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STRATEGY
Latest Developments in Regional Headquarters in Shanghai
Originally published in HSBC Guide to Treasury and Cash Management in Asia Pacific 2006 July 31, 2006
Simon F. Huang, Shanghai Foreign Investment Commission
Shanghai, home to more holding companies than any other city in China, is a preferred location for its dynamic and vibrant economy. But setting up a regional headquarters there can pose some restrictions - for example on shared service centres and in terms of increasing costs.
- Shanghai has more holding companies than any other city in China.
- Beijing is preferred in the regulated sectors but, for market-oriented companies, Shanghai is preferred for its dynamic and vibrant economy.
- There are both benefits and pitfalls for multinational companies setting up their holding companies in China.
- It is a challenge finding a viable structure that is compatible with external regulatory bodies while, at the same time, satisfying all internal groups.
In June 2005, Shanghai reached two significant milestones in its relatively recent history of hosting regional headquarters of multinational companies (MNCs). First, ST Semiconductor China Holding Company became the 100th MNC to set up its regional headquarters in Shanghai since 2002 when the city launched its regional headquarters policy. Second, the admission of ST Semiconductor China Holding Company brought the number of holding companies in Shanghai to 122 - more than any other city in China.
Facts and Figures
Among the 122 MNCs to have chosen Shanghai, 10 have been granted regional headquarters (RHQ) status by China's Ministry of Commerce (MOC). They are Alcatel, BASF, Unilever, Bayer and Ciba from Europe, General Motors and Emerson from the US, and Suntory, APP and GiTi Tire from Asia. Also, in the past three years, 12 holding companies - including BASF, Bayer, Philips, Robert Bosch, Ford and Yamaha - have relocated from other cities to Shanghai. Meanwhile, Shanghai's municipal government has awarded RHQ status to 106 foreign-invested companies. Of these, 72 are holding companies and 34 are management companies.
A holding company, or umbrella company, is defined by the MOC as a foreign-invested company that specialises exclusively in investment and the management of investing companies. The minimum registered capital for a holding company is USD30m. RHQs granted by MOC refer to holding companies with registered capital of more than USD100m, or with registered capital of more than USD50m and total profits of over RMB100m and total assets of over RMB3bn. Alternatively, RHQs granted by the Shanghai government refer to either a holding company or a management company established under the relevant municipal regulations.
Holding Companies in China - the Big Picture
By the end of 2004, it was estimated that nearly 300 MNCs had received approval to set up holding companies in China. It is not surprising to note that over 80 per cent of them are concentrated in two cities - Beijing and Shanghai. The rest are scattered across Guangdong and several other provinces.
Further breaking down the figures for Beijing and Shanghai, we find that most of the holding companies engaged in regulated sectors such as automobiles, telecommunications and petroleum have tended to set up in Beijing. Of course, the main reason for this is that in the regulated sectors, the central government plays a crucial role in market access. Hence, foreign companies need to put their senior management teams and a lot of their resources into Beijing to support the frequent interaction with the central government. On the other hand, for market-oriented companies, Shanghai, with its dynamic and vibrant economy, is the preferred location.
Another interesting feature to note is that Asian companies, especially those from Japan and Korea, have tended to situate their holding companies in Beijing while companies from Western countries have tended to locate theirs in Shanghai. This demonstrates a significant cultural difference between the East and the West - Japanese and Korean companies place themselves in close proximity to the central government to enable them to maintain and nurture a close relationship with the government, while Western companies are more pragmatic in their choice of location, favouring cities that are more market-oriented.
Benefits and Pitfalls of Holding Companies
For those MNCs with considerable investment in China, the benefits of setting up a holding company include:
- better control of the Chinese operation - holding companies host the senior management teams, most of them expatriates who manage centralised business functions within China
- consolidation of procurement and sales functions to reduce operational costs
- consolidation of support functions such as human resources and finance to save management costs
- greater financing capability - holding companies, subject to scale, can borrow up to six times more than their registered capital to reinvest in other approved projects, and all investments from holding companies are regarded as foreign investment
- cash pooling to reduce costs - holding companies can choose to set up a financial company, whose minimum registered capital is RMB100m, or use entrusted loans provided by banks to achieve cash pooling
- image-building and commitment to the Chinese market - establishing a holding company is viewed by the Chinese government as a huge commitment to the domestic market and, for the MNCs, is a boost to their image-building
- incentives from local government - all qualified RHQs receive incentives as set out in the 'Interim Regulation on Encouraging Multinational Companies Setting up Regional Headquarters in Shanghai', promulgated by the municipal government in 2002
Of course, every coin has two sides, and there are pitfalls in setting up a holding company. They can include the following:
- high requirement of fresh capital - the minimum registered capital of USD30m is a hurdle, so a company needs to have a large expansion plan before it decides to set up a holding company
- liabilities to undertake investment projects in due time - the minimum registered capital has to be injected into China within two years to undertake the projects specified in the holding company's application documents
- adding another layer in the current structure may induce more management costs
- trapped cash - a holding company has to provide three reserve funds before repatriating profits
- business tax in shared services when holding companies provide centralised services (for example, human resources) that were originally conducted separately by foreign-invested companies, the provision will be regarded as a transaction between two independent legal entities, thus incurring business tax
Opportunities and Challenges
Undoubtedly, Shanghai will continue to host more MNCs' regional headquarters. The driving force behind this is that more and more companies feel they cannot afford not to invest or conduct business in China. When their investment in China exceeds a critical mass, it is essential to centralise many of their business functions in one location. Shanghai and the neighbouring area, with its dynamic and vibrant economic environment, is the most popular destination for foreign investment.
However, those companies that set up regional headquarters in Shanghai may still find it difficult to bring in all the functions an RHQ should have. For example, shared services may not be fully achieved for tax reasons, and the regional treasury function will still be located outside mainland China because of the strict regulation of inflow and outflow of foreign exchange. Furthermore, the ever-increasing cost of doing business in Shanghai is challenging the city's attractiveness in the region.
Conclusion
The structure of a foreign company operating in China is particularly relevant to its performance. Even companies that seem to be doing well can be much more successful if they adopt an alternative structure from the beginning. However, for MNCs, it is a challenge to identify a viable structure that is compatible with external regulatory bodies while, at the same time, satisfying the wishes of all internal groups. This is an area where the Shanghai Foreign Investment Commission, together with other banking professionals, can add value for their clients.
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