Under the microscope: China’s M&A security review regime

Asecurity review system for mergers and acquisitions (M&A) of domestic enterprises by foreign investors is designed to regulate foreign investors by reviewing their M&A where there may be potential risks against national security.

Article 31 of the Anti-Monopoly Law provides that where a foreign investor participates in the concentration of undertakings by merging and acquiring a domestic enterprise, or by any other means that involve national security, the matter shall be subject to a review on national security as is required by the relevant state regulations, in addition to a review on the concentration of undertakings in accordance with the provisions of this law.

The main legal bases of the system also include: Notice on Establishment of the Security Review System on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (document No.6) issued by the General Office of the State Council; the Interim Provisions of the Ministry of Commerce (MOFCOM) on Issues Regarding Implementing Security Review System on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors; and the Provisions of the Ministry of Commerce on Implementing Security Review System on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors.

US security review

The US has led the way among jurisdictions that impose increasing restrictions on foreign investors in respect of national security review since the Exon-Florio Amendment was passed in 1988, which heralded the establishment of its national security review system. The Committee on Foreign Investment in the United States (CFIUS) acts as the regulatory authority in charge of reviewing all M&A by foreign investors with potential threats to its national security. CFIUS is composed of nine members: the Secretary of Treasury, the Secretary of State, the Secretary of Defence, the Secretary of Commerce, the Secretary of Homeland Security, the Attorney-General, the Secretary of Energy, the US Trade Representative and the Director of the Office of Science and Technology Policy.

CFIUS applies voluntary notification, by which it is open for transaction parties to decide whether a review should be initiated, and CFIUS may take initiatives to review transactions that it believes may contain a security risk. The security review system in the US has a wide definition of national security. CFIUS will examine and confirm whether a company should notify CFIUS according to specific circumstances of every transaction, including the level of control by acquirers, the types of the acquired technologies and products, and the foreign investor’s transactions track record in the US.

CFIUS has the power to stop a transaction that it believes may threaten national security and the public interest. Many Chinese investors – including Huawei Technologies, Sany Heavy Industry, and China National Offshore Oil Corporation – had to drop plans for investment or acquisitions in US enterprises after CFIUS stepped in.

PRC security review

Pursuant to document No. 6, the M&A of domestic enterprises by foreign investors falls into four categories: (1) a foreign investor purchases the equity of a domestic non-foreign-invested enterprise or subscribes for increased capital, which makes such domestic enterprise become a foreign-invested enterprise; (2) a foreign investor purchases the equity of the Chinese shareholder in a domestic foreign-invested enterprise or subscribes for increased capital; (3) a foreign investor establishes a foreign-invested enterprise, through which it purchases and operates the assets, or purchases the equity of the domestic enterprise; (4) a foreign investor purchases directly the assets of a domestic enterprise, by which it makes investment and sets up a foreign-investment enterprise.

Review scope

The scope of security review covers: (1) foreign investors’ M&A of domestic military armament enterprises and suppliers, enterprises adjacent to key and sensitive military facilities, and other entities that are crucial to national defence and security; (2) M&A of enterprises engaged in industries related to national security, such as important agricultural products, important energy and resources, important infrastructure, important transportation services, key technologies and major equipment manufacturing, the control of which may be obtained by the foreign investors.

The security review is performed by the State Council Inter-Ministerial Joint Committee, which is led by the National Development and Reform Commission and MOFCOM under the guidance of the State Council and undertakes a security review based on the industries and fields of the M&A by foreign investors.

Major obligations

The committee’s major obligations include the following: to analyse the influence imposed on national security by M&A by foreign investors; to research and co-ordinate on major issues arising in the process of reviews; and to undertake reviews and make decisions on M&A of domestic enterprises by foreign investors, where a security review is required.

The application of a security review has three scenarios: (1) a foreign investor takes the initiative to notify MOFCOM of its application, which is a popular international practice currently, and local commerce authorities may require a foreign investor to submit an application for security review if it finds an M&A transaction requires one in its procedures; (2) relevant authorities of the State Council, national industry associations, counterpart enterprises or downstream and upstream enterprises jointly file the application for a security review; (3) the State Council’s joint committee undertakes a security review based on the committee members’ functions and powers, acting on suggestions put forward by MOFCOM.

Two stages

A security review has two stages: general review and specific review. For general review, the joint committee sends a written consultation to relevant authorities and the review lasts up to 30 working days. The special review will apply only when the relevant authorities consider that the transactions will affect national security.

A special review is required to be completed within 60 working days, during which time the joint committee performs a security evaluation and reviews. The decision is left to the State Council where the joint committee has serious differences in opinion. A foreign investor is entitled to change or revoke an M&A transaction during the process of a security review.