China's New National Security Law
Developments in China's national security regulation, and contrasts the position with that existing in Australia and the USA as of 29 July 2015.
The Standing Committee of the National People’s Congress, have approved the National Security Law of the People’s Republic of China, effective as of 1 July, 2015. The concept of national security is of extreme importance, especially due to the interconnectivity of contemporary society and the ability of each country and their economy and security to be linked to events across the globe, therefore impacting on every individual worldwide.
The national security law is divided into seven chapters that include the following:
(a) the guiding principles;
(b) the definition of national security;
(c) the functions and responsibilities of the National People’s Congress and the various branches of the government;
(d) the key elements of the national security regime such as intelligence collection, risk assessment, conducting national security reviews, and responding to states of emergency;
(e) the mechanisms for allocating resources to national security work;
(f) the obligations of citizens and corporations in assisting the government in protecting national security; and
(g) the supplementary provisions.
The National Security Law encompasses a broad concept of national security in comparison to its more conventional 1993 national security law prior to the enactment of the current National Security Law, which was designed mainly to defend China against espionage activities. The new National Security Law covers matters in relation to politics, the military, the economy, finance, culture, technology, territorial sovereignty, cyber-security, ideology, religion, as well as matters extending beyond the borders of China to include the polar regions, the international seabed, outer space and cyber-space.
In particular, Article 2 of the National Security Law provides the definition of national security to refer to the relative absence of international or domestic threats to the state’s power to govern, sovereignty, unity and territorial integrity, the welfare of the people, sustainable economic and social development, and other major national interests, and the ability to ensure a continued state of security. However, the following articles provide for the discussion of politics, the military, the economy, finance, culture, technology and territorial sovereignty, therefore broadening National Security Law’s definition of national security beyond the conventional and narrower concept of merely national defense.
Due to the National Security Law’s broad scope of application, there is concern amongst the business community in relation to the additional restrictions and scrutiny on business activities in China on national security grounds, especially in terms of the National Security Law’s involvement in economic development, which may have serious implications if in addition to the existing laws and regulations, commercial activities and investments are also regulated under the broad and unclear perspective of national security. Although such broad provisions contained in the National Security Law will be further clarified through implementing regulations, the National Security Law is still extensive on implications but lacking in specifics, therefore causing uncertainty in terms of practical application and impact.
One of the main concerns relates to foreign investment and the additional restrictions and scrutiny placed on foreign activities in China. Specifically, Article 59 of the National Security Law provides the State will establish national security review and oversight management systems and mechanisms, conduct national security review of foreign commercial investment, special items and technologies, internet information technology products and services, projects involving national security matters, and other major matters and activities that impact or may impact on national security. While this requirement is not particularly new because the Chinese government already conducts national security reviews in various areas and investments under existing laws and regulations, foreign companies are mainly concerned of any new national security review regimes in relation to foreign investment and IT products and services which may be introduced via the National Security Law.
Prior to the enactment of the National Security Law, the national security review requirements on mergers and acquisitions involving acquisitions of Chinese companies by foreign investors was imposed through the Circular on Establishing the Security Review System for Mergers and Acquisitions of Enterprises within China Involving Foreign Investors, whereas any greenfield non-M&A establishments involving foreign investors were left alone with no applicable national security review requirements. However, the Tentative Measures for National Security Review of Foreign Investments in Free Trade Zones enacted earlier in 2015 did a pilot run of a national security regime in China’s free trade zones, which were Shanghai, Guangdong, Tianjin and Fujian, and involved the application of the regime to mergers and acquisitions transactions as well as other foreign investments, including greenfield investments.
Due to the enactment of the National Security Law, it may be expected that the full regime required currently only for the free trade zones will be implemented nationwide, therefore widening the reach of the authorities to enforce and further scrutinise foreign investment. Also, the consequence of having such a broad definition for the concept of national security may potentially indicate the legislature’s intent on expanding the National Security Law’s scope of application to additional sectors, along with the current listed 57 industry sectors. Therefore, foreign investors will now have to be careful to ensure the requirements of the national security regime are followed.
Furthermore, Article 59 provides for the national security review of Internet information technology products and services, the scope and procedures of which are not defined in the National Security Law. Therefore, this provision has the potential to go beyond any mergers and acquisitions plans, greenfield investments or specific investment plans. This provision has the potential to cause significant entry barriers for international suppliers of IT products and services into the Chinese market, and along with the draft Anti-Terrorism or draft Cyber-Security Law; the Chinese government have many avenues through which they can scrutinise foreign products and services.
Foreign Investment Law
China already has laws regulating foreign investment, therefore the National Security Law will be complementing the draft People’s Republic of China Foreign Investment Law, which was released on 19 January 2015 by the Ministry of Commerce (MOFCOM) for public opinion. Foreign investment is particularly important to an economy, and it is essential in providing the capital to assist the creation of productive enterprises, therefore China’s attempt to finally revamp the legal regime in relation to foreign investment illustrates their acknowledgement of foreign investment to the growth and sustainability of China’s economy.
The draft Foreign Investment Law is extensive, and provides for the following:
(a) the definition of foreign investors and foreign investments;
(b) the regulation of foreign invested projects and associating entry permits;
(c) the procedures for national security review of foreign invested projects;
(d) the creation of an information reporting system for foreign investment;
(e) the promotion and protection of foreign investment and coordination and handling of complaints in relation to foreign investment; and
(f) the liability for any breaches.
The definition of foreign investors is broad, as it is not limited to foreign nationals or foreign incorporated entities, but includes enterprises incorporated in China which are controlled by foreign investors, therefore extending the Foreign Investment Law’s reach in regulating foreign investment. Also, the definition of foreign investment goes beyond the traditional methods of foreign investment activities, as in addition to greenfield projects, foreign invested entities, the acquisition of shares, the Foreign Investment Law also covers the holding of certain rights and interests over assets owned by, or voting rights, in a domestic enterprise. Specifically, foreign investment refers to any of the following investment activities conducted, directly or indirectly, by foreign investors:
(a) establishing domestic enterprises, which are enterprises incorporated in China in accordance with Chinese laws, which can either be enterprises with foreign investment, or wholly domestic owned;
(b) acquiring shares, equity interests, certain rights and interests over assets, voting rights or other similar interests and rights in a domestic enterprise;
(c) financing, with a term of one year or more in any domestic enterprises in which one or more foreign investors hold an interest or right described in the point above;
(d) obtaining the concession rights to explore or develop natural resources in China, or obtaining concession rights to construct or operate infrastructure facilities in China;
(e) acquiring land use rights, ownership of buildings and other real property rights in China; and
(f) controlling or holding interests or rights in any domestic enterprise through contract, trust or other arrangement.
Therefore, the concept of foreign investment is relatively broad under the Foreign Investment Law, which gives room for the government to regulate over an increasing number of activities in China.
The existing national security review regime will be integrated into the Foreign Investment Law where MOFCOM will review foreign investor(s) applications for an entry permit. MOFCOM or its provincial counterparts will consider a proposed foreign invested project requiring an entry permit in relation to the implications such a project may have on national security, and if necessary, MOFCOM may suspend the entry permit review and require the foreign investor(s) to submit an application for national security review. In this process, the State Council will set up an Inter-ministry joint meeting for national security review, which is jointly set up by MOFCOM and the National Development and Reform Commission (NDRC), and in the two-step review approach, the general review will decide whether the proposed foreign investment is likely to jeopardise national security, and if so, the special review will examine in details and decide whether the proposed foreign investment will or may jeopardise national security.
The position in Australia
The Australian government is extremely open to foreign investment as it assists in building Australia’s economy and enhances the wellbeing of Australians by supporting economic growth and prosperity, as well as create jobs, encourage innovation and promote competition.
Australia’s foreign investment framework is implemented through the Foreign Acquisitions and Takeovers Act 1975 (Cth) and the Australian government’s foreign investment policy, which clarifies several aspects of the legislation and imposes additional obligations which do not have the force of law but with which overseas investors are expected to comply. Under the Act, the Treasurer reviews investment proposals on a case-by-case basis to make a decision as to whether the proposals are contrary or supportive of Australia’s national interest. The Treasurer relies on advice from the Foreign Investment Review Board (FIRB), who works with applicants to ensure Australia’s national interest is protected; therefore, maximising investment flows while protecting Australia’s interests.
Australia’s foreign investment rules regulate investment proposals by foreign persons, who are generally:
(1) an individual who is not ordinarily a resident in Australia; and
(2) a corporation where a foreign person (including associates) holds 15% or more of the issued shares, units or voting power or where several foreign persons (including associates) hold 40% or more of the issued shares, units or voting power.
Under the Foreign Acquisitions and Takeovers Act 1975, the Treasurer has the power to review and block the following proposals by foreign persons:
(a) most acquisitions of interests in Australian urban land;
(b) any acquisition of a substantial interest, which is where a foreign acquirer and its associates would hold or control 15% or more of the issued shares or units or voting power, in an Australian corporation, or an increase in a substantial interest, where the value of the assets of that corporation exceeds $248 million;
(c) any acquisition of an aggregate substantial interest, which is where a group of unrelated foreign acquirers and their associates would, after the acquisition, hold or control 40% or more of the issued shares or units or voting power, in an Australian corporation where the value of the assets of that corporation exceeds $248 million;
(d) any acquisition of an Australian business where the assets are valued at more than $248 million;
(e) any acquisition of control of an Australian corporation where the assets of the corporation are valued at more than $248 million;
(f) any acquisition of a substantial or aggregate substantial interest in an offshore corporation which has gross assets valued at more than $248 million, where the assets of that corporation that are comprised of Australian land, Australian mineral rights or shares in an Australian corporation constitute 50% or more of the total assets of that corporation; or
(g) any acquisition of a substantial or aggregate substantial interest in an offshore corporation, where the assets of that corporation that are comprised of Australian land, Australian mineral rights or shares in an Australian corporation constitute less than 50% of the assets of that corporation, but those Australian assets are valued at more than $248 million.
Furthermore, there are separate legislation providing additional requirements for foreign investments, including requirements such as:
(a) foreign investment in the banking sector must be consistent with the Banking Act 1959, the Financial Sector (Shareholdings) Act 1998 and banking policy;
(b) total foreign investment in Australian international airlines is limited to 49 per cent;
(c) the Airports Act 1996 limits foreign ownership of airport offered for sale by the Commonwealth to 49 per cent, with a 5 per cent airline ownership limit and cross ownership limits between Sydney airport and Melbourne, Brisbane and Perth airports;
(d) the Shipping Registration Act 1981 requires a ship to be majority Australian-owned if it is to be registered in Australia; and
(e) aggregate foreign ownership of Telstra is limited to 35 per cent of the privatised equity and individual foreign investors are only allowed to own up to 5 per cent.
The national interest of Australia is one of the important considerations when considering a proposal, therefore each proposal undergoes an examination to determine if the proposal is contrary to Australia’s national interest, and while the term ‘national interest’ is not defined under the relevant legislation, the national interest criteria includes:
(a) the impact of the proposal on national security;
(b) the impact of the proposal on competition;
(c) the impact of the proposal on other Australian government policies including tax and the environment;
(d) the impact of the proposal on the economy and the community; and
(e) where the investor is a foreign government investor, the character of the investor, and in particular, whether it operates on a transparent commercial basis, is subject to adequate and transparent regulation and supervision and adopts good corporate governance practices.
Under the Foreign Acquisitions and Takeovers Act 1975, the Treasurer has 30 days to consider an application and make a decision. However, the Treasurer may extend this period by up to a further 90 days by publishing an interim order, which is issued under circumstances where a proposal is complicated or if insufficient information has been provided.
The position in the United States of America
The United States, as the largest foreign direct investor globally and the largest recipient of foreign direct investment, has always sought to find a balance between embracing an open market and regulating over national security simultaneously. Therefore, because of the US’s spread of economic activity across national borders, the US has important economic, political, and social interests at stake in the development of international policies regarding direct investment, as well as ensuring their laws on foreign investment in relation to national security are of the highest quality.
The Committee on Foreign Investment in the US (CFIUS), the inter-agency committee of the US Government responsible for reviewing national security implications of foreign investments in US companies or operations, was established in 1975 and operates under the discretion of the President and is chaired by the secretary of the Treasury. The CFIUS includes the heads of many departments, including the justice, homeland security, commerce, defense, state, and energy departments, as well as the US trade representative and the director of the Office of Science and Technology Policy.
Initially, the authority of the President to suspend or prohibit certain transactions was initially provided by section 721 of the Defense Production Act of 1950 by a 1988 amendment known as the Exon-Florio amendment. However, the Foreign Investment and National Security Act of 2007 (FINSA) substantially revised section 721 to provide for national security reviews of foreign investments. The FINSA maintains the narrow scope of CFIUS’s review process by focusing solely on genuine national security concerns and not broader policy concerns posed by mergers, acquisitions, and takeovers that could result in foreign control of a US business, and follows CFIUS’s efficient timeline by requiring CFIUS to conclude a review in 30 days and an investigation, if needed, in a subsequent 45 days.
In relation to an investigation, the CFIUS can conduct an investigation of the effects of a transaction on the national security of the US, and take any necessary actions in connection with the transaction to protect the national security of the US. This applies in cases where a review of a transaction results in a determination that:
(a) the transaction threatens to impair the national security of the US and that threat has not been mitigated during or prior to the review of a transaction;
(b) the transaction is a foreign government-controlled transaction; or
(c) the transaction would result in control of any critical infrastructure of or within the US by or on behalf of any foreign person, if the Committee determines that the transaction could impair national security, and that such impairment to national security has not been mitigated by assurance provided or renewed with the approval of the Committee; or
(d) the lead agency recommends, and the Committee concurs, that an investigation be undertaken.
With regards to national security, the President or the President’s designee may, taking into account the requirements of national security, consider, amongst other things:
(a) domestic production needed for projected national defense requirements;
(b) the capability and capacity of domestic industries to meet national defense requirements, including the availability of human resources, products, technology, materials, and other supplies and services;
(c) the control of domestic industries and commercial activity by foreign citizens as it affects the capability and capacity of the US to meet the requirements of national security;
(d) the potential effects of the proposed or pending transaction on sales of military goods, equipment, or technology to any country identified by the Secretary of State or the Secretary of Defense as posing a potential regional military threat to the interests of the US;
(e) the potential effects of the proposed or pending transaction on US international technological leadership in areas affecting US national security;
(f) the potential national security-related effects on US critical infrastructure, including major energy assets;
(g) the potential national security-related effects on US critical technologies;
(h) the long-term projection of US requirements for sources of energy and other critical resources and materials; and
(i) such other factors as the President or the Committee may determine to be appropriate, generally or in connection with a specific review or investigation.
If CFIUS finds the transaction does not present any national security risks or relevant provisions of the law provide adequate and appropriate authority to address the risks, CFIUS will advise the parties in writing that CFIUS has concluded all action under section 721 with respect to the transaction. However, if CFIUS finds a transaction presents national security risks and relevant provisions of the law do not provide adequate authority to address the risks, CFIUS may enter into an agreement with, or impose conditions on, parties to mitigate such risks or may refer the case to the President for action, in which case the President has 15 days to act.
Today, many countries have legislation and regulations in relation to foreign investments in order to ensure the protection and security of a country’s economy and national security. While most countries regulate over foreign investment and national security within a narrow scope of national defense only, China’s National Security Law has expanded national security concerns from the main area of national defence into a wide range of geopolitical, cultural, and economic issues, and is controversial due to the potential for abuse of power. Foreign companies in China will have to deal with further uncertainty when conducting business operations as a consequence of China’s attempt to handle security-related matters with a national law that seeks to keep pace with the challenges presented by issues such as globalisation and information technology.
ABOUT THE AUTHOR: Matthew Murphy
Matthew Murphy is a Partner in the MMLC Group. Matthew focuses on international FDI and M&A matters, and is also a China IP expert.
Matthew would like to thank Joyce Chng for her valuable contributions to this article.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.