Attributed to implementing the reform and opening-up policy, China embraced an influx of international capital and thus gained significant economic growth over the past 40 years. Nowadays, with the escalation of geopolitical tensions and the trend of de-globalization, especially when the United States enacted the Foreign Investment Risk Review Act and designated the People’s Republic of China as one of the foreign adversaries, China correspondingly amended its strategy on utilization of foreign investments. While simplifying foreign investment procedures and expanding foreign access to certain industries areas to an extent, China also launched the regulatory system for the national security review of foreign investment.
The Negative List is one of China’s management models that refers to special administrative measures for the access of foreign investment in specific industries or areas, constituted by two parts: prohibited investment and restricted investment. In summary: (a) Foreign investors shall not invest in the sectors where foreign investment is prohibited, e.g., mining, tobacco, and news organizations, etc.; (b) For the restricted investment areas, foreign investors shall conform to the investment conditions, such as shareholding limits and senior management requirements. For instance, the foreign share ratio for most value-added telecommunications services shall not exceed 50%; (c) For the areas beyond the Negative List, no extra approval is required as the Chinese government grants national treatment to the foreign investor.
The Chinese government launched the Negative List model in 2017 and has periodically amended it. The latest revision of the Negative List relieved over half of the restrictive measures in the 2017 edition, demonstrating China’s continued willingness and ongoing efforts to attract foreign investment and stimulate economic growth. For most global capital investors and strategic investors, the scope of direct investment in Chinese domestic industries through M&A transactions has further expanded.
On the other hand, China has amended its security review regime by promulgating the Measures for the Security Review of Foreign Investment. Compared to the previous national security review system, the new national security review (“NSR”) mechanism broadened the transaction coverage and specified a more defined review process.
Under the Measures for the Security Review of Foreign Investment, the following industry sectors require a foreign investment governmental report:
a. investment in the arms industry, an ancillary to the arms industry;
b. any other field related to national defense security and investment in an area surrounding a military installation or an arms industry facility; or
c. investment in essential agricultural products, vital energy and resources, critical equipment manufacturing, necessary infrastructure, essential transportation services, essential cultural products and services, substantial information technology and Internet products and services, critical financial services, key technology, or any other important field related to national security, resulting in the foreign investor's acquisition of actual control of the enterprise invested in.
Where the reported foreign investment passes security review, the foreign investor then may invest; otherwise, it may not make invest, or if it has invested, it shall dispose of its resultant equities or assets within a specified period and take other necessary measures to restore the state before the investment and eliminate the adverse effect. Under certain circumstances, the security review may be passed conditionally, subject to mitigation factors.
Nevertheless, after the promulgation of Measures for the Security Review of Foreign Investment, China still needs to issue corresponding implementation rules to specify the terms therein, including defining those industrial sectors that may trigger NSR. In practice, foreign investments in specific sensitive industries like semiconductors, AI, and data centers are more likely to trigger NSR.
In the international investment markets, some may say the People’s Republic of China modeled its Security Review Measures after the Committee on Foreign Investment regime in the United States. For instance, both of them established governmental bodies with which parties can report and which will make national security decisions. The concepts of “control” are similar and are tied to the ability of the foreign investor to influence the enterprise. However, at the current stage, the procedures, criteria, and considerations of the Chinese government during NSR are not as publicly transparent as those of the United States. Therefore, it is still advisable for foreign investors to continuously monitor changes in NSR regulations and practices in China and conduct NSR assessments when contemplating the M&A transaction involving Chinese factors.
Under the volatile global condition, China’s cross-border M&A market presents considerable opportunities and challenges. It’s essential to provide a balanced view and conduct thorough compliance research to assess risks and develop a well-informed strategy to navigate the complexities of the Chinese market.
