New SASAC rules signal greater transparency and accountability

There has been some suggestion that there is a “crackdown” by Chinese authorities on outbound foreign direct investment (OFDI) by Chinese State-owned Enterprises.

I have seen no evidence to suggest that the new rules announced by China’s State Assets Supervision and Administration Commission (SASAC) are anything more than the legitimate and reasonable wish of the Chinese government to get greater comfort about the quality of the investment decisions to maximise the benefits of the transactions. They do not signal an end or decline in OFDI which is largely driven by a readjustment of China’s economic growth model.

The new measures come into effect from May 2012. They restrict an SoE from making any OFDI in non-core business areas except in special circumstances as approved by SASAC. The measures also provide that SoEs must report to SASAC prior to making major OFDI related to their core businesses with details of an investment plan and financing sources. If an SoE breaches the rules and suffers a major loss, SASAC has reiterated that the enterprise and related persons will be held accountable.
Despite first impressions, these new rules are no more than a step in the evolution of SASAC’s current OFDI rules. Significantly, the 2011 Interim Measures require SoEs to procure feasibility studies and due diligence for all OFDI.

In particular where:

• state-owned assets located in the PRC are used as consideration for an overseas investment, an appraisal conducted by a domestic valuation institution is required; and
• an off-shore subsidiary of an SoE is to purchase overseas assets, a professional institution of sufficient expertise and reputation must be engaged to conduct a valuation or appraisal of the transaction.

The transaction price must then be based on these appraisals.
As a package, the 2011 and 2012 measures reflect a desire to strengthen the investment processes and accountability of SoEs. Statements from Chinese officials have indicated the aim of the new rules is to prevent SoEs from blindly diversifying into high risk sectors or making speculative investments abroad.

The new measures reflect a growing sophistication of Chinese authorities in managing risks associated with OFDI. They do not signal an end or decline in OFDI. Indeed, China’s accumulative OFDI is forecast to grow by 17% between 2011-15 reaching US$560 million by 2015.
Earlier this year MOFCOM reaffirmed China’s commitment to its “Going Out Policy”, stating the Government will guide and encourage local companies to enhance cooperation and invest abroad in manufacturing, energy, culture and engineering. MOFCOM has also stated that China will promote outbound investment in service sectors including finance, architecture, tourism, education and telecommunications. This reflects a logical shift in Chinese OFDI toward commercial operations in advanced economies like Australia.

The scale of businesses operated by SoEs abroad has grown exponentially as has the range of sectors in which they are investing and the complexity of the investment transactions.
While the direct effect of the new rules cannot be measured, the rules may imply a shift in the nature of Chinese OFDI in Australia with a focus on joint ventures or minority stakes in quality proven assets. This is a trend that we have already seen emerging.

The message for Australian vendors is they must understand and appreciate a SoE’s investment criteria and structuring requirements to formulate a successful deal. SoE’s will be focused on thorough due diligence, careful structuring and negotiation of the transaction to maximise synergies and benefits. Where JVs are the chosen investment method, management of relationships between the two partners will be critical to success.

I welcome SASAC’s strengthening oversight of Chinese OFDI. Ultimately, the new measures encourage accountability and transparency, two of the key principles underpinning investment by government related entities in Australia’s Foreign Investment Policy.