After a period of consultation, China's Ministry of Commerce (Mofcom) has finalised key aspects of the country's new security review process for M&A deals in which foreign investors merge with or take control of Chinese enterprises in sensitive sectors.
Mofcom's newly published Rules of Ministry of Commerce on Implementation of Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors ("Security Review Rules") take effect on 1 September 2011, and replace interim rules that were published in March and subject to a consultation process.
The finalised Security Review Rules differ only slightly from the previous interim rules, which were summarised in our previous legal updates: New Rules Issued Regarding China’s Security Review Process For Foreign Investment and New Review Procedures for Foreign Investment in China. The basic principle of the new security review process remains unchanged - being that M&A deals will need to be notified to and approved by a new Inter-Ministerial Committee ("Security Review Committee") if they would result in a foreign investor merging with or acquiring Chinese enterprises in (or supporting) the military sector, or lead to the foreign investor taking control of Chinese enterprises in other sensitive sectors (including key agricultural products, key energy and resources, important infrastructure, important transport systems, key technology and critical equipment manufacturing) and thereby have a bearing on China's national security. Although tying in to references to security review in China's Anti-Monopoly Law, the new review process operates separately to anti-monopoly merger review and other foreign investment approval processes.
The Security Review Rules outline the required content of notifications to the Security Review Committee, specify the timeframe and procedural steps of the review process, and reference the decision-making powers of the committee (which includes a power to block or impose conditions on deals). All of these aspects are summarised in our previous linked updates, and no substantive changes have been made to these areas between the interim and now-finalised version of the rules.
The substantive changes that have been made include the following:
- The finalised rules make it clear that in considering whether an M&A transaction falls within the scope of security review, Mofcom will look both at the substance and actual impact of the arrangements (rather than the form). Specifically, the finalised rules make it clear that foreign investors should not try to avoid the review process by utilising nominee holding structures, trust arrangements, multilayer investment and reinvestment structures, leasing or lending arrangements, or other contractual control mechanisms, and confirm that the security review requirement will still apply where such cases are identified. It should be noted that Guidelines relating to the security review process have been issued by the Department of Foreign Investment Administration of Mofcom, and these guidelines now require that parties submit a written guarantee that they have not sought to avoid the security review process such as by utilising an arrangement of the type mentioned.
This new provision may have a significant impact on the structuring of many cross-boarder M&A deals going forward. Previously, there have been attempts by foreign investors to circumvent various PRC regulations restricting the type of entities who can control Chinese enterprises or other enterprises participating in key sectors in China by structuring their deals in a manner that effectively disguises the extent to which the target Chinese is to come under foreign control. However, it appears that Mofcom is becoming more wary of this type of arrangement, and is developing stricter measures to deal with it. It is likely this approach will be seen in other areas of PRC regulation going forward beyond the field of national security review.
- New wording has been added to pre-existing provisions empowering government departments, industry associations and industry participants to alert the Chinese authorities to deals that they consider should be subject to security review. The new wording states that Mofcom (which effectively acts as the gatekeeper for referring deals to the Security Review Panel) may "require relevant explanations" from entities who make such referrals. The precise meaning of this is not clear. It may be that this simply reflects the ability of Mofcom to liaise with the relevant entities to obtain all necessary details, however it may also reflect concern about the potential for the referral process to be misused by (in particular) competitors of the parties proposing to enter into a relevant M&A deal - and to empower Mofcom to enquire where necessary into whether a referral is made simply in an attempt to cause difficulties and delay for transactions.
- The interim rules provide that prior to the formal application of security review, the applicable may apply to Mofcom for consultation on the relevant procedural issues. The finalised rules supplement the provision in the interim rules by making it clear that such consultation appointment is not a requisite step for an applicant to submit its application for security review. Further, the comments and opinions given by Mofcom during this consultation process should not be treated as binding and having legal effect and should not be used as the basis for any formal application.
- Mofcom and other entities involved in the security review process are now expressly required to keep state secrets, trade secrets, and other related secrets confidential.
It is not surprising to see a confidentiality obligation provision be formally introduced as such concept has already been addressed in the anti-monopoly review system. As the two review systems interact, we believe this development of law is a natural result of the effort to keep the two systems consistent and unified.
Unfortunately, the finalised rules fail to clarify a number of important issues relating to the security review process, such as how parties can self-assess whether their deals may be considered to have a bearing on China's national security when the Chinese authorities have so far only published a very broadly worded and non-exhaustive list of sectors that may be considered 'sensitive' in this respect (refer the sectors mentioned further above, which are listed in the Notice of the General Office of the State Council on the Establishment of the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors).
Although the Security Review Rules contemplate that parties may consult with Mofcom "in respect of procedural issues", which will presumably include this aspect, the scope of uncertainty seems unworkably large. Not only will this cause unnecessary anxiety in relation to many foreign investment deals, it may also hinder the ability of foreign investors to secure other required approvals in a timely manner. This is because the rules state that local bureaus of commerce must suspend their own (i.e. foreign investment approval) review of transactions that they consider fall within the scope of security review and refer these deals to Mofcom, and there is a real risk that in seeking to ensure compliance with this aspect of the rules the local bureaus will be prone to adopting a very broad interpretation of what may be a 'sensitive' sector/investment (and thereby refer all manner of deals to Mofcom for a decision on whether security review should occur, and suspend their own reviews pending such decision). There have been reports that local bureaus of commerce are in possession of a more detailed list of sensitive industries, but any such list has not been made public.
The Chinese authorities do not publish information on transactions reviewed by the Security Review Committee, so it is difficult to assess the impact the new review process is having at the present time. As things stand, the process look set to remain relatively opaque for some time yet, and is going to require careful navigation by foreign parties looking to invest in China going forward.
A flowchart outline of the security review process is available here.