Germany continues to be a popular investment destination for Chinese investors in Europe. Chinese investors, as a new and strong force, show up frequently in auction processes in the German M&A market. While sellers and financial advisors alike appreciate the high prices Chinese investors are often prepared to pay, Chinese bidders tend to have a reputation for not being able to keep pace with European or US bidders, and for offering less transaction security because of Chinese regulations for outbound investments. Questions that regularly come up include the following:
- What is the Chinese regulatory framework for outbound investments, and what are the key points to factor in when assessing the overall attractiveness of a Chinese bidder in the bidding process?
- What is the Chinese government’s real intention? Various ongoing regulatory changes in China seem to conflict–for example, a tightening of foreign exchange control on one the hand, and an easement of the filing system for Chinese outbound investment on the other hand.
- How does the current foreign investment review regime in Germany, as amended, affect transaction security, particularly as applicable to Chinese investors?
This article aims to answer these questions by giving a brief overview of (i) the basic Chinese regulatory framework for Chinese outbound investments (Section 2) including recent changes (Section 3) and (ii) the applicable regime under the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz) (Section 4), before concluding with a summarizing assessment (Section 5).
2. The Regulatory Framework in China for Chinese Outbound Investments
Generally, any outbound investment by a Chinese enterprise must be approved by, or at least recorded with, the competent authorities and their local-level bodies before it can be closed. Each competent authority has its own approval or filing requirements for outbound investments, which differ according to the type of investor, the amount of investment in question and other relevant factors. The competent authorities are as follows:
2.1 The National Development and Reform Commission (NDRC)
The current NDRC regulatory framework for outbound investments is mainly a record filing system.1 Approval2 is required only in exceptional cases. The approval procedure is triggered only by investments involved in sensitive countries and regions (jurisdictions with no diplomatic relationship with China or subject to UN sanctions) or sensitive industries, such as those relating to weapons, cross-border water resources or news media. The NDRC reviews outbound investments to assess whether the investment target helps to foster the Chinese economy as laid down in the “Chinese 2025 plan” and the “belt road initiatives,” for example.
2.2 The Ministry of Commerce of the People’s Republic of China (MOFCOM)
The MOFCOM regulatory framework for outbound investments is also mainly a record filing system. Specific approval is required only in exceptional cases, such as the establishment of overseas companies in sensitive countries/ regions or sensitive industries. The purpose of any review undertaken by MOFCOM is mainly to determine if the establishment of overseas entities is carried out in compliance with applicable procedures for outbound investments. The application documents required for recordfiling for NDRC and MOFCOM are basically the same. After both, NDRC and MOFCOM record filings have been accomplished, the investor must contact State Administration of Foreign Exchange (SAFE) qualified banks for foreign exchange registration and fund remittance.
2.3 The State Administration of Foreign Exchange and SAFE-Qualified Banks
The regulatory framework for outbound investments provides that SAFE-qualified banks in China deal directly with the foreign exchange registration of outbound investment transactions and process subsequent matters, such as opening capital accounts and remitting outbound funds, while SAFE indirectly supervises the foreign exchange registration of outbound investments. However, since November 2016, when the Chinese rules for capital control became stricter for transactions with overseas fund transfers in excess of USD 5 million, any foreign exchange registration and remittance has required permission from SAFE before it can be dealt with by qualified banks. In addition, the local SAFE authority now interviews the relevant Chinese investors to assess the authenticity and compliance of the outbound investment target. In summary, SAFE has moved to center stage from its previous indirect supervision function since the capital control measures were intensified.
Besides the aforementioned generally applicable regulatory framework, there are specific regulatory aspects that apply to state-owned enterprises (SOEs) and listed companies, respectively, both of which are the main players in the outbound investment market.
2.4 The State-Owned Assets Supervision and Administration Commission of the State Council (SASAC)
Under the SASAC Rules, a central SOE3, or any of its subsidiaries which intends to purchase or merge with an overseas listed company, or to otherwise make any major overseas investments, must report the intended transaction to the SASAC for filing or approval, whichever the case may be, and the process must be completed before starting the record filing or approval process with the NDRC. At the beginning of 2017, the SASAC released a list of industry categories in which SOEs are not allowed to invest. In addition, SOEs must not invest in businesses outside their sector of business activity.
2.5 The China Securities Regulatory Commission (CSRC) and Stock Exchanges
CSRC approval is required only for an overseas investment by a Chinese-listed company if the outbound investment constitutes a so-called “material asset restructuring”4 of the listed company. Chinese outbound investments in Germany usually do not meet these criteria.
Cash transactions that do not constitute a material asset restructuring of listed companies account for the majority of outbound investment for Chinese-listed companies.
However, pursuant to the relevant rules of the Shanghai and Shenzhen Stock Exchanges, if a listed company purchases assets which fulfill certain criteria requiring a disclosure of the transaction,5 either a board meeting or a shareholders’ meeting (subject to the company’s articles of association) must be held to review and approve the intended transaction. Pursuant to approval, an announcement must be released in a timely manner that briefly describes the basic conditions of the transaction with information on the deal structure, the counterparty, the target, the main terms of the transaction agreement, the purpose of the acquisition and the impact on the company. Listed companies generally do not need to suspend trading or accept exchange inquiries.
3. Recent Changes to the Regulatory Framework in China for Chinese Outbound Investment
The regulatory framework applicable to Chinese outbound investments was substantially amended by the so-called Measures for the Administration of Overseas Investment of Enterprises (Measures), which took effect on March 1, 2018. The most relevant changes introduced by the Measures, which overall aim to encourage outbound investments, are summarised below:
3.1 Cancelling the Requirement of Project Information Report before Submitting Any Binding Offer
Prior to the Measures, in M&A or bidding projects where the investment volume by the Chinese investor amounted to USD 300 million or more, the Chinese investor was required to submit an additional project information report to NDRC before starting any substantive work, such as signing a binding agreement or the proposal of a binding offer. Since the Measures came into effect, this requirement has become obsolete.
Under the old regime, after receiving the project information report, NDRC would issue a confirmation letter within seven days if it deemed the project to be in line with outbound investment policies. In cases where there were several Chinese investors bidding for a project valued at USD 300 million or more, only one of the investors could ultimately get the confirmation letter to submit a binding offer (so as to avoid a situation where several Chinese investors compete with each other, driving up the purchase price for the potential investment).
Nowadays, in auction processes with a transaction value of more than USD 300 million, Chinese investors must no longer submit a project information report to the NDRC and await pre-approval in the form of a confirmation letter to submit their binding offers. This change puts Chinese investors on equal footing with other international and European bidders in terms of pace to submit their binding offers; sellers no longer need to consider extending deadlines for the submission of binding offers just because Chinese investors are in the process.
In addition, more than one Chinese investor can submit a binding offer, giving the seller the opportunity to choose its preferred bidder amongst several (Chinese) investors–a fact that sellers will appreciate from a price competition perspective.
3.2 Postponing the Requirement to Get Approval or a Filing Notice from Pre-Signing to Pre-Closing
Prior to the Measures, obtaining a record filing notice letter was a signing condition for outbound investments. A Chinese investor could not sign the SPA on the outbound investment prior to filing the transaction and receiving the relevant record filing notice letter.
Under the Measures, Chinese investors must no longer obtain the record filing notice letter before signing, but rather only before closing. This change from a signing condition to a closing condition should speed up the process toward signing when dealing with Chinese investors. The requirement of obtaining the record filing notice from the Chinese authorities is hence brought in line with the standard European or German closing requirements of obtaining merger clearance and clearance for foreign investment control.
While parties may now reach signing somewhat quicker, transaction security may have decreased. Against this background, it is advisable for the seller to consult early in the process with a Chinese outbound advisor experienced in the Chinese regulatory framework to assess potential obstacles to closing due to Chinese regulations.
In addition, agreeing on a break-up fee that shall become due for the Chinese investor in case the required record filing letter is not obtained, may be a good indication of the buyer’s confidence to obtain the record filing notice letter.
3.3 Simplification of Application Process through Option to Bypass Intermediary Review by Local DRCs
In the former regime, any application by local enterprises to NDRC was required to be submitted to local DRCs, which would then forward the application to NDRC after a preliminary review. Depending on the efficiency of the relevant local DRCs, the preliminary review process could be rather time-consuming.
The Measures stipulate that local enterprises may now choose to apply directly to the NDRC without the need to submit any application to local DRCs first. The regional factor has thus become less relevant and the application process can, if so desired, be streamlined.
3.4 Comprehensive Online Platform to Finish All Required Applications and Filings without Having to Visit the NDRC In-Person
All outbound investment-related regulatory matters can now be completed online. Chinese investors can use the established online platform to handle such matters as information exchange, approval, filing, supervision and penalty issue. The new online-based procedures should shorten approval and filing periods.
4. Regulatory Framework in Germany for Chinese Outbound Investment
In Germany, in order to protect public security and order, the Federal Ministry for Economic Affairs and Energy (BMWi) may review acquisitions of German targets by foreign–including Chinese–investors.
A relevant acquisition under the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz, or AWG) is any direct or indirect acquisition of at least 25 percent of the voting rights in a German company by a foreign investor. Voting rights of any third parties are attributed to the investor if it holds 25 percent of the voting rights in the third party, or if it has a voting agreement in place with the third party. Thus, even indirect acquisitions (through [intermediate] holding companies) may be subject to review.
Currently, there are two investment review regimes in place: (i) a sector-specific investment review for investments by any non-German investor investing in targets active in security-sensitive areas (in particular the defencesector and crypto technology), and (ii) a cross-sectoral investment review for investments in all other sectors by any foreign investor located outside the territory of the European Union or the European Free Trade Association region.
The following overview focuses on the cross-sectoral investment review, since it accounts for the majority of investment cases. The key criterion for the cross-sectoral investment review is whether any foreign investments could endanger public security and order in Germany.
In July 2017, an amendment to the German Foreign Trade and Payments Ordinance (Außen wirt schafts ver ordnung, or AWV) came into effect (the New Rules), which inter alia introduced examples of targets that, if acquired, could pose an enhanced risk of threatening public order or security. The list of examples includes operators of critical infrastructure (e.g., in industries such as energy, IT and telecommunications, transportation and traffic, health care, water, finance, insurance and nutrition) as well as developers of software for critical infrastructure and certain other industries (such as cloud computing and telematics). As Chinese investors have traditionally shown a specific enthusiasm for acquiring German tech companies, and many of the listed industries are contained in the Chinese 2025 plan and the belt road initiative, they have certainly taken careful note of the New Rules. The New Rules follow a certain trend toward closer scrutiny of foreign (including Chinese) investments into Germany, as illustrated by cases such as KUKA, Osram, Aixtron and most recently 50Hertz and Leifeld Metal Spinning.
Pursuant to the New Rules, any transaction in any area that qualifies as critical must be notified in writing to the BMWi. Prior to the New Rules, such notification requirement existed only for the sector-specific investment review, not for the cross-sectoral review.
In areas in which there is no notification requirement, the investor may freely choose not to notify the transaction to the BMWi. In these cases, the BMWi can open investigations within three months after it becomes aware of the acquisition, and at the latest five years after the conclusion of the acquisition agreement. The legal uncertainty resulting from the five-year longstop date introduced by the New Rules can be avoided by notifying the transaction to the BMWi and requesting a certificate of non-objection. In fact, it may be advisable in many cases to approach the BMWi voluntarily.
In terms of timing, most investors notify the transaction and apply for a certificate of non-objection between signing and closing the envisaged transaction. However, pursuant to a contested yet prevailing view amongst legal experts, filing the application would be admissable even before signing. In such an instance, however, the transaction documentation should be in final or close to final form, to avoid further review at a later stage based on authorities’ assumption that the conditions of the transaction (or, as in the case of Aixtron, the circumstances) might have changed as compared to the point in time when the pre-signing application for non-objection was made.
If the BMWi does not launch an in-depth review within two months after receipt of the notification (and the application for a certificate of non-objection, as the case may be) or grant the requested certificate, a certificate of non-objection is deemed to have been granted after expiry of the two-month period.
If the BMWi decides to launch an in-depth review within the two-month capture period, it has four months (following receipt of all documents required and requested for the in-depth review) to assess and potentially restrict or prohibit the transaction.
Overall, under the New Rules, a (voluntary) notification combined with an application for a non-objection certificate to the BMWi is typically recommended for the sake of transaction security, at least if the target– after a preliminary assessment–could be deemed active in any of the critical areas. A clearance or deemed clearance under the applicable AWG/AWV should be considered as a closing condition.
Compared with European investors bidding in auction processes for German targets, Chinese investors are burdened with additional regulatory requirements in China and also, potentially, to some extent, in Germany. However, in many cases, Chinese investors continue to be an attractive choice for sellers because they tend to offer high purchase prices and grant the opportunity to access the Chinese market.
The Chinese government, despite certain regulatory restrictions, continues to encourage outbound investments, as illustrated by the Measures. According to guidance on outbound investments issued by China’s State Council in 2017, the Chinese government is furthermore obliged to provide more convenient services regarding approval/filing processes, foreign exchange and other services in order to encourage outbound investments in areas which fall under the Chinese 2025 plan and the belt road initiatives, such as infrastructure, energy, high-tech manufacturing, automation, key software and hardware, and logistics targets.
- Pursuant to the record filing system, a transaction cannot be closed without obtaining a record filing notice issued by NDRC or local Development and Reform Commissions (DRCs). The issuance of such notice is conditioned on the review of the completeness and authenticity of application documents. Typically, the subject/target in the application form is not scrutinised substantially. ↩
- The granting of any approval is conditioned on an in-depth review of the subject/target itself. ↩
- Central SOEs are SOEs that are owned by the Chinese central government, while local SOEs are separately owned by different local governments. The local rules applicable in each province or municipal city are based on the SASAC Rules. ↩
- A transaction constitutes a material asset restructuring if the listed company or any of its subsidiaries purchases an asset which is out of the scope of its daily operating business and additionally one of the following criteria are met: (i) the total value of assets purchased in the latest fiscal year accounts for more than 50 percent of that of the listed company (on a consolidated basis) for the same period; (ii) the operating income generated by the purchased assets in the latest fiscal year accounts for more than 50 percent of that of the listed company for the same period; (iii) purchased net asset value in the latest fiscal year accounts for more than 50 percent of that value of the listed company at the end of the same period and also exceeds RMB 50 million. ↩
- A disclosure is required if any figure such as total assets, operating income or profits of the acquired asset in the most recent year is in excess of 10 percent of that of the listed company for the same period. ↩