On Feb. 3, the General Office of China’s State Council issued the Circular on Establishing a Security Review System for Mergers and Acquisitions of Onshore Enterprises by Foreign Investors (the “Circular”), which just became effective on March 5.
The panel functions similarly to its U.S. counterpart, the Committee on Foreign Investment in the United States (CFIUS) under the U.S. Department of the Treasury. Unlike CFIUS, which is chaired by Secretary of the Treasury and includes representatives from 16 U.S. departments and agencies, China’s panel is jointly headed by two of its ministry-level agencies, the National Reform and Development Commission (the agency in charge of economic policies) and the Ministry of Commerce (the key regulator of foreign investment). Other ministries will be called upon for consulting purposes based on each particular transaction.
The Circular sets out the scope, content, working mechanism and procedure for merger and acquisition security review. It also provides a degree of clarity and certainty to foreign investors in cross-border acquisitions. However, as “national security” can be broadly interpreted, relevant Chinese authorities will certainly have discretion to the interpretation of some provisions and the scope of application of such provisions.
Coming under scrutiny are foreign mergers and acquisitions of domestic enterprises in certain obvious sectors such as military industry and industry related to national defense and security. The Circular also applies a concept of “actual control” in terms of foreign merger and acquisition of domestic enterprises in sectors such as major agricultural products, major energy and resources, infrastructure, transportation services, key technologies and major equipment manufacture. It is interesting to note that any foreign merger and acquisition of domestic enterprises “located near major and sensitive military facilities” is subject to review, while most of such facilities are in fact unknown to the public. Moreover, the Circular does not define a limit as to how far from military facilities it must be, allowing this provision to create much uncertainty for foreign investors as well as greater discretion in their review for the Chinese regulators.
The acquisition of actual control by foreign investors means foreign investors become the holding shareholders of or actually control a domestic enterprise after the merger and acquisition. The Circular defines “actual control” to the extent possible. It adopts a hard threshold of direct or indirect holding of 50 percent or more of equity of the target entity. Percentage of foreign ownership is calculated in aggregate. In addition, certain transactions that fall short of the 50 percent threshold but where foreign investors will obtain the actual control over the target’s business are also subject to review. Such transactions include those where foreign investors hold sufficient voting right to influence the resolutions to be adopted by the shareholders meeting or the board of directors and other circumstances where foreign investors actually control a domestic enterprise’s operational, financial, personnel, technology and other matters. Such non-exclusive list is seen as a development from previous regulations on acquisition of domestic enterprises by foreign investors. For instance, the 2006 Provisions Concerning the Acquisition of Domestic Enterprises by Foreign Investors, which is the predecessor regulation on the same subject, only uses the percentage of equity holding as a threshold. The Circular undoubtedly will be putting much stricter limitations on foreign investment.
As for how the U.S. has responded to Chinese investors, since China started expanding its offshore investment into the U.S., CFIUS has been reported to be closely scrutinized deals involving Chinese acquirers and challenged several. To name a few: Lenovo’s acquisition of IBM’s personal computer and laptop unit; state-owned China National Offshore Oil Corporation’s failed acquisition of UNOCAL (2005); Huawei abandoned its bid to acquire a 19 percent stake in 3Com after coming under politically-charged CFIUS scrutiny (2008); Northwest Nonferrous abandoned its bid to purchase Firstgold, a Nevada mining company, after CFIUS indicated that it would recommend that the President block the deal (2009); Tangshan Caofeidian Investment Corp withdrew notification of its bid for Emcore’s fiber optics division in light of CFIUS’s objections (2010); members of Congress unsuccessfully lobbied CFIUS to block Anshan Steel-Steel Development Company’s purchase of a minority stake in a reinforcing bar manufacturing plant (2010); CFIUS is currently reviewing AVIC International’s purchase of Teledyne’s general aviation piston engine business.
Coincidentally, on the same day that China’s State Council released the Circular, CFIUS reportedly proposed its recommendation that President Barack Obama block China Huawei’s $2 million acquisition of 3Leaf System assets. The impact that the Circular will have on U.S. investment in China and its effect on U.S.’s attitude towards Chinese investors remains to be seen.
Additional information can be found at: http://www.ssd.com/new_review_system_for_foreign_investor_m&a_deals_with_domestic_enterprises.
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