Geopolitical tensions have by no means doused Chinese enterprises’ enthusiasm for outbound direct investment. However, they are required to be more selective with their targets. Wu Xiaohui, general counsel and chief compliance officer at China Southern Power Grid International, details the key indicators for measuring the investment viability of a target country or region
OUTBOUND INVESTMENT refers to an investing entity acquiring ownership, operating and management rights, and other related rights and interests in an overseas company or assets by investing money, negotiable securities, physical goods, intellectual property, technology or asset rights such as equity or claims, or by providing security.
Given the unfamiliar economic, cultural and legal environments overseas, as well as the complex and constantly changing international political landscape, Chinese enterprises opting to “go global” often find opportunities juxtaposed with crises, and benefits with risks. In this regard, country-specific risk assessment is nothing short of a compulsory course for overseas venturers.
Profiling your targets
To summarise from the assessment data published by the World Bank, the International Monetary Fund (IMF) and the United Nations, the investment climate of a country is determined chiefly by three indicators: political stability, social governance capacity and the level of economic development.
Political stability is the order maintained in a political system. This is the first and foremost factor to consider when assessing outbound investment risks. When selecting an investment target, it is wise to avoid countries and regions with a relatively high likelihood of terrorist activities, violent conflicts, state expropriation, coup d’état or anti-Chinese demonstrations, so as to avoid incurring investment losses or even, in the worst-case scenario, getting wiped out. High political stability of a country often translates into lower investment risks, and vice versa.
Social governance capacity is the ability of a country to apply various systems to manage its multitude of affairs. Good social governance capacity is a key condition for sustainable development and the realisation of shared growth. The four indicators of a country’s social governance index, as published by the World Bank, are government effectiveness, control of corruption, regulatory quality and the rule of law.
Where investment is made in a country with weak social governance capacity, the company may encounter a host of problems, such as corruption among government officials, low efficiency of administrative authorities, deficient laws and regulations and inadequate government regulation, which seriously hamper investment returns.
The level of economic development refers to an attained degree of socioeconomic development. A country’s high level of socioeconomic development is embodied by high consumption demand per capita, regulated and standardised engagement in economic activities and, as a result, lower investment risks.
Furthermore, China Export & Credit Insurance Corporation (Sinosure), having analysed statistics and assessment indicators released by such organisations as the Economist Intelligence Unit, the International Centre for Settlement of Investment Disputes, the United Nations Conference on Trade and Development, the IMF, Forbes and Fitch Ratings along the dimensions of political risk, economic risk, business environment risk and legal risk, divides the country-specific risk levels into three categories: high, medium and low. It also sorts the future risk outlook into three categories (positive, stable and negative) and the country-specific sovereign credit risk levels into four categories (high, medium, low and risk event).
Sinosure additionally puts forward policy recommendations for country-specific risks and develops products, including political insurance policies, to provide robust intellectual and insurance support for Chinese enterprises going global. In particular, Sinosure looks at each type of risk along the following axes:
- Political risk: state governance, political stability, government intervention, social stability and international environment;
- Economic risk: macroeconomy, monetary and financial affairs, fiscal balance, public debt, international balance of payments, and bilateral trade and commerce;
- Business environment risk: measures to attract foreign investment, infrastructural development, the cost of doing business and energy security; and
- Legal risk: rule of law index, dispute resolution, foreign investment access, environmental protection and worker protection.
Keeping risks at bay
Judging from the above country-specific risk assessments, when a Chinese enterprise looks for a lower-risk target country, it additionally needs to consider in advance the issue of risk prevention and control, mainly involving outbound direct investment (ODI) approval in China, foreign direct investment (FDI) approval in the host country, project due diligence and a review of key project agreements.
- China ODI approval
This type of approval primarily involves the State-owned Assets Supervision and Administration Commission (SASAC), the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOC), the State Administration of Foreign Exchange and other regulatory authorities. In the case of state-owned enterprises (SOEs), they also face ex ante, interim and ex post oversight by the SASAC.
Ex ante oversight concerns the SOE’s five-year development plan and annual investment plans, as well as oversight of the outbound investment (prohibited and special oversight) project by means of a negative list. Interim oversight involves random monitoring and inspections of major outbound investment projects. Ex post oversight includes such tasks as the assessment of information submission on, and operation of, the investment project.
The countries and industries targeted for investment are subject to sensitivity tests by the NDRC and the MOC. Approval from both authorities is required for investments in sensitive countries or regions, or in sensitive industries, while other projects require the completion of record filing procedures. If the enterprise needs to exchange currency before outbound remittance, or set up security provided by a domestic bank, it will need to carry out foreign exchange registration with the foreign exchange authority in advance.
- Host country FDI approval
Such approvals can involve foreign investment access, industry restrictions, the foreign investment ratio, foreign exchange policy, localisation requirements, labour protection and tax policies. For some countries, reviews focusing on national security, anti-monopoly measures or countervailing duty may also be added to the mix. Professional agencies offering tax, regulatory or legal advice may be called on to assist in understanding specific issues, ensuring that there are no FDI prohibition issues and the legal risks are in check.
- Due diligence
Due diligence is a process of risk discovery, identification, assessment, and prevention and control. The specifics of due diligence vary, depending on the type of the project, but generally include finance, taxation, regulation, technology, human resources, risks and legal standings.Engaging a suitable due diligence consultant is paramount, as only a project-specific and highly professional due diligence team can ensure that the basic facts and risks of a project are fully discovered and brought to light, and that project risks can be minimised through effective risk control measures to ensure investment success.
For China Southern Power Grid International projects, we determine the scope, criteria and depth of due diligence in light of the nature of the project. Is it an equity acquisition, greenfield investment or an engineering, procurement and construction (EPC) general contracting?
Accordingly, we guide the legal advisor team to fully understand the legal facts of the project and the legal relations between the stakeholders, and review the key agreements through analysis of the legal environment, five major legal relationships and 33 review points. In particular, the relationships consist of those between the investor and China, the investor and the host country, the investor and the transaction counterparty/partner, the investor and the target company/project company, and the project company and the subcontractor. Thus, the team issues its legal opinions and proposes effective legal measures to address risks.
- Transaction structure and key agreements
The chief considerations for a project transaction structure are risk segregation and tax incentives. Depending on the tax incentives, exchange control, the legal environment, financing advantages, divestment convenience and other such factors, an enterprise may consider whether to set up a special purpose vehicle company (and if so, with how many layers), while evaluating if the objective of risk segregation has been attained.
The result of project due diligence and risk control measures should ultimately be reflected and implemented in key agreements, such as the share purchase agreement (SPA), the shareholders’ agreement, the articles of association (AoA) of the target company, the build-operate-transfer (BOT) agreement/concession agreement, the land lease agreement, the power purchase agreement (PPA), and the EPC general contract.
In a share purchase agreement, core clauses are those on the transaction subject, definition clauses, the subject matter of the acquisition, conditions precedents, price adjustment, representations and warranties, termination, breach and damages, governing law and dispute resolution.
In an EPC general contract, core clauses include those on the signatory entities, project details, rights and obligations of the owner and the contractor, representations and warranties, commencement of work, the construction schedule, inspection and completion acceptance, payment, transfer of ownership, insurance, compensation and limitation of liability, breach of contract and remedies, termination, governing law and dispute resolution.
When it comes to these core clauses, it is necessary to strive for “every inch of the ground” to secure beneficial provisions or, failing that, set out clauses that at least achieve a relative balance of rights, obligations and liabilities.
Finally, with respect to the governing law and dispute resolution clauses, preference should be given to the favourable governing law (e.g. Chinese law) and selecting venues such as the China International Economic and Trade Arbitration Commission for institutional arbitration. Even if the other party objects, this can be used as a bargaining chip to compel them to make commercial concessions.
Where Chinese law is not an option for governing law, English law may be a suitable alternative, with English selected as the language of arbitration. This is because, in the event of a contract dispute that goes to arbitration, there is usually no shortage of available lawyers proficient in English law and fluent in English. Also, English law is familiar to most arbitral tribunals.