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China allows foreign direct investments in RMB
Foreign companies that hold RMB deposits outside of China can now use those offshore RMB amounts for foreign direct investments ("FDIs") into China. This new development follows the trend of the gradual internationalisation of the RMB. It will also further promote the development of the offshore RMB bond and financing markets, especially in Hong Kong.
Use of offshore RMB in FDI transactions
The internationalisation of the RMB can result in foreign companies holding surplus offshore RMB deposits. Although foreign direct investment in RMB was not entirely prohibited previously, it required reviews and approvals from MOFCOM and PBOC (both at the central government level), which was generally considered lengthy and unpredictable. The Chinese government has recently implemented new regulations to improve this process.
Under a circular of the Ministry of Commerce ("MOFCOM") dated 12 October 2011 (the "Circular") and a further regulation by the PBOC dated 13 October 2011 (the "Regulation") non-financial foreign investors can now transfer RMB funds back into China that they have legally obtained offshore.
According to the Circular "legally obtained offshore" includes RMB obtained offshore as a result of:
- cross-border trade settlements
- dividend distributions, disposal of equity interests, reduction of registered capital or liquidation of a foreign invested enterprise ("FIE")
- RMB funds raised lawfully outside of China, including issuances of offshore RMB bonds or other RMB denominated securities.
There are, however, some limitations to the use of offshore RMB for FDIs. According to the Circular, FDIs in RMB are prohibited in negotiable securities and financial derivatives. Also, foreign investors cannot use overseas-obtained RMB to provide entrusted loans or to repay domestic or overseas loans. The prohibition on securities trading, however, does not apply to strategic investments by foreign investors in Chinese listed companies through participating in private placements and equity transfers by agreement.
MOFCOM Approvals
FDIs in RMB are now subject to the same approvals as FDIs in foreign currencies, such as US dollars. In addition, the same ownership restrictions for certain industries apply, as does the national security and merger review (see below). As a result the same distinction between central and local MOFCOM will apply for FDIs in RMB as for other investments. According to the Circular, Central MOFCOM approval is therefore required if the investments:
- equal or exceed RMB300 million
- are made in certain financing industry sectors, including target companies engaged in providing guarantees, financial leasing, credit loans or auctions
- involve investments in foreign invested companies, foreign invested venture capital enterprises, or foreign invested equity investment enterprises
- involve investments in any sector subject to national macro-control policies, such as cement, iron and steel, electrolytic aluminum and shipbuilding.
According to the PBOC Notice, PBOC approval is no longer required for FDIs in RMB. Instead, the PBOC requires FIEs with RMB investments to be registered with its local PBOC branch.
China implements a permanent national security review on inbound M&A
China's temporary national security review ("NSR") on inbound M&A transactions became permanent on 1 September 2011. The new permanent NSR has an additional anti-circumvention provision that was not included in the temporary NSR. This anti-circumvention provision can potentially be used by MOFCOM to clamp down on the use of Variable Interest Entity ("VIE") structures.
Prior to the implementation of the NSR, foreign investment in China generally dealt with two government agencies for review and approval: the National Development and Reform Commission (“NDRC”) and central or local MOFCOM. These agencies both need to approve acquisitions of Chinese entities by foreign investors, in which process project feasibility and possible interference with China's public interests and industry policies are reviewed.
Under the new M&A security review system, mergers and acquisitions involving sectors that are considered to be strategically important to the national security of China, such as national defence, agriculture, energy and resources, infrastructure, transport, technology, and manufacturing of important equipment, are subject to a security review prior to the NDRC and MOFCOM approval procedures mentioned above.
The new permanent security review rules contain an anti-avoidance provision that was not included in the previous interim rules. This anti-circumvention provision provides that when determining whether a transaction falls within the scope of the security review, the material content of the transaction and its actual impact are to be taken into account. It also provides that foreign investors cannot structure a transaction in order to avoid a security review, for example by using proxy holdings, trusts, multiple-layer reinvestments, leasing, loans, offshore transactions and control by agreement, etc.
"Control by agreement" includes the use of Variable Interest Entity (VIE) investments. In a VIE structure a fully or partially foreign-owned PRC company has control over a PRC operating company which holds the necessary licence(s) to operate in a FDI restricted or prohibited sector. The foreign investors use contractual arrangements to obtain de facto control over the operating company. VIEs have been a popular structure in the last decade. However, the new permanent NSR potentially could be used by MOFCOM to prevent or limit transactions that use a VIE structure. There are yet no precedent cases to provide further guidance on this.
For more information please also see our article on the temporary NSR in our March 2011 China Update (which can be found here).
MOFCOM conditionally approves Uralkali's merger with Silvinit after anti-monopoly review
Foreign companies involved in non-Chinese mergers need to be aware of scrutiny by the Chinese anti-monopoly authority MOFCOM and possible conditional measures that can be imposed, especially if the merged companies provide key raw materials to China. This can be derived from MOFCOM's recent conditional clearance of the merger between Uralkali and Silvinit.
Background
Uralkali and Silvinit are two leading Russian potash producers that recently merged in a USD 7.8 billion merger. Prior to MOFCOM's conditional approval, the merger proposal was already approved by anti-monopoly authorities in Russia, Brazil, Poland and Ukraine.
MOFCOM accepted the notification of the merger on 14 March 2011 and carried out a two-phase 81-day review (the phase one review is 30 calendar days and the phase two review is 90 calendar days). On 2 June 2011, MOFCOM issued conditional approval in which certain behavioural remedies were imposed. This is the seventh conditional approval decision made by MOFCOM since the Anti-Monopoly Law of China took effect three years ago.
The following are some interesting aspects of MOFCOM's decision:
Market definition and competitive assessment
With regard to the relevant market definition, MOFCOM considered the potassium chloride market as the relevant product market based on the lack of substitutability between potassium chloride based fertilizers and other fertilizers in terms of the product characteristics and use.
As China is primarily an import market for potassium chloride, MOFCOM considered both the global and Chinese market. It appears that MOFCOM used a possible further delineation of the geographic market by separating trading by ocean freight from trading by "border".
Moreover, MOFCOM noted that the merger would create the second largest exporter of potassium chloride with a market share of over one-third of the global market. It also pointed out that China relies heavily on imports for potassium chloride, of which more than 50% are from Uralkali, Silvinit or their affiliated companies.
As a result MOFCOM concluded that there were a number of competition concerns. First of all, the concentration in the relevant market would increase after the merger. The increased market power could also restrict competition in the global ocean shipping market, while there also were concerns about the border trading market, as the number of major suppliers in that market would drop from three to two. MOFCOM also considered there to be an increased risk of coordination between major global players and took high entry barriers into account.
Remedies imposed
After several rounds of negotiations MOFCOM finally accepted a remedy package. These remedies are basically a standstill commitment, pursuant to which the merging parties will have to:
- follow the current mode of sale, which includes price negotiations for spot sales (on a per-transaction or per-month basis) and contract sales (semi-annually or annually)
- continue to supply a broad range and sufficient volume of potassium chloride products
- follow current negotiation procedures, taking into account historical and current trading situations with their Chinese customers
- appoint a monitoring trustee and report on the progress to MOFCOM on a six-month basis or upon request.
Conclusion
The decision provides more elaborate reasoning and this is clearly presented compared with previous decisions, in line with MOFCOM's development into a more sophisticated and efficient anti-monopoly authority. The decision also shows MOFCOM's willingness to accept behavioural or non-structural remedies. MOFCOM stressed, moreover, that China is highly dependent on potassium chloride and made a distinction between seaborne and cross-border trade. This could indicate that MOFCOM, at least in part, was motivated by industrial policy concerns. For companies that provide key raw materials to China, it will therefore be interesting to see how strictly MOFCOM will monitor and enforce compliance with the conditions imposed.