Following the signing of the main parts of the Closer Economic Partnership Arrangement (CEPA) on 29th June 2003, Hong Kong and the Mainland signed the six Annexes to the main text of the Arrangement on 29th September 2003, setting out the implementation details. To be implemented from 1st January 2004, the Arrangement is to ensure Hong Kong will be "economically interlocked" with the Mainland and that smaller Hong Kong companies will benefit from the opening-up and liberalisation on the Mainland beyond China's commitments in its WTO accession. With CEPA, 90% of Hong Kong domestic exports to the Mainland can enjoy zero tariffs. Also, CEPA opens up 18 service industries to Hong Kong companies. More important, CEPA provides long-term opportunities for Hong Kong people to establish business or work on the Mainland.

CEPA - A Special Arrangement Abiding by International Practices

CEPA is the first bilateral Free Trade Agreement (FTA) for both the Chinese Mainland and Hong Kong. It abides fully by the WTO's requirements on FTAs. While the Agreement eliminates substantial trade and investment barriers between Hong Kong and the Chinese Mainland, it does not raise any obstacles for other economies' access to the two markets. Consistent with the provision of the General Agreement of Trade in Services (GATS), companies in Hong Kong with substantive activity are qualified as Hong Kong companies for the entitlement of the benefits under CEPA.

Opportunities in Trade in Goods

Starting from 1st January 2004, 273 types of products made in Hong Kong can be exported to the Mainland free of tariff. This, together with China's commitments upon accession to the WTO, will allow about 90% of Hong Kong domestic exports to the Mainland to enjoy zero tariffs. The annual savings in tariffs are estimated to be HK$750 million. Moreover, zero tariffs will also be applied latest by January 2006 upon applications by manufacturers in Hong Kong to other products made in Hong Kong for accessing the Mainland market.

A product is qualified as "made in Hong Kong" if it fulfills the rules of origin under CEPA. For 70% of the 273 types of products covered in the initial phase for tariff-free importation, Hong Kong's existing origin rules using the "specific manufacturing process" criterion will be adopted as the CEPA origin rules. For the rest, either the "change in tariff heading" approach or the "30% value-added" requirement will be used. The 30% value-added rule compares favourably with other free trade areas' thresholds, which range from 40% to 60%.

Apart from zero tariffs enjoyed by products made in Hong Kong, products made by Hong Kong and/or traded by Hong Kong will also benefit from CEPA in other ways. Upon China's WTO accession, many Hong Kong manufacturers with production on the Mainland would like to develop China as their domestic market. However, their market penetration efforts have been somewhat hindered by the underdeveloped distribution system on the Mainland. Many hazards in developing the China market such as payment problems and intellectual property rights protection now facing Hong Kong manufacturers can hopefully be alleviated as more Hong Kong players will be allowed to engage in distribution business on the Mainland under CEPA.

The immediate benefit of the trade in goods is the saving in tariffs, thus increasing the price competitiveness of Hong Kong's domestic exports of consumer products into the Mainland. Industries that are more likely to be benefited include fashion, jewellery and high-end watches.

A longer-term effect of the zero-tariff agreement is the potential for attracting more high value-added manufacturing activities to be located in Hong Kong, and promoting development of brand products made in Hong Kong to emerging middle-class consumers on the Mainland.

Capitalising on the advantage of Hong Kong in intellectual property rights protection, free trade and investment environment, and reputation in cosmopolitan design, Hong Kong is in a good position to develop high intellectual property (IP) value industries that target the Mainland market.

For high-end products such as designers' clothing and fashion accessories, and industries that involve proprietary technology (since the IP input accounts for a much larger share than labour and other inputs in the total cost structure), production in Hong Kong may still be justifiable. However, since the high IP value industries are knowledge-based and would not be massive in scale, the effect of job creation in Hong Kong, especially for unskilled workers, would only be moderate.

Opportunities in Trade in Services

CEPA provisions on market access cover a total of 18 service industries. These include: management consulting, convention and exhibition, advertising, accounting, construction and real estate, medical and dental, distribution, logistics, freight forwarding, storage and warehousing, transport, tourism, audio-visual, legal, banking, securities, insurance, and value-added telecommunications services.

To be entitled to the benefits of CEPA, a service company, regardless of the nationality of its investors or shareholders, must have substantive business activity in Hong Kong by fulfilling the following criteria:

In addition, companies in different service industries have to meet different extra criteria to ensure that they have been engaging in substantive business operations in such an industry for a minimum period (usually three to five years) in Hong Kong. Although the exact requirements for a company to be qualified vary by industries, the assessment will be on a non-discriminatory and objective basis. Foreign companies can be regarded as a "Hong Kong company" one year after acquiring majority shares in a Hong Kong company through merger or acquisition.

Although the liberalisation measures vary from industry to industry, China has taken into account the special niche of Hong Kong as CEPA commitments go beyond the country's WTO accession protocol, for example, the opening-up of exhibition business to Hong Kong companies.

Besides the exhibition industry, Hong Kong's niche in the audio-visual industry is well recognised. With the quota free access to the Mainland of Chinese language films produced in Hong Kong and the relaxation on the co-production requirements, CEPA paves the way for the recovery of Hong Kong's film industry by creating great potential in the Mainland market. More important, it provides a very good avenue for Hong Kong to post itself as a modern and dynamic metropolis before Mainland's consumers.

The framework of CEPA is intentionally designed to help smaller companies, whether they be indigenous or foreign-owned, in Hong Kong. Under China's WTO protocol, the thresholds of entry to the Mainland's service sector are too high for Hong Kong companies in most service industries. CEPA lowers the thresholds for Hong Kong companies, allowing them an "effective" market access to the Mainland's service sector. Lowering the thresholds for Hong Kong banks to expand on the Mainland and allowing Hong Kong law firms to share offices with their Mainland counterparts are significant measures to increase the feasibility of Hong Kong service providers to do business on the Mainland.

Not only Hong Kong products or Hong Kong companies but also Hong Kong professionals and residents will benefit from CEPA. Hong Kong professionals in the securities and insurance industries can apply to practise on the Mainland and Hong Kong permanent residents with Chinese citizenship are permitted to sit the legal qualifying examination on the Mainland. Moreover, Hong Kong permanent residents with Chinese citizenship are formally permitted to engage in retail activity in Guangdong. All this suggests that in future more Hong Kong people are likely to seek employment and business opportunities on the Mainland.

Hong Kong as a Financial Centre and Its Special Relations with the Pearl River Delta

CEPA will strengthen Hong Kong's role as an international financial centre for China and the region. Under CEPA, the Mainland supports Chinese banks in re-locating their international treasury and foreign exchange trading centres to Hong Kong. They are also encouraged to expand their banking business in Hong Kong through acquisition. In the process of financial reform on the Mainland, the financial intermediaries in Hong Kong will be fully utilised.

Given the proximity of Hong Kong to the Pearl River Delta (PRD), CEPA has a special meaning to the closer co-operation of the two places. With CEPA, the PRD will continue to grow from strength to strength as the world's manufacturing centre, fully supported by the business services provided by Hong Kong companies. Waiving Hong Kong lawyers' residency requirements for operating in the PRD is just an example of the special convenience provided by CEPA to enhance the partnership of the Greater PRD.

Overall Impact on Hong Kong

CEPA will leverage on the institutional strengths of Hong Kong and the huge market potential on the Mainland under the "one country, two systems" principle for revitalising the Hong Kong economy and modernisation of the Chinese Mainland. Given the eased market access to the Mainland and the stringent protection of intellectual property rights in Hong Kong, the city will be the first choice to supply products and services with "high content of intellectual property" for the Mainland market. Creativity will be the key determinant for Hong Kong people and companies to succeed on the Mainland while developing into a "knowledge-intensive" service hub is the future of this territory.

CEPA indeed creates the "environment" for Hong Kong products, Hong Kong companies (particularly medium-sized companies), Hong Kong professionals and residents to have an "effective" access to the Mainland. It does not provide them with "privileges" to enjoy exclusive rights in the Mainland market. They have to face intensifying competition in this large market from both local suppliers as well as multinational players. As China will continue to open up on schedule in accordance with its WTO commitments, the window of first mover advantage for Hong Kong players is brief.

The impact of CEPA on the service sector is likely to be greater than that on the manufacturing sector. This is particularly true when services, accounting for only 34% of China's GDP, have become a constraint on the country's economic development. Contributing 87% to the domestic economy, services are well developed in Hong Kong and will be able to contribute more to the modernisation of the Mainland under CEPA. Although the immediate benefit of CEPA for industrial employment in Hong Kong may only be moderate, much more future employment opportunities in the service sector will be created across the boundary. The overall effect on total employment could be significant.

Immediate trade and employment creation is, of course, important to Hong Kong, but the long term effect of CEPA is much more substantial. Indeed, the pace of Hong Kong's economic restructuring will accelerate under CEPA. While the impact will evolve over time, it is likely to be reflected more in Hong Kong's GNP than in its GDP. The opportunities arising from CEPA are not limited to activities within the HKSAR but go much farther into the Mainland.

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