A new security review mechanism for foreign-invested M&A deals adds to the regulatory burden of foreign investors acquiring Chinese domestic enterprises. However, as similar though less comprehensive provisions already exist, the new rules do not necessarily increase the risk of foreign-invested M&A transactions being prohibited.
The new M&A security-review rules are set out in the Notice on Establishment of a Security Review System for Acquisition of Domestic Enterprises by Foreign Investors (Notice), which was recently issued by the State Council and which will be effective from 5 March 2011.
While the scope of the review only covers certain types of foreign-invested M&A deals (see below), the Notice suggests that all foreign investors must give notice to the Chinese Ministry of Commerce (MOFCOM) when acquiring a Chinese domestic enterprise. MOFCOM will then decide whether to initiate an M&A security review. The Notice does not clarify whether M&A deals signed but not completed by 5 March 2011 require notification.
Following established practice with merger-control notifications, we would suggest that foreign investors discuss each transaction with MOFCOM to determine whether an M&A security-review notification is required. Clarification should also be sought as to what material must be included in an M&A security-review notification.
It is hoped that implementing rules, if and when issued, will (i) set out specific thresholds for when security-review notifications are required and (ii) identify the materials required in a notification.
M&A transactions under scrutiny
M&A security reviews are required for foreign-invested acquisitions of military enterprises and foreign-invested acquisitions that result in the foreign investor(s) gaining "control" over "key domestic enterprises". Both equity and asset deals are covered. Acquisitions of foreign-invested enterprises are also covered.
Military enterprises are those that are:
- owned by or support the military
- involved in national defence
- located near key and sensitive military facilities
Key domestic enterprises include those in the following industries:
- energy and resources
- major equipment manufacturing
Some of these key domestic enterprises correspond to the industries designated as "key" by the National Development and Reform Commission (NDRC) in December 2006. The Notice does not specify criteria for determining whether a particular enterprise is "key".
Foreign investors will be considered to have control over a domestic enterprise if (i) one or more foreign investors hold an aggregate equity stake of 50% or more, (ii) a foreign investor has sufficient voting rights to have a major impact on shareholder or board decisions, or (iii) a foreign investor has the ability to exert actual control in any other way.
An inter-ministerial panel will be established to conduct M&A security reviews and issue decisions. The Ministerial Panel will be run principally by the NDRC and MOFCOM, with the State Council providing overall leadership.
M&A security reviews
Factors to be considered by the Ministerial Panel during an M&A security review include the impact of the M&A transaction on:
- national security, including manufacturing and service capacity in the defence sector
- stability of the state economy
- social order
- R&D capacity for key technologies relating to national security
Timing and process
Although not mentioned in the Notice, it should be possible for M&A security review notifications to be given at the same time as any merger-control notification. As the maximum time for merger-control reviews (i.e., 180 days) exceeds that for M&A security reviews (i.e., 95 working days (approximately 133 days)), the M&A security review process should not unduly delay M&A deals that also require merger-control clearance. However, for M&A transactions that do not require merger-control clearance, the M&A security review process brings with it the potential for delayed transactions.
Click Here to view the main steps and the timing of each.
Although the foreign investor may terminate or modify the transaction during an M&A security review hearing, the Notice does not grant any right to be heard by, or to present additional materials to, the Ministerial Panel.
If the Ministerial Panel concludes that an M&A transaction has exerted, or is likely to exert, a major impact on national security, then it is required to order MOFCOM (and other relevant departments) to either terminate or appropriately modify the transaction. Unlike merger control decisions, there is no obligation for the Ministerial Panel to publish conditional approvals or prohibitions.
Although the rules lack clarity in a number of regards, they nevertheless represent a step forward when compared with the pre-existing rules. Foreign investors in China's agriculture, energy, equipment manufacturing, and technology sectors, and those with military-related interests, will need to pay particular attention to the Notice. Practical experience, and/or implementing rules, will help to clarify the Notice going forward.