China's tech rules make It hard for U.S. firms to take control

A year ago,Hewlett-PackardCo.’s then-head of enterprise business,Bill Veghte,sat at China’s elite Tsinghua University, a bowl of hydrangea arranged before him in keeping with Chinese meeting style.

Against a purple backdrop announcing the arrival of a “Chinese Technology Powerhouse,” Mr. Veghte said: “Today we start the next chapter.”

And with that, a U.S. business became a Chinese one.

Since H-P sold 51% of its China networking business to Tsinghua Unigroup, an affiliate of the university, sales have revived. They are up 40% in the first four months of this year, compared with a 1% decline for all of last year, saidTony Yu,chief executive of the unit’s reincarnation, the New H3C Group.

“Once we became Chinese, some hurdles were gone,” Mr. Yu said in an interview.

Western companies have struggledwith China’s increasingly stiff cybersecurity regulationsand many U.S. tech firms are now finding that their best way to go forward in China is by strengthening joint ventures and conducting more of their businessthrough Chinese partners.

MicrosoftCorp.,QualcommInc.andCisco SystemsInc.—which all have faced headwinds in China, including antitrust probes and espionage accusations—have formednew Chinese joint ventures in the past yeartailored to meet Chinese security requirements. Newer companies such as Uber Technologies Co. have chosen to enter China through purely Chinese ventures with all their data stored in the country.

Beijing has recently shifted to a softer sell. At a tech meeting last week in China’s south, PremierLi Keqiangreiterated that security rules apply equally to all companies registered in China and pledged “a more fair, transparent and predictable investment environment.”

In practice, China has shown little sign of letting up; earlier this year, it further tightened restrictions on online publishing by foreign companies. In April, Chinese regulators blockedAppleInc.’s iBook and iMovie services.

New technologies have connected the world more than ever, but in something of a paradox they grow increasingly dissimilar between regions as governments dictate local terms. In Europe, websites such as Google and Wikipedia increasingly diverge from their U.S. versions as European courts uphold individuals’ “right to be forgotten.” The same model of a smartphone bought in India and Indonesia will likely soon contain different components because of local sourcing regulations.

After Edward Snowden’s revelations about U.S. government spying in 2013, Chinese regulators have used both carrots and sticks to push foreign tech suppliers to localize product development and data.

A slate of new cybersecurity laws requires technology companies to store their data in China, submit to security checks andhelp the government with decryption if requested. Government agencies and key industries have been urged to adopt “secure and controllable” technologies, a term widely interpreted to mean Chinese products.

Companies have also been prodded individually: Last month after a visit from Apple Chief ExecutiveTim Cook,China’s technology ministry urged the iPhone maker to deepen its local partnerships and provide a “more secure user experience” to Chinese customers.

Qualcomm PresidentDerek Aberlesaid in a recent interview in Beijing that the company’s new China-controlled joint venture for server chips would likely develop “something very specific to China” in the security area.

“They can take our platform and innovate on top of it and provide those components that wouldn’t necessarily be coming from us,” he said.

Qualcomm announced several new investments in China after it agreed to pay a roughly $1 billion antitrust fine and renegotiate its licensing agreements with Chinese companies.

Foreign trade groups say China’s cybersecurity rules make it difficult to do business except through a Chinese company. More than 20 U.S. and international associations signed a letter to China’s insurance regulator on Wednesday to protest draft security rules with data provisions and other requirements for the sector that they said would be an obstacle to trade.

Neither the insurance regulator nor the commerce ministry responded to requests for comment on the letter.

While big companies have moved forward with joint ventures, the obstacles have put a damper on deals overall. The number of investments where a U.S. tech company acquired more than 50% in a Chinese company fell from 15 in 2011 to only one in 2015, according to research firm Dealogic.

To be sure, mistrust goes both ways. Huawei Technologies Co., in particular, has been virtually shut out of the U.S. telecommunications sector after a U.S. congressional report in 2012 suggested Beijing could use the company’s equipment for spying.

Huawei has said it doesn’t assist China’s government in espionage and has aligned itself with U.S. companies on security issues as it expands internationally. Huawei’s rotating chief executive took the unusual step last year of publicly urging Beijing to stay open to the best global technology.

In an effort to stem the two-way damage, Huawei and Microsoft—which faces a continuing antitrust investigation in China—are partners in a “Breakthrough Group” that is writing a so-called buyer’s guide for commercial enterprises to help them evaluate potential risks of various technology products, said the project coordinator,Bruce McConnell,a former U.S. Department of Homeland Security cyberspace expert who is now vice president at New York-based advisory EastWest Institute.

U.S. trade lobbyists say the global supply-chain fragmentation increases cost and vulnerability. “By trying to wall off your network, you have untested systems and that increases the risk of security flaws,” saidErin Ennis,senior vice president of the U.S.-China Business Council.

China’s officials have acknowledged the need to balance security imperatives with the economic value generated from open information flow.

“We must strictly control data flow across borders,” said Liu Yong, a tech-industry researcher with China’s main economic-planning agency at a recent conference. “But at the same time, we must be aware that data can only reach its greatest value through its flow.”

At New H3C, Mr. Yu said the company is better poised to land orders from China’s government and other sensitive sectors under local ownership.

“The fields we can plow have broadened,” he said.

(THE WALL STREET JOURNAL)