The Provisions on the Takeover of Domestic Enterprises by Foreign Investors (China’s M&A Rules)

The Ministry of Commerce (MOFCOM) is the main regulating and approval authority for cross-border M&A transactions. On 8 August 2006, MOFCOM, the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), the State Administration of Taxation (SAT), the State Administration of Industry and Commerce (SAIC), the China Securities Regulatory Commission (CSRC) and the State Administration of Foreign Exchange (SAFE) jointly issued the Provisions on the Takeover of Domestic Enterprises by Foreign Investors (M&A Rules), which came into effect on 8 September 2006 and was further revised in 2009.

The M&A Rules represented a significant step in the development of China’s regulation of foreign acquisitions of Chinese companies. The requirements imposed by the M&A Rules had significant consequences both for foreign private equity investors entering the Chinese market and for Chinese businesses seeking access to overseas funds.

The key features of the M&A Rules are:

• illustrate greater government focus on cross-border M&A transactions
• require approval by MOFCOM or its local counterparts of M&A transactions that fall into the restricted business defined by the Negative List, otherwise the acquisition only needs to be filed with MOFCOM
• require registration with SAIC
• impose restrictions on round-trip investments by a Chinese resident
• require CSRC approval for IPOs involving offshore SPVs holding China assets
• allow the use of foreign companies’ shares in the acquisition of China companies (share swap)
• require Central MOFCOM approval for foreign acquisition of control of PRC company which involves a key industry, which may affect national security or ownership of a well-known Chinese brand
• confirm MOFCOM as the key regulator of M&A related anti-trust issues
• confirm MOFCOM as the key regulator of M&A related anti-trust issues

Scope of China’s M&A Rules

The M&A Rules apply to Equity Acquisitions and Asset Acquisitions.

An Equity Acquisition is defined as a foreign investor’s purchase of equity in an enterprise other than a foreign invested enterprise (FIE) (a Domestic Company) or the subscription by a foreign investor for new shares in a Domestic Company resulting in the conversion of the Domestic Company to a FIE.

An Asset Acquisition is defined to include:

1. a foreign investor’s establishment of a foreign invested enterprise in China which purchases and operates the assets of a domestic enterprise; and
2. a foreign investor’s purchase of assets from a domestic enterprise which are then invested in a foreign invested enterprise in China established to operate such assets.

All acquisitions covered by the M&A Rules require approval by/filing with MOFCOM approval, either at the central government level or at the provincial level depending on the investment amount.

In the case of a foreign investor’s acquisition of shares in a Domestic Company that is listed on a Chinese stock exchange, the acquisition will need to comply with the Measures for Administration of Strategic Investments by Foreign Investors in Listed Companies as well as the M&A Rules. An acquisition of shares in a listed company is additionally required to comply with the Measures for the Administration of the Takeover of Listed Companies. If the foreign investor acquires equity of a state-owned enterprise (“SOE”) or assets owned by an SOE, in addition to compliance with the M&A Regulations, extra requirements under Measures for the Supervision and Administration of the Transactions of the State-Owned Assets of Enterprises should also be followed.

The M&A Rules do not apply to M&A transactions involving FIEs which are governed by the regulations governing the transfer of equity interests in FIEs. Likewise, the M&A Rules do not apply to M&A transactions involving financial institutions (including banks and insurance companies).

After China’s M&A Rules

Since the 2006 implementation of the M&A Rules, scarcely any red chip restructurings have been approved under the rules. This has effectively prevented the reorganisation of Chinese companies under offshore holding company structures.

This effective prohibition on round-trip investments was confirmed in the Foreign Investment Examination and Approval Management Guidance Handbook issued by MOFCOM in December 2008. The Handbook states that MOFCOM will only consider the approval of a round-trip investment application in two situations:

1. if the offshore acquirer is a listed company; or
2. if :

   (a) the formation of the offshore acquirer has been duly approved;

   (b) the offshore acquirer has commenced operations; and

   (c) the offshore acquirer will fund the acquisition from profits.

With these two exceptions, the majority of round-trip transactions continue to be prohibited.

The M&A Rules did not however put a stop to offshore financings and listings of Chinese companies. The number of both has remained high, although many such deals involved companies that were restructured prior to the M&A Rules’ effective date.

Otherwise, alternative structures have been used to address the challenges to round trip investments posed by the M&A Rules. Many of these have involved variations on the VIE structure or JV structure.