VZCZCXRO9956
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #8225/01 2412340
ZNR UUUUU ZZH
P 292340Z AUG 06
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 5491
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHOO/CHINA POSTS COLLECTIVE

UNCLAS SECTION 01 OF 02 BEIJING 018225 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EB/CBA AND EAP/CM 
STATE PASS USTR STRATFORD/WINTER/MCCARTIN 
USDOC FOR ITA/MAC/AP/MCQUEENTREASURY FOR OASIA/ISA KOEPKE 
AND DOHNER 
E.O. 12958: N/A 
TAGS: ECON EINV EFIN KIPR CH
SUBJECT: MOFCOM TO SPECIAL REPRESENTATIVE MERMOUD: MERGER 
RULES IN LINE WITH LIBERALIZATION 
 
THIS MESSAGE IS SENSITIVE BUT UNCLASSIFIED.  PLEASE HANDLE 
ACCORDINGLY.  NOT FOR DISTRIBUTION OUTSIDE USG CHANNELS. 
 
SUMMARY 
------- 
 
¶1. (SBU) China's proposed merger and acquisition (M&A) rules 
do not signal a shift in attitude towards foreign 
investment, according to the Ministry of Commerce (MOFCOM) 
Director General (DG) in charge of the drafting process, who 
met on August 28 with EB/CBA Mermoud.  The DG argued that 
China, as an economy in transition, needs to regulate and 
supervise how the assets of state-owned enterprises (SOEs) 
are valued when such assets are sold off as part of 
privatization.  END SUMMARY 
 
MEETING DETAILS 
--------------- 
 
¶2. (U) Special Representative for Commercial and Business 
Affairs Frank Mermoud met on August 28 with PRC Ministry of 
Commerce Department of Treaty and Law Director General Shang 
Ming and Deputy Director Wen Xiantao.  The central focus of 
the meeting was draft merger and acquisition (M&A) rules 
made public by the Chinese government on August 8. 
 
BACKGROUND ON THE PROPOSED M&A RULES 
------------------------------------ 
 
¶3. (U)  The Ministry of Commerce (MOFCOM), together with the 
State Administration of Foreign Exchange (SAFE), the State 
Administration for Taxation, the State Administration of 
Industry and Commerce, the China Securities and Regulatory 
Commission (CSRC), and the State Owned Assets Supervision 
and Administration Commission (SASAC), promulgated the 
"Measures on Acquisitions of Domestic Enterprises by Foreign 
Investors" to replace the "Provisional Measures on 
Acquisitions of Domestic Enterprises by Foreign Investors" 
that have been in effect since April 2003.  The draft rules, 
released on August 8, are to become effective on September 
¶8. 
 
¶4. (U) According to an analysis prepared by the law firm 
Paul Hastings, the proposed rules expand the original 26 
sections to 61 sections, and further organize the 61 
sections into six articles.  The proposed rules strengthen 
MOFCOM's supervisory role, in part by requiring its approval 
in the following areas 
 
  -- restructuring activity of Chinese businesses offshore 
 
  -- acquisitions where the acquirer would: 
     o control an enterprise in an "important industry"; 
     o control an enterprise that owns "famous trademarks" 
       or "well-known Chinese trade names"; or gain the 
       ability to affect "China's economic security". 
 
¶5. (U) The proposed rules also provide for "equity swap" and 
thus allow for the following cashless transactions: 
 
  -- corporate restructures for initial public offerings in 
     foreign exchanges; and 
 
  -- acquisitions by foreign listed companies using their 
     own shares. 
 
CONCERNS, CONFUSION, AND A NEED FOR CONSULTATION 
--------------------------------------------- --- 
 
¶6. (SBU) Mermoud observed that the draft M&A rules have 
caused concern and confusion in the foreign business 
community.  AmCham and industry representatives had 
complained to him about insufficient opportunities to 
provide input during drafting.  Mermoud emphasized the 
importance of clear and transparent regulations as well as a 
follow-up process that enables those affected by the rules 
to truly understand their meaning.  He also asked specific 
questions about various draft articles. 
 
POSITIVE SPIN... 
----------------- 
 
¶7. (SBU) DG Shang said the goal of the rules is to provide a 
new legal channel for domestic entities to strengthen 
themselves, including by listing in foreign locations. 
Shang said the draft rules are not really new but should 
 
BEIJING 00018225  002 OF 002 
 
 
instead be understood as a revision of those that came into 
effect in 2003.  The changes are being made in a context of 
continued opening and reform by the PRC.  There has been no 
change in attitude towards foreign investment, press and 
media commentaries about "unrelated" acquisition cases 
(presumably CNOOC and Lenovo) notwithstanding. 
 
... AND A CLAIMED POSITIVE RESPONSE 
----------------------------------- 
 
¶8. (SBU) Shang said the PRC reached out for comments from 
Chinese government ministries, foreign investors, and 
foreign governments.  The response from "society" to the 
draft has been positive.  He acknowledged that there had 
been some questions and confusion -- it is a long and hard 
to understand document -- but asserted that MOFCOM is 
working to improve understanding of the draft.  According to 
Shang, the PRC does not wish to place new burdens or 
restraints on investors. 
 
IN LINE WITH INTERNATIONAL PRACTICE 
----------------------------------- 
 
¶9. (SBU) Shang underscored China's focus on compliance with 
WTO commitments and desire to operate in line with 
international practice.  He acknowledged outside concerns 
about "economic security" references in the draft rules, a 
concept he asserted as also in line with the policies of 
other countries.  The reference to economic security not 
only pre-dates the recent draft revision but is also 
embedded in United States and European Union policies and 
practices.  The fundamental issue, according to Shang, is 
how the national economy operates in people's lives. 
 
VALUATION ISSUE 
--------------- 
 
¶10. (SBU) Shang, noting that China still regulates the 
movement of capital into and out of the country, said it is 
important for ministries and agencies to pay attention to 
the prices that SOE managers attract for state assets when 
they are privatizing, a process that must be supervised. 
Certified Public Accountant (CPA) firms under Ministry of 
Finance (MOF) supervision and "evaluation associations" will 
play a key a role in ensuring that prices set are in line 
with actual value.  CPA firms that cheat will be brought to 
MOF's attention.  The overall goal is to make transactions 
fair.  This process will be about credibility and good 
faith, according to Shang. 
 
OTHER AREAS OF SIGNIFICANCE 
--------------------------- 
 
¶11. (SBU) Referring to restrictions involving ownership of 
brands and trademarks, Shang said that there are many 
traditional brand names and special techniques from Chinese 
history that are to be protected, and that this is a part of 
maintaining China's heritage. 
 
¶12. (SBU) Shang said that one significant change in the new 
draft is the use of stock as payments for M&A, an approach 
that will lower the cost of funds to domestic enterprises. 
In Shang's view, it is domestic entities rather than foreign 
investors that will be most affected by the changes, 
especially those entities that move funds offshore into 
"special purpose vehicles" and then invest those funds back 
into China  (Note: "round-tripping," a practice often 
motivated by tax and other legal considerations.  End Note). 
 
COMMENT PERIOD 
-------------- 
 
¶13. (SBU) Responding to suggestions from Mermoud, Shang said 
it is not possible to extend the commentary period for the 
rules (Note: The rules become effective September 8. End 
Note.) because six ministries were involved in setting up 
the timetable.  Shang did however agree to Mermoud's request 
that he accept a list of questions from the Embassy in order 
to provide further clarification about the draft rules in 
advance of their coming into force. 
 
SEDNEY