- Under China State Council’s recent Notice, the National Security Review regime will only apply to foreign domestic deals where (a) the target domestic business is involved in a business that concerns national defense security; or; (b) the target domestic business is involved in a business that concerns national economic security, and the foreign acquiring business intends to acquire de facto control of the target domestic business.
- Neither of the terms “national defense security” or “national economic security” are defined in the Notice, presumably in order to give the regulators flexibility.
- Pursuant to the Notice, a foreign business (or a group of foreign businesses) acquires de facto control over a domestic company when it or they: (a) acquire 50 percent or more of the shares of the target domestic company; (b) otherwise has significant influence or operational control over the target domestic company
On 3 February 2011, China’s State Council released a notice which, for the first time, formalizes and sets out a national security review (“NSR”) process for foreign acquisitions of domestic companies in China. This notice is entitled “Notice by the General Office of the State Council in relation to the institution of the National
Security Review system for mergers and acquisitions of domestic enterprises by Foreign Investors” (“Notice”). This Notice (and consequently, China’s NSR regime) came into force on March 5, 2011. This article sets out in some detail the boundaries of China’s NSR
As mentioned above, the Notice contains the precise boundaries as to how the NSR regime will operate. Thus far, it is not clear if any deals (or any deals for that matter) have come under the scrutiny of this regime.
On March 4, 2011, China’s Ministry of Commerce (“MOFCOM”) (the primary coordinating agency in charge of overseeing or coordinating the national security review process) published rules entitled “Interim Rules for Implementation” (the “Interim Rules”) detailing how the NSR process will be initiated, the types of documentation to be submitted (in relation to an application for an NSR), and the manner in which the NSR will be conducted.
The Interim Rules is only active for approximately five months. During such time, the effect of the Interim Rules was tested by MOFCOM. On 25 August 2011, MOFCOM released the MOFCOM Rules for Implementation of Relevant Issues regarding National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “NSR Rules”). The NSR Rules replaced the Interim Rules as of 1 September 2011.
In fact, the concept of scrutinizing foreign-domestic deals for “national security” issues is not new in China. This concept was first formally introduced by regulations entitled “Provisions re Guiding Foreign Investment 2002”. Article 7 of the aforementioned provisions prohibits foreign investment that might jeopardize China’s national security. Further, Article 31 of the Anti-Monopoly Law also states that all foreign funded mergers and acquisitions of domestic businesses will be reviewed for national security issues in accordance with rules set out by the Chinese government. Until the enactment of the Notice, the Interim Rules, and the NSR Rules, however, there has never been any visibility or transparency in relation to how China’s NSR regime would be conducted.
III Will All Foreign-Domestic Deals Be Caught by the NSR Regime?
Pursuant to the Notice, the NSR regime will only apply to foreign domestic deals, provided:
a) the target domestic business is involved in a business that concerns national defense security (“national defense security businesses”); or
b) the target domestic business is involved in a business that concerns national economic security (“national economic security businesses”), and the foreign acquiring business intends to acquire de facto control of the target domestic business.
National defense/economic security. In relation to (a) above, neither the term “national defense security” nor the term “national economic security” (or even “national security” for that matter) have been defined within the Notice and the NSR Rules.
The Notice does state, however, that national defense security businesses would include businesses which operate within the military industry and businesses which are located adjacent to major or sensitive military facilities. In relation to national economic security businesses, the Notice states that these could include businesses which deal with: major agricultural products; the major energy and resources sectors; “important” infrastructure; transportation services; and “key” technologies as well as other “key” manufacturing equipment which have to do with national security. The Notice makes it clear that the above lists aren’t exhaustive.
We think the “national defense security businesses” and “national economic security businesses” categories haven’t been defined in the Notice or in the NSR Rules so that this gives adequate room for the authorities to bring into line a transaction which may impinge on national security.
One useful point of reference, in the meantime, is to look at past decisions, regulations and guidance notes from government agencies, including the State Council, MOFCOM and the National Development Reform Commission (“NDRC,” another agency who is expected to be involved in the NSR processes) in order to get a hint of the types of businesses that could fall under the above mentioned categories.
For instance, in 2006, the State Council issued the “State Council’s Opinions on Revitalizing the Machinery Manufacturing Industry” which lists out 16 categories of businesses the Chinese Government considers could have a significant impact on national economic security and national defense construction. These include businesses which involve: power generation equipment; power transmission and transformation equipment; coal or mining industry equipment; marine oil engineering equipment; the high-speed train; environmental protection equipment; textile machinery; and agricultural equipment.
Another instance of a document which might be referred to in the context of figuring out which businesses fall into the national defense or national economic security businesses categories is a press release issued by the State-Owned Assets Supervision and Administration Commission dated December 18, 2006, entitled “National Economy Should Maintain Absolute Control of 7 Industries”. In this press release, seven industries were identified as having a large bearing on China’s national security and the economy. These are: defense; power generation and distribution; oil; petrochemicals; telecommunications; coal; aviation; and shipping.
De facto control. Pursuant to the Notice, a foreign business (or a group of foreign businesses) acquires de facto control over a domestic company when it or they: (a) acquire 50 percent or more of the shares of the target domestic company; (b) otherwise has significant influence or operational control over the target domestic company. The Notice also sets out examples where the foreign business would have significant influence or operational control over the domestic business; these include where the foreign business has control over the resolutions of general meetings or shareholders meetings; making decisions in relation to the operations of the target; making decisions in relation to issues to do with human resources, finances and technology.
Overall, a transaction will fall under the purview of the NSR regime if:
- the transaction involves a foreign business merging with or acquiring a domestic business; and
- if the scope or nature of the domestic business involves national defense; or the scope or nature of the domestic business involves national economic security, and the foreign acquiring business intends to acquire de facto control of the target domestic business.
IV Which Agencies Are in Charge of the NSR Regime?
The Notice stipulates that a ministerial joint committee (“Joint Committee”), led by the NDRC and MOFCOM will be set up to evaluate deals against the NSR regime.
V How Would a NSR Be Initiated and by Whom?
The Notice stipulates that a NSR may be triggered either by the foreign business involved in the deal or upon request by third parties. The Notice contemplates that third parties could include government departments, industry associations and other businesses.
Both foreign businesses and third parties are expected to submit all applications to the Foreign Investment Division of MOFCOM for an initial review. If MOFCOM decides that the deal does fall within the purview of the NSR regime, MOFCOM will then submit the matter to the Joint Committee to commence the NSR process.
The NSR Rules provide that if transactions fall under the purview of the NSR regime, then foreign businesses should file the application with MOFCOM. If the merger or acquisition involves two or more foreign businesses, then these could file the application as joint applicants. It should be noted that from the way this provision is being phrased in the NSR Rules, it appears that the authorities consider that the foreign participants should be responsible to notify deals which might fall under the purview of the NSR.
Pursuant to the NSR Rules, once an application is filed with MOFCOM, MOFCOM will conduct an initial review in order to ensure that all necessary documents and materials have been submitted. MOFCOM will then send the applicants an “official acceptance.” After receiving official acceptance, the applicant is obliged to put the transaction on hold for 15 working days during which MOFCOM will determine whether the transaction should be passed onto the Joint Committee. If so, MOFCOM will notify the applicants and also notify the Joint Committee within five working days. If applicants do not hear from MOFCOM within 15 days, applicants may proceed to implement the transaction.
VI What Are the Stages of Review?
Pursuant to the Notice, there are two stages of review in relation to the NSR process conducted by the Joint Committee: a “General Review” stage and a “Special Review” stage (if required).
General Review. First, the proposed deal will go through a General Review. This stage will span for a maximum of 30 working days from the date in which the Joint Committee receives MOFCOM’s application. During this period, the Joint Committee will determine if the proposed deal is clear of national security concerns or whether more time is required to evaluate the proposed deal. During this stage, the Joint Committee will also solicit opinions from other relevant government departments. The determination as to whether the proposed deal is clear of national security concerns or whether more time is required to evaluate the proposed deal will be determined by the number of government departments invited to join this process—all determinations will be adopted on a unanimous basis. In other words, if even one department is of the view that the proposed deal is likely to affect national security, the Joint Committee is obliged to move the deal through to the Special Review stage for further consideration and evaluation.
Special Review. This stage will span for a maximum of 60 working days. During this period, the Joint Committee will evaluate the deal in more detail. The Joint Committee will decide during this stage whether the proposed deal is free of national security concerns or whether there are national security concerns and the proposed deal is prohibited.
In fact, pursuant to the Notice, there are really three outcomes stemming from an NSR process:
- No Concern: the Joint Committee may decide that there are no national security concerns. The applicant may then go ahead and apply for all other regulatory approvals and close the deal.
- Some impact: the Joint Committee may decide that the proposed transaction has some impact on national security and ask that the applicant make the relevant amendments or revisions to the proposed deal such as to mitigate the impact on national security. After the relevant revisions or amendments are undertaken, the applicant will be asked to re-submit an application to the Joint Committee for another review, before the Joint Committee will clear the proposed deal.
- Major impact: the Joint Committee will prohibit the proposed transaction because the transaction either has had or will have a severe negative impact on national security. The Joint Committee may also undertake “measures” to eliminate such an impact on national security such as by asking the applicants and participants to undertake a transfer of shares or assets. It should be noted that the way the provision addressing this point is phrased in the Interim Rules, it would appear that the NSR regime contemplates dealing with both deals which have yet to be closed and deals which have already been closed.
We note that there is no mention in the Notice or in the NSR Rules in relation to whether the applicants may file for a review of the Joint Committees’ decision.
VII Flow Chart Summarizing the NSR Process
The following is a flow chart summarizing the NSR process.
Annex – Flowchart summarizing China’s NSR process
 Compared with the Interim Rules, the key change we see in the NSR Rules is that MOFCOM clearly states that the authority will assess the applicability of the national security review (NSR) process from the substance and actual impact of a transaction; and that foreign investors shall not evade the NSR regime via alternative transaction structures, including but not limited to warehousing arrangements, trusts, multi-tier investments, leases, loans, contractual control, or offshore transactions, etc.
CHINESE UPDATE – China’s Next 30 Years: From “Scale Dividend” to “Productivity and Institutional Dividend”
Dr. Qin argues that 2010 marked a major turning point for the Chinese economy, reflecting the end of 30 years of high speed growth. China’s aging population and decelerating urbanization and the impending global rebalancing will require China to shift gears from an export dependent model to a more internally focused economy. The theme for the next 30 years is to achieve endogenous growth through improvement of human capital, technical innovation (including resource utilization), the upgrading of the industrial structure from low value added to high value added, and increased market reforms to let the “invisible hand” do its work.
- Despite Argentina’s high inflation and a lack of certain structural reforms, there has been an increase in the M&A activity in the country during 2011. This increase has mainly been driven by strategic investors and to a lesser degree by venture capital and private equity funds attracted by Argentina’s GDP robust growth and the high yield on the rate of returns that Argentina is offering to foreign investors in certain key sectors of the economy such as agribusiness, renewable energy and biofuels, mining, food production, distribution and processing, software and information technology, logistics and infrastructure, telecommunications, pharmaceutical and retail business.
- During 2011 there has been an impressive influx of Chinese investment into the hydrocarbon sector, as well as in other strategic sectors such as financial services. The largest transactions occurring in 2011 include the acquisition by Sinopec of Occidental Petroleum and the purchase of Standard Bank by ICBC. Other BRIC investors, such as Brazil’s Banco do Brasil, and India’s Essar Aegis, also accounted for some of the most important recent M&A transactions.
- Concurrently with the increasing appetite for raw materials, there is a continuing trend of M&A in the highly regulated public services sector, driven by international utilities companies selling their participations generally to local groups, as increases of tariffs of public utilities services in Argentina continue to fall behind the inflationary process and devaluation of the Argentine peso. This trend may change in the near future as the Argentine Government has recently announced the reduction and/or elimination of energy subsidies, which in turn may lead to an increase of public utility services tariffs.
- The Cristina Fernandezde Kirchner administration, re-elected on October 23, recently imposed new requirements on oil, mining and insurance companies, ending exemptions that enabled them to convert most of their Argentine profits into foreign currencies outside the country. Until the new regulation, oil and natural gas companies were allowed to keep up to 70% of their export proceeds offshore, mining companies could keep up to 100% of their export proceeds offshore and insurance companies were allowed to keep 50% of their investments and funds outside the country. While the new regulation is not expected to cause any meaningful changes in the oil, mining and insurance companies’ day-to-day operations, it is not clear how these new capital controls and regulatory changes may affect the investment and M&A activity in these sectors in the years to come.
- Additionally, in an attempt to slow accelerating capital flight from the country, on October 28, 2011 the Central Bank of Argentina issued a new requirement for non-Argentine investors to repatriate Argentine pesos collected in Argentina as a consequence of a sale or liquidation of the direct investment, capital reduction and reimbursement of capital contributions inArgentina. Pursuant to the new regulation, a non-Argentine investor will not be allowed to have access to the FX market to purchase foreign currency with Argentine pesos collected in Argentina and transfer it abroad as a result of a subsequent sale or liquidation of an investment or capital reduction or reimbursement, unless the foreign investor evidences that the funds originally paid for such investment or disbursement for the capital contribution, as applicable, were transferred to Argentina and sold in the FX Market. Prior to the new regulation, the non-Argentine investor was not obliged to demonstrate that the funds paid for its investment or disbursement for its capital contribution had been transferred and sold in the FX Market (i.e. brought to Argentina and sold for Argentine pesos) in order to be allowed to repatriate (i.e. have access to the FX Market to purchase foreign currency with Argentine pesos and transfer it abroad) the funds collected in Argentina as a consequence of a subsequent sale or liquidation of such investment, or capital reduction or reimbursement. From a practical standpoint, foreign investors will be allowed to settle the transactions outside of Argentina, although if they sell their investment for pesos in Argentina –which is very unusual- they will not be able to acquire foreign currency in the country unless they demonstrate that the funds paid originally for its investment were transferred and sold in the FX Market.
During late 2010 and the first semester of 2011 there has been an increase in M&A activity in Argentina, mainly driven by strategic investors and to a lesser degree by venture capital and private equity funds attracted by Argentina’s GDP growth and the high yield on the rate of returns that Argentina is offering to foreign investors in certain key sectors of the economy, such as agribusiness, renewable energy and biofuels, mining, food production, distribution and processing, software and information technology, logistics and infrastructure, telecommunications, pharmaceutical and retail business.
Most of these M&A transactions involved strategic investors from BRIC countries that have turned their attention to Argentina’s vast natural resources. As an example, during 2011 there has been an impressive influx of Chinese investment into the hydrocarbon sector (CNNOC and Sinopen), as well as acquisitions in other strategic sectors such as financial services (ICBC). In turn, Brazilian (among others, Banco do Brasil) and Indian (Essar Aegis) investors also participated in most of the largest transactions occurring in 2011.
The presidential elections held in October 2011 and the financial crisis affecting developed countries added some uncertainty during the second semester of 2011, but inflationary issues, rather than elections, caused a slow-down in M&A activity at the year’s close. As a result, since July there have been small to mid-sized acquisitions, while larger transactions were sprinkled about.
In general, traditional long-term investors usually acquire total control of targeted companies. Recently; however, in a few cases we have seen traditional investors structuring two-tier acquisitions by purchasing equity control for a fixed cash price while having a call option on the equity balance retained by sellers, exercisable at a price resulting from an earn-out formula. The latter acquisition structure is more commonly seen in venture capital and M&A transactions. Minority investments are rare in Argentina and usually only seen in cases of government-regulated sectors such as energy and broadcasting and in some private equity and venture capital M&A transactions where funds co-invest (as a strategic partner) together with the controlling purchaser of the target company. In the latter cases, such funds look for high-yield, medium-term rates of return in their invested capital, using not more than 10 percent of their limited partners committed capital.
In addition to the earn-out’s components in the purchase price, international listed and unlisted funds are also offering mixed purchase price packages to sellers which include part of the price being paid in cash and part paid in stock of the listed or parent unlisted controlling company of the purchaser. In the agribusiness and real estate sectors, it is also common to find private equity and venture capital funds contracting with local independent management and operation companies to run their acquired businesses in Argentina.
Since the 2001 economic crisis in Argentina, M&A transactions are mostly unleveraged since the cost of local debt is still high, with only some exceptions mainly relating to the acquisition by local investors of governed regulated or internationally listed utilities, such as the case of the purchase by the Petersen Group of a minority stake in oil company YPF. Multilaterals often take a portion of the equity of the target company and provide leverage to the purchaser to pay the purchase price or to carry out post-money investments to expand the business of the target company.
Transactions which are deemed to be economic concentrations must be notified and require the authorization of the Antitrust Commission. Notification must be made prior to or within one week of the first to occur of either (i) the date that any transfer effectively occurs, or (ii) the publication of any cash tender or exchange offer. Currently, the proceedings to obtain antitrust authorization normally take between 12 and 18 months depending on the complexity of the transaction from a competitive stand-point.
While there is a continuous trend of M&A activity in the most competitive sectors of the economy, there is also M&A activity in the highly regulated public services sector, driven by international utilities companies pulling out of the country by selling their participations to local groups, as increases of tariffs of public utilities services in Argentina, some of which have been frozen since 2002, continue to fall behind the inflationary process and devaluation of the Argentine peso. However, President Cristina Kirchner, re-elected on October 23, recently announced that her government will review its energy subsidies, including water, natural gas, and electricity subsidies for reductions and possibly eliminations, as Argentina faces a more difficult world economic situation in the months ahead. The announcement may lead to an increase of public services tariffs, which may cause the current M&A trend in the public utilities sector to change substantially in the future.
New Regulations affecting repatriation of foreign investments
- Hydrocarbons and Mining Industry
On October 26, 2011, the Argentine Government reinstated the obligation of hydrocarbon companies (producers of crude oil and its derivatives, natural gas and liquid petroleum gas) and mining companies to sell the foreign currency proceeds of their exports in the local foreign exchange market.
In Argentina, simultaneously with the freeze of bank deposits and the establishment of restrictions on cross border transfers in the 2001 crisis, one of the main measures adopted by the Argentine Government was the reinstatement of the obligation to repatriate export proceeds (which has always been one of the first sources of foreign currency and a tool used to maintain the value of the Peso against the US Dollar).
However, the hydrocarbons and Mining industry were benefited by certain exemptions to such obligation.
Since December 22, 2002, producers of crude oil, natural gas and liquid petroleum gas were no longer required to repatriate 70% of the foreign currency proceeds of their exports of freely disposable crude oil and its derivatives.
Also, since February 27, 2003, any mining company which has qualified for the foreign exchange stability regime during the period March 27, 1991 – December 12, 2001, was exempted from the obligation to repatriate the foreign currency proceeds of exports of mining goods. Since June 17, 2004, mining companies that qualified for the stability regime after June 27, 2004 were also exempted from the obligation to repatriate to Argentina their export proceeds.
As from October 26, 2011, such benefits were lifted by the Argentine Government and therefore, hydrocarbon and mining companies are now obliged to sell in the local foreign exchange market the foreign currency proceeds of their exports.
- Insurance Industry
Pursuant to a resolution issued by the Argentine Superintendency of Insurance, within a 50 day-period counted as from October 27, Argentine insurance companies must transfer any investment or cash kept abroad to Argentina. After such period, insurance companies may not make any investment or keep cash abroad. For that purpose, the insurance companies must submit an affidavit of any investment kept abroad within a 10-day period.
However, investments may be kept abroad only if expressly authorized by the Federal Superintendency of Insurance provided that there is no local investment available to reasonably support the commitment of the insurance company.
- Repatriation of Foreign Direct Investments
As from October 28, 2011 (the “Effective Date”), in order for a non-Argentine investor to be allowed to have access to the local foreign exchange market (“FX Market”) to purchase foreign currency with Argentine pesos collected in Argentina and transfer it abroad as a result of a subsequent sale or liquidation of an investment or capital reduction or reimbursement, the non-Argentine investor must evidence that the funds originally paid for such investment or disbursement for the capital contribution, as applicable, were transferred to Argentina and sold in the FX Market (the “Transfer Requirement”).
Until the Effective Date, a non-Argentine direct investor could repatriate funds in Argentine pesos collected in Argentina as a result of the sale or liquidation of its investment or a capital reduction or reimbursement, provided only that a minimum waiting period of 365 days had elapsed since the investment had been made. As from the Effective Date, the Transfer Requirement has to be complied with too.
The Communication sets a “burden” to be met by any non-Argentine resident who may need to purchase foreign currency in the FX Market to repatriate Argentine-Peso denominated funds collected as a result of the sale or liquidation of an investment. Conversely, if the foreign investor believes that it will not need to repatriate, it is not required to comply with the Transfer Requirement, and therefore, the purchase price of such investment and any capital contribution may be kept abroad.
Over the second semester of 2010 to date, significant M&A transactions in Argentina include the following:
- Aegis Netherlands II B.V. and Aegis Services Australia Pty. Ltd. (from the Essar and Aegis Group) acquired D.A.S.’ and Y&R Inversiones Publicitarias S.A.’s shares in Actionline de Argentina S.A. and Sur Contact Center S.A., taking its first step into the Latin American BPO and marketing communications business.
- Banco do Brasil S.A., the major Latin-American bank controlled by the Brazilian Federal Government, acquired 51% of the stockholding of Banco Patagonia S.A., the forth major Argentine private financial entity.
- Banco Supervielle S.A., Grupo Supervielle S.A. and Banco Regional de Cuyo S.A. acquired GE Capital Corporation’s and GE Capital International Holdings Corporation’s shares in GE Compañía Financiera S.A. (GE Money Argentina) (currently, Cordial Compañía Financiera S.A.).
- Bridas Corporation, an independent oil and gas holding company based in Argentina, acquired Exxon Mobil International Holdings Inc.’s shares in Southern Cone International Holdings Llc. (ultimately, Esso Petrolera Argentina S.A., Esso Standard Paraguay S.R.L. and Esso Standard Oil Company -Uruguay- S.A.).
- China Petrochemical Corporation (SINOPEC), China’s largest oil company and Asia’s largest oil refiner, acquired the Argentine oil and gas business from Occidental Petroleum Corporation, an international oil and gas exploration and production company.
- Dufry A.G., a global travel retailer with operations in 45 countries, acquired Interbaires S.A., the leading travel retailer inArgentina that operates duty free shops in the five main airports of Argentina.
- Frigorífico Regional Industrias Alimenticias Reconquista S.A. (from the Vicentín Group), an Argentine company dedicated to the production and processing of beef, acquired Finexcor S.R.L.’s (from the Cargill Group) meat processing unit located in Nelson, Province of Santa Fe. In addition, Compañía Bernal S.A. acquired Finexcor S.R.L.’s meat processing unit located in Bernal, Province of Buenos Aires.
- Glaxosmithkline PLC., a global pharmaceutical, biologics, vaccines and consumer healthcare company, acquired Laboratorios Phoenix S.A.C. y F., an Argentine pharmaceutical company focused on the development, marketing and sale of branded generic products.
- SABMiller PLC., one of the world’s largest brewers with presence in six continents, acquired through two affiliated entities, all of the shares of Cervecería Argentina Sociedad Anónima Isenbeck (from the Warsteiner Group), the third largest brewer in Argentina.
- The China National Offshore Oil Corporation (CNOOC International LTD.), who operates as an investment holding company which, through its subsidiaries, owns and operates oil and gas reserves, acquired from Bridas Energy Holdings LTD. a 50% stake in Argentina’s Bridas Corporation, aBuenos Aires based oil and gas exploration and production company.
- Zurich Financial Services Group, through a holding company, acquired 51% of the stockholding of Santander Río Seguros S.A., one of the largest insurance companies in Argentina.
GERMAN UPDATE – New Disclosure Requirements to Prevent Secret Stake-building in German Listed Companies
- New share- and instrument holding disclosure rules concerning German listed companies go into force on 1 February 2012.
- The new rules particularly intend to prevent secret stakebuilding in listed companies.
- The new rules are likely to have a significant impact on public takeovers.
- The rules may also apply, under particular circumstances, to non-German companies listed on a German stock exchange.
Germany tightens disclosure requirements for significant shareholdings
In April 2011, the Law on the Strengthening of Investor Protection and the Improvement of Financial Markets (Gesetz zur Stärkung des Anlegerschutzes und zur Verbesserung der Funktionsfähigkeit des Kapitalmarkts – “AnSFuG“) was passed. The AnSFuG tightens, inter alia, the disclosure requirements for shareholdings in German listed companies. The main objective of the new legislation is to capture arrangements which so far fell outside the existing disclosure requirements, even though they may be (and have been) used to build up positions in a German listed company (“creeping-in”). The new disclosure requirements will enter into force on 1 February 2012. The rules may also apply, under particular circumstances, to non-German companies listed on a German stock exchange.
I. Existing German Notification Requirements
The German provisions on the disclosure of significant shareholdings conferring voting rights are set out in the German Securities Trading Act (Wertpapierhandelsgesetz – “WpHG“). Based on the European Transparency Directive (Directive 2004/109/EG), the WpHG requires owners of shares in German listed companies to disclose their voting rights by notifying the issuer and the German Federal Financial Services Supervisory Authority (“BaFin“) if certain thresholds (3%, 5%, 10%, 15%, 20%, 25%, 30%, 50% and 75%) are reached or crossed. The disclosure requirements applicable to owners of shares are supplemented by provisions which attribute to the notifying shareholder voting shares owned by certain other related shareholders (e.g. shares owned by subsidiaries, shares held by a third party for the account of the notifying party, acting-in-concert). These disclosure requirements applicable to shareholders remain unaffected.
In addition, the current disclosure requirements catch financial instruments which entitle the holder to acquire voting shares, such as call options. Voting shares which can be acquired under such financial instruments must be added to direct or attributed voting share ownership. These disclosure requirements, however, so far, do generally not capture arrangements (such as certain securities lending transactions and repos) which do generally not fall within the ambit of the “financial instruments” definition.
II. Overview of Main Amendments
The following key changes to the German disclosure rules for significant shareholdings will be introduced:
- The existing disclosure requirements for “financial instruments” are extended to include “other instruments” (which do not qualify as financial instruments) granting the right to acquire voting shares.
- New disclosure requirements are introduced for instruments which do not grant an enforceable right to acquire voting shares but still make an acquisition of voting shares (at least economically) possible.
There will, consequently, in future be three disclosure regimes, i.e. (i) for voting shares (§§ 21, 22 WpHG), (ii) instruments granting the holder an enforceable right to acquire voting shares (§ 25 WpHG), and (iii) instruments which do not grant an enforceable right to acquire voting shares but make such acquisition possible (§ 25a WpHG). These disclosure regimes are distinct, but linked by the provisions requiring the aggregation of positions held in each of the different categories.
1. Other Instruments Granting a Right to Acquire Voting Shares (§ 25 WpHG)
The disclosure requirements for financial instruments are amended to include “other instruments” granting their holder the right to acquire voting shares.
As a consequence, the following instruments may, for example, be relevant for purposes of this disclosure requirement:
- Rights for the delivery of voting shares under a share purchase agreement (or other agreement such as a shareholders´ agreement) with deferred delivery or subject to conditions precedent under the exclusive control of the purchaser (e.g., approval of corporate bodies of purchaser).
- Rights for the redelivery of voting shares under a securities lending agreement or repurchase agreement.
2. Instruments making it possible to acquire voting shares (§ 25a WpHG)
New disclosure requirements are introduced for instruments which “make it possible” to acquire voting shares. In contrast to the already existing disclosure requirements for instruments granting a right to acquire voting shares, the instruments captured by the new provision do not grant a legally enforceable right to acquire shares. However, due to their particular economic features or their underlying business logic, they may bring about the opportunity for the holder to acquire voting shares. Furthermore, it will be sufficient for disclosure purposes, if a third party rather than the holder of the instrument is entitled to acquire voting shares (e.g. by way of a contractual agreement for the benefit of third parties / Vertrag zugunsten Dritter).
This broad and somewhat imprecise new rule is complemented by two statutory provisions exemplifying circumstances under which arrangements are deemed to make the acquisition of voting shares possible:
- The counterparty might be able to hedge its risks arising under the instrument, in whole or in part, by holding voting shares; for the disclosure requirements in a given case it is, however, irrelevant whether such hedging actually takes place.
- The instrument provides for the right or the obligation to acquire voting shares.
a) Possibility of hedging through the holding of voting shares
The possibility of hedging through the holding of voting shares will, for example, inevitably be given in a cash settled transaction which confers the economic benefit and burden arising out of voting shares upon the holder of the instrument. Thus, for the new disclosure requirements it is not decisive whether an instrument provides for a cash settlement or the physical delivery of the underlying shares.
As a consequence, the following cash-settled instruments may have to be disclosed:
- Total return equity swaps (from the perspective of the counterparty exposed to the economic risks and benefits of the underlying shares)
- Cash-settled long call/short put options/ contracts for difference
b) Right or obligation to acquire voting shares
As far as the right or obligation to acquire voting shares is concerned, an instrument may be regarded as making the acquisition of voting shares possible within the meaning of the new law even if the initiative for the acquisition of the shares must come from the other party to the transaction. Further, the new provision also captures instruments granting the right to acquire voting shares when these instruments are only subject to conditions whose fulfillment is not under the exclusive control of its holder. Currently, instruments (even in the form of financial instruments) are generally not captured by the existing disclosure requirements if such conditions are agreed.
Neither the new law nor the accompanying legislative materials contain any specific exemption for agreements under corporate law (share purchase agreements, shareholders´ agreements, articles of association), which make it possible to acquire voting shares. The practical handling of such broad obligation will need to be thoroughly reviewed.
As a consequence, the following instruments may, inter alia, be relevant:
- Rights for the delivery of voting shares under a share purchase agreement (or other agreement) which are subject to conditions precedent not under the exclusive control of the purchaser (e.g., merger control clearance, approval of corporate bodies of seller)
- Put options on voting shares with physical delivery (from the perspective of the option writer) unless the bond may exclusively be covered by newly issued shares; this may, inter alia, include the put right of the issuer under a mandatory convertible bond (Pflichtwandelanleihe)
- Rights for the delivery of voting shares under a stock option plan subject to certain vesting conditions
3. Instruments Referring to Baskets or Indices
A disclosure requirement only arises if an instrument relates to voting shares in German listed companies. There is no requirement, however, for the instrument to relate exclusively to such shares. The new disclosure requirements also cover financial instruments referring to baskets or indices. The new law does not require any minimum weight of a particular share within a basket or index in order for the underlying instrument to be relevant for disclosure purposes. However, the German Ministry of Finance is authorized to exempt certain financial instruments from the new disclosure requirements by executive ordinance. It remains to be seen whether the German Ministry of Finance will introduce any safe harbour provisions for well-diversified instruments with a multitude of underlying shares.
4. Disclosure Requirement, Relevant Thresholds and Aggregation Rules
Notifications of significant holdings in relevant instruments are subject to the same publication requirements as notifications of significant shareholdings. This means, in particular, that the relevant issuer must publish information on such holdings received from an instrument holder without undue delay but at the latest within three business days of receipt of the notification.
Whereas the lowest threshold for the disclosure of voting shares held or attributed to the notifying party is 3 % under German law, financial and other instruments relating to voting shares must only be disclosed if they relate to 5 % or more of the voting shares of the listed company. The new law does not provide for long and short positions to be netted off for purposes of the disclosure requirements applicable to significant shareholdings.
In order to determine whether a threshold for the disclosure requirements applicable to financial and other instruments has been reached or crossed, own or attributed shares, instruments granting a right to acquire voting shares and instruments making it possible to acquire voting shares must be aggregated. Besides specifying the aggregate number of voting shares, the relevant notification must, however, differentiate between own and attributed voting shares, instruments granting a right to acquire voting shares and instruments making it possible to acquire voting shares.
The number of voting rights to be disclosed for financial and other instruments is generally determined by the number of shares which can be acquired under the instrument. If the instrument does not relate to a specific number of shares, the number of voting rights must be determined by the amount of shares which the other party would require for a full hedge of its position under the instrument. For instruments which refer to a basket or index, the pro rata amount of the underlying share in the basket or index must be considered. The AnsFuG authorizes the German Ministry of Finance to issue an executive regulation specifying, inter alia, the details of the calculation.
5. Transitional Provisions
The new disclosure requirements will also be relevant for holdings acquired before and still held when the new law enters into force on 1 February 2012. On this date, a party holding instruments making it possible to acquire 5 % or more (taking into account the aggregation rules) of the voting shares of a German listed company, must disclose this holding without undue delay but at the latest within 30 trading days. Existing structures should, therefore, be carefully reviewed.
Non-compliance with the disclosure requirements for voting shares may lead to the loss of rights arising under such shares, including dividend rights and voting rights. The same may apply to attributed voting shares, depending on which attribution rule has been violated. In addition, non-compliance may result in a fine from the BaFin.
Non-compliance with the disclosure requirements applicable to financial and other instruments generally does not lead to a loss of rights under the underlying shares even after they have actually been acquired. BaFin may, however, fine such non-compliance. The maximum fine will be increased to EUR 1,000,000 per violation by the AnsFuG.
CHINESE UPDATE – MOFCOM Conditionally Clears Acquisition (Requiring Disposition) by Private Equity Investor, Dispelling Notion that Private Equity Deals Are Less Subject to Anti-Trust Challenge in China
- MOFCOM conditionally cleared the acquisition of Savio Macchine Tessili S.p.A ofItaly by Alpha Private Equity Fund V, a European private equity firm, subject to certain disposition conditions.
- This is the first conditional decision relating to a private equity investor that grants conditional approval. Historically, PE firms have believed that their transactions were very unlikely to be subject to Chinese merger control.
- The decision illustrates that MOFCOM regards PE investors the same way it does strategic acquirors.
On October 31, 2011, the Ministry of Commerce (“MOFCOM”) published an announcement that MOFCOM conditionally cleared the merger control notification for the acquisition of Savio Macchine Tessili S.p.A. (“Savio”) by Penelope S.r.l. (“Penelope”).
Key Factors Considered by MOFCOM
According to the announcement, in reviewing this concentration of business operators, MOFCOM has considered various factors under Article 27 of the Anti-Monopoly Law of China (“AML”), including the following:
MOFCOM believes that this transaction will eliminate or restrain the competition in the market of electronic yarn clearers for automatic winders. An electronic yarn clearer for automatic winders is a monitoring device assembled on an automatic winder with the function to inspect defective yarns and then to repair them automatically. The device could repair the defects in yarns within an extremely short time and no other devices have this function. The market for electronic yarn clearers for automatic winders constitutes a single product market.
After investigations, MOFCOM finds that Uster Technologies Ltd. (“Uster”) and Loepfe Brothers Ltd. (“Loepfe”) are the only two manufacturers worldwide for electronic yarn clearers for automatic winders. The market shares of Uster and Loephe in 2010 were respectively 52.3% and 47.7%, and those figures forChina market were similar.
Furthermore, Alpha Private Equity Fund V ( “Alpha V”), the wholly-controlling shareholder of Penelope (the acquirer), is a private equity fund, and holds 27.9% of the shares in Uster, as its biggest shareholder; while Loepfe is a wholly-owned subsidiary of the target company, Savio.
Therefore, MOFCOM believes that, after the completion of this proposed concentration, there is a possibility that Uster and Loephe may have Alpha V coordinate their business activities and thus eliminate and restrict the competition in the market of electronic yarn clearers for automatic winders. Meanwhile, it is possible that Alpha V could also eliminate and restrict the competition through the control over and influence on Uster and Loephe.
Decisions by MOFCOM
MOFCOM decides to approve the proposed concentration with restrictive conditions, requiring Apef 5, the ultimate controlling entity of Alpha V, to transfer its shares in Uster to an independent third party within 6 months after MOFCOM’s Review Decision and it shall not participate in or have influence on the business or operational activities of Uster before completing the Uster share transfer.
- This is the first decision that MOFCOM had made on PE acquisition cases with conditions, which reflects that MOFCOM treats PE and other industry investors equally in merger control review and does not distinguish them due to certain characteristics of PE.
- The definition of electronic yarn clearers for automatic winder market as the single relevant market has further shown MOFCOM’s tendency to define a much smaller product segment as the relevant market in its review, and thus requires the applicants to provide the market data for such narrowly defined relevant market and considers the competition effect in a smaller product market.
- When explaining the entry barriers of electronic yarn clearers for automatic winder market, the announcement specifically mentions that the product technology has been protected by patents and other intellectual property rights, and therefore it is difficult for new enterprises to enter into the relevant market. However, it does not illustrate whether any other substitute technologies do exist or whether any licenses of such patent technology are accessible. If the market entry difficulty is assessed only based upon the existence of patent in the relevant product, so as to determine that the business operators possessing such technology may eliminate or restrict competition in such narrow scope of product segment market, the result of such practice may frustrate the incentives or creativities of business operators to develop new products and thus would go against the purpose of competition laws, which is to promote competition, increase efficiency and protect interests of consumers.
- Finally, the announcement mentions that MOFCOM raised its competition concerns about the transaction on September 15th, shortly after September 5th when the case was officially accepted by MOFCOM, and the applicants submitted resolution plan on September 23rd; MOFCOM and applicants had several consultations afterwards on how to eliminate competition concerns and MOFCOM made the decision with conditions on October 30th. The aforesaid details show that it is important for the applicants, who are likely to be imposed with restrictive conditions, to take part in consultations with MOFCOM on issues relating to eliminating or restricting competition as early as possible during the merger control review process.