Legal Trends 2016: China
ONE | CHINA-LISTED FIRMS BECOMING BUYERS
Buyers listed on the Shanghai and Shenzhen stock exchanges will become more active in the international M&A marketplace in 2016, creating new avenues for liquidity for Canadian investors and new challenges for Canadian dealmakers. Despite a well-publicized correction in June and ongoing volatility through the second half of 2015, China’s stock markets continue to reflect high valuations by developed market standards, creating an arbitrage opportunity for China-listed firms in acquiring overseas assets. In addition to the economic incentives, the China Securities Regulatory Commission (CSRC) is making acquisitions by Chinese listcos easier by limiting the approvals required for M&A transactions not financed by a domestic equity offering. This introduces a large and attractive pool of potential buyers for Canadian sellers, as investors from China are more generally seeking a broader array of acquisition opportunities. However, as these new buyers become more active, sellers and their advisers will need to consider the impact on their sale process of any parallel Chinese equity financing and related timing issues.
TWO | BROADER FOCUS OF OUTBOUND M&A
The sectoral focus of Chinese investment into Canada will broaden in 2016 as China’s economy shifts away from its 30-year mainstay investment-driven growth model toward domestic consumption and services-led growth. China’s outbound M&A is increasingly being driven by China’s move up the value chain against a backdrop of slowing domestic growth and its increased policy support for overseas M&A. In November, Prime Minister Li Keqiang pledged that China would invest US$1-trillion overseas in the next five years, compared with just US$600-billion from 2005 to 2014. Although we expect resources will remain a key focus of Chinese investment in Canada, Canadians will see a broadening focus of Chinese investment going forward. Buyers from China will increasingly be seeking assets across a range of sectors, including technology, advanced manufacturing, agri-food, real estate and infrastructure, with an emphasis on technologies, processes and brands with significant growth potential in China’s market.
THREE | LEVELLING THE PLAYING FIELD IN FAVOUR OF CHINESE BIDDERS
China’s regulators will continue to relax their control over outbound investments in 2016. Chinese buyers of Canadian assets have been at a disadvantage in competitive sale processes due to the need to obtain several approvals from China’s regulators before making offers and closing transactions. The uncertain timing and lack of transparency in the approval process has often led Canadian sellers to require a more substantial premium, sometimes supplemented by a break fee, from China-based bidders to compensate for the perceived additional risk. Recently, however, investors from China have started to enjoy a more level playing field that will require an adjustment to the expectations of Canadian sellers and their advisers.
China’s overseas investors have to deal with at least three of China’s regulatory agencies when making an outbound acquisition: the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM) and the State Administration of Foreign Exchange (SAFE). In the past two years, these regulators have each taken significant steps toward relaxing their approval requirements. For example, in 2015, the NDRC adopted a largely hands-off approach, with preapproval now required only for investments involving a “sensitive region or sector.” MOFCOM has adopted a similar approach to approvals, while SAFE also relaxed its requirements, including by taking itself out of the foreign exchange registration process for outbound investments in favour of direct registration by buyers with designated banks. Some hurdles remain: State Council (China’s cabinet) approval is still needed for deals valued at more than US$2-billion, and bidders from China still must get an NDRC “confirmation report” before making offers valued at US$300-million or more. Still, this progress on the regulatory front is expected to create a more competitive environment for bidders from China.
FOUR | CHINA’S SAVERS BECOME MORE INTERNATIONAL
Among the most long-awaited prospects for both foreign and domestic asset managers in China is the continued opening of China’s borders to the free flow of financial investment. Following the International Monetary Fund’s early December announcement that it will include the Chinese yuan renminbi (RMB) in its reserve currency basket, China will continue to gradually open its capital account in 2016, providing a growing number of investment outlets to China’s savers and new opportunities for foreign asset managers. China’s annual savings rate is US$5-trillion, compared with approximately US$3-trillion in the United States. However, while we have witnessed massive increases in China’s foreign direct investment globally in the past decade, China’s savers are still largely restricted to domestic investment opportunities because of its foreign exchange control regime.
China’s central bank and regulators have accelerated the gradual and deliberate process of opening its capital account in the past two years, and this is expected to continue as China moves toward full capital account convertibility. For example, the Shanghai-Hong Kong Connect program provides Chinese investors access to Hong Kong’s H-share market. A similar program is expected in the coming months involving the Shenzhen, while links with other major international exchanges may also be announced in 2016. The relaxed foreign exchange rules in the Shanghai Pilot Free Trade Zone and under the separate Qualified Domestic Limited Partner program have been used to convert RMB raised from Chinese investors to U.S. dollars for use in overseas investments. Similarly, the recently expanded Qualified Domestic Institutional Investor program allows China’s financial institutions to invest in overseas markets. Finally, the recently introduced Qualified Domestic Individual Investor program offers qualified individual investors from China special access to overseas opportunities. Development and expansion of these programs is expected to offer significant new opportunities to China’s investors and their advisers.
FIVE | INCREASED REGULATORY ATTENTION IS ANTICIPATED
As firms from China expand their global footprint through M&A and other investment transactions, we are witnessing an increase in challenges to transactions under the foreign investment review or national security legislation of several developed countries. Regulators in Canada, Australia and the U.S. have each challenged transactions involving Chinese investors based on these rules in the past year, and this trend is expected to continue as the number and breadth of investments continues to increase. Planning for and managing this kind of regulatory challenge require that Chinese buyers adopt a multi-pronged approach involving experienced advisers across a range of specialties, including legal and government relations.
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