Cablegate: China Targets Online Games: Battles On

VZCZCXRO1807
OO RUEHCN RUEHGH RUEHVC
DE RUEHBJ #2899/01 2891056
ZNR UUUUU ZZH
O 161056Z OCT 09
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6474
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEHIN/AIT TAIPEI 7403
RUEHKO/AMEMBASSY TOKYO 0069
RUEHUL/AMEMBASSY SEOUL 1372
RUEHGV/USMISSION GENEVA 2551
RUEAHLC/DHS WASHDC
RUCPDOC/USDOC WASHDC
RUEAWJA/DEPT OF JUSTICE WASHDC
RHMCSUU/FBI WASHINGTON DC

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

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