China's new M&A review rules: a comparison with the US
China recently unveiled a new national security review mechanism for foreign acquisitions. This article considers the new rules and compares them to similar rules in the US.
This article is part of the PLC multi-jurisdictional guide to M&A. For a full list of jurisdictional Q&As visit www.practicallaw.com/acquisitions-mjg.
China recently unveiled a new national security review mechanism for foreign acquisitions. This article considers the new rules and compares them to similar rules in the US, looking at the:
Scope of review.
Impact and future outlook.
On 12 February 2011 the State Council of China announced that China would institute a new national security review (NSR) regime applicable to a proposed foreign investment in, or acquisition of, a domestic Chinese enterprise. It did this by publicly announcing a Circular (adopted on 3 February 2011) which formally implements certain articles of China's Anti-Monopoly Law (AML) and sets out rules on the scope, content, mechanism and procedures of the NSR. These rules will operate in parallel with the AML's anti-monopoly merger review provisions (AML Merger Review).
In addition, the Chinese Ministry of Commerce (MOFCOM) issued interim implementing rules (Implementing Rules) in respect of the NSR, which apply from 5 March to 31 August 2011. MOFCOM's public consultation on the Implementing Rules ended on 10 April 2011.
Led by the State Council, a cross-ministerial NSR panel (Panel) will review a proposed M&A transaction to assess the extent to which it raises certain national security or related concerns. The China National Development and Reform Committee (NDRC) and MOFCOM will take the lead role in co-ordinating the authorities that conduct the NSR. After completing a NSR, the Panel will effectively have the power to block the deal, or impose conditions on it, if it considers that such measures are appropriate to address the identified concerns.
Although the effects of the NSR are unclear at this stage, it imposes a regulatory burden in addition to the existing mergers control, and possible new barriers for those venturing into China and seeking growth through M&A.
In the US, under the Foreign Investment and National Security Act (FINSA), acting through the Committee on Foreign Investment in the United States (CFIUS), the President can investigate proposed transactions that may result in control of a US business by a foreign person, and can suspend or block those transactions if they threaten to impair the national security. FINSA was enacted in 2007, and the US Department of the Treasury issued related final implementing regulations in 2008.
CFIUS is chaired by the Secretary of the Treasury and includes representatives from several other US Government departments and agencies, including, Homeland Security, State, Defense, Commerce, Justice, Energy, Labor, the US Trade Representative, and the Director of the Office of Science and Technology Policy. For each transaction before CFIUS, the US Department of the Treasury appoints a lead agency. The lead agency, acting on CFIUS' behalf, can negotiate, enter into, and enforce mitigation agreements or conditions with parties to covered transactions that pose a threat to national security.
Governance and authority differ substantially between the US and Chinese review processes. Although, as in the US process, the Chinese central government may initiate a review without notification by a transaction party, under the Chinese regime, local officials can refer a transaction to MOFCOM, as can non-governmental parties such as a competitor or an upstream or downstream related business entity.
The FINSA requirements are better known due to a longer history of government practice. However, CFIUS does not generally publish official guidance on particular factual situations and it does not report on its deliberations. Nor does it comment on its instructions to deal parties, including where it has advised the President that a deal should be blocked. Presidential decisions on a CFIUS review, with the resulting larger amount of public information, are exceedingly rare. However, CFIUS publishes annual reports to Congress, providing aggregate information and statistical summaries on its reviews.
A broader dissimilarity with the Chinese law is that US review of foreign investment is potentially more fractured, with national security reviews and other legal reviews scattered among several agencies in separate processes.
With regard to competition law, US anti-trust law does not operate as an explicitly parallel process to a CFIUS transaction review, although those reviews can be roughly simultaneous if the parties so choose. Potentially similar analyses, for example, related to control, scope, and industry definition, have separate legal requirements. In fact, as discussed later with regard to the scope of national security reviews, CFIUS regulations specifically avoid a focus on broader economic or other national interests. Where a transaction meets legal requirements under US competition law, a foreign acquisition may require filing with US authorities and a separate review process. Foreign investors should also be aware that US states have separate competition laws and separate enforcement authorities.
Foreign investors in China are caught by the NSR Rules if a proposed M&A transaction involves two categories of Chinese company:
Chinese domestic enterprises that engage, or are involved, in military industry, are located close to a military site that is key or sensitive, or any other entities related to defence and national security.
Notably, some of these NSR sectors overlap with the nine pillar industries announced by China's State Council and State Assets Supervision and Administration Commission in December 2006 as sectors in which state-owned enterprises should play a leading role.
The Circular also states that the PRC government will issue separate security review regulations for foreign companies engaged in relevant foreign investments in or acquisitions of domestic financial institutions, but it remains unclear when these regulations will be published.
Companies that are key domestic market players in certain industries or sectors (such as agriculture, energy and resources, infrastructure, transportation, technology and manufacturing) but only if:
the transaction may affect the interests of Chinese national security; and
that as a result of the transaction, the foreign purchaser would obtain control of the new entities.
Control is defined as a foreign investor, through M&A, becoming a controlling shareholder or taking actual control of a domestic enterprise. This includes:
a foreign investor, together with its parents and subsidiaries, or several foreign investors together, obtaining ownership of 50% or more of the share capital of the relevant Chinese enterprise as a result of the transaction;
a foreign investor, holding voting rights (though less than 50%) that are sufficient to exercise a major influence on corporate decisions; or
taking actual control over decision-making, finance, human resource or technology of domestic enterprise through any other means.
The Circular provides little guidance as to the circumstances in which voting or other rights accompanying minority shareholdings will be regarded as giving the minority shareholder control over the invested enterprise. This mirrors the position under implementing guidelines pertaining to an AML Merger Review, where the review is also usually only triggered if control is acquired over a target enterprise.
Domestic companies that fall within the scope of the NSR include both foreign invested enterprises (FIEs) and non-FIEs. The Circular confirms that investors located in Hong Kong, Macau and Taiwan will be considered to be foreign investors for the purposes of the NSR process.
Four categories of M&A transactions are covered by the NSR Rules:
A foreign investor that acquires an equity interest in a non-FIE or subscribes for an increase in the registered capital of a non-FIE, thereby converting the non-FIE into an FIE.
A foreign investor that acquires the equity interest of the Chinese shareholder(s) in an FIE or subscribes to an increase in the capital of the FIE.
A foreign investor that establishes an FIE and uses it to purchase and operate assets of a domestic enterprise, or to acquire an equity interest in a domestic enterprise.
A foreign investor that directly purchases assets of a domestic enterprise and uses those assets to establish an FIE which will operate those assets.
In the CFIUS process, a covered transaction includes an acquisition by a foreign person of any part of an entity or of assets, if such part of an entity or assets constitutes a US business.
A US business is defined as any entity, irrespective of the nationality of the persons that control it, engaged in inter-state commerce in the US. An entity not only means a commercial enterprise but also assets (whether or not organised as a separate legal entity) operated as a business undertaking in a particular location or for particular products or services.
CFIUS may review any merger, acquisition, or takeover, by or with any foreign person, that could result in control of a US business by a foreign person, to determine its potential impact on national security.
Under the regulations, control means direct or indirect power, whether or not exercised, to determine, direct, or decide important matters affecting an entity, through the ownership of a majority or a dominant minority of the total outstanding voting interest in an entity, board representation, proxy voting, a special share, contractual arrangements, formal or informal arrangements to act in concert, or other means.
Shareholding and board participation are relevant factors in the control analysis, but CFIUS regulations do not make either dispositive. However, CFIUS expressly exempts transactions in which a foreign person holds or acquires 10% or less of a US business's outstanding voting interests and does so only as a passive investment.
A foreign person is defined as any foreign national, foreign government, or foreign entity or any entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity. A foreign person can include state-owned enterprises, government pension funds, and sovereign wealth funds, as well as government agencies.
Scope of review
The Panel will review an M&A transaction in the context of its impact on:
The steady running of the national economy.
The general order of Chinese society.
The capacities for research and development of key technology related to national security.
The Circular indicates that the NSR will, in particular, consider the effect of the relevant transaction on the target enterprise's ability to produce or provide goods for the domestic market, services, equipment, and facilities relating to national security. No elaboration is provided in relation to the other areas of focus mentioned in the Circular.
The broad terminology used in the Circular, and particularly, the Panel's ability to refer to the impact of a transaction on the stable operation of China's economy and social order, allow the Panel wide discretion to scrutinise and restrict foreign investment in China that is seen to be at odds with the country's unique socialist market economy and social development goals.
In addition, while the scope of NSR is limited, the AML Merger Review already allows MOFCOM to consider the impact of any proposed transaction (whether or not conducted inside China) on China's national economic development and industrial policy goals. Indeed, there is speculation that these considerations may have played a key role in MOFCOM's only prohibition decision under the AML Merger Review system so far, the veto of Coca-Cola's proposed acquisition of China's Huiyuan Juice Group in March 2009.
CFIUS regulations do not directly define national security other than to note that it includes issues related to homeland security.
However, CFIUS regulations and guidance emphasise that the Committee will focus narrowly on genuine national security concerns, not broader economic or other national interests.
FINSA sets out national security factors that CFIUS considers in weighing whether a deal poses a potential national security risk. These include:
The potential effects of the transaction on the domestic production needed for projected national defence requirements.
The potential effects of a foreign person's control of domestic industries and commercial activity on the capability and capacity of the US to meet the requirements of national security.
The potential effects of the transaction on US international technological leadership in areas affecting US national security.
The potential national security-related effects on US critical technologies.
The potential effects on the long-term projection of US requirements for sources of energy and other critical resources and material.
The potential national security-related effects of the transaction on US critical infrastructure, including major energy assets.
The potential effects of the transaction on the sales of military goods, equipment, or technology to countries that present concerns related to:
chemical, biological, or nuclear weapons proliferation; or
regional military threats.
In applying critical infrastructure factors, CFIUS focuses on whether a system or asset is so vital to the US that the incapacity or destruction of the particular system or asset would have a debilitating effect on national security. Critical technologies include:
Defence articles or services.
Dual-use items regulated under the International Traffic in Arms Regulations, Export Administration Regulations, and other regulations.
Foreign investors proposing to undertake an acquisition of a domestic enterprise will be required to apply to MOFCOM for its review.
If MOFCOM determines that the transaction falls within the scope of the NSR Rules it will within five days request the Panel to be set up to conduct a general NSR and this review may last up to 30 days.
Relevant regulatory authorities, national industry associations, affected domestic companies or competitors may also make NSR submissions through MOFCOM and the panel will then decide whether to commence the NSR process.
If the particular transaction fails to pass the general NSR requirements, the NSR Panel will commence a special NSR, which may last up to 60 days. The Panel or the State Council (if the Panel fails to reach an agreement) will make a decision and notify MOFCOM, which will subsequently notify the applicant of its determination.
Under the CFIUS process, parties to prospective transactions that might have national security implications typically submit joint voluntary notifications to CFIUS (see box, CFIUS voluntary notice requirements). CFIUS also has the authority to initiate a review of the transaction and to mitigate any threat to the national security that arises.
On receiving a notice from transaction parties, the CFIUS Staff Chairperson establishes whether the notice is complete. If the notice is complete, it is circulated to all CFIUS members. A review period of up to 30 days begins on the next business day, during which CFIUS members assess possible national security concerns related to the transaction.
If CFIUS finds national security concerns with a covered transaction, at the end of the review, it may initiate an investigation, which must then be completed within 45 days. Generally, an investigation ensues where CFIUS finds that a covered transaction either:
Raises a national security threat.
Is a foreign government-controlled transaction.
Would result in a foreign person's control of critical infrastructure.
If CFIUS decides that a transaction should be prohibited or terminated, it will advise the President of this and request his decision. For an overview of this process, see flowchart FINSA transaction review.
With CFIUS' permission, parties to a transaction may request withdrawal of their notice at any time during the review or investigation stages. If CFIUS plans to initiate an investigation, parties typically withdraw their notice, pending further discussion with the government.
It remains unclear what effect these new rules will have on foreign investors who are seeking an acquisition-driven growth strategy in China. However, they do raise concerns because the scope of the NSR set out in the Circular is very broad and general, which may effectively grant the NDRC, MOFCOM and other regulatory authorities a wide discretion to block, terminate, or impose conditions on a proposed M&A transaction.
The Circular is silent on whether the new rules will apply retrospectively to already completed or signed but not completed M&A transactions, or instead whether the requirements will only apply to new transactions executed after 5 March 2011 when the rules took effect. It is also unclear whether foreign inbound M&A that results in increased investment in fixed assets or changes to state-owned equity interests will also have to comply with new rules.
It appears that the NSR process will run in parallel with any AML Merger Review. Accordingly, where a foreign investor proposes to acquire or take a relevant stake in a domestic Chinese enterprise, and that transaction triggers the mandatory AML pre-notification provisions in Chapter IV of the AML, it appears that notifications may need to be made to both MOFCOM's Anti-Monopoly Bureau and to a separate part of MOFCOM involved in referring cases to the Panel. In some cases, for example, where the turnover of the parties involved in a particular transaction does not trigger the mandatory anti-monopoly pre-notification provisions, only notification to the Panel is required.
There have been a number of high-profile transactions in the past six years that have not been completed due to CFIUS concerns or broader US Congressional concerns. These include a number of instances where the foreign investor was Chinese, including Huawei's attempt to acquire 3Com and 3Leaf, and a Chinese company's attempt to purchase a mine in Nevada. In the latter case, based on disclosures made by the Chinese company, the location of the mine may have been considered by CFIUS to be too close to a US defence installation. With respect to Huawei 3Leaf deal, the transaction involved acquisition of intellectual property and the hiring of certain 3Leaf employees, rather than equity or voting interests. (3Leaf was already insolvent at the time.) Also, Huawei had sought and received approval from US export control authorities related to the deal. Nonetheless, CFIUS ultimately required the deal to be unwound. In the 3Leaf acquisition, the parties apparently did not file with CFIUS until the US Government asked (or perhaps instructed) them to. This example shows that foreign investors should err on the side of notifying a transaction to CFIUS (formally or informally), to avoid suspicions that may arise in the absence of any contact with the government.
Because the information surrounding individual reviews is kept confidential by the government (releasable only by the parties to a transaction themselves), it is difficult to know exactly whether CFIUS is straying from its mandate of welcoming foreign investment while protecting national security. Given the transactions proposed by Chinese companies that failed under CFIUS review, and the fact that the Australia's Foreign Investment Review Board has also rejected several proposed deals in recent years that would have provided Chinese enterprises with significant interests in Australian mining and resources enterprises, some analysts have expressed concern that the Panel may be tempted to wield its powers under the security review process in a way that is as much about reacting to the decisions of foreign regulators as it is based on genuine appraisal of the security issues raised by specific deals. Although, contrary to the impression that may exist from these high profile events, anecdotal and more general evidence suggests that CFIUS is limiting itself to true national security concerns.
Foreign investors seeking growth in China through M&A will find themselves facing new regulatory hurdles and possible barriers related to national security reviews. In addition to existing administrative burdens (such as AML merger control notifications, industry-specific approvals and state-owned assets related permits, after they have managed to complete due diligence and agree contractual terms), the NSR regime will represent a further source of deal risk.
The international community will be watching closely to see the extent to which the Panel takes advantage of its broad powers to identify security-related concerns arising from proposed transactions and then block or impose conditions on them.
For now, companies looking to make acquisitions in China or acquire control of domestic companies, particularly in sensitive sectors, will need to be aware of the need to apply to MOFCOM for a security review and approval of relevant deals, and consider how this process may impact the timing and overall prospects of their deals.
However, it must also be recognised that the Chinese authorities already possess a broad range of powers to curb foreign investment, including by means of the AML Merger Review process, the Rules on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (which allow MOFCOM to challenge transactions in which foreign investors acquire control of domestic entities in key economic sectors or affecting national economic security or famous Chinese brands) and other regulatory approval mechanisms. These mechanisms have already been used to force or pressure the abandonment of a number of major foreign investment proposals in China, including the previously mentioned Coca-Cola/Huiyuan deal and the bid by US private equity firm Carlyle Group to buy a stake in China construction equipment manufacturer Xugong Group in 2005.
Accordingly, while the NSR process may add another layer of regulation to inbound deals and raise the prospect of transaction delays, it is unlikely to alter significantly the existing risk profile for foreign investment in China.
Usefully, introductory wording in the Circular expressly recognises that foreign M&A and investment in China has promoted the diversification of foreign investment utilisation and contributed to the optimisation of resource allocation, technology improvements, and the development of enterprise management. While it remains to be seen whether the Panel's decisions will demonstrate an ongoing recognition and support of such benefits from foreign investment, foreign businesses will be encouraged by the inclusion of this wording in the Circular and the fact that since its publication, NDRC officials have been keen to stress publicly that China will not use the Panel as a weapon to block normal foreign investments.
Many foreign investments in the US are subject to review to determine whether they could threaten national security. Commercial competitors of foreign acquirers sometimes try to influence this process to stop potential transactions. Foreign acquisitions in a wide range of US industries will likely require this type of regulatory approval and the associated political risk management before investors can complete them. Therefore, informed legal and political advice is critical for foreign investors in the US to be successful and prudent investors will consider submitting many foreign investments for CFIUS review.
Who can institute a MOFCOM review?
For a pdf of this flowchart, click here.
Documents required for NSR
A national security review application form signed by the applicant and a description of the transaction.
Notarised identity proof of each foreign investor and its attorney (and the power of attorney).
Description of the foreign investor and associated entities (including the actual controller) and their relationship with the government of the relevant country.
Description and corporate documents of the target company in China.
Details of the proposed foreign-investment enterprise after acquisition.
For a share transaction, the share purchase agreement or subscription agreement, shareholder resolutions of the target and relevant valuation report.
For an asset transaction, target's resolution to sell assets, asset acquisition agreement and relevant asset valuation report.
Information related to the foreign investor's control of the shareholding and management of the company after the acquisition.
Any other information requested by MOFCOM.
FINSA transaction review
For a pdf of this flowchart, click here.
CFIUS voluntary notice requirements
Valuation of interests or assets to be acquired.
description and analysis of business activities, for example, from annual reports, including market share and competitors;
location of manufacturing facilities;
description of US government contracts;
cyber security plan;
description and relevant classifications of items subject to the Export Administration Regulations, the US Munitions List, Department of Energy export authorisation, and other regulations;
description of technology with military application.
Foreign person information:
description of business and business of ultimate parent, for example, as in annual report;
plans to modify business of target, including with regard to shutting down or moving production abroad, altering or terminating certain contracts, eliminating domestic supply;
control by a foreign government;
personal identifier information for board members and senior officers.
Other filings with the US Government related to the transaction.
Most recent annual report of transaction parties and certain affiliates.
Organisation chart showing persons with control over foreign person.
Analysis of potential treatment of transaction under CFIUS regulation.
Certification of each party.
Mayer Brown International LLP
Qualified. China, 1996; England and Wales, 2010
Areas of practice. Cross-border M&A listings and secondary issues; joint ventures; private equity transactions; general corporate and commercial matters.
Extensive experience advising multinational corporations and financial institutions on conducting business in China, as well as advising Chinese companies on overseas investment, acquisitions and IPOs on London, Frankfurt, Shenzhen and Hong Kong stock exchanges.
Hannah CL Ha
Mayer Brown JSM
Qualified. Hong Kong, 1992; England & Wales, 1992; New York, US, 2003; New Zealand, 1998; Australia (Queensland) 1996, (NSW) 1996, (Victoria) 1996, (Tasmania) 1994
Areas of practice. Foreign direct investment and merger control issues in China; cross-border M&A private equity transactions; general corporate and commercial matters.
Assisting multi-national corporations in rolling out anti-trust and anti-corruption compliance programmes in China.
Timothy J Keeler
Mayer Brown LLP
Qualified. New Jersey, US, 2006; District of Columbia, US, 2007
Areas of practice. International trade law and economic policy matters.
An attorney in Mayer Brown's Government and Global Trade Group with a background working in the US Executive Branch and Congress on major economic, legislative and regulatory issues.
Michael A Wallin
Mayer Brown International LLP
Qualified. Australia, 1994
Areas of practice. Cross border mergers; acquisitions and disposals; private equity investments; joint ventures and venture capital.
Leader of Mayer Brown's London based China Focus Group.
Presented at several conferences on issues relating to outbound investment by Chinese companies to the UK, including the 2010 CIFIT conference in Xiamen as a guest of the Investment Promotion Agency of the Ministry of Commerce, China (CIPA).
In 2010, lead a Mayer Brown team assisting CIPA in the publication of investment guides for Chinese enterprises investing in the UK and Germany.