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Cablegate: Mofcom to Special Representative Mermoud: Merger

VZCZCXRO9956
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #8225/01 2412340
ZNR UUUUU ZZH
P 292340Z AUG 06
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 5491
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHOO/CHINA POSTS COLLECTIVE

UNCLAS SECTION 01 OF 02 BEIJING 018225

SIPDIS

SENSITIVE
SIPDIS

STATE FOR EB/CBA AND EAP/CM
STATE PASS USTR STRATFORD/WINTER/MCCARTIN
USDOC FOR ITA/MAC/AP/MCQUEENTREASURY FOR OASIA/ISA KOEPKE
AND DOHNER
E.O. 12958: N/A
TAGS: ECON EINV EFIN KIPR CH
SUBJECT: MOFCOM TO SPECIAL REPRESENTATIVE MERMOUD: MERGER
RULES IN LINE WITH LIBERALIZATION

THIS MESSAGE IS SENSITIVE BUT UNCLASSIFIED. PLEASE HANDLE
ACCORDINGLY. NOT FOR DISTRIBUTION OUTSIDE USG CHANNELS.

SUMMARY
-------

1. (SBU) China's proposed merger and acquisition (M&A) rules
do not signal a shift in attitude towards foreign
investment, according to the Ministry of Commerce (MOFCOM)
Director General (DG) in charge of the drafting process, who
met on August 28 with EB/CBA Mermoud. The DG argued that
China, as an economy in transition, needs to regulate and
supervise how the assets of state-owned enterprises (SOEs)
are valued when such assets are sold off as part of
privatization. END SUMMARY

MEETING DETAILS
---------------

2. (U) Special Representative for Commercial and Business
Affairs Frank Mermoud met on August 28 with PRC Ministry of
Commerce Department of Treaty and Law Director General Shang
Ming and Deputy Director Wen Xiantao. The central focus of
the meeting was draft merger and acquisition (M&A) rules
made public by the Chinese government on August 8.

BACKGROUND ON THE PROPOSED M&A RULES
------------------------------------

3. (U) The Ministry of Commerce (MOFCOM), together with the
State Administration of Foreign Exchange (SAFE), the State
Administration for Taxation, the State Administration of
Industry and Commerce, the China Securities and Regulatory
Commission (CSRC), and the State Owned Assets Supervision
and Administration Commission (SASAC), promulgated the
"Measures on Acquisitions of Domestic Enterprises by Foreign
Investors" to replace the "Provisional Measures on
Acquisitions of Domestic Enterprises by Foreign Investors"
that have been in effect since April 2003. The draft rules,
released on August 8, are to become effective on September
8.

4. (U) According to an analysis prepared by the law firm
Paul Hastings, the proposed rules expand the original 26
sections to 61 sections, and further organize the 61
sections into six articles. The proposed rules strengthen
MOFCOM's supervisory role, in part by requiring its approval
in the following areas

-- restructuring activity of Chinese businesses offshore

-- acquisitions where the acquirer would:
o control an enterprise in an "important industry";
o control an enterprise that owns "famous trademarks"
or "well-known Chinese trade names"; or gain the
ability to affect "China's economic security".

5. (U) The proposed rules also provide for "equity swap" and
thus allow for the following cashless transactions:

-- corporate restructures for initial public offerings in
foreign exchanges; and

-- acquisitions by foreign listed companies using their
own shares.

CONCERNS, CONFUSION, AND A NEED FOR CONSULTATION
--------------------------------------------- ---

6. (SBU) Mermoud observed that the draft M&A rules have
caused concern and confusion in the foreign business
community. AmCham and industry representatives had
complained to him about insufficient opportunities to
provide input during drafting. Mermoud emphasized the
importance of clear and transparent regulations as well as a
follow-up process that enables those affected by the rules
to truly understand their meaning. He also asked specific
questions about various draft articles.

POSITIVE SPIN...
-----------------

7. (SBU) DG Shang said the goal of the rules is to provide a
new legal channel for domestic entities to strengthen
themselves, including by listing in foreign locations.
Shang said the draft rules are not really new but should

BEIJING 00018225 002 OF 002


instead be understood as a revision of those that came into
effect in 2003. The changes are being made in a context of
continued opening and reform by the PRC. There has been no
change in attitude towards foreign investment, press and
media commentaries about "unrelated" acquisition cases
(presumably CNOOC and Lenovo) notwithstanding.

... AND A CLAIMED POSITIVE RESPONSE
-----------------------------------

8. (SBU) Shang said the PRC reached out for comments from
Chinese government ministries, foreign investors, and
foreign governments. The response from "society" to the
draft has been positive. He acknowledged that there had
been some questions and confusion -- it is a long and hard
to understand document -- but asserted that MOFCOM is
working to improve understanding of the draft. According to
Shang, the PRC does not wish to place new burdens or
restraints on investors.

IN LINE WITH INTERNATIONAL PRACTICE
-----------------------------------

9. (SBU) Shang underscored China's focus on compliance with
WTO commitments and desire to operate in line with
international practice. He acknowledged outside concerns
about "economic security" references in the draft rules, a
concept he asserted as also in line with the policies of
other countries. The reference to economic security not
only pre-dates the recent draft revision but is also
embedded in United States and European Union policies and
practices. The fundamental issue, according to Shang, is
how the national economy operates in people's lives.

VALUATION ISSUE
---------------

10. (SBU) Shang, noting that China still regulates the
movement of capital into and out of the country, said it is
important for ministries and agencies to pay attention to
the prices that SOE managers attract for state assets when
they are privatizing, a process that must be supervised.
Certified Public Accountant (CPA) firms under Ministry of
Finance (MOF) supervision and "evaluation associations" will
play a key a role in ensuring that prices set are in line
with actual value. CPA firms that cheat will be brought to
MOF's attention. The overall goal is to make transactions
fair. This process will be about credibility and good
faith, according to Shang.

OTHER AREAS OF SIGNIFICANCE
---------------------------

11. (SBU) Referring to restrictions involving ownership of
brands and trademarks, Shang said that there are many
traditional brand names and special techniques from Chinese
history that are to be protected, and that this is a part of
maintaining China's heritage.

12. (SBU) Shang said that one significant change in the new
draft is the use of stock as payments for M&A, an approach
that will lower the cost of funds to domestic enterprises.
In Shang's view, it is domestic entities rather than foreign
investors that will be most affected by the changes,
especially those entities that move funds offshore into
"special purpose vehicles" and then invest those funds back
into China (Note: "round-tripping," a practice often
motivated by tax and other legal considerations. End Note).

COMMENT PERIOD
--------------

13. (SBU) Responding to suggestions from Mermoud, Shang said
it is not possible to extend the commentary period for the
rules (Note: The rules become effective September 8. End
Note.) because six ministries were involved in setting up
the timetable. Shang did however agree to Mermoud's request
that he accept a list of questions from the Embassy in order
to provide further clarification about the draft rules in
advance of their coming into force.

SEDNEY

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