2020 was a year full of challenges for international investors – one of those being the development of the national security review regimes (NSR) in various major economies in response to the rise of amplified protectionism around the world. We have closely followed such development in UK, Germany (please read also our newsletters : What you need to know about the new National Security and Investment Bill? and the National Security and Investment Bill ); and in particular China.
On December 19, 2020, China's National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM") jointly issued the Measures for the Security Review of Foreign Investments ("New NSR Measures"), which came into force on January 18, 2021. It is not surprising that the Chinese government is coming on the heels of recent reforms in EU in 2020 by introducing the new NSR Measures. In our observation though, compared with other main jurisdictions like UK and Germany, the New NSR Measures capture less industries and require higher control threshold for the review of foreign investment in non-military business sectors.
In the following, we will give a historical review of NSR regimes in China (including a case study) and address some common questions often raised by foreign investors.
Background of NSR in China and relevant case study
China first introduced their NSR framework in 2011 when the State Council released the Circular on the Establishment of a System for Security Review of Acquisition of Domestic Enterprises by Foreign Investors (“2011 Circular”). To implement this framework, MOFCOM later issued the Regulations for implementation Security Review of Acquisition of Domestic Enterprises by Foreign Investors, specifying application requirements and procedures (“2011 MOFCOM Regulation”) (collectively referred to as “Previous NSR Rules”).
Pursuant to the 2011 Circular, the State Council has set up a joint ministerial panel ("the Panel") to conduct review. The Panel is under the leadership of the State Council and is led by the NDRC and the MOFCOM. The 2011 Circular laid out the general framework for the review by addressing (1) investment by foreign investors into military and related business or into any business in geographic locations in close proximity of military facilities, and (2) acquisition by foreign investors for control in Chinese companies (domestic and FIEs) falling into six sectors, i.e. agriculture, energy and resource, infrastructure, transportation services, key technology and equipment manufacture. It is a three-stage review, including jurisdictional review stage, general review stage and special review stage. MOFCOM (this role was transferred to NDRC in 2019) is in charge of jurisdictional review and decides whether to submit to the Panel for substantive general review. During the general review, the Panel has the right to initiate the special review if it sees there is impact on the national security. The Panel can also submit to the State Counsel for final decision if they cannot reach a consensus. Investors are not allowed to close their deals before they receive the clearance.
There might be strong political influence in the review, since the covered transaction and sectors are vaguely defined, making it legally difficult to ascertain if certain transactions fall under the review scope. Despite the request for further clarification from business and legal communities, the Chinese regulators and Supreme People’s Court made no attempt to resolve above situation.
Further, there is no public information or public channel to receive information concerning the details of the Panel such as composition and its decision making process. So far there is also no information whether the Panel has ever blocked any deal on the ground of national security since 2011.
From our own experiences navigating European companies through such review process, it is our general observation that the whole review process is not transparent and often important information such as the officials’ consideration and their application of law and reasoning are not sufficiently addressed.
Case study
In 2005, the intended acquisition of Xugong Group Construction Machinery by the US private equity firm Carlyle Group did not obtain required MOFCOM approval for the reason that Xugong is a SOE and a major supplier to the Chinese military army. This was the first time Chinese government blocked a deal for security reason even before the roll-out of the Previous NSR Rules.
In 2020, Yonghui terminated its intended acquisition of Zhongbai group, allegedly because of failure to pass NSR process. Yonghui, Zhongbai and NDRC never confirmed such NSR allegation.
Zhongbai is a major warehousing and logistics services provider. It provided catering services to 2019 Military World Games and operates several retail stores in certain military colleges in Wuhan. There are some commentators who inferred that Zhongbai’s essential role as a retailer supplier to the Chinese military troop and its SOE background was the major concern that the deal did not get through in the end.
In both above cases, the targets are SOE and military suppliers. Although the Chinese NSR regime has not addressed State-owned assets or enterprise, in our observation, it is an unspoken reality that acquisition of SOEs are much likely on the radar of the NSR review.
Highlights of New NSR Measures
Compared to the Previous NSR Rules, no radical changes have been introduced under the New NSR Measures. The whole structure remains simple, with only 23 clauses. The three-stage review process has remained, and ambiguity as regards the covered sectors is still unanswered.
- The scope of “foreign investment” is expanded now including greenfield investment (note, the Previous NSR Measures only apply to acquisitions) and indirect investment and provides for a coverage in correspondence with the Foreign investment Law (“FIL”). Presumably, VIE structure and offshore acquisition may fall into above definition.
- The list of sensitive sectors with national security implication has been extended and additionally includes critical cultural products and services, critical information technology and Internet products and services, critical financial services.
- Review authority and process are streamlined. The Panel is replaced by a working office (“Office”) under NDRC, which is jointly led by NDRC and MOFCOM. Without the involvement of other ministries and the State Council, the review process will likely be less time consuming and more efficient.
- Public M&A is carved out. Public M&A shall be subject to the review of China Security Regulatory Commission (CSRC). During a recent press conference, a NDRC spokesman mentioned that CSRC has started to formulate separate rules together with the Office.
- The decision made by the Office shall be final. This is provided under the Article 35 of FIL.
- Whistle blower mechanism has been introduced, which enables any person to report to the Office information to any transaction if such person believes there is a national security concern.
Open questions and comments
Question: is the NSR applicable in relation to acquisitions (transfer of equity) of existing FIEs which were established with or without NSR review?
In our view, the possibility cannot be ruled out, for three reasons, (1) the New NSR Measures do not exclude their application on acquisitions of FIEs; (2) the business and operation of FIEs may also evolve and change over time since their establishment; (3) NSR is highly politically driven, whether and to what extent a national security concern has arisen also depends on the home country of the foreign investors.
Question: is there a way to know if a certain transaction falls into the scope of covered transaction?
Under the New NSR Measures, the Office will accept the consultation request from a foreign investor. Foreign investor may use channels to seek clarification. It is suggested to keep a meeting memo to record relevant discussion with the Office.
Question: when shall foreign investors start the application of NSR?
Under the Previous NSR Rules, the foreign investor has to submit signed transaction documents as part of the application package. Thus, it has to start the NSR between signing and closing. Under the New NSR Measures, the application material is more simplified and mainly includes (1) Application Letters; (2) Investment Proposal; (3) Statement as to whether foreign investment may impact national security; (4) other materials requested by the Office. Foreign investors shall start the application process much earlier, for example following signing of a letter of intent. Considering the whole NSR process may take 115 working days if special review process is triggered, it is recommended to start the process as early as possible.
Question: given the German government recently blocked several envisaged acquisitions by Chinese investors (i.e. State Grid’s proposed acquisition of power grid operator 50Hertz in 2018; China Aerospace and Industry Group (CASIC) contemplated takeover of satellite and radar technology firm IMST), will we see more and more NSR review with a focus on German investment in China?
The possibility cannot be ruled out. It is provided in the FIL, where any country or region takes any discriminatory prohibitive or restrictive measures against the Chinese investment, Chinese government may take corresponding measures against the said country. Having said this, the conclusion of key principles of EU-China Comprehensive Agreement on Investment (CAI) would be a positive signal also in terms of eliminating the abuse of the NSR review process. According to the introduction displayed on the website of European Commission, the official version of CAI will likely be finalized and executed around 2022.
