The negative list of Ministry of Commerce of the PRC or National development and reform commission negative list is a summary of three kinds of lists that are included in the foreign investment law of China. They are denoted as the MOFCOM negative list or the NDRC negative list. The MOFCOM negative list or NDRC negative list is the negative lists for Chinese market access because it provides the guideline to both domestic and foreign investors. In addition, the MOFCOM negative list or NDRC negative list are China foreign investment catalogs which give details to foreign investors on which industries are limited or prohibited to enter and which are encouraged.

As the table above shows, there are 34 industries have limits or prohibitions for foreign investors to enter the Chinese market. Although Shanghai Pilot-Free trade zones and other similar free trade areas have fewer restrictions, sectors that are limited to foreign investment are almost the same.

Who are the issuers?

China negative list has two names because MOFCOM negative list refers to The Ministry of Commerce of the People’s Republic of China, and NDRC negative list refers to National Development and Reform Commission of China; they are the issuers of China negative list and reserve all the rights of interpretations. Both departments are the central bodies that regulate domestic and foreign investment and business operations, according to the China negative list. Branches of Industrial and Commercial Bureau all around the country help MOFCOM and NDRC to monitor whether companies act by China negative list.

Three kinds of negative lists in China

At first, the MOFCOM negative list or NDRC negative list included only two sub-lists aiming at foreign investors. Now the MOFCOM negative list or NDRC negative list includes three kinds of negative lists in China, according to the information released on the two websites: The Ministry of Commerce of the PRC and the  National Development and Reform Commission of China, respectively are The Negative List on Market Access, The Special Administrative Measures for Access of Foreign Investment (Negative List) and The Special Administrative Measures (Negative List) for Foreign Investment Access in Shanghai Pilot-Free Trade Zones.

Among these three lists, The Negative List on Market Access aims to both domestic and foreign investors, and this list has three main enclosed documents:

1. A detailed list to demonstrate which industries are forbidden or permitted for investors to enter, what licenses do investors need to have before they operate a business in those industries;
2. The clauses of prohibitive actions, which demonstrates the prohibitive actions throughout the business operations;
3. An additional revision to the incorporated document – The Directory Catalogue of Industries Restructuring.

The remaining two lists are known as China FDI negative lists, aimed at foreign investors. The lists designate how foreign investors can operate a business in both the general Chinese administrative area and a free trade area in terms of equity requirement, management requirement, etc..

Which sectors are now at risk

The China negative list, also known as the negative industry list in China, is for investors to find out whether the industries they decide to enter is in violation with China’s policies.. Above all, the Special Administrative Measures for Access of Foreign Investment and Foreign Investment in Free Trade Zones are the prior industry references for foreign investors, and these regulations are also deemed as China FDI negative list or China foreign investment catalog. Despite China having eliminated some sectors on the lists to promote an open market, basic industries – including the power sector, transportation, telecommunication, and mining – are still prohibited or largely limited to foreign investors in general Chinese administrative area, as well as broadcasting, the legal profession, and environment-related ones. Exceptions exist for foreign investors who pour their capital into Shanghai Pilot-Free Trade Zones, with fewer prohibited or limited industries and fewer restrictions on shareholding and management level.

Although restrictions are evident, the China FDI negative list removes some limits and prohibitions in some industries, downsizing the negative industry list to some degree. The financial sector seems to benefit most in the change, especially for service industries. For example, although the shareholding remains under 51% in total for foreign investors in securities, futures and insurance companies now, these companies will have no foreign shareholding restrictions in China after 2021, according to the clauses on the Special Administrative Measures for Access of Foreign Investment and Foreign Investment in Free Trade Zones.

The automotive industry is also another potential market. Special purpose vehicle and new-energy vehicle sectors are welcomed to foreign investors in any corporate mode. Despite the foreign shareholding restrictions in China on commercial vehicle and passenger car sectors remain, China FDI negative list shows that the limits will be phased out in 2020 for commercial vehicle and in 2022 for a passenger car. Currently, Tesla, the advanced electronic car manufacturer, has been permitted to set up its car production site in Shanghai, China, without any Chinese shareholders.

However, The Negative List on Market Access, the negative list for the Chinese market access, also need to be considered as a part of negative industry list when foreign investors invest in an industry in China, and based on the content of this list, industries related to finance and internet are right now under China government’s severe scrutinization. For example, companies which are not financial institutions or do not operate economic activities cannot name themselves with words related to finance such as banking, insurance, asset management, and etc..

Consequences and developments of the negative list in China

MOFCOM negative list or NDRC negative list brings limits to foreign investors to expand their business empire in China. Except for the industries that are prohibitive to enter, the remaining sectors have limits for foreign investors on shareholding, making them consider the ways of starting their business in China market. Entry mode is one of the elements.

Partnership or Associates as a corporate entry model instead of WFOE?

The China negative list restrains the entry of foreign investors to China. In industries that have limits on shareholding or forms of enterprises, foreign investors may give up on WFOE (wholly foreign-owned enterprises) and turn to other ways of entering China’s market. China FDI negative list, the Special Administrative Measures for Access of Foreign Investment and Foreign Investment in Free Trade Zones, does provide individual instructions or recommendations like partnerships or associates as choices for foreign investors to enter certain industries. However, investors who are inclined to maintain full control of the company would try on different resorts to enter the Chinese market as well as fulfill their ownership without violating the regulations of Negative list for the Chinese market access.

One way to bypass the regulations of China negative list for investors is setting up a subsidiary in China as a Chinese corporation, and use this subsidiary – which is not limited by China FDI negative list – to invest the industries that foreign investors are not allowed to enter. Another way is to leverage the contracts signed by both investors and investees who are in prohibited industries for foreign investors to control the investee and obtain economic benefits, which is a way similar to how Chinese companies to be listed outside mainland China (e.g., Hong Kong). Other than that is is time-consuming, the breach of contracts is a potential risk.

Narrowing scopes and reducing sectors on the China FDI negative list

Fortunately, there is good news for foreign investors wanting to get access to the Chinese market directly. The Chinese government now strives to remove redundant restrictions in the negative list for Chinese market access in order to stimulate its economy, and this trend is expected to continue. Below shows the changes of negative list for the Chinese market access, and it reduces the restrictions every year.

What are unreliable entities list in China?

In early June, The Ministry of Commerce of China stated that China would issue the “Unreliable Entities List in China” to safeguard national security, public interest, and Chinese enterprises’ legal interest. Four factors are put forward as the consideration of putting any foreign individuals or enterprises on the list. The unreliable entities list is seen as a new part of the MOFCOM negative list or NDRC negative list, and as a signal that foreign capital is even harder to enter the Chinese market.

Standards and target entities of unreliable entities list in China

The unreliable entities list in China is somewhat different from existed negative list of Ministry of Commerce of the PRC or China negative list. MOFCOM negative list or NDRC negative list can be seen as the negative industry list, and it sets up the limits and prohibitions on industries and shareholdings, which are denoted in the clauses of MOFCOM negative list or NDRC negative list . However, the targets of unreliable entities list in China are more specific: instead of industries or shareholding limits and prohibitions, China would ban foreign individuals or enterprises if they don’t obey market rules, violate contracts and block, cut off supply for non-commercial reasons or severely damage the legitimate interests of Chinese companies.

Is it harder to enter the Chinese market now?

On Twitter, reactions are different for the issue of unreliable entities list in China. Some only express the desire to see the result of this incident; others oppose or satirize Chinese unreliable entities list.

When it comes to the reactions of Chinese netizens, comments are more unified and official as they support this countermeasure in response to Huawei ban.

The reactions of netizens look like the small picture of the incident of unreliable entities list in China. Most believe that the unreliable entities list in China is a response to the Huawei ban. Whether this policy will be enforced permanently and effectively depends on the following reactions and policies of the U.S. government. Considering this situation, it seems investors from the U.S. may encounter potential risks due to the changing trends of US-China trading relationships than investors from other areas.

Author: Dennis Deng

Make the new economic China Paradigm positive leverage for your business

Do not hesitate to reach out our project managers at dx@daxue-consulting.com to get all answers to your questions

This article China negative list: Is your company qualified to run a business in China? | Daxue Consulting is the first one to appear on Daxue Consulting - Market Research China.

A well-conceived merger and acquisition process (M&A process) between a Chinese buyer and a foreign target company can produce great value for all stakeholders. This is because Chinese buyers are becoming increasingly proficient and sophisticated in the M&A process, as evidenced by the high volume of international deals executed over the past three years. Forecasts show that China outbound M&A will continue apace. Therefore, foreign companies must accept it and learn to cooperate with their Chinese counterparts. This shouldn’t be a challenge however as it has been proven that merging with a Chinese company can be a win-win, with a variety of mutual benefits including tremendously improved access to the Chinese market.

Undertaking an M&A process is a serious and time-consuming operation. It requires attentive planning, pro-active teams, and the support of both legal and financial advisors to allow CEOs to smoothly understand the transaction’s dynamics. Being backed up by trusted and skilled partners is fundamental to overcome challenges (i.e. cultural mismatch, lack of negotiation skills, etc.) and produce a satisfying outcome. Daxue Consulting is experienced in solving these hitches on a marketing front and identifying other partners that can be brought in to bridge other gaps in the M&A process. By identifying the main advantages of China outbound M&A and debunking common prejudices that still affect the global perception of Chinese buyers, firms like S.J. Grand Financial has helped companies navigate the facets of a transaction with China. They provide a simplified M&A process divided into 8 main steps, developed in the following article. Although the 8 step M&A process described can be found true regardless of the industry or size of the deal, companies must be aware of the key role advisors playing the whole M&A process.

[ctt template=”2″ link=”gbd8o” via=”yes” ]“ M&A process requires attentive planning, pro-active teams, and the support of both legal and financial advisors to allow CEOs to smoothly understand the transaction’s dynamics.”[/ctt]

China outbound M&A by the numbers

In recent years, China has become a major player in overseas mergers and acquisitions due to the Government’s encouragement to invest and expand Chinese businesses abroad. Both State-Owned Enterprises and companies from the private sector have been hungry to enter new global markets by either merging with or acquiring foreign complementary enterprises.

2016 was the most dynamic year for China outbound M&A with both the number and value of deals hitting record amounts. Within the U.S. market alone, 225 deals were closed in 2016; while the year after, in 2017, 210 deals were closed to a total value of around USD 35 billion. Regarding China outbound M&A in Europe, the UK ranks first for number of deals, followed by Germany and Italy. Chinese investors spent more than USD 10 billion in the acquisition of German companies, focusing on robotics, manufacturing, machinery, and environmental technology industries. 168 Chinese groups invested in Italy by the end of 2016, attracted not only to the luxury and fashion sectors, but also manufacturing.

China outbound M&A has registered a higher and higher growing trend over history. A report published by Rhodium Group and the Mercator Institute for China Studies (MERICS) shows that Chinese FDIs in the EU totaled more than EUR 35 billion in 2016, a 77% raise from 2015.

The graph below shows this trend, marking a drastic fall after 2016.

China outbound M&A activity since 1986 has been on a steady rise.Source: IMAA, 2018.

The recent decline in global M&A process by China can be explained by the Chinese government’s strengthening of rules to prevent irrational outflows of money leaving the country. In parallel, the Trump’s Administration and some European countries have started monitoring Chinese investments more closely than before. Governments have moved towards taking a more controlling role on one side to protect their national industries, and on the other side to control renminbi fluctuations.

According to Reuters, China outbound M&A declined 41% in value and 11% in number in 2017. Singapore was the largest recipient of new investments, followed by the U.S.A. and the U.K. Forecasts for 2018 predict that M&A process by Chinese companies will pick up, due to not only the Belt and Road Initiative (BRI) but also government encouragement across a multitude of industries. Among these, it is worth noting that food safety, healthcare and services sectors are forecast to grow significantly in China.

The Regulations Behind the M&A Process in China

One of the reasons behind high China outbound M&A numbers is that the Chinese Government and the country’s regulatory framework are in favor of mergers and acquisitions, both domestically and overseas. On one hand, the P.R.C. Government provides domestic companies with the strategic imperative to boost internationalization through M&A process. The guideline has been followed not only by State-Owned Enterprises, which are undergoing a structural reform, but also by private companies, equity funds, and insurance firms. On the other hand, Chinese regulations are flexible and support companies willing to grow organically.

The approval process for Chinese investors looking for international expansion via outbound M&A has been relaxed over time. As of November 2017, Beijing issued new guidelines, targeting outbound M&A process, which will enter in force in 2018. New instructions include:

• List of sensitive and restricted areas of investment;
• Focus on national security and fair competition;
• Limitations to investments in real estate, hostelry, entertainment industries;
• Abolition of the State approval for Chinese companies investing +USD 300 million;

Given the abolition of the State approval for investors spending more than USD 300 million in one deal, it is possible to forecast that Chinese outbound M&A will once again grow considerably for the foreseeable future.

On the contrary, foreign countries’ M&A process regulations are restrictive, especially against China. After the Chinese overseas “shopping” peak in 2016, foreign authorities raised barriers. Germany, the most targeted country for China outbound M&A in 2016, rolled out new restrictions for national security. The Committee on Foreign Investment in the United States (CFIUS) reported that notices filed from 2013 to 2017 kept increasing: from 143 notices in 2015, 172 in 2016, to around 200 in 2017.

The Common Challenges of Chinese Global Acquisitions

Often, if a Chinese company is the acquiring party in an M&A process there will be a multitude of specific challenges to overcome due to different cultural backgrounds and business practices. Some differences between Chinese and Western firms in a given M&A process may include:

• The dynamic value of oral agreements in Chinese culture vs. thestatic value of written contracts in the West.
• The importance of hierarchy in Chinese culture;
• The collectivist way to express plans, strategies, and details typical of China vs. the individualist way of expressing ideas, details, strategies in the West;
• The nature of business relationships, which is personal in China and often less important in the West.

There are strategies to achieve a good level of cultural fit both during the M&A process and, especially, during the integration phase. There are also practical tools that can support these international transactions. Working hand-in-hand with advisory firms experienced with the Chinese market, for example, is often beneficial to structure a long-lasting powerful merger or acquisition in China.

Although obstacles can be daunting, the M&A process is a widely accepted strategy for growth. Chinese investors are becoming more and more proactive and diligent in their dealmaking.

Debunking myths about China M&A

As forecasts predict the involvement of Chinese companies in worldwide cross-border ventures will continue to be strong, foreign companies should be aware of benefits successful China outbound M&A could bring them. Even today, it is still a common misperception that Chinese companies simply go abroad to steal IP and limit local company’s abilityto tap into China and other Asian markets. Management of potential target enterprises may be prejudiced against cash-rich Chinese buyers during the M&A process.

Nevertheless, when analyzing recent cross-border transactions by Chinese companies, results in terms of revenues, production chain’s level of safety, and market share growth may surprise readers.

The table below shows four successful M&A processes conducting by a Chinese buyer and a non-Chinese counterpart.

Not every transaction can reach a satisfactory conclusion. Examples of China outbound M&As that failed to deliver the expected results and intended value are many. Cultural mismatch, inability to get control of operations, falsified finances, and many other situations can turn a once promising deal into an unfortunate failure. This is why the role of M&A advisors is so important: to guide the M&A process as smoothly as possible.

Although failures can happen, taking a risk to increase revenues and enter new markets through M&A could make or break your company.

But you should ask, why would a Western company enter an M&A process with specifically a Chinese company? SJ Grand examined four benefits sellers may find when merging with a Chinese firm. These four advantages should outweigh some of the common prejudices that still influence global recognition over Chinese entrepreneurs.

The Benefits of Acquisition by a Chinese Firm

Access to the Chinese market

Probably the main advantage of merging with a Chinese counterpart is gaining access to the second biggest market in the world. With a middle class of over 420 million people and an ever-raising per capita income (around USD30.000 per year in Shanghai, Beijing, and Tianjin), China represents a fruitful market, especially for companies in specific B2C sectors (such as cosmetics, healthcare, food&beverage, luxury, etc.). Considering as well that China boasts 112,000 km of railways (of which 16,000 are for high speed trains), 7 of the 10 world’s busiest ports, and 218 major civilian airports (as of 2016), the scale of business opportunity for B2B companies is also considerable. Moreover, China’s outbound M&A process has focused on strategic sectors driven by the frameworks outlines by the government in Beijing.

The most targeted sectors for M&A process in China for the period 2014-today have been the following:

• Raw materials and energy;
• Robotics, advanced manufacturing, industrial automation;
• Advanced technology and Internet of Things (IoT).

As China is transforming its economy from being the world’s cheapest factory to one driven by technology, industrial know-how, and internal consumption, the strategic priorities of buyers within China are evolving in a similar ambitious direction.

Retention of Company Control

In most cases, Chinese buyers do not seek to immediately change the target company’s ownership. Even after buying a majority stake, Chinese investors will most likely let the target company’s teams manage and control day-to-day operations. Typically, Chinese buyers have strong interest in retaining local managements. They recognize that local staff are more familiar with the non-Chinese market dynamics business. Also, they positively value the intellectual property a business has developed over years and they prioritize maintaining internal knowledge by retaining talent.

[ctt template=”2″ link=”gbd8o” via=”yes” ]“Even after buying a majority stake, Chinese investors will most likely let the target company’s teams manage and control day-to-day operations. ”[/ctt]

Access to Funds

A big advantage of merging with China is access to funds. Many European companies struggle due to a lack of cashflow. They run on debt, and they strive to invest in new areas to upgrade. Chinese investment represents an attractive option to solve this problem.

However, frequently the origin of Chinese money is not 100% clear. Money could come from Government organizations and investment vehicles, less known private equity funds and other bodies interested in an M&A process. Escrow funding represents a solution to avoid uncertainty and make sure the deal amount as agreed upon will be received, often with the aid of expert attorneys.

Growth Potential

Being acquired by a Chinese company after an M&A process means access to the Chinese market. Consequently, the target company can gain local market share by increasing its consumer base, thus, expanding its global market share. Becoming part of a big corporation can lead to the target company reducing costs by achieving economies of scale. Competition can be disrupted by combining resources, allowing knowledge to flow, and eliminating threats. Navigating successful cross-border M&A processes becomes a competitive advantage for both the buyer and the seller.

What the Chinese Investor Looks for in a Target Company

Merging with a Chinese buyer could result in gaining competitive advantage. Underlining behaviors, trends, and preferences that are recently characterizing a China cross-border M&A process can allow target companies to prepare themselves for a potential acquisition.

Because they are acquiring more and more experience, Chinese investors are becoming thoughtful, diligent and sophisticated. They carefully choose the company to buy based on stringent valuations before the M&A process. This includes due diligence over the target company’s operations, financials, and staff amongst other facets.

Buyers prefer to approach sellers with positive balance sheets, positive EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), eye-catching product ranges and innovative processes or technologies. Normally, if a potential seller does not stand out of the crowd, Chinese buyers will not spend time in assessing its value during the M&A process. Chinese investors should be considered as legitimate and rational interlocutors.

The M&A Process between a Chinese Buyer and a Foreign Seller

Even if target companies are intimidated by a variety of aspects during the M&A process with a Chinese firm, including cultural mismatch and negotiation setbacks, the cross-border M&A process can be made easier through a standardized approach divided into 8 main steps. These 8 stages include the commitment of a selected advisor and a trusted lawyer. Furthermore, with China involved in the transaction, the importance of both valuation and integration phases must be stressed in the M&A process.

The 8 main steps of the M&A process described below are a simplification. Carrying out a comprehensive M&A process from A to Z requires time, strategy, negotiation and strong technical skills.

M&A Process Main Steps:

The M&A process between a Chinese acquiring company and an overseas entity (target company, target, or the seller) could begin with the hand out of a teaser. A teaser is a short presentation used to solicit the buyer’s (or buyers) interest. Normally, the teaser is prepared by an advisor. Initial steps of a merger and acquisition can either involve:

• one seller/one buyer; or
• one seller/multiple potential buyers.

When there are only two entities involved in the transaction, a first contact can be established after the teaser’s valuation. When the first contact between parties is made, it is of vital importance to sign a Non-Disclosure Agreement (NDA). This document will prevent the possibility to share confidential information with third non-authorized parties. By being authorized to collect data about the target company, the buyer starts picturing the deal’s value. It can initiate visualizing the seller’s positive and negative sides.

At this point, the draft and consequent signature of a Letter of Intent (LOI) is key to communicate the will to proceed with the transaction. Typically, a LOI includes both binding and non-binding provisions. The LOI states the buyer’s interest and gives the seller an idea about the purchasing offer, payment system, and non-competition obligations.

Once both parties agreed and signed the LOI, the Chinese buyer and its advisors can start preparing the Due Diligence phase of the M&A process. This phase is of particular importance as it lets the buyer investigate the seller, acquiring all the necessary information to prepare an offer. More precisely, the information that the buyer should obtain mainly belong to the following areas:

• Financial Department;
• Management and business strategy;
• Operations and supply chain;
• Legal Department;
• Human Resources Department and staff.

Due diligence is a structured process. One should consider as many details as possible to acquire information, reduce uncertainties and prevent unpleasant surprises in the M&A process. The due diligence’s ultimate product is the due diligence report, which summarizes what has been investigated and collects findings.

If the Chinese buyer is satisfied with the due diligence report, it can produce the Sales and Purchase Agreement (SPA). This last document is the definitive acquisition agreement and it can take various forms, depending on the type of transaction itself.

The SPA should contain all the details regarding the transaction, intellectual property rights, warranty, compliance with laws, provisions on the accuracy of financial statements. In addition, it must include the purchase and payment terms, post-closing adjustments, conditions to the closing of the transaction, termination rights (i.e. it can happen that the buyer finds out that the seller did not meet some conditions during the transaction), clauses to protect the seller after the deal’s closure, etc. A Sales and Purchase Agreement should include as many details as possible to protect both parties and should be carefully drafted by a trusted lawyer.

As said, these 8 steps aim simplifying the understanding of any M&A process, which can actually take up to 12 months to be completed. Finding the appropriate price and terms of acquisition is a fine art that involves technical and persuasion skills. The seller must be protected to avoid any potential harm; it must be sure about the transaction price, payment terms, and conditions.

When the transaction process reaches its end, a very delicate phase of the M&A process begins. The integration stage, or post-acquisition, sets out how the new merged or acquired company will work. This is perhaps the most difficult part of the process: teams must be integrated, a common strategy must be pointed out, rules and routines must be defined, and so on. A successful and time-saving solution is to start the integration process when the deal is officially announced. Identify priorities and make important decisions, those that can be immediately addressed, when the transaction is taking place to avoid being lost afterwards.

In any case, it is important for interested parties to take their time, choose their integration team leaders wisely, and commit to one corporate culture.

Looking Forward on the M&A Process in China

As we acknowledge the importance of China in the global M&A landscape, companies should prepare to benefit from the attractive set of values described above. They should get ready to capture the advantages garnered by a transaction with a Chinese counterpart. But they must act with judgment, rationality, and tact. Chinese buyers are growing in experience, sophistication and resourcefulness. Winners in this game will bring bespoke approaches to both the M&A process and its integration phase. Each deal must be tailored according to parties and circumstances as there is no perfect recipe to close every fruitful deal. Nevertheless, the involvement of trusted advisors, who support the M&A process, can make the difference when signing the offer and start running a new entity.

Get in touch with one of SJ Grand’s advisors to gain more insightful information about China outbound M&A and how to take advantage of the lucrative Mainland market.

This article was written by our partner S.J. Grand, see below for more information.

S.J. Grand Company Profile

S.J. Grand Financial and Tax Advisory is a tax & management consulting boutique founded in 2003 in China. S.J. Grand has been advising over 1000 international clients on their development and profitability strategies in the PRC, including BNP Paribas and Bank of the West. Believing in transparency and internal control as tools to succeed in China, the firm delivers practical solutions from accounting and taxation to restructuring and optimization, with a strong reputation in dealing with fraud prevention and risk mitigation.

S.J. Grand created OBK Labs, in which it developed its proprietary APP: a powerful workflow management system that exploits the power of artificial intelligence and data analytics in multilingual environments to boost efficiency, slash costs and root out fraud.

Founded by Stephane J. Grand, alumnus of HEC Paris (MBA), La Sorbonne  (Ph.D. in Chinese contract law) and the Fletcher School of Law and Diplomacy (MALD), the firm now counts four offices in China and one liaison-office in Paris.

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