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The feasibility of cross-border share swap between foreign investors and Chinese A-share listed companies under the PRC Foreign Investment Law

The New Foreign Investment Law establishes a system of pre-entry national treatment plus a negative list management for foreign investment, demonstrating China's determination to further open up and attract foreign investment. It can be expected that the regulations regarding cross-border share swap will also be further streamlined.


From 1 January 2020, with the implementation of China’s "Foreign Investment Law" and its supporting regime (collectively hereinafter referred to as the "New Foreign Investment Law"), China's opening-up to foreign investors has moved a big step forward. The New Foreign Investment Law has comprehensively established a system of pre-entry national treatment plus a negative list management for foreign investment. Except for those covered in the negative list, the admission of foreign investment no longer requires approval of or filing with the competent authorities. On 10 March 2020, the executive meeting of the State Council requested that the items of negative list against foreign investment access should be further reduced. In the context of China's deepening reforms and facilitating foreign investment policies, this article intends to analyze the feasibility of cross-border share swap between foreign investors and Chinese A-share listed companies.

 

Cross-border share swap in this article refers the subscription by a foreign investor of the newly issued shares of a domestic A-share listed company with the equities it owns in an overseas company or companies as the consideration.

 

1. Advantages of China's business environment and A-share market

 

China absorbed US $134.97 billion foreign investment in 2018, ranking second in the world. By the end of 2018, China had 961,000 foreign-invested enterprises and absorbed an aggregate of US $2.1 trillion in foreign investment. China has become one of the world's largest host countries for foreign investment. According to the World Business Environment Report 2019 published by the World Bank, China's business environment has increased significantly by 32 places from the previous year, ranking 46th among 190 economies. In the past year, China has set a new record for the number of reforms implemented to improve the business environment for SMEs(small medium enterprises), ranking among the top 10 in the world in terms of business environment improvement this year. [1]

 

Due to the Coronavirus pandemic and the impact of other factors, the three major US stock indexes have triggered four times in consecutive the Circuit Breaker in March 2020, setting a historical record. In contrast to the US stock market, the major stock exchange indexes in China, i.e. Shanghai Securities Composite Index, the Shenzhen Securities Component Index, the SME(Small and Medium Enterprise) Composite Index and the GEM(Growth Enterprise Market) Index, have appreciated by -1.75%, 9.33%, 12.09%, and 19.50% respectively, significantly outperformed other major global market indexes, and showed better stability and growth potential. Currently foreign investors only own 5.8% of the market value of the Chinese listed companies, which is much lower than South Korea's 34.7% and Japan's 29.1%.[2] In the long run, we believe the proportion of foreign-owned shares in Chinese A-share listed companies will continue to increase, and the value of the Chinese A-shares will continue to outperform other global capital markets.

 

2. Cross-border share swap is attractive for Chinese A-share listed companies

 

In the first half of 2019, the total amount of transactions disclosed by Chinese A-share listed companies involving cross-border mergers and acquisitions was approximately US $ 4.598 billion. As in the same period of 2018, half of the cross-border mergers and acquisitions of A-share listed companies involved manufacturing industries, the pharmaceutical industry and the mining industry, [3] which indicates that the cross-border deals of A-share listed companies, with focus on industrial synergy, continued to be driven by the need of industrial upgrading. A-share companies are striving to maintain their competitiveness by investing in leading foreign high-tech companies, integrating high-quality resources, and opening up overseas markets.

 

From a cost advantage point of view, compared to cash payments, cross-border share swap can significantly reduce the financing burden and capital cost of A-share listed companies, reducing tax costs, and avoid foreign exchange issues.

 

3. The implementation of the New Foreign Investment Law further reduced the domestic regulatory barriers to cross-border share swap.

 

Although China's A-share listed companies have made frequent overseas mergers and acquisitions in recent years, there have been few cases of overseas mergers and acquisitions consummated through cross-border share swap. One of the key reasons is the strict regulations in China restricting the extensive implementation of cross-border share swaps.

 

Prior to the implementation of the New Foreign Investment Law, cross-border share swap mergers and acquisitions are subject to the approvals of or filings with domestic authorities, such as the Ministry of Commerce of the PRC(hereinafter referred to as the “MOFCOM”) and China Securities Regulatory Commission. However the PRC authorities have rarely approved cross-border share swap transactions. It is mainly because stringent conditions set by the “Provisions on the Merger and Acquisition of Domestic Enterprises by Foreign Investors” and the “Administrative Measures for Strategic Investment by Foreign Investors in Listed Companies” (collectively hereinafter referred to as the “Supervision Measures”). Based on the Supervision Measures, cross-border share swap transactions need to meet the certain requirements, including, among others, the following: 1) the oversea target should be special-purpose companies or overseas listed companies, 2)a foreign investor's strategic investment in listed companies must meet a certain scale, and 3)the shareholding ratio after the first investment should not be lower than 10% of total share capital of the A-share listed company and so on.

 

However, upon our public research and available information, we noticed that in practice, the application of the “Supervision Measures” is vague and unclear. In some cross-border share swap transactions, listed companies claimed that the “Supervision Measures” is not applicable due to certain reasons and as such the shareholding ratio after the first investment of foreign investor could be lower than 10% of total share capital of the listed companies. The practice seems to be acquiesced by the authorities because no punishments have been found so far after closing of such deals. Though the practice shows feasibility to conduct cross-border share swap transactions under specific conditions with prior consultation with the authorities, there are potential risks because the “Supervision Measures” have not provided such exceptions explicitly. However, we noticed that after the implementation of the New Foreign Investment Law, MOFCOM stated clearly that the provisions of the "Supervision Measures" that conflict with the Foreign Investment Law should no longer be valid, and the "Supervision Measures" should be revised in time to meet the latest requirements of the New Foreign Investment Law[4], which shows the determination of domestic authorities to deepen implement the spirit of New Foreign Investment Law and establish a looser regime for foreign access in cross-border share swap transactions.

 

4. Conclusion

 

The New Foreign Investment Law establishes a system of pre-entry national treatment plus a negative list management for foreign investment, demonstrating China's determination to further open up and attract foreign investment. It can be expected that the regulations regarding cross-border share swap will also be further streamlined.

 

We are currently assisting a Chinese A-share listed company conducting cross-border share swap and coordinate overseas lawyers to provide full legal services, including but not limited to conducting legal due diligence, issuing legal opinion about the overseas target and its subsidiaries in different countries, drafting and finalizing the transaction agreement and other essential documents, and assisting with the application for relevant approvals. Specifically we assisted the client in communicating with the PRC authorities about the legal issues of cross-border share swap under the New Foreign Investment Law, and the project is progressing smoothly.

[1] “China has become one of the world's largest foreign investors”, https://baijiahao.baidu.com/s?id=1647831164343941004&wfr=spider&for=pc.

[2] “Global Financial Markets "Black Monday" Causes Hedge Demand to Surge, A-share Advantages Highlight”, http://www.xinhuanet.com/2020-03/11/c_1125693443.htm.

[3] “Data analysis report on cross-border overseas investment of A-share listed companies in the first half of 2019”,http://www.legalminer.com/post?id=3541.

[4]“Q&A on the website of the Ministry of Commerce, PRC”, https://gzlynew.mofcom.gov.cn/gzlynew/servlet/SearchServlet?OP=getCommentAnswer&id=08f35f7fa07044c5bb827b00c9800b09&siteid=&orderFiled=undefined


For more information, please contact:

Arthur Chen

Partner

Chen & Co. Law Firm

Tel:+86 10 5690 7858

Email:czj@chenandco.com

Joe Lu

Associate

Chen & Co. Law Firm

Tel:+86 21 2228 8402

Email:yongzhou.lu@chenandco.com


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