China’s National Security Law (2015) and Foreign Investment Law (2019) both mentioned its national security review procedure, putting the Chinese version of the US’s CFIUS regime under the spotlight. As the Chinese government is gradually reducing its oversight over foreign investment and shifting away from onerous market entry licenses and registrations, the national security review will undoubtedly become increasingly important, especially for global transactions involving Chinese companies. The widened scope of the review, coupled with the lack of transparency in enforcement practice, creates substantial uncertainty for foreign investors. This article provides some insights into the national security review procedure in 12 FAQs.Q&A
What is the national security review in China?
The national security review is a CFIUS-like regime, a review of foreign investment in domestic enterprises of the defense sector and other sectors concerning “national security.” It was first established under the Notice of the General Office of the State Council on Establishing the Security Review System for the Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, issued by the State Council in 2011 (hereafter the 2011 rule). The Ministry of Commerce (hereafter MOFCOM), one of the reviewing agencies, also released implementing rules in 2011.
In 2015, the State Council announced another notice on conducting national security reviews of foreign investment in pilot free trade zones (hereafter the free trade zone rule), to govern the review process in the country’s 18 free trade zones (as of February 2020). Based on this rule, the national security review in the free trade zones is similar but slightly different from the rest of China, as indicated below where relevant.
What types of transactions are covered by the national security review?
The 2011 rule defines two types of transactions to be covered by the regime:
foreign investment via an M&A transaction into a domestic enterprise in the defense sector (including enterprises in the vicinity of key or sensitive military installations);
foreign investment via an M&A transaction into a domestic enterprise related to national security, if the foreign investor could obtain actual control over the enterprise.
For the second type of transaction, it is important to clarify what are the key industries “related to national security”, and how the concept of “control” should be defined. According to the 2011 rule, the key industries include agriculture, energy, infrastructure, technology and equipment manufacture. MOFCOM also circulated an unofficial list of key industries with more refined categories, which is usually relied on in practice. As for “control”, the 2011 rule limits the idea to the ownership, sole or combined, of more than 50 per cent of the shares, or sufficient voting power to materially influence the resolutions of the shareholders’ meeting or the board, or other types of actual control.
It is noteworthy that since the 2011 rule is strictly limited to “foreign investor’s M&A of a domestic enterprise”, a foreign-to-foreign transaction is not covered.
The free trade zone rule is broader than the 2011 rule, though it also defines the two types. It not only covers M&A transactions but also greenfield investment. Specifically for the second type, the key industries additionally include culture and information technology.
Who is in charge of the national security review?
The review work is undertaken by an inter-ministerial panel, led by the National Development and Reform Commission (hereafter NDRC) and MOFCOM, and joined by other government agencies depending on the specific sector involved.
Before April 2019, the filing was made to MOFCOM as the leader of the panel. Due to the change of department functions, now the filing materials are submitted to and accepted by the NDRC. NDRC will also inform the relevant parties of the panel’s final decision.
How is the review process triggered?
The process of national security review can be triggered through a filing made by the investor, referrals from other government agencies, or reports from third parties:
For a transaction falling under the scope of the 2011 rule, the foreign investor is required to file a notification with the NDRC, which will conduct a preliminary screening in around 15 working days, and thereafter within five working days forward the qualified notification to the inter-ministerial panel for review. However, the regime is still widely regarded as a voluntary filing system, because there is no fine for failure to file a notification.
The 2011 rule also provides that other departments under the State Council, industry associations, or other enterprises (competitors, upstream or downstream enterprises) can also propose that the authority launch a review. For example, the State Administration for Market Regulation (hereafter SAMR), the authority responsible for merger control and also a member of the inter-ministerial panel, may share information learned during the merger review process with the panel. Upon such a proposal or referral, the inter-ministerial panel can decide at its own discretion whether to open a national security review process or not.
How long will the process take?
The review process of the inter-ministerial panel includes two phases:
General Review (30 working days): After the filing is forwarded to the inter-ministerial panel, within five working days the panel will solicit opinions from relevant government agencies, which shall give responses within 20 working days. Then the panel will inform the parties within the next five working days whether it will close the review or launch the next phase.
Special Review (60 working days or longer if submitted to the State Council): The panel will launch a special review if any relevant government agency has national security concerns about the transaction, and it will then come to a final decision. However, if a consensus cannot be reached within the panel, the case will be submitted to the State Council and then no time limit applies.
How does the national security review evaluate the risk profile of a particular transaction, and what are the possible outcomes?
The 2011 rule specifies that a transaction should be evaluated from the following four aspects:
its impact on defense and security;
its impact on economic stability;
its impact on social order; and
its impact on R&D capabilities of critical technologies that have a bearing on national security.
The free trade zone rule additionally includes two areas to be assessed: the impact on cultural security/public morality; and the impact on cybersecurity.
If the inter-ministerial panel determines that the transaction would have a significant impact on national security, it may require the parties to take relevant measures, such as a transfer of shares or assets, or it may even prohibit the transaction, to eliminate the impact. Nonetheless, the notifying parties can propose to modify the transaction structure or even withdraw anytime during the review process.
How often does the panel determine that a transaction has national security concerns?
The national security review process is pretty opaque in China. The authority is not required by law to publish prohibition decisions, approval decisions, or remedial measures imposed. Nor does it produce any report as the CFIUS committee does annually. Therefore, the public are not aware of how many cases there are every year, or how often a transaction is challenged or withdrawn.
Is it possible to challenge a decision made by the national security review?
No, decisions of a national security review are not subject to administrative reconsideration or judicial review. A decision made by the inter-ministerial panel or the State Council is final.
Are there any cases of a national security review that might provide insights?
Last year, one acquisition attracted a lot of attention. The acquirer, Yonghui Superstores (hereafter Yonghui), as a listed company on the Shanghai Stock Exchange, made several announcements on how its national security review process was progressing.
The top shareholder of Yonghui (with a 19.99% stake) is a foreign company, making Yonghui a “foreign investor.” Both Yonghui and the target, Zhongbai Group, mainly operate in the retail industry, a key industry included in MOFCOM’s list. Through this transaction, Yonghui will become the top shareholder of Zhongbai Group and thus acquires “actual control”. Therefore, based on these facts, the review process was triggered.
Yonghui made an announcement on August 23 that it had received the notice from the NDRC on the national security review (only one day after it received merger review clearance from SAMR), and was preparing filing materials and communicating with the authority on this matter. On November 13, it announced that the NDRC had begun the second phase, the “Special Review,” meaning that the transaction might have “national security concerns”. However, on December 16 Yonghui announced the withdrawal of its tender offer to acquire Zhongbai. Although Yonghui was silent on the reason for its withdrawal, it was believed to relate to the national security review process. On December 28, Yonghui announced that the NDRC had informed it of the termination of the review process.
What steps can be taken to protect foreign investors from such outcomes, or to facilitate the review?
Although notification is considered voluntary, foreign investors are encouraged to make a filing if the transaction might fall under the 2011 rule, or alternatively, proactively approach the authority to schedule a meeting. According to MOFCOM’s implementing rules, before commencing a formal filing, a foreign investor can apply for a consultation on the procedural issues. Such a consultation can help achieve predictability and mitigate risks related to the national security review.
It is always important for foreign investors that are interested in the sensitive industries in China to schedule ahead. The review could take 30 working days, 90 working days, or even longer (if submitted to the State Council). Buyers should be careful about completing transactions before obtaining approval, since the authority has the power to order divestiture, creating huge uncertainties for the trading parties. It is also worth incorporating relevant clauses in the agreement to manage the risks, such as making the national security approval a condition precedent, or setting a long stop date before which the approval must be obtained.
How does the national security review interact with other administrative procedures related to M&A or foreign investment, for example, the merger control procedure?
Generally, the national security review is parallel to other procedures, including merger control or sector-specific licenses. But if a competent authority responsible for another procedure is a member of the inter-ministerial panel or makes referrals to the panel, it can trigger the review process. For example, as mentioned in Q4, if the merger control authority, SAMR, believes that a transaction may fall under the national security review, it will inform the NDRC of the transaction and prompt the parties to file notifications for a national security review. Nonetheless, the decision making of the national security review is independent of other procedures.
However, according to the free trade zone rule, the approval or review of foreign investment handled by a competent authority in the free trade zones will be conditioned upon the approval by the national security review. It means that the free trade zone authorities will suspend relevant procedures and wait for the decision of the national security review.
Do you expect the number of national security reviews to increase in the future?
The quick answer is yes. With the enactment of the Foreign Investment Law in 2019, China began adopting a national treatment regime with a country-wide list of exceptions. It signals that Chinese government’s oversight of foreign investment will be reduced and there will be a shift away from all kinds of market entry licenses and registrations. The national security review, as well as merger control, will be two of the few ex ante regulatory regimes that remain important. Both of them are written into the new Foreign Investment Law.
The national security review should also be seen in the broader context of the Chinese government’s efforts to strengthen the protection of national security. The national security review regime was enshrined into the National Security Law in 2015. To give another example, China’s Cybersecurity Law, which became effective on June 1, 2017, provides additional national security review requirements and standards for companies engaged in or seeking to engage in network and data operations in China.