New interim rules governing foreign investments by large Chinese central government controlled State‐Owned Enterprises ("SOE") have been promulgated and are effective since May 1st, 2012. The new rules in questions are specifically targeted at "Central Government Controlled SOEs", known in China as Yang Qi. Officially there are 117 such Yang Qi. The list may become shorter as the State‐Owned Assets Supervision and Administration ("SASAC") of the State Council plans to further consolidate those companies. The new requirements have a direct bearing for Canadians involved with such an investment partner.
The Context
Chinese outward foreign direct investment ("FDI") has become a major force in the global economy. In 2010, China ranked as the fifth largest international investor in the world while just a few years ago such Chinese outbound flows were marginal. Canada has been a significant recipient of these Chinese FDIs, no doubt because of the complementarities of our economies: we have the natural resources they need to fuel their economic growth.
China direct investments in the territory covered by Quebec's Plan Nord are a case in point. In several instances, they have been the key to the development of important projects. The $240 million investment by Wuhan Iron and Steel Corp. ("WISCO") was instrumental in the successful development of Consolidated Thompson Bloom Lake project. Following the acquisition of Canadian Royalties by the Canadian subsidiary of Jilin Jien Nickel Industry in January 2010, the construction of the Nunavik Nickel project was restarted. In January 2012, Wisco has made a $91 M investment in Adriana Resources to support the development of the Lac Otelnuk iron ore property. Chengdu Tiangi Industry Group is a strategic investor in Nemaska Lithium. There are no reasons to suggest that such inflows should abate soon. The great majority of these FDIs has been and will continue to be made by SOEs.
Foreign investments by SOEs have not been problem‐free. At the April 2012 high level Baoa Forum for Asia, Zhou Ziaochum, Governor of the Peoples' Bank of China, commented that "although we are large traders with many countries,...our investors are not familiar with the investment environment, legal systems, and financial markets in foreign countries. This will take some time to improve". Shao Ning, Vice‐President of the SASAC of the State Council was even more blunt: "I'm a little bit concerned about the Chinese enterprises going global because they lack the ability to operate internationally, have limited talent available, and know little about the foreign investment environment, especially the judicial environment". Not surprisingly such harsh assessments of performance and capabilities spurred new regulations.
The Scope of the new Regulation
Central government controlled SOEs are under the authority of the SASAC of the State Council. Concerned by the number of prominent foreign investment failures, the increasingly strident criticisms Chinese FDIs attract in countries around the world and a realisation that SOEs may not possess the management skills to deal abroad, SASAC adopted on March 18, 2012 a regulation governing the supervision and management of offshore investments by SASAC controlled SOEs ("Regulation"). These became effective on May 1st, 20121.
Offshore investments subject to the Regulation include fixed assets investments, equity investments and other investment activities by the SOEs under the direct supervision of SASAC and by all their wholly‐owned and holding subsidiaries. SOEs owned by provincial governments or very large municipalities directly under the State Council are not subject to SASAC control. These SOEs and Chinese private investors will continue to operate under different requirements, a situation that requires added caution by potential recipients of Chinese investments.
The Regulation makes both the enterprise under its ambit and their management responsible for ensuring compliance and accountable for Chinese FDIs that result in losses. The sanctions associated with this emphasis on personal responsibility, particularly in cases of material losses, should encourage strict conformity with the spirit and letter of the law.
The essential features of the Regulation can be summarized as follows. The SOEs must:
- Prepare and submit for approval by SASAC their annual offshore investment plan, including the sources of funding for the program and the financing plan and capital structure for each major project.
- Develop and implement a rigorous management system to assess investments opportunities, manage the risks inherent to such investments and audit their performance on an ongoing basis.
- Avoid investments in non‐core businesses. Such investments may be allowed only if necessary to the success of the SOEs business plan and specifically authorized and controlled by SASAC.
- Abide by the laws and policies of the countries where the investment is made and respect the local customs.
- Retain domestic and foreign advisors to assist in the implementation of the management systems and processes, the assessment of investments opportunities and the completion of the investments.
This obligation is a direct response to the concerns voiced about the competencies of Chinese managers to deal in foreign environments and a counter to their notorious reluctance to incur and pay professional fees.
Implications for Canadian Companies
The Regulation affect all Canadian companies involved with a SOE investment. Proper due diligence will require answers to the following questions:
Is the SOE subject to the Regulation?
- Large SOEs tend to have multiple subsidiaries which often operate quite autonomously. The opacity of their corporate structures heightens the risks of running afoul of the Regulation.
What is the core business of the SOE?
- This simple question may prove difficult to determine since many SOEs carry widely diverse activities and the Regulation does not provide a definition of "non‐core business".
Did the SOE comply with the Regulation and obtained the required authorizations?
It is too early to measure the impact of this new Regulation. One would expect that they would result in better investments and investment partners and promote a greater degree of probity and due diligence in SOEs foreign investment activities. It may also hasten the recognition that it is not necessary to own and control a mine or other producer to ensure future supply. A minority interest coupled with a long‐term off‐take or supply agreement will achieve the same result in the great majority of cases.
Footnotes
1. "The Interim Measures on Supervising and Managing Offshore Investments", State‐Owned Assets Supervision and Administration Commission, 18 March 2012.
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