China’s Data Center Sector: Industry and Regulatory Insights

China’s rapid rise as a global technology powerhouse is largely supported by its thriving data center ecosystem. This article explores the catalyst factors behind its remarkable growth, influential players in the ecosystem, and key regulatory frameworks.

In the midst of a technological revolution marked by the surge in AI adoption and the transformation of global supply chains, China has embarked on a remarkable journey that has propelled it from a technology follower to a global technology powerhouse.

At the epicenter of this transformative shift lies its burgeoning data center ecosystem—a realm where innovation, economics, and technological prowess converge to shape the digital landscape.

In this article, we navigate China’s data center sector, focusing on the factors driving its unprecedented growth, key players, and the regulatory framework.

China’s data center boom: An overview

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In recent years, China has focused much attention on its data center sector. This has given rise to a data center ecosystem that’s both economically impactful and technologically advanced.

As such, China’s data center market is expected to reach a revenue of US$69 billion by the end of 2023 and a market volume of US$86 billion by 2027. The growth trajectory reflects a consistent compound annual growth rate (CAGR 2023-2027) of 5.70 percent.

The sector’s growth is primarily led by the IT infrastructure segment, projected to achieve a market volume of approximately US$47 billion in 2023.

Factors driving the demand for data centers in China

Digital services proliferation

The proliferation of digital services has emerged as a paramount driver behind the escalating demand for data centers in China. With the rapid digitization of various industries, ranging from e-commerce to entertainment and finance, the production and consumption of digital content have surged. This influx of digital transactions, communications, and interactions generates an exponential volume of data. As businesses endeavor to optimize their operations and customer experiences, they inevitably require the robust infrastructure that data centers provide to accommodate, process, and store this burgeoning data flow.

Cloud computing adoption

The adoption of cloud computing has also revolutionized the landscape of business operations by offering unparalleled flexibility, scalability, and efficiency. As enterprises increasingly embrace cloud-based solutions to enhance collaboration, data accessibility, and cost-effectiveness, the need for data centers becomes intrinsic. Data centers serve as the backbone of cloud services, facilitating the seamless deployment and management of virtualized environments.

Internet of Things (IoT) expansion

The rapid expansion of the Internet of Things (IoT) ecosystem amplifies the demand for data centers as it heralds an era of interconnectedness and data-driven insights. IoT encompasses a network of devices, sensors, and systems that exchange data and enable real-time monitoring and analysis. As China spearheads initiatives to transform cities into smart urban landscapes and industries into intelligent production systems, the exponential surge in IoT devices is inevitable. Data centers serve as the hub for processing and analyzing the constant stream of data generated by these interconnected devices.

Demand for hyper-converged solutions

The increasing demand for hyper-converged data centers is another significant driver of market growth. Converged infrastructure solutions provide an efficient approach to managing data centers by integrating servers, storage, networking, and virtualization tools into ready-to-use packages. This approach, known as hyper-convergence, allows IT service providers to merge different technologies into a single system architecture.

Key players of China’s data center sector

China’s data center sector is a melting pot of both local and foreign players, contributing to the industry’s dynamism and innovation. These key stakeholders play a pivotal role in shaping the landscape of data centers within the country.

Local industry leaders include:

• China Telecom Corporation: As one of the largest state-owned telecommunications companies in China, China Telecom holds a significant presence in the data center sector. Leveraging its extensive network infrastructure, the company provides a wide array of data center services to cater to the diverse needs of businesses across the nation.
• China Mobile Limited: Another prominent state-owned telecommunications giant, China Mobile, is a vital player in China’s data center landscape. The company’s focus on 5G technology integration and network services is closely linked to the expansion of data centers to support increased connectivity and digital services.
• Tencent Cloud: A subsidiary of the tech conglomerate Tencent Holdings, Tencent Cloud is a major player in China’s cloud computing and data center ecosystem. Known for its expertise in cloud solutions, Tencent Cloud offers a range of services, including cloud computing, AI, and data storage, catering to the evolving demands of China’s tech-driven businesses.
• Alibaba Cloud: Although a local giant, Alibaba Cloud, the cloud computing arm of Alibaba Group, holds a prominent position in the global technology landscape. Its foray into China’s data center sector has further solidified its influence, offering advanced cloud and data center solutions to both local and international clients.

On the other hand, foreign entrants with significant impact on the market include:

• Amazon Web Services (AWS): AWS, a subsidiary of Amazon, has ventured into China’s data center market with its cloud computing offerings. This move aligns with its global expansion strategy, aiming to provide its internationally recognized services to the rapidly growing Chinese digital economy.
• Equinix: As a multinational data center and colocation provider, Equinix has established its footprint in China, offering advanced interconnection solutions. Equinix’s expertise in facilitating direct and secure connections between businesses underscores its relevance in China’s evolving digital ecosystem.

Market oversight and regulatory framework

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China’s Negative List of Special Management Measures for Foreign Investment Access (2022) continues to impose restrictions on sectors, such as telecommunications, which encompasses data center operations. These restrictions align with China’s commitments upon joining the WTO and stipulate that foreign investors can hold no more than a 50 percent stake in value-added telecommunications services (excluding e-commerce, domestic multi-party communications, storage and forwarding, and call centers). Basic telecommunications enterprises are required to be under Chinese control. One of the aspects hindering foreign direct access to control of the total investment in the telecom sector is, for example, the difficulty to obtain required licenses (such as the Internet Data Center license, explained in the sections below).

However, foreign capital has found avenues to intervene, utilizing methods like the Variable Interest Entity (VIE) structure, agency models, and technology transfers.

Competent authorities

The Ministry of Industry and Information Technology (MIIT) holds a central role in overseeing China’s data center industry. Its responsibilities cover a broad spectrum:

• Policy formulation: The MIIT devises and executes industry plans, policies, and strategies to enhance the industry’s layout and structure.
• Legal frameworks: It drafts relevant legal frameworks and industry rules, ensuring compliance and consistency.
• Technical standards: The MIIT sets technical standards, supervising quality management across the sector.
• Trend monitoring: Keeping an eye on industry trends, it gathers and shares vital information, offering predictive insights and solutions.
• Collaborative solutions: It collaborates to address industry challenges and provides strategic recommendations.

Within the MIIT, the Telecommunications Administration Bureau oversees telecommunications and information services within legal boundaries. This includes:

• Market oversight: The bureau formulates market oversight policies, ensuring fair market access and safeguarding user interests.
• Network management: It manages communication network numbering, domain names, and addresses nationally and internationally.
• Emergency communication: The bureau coordinates disaster emergency communication and manages military communication readiness.

At the local level, provincial Telecommunications Administration Bureaus supervise telecommunications activities. Working under State Council guidance and national regulations, they handle:

• Network planning: Planning and managing local networks, both public and specialized.
• Licensing: Issuing local telecommunications business operation licenses.
• Resource allocation: Allocating local spectrum and numbering resources.
• Service quality: Ensuring fair pricing and service quality.

Key regulation

China’s data protection landscape has undergone significant evolution, with notable developments in 2022 and expectations for further changes in 2023. The regulatory focus has shifted towards refining data protection legislation, recognizing data’s value, and establishing mechanisms for cross-border data transfers. These changes have direct implications for data center operations within the country.

Refinement of the data protection law in 2022

China’s data protection legislation saw a phase of reform and updating in 2022. Implementing rules were introduced to enforce data protection regimes outlined in the Data Security Law (DSL) and the Personal Information Protection Law (PIPL). Several key developments stand out, as illustrated in the table below, which includes some of the revised methods for cross-border data transfer that mainly apply to the so-called critical information infrastructure operators (CIIOs) and state agencies that gather data from Chinese users.

National data strategy and evolution in 2023

In December 2022, a national data strategy policy highlighted the value of data as a national resource, aiming to activate data’s potential and boost the digital economy. The policy emphasizes categorization, classification, authorization of data, exploration of data rights distribution, and establishment of data trading rules. It encourages the establishment of international rules for cross-border data flows.

As such, in 2023, we anticipate further legislative developments. Key regulations, including the Measures for the Administration of Network Data Security and rules on the identification of important data, are expected to be finalized. More sector-specific data regulations and rules will be promulgated, providing clearer guidance for companies processing data in their operations.

Moreover, China’s efforts to bolster its digital economy are set to receive a significant boost next year with the introduction of updated accounting rules that allow companies to include data resources as “intangible assets” or “inventories” in their financial statements. The Interim Provisions on Accounting Treatment of Enterprise Data Resources, issued by the Ministry of Finance, stipulate that corporate data meeting relevant accounting standards can be classified as intangible assets, while data held for sale in daily business operations can be recognized as inventories.

As observed by the SCMP, this move is the latest in Beijing’s efforts to advance its digital economy by applying commercial rules to data. These accounting changes will not only allow data-related spending to be capitalized to improve business performance, but they will also increase the value of data resources held by enterprises, leading to improved management and application of these assets.

Structures of foreign investment in China’s data centers

The VIE structure and concerns regarding its use

Foreign investors often use the VIE structure to invest indirectly in data center projects in China. This structure is popular among companies like GDS Holdings and 21Vianet Group, as well as Alibaba, Tencent, and Baidu in various sectors. Under this model, foreign investors retain final control over the Chinese domestic operating entities through a series of contractual arrangements rather than direct shareholding. The Chinese entity must also hold the so-called ‘IDC license’. The B11 License, also known as the IDC License, is necessary for companies that provide Internet Data Center (IDC) services, which involve offering placement, agency maintenance, system configuration, and management services for users’ servers and other Internet/network-related equipment through outsourced leasing. It also includes the lease of database systems, servers, equipment storage spaces, communication lines, export bandwidth on an agency basis, and other application services.

This grants foreign investors control and profits despite lacking direct equity. Nevertheless, the Chinese government’s attitude towards VIE structure remains vague. There is no clarification in the Foreign Investment Law on whether it is a legitimate investment option and whether it falls within the scope of ‘foreign investment’.

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However, recent developments suggest the PRC government might tolerate the VIE structure’s use for data center investments. In 2020, for example, the State Administration for Market Regulation (SAMR), for the first time, officially acknowledged a merger control filing for the consolidation of operators, known as an AML Filing. This filing pertained to a transaction that employed the VIE structure. Prior to this event, it was customary in the market to refrain from submitting AML Filings for transactions involving VIE arrangements.

That said, the VIE structure may still not be as effective as direct ownership due to transfer pricing concerns and potential revenue issues.

Commercial cooperation models

Another way is through commercial cooperation with Chinese partners, choosing between the technical support or co-investment model, which entails:

• Technical support model: An example of this investment model can be found in the cooperation between Microsoft and 21Vianet Group for Azure cloud services. In these cases, the foreign investor licenses its brand and technology to the Chinese IDC License holder, providing technical support for fees. The foreign investor doesn’t control the licensee’s governance but uses contractual restrictions to ensure quality. This model offers control and revenue through licensing and service fees.
• Co-investment model: This model, on the other hand, has been used by strategic and private equity investors like KDDI, Equinix. Following the co-investment model, the Chinese IDC License holder owns IDC equipment, while the foreign investor’s subsidiary owns the real estate and provides non-telecom services. This model simplifies capital investment, and the foreign subsidiary can benefit from asset depreciation.

Further Considerations for foreign businesses and investors

As the landscape of China’s data center industry continues to evolve, foreign businesses and investors must navigate a complex array of factors that shape their engagement. While innovation remains a universal theme, several distinctive aspects warrant attention.

• Oversupply dynamics: The intricate interplay between supply and demand dynamics in the data center realm necessitates careful consideration. Amidst the industry’s expansion, indicators of oversupply have emerged in aggregate figures, yet this trend contrasts with segments experiencing soaring demand, mirroring the broader dynamics of China’s market landscape. Discerning investors should scrutinize specific sub-segments to identify areas of sustained growth and potential inefficiencies.
• Government incentives and subsidies: A hallmark of China’s data center industry is the role of government incentives and subsidies in driving its trajectory. The rationale behind constructing large data centers with relatively low utilization rates is closely tied to government subsidies and their long-term economic outlook. These incentives reflect the government’s strategic vision, aiming to cultivate industry growth and bolster technological advancement. Foreign investors keen on capitalizing on these dynamics should remain attentive to policy shifts that might shape the industry’s direction.
• Data security imperatives: Data security ranks high among the paramount concerns for foreign businesses and investors seeking engagement in China’s data center sector. The country’s stringent focus on safeguarding data underscores the need for comprehensive data protection strategies. Understanding the nuanced regulatory landscape, including the Cybersecurity Law and related regulations, is essential to navigating this aspect of the business environment effectively.
• Challenges and opportunities in localization: Navigating China’s data center industry involves recognizing the prominence of local players. While foreign firms may enter partnerships or collaborations with domestic entities, the dominance of Chinese players in the local market landscape remains apparent. Acknowledging this reality and capitalizing on collaboration opportunities with established players can be instrumental in fostering a meaningful presence within the industry.

In summary, while certain themes in China’s data center industry align with global trends, the distinct national context introduces nuances that demand careful consideration.

Foreign businesses and investors must grapple with oversupply dynamics, decipher the impact of government incentives, prioritize data security imperatives, localize strategies effectively, and navigate techno-nationalism. Balancing these factors while harnessing the industry’s growth potential positions savvy investors to thrive in China’s dynamic data center ecosystem.

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