Canada: China’s New Foreign Investment Legislation Encourages Participation In Biotech Industry

Originally published in The Lawyers Weekly, March 2, 2007.

China offers enormous, but largely unrealized, opportunities for North American biotechnology and pharmaceutical firms. Those looking to either gain a market foothold or acquire complementary capabilities, products and platform technologies may benefit from a low cost base for research and development, liberal policies toward discovery and clinical research, a large pool of qualified researchers and technologists, and ever-increasing government funding and incentives.

Until recently, the vast majority of foreign direct investments in the Chinese biotechnology sector have come from large multinational pharmaceutical companies, and many of those investments have taken the form of joint ventures. However, China’s gradual relaxation of its historical opposition to foreign ownership of domestic companies has prompted firms to look beyond joint ventures as the primary vehicle for participating in the Chinese biotechnology industry.

Mergers and acquisitions (M&As) are becoming the preferred method of participation, because they enable greater control over quality, intellectual property and other strategic issues. High-profile examples of recent deals include Qiagen’s (Hilden, Germany) acquisition of TianWei Times (Beijing) and PG Biotech (Shenzhen); GNI’s (Tokyo, Japan) merger with Shanghai Genomics (Shanghai); and Invitrogen’s (Carlsbad, California) purchase of Shanghai BioAsia Biotechnology (Shanghai).

As biotechnology and pharmaceutical firms are increasingly looking to M&As as a viable strategy for growth, diversification and risk management, the "right" Chinese firms can be expected to garner much attention from Western suitors.

Three recent developments in Chinese law may influence a firm’s decision to enter China.

As part of its rapidly developing regulatory regime, China recently amended its rules governing the acquisition of domestic companies by foreign investors. The new rules represent a further acceptance of cross-border M&As in line with international practice in that they expressly permit the use of equity consideration in corporate transactions, which was not feasible in the past. This development should be welcomed by research-based or clinical-stage firms that often rely on equity consideration as a primary currency in financing transactions.

Unfortunately, the regulators’ attempt to move quickly to establish a robust regulatory framework has left some ambiguities that may cause concern. For example, the new rules provide an additional layer of scrutiny by the ministry of commerce if the merger "involves any critical industry, affects or may affect the security of [the] national economy, or causes transference of actual control over the domestic enterprise who possesses a resound trademark or China’s time-honored brand." However, the terms "critical industry", "affects", "security of the national economy", "resound trademark", and "time-honored brand" are all undefined and appear to give considerable discretion to regulators to reject or unwind transactions. Commentators have opined that this uncertainty, coupled with existing limits on foreign investment in industries such as energy, communications, media, auto manufacturing and finance, may have a negative impact on the overall level of M&A activity.

Even so, the cost-benefit analysis favours firms’ transacting in the biotechnology industry since foreign investment and participation has, by and large, been encouraged by the Chinese government in the past. There is little indication that this trend would not continue in the future or that the new rules would be used to hinder transactions in this industry.

The key to M&As in China is patience. A deal can take several months longer to close in China than elsewhere because more regulatory approvals are typically needed. Furthermore, foreign firms need to be flexible in dealing with potential targets because the latter would likely be relatively small and unfamiliar with the M&A process. As with all M&A transactions, doing the right homework and taking the right due diligence approach will go a long way to alleviating future difficulties.

A longer-term consideration for foreign firms is the Chinese government’s planned unification of corporate tax rates. Reports suggest that lawmakers plan to enact a bill that would eventually unify income tax rates for domestic and foreign companies at 25 per cent. Currently, the rates stand at 15 per cent for foreign companies and 33 per cent for their domestic peers. Even though this reform has resulted in a more costly operating environment, the planned unified rate is still relatively low compared with rates in developed markets.

However, what is more important for biotechnology firms is the accompanying reform to China’s preferential tax policies, which have in the past focused on geographical locations such as designated Hi-Tech Industry Development Zones and Special Economic Zones. The new policies will instead focus on designated industries. Reports suggest that "encouraged" hi-tech enterprises will be eligible for a reduced income tax rate of 15 per cent, and more tax incentives will be granted to start-up companies.

Though the text of the new corporate tax bill and accompanying policies have not yet been released, indications are that the government’s historical support of the biotechnology industry will be retained or strengthened through tax incentives.

Any discussion about biotechnology in China must include the issue of IP protection. Indications are that China may have finally turned the corner on this front, as exemplified by the now-famous Viagra (sildenafil citrate) saga. After overturning the Patent Review Board’s decision invalidating Pfizer’s Chinese patents in June 2006, the Beijing No. 1 Intermediate People’s Court again upheld the validity of the patents in December 2006, in an infringement action against two Chinese generic manufacturers.

The very fact that generic companies have gone to court to challenge Pfizer’s patents, instead of simply marketing infringing products, is itself evidence of the maturation of the Chinese IP regime. This, coupled with similar court victories for the likes of Starbucks, Louis Vuitton and Prada in trademark cases, indicates a greater acceptance of the force of IP rights. This should provide some assurance for biotechnology firms looking to invest in China.

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