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As you may be aware, on March 7, 2003, the PRC Ministry of Foreign Trade and Economic Cooperation ("MOFTEC")[fn1], the State Administration of Taxation ("SAT"), the State Administration of Industry and Commerce ("SAIC") and the State Administration
of Foreign Exchange ("SAFE") jointly issued the Provisional Measures on Foreign Investors Merging with and Acquiring Domestic Enterprises (the "M&A Rules"), which took effect on April 12, 2003.
In the first such regulations adopted in China, the M&A Rules include antitrust filing provisions aimed at preventing over-concentration
and unfair competition in the marketplace. This memo summarizes these provisions and discusses their implications for foreign
investors' M&A transactions in China.
Scope of the Antitrust Filing Requirement
Significantly, although the M&A Rules deal primarily with foreign investors' merging with or acquiring domestic Chinese enterprises,[fn2] the antitrust filing provisions not only apply to foreign investors' merging with or acquiring purely domestic Chinese enterprises,
but also apply to offshore M&A transactions involving offshore entities with operations in China.
In case of a foreign investor's acquisition of an equity interest in an FIE, the M&A Rules provide that such transaction should
be governed by other laws and regulations, in particular, the Several Provisions Concerning Changes to the Equity Interests of Investors in Foreign-invested Enterprises, promulgated by MOFTEC and SAIC on May 28, 1997. However, the M&A Rules further provide that, where other regulations are
silent on specific issues, the provisions of the M&A Rules should be followed as a reference. Since currently there is no
other PRC regulations dealing with antitrust filing with respect to a foreign investor's acquisition of newly-issued or outstanding
equity interests in an FIE, such a transaction would be subject to the antitrust filing provisions contained in the M&A Rules
for reference.
The M&A Rules are also silent with regard to an asset acquisition from an FIE by a foreign investor, and currently no other
PRC laws or regulations provide specific guidance. Based on informal inquiries with MOC, we believe that such a transaction
would also be subject to the antitrust filing provisions contained in the M&A Rules for reference.
Government Agencies in Charge of Antitrust Filing in Merger & Acquisition Transactions
The M&A Rules expressly grant both MOFTEC (and now the Ministry of Commerce ("MOC")) and SAIC the power to regulate the antitrust
filing and to conduct the antitrust review in merger & acquisition transactions. However, the M&A Rules are silent on the
allocation of responsibilities between these two agencies in reviewing the antitrust filing, which could present procedural
challenges in the initial phase of the M&A Rules' implementation.
Antitrust Filing on Foreign Investors' Merging with and Acquiring Domestic Enterprises
The Basic Filing Tests
Article 19 of the M&A Rules provides that the foreign investor must report to MOC and SAIC if a foreign investor's merger
with or acquisition of a domestic enterprise (the "Transaction") meets any one of the following conditions:
- The current year China market turnover of one of the parties in the Transaction exceeds RMB1.5 billion (approximately US$181
million);
- The foreign investor has merged with or acquired over 10 domestic enterprises in the associated industry within one year;
- The China market share of one of the parties in the Transaction has already reached 20%; or
- The Transaction will result in not less than 25% China market share of one of the parties in the Transaction.
Issues to be Clarified
A number of key issues remain to be clarified with respect to application of these tests:
- Transaction Parties. First, the M&A Rules do not define the term "one of the parties in the Transaction." Given that M&A transactions can involve
multiple parties, the lack of such a definition can lead to questions. For example, in case of a foreign investor's acquisition
of outstanding shares in a domestic enterprise, it is unclear whether the term "one of the parties in the Transaction" is
intended to include, as would normally be the case, only the selling shareholder and the foreign buyer (and its affiliates),
or whether it also includes the issuer of the shares itself.
- Affiliate Status/Attribution. Second, in an attempt to prevent foreign investors from avoiding the filing requirement through the use of acquisition vehicles,
the M&A Rules provide that the term "one of the parties in the Transaction" includes all affiliates of the foreign investor
for purposes of meeting the above tests. However, the M&A Rules unfortunately do not further define what constitutes a foreign
investor "affiliate" for these purposes. Parent or group revenues presumably would be attributed to an acquiring entity for
purposes of determining whether the turnover test described above is met. Treatment of non-controlled subsidiaries and non-controlling
parent entities is less clear. Lack of a clear "affiliate" definition and clear attribution guidelines is likely to give rise
to unnecessary confusion and increased transaction costs (in the form of prefiling administrative consultation).
- Recent Acquisitions. Third, in connection with the test that the foreign investor has merged with or acquired over 10 domestic enterprises in
the associated industry within a given year, the M&A rules include no definition to the term "associated industry," which
could be interpreted broadly. Moreover, it is also unclear whether the relevant time period is any given 12-month period,
or any calendar year.
- Market Definition. Fourth, with respect to the market share test, it is unclear whether the "China market share" refers to market share in
a defined industry, or with respect to a specific product or service. The M&A Rules also offer no guidance regarding the methodology
for calculating the China market share of a specific party in the Transaction, or what party(ies) is/are authorized to make
such determination.
- Compliance and Penalties. Finally, it remains unclear whether enforcement responsibility lies primarily with MOC and/or SAIC, or whether self-compliance
will be relied upon for enforcement. The M&A Rules also do not specify the legal consequences for failure to file such an
antitrust report.
Other Events Triggering Reporting Obligations
Even if none of the foregoing tests are met, a foreign investor can still be required to submit a report if:
- The filing is requested by domestic enterprises that are competitors with one or more of the transaction parties, relevant
authorities, or industry associations; and
- MOC or SAIC believe that the transaction will result in the foreign investor holding a "very large" market share (also not
defined), or there exist other important factors that will seriously influence market competition or the national economy
and the livelihood of the people and national economic safety.
Antitrust Review
Once the report is filed, if MOC and SAIC believe the Transaction might cause excessive concentration in the domestic market,
impede or disturb rightful competition, or otherwise harm domestic consumers' interests, they are required to jointly or separately
cause relevant government departments, enterprises and other concerned parties for a public hearing within 90 days of the
report. MOC and SAIC will then decide whether to approve or reject the application. Based on informal inquiries with the MOC,
it appears that the approval decision would be made within such 90-day period regardless of whether a public hearing is held.
Since the M&A Rules give no guidance on the methodology in determining whether a transaction would result in excessive concentration,
impeding or disturbing rightful competition, and harming domestic consumers' benefits, MOC and SAIC in effect enjoy full discretion
to determine whether a specific transaction presents serious antitrust concerns. For foreign investors contemplating an acquisition
in China, this is likely to create completion risk and increase transaction costs.
Antitrust Filing for Offshore M&A Transactions Involving Operations in China
The Filing Tests
Similar to Article 19, Article 21 of the M&A Rules, which applies to offshore M&A transactions involving operations in China,
provides that if any of the following tests are met in a given offshore merger or acquisition (an "offshore transaction"),
the parties are required to file a merger plan with MOC and SAIC (1) prior to any public announcement regarding the transaction
or (2) simultaneously with any filing with the government authority of its jurisdiction of incorporation:
- One of the parties in the Offshore Transaction holds assets in China worth over RMB3 billion (approximately US$362 million);
- The current year China market turnover of one of the parties in the Offshore Transaction exceeds RMB1.5 billion (approximately US$181 million);
- The China market share of one of the parties in the Offshore Transaction (including its affiliates) has already reached 20%;
- One of the parties in the Offshore Transaction (including its affiliates) has a 25% market share in China as a result of the Offshore Transaction; or
- One of the parties in the Offshore Transaction has direct or indirect equity interest in more than 15 foreign-invested enterprises in the corresponding industry as a result
of the Offshore Transaction.
It is interesting to note that for purposes of meeting the asset and turnover test, as well as the test on the number of foreign-invested
enterprises owned, the term "one of the parties in the Offshore Transaction" does
not include affiliates. Accordingly, the use of acquisition vehicles could facilitate avoidance of application of these tests.
However, the M&A Rules provide that for purposes of the China market share test, the China market shares of both the transaction
party itself
and its affiliates should be included.
Issues to be Clarified
Similar to foreign investors' merging with or acquiring domestic enterprises, Article 21 fails to define the term "one of
the parties in the Offshore Transaction," nor does it define the term "affiliates" of one of the parties in the Offshore Transaction.
It also offers no guidance regarding the methodology for calculating the China market share of specific party in the Offshore
Transaction, or what party(ies) is/are authorized to make such determination.
Antitrust Review
Similar to Article 19, Article 21 of the M&A Rules provides that MOC and SAIC will examine whether the merger or acquisition
will cause excessive concentration in the domestic market, impede or disturb rightful competition, or harm domestic consumers'
benefits and then issue and approval or disapproval. Again, no guidance is provided regarding methodology for determining
whether these criteria are satisfied. Moreover, unlike Article 19, Article 21 gives no timeline on the approval process, nor
does it say anything about public hearing.
Exemption from Antitrust Review
Under Article 22 of the M&A Rules, if the transaction has the potential to have a positive impact on competitive conditions,
involves restructuring a loss-making enterprise and assures employment, introduces advanced technology and managerial talent,
improves the company's international competitiveness, or improves the environment, the parties may apply to MOC and SAIC for
an exemption from antitrust inquiry.
Most of these criteria are relatively vague and thus are in effect subject to the sole discretion of MOC and SAIC. The most
useful exemption, however, may be that for a transaction involving restructuring of a loss-making enterprise in a manner which
assures employment. Such a restructuring may serve to avoid the antitrust filing requirement for many M&A transactions.
Further Observations
The M&A Rules provide, for the first time in the PRC's history, a conceptual antitrust framework for certain cross-border
M&A transactions involving China. The M&A Rules' filing requirements are an important step forward toward eventually bringing
China's M&A regulatory environment into conformity with international practice. Further implementing regulations will be needed,
however, to clarify and maximize the practical utility of the policy positions embodied in the M&A Rules, and the open issues
identified above.
Compared with jurisdictions in other major world markets, China's antitrust regime is in its infancy. The near-term effect
of the M&A Rules' antitrust provisions may be to raise more questions than they resolve, and foreign investors may face more
uncertainty in proposed acquisitions than was previously the case. The assistance of counsel will be important in confirming
policy views and the presence of a PRC antitrust filing requirement in connection with potential transactions, especially
during the transitional period before more detailed implementing regulations are promulgated.
Footnotes
1: With the restructuring of certain ministries under PRC State Council announced approved in March 2003 by the National
People's Congress, the functions of MOFTEC have been assumed by the Ministry of Commerce.
2: For purposes hereof, "foreign investors' merging with or acquiring domestic enterprises" refers to (i) foreign investors'
purchase of equity interests in domestic enterprises from the existing shareholders, (ii) foreign investors' purchase of newly-issued
capital stock of domestic enterprises, (iii) foreign-invested enterprises' ("FIEs") purchase, and subsequent operation, of
assets of domestic enterprises, and (iv) foreign investors' purchase of assets of domestic enterprises and subsequent establishment
of FIEs to operate such assets.
