UPDATED-On May 27, 2016, one of the world’s leading construction equipment manufacturers, Zoomlion Group, announced that the company had decided to terminate negotiations of its proposed acquisition of Terex. The value of the discontinued transaction is said to be at least $3.4 billion. The news resulted in much speculation on the market, especially in the western world.
“The only reason we terminated the negotiation with Terex was the price,” said Zoomlion Group president Changjun Sun. However, regardless of Mr. Sun’s statements, many western reporters and analysts believe this is a sign that Chinese capital is receding on the international M&A market. Of the $100 billion mainland China companies spent on overseas investments in 2015, approximately $55 billion went on M&A transactions.
While China was definitely the dark horse of 2015, people are worried its domestic economic downturn may slow the horse down in 2016. Some analysts also see the failure of the Zoomlion–Terex and Anbang–Starwood Hotels mergers as evidence that the Chinese authorities are tightening up their policies on overseas investment and foreign exchange.
However, as a Chinese law firm that specializes in cross-border M&A, we hold the opposite opinion. We see the following drivers for Chinese companies to invest overseas:
Assets with high potential are becoming rare in the domestic market: Chinese investors are used to investing in mining and real estate and these assets are currently seriously over-valued. In addition, uncertainty about policies towards these industries has increased the associated risks. When investors turn their eyes to manufacturing industry, they find that it is also facing serious issues due to the economic slowdown. However, capital will always find a way out, and a lack of good targets in the domestic market will force capital to “go abroad”.
Although the Chinese stock markets are volatile,there is no doubt that good assets are always valued more highly here: Sometimes, the Chinese stock market valuation of an asset can be several times higher than Wall Street. As a result, Chinese listed companies are driven to purchase good targets overseas using funds raised on the Chinese stock markets.
Despite western analysts’ commonly held beliefthat legal and policy scrutiny of cross-border transactions is strict in China, we see many examples of more relaxed regulations. Moreover, state-owned enterprises (SOEs) that have conducted most of the major transactions on the international M&A market in previous years, are being offered more incentives to invest overseas under the Chinese government’s “Belt and Road Initiative”. SOEs are also receiving financial support – mainly in the form of loans with preferred interest rates – for their overseas investments under same initiative.
Serious challenges faced by manufacturing industry have prompted China to unveil an ambitious plan to encourage innovation and to raise efficiency in an effort to enhance the sector’s competitiveness. Acquiring foreign companies with innovative high-tech technologies would not only be useful, but would also be necessary in helping to achieve this goal.
Driven by these factors, we believe that 2016 will be the beginning, not the end, of an international buying spree for China. The numbers also support our opinion. In the first quarter of 2016, companies from mainland China have concluded 115 M&A transactions worldwide with a value of $82.6 billion. According to Xinhua Finance, this figure increases to $111 billion if we start counting from January 2016 to May 2016, which indicates 48 percent growth compared to the same period for 2015. During this period, the state-owned chemical company, ChemChina, made a $43 billion offer for the Swiss seeds and pesticides group Syngenta, which, once concluded, will become the biggest M&A transaction in the history of China.
Even though regulatory hurdles contributed to Anbang’s failure to acquire Starwood Hotels, we do not agree with claims that the Chinese government is trying to restrict overseas investment. As an insurance company, Anbang is subject to some of the tightest regulation in the world, whatever the jurisdiction. Currently, most cross-border transactions by Chinese investors must be filed with, or approved by, the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM), and the State Administration of Foreign Exchange (SAFE). Furthermore, SOEs may also be required to obtain the approval of the state-owned Assets Supervision and Administration Commission (SASAC); listed companies may be required to obtain the approval of the China Securities Regulatory Commission (CSRC); and insurance companies and financial institutions may be required to obtain approval from their respective regulatory authorities, namely, the China Insurance Regulatory Commission (CIRC) and the China Banking Regulatory Commission (CBRC).
On one hand, for most M&A transactions, Chinese buyers face much looser regulatory controls then every before. For example, the NDRC published the draft of Regulations on the Administration of Investment Projects Subject to Government Verification and Approval and Investment Projects Subject to Government Record-filing in July 2015 (due to be implemented in 2016).
Under these new regulations, most cross-border investment projects are only required to be filed, post-closing, with the NDRC. This means that for most M&A investments NDRC approval or filing will no longer be a precondition for converting Chinese currency into US dollars.
Moreover, under the new regulations, documents to be filed with the NDRC are simplified. As for filing with MOFCOM, the current legislation only requires “approvals” of MOFCOM to be obtained for investments that involve sensitive countries, regions or industries. All other investments are only required to be filed with MOFCOM for “recording” purposes, instead of “approval”.
Although “recording” is still a precondition for converting currency, in most cases it is not difficult to obtain. According to the statute, such “recording” should be carried out within three working days of submission. We sometimes experience days or weeks of delay for such “recording”, but the delays are not significant.
The ministry has also set up a user-friendly system that allows investors to file overseas investment projects online. Many experts in China expect the red tape to be further simplified after implementation of the new NDRC regulations. As of June 1, 2015, new SAFE regulations authorized banks to handle foreign exchange registration for overseas investments. Now, investors no longer have to waste valuable time on SAFE registration. Instead, they can simply apply to their bank, who can deal with it in one day.
On the other hand, the Chinese government is tightening restrictions on the use of capital in certain areas. For example, recent rumors circulating on the market suggested that the CSRC was no longer allowing listed companies to raise funds by private placements if the funds were going to be invested in the following industries: internet (P2P) finance, video games, film and TV, and virtual reality. Although the commission denied the rumors, listed companies do find it difficult to obtain CSRC approval when attempting to raise capital for these particular industries.
We believe this indicates a tendency of the CSRC to control the bubble of the Chinese stock markets in these hot but volatile industries. Because Chinese listed companies are responsible for a considerable number of overseas M&As, and because other transactions are aimed at reselling the target companies to listed companies, CSRC regulations are likely to curb the number of transactions within these industries.
Chinese private equity funds are also important buyers on the M&A market. However, as a measure to reduce scamming on the Chinese financial market, the authorities have, for several months, prevented private equity management companies from registering.
Moreover, the CIRC and the CBRC are apparently trying to control overseas investments made by Chinese banks and insurance companies. We believe this measure is aimed at stabilizing China’s finance and insurance markets. While the Chinese government is under pressure to stabilize the value of the Chinese Yuan (and though it cannot be proved), it is quite possible that the government wishes to control capital outflows in the case of acquisitions that require enormous amounts of US dollars.
In conclusion, it is our opinion that the Chinese government’s scrutiny of cross-border transactions will be further loosened in the near future, although certain measures will be introduced in order to build a healthier capital market. Until the Chinese Yuan becomes a completely market oriented currency, the government may maintain a certain amount of control over capital outflow, but most transactions will not be unduly affected unless they are extremely large.
Instead of pointing the finger at controls imposed by the Chinese government, we believe the cause of uncertainty about the tendencies of Chinese players on the M&A market lies elsewhere. For example, a survey conducted by O'Melveny & Myers shows that 47 percent of Chinese companies interviewed believe that the activity of the Committee on Foreign Investment in the United States (CFIUS) is the major cause for concern regarding their US investment plans.
According to a report by the China International Capital Corporation (CICC), since January 2016, the value of failed M&A transactions by Chinese investors abroad has reach $27 billion. This is the highest it has ever been. However, in comparison with the Chinese government’s regulatory controls, US federal government scrutiny – in particular the CFIUS review – has contributed much more to failures on the M&A market, including Tsinghua Unigroup’s $3.79 billion bid for Western Digital.
We believe that a slowdown in Chinese buying may occur in the second half of 2016, due to uncertainty in US policy towards China and caused by the upcoming American presidential election. People believe that during the election period CFIUS will be reviewing even more of China’s strategic investments.
However, the good news is that the state council of China recently announced that negotiation of the Bilateral Investment Treaty (BIT) between China and the US is entering the final stage. During the negotiation, one of the key issues was the two countries’ national security measures. The BIT is expected to build an equal and transparent system of security scrutiny for both countries. We believe the BIT will significantly encourage more Chinese investors to enter into the US M&A market. Nevertheless, what frightens investors most is not the scrutiny itself, but the opacity and bureaucracy involved in its execution.
Yongyuan Li and Lin Yang are partners at Yingke Law Firm, headquartered in Beijing, China.