Recently, General Office of the State Council issued the Notice of Launching the Security Review System for Acquisitions of Domestic Enterprises by Foreign Investors (“the Notice”). The Notice will come into effect on March 5, 2011.

Recently, General Office of the State Council issued the Notice of Launching the Security Review System for Acquisitions of Domestic Enterprises by Foreign Investors (“the Notice”). The Notice will come into effect on March 5, 2011.

Security review system for acquisition of domestic enterprises by foreign investors (hereinafter referred to as "Security review") is neither created by China, nor meaning to deter foreign investment. A lot of developed countries have set up M&A Security review for many years to protect their own national security related interests. China already started Security review a few years ago, but it hasn’t yet released the formal regulations until now. The Security review system covers two sectors:

i) foreign investors’ acquisition of military industrial enterprises or military industry related supporting enterprises, enterprises located near key and sensitive military facilities, and other entities relating to national defense;

ii)foreign investors’ acquisition of key domestic enterprises in areas such as agriculture, energy and resources, infrastructure, transport, technology, assembly manufacturing, etc., whereby the foreign investors might acquire the actual controlling right thereof.

Here we need to clarify the two concepts mentioned above, the “foreign investors’ acquisitions” and the “actual controlling right”.

In accordance with the Notice, “Foreign investors’ M&As” means:

i) A foreign investor’s purchase of the equity of a non-foreign-invested enterprise in China, or subscription of the capital increase of a non-foreign-invested enterprise in China, thereby transforming said enterprise into a foreign-invested enterprise;

ii) A foreign investor’s purchase of the equity held by Chinese shareholders in a foreign-invested enterprise in China, or subscription of the capital increase of a foreign-invested enterprise in China;

iii) A foreign investor establishes a foreign-invested enterprise, purchases by agreement the assets of a domestic enterprise through said foreign-invested enterprise, and operates such purchased assets, or purchases the equity of a domestic enterprise through the said foreign-invested enterprise; or

iv) A foreign investor directly purchases the assets of a domestic enterprise and uses the purchased assets to invest and establish a foreign-invested enterprise for operation of such assets.

“Actual controlling right” means:

i) Ownership of 50% or more equity interest by the foreign investor, its controlling parent company and controlled subsidiaries;

ii) Ownership of 50% or more equity interest by multiple foreign investors;

iii) Ownership of less than 50% of equity interest but having the voting right to exert major influence at shareholders’ or directors’ meetings; or

iv) A transfer of actual control, including control over business decisions, finance, human resources, technology, to foreign investor(s).

According to the Notice, the contents of Security review are:

i) Impact of the M&A transactions on the national security, including the domestic product manufacturing capacity, domestic service provision capacity, and relevant equipment and facilities needed for the national security;

ii) Impact of the M&A transactions on the stable operation of national economy;

iii) Impact of the M&A transactions on the basic living of the people; and

iv) Impact of the M&A transactions on the R&D capacity for key technologies related to the national security.

Foreign investors engaging in M & A activities in China need to pay more attention to the newly announced Notice. There is no doubt that the Notice will add complexity and uncertainty to foreign investor’s M & As in China.