The title of the measures may cause some confusion. The China Securities Regulatory Commission (CSRC), Measures for the Administration of Financial Consultancy Services for Mergers, Acquisitions and Reorganisations of Listed Companies are actually more to do with the administration of financial consultancy services, with a focus on the approval and licensing process, than they are to do with rules relating to mergers and acquisitions.

The measures are the latest reform the Chinese government has issued as it continues to bring its regulations in line with the international community. As with a number of laws issued this year, for example the PRC Anti-monopoly Law and the PRC Employment Contract Law, lawyers have applauded the government’s objective, but many question its interpretation and lack of clarity.

While the CSRC still acts as the regulator for M&A activities and reorganisation of listed companies, the measures have weakened its position. The measures outline the roles and responsibilities of financial advisers and provide details on the issuing of licences which will allow financial advisers to provide consultancy services and opinions on the transactions. These licences, Financial Consultancy Services Licences, are to be issued by the CSRC.

The result is a change in the CSRC’s role from a complete authority to a supervisory role. The CSRC has the power to override any decisions or opinions passed on by advisers, while advisers are required to cooperate with the Commission throughout the entire review and approval process. In other words, the buck still stops with the CSRC.

This brings China more in line with other jurisdictions with regards to the regulation of the securities market, where self-regulation strengthens the positions of intermediary bodies (eg auditors, accounting firms, securities companies) empowering them to provide independent and objective professional services and guidance.

Article 2 of the measures outlines the scope of what the financial consultancy services (advisers) role entails.

The term “financial consultancy services for mergers, acquisitions and reorganisations of listed companies” means the provision of professional services such as transaction valuation, proposal design and issuance of professional opinions for merger, acquisition and reorganisation activities, such as takeovers, material asset reorganisations, mergers, divisions and share buybacks of listed companies, that have a material effect on the equity structure, assets and liabilities, revenue and profit, etc. of the listed companies.

The result for lawyers in China is they need only concentrate on the legal aspect of any advice dispensed and not burden themselves with the financial side of transactions.

“In the past the liability between a lawyer and a financial consultant has not been clear, previously when a client wanted him to sign a legal opinion the lawyer might sign it even if he was not sure about the financial feasibility of the project, with these measures, the lawyer just needs to worry about the legal aspect of the project,” says Grandall’s Zhan Hao.

Good in principle but questions remain

There are certain requirements that need to be met in order for a financial consultancy services licence to be issued. Articles 6 – 17 of the measures clearly define the qualification requirements needed to apply for licences. In particular, Article 8 determines:

An asset appraisal firm, accounting firm, law firm or relevant personnel wishing to engage in financial consultancy shall establish a separate dedicated firm.

As local law firms are permitted to apply for a licence to provide financial consultancy services, the issue of a conflict of interest has been raised, despite some strict and clearly defined guidelines.

“The introduction of the measures on the one hand guarantees the standard and the quality of service of financial consultancy bodies, but on the other hand it virtually reinforces the monopoly of certain types of institutions which will not be conducive to fair market competition,” says JSM’s Yanni Song.

“There have been accounting firms or evaluation institutions which have long acted as auditors or valuers for a certain listed company, but have also acted as financial advisers in the event of some merger or reorganisation activities of the same listed company. This creates a potential conflict of interest, and affects the independence and objectiveness of its opinions, the case of Arthur Andersen and Enron is a typical example,” she adds.

However counter-balancing this are the business rules set out in the measures which detail the duties required by advisers and include establishing internal reporting systems, conducting due diligence and maintaining an independent approach.

“The role of a financial adviser is that of an expert, who needs to negotiate a number of laws and regulations, you are establishing yourself as an expert in the field and are liable to being sued by the public should the information or opinion you provide prove not be correct, as there are shareholder issues at stake,” says Basil Hwang from Dechert.

Despite the government’s best efforts in establishing a transparent approval process there are still questions relating to how successful the measures will be in reality. The very nature of the M&A business and the procedures related to the reorganisation of listed companies means there is no way of guaranteeing an effective and watertight process, particularly in the context of insider trading and personal relationships in the market.

“In that sense, the “qualification” of financial advisors can be (seen as) a necessary step for more mature securities markets, but (the measures) will never replace the need of a true culture of independency and transparency,” says Gide Loyrette Nouel’s Hubert Bazin.

Less government intervention means less regulation

As China’s M&A market is set to grow, the CSRC’s measures are timely. Establishing a market governed by self-regulation and decreasing the number of administrative approvals is long overdue. However the added responsibility of providing opinions on market activity will also come with a possible rise in costs for those seeking approvals.

“As the CSRC-approved financial advisers shall have duty of care not only to their clients, but also to the CSRC, the stock exchange, and public investors, they will spend more time and make more efforts on looking into the business of listed companies,” says Xudong Ta from Jun He Law Offices.

However many feel the impact of possible cost increases will have a minimum impact in the overall scheme of market activity.

At the end of the day investors want clarity and a seamless process in order for their business activities to be measured and monitored. One criticism of the law is there is no safety net to ensure the licencees will be able to undertake their roles in a fair and proper manner.

“The promulgation of the measures is only one of the attempts that the CSRC is making to reduce administrative approvals and to increase the functions of professionals in market regulation and supervision. However, whether this attempt can succeed depends finally on whether the financial advisers are able to properly discharge their responsibilities as frontline watchdogs in a fair competition market, and whether the CSRC will in practice shift more power to the financial advisers,” says Gide’s Bazin.

A point not lost on Hwang.

“The rules do not provide detail as to what international companies such as the big four accounting firms or the foreign law firms can play a role, they need sufficient domestic knowledge and to be able to advise on domestic issues and foreign law firms by their very nature and not allowed to practice local law.”

Therefore the door is also open for large investment banks and auditing firms (see box ‘A possible role for the big-four?’) to apply for financial consultancy services licences, a prospect that is not clearly spelt out in the measures.

“Increasingly you are going to see some big players wanting to do everything themselves and not seek the services of an external adviser, so clearly to what extent this will be possible is a bit of a grey area,” says Clifford Chance’s Terence Foo.

The investment banks do not see themselves being able to take on the work of advisors and see little change in the status quo.

“Perhaps, some foreign firms might prefer setting up joint ventures with local practitioners; I don’t think any of the foreign practitioners are allowed to offer the full range of M&A services to PRC listed companies on a wholly foreign owned basis, because most of these transactions will involve domestically listed securities,” says Tammy Wan, Executive Director, Mergers & Acquisitions, Royal Bank of Scotland Group.

Wan suggests that the Chinese market needs experienced and knowledgeable service providers on the ground in operational roles, and this is where the investment banks will be able to add value.

“As practitioners may be exposed to potential liabilities (particularly with respect to the post transaction compliance requirements), I think practitioners, who opt to set up their M&A practice on a JV basis, may want to carefully consider the balance of the overall managerial and operational control to ensure strict compliance with the applicable laws. It is obviously important to the CSRC and the market that service providers perform on par with international standards. I can see that a lot of on-the-job training may be required.”

Other banks are taking a wait and see approach to determine how the measures will affect the market activity and mood.

However, one senior manager from an international investment bank claims the CSRC’s measures are ineffective and fall well short of the mark for improving the M&A process in China.

“In terms of doing full-blown M&A advisory work, there really aren’t that many experienced and qualified bankers in China and ironically the people who are most experienced are those who are engaged in international transactions, and the regulations are not clear as to whether this experience qualifies. In terms of the domestic market, you might think that local bankers who engage in extensive corporate restructuring work in connection with IPOs ought to be capable of delivering professional M&A advice, but it is not clear whether this experience qualifies either.”

What is clear is that the aim of the measures is to promote accountability in the market. In places such as Hong Kong and the US, self-regulation is a tried and trusted approach. However, for China to create a market similar to that of Hong Kong’s or the US, the CSRC needs to release further details and clarity in relation to the measures before issuing the first licences. Put simply, the market needs the support from high-quality capital markets service providers, and it is the law’s role to establish this landscape. Only then will there be an increase in China’s M&A market, and more importantly an improvement as well.

This entry was posted on Monday, September 29th, 2008 at 7:55 am and is filed under China Legal News. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.