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24 July, 2017
Introduction and executive summary
In recent years, Chinese outbound investments have increased dramatically as the PRC government has encouraged PRC companies to look for overseas investment opportunities to acquire brands, technology and to build an international footprint.
However, since third quarter of 2016, the PRC government has made it more difficult for PRC companies to move money offshore. The reasons for the policy shift can be broadly summarised as follows:
a) remittance and exchange of RMB for the purpose of outbound investments have contributed to the downward pressure on the RMB:US$ exchange rate and the reduced foreign currency reserves (down to around US$3 trillion from a high of around US$4 trillion);
b) some outbound investments are perceived to have been speculative without clear strategic or commercial justifications; and
c) the valuation of many PRC listed companies have increased significantly and has become very high on a per-metric-basis.
Issue of new shares to the public in the PRC can provide PRC listed companies with very cheap financing. The securities regulator has stepped in to protect investors and the market.
This recent policy shift has resulted in terminated M&A projects and an increased deal uncertainty for those which may still succeed. Interestingly, the tightening has taken the form of "window guidance" to financial institutions and a host of other practical measures without any significant changes to the major rules and regulations governing outbound investments. Accordingly, the situation is relatively fluid. In this briefing we will provide an overview of the situation prior to the recent curbs of foreign outbound investment (see section 2), provide an overview of these curbs (see section 3) and finally explain changes to the securities regulations which make it more difficult for PRC listed companies to raise equity to finance overseas investments (see section 4).
Foreign investment until third quarter of 2016
In December 2013, the State Council – China's highest executive organ – issued a decision to reform the regulatory approval process in order to promote outbound investment. Echoing the State Council's decision, in 2014, the two government authorities in charge of outbound investments – the National Development and Reform Commission ("NDRC") and the Ministry of Commerce ("MOFCOM") released new rules respectively to streamline the approval regime for outbound investment. The new rules made record-filing, rather than verification and approval, the default rule.
SAFE which oversees, among other things, exchange and remittance of RMB, also issued a series of rules and policies aiming at facilitating outbound investment. With effect from June 2015, SAFE's approval was no longer required for exchanging RMB into the required foreign currency and wire the funds offshore for the purpose of outbound investment. Chinese enterprises only needed to make a registration with SAFE through a local bank and the subsequent matters (e.g. opening an account, purchasing the required foreign currency, etc.) were handled directly by that bank.
The regulatory overhaul commencing in 2013 was a significant shift to previous regulations which required outbound investments to be approved by the relevant government authorities on a case-by-case basis after a varying degree of vetting.
Recent curbs on outbound investments
Since end of 2016, the Chinese government has taken various measures to tighten the control over outbound investments and outbound capital flows. These measures have taken the form of "window guidance" to financial institutions and a host of other practical measures but have so far not resulted in major changes to the actual regulations.
The following outline sets out the measures which relevant parts of the Chinese government have taken (or were reported, by notable and reliable sources1, to have taken):
a) Directions from the State Council
It was reported that in late November 2016, the State Council sent a draft circular to all government departments, requiring them to (i) ban outbound investments above US$10 billion; (ii) ban mergers and acquisitions of more than US$1 billion outside a Chinese investor’s core business; and (iii) halt foreign real estate deals by SOEs involving more than US$1 billion.
b) Joint Statement by the regulators
On 6 December 2016, NDRC, MOFCOM, the People's Bank of China ("PBOC"), and SAFE jointly held a press conference stating that the Chinese government will pay particular attention to the following outbound investment transactions: (i) large investments in business outside the Chinese investor's core business; (ii) outbound investments made by limited partnerships; (iii) investment in offshore targets that have asset values that are larger than the Chinese acquirers; (iv) investment by a newly established vehicle without any substantial operations; and (v) "irrational" overseas investments in certain industries, specifically real estate, hotels, film, entertainment and sports clubs (the "Joint Statement").
c) Crack down on illegal capital transfers by SAFE
It has been reported that on 8 December 2016, SAFE commented that the regulators would continue to crack down on illegal capital transfer disguised as outbound investment. The authority would closely monitor abnormal outbound investment activities, such as (i) newly established firms investing overseas without real business; (ii) company's outbound investment volume that substantially outweighs its registered capital; (iii) investment targets unrelated to a company's main business; and (iv) abnormal sources of company capital related to suspected illegal asset transfers and underground lending.
d) MOFCOM's enhanced online filing system
On 2 December 2016, MOFCOM enhanced its online filing system for outbound investments to strengthen the verification of the authenticity of notified transactions. The Chinese investors are required to submit additional comprehensive information and documents2 in support of the application. After the introduction of the enhanced online filing system, MOFCOM will only formally accept an application for filing or verification of an outbound investment after it has examined the transaction's authenticity.
e) NDRC increased the documentary requirements
On 1 December 2016, NDRC modified its standard reporting form and required additional information and documents proving the Chinese investors' due incorporation, operations and financial status. This process applies to the additional pre-signing NDRC filing for certain larger overseas investments (US$300 million or above).
f) Internal review criteria adopted by MOFCOM and NDRC
It has been reported3 that MOFCOM and NDRC (and their local counterparts) adopted a number of internal criteria during their review of proposed outbound investments. Accordingly, the requirements would include (i) the Chinese investor having a liabilities-to-assets ratio below 70% and a return-on-equity ratio above 5% for the previous year; (ii) in case of an acquisition of shares in an overseas listed company, at least 10% shares shall be acquired; and (iii) the investment vehicle shall have been established for more than one year with a net asset value higher than that of the overseas target.
According to the report4 , investments exceeding a certain threshold (the "Ceiling Value") are not likely to get approved/filed. Different local MOFCOM and NDRC officials indicate that the Ceiling Value is somewhere in the range of US$300 million (regardless of the industry or the investment's relevance to the investor's core business) to up to US$5 billion (in case of investments within the investor's core business, excluding real estate, hotels, film, entertainment and sports clubs).
Since MOFCOM's and NDRC's criteria are not publicly available, none of the above information can be easily verified.
g) Tightened scrutiny on foreign exchange transactions by PBOC and SAFE
It is reported that PBOC and SAFE have been setting up meetings with every company planning to invest US$5 million or more into overseas projects and whose foreign exchange registration with the authorities was completed after 28 November 2016.
Those companies that have already been approved or were otherwise qualified to invest in overseas projects and had completed the foreign exchange registration process, but had not settled payment before 28 November 2016, were also required to attend compulsory talks set up by PBOC and SAFE.
The regulators further required that from 28 November, all banks must report to the central government any foreign exchange transactions of US$5 million or more. SAFE supervises and may halt any on-going overseas direct investment projects in which Chinese investors need to transfer more than US$50 million out of the country. Approval will be subject to a review of the authenticity and legality of the company's outbound investment plans.
h) Limits on RMB payments by PBOC
Curbs on international RMB payments are other examples of capital control measures intended to relieve downward pressure on the RMB currency.
PBOC has revised its rules on cross-border lending by China-domiciled companies. After the changes, RMB denominated loans to the overseas subsidiaries of a PRC company cannot exceed 30% of the lender's equity and has to be recorded by SAFE.
Previously, no similar limit was imposed on this type of transfers, which was encouraged by the Chinese government as part of its larger effort to internationalise RMB. The concern is that once RMB exits Mainland China into an offshore market, conversion into foreign exchange then becomes unregulated. Heavy offshore RMB selling can cause divergence between the onshore and offshore exchange rates, but the gap between two exchange rates eventually narrows due to arbitrage by banks and companies with access to both markets.
i) Stricter supervision of cross-border bank guarantee/SBLC
We understand that some PRC banks have recently received non-public "window guidance" from SAFE . According to such guidance, the issuance of cross-border guarantees and Stand by Letter of Credit ("SBLC") by these banks shall now be subject to SAFE's pre-review as well. Previously, the issue of cross-border guarantee or an SBLC by a PRC bank was not subject to as much scrutiny and could in some cases reduce some of the delays and uncertainties resulting from recent curbs on outbound investment.
Tightening up of the securities regulations
The China Securities Regulatory Commission ("CSRC") must approve any issue of shares or public issue of bonds by listed companies. CSRC has recently tightened the rules to restrict excessive and frequent fundraising on the domestic market by listed companies. This has affected the ability of Chinese listed companies from raising the funds necessary to make large acquisitions inside and outside of China. According to a Q&A document issued by the CSRC on 17 February 2017, these three criteria apply to a fundraising application by a listed company:
a) the proposed number of shares to be issued in a private placement shall not exceed 20% of its currently issued total share capital;
b) at least 18 months must have passed between a share issue, rights issue or private placement and the most recent fundraising (including IPO, placement, rights issue and private placement). This does not apply to issuance of convertible bond or preference shares or certain fundraising in the Growth Enterprise Market; and
c) the listed company must not already hold significant financial investments (such as financial assets held for trading, liquid financial assets, third-party receivables, etc.).
1 These sources include traditional media such as Xinhua News Agency, Reuters, Financial Times and the South China Morning Post.
2 See http://femhzs.mofcom.gov.cn/fecpmvc/pages/fem/
3 This was reported by Mergermarket.
4 This was reported by Mergermarket.
For further information, please contact:
Michael Sheng, Partner, Ashurst
michael.sheng@ashurst.com
