Unfinished regulations delay China M&A.

At the end of last year, it seemed like a new dawn. Eight months later, it is still midnight for foreign investors interested in M&A.

At the end of 2002, in a move that seemed to give a Christmas present to foreign investors, the Chinese government came out with legislation opening up all classes of listed and non-listed Chinese shares to foreign mergers and acquisition.

"Allowing the previously jealously guarded State-owned shares of listed companies to be made available to foreign investors was groundbreaking," says Stella Leung, a partner at law firm O'Melveny and Myers.

The document that came out in November 2002 promised that the non-tradable legal person and state shares (the former owned by state entities, such as other SOEs, and the latter by the government ministries) would be made available to foreign investors. This was supplemented in January and April 2003 by legislation, which confirmed the principal at using foreign capital to help restructure SOEs, as well as rules for facilitating the process respectively.

But Leung points out that much of this legislation was couched in general terms, and no detailed legislation about how to effect such M&A transactions has yet been published.

Between January 2002 to April this year, cases of foreign-invested enterprises buying or merging with Chinese operations number just 40, amounting to a total of $3.3 billion according to the Holyhigh consulting company based in Beijing.

Of that total, some 22 cases were in manufacturing, with wholesale and retail accounting for 12, service-related acquisitions for three cases and finance and real estate ventures for two cases each.

Compared to the $50 billion China attracts each year, the roughly $3 billion that came in via M&A is small. Still, such is the attraction of the Chinese market than many believe this figure can only increase in value.

A conference in August attracted numerous US, European and Japanese delegations. But there was common complaint that inspite of the recently issued legislation, the tried and tested options of a joint venture, a co-operative venture, or a wholly owned foreign enterprise were the still the only practical models to use in coming into China.

Such ventures, in contrast to what the new legislation could achieve, are brand new ventures, with all the cost and conflicts that often arise.

The set of concrete regulations that would permit the M&A of non-listed companies is still being drafted by the State Council and the set of regulations that would apply to listed companies is being hammered out by the often competing agencies of the China Securities Regulatory Commission (CSRC), the Ministry of Finance, the state Asset Management Commission and the commerce department. The fact that foreign investors are not clear about which one is the primary regulator has been discouraging progress, point out observers, since in the absence of legislation, they can only proceed in close partnership with government officials.

Observers say regulators are apparently unhappy at abuses that have occurred in the market, involving nominees and trust companies, to circumvent the rules, and are intent on tying foreign and domestic companies into a strict framework.

That means that any venture by foreign companies to make a bid for a domestic company will ultimately always have to be signed off one of the regulatory organs. That leaves a huge amount of discretion with those same regulators, and is off-putting to foreign investors.

Put that together with hidden costs of existing mergers - hidden liabilities, unclear and complicated tax structures, local protectionist measures and opaque ownership rights, and it is not surprising foreign investors prefer to start from scratch with their own site.

The reforms which the central bureaucracy is undergoing are also slowing down progress. However, when these are accomplished, it looks as if the division of labour will be the following: the sale of non-financial, state-owned institutional assets will be supervised by the state asset management commission, and the ministry of finance will oversee M&A within financial institutions. The CSRC will have the important task of ensuring the correct disclosure of information.

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