On 5 March 2011, China will implement its first National Security Review (NSR) regime. This NSR regime will govern foreign acquisitions of domestic companies. The precise boundaries of this NSR regime has been set out in a notice (specifically, a Notice on Establishing National Security Review by Foreign Investors issued by the State Council1. ).
We know, from the notice mentioned above that, broadly, a foreign-local transaction may only be caught if: (a) the foreign company acquires de facto control over a local company; and (b) the local company is involved in selling goods or services in relation to either national defense security or national economic security. [Note that if a foreign company acquires a local company involved in selling goods or services in relation to national defense security, the threshold set out in (a) (i.e. de facto control) does not need to be established. In other words, the transaction will come under the purview of the notice, despite there being no de facto control.]
This article outlines the above mentioned two thresholds (i.e. de facto control) and what is meant by national defense and national economic security in more detail.
De facto control. Pursuant to the notice, we know that de facto control refers to a situation where a foreign investor (or a group of foreign investors): (a) acquire 50% or more of the shares of a target company; (b) otherwise has significant influence or operational control over the target. Some examples of significant influence or operational control include exercising material influence over the resolutions of general meetings or shareholders meetings; making decisions in relation to the operations of the target; making decisions in relation to issues to do with human resources, finances and technologies etc. In other words, a lot centers on the concept of "control" – this is a well tested used corporate or commercial term or concept – in China and in other jurisdictions.
National Defense Security and National Economic Security. Pursuant to the notice, we know that in order for a proposed transaction to be caught by the NSR regime, the local company must be one which partakes in a business to do with national defense security or national economic security.
The notice indicates that businesses to do with national defense security includes businesses which amount to domestic military industrial enterprises, businesses associated with the military industry; businesses located in the peripheries of important or sensitive military facilities; and businesses which otherwise have a bearing on national defense.
The notice also indicates that businesses to do with national economic security include businesses in the following areas: agricultural products, important energy and resources, important infrastructure, important transportation services, key technologies, key equipment manufacturing.
The notice makes it clear that the lists above are not exhaustive lists.
Since the publication of the notice, we have been receiving requests by clients who are concerned in relation to whether their industries will be caught by the "national economic security" list above.
Our response to them is that we think that the concepts of "national defense security" and "national economic security" are deliberately broad in the notice. The objective of which is to be able to bring into line a transaction which may impinge on national defense or national economic security in China. We also expect that either the State Council or the authorities in charge of the NSR review process (the Ministry of Commerce (MOFCOM) and the National Development Reform Commission (NDRC)) will publish implementation rules or more detailed explanation in relation to which transactions are expected to be "caught" by the NSR regime.
In the meantime, we are of the view that a good reference is to look back at past decisions, regulations and guidance from the State Council, MOFCOM and the NDRC to figure out which industries or sectors may potentially fall under the purview of the NSR regime.
For instance, in 2006, the State Council issued an opinion which sheds some light into what may amount to a "key equipment manufacturing" business. Specifically, the State Council’s Opinions on Revitalizing the Machinery Manufacturing Industry state that the following 16 categories of businesses would have significant impact on national economic security and national defense construction:
• businesses involving large-scale clean and high efficient power generation equipment;
• businesses involving power transmission equipment and transformation equipment;
• businesses involving megaton large-scale ethylene complete equipment and that of the p-xylene (PX), purified terephthalic acid (PTA) and dion complete equipment;
• businesses involving large-scale coal chemical industry complete equipment;
• businesses involving large-scale thin slab cold-hot casting and rolling complete equipment and coating process complete equipment;
• businesses involving large-scale integrated underground coal mining, elevating and washing equipment;
• businesses involving large-scale marine oil engineering equipments;
• businesses involving core technologies in relation to the high-speed train, novel subway vehicles and other equipment;
• business involving large-scale environmental protection equipment;
• businesses involving large-scale construction machinery such as large section rock road headers;
• businesses involving automatic control system of important project and key precise testing instrument;
• business involving high-speed numerical control equipment, numerical systems and functional units;
• businesses involving new types of textile machinery;
• businesses involving new types and high horse powers in relation to agricultural equipment;
• businesses involving key equipment in relation to integrated circuit, manufacturing equipment in relation to New Panel Display, manufacturing equipment in relation to electronic components, whole machine loading equipment, digital medical image equipment and specialized equipments for bioengineering and medicine manufacturing purposes; and
• businesses involving civil airplanes, engines and airborne equipment.
Aside from the opinion above, there are also other documents issued by the Chinese authorities which may assist in the interpretation of what constitutes a business bearing on national economic security and national defense security. For instance, on 18 December 2006, the State-Owned Assets Supervision and Administration Commission (SASAC) issued a press release entitled "National Economy Should Maintain Absolute Control of 7 Industries". This press release listed the following 7 industries which, according to the SASAC, would have large bearing on national security and on the "lifeline" of the national economy. They are: (a) defense; (b) power generation and distribution; (c) oil; (d) petrochemicals; (e) telecommunications; (f) coal; (g) aviation; and (h) shipping.
While the above mentioned opinion and SASAC press release gives some indications as to what types of businesses or sectors may fall under the purview of the NSR regime, nothing is set in stone, till we receive further guidance from either the State Council, MOFCOM or the NDRC. If in doubt as to whether your proposed transaction would fall under the purview of the NSR regime, we recommend that legal advice may be sought.
1 For more on these regulations, please see article entitled "National Security Review Mechanism Formally Established in China" dated 18 February 2011.