Current NSR regime

Recent review of Yonghui’s proposed acquisition of Zhongbai

Our observations


On 1 January 2020, China’s Foreign Investment Law (FIL) and the Implementation Regulations of the Foreign Investment Law came into effect (see our e-bulletin – China set to implement the new Foreign Investment Law). Under both the FIL and the implementation regulations the State is responsible for establishing a security review system for foreign investments which will require a review of those that could affect national security. This elevates the national security review (NSR) regime to the national law level and will expand the scope of NSR to cover all foreign investments in China from the current regime which applies to foreign acquisitions. The detailed operating rules on the NSR regime under the FIL have yet to be released.

In this e-bulletin, we highlight the key requirements under the current NSR regime and explore the recent developments. 

Current NSR regime

Originally introduced in 2009 by the Provisions on Foreign Investors’ Merger with and Acquisition of Domestic Enterprises, the scope and impact of the NSR regime has been progressively enhanced for foreign investment projects. The current NSR regime, which applies to all foreign acquisitions, is contained in two major regulations which were introduced in 2011: the Notice of the General Office of the State Council on Launching the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (NSR Notice) and the Provisions of the Ministry of Commerce on the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (NSR Provisions).

Key sectors for national security

National security is defined in the National Security Law as the status where the political power of the State, sovereignty, unity and territorial integrity, people’s well-being, sustainable development of the economy and society, and other significant interests of the State are relatively free from danger and threats within and outside the State, and the country’s capability for safeguarding continued security. The National Security Law also identifies several important and key sectors vital to the national economy which are to be protected by the NSR regime. These include finance, resources and energy, food safety, culture, technology, internet and cybersecurity, ecological and environment protection, nuclear power and nuclear technology and the exploration and use of outer space, international seabed areas and polar regions.

Scope of NSR

The NSR Notice and the NSR Provisions set out the types of transactions that will be subject to an NSR process. They apply to a foreign acquisition of a domestic enterprise, either through an equity or asset acquisition or other means which is considered to circumvent the NSR process (such as through the use of a nominee holding structure, trusts, multi-level reinvestment, leasing, lending, contractual arrangement or offshore structures), if the target involves any of the following elements:

  • Military industry enterprises and military industry support enterprises;

  • Enterprises near key and sensitive military facilities;

  • Any business related to national defense security; or

  • Any of the following enterprises related to national security where the foreign investor may obtain actual control of the enterprise after the acquisition:

    • important agricultural products;

    • important energy and resources;

    • important infrastructure;

    • important transport services; or

    • key technology and manufacture of major equipment.

For foreign acquisitions of domestic financial institutions, the NSR Notice also requires the government to issue a separate set of NSR rules, although none have been released yet.

Review standards

The NSR Notice requires the joint committee (chaired by the National Development and Reform Commission (NDRC), under the leadership of the State Council) to review the impact of the foreign acquisition from the following perspectives:

  • National defense security, including domestic product manufacturing capacity, domestic service supply capacity and the relevant equipment and facilities required for national defense;

  • National economic stability;

  • Social order; and

  • Research and development capacity for key technologies related to national security.

Enhanced NSR regime in FTZs

A more extensive and enhanced NSR regime applies in the pilot free trade zones, covering not only foreign acquisitions, but also all foreign investment projects, including establishing new enterprises. In May 2015, the Notice of the General Office of the State Council on Printing and Distributing the Trial Measures for the National Security Review of Foreign Investment in Pilot Free Trade Zones (FTZ NSR Notice) came into effect which extends the scope of NSR to foreign investment in certain additional sectors, namely (i) important culture and (ii) important information technology products and services where the foreign investor acquires actual control after the investment.

The FTZ NSR Notice also sets two additional review standards, namely (i) cultural security and public morality; and (ii) State cybersecurity. 

Recent review of Yonghui’s proposed acquisition of Zhongbai

In August 2019, Yonghui Superstores disclosed that it had received a notice from the NDRC requesting information on its acquisition of a controlling interest in Chinese state-owned retailer, Zhongbai Holdings. This came two days after the State Administration for Market Regulation had given its merger control clearance for the deal. In September 2019, the NDRC notified Yonghui that it had initiated a general review process and, in November, further notified the company that a special review process had been initiated.

One of the factors behind the NDRC review is that 19.99% of the shares in Yonghui are foreign-owned by Dairy Farm International (which is 78% owned by Jardine). Whilst there has been no official confirmation from the NDRC as to its concerns about the deal or the standards it is applying to assess it, it is believed that the primary concerns relate to Zhongbai’s essential role as the major provider of warehousing and distribution as part of the catering services to the 2019 Military World Games in October 2019 and Zhongbai’s store network in certain military colleges in Wuhan. For national defense concerns, it is irrelevant whether the foreign investor will obtain a controlling interest in the target company. The review may also involve concerns in relation to the retail sector being considered a sensitive sector, in which case, the NSR process only applies if the foreign investor is seeking a controlling interest in the target company.

The NDR process didn’t go through. It ended up with Yonghui cancelled its proposed acquisition of Zhongbai in December 2019, as the parties have reached an MOU which provides for a good alternative for the parties to achieve the original strategic goals. 

Our observations

Worldwide, various countries and regions are expanding their national security review standards. In August 2018, the United States enacted the Foreign Investment Risk Review Modernization Act. On 13 January 2020, the US Department of Treasury issued its final regulation to implement the changes required by that Act which will come into effect on 13 February 2020 and will significantly expand the jurisdiction of the Committee on Foreign Investment in the United States. In March 2019, the European Union adopted new regulations to create a system to cooperate and exchange information on investments from non-EU countries that may affect security or public order.

Following this general trend, the new FIL provides that where any country or region takes any discriminatory, prohibitive or restrictive measures, or other similar measures against China in terms of investments, China may take corresponding measures against such country or region. Given the complicated and broad political considerations, the NSR regime brings uncertainties for foreign investors in China. With continuous efforts to open the foreign investment regime and the reductions to the negative lists, NSR is becoming an increasingly important measure for the government’s administration in reviewing foreign investment transactions. In light of this, it is crucial for foreign investors to plan ahead for their foreign investment transactions which involve sensitive industries or may otherwise have any national security concern.

The current NSR regime is based on general principles and the underlying standards are not clearly defined. While the new FIL and the implementation regulations themselves do not contain detailed operating rules and enforcement provisions in respect of the NSR procedures, we expect that the relevant government authorities will release more detailed rules in due course.