New Rules Proposed For Chinese Merger Control

Important changes are expected in the operation of the Chinese merger control regime. The Standing Committee of the National People's Congress in the People's Republic of China ("PRC") adopted its first comprehensive antitrust law, the Anti-Monopoly Law ("AML"), in August of 2007, including an antitrust review regime for mergers and acquisitions. The AML will become effective on August 1, 2008, and will bring about wide-ranging changes. This client alert serves as a short overview only of just one aspect of the changes, namely, the proposed merger control rules and merger review process. Existing merger control rules, which have been applicable only to foreign companies and have had no formal enforcement mechanism, will be replaced. To this end, the Legislative Affairs Office of the State Council of the PRC recently issued a Draft Regulation on Notification of Concentration of Undertakings (the "Draft Regulation") that provides critical guidance on some issues upon which the AML is notably silent (i.e., filing thresholds and what types of transactions may trigger filing obligations). Below we discuss the rules that have been clarified by the Draft Regulation, as well as some of the ambiguities that remain about their practical operation.

DETERMINING WHETHER A TRANSACTION IS REPORTABLE UNDER THE AML

Mergers and acquisitions caught by the AML are referred to as "concentrations of undertakings," mirroring the vocabulary of EU merger regulation. The Draft Regulation indicates two key steps in determining whether a transaction is reportable and clearance by the Chinese authorities is required. The first inquiry is whether the transaction qualifies as a "concentration of undertakings" as set forth by the AML. The second inquiry is whether the transaction exceeds certain quantitative thresholds as proposed in the Draft Regulation.

Does the Transaction Qualify as a Concentration of Undertakings?

The AML sets forth three types of transactions that qualify as a concentration of undertakings:

1. A consolidation of undertakings (i.e., merger);
   
   
2. The acquisition of control through the acquisition of equity or assets of the target; or
   
   
3. The acquisition of control through contracts or other means, or by possessing an ability to decisively influence the target.
   
   

Defining the scope of "control" and "decisive influence" either through precedent or published guidelines will be critical for the certain operation of PRC merger review. The Draft Regulation does provide some new clarification to the critical terms "control" and "decisive influence," although not comprehensive definitions.

According to the Draft Regulation, "control" is acquired by:

• Acquiring 50 percent or more of the voting shares or assets of the target;
  
  
• Having the ability to effectively control the majority voting rights of the target;
  
  
• Being able to decide the appointment of at least half of the target's board of directors;
  
  
• Becoming the largest holder of the voting shares or assets of the target; or
  
  
• Any other circumstances where the anti-monopoly enforcement agency of the State Council ("AMEA") determines "control" to have been acquired.
  
  

The first three indicia of control are akin to the approach to concentrations by EU merger authorities. The "largest shareholder" criterion, however, is novel and suggests a very broad scope as well as difficulties of application. Without further clarification or guidance it is unclear how this test would operate. For example, an investment vehicle such as a mutual fund that has a relatively small share (e.g., 5 percent) of a large company's overall float may be the company's largest shareholder. Is it envisaged by the Draft Regulation that any acquisition of additional stock by this passive investor could potentially trigger a filing? It is also noteworthy that the Draft Regulation gives the AMEA the latitude to define further circumstances under which control may be acquired.

Similarly, the exact scope of "decisive influence" remains undetermined for the time being. The Draft Regulation refers to "decisive influence" as the ability to decisively influence the production and/or operation decisions of another undertaking. However, to what type of decisions this ability must relate is a key question. In EU jurisprudence, for instance, "decisive influence" refers to the effective exercise of rights of management or assets of another undertaking and must be of sufficiently long duration that a change in the structure of the market would take place. It is hoped that prior to implementation of the new rules, further guidance on this definition by the enforcement agency can be provided.

Does the Transaction Meet Quantitative Filing Thresholds?

If the transaction qualifies as a concentration of undertakings, the second inquiry is whether the transaction meets certain threshold requirements. The Draft Regulation provides the following three thresholds under which notification is required:

1. During the previous fiscal year, (i) total global revenues of all businesses participating in the concentration exceeded RMB 9 billion (approx. $1.28 billion) and (ii) at least two of the businesses participating in the concentration had revenue of more than RMB 300 million (approx. $42.74 million) within China;
   
   
2. During the previous fiscal year, (i) total revenue within China of all of the businesses participating in the concentration exceeded RMB 1.7 billion (approx. $242.2 million) and (ii) at least two of the businesses participating in the concentration had revenue of more than RMB 300 million (approx. $42.74 million) within China; or
   
   
3. The concentration will cause the businesses participating in the concentration to possess more than 25 percent of an industry's market share in China.
   
   

The first two draft thresholds require that more than one party has a presence in China, which differs from the existing rules where, under certain circumstances, one party alone could trigger a filing obligation. This is a noteworthy development as it ensures that a transaction has an appropriate nexus to China before a filing is required. Nevertheless, there remains some ambiguity with regard to the first two thresholds as the method for calculating revenue is still to be stipulated.

Additionally, it is important to note that there is a provision for the AMEA, in the absence of any of the thresholds being triggered, to require parties to a concentration to submit a notification if the concentration would eliminate or restrict competition. While a number of merger authorities around the world retain this type of discretion, the real question is how broadly the AMEA may exercise its discretion. We understand that an internal draft of the Draft Regulation specifically enabled the reviewing authority to compel a filing upon the request of competitors or other interested parties. That language has been removed, however, the broad language of the Draft Regulation may suggest that the enforcement agency will be able to require a filing based on information received from competitors. In comparison, the US antitrust authorities can certainly investigate a non-reportable deal, but they cannot compel a filing and thus condition closing of the transaction on receipt of regulatory approval. Guidance will be very important on how frequently the competent authority intends to use this provision in practice.

Further guidance on the application of the 25 percent market share test will also be eagerly sought. The Draft Regulation appears to require that a transaction would only be reportable if the combined share of the parties exceeds 25 percent as a result of the transaction. Nonetheless, application of market share thresholds by the enforcement agency will be difficult for businesses to predict, especially given that there is very little precedent in China for defining markets.

THE NEW MERGER REVIEW AUTHORITY AND PROCESS

AMEA has been designated as the new enforcement agency to be established by the State Council, but its composition, structure, and extent of its authority are as yet undefined. It is likely that some of the staff of AMEA may come from the Anti-Monopoly Investigation Office of the Ministry of Commerce ("AMIO"). Currently, AMIO is primarily responsible for conducting merger review under the existing regime. AMIO published a guideline in March 2007, offering some clarity to the merger review process, some of which are codified in the Draft Regulation.

A comparison of the procedural guidelines under the new and existing regimes are set out below:

Finally, it should be noted that in addition to the factors traditionally considered by most merger review authorities, the AML specifically permits the Chinese regulators to examine "the effect of the proposed concentration on the development of the national economy." This is a unique feature to the Chinese merger review regime. From a substantive standpoint, this factor potentially introduces non-competition related issues and, therefore, additional uncertainty to the Chinese merger review process.

CONCLUSION

The comment period on the proposed draft expired on April 12, 2008. The Legislative Affairs Office has not yet indicated if revisions can be expected. Until the new thresholds are confirmed the existing rules remain in place. Given the undeniable global importance of the Chinese market, businesses will desire certainty as to the substantive and procedural standards of China's merger review regime. The additional clarity that the Draft Regulation brings to the AML is likely just the first step in providing the necessary guidance on the questions that remain.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.