A policy change in China will significantly restrict hedge funds access to corporate records. But local corporate agencies could present an alternative access route to information, at least in the short-term.
As revealed by IFLR last week, and reported by the Wall Street Journal, a new policy has been introduced over the past few months by Administrations of Industry and Commerce (AICs) in Shandong and Tianjin provinces as well as parts of Shanghai and Beijing. It prevents deal counsel from independently examining and copying the content of a companys AIC files - one of the major sources of legal materials in a due diligence process.
It remains possible, however, to search certain basic corporate information on the AIC website. But only with a proof of claim to the court or the target companys written permission, in accordance with the Regulation on Review of Company Recording Files.
Offshore hedge funds are likely to be the most severely impacted by this. As they rarely deal directly with a company before making an investment, they cannot expect permission from a target company to access their records.
Market participants in Beijing and Shanghai have advised those that cannot attain the cooperation of a target to rely on background agencies, and research organisations operating in China to source the required information for them.
Kirkland & Ellis Shanghai-based corporate partner Chuan Li said AICs across China had become increasingly reluctant to grant access to the corporate financial and performance records, such as annual audit reports and equity ownership changes, typically required by hedge funds.
We used to be able to rely on local PRC lawyers to help us obtain such information, but recently even local law firms have been refused access by AICs to anything beyond a copy of a companys business licence, he said.
Chinese authorities have yet to formally announce the policy change, however. And that presents a loophole for hedge funds that do not have buy-in from a target company.
One Beijing-based law firm partner said until the policy was clarified by way of a national directive, investors could still legally mandate so-called corporate agents to source the required data on their behalf.
Such agents are locally-operating service providers specialised in approaching AICs on behalf of local and foreign parties, normally for a fee up to $1000. Although as Fredrik, at the China Finance Blog has subsequently warned, this could increase as restricted access drives up the price of reliable Chinese due diligence.
Nonetheless, the Beijing partner said as the sole remit of such agents is dealing with AICs, agents usually have strong longstanding relationships with the relevant bureaucrats in these agencies, and might still be able to access data others cannot.
Law firms operating in China could usually make the necessary referrals to reputable agents, he said.
But he warned the efficiency of the strategy would vary considerably depending on the AIC involved, and that as soon as the policy was formalised at a national level the workaround would no longer be legally viable.
Weil Gotshal & Manges Shanghai counsel Helen Jiang said certain types of investigation firms could prove an alternative option, where PRC lawyers or corporate agents were unable to access information.
Ben Rowse, the Asia head of investigative firm Nardello & Co, said investigators on the ground in China were not just limited to AIC records and other forms of public records.
Good investigators would have established networks of trusted and informed sources who they can reach out to for their expertise and knowledge, he said. A New York-based hedge fund is unlikely to have such a network.
In authoritarian countries such as China where information access restrictions apply, obtaining human intelligence through discreet enquiries with well-placed sources is often critical to understanding the full picture and identifying potential pitfalls and issues of concern, he said.
It has been reported the move aims to better regulate the use of company information. Previously domestic lawyers, the police and Chinas national security bureau, among others, could undertake company AIC searches. But some smaller firms and sole practitioners had begun misusing this privilege by passing information along to unauthorised foreign and local parties for a fee.
Sources in Beijing believe it is more likely to be a reaction to repeated challenges from research firm Muddy Waters, to publicly-reported ChinaCo financial results, however.
There is speculation too that the move was prompted by a recent probe into commercial information provider Dun & Bradstreet, amid allegations it violated Chinas consumer-privacy laws. And that its a knee-jerk reaction to a series of recent high profile and highly embarrassing public relations disasters involving Bo Xilai, Sino Forest and all the other Muddy Waters-inspired exposes of fraudulent overseas-listed Chinese companies.
Certainly, while the information restrictions are not insurmountable from a due diligence perspective, they send a rather disturbing message to investors about the state of the playing field in China.
Less transparency will erode investors' confidence in Chinaco disclosure. And as Business Insider's Stan Abrams has since pointed out that could be bad for joint ventures, license agreements, and even supply/manufacturing deals.
According to Jiang, PRC lawyers are trying to find some solutions. Shanghai Bureau of Justice has already had several rounds of discussion with Shanghais AIC, she said. She was hopeful they would work out something this or next month. No improvement has been made in Beijing so far, however.