The phrase “Big Bang” was used to refer to the sudden deregulation of London’s financial markets on 27 October 1986. Because of changes to the London Stock Exchange's rules on that day, fixed commission charges were abolished, open-outcry trading was replaced by electronic, screen-based trading, the structure of the financial markets was altered and market activities significantly increased. The effects of “Big Bang” were dramatic, with London's prominence as a world’s financial center decisively strengthened.
China is experiencing its own “Big Bang” through unprecedented deregulation of its outbound investment approval framework. Over the last twelve months, there have been significant changes in the Chinese governmental approval and filing regimes for Chinese outbound investments. As a result, the approval and filing processes have been greatly simplified and streamlined.
The key changes include those to the NDRC approval regime, the MOFCOM approval regime and the SAFE registration/approval regime with respect to Chinese outbound investments.
Chinese investors intending to “go global” have greatly benefited from those changes. It is further expected that this trend of reform will continue as the new administration is determined to support Chinese enterprises in fulfilling their international aspirations.
The NDRC approval regime
The National Development and Reform Commission (“NDRC”) changed its rules twice in 2014, first in April through the Measures for the Administration of Approval and Filing of Outbound Investment Projects (the “New Measures”) and then in December through an amendment to the New Measures.
Under the New Measures, the key changes include:
- confirmation from the NDRC prior to commencing “substantive work” is required only for outbound investments exceeding US$300 million (previously it was US$100 million) and carried out through auction processes or acquisitions. “Substantive work” includes the submission of any binding offer or any formal bidding document or the execution of any legally binding agreement;
- an NDRC approval is required only where (i) the investment amount exceeds US$1 billion or (ii) the investment is in a sensitive country, region or sector. All other outbound investments only need to be filed with the NDRC or its provincial counterparts; and
- an outbound investment conducted through an offshore entity controlled by a PRC legal person no longer requires approval or filing, unless the investment involves the PRC parent providing financing or guarantee to the offshore entity.
In its December amendment to the New Measures, the NDRC further abolished the requirement that any outbound investment exceeding US$1 billion must obtain its approval. Therefore, the prevailing law is that, regardless of the investment amount, only an outbound investment in a sensitive country, region or sector would require the NDRC’s approval (if such investment exceeds US$2 billion, the State Council’s approval will be required); all other outbound investments will only need to be filed with the NDRC or its local counterparts. However, the requirement for certain types of transactions to seek confirmation from the NDRC prior to commencing substantive work remains unchanged.
The MOFCOM approval regime
The Ministry of Commerce of the People’s Republic of China (“MOFCOM”) published its Measures for the Administration of Outbound Investments in September 2014. The key changes introduced by the new rules include:
- clarification of regulated activities: the new rules apply to outbound investments by way of establishment, merger or acquisition or other means resulting in a Chinese domestic enterprise owning or acquiring ownership, control, management rights or other interests in foreign enterprises (excluding financial institutions);
- relaxation of approval requirements: outbound investments in sensitive countries, regions and sectors need to be approved by the MOFCOM; all other transactions (regardless of the investment amount) only need to be filed with the MOFCOM or its provincial counterparts; and
- interactions with the NDRC approval process: the MOFCOM no longer requires an applicant to submit “approval or filing confirmation issued by relevant PRC authorities” as part of the MOFCOM application. That may mean that the NDRC approval or filing is no longer a pre- requisite to the MOFCOM review. Accordingly, Chinese investors may be able to proceed with the NDRC and MOFCOM approval processes in parallel.
The SAFE registration/approval regime regarding capital outflow
Cross-border security and guaranteeThe State Administration of Foreign Exchange of China (“SAFE”) relaxed its restrictions on cross- border security and guarantees in May 2014 through the Regulation on Foreign Exchange Administration of Cross-border Guarantee. Under the new rules:
- PRC financial institutions, companies and individuals can freely provide a guarantee in relation to the debt of an unrelated foreign debtor (previously there must be a direct or indirect equity relationship between the foreign debtor and the PRC guarantor);
- no prior approval from SAFE is required before entering into any outbound guarantee transaction; and
- there is generally no limitation on the total amount of the outbound guarantee provided by one onshore guarantor (subject to certain restrictions).
Remittance of upfront expenses and others
According to the Circular on Further Easing Foreign Exchange Control Policy of Capital Accounts issued by SAFE in January 2014, remittance of upfront expenses for an outbound investment (i.e. funds to be remitted abroad before the NDRC filing or approval processes have been completed) of an amount no more than US$300,000 and below 15% of the total Chinese investment amount will no longer require SAFE's approval. Such remittance can be processed by a bank.
In February 2015, SAFE further reformed the PRC foreign exchange registration process involved in a cross-border investment through the Notice on Foreign Exchange Management Policy about Further Simplification and Improvement of Direct Investment. The key changes relating to outbound investment introduced by the new rules are as follows:
- subject to certain exceptions, all foreign exchange registration procedures that need to be undertaken with SAFE under the current rules including the registration of upfront expenses and the registration of outbound investments and special purpose entities outside the PRC will, from 1 June 2015, be handled through designated banks directly, rather than through SAFE;
- upfront expenses of an amount in excess of US$300,000 per project or more than 15% of the Chinese investor’s total investment and the conversion of cross-border loans in outbound investments to equity will still require approvals from or filings made with SAFE; and
- foreign exchange registration will cease to be required for investments made by an entity outside the PRC which is established or controlled by a PRC entity.
IMPACTS ON DEAL PRICING, CERTAINTY AND TIMING
The success of a cross-border M&A transaction largely depends on certainty, timing and pricing. Traditionally, Chinese buyers are disadvantaged due to uncertainty caused by having to obtain relevant PRC governmental approvals as well as the significant time gap between signing and closing because of those approval processes. The uncertainty and time gap often result in foreign sellers demanding a deal premium, often called the “China premium”, and/or break fee from Chinese buyers.
Following the regulatory reforms stated above, sophisticated overseas sellers may now be less inclined to regard the prerequisite Chinese regulatory approvals as “walk rights” of Chinese buyers. The result is that Chinese buyers may be able to reduce the “China premium” especially in disposals conducted through auction sales, and improve the economic returns on their outbound investments.
However, the following issues still remain outstanding even after the series of reforms:
- an outbound acquisition with a total investment value exceeding US$300 million need be notified to and confirmed by the NDRC prior to commencing substantive work;
- the NDRC filing applications will still be assessed substantively based on similar factors as those considered under the approval process; and
- remittance of upfront expenses abroad remains a practical difficulty notwithstanding the reforms.
Moreover, aside from these issues, Chinese investors also face other challenges and complexities in overseas investments. Differences in culture, practice and management style prove to be challenging for Chinese investors as well as the overseas sellers and the target’s management.
The speed and magnitude of these regulatory reforms and deregulation with respect to Chinese outbound investments were unprecedented. The easing of restrictions comes at a time when Chinese outbound investments are gathering real momentum. China’s demand for advanced technology, brands and markets from abroad will remain high. In addition, China’s ambitious initiative of the Silk Road Economic Belt and Maritime Silk Road programme promises to offer Chinese funding, expertise and industrial technology in the implementation of massive infrastructural projects across Asia, Africa and Europe. These projects, ranging from the construction of airports and railways to the redevelopment of deepwater ports, represent important opportunities for Chinese companies to expand and diversify their businesses by going global.
Our recent experience shows that Chinese investors have become more confident and assertive during the course of conducting their overseas acquisitions, and increasingly they have been resorting to qualified advisers who are familiar with the ins and outs of an outbound transaction.
We believe that further regulatory reforms will continue with a view to further relaxing and simplifying the PRC governmental approval processes for outbound investments. Restrictions from home regulators will be increasingly less of a concern for Chinese investors, allowing them to compete with other potential buyers on more equal ground and focus instead on more important issues.