The New Antimonopoly Law And Its Impact On Foreign M&A Transactions

Article by Thomas M. Shoesmith, David Tang and Jinjian Huang

On August 30, 2007, after debates dating to the 1980s, the Standing Committee of the National People's Congress (NPC), China's top legislature, completed its third official reading of the draft Antimonopoly Law, and finally adopted it as the nation's first comprehensive Antimonopoly Law (Law). It will become effective on August 1, 2008. The Law targets four types of "monopolistic conduct:" monopoly agreements, abuse of dominance, administrative monopoly, and concentrations. This article discusses the differences in terms of concentrations under the Law and the existing antimonopoly-related rules.

Under the present system, China does not have comprehensive antimonopoly legislation. Rather, the Ministry of Commerce (MOFCOM) and State Administration of Industry and Commerce (SAIC) have adopted regulations concerning antimonopoly review in the Regulations on the Mergers & Acquisition of Domestic Enterprise by Foreign Investors (M&A Regs) and Guidelines on Antitrust Filings for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (Filing Guidelines). These regulations and guidelines only focus on foreign acquisitions and do not provide a nationwide plan to combat monopolistic behavior.

The Law will substantially change the government's approach to antimonopoly review on M&A transactions under the M&A Regs and the Filing Guidelines in three aspects:

I. The Antimonopoly Review Body

II. The Antimonopoly Review Thresholds

III. The Antimonopoly Review Process

I. The Antimonopoly Review Body

As detailed below, the Law changes the antimonopoly enforcement mechanism as well as the antimonopoly review body.

A. Antimonopoly Review Body Under the New M&A Regulations

Under Articles 20 and 21 of the M&A Regs, both MOFCOM and SAIC are permitted to conduct antimonopoly reviews of M&A transactions. The M&A Regs, however, are silent as to the extent of each agency's responsibilities and reviewing standards, methods and procedures. As a result, the two administrations have been wrangling over control of antimonopoly matters and issued their own procedural requirements. In practice, MOFCOM generally has been more active in reviewing reported transactions, while SAIC has assumed a more passive role because it is the traditional watchdog for foreign investment in China and usually centralizes the administration of foreign-related matters.

B. Antimonopoly Review Body under the Law

The Law changes the current enforcement structure of the antimonopoly regulations by establishing a multitier enforcement mechanism to implement the Antimonopoly Law: (1) the State Council will establish an Antimonopoly Commission "to organize, harmonize, and supervise the antimonopoly work;" (2) the State Council will create an Antimonopoly Enforcement Authority (AEA); and (3) the AEA will have discretion to authorize "the corresponding organs of the People's Government of Province, autonomous region, and municipality to perform antimonopoly functions." (See Law Arts. 9, 10.)

The centralized Antimonopoly Commission under the State Council, as the supervising institution, will organize, harmonize, and supervise antimonopoly work in general, such as formulating competition policies, investigating and evaluating general market competition conditions, making and publishing the antimonopoly guidelines, as well as coordinating the AEA. (See Law Art. 9.)

The AEA, as an executive institution, will be charged with specific enforcement responsibilities. For example, the AEA will have the authority to authorize local branches at the provincial level to perform antimonopoly work where necessary. Thus, parties to a reportable transaction should notify the AEA so that an antimonopoly review can begin.

C. Unsettled Issues under the Law

The Law, however, does not specify in which institution-MOFCOM or SAIC-the AEA will exist. It only grants the State Council the power to establish the specific enforcement institution. Given that MOFCOM and SAIC are currently enforcing antimonopoly reviews under the M&A Regs, it is likely that one of the two agencies will become the AEA. At the very least, the current personnel of the two agencies who are conducting merger reviews are very likely to continue to perform similar functions.

In addition, the Law does not specify the legal relationship between the Antimonopoly Commission and the AEA. It simply provides that the Commission should cooperate with and supervise the AEA, but it does not specify what happens if there are conflicts between the two agencies. Also, the Law allows the AEA to authorize local government at the provincial level to perform antimonopoly work under the central guidance of the AEA. This would benefit the effectiveness of implementation. However, the Law does not clarify the specific role of the authorized local branches at the provincial level-and to what extent the local branches would be independent of the local government. This might open the door to local protectionism and impede the effectiveness of the Law. We expect that the Implementing Rules will clarify these issues to make the Law more practical and effective.

II. Antimonopoly Review Thresholds

The Law identifies specific thresholds that trigger the requirement of an M&A transaction review. If an M&A transaction meets the review threshold, the acquiring party must submit notification to the review body, including the necessary supporting documents, before the transaction can proceed.

A. Thresholds Under the M&A Regs

The M&A Regs only apply to M&A transactions involving a foreign party. They govern both transactions wherein a foreign party directly acquires a Chinese entity or the assets of a Chinese enterprise (onshore transactions), and transactions concluded entirely outside China if either the buyer or the seller has operations or subsidiaries in China (offshore transactions). The thresholds for antimonopoly review are different for these two types of transactions.

1. Thresholds for Onshore M&A Transaction Review

Under Article 2 of the M&A Regs, there are two types of onshore M&A transactions: (1) "equity transaction" in which a foreign enterprise either (a) purchases equity interests in a domestic enterprise and subsequently converts that domestic enterprise into a foreign-invested enterprise (FIE), or (b) subscribes for a capital increase in a domestic enterprise and subsequently converts that domestic enterprise into an FIE; and (2) "asset transaction" through which a foreign enterprise either (a) establishes an FIE to purchase and operate the assets of a domestic enterprise, or (b) purchases such assets for contribution to the establishment of a new FIE. An onshore transaction can be subject to either mandatory or discretionary review, depending on the following factors:

Mandatory review. An onshore transaction is subject to mandatory notification and review if any party to the transaction, including any foreign party's affiliates:

• Has a turnover in China for the current year exceeding RMB 1.5 billion (approximately US $194 million);

• Has acquired more than ten domestic enterprises in related industries in China within one year;

• Had a China market share of 20% or more before the M&A transaction; or

• Will have a 25% or greater market share in China after the M&A transaction.

Discretionary review. Even if none of the foregoing tests is met, Article 51 provides for a discretionary review upon the request of domestic competitors, industry regulators, or industrial associations. MOFCOM and SAIC minght still review an onshore M&A transaction if they determine that the transaction involves "a significant market share," or there are other factors that will "seriously influence market competition." Article 3 further supports this by stating that foreign investors "must not disturb social and economic order or impair the social and public interests." These broad terms might provide substantial room for domestic competitors, industry regulators, or industrial associations to request review of onshore transactions, regardless of their competitive significance.

Review on national security grounds. In addition, the M&A Regs establish the foundation for review of onshore transactions on national security grounds. Article 12 requires parties to report to MOFCOM any onshore transaction that "results in actual control by a foreign investor and involves key industries, has factors imposing or possibly imposing material impact on the economic security of the State, or would result in transfer of actual control in a domestic enterprise which owns any well-known trademarks or Chinese historical brands." If the parties fail to report transactions with actual or potential "material impact" on the "economic security of the State," MOFCOM "together with other relevant departments" may act to block, modify, or unwind the transactions. Although this provision is not directly related to the antimonopoly review chapter of the M&A Regs, it provides noncompetitive elements such as national security and protection of domestic industry to be factored into the consideration of the antimonopoly review.

2. Thresholds for Offshore M&A Transaction Review

The term "offshore transaction" is not defined anywhere in the M&A Regs. It could potentially cover nearly any transaction occurring outside China. Under Article 53, an offshore M&A transaction is subject to review if any party to the transaction:

• Owns more than RMB 3 billion in assets in China (equal to approximately US $388 million);

• Has business turnover in China for the current year exceeding RMB 1.5 billion (approximately US $194 million);

• Has a China market share of 20% or more (including all affiliates);

• Will have a Chinese market share of 25% or more as a result of the transaction (including all affiliates); or

• Will hold, directly or indirectly, an equity interest in more than fifteen FIEs in related industries in China as a result of the transaction.

Nevertheless, it would be rather impractical for Chinese authorities to reach out to global acquisitions wherein the acquirer is not a Chinese entity, or the target company does not sit in China.

3. Exemptions from M&A Transaction Review

Article 54 of the M&A Regs provides certain exemptions from review. It states that any party to the M&A transaction can apply for exemption from review if one of the following conditions is met:

• The transaction would improve the market's competitive environment;

• The transaction restructures a loss-making enterprise and safeguards employment;

• The transaction includes advanced technology and skilled personnel in China and increases the enterprise's global competitiveness; or

• The transaction improves the environment.

B. Thresholds Under the Law

The Law applies to both foreign and domestic companies. Under Article 2, it covers both monopolistic conduct inside and outside China that eliminates or has a restrictive effect on competition in the Chinese domestic market. The antimonopoly review of an M&A transaction is governed by Chapter 4, Concentration of Undertaking, which prohibits concentrations that might lead to the elimination or restriction of effective competition.

An M&A transaction is included as a form of concentration under Article 20, which defines "concentration of undertakings" as "mergers; acquisition of control of other undertakings through means of acquisition of shares or assets; or acquisition of control or the capability of imposing decisive influence over other undertakings by contract or other means."

1. Thresholds for Review

Under Article 21, a concentration of undertakings that "meets the relevant thresholds for report and filing as stipulated by the State Council" will be required to make a filing with the AEA; otherwise, the concentration shall not be carried out. For concentrations that "have or may have the effect of eliminating or restricting competition," the AEA can block a transaction or approve it, subject to restrictive conditions.

In earlier drafts of the Law, notification and review were required if the aggregate worldwide turnover of all parties to the transaction exceeded RMB 12 billion (approximate US $1.5 billion) and one of the parties had a PRC turnover exceeding RMB 800 million (approximately US $105 million). This threshold was widely criticized because many multinational companies doing business in China can easily satisfy it, meaning that whenever these companies plan to engage in M&A transactions anywhere in the world, they will have to notify the antimonopoly authority in China, no matter how remote the effect of the transaction on China's market.

The Law thus removes this threshold and instead expressly leaves the relevant notification thresholds to be specified in the Law's implementation regulations (Implementing Regs). It is expected that the State Council will publish the Implementing Regs before the Law becomes effective on August 1, 2008.

2. Exemptions from Review

Even though the thresholds for review are not clear from the Law, Article 22 provides certain exemptions from review. It states that if any of the following conditions are met, the parties may conclude the M&A transaction without notifying the antimonopoly authority:

• One party to the transaction owns more than 50% of the total voting shares or assets in the transaction; or

• A non-party to the transaction owns more than 50% of the total voting shares or assets in the transaction.

These exemptions allow mergers between a parent company and its subsidiaries, or mergers among all subsidiaries of the same parent company, to be exempt from antimonopoly review.

3. Affirmative Defenses to Prohibition of Concentration

Even if the transaction will eliminate or restrict effective competition, under Article 28 the AEA can still allow the concentration if the parties to the transaction can prove:

• The advantages of the transaction on improving competition would outweigh the harms caused by the transaction; or

• The transaction is in harmony with the public interest.

4. National Security Review

In addition to an antimonopoly review, Article 31 provides that concentrations involving a foreign investor might have national security concerns that subject the transaction to national security review in accordance with relevant regulations. This article is perhaps the most controversial provision in the Law.

This is not the first time we have seen a national security check as part of Chinese legislation. As discussed above, the M&A Regs laid the foundation for review of onshore transactions on national security grounds, although the focus there was mainly on national economic security. In December 2006, the State Council released a list of strategic sectors in which the State would retain control, including military manufacturing, power production and grids, petroleum, gas and petrochemicals, telecom manufacturing, coal, civil aviation, and shipping. The national security review under the Law would no doubt apply to foreign acquisitions in such listed sectors. It is, however, unclear to what extent and how such national security reviews will be applied.

Many commentators are worried that China will abuse this provision by using national security concerns as an excuse to protect its companies and industries. Recent transactions indicate that these worries are not baseless. During the discussion on the second reading on the draft of the Law in June 2007, some legislators cited the acquisition of Xuzhou Construction Machinery Group (the largest Chinese construction machinery manufacturers) by Carlyle Group (a U.S. private equity firm) and the acquisition of Supor (a major Chinese cookware company) by SEB (a French cookware company) as examples of transactions concerning national security. Both transactions are unlikely to give rise to national security concerns in other jurisdictions, and yet both were subject to close scrutiny by the Chinese government with the belief that the takeover of national champions by foreign investors would be detrimental to national economic security. Thus, foreign investment might now face added hurdles under this new provision.

C. Implications for Foreign M&A Transactions and Unsettled Issues

1. Implications of the Changes to the Thresholds

The changes in the thresholds for antimonopoly review under the Law will no doubt have implications for China-related M&A transactions:

First, the current antimonopoly review scheme under the M&A Regs only applies to foreign investors, and is widely criticized as inconsistent with China's WTO commitments. The Law discards this practice and applies equally to the conduct of foreign and domestic enterprises. Thus, all M&A transactions, rather than only those transactions involving foreign parties, are potentially subject to antimonopoly review under the Law.

Second, the Law avoids adopting any specific notification and review thresholds and leaves them to be specified by State Council later in the Implementing Regs. This would allow the enforcement authority to adjust the thresholds from time to time. This flexibility, which is absent in the M&A Regs, would allow the thresholds to keep up with the ever-changing needs of Chinese economic development. Moreover, foreign companies may be able to provide their input on the development of a more reasonable notification threshold and potentially reduce compliance and transaction costs.

Third, the Law provides two exemptions that are absent in the M&A Regs. The exemptions under the Law would allow a parent company to merge with its subsidiaries or to let its subsidiaries merge with each other without being subject to antimonopoly review. The M&A Regs, however, allow the parties to the M&A transaction to apply for exemptions from review under certain circumstances. Under the Law, even if the transaction is qualified for the exception pursuant to the M&A Regs, it still has to file the notification with supporting documentation if the transaction meets the thresholds. This might impose unnecessary burdens on parties to transactions that present no actual competitive concerns.

Finally, the Law formalizes the national security review requirement. Although the M&A Regs lay the foundation for review of M&A transactions involving foreign parties on national security grounds, the parties are only required to notify MOFCOM if specific conditions are met. Under the Law, if the M&A transaction involving foreign parties has national security concerns, in addition to the regular antimonopoly review under the Law, the transaction will also be subject to national security review in accordance with the M&A Regs. It is still too early to predict the potential impact of the national security review on M&A transactions involving foreign parties, because the scope and standards for national security review are still unclear. Nonetheless, this potential additional review should raise foreign investors' awareness, because it may influence structuring decisions for any M&A transaction involving foreign parties.

2. Issues for Clarification

Despite the positive implications of the changes on antimonopoly review thresholds in the Law, many issues remain unsettled and are expected to be clarified in the Implementing Regs, including:

What degree of control is required to constitute a "concentration" under the Law;

What is the exact meaning of the term "decisive influence" for a given transaction to constitute a concentration;

What the "relevant notification thresholds" will be;

What the scope and standards for national security review are, and how they will be applied.

III. Antimonopoly Review Procedures

Review procedures under the Law are more detailed than those in the M&A Regs, including the review process, factors for consideration, enforcement measures, administrative reconsideration, and judicial review.

A. Review Process Under the M&A Regs

The M&A Regs provide little direction on the specific procedures and filing materials needed for notification and antimonopoly review. The Filing Guidelines add more details in this regard.

1. Who Should File?

Under the M&A Regs, if the thresholds for an onshore M&A transaction review are met, the acquiring party must notify MOFCOM and SAIC. However, the M&A Regs are silent on which party should file the notification for offshore transactions. Under the Filing Guidelines, the acquiring party is generally responsible for filing for both onshore and offshore transactions, but either party or both parties can independently or jointly file.

2. When to File?

For onshore transactions, the M&A Regs do not specify when the parties should report the transaction. The Guidelines require that the filing must be made after the execution of the acquisition agreements but before the public announcement of the transaction. For offshore transactions, both the M&A Regs and the Guidelines require that the parties file before the plan is publicly announced or at the same time it is submitted to the regulatory authorities of the country in which the transaction will occur.

3. What to File?

The M&A Regs do not specify what documents must be filed. The Guidelines from MOFCOM and SAIC remedy this problem by providing a detailed description of the materials that need to be filed. MOFCOM requires:

• Application letter signed by the applicant or its attorney;

• Applicant's ID certificate or registration certificate;

• Power of attorney authorizing an attorney or employee to submit the documents;

• Basic information of the parties, including name, domicile, business scope, types of enterprise, title and contact details of the liaison person, turnover of the latest fiscal year (global and China), scale of the enterprise, position in the industry, and history of the enterprise;

• Names of and introduction to the enterprises and individuals that are connected to the parties of the M&A transaction;

• Approval certificates and business licenses of enterprises, representative offices, branches, and other entities established by the parties of the M&A transaction;

• Definition of the relevant market;

• Latest two years' turnovers and market shares of the parties in the relevant markets as well as sources of the data and basis of calculation;

• Largest five competitors in the relevant market;

• Supply and demand structure of the relevant market;

• Competition in the relevant market;

• Documents of the M&A transaction;

• The parties' preceding year's audited financial statements;

• Application for the exemption of review;

• Industrial association of the relevant markets;

• Approval and report of the M&A transaction in other jurisdictions;

• Statement made by the parties declaring the authenticity and accuracy of the information in the application; and

• Other documents required by MOFCOM.

SAIC's documents list is shorter as compared with that of MOFCOM:

• Basic information of the parties to the M&A transaction: names, domiciles, and business scopes of the parties; documentation concerning the establishment of subsidiaries and branches of the parties, and the names of holding companies;

• Outline of the transaction: nature, price and industry or products involved, proposed closing date, and reason for the M&A transaction, etc.;

• Audited financial reports of the parties for the preceding accounting year (the major parts should be in Chinese);

• Influence analysis of the M&A transaction on the related markets' competition: market condition of the related markets and names of the four biggest competitors; changes of market share after the transaction; influence on the domestic market competition, etc.;

• Report on M&A transactions in other countries;

• Power of attorney (if the reporting party retains a Chinese law firm to submit the antitrust report in the firm's own name, the Chinese law firm should submit a power of attorney issued by the reporting party to SAIC); and

• Other information requested by the authorities.

4. Review and Approval

The M&A Regs do not provide much detail on how and when MOFCOM and SAIC will review and approve or disapprove a reported transaction. They only provide that, for onshore transactions, if MOFCOM and SAIC conclude that the transaction might result in excessive concentration so as to jeopardize fair competition and harm consumers' interests, a hearing will be held within 90 days of receiving all requisite documents to decide whether or not to allow the transaction. (See M&A Regs, Art. 52.)

The Filing Guidelines add more details on this. They provide that the review will be conducted within 30 working days, starting from receipt of all filing materials. If the filing party does not receive notice of further review within this 30-working-day period, it obtains clearance and may continue with the transaction. If the filing party receives such notice, the time limit will be extended to 90 working days. During this 90-working-day period, MOFCOM will conduct a formal hearing, and the filing party must provide more materials and additional explanations.

B. Review Process Under the Law

The procedures and filing materials for antimonopoly review under the Law are similar to those under the Filing Guidelines, with some exceptions.

1. Who Should File?

The Law does not specify who should do the filing if the transaction meets the notification threshold. This will likely be clarified in the Implementing Regs.

2. When to File?

If the notification threshold is met, the parties must notify the AEA and get clearance before the transaction can be concluded. Still, this is rather ambiguous and requires further interpretation in the Implementing Regs.

3. What to File?

Article 23 of the Law identified a list of documents that must be filed if the notification threshold is met. These documents include:

• The notification, including basic information about the parties, and the proposed closing date of the concentration;

• The evaluation report on the effects of the concentration on relevant market competition;

• The concentration agreements;

• Audited financial statements for the undertakings involved in the concentration for the previous fiscal year; and

• Other information required by the AEA.

If the documents submitted are not complete, the notifying party should supplement them within a set period. Otherwise, it will be deemed that no notification has been made. (See Law Art. 24.)

4. Review and Approval

The review and approval procedures under the Law are similar to those specified in the Filing Guidelines. After receipt of the required documents, the AEA has 30 days within which to decide whether to take further review actions. Until the AEA makes a decision, the transaction should not proceed. However, if the AEA does not make a decision within 30 days, or decides no further review action is needed, the transaction can be concluded. (See Law Art. 25.)

If the AEA calls for further review, it has 90 days within which to approve or disapprove the transaction. But the AEA may extend the review process for up to 60 days under one of the following circumstances:

• The parties agree to extend the time limit;

• The documents submitted are inaccurate and need further verification; or

• The relevant circumstances have significantly changed after notification by the parties.

Besides approval and disapproval, the Law also provides a new form of decision: approval with restrictive conditions. Under Article 29, where a concentration is approved, the AEA may impose restrictive conditions on the concentration to reduce the adverse impact on competition by the transaction. This gives the AEA discretion to attach restrictive conditions to any approved transactions.

C. Factors for Considerations

The M&A Regs and Filing Guidelines do not identify what factors should be considered in making a determination. They only provide a principal substantive standard: whether a transaction will cause "excessive concentration in the domestic market, impede fair competition, and harm the interests of domestic consumers." (See M&A Regs Arts. 51, 52)

In contrast, the Law provides more stringent standards concerning how the AEA should conduct its antimonopoly review. In addition to a general standard that a transaction will be disapproved if it "has or may have the effect of excluding or restricting competition," the Law provides a list of factors in Article 27. The factors largely depend on the expected effect of the transaction on the relevant industry's competitive environment and economic efficiency. These factors include:

• The market shares and market power of the parties to the M&A transaction;

• The concentration in the relevant market;

• Expected effect on market entry and technological advances;

• Expected effect on consumers and relevant suppliers and distributors;

• Expected effect on national economic development; and

• Other factors that the AEA deems appropriate.

In addition to the above factors, the AEA has considerable discretion in performing antimonopoly reviews, such as consideration of national economic development, expected effect on consumers and market share, and so on.

D. Enforcement Measures

Neither the M&A Regs nor the Filing Guidelines specify the legal consequences for failing to comply with the reporting rules. The Law, however, includes a number of enforcement measures. If the parties to an M&A transaction fail to provide notice of the transaction or implement the transaction before approval, the AEA can impose a fine of no more than RMB 500,000 (approximately US $66,480). The AEA can also order cessation of the transaction or order the parties to dispose of stock, transfer part of the business, or take other necessary measures to correct the situation within a certain period of time. (See Law Art. 48.)

E. Appeal

The Law also provides for legal relief, which is absent from the M&A Regs, to the parties to the M&A transaction. If the parties to the transaction or interested parties are dissatisfied with a decision made by the AEA, they can apply to the AEA for administrative reconsideration. If the parties are still dissatisfied following the reconsideration, they can file for judicial review. (See Law Art. 53.)

IV. CONCLUSION

The Law appears to provide the scope, clarity, and government power necessary to effectively monitor the competitive impact of M&A transactions. It avoids setting notification and review thresholds, and allows the State Council to specify them and later adjust them, if needed. Also, it applies to both foreign and domestic enterprises to avoid protectionism. In addition, it provides much more clarity to the antimonopoly review body and review procedures. Thus, foreign investors doing business in China will benefit from the greater transparency, predictability and accountability of the antimonopoly review of M&A transactions provided by the Law.

There are, however, still many issues to be clarified. Particularly, the Law adds one more potential hurdle for foreign investments: national security review. It is unclear to what extent and how the national security review will be applied. Like many other Chinese laws, the Law only establishes a general legal framework. Many specific issues such as merger notification thresholds, exact meaning of some key terms such as "control" and "decisive influence," and the allocation of responsibilities among the Antimonopoly Commission, AEA, and authorized local branches are likely to be addressed in the Implementing Regs, which are expected to be released soon.

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.