On December 19, 2020, China’s National Development and Reform Commission (“NDRC”) and Ministry of Commerce (“MOFCOM”) jointly issued the Measures on National Security Review of Foreign Investments (“Review Measures”). These measures, which took effect on January 18, 2021, identify a new regulatory authority that will review direct and indirect foreign investments in China on national security grounds and establish a new Chinese foreign investment review regime.
The Review Measures build upon earlier rules governing foreign M&A activity involving Chinese targets, and they implement aspects of the Foreign Investment Law (“FIL”) (which took effect in January 2020) and the National Security Law.1 The Review Measures go beyond these prior rules in both authority and scope, and detail a review mechanism headed by NDRC and MOFCOM not dissimilar to the Committee on Foreign Investment in the United States (“CFIUS”). A new review body, the Authority of the Security Review of Foreign Investments (“Security Review Authority” or “SRA”), will be led jointly by NDRC and MOFCOM and is empowered to review foreign investments in China.
The Review Measures cover a wide range of investment activity. Notably, covered investments include both direct and indirect investment activities conducted by foreign investors. This includes foreign investors (i) alone or jointly with other investors investing in new projects or establishing enterprises in China; (ii) acquiring equity or assets of domestic enterprises through merger and acquisition; and (iii) investing in China through other means.2 (This third category appears to allow for considerable breadth of discretion by the SRA.) Investments in listed companies impacting national security also will be subject to review by the China Securities Regulatory Commission in conjunction with the SRA (under regulations to be separately promulgated).3
It remains unclear what is meant by “other means” under the Review Measures. However, the 2015 Measures for the Pilot Program of National Security Review of Foreign Investment in Pilot Free Trade Zones (“FTZ Measures”) may offer guidance in this respect. In addition to having identical subsections as (i) and (ii) above, the FTZ Measures define foreign investment to include investments via agreement-based control mechanisms, trust, reinvestment, offshore transaction, lease, convertible bond, holding shares on behalf of others, and (again) other means.4 In our view, it is likely that Chinese authorities will largely follow the FTZ Measures and deem foreign investments such as offshore transactions as covered investments. This approach could also potentially capture the variable-interest entity or VIE structure (though this would present widespread challenges to investors and China’s private sector).
The scope of the Review Measures is broad. A filing is required for foreign investments in industries associated with the military and national security, as well as for foreign investments in entities located in close physical proximity to military and military industrial facilities (“Military-related Industries”).5 A filing is also required for foreign investments where “actual control” is obtained over entities (existing or newly-established) in industries designated as “important”,6 including agricultural products, energy and resources, infrastructure, transportation services, equipment manufacturing, information technology, internet products and services, financial services, “critical” technologies, cultural products and services, and other important fields (“Important Industries”).7 “Actual control” refers to (i) holding more than 50 percent of a target’s equity; (ii) holding less than 50 percent of a target’s equity, but with significant voting rights; and (iii) “other circumstances” allowing a foreign investor to have a significant impact on the business decision-making, personnel, finance, and technology of the enterprise. Both the “other important fields” prong of the targeted industries test and the “other circumstances” prong of the actual control test offer the authorities a wide scope of discretion.
In practice, foreign investments in Military-related Industries and foreign investments in Important Industries gaining actual control require a filing. Failure to make a required filing may result in penalties (see below). We also note that relevant agencies, enterprises, social organizations, and the general public may propose to the SRA that it initiate a security review over a particular foreign investment if they believe the investment impacts or may impact national security.8 Therefore, foreign investors will need to carefully analyze whether a contemplated investment is covered by the Review Measures as filings are now functionally required. Reviews will be conducted according to a multi-stage review process set to a designated timeline (in a manner similar to the process administered by the CFIUS in the United States).
Parties do have the opportunity to consult the SRA. While the SRA is not expected to provide informal opinions (for example, regarding whether a filing is required for a particular investment transaction), our understanding from informal discussions with relevant officials is that consultation will be for the purpose of clarifying questions investors might have and assisting investors in coming to their own conclusion as to whether an SRA filing is required.
Required Application Materials
Following any preliminary consultation, if a filing is required, parties must submit the following:
The SRA will not publicize the existence of a filing, and materials submitted in connection with a filing will be kept confidential.9
Initial Decision (15 working days)
Within 15 working days, a preliminary decision will be made as to whether it is necessary to conduct a national security review of the investment. The security review consists of a general review and a special review. If the SRA decides that no security review is required, the parties may move forward with the investment. If not, the parties proceed to the general review.
General Review (30 working days)
A general review will be completed within 30 working days of the initial decision to conduct a security review. The investment will be cleared if the investment is deemed to not affect national security, otherwise the SRA shall notify the parties in writing of its initiating a special review process.
Special Review (60 working days)
A decision under the special review procedure must be completed within 60 working days and may result in either (i) clearing the investment, (ii) prohibiting the investment, or (iii) conditionally permitting the investment. Required conditions will be implemented under the supervision of the SRA and relevant local level authorities. These authorities will also be empowered to conduct on-site inspections to verify compliance.10
Under special circumstances, this 60 working day review period may be extended by the SRA. Moreover, the SRA may request additional materials from filing parties and the time taken to provide those materials will not be factored into the statutory review period timeline. The parties may at any time during the review period modify or cancel the proposed investment. If amended, the review period will be recalculated from the date when the SRA receives the revised investment plan from the filing parties.
While this issue is not addressed explicitly in the new measures, it is anticipated that decisions of the SRA will be released only to transaction parties and will not be made public.
Parties may be required to refile with the SRA if modifying the transaction after obtaining clearance from the SRA. In the absence of any such modification, however, it is expected that the SRA clearance granted at the conclusion of its review of a transaction will be “evergreen.”
The SRA may order a filing be made within a specified timeline and/or order the disposal of relevant assets and take all necessary measures to unwind any effects of the investment and its impact on national security where parties
Such parties will also be blacklisted in China’s National Enterprise Credit Information Publicity System and may be further punished under other relevant regulations.
The Review Measures provide important detail to China’s emergent foreign investment security review regime. These developments indicate a more mature regime that goes beyond previous rules limited to foreign M&A activity. These are important steps towards a unified regime primarily comprised of the FIL, National Security Law, and foreign investment negative list, as well as the recently promulgated Export Control List and Unreliable Entities List (in response to like measures by the United States). That said, the Review Measures notably lack a clear set of factors to be employed in arriving at final SRA decisions. Such ambiguity is not uncommon in national security laws, and NDRC has indicated that further guidance is forthcoming.11
China’s foreign investment security review regime is largely developing between two parallel trends. On the one hand, Beijing has recently further winnowed the number of sectors restricted to foreign investment in its negative list while continuing to emphasize that the country is open for business. On the other hand, Beijing has announced restrictive measures such as its Export Control List and an Unreliable Entities List. These developments should be considered in the context of complicated and evolving trade relations with the United States but may also indicate a desire to assert control over key sectors of the economy. Indeed, according to NDRC, “[o]nly by tightening the fence against security risks can China lay the solid foundations for a new round of opening up that is broader, wider and deeper.”12
1) Notice on the Establishment of the Security Review System on Mergers and Acquisitions of domestic Enterprises by Foreign Investors (Circular No. 6) (2011) GENERAL OFFICE OF THE STATE COUNCIL OF CHINA.
2) Review Measures Art. 2.
3) Review Measures Art. 21.
4) FTZ Measures Art. 2.3.
5) Review Measures Art. 4(1).
6) A term undefined under the Review Measures.
7) Review Measures Art. 4(2).
8) Review Measures Art. 15.
9) Review Measures Art. 20.
10) Review Measures Art. 13.
11) Press Release: Improve the foreign investment security review system to escort a higher level of opening to the outside world-the person in charge of the Foreign Investment Security Review Working Mechanism Office answers reporters’ questions on the "Foreign Investment Security Review Measures", NATIONAL DEVELOPMENT AND REFORM COMMISSION (19 December 2020), available at (Chinese) https://www.ndrc.gov.cn/xwdt/xwfb/202012/t20201219_1255024.html.
12) Supra note 11.