How preferential trade agreements address market distortions from state enterprises

3. The definition of state enterprises under preferential trade agreements

Negotiating and introducing a definition of SEs in a PTA constitutes a crucial first step in Parties’ efforts to insert disciplines on SEs as it delineates the scope of such disciplines. More specifically, it determines the reach of the obligations imposed on both SEs and governments in their relationships with SEs, and of the provisions placing obligations of transparency on governments. An overly broad definition risks capturing situations that do not involve control by the state over an enterprise. On the contrary, too narrow a definition may fail to capture trade distortive practices of both: (i) governments in their relationships with enterprises, in which they have important, albeit not a majority of, ownership shares, or over which they have control, and; (ii) enterprises, which by virtue of their state ownership, be it direct, indirect, or by virtue of state investment or control provide support to other state or private enterprises.

3.1. Insights from the OECD MAGIC database on the complexity of government ownership structures

Drawing on information collected on government ownership over time (2005‑24) for the companies covered in the OECD MAGIC database (see The measurement of government ownership under the OECD MAGIC database in Annex A), the OECD has found government ownership in industrial sectors to involve at times complex shareholding structures. The analysis has notably identified four different types of government ownership structures, which vary in complexity. They can be described as follows:

• Type 1: Direct, single government ownership: A company may be directly owned by one government entity, which is either its majority or only shareholder.

• Type 2: Direct, cumulative government ownership: Ownership of a company may be split horizontally between different government entities, including between central and subcentral entities. In such instances, each of these entities owns enough shares to be deemed a major shareholder but not enough to exercise majority control on their own. The percentage of government ownership is calculated by adding all the shares owned by the various government entities.

• Type 3: Indirect, vertical government ownership: Government ownership can also occur at the vertical level through a chain of ownership. In this case, a company is ultimately owned by one government entity through other SEs or chains of shell entities serving as intermediaries. While in some instances, there may be only one entity separating the government from the company, in other circumstances, several entities can serve as intermediaries between the government and the company. This may render particularly complex the identification of the percentage of government ownership shares of the company as it necessitates tracing back the chain of entities separating the government from the company, as well as identifying the shares owned by the government in each of those entities, which itself can be difficult (Annex A).

• Type 4: Combination of direct, cumulative government ownership and indirect, vertical government ownership: Measuring government ownership may prove even more challenging where the percentage of government ownership shares results from both direct, cumulative government ownership and indirect, vertical government ownership.

While some of the companies covered in the OECD MAGIC database are directly owned by one government entity as a majority or single shareholder (Type 1), other companies majority-owned by governments have complex and, at times, opaque shareholding structures, including shares disseminated horizontally across different government entities (Type 2), shares ultimately held by a government entity through a chain of ownership (Type 3), or a combination thereof (Type 4). A quantitative analysis of those different types of ownership shows that most companies covered in MAGIC with at least 25% of government ownership belong to Type 4.

3.2. The definitions of state enterprises differ across preferential trade agreements

While PTAs containing disciplines on SEs normally offer a definition of the term, there is no harmonised definition of SEs across PTAs.1 Based on information on PTAs collected by the OECD, four categories of definitions can be identified. Table 1 gives an overview of the various definitions encountered by replicating the wording traditionally used in the PTAs concerned, as well as specifying their different versions. This table, while not offering an exhaustive list, shows the different nuances in the definitions and the determining factors used under each category of definition to conclude that an enterprise is a SE. The exact coverage of these definitions, and hence their possible limits, is subject to different interpretations in the academic literature (Miner, 2016[12]; Nemoto, 2019[13]; Matsushita and Lim, 2020[14]; Gao and Zhou, 2022[11]). In most cases, however, SEs must be mainly engaged in “commercial activities”, namely activities the main object of which is the production of a good or supply of a service, which will be sold in the relevant market in quantities and at a price determined by the enterprise, and are undertaken with an orientation toward profit-making.

The definitions of SEs vary across the different PTAs, with some envisaging rather broad coverage by capturing entities directly and indirectly owned or controlled by the government, including through voting rights or the presence of government representatives within the entity’s management bodies. Note that the definition of state-owned enterprises included in the revised OECD Guidelines on Corporate Governance of State-Owned Enterprises (OECD, 2024[15]) has a similarly broad coverage. The remainder of this section thus analyses which elements forming the definition of SEs are particularly relevant to reflect (i) the complex ownership structures of firms majority-owned by governments and (ii) the possible presence of government control for firms having 25%-50% governments ownership. While this discussion does not aim to offer any authoritative interpretation of the different definitions of SEs used in PTAs, it is designed to shed light on the extent to which majority-owned SEs and companies with 25%‑50% government ownership could fall under the SEs disciplines of certain PTAs. Given the crucial role of the definition of SEs in PTAs, such analysis could help inform future bilateral, plurilateral, or multilateral discussions on the issue.

Table 1. The scope of the disciplines on state enterprises may vary according to how state enterprises are defined

	The traditional wording used in the different PTAs	Additional information on existing variations of the definition
Category A State enterprise means:	“[E]nterprise that is owned or controlled through ownership interests by a Party”	Category A may, at times, be complemented by a footnote indicating that: “For greater certainty, ownership, or control through ownership interests, may be direct or indirect.” In at least one identified case, the definition of Category A includes an additional element: state enterprise may be owned or controlled through ownership interests by the central or a regional government of a Party.
Category B State-owned enterprise means:	“[E]nterprise that is principally engaged in commercial activities in which a Party directly owns more than 50% of the share capital; controls, through ownership interests, the exercise of more than 50% of the voting rights; or holds the power to appoint a majority of members of the board of directors or any other equivalent management body”	State enterprise is defined separately from SOEs as an enterprise “owned or controlled through ownership interests by a Party.”
Category C State-owned enterprise means:	“[E]nterprises that is principally engaged in commercial activities and in which a Party: (a) directly or indirectly owns more than 50% of the share capital; (b) controls, through direct or indirect ownership, the exercise of more than 50% of the voting rights; (c) holds the power to control the enterprise through any other ownership interest, including indirect or minority ownership; or (d) holds the power to appoint a majority of members of the board of directors or any other equivalent management body.”	Indirect ownership under paragraph (a) refers to instances where a Party “holds an ownership interest in an enterprise through one or more state enterprises of that Party. At each level of the ownership chain, the state enterprise – either alone or in combination with other state enterprises – must own, or control through ownership interests, another enterprise.” It is considered that a Party holds the power to control the enterprise under paragraph (c) if “through an ownership interest, it can determine or direct important matters affecting the enterprise, excluding minority shareholder protections.” Establishing control under paragraph (c) follows a case-by-case approach, taking account of all relevant legal and factual elements (e.g. the power to determine or direct commercial operations, including major expenditures or investments; issuances of equity or significant debt offerings; or the restructuring, merger, or dissolution of the enterprise). State enterprise is defined separately from SOEs as an enterprise “owned or controlled through ownership interests by a Party.”
Category D State-owned enterprise means:	“[E]nterprise that is engaged in commercial activities in which a Party: (a) directly owns more than 50% of the share capital; (b) controls directly or indirectly through ownership interests, the exercise of more than 50% of the voting rights; (c) holds the power to appoint a majority of members of the board of directors or any other equivalent management body; or (d) has the power to legally direct the actions or otherwise exercises an equivalent degree of control in accordance with its laws and regulations.”	Various versions of paragraph (d) could be found, namely inter alia: can exercise control over the strategic decisions of the enterprise; has the power to exercise control over the enterprise. For the establishment of control, all relevant legal and factual elements must be taken into account on a case-by-case basis, holds the power to control the enterprise through any other ownership interest, including indirect or minority ownership.

Note: Although it is not reflected in the table, the EU-China CAI also contains a Category D definition. The agreement does not, however, expressly refer to the concept of SEs and instead refers to “covered entities”. These “covered entities” are subject to the specific disciplines on SEs further explained below. Importantly, the agreement specifies that the listing of “covered entities” is “for the purpose of defining the scope of application of this sub-section and does not presume its existence in either Party.” See Article 3bis(1)(a) and (b) CAI.

3.3. Relevant elements in the definitions of SEs

A first relevant element within the definitions of SEs is the consideration that a company with direct majority government ownership – that is, direct ownership of more than 50% of the share capital – is an SE. This element would allow to capture Type 1 government ownership structures and possibly Type 2 structures, provided that the different government entities, which together directly own more than 50% of the company’s shares, are themselves state-owned. As a result, firms with 50%+ state ownership would fall under any SE disciplines contained in PTAs that include such elements in their definition of SE. In contrast with the concept of “public body” as interpreted by the Appellate Body, which requires additional evidence of “governmental authority” beyond majority ownership,2 a definition with such elements would suffice to prove that a firm in which the state directly owns 50% or more of the share capital constitutes a SE.

Other elements within the different definitions of SEs capturing indirect ownership by governments may be pertinent since, as illustrated through Types 3 and 4 government ownership structures, this form of ownership by government can be particularly prevalent. In covering indirect government ownership, definitions of SEs could take account of instances where (i) companies are ultimately majority-owned by one government entity through other SEs or chains of shell entities or (ii) companies are ultimately state-owned through both horizontal and vertical government ownership.

As explained above, there may be instances where a government does not have majority ownership in a firm yet holds more than 50% of the voting rights through direct or indirect ownership interests. Although this situation is less common, including in China,3 its existence may require Parties to a PTA to take account of such a possibility when defining SEs. Last but not least, on some occasions, a government may exercise control over a company, despite being a minority shareholder. Government control can occur through, for instance, the presence of government officials serving as officials or members in the entity’s board of directors, the participation of the governmental body regulating SEs in the companies’ decisions, or the government’s involvement in the appointment, dismissal, or remuneration of senior executives, members of the board of directors, or any other equivalent management body. Such a possibility would need to be factored in when defining SEs in a PTA.

Notes

← 1.  Note that many PTAs refer to SOEs. Some agreements, such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, the Australia-Peru FTA, and the USMCA have a definition of SE and SOE, with the substantive obligations primarily applying to SOEs. This report uses the term SEs in accordance with earlier OECD work undertaken for the Trade Committee.

← 2.  Appellate Body Report, US-Anti-dumping and Countervailing Duties on Certain Products from China, WT/DS379/AB/R, adopted 11 March 2011, para 317. In its Report, the Appellate Body called for additional evidence, beyond majority ownership, to prove that an entity “possesses, exercises, or is vested with governmental authority.” There is, however, no clear guidance with respect to the adequate range of evidence needed. See Box 1.

← 3.  Chinese corporate law has traditionally maintained the “one-share-one-vote” principle. Since 2019, however, China has introduced specific rules allowing the so-called “dual-class equity structure” (DCES) for innovative companies wishing to be listed at the Shanghai Stock Exchange. In doing so, Chinese authorities have followed many major jurisdictions, which have already adopted the DCES, such as the United States, Japan, Singapore, and Hong-Kong (China). Under this structure, a company issuing share capital has two classes of ordinary shares that carry unequal voting rights at shareholder general meetings. One class of shares with special voting rights typically benefit the company’s founders, possibly enabling them to retain control over the company although they own less than 50% of the company’s shares. The DCES in China has nonetheless remained limited so far: only innovative firms in science and technology sectors can apply for listing with a DCES to the Science and Technology Innovation Board of the SSE, also known as Star Board – which is an addition of the SSE’s Main Board. Moreover, Chinese authorities have set out a rather stringent permit system with different sets of safeguard measures to protect investors and avoid providing controlling shareholders with perverse incentives to exercise their discretion and oversight for their private benefits at the expense of the company. As a result, only eight companies had achieved listings with a DCES at the end of 2023. For more information on DCES in China, see (Yan, 2020[26]), (Yan, 2024[27]), and (Kang and Ling, 2023[28]).