China’s New M&A Regulations

I. Introduction

The first piece
in this series (A Warning to Foreign Companies Entering "Sensitive" U.S. Markets, in the September 6th, 2006 edition of this publication) discussed the attempts of foreign companies to enter "sensitive" areas of the US
economy, focusing on how the US government derailed the purchase of US
companies by foreign entities. [1] This
piece will discuss the Chinese government's new regulations covering
M&A transactions involving foreign investors purchases of Chinese
companies will affect the M&A market and possible motivations behind the new legislation.   

II. Analysis

On Aug. 8, 2006, the People's Republic of China ("PRC")'s  Ministry
Foreign Commerce ("MOC") issued new regulations ("Revised Provisions")
on M&A transactions in China. [2] These new regulations would
simultaneously ease and impede foreign acquisitions by allowing all
stock purchases, but also requiring government approval of most M&A
transactions involving offshore entities. [3] The Revised Provisions
went into effect on Sept. 8, 2006, replacing the interim provisions
issued in 2003. [4]

This piece will first focus on two main areas of rule-making: share
exchanges involving off-shore entities (whether foreign or domestically
controlled) and domestic Chinese companies, and the additional
regulatory approval requirements for foreign purchases of Chinese
companies.  The piece will then discuss the possible effects on foreign
purchases of Chinese entities and possible motivations behind the law.

III. Share Exchanges

For the first time, foreign buyers will have authorization to "pay
for stakes in Chinese companies in shares instead of in cash." [5] This
new option will give foreign buyers increased flexibility and will
bring China in line with international practice. [6]

However, in order to take advantage of these rules, the parties must satisfy a number of conditions including:

  • the acquirer's shares must be tradable on an overseas stock exchange;
  • the offshore company's trading price must be "stable" for one year preceding the transaction;
  • the shareholders of the target company must be the legal owner of the shares, which must also be legally transferable;
  • the shares of both the acquirer and target must be unencumbered. [7]

IV. Increased Regulatory Scrutiny

While the new regulations increase business' flexibility in how they
pay for their purchases, they also raise new regulatory hurdles to
approval.  For most transactions involving offshore restructurings,
firms must obtain prior approval from the MOC. [8] The
regulations "confer broad new powers to block investments in key
industries if they are deemed to be a danger to China's economic
security," "alter control of a key Chinese brand," or involve a firm
with more than 2,000 employees. [9]

As always, "the devil [will] be in the detail[s] and the
implementation of the regulations." [10] Some investors are concerned
that the rules "put the onus on the buyer and seller to declare if the
deal might affect . . . economic security." [11] Moreover, the rules
"are pretty vague about what you've got to report, what's influencing
economic security," says John Grobowski, co-managing partner of Baker
& McKenzie's Shanghai office. [12] He continued, "[t]his puts a
pretty heavy burden on the parties involved in the transaction to make
those kind of determinations." [13]

"Furthermore, if an M&A transaction is completed without the
required MOFCOM review and approval, the Revised M&A Provisions
authorize MOFCOM to either rescind the M&A transaction or
retroactively amend the agreed contractual terms and conditions of the
M&A transaction." [14] Thus, if the companies miscalculate, and
determine, inaccurately, that the deal does not require review by the
Chinese government, it can have very serious consequences.  Therefore,
companies will likely be very cautious in determining whether to
request government review.  While the review process is not especially
time consuming, requiring a decision within thirty days, the government
has not yet indicated the level of scrutiny that will be applied. [15]
Thus, firms should be very careful when considering purchases of
companies that might trigger this review process.

V. Effects on the Foreign M&A Markets

According to The Financial Times, "It is tempting to conclude that
one of the world's toughest markets for mergers and acquisitions is
getting tougher." [16] While, as noted above, the regulations
strengthen the regulatory scrutiny, they simultaneously ease some parts
of the process.  "The approval process will be more streamlined", and
all relevant ministries are on board. [17] The old regulations, on the
other hand, gave power to a ministry which seemed "unaware of its new
responsibilities." [18]

However, experts doubt the new rules will "have a big impact on
M&A because big takeovers are already subject to strict vetting."
[19] The most important factor will be how the regulations are applied
as the blocking provisions are subject to wide interpretation. [20]

VI. Motives Behind New Regulations

Leaders claim that China, the developing world's biggest recipient
of foreign investment, isn't closing off its economy. [21] Rather, their motivation
stems from the "government's growing preoccupation with helping the
expanding universe
of Chinese companies and pressing domestic issues such as poverty and
wealth disparities." [22] However, "because the new restrictions are
part of a broader policy shift —
rather than some temporary interest in penalizing foreign businesses —
it's a potentially scarier development for foreign companies." [23]

There also seems to be an element of domestic politics in play.
"Increasingly savvy domestic companies — some of whom have been
in their efforts to expand overseas — are seizing the moment to push
for moves they hope will strengthen them against outside competitors."
[24] "'As local Chinese companies become more competitive, they are
more sophisticated in using whatever means are available to them to
maintain their position,' says Henry Wang, a lawyer with DLA Piper
Rudnick Gray Cary in Shanghai. 'They are using a combination of the
media and government help.'"  As Chinese companies become more
sophisticated, they appear to be emulating their American counterparts,
taking advantage of the ability to lobby the government to produce
positive results.

VII. Conclusion

While the new regulations simplify some areas of the M&A market,
by allowing all stock mergers, they also create new barriers to entry
into the Chinese market.  However, once companies adopt to, and
understand how the new rules will affect business, the rush into China
will probably resume at an even greater pace.


[1] David Lee, A Warning to Foreign Companies Entering Sensitive U.S. Markets,
Journal of the Business Law Society, Sept. 18, 2006,
(last viewed Oct. 17, 2006).

[2] DLA Piper Rudnick Gray Cary, Revisions to 2003 M&A
Regulations, (Aug. 9, 2006) (Unpublished report on file with author)
[hereinafter Revisions].

[3] Id.

[4] Id.

[5] Eadie Chen and Langi Chiang, New Rules Could Be Boon and Bane for Chinese M&A, Reuters, Aug. 9, 2006, available at .

[6] Id.

[7] Supra note 2, Revisions.

[8] Id.

[9] Supra note 5, New Rules.

[10] Id.

[11] Id.

[12] Id.

[13] Id.

[14] Supra note 2, Revisions.

[15] Id.

[16] Chinese Deals, The Financial Times, Aug. 10, 2006, available at

[17] Id.

[18] Id.

[19] Supra note 5, New Rules.

[20] Supra note 16, Chinese Deals.

[21] Andrew Batson and Mei Fong, In Strategic Shift, China Hits Foreign Investors With New Hurdles, Wall St. J., Aug. 30, 2006, at A1.

[22] Id.

[23] Id.

[24] Id.

[25] Id.