New rules for M&A in the PRC
Commencing 1 September 2011, China has a new ‘security review’ system for mergers and acquisitions of domestic enterprises by foreign investors.
Far from being a new hurdle for foreign investors to jump over, the new regime is intended to "increase the transparency and predictability of China's reviews of foreign investment and promote more ordered mergers and acquisitions in China."
Interestingly, the new procedures bear some similarities to Australia’s Foreign Investment Review Board (FIRB), which has ruled on planned Chinese investments in Australia and which can block deals it deems not to be in the national interest. FIRB advises Australia's treasurer, who has the final say.
China’s new ‘security review’ rules have established an Interdepartmental Committee system to review acquisitions of domestic enterprises.
The Interdepartmental Committee will be led day to day by the National Development and Reform Commission (NDRC) and Ministry of Commerce (MOFCOM) under the guidance of the State Council.
Like the FIRB, the Interdepartmental Committee is expected to involve other departments as required for information or to build consensus in the government but it will not necessarily invite those departments to take an active role in the review process.
Determining what is considered ’in, or not in, the national interest’ is dependent upon the way that foreign investor is controlled in China.
Under Chinese rules all foreigners and acquisitions are regulated according to industry groupings that are either encouraged, permitted, restricted or prohibited. Some economic sectors that are restricted or prohibited are analogous to areas of mandatory review under Australia's foreign interest rules (eg aviation and telecommunications) and some have no equivalent (eg the processing of traditional green tea).
In almost all cases the threshold for security review will be that the foreign investor must acquire “actual control” of the enterprise. ‘Actual control’ includes situations where any foreign investor or combination of investors will hold more than 50% of an enterprise’s equity, or where voting rights give a foreign investor significant influence over shareholder meetings or board meetings.
It seems that Chinese regulators are to be given a broad mandate when reviewing transactions. The Interdepartmental Committee will examine the transaction’s influence on national defence, economic stability, basic societal order and research and development capacity related to national security.
In the Chinese context, "national security” appears to be a more embracing and complex concept than would be typically found in a western definition, but one that is not totally inconsistent with what has been applied in Australia.
In Australia the equivalent national interest test has been described as “… something that is defined by the Australian Government and the Australian people. It is not static and cannot be defined in a mechanical way.”
Like the PRC model Australia’s foreign investment legislation does not provide a mechanical definition or guidelines against which to measure the national Interest. FIRB, as the advisory body to the Treasurer, is not obliged to reveal either how it arrived at a decision or what it recommends to the Treasurer.
It is in fact rare for the Treasurer to issue formal reasons for the approval or prohibition of transactions. Earlier this year the Treasurer took the unusual step of providing some insight into his thinking in prohibiting the acquisition of ASX by SGX. However, this is far from the norm.
In Australia the national interest includes:
- preserving of national security;
- preserving of Government revenue;
- evidence that the participant will respect Australian law and business practices;
- avoiding of inappropriate levels of competition or excessive concentration;
- consistency with Government policies; and
- the character of the investor.
Much like China the most ambiguous and difficult to predict is the national security test. This test has on occasions been applied to prohibit acquirers from purchasing mining assets that were considered too close to the Woomera prohibited area and in the SGX transaction it was considered by reference to the systemic security of Australia’s financial system.
In the SGX takeover there is no doubt the Treasurer formed the view that a takeover of ASX may have meant a loss of “full regulatory sovereignty” that might have impacted on Australian regulatory authorities’ capacity to protect the system from financial crisis.
Australia’s regulatory regime sits in the mid-point of OECD countries in terms of its relative level of restrictiveness. The OECD’s FDI Regulatory Restrictiveness Index (FDI Index) measures statutory restrictions on foreign direct investment in 49 countries, including all OECD and G20 countries, and covers 22 sectors. Australia’s score is held back by the fact that the national interest test is seen as a “discriminatory screening requirement”.
Australia ranks seventh among the 34 advanced nations on an index measuring the height of the barriers countries put in front of international companies wanting to invest. This is despite Australia being decidedly pro-investment and the fact that the national interest test to reject foreign investments is rarely invoked.
The OECD’s annual Going for Growth found that screening might create uncertainties that limit foreign direct investment. Indeed the review suggested that:
Transparency would be enhanced by more information on the criteria applied in government decisions and by involving specialist agencies (e.g. national securities) in the review process of FDI approval.
China’s foreign investment regulatory regime is currently ranked as the second most restrictive on the FDI Index. However, with the introduction of a transparent set of rules and procedures governing security reviews of cross-border M&A transactions, we would hope to see China improve its score in future versions of the FDI Index.
Both the Australian and Chinese governments have chosen a model that allows them to retain the flexibility to be able to deal with the consequences or externalities that may arise from a foreign takeover.
As noted by the OECD there is potentially great merit in both governments providing greater transparency around the assessment process so that there is more certainty for foreign investors. Communicating how and why decisions to approve or prohibit transactions would be one way to provide transparency by which others could judge how the process operated.