14 July, 2015
On July 1, 2015, the National People's Congress passed the People's Republic of China National Security Law ("NSL"). It took effect from the date of promulgation. The concept of national security under the NSL is incredibly broad, covering matters ranging across politics, the military, the economy, finance, culture, technology, territorial sovereignty, cyber security, ideology and religion. Furthermore, its scope of application extends far beyond China's borders to the polar regions, the international sea- bed, outer space and cyber space.
Not surprisingly, the NSL's broad scope of application has created a great sense of foreboding amongst the foreign investment community, concerned with the law's impact on investments and future opportunities in China. Drafted as broad brush framework legislation that will need to be clarified through implementing regulations, the NSL is long on implications but short on specifics that help clarify its practical impact. What is clear is that the NSL will impose additional restrictions and scrutiny on foreign activities in China on national security grounds.
China had a more conventional national security law prior to the enactment of the NSL. The 1993 national security law was largely designed to defend China against espionage activities. In November 2014, China revised and restyled the old national security law as the People's Republic of China Counter- Espionage Law to make way for the NSL, which was being drafted then with a much broader scope of application in mind.
Broad definition of national security
The NSL defines national security as "the status whereby there is a relative absence of international or domestic threats to the state's power to govern, sovereignty, unity and territorial integrity, the people's welfare, sustainable economic and social development, and other significant national interests, as well the ability to maintain security on a continuous basis".
This general definition is followed by topical sections on politics, the military, the economy, finance, culture, technology and territorial sovereignty to cyber security, ideology and religion. Clearly, the NSL takes a broad and flexible approach in defining national security which goes beyond the more conventional and narrower concept of national security revolving around national defense. From a business perspective, the key concern is in the reference to "economic development" as being seen as part of China's national security – i.e. in addition to the existing laws and regulations, commercial activities and investments will be considered separately in the light of the broad and amorphous perspective of national security.
Expanded national security review regime
Article 59 of the NSL provides that certain types of foreign investments, key technologies, network information technology products and services ("IT Products and Services", the term "network" may extend the application of the NSR requirement beyond IT Products and Services delivered via the Internet, another example of the broad theme of the NSL), construction projects and other major activities that have national security implications will be subject to broad national security review ("NSR") requirements.
The NSR requirement is not new – the Chinese government already conducts NSRs in various areas and investments under existing laws and regulations. For example, foreign trade laws in China allow the Chinese government to impose restrictions on imports and exports by reason of national security considerations. Further, certain categories of construction project are subject to NSR requirements before they can be undertaken. Of the utmost concern to foreign companies are the NSR regimes in relation to foreign investment and IT Products and Services, which we discuss further below.
NSR in relation to foreign investments
Prior to the enactment of the NSL, the Chinese government imposed NSR requirements on mergers and acquisitions ("M&A") involving the acquisition of Chinese companies by foreign investors in the form of the Circular on Establishing the Security Review System for Mergers and Acquisitions of Enterprises within China involving Foreign Investors ("NSR Circular") issued by the State Council in 2011. The NSR Circular applies to M&A transactions whereby a foreign investor acquires equity in, and/or assets of, a domestic enterprise in China. In contrast, greenfield non-M&A establishments by foreign investors are not subject to the NSR requirement.
Separately, earlier this year, the Chinese government issued the Tentative Measures for National Security Review of Foreign Investments in Free Trade Zones ("FTZ NSR Measures"), which pilot run a NSR regime in China's free trade zones (i.e. the Shanghai Pilot Free Trade Zone, the Guangdong Pilot Free Trade Zone, the Tianjin Pilot Free Trade Zone, the Fujian Pilot Free Trade Zone and other pilot free trade zones). The NSR regime under the FTZ NSR Measures applies not only to M&A transactions but also other foreign investments, including greenfield investments. With the NSR requirement in the NSL, it is anticipated that the full- blown regime for foreign investment scrutiny in the FTZ NSR Measures will be rolled out nationwide, subject to more specific implementing rules to be enacted. There may be a potential overlap between the NSR requirements and the above mentioned security review processes. The lack of clarity on the processes and requirements as well as key determinants of the review process is of concern.
Further, with the broad definition of the national security concept in the NSL, the scope of industrial sectors that may be subject to NSR is likely to grow. In the past, the Ministry of Commerce – one of the main authorities responsible for implementing NSR – listed 57 industry sectors where M&A transactions by foreign investors may be subject to the NSR under the NSR Circular. With the NSL, additional sectors may be subject to NSR scrutiny given the lack of clarity and specificity in the NSL. For example, cultural products (which may be considered of concern to "the people's moral standards") may potentially become subject to the NSR process. Going forward, foreign investors into China will therefore need to ensure that they do not run afoul of the potentially expanded NSR requirements.
NSR for IT Products and Services
The NSL calls for the establishment of a domestic Internet and information security safeguarding mechanism. In particular, the new law requires, in very broad terms, that core network technology, critical infrastructure, information systems and data in important areas to be stored and kept "safe" and "controllable."
Importantly, the NSL further creates a NSR requirement for IT Products and Services, the scope and procedure of which are not defined in the NSL. This requirement goes beyond M&A transactions, greenfield investments or specific investment plans.
The new NSR requirement will have significant implications for providers of foreign IT Products and Services operating in China or selling in China, who may already, be 'feeling the heat' as a result of the draft Anti-Terrorism Law, the draft Cybersecurity Law, and other recent industry-specific rules and drafts. Suppliers to the banking sector will remember the recent guidelines issued to banks in China requiring them to achieve targets for "secure" and "controllable" technologies in their IT systems which were shelved following pressure from various foreign lobby groups. Clearly, international suppliers of IT Products and Services are likely to face significantly higher entry barriers to the China market than their Chinese competitors. The overlapping rules will give the Chinese government authorities plenty of avenues through which they can scrutinize foreign products/services more closely and require disclosure of key know-how (e.g. encryption technologies).
Implications for merger control review
Although the NSR and the merger control review run in parallel, the NSL may also have an impact on some complex merger control cases.
The Anti-Monopoly Law pursues multiple goals, including "safeguarding…the public interest, and promoting the healthy development of the socialist market economy." The factors to be considered in the merger control process include "the impact of the concentration between business operators on the development of the national economy."
Against this background, it is possible that the broad definition of national security in the NSL could further complicate the merger control review in China. For example, government departments that are more sensitized toward national security issues, such as the Ministry of National Security and the National
Development and Reform Commission, may have additional incentives to get involved in the merger control process relating to specific transactions.
With its 84 provisions, the NSL expands national security concerns from the core area of national defense to a wide range of geopolitical, cultural and economic issues that have more to do with tightening the ruling Communist Party's grip on China. The NSL may also provide a source of principles to be taken into account when government bodies draft policies or further regulations.
Foreign companies doing business in or with companies in China will need to brace themselves for further uncertainty until we have greater visibility on how the NSL will be implemented in practice. However the overall effect of this and other legislation currently going through the system is to make foreign investors increasingly nervous about the impact on their existing and future investments in China, and there is a worrying sense that China may be looking inwards rather than outwards for its future growth and prosperity.
Andrew McGinty, Partner, Hogan Lovells