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Business
Print Edition> Business
UPDATED: September 26, 2011 NO. 39 SEPTEMBER 29, 2011
Proceed With Caution
China adopts security review system for foreign mergers and acquisitions of domestic companies
By LAN XINZHEN
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China's M&A security review system complies with the WTO's security exceptions principle. While China will not change its policies about opening up and utilizing foreign investment, it will strengthen investment cooperation with other countries and build a more liberal multinational investment system and legal environment.

The review system will encourage and standardize M&As by foreign investors and is consistent with China's earlier policy of diversifying the utilization of foreign investment, said Wang Zhile, Director of Beijing New Century Academy on Transnational Corporations.

On April 6, 2010, the State Council issued a document setting out guidelines on the future development of China's foreign investment policies. The document supported listed domestic companies introducing strategic foreign investors, and established a standard process for foreign capital portfolio investment and M&As.

No harm to reform

The MOFCOM said that the safety review provisions will help to further China's opening up. More importantly, it will regulate and promote the healthy development of foreign investment in China.

As the Chinese market matures, foreign M&As of domestic enterprises have increased. China's anti-monopoly law passed in August 2007 requires foreign companies to pass a national security test when they merge with or acquire a Chinese company that may affect China's national security.

The provisions are the extension of the anti-monopoly law, said the MOFCOM.

According to the provisions, where M&A of a domestic enterprise by a foreign investor is subject to M&A security review, the foreign investor shall file an application for M&A security review with the MOFCOM. When two or more foreign investors jointly make a M&A, an application for M&A security review may be filed with the MOFCOM by all the foreign investors, or by one foreign investor designated by all the investors.

When a foreign investor merges with or acquires a domestic company and the State Council or related departments believe that a security review needs to be conducted of the M&A, they may make proposals for an M&A security review to the MOFCOM and submit explanations with regard to the circumstances in question, and the MOFCOM may request interested parties to submit relevant explanations.

When the transaction is subject to M&A security review, MOFCOM shall submit its recommendations to the Joint Ministerial Panel responsible for reviewing foreign takeovers of Chinese companies within five business days. When the Joint Ministerial Panel believes that the M&A security review is indeed necessary, the MOFCOM will require the foreign investor to file an application for M&A security review according to the provisions.

For foreign investors, the provisions do not mean that China is deviating from its opening-up policy, said Hong Tao, a professor with the School of Economics of Beijing Technology and Business University. The provisions aim to prevent monopoly through protecting some domestic brands and enterprises and implementing safety review on foreign investors' M&As, Hong said.

If foreign investors want to expand product lines, establish production bases and complete assembly lines through M&As, relevant supervisory departments should give them the green light, said Song Hong, a researcher with the Institute for World Economy and Politics of Chinese Academy of Social Sciences.

But China should be alert that some large multinational companies intend to destroy domestic brands with hostile takeovers, said Song.

Compared with previous rules that govern the security review of foreign investors' M&A deals, the new regulation made it clear for the first time that foreign investors are not allowed to avoid the review by any means whatsoever, which includes using the variable interest entities (VIEs) model, a common practice in the Internet sector.

By using the VIE model, Internet companies usually register overseas, thus giving the overseas company real control over its domestic assets.

"The new regulation solved a major loophole in the previous rules by stating that 'trickery' and any other means of avoiding the review process are strictly prohibited," said Mei Xinyu, a researcher at the Chinese Academy of International Trade and Economic Cooperation under the MOFCOM.

- MOFCOM data show that China absorbed $105.74 billion in FDI in 2010 and M&As accounted for about 3 percent of the total FDI.

- The world's FDI in 2010 reached $1.12 trillion, more than 70 percent of which was investment through M&As.

- According to the China Merger & Acquisition Report 2010 by Zero2IPO Research Center, Chinese enterprises completed 1,798 M&A deals in 2010, with 30 deals by foreign investors.

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