Crossing the river by feeling the stones

When it comes to investments in China, the “legal” landscape is made up of not only laws, rules and regulations promulgated by the government, but of behavior of market participants as well.

In December 2008, the Ministry of Commerce (MOFCOM) reissued its foreign investment catalogue – in part to revise equity ownership limits for foreign investments in China. In 2009, MOFCOM did not promulgate more rules to further relax approval requirements for foreign investments; neither did the State Administration of Foreign Exchange issue new rules to relax foreign exchange control in a blanket fashion. However, it would be a mistake to believe there was no change last year to the legal landscape for making investments in China.

First, it was believed that in an effort to sustain economic growth through ample supply of liquidity, individual local or provincial regulators were more cooperative when they reviewed foreign investment applications, leading to a de facto relaxation of investment atmosphere for foreign investors.

Second, international investors are increasingly doing deals with companies listed in Hong Kong, London and other markets, but with underlying Chinese assets. As an example, some funds managed to capitalise on the depressed capital markets in early 2009: TPG Capital invested $81 million into Daphne International; Bain Capital invested at least $233 million into Gome Electrical Applicances; and TPG and Hony Capital invested $213 million into Wumart Stores. All these 2009 deals were more driven by Hong Kong Stock Exchange listing rules and Hong Kong Securities & Futures Commission regulations than MOFCOM foreign investment rules. Savvy international investors, for their “Chinese” investments, are building their knowledge of the listing rules and securities laws of different markets outside China.?
Third, many global fund managers are seeking to establish Renminbi (RMB) funds in the hope that such funds would, in the not so distant future, attain “domestic” status when investing so that approvals will no longer be needed (and therefore leveling the playing field with indigenous RMB funds). In December 2009, the State Council issued the Administrative Measures for the Establishment of Partnership Enterprises by Foreign Entities or Individuals in China (Decree No. 567); then in January 2010, the State Administration for Industry and Commerce (SAIC) issued the Administrative Measures for Registration of Foreign-Invested Partnerships (Decree No. 47). These decrees initially raised the hope among foreign fund managers that they could start forming foreign-invested RMB funds in the form of Chinese partnerships.

However, Article 14 of Decree No. 567 made clear that the government will be issuing further rules to regulate partnerships whose principal business is “investment” (i.e., funds) and the market soon learned that SAIC offices would not register foreign-invested partnerships that are funds. These hurdles have not diminished the interest of global private equity players in establishing their own RMB fund vehicles (whether as purely domestic funds managed by foreign fund managers, foreign-invested venture capital enterprises, or synthetic structures with both foreign and domestic investors) – Blackstone, Carlyle, CLSA, Far Eastern and Prax Capital all recently announced formation of new RMB funds. In the meantime, the market eagerly awaits further rules to either regulate foreign-invested RMB funds or establish qualifications for foreign limited partners who wish to invest in RMB funds.

Fourth, as the RMB continues to strengthen and the A-share market continues to develop, more and more international investors are open to investing directly into Chinese companies under Chinese law (which has become a strong trend after the promulgation of Provisions of Foreign Investors’ Acquisitions of Domestic Enterprises, commonly known as Circular No. 10, in August 2006), instead of investing in offshore companies under a red-chip structure.  The complications, delays and uncertainties of investing onshore, however, feed the interest in becoming “domestic” investors by establishing RMB funds.

Finally, various major global players are beginning to focus on Chinese companies that have global ambitions so that, in addition to plain capital, they can bring other value, such as industry expertise, global network of customers or suppliers, or even foreign acquisition experience, to bear. This investment strategy would involve not only Chinese law related to foreign investments into China, but perhaps laws related to outbound investments (such as the Measures on Administration of Outbound Investment promulgated by MOFCOM in March 2009), and laws in other jurisdictions in which the Chinese corporate wishes to do business or makes acquisitions as well – making the legal landscape for “investing in China” even more complex.