Janet Hui
JunHe, Beijing
xrr@junhe.com

Selina Li
JunHe, Beijing
lishj@junhe.com

Introduction

With increasing global geo-political tension, many major economies have established or amended their security review regimes to strengthen foreign investment national security review (NSR) enforcement, and China is no exception.

In 2020 China promulgated the Foreign Investment Law and the national security review system is one of the key regulations for foreign investment. Following this, in 2021 the National Development and Reform Commission of the PRC (NDRC) and the Ministry of Commerce of the PRC (MOFCOM) further promulgated the Foreign Investment Security Review Measures (‘the 2021 NSR Measures’), which launched the regulatory system for the national security review of foreign investment.

Now, with the shortening of the number of items on the negative list for foreign investment in China, and given the continuing tension between countries, national security reviews for foreign investment plays an increasingly important regulatory role in China’s foreign investment landscape. It is an essential consideration that cannot be overlooked by cross-border investors during the foreign investment process.

This article focuses on some of the frequently asked questions regarding NSR for foreign investment in China. It aims to assist prospective cross-border investors and other potential foreign investment stakeholders to better understand the national security review regime in China.

Frequently asked questions

1. How is foreign investment defined in national security reviews？

The concept of ‘foreign investment’ is very broad and theoretically captures all types of foreign investment in China, including greenfield investment, foreign investment acquisition, variable interest entity (VIE) structures, nominee holdings and others.

It should be noted that, prior to the release of the 2021 NSR Measures, greenfield investments outside the Shanghai free trade zone were not included within the scope of NSR. However, with the 2021 NSR Measures, greenfield investments have now been brought into the national security review regime.

Foreign indirect investments have also been included as foreign investment that will trigger a national security review. As a result, even in cases of foreign-to-foreign transactions, if the target involves China entities, foreign investors should take PRC national security reviews into consideration.

2. What kind of transactions trigger national security review filing requirements?

According to the 2021 NSR Measures, foreign investment is subject to an NSR if it falls into any of the following categories:

• Category one: investments in the military, national defence or related industries, and investments in the surrounding areas of military facilities and military-industrial facilities.
• Category two: investments in important fields relating to national security, such as agriculture, energy and resources, critical equipment manufacturing, infrastructure, transportation services, cultural products and services, information technology, internet products and services, financial services and key technologies. Additionally, if the actual controlling right of the target will be vested in foreign investors.

In summary, there are two categories of foreign investments that may trigger an NSR filing requirement. The first category is military related foreign investment, including investments in military industries or assets located around military facilities. All such foreign investments fall within the scope of an NSR, regardless of the shareholding percentage of the foreign investor directly or indirectly in the invested target. The other category is related to sensitive sectors; if a foreign investor would acquire the controlling interest of a target, the transaction would fall within this.

It can be concluded that military related investment is a red line for foreign investment, therefore, when a foreign investment involves military related factors, it is advisable for investors to be very careful. Though the provisions seem quite clear, in practice, there are still some circumstances that require further assessment. For instance, if a target involves products that may be used for military purposes but are actually supplied for a non-military purpose, will this fall within the scope? Also, what is the range whereby a location would be deemed as being within the surrounding area of a military facility? There has been no official response to these questions, and they need to be assessed on a case-by-case basis. An official consultation with the NDRC may be necessary.

Though there is a list of sensitive sectors under the 2021 NSR Measures, the scope is very broad and there is a catch-all provision which extends the scope even wider. Our suggestion is that parties exercise caution and seek professional advice regarding the risk of triggering an NSR in such cases, especially in cases where the market share or influence of the target is not negligible in the relevant market. This also would effect cases involving sensitive sectors such as semiconductors, artificial intelligence, material energy, key technologies or data security.

3. Are minority investments likely to trigger a national security review of foreign investment?

Yes. As mentioned above, there are two categories of foreign investments subject to NSR, and neither of them is solely determined by the quantity of the equity acquired by foreign investors. If the foreign investment is military-related, even a minority equity stake acquired by a foreign investor will trigger NSR; if the foreign investment is within the scope of a sensitive sector, it would depend on whether the foreign investor acquires the actual controlling right of the target, and even for a minority interest, there is a risk that it may be deemed as acquiring the actual control of the target.

Specifically, the 2021 NSR Measures adopt a broad definition of ‘control’, which includes scenarios whereby foreign investors have significant influence over the invested enterprise in terms of operational decisions, personnel, finance, technology, and other aspects. This is similar or even broader than the definition of ‘control’ under the merger-control filing regime in China. According to the current regulations, if a foreign investor holds a minority equity which contains veto power over certain significant matters of the target company (ie, negative control), the foreign investor will also be considered as having acquired the actual control over the target, making such foreign investment subject to the sensitive sector category of NSR.

4. Are there specific NSR regulations targeting certain sectors?

China has not yet issued specific rules to further specify the term ‘sensitive sectors’ that may trigger NSR. However, based on our experience and observations, foreign investments in certain sensitive sectors are more likely to trigger NSR in China, for instance, sectors such as semiconductors, AI, and other industries that may involve material energy, key technology or data security.

In certain industries, separate industrial laws and regulations may stipulate that foreign investments in those industries should undergo NSR. For example, in the automotive industry, the Administrative Provisions on Investment in the Automobile Industry stipulates that significant automotive investment projects involving foreign investment should undergo security reviews. Based on our experience, the automotive sector is a key sector of focus for the reviewing authorities.

5. What is the competent authority? Are there any other departments or government authorities involved in the review?

China has established a working mechanism for the security review of foreign investments to be responsible for organising, coordinating and guiding the security review of foreign investments. The office of the working mechanism is set up under the NDRC, and led by the NDRC and the MOFCOM, undertaking the routine work of the security review of foreign investments.

Like the Committee on Foreign Investment in the United States (CFIUS), during an NSR process, NDRC may also involve other departments or seek opinions from other departments based on the specific circumstances of the foreign investment. For example, projects involving sensitive data may involve the Cyberspace Administration of China; for projects related to military matters, the opinions of the military department will also be sought. This approach allows for a comprehensive and thorough review, which can cover all relevant aspects of the national concern for a specific transaction.

6. Can pre-communication be conducted before submitting NSR filing?

There is an investor consultation mechanism before NSR filing. According to the 2021 NSR Measures, prior to the filing of a foreign investment to the NDRC, the concerned parties may consult the NDRC regarding the relevant issues.

If the concerned parties wish to obtain a definitive answer as to whether NSR is triggered, a consultation can be made with the NDRC. The NDRC requires the provision of the names of the parties and specific information regarding the project before it considers accepting a consultation meeting request and before it provides guidance or views in this regard.

The benefit of such consultation is that the parties can obtain a response from the authorities on whether NSR will be triggered before the transaction is closed, helping to avoid a blind filing. However, the consultation also has its drawbacks, and the most significant one is the uncertainty regarding the time required to receive a response. Currently, there is no regulation specifying the timeframe for a response to a NDRC consultation. Based on our experience, it may take two or three months or even longer. After the submission of a consultation, the parties usually wait for a response from the NDRC before proceeding with the closing of the transaction. Therefore, when deciding whether to proceed with a consultation with the NDRC, investors are advised to consider the timeline.

7. When should the filing be submitted?

The filing can be submitted at any time before the deal closing, and normally, since the transaction documents are part of the filing documents required, such process can only be initiated when the transaction documents are ready. In practice, there are precedents whereby the NDRC accepts a non-binding transaction document (such as a term sheet) to initiate the review process. As such, there is room to discuss with the NDRC whether a non-binding transaction document is acceptable, though the response from the NDRC may vary case by case. If such a request is accepted by the NDRC, it is very likely that the NDRC will further require the parties to supplement the definitive transaction documents in a timely manner, when such documents are ready.

8. Who is responsible for submitting the filing?

While it is typical for foreign investors to be the primary applicants for the NSR, the regulations allow either foreign investors or the relevant domestic parties to initiate the application to the NDRC before the investment is implemented.

If the transaction involves domestic parties, and where the domestic parties desire, they may also act as joint applicants with the foreign investors to submit the application. With this approach, the domestic parties can be kept simultaneously updated on the progress of the NSR.

9. How long does the review process take?

According to the 2021 NSR Measures, the NDRC shall, within 15 working days from the date of receipt of the submission, decide whether the foreign investment is subject to NSR. If the NDRC decides the foreign investment triggers NSR, it will conduct a general review of the foreign investment, which shall be completed within 30 working days from the date of the decision. If the foreign investment involves, or may involve, a national security concern, the NDRC may decide to further initiate a special review of the declared foreign investment, which shall be completed within 60 working days; in extreme cases, the review period may be further extended.

Though generally there are statutory timelines for each national security review phase, there is still uncertainty regarding the review timeline. Firstly, the calculation of the review period will only start when all the filing documents meet requirements, which may lead to uncertainty as to the starting point of the review period. Further, during the review process, the NDRC may require the concerned parties to supplement the relevant materials and/or information, and the clock will stop for the parties to prepare such supplemental materials/information. In extreme cases, there is no time limit if the transaction enters into the special review phase.

Due to these reasons, the timing to obtain NSR clearance will be determined on a case-by-case basis. For projects that do not enter into the general review (ie, at the preliminary review stage), typically it may take two or three months or even longer to get the clearance; for projects that have entered into the general review and special review process, it is difficult to say; usually it will take at least six months from the submission date. It is worth noting that the above timings to obtain NSR clearance varies, depending on the specific circumstances of the project.

10. Can the parties proceed with the transaction prior to the completion of NSR?

According to the 2021 NSR Measures, for a foreign investment that triggers an NSR filing requirement, the parties shall not implement the foreign investment before obtaining clearance from the NDRC. There is no official definition as to what constitutes an ‘implementation’; in practice, generally the closing of a transaction will be deemed as a typical interpretation of such implementation. As such, under no circumstances shall the parties close the transaction before obtaining final responses regarding NSR from the NDRC.

11. Are there any measures in place to protect the confidential information of the parties?

In certain cases, the parties involved may have concerns as to whether information may be leaked to any third party other than the authorities. Foreign investors can be reassured that Chinese laws and regulations contain provisions to protect the confidentiality of all parties’ trade secrets.

According to the Foreign Investment Law and the 2021 NSR Measures, administrative organs and personnel involved in the security review process are obligated to maintain the confidentiality of any trade secrets they become aware of regarding foreign investors and foreign-invested entities. They are strictly prohibited from disclosing or illegally providing such information to third parties. Any administrative personnel found to have disclosed trade secrets obtained during the foreign investment security review process will be subject to appropriate disciplinary measures in accordance with the law.

12. Are parties allowed to provide remedial measures? Will the competent authority suggest taking remedial measures?

This may depend on the specific situation of the case. In certain cases, the NDRC may grant conditional approval, and the parties should implement the investment in accordance with the conditions attached when implementing the investment. These conditions are essentially the remedial measures that the parties are required to take. Like the practices of the CFIUS, typical remedial measures include, but are not limited to, carving out certain sensitive assets from the transaction, and ensuring that certain facilities, equipment and data remain solely within China’s territory.

13. Is it possible to appeal against the final decision of non-approval or conditional approval?

A decision on a security review made in accordance with the law shall be final, and the parties have no right to appeal.

14. Will there be fines or other penalties for completing a transaction without submitting the filing or obtaining approval?

Although no administrative fines will be imposed if the parties have completed a transaction without the declaration of NSR, the parties may face other penalties. In the case of failure to lawfully submit a national security review (including non-declaration, providing false information, or other violations) or failure to implement the investment according to the conditions (in cases where the investment was approved with conditions), if the parties refuse to rectify the situation, the NDRC may order the parties to dispose of their equity or assets within a specific time period and take other necessary measures to restore the status quo before the investment and eliminate any impact on national security. Moreover, poor credit records may be included in the relevant national credit information system, and joint disciplinary actions may also be imposed by industrial associations, banks or such other organisations in accordance with the relevant regulations.

15. How should investors coordinate the national security review with other regulatory reviews in China, such as merger control reviews?

NSRs and other investment regulatory reviews, such as merger control filings, are independent of each other. In theory, NSR can be conducted simultaneously with other investment regulatory reviews. However, it should be noted that different cases may have different situations. There are cases where the official in charge of one Chinese regulatory approval may check the progress of the other Chinese regulatory approvals before making a final decision.

Conclusion

China is continuously strengthening its NSR enforcement for foreign investment. We note that the NDRC is becoming increasingly proactive in conducting NSR, rather than relying on voluntary declarations from investors. Based on our experience, the scope of NSR is expanding to cover a broader range of sectors and industries.

Like NSR regimes in other countries, the procedures, criteria and considerations of the NDRC during NSR are not publicly transparent.

It is crucial to assess the risks of triggering NSR in foreign investments and take appropriate measures to address these risks when they arise. Therefore, we advise foreign investors to closely monitor changes in NSR regulations and practices in China and conduct evaluations of PRC NSR when contemplating any transaction involving Chinese factors.

It should be noted that this FAQ offers a general perspective based on existing rules and practices. It does not constitute legal advice on specific issues under any context and is subject to updating as regulations and practice evolve.