By Richard Butterwick, Cathy Yeung, Yilong Du, Karima Salway
Overseas direct investment by Chinese companies increased significantly in 2016 to US$212 billion, a 143% increase from 2015. While outbound M&A interest remains strong in China, recent measures taken by the Chinese government to scrutinise transaction fundamentals more closely and slow capital outflows may impact deals in 2017. Consequently,
what should European corporates know and do in order to minimise the risk of an aborted deal?
1. Why Do the Deal?
Chinese regulators are focusing on the authenticity and commercial purpose of deals by Chinese companies. Acquisitions with a solid rationale that benefit the Chinese economy are unlikely to be rejected outright. So-called “irrational” deals (outside of a Chinese buyer’s core sector, particularly in the real estate, media, sports or hospitality sectors) will face greater regulatory hurdles and carry a higher abort risk. European corporates and their advisers need to factor this into any approach from a Chinese company.
2. Who Is the Buyer?
European corporates need to understand whether they are dealing with a private company, a publicly listed company or a state owned enterprise (SOE). Acquisitions by SOEs, with links to government departments, are less likely to be hindered by the rule-tightening. Deals worth less than US$300 million should also be safe, as smaller deals have a streamlined approval process. Overseas subsidiaries of Chinese parents with sufficient assets and financing capacities, offshore Chinese heritage companies and USD funds managed by PRC based firms will generally not be affected.
3. Where Is the Money Coming From?
Chinese investors typically raise all or a portion of the purchase price within China, whether on balance sheet, via an existing or new bank facility, through a private placement of equity and/or from co-investors. The People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) have directed Chinese banks to more closely monitor any remittance of funds, and banks have slowed FX remittance out of China even where FX registration has completed. Banks are also under pressure to scale back their provision of cross-border security and onshore deposit-backed offshore lending.
M&A teams should seek, at an early stage, to ascertain the sources of funds. European corporates may prefer to deal with an offshore entity affiliated with a Chinese buyer, which holds cash overseas (either in escrow or with a supporting standby letter of credit for the purchase and break fee costs) and is able to sidestep FX difficulties.
4. How Long Will the Deal Take?
European corporates and Chinese buyers should engage early in deal timetable planning as Chinese buyers must file a significant amount of information which will take time to prepare. Work on obtaining state approvals should begin as quickly as possible, even on a no-names basis.
Certain transactions will not benefit from the streamlined filing process, including:
- Transactions of ≥ US$10 billion
- Transactions of ≥ US$1 billion involving overseas targets unrelated to the Chinese buyer’s core business
- Transactions using PRC partnership structures
- Outbound minority investments in overseas listed companies
On a procedural level, Chinese buyers now need to:
- Provide more information when submitting a project information report to the National Development and Reform Commission (e.g. their financial statements, details of sources of funding and target due diligence reports)
- Conduct supervisory interviews with the PBOC or SAFE when making outward remittances > US$5 million. SAFE is required to review the authenticity and compliance of a transaction involving the purchase of foreign currency, payment of foreign exchange or outward remittance of funds over US$5 million before a Chinese bank can process such transaction
The State-owned Assets Supervision and Administration Commission (SASAC) is expected to issue a negative list in respect of transactions conducted by SOEs directly owned and managed by the central government. The list will identify transactions that are prohibited and transactions that are only permitted after SASAC approval.
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