Private equity activity in China in 2016 moderately cooled down from the all-time peak level in 2015, with a year-on-year decline in terms of both volume and value of investments. According to AVCJ Research, the market research division of the Asian Venture Capital Journal, based on its data as of 19 January 2017, there were 1,068 private equity investments (of which 823 were publicly disclosed) with an aggregate amount invested of US$49.3 billion in China in 2016. Compared with 1,338 investments with an aggregate amount invested of US$70.5 billion in 2015, the total volume of investments decreased by 20.2 per cent and the total value of investments decreased by 30.0 per cent in 2016.
The distribution among different investment types in 2016 exhibited a further uptick of start-up and early stage investments, and a slump in buyouts and private investments in public enterprises (PIPE) financing compared with that of 2015. According to AVCJ Research:
- a investments at expansion and growth stages stayed ahead of other investment stages at US$19.07 billion or 38.7 per cent of total investment value in 2016, down from US$28.85 billion or 40.9 per cent in 2015;
- b venture capital deals in the start-up and early stages rose from US$12.99 billion or 18.4 per cent of total investment value in 2015 to US$15.88 billion or 22.5 per cent of total investment value in 2016;
- c PIPE trimmed down to US$5.79 billion or 11.7 per cent of total investment value in 2016 from US$9.39 billion or 13.3 per cent of value in 2015; and
- d buyouts declined sharply from US$15.50 billion or 22.0 per cent of total investment value in 2015 to US$7.76 billion or 15.7 per cent of total investment value in 2016.
Although buyouts remained relatively less frequent in comparison with deal activity in many other jurisdictions, and its share declined in 2016 compared with 2015, it remains an important type of private equity investment in the Chinese market. The buyouts trend that began in 2010 further emerged in 2011, grew in 2012 to 2014 amid going-private transactions involving China-based companies, particularly companies listed in the United States, and boomed to be the bandwagon in 2015 as many US-listed Chinese companies received going-private proposals in prospect of seeking future listing on China’s A-share market or Hong Kong stock exchange, followed by a decline in 2016. Despite the overall decline in 2016, the going-private space remained relatively active in 2016. Based on statistics obtained through searches on Thomson ONE, the Thomson Reuters database, of the 184 going-private transactions that have been announced since 2010, 39 did not proceed (14 of which involved private equity sponsors) and 124 have closed (five in 2010, 13 in 2011, 19 in 2012, 18 in 2013, 25 in 2014, 14 in 2015, 29 in 2016 and one in 2017). As of 31 December 2016, 21 going-private transactions were pending, including three announced in 2012, one announced in 2013, two announced in 2014, seven announced in 2015 and eight announced in 2016. Of the 124 completed going-private transactions, 31 involved private equity sponsors, and of the 21 pending going-private transactions, six involved private equity sponsors.
In respect of exits via IPO, China experienced the longest moratorium of A-share IPOs in history from November 2012 through December 2013, and another four-month moratorium of A-Share IPOs in 2015. Private equity-backed IPOs in 2016, an exit route China-focused private equity funds used to heavily depend on, continued to retreat from 2015 with a 31.9 per cent decrease in terms of value realised in listing, despite the slight 8.9 per cent increase from 2015 in terms of deal count, according to AVCJ Research. Exits via trade sales and secondary sales, accounting for 55.2 and 12.1 per cent respectively of private equity-backed exits in 2015, and 80.8 and 5.9 per cent respectively in 2016, according to AVCJ Research, remained the dominant exit options for private equity funds in 2016, and likely will continue to maintain this position for the foreseeable future.
2016 has also witnessed record-hitting levels of activity in Chinese outbound M&A. Chinese investors are more and more active and discerning in acquiring mature assets in advanced economies, and notching up a series of high-value cross-border M&A deals. According to PwC M&A 2016 Review and 2017 Outlook, based on data from Thomson Reuters, China Ventures and PwC’s analysis, compared with 2015, Chinese outbound M&A in 2016 surged 142 per cent in terms of the number of announced deals to 923 and 246 per cent by announced deal value to a record high of US$220.9 billion, which exceeded the combined deal value in the previous four years. The proposed US$43 billion acquisition of Syngenta AG, a Swiss agrochemical and seeds company, by China National Chemical Corporation, a Chinese state-owned chemical company and Fortune Global 500 company, if completed, will overtake CNOOC’s 2012 purchase of Canadian energy company Nexen to become the biggest outbound investment ever made by a Chinese buyer. Announced in February 2016, the transaction is currently under merger review at the European Commission and other regulatory review. Outbound M&A backed by Chinese financial investors also heated up in 2016, more than doubling in terms of announced deal volume and rising 149 per cent in terms of announced deal value to US$38.1 billion compared with 2015.
II REGULATORY FRAMEWORK
i Acquisition of control and minority interests
China’s Companies Law, which became effective on 1 January 2006 and was amended in 2013 with effect from 1 March 2014, sets out the governance framework for the two types of Chinese companies: company limited by shares and limited liability company. A Chinese entity in which a non-Chinese investor owns an equity interest is called a foreign-invested enterprise (FIE), of which there are several types, including a wholly foreign-owned enterprise (WFOE), an equity or cooperative joint venture (CJV), and a foreign-invested company limited by shares (FICLS). FIEs are subject to separate statutes in addition to the Companies Law, including the Law on Wholly Foreign-Owned Enterprises (which applies to WFOEs), the Law on Sino-Foreign Equity Joint Ventures and the Law on Sino-Foreign Cooperative Joint Ventures (which respectively apply to the two types of joint ventures), and the Interim Provisions on the Establishment of Foreign Invested Companies Limited by Shares (which applies to a FICLS), including their respective implementation rules. The Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (M&A Rules), jointly issued by six governmental agencies in 2006 and amended in 2009, establish a general legal framework under which non-Chinese investors can acquire the equity or assets of a Chinese company. There are also other statutes and rules governing transfers of equity, mergers and other transactions involving FIEs.2
On 19 January 2015, the central Ministry of Commerce (MOFCOM) released a draft of the proposed new Foreign Investment Law (Draft FIL) for public comment. The Draft FIL proposes sweeping reforms to the current Chinese foreign investment legal regime by removing many distinctions between FIEs and Chinese domestic entities and streamlining the oversight of foreign investments, while raising substantial uncertainty as well. If the Draft FIL were to be formally promulgated, the Law on Wholly Foreign-Owned Enterprises, the Law on Sino-Foreign Equity Joint Ventures and the Law on Sino-Foreign Cooperative Joint Ventures would likely be repealed, while other statutes and rules on foreign investments would require amendments to adapt to the new regime.
Government approval regime
An acquisition of or investment in a Chinese company by a non-Chinese investor is subject to a multi-layered government approval and registration process. Subject to the recent developments described in Section IV.i, infra, in respect of the record-filing regime applicable to FIEs, the highest-level of scrutiny is applicable to onshore investments (that is, direct acquisitions of equity in Chinese companies), which require the approval of the National Development and Reform Commission (NDRC) or its local counterpart and central MOFCOM or, if the size of a greenfield investment falls below US$300 million, or the size of an acquisition falls below US$100 million or the size of either an acquisition or other investment in ‘restricted’ sectors specified in the Foreign Investment Catalogue (as discussed below) falls below US$50 million, MOFCOM’s local counterpart. Approval at the local level typically can be obtained within one month, but approval from central MOFCOM and the NDRC often takes several months or longer. If a transaction is subject to antitrust or national security review as discussed below, MOFCOM or its local counterpart would typically defer review until such antitrust or national security reviews are completed.
Whether MOFCOM and NDRC will grant approval for a transaction depends in part on the Catalogue for the Guidance of Foreign Investment Industries (Foreign Investment Catalogue), jointly published by MOFCOM and the NDRC, which classifies sectors of the Chinese economy as ‘prohibited’, ‘restricted’ or ‘encouraged’ (with unclassified sectors deemed as ‘permitted’). Whereas a non-Chinese investor can acquire full ownership of a company in most ‘encouraged’ and ‘permitted’ sectors (and often benefits from special advantages when acquiring a company in an ‘encouraged’ sector), to invest in most ‘restricted’ sectors, a non-Chinese party is required to team up with a Chinese partner (and in some cases the Chinese partner must maintain a controlling stake). Investments by a non-Chinese party in a ‘prohibited’ sector are typically prohibited.
In addition to these general approval requirements, foreign investment in several industries, such as construction or telecommunications, is subject to approval from the regulatory authorities governing the applicable industry.
An indirect investment in China by way of an investment in an offshore holding company that owns equity of a Chinese FIE is not subject to the MOFCOM or NDRC approvals applicable to an onshore investment; however, both an onshore and an offshore investment may be subject to China’s antitrust and national security review schemes.
Under the Anti-Monopoly Law (AML), which became effective on 1 August 2008, an antitrust filing with MOFCOM is required for any transaction involving a change of control if the sales in China in the prior accounting year of each of at least two of the parties exceeded 400 million yuan, and either the parties’ aggregate worldwide sales in the prior accounting year exceeded 10 billion or the parties’ aggregate sales in China in the prior accounting year exceeded 2 billion. According to MOFCOM’s 2016 annual review relating to AML, throughout 2016, MOFCOM received 378 merger notifications (7.4 per cent more than in 2015) and closed 395 cases (19 per cent more than in 2015), among which MOFCOM imposed conditions on two transactions (the same number as in 2015). On 30 May 2016, MOFCOM announced its approval of Walmart’s petition for removing the restrictive conditions imposed by MOFCOM in the prior conditional antitrust clearance decision made in 2012 with respect to Walmart’s purchase of 33.6 per cent shares in Niuhai Holdings Limited, which is the offshore financing vehicle of Yihaodian, a leading online supermarket and e-commerce platform in China. This was the second decision made by MOFCOM to remove restrictive conditions, which followed MOFCOM’s decision announced in January 2015 to remove a restrictive condition imposed on Google’s acquisition of Motorola Mobility. In May 2016, MOFCOM published three administrative decisions to impose fines on three transactions for failure to comply with the merger notification requirements. These three decisions were new instances of penalties imposed by MOFCOM for violation of the merger notification requirement following the first such type of decision published in 2014 imposing fines on a merger transaction for non-compliance with the merger notification requirement (while there were two other MOFCOM decisions published in 2014 imposing fines on Western Digital for its non-compliance with the restrictive conditions imposed by MOFCOM in its merger control clearance decision relating to its acquisition of Hitachi Storage), and four MOFCOM decisions published in 2015 imposing fines on four merger transactions for non-compliance with the merger notification requirement.
In February 2011, China’s State Council issued Circular 6, which established a national security review scheme for the acquisition of a Chinese business by one or more non-Chinese investors. Two broad transaction types are subject to Circular 6 review: the ‘acquisition’ of any stake (regardless of the size) in a military enterprise, a supplier to a military enterprise, a company located near sensitive military facilities or any other company relating to national defence; and the ‘acquisition’ involving ‘control’ of a Chinese company whose business involves ‘key’ agricultural products, energy and resources, infrastructure, transportation services or technologies or manufacturing of equipment and machinery ‘affecting national security’. In April 2015, the General Office of State Council issued the Tentative Measures for the National Security Review of Foreign Investment in Pilot Free Trade Zones (FTZs), which took effect in May 2015. Under these Tentative Measures, the national security review extends to foreign investment in important cultural and IT products sections that are vital to national security and in which foreign investors have de facto control over the invested entities. The types of foreign investments regulated by these Tentative Measures include sole proprietorships, joint ventures, equity or asset acquisitions, control by contractual arrangements, nominal holdings of interests, trusts, reinvestments, offshore transactions, leaseholdings and subscriptions of convertible bonds. The Draft FIL has attempted to codify the national security review as part of the foreign investment review regime, and seeks to broaden the scope of review by expressly allowing all types of foreign investment (not limited to ‘acquisition’) to trigger the review and expanding the list of factors that can be taken into account in the review.
Both China’s antitrust and national security review schemes provide Chinese authorities with wide discretion to determine whether a transaction is subject to review or, if subject to review, whether it should be blocked. Under Circular 6, the meanings of ‘key’ and ‘affecting national security’ are undefined. Provisions issued by MOFCOM in 2011 to implement Circular 6 prohibit an investor from circumventing the national security review by structuring a transaction by way of nominee arrangement, trust, multilayered reinvestment, lease, loan, contractual control, offshore transaction or other such structures. Under both the AML and Circular 6, and other regulations regarding antitrust or national security review, ‘control’ is defined broadly and includes having voting rights sufficient to exercise a major impact on board or shareholder resolutions, particularly with respect to key business or operational decisions. As such, private equity investments involving certain customary protections (e.g., veto rights, supermajority voting requirements, negative covenants) arguably could be interpreted to involve ‘control’ under both statutes. If there is ambiguity as to whether a filing is required, it is usually prudent for an investor to make a filing to avoid adverse consequences later. In June 2014, MOFCOM issued the revised guidelines on antitrust filings, with attempts to clarify the moderately controversial concept of ‘control’ in the context of antitrust filing, and to provide for a formal pre-filing consultation with the Anti-Monopoly Bureau of MOFCOM available to investors to assist them in determining whether a filing would be triggered. If a transaction is subject to national security or antitrust review, MOFCOM conducts a policy-driven review to determine whether the transaction can proceed unimpeded: it considers not only the effect of a transaction on national security or competition, as applicable, but also takes into account its effect on the public interest and the stability of the national economy and social order, as well as the views of industry associations and other market participants.
Further, the M&A Rules contain, in effect, a restriction on ‘round-trip’ investments by requiring MOFCOM approval for any acquisition of a Chinese company by an offshore company formed or controlled by any Chinese entity or individual affiliated with the Chinese target company. Typically, this approval is not granted. Where the offshore structure was in place prior to the adoption of the M&A Rules in 2006, however, the acquisition of a Chinese target by the offshore entity is still permitted.
In contrast, the Draft FIL is proposing a shift from current case-by-case approval for all foreign direct investments to a refined regime, namely an ‘entry clearance review’, applicable only to foreign investments in ‘restricted’ sectors on a Negative List that is to be promulgated (which, it is expected, will supersede the Foreign Investment Catalogue). However, if the Draft FIL materialises and the concept of ‘de facto control’ is adopted by MOFCOM in determining whether an entity will be treated as an FIE or a Chinese domestic entity and assessing whether certain foreign investors may participate in those sectors on the Negative List, certain types of indirect investments may unprecedentedly come within the purview of Chinese regulators.
Governance of and exit from onshore joint ventures
The Chinese corporate law and regulatory framework applying to FIEs make it difficult for shareholders in a Chinese company to obtain or enforce contractual rights that are considered fundamental for private equity investors in other jurisdictions, including rights pertaining to governance and exit. First, members of an onshore equity joint venture (EJV) have rights of proportional representation on the board, meaning that a Chinese partner typically has the right to appoint at least one director. Further, certain important corporate acts of any joint venture must be unanimously approved by the board, including:
- a any amendment to the articles of association (which is required in connection with any equity transfer);
- b any liquidation or dissolution;
- c any increase or decrease in registered capital; and
- d any merger or division.
As a result, a non-Chinese investor with a majority stake in a joint venture cannot obtain complete control because the minority partner has statutory veto rights via its representative on the board.
Moreover, it may be difficult for a non-Chinese investor to enforce certain exit-related provisions that are often key terms of a private equity investment. Transfers of equity in an onshore joint venture are subject to a statutory consent right and right of first refusal by all other members. Theoretically, such rights can be waived in advance in the joint venture contract. In practice, however, a transfer of a shareholder’s interest in a Chinese joint venture requires amendments to the joint venture contract and articles of association as well as the approval of MOFCOM or its local counterpart. Because an amended joint venture contract (which MOFCOM expects to review to approve a transfer) requires signatures from all shareholders, the other shareholders’ cooperation is necessary in connection with any transfer. The same difficulties arise for a private equity investor seeking to enforce a call right, put right or drag-along right against the Chinese shareholders (a tag-along right is easier to enforce, as the party with the tag right can attempt to block a transfer if the transferor fails to comply with the other shareholders’ tag-along right). If the Chinese shareholder is a state-owned enterprise (SOE), enforcement is even more difficult, as a transfer of an SOE’s interest in a joint venture is subject to a statutory appraisal and an open bid procedure, unless waived by the appropriate authorities. Regardless of what rights may be contained in a joint venture contract, a local Chinese court injunction granting specific performance against a Chinese shareholder and in favour of a foreign investor is far from certain.
Implications of regulatory framework on transaction structure
To avoid the requirements of obtaining NDRC and MOFCOM approval and to enhance structuring flexibility, foreign private equity investors typically prefer to invest in China through an offshore investment. The ideal transaction structure, when feasible, is for the foreign investor to invest alongside a Chinese partner in an offshore Cayman or British Virgin Islands company, with such company owning 100 per cent of a Chinese WFOE (often indirectly through a Hong Kong entity, to obtain preferential treatment on dividends). This structure also allows the foreign investor to benefit from transaction agreements governed by foreign law and to avoid the need to enforce its rights in China. Because of foreign ownership limitations and the prohibition on ‘round-trip’ investments, however, this offshore structure is seldom available for foreign investments in Chinese targets that have not formed an offshore holding structure prior to the effectiveness of the M&A Rules.
Many non-Chinese investors use a ‘variable interest entity’ (VIE) structure to invest (indirectly) in China to avoid seeking certain Chinese regulatory approvals. Under a VIE structure, Chinese individuals, often the founders, are the registered shareholders of a domestic operating company, which holds the required licences and permits needed for the business to operate. An investor (often in conjunction with the founders) then forms a WFOE through an offshore entity it owns, and the WFOE enters into a series of contractual arrangements with the operating company and its registered shareholders pursuant to which the WFOE obtains control and an economic interest in such operating company. These contractual arrangements can take many forms, but often include an exclusive service or licence agreement, a voting proxy agreement, share pledge agreement and loan agreement, and an exclusive option agreement (together with a form of equity transfer agreement) allowing the WFOE (when permitted by Chinese law) or its appropriate affiliate (or affiliates) or designee (or designees) to acquire the equity interests or assets of the operating company. Commentators frequently note that the VIE structure is legally risky given that it arguably violates the spirit (if not the letter) of Chinese regulations; however, Chinese companies continue to use this structure.
However, the Draft FIL is a strong signal from the government of its long speculated-upon attempts to address VIE structures, primarily by formalising the regulation of a VIE structure via the concept of ‘de facto control’, as previously mentioned. This warrants the vigilance of current and future investors, and would have a profound impact on prospects of investment in certain Chinese businesses. The Draft FIL has clarified that future investments via VIE structures controlled by foreign investors will be treated as foreign investment, which may trigger entry clearance and other reviews. Further, instead of godfathering the pre-existing VIE structures, the Draft FIL leaves a placeholder for how pre-existing VIE structures would be handled under the new regime, while an explanatory note from MOFCOM accompanying the Draft FIL puts forth suggested approaches in dealing with businesses with VIE structures. In this note, MOFCOM has left room for public comments and undertakes to propose solutions upon further study.
ii Fiduciary duties and liability
Fiduciary duties of directors, officers and supervisors
The Companies Law is the primary statute regulating the actions and duties of directors, officers and supervisors of a Chinese company. Pursuant to the Companies Law, a director, officer or supervisor must abide by the laws, administrative regulations and articles of association of the company, and has a duty of loyalty and a duty of care to the company. As in many other countries, a breach of duty may give rise to civil, administrative or criminal liability. A particular concern to a private equity investor in China, however, is that a director, officer or supervisor may be liable for criminal liability not only for his or her own wrongdoing, but also for crimes committed by the company if he or she is the ‘manager directly in charge’ or ‘person directly responsible’ for the management of the matter with respect to which a specific criminal act was committed by the company. This risk of personal liability for company wrongdoing is more acute for a director or officer who is also the chair of the board, executive director or legal representative of the company or who otherwise serves in a senior management capacity, such as general manager or chief financial officer. Most non-Chinese private equity funds are comfortable appointing their representatives to the boards of Chinese companies notwithstanding the risk of liability, often while seeking to ensure that their representatives are not assigned responsibility for any specific matters. While directors and officers insurance and indemnification agreements may protect against civil liability, many types of administrative or criminal liability cannot be mitigated with insurance and indemnification.
Chinese tax exposure
Since January 2008, China’s Enterprise Income Tax Law (EIT Law) has imposed a 10 per cent capital gains tax on the sale of a domestic Chinese company by a foreign investor. On 3 February 2015, the State Administration of Taxation of the PRC issued Circular (2015) No. 7 (Circular 7) on Chinese corporate income tax treatments of indirect transfers of PRC assets (including equity interest in a Chinese company) by non-resident enterprises. Under Circular 7, an indirect equity transfer of a Chinese entity by an offshore seller (such as selling the equity of an offshore holding company) that does not have a reasonable commercial purpose and is structured to avoid applicable Chinese taxes will be recharacterised by the Chinese tax authorities as a direct equity transfer of the Chinese entity for Chinese tax purposes, and the offshore seller will be required to pay capital gains tax for the transaction. Although the parties to such offshore transaction have the discretion to determine whether to make a Circular 7 filing to report such offshore transaction for Chinese tax authorities’ assessment for Chinese tax purposes, Circular 7 employs a penalty structure designed to motivate the parties to offshore transactions involving indirect sales of Chinese companies to report potentially taxable transactions to the tax authorities. Because of the uncertainty and evolving practice of the Circular 7 regime regarding what will satisfy the tax authorities as a non-tax-avoidance justification and having reasonable commercial purpose for the offshore sale of Chinese entities, many practitioners interpret the application of Circular 7 in a broad way, and recommend making Circular 7 filings to reduce the risks and potential penalties for evading Chines tax obligations.
An offshore vehicle established by a non-Chinese private equity investor to make an investment in a Chinese company will be treated as a ‘PRC-resident enterprise’ under the EIT Law, and will be subject to a uniform 25 per cent enterprise income tax on its worldwide income where such offshore vehicle’s de facto management body is in China. Although the law is unclear, factors that the State Administration of Taxation may take into account in determining tax residency include whether:
- a the offshore vehicle locates its senior management and core management departments in charge of daily operations in China;
- b financial and human resources decisions of the offshore vehicle are subject to determination or approval by individuals or bodies in China;
- c the offshore vehicle’s major assets, accounting books, company seals, and minutes and files of board and shareholders’ meetings, are kept or located in China; and
- d at least half of the offshore vehicle’s directors or senior management reside in China.
To mitigate the risk that any dividends, sale proceeds or other income received by an offshore vehicle are subject to such tax, an offshore vehicle should take steps to establish that it is not effectively managed and controlled in China.
Securities Exchange Commission (SEC) enforcement actions
The SEC Enforcement Division has continued to focus on companies with operations or activities, or both, in China, but that are trading on US exchanges. While the SEC enforcers have always been interested in investigating allegations of accounting fraud, they have expanded their focus to books and records and internal controls issues even in the absence of accounting fraud. The SEC’s expanded enforcement focus is not surprising given there have been fewer instances of pervasive accounting abuse in 2016, such as Chinese reverse-merger fraud or stock-option backdating.
For companies with operations in China, the SEC has utilised the accounting provisions of the Foreign Corrupt Practices Act (FCPA), which requires all issuers3 to have a system of internal accounting controls that provides reasonable assurance that transactions are according to management directives and are properly recorded; and make and keep accurate books, records and accounts that accurately and fairly reflect transactions and the distribution of the company’s assets.4 Unlike the anti-bribery provisions of the FCPA,5 the accounting provisions do not require the underlying conduct to have jurisdictional nexus with the US or any evidence showing corrupt payments. Therefore, the SEC enforcers frequently invoke the accounting provisions on grounds of deficient or false records, or inadequate internal controls, or both.
Among the 25 corporate FCPA cases brought by the SEC in 2016, over 50 per cent involved a multinational’s Chinese subsidiaries or their activities in China, or both. Among others, one of the world’s premier investment banks, JP Morgan Chase & Co, agreed to pay more than US$130 million to settle SEC charges that the bank provided valuable job and internship opportunities to relatives and friends of senior government officials in Asia (in particular, almost 100 hires after alleged requests from more than 20 Chinese state-owned entities’ officials) in exchange for lucrative investment banking businesses.6 Additionally, JP Morgan was expected to pay US$72 million to the US Department of Justice (DOJ) and US$61.9 million to the Federal Reserve Board of Governors for the alleged conduct, bringing the total financial penalty to more than US$264 million.7 Similarly, on 1 March 2016, Qualcomm agreed to pay US$7.5 million to the SEC to settle charges that the company provided full-time employment and paid internship opportunities, as well as lavish gifts and entertainment, to relatives and friends of Chinese government officials to influence these officials’ decisions on adopting Qualcomm’s mobile network technologies.8
Other significant FCPA enforcement cases brought by the SEC in 2016 include:
- a On 23 March 2016, the Swiss-based pharmaceutical company Novartis AG agreed to pay US$25 million to settle SEC charges that employees of the company’s Chinese subsidiaries used a ‘pay-to-prescribe’ scheme to provide gifts, recreational travel and fake studies to reward Chinese public hospitals’ health service providers who prescribed Novartis medications.9
- b On 30 September 2016, the UK-based pharmaceutical company GlaxoSmithKline agreed to pay US$20 million to settle SEC charges that employees and agents of the company’s Chinese subsidiary and joint venture partner provided cash, entertainment, gifts, travel and other items of value to influence the prescription decisions of Chinese public hospitals’ health service providers.10
- c On 4 February 2016, SciClone Pharmaceuticals agreed to pay US$12 million to settle SEC charges that the company provided improper payments to Chinese public hospitals’ health service providers to increase sales.11
- d On 29 December 2016, wire and cable manufacturer General Cable agreed to pay more than US$55 million to the SEC and nearly US$20.5 million to the DOJ to settle FCPA violations where its overseas subsidiaries made improper payments to foreign government officials to win business in Angola, Bangladesh, China, Egypt, Indonesia and Thailand. The company agreed to pay an additional US$6.5 million penalty to the SEC to settle separate accounting-related violations. 12
- e On 30 August 2016, the SEC announced that UK-based biopharmaceutical company AstraZeneca has agreed to pay more than US$5 million to settle charges that it violated the books and records and internal controls provisions of the FCPA as a result of its wholly owned subsidiaries in China and Russia making improper payments to foreign officials.13
SEC enforcers not only brought FCPA actions against companies with Chinese operations in 2016; they have also imposed sanctions against China-based individuals on multiple occasions. On 13 September 2016, the former chair and CEO of a Florida-based technology company, Harris Corp, Jun Ping Zhang (Ping) agreed to pay US$46,000 in civil penalties and enter an SEC cease and desist order from future FCPA violations. The SEC alleged that Ping facilitated and directed his sales staff to use fabricated expense receipts to pay for gifts to officials at China’s state-owned hospitals to influence the officials’ decisions to purchase the company’s products and services. Notably, the SEC declined to take any action against Ping’s employer, Harris Corp, because Harris Corp discovered the conduct five months after acquiring the Chinese business that was led by Ping and then self-reported the conduct to the SEC and DOJ. Harris Corp had further terminated all of the implicated employees and shut down its China operations. Harris Corp reported that the DOJ had closed its investigation without bringing any charges against the company.
In 2016, the SEC also continued to focus on two other areas of enforcement involving Chinese traders: cybersecurity and insider trading. On 27 December 2016, the SEC announced charges against three Chinese hackers for allegedly stealing and trading confidential and material M&A information from two prominent New York law firms concerning their clients listed on US exchanges.14 This enforcement action marked the first time that the SEC has charged individuals for hacking into a law firm’s computer system. In a parallel action, the US Attorney’s Office for the Southern District of New York announced related criminal charges. At the time of writing, one of the hackers has been arrested in Hong Kong and is waiting for extradition to the US, while the other two remain at large. Furthermore, on 9 June 2016, a Chinese trader agreed to pay more than US$756,000 to the SEC to settle insider trading charges. It was alleged that the trader obtained material, non-public information when he served as a consultant to two Chinese private equity funds for a buyout deal and then generated illegal profits from the information.15
Chinese authorities’ enforcement actions
In addition to heightened scrutiny from US regulators, foreign private equity investors also face risks posed by Chinese authorities’ anticorruption and antitrust enforcement actions. Such risks were showcased in continued enforcement actions against multinational companies.
Chinese anticorruption enforcement update
In 2016, Chinese regulators continued to focus on anticorruption enforcement against multinational companies that started with the highly publicised investigation of GlaxoSmithKline in 2014. Chinese regulators focused anticorruption enforcement on the pharmaceutical, medical device, automotive and construction industries, as well as new areas such as the internet. In October 2016, the Administration for Industry and Commerce (AIC) imposed a fine against tyre giant Bridgestone for commercial bribery. The fine amounted to 150,000 yuan, and included disgorgement of approximately 17.4 million yuan in illegal gains. Bridgestone was found to have offered shopping cards to retailers in exchange for product sales. Hewlett-Packard was also investigated for its connections to the son of a high-ranking government official. The criminal judgment, released on 14 July 2016, disclosed that a Hewlett-Packard employee bribed the son of the official and his close associate in an amount of over 1 million yuan to win bids for two projects.
In addition to targeting multinational companies, the Central Commission for Discipline Inspection (CCDI) commenced an inspection of the major SOEs in the financial services sector in late 2015, including the People’s Bank of China, the central bank, China’s stock exchanges, China’s banking, security and insurance regulatory commissions, and other state-owned banks and insurers. CCDI continued its sweep in the financial services sector in 2016. In 2016, employees of several securities companies were reported to have been arrested in connection with alleged bribery of government officials in order to win projects.
The continuing anticorruption campaign was also bolstered by additional regulation in 2016. On 25 February 2016, the Legislative Affairs Office of the State Council released the draft amendment to the Anti-Unfair Competition Law (AUCL), the primary legal authority in China on commercial bribery. The draft amendment introduces a number of significant changes to the AUCL, including a broader definition of commercial bribery, increased penalties for commercial bribery by companies, vicarious liability for acts of employees, and tightened record and bookkeeping requirements. The AUCL currently provides for an administrative fine of 10,000 yuan to 200,000 yuan, plus the confiscation of illegal gains. The draft amendment increases the fine to 10 to 30 per cent of the revenue generated from the business involving commercial bribery. How these changes will impact enforcement and penalties is yet to be seen.
Chinese antitrust enforcement update
In 2016, China continued its aggressive antitrust enforcement actions. China’s enforcement authorities issued the most penalty decisions (27) in one year, including a number of high-profile enforcement actions against multinational corporations that resulted in significant penalties totalling hundreds of millions of US dollars. Three of the largest fines included Tetra Pak, Medtronic and General Motors. On 9 November 2016, the AIC fined Tetra Pak, a multinational food packaging company, for abusing its dominant position in China’s aseptic packaging machine, technology service and materials markets. The AIC imposed fines totalling 668 million yuan, which amounted to 7 per cent of Tetra Pak’s 2011 sales revenue from the relevant products. On 5 December 2016, NDRC fined Medtronic 118.5 million yuan, or 4 per cent of its 2015 sales revenue from relevant products, for price fixing and setting limits on resale prices in the markets of cardiovascular, rehabilitation therapy and diabetes devices. Likewise, on 23 December 2016, the NDRC’s Shanghai branch fined SAIC-GM for manipulating resale prices through agreements with distributors, imposing a penalty of 201 million yuan, or 4 per cent of SAIC-GM’s 2015 sales revenues from relevant products.
Antitrust enforcement, targeting specific industries like the automotive and pharmaceutical device industries will likely continue into 2017, as Chinese authorities become increasingly sophisticated and willing to tackle larger and more complex antitrust cases.
iii Chinese outbound M&A
Chinese outbound investment approval and filing regimes
A proposed outbound investment in overseas target assets by a Chinese investor is subject to a series of outbound investment approvals and filings with the competent PRC authorities depending, inter alia, on the country, region and industry of the target assets, the investment amount, and the identity and ownership structure of the Chinese investor. The Chinese outbound investment approvals and filings are not applicable nor available to Chinese individual investors.
NDRC regulates Chinese companies’ outbound investment activities on a project-by-project basis through a multi-layered approval and filing regime. A Chinese investor is required to make a filing with NDRC’s local counterpart and obtain an NDRC filing notice for an outbound investment transaction with a size of Chinese investment below US$1 billion that does not involve a ‘sensitive country or region’ (countries and regions that are sanctioned, subject to war or civil commotion, or have no diplomatic relations with the PRC) or a ‘sensitive industry’ (such as basic telecommunication, cross-border hydro-resources development, large-scale land development, main electricity transmission line and grid, and media). If a transaction is of a size of above US$1 billion, or involves a ‘sensitive country or region’ or a ‘sensitive industry,’ the Chinese investor is required to apply for and obtain an outbound investment approval from central NDRC (or an approval from the State Council in cases of a transaction of a size of above US$2 billion and involving a ‘sensitive country or region’ or a ‘sensitive industry’). In addition, if the size of a Chinese outbound investment reaches or exceeds US$300 million, the Chinese investor is required to submit a project information report to NDRC before signing a definitive purchase agreement, submitting a binding offer or bid or submitting applications with foreign governmental authorities, and central NDRC will grant a project confirmation letter after its review as a ‘green light’ to allow the Chinese investor to continue pursuing the potential transaction. Such NDRC project confirmation letter is a pre-condition for a Chinese investor to enter into a definitive purchase agreement with a foreign seller, or submit a binding offer or bid in an auction or bidding process.
MOFCOM regulates Chinese companies’ outbound investment activities from industry and trading perspectives. A Chinese investor is required to make a filing with the provincial MOFCOM and obtain a certificate of outbound investment for an outbound investment that does not involve a ‘sensitive country or region’ or a ‘sensitive industry.’ If a transaction involves a ‘sensitive country or region’ or a ‘sensitive industry’, the Chinese investor is required to apply for and obtain an outbound investment approval from central MOFCOM.
NDRC and MOFCOM approvals and filings are typically the pre-closing procedures on the part of Chinese investors in outbound investment transactions, particularly if the Chinese investor needs to establish an offshore subsidiary or to use onshore financing (whether equity or debt financing), or both, to complete the transaction. If a Chinese buyer uses an existing offshore entity as the acquisition vehicle, and has sufficient funds offshore to complete the transaction, NDRC and MOFCOM approvals and filings, and even registration with the State Administration of Foreign Exchange (SAFE) as described below, may not be required by the parties as closing conditions (although the Chinese buyer may nevertheless go through the process to obtain NDRC and MOFCOM approvals and filings for them to be able to repatriate funds from the relevant investment back to China in the future).
After obtaining NDRC and MOFCOM approvals and filings, a foreign exchange registration with SAFE through a local Chinese bank is required for currency conversion and remittance of the purchase price out of China. However, this will not be applicable if the Chinese investor uses offshore capital to fund the transaction. A foreign exchange registration would also be required in the case of an earnest deposit to be paid from China to overseas immediately upon, or within a short period of time from, the signing of a definitive purchase agreement. Upon registration, a Chinese investor may remit the registered amount of the deposit to offshore. However, if a Chinese investor uses its offshore funds to pay the deposit, this registration may not be applicable. Such registration can be handled by a local Chinese bank if the amount of the deposit does not exceed US$3 million or 15 per cent of the purchase price and concurrently with the NDRC project confirmation process. Payment of deposits of higher amounts needs to be approved by SAFE on a case-by-case basis after completing the NDRC project confirmation process.
A Chinese SOE buyer may also need approvals from the State-owned Assets Supervision and Administration Commission of the State Council or its local counterparts, or sometimes alternatively approvals from its group parent company. Depending on the transaction value and structure, a Chinese-listed company may need to obtain stockholder approval before closing and make necessary disclosures required by the Chinese securities exchange rules.
Since late 2016, it has been reported that the increasing flow of Chinese outbound investment activities has become a source of concern to Chinese authorities, which have adopted more stringent control and supervision of outbound investment activities and capital flow. In an official press release dated 6 December 2016, the central governmental authorities, including NDRC, MOFCOM and SAFE, in their response to a media inquiry on tightened scrutiny of outbound investment transactions, said that they had been alerted to some irrational outbound investment activities in real estate, hotels, film studios, the entertainment industry and sports clubs, and potential risks associated with overseas investment projects involving:
- a large investments in businesses that are not related to the core businesses of the Chinese investors;
- b outbound investment made by limited partnerships;
- c investments in offshore targets that have an asset value larger than the Chinese acquirers;
- d projects that have very short investment periods; and
- e Chinese onshore funds participating in the going-private of offshore-listed China-based companies.
The tightened control on outbound investment activities and capital flow not only affect Chinese investors, but also are relevant to international private equity players from at least two perspectives: when a private equity player intends to partner with a Chinese investor in an M&A outside of China, or when a private equity player is considering a Chinese buyer for a trade sale as its exit route. In these scenarios, the private equity investor needs to take into account the potential risk that the Chinese party may not be able to come up with sufficient funds offshore in time to complete the transaction offshore.
Foreign investment approvals
The US, the EU and countries scrutinise or regulate international business activities, including relevant Chinese outbound investment activities, to achieve national security, foreign investment control, and competition law and other objectives. In connection with Chinese investors’ investing in or acquiring target assets in the US or EU Member States, the relevant parties should be aware of potential foreign approvals that may be mandatory or necessary in the jurisdiction where the target is located depending on the nature and size of the transactions, which may include US and EU merger control review and Committee on Foreign Investment in the United States (CFIUS) review. A CFIUS review is often perceived by parties to Chinese outbound investments as one of the major foreign regulatory hurdles.
CFIUS is an inter-agency committee of the US government that is empowered to review transactions that result in control of a US business by a non-US person to evaluate whether such transactions may create a national security risk. CFIUS establishes the process for reviewing the national security impact of foreign investments, joint ventures and other investments into US-located businesses, and CFIUS analyses a broad range of national security factors to evaluate whether a transaction may create a national security risk to the US. Although the CFIUS notification process is voluntary, transactions not voluntarily notified to CFIUS may be investigated or even unwound post-closing. Therefore, parties to transactions that involve Chinese buyers often need to assess whether the proposed transaction could raise national security concerns and potential CFIUS risks, and be prepared to develop and execute parallel workplans to address concerns of CFIUS and other interested parties.
CFIUS risks are highlighted by some recent Chinese outbound investment transactions abandoned or terminated due to CFIUS issues, including:
- a the executive order issued by President Obama in December 2016 blocking the proposed acquisition of German semiconductor manufacturer Aixtron SE’s US business by a group of Chinese investors led by Fujian Grand Chip Investment Fund LP;
- b the termination in January 2016 of the attempted acquisition of Philips NV’s Lumileds LED business by a consortium of Chinese investors led by GO Scale Capital due to parties’ failure to address national security concerns raised by CFIUS;
- c termination in February 2016 of the proposed investment in Western Digital by Unis Union and Unisplendour after CFIUS determined to investigate the transaction; and
- d rejection by US chipmaker Fairchild Semiconductor International in February 2016 of a bid from China Resources Microelectronics citing an ‘unacceptable level’ of CFIUS risk.
III YEAR IN REVIEW
i Recent deal activity
The trend of US-listed Chinese companies going private heated up in 2015 and continued in 2016. Based on statistics obtained through searches on Thomson ONE, during 2014, eight US-listed going-private transactions were announced and 17 were closed; during 2015, 25 US-listed going-private transactions were announced and six were closed; and during 2016, 15 US-listed going-private transactions were announced and 18 were closed.
The struggle by some Chinese companies against market research firms and short sellers has often provided interesting perspectives on the environment faced by Chinese companies listed in the US. Market research firms, and short sellers such as Muddy Waters Research and Citron Research, building on their successes in past years, continued to target Chinese companies listed in the United States in 2016 by issuing critical research reports. The business model of such firms appears to be issuing negative research reports on a public company while simultaneously taking a short position in the company’s stock, which often enables such firm to make substantial profits, even if their research and accusations are not ultimately proven correct. Notably, these firms have not limited their coverage to companies listed through reverse takeovers (RTOs),16 which are commonly considered to have lower profiles and to be more prone to disclosure issues. Following the consequential coverage by Muddy Waters of Orient Paper Inc in 2010 and Sino-Forest Corp in 2011, the most notable case in 2012 arose when, on 18 July 2012, Muddy Waters published on its website a scathing report on New Oriental Education & Technology Group Inc, sinking the company’s share price to US$9.5 by 35 per cent in one day. New Oriental is widely considered one of the more reputable and well-run Chinese companies listed in the US and went public in a traditional IPO. The company’s stock price subsequently recovered to US$13.90 a month and a half after the Muddy Waters report came out, suggesting the market’s belief that the accusations were not justified. From 2011 to 2012, Citron Research, Anonymous Analytics and certain other short-selling organisations and individuals have issued a series of reports that portrayed Qihoo’s business and financial position as overvalued and fraudulent, which were rebutted by Qihoo and which proved to be fruitless attacks resulting in little impact on the share price of Qihoo, suggesting that investors in the US market could remain rational when facing this type of short-selling attempt. On the other hand, on 24 October 2013, Muddy Waters published an 81-page report labelling Beijing-based mobile provider NQ Mobile Inc a ‘massive fraud’, sending the company’s share price tumbling more than 60 per cent in three days. NQ’s share price experienced substantial recovery during Q4 2013 and Q1 2014, but has lost more than 80 per cent in value amid continued attacks by Muddy Waters, and currently trades at around one-sixth of its 2013 high.
Regardless of the ultimate outcome, the fact that a single research report could inflict so much substantial and sudden damage to a company’s stock price strongly suggests a widespread underlying lack of confidence in listed Chinese companies. The success of these research and short-selling firms could also be partially attributed to a lack of access to and understanding of the Chinese business environment and markets, which has afforded a few firms that have conducted on-the-ground research outsized influence in the market. Further, such critical coverage, which often involves allegation of disclosure issues or even fraud, have attracted regulatory attention and shareholder lawsuits, and may have encouraged less-than-generous media coverage of Chinese companies in general. For instance, in 2013, the SEC publicised its investigations into, and charges imposed against, US-listed China MediaExpress and its chair and CEO for fraudulently misrepresenting its financial condition to investors in SEC filings dating back to November 2009, and against RINO International Corporation, a China-based manufacturer and servicer of equipment for China’s steel industry, and its chair and CEO for a series of disclosure violations based on accounting improprieties, after Muddy Waters initiated coverage of its investigation into fraud by, and issued negative reports against, these companies from 2010. The above factors, in turn, are believed to have contributed to suppressed valuations of US-listed Chinese companies in general.
Amid continued pressure from regulators, unfavourable media coverage, short-selling activities and shareholder lawsuits, the stock prices of many US-listed Chinese companies remained depressed from 2013 to 2016. Further, even Chinese companies relatively free of negative coverage often felt that their business model and potential are not fully appreciated in the US market, and that they would be more favourably received by a market closer to China – for example, the Hong Kong Stock Exchange or the Chinese A-share market – where market research and media coverage are seen as being more positive and reflecting a proper appreciation of the business culture and environment in China, resulting in a better understanding of the specific business models and potential of the companies covered. At the same time, the booming domestic Chinese stock market (with an average price-earnings ratio (P/E ratio) of 15.91 at the end of 2016 and 17.61 at the end of 2015) for A-share listed companies listed on the Shanghai Stock Exchange and an average P/E ratio of 41.62 at the end of 2016 (and 53.34 at the end of 2015) for A-share listed companies listed on the Shenzhen Stock Exchange) often offered valuations several times greater than those offered in the US.
The disparity in valuation levels and perceived receptiveness naturally present a commercial case for management and other investors to privatise US-listed Chinese companies, with the hope of relisting them in other markets. One of the most significant going-private transactions announced and signed during 2015 was the proposed acquisition of Qihoo 360 Technology Co Ltd by a consortium consisting of its co-founder and chair, Hongyi Zhou, its co-founder and president, Xiangdong Qi and certain other investors, in a transaction valuing the NYSE-listed company at approximately US$9.3 billion (not taking into account shares to be cancelled for no consideration). This deal was closed in July 2016 and was the largest privatisation of a US-listed Chinese company (the second-largest being the take-private of Qunar Cayman Islands Ltd by Ocean Imagination LP, which was signed in 2016, valuing Qunar at US$4.59 billion).
While earlier going-private transactions involving US-listed Chinese companies tend to have smoother processes, some more recent transactions of this type went through more eventful processes, suggesting increased challenges in completing such transactions in a more competitive deal-making environment with a shrinking pool of desirable targets. For example, in the going-private transaction of NASDAQ-listed Yongye International Limited, the initial bid of the buyer consortium led by Morgan Stanley Private Equity Asia and the company’s CEO failed to receive the requisite shareholder approval, and the transaction was approved in a subsequent shareholder meeting only after the buyer consortium raised its bid by 6 per cent. In the going-private transaction of hospital operator Chindex International Inc, the initial offer of US$19.50 per share from the buyer consortium comprising Shanghai Fosun Pharmaceutical, TPG and the company’s CEO was countered by a rival offer of US$23 per share received by the company in the ‘go shop’ period, and the buyer consortium eventually had to raise its offer to US$24 a share to secure the transaction, raising the total price tag to US$461 million. A more recent case that has drawn market attention is iKang Healthcare. While the iKang special committee was considering a going-private proposal submitted in August 2015 by a consortium led by Ligang Zhang, its founder, chair and CEO, and FountainVest, in November 2015, the iKang board received a competing proposal from a consortium led by one of iKang’s main competitors, Meinian Onehealth Healthcare (Group) Co, Ltd, a Shenzhen-listed company. The founder-led consortium and the Meinian-led consortium have since engaged in an intense publicity war, and despite the fact that iKang’s board adopted a poison pill in an apparent attempt to thwart Meinian’s bid, Meinian increased its offer price for a second time. In June 2016, after the board of directors of iKang received a competing go-private proposal from Yunfeng Capital (a private equity firm co-founded by Alibaba Group Holdings Ltd’s Jack Ma and Focus Media Holdings’ David Yu) to acquire the entire share capital in iKang, both the founder and the buyer group led by Meinian determined and notified iKang to withdraw their go-private proposals involving iKang.
The going-private trend was not limited to entities resulting from an RTO; 12 of the 15 US-listed China-based companies that announced receipt of a going-private proposal in 2016, for example, were Cayman Islands companies (and one was a British Virgin Islands company) that accessed the public markets through a conventional IPO, compared with 23 Cayman Islands companies out of 24 US-listed China-based companies in deals announced in 2015, and four Cayman Islands or British Virgin Islands companies out of five significant China-based companies in deals announced in 2014. While companies listed through RTOs may be easier targets of short sellers, companies that listed in the United States through a conventional offering may be more appealing targets for private equity investors given that these companies are often perceived to be stronger and less likely to have accounting or securities law compliance issues, and thus more likely to grab a higher valuation in the future.
A majority of US-listed China-based companies involved in going-private transactions in recent years are incorporated in the Cayman Islands. This was driven in part by the introduction of new merger legislation in the Cayman Islands in April 2011, which made statutory mergers under the Cayman Islands Companies Law an attractive route to effect a going-private transaction. The merger process typically requires the buyer group to form a new Cayman Islands company that will merge with, and be subsumed by, the listed Cayman target. Under the 2011 amendments to the Cayman Islands Companies Law, the shareholder approval threshold for a statutory merger was reduced from 75 per cent to a two-thirds majority of the votes cast on the resolution by the shareholders present and entitled to vote at a quorate meeting, absent any higher threshold in the articles of association of the target company. The lower approval threshold makes it an attractive option when compared with either a ‘squeeze out’ following a takeover offer, which would require the buyer consortium to obtain support from 90 per cent of the shareholders, or a scheme of arrangement, which would add time and costs arising from the court-driven process.
Most of the transactions that closed in 2016 took between two and four months from the conclusion of definitive agreements to close (the rest typically took five months or longer from such time to close) and were structured as a one-step, negotiated merger (as opposed to a two-step transaction consisting of a first-step tender offer followed by a second-step squeeze-out merger, which is the other basic approach to acquire a US public company). In a one-step merger, a company incorporated in a US state will be subject to the US proxy rules, which require the company to file a proxy statement with the SEC and, once the proxy statement is cleared by the SEC, to mail the definitive proxy statement to the shareholders and set a date for its shareholders’ meeting. Transactions involving affiliates (e.g., management) are ‘going-private’ transactions as defined under Rule 13e-3 of the Securities and Exchange Act, also commonly referred to as ‘13e-3 transactions.’ A 13e-3 transaction requires making additional disclosures to the public shareholders, including as to the buyer’s position on the fairness of the transaction. An important implication is that, whereas the SEC reviews only a fraction of all proxy statements, it routinely reviews 13e-3 transactions, which can lengthen the process by several months. Companies incorporated outside the United States and listed on US stock exchanges (including the recent going-private targets that often are incorporated in the Cayman Islands or the British Virgin Islands) are known as foreign private issuers (FPIs). FPIs are not subject to the proxy rules, but they are subject to 13e-3 disclosure obligations and are required to include as an exhibit to their 13e-3 filings most of the information that is required to be disclosed in a proxy statement by a US domestic issuer. Accordingly, both a transaction involving a US domestic company and a 13e-3 transaction involving an FPI follows a comparable timetable for the purposes of SEC review.
It is worth noting that the recent tightening of control on capital flows out of China, including regulations restricting Chinese onshore funds from participating in the going-private of offshore-listed China-based companies, may deter or have deterred the speed of going-private of offshore listed China based companies. It remains to be seen how long the tightened control on outbound capital flow will last and its exact impact on going-private transactions involving Chinese companies.
Other notable transactions
Consolidations in the vying internet and technology industry in China has been soaring and hitting headlines since 2015. In February 2015, Didi Dache and Kuaidi Dache, two of China’s leading ride-hailing apps, announced their US$6 billion stock-for-stock merger which was closed weeks thereafter, creating Didi Kuaidi (later rebranded as Didi Chuxing), one of the world’s largest smartphone-based transport service providers. In August 2016, Didi Chuxing announced its acquisition of Uber China (Uber’s China business), which was valued at around US$8 billion. After the transaction, Didi Chuxing was estimated to be worth around US$35 billion. Uber obtained a 17.7 per cent stake in Didi Chuxing and became its largest shareholder, with other existing investors in Uber China, including Chinese search giant Baidu Inc, taking another 2.3 per cent stake in Didi Chuxing. In April 2015, NYSE-listed 58.com purchased a 43.2 per cent fully diluted equity stake in Ganji.com for US$1.56 billion, initiating the long-term strategic combination of these two major online classified providers in China. In October 2015, two major online-to-offline (O2O) service providers in China, the group-buying service Meituan.com and restaurant review platform Dianping Holdings, announced a merger to create a US$15 billion giant player in China’s O2O market covering restaurant review, movie booking and group buying businesses. In late October 2015, China’s largest online tourism platform, Ctrip, announced the completion of a share exchange with Baidu, Inc through which it gained control of its rival Qunar. The transaction formed a dominant player in the online trip booking market in China valued at US$1.56 billion. In January 2016, Meilishuo.com, a Chinese fashion retailer backed by Tencent Holdings Ltd, announced its merger with its chief rival Mogujie.com to form the biggest fashion-focused e-commerce service provider in China with a valuation of nearly US$3 billion.
Another noteworthy theme from 2013 to 2016 was private equity investors’ participation in the mixed ownership reform of China’s SOEs, where Chinese SOEs introduce private investors as minority shareholders. The highlight of this theme was the US$2.4 billion acquisition in 2014 of a 21 per cent equity interest in China Huarong Asset Management Co, Ltd, one of the largest asset management companies in China, which became listed on the Hong Kong Stock Exchange in 2015, by a consortium of investors including China Life Insurance (Group) Company, Warburg Pincus, CITIC Securities International Company Limited, Khazanah Nasional Berhad, China International Capital Corporation Limited, China National Cereals, Oils and Foodstuffs Corporation (COFCO), Fosun International Ltd and Goldman Sachs. Warburg Pincus was reported to have bought the largest portion of the 21 per cent stake for close to US$700 million.
Third-party debt financing continues to be available for acquisitions of Chinese companies by private equity investors. One key challenge, however, is that a Chinese target does not generally have the ability to give credit support (by way of guarantee or security over its assets) to a lender of offshore acquisition finance debt.
Many of the going-private transactions of US-listed Chinese companies involved debt financing, with the terms of the financings reflecting various commercial and structural challenges. The acquisition debt is typically borrowed by an offshore acquisition vehicle with the borrower giving security over its assets (including shares in its offshore subsidiaries) to secure repayment of the debt. As was the case in 2011 and 2012, the typical lender in these transactions spanned a wide range of financial institutions, from international investment banks to Chinese policy banks and offshore arms of other Chinese banks.
The Focus Media financing remains the standout transaction among debt-financed going-private transactions, due mainly to the size (US$1.52 billion) and complexity of the debt financing facility and the large consortium of both major international banks (Bank of America Merrill Lynch, Citibank, Credit Suisse, DBS Bank, Deutsche Bank and UBS) and offshore arms of Chinese banks (China Development Bank, China Minsheng and ICBC) that provided the financing. The 7 Days Inn financing was another notable debt-financed going-private transaction that was largely financed by a syndicate of Asian banks (Cathay United Bank, China Development Industrial Bank, CTBC Bank, Entie Commercial Bank, Nomura, Ta Chong, Taipei Fubon Commercial Bank, Bank of East Asia and Yuanta Commercial Bank). The debt financing for the Giant Interactive take-private was also underwritten and arranged by a large syndicate of banks, including China Minsheng Banking Corp, BNP Paribas, Credit Suisse, Deutsche Bank, Goldman Sachs, ICBC International and JP Morgan in an aggregate amount of US$850 million. It can perhaps be considered as a positive signal for any future going-private transactions that such a large number of financiers were comfortable to commit to funding this type of event-driven financing.
One notable development since 2015 is reflected in the going-private of Qihoo. Rather than obtaining the debt financing in US dollars offshore, the entire financing of a yuan equivalent of approximately US$3.4 billion was provided by one Chinese bank (China Merchants Bank (CMB)) onshore in yuan, with the buyer group having obtained the required Chinese regulatory approvals to convert the yuan funded by CMB into US dollars for payment of consideration to Qihoo’s shareholders offshore. It remains to be seen whether this relatively novel deal structure will gain popularity as both Chinese regulatory authorities and financial institutions gain more familiarity with this type of take-private transactions involving US-listed and China-based companies. The tightened control over outbound capital flow since late 2016 discussed above may deter the wide usage of this type of deal structure.
Another emerging theme in these offshore financing structures is that borrowers are seeking to access liquidity from the US debt markets in respect of what are essentially acquisitions of Chinese-based businesses – including as a means for a take-out for bridge financing originated out of Asia.
iii Key terms of recent control transactions
Deal terms in going-private transactions
Most of the Chinese going-private transactions have involved all-cash consideration. Among the US-listed going-private transactions that closed during 2016, the per-share acquisition price represented an average premium of 25.6 per cent over the trading price on the day before announcement of receipt of the going-private proposal, according to statistics obtained through searches on Thomson ONE.
In a 13e-3 transaction (typically the going-private of a US-listed company involving company affiliates), the board of directors of the target typically appoints a special committee of independent directors to evaluate and negotiate the transaction and make a recommendation. If the target is incorporated in the United States, the transaction almost inevitably will be subject to shareholders’ lawsuits, including for claims of breaches of fiduciary duties, naming the target’s directors as defendants. Because the target’s independent directors often include US residents, a key driver of a transaction’s terms is the concern for mitigating shareholders’ litigation risk. Although no litigation claims for breach of fiduciary duties in a Chinese going-private transaction involving Cayman or British Virgin Islands companies were reported to the public in 2015, it remains possible that, as the going-private trend persists, plaintiffs’ firms will begin to articulate creative arguments in Cayman mergers, and the Cayman courts may look to the body of Delaware law as persuasive precedent for adjudicating claims of breach of fiduciary duties. As a result, whether a going-private transaction involves a US or Cayman-incorporated target, targets typically insist that certain key merger agreement terms (in addition to the deal process) be within the realm of what is ‘market’ for similar transactions in the United States.
An important negotiated term in many going-private transactions is the required threshold for shareholder approval. Delaware law requires that a merger be approved by shareholders owning a majority of the shares outstanding. Special committees often insist on a higher approval threshold, however, because under Delaware law, the burden of proving that a going-private transaction is ‘entirely fair’ to the unaffiliated shareholders shifts from the target directors to the complaining shareholders if the transaction is approved by a majority of the shareholders unaffiliated with the buyer group (i.e., a ‘majority of the minority’). In US shareholder litigations, this burden shift is often seen as outcome-determinative. Under Cayman law, there is no well-defined benefit for the company to insist on a higher approval threshold than the statutory requirement of two-thirds of the voting power of the target present at the shareholder meeting.
Another key negotiation point is whether the target would benefit from a go-shop period, which is a period following signing of the transaction agreement during which the target can actively solicit competing bids from third parties. When defending against a claim of breach of fiduciary duty in Delaware, a company and its directors may point to a go-shop period in a merger agreement as a potentially helpful fact. Under Cayman law, however, there is not as much well-defined benefit for the company to insist on a go-shop period if the buyer consortium already has sufficient voting power to veto any other competing merger proposal.
Deal terms in growth equity investments
Deal terms are more difficult to evaluate and synthesise in private transactions, where terms are not publicly disclosed. Generally, in the context of a growth equity investment (which, as we have seen, remains the dominant type of deal both by number of deals and by aggregate amount invested), private equity investors often continue to expect aggressively pro-buyer terms. This expectation applies whether a transaction involves an onshore Sino-foreign joint venture or an investment offshore alongside a Chinese partner. In a subscription agreement for a growth equity deal, an investor typically benefits from extensive representations and warranties against which the company makes only limited disclosures; in some cases, an investor has knowledge that some representations may not be accurate, but still insists on a representation to facilitate a potential indemnification claim later. It is not uncommon for an investor to also enjoy an indemnity provision with a cap on the amount of losses subject to indemnification as high as the purchase price (or no cap at all), but with no deductible or threshold and with an unlimited survival period. Shareholders’ agreements often contain similarly pro-investor terms, such as extensive veto rights (even in the case of a relatively small minority stake) and various types of affirmative covenants binding the company and its Chinese shareholders. If an investment is structured offshore (through, for example, a Cayman company that owns a Chinese subsidiary), a private equity investor may enjoy ‘double-dip’ economics pursuant to which, in the event of a liquidation or sale of the company, the investor is entitled to first, a liquidation preference before any of the Chinese shareholders receive any proceeds, and second, such investor’s pro rata share of the remaining proceeds based on the number of shares it owns on an as-converted basis. Because there is no well-defined ‘market’ when it comes to transaction terms in Chinese growth equity deals (unlike in going-private transactions), however, issuers also have opportunities to request, and sometimes obtain, terms that are very favourable to them. In growth equity deals in China, investors typically seek valuation adjustments or performance ratchet mechanisms, which can be structured as the adjustment to conversion prices of preferred shares that may be exchanged into larger number of common shares at offshore level, or by compensation or redemption of equity interest in cash or transfer of equity interest to investors by the founder(or founders) or original shareholders at onshore level without consideration or with nominal consideration, so as to justify adjusted valuation of the target company following the failure to achieve target operating results. In Chinese growth equity investments, the parties’ respective leverage and degree of sophistication are more likely to dictate the terms that will apply to a transaction than any market practice or standard. In more recent transactions, growth equity investments into high-growth technology companies have begun to contain less investor-friendly deal terms (e.g., new investors receiving pari passu liquidation preference with previous investors) as the competition by private equity firms to make investments into this sector continues to heat up.
For a private equity investor with sufficient commercial leverage, the key challenge often lies not in convincing the investee company or its Chinese shareholders to agree to adequate contractual terms, but rather in getting comfort that an enforceable remedy will be available in the event that the Chinese counterparty reneges on its contractual obligations. One potential antidote to the difficult enforcement environment onshore is to seek a means of enforcement offshore. An investor can get comfort if it obtains, for example, a personal guarantee of the Chinese founder backed by assets outside of China, governed by New York or Hong Kong law and providing for arbitration in Hong Kong as a dispute resolution venue. Such a guarantee, however, is rarely available (because the Chinese founder may not have assets outside of China) and, even when potentially available, is often unacceptable to the founder. A more realistic alternative is for a private equity investor to seek the right to appoint a trusted nominee in a chief financial officer or similar position (who could monitor an investee company’s financial dealings and compliance with its covenants to its shareholders). An investor may also seek co-signatory rights over the target company’s bank account, in which case an independent third party (the bank) will ensure that funds are not released other than for purposes agreed to by the investor.
Among the US-listed going-private transactions that closed during 2016, the parties took an average of four months from the announcement of the going-private proposal to reach definitive agreement, and a further four months on average from signing the definitive agreement to close the transaction. Typically, the pre-signing timetable is less predictable and to a large extent driven by negotiation dynamics, the finalisation of the members of the buyer consortium and the parties’ willingness to consummate the deal, which in turn is affected by market conditions, availability of equity and debt financing, and various other factors. On the other hand, the post-signing timetable is typically largely driven by the SEC review process and shareholder meeting schedule, and as a result is relatively more predictable. That being said, the going-private of Shanda Games took more than seven months from the signing of a definitive agreement to close, substantially longer than what typically is required of the SEC review and shareholder approval processes, due to, inter alia, changes in the composition of the buyer consortium after signing. The going-private of Qihoo and Xueda Education also each took more than seven months from the signing of a definitive agreement to close, reportedly due to the procedures required to obtain outbound investment regulatory approvals or complete other governmental formalities relating to relevant Chinese onshore buyers. While these are more exceptions than the norm, these transactions do flag for market participants the significant time and resource commitment required of participants in a going-private transaction, and the ever-changing dynamics of market demand and within the buyer consortium (including the time to have all the necessary funds in place), all of which factors could affect the timetable to completion.
At the forefront of the privatisation wave in the US and Chinese markets, Focus Media achieved a 45.7 billion yuan backdoor listing on the Shenzhen Stock Exchange in December 2015 through Hedy Holding Co Ltd after a reverse merger, which followed Focus Media’s 2013 going private and delisting from the US led by a consortium of private equity investors. This deal represented the first re-listing of a once NASDAQ-listed company on the A-share market, and has blazed a trail for US-listed Chinese companies seeking to go private and thereafter re-list in the domestic market. Giant Interactive achieved a 13.1 billion yuan backdoor listing on the Shenzhen Stock Exchange in April 2016 through Chongqing New Century Cruise Co Ltd after a reverse merger, which followed Giant Interactive’s 2014 going private and de-listing from the US led by a consortium consisting of Giant Interactive’s chair Shi Yuzhu and private equity investors, including Baring Private Equity Asia, Hony Capital and CDH Investments, making Giant Interactive the first once US-listed Chinese online game company getting re-listed on the A-share market.
As US listings of Chinese companies picked up in 2016, the Shanghai-based logistics company ZTO Express, backed by Sequoia Capital as an early stage investor and Warburg Pincus, Hillhouse Capital Group, Gopher Asset and Standard Chartered Private Equity, who invested in a Series A financing of the company in 2015, raised US$1.4 billion in its listing on NYSE in October 2016, ranking as the largest IPO by a Chinese company in the US in 2016, and second-largest after Alibaba for US IPOs of China companies in history.
Another recent highlight for private equity-backed IPOs was the debut of China Huarong Asset Management Co, Ltd, which ranked as the third-largest offering in Hong Kong in 2015, with a value of around US$2.3 billion and with a suite of pre-IPO strategic investors including China Life Insurance (Group) Company, Warburg Pincus, CITIC Securities International Company Limited, Khazanah Nasional Berhad, China International Capital Corporation Limited, COFCO, Fosun International Ltd and Goldman Sachs, following the acquisition of a 21 per cent equity interest in China Huarong by these investors, which closed in August 2014.
Also noteworthy is the IPO of Beijing Baofeng Technology Co, Ltd on the Shenzhen Stock Exchange in 2015, which became the first ever listing of a Chinese internet company on China’s A-share market after phasing out its variable interest entity (VIE) structure, and trailblazing a trend of Chinese technology companies tearing down VIE structures and seeking to be listed on Chinese or Hong Kong stock exchanges.
Finally, another recent highlight in exits via a trade sale is the sale by two funds affiliated with China International Capital Corporation of their 32 per cent equity interest in Jiangyin Tianjiang Pharmaceutical Co, Ltd, China’s largest manufacturer of concentrated traditional Chinese medicine granules, to Hong Kong-listed China Traditional Chinese Medicine Co Limited in a transaction announced in January 2015 and completed in October 2015, which valued the target at over US$1.5 billion.
IV REGULATORY DEVELOPMENTS
i MOFCOM record-filing regime in regulating FIEs
On 3 September 2016, the Standing Committee of the National People’s Congress of the PRC adopted a decision to amend and restate four PRC FIE laws, including the Law on Wholly Foreign-Owned Enterprises (which applies to WFOEs), the Law on Sino-Foreign Equity Joint Ventures (which applies to EJVs), the Law on Sino-Foreign Cooperative Joint Ventures (which applies to CJVs) and the Law on the Protection of Investment of Taiwan Compatriots. These amendments took effect on 1 October 2016. These amendments replaced the previous MOFCOM approval requirements with a record-filing regime nationwide for all FIEs that are not subject to ‘national market access restrictions’ (which refers to the prohibited and restricted categories in the Foreign Investment Catalogue as well as any encouraged categories with minimum Chinese shareholding or senior management nationality requirements) in respect of:
- a WFOEs’ establishment, consolidation, divestiture, extension of term and other key corporate changes;
- b EJVs’ joint venture contracts, articles of association, extension of term and early termination;
- c CJVs’ cooperative contracts, articles of association, extension of term, transfer of JV interest and designation of third-party management; and
- d establishment of enterprises invested by Taiwan compatriots.
On 8 October 2016, MOFCOM promulgated the Provisional Measures for Record-filing Administration of the Establishment and Changes of FIEs (MOFCOM Order  No. 3) (FIE Record-filing Rules), which took effect on the same date. The FIE Record-filing Rules set out the procedures of the new record-filing regime to replace the approval regime for applicable foreign investment and FIE matters. Such filing regime is applicable to the incorporation of FIEs, and filings of FIEs’ corporate changes, except for matters that are subject to ‘national market access restrictions’. Filings shall be made through MOFCOM’s online Foreign Investment Integrated Administration Information System.
NDRC and MOFCOM have clarified that the new record-filing regime does not change the current regulatory approval regimes applicable to:
- a foreign investments (either greenfield investments or through an M&A, irrespective of investment amount) in a restricted or prohibited sector under the Foreign Investment Catalogue, or an encouraged sector where there are restrictions on the foreign equity ratio or the identity of senior management under the Foreign Investment Catalogue;
- b any acquisition of domestic enterprises (non-FIEs) in the PRC by foreign investors, which shall be subject to the M&A Rules; and
- c foreign investors’ investment in listed companies, which shall be subject to the Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors.
ii Negative List market entry system
On 19 October 2015, the State Council of the PRC issued the Opinion on the Implementation of the Negative List Market Entry System. The Opinion reflects the Negative List approach that was first applied in China (Shanghai) Pilot Free Trade Zone, and was later introduced to pilot FTZs in Guangdong, Fujian and Tianjin. Implementation of a Negative List approach is also provided under the Draft FIL. According to this Opinion, the Negative List regime is scheduled to be trialed in certain areas (announced to be Tianjin, Shanghai, Fujian and Guangdong) from 1 December 2015 to 31 December 2017, and to be officially rolled out nationwide from 2018. NDRC and MOFCOM are taking the lead in drafting the Negative List and the determination of trial areas. The Negative List will mainly include a market access negative list and a foreign investment negative list. The market access negative list will be a control measure equally applicable to domestic and foreign investors, and will set out the same requirements for market access management purposes for all business operators. The foreign investment negative list will apply to foreign investors’ investment and operation activities in China, and act as special control measure targeting market access by foreign investment.
On 2 March 2016, NDRC and MOFCOM jointly issued the Draft Negative List for Market Access (Trial Version). The Draft Negative List contains 232 ‘restricted’ (i.e., subject to approval) and 96 ‘prohibited’ items, and these items were partly compiled from existing laws, regulations and administrative catalogues, and also include new restrictive or prohibitive measures (for example, an approval requirement for collaborations between domestic media and foreign news agencies, and a content censorship requirement for gaming and entertainment equipment prior to sale of the same in China). The measures specified in the Draft Negative List will apply to both Chinese and foreign investors. This Draft Negative List is pilot-run in Tianjin, Shanghai, Fujian and Guangdong.
iii Expansion of areas and new regulatory regime for pilot FTZs
On 28 December 2014, the Standing Committee of the National People’s Congress promulgated new rules to establish pilot FTZs in Guangdong, Tianjin and Fujian, and to expand the area of the current China (Shanghai) Pilot Free Trade Zone. The new rules took effect on 1 March 2015. Under the new rules, the current MOFCOM approval requirements for the following matters would become simplified filing requirements:
- a FIE formation; extension of FIE operation term;
- b division, merger or other material changes for WFOE;
- c dissolution of an EJV;
- d material changes to joint venture contracts and articles of association for a CJV; and
- e transfer of interests in a CJV or entrusted management of a CJV.
Thereafter, several new rules have been promulgated to streamline regulatory approval requirements or relax foreign investment restrictions in the FTZs, including the following developments.
On 8 April 2015, the General Office of State Council of the PRC issued the Special Administrative Measures for Foreign Investment Access in Pilot Free Trade Zones (FTZ Negative List) applicable to the four FTZs, which took effect 30 days following the date of issuance. Such FTZ Negative List, subject to adjustment as appropriate by the authorities, contains industry-specific measures and uniform measures applicable to all industries. Foreign investment in FTZs in industry sectors other than those specified in the FTZ Negative List will be administered in accordance with the principle of equal treatment of domestic and foreign investors, and the relevant FIEs can be established by a company-registration procedure with no foreign investment approvals required.
On 8 April 2015, central MOFCOM issued the Administrative Measures for the Record-filing of Foreign Investment in Free Trade Zones (for Trial Implementation) (FTZ Record-filing Measures), which took effect 30 days following the date of issuance. Where a foreign investor makes an investment in a sector other than those specified in the FTZ Negative List, the record-filing of the incorporation, as well as subsequent changes of a foreign-invested enterprise and its joint venture contract and articles of association, shall be subject to the FTZ Record-filing Measures. The FTZ Record-filing Measures underscore that, where a foreign investor is to incorporate an enterprise in FTZs engaging in a business not in the FTZ Negative List and subject to the record-filing regime, the foreign investor shall, after having obtained the corporate name clearance, log onto an online one-stop FTZ platform to submit a filing application either before the implementation of investment (i.e., issuance of business licence for incorporating a new FIE) or within 30 days of the implementation of the investment. The filing authority will scrutinise whether the matter submitted should be subject to filings, and if they decide that it should be, the authority should complete the filing formality within three business days.
On 25 August 2015, central MOFCOM issued Shang Zi Fa  No. 313, an opinion on supporting the innovative development of FTZs (Circular 313) with immediate effect. Circular 313 relaxes the requirements for FIEs in FTZs to engage in the direct selling business, and allows foreign investors to establish foreign-invested pawn enterprises and WFOEs for the construction and operation of gas stations in FTZs.
On 19 July 2016, the State Council of the PRC published the Decision on Provisional Adjustment of Administrative Rules and Regulations in Pilot Free Trade Zones (Circular 41). Based on Circular 41, among other changes, in designated FTZs (which may include the expanded area of Shanghai FTZ in respect of certain changes), certain restrictions on foreign investments (including restrictions on foreign shareholding ratios or full foreign ownership) set forth in the Foreign Investment Catalogue and other existing regulations are temporarily lifted in the following sectors:
- a exploration and development of oil and natural gas (including oil shale, oil sand, shale gas, coal bed methane and other non-conventional oil resources);
- b usage of mining gas;
- c processing of edible oils from soybean, rapeseed, peanut, cottonseed, tea seed, sunflower seed, and palm;
- d manufacturing of biofuels (ethanol and biodiesel);
- e manufacturing of motorcycles;f manufacturing of certain rail equipment;
- g construction and operation of gas stations;
- h construction and operation of comprehensive water-conservancy hubs;
- i manufacturing and R&D of electronic equipment for autos;
- j manufacturing of energy storage batteries for new energy vehicles;
- k steel production;
- l selection and breeding of new types of agricultural goods and production of seeds;
- m purchase of grain, wholesale of grain and cotton, and establishment of large-scale agricultural wholesale markets;
- n accreditation and certification agencies;
- o air cargo sales agencies, warehousing, ground services and food services;
- p performance (entertainment) agent companies;
- q marine shipping brokers, marine shipping services and management services;
- r printing published materials; and
- s entertainment centres.
iv PRC Cybersecurity Law
On 7 November 2016, the Standing Committee of the National People’s Congress of the PRC passed the PRC Cybersecurity Law, which will take effect on 1 June 2017. The Law applies to all data transmitted and stored in networks within the PRC. The Law sets forth broad restrictions for cross-border data transfers, and specifies administrative and criminal liabilities (including penalties on foreign cyber attackers). One of the most significant provisions in the Law is the defined scope of network operators of ‘critical information infrastructure’ (CII), which covers information infrastructure used in public communications and information services, energy, transportation, water conservancy, finance, public services and e-government, and any infrastructure that, if it were to be destroyed, lose functionality or suffer a data leakage, may cause a material threat to national security, the social or economic wellbeing of the nation, or the public interest. The Law sets a high standard for cybersecurity protection obligations of CII operators.
Among other regulatory requirements, all personal and important data collected and stored by CII operators are required to be stored onshore subject to certain PRC localisation requirements, and restricted from cross-border transfers without proper security assessment and clearance; and if any purchase of network products or services may have an impact on national security, CII operators are required to pass certain national security reviews conducted by cybersecurity authorities.
In light of increased scrutiny by regulators in both the US and China, foreign private equity investors in China continue to increase their focus on rigorous pre-transaction anticorruption due diligence, taking steps to ensure that any improper conduct has ceased prior to closing and implementing robust compliance policies after closing. In high-risk scenarios, such as transactions involving companies where significant government interactions are necessary for their operations, the process can be complex and expensive.
We expect several key factors to impact the level of deal-making activities in 2017 as compared to 2016. One key theme of the region going into 2017 is to what extent and in what sectors and geographical regions China will maintain its economic growth. As China continues to manage a ‘soft-landing’ and to restructure its economy, certain investors may find new opportunities, while other investors may shy away from deal making due to increased uncertainty and a less rosy outlook. The regulatory landscape is also a key factor that would impact investment patterns. The regulators’ tightened scrutiny of outbound investments may have the effect of slowing down Chinese outbound M&A, and bring some financial investors’ focus and interest back to the PRC domestic markets. Another related factor is the trend of yuan devaluation, and the government’s currency policies and efforts in stabilising the exchange rate of the yuan and related capital outflow. A continued slowdown of the economy or further devaluation of the currency, or both, may further change the market’s expectation regarding the value of the yuan, and needs to be taken into account in the evaluation of investment opportunities in the region for the short to mid-term. Exits via IPO for private equity investors may present challenges given the difficulties in accessing domestic A-share listings, and exits via trade sales or secondary sales may continue as the main exit route for a long period. Chinese banks could come to play a larger role in this type of transaction and M&A activities in the region in general given their still-strong capital position and Chinese regulators’ increased familiarity with international transactions and increased willingness to approve such transactions, and as these banks accumulate more experience across the table from major international players. One final factor to flag is the increasing role played by Chinese private equity funds in regional and international deal making. They are already playing major roles in a number of recently signed or closed transactions, including Qihoo and iDreamSky, and their presence in the market is likely to further increase as a result of the development of more onshore-oriented deal structures (such as that employed in Qihoo), which would allow these funds to fully utilise their vast reserve of onshore capital, and the larger role played by onshore Chinese banks with which the Chinese funds are more familiar.
While going-privates of Chinese companies listed in the US are slowing down, in 2017 there could be increased market attention on going-privates or takeovers of Chinese companies listed on the Hong Kong Stock Exchange. Two remarkable transactions heading the trend of the going-private of Hong Kong-listed companies are Blackstone’s US$322.6 million takeover of property and construction group Tysan Holdings, which was launched in August 2013 and closed in January 2014, and Carlyle’s take-private of Asia Satellite Telecommunications Holdings Ltd, where Carlyle agreed to buy out General Electric’s 74 per cent stake in the company for up to US$483 million, which was launched in December 2014 and closed in May 2015. In May 2016, Hong Kong-listed Wanda Commercial Properties’ controlling shareholder, Dalian Wanda Group, on behalf of joint offerers including Pohua JT Private Equity Fund LP, Ping An of China Securities and Shanghai Sailing Boda Kegang Business Consulting LLP, made an offer valued at US$4.4 billion for the going-private of Wanda Commercial Properties, the largest going-private offer in the history of the Hong Kong Stock Exchange . The deal was completed and Wanda Commercial Properties was delisted from the Hong Kong Stock Exchange in September 2016.
1 Huimin (Amie) Tang is a partner at Kirkland & Ellis International LLP and Xiaoxi Lin is a partner at Kirkland & Ellis. The authors wish to give special thanks to their Kirkland & Ellis Asia colleague Kanglin Liu for his significant contributions to this chapter, as well as Kirkland & Ellis Asia colleagues Pierre Arsenault, David Patrick Eich, Chuan Li, Gary Li, Douglas Murning, Jesse Sheley, David Zhang and Tiana Zhang for contributing to this chapter.
2 These rules include the Certain Provisions on Change of the Equity Interests of the Investors of a Foreign-Invested Enterprise, the Provisions of the Ministry of Foreign Trade and Economic Cooperation and the State Administration for Industry and Commerce on Merger and Division of Foreign-Invested Enterprises, and the Interim Provisions on Investment Made by Foreign-Invested Enterprises in China.
3 The term ‘issuer’ refers to any entities required to register under 15 USC 78 or file reports under 15 USC 78o(d). Therefore, foreign entities with American Depository Receipts are considered ‘issuers’ for the purpose of the FCPA.
4 15 USC 78m(b)(2)(A)-(B).
5 The FCPA’s anti-bribery provision prohibits making or offering any corrupt payment to any foreign government officials. The anti-bribery provisions apply to US ‘domestic concerns’ and any person in the territory of the US as well as the issuers. 15 USC 78dd-1-3.
6 17 November 2016, ‘JPMorgan Chase Paying $264 Million to Settle FCPA Charges’, Rel. No. 2016-241, available at www.sec.gov/news/pressrelease/2016-241.html.
8 1 March 2016, ‘SEC: Qualcomm Hired Relatives of Chinese Officials to Obtain Business,’ Rel. No. 2016-36, available at www.sec.gov/news/pressrelease/2016-36.html.
9 23 March 2016, ‘Novartis Charged with FCPA Violations,’ File No. 77431, available at www.sec.gov/litigation/admin/2016/34-77431-s.pdf.
10 30 September, ‘GlaxoSmithKline Pays $20 Million Penalty to Settle FCPA Violations,’ File No. 3-17606, available at www.sec.gov/litigation/admin/2016/34-79005-s.pdf.
11 4 February 2016, ‘SciClone Charged with FCPA Violations,’ File No. 34-77058, available at www.sec.gov/litigation/admin/2016/34-77058-s.pdf.
12 29 December 2016, ‘Wire and Cable Manufacturer Settles FCPA and Accounting Charges,’ Rel. No. 2016-283, available at www.sec.gov/news/pressrelease/2016-283.html.
13 30 August 2016, ‘AstraZeneca Charged with FCPA Violations,’ File No. 3-17517, available at www.sec.gov/litigation/admin/2016/34-78730-s.pdf.
14 27 December 2016, ‘Trading on Hacked Nonpublic Information Stolen From Two Law Firms,’ Rel. No. 2016-280, available at www.sec.gov/news/pressrelease/2016-280.html.
15 9 June 2016, ‘Consultant to Chinese Private Equity Firms Settles Insider Trading Charges,’ Lit. Rel. No. 23564, available at www.sec.gov/litigation/litreleases/2016/lr23564.htm.
16 In a typical RTO, a private company merges with a publicly traded company (often a ‘shell’ having limited assets and operations at the time of the RTO) through which process the private company injects its assets into the public company and the shareholders of the private company become controlling shareholders of the public company. As a result of the merger, the (formerly) private company’s business essentially becomes listed without that company having paid the cost, or gone through the vigorous vetting process and fulfilled the burdensome disclosure requirements of an IPO.