In March, Chinese regulators made headlines when they announced a change to the animal testing requirements that the country had previously maintained for imported cosmetics. That change, which comes in the form of an exemption from mandatory pre-market animal testing for general cosmetics goods, and which stands to have significant implications for non-native brands, came into effect on May 1. The size and growth of the cosmetics market in China means that every international beauty brand must be looking at China. However, the mandatory animal testing requirements imposed by Beijing on imported cosmetics have posed a major dilemma for many cruelty-free brands. While China has not banned animal testing for all cosmetics, the new regulations provide a pathway for international cosmetic brands to enter the China market and remain cruelty-free.
With the new regulations in play, international brands need to bear in mind that although there is now a pathway to enter the market in a cruelty-free manner (and without relying in third-party marketplaces, such as Alibaba’s Tmall), this path will still require a lot of careful navigation given the greater scrutiny and regulatory paperwork that will come as a result. One regulatory challenge that beauty brands need to be aware of comes in the form of appointing a Domestic Responsible Agent.
What is a Domestic Responsible Agent? First introduced into the Chinese legal cosmetics regime by the Notification 2017 No.7, and on the heels of a successful trial in the Shanghai Pudong New Area, the Domestic Responsible Agent program covers all of China. In short, the concept of Domestic Responsible Agent means that with respect to imported cosmetics, there must be a party situated in China that can be held accountable in the event of a safety issue arising in respect to such products. The Domestic Responsible Agent is a pre-requisite to apply for a National Medical Products Administration (“NMPA”) Product Registration – and therefore, in order to have a product registration in China means you will need to have a Domestic Responsible Agent.
What has Changed? Although, the Domestic Responsible Agent requirement has been in place since 2017, the regulations and the requirements that they entailed were relatively lax. There was no specific qualification, no requirement to have a quality management system, no requirement on personnel, no recall systems in place, etc. While there was an obligation upon the Domestic Responsible Agent with respect to quality and safety, these requirements were vague.
The newly-enacted Regulations on Supervision and Administration of Cosmetics have changed this dramatically. Companies’ Domestic Responsible Agents now must meet specific – and rigorous – requirements, and are subject to very serious potential liability, including major fines, employment bans and even criminal liability.
Who can be a Domestic Responsible Agent? Legally, the main requirement is that the Domestic Responsible Agent must be established in China. Initial reports indicate that the NMPA is carrying out rigorous on-site inspections and grading of Domestic Responsible Agents, which means that unqualified candidates will not be permitted to act as Domestic Responsible Agents. With that in mind, Domestic Responsible Agents for international brands are likely to be one of the following …
Chinese Distributor (or JV or other partner) – At least some international cosmetics companies have relied upon their distribution partners as their responsible agent, which we have generally discouraged on the basis that it cannot be guaranteed that a company’s Chinese distributor will follow the rules set out by the international brand. Beyond that, having the NMPA registration in its name, gives the distributor a lot of leverage, which could prove problematic for the brand.
In light of the new regulations and especially given the greater scrutiny in screening Domestic Responsible Agents that is currently underway, many international brands will likely look to this model if they do not, at least in the short term, have the resources to establish a Domestic Responsible Agent of their own. Accordingly, if international brands intend to appoint their Chinese distributors to act as their Domestic Responsible Agent, it is important to: 1) select the right partner; 2) have a clear contractual basis; 3) have an audit and supervision plan in place; and 4) have an exit plan in the event the relationship sours in the future.
The exemptions for animal testing will very likely lead to even more Chinese distributors reaching out to non-native brands that have not yet launched in China. Brands are advised to be diligent in picking a partner, to have the a contract in place outlining the relationship, and to exercise oversight over the Agent.
Regulatory Experts or Consultants – In the past in order to avoid providing a Chinese distributor with too much leverage, many international brands have opted to appoint a third party – often a regulatory advisor or even just an independent consultant – as their Domestic Responsible Agent. This is likely to be less common going forward because: 1) few of these third parties will meet the NMPA requirements or pass the inspection; and 2) those who have sufficient experience will be very wary of the potential liability (e.g. including responsibility for document submission authenticity, and product recall).
Wholly Foreign Owned Enterprise (“WFOE”) – Finally, China has a relatively liberal attitude to establishing WFOEs for cosmetic companies. There are great advantages of using a WFOE, such as the having the ability to exert greater control, avoid misalignment with a distributor (or JV partner), and maintain your own team on the ground. The procedure is quite straightforward – a brand will need to apply for the establishment of a WFOE that has a business scope that includes “sale and import of cosmetics” and complete relevant registration formalities with customs. Generally, the establishment of such a WFOE will take approximately 6 to 8 weeks.
Intended to function at least in part as a Domestic Responsible Agent, a WFOE will need to have an actual, physical office (i.e. not a virtual office), as the NMPA will carry out an inspection of that office, as well as of any warehousing space. It should also be noted that if an international brand intends to import products into China from ports other than the local port where the WFOE is registered, then a relevant filing of consignee location must be completed on the NMPA system before imports can commence. The WFOE will also be responsible for making product distribution registrations and also reporting adverse reactions regularly.
All in all, the new 2021 exemption from animal testing for certain imported cosmetics will lead to even greater interest on the part of international cosmetic brands, particularly in light of the size and rate of growth of the Chinese cosmetics market. To date, China’s animal testing regime has largely meant that many cruelty free brands have been forced to avoid the China market or only supply via cross-border e-commerce sites, as opposed to maintaining their own operations. Accordingly, the vast majority of international cosmetic brands do not have NMPA registrations and therefore, have not come across the Domestic Responsible Agent concept in the past.
Nonetheless, in order to make use of the exemption and trade more freely in China, companies will need NMPA registrations and to appoint of a Domestic Responsible Agent. Many brands will establish WFOEs to support their market entry, but it is likely that in most cases, the WFOE will not (at least in the short term) will be able to meet the requirements of being a Domestic Responsible Agent. As such, many brands will need to rely on Chinese partners. And regardless of the partner, international brands should ensure that they have a detailed and sound contract detailing the relationship and an exit plan if the relationship does not work out. In particular, brands will be well advised to ensure they keep as much of their intellectual property and business details confidential, and also remain involved in the Chinese arm of their business so they can keep track of all developments.
Mark Schaub is the Managing Partner at King & Wood Mallesons, where he specializes in foreign direct investment, cross border M&A, intellectual property, and private equity investment in China.