China strengthens foreign investments' national security review

China has recently introduced a new national security review regime for any foreign investment that affects or may affect China’s national security. The new regime requires parties to apply for a national security review by a working office, led by the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM) prior to completing a relevant transaction. The regime is not completely new - it updates the existing foreign investment national security review requirements and formalises certain pilot regimes, expanding their application nationwide.

In this bulletin we highlight the key features of the new regime and its impact on foreign investment transactions.

Background

In 2011, the State Council and MOFCOM each introduced regulations to establish a national security review regime for mergers and acquisitions. This was, however, limited in scope to only mergers and acquisitions of domestic enterprises by foreign investors. In 2015, a broader national security review trial regime was launched for different types of foreign investment in the pilot free trade zones. On 1 January 2020, the Foreign Investment Law came into force which provided for a national security review regime to be established for foreign investments which may affect national security. The Measures for the Security Review of Foreign Investment (Measures), which came into force on 18 January 2021, establish the new regime.

Highlights of the New Regime

Foreign investments subject to national security review

Foreign investments subject to national security review are defined under the Measures as:

1. a foreign investor, solely or jointly with any other investors, investing in a new project or establishing an enterprise in China;

   
   

2. a foreign investor acquiring the equity or assets of any enterprise in China by means of merger and acquisition; or

   
   

3. a foreign investor making investment in China by other means.

The Measures also extend to a foreign investor’s purchase of a domestic company’s shares listed on stock exchanges. We understand that the drafting of supporting provisions in this respect has commenced but no specific timeline for their release has yet been published.

The scope of investments caught by the new regime includes:

1. investments in industries such as military and military support that concern national defense and security, as well as investments in locations near to military installations and military facilities; and

   
   

2. investments in any other important non-military fields that concern national security (for example important agricultural products, important energy and resources, important infrastructure, important cultural products and services, and important information technology) if the foreign investors obtain “actual control” over the enterprise.

Importantly, the Measures have added two sectors not covered in the previous regime, namely important internet products and services and important financial services. The Measures are silent on the standard for determining what is “important” (or “significant” or “key”). This gives the security review authorities discretion to make decisions in line with national interests and the international and domestic political and economic environment at the time.

“Actual control” is when: (i) a foreign investor holds a 50% or more equity interest in the enterprise; (ii) a foreign investor holds a less than 50% equity interest, but enjoys voting rights that can have a significant impact on resolutions of board of directors, shareholders’ meetings, or general meetings of shareholders; or (iii) there are other circumstances that cause a foreign investor to have a significant impact on aspects such as the business decision-making, personnel, finance or technology of the enterprise.

Security review authority

The Measures replace the previous inter-ministerial joint conference system with a new working mechanism for conducting national security reviews. A working office has been set up which is led by NDRC and MOFCOM. Unlike the inter-ministerial joint conference, the working office is a permanent institution which undertakes the routine work of national security review.

In practice, the types of transaction that require a security review normally involve sectors such as national defense and military, information technology and agricultural products. Given this, it is likely that the new working office will adopt a similar consultation process to that previously in place with the relevant administrations (for example the Ministry of National Defense and the Ministry of Industry and Information Technology) to solicit professional opinions.

Procedures and timelines

The national security review process can be initiated in two ways:

1. the foreign investor or the relevant domestic party can submit a filing to the working office before implementing an investment; or

   
   

2. relevant authorities, enterprises, social organisations or the public can request that the working office commence a review if they consider that a foreign investment would affect national security.

The Measures have expanded the scope of parties who can make a filing to the relevant domestic parties, and establish a public supervision mechanism.

The Measures have added a preliminary review stage to the national security review process which is now in three stages:

1. Preliminary review – The working office shall, within 15 working days of receiving materials that meet the filing requirements, decide whether to commence a national security review.

   
   

2. General review – The working office shall, within 30 working days from starting a national security review, decide between approval or proceeding to the next stage of review.

   
   

3. Special review – Foreign investments that fail to pass the general review will be subject to special review for a period of 60 working days (subject to extension).

Relevant parties may also consult with the working office before submitting a formal filing, for example to make a preliminary enquiry as to whether a filing is required.

Liabilities for violation

The Measures have clarified for the first time the liabilities for breaching the national security review requirements, filling a gap in the previous legislation.

If the relevant parties fail to make a national security review filing where it is required, the working office has the right to order that the investment be unwound within a prescribed period, if it considers that the transaction may jeopardise national security. In addition, the non-compliance will be recorded into the national credit system which will have a negative impact on the parties’ credit record.

Where the impact of a foreign investment on national security can be mitigated by certain measures, the working office may approve the foreign investment if written undertakings are given to comply with the measures. This is consistent with the approach adopted in the pilot free trade zones.

Our Observations

Recently, many countries and regions have established and updated their foreign investment national security review regimes. For example, the United States adopted the Foreign Investment Risk Review Modernization Act in 2018 to extend the jurisdiction of its national security review and implement a mandatory filing system for merger and acquisition transactions. The European Union also adopted a new foreign investment national security review regime which became binding on member states in 2020. China’s new national security review regime has built on its experience from China’s prior regime and borrowed practices from the other major countries and regions.

On one hand, the Measures have made the national security review regime for foreign investments broader, which may result in increased caution by investors in making investment decisions in industries or areas which may have national security concerns. On the other hand, the Measures provide a clearer legal framework for determining the rights, responsibilities and liabilities of the regulatory authorities and the investors. As such, the Measures provide certainty on the requirements and the legal risks, which is a positive step for promoting foreign investments.

Given the current lack of supporting rules and practical cases, interested parties should closely follow developments to the relevant rules and practices. We would also encourage parties to consult the working office for clarification in relation to specific situations as needed.

KEY CONTACTS

Nanda Lau 刘依兰

Head of Shanghai Office

Nanda.Lau@hsf.com

Gavin Guo 郭武汉

International Partner

Kewei (Shanghai)

Gavin.Guo@hsfkewei.com

Angela Zhao 赵秋丹

Senior Associate

Shanghai

Angela.Zhao@hsf.com

Weili Zhong 钟卫利

Associate

Beijing

Weili.Zhong@hsf.com

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