China’s Export Control Law, which came into effect on December 1 2020, regulates the export of sensitive technologies from China. Our latest explainer takes a closer look at the law and what affected parties both inside and outside of the country can expect from the changes.
In-house counsel from corporates and private equity firms alike believe that Chinese regulators will use the law to intervene with M&A transactions involving technologies that are crucial to China’s national interests.
What’s the Export Control Law about?
The Export Control Law is a framework that restricts exports of military and dual-use products as well as technology for national security and public policy reasons. Chinese regulators can prohibit exports and transfers of products, technology and services based on product features or end uses. Exporters will need to seek licenses for export transactions not covered by published control lists.
What’s the purpose of creating a new law?
Before the Export Control Law was created, China’s export control rules were peppered throughout a series of laws, such as the Customs Law, Criminal Law and the Foreign Trade Law. The new rule puts it all in one place for the first time.
Chen Zhu, partner at Morrison & Foerster, said that existing export control rules involve a variety of authorities, including multiple departments within the Department of Commerce as well as the State Council and Central Military Commission.
“One aim of the Export Control Law is to consolidate and streamline various mechanisms for controlling sensitive exports and we can expect to see implementing regulations in the near future,” he said.
The Export Control Law shares similarities with the US’ economic sanctions and export controls regime as both are list-based regimes with licensing and delisting mechanisms.
“Both empower the implementing government unilaterally to restrict financial transactions, trade and visa privileges,” he said.
Jon Cowley, partner at Baker McKenzie, said that in addition to the Export Control Law, China has expanded the catalogues of technologies subject to the country’s Technology Export Regulations, which prohibit or restrict transfers of certain categories of technology and know-how.
Some of the technologies that China has restricted include aerospace bearing, unmanned aerial vehicle, and laser technology.
How does the law compare with Cfius?
When looking into new laws restricting the inflows and outflows of information and knowledge from a country, the gold standard is the United States’ Committee on Foreign Investment in the United States (Cfius). Cfius has been strengthened in recent years, which it is largely understood is to prevent the flow of technologies from the US to China.
In comparison, Peter Wittmann, partner at private equity firm ACE Equity Partners, said that China’s new law signals a more formalised way of scrutinising transactions, particularly those involving sensitive technologies and intellectual property.
“It’s applying the same thinking as we have seen from US’ Cfius, Canada’s Investment Canada Act, and similar laws in some European countries,” he said.
Compared to regulations in the US and the EU, China’s export control remains vague. This has so far proven challenging for parties involved in M&A transactions.
“It unclear what exactly is caught by the new rule but the law isn’t unexpected because many countries already have similar measures,” said Goh. “China is just late to introduce such a rule.”
Compared to Cfius, which is has been around for quite some time and is quite clearly defined, China’s Export Control Law is relatively new.
“Because of its history, it shouldn’t come as a surprise that Cfius has a much more well-established and institutionalised process,” said Wittmann.
He added: “The law should be regarded as a positive step; it is providing a framework to buyers involved in M&A transactions and formalising criteria and processes. As it’s also a direction that other countries are going, China needs to move in the same direction to be able to give reasoning on why it’s stopping transactions.”
How should parties in M&A transactions prepare?
Bo Yang, partner at Jingtian & Gongcheng, said that in addition to paying close attention to the development of China’s control lists of items and entities, buyers should conduct due diligence on target companies by doing a thorough export control risk assessment.
“It’s important to include specific provisions in transaction documents for export control to prevent potential commercial risks,” he said.
Raymond Goh, group general counsel at China Travel Service, said that sellers in M&A transactions would want to push the risk of the Export Control Law onto buyers in sale and purchase agreements to make sure that buyers can’t just walk away if the Chinese regulators stop a sale.
He said that for buyers should consider anything that can be used as a reason to stop a sale due for national security reasons.
“Technologies such as those for military use, artificial intelligence, autonomous vehicles and surveillance, that are sensitive and could be weaponized, will need to get clearance,” he said. “Businesses such as data centres and cloud computing which could be subject to foreign infiltration are also ones to watch.”
What are good tips for parties in M&A transactions to keep in mind?
For buyers, Goh said that they should be on good terms with Chinese regulators, especially if they have not dealt with them before.
“It’s important for buyers of Chinese companies to introduce themselves to Chinese regulators if they don’t have a previous relationship, in order to change that and ensure that they have no misconceptions about your organisation,” he said.
He adds that for buyers who are unfamiliar with the Chinese regulators, asking the seller to help is a good approach to take – especially if the business is a state owned entreprise.
“Chinese companies can help because they understand the maze to get to regulators,” he said.
Another tip for buyers is to consider getting a public relations firm involved before a transaction happens.
“You never know if there might be a backlash on WeChat to oppose a transaction,” said Goh. “If nothing happens, it’s good, but if something does, it’s good to have someone who can manage the process. Regulators are influenced by the public and time delay can be fatal to a transaction.”
According to Wittmann, it will remain important for transacting parties to engage with local, provincial and state level regulators in transactions to ensure multi-lateral alignment of interests.
“Any and each of the parties involved may raise issues that could become an obstacle in the deal and potentially jeopardise a transaction,” he said.
How might geopolitical tensions affect the application of the Export Control Law?
In addition to having local advisers with good connections with regulators, it’s important to be aware of the general pace and movements in the regulatory landscape – not only in China, but also internationally – so not to face any potentially reciprocal issues.
“In general, regulators are usually behind industry developments,” said Wittmann. “As such, it will become increasingly more important to remain appraised as to what industries and technologies are deemed sensitive.”
He added that many definitions of technologies are broad by design and as such, need to considered carefully before executing a transaction. This is so as not to run into potential difficulties with regulators.
For example, in the US, vicinity to military installations were criteria to exert more scrutiny by Cfius in certain real estate and wind farm transactions.
However, Wittmann said that putting something down on paper does not mean that regulators can’t stop a transaction that is not caught by the rules.
As China-US trade tensions continue to boil over, for Chinese companies that want to work with US buyers, the wise path to take for the time being may be to wait and see or to seek buyers outside the US, as there is fear that the Chinese regulators will try to stop deals.
According to a counsel at a Chinese company, the message from the company’s management is to avoid any US company in transactions.
“If you’re a US company, Chinese companies will not touch you at the moment because they will run into political risk,” he said. “Our management has told us to avoid any US firm in transactions and to avoid paper trails with these businesses.”
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