China M&A in 2020: Key issues for foreign investors to consider

Introduction

With the promulgation of the PRC Foreign Investment Law (FIL) and the amendments to a few other laws and regulations in recent years, the landscape of the regulatory regime with respect to foreign investment in China has been reshaped, which has significant impact on both greenfield investments and M&A transactions by foreign investors in China. After the FIL comes into effect on January 1, 2020, foreign-invested enterprises will, generally speaking, be in the same position as domestic enterprises in terms of the formation, corporate governance, operation and dissolution, and be subject to the same subscribed capital system. However, when foreign investors acquire Chinese companies, they still need to consider, among many other matters, the following key issues. 

Market entry

China now adopts a “negative list” regime setting out the industry sectors in which foreign investment is prohibited or subject to restrictive measures. Foreign investment in any listed restrictive industry will be subject to the approval by the foreign investment regulatory authority while foreign investment falling outside of the negative list will enjoy national treatment and be only subject to filing requirements. 

China has established 18 pilot free trade zones (FTZs) which adopt a separate “negative list” that is a bit shorter than the nationwide negative list. It means that some industry sectors or businesses which are not opened up to foreign investment outside FTZs may be permissible in FTZs.

Onshore structure vs offshore structure

Similar to many other jurisdictions, acquisition of a Chinese company by foreign investors may be structured as a share deal or an asset deal. A share deal may be structured either onshore or offshore whilst an asset deal would have to be structured onshore as a corporate vehicle will be required to host the assets acquired.

Compared with offshore structure, onshore acquisition enjoys less flexibility in terms of determining the term and conditions for the transaction, selection of governing law and associated dispute resolution mechanism, etc. PRC regulatory procedures will apply and certain statutory requirements have to be followed, for instance, foreign purchasers are required to pay off the consideration to Chinese sellers within a prescribed period of time, which makes the earn-out mechanism infeasible. Tax implications may also be different under the two structures. Similarly, at the time of divestment, foreign investors may also prefer to structure the transaction offshore.

Special rules and industry-specific requirements

Depending on the nature of the target, special rules and industry-specific regulations may apply to the acquisition by foreign investors. For example, investment in financial service industries shall be subject to industry-specific regulations issued by the respective regulatory authorities; and foreign investment in China stock exchange listed companies is subject to the listing rules and specific requirements governing foreign investors’ strategic investment in listed companies, e.g. acquisition of no less than 10 percent of the issued shares of the targets.

Cross-border transfer of funds

Due to China’s stringent foreign exchange control regime,  the inflow of investment funds, the repatriation of dividends and the outflow of proceeds from the divestment by foreign investors are subject to various foreign exchange control requirements and must follow special procedures. 

National security review

Any foreign investment which may pose potential impact on national security shall be subject to a security review under the FIL. The regulatory authorities are upgrading the existing rules related thereto which were issued in 2011 but have not been actively enforced to date. 

Merger control filing

A merger control filing requirement may arise if the transaction constitutes a concentration of business and the applicable turnover thresholds are met by the relevant business undertakings. Merger control clearance is usually listed as one of the conditions to the closing of any acquisition.

Additional considerations

• Sanctions: China is enacting an “unreliable entity list” of foreign entities and individuals whose uncommercial acts are detrimental to the interests of Chinese enterprises. China may also adopt measures on a reciprocal basis against any country or region which has adopted discriminative measures for investment from China.
• Anti-bribery and anti-corruption: Adequate due diligence should be carried out prior to the transaction and necessary provisions should be incorporated in the transaction documents to reduce potential bribery and corruption risks in light of the increasing efforts of Chinese enforcement authorities in combating bribery and corruption in the commercial sector.
• Cybersecurity and data privacy: Over the past several years, China has developed a robust cybersecurity and data privacy regime and Chinese regulators have taken enforcement actions against non-compliance. It is extremely important that investors should conduct sufficient due diligence to address the legacy cybersecurity and data privacy issues and concerns and build in proper protections in the M&A transactional agreements for risk mitigation.
• Continuing legislative development: After promulgation of the FIL, the existing foreign investment-related rules are being reviewed and updated by relevant legislative/governmental authorities. New rules are expected to be released progressively and some matters discussed in this article may need to be revisited under the new rules.