China's temporary national security review ("NSR") on inbound M&A transactions became permanent on 1 September 2011. The new permanent NSR has an additional anti-circumvention provision that was not included in the temporary NSR. This anti-circumvention provision can potentially be used by MOFCOM to clamp down on the use of Variable Interest Entity ("VIE") structures.
Prior to the implementation of the NSR, foreign investment in China generally dealt with two government agencies for review and approval: the National Development and Reform Commission (“NDRC”) and central or local MOFCOM. These agencies both need to approve acquisitions of Chinese entities by foreign investors, in which process project feasibility and possible interference with China's public interests and industry policies are reviewed.
Under the new M&A security review system, mergers and acquisitions involving sectors that are considered to be strategically important to the national security of China, such as national defence, agriculture, energy and resources, infrastructure, transport, technology, and manufacturing of important equipment, are subject to a security review prior to the NDRC and MOFCOM approval procedures mentioned above.
The new permanent security review rules contain an anti-avoidance provision that was not included in the previous interim rules. This anti-circumvention provision provides that when determining whether a transaction falls within the scope of the security review, the material content of the transaction and its actual impact are to be taken into account. It also provides that foreign investors cannot structure a transaction in order to avoid a security review, for example by using proxy holdings, trusts, multiple-layer reinvestments, leasing, loans, offshore transactions and control by agreement, etc.
"Control by agreement" includes the use of Variable Interest Entity (VIE) investments. In a VIE structure a fully or partially foreign-owned PRC company has control over a PRC operating company which holds the necessary licence(s) to operate in a FDI restricted or prohibited sector. The foreign investors use contractual arrangements to obtain de facto control over the operating company. VIEs have been a popular structure in the last decade. However, the new permanent NSR potentially could be used by MOFCOM to prevent or limit transactions that use a VIE structure. There are yet no precedent cases to provide further guidance on this.
For more information please also see our article on the temporary NSR in our March 2011 China Update (which can be found here).