China

Price and Profit Controls

In efforts to gain control of health care spending, the State Development and Planning Commission (SDPC) proposed price/profit controls on drugs to regulate the pharmaceutical market in late-1996. The Chinese Government's pending imposition of burdensome and discriminatory price controls on pharmaceuticals by the end of 1998 is the most serious issue currently facing the research-based pharmaceutical industry in China. Although some progress to revise the original draft regulations for the price/profit controls was made recently through industry efforts addressing the potentially damaging effects of the controls, the Chinese Government has gone ahead to publish the pricing regulations with an effective date of December 1, 1998.

The Chinese government stated that the purpose of the price controls has been to reduce unfair competition by controlling the prices of joint-venture products (i.e., joint ventures between state and foreign companies), and stimulate company mergers to eliminate low-quality manufacturers. The international industry believes, however, that the new price control system is a means for the Ministries to "jockey" for power over public policy and an effort to help/protect state-owned enterprises from foreign competition. For imported products, the SDPC shifted pricing authority away from the former State Pharmaceutical Administration of China (SPAC) to SDPC's own Price Administration Bureau (PAB), an agency which does not have direct knowledge of the pharmaceutical sector or foreign investment in that sector. In addition, the SDPC has strengthened its price control mechanisms through provincial price bureaus.

PhRMA understands that the current version of the national price and profit controls began gradual implementation as of December 1, 1998 and will affect some companies and some sectors of the Chinese health care system before others. From the previous drafts of the price regulations to which PhRMA and its member companies were given access, the following was clear:

(1) The proposed price control regulations, on their face, discriminate against foreign pharmaceutical products and thus appear to be fundamentally inconsistent with the World Trade Organization's "national treatment" principle.

(2) In violation of GATT Article III:4 and the WTO Agreement on Trade-Related Investment Measures ("TRIMs"), the proposed Chinese regulations (a) promote "import substitution," (b) establish different and less favorable procedures and formulas for pricing imported pharmaceuticals, and (c) bestow an array of benefits on Chinese-made products that are not afforded to "like" imported products.

(3) The Chinese government also appear to violate GATT Article III:4 by removing disproportionately large numbers of imported drugs from the National Essential Drug Reimbursement List for purposes of promoting import substitution. Such de facto discrimination contravenes the WTO's national treatment principle.

(4) The proposed regulations seem to lack transparency and invite protectionist abuses.

PhRMA continues to believe that, if the proposed price control regulations are allowed to go into effect, they would constitute a major market access barrier to U.S. pharmaceutical exports. Such a step could have disastrous implications for future sales of research-based U.S. pharmaceuticals in China's rapidly expanding market.

PhRMA emphasizes that China's proposed price control regulations would be self-defeating and counter-productive. The primary burden would fall on Chinese patients, who would be denied access to innovative life-saving medicines developed abroad. Moreover, absent adequate rewards for innovation, it will be difficult for China to attract substantial foreign investment in its state-owned pharmaceutical sector.

While China is fully capable of building an internationally competitive, research-based industry, this important goal cannot be achieved unless the pharmaceutical market is opened up to foreign competition without discriminatory regulatory barriers. Furthermore, intellectual property must be adequately protected, and investment in innovative research and development adequately rewarded. Around the world, price controls have repeatedly failed to achieve even their most basic purpose -- containing health care costs.

While it has been reported to PhRMA that the most recent version of the controls offer improvements over previous drafts, PhRMA remains concerned about significant aspects of these controls and the way in which they could be implemented. As of the end of November 1998, PhRMA understands the details of the controls in their most recent form as follows:

• Class I (drugs discovered, developed and produced in China) and Class II (drugs for which Phase I and Phase II of the clinical research was conducted in China) new drugs will enjoy a three-year period of "relaxed control" from the date of approval;
• New products approved under Category I to Category V can keep their original profit ratio for a period of five years after expiration of the new drug protection period;
• For patent-protected compounds, locally produced raw materials approved under "Category IV" (products marketed elsewhere in the world), will be granted 30% profit and finished goods 20% profit. Traditional Chinese Medicines (TCMs) in finished form will be granted 20% and biologicals 35%.
• In a Good Manufacturing Practices (GMP) approved plant, locally produced raw materials (old products) will be allowed a profit margin of 15% and finished goods will be allowed 11%. Biological finished goods will be allowed 23% and TCMs will be allowed 15%.
• For specialty drugs after the expiration of new drug protection period, raw materials will be allowed a 20% profit margin, and finished goods will be allowed 15%. Specialty drugs include anti-cancer drugs, anesthetics, birth controls products, etc.

PhRMA also understands that the Government of China intends to allow GMP plants higher margins for products they produce. For enterprises seeking a higher price than the controlled price based on quality, safety and clinical efficacy, a public hearing will be held by the Pricing Bureau of the SDPC to review such an application.

For popular brands of TCMs, applications to see a higher price will be reviewed by the Pricing Bureau and State TCM Administration.

PhRMA also understands that there will be controls on advertising and "drug selling expenses." According to the new rules, the originators of medicines will be allowed 25% of sales for drug selling expenses, while those who do not represent the originator will be allowed 10%. Normally, "selling" expenses should include: advertising, promotion, sales representatives' salaries, incentives, TM&E, training, marketing, product registration, clinical studies, distribution and freight. In March of every year, enterprises must report to their local pricing bureau an analysis of selling expenses by products.

The Chinese Government also has stated its objectives to control discounts to hospitals, clinics and other end users. Pharmaceutical enterprises cannot offer discounts higher than 5%, while the seller must indicate on the invoice the actual selling price net of discount.

Excessive profits by wholesalers over and above 5% are illegal and will be confiscated by local authorities. In March of every year, according to the new regulations, medical units must report their income from wholesale and retailing of drugs to the local (e.g., provincial) pricing bureau.

The Chinese Government reportedly has suggested that medical units should raise medical fees to offset lower income from drugs, although it does not suggest how the medical units may go about doing this. For those territories that find it difficult to raise medical fees, an additional 3% profit allowance will be given to county units, and an additional 8% profit allowance given to village units.

In late 1996, the international pharmaceutical industry launched a concerted campaign to convince the Chinese Government that the controls would not accomplish what they sought and would, in fact, be counterproductive to their goals. As a result, the international industry reached a tentative agreement with the Chinese Government to allow some leeway for higher margins for innovative foreign manufactured pharmaceuticals.

At an industry briefing in October 1998, PAB Director General Bi Jing Quan presented SDPC's possible modifications to the original proposal. As mentioned above, PhRMA understands that the new regulations will begin to go into effect on December 1. The pharmaceutical industry acknowledges that the Chinese Government has made an effort in its declarations to more fairly compensate foreign manufacturers for their investments. However, there are some questions that remain regarding the regulations and their implementation. These include:

• The regulations reportedly declare that for balancing purposes, low margins will apply to imported medicines of high value. (Foreign medicines which are used in large quantities impacting market share are considered high value and importation and pricing are to be restricted by the State.) Not only is artificial manipulation of trade flows prohibited under the WTO, but this means that SDPC could determine the equilibrium price at port, as well as the wholesale and retail prices, resulting in trade-distorting subsidies to dealers for handling domestically-produced medicines.
• The proposed regime requires that foreign companies share sensitive proprietary information in order to calculate the appropriate price/profit margin for imports such as the ex factory price, sales income, profit, and net income margin of drugs produced by joint ventures in China. Disclosure of these data provides competitive intelligence easing the piracy of foreign products.
• In a previous version of the price controls, there was some assurance of an appropriate profit to domestically produced products for recovery of reasonable costs including allotments for the R & D expenditures of new medicines and recognition of quality manufacturing and therapeutic benefits of innovative technologies. These premiums were not provided for imports in the previous version of the regulations. It is not yet clear whether this problem has survived in the new regulations.

The research-based pharmaceutical industry will spend over 20% of its annual sales revenues in 1998 on R&D, or around US$21 billion. This amount is higher by far than any other industrial sector. The drug industry provides not only highly skilled jobs but advancements in science, technology, research, medicine, marketing, manufacturing and sales.

The current changes to the proposed pricing structure do not recognize R&D investments made by international companies within China, or the need for China to bear some of the burden for global R&D expenditures to avoid being a "free rider". Without further modifications to the draft regulations, the price controls will discourage the establishment of research and development capabilities in China, continued capital investment and manufacturing, technology transfer, and additional hiring and training of Chinese staff. Medical education programs in certain therapeutic areas will be affected as well as the substantial support PhRMA companies give to patient education.

Research-based pharmaceutical firms administer worldwide R&D programs and make difficult choices among nations, therapeutic areas and specific drugs in selecting where to invest their R&D funds. The Chinese Government should continue with further revisions to the proposed price controls on pharmaceutical products in China, unless they wish to see a significant reduction of investment by the research-based pharmaceutical industry in China.

Recommendations

Price controls would create significant economic distortions, shifting costs to administration and to government bureaucracies, which would make decisions about drugs instead of the usual players in the marketplace such as physicians. Furthermore, price/profit controls would undermine the spirit of economic and trade liberalization which the WTO represents and deprive foreign firms of many of the benefits conferred through Chinese accession to that body.

The research-based pharmaceutical industry requests the U.S. Government's support in deterring the Chinese Government from implementing discriminatory and onerous price controls on foreign manufactured pharmaceuticals, and by pursuing the Chinese Government's demonstration of national treatment and transparency principles to the pricing system for this important sector as a condition for WTO accession.

Protection of Intellectual Property

In 1992, the U.S. and China negotiated a Memorandum of Understanding (MoU) to provide 7.5 years of marketing exclusivity to U.S. pharmaceuticals not introduced during a designated "Administrative Protection" period (1986-1992.) Chinese law implementing the agreement states that anyone who has not obtained a certificate for Administrative Protection (AP) is prohibited from manufacturing or selling the subject product during the term of exclusivity. The law also provides that the owner of the certificate can request the authorities to stop local companies from manufacturing or marketing the pharmaceutical, and can institute legal proceedings to recover economic damages for infringement.

In 1994, however, new legislation was passed (Notice 72) that nullifies this patent protection for U.S. pharmaceuticals. Notice 72 states that domestic pharmaceuticals which were given approval by MOH during the examination of AP for a foreign manufacturers shall be considered a legally marketed and manufactured and shall not be considered an infringement of AP.

This "loophole" encourages MOH to grant certificates to local companies for copies of products before the AP certificate is granted to foreign manufacturers by the now defunct SPAC. Furthermore, industry intelligence indicates that MOH certificates are being granted even if the local company has not complied with all MOH regulations or is not truly ready to market the product.

According to the 1992 MoU, Article 2 of the regulations for Administrative Protection provide that:

"The competent Chinese authorities will prohibit persons who have not obtained a certificate for Administrative Protection from manufacturing or selling the subject product during the term of Administrative Protection."

Enforcement of Administrative Protection has been governed by Article 18 and 19 of the Regulations which were approved by the State Council and promulgated by the former SPAC in December 1992. Article 18 provides that the MOH under the State Counsel and provincial municipal health authorities shall not allow anyone other than the patent owner who has obtained Administrative Protection from manufacturing or selling the product.

Article 19 provides that the Administrative Protection Certificate owner can request the authorities under the State Council to stop local companies from manufacturing or marketing the pharmaceutical. The Administrative Protection Certificate owner also can institute legal proceedings in the people's court to recover economic damages.

PhRMA believes that Notice 72 is not consistent with Articles 18 and 19 of the Administrative Protection Regulations cited above. Paragraph two of the Notice states that the pharmaceuticals (applied for by local companies) which were approved by the Ministry of Public Health during the examination of Administrative Protection shall be considered as legally marketed and manufactured and shall not be considered as an infringement of Administrative Protection. As such, Notice No. 72 clearly violates the period of marketing exclusivity provided for in the MoU.

Recommendations

It is not yet clear how the Administrative Protection will be implemented, with the demise of the SPAC, and the assumption of responsibilities for Administrative Protection by the new State Drug Authority (SDA). PhRMA urges the U.S. Government to seek clarification from the Chinese Government as to how the program of Administrative Protection will be implemented by the SDA. The U.S. Government also should seek a revocation of Notice 72 and a reinstatement of the 7.5 years of marketing exclusivity in China for products protected by Administrative Protection. In addition, industry seeks enforcement to stop local companies from all research, development or marketing activities relating to products protected by Administrative Protection.

Other Trade Issues

• Import policies: Chinese Government policy discourages imports through delays in processing and approving import registration are routine. If there is a locally produced generic copy of a product in China, the chances of a foreign firm obtaining an import permit are far from certain. Where import licenses are granted, they are for a limited 3 year period only. Price reductions have been imposed on many imported products.

• Tariffs: Imported products are subject not only to customs duties of 14%, but also to Value Added Tax to 17%, resulting in an effective net import duty of over 30%. In the context of the Chinese application to join the WTO, PhRMA would expect a rapid reduction of import duties to achieve the WTO goals for zero tariffs on medicines.

• Distribution System: The current distribution system is such that products are sold to wholesalers through importing agents and may pass through as many as eight distribution levels before reaching hospitals. This convoluted distribution chain tends to inflate the prices of products, makes it difficult to ensure that products are properly stored and are received by the patient in good condition.

• Rules for Packaging Products in China: Current rules do not allow products to be treated as locally produced, when the only work done in China involves packaging finished products. Since most international companies typically package in China for the first few years, and then invest later if the market warrants such investment, it is unreasonable to expect international companies to invest in formulation plants for products with no sales history. Restrictions on repackaging may force many companies to import only into China, however, imported product use is restricted by many city and provincial formularies, thus further limiting the potential of the industry's innovations.

• Generic labeling: China has been considering a move to generic labeling, whereby the generic name would appear in a large bold type, while the brand name would be much smaller. If adopted, this proposal reduces the intellectual property value of trademarks and would be strongly opposed by industry.

• Ethics and Code of Conduct: PhRMA member and other international companies in China are bound by the pharmaceutical marketing code of the International Federation of Pharmaceutical Manufacturers Associations (IFPMA), while local companies are not.

• Counterfeiting: Counterfeiting of pharmaceuticals is a significant problem in China. Counterfeit versions of patented medicines are believed to have been manufactured in China, both for sale within the country and for export. PhRMA requests that the Chinese government exert greater pressure and apply stronger penalties to stop this highly dangerous practice.

Recommendations

The U.S. research-based pharmaceutical industry, as represented by PhRMA, believes that the United States Government should continue to support renewal of China's MFN status, since the maintenance of an open and liberal trading relationship is in the interest of both countries. The renewal of China's MFN status should provide the foundation for seeking further improvements in China's business and commercial practices that will bring them into line with the global standards of the World Trade Organization, to which China seeks accession.

PhRMA does ask the full support of the U.S. Government in seeking to overcome the aforementioned trade barriers for the researched-based pharmaceutical industry in China. Resolution of the problems facing the pharmaceutical industry in China will help ensure our industry's support for China's WTO accession.

Potential Exports/Foreign Sales

It has been difficult to measure precisely the size of China's pharmaceutical market, and the shares held in that market by foreign and domestic pharmaceutical companies. Today, there are 12 PhRMA member affiliates in China, which PhRMA estimates enjoy approximately a 12 per cent share of the China pharmaceutical market of US$6 billion (for finished formulations of western medicines) or around US$720 million in annual sales.

It also is difficult to determine precisely the impact of the imposition of price and profit controls on the share that PhRMA member company affiliates enjoy in the China pharmaceutical market. It is clear that the Chinese Government intends the price and profit controls to have a dampening impact on the success of the international industry in China. If the new rules are implemented in a way that protects the domestic industry from competition with the Joint Venture companies, and favors the former, the impact could be significant.

It also is difficult to determine whether the total number of pirated products (as a percentage of all products on the market in China) has fallen substantially in the last five years, a result of the enactment of improved intellectual property protection or improved enforcement of these "IP" laws. PhRMA member companies in China estimate that a substantial part of the market still is dominated by pirated or counterfeit products.

PhRMA estimates that the potential size of its companies' share of the pharmaceutical market for finished formulations of western medicines could reach US$1.4 billion, if the aforementioned problems encountered by PhRMA member companies in China were rectified.

Documents Required for Pipeline Protection in China
Starting March 1995¹

1. Power of Attorney issued by Patent Holder/assignee to Huake (1 month)

2. Completed Application Form to be signed by patent holder/assignee (1 month)

3. Patent Certificate issued by patent office (2 - 3 months)

4. Certificate issued by Patent Office certifying all renewal fees are paid (2 - 3 months)

5. Certificate issued by Patent Office certifying Patent Assignment from patent holder to Assignee. (2 - 3 months)

6. Product Manufacturing or Marketing Approval Certificate issued by health authorities of originating country. (2 - 3 months)

7. Sales/Manufacturing Contract between originating country and PPL, which must be notarized and legalized. (2 - 3 months)

8. Contract Notarization documents including:

i. Notarized & Legalized copy of the Trade Register. (2 - 3 months)

ii. According to Chinese Regulation, the contract should be signed by chairman of Board Directors.

a) If the contract is signed by chairman of Board of Directors, then we should submit:

• notarized & legalized statement in which the chairman should state when & where signed the contract. The contract copy and ID copy of the chairman should be attached to the statement. (2 - 3 months)

  b) If the contract is signed by general manager, but not the chairman of Board of Directors, then we should submit:

• notarized & legalized statement in which the general manager should state when & where signed the contract. The contract copy and ID copy of the general manager should be attached to the statement. (2 - 3 months)

  A notarized and legalized power of Attorney in which the chairman of the Board of Directors authorizes the general manager to sign the contract. The ID copy of the chairman should be attached. (2 - 3 months)

Note

¹Number of months in parentheses show length of time required to accomplish each step under normal circumstances.