On December 19, 2020, China's National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM") jointly issued the Measures for the Security Review of Foreign Investments ("New FISR Measures"), which aim to safeguard Chinese national security by scrutinising certain foreign investment transactions into China.
The New FISR Measures are not the first rules issued by the Chinese government to address potential national security issues posed by foreign investments into China. In 2011, China's State Council and MOFCOM issued a set of rules regarding security review of foreign investment transactions into China (the "2011 Rules"). Pursuant to the 2011 Rules, a ministerial review panel ("MRP") was established by NDRC and MOFCOM, which was granted the power to conduct national security reviews of foreign investments in Chinese domestic enterprises. However, the 2011 Rules did not clearly define the specific sectors targeted for review and, according to publicly available information, have rarely been invoked since its promulgation.
In 2015, China's State Council issued new measures (together with the 2011 Rules, the "Existing FISR Rules"), providing for an expanded national security review process. However, the process was limited to review foreign investments in various free trade zones in China.
The National Security Law ("NSL") also became effective in 2015. The NSL provided that China would establish rules and mechanisms to conduct national security review of foreign investments in China that may impact national security.
On 1 January 2020, the Foreign Investment Law (the "FIL") became effective. The FIL is widely considered to be a monumental legislation, marking the beginning of a new era for foreign investments in China. The FIL reiterates, albeit briefly, that China will establish a security review system for foreign investments.
Less than a year later, the New FISR Measures were formally introduced. While the New FISR Measures expand the scope of national security review compared to the Existing FISR Rules, they still describe targeted sectors in broad strokes, leaving substantial room for interpretation and speculation.
Reviewing Authority, Mandatory Review and Pre-Application Consultation
Reviewing Authority. Under the New FISR Measures, the reviewing authority will be a working mechanism to be jointly led by NDRC and MOFCOM. The office of the working mechanism (the "FISR Office") will be responsible for the organisation, coordination and direction of security review of foreign investments in China, and have the authority to review foreign investment transactions when an application for review is submitted or prompted by recommendations from other government agencies, enterprises, social groups or the general public.
Mandatory Review. Under the New FISR Measures, parties to foreign investment transactions that fall within the scope of transactions subject to security review (see below for more details) are required to proactively apply to the FISR Office for review before they carry out such transaction. If a party fails to submit an application in connection with a foreign investment transaction that is subject to security review, the FISR Office may require the relevant parties to submit an application for review within a designated period of time. If such parties still fail to submit an application, the FISR Office may order the disposal of the equity interest or assets acquired by the foreign investors, or take other actions to reverse the foreign investment transaction.
Pre-Application Consultation. The New FISR Measures also allow parties to a foreign investment transaction to consult with the FISR Office prior to the submission of application if they have any questions.
Scope of Transactions Subject to Security Review
According to the New FISR Measures, a foreign investment transaction is subject to security review if:
- it is (i) in sectors related to national defence and security, such as arms and arms related industries; or (ii) in geographic locations in close proximity of military facilities or defence-related industries facilities; or
- it (i) involves critical sectors significant for national security, such as critical agricultural products, critical energy and resources, critical equipment manufacturing, critical infrastructure, critical transportation services, critical cultural products and services, critical information technology and Internet products and services, critical financial services and key technologies; and (ii) will result in foreign investors' obtaining actual control of the invested enterprise.
Definition of "Foreign Investments". Consistent with the FIL, the New FISR Measures define "foreign investments" as direct or indirect investment activities conducted by foreign investors, including (i) investments to initiate a new project or establish a new enterprise in China, either independently or jointly with other investors; (ii) acquisition of equity interest or assets of an enterprise in China; and (iii) investments through other structures in China. The definition gives the regulator plenty of room for interpretation, and we believe investments via a variable interest vehicle ("VIE") will likely be captured by the definition.
Definition of "Actual Control". The New FISR Measures provide that foreign investors will be deemed to have "actual control" over an invested enterprise if: (i) foreign investors hold more than 50% of the equity interest in such enterprise; (ii) even if foreign investors hold less than 50% of the equity interest in such enterprise, such foreign investors can exert significant influence at the shareholder or board level by virtue of voting rights; or (iii) other circumstances under which foreign investors can exert significant influence over the operational decision making, personnel, finance and technology of the invested enterprise.
Review Process and Timeline
According to the New FISR Measures, the typical timeline for the security review of a foreign investment transaction is set forth below:
- Preliminary Review. Upon the receipt of an application for foreign investment security review, the FISR Office shall make a preliminary decision on whether such foreign investment transaction is subject to general review within fifteen (15) working days and inform the applicants of its decision in writing.
- General Review. If the FISR Office decides that a foreign investment transaction should be subject to general review at the conclusion of the preliminary review, it shall conduct and complete the general review within thirty (30) working days after the date on which its preliminary review decision is made. Upon completion of the general review, the FISR Office shall provide written notice to the applicants whether the proposed foreign investment transaction is approved or subject to special review if it affects or may affect national security.
- Special Review. If the FISR Office determines that a proposed foreign investment transaction should be subject to special review at the conclusion of the general review, the FISR Office shall conduct and complete the special review within sixty (60) days after its commencement. However, under special circumstances, the FISR Office may extend the special review at its own discretion and notify the applicants of its decision of the extension in writing. The FISR Office will issue its final decision to applicants after the completion of the special review. During FISR Office's review, foreign investors are prohibited from making the proposed investment. In other words, the security review of a foreign investment transaction must be completed prior to the closing of a foreign investment transaction that is subject to such review.
The outcomes of a security review of foreign investment transactions include:
- If a foreign investment transaction will not affect national security, the FISR Office shall approve the transaction;
- If a foreign investment transaction will or may impact national security, but such impact can be eliminated and the relevant parties accept mitigation measures, the FISR Office may approve the transaction with such mitigation measures; and
- If a foreign investment transaction fails the security review, the FISR Office shall reject the transaction.
It is worth mentioning that according to the FIL, the decision of security review shall be final, which means that a decision made by the FISR Office may not be administratively reconsidered or contested in court.
Targeted Sectors Remains Vague. The New FISR Measures remain vague in certain key areas, especially the targeted sectors. For example, the description of targeted sectors in the New FISR is broad, qualified by materiality and lack of specificity, which will likely invite different interpretation and speculation.
Expanded Scope of Transactions Subject to Security Review. The New FISR Measures expand the scope of transactions subject to security review in the 2001 Rules by including the following foreign investment transactions: (i) foreign investments in geographical locations within near proximity of any military facilities and defence-related industries facilities; and (ii) foreign investments in critical cultural products and services, critical information technology and Internet products and services and critical financial services where foreign investors will also gain actual control of the invested enterprise.
National Security Review of Public M&A Transactions. According to the New FISR Measures, rules for the implementation of the New FISR Measures for foreign investments in publicly traded companies will be formulated in the future. This is the first time public M&A transactions are explicitly mentioned in the context of national security review. If the definition of "domestic company" under the New FISR Measures includes companies listed in China or companies listed overseas but with main or significant business operations in China, the implication of the New FISR Measures may extend beyond the usual concept of foreign investments security reviews.