China’s New Regulation on Foreign M&A: Green Light or Red Flag?

Abstract

With China’s entry into the World Trade Organization (‘WTO’), the gradual opening of previously closed industry sectors to foreign investment and the continued strong growth of the Chinese economy, merger and acquisition (‘M&A’) activity has become an increasingly attractive alternative to greenfield investment to foreign investors. In the 1980s, the first wave of foreign direct investment (‘FDI’) in China mostly took the form of joint ventures, including equity joint venture enterprises (‘EJV’) and contractual joint venture enterprises (‘CJV’). A second wave followed in the 1990s in the form of wholly foreign-owned enterprises (‘WFOE’). Now a third wave – cross-border M&A – is gaining strength. Foreign investors are becoming more inclined to invest in China by merging or acquiring existing Chinese companies, particularly the leading players in the fields, because M&A transactions offer foreign investors immediate market access with minimal business risk and the acquired business can be converted to foreign-invested enterprises (‘FIE’) for favourable treatment. The increased pace of foreign M&A activity has contributed to restructuring of the foreign M&A regime in China. On 8 August 2006, six Chinese government agencies, led by the Ministry of Commerce (‘MOFCOM’) of the People’s Republic of China (‘PRC’), jointly promulgated the Provisions on the Takeover of Domestic Enterprises by Foreign Investors (‘2006 Regulation’). This Regulation became effective on 8 September 2006, replacing the previous Tentative Provisions on the Takeover of Domestic Enterprises by Foreign Investors (‘2003 Tentative Regulation’), which were in force since 12 April 2003. The 2006 Regulation, taken together with several other instruments issued either before or after its promulgation, constitutes a systematic regulatory framework governing foreign M&A activity in China. This paper considers the central features of this newly introduced 2006 Regulation and then analyses the factors responsible for its adoption. This paper also examines the possible implications it will have for foreign M&A transactions in China, which includes a discussion on the problems with the enforcement of the 2006 Regulation and a proposal for improvement.