By Wu Ye and Luo Yi King & Wood Mallesons’ Corporate & Securities group
On 30 July 2017, a beautiful sunny Sunday in midsummer, without expectation the Ministry of Commerce (“MOFCOM”) issued two documents relating to foreign investment in China. This was only two months after MOFCOM released draft measures.
The inclusion in the record-filing system of foreign mergers and acquisitions not involving special access administrative measures (negative list) and related-party M&A signals that foreign investment in China has entered an era known as the “Pre-establishment National Treatment (PENT) and negative list”.
King & Wood Mallesons has more than a decade of foreign investment experience, and has closely followed up with foreign investment regulatory regime from case-by-case approval to the latest record-filing system. Last year we published two articles – Farewell to the Era of Case-by-Case Foreign Investment Approvals and What a Negative List! We discussed the content, impact and trajectory of the reform on incorporation and changes to foreign-invested enterprises. All foreign M&A is now subject to the record-filing system. This marks the beginning of a new chapter for foreign investment in China and new opportunities.
Milestones in the development of the record-filing system
The reform to the new system has been ongoing for the last three years. It has been trialed in free trade zones since December 2014 and was finally implemented in July 2017. In previous articles we pointed out that the earlier systems had imperfections. However the 2017 Catalogue for the Guidance of Foreign Investment Industries and the Decision correct the issues of absence of a national-level uniform negative list and the loopholes in the systems’ scope of application. This marks the official beginning of an overall “PENT and negative list” regulatory era for foreign investment in China.
Background of the Decision
1.Practical foundation and support by foreign investors
Since the adoption of record-filing in October 2016, procedural requirements have been greatly simplified. Record-filing takes only 3 working days on average. This is much more efficient than the 20 working days that approval previously took. Material can now be filed online via the foreign investment integrated management information system (the “integrated management system”).
“It is a huge leap to reduce one month to just two days! We are indeed enjoying the great convenience brought by record-filing,” an officer from Adient Management (China) Co., Ltd. said.
The success of record-filing for incorporation and change of foreign-invested enterprises and the positive response from foreign investors serve as a practical reference and feasible prediction for its application in foreign M&A.
2. Improved institutional basis
On 23 May 2017, the 35th meeting of the Central Leading Group for Comprehensively Deepening Reform approved the Catalogue for the Guidance of Foreign Investment Industries (2017 Revision), to advance the opening-up of key sectors and ease market access for foreign investment and improve the opening-up level in the service, manufacturing, and mining industry by creation of a “negative list”.
On 28 June 2017, NDRC and MOFCOM jointly issued the Catalogue for the Guidance of Foreign Investment Industries (2017 Revision) (the “2017 Catalogue”) which replaced the existing 2015 Catalogue. Instead of the previous division of industries into encouraged, restricted and prohibited categories, the 2017 Catalogue has only two categories: the encouraged category and the Special Administrative Measures for the Entry of Foreign Investment (the “negative list”). The negative list is further divided into two categories: restricted and prohibited. However, restrictions which apply to both domestic and foreign investments and restrictions which are not relevant to entry are not included in the negative list. The 2017 Catalogue provides a uniform negative list on a national level and perfects the management model of pre-establishment national treatment plus a negative list, laying an institutional foundation for the implementation of record-filing for foreign M&A.
On 28 July 2017, Premier Li Keqiang held an executive meeting of the State Council to promote the attraction of more investment and to build a more open environment. It was decided at the meeting to expand the management model of PENT plus a negative list in free trade zones nationwide; speed up the “single window, single format” administration in the record-filing and registration of foreign-invested enterprises; and improve legislation on foreign investment. Record-filing for foreign M&A will arrive, driven by top-level policy support and the success of record-filing for incorporation and changes of foreign-invested enterprises.
Focus of revision
The revision brings foreign M&A under the record-filing system if special administrative measures and related-party M&A are not involved in the following situations:
- merger and acquisition of non-foreign-invested enterprises in China
- strategic investments in listed companies by foreign investors
Major focuses of this revision are:
1.Merger and acquisition of domestic companies and strategic investments in listed companies by foreign investors that fall under the scope of record-filing are subject to record-filing.
Merger and acquisition of domestic companies by foreign investors includes equity and asset acquisition.
Equity acquisition means:
- The acquisition of equity of shareholders of domestic non-foreign-invested enterprises; or
- the subscription to additional capital of domestic companies by foreign investors to convert such domestic companies into foreign-invested enterprises.
Asset acquisition means:
- the incorporation of foreign-invested enterprises by foreign investors to acquire and operate assets of domestic companies by agreement; or
- the acquisition of assets of domestic companies by foreign investors by agreement and investment of those assets to establish foreign-invested enterprises for operation of such assets.
The strategic investments in listed companies by foreign investors means:
- the acquisition of “A-shares” in listed companies which have undergone equity separation reform through medium- and long-term strategic M&A investment of a certain scale; or
- the acquisition of “A-shares” in new listed companies after the equity separation reform through medium- and long-term strategic M&A investment of a certain scale.
According to the Decision, if special administrative measures stipulated in the 2017 Catalogue and related-party M&A are not involved, merger and acquisition of non-foreign-invested enterprises in China and strategic investments in listed companies by foreign investors shall be subject to record-filing. Merger and acquisition of non-foreign-invested enterprises in China and strategic investments in non-foreign invested listed companies that fall within the scope of record-filing should be treated as an incorporation of a new foreign-invested enterprise. This requires completion of the Application Form for Incorporation and uploading other materials through the integrated management system. The introduction of a new strategic investment into foreign invested listed companies under the scope of record-filing should be treated as a change of foreign-invested enterprises. In this case, an Application Form for Change must be completed, along with the uploading of other materials through the integrated management system.
2.Reduce submission requirements and improve efficiency
The most significant change brought by the foreign M&A record filing system is its simplification of application materials. For example, under the approval system, one had to supply asset/equity valuation reports, statement of domestic target company’s investments in other enterprises (in the case of equity M&A) and the preceding financial year’s financial audit report of the domestic target company (in case of equity M&A).Under the record filing system, applicants only need to provide assessed value, the reference number of the financial audit reports and indicate if any enterprise invested by the target company is subject to special access administrative measures in the Application Form for Incorporation. The record filing system has effectively reduced the materials needed.
Processing time has dropped sharply. Also, the process is much quicker under the new system. Under the approval system, it took 30 days to complete the procedure after submission of all required materials.Under the record filing system the prescribed processing period is only 3 days after all required materials have been uploaded. In principle, the record filing and the industrial and commercial registration of foreign-invested enterprises may proceed at the same time, which further speeds up the process.
Record-filing has simplified the application materials and enhance efficiency, which reveals the reformatory trend of the management of foreign investment, from prior approval to regulation during and after investment.
3.Ultimate control structure of foreign-invested enterprises required
The Decision seeks disclosure of the “ultimate control structure of a foreign-invested enterprise”. Previously, it was the applicant who determined the ultimate controller and disclosed the ultimate controller’s information, type and control mode in the Application Form for Incorporation. We consider that the newly added “ultimate control structure of a foreign-invested enterprise” refers to the entire shareholding structure of the relevant foreign-invested enterprise including its ultimate actual controller. MOFCOM will no longer rely on the applicants’ discretion and may comment on the accuracy of the determination of the ultimate actual controller and the clarity of the shareholding structure of a foreign-invested enterprise based on the control structure. As M&A has just been subject to record-filing system, MOFCOM’s real intention in requiring the foreign invested enterprises to upload the ultimate control structure is to be further explored through practice.
4.Related-party M&A is still subject to MOFCOM’s approval
Related-party M&A refers to when domestic companies, enterprises or individuals, through their duly established or controlled company outside China, merge with or acquire any affiliated domestic companies.
According to Article 11 of the Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (“M&A Provisions”),
“if domestic companies, enterprises or individuals merge with or acquire their affiliated domestic companies through a duly established or controlled company outside China, such merger and acquisition shall be submitted to the MOFCOM for examination and approval. The parties to the merger and acquisition shall not circumvent such approval requirement by disguising the transaction as a pure foreign investment or by other means.”
In the Decision, M&A between affiliates is explicitly excluded from the scope of record filing, reflecting the strict stance on affiliated transactions by MOFCOM. Any related-party M&A shall be submitted to MOFCOM for approval in accordance with the M&A Provisions, whether or not it is subject to any special access administrative measures.
5.Equity of overseas ordinary companies may be used as consideration for merging with or acquire a domestic enterprise by foreign investors
Under the approval system, certain special requirements had to be met for a foreign investor to merge with or acquire a domestic enterprise by using its equity in overseas companies (“cross-border equity swap”). Specifically, overseas companies involved in a cross-border equity swap must be overseas listed companies or SPVs. This meant that a foreign investor could not use its equity in overseas ordinary companies as consideration for the M&A transaction.
However, under the new system, the Decision states that:
“if a foreign investor pays with its equity in overseas companies, an Outbound Investment Certificate for the domestic enterprise which obtains the equity of overseas companies shall be submitted”.
This means, as long as the M&A accomplished through a cross-border equity swap meets the record-filing conditions, it is subject to record-filing in accordance with the Decision. Related overseas companies will not need to be SPVs or overseas listed companies. Therefore, foreign investors may use their equity in overseas ordinary companies as consideration for M&A transactions. In this way, foreign investors have more options to fund their M&A deals.
What will become of foreign investment in China
1.Foreign M&A will become the main model for foreign investment
Statistics from the Ministry of Commerce show that in 2016, 27,900 foreign-invested enterprises were established. This is an increase of 5% from 2015. China’s actual use of foreign capital amounted to RMB 813.22 billion (USD 126 billion), increasing by 4.1%. From January to June 2017, 15,053 foreign-invested enterprises were founded, increasing by 12.3% from the corresponding period of 2016. The actual use of foreign capital reached RMB 441.54 billion, decreasing by 0.1%. In general, foreign M&A is a major form of foreign investment. Take US-funded investment as an example – except in 2015, the total amount of US M&A investment in China increased every year. From January to June this year, investment by US companies through M&A increased by 2.3%.
Based on the effect of the implementation of record-filing in the incorporation and changes of the foreign invested enterprises from last October, the implementation of the record-filing system has streamlined procedures and documents and improved efficiency. It has been received with appreciation by investors. Its implementation in foreign M&A investment, will make foreign investment more convenient and time-efficient. Risks and uncertainties over M&A cases will greatly reduce. Compared to green field investment, M&A investment saves investment cost, optimizes resource allocation and improves capital efficiency. Therefore, we believe this reform will attract more foreign M&A investment.
2.There will be an increase in foreign investment
The Decision significantly streamlines the documents required for filing, representing a shift from prior approval to regulation during and after investment. This increased efficiency will attract more foreign capital into the market and allow foreign investors to be more active in the market. The Decision also extends the range of filing to investing in domestic listed companies by foreign investors. Previously, potential foreign investors had to meet certain requirements to become shareholders of listed companies, and only the foreign investors that meet such requirements and approved by MOFCOM are able to become the shareholders of the listed companies. The new filing system that replaces this approval process will greatly reduce such difficulties for foreign investors making strategic investments in listed companies. It will also reduce investment costs. Therefore, we can reasonably anticipate an increase in foreign investment in the domestic capital market.
3.Almost equal treatment for foreign investment capital and domestic capital
The Decision means that incorporation and change of foreign-invested enterprises and foreign-funded M&A will be subject to the management model of “PENT and negative list”. This action represents China’s resolutions to authority streamlining, combining delegation and regulation, service optimization and attracting foreign investment. With a series of reforms (except for industries in the negative list) foreign investment activities basically receive equal treatment with domestic capital. There are no material differences in application procedures, processing timeframe, regulation method, industry policy and tax treatment. The differences between foreign capital and domestic capital have further reduced.
4.Expectations for Foreign Investment Law
With the platform offered by KWM, we have participated in the consulting and counselling work for amendment of the three existing foreign investment laws and the enactment of the Foreign Investment Law (draft). This has given us insight into the direction of the States’ reform, which is further opening up and simplifying and optimizing the foreign investment environment. Although these reform measures are a big step in the right direction and are quite effective, there are still issues to be solved. These include – a lack of transition, an immature system, a lack of supporting rules, and conflicts between filing measures and other special laws. We believe that the reform will lead to a phase-out of the Catalogue for the Guidance of Foreign Investment Industries, an equal market entry mechanism for foreign and domestic capital, uniform laws and regulation of domestic and foreign capital, establishment of a regulation method of “limited approval and full report” and the release of a new Foreign Investment Law.
As legal practitioners that have get used to foreign investment approval system for the past decade, we have also undergone a process of gradually adapting to the record-filing system. Since our country is taking a more open, transparent and market-oriented attitude to foreign capital, market players and participants should embrace changes and respond to challenges with an open mind. We sincerely look forward to expecting that foreign investors continue to increase their investment by introducing more high-end, intelligent and greener projects in China, so that they can become real engine to optimize industrial structure, promote economic transition and protect the eco-environment while enjoying the benefits of policy reform in China as always.
 the Decision on Revising the Interim Administrative Measures for the Record-filing of the Incorporation and Change of Foreign-invested Enterprises (“the Decision”) and the 2017 No. 37 Announcement on Matters Related to the Administration of the Record-filing of the Incorporation and Change of Foreign-invested Enterprises (“the Announcement”)
 Interim Administrative Measures for the Record-filing of the Incorporation and Change of Foreign-invested Enterprises (“the Draft)”.
 Cited from “Four Months After Record-filing for Foreign-invested Enterprises: Easier Investment, Happier Foreign Investors” (《外资备案制全面实施四个月：投资更便利 外企很满意》), People.cn, 25 January 2017.
 It is suggested to consult and confirm with local commerce department, or administration for industry and commerce before processing, since local practices may differ.
 In previous practices under M&A approval system, a common review criterion agreed by MOFCOM and the China Securities Regulatory Commission was that both parties in a cross-border equity swap must be listed companies. Under the current record filing system, detailed regulations need to be made with respect to specific operation procedures for cross-border equity swap and to be verified in practice.
 Source: Regular Press Conference of the Ministry of Commerce (13 July 2017)
 Source: Regular Press Conference of the Ministry of Commerce (3 August 2017)
 In accordance with the Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors
 Such as entity type, total asset, shareholding of the listed company and lock-up period.
 The Law on Sino-foreign Equity Joint Ventures, the Law on Wholly Foreign-owned Enterprises, and the Law on Sino-foreign Cooperative Joint Ventures