China’s curbs on capital outflows are being felt in the volume of outbound M&A transactions, but measures should be short term and solid investments with real business cases are still getting the green light, according to lawyers Asialaw spoke to in China.
A combination of global political uncertainty and market sentiment about the overvaluation of the renminbi have motivated Chinese investors to diversify into foreign assets. After $654 billion flowed out of China and its foreign exchange reserves declined by $320 billion in 2016, the Chinese government implemented policies that scrutinise outbound investments more closely as it tries to maintain the strength of the RMB and to stop money from leaving the country in such large amounts.
Policies to curb capital outflows
Government measures are affecting six types of outbound investment:
- Extra-large outbound investments, which include: outbound real property acquisitions or developments by state owned enterprises with an investment value of $1 billion or above; outbound investments of more than $1 billion outside the core business of a Chinese buyer; and outbound investments of $10 billion or more
- Overseas direct investments by limited partnerships
- Minority investments of 10% or less of shares in overseas listed companies
- Overseas direct investment where the size of the target is larger than the size of the Chinese buyer
- Privatisation of overseas listed companies ultimately owned by Chinese companies or individuals
- Overseas direct investment that will result in a high-debt to asset ratio and low return on equity
“The policies from the People’s Bank of China and the National Development and the State Administration for Foreign Exchange are targeting some types of outbound investment, such as acquisitions by state owned enterprises of real estate of $1 billion or more, and outbound investment of $1 billion or more by Chinese companies in a non-principal business. The targeted types will unlikely pass the scrutiny by the Chinese government,” says He Fang, partner at JunHe.
“Individuals are using outbound investments as a way to get money out,” says Libin Zhang, partner at Broad & Bright.
“Companies with limited liability partnership structures are accumulating money from individuals,” says He. “The government doesn’t want individuals to move money out because of speculation, for example, making investments that are not real outbound investments but mainly for moving money out, or Chinese investors are private equity funds and asset management companies accumulating or gathering funds through a chain of complicated money.”
Still winning approval
While certain types of outbound investments are getting extra scrutiny, investments with solid plans and not just being used as vehicles to transport money out of the country are getting approved, especially those that are in line with China’s One-Belt-One-Road initiative.
“Chinese regulators are strengthening the review of documents and are regulating through practice,” says He. “Outbound M&A is effectively slowing down with the higher scrutiny of documents to find fishy investments.”
“In the application process, those that are successful are making a good case for outbound and fit under the Belt and Road initiative with a lasting effect and good potential for return on investment,” says Zhang.
“Limited liability companies will be checked on whether they’ve been newly set up, where their money comes from for potential fraud and the capability for an outbound transaction,” says He. “For example if the company only owns RMB1 million and the outbound transaction is worth RMB1 billion, the company will have to justify it.”
“Real outbound investments with a strong business case for profitability and commercialibility are still possible,” says Zhang.
Getting around curbs
The increased scrutiny of outbound investments is having an impact on the competitiveness of Chinese buyers, especially in auctions, but the measures are likely to be temporary. “The procedures being used to scrutinise investments are slowing down the approval process, making Chinese companies less competitive in competing for targets,” says Zhang.
He says outbound investors have other ways of putting their money in deals overseas: “Projects that are in good business with money outside China and have done transactions before can use offshore funds to refinance investments.”
“Those with extra assets domestically can use funds as collateral in a Chinese bank and an overseas branch can use foreign exchange funds to make collateral based funding arrangements to finance projects,” says Zhang. “However, the foreign exchange application and approval process will be strict, and banks are acting slowly on remittances and the amount of foreign exchange will be subject to quota, so funds can’t be remitted all at once.”
“The curbs on capital outflows are likely to be temporary ad hoc measures,” says Zhang. “On the domestic front, China is creating the next wave of liberalising and drawing investors’ attention back to domestic investments such as loosening the process for IPOs.”
Despite the curbs on capital outflows, optimism is strong that outbound M&A will continue to grow. Chinese investors looking for outbound opportunities, however, will need to make sure that there is sufficient evidence of good potential return on investment and that funds are being used for real investments. Countries seeking to attract investments from China will need to take note of the capital flight measures as they may affect whether investments can be carried out to completion. Measures such as break fees may need to be included in transactions to alleviate risk. Both Chinese investors and those looking to do investment with China will have to continue to pay attention to the development of outbound investment restrictions.