China's temporary national security review
("NSR") on inbound M&A transactions
became permanent on 1 September 2011. The new permanent NSR has an
additional anti-circumvention provision that was not included in
the temporary NSR. This anti-circumvention provision can
potentially be used by MOFCOM to clamp down on the use of Variable
Interest Entity ("VIE") structures.
Prior to the implementation of the NSR, foreign investment in
China generally dealt with two government agencies for review and
approval: the National Development and Reform Commission
("NDRC") and central or local MOFCOM. These agencies both
need to approve acquisitions of Chinese entities by foreign
investors, in which process project feasibility and possible
interference with China's public interests and industry
policies are reviewed.
Under the new M&A security review system, mergers and
acquisitions involving sectors that are considered to be
strategically important to the national security of China, such as
national defence, agriculture, energy and resources,
infrastructure, transport, technology, and manufacturing of
important equipment, are subject to a security review prior to the
NDRC and MOFCOM approval procedures mentioned above.
The new permanent security review rules contain an
anti-avoidance provision that was not included in the previous
interim rules. This anti-circumvention provision provides that when
determining whether a transaction falls within the scope of the
security review, the material content of the transaction and its
actual impact are to be taken into account. It also provides that
foreign investors cannot structure a transaction in order to avoid
a security review, for example by using proxy holdings, trusts,
multiple-layer reinvestments, leasing, loans, offshore transactions
and control by agreement, etc.
"Control by agreement" includes the use of Variable
Interest Entity (VIE) investments. In a VIE structure a fully or
partially foreign-owned PRC company has control over a PRC
operating company which holds the necessary licence(s) to operate
in a FDI restricted or prohibited sector. The foreign investors use
contractual arrangements to obtain de facto control over
the operating company. VIEs have been a popular structure in the
last decade. However, the new permanent NSR potentially could be
used by MOFCOM to prevent or limit transactions that use a VIE
structure. There are yet no precedent cases to provide further
guidance on this.
For more information please also see our article on the
temporary NSR in our March 2011 China Update (which can be found
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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