China: Recent Development in China’s New Energy Auto Industry and M&A of Foreign Investors

Last Updated: 17 August 2014
Article by George Zhao and Dai Mu

In China, the new energy automobiles (NEAs) are currently defined as vehicles utilizing advanced technical know-how, new technologies and new structures, which use unconventional vehicle fuel as the power source (or conventional vehicle fuel but new in-vehicle power devices). The NEAs are defined as vehicles that integrate advanced technologies in power control, including hybrid electric vehicles, battery electric vehicles (BEV, including solar energy vehicles), fuel cell electric vehicles (FCEV), hydrogen engine vehicles, other new energy vehicles (e.g., efficient energy storage device and methyl ether), and products enumerated in China's industrial policies1.

NEAs are of tremendous significance to the sustainable development of China's auto industry, contributing to the alleviation of environmental and resource burdens, and the enhancement of national competition2 at a global level3. In accordance with applicable Chinese industrial policies and economy development plans, NEAs are considered as: (1) an important part of China's auto industry, under which strict legal restrictions4 and limitations5 are imposed on foreign investment, from design, manufacture to sales; (2) strategic emerging industry in China6, receiving governmental preferential treatment regarding tax and financing7; also a critical path8 to realizing national energy conservation and emission reduction goals9; and (3) involving various other fields such as R&D10, manufacturing, supporting facilities, and power battery recycling, each of which is subject to different regulatory regimes in China that investors should beware of.

  1. Market access for foreign investment in NEA industry

Foreign investors intending to acquire domestic NEA companies shall be subject to the statutory requirements set out in the relevant industrial policies. According to the Catalogue of Industries for Guiding Foreign Investment, NEA components (i.e. power battery) belong to encouraged investments. However, foreign investors may only set up joint ventures with Chinese partners and foreign investors' equity in the joint ventures may not exceed 50 percent. At the same time, manufacturers must comply with the requirements set out in the Policy on Development of the Automotive Industry and the Rules on the Production, Admission, and Administration of New Energy Automobiles. In order to manufacture NEAs, foreign-invested enterprises shall obtain admission qualifications for both the enterprise and final products.

The overall regulatory environment of China's automobile industry can be characterized as follows: the government restricts investments in whole vehicle manufacturing, while encouraging investments in auto parts and components manufacturing. With respect to foreign investment in the NEA sector, besides the equity restrictions imposed on power battery manufacturing joint ventures, critical parts and components manufacturing is permitted for wholly foreign-owned enterprises. According to the State Council's Catalogue of Investment Projects Subject to Government Verification (2013 Version), new projects for components manufacturing are only subject to the filing procedures and no longer require governmental verification. Since the motors of NEAs are different from traditional engines, they need to meet the new national technical standards for electric motors11.

However, since the 2004 amendments to the Catalogue of Industries for Guiding Foreign Investment, the whole vehicle manufacturing industry is no longer a category for encouraged investments and now receives strict regulatory oversight. Foreign capital entering into the NEA manufacturing sector must be in the form of joint ventures and Chinese equity interest shall not hold less than 50 percent of the registered capital. When foreign investors intend to enter the Chinese market via acquisitions, they are not allowed to invest in more than two joint venture manufacturers that produce vehicles in same category12. Investors should note that, new NEA manufacturing is allowed only if it has been approved by the Ministry of Industry and Information Technology of the PRC ("MIIT"). If newly-established vehicle enterprises or existing vehicle enterprises intend to produce other types of NEAs beyond their existing product line, they shall first go through the verification or filing procedure for new projects in accordance with the regulatory requirements for such investment13.

  1. National security review

For the time being, China's national security review of foreign investments is led by the Ministry of Commerce ("MOFCOM") and the National Development and Reform Commission ("NDRC"), and is mainly administered through the Inter-Ministerial Joint Meeting. According to the Interim Provisions on the Takeover of Domestic Enterprises by Foreign Investors, Notice on the Establishment of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors and other regulations, foreign investment in the following sectors shall be subject to national security review: investment in "key industries", industries that "may affect national economic security", enterprises that " have well-known trademarks or time-honored brands", and enterprises " that involve important agricultural, energy and resources, infrastructure, transportation services, key technologies, critical equipment manufacturing, etc. "

As NEA manufacturers must satisfy the equity ratio limitations set out in the industrial policies, the foreign acquisition of equity interests in Chinese auto makers may trigger national security reviews. In designing a deal structure, investors shall bear in mind the likelihood of obtaining such regulatory approvals. At the same time, foreign investors shall carefully consider the appropriate acquisition form (i.e. spin-off, reorganization) and shareholding structure on the basis of the evaluation of a target company's outstanding debt and risks in taxation as well as in other areas.

According to the Catalogue of Key Technology and Products subject to Independent Intellectual Property Rights14, NEA, its key parts and its supporting facilities are classified as technologies that are significant to economic development, industry upgrading and national security. In the event of foreign acquisitions of the above-mentioned technologies, equities or assets, national security review will potentially be triggered15. Since key parts of new energy vehicles are not clearly defined in the above-mentioned catalogue, relevant authorities will use their discretion in determining whether a proposed transaction is subject to such a review. For transaction parties, it is necessary to make suitable arrangements with the Chinese partners in terms of technology center setup, patent licensing and trade secrets protection.

  1. Preferential policies for foreign investment

At the national level, NEA enterprises as well as NEA products will be subject to the catalogue management regime ("Catalogue of Recommended Models for the Project of Energy Conservation and New Energy Automobile Demonstration", "the Catalogue"). Chinese government conducts dynamic management on vehicles and enterprises in the Catalogue: the industry regulatory authority will conduct sample tests of listed autos to verify their real-time operation status in pilot cities, and remove unqualified NEA products and their manufacturers16. Only listed ones may enjoy governmental subsidies.

According to the Notice on Further Carrying Out the Promotion and Application of New Energy Automobiles17 released in 2013, which clearly states "the scope of the vehicles which enjoy central government subsidies should be limited to pure electric vehicles, plug-in hybrid vehicles and fuel cell vehicles". Furthermore, when calculating the average fuel consumption, the NEA emissions are largely based on the foregoing three types. The subsidy policies enjoyed by foreign investors engaged in the production of NEAs would be identical to those enjoyed by domestic manufacturers.

At the local level, the pilot cities adopted local financial subsidy policies to support this industry. For example, Beijing's local policy clearly demonstrates that the product range of demonstration of the new energy minibus will be limited to the scope of the Catalogue18. Beijing also introduced a series of "Beijing Municipal Catalogue for New Energy Minibus Models and Manufacturers". According to the provisions of the Municipal Rule on Subsidy Management, only the new energy minibus listed in Beijing's local catalogue may enjoy subsidiary funds from the Beijing government. The Shanghai Economic and Information Commission also introduced its own catalogue series (Shanghai Municipal Catalogue for new energy minibus models and manufacturers), such that only the products and enterprises included in this catalogue could enjoy Shanghai's preferential policies. According to a recently released regulation19 by State Council, "local variants" of the NEA catalogue will be replaced by a national one.

  1. NEA promotions and encouragement

As the government policy of auto procurement shows its preference towards NEAs, relevant manufacturers may adjust their existing product lines to seize such opportunity. According to the Circular on Continuing Launching the Promotion and Application of New Energy Automobiles jointly released by MOF, MOST, MIIT and NDRC, the requirements for pilot cities and areas shall include: during 2013-2015, the cumulative amount of NEAs should not be less than 10,000 in mega-cities or the key areas, and the cumulative number for other cities or regional areas should not be less than 5,000; government agencies, public institutions and other departments shall take NEAs as a prior option for procurement; and, the ratio of newly procured or upgraded NEAs in public transportation, official service, the logistics industry, and sanitation services shall not be less than 30 percent of the total procurement20.

NEAs will create a huge impact on public transportation and car rental industry. According to the Circular on Initiating Pilot Subsidy Program of Purchasing New Energy Auto for Individual Use jointly released by MOF and MOFCOM, enterprises engaged in car rental and power battery rental will enjoy central government subsidies just as individual purchasers of NEAs, from which the customers can benefit the subsidized price. According to available online information, the Shanghai Transportation Committee recently launched a research project on NEAs in Shanghai's car rental market. The low renting and running cost of NEAs helps raise awareness among consumers of this type of cars and thereby helps increase its popularity. Also, Beijing, Hefei (in Anhui province), and other China cities have purchased large numbers of NEAs for taxi companies. This is undoubtedly a great development for the NEA industry.

  1. Conclusion

For foreign enterprises intending to enter China's NEA industry, a more realistic transactional path is to form joint ventures with existing domestic automobile manufacturers or to make equity and asset acquisitions. In terms of green field investment in NEAs and parts manufacturing, foreign investors can enjoy the commensurate preferential policies with domestic enterprises in many areas. However, in order to realize synergies from acquisitions and ensure success in the NEA business, foreign investors need to be aware of the legal risks, regulatory requirements, and technical standards governing the design, production, sales and maintenance of NEAs in China.

Footnotes

1Access Management Rules for New Energy Vehicle Production Enterprises and Products released by Ministry of Industry and Information Technology, effective as of July 1, 2009

2Circular on Guidance Opinions of Expediting and Cultivating Superiority Position in International Cooperation and Competition released by the General Office of State Council, effective as of May 24, 2012

3Notice of the State Council on Issuing the Planning for the Development of the Energy-Saving and New Energy Automobile Industry released by State Council, effective as of June 28, 2012

4Such policies may include PRC regulations on Auto industry development plan, foreign investment in auto industry, auto taxation, auto financial and credit services, etc.

5Circular on Opinions of Adjustment to Auto Industry Structure released by NDRC, effective as of December 20, 2006

6Decision on Accelerating the Fostering and Development of Strategic Emerging Industries released by State Council, effective as of October 10, 2010

7Guiding Opinions on Further Doing a Good Job in Supporting the Restructuring and Revitalization of Key Industries and Curbing Overcapacity in Some Industries through Financial Services jointly released by PBOC, CBRC, CSRC and CIRC, effective as of December 22, 2009

8Notice on Issuing the Energy Conservation and Emission Reduction Plan during the "Twelfth Five-Year Plan" Period released by State Council, effective as of August 06, 2012

9Industrial action plan to address climate change (2012-2020) jointly released by MIIT, NDRC, MOST and MOF, effective as of December 31, 2012

10General Planning for Technological Innovations of Industries during the 12th Five-Year Plan Period released by MIIT, effective as of November 04, 2011

11This technical standard is still under draft, the draft GB/T 18488.1—201× will replace GB/T 18488.1-2006 and GB/T18488.2-2006

12Policy on Development of Automotive Industry, Article 48, "...The same foreign investor may establish no more than (including two) two joint venture enterprises in China that undertake the production of the same kinds (the classes of passenger cars, commercial cars and motorcycles) of whole automobile products. If the foreign investor merges other automobile production enterprises in China together with the Chinese joint venture partner, it may not be restricted by the said two joint ventures..."

13Admission Management Rules on NEA Manufacturer and Products chapter 3, specify the entry management and requirement for NEA manufacturers and products

14See the Catalogue of Key Technology and Products subject to Independent Intellectual Property Rights.

15In 2007, a Germany company (Schaeffler)'s proposed acquisition of Luoyang Bearing Co., Ltd. had been rejected by the Chinese government, refusing to approve any proposal regarding acquiring of 100% equity interest or controlling equity interest of that company. Please note that Provisions on the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors had not released by MOFCOM at that time.

16Notice on Further Promoting the Pilot Program for Energy Conservation and New Energy Automobile Demonstration and Popularization jointly released by MOF, MOST, MIIT and NDRC, effective as of October 14, 2011

17Notice of the Ministry of Finance, the Ministry of Science and Technology, the Ministry of Industry and Information Technology and the National Development and Reform Commission on Continuing on the Promotion and Application of New Energy Automobiles, effective as of September 13, 2013

18Beijing Municipal Provisions on Management of Approval and Recording for Demonstration New Energy Minibus Manufacturers and Products Article 4

19Guiding Opinions on Accelerating the Promotion of the Application of New Energy Vehicles released by General Office of the State Council, effective as of July 14, 2014

20Guiding Opinions on Accelerating the Promotion of the Application of New Energy Vehicles released by General Office of the State Council, effective as of July 14, 2014

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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