Linklaters China Report Document Singles 5738

7/28/2019 Linklaters China Report Document Singles 5738

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Strategy and opportunity.Chinas growth on the world stage

linklaters.com/chinareport


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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

2 Chinas growth on the world stage


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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


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


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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


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


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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


2005 2006 2007 2008 2009 2010 2011 2012 to 1 Oct



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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%


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


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


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


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


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


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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




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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


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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


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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

[email protected]

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

[email protected]

Annabella FuPartnerTel: (+86) 10 6535 0660Mob: (+852) 9010 2494

[email protected] DouglassPartnerTel: (+86) 10 6535 0638Mob: (+86) 138 1125 4265

[email protected]

AustraliaJeremy LowPartnerTel: (+61) 2 9230 4041Mob: (+61) 404 056 479

[email protected]

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

[email protected]

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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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

[email protected]

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

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