linklaters china report document singles 5738
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Strategy and opportunity.Chinas growth on the world stage
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Mahjong is a game o strategy and opportunity. Originating in
China, it is now played all over the world. The our playing tiles
shown are the wind tiles, one or each direction. These carry
special signifcance as they can provide an opportunity or
players to win additional points.
As China reaches out to the rest o the world and theworld increasingly interacts with China agile, imaginative
organisations that combine strategy with emerging
opportunities will achieve the most success.
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Executive summary 1
1. Chinas macroeconomic trends 2
1.1 Key steps in Chinas growth to 2030 2
1.2 Re-balancing the economy 4
1.3 Internationalising the RMB 5
1.4 China inbound investment 6
1.5 China outbound investment 6
2. Internationalising the RMB 8
2.1 Increasing trade settlement in RMB 8
2.2 Growth o RMB nancial products 11
2.3 RMB: ully and reely convertible? 14
2.4 Potential revolution in RMB settlement systems 16
3. China inbound investment 18
3.1 Chinas key inbound regional and sector targets 18
3.2 Addressing challenges in inbound M&A 19
3.3 Strategies or success 21
4. China outbound investment 224.1 Chinas key outbound regional and sector targets 22
4.2 Interlocking reasons behind Chinas global M&A 26
4.3 Strategies or success 29
5. Chinese inbound and outbound M&A checklist 32
6. Key contacts 34
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China is at a turning point. Propelled to
be the worlds second largest economyby thirty years o exponential GDPgrowth, China now aces a slowdown and
signicant macro-economic questions.Compounding this is the constant, anddramatic, evolution o the global economic
landscape. Chinas response will determineits own role on the world stage or at leastthe next thirty years and signicantly
impact the rest o the world.
That response, outlined in Chinas 12th
Five Year Plan, is being implemented inthree linked developments. Increased
domestic consumption, not the export-ledstrategy o the past, must drive economicgrowth. Re-denominating trade fows intoChinas currency, the RMB, will mitigate
the infationary pressure o a tradesurplus paid or primarily in US dollarsat a pegged exchange rate. Chinas vast
oreign exchange reserves will increasinglybe invested in real overseas assetsrather than Western government bonds.
Internationalising the RMB is the vehicleor greater capital account liberalisationand increasing outbound investment.
These macro-economic drivers underpinChinas 12th Five Year Plan, which was
launched in 2011 beore the 2012/2013leadership changes so emphasisingthe collective commitment o Chinas
leadership to economic continuity amidpolitical change.
Chinas aim to re-balance its growth byboosting domestic consumption willenhance Chinas stability as its economic
structure becomes large, open and morelike the US, the only economy larger thanit. To achieve this, China needs widespread
reorm. It must improve its eciencyand innovation. Its nancial systemrequires reorm, to strengthen and
widen unding sources and nancialinstitutions, and its capital accountrequires urther liberalisation.
Chinas project to internationalise use othe RMB is key. Driven by cross-borderRMB trade settlement, China has already
taken signicant strides towards makingthis vision a reality. Since launching a 2009pilot scheme, the proportion o Chinas
worldwide trade settled in RMB hasballooned rom less than 0.5% in 2009 to10-15% or 2012. Chinas counterparties
are increasingly choosing to transact inRMB because this is to their advantage.
RMB-denominated trade uels expansiono an oshore pool o RMB liquidity,available globally. The range o RMB
nancial products is steadily increasing rom dim sum bonds to loans and letterso credit. Oshore hubs outside mainland
China, ocused on Hong Kong, London,Singapore and Taipei, act as Chinasbridges to the rest o the world or
RMB currency settlement and RMBnancial products.
And a quiet revolution is brewing. ChinasApril 2012 announcement o a orthcomingnew payment system (China International
Payments System) heralds a major changein RMB clearance and settlement. For
the rst time allowing international banksa direct relationship with Chinas centralbank, the Peoples Bank o China, thisadvance expected by mid-2013/2014
could truly globalise the RMB.
Simultaneously and related to the moves
to increase more fexible use o the RMB,China recognises the strategic imperativesto increase its outbound oreign direct
investment and attract targeted oreigninvestment into China. Whilst inboundinvestment into China remains important
and increasingly targets Chinese priority
sectors and regions, so ocusing on qualitynot quantity o oreign investment, it is
outbound investment that will be Chinasocus in the next thirty years. China aims touse this to move up the value chain, away
rom low-cost manuacturing, towards
output driven by innovation, and so avoidthe so-called middle income country trap
at which GDP growth plateaus.
This will require Chinese companies to
go global. Increasing outbound M&Awill develop internationally competitivecompanies and integrate China deeper into
the global economy. Investing over $327bnin outbound M&A since 2005 and growingits share o global outbound M&A rom
0.8% in 2005 to 5.5% in 2011, China hassignalled its intent.
Driven by diverse actors, rom purenancial investment to oreign brand/know-how acquisition, securing natural
resources and strengthening ties with keymarkets, China is conducting its M&Ain a changing global landscape. This
presents unoreseen opportunities, orexample emanating rom the Eurozonedebt crisis, and the challenges o a
recessionary environment and stallingdemand in certain sectors. A nimbleresponse, coupled with more transparent
outbound policy and decision-making, willacilitate Chinas outward growth strategy.Equally crucial to success are practical
strategies to execute transactions, romtargeted government support to suitabledeal structures minority stake or outright
acquisition given potential regulatory andcommercial hurdles.
For todays non-Chinese marketparticipant, whether corporate or nancialinstitution, this means deciding how and
when to engage with China. Given thecomplexity, and oten lack o visibility, othe challenges and opportunities ahead,
it is key to have a detailed understandingo the ull picture. For China, constant
extension o its international capabilitieswill enable it to implement its growth planor the next thirty years, so developing amore sustainable path or itsel and the
world economy.
Executive summary
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1. Chinas macroeconomic trends
> 1.1
Key steps in Chinas growthto 2030
Over the last thirty years since the starto market-oriented reorms, China has
successully used inbound oreigndirect investment (FDI) to expand itsmanuacturing and export capacity and
so ast-track its GDP growth. Since 1980China has consistently posted GDPgrowth gures exceeding those o the
mature US/Western European economiesand requently revealing exponentialeconomic growth (graph 1). But with
growth levelling, the next thirty yearsrequire a resh approach.
Characterised by a shit in Chinasgrowth paradigm, the next phaserequires technological progress and so
necessitates increasing outbound FDI.Chinas going global policy, launched in2000, now supplements its open door
policy by encouraging its rms to go outas well as to pull in FDI. Relying onthis key strategy or uture growth, China
will increasingly depend on its ability toproduce globally competitive companies
to help it move up the value chain andovercome the middle income countrytrap the point where a countrys growthslows ater reaching about $14,000
o income per capita (adjusted orpurchasing power parity), which China isorecast to reach by 2020. The new phase
is thereore likely to centre on globalintegration and outbound investment.
Graph 1: China, USA and Western Europe GDP growth, 1980 2014
Rea
lGDP
yearon
yearpercen
tagec
hange
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
(est.)
2013
(est.)
2014
(est.)
China USA Western Europe
20
15
10
5
0
-5
Source: IMF
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Focused on ensuring sustainable growth and
targeting the right quality of growth, China
is moving from a manufacturing economy to a
highly productive, innovation-driven economy.
This will have profound implications worldwide.
Simon Davies
Firmwide Managing Partner
This approach brings additional
macroeconomic benets. Buying realassets instead o government bonds willreduce Chinas oreign exchange reserves
rom its record $3.3trn (graph 2) and helpto balance its current account surpluswith its capital account. China has a net
US dollar infow on its current accountas its exports exceed its imports, butcan counter this on its capital account
by spending US dollar reserves on realassets. This also allows China, concernedabout the US scal position, to diversiy
out o US Treasury bonds passively,not selling its holdings but also not
accumulating more US government debt.
As part o its new global economicpolicy, China has launched a policy
to internationalise use o the RMB viaoshore centres. This strategy permitsoshore RMB to be used internationally
without opening access to the Chinesedomestic market. Gradual capital accountliberalisation allows China to reap the
benets o wider use o its currencybut not unleash potential domesticdiculties in its developing nancial
system. Improving the fexibility o the
pegged RMB exchange rate that is closelyaligned with the US dollar is important as
historically-low US interest rates, expectedto be held near zero until at least mid2015, are anticipated to boost capital
infows to the higher interest rate Chineseeconomy. This has the potential to leadto asset bubbles and increase infation.
Internationalising the RMB and increasingthe RMB exchange rates fexibility willthereore be central in the new phase in
helping China to manage these issuesand keep its economy on a stable ooting.
Highlighting this structural shit inthe major policy document o its 12thFive Year Plan (2011-2015) and the
World Bank and Chinas State CouncilDevelopment Research Centres China2030 report, China is careully planning
the key steps to reorm its economyinternally and externally and so set itselon an assured path to continued growth.
Value Source: Bloomberg
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
Jan-12
May-12
Sep-12
ValueofFXreserves($bn)
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Graph 2: Chinas foreign exchange reserves, 2004 2011
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> 1.2
Re-balancing the economyInternally, a key step is re-balancing theareas o growth in its economy. IncreasingChinas stability, this will allow it to
develop an economic structure closer tothat o the only world economy larger thanit the US. Despite the US being one o
the worlds top three traders, its economyis largely driven by domestic demand.
China started to plan or this in earnestin its 12th Five Year Plan. This joins
structural reorms to re-balanceconsumption and investment with aocus on eciency, requiring Chinato innovate more and develop seven
so-called strategic emerging industries,listed in Section 3.1, to orm Chinas neweconomic backbone. The disruption o
the 2008 international nancial crisisand its impact on Chinas Westernmarkets increased the impetus behind
re-balancing. Chinas overall objective inmaking this adjustment is to transorm itseconomy into a more sustainable model,
becoming large and open like the USand avoiding the volatility plaguing
small, open economies such as thosein developing Asia.
To re-orient towards domestic demandmeans, in practice, boosting consumption
in China and reducing the savingstendencies o Chinese households andcompanies. Chinese consumption ellrom around 50% o GDP in the 1980s
and early 1990s to nearly one-third by thelate 2000s. Simultaneously, total savingsrose. In contrast, developed economies
consumption is typically above this, atbetween 50% and two-thirds o GDP.
To change Chinese household andcompany saving habits requires changes
to Chinas nancial system, including
acilitating bank/capital market creditor private companies. At present, an
under-developed nancial system andscarcity o unding sources means thatChinese banks rely heavily on deposits.Consequent concern over banks and
their legacy o non-perorming loansindicates the need or reorm anddictates the gradual approach to opening
Chinas capital account and RMBinternationalisation. To move aster isto risk imploding the domestic
economy as money may leave Chinasnancial system.
China is increasingly affecting the global
terms of trade as it promotes domestic
consumption, internationalisation of the RMB,
targeted foreign investment into China and
significantly escalating outbound Chinese M&A.
Fang Jian
National Managing Partner China
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This too explains Chinas preerence or
a gradual approach, leading it to createoshore RMB centres, rst in Hong Kongrom July 2010 and subsequently in
London, Singapore and, most recently,Taipei, rather than undertaking a greater,immediate loosening o capital controls.
Gradual capital account liberalisationshould also impact Chinas exchangeand interest rates, moving towards
these being market, not government,set. Feeding back into Chinas domesticeconomy, rates in the oshore pool and
the domestic economy should moveever closer.
The RMBs increasing prominence mayultimately propel it to be a global reservecurrency. Even i not a key Chinese
objective, despite the attendant benetssuch as lower borrowing costs, thismay be an inevitable consequence o
the RMBs globalisation and potentialto rival the US dollar. Some centralbanks, or example in Arica, already
hold RMB reserves. For China, reormo its nancial and monetary policy andinstitutions, which may contribute to theRMB attaining reserve currency status,
is necessary rst and oremost to benetthe Chinese economy.
> 1.3
Internationalising the RMBExternally, key areas o ocus areinternationalising the RMB and reormingChinas capital account. Fundamental in
achieving this is increasing the RMBsuse in cross-border trade settlement byusing it as an invoicing currency and
promoting currency swaps which usethe RMB as the payment currency. Asnoted in Section 2.1, the proportion o
Chinas worldwide trade settled in RMBhas grown signicantly since 2009.Simultaneously, China has agreed an
increasing number o bilateral currencyswaps with its trading partners. By 2020,China aims to have developed RMB use
in trade nance, project nance andFDI, and expanded the RMB bond andderivatives markets to support this.
Capital fows, outward and inward, havegrown steadily since China acceded
to the World Trade Organisation inDecember 2001. As shown in Section2.3 and Chinas relaxation o capital
controls, China is increasinglyliberalising its capital account. This
supports its policy to promote outboundFDI in order to overcome the middleincome country trap. But much moreremains to be done and how ar to
open the capital account is undecidedas China worries about the potentiallydestabilising eects o short-term
portolio capital or hot money fowsseen in the 1998 Asian nancial crisis.But, or longer-term investment such
as FDI and M&A, subject to stateapproval, the capital account is graduallyopening and supported by the move to
internationalise the RMB. China will useits oreign exchange reserves to nanceoverseas M&A deals, which also helps
to reduce its accumulation o reserves inWestern government debt.
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> 1.5
China outbound investmentChinas successul outboundimplementation o its going globalpolicy is key. Recognising that its
growth will slow in the coming decades,and wary o alling into the middleincome country trap, China aims
to upgrade technologically, developglobally competitive rms and produceinnovation. In practice, this means
having companies that can learn, operateand compete in developed markets andcompanies that acquire internationally
recognised brands, bring them back toChina and develop the domestic market.Countries that have joined the ranks o
rich nations, such as Japan and SouthKorea, share this trait. China is keen toemulate them and do the same.
A continuing staple ingredient inachieving continued growth including
re-industrialisation and upgradingexisting productive capacity is Chinasneed to secure commodities. But China
is increasingly reaching beyond this,acquiring a broader range o assets in
line with its 12th Five Year Plan. Thisincludes buying more global brandsand overseas technology and promotingChinese service industries such as
banking. The dawn o a second Chineseindustrialisation, ocused on upgradingand development, will have ar-reaching
global consequences.
> 1.4
China inbound investmentChinas continuing drive to pull in oreigninvestment is key. By opening sectorsstrategically important to it to oreign
ownership, China aims to gain overseasexpertise, upgrade its economy and somove up the value chain. This also helps
China to maintain its employment ratein the ace o low-cost manuacturingtranserring rom it to economies with
lower labour costs. Favoured sectorsinclude the seven strategic emergingindustries identied in Chinas 12th
Five Year Plan and others expected toboost domestic consumption, sore-balancing its economy, and help
China meet its social goals, such asincreasing urbanisation and improvedpublic healthcare and pensions.
Inbound investment in other sectorswill continue, but may in practice berelatively more challenging.
China needs to oster conditions to supportthis policys practical requirements.
Continuing to develop the Chinese legalsystem to increase its transparency and
meet oreign investors expectationsis undamental. New M&A and anti-monopoly laws go some way to addressthis, but work remains to be done.
An integral part o Chinas growthover the last thirty years, inbound FDI
remains important or China to shapeits economic development over the nextthirty years. In the last decade inbound
FDI has risen rom $72bn in 2005 toover $123bn in 2011. This signalsthe importance to China o securing
targeted inbound oreign investment and
expertise as it strives to move away romits role as the worlds manuacturer to a
globally competitive, balanced economy.
Outbound FDI has increaseddramatically since the mid 2000s whenthe rst commercial investment by a
Chinese rm was permitted with TCLs2004 purchase o Frances Thomson.Subsequent outbound FDI has increased
rom $12.3bn in 2005 to over $65bnin 2011, representing a 428% increaseover this six year period. China could be
on track to demonstrate that its industrialcapacity is not only a unction o oreigncompanies purchasing its exports,
but also indicates more widespreadupgrading o its industry. Chinascompanies increasingly going global
points to a policy aim being realised.
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2. Internationalising the RMB
An internationalised RMB
the currency o the worldssecond largest economy andlargest trading nation has thepotential to reshape the globalnancial landscape.
For CFOs and corporatestrategists, this means decidingwhen and how to engage withthe RMB, decisions complicatedby the absence o a published
Chinese roadmap and Chinasunique position. Chinese capitaland currency controls protect adeveloping domestic economynot yet ready or internationalexposure. Driving creation ooshore RMB nancial centresand impacting the developmento RMB nancial products, thechallenges ahead are complexand distinctive.
> 2.1
Increasing trade settlementin RMB
Chinas unprecedented move tointernationalise its currency started to gain
traction in 2009 as China concentratedon redenominating its trade fows intoRMB. Establishing a limited RMB trade
settlement pilot scheme within Asia inJune 2009, it quickly expanded this to therest o the world in June 2010 and nallyextended it to all Chinese enterprises in
August 2011. As the scheme grew, so didthe proportion o Chinas worldwide trade
settled in RMB rom less than 0.5%in 2009 to 8% in 2011, and 10-15%or 2012 (graph 3). Already displayingstriking growth, up to one-third o all
Chinas trade and up to hal o its tradewith developing countries has beenpredicted to be settled in RMB by 2015.
The advantages to China are clear.Increasing use o its own currency
or trade settlement reduces oreignexchange rate risk and transactioncosts. More undamentally, the macro-
economic reasons underpinning Chinas
internationalisation o the RMB, outlinedin Section 1, reveal the range o benets
anticipated. Taken together with theunderlying political drivers, the Chineseauthorities cannot allow the RMBs
internationalisation to ail or be reversed.This is evidenced in their continuingpublic commitment, irrespective o
changes in the Chinese leadership.
Chinas currency: at a glance
Overview: in practice, the terms
renminbi, yuan, RMB and CNYinterchangeably indicate Chinascurrency. The key distinction is
between CNY, denoting currencydeliverable onshore, and CNH,denoting currency deliverable oshore.Successul RMB internationalisation
is likely to remove this distinction asthe onshore and oshore currenciesultimately converge.
Renminbi: ocial currency o China;
means peoples currency; issued bythe Peoples Bank o China (Chinascentral bank).
Yuan: primary unit o renminbi; meansround, refecting the coins shape.
RMB: abbreviation o renminbi.
: currency symbol or yuan.
CNY: code or RMB deliverableonshore mainland China.
CNH: code or RMB deliverable
oshore in Hong Kong; distinguishesonshore rom oshore currency
in clearing and settlement systems;promotes incorrect perception oseparate currency.
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Driven by market forces, the RMB is taking
off as a major world currency increasingly
used to settle trade, fuelling RMB financial
products growth and even held in some central
bank reserves.
Andrew Malcolm
Partner Capital Markets
Graph 3: RMB trade settlement: key landmarks
Key Chinesepolicy
Impact onChinese
provinces/cities
% o Chinascross bordertrade settledin RMB
Pilot scheme
expanded
radically
(June)
Two-way RMBtrade settlement
permitted between(i) participatingenterprises in 20 Chineseprovincesand cities and(ii) rest o world
2%
Pilot scheme
expanded
nationwide
(August)
Two-way RMB
trade settlement
permitted between(i) participating
enterprises in all
China and(ii) rest o world
8%
Pilot scheme
established
(June)
Two-way RMB trade
settlement permitted between
(i) participating enterprises in5 Chinese cities and(ii) Hong Kong, Macau,ASEAN countries
Less than 0.5%
2009 2010 2011 2012
10-15% (projected)
Pilot scheme
ully implemented
Two-way RMB trade
settlement ully permitted
worldwide or allChinese enterprises
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The advantages to Chinas international
trading partners are also clear. Anincreasingly wide geographical distributiono RMB settled trades shows over 20%
o all RMB trades being settled withcounterparties mainly beyond Asia (graph4). This announces a new commercial
reality counterparties are settling tradein RMB because it benets them. Forexample, a oreign company asking a
Chinese exporter or a RMB quote anda oreign currency quote will oten ndthe RMB quote cheaper. Alternatively,
the typically easier and cheaper accessto RMB currency swaps in the oshore
market attracts oreign companies tohedge their exposures and so improve
the transactions overall pricing.
For Chinese trade to be redenominatedsuccessully and broadly into RMB three
key points must be addressed. First,the oshore currency must be availableglobally: China trades globally. Second,
the oshore currency must be the sameas the onshore currency. A Chineseexporter receiving RMB in payment rom
the oshore pool must be able to usethose monies onshore to pay wages andbuy materials. Third, an oshore RMB
capital market and pool o liquidity areneeded to acilitate RMB trade fows.This will provide the liquidity, nancing,
hedging and investment products needed
or Chinas trading partners to use theoshore currency.
Hong Kong currently acts as mainlandChinas settlement hub and so provides
the ramework or this. RMB accountsare available worldwide through director correspondent bank participation
in Hong Kongs RMB Real-Time GrossSettlement System (RTGS). Bank o China(Hong Kong) Limited (BoC HK) is the sole
oshore clearing and settlement bank orRMB and controls the fow o RMB intoand out o the oshore pool, so preserving
a single RMB currency. And Hong Kongsaccumulating RMB deposits provide apool o liquidity and a capital market.
As RMB trade settlement has increased,so RMB deposits in Hong Kong have
grown, rom only RMB90bn ($14bn)in June 2010 to RMB627bn ($99bn)in November 2011. But then they
contracted in the next ve months by12%. This has renewed debate about howliquidity in the oshore RMB pool can
grow. Chinas continuing trade surplusmay appear to drain the oshore pool asthese RMB monies fow back to China,but in act China looks set to increase
this pool via its growing dealings withdeveloping markets, with whom it has
a net trade decit. There is the addedpotential to increase RMB capital fowsthrough Chinas increasing outboundinvestment, as discussed in Section 4,
particularly as the regulatory rameworkor using RMB in outbound investment isalready in place. These outbound RMB
capital fows, by investment or nancings,will grow the oshore pool.
Graph 4: Geographical distribution of RMB settled trades
Source: PBoC/BBVA ResearchNote: As of end-January 2012
Hong Kong
Singapore
Taiwan
Japan
Macau
Others
63.6%
7.7%
2.6%
2.5%
2.4%
21.1%
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> 2.2
Growth o RMB nancialproducts
With an oshore RMB pool oliquidity a prerequisite to successul
internationalisation o Chinas currency,attention is shiting towards growingthis via an increasing range o RMB
nancial products.
The oshore RMB bond market is
fourishing, with strong volumes o RMBdenominated bonds issued oshoresince 2010 (graph 5) and an increasing
geographical spread in issuers (graph6). So-called dim sum bonds, RMBdenominated bonds issued by Chinese
or non-Chinese companies in oshoremarkets, have been issued in HongKong since 2010 and, more recently, in
London. It is now common or issuersin Asia, Europe and the US to add RMBas a drawdown option to their medium
term note (MTN) programmes. Tradenance in the orm o RMB denominatedletters o credit and actoring acilities is
available. A market or RMB denominatedloans is developing, supported by a
maturing interbank rate. Diversicationinto more structured products continues,or example with a RMB denominatedREIT listed in Hong Kong in 2011 and
successul RMB denominated Islamicsukuks in 2011 and 2012 highlightinginterest among Gul investors.
Chinas Ministry of Finance has shown clear
support for the growing offshore RMB bond
market with its multi-tranche sovereign RMB
bond issues to benchmark the market.
William Liu
Partner Capital Markets
Graph 5: Dim sum bond issuance, 2008 2012 (1 October)
Source: Thomson Reuters
2008
$0.879bn
2009
$1.903bn
2012 (to 1 October)
$11.378bn2011
$17.944bn2010
$5.987bn
Graph 6: Dim sum bond issuance by issuer, 2011 2012 (1 October)
Dea
lvalue($m)
Germ
any
US
Fran
ce
Sout
hKo
rea
Japa
nUK
Singa
pore
Taiw
anIn
diaUA
E
Austr
alia
Mex
ico
Swed
en
Neth
erlan
ds
Austr
ia
Caym
anIslan
ds
Mala
ysia
New
Zeala
ndBr
azil
Vietn
am
1,400
1,200
1,000
800
600
400
200
0
Source: Thomson Reuters
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This expansion has varied implications.
First, there is a high level regional/jurisdictional divergence in approach. Asialeads the pack in product take-up, with
some jurisdictions, such as Singapore,Japan and Korea, showing strong RMBdeal fow, and others, such as Thailand,
Australia and Indonesia, at earlier stageso indicating interest. Europe seesemphasis on RMB drawdown options
under existing MTN programmes but agrowing number o standalone RMB deals.Second, greater product usage, coupled
with changing expectations in relationto slowing RMB appreciation, is moving
RMB capital markets to internationalstandards. Exhibited in an increasinginvestment grade/high yield split, bondissues are now likely to be allocated to
the appropriate part o the market andappropriate credit enhancement taken rom onshore guarantees and Chinese
bank-issued letters o credit to keepwellagreements and letters o support. Third,market participants increasingly need to
develop a practical response to uniquelyChinese issues. A key example is the useo currency allback clauses, providing
that contractual RMB payments canbe made in another specied currency,such as Hong Kong or US dollars, i a
Chinese currency-related disruption eventoccurs. With ull internationalisation o theRMB, the need or this provision shoulddisappear. In the meantime, parties will
need to consider the appropriate approachto such a provision on each transaction.
Hong Kong remains the current worldcentre or RMB product development,
so giving rise to a misplaced perceptionthat the oshore RMB is a Hong Kong-based market. Even market terminology
augments this perception, or examplewith the tag dim sum bond reerringto a Hong Kong snack and so giving this
product a local eel. Yet the reality is o anincreasingly global picture.
London is being promoted as a tradingcentre to harness its nancial prowessto make available both the RMB as a
currency and RMB nancial products
in the European time zone. Followingthe January 2012 announcement by the
Hong Kong Monetary Authority and theUK Treasury o a private sector-led orumto develop the oshore RMB market in
London, steps have already been takento substantiate this, or example with aRMB2bn dim sum bond issue by HSBC inApril 2012. Oering deep, sophisticated
and leading capital markets as well as abridge to Europe and the US, London isopening a channel or trade settlement
in RMB which in turn will promote theRMBs growth. Other nancial centres
too play key roles. Paris has seen a spate
o dim sum bond issuance by French
issuers. Singapore was picked by Chinain July 2012 as a new RMB clearingcentre, with a Chinese bank authorised to
clear RMB there. Expected to oer costbenets and route more RMB trade fowsthrough Singapore, this has the potential
to develop Singapore into the regional hubor RMB services to south-east Asia, socapitalising on Singapores existing strong
trade links with this region. Most recently,Taiwan has established an agreement orone o Chinas banks operating in Taipei
to oer RMB there.
Development o the oshore RMBnancial markets is gradual. IncreasingRMB trade settlement encourages banksto provide RMB nancial instruments
necessary to underpin wider use oChinas currency. In turn this promotescapital markets growth, and so on. The
pace o development over the past twoyears demonstrates that the RMBsinternationalisation is well under way.
While there remains much urther to go,the logical conclusion is convergence ultimately the oshore pool and the
onshore capital markets will merge, with
ull convertibility o the RMB.
RMB denominated derivatives as
investment products, not just
hedging instruments, are a key
growth area in the RMB financial
product range.
Chin-Chong Liew
Partner Capital Markets
London offers China numerous advantages not least a time zone which bridges Asia,
Europe and the US and, critically, deep and
leading financial markets to develop RMB
financial products.
Nigel Pridmore
Partner Capital Markets
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> 2.3RMB: ully andreely convertible?
The inconvertibility o the RMBis probably the single mostsignicant obstacle to its continuing
internationalisation. The act that it is notreely convertible means, to many, thatliquidity must be a problem, that capital
controls bar access to RMB denominatedassets, that the oshore RMB is notreal Chinese currency and thatinternationalisation cannot succeed until
the capital account is opened. The saercourse, runs this school o thought, is toawait ree convertibility beore engaging
with the Chinese currency.
The reality is signicantly more nuanced.Since August 2011, the RMB is eectivelyalready convertible on the current
account, albeit at the ocial exchangerate. This is the result o expanding the
trade settlement scheme to cover thewhole o China and trading counterparties
worldwide. In the oshore market, theRMB is reely convertible or any purposeas settlement through Hong Kong alls
outside the jurisdiction o Chinesecurrency controls. China does, however,maintain capital controls and these
remain a constraint on convertibility. Yeteven here, with China wary o opening itscapital account or the reasons discussed
in Section 1.3, the pace o liberalisationhas picked up considerably, as Chinasrelaxation o capital controls shows.
Chinas relaxation o capital controls
Inbound Outbound
2006 Qualied Financial Institutional Investors (QFII) regime
(introduced 2002) expanded.
Qualied Domestic Institutional Investors (QDII)
regime introduced.
2007 QFII quota tripled to $30bn.
2010 Limited access to PRC bond markets or designatedoshore banks.
2011 RMB QFII (RQFII) regime introduced. RMB overseas direct investment regime established.
No regulatory approval required or cross border RMBloan to oreign invested enterprise (FIE); approvals orRMB capital injection streamlined.
Pilot schemes announced in Shenzhen and Wenzhou oroutward remittance o RMB.
2012 QFII quota raised to $80bn.
Qianhai Shenzhen-Hong Kong Modern Service IndustriesCooperation Area announced.
Qianhai announcement includes outward remittance oRMB project loans.
RQFII quota tripled to RMB70bn ($7.95bn).
Although reerences to Chinas tightlycontrolled capital account are common,
channels or capital to enter and leaveChina are, in act, actively promoted,with those or RMB denominated
capital receiving particular attention.For example, 2012 has seen increasingactivity in RMB denominated exchange-
traded unds (ETFs). The rst to belisted in Hong Kong provided ordirect investment in mainland China
stock markets and attracted a marketcapitalisation o RMB4bn, and twosubsequent ETFs received approval orRMB7bn. Although the ocus to date has
been on the capital markets, this shitsattention to the onshore equity markets,and in sizeable amounts.
Two points are worth emphasising. First,
a key priority since the 2011 expansiono the trade settlement scheme has beenxing the ability o oshore RMB bond
issuers to bring the proceeds onshoreor investment. This resulted in fowsout o the oshore pool. Subsequentcapital account reorm has laid the
ramework or RMB to exit China in orderto swell the oshore pool. Second, theChinese authorities are taking a careul,
gradual approach both to the RMBsinternationalisation and the associatedloosening o initially current account and
now capital account controls. The likelyresult o these reorms is ull, but not ree,convertibility o the RMB. In contrast to a
reely convertible currency, such as theUS dollar, which is convertible without
any regulatory restraint whatsoever, acurrency may be ully, but not reely,convertible in the sense o convertibleon every item o the capital account, but
still subject to a quota, reporting, ling or
similar. This is clearly the direction being
ollowed or the RMB and ts with theneed o the Chinese authorities to protectthe developing domestic markets rom
hot money or short-term portoliofows thought to be de-stabilising or anunder-developed nancial system.
Convertibility o the RMB will not be abig bang event which precedes and
enables the RMBs internationalisation.
Instead, internationalising the RMB isproceeding in tandem with reorm o
Chinas capital account. To wait or reeconvertibility will be to miss the boat. Fullconvertibility is the key landmark and will
indicate that the oshore and onshoremarkets have converged, or examplein oshore RMB exchange and interest
rates providing a reliable guide and matchor onshore rates. This will signal thatChinas domestic markets are in line with
international markets and ready to openully to international participation. Theconsequences o this process or capital
fows, particularly the fow o capital out oChina, are discussed in Section 4.
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> 2.4Potential revolution in RMBsettlement systems
Another practical actor drives Chinascapital controls and currency strategy the need to keep distinct currency which
is oshore and currency which is part oChinas domestic money supply.
Currently managed by BoC HK actingas sole clearing and settlement bank oroshore RMB, the system allows oshore
RMB to be truly oshore mainlandChina and ree o all onshore controls.Other currencies which have attempted
a measure o oshore use, such as theJapanese yen and the new Taiwanesedollar, have created a rule-bound system
o oshore accounts which are part o thedomestic settlement system. As shown ingraph 7, Chinas use o Hong Kong means
that oshore RMB is identiable becauseit settles in Hong Kongs RMB RTGS,outside the Chinese domestic system
CNAPS. An electronic link between thesetwo systems allows a regulated passage
or unds to pass into and out o theoshore pool.
This settlement system has worked well.Its fexibility was conrmed when Londontook on a new role as an oshore RMB
trading centre in early 2012. Accessto the oshore pool is provided simplythrough the existing inrastructure in
Hong Kong, with the system stayingopen until 11.30pm local time rom July2012 to provide real time access during
Londons trading day.
But the current set-up presents
bottlenecks. Oshore settlement is doneoutside the purview o Chinese oreignexchange and capital controls on the
books o BoC HK. Concerns about creditconcentration risk were addressed byintroducing a nightly sweep or unused
unds to a duciary account maintainedwith PBOC, giving access to centralbank credit. But this lacks transparency
and is operationally cumbersome. Alltransactions in the oshore currency mustalso be settled with commercial bank
money (a claim on BoC HK) rather thanwith central bank money. This eaturealone disbars the RMB rom eligibility or
settlement through the CLS system whichhandles the majority o internationalsettlement in eligible currencies in
central bank money.
Graph 7: The present: offshore RMB settled indirectly via BoC HK
Central bankPeoples Bank o China
Onshore
Clearing
Agreement
Omnibus Client Account
Deposits with PBOC
Oshore
Settlement Accounts
Commercial bankBank o China Hong Kong
FA SA
Fiduciary Accounts
Commercial bank
Individual/
corporate
account
Individual/
corporate
account
Commercial bank
Individual/
corporate
account
Individual/
corporate
account
FA looksthrough
to PBOC
*as at end o December 2011 (HKMA)
Hong Kong RMB
RTGS System
187 participating banks
across 30 countries in6 continents*
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In April 2012, PBOC announcedits intention to create a new China
International Payments System (CIPS).This could prove to be a decisive catalystor acceptance o the oshore RMB as a
major world currency. Details are scant,but the systems announced eaturesare that it will be a modern electronic
system operated by PBOC, separate romthe domestic CNAPS but linked to thisto permit transers between the two and
reserved or the oshore currency,with access limited to international
banks. Most importantly, it will allowsettlement o transactions in the oshorecurrency backed directly by central bankmoney. Graph 8 indicates how it is likely
to operate.
The announced implementation timeline
is an ambitious two years. I CIPS isdesigned to use international SWIFTmessaging protocols, to allow CLS
eligibility and to provide or nality osettlement, its implementation could bethe operational advance which will truly
globalise the RMB.
Graph 8 notes:
> CIPS structure/operation: to be conrmed diagram is indicative only
> Key eatures: (i) link domestic and overseas participants directly, (ii) adopt
global standards
> Languages: multiple, including Chinese and English
> Time zones: 17-18 working hours
> Announced: April 2012
> Intended operational date: mid 2013-2014
Graph 8: The future: offshore RMB settled directly with PBOC
Onshore
Graph 8: The future: offshore RMB settled directly with PBOC
Oshore
Individual/
corporate
account
Individual/
corporate
account
Individual/
corporate
account
Individual/
corporate
account
Individual/
corporate
account
Individual/
corporate
account
China
International
PaymentSystem (CIPS)
Commercial bank Commercial bankCommercial bank
Central bankPeoples Bank o China
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3. China inbound investment
Inbound oreign investment
has been a core strategic toolin Chinas growth over the lastthirty years and, as China looksahead, remains important.But China is now adoptinga more targeted approach,prioritising certain sectorsand regions. Inbound M&A inpreerred areas is acilitatedand encouraged. Added to thebroader backdrop o a business
environment sometimesdicult to navigate, it is key ororeign investors to analyse thechanging Chinese landscape.
> 3.1
Chinas key inbound regionaland sector targets
Inbound M&A into China was relativelyconsistent between 2005 and 2012,
revealing its continuing importance. Neverdipping below $19bn annually, and thisduring the 2008 global nancial crisis, it hit
a high o over $37bn in 2011. But beneaththe headline numbers, a pattern o diverseinvestment is clear.
Sectors prioritised by China or inbound
M&A are consistent with the seven strategicemerging industries biotechnology, newenergy, high-end equipment manuacturing,energy conservation/environmental
protection, clean-energy vehicles, newmaterials and inormation technology highlighted in its 12th Five Year Plan.
Backed by government incentives to invest,and with oreign ownership thresholdsprogressively relaxed, in these sectors,
inbound M&A has steadily increasedsince 2008 in higher-value addedsectors, whilst being comparatively low
in energy/power and materials (graph 9).
Simultaneously, or the reasons outlinedin Section 1.4, opportunities or inbound
M&A are increasing in sectors givingaccess to the services sector, an areapromoted by the Chinese government,
ranging rom consumer staples, cars andpharmaceuticals to nancial products. Forexample, oreign investors have acquired
well-known Chinese retail brands, includingUS Yum!s 2011 $566m acquisition oChinese restaurant chain Little Sheep.
Graph 9: China inbound M&A by target sector, 2005 2012
Dealvalue($bn)
Numberofdeals
Energy and Power
Deal count
Materials Financials Telecommunications Industrials
Consumer staples Real Estate High technology Other
40
35
30
25
20
15
10
5
0
700
600
500
400
300
200
100
0
Source: Thomson Reuters
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
18 Chinas growth on the world stage
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Chinese regulation, foreign ownership rules,
regulators attitude and government incentives
all help steer foreign investment to areas
strategically important to China.
Betty Yap
Partner Head o China Practice
Joint ventures marrying foreign technologyand premium products with local Chinese
manufacturing knowhow and distribution
networks offer potential to innovate and
unlock new markets.
Simon PohPartner Corporate
Where China may once have rejected
such transactions, as with Coca-Colas2009 ailed $2.4bn acquisition oHuiyuan Juice, recent strategic oreign
M&A investments have been more, iconditionally, accepted. This gradualapproach is replicated in Chinas
incremental liting o oreign investmentrestrictions in dierent sectors, orexample in its recent adjustments
to its Foreign Investment IndustrialGuidance Catalogue. Regulatory changesinclude initiating practical alternatives
to traditional models. For example,new Chinese regulations permit oreign
invested limited liability partnerships tobe established. Providing a more fexibleinvestment approval process than thato the traditional xed asset-centred joint
venture model, this structure acilitatesinbound M&A in the services sector keyto China as it seeks to sponsor innovation
and move up the value chain.
Internationally, China has signed a
network o bilateral trade treaties,including with Brazil, Russia, the USand the UK, and agreements with Hong
Kong, Macau and Taiwan, to support
inbound M&A. Coupled with internationalinvestors access on preerential terms to
certain sectors, consistent with Chinaspriorities, in certain areas, such asinterior regions away rom the developed
eastern seaboard, this enables China todirect oreign investment to sectors andgeographies important to it. This strategy
oers oreign investors clear opportunitiesor inbound M&A.
> 3.2
Addressing challenges ininbound M&A
Despite attracting high volumes oinbound FDI, China can be a challenging
market or international companies topenetrate. Key to allowing them to exploitthe opportunities oered and develop
successul Chinese operations, and Chinato win oreign investment essential orupgrading its economy, is addressing
these challenges practically.
First, China is still developing its legal
system to meet oreign investorsexpectations o clarity and certainty.With current discretion on applying
rules and sometimes opaque decision-making, or example in the Ministry oCommerces (MOFCOM) imposition o
competition clearance conditions withoutaccompanying analysis, uncertaintyoten prevails. Chinas reorms to date,
including modernising the court system,appointing more sophisticated judgesand introducing a thirty day minimum
consultation period or new legislation,improve the position but work remains to
be done.
Second, oreign companies may ndit more dicult to invest in sectors not
earmarked by the Chinese government.For example, mandatory requirements toorm joint ventures with Chinese partners
and ownership restrictions in certainsectors, including nancial services, mayinhibit oreign investment. In response,
China needs to continue to re-assess itsapproach to required approval levels.
Third, China historically does not havea ully robust regime or protectingintellectual property, a key concern
or oreign investors required to
transer technology to obtain Chinesemarket share as part o joint venture
agreements, so helping China to upgradetechnologically. In reply, China hascontinued its eorts in enorcing oreign
investors intellectual property rightsparticularly ater adopting strict WTOstandards upon its accession in 2001.
For example, Michelin in 2010 andHonda in 2011 scored Chinese courtvictories in protecting their names, marks
and logos. But there remains more to doin this area.
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Finally, an overall perception o abusiness environment unriendly tointernational investors sometimes exists.
From preerential treatment o domesticenterprises to stricter law enorcement,oreign investors can ace signicant
diculties. For some, ultimately this,coupled with rising labour costs, meanswithdrawing rom China or divesting/
licensing parts o their operationsto Chinese companies. For others,identiying sector-specic opportunitiesand oering strategic partnerships or
acquisitions conerring essential knowhowis the key to success.
A deepening appreciation of each others
priorities and the unique features of Chinese
M&A will aid successful deal execution.
Nicola Mayo
Partner Corporate
> 3.3
Strategies or successForeign investors adopt dierent strategiesor investing in Chinese state-ownedenterprises (SOEs) and private companies,
shaped around their unique eatures.For SOEs in core industries, ull oreignownership remains out o reach. Instead,
acquisition o stakes is possible, with evensome examples o a oreign investor buyinga majority stake, as in Carlsbergs 2010
RMB2.38bn successul bid to becomethe largest shareholder o state-ownedChongqing Brewery. Other inbound M&A
opportunities include acquiring SOEnon-core assets, divested as China seeksto break state monopolies, energise the
private sector and uel uture economicgrowth, and partnering with SOEs in sectorsneeding inbound technology transer.
Private companies oer greater inboundM&A opportunities. Free rom SOE-related
restrictions, Chinese private companiesare increasingly owned and managedby an overseas educated/experienced
second generation. As a new breed oChinese entrepreneur evolves, more open
to and knowledgeable about internationaltechnology and business, oreign investorsare able to deepen their relationships withChinese private companies to the benet
o both.
It is important to recognise that Chineseparties have a dierent overall approach
to M&A transactions to that o theirnon-Chinese counterparts. This aectseverything rom the style and content onegotiations to dispute resolution and
enorcement expectations. Whilst theChinese business community is steadilyaccumulating international deal experience,
Chinese parties do thereore still ace manychallenges in deal execution. They are notnegotiating in their mother tongue. They are
typically not ully amiliar with internationalM&A documentation, based on English orUS models. Conversely, the law governing
such documentation is typically Chinese.
To achieve success, this requires thenon-Chinese party to invest time acrossall management levels in developing adeal structure, process and style which
ts the Chinese party and acquiring moreknowledge o Chinese law and practice.The Chinese party will correspondingly
need to invest time in understandingWestern processes and documentation.This inevitably requires both sides to adjust
their expectations.
As Chinese law typically governs China inbound
M&A documentation, it is key for international
investors to expand their knowledge of Chinese
law and practice.
Richard Gu
Senior Consultant Corporate
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4. China outbound investment
Despite launching its going
global policy in 2000, Chinaonly saw real progress in itsoutbound investment in thesecond hal o the decade.Since 2005 China has investedover $327bn in outboundM&A and its share o globaloutbound M&A has grownrom 0.8% in 2005 to 5.5% in2011 (graph 10). A closer lookreveals a more complex picture
as Chinas outbound M&Astrategy continues to evolve ina changing global landscape,where opportunities abound andgrowth potential is signicant.
> 4.1
Chinas key outbound regionaland sector targets
Initially Chinas expenditure on globaloutbound M&A was modest, at just
$9.4bn in 2005. But rom 2006 itrocketed, doubling year-on-year beorepeaking at $70bn in 2008. With the
2008 international nancial crisis,China reined in its investment. Pullingback to $47bn in 2009, it levelled outat $54bn in 2010 and $57bn in 2011,
indicating sustained commitment tooutbound M&A but recognition o
seismic international changes.
Chinas regional targeting refects thisstance (graph 11). Its three main target
regions in this period were the rest oAsia attracting almost $100bn, theAmericas attracting over $73bn, and
Europe attracting $68bn. Chineseoutbound M&A in the rest o Asia peakedin 2008 at $45bn but then plummeted
to just $10bn and $11bn in 2010 and2011 respectively. As Chinas investmentin Asia decreased, so its investment in
the Americas and Europe increased. Bothregions display signicant growth, withChinese outbound M&A in the Americas
in 2012 already rivalling its 2010 high o
$30bn and Europe attracting just under$17bn in 2011.
Graph 10: Chinas share of global cross border M&A, 2005 and 2011
6%
5%
4%
3%
2%
1%
0%
Source: Thomson Reuters
Chinasshareoftotalcross-borderM&A%
Outbound Inbound
2005 2011
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Backed by Chinese bank lending, Chinas strong
interest in Africa and Latin America targets
natural resources key for Chinas economy.
Thomas Ng
Partner Banking & Projects
In Australasia and Arica, China has
spent less. From 2005 to 2012, Chineseoutbound M&A totalled $28bn inAustralasia and approaching $20bn in
Arica. Australasia has seen growinginvestment, rom $2bn in 2007 up to$10bn in 2011. In Arica, investment has
been more contained and consistent.Although limited in 2008 and 2009, Chinasoutbound Arican investment has been
between $4bn and $6bn in other years.
In brie, China has grown its presence in
every region. Fundamental in progressingtechnologically and producing globally
competitive rms, so avoiding the middleincome country trap described in Section1.1, is its global investment in developedand emerging markets alike.
Graph 11: China outbound M&A by target region, 2005-2012
Dealvalue($bn)
Numberofdeals
Asia excl. China
Deal count
Americas Europe Australasia Africa Middle East
80
70
60
50
40
30
20
10
0
300
250
200
150
100
50
0
Source: Thomson Reuters
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
Graph 12: China outbound M&A by target sector, 2005-2012
Dealvalue($bn)
Numberofdeals
Energy and Power
Deal count
Mater ials F inancials Telecommunicat ions
Industr ials Consumer staples
80
70
60
50
40
30
20
10
0
300
250
200
150
100
50
0
Source: Thomson Reuters
Other
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
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Spotlight on Canada and Brazil
In Canada, Chinese M&A investment,growing rom $153m in 2005 to$18.7bn in 2012 (to date), targets
Canadian energy/mineral assets.Landmark deals, such as ChineseCNOOCs 2012 announced $15.1bn
acquisition o Canadas Nexen,stand against a backdrop o smallerChinese acquisitions o Canadian
natural resources. Despite Canadastraditional openness to investment, akey issue is its attitude to such deals.
Canadas 2010 blocking o BHP
Billitons proposed $38.6bn purchaseo Canadas Potash Corporation
highlights the potential to stopcertain transactions.
In Brazil, which has receivedover 65% o Chinas $33bn M&Ainvestment into Latin America since
2005, a range o assets holds appeal.Displaying increasing diversicationthrough its acquisition o Brazilian
industrials, consumer staplesand high technology, China hasnonetheless avoured energy/power
and materials in Brazil.
Graph 13: China outbound Australia M&A by target sector, 2005-2012
Dealvalue($bn)
Numberofdeals
Energy and Power
Deal count
Materials Financials Consumer staples Other
10 50
45
40
35
30
25
20
15
10
5
0
Source: Thomson Reuters
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
9
8
7
6
5
4
3
2
1
0
Graph 14: China outbound North America M&A by target sector, 2005-2012
Dealvalue($bn)
Numberofdeals
Energy and Power
Deal count
Materials Financials Industrials Other
30
25
20
15
10
5
0
60
50
40
30
20
10
0
Source: Thomson Reuters
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
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Chinas ongoing imperative to secure
natural resources is clear. O the $327bninvested since 2005, $130bn has beenploughed into energy/power, and $70bn
into materials. These two sectors accountor over 60% o Chinas global outboundM&A in this period (graph 12). As shown
in graphs 13-16 and discussed in theSpotlight on Canada and Brazil, naturalresource-rich countries are among Chinas
prime targets.
By contrast, the nancial services sector
shows more selective investment, with2008 marking a turning point. Beore
the 2008 nancial crisis and ensuingbank ailures, increased bank regulation/capital requirements and investor losses,China invested strongly, with its 2007
nancial services investment totalling$22bn. Collapsing to $6bn in 2008, thishas since been low, at between $2bn
and $4bn annually.
Seeing ewer opportunities in WesternEuropes troubled banking sector, China
has looked mainly south. Since 2008it has made targeted investments inLatin American and Arican nancial
services. For example, in 2011 ChinasICBC agreed to acquire Standard BankArgentina. Seeking emerging markets
expansion, China aims to serviceChinese rms investing in those marketsand to tap into a new local market.
Globally, China is using its nancialservices M&A investments strategically
to complement its other key goals. With
a strong banking network established inWestern Europe, it is now likely to ocus
on increasing this networks capital,so developing its lending platorm orChinese corporates with European
M&A ambitions. Elsewhere, Chinesebanks are opening branches to acilitate
nancings by Chinese bidders and todevelop business with borrowers newto China, including providing nance
in RMB. This both develops Chinesebanks international capability as a tool toacilitate Chinese companies growth on
the world stage and increases Chinesebanks presence in nancings globally.
China is also diversiying into otherasset types. Globally and regionally,it is increasingly targeting a broader
range o sectors, including telecoms,industrials and consumer staples suchas ood/beverage, high technology,
healthcare and retail. This ts with its12th Five Year Plan objective to developthe seven strategic emerging industries
listed in Section 3.1 and shows Chinaimplementing its going global policyas it seeks to innovate, learn in
developed markets and increasedomestic consumption.
Graph 15: China outbound Latin America M&A by target sector, 2005-2012
Dealvalue($bn)
Numberofdeals
Energy and Power
Deal count
Materials Financials Industrials Consumer staples
25
20
15
10
5
0
14
12
10
8
6
4
2
0
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
Source: Thomson Reuters
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> 4.2
Interlocking reasons behindChinas global M&A
The single largest driver or Chinasoutbound M&A is its need to secure
natural resources to support upgradingand developing its industrial capability, asexplained in Section 1.5. Beyond this, the
broadening range o asset types acquiredand deepening reach into more countriesreveal an increasing range o actorsbehind Chinas outbound M&A.
First, China wants to make protable
nancial investments in assets generatingsteady revenue, accessing comparativelywealthy overseas markets. These oer
cash-rich China a welcome alternative todeepening its oreign currency reserves,enabling it to balance its portolio and
achieve a stable return on investment.Inrastructure assets in mature Westernmarkets appeal as they are established,regulated and typically give a good return.
CICs 2012 acquisition o a stake in the UKsThames Water exemplies this trend.
Second, it wishes to acquire well-
known oreign brands and products,together with their related knowhowand technology. Taking these back toChina is intended to unlock a new home
market, tapping into Chinas aspirationsas a growing economy that wishes toovercome the middle income countrytrap. For example, through its 2012
acquisition o a 1.2bn stake in UK-basedWeetabix, Chinas Bright Food aims todevelop this Western ood brand or
evolving Chinese tastes. Similarly Westernluxury brands appeal, oering potential
to open new, high-end markets in Asia.For example, Chinese investors acquiredstakes in 2012 in Italys prototype andsports car manuacturer, De Tomaso
Automobili S.p.A., and Italys luxury yachtmanuacturer, Ferretti S.p.A.
Third, it wishes to enter new countries.This allows China to access new marketsin those countries and to leverage
such investments strategically to openor deepen relationships with otherjurisdictions linked to those countries.
Chinas recent investments in Portugalare a case in point. Through ChineseThree Gorgess 2011 acquisition o a
2.69bn stake in Energias de Portugal(EDP) and Chinese State Grids 2012acquisition o a 387m stake in Redes
Energticas Nacionais (REN), China hasgained new markets in Portugal. But themore signicant benets to China extend
much urther. Three Gorges targetedEDPs broader markets, including Braziland the rest o Europe. Through REN,
State Grid sought to access the wider
European power market and strengthenties with key Arican and Latin Americancountries including Portugals ormer
colonies Brazil, Angola and Mozambique.Both directly and indirectly, this type otransaction integrates China more deeply
into the global landscape.
Finally, China will take advantage o
market conditions. Although Chinasunderlying strategic objectives provide themain impetus or a transaction, a trend o
opportunistic acquisitions is visible. Forinstance, the Eurozone crisis has createdunexpected opportunities. Troubled
Portugal and Italy have attracted ChineseM&A investment recently, with Portugalsorced asset divestment programme ater
its May 2011 EU bailout triggering $6bnasset sales to China in 2011 alone.
The Eurozone debt crisis has afforded China
unexpected opportunities to invest in
countries such as Portugal, so gaining new
markets and strengthening global relationships.
Jorge Bleck
Partner Corporate
Graph 16: China outbound Africa M&A by target sector, 2005-2012
Dealvalue($bn)
Numberofdeals
Energy and Power
Deal count
Materials Financials Industrials
7
6
5
4
3
2
1
0
12
10
8
6
4
2
0
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
Source: Thomson Reuters
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Europe: one country?
Seen rom China, Europe can look like
a single country. With an overarchingEurope-wide political and legal rameworkand a single currency or Eurozone
countries, this perception holds sometruth, but it conceals much.
Individual countries, with their own legaland regulatory regimes, make up Europe.
Aecting matters such as tax, company,competition and employment/pension law,it is essential to be able to navigate each
countrys regime in order to do businessin Europe.
The asset opportunities oered acrossEurope are varied. Italys luxury brands,
Germanys automotive/engineeringstrengths and Western Europeaninrastructure assets all appeal to
Chinese purchasers. In Russia, ChineseM&A ocuses on natural resources,complementing Chinas involvement in
Russian power projects and oil/gas supplyrom major Russian corporates.
From seeking good financial investments to
acquiring foreign brands and knowhow, and
deepening their global relationships, diverse
factors motivate Chinas outbound M&A.
Judie Ng Shortell
Partner Corporate
Graph 17: China outbound Western Europe M&A (i) target country and (ii) target sector, 2005-2012
(i) China outbound Western Europe M&A by target country (ii) China outbound Western Europe M&A by target sector
Dealvalue($bn)
Numberofdeals
20
18
16
14
12
10
8
6
4
2
0
40
35
30
25
20
15
10
5
0
UK
Deal count
Italy
France SwedenPortugal
Netherlands Germany Other
Energy and Power
Deal count
Industrials
Materials Financials
Consumer staples Other
2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
Dealvalue($bn)
Numberofdeals
20
18
16
14
12
10
8
6
4
2
0
35
30
25
20
15
10
5
02005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
Source: Thomson Reuters
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> 4.3
Strategies or successThe structure o a transaction is key toits success. In the early days, Chineseentities tended to seek 100% control
o the oshore target rom day one.But cultural dierences, or example inmanagement style, transer o knowhow
essential to the business and the logisticalchallenge o integrating two very dierenttypes o company present signicant
diculties in practice. Whilst outrightacquisitions still take place, there isthereore a clear trend away rom this.
The structure now consistently preerredis acquisition o a stake in the target(graph 18).
This structure oers the Chinese purchaserclear advantages. It can ease into a new
environment. I the seller remains involved,it may exploit the sellers knowledge o thebusiness, so gaining the expertise it keenly
wants. Finally, it may seek equity step-uprights, with a put/call option, to obtain100% control in the uture.
This structure may also holddisadvantages. It may exclude the
Chinese purchaser rom transactionswhich must be done by outright sale,such as time-critical deals motivated by
nancial distress or government/authority
ordered divestments triggered by theEurozone crisis. Anti-trust issues will
require careul consideration. While aninitial minority interest acquisition maynot trigger competition clearances, the
exercise o subsequent step-up rights mayrequire these.
Given the complementary strengths oChinas SOEs and private equity unds, theChinese government is encouraging these
two groups to join orces on outboundM&A. Acquisition-savvy private equityunds can assist less-experienced SOEs
with deal execution, and capital-richSOEs, in substantially unding theacquisition, can create private equity
investment opportunities. Pointing to agrowing trend o partnership, examplesinclude SOE Sanys January 2012
investment alongside CITIC inGermanys Putzmeister.
Chinese companies have clear
strategic goals when making their
outbound investments, and can often
achieve these through majority or
minority stakes.
Clodagh Hayes
Partner Corporate
Graph 18: China outbound M&A by deal structure, 2005-2012
Percentageofdeals(%)
Minority interest Majority interest Merger Asset Acquisition Other
100
90
80
70
60
50
40
30
20
10
02005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct
Source: Thomson Reuters
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But whether this structure will be wholly
successul remains to be seen. SOEstypically make strategic acquisitions andhave a long-term perspective, whereas
private equity unds seek capital growthand an appropriate exit and take ashorter-term view. A potential solution is
or the SOE to buy out the private equityinvestment, possibly under the terms o aput/call option.
Chinese banks have a key role to play insupporting Chinas outbound M&A. As the
largest banks in the world, with strongerbalance sheets than their European and
North American counterparts, they giveChinese bidders unparalleled access toacquisition nancing. Their balance sheetstrength also allows them to renance
target debt and provide extendedpost-acquisition nancing, an advantagewhich can dierentiate Chinese bidders.
For example, a key actor in Three Gorgeswinning the 2011 bid or PortugueseEDP was the 1bn nancing provided by
China Development Bank to EDP as parto the bid.
Chinese companies need to addresspotential overseas suspicions as to their
intentions post acquisition. With oreignsellers concerned that China may simplyclose the targets existing operations and
migrate all technologies back to China,occasional international reluctance toengage with China may dampen Chinese
outbound M&A. In response, Chinesecompanies are demonstrating morewillingness to commit to the targets local
markets, recognising the need to tapinto the global talent pool, to stay at theoreront o technological development andcompetitiveness, and the levelling playing
eld in labour costs between China and itsinternational competitors.
The acquisition process itsel may requireadjustment to t Chinese purchasers, withthe oten-used Western auction requiring
speed and certainty. With examples oChinese purchasers ailing to acquireassets in auction sales, practical solutions
are essential. International sellers lookingto attract Chinese bidders may need toadapt their processes, possibly introducing
a pre-auction stage to give potentialpurchasers more time or preparing ormore detailed vendor due diligence.
Notably, Chinese sovereign wealth undsare not required to obtain the samegovernment approvals as other Chinese
entities, giving them a comparativeadvantage. Appealing to an internationalseller as they can oer more deal certainty
and aster deal execution, this hascontributed to a trend o outboundM&A investment by these unds asthey couple regulatory advantage and
deepening deal experience.
Increasing Chinese knowledge of the Westernauction process, together with international
sellers adapting their processes to fit Chinese
purchasers, will nurture more successful China
outbound M&A.
Wolgang Sturm
Partner Corporate
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Continuing to extend international sellers
knowledge of Chinese-specific issues, and Chinese
purchasers familiarity with international M&A
documentation, will help address practical
challenges in deal execution.
Peter Goes
Partner Corporate
Finally, the deal execution challenges
discussed in Section 3.3 apply equallyto outbound M&A. Additionally, the lawgoverning outbound M&A documentation
is typically not Chinese but aninternationally recognised law, such asEnglish or New York law. Any change to
this position is likely to take time, requiringa developed Chinese legal regime witha consistent history o interpretation and
enorcement and a large population oplayers amiliar with that regime.
Entities who count Chinese nationalswith international education and deal
experience, or vice versa, among theiremployees have a natural advantage.Conversant with issues o style andsubstance on both sides o the table, and
potentially fuent in Chinese and English,they are best-equipped to handle themyriad challenges o a transaction. In other
cases, practical alternatives can assist. Forexample, using advisers with combinedChinese/international capability and
constantly extending knowledge o eachsides position both have a role to play.
The colour red and the Chinese knot carry special
signifcance in China. Together they symbolise theexpression o good wishes, or everything rom unity
and harmony to prosperity and achievement. The
giving o a Chinese knot in a business relationship
is oten auspicious a way to wish the recipient
every success.Unless stated otherwise, reerences to $ are to US dollars and
reerences to China are to mainland China.
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5. Chinese inbound andoutbound M&A checklist
Deal rationale Key commercial drivers: determine approach to key issues (e.g. deal structure, due diligence,timetable, post-deal integration).
Key attributes (e.g. people, assets, products, markets, licences): check t purpose.
Risk profle Key risks: assess political, sector, compliance risk.
Counterparty Key issues: identiy counterpartys ultimate stakeholders, possible post-deal role, incentives required,oshore assets available as security Chinese enorcement issues.
State-owned counterparty: consider sovereign immunity, potential extra regulatory scrutiny, valuation/
bidding requirements (I).
Investment
restrictions
Key issues: identiy oreign ownership restrictions, investor eligibility requirements, limits on presence(number o joint ventures, permitted investments) (I).
Policy issues Foreign investment issues: consider national security, continuance o incentives/subsidies, targetbusiness licences.
Approvals Key Chinese approvals: identiy approval requirements o MOFCOM/Chinese nancial regulator/otherChinese government or regulatory body, competition clearances Chinese remedies possibly stricter than
US/EU (I), internal approvals, third party consents (e.g. statutory/contractual pre-emptive rights) (I).
Timing: assess impact on timetable o approval requirements.
Acquisition
structure
Key eatures (e.g. onshore/oshore target, equity/asset acquisition, ownership restrictions):determine appropriate structure.
Possible structures: map options (e.g. outright control, majority or minority stake step-up rights/putor call option, joint venture, partnership) to deals requirements.
Tax: identiy withholding tax liability and treatment.
> Chinese inbound and outbound M&A checklist: or non-Chinese market participants
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Financing structure Acquisition nancing: identiy unding required and available sources.
Ongoing nancing: identiy unding required and available sources, debt: equity ratio/thincapitalisation restrictions (I).
Chinese banks: consider potential role as nance provider.
Chinese exchange controls: may impact purchase price remittance.
Due diligence Local practice: determines appropriate approach.
Practical issues: assess timing, extent o available/desired inormation, acilitating role or meetings.
Deal protection Overarching principles: consider appropriate overall investment principles and approach to key
commercial issues.
International warranty package: consider Chinese receptiveness, importance o disclosure to assessdeals risk prole (I).
Price protection: xed price valuation to be nalised early, payments in kind and deerredconsideration restricted in China (I).
International valuation techniques: check acceptable to Chinese party.
IP rights: consider protection in China, registration (I).
Legal issues: check choice o law, dispute resolution arbitration/courts, enorcement options.
Chinese language: translations or language o documents.
Governance Key policy: consider control rights, 50-50 or minority protection.
Local practice: impacts management, governance, step-up/exit rights.
Integration Key issues (e.g. compliance structure, local culture, management, licensing):impact post-deal-integration.
The above checklist highlights issues to be considered on Chinese
M&A, both inbound and outbound. Additionally, points highlighted
with I are or consideration on Chinese inbound M&A only.
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This report has been authored by Linklaters Partners Fang Jian, Andrew Malcolm and Nigel Pridmore and Counsel Kirsty Thomson. Linklaters would like to thank economist
Dr. Linda Yueh or her helpul insights on the economics portion o this report.
This report is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other
areas o law, please contact one o the contacts listed in the report.
6. Key contacts
ChinaFang JianPartnerTel: (+86) 21 2891 1858Mob: (+86) 138 0190 5559
Betty YapPartnerTel: (+852) 2842 4896Mob: (+852) 9183 [email protected]
Tom NgPartnerTel: (+86) 10 6535 0629Mob: (+86) 136 0111 [email protected]
Simon PohPartnerTel: (+86) 21 2891 1828Mob: (+86) 136 0164 [email protected]
Judie Ng ShortellPartnerTel: (+86) 10 6535 0653Mob: (+86) 158 1028 0954
Annabella FuPartnerTel: (+86) 10 6535 0660Mob: (+852) 9010 2494
[email protected] DouglassPartnerTel: (+86) 10 6535 0638Mob: (+86) 138 1125 4265
AustraliaJeremy LowPartnerTel: (+61) 2 9230 4041Mob: (+61) 404 056 479
IndiaSandeep KatwalaRegional Managing Partner EEMEAHead o India GroupTel: (+44) 20 7456 5972Mob: (+44) 7810 794 [email protected]
Indonesia
Sophie MathurPartnerTel: (+65) 6692 5703Mob: (+65) 9657 [email protected]
JapanPeter FrostPartnerTel: (+81) 3 6212 1212Mob: (+81) 90 8487 [email protected]
SingaporeKevin WongManaging Partner SingaporeTel: (+65) 6692 5733Mob: (+65) 9638 [email protected]
Stuart BedordPartnerTel: (+65) 6692 5799Mob: (+65) 9113 [email protected]
ThailandWilailuk OkanurakPartnerTel: (+66) 2305 8024Mob: (+66) 81 828 [email protected]
Nicola MayoPartnerTel: (+86) 21 2891 1848Mob: (+86) 138 1650 [email protected]
Peter GoesPartnerTel: (+86) 10 6535 0618Mob: (+86) 139 1030 [email protected]
Teresa MaPartnerTel: (+852) 2842 4174Mob: (+852) 9020 [email protected]
Tien-yo ChaoPartnerTel: (+852) 2901 5418Mob: (+852) 9660 [email protected]
Pui Hong ChikPartnerTel: (+86) 10 6535 0633Mob: (+86) 139 1089 [email protected]
Richard GuSenior ConsultantTel: (+86) 21 2891 1839Mob: (+86) 136 0160 6156
Hong Kong SARAndrew MalcolmPartnerTel: (+852) 2842 4803Mob: (+852) 9102 [email protected]
William LiuPartnerTel: (+852) 2901 5257Mob: (+852) 9768 [email protected]
Chin Chong LiewPartnerTel: (+852) 2842 4857Mob: (+852) 9303 [email protected]
Hwang Hwa SimPartnerTel: (+852) 2842 4103Mob: (+852) 9108 [email protected]
Matthew MiddleditchPartnerTel: (+852) 2901 5352Mob: (+852) 9017 [email protected]
ASIA
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Regulation Authority.
The term partner in relation to Linklaters LLP is used to reer to a member o Linklaters LLP or an employee or consultant o Linklaters LLP or any o its aliated rms or entities
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www.linklaters.com/regulation or important inormation on our regulatory position.
Linklaters LLP 2012
BelgiumFranois De BauwPartnerTel: (+32) 2501 9410Mob: (+32) 475 461 [email protected]
FranceMarc LoyPartnerTel: (+33) 1 56 43 58 02Mob: (+33) 61624 [email protected]
Gilles EndroPartnerTel: (+33) 1 56 43 58 86Mob: (+33) 61451 [email protected]
GermanyPeter WaltzPartnerTel: (+49) 697 1003 457Mob: (+49) 172 65 35 [email protected]
Wolgang SturmPartnerTel: (+49) 211 2297 7646Mob: (+49) 172 25 36 [email protected]
Sebastian DaubPartnerTel: (+49) 697 1003 140Mob: (+49) 162 24 30 [email protected]
ItalyGiovanni PedersoliPartnerTel: (+39) 02 8839 352 45Mob: (+39) 33569 [email protected]
LuxembourgFreddy BrauschManaging Partner LuxembourgTel: (+352) 26 08 8231Mob: (+352) 691 10 [email protected]
NetherlandsPieter Riemer
Regional Managing Partner Western EuropeTel: (+31) 20 799 6230Mob: (+31) 6 1371 [email protected]
PolandTomasz ZorawskiPartnerTel: (+48) 22 526 5120Mob: (+48) 600 09 [email protected]
PortugalJorge BleckPartnerTel: (+351) 21 864 00 12Mob: (+351) 91 721 31 48
RussiaKim LatypovPartnerTel: (+7) 495 797 9748Mob: (+7) 916 501 [email protected]
SpainIigo BerricanoPartnerTel: (+34) 91 399 60 10Mob: (+34) 60791 [email protected]
SwedenElisabet LundgrenPartnerTel: (+46) 8 665 67 77Mob: (+46) 7032 [email protected]
United KingdomNigel Pridmore
PartnerTel: (+44) 20 7456 4041Mob: (+44) 7584 517 [email protected]
William BuckleyPartnerTel: (+44) 20 7456 3312Mob: (+44) 7748 936 869wil