MOFCOM issues implementing rules for new security review of foreign M&A transactions
11 March 2011
Under the terms ofthe Notice concerning Security Review of Mergers and Acquisitions of Domestic Enterprises by Foreign Investors issued by the State Council (the Notice), foreign M&A transactions in a wide range of sectors are to be subject to an additional process of "security review" aimed at scrutinising M&A transactions for their potential effect on "national defence" and "national security" (Allen & Overy's earlier eAlert on the Notice can be accessed via this link: Security Review of Mergers and Acquisitions of Domestic Enterprises by Foreign Investors).
The State Council's Notice has caused considerable unease amongst the foreign business community in China, especially on account of the extremely broad range of sectors potentially caught by the new regime, confusion as to precisely which types of investment fall within the scope of the Notice (particularly in the context of minority investments), the vague criteria against which transactions will be assessed, the uncertainty as to how the application process should be conducted in practice, and the retroactive application of the Notice.
On the date of the entry into force of the Notice (5 March), the Ministry of Commerce (MOFCOM), the Chinese governmental authority with general oversight of the security review process, adopted a set of Temporary Provisions for the Implementation of a System of Security Review for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the Temporary Provisions ). These Temporary Provisions provide greater detail with respect to the documents to be submitted as part of a security review application, and establish a pre-application consultation mechanism akin to that available in the anti-monopoly merger control context. On the whole, however, the Temporary Provisions do not provide any substantive guidance regarding the sectors involved, the types of transactions caught and the criteria against which they will be assessed. Foreign investors in China will therefore need to keep a close eye on how the security review system evolves in practice, especially as regards the type of transactions required to be submitted for review.
Unprecedented trial period for the Temporary Provisions
It is not uncommon for regulatory authorities in China to release draft versions of implementing regulations, soliciting comments from public stakeholders and then incorporating that feedback in the final version of the laws. However, in issuing the Temporary Provisions, MOFCOM has adopted the unique approach of soliciting comments from the public in respect a law that will enter into effect immediately (5 March 2011). The public has been offered a period a just over a month (5 March to 10 April 2011) to submit comments on the Temporary Provisions. Taking account of feedback from the public as well as its own assessment of the practical implementation of the Temporary Provisions, MOFCOM intends to undertake amendments to the Temporary Provisions with a view to issuing a final version before the Temporary Provisions expire on 31 August 2011.
Pre-application consultation process
The Temporary Provisions contain no further guidance as to the sectors subject to security review, the types of transactions caught, and the criteria against which they will be assessed. This is despite earlier news reports suggesting that specific turnover thresholds for certain industries might be part of the detailed implementing regulations issued by MOFCOM.  The Temporary Provisions do, however, establish a pre-application consultation mechanism by which foreign investors can seek advice on the "procedural issues involved in an M&A transaction involving a domestic enterprise". Although it is unclear what precisely is meant by "procedural issues", this appears to provide a channel of communication through which foreign investors engaged in M&A transactions in China can seek guidance as to whether they should apply for security review of their transactions. It remains to be seen whether foreign investors will be able to obtain sufficient legal certainty by undertaking pre-application consultations with MOFCOM; this has not always been possible in the case of the pre-filing consultation mechanism established as part of the PRC anti-monopoly merger control regime.
Documents to be submitted as part of security review application
The Temporary Provisions provide a detailed list of the documents to be submitted should a foreign investor decide that it is engaged in an M&A transaction falling within the scope of the State Council's Notice. In summary, these include:
- a security review application form (that has not yet been published by MOFCOM);
- a description of the M&A transaction and the foreign investor group, an explanation of its relationship with relevant national governments and a description of the targeted domestic enterprise including a copy of its articles of association, business licence and audited financial report from the previous year;
- information regarding the company to be established following the M&A transaction, including the company's articles of association and other relevant major contracts, as well as a list of the company's directors and senior management (though, to the extent that the company does not yet exist, this request would appear difficult to satisfy);
- the relevant transaction documents; and
- if the merger or acquisition is constituted not by a majority shareholding or assets purchase but by the foreign investor obtaining de facto control over the domestic enterprise, an explanation of the circumstances giving rise to such de facto control.
Although the list of documents and information appearing in the Temporary Provisions is extensive, none of the information requested from the applicant appears in any way directed at what presumably should be the core concern of the authorities in conducting the security review, namely whether the transaction is likely to have any adverse effect on "national defence" or "national security".
Relationship with MOFCOM investment approval at the local level
One of the key issues left unresolved by the State Council's original Notice was the relationship between the security review process and other approvals required for foreign investment in China. The Temporary Provisions provide further guidance as to how MOFCOM will internally coordinate the security review process with the investment review process conducted by MOFCOM at the local level. For one, the Temporary Provisions provide that where a local MOFCOM division receives a standard investment approval application in respect of an M&A transaction that it believes should be subject to security review, but in respect of which no security review application has been made, it should refuse to accept the investment approval application and issue written instructions for the applicant to submit a security review application to MOFCOM at the central level. In addition, the Temporary Provisions further provide that, as soon as central MOFCOM has accepted a security review application for an M&A transaction, the local MOFCOM must suspend any standard investment review that it has commenced in respect of the same transaction. The Temporary Provisions do not clarify the relationship between security review and the anti-monopoly merger control review process, but with both applications conducted with considerable involvement by MOFCOM at the central level, it arguably makes sense for both applications to be carried out in parallel.
Timing and process
The Temporary Provisions do not provide any further detail on the overall timing of the review process. As originally set out in the State Council's Notice, MOFCOM has 15 working days from its receipt of an application to decide whether to refer the M&A transaction for security review by an "Interdepartmental Committee" consisting of representatives from various Chinese government departments. MOFCOM then has five days from its receipt of the written opinion of the Interdepartmental Committee to inform the applicant or parties to the transaction of the decision in writing. As it stands, foreign investors will play an essentially passive role, providing basic information concerning their transaction but having little opportunity to contribute on the substantive issues at stake.
The only gloss on the overall procedures contained in the Temporary Provisions is to emphasise that the original 15-working-day time limit for MOFCOM's review of the application only runs from the time that MOFCOM deems the documentation submitted by the applicant complete and issues a formal acceptance notice to the applicant. Based on our experience in the anti-monopoly merger control context, this commonly adds a further fortnight (or more) to the overall time required as part of the review process, as it is common for MOFCOM to issue further questions to the parties regarding their notification documents before issuing a formal acceptance notice.
The speed with which MOFCOM has issued these Temporary Provisions indicates that it is acutely aware of the concerns amongst the foreign business community in China as to the operation of the new security review regime. Foreign investors will also welcome the opportunity to offer their views on the Temporary Provisions, which they will be able to do until 10 April 2011. Nevertheless, in their current form the Temporary Provisions provide merely a basic framework and incomplete practical guidance regarding the security review regime. Key areas of concern remain. Most importantly, the Temporary Provisions do not attempt to offer any more detailed guidance to foreign investors on key issues, namely the sectors and types of investment that fall within the scope of the security review regime, the criteria against which transactions will be assessed, the uncertainty as to how the application process should be conducted in practice, and the retroactive application of the Notice.
In the light of this, foreign investors undertaking M&A activities in China might need to factor-in these uncertainties and possible delays when getting their deals approved in China, in addition to existing foreign investment and merger control approvals.