The Chinese pharmaceutical market is experiencing double-digit growth and will become the world's second-largest market after the United States by 2016, according to IMS Health. Total market size is anticipated to reach US$116.8 billion in 2015 and will further expand for the following 10 years.1 While such rapid growth makes China an increasingly attractive market for multinational pharmaceutical companies, a key strategic question for global market leaders is how to adapt their product portfolios to this heterogeneous market.
Developing a pharmaceutical business in China poses many regulatory and commercial challenges, including navigating the process to enter the marketplace, localize manufacturing, and transfer licenses to local entities, as well as being compliant with new, rigorous drug manufacturing standards being enacted as part of China's health care system overhaul.
Global players are exploring various opportunities to acquire or form joint ventures with local companies. hey are also considering how to localize their development or manufacturing activities, because national policies appear to favor indigenous innovation. Locally developed or produced new drugs will normally benefit from accelerated regulatory reviews and improved market access conditions.
A critical issue in any corporate transaction or localization initiative in China is how to assign the relevant product licenses. Under the current Chinese regulatory framework for pharmaceuticals, a drug license is not a market authorization but an authorization for manufacturing or importation. The holder of a drug license must be a manufacturer. In light of this regulatory requirement, drug license transfers typically follow the regulatory pathway for transfer of manufacturing technologies, which is provided by the China Food and Drug Administration ("CFDA2") in the Administrative Regulations on Registration of Technology Transfer for Pharmaceutical Products published on August 19, 2009 (the "Transfer Rules").
Technology transfer is defined as a process in which (i) the owner of technologies of a drug product (the "Transferor") assigns such technologies to a drug manufacturer (the "Transferee"), and (ii) the Transferees registers the drug product with the CFDA in its own name.3 Typically, the Transferor and the Transferee are drug manufacturers duly registered with the CFDA and the Transferee must possess the manufacturing permits necessary for producing the subject product.5 In addition, the Transferor shall transfer technologies of all specifications of a drug product under the same dosage form to one Transferee.6 In order to obtain the product license, the Transferee must convince the CFDA that it is able to produce the drug product with the same quality as that produced by the Transferor based on the transferred technologies.7
Options for Technology Transfer
The Transfer Rules offer two options for drug technology transfer in which the subject drug is locally produced, i.e. (i) transfer of technologies for new drugs within the monitoring period or (ii) transfer of manufacturing technologies. Under the first option, the subject drug must be a locally developed or manufactured new drug, and is within the monitoring period.8 In the event that the technologies for a new drug are owned by multiple parties, the consent to transfer by all owners of the new drug is required and all owners need to sign the technology transfer agreement with the Transferee. Upon completion of new drug technology transfer, the Transferee will have to undertake regulatory obligations originally imposed on the Transferor, e.g. monitoring and reporting of adverse drug reactions and the conduct of Phase IV studies.9
The second option for drug technology transfer is relevant to license transfer involving generics, which can be achieved through transfer of manufacturing technologies between affiliates. The CFDA defines the term "affiliate" narrowly, in which one party must own over 50% equity in the other party, or two parties must be under common control by another drug manufacturer through more than 50% equity ownership.10
In the event that the subject drug is manufactured outside China, drug technology transfer is permitted when the Transferor has an import license for the product and the Transferee applies for manufacturing the product locally based on the Transferor's technology. The quality of the product produced by the Transferor and by the Transferee must be consistent. Accordingly, the manufacturing process, the quality standard, the source of active pharmaceutical ingredient and the excipients to be adopted by the Transferor shall remain unchanged to those used by the Transferee.
The application for drug technology transfer needs to be submitted to the provincial Food and Drug Administration (the "Provincial FDA") where the Transferee is located.11 The application dossier shall include various documents required by the CFDA, such as the drug registration certificate, the drug manufacturing licenses for both the Transferor and the Transferee and manufacturing-related technical documents.12 The Provincial FDA will review the application dossier and also conduct on-site inspection at the Transferee's manufacturing site. The Transferee is required to produce three batches of samples, which are to be tested by the local Institute of Drug Control. After the administrative review by the Provincial FDA, the Center for Drug Evaluation ("CDE") under the CFDA will perform a technical review and formulate its proposal in reliance of the Provincial FDA's on-site inspection report and sample testing report. CDE may propose to approve or disapprove the application, and may also require the Transferee to undertake clinical studies before it formulates the decision.
If the application is approved, the CFDA will register the drug product in the Transferee's name and simultaneously cancel the product license previously registered in the Transferor's name, except that in the case of manufacturing technology transfer for an imported drug, the Transferor's import drug license will remain valid. However, if the Transferor imports the drug in bulk for repackaging in China, both the import drug license of the bulk product and the repackaging license owned by the local repackaging entity will be cancelled.13
Compared to a regular filing for generic drug licenses, clinical studies are not necessarily required when transferring drug licenses from one manufacturer to another following the drug technology transfer route. It therefore makes drug technology transfer an attractive alternative to a regular generic drug application, because the registration timeline may be significantly reduced and a substantial amount of expenses for clinical studies may be saved.
The landscape for the pharmaceutical industry is also affected by a critical moment of transition in China's healthcare system. In 2009, China announced its ambitious plan to "deeply reform the healthcare system" and aimed at universal and affordable healthcare coverage to all citizens by 2020. In response to the reform plan, the Ministry of Health and the CFDA have adopted numerous legislative and policy initiatives re-shaping the landscape of the healthcare industry in China. Amongst those initiatives, the new GMP (Good Manufacturing Practice) published by the Ministry of Health on February 12, 2011 is believed to create profound impacts on the pharmaceutical industry in China as it significantly raised the standards for drug manufacturing and could eliminate poor performers from the market. Manufacturers of sterile drugs are required to comply with the new GMP prior to December 31, 2013 and other drug manufacturers are to be certified prior to December 31, 2015. Failure to comply with the new GMP by the end of the grace period will subject drug manufacturers to cease of production and suspension/denial of product registration.14
The CFDA has announced a series of new rules facilitating the transition to the new GMP requirements, including recent changes to the Transfer Rules through a circular promulgated by the CFDA on February 22, 2013 (the "CFDA Circular"). To the extent that the product in question is not a biological product, the CFDA Circular expands the scope of applicability of the Transfer Rules to cover the following scenarios, under which the Transferor and the Transferee do not have to be affiliates:
- When a drug manufacturer (the Transferor) relocates its entire manufacturing facilities to a new site, it can transfer its manufacturing technologies to the drug manufacturer (the Transferee) incorporated on the new manufacturing site; or
- A drug manufacturer (the Transferor) is permitted to transfer manufacturing technologies to another drug manufacturer (the Transferee) incorporated in China with the new GMP certification, if the Transferor decides not to upgrade its manufacturing facilities in full or in part.
The CFDA Circular also expands the definition of the term "affiliate" to include a scenario where the Transferor and the Transferee are under common control by a third party which may not be a drug manufacturer.15
Another noticeable change to the Transfer Rules is the delegation by CDE of the authority of technical review to Provincial FDAs. Provincial FDAs need to build the necessary capabilities and infrastructure, and seek the CFDA approval before engaging in technical reviews. While the CFDA has been constantly criticized for the lengthy approval process due to lack of personnel,16 this delegation of authority is expected to significantly expedite the approval process for drug technology transfer.
Implications to Multinational Companies' Localization Strategy
China now ranks as one of the most attractive M&A destinations for foreign pharmaceutical manufacturers in Asia from the perspective of cost, risk and market opportunity.17 Many leading multinational players are actively searching for acquisition targets in China. Sanoi's acquisition of BMP Sunstone Corporation, a China-based specialty pharmaceutical company for about US$ 521 million is the largest M&A deal in China's pharmaceutical industry to date.18 In addition, the Chinese government made an explicit mission statement in its 12th Five Year Plan19 to actively support mergers, acquisitions and restructuring in the pharmaceutical sector in order to consolidate the industry and achieve more economies of scale.
In spite of the commercial aspiration and favorable policies, it is not always easy to structure corporate transactions under China's unique regulatory regime. Under the current regulatory framework, drug licenses are personal to the manufacturers and therefore are not transferrable. If a multinational pharmaceutical company is interested in acquiring certain drugs from another company in China, it has to acquire the license holder through equity acquisition in order to obtain an indirect control on the relevant drugs. Obviously, the equity acquisition structure would expose the buyer to potential risks in various areas, such as product quality issues, financial liabilities, EHS (environmental health and safety) compliance, employment and FCPA risks, most of which could negatively affect the success of transactions. The post-acquisition integration is also a tremendous challenge for multinationals due to cultural differences, misalignment of compliance requirements, language barriers and other reasons.
The recent changes to the Transfer Rules may create another avenue for multinational companies when pursuing acquisitions in China. For example, if a multinational pharmaceutical company is interested in a generic product held by a local manufacturer which cannot be certified under the new GMP, it may acquire manufacturing technologies of the generic drug through a Chinese subsidiary which is a duly registered drug manufacturer. If such subsidiary is not available to serve as an acquiring vehicle, the multinational company may choose to incorporate a drug manufacturing entity in China by the specific deadline set forth in the CFDA Circular to capture this opportunity.20 The relevant drug product license would be essentially transferred as assets to the buyer through drug technology transfer, possibly without any clinical studies. The asset transfer model presents a few advantages over the prevailing equity acquisition model. The buyer would not inherit any liabilities from the seller. Furthermore, it may not be necessary to seek additional approvals from the Ministry of Commerce and the Stated Administration of Industry and Commerce (or their respective local counterparts).
Nonetheless, uncertainty associated with the asset transfer model may arise after drug product licenses are transferred to the Transferee, because the same product owned by the Transferee is to be registered in a new license and may not be deemed identical to the product owned by the Transferor. The change in product identity as a result of change in the product license may prevent the Transferee from claiming the same status as the Transferor during the tendering and hospital listing process.
China's dynamic pharmaceutical market is, not surprisingly, attracting interest and investment from the leading global pharmaceutical companies. But adapting to the regulatory landscape in China is not easy and requires careful, long-term strategic planning that takes into account a myriad of factors.
The Transfer Rules enable multinational pharmaceutical companies to localize their manufacturing activities for certain imported drugs in order to compete more effectively against domestic players during market access. The recent CFDA Circular further eases requirements for drug license transfers, and provides promising opportunities for deal executions under an asset acquisition structure, particularly in relation to generic drugs. Companies should carefully compare risks and benefits associated with an asset acquisition structure versus an equity acquisition structure when implementing their localization strategies in China.
Originally published in Update magazine, May/June 2013 Issue.
1. The Chinese Pharmaceutical Market 2012-2022 report published on December 6, 2011 by Visiongain, a business information provider. The report is available at Visiongain website - http://www.visiongain.com/Report/726/Chinese-Pharmaceutical-Market-2012-2022
2. The State Food and Drug Administration ("SFDA") has been recently renamed as the China Food and Drug Administration due to a recent organizational restructuring initiated by the PRC State Council.
3. Article 3 of the Transfer Rules.
4. Technology transfer is not permitted where the drug is a narcotic drug, a Class I psychotropic drug, an active pharmaceutical ingredient for a Class II psychotropic drug or a precursor chemical drug (Article 16 of the Transfer Rules).
5. The Transferor may be a research organization which owns the New Drug Certificate and would like to transfer the related technologies to a drug manufacturer as the Transferor does not have any manufacturing capabilities.
6. Article 15 of the Transfer Rules.
7. Article 11 of the Transfer Rules.
8. The term "new drug" is defined in Article 83 of the Implementation Regulations of the Drug Administrative Law by the PRC State Council (effective on September 15, 2002). The CFDA has the authority to implement administration protection over new drugs by providing a monitoring period for up to five years. During the monitoring period, the CFDA will not permit other companies to produce, improve or import the same drug product (Article 66 of the Administrative Regulations on Drug Registration by the CFDA (effective on October 1, 2007). If the new drug monitoring period has expired, said drug will be eligible for transfer of its manufacturing technology.
9. Article 8 of the Transfer Rules.
10. Article 9 of the Transfer Rules.
11. If the Transferor and the Transferee are not subject to the same Provincial FDA, the consent by the Provincial FDA where the Transferor is located will also be required (Article 18 of the Transfer Rules).
12. The required documents are listed in the Appendix of the Transfer Rules.
13. Article 21 of the Transfer Rules.
14. The Circular on Implementation of new GMP by the CFDA on February 25, 2011.
15. Under the original Transfer Rules, the controlling party must be a drug manufacturer.
16. The agency had only 120 reviewers to handle nearly 7,000 applications made in 2012, according to CDE's annual report for 2012.
17. China's pharmaceutical industry – Poised for the giant leap by KPMG in 2011.
18. China lures global drug makers (September 20, 2010, Reuters).
19. According to the Twelfth Five-Year Plan (2011-2015) for the Development of Pharmaceutical and Medical Device Industries published by the Ministry of Industry and Information Technology of China on January 19, 2012, the aggregated market share of the top 100 companies in the pharmaceutical sector will exceed 50% by 2015.
20. Pursuant to the CFDA Circular, the application can only be accepted if it is filed prior to December 31, 2016 (or December 31, 2014 if the subject product is a sterile product).
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