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Current Regulatory Framework and Background
China’s foreign investment national security review (“Review”) is a separate national regulatory control which has thresholds different fromChina’s anti-trust review of offshore and onshore business concentration transactions. It was officially established following the State Council’s Circular Concerning the Establishment of Security Review System for Foreign Investors’ Merger and Acquisition of Domestic Enterprises issued on 3 February 2011 and effective on 6 March 2011 (“2011 Circular”).
Over the past years, the Review has been further elaborated and implemented by ministerial rules by the Ministry of Commerce (“MOC”) (including the Interim Provisions Concerning Certain Matters Related to the Security Review System for Foreign Investors’ Merger and Acquisition of Domestic Enterprises effective on 5 March 2011 which was later repealed by the Provisions Concerning the Security Review System for Foreign Investors’ Merger and Acquisition of Domestic Enterprises issued on 25 August 2011 and effective on 1 September 2011) (together with 2011 Circular, collectively referred to as “2011 Rules”).
As of 28 December 2014Chinahas established four pilot free trade zones respectively located in the designated areas inShanghaiMunicipality, andTianjin,GuangdongandFujianProvinces(collectively “Pilot Free Trade Zones”). On 8 April 2015, the State Council issued the Interim Measures Concerning the National Security Review of Foreign Investment in Pilot Free Trade Zones effective as of 8 May 2015 (“2015 PFTZ Rule”) which expands the definition and scope of “transactions legally subject to Review” to catch all types of foreign investments in Designated Sectors (as defined below) within Pilot Free Trade Zones.
On 19 January 2015, a Draft China Foreign Investment Law (“Draft Law”) circulated by MOC for public comments included a detailed chapter which stipulates the scope and procedures of the Review, confirms the binding effect and “non-appealable” legal status of the Review results, introduces a penalty and punishment mechanism as well as further specifies consequences resulting from the violation of the Review legal requirements, among others. The Draft Law, if adopted, will replace the current lower statutory legal basis of the Review, i.e., “Government Rules” with a more advanced legislative form i.e., “Law”, depict the detailed requirements of the Review and clarify those areas which the existing government rules either fail to address or are found ambiguous. The Draft Law is still at legislative review stage. It is unclear at the moment when and to what extent it will be adopted.
Legal Significance of the Review
In order to lawfully proceed further and to secure other necessary government approvals, registrations or filings, all transactions which are legally subject to Review and “all transactions which are legally subject to Review as a result of any of its subsequent modifications or changes” must first be filed to MOC to initiate the Review process and obtain an affirmative Review result issued by Review Authority (as defined below). Failing to do so, the parties to any such transaction will be requested to cease the transaction and relevant activities. Here, “all transactions which are legally subject to Review as a result of any of its subsequent modifications or changes” refer to transactions which are not submitted to Review Authority for Review or which have been determined by Review Authority as having no national security effect after the Review, are legally subject to Review as a result of the occurrence of any of their subsequent modifications or changes (including any modification of the transactions themselves or relevant agreements or deal documents, any change of business activity or offshore actual controller(s), and/or other changes).
The National Development and Reform Commission (“NDRC”), MOC and their local counterparts are under a duty to monitor, manage, check and verify foreign investment activities in China (including without limitation, those transactions approved with or without condition following the Review) to ensure the proper implementation of the Review system.
Transactions and Sectors Subject to Review
Below is a comparison chart showing the applicability, sectors and types of transactions subject to Review and the definition of “control” respectively provided by the 2011 Rules and the 2015 PFTZ Rule.
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2011 Rules |
2015 PFTZ Rule |
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Applicability |
l 2011 Rules are applicable to foreign investors’ merger or acquisition of Chinese enterprises in Designated Sectors (as defined below); l National security review of the merger or acquisition of Chinese enterprises by investor(s) from Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region will be conducted by reference to 2011 Rules; l Transactions involving new fixed-asset investment require additional government approval pursuant to the relevant regulations concerning the administration of fixed-asset investments; l Transactions involving the change of ownership of state-owned assets require additional government approval pursuant to relevant state-owned asset regulations. |
l 2015 PFTZ Rule is applicable to foreign investment in Designated Sectors (as defined below) within Pilot Free Trade Zones; l 2015 PFTZ Rule is also applicable to investment within Pilot Free Trade Zones by foreign invested equity investment enterprises, foreign invested venture-capital investment enterprises, and investment companies; l National security review of the investment by investor(s) from Hong Kong Special Administrative Region, Macao Special Administrative Region and Taiwan Region within Pilot Free Trade Zones will be conducted by reference to 2015 PFTZ Rule. |
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l Neither 2011 Rules nor 2015 PFTZ Rule is applicable to foreign investment in financial sector which will be regulated separately. |
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Sectors Subject to Review (“Designated Sectors”) |
l Chinese military enterprises, military ancillary enterprises, other entities related to national defense, and Chinese enterprises located in areas surrounding material or sensitive military facilities; and l Other Chinese enterprises which are relevant to national security, such as enterprises of material agricultural products, energies and resources, infrastructures, transportation services, core technologies as well as major equipment and manufactures, provided that foreign investor(s) may acquire “actual control” of the acquired enterprise(s).
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l Military sectors, military ancillary sectors, other sectors related to national defense, and geographic areas surrounding material or sensitive military facilities, within Pilot Free Trade Zones; and l Other domestic sectors within Pilot Free Trade Zones which are relevant to national security, such as sectors of material agricultural products, energies and resources, infrastructures, transportation services, cultures, information technology products and services, core technologies as well as major equipment and manufactures, provided that foreign investor(s) acquire “actual control” of the invested enterprise(s) . |
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Types of Transactions Subject to Review (“Transaction”) |
Merger or acquisition of Chinese enterprise(s) by foreign investor(s) include the following types of transactions: l Foreign investor(s) purchase equity or subscribe to capital increase in Chinese enterprise(s), and as a result Chinese enterprise(s) are converted into foreign invested enterprise(s) (“FIEs”); l Foreign investor(s) purchase equity held by Chinese shareholder(s) in FIE(s) or subscribe to capital increase in FIE(s); l Foreign investor(s) set up FIE(s) and, through such FIE(s), purchase and operate assets of Chinese enterprises or purchase equity in Chinese enterprises; or l Foreign investor(s) directly purchase assets of Chinese enterprises and contribute such assets to registered capital of FIE(s) which are set up to operate such assets. |
Investment by foreign investor(s) within Pilot Free Trade Zones include the following types of investments: l Foreign investor(s), alone or jointly with other investors, invest in new projects or set up new enterprise(s); l Foreign investor(s) acquire equity or assets of existing enterprise(s) through merger or acquisition; l Foreign investor(s) make investment by means of Variable Interest Entities (“VIE”), entrustment, trust, reinvestment, offshore transactions, leasing, subscription of convertible bonds, etc. |
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Definition of “Control”
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The acquisition of actual control by foreign investor(s) means that foreign investor(s) become the controlling shareholder(s) or actual controller(s) of Chinese enterprises through merger or acquisition, which include the following circumstances: l Where foreign investor, its parent company and subsidiary(ies) together own at least 50% shareholding interest in total following the merger or acquisition; l Where a number of foreign investors own at least 50% shareholding interest in total following the merger or acquisition; l Where foreign investor(s) own less than 50% shareholding interest in total following the merger or acquisition, but the voting rights associated with such shareholding interest are sufficient to exert material influence on resolutions of shareholders’ meeting or the board of directors; or l Other circumstances which result in the transfer of actual control of Chinese enterprise(s)’ business decisions, finance, personnel, and technologies, etc to foreign investor(s). |
The acquisition of actual control in the invested enterprise by foreign investor(s) include the following circumstances: l Where foreign investor and its affiliated investor(s) together own at least 50% shareholding interest in total of the invested enterprise; l Where a number of foreign investors own at least 50% shareholding interest in total of the invested enterprise; l Where foreign investor and its affiliated investor(s) or a number of foreign investors own less than 50% shareholding interest in total of the invested enterprise, but the voting rights associated with such shareholding interest are sufficient to exert material influence on resolutions of shareholders’ meeting or the board of directors; or l Other circumstances which may result in the material influence by foreign investor(s) on the invested enterprise’s business decisions, personnel, finance, and technologies, etc. |
Authorities Responsible for Conducting the Review
The State Council has set up a joint ministerial working panel to carry out the Review (“Review Authority”) under the State Council’s leadership. The Review Authority is led by the NDRC and the MOC who may involve other government authorities as per industry(ies) and sector(s) involved.
What the Review Entails?
The Review may entail the assessment on the effect by foreign investment on national defense, including the effect on domestic capacity to produce products and to provide services as national defense may require as well as the effect on facilities related to national defense. The Review may also assess the effect by foreign investment on the stability of national economy, the basic social order as well as the capacity to research and develop core technologies related to national security. In Pilot Free Trade Zones, the Review may also assess the effect by foreign investment on the national cultural security, the public moral as well as the national network/internet security.
The Draft Law introduces a detailed but not exhausted list of factors to be assessed under the Review. The list is broader and more specific compared with those under the existing government rules. According to the Draft Law, the Review may also assess the effect by foreign investment on leading position ofChina’s technologies in the national security sector and whether foreign investment is controlled by foreign government(s), among others.
Who May Apply for Review?
The Review process generally will be initiated by application to MOC by foreign investor(s) who is/are one of the parties to the Transaction.
However, if foreign investor(s) does/do not first file application to MOC for Review of a Transaction, it/they may be requested to do so:
(a) by MOC, if Review Authority holds an opinion that it is necessary to conduct the Review of the Transaction upon its review of proposals submitted, via MOC, by relevant governmental authorities of the State Council, national industrial associations, competitors as well as upstream and downstream enterprises; or
(b) by MOC’s local counterpart, if it finds that the Transaction is subject to Review during its review of foreign investor(s)’ application for obtaining foreign investment approval or registration or filing necessary for effectuating the Transaction. In the meantime, MOC’s local counterpart will also keep MOC informed in this regard.
Procedures and Timeline of the Review
All timelines in the chart below are maximum statutory periods and pursuant to which at least 115 working days (nearly six months) will be required for completing the Review process commencing from the acceptance of the application by MOC until MOC’s notification of the Review result. In practice, by taking into account the time required for attending pre-consultation, preparing and submitting application and additional documents/information as well as answering to queries from Review Authority by the parties to the Transaction, the actual total timeline required for completing the Review process and obtaining the Review result for a Transaction will exceed six months.
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5w/d |
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Conduct non-binding pre-consultation with MOC on procedural matters. (Pre Consultation-- Optional) |
File application to MOC.
(Application to MOC) |
If MOC accepts application and believes that the Transaction is subject to Review, MOC will issue written confirmation to applicant within 15 w/d following its acceptance of the application. If no written confirmation is issued, upon expiry of 15 w/d period, the parties to the Transaction can complete other relevant legal formalities and the Transaction can proceed. (Phase I : Pre-Review Assessment by MOC) |
If a Transaction is subject to Review, MOC shall forward application to Review Authority within 5 w/d. (MOC to Send Application to Review Authority for Review) |
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Timeline 30 w/d
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Review Authority will first launch Preliminary Review and seek opinions from relevant government authorities and agencies. If all government authorities and agencies consulted hold an opinion the Transaction does not have national security effect, Review Authority will not conduct Further Review and will notify MOC of its decision in writing. (Phase II : Preliminary Review by Review Authority) |
However, if any of the government authorities and agencies consulted believes that the Transaction may cause national security effect, Review Authority will conduct Further Review by conducting security evaluation and review and make decision if consensus can be reached, or report to the State Council to make decision if no consensus is reached, and then notify MOC of the decision. (Phase III: Further Review by Review Authority) |
MOC will notify applicant/parties to the Transaction as well as its responsible local counterpart of the Review result in writing.
(MOC to Notify Review Result) |
Review Results and Implications
Generally, the Review may end up with any of the following THREE different results:
1) (a).Approval : Where a Transaction does not have national security effect, it will be approved to proceed and to complete other government approval, registration or filing formalities necessary for effectuating the Transaction;
2) (b).Approval on Condition : Where a Transaction has or may have national security effect and such effect can be eliminated through imposing conditions or taking effective measures (such as the transfer of relevant equity or assets, or change of investment plan, or other measures), it will be approved on condition to proceed and to complete other government approval, registration or filing formalities necessary for effectuating the Transaction; or
3) (c).Disapproval :
i) Where a Transaction has caused or may have caused material national security effect and such effect cannot be eliminated through imposing conditions or taking effective measures, the parties to the Transaction will be requested to cease the Transaction; or
ii) Where a Transaction may have national security effect and it has not yet been implemented, the parties to the Transaction must cease the Transaction. If the applicant does not modify the Transaction or application documents and resubmit them for Review, neither application for securing other government approvals, registrations or filings required for effectuating the Transaction nor the carrying-out of the Transaction are allowed.
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Note: This document (including information contained herein) is for general information only and is not legal advice or opinion for any purpose.
All rights reserved. No part of this document may be copied, reproduced, circulated or otherwise transmitted without prior permission in writing of Shanghai Hui Xiao Law Consulting Group and its author Xiaoyun Xie (Ellen).
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About The Author:
Xiaoyun XIE (Ellen) admitted in China and California, consultant at Hui Xiao Law (Research) Center, has more than 10 years of experience in serving multinational companies. Ms. Xie’s practice area is broad with a focus on mergers and acquisitions, corporate restructurings, foreign direct investment, labor and employment, corporate governance and compliance, as well as private wealth management matters.
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