Beijing Tightens Internet Rules

HONG KONG (01/27/2000) - A flurry of Internet-related regulations by the Beijing government, some recently announced and others expected soon, could chill foreign investment in Mainland China and make it more difficult for foreign businesses to operate there, according to market observers.

The regulations cover a wide range of concerns, including transmission of unapproved information, use of data encryption technology and initial public offerings of businesses in China.

The rules, created by several different agencies, most likely reflect the government's fear of the impact the Internet may have on China's society, politics and commerce, several market experts said today.

The result could be that the rules hamper the development of China's Internet industry and shift the focus of investment elsewhere in the region, according to one analyst.

"This is a variety of ministries making decisions that make sense in their own right, but when put together, can be very inhibitive," said Joe Sweeney, a research director at Gartner Group Inc., in Hong Kong.

Rules published yesterday in the official People's Daily reportedly forbid Internet users from transmitting state secrets -- a term that has been used to describe almost any information unapproved by the government -- and liable for the spread of that information inside or outside the Mainland.

A set of regulations introduced in October by a state data-encryption agency also outlaws the use of foreign software with encryption capabilities, Sweeney said. It also requires companies to notify the government by next Monday of the name, location, e-mail address, and other information for all their users of encryption-capable software.

Another cause of concern is new, stricter rules on government approval of share offerings that are expected soon from the state Securities Regulatory Commission. The rules would require any company that is primarily Chinese -- a definition that could include some joint ventures formed by foreign companies -- to get approval for a share offering made anywhere in the world.

The regulations on encryption are too strict for multinational companies to follow, because most of the software they need must come from outside China, according to Sweeney. He advises companies to give the government a list of all their employees and all the software they use.

"Companies just have to know that technically, they will be in violation of these edicts," Sweeney said. The danger is that a competitor for a government contract could use that fact against the company, he said.

"If you're in a weak bargaining position, it can be used against you," Sweeney said.

Chinese government officials have said informally that the real target of the encryption regulations is software specifically designed for encryption, according to Lester Ross, an attorney in the Beijing office of Paul, Weiss, Rifkind, Wharton & Garrison.

"That alone is a problem for a number of people," Ross said. The rules are likely to have the effect of making all transmitted data visible to the government -- which in some cases might be a commercial competitor, he said.

"It will have a very serious impact on people's willingness to do business in China," Ross said. "People are afraid of the inability to preserve commercial secrets."

Ross said the expected regulations on share listings appear to be a further tightening of rules that have been in place for several years. The primary target would be startups created in China that go outside the country to go public.

"If you just migrate the legal entity offshore and inject the assets into the mainland entity, it's still subject to their regulation," Ross said. Such listings, sometimes called "red chips," typically have taken place in Hong Kong, he said. Large foreign companies that simply have assets in China probably would not be subject to the rules -- but enforcement is likely to depend on individual cases, Ross added.

Those regulations are likely to be modified several times after they are released, Gartner Group's Sweeney said. Such uncertainty can hurt the development of China's Internet industry, he said.

"Flip-flopping of laws is more damaging than the government making one statement of where it stands," Sweeney said.

As a result, investors in Greater-China Internet ventures are more likely to look toward places such as Taiwan and Singapore, he said.

"It's just isolating Chinese "dot-coms", sucking out cash that Chinese companies should be getting," Sweeney said.

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