China’s new security review measures for speculation in ‘sensitive’ areas

China’s Measures for the Security Review of Foreign Investments (NSR Measures), jointly published by the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM), came into force on 18^th January 2021. This article by Jessica Lin,legal consultant, and Shirley Sung, director of Corporate Services at Tricor China will provide a brief introduction to the contents of the NSR Measures and how they may affect foreign direct investment.

————————————-

The NSR Measures are a refinement of the provisions for foreign investment security review in the Foreign Investment Law that came into effect in early 2020, and represent the latest developments in the People’s Republic of China’s (PRC’s) efforts to build a NSR framework for foreign investments. The NSR Measures consist of 23 articles, which are summarised below.

Review scope

Under Article 4, the Foreign Investment Security Review Working Mechanism Office (the Working Mechanism Office) must be notified if any foreign investment into certain ‘sensitive’ areas is being contemplated. The parties concerned should not proceed with the contemplated investment before they receive security review clearance from the Working Mechanism Office. The areas for which investment must be approved are divided into two categories; national defence and ‘important’ fields in national security, for example, anti-terrorism, cybersecurity, energy security or public health security.

National defence

This includes investment in the arms industry, an ancillary to the arms industry or any other field related to national defence security, as well as investment in a military industry facility or an area surrounding a military industrial installation.

Important fields

This category includes investment in areas related to national security, such as: important agricultural products; important energy and resources; critical equipment manufacturing; important infrastructure; important transportation services; important cultural products and services; important information technology and Internet products and services; important financial services, or any other important field; and which results in the foreign investor’s acquisition of actual control of the enterprise being invested in.

“Actual control” refers to cases where:

• The foreign investor and its affiliates hold 50 per cent or more of the equity interests in the enterprise.
• The foreign investor and its affiliates hold less than 50 per cent of the equity interests in the enterprise, but its/their voting rights can materially influence the decisions of the board of directors, the shareholders or the general meeting of shareholders.
• There are other factors allowing the foreign investor to have significant influence over the enterprise’s business decisions, or human resources (HR), financial and/or technology matters, among others.

Parties that are uncertain as to whether their contemplated investment requires an NSR may consult the Working Mechanism Office for clarification.

Application mechanism

A proactive application is where parties themselves initiate the application to the Working Mechanism Office for a review of any foreign investment that falls within scope of the NSR before proceeding any further.

The Working Mechanism Office also has the power to require parties to apply – a passive application. If a party concludes an investment that falls under the scope of the NSR Measures without obtaining prior approval, the Working Mechanism Office can order it to apply for approval within a specified period of grace.

Procedures and timeframe

According to the NSR Measures, once a foreign investor has notified the Working Mechanism Office of its intention to invest, the following procedures will apply:

• Preliminary review: The Working Mechanism Office will decide within 15 business days of receiving the complete notification materials whether an NSR is required.
• General review: Within 30 business days, the Working Mechanism Office will notify the relevant party/parties of either the result of the general review or its decision to proceed to a special review.
• Special review: Cases with specific national security concerns will proceed to this stage. Generally, the special review will be completed within 60 business days, but this period may be extended if required.

Review decisions and sanctions

The Working Mechanism Office may come to one of the following decisions after the NSR:

• Approval of the proposed investment, if the office is of the view that the foreign investment does not impact national security.
• Prohibiting the investment if it is of the view that the foreign investment impacts national security.
• Approval of the proposed investment with additional conditions, if the foreign investment impacts national security but this potential impact can be eliminated through fulfilment of the additional conditions by the foreign investor.

Enforcement authority

The Working Mechanism Office will be responsible for routine work concerning security reviews of foreign investments. For any violation of the NSR Measures, including any failure to notify the Working Mechanism Office of notifiable investments, submission of fraudulent materials or non-compliance with the specified additional conditions, the Working Mechanism Office may order the relevant investment to be modified or unwound within a specific timeframe. The relevant entity may also be blacklisted in the PRC’s national credit information system, which would in turn have an adverse impact on the entity’s reputation and commercial creditworthiness.

Conclusion

The NSR Measures are an important provision for security reviews of foreign investment in China, helping to achieve wider opening up, but in terms of areas requiring security review, the relevant criteria for the word ‘important’ are not specified. Therefore, many expect the authority to be more flexible during implementation and enforcement. However, foreign investors should ensure they fully understand whether the field they are investing in involves security issues before taking any action, and apply for security clearance if necessary, so as to prevent their investments from being terminated due to related issues.

With the opening up of the financial sector in recent years, large amounts of foreign investment have entered China. Unlike general investment activities, the investment of funds may involve multiple fields and levels; therefore, foreign funds should first consider the potential impact of a security review on a specific project to make the most appropriate investment decisions.

Tricor Group is the leading business expansion specialist in Asia. Tricor China team is committed to providing one-stop solutions for foreign investors to enter and operate in mainland China and for domestic companies to accelerate their growth in Asia and beyond. We specialise in entity formation, internal compliance and health check, financial planning and analysis, tax advisory and compliance, HR and payroll services, fund administration and ODI services, etc.