CHINA (PRC FIRMS): An Introduction to Corporate/M&A
CHINA (PRC FIRMS): Trends and Development of Corporate/M&A
Despite the uncertainty of the risk brought by the COVID-19 pandemic, the global economy has been on its way to recovery in 2021, which sets the tone for China’s M&A transactions.
Outbound M&A
China’s overseas investment increased in 2021, which continued the rebound since late 2020. The value of outbound M&A by Chinese investors in the first three quarters of 2021 (USD46.3 billion) rose by 79% year-on-year, while the announced deal volume reduced by 3%, based on an EY report (“Overview of China outbound investment of the first three quarters of 2021”). However, the report also notes that the value was still 13% less than the same period of 2019, showing that the recovery did not fully offset the 2020 disruption. The deals were mainly in the sectors of TMT, financial services, consumer products, healthcare and life sciences, and advanced manufacturing and mobility.
The most popular investment destination for Chinese enterprises for the first three quarters has been Asia, accounting for 45% of the overall value of China overseas M&A deals, according to statistics released by the same EY report. The growing deal interest is expected to be sustained with the Regional Comprehensive Economic Partnership (RCEP) agreement going into effect in 2022. Driven by the ”Belt and Road” initiative, investments into Latin America rose rapidly, where China-related M&A deals saw an uptake by 2,482% in value year-on-year, mainly in the power and utilities sector.
In the previous few years, there has been a rise of trade protectionism worldwide. Particularly, in the US, Chinese investment is subject to stricter and broader scrutiny by the Committee on Foreign Investment in the United States (CFIUS), following the enactment of the Foreign Investment Risk Review Modernization Act and Provisions Pertaining to Certain Investments in the United States by Foreign Persons. Although such scrutiny and barriers still may exist, China overseas M&A is facing an investing environment and regulatory regimes with a bit more certainty now.
Inbound M&A
According to the Ministry of Commerce (MOFCOM), China's actual use of foreign investment during the first 10 months of 2021 amounted to USD147.80 billion, up 17.8% year-on-year. Considering the complex impact by the COVID-19 pandemic, there are both opportunities and challenges in M&A investment. The new development strategy of “Dual Circulation”, an economic strategy first raised by China’s leadership in May 2020, aims at a shift from the country’s export-oriented economy to a self-reliant production and demand, with domestic economic circulation and international circulation complementing each other. This transition indicates better prospects for inbound M&A transactions involved in China’s local economic upgrading.
A series of important laws and regulations in relation to inbound M&A took effect in 2021. On 1 January 2021, the Civil Code came into force, which guides and regulates commercial activities from a fundamental perspective. The transaction parties should particularly watch out for any compliance risks associated with the new Export Control Law since 1 December 2020 and the Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures (“Blocking Rules”) from 9 January 2021. Moreover, the recent development of foreign investment legal framework is pertinent as well, which is predicted to deeply impact future M&A transactions.
Public M&A
China’s capital markets have boomed in recent years. Following the new PRC Securities Law coming into effect in March 2020, China continues with its capital market reform. In addition to the Shanghai Stock Exchange (SSE) opening its registration-based “STAR market” (Sci-Tech innovation board) in 2019, the Shenzhen Stock Exchange (SZSE) also adopted in June 2020 the “Registration-Based” securities issuance system on its “ChiNext board” (China’s growth enterprise market); and so is the Beijing Stock Exchange (BSE) which recently opened in November 2021.
As more public listed companies have sufficient funds raised at their disposal, and with the eased efficient regulatory procedures regarding M&A investment, it is anticipated that more M&A deals will arise involving public companies. Recently, there have been a few transactions where listed companies take over other listed companies, either within the jurisdiction of the same stock exchange or across stock exchanges. Such takeover transactions between two or more public companies indicate further industry consolidation. Another trend is that there are an increasing number of cash deals, with much less stock-backed deals than before. It is partly attributed to the fact that those companies neo-listed usually have sufficient cash flow. Another main reason is that such companies have enjoyed a relatively high valuation when going public, and any attempt to issue new stocks on a high-value base to pay the consideration for acquisitions might be easily challenged by the regulatory authorities, hence cash deals are much preferred.
Two Regulatory Changes with Profound Impacts on M&A
The Foreign Investment Security Review Rules
One major regulatory development was the promulgation of the Rules on Security Review of Foreign Investment (Security Review Rules) by China’s National Development and Reform Commission (NDRC) and the MOFCOM on 19 December 2020. The Security Review Rules took effect on 18 January 2021 and came on the heels of implementation of China’s Foreign Investment Law that went into effect on 1 January 2020.
With this new Security Review Rules came into force, China has revamped its national security review framework. These rules have significantly expanded the scope of the transactions that are subject to national security review, including M&A transactions and green-field investments. In addition, offshore transactions would also fall within the scope reviewed by the Chinese authorities, provided that the target company’s Chinese subsidiary(ies) operates in one of those covered industrial sectors.
China first introduced its national security review framework back in 2011. Since then, however, very few cases have been disclosed and reported in this framework. Unlike the merger control review, the Chinese government has not published and specified cases that have been reviewed, approved, or rejected. Therefore, there is not much practical guidance on how the Chinese government reviews a transaction from a national security perspective.
At this moment, it is not clear whether detailed implementing rules will be issued soon to provide further guidance. In the meantime, when planning and structuring a transaction that involves China, one needs to consider the requirements under the Security Review Rules. More specifically speaking, security review filing and/or clearance has to be one of the conditions of implementing a transaction that has national security implications in China.
The Anti-Foreign Sanctions Law
In addition to the Blocking Rules and the Rules on Unreliable Entity List (Unreliable Entity List Rules), it is worth noting the Anti-Foreign Sanctions Law (AFSL) recently became effective as of 10 June 2021 in China. Although this new law may be more related to trade sanctions, parties involved in M&A transactions shall take it into account when negotiating deals.
With only 16 articles, the AFSL appears to be more of China’s political declaration in response to the sanctions imposed by its Western counterparts. However, some of its provisions may have, to some extent, realistic implications on M&A transactions. For example, Article 6 authorises the Chinese central government to take measures to prohibit or restrict entities and individuals within China (presumably including foreign invested companies) from engaging in transactions or cooperation with those foreign entities or individuals subject to China’s countermeasures. Article 12 further prohibits any entity or individual from implementing or assisting in implementing discriminatory restrictive measures imposed by foreign countries against Chinese entities or individuals, failure of which may enable such Chinese entities or individuals to sue the violating entities or individuals in Chinese courts. In this regard, these clauses may essentially offer Chinese entities and individuals a justified exit mechanism to walk away from M&A deals.
Relations between the AFSL, the Blocking Rules and the Unreliable Entity List Rules
The AFSL harmonises the relations among these three laws and regulations. Article 13 of AFSL legitimises the Blocking Rules and the Unreliable Entity List Rules by offering a clear legal basis for these two rules, providing that administrative regulations and departmental rules may also stipulate necessary countermeasures against acts that endanger China's sovereignty, security or development interests.
Our observations
It is still a question on how and to what extent the AFSL will actually impact M&A transactions involving Chinese parties. Nevertheless, the following few things might reasonably be anticipated.
- Deal uncertainty: The AFSL may further add to the uncertainty of M&A deals created by the Blocking Rules and the Unreliable Entity List Rules. As discussed above, it may essentially offer Chinese entities and individuals a justified exit mechanism to walk away from M&A deals. In addition, the Chinese side needs to conduct more comprehensive background check on its foreign counterpart to confirm whether the foreign counterpart and its affiliates are subject to China’s countermeasures.
- Dilemma: The AFSL may further put Chinese and foreign parties to transactions into an awkward dilemma, i.e., either they observe the blocked foreign laws or comply with the countermeasures or injunctions imposed by the AFSL or the Blocking Rules. This may essentially force foreign companies (including their Chinese subsidiaries) to take sides, which could seriously hinder future M&A transactions.
Overall, the year of 2021 has been a challenging one for China’s cross-border M&A. The recovery of the economy is a big driver of the upturn of investment activities, while the promulgation of new laws and regulations, most of which are purported to safeguard the national security and national interests, imposes greater scrutiny on M&A transactions. It depends on how the international political and economic landscape is changing, and how far the Chinese government is heading towards its reviewing and supervising regime as well as its countermeasures against its Western counterparts. With a general legal framework having been established, parties to global M&A deals shall adapt investment strategies to the evolving regulatory regime.