The Private Equity Review: China

I Overview

The robust recovery in China's private equity transactions from late 2020 continued in the first half of 2021, partially attributable to the implementation of the 'dynamic zero-case' policy by the Chinese authorities in face of the new covid-19 pandemic reality. The volume of private equity transactions dropped slightly in the third quarter of 2020, reacting to the policy uncertainty associated with the Beijing tightening the reins on the technology sector and the regulatory upheaval by both Chinese and US authorities on overseas listing of Chinese technology start-ups, and picked up again in the fourth quarter of 2020 with an all-time high of US$44.4 billion private equity fund deployment over the same period. This included the US$9.5 billion restructuring of Chinese chipmaker Tsinghua Unigroup led by JAC Capital and Wise Road Capital, and the US$6 billion pre-IPO commitment by PAG to the shopping mall operator Wanda Commercial Management Group. The year 2021 witnessed a substantial growth in both the volume and value of private equity investments in China, including 2,577 private equity investments (of which 1,261 were publicly disclosed) for an aggregate investment amount of approximately US$127.48 billion, according to AVCJ Research, the market research division of Asian Venture Capital Journal.2 This represents an 11.1 per cent increase in total investment volume and 24.3 per cent increase in total value compared with the 2,320 investments for an aggregate investment amount of approximately US$102.54 billion in 2020. China remained the most active private equity market in Asia and contributed approximately 36.7 per cent of the total value of private equity investments in the Asia-Pacific region in 2021.

Compared with 2020 statistics, the investment distribution based on financing stages in 2021 exhibited a slight increase in start-up and early-stage investments, a continued decrease in buyout investments (including management buyout, management buy-in, leverage buyout and turnaround or restructuring stages), a significant expansion in growth-stage investments, a meaningful decline in the private investment in public equity (PIPE) financing and a further decline in mezzanine and pre-initial public offering (pre-IPO) stage investments. According to AVCJ Research, investments in buyout transactions dropped from US$16.920 billion or 16.5 per cent of total investment value in 2020 to US$12.323 billion or 9.7 per cent of total investment value in 2021; investments in PIPE financing dropped from US$19,247 billion or 18.8 per cent of total investment value in 2020 to US$6.274 billion or 4.9 per cent of total investment value in 2020; investments at expansion and growth stages still stayed ahead of other investment stages in terms of the value, at US$78.205 billion in 2021, while representing a continued increase in terms of the proportion, from 48 per cent of total investment value in 2020 to 61.3 per cent of total investment value in 2021; investments at mezzanine and pre-IPO stages slightly decreased from US$10.731 billion in 2020 to US$9.628 billion in 2021; and investments at the start-up and early stages represented a bigger proportion of total investment value in 2021 than in 2020, expanding from 6.2 per cent of total investment value in 2020 to 8.6 per cent of total investment value in 2020.

The rise in China-based private equity buyouts in 2020 is consistent with the general trend in that space since 2010. In general, buyout investments in China have remained relatively less frequent in comparison with many other jurisdictions. Buyout activities experienced an increase in 2010 and 2011, further strengthened in 2012 to 2014 amid the growing popularity of going-private transactions involving China-based companies, particularly companies listed in the United States, and increased significantly again in 2015 as many US-listed Chinese companies received going-private proposals at the prospect of seeking a future listing on China's A-share market or the Hong Kong Stock Exchange. After experiencing a decline in 2016 and a short recovery in 2017, buyout activities in China hit a record low in 2018 and further dropped to the lowest point in history in 2019, and going-private activities were almost suspended. Both buyout and going-private activities experienced a strong rebound in 2020, which did not continue into 2021. Based on statistics obtained through searches on the Thomson Reuters database Thomson ONE, of the 259 going-private transactions announced since 2010, 41 did not proceed and 167 have closed (12 closed in 2010, 16 closed in 2011, 24 closed in 2012, 26 closed in 2013, six closed in 2014, 28 closed in 2015, 17 closed in 2016, eight closed in 2017, two closed in 2018, 10 closed in 2019, 12 closed in 2020 and six closed in 2021). As at 31 December 2021, 34 going-private transactions were pending, including two announced in 2012, two announced in 2014, two announced in 2015, three announced in 2016, one announced in 2017, three announced in 2018, two announced in 2019, 13 announced in 2020 and six announced in 2021.

Private equity-backed IPOs is an exit route heavily relied upon by China-focused private equity funds. Chinese A-share IPOs experienced a dramatic decline in 2018 on account of the backlog of IPO applications caused by tightening review standards. In 2019, China inaugurated its science and technology innovation board (the STAR Market), trying to kick off the country's much-anticipated capital market reform and implement a registration-based IPO regime to address investors' concern on potential backlog. In the wake of the launch of the new regime, 202 Chinese enterprises accomplished A-share IPOs successfully in 2019 (including 70 companies that were successfully listed on the STAR Market), which hit the highest watermark over the past five years. Following this trend, the number of private equity-backed IPOs reached 199 in 2020, which effectively doubled the number in 2019. In 2021, due to the continued promotion of the registration-based IPO regime, the number of A-share IPOs increased significantly compared with 2020, with 520 Chinese enterprises accomplished A-share IPOs successfully in 2021, increasing 18.99 per cent year to year and 399 of which are listed under the new registration-based regime, representing 76.73 per cent of the total A-share IPOs. The reform of the listing system in China gradually delivered the optimistic confidence to the private equity investors in the domestic market in China. That being said, the STAR Market and other boards in mainland China were noticeably quiet in the second half of 2021 partly because of the chilling effect of the swift measures by Chinese authorities to curb 'disorderly expansion of capital at the expense of public interests' in the technology sector and partly because of the heightened US scrutiny over China-based technology companies seeking overseas listing.

Exit via trade sales, accounting for 82.5 per cent of private equity-backed exits in 2021 (in terms of deal amount),3 remains the dominant exit route for private equity funds in 2021 and are likely to maintain this position in the foreseeable future. Secondary sales are thriving year on year, accounting for 17.5 per cent of the total exit proceeds in 2021 and up from 5.5 per cent in 2020. This changing dynamic emerged in 2020 when existing investors were arguably slow to respond to the new reality presented by the pandemic and private equity players seized on the opportunity to retain hold, spurred by cheap debt and a larger fund size, making them competitive bidders. Sponsor-to-sponsor transfer is also trending in secondary sales. Five of the 10 largest exits (including all the top three) in the Asia market in 2021 (though not in China) saw assets passed from one private equity firm to another.

Chinese outbound M&A deal activity picked up in 2021 on the back of uncertainty regarding the duration and effects of covid-19 on a global level, though the announced Chinese outbound M&A value was still 13 per cent less than 2019 before the pandemic. Strong participation of private equities and investment companies in the Chinese overseas M&A was observed. Nearly half of the announced overseas deal value and over 40 per cent of the deal volume in 2021 where each transaction exceeded US$500 million were backed up by investor groups of private equities and investment companies, representing a year-on-year increase of 20 percentage points in terms of both deal value and volume. On the other hand, state-owned enterprise-backed Chinese outbound investments (which were the mainstream of the outbound investments in 2016) steered their attention back to the domestic market, resulting in a very low value of investments overseas at only a tenth of the 2016 peak.

II Legal framework

i Investments through acquisition of control and minority interests

Under Chinese law, foreign investment in China can be conducted through various channels including incorporation of a greenfield enterprise, acquisition of equity interest, assets or other similar interest. An enterprise incorporated under Chinese law with all or part of its investment from a foreign investor (in the Chinese foreign investment law context, investors from Hong Kong Special Administrative Region, Macau Special Administrative Region and Taiwan are deemed special foreign investors) is called a foreign-invested enterprise (FIE), which may be formed as a company limited by shares, limited liability company, general partnership or limited partnership. The governance framework of such legal entities are set out in the current Company Law (for companies) (see latest development of the Company Law in Section IV.v), which became effective on 1 January 2006 and was amended in 2013 and 2018 with effect from 26 October 2018, and the Partnership Enterprise Law (for partnerships), which was first adopted on 23 February 1997 and amended in 2006 with effect from 1 June 2007.

In 2019, China abolished a series of laws and regulations that had governed FIEs in the past and further adopted a brand new regime in favour of foreign investors. Starting from 1 January 2020, FIEs shall have been subject to the Company Law, the Foreign Investment Law (the FIL), which was promulgated on 15 March 2019 and became effective on 1 January 2020, and the Regulation on the Implementation of the Foreign Investment Law (the FIL Implementation Regulation), which was promulgated on 26 December 2019 and became effective on 1 January 2020. Under the new legal regime, foreign investments will receive national treatment (i.e., foreign investors will be treated in a way that is no worse than that of Chinese domestic investors) and a negative list management system (i.e., other than specific industries or areas as set forth on the Foreign Investment Negative List (as discussed below) are prohibited or restricted (i.e., subject to certain entry conditions) from foreign investment, all the other industries or areas of investment are open for foreign investment without any limitation). The FIL and the FIL Implementation Regulation have also emphasised the protection and promotion of investment and rights and interests (including intellectual property rights) of foreign investors in China, and the relevant regulation have reaffirmed that all the national policies related to supporting the development of enterprises shall equally apply to foreign-invested enterprises. FIEs are also guaranteed to have equal opportunities to participate in the formulation of standards and government procurement activities through fair competition. Another significant change under the new regime is that FIEs' structures, governance and voting procedures are made fully compatible with those of domestic enterprises and subject to the Company Law, which provides more flexibility for the operation of FIEs. Notably, FIEs formed under the Law on Wholly Foreign-Owned Enterprises (for WFOEs), the Law on Sino-Foreign Equity Joint Ventures (for EJVs), the Law on Sino-Foreign Cooperative Joint Ventures (for CJVs) (collectively, the Old FIE Laws, which have been replaced by the FIL) with certain corporate governance rules that were different to those under the Company Law have been granted a five-year grace period until 1 January 2025 to convert their governance structures and amend their charter documents to comply with the requirements under the FIL and Company Law. If they fail to make the changes within the grace period, the registration authority will no longer process their applications for registration or filing matters.

A new information-reporting system has also replaced the historical approval and record-filing regulatory system for the establishment and changes with respect to FIEs. Prior to the implementation of the FIL and before the FIL Implementation Regulation became effective (i.e., 1 January 2020), FIEs needed to conduct record filing for information on the enterprise, foreign investment, general mergers and acquisitions made by foreign investors and changes to such information through two channels: (1) the MOFCOM foreign investment record-filing system; and (2) the company registration system and enterprise credit information disclosure database of State Administration of Market Regulation (SAMR, the enterprise registry agency that records all enterprise registration information of legal entities incorporated under Chinese laws, whether domestic companies or FIEs). With the implementation of the FIL and the Foreign Investor Information Reporting Measures (the Reporting Measures), which were issued by MOFCOM and SAMR on 30 December 2019 and took effect on 1 January 2020, MOFCOM's record-filing system has been replaced by an unified information reporting system for the establishment of FIEs and their subsidiaries, changes to FIEs and their subsidiaries, and annual reporting. In practice, this information-reporting system is integrated as part of the regular online registration procedure with the State Administration of Market Regulation, information already submitted to SAMR by FIEs will be shared with MOFCOM and does not need to be separately submitted again by FIEs or foreign investors in information reports.

Foreign investment in the form of acquisition of equity or assets of Chinese companies by foreign investors under the new information-reporting system are no longer subject to regulatory approvals (as required by the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the M&A Rules), jointly issued by six governmental agencies in 2006 and amended in 2009), provided that the transaction does not trigger 'special management measures for foreign investment access' under the Special Administrative Measures (Negative List) for the Access of Foreign Investment (the Foreign Investment Negative List) (see further discussion below).

Regulatory regimes applicable to foreign investments

Investment access of foreign investors in China is subject to the negative list management. The Foreign Investment Negative List, jointly published annually by MOFCOM and NDRC (with the latest edition published on 27 December 2021 and effective from 1 January 2022, see further discussion on the amendments in the 2021 edition in Section IV.iii), lists the industries where special management measures for foreign investment access are applicable. The Foreign Investment Negative List specifies only two categories of industries: industries in which foreign investment is prohibited and industries in which foreign investment is allowed with certain investment restrictions. Industries not mentioned by the Foreign Investment Negative List are deemed 'permitted' (i.e., not subject to the special management measures for foreign investment access). On 27 December 2020, NDRC and MOFCOM promulgated the Catalogue of Encouraged Industries for Foreign Investment (2020) (the Catalogue of Encouraged Industries), which became effective on 27 January 2021. The Catalogue of Encouraged Industries consists of two sub-catalogues (the list applicable to the entire country and the list applicable to China's central, western and north-eastern regions and Hainan province only). While a foreign investor can acquire full ownership of a company in most encouraged and permitted sectors (and is often entitled to special advantages compared to domestic investors when acquiring a company in an encouraged sector), to invest in most sectors subject to the special management measures for foreign investment access (i.e., restricted industries), a foreign investor is required to team up with a Chinese partner (and, in some cases, the Chinese partner must maintain a controlling stake). Investments by a foreign party in a prohibited sector are typically prohibited; investments by a foreign party in non-prohibited sectors stipulated in the Foreign Investment Negative List will require the applicable project-based approval of the National Development and Reform Commission (NDRC) if the size of a greenfield investment or the total investment amount in a target enterprise (including capital increase) is US$0.3 billion or more; or of its local counterpart if such amount is below US$0.3 billion. Approval at the local level can typically be obtained within typically one month, but approval from central NDRC often takes several months or longer. If a transaction is subject to an antitrust or national security review, as discussed below, NDRC or its local counterpart will typically defer review until the antitrust or national security reviews are completed. Apart from these general approval requirements, foreign investments in several industries, such as construction and telecommunications, are subject to approval from the relevant Chinese regulatory authorities governing the applicable industries. An indirect investment in China by way of an offshore investment in an offshore holding company that owns equity of an FIE is not subject to MOFCOM and 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.

The antitrust regime in China is established and governed by the Anti-Monopoly Law of the People's Republic of China (AML), which became effective on 1 August 2008. Under the AML and the Rules of State Council on Declaration Threshold for Concertation of Undertaking first promulgated on 3 August 2008 and revised in 2018 with effect from 18 September 2018, an antitrust filing with SAMR anti-monopoly authority 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 involved exceeded 400 million yuan, and all of the parties' aggregate worldwide sales in the prior accounting year exceeded 10 billion yuan or the parties' aggregate sales in China in the prior accounting year exceeded 2 billion yuan. On 26 July 2019, SAMR published three new anti-monopoly regulations (the Interim Provisions on the Prohibition of Monopoly Agreements, the Interim Provisions on the Prohibition of the Abuse of Market Dominant Status and the Interim Provisions on Prevention of the Abuse of Administrative Power to Exclude or Restrict Competition as the guideline on enforcement of the AML). These three regulations became effective on 1 September 2019. On 23 October 2021, the Standing Committee of National People's Congress (NPC) further released a draft of the amendment to the Anti-Monopoly Law (the Draft AML) for public comment (see further discussion in Section VI.iv), which significantly increases the consequences for non-filing for antitrust review.

The regime of Chinese national security review of foreign investment was introduced in 2011 by the Notice of the General Office of State Council on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (Circular 6), outlining the principles, scope and procedures of security review. On 25 August 2011, MOFCOM issued the Provisions on Implementation of Security Review System for Mergers and Acquisition of Domestic Enterprises by Foreign Investors, providing further guidance on the national security review. The General Office of the State Council later issued the Tentative Measures for the National Security Review of Foreign Investment in Pilot Free Trade Zones, which took effect in May 2015 (the Tentative Measures), extending the application of national security review to important culture and information technology products sectors 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 proprietorship, joint venture, equity or asset acquisition, control by contractual arrangements, nominal holding of interests, trust, re-investment, offshore transactions, leasehold and subscription of convertible bonds. To further implement the requirement under the FIL of establishing a national security review of foreign investment, on 19 December 2020, NDRC and MOFCOM jointly issued the Measures on Security Review of Foreign Investment, which took effect on 18 January 2021 (the FISR Measures). The FISR Measures amend the previous review framework stipulated by the Tentative Measures and provide detailed rules to tackle the rising national security concerns and to address the global trend of strengthening national security review on foreign investment. NDRC will establish a working office (the Security Review Office) led by NDRC and MOFCOM to undertake the routine security review work and coordinate with other governmental authorities involved in the security review. Sectors listed under the FISR Measures that are subject to security review are divided into two categories: (1) foreign investment in military, military support and other areas related to national defence and security, as well as investments in the proximity to military and military-related industrial facilities; and (2) foreign investment in important agricultural products, energy and resources, manufacturing, infrastructure, transportation services, cultural products and services, information technology and internet products and services, financial services, key technologies, and other important areas that are relevant to national security, through which the foreign investors obtain actual control of the invested enterprises. While the term 'control' is clearly defined in the FISR Measures as 'holding 50 per cent or more of the equity of an enterprise; holding voting rights that can have significant impact on the resolutions of the board of directors, the board of shareholders or the shareholders' meeting or other circumstances that create significant impact on the enterprise's business decision-making', the FISR Measures do not specifically define 'important' and attach a broad meaning to 'national security', leaving a wide discretion to the review authority. As such, private equity investments involving certain customary protections (e.g., veto rights, supermajority voting requirements and negative covenants) could arguably be interpreted to have 'control' under the FISR Measures. In the event of any ambiguity as to whether a filing is required, it is usually prudent for an investor to make a filing to avoid adverse consequences later.

Governance of and exit from Sino-foreign joint ventures

Since the FIL became effective, all FIEs are regulated pursuant to the Company Law, the FIL and the FIL Implementation Regulation, which enables foreign shareholders in an FIE to more easily obtain or enforce certain contractual rights that are considered fundamental for private equity investors in other jurisdictions, including rights pertaining to governance and exit, compared with the old regulatory framework that applied to FIEs before the adoption of the FIL, as some previous onerous requirements on corporate governance of FIEs have been abolished (e.g., for Sino–foreign equity joint ventures, certain key corporate actions required unanimous approval by the board; a Chinese partner typically had the right to appoint at least one director, which basically gave the Chinese partner certain veto rights regardless of its shareholding percentage).

If the Chinese shareholder is a state-owned enterprise (SOE), enforcement may be a bit difficult, as a transfer of an SOE's interest in a joint venture is subject to a statutory appraisal and an open bidding 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 the regulatory framework on a transaction structure

To avoid going through the formalities with NDRC and MOFCOM (for any approval or information reporting) 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 that the foreign investor invests alongside a Chinese partner in an offshore Cayman Islands or British Virgin Islands company, with the company owning 100 per cent of a Chinese WFOE (often indirectly through a Hong Kong entity, to obtain preferential tax treatment on dividends). This structure also allows the foreign investor to benefit from transaction agreements governed by foreign laws and to avoid the need to enforce its rights in China.

Many foreign investors use a 'variable interest entity' (VIE) structure to invest (indirectly) in China to avoid seeking certain Chinese regulatory approvals on the business of Chinese enterprises (approvals that will not or will not be expected to be granted to FIEs). Under a VIE structure, Chinese individuals, often the founders, key management members or their relatives, are the registered shareholders of a domestic operating company, which holds the required licences and permits needed for the business to operate. A foreign investment entity (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 domestic operating company and its registered shareholders pursuant to which the WFOE obtains control and an economic interest in the operating company whose financial statements will be consolidated by the WFOE and its group companies. These contractual arrangements can take many forms, but often include an exclusive service or licence agreement, a voting proxy agreement, a share pledge agreement and a 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 affiliates 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 explicit text) of Chinese regulations; however, Chinese companies, including some of the large public companies, such as Alibaba, Baidu and Tencent, continue to use this structure.

The FIL and the FIL Implementation Regulation chose to remain silent on the topic of VIE. It is understandable that, given the large number of enterprises currently adopting the VIE structure, the potential impact of changing the status quo may be significant and unpredictable. Notably, the FIL provides that foreign investment includes the circumstance where a foreign investor acquires shares, equities, property shares or any other 'similar rights and interests' of an enterprise within the territory of China. 'Similar rights' is a term broad enough to include interests derived from a VIE structure. It not only affords companies enough room to manoeuvre but also gives the government ground to assert jurisdiction over the VIE structure when the time is right. In the recent Q&A with CSRC (as defined below) officials on the new overseas listing rules (see further discussion in Section IV.ii), it was specifically noted that domestic enterprises with VIE structure may conduct overseas issuance and listing of securities as long as they are compliant with the applicable laws, regulations and regulatory filing requirements on foreign investment, industry access, cybersecurity, data security and others.

ii Fiduciary duties and liabilities

Fiduciary duties and potential liabilities of directors, officers and supervisors under Chinese law

The Company Law is the primary statute regulating the actions and duties of directors, officers and supervisors of a Chinese company. Pursuant to the Company Law, a director, officer or supervisor must abide by the laws, administrative regulations and articles of association of the company, and has duties of loyalty and care to the company. Similar to many other countries, a breach of duty by a director, officer or supervisor of a Chinese company 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 chairperson of the board, executive director or legal representative of the company or who otherwise serves in a senior management capacity, such as a general manager or chief financial officer. Under the Securities Laws promulgated on 28 December 2019 and in effect from 3 March 2020 (the Securities Law), directors, supervisors and senior officers of a public company in China shall bear compensation liability jointly and severally with the company for damages suffered by investors owing to any false records, misrepresentation or material omission in the information disclosure made by the company unless they can prove that they are not at fault. Often by way of seeking to ensure that their representatives are not assigned responsibility for any specific matters, most non-Chinese private equity funds are comfortable appointing their representatives to the boards of Chinese companies, despite the risk of liability. While directors' and officers' insurance and indemnification agreements may protect against civil liability, many types of administrative or criminal liability cannot be mitigated by insurance and indemnification.

Chinese tax exposure

Since January 2008, China's Enterprise Income Tax Law (the 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 People's Republic of China (PRC) issued Circular (2015) No. 7 (Circular 7) on Chinese corporate income tax treatments of indirect transfers of Chinese 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 that is structured to avoid applicable Chinese taxes will be re-characterised 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 it is within the discretion of the parties to such offshore transactions to determine whether to make a Circular 7 filing to report the offshore transaction for the Chinese tax authorities' assessment for Chinese tax purposes, Circular 7 employs a penalty structure designed to motivate parties to offshore transactions involving indirect sales of Chinese companies to report potentially taxable transactions to the Chinese tax authorities. Because of the uncertainty under the Circular 7 regime regarding what will satisfy the Chinese tax authorities as a non-tax-avoidance justification with reasonable commercial purpose for the offshore sale of Chinese entities, and regarding the evolving market practice with respect to these matters, 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 Chinese 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 flat 25 per cent enterprise income tax on its worldwide income if the offshore vehicle's de facto management body is in China. Although the language of the law is unclear, factors that the State Administration of Taxation may take into account in determining tax residency include whether: the offshore vehicle locates its senior management and core management departments in charge of daily operations in China; financial and human resources decisions of the offshore vehicle are subject to determination or approval by individuals or bodies in China; 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 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 might be subject to this tax, an offshore vehicle should take steps to establish that it is not effectively managed and controlled in China.

iii Governmental enforcement actions

Update on FCPA enforcement and developments

The year 2021 saw a modest decline in the Foreign Corrupt Practices Act (FCPA) enforcement actions. In 2021, the US Department of Justice (DOJ) and SEC brought FCPA enforcement actions against four companies and imposed financial penalties totalling US$282 million. Of the four corporate FCPA enforcement cases, two involved activities by multinational companies and their subsidiaries in China.

In September 2021, WPP plc, the world's largest advertising group, agreed to pay more than US$19 million in fines and disgorgement to the SEC to settle charges that it violated the anti-bribery, books and records, and internal accounting controls provisions of the FCPA. The government alleged that WPP made improper payments to tax officials in China, resulting in significant tax savings to WPP's China subsidiary. In January 2021, Deutsche Bank AG, the largest German financial institution and a US issuer, agreed to pay more than US$122.9 million in fines and disgorgement to resolve SEC and DOJ charges arising out of alleged improper payments to foreign government officials in China and other countries. Specifically, the government alleged that Deutsche Bank paid a consultant at least US$1.6 million to help the bank establish a clean-energy investment fund with a Chinese government entity.

Despite fewer FCPA enforcement actions in 2021, several notable steps taken by the Biden administration signal that FCPA enforcement activity will return to the level seen in previous years. Indeed, at the American Conference Institute's 38th Annual FCPA Conference in December 2021, DOJ and SEC representatives stated that the government had a strong pipeline of investigations involving corporate misconduct, and that they anticipate a forthcoming surge in corporate enforcement in 2022.

In particular, on 3 June 2021, President Biden released the National Security Study Memorandum, establishing countering corruption as a 'core national security interest' and launching an interagency review of existing anti-corruption efforts. On 6 December 2021, the Biden administration released the first-ever 'United States Strategy on Countering Corruption'. The Strategy sets out a strategic interagency and cross-border approach to combating corruption, including expanding criminal and civil law enforcement of foreign bribery cases through the FCPA, leveraging anti-money laundering (AML) laws in the fight against corruption, and improving coordination with foreign governments to reduce transnational corruption. In addition, in a 28 October 2021 speech on corporate criminal enforcement under the Biden administration, Deputy Attorney General Lisa Monaco announced several immediate changes to the DOJ's corporate criminal enforcement policies that could significantly impact pending and future corporate enforcement matters, including FCPA investigations. The key changes include:

  1. when determining whether to enter into a deferred prosecution agreement (DPA) with a company (the main avenue through which companies settle FCPA cases), the DOJ will consider all past misconduct, including criminal, civil, and regulatory offenses outside of the FCPA context and recidivist behaviour to determine whether the company should be granted the benefit of a deferred prosecution agreement;
  2. reiterating prior guidance that corporations under investigation are expected to provide non-privileged information about all individuals involved in corporate misconduct to gain full credit for cooperation – i.e., re-emphasising the DOJ's focus on holding individuals accountable for corporate crime; and
  3. re-emphasising the role of corporate monitors as part of DPAs to ensure that companies do not continue to violate the FCPA.

Update on the Holding Foreign Companies Accountable Act

The Holding Foreign Companies Accountable Act (HFCAA), which was signed into law in December 2020, prohibits the securities of a foreign reporting company from being listed on US securities exchanges if the SEC identifies the company as a Commission-Identified Issuer for three consecutive years. On 2 December 2021, the SEC adopted amendments to finalise the HFCAA's implementing rules. The HFCAA and the SEC's implementing rules could have a significant impact on US-listed Chinese companies who rely on auditors are not currently subject to inspection or investigation by the Public Company Accounting Oversight Board (PCAOB).

How the HFCAA operates:

  1. Commission-identified issuer: the SEC will identify reporting companies that have retained a registered public accounting firm with a branch or office that: (1) is located in a foreign jurisdiction; and (2) the PCAOB is unable to inspect or investigate due to a position taken by an authority in the foreign jurisdiction. The foreign jurisdictions most applicable under the HFCAA include Hong Kong and mainland China.
  2. Trading prohibition: after it is conclusively identified as a commission-identified issuer for a third consecutive year, the SEC will issue an order prohibiting the trading of a reporting company's securities.

Assuming a US-listed company is first identified by the SEC as a commission-identified issuer based on the 2021 annual report it is expected to file in April 2022, the earliest time for a potential delisting of the company is after the filing of its annual report for the fiscal year 2023, in April 2024. However, the US Senate passed a bill in June 2021 to accelerate this time period to two consecutive years. This bill is currently being considered by the US House of Representatives. As a result of the HFCAA, an increasing number of US-listed Chinese companies have carried out, or are currently seeking dual listing in Hong Kong by either secondary listing or dual primary listing in case the companies are de-listed from the Nasdaq Stock Market (Nasdaq) or the New York Stock Exchange (NYSE). Meanwhile, US and Chinese regulatory authorities, including the Chinese Securities Regulatory Commission (CSRC) and PCAOB, continue to negotiate how to advance cooperation on audit oversight of public companies.

Chinese anti-corruption enforcement

In addition to scrutiny from US regulators, private equity firms also face potential enforcement risks from Chinese authorities. In 2021, anti-corruption enforcement remained a top priority for Chinese authorities. Most notably, in September 2021, the Central Commission for Discipline Inspection of the Communist Party of China (CPC), the National Supervisory Commission, and other CPC departments and government agencies jointly issued the Opinions on Further Promoting the Investigation of Bribery and Acceptance of Bribes (the Opinions). The Opinions emphasise China's renewed focus on bribe-givers and commercial bribery. Importantly, the Opinions re-emphasised Chinese government's commitment to crack down on individuals and entities that offer or pay bribes to government officials, instead of focusing just on recipients of bribes. In addition to the areas that have traditionally been subject to anti-corruption scrutiny for many years (e.g., food, drugs and medical care), the new anti-corruption regime explicitly includes finance industry as a target for enforcement. The Opinions also give Chinese authorities authority to establish 'blacklists' whereby individuals and entities, including multinational companies, can be blacklisted for offering or paying bribes to government officials and counterparties. If blacklisted, companies face restrictions on the operation of their businesses. It remains unclear from the Opinions what would happen to a multinational company's operations and assets in China in the event of a blacklisting, and the ambiguity may give enforcement agencies some discretion in imposing blacklisting.

Chinese antitrust enforcement

In addition to legislative reforms (featured by the ongoing amendment and revision to the current AML), China's antitrust regulatory agency has undergone significant changes in 2021. In November 2021, China created the stand-alone State Anti-Monopoly Bureau, which was previously housed under SAMR. The establishment of State Anti-Monopoly Bureau coincided with a series of antitrust crackdowns that started in December 2020, when SAMR began fining major technology companies for gun-jumping.

  1. In April 2021, SAMR penalised Alibaba for abusing its dominant position in China's online retail platform market by using a 'choose one from two' mechanism that punished merchants who operated online stores on Alibaba and its rival platforms or who ran promotions at the same time on both platforms. SAMR fined Alibaba approximately 18.23 billion yuan, or 4 per cent of its domestic annual sales in 2019. The fine is the largest fine ever assessed in China's enforcement history and ranks among the top three antitrust enforcement fines globally. As part of the administrative order, Alibaba is to submit annual compliance reports to SAMR for three years.
  2. In October 2021, SAMR imposed a fine of 3.44 billion yuan against Meituan, a food delivery giant in China, also for its 'choose one from two' practices. The fine amounted to 3 per cent of Meituan's domestic annual sales in 2020. Meituan also is required to provide compliance reports to SAMR for three years.
  3. In November 2021, SAMR announced 43 antitrust enforcement decisions against technology companies including Alibaba, Meituan, Baidu, Didi, JD.com, Tencent, and ByteDance for failing to seek regulatory approval in advance for mergers and acquisitions. In all the cases, the companies were alleged to have caused an unlawful concentration of business operations, but were not considered to have limited or restricted competition. The companies were fined 500,000 yuan, the maximum fine, for each transaction.

iv 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 approval, filing and reporting requirements with competent Chinese authorities depending, inter alia, on the location and industry of the target assets, the investment amount, and the identity and ownership structure of the Chinese investor. An outbound investment made by Chinese individual investors through onshore or controlled offshore vehicles will be subject to relevant NDRC and MOFCOM filing or reporting mechanisms.

NDRC regulates Chinese companies' outbound investment activities on a project-by-project basis through a multilayered approval and filing regime. Under the Administrative Measures for Enterprise Outbound Investment (Regulation No. 11), which took effect on 1 March 2018, a Chinese investor is required to make a filing with NDRC or its local counterpart (depending on whether the Chinese investor is a centrally managed SOE and whether the investment size (including equity and debt investments made by not only the Chinese investor but also the offshore entities controlled by the Chinese investor) reaches US$300 million) and obtain an NDRC filing notice for an outbound investment transaction that does not involve a 'sensitive country or region' (countries and regions that are subject to investment restrictions under international treaties, war or civil commotion, or that have no diplomatic relations with China) or a 'sensitive industry' (which was further clarified by NDRC in 2018 (see below for more details)), and, in cases where the 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 NDRC. In parallel with Regulation No. 11, NDRC promulgated a Catalogue of Sensitive Industries for Outbound Investment 2018 (the Sensitive Industries Catalogue) in January 2018, with effect from 1 March 2018 and released the Answers to Frequently Asked Questions Concerning Outbound Investment by Enterprises (the Answers to FAQs) in June 2018 on its website (which was updated in July 2021), providing clarification for frequently asked questions regarding the application of Regulation No. 11. NDRC made rather restrictive interpretations on the scope of sensitive projects. These industries or projects include real estate, hotels, offshore equity investment funds or investment platforms without specific underlying industrial projects, sports clubs, cinemas and the entertainment industry. The designation of real estate, hotels and offshore equity investment funds or investment platforms without specific underlying industrial projects as sensitive industries has drawn substantial attention, as there were significant amounts of investment in these industries both in numbers and deal values in the few years before 2018. Regulation No. 11 adopts a control-based approach that includes in the verification scope all sensitive projects made by offshore entities under the control of Chinese investors, regardless of whether or not the Chinese investors provide financing or guarantees for these projects. The Answers to FAQs also include detailed explanations and instructions for each of the sensitive industries to clarify the scope of application of sensitive projects.

Aside from the multilayered approval and filing regime implemented by NDRC, outbound investment transactions are also subject to the reporting and filing requirements implemented by MOFCOM. Under the Interim Measures for the Recordation (or Confirmation) and Reporting of Outbound Investment (Circular No. 24), which was promulgated by MOFCOM on 8 January 2018, each Chinese investor that conducts an outbound investment transaction shall file the details of the outbound transaction made by it with MOFCOM or its local counterpart. Circular No. 24 applies the same criteria under Regulation No. 11 for the initial filing or reporting of an outbound investment transaction. Circular No. 24 further requests the Chinese investor to update its filings with respect to the approved outbound investment transaction with competent MOFCOM on a periodic basis. On 1 July 2019, MOFCOM promulgated the Implementation Regulation of Interim Measures for the Recordation (or Confirmation) and Reporting of Outbound Investment (Circular No. 24 Implementation Rules), which provides the filing requirements in detail. Under Circular No. 24 Implementation Rules, each Chinese investor shall file a semi-annual report with respect to the approved outbound investment every six months, which shall include, without limitation, the financial performance of the invested foreign business. If the Chinese investor encounters any problem with respect to the approved outbound investment (e.g., war, governmental default, major health emergency), it shall promptly report the event to competent MOFCOM.

NDRC approvals and filings and MOFCOM initial 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 approvals and filings and MOFCOM initial 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 of obtaining and completing NDRC approvals and filings and MOFCOM initial approvals and filings to be able to repatriate funds from the relevant investment back to China in the future). However, the new NDRC outbound rules that impose reporting obligations on an investment of US$300 million or more made by an offshore entity controlled by a Chinese investor utilising offshore financing, which will be a new post-closing government filing.

After obtaining NDRC approvals and filings and MOFCOM initial approvals and filings, a foreign exchange registration with SAFE through a local Chinese bank is required for the currency conversion and remittance of the purchase price out of China. However, SAFE registration will not be applicable if a Chinese investor uses offshore capital to fund the transaction where there is no cross-border guarantee arrangement relating to such offshore capital source. Additionally, a foreign exchange registration would be required in the case of an earnest deposit to be paid from China to overseas immediately upon or within a short period of 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. The registration can be handled by a local Chinese bank concurrently with NDRC project confirmation process if the amount of the deposit does not exceed US$3 million or 15 per cent of the purchase price. Payment of deposits of higher amounts must be approved by SAFE on a case-by-case basis after completing NDRC project confirmation process.

A Chinese SOE as a buyer may also need approvals from the state-owned Assets Supervision and Administration Commission of the State Council or its local counterpart, or sometimes, alternatively, approvals from its group parent company. Depending on the transaction value and structure, a Chinese-listed company may need to obtain stockholders' approval before closing and make the necessary disclosures required by the Chinese securities exchange rules. The State Council requires the establishment of share capital systems for SOEs and improved auditing systems to monitor SOEs' outbound equity investments. This principle, accompanied by current rules applicable to SOEs' investments (e.g., appraisal), are regarded as intended to preserve and increase the value of state-owned overseas assets.

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, who have adopted more stringent control and supervision on 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 over outbound investment transactions, mentioned 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: large investments in businesses that are not related to the core businesses of the Chinese investors; outbound investments made by limited partnerships; investments in offshore targets that have assets of a value greater than the Chinese acquirers; projects that have very short investment periods; and Chinese onshore funds participating in the going-private of offshore-listed China-based companies. Further, on 4 August 2017, the State Council issued the Guidance Opinions on Further Promoting and Regulating Overseas Investment Direction (the Guidance Opinions), which highlighted certain industry-specific guidance affecting Chinese outbound investments, including: encouraging investments in overseas high-tech and manufacturing companies and in setting up overseas research and development (R&D) centres; promoting investments in agricultural sectors; regulating investments in oil, mining and energy sectors based on an evaluation of the economic benefits; restricting investments in real estate, hotels, cinemas, the entertainment industry and football clubs; and prohibiting investments in the gambling and pornography sectors. Under the Guidance Opinions investments in offshore private equity funds or investment vehicles that do not have investment projects are classified as restricted investments, which would be subject to pre-completion approvals by NDRC. The aforementioned measures were formally adopted in the Sensitive Industries Catalogue promulgated in 2018.

The tightened control on outbound investment activities and capital flow not only affects Chinese investors but is also relevant to international private equity participants from at least two perspectives: when a private equity participant intends to partner with a Chinese investor in M&A activities outside China or when a private equity participant is considering a Chinese buyer for a trade sale as its exit route. In these scenarios, the private equity investor must 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 or ultimately complete the transaction. Further, when private equity investors consider a Chinese buyer as a potential exit route, in addition to the completion risk, a private equity seller would be well advised to also consider the risk profile of the transaction and the target business in the context of Chinese regulations (including the relevant industry, the financing structure and the identity of the Chinese buyer) to evaluate the related risks and impacts, including reputational risks and social impacts, if the Chinese buyer was required to divest the business shortly after completing the transaction or was unable to provide the required funding offshore for the business, which might put stress on various aspects of the operation of the business and might also force a premature sale.

Non-Chinese investment approvals

The United States, the European Union (EU) and other countries scrutinise or regulate international business activities, including relevant Chinese outbound investment activities, to achieve objectives related to, inter alia, national security, foreign investment control and anti-monopoly. In connection with Chinese investments in the United States or EU countries, the relevant parties should be aware of potential non-Chinese approvals that may be mandatory or necessary in the jurisdiction where the target is located depending on the nature and size of the transaction, which may include US and EU merger control review, and a Committee on Foreign Investment in the United States (CFIUS) review.

A CFIUS review is often perceived among parties to Chinese outbound investments in the United States as one of the major foreign regulatory hurdles. The scrutiny of acquisitions by Chinese companies has been further intensified in the United States (following the reform of CFIUS legislation in late 2018) and in some other western countries. CFIUS is an interagency committee of the US government that is empowered to monitor foreign direct investment in the United States by a non-US person, to evaluate whether the transaction may create national security risks. CFIUS establishes the process for reviewing the national security impact of foreign investments, joint ventures and other investments into the United States, and analyses a broad range of national security factors to evaluate whether a transaction may create a national security risk to the United States.

On 13 August 2018, US President Trump signed into law the Foreign Investment Risk Review Modernization Act (FIRRMA), which substantially reformed and expanded the jurisdiction and powers of CFIUS, including (1) expanding the jurisdiction of CFIUS, which expressly included not only controlling direct investments, but also certain non-controlling investments for the first time; (2) adopting a mandatory declaration process for certain covered transactions together with mandatory waiting periods for the closing of those transactions; (3) extending the statute timeline in respect of the review process; and (4) granting enforcement authority for CFIUS to suspend transactions. On 11 October 2018, CFIUS further promulgated a pilot programme, which took effect on 11 November 2018, strengthening and detailing regulations affecting 27 identified industry sectors (e.g., R&D in biotechnology, petrochemical manufacturing and semiconductor and related device manufacturing). To further enhance the pilot programme promulgated in October 2018, on 17 September 2019, the US Department of the Treasury promulgated the Draft Implementation Regulation of FIRRMA (the Draft FIRRMA Implementation Regulation). The Draft FIRRMA Implementation Regulation introduces the concept of a 'technology, infrastructure and data (TID) US business' for the first time to further emphasise the gravity and sensitivity of foreign investment in business sectors relating to intellectual property, critical infrastructure and personal data. According to the Draft FIRRMA Implementation Regulation, CFIUS further expanded its jurisdiction to all 'covered investments', which includes any investment made by a non-US investor in a TID US business. On 13 January 2020, the US Department of the Treasury published the finalised Draft FIRRMA Implementation Regulation, which became effective on 13 February 2020. Given that the relationship between the United States and China has deteriorated since the Trump administration took office and has dropped to a record low point as a result of the US–China trade tension that began in 2019 and was carried over into the Biden administration, FIRRMA, the pilot programmes implemented by CFIUS and the Draft FIRRMA Implementation Regulation are likely to have a dramatic and disproportionate impact on Chinese outbound investments into the United States, especially investments in highly sensitive areas (particularly, any TID US business and potential access to personal data of US citizens) in the near future.

According to the CFIUS annual report covering calendar year 2020 (the CFIUS Annual Report) released on 26 July 2021, CFIUS has ramped up its outreach on 'non-notified' transactions where CFIUS identifies such transaction not voluntarily filed through a variety of methods such as interagency referrals, tips from the public, media reports, commercial databases or congressional inquiries and requests submission of notification on the transactions for its consideration, a trend that will persist throughout 2022. In 2020, investors from China (including Hong Kong) made a total of 26 filings (20 joint voluntary notices and six declarations), down from a total of 32 filings in 2019 and 56 filings in 2018, which among other things has resulted in increased scrutiny of Chinese investment in US companies. In practice, CFIUS has taken an interest in transactions involving a seemingly benign investor or company based on actual or perceived exposure to Chinese influence as a result of such connections. The CFIUS Annual Report also indicates that the potential for transfer of export-controlled technologies to third parties not directly related to the buyer can also be a source of national security risk.

Recent major Chinese outbound investment transactions abandoned or terminated on account of CFIUS issues are listed as follows: the abandonment in December 2021 of the US$1.4 billion acquisition of MagnaChip Semiconductor Corporation (a South Korean semiconductor company listed on NYSE) by a Chinese private equity Wise Road Capital LTD; the termination (through a presidential order) in March 2020 of the US$35 million acquisition of StayNTouch, Inc by Beijing Shiji Information Technology Co, Ltd and divestment of ownership and interest acquired; the abandonment in May 2018 of the US$23.2 million additional investment in UQM Technologies, Inc (listed on NYSE) by China National Heavy Duty Truck Group Co, Ltd (which will increase its ownership in UQM to 34 per cent); the abandonment in May 2018 of the US$9.9 million acquisition of a 45 per cent share in Akron Polymer Systems by Shenzhen Selen Science and Technology; the termination in March 2018 of the US$16.5 million acquisition of Waldo Farms Inc by Beijing Dabeinong Technology Group; the abandonment in May 2018 of the US$200 million acquisition of a controlling stake in US hedge fund Skybridge Capital by HNA Group; the abandonment in February 2018 of the US$100 million acquisition of 63 per cent shares in Cogint Inc (listed on Nasdaq) by Bluefocus because of the parties' failure to obtain CFIUS approval; the termination in February 2018 of the US$580 million acquisition of US semiconductor testing company Xcerra Corp by Hubei Xinyan Equity Investment Partnership because of the parties' failure to obtain CFIUS approval; the termination in January 2018 of an attempted US$1.2 billion strategic acquisition of US money transfer company MoneyGram International Inc by Chinese financial service provider and affiliate of Alibaba, Ant Financial Services Group, because of CFIUS refusal of approval over national security concerns; the termination in November 2017 of a US$100 million investment in US financial services firm Cowen Inc by CEFC China Energy Company Limited; the executive order issued by President Trump in September 2017 blocking a proposed US$1.3 billion sale of Lattice Semiconductor Corporation, a publicly traded US manufacturer of programmable logic chips, to a Chinese state-backed private equity firm; the abandonment in September 2017 of the US$285 million proposed 10 per cent equity investment in HERE Technologies by a part-Chinese consortium; the termination in July 2017 of the US$103 million acquisition of US in-flight entertainment company Global Eagle by the Chinese conglomerate HNA because of the parties' inability to obtain CFIUS approval; 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; 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 because of the parties' failure to address national security concerns raised by CFIUS; the termination in February 2016 of the proposed investment in Western Digital by Unis Union and Unisplendour after CFIUS determined to investigate the transaction; and the rejection by US chipmaker Fairchild Semiconductor International in February 2016 of a bid from China Resources Microelectronics citing an 'unacceptable level' of CFIUS risk.

Western countries other than the United States have tightened control over investment by Chinese companies in certain sensitive industries as well, which has resulted in the termination of certain acquisition attempts by Chinese companies. Germany enacted an amendment to the German Foreign Trade and Payments Ordinance (AWV) in July 2017, pursuant to which any acquisition of at least 25 per cent voting rights of German companies by a non-European Economic Area investor is subject to a foreign investment control approval by the German government. On 20 December 2018, Germany promulgated a new amendment to the AWV, lowering this threshold to 10 per cent for certain investments in 'critical infrastructure' or 'military-related products' industries. Notable examples of failed attempts by Chinese companies in Germany include an attempted takeover of the Westphalian mechanical engineering company Leifeld Metal Spinning on 1 August 2018 by Yantai Taihai, a leading participant in the Chinese nuclear sector.

III Year in review

i Recent deal activity

Going-private transactions

The trend of US-listed Chinese companies going private heated up to record levels in 2015 and 2016, retreated from these peak levels in 2017, waned further in 2018 and 2019, revived in 2020, and cooled slightly in 2021. Based on statistics obtained through searches on Thomson ONE: during 2014, four US-listed going-private transactions were announced (with four withdrawn) and three were closed; during 2015, eight US-listed going-private transactions were announced (with seven withdrawn) and 18 were closed; during 2016, eight US-listed going-private transactions were announced (with five withdrawn) and six were closed; during 2017, three US-listed going-private transactions were announced and one was closed; during 2018, five US-listed going-private transactions were announced (with one withdrawn); during 2019, four US-listed going-private transactions were announced and none was closed; during 2020, 15 US-listed going-private transactions were announced and six were closed; and during 2021, five US-listed going-private transactions were announced and six were closed.

The struggle by some Chinese companies against market research firms and short sellers such as Muddy Waters Research, Citron Research and Blue Orca Capital has often provided interesting perspectives on the environment faced by Chinese companies listed in the United States. These market research firms and short sellers have gained name recognition by issuing critical research reports targeting Chinese companies listed in the United States. The business model of such firms appears to involve issuing negative research reports on a public company while simultaneously taking a short position in the company's stock, which often enables these firms 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),4 which are commonly considered to have lower profiles and to be more prone to disclosure issues than companies listed through a traditional IPO process.

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 a scathing report on New Oriental Education & Technology Group Inc on its website, sinking the company's share price to US$9.50 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 United States, and it went public in a traditional IPO. The company's stock price subsequently recovered to US$13.90 one and a half months after the Muddy Waters report came out, suggesting the market's belief that the accusations were not justified. On 14 November 2018, Blue Orca Capital issued a short-selling report, accusing Pinduoduo Inc, a social commerce company in China, of inflating revenues and falsely trimming losses. Blue Orca Capital predicted a 59 per cent drop in the company's stock price in its negative report, whereas Pinduoduo's stock price experienced a surge after the announcement of its quarterly result following Blue Orca Capital's report, suggesting that investors in the US market as a whole can act quite independently of such negative research reports and short-selling attempts. 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 Mobile's share price experienced substantial recovery during the fourth quarter of 2013 and the first quarter of 2014 but lost more than 80 per cent in value amid continued attacks from Muddy Waters and traded below US$4 (or less than one-fifth of its 2013 high) for most of 2017. NQ Mobile Inc was eventually delisted from the NYSE on 9 January 2019.

Regardless of the ultimate outcome, the fact that a single research report could inflict sudden and substantial damage of this nature on a company's reputation and 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 have afforded a few firms that have conducted on-the-ground research outsize influence in the market. Further, their critical coverage, which often involves allegations of disclosure issues or even fraud, has 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 and charges against US-listed China MediaExpress and its chair and CEO for fraudulently misrepresenting the company's 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 (or shortly before) Muddy Waters initiated coverage and issued negative reports regarding these companies.

Amid continued pressure from regulators, unfavourable media coverage, short-selling activities and shareholder lawsuits, the stock prices of many US-listed Chinese companies are perceived to be consistently depressed. Further, even Chinese companies relatively free of negative coverage have often felt that their business model and potential are not fully appreciated by 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-to-earnings (P/E) ratio of 18.02 at the end of 2021, 16.76 at the end of 2020, 14.55 at the end of 2019, 12.43 at the end of 2018, 18.08 at the end of 2017, 15.91 at the end of 2016 and 17.63 at the end of 2015 for A-share listed companies listed on the Shanghai Stock Exchange, and an average P/E ratio of 33.03 at the end of 2021, 34.51 at the end of 2020, 26.15 at the end of 2019, 20 at the end of 2018, 36.21 at the end of 2017, 41.21 at the end of 2016 and 52.75 at the end of 2015 for A-share listed companies listed on the Shenzhen Stock Exchange) often offered valuations several times over those offered in the United States.

The disparity in valuation levels and perceived receptiveness naturally presented 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 to date was the proposed acquisition of Qihoo 360 Technology Co Ltd by a consortium consisting of its co-founder and chair, Mr Hongyi Zhou, its co-founder and president, Mr Xiangdong Qi, and certain other investors, in a transaction valuing the NYSE-listed company at approximately US$9.3 billion (not taking into account rollover shares to be cancelled for no consideration). This deal was closed in July 2016 and remains the largest privatisation of a US-listed Chinese company.

While earlier going-private transactions involving US-listed Chinese companies tended to run more smoothly, some more recent transactions of this type went through more eventful processes, suggesting the challenges in completing such transactions have been increased by a more competitive deal-making environment with a shrinking pool of desirable targets and a more seasoned shareholder base. 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 shareholders' 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 been drawing 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 then engaged in an intense publicity war, iKang's board adopted a poison pill and Meinian increased its offer price for the second time. In June 2016, after the board of directors of iKang received a competing going-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-led consortium and the Meinian-led consortium withdrew their going-private proposals. After 21 months' negotiation, a reorganised consortium led by Yunfeng Capital, Alibaba Group Holdings, Boyu Capital, Ligang Zhang and Boquan He, the vice president of iKang, managed to enter into a merger agreement on 26 March 2018, pursuant to which the reorganised consortium proposed an offer at US$41.20 per share (or US$20.60 per American depositary share (ADS) of the company), with a total value of approximately US$1.097 billion. This offer was approved by iKang's general shareholders' meeting on 20 August 2018, and the merger was closed and officially announced on 18 January 2019. In addition, recently, another going-private deal attracted public attention. A buyer consortium led by Centurium Capital and including CITIC Capital, Hillhouse Capital, Temasek Holdings and the management team first announced its indicative proposal to privatise the Nasdaq-listed China Biologic Products Holdings, Inc (China Biologic), a leading blood plasma-based biopharmaceutical company, for US$4.59 billion in cash on 18 September 2019. On 19 November 2020, the two sides reached an agreement for the consortium to purchase the outstanding shares of China Biologic not already owned by the consortium members at US$120 per share, implying a valuation of US$4.76 billion for China Biologic. The privatisation transaction was closed on 20 April 2021.

The going-private trend was not limited to entities resulting from an RTO. 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 of higher quality and less likely to have accounting or securities law compliance issues, and thus are more likely to grab a higher valuation later on, whether in an IPO in a market closer to China or a trade sale. Indeed, all of the examples discussed above involved companies listed through a traditional IPO.

A majority of US-listed China-based companies involved in going-private transactions in recent years are incorporated in the Cayman Islands. Three out of five US-listed China-based companies that announced receipt of a going-private proposal in 2021 were Cayman Island companies that accessed the public markets through a conventional IPO, compared with five Cayman Islands company out of seven US-listed China-based companies in deals announced in 2020, two Cayman Islands companies out of four US-listed China-based companies in deals announced in 2019, one Cayman Islands companies out of five US-listed China-based companies in deals announced in 2018, one Cayman Islands company out of three US-listed China-based companies in deals announced in 2017, six Cayman Islands companies out of eight US-listed China-based companies in deals announced in 2016, seven Cayman Islands or British Virgin Islands companies out of eight US-listed China-based companies in deals announced in 2015, and four Cayman Islands or British Virgin Islands companies out of four China-based companies in deals announced in 2014. This was driven in part by the introduction of new merger legislation in the Cayman Islands in April 2011, which made statutory merger under the Cayman Islands Companies Act 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 Act, 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, in the absence of any higher threshold in the articles of association of the target company. In addition, a merger under the Cayman Islands Companies Act is not subject to the 'headcount' test required in a scheme of arrangement, the primary route for business combination under the Cayman Islands Companies Act before merger legislation was introduced in the Cayman Islands. The headcount test requires the affirmative vote of 'a majority in number' of members voting on the scheme, regardless of the amount or voting power of the shares held by the majority, which means that a group of shareholders holding a small fraction of the target's shares could block a transaction. The lower approval threshold makes mergers an attractive option when compared with either a 'squeeze-out' following a takeover offer, which would require the buyer to obtain support from 90 per cent of the shares, or a scheme of arrangement, which would involve substantial closing uncertainty on account of the headcount test, as well as added time and costs arising from the court-driven process.

Most of the going-private transactions that closed in 2018 and 2017 took between two and five months from the signing of definitive agreements to closing of the transactions (the rest took five months or longer) 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 another common approach to acquire a US public company). For those going-private transactions that closed in 2021 and 2020, around two-thirds were structured as a two-step transaction and took between 13 months and 19 months from signing to closing while the remaining one-third were structured as a one-step merger and took between four months and eight months from signing to closing. 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 further subject to Rule 13e-3 of the Securities and Exchange Act and are commonly referred to as '13e-3 transactions'. A 13e-3 transaction requires the parties to the transaction to make additional disclosures to the public shareholders, including as to the buyer's position on the fairness of the transaction. An important related impact is that, whereas the SEC reviews only a fraction of all proxy statements, it routinely reviews disclosure in 13e-3 transactions, which can lengthen the transaction process by several months. Further, companies incorporated outside the United States and listed on US stock exchanges (including recent going-private targets that often are incorporated in the Cayman Islands or the British Virgin Islands) are known as foreign private issuers (FPIs). While FPIs are not subject to the proxy rules, they are subject to 13e-3 disclosure obligations, and if they are engaged in a 13e-3 transaction, they would be required to include as an exhibit to their 13e-3 filings information that is typically very similar to a proxy statement prepared by a US domestic issuer. Accordingly, both a transaction involving a US domestic company and a 13e-3 transaction involving an FPI follow a comparable timetable for purposes of SEC review.

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 also create hurdles for going-private transactions of offshore-listed China-based companies as these transactions typically involve buyer parties or financing, or both, from China. 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.

Another key recent trend in going-private transactions of US-listed Chinese companies that are incorporated in the Cayman Islands is the rise of dissenting shareholders in such deals. Many of the US-listed and Cayman-incorporated Chinese companies that have recently gone private are facing dissenting shareholder litigations under Section 238 of the Cayman Islands Companies Act by investors who claim that their shares are worth more than the offer price. Often, the buyer groups are accused of forcing through low-ball offers by virtue of their significant voting rights. Low-ball offers are possible partially because Cayman Islands law allows buyer groups to vote their shares, including super voting shares, together with the other shareholders, towards the two-thirds in voting power represented by shares present and voting at the shareholders' meeting required for approval of the merger. For example, the buyer groups in the take-private of Mindray and Shanda Games held 63.1 and 90.7 per cent, respectively, in voting rights in the relevant target companies. Some private equity shareholders in going-private transactions have publicly complained or made Schedule 13D filings with the SEC about low-ball offers from Chinese buyout groups.

In January 2017, the Cayman Islands Grand Court delivered its interlocutory judgment regarding the Blackwell Partners LLC v. Qihoo case, in which it decided that interim payments could be requested by dissenting shareholders and granted by the court during the judicial proceedings for the merger transactions initiated under Section 238 of the Cayman Islands Companies Act. In April 2017, the Cayman Islands Grand Court delivered its ruling in the Shanda Games case, in which it found that the fair value of the shares owned by the dissenting shareholders (which were all funds managed by Hong Kong-based fund manager Maso Capital) was more than double the consideration offered in the take-private scheme (although the Cayman Islands Privy Council then partially scaled back such fair value by applying a 'minority discount' in the valuation method in its appellate decision in January 2020). These decisions, in hindsight, are perceived to be instrumental in shaping the dissenting shareholder landscape in the Cayman Islands. The Shanda Games case was the second Cayman court decision on fair value in a merger, and the first one that required the Cayman court to determine the value of a company with assets and business operations in China. While the Shanda Games decision further propped up expectations of dissenting shareholders of a court-determined fair value that is substantially higher than the price offered by the buyer group, the Qihoo decision (together with a few other similar decisions) perhaps dealt the more decisive blow by enabling the dissenting shareholders to recover interim payments (which are often equal to the price offering in the take-private) relatively soon after initiation of litigation, significantly reducing the cost of funds for dissenting shareholders.

Currently, several similar additional cases are pending in the Cayman Islands courts, and it remains to be seen whether future Cayman court decisions will balance market expectations and discourage speculative dissenters. One of the cases demonstrating these balancing efforts is the decision of the Cayman Islands Grand Court in the going-private transaction of eHi Car Services Ltd (eHi), the provider of passenger car rental services in China. In June 2018, the Cayman Islands Grand Court decided that the dissenting minority shareholder of eHi could not pursue a winding-up petition intended to delay, or to gain leverage for, a competing merger bid for the privatisation of eHi. To compete against a proposal at US$13.35 per ADS offered by a consortium led by Baring Private Equity Asia Limited and Ruiping Zhang, the chairman of eHi group, Ctrip Investment Holding Ltd, a dissenting minority shareholder of eHi, submitted a counter proposal at US$14.50 per ADS. This proposal, although at a higher offer price, was not recommended by the special committee to the board of directors of eHi because it was considered to be a last-minute increase from the price offered in the proposal submitted by Baring and the chairman. Ctrip Investment Holding Ltd then presented a winding-up petition together with an immediate injunction to the Cayman Islands Grand Court. The court struck out the winding-up petition in its entirety on the ground of abusive use of the winding-up jurisdiction by the dissenting shareholder. Although a reorganised consortium led by Ctrip Investment Holding Ltd and Ocean Imagination LP eventually won the competing bid with a revised proposal at US$15.50 per ADS in May 2018, the Cayman Islands Grand Court's decision in this case now stands as an exemplary case for the principle that a winding-up petition may not be abusively used by dissenting shareholders to avoid a going-private transaction.

Other notable transactions

Consolidations in the vying internet and technology industries in China have been soaring and hitting headlines for several consecutive years. 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, and 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 the largest shareholder of Didi Chuxing, 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, film 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$15.6 billion. In January 2016, Meilishuo.com, a Chinese fashion retailer backed by Tencent Holdings Ltd (Tencent), 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. In September 2017, the merger of two major online film-ticketing platforms was announced between Maoyan (majority-owned by Chinese television and film company Enlight Media) and Weying (backed by Tencent). Following the merger, the combined Maoyan-Weying entity will control 43 per cent of China's online ticketing market, according to Enlight Media's announcement. In April 2018, Ele.me, a leading online food order and local delivery services platform in China, announced the completion of its merger into Alibaba Group Holdings Limited (Alibaba), with a valuation of US$9.5 billion. Following the merger, Ele.me has become a part of the Alibaba ecosystem by complementing Alibaba's current local services platform, Koubei, and providing extended synergies to Alibaba's new retail business sector in the long run. In September 2019, Kaola.com, a leading cross-border e-commerce platform in China, announced the completion of its merger into Alibaba, with a valuation of US$2 billion. Kaola.com was one of the biggest competitors of Tmall.com (the core cross-border e-commerce platform of Alibaba) in the field of cross-border e-commerce business in China. Upon the merger, Kaola.com retains its trade name and independent operations, while the management team of Tmall.com took charge of the corporate governance of Kaola.com. On 14 April 2020, Jumei International Holding Ltd (Jumei), a leading fashion and lifestyle solutions provider in China, announced the completion of its merger with Jumei Investment Holding Ltd, a unit of Super ROI Global Holding Ltd, with a valuation of US$126.51 million. Following the merger, Jumei will have greater flexibility to focus on long-term business goals, including pursuing strategic truncations and acquisitions, without the constraint of the public market's emphasis on quarterly earnings. On 28 September 2020, SINA Corporation (SINA), a leading online media company serving China and the global Chinese communities, announced that it has entered into a merger agreement, pursuant to which New Wave MMXV Ltd agreed to acquire the remaining 87.878 per cent interest in SINA for a total US$2.59 billion in a leveraged buyout transaction, via an unsolicited management buyout offer. On 23 March 2021, SINA officially announced the completion of privatisation and delisting from Nasdaq in the United States. On 17 August 2020, Yintech Investment Holdings Limited (Yintech), a leading provider of investment and trading services for individual investors in China, announced that it had entered into a merger agreement, implying an equity value of Yintech of approximately US$540.2 million. On 19 November 2020, Yintech announced the completion of its merger with Yinke Merger Co Ltd. On 21 June 2021, 51job, Inc (51job), a Chinese human resources and job search provider, announced a definitive agreement and merger plan with Garnet Faith Limited, to be taken private for US$5.7 billion. The deal was expected to be one of the largest deals recorded for a recruitment marketplace business. The consortium of investors that formed Garnet Faith Limited includes DCP Capital Partners, Ocean Link Partners, 51job's CEO/co-founder Rick Yan, and Japan-based recruitment giant Recruit Holdings, the company's largest shareholder. On 8 November 2021, 51job announced that its privatisation plan may not be completed in the second half of 2021 as planned due to the regulatory changes in China. The company's recent announcement notes that certain members of the buyer consortium have been 'in consultation with Chinese regulators on recent regulatory changes' and 'a clear timeline to its completion cannot be provided at this time.' On 12 January 2022, 51job received a proposal from the consortium to reduce the merger consideration by approximately 28 per cent.

Apart from the iconic mergers described above, the headline private equity investments in 2018 primarily focused on China's technology industries. In April 2018, Pinduoduo Inc, the leading 'new-ecommerce' platform, which features a team purchase model, announced the completion of its pre-IPO financing at a valuation of US$15 billion with Sequoia Capital and Tencent. In June 2018, Ant Financial Services Group, the leading online payment service provider and the financial arm of the Alibaba Group, announced the completion of its US$14 billion Series C financing (with a valuation of US$150 billion) from a series of private equity and sovereign funds, including Baillie Gifford & Co, BlackRock Private Equity Partners, Canada Pension Plan Investment Board, The Carlyle Group, General Atlantic LLC, GIC Special Investments, Janchor Partners, Khazanah Nasional Bhd, Sequoia Capital, Silver Lake Partners, T Rowe Price, Temasek Holdings and Warburg Pincus. In October 2018, ByteDance/Toutiao, the leading internet content platform in China, announced the completion of its pre-IPO financing at a valuation of US$75 billion from leading global private equity funds, including General Atlantic, KKR, Primavera and SoftBank. In 2019 and 2020, the highlights of private equity investments still targeted China's information technology industries. In February 2019, Chehaoduo Group (Guazi.com/Maodou.com), the leading e-commerce platform for used vehicles in China, announced the completion of its pre-IPO financing at a valuation of US$1.5 billion with SoftBank Investment Advisers. In November 2019, Cainiao Network Technology, one of the leading internet-based logistic service providers in China, announced the completion of its US$3.3 billion Series B financing pursuant to which Alibaba became the largest and controlling shareholder of the company. In December 2019, Kuaishou.com, the leading short video content provider and social platform in China, announced the completion of its pre-IPO financing at a valuation of US$3 billion from a series of private equity investors, including Boyu Capital, Sequoia Capital, Yunfeng Capital, Tencent and Temasek Holdings. On 18 September 2020, 58.com Inc., China's largest online classifieds marketplace, announced the completion of its merger (representing a deal size of US$8.39 billion) with Quantum Bloom Group Ltd where 58.com, General Atlantic, Ocean Link and Warburg Pincus will collectively hold 85 per cent of the company upon the completion. In 2021, the real estate industry maintained stable development and attracted private equity investments. In August 2021, Chinese conglomerate Dalian Wanda Group raised nearly US$6 billion for its commercial property management business ahead of its Hong Kong IPO, in one of China's biggest such fundraising in 2021. Hong Kong-based private equity firm PAG led the fundraising, with US$2.8 billion of the unit. PAG's investment includes a US$1.9 billion equity portion and US$933 million form a syndicated loan facility. Other investors include developer Country Garden, private equity firm CITIC Capital and tech giants Tencent and Ant Financial Services Group. The fundraising underscores investors' confidence in the Chinese commercial property market.

Another noteworthy trend in recent years has been 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 trend 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 that was 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, Fosun International Ltd and Goldman Sachs. Warburg Pincus was reported to have bought the largest portion of such 21 per cent stake for close to US$700 million. In August 2017, Wealth Capital, a Beijing-based private equity firm, set up a 5 billion yuan investment fund in Beijing targeting SOEs undergoing mixed ownership reform, in which the state-backed China Structural Reform Fund (a 350 billion yuan SOE restructuring fund backed by investors including China Chengtong Holdings Group, China Merchants Group and China Mobile) has invested and Wealth Capital acts as the fund manager, which is just one of many similar SOE reform-targeted funds that are being set up by state-owned capital and private equity funds across China.

ii Financing

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 debt financing. Further, with a view to deleveraging and strengthening the economy, the Chinese authorities imposed various new foreign debt controls in 2018, which will impact the availability of security and financing to be provided by Chinese entities and financial institutions. For instance, insurance companies have been restricted from providing outbound guarantees for offshore debt, domestic Chinese companies raising foreign debt have been subject to higher governance standards, local government entities have been prohibited from providing outbound guarantees for offshore borrowing, and real estate companies have been restricted from using foreign debt in relation to real estate projects. The covid-19 pandemic made the fundraising prospect even worse. In the first quarter of 2020, the amount and number of funds raised showed a year-on-year percentage (YoY) decrease, large-scale fundraising was impeded, the raising period was lengthened, and previous funds were postponed to the current period to complete raising. The fundraising amount decreased by 19.8 per cent YoY in the first quarter, and increased by 8.5 per cent in the second quarter, but it still showed a drop of 36.5 per cent YoY. In 2021, China-focused fund managers and general partners raised more than US$19 billion for US dollar-denominated funds, comfortably beating the 2020 total. However, nearly three-quarters of commitments were made before July, when the newly NYSE-listed Didi Chuxing was investigated by US regulators. Following a string of other regulatory interventions, it was enough to make investors hold fire. Numerous private equity and venture capital firms have seen fundraising processes slow or planned closes delayed as a result. Industry participants are not confident of a return to form in 2022.

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, including the target) 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, mainly due 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, the 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 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 financing structure.

Another emerging trend in these offshore financing structures is that borrowers are seeking to access liquidity from the offshore debt markets in respect of what are essentially acquisitions of China-based businesses – including as a means to take out bridge financing originating outside Asia.

iii Key terms of recent control transactions

Deal terms in going-private transactions

Most Chinese going-private transactions have involved all-cash consideration. Among the US-listed going-private transactions that closed during 2017, the per-share acquisition price represented an average premium of 17.5 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 (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 to the board. 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 Islands or British Virgin Islands companies were reported to the public in 2017, 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 constitutes the '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 at least a majority of the shares outstanding. However, special committees often insist on a higher approval threshold, because under Delaware law the burden of proving that a going-private transaction is 'entirely fair' to the unaffiliated shareholders often 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 shareholders' meeting.

Another key negotiation point is whether the target would benefit from a go-shop period, which is a period following the signing of a 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 de minimis 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 (e.g., through 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, the investor's pro rata share of the remaining proceeds based on the number of shares it owns on an as-converted basis. However, because there is no well-defined market when it comes to transaction terms in Chinese growth equity deals (unlike in going-private transactions), 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 a 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 founders or original shareholders at onshore level without consideration or for nominal consideration, so as to achieve adjusted valuation of the target company following the failure to meet specified performance targets. In Chinese growth equity investments, the parties' 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 recent years, 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 competition among 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 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 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.

iv Exits

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 United States led by a consortium of private equity investors. This deal represented the first relisting 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 relist in Chinese domestic market. Giant Interactive achieved an 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 relisted on the A-share market. Qihoo, after its largest going-private of a US-listed Chinese company to date, has received the Chinese securities regulatory authority's approval for a relisting in China under the new name of Technology 360 through back-door listing via Shanghai-listed Jiang Nan Jia Jie.

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 the Series A financing of the company in 2015, raised US$1.4 billion in its listing on the NYSE in October 2016, making it the largest IPO by a Chinese company in the United States in 2016, and, after Alibaba, the second-largest in history for US IPOs of Chinese companies.

Another noteworthy IPO was 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 VIE structure, trailblazing a trend of Chinese technology companies tearing down VIE structures and seeking to be listed on Chinese or Hong Kong stock exchanges.

In the first quarter of 2020, because of the delay in the transaction progress as a result of the outbreak of the covid-19 pandemic, the number of exits failed to continue the growth in 2019, down 6.9 per cent YoY. Shanghai Stock Exchange STAR Market has been running well for one year, driving the number of IPOs of invested enterprises in the first quarter. IPO exits accounted for more than 70 per cent of the total exits. The number of M&A/backdoor transactions has decreased by more than 30 per cent compared with the same period of last year. Rare investment firms were adopting short-term arbitrage strategies. The return and internal rate of return (IRR) of value investors with longer investment horizon are generally higher.

The wave of privatisations of Chinese enterprises in the US market in 2021 was stirred in the first half of the year by the passage of HFCAA (see details in Section II.iii) which required auditors of foreign public companies to allow the Public Company Accounting Oversight Board to inspect their audit work papers for audits of non-US operations (which potentially clashes with applicable accounting and securities regulations in China) or face the risk of compulsory delisting; and in the second half, intensified by the game between US and Chinese securities regulatory authorities over the VIE structure commonly adopted by China-based companies and the regulatory spotlight shed on cybersecurity and data security concern in overseas listing (by making an example of Didi Chuxing which has announced its plan to delist from the NYSE and pursue a listing in Hong Kong) by Chinese authorities. Meanwhile in November 2021, the Hong Kong Stock Exchange (HKEX) published a set of new policies (including a lower minimum valuation threshold and a more relaxed listing structure) to accommodate secondary listing of Chinese enterprises delisted from the US market. According to a Reuters article,5 by the end of 2021, among 240 US-listed China-based companies, 19 has completed HK listings, accounting for approximately 70 per cent of the aggregate market value of such companies, and among the remaining companies, 27 would satisfy the HK listing standards, representing a total market value of US$250 billion.

Despite the coming winter in the US market for China-based companies, the number of US IPOs and amount raised by China-based companies in such IPOs still surpassed those of 2020. Given the relatively relaxing financial standards and audit requirement, Nasdaq will remain attractive to medium-sized to small China-based companies (generally those with a market value lower than US$0.1 billion or that are still in the red) that fall short of the listing standards for China A-Share or HKEX main board.

With respect to transactions involving special purpose acquisition companies (SPACs), both the SPAC side (with regard to fundraising and public offering of a SPAC) and the de-SPAC side (with regard to the M&As and other business combination activities taken by a SPAC and relevant PIPE transactions) witnessed significant growth in Asia in 2021. As SPACs move to the mainstream of M&A transactions, private equity firms begin to sponsor acquisition vehicles even though SPACs represent their direct competitor for private assets in a traditional sense. However, by the same token, de-SPAC transactions also create new source of liquidity for exits as a fast track to the public market. That said, China-based targets are less attractive to sponsors given the recent capricious regulatory environment in China and the US compared with other regions in Asia. HKEX, however, has announced the introduction of the SPAC mechanism in December 2021, laying the foundation of a hub for SPAC deals involving China-based targets and providing more liquidity opportunities for private equity funds. It remains to be seen whether SPACs will gain popularity in the Hong Kong market as they have in the past year in the US market.

Sponsor-to-sponsor sales contributed to 33 per cent of the exit proceeds in Asia in 2020, up from 21 per cent in 2018. This trend was intensified as 2021 progressed, reaching US$17.8 billion in the fourth quarter, though capital was concentrated in a relatively small number of deals. In January 2022, Hong Kong-based Baring Private Equity Asia announced its sale of customised technology solutions provider Interplex (which has significant operation in China) to private equity funds managed by Blackstone Inc for an enterprise value of US$1.6 billion. Sponsor-to-sponsor deals provide opportunities for private equity investors to be more creative in generating value. While such deals have previously been viewed as inefficient due to repeated transaction fees and other costs, involvement of private equity firms on both sides has the benefit of speeding up the entire transaction process. For example, the due diligence process in sponsor-to-sponsor deals can be completed at a faster pace compared to other transactions and as such, the extra time saved allows private equity investors to focus more on strategy and creative solutions. As current market conditions and regulatory difficulties making IPOs a less attractive exit option than before, the option to sell to a strategic buyer that is looking for growth or another peer private equity firm that has the ability to capitalise on synergies and take the company to a new performance level seems to be a win-win alternative.

IV Regulatory developments

i Legal developments in cybersecurity and data security

Ever since the implementation of the National Security Law in 2015 and the Cybersecurity Law in 2017, cybersecurity and data security have been brought into the dimension of overall national security. Cybersecurity and data security, as two separate but intertwined regimes, experienced a booming year in 2021, with the issuance of more than 50 new laws and regulations, amendments and legislation drafts from central to local levels, across different departments and industries.

On 1 June 2021, the Standing Committee of NPC promulgated the Data Security Law, which took effect on 1 September 2021. The Data Security Law regulates the data processing activities of data processors, establishes a data classification and management system, emphasises the protection of important data, and strengthens the risk management for cross-border transfer of important data. Notably, the Data Security Law specifies that entities and individuals may not provide data stored in China to non-Chinese judicial or law enforcement bodies without the prior consent of the competent Chinese authorities, and non-compliance with this regulation may result in a fine of up to 5 million yuan and suspension or termination of operation. This provision echoes Article 177 of the Securities Law that draws special concern from US securities regulators. Article 177 of the Securities Law prohibits organisations and individuals from providing documents or materials relating to securities business activities (including but not limited to security trading and investment, securities underwriting and sponsoring, securities brokerage, financial or investment advisory relating to securities investment) upon request from overseas securities regulatory authorities in their investigation or evidence collection process without the consent of the Chinese securities regulatory authorities.

On 20 August 2021, the Standing Committee of NPC promulgated the Personal Information Protection Law (PIPL). Taking effect on 1 November 2021, PIPL regulates the entire life cycle of personal information processing (including the collection, storage, use, processing, transmission, provision, disclosure and deletion of personal information), enhances protection of rights of users and individuals in personal information processing activities (such as imposing requirements on general and individualised consent and limiting use of meta data in personalised marketing), and clarifies the obligations of data processors in respect of personal information. Furthermore, industry-orientated data security laws and regulations, such as the Security Protection Regulations for Critical Information Infrastructure promulgated by the State Council on 30 July 2021 and took effect on 1 September 2021, the Administrative Measures on Credit Investigation Business promulgated by the People's Bank of China on 27 September 2021 and took effect on 1 January 2022 and the Several Provisions on Automotive Data Security Management (for Trial Implementation) jointly promulgated by five governmental agencies and took effect on 1 October 2021, supplement PIPL in specific sectors and contribute to a more accurate and comprehensive regulatory system on protection of personal information.

The most prominent development in cybersecurity and data security regime in 2021 may be the issuance by the Cyberspace Administration of China (CAC) of the Administrative Regulations on Network Data Security (Draft for Comments) (the Draft Data Security Regulations) on 14 November 2021 and the final version of the Measures for Cybersecurity Review (the 2022 Cybersecurity Review Measures) on 4 January 2022 (to take effect on 15 February 2022), which repealed and replaced the old Measure for Cybersecurity Review promulgated in 2020. Under the 2022 Cyber Security Review Measures, cybersecurity review may be launched by notice of the Cybersecurity Review Office of CAC under the inter-agency cybersecurity review working mechanism when a cybersecurity review is deemed necessary, by voluntary application of a critical information infrastructure operator when such operator anticipates national security risks in its procurement activities, or by mandatory application of an online platform operator (defined under the Draft Data Security Regulations as a data processor who provides internet platform services such as internet publishing, social networking, or online transactions, payment or audio-visual services) who seeks to go public abroad (typically interpreted to exclude Hong Kong, but include foreign countries such as the US, subject to further official clarification) and who possesses the personal information of more than 1 million users.

Both the Draft Overseas Listing Administrative Provisions and the Draft Overseas Listing Filing Measures (see Section IV.v below) mandate that clearance from cybersecurity review (if applicable) is a precondition for a successful filing with CSRC for overseas securities offering and listing by a domestic enterprise. If it is found through cybersecurity review that the overseas listing may compromise national security, the domestic enterprise may be required to divest the relevant business assets or to take other actions to prevent and avoid the impact on national security. If the domestic enterprise conducted the overseas securities offering and listing despite the cybersecurity risks, the domestic enterprise will be warned by CSRC, CAC or other regulators under the State Council and may be liable for a fine of between 1 million and 10 million yuan; suspension of business or revocation of licences or permits (including business licences) may also be imposed for severe violations. The controlling shareholder, actual controller, directors, supervisors and senior officers of such domestic enterprise, as well as the underwriters and law firms providing services in the overseas securities offering and listing (which fail to fulfil their duties to supervise and urge the enterprise to comply with the relevant regulatory requirements) may also receive a warning and be liable for a fine of more than 0.5 million yuan but less than 5 million yuan.

The Draft Data Security Regulations make a clear distinction between going public abroad, in Hong Kong and overseas (interpreted as including both Hong Kong and foreign countries). A data processor that seeks to go public abroad and that handles the personal information of more than 1 million users must undergo a mandatory cybersecurity review; a data processor that seeks to go public in Hong Kong that has or may have an impact on national security must also apply for a mandatory cybersecurity review (i.e., Hong Kong listing does not provide a safe harbour for cybersecurity review in case of any national security implication); a data processor that handles important data or seeks to go public overseas must conduct an annual data security assessment (either itself or through data security service providers) and submit an annual assessment report to local counterparts of CAC. Nevertheless, a comprehensive data security review system is yet to be established (which has been proposed in the Data Security Law). It remains to be seen whether any such system would be established through future legislation similar to the 2022 Cybersecurity Review Measures.

ii New guidelines on overseas listings of domestic companies

A series of new guidelines on overseas listings of domestic companies were launched at the end of 2021 and instantly drew wide attention and aroused heated discussions. The 2021 Negative List (issued on 27 December 2021) for the first time expressly states that domestic enterprises operating in prohibited sectors will have to seek permission from the regulator that regulates its business before listing overseas, and if approval is given, foreign investors may not hold more than 10 per cent for each single investor or more than 30 per cent in the aggregate of the shares of such enterprise and no foreign investor can participate in the management of such enterprise.

On 24 December 2021, CSRC released the Administrative Provisions of the State Council Regarding the Overseas Issuance and Listing of Securities by Domestic Enterprises (Draft for Comments) (the Draft Overseas Listing Administrative Provisions) and the Measures for the Overseas Issuance of Securities and Listing Record-Filings by Domestic Enterprises (Draft for Comments) (the Draft Overseas Listing Filing Measures), both of which held a period for public comments that expired on 23 January 2022. The Draft Overseas Listing Administrative Provisions and the Draft Overseas Listing Filing Measures regulate the system, filing management and other related rules in respect of the direct or indirect overseas (typically interpreted to include Hong Kong) issuance of listed and traded securities by domestic enterprises and provide directional guidance to China's reform plan on the supervision of overseas listing. The types of overseas issuance and listing of securities regulated by the Draft Overseas Listing Administrative Provisions include a 'direct listing' where the domestic enterprise (a company limited by shares) issues public securities to be listed and traded on an offshore stock exchange such as the stock exchanges in Hong Kong and the US; and an 'indirect listing' where the domestic enterprise's non-PRC parent whose primary business activities are in China acts as the issuer and the determination of whether the listing standards are met is based on the equity, assets or income of the domestic enterprise or the rights and interests relating thereto (including the rights to control or manage the domestic enterprise through a VIE structure). The Draft Overseas Listing Administrative Provisions (OLAP) introduced a filing-based system where domestic companies seeking for direct or indirect overseas securities offering and listing shall first complete filing procedures with CSRC before such securities offering and listing. For 'indirect' overseas listing of domestic enterprises, whether any filing with CSRC for such listing is required depends on, in particular, whether the following conditions are satisfied: (1) the operating income, total profits, total assets or net assets of the domestic enterprise in the latest accounting year account for more than 50 per cent of the relevant data in the issuer's audited consolidated financial statements for the same period; and (2) most of the senior officers in charge of business operations and management are Chinese citizens or have habitual residence within the territory of China, and the main business operations are located or carried out mainly within the territory of China (which does not include Hong Kong for purposes of the above condition). It remains unclear whether the final OLAP will require both of the above conditions, or just one of them, to be satisfied for the CSRC filing requirement to apply. Furthermore, the Draft Overseas Listing Administrative Provisions clearly specify that its jurisdiction extends not only to listed securities, but also depository receipts, convertible corporate bonds, and other equity instruments. In other words, the different securities offering and listing models, such as IPOs, DPOs, RTOs and SPACs, will all be subject to CSRC's jurisdiction under the Draft Administrative Provisions. To complete the filing, the domestic enterprise shall present, among other things, opinions from CAC evidencing the completion of cybersecurity review and approval (if applicable) and approvals from its business regulators. In addition, the Draft Overseas Listing Administrative Provisions propose a parallel post-listing disclosure system where the domestic enterprise shall disclose to CSRC matters relating to follow-on offerings, material changes of business, material impact on a permit, change of control, change of listing plans or regulatory actions by any overseas securities regulator.

The Draft Overseas Listing Administrative Provisions also stipulated the following 'red lines' where overseas securities offering and listing of a domestic enterprise shall be prohibited: (1) specific prohibition imposed by national laws and regulations (such as prohibition on the financing of curriculum-based tutoring institutions by way of public listing); (2) a finding of threat or danger to national security as reviewed and determined by competent review authorities under the State Council; (3) existence of material ownership disputes over the equity, major assets or core technology, etc., of the issuer; (4) corruption, bribery, embezzlement, misappropriation of property or other criminal offenses disruptive to the order of the socialist market economy committed in the past three years by the domestic enterprise or its controlling shareholders or actual controllers, or ongoing judicial investigation on the domestic enterprise or its controlling shareholders or actual controllers for suspicion of criminal offenses or major violations of laws and regulations; (5) administrative punishment for severe violations imposed on directors, supervisors, or senior executives of the domestic enterprise in the past three years, or ongoing judicial investigation on such persons for suspicion of criminal offenses or major violations of laws and regulations; and (6) other circumstances as prescribed by the State Council.

While the Draft Overseas Listing Administrative Provisions and the Draft Overseas Listing Filing Measures provide long-anticipated guidance on the regulatory requirements and procedures on overseas issuance and listing of securities by domestic enterprises, there are quite a few ambiguities and practical questions such as application of standards on filing requirement; implementation of a transitional period and treatment of ongoing listing applications; enforcement actions on cases with national security risks and domestic enterprises who fail to fulfil filing obligations, which remain to be answered in the final version of such provisions and measures and subsequent implementation rules and guidelines.

For private equity investors, overseas securities offering and listing of domestic enterprise have been and remain a major exit strategy. For a long time, due to unpredictability in domestic regulatory procedures, listing timelines and regulatory attitude towards the VIE structure, domestic enterprises tend to choose indirect listing over direct listing as their model for overseas listing. As such, private equity investors are limited by the future listing choices of the domestic enterprises and the relevant closing process is often delayed by the need to establish an overseas structure for future listing. The new guidelines on overseas listing of domestic enterprises, by unifying the regulatory systems for various overseas listing options and financing channels, create a system where no one structure is preferred by law to another. This dynamic might be anticipated to afford private equity investors more room and convenience in terms of investment and exit strategies.

iii Amendments to the foreign investment catalogues

On 27 December 2021, NDRC and MOFCOM jointly issued the Foreign Investment Negative List (2021) (the 2021 Negative List), which took effect on 1 January 2022, and repealed, on the same date, the Foreign Investment Negative List (2020) (the 2020 Negative List). Similar to the 2020 Negative List, the 2021 Negative List only lists those industries subject to special management measures for foreign investment access but the 2021 Negative List further shortens the list from 33 restricted and prohibited items (in the 2020 Negative List) to 31, which may be viewed as a step towards loosening restrictions on market access. The key changes in some of the sectors of particular focus including the following: the sector of manufacturing of passenger vehicle is fully open to foreign investment, as signified by the removal of prior limitations on foreign ownership percentage of automobile manufacturers and that the same foreign company can only establish two or less joint ventures in China to produce similar vehicle products; further, foreign capital is allowed to enter the industry of production of ground receiving facilities of satellite television broadcasting and the key components thereof.

On 27 December 2020, NDRC and MOFCOM jointly issued the Catalogue of Encouraged Industries, which came into effect on 27 January 2021, and contains a list applicable to the entire country, and another list only applicable to China's central, western and north-eastern regions and Hainan province. Compared with the list of the encouraged industries in the Foreign Investment Catalogue (2017 Edition) and the Foreign Investment Catalogue of the Priority Industries in Central and Western China (2017 Edition), the number of industries in which foreign investment is encouraged has been expanded. More than 80 per cent of the new additions and revisions of the nationwide list fall within the manufacturing sector, which supports and encourages foreign investment into high-end manufacturing, intelligent manufacturing, green manufacturing and relevant areas. The list applicable to central, western and north-eastern regions and Hainan province is more focused on labour-intensive industries and advanced and applied science industries, as well as the construction of supplementary facilities, encouraging foreign-invested businesses to move to those regions.

On 27 December 2021, NDRC and MOFCOM jointly issued the Special Administrative Measures (Negative List) on Foreign Investment Access to the Pilot Free Trade Zone (2021) (the 2021 FTZ Negative List), which took effect from 1 January 2022. The 2021 FTZ Negative List is the ninth version of the FTZ Negative List since the State Council issued the Opinion on the Implementation of the Negative List Market Entry System for the first time in 2015, introducing the negative list approach that was first applied in China (Shanghai) Pilot Free Trade Zone (FTZ). On 30 August 2020, the State Council released overall plans for launching three new FTZs in the provinces of Beijing, Hunan and Anhui, bringing the total number of FTZs to 21. These FTZs are located in Shanghai (2013), Guangdong, Tianjin and Fujian (2014), Henan, Hubei, Liaoning, Shaanxi, Sichuan, Chongqing and Zhejiang (2017), Hainan (2018), Shandong, Jiangsu, Guangxi, Hebei, Yunnan and Heilongjiang (2019) and Beijing, Hunan and Anhui (2020). With the enforcement of the FIL, the negative list approach has been adopted as a nationwide policy. Foreign investments in the FTZs may enjoy even fewer investment restrictions and more convenient procedures compared with investments outside of the FTZs. Compared with its 2020 counterpart, the 2021 FTZ Negative List further deleted all the restricted sectors in manufacturing specified in the 2020 edition and opened up the social survey sector to foreign investment (with certain shareholding limitation). Compared with the nationwide 2021 Foreign Investment Negative List, the 2021 FTZ Negative List further relaxed the foreign investment prohibitions and restrictions in the following sectors: selection, breeding and production of new varieties of wheat and corn; fishing of aquatic products in the sea and inland waters under Chinese jurisdiction; printing of publications; processing techniques of traditional medicine and production of Chinese patent medicine products with a secret formula; artistic performance groups; and market survey and social survey. It is expected that the FTZ Negative List will continue to be the benchmark for future amendments of the nationwide Foreign Investment Negative List.

iv Draft Amendment to Company Law

On 24 December 2021, the Standing Committee of NPC issued the draft Amendment to the Company Law (the Amended Company Law Draft) for public comments until 22 January 2022. To sum up, the approximately 70 substantive changes in the Amended Company Law Draft are intended to refine special provisions on state-invested enterprises, improve the company establishment and exit system, optimise corporate structure and corporate governance, optimise the capital structure, tighten the responsibilities of controlling shareholders and management personnel, and strengthen corporate social responsibility. In particular, the Amended Company Law Draft, among other changes, made the following notable amendments: expands the scope of capital contributions to include equity and creditors' rights, which may potentially open the door for share swap and direct debt-equity conversion; emphasises the executive function of the board of directors; allows companies limited by shares to issue classes of shares having different rights in terms of distribution, voting rights or transfer restriction; offers a speedy capital reduction option to companies unable to make up for the losses; tightens the regulation of related-party transactions by expanding the scope of related parties and increasing the reporting obligations on related-party transactions; elevates corporate social responsibility to the level of legal obligation, thereby requiring businesses to take into full account the interests of employees and consumers as well as social interests such as environmental protection in their operations. We shall wait and see to what extent such changes, which will still be subject to multiple rounds of review and revision, will eventually be built into the final version of the Amended Company Law.

v Changes to China's antitrust regime

The Draft AML issued on 23 October 2021 proposes significant changes to the existing AML, including:

  1. imposing harsher penalties for violations, including (1) increasing the maximum fine for failure to notify notifiable transactions to the AMR and imposing punitive fines for repetitive violations, and (2) introducing penalties against individuals, including legal representatives and members of the management of a company. For example, the maximum fine is proposed to be significantly increased from 500,000 yuan to 5 million yuan for the non-filing of an antitrust review that should have been submitted but did not raise competition concerns, and 10 per cent of the previous year's turnover of the subject company for non-filing of an antitrust review that should have been submitted and did in fact raise competition concerns;
  2. establishing safe harbour rules to exempt agreements concluded by companies with small market shares. Specifically, when a company that has entered into a monopoly agreement can prove that its market share in the relevant market is lower than the standard to be set by the enforcement agencies, the monopoly agreement may qualify for an exemption from antitrust scrutiny, absent evidence of competitive harm. It remains to be seen what the market share threshold for the Safe Harbour rule might be; and
  3. reforming the current merger control regime by introducing a 'stop-the-clock' mechanism. Under the reformed 'stop-the-clock' mechanism, SAMR may suspend the running of the statutory review period in certain circumstances, including when (1) the business operators fail to submit documents and materials required for the statutory review, (2) new circumstances and facts emerge that have a significant impact on the examination, and (3) the restrictive conditions attached to the concentration of business operators need to be further evaluated.

As the Draft AML will be subject to additional rounds of review and comment before it can be officially adopted and may be further revised during the review process, it is unclear whether and when the above changes will become binding in law. On 7 February 2021, the Anti-Monopoly Committee of the State Council promulgated the Anti-Monopoly Guidelines for the Platform Economy Sector (the Platform Economy AML Guidelines), which provide detailed rules for the implementation of AML in the internet platform industry. Use of algorithms, technology and platforms to engage in practices such as price discrimination and exclusivity undertakings will be regulated and sanctioned by the anti-monopoly enforcement agency of SAMR. This might signify a trend that certain important industries such as finance, technology and media could become key targets for the merger control review by the antitrust authorities.

V Outlook

While 2021 witnessed booming private equity activity in China, the uncertainty associated with both the US–China relationship and the covid-19 pandemic remains, and ongoing economic challenges present dealmakers with both risks and opportunities. Investors will be required to navigate the market more carefully and identify quality assets and value-creating opportunities as well as develop competitive investment strategies and ensure good exits for existing portfolios in the context of any market disruption.

Looking forward into 2022, we expect several key factors to impact the level of dealmaking activity. The impact of the covid-19 pandemic continues to be unpredictable and China's overall economic performance in 2022 will continue to face significant challenges. Internally, China is continuing to push towards opening up and is focusing on quality growth while having to implement aggressive measures such as strict lockdowns, quarantine, mass testing and travel controls under the 'dynamic zero-case' pandemic-control policy. Externally, the China–US economic and political tensions linger.

The regulatory landscape is also a key factor that may impact investment patterns. In terms of the foreign investment regulatory regime, as China continues to broaden access to its market by foreign investors and improve the foreign investment environment through the introduction of FTL, negative list management system, the Catalogue of Encouraged Industries and the launching of various FTZs, foreign investors may see new opportunities in the reorganisation, consolidation and restructuring of SOEs, listed companies, financial institutions and top-notch start-up firms and in broader and fast-growing industry sectors. Investors may also shy away from traditional industries or over-leveraged sectors where the country's regulators may look to curb excessive capital inflow. Key industries such as healthcare, renewable energy and smart manufacturing are likely to become the driving forces from which significant transactions can be generated. On the other hand, increasing regulatory challenges (both in China and at a global level) in antitrust enforcement, national security protections, and a greater focus on data protection and cybersecurity will give rise to more complex deal-making, and private equity investors will have to make the necessary adjustments to their Chinese investment and exit strategies and come up with creative deal structures.

Going-privates will likely pick up again in 2022, as the threat of delisting companies under the HFCAA looms even larger and the US–China tensions continue to increase, while Hong Kong readies to embrace secondary listings of China-based enterprises flowing back from the US market. With a strong record in 2021 in the Asia market, SPACs could remain attractive to private equity investors, both in their capacity as sponsors of SPAC vehicles and as sellers looking for an alternative path to liquidity.


Footnotes

1 Rongjing Zhao and Bryan Jin are partners at Kirkland & Ellis International LLP. The authors wish to give special thanks to Oliver Zhu and Chuqing Ren for their significant contributions to this chapter, and to other Kirkland & Ellis Asia colleagues, Joey Chau, Daniel Dusek, David Patrick Eich, Paul Guan, Chuan Li, Gary Li, Nicholas Norris, Jesse Sheley, David Zhang, Tiana Zhang, Jodi Wu and Yue Qiu, for contributing to this chapter.

2 AVCJ data as of 27 January 2022.

3 ibid.

4 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), whereby 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 or fulfilled the burdensome disclosure requirements of an IPO.

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