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Dealing with the Chinese Investment Wave
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Dealing with the Chinese Investment Wave: Overhauling the Western Response

Integrity initiative Op-Ed

The Western, and particularly the EU, regulatory machine is unfit for purpose when it comes to dealing with China and other non-OECD Investors.

Introduction: An Inward Investment Regime Fit Only for ‘Friends’

This paper argues that the West and in particular the European Union is facing a major regulatory crisis, as the ‘emerged markets’--first China, later India, and subsequently other emerged or emerging states--economically advance to the point that they are able to invest substantially in the West. Particularly since the onset of the financial crisis in 2008, an ever-increasing flood of emerging market investment, particularly from China, has made its way into Western states. Last year was the first year that China invested more in the United States than US companies invested in China.1 The EU also saw notable Chinese investments in 2015 including Chemchina’s acquisition of Italian Pirelli, the final part of the acquisition of British Weetabix by Bright Foods and the Portuguese Banco Espirito Santo de Investimento by Haitong Securities. Already announced Chinese cross border deals in the first quarter of 2016 are valued at $100 billion, greater than those for the whole of 2015.2 Of the two most notable deals one is in the US, the proposed acquisition of the Chicago Stock Exchange by Chongqing Casin Enterprise Group, and the other in Europe, the acquisition of Swiss Syngenta by Chemchina. The latter will be the largest Chinese investment ever made in the West to date, valued at $43 billion.

In principle the Western liberal open market democracies are happy to receive inward investment from third states. However, there are a range of issues that both Europeans and Americans need to consider. First, the lack of reciprocity in emerged markets where, in China, for example, it can be extremely difficult if not impossible to acquire major Chinese corporates, particularly companies which have valuable technology or intellectual property rights. Second, the state control and surveillance of Chinese companies and the potential implications for Western states’ national security if companies are acquired by Chinese state-influenced or controlled corporations. A third concern is that, following the acquisition of a Western firm, there is the risk of Chinese domestic market access restrictions being imposed on rival Western firms which compete with the acquired business.

Some non-EU states3 have foreign investment review requirements. Perhaps the best-known of these is the Committee on Foreign Investments (CFIUS) regime in the US, which although opaque, does provide some means to consider the potential national security and national interest implications of proposed transactions4 Both Americans and Europeans recognise immediately the potential influence opportunities as well as security risks that the acquisition of major commercial assets by Russian companies could provide.5 For example, the EU’s 2009 Gas Directive has built-in protections (drafted with Gazprom in mind) so that when a non-EU entity wishes to acquire control of a gas transmission system or a gas transmission operator, a review has to be carried out to assess whether that acquisition might “put at risk the security of energy supply” of the Member State and the European Union6. Yet so far there has been no similar recognition in relation to Chinese acquisitions despite the scale of state surveillance, control and leverage over corporate China in the hands of the Chinese Communist Party, and the scale of investment, which dwarfs Russian investment into EU Member States and the United States7.

This paper argues for an overhaul of Western regulatory law and policy in respect of inward investment. It was one thing to have a lightweight investment regime when inward investment was largely a matter of investment from friends within the OECD states who share concepts of the rule of law, democracy, independent and autonomous state institutions and independently-held commercially focussed companies. When inward investment begins to flow from states that do not share such values we have to overhaul our regulatory policies and legislation to deal with this new challenge.

The Chinese and Emerging Market Investment Problem

From the end of the Second World War foreign investment was largely a transfer of capital amongst friends, allies and supporters in developed and developing countries. In 1945, what became the free world was largely shattered from war, particularly in Western Europe and Japan. The rest of the world was for the most part either Communist, soon to be Communist, belonged to a European Empire or Latin American, and therefore save for Latin America, not even able to be an importer of much foreign capital. The United States with 50% of global GDP was the benevolent exporter of capital to the shattered free world. By the 1960s a revived Western Europe and Japan were also engaged in capital export both to each other and the United States. All three engaged in capital export to Latin America and the now former European colonies. In the 1990s with the collapse of Communism, Central and Eastern Europe, the former Soviet Union and Communist China became receivers of Western capital. There have been Chinese acquisitions of Western companies over the last decade. The Chinese Communist Party encouraged Chinese companies to ‘go global’ as far back as 2002. Most of the early investments were in developing countries and largely concerned energy, land and other natural resources. Only in recent years have we seen a shift to investment into Western countries. One of the earliest sizeable Western investments was Lenovo’s $1.25 billion acquisition of IBM’s personal computer business in 2005. However, it is only since the global financial crisis in 2008 that we have begun to see a significant acceleration in Chinese acquisitions culminating in a flood of deals and most recently the largest deal yet, the $43 billion deal by Chemchina to acquire Syngenta.

At first sight the flood of deals and capital into the West and particularly the distressed European Union, still dealing with the after effects of the banking crisis, should be warmly welcomed. The European democracies have traditionally been open and welcoming to foreign capital, first US capital and then later Japanese capital. China joined the World Trade Organisation 15 years ago committed to liberalising its markets. It has created a functioning stock exchange, economic regulators, an antitrust regime, and there are commercial courts and liquid financial markets. On the face of it, China has all the institutions that one would expect in the West necessary to run a free and open market. So there should be no reason not to accept flows of Chinese capital into the US and the EU.

The great difficulty, however, is that while formally China has all the institutions that are required to run an open market economy, in practice no such open market economy exists, even after 15 years of WTO membership.8 The Chinese Communist Party remains at the centre of a controlling web of surveillance, ownership, support and incentive that ensure the party’s interests and not open market choices remain paramount across the economy.

The Party-State’s control over the economy can be demonstrated by considering the state’s direct shareholdings in industry. The world’s largest shareholder, the Supervision and Administration Commission (SASAC), is an agency operating under the State Council, the Chinese Cabinet. SASAC is the shareholder in 106 state-owned non-financial enterprises. Combined with the 25,000 or so companies owned by state or regional authorities, SOEs make up between one-third to 40% of GDP and 60% of state revenue.9 The SOEs are heavily supported by the state and have access to discounted, water, land and energy, subsidies and preferential low interest rates.10 While SOEs often demonstrate some autonomy from the state they are subject to review, and removal of their senior officials by state action.11 It is true that between 1997 and 2005 the state did engage in a liberalising reform process. The number of SOEs was reduced and the number of SOE employees fell from 70 million in 1997 to 37 million in 2005.12 However, since the beginning of the financial crisis that reform has gone into reverse. State stimulus programmes have deployed the SOEs front and centre to generate economic activity with large cheap credit lines from state banks and subsidies from regional and central government. Cash has been thrown at new plants and equipment without reference to commercial need.13

The situation for private Chinese companies is somewhat more complex. Often the ‘private company’ will in fact have some element of state ownership.14 Even if that is not the case, given that the monopoly of power is in the hands of the Communist Party along with control of substantial commercial benefits which can be made available to compliant corporates, the private sector has substantial incentives to be amenable to Party-State interests. The private sector understands that to succeed it needs to be able to access the state structures to obtain the benefits and protection the state offers. Hence there is an incentive to resort to corrupt practices to build access into the state’s largesse and protection.15

An effective strategy for private companies to demonstrate their value to the state and obtain support and protection is to deliver the one thing that the Chinese Communist Party values above all else: economic growth. Hence Huawei, a private company, by building a successful and innovative telecommunications company, was favoured by the Chinese state over less innovative and successful SOEs. As a result Huawei obtained access to capital, soft loans and subsidies to enable it to grow much more quickly than it might otherwise have done.16

Across both SOEs and large private Chinese companies, members of the senior management team will have or hold senior Party positions as Delegates to the People’s Congress or sit as members or secretaries on local, regional and party committees.17 Nor are such Party positions limited to executives from SOEs. As Milhaupt and Zheng found, from publicly available information, in 95 out of 100 of the top one hundred private firms, the founder or de facto controller of the business is currently or formerly a member of the central or local party-state organisations such as People’s Congresses and People’s Political Consultative Conferences.18

The Chinese state has in addition a range of extra-legal controls over large private companies. These include interviews with the executives of the National Development and Reform Commission (NDRC). In theory the NDRC only has authority to interview the limited number of firms subject to its price control regime. In fact the interview process is used extensively across the private sector to encourage and compel compliance with policies favoured by Party and State.19

Another form of extra-legal control is found in industry associations. As part of the ‘liberalisation’ of the Chinese economy, ministries supervising many market sectors were abolished. However, many of the former ministry supervisory staff then joined the newly-formed industry associations and continued to carry out on the state’s behalf active supervision of their respective sectors. The extent of compulsion and policy direction undertaken in industry associations was demonstrated in a recent US price-fixing case.20 The China Chamber of Commerce for the Import and Export of Medicine and Health products had created an export price regime for vitamin C. All export prices were subject to review and approval by the Chamber. The defendants argued that the Chamber was an organisation through which the Chinese government exercised state powers of compulsion. The Chinese Ministry of Commerce (MOFCOM) went so far as to file an amicus brief in support.21

The Chinese state does not seek to control every jot and detail of the operations of SOEs and large private companies. However, when its interests are engaged or its policies require it, SOEs and private companies must bend to the state’s will. This again can be demonstrated by the raft of restructuring operations ordered by the state in a number of market sectors. Even private companies have had to surrender their independence for the greater good.22

The other major factor that has to be taken into account is the scale of state financial support for both SOEs and large private companies. It is difficult to get a clear picture of the scale of state subsidies provided to SOEs. However economic detective work by two American economists gives some sense of the scale of the support provided to SOEs. They estimate that the subsidy support to SOEs between 1985 and 2005 was above $300 billion - at a time when China was a much smaller economy than today.23 Given the state support subsequently provided to SOEs following the financial crisis, the overall numbers are likely to have been much larger over the last decade. The state also provides subsidies to large and successful private Chinese firms such as Geely Automobile and Huawei.24

The greatest source of state support, however, is less from subsidies and far more from bank loans provided by major state-controlled banks and banks controlled by local and regional government. It was for instance a regional bank which provided much of the financial support permitting Geely to acquire Volvo. The difficulty here is that the loans are often at non-commercial rates and on terms that would not be considered by any listed bank operating in a functioning market economy. SOEs and favoured private companies can take out almost endless state banks loans, lose money and yet continue to access even more credit from central and regional state controlled banks. The proposed Chemchina acquisition of Syngenta is a good example. Chemchina is in poor financial shape. It made a net loss of RMB 889 million in the third quarter of last year. It carries a debt load of RMB 156.5 billion ($24 billion). The debt load is the equivalent to 9.5 times EBITDA. As The Financial Times points out, the international standard for excessive leverage is 8 times EBITDA.25 Yet this company is seeking to undertake a $43 billion overseas acquisition - the largest in its country’s history.  No Western-listed corporate entity could even begin to contemplate such a deal with that sort of debt profile. It is only the guarantee of Chinese state support and the support of state banks that make this deal feasible for Chemchina, and have allowed it to attract some Western banks to take part in the loan syndication.

This scale of Chinese state control over both SOEs and the private sector is extremely damaging to the long term economic health and growth prospects of the Chinese economy. In the SOE sector it has the effect of allowing zombie companies to stagger on, and results in an immense misallocation of capital which could be better deployed in investing in new businesses and infrastructure which would deliver growth. Clearly the SOEs are likely to seek to defend their economic privileges. They are unfortunately now likely to be allied with the large private companies who also benefit from state funding, cheap loans, and market protection. Both have an interest in defending the status quo, making it much more difficult for the Communist Party leadership to undertake credible economic reform, even if it wanted to.

From a non-Chinese perspective however, the principal concern is the impact on Western economies of a wave of Chinese investment by companies which are funded by the state, supervised by party and state officials and required, on any issue which engages the state’s interest, to follow that interest.

The Chinese Investment Wave: A Cause for Concern?

Chinese SOEs and private companies have acted on the Party’s call to ‘Go Global’.26 In the three years from 2011 to 2014 China was able for the first time in each year to be third largest exporter of foreign capital.27 The Berlin-based Mercator Institute estimates that by 2020 China’s stock of foreign investment could have grown from $800 billion in 2014 to over $2 trillion.28 In 2015 for the first time there was more Chinese investment in the US, than US investment in China.29 It is also clear that Chinese companies have a substantial interest in investing in Europe. Europe has large number of international brands and high technology--and with the depressed economy, assets are often cheap. In addition, there are few of the meddlesome American security concerns to worry about-at least not at the EU level.30

There are a number of reasons why the Chinese state and Chinese companies (public and private) are keen to acquire Western assets. Much of the reasoning is perfectly legitimate and commercial. After two decades of spectacular growth the Chinese economy is now slowing down. Chinese companies are looking for new sources of growth, and assets in the West after the financial crash have often been cheap, and offered opportunities for higher margins and growth and the fulfilment of Chinese strategic objectives. Chinese overseas investment has also changed its focus from seeking energy resources and commodities in developing countries to seeking assets further up the value chain. In order to develop the Chinese economy its companies need access to Western markets and international brands they can develop; western supply chains; marketing knowhow and high technology. 

There are also opportunities for acquiring undervalued international brands in the West and then using Chinese resources and the huge Chinese market to substantially grow sales and enhance the brand. For instance, the Chemchina acquisition of Pirelli makes a lot of sense for Chemchina which previously had no major tyre brand to compete with on home or foreign markets. It can use the Pirelli brand to compete more effectively on the domestic market, growing sales and enhancing the brand and providing a basis for developing the brand in foreign markets. Another example is Wensli’s acquisition of French silk firm Marc Rozier. It is Wensli that provides the capital and markets to grow the business and enhance the brand, providing China with access to high quality luxury markets.31

A further legitimate reason for seeking overseas assets is China’s desperate need for food security. China has approximately one-fifth of the global population but only 10% of the world’s arable land. What little arable land it has is heavily subject to pollution, degradation and infertility. This means Beijing puts a premium on food security: the acquisition of farming land in third states; food producers; food processors; and high technology scientific companies that can improve yields. 

While all of these reasons for foreign acquisitions are legitimate and understandable, the close connection between Chinese companies, whether SOEs or private, and the state, nevertheless should trigger significant security concerns. The United States has the CFIUS review process, whereby the Treasury Department in co-ordination with other government departments can make recommendations to the President in respect of a review, and that is an important tool. In the 3leaf deal the technology company Huawei found that its small ($2 million) transaction came suddenly under the political spotlight followed by a full CFIUS review, with the Committee being prepared to recommend a veto of the deal32. SOE Tsinghua Unigroup never even got as far as facing a formal CFIUS review in its $28 billion bid for chip maker Micron Technology, before facing such a political storm that it withdrew.33 Even SOE Shuanghui’s acquisition of pork food processor Smithfields Foods was subject to a CFIUS review, in which properties near US military sites were required to be sold off before the deal could proceed.34 Currently Chinese group CECG is seeking to acquire the Chicago Stock Exchange and already 45 congressmen are petitioning for a full ‘rigorous’ review of the deal.35 The Chinese-backed bid for Affymetrix is raising similar calls for a thorough CFIUS review.36

State surveillance and control of public and private companies in a context where the acquisitions involve communications technology are particularly likely to cause concern to foreign governments. This is reinforced in the United States by the concern over cyber attacks from China and particularly in respect of cyber attacks which appear to have government consent or support.37 At the very least Chinese companies should have to be subject to a significant degree of due diligence before proceeding with transactions in the US in the security, technology and communications sector.

A recent American Security Project survey indicates that 80% of those polled in the United States are uncomfortable with takeovers by foreign state-owned enterprises and that 91% are concerned that China is taking over US assets to bolster its own industries and strategic assets, with 72% concerned that Chinese companies have an unfair advantage.  The poll also showed that US voters see food safety as a national security issue, with 93% taking the view that the U.S. government should scrutinise transactions in the agricultural sector more carefully to ensure U.S. food safety as part of the regulatory review process.38

Certainly, security concerns can also arise from the sense of threat that flows from large-scale land acquisitions. Several developing countries introduced foreign land acquirer blocking statutes which were targeted at China.39 More recently, both competing Chinese bids for the Australia’s largest cattle farmer S. Kidman and Co were blocked by the Australian Federal Government following a blocking recommendation from the Foreign Investment Review Board (FIRB) as not in the national interest. The formal reason was that one quarter of the land under the bid was near a weapons testing centre.40 However, the sense of loss of control of national land assets was probably the far greater concern. If the acquisition had proceeded a Chinese company linked to the Chinese state would have controlled 1.3% of Australia’s total land area and 2.5% of Australia’s agricultural land.

A further concern for many western businesses is that once one Western firm is acquired by a powerful state-supported Chinese company, its rivals may find that the Chinese domestic market becomes substantially locked down to them. The proposed Syngenta acquisition provides a very good illustration of the potential problem. If Chemchina acquires Syngenta, will only Syngenta seeds and pesticides be authorised for sale in China? Will other competitors be able to effectively sell their products on the Chinese market? Will they be granted the regulatory authorisations they need from various Chinese regulatory bodies, which are ultimately state-directed? Worse still, will farmers who want to sell their crops into the Chinese market only be able to use Syngenta seeds? Would in effect Western farmers have to use seeds to produce crops whose intellectual property rights were controlled by Chinese state controlled companies? A further concern is that the size of the Chinese market is potentially so large that in some seed lines the Syngenta seeds might become the dominant seed all farmers would have to use worldwide.

This concern as to enhanced trade discrimination triggered by the acquisition of Western companies is a reasonable concern given the discrimination that Western companies already face in China. According to a recent American Chamber of Commerce report, restrictions on foreign firms’ operations are actually increasing. The US report finds that ‘market access limitations appear in every sector of the Chinese market’. Nearly 78% of companies reported that an unclear regulatory environment hindered their China business, 67% reported difficulty in enforcing their contractual terms, and 63% say that the favoured domestic firms hinder their business41. Given the level of market restrictions currently in place it is not surprising that the US has brought more than twice as many WTO trade dispute cases against China than any other WTO member.

Another concern is Western blindness as to the consequences of control by the state of Chinese companies in our regulatory systems. As discussed above, in the Vitamin C Antitrust Litigation case, the US Federal Judge focussed on the legal texts and did not appreciate the economic, political and commercial ecosystem which ensured compliance with the wishes of the Chinese government. A further concern is that regulators will simply not recognise in their surveillance of markets where there could be a major market distortion issue because of the activities of a number of state-influenced Chinese companies. For example, if one looks at the market that has developed around the Platts Dubai oil window, there are now significant oil flows through that market which impact global prices. That market is now substantially influenced by two Chinese state-owned energy trader subsidiaries, China Oil and Unipec42. In that case there may or may not be collusion, but as a matter of policy, do Western antitrust regulators look more closely when there are two or more Chinese companies in the market potentially influenced or controlled by the state who may have the capacity to set pricing in the market?43

A further aspect has arisen in EU merger cases, but has not resulted in a definitive answer in any case to date. That is the question as to whether DG Competition, the European Commission’s antitrust arm, is properly taking account of the connections between Chinese companies44. If an SOE is in fact ordered by SASAC to work closely with several other SOEs in the same sector, is the undertaking really one SOE or is it part of a corporate ‘group’ that comprises all the SOEs in the sector? If private Chinese companies particularly in a specific market sector are run together by industry associations, receive access to the same funding and accept directions from the same quasi-state agencies, should they be treated as a single undertaking? This has both jurisdictional and substantive implications in merger control. There also has to be consideration of vertical links between state-owned commodity producers and state-owned manufacturers and wholesalers, to ensure that there is not price co-ordination up and down the supply chain45.

Yet another concern flows from the state control and influence over SOEs and private companies and compliance with the listing and disclosure requirements on Western exchanges. One point made by McGregor in his book, The Party, is that, ever since the very first initial public offering (IPO) by Shanghai Petroleum, no Chinese IPO listing on Western exchanges or in publishing a takeover prospectus has ever disclosed the role of the Party in the operations of the firm. It would appear at first sight to be the case in most Western jurisdictions that this would constitute a material non-disclosure. At one level this would be because the Party can directly affect personnel choices in the senior management of the firm, as well as the projects that are undertaken, financing and overall direction. At another level this Party direction is formally in contravention of Chinese law. If the established business practice in China is for the Party to direct firms when its interests are engaged as is contended in this paper, and that practice is in direction contravention of the ordinary applicable law, then surely it should be disclosed to potential shareholders before they actually invest? Furthermore, wherever Party direction of a firm undermines shareholder value would there not be a possibility of actions by shareholders for recovery of losses against the firm? For example, in 2004, the Party’s Central Organisation Department46 suddenly announced that the top executives at the three largest telecommunications state-owned companies, China Mobile, China Unicom and China Telecom, were going to be reshuffled. Two were listed on overseas exchanges and another was preparing to list offshore. The share price of the firms involved took a considerable hit due to this action47. As Chinese investment accelerates in the West, the non-disclosure of party control and influence is likely to become an issue upon which market regulators will focus.

The subsidies and soft loans provided to both SOEs and private firms cause still more concern. State money and state subsidised cheap loans enable Chinese firms to obtain Western assets which would be otherwise beyond their reach. The cheap or free money tips the playing field in favour of the Chinese as acquirers and disadvantages everyone else. One might argue that money is money, and as long as the Chinese are offering attractive prices for Western assets they should be entitled to acquire them. However, the EU particularly has spent 50 years building an increasingly effective state aid regime in order to reduce market distortions and improve the quality of competition in the economy. There must be concern as to the extent to which Chinese cheap money can cause distortions of the kind that EU state aid law seeks to eliminate.

There is also a worry that often, as with Syngenta, the levels of bidder debt are, by Western parameters, extreme. It is very telling that one-fifth of all Chinese companies are in negative cash flow and one-third had debts three times their assets in 2015.48 The concern here focuses on the financial viability of Chinese companies entering Western markets, which could in fact damage the assets and the employment opportunities and overall market prospects of the companies they acquire. It also raises concerns that with high all-cash bids the Chinese are crowding out much better run, less debt-encumbered and more experienced companies in the EU, US and Japan as potential acquirers. Those better-run firms may well generate more growth from the assets they acquire in the longer term, and are more likely to generate employment and greater tax revenues in the home jurisdiction of the acquired company and abroad.

A recent example of this trend is the ostensibly private company Anbang Insurance. This firm was only founded just over a decade ago. Very little public information is available about the firm in terms of ultimate owners, debt profile and board members. Yet in 2014 a new cash call saw 31 new investors subscribe to shares taking Anbang’s share capital from RMB 12 billion ($1.8 billion) to RMB 62 billion ($9.6 billion). Overnight Anbang overtook in size, if not premiums, China Life and the other major Chinese insurance players. It has subsequently acquired a series of insurance companies and more recently launched a $6.5 billion bid for Strategies Hotels and Resorts, and a $13 billion bid for Starwood hotels. It is unclear where the funds come from to fund these acquisitions. The company has no obvious track record in the hospitality sector and certainly not at this scale. The chairman appears to be related to senior members of the Chinese leadership and the offers, being all cash, do not trigger disclosure requirements. The targets have no idea from publicly available information who are the ultimate owners of the company or even the debt profile of Anyang.49

There are WTO anti-subsidy rules enacted into EU law, which allow the imposition of countervailing duties on imports into the EU.  In addition, the EU can make a direct complaint to the WTO if it believes China has breached WTO subsidy rules.  But it is not immediately obvious how either discipline can be used at the front end of a proposed transaction involving a Chinese acquirer financed by cheap loans, subsidies or under-priced inputs from central and local government. 

Overhauling the Western Response

Given that this wave of Chinese investment into the European Union has only begun to reach scale in the last few years, it is not surprising that the EU institutions have not yet fully realised the implications. The European Commission starts from the basis that China is a WTO member with similar market institutions as the Member States. However, a closer examination, as explained above, demonstrates that in fact behind the market façade, the Chinese Communist Party stands at the centre of a web of connections, surveillance, incentives and compulsion that ensure that when the state’s interests are engaged those interests are followed by all SOEs and large private companies.

Facing an ever-increasing wave of Chinese investment, the Union and its Member States have to consider how best to protect their interests. Clearly many investment deals will be benign, but others will raise trade discrimination interests and still others direct security concerns. 

One issue for consideration is whether the Union can develop its own CFIUS or CFIEU model. Currently a few states such as Germany have comprehensive foreign investment review. Most do not. The Union is much better placed than most Member States to make an overall assessment of the threat to trade or security interests. A direct CFIEU copied from the US would not however work in the EU context due to national sovereignty concerns. Nevertheless there are lessons from the US that are valuable in developing a CFIEU. One lesson is that the very raising of a CFIUS process and certainly the conduct of a CFIUS process can be enough to lead to many problematic deals being withdrawn. An approach that may work in the European Union would to operate a two track process whereby the European Commission will examine any deal put to it by a Member State or the European Parliament, and the Member States would retain their own independent powers to investigate any transaction50. Any Commission recommendation to block a transaction would require a qualified majority to approve. The practice from CFIUS procedures would suggest that even getting to the stage that the Commission would recommend blocking would be sufficient in most cases to result in the deal being withdrawn by the putative acquirer.

A second proposal would be for all Western states, and principally the EU and the US, to overhaul their corporate law, particularly their listing rules to deal adequately with state-owned and state-influenced companies. Western legal regimes should be strengthened so that they would expressly require disclosure of any third party who has an influence or control over the company. Equally in respect of transparency, all cash offers should be subject to a disclosure regime. The Securities and Exchange Commission should work with EU regulators to investigate previous IPOs and takeovers where there may be evidence of undisclosed state control over the acquirer. Such an investigation would act also as a warning to any potential state-controlled investors that they would in future have to make a full disclosure of the extent of the control or influence of their non-corporate controlling entities.

The third consideration for the Union is the realisation that, with the new large-scale wave of Chinese investment into Europe, Chinese domestic trade discrimination against EU and US companies can no longer be ignored. There is a non-trivial risk that China will selectively come in and take over Western competitors, as described above in respect of Syngenta, and then proceed to lock out all other Western competitors from the Chinese market. Worse still the acquired Western competitor supported with cheap Chinese capital and access to the huge Chinese market could become the dominant player in its market worldwide. At the very least the EU needs to work with the United States to establish the principle that, for market access to the US and the EU, China has to provide credible, non-discriminatory access to Chinese markets.

CFIUS and other Western investment regimes could co-ordinate when it comes to the Chinese acquisition of Western companies. So for example, when a Chinese acquisition could result in market lockdowns for the other Western producers seeking market access to China, the Western investment regimes could impose conditions on the transaction. For instance, evidence of market restrictions or lockdown following a Western acquisition by a Chinese company in the sector in which the acquired company operates in China, should be a basis for reopening the review of the transaction and ultimately an order to unscrambling the transaction.

One major issue for foreign investment reviewers in government agencies, agencies dealing with anti-dumping and anti-subsidy regimes, financial regulators and antitrust regulators is simply having enough knowledge of how Chinese companies really operate and who really owns and controls them. A measure worth considering would be to create an economic and political intelligence service, perhaps run by several Western countries which can provide the resources to run such a service. Western regulators would be able to use that information in assisting them in making accurate and evidence-based decisions on the corporate entities they are dealing with.

A further question concerns the appropriate response to the prospect of the expiration in December 2016 of China’s WTO Protocol on Accession. When the Protocol was signed by Western states and China in 2001 the assumption was that China would develop into a fully-fledged market economy. As argued above, China has not developed into a free and fully-functional market economy. The forms of state command and compulsion combined with financial support allow much of the market distortions and state influence of the old command economy to be maintained. It would appear at first sight that formally the EU and the US will lose the capacity to use third country analogue pricing in December 2016. However, the underlying assumption in agreeing to the Protocol (and indeed in China becoming a WTO member at all) was that China undertook to become, over time, a functioning market economy. China has comprehensively failed to do so, even though on the fact of it, it now has in place many of the outward trappings and institutions which allow it to claim it is the same as the West. The EU and the US have a compelling contractual argument that China has failed to comply with its side of the bargain. While China can be expected to bring a case in the WTO if the EU does not amend its domestic anti-dumping legislation in line with the expiry of the Accession Protocol, a compelling counter-claim by the EU in that forum would be that present day reality does not match what was envisaged when the Accession Protocol was negotiated over 15 years ago.

But there is a bigger picture in which all argument about MES is beside the point.  By acquiring companies within the European Union, the Chinese Party-State simply bypasses the need to import. And therefore WTO trade defence mechanisms lose all relevance, at least in relation to European-based manufacturing.

Competition law on both sides of the Atlantic also needs to burrow beyond the façade of the Chinese market economy and look at the reality of the impact of extensive state control and supervision across the world’s second largest economy. Regulators should be looking at two major issues. First, the prospect in many markets for Chinese state companies operating in the same market to co-ordinate in breach of Section 1 of the Sherman Act and Article 101(1) TFEU. Second, work to establish how to apply competition law effectively to acquisitions where the Chinese state has interests across a whole market sector. This would again suggest policy and case co-ordination between in the first instance the Antitrust Division of the US Department of Justice and the European Commission’s DG Competition.

For the first time in modern history Europe and the United States are facing a wave of foreign investment from a non-OECD state which is not an ally and does not share or practice our common values. The West has to take steps to protect its legitimate interests, including both security and trade interests.

  • 1. Pittenger, Chinese Bid for Chicago Stock Exchange Must be Fully Investigated, Fox News, 23rd February 2016.
  • 2. China Bank Governor Warns Over Corporate Debt, The Financial Times, 21st March 2016.
  • 3. Australia has the Foreign Investment Review Board (FIRB) which makes recommendations to the Treasurer, and Canada reviews foreign investment under the Investment Canada Act.
  • 4. For a description of US CFIUS procedures see US Department of the Treasury:[/fn].

    Some EU Member States, but not all, have forms of foreign investment review, but there is no EU-level foreign investment review process that allows scrutiny of the implications for the whole Union. 

    A further concern in both the EU and the US is the extent to which Western concepts of markets and their institutions mislead Western regulators when assessing Chinese companies’ compliance with antitrust and other regulatory regimes. There is also a broader under-discussed question for Europeans and Americans as to the potential negative effects of Chinese investments on governments, parliaments, media and the public in the West. Meunier, A Faustian Bargain or Just a Good Bargain? Chinese Foreign Direct Investment and Politics in Europe (2014) Asia-Europe Journal, 143 et seq.

  • 5. The UK government for instance sought to block Mikhail Fridman’s acquisition of assets in the British North Sea. See Bershidsky, Not all Russian Billionaires are Putin Cronies, Bloomberg View, 5th March 2015.
  • 6. Directive 2009/73/EC of the European parliament and of the Council of 13 July 2009 concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC, OJ L 211/94, Article 11.
  • 7. This may well be because following the financial crisis and the ongoing Eurozone crisis. EU Member States have focused on fresh foreign investment and not looked too closely at the downside. McGregor in his book, The Party: The Secret World of China’s Communist Rulers, Allen Lane, London (2010) provides some evidence that the Europeans were willing after the financial crisis to remove most restraints on Chinese investment. See in particular the prologue to the book.
  • 8. It should be noted that Western states assumed that over 15 years China would reform significantly enough to become a fully functioning market economy. On that basis they agreed a Protocol of Accession where for 15 years they would be able to ignore Chinese prices and costs in anti-dumping cases and instead base the calculation of dumping margins on external benchmarks. In essence this means that for the last decade and a half the EU and other WTO members have been applying non market economy methodologies to China. The concession contained in the Accession Protocol expires on 11th December 2016. There is now a major debate in Brussels and Washington as to whether to grant China market economy status at the end of 2016. The clear tenor of this paper is that neither the US nor the EU should grant China market economy status.
  • 9. See China lags on SOE Reform Goal, RFA, 10th December 2015, and China’s Grip Still Tight on SOEs, The Conversation, 17th September 2015.
  • 10. Milhaupt & Zheng, Beyond State Ownership: State Capitalism and the Chinese Firm (2015) Georgetown Law Journal 667.
  • 11. In respect of state control over executives in SOEs and large private companies see The Party, op cit, Chapter 2 for a discussion for policy and examples of state control over major corporate entities and Chapter 3 for the role of the Party’s Central Organisation Department in appointing, reviewing and removing executives.
  • 12. However as McGregor explains, this reform was not privatisation in the Western sense. Its aim was to make the SOEs more efficient and capable of generating rather than losing money. It did not mean actual privatisation wherein the state loses ownership and control of the privatised entities. See The Party, op cit, especially Chapter 2.
  • 13. National Service is Not Whipping Chinese Banks into Shape, Financial Times, March 8th 2016.
  • 14. For example the recent counter offer by Anbang Insurance for Starwood Hotels. Anbang is unlisted and not a SOE. However, Wu Xiaohui who founded Anbang in 2004 is married to the granddaughter of Deng Xiaoping. For a further discussion of the Anbang acquisition see part 4.0.
  • 15. Milhaupt & Zheng, op cit, 692.
  • 16. Milhaupt & Zheng, op cit, 685.
  • 17. McGregor, op cit, Chapter 2.
  • 18. As they point out, the fact that such information could not be found does not mean that the other firms did not have deep Party connections. They note that in the case of Huawei it may well be that the firm’s connections to the political establishment may have been kept informal to avoid suspicion as to the firm’s true motives. Milhaupt & Zheng, op cit, 684
  • 19. Milhaupt & Zheng, op cit, 687.
  • 20. Re: Vitamin C Antitrust Litigation, 810 F.Supp. 2d 522 (E.D.N.Y. 2011) 109 at 528-529.
  • 21. In the event the Federal District judge took a formalistic approach focussing on the text of the Chinese regulations without a broader consideration of the Party-State ecosystem in which Chinese private firms have to operate and so formed the view that in the absence of an express requirement to comply with the Chamber’s measures, there was no state compulsion.
  • 22. There is for example the long saga of the Shazdong Rizhao Steel company, a private sector steel company faced with being restructured into an SOE as part of a state restructuring plan. Despite resistance from the owners of the private company the restructuring was completed. See Sheng, Hong and Zhao, China’s State Owned Enterprises, Nature, Performance and Reform, World Scientific Publishing, Singapore (2012) 145-148.
  • 23. Haley & Haley, Subsidies to China’s Industry (2013), Oxford, OUP.
  • 24. Forney & Khawaja, Public Funds for Private Firms, (2013) Fathom China Ltd, 10.
  • 25. Debt Levels Cast Cloud over March of China Inc, Financial Times, 3rd February 2016.
  • 26. The Party recently reaffirmed the global mission of Chinese businesses. See China Stresses Finance for Companies “going Global” Xinhuanet, 24th December 2014.
  • 27. Riding the Silk Road: China Sees Outbound Investment Boom, Ernst & Young (2015), 2-4.
  • 28. The Second Wave, The Economist, 26th October 2013.
  • 29. Pittenger, op cit.
  • 30. Bershidsky, China Wants to Buy Europe, Bloomberg View, 23rd March 2015.
  • 31. The New Silk Road, The Economist, 12th September 2015.
  • 32. Huawei backs away from 3leaf acquisition, Reuters, 19th February 2011.
  • 33. Reported Chinese offer for Micron Faces Far too Many Hurdles, Reuters, 15th July 2015.
  • 34. Smithfield Receives US Approval for Biggest Chinese Takeover 7th September 2013.
  • 35. Chinese takeover of Chicago Stock Exchange” Congressman Pittenger leads 45 members of congress in requesting rigorous investigation, Press Release, Rep Pittenger, 17th February 2016.
  • 36. US congresswoman asks for Cfius review of Chinese-backed offer for gene-testing company, by Jeff Bliss, MLex, 22nd March 2016.
  • 37. China in focus as cyber attacks hit millions of US Federal workers, Reuters, 5th June 2015.
  • 38. See American Voters View Trade and Foreign investment in the U.S. with Skepticism, 21st March 2016, at
  • 39. Over the first half of this decade a series of blocking statues have been enacted across Latin America commencing in Brazil in 2010, followed by Argentina and then more recently Uruguay.
  • 40. Statement on Decision to Prevent Sale of S.Kidman and Co Limited, Press Release, Office of the Treasurer of the Commonwealth of Australia, 19th November 2015. It is understood that the vendor is trying to restructure the transaction so that if Chinese or other foreign bidders are successful, the new version of the transaction will be deemed to be consistent with Australia’s national interests. Meanwhile attempts are being made to find alternative Australian buyers. Following considerable public debate on the Kidman sale and other high-profile acquisitions, the Australian Treasurer announced a policy change so that from 31st March 2016, the FIRB will have to assess the sale of critical infrastructure assets sold by Australian State and Territory governments to private foreign investors. Previously, FIRB assessment was only required when such assets were sold to state-owned enterprises. See media release “Critical asset sales to fall within foreign review net”, 18th March 2016.
  • 41. 2015 China Business Report, Amcham Shanghai (2016).
  • 42. For a description of the operation of the market surrounding the Platts Dubai Price Window see Oil Market in Transition and the Dubai Crude Oil Benchmark (2014) OIES.
  • 43. If the two oil traders were found to be colluding on prices one line of defence would be to argue that they were in fact part of the same undertaking owned and controlled by the Chinese state. However, that line of argument would then have a major impact on any merger control review processes in the energy sector in which Chinese energy companies engaged and also raise additional questions about the accuracy of any IPO or other prospectus that was provided in respect of a Chinese energy company.
  • 44. So far the approach of the European Commission has been to recognise that all Chinese SOEs might need to be treated as belonging to the one corporate “group”, but managing to leave the question open in each case involving an SOE acquirer on the basis that on either analysis, no competition issues would arise. See for example, Case No. M.7709 Bright Food Group/Invermik, 14th September 2015; Case No. M.7643 CNRC/Pirelli, 1st July 2015; Case No. M.6807 Mercuria Energy Asset Management/Sinomart KTS Development/Vesta Terminals, 7th March 2013; Case No. M.6461 TPV/ Phillips TV Business, 24th February 2012; Case No. M.6141 China National Agrochemical Corporation/Koor Industries/Makhteshim Agan Industries, 3rd October 2011; Case No. M.6113 DSM/Sinochem/JV, 19th May2011 and Case No. M.6082 China National Bluestar/Elkem, 31st March 2011. If presented with a merger between two Chinese SOEs, presumably the EC would have to decide the issue definitively, to ascertain whether it even had jurisdiction to review the transaction.
  • 45. For example, see the discussion in the ACCC review of the Chinalco (Aluminium Corporation of China)-proposed acquisition of interests in Rio Tinto PLC and Rio Tinto Ltd, ACCC, 25th March 2009. Rather like the European Commission, the ACCC recognised the issue of potential co-ordination between Chinese state-controlled companies, however, found grounds to avoid making a decision in that specific case. The twist in that case was the potential for upstream-downstream co-ordination between the Chinese control of iron ore as a result of this acquisition and state control of steel mills further up the supply chain.
  • 46. The Central Organisation Department is the Party’s senior personnel office. This bald statement does not capture the nature of the Department. McGregor resorts to a US analogy to explain its role. “The best way to get a sense of the dimensions of the department’s job is to conjure up an imaginary parallel body in Washington. A similar department in the US would oversee the appointment of the entire US cabinet, state governors and their deputies, the majors of major cities, the heads of all federal regulatory agencies, the chief executives of GE, Exxonmobil, Wal-Mart and about fifty of the remaining largest US companies, the justices of the US Supreme Court, the editors of the New York Times, the Wall Street Journal and the Washington Post, the bosses of the big TV networks, the Presidents of Yale and Harvard and other big universities, and the heads of think tanks like the Brookings Institution and the Heritage Foundation.” The Party, op cit, Chapter Three.
  • 47. McGregor reports, ‘According to a prominent Chinese banker it was ignorance. “The Party did not even stop to think about the board and its legal responsibility for choosing the chairman and senior executives”…He said, “The Central Organisation Department is totally ignorant about such processes. This is not just about protocol. The issue goes much deeper than that. It goes directly against Chinese securities law, enacted by the National People’s Congress, which says the chairman’s job cannot be influenced by any outside body”. The Party, op cit, Chapter 3. Nevertheless The Central Organisation Department undertook another major reshuffle of senior executives in the airline sector in 2009.
  • 48. China Inc, the Quest for Cash Flow, The Financial Times, 18th March 2016.
  • 49. Ibid.
  • 50. There is a precedent in the text and practice contained in Article 11 of the EU’s 2009 Gas Directive. Article 11 provides for review of owners or potential owners of pipelines, where they are non-EU persons. The assessment criteria focus strictly on the energy supply security of the relevant Member State and the EU as a whole. The Member States lead but the Commission maintains a supervisory role.

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