Cablegate: China: New Merger Rules Spark Concern

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RUEHSH/AMCONSUL SHENYANG 6851
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UNCLAS SECTION 01 OF 03 BEIJING 019278

SIPDIS

SENSITIVE
SIPDIS

SHANGHAI PASS AMBASSADOR

STATE PASS USTR FOR
STRATFORD/ALTBACH/WINTER/MCARTIN/READE

USDOC FOR U/S LAVIN AND ITA/MAC/AP

TREASURY FOR ISA - DOHNER AND CUSHMAN

GENEVA FOR USTR

E.O. 12958: N/A
TAGS: ETRD WTRO ECON EINV PGOV CH
SUBJECT: CHINA: NEW MERGER RULES SPARK CONCERN

(U) THIS REPORT IS SENSITIVE BUT UNCLASSIFIED, AND
CONTAINS BUSINESS PROPRIETARY INFORMATION. PLEASE
PROTECT ACCORDINGLY. DO NOT SHARE OUTSIDE THE
U.S. GOVERNMENT.

REF: BEIJING 2924

1. (SBU) Summary. On August 8, the Ministry of
Commerce (MOFCOM) released new regulations governing
foreign acquisitions of domestic enterprises. Local
observers were pleased that the regulations allow for
equity swaps but are concerned with vague language that
appears to give MOFCOM considerable discretion to block
or delay deals. Despite assertions from MOFCOM
officials from the Minister on down that the new
regulations do not signal a shift in China's openness
to foreign direct investment (FDI), virtually all of
our Beijing-based U.S. business contacts believe the
regulations reflect a general rise in economic
protectionism. Furthermore, embassy contacts in
industry, investment banking and legal services all
report significant new difficulties in completing
foreign acquisitions involving a controlling stake of a
Chinese company. END SUMMARY.

Overview of New Regulations
---------------------------
2. (U) The new M&A regulations were jointly drafted and
issued by six different ministries: MOFCOM, the State-
owned Assets Supervision and Administration Commission
(SASAC), the State Administration of Taxation (SAT),
the State Administration of Industry and Commerce
(SAIC), the China Securities Regulatory Commission
(CSRC) and the State Administration of Foreign Exchange
(SAFE). These regulations serve to strengthen MOFCOM's
supervisory role, in part by requiring its approval of
deals it believes impact state economic security or
involve famous Chinese brands. They also thrust MOFCOM
into the role of determining if the acquisition target
has been appropriately valued. They only positive
aspect that U.S. industry sees in these regulations is
the creation of a legal framework for cashless, stock
swap-based mergers or acquisitions.

3. (SBU) The regulations went into effect on September
8 - thirty days after they were made public. MOFCOM
Department of Treaty and Law Director General Shang
Ming told EB/CBA Special Representative Mermoud in late
August that the regulations were circulated to
government offices, law firms, and companies for
comment. However, the local American Chamber of
Commerce reports that regulators did not seek comments
from American firms in a broad or meaningful way. We
are unaware of any WTO member state governments having
been afforded opportunity to comment prior to issuance
of the regulations on August 8. A major U.S.
investment bank also relayed to us that CBRC officials
had expressed concern with the way the regulations were
drafted and would look to the implementing rules
process to correct deficiencies.

Problem Areas
-------------
4. (SBU) Multiple U.S. industry contacts have
identified the following elements of the regulations as
worrisome:

A) Article 12 calls for MOFCOM's approval of any

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deal involving a "major industry", having "impact on
the state economic security" or concerning "famous
trademarks or traditional Chinese brands." This vague
language is so inclusive that industry believes it will
allow MOFCOM to prevent any deal at will.
B) Article 14 requires that MOFCOM approve the
valuation of any merger or acquisition. It is unclear
who will be able to qualify as a mandatory "relevant
asset appraisal organ." This clause could be used to
block deals by inflating asset valuation. MOFCOM
Department of Treaty and Law Director Wen Xiantao
recently told EB/CBA Special Representative Frank
Mermoud that this article was drafted because recently
a number of Chinese firms had been sold off too cheaply
and MOFCOM wanted to ensure that foreign firms paid
"the right price." Director Wen was unable to answer
questions about what qualifications and experience will
be required of the accountants who determine the
appropriate valuation, nor was he able to clarify on
what basis they would determine the value. Wen said
that these questions were too technical and suggested
that such inquiries be directed to the Ministry of
Finance.
C) Article 30 requires an "acquisition consultant"
be hired to complete a stock swap-based deal. Article
31 lays out subjective guidelines as to who will be
able to qualify as such a consultant. The guidelines
include the requirements that the acquisition
consultant have a "good reputation", no "significant"
criminal record and the "capability to conduct" the
investigation. These subjective regulations could be
used to qualify or disqualify potential acquisition
consultants at MOFCOM's whim.
D) Chapter 5 of the regulations requires MOFCOM
approval for any deal that meets specific criteria or
involves "very large market share" or "other important
factors" that affect competition. Again, this law is
so subjective as to give MOFCOM a free hand to block or
approve of any deal as it sees fit based on undefined
antimonopoly rationale. When asked about this
provision, Director General Shang Ming explained that
this provision will only be used until a broad anti-
monopoly law is passed. At that point, the anti-
monopoly law will trump the anti-monopoly provisions in
these regulations.

Anecdotal Confirmation
----------------------

5. (SBU) Although it is difficult to gather statistics
on whether completing a merger or acquisition in China
has become more challenging for foreign companies or
not, all of the anecdotal evidence suggests that it
has. A representative from JPMorgan recently told
econoff that all foreign acquisitions his firm is
working on that involve acquisition of a controlling
stake in a Chinese firm are "dead in the water,"
although deals involving minority stakes are still
going through. A representative from Caterpillar told
econoff that Caterpillar is no longer able to secure
approval to acquire Chinese companies, although
greenfield investments are still proceeding. At a
recent AmCham Board of Governors meeting all members
present agreed that they were finding it increasingly
difficult to gain regulatory approval for investment in
China. There are also a number of high profile
international deals - including Carlyle's proposed
acquisition of Xugong machinery, Citibank's attempted

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investment in Guangdong Development Bank, and French
firm SEB's proposed takeover of Zhejiang Supor cookware
- that have stalled or failed and become frequently
featured, usually negatively, in Chinese media. Many
contacts have reported that although it is increasingly
difficult to gain control of a Chinese firm, it is
still possible to secure a minority stake, especially
if the foreign firm is willing to transfer technology
as part of the deal.

6. (SBU) Contacts are divided on what the source of the
opposition to foreign investment is. However, all
agree that it is primarily directed at foreign firms
seeking control of existing Chinese companies. Some
U.S. industry representatives believe that it is
general economic protectionism, some that it is part of
a desire to develop globally recognizable Chinese
brands and some that it is a reaction to a perception
that WTO requirements have given too much to foreign
firms for too little. Regardless of the reasons behind
it, the volume of evidence suggesting that China is
becoming less welcome to foreign investment, especially
when it involves ceding control of a Chinese firm to a
foreign one, is difficult to ignore.

RANDT

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