Revving and ready

Chinese outbound companies have never been fuelled with so much energy. Richard Li explores how the authorities are supercharging the country’s outbound vehicles.

If China were a racing car, it would be spinning wheels and burning rubber right now in hot pursuit of overseas investment. Recent regulatory changes at the top level have made it much easier for outbound investors to get “go out” permission, and this has enabled their overseas structures to become more powerful vehicles for outbound acquisitions. All this could fuel the economy’s current hot outbound activity.

A combination of several reasons has driven the central government to ignite companies’ outbound ambitions. “As Chinese companies develop, industrial and technological upgrading becomes necessary, while the domestic market has become increasingly saturated – so they need to go out to develop other markets,” observes Charles Guan, managing partner of Grandall Law Firm’s Shanghai office.

“Also, with many years of development Chinese companies have become much more mature, and stronger in international competition. Meanwhile, both the foreign exchange reserves of the country and the capital reserves of the company have now become more sufficient than before.”

After the State Council published a new catalogue on investment approval, both the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM) followed suit to revise their mechanisms for the review of outbound investment, putting a full stop to approval requirements for a broad range of investment.

[ihc-hide-content ihc_mb_type=”show” ihc_mb_who=”1″ ihc_mb_template=”2″ ]

“So far this year, Mergermarket data show that we are just 30 outbound deals away from matching 2013’s 160 [deals] … Furthermore, the share of outbound acquisitions that are directed towards other regions besides Asia is currently higher than last year,” notes Kirsty Wilson, the global research editor at Mergermarket. “The new regulations announced, which allow less regulatory hurdles for outbound acquisitions as well as a sense of confidence for deal making outside of Asia’s borders, could be influencers for this boost in activity.”

Guan says in general China is active in Western and Eastern Europe, Latin America and Southeast Asia. “In Europe, Chinese investors are active in the high-end manufacturing sector, with investment in countries such as Germany and Poland. The technologies in Germany and its surrounding countries are generally more advanced than many Chinese companies, so acquisitions can bring Chinese companies higher technologies, and the factories and equipment of the target,” he says.

“In Latin America and Southeast Asia, due to the wealth of natural resources, Chinese investments are mainly related to electric power and energy projects. Meanwhile, Chinese co-operation with countries in Central Asia and Africa has also been increasing.”

Guan says large private companies have long since started their business layout overseas. “For example, companies in internet-related sectors have made investments or acquisitions in Japan, South Korea and even the US.” The State Administration of Foreign Exchange (SAFE) has also issued new rules to facilitate the use of special purpose vehicles (SPVs), a common instrument for Chinese companies’ overseas investments.

Offshore jurisdictions seem to be an important channel for China’s outbound mergers and acquisitions (M&A). Based on publicly available information, “in the first six months of 2014, offshore as a region has made up a significant proportion of Chinese overseas M&A activity, approximately a third of volume and of value,” says Judy Lee, a Hong Kong-based partner at Appleby.

“Our analysis of Chinese investment in the offshore jurisdictions where Appleby operates shows that Chinese [companies], acting as acquirers, were involved in 51 offshore-based deals in the first half of 2014,” she continues. Two prominent deals are the US$5.1 billion acquisition of CITIC Pacific by National Council for Social Security Fund and other strategic investors, and the US$3 billion acquisition of Giant Interactive Group by Giant Investment.

According to a PwC report in August, privately owned enterprises (POEs) continued to be an important source of China’s outbound activity in the first half of 2014, while the overseas growth of state-owned enterprises (SOEs) was slower. Telecoms, technology and real estate were important sectors for POEs’ overseas M&A.

“POEs are already changing the landscape of China’s outbound M&A – recent outbound M&A activities are increasingly led by POEs for purely commercial rather than political or strategic objectives, and they are obtaining finance for their acquisitions from international banks rather than relying on support from state-owned banks,” says Vivian Lam, a Hong Kong-based partner at Paul Hastings.

“In future, POE participation in global M&A transactions will only increase, as China continues to liberalise the outbound regulatory regime to encourage offshore investments by Chinese companies,” Lam says.

Xu Ling, a Beijing-based partner at Guantao Law Firm, says POE decisions in cross-border M&A are more market-driven, and they face less policy risks than SOEs. “But compared to SOEs, POEs are less strong and resistant to risks, so it remains to be seen who will play a more important role in the overseas M&A market in future.”

One thing is certain – whether state-owned or private, Chinese companies with overseas horizons need to keep abreast of China’s significant changes in regulation.

New outbound rules

On 2 December 2013, the State Council issued the Catalogue of Investment Projects Subject to Governmental Approval (2013), which took effect on the same date and replaced the 2004 version. In response to the new list, both the NDRC and MOFCOM revised their regulatory rules on Chinese companies investing overseas.

The NDRC published the Administrative Measures on Approval and Record Filing of Outbound Investment Projects, which became effective on 8 May 2014.

Zheng Xilin, a Beijing-based partner at AnJie Law Firm, says the NDRC has shifted focus from approval to recordation in its regulatory practice on outbound investment. In the new rules, only record filing is required for outbound investments that are less than US$1 billion and not related to sensitive countries, regions or industries.

“So in practice, a majority of outbound investments will fall within the scope of record filing,” Zheng says. “The notifying party is not required to submit an application report, but only needs to complete the record filing form and necessary attachments, and this can help companies save much time and cost to prepare notification materials.”

Among outbound deals qualified for record filing, for those less than US$300 million by local enterprises, the NDRC allows the companies to file records with the investment authorities at provincial level. “These measures will streamline regulatory approval procedures for outbound investments by delegating more approval authority to the local counterparts of the regulators,” says Lam from Paul Hastings.

Lam says the less burdensome review process helps Chinese companies compete. “For example, in a bidding situation, where timing and certainty of transaction are paramount considerations, the onus of having to undergo protracted regulatory approvals could make an acquirer’s bid unattractive to the seller,” she says.

Yao Jian, a Beijing-based senior lawyer at Jingtian & Gongcheng, thinks that “the medium to small-sized takeover deals, both private and public, will benefit more, compared with large deals, which are still subject to approval, and greenfield projects, in which case time is not of essence”.

Private enterprises will benefit a lot from the new regulations, adds Xu Guojian, the Shanghai-based managing partner of Boss & Young. “The simplification of the approval or filing procedure related to outbound investment can greatly reduce the costs of outbound investment of private enterprises,” he says. “The approval for the outbound investment of private enterprises is always harder than for SOEs, but the new regulations will help private companies.”

But uncertainties still linger. “All of the new regulations potentially provide a more streamlined process for outbound M&A, but the key, as ever, is with implementation,” warns Kit Kwok, a Shanghai-based partner at DLA Piper. “The new regulations, however, still leave plenty of room for the authorities to assert their views in the process whenever they deem it necessary.”

For example, Zheng, from AnJie, says “the NDRC hasn’t given a specific list of sensitive countries or industries … this means the scope for record filing is uncertain. Competent authorities should give more clarification to the scope for approval and record filing in their outbound investment rules.”

MOFCOM has also taken action. Its Administrative Measures on Outbound Investment were to be effective from 6 October. Similar to the NDRC rules, MOFCOM has also removed the approval requirement for a wide range of overseas investments.

Song Yaxin, a Beijing-based partner at Jia Yuan Law Offices, says that under the new MOFCOM measures, the submission of approval or record filing documents from other authorities is no longer listed as a prerequisite for the MOFCOM review. “Our understanding of the rule is that the MOFCOM and NDRC reviews can happen concurrently,” he says.

Like the NDRC rules, only investments related to sensitive countries, regions, and industries are subject to the approval of MOFCOM. For all other investments, only record filing is required with MOFCOM or its provincial counterparts, according to Sun Jie, a Beijing-based associate at Jia Yuan.

Although Chinese companies may be stimulated by the new rules to go overseas, they should always bear prudence in mind. “Lack of global experience has made some Chinese companies rely too much on the global capacity and operation platform of the target company. As a result, they may not be able to achieve their objectives, and their investment may fail even if the target is successfully acquired,” says Xu Ling, from Guantao.

“So before starting any overseas acquisition, the domestic investor must be clear about the aim of the acquisition and its market orientation, and fully evaluate the investment risks. In the process, they must work out a strategy for integrating the target company – not blindly follow the outbound M&A wave,” she cautions.

Special purpose vehicles

Jay Ze, a Beijing-based partner at Eversheds, says most Chinese companies go through SPVs in their outbound M&A. “Tax arrangement and investment protections are the major factors to be considered in setting up cross-border M&A structures, but China currently has not signed bilateral tax treaties or bilateral investment treaties with many other countries – for example, the US and African or Latin American countries,” he says.

“If the target country for a Chinese outbound investor has not signed such treaties with China, but with a third country, then the Chinese investor needs to set up an SPV in that third country.”

Given the extensive use of SPVs in China’s outbound M&A, the country’s investors may benefit from two recent circulars issued by SAFE, both related to the use of overseas SPVs.

Circular No. 29

On 1 June, the Provisions on Foreign Exchange Administration for Cross-border Guarantee, issue by SAFE, took effect. The circular for publishing the provisions is coded as Hui Fa [2014] No. 29.

Ze says the new provisions will assist with onshore guarantees for offshore debt. “Such guarantees are commonly used to finance Chinese companies’ overseas M&A,” he says. “The overseas M&A platforms set up by Chinese companies are often SPVs, which do not have their own assets; since these SPVs have no assets to pledge for borrowing foreign currencies overseas for acquisitions, they need their onshore parent companies to provide assets in China as the pledge.”

Ze says the old provisions imposed many restrictions on such guarantees. “In the past, onshore companies had to apply and obtain a quota before they could enter into a guarantee agreement, but now this is no longer required,” he says. “Besides, the new provision no longer imposes any limitation on the maximum amount of guarantee.”

Another move towards deregulation is the removal of the need for approval. “In the past, SAFE’s approval requirements for foreign debt, and the difficulty in obtaining such approval, largely blocked the possibility of cross-border guarantee-based financing in cross-border M&A transactions,” notes Chen Li, a Beijing-based partner at Akin Gump Strauss Hauer & Feld.

“Circular 29 has eliminated the SAFE approval requirement before registration, and now only post registration is required … This circular has opened a long blocked financing channel and will thus facilitate Chinese buyers’ outbound investments across the globe.”

For SOEs, however, Ze says that the State-owned Assets Supervision and Administration Commission (SASAC) may still have restrictions on the maximum amount of guarantee. “In a recent cross-border M&A deal, I represented a central SOE … They told me that SASAC still imposes limits on their amount of guarantee, which is not permitted to exceed a certain percentage of their net assets.”

Chinese companies also need to take care in their use of overseas loans. “The proceeds of an offshore debt backed by the onshore guarantee can only be used within the debtor’s ordinary scope of business, and without SAFE’s permission the proceeds cannot be remitted into China,” Ze says.

Circular No. 37

In July, SAFE issued another update related to the use of SPVs – this time a circular regulating the investment, financing and round-trip investment by Chinese residents (including domestic companies and individual residents) through SPVs, coded as Hui Fa [2014] No. 37. Circular No. 37 has come into force and replaced its predecessor coded as Hui Fa [2005] No. 75.

“Circular 37 highlights a focus on outbound investment. Circular 75 discussed ‘raising capital outside China’, whereas Circular 37 discusses ‘raising capital and investing outside China’. The one additional word makes a major difference,” says Maurice Hoo, a Hong Kong-based partner at Orrick.

“Circular 37 simplifies and creates a more favourable environment on Chinese companies’ outbound M&A activities using offshore structures,” adds Kristy Calvert, the China managing director of Ogier.

According to Calvert, Circular No. 37 allows Chinese residents to form SPVs for both financing and investment, while SPVs could only be used for financing under Circular No. 75. While the old circular set the limitation that Chinese residents could only establish SPVs with their domestic assets or interests, Circular No. 37 has expanded this to their offshore assets or interests as well. “Essentially, Chinese residents can establish an SPV without first needing to have a domestic enterprise in place,” she says.

“According to our understanding of Circular 37 itself, after foreign exchange registration, domestic individual residents can use currencies and other methods to do overseas investment directly, which makes it more convenient for individuals to invest overseas” notes Liu Yue, a Beijing-based partner at Jia Yuan.

“However, according to our previous consultation with the foreign exchange administrations in Beijing, Tianjin and other places, SAFE hasn’t started to allow domestic individuals to invest overseas with currencies,” he says, adding this still awaits final confirmation from state and local foreign exchange authorities.

Anti-corruption

While China is loosening its control on outbound investments, its current anti-corruption campaign may make some decision makers hesitate over their overseas ambitions.

Xu Ling, from Guantao, says China has maintained high anti-corruption pressure on an increasing number of sectors since the 18th national congress, and some large SOEs have been involved. “In the short term, inspections, anti-corruption investigations, designation of auditors and the fall of SOE senior managers are all likely to somewhat slow down the overseas M&A plans of some SOEs,” she says. But she believes the impact of the anti-corruption wave will be limited.

“In the long term, the anti-corruption campaign may help bring out the vitality of SOEs … Problems revealed in the anti-corruption campaign may enable SOEs to realise what needs to be cured, and thus they can grow more competitive for overseas expansion,” she says. “SOEs will continue to have the advantage of both financial and policy support, plus the positive effects of SOE reforms. I’m still optimistic about the SOE’s strength for overseas growth,” she says.

Xu Guojian, from Boss & Young, says China’s intense anti-corruption campaign is likely to have a detrimental influence on part of China’s outbound activities, but such influence will be short term. “Large deals without the governmental background will continue to be made. Meanwhile the official anti-corruption campaign will mainly affect some SOEs, so private companies will play a more important role in future,” he says.

Yao, from Jingtian & Gongchen, doesn’t believe the anti-corruption campaign has cooled China’s outbound investment. “We did see cooling down in some industries, for example, iron ore mining, but this is rather a reaction to the downward [trend] of the particular industry, rather than reaction to the anti-corruption campaign,” he says.

“But some other industries have been more active than ever. For example, agriculture is getting much hotter. We have been advising clients on many projects in agriculture business in Australia, North America, South America, Southeast Asia and Africa,” Yao says.

[/ihc-hide-content]