Taiwan and restrictions on China-bound investments

Since Taiwan's new president took office in May this year, the government has promised to relax various restrictions on its ties and exchanges with China. Taiwan's semiconductor and flat panel industries are now eagerly awaiting changes to the investment rules that have prevented companies from setting up operations involving advanced technologies in China.

President Ma Ying-jeou has on several occasions spelled out the principles for lifting the China-bound investment restrictions. First, after the restrictions are eased, Taiwan's IT industry can remain competitive globally, and its share of global market for IC and semiconductor will not be affected. Second, the advanced technologies developed by Taiwan players and their intellectual property must be well protected in China.

Signs in the market have indicated that an announcement from the government is expected in September.

History

Separated since a civil war in 1949, Taiwan and China have been governed independently. Tensions between the two sides have been easing since Ma took office, but the political wrangling and China's military threat against Taiwan remain.

Animosity between the two sides had prevented them from having any exchange until 1987 when Taiwan started allowing its people to go visit their families and relatives in China. In 1992, Taiwan implemented a set of laws to govern its relations with China. Since then, the laws have been revised seven times trying to cope with the development across the Taiwan Strait. But the revisions to the laws have barely been able to catch up with the fast development in the ties between the two sides.

For the semiconductor and displays industries, the restrictions on China-bound investments have been in place to keep advanced technologies in Taiwan while allowing mature processes to be exported to China. It has been meant to maintain a technological gap that gives Taiwan advantage over China. But that gap is narrowing fast as China's quick industrial development and vast market has attracted foreign companies to set up operations there. Taiwan' industry players are therefore asking the government to lift the restrictions so that they can have a fair chance to compete with the foreign competitors in China.

The government is now mulling the biggest changes to the laws since their implementation. But top priority will still be given to Taiwan, with the government considering requiring companies in the semiconductor and LCD panel sectors to invest further to upgrade their technological levels in Taiwan before they can be allowed to export less sensitive technologies to China.

The 40% investment cap

One of the current restrictions stipulates that the total investment in China by a Taiwan company may only be as much as 40% of the net worth of that company. For example, Taiwan-based firms with a net worth of at least NT$5 billion (US$164.8 million) can invest the equivalent of 40% of the amount in China, while the cap for companies with net worth of NT$5-10 billion and over NT$10 billion are limited at 30% and 20%, respectively.

In July, Taiwan's Executive Yuan announced the raising of the ceiling on China-bound investments to 60% for most companies in Taiwan, with those changes expected to go into effect in August.

The Cabinet also gave the green light to initiatives by the Financial Supervisory Commission to lift or relax the limits on funds raised domestically or overseas for mainland China-bound investment.

Companies headquartered in Taiwan, or foreign multinational enterprises' subsidiaries on the island, will be able to use 60% of funds collected in Taiwan for investment on the mainland. There will be no limit to capital raised abroad. At present, companies are not permitted to use any of the funds they raise in Taiwan for investment on the Chinese mainland, but can use 20-40% of that raised overseas.

In addition, the MOEA (Ministry of Economic Affairs) has simplified the review system for capital flow to mainland China. Any local companies or individuals making investments under US$1 million will now be able to report the transaction to the MOEA up to six months after the investment has been made. The existing threshold is US$200,000.

Special case-by-case investment approval will only be required if a project has an accumulated capital of US$50 million, as compared to US$20 million previously. All other investments will be reviewed in a more streamlined manner, with the MOEA's Investment Commission establishing a one-month processing deadline.

At present, all proposed investment projects above US$20 million in mainland China are subject to a case-by-case review on a wide range of issues, including technology transfer, labor policy, national security, fiscal status, business plans and matching investment in Taiwan.

Source: Ministry of Economic Affairs Investment Commission, compiled by Digitimes, August 2008

Banned segments

All companies are banned from investing in certain segments in China, such as advanced packaging and testing operations, 0.18 micron-and-below semiconductor fabs, and front-end LCD panel production.

Investment in 8-inch fab currently needs to obtain approval on a case by case basis. A company must meet certain qualifications before their 8-inch China fab project could be approved: It must have an 8-inch fab where volume production has been running for six consecutive months, and one company can only set up a maximum of three 8-inch fabs in China. So far, only Taiwan Semiconductor Manufacturing Company (TSMC) has been allowed to build an 8-inch fab (Fab 10) in China. Fab 10 ramped up production in October 2004.

There had been speculations that the government would give the green light to an 8-inch 0.18 micron China fab project by Powerchip Semiconductor Corporation (PSC) at the end of 2006. It had been said that Renesas Technology would go to China along with PSC. But the memory business has since then been hit by a slump, and PSC's China fab project remains an uncertainty. At any rate, semiconductor players are still prohibited from setting up 12-inch fabs or other operations using technology processes beyond 0.18 micron although that may be changed soon. For the packaging and testing sector, the government has lifted a ban on low-end operations.

For the display industry, companies have only been allowed to run LCD module (LCM), TV assembly plants, or backlight unit (BLU) plants in China, while the array and cell processes have been tightly protected LCD panel technologies. But the government now allows the export of cell process technologies to China for the making of four-inch and smaller panels.

Bending the rules

While it is hardly possible for any of the Taiwan LCD makers or foundries to set up banned operations in China without the Taiwan government knowing, there are ways that companies would take to circumvent the 40% investment cap for businesses that are allowed. Some companies which are not listed in Taiwan may choose to be listed in Hong Kong or other markets and in turn make investments in China as foreign investors, rather than ones from Taiwan. Foreign investors may buy out Taiwanese companies, have them delisted from Taiwan's stock markets, and change them into foreign firms who will have see restrictions on China-bound investments. Still some others may spin off part of its operations, which will then move their bases overseas so that they can invest in China. These companies defeat the restrictions but at the same time see their costs increase because of such circumvention, which is also creating unfair competition against law-abiding companies, as well as difficulties for government monitoring.

One of the most controversial cases in recent years concerning alleged breach of the restrictions involves the world's number pure-play foundry United Microelectronics Corporation (UMC) over its investment in China-based Hejian Technology. UMC's founder Robert Tsao stepped down as company chairman in December 2005, a few months after the government started investigating the Hejian investment. He was indicted in January the next year for alleged breach of trust and violations of the accounting law. UMC also received a fine. Tsao has maintained that the UMC investment in Hejian is legitimate, and the case has yet to settle.

Restrictions expected to ease

The government originally was expected to further relax the China-bound investment restrictions for the semiconductor and panel industries in August 2008, but has decided to delay the action until September. Economics minister Chii-Ming Yiin revealed that under the present planning, 12-inch fabs will get the green light, and processes allowed will move up to 0.13-micron from the present 0.18-micron. He explained that the Wassenaar Agreement only impose export restrictions in terms of process technologies, but not in terms of the wafer sizes. Therefore makers can decided whether they need to build 12-inch fabs in China judging from their capacity needs, he said.

Makers' responses

Semiconductor players welcome the government's expected moves and remain optimistic. But they see no pressing needs to build 12-inch fabs in China, as their current 12-inch capacities in Taiwan are still sufficient.

In fact, leading pure-play foundries Taiwan Semiconductor Manufacturing Company (TSMC) and United Microelectronics Corporation (UMC) recently expressed indifference over a potential policy relaxing restrictions on constructing 12-inch wafer fabs in China, as all of them have a deep-rooted 12-inch wafer fab foundation in Taiwan.

When semiconductor demand takes off in the local China market, that will be a judging factor for making the move, said Rick Tsai, CEO of TSMC. While saying that TSMC welcomes an open policy, Tsai added that investing in 12-inch wafer fabrication in China would require taking economic and administrative issues into account.

Morris Chang, chairman of TSMC, indicated that TSMC would focus on expanding its 12-inch wafer capacity at its Hsinchu, Taiwan base. Tsai noted that TSMC is consistently growing its capacity at its Shanghai 8-inch fab (Fab 10). He highlighted that its customer base at Fab 10 is broad and he believes that Fab 10 will be a direct beneficiary of a booming semiconductor industry in China. But both TSMC executives said there seems to be no urgency to invest in 12-inch wafer fabrication in China.

Shih-Wei Sun, CEO of UMC, said the company has no special comments about potential 12-inch wafer fab investment in China. Company CFO Chi-Tung Liu added that UMC has no plans yet to construct a 12-inch fab in China, as the company will focus on expansion at Fab 12B in the near term. Monthly capacity at Fab 12B could reach 50,000 wafers in the future, he added. UMC has taken three years to ramp capacity at Fab 12A to a 30,000 wafer level.

For memory makers, Powerchip Semiconductor Corporation (PSC) commented that it welcomes the potential relaxation of investment restrictions. However, company executives stressed that many issues such as location, cost structure and markets have to be taken into consideration when assessing whether to proceed with investment.

Moreover, according to sources in Taiwan's DRAM industry, despite having its fundamental competitiveness built on cost, moving DRAM production in China does not seem to be a viable move.

Construction of a 12-inch DRAM fab costs approximately US$2 billion, an amount that is going to weigh on makers for years before equipment is completely depreciated. So, if industry players are purely hoping cost could be saved by moving across the strait, they are fundamentally wrong because the construction cost is the only real difference by region.

However, a different scenario might come to light if local government bodies in China would be willing to subsidize fab construction, as evident in the partnership between the Wuxi provincial government and Semiconductor Manufacturing International Corporation (SMIC). But this may not be a realistic option for Taiwan players because of political issues.

Labor costs of course are a powerful motivation for considering moving production to China, but the saving might not compensate for the costs of developing an infrastructure to train engineers. As the semiconductor industry in Taiwan is well established and maintains strong ties with local universities, there is always a strong pool to choose from for potential engineers, and recruitment is not an issue at all. But the situation in China is probably not as developed.

Another issue for semiconductor makers is the cluster effect. This is noticeable difference between China and Taiwan in the DRAM industry. There are more than 10 DRAM fabs located between Linkou and Taichung (within 300km) with backend fabs adjoining DRAM fabs in the area. But in China, such a cluster has yet to be developed.

The industry sources cited feedback from major DRAM players in Taiwan, and commented that the key driving force for DRAM makers would be financial. Taiwan's DRAM makers would be much more likely to increase their investments in China if they were to receive monetary support from China's government is possible.

Other sources in the industry commented that investment in China would be viable when the local market demand could support the capacity. However, the freedom and flexibility of having the option to invest would be welcome.

Packaging

On the packaging side, the story may be a little different, as packaging houses may look to invest in China to support backend operations for not necessarily run by Taiwan chipmakers.

Taiwan's MOEA made a major move in 2007, when it lifted a ban on Taiwan's investment in China for IC lead frames, with the idea the new policy would help packaging and testing houses reduce costs for their China-based production.

At the same time the government lifted the ban, it approved investment applications in China from four Taiwan-based packaging and testing houses. The total investment amount was nearly US$100 million.

Advanced Semiconductor Engineering (ASE), Siliconware Precision Industries (SPIL), Walton Advanced Engineering (WAE) and Greatek Electronics received approval to invest US$21.6 million, US$30 million, US$18 million and US$30 million, respectively, in China. ASE used its portion to buy 60% of NXP's Suzhou plant in China while the remaining three players indicated that their investments would be for their existing fabs.

However, that approval came with the condition that ASE invest at least NT$40 billion in Taiwan before 2010, while the required amounts for the other three are NT$20 billion for SPIL, NT$10 billion for WAE and NT$5 billion for Greatek. Should the conditions not be followed, the MOEA can fine the companies.

Chang Wah Electromaterials (CWE), a Taiwan-based provider of semiconductor packaging materials and equipment (including lead frames), said the company plans to apply for approval of lead frame investments in China in 2008.

Source: Companies, compiled by Digitimes, June 2007

Article translated by Rodney Chan