I OVERVIEW OF M&A ACTIVITY
This year’s all-encompassing M&A issue has been the dramatic effect on deal activity of outbound foreign exchange controls being imposed. Conversely, foreign investment regulations are being relaxed to counter capital outflows, leading to a surge in inbound M&A. The adoption of a more favourable framework for inbound foreign investment in the near future may sustain the surge.
Most media coverage has been given to the effect of stricter foreign exchange controls initiated in November 2016 that have dampened the outbound M&A climate. The fall in outbound transactions is a sudden reversal of the unprecedented heights of last year, with deal value at the end of 2016 standing at US$225 billion, as reported at the time by Dealogic.2
Banking authorities last year became concerned about the tremendous growth of capital outflows, which chipped away at national foreign currency reserves and caused a depreciation of the renminbi. To curb these outflows, foreign exchange controls were instituted, making uncertain the availability of funds necessary for outbound acquisitions.
Thompson Reuters deal data confirm a large drop this year in outbound M&A.3 In the period from the start of the year to 7 June compared to the same period in 2016, outbound deal value plummeted around 62 per cent. However, inbound M&A is up about 27 per cent for the same period. When broken down into Q1 and Q2 up to 7 June, the data show inbound M&A growth accelerating fast in the latter period. Even outbound M&A appears to be recovering, with greater deal value in outbound M&A in Q2 up to 7 June compared to even the same partial quarter in 2016.
A running theme throughout this chapter is deal dualism, as the tightening and easing of regulations on outbound and inbound M&A respectively are concurrent.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
There is no unified M&A law governing all M&A activities. Rather, specific M&A activities are subject to different sets of laws and regulations depending on the type of buyer, the target and specific legal issues implicated in the deal. Foreign investment in certain industries requires approval from the competent regulatory body (e.g., investment in banking is overseen by the China Banking Regulatory Commission, and is subject to shareholding limits by foreign investors).
i Inbound M&A
In the context of inbound M&A, the laws and regulations applicable to foreign investment in China will generally apply.
Foreign Investment Industry Catalogue (Catalogue)
One key initial consideration for an inbound M&A transaction is the category of industry in which the target is classified, and whether and to what extent the industry is open to foreign investment.
The Catalogue serves as the main legal basis under which the government regulates foreign investment industry entry into China.
In the current effective Catalogue (Catalogue 2017), industries are categorised as ‘encouraged’ or subject to ‘special foreign investment access administrative measures’ (Negative List). The Negative List contains all restrictive measures on foreign investments, which are further divided into two subcategories: ‘restricted’ or ‘prohibited’. Restrictive measures are typically structured as either limits on the equity interests that the foreign investor can hold (e.g., some sectors require Chinese joint venture (JV) partners, and in some cases it is mandated that the Chinese JV partner holds a majority equity interest), or senior officers are mandated to be Chinese. Industries categorised as ‘prohibited’ are not open to foreign investment.
While the Negative List does include all restrictive measures applicable to specifically foreign investment, there are still separate restrictions on domestic investment that would be applicable also to foreign investment (e.g. operation of theme parks, the construction of golf courses and the gaming industry).
China recognises a wide range of business vehicles. The three basic forms are the limited liability company, company limited by shares and partnership. A business establishment as a result of foreign investment will be generally referred to as a foreign invested enterprise (FIE).
The most common forms of FIEs are:
- a JVs between domestic and foreign partners, including equity JVs and cooperative JVs;
- b wholly foreign-owned enterprises;
- c foreign-invested holding companies;
- d foreign-invested companies limited by shares (FICLS); and
- e foreign-invested partnerships.
Inbound M&A transactions by foreign investors are primarily governed by the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (M&A Regulations)4 developed by the Ministry of Commerce (MOFCOM).
The M&A Regulations mainly concern:
- a the acquisition of equity interest in and assets from Chinese domestic enterprises;
- b the establishment of offshore vehicles for the purposes of listing Chinese assets through an offshore IPO;
- c the establishment of FIEs by offshore entities set up or controlled by Chinese domestic enterprises and Chinese residents; and
- d the swapping of shares between a foreign company or its shareholders and the shareholders of a Chinese domestic enterprise.
The M&A Regulations also provide detailed procedures and rules regarding the acquisition of domestic companies by foreign investors, including approval procedures, acquisition prices and terms of payment.
However, the M&A Regulations are not comprehensive, and do not apply to the following inbound M&A transactions by a foreign investor: acquisitions of the equity or subscription of a capital increase of an existing FIE (instead covered by separate sets of regulations on equity changes of the investors of FIEs);5 mergers between or acquisitions of a domestic enterprise through an existing FIE (instead, the ambit of regulations for mergers and divisions of FIEs and reinvestment by FIEs); 6 and acquisitions of a domestic limited liability company and the transforming of the same into a FICLS (instead governed by regulations on establishment of an FICLS)7.
If a foreign investor’s acquisition of a domestic enterprise has a bearing on national security, the acquisition may also be subject to a national security review by a ministry level co-chaired committee, generally involving MOFCOM, the National Development and Reform Commission (NDRC) and, if necessary, other governmental regulators.
As a result of the reform of the paid-in capital registration system in late 2013 and early 2014, the People’s Republic of China Company Law and relevant regulations on foreign investment have been revised, whereby the paid-in capital registration system and the minimum registered capital requirements have been substantially changed or removed, and the administrative procedures for establishing a company have been simplified.
As a result of the above reform, since 2014, there is:
- a no statutory schedule for capital contributions;
- b no minimum capital requirement, unless otherwise provided by laws or regulations;
- c no minimum initial contribution;
- d no minimum ratio of cash contribution; and
- e no capital verification.
Acquisition of state-owned assets or equity
Inbound M&A transactions aimed at acquiring state-owned assets or equity will be subject to a rather complex legal regime as well as strict supervision by the Chinese authorities, including the State-owned Assets Supervision and Administration Commission of the State Council (SASAC). In general, sales of state-owned assets or state-owned enterprises (SOEs) (with few exceptions) must be approved by SASAC (or its provincial and local counterparts) or by the relevant SOEs that are empowered with approval authority. Acquisitions of state-owned assets or SOEs will also be subject to a mandatory appraisal conducted by a qualified appraiser and, as a general principle, the actual transfer price for the state-owned assets or equity shall not be less than 90 per cent of the value determined by the appraiser, except if a price lower than such 90 per cent threshold is approved by the competent authority.
Inbound M&A transaction involving A-shares listed companies
PRC domestic stock exchange-listed companies currently issue two classes of shares, namely:
- a A-shares, which are renminbi-denominated shares reserved for Chinese investors, qualified foreign institutional investors (QFIIs), renminbi qualified foreign institutional investors (RQFIIs) and qualified foreign strategic investors; and
- b B-shares, which are renminbi-denominated shares that are traded in foreign currency (in US dollars on the Shanghai Stock Exchange, and in Hong Kong dollars on the Shenzhen Stock Exchange), and that are available for purchase by both Chinese and foreign investors.
To qualify as a foreign strategic investment in a domestic listed company, a foreign investor needs to purchase at least 10 per cent of the A-shares of a listed company, either by way of a private placement or a share transfer, and generally be subject to a three-year lock-up period and other prescribed conditions.
In addition, to purchase through QFIIs or RQFIIs, or through qualification as a strategic investment, a foreign investor may acquire A-shares indirectly through an existing FIE that holds or is eligible to hold A-shares of a listed company.
ii Outbound cross-border investments
With respect to outbound M&A transactions by Chinese investors, approvals and registrations must be obtained or conducted through NDRC, MOFCOM and the State Administration of Foreign Exchange (SAFE). For SOEs, there are additional reporting obligations and a required approval from SASAC (not covered here in detail).
For an overseas bidding process in which the amount of the Chinese investor’s investment reaches or exceeds US$300 million, a preliminary information report to NDRC, and its return confirmation letter (small pass) regarding a proposed acquisition, are required prior to engaging in substantive work with foreign parties. The small pass is typically received within seven business days of receipt of the preliminary information report.
In addition, prior to the signing of the definitive transaction agreement, a Chinese investor should file a notice with NDRC to obtain a ‘filing notification’. In practice, however, the filing is usually made after signing the definitive agreement, with receipt of the filing notification as a condition precedent to closing. To make such filing, a ‘project filing application form’ must be completed, along with the submission of certain application documents, including corporate resolutions, transaction agreements and a letter of intent regarding financing (if applicable), to NDRC. Upon acceptance of the project filing application form, a filing notification is typically received within 20 business days from the date that the application satisfies the filing requirements.
Following the execution of the definitive transaction agreements, an ‘application form of outbound direct investment’ should be submitted online to MOFCOM. The application package includes the application form, transaction agreements, the business licence of the buyer, an export permit for products or technologies (if applicable), and a statement from officers of the companies warranting the veracity of the proposed outbound investment. MOFCOM approval is typically received within 10 to 15 business days from the date that the application satisfies the filing requirements, and culminates with the issuance of an ‘enterprise overseas investment certificate’.
After obtaining an enterprise overseas investment certificate from MOFCOM, an ‘application form of foreign exchange registration on outbound direct investment’ is made to a commercial bank under the supervision of SAFE, which will include the business licence of the buyer and the enterprise overseas investment certificate, along with a statement of foreign exchange funding sources. Following submission, an ‘overseas investment foreign exchange registration certificate’ will be issued to the buyer.
The above timelines are ideal scenarios, and curbs on and verification of outbound M&A this year have meant practical changes in this area (see Section III, infra).
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
i Recent reforms and relaxed inbound M&A environment
The inbound M&A environment has become more open following a long-term plan to ease foreign investment restrictions. However, from last year, the added impetus of attracting capital to combat renminbi outflows has accelerated its opening up. For these reasons, a raft of notable changes have recently been enacted, including the following:
- a Catalogue 2017;
- b a nationwide negative list administration mechanism;
- c a new free trade zone (FTZ) negative list; and
- d from 2016, the approval system is supplanted by a record-filing system.
Catalogue 2017 was released on 28 June 2017 and became effective on 29 July 2017. In Catalogue 2017, 30 restrictions on foreign investment from Catalogue 2015 were removed, such as, inter alia, restrictions on rail transportation equipment manufacturing, motorcycle manufacturing, fuel ethanol production and oil processing, services in relation to road passenger transport, ocean tally cargo, credit enquiry and rating firms, and construction and operation of large-scale agricultural products wholesale markets. Additionally, a number of high-tech industries such as virtual reality and augmented reality devices have been given special incentives to attract foreign investment.
Nationwide negative list administration mechanism
Pursuant to the Opinions of the State Council on Implementing the Market Access Negative List (Negative List Opinions) issued by State Council on 2 October 2015, the unified nationwide negative list administration mechanism will premiere in 2018, following pilot programmes launched in the period between 2015 and 2017.
The negative list approach is a simplified process whereby only an investment in an industry falling within the negative list is restricted or prohibited from foreign investment, and is subject to approval. Industries outside of the negative list will only need to go through record filing procedures, rather than being subject to the case-by-case approval system previously applicable under the Catalogue. All market participants may enter the relevant industries or businesses not included in the negative list on an equal basis in accordance with the law.
Trials of the negative list administration mechanism were initiated as early as 2013 in four pilot FTZs in Shanghai, Guangdong, Fujian and Tianjin (seven new FTZs in the Liaoning, Zhejiang, Henan, Hubei, Sichuan and Shanxi provinces, and in the municipality of Chongqing, are in the works, bringing the total number of FTZs to 11).
Building on the FTZ experience and also in line with the Negative List Opinions, in October 2016 MOFCOM and NDRC jointly issued Announcement No. 22 (2016) by adopting a temporary nationwide negative list to set the stage for the implementation of the nationwide negative list. Along with the official release of the nationwide negative list, which is also referred to as ‘special foreign investment access administrative measures’ in Catalogue 2017, the era of a unified nationwide negative list administration mechanism has begun.8
New FTZ negative list
On 16 June 2017, the new Special Administrative Measures for Foreign Investment Access to Pilot Free Trade Zones (New FTZ Negative List) was released to replace the former version issued in 2015, and became effective on 10 July 2017. The new FTZ negative list applies to FTZs only.
Compared with its 2015 version, the new FTZ negative list has been reduced 10 categories and 27 administrative measures in respect of sectors such as aviation manufacturing, waterway transportation, banking services and education.
New record-filing system
On the same date that Announcement No. 22 (2016) was issued, MOFCOM promulgated the Provisional Administrative Rules on Foreign-Invested Enterprises’ Establishment and Amendment (Record-Filing Regulations), whereby a uniform record-filing administration system has been put in place in line with the implementation of the negative list mechanism. The Record-Filing Regulations were further amended on 30 July 2017.
Under the Record-Filing Regulations, the establishment of and most changes in existing FIEs, including transformation of non-FIEs into FIEs through an acquisition, strategic investment, merger or other method, no longer trigger the requirement of the prior approval of MOFCOM, except for those FIEs involving special foreign investment access administrative measures under the negative list or are subject to antitrust or national security review, and acquisitions of domestic enterprises by foreign investors falling under the M&A Regulations.
All record filings are required to be carried out via a uniform online platform, which accordingly largely eliminates the uncertainty of different interpretations by local officials.
ii Strict measures for and scrutiny of outbound M&A
In the current tightened outbound environment in China, SAFE, NDRC and MOFCOM are more closely examining the veracity and compliance of proposed transactions to make sure that they are not cloaked as investments to evade capital controls. To some extent, more scrutiny has turned registrations that were taken for granted as a clerical act into a process to obtain an approval.
The stricter measures could be interpreted as going beyond checking veracity. A new criteria has been set forth to deny ‘irrational’ outbound M&A, evaluating investments in particular in real estate, trophy hotels, cinemas, entertainment and football clubs. A prime example of a proposed transaction faltering under this criteria was the terminated bid for Dick Clark Productions (the US production company behind the Price is Right game show) by Wanda Investments after foreign exchange controls became an insurmountable barrier. Other types of ‘irrational’ outbound investments include proposed transactions made by limited partnership entities, large investments unrelated to a firm’s core business and companies that set up investment vehicles in a rush, and well-resourced subsidiaries controlled by much more thinly capitalised parent firms will face scrutiny and a higher likelihood of denial.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Foreign involvement is more prominent in outbound M&A transactions. For a start, aggregate outbound deal value is several times higher than it is with inbound M&A transactions. Adding to the salience of outbound deals, the sudden tidal wave of Chinese outbound investment has made a big splash in the worldwide deal community, among host governments and even with the general public in destination countries.
Despite the often lukewarm reception for Chinese investment, last year the US emerged as the major national destination for outbound Chinese M&A. The most popular destinations in Europe were the UK and Germany. The most noteworthy outbound deal in 2016 was the US$43 billion purchase by ChemChina of Swiss-based agribusiness giant Syngenta. The deal was successfully pushed through in the summer of 2017.
Many inbound M&A transactions involve investment by a Hong Kong entity of a PRC company. Outside of this Mainland–Hong Kong nexus, inbound deals come from a diverse array of first world countries, with no capital-exporting nation standing out. This year’s largest inbound M&A transaction was the approximately US$5 billion proposed acquisition by Softbank of Japan in Didi Chuxing, a ride sharing app.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
i Outbound M&A in the Belt and Road era
The signature international initiative of the Xi administration is the Belt Road Initiative (also known as Belt and Road), which aims to economically integrate Eurasia through physical connectivity and increased lending, investment and financial integration. Belt and Road was launched in 2014, but the summit held in May 2017 in Beijing drew 29 heads of state and was thus considered the grand launch party.
A number of investment funds have been established, mostly since 2014, to encourage outbound M&A to Belt and Road countries and other developing world regions. The US$40 billion Silk Road Fund is the largest state-backed global investment fund for Belt and Road investment. The Green Silk Road Fund, China–ASEAN Fund, China–Central and Eastern Europe Investment Fund, Russia–China Investment Fund, China–Eurasia Economic Cooperation Fund and China–United Arab Emirates Fund target investments within areas that form the core geography of Belt and Road. While Africa is largely and Latin America is completely outside of Belt and Road, there are several state-backed investment funds chartered for those regions, including the Community of Latin American and Caribbean Nations–China Investment Fund, China–Latin America and Caribbean (LAC) Industrial Cooperation Fund, China–LAC Investment Fund, China–Mexico Investment Fund, China–Portuguese Speaking Countries Cooperation Fund in Latin America; the China–Africa Industrial Cooperation Fund, Africa Growing Together Fund, China–Africa Development Fund in Africa; and the South–South Cooperation Fund and South–South Climate Fund in the developing world.9
In total, the funds exceed well over US$100 billion, and are expected to scale up even further in coming years. While these funds are creations of state initiatives and are backed by SOEs and financial institutions, they operate as conventional private equity (PE) funds seeking healthy returns with free reign to choose their M&A investments. The funds generally do not take the lead: in a conventional M&A transaction, funds join forces as a junior partner with SOEs and private companies in a buyer consortium.
ii Committee on Foreign Investment in the United States (CFIUS) and investment prohibitions
It is not only governmental approvals that have slowed down outbound M&A: governments in prime destination countries have objected to Chinese outbound M&A. The barrier posed to US deals by CFIUS, a multi-agency committee that reviews cross-border M&A involving a US business for national security concerns, is well known to Chinese dealmakers for blocking deals for sundry reasons (e.g., the acquisition of an iconic San Diego hotel was prohibited in 2016 due to its close proximity to a naval installation). CFIUS has become more heavy-handed, with denials of a string of major proposed semiconductor acquisitions from 2014 to 2016, leaving Chinese buyers with the impression of a barricade against the purchase of any large US semiconductor company by a Chinese acquirer. In 2016, the long reach of CFIUS was felt when it disallowed a bid by Grand China Investment for the US subsidiary of Aixtron AG, a German semiconductor company that had about a quarter of its operations in the US, making the entire bid infeasible.
While holding a more open attitude to foreign investment by China, Germany also has a foreign investment review process, albeit low key. However, the sale of German robot maker Kuka to Midea of China, which was announced in 2016, prompted debate about exercising the power to block future deals. The concern here does not concern national security grounds, but rather preventing prized German manufacturing companies like Kuka from being sold to an export competitor like China.
It is not all bad news for Chinese outbound M&A. The Russian natural resource sector is subject to numerous restrictions on foreign ownership of large assets based on a 2008 strategic investment law (Strategic Law) prepared with China in mind. However, Russian policy has been reversing course. An acquisition for a stake in a LNG project in the Yamal Peninsula by a Chinese consortium including the Silk Road Fund went forward through an exemption granted in a bilateral treaty passed in 2016 by Parliament. This year, China Gold’s proposed acquisition of a large gold deposit, barred by the Strategic Law, is also expected to be permitted through a bilateral treaty.
Under Prime Minister Trudeau, Canada is much friendlier towards Chinese M&A transactions than it was under his predecessor. In January 2017, the Trudeau government cancelled an order issued by his predecessor’s cabinet to unwind a completed M&A transaction by a Chinese buyer, a move that is seen as resetting Sino–Canadian investment.
iii Possible rise in reverse break fees
There is anxiety among sellers that either the government through foreign currency controls or host governments through investment reviews will curb or prohibit proposed transactions. This has caused some wrangling over reverse break fees, with media reports on large increases in reverse break fees for Chinese buyers out of fear of government-caused deal failure.
We have encountered these anxieties in recent negotiations in the form of requests for a higher reverse break fee. The issue of high reverse break fees, rather than underlying government approval, could itself become a deal breaker. However, an analysis of the most recent data involving Chinese outbound buyers shows that a rise in break fees is not reflected in the terms in transaction agreements. Based on a sample of six deals in 2017 and 15 deals in 2016 in which details of break fees are available, the average percentage of deal value agreed as a reverse break fee has not risen in 2017 compared to 2016, standing at approximately 6 per cent.10 However, four out of six deals in the 2017 sample had a reverse break fee higher than the break fee, while six out of 15 deals in the 2016 sample had a higher reverse break fee, indicating that sellers are more conscious of approval risks related to Chinese deals.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
As policymakers have sought to reduce the outflow of currency from China since the end of 2016, stricter screening implemented by NRDC, MOFCOM and SAFE has had a severe effect in curtailing the availability of domestic financing for outbound M&A, and especially for proposed transactions fitting the criteria for highly scrutinised deals (see Section III, supra).
Some proposed transactions are better positioned than others. We note that high-profile transactions with aims aligning with marquee policy initiatives like Belt and Road by SOEs can continue to count on financing for high-dollar-value outbound transactions. However, even buyers that get approval for remitting abroad acquisition financing or other funding will face bureaucratic hurdles. While MOFCOM and NDRC have more involved roles in industrial policy and are more sympathetic to deals with rationales that match economic planning, SAFE, on the other hand, is more geared to watching the foreign exchange reserves and stability of the renminbi, causing it to impose restrictions on the time period and amounts that can be converted and wired abroad even for transitions examined and recorded by NDRC and MOFCOM.
Chinese investors have sought alternative modes of fundraising that are perceived to endure less domestic regulatory scrutiny, including the use of:
- a neibaowaidai;
- b cash collateral to domestic banks for issuing standby letters of credit or bank guarantees to overseas lenders;
- c loans advanced by foreign lenders to overseas Chinese investors’ subsidiaries secured by assets located outside China; and
- d equity and debt issuance in overseas markets.
PE has a vigorous presence in domestic and cross-border deals. Overall, PE accounted for US$49 billion by deal value in 2016 according to Bain & Co, and early stage investments are a notable subset.11 Early stage PE is expected to continue making a strong showing in 2017 with money pouring into the sharing economy, and especially a nationwide bike-sharing craze. Another new outbound PE trend to watch out for is ramping up of state-backed global investment funds as part of Belt and Road (see Section V, supra, for further details).
VII EMPLOYMENT LAW
M&A transactions have triggered labour disputes or strike events leading to collective labour arbitration, hindering the completion of deals.
Labour relations are established in the form of labour contracts and barring any change to the subject qualification of the labour contract,12 labour relations are usually not affected. According to Article 40 of the Labour Contract Law and Article 26 of the Labour Law, a target has the right to terminate a labour contract if a material change in the objective circumstances relied upon at the time of conclusion of the labour contract renders it impossible for the seller to perform and, after consultation, the employer and the employee are unable to reach an agreement on amending the labour contract. As such, unless the M&A transaction leads to a ‘material change of the objective circumstances’ or the ‘subject qualification’ of the seller being eliminated, the seller does not hold a unilateral right to terminate the labour contract.
Whether an M&A transaction has caused a change in either condition depends in large part on the type of transaction. In general, a share acquisition does not affect the change of the legal subjects of the parties. Nor is it a ‘material change of the objective circumstances’ to the labour contract, so this type of transaction has no basis in providing the seller with the unilateral right to terminate the labour contract. In the case of an asset acquisition or business reorganisation, if it involves a transfer of assets, then this may constitute a ‘material change of the objective circumstances’, and the seller may unilaterally terminate the labour contract with employees.
Even though there is a right to unilaterally terminate a labour contract, the seller still must hold good faith negotiations with the employee to work out a comparable position before exercising termination. If the labour contract is terminated, sellers must provide severance based on the number of years that employees were employed by them. In the case of large-scale layoffs of employees, sellers must carry out negotiations with the employees’ labour union and the local government to formulate a plan that includes providing advance notice to the employees.
VIII TAX LAW
The State Administration of Taxation (SAT) levies enterprise income tax (withholding tax) of 10 per cent on the taxable income obtained by non-resident enterprise (NRE) transferors through cross-border M&A. In 2016, the policy and rules for the taxation of NRE in cross-border M&A transactions were stable, with few changes. However, due to an increase in the auditing of NREs, disputes with SAT over the interpretation of tax rules have grown.
The principal sources of rules regarding the treatment of taxable income for NREs in M&A transactions are Circular (2009) No. 59 and Circular (2009) No. 698 (Circular 698). Deficiencies in the drafting of Circular 698 have caused many controversies in terms of tax collection and enforcement, leading SAT to publish guidance announcements – SAT Announcement (2011) No. 24, SAT Announcement (2013) No. 72 and SAT Announcement (2015) No. 7 – through which it has constantly further amended and explained Circular 59 and Circular 698.
IX COMPETITION LAW
M&A transactions meeting statutory thresholds and circumstances constituting a ‘concentration of undertakings’ (e.g., an acquisition of control over a target) are subject to the merger control provisions of the Anti-Monopoly Law. If in the preceding financial year either the combined global turnover of the undertakings (e.g., the buyer or the target) exceeds 10 billion renminbi, and the PRC turnover of each of at least two of the undertakings exceeds 400 million renminbi, or the combined PRC turnover in the preceding financial year exceeds 2 billion renminbi and the PRC turnover of each of at least two of the undertakings exceeds 400 million renminbi, then the transaction must obtain clearance from MOFCOM.
Last year, MOFCOM received 378 filings for merger clearance, a huge increase from the several dozen filings received in 2008. The vast majority of filings were officially accepted, and 82 per cent of clearances obtained in 2016 were approved during the Phase I stage of review. The overall clearance process starting from official acceptance of the filing runs for 30 calendar days during Phase I and continues into Phase II for a statutory period of 90 days, subject to a possible 60-day extension, before MOFCOM issues a decision of cleared, cleared with conditions or prohibited.
It is noteworthy that the vast majority (78.6 per cent) of merger filings were notified as simple cases in 2016 under a fast track procedure established in 2014 that requires less documentation to be submitted to MOFCOM. In 2016, 98.6 per cent of simple cases cleared during the Phase I stage of review.
The following types of transactions are generally able to avail of the simple case procedure:
- a horizontal mergers where the combined market share of the parties is less than 15 per cent;
- b vertical mergers where each party has a market share of less than 25 per cent;
- c acquisitions of shares or assets of a non-Chinese company that does not conduct economic activities in China;
- d the establishment of a non-Chinese joint venture that does not conduct economic activities in China; and
- e changes in control of a joint venture whereby the joint venture becomes controlled by one or more of the previously jointly controlling parents.
There is no sign yet that foreign exchange controls imposed since November 2016 will be lifted. However as noted in our introduction, the latest data at the time of writing indicate a turnaround for outbound M&A, with activity in the second quarter up to 7 June showing strong improvement relative to the same period in 2016.
While the stability of the renminbi is of vital interest, we believe recent capital controls are temporary, as long-term industrial policy encourages outbound investment. The Belt and Road initiative’s debut on the world stage will make it a force for advocating outbound M&A, driving lending and investment from China to the rest of the world, particularly the low and middle-income countries of Eurasia. ‘Made in China 2025’ is another marquee long-term economic policy aiming to improve Chinese manufacturing capabilities, a process that requires investment and expansion abroad.
We do not expect deal dualism to be the long-term trajectory once both inbound and outbound M&A in the Chinese deal universe improve.
1 Wei (David) Chen is a managing partner, Yuan Wang is a partner and Kai Xue is an associate at DeHeng Law Offices. The authors would like to thank Tong Yongnan, Wang Guan, Wang Yuwei, Hu Tie, Zhang Xu, Feng Chen, Shen Sisi and Dong Jie for their assistance in preparing this chapter.
2 ‘After $225 Billion in Deals Last Year, China Reins In Overseas Investment’, New York Times (12 March
2017). The article cites figures from Dealogic released at the start of 2017, including pending deals, some of which would be withdrawn later in the year, especially after the tightening of foreign exchange controls.
3 Analysis of Thompson Reuters data by DeHeng Law Offices. We included all deals, including those completed, pending and withdrawn, to ensure similarity between data sets from 2016 and 2017. The variable ‘transaction value excluding assumed liabilities (US$ million)’ was used to calculate the deal
4 As last amended on 22 June 2009.
5 Mainly, Certain Regulations on the Change of Investors’ Equities in Foreign Investment Enterprises promulgated by the former Ministry of Foreign Trade and Economic Cooperation (the predecessor of MOFCOM) and State Administration for Industry and Commerce on 28 May 1997.
6 Mainly, Regulations on the Merger and Division of Foreign Invested Enterprises promulgated by the former Ministry of Foreign Trade and Economic Cooperation and State Administration for Industry and Commerce on 22 November 2001, and Provisional Regulations on the Reinvestment of Foreign Invested Enterprises in China promulgated by the former Ministry of Foreign Trade and Economic Cooperation and State Administration for Industry and Commerce on 25 July 2000.
7 Mainly, Provisional Regulations on the Establishment of Foreign Invested Companies Limited by Shares as last amended on 28 October 2015.
8 Currently there are two sets of negative lists simultaneously implemented in China: the FTZ negative list and nationwide negative list, with essentially the same content and substantial overlap. However, there are some differences; for example, the FTZ negative list is more descriptive than the nationwide negative list, particularly regarding finance, transportation, storage and postal services.
9 Presentation on ‘China’s Global Development Consortia’ by Kevin P Gallagher and William Kring of Global Economic Governance Initiative Pardee School of Global Studies.
10 Our analysis averaged reverse break fees from our sample using the highest percentage in the case of multi-tier reverse break fee structures regardless of whether the higher value is connected to a government approval trigger.
11 ‘IT to remain hot draw among private equity punters’, China Daily, 14 April 2017): www.chinadaily.com.cn/m/shanghai/lujiazui/2017-04/14/content_28998505.htm.
12 According to the relevant provisions of the Labour Contract Law, an enterprise with the subject qualification of labour and employment means it is established in the territory of PRC, has not been declared bankrupt according to law, and no business licence has been revoked, has been ordered to close, has been revoked or has been decided to be dissolved ahead of schedule.