China’s State Council has announced a new system to review national security implications of foreign direct investment in China. The new rules take effect on March 5, 2011, writes Minter Ellison’s Geraldine Johns-Putra from Hong Kong.
China has previously introduced rules requiring oversight of foreign investment in potentially sensitive areas. In 2006, it mandated filings to be made with the Ministry of Commerce (MOFCOM) for foreign investments in key industries, affecting national economic security or involving a famous trademark or time-honoured brand.
In 2008, China’s Anti-Monopoly Law introduced merger control provisions prohibiting anti-competitive transactions without the approval of the Anti-Monopoly Bureau. The Anti-Monopoly Law also permitted the State Council to review transactions affecting “national security”, although no guidelines have been issued until now.
With this latest announcement, the Chinese authorities look to be finally moving to a formal system of review of foreign investments that could have a politically, militarily or economically sensitive impact. This is comparable to the powers of the Australian Foreign Investment Review Board (FIRB), which enables the Australian Treasurer to block foreign investments deemed contrary to national interest.
Affected sectors
The State Council announcement requires foreign investors acquiring domestic enterprises to make an application to MOFCOM, regardless of the investment sector. (In comparison, the Australian FIRB process requires applications only if the investment is in a specific sector, such as media or real estate, or if the investment meets a specified monetary threshold.)
MOFCOM then must refer the application to an inter-agency panel responsible for analysing the national security implications and reaching a decision.
Sectors within the scope of the review are:
· Military industrial enterprises, enterprises surrounding key sensitive military installations and other enterprises connected to national security; and
· Important agricultural products, energy and resources, critical infrastructure, transportation services, key technology and major equipment manufacturing related to domestic security, where the transaction will result in a foreign investor acquiring effective control.
Effective control here means that the transaction results in the foreign investor holding 50 percent or more of the target (together with its affiliates), holding either itself or with other foreign investors 50 percent or more of the target, having sufficient voting control to significantly influence shareholder meetings, shareholder general meetings or board meetings or having other decision-making powers over the finances, personnel or technology of the target.
The review focuses on the impact of transactions upon national security (including domestic production capabilities to meet defence requirements, domestic services capabilities and equipment and facilities), the stable operation of the national economy, basic social order and key technology and R&D capabilities of national security.
Implications for foreign investors
Following the announcement of the new system, MOFCOM issued Interim Provisions which clarified a number of procedural matters relating to the system. These specify that the security review application must be made to Central MOFCOM. If an application to approve a foreign M&A transaction is made to a local-level MOFCOM without the security review application having been made and the local MOFCOM’s view is that the transaction should undergo the review, it will request that the applicant submit the necessary application to Central MOFCOM and refuse to process the application until the security review is completed. The announcement presents practical challenges for foreign investors.
The process comprises a general review, and if required, a further special review. Both are undertaken by the inter-agency panel on the basis of comments canvassed from government departments and other agencies. The announcement provides for a maximum 35 working days between application and notification of the decision, if no special review is required. A special review potentially adds 60 working days, and, if the views of the panel diverge from those canvassed, the matter must be referred to the State Council for decision, for which no timing is specified.
Apart from the uncertainty in timing if the State Council becomes involved, the timetable is broadly comparable to the Australian process, which may take up to 40 days for examination and notification of the decision, with extension of a further 90 days in rare cases.
If the proposed acquisition has caused or may cause a significant impact on national security, the Chinese authorities may require termination of the proposal, reversal of any share or asset transfers or other measures to eliminate the impact on national security.
Documentation
The Interim Provisions specify the application documents that must be submitted, which, in addition to the normal application documents for a foreign investment, include a description of any relationship between the foreign investor and national governments and the proposed changes in the controllers of the target.
The Interim Provisions are effective until August 31, 2011. MOFCOM is calling for public comment on the Interim Provisions until April 10, 2011 as part of a review. It is expected that MOFCOM intends will issue amended provisions upon the expiry of the Interim Provisions, based on this review.
It is tempting to view the move as a tit-for-tat response by China after having several of its overseas investments blocked or restricted, including FIRB’s 2009 decision to reject a majority investment by China Non-Ferrous Metal Mining (Group) Co. Limited into rare earth miner Lynas Corp, which scuttled that deal.
This ignores the fact that sensitive deals in China already potentially face obstacles, such as Carlyle’s planned investment into construction machinery giant Xugong in 2006 and more recently Coca-Cola’s proposed acquisition of juice-maker Huiyuan, which was rejected on anti-monopoly grounds.
What the notice actually achieves is a clearer regulatory framework rather than an ad-hoc process or recourse to anti-monopoly grounds. It is also consistent with national interest review measures in other countries, such as FIRB and the United States Committee on Foreign Investment (CFIUS) regulations. ■
*Geraldine Johns-Putra is a Senior Foreign Legal Consultant in the Corporate and Commercial practice of Minter Ellison’s Hong Kong office. She specialises in China-related corporate transactions and private equity. She has led and advised on many China cross-border M&A deals, including a number of foreign investments in financial and industrial sectors in China.
