China’s new regulations on internet advertising will add additional costs for some Chinese businesses, but Fitch Ratings believes the new rules will foster healthier development of the industry over the longer term.
The State Administration for Industry and Commerce passed long-awaited regulations, which go into effect on 1 September, to protect consumers against false claims and to prevent misleading practices in internet advertising. Fitch said the country currently doesn’t have any national laws or regulations that specifically regulate this space.
Pay-for-performance (P4P) services from Alibaba and Baidu will be reclassified as internet advertising under the new regulations, which explicitly categorise paid search as advertising for the first time. All paid advertising in search results will need to be clearly identified.
Alibaba and Baidu will likely need to pay a 3 per cent surcharge on certain P4P services on top of the existing 6 per cent value-added tax (VAT), because advertising services are subject to a cultural business construction fee under China’s law. The impact on profitability should be manageable, given that P4P services have high margins, Fitch said.
The agency said the credit profiles of the Chinese internet majors – Alibaba, Baidu and Tencent – should remain intact.
Pushback from leader
Alibaba argued that its P4P service is different from traditional advertising services and search advertising, since buyers come to its platforms to find products and services. However, the new regulations cover any internet service with the purpose of promoting goods and services.
Fitch believe the reclassification of P4P services as internet advertising may not require Alibaba and Baidu to transfer their P4P businesses to their variable interest entities (VIEs). Currently, their P4P businesses are mainly conducted through their wholly foreign-owned enterprises, which do not hold internet content provision licences but are qualified to conduct advertising businesses.
The VIEs hold licences that allow them to publish internet advertisements through websites.
“We understand that Alibaba and Baidu are studying any potential requirement for structural change and aim to minimise potential impact on businesses, if any,” the ratings firm said in a statement.
VIE arrangements are used in China’s internet sector to get around restrictions on foreign direct ownership, and are a credit weakness for Chinese internet companies as they may not be as effective in providing control as direct ownership or may face legal challenges in the future.
China’s advertising laws and regulations require advertisers, advertising operators and advertising distributors to ensure the content they prepare or distribute is fair and accurate and complies with applicable laws. In addition, the rules require internet advertising operators and distributors to verify advertisers’ qualifications.
But Fitch noted that Chinese internet firms have been taking steps to protect consumers.