CHINA TARGETS ONLINE GAMES: BATTLES ON

UNCLAS SECTION 01 OF 02 BEIJING 002899 SENSITIVE SIPDIS State for EAP/CM - WKlein, SFlatt State for EEB/CIP - SFlynn, FSaeed USTR for Awinter, JMcHale, TWineland, AMain Commerce for MAC Commerce for ITA - IKasoff, NMelcher DOJ for CCIPS - MDubose and SChemtob FBI for LBryant State for White House OSTP Ambassador Richard Russell NSC for Melissa Hathaway E.O. 12958: N/A TAGS: ETRD PGOV PHUM SOCI SCUL ECON CH SUBJECT: CHINA TARGETS ONLINE GAMES: BATTLES ON SEVERAL FRONTS SENSITIVE BUT UNCLASSIFIED - PLEASE HANDLE ACCORDINGLY. ¶1. (SBU) Summary. China's General Administration of Press and Publication (GAPP) issued a circular on October 10 prohibiting foreign investment in the domestic online games operations through joint ventures, wholly-owned enterprises and cooperatives. The new directive comprehensively prohibits foreign firms from virtually any involvement with Chinese gaming firms and is the first time Chinese authorities have expressly prohibited contractual and other control arrangements used to facilitate foreign investment. Implementation remains unclear given the lack of MOFCOM endorsement, but hostility toward foreign interests in this multi-billion dollar sector, with an estimated 65 million online Chinese gamers, is readily apparent. End summary. ¶2. (SBU) China's would-be online game industry regulator and copyright watchdog, the General Administration of Press and Publication (GAPP), issued a circular (Notice 13) on October 10 prohibiting foreign investment in domestic online game operations through joint ventures, wholly owned enterprises and cooperatives. The new directive comprehensively restricts foreign firms from indirectly influencing Chinese game firms through agreements or technology support. ¶3. (SBU) While foreign online game interests have long operated in a nebulous regulatory universe here, using such devices as "variable interest entity" (VIE) agreements to operate here, this latest development pinpoints two main issues: PRC regulatory territorial battles in the burgeoning online universe are intensifying, creating more uncertainty for technology firms; additionally, targeted hostility toward foreign interests in the online sector is becoming increasingly overt. China's online game sector is one of the world's fastest growing where 2009 sales are expected to rise 30 to 50 percent to USD 3.5 to 4 billion, and may reach USD 5.5 billion by 2012, according to Pearl Research, dwarfing U.S. film industry interests here. Regulatory Battle: Hostility to Foreign Gaming -------------- - ¶4. (SBU) GAPP has recently lost ground in its regulatory purview over online content to the Ministry of Culture given separate State Council July 2008 Regulation and a Ministry of Culture September 2009 Interpretation pronouncements, which seemed to conclude content license purview for online operations, among other authorities, resides with the Ministry of Culture (MOC). This latest development thus heightens tensions between GAPP and MOC. ¶5. (SBU) As friction develops over the role of regulatory approval, one U.S. company, "Activision Blizzard," faces protracted challenges. A Chinese firm, NetEase, earlier this year obtained the China operating license for Blizzard's world-wide blockbuster, World of Warcraft, following Blizzard's decision to cut ties with its prior licensee, "THE9". World of Warcraft, however, has yet to receive a new license since moving over to NetEase and has been unavailable online legally in China since June 1, 2009, with some local analysts BEIJING 00002899 002 OF 002 speculating that Chinese regulators have decided to more vigorously scrutinize the new NetEase contractual arrangement with Blizzard. Industry Interests Massive; Consensus Lacking -------------- ¶6. (SBU) Washington colleagues have been in touch with the leading online gaming industry association, Entertainment Software Association, but note that association has yet to react definitively to the latest development. Embassy has also yet to receive approaches requesting USG engagement at this stage, though local industry association USITO, AmCham, and our EU colleagues have queried whether we are preparing to weigh in. We remain engaged with interested parties to facilitate a consistent message should USG support be desired. ¶7. (SBU) Law firm Morrison Foerster's Hong Kong offices also on October 16 released its China Update, noting the GAPP notice has captured the attention of the China internet gaming, private equity, and venture capital investment community. Notice 13, if applied literally and uniformly, according to Morrison Foerster, would render the VIE structure used by many Chinese gaming portals invalid and illegal. However, Morrison Foerster's China update notes it is too early to determine whether Notice 13 will be successfully implemented given it has not yet been endorsed by other PRC authorities, most importantly MOFCOM. ¶8. (SBU) A Beijing-based U.S. online game entrepreneur echoed similar sentiments regarding GAPP's notice. The entrepreneur's most recent business efforts met an unfortunate demise in 2008 following several years' effort to launch an online company, Red Mushroom. He views GAPP's notice as another negative harbinger for the lack of transparency in China's operating environment, which he said will only get tougher, including more bias against foreign participation. However, he notes GAPP's circular was unlikely to be supported by other PRC authorities as it would mean profitable Chinese online game operators, such as NetEase, Sohu, THE9, will become illegal, eliminating a lucrative industry, which is heavily-reliant on foreign participation. This entrepreneur, however, believes that if the notice is ultimately implemented, it will be used selectively to target non-domestic interests. ¶9. (SBU) Comment: Post views with concern these developments in the online game sector, which compound a climate of confusion regarding appropriate regulatory bodies and action in this lucrative sector. In a best case scenario, the Ministry of Commerce may assert a firm hand, given its investment implications, and determine GAPP has no authority to issue such foreign investment restrictions. In any case, given the stakes, we expect the competition between the PRC regulatory bodies to regulate and control this sector will continue to intensify and create obstacles to U.S. companies' access. Meanwhile, major Chinese game companies, such as Perfect World, KingSoft, NetDragon, are increasingly expanding in the U.S. domestic market. HUNTSMAN