China's New National Security Review Will Examine Foreign Investment in Chinese Companies

The State Council of the People's Republic of China has published a notice detailing its national security review ("NSR") procedure for the acquisition by foreign investors of domestic Chinese companies ("NSR Notice"). The NSR Notice, which implements Article 31 of the PRC Anti-Monopoly Law, will be applicable as of March 6, 2011.


The NSR Notice provides for review and potential rejection of acquisitions of Chinese companies by foreign investors where such acquisitions could affect national security, economic stability, social order, or research and development capabilities relating to key technologies. It applies to acquisitions in a wide range of industry sectors.


As with many of these types of rules found in other jurisdictions, the NSR Notice leaves great discretion in the hands of Chinese government agencies. Whether these rules will constitute another serious obstacle for foreign companies doing business in China will depend on how they are applied in practice.




The NSR Notice represents the culmination of a vigorous debate that has been underway in China for years regarding the perceived national security issues arising from foreign acquisitions of domestic companies, with particular concern focused on "strategic and sensitive" industries and Chinese "national champions."


The new rules must be read in light of the close scrutiny that the U.S. government has paid to Chinese foreign investment in the U.S. Public information suggests that the U.S. agency responsible for national security review of foreign investment under the so-called CFIUS procedure has sought to unwind Chinese acquisition of U.S. technology. (For more information on the U.S. CFIUS process, see the Jones Day Commentary "Exon-Florio Alert: Regulations Implementing FINSA Take Effect.")


Which Transactions and Sectors Are Subject to NSR?


The NSR potentially has a very wide scope, in terms of sectors and types of transactions.


Applicable Sectors. The NSR applies to proposed acquisitions of domestic enterprises not only in the defense sector but also where those acquisitions otherwise bear on national security. This includes areas such as agriculture, energy, transportation, technology, and equipment manufacture. There is no further clarification on what these terms actually will cover.


Types of Transactions. The NSR applies to any transaction in which a foreign investor gains control of a domestic enterprise or its assets. In particular, the following situations are covered:


  • Foreign investors purchase equity in a domestic non-foreign invested enterprise ("non-FIE"), thereby transforming it into a foreign-invested enterprise ("FIE").
  • Foreign investors purchase equity held by Chinese shareholders in a domestic FIE or subscribe to a capital increase in same.
  • Foreign investors establish an FIE and such FIE purchases assets from or equity in a domestic enterprise.
  • Foreign investors directly purchase assets of a domestic enterprise and use these assets to establish an FIE that operates these assets.


Definition of Control. The NSR Notice defines "control" to include situations in which: (i) foreign investors own more than 50 percent of the shares; (ii) a foreign investor owns less than 50 percent of the shares but has sufficient voting rights to exert a material influence over the shareholders vote and resolutions of the board of directors; and (iii) foreign investors otherwise gain actual control of management decisions, human resources, or technologies.


Who Is Conducting the NSR?


The State Council has set up a joint ministerial panel ("the Panel") to conduct NSR. The Panel is under the leadership of the State Council and is led by the National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM"). It includes other relevant agencies depending on the industry sector involved.


What Does the Review Entail?


The Panel will assess the effect of the transaction on national security, including the effect on the capacity to produce domestic products, equipment, and facilities related to national security. It also will assess its effect on the stability of the national economy, on basic social order, and on research and development capabilities for key national technologies.


What Is the NSR Procedure?


A foreign investor will have to file a notification with MOFCOM regarding any transaction falling under the scope of the NSR rules. Third parties also may refer to MOFCOM any transaction for which they deem NSR necessary. Following receipt, MOFCOM will submit the case to the Panel within five working days if MOFCOM believes the transaction is subject to NSR review.


The Panel will first conduct a shorter "general review," which potentially may be followed by a more intensive "special review."


General Review. Within five working days of receiving the notification from MOFCOM, the Panel will request the views of all relevant government agencies, which then have 20 working days to respond in writing. Within five working days after receiving comments from the agencies, the Panel must notify MOFCOM whether a special review should be conducted. Hence, in total, the general review at most will take 35 working days.


According to the NSR Notice, if all of the commenting agencies are of the view that no further review is warranted, the Panel will not initiate a special review. However, if some of the agencies believe that the transaction may affect national security, then a special review will be undertaken.


Special Review. The special review can take up to 60 working days (in addition to the 35 working days for general review). If the Panel is able to reach a consensus, it will notify its decision to MOFCOM. If the Panel cannot reach a consensus, it will submit the matter to the State Council for decision. MOFCOM will notify the applicant of its decision in writing.


Participation of the Applicant to the Procedure. The parties to the transaction must cooperate with the Panel during the review, submit documents and information needed for review, and respond to any questions. They also may apply to MOFCOM to modify their transaction plans or withdraw their application.


Possible Measures. If the Panel concludes that the transaction may affect national security, the Panel will request that MOFCOM and other agencies take the appropriate measures to eliminate such impact, such as by ordering the termination of the transaction or directing transfer of shares or assets. However, there are no explicit sanctions for failure to make an NSR application.


What Is the Interplay with the Merger Control Procedure?


Different Thresholds. Not all transactions subject to merger review under the AML will be subject to NSR, only those involving control over a domestic enterprise in a key sector. Mergers between foreign companies or between domestic companies will not be subject to NSR. Conversely, not all transactions subject to NSR simultaneously will be subject to merger control review—for example, when the parties do not meet the merger control thresholds and MOFCOM does not sua sponte initiate antitrust review. (For more information on China's merger filing requirements, see the Jones Day Commentary "New Merger Notification Thresholds Under the AML Published.")


Timing. Although the NSR Notice provides some timing details for NSR itself, some questions remain open. It is unclear how MOFCOM will treat transactions that are notified both under the AML merger control process and the NSR Notice. The NSR Notice does not specify by when an NSR application must be made, including whether it can be submitted prior to finalization of the transaction agreements merely on the basis of a memorandum of understanding. By contrast, MOFCOM increasingly requires final executed transaction documents before formally initiating antimonopoly merger review.


Notion of Control. The definition of "control" under the NSR Notice seems consistent with MOFCOM's practice in the merger control context (See "China: Merger Control," The Asia-Pacific Antitrust Review, 2010). One possible exception could be where a foreign investor buys a stake in a domestic company, thereby increasing total foreign ownership above 50 percent, but no individual foreign shareholder will have control. It is likely that such a scenario would not trigger a merger control notification because of the absence of a change in control. However, it could trigger a notification under the NSR Notice, because several foreign investors now will together own more than 50 percent of the shares. One problem is that under certain circumstances, a foreign investor might be unaware that its acquisition of shares will increase foreign ownership above 50 percent and thus require an NSR Notice, such as with publicly listed companies.


China's "CFIUS"?


While China's new national security review procedure bears some resemblance to the U.S. CFIUS process, there are significant differences as well. Overall, both have the same basic goal—to review foreign investments in domestic companies for their effect on national security. However, China defines "national security" much more broadly than does the definition used in CFIUS review. For example, although the U.S. statute—the Foreign Investment and National Security Act ("FINSA")—includes "critical infrastructure" in the definition of "national security," the CFIUS regulations specifically reject defining classes of systems or assets as "critical infrastructure." CFIUS also explicitly has rejected the inclusion of the concept of "economic security" in the definition of "national security," although as a practical matter CFIUS does consider economic issues if they affect national security. By comparison, China's NSR Notice expressly indicates that "national security" will include such economic concerns as impact on domestic capacity, the domestic economy, "basic social order," and domestic R&D capabilities.




It remains to be seen whether China's NSR process will result in economic protectionism or even will consider economic protection issues. The Notice appears to allow for such considerations, if desired. In contrast, the U.S. CFIUS regulations specifically disavow economic protectionism and reiterate U.S. government policy to encourage direct foreign investment in United States industries.


The text of the State Council's Notice and an unofficial translation can be viewed on the Jones Day web site.


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