January 2018 Issue
Driven by the globalisation of the mergers and acquisitions (M&A) market and the emergence of Asia as a key player, global M&A activity reached nearly $5 trillion in 2015. The Asia market, and China in particular, is playing an increasingly important role in global M&A activity with Asian transaction volume nearly tripling from $259bn in 2013 to $735bn in 2015.
However, M&A activity was down in the first half of 2017. This was for three principal reasons: (i) Asian companies have been taking a ‘wait-and-see’ approach; (ii) restrictions have been imposed on capital outflows from China, designed to curb the country’s depleting foreign exchange reserves; and (iii) the politically-charged environment and regulatory hurdles increase implementation risks and complexity, often resulting in deals failing to complete.
Nevertheless, outbound M&A activity increased slightly in Q3 2017, with 2384 announced transactions (compared with 2340 in Q2, representing the second smallest quarterly total of the last five quarters), particularly on lower value but strategically critical investments in the technology and consumer-focused sectors. As China continues to transform its economy from export-driven manufacturing to technology, Chinese companies are looking to acquire North American and European companies to enhance their technological capabilities.
China’s outbound M&A activity totalled $59bn in 2015, an 18 percent year-on-year increase. In the first four months of 2016, Chinese buyers eclipsed 2015 volumes with outbound activity reaching $96bn, a more than fivefold increase over the same period in 2015, and reflecting China’s enthusiasm for ‘One Belt, One Road’ infrastructure projects.
There was a slow start for the M&A market in China in 2017. The increased regulatory oversight governing capital outflows from China put a brake on Chinese investment overseas, leading to a sharp decline in Chinese outbound activity. Outbound M&A transactions are undoubtedly more difficult to complete today compared to the pre-November 2016 period. The increased complexity for outbound transactions is due to the uncertainty created by current regulatory concerns, particularly the need to obtain governmental approval and clearance for funds to be remitted outside China. As a result, the tightening regime has adversely impacted the ability of Chinese bidders to close an outbound transaction; as such, Chinese outbound M&A activity experienced a downturn of 42 percent in the first six months of 2017.
On 18 August 2017, the Chinese government published outbound investment guidelines aimed at regulating overseas acquisitions by formalising previously published rules and unofficial measures. The guidelines classified the types of investments and sectors that are considered ‘encouraged’, ‘restricted’ or ‘prohibited’. The guidelines also noted that outbound transactions falling within China’s ‘Going Out’ policy or ‘One Belt, One Road’ initiative will continue to receive strong governmental support.
As the foreign exchange reserve of China has stabilised and as the renminbi appreciated in the final months of 2017, it is anticipated that the restrictions on outbound M&A activities may relax. There have been rumours that some of the Chinese local foreign exchange authorities are starting to unwind their cross-border remittance policies to a certain degree. As clarity has begun to emerge over the regulatory attitude of China, more outbound activity was recorded in Q3 2017 and momentum will gather as recovering economic fundamentals will continue to dampen the need for restrictions on capital outflows.
To address the regulatory concerns, Chinese bidders should, early in the process, commit significant deposits to structure transactions with offshore funds to avoid issues later.
Recent trends in outbound M&A activities
China’s era of double-digit GDP growth was characterised by rapid industrial expansion and urbanisation, and with its state-owned enterprises relying on outbound M&A activities in the energy and resources sectors to cater for its developmental needs. Yet, as the Chinese economy has matured and growth settled down to a more sustainable level, the recent wave of outbound M&A activity has been characterised by broader sectors focusing on technology, industrial know-how and retail, which, in turn, mirrors the broader economic transition that is currently underway.
Nonetheless, there has been a surge in technology-focused M&A activities as corporations, banks and other financial institutions begin to invest in innovative technology to increase business efficiency, reduce costs and improve access to and delivery of financial services. The implementation of ‘One Belt, One Road’ has earmarked information technology, automation and high-speed rail to support its objective. We believe China’s outbound M&A activities will continue to surge; cross-regional M&A activity can be a value-enhancing strategy for Chinese companies looking to strengthen their technological capabilities.
Although 2016 has seen a surge of M&A transactions in China, the value of reported M&A activity in Hong Kong was significantly lower compared to 2015. While there was a fall in activity in the first half of 2016, the second half recorded higher transaction volume due to a combination of Hong Kong companies becoming acquisition targets and platforms for China’s outbound investment, and the restructuring exercises of conglomerates and Hong Kong-listed companies to streamline operations.
As China tightened regulatory controls on capital outflows to curb renminbi depreciation and engage more scrutiny on outbound transactions, there has been a knock-on effect on transaction activities in Hong Kong. We expect Hong Kong to benefit from the recent rise in Chinese outbound investments as foreign exchange reserves stabilise in the final months of 2017.
We believe M&A activity will steadily increase in Hong Kong with growing regulatory support for FinTech and internet-based businesses. Furthermore, ‘One Belt, One Road’ has created opportunities for Hong Kong companies to further expand internationally, particularly in the infrastructure and resources sectors.
Simon Luk is a partner and Nan Sze is an associate at Winston & Strawn. Mr Luk can be contacted on +852 2292 2222 or by email: firstname.lastname@example.org. Ms Sze can be contacted on +852 2292 2159 or by email: email@example.com.
© Financier Worldwide
Simon Luk and Nan Sze
Winston & Strawn