CMS, China | China Enacts Further Measures for Security Review of Foreign Investment




CMS, China

China Enacts Further Measures for Security Review of Foreign Investment

Dear Sir or Madam,

Certain types of foreign investment into China are subject to security review, which is a considerable concern for foreign investors. After the PRC Foreign Investment Law took effect, the exact scope and procedures of the security review were unclear. The National Development and Reform Commission and the Ministry of Commerce on 19 December 2020 now issued the Measures for Security Review of Foreign Investment (the "Measures"). They took effect on 18 January 2021. The Measures establish and provide more detailed provisions for the security review system of foreign investment. Please find below an overview on the key issues of the Measures.

Kind regards,
CMS, China

On 19 December 2020, the National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM") jointly issued the Measures for Security Review of Foreign Investment (the "Measures"). The Measures took effect on 18 January 2021. Stipulations on security review of foreign investment are not new in the People's Republic of China ("PRC") and can be traced back as early as to the review of foreign-related M&A projects regulated in the then-effective Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors. Under the existing PRC laws and regulations, foreign investments related to certain security-related industries, such as military, national defense as well as certain key agricultural products, energy, resources and infrastructures of foreign investment, are subject to security review.

The Measures consist of 23 articles and are made on the basis of existing laws and regulations of the PRC such as the PRC Foreign Investment Law and the PRC State Security Law. Below is an overview on the key issues of the Measures.

1. The Current PRC Security Review System
   
  Before the Measures were issued, provisions related to national security review are mainly included in:
   
  the PRC Anti-Monopoly Law (issued on 30 August 2007 and effective since 1 August 2008),
     
  the Circular of the General Office of State Council on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors (issued on 3 February 2011 and effective since 4 March 2011),
     
  the Provisions of the Ministry of Commerce on the Implementation of the Safety Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors (issued on 25 August 2011 and effective since 1 September 2011),
     
  the Circular of the General Office of the State Council on Issuing the Tentative Measures for the National Security Review of Foreign Investment in Pilot Free Trade Zones (issued on 8 April 2015 and effective since 8 May 2015),
     
  the PRC State Security Law (issued on and effective since 1 July 2015),
     
  the PRC Foreign Investment Law (issued on 15 March 2019 and effective since 1 January 2020), and
     
  the Implementing Regulations of the PRC Foreign Investment Law (issued on 26 December 2019 and effective since 1 January 2020).
     
  Article 35 of the PRC Foreign Investment Law confirms that the State shall establish a security review system for all relevant foreign investment, under which security review shall be conducted for foreign investment influencing or possibly influencing State security. Similar provisions are included in Article 59 of the PRC State Security Law, which states that the State shall establish systems and mechanisms for national examination and supervision, carry out State security examination on foreign investment, specific items, key technology, network information technology products and services, construction projects related to State security, and other significant matters and events, so as to prevent and neutralize State security risks in an effective way.

Now, the Measures, in a further step, establish and provide more detailed provisions for the security review system of foreign investment as intended by the PRC Foreign Investment Law and the PRC State Security Law.
   
2. Scope of Security Review under the Measures
   
  In line with Article 2 of the PRC Foreign Investment Law, Article 2 of the Measures confirm that "foreign investment" refers to any investment activity carried out directly or indirectly by a foreign investor within the territory of the PRC, involving the following circumstances:
   
  (1) a foreign investor, solely or jointly with any other investor, invests in the construction of a new project or the establishment of an enterprise in the PRC;
     
  (2) a foreign investor, by means of merger and acquisition, acquires the equity interests or assets of any enterprise in the PRC; or
     
  (3) a foreign investor makes investment in the PRC by other means.
     
  It is not expressly specified what "other means" of foreign investment shall be subject to security review under the Measures. However, some Chinese legal practitioners believe that foreign investment made through agreement-based control, holding under authorization, trust, reinvestment, overseas transactions, lease, subscription of convertible bonds, etc. shall all be covered.

According to Article 21 the Measures, they also apply where an investor from Hong Kong, Macao or Taiwan makes any investment that has or possibly has an impact on State security.

Further, according to Article 22 of the Measures, where a foreign investor purchases the stocks of any enterprise in China through a stock exchange or any other securities exchange approved by the State Council, thus, having or possibly having an impact on State security, the Measures shall also apply.
   
3. Two Categories of Foreign Investment under Security Review
   
  Article 4 of the Measures divides the security review on foreign investment into two categories, i.e. (1) foreign investment that all shall be declared and reported to the working mechanism for the security review of foreign investment, and (2) foreign investment that shall be declared and reported only when the foreign investors have obtained the actual control over the enterprises invested in.
   
  a) In case of foreign investment in sectors of military industry and military-supporting industry that concern state defense and security, as well as investments made in areas surrounding military facilities and military industry facilities, a foreign investor or a party concerned in the PRC shall declare its proposed investment to the Working Mechanism Office established under the NDRC and led by NDRC and MOFCOM (“Working Mechanism Office”) prior to making the investment.
     
  b) In case of foreign investment in any important agricultural product, important energy and resources, major equipment manufacturing, important infrastructure, important transportation services, important cultural products and services, important information technologies and internet products and services (newly added), important financial services (newly added), key technologies and other important fields that concern State security, the foreign investor or the party concerned in the PRC also shall declare its proposed investment to the Working Mechanism Office prior to making the investment and after obtaining the actual control over the enterprises invested in. A foreign investor shall be regarded to have obtained the actual control over the enterprises invested in, if any of the following conditions is met:
     
    (1) the foreign investor holds 50% or more equity interests of the enterprises invested in;
       
    (2) the foreign investor holds less than 50% equity interests of the enterprises invested in, but the voting rights enjoyed by it can have a significant impact on the resolutions of the Board of Directors, Shareholders' Meeting or General Meeting of Shareholders; and
       
    (3) other circumstances that cause the foreign investor to have a significant impact on the business decision-making, personnel, finance and technology, etc. of the enterprises invested in.
       
  Compared to the so far existing laws and regulations, the scope of foreign investment under security review has been extended from "foreign investors' M&A of certain domestic enterprises and now covers a larger scope of foreign investment. Unfortunately, however, the description of the industry sectors covered still remains rather general. The Measures do not provide more detailed definitions or explanations on the exact scope of foreign investment under security review in the sectors mentioned above in items 3.a) and 3.b). In case of doubts, under Article 5 of the Measures, a foreign investor or party concerned in the PRC may consult the Working Mechanism Office about relevant issues prior to making a declaration of any foreign investment. Whether a certain proposed foreign investment project is subject to security review shall be subject to the decision of the Work Mechanism Office.
   
4. New Working Mechanism for Security Review of Foreign Investment and Its Working Timeline
   
  According to Article 3 of the Measures, the State shall establish a Working Mechanism Office for the security review of foreign investment under the NDRC and led by NDRC and MOFCOM. According to Article 6 of the Measures, a foreign investor or party concerned in the PRC making a declaration of any foreign investment to the Working Mechanism Office shall submit the following materials:
   
  declaration form;
     
  investment plan;
     
  a statement on whether the foreign investment has an impact on state security; and
     
  other materials requested by the Working Mechanism Office.
     
  a) Phases of Security Review

Security reviews of foreign investment are divided into two phases, i.e. general reviews and special reviews. General reviews are security reviews made, if the Working Mechanism Office deems it necessary to conduct a security review of the relevant declared foreign investment. Upon general review, if it is deemed that the foreign investment declared will not have an impact on State security, the Working Mechanism Office shall make a decision that the security review has been passed. Where, upon a general review, the Working Mechanism Office considers that the project has or possibly has an impact on State security, the authority shall decide to initiate a special review.
     
  b) Timeline of Security Review

According to Articles 6 to 11 of the Measures, the Working Mechanism Office shall, within fifteen working days from the date of receipt of materials that are submitted by a foreign investor or party concerned in the PRC or forwarded by the relevant department under the People's Government of a province, autonomous region or municipality directly under the Central Government, make a decision on whether it is necessary to conduct a security review of the relevant project, and notify the foreign investor or party concerned in the PRC thereof in writing.

Where the Working Mechanism Office decides to conduct a security review, a general review shall be completed within thirty working days from the date of the decision being made.

The Working Mechanism Office shall, if deciding to initiate a special review, make a decision after the review within sixty working days from the date of initiation. In exceptional cases, the period of review may be extended. If the period of review is extended, the foreign investor or party concerned in the PRC shall be notified thereof in writing.

During the period of security review, the foreign investors or parties concerned in the PRC may modify their investment plan or withdraw their investment. Where a foreign investor or party concerned in the PRC modifies its investment plan, the period of review shall be recalculated as of the date on which the Working Mechanism Office receives the modified investment plans. If the foreign investor or party concerned in the PRC withdraws its investment, the Working Mechanism Office shall terminate the review.
     
5. Potential Results from the Security Review of Foreign Investment
   
  According to Articles 9 and 12 of the Measures, where, upon a general review, the declared foreign investment is deemed to have no impact on State security, the Working Mechanism Office shall make a decision of passing security review and the foreign investor or party concerned in the PRC may make the investment.

Where the declared foreign investment has an impact on State security but such impact can be eliminated through additional conditions, and the foreign investor or party concerned in the PRC makes a written commitment to accept such additional conditions, a decision of passing security review with conditions shall be made with such additional conditions set out in the decision.

Where the declared foreign investment has an impact on State security and the impact on State security cannot be eliminated through additional conditions, a decision of not passing security review/prohibiting investment shall be made and the foreign investor or party concerned in the PRC shall not make the investment.

For easy reference, below please find a flowchart of the security review as provided by the Measures:
   
  Ulrike Glueck
   
6. Consequences of Incompliance with the Measures
   
  Possible sanctions in case of non-compliance are as follows:
   
  a) The working mechanism office shall order the foreign investor or party concerned in the PRC to make a declaration within a prescribed time limit, if such foreign investor or party concerned in the PRC directly makes an investment without making a declaration, as regulated under Article 16 of the Measures.
     
  b) The working mechanism office shall order the foreign investor or party concerned in the PRC to make corrections, if such foreign investor or party concerned in the PRC
     
    provided any false material for or concealed relevant information to the working mechanism office, or
       
    failed to make its investment under additional conditions in case of passing security review with conditions.
       
  c) The working mechanism office shall revoke the relevant decision if the foreign investor or party concerned in the PRC provided false material or concealed relevant information to pass the security review by fraud.
     
  d) The working mechanism office shall order the foreign investor or party concerned in the PRC to dispose of equity interests or assets within a prescribed time limit and take other necessary measures to restore equity interests or assets to the State before the investment was made and eliminate the impact on State security, if
     
    such foreign investor or party concerned in the PRC directly made an investment without making a declaration and refused to make the declaration,
       
    such foreign investor or party concerned in the PRC has already invested despite prohibitions,
       
    such foreign investor or party concerned in the PRC provided any false material or concealed relevant information to the working mechanism office and has already made the investment, or
       
    such foreign investor or party concerned in the PRC failed to make its investment under additional conditions in case of passing security review with conditions and refused to make the declaration.
       
  Further, should any foreign investor or party concerned in the PRC breach any other provision of the Measures, such breach shall be included in the State credit information system as a bad credit record and subjected to joint disciplinary action, If so, the foreign investor or party concerned in the PRC or some of its certain personnel may be subject to restrictions and prohibitions in business operations in the PRC.
   
7. Conclusion
   
  The Measures, together with the PRC Export Control Law (for more details, please refer to our previous newsletter "China Enacts First Export Control Law") and the Provisions on the List of Unreliable Entities, form part of a revised PRC supervisory system on foreign investors and foreign trade partners of PRC companies. The stipulations of the Measures, however, are rather broad and general. Definitions of certain terms such as "important sectors" and "key technologies", the specific time point to submit declarations to the Working Mechanism Office are not yet clarified and shall be further specified in further regulations. As to purchase of stocks of any enterprise in the PRC through a stock exchange or any other securities exchange approved by the State Council, the NDRC and MOFCOM already confirmed in a press conference that more detailed regulations will be issued later.

Further, it is to be noted that, even though the PRC has further reduced its restricted or prohibited items in its Special Administrative Measures (Negative List) for Foreign Investment Access, 2020 Version and Special Administrative Measures (Negative List) for Foreign Investment Access to Pilot Free Trade Zone, 2020 Versions, especially in sectors of telecommunications and finance, security review for important information technologies and internet products and services as well as important financial services, for the first time, have been added by the Measures to the sectors subject to security review (for details please see item 3.b) above). This means that although fewer items are covered under the negative lists of foreign investment in the PRC, this does not mean that the Chinese governmental authorities are paying less attention to proposed foreign investment in these areas and can still exercise control through the security review system of foreign investment.

Foreign investors or parties concerned in the PRC are therefore recommended to keep a close eye on the further regulations or explanations to be issued out by NDRC and MOFCOM in the future and to consult the Working Mechanism Office in due time in advance to check whether their intended investment will be subject to any security review under the Measures.

In case you have questions or for further information, please contact the authors of this newsletter:

Ulrike Glueck Dr Ulrike Glueck
Managing Partner
Head of Corporate Practice
Area Group
CMS, China

T +86 21 6289 6363
E ulrike.glueck@cmslegal.cn
CMS Angela Chen
Junior Associate
CMS, China


T +86 21 6289 6363
E angela.chen@cmslegal.cn

CMS Lei Shi
Junior Associate
CMS, China


T +86 21 6289 6363
E lei.shi@cmslegal.cn
 

 


This information is provided for general information purposes only and does not constitute legal or professional advice. Copyright by CMS, China.

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