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Focus: New national security review mechanism targets inbound M&A in China

18 February 2011

In brief: The Circular on the Establishment of National Security Review Mechanism in relation to Foreign Merger and Acquisition Activities of Domestic Enterprises (Guofaban 2011 No.6), which formally establishes the national security review mechanism and takes effect in early March 2011, has been issued. Partner David Wenger and Special Counsel Frank Fan report.

How does it affect you?

  • The long-awaited new rules set out, for the first time, specific guidance on the national security review (NSR) process for inbound merger and acquisition (M&A) transactions in the People's Republic of China (the PRC), following the inclusion of brief mentions of similar reviews in Circular 10 of 2006 and the Anti-Monopoly Law of the People's Republic of China (the AML) in 2008.
  • The NSR is a separate process from any antitrust review undertaken by the Ministry of Commerce (the MOC). Foreign investors in certain sectors may meet stronger scrutiny of their merger deals, as the new process gives Chinese regulators greater power, including to block transactions.


Circular 6 applies to M&A transactions involving:

  • foreign investors; and
  • investors from the Hong Kong and Macau Special Administrative Regions and Taiwan.

Existing national security reviews

The Regulations Related to Foreign Investors Merger and Acquisition of Domestic Enterprises (Circular 10), jointly issued by six ministries of the PRC in 2006 (and later amended in June 2009), first introduced the idea of an official review mechanism to protect national economic security in M&A transactions involving domestic enterprises. Circular 10 requires foreign investors to comply with MOC reporting rules for the acquisition of certain domestic targets in key industrial sectors, or that hold well-known trademarks or brands in China, that will, or may, affect PRC national economic security. However, no further rules or guidelines have been issued beyond Circular 10.

In August 2008, the AML further stressed the necessity of government review of acquisitions (or other forms of concentrations resulting from foreign investment) that may impact on PRC's national security but, again, no specific rules or guidelines were issued.

National security review mechanism

On 12 February 2011, the long-awaited Circular on the Establishment of National Security Review Mechanism in relation to Foreign Merger and Acquisition Activities of Domestic Enterprises (Guofaban 2011 No.6) (Circular 6) was published by the PRC State Council.

Scope of the NSR

Circular 6 provides that the NSR provisions will apply to the following:

  • foreign acquisitions of domestic military industrial enterprises and their auxiliary enterprises, as well as enterprises located near important and sensitive military facilities and other organisations involved in national security; and
  • foreign acquisitions resulting in control of domestic enterprises that may have an effect on national security in areas such as agriculture, energy and resources, infrastructure, transport, technology and important equipment manufacturing industries, with control being broadly defined as actual or de facto control, or more than one foreign investor holding an aggregate of more than 50 per cent of the equity of the target.

Circular 6 also clarifies that where the foreign acquisition of a domestic enterprise involves:

  • new investment in fixed assets;
  • a change in State-owned equity; or
  • the acquisition of domestic financial institutions,

such transactions will be approved by PRC regulators according to existing PRC laws and regulations, but will not be subject to the NSR mechanism under Circular 6.

Content of security review

The NSR process will focus on the impact on:

  • national security (including domestic production manufacturing capacity, domestic service provision capacity and the relevant equipment and facilities needed for national security);
  • national economic stability;
  • basic living standards in the PRC; and
  • the research and development capacity of key technologies for national security.

Multi-ministry review mechanism

The review process is as follows:

  • the State Council will establish a Multi-ministry Foreign Investment Security Review Committee (the Committee) to conduct the security review;
  • under the leadership of the State Council, the Committee will be led by the National Development and Reform Commission and the MOC, who will act together with authorities from the relevant industries to conduct the security review;
  • applications shall be submitted to the MOC by the foreign investors who plan to undertake a domestic acquisition. Where a transaction falls within the scope of the security review, the MOC will provide the Committee with the application for review within five business days;
  • the relevant departments of the State Council, national trade associations, enterprises in the same line of business and other enterprises connected to the business may also ask the MOC to conduct an NSR into a particular transaction. In these circumstances, an NSR will be conducted where the Committee considers it necessary; and
  • the Committee will first conduct a general review of the proposed acquisition as submitted to the MOC. Where a deal is not approved during the general review, a special review will follow. Approval will only be given during the general review if all the relevant departments agree that the proposed transactions will not have any impact on national security and that a special review is unnecessary. Decisions following from any special review will ultimately be made by the State Council.

Impact on national security

If it is determined that a transaction has had, or is likely to have, a major impact on national security, the committee will require the MOC (together with the relevant departments) to take action either to:

  • terminate the deal; or
  • take other steps to eliminate the effect on national security, such as transferring the relevant shares or assets to another entity.

Following-on implementation rules

It is general practice in the PRC that, following the publication of a general policy by the State Council, the relevant PRC ministries issue detailed rules and procedures to implement that policy. While Circular 6 contains a general list of strategically important and sensitive industries in which transactions by foreign entities will be subject to the NSR, further details are required as to the level of investment or other criteria that will need to be met before the NSR procedure will be invoked. Detailed rules are expected to be released soon.

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