as the ChAFTA goes through the formal adoption process and report to you again once it has been fully implemented.