Advisory Board

  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Peter Clarke
  • Barry Diller
  • IAC/InterActiveCorp
  • Fu Chengyu
  • China National Petrochemical Corporation (Sinopec Group)
  • Richard J. Gnodde
  • Goldman Sachs International
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V.
  • Jiang Jianqing
  • Industrial and Commercial Bank of China, Ltd. (ICBC)
  • Handel Lee
  • King & Wood Mallesons
  • Richard Li
  • PCCW Limited
  • Pacific Century Group
  • Liew Mun Leong
  • Changi Airport Group
  • Martin Lipton
  • New York University
  • Wachtell, Lipton, Rosen & Katz
  • Liu Mingkang
  • China Banking Regulatory Commission (CBRC)
  • Dinesh C. Paliwal
  • Harman International Industries
  • Leon Pasternak
  • BCC Partners
  • Tim Payne
  • Brunswick Group
  • Joseph R. Perella
  • Perella Weinberg Partners
  • Baron David de Rothschild
  • N M Rothschild & Sons Limited
  • Dilhan Pillay Sandrasegara
  • Temasek International Pte. Ltd.
  • Shao Ning
  • State-owned Assets Supervision and Administration Commission of the State Council of China (SASAC)
  • John W. Snow
  • Cerberus Capital Management, L.P.
  • Former U.S. Secretary of Treasury
  • Bharat Vasani
  • Tata Group
  • Wang Junfeng
  • King & Wood Mallesons
  • Wang Kejin
  • China Banking Regulatory Commission (CBRC)
  • Wei Jiafu
  • Kazakhstan Potash Corporation Limited
  • Yang Chao
  • China Life Insurance Co. Ltd.
  • Zhu Min
  • International Monetary Fund

Legal Roundtable

  • Dimitry Afanasiev
  • Egorov Puginsky Afanasiev and Partners (Moscow)
  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Johan Aalto
  • Hannes Snellman Attorneys Ltd (Finland)
  • Nigel P. G. Boardman
  • Slaughter and May (London)
  • Willem J.L. Calkoen
  • NautaDutilh N.V. (Rotterdam)
  • Peter Callens
  • Loyens & Loeff (Brussels)
  • Bertrand Cardi
  • Darrois Villey Maillot & Brochier (Paris)
  • Santiago Carregal
  • Marval, O’Farrell & Mairal (Buenos Aires)
  • Martín Carrizosa
  • Philippi Prietocarrizosa & Uría (Bogotá)
  • Carlos G. Cordero G.
  • Aleman, Cordero, Galindo & Lee (Panama)
  • Ewen Crouch
  • Allens (Sydney)
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Rachel Eng
  • WongPartnership (Singapore)
  • Sergio Erede
  • BonelliErede (Milan)
  • Kenichi Fujinawa
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Manuel Galicia Romero
  • Galicia Abogados (Mexico City)
  • Danny Gilbert
  • Gilbert + Tobin (Sydney)
  • Vladimíra Glatzová
  • Glatzová & Co. (Prague)
  • Juan Miguel Goenechea
  • Uría Menéndez (Madrid)
  • Andrey A. Goltsblat
  • Goltsblat BLP (Moscow)
  • Juan Francisco Gutiérrez I.
  • Philippi Prietocarrizosa & Uría (Santiago)
  • Fang He
  • Jun He Law Offices (Beijing)
  • Christian Herbst
  • Schönherr (Vienna)
  • Lodewijk Hijmans van den Bergh
  • De Brauw Blackstone Westbroek N.V. (Amsterdam)
  • Hein Hooghoudt
  • NautaDutilh N.V. (Amsterdam)
  • Sameer Huda
  • Hadef & Partners (Dubai)
  • Masakazu Iwakura
  • TMI Associates (Tokyo)
  • Christof Jäckle
  • Hengeler Mueller (Frankfurt)
  • Michael Mervyn Katz
  • Edward Nathan Sonnenbergs (Johannesburg)
  • Handel Lee
  • King & Wood Mallesons (Beijing)
  • Martin Lipton
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Alain Maillot
  • Darrois Villey Maillot Brochier (Paris)
  • Antônio Corrêa Meyer
  • Machado, Meyer, Sendacz e Opice (São Paulo)
  • Sergio Michelsen Jaramillo
  • Brigard & Urrutia (Bogotá)
  • Zia Mody
  • AZB & Partners (Mumbai)
  • Christopher Murray
  • Osler (Toronto)
  • Francisco Antunes Maciel Müssnich
  • Barbosa, Müssnich & Aragão (Rio de Janeiro)
  • I. Berl Nadler
  • Davies Ward Phillips & Vineberg LLP (Toronto)
  • Umberto Nicodano
  • BonelliErede (Milan)
  • Brian O'Gorman
  • Arthur Cox (Dublin)
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz (New York)
  • Sang-Yeol Park
  • Park & Partners (Seoul)
  • José Antonio Payet Puccio
  • Payet Rey Cauvi (Lima)
  • Kees Peijster
  • COFRA Holding AG (Zug)
  • Juan Martín Perrotto
  • Uría & Menéndez (Madrid/Beijing)
  • Philip Podzebenko
  • Herbert Smith Freehills (Sydney)
  • Geert Potjewijd
  • De Brauw Blackstone Westbroek (Amsterdam/Beijing)
  • Qi Adam Li
  • Jun He Law Offices (Shanghai)
  • Biörn Riese
  • Jurie Advokat AB (Sweden)
  • Mark Rigotti
  • Herbert Smith Freehills (Sydney)
  • Rafael Robles Miaja
  • Robles Miaja (Mexico City)
  • Alberto Saravalle
  • BonelliErede (Milan)
  • Maximilian Schiessl
  • Hengeler Mueller (Düsseldorf)
  • Cyril S. Shroff
  • Cyril Amarchand Mangaldas (Mumbai)
  • Shardul S. Shroff
  • Shardul Amarchand Mangaldas & Co.(New Delhi)
  • Klaus Søgaard
  • Gorrissen Federspiel (Denmark)
  • Ezekiel Solomon
  • Allens (Sydney)
  • Emanuel P. Strehle
  • Hengeler Mueller (Munich)
  • David E. Tadmor
  • Tadmor & Co. (Tel Aviv)
  • Kevin J. Thomson
  • Barrick Gold Corporation (Toronto)
  • Yu Wakae
  • Nagashima Ohno & Tsunematsu (Tokyo)
  • Wang Junfeng
  • King & Wood Mallesons (Beijing)
  • Tomasz Wardynski
  • Wardynski & Partners (Warsaw)
  • Xiao Wei
  • Jun He Law Offices (Beijing)
  • Xu Ping
  • King & Wood Mallesons (Beijing)
  • Shuji Yanase
  • OK Corporation (Tokyo)
  • Alvin Yeo
  • WongPartnership LLP (Singapore)

Founding Directors

  • William T. Allen
  • NYU Stern School of Business
  • Wachtell, Lipton, Rosen & Katz
  • Nigel P.G. Boardman
  • Slaughter and May
  • Cai Hongbin
  • Peking University Guanghua School of Management
  • Adam O. Emmerich
  • Wachtell, Lipton, Rosen & Katz
  • Robin Panovka
  • Wachtell, Lipton, Rosen & Katz
  • Peter Williamson
  • Cambridge Judge Business School
  • Franny Yao
  • Ernst & Young

Legal Regimes

CHINESE UPDATE – Brief Commentary on the Foreign Investment Law

Contributed by: Adam Li, JunHe LLP (Shanghai)

Editors’ Note: Contributed by Adam Li, a partner at JunHe and a member of XBMA’s Legal Roundtable.  Mr. Li is a leading expert in international mergers & acquisitions, capital markets and international financial transactions involving Chinese companies.  This article was authored by Mr. Zheng Yu, a partner at JunHe. Mr. Zheng has broad experience advising multinational companies on their business and investment projects in China, including complex foreign direct investments, cross-border M&A, dispute resolution (arbitration and litigation), corporate compliance, employment issues and tourism real estate projects in China.  Xiao Wang, an associate at JunHe, also contributed to the article.

Brief Commentary on the Foreign Investment Law (Draft)
Changes, Highlights and Expectation

On December 26, 2018, the National People’s Congress published the Foreign Investment Law of the People’s Republic of China (Draft) (the “New Draft”) in order to solicit public opinion. The New Draft is a revised version of an earlier draft of the Foreign Investment Law, originally issued by the Ministry of Commerce for public comment almost four years ago (the “First Draft”). The New Draft is significantly shorter than the earlier version, comprising just 39 articles, compared with the 170 articles that made up the First Draft. This would seem to indicate that the overall legislative goal for the Foreign Investment Law has shifted from its previous highly detailed operational approach to one that is now focused on principles and guidance.

This article provides an overview of the structure of the New Draft, particularly in relation to the major changes since the First Draft, analyzes some key elements, and provides comments and suggestions as to how the New Draft might be improved.

1.  – Structure of the New Draft

1.1 – Sections

The New Draft comprises five main sections:

  1. Definition and scope of foreign investment
  2. Investment promotion
  3. Investment protection
  4. Investment administration
  5. Legal liability

1.2 – Major Differences from the First Draft

The following table provides a summary of the content of each of the five main sections of the New Draft and highlights the key differences when compared with the First Draft.

Main Content

New Draft

Major Differences

from First Draft

Definition

The New Draft defines foreign investment (Article 2) as “any investment activity directly or indirectly carried out by foreign natural persons, enterprises or other organizations (“foreign investors”) within the territory of China”.

Specifically, the New Draft describes three types of investment activities that represent foreign investment:

  1. Foreign investors, separately or jointly, investing in new construction projects, establishing foreign-invested enterprises, or increasing investment in invested enterprises, in mainland China;
  2. Foreign investors acquiring, by means of merger and acquisition, shares, equity interests, shares of property or other similar interest in enterprises in mainland China; and
  3. Foreign investors making investments in mainland China through other means as provided by laws, administrative regulations or State Council provisions.

Whereas in the First Draft, foreign investors included “governments of other countries or regions as well as their affiliated departments or offices”, they are not mentioned in the New Draft, and so it is not clear whether they will be permitted to conduct foreign investment in the updated version.

Compared with the First Draft, the scope of foreign investment in the New Draft is significantly narrower, and, with the exception of the “catch-all clause”, is limited to foreign investors’ establishment of foreign-invested enterprises in mainland China by means of new set-up (i.e. greenfield investment) or merger/acquisitions.

The activities included in the First Draft listed below are no longer classified as foreign investment under the New Draft:

  1. Provide financing with a term of more than one year to an enterprise in China in which it owns shares, equity interests, shares of property or other similar interests;
  2. Obtain concession rights to (a) explore and exploit natural resources, or (b) construct or operate infrastructure within the territory or jurisdiction of mainland China;
  3. Acquire real estate rights, such as land use rights or building ownership in mainland China;
  4. Control or own interests of domestic enterprises by contract, trust or other means; and
  5. Transactions conducted outside mainland China shall be considered a foreign investment if such transactions will result in the transfer of the de facto control of a domestic enterprise to a foreign investor.

Investment Promotion

The New Draft emphasizes the aim of establishing a stable, transparent and predictable investment environment (Article 3), and clarifies that national policies in support of the development of enterprises shall apply to foreign-invested enterprises consistently with how they are applied to domestic-invested ones (Article 9). It was not clear in the First Draft whether national policies in support of the development of enterprises would be consistently applied to foreign-invested enterprises.

Investment Protection

The New Draft provides protection for investment in respect of state expropriation, profit remittance, intellectual property rights protection, technology transfer, administrative interference, governmental commitments and foreign investors’ complaints, namely that:

  1. The state shall not expropriate foreign investments. Should expropriation be required in the public interest, such expropriation shall be conducted in accordance with legal procedures and fair and reasonable compensation should be provided (Article 20);
  2. Foreign investors’ capital contributions, profits and capital gains may be freely remitted outside China in RMB or foreign currency (Article 21);
  3. The intellectual property rights of foreign investors and foreign-invested enterprises shall be protected in accordance with the law. The terms for any technology cooperation shall be determined through negotiation between the parties to the investment. Administrative means shall not be used to compel the transfer of technology (Article 22);
  4. Foreign investment rules formulated by the Chinese government and its relevant departments shall be in compliance with laws and regulations, and shall not illegally (i) impair the legitimate rights of or impose additional obligations on foreign-invested enterprises; (ii) set any conditions for market access or exit, or (iii) intervene or influence normal production and operation activities of foreign-invested enterprises (Article 23);
  5. Local governments and their relevant departments shall strictly abide by all policy commitments made in accordance with law, and contracts concluded according to law. If any amendment to such commitments or contracts is required in the national or public interest, such amendment must be conducted through legal procedures and within authorized jurisdiction. Any loss to foreign investors or foreign-invested enterprises incurred thereof shall be compensated (Article 24); and
  6. The complaint submission and handling mechanism for protecting rights of foreign-invested enterprises shall be improved (Article 25).
Compared with the First Draft, the New Draft points out and emphasizes for the first time the following responsibilities of governments to protect foreign investment:

  1. Administrative means shall not be employed to compel the transfer of technology;
  2. Foreign investment rules shall be formulated in compliance with laws and regulations; and
  3. Government shall strictly keep all policy commitments made in accordance with law, and perform all contracts concluded according to law.

Investment Administration

The New Draft specifies three investment administrative systems for foreign investment:

  1. Pre-establishment National Treatment and Negative List administrative system (Article 27);
  2. Foreign Investment Information Reporting system (Article 31); and
  3. Foreign Investment National Security Review system (Article 33).
The New Draft sets out only the principles that underlying the three administrative systems for foreign investment. The First Draft, by contrast, provided highly detailed, practicable provisions for each of the three systems in respect of specific content, conditions, application requirements, elements for review, review procedures, time limits, etc. The implementation of the three systems under the New Draft will be dependent upon the concurrent formulation and implementation of any relevant supporting regulations.

Legal Liability

The New Draft stipulates the following legal consequences for any violation of the negative list or laws and regulations:

  1. Violation of the Negative List
    Foreign investors shall be ordered to make rectification or stop investment activities, or dispose of shares and assets within the prescribed time limit, or take other necessary measures to restore to the original state prior to investment. If there have been any gains derived from such investment, such gains shall be considered illegal and confiscated by the government.
  2. Violation of laws and regulations
    Foreign investors shall be subject to investigation in accordance with laws, blacklisted in credit information systems, and subject to sanctions taken by relevant authorities.

Compared with the First Draft, the New Draft does not stipulate any legal consequences for the violation of Information Reporting or the National Security Review system. In addition, administrative sanctions are also removed from the possible legal consequences of a violation of the negative list. Under the First Draft, this could have resulted in a fine of between RMB 100,000 and RMB 1,000,000, or up to 10% of the illegal investment amount.

 

2. – Highlights of the New Draft

Among the highlights of the New Draft are the clear responses to various long-held concerns from foreign investors and foreign-invested enterprises, which should go some way to improving the environment for foreign investment and shoring up foreign investors’ confidence in investing in China. They include:

2.1 – National treatment: Unless otherwise stipulated by laws or administrative regulations, national policies to support of the development of enterprises will apply in the same way to foreign-invested enterprises as they do to domestic-invested ones (Article 9);

2.2 – Prevention of compulsory technology transfer: The terms of any technology cooperation associated with foreign investment shall be determined by all investment parties through negotiation. Administrative means should not be used by administrative agencies or their officers to compel the transfer of technology transfer (Article 22); and

2.3 – Governmental commitment: Local governments and their relevant departments shall strictly keep all policy commitments made according to law, and perform contracts concluded according to law (Article 24).

3. – Comments and Suggestions to Improve the New Draft

While the New Draft incorporates various advances, we believe there remain further opportunities for improvement or clarification in order to ensure the clear operability of the New Draft after its formal issue:

1. – Definition of “Foreign Investor” and “Foreign Investment” (Article 2, Paragraph 2) For the purpose of this law, foreign investment refers to any investment activity directly or indirectly carried out by foreign natural persons, enterprises or other organizations (“foreign investors”) within the territory of China”, including…

Comments/Suggestions

We believe that the current definitions of “foreign investor” and “foreign investment” are insufficiently clear, and that as they stand, they may cause confusion in practice. The main issues are:

(i)       It is not clear whether “foreign investors” includes foreign or regional governments, and international organizations.

(ii)     Since, in addition to direct investment, the definition of investment includes “indirect investment”, it is not clear whether for an investment in China, the identity of its foreign investor shall be determined by such investor’s ultimate controlling shareholder.

(iii)   It needs to be clarified whether an investment made in China by an overseas company that is controlled by a Chinese company will be classified as “foreign investment”.

We believe that it is necessary to clarify in the New Draft whether the identity of a “foreign investor” will be determined by the place of registration of the foreign investor that directly holds shares, equity or interest of the invested enterprise in China, or by the place of registration of the ultimate controller of such foreign investor. If it is the latter, a definition of “control” is also required.

Given the increasing number of overseas investments emanating from China, a lack of such criteria may lead to severe confusion regarding whether investment in China conducted by overseas companies directly or indirectly controlled or wholly-owned by Chinese enterprises or natural persons will be governed by the Foreign Investment Law.

Moreover, with increasing numbers of Chinese citizens migrating overseas and foreign citizens becoming resident in China, we suggest that there is a need for clarification as to whether an enterprise invested in China by foreign individuals that acquire Chinese nationality or by Chinese citizens that obtain foreign nationality shall be governed by the Foreign Investment Law.

2. – Disclosure of Judicial Awards (Article 10, Paragraph 2) Regulatory documents and judicial awards in relation to foreign investment shall be timely disclosed to the public pursuant to laws.

Comments/Suggestions

We suggest the need to clarify that the disclosure of judicial awards related to foreign investment shall not apply to cases involving state secrets or business secrets.

3. – Negative List (Article 27)

Foreign investors shall not invest in prohibited areas on the negative list for foreign investment access.  

Foreign investors investing in restricted areas in the negative list for foreign investment access shall comply with the conditions provided by the negative list.  

Foreign investment in areas outside the negative list for foreign investment access shall be administered under the principle of consistent treatment for domestic and foreign investment.

Comments/Suggestions

Since the scope of foreign investment negative lists applied in free trade zones is different from that of the national version, we suggest there is a need to clarify that the negative list of the relevant free trade zone shall prevail if it is different from the national version.

4. – National Security Review (Article 33) China shall establish a foreign investment national security review system to perform security reviews on foreign investment that affects or may affect national security. National security decisions made according to the law shall be final.

Comments/Suggestions

The New Draft only provides that there shall be a foreign investment national security review system, without further specifying any detailed rules, such as in terms of the scope and content of the review, requirements of application documents, procedure or time limit of the review, etc. Currently, the only rules that regulate a national security review of foreign investment are the Notice of the General Office of State Council on the Establishment of a Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors[1] and the Notice of the General Office of State Council on the Promulgation of the Trial Measures on National Security Review for Foreign Investments in Pilot Free Trade Zones[2]. There is no clear legal basis for a national security review of foreign-invested enterprises that will be newly incorporated outside free trade zones. We suggest that an ancillary foreign investment national security review regulation shall be formulated and implemented simultaneously with the Foreign Investment Law.

In addition, with the New Draft indicating that a review decision shall be “final”, we suggest there is a need to clarify whether “final” should be taken to mean that a decision cannot be appealed, whether through administrative reconsideration or administrative litigation.

Furthermore, as a national security review is an important element in the administrative system for foreign investments, in order to ensure its effective compliance and implementation, we suggest that the legal consequences of any violation of the national security review filing obligation be provided in the Foreign Investment Law.

5. – Transition from the Laws on FIEs This law shall come into force as from MM/DD/YYYY, on which the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures, the Law of the People’s Republic of China on Wholly Foreign-owned Enterprises and the Law of the People’s Republic of China on Sino-foreign Cooperative Joint Ventures shall be repealed simultaneously.

Comments/Suggestions

Following the reforms to the system for filing foreign-invested enterprises and the introduction of the negative list, foreign-invested projects outside the scope of the negative list have been required only to file, with the set-up of such enterprises governed by the Provisional Measures on Administration of Filing for Establishment and Change of Foreign-Invested Enterprises (Amended version)[3]. Foreign-invested projects that fall within the negative list shall still be subject to approval and governed by the three separate laws that apply to the three kinds of foreign-invested enterprises (FIEs), and to the respective implementation regulations.

With the three laws on FIEs and their implementation regulations due to be repealed simultaneously upon the effectiveness of the Foreign Investment Law, it will be necessary to issue a regulation for approval of foreign investment projects that are subject to approval under the negative list. This will provide a clear legal basis for implementing the relevant approval requirements, procedures, time limit, etc. applicable to foreign investment projects under the negative list after the three laws on FIEs have ceased to be effective.

6. – Governing Law of Joint Venture Contract and Cooperative Contract N/A

Comments/Suggestions:

Article 12 of the Implementing Regulation of the Law of the People’s Republic of China on Sino-foreign Equity Joint Ventures provides that, “the formation of a joint venture contract, its validity, interpretation, execution and the settlement of disputes under it shall be governed by the Chinese law.” Article 55 of the Implementing Regulation of the Law of the People’s Republic of China on Sino-foreign Cooperative Joint Ventures provides that, “the formation of a cooperative contract, its validity, interpretation, execution, and the settlement of disputes under it shall be governed by Chinese law.”

The above regulations shall be repealed once the Foreign Investment Law comes into effect. In the absence of any rules in the New Draft regarding the law governing joint-venture contracts, cooperative contracts or relevant share transfer contracts, it remains unclear whether the parties to joint venture or cooperation contracts will be free to choose themselves which is the governing law, pursuant to the PRC Contract Law. We suggest that this point be further clarified in the Foreign Investment Law.

7. – Applicability of Foreign Investment Law to Investors from Hong Kong, Macau and Taiwan N/A

Comments/Suggestions:

The definition of “foreign investor” in the New Draft does not cover investors from Hong Kong, Macau or Taiwan, whose investments in mainland China were previously considered to be “foreign investment”. Therefore, we suggest that the Foreign Investment Law clarify whether the law shall apply, by reference, to investment in mainland China made by investors from Hong Kong, Macau and Taiwan.

 

4. – Outlook

President Xi Jinping announced at the 2018 Annual Meeting of Boao Forum for Asia that China will take major measures to expand its opening up and create a more attractive investment environment. The issuance of the Foreign Investment Law will be an important step in China’s ongoing objective to open up and to attract more foreign investment. We hope the New Draft can be further improved in order to ensure that the Foreign Investment Law is able to support the attainment of these goals.

JunHe will closely follow the progress of this important legislation and provide relevant updates accordingly.

[1] Guo Ban Fa [2011] No. 6

[2] Guo Ban Fa [2015] No. 24

[3] 2017 Decree No. 2 of Ministry of Commerce, July 30, 2017

 

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

CHINESE UPDATE – Bond Market Enforcement to be Unified under the CSRC

Contributed by: Adam Li, JunHe LLP (Shanghai)

Editors’ Note: Contributed by Adam Li, a partner at JunHe and a member of XBMA’s Legal Roundtable. Mr. Li is a leading expert in international mergers & acquisitions, capital markets and international financial transactions involving Chinese companies. This article was authored by Ms. Man Wu, counsel at JunHe. Ms. Wu has ample experience in drafting rules as well as the investigation and supervision of different entities, such as listed companies, securities companies and fund management companies. Ms. Wu also worked for the China Securities Regulatory Commission (CSRC) for 13 years before joining JunHe.

Bond Market Enforcement to be Unified under the CSRC

On December 3, 2018, the People’s Bank of China (the “PBOC”), the China Securities Regulatory Commission (the “CSRC”) and the National Development and Reform Commission (the “NDRC”), were authorized by the State Council to jointly issue their Opinions Concerning the Relevant Issues on Further Strengthening Law Enforcement in Bond Market (the “Opinions”). The issuing of the Opinions takes place within the current environment of “Strong Regulation” and is an indication of the State Council’s intention to build a coherent law enforcement framework for the bond markets by strengthening cooperation among the financial regulatory authorities.

China has long had two separate and differentiated bond markets – the interbank bond market and the exchange bond market – each regulated by various regulatory bodies. While not intending to alter any existing administrative and self-regulatory powers and responsibilities, the Opinions stipulate that the CSRC should be responsible for the enforcement of any illegal activities that might occur in both markets. The CSRC has previously investigated various one-off instances of violations within the bond markets. The issuing of the Opinions signifies the intention to establish a more systematic and long-term approach, thereby providing a stronger guarantee of law enforcement in the interbank bond market.

The Opinions include various important provisions, as follows:

I. Clarifying the Scope of Law Enforcement and Punishment Measures

The CSRC’s newly-unified law enforcement framework will cover all categories of bonds traded in the interbank and exchange bond markets, including corporate bonds, enterprise bonds, financial bonds and debt financing instruments issued by non-financial enterprises. The Securities Law will be the applicable law for defining violations of laws and regulations and any pertinent penalties for information disclosure, insider trading or market manipulation. It is our observation that the Opinions may imply that the definition of “Securities” within the Securities Law should be expanded to include all instruments issued in the interbank bond market.

The Opinions stipulate that any illegal activity on the part of commercial banks or securities companies in their underwriting of the various categories of bonds shall be punished in accordance with Article 191 of the Securities Law. It is noteworthy that Article 191 of the Securities Law indicates that the penalties are applicable to securities companies, but does not refer to commercial banks per se. Since the Legislation Law and the Administrative Penalty Law provide limitations on the extent to which administrative regulations can be used to impose administrative punishment and on the type and strength of such administrative punishment, it remains to be seen whether and how the CSRC will implement Article 191 of the Securities Law to punish commercial banks for any violations in underwriting of bonds.

In addition, the Opinions also provide that should the CSRC discover that a serious violation has been committed, it may impose a securities market ban on the relevant person for a given period, up to a lifetime ban. Violators could be prohibited from working in the securities business for any employer, current or future, and serving as a director, supervisor or senior executive with an employer or any other listed companies or non-listed public companies. Should the CSRC suspect that a crime has been committed, the relevant information will be provided to the public security agencies for further investigation, who if necessary will impose the applicable criminal punishment.

II. Elements to Facilitate Unified Law Enforcement by CSRC

The Opinions expressly stipulate three key elements to facilitate the CSRC’s unified enforcement power over the bond markets:

Firstly, for the purpose of law enforcement for the bond markets, the CSRC shall have the powers to implement the measures listed in Article 180 of the Securities Law, including conducting onsite inspections, investigating and collecting evidence, making inquiries of entities and individuals related to any matters under investigation, checking and duplicating all relevant documents and materials, freezing or seizing properties or important evidence that is concerned, and restricting the purchase and sales of securities.

Secondly, the CSRC shall have the power to acquire trading records, registration, custodianship and settlement documents and information disclosure or other evidencing documentation from bond market self-disciplinary organizations, exchanges, trading platforms, registration, custodian and settlement institutions and other institutions participating in the market. If necessary, the CSRC may acquire the personal credit reports, social insurance, customs and tax payment records, AIC registration documents, correspondence records or other information about entities and individuals involved in the matter under investigations from the relevant authorities or institutions in accordance with the law.

Thirdly, any entities or individuals under investigation are obliged to provide assistance with such investigations. Should they fail to provide the required assistance, the CSRC may propose that the relevant financial regulatory authority or competent department should order the entity or organization to which such individual belongs to impose a disciplinary punishment, or propose to cancel the individual’s post-holding qualification or even ban the person from working in the finance industry.

III. Setting out the Regulators’ Collaboration Mechanism

The Opinions set out a clear requirement to build a collaboration mechanism, under which the PBOC and the NDRC shall collaborate with the CSRC to strengthen the CSRC’s law enforcement in the bond markets, including establishing mechanisms to be able to jointly discuss cases, issuing written opinions to the CSRC on case-related technical issues and assisting in handling the work involved in administrative reconciliation and litigation. The Opinions also require the PBOC and the NDRC to promptly convey relevant evidence on any bond violations to the CSRC.

According to the CSRC’s Bulletin on Law Enforcement in Bond Market issued on December 3, during 2018 the CSRC investigated six bond market violation cases, including those relating to fraud issuance, false statement and market manipulation. We anticipate that having issued the Opinions, and with the regulators’ collaborative mechanisms in place, the bond markets will henceforth face a more severe enforcement environment. The CSRC is expected to further strengthen their investigations and to take additional efforts to uncover any violations in both the interbank and exchange bond markets.

We will continue to monitor any developments related to the law enforcement of bond markets and look forward to sharing them with our valued clients.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

 

U.S. UPDATE – SEC to Study Quarterly Reporting & Earnings Guidance and their Contribution to Short-Termism

Contributed by: Sabastian V. Niles, Partner, Wachtell, Lipton, Rosen & Katz (New York)

Editors’ Note: This article was authored by Sabastian V. Niles of Wachtell, Lipton, Rosen & Katz.

SEC to Study Quarterly Reporting & Earnings Guidance and
their Contribution to Short-Termism

In a potentially significant step for public companies and the U.S. economy, the SEC today launched a formal comment process aimed at optimizing the periodic reporting system for U.S. companies.  The SEC’s review is wide-ranging, reaching whether reforms could and should be made to discourage quarterly forward-looking earnings guidance, the reasons for quarterly earnings releases and their content, whether Form 10-Qs are useful or overly burdensome or duplicative, the possibility of moving to mandatory or optional semi-annual reporting for all or some reporting companies, the degree to which the frequency of reporting and guidance may lead managers to focus on short-term results to the detriment of long-term performance, the identification of other factors that may promote short-termism and whether there are relevant learnings from other markets where companies can report on a six-month or other schedule.

For most companies, quarterly reporting consumes substantial time and expense and imposes opportunity costs, as management teams focus on quarterly results.  These quarterly cadences are often deeply disconnected from long-term business cycles, key business drivers, customer dynamics, innovation opportunities and market realities.  Three-month cycles are also disconnected from the time frames over which retail investors who are saving for retirement, looking to buy a home and pay college tuition are seeking a return.  A thorough examination of the topic – with a view towards striking the right balance among reasonable transparency, reducing regulatory burdens and encouraging companies to focus not on the quarter but on the long-term – is a very worthy project for the SEC.

Unlike other markets, U.S. companies do not currently have the option of discontinuing quarterly reporting, and it remains to be seen whether the outcome of the SEC’s review will result in substantial changes to the quarterly reporting and disclosure system.  U.S. companies can, however, decline to give quarterly earnings guidance and take other actions to promote a long-term orientation for their investors, employees and internal strategic and business decision-making.

Whatever the SEC’s ultimate decisions may be, we do expect companies to become increasingly proactive in putting near-term results in the context of long-term strategy and objectives; using quarterly calls and releases to discuss progress towards important operational and financial goals that take time to achieve; and replacing quarterly rhythms with broader, multi-year frameworks for value creation with time frames that align with business, end market and operational realities.  We also encourage responsible long-term investors to support these initiatives, as many do.

Sabastian V. Niles

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

CHINA UPDATE – China is Taking Solid Steps to Open its Banking Sector

Editors’ Note: Chen Yun is a partner specializing in banking, finance and foreign exchange law. Wang Rong and Liang Yixuan also contributed to this article.

After the promulgation of the State Council’s Decision on Amending the Regulations of the People’s Republic of China (“PRC”) on the Administration of Foreign Funded  Banks (Consultation Paper) (the “Administrative Regulations Consultation Paper”) in late October 2018, the China Banking and Insurance Regulatory Commission (“CBIRC”) released the Decision on Amending the Implementation Rules of the Regulations of the PRC on the Administration of Foreign Funded Banks (Consultation Paper) (the “Implementation Rules Consultation Paper”, together with the Administrative Regulations Consultation Paper, the “Consultation Papers”) on 28 November 2018 to solicit public opinions.

The main purposes of amending these two legislations, which are of ultimate importance to the supervision of foreign funded banks (“FF Banks”) are to put into practice the country’s opening-up policies in the banking sector, to make law to implement the opening-up measures in the banking sector, which have been repeatedly referred to by senior government officials in various summits and public speeches, and to further liberalize the foreign investment in China’s banking sector.

The amendments made by the Consultation Papers focus on the following aspects:

  • Allowing foreign banks to maintain PRC branches (“FB Branches”) and locally incorporated banks in China (“FB LIBs”) at the same time
  • Lifting the restrictions on the conducting of the RMB business by FB Branches and FB LIBs
  • Broadening the business scope of FB Branches and FB LIBs
  • Relaxing the operating funds requirements for FB Branches

Ⅰ. Institutions Subject to the Regulation of the Consultation Papers

As early as 17 August 2018, CBIRC abolished the Administrative Measures on Equity Investment by Foreign Funded Financial Institutions in Chinese Funded Financial Institutions, and removed the 25% ceiling of foreign shareholding in a Chinese funded commercial bank by amending the Implementation Measures of the Administrative Licensing Items for Chinese Funded Commercial Banks.  It is also stipulated that a commercial bank will be regulated as the category of the bank as the one when and into which the foreign investment is made.

Therefore, foreign banks may set up from scratch joint-venture FB LIBs (“JV Banks”) or wholly foreign owned FB LIBs (“WFOBs”) regulated as FF Banks, or may otherwise become, by way of making investments into Chinese funded commercial banks, the shareholders of joint-venture banks with more than 25% foreign ownership or wholly foreign owned banks, which are converted from and regulated as Chinese funded commercial banks.

Notwithstanding the above, the institutions subject to the regulation of the Consultation Papers remain those regulated as FF Banks, namely WFOBs, JV Banks, FB Branches and PRC representative offices of foreign banks. As far as joint-venture banks or wholly foreign owned banks converted from and regulated as Chinese funded commercial banks as the result of the investment by foreign banks are concerned, the Consultation Papers do not apply.

Ⅱ. Allowing Foreign Banks to Maintain FB Branches and FB LIBs at the Same Time

One of the most appealing changes made by the Consultation Papers is that foreign banks would be allowed to maintain both FB LIBs (i.e. WFOBs and JV Banks regulated as FF Banks) and FB Branches) at the same time. As a result, foreign banks would no longer be forced to make a hard choice between local incorporation and keeping FB Branches.

Back in late 2006, when converting their FB Branches into WFOBs, foreign banks were allowed to retain an FB Branch to carry on their foreign exchange (“FX”) wholesale business for a certain period of time (i.e. a transition period), in order to facilitate the to-be-established WFOBs to meet the relevant regulatory indicators requirements and to facilitate the retained branch to phase out the outstanding FX wholesale business, only that such retained branch shall be closed upon the expiry of the transition period.

However, in the Implementation Rules of the Regulations of the PRC on the Administration of Foreign Funded Banks which was promulgated on 1 July 2015 and took effect on 1September of the same year, the relevant provisions on the retention of an FX wholesale business branch upon local incorporation of foreign banks were deleted, thus made such approach no longer workable.  In practice, CBIRC (then the China Banking Regulatory Commission) also rejected the application from any foreign bank for retaining an FX wholesale business branch when converting its FB Branches into a WFOB.

This policy change directly led to the delay in the local incorporation process of some foreign banks since, without the FX wholesale business branch retained, their to-be-established WFOBs may not meet the specific regulatory indicators requirements.

Now, the change made by the Consultation Papers allowing foreign banks to maintain both FB LIBs and FB Branches (although the Consultation Papers require that in such circumstances, the FB Branches would only be allowed to conduct the wholesale business, with a substantial breakthrough being that such wholesale business covers not only FX business but also RMB business) at the same time would make it easier for foreign banks to enter into the China market.

It is worth mentioning that the Consultation Papers also set out prohibitions or restrictions on the independence and the risk isolation mechanism of the management, personnel, business, information and related party transactions of FB LIBs and FB Branches.

Ⅲ. Lifting the Restrictions on the Conducting of the RMB Business

With regard to the RMB business, the following material changes are made by the Consultation Papers:

  • The “waiting period” (i.e. a period of time for which an FB LIB or an FB Branch shall open business before applying for conducting the RMB business) for the RMB business of FB LIBs and FB Branches is cancelled;
  • The minimum amount required for FB Branches to accept the fixed term deposit from Chinese citizens is lowered from RMB 1 million to RMB 0.5 million;
  • FB LIBs or FB Branches are allowed to conduct the preparatory work for the RMB business simultaneously with that for setting up FB LIBs or FB Branches, and to submit the application for the opening of the RMB business simultaneously with that for the business opening of FB LIBs and FB Branches. Thus, the RMB business may be opened Day One when FB LIBs and FB Branches open their businesses; and
  • In the case of multiple FB Branches, the managing FB Branch may authorize other FB Branches to conduct the RMB business as long as the managing FB Branch itself has obtained the RMB business license.

Ⅳ. Broadening the Business Scope

The Administrative Regulations Consultation Paper includes “acting as the issuance agent, payment agent and/or underwriter of Chinese government bonds” into the business scope of FB LIBs and FB Branches. Thus, the business scope of an FB LIB is substantially the same as that of a Chinese funded commercial bank.

In addition, the Implementation Measures Consultation Paper restates that the following types of business of FB LIBs and FB Branches are subject to the afterwards reporting requirement only, which was provided in the Circular on the Conducting of Certain Businesses by Foreign Funded Banks (the “Circular”) issued by the General Office of CBIRC on March 10, 2017 and now documented into a regulation by CBIRC: (1) acting as the issuance agent, payment agent and underwriter of Chinese government bonds; (2) providing custody, escrow and guardianship services; (3) providing consultancy services such as financial advisory services; (4) providing overseas wealth management services for and on behalf of the clients; and (5) such other businesses as CBIRC may deem to be subject to the afterwards reporting requirement.

Furthermore, the Implementation Measures Consultation Paper restates the regulations of the Circular allowing the intra-group cooperation (namely, allowing FB LIBs and FB Branches to cooperate with their parent bank groups to provide comprehensive financial services to Chinese enterprises in offshore bond issuance, listing, acquisition, financing and the like by taking the advantages of their global service networks.

Ⅴ. Relaxing the Operating Funds Requirements for FB Branches

In respect of the operating funds requirements of FB Branches, the Consultation Papers have made the following adjustments as well:

Ⅵ. Other Changes and Our Observations

Apart from the above significant changes, the Consultation Papers also make certain changes in the areas such as the outsourcing activities conducted by FB LIBs and FB Braches and their termination and liquidation.

Although the Consultation Papers are subject to the solicitation of public opinions before finalization, one can be assured that China is on the track of more opening-ups in its banking sector.

With abundant experience of assisting foreign funded financial institutions in setting up their PRC presences, carrying on their business in compliance with the law, exploring new business boundaries and seeking business cooperation, King & Wood Mallesons is right here standing by to hold your hands crossing the jungle!

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

ISRAELI UPDATE – Israel’s Anti-Concentration Law: An Opportunity for New Players

Contributed By: Shirin Herzog, Ron Gazit, Rotenberg & Co.

Editors’ Note: Contributed by Shirin Herzog, head of the Mergers and Acquisitions, Securities and International Transactions Department in the Israeli firm of Ron Gazit, Rotenberg & Co. Ms. Herzog handles a variety of Israeli and cross-border merger and acquisition transactions, for public and private companies, and private equity transactions. This post is based on a recent blog post by Ms. Herzog first published in The Times of Israel on November 30, 2017.

As we conclude the contested law’s first phase, its widespread impact is felt on the Israeli market

Known from ancient times as a land of milk and honey, nowadays the nation of Israel is also a nation of opportunity. The law commonly referred to in Israel as the “Concentration Law,” requires investors deemed to be overly concentrated in the Israeli market to sell or take other actions regarding prime assets. By the same token, these investors may also be restricted from acquiring further Israeli assets. While some existing players in the Israeli market (mostly Israelis) may be harmed by the law, it has created significant opportunity for new players.

In the four years since the law was enacted, we have witnessed a considerable number of transactions driven by its requirements.

The law set up a few milestones, the first is December 10, 2017, by which Israeli conglomerates having multiple layers of publicly-traded subsidiaries (legally existing structures, also known as “pyramids”) must be flattened to a maximum of three layers of public companies; by way of sale, going private, redemption of public debt, merger, etc.

The last conglomerate to comply with this requirement was the IDB Group. On November 22, 2017, just days before the deadline, IDB Development sold its controlling interests (71%) of Discount Investments to a private company held by Eduardo Elsztain, who is also the controlling shareholder of the IDB Group. Accordingly, Discount Investments remained a publicly-traded company, but became a sister company of IDB Development, instead of its subsidiary – removing one public layer at the pyramid’s top.

Those who closely follow the Israeli financial media surely know there’s nothing like IDB to kindle populist debate and criticism of politicians and journalists alike. This deal was no exception. Many argued that the deal’s structure and financing breached the Concentration Law’s letter and spirit, and some even called for legislation of deal-blocking regulations. I have a different take on this situation. A thorough analysis of the Concentration Law (formally, The Law for Promotion of Competition and Reduction of Concentration of 2013), together with its explanatory notes, leads me to conclude that the deal breaches neither the law nor its spirit. The specifics of the analysis deviate from the scope of this piece, but in a nutshell, the provisions relating to pyramid-flattening cover only the number of public layers and they do not restrict transactions within a conglomerate that meet this number of layers criterion. Unlike the other components of the law described below, neither separation of assets held nor concentration considerations apply. Moreover, any legislation restricting the manner of doing business should be interpreted narrowly and should not apply retroactively.

The Concentration Law has already significantly succeeded in reducing the number of layers in many Israeli public-companies’ pyramids. According to a study conducted by the Israel Securities Authority, as of September 2017, only 13 companies kept the third to fifth layers of pyramids, compared to 67 such companies upon commencement of the preparatory process of the Concentration Law’s legislation in 2010. The IDB Group, a perceived catalysator of the law, had seven such companies in September 2017, compared to 27 in 2010. The recent IDB deal reduced a layer at the top of the pyramid, turning four “third-layer companies” into “second-layer companies,” no longer restricted by the Concentration Law. Thereafter, IDB still has three companies in the pyramid’s third layer.

The second milestone under the law is only two years away. By December 10, 2019, pyramid structures should be further flattened to no more than two layers of public companies. By that deadline, another component of the Concentration Law also becomes effective. It relates to separation of cross-holdings of mega Israeli financial companies (generally, companies managing assets exceeding NIS 40 billion; US $11.4 billion) and mega Israeli “real” (namely, non-financial) companies (generally, companies having revenue or debt in Israel exceeding NIS 6 billion; US $1.7 billion).

Two years may seem like a long time, but it is not. Considering the market conditions, the harsh sanctions on a breach (forced sale by a trustee) and the precedents in recent years, especially in the regulated insurance space, selling such assets could take a long time – and no seller wants to resort to a forced sale at the last moment. Much like a game of musical-chairs, no one wants to remain standing when the music stops.

Indeed, we are already seeing many transactions and separation actions in the market. The Delek Group (concentrating on gas, oil and real estate) has attempted to sell its Phoenix Insurance Company several times, as did the IDB Group with its Clal Insurance Company. Alas, the potential buyers did not stand up to the regulator’s standards. Apax Partners sold Tnuva Dairies in a well-orchestrated deal in 2015, ahead of the curve. In another case, Bino Group, the controlling party of both The First International Bank of Israel and Paz Oil Company, was bound by the Concentration Law to choose between these two prime assets, and opted to decrease its holdings in the latter company.

In parallel, seeds of the third component of the Concentration Law are starting to bud. Under that component, overall-market concentration and sectoral competitiveness considerations must be taken into account when government rights or assets, such as telecommunication licenses or exploration concessions, are allocated. A pioneering example was the restriction of The Israel Corporation from entering the emerging field of oil-shale exploration.

The Concentration Law is unprecedented both in its widespread effect over the Israeli economy and in the aggressive remedies it applies to increase competition in the allegedly-concentrated market. The law does not include “grandfather clauses” exempting existing structures and holdings, resulting in Israeli investors being forced to sell or take other actions regarding prime assets within a limited time. All the while, these Israeli investors may also be prohibited from acquiring further Israeli assets, consequently shifting investments and debt out of Israel.

The good news is these restrictions on current players in the Israeli market create opportunities for new players. From the perspective of non-Israeli investors, the Concentration Law constitutes a regulatory springboard, giving them an advantage over existing concentrated players. Opportunity is certainly ripe for newcomers to the Israeli market.

The above does not constitute legal opinion or an investment recommendation.

The views expressed herein are solely those of the author and have not been endorsed, confirmed, or approved by XBMA or any of the editors of XBMA Forum, nor by XBMA’s founders, members, contributors, academic partners, advisory board members, or others. No inference to the contrary should be drawn.

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