Shanghai free-trade zone

Caveat on Shanghai experiment

Despite hopes for the free-trade area, experts warn it will not be able to create the same free and fair legal system that Hong Kong enjoys

PUBLISHED : Monday, 25 November, 2013, 11:42am
UPDATED : Tuesday, 26 November, 2013, 1:58am

Shanghai is keen to copy Hong Kong’s economic model for its newly launched free-trade zone. But finding an equivalent for the centuries-old common-law system the former colony inherited from Britain may be easier said than done.

Law experts warn that potential legal risks and uncertainty may hinder the mainland’s financial capital’s attempts to lobby foreign businesses now active in Hong Kong to move north.

The mainland’s first free-trade zone has already attracted opposition from several regulators of ministerial level concerned about losing their powers if the zone is given too much freedom.

Some analysts believe this has cast a shadow over the outlook for the zone, which was officially launched at the end of September.

Unlike Hong Kong, the Shanghai free-trade zone does not have its own controlled border.

Hong Kong also enjoys an independent judiciary, creating a safe legal environment for foreign investors. The city’s partial autonomy is safeguarded by late paramount leader Deng Xiaoping’s “one country, two systems” principle, in force since the city’s historic handover in 1997.

Susan Finder, a legal analyst with Practical Law China and a former lawyer with Freshfields in Hong Kong, said that while the legal system in the Shanghai free-trade zone would be a few steps ahead of the rest of the country, it would not be dramatically different.

Foreign investors may continue to find that business disputes, especially with local business partners, will be heard in local courts that are often easily influenced by the government.

The government wants to become more in line with international practice, but this doesn’t mean that they can just import law from New York and stick it in the free-trade zone
Susan Finder, Practical Law China

“It is a misconception that Shanghai could be just like Hong Kong. Any institutional change will be slow. The idea is to have controlled experiments in the free-trade zones and then make adjustments before rolling it out to the whole country,” Finder said.

“The government wants to become more in line with international practice, but this doesn’t mean that they can just import law from New York and stick it in the free-trade zone.”

Indeed, government officials in Shanghai are worried about how they should handle business disputes in the free-trade zone, especially those involving major foreign investors.

“Of course, so far we don’t have any disputes. I think if we have a big problem some day, it will be ultimately up to our Supreme People’s Court,” said a government source who declined to be identified owing to the sensitive nature of the matter.

“Things will get clearer only next year.”

The source said a set of new governing laws for the free-trade zone would be reviewed and passed by the Shanghai Municipal People’s Congress, most likely in the first quarter of next year.

Confidence in the local judiciary, meanwhile, is not high. Earlier this year, several senior judges in Shanghai were caught with prostitutes. The case shocked the public, forcing the local government to sack the judges.

A Hong Kong-based lawyer, who declined to be named, said the main concern of clients about working on the mainland continues to be “corruption, the validity and enforceability of contracts and reliability of business partners”.

“Efforts by China to improve in these areas, such as what they’re doing with the free-trade zone, might help in the long term,” the lawyer said.

“But for now, Hong Kong is still the ideal place in Asia for international businesses to deal with legal issues. My clients have faith that they have the ability to enforce contracts in Hong Kong, as it is a fair place with an established history of the rule of law.”

If they fail to build a proper legal system within five years, there will be chaos
Xiao Geng, Fung Global Institute

Some scholars expect the Shanghai government to make changes gradually, while others say it is possible to revamp the entire legal system with support from the central government.

“I think it is entirely realistic that they could set up an international court of arbitration and allow a more independent judicial system in the Shanghai zone, where foreign judges and lawyers would contribute,” said Xiao Geng, vice-president of research at the Fung Global Institute.

“If they fail to build a proper legal system within five years, there will be chaos.”

But other experts quickly poured cold water over Xiao’s optimism.

“Certainly, the Shanghai free-trade zone will have the opportunity to introduce minor institutional changes and be more permissive about granting business licences and provide for different tax and customs arrangements,” said Nicholas Howson, a China law specialist at the Michigan Law School.

“But the idea that it will be subject to governing law distinct from the law of the People’s Republic of China is a non-starter.”

The Shanghai government has signalled it will err on the side of slow, cautious change.

Han Zheng, the city’s party secretary, told local media the free-trade zone’s architects had built a system that would balance commercial innovation and risk control.

“[It] is a move towards establishing a market economy and integrating it with international rules,” he said in an interview with Caixin magazine published on November 14.

“In the process, we need to give ample consideration to China’s characteristics, rather than simply copy from others.”