The Cabinet of China, the State Counsel, promulgated the Notice on the Establishment of the National Security Review Mechanism for the M&A of the Domestic Enterprises by the Foreign Investors on Feb. 12, 2011 (the Security Review Rule). Since the implementation of the Anti-monopoly Law of the PRC as of August 1, 2008 (the AML), the relevant component authorities (the AML Authority) have issued a lot of detailed regulations and rules for the clarification of the vague in the AML and for guidance in the daily practice (the Detailed Rules). The Detailed Rules bring more transparency to both the officials in the AML Authority and the players in the market. Among those Detailed Rules, only the Provisions of the State Council on Thresholds for Prior Notification of Concentrations of Undertakings were issued by the State Council in the form of decree. This Security Review Rule is the second one issued by the Cabinet. This article will analyze it for the interested readers and potential foreign acquirer to solve some of their concerns.
National Security of China
The Security Review Rule comes from Article 31 of the AML which states that
“where a foreign investor participates in the concentration of undertakings by merging or acquiring a domestic enterprise or by any other means (the Deal), and national security is involved, besides the examination on the concentration of undertakings in accordance with this Law, the examination on national security shall also be conducted according to the relevant provisions of the State.”
It took more than two years after the implementation of the AML for the promulgation of this Security Review Rule which can only be drafted and formed by the State Council due to its significance. Although there is no clear definition of “national security” which is hard to do so without the unanimous definition having been reached around the world, we can summarize the most concern of the Chinese government when they are discussing the national security of China in the Security Review Rule:
- National Defense
This is interpreted as the effect of the Deal on the productivity of domestic products, the capacity of domestic service and the relevant equipment and facilities demanded in the defense.
- National Economic Safety
The effect on the stability of the economic performance should be considered. This can be regarded as the economic safety of China. The national economic safety was first mentioned by the MOFCOM as the factor in assessment of the M&A of the domestic enterprises by foreign investors in the Interim Provisions for Foreign Investors to Merge Domestic Enterprises (2003). We are not aware of any case that is refused by the MOFCOM due to the national economic concern. The Huiyuan and Coca-Cola case may be construed to some extent as being rejected for this concern, but the official press of the MOFCOM does not list this as the rejecting reason.
- National Social Safety
The impact on the basic order of social life is also one of the standards. There is no doubt that this will cover the impact of the Deal on the public interests, such as public order and moral, which will increase the uncertainty about how to define the national social safety. This factor also can be broadened as the political security. As the fact that the Communist Party is exhausting to keep the stability of the society, the foreign investor may pay much attention to the effect of the Deal to the local or national community, such as the employment problems.
- National Technical Safety
The component authority will consider the effect of the Deal on the R&D capability of the key technology in connection to the national security. Technology is the competing edge for each nation state. The nations nowadays have to resort to the ever advanced technology to protect them in the military aspect, compete each other in the economy aspect and guide the development of the society. At this stage, we do not anticipate that China will use this leverage to block any Deal since China is still lack of the R&D ability and remains the World Factory.
As a developing and resource-scarce country, the Cabinet does not absorb the energy and natural resource into the factors consisting of the national security (but regulated as an industry, see the discussion below). Chinese government may worry that it will cause the tension of foreign investor about the open policy of China. On the other hand, China still needs the input of foreign investors in energy and natural resource industry. For example, China needs the technology in offshore drilling, CBM and shale gas, etc. and the fund for venture exploration in CBM.
Another key component of national security is the environment. As we know, the development of Chinese economy in the past 30 years since its opening door in late 1970s is achieved at the cost of serious and irreparable environment damages. It is almost the consensus that the environmental pollution should be prevented immediately in foreign or domestic investment. However, this consensus has not been incorporated into this Security Review Rule.
The Industries to be Reviewed
The Security Review Rule lists the industries of the target companies that are required going through the national security review:
- Military-related enterprises
These enterprises include the military enterprises and the enterprises providing support to the military enterprises, and the enterprises located around the key and sensible military facilities (the Military Area). It means that if the target company is doing the business which has nothing to do with military, but it is located in the Military Area, the Deal also requires the review.
The other units or organizations that are in connection with the national defense are also categorized as the military-related enterprises.
- The other industries
? Key agriculture products
? Key energy and resource
? Key infrastructure
? Key transportation service
? Key technology
? Key equipment manufacturing
The attached conditions for these other industries are a) they are related to the national security, and b) the foreign investor may obtain the controlling power or majority of the target enterprises involving the above industries.
As we discussed above, the Chinese regulators do not absorb energy and natural resource to the concept of national security, but regulate it as a special industry which may be subject to the national security review if the Deal meets the two conditions. Although this is not a wise choice for the Chinese regulators, it leaves opportunity for foreign investors in the traditional and especially the new and renewable energy industries and natural resource industry.
The Security Review Rule sets out the types of the Deal, i.e. the assets and equity M&A, similar to the clarifications in the Provisions for Foreign Investors to Merge Domestic Enterprises (2009 Provisions). Moreover, the difference between the Security Review Rule and the 2009 Provisions is that the existing foreign investment enterprises in China are included as a target company in the Security Review Rule. It also uses the Corporate Law of China and the guidelines to the listing companies as the basis to define the “controlling power” (or majority).
The Regulator of National Security Review
As authorized by the Security Review Rule, the inter-ministry panel (the Panel) will be set up and responsible for the national security review of the Deal. This Panel will be lead by the SDRC and MOFCOM and composed of the other ministries where the Deal is related to, such as the MOD, MIIT, MLR, MOT, MOR, MOST and MOA, etc.
We believe that MOFCOM will play a key role in this review due to its familiarity with the concentration review and the approval of foreign investment. But we still need to see how the work will be internally assigned between the Anti-monopoly Bureau (the AMB) and the Department of Foreign Investment Administration (the DFIA) in the MOFCOM. As shown on the website of the AMB and the DFIA, the Security Review Rule has been published on the webpage of the DFIA, but not the AMB. It seems that the DFIA will take the responsibility of national security review and the AMB will focus on the concentration review. In any event, both of them need clarify their relationship and cooperation in the coming workload. We also note that the Minister of MOFCOM said at the end of 2010 that MOFCOM will combine the procedures of foreign investment approval, anti-monopoly review of the concentration of undertakings and the security review of the Deal. For the foreign acquirer, it is necessary to consider the strategy of which procedure should be started first in order for successful pass of all the approvals and reviews at this stage.
The Procedure of the National Security Review
Who are initiators?
In accordance with the Security Review Rule, the following bodies have the right to request the Panel to initiate the national security review:
- MOFCOM
- The other relevant departments or ministries under the State Council
- National-wide industrial organizations
- The enterprises in the same industry of the target company
- The upstream and downstream enterprises of the target company
(for the last four bodies collectively as the Relevant Bodies)
The MOFCOM can submit the request to the Panel for national security review if they received the notification or application from the acquirer and believed that the Deal should go through the national security review. This submission should be done within 5 business days after it decides the national security review is necessary.
If the acquirer do not submit notification to the MOFCOM or MOFCOM decides not to submit the request for national security review to the Panel, any body listed above, except for the MOFCOM if it consider the request unnecessary, has the right to recommend the Panel to initiate the national security review through MOFCOM. It seems that, in this case, the MOFCOM is obliged to forward these recommendations to initiate the national security review without any discretion. It should be noted that there are no timeframe for the MOFCOM’s forwarding job.
The review of the Panel
The Security Review Rule stipulates a two-step procedure. The first step is the preliminary review and the second step is the special review which is required if the Deal causes more anxiety of the Panel in the first step.
- The preliminary review
The preliminary review will be a consultation with the Relevant Bodies listed above by the Panel in writing. The consultation should be done within 5 business days after the Panel receives the request from the MOFCOM. And the Relevant Bodies shall give the comments on the Deal within 20 business days once they receive the consultation letter from the Panel. Unless all the Relevant Bodies hold the opinions that the Deal will affect the national security, the Deal shall be moved to the next step for the special review.
- The special review
If any of the Relevant Bodies believes that the Deal will affect the national security, the Panel shall initiate the special review procedure within 5 business days after it receives this opinion. The Panel will have the Deal be assessed in the aspect of national security and review the Deal based on the assessment report. If the absolute majority of the members of the Panel reach a conclusion (positive or negative), the Panel shall issue its decision. If the members of the Panel hold significantly different opinions on the Deal, the Deal shall be submitted to the State Council for review. In any event, the Panel shall complete the special review within 60 business days after its initiation of the special review. Otherwise, the Panel shall pass on the Deal to the State Council.
During the process of the national security review, the acquirer and the target company has the obligation to cooperate with the Panel on providing the required documents and information and responding to the enquiries. In addition, the acquirer may modify or withdraw the Deal.
The measure to take by the Panel
If the Panel concludes that the Deal has or will affect the national security, it can require the MOFCOM, who will consult and cooperate with the other relevant government authorities, to terminate the Deal, or force the acquirer to transfer its equity, assets or take the other measures for the purpose of eliminating the effect of the Deal on the national security. It seems that the Panel will only let the acquirer know (through the MOFCOM) whether the Deal will affect the national security or not at first. The Panel will issue a separate order or notice to the MOFCOM on what the actions should be taken by the acquirer and the target company. It is anticipated that the MOFCOM will have more saying to the solutions.
Conclusion
The Security Review Rule draws the main roads in the map for the market players and regulators to follow. We can see the progress of China in the transparency of its approval mechanism. We also note that the Security Review Rule excludes its application to the foreign investment in connection with the fixed property investment, transfer of state-owned assets and acquisition of the domestic financial institutions. As we know that Huawei, a Chinese company, has announced to withdraw its plan to buy the assets of 3Leaf following the recommendation of CFIUS on 21 Feb. 2011, it is only 10 days ago that China issued this Security Review Rule. In any event, we do hope that the two nations will not use the “national security” as an excuse to kill the deal in the market of market economy.
Disclamier:
This article is the general comments of the author himself and can not be construed and constitute an formal legal opinion. If you need the legal opinion, please contact the author Edwin Zhiguo Li at email edwinzhiguoli@gmail.com or mobile 0086-15010017763.
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