Smart dragons will tread carefully this year. Our survey of legal professionals suggests consolidating your business position and scanning the horizon for regulatory changes. But there are still some hot opportunities, writes Alice Gartland

It’s not just the Chinese leadership that will be getting its house in order in 2012. We asked our readers to identify the key legal issues they believe will face business in the coming months and a resounding warning is to dig in and be watchful of legislative reforms that may affect your business. The consolidation and adaptation of legislation and business strategy will be the key characteristics for the Year of the Dragon.

On the inbound side, continued refinements to the Anti-Monopoly Law (AML) will place companies under greater regulatory scrutiny. Businesses will also be keeping a close eye on tax reform, which is set to evolve throughout the year.

On 24 December 2011, the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM) issued the latest version of the Catalogue for the Guidance of Foreign Investment Industries (revised in 2011), effective as of 30 January, 2012 (the Catalogue). The Catalogue confirms China’s developmental trajectory towards R&D and green technology. In line with the Catalogue, “we expect a further decrease of investment in heavy industry projects and a continued increase of investment in consumer-related industries, R&D, high-tech and environmentally related industries, as well as service industries”, says Ulrike Glueck, managing partner at the Shanghai office of CMS China.

Developments in IP legislation will also provide much needed support for the intellectual property rights (IPR) strategies of domestic and foreign enterprises. IP litigation is also expected to increase as IPR protection becomes a strategic business tool for domestic as well as foreign companies in China’s high-tech economy.

Although investment in renewable energy and high technology is set to flourish, many investors will be considering their positions. The fate of the variable interest entity (VIE) structure continues to be unclear (see China Business Law Journal, Issue 9, Volume 2, page 19).

“Nothing’s been resolved,” says Robert Woll, a partner at WilmerHale, adding “it’s not clear when and where action will be taken to clarify this”. Woll says the continuing uncertainty is having an impact on transaction pipelines. The VIE can basically be defined as an entity which, via a series of contracts, is used to allow foreign access to business restricted to Chinese by in effect (or in theory) giving control and risk to the foreign entity.

Private equity (PE) investors are also facing more challenging times with the macroeconomic climate bringing about increasing “exit pressure”, says Jason Wang, a partner at Han Kun Law Offices in Shenzhen.

On the outbound side, investments will continue to flourish, particularly in the energy sector. But 2012 may also be a time where we see Chinese companies start to “rationalise their portfolios” with “sell-downs and strategic sales compiled with new acquisitions”, says David Blumental, managing partner of Vinson & Elkins’ Shanghai office.

Chinese investors will also continue to be subject to intense scrutiny by overseas regulators. So it’s not all plain sailing, and “active businesses and policy adjustment will jointly arouse more disputes”, predicts Dennis Deng, a senior partner and director of the international practice division at Dacheng Law Office in Beijing.

While this may not be a time for radical change, it is a time for firming up positions. In turn, businesses are placing greater emphasis on the importance of integrating in-house counsel in their decision making. They are no longer just fire-fighters for when things go wrong, but are much more integrated into the development of business strategy, explains Wendy Wang, the chief legal officer at Mary Kay (China) Cosmetics Co, Ltd.

Energy is hot

Despite the need for caution, opportunities still abound. Energy is a “hot area” for both outbound and inbound investments, says Woll. On the outbound side, the focus is on the overseas ambitions of state-owned enterprises (SOEs) and on the inbound side, the emphasis is on renewables. Joanne Cao, the legal manager at CSI Solar Power (China) Ltd in Suzhou, highlights “favourable” government policies that support green technology and new energy businesses.

David Blumental, the managing partner at Vinson & Elkins’ Shanghai office − the firm that recently advised SINOPEC on its acquisition of a 37.5% equity interest in Yanbu Aramco Sinopec Refining Company (YASREF) Ltd in Saudi Arabia – says the macroeconomic climate is “not having an impact” on his clients’ desire to go abroad. It’s “a bigger year than 2011 for our clients”, he says. Rob Patterson, a partner at Vinson & Elkins’ Beijing office, forecasts the trend will be towards “downstream investments” like the oil refinery joint venture in the Yanbu deal, where there will be most activity. Chinese companies are looking for “meaningful” acquisitions, “ones that are likely to succeed, able to succeed in a reasonable timeframe and that are sizeable”, adds Blumental. Latin America, Africa and North America will be the main areas for energy investment.

Lu Yi, counsel at Paul Hastings, sees growth in outbound investment in infrastructure, where the UK and Germany are particularly attractive markets. Going private (de-listing) transactions concerning listed Chinese companies in the US are also set to continue, predicts Woll.

More scrutiny

Deng, Jason Wang and Patterson all cite the National Security Review (NSR) that came into effect on 1 September 2011 as being one of the most significant legislative developments in recent months, and one that continues to be on the minds of their clients. Deng describes how Dacheng Law Offices are working closely with their clients to identify whether their transactions fall within the scope of the review in terms of both the “substance” and “impact” of the transaction.

The NSR has added another layer of regulatory scrutiny on top of the existing AML, which also continues to be refined.

The Interim Provisions on Assessment of the Impact of Concentration of Undertakings on Competition (the Provisions), which came into effect on 5 September 2011, and the Provisional Rules on the Investigation and Handling of Concentrations between Undertakings not Notified in Compliance with the Law (the Provisional Rules), which came into effect on 1 February 2012, are a “signal” that the Ministry of Commerce (MOFCOM) “may strengthen” its enforcement behaviour, says John Ren, the managing partner of T&D Associates in Beijing.

Ren expects the AML will be “deepened” further in the next year, in line with comments made by Shang Ming, the director general of MOFCOM’S Anti-Monopoly Bureau, at a press conference on 29 December 2011.

The Provisional Rules set out the official investigation procedure and sanctions for companies that fail to notify their mergers, including a fine of up to RMB500,000.

Ren describes how, “despite the amount of notifications of concentration of undertakings soaring year by year, there are still huge [numbers of] M&As which have met the notification threshold” but have not filed with MOFCOM. He says it’s a real problem that “MOFCOM needs to resolve in order to maintain the seriousness of the Anti-Monopoly Law”.

Blumental agrees that the regulators tend to be “overwhelmed” with the number of filings. But he says these developments suggest the AML is beginning to “take more shape”. Although “no public sources suggest that MOFCOM has challenged any unreported transactions”, Jason Wang says companies should “seriously consult with their legal advisors on anti-trust issues” to avoid non-compliance costs.

Lu agrees that the AML legislation is not “100% clear” and a pre-filing consultation is the sensible approach. Patterson advises that regular communication with MOFCOM on developments and discussions on a “no names” basis is a practical route to follow.

Foreign focus

It’s not just the Chinese regulators that will be keeping busy. Patterson says there’ll be “increased scrutiny by overseas regulators on Chinese outbound investment and the impact that such investment has on host jurisdictions, particularly in relation to SOEs”. Having good local counsel and “people on the ground who have good connections with the regulators” is more important now than ever.

Chinese SOEs investing abroad need to demonstrate to both their counterparties and the competition regulators that they are “acting as a commercial interest”, says Blumental. He gives the example of needing to persuade counterparties that the Chinese government approvals required for an SOE to successfully complete a transaction are outside the control of the SOEs and do not provide a “backdoor” mechanism for them to terminate a transaction. This can be demonstrated by “contractual commitments” as well, he advises.

Brian Beglin, a partner at Bingham McCutchen LLP’s newly opened Beijing office, warns SOEs “are and will continue to be viewed as arms of the government” and certain industries “will be closed to them, or subject to restrictions”. However, most will remain open, and “careful planning and attention to political realities can produce success instead of failure for SOEs”. Beglin also points out that although private Chinese companies will have more leeway, “the political undertones of China’s overall relations with most Western countries” mean that “attention to the intersection between law and politics will be important to them as well”.

Taking stock

The theme of greater scrutiny is also trickling over to the Hong Kong Stock Exchange, where a major trend for the coming months is “the increasing scrutiny being paid by the regulatory authorities to due diligence investigations performed by sponsors in initial public offerings [IPOs],” explains Richard Chalk, head of Asian dispute resolution practice at Freshfields Bruckhaus Deringer. “In anticipation of this, we have been working with our sponsor clients on ensuring that detailed due diligence is carried out, and advising them of their increasing obligations in the current regulatory climate,” Chalk says.

“One of the key challenges for our clients is to ensure that they can realistically achieve what is expected of them by the regulators, while still working under real market conditions and timing pressures, where information is not always readily available and reliable.”

Michael Liu, a senior partner at Jin Ding Partners in Nanjing, also describes how with the arrival of new China Securities Regulatory Commission (CSRC) Chairman Guo Shuqing, the commission “vowed to adopt more market-orientated measures in the IPO review process” to improve transparency. The extent of such measures remains to be seen.

Tax reform

No-one needs to be told that tax reforms in China are worth scrutiny. Xu Gang, the director and associate general counsel at Wal-Mart (China) Investment Co Ltd, cites reform of the tax system as one of the main areas that will keep him and his team busy in the coming months.

Glueck believes the introduction on 1 January 2012 of a pilot system in Shanghai for the gradual replacement of a business tax (BT) by a value-added tax (VAT) on certain lines of services will be one of the key issues for CMS China’s clients. Liu Tianyong, managing partner of tax specialists Beijing Hwuason Law Firm, agrees it will have “a gradual but profound impact”.

Glueck explains that this reform is “generally viewed as a tax reduction programme, due to the input-output credit system available under the VAT regime. However, the exact impacts are complex and in some cases, the actual tax burden could also increase”. Glueck says the VAT reform is expected to be extended throughout China and cover more services, ultimately eliminating the BT system. “However, there is no specific time schedule for this at the moment.” Liu Tianyong adds that “Beijing has also put its BT/VAT pilot programme on the agenda”.

Glueck expects an increase in tariffs and fees “in both hidden and transparent ways” this year. “During the last year, it could be perceived on several occasions that the Chinese government tried to increase revenues without officially raising taxes,” she says. “One of these cases is the mandatory coverage of foreigners working in China in the Chinese social insurance system.” Although these regulations are yet to be fully implemented, “they will increase the costs of foreign labour and potentially make China a less attractive place to be for expatriates. Further similar attempts of increasing government revenue without raising taxes may also be seen in 2012”.

Rise in IP litigation

Chen Jihong, a partner at Zhong Lun Law Firm, describes how under The Promotion Plan for the Implementation of the National Intellectual Property Strategy in 2011 the reform of tribunals relating to IP cases has begun. He says the reforms “will be helpful to improve the judicial quality and the professionalism of the IP judges”. This is timely, because IP litigation is definitely on the increase. As the government promotes developments in R&D and high-tech, the ability of domestic and foreign investors to protect their IP portfolios is critical.

Ella Cheong, founder and chair of Ella Cheong Associates, sees increasing demand from “domestic and overseas investors” regarding the enforcement of Intellectual Property Rights. August Zhang, an executive at Rouse & Co, predicts “patent litigation in the pharmaceutical and electronic sectors” will be a significant trend for 2012. He also foresees amendments to trademark law and criminal law on IP crimes.

Private equity

On the private equity front, Woll says 2012 will be a time of “more onerous requirements for PE Funds”.

Jason Wang describes how the Notice on Promoting Regular Development of Equity Investment Enterprises [2011] No. 2684 (Fa Gui Ban Cai Jin [2011] No.2864) (2864 Notice), issued by the NDRC on 23 November 2011, launched a national programme concerning mandatory record filing, standardised operation and information disclosure administration of equity investment enterprises. While the NDRC seeks to standardise the regulation of PE in China, the PE industry is facing “great exit pressure in light of the macroeconomic conditions and the weak capital markets”, he says. “To ease their exit pressures, VC [venture capital]/PE investors will actively facilitate investee companies to get listed on domestic and/or foreign stock exchanges.” Still, Wang believes technology, media and telecoms (TMT) will remain a “hot area” for PE investments.

Getting integrated

There is increasing pressure for greater involvement from legal departments in business decisions, observed a number of in-house counsels.

Wendy Wang observes that companies are now viewing in-house lawyers as “partners who will help the business grow”. This change in mindset is affecting the roles and responsibilities of in-house counsels.

“Business expects in-house counsel to tell them ‘how’ and give them options. [They]are playing a more and more important role from the very beginning of a project” and are able to make a bigger contribution “to the steady growth of [a]company in a more collaborative way”.

With that comes a greater emphasis on training and development, which is difficult to manage when many in-house counsels find that there is “limited time to attend legal training courses, seminars etc.” says Catherine Wang, general counsel for DSM (China) Ltd in Shanghai.