China's quota change heralds reform

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Is it possible that from such a high level dispute as the one over foreign access to the Chinese theatrical film market can emerge a solution that is good for everyone?

This week's announcement that China will enlarge its import quotas seems to have been welcomed by Chinese and US governments, studios and independents. And Chinese rights buyers were out in force at the recent film market in Berlin.

The deal which was announced by China's vice president Xi Jinping and the US vice president Joe Biden late on Friday night in Los Angeles delivers two immediate and visible changes. But arguably its long term impact is much wider and could bring systemic change to China's distribution model.

With immediate effect China has enlarged its quota for revenue sharing imports of foreign films from 20 per year to 34 per year. The extra 14 films are "enhanced" films made in 3-D, IMAX or animations.

Second, the revenue that is shared with the rights owner (aka rentals) is almost doubled. Until now rentals were paid on a sliding scale ranging from 13%-17% of receipts. Under the new scheme these will be a simple to understand 25%. With Hollywood films regularly approaching or exceeding $100 million at the Chinese box office — Kung Fu Panda 2 ($96.5 million) and Transformers: Dark of the Moon ($173 million) – the immediate impact is a huge cash boost for the US studios.

But the moves have been quietly welcomed by China industry figures as well. Director Gao Qunshu said that the space for local, Chinese films may shrink, but that competition will be good for the Chinese industry. "There will be pressure, but taking the changes as a motivation to make better films is the only way out. More 'lame' works will be driven out of the market," he said. The official People's Daily newspaper quoted Yuan Xin, VP of Stella Mega International Group, as saying: "The box office of domestic movies will definitely be impacted, which means Chinese movie makers have to work [harder] to improve their competitiveness."

Some things will not change. The Chinese government will continue to take a cultural perspective of the film industry. And it will continue to operate a two-speed system, with revenue sharing films and flat fee imports in different categories and certain protections for the local industry. Nor is censorship going to go away.

But other details of the Xi-Biden agreements represent significant liberalisation:

- While the 14 extra import slots are for "enhanced" films, the new rules will also allow the distribution of their conventional 2-D equivalents, thus adding up to a real 34 film import quota

- China will allow a second, national distributor to release imported revenue-sharing films. Currently, the state-owned China Film Group Corporation has a practical monopoly on this lucrative business. (Second-string SOE Huaxia Film Distribution Co Ltd is not seen as having much strength or marketing skills.)

- Transparency. Foreign rights owners will have access to censorship decisions and to know the terms of deals between import companies, distributors and exhibitors. At present Chinese firms regularly strike licence deals at film markets, but months later many seek to cancel the agreements claiming that the film has been blocked by censors. In the new era, suppliers may be able to negotiate with the censors on problem items or substitute alternative films into previously signed import agreements.

While the headlines have largely been about Hollywood, foreign film groups hope that the expanded quotas will mean more chance for Asian and other foreign titles to find theatrical distribution in China.

By enlarging the revenue-sharing quota, there may now be less pressure on the flat-fee slots and less back door manipulation that turns some flat fee deals into unofficial revenue sharing deals. This could give more room for South Korean and Japanese films or the growing number of Chinese-language films now emerging from Malaysia and Singapore. US independent films such as The Expendables, Sanctum and Priest have already achieved distribution in China.

There are now numerous ways for foreign films to enter China:

- 20+14 revenue sharing quota

- 40 film (approx.) flat fee quota

- co-productions, which has been the growth axis of the past couple of years

- imports for TV, especially CCTV's movie channel CCTV-6

- imports for online video, currently unlimited in number.

The past year's background activity helps explain where things may now be heading.

March last year was the deadline by which China was obliged to act on a ruling by the World Trade Organisation and open its entertainment markets. The March 2011 deadline came and went with no apparent action from China. And at subsequent WTO meetings China continued to say that it would find it difficult to comply with the (previously appealed) ruling, arguing that this was a cultural matter.

However still the surface, the diplomatic efforts in Washington were mounting. Lobbied by the Hollywood studios, represented by the Motion Picture Association, and the independent sector as represented by the Independent Film & Television Alliance, US lawmakers were given a new understanding of the issues.

The US film industry argued that cinema in China should no longer be regarded as a developing market, in need of protection while it achieves scale. Rather it should now be treated as a major territory on a par with the leading European film markets such as France, the UK or Germany, when measured by the number of films released, screens, box office or admissions.

With theatrical box office that grew by 29% to some $2.03 billion, China ranked as the world's third largest box office territory in 2011, ahead of France (approx. $1.8 billion) and behind Japan ($2.33 billion). It produced 791 films. And it saw 803 new cinema complexes open, creating 3,030 new cinema screens – 50% more than the entire number of cinema screens in South Korea.

With numbers on that scale, the lobbyists argued, China's market conditions should be measured against its European peers. Taking that message to the negotiating table, the US Trade Representative kept the pressure on China to open up, and presented it as the Middle Kingdom's chance to take its rightful place in the big league.

"We see it a China stepping up, not as a US win," says Jean Prewitt, president and CEO of IFTA.

The grown-up new rules on transparency and a second national distributor are expected to mean more competition and more contractual certainty in a market where regulatory visibility and market mechanics have often been murky.

With foreign rights holders supposedly now able to insist on seeing censors' decisions and deal terms concerning their films, they will have a much clearer understanding of items like screen counts, marketing spend and a truer representation of box office. That may increase the levels of trust between foreign rights holders and Chinese buyers and allow the market to evolve.

"I expect we will increasingly see China becoming a pre-sales market as it gets closer to the European model," says Prewitt. "And as other distributors come in that will bring innovation, and we believe that will increase the pressure on SARFT to approve non-standard deals."

Currently the Chinese companies, which present themselves as distributors but in most instances are simply intermediaries, mainly buy rights to completed films. Were Chinese buyers to join the front ranks of heavyweight international companies that pre-buy rights, China would swiftly have a much greater role in international film financing, with all that entails.

Something on these lines has already been happening in the last year.

To fill all those new screens with movies that keep the turnstiles spinning, Chinese buyers have massively bid up rights prices for commercial films. "Prices in China have risen by five or ten times in the past 12 months," said Nicolas Chartier, president of US sales agency and packager Voltage Pictures, speaking at a seminar in Berlin this month.

The past year has also seen surges in US interest in co-production with Chinese partners and much excited talk of making Chinese-themed films in English for a global audience. Leading the charge have been companies including Legendary Pictures, Relativity, Village Roadshow and DreamWorks Animation. (Xi Jinping was expected to have announced last week's tie up between DreamWorks and Shanghai Film Group, but was presumably side-tracked by the quotas manoeuvrings.)

At the same time, Chinese companies such as Bona, Huayi Brothers and LePictures have begun investing in English-language pictures. And the last two weeks have seen the announcement in China of two huge film investment funds, one private sector, one state backed, whose stated objective is to use their firepower to build industry bridges between Beijing and Hollywood.

The vice presidents' agreement will have to be integrated into China's upcoming Film Promotion Law, which is currently a discussion document doing the rounds. And it will have to be reviewed in five years, to see what levels of compliance have been achieved. However, given how much has happened in the ten years since the Chinese government began to reform the film industry, it seems fair to think that the Chinese cinema industry will be a very different place five years from now.

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