The Chinese M&A market in 2019 was the lowest it has been since 2014. The decline in both outbound and domestic M&A transactions continues compared with 12 months ago, which reflects both the general situation of the PRC economy and the challenge posed by the escalating China-US trade war to various industries. However, even though the transaction volume of the Chinese domestic M&A market has decreased compared to 2019, the reported number of transactions has increased, which may reflect that more SMEs are in the market now. With regard to outbound investment, Chinese investment in the USA decreased significantly, as well as investment in major European countries, however, investment in One Belt One Road (OBOR) countries continues to rise.
The Economy in China has suffered from the impact of the COVID-19 outbreak and the accompanying travel restrictions. As a result, the number of deals in Mainland China and Hong Kong is down more than 50% compared to the same period in 2019. While the value of those deals is down over 75% compared to 2019. It seems that the economic recovery following the COVID-19 outbreak will be more complicated than the one following the 2003 SARS outbreak since China’s growth was already slowing, its economy is loaded with debt, and credit has been harder to come by.
The Chinese capital markets also suffered losses from the COVID-19 outbreak but are still stable compared to other parts of the world, partially because of the loosening of credit lines by the Chinese government and the state-controlled banks. Therefore, we believe that mergers and acquisitions by listed companies and the acquiring of listed companies may be stable or slightly increase in the year of 2020.
Given the global economic slowdown, we understand outbound investment will continue to decline. The exceptions will be large, cash-rich companies seeking to mitigate the disruption caused by the outbreak and adapt to new industrial patterns. These companies – some of which are also looking to reduce their production costs by shifting portions of their operations from China to lower cost regions – are still eagerly searching out new opportunities abroad. Furthermore, we also expect that ongoing consolidation within many industries in China will further increase as smaller firms struggle during this period.
According to data from the Zreo2IPO Database, as the result of the China-US trade war, Chinese overseas mergers and acquisitions fell by a large margin in 2019, with the number of transactions decreasing by 50% year-on-year, and the scale of transactions decreasing by 40% year-on-year. However, M&A transactions along the One Belt One Road route are still on a roll, as South Asia and Southeast Asia remain popular areas for Chinese overseas M&A. Foreign direct investment in Chinese companies has not decreased significantly. Buyout fund KKR acquired 70% of NVC Lighting China for USD794 million, which was the largest foreign M&A in 2019. Besides that, funds including the Pacific Alliance Group and the Carlyle Group have implemented one or several large-scale M&A investments in Chinese companies.
In terms of domestic M&A, listed companies initiated most of the ten largest mergers and acquisitions in 2019. However, most of these deals are asset injection by the majority shareholders. Difficulties in fundraising have impeded such financial investors as private equity and venture capital firms in M&A, but the investment of Hillhouse Capital Group in Gree Electric Appliances, Inc of Zhuhai is still notable.
From a regulatory perspective, the start of the China Science and Technology Innovation Board in 2019 initiated a substantial and systematic reform of the Chinese corporate M&A market. The reforms are mainly reflected in four major areas:
It is very clear that the reforms of the Science and Technology Innovation Board can be regarded as the future direction of Chinese stock market innovation. The entire Chinese M&A and restructuring system will gradually move in the same direction.
Because of the COVID-19 epidemic, many companies have been unable to fulfill their contractual obligations. To shield those companies from legal risk, China has issued more than 1,600 force majeure certificates. The certificates are meant to exonerate companies for their non-performance by “proving” that they experienced circumstances beyond their control and therefore cannot be subject to legal action or contractual penalties. To date, the force majeure certificates apply to contracts with a combined value of roughly USD16 billion. In addition, as it seeks to ramp up economic activity, China has eased some of its regulatory burdens. The State Administration for Market Regulation (SAMR) – China’s antitrust authority – now requires companies to submit pre-merger notifications online and has vowed to improve the efficiency of transactions subject to simple case review. Previously, the SAMR required all submissions to be filed in person with hard copies. The General Administration of Customs also released measures meant to speed up inspection times for imported raw materials, food, and agricultural products, while also simplifying import registration and filing procedures.
Furthermore, during this hard time, we have access to tools not available during prior market scares. Including virtual data rooms and video conferencing services. Most steps of the M&A transaction could be completed remotely and people all understand the value of being digital today.
According to data from ChinaVentureSource, most of the completed M&A deals in China in 2019 were in industrial sectors such as manufacturing, bio-technology, medical and health, IT, construction and engineering, and green technology. Among which, manufacturing has contributed the largest portion of M&A activities, nearly 20%. The most significant individual combination was Wanhua Chemical’s merger with its’ holding shareholder, Wanhua Chemical Industry which is valued at USD8.2 billion.
Many different means of transaction are used to acquire a company in China. For mergers and acquisitions among state-owned enterprises, allocation or free transfer on the State-Owned Assets Supervision and Administration Commission (SASAC) approval is the norm; transactions relating to public companies, as in other jurisdictions, are through share swaps or payment by shares. However, for other transactions, cash and debt assumptions are commonly used. A recent innovation is that public companies can purchase assets by issuing directed convertible bonds or priority shares.
It is worth mentioning that asset transactions are rarely used in M&A in China, given various regulatory and tax issues. For example, transactions relating to property, if conducted through an asset transaction, will be subject to land VAT that is likely to amount to up to 60% of its increased value. China is a highly regulated market and the licensing and approval relating to a transaction are likely to corresponded to the corporate entity rather than the asset.
Primary regulators for M&A activities include:
China has renewed its pledge to open its markets and level the playing field for foreign enterprises, after progress towards a deal in its trade war with the USA. In 2019, China introduced a number of measures to widen market access for foreign enterprises, including issuing a shortened "negative list" of areas in which foreign investment is banned or limited. The China Banking and Insurance Regulatory Commission also recently introduced plans to broaden the scope of business for foreign banks and insurance companies in the country. In particular:
The Negative List
The 2019 version of the Special Management Measures for Foreign Investment Access in Pilot Free Trade Zones (the negative list) contains 40 categories of restricted investment, eight fewer than the previous year. Foreign investment limitations have been loosened or removed in the transportation, infrastructure, culture, telecommunications, agriculture, mining and manufacturing sectors. Furthermore, Chinese regulatory authorities will amend the negative list again in 2020, continuing to lift the limit on foreign investment in China.
Equalisation of Regulation of Foreign and Domestic Capital
The China Banking and Insurance Regulatory Commission has released 12 new measures, whose purpose is to equalise the treatment of domestic and foreign capital used to conduct M&A. This involves:
Foreign Investment Restrictions
In October 2019, the State Council announced there would be a gradual elimination of restrictions on foreign equity invested in the securities, banking and insurance industries in 2020.
In China, the main regulations governing antitrust issues in business combinations include the Anti-monopoly Law of the PRC, the Regulation on Declared Threshold for Concentration of Business Operators issued by the State Council, Measures for the Declaration of the Concentrations between Undertakings issued by MOFCOM and Guiding Opinions on Declaring the Concentration of Undertakings issued by MOFCOM.
The main labour law regulations in China include the Labour Contract Law of the PRC, the Implementing Regulations of the Labour Contract Law of the PRC, the Social Insurance Law of the PRC and the Law of the PRC on Mediation and Arbitration of Labour Disputes.
The strengthening of labour protection in China has significantly increased the risk of labour disputes in M&A activities because: (i) the M&A itself is not a legitimate reason for termination of a labour contract; (ii) the acquirer may be required to bear the risk of paying the unpaid social insurance of the target company. A plan for working arrangements may need to be submitted for government approval and when disputes arises, the government-backed labour arbitration institutions will normally take the employee’s side for reasons of social stability.
The MOFCOM established the current National Security Review (NSR) system in China. The Anti-monopoly Law promulgated by the State Council in 2008 first commissioned an NSR of M&A transactions by foreign investors. In 2011, China commissioned a national security review of M&A transactions by foreign investors through the Circular of the General Office of State Council on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors (the Circular).
According to the Circular, the scope of the M&A security review includes foreign investor M&A in:
For all foreign M&A falling within this scope, applications shall be submitted to MOFCOM for approval in advance, and it will establish an inter-departmental commission to review the transaction and make a final decision.
The Foreign Investment Regulations also emphasise the principles for national security review. It is foreseeable that more specific regulations, with respect to the scope and decision-making procedures will follow later. With the general loosening of foreign investment restrictions, however, national security review is likely to be strengthened.
Xinhua Medical v Chengdu Yingde (Shareholder's Compensation Case)
This judgment showed that Xinhua Medical and Chengdu Yingde shareholder, Sui Yong, and nine other defendants, signed a compensation agreement on 18 April 2014, which stipulating that the defendants should make performance compensation to the plaintiff. The compensation amount is twice the amount of outstanding performance indicators. Due to Sui Yong's failure to fulfil the prescribed performance promises of 2016 and 2017, Xinhua Medical sued and requested Sui Yong and others to pay CNY380 million in performance compensation and delayed interest.
The Shandong Higher People's Court ruled that Sui Yong and the other defendants bear 70% of the liability for performance compensation, CNY133 million in total. The grounds for this decision are that the plaintiff Xinhua Medical actually participated in the management of Chengdu Yingde, and therefore was responsible for the performance. Meanwhile, Xinhua Medical had participated in daily control of Chengdu Yingde，and this behaviour violated normal rules of the Valuation Adjustment Mechanism, as well as the Contract Law. It can be treated as breaking the agreement only if the plaintiff has no control over the targets and bears the downside risk.
When the case was closed, the structure that the acquirer established for the target company has a significant influence on us.
The CSRC unveiled special regulations for major asset restructuring of companies listed on the STAR Market. The Shanghai Stock Exchange (SSE) similarly released a draft of special regulations for major asset restructuring of companies listed on the STAR Market, which elaborated that deals such as those involving science and technology (sci-tech) companies purchasing assets via issuing stocks would be reviewed by the SSE, the entire procedures taking no more than 45 days. The CSRC will make decisions as to whether or not to approve the transaction within five days of collecting all the paperwork from the SSE. Legitimate restructuring plans could be established in as little as one month because of the enormous efficiency improvements.
The possible payment methods for sci-tech companies conducting M&A have also been expanded, sci-tech companies can issue private convertible bonds to acquire assets in accordance with the regulations of the CSRC. It also simplifies the review procedure, especially for the legitimate restructuring deal, and for deals that meet “small & fast” standards.
In October 2019, the CSRC promulgated the Decision on Revising the Administrative Measures for the Material Asset Reorganisation of Listed Companies. This simplifies the recognition criteria for reorganisation of listed companies, abolishes the “net profit” requirement, and means that the CSRC will allow companies related to the high-tech and emerging sectors of strategic importance to restructure and list on the STAR Market.
It appears that bidders will build a stake in the target company before contacting it or making an announcement about the proposed acquisition. However, Chinese law requires bidders to fulfil the disclosure obligations when they obtain a certain percentage of the target company’s equity. According to the Measures for the Administration of the Takeover of Listed Companies (the M&A Measures) decreed by the CSRC in 2014, where the change in equity of the investor, and any persons acting with the investor, amounts to 5% of the issued shares of a listed company through securities transactions on a stock exchange, a report on the change in equity must be prepared within three days of the event and a written report to the CSRC and the stock exchange must be submitted. The listed company must be notified, and an announcement must be made. Shares in the listed company may not be traded during this period.
According to the M&A Measures:
A listed company can prevent malicious acquisitions by modifying the company's articles of association, to, for example, lower the threshold for disclosure, changing the terms of directors, and increasing the proportion of voting shares. Some listed companies, such as World Union and Yahua Shares, have stipulated in their articles of association, respectively, reducing the 5% shareholding ratio attached to reporting obligations to 3%, and stopping trading within the relevant period, to prevent malicious acquisitions.
Modification of companies' articles of association has increased in recent years. Although they have not violated the prohibition articles of the law, this has attracted the attentions of the exchanges. After announcing amendments to their articles of association, listed companies may receive an amendment Letter of Concern from the relevant exchange. For instance, the Inner Monglia Yili Industrial Group Co,Ltd tried to modify the company's articles of association to add anti-takeover clauses, but after being questioned by the exchange, the company finally gave up. According to China's current regulatory requirements, provisions of the articles of association of listed companies that involve corporate control clauses must comply with the provisions of laws and administrative regulations, and anti-takeover clauses that restrict shareholder's legal rights must not be established.
Derivatives were recently introduced to the Chinese stock market and only very limited types of derivatives, for a limited number of listed companies, are traded. Even though derivative dealings are allowed in M&A transactions with respect to listed companies in China, dealing in derivatives as a means of pursuing M&A or as a risk control mechanism is only tentatively used in a small number of transactions. For example, the Shenzhen Stock Exchange issued the Shenzhen Stock Exchange Pilot Trading Rules for Stock Options. Stock option contracts can be listed, traded, and exercised on the Shenzhen Stock Exchange. The buyer of an option can decide whether to exercise the option within the contract period; one can buy or sell a corresponding amount of the contract at a specific price. In addition, both the Shenzhen Stock Exchange and the Shanghai Stock Exchange allow listed companies to issue warrants and trade them. Members should exercise warrants through the exchange trading system. The exchange will also publish the tradable amount of each warrant, and publish lists of holders who possess 5% or more of the tradable amount of each warrant before the daily opening.
In M&As of listed companies, trading of derivatives must be fully disclosed.
The Securities Law of the PRC (Securities Law)
The Securities Law has brought derivatives under supervision. According to the Securities Law, the administrative measures for the issuance and trading of derivatives shall be prescribed by the State Council.
The Administrative Measures for the Information Disclosure of Listed Companies (Disclosure Measures)
The Disclosure Measures demonstrate that if there is a material event that may have a relatively great impact on the trading prices of the securities of a listed company, and their derivatives, and investors have no knowledge of it, the listed company shall immediately disclose it and give explanations of the cause, the current status and the possible impact.
The Notice Concerning the Pilot Business of SME Exchangeable Private Bonds
This Notice, promulgated by the Shenzhen Stock Exchange, on 31 May 2013, was the first regulation specific to private exchangeable bonds (XB). In the Administrative Measures on the Issuance and Transaction of Corporate Bonds promulgated by the CSRC in 2015, it was mentioned that shareholders of listed companies may issue corporate bonds with conversion terms. Subsequently, the Interim Measures for the Administration of Non-public Issuance of Corporate Bond Business promulgated by the Shanghai and Shenzhen Stock Exchanges explicitly included private XB in the regulatory framework, and clarified the scope and implementation details of private XB.
The current laws and regulations do not place restrictions on private XBs. Shareholders of listed companies who want to issue private XBs only need to attain approval from the exchange, and for filing on the exchange. The conditions are that the stocks used to exchange must not be subject to judicial restrictions or other rights restrictions before the bond issuance, and there must be no restrictions on sales and no breach of the issuer's commitment to the listed company. The bond can be converted six months after issuance.
Whether dealings in derivatives (or in combination of shareholding) will constitute an antitrust issue is vague in Chinese law. However, if such dealings constitute a merger of businesses, they may still be subject to an antitrust review.
Shareholders have to make the purpose of their acquisition and their intention regarding control of the company known. According to the M&A Measures, where the equity in which the investor and persons acting with the investor amounts to 5% or more of the issued shares of a listed company, the investor and persons acting with the investor shall prepare a simplified report on changes in equity containing the purpose of the shareholding and whether there is an intention to increase the equity held in the listed company continuously within the next twelve months.
Where there is a takeover of the listed company’s shares by way of a tender offer, the investor must prepare a report explaining the purpose of the takeover.
If the tender offer method is adopted, when the tender offer is issued in accordance with the Securities Law, the acquirer must announce the acquisition and file the report of the listed company stating:
If the acquirer needs to modify the tender offer, it shall file an announcement in time, stating the specific modifications.
If an acquisition by agreement is adopted, when the agreement is reached, the acquirer must report the agreement to the securities regulatory authority of the State Council and the stock exchange within three days, and make an announcement. The acquisition agreement shall not be fulfilled before the announcement.
Market practice on timing varies. The general practice is that listed companies will not disclose potential transactions prematurely. In some cases, the listed company does not perform the obligation of information disclosure in a timely manner even if the investor and the listed company have signed a share purchase agreement. In this instance, the CSRC and the stock exchange will censure the chairman and/or secretary of the board publicly and will impose a penalty on the company.
On 27 August 2019, the Jiangsu Regulatory Bureau of the CSRS punished Ye Chiu Metal Recycling (601388) for not disclosing a major asset purchase deal in a timely manner by giving a warning to the company and imposing a fine on it of CNY300,000, and giving a warning to its chairman and the secretary of its board of directors and imposing fines of CNY30,000 on them.
Due diligence mainly fulfils two purposes, one is for the buyer's need to further understand the vender, the other is meeting the competent authority's requirements on acquisition disclosure/report.
Commonly, in the first phase (before the price and transaction structure is confirmed), the vendor will provide no internal due diligence documents except some publicly available materials and the bidder will usually be largely reliant on relevant market information.
In the second phase (once the transaction structure and price have been confirmed), the due diligence documents provided by the vendor are more extensive in scope and usually cover all issues during the reporting period, including a company's history, business, assets, finance, tax, environmental, personnel, social security funds and housing fund, pending litigation and arbitration, administrative penalties and other matters relating to its existence and operation.
In China, exclusivity is usually demanded in M&A transactions. However, the period of exclusivity usually ranges from a few weeks to several months. The exclusivity period could also be extended in the particular circumstances.
With regards to standstill, pursuant to the M&A Measures, in the case of a tender offer, the purchaser shall not, after the announcement is made and before the takeover term expires, sell any share of the target company, nor may it buy any share of the target company by any means other than those stipulated in the tender offer or that go beyond the conditions as stipulated in the tender offer.
In addition, if, by trading securities on a stock exchange, an investor holds equity shares accounting for 5% of the issued shares of a listed company, they shall not trade the stock of the listed company within three days of the occurrence of the fact. And if, by a transfer agreement, the investor owns equities in a listed company that attain or exceed 5% of the issued shares of the listed company, or after the shares whose entitlements are held by an investor reach 5% of the issued shares of a listed company, if the proportion of the shares whose entitlements are held by the investor increases or decreases by 5%, they shall perform the previously mentioned obligation of reporting and announcing. Before the said investor gives a report and makes an announcement, they shall not buy or sell the shares of the listed company again.
According to the M&A Measures, in the case of an acquisition of shares of a listed company by a tender offer, the bidder shall prepare a tender offer report and engage a financial consultant and notify the target company. The report must include the price, quantity and proportion of the shares under consideration, plus the takeover period. Where an offeror needs to make changes to a takeover offer, the offeror shall promptly make an announcement, state the specific changes in question, and notify the target company.
Upon expiry of the takeover period, the bidder must purchase the shares pursuant to the terms agreed in the tender offer. Generally, no other agreement or contracts will be implemented.
Chinese domestic M&A is generally speedy. Most deals will be closed within three to six months. Cross-border transactions, since various approvals will be required, may take an additional three to six months. Some transactions are announced and transactions documents are quickly signed, but actually closing the deal can take a long time because of the various approvals required and also the lack of scrutiny involved in preparation for the operation.
According to the Securities Law and the M&A Measures, if the shares held by an acquirer in a listed company amount to 30% of the issued shares through securities transactions on the stock exchange or agreement acquisition, and the acquirer continues to increase his or her shareholding, the acquirer must propose a takeover by way of an offer, which may be general or partial.
Unless exempted by the CSRC, if a purchaser:
Cash, including cash plus an assumption of debt, is the most commonly used form of consideration in China. For tender offers relating to listed companies, only a public floating of shares may be used as consideration, otherwise cash must be provided as an alternative. In an acquisition by a listed company, the use of shares, though normally not preferred on the seller’s side, is common.
Takeover offers which are conditional on approval being obtained, divestiture and/or the incorporating of certain assets plus third-party consent are extremely rare in China. For takeovers of Chinese listed companies, the conditions of a takeover offer generally include the number of shares to be acquired, the price, the term, the conditions for taking effect, etc. Conditions attached to the offer are not prohibited by PRC laws and regulations. In PetroChina’s takeover of Liaohe Oilfield (000817), for example, PetroChina set the standard for delisting as a condition of the offer. Namely, if Liaohe Oilfield failed to delist, PetroChina would abandon the acquisition.
Conditions for the effectiveness of the tender offer shall be set forth in a takeover offer. It is a relatively common condition that the proportion/number of shares to be purchased shall reach a certain amount or proportion. That is, if the proportion/number of shares to be purchased fails to meet the required number upon the expiration of the tender offer period, the tender offer shall not be effective and the shares to be purchased would not be acquired.
According to the M&A Measures, if a listed company is taken over by means of tender offer, the proportion of shares to be purchased shall not be lower than 5% of the issued shares of the said listed company.
Although a merger or acquisition being conditional on the bidder obtaining financing is not prohibited or restricted by PRC laws and regulations, it is infeasible in general practice. Commonly, obtaining financing is a preconditions for a business combination. As the M&A Measures provides that the acquirer shall engage a financial consultant to conduct due diligence on the acquirer’s capacity to pay the takeover price and the source of funds, the business combination may not be approved by shareholders if such combination is conditional on the bidder obtaining financing.
Break-up fees are commonly used in China as security measures. However, they are normally not very high and may simply recover the expenses to be paid to intermediaries. Other security measures – including match rights, force-the-vote provisions and non-solicitation provisions – are rarely used and may be regarded as violating the interests of shareholders and the fiduciary duties of directors.
Chinese Domestic M&A mainly includes acquisition by tender offer and by agreements. In general, break-up fees may not be a condition attached to the tender offer. For acquisitions by agreement, break-up fees borne by the principal shareholders of a listed company may be one of conditions attached to the acquisition. But the listed company may not agree to bear the break-up fees as it may impair the interests of minority shareholders.
If a bidder does not seek 100% ownership of a target company, he or she may seek an "acting in concert" agreement from other major shareholders so as to ensure control of the target company. Acting in concert refers to the act or fact of an investor working together with other investors through an agreement or any other arrangement to jointly increase the quantity of voting shares under their control in a listed company.
According to China’s Interim Administrative Regulations on Share Issuing and Trading, a shareholder may authorise someone to exercise his or her voting right. However, anyone who has canvassed the rights of consent or voting rights of 25 or more persons must observe the regulations of the CSRC concerning information disclosure and the making of reports.
According to the Securities Law, the board of directors, independent directors, shareholders holding 1% or more of voting shares of a listed company or an investor protection institution formed in accordance with the provisions of laws, administrative regulations or the provisions issued by the securities regulatory authority of the State Council may, as the solicitor, publicly request that shareholders of the listed company entrust them to attend the shareholders' meeting and to exercise the right to make proposals, the right to vote and other rights of shareholders on their behalf or entrust a securities company or a securities service institution to do so.
Voting right authorisation, plus the acquiring of shares below the control/tender offer threshold, will by nature constitute a change of control. Thus, it has been regarded as constituting an acting-in-concert agreement and will be subject to a disclosure liability and will trigger a tender offer according to the analysis of relevant cases in 2018 and the Business Guidelines for Disclosure of Information on Acquisitions and Changes in Share Equity of Listed Companies (Draft for Opinions) respectively published by the Shanghai Stock Exchange and the Shenzhen Stock Exchange.
Squeeze-out mechanisms and short-form mergers are extremely rare in China, as a listed company is delisted if shares held by the public are less than a certain proportion, and listed company status is very valuable in the Chinese market. According to the Securities Law and the M&A Measures, if the acquirer holds more than 75% of the acquired company with a total equity of CNY30 million to CNY400 million, the acquired company will be delisted; if the acquirer holds more than 90% of the acquired company with a total equity of CNY400 million, the acquired company will be delisted.
However, according to the Several Opinions on Reforming, Improving and Strictly Enforcing the Delisting System for Listed Companies, which was revised on 27 July 2018, the CSRC is encouraging research into, and the establishment of, a system for squeeze-out mechanisms, including trigger conditions and remedy procedures.
In transactions involving the purchasing of three listed companies, Jilin Chemical, Jinzhou Petrochemical and Liaohe Oilfield, by PetroChina, the three listed companies were delisted due to the non-compliance of their equity distribution with the listing conditions under the Securities Law. After delisting, there were still a small number of remaining shareholders who were unwilling to sell their shares. However, due to the lack of a squeeze-out mechanism, PetroChina was not able to compulsorily acquire the relevant shares.
With respect to obtaining irrevocable commitments, it is not prohibited by PRC laws and regulations. But, in practice, it is rare that a major shareholder of a listed company issues a letter of commitment to the purchaser in Chinese domestic M&A as this may be deemed to impair the interests of minority shareholders from the perspective of regulatory authorities. However, major shareholders of the listed company may still issue a letter of commitment to the purchaser without publicising that commitment.
As mentioned above, according to the relevant laws and regulations of PRC, if an investor and the persons acting in concert hold equity shares accounting for 5% or more of the issued shares of a listed company, they shall perform the obligations of reporting and announcement.
Furthermore, as described in 4.5 Filing/Reporting Obligations, the listed company shall disclose the bid according to the Disclosure Measures, in certain cases.
A business combination through trading securities on a stock exchange or by a transfer agreement, according to the M&A Measures, in which the investor and the persons acting in concert, who hold equity shares accounting for 5% or more ,but not exceeding 30%, shall be disclosed by preparing an equity change report and publishing an announcement.
If the proportion of acquired shares is between 5-20%, the investor, and parties acting in concert, shall formulate a simplified report on the alteration of entitlements, which shall generally include the following:
If the proportion of shares reaches or exceeds 20%, but does not exceed 30%, the investor, and the parties acting in concert, shall formulate a detailed report on the alteration of entitlements disclosing, as well as the information prescribed in the preceding paragraph, the following:
If the purchaser adopts the means of tender offer to purchase the shares of a listed company, such a takeover shall be disclosed by preparing a tender offer report and publishing an announcement. A tender offer report shall generally state the following matters:
Bidders need to disclose financial statements. Specifically, bidders must disclose their financial statements for the previous three years, among which, the one for the most recent year must have been audited. If the financial condition of a bidder has changed materially in the most recent fiscal year, that bidder shall provide the latest financial statement. If a bidder has existed for less than one year or was set up for the special purpose of the acquisition, it shall disclose financial statements of its actual controllers or controlling companies. If bidders are domestic listed companies, disclosure of financial statements for the most recent three years may be waived, but the name of the newspaper publishing the annual report and date of publication shall be specified. If bidders are overseas investors, their financial statements must be produced in accordance with international accounting standards.
It’s not necessary to disclose transaction documents in full. In the acquisition, or the material assets reorganisation, of a listed company, a basic background and the key factors of the transaction – such as the subject matter, counterparty, quantity of shares, price, method of payment, conditions of transactions and approval issues – need to be disclosed but it’s not mandatory to disclose any transaction document in full.
Generally, the directors in a business combination bear a duty of loyalty and a duty of diligence to the company and shall treat all acquirers fairly. Specifically, the board of directors of the target company shall make investigations, propose suggestions to shareholders and announce a report in respect of the acquisition. Without the approval of the shareholders' general meeting, the board of directors shall not take actions which will have significant impact on the assets, liabilities, interests or operating results of the company. Basically, the directors’ duties (including independent directors) are owed only to the company and the shareholders, instead of all stakeholders. The establishment of an independent director system, however, is aimed at protecting the interests of minority shareholders.
Different from the board of directors, there should be a certain proportion of employee representatives (not less than one-third) on the board of supervisors. Therefore, to a certain extent, the supervisors represent the interests of stakeholders, in addition to the interests of the company and its shareholders.
It is not common for boards of directors to establish special or ad hoc committees for the purpose of business combinations. However, when some directors have a conflict of interests, the said directors shall recuse themselves. Besides, independent directors in a listed company also sometimes take on the roles of special or ad hoc committees.
Specifically, if the directors, supervisors, senior management, or employees of a listed company or a company controlled or entrusted by such directors, supervisors, senior management, or employees propose(s) to acquire the listed company, a resolution shall be passed by non-related directors and approved by two-thirds or more of the independent directors before being approved by non-related shareholders at the shareholders' general meeting. The independent directors shall, prior to making a presentation of their opinion, engage an independent financial consultant to issue a professional opinion.
Independent directors of a listed company shall present independent opinions on material assets reorganisations. If the material assets reorganisation constitutes a related-party transaction, independent directors may engage an independent financial advisor separately to express an opinion on the impact of the present transaction on the non-related shareholders.
There is no so-called business judgement rule in China. In China, the duty of diligence imposed on directors is demanding. Under China's corporate governance structure, decision-making powers over important matters generally belong to shareholders, and the authority of the board of directors is limited. As far as takeovers are concerned, the ultimate decision-making powers – on whether to accept the takeover and whether to take anti-takeover measures – belong to the general meeting of shareholders. Thus, directors' liabilities in takeover situations are not so prominent as there is not much room for discretion on the part of the management or board.
Although the business judgement rule has not been officially introduced into China, the essence or notion of the business judgement rule has been reflected in certain court rulings. That is, as long as a director has not violated applicable laws and regulations or a company's articles of association, follows relevant rules and procedures, and the questioned result was not caused by the director intentionally or with gross negligence, a director shall not be liable for his or her decision, even if the decision resulted in losses to the company. The M&A Measures, however, specify the standard for the duty of diligence for directors – including directors’ duty of investigation, report and suggestions and certain behaviours that are prohibited (see 8.1 Principal Directors' Duties) – which provides certain standards for courts dealing with directors' liabilities in takeover situations, and a basis for the possible introduction of a business judgement rule in the future.
In the acquisition of a listed company, the board of directors of the target company shall engage an independent financial consultant, normally an investment bank, to issue a professional opinion. In the case of an acquisition of a listed company by its directors, supervisors, senior management or employees, the listed company shall engage a qualified asset valuation institution to issue an asset valuation report, and the independent directors shall separately engage an independent financial consultant.
In the material assets reorganisation of a listed company, the listed company shall engage an independent financial advisor, a law firm, and an accounting firm that has the relevant securities business qualifications to issue opinions. The independent financial advisor and law firm shall, in a prudent manner, verify whether or not the material assets reorganisation constitutes a related-party transaction. If the pricing for the asset trading is based on asset evaluation result, the listed company shall engage a qualified asset evaluation institution to issue an asset evaluation report.
According to China’s Enterprise State-Owned Assets Law, if the transaction involves any transfer of state-owned assets, the minimum transfer price shall be determined in a reasonable manner on the basis of a price that has been evaluated in accordance with the law and recognised by an organ that performs the duties of an investor or approved by the people's government at the same level after being reported by such an organ.
Conflicts of interest have been the subject of judicial scrutiny and also of scrutiny by securities regulators. Generally, no controlling shareholder, actual controller, director, supervisor or senior officer of a company may damage the interests of the company by taking advantage of his or her affiliated relation, otherwise they shall be liable for compensation.
Specifically, no director or senior officer may, without first obtaining the consent of the general meeting of shareholders:
If a transaction constitutes a related-party transaction, a listed company shall follow principles of impartiality, voluntariness and compensation for equal value; guarantee the impartiality and fairness of the transactions; go through corresponding procedures of deliberation in accordance with the laws, administrative regulations, CSRC provisions and the company's articles of association; and make timely disclosures. Any director of a listed company involved in a related-party transaction shall not exercise his or her voting right on the board of directors in relation to the transaction either on his or her own behalf or on behalf of any other director. Any shareholder of a listed company involved in a related-party transaction shall not exercise his or her voting right at the general meeting of shareholders in relation to the transaction either on his or her own behalf or on behalf of any other shareholder.
Hostile tender offers targeting listed companies are not prohibited by law, but are still not that common due to the special equity structure of listed companies in China.
Generally speaking, the decentralisation and liquidity of the target company's equities are the premise of a hostile takeover. Unlike the decentralisation of shareholding and market-oriented management of public companies in much of the rest of the world, most Chinese listed companies have a concentrated shareholding structure. Large listed companies are mainly state-owned companies or family-owned companies, in which there is normally a major shareholder holding the controlling position, and these major shareholders often hold restricted shares. Under this kind of equity structure, hostile takeovers rarely occur as, without the consent of the controlling shareholder and the management, the acquirer cannot take actual control of the listed company.
However, with the great changes seen in the corporate governance environment, the market itself as well as the legal environment in recent years, especially in the modern and market-oriented development of Chinese listed companies, the incidence of hostile takeover may increase.
Defensive measures in general (such as disposal of assets, the issue of new shares, etc) were prohibited by the CSRC in 2002 through provisions in the M&A Measures. This regulation, however, was revised in 2006 with the prohibition provisions deleted. Directors are currently allowed to use defensive measures in China.
As noted in 9.1 Hostile Tender Offers, hostile tenders are not that common in China, therefore generally there is not much call for defensive measures. According to our observation of hostile takeover cases in recent years, common defensive measures include suspension strategies, litigation strategies, "white knight" plans, "shark repellent" Strategies and "golden parachute" clauses.
By adopting a suspension strategy, the target company makes an announcement of a trading suspension of its shares after receiving tender offers. On the one hand, it offers time for the target company to find a white knight and take other defensive measures, and, on the other hand, it will increase the costs of the acquirer holding shares of the target company, which may cause the acquirer to abandon the acquisition plan due to lack of funds.
A litigation strategy involves winning time and preventing acquisition by initiating legal proceedings or other proceedings against the acquirer. In both the classic hostile takeover cases discussed below, the target companies adopted legal strategies to try to prevent hostile takeover.
White Knight Plan
In a white knight plan, when hostile acquisitions occur, the target company actively searches for friendly persons or companies with good intentions and seeks opportunities to be acquired by them, so as to rescue the target company and expel the hostile acquirers. Such bona fide third parties, the so-called white knights, will compete with the hostile bidders, resulting in third parties and malicious buyers bidding for shares of the target company. In the case of Baoneng's acquisition of Vanke (discussed below), China Resources was identified as the white knight of Vanke.
Shark Repellent Strategy
In a shark repellent" strategy, a listed company, by amending the articles of association, limits the number of directors to be re-elected or the right of directors to be removed by the general meeting of shareholders.
Golden Parachute Clause
The golden parachute clause generally refers to an agreement entered into by senior executives (including directors, supervisors and management) and the company, in which the company agrees that senior executives can get large severance compensation when they leave the company, and generally it is only triggered when the company is acquired or merged or other events involving a change of control occur. There are only a few cases of golden parachute clauses occurring in China nowadays. For example, the articles of association of China Bao'an Group Co, Ltd (adopted at the general meeting of shareholders on 29 June 2016) stipulate that if the company is taken over – and the duties of the company's directors, supervisors, president and senior management are terminated early as a result – the company must pay economic compensation equivalent to more than ten times the total annual salary and welfare benefits immediately.
The hostile takeover of Vanke Group Co, Ltd by Baoneng Group Investment Co, Ltd, in 2015, and the hostile takeover of ST Tiochemical by Hangzhou Zhemingtou Tianhong Investment Partnership, in 2016, both adopted the suspension strategy, the litigation strategy and the white knight plan.
A high standard of fiduciary duty will be applied to directors when enacting defensive measures. As mentioned in 9.3 Common Defensive Measures, only a few defence measures are applicable, and the directors may be required to justify the reasonableness of the measures to the supervisory authorities. Specifically, in the acquisition of a listed company, the board of directors of the target company shall make investigations, propose suggestions to shareholders and announce a report in respect of the acquisition. Without the approval of the shareholders' general meeting, the board of directors shall not take actions which will have significant impact on the assets, liabilities, interests or operating results of the company.
As noted above, according to the M&A Measures, the shareholders’ meeting has the power to make a decision on whether to accept the tender offer. The directors’ rights to take actions that prevent a business merger are limited. Therefore, directors cannot "just say no".
Litigation is common in connection with M&A deals in China. According to our observation, litigation related to M&A deals may happen to deal with:
Litigation typically occurs post-closing. Disputes related to M&A deals, as mentioned in 10.1 Frequency of Litigation, normally happen after completion of the transaction and, as acquisition of a listed company shall be subject to disclosure procedure and review by the CSRC, disputes rarely happen until the completion of the transaction. Significant changes in the target company may prevent the transaction proceeding.
Shareholder activism is not yet an important force in China. However, with the development of the Chinese stock market, the prosperity of institutional investors and the improvement in securities regulations, it is foreseeable that such activism will likely be strengthened in the near future.
Researches and cases have shown that more minority shareholders are actively participating in shareholder meetings and in online voting for listed companies, especially for institutional investors. China Securities Small and Medium Investors Service Center Co, Ltd, established in 2014, which provides a new way for small and medium investors to exercise shareholders' rights, and is an innovative development of shareholder activism.
Shareholder-derived litigation has happened from time to time in recent years. When the legitimate rights and interests of the company are infringed illegally – and the directors, supervisors and senior managers fail to initiate a lawsuit – then the shareholders of the company may sue in their own name, for the benefits of the company, and the compensation claimed will be attributed to the company. This is also an important manifestation of shareholder activism in China.
Activists in China are focused on the unfair disposal of corporate assets and financial or accounting fraud.
As described in 11.1 Shareholder Activism, activists generally focus on unfair transactions and fraudulent behaviour, which affect the rights of companies detrimentally. M&A transactions, in contrast, generally help to enhance the value of companies and will be encouraged. Spin-offs or major divestitures generally receive a complicated response, since there is a lack of sufficient information to make an accurate judgment.
There are more and more cases where individual minority shareholders and institutional investors successfully interfere with the completion of an announced M&A and restructuring transaction, even though it is not a major challenge for most listed companies where the majority of individual and institutional shareholders remain passive. Institutional investors' active participation in corporate governance may be common abroad, while in China it has still not developed as a mature practice.
The novel coronavirus (COVID-19) outbreak is, without doubt, currently the top issue bringing significant uncertainties to the People’s Republic of China (China). Further, effects are spread globally, affecting the global economy and is, therefore, having a knock-on effect on socio-economic activities. With the potential negative impact on GDP growth in China in 2020, there may be new opportunities, especially in the corporate M&A market. For example, in sectors severely impacted by the COVID-19 outbreak such as the catering and traveling industry, reorganisation or M&A activities are expected to increase considerably. Investments in remote office systems, such as ZOOM, or online education and the likes are also expected to prosper.
To put the COVID-19 outbreak in context, the overall effect of the Severe Acute Respiratory Syndrome (SARS) crisis in 2003 pale in comparison due to its minor and short-lived effects. SARS was only widespread in some cities in China such as Beijing and Guangzhou. In contrast, the COVID-19 outbreak first took place in Wuhan, a large industrial and transportation hub in central China, right before the lunar new year holiday. Before the city was locked down, the virus had spilled across China and even beyond the Chinese border due to the transportation flow of people heading home for the long lunar new year holiday. Economically, in 2003, China was at the starting point of a rapid development resulting from the accession to the World Trade Organisation (WTO). State-owned enterprises were under a reform to retreat from various industries, leaving great opportunities for entrepreneurs. Increasing foreign capital flew into China as a result of strong exports and encouraging foreign direct investment (FDI) policies. The government had a vast space in which to implement an entire set of expansionary fiscal policies.
Today, China has entered a stage of steady domestic development and is facing an increasingly complicated external environment, which is further intensified by the trade disputes between China and the United States (USA). The depression of the global market to be caused by the pandemic will, unsurprisingly, hold back the Chinese M&A market. After years of fiscal expansion, the government is increasingly cautious on using economic stimulus tools. Under which, going into 2020, the COVID-19 outbreak causes even more uncertainties and complexity factors to surface, which is likely to affect socio-economic activities and potential deals in the Chinese M&A market.
Amid the COVID-19 outbreak, the Chinese government reacted swiftly to the situation by promulgating a plethora of policies, including requiring banks to provide financing support, subsidising certain enterprises for interest payment, allowing enterprises to postpone the payment of rent and labour insurance, and postponing the deadlines for listed companies for the disclosure of financial reports. Certain industrial sectors and enterprises may get more support than before. For instance, enterprises engaging in the development of equipment to fight the epidemic may enjoy lower financing costs. Even with such supporting policies, enterprises short of cash flow will still find it difficult to survive the epidemic if it were to last for months. This will drive dealmakers with abundant cash to look for cheaper targets.
Moreover, the epidemic would cause major changes to work and life-style. Certain industries may benefit from the increasing demand for products and services that can help people live and work under the threats of widespread infectious diseases, whilst other, outdated business models might be abandoned. Consequently, dealmakers will adjust the valuation methods to reflect the changes. Lastly, the long break of economic activity in many cities may hit global supply chains such that enterprises might have to consider moving production out of China, and enterprises short of liquidity might have to dispose of their assets, both resulting in an increase in cross-border transactions.
COVID-19 may also have impacts on the performance of executed transactions. Chinese governmental authorities, trade associations, arbitration institutions and courts have declared that they will assist enterprises in obtaining force majeure certificates. However, whether a force majeure argument can be justified remains to be decided in the context of a specific transaction and disputes on the causation in relation to the influence that the COVID-19 outbreak caused may occur. Disputes could also arise out of a “material adverse change/material adverse effect” clause, under which termination rights can be triggered. In addition, due to the travel restrictions and potential exposure risks involved in face-to-face meetings, dealmakers and advisory firms will require more innovative solutions in conducting due diligence and further executing the full M&A life cycle. The outbreak could also increase uncertainty during the period from the signing and closing of a deal.
US-China Trade Disputes
Phase One agreement
The USA and China have been engaged in an economic conflict since 2018 when President Trump imposed tariffs and trade barriers on China (among other nations). Negotiation attempts have brought execution of the “Phase One” agreement on 15 January 2020. The Phase One act, formally known as the Economic and Trade Agreement between the United States of America and the People’s Republic of China, became effective on 14 February 2020. Currently, its execution faces uncertainties and complexities as a result of the COVID-19 outbreak.
Under the deal, China committed, inter alia, to increase US imports by at least USD200 billion above the 2017 level within the next two years and to improve its protection of intellectual property rights. The USA has conceded to halve part of the new tariffs imposed on China. The signing of the Phase One agreement is seen as a temporary truce rather than an end of the dispute, as a large portion of the tariffs imposed still remain. It is believed that the Phase One agreement only deals with the easier aspects of the disputes between the parties.
Influence on outbound China investments
In terms of M&A, global M&A fell by 16% from the same period last year in the third quarter of 2019, hitting the lowest quarter volume since 2016 according to data compiled by Refinitiv. In the same report, statistics show that deals in Asia plunged by 20% due to the US-China trade dispute and Hong Kong’s pro-democracy protests, reaching its lowest since 2017. Throughout 2019, due to the volatility brought about by the trade dispute, companies were seeing more risks, and were less likely to take an aggressive approach in engaging in M&A activities. Deals decreased significantly and became more slow-paced due to the cautious attitude. Discrepancies between the parties made it difficult to come to a consensus, which resulted in frequent cases of deals being called off just before closing. The growing uncertainties of market prospects and fears of a continuous downward spiral of China’s economy, compounded by other negative factors such as outbreak of the COVID-19 epidemic, may cause M&A activities to continue to plunge even further in 2020.
For outbound investments, the so-called “Made in China 2025” programme has raised an alarm for US lawmakers and the USA has since tightened the restrictions on Chinese-led investments and mergers by intensifying scrutiny and broadening the jurisdiction of the Committee on Foreign Investment in the US (CFIUS). The new powers will make it possible for CFIUS to thoroughly scrutinise and restrict investments from China, particularly in the high-technology and other sensitive industries involving “critical technologies”. Although the new program for foreign investment review by CFIUS does not single out specific countries, it is generally believed that the selected industries primarily reflect concerns with Chinese investment trends. Furthermore, the technological rivalry between the USA and China has quickly escalated with the campaign against Chinese technological companies such as ZTE and Huawei, and the Trump Administration barring US companies from using Chinese telecommunications network equipment in the USA. This in turn results in retaliation, with China delaying its approval on or blocking deals involving US companies such as Qualcomm's proposed USD44 billion takeover of the Dutch chipmaker, NXP.
The increased screening from CIFUS and the technological rivalry have hugely affected China’s outbound investment in the USA. Analysts in EY have stated that Chinese acquisition of American companies fell by almost 95% from its highest point of USD55.3 billion in 2016 to USD3 billion in 2018. Increasing difficulties in investing in the USA have triggered Chinese firms to alter their investment schemes by investing in other regions such as the European Union (EU) and Southeast Asian countries. Coupled with the “One Belt One Road” initiative, there is an increasing number of deals made in Asia, Europe and Africa in industries such as infrastructure, natural resource, agriculture and logistics.
Resulting in relocation
Throughout the trade dispute, the US government has imposed tariffs on more than USD360 billion of Chinese goods, and China retaliated with tariffs on more than USD110 billion of US products. The tariffs being imposed on Chinese products have caused China-based manufacturers, both domestic and foreign invested, to invest in or relocate to other regions or countries. More investments on value-added projects are being moved to the Taiwan and Singapore, among others, while more manufacturing capacities of the lower end of the supply chain are being moved to other developing countries, such as Vietnam, Indonesia and India.
Influence on inbound foreign investments
The trade dispute and the relocation of investments away from China have caused China to further open its market to foreign investment and level the playing field for foreign investors. Amid the trade dispute, the People’s Republic of China Foreign Investment Law and its implementing regulations (Foreign Investment Law) came into force on 1 January 2020. The new statute relaxes regulations on foreign investments by streamlining the investment administration process, emphasising the protection of investments to respond to foreign investors’ concerns, and giving equal treatment to domestic and foreign-invested companies, except where investments are made in industries which are prohibited or restricted under the Special Administrative Measures for the Access of Foreign Investment (Negative List).
During the trade dispute, China shortened the Negative List twice, in 2018 and 2019, loosening restrictions on foreign investment and allowing for larger foreign ownership of key industries such as financial services, energy, telecommunications, automotive, etc. For example, under the latest Negative List, the limit on foreign ownership in securities companies was increased from a third to 51% with the undertaking that 100% foreign ownership will be allowed by 2021. Similarly, foreign investors currently may hold up to 50% ownership in automotive business (except for special vehicles and new energy vehicles), and each foreign investor may invest in up to two automotive manufacturers. The Chinese government undertakes to remove the forgoing restrictions in 2020 and 2022, respectively. The use of the Negative List aims to reduce the scope of discretionary administrative review on foreign investment transactions and to build confidence from foreign investors due to the certainty in being able to rely on a definitive official list rather than discretionary interpretation of the laws and policies.
Being one of the largest markets, globally, China’s liberation by further opening its market will attract investors to devour the opportunities lying within the loosened restrictions. Enhanced foreign investor protections are also expected to increase inbound investment and M&A deals.
China’s transformation of the economy
Recent trends also suggest that the trade dispute is contributing to China’s transformation of its economy from an export-driven economy to one driven by consumption, technology and innovation. It is a popular view that the trade dispute with the USA has served as a wake-up call for China, whereby China cannot afford to continue to rely on western technologies for its development and growth. Therefore, China must change from being a major manufacturing power to a leader in technological innovations. As such, sectors such as consumption, technologies and healthcare deserve more attention from investors looking for new opportunities in China.
China’s strengthening of intellectual property protection
To a large extent, the trade dispute and the Phase One agreement have expedited China’s steps to strengthen its protection of intellectual property rights. China has long adopted a practice of trading its market for technologies. As a result, foreign investors often need to transfer their intellectual property rights as a condition for entry into the Chinese market. The USA has a long history of complaining about China’s feeble protection of intellectual property and weak enforcement against intellectual property infringements.
But even without the trade dispute, enhancing protection of intellectual property rights is inevitable for China as “it transforms from a major intellectual property consumer to a major intellectual property producer”. Under the new Foreign Investment Law, forced transfer of intellectual property by foreign companies using administrative measures are explicitly prohibited and stronger protections for foreign intellectual property and trade secrets are stressed. The amended Trademark Law and the proposed amendments to the Patent Law both stipulate to increase punitive damages for malicious infringement.
Overall, the trade dispute between the USA and China are not only about trade and business. It is also the inevitable result of the competition for technological supremacy and fundamental ideological and cultural differences between the two largest economies in the world. The trade dispute has had a lasting impact on not only both parties of the dispute, but also the rest of the world. With the signing of the Phase One agreement, the prospect looks brighter for the moment. However, uncertainties remain as to whether the deal will be properly implemented and whether the parties may come to terms as to a second phase. If not, the already turbulent environment for investment and M&A in China will become increasingly challenging in the years ahead.
Developments in China’s Legal Framework on Cross-border M&A
Worldwide outbound M&A activity by Chinese investors in 2019 increased by 42.27% in value over 2018 standards based on disclosed deal volumes (USD206 billion), though the number of transactions (462) declined by 6.1%, according to Morning Whistle. The leading industries in M&A activity by deal number were manufacturing, finance and TMT. The USA, the United Kingdom (UK) and Germany remain the top three destinations, although Chinese investment in the USA has significantly decreased in number over 2018 due to a combination of factors, particularly the China-US trade dispute and the tightening scrutiny over Chinese investment in the USA by CIFUS. With the temporary truce of the trade dispute following the Phase One agreement and the finalisation of the FIRRMA regulations, investment activity in the US is expected to pick up in 2020. Driven by the “One Belt, One Road” initiative, Chinese investment in the Silk Road countries, including India, Latin America and the Association of Southeast Asian Nations (ASEAN) countries, is increasing on a yearly basis and the momentum is likely to continue through 2020.
The past few years witnessed a rapid growth of outbound M&A activity from China, creating a challenge for Chinese regulators. In order to curb anomalies in the growth of outbound investments, the China National Development and Reform Commission, Ministry of Commerce (MOFCOM) and the State Administration of Foreign Exchange (SAFE), the key gatekeepers overseeing outbound investment from China, intensively promulgated a series of rules and regulations in 2017 attempting to streamline the governmental procedures to guide Chinese investors towards rational investment actions. In the following years of 2018 and 2019, China’s outbound M&A activities displayed a generally matured rationality and, accordingly, promulgation of new regulations have mitigated the pace as well. Overall, there have been no material revisions made to primary regulations relating to overseas direct investment.
Furthering the opening-up and facilitating foreign investments was the keynote of the 2019 M&A policies, which is also essential to China’s economic development. The implementation of the new Foreign Investment Law on 1 January 2020 marks China’s entry into a new era of foreign investment regulations, bringing far-reaching impact on M&A of wholly Chinese owned enterprises by foreign investors (“Foreign M&A”) in China.
Under the previous legal regime governing inbound M&A in China, especially Provisions on M&A of Domestic Enterprises by Foreign Investors (M&A Regulations) promulgated in 2006 and later revised in 2009, Foreign M&A were subject to the approval of the competent commerce authority, under which, Foreign M&A involving cross-border share swap and strategic investments in Chinese listed companies are subject to the approval of the MOFCOM.
Following the implementation of the Interim Measures for the Record-filing Administration of the Formation and Modification of Foreign-Invested Enterprises in 2016 (Record-filing Measures), the case-by-case approval requirement for Foreign M&A under the M&A Regulations was abolished and replaced by a simplified Record-filing mechanism. Foreign M&A, including those involving cross-border share swap and strategic investments in Chinese listed companies, only needs to be filed with the commerce authority for record. Therefore, the pre-requisite procedure for registration for change of shareholders by the target company (Company Registration) is no longer required, provided that the transactions do not fall under the Negative List.
With the coming into effect of the Foreign Investment Law, the Record-filing Measures ceased to be effective. The Foreign Investment Law provides that, where a Foreign M&A takes place, an initial information report shall be submitted electronically via the Enterprise Registration System in parallel with the Company Registration, which is a further streamlined process following the record-filing system.
Under the new legal regime, the MOFCOM, which used to serve as the primary government agency overseeing foreign investment over the years, has withdrawn from the “frontline” of foreign investment administration. Instead, the shared responsibilities of playing the “gatekeeper” role now fall on the market supervision and administration departments, the relevant industry authorities and other “competent authorities”, who shall jointly ensure the effective enforcement of the Negative List. In spite of the forgoing, it is worth noting that the Negative List specifically includes Foreign M&A between related parties (Related Party M&A) in addition to certain prohibited or restricted industry categories. It is provided that Related Party M&A shall be administered in reference to the current-in-effect provisions. Whether Related Party M&A will continue to be a subject under examination and approval by the MOFCOM, even in the new era, is still a question yet to be answered.
Not surprisingly, the Foreign Investment Law is silent on the Variable Interest Entities (VIE) issue. Although the definition of “foreign investment” as provided in Article 2 of the People’s Republic of China Foreign Investment Law includes “a foreign investor’s acquisition of any share, equity, share of property or other similar rights of an enterprise located within the territory of China”, in which the concept of “similar rights” could arguably be interpreted to cover the VIE structure, leaving room for future legal enforcement where and when necessary. Nevertheless, as the latest 2019 version of the Negative List has been succinctly reduced to include only 40 entries, with further loosening of restrictions on foreign investment along the way, the VIE model could hopefully become a diminishing issue going forward.
Under the abolished People’s Republic of China Sino-Foreign Equity Joint Ventures Law and the People’s Republic of China Sino-Foreign Contractual Joint Ventures Law, transfer of equity interest of foreign investment enterprises (FIE) requires unanimous consent of all non-transferring shareholders. Under the system contemplated by the Foreign Investment Law, the People’s Republic of China Company Law shall equally apply to the transfer of equity in an FIE the same way as a domestic company. Under which, no shareholder consent is required for equity transfer between current shareholders, and consent from only half of the voting rights of non-transferring shareholders is required with obligations placed on dissenting shareholders to purchase the equity subject to the transfer. This change evidently increases the liquidity of equity interest held by foreign investors in China.
Following the effectiveness of the Foreign Investment Law, a large number of regulations, rules and regulatory documents may need to be amended or even abolished, including the M&A Regulations, one of the most relevant governing rules for Foreign M&A. It is not yet crystal clear whether provisions under the M&A Regulations such as the conditions for cross-border equity swaps, the requirements of asset evaluation as basis for pricing as well as the payments schedule in Foreign M&A, will still be applicable. Moreover, while the Foreign Investment Law provides that it will govern reinvestment activities by FIEs in China, the Interim Provisions on Investment Made by Foreign-Invested Enterprises in China enacted in 2000 has not been expressly nullified, and it remains to be seen how these rules can merge and come into play together.
It is noteworthy that, in October 2019, SAFE promulgated rules explicitly lifting restrictions on FIEs which are not investment companies with respect to using their registered capital for reinvestment in China, provided that the reinvestment complies with the law and does not fall under the Negative List. These new rules are expected to boost reinvestments made by FIEs in China with smoother funding sources, which is consistent with the legislative purpose of the Foreign Investment Law to promote foreign investment activities in China.
Merger control and national security review
China adopted its Anti-monopoly Law in 2007 and has now become one of the three major jurisdictions in terms of merger control. Since March 2018, the newly established State Administration for Market Regulation (SAMR) has become the competent authority for all anti-monopoly enforcement matters, including anti-monopoly review of concentration of undertakings (ie, merger control review). Within the Anti-monopoly Bureau of SAMR, three divisions are tasked to review merger control filings while another division is responsible to investigate suspected illegal concentration of undertakings (ie, gun-jumping violations).
In 2019, SAMR received 503 merger control filings, initiated review over 462 filings and concluded review over 465 filings. Among the 465 filings, no case was prohibited, five cases were approved with restrictive conditions, while all the remaining 460 cases were approved without conditions (accounting for 98.9%). Out of the five cases approved with restrictive conditions, four are concentration between foreign companies, including American, Canadian and European companies, while one is concentration between a Chinese company and a European company.
In general, SAMR has enhanced the efficiency of its review. More than 80% of the filings were initiated as simple case, and the review period of time from initiation to clearance for most simple cases were less than 20 days. However, review of the five cases eventually approved with restrictive conditions were time-consuming. The average review period was 353 days.
In 2019, SAMR has investigated 36 cases of gun-jumping violations and made punishment decisions in 18 cases. Till now, the only punishment made is imposition of fines and the highest amount of fine to date is RMB400,000. However, it should be noted that SAMR has proposed to significantly increase the upper limit of fines to 10% of the turnover in the preceding year, which implies that a fine of millions of dollars or more would be possible in the future.
Turning to national security review, its importance for M&A in China becomes more prominent considering that China has comprehensively implemented the Negative List regime and that the Negative List has been significantly shortened in recent years. National security review was formally introduced in China through a notice of the General Office of the State Council in 2011 ("2011 Notice"), followed by interim rules promulgated by MOFCOM in the same year ("2011 Interim Rules"). The new Foreign Investment Law includes a provision (ie, Article 35) confirming the establishment of the national security review. As this provision does not contain detailed rules, review of M&As remains subject to the 2011 Notice and the 2011 Interim Rules, until further regulations or rules are promulgated.
Two developments in 2019 are worth noting. First, since 30 April 2019, the National Development and Reform Commission (NDRC) has replaced MOFCOM to act as the authority to receive applications for national security review and to deliver review decisions. Second, it was publicly reported for the first time that an acquisition was cancelled thanks to its pessimistic prospect to pass the national security review. In Yonghui’s acquisition of Zhongbai, Yonghui, a listed company, announced that it received a notice from NDRC requiring it to apply for national security review on 21 August 2019, only two days after Yonghui announced that it has received clearance of merger control review from SAMR. On 13 November 2019, Yonghui announced that NDRC, after completing general review, had decided to launch special review over the acquisition. On 17 December 2019, Yonghui decided to cancel the acquisition.
As a big step forward, China opened a new stock trading market in Shanghai Stock Exchange (SSE) since mid-2019 named the STAR (Sci-Tech innovation board) Market.
As indicated in accordance with its official slogan “Where the Rising Star Companies Cluster”, the STAR Market aims to welcome high-tech companies especially those engaging in TMT sectors to go public in China. It mainly supports high-tech industries and strategic emerging industries such as New Generation IT; High-end Equipment; New Materials; New Energy; Energy Conservation & Environmental Protection; Biomedicine. It promotes the deep integration of Internet; Big Data; Cloud Computing; Artificial Intelligence and Manufacturing.
Under the “Pilot Registration-Based IPO System”, SSE plays a key role in reviewing the initial public offering (IPO) filings on this Market, compared to the IPO filings with other markets in Shanghai or Shenzhen, which are under substantial review by the China Securities Regulatory Administration (CSRC). The STAR Market is much more open to IPO filings from TMT sectors. Among other purposes, it provides diversified listing standards, which makes it is possible for issuers which has not yet make profits, such as biomedicine companies, to go public. It also tolerates companies with different governance structure such as dual class voting rights and allow pre-IPO employee options to mature after the listing, which were almost impossible under the other markets due to the substantive CSRC reviews. Currently, the new People’s Republic China Securities Law (Securities Law) amended in December 2019 which came into effect on 1 March 2020, has codified the Registration-Based IPO System which had been on pilot run under the STAR Market for nearly a year. With the new Securities Law coming into force, the Registration-Based IPO System will also be implemented on the Shenzhen Stock Market (SZSE).
It is anticipated that, with the IPO reform on both the SSE and SZSE markets, increasing TMT companies may choose to go public in the Chinese capital market, which used to be burdened by the extensive CSRC review. The Chinese capital marker is now much more attractive with the increased efficiency in the reformed review process and the high yield prospects. Therefore, there is an anticipated trend that investment and M&A activities will pay more attention on high-tech industries and strategic emerging industries promoted by the STAR Market and the forthcoming SZSE new board.