This article originally appeared in Agenda magazine. Check out the current issue here.
At its heart, the global system of foreign direct investment is all about getting into a market, by hook or by crook, before your competition. Often times, markets are already open, and setting up shop is merely a matter of negotiating the deal. In other cases, however, markets remain stubbornly closed, and companies are left with a choice: throw up their hands and wait until the law changes, or find a creative solution to foreign investment restrictions. In China, some of these solutions, for example the use of Variable Interest Entities, work so well that they become the preferred, or default, structures for certain industries, while others turn out to be untenable.
One such negative outcome may be playing itself out in the film industry right now. Last month, the State Administration of Radio, Film and Television (SARFT) issued a cautionary statement about the misuse of certain Sino-foreign co-productions, reminding film studios that these structures should not be used improperly.
What’s going on here exactly? For the most part, film co-productions have been utilized properly and effectively in China over roughly the past 15 years. The law allows a foreign film studio to either hire a Chinese enterprise to make a film locally, or alternatively an ad hoc structure can be built up where the two partners share in the investment, production and profits.
Most co-productions have been used to make films meant primarily for the China market. They are shot in China, include a primarily Chinese cast, and are filmed in the Chinese language. While these films may be distributed internationally, the bulk of the proceeds come from the China box office. With the exception of films like Crouching Tiger, Hidden Dragon, which was quite successful outside of China, co-produced films have not had a tremendous impact elsewhere.
Similar to Joint Ventures, a co-production is not likely to be the first choice of a foreign film studio, which may have the ability to finance a project themselves and many decades of institutional knowledge and industry expertise. So why do they saddle themselves with a local partner?
The answer is a familiar one: because they have to. Yes, the foreign studio could hire Chinese actors and screenwriters and film movies in Los Angeles, or London, or anywhere in the world. That production might not even cost more than doing so inside China.
The problem is not with the production, though, but rather with distribution. If you want to screen a foreign film in China, you have to obtain permission, and China maintains a quota on foreign film imports. So while a foreign studio may prefer to produce that made-for-China movie all by itself in Los Angeles (although this may be changing), getting that film into China might be impossible.
Co-productions are a solution to that problem and others. All films that are made by co-production are considered to be domestic and therefore are not required to go through the importation process. Co-produced films are also not subject to the same “blackout date” problem that plagues the scheduling of imported films, and foreign co-production partners are allowed to take a higher share of profits than for studios whose films are imported. This is considered to be a win-win: China gets the financing and expertise from abroad, and the foreign studios obtain access to the local market. What could be better?
Some clever foreign studio executives apparently thought that co-productions were not living up to their potential. They liked the idea of getting around the import quota, but they were also stuck with making movies that were really only suitable for the China market. Although box office numbers here have been growing quickly, the U.S. market is still number one.
The solution? Co-productions in name only, just the bare minimum in terms of Chinese actors, domestic production and China-related story lines. Reporting on SARFT’s complaints, the Wall Street Journal explained how the game is being played:
“Looper,” set for release in China in late September, stars Hollywood actor Bruce Willis and was produced by U.S. company Endgame Entertainment and Chinese partner DMG Entertainment. The film features one Chinese actress, Xu Qing, and several scenes shot in Shanghai. Those scenes, however, will only make it into the Chinese versions of the film, according to a report from the Los Angeles Times, which said the scenes didn’t test well with U.S. viewers and so were cut from the Western release.
Does Looper still qualify as a co-production? Perhaps, if one uses a very narrow interpretation of the law, and the studio is able to convince SARFT that Joseph Gordon-Levitt was born in Jilin. One can almost imagine Endgame and DMG being questioned by the authorities about their co-production and using the disingenuous excuse: “Was that wrong? Should we not have done that? We gotta plead ignorance on this thing, because if anyone had said anything to us at all when we first started that that sort of thing is frowned upon…” I suspect that SARFT might be willing to accept that in the short term, but they have sent out a clear warning that they are not pleased at this violation of the spirit of the law.
For the foreign film studios, the question then is whether this is the beginning of a crackdown that will force co-productions back to traditional made-for-China theatrical pictures. That remains to be seen, but SARFT’s comments are certainly a shot across the bow.
From the perspective of global foreign investment, it is ironic that these foreign studios have sought to play the “we’re just following the law as it is written” game against China. Many Chinese companies, after all, have themselves skirted rules by creative manipulation of both Chinese and foreign law. Just look at the typical Chinese company that achieved a foreign listing without all those pesky disclosure requirements by use of the so-called “reverse merger” process.
Companies will try just about anything to pry open a market. At the margins, some of their more creative attempts can lead to spectacular opportunities, while others can end in slapdowns from the regulatory authorities. It looks the latter scenario for some foreign film studios and their “co-productions.”