China's Ministry of Commerce (MOFCOM) on August 25 issued
the Regulations on the Implementation of the Security Review System
for Mergers and Acquisitions of Domestic Enterprises by Foreign
Investors (the "Regulations") (see Attachment below). The
Regulations, which took effect on September 1, replace the
Temporary Regulations on which
we reported earlier this year.
The Regulations in some respects provide less detail on the
national security review filing procedure. While the documentation
requirements for a national security review notification under
Article 5 are carried over from the Temporary Regulations, the
earlier details on the duration of a national security review have
been deleted. In other words, a national security review may have
an open-ended duration. This is particularly important given that
the review is suspensory in nature, i.e., the transaction may not
be concluded until a required review is completed, and also may be
unwound if a transaction subject to review is not notified.
The Regulations provide more clarity on the issue of indirect
control. An M&A transaction that otherwise falls within the
scope of review under Article 9 will be subject thereto even if
foreign control is exercised indirectly through such means as
nominee shareholders, trusts, multi-level reinvestments, leases,
loans, control by agreement or offshore transactions. Control by
agreement refers to contractual arrangements through so-called
variable interest entities ("VIEs") in which domestic
agents obtain licenses on behalf of a foreign party in industries
where direct foreign investment is otherwise prohibited or
restricted, such as telecommunications and media. It is conceivable
that the disclosure of indirect foreign control in the course of a
national security review could then be invoked by the relevant
regulatory agency to bar an M&A transaction that would not
itself be determined to materially impact China's national
security, e.g., a foreign company's indirect acquisition of
control of a Chinese lifestyle or sports magazine publisher.
Reports of a broad internal list of industries subject to national
security review may make this possibility particularly
likely.
Article 3 separately invites national-level industry or trade
associations, competitors, and upstream and downstream enterprises
to request a national security review of a proposed transaction.
This provision, which has counterparts in anti-dumping and
anti-monopoly regulations, would seem to be misplaced in a national
security review where the government, rather than private parties,
would be most aware of threats to national security. It effectively
gives domestic parties another weapon to inhibit expansion into
China by foreign companies through mergers and acquisitions.
A fundamental shortcoming of the Regulations is the lack of
clarification with respect to the scope of industrial sectors
subject to national security review. The
Notice Concerning Establishment of the Security Review System on
Mergers and Acquisitions of Domestic Enterprises by Foreign
Investors (State Council, February 2011, the
"Notice") only provides in general terms that the
scope of review includes military and national defense-related
transactions; transactions involving important agricultural
products, energy and resources, infrastructure facilities, and
transportation services; core technologies; and important equipment
manufacturing enterprises. However, we understand that MOFCOM has
subsequently circulated an internal document listing 50 to 60
specific industries subject to security review. This document is
currently being implemented by commerce bureaus and commissions at
the provincial and municipal levels, even though it has not been
formally promulgated. The list of industries in the internal
document appears to be overly broad as it includes industries
without apparent nexus to national security, such as medical device
companies. Unless MOFCOM provides specific guidance in this regard
through formally promulgated rules and regulations, we would expect
that the security review will be widely applied to raise additional
regulatory hurdles or even block many M&A transactions by
foreign investors involving China.
Download
MOFCOM Regulations.pdf
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