Keeping on top of China’s ever-changing, overly complicated and often contradictory regulatory environment is a continuing challenge for foreign investors.
The drama took a turn for the better in March when the Ministry of Commerce (MofCom) delegated the approval of foreign direct investment (FDI) transactions to its local counterparts at the provincial, municipal and local levels. This surely bodes well for anyone looking to invest in the only economy likely to see substantial growth during the next 18 months.
The motivation behind this move – detailed in Circular 7 – is clear. Since the onset of the global financial crisis, FDI inflows to China have dropped dramatically – 21% year-on-year for the first four months of 2009 alone.
Domestic banks are lending more to pick up the slack, but mostly to large state-owned enterprises (SOEs), not the smaller private companies that are the principal growth drivers for China’s economy. By delegating the power of decision to local MofCom offices, Beijing hopes to streamline the FDI approval process.
Foreign investors have been looking for ways around China’s "M&A Rules" since they were released in September 2006. By requiring that all FDI transactions be centrally approved, regulators aimed to slow the torrent of speculative money entering China, stem the exodus of Chinese assets into the hands of foreign investors, and clamp down on locals who were dodging tax by moving ownership of their businesses offshore. The net effect was a roadblock for Chinese firms (and their investors) that were seeking an exit on a foreign exchange, and a suffocating bottleneck for those trying to get deals done in China.
Fast-forward to the present and Beijing is more concerned about unemployment-fueled unrest than speculative investments, which evaporated nearly overnight. Clearly something needed to be done to reinvigorate the flow of foreign capital into China. Delegating approval away from the bottleneck surely seems like a good place to start.
But the real benefit isn’t simply the redistribution of workload to a larger pool of bureaucrats – it’s the delegation of decision-making to gatekeepers who have a different agenda.
Bureaucrats in Beijing prioritize China’s macroeconomic needs and Communist ideology when making decisions. Hence their concerns about hot money and hyper growth rates, and their indignation at the flight of Chinese assets and the rise of foreign investors. For local bureaucrats, however, their upward mobility in the hierarchy often depends on the economic progress of their constituency: Attracting FDI not only boosts the economy but is often a badge of merit. Consequently, local MofCom is likely to be a gate opener rather than a gatekeeper.
This is especially true for investments in companies that must first be moved offshore in preparation for an exit on a foreign exchange.
Additional M&A regulations issued in 2007 required approval from central MofCom to set up an offshore structure. However, this approval was rarely granted, forcing investors to come up with circuitous and often prohibitively complicated methods for moving the ownership out of China. Requests to set up offshore structures will most certainly receive a warmer response when submitted to local MofCom officials.
Not so fast
But this doesn’t mean foreign investors can freely list Chinese firms on NASDAQ. Circular 7 deputes decision power only for deals involving industries that are "permitted" or "encouraged." Although the language is characteristically vague, it means that sensitive industries (natural resources, defense, and so on), are still well-guarded by central MofCom. Local officials may revel in the freedom to attract FDI to their backyard, but they know not to cross the line.
Circular 7 will undoubtedly make life much easier for those of us that make a living by investing foreign capital into Chinese companies. Ironically, there are a lot fewer of us who are active enough these days to even notice a difference.
Nonetheless, with the global markets beginning to show signs of life, and China’s economy leading the pack, foreign investors will likely be returning in droves before the year is up. And that’s precisely when we should expect Beijing to sew yet another patch to the regulatory tapestry.