Chinese Outbound Foreign Direct Investment Faces Rigorous Scrutiny

Times are changing for the global financial community. China was the largest investor in developing economies in 2010 and 2011, with total outbound foreign direct investment (OFDI) amounting to US$60 billion annually and projected to reach US$150 billion by 2015. Furthermore, Chinese leaders have now officially prioritized Chinese outbound investment over the historical priority of inbound foreign direct investment.

China’s support for OFDI, however, has a strategic basis and is highly selective. The purpose is to focus outbound investment in a manner that fosters the growth and development of strategic Chinese industries, not to generally liberalize or relax foreign investment or foreign exchange policy. Priority investments would include those that expand markets for Chinese companies, obtain critical know-how and technology, and secure resources for China’s internal growth. According to the 12th Five-Year Plan and the officially issued OFDI catalogue, priority should be given to the following industry sectors:

Energy
Energy conservation
Raw materials
Biotechnology
Agriculture
Services
High-end manufacturing
Innovative technologies

Although China has prioritized OFDI, it is moving cautiously and carefully. State-owned enterprises (SOEs) and their subsidiaries have typically served as the primary conduit for investment, and appear poised to continue to lead the campaign. However, recent comments by Chinese leaders and the Chinese media suggest there is growing support for investment abroad by smaller and medium-sized Chinese enterprises, particularly in the form of corporate acquisitions.

As such non-SOE Chinese companies pursue greater opportunities abroad, they will have to endure close regulatory scrutiny in the form of a rigorous official approval process and a demanding on-going annual review. Compared to their SOE counterparts, the formal approval process will often include an additional level of formal evaluation by the Chinese government’s Development and Reform Commission (DRC) to ensure such investments coincide with China’s broader strategic goals. Thereafter, the proposal will also be considered by the Ministry of Commerce (MOFCOM) to evaluate the competence of the investor and soundness of the investment plan.

China’s SWFs and SOEs Lead the Way
China’s sovereign wealth funds (SWF) are a driving force in the nation’s financial expansion abroad, making investments from their very large pool of foreign currency reserves. These SWFs include the China Investment Corporation (CIC) and Safe Capital, which is a division of the State Administration of Foreign Exchange (SAFE). As noted, China’s vast SOE network serves as the primary conduit of investment for CIC and Safe Capital, carefully monitored and supervised by regulatory agencies such as the State-Owned Assets Supervision and Administration Commission (SASAC). However, some smaller SOE investments may be internally driven and not likely to rise to the level of heightened regulatory scrutiny.

Compared with past efforts, what may be different in the reliance upon SOEs to carry China’s investments abroad is that the new strategy includes SOEs drawing more heavily upon the expertise and resources of foreign professionals to advise and implement investment decisions. It’s not uncommon these days to see the biggest names of the global financial and legal industries visiting China’s SOE headquarters to pitch their services and advise on the latest investment proposal. There is heightened concern with successful execution after recent high profile blunders. CNOOC’s recent acquisition of Canadian oil producer Nexen is a model example of a successfully executed investment compared with its failed efforts to acquire Unocal in 2005. The Nexen investment is closely aligned with China’s OFDI strategic objectives and is being successfully carried out with only mild controversy. China National Gold Group’s pursuit of African Barrick Gold is another current example.

Scrutiny by Multiple Chinese Agencies
For private Chinese companies wishing to invest abroad, the three Chinese government authorities of critical importance necessary to obtain OFDI approval are:

The Development and Reform Commission (DRC)
The Ministry of Commerce (MOFCOM)
The State Administration of Foreign Exchange (SAFE)

Approval by these agencies may require review at either their provincial or central government-level branches, depending upon the specifics of the proposed investment. For the highest value investments, the DRC would also need to forward the application to the Chinese central government’s State Council for review.

By contrast, China’s SOEs may pursue an abbreviated approval process that eliminates the need for approval by the DRC, provided the investment is below certain thresholds (less than US$30 million for resource exploration and exploitation investments, or when the foreign exchange involved is less than US$10 million). Since China’s SOEs are supervised and closely monitored by SASAC, government participation in investment decision-making (and tacit approval) would presumably have begun at an early stage.

In the final step of the investment approval process for private Chinese companies, SAFE would review the tentatively approved application to grant the final stamp of approval.

The term “investment” refers here to the Chinese investor’s contribution by way of currency, marketable securities, goods, intellectual property, technology, stock equity, creditor’s rights or other assets or rights, or the provision of a guaranty.

Regulatory Approval Thresholds
The monetary value of a proposed investment is a decisive factor in determining which approval is required. The investments must also be analyzed and broken down by type according to the following categories:

Resource exploration and exploitation (including for such natural resources as crude oil and gas mineral and other resources)
Projects of non-resource exploration and exploitation
Special projects

Special projects include:

Projects in countries that have not established diplomatic relations with China
Projects in countries that are subject to international sanctions
Projects in countries and regions at war or in ferment
Overseas investments involving basic telecom operations, cross-border development and utilization of water resources, large-scale land development, news media, and other special sensitive industries.

Provincial Development and Reform Commission
If a private Chinese company invests in a project of either of the two types listed below, then the project would be subject to the approval of the DRC at the Chinese provincial level.

Resource exploration and exploitation in an amount less than US$300 million
Non-resource exploration and exploitation in an amount less than US$100 million

By way of background, China has 33 provincial-level divisions, including 22 provinces, 4 municipalities, 5 autonomous regions, and 2 special administrative regions. For approval purposes, provincial-level equivalents are the governments of these divisions. The four municipalities directly under the Chinese central government are Shanghai, Beijing, Tianjin, and Chongqing.

National Development and Reform Commission
Chinese overseas investments in resource exploration and exploitation in an amount reaching US$300 million or more, or non-resource related development projects in an amount reaching US$100 million or more, would be subject to the approval of the National Development and Reform Commission (NDRC).

Regardless of the amount, so-called “special projects” must be reported to the NDRC for review and consideration after the provincial-level DRC conducts a preliminary examination, or shall be directed to the State Council after the NDRC conducts its own preliminary review.

Ministry of Commerce
Overseas investments between US$10 million and US$100 million, or that involve energy-related investments or that entail “other domestic investment,” are subject to the approval of MOFCOM at the provincial level.

Chinese outbound investments of US$100 million or more are subject to MOFCOM approval at the central government level. Likewise, investments in sensitive geopolitical locations also require MOFCOM review at the central government level and would likely receive heightened scrutiny, including investments in the following:

Where the legal jurisdiction of the investment destination has no diplomatic relations with China
Where the destination has been identified as a region of particular sensitivity by MOFCOM or the Ministry of Foreign Affairs
Where there is a complicated repatriation structure involving a special purpose entity
Where multiple jurisdictions are involved

State Administration of Foreign Exchange
SAFE reviews the outbound investment from the point of view of foreign exchange controls. If the foreign exchange amount is no more than US$10 million, then only provincial-level SAFE need approve. If the amount is above US$10 million, then SAFE at the central government level must review the investment.

Note that representatives of SAFE, the DRC, and MOFCOM have confirmed there is no floor below which approval need not be sought. However, where a Chinese individual seeks to convert and transmit funds abroad in lesser amounts such as US$50,000 or more on an annual basis, he or she may only be required to register with SAFE and in some cases may first need to obtain the pre-approval of MOFCOM. There is a general understanding that outbound monies amounting to US$50,000 or less do not need to undergo review.

Recently SAFE has taken a special interest in “round trip” investments where a Chinese person establishes and capitalizes a foreign entity that then reinvests in China. Under SAFE Circulars Numbers 19, 75, and 106, this kind of investment must be registered with SAFE and any subsequent changes of a substantial nature further recorded with SAFE.

Project Bidding
Note that any Chinese investor bidding for an overseas project must still pursue approval according to the formal procedures outlined herein. The fact that the investor may not win the bid does not excuse the enterprise from the approval requirements. Certainly if the bid exceeds US$100 million, then pre-approval would be required. However, according to officials contacted, if the project bid is under USD$100 million, then the investor may be able to proceed with bidding without having obtained pre-approval, but must remain in on-going consultation with DRC and MOFCOM officials and seek official approval after the successful completion of bidding.

Development and Reform Commission Review Process
As set forth above, for lesser investment amounts, only provincial-level DRC approval is required. For instance, if the overseas investment has the previously mentioned purpose of resource exploration and exploitation and has an investment amount of less than US$300 million, then the project may submitted directly to the provincial DRC or equivalent provincial-level government. If the investment in a non-resource related project in an amount less than US$100 million, then it may also be submitted directly to the provincial DRC or equivalent provincial-level government.

With respect to each of these submissions, the DRC or equivalent must decide to accept or reject the application within five days and shall issue the Registration Approval Form for Local Major Overseas Investment Projects. The period of such review may last 20 days or longer, depending upon the circumstances. An extended review period is possible. Before issuing the approval, the relevant government division shall register the application with the NDRC.

For those investments exceeding substantial thresholds, NDRC review and approval is absolutely required. For resource exploration and exploitation-related investments reaching US$300 million and beyond, or non-resource development related investments reaching US$100 million or more, investment applications must be submitted directly to the NDRC.

The NDRC shall, within 20 working days of its official acceptance of such investment project application documents, complete its review or submit the application to the State Council. The NDRC may in some instances extend the review for an additional 10 days beyond the normal 20 working days review. The proscribed review period would not include time granted to a consulting firm to consider the application on behalf of the NRDC or State Council.

The aforementioned “special projects,” regardless of the amount of the investment, must be forwarded to the NDRC for approval after the provincial-level DRC conducts a preliminary review. In some cases it must be passed to the State Council for review after the NDRC conducts its own preliminary review. Any investment in Taiwan, no matter the amount, must be sent to the NDRC for review and may be forwarded to the State Council for review after being preliminarily examined by the NDRC.

There are no mandatory application documents required in the course of application to the DRC. Documents to be reviewed by the DRC may include those which:

Describe the investment with supporting details
Evidence of the satisfactory completion of corporate formalities
Demonstrate the financial wherewithal of the investor
Confirm the financing commitments of participating financial institutions
Fulfill other project or investment-related documentation requests of the DRC (e.g., a framework agreement)

Throughout the DRC review process, officials will consider how closely the proposed investment corresponds to the standards identified in the officially-promulgated “Guidance Catalogue of Outward Foreign Direct Investment in Foreign Countries and Industries,” a document that details those geographic locations and industries of highest investment priority to Chinese authorities. It would likely be one of the most important guiding documents considered during the approval process.

The catalogue is highly detailed and identifies specific industries in specific countries where investment is officially prioritized. For instance, it is so specific that it lists the Syrian property industry as a preferred investment, an investment priority that may now have come under review because of the on-going civil war. The document is very similar to the “Foreign Investment Catalogue of FDI,” which categorizes priority inbound investment. Because China’s economic development and the global economy are highly dynamic, the DRC would likely consider the catalogue’s priorities in light of ongoing economic development and current issues in foreign currency exchange and international trade, among others.

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