Issuing Body: General Office of the State Council
Issuing Date: February 3, 2011
Effective Date: March 5, 2011
Seeking to implement a key element of China's two-and-a-half-year-old Anti-Monopoly Law, China's State Council has established a formal security review system to oversee foreign mergers and acquisitions that involve "national security," with a joint ministerial panel responsible for oversight. The General Office of the State Council issued the Notice on the Establishment of a Security Review System for Foreign Mergers and Acquisitions of Domestic Enterprises (M&A Security Review Notice) on February 3, 2011. The new rules, which take effect March 5, have been anticipated since before the Anti-Monopoly Law took effect in August 2008; in accordance with Article 31 of that law, foreign mergers and acquisitions of domestic enterprises that involve national security are subject to national security review, in addition to merger control review for possibly anti-competitive effects.
The Joint Ministerial Panel is led by the National Development and Reform Commission (NDRC) and Ministry of Commerce (MOFCOM), under direct oversight of the State Council. The panel is responsible for assessing the impact on national security of foreign mergers and acquisitions of domestic enterprises, researching and coordinating key elements of the security review, and ultimately making decisions based on the review. The panel will conduct reviews along with relevant government agencies, depending on the sectors and industries that are involved.
Scope of Security Review
A security review is required when one or more foreign investors become the controlling shareholder or de facto controller of a domestic enterprise in a merger or acquisition and that domestic enterprise is involved in any of a number of broadly defined sectors:
- the defense industry;
- enterprises that support China's defense industry or that surround key and sensitive military facilities;
- other entities related to national security;
- key agricultural products;
- key energy and resources;
- crucial basic infrastructure;
- key transportation services; or
- key technology and equipment manufacturing.
Foreign mergers and acquisitions of domestic financial institutions are not covered by the M&A Security Review Notice, and are subject to separate rules that have yet to be enacted. It is not known when those financial industry rules will be issued.
The M&A Security Review Notice covers transactions made by investors from Hong Kong, Macau, and Taiwan.
In accordance with the M&A Security Review Notice, the following types of transactions are considered to be foreign mergers or acquisitions (and thus, depending on the industry, potentially subject to review):
- A foreign investor purchases an equity interest in a domestic enterprise that is not a foreign-invested enterprise (FIE), or subscribes to an increased portion of the registered capital increase of a domestic enterprise that is not an FIE; and after the purchase, the domestic enterprise converts into a foreign-invested enterprise.
- A foreign investor purchases the equity interest of Chinese shareholders of a foreign-invested enterprise, or subscribes to an increased portion of the registered capital of an FIE.
- A foreign investor establishes an FIE in China, then purchases the assets of a domestic enterprise through the established foreign-invested enterprise and operates the purchased assets; or the FIE purchases an equity interest of a domestic enterprise through the established foreign-invested enterprise.
- A foreign investor purchases the assets of a domestic enterprise, then establishes a foreign-invested enterprise in China with the purchased assets and operates the purchased assets.
The M&A Security Review Notice clarifies that foreign investors are considered to be the controlling shareholders or de facto controllers of a domestic enterprise in situations where:
- After completion of the transaction, the foreign investor, its controlling parent company, and controlling subsidiaries hold 50 percent or more of the equity of the domestic enterprise.
- After the transaction, multiple foreign investors together hold 50 percent or more of the equity of the domestic enterprise.
- A foreign investor holds less than 50 percent of the equity of the domestic enterprise after the transaction, but its voting rights are sufficient to exert a material influence over resolutions made by shareholder meetings or the board of directors of the domestic enterprise.
- Other situations in which foreign investors hold de facto control over management, decision-making, finances, human resources, or technology.
M&A Security Review Contents
For a security review, the Joint Ministerial Panel and cooperating agencies should assess the effect of foreign mergers and acquisitions in the following areas:
- The impact of the transaction on national security, including its effect on the manufacturing and service capacity of domestic products needed for national defense and on relevant equipment and facilities.
- The impact of the transaction on national economic stability.
- Its impact on "basic social life order" (a vague term, the meaning of which will only be known with time and application).
- How the transaction will affect the research and development ability of key technology related to national security.
M&A Security Review Procedures
Foreign investors who are considering a merger or acquisition which may have an impact on national security should apply with MOFCOM for a security review by the Joint Ministerial Panel pursuant to the M&A Security Review Notice. MOFCOM should submit the application for review to the panel within five working days, if the deal is subject to review.
Departments of the State Council, relevant national industrial associations, enterprises in the same industry as the domestic enterprise to be acquired, and upstream or downstream enterprises may suggest a security review to MOFCOM. MOFCOM will forward the suggestion to the Joint Ministerial Panel, which has the right to decide to whether to conduct a review.
Procedurally, a deal is first given a "general review" by the Joint Ministerial Panel. If it fails to pass the general review, the panel will undertake a "special review." The M&A Security Review Notice requires the Joint Ministerial Panel to solicit, in writing, the comments of relevant agencies within five working days of receiving a review application from MOFCOM. Agencies, in turn, are required to send their written comments to the panel within 20 working days.
If all agencies involved hold the view that the deal under review does not have any impact on national security, a special review will not be initiated. The Joint Ministerial Panel should make a final review conclusion based on the comments of agencies that were consulted, and notify MOFCOM of its decision within five working days of collecting the agencies' comments.
If any agency thinks the deal under review may have an impact on national security, the Joint Ministerial Panel should initiate a special review within five working days of receiving the agency's written comments. For the special review, the panel will coordinate a security assessment of the proposed deal, and then review the transaction based on the results of that assessment. If there is great divergence in security review opinions, the panel should submit a report to the State Council for rendering of a final decision. The panel is required to complete its special review within 60 working days.
In the course of a security review, an applicant may apply with MOFCOM to alter or revoke the transaction.
MOFCOM is required to notify applicants of final security review decisions in writing.
If a transaction is determined to have an impact on national security, or may have a material impact on national security, the Joint Ministerial Panel may, in accordance with the M&A Security Review Notice, require MOFCOM to work with relevant agencies to terminate the transaction. Alternatively, MOFCOM may require investors to take remedial measures to eliminate the effect of the transaction on national security, such as transferring an equity interest or assets.
The M&A Security Review Notice uses a relatively broad definition of "national security," which may provide MOFCOM, the NDRC, and other Chinese government agencies with more discretion to interpret the meaning of this key term. It remains to be seen how the panel will interpret this term in practice.
While the regulatory burden will certainly increase for deals subject to security review, we do not expect the Chinese government to use these review procedures as a tool to block a significant number of cross-border deals.
It was recently reported that MOFCOM is in the process of formulating implementing rules and operating guidance for the M&A Security Review Notice, which will bring more certainty and transparency to the process. China Law Update will keep a close eye on those rules and guidelines.