High-flying outbound investors are encountering severe turbulence that threatens to throw their best opportunities into a tailspin, writes Richard Li
Chinese investors looking abroad have been flying into rough weather of late. While the central government has been making encouraging noises about outbound investment in recent years, it has also considerably beefed up its oversight of specific areas and investment transactions.
And while flying into overseas company acquisitions should be simple, European and American regulators are buffeting investors with more stringent reviews of domestic investments by foreign investors. Prevailing winds have blown many a would-be Chinese investor off course.
Even as the Belt and Road Initiative provides a global runway for overseas investment opportunities, Chinese enterprises face greater challenges, all of which will require much more thorough preparations.
“If the understanding of the laws and regulations of a target investment country is insufficient, or if the preliminary preparatory and pre-planning work on a project is insufficient, this will affect the entire schedule for the project, and the investment success rate,” warns Zhang Yi, chairman of the China management committee at King & Wood Mallesons.
He says that such things as a competitive bid or a revision in relevant policies of the target investment country could occur during the course of the project, and the response to, and resolution of, such an issue requires an experienced legal team that can not only offer professional support, but also have a good knowledge of local politics, culture and commercial practices. Anti-monopoly, intellectual property and other such multi-layered legal issues require seamless preparation and response by domestic Chinese lawyers leading local lawyers in a target investment country.
Michael Wang, vice-chairman of the China management committee at Dentons, says that to assist a client in carrying out an outbound investment transaction, it is necessary to construct an overall risk prevention system. For example, first conduct detailed research on the foreign investor access system, company law framework, tax regime, labour law system, environmental protection requirements, exchange control requirements, etc., of the country where the acquisition target is located. “Second, an investigation of the investee entity or target assets needs to be conducted to confirm the legal qualifications and compliance of the future partner and investee entity, and whether there are any defects in the target equity or target assets,” he says.
Different investment destinations necessarily have different investment law environments, he adds. “The favourability of the investment environment may be even more important than the quality of the project. The various laws of the investment host country determine how an enterprise is to invest and even whether or not to invest.”
Lin Zhong, managing partner in the Shanghai office of EY Chen & Co. Law Firm, also reminds investors to pay attention to the issue of managing risks in overseas investments. “The precondition to managing and controlling risks is being fully aware and having a sound grasp of the risks faced by the overseas investment project, and carrying out an assessment of the overall investment and operating risks,” he says. “Attention should be paid to 10 independent risk criteria, namely security, political stability, government effectiveness, legal and regulatory environments, macroeconomic risks, foreign trade and payment issues, labour market, financial risks, tax policies and the quality of the local infrastructure.”
For enterprises under the central government, anti-monopoly compliance is extremely important. Xie Yu, a partner in Beijing at Grandall Law Firm, says it is necessary to “communicate and exchange ideas on the [anti-monopoly] filing work at the outset of a deal. When going global, some enterprises under the central government rock the foreign market because of their massive product and market capabilities, frightening foreign business operators in the same industry, causing an increase in the anti-monopoly resistance to the merger.”
In addition to uncertainty at the regulatory level, Chinese investors need to pay attention to the difficulties in actual practice when investing overseas. “At the operational level, most domestic Chinese enterprises hope to achieve control of the operations and decision-making of an offshore target company through an acquisition that is wholly owned, or in which they have a controlling interest,” says Wang Pei, a partner in Beijing at Haiwen & Partners. “However, in practice, realization of such a hope is subject to numerous uncertainties and operational difficulties, for example, selecting directors and senior officers who are reliable and understand the local business and legal environments is a major challenge. Furthermore, the strict control of the [central] government over foreign exchange often results, in practice, in difficulties in the outward remittance of investment funds.”
Christoph Schroeder, a partner at CMS China’s Shanghai office, also observes that Chinese investors have a tendency to believe that once they have become the shareholder of a company they can do whatever they want with the company, or fully control it. “They overlook that, for example, the shareholder does not, by way of such shareholding, own all intellectual property rights of the company, or the managing director of a German GmbH has certain powers which cannot be taken away from him/her,” he says.
Pan Xinggao, a partner at Commerce & Finance Law Offices in Beijing, says the main issue faced in investing in developing countries is the restrictions on foreign investment in local laws. The main legal issues faced in investing in developed countries are the protection of workers’ rights by labour unions, the difficulty in cutting personnel and the relatively high remuneration that the buyer is required to pay employees. Furthermore, in developed countries, “it is local professional managers that actually manage the target enterprise, and the legal systems and traditional practice do not support the buyer actually controlling the target enterprise through having a controlling interest”, says Pan.
Pan reminds Chinese investors to avoid blind investment and pay attention to cultural and language differences (including dress and appearance, timing of meetings, written communication, etc.). Other issues that Chinese investors need to pay attention to include “acquisition plan designs that are not sufficiently rigorous, unfamiliarity with or failure to abide by the Western acquisition procedure (particularly in a bidding process that is arranged according to a timetable), lack of a detailed business plan and procedure management plan, and lack of risk response measures.”
For legal advisers, facilitating communication between transaction parties is a big issue. “In addition to the apparent and well-known language barriers, a lot of explanations must be given to both sides in order to make them understand each other’s objectives and finally to be able to push the deal through,” says Schroeder.
Additionally, domestic examination and approval cannot be ignored in an overseas investment. “Evading the examination and approval of the competent domestic authorities will lead to compliance risks and defects at the time of transfer of the project, planting latent troubles for any subsequent transaction,” says Michael Wang.
Schroeder says that Chinese regulators’ control over outbound investment and foreign exchange is sometimes a challenge for Chinese companies’ overseas acquisition process, especially public takeovers and bidding procedures. “It means that the Chinese investor either cannot meet the time requirements for the completion of the transaction at all, or has a considerably weaker position than bidders from other countries,” he says.
In December 2017, the National Development and reform Commission (NDRC) issued the Administrative Measures for the Outbound Investments of Enterprises (order No. 11), which entered into effect on 1 March 2018. “Order No. 11 is the first set of regulations issued after tightening of the policies on outbound investment by the regulator in 2016, and expressly sets out the regulatory requirements in respect of outbound investments, providing enterprises with sounder guiding principles for outbound investment,” says David Chen, managing partner in Beijing at DeHeng Law Offices.
He says order No. 11 strengthens after-the-fact oversight (for example, it requires the provision of reports after an outbound investment), and provides more detailed categories of sensitive projects (including real estate, hotels, multiplex theaters, the leisure industry, sports clubs as sensitive industries); investment abroad in such sectors requires prior approval. On the other hand, order No. 11 has also relaxed the application procedure to a certain extent, for example relaxing the time requirements for securing recordal or approval, and extending the period of validity of such recordals or approvals from one to two years.
OVERSEAS IP STRATEGY
Spring Chang, the founding partner in Beijing of Chang Tsi & Partners, says that in addition to traditional European and American markets, Chinese enterprises are beginning to carry out more confirmations of intellectual property rights in Southeast Asian markets. “We would contend that this trend is, on the one hand, due to these countries’ relative proximity to China while also being intimately connected to the degree of activity of their markets, and on the other hand is also indirectly influenced by China’s increasing national power, upgrading of production capacity and manufacturing industries gradually turning from China toward these countries,” she says.
Spring Chang warns Chinese enterprises that they must abide by local rules and understand local policies. “A number of Southeast Asian countries offer Chinese investors preferential policies. However, we should also realize that, in terms of IP protection, these countries are at a stage through which China once passed: pirate registrations common, infringement serious. Accordingly, before investing in these countries, we would recommend doing sufficient IP planning in advance.”
He Jing, a senior consultant in Beijing at AnJie Law Firm, says the pace of internationalization of Chinese enterprises has been continuously increasing in recent years, but they have also encountered all manner of risks in this process. Although Chinese enterprises’ awareness of the protection of, and their capacity to protect, IP overseas is continuously growing, “on the whole, due to weaknesses in the foundations of such aspects as human talent, funding and information, their IP protection and management capabilities remain somewhat weak”, he says. “The pirate registration abroad of Chinese enterprises’ trademarks, as well as their being subjected to bad-faith legal actions and investigations, their falling into the patent traps set by competitors, and unfavourable IP clauses in investment co-operation agreements, have all frequently cropped up, and for small and medium-sized enterprises, these problems are particularly pronounced.”
He Jing reminds Chinese enterprises to place emphasis on carrying out patent filings and registering trademarks in target countries, duly carrying out IP planning and proactively engaging in the safeguarding of their IP rights overseas, while also strengthening their co-operation with other Chinese enterprises operating overseas. An enterprise that is carrying out a foreign acquisition “needs to pay particular attention to whether title to IP vests in the target company, whether the target company has registered its trademarks and patents around the world, whether the target company has taken sufficient measures to protect its trade secrets, as well as the technology import and export restrictions and national security review system of the country where the target company is located so as to avoid legal obstacles standing in the way of subsequent technological imports and licences,” he says.
Dang Xiaolin, general manager of Sanyou Intellectual Property Agencyin Beijing, says many export-oriented enterprises have increased their awareness of respecting IP, and freedom to operate (FTO) searches have become common in legal practice. “However, in actual commercial activities, based on considerations of cost and a lack of understanding of foreign legal systems and procedures, many enterprises still need to enhance their knowledge in this respect and bring the same to bear in their actions to avoid being placed in an extremely passive stance if a patent holder files a charge of infringement,” he says. “Before an enterprise steps out overseas, we recommend that it carry out IP due diligence, conducting an IP risk assessment mainly with respect to patents, trademarks and copyrights, so as to eliminate risks before they arise.”
Sanyou once assisted a Chinese enterprise in carrying out a risk warning before exporting products, conducting a validity search and analysis of a patent valid in a number of European countries. “We had strong reason to believe that that patent’s validity was low, and engaged a German patent lawyer to carry out a further analysis, following which we established contact and held consultations with the European patent holder. Ultimately, the merchandise was exported to Europe without paying any royalty, and to this date, after many years, the patent holder has not filed an infringement charge,” says Dang Xiaolin.
The US and Europe. According to Milton Cheng, the managing partner of Baker McKenzie’s Hong Kong office, under the Trump administration, reviews by the Committee on Foreign Investment in the United States (CFIUS) are taking longer, with more and broader questions about buyers’ and sellers’ businesses and prior transactions. In 2007, the CFIUS handled 138 cases; in 2017 the number rose to nearly 250.
Chinese investment has plummeted significantly in the first half of 2018. “In the US, Chinese sentiment has been undermined by their perceptions of no longer being welcomed by the policies promoted by President Trump and suspicion of how they will be treated under government approval processes such as CFIUS,” says Peter Corne, head of Dorsey & Whitney’s Shanghai office.
Jeffrey Sun, a partner at Orrick in Shanghai, says that with respect to Chinese investments in the US in the past 12 months, navigating the CFIUS and the Foreign Investment Risk Review Modernization Act (FIRRMA) landscape has been the most challenging. But he remains optimistic: “Investments in the US these days have not stopped as many would imagine at first blush; instead, it requires careful structuring and discussions with both sides of the table to increase the chances of a successful transaction.”
Milton Cheng says other advanced economies such as the EU are also rethinking their approaches to foreign investment policy. “While a more careful review does not mean a deal will be bound to be blocked, it does mean that local governments will require more information on each deal to be disclosed. This will lead to increased cost of compliance and longer deal timelines.”
John Xu, a partner at Linklaters in Shanghai, says the European Commission issued a proposal in September 2017 for a regulation establishing a common framework for screening foreign investments, based on a request made by France, Germany and Italy. “The proposal is the result of strong political demand following a series of takeovers of European companies perceived as not being justified by economic reasons,” he says.
Betty Louie, a partner at Orrick in Beijing, also observes that “many EU countries have amended or are considering amendments that would broaden the scope of their country’s foreign investment security regulations”, and she adds that many Chinese investors are not aware of each country’s requirements and possible amendments. “Therefore, for Chinese investments in Europe, we counsel and navigate those Chinese companies with precision, and properly structure the deal.”
In Germany, there is an amendment to the country’s Foreign Trade and Payments Ordinance that John Xu says entitles the Federal Ministry of Economic Affairs and Energy to forbid or restrict the direct or indirect acquisition of a stake in a company by a non-EU investor if public safety or public order is threatened, and if 25% or more of the voting rights are acquired. “The Chinese outbound investors would be impacted by a potential takeover block [for] non-EU acquirers,” he says. “Extended time limits and deadlines would be expected for approval procedures to allow more regulator scrutiny.”
Michael Burian, a partner at Gleiss Lutz in Stuttgart, says the amendment of the ordinance in July 2017 is the biggest challenge for Chinese investors. “Although it is rare for authorities to ultimately prohibit transactions, authorities are now closely reviewing and monitoring Chinese investments, even in non-sensitive sectors, often resulting in a delay of several months between signing and closing,” he says. “In a recent case, the authorities also unexpectedly applied the stricter sector-specific foreign investment review regime to a transaction.”
In the face of stricter scrutiny, risk analysis and active communication with the regulator may help get through a deal. “As corporate China becomes more active in international M&A over the years, it has notably become more aware of the benefit of conducting risk assessment early in the deal cycle, particularly as the process and time frame for screening investments can vary widely from country to country, and may not be as predictable as statutory provisions suggest,” says Milton Cheng from Baker McKenzie.
“We often work with our clients to engage with the relevant regulatory authorities early to identify and quantify risks. Maintaining a dialogue with the relevant authorities not only helps our clients better predict the deal timetable and structure the deal, but more importantly the regulators are more likely to be receptive of the deal as they often see early engagement as a sign of respect.”
Also, not all developed economies are nervous about Chinese companies, and some financial hubs in Europe offer good capital platforms for them. Xavier Le Sourne, a partner at Elvinger Hoss Prussen in Hong Kong, says Chinese financial institutions have asked the firm in the past few months about Luxembourg’s legislative framework regulating securitization. Securitization is widely promoted in Luxembourg and within the EU.
“With regard to PRC originators, the securitization of claims held on their balance sheet appears as an alternative to increasing their lending capacities to the real economy and fostering the growth of the country, by also permitting European investors to take an active, although possibly minority, role through an exposure to Chinese assets,” says Le Sourne.
“In certain cases, the non-EU originator, sponsor or original lender will need to retain on an ongoing basis material net economical interest of not less than 5% in the securitization. This would further enhance the position of Luxembourg as a jurisdiction of choice for PRC firms to continue their global development.”
Russia. Sharon Shi, a senior partner in Shanghai at AllBright Law Offices, warns investors that the Russian legal regime is unlike China’s. “Certain provisions of Russian laws are completely different from those of China,” she says. “Accordingly, when investing in Russia, it is imperative to find local lawyers to obtain a detailed understanding of its laws. Things cannot be taken for granted.” For example, if the parties provide an arbitration clause in their contract, a Chinese court would not, in general, accept a dispute between the parties, but the matter is handled differently in Russia.
She says that in one project, a Chinese party and its Russian partner provided an arbitration clause in their contract. Accordingly, when a controversy arose between the parties, the person in charge of the Chinese party thought that the Russian party would apply for arbitration and, at such time, the arbitration tribunal would notify them. However, the Russian party instituted a legal action against the Chinese party directly in the local court. The court issued a summons to the Chinese party. The working personnel did not pay attention to checking and accepting the couriered item, and failed to respond. In accordance with Russian law, the local court deemed that the Chinese party did not object to the jurisdiction by the court and tried the case ex parte, rendering an adverse judgment against the Chinese party.
David Chen, from DeHeng, describes a project in which the firm assisted a state-owned enterprise in acquiring equity in a strategic Russian mining company, the target assets of the project being a strategic level gold mine located in Russia. “Russian law specifies that where a foreign state-owned enterprise seeks to acquire more than 5% of the equity in a strategic mining company, the prior approval of the foreign investment regulatory commission, headed by the Russian premier, is required, and it prohibits foreign state-owned enterprises from securing control of strategic-level companies,” he says.
David Chen says that with the assistance of DeHeng, the parties ultimately determined and adopted an agreement signed between the Chinese and Russian governments to forge a completely new path for the project. The intergovernmental agreement has now been executed and is awaiting approval before going into effect. It is anticipated that the project will close in the second half of the year.
Southeast Asia. With the promotion of the Belt and Road Initiative, investment in Southeast Asia by Chinese enterprises is continuously increasing. Sharon Shi reminds investors to pay particular attention to anti-corruption compliance. At the beginning of 2018, a Chinese enterprise offered bribes to government officials in a project in co-operation with the Bangladeshi government, following which the Bangladeshi government issued an order cancelling the project. The Penal Code of Thailand also contains severe penalties for bribing government officials.
“The anti-corruption regulations of Southeast Asian countries that apply to foreign investors are continually being improved, and are becoming increasingly stricter,” says Sharon Shi. “A Chinese enterprise that practises bribery abroad not only violates local laws, but also violates domestic Chinese laws.”
Latin America. Energy, mining, natural resources and infrastructure sectors remain the sectors attracting more Chinese clients into Latin America, says Antonio Sánchez Cerbán, a partner at Uría Menéndez in Beijing. He points out that there is an increasing interest in Chinese companies investing in Cuba, mainly in the energy and infrastructure sectors. “Regulatory and practical challenges vary substantially depending on the jurisdiction where the investment takes place,” he says. “In more exotic jurisdictions such as Cuba, doing business can be especially challenging because of the lack of some basic standards inspiring M&A transactions. In general, we could say that political instability is a source of issues in connection with transactions in Latin America, where many large projects are promoted by the respective local governments.”
THE RUSH TO LIST IN HONG KONG
Since the beginning of 2018, the trend of Chinese enterprises going abroad to list has continued to heat up, with Hong Kong being one of the favoured destinations. “During the first half of this year, foreign capital market business, particularly equity capital market business, has been extremely active,” says Zhu Xiaohui, managing partner in Beijing of Tian Yuan Law Firm. “For numerous reasons including the amendment of the listing rules of Hong Kong Exchanges and Clearing Limited, and the significant reduction in the approval rate for domestic IPOs, many enterprises in the pharmaceutical, educational, TMT, internet finance and other such businesses are opting for offshore equity financing. More educational and TMT enterprises that traditionally chose to list in the US are turning to Hong Kong instead.”
At the end of 2017, HKEx reformed its listing system, permitting listed enterprises to use weighted voting right structures. Furthermore, qualified innovative biotech companies that have not yet turned a profit, or that do not yet have revenue, are now permitted to list on the main board of HKEx.
“The opening of the green channel that is a listing in Hong Kong has got growing mainland enterprises, particularly innovative pharmaceutical and bioengineering companies, very excited about listing in Hong Kong,” says Lin Zhong, managing partner in the Shanghai office of EY Law Firm. “How pharmaceutical enterprises grasp this opportunity to list in Hong Kong, and how they further improve and enhance their IP strategy and planning, are issues that are being closely watched by enterprises. In doing their IP strategy planning, pharmaceutical enterprises need to pay particular attention to such key issues as patent quality, planning and strategy, invalidation and infringement lawsuits.”
However, Sharon Shi warns that “the capacity of the Hong Kong market is in fact limited. Whether the Hong Kong market, against the background of an unstable international macroeconomic situation, has so many investors who can provide unlimited investment to mainland listed enterprises is an issue deserving serious consideration.” She says that in the first quarter of 2018, Hong Kong IPOs encountered a situation where the number of enterprises that listed increased but their financing proceeds decreased.
“Furthermore, experienced intermediary firms, law firms and accounting firms are all booked up, compelling many enterprises that are hoping to list to select intermediary firms without much experience,” says Sharon Shi. “We recommend that enterprises examine themselves to see whether they actually satisfy the conditions for listing and that they stagger their listing timing to the greatest extent possible so as to allow themselves to select a good intermediary team and a suitable occasion for listing.”
With respect to Belt and Road projects, high risks politically, financially and legally are issues that commonly exist in investing overseas, particularly in developing countries, and this is the case for Belt and Road projects. Investors in countries along the Belt and Road need to take precautions against the operational, political and legal risks that may arise.
Chairman of China Management Committee
King & Wood Mallesons
With respect to outbound investment, attention needs to be paid to the different features of the corporate governance structures, equity relationships and the employment relationships between company and employee in different countries. Clients, however, often think of these issues in light of Chinese practice.
PacGate Law Group,
In terms of international trade, the direct effect of the China-US trade war is the increase in customs duties. And the forceful intervention in international trade, investment and other commercial transactions by the governments of various countries, particularly the US government, has shaken enterprises’ confidence in the US and even the entire globe’s governing system (of course also including the rule of law).
Highways Law Firm，
In regard to construction and energy, green finance projects is an area that is rapidly growing in the region, as well as globally, thanks to increased regulatory/political pressures and from companies deploying it as a tactic to attract investment.
Last year China took the lead in terms of green bond issuances, accounting for 20.6% of the global total. This is largely in part to its Belt and Road Initiative and its aims to transition to a greener economy. This year, however, other countries in the region are springing up as well, and investors should not overlook other countries.
Holman Fenwick Willan
Hong Kong and Shanghai
When it comes to Europe, and in particular Spain and Portugal, we still see a seller’s market with a growing preference for controlled auctions that may cause practical difficulties to Chinese companies. In our experience, some Chinese companies struggle with meeting the aggressive deadlines that are inherent to controlled auctions.
ANTONIO SÁNCHEZ CERBÁN
Partner, Uría Menéndez, Beijing
[With regard to Chinese companies’ outbound investments], one issue that clients are likely to overlook is that some of them care more about the result of a dismissal, but pay little attention to the discrimination issue during the process.
Senior Partner, River Delta Law Firm, Shanghai
Luxembourg … provides an element of stability and neutrality in this evolving environment that is very suitable in a capital-raising environment. With full access to the market and the capacity to levy funds within the EU and far beyond in Asia, a very comprehensive fund toolbox and financing and structuring capabilities through the use of SPVs [special purpose vehicles], Luxembourg is perceived by the Asian asset management industry as a competitive and highly skilled jurisdiction.
The impact of the new quotas QDII [Qualified Domestic Institutional Investors] and QDLP [Qualified Domestic Limited Partner], decided by China in April 2018, has already been felt in Luxembourg and there is no doubt that the two re-opened Chinese programmes will further foster activity between the two countries.
XAVIER LE SOURNE
Partner, Elvinger Hoss Prussen
The legal systems that protect labour in European countries are very sound. In practice, we would not recommend starting to think about labour systems only after completion of the investment in a project. Instead, it would be better to promptly establish in accordance with the law contacts with the target company’s labour union at the appropriate time and secure its approval for the project investment.
Partner, Haiwen & Partners, Beijing
Chinese companies are always pleasantly surprised with how easy it is to do business in Ireland. Ireland is very welcoming for new investors and is favoured by Chinese investors for the following areas of investment: aircraft finance; payment services; fintech; biotechnology; medical devices; agriculture; and renewable energy.
Partner, A&L Goodbody
We have received many requests from our Chinese clients after the ZTE case to inquire about US export control regulation. As the US export control reform effort proceeds, we have been helping our clients to understand these changes and how they impact their business.
We help companies classify their products on the Commerce Control List and the US Munitions List, make formal classification requests, assist in the preparation of licence applications and engage in compliance planning and support training efforts.
Partner, Pillsbury, Beijing and Shanghai