M&A in Asia - China in the spotlight

Linklaters examines the impact of China''s M&A regulations for foreign investors.

As China moves to meet the criteria of the WTO accord, its relaxation of restrictions against foreign trade and investment have been largely applauded by the international community. But it is also interesting to note that that some of the more recent laws passed by the Chinese Government over the past twelve months have been driven by the authorities' own desire to deepen economic reform in order to recapitalise the state-sector and create an even more attractive environment for foreign investment.

Soon after accession, China undertook the mammoth task of updating its M&A regulations to make them consistent with WTO obligations. Whilst some critics have commented that non-tariff and other administrative barriers still exist, or were even erected to protect Chinese interests in the more lucrative, and in some cases, politically sensitive sectors such as telecoms and agriculture, China has on the whole lived up to its side of the WTO bargain.

A lack of transparency in China's legal system and the less than perfect corporate governance standard of Mainland companies have long been cited as possible hindrances to ensuring a continuing inward flow of foreign direct investment. With the recent introduction of the Take Over and Disclosure Procedures, which set out a regime governing the acquisition of a substantial or controlling stake in Chinese listed companies and the associated disclosure requirements, China has taken a big step in bringing its regulatory M&A framework closer to the international norm. In line with international financial market expectations, the emphasis is on disclosure, both from the perspective of the party acquiring and the one being acquired.

China's new M&A regulations have generated considerable interest amongst the international investment community and with them, present significant new opportunities to foreign investors.

One of the more significant changes is a lifting of the prohibition against the transfer of state-owned shares of PRC listed companies to foreign investors

In fact, some of last year's most high-profile deals in China - including Citibank's purchase of a 5% equity stake in Shanghai Pudong Development Bank - would not have been possible without these new regulations.

However, despite the lifting of the restrictions on the transfer of state shares, a level of uncertainty remains regarding their possible disposal at a later date.

Although any unlisted state shares acquired by a foreign investor carry the same shareholder rights as A-shares (domestically-listed Renminbi denominated), foreign institutions holding state shares are still in the dark over regulatory procedure should they decide to convert their unlisted shares for their listed counterparts.

Under current laws and regulations, there is still no mechanism for foreign institutions to do this. Having said that, it has now become quite clear that the Chinese government has come to recognise the importance of exit arrangements for foreign investors. This is evidenced by the recent introduction of regulations providing a mechanism for foreign investors to exit from B-share (domestically-listed and traded in US$ or HK$ for foreign investors) companies. We believe it is only a matter of time before a similar exit mechanism is made available to A-share companies.

It is clear the new regulations are not without teething problems and still leave many questions unanswered, such as to what extent are they applicable to foreign investors. Also, would the usual cap on investment limit still apply apply, or is there the option of an exemption clause from the Chinese regulatory authorities?

And unlike the listing rules of other more developed jurisdictions, the new regulations do not provide for compulsory acquisition of shares from all shareholders once a sufficient percentage of shareholders have accepted an acquirer's general offer to take over a company. We expect additional regulations will be introduced shortly to provide answers to these questions.

Whilst we expect a substantial amount of M&A activities will continue to take place offshore through sales of special purpose vehicles, the number of international M&A transactions effected onshore is likely to increase significantly in the coming years. The Chinese government's desire to use foreign investment to recapitalise state-owned enterprises and the preference of multinational corporations buying into existing businesses over launching their own start-ups in what are already competitive markets, will clearly be drivers for onshore transactions. As the assets up for sale would invariably be held by their Chinese vendors directly, the new M&A regulations will certainly play a pivotal role in shaping the way transactions are done in the future.

With China tipped to be the main source of foreign investment activities in Asia this year, advisers and business professionals ignore them at their own peril.

Be warned, the rules of the game are rapidly changing.

Thomas Ng is managing associate of China Group at law firm Linklaters and was an advisor to Citibank in its acquisition of shares in Shanghai Pudong Development Bank.

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