Generally, all outbound investments by Mainland Chinese investors are subject to approvals or filings with Chinese governmental authorities, including the National Development and Reform Commission (“NDRC”), the Ministry of Commerce (“MOFCOM”), and the State Administration of Foreign Exchange (“SAFE”), which converts Renminbi into foreign currency and remits the funds out of Mainland China. Over the past few years, the market has witnessed a dramatic increase in outbound investments by Chinese entities, driven in part by governmental policies encouraging acquisitions of quality assets and technologies abroad, which included reducing the burdens for regulatory approval on such outbound investments. However, starting in 2016, Chinese authorities became concerned with the volume of capital outflow, particularly against the quality and nature of some of the investments made abroad, and began taking a more cautious and restrictive approach to approving such outbound investments.
Types of Transactions Affected
In December 2016, the NDRC, MOFCOM, SAFE and the People’s Bank of China (“PBOC”) jointly announced their intention to closely monitor and review overseas investment activities. Based on the joint announcement, market intelligence and informal communications, we understand Chinese regulators are focusing specifically on the following types of transactions:
- real estate acquisitions by state-owned enterprises of US$1 billion or more;
- acquisitions not within the investor’s core business of US$1 billion or more;
- acquisitions generally of US$10 billion or more;
- minority investments in listed companies with a stake less than 10%;
- investments by limited partnerships (which often had been used to raise funds for specific outbound transactions) or by newly formed companies with limited history;
- acquisitions of targets that are larger than the Chinese buyer; and
- privatizations of Chinese businesses listed abroad (which are often listed using offshore, such as Cayman, holding structures).
In addition, the Chinese authorities placed particular scrutiny on outbound investments in real estate, hotels, studios, entertainment and sports clubs because they perceive these areas to be comprised of many past “irrational” investments.
Foreign Exchange Controls
SAFE implemented internal practices (although not announced publicly) aimed at controlling and reducing the outbound flow of foreign currency from China. These measures include directing banks to report all capital account payments overseas of $5 million or more to SAFE’s central office in Beijing for clearance. Additionally, SAFE’s central office enacted strict reviews on outbound investments remittances of US$50 million or more in order to verify the authenticity of these transactions. Banks are subsequently required to monitor and maintain a strict balance between capital inflow and outflow (which has the effect of restricting a bank’s ability to convert RMB into foreign currency for their clients, including outbound investments that otherwise were previously approved).
The Chinese government has publicly stated that it remains supportive of, and encourages, rational and “legitimate” investments abroad by Chinese investors. As such, the NDRC and MOFCOM continue to accept outbound investment filings (although both organizations now require more detailed information about the transaction as part of the move towards closer review of investments). However, in practice it has become noticeably more difficult for Chinese investors to obtain outbound investment approvals and particularly to remit funds out of Mainland China—the accelerated pace of capital outflow in 2016, combined with RMB depreciation, will likely cause regulators to continue to scrutinize and control outbound investments in the immediate future.
We would like to highlight the following implications for private equity clients:
- In the past few years, Chinese investors have become active participants in secondary sales of and auctions for portfolio businesses held by exiting financial sponsors. Given the recent regulatory changes, sponsors seeking to sell businesses to Chinese buyers should check to see if the transaction requires Chinese regulatory approvals. It would be prudent for sponsors, at this time, to seek the availability of alternative transaction and funding structures that do not require the aforementioned approvals whereby increasing deal certainty. Sponsors looking to sell business to Chinese buyers should also raise the issue of the ability of the buyer to obtain the necessary approvals to complete the transaction, which covers remitting funds out of Mainland China. To further safeguard their transactions, sponsors should put in place deal protections, such as signing deposits (placed in an escrow account outside of Mainland China) to backstop a reverse break fee covering Chinese regulatory approvals for the transaction.
- The regulatory changes present sponsors with more opportunities to collaborate with Chinese corporates on outbound transactions, including consortiums and co-investments. Chinese investors remain highly interested in international acquisitions, but face regulatory burdens and newly enacted controls on fund outflows. In this current climate, while sponsors have to focus more on post-closing arrangements, particularly on exit strategies, there exists greater room for cooperation and collaboration with Chinese corporates keen on investing abroad.
 Depending on the identity of the Chinese investor, approvals by or filings with other Chinese governmental authorities may also be required, for example the State-owned Assets Supervision and Administration Commission of the State Council (SASAC, for State-owned enterprises) or the Shanghai/Shenzhen Stock Exchange (for companies listed in China).
 Based on PBOC and SAFE statistics, China’s FX reserve dipped below US$3 trillion in January 2017, against a historic high of US$4 trillion in 2014.