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FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC IMMEDIATE 9637
INFO RUEHOO/CHINA POSTS COLLECTIVE

C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 003363 
 
SIPDIS 
 
STATE PASS USTR 
EEB FOR OIA 
 
E.O. 12958: DECL: 08/29/2018 
TAGS: CM ENIV ETRD INRA
SUBJECT: CHINA'S INVESTMENT SECURITY REVIEW SYSTEM 
 
Classified By: ECON MINISTER-COUNSELOR, ROBERT LUKE, REASON 1.5(B) 
 
¶1. (C) SUMMARY AND COMMENT: Recent publication of ministerial 
organizational plans reaffirms China's intent to establish a 
formal interagency national security review mechanism for 
foreign investments in China, with the Ministry of Commerce 
(MOFCOM) and the National Development and Reform Commission 
(NDRC) as key players in the review process.  China's new 
Anti-Monopoly Law, which was recently implemented, calls for 
establishment of a formal review mechanism, although 2006 
revisions to the M&A regulations had already established 
similar requirements, specifically to review the "national 
economic security" implications of foreign transactions. 
While national security considerations have apparently played 
an informal role in a relatively small number of investments 
to date, China has been moving deliberately for several years 
to make its national security review of investments more 
deliberate and formal.  Specific details on how the more 
formal interagency review would be conducted and which 
agencies will perform what roles remain unclear.  Also 
unclear is how China defines "national security" and 
"national economic security," the two key terms used in the 
relevant sections of recently published ministerial 
organizational plans and other regulations.  END SUMMARY. 
 
--------------------------------------------- ------- 
Ministerial Organizational Plans -- San Ding Fang An 
--------------------------------------------- ------- 
¶2. (C) A recent Wall Street Journal article discussed the 
issue of implementation of a national security review 
mechanism for foreign investment in China.  This was one of 
the provisions of China's Anti-Monopoly Law that recently 
took effect, and as such, we expect such a procedure will be 
put in place in relatively short order.  The WSJ article 
referred to organizational plans published recently stating 
that China will establish a "joint ministerial meeting" to 
investigate concerns arising from foreign companies 
investments in China.  The organizational plans referred to 
are ministerial blueprints for personnel and substantive 
responsibilities known as the "San Ding Fang An" which have 
been released for most Ministries including MOFCOM and NDRC. 
 Embassy has translated the relevant portions of these 
blueprints at the end of this message.  Identical language 
regarding the national security review is contained in both 
plans (below). 
 
¶3. (C) The entire investment review process in China has been 
in flux for several years, and it is likely to be some time 
before any new procedures are fully functional and 
sufficiently clear to avoid confusion among foreign 
investors.  It is also important to note that many of the 
regulations that have been adopted recently appear to overlap 
one another and the lines of authority between bureaucratic 
players like MOFCOM and NDRC are far from clear.  What we 
know about the existing system and the evolution of the new 
review procedures has been gleaned from a variety of meetings 
with MOFCOM, NDRC and other sources over the past year or so. 
 As recently as the SED Investment Forum held in June in 
Washington, it was clear that the national security review 
process was still a work in progress, and that the 
bureaucratic lines had yet to be clearly drawn. 
 
--------------------------------------------- ---- 
Investment Catalogue Spells out the General Rules 
--------------------------------------------- ---- 
¶4. (C) The Guidance Catalogue for Foreign Investment 
Industries jointly promulgated by MOFCOM and NDRC and 
approved by the State Council sets out the three categories 
of investment by industry sector:  those forbidden, 
restricted and encouraged.  Investment in sectors not listed 
in one of these three categories is considered permitted. 
With neither the status of law or regulation, the catalogue 
is intended as indicative of how NDRC and other ministries 
would likely act in reviewing individual investment proposals 
under China's laws and regulations governing fixed asset 
investment.  Under Chinese law, all investments require some 
sort of government approval.  For foreign investments, 
depending on the size of the project, some approvals may be 
given at the local level, while others would require NDRC 
and/or central ministry approval or from the State Council. 
 
¶5. (C) One interesting question has always been whether the 
investment catalogue applies equally to green field foreign 
investment as well as cross-border M&A transactions.  One 
provision in the revised 2006 Interim Provision on the 
Takeover of Domestic Enterprises by Foreign Investors state 
this to be the case.  But when this question was posed to an 
official from the NDRC's Foreign Capital Utilization Division 
during the State-NDRC dialogue in April, that official 
replied, "for the time being, yes."  He later explained that 
 
BEIJING 00003363  002 OF 003 
 
 
this may change with implementation of the new national 
security review mechanism which was then under discussion. 
 
--------------------------------------------- --------------- 
Previous Regulations Excluded NDRC from the Decision Process 
--------------------------------------------- --------------- 
¶6. (C) Revisions to the M&A regulations for foreign 
enterprises announced jointly by MOFCOM, SASAC, CSRD, the 
State Administration of Taxation, SAIC, and SAFE in 2006 
formalize an "economic security" review procedure, which 
ministry sources tell us made explicit what has always been 
in place informally.  Under the revised 2006 revisions, 
several factors were singled out as requiring a review 
initiated by MOFCOM and conducted conjunction with other 
ministries.  These included transactions which could lead to 
foreign control of a domestic enterprise in an important 
industry or which have an impact on national economic 
security or lead to the takeover of a domestic enterprise 
which holds a famous trademark or brand.  Foreign companies 
initiating such transactions are required to apply for review 
by MOFCOM as the lead ministry in obtaining approval by 
foreign firms involved for M&A transactions involving Chinese 
companies.  Sources at NDRC told us MOFCOM passes specific 
transactions to the relevant ministries for review.  In some 
cases, MOFCOM itself would conduct the review (for example, 
retail and distribution investments), while financial 
transactions would go to the People's Bank and the relevant 
financial regulators, and industrial projects would go to 
NDRC and the relevant line ministry.  This description of the 
process predated the transfer of industrial policy functions 
from NDRC to MIIT, so it is unclear whether NDRC would now 
play the same role in reviewing M&As in specific industrial 
sectors. 
 
¶7. (C) One interesting aspect of the 2006 M&A revisions, was 
that it failed to specifically give NDRC a role in the review 
process.  At the June Investment Forum, NDRC Vice Chairman 
Zhang Xiaoqiang clarified NDRC's role in the process by 
noting that any M&A that could potentially lead to an 
additional investment in the acquired company or a change or 
expansion of business activities would be considered to 
require NDRC approval under China's investment law.  Since it 
is unlikely that any foreign M&A would not fall in this 
category, all significant foreign M&As would continue to 
require a review by NDRC.  Specific language to this effect 
has in fact been added to both Ministry's San Din Fang An 
plans (see below). 
 
--------------------------------------------- --------- 
Economic Security and the Carlyle and Blackstone Cases 
--------------------------------------------- --------- 
¶8. (C) To date, we have yet to hear anyone define what is 
meant by "economic security," although there has been plenty 
of debate over the term even in public fora.  One recent M&A 
conference attended by Econ M/C featured a speaker from a 
prominent MOFCOM-affiliated institute who expressed concern 
about the impact of economic security reviews on investment 
flows and called for a broad definition of economic security 
to include ensuring the stability of international investment 
flows.  MOFCOM speakers at the same event, including Treaties 
and Law Director General Shang Ming, shed no light on how 
they interpreted the term.  According to Wang Zhile, director 
of MOFCOM's Research Center on Transnational Corporations 
(CAITEC), there have been only a handful of reviews conducted 
of foreign M&A transactions.  One he cited was Carlyle's 
attempted purchase of Chinese heavy equipment maker Xugong. 
According to Wang, in this case, the original analysis of the 
effect of the transaction on Chinese industry was conducted 
by the industry association itself and was heavily influenced 
by the views of potential competitors of Xugong.  MOFCOM then 
asked its own anti-dumping specialists to conduct an injury 
analysis on the proposed transaction and they concluded the 
domestic industry would not be hurt by the acquisition. 
However, despite repeated revisions of the terms of the 
acquisition ending with a proposal for less than a 
controlling stake, Carlyle's bid was never approved by the 
State Council.  It was held up over various concerns, 
including at NDRC which had expressed reservations about 
provisions for technology transfer. Ultimately the deal 
collapsed when Xugong  itself apparently lost interest in 
being acquired.  Although sources have told Embassy that NDRC 
eventually agreed to approve the deal, no such decision was 
actually announced.  A second case cited as having undergone 
a review is Blackstone's acquisition of a less than 
controlling stake in SOE chemical maker China National 
Bluestar.  We have no information regarding this review, 
except to note that Bluestar had itself earlier been the 
subject of a possible CFIUS review for its proposed 
acquisition of a high temperature boiler maker Harper 
Furnace, a proposal that was later dropped. 
 
BEIJING 00003363  003 OF 003 
 
 
 
--------------------------------------------- ------- 
National Security Review under the Anti-Monopoly Law 
--------------------------------------------- ------- 
¶9. (C) The final piece of the puzzle and the one that is the 
least understood at this point is how the national security 
review mandated in the Anti-Monopoly Law will actually be 
carried out.  Questions remain, about why this provision was 
inserted in the AML in the first place.  It was not in the 
final draft submitted by the State Council to the NPC, and 
appears to have added during the second reading in the NPC in 
August 2007.  The general consensus seems to be that the AML 
provided a convenient platform to bless such a requirement 
through legislation rather than regulation.  However, doing 
so has led to fears that this provision could be used to 
promote protectionist policies in the AML review.  As MOFCOM 
has responsibilities for conducting other reviews under the 
AML, it would also makes sense for MOFCOM to serve as the 
point of contact for foreign companies to submit information 
required for the national security review.  This appears to 
be the proposed procedure outlined in the San Ding Fang An 
plans. 
 
¶10. (C) Another interesting question is how the two concepts 
of national economic security and national security relate to 
one another.  The language in the San-ding Fang An sheds 
little light on this issue, noting only that MOFCOM will 
accept and reply to the foreign company's application for M&A 
approval.  Aspects relating to national security will be 
reviewed by an inter-ministerial committee.  Aspects relating 
to additional fixed asset investment will be regulated under 
the China's fixed asset investment law.  Major cases 
involving national security will require the convoking of an 
inter-ministerial investigation. 
 
--------------------------------------------- -------- 
Translation of the NDRC and MOFCOM "San Ding Fang An" 
--------------------------------------------- -------- 
¶11. (U) Embassy informal translation of the relevant 
provisions that appear in both the NDRC and MOFCOM 
organizational plans (San Ding Fang An): 
 
"NDRC, MOFCOM and related ministries will establish and 
inter-ministerial joint conference mechanism for security 
reviews of foreign acquisitions and mergers with domestic 
enterprises.  MOFCOM is the responsible ministry for handling 
this process, and will respond to applications that foreign 
investors file in order to acquire and merge domestic 
businesses.  For acquisition and merger applications subject 
to security review, the inter-ministerial joint conference 
will conduct a review; for applications involving incremental 
investments of fixed capital, the state rules for the 
administration of fixed capital investments will apply; if 
major matters of security concern are involved, an 
inter-ministerial joint conference will assemble to address 
relevant issues." 
 
RANDT