CHINA'S INVESTMENT SECURITY REVIEW SYSTEM

C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 003363 SIPDIS STATE PASS USTR EEB FOR OIA E.O. 12958: DECL: 08/29/2018 TAGS: CM ENIV ETRD INRA SUBJECT: CHINA'S INVESTMENT SECURITY REVIEW SYSTEM Classified By: ECON MINISTER-COUNSELOR, ROBERT LUKE, REASON 1.5(B) ¶1. (C) SUMMARY AND COMMENT: Recent publication of ministerial organizational plans reaffirms China's intent to establish a formal interagency national security review mechanism for foreign investments in China, with the Ministry of Commerce (MOFCOM) and the National Development and Reform Commission (NDRC) as key players in the review process. China's new Anti-Monopoly Law, which was recently implemented, calls for establishment of a formal review mechanism, although 2006 revisions to the M&A regulations had already established similar requirements, specifically to review the "national economic security" implications of foreign transactions. While national security considerations have apparently played an informal role in a relatively small number of investments to date, China has been moving deliberately for several years to make its national security review of investments more deliberate and formal. Specific details on how the more formal interagency review would be conducted and which agencies will perform what roles remain unclear. Also unclear is how China defines "national security" and "national economic security," the two key terms used in the relevant sections of recently published ministerial organizational plans and other regulations. END SUMMARY. -------------- -------------- Ministerial Organizational Plans -- San Ding Fang An -------------- -------------- ¶2. (C) A recent Wall Street Journal article discussed the issue of implementation of a national security review mechanism for foreign investment in China. This was one of the provisions of China's Anti-Monopoly Law that recently took effect, and as such, we expect such a procedure will be put in place in relatively short order. The WSJ article referred to organizational plans published recently stating that China will establish a "joint ministerial meeting" to investigate concerns arising from foreign companies investments in China. The organizational plans referred to are ministerial blueprints for personnel and substantive responsibilities known as the "San Ding Fang An" which have been released for most Ministries including MOFCOM and NDRC. Embassy has translated the relevant portions of these blueprints at the end of this message. Identical language regarding the national security review is contained in both plans (below). ¶3. (C) The entire investment review process in China has been in flux for several years, and it is likely to be some time before any new procedures are fully functional and sufficiently clear to avoid confusion among foreign investors. It is also important to note that many of the regulations that have been adopted recently appear to overlap one another and the lines of authority between bureaucratic players like MOFCOM and NDRC are far from clear. What we know about the existing system and the evolution of the new review procedures has been gleaned from a variety of meetings with MOFCOM, NDRC and other sources over the past year or so. As recently as the SED Investment Forum held in June in Washington, it was clear that the national security review process was still a work in progress, and that the bureaucratic lines had yet to be clearly drawn. -------------- -------------- Investment Catalogue Spells out the General Rules -------------- -------------- ¶4. (C) The Guidance Catalogue for Foreign Investment Industries jointly promulgated by MOFCOM and NDRC and approved by the State Council sets out the three categories of investment by industry sector: those forbidden, restricted and encouraged. Investment in sectors not listed in one of these three categories is considered permitted. With neither the status of law or regulation, the catalogue is intended as indicative of how NDRC and other ministries would likely act in reviewing individual investment proposals under China's laws and regulations governing fixed asset investment. Under Chinese law, all investments require some sort of government approval. For foreign investments, depending on the size of the project, some approvals may be given at the local level, while others would require NDRC and/or central ministry approval or from the State Council. ¶5. (C) One interesting question has always been whether the investment catalogue applies equally to green field foreign investment as well as cross-border M&A transactions. One provision in the revised 2006 Interim Provision on the Takeover of Domestic Enterprises by Foreign Investors state this to be the case. But when this question was posed to an official from the NDRC's Foreign Capital Utilization Division during the State-NDRC dialogue in April, that official replied, "for the time being, yes." He later explained that BEIJING 00003363 002 OF 003 this may change with implementation of the new national security review mechanism which was then under discussion. -------------- -------------- Previous Regulations Excluded NDRC from the Decision Process -------------- -------------- ¶6. (C) Revisions to the M&A regulations for foreign enterprises announced jointly by MOFCOM, SASAC, CSRD, the State Administration of Taxation, SAIC, and SAFE in 2006 formalize an "economic security" review procedure, which ministry sources tell us made explicit what has always been in place informally. Under the revised 2006 revisions, several factors were singled out as requiring a review initiated by MOFCOM and conducted conjunction with other ministries. These included transactions which could lead to foreign control of a domestic enterprise in an important industry or which have an impact on national economic security or lead to the takeover of a domestic enterprise which holds a famous trademark or brand. Foreign companies initiating such transactions are required to apply for review by MOFCOM as the lead ministry in obtaining approval by foreign firms involved for M&A transactions involving Chinese companies. Sources at NDRC told us MOFCOM passes specific transactions to the relevant ministries for review. In some cases, MOFCOM itself would conduct the review (for example, retail and distribution investments),while financial transactions would go to the People's Bank and the relevant financial regulators, and industrial projects would go to NDRC and the relevant line ministry. This description of the process predated the transfer of industrial policy functions from NDRC to MIIT, so it is unclear whether NDRC would now play the same role in reviewing M&As in specific industrial sectors. ¶7. (C) One interesting aspect of the 2006 M&A revisions, was that it failed to specifically give NDRC a role in the review process. At the June Investment Forum, NDRC Vice Chairman Zhang Xiaoqiang clarified NDRC's role in the process by noting that any M&A that could potentially lead to an additional investment in the acquired company or a change or expansion of business activities would be considered to require NDRC approval under China's investment law. Since it is unlikely that any foreign M&A would not fall in this category, all significant foreign M&As would continue to require a review by NDRC. Specific language to this effect has in fact been added to both Ministry's San Din Fang An plans (see below). -------------- -------------- Economic Security and the Carlyle and Blackstone Cases -------------- -------------- ¶8. (C) To date, we have yet to hear anyone define what is meant by "economic security," although there has been plenty of debate over the term even in public fora. One recent M&A conference attended by Econ M/C featured a speaker from a prominent MOFCOM-affiliated institute who expressed concern about the impact of economic security reviews on investment flows and called for a broad definition of economic security to include ensuring the stability of international investment flows. MOFCOM speakers at the same event, including Treaties and Law Director General Shang Ming, shed no light on how they interpreted the term. According to Wang Zhile, director of MOFCOM's Research Center on Transnational Corporations (CAITEC),there have been only a handful of reviews conducted of foreign M&A transactions. One he cited was Carlyle's attempted purchase of Chinese heavy equipment maker Xugong. According to Wang, in this case, the original analysis of the effect of the transaction on Chinese industry was conducted by the industry association itself and was heavily influenced by the views of potential competitors of Xugong. MOFCOM then asked its own anti-dumping specialists to conduct an injury analysis on the proposed transaction and they concluded the domestic industry would not be hurt by the acquisition. However, despite repeated revisions of the terms of the acquisition ending with a proposal for less than a controlling stake, Carlyle's bid was never approved by the State Council. It was held up over various concerns, including at NDRC which had expressed reservations about provisions for technology transfer. Ultimately the deal collapsed when Xugong itself apparently lost interest in being acquired. Although sources have told Embassy that NDRC eventually agreed to approve the deal, no such decision was actually announced. A second case cited as having undergone a review is Blackstone's acquisition of a less than controlling stake in SOE chemical maker China National Bluestar. We have no information regarding this review, except to note that Bluestar had itself earlier been the subject of a possible CFIUS review for its proposed acquisition of a high temperature boiler maker Harper Furnace, a proposal that was later dropped. BEIJING 00003363 003 OF 003 -------------- -------------- National Security Review under the Anti-Monopoly Law -------------- -------------- ¶9. (C) The final piece of the puzzle and the one that is the least understood at this point is how the national security review mandated in the Anti-Monopoly Law will actually be carried out. Questions remain, about why this provision was inserted in the AML in the first place. It was not in the final draft submitted by the State Council to the NPC, and appears to have added during the second reading in the NPC in August 2007. The general consensus seems to be that the AML provided a convenient platform to bless such a requirement through legislation rather than regulation. However, doing so has led to fears that this provision could be used to promote protectionist policies in the AML review. As MOFCOM has responsibilities for conducting other reviews under the AML, it would also makes sense for MOFCOM to serve as the point of contact for foreign companies to submit information required for the national security review. This appears to be the proposed procedure outlined in the San Ding Fang An plans. ¶10. (C) Another interesting question is how the two concepts of national economic security and national security relate to one another. The language in the San-ding Fang An sheds little light on this issue, noting only that MOFCOM will accept and reply to the foreign company's application for M&A approval. Aspects relating to national security will be reviewed by an inter-ministerial committee. Aspects relating to additional fixed asset investment will be regulated under the China's fixed asset investment law. Major cases involving national security will require the convoking of an inter-ministerial investigation. -------------- -------------- Translation of the NDRC and MOFCOM "San Ding Fang An" -------------- -------------- ¶11. (U) Embassy informal translation of the relevant provisions that appear in both the NDRC and MOFCOM organizational plans (San Ding Fang An): "NDRC, MOFCOM and related ministries will establish and inter-ministerial joint conference mechanism for security reviews of foreign acquisitions and mergers with domestic enterprises. MOFCOM is the responsible ministry for handling this process, and will respond to applications that foreign investors file in order to acquire and merge domestic businesses. For acquisition and merger applications subject to security review, the inter-ministerial joint conference will conduct a review; for applications involving incremental investments of fixed capital, the state rules for the administration of fixed capital investments will apply; if major matters of security concern are involved, an inter-ministerial joint conference will assemble to address relevant issues." RANDT