What China’s automotive industry sweep tells us about its enforcement agenda

March 23, 2015

Chinese antitrust regulators are now firmly focused on the automotive industry and have taken a series of competition enforcement actions against a number of high-profile carmakers and auto-parts manufacturers. While some see this as essential regulatory action to ensure fair competition and reduce what are perceived to be artificially-high prices, others have criticised the Chinese Government for having ulterior protectionist motives.

The EU, for example, has voiced its concern over what it considers to be inconsistent targeting of foreign carmakers in recent Anti-Monopoly Law enforcement actions. However, in defence of the Anti-Monopoly Bureau of the National Development and Reform Commission, Director General Xu Kunlin noted that only 33 of the 335 anti-monopoly cases investigated by the Commission from enactment of the Anti-Monopoly Law through to September 2014 involved foreign companies.

Despite the foreign pressure, domestic authorities have taken a further measure to claw back the substantial market power held by foreign carmakers. In January this year, the Shanghai Commission of Commerce and the Shanghai FTZ Administrative Committee issued a joint circular formally launching a pilot programme for the parallel importation of cars, with the aim of reducing prices for Chinese buyers.

What is parallel importation?

Parallel importation is a form of arbitrage (where non-counterfeit goods are purchased from a market where the retail price is cheaper and sold in a market where the retail price is more expensive). Goods concerned are often of high value, with an internationally-recognised brand. Because of the retail price difference, both the arbitrageur and the ultimate buyer gain.

While generally perceived to represent an increasingly-globalised free market, parallel importation will invariably affect the local official distribution networks that are likely to have made large investments to market the goods in the domestic market. For multinational manufacturers, the existence of parallel importation reduces their power to segment the various markets across the world and maintain price-differentiation strategies. This introduction of a counter market force, however, is exactly what the Chinese Government wants to promote more competition in its automotive industry.

Clarification of legal position

Parallel importation of cars has existed in China for some time. Importers have bought cars from countries such as the United States, where the retail price for equivalent car models may be as little as 50 percent of that in China, and sold them at a significant discount outside of the car manufacturers’ official dealership networks. Prior to the pilot programme, however, the legality of this alternative source for imported vehicles was unclear.

While exclusive rights attached to registered trademarks are protected under Article 52 of China’s Trademark Law, and a glance through its wording may suggest that parallel imports would fall within the ambit of the provision, the Law does not expressly address parallel importation. In addition, the Chinese courts have sidestepped the issue in most related intellectual property cases.

For example, in a case between lingerie retailer Victoria’s Secret and a Chinese parallel importer of its goods, rather than deciding on the legality of parallel imports, the Chinese court focused on determining whether the goods in question were genuine and whether the defending company falsely claimed official distribution rights.

In another case involving tyre company Michelin and a Chinese parallel importer that purchased tyres from Japan, the court found that Michelin’s registered trademark had been infringed. This was solely because the tyres did not obtain the required compulsory product certification and thus increased the risk of reputational damage arising from potential sub-par safety standards. Consequently, the parallel importation of cars previously functioned in the shadows as a grey market.

Formal legalisation of the parallel car import market

With the introduction of the pilot programme, dealers will now be able to import cars from foreign markets without the consent of the manufacturer, and this will be officially recognised as a legitimate source to buy foreign cars. While the programme currently only applies within the Shanghai FTZ, plans have already been made to expand it to other cities in China, such as Tianjin.

In addition to formally allowing dealers to directly purchase cars from foreign markets, the pilot programme also addresses the consumer concern of guarantees and after-sales support of parallel imported cars, with the responsibilities to be borne by the dealers participating in the scheme. This includes setting up a repair service and parts supply network proportionate to the operational scale of the dealer. As part of this new requirement, the Shanghai FTZ Commission will implement a quality system to ensure the warranty programmes offered by participating dealers are on par with that of the official dealer. This string of initiatives will likely ease consumer concern on after-sales support, thereby further promoting the parallel car import market.

Looking beyond automotive industries

Whether it is for protectionist reasons or to genuinely encourage fair competition, the Chinese authorities are ramping up their regulatory efforts.

Another observation that may be drawn is the tendency for authorities to take action by industry, similar to the United States Securities and Exchange Commission ‘industry sweeps’ with which Foreign Corrupt Practices Act experts have become all too familiar.

While the current focus is on the automotive industry, China’s own industry-focused regulatory activities have already swept through the markets of consumer electronics, Chinese luxury liquors, infant formula, pharmaceuticals and technology. And these sweeps look as if they will continue.

Faced with increased scrutiny, companies should recognise that the days of unfettered profit maximisation in China have passed. A much higher standard of competition law compliance is now necessary to mitigate risks in the volatile Chinese regulatory environment. As a minimum, companies must implement a comprehensive competition law compliance programme comprising clearly-articulated policies, regular training and communications, and robust control mechanisms. In light of the recent focus on selling malpractices, it is also a good idea for companies to start reviewing their current distribution model to identify any weak points that might subject them to regulatory action. In doing so, companies may want to take a more conservative and stringent approach, rather than simply applying international standards.

One key area to focus on is how products are priced. This appears to be a topic of interest for the government. Article 17 of the China Anti-Monopoly Law expressly forbids the abuse of a dominant market position to set ‘unfairly high prices’. This appears to be open to broad interpretation. It has also been seen in many previous cases that companies under investigation voluntarily lower their prices before any official action is taken in the hope that regulators will be more lenient. As evidenced in previous enforcement actions, the perception of unreasonably high prices forms one of the key drivers in deciding whether regulators should focus on a particular market.

Even with strong competition law compliance programmes in place, companies should be prepared for the radically different enforcement style of the Chinese authorities. Studies indicate that aggressive enforcement by Chinese regulators has caused general concern as to whether the principles of procedural justice and non-discrimination are strictly upheld during investigations. Enforcement transparency is an area that requires improvement by the Chinese authorities, and companies have sometimes found themselves unclear as to which laws or provisions they have breached. It would therefore be good practice to have employee guidelines in place for handling any interaction with regulators, particularly on responding to dawn raids.

While it is always better for a company to proactively prevent misconduct rather than passively react to regulator action, this is especially the case in China, where regulatory action is highly unpredictable.

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