Security law will scare investors, lawyers say

PUBLISHED : Monday, 14 March, 2011, 12:00am
UPDATED : Monday, 14 March, 2011, 12:00am

Beijing's new national security law will create uncertainties for foreign investors hoping to acquire mainland companies, lawyers say.

The law - the Security Review System on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors - took effect on March 5.

'It creates greater uncertainty for foreign investors,' said Edmund Sim, a partner at Appleton Luff, an international law firm.

'Unlike China's existing anti-monopoly law, there are no value or market share criteria that trigger application of this new law. By introducing more uncertainty into the foreign investment process, this new law will discourage investment into China.'

A document by WilmerHale, an international law firm, warned: 'The Security Regulations will potentially subject a large number of merger and acquisitions (M&A) by foreign investors in China to an additional layer of review.'

Attempts by mainland companies to acquire foreign firms have already been blocked by foreign governments on national security grounds.

In February, Shenzhen-based Huawei Technologies, the country's largest telecommunications equipment manufacturer, called off its US$2 million bid for part of 3Leaf Systems, an insolvent IT company in the United States, after initially refusing the US government's request to withdraw on national security grounds.

Conversely, in 2008 US private equity firm Carlyle Group retreated from attempts to buy a controlling stake in tractor parts maker Xugong after three years of bureaucratic hold-ups. During the process, mainland media raised eyebrows by claiming Xugong was a strategic national business.

Last week Minister of Commerce Chen Deming told state media: 'We have many companies that hope to invest in the US. Recently, Huawei's attempt to acquire 3Leaf Systems ran into difficulties. So we need to negotiate the protection of investments between both sides, and enable Chinese companies to receive legal protection overseas.'

China's non-financial overseas investments reached US$59 billion last year, equivalent to 60 per cent of foreign investment in the country, Chen said. He hoped that in five to 10 years, this investment flow would be evenly balanced, adding that overseas investments would increase in future.

The national security review law was driven by the fact that China led the world in attracting US$100 billion in foreign investment last year, and also the expectation of more acquisitions of Chinese companies by foreign investors, WilmerHale said.

'China is doing what a lot of countries have been doing much earlier,' said Tracy Wut, a partner at Baker & McKenzie, an international law firm. 'It is better that China's law is now more in line with international practice.'

The national security review law covers the defence sector including mainland firms that supply the country's defence industry, as well as non-defence sectors involving companies and technologies that have a bearing on national security. In the non-defence sector, companies and products in agriculture, energy, resources, infrastructure, transport and technologies can come under this law if deemed to affect national security.

Under the new law, national security includes not only military defence but also 'national economic stability' and 'social order'.

The idea of a national security review of foreign acquisitions in China is not new, said Wut. 'What is new is that it sets out for the first time the formal process of how foreign companies file an application for a national security review of their acquisition of Chinese companies. In the past, there was no formal system for foreign companies to file for an application for a national security review.'

Applications are filed to the Ministry of Commerce. The central government agencies conducting the national security review are led by the Ministry of Commerce and the National Development and Reform Council, in consultation with other ministries that constitute a joint committee.

For most straightforward cases, the law requires the mainland authorities to respond within 35 days to the application, said Lui Chunfai, special counsel at Baker & McKenzie. 'In the majority of cases which are not problematic, you have a clear prescribed timeline. You don't have to wait in suspense.'

In more sensitive and difficult cases, the review can go to the State Council, but the law does not say how long it will take, Lui said.

In the past, the authorities assessed national security issues in relation to foreigners' acquisitions of mainland firms on a very ad hoc basis, Lui said. 'The Chinese government agencies approving the foreign acquisition would take national security as part of the overall consideration. It was more of a black box, you never new how they considered it.

'This law makes it less of a black box. This makes the approval process more streamlined and transparent. The new regime enables foreign parties to apply and obtain express clearance. This provides certainty for an investor by making sure there won't be surprises springing up.'

However, there are areas of implementation of this law that are not clear, said Wut. 'One sensitive area is key technologies that have a bearing on national security.'

Lui said: 'Because the industry sectors are not well defined and the terms such as 'key technology' are too broad, deal-makers will scratch their heads over whether, for example, investment in a software start-up in Chengdu would come under the purview of the new regime and require a filing. There will be ambiguities, until the interpretative stance and enforcement trends manifest themselves over time.'

At present, the law sets no threshold on the value or size of the transaction, said Wut.

'It will be onerous if transactions of small sizes are caught. Without a threshold, the Ministry of Commerce will find thousands of applications on its desk. How will they handle it?'

Awash with dollars

The national security law was driven by foreign investment last year, in US dollars, in China that totalled: $100b