On December 19, 2020, the Ministry of Commerce (MOFCOM) and the National Development and Reform Commission (NDRC) jointly promulgated the Measures on Foreign Investment Security Review (the "Security Review Measures"). The Security Review Measures, which will come into effect on January 18, 2021, is the implementing rules of the foreign investment security review system established by the Foreign Investment Law. Together with the Negative List of Foreign Investment, the Security Review Measures will have a significant impact on foreign investors' investments in certain industries in China.
Under the Security Review Measures, a working mechanism office (the "Working Mechanism Office") will be in charge of the national security review which will be led by NDRC and MOFCOM. The other members of the Working Mechanism Office are not specified in the Security Review Measures, but it's likely that the relevant supervising authorities with jurisdiction over the relevant industries will also be involved in the review process.
The Security Review Measures requires a "foreign investor" or the relevant Chinese entity(ies) to submit a prior declaration with the Working Mechanism Office in terms of the foreign investment falling within the scope of industries subject to national security review.
Under the Security Review Measures, foreign investments refer to the investment activities directly or indirectly by a foreign investor within the territory of China, including the following circumstances:
- a foreign investor alone or jointly with other investors invest in new projects or establish enterprises in China;
- a foreign investor acquires the equity or assets of China domestic enterprises by way of merger and acquisition; and
- a foreign investor makes investments in China in any other form.
The Security Review Measures fails to provide examples of other forms of foreign investment subject to national security review. That said, the definition of "foreign investment" under the existing foreign investment security review rules applicable to investments in China Pilot Free Trade Zones may help to determine whether other forms of foreign investment may be subject to security review which reads as follows: "investments by way of contractual control, entrustment shareholding, shareholding in trust, reinvestments, overseas transactions, leases, subscriptions for convertible bonds".
Scope of Industries Subject to Security Review
Under the Security Review Measures, the following industries and transactions will be subject to national security review:
- industries relevant to "national defense security" such as military industry and military supporting industry; investments in areas close to military facilities and military industry facilities (the "Type I Investments");
- industries relevant to "national
security" where a foreign investor "acquiring actual
control" of the investee company, including the following
- important agricultural products;
- important energy and resources;
- important equipment manufacturing;
- important infrastructure;
- important transportation services;
- important cultural products and services;
- important information technology and internet products and services;
- important financial services;
- critical technologies; and
- other important industries (collectively the "Type II Investments")
Acquiring actual control of an entity would mean:
- acquiring more than 50% of shares;
- acquiring less than 50% of shares but acquiring voting rights that enable to significantly influence the board of directors and shareholders' resolutions; or
- acquiring material influence over the business decisions, personnel, finance, and technology of the investee companies through other means.
The Security Review Measures does not provide for an exhaustive list of "actual control" scenario (i.e., no detailed elaboration on "significantly influence" or "other means"). Again, the factors that are taken into account by the Chinese authorities when determining the "actual control" under the Guiding Opinions for the Declaration of Merger Control would be a good reference for foreign investors in this regard. "Important" and "Critical" are not defined in the Security Review Measures either. The unclear issues will leave the Working Mechanism Office with a wide margin of interpretation and discretion when assessing the transactions.
Based on the Security Review Measures, we summarized below the steps and timeline in connection with the national security review:
- Initial Review: The Working Mechanism Office will determine whether a transaction should be subject to a general review process within 15 business days from the date on which the declaration is accepted.
- General Review: If a general review is required, the Working Mechanism Office will determine whether there are national security concerns within 30 business days after the Initial Review.
- Special Review: If a general review reveals national security concerns, the Working Mechanism Office will initiate the special review process which may take up to 60 business days (or even longer period under special circumstances) to be decided by the Working Mechanism Office. The Working Mechanism Office may make approval, conditional approval or denial decision. A conditional approval applies where the Working Mechanism Office can set up compliance requirements to eliminate the impact on national security and foreign investors or relevant parties agree to comply with such requirements.
Comparison with CFIUS Review
CFIUS is an interagency committee authorized to review certain transactions involving foreign investment in the United States, in order to determine the effect of such transactions on the national security of the United States. Recently, CFIUS has increased scrutiny over transactions involving Chinese parties in the U.S., especially in the industries pertaining to national defense, telecommunications, energy, and high-tech pursuant to the Foreign Investment Risk Review Modernization Act and its implementing regulations (collectively "FIRRMA").
The Security Review Measures and FIRRMA have similar regulatory thinking in terms of scope of transactions/industries subject to security review, declaration process and some other aspects. There are, however, a few important differences between the Security Review Measures and FIRRMA.
- Greenfield investment
It's clear that the Security Review Measures includes greenfield investments. However, greenfield investments may be beyond the reach of CFIUS (excluding the scenario where a foreign investor establishes a new US entity to conduct a merger and acquisition in the United States).
- Scope of investments subject to review
FIRRMA is more detailed than the Security Review Measures in terms of scope of investments subject to review.
Under FIRRMA, CFIUS has authority to review "covered control transaction" and "covered non-controlling investment" (i.e., certain non-controlling investments in US businesses) which includes (i) a foreign person invests in a US business that is involved in critical technology, critical infrastructure, or sensitive personal data (collectively, TID US business), and (ii) the foreign person acquires at least one of the following rights: access to material nonpublic technical information, board membership or observer rights, or any involvement in substantive decision making of the TID US business.
However, the Security Review Measures only lists the types of investments and industries that are likely to be subject to national security review without detailed requirements, and as such the specific scope of transactions/industries subject to review may be expanded or narrowed by the governmental authorities.
- Voluntary vs. Mandatory
The Security Review Measures provides that foreign investors or relevant Chinese domestic parties should take the initiative to submit a declaration to the Working Mechanism Office before implementing the Type I Investments or Type II Investments. Based on our understanding, this is a mandatory requirement.
On the contrast, FIRRMA provides for two types of declaration: voluntary declaration and mandatory declaration. Parties to covered transactions involving a TID US business must submit a mandatory declaration at least 30 days prior to the implementation of the transaction in certain specific circumstances. For transactions which are not subject to the mandatory declaration requirements, parties are not affirmatively required to submit the transaction for review by CFIUS.
Notwithstanding the above, both CFIUS and the Working Mechanism Office reserve the right to request relevant parties to file a declaration if they do not do so voluntarily.
After the Security Review Measures comes into effect, foreign investors, before making investments in China, need to consider whether such investments will be subject to national security review pursuant to the Security Review Measures. In addition to consulting with professional service providers (e.g., law firms), they may also consider communicating with the Working Mechanism Office directly in order to determine whether the foreign investment will be subject to security review. In addition, foreign investors should take account of the new regime in deal negotiation and transaction documents, in particular in terms of transaction timeline and transaction feasibility.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.