Foreign investors have been allowed to buy or trade A shares since 2002. Foreign investors can acquire A shares through investing as qualified foreign institutional investors or strategic investors.

Acquiring A-shares through investing as QFIIs. A qualified foreign institutional investor (QFII) means a foreign fund management institution, insurance company, securities company or other asset management institution that meets the conditions prescribed in the Tentative Procedures on Administration of Securities Investments in China by Qualified Foreign Institutional Investors, effective as of 1 September 2006 (QFII Regulations), and has been approved by the China Securities Regulatory Commission (CSRC) to invest in the PRC securities market and obtained a quota approved by the State Administration of Foreign Exchange.

In order to apply for QFII status, the applicant needs to satisfy certain requirements regarding asset value under management, capital and operation history. For example, for an applicant which is a fund management institution, it needs to have engaged in fund business for not less than five years and have managed assets of not less than US$5 billion (about EUR3.9 billion) in the most recent fiscal year. For a security firm, it needs to have engaged in securities business for not less than 30 years, to have paid-up capital of not less than US$1 billion (about EUR790 million) and to have managed securities assets of not less than US$10 billion (about EUR7.9 billion) in the most recent fiscal year. As of March 2006, 35 foreign institutional investors were granted QFII status. The total investment quota for all the QFIIs is currently capped at US$10 billion (about EUR7.9 billion).

Within the approved investment quota, a QFII may invest in, for example, RMB denominated financial instruments, A shares and convertible bonds and enterprise bonds listed on the domestic stock exchanges. Securities investments by QFIIs are subject to the requirements of the Catalogue.

QFIIs cannot control listed companies because they are subject to shareholding caps:

Rather than imposing a uniform restrictive period on all QFIIs regarding outward remittance of investment by QFIIs, the State Administration of Foreign Exchange (SAFE) now has discretion in imposing restrictions on the period in which outward remittance may be made as well as adjusting such restrictions, taking into account factors including the PRC’s general economic and financial position, supply and demand of foreign exchange and foreign reserve positions.

Acquiring A shares through investing as strategic investors. Since 31 January 2006, if foreign investors intend to make medium or long-term strategic acquisition investments of a certain size in A share listed companies, they may invest in A shares as strategic investors.

However, only the A shares of those listed companies that have completed the conversion of their non-tradable shares into tradable shares (see below, Non-tradable domestic shares) are available for acquisition by foreign investors.

To qualify as a strategic investor, either:

Subject to the Catalogue and any other applicable industry–specific restrictions, there is no shareholding cap on strategic investments. Rather, there is a minimal percentage requirement in respect of the shares to be acquired by strategic investors. The percentage of shares held after an initial investment may not be lower than 10% of the issued shares of the listed company. Therefore, strategic investors are technically able to control A share listed companies. (This would not be possible if they invested through QFIIs, as the aggregate shareholding of QFIIs in a listed company cannot be more than 20% of the issued shares of the listed company.)

A foreign investor can make a strategic investment in a listed company through buying shares from existing shareholders, or a private placement of new shares by the listed company.

According to the Strategic Investor Regulations, foreign investors have to pay for the strategic investment in foreign currency. It is not clear whether they can use RMB profits derived from their investments in the PRC, or securities held or controlled by them as consideration for the acquisition.

Any strategic investment by a qualified strategic investor is subject to the approval of the Ministry of Commerce of China (MOFCOM). The strategic investment has to be completed within 180 days from the grant of approval by MOFCOM.

Except for some specified circumstances, A shares acquired in a strategic investment may not be transferred for a period of three years.

Takeover Code implications. As non-tradable shares have become available to foreign investors and they are increasingly being converted into shares which can be traded freely on the stock markets, it is now possible for foreign investors to take over listed companies in the PRC.

The takeover regime is principally governed by the Procedures of Administration of the Takeover of Listed Companies which became effective as of 1 September 2006 (Takeover Code) and the amended Securities Law, which became effective as of 1 January 2006. The takeover regime aims to encourage the merger and acquisition activities of listed companies in China. The Takeover Code provides that any acquisition or disposal of shares by foreign investors is subject to the approval of PRC authorities, applicable PRC laws and the jurisdiction of PRC courts and arbitration commissions.

An investor may acquire listed shares by means of open market purchase and private agreement (until its shareholding reaches 30% of the issued shares of the target company), as well as by tender offer.

There are two kinds of tender offer: a general tender offer and a partial tender offer. Under a general tender offer, the acquirer tenders an offer to all shareholders of the company to acquire all of their shares. Under a partial tender offer, the acquirer tenders an offer to all shareholders of the company to acquire only part of the issued shares of the target company. A tender offer must be made for a minimum of 5% of the target company’s issued shares.

When interests in the shares owned by an investor reach 5% of the total issued shares of the target company, the investor must, at the same time and within three days of the purchase:

It cannot purchase or sell any shares within the above period.

When the interests in shares owned by the investor increase or decrease by 5% (or more in the case of a private agreement), similar disclosure requirements and lock-up restrictions apply within up to five days of the purchase or sale (depending on the date of announcement, and whether the purchase or sale is on- or off-market).

If an investor intends to acquire the shares of a listed company resulting in the interests in shares held or owned by the investor exceeding 30% of the issued share capital of the target company, it is under an obligation to make a general or partial tender offer for those shares in excess of 30%, unless an exemption is obtained from the CSRC. An investor indirectly coming to own interests in shares exceeding 30% of the issued share capital of a target company is also required to make a general tender offer for the shares of the target company, unless exempted by the CSRC.

No compulsory acquisition scheme exists in the PRC. A buyer cannot compel an unwilling shareholder to sell its shares, no matter what percentage of the issued shares it already holds or controls. This may be an issue for a buyer who intends to acquire 100% of the issued shares of a listed company.

The minimum permissible price offered by an investor in a tender offer must not be less than the highest price the investor has paid for the target company’s shares during the six months before the date of publication of the takeover announcement.

An investor may use cash, legally transferable securities or a combination of cash and legally transferable securities as consideration for the offer. However, where an investor makes a general tender offer with an intention to delist the target company after the takeover, or makes a general tender offer after failing to obtain an exemption from the CSRC, the investor must make a cash offer or provide a cash alternative as consideration.

An investor is also required to provide a cash alternative to shareholders of the target company in a share exchange offer where the shares offered as consideration are not listed.

In a cash offer, 20% of the total takeover consideration must be deposited into a bank account designated by the China Securities Depository and Clearing Corporation Limited (CSDCC). If listed securities are used as consideration, all such securities must be delivered into the custody of the CSDCC.

If an investor acquires 20% or more of the outstanding shares of a target company, it must engage a financial adviser to provide certain opinions to the CSRC.

An investor making a tender offer for the shares of a listed company must also engage a financial adviser which has to state whether the investor has the ability to implement the offer in full.

For 12 months after the completion of a tender offer, the financial adviser is required to continue to supervise and guide the investor and the target company in relation to compliance with relevant laws, regulations, stock exchange rules and the articles of association of the target company.

From the time of the publication of a takeover announcement until the expiry of the tender offer period, the directors and senior management of the target company can only continue operating within the ordinary course of business of the target company, or in accordance with shareholders' resolutions. They are not allowed to take certain actions that may frustrate the offer unless those actions are approved by the shareholders in a general meeting.

The PRC government established the B share stock markets in the early 1990s in order to attract foreign currency investment. B shares are denominated in RMB but subscribed for and traded in foreign currency. They used to be available for subscription and trading only by foreign investors and Chinese citizens residing abroad. Since February 2001 Chinese citizens have been allowed to acquire and trade B-shares.

Unlike the acquisition of A shares, there are, subject to the Catalogue and any other applicable industry-specific restrictions, no restrictions on the acquisition of B shares by foreign investors. However, there are far fewer B share listed companies than A share listed companies. As of 17 March 2006, there were in total 99 B share listed companies compared with 1350 A share listed companies.

Since the beginning of the 1990s, more and more Chinese companies have listed on overseas stock exchanges in, for example, Hong Kong, New York and London. In these overseas stock markets, foreign investors can buy the overseas listed shares of PRC companies in accordance with PRC and local law and regulations.

Non-tradable domestic shares are shares of listed PRC companies which are held by State-owned entities or legal persons. They are not tradable in stock markets.

Before the reform to integrate separated equity ownership for companies with A shares listed in the PRC (see below), non-tradable domestic shares made up about two-thirds of the total capitalisation of the A share market.

Foreign investors have been formally allowed to buy non-tradable shares of A share listed companies since 1 November 2002, subject to the Catalogue and any applicable industry-specific restrictions.

Requirements for the transfer of non-tradable domestic shares. The parties to a share transfer may reach a non-tradable share transfer agreement by public bidding or through private negotiation. All the transfers must be carried out through the Shanghai Stock Exchange or Shenzhen Stock Exchange.

Before a selling shareholder transfers its non-tradable shares, it must submit an application to the CSDCC. After a share transfer agreement has been reached, the parties must apply to the stock exchange concerned for confirmation that their share transfer complies with applicable laws and regulations. After obtaining confirmation, the parties must apply to the CSDCC to carry out the ownership transfer registration and registration of a change in the nature of the shares (if necessary).

After full payment of the transfer price, foreign investors are subject to a lock-up period of 12 months before they can transfer the purchased shares.

The transfer of non-tradable domestic shares to foreign investors does not entitle listed companies to preferential treatment as foreign-invested enterprises.

Reform to integrate separated equity ownership. The existence of separate classes of equity (A shares and non-tradable domestic shares) has led to differential pricing between the two classes and other issues associated with the lack of liquidity in the domestic shares. In a bid to reform the system, in April 2005 the CSRC promulgated the Issues Relevant to Pilot Reform Projects Regarding the Separation of Equity Ownership and Trading Rights of Listed Companies Circular. The CSRC has requested all A-share listed companies to complete the conversion of non-tradable shares into tradable shares by the end of 2006. As a result, a foreign investor is less and less likely to acquire a shareholding in a company listed in the PRC by purchasing its non-tradable domestic shares.

Acquisitions of shares of domestic companies by foreign investors are governed by the Interim Rules on the Acquisition of and Merger with Domestic Enterprises by Foreign Investors (M&A Rules), which became effective on 8 September 2006.

Domestic companies do not include FIEs. Acquisitions conducted by the foreign investor itself or through one of its established HCs or FFVIEs in the PRC fall within the scope of the M&A Rules.

Foreign investors may acquire equity interests from an existing shareholder of the target company or subscribe for additional capital of the target company.

Payment. In the case of an acquisition of existing equity interests, a foreign investor must, within three months of the date of issue of the revised business licence of the target company, pay the full consideration to the seller. In special circumstances where the payment period has to be extended, subject to the approval of the examination and approval authority, the foreign investor must pay at least 60% of the full consideration within six months of the date of issue of the revised business licence and pay off the full consideration within one year.

In the case of an acquisition of additional registered share capital of a domestic company, a foreign investor must pay at least 20% of the increased registered capital at the time the target company applies for a revised business licence, with the balance of the consideration to be paid within two years of the acquisition.

The M&A Rules have been amended to allow the consideration to be in the form of freely transferable shares of the foreign investor.

A foreign investor proposing to pay for the acquisition in shares must be duly incorporated in a country with a sound and established corporate legal system. It needs to be listed on a stock exchange with a sound securities trading system, and its senior management must not have been penalised by any supervisory authorities within the last three years.

The consideration shares must satisfy certain conditions. For example:

Approval procedure. The acquisition has to be approved by MOFCOM and be registered with SAIC (or their respective local bureaux). The level of approval and registration will depend on the industry and size of the transaction. Where a special regulated industry is involved, an approval from the competent industry authority must also be obtained (see Investing in China: finding the right vehicle.).

Documents required for the approval and registration procedure include the equity transfer agreement (or the subscription agreement in the case of an acquisition of increased capital), the joint venture contract (if the target company is restructured into a JV), the articles of association of the target, and other documents to evidence the incorporation, existence, and financial standing of the foreign investor.

The approval authority is required to make a decision within 30 days of receiving the full set of documents. If it decides to approve a transaction, it will issue an Approval Certificate. With this Approval Certificate, the target has to update its registration with SAIC (or its local bureau) within 30 days. The SAIC (or its local bureau) will then issue a revised business licence.

If a foreign investor has already set up an FIE in the PRC, it may use that FIE as an acquisition vehicle to buy a domestic target. References to FIEs in this section include contractual joint ventures (CJVs), equity joint ventures (EJVs), wholly foreign owned enterprises (WFOEs) and foreign invested joint stock companies (JSCs). For this purpose, FIEs do not include HCs and FFVIEs. Acquisitions conducted by FIEs fall with the scope of the Interim Provisions on Investment in China by Foreign Investment Enterprises, which became effective on 1 September 2000. (For more information on FIEs, CJVs, EJVs, WFOEs and JSCs, see Investing in China: finding the right vehicle.)

Acquisitions conducted by FIEs are also subject to the Catalogue.

Qualifications for making investments. In order to qualify as an acquisition vehicle, the FIE must meet the following requirements:

Registration and approval. If the target that the FIE is acquiring falls in the encouraged or the permitted category under the Catalogue, the acquisition does not need approval from MOFCOM or its local bureau. The target’s registration with SAIC or its local bureau should be updated.

If the target falls in the restricted category under the Catalogue, the transaction must be approved by MOFCOM or its relevant local bureau at provincial level.

The target will remain a domestic company, although its business licence will indicate that it is FIE-invested. The target is not eligible for the preferential treatment applicable to FIEs, even if the indirect foreign participation is 25% or more (unless the target is located in the middle or western regions of the PRC).

References to FIEs in this section include EJVs, legal person CJVs, WFOEs and unlisted foreign invested JSCs. Acquisitions of equity interests in such FIEs fall within the scope of the Several Provisions on Change of Investors of Foreign Invested Enterprises which became effective as of 28 May 1997 (1997 Provisions).

Foreign investors may acquire equity interests from an existing domestic or foreign investor of an FIE, or subscribe for additional registered capital of the target.

Similar to acquisitions of domestic companies, a foreign investor may choose to carry out the acquisition itself or through one of its established HCs or FFVIEs.

The procedure and approval requirements on acquisition of FIEs are less onerous than those for domestic companies. However, an approval for the acquisition is still required from the original approval authority. Documents to be submitted include the equity transfer agreement (or the subscription agreement in case of an acquisition of additional capital), and amendments to the existing joint venture contract and articles of association.

A foreign investor may also use its existing FIEs (other than HCs or FFVIEs) to carry out an acquisition of equity interests in FIEs. In this case, the procedures relating to the acquisition of domestic companies by existing FIEs will generally apply (see above, FIE acquisitions of domestic targets).

Foreign investors are not allowed to operate assets in the PRC without having an actual presence in the country.

The M&A Rules provide a foreign investor with two options to structure an assets acquisition:

Acquisitions by foreign investors, HCs, or FFVIEs. One option provided by the M&A Rules to structure an assets acquisition is for the foreign investor itself to acquire the assets directly. A foreign investor using its existing HC or FFVIE to carry out the acquisition has to follow the same procedure as for an acquisition carried out by itself. The acquired assets must be operated by an FIE which has to be established. Those assets are not allowed to be operated until the FIE has been established.

The procedure involves two steps: the assets acquisition and the establishment of the new FIE.

Technically, the assets transfer agreement will only become effective on the establishment of the FIE being approved by the approval authority. The procedure for establishment of the FIE is the same as for a normal incorporation, including MOFCOM approval and SAIC registration.

Payment for the assets is subject to the statutory payment schedule under the M&A Rules, which is essentially the same as that for an equity acquisition by a foreign investor in a domestic company.

Acquisitions by newly established FIEs. A foreign investor may decide to set up an FIE first as a vehicle to acquire the assets. The consideration must be paid by the FIE and not by the foreign investor, in line with the timing requirement in the M&A Rules, in other words, generally within three months of the date of issue of the business licence of the new FIE if the consideration is in cash, or within six months of the date of issue of the business licence if the consideration is in kind.

This procedure also involves two steps, namely the establishment of the new FIE and the assets acquisition. After the name pre-registration for the intended FIE, it can pre-sign the assets purchase agreement with the seller. Then the application for establishment of an FIE can commence. Upon the issue of a business licence, when the FIE is established, the agreement becomes effective.

Acquisitions by existing FIEs. An acquisition of assets by an existing FIE falls outside the M&A Rules. This acquisition will be deemed to be a normal assets acquisition conducted by an FIE.

An FIE can merge with a PRC target. The target can either be an FIE (in the form of a legal person) or a domestic entity. Cross border mergers are still not available under the current PRC regulatory regime, which means that a foreign investor will not be able to merge directly with a PRC entity.

Types of merger. There are two types of merger:

Form of companies established after merger. The company remaining or to be established after the merger of:

Special issues when a domestic company is the target. If the target company is a domestic entity, it must be a PRC company established and existing in accordance with PRC Company Law, either in the form of a limited liability company or joint stock limited company. It may not be a partnership or assume non-legal person status.

The Catalogue applies so that the company remaining or to be established after the merger is not allowed to hold shares in companies operating in the sectors falling within the prohibited category in the Catalogue (see Investing in China: finding the right vehicle).

Each party to the merger agreement is required to warrant to employ fully or to make reasonable arrangements for the existing staff and workers of the merging target.

Approval and registration. The merger must be approved by the original approval authority for the establishment of the FIE. Where there are two or more approval authorities, the company to be dissolved needs to submit an application for dissolution due to merger to its original approval authority before the application for approval for merger is submitted.

After approval, the company after merger must update its registration with a number of authorities such as tax, customs, foreign exchange and SAIC. The company to be dissolved is also required to carry out de-registrations with such authorities.

An FIE can be divided into two or more companies. There are two types of division:

A division must be approved by the original approval authority for the establishment of the FIE. Update registrations or de-registrations have to be made with a number of authorities such as tax, customs, and foreign exchange and SAIC. Where a new company will be established due to the division, the procedure to establish a new FIE will apply.

There are a number of common requirements that apply in relation to both mergers and divisions.

Decision from the highest company organ. Both mergers and divisions require approval from the highest authority within the companies in accordance with their respective articles of association. If limited liability companies are involved in the merger or division, the highest authority is the board of directors. Where any joint stock limited company is involved, the highest authority is the shareholders meeting.

Public notice and creditors’ consent. The procedure for both mergers and divisions involves statutory requirements for the company concerned to give notice to its creditors, and to publish in a newspaper at the provincial level details of the debt arrangement plan. If any creditor is not satisfied with the debt arrangement plan, it may request to be repaid early or be given additional security.

Assumption of rights and obligations. The new entities after merger or division will be jointly and severally liable for the debts of the companies before the transaction.

Continuing to be an FIE with foreign participation over 25%. Any merger or division of an FIE is not allowed to cause the foreign participation to fall below 25% in any of the resulting entities.

Twenty-nine years after it opened its doors to the outside world, China has successfully attracted foreign investment worth billions of US dollars. Foreign investors are provided with many options when considering investing in China. They can set up a direct establishment, which is introduced in Part one of this article (see Investing in China: finding the right vehicle); or they can expand through mergers and acquisitions of Chinese enterprises or businesses, which is considered above. Recently, China has started reviewing its legal regime in respect of foreign investment to facilitate foreign investments further, but at the same time tightened up control over foreign investments in strategically-important enterprises and businesses. It will be interesting to see how this will impact on foreign investments into China in the future.