China Merger Review: A New Gauntlet for Global M&A


Courtesy of The M&A Lawyer . Subscribe now to get timely, in-depth coverage of Mergers and Acquisitions legal news.

China's merger review regime has rapidly become an important regulatory obstacle for both China-specific and global M and A transactions as China has become first a key manufacturing base and later a major market for European and American companies. Relatively low turnover thresholds require many transactions to be filed in China, even if they are offshore with little connection to China. The increasingly long timeframe even for routine merger approvals has started to delay the closing of many cross-border deals. The review process itself includes an unpredictable mix of aggressive antitrust theories, the need for parties to disprove potential problems, and non-transparent opportunities for trade associations, government departments and third parties to voice complaints that are not limited to competition issues.

Background

The Chinese Anti-Monopoly Law (AML) came into effect three years ago, after more than a decade of consideration. Its merger control scheme supplanted an earlier interim scheme that affected only foreign acquirers and utilized market share-based reporting thresholds. The Anti-Monopoly Bureau (AMB) of the Ministry of Commerce (MOFCOM), the Chinese government ministry that also oversees foreign investment and trade, is responsible for merger review. It has promulgated several sets of implementing rules addressing both substantive review and remedies. The China reporting thresholds start at RMB 400 million in China sales, or approximately US$63 million, for each party to the transaction. Most M and A transactions as well as joint ventures (a common form of foreign investment into China) are covered. As of August 2011, MOFCOM had reviewed more than 240 merger cases. It has blocked only one transaction, Coca-Cola's proposed acquisition of Chinese juice producer Huiyuan. It also has subjected seven additional deals to conditional approval, all foreign-to-foreign transactions that primarily involved offshore entities and assets: InBev/AB; Mitsubishi/Lucite; Pfizer/Wyeth; GM/Delphi; Panasonic/Sanyo; Novartis/Alcon, and Silvinit/Uralkali. MOFCOM only makes public its decisions blocking transactions or imposing remedies. It discloses no public information about merger filings or unconditional approvals.

Despite concerns from outside observers, MOFCOM's proportion of conditional approvals and rejections to date is only around 3.3%, largely consistent with other major jurisdictions. The problem instead mainly is that an unusually high number of cases are taken into second-phase review, leading to lengthy delays in closings.

Procedure

China's merger review scheme is a mandatory pre-closing approval process. Although there is no deadline for filing a merger notification, the increasing time required for most reviews now has started to delay closings of global deals.

The MOFCOM review process has four stages. First, the parties must file a merger application and wait for MOFCOM to accept the filing as complete ("Phase 0"). Before acceptance, the clock does not start to run on the formal time periods contained in the AML. MOFCOM does not yet have a short-form application or expedited review process. It frequently issues several rounds of requests for additional information prior to formal case acceptance, so that it may take several weeks (and possibly up to several months) before a filing is accepted. It is possible to engage in pre-filing consultation with MOFCOM to learn and address some issues ahead of the formal filing attempt, but this does not appear to result in any significant overall timing benefit.

After acceptance, MOFCOM starts its initial review period ("Phase 1"). It has 30 days from filing acceptance to decide whether further investigation is required. MOFCOM normally uses this time to solicit opinions from other government agencies, trade associations, customers, suppliers and competitors. If the 30-day initial waiting period passes without notice to the parties then the transaction will be deemed as approved. Importantly, MOFCOM does not need to justify why it puts a case into second- or third-phase review.1

If a second-stage investigation is started, MOFCOM will issue a written notice to the parties without any public announcement. It then has an additional 90 days to conduct a more detailed review ("Phase 2"). In cases without substantive concerns, parties typically still can obtain clearance early within Phase 2, often in the first 30 days. High-profile cases or those raising competition or other ( e.g., industrial policy) issues sometimes take the full 90 days and even beyond.

The review period also can be extended another 60 days (a so-called "Phase 3") for cause, including changed circumstances, the provision of inaccurate information, or the parties' consent. Some more controversial or "high-profile" cases have reached this stage. Others appear to have been withdrawn at this stage to avoid ultimate rejection.

Official statistics at the end of 2010 reported that only 40% of cases went into Phase 2, but anecdotal evidence indicates a substantially higher proportion, especially for significant transactions involving foreign parties. The merger review process appears to have further slowed in 2011, so that clearance within Phase 1 now is very rare even for deals with no indication of any concern ( e.g., no overlap, low market shares, and no significant vertical relationships). These delays reportedly are due to a high caseload and a relative lack of staff resources, as well as to delays stemming from MOFCOM's practice of soliciting opinions from other governmental authorities. Altogether, the review process can require up to 180 days (30+90+60) of official review in addition to several weeks or more required for the pre-filing process. It currently takes three to four months (from the initial filing attempt) to obtain MOFCOM clearance in most transactions. Conditional approval and other difficult or high-profile cases usually take longer--in some cases nine months or more. On the other hand, a handful of cases have been handled quickly within Phase 1 even where conditions were imposed, if the parties are able to articulate and provide evidence for their exigency arguments as well as address any substantive concerns through proposed remedies.

Finally, the AML also mentions a separate national security review (NSR) process for foreign acquisitions of Chinese companies.2 Subsequent regulations have outlined an NSR system that appears very similar to the U.S. CFIUS review. In February 2011, the PRC State Council promulgated a Notice establishing the institutional and procedural mechanisms for this NSR process. It specifies that acquisitions involving covered sectors including defense, key agricultural products, key technologies, transportation, infrastructure, and key equipment manufacturing--many of which are undefined and subject to interpretation--must submit their transactions for NSR approval or take the risk that their transactions later will be overturned or undone. The review is to be conducted by a joint ministerial panel that includes MOFCOM, NDRC (the price and industrial policy regulator) and other relevant agencies, but so far no transaction is known to have been submitted for or undergone NSR review. There remains no clear indication of what sorts of transactions are likely to be rejected on what NSR grounds. However, the Chinese government takes a broad view of "national security," to include, for example, economic security, social order, and R and D capabilities relating to key technologies. This is in addition to MOFCOM's own review, which also must consider policy issues such as the effect of the transaction on national economic development and the public interest as part of the antitrust merger review process.

Substantive Review

Delays in the China merger review process also stem in part from a fairly aggressive approach to antitrust enforcement and an increasing amount of detailed follow-up on the substantive aspects of merger filings.

A clear definition of the relevant markets is required by MOFCOM for all merger filings. Extensive follow-up questions regarding demand and supply substitution have become routine if these issues are not elaborated in the initial filing. MOFCOM does not appear to welcome suggestions from parties to leave open the issue of market definition, and generally requires them to take a position on market definition whether or not any competition issue may exist.

Even where the relevant markets appear to be worldwide in scope, MOFCOM will insist upon China-specific market data that often are more difficult to obtain. MOFCOM generally focuses on the impact of a proposed merger on the local Chinese market, paying particular attention when the relevant products are viewed as important to the development of the Chinese economy. For example, in a merger between two Russian potash (fertilizer) producers, MOFCOM imposed a remedy aiming at securing the availability of supply to Chinese customers,3 rather than focusing on whether the global potash market would remain sufficiently competitive. Most of the eight published negative MOFCOM decisions have involved horizontal transactions with significant (over 40%) combined market shares. In practice, however, MOFCOM appears to begin to look closely at proposed transactions once combined market shares exceed 10%, even if the overlap (and thus incremental increase in market concentration) is minor. Higher market shares or possession of a leading position frequently are presumed to have anti-competitive effects, with parties required to provide evidence to disprove such a presumption rather than vice versa. MOFCOM also appears closely to examine any actual or potential vertical relationships, no matter how small the current dealings between the parties. Detailed information about the products involved, the value of any vertical transactions, and the market shares of the parties in the upstream and downstream markets must be provided to MOFCOM during the filing process. In the GM/Delphi decision, MOFCOM asserted that GM had a leading market position (without disclosing specific market shares) and imposed obligations, for example, to maintain a stable supply of parts to competing automobile manufacturers; to continue purchasing from competing parts suppliers; and for non-discrimination and other conditions to preclude foreclosure of customers or trading parties.

Similarly, MOFCOM frequently raises questions about complementary products and bundling effects, although what is "complementary" generally is left undefined. This appears to be the result of a broad concern about portfolio effects and the ability of large multinational companies to use their financial or other might to prevent competition in the local market by smaller domestic firms. For example, in the Coca-Cola/Huiyuan case, MOFCOM stated that, "upon completion of the concentration, Coca-Cola would be able to leverage its dominance in the carbonated soft drinks market to the juice beverage market, which would eliminate or restrict competition among existing juice beverage companies." Indeed, the AML expressly requires MOFCOM to consider effects on other undertakings as well as on consumers.

Issues apart from competition law expressly are included in the China merger review process. MOFCOM routinely solicits comments from the National Development and Reform Commission ("NDRC") and the Ministry of Industry and Information Technology ("MIIT"), two government ministries that primarily are concerned with industrial policy issues (although NDRC also is responsible for enforcement against price-related AML violations such as cartels). Opinions from these or other government authorities can delay or even derail antitrust review, and in some cases MOFCOM may suggest withdrawal and later refiling pending the resolution of such industrial policy concerns raised by other regulators. Similarly, complaints from local competitors or trade associations also can delay the review process or even prompt the imposition of restrictive conditions. MOFCOM's template of follow-up questions also includes a question asking the parties to confirm that the parties have no compliance issues with regard to other Chinese laws, including those relating to the incorporation, operation, management, and approval of foreign investment.

Due to the lack of transparency of MOFCOM's review process, and the relatively low level of detail in its published decisions, it remains unclear exactly how MOFCOM conducts its substantive review and comes to its decisions. For instance, it is very difficult to ascertain what legal principles, arguments and analytical methods (including economic data and analysis) it considers, as well as the standards of proof it requires internally for establishing or disproving the possibility of anti-competitive effects.

Strategies

Given that MOFCOM's review process now is likely to take longer than that of other jurisdictions, and may as result delay many closings, it is important for parties to anticipate and address some of these issues at the outset. In this respect, it often is evident that merging parties and their counsel simply may not be taking Chinese merger review seriously enough. For example, some merging parties treat MOFCOM review almost as an afterthought, only turning their attention to China after U.S. and European merger reviews are safely finished or at least far along. This makes it difficult to plead urgency to MOFCOM when, a few months later, the parties are waiting only for MOFCOM's approval to close the deal.

Similarly, many merging parties still believe that they can simply handle the China merger review process simply by copying and pasting filings they have made in other jurisdictions, such as the European Union. This often simply leads to more questions and delay, because MOFCOM specifically analyzes the impact of a proposed merger on the local Chinese market and insists upon detailed evaluations by the parties of competitive effects in China.

Hence, parties are strongly advised to develop China-specific data early on in the process of preparing filings for a transaction, and to be prepared and in a position to file with MOFCOM as soon as possible after closing. This will help at least to minimize the additional delays caused by the Chinese merger review process and maximize the chances for successful early clearance.

Peter Wang and Sbastien Evrard are partners and Yizhe Zhang is a senior associate in Jones Day's China Antitrust Practice. They are resident in the firm's Beijing and Shanghai offices. Contact: pjwang@jonesday.com, sjevrard@jonesday.com or yzhang@jonesday.com.

End Notes

1 Compare this to the EU Merger Regulation, under which a case only can be put into Phase II if the European Commission has serious doubts about the compatibility of the transaction with competition law.
2 For more details on the PRC National Security Review process, see http://www.jonesday.com/files/Publication/682071da-59c8-4fe2-a7f7-23ea25046b33/Presentation/PublicationAttachment/a7f545ab-bb6c-485f-8688-2540406f565e/China%20New%20National%20Security%20Review.pdf.
3 See http://www.jonesday.com/antitrust-alert--china-approves-merger-between-russian-potash-producers-but-requires-they-continue-to-supply-the-chinese-market-06-13-2011/.