China Strengthens its National Security Review

EARLIER THIS YEAR, China issued a set of procedures that strengthen its review of acquisitions of sensitive assets by foreign investors. The process could significantly delay transaction approval by the Chinese government. Indeed, the procedures grant the government broad powers to amend and cancel transactions that it deems to have national security implications.

The “Security Regulations” apply to a broad range of transactions in sensitive sectors including agricultural products, energy, resources, infrastructure, transportation, technology and equipment manufacturing. Even if the investment target is unrelated to national security, the government can review any transaction located near sensitive military facilities.

Transactions that fall within the scope of the regulations include directly purchasing equity shares in a domestic enterprise; purchasing a local shareholder's interest in a foreign-invested enterprise (FIE); purchasing assets or equity from a domestic enterprise through a FIE; and directly purchasing assets of a domestic enterprise.

Transactions that produce over 50 per cent foreign ownership or de facto control will be subject to a security review. Control occurs when a foreign investor, its parent, and any controlled subsidiaries hold more than fifty per cent of the target's shares; when multiple foreign investors hold more than 50 per cent of the shares; when the voting power of the foreigner's share, even when under 50 per cent could have a material impact on shareholders' meetings, the general assembly of shareholders or the board of directors; and when foreigners obtain de facto control of the target's business decisions, financial affairs, personnel, technologies or other important business elements.

The Ministry of Commerce (MOFCOM) and the National Development and Reform Commission (NDRC) are the regulating agencies, with the State Council having the last word. The regulators will analyze a transaction's impact on national defense, economic stability, social order and key technologies.

MOFCOM and NDRC will organize a special committee, called the “Joint Committee,” composed of relevant agencies to oversee matters falling within the Security Regulations. Investors in transactions suspected to have national security implications must submit the transactions to MOFCOM for review.

Adding to the uncertainty, the regulations also allow the State Council, a national trade association, a company in the same industry and even an upstream or downstream enterprise to apply for a review.

MOFCOM has five days to decide whether a security review is required. If it so decides, it must request the Joint Committee to review the transaction.

The regulations then set out two stages for a security review by the Joint Committee. Overall, if the security review stops at the first stage, it can take up to 35 business days.

But where any relevant department concludes that national security is affected, the second step is triggered, which can take as long as 95 days, not including the time it takes the State Council to make a final decision (which has no time limit).

The greatest difficulty in the process may be that it can be hard to determine whether a transaction is covered by the Security Regulations. The unclear wording of the regulations, for example, has led some observers to suggest that even a small foreign ownership investment in a sensitive sector can trigger a security review.

There is also some concern that the Security Regulations may be retroactively applied. Many lawyers are advising clients to submit a review for any sensitive-sector transaction that is still in the executory stage.