Takeover Law in the UK, the EU and China: State Interests, Market Players, and Governance Mechanisms 9783030723446, 9783030723453

Table of contents :
Preface
Contents
Understanding Takeover Law in the Global Context
1 Introduction
2 Power Restructuring
3 The Rise of Economic Nationalism
4 Impact on China´s Domestic Takeover Market
5 Will China Reshape the Global System?
6 What Can the EU Learn from China, and What China Can Learn from the EU?
7 Conclusion
References
Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China
1 Introduction
2 Economic Model and the Focus on Its Industry Policy
2.1 Differences in National Economies and the Impacts on the Takeover Regulatory Model
2.2 UK´s Self-regulatory Model and the Influence of the Financial Services Industry
2.3 China´s Economic Model and Lack of Institutional Investors
2.4 The Problem of Shadow Banking and Its Impact on the Takeover Market
2.5 The Role of Financial Institutions Implementing State Policy
3 The Ownership Structure
3.1 The UK´s Dispersed Model and China´s Concentrated Model
3.2 The UK´s Dispersed Shareholding Market and Its Influence on the UK Takeover Market and Its Regulatory Model
3.3 China´s Concentrated Ownership Structure and Its Reforms
3.4 Ownership Structure and Takeover Law in China
3.4.1 Non-frustration Rule
3.4.2 Mandatory Takeover Bid Rule
4 The Institutional Arrangements of the Takeover Law Framework
4.1 Policy Based Regulatory Model
4.2 China: The Late Comer to Adopt a Takeover Market
4.2.1 CSRC Approaches to the Non-frustration Rule and De Facto Defensive Tactics
4.2.2 Lack of Independent Market Players and the Role of SOEs and SASAC
5 Looking Forward
5.1 Takeover Laws and Regulations
5.2 Market Players
5.3 Regulatory Models: CSRC Centralism and Self-Regulation Model
6 Conclusion
References
On the Supply Side of Western Hostile Takeover Law and Its Implications for China
1 Introduction
2 Retrospect of the Original Regulatory Models
2.1 History Retrospect
2.2 The Impact of Path Dependency
2.3 Implications So Far
3 The Chinese Regulatory Model
3.1 Reflections of the Substantive Law
3.2 Reflections on Supervisory Practice
3.3 Chinese Fiduciary Duty: A Comparison with the U.S.
3.4 Chinese Self-Regulation: A Comparison with the U.K.
3.5 Chinese Board Neutrality Rule: A Comparison with the E.U.
3.6 Chinese Mandatory Bid Rule: A Comparison with the U.K. and the E.U.
4 Future Legal Improvements
4.1 Modifications of the Board Neutrality Rule
4.2 Improvements of the Mandatory Bid Rule
4.3 Advices for the Limited Self-regulation in China
4.4 Empowering the Institutional Investors in China
5 Ending Remarks
References
The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the U...
1 Introduction
2 The Three Modes of the Takeover Regulation
2.1 Courts: e.g. ``Fiduciary Duty Centered Mode´´ of the US
2.2 The Self-Regulatory Model: e.g. the UK
2.2.1 The Takeover Panel and the City Code
2.2.2 No Frustrating Action Principle
2.2.3 Principle of Equal Treatment of Shareholders
2.3 The Governmental Regulation Regime: e.g. The CSRC Centralism Regime of China
3 The UK´s Self-Regulatory Model and the Takeover Panel: History, Path Dependence, and Reflections
3.1 From Shareholder Centric to Self-regulatory System
3.2 Understanding the UK Self-Regulatory Model
3.2.1 The Path Dependence: Formidable Institutional Investors and Unfading Takeover Panel
3.2.2 Special Background of Self-regulation
3.3 Incomparable Advantages of Self-regulatory Mode
3.4 Functional Premise of Self-regulatory Mode
4 China´s CSRC Centralism Takeover Regime: Linkage with and Divergence from the UK
4.1 The Hostile Takeover Regulatory Law of China
4.2 The Dilemma of Chinese Takeover Regulation
4.2.1 The Board Centrism Anti-takeover Provisions
4.2.2 The ``CSRC Centralism´´ Path Dependence
4.3 Linkage with the UK: Reflections of the Substantial Law
4.4 Divergence from the UK: China´s MAR Committee
5 The Future of China´s Takeover Regulatory Regime: Learned Self-regulation from the UK Experiences
5.1 Optimal Choice of Modes of China: Learn Something from the Self-regulatory Regime in the UK
5.2 Make the Self-Regulatory Institutions Work in China
5.2.1 The Problems of the Chinese Takeover Law in the Mirror of the UK´s Success
5.2.2 Pieces of Advice for the Limited Self-regulation in China
5.3 Empowering the Institutional Investors in China
5.4 Borrowing Efficiency-Adding Clauses from the City Code
6 Conclusion
References
Disclosure Rules in Takeovers: Making Sense of Fragmentation in German Law
1 Introduction
1.1 Complexity
1.2 Evolution of Regulation
1.3 The Area of Takeover Laws
2 Layers of Regulation
2.1 Layer 1
2.2 Layer 2
2.3 Layer 3
2.4 Layer 4
3 The Layers in Context
3.1 Disclosure Rules in Layers 1 and 2
3.2 Corporate Governance and Capital Markets at the Interface Between Private and Public Interest: Disclosure Rule in Layers 3...
4 Modes of Acquisition and Types of Interest
5 Application of the Layers in Practice
5.1 The Threshold Rule of §33 WpHG
5.2 Industrial Policy and Capital Market Law: The Challenges of Layer 4
6 Conclusions
References
``The Takeover Mirror´´
1 Introduction
2 Developments in 2018, 2019
2.1 Developments in the First Half-Year Report of 2018
2.2 Developments in the Annual Report of 2018, Most Recent Developments
3 Analysis of Megadeals
3.1 China Three Gorges´s Failed US$ 10.8 Billion Acquisition of EDP Energias de Portugal
3.1.1 Introduction of the Companies in Question
3.1.2 Overview of the Offer
3.1.3 Shareholder Structure and Voting Rights
3.1.4 Present Situation
3.2 China´s Geely´s US$9 Billion Acquisition of Stake in Daimler
3.2.1 Introduction of Companies Concerned
3.2.2 Overview of the Offer
3.2.3 Follow-up
4 EU Legislation
4.1 Disclosure
4.2 Mandatory Offer
4.3 EU Investment Screening Regulation
4.3.1 Some Features of the Proposed Legislation
5 China MandA Legislation
5.1 Fundamental Regulation of Foreign Mergers and Acquisitions of Domestic Enterprises
5.2 Limits on Industries Entry
5.3 Regulations on Security Review and Anti-Monopoly Investigations
5.3.1 Security Review
5.3.2 Anti-Monopoly
5.4 Transfer of State-Owned Property Rights and Equity
5.5 Listed Company
5.6 Foreign Exchange Control
5.7 Approval and Filing
5.8 QFII (Foreign Investment in Securities Products)
5.8.1 Qualification Procedures
Open Accounts
Custodian´s Obligation
Additional Condition
6 Mirror Case
6.1 Daimler Acquires Geely
6.1.1 Geely´s Profile
6.1.2 Limits on Industries Entry
6.1.3 Different Ways of Carrying Out MandAs
Direct
Negotiation
Approval and Filing
Business Licence
Payment Requirements
Anti-Monopoly
Security Review
Indirect
Securities and Futures Ordinance
Disclosure
Mandatory Offers Under the Hong Kong Codes on Takeovers and Mergers
The Minority´s Right to be Bought Out
Supervision
6.2 EDP Acquires CTG
6.3 Conclusion
7 New Development in China
Mergers and Competition in Digital Markets: Learning from Our Mistakes
1 Introduction
2 The Law
3 The WhatsApp Decision
3.1 Multi-Homing
3.2 Explosive Growth Dynamic Market
4 The Instagram Decision
5 First Mover Advantages in Internet Markets
6 The Flaw
7 Implications for Competition Law and Policy
7.1 Market Definition
7.2 Virgin Markets and Established Markets
8 Conclusion
References
Books
Journals
Webpages
Working Papers
Conference Papers
Reports
Newspapers
Commission Decisions Setting Up Expert Groups
Guidelines
The Amendment of Anti-Monopoly Law of Merger Remedies: Based on the Empirical Analysis in China
1 Background
2 Legal System for and Rules on Merger Remedies in China
2.1 AML Enforcement Agency
2.2 Legal System for Concentration of Undertakings
2.3 Rules Under Merger Remedy System
3 Basic Logic of Restrictive Conditions
3.1 Value and Positioning of Restrictive Conditions
3.2 Structural Remedy and Behavioral Remedy
3.2.1 Structural Remedy
3.2.2 Behavioral Remedy
3.3 Debate Over Whether Structural or Behavioral Remedy Is Preferred
4 Practice and Reflection on Merger Remedies in China
4.1 Practice of Merger Remedies
4.2 Reflection on Precedence of Remedies
5 Improving the System of Imposing Restrictive Conditions
5.1 Basic Principles for Remedy
5.1.1 Principle of Necessity
5.1.2 Principle of Minimum Intervention
5.1.3 Principle of Effectiveness
5.2 Expertise and Neutrality of Divesture Trustee and Supervisory Trustee
5.3 Increasing Negative Consequences of Illegal Concentration
References
Evaluating the Mandatory Bid Rule for Takeover Law in China: An Empirical and Comparative Analysis
1 Introduction
2 The Nature and Origins of the Mandatory Bid Rule
3 The Policy Goal of the Mandatory Bid Rule in the UK Takeover Code
3.1 Protecting Minority Shareholders
3.2 Equal Treatment
4 Creating and Destroying Value Through Takeovers: Theoretical and Empirical Evidence
4.1 Value Creation and Destruction in Theory
4.2 Value Creation and Destruction in Practice: Empirical Evidence from the UK and US
4.2.1 Short-Term Effects of Takeovers on the Value of Companies
4.2.2 Long-Term Effects of Takeovers on the Value of Companies
5 The Mandatory Bid Rule in China
5.1 Initial Introduction and Later Reforms to the Mandatory Bid Rule in China
5.2 Regulatory Attitude Towards the Mandatory Bid Rule
6 Evidence from China
6.1 Aims and Scope of the Study
6.2 The Source of Data
6.3 The Sample for Data Analysis
6.4 Methodology
6.5 Two Parameters of Empirical Study
6.6 Results from Data Analysis
6.6.1 The Relationship Between Cumulative Abnormal Return and Holdings
6.6.2 The Relationship Between Cumulative Abnormal Return and Bidders´ Aims
7 The Mandatory Bid Rule in China: Looking to the Future
7.1 Amendments to the Proportional Partial Bid Rule
7.2 Trigger Points
7.3 Parties Acting in Concert
7.4 Tactics for Circumventing Mandatory Bid Obligations
8 Conclusion
References

Citation preview

Joseph Lee  Editor

Takeover Law in the UK, the EU and China State Interests, Market Players, and Governance Mechanisms

Takeover Law in the UK, the EU and China

Joseph Lee Editor

Takeover Law in the UK, the EU and China State Interests, Market Players, and Governance Mechanisms

Editor Joseph Lee School of Law University of Exeter Exeter, United Kingdom

ISBN 978-3-030-72344-6 ISBN 978-3-030-72345-3 https://doi.org/10.1007/978-3-030-72345-3

(eBook)

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Preface

This book was born out of two seminars organised at Tsinghua University in China and at the University of Exeter in the UK. Its aim is to re-examine takeover law at this critical time when global economies are being re-shaped by new international relations between major economic and political powers, largely caused by China’s participation in the global takeover market. This restructuring of global power has raised a number of theoretical, legal, and practical challenges concerning the takeover market. Up to now, the prevailing view has been that takeover law should have the objective to ensure the well-functioning of an efficient market for corporate takeovers. However, this view has started to be questioned. Policy makers have begun to limit the application of free market theory to corporate takeovers as a result of internal pressure from their electorates as well as from perceived foreign threats. At the beginning of the millennium, the EU subscribed to this theory of market efficiency in order to construct the EU Takeover Directive which has subsequently influenced emerging markets such as China in shaping their takeover law. The UK’s influence on the EU Takeover Directive as well as on China’s development has also been significant. However, the Brexit referendum in 2016 sent a strong political message to policy makers. There is now a general feeling that growing economic and social imbalances demonstrate that London’s international financial market is disconnected from the UK’s overall economy. Yet policy makers have not been able to make any significant reform to takeover law to rebalance this perceived disconnect. UK takeover law is based on the US market efficiency theory but in an ‘improved’ version with a stronger emphasis on minority shareholder protection, transparency, and legal certainty. This gives more power to financial market participants but reduces the power of the judiciary, as the guardian of justice, to provide redress for human suffering caused by takeovers. Politicians do not make proposals to change what is believed to be working well for the country. Brexit means that less will be done to address any imbalances due to corporate takeovers as emphasis is placed on making the UK a more competitive global financial centre. Will the EU amend its Takeover Directive as a response to the competing UK model? Some member states may begin to make themselves more competitive for corporate v

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Preface

domicile and listing and formulate takeover law in a way that favours minority shareholder protection, thereby attracting capital. The study of takeover law can no longer be focused on Western markets. China’s outbound M&A activities have alarmed many Western policy markets and the USA has taken a tough stance by engaging in a trade war, a technology war, and to some extent a finance war with China. For many years, China has diligently studied the Western models and adopted some of their elements to develop its own financial market. While there are gaps in governance, China’s impressive development and its successes are starting to have an impact on takeover market theory. The restrictions imposed on Chinese takeovers by some Western economies are a direct challenge to the transformative power of the market economy on the political system. This will feedback to the US, EU, and UK takeover models and the lesson may be that policy and political considerations should be embedded in the free market economy. The White Paper on levelling the playing field as regards foreign subsidies, adopted by the European Commission on 17 June 2020, proposes that the Commission can block a takeover if the Commission believes that foreign subsidies given to the buyer may distort competition in the EU. The UK National Security and Investment Bill, if enacted, will give the UK government power to block M&A and investment activity that could create a national security risk. If politics and policy start to intervene in the global takeover market, we will begin to see that it becomes more national (within the USA and China), regional (within the EU), and less global. This book shows how the UK, the EU, and China have been building their takeover markets and governance. There are major differences in their governance mechanisms, reflecting the interplay between market interests and political powers. In the life of this project, I have witnessed how Brexit has unfolded, tensions between the EU and the UK, the US–China trade war, and the global COVID-19 pandemic. The USA will have a new administration in 2021. Vaccines are being rolled out globally. I have just learnt that the EU and the UK have reached an agreement on trade a few minutes ago. The world needs much more sincere, honest, and transparent cooperation. If we can apply virtuous principles to aggressive and unkind hostile takeover tactics, freedom and good law in the marketplace can be preserved and continue to serve our common goal of sustainability. London, UK 24 December 2020

Joseph Lee

Contents

Understanding Takeover Law in the Global Context . . . . . . . . . . . . . . . Joseph Lee

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Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Joseph Lee and Yonghui Bao

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On the Supply Side of Western Hostile Takeover Law and Its Implications for China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ciyun Zhu and Linyao Tang

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The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Zhaohui Shen, Linyao Tang, and Charlie Xiao-chuan Weng

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Disclosure Rules in Takeovers: Making Sense of Fragmentation in German Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 Maren Heidemann “The Takeover Mirror” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 Victor Meijers, Ailin Song LL.M, and Renée Otten Mergers and Competition in Digital Markets: Learning from Our Mistakes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191 Matthew Cole The Amendment of Anti-Monopoly Law of Merger Remedies: Based on the Empirical Analysis in China . . . . . . . . . . . . . . . . . . . . . . . 217 Chenying Zhang Evaluating the Mandatory Bid Rule for Takeover Law in China: An Empirical and Comparative Analysis . . . . . . . . . . . . . . . . . . . . . . . . 255 Joseph Lee, Yonghui Bao, and Jinlin Li vii

Understanding Takeover Law in the Global Context Joseph Lee

Abstract This chapter discusses the political economy of global takeover laws in light of the current power restructuring in the global economy brought about by events such as Brexit and the US-China trade war. It discusses how such changes may give rise to economic nationalism, and analyses how China will react in the global takeover market, in its M&A activities in the US and EU markets, in its regulatory responses to domestic takeover laws, and in its approaches to foreign financial intermediaries providing services in the Chinese market. Neoliberalism has provided the theoretical basis for the development of the takeover market and takeover governance but we may now begin to see more policy-based interventions. Digital economy, tech giants’ governance, and climate change initiatives are areas where policy considerations will shape the market and its governance. The US and EU have been influencing global takeover market and its governance. China will start to be a player—not only as a rule-taker in the global takeover market, but a rulemaker in its governance.

1 Introduction This book is based on two seminars on takeover law held in Beijing in 2017 and in London in 2018. They form part of the Exeter-Tsinghua research project on takeovers and corporate governance; a project funded by the University of Exeter. This chapter attempts at gaining a deeper understanding of takeover law by analysing the key issues raised in this project against the background of the current geo-political and economic context. It is structured as follows. Section 2 analyses power restructuring in the current global economy. Section 3 examines how this power restructuring may give rise to economic nationalism. Section 4 shows how these two factors may have an impact on the Chinese domestic takeover market and governance. Section 5 discusses the influence of China on the global takeover J. Lee (*) School of Law, University of Exeter, Exeter, United Kingdom e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_1

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market and governance. Section 6 explores areas where China may learn from EU and vice versa. Finally, some concluding remarks will be made.

2 Power Restructuring In the past few years, we have witnessed a number of major global political events that have changed economic and political relations among global powers.1 This also has an impact on international and geopolitical relations. The US-China trade war has affected not only global economies but also regional and bilateral relationships with China.2 Brexit has not only affected the unity of the European Union but also created opportunities for bilateral relations with China within the EU block and between UK and China.3 China has both political and economic ambitions, and has expressed them through controversial projects such as ‘One Belt One Road’4 in order to engage, as a major economic and trading nation, with the global liberal economic system.5 These changes have also exposed gaps in expectation between China, the EU and the US.6 A major issue in the US-China trade war is access to China’s services sector and in particular,7 financial services in which western economies currently have a competitive advantage.8 The restrictions applied by China in the services sector, including financial services, have sparked a more general mistrust of China’s approach which is perceived as an attempt to gain an unfair trade advantage.9 Among other examples, one might cite the alleged intellectual property right (“IPR”) violations by China10 and the security issues raised with respect to European inbound M&A.11 The US and UK’s treatment of Huawei,12 an integrated technology and telecommunication company, and the heightened scrutiny of China’s M&A activities in the EU, UK and US13 are the consequence of the

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Basedow (2019). Meltzer and Shenai (2019). 3 Gee et al. (2016). 4 ‘One Belt One Road’ Initiative has been regarded as a ‘twenty-first century silk road’, and it was made up of a ‘belt’ of overland corridors and a maritime ‘road’ of shipping lanes. This initiative includes 71 countries from south-east Asia to Eastern Europe and Africa. For detailed introduction, see Kuo and Kommenda (2018). 5 Weber (2020). 6 Weber (2020). 7 Wong and Koty (2020a). 8 Financial Times (2020). 9 Petsinger et al. (2019). 10 Li and Alon (2019). 11 See chapter “Disclosure Rules in Takeovers: Making Sense of Fragmentation in German Law”. 12 Millward (2020). 13 Moon (2018). 2

Understanding Takeover Law in the Global Context

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unequal access to the Chinese market which is also evidenced in the trade deficit between China and the western economies.14 The trade deficit between China and the EU stood at 164 billion Euros in 2019.15 China is the third largest partner for EU export of goods and largest for EU imports of goods.16 China’s relations with western countries have deteriorated further as a result of the situation in Hong Kong and the protests there against Beijing’s recent amendments to the laws on extradition and national security.17 This deterioration in relationships has not only affected Hong Kong’s ability to act as a hub for the western financial services sector to provide finance to mainland Chinese companies in the future,18 but also the possibility of creating a market competition model for mainland China and Hong Kong, equivalent to the competition within the EU market.19 This research project started before the US-China trade war began and before Britain’s departure from the European Union. At the time of writing, China’s relationships with western economies especially those of the US and the UK continue to be turbulent.20 We have witnessed many Chinese companies delisting in the US, with an increased capital inflow to Hong Kong and mainland Chinese capital markets.21 This may reduce the incentive for China to make listing on its capital market more attractive.22 The US tech-companies are relocating their manufacturing operations from China to the US and to India23 as a consequence of the increased tariffs on Chinese goods and security measures imposed by the Trump administration.24 These events change the power dynamics in the development of takeover law: US politics and the US political stance are increasingly significant while market players are taking a more subordinate role.25 The revision of the UK takeover law with the intention of taking a more detailed approach to scrutinising foreign takeover26 is but one example of this.

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Cainey and Nouwens (2020). Eurostat (2020). 16 Eurostat (2020). 17 Giles (2020). 18 Li (2018). 19 See chapter “On the Supply Side of Western Hostile Takeover Law and its Implications for China”. 20 Ford and Hughes (2020). 21 He (2020). 22 He (2020). 23 WIRED (2019). 24 Wong and Koty (2020b). 25 Graaff et al. (2020) and Meltzer and Shenai (2020). 26 Payne (2020) and Boland (2020). 15

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3 The Rise of Economic Nationalism The concentration of financial power in the US and dominance of US tech companies have spurred China to foster its own national champions under state control in order to compete globally.27 In Europe, we have witnessed the London Stock Exchange’s rejection of the Hong Kong Stock Exchange’s takeover bid on the basis of security concerns.28 In addition, the UK has changed its takeover law in response to security concerns about China,29 mainly in response to the Hong Kong issue but also to reinstate its strategic partnership with the Trump’s administration’s stance on China. While the EU has not taken a concerted step to change its relationship with China, the departure of the UK from the EU has weakened the block’s current ability negotiate a good trade deal with China.30 This has reduced its ambition of gaining more access to the Chinese market and of affirming its values on issues such as human rights.31 Since 2016, the EU has struck trade deals with other Asian countries such as Japan and Vietnam.32 There is a currently competition between the EU and the UK to secure enhanced access to the Chinese market33 and that in turn has meant that China has more power to explore differences between the EU and the UK when they do not take a united approach to such issues as regulatory standards. The principle of free movement of capital has a strong focus on the efficient allocation of resources and independent monitoring of the global economic system, including cross-border takeovers and M&A.34 But currently the idea of a global economic system and the favour for cross-border takeovers and M&A are in regression.

4 Impact on China’s Domestic Takeover Market In this book, we have explored the themes and issues relevant to economic power relations in the context of corporate takeovers. They expose the differences in the economic and political developments between China, the EU, and the US. The UK’s primary interest in takeovers lies in the financial services sector where financial intermediaries (the private sector) act as gatekeepers for market governance.35 In 27

Lippert and Perthes (2020). London Stock Exchange (2019). 29 Payne (2020). 30 European Movement International (2016). 31 Herrero and Xu (2016) and Winders (2016). 32 European Commission (2020). 33 HM Government (2018). 34 European Parliament (2020). 35 See chapter “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China”. 28

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China, state industrial policy is directed towards optimising capital by diversifying state-owned enterprises and dispersing corporate share ownership.36 Yet, this does not prevent China from fostering national champions, and state-owned enterprises use the takeover market to dispose of under-performing assets.37 Private sector financial intermediaries do not play as significant a governance role as they do in the EU and UK because the financial services sector in China still has as its main role that of distributing funds according to state policy, which means that they are not independent of the state.38 This affects the ability to develop new services and products in the sector. It also affects the relationship between the state regulators and clients and shapes takeover market governance.39 This also explains why China has been cautious in allowing foreign financial intermediaries to operate in China.40 China’s financial institutions do not have a competitive advantage because the equity market is still developing,41 as are laws on asset management,42 and significant principles of corporate governance such as fiduciary duty are yet to be introduced.43 There is much infrastructural work needed to establish a rule-based Chinese financial market44 and a premature opening up of its financial services sector could cause a shock to the Chinese market as happened in the Asian financial crisis in 1998.45 China has been learning more about the in-depth operation of the takeover market from Hong Kong46 and even though it has adopted the UK takeover law model via Hong Kong, it has revised many of the UK provisions to meet its own economic policy objectives.47 China is evidently keen to establish rule-based governance of the takeover market while at the same time rejecting UK-style market-led governance.48 When will China move away from the state regulatory centrism to a UK style of self-regulation?49 It is unlikely to happen soon. When will China adopt the US court-led governance based on the principle of fiduciary duty and the class action

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Ibid. Milhaupt and Zheng (2015). 38 See chapter “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China. 39 Ibid. 40 Bradsher (2017). 41 Aberdeen Standard Investments (2019). 42 Xu et al. (2019). 43 OECD (2011). 44 Bughin et al. (2019). 45 Federal Reserve Bank of San Francisco (2009). 46 Lin (2017). 47 Cai (2011). 48 See chapter “The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China”. 49 See chapter “On the Supply Side of Western Hostile Takeover Law and its Implications for China”. 37

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enforcement model?50 This is even less likely. A court-led model only has real benefits when there is a true separation of powers, stable law, and courts with the ability to adjudicate disputes rather than relying on the guidance of the Supreme Court and other state regulators. Politically, the Chinese state plays a dominant role in regulating the takeover market, more so than its courts, and the CSRC, the state takeover market regulator, can directly intervene in the takeover process.51 It has the power to dispense with the mandatory bid requirement and there is evidence that if a takeover involves stateowned enterprises, the CSRC always grants exemption from mandatory bid rules in line with state industrial policy.52 Such preferential treatment of state-owned enterprises is unlikely to be seen in the US or the EU, either by the regulators or in the courts. Yet, we have begun to see the US and UK governments taking account of policy reasons such as national security or industrial policy in determining the outcome of a takeover.53 In the EU, the board neutrality principle is also beginning to be eroded by other policy considerations.54 The departure of the UK from the EU bloc may allow even more flexibility in the board neutrality rule as this was a particular issue for the UK in the EU Takeover Directive negotiation.55 In the future, the EU and UK may take different approaches to takeovers and regulatory standards so that they may diverge in terms of board neutrality, the disclosure regime, and the breakthrough rule. Board neutrality has up to now been a cornerstone of the EU takeover law56 and China has followed suit instead of taking the US fiduciary duty based approach.57 If the EU finally revised this rule in the Takeover Directive, China may see this as an unstable principle in takeover law and may change its position accordingly. The result would be to slow down the process of dispersing share ownership in state-owned enterprises and would affect China’s internal economic transformation.

50 See chapters “On the Supply Side of Western Hostile Takeover Law and its Implications for China” & “The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China”. 51 See chapter “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China. 52 See chapters “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China”, “On the Supply Side of Western Hostile Takeover Law and its Implications for China” & “The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China”. 53 Meltzer and Shenai (2019). 54 Beuerle et al. (2011). 55 Mukwiri (2020). 56 Habersack (2017). 57 See chapter “The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China”.

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5 Will China Reshape the Global System? It may be that China will be able to export its economic model and reshape global governance.58 But it is difficult to define the current Chinese model and to predict how it will change in the future, who will choose to adopt it or how overall global financial markets will change. In terms of the infrastructure supporting the takeover market, there are more takeovers, especially hostile takeovers, in China than in Japan.59 China has so far shown its willingness to use the market mechanism to facilitate its economic growth as well as to distribute economic benefits to investors.60 China has also introduced a broad legal framework for takeovers, including general principles of investor protection, market transparency, and corporate governance. The rules and principles in Chinese takeover law can be compared with the other models such as UK and EU in order to measure their effectiveness and efficiency.61 There is no evidence that China’s takeover model is moving away from its core values and general policy, and there is evidence that China is developing its asset management industry to act as intermediaries in the takeover market.62 There have been changes in the law to open up China’s financial services sector to foreign providers,63 yet the internationalisation of its financial market still lags behind the takeover markets of the UK and the EU.64 The lack of internationalisation of the Reminbi (RMB) and the restrictions on capital flow also create disincentives for foreign investment in China.65 Internationalisation of China’s financial market sector and its currency, along with relaxation of the restrictions on capital flow could catalyse a more international takeover market, as would a better disclosure regime,66 better access to foreign takeovers,67 and a more effective dispute resolution mechanism to protect domestic and foreign investors.68 But the question is whether China is willing to take such action considering the competitiveness of this sector, the systemic risk, and the impact on its political grip

58

Economy (2020). Lee (2017). 60 Zhou and Xiao (2018). 61 See chapter “Evaluating the Mandatory Bid Rule for Takeover Law in China: An Empirical and Comparative Analysis”. 62 See chapter “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China. 63 Xinhua Net (2020). 64 Kharpal (2020). 65 See chapter “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China. 66 See chapter “Disclosure Rules in Takeovers: Making Sense of Fragmentation in German Law”. 67 See chapter ““The Takeover Mirror”: On the EU Side of the Looking Glass, Most Regulatory Checks Are Ex Post, Not Ex Ante”. 68 See chapter “The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China”. 59

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on its economic development and social transformation.69 In the EU, there have been concerns about violations of IPRs by Chinese companies at home and abroad.70 This has always been a major consideration in any takeover where the bidder’s primary aim is to acquire the intellectual property developed by the target company and the control premium paid does not reflect the true value of the target company’s IPRs.71 This is also why Japanese companies are structurally protected against foreign hostile takeovers, through cross-shareholdings and restrictions on takeover financing.72 Would China adopt the Japanese approach or would it use investment law to prevent the outflow of IPRs developed by Chinese companies? As the second largest global economy, China has joined the US and EU in using competition law to influence global economic development, especially in the technology sector.73 Such soft power is also a leverage to political and economic relations with the US and EU.74 There are some implications here for competition law. Western economies such as the UK and EU may focus on fostering national champions in response to the economic rise of Chinese companies in a way that will see EU competition law becoming more merger-friendly and possibly even with increasing hostile takeovers.75 There will be more policy-based considerations by the regulators as they determine the outcome of a takeover—both friendly and hostile. This will show a shift from the liberal and policy-neutral open market approach to a more policy-determinant approach. China regularly uses industrial policy to influence the outcome of domestic takeovers or to change the domestic market structure.76 It is important to observe whether western economies such as the UK and EU increase their use of industrial policy and regulatory objectives in this way to influence takeovers, and if so, what policies will be favoured.77 The techsector and environmental issues have begun to shape the global economic governance and this is now an area where we may see either convergent or divergent approaches between the EU and China.78 How these issues will contribute to economic nationalism and protectionism is still to be seen. The EU’s human

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Orsmond (2019). European Commission (2018). 71 Gabriela (2013). 72 Lee (2017). 73 See chapters “Mergers and Competition in Digital Markets: Learning from our mistakes” & “The Amendment of Anti-monopoly Law of Merger Remedies: Based on the Empirical Analysis in China”. 74 Buthe (2014). 75 See chapters “Mergers and Competition in Digital Markets: Learning from our mistakes”. 76 See chapter “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China. 77 See chapters ““The Takeover Mirror”: On the EU Side of the Looking Glass, Most Regulatory Checks Are Ex Post, Not Ex Ante”, “Mergers and Competition in Digital Markets: Learning from our mistakes” & “The Amendment of Anti-monopoly Law of Merger Remedies: Based on the Empirical Analysis in China”. 78 Hobbs (2020). 70

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rights-based governance has not significantly influenced the development of corporate law, capital market regulation or the takeover market. However, legal principles enshrined in the EU General Data Protection Regulation (GDPR) that are based on human rights will affect the development of the tech companies by creating a free flow data market (or a data fortress) which may exclude countries such as China with no equivalent protection.79 Will human-rights based governance lead the development of the global financial markets? We will need to see how successful the EU is at playing such a role in international trade negotiations, particularly with the US and China. For the environmental protection initiatives, there has been no major evidence on how sustainable financing will influence the takeover market.80 China is familiar with sustainable financing and this is an area where the EU is keen on working with China to develop an accord that might be included in EU-China trade deal negotiations.81 How environmental protection is eventually reflected in the relevant takeover laws is still an open question.

6 What Can the EU Learn from China, and What China Can Learn from the EU? What factors have contributed to China’s exceptionally fast rate of economic growth? It is often said that China’s economic success is a result of manufacturing with low wages, at the expense of the environment, and with strong state control.82 Whether or not that is true, it is unlikely that EU can learn from China’s experience for its own development as the two economies are at very different economic stages and operate under very different political regimes. However, their respective models can offer lessons to other developing economies such as India, Russia, and Brazil. Even though China’s development is very much state-led, there is still property right protection through the developments in company law and corporate governance,83 the capital markets function under a regulatory framework that disperses investment power and protects investors, and competition has been created to stimulate economic growth.84 The so-called ‘socialist market economy model with Chinese characteristics’ is still evolving.85 The financial market is still immature,86 financial intermediaries do not act as independent market gatekeepers, and the equity market

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Leplay (2020). OECD (2017) and Atanassov (2012). 81 Wang (2018). 82 Morrison (2019). 83 Jiang and Kim (2020). 84 Knight and Ding (2009). 85 Hong (2020) and Lim (2013). 86 Ellyatt (2018). 80

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needs to develop further. Furthermore, company law reform is ongoing87 and the rules for capital markets are being developed to strengthen the asset management sector to deal with hedge funds and derivative markets.88 China’s development over the past 30 years is not necessarily a guide to its future, and it still has much to learn from the EU and other advanced economies about many aspects of the law on takeovers and M&A for it to continue its development. It would be wrong to assume that the ‘socialist market economy with Chinese characteristics’ is now a stable model. More change will come and more will need to be learnt from the EU and the UK in terms of board fiduciary duty,89 the regulatory framework for asset management,90 the market disclosure regime,91 market access regulation,92 detailed takeover rules,93 corporate governance,94 and competition law.95

7 Conclusion Neoliberalism provided the theoretical basis of the development of the global takeover market. The takeover market has become a very important part of the global financial markets and the financial intermediates have also been structured to provide services for the takeover market to function and deliver the result of efficient allocation of capital. The US, EU and China have all subscribed to this theoretical basis and structured their respective capital markets and laws to accommodate takeover activities. However, the differences in their laws and practices have also demonstrated the level of their belief or doubt in this theoretical basis. These three jurisdictions have taken strategic positions to enhance their interests and manage risks in the game of cross-border takeovers. It is hard to predict if the major economies will continue to embrace the idea of the takeover market as an efficient way to allocate capital. The political economy of takeover law has so far been shaped

87

Shevlin (2018). ASIFMA (2018). 89 See chapter “On the Supply Side of Western Hostile Takeover Law and its Implications for China”. 90 See chapter “Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China”. 91 See chapter “Disclosure Rules in Takeovers: Making Sense of Fragmentation in German Law”. 92 See chapter ““The Takeover Mirror”: On the EU Side of the Looking Glass, Most Regulatory Checks Are Ex Post, Not Ex Ante”. 93 See chapter “Evaluating the Mandatory Bid Rule for Takeover Law in China: An Empirical and Comparative Analysis”. 94 See chapter “The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China”. 95 See chapters “Mergers and Competition in Digital Markets: Learning from our mistakes” & “The Amendment of Anti-monopoly Law of Merger Remedies: Based on the Empirical Analysis in China”. 88

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by major economic powers -such as the US and the EU. China, on the other hand, does not yet have the capability to export its takeover market model or its law to more advanced economies. However, how Chinese companies engage in global M&A, how the Chinese government implements the law, and how foreign players are allowed to have a role in the Chinese market are beginning to be important contributing factors in shaping the global governance of the takeover market. The approach to the digital economy with the tech giant operations and major policies such as climate change initiatives may act as game changers for global takeovers in the years to come. These are areas where China—as the second largest world economy with two major capital market exchanges in Shanghai and Shenzhen— will want to have a strong voice.

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Kuo L, Kommenda N (2018) What is China’s Belt and Road Initiative? https://www.theguardian. com/cities/ng-interactive/2018/jul/30/what-china-belt-road-initiative-silk-road-explainer. Accessed 31 Aug 2020 Lee J (2017) The current barriers to corporate takeovers in Japan: do the UK takeover code and the EU takeover directive offer a solution. Eur Bus Org Law Rev 18:761–783 Leplay E (2020) Data Privacy Law in China: Comparison with the EU and US Approaches. https:// pernot-leplay.com/data-privacy-law-china-comparison-europe-usa/. Accessed 3 Sept 2020 Li S, Alon I (2019) China’s intellectual property rights provocation: a political Economy view. J Int Bus Policy 3:60–72 Li Y (2018) Hong Kong in China’s Financial Globalisation. Asian Surv 58:439–463 Lim K (2013) Socialism with Chinese characteristics’: uneven development, variegated neoliberalisation and the dialectical differentiation of state spatiality. Prog Hum Geogr 38:221–247 Lin W (2017) The Vanco takeover: revisiting the takeover defences regulation in China. Company Lawyer 38:153–154 Lippert B, Perthes V (2020) Strategic Rivalry between United States and China: Causes, Trajectories, and Implications for Europe. SWP Research Paper. https://doi.org/10.18449/2020RP04 London Stock Exchange (2019) Rejection of Conditional Proposal from HKEX. https://www.lseg. com/resources/media-centre/press-releases/rejection-conditional-proposal-hkex? accepted¼7aaa73d747a1fedcf3a9f6caa1fa62f7. Accessed 31 Aug 2020 Meltzer J, Shenai N (2019) The US-China Economic Relationship: A Comprehensive Approach. https://www.brookings.edu/wp-content/uploads/2019/02/us_china_economic_relationship.pdf. Accessed 31 Aug 2020 Meltzer J, Shenai N (2020) Why the Purchase Commitments in the US-China Trade Deal Should Not be Replicated, Ever. American Enterprise Institute. https://www.brookings.edu/blog/upfront/2020/02/04/why-the-purchase-commitments-in-the-us-china-trade-deal-should-not-bereplicated-ever/. Accessed 3 Sept 2020 Milhaupt C, Zheng W (2015) Beyond ownership: state capitalism and the Chinese firm. Georgetown Law J 103:665–722 Millward D (2020) UK’s Ban on Huawei Shows Power of US in Trade Negotiations. https://www. telegraph.co.uk/politics/2020/07/15/banning-huawei-may-have-uks-best-option-secure-ustrade-deal/. Accessed 31 Aug 2020 Moon L (2018) Chinese Overseas Deals Fall Amid Heightened Scrutiny in US. https://www.scmp. com/business/global-economy/article/2160734/chinese-overseas-deals-plunge-amid-height ened-scrutiny-us. Accessed 31 Aug 2020 Morrison W (2019) China’s Economic Rise: History, Trends, Challenges, and Implications for the United States. Congressional Research Service of CSR. https://www.everycrsreport.com/files/ 20190625_RL33534_088c5467dd11365dd4ab5f72133db289fa10030f.pdf. Accessed 31 Aug 2020 Mukwiri J (2020) The end of history for the board neutrality rule in the EU. Eur Bus Org Law Rev 21:253–277 OECD (2011) Corporate Governance of Listed Companies in China: Self-Assessment by the China Securities Regulatory Commission. https://www.oecd.org/corporate/ca/ corporategovernanceprinciples/48444985.pdf. Accessed 31 Aug 2020 OECD (2017) Investment Governance and the Integration of Environmental, Social and Governance Factors. https://www.oecd.org/finance/Investment-Governance-Integration-ESG-Factors. pdf Orsmond D (2019) China’s Economic Choices. https://www.lowyinstitute.org/publications/chinas-economic-choices. Accessed 3 Sept 2020 Payne A (2020) UK to Tighten Takeover Rules for Groups Vital to Virus Response. https://www.ft. com/content/6134da26-3d60-41a1-bd51-284db1620101. Accessed 31 Aug 2020 Petsinger M, Wang J, Jie Y, Crabtree J (2019) US-China strategic competition: the quest for global technological leadership. Research Paper of Asia-Pacific Programme and the US and the

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Americas Programme. https://www.chathamhouse.org/sites/default/files/publications/research/ CHHJ7480-US-China-Competition-RP-WEB.pdf. Accessed 31 Aug 2020 Shevlin A (2018) The Impact of China’s New Asset Management Regulations. https://am. jpmorgan.com/us/en/asset-management/liq/insights/liquidity-insights/china-money-marketresource-centre/the-impact-of-chinas-new-asset-management-regulations/. Accessed 31 Aug 2020 Wang Y (2018) China’s Green Finance Strategy: Much Achieved, Further to Go. https://www.lse. ac.uk/granthaminstitute/news/chinas-green-finance-strategy-much-achieved-further-to-go/. Accessed 31 Aug 2020 Weber I (2020) Origins of China’s contested relation with neoliberalism: economics, the World Bank, and Milton Friedman at the Dawn of reform. Global Perspect. https://doi.org/10.1525/gp. 2020.12271 Winders S (2016) Brexit and Free Trade: Would a Post-Brexit UK be Better Able to Sign Free Trade Agreements with the Rest of the World? https://www.brugesgroup.com/images/papers/ brexitandinternationalfreetrade.pdf. Accessed 31 Aug 2020 WIRED (2019) Trump’s Trade War Isn’t Just a US-China Problem. https://www.wired.com/story/ us-china-trade-war-spills-over/. Accessed 31 Aug 2020 Wong D, Koty A (2020a) The US-China Trade War: A Timeline. https://www.china-briefing.com/ news/the-us-china-trade-war-a-timeline/. Accessed 3 Sept 2020 Wong D, Koty A (2020b) The US-China Trade War: A Timeline. https://www.china-briefing.com/ news/the-us-china-trade-war-a-timeline/. Accessed 31 Aug 2020 Xinhua Net (2020) China to Further Open Capital Market: Regulator. http://www.xinhuanet.com/ english/2020-08/03/c_139261138.htm. Accessed 31 Aug 2020 Xu Q, Zhang I, Chan K (2019) How Global Asset Managers Can Step In as China Opens Up. https://www.bcg.com/publications/2019/global-asset-managers-can-step-in-as-chinaopens-up. Accessed 31 Aug 2020 Zhou C, Xiao B (2018) China’s 40 Years of Economic Reform that Opened the Country Up and Turned It into a Superpower. https://www.abc.net.au/news/2018-12-01/40-years-of-reformthat-transformed-china-into-a-superpower/10573468. Accessed 31 Aug 2020

Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment Between UK and China Joseph Lee and Yonghui Bao

Abstract In this chapter, the takeover market is used as an example to examine the extent to which regulatory alignment between the UK and China is possible. The focus is on the role of financial intermediaries in the two markets and how they may influence the governance model of transfer of corporate control by an open offer to the shareholders of the target company (a takeover bid). This chapter argues that the policy goals are very different, making regulatory alignment difficult to be realised. There are differences between the UK and China in their economic model, ownership structure and institutional arrangements, which is reflected in the differences in the interests served by takeover law in the two regimes. The design of the framework for takeover law in the UK empowers financial market participants, so as to attract capital to the London markets. In contrast, China’s takeover law is mainly aimed at facilitating industrial restructuring and creating globally competitive national companies (national champions). Hence, the UK’s shareholder-centred takeover model, with a strong focus on financial intermediaries and international investors, could not easily be replicated in China. However, the UK model could provide lessons for China as it develops its takeover market, extends its market structure reform, develops independent financial intermediaries and attracts an increasing number of investors.

1 Introduction Regulatory alignment is a means to achieve an interconnected market, which is an aim of the EU.1 However, without regulatory alignment, an integrated market is unlikely to be successful,2 or if it is implemented, its scope would be limited.

1 2

Armstrong (2018). European Parliament (2018).

J. Lee (*) · Y. Bao School of Law, University of Exeter, Exeter, United Kingdom e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_2

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Financial intermediaries such as investment firms and asset funds would have to operate in a different regulatory system and with different value chains. There would be limited synergies to be gained by companies, investors, and financial intermediaries, as they would continue to choose favourable places for raising capital, for realising their investment returns, and for gaining revenue. Without regulatory alignment, financial intermediaries would be unlikely to achieve synergy in their operations.3 In this chapter, we use the takeover market as an example to examine the extent to which regulatory alignment between the UK and China is possible. We focus on the role of financial intermediaries in the two markets and examine how they may influence the governance model of transfers of corporate control by an open offer to the shareholders of the target company (a takeover bid). The preconditions for hostile takeovers include: sufficiently dispersed ownership structure, macroeconomic factors such as the traded value of target firms’ equity being below their asset value, and the bidder having sufficient funding.4 Until very recently, China’s capital market did not fulfil such preconditions, especially on attractive targets with dispersed shareholding, and bidders’ adequate funding.5 The Vanke takeover case,6 an unsuccessful hostile takeover attempt by Baoneng, shows that hostile takeovers have become a reality in China’s capital market.7 This case demonstrated that crucial problems existed in the takeover market there: systemic risks raised by shadow banking, drawbacks of sectoral supervisions in the financial (takeover) market, vagueness of takeover regulations, state (or local governments) intervention and corporate governance issues, such as information disclosure. There are five sections of this chapter. Section 2 focuses on how the role of the financial services industry in the national economy model influences the governance of the takeover market. Section 3 examines how such a role influences the ownership structure of listed companies, which, in turn, affects the rules for minority shareholder protection. Section 4 investigates how the institutional arrangements of the takeover regulatory framework might be influenced by financial intermediaries. Sections 5 and 6 draw some conclusions and discusses possible moves by the UK and China.

3

Tella (2019). Armour and Skeel (2007). 5 Huang (2019). 6 For introduction of facts of the Vanke takeover battle (by Baoneng). 7 Armour and Skeel (2007). 4

Conflict of Goals in Takeover Law: The Impossible Regulatory Alignment. . .

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2 Economic Model and the Focus on Its Industry Policy 2.1

Differences in National Economies and the Impacts on the Takeover Regulatory Model

There is a distinct policy difference between the UK and China, and such a difference reflects in the countries’ takeover policies and regulations. The financial services industry is a pillar of the current UK economy, and the takeover market provides major revenue to the industry’s financing, advising, brokering, and asset management sectors. The financial services industry also performs an independent gatekeeping role to ensure a smooth and orderly takeover market. China is a manufacturing economy, and its financial services industry mainly serves the domestic economy. There is little internationalisation in its financial services industry and it does not act as an independent gatekeeper for the takeover market. The Chinese capital market lacks the UK’s independent professional investors. Such a structural difference leads to a different approach to policy with regard to takeovers and hence, to different regulatory systems: the UK’s is one of self-regulation8 while the Chinese state uses a command-and-control model.9

2.2

UK’s Self-regulatory Model and the Influence of the Financial Services Industry

The financial services industry is critical to the UK economy. The sector contributed £110 billion to the UK economy in 2017, which was 6.5% of total economic output; 50% of this was generated by the financial services industry in London. There were 1.1 million financial services jobs in the UK, which was 3.2% of all jobs. Exports of UK financial services were worth £61 billion in 2016, and imports were worth £11 billion. For 2016–2017, the UK financial sector as a whole contributed £71.4 billion in taxes (which includes wider measures of taxation such as business rates), totalling 11.5% of total government receipts. Annual financial revenues from the UK industry are approximately £200 billion; £90–95 billions of this is domestic business, £40–50 billion relates to the EU, and £55–65 billion relates to the rest of the world. The London Stock Exchange, though not as large as the Shanghai or Tokyo

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Lee (2017). Xi (2015).

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Stock Exchanges based on capitalisation, is more international, with non-UK investors holding 53.9% of the value of the UK stock market at the end of 2016.10 Hence, the UK Corporate Governance Code and the design of the framework for takeover law empower financial market participants to attract capital to the London markets.11 Financial market participants have direct steering power over the design, development, and decision making of individual cases as well as over areas for further reform. The Takeover Panel comprises up to thirty-six members, representing a breadth of expertise in takeovers, securities markets, industry and commerce. Twelve members are appointed by the major financial and business associations.12 The hard law of the Companies Act 2006 simply confers powers on the panel to enforce the code but does not regulate the constitution of the panel, its composition or its power. The Takeover Code and Takeover Panel are beyond the immediate remit of Parliament and the Judiciary. However, it would be incorrect to say that the Takeover Code is soft law operating as the Corporate Governance Code does, or that it is hard law interpreted and enforced as the provisions of Companies Act 2006 are. The Takeover Code and the Takeover Panel are practical solutions to specific problems that financial market participants face and are aimed at ensuring a competitive market for corporate control. Financial intermediaries play a role in providing finance, advisory services, and gatekeeper functions in UK takeovers. Unlike in China, UK banks are not restricted in providing financing to bidders. Lending is a commercial decision, and the government does not impose control or supervision of takeover funding. In fact, it is a requirement under the Takeover Code that the bidder needs to ensure funding is in place, which is usually provided by a letter of guarantee from a bank rather than by cash from the bidders’ account.13 And such bank letters of guarantee satisfy the Takeover Panel. Investment banks also provide advice on the processes of the Takeover Panel. Since investment banks are experienced in acting as a sponsor in an initial public offering, they are experienced in takeover processes, the valuation of share prices, and the impact of a bid on the secondary market. Although the Takeover Code does not require an advisor in the takeover process, as is required in an IPO, in practice, bidders and target companies appoint investment banks as advisers in both solicited (friendly) and unsolicited (hostile) takeovers.14 Such practices are common because expert valuation reports are required for setting the offer price, preparing the financing, obtaining approval from the board and shareholders, and satisfying the pension requirement.15 Investment banks also have better insight into setting the offer price, taking into account any subsequent revision due to

10

National Statistics (2016). Lee (2017). 12 The Takeover Panel (2020). 13 Takeover Code, General Principle 5, Rule 24.16 and Rule 25.8. 14 Bodnaruk et al. (2009). 15 Ibid. 11

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the target board’s rejection or a bid from a white knight.16 The revenue gained by UK banks amounted to GBP 108–117 billion and a total of 2.2 million people were employed in professional services such as accounting, legal, and advisory services in the UK in 2016. Investment banks also provide securities services. As investment banks provide securities intermediation services—holding securities in trust for the clients, they are in a better position to act as a proxy in a takeover fight, especially for the end investors who may not have detailed knowledge of the bidder’s offer or the target management’s strategy as they decide whether to accept or reject. Investment banks, when holding the intermediated shares through investment funds and custodian services, are in a better position to gauge the market sentiment and mobilise votes in a takeover fight. For example, when Unilever was considering relocating from London to Rotterdam, the shareholders were mobilised to reject the board’s suggestion. Investment banks played a significant role in this decision, as such a relocation would result in the loss of revenue for some of the banks, particularly if UK-based banks were not able to offer services to clients based in the EU due to the loss of the passporting right. Even though more than 50% of UK shares are held by foreign investors (end investors), UK banks provide custodian services for them. In other words, in the majority of cases, UK banks exercise voting rights, either as proxies or trustees, on behalf of their end investors, such as funds based outside of the UK. Financial institutions act as gatekeepers in many ways. Since the takeover process is based on the detailed rules in the Takeover Code, it is unlikely for a non-market player to launch a random takeover bid without the necessary finance, advice, and securities services. Under China’s circumstances, recent cases, such as Vanke takeover case (by Baoneng) revealed that financial intermediaries developed asset management plans (funds) which assisted commercial banks to conduct regulatory arbitrage.17 In this model, the commercial banks charged a fixed rate from the leveraged bidder and financial intermediaries charged a commission fee from the leveraged bidders.18 Asset managers gave the right of control of asset management funds to the leveraged bidder rather than the independent management.19 Hence, the financial intermediaries lost their independent ability to manage the funds. In the UK, banks need to confirm the bidders’ financing,20 hence a financially underprepared bidder is unlikely to satisfy the Takeover Panel about its ability to pay without the support of a reputable bank.21 Furthermore, target companies, if listed on a UK exchange, are subject to corporate governance requirements22 So such companies need to provide valuation reports to satisfy the board as well as its

16

Ibid. Liu and Lou (2016). 18 Ibid. 19 Ibid. 20 Takeovers Code, Rule 19. 21 Takeovers Code, Rule 24.8. 22 Takeovers Code, Rule 24.10. 17

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shareholders.23 For the target company, the board needs to obtain an independent valuation report,24 which may cause the shareholders to accept or reject the offer.25 Such independent advice from banks limits boards’ conflicts of interest, such as CEOs’ personal egos or board entrenchment, in a takeover contest.26 Furthermore, investment banks have better insight into the secondary market of different trading venues.27 Therefore, information about prior dealings between the bidder and the target company is more likely to be known within the investment circle. This knowledge can prevent the bidders from avoiding having to pay the highest price obtained in the preceding 12 months before the mandatory offer is triggered, as is required under the Code to protect minority shareholders.28

2.3

China’s Economic Model and Lack of Institutional Investors

The experience of the UK as a leading global centre for international financial and related professional services, such as banking, equity and bond markets, and fund management industries, provides lessons for China with regard to its ambition to become a financial power house. For example, many scholars are suggesting that China should learn from UK’s “twin-peak” financial supervision model to “balance the regulatory tasks for the over-concentrated risk in China’s large banking sector but the underdeveloped securities market”.29 However, China has a different market structure than the UK’s highly dispersed and liberalised market with its relatively concentrated ownership, strong state-owned or controlled enterprises that hold significant market shares, and non-independent financial institutions.30 The financial services industry is increasingly important to China’s economy. The contribution of the financial sector to China’s GDP growth has increased from 2183.68 billion RMB in 2009 to 7061.03 billion RMB in 2018. The sector also accounted for 6.993 million people in employment in 2018 compared with 4.49 million in 2009.31 Although the financial sector plays an increasingly significant role in the growth of the national economy, China has also experienced a soaring trade deficit with regard to the export and import of financial service industries from 2010 to 2012, with a deficit of 765 million RMB in the former and 2.86 billion RMB in the 23

Takeovers Code, Rule 3.1 and Rule 26.3. Takeovers Code, Rule 3.3 and Rule 16.2. 25 Takeovers Code, Rule 25.2 (a). 26 Kershaw (2016). 27 Servaes and Zenner (1996). 28 Takeovers Code, Rule 9.5. 29 Han (2017). 30 Armour et al. (2002a, b). 31 National Bureau of Statistics of China (2018). 24

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latter. The capital market in China has been criticised for a lack of sufficient professional institutional investors and it remains a retail investor-oriented market.32 In recent years, the China Securities Regulatory Commission (CSRC), the watchdog of China’s securities market, has vigorously promoted the development of institutional investors. Commercial banks, securities investment funds, insurance companies, pension funds, and securities companies have grown at a gradual pace.33 Institutional investors are increasingly changing their role from passive shareholders and speculative traders to active shareholders engaging in the governance of their portfolio companies.34 As a result, essential rules and regulations for protecting the interests of minority shareholders have been adopted.35 There has been a series of cases in which institutional investors were in disagreement with the resolution of the board of directors and revoked board motions. For example, in 2010, the Shuanghui Group, which is listed on the Shenzhen Stock Exchange, intended to abandon the pre-emptive right, leading to some asset funds voting against and eventually revoking the board resolution. This case was regarded as the first case in which the institutional investors invalidated the plan of the major shareholders.36 Subsequently, there have been several cases in which institutional investors actively participated in corporate governance and rejected the proposals of major shareholders. These efforts made by institutional investors actively brought the corporate governance rules into practice and promoted Chinese corporate governance standards. Although the number of such cases and the level of institutional shareholders’ engagement in corporate governance in China remain limited, there is an upward trend in the percentage of the total floating A-shares held by institutional investors, from 5% in 2003 to over 45% in 2016.37 Among them, foreign investors hold 2.66% of the market shares.38 The Corporate Governance Code of Listed Companies (2018 revision) emphasises the positive effects that institutional investors make to improving the corporate governance of their portfolio companies, and it encourages institutional investors and financial intermediaries to engage in the process of corporate governance.39 If institutional investors are actively involved in their portfolio companies’ corporate governance, they can act as efficient external monitoring mechanisms. For instance, when a company encounters a takeover bid, institutional investors could voice their opinions on whether the takeover bid should be accepted or rejected, based on their professional skills and with sufficient market information, through exercising voting rights, inquiry rights and advisory right. Hence, the active

32

Xi (2006). As of 2018, the market value of funds in China amounted to 130 billion. 34 Xi (2006). 35 Ibid. 36 Ibid. 37 The figure was 19.86% in accordance to the survey report conducted by OECD in 2017. 38 WFE data in 2016; also see OECD Survey of Corporate Governance Frameworks in Asia 2017. 39 Corporate Governance Code of China’s Listed Companies, Art. 78, 79, 80, 81 & 82. 33

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involvement of institutional investors is able to promote the development of an active market for corporate control. Meanwhile, an increasing number of foreign institutional investors are participating in China’s financial market following China’s commitment to opening the capital market. Foreign institutional investors take a more active part in the corporate governance of portfolio companies as independent institutional investors, compared with domestic institutional investors. This is despite the fact that there are ownership requirements and currency restrictions for foreign investors, and these requirements are less likely to be removed entirely in the short term. However, some of the restrictions that have been in force for a long time have been relaxed as new policies and regulations are gradually introduced. For instance, in accordance with the Chinese-Foreign Equity Joint Ventures Law, the proportion of an investment that is contributed by foreign joint ventures generally had to be more than 25% of the registered capital of a joint venture.40 Otherwise, foreign investors are not normally eligible to receive preferential tax treatment.41 When the Foreign Investment Law (FIL) came into force in January 2020, the minimum shareholding requirements of foreign investors were removed, and this provides more flexible options for foreign investors as minority shareholders. In terms of currency restrictions, FIL does now allow foreign investors to remit their contributed capital, profits, capital gains, asset disposal income, intellectual property license fees, legally obtained damages and compensations, or liquidation proceeds overseas in RMB or any other foreign currency,42 although in practice foreign investors are still not able to engage freely in cross-border remittances.43 FIL was interpreted as an olive branch to the US amid trade war negotiation. The law confirms that national policies favouring the development of enterprises will be applicable to foreign-invested enterprises (national treatment).44 Meanwhile, it should be admitted that although FIL provides various ways in which the current broad principles of the law on foreign investment can be changed, further explanation is needed to clarify and guide the practice.45 It is expected that foreign investors will play the role of independent institutional investors incrementally. In 2018, President Xi Jinping said that China will create a more attractive investment environment for foreign investors.46 The Securities Law revision that came into force on 1st March 2020 amended the rules governing takeovers to enhance the requirements of information disclosure and strengthen investor protections. For instance, if an acquirer fails to comply with information disclosure rules, the corresponding voting

40

Chinese-Foreign Equity Joint Ventures Law, Art. 4. See ‘Notice Concerning the Relevant Issues on Strengthening the Approval, Registration, Foreign Exchange Control and Taxation Administration of Foreign-Funded Enterprises (2003)’. 42 Foreign Investment Law, Art. 21. 43 Schaub et al. (2019). 44 Foreign Investment Law, Article 9. 45 Koty (2019). 46 Xin Hua News (2018). 41

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rights of the acquired shares will be suspended.47 There are also enhanced duties on acquirers. For instance, an acquirer is not allowed to withdraw a takeover bid within the period of acceptance, as specified in the takeover bid, and is also prohibited from lowering the acquisition price or the number of shares intended to be acquired and from shortening the acquisition period.48 In conclusion, recent reforms and market developments, while still falling short of full “liberalisation”, can make, and are intended to make, the Chinese takeover market more attractive to foreign investors.

2.4

The Problem of Shadow Banking and Its Impact on the Takeover Market

As the takeover market develops, banks have been using off-balance-sheet lending to finance takeover bids.49 Financial institutions play an important role in financing small and medium-size enterprise (SMEs) in China.50 Compared with state-owned enterprises (SOEs), private enterprises encounter difficulties in obtaining bank loans. Due to the dominant position of SOEs in the market, they are regarded as qualified borrowers with lower default risks than SMEs.51 As a result, SOEs and state sectors, such as local governments, rely heavily on the privilege of obtaining lower cost loans from state-owned banks. In contrast, SMEs, as the contributors of 60% of GDP, only receive 30% of bank loans. The financing needs of SMEs promote the development of “shadow banking” in China. Asset management products developed by various financial institutions, the major contributors to shadow banking, provide financing to SMEs and industries that are restricted in their ability to obtain bank loans as a matter of policy. However, this result has increased systemic risks. From 2016, unsolicited bidders have been financed by shadow banking financiers in the takeover of target listed companies, such as the takeover of Vanke by Baoneng. The total amount of shadow banking amounted to 100 trillion RMB in 2018, leading to the IMF’s warning of shadow banking’s high risk to China’s financial stability. China’s regulators have also begun to address the threats of shadow banking by strict enforcement of new regulations. However, the booming shadow banking industry has been providing liquidity to SMEs for over 10 years and is unlikely to be closed entirely.52 In addition, financial intermediaries have recently been taking an active part in financing hostile takeovers. In the Vanke case, several commercial banks and insurance companies financed the hostile bidder with a “high-

47

Securities Law (2019 revision), Art. 63. Securities Law (2019 revision), Art. 68. 49 Shen (2014). 50 Sender (2011). 51 SMEs as the creators of 60% of China’s GDP only enjoy 30% share of bank loans. 52 China Banking News (2018). 48

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leverage” strategy.53 In response, policy makers introduced rules to regulate the financing of takeovers by financial intermediaries to reduce systemic risks. They have, for example, restricted the proportion of financial intermediaries investing in the equity market and attempted to govern the shadow banking business within the legal framework of the newly introduced asset management rule. At the same time, to support the ‘optimisation of the industry structure’,54 which is a state economic policy, regulators require that banking financial institutions provide takeover loans in an active and steady manner rather than banks close all the channels for the financing of takeovers.55 One of the distinctive requirements of this rule is that commercial banks are required to separate their asset management department and normal bank loan business departments by establishing a separate asset management subsidiary. If the parent companies are prevented from interfering in the activities of their asset management subsidiaries, the independent asset management industry could be an efficient institutional investor acting as an external monitoring mechanism.56 The newly introduced rules on asset funds can help develop professional asset managers who can act as independent institutional investors.

2.5

The Role of Financial Institutions Implementing State Policy

Financial institutions in China are more likely to be influenced by government policies than those in the UK.57 In some cases, the goal of financial institutions’ investments is not for profit maximisation but to implement policy guidelines issued by the government.58 The majority of the major players in the securities market are state-controlled institutions via individual SOEs or a number of them.59 The policy goals of governments could, therefore, exert great influence on investment decisions.60 For instance, the CSRC released the “Regulations on Equity Management for Securities Companies (draft for comments)” in March 2018, which clearly indicates that the net asset of the controlling shareholders of securities companies should not be less than 100 billion RMB. In addition, there are also threshold requirements on profitability for the last 5 years and sustained profitability. Only 30 listed companies out of more than 3500 A-share listed companies in China meet the threshold requirement of 100 billion RMB on net assets, and most of them are 53

Huang (2019). Opinions on Promoting Enterprise Merger and Restructuring, Article 1. 55 The State Council (2014a). 56 Shen (2016). 57 Zhu (2004). 58 Ibid. 59 Loubere and Zhang (2015). 60 Ibid. 54

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larger-scale financial institutions and SOEs. As a result, the controlling shareholders of the majority of the 20 securities firms with the largest shares of the M&A market in 2017 were SOEs or state-controlled enterprises. Furthermore, policy intervention by the government in the decisions of financial institutions and some investment decisions made by securities companies is common.61 For instance, there were securities companies that established asset management plans to invest in SMEs and some private enterprises following the guidelines of the government to bail out SMEs and private enterprises, such as Guotai Junan Securities Company and Guoyuan Securities Company, which are state-controlled enterprises. Due to their state-controlled status, securities companies may “pursue many non-economic goals and create non-economic criteria for assessing the performance of financial institutions”.62 Therefore, the research reports of securities companies are influenced by the policy goals of the government and assessment criteria established by regulators. For example, to tackle the financing difficulties of SMEs, the CBIRC added the growth of loan ratios for SMEs as one of the assessment criteria of the performance of commercial banks.63 It should be noted that optimising the market structure is a state policy. Based on this policy, regulators favour mergers and acquisitions in the market. Thus, the takeover law together with the economic model and reforms in the ownership structure provide an opportunity to develop an active market with corporate control. Additionally, under the influence of the policies, there is the possibility that financial intermediaries will be more willing to provide loans to bidders.

3 The Ownership Structure 3.1

The UK’s Dispersed Model and China’s Concentrated Model

The UK has a dispersed ownership structure, which has been achieved after almost five decades of industrial transformation,64 in contrast to the dominance of controlling shareholders in many China’s listed companies. Although dispersion in the ownership is a distinct feature of the UK capital market, the overall holdings of institutional shareholders (foreign and domestic) and retail investors varied over time. In the UK, the primary institutional clients of asset management firms are

61

Shen (2016). Ibid. 63 See ‘Notice on Further Improving the Quality and Effect of Financial Services for Micro and Small-sized Enterprises in 2019’. 64 Coffee (2001). 62

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pension funds and insurance companies.65 There was an increasing trend in the holdings of insurance and pension funds from 10% and 6.4% in 1963 to 23.6% and 22.1% in 1997 respectively.66 The expansion of holdings of insurance and pension funds before the years around 1997 was due to the post-war punitive tax regime of investment income and savings of retirement.67 During that time, institutional investors could exert influence on operations of portfolio companies. However, a sharp decrease in holdings of UK quoted shares by UK institutional investors followed in the years after around 1997. As the primary institutional clients, insurance and pension funds’ holdings decreased to 4% and 2.4% respectively in 2018.68 Such a downward trend was caused by various reasons, such as the change in tax regime for pensions, mark-to-market accounting and other regulatory changes.69 In addition, the relaxation of exchange control in 1979 gradually led to a geographical diversification of the holdings of UK institutional investors, which was reflected in the decreased holdings of UK quoted equites by domestic investors and increased holdings by foreign investors.70 Specifically, from 1963 to 2018, the UK witnessed a sharp increase in the holdings of foreign investors from 7% to 54.9%. In 2018, over half of the foreign holdings were in the possession of institutions from North America (51.3%), Europe (24.1%) and Asia (15.7%).71 By contrast, the holdings of individual shareholders declined from 54% to 13.5% in the same time period.72 Although over half of UK quoted equities have been held by foreign institutional investors, the UK remains one of the world’s prominent centres for portfolio management on behalf of investors.73 40% (3.1 trillion GBP) of all assets in the UK is still managed by the UK asset managers on behalf of overseas investors, which is unchanged from 2017.74 In such a dispersed shareholding environment, agency costs of shareholders are potentially high.75 To deal with this problem, coordinated actions of shareholders in the UK system were conducted to influence the operations of portfolio (or investee) companies since 1960s.76 There are two approaches for activist shareholders to influence portfolio companies’ operations,: the first is to influence the management of their portfolio companies directly, and the second is to influence the rules that hold

65

The Investment Association (2018). Office for National Statistics (2018a, b). 67 For detailed discussions, see Paul (1993). 68 Office for National Statistics (2018a, b). 69 For detailed discussion, see Andrew (2014). 70 Davis (2015). 71 Office for National Statistics (2018a, b). 72 Ibid. 73 The Investment Association (2019). 74 Ibid. 75 Armour et al. (2009). 76 Davis (1993). 66

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the management accountable to shareholders.77 In terms of direct intervention into investee companies’ operation, due to the considerations of prudential investment strategy and portfolio diversification, individual institutions normally hold relatively small portion of shares of any single investee company.78 Hence, the cost of shareholder coordination for direct intervention in management of investee companies would be high. Alternatively, there is evidence supporting the proposition that institutional investors influence the governing rules of industry to make them more shareholder-friendly.79 As will be discussed, the adoption of a self-regulatory Takeover Code is a consequence of financial intermediaries’ contributions during the rule making process.80 For instance, the board neutrality rule under the takeover code provides opportunities for institutional investors to intervene in the management of portfolio companies.81 In theory, shareholder activism and takeovers are two kinds of governance mechanisms. The market for corporate control could be a disciplinary force as an external monitoring mechanism, known as ‘Sword of Damocles’, which incentivises corporate managers to take efforts to maximise corporate value and discipline complacent and inefficient managers.82 It is submitted widely that the UK market for corporate control plays such governance role.83 For instance, in the unsuccessful takeover bid for Illumina by Roche, it is argued that the takeover threat kept the management teams focused on shareholders’ interests.84 However, as Charkham argues, it would be better if institutional investors replaced inefficient management rather than leaving it to the takeover market to exert such a disciplinary force, which would ultimately be depending on the economic interest of a sufficient number of shareholders to sell or keep their shares.85 Hence, the UK public policy recently encourages institutional shareholders to be actively involved in the management of portfolio companies to tackle the problem of short-termism in investment strategy. The introduction of ‘Stewardship Code’ sets high expectations of institutional investors to conduct responsible allocation, management and oversight of capital for creating long-term value for clients.86 The Code emphasises the integration of investment and stewardship, and also requires investors to explain how they have fulfilled their stewardship duties.87 Such pro-intervention policies could improve the governance of portfolio companies, so as to reduce the chance to become targets of

77

Ibid. Ibid. 79 OECD (2011). 80 Armour and Skeel (2007). 81 Huang and Chen (2018). 82 Kershaw (2016). 83 Ibid. 84 LEX (2012). 85 Charkham (1989). 86 Financial Reporting Council (2020). 87 Ibid. 78

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hostile bidders. This may partially explain why the hostile takeovers become infrequent nowadays. In the UK, control of the processes and outcome of takeovers has shifted from the state to the asset funds.88 In China, the process of such a shift in control has only just begun,89 with the policy of mixed ownership structure reform and new measures to address shadow banking. However, there is still a lack of sufficient regulation to ensure the independence of asset management, which cannot be achieved simply by takeover law and regulation. Although the new asset management rules came into force in 2018 to address shadow banking, the rules only provide a framework for developing an independent asset management industry and areas such as liquidity management and information disclosure about asset management subsidiaries were not addressed by these rules. It is unlikely in the short term or even in the longer term that international investors will make up the majority of the ownership of listed companies. The UK’s shareholder-centred takeover model, with a strong focus on financial intermediaries and international investors, would not be easily replicated in China. At best, the Chinese takeover law aims at corporate structuring to facilitate mixed ownership control and to facilitate optimising the industrial organisational structure.90

3.2

The UK’s Dispersed Shareholding Market and Its Influence on the UK Takeover Market and Its Regulatory Model

The high degree of dispersed ownership structure among UK listed companies along with the lack of the constraints of controlling stakes by governments, the vertical and horizontal cross-shareholdings91 and the control by major shareholders allows shareholders, especially institutional shareholders and funds, greater opportunity to realise returns on a takeover.92 An estimated 22% of the value of UK quoted shares is held by asset managers. Hence, a regulatory objective of the Takeover Code is to facilitate market participants, especially offeree companies, to realise returns on their investment.93 These will in turn support better access by companies to external financing and investment because the fund industry plays an important role in raising capital.94 Therefore, non-frustration rules (no post-offer defences),95 mandatory bid 88

Bishop and Kay (1989). Shahid et al. (2005). 90 Huang and Chen (2018). 91 Lee (2017). 92 Ibid. 93 Ibid. 94 The Investment Association (2017). 95 Takeovers Code, Rule 21.1. 89

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rules,96 no break fee arrangement,97 no deal protection measures,98 and the requirement to identify potential bidders by the offeree board99 ensure that the opportunity to realise investors’ returns on their investment are not eliminated by the offeree board (target board). Even the requirement regarding the offeror’s financing arrangement100 is less burdensome than that of some countries that require funds (cash) to be in place (in a bank account) before an announcement of the offer can be made. This reduces costs for the bidder. The dispersed ownership structure in the UK is linked to its policy to develop the UK as not only the centre of the financial industry but also the hub of the fund management industry. The number and value of funds that London hosts is greater than those of Frankfurt and Tokyo.101 The Frankfurt and Tokyo markets have a more concentrated share ownership structure and a high degree of cross-shareholding, which present some corporate governance problems.102 The fund management industry in the UK offers investment outlets to both UK and international investors. Although 22% of UK listed shares are held by the fund management industry, shares beneficially owned by intuitional shareholders, such as pension funds and insurance companies, are intermediated through the fund management industry: investment schemes, hedge funds, and private equity houses. These funds invested in listed companies take a minority stake and seek investment returns, normally in the short term; they do not seek to take control of management. The level of the involvement of these funds in influencing management decisions, through shareholder activism or engagement, depends on their investment strategies based on their investment mandates or policies. In this regard, minority shareholder protection in the Takeover Code directly protects the interests of the fund management industry.103 To further develop the fund management industry, the Stewardship Code was introduced with the aim of enhancing the accountability of fund managers to their clients.104 Under the Code, fund managers should exercise their voting rights to hold the corporate management to account in accordance with the best practice principles in the Corporate Governance Code.105 The UK market significantly differs from the US market in the use of litigation as an investment strategy to hold the board to account and to realise returns on investment.106 In the US, litigation is often used as an investment strategy, either

96

Takeovers Code, Rule 9.1. Takeovers Code, Rule 24.16. 98 Lee (2017). 99 Takeovers Code, Rule 2.2. 100 Takeovers Code, Rule 24.16, Rule 25.8. 101 Cassis and Wojcik (2018). 102 Franks and Mayer (2017). 103 Lee (2017). 104 Reisberg (2015). 105 The UK Stewardship Code, Principle 2. 106 Armour et al. (2002a, b). 97

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to hold management to account or to obtain redress.107 Class action lawsuits have been used against boards for giving misleading information or breaching their duties.108 In takeovers, class action lawsuits have been used to prevent defences adopted by board managers in a takeover bid. Although in the UK, the Takeover Code removes such a litigation strategy from fund managers,109 the non-frustration rules, the no break fee arrangement, and no deal protection measures empower fund managers and shareholders in the offeree companies.110 Furthermore, the mandatory bid regimes ensure that the funds will ‘share’ the control premium.111 The requirement that the offeree board identifies other potential bidders aims at maximising this control premium.

3.3

China’s Concentrated Ownership Structure and Its Reforms

Compared to the UK’s dispersed shareholding model, China has a relatively concentrated shareholding structure, and SOEs account for a large percentage of the total market value. As of 2017, there are 953 state-controlled listed enterprises with 51.4% of the total market value of the total floating A-shares. Hence, hostile takeovers are rare in China. Although the ownership structure is still concentrated, China has witnessed a trend to increase capital market liquidity since 1978 when the national strategy of “reform and opening up” was adopted. The current concentrated shareholding structure has been strongly related to China’s political structure since the Chinese Communist Party (CCP) began to rule China in 1949. At that time, China adopted the style of the former Soviet Union’s centralised and planned economy and ever since, SOEs have been regarded as part of the government. Corporate governance systems were therefore extremely similar to the system of state government. For instance, SOEs were owned by the state, and the senior managers were appointed or dismissed by administrative bodies. Furthermore, the operation of SOEs was not aimed at profit-maximisation but followed the plan of the state. Since 1978, whether national strategy of “reform and opening up” by Deng Xiaoping was adopted, an increasing number of listed companies have been transferred to the private sector. The state has been gradually releasing power to the market by firstly, adopting the goal of establishing a socialist market economy, which was launched during the “Fourteenth National Congress of the CCP” in 1992, and secondly, promoting privatisation through measures such as the “Split Shareholding Structure Reform” 107

Steinitz (2012). Ibid. 109 Lee (2017). 110 Ibid. 111 Ibid. 108

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and “Mixed Ownership Reform”. The outcomes of the various reforms have improved the market, although the market in China is still not as liberal as those of advanced market economies. Explicitly, the aim of SOE reforms was “to introduce the modern corporate governance system with the characters of separate ownership and management, defined property rights, explicit scope of powers and responsibilities”.112 After the completion of the ‘split shareholding structure reform’, all the shares of listed companies became freely tradable on the secondary market.113 According to the data released by the State-owned Assets Supervision and Administration Commission (SASAC), as of March 2018, over 90% of SOEs have completed the mixed ownership reforms. Based on China’s SOE reforms, we expect that China will continue to release power to the market by deepening the SOE reforms, and SOEs will compete freely in the market with less administrative intervention while the process of perfecting China’s characteristic legal systems and capital market continues. With the progression of a mixed ownership structure, the fundamental direction of the reform of state-owned assets and enterprises is to combine state-owned capital invested in companies with other social capital under mixed ownership. The state will invest in the company and be a non-controlling shareholder. That is, under mixed ownership, the state-owned economy will persist in the form of shareholders like its private counterparts. It is the investors of the companies rather than an administrative organ, which will realise the integration of state-owned capital and private capital and allow the mixed ownership enterprises to become true market players. That is not to say that China will precisely mimic western capitalisation and corporate structure and establish a highly dispersed shareholding structure. There are differences in the nature of the firms, markets, cultures and political orientations between China and advanced economies that impede the convergence of corporate structure.114 Some Chinese scholars have argued that the corporate governance regime in western countries is not appropriate for Chinese corporations because of the different legal and institutional arrangements, so the simple transplantation of rules from other jurisdictions may not combat Chinese issues.115 It can even be dangerous to transplant corporate governance rules that ignore local realities.116 Therefore, the transplant of advanced rules from developed financial jurisdictions needs to be adapted to the indigenous context. Mixed ownership reforms are still steadily progressing.117 The report of the “19th Congress of the CCP” established that China will deepen the reform of SOEs, develop a mixed ownership economy, and cultivate globally competitive worldclass companies. Takeover is recognised by the Chinese government as an efficient

112

CCP (1982). Cai (2011a, b). 114 Bebchuk et al. (1999). 115 Xianchu (2003). 116 Wolff (2004). 117 Ibid. 113

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tool for realising this aim.118 In addition to the key sectors of the national economy and security, the Chinese government is gradually releasing power to the market regarding free trade. Under the mixed ownership structure guidance, the SASAC has ruled that if an SOE could be controlled by private sectors, the state-owned shares may flow out entirely or may remain in a non-controlling status.119 The governor of the SASAC announced that the SASAC will encourage the subsidiaries of SOEs to be listed on the Science and Technology Innovation Board, a newly introduced board in the Shanghai Stock Exchange, which is a Chinese version of the Alternative Investment Market in the UK. Additionally, according to the SASAC’s announcement, the SASAC will, through a variety of approaches, promote the restructuring of these kinds of SOEs and achieve a diversified ownership structure.

3.4

Ownership Structure and Takeover Law in China

The monitoring function of the takeover market has been well developed in advanced economies; by contrast, this kind of market is underdeveloped in China. Before the Split Shareholding Structure Reform, two-thirds of the total shares of listed companies in China were non-tradable, and therefore, it was impossible for an acquirer to take over a target through share acquisitions in the secondary market without friendly negotiation or approval by state administrative bodies.120 A study conducted in 2009 revealed that tender offers are rare in the Chinese market.121 In most M&A cases, there are strong political connections between the acquirer and target company.122 However, under the guidance of the mixed ownership structure reform, the state has gradually released power to the market and plays the role of a non-controlling shareholder in the majority of situations. In addition, the state council has recognised the positive effects of takeovers and published guiding opinions on promoting takeovers and restructuring activities to “optimise the industrial organizational structure, accelerate the transformation of the economic development mode and structural adjustment and improve the development quality and benefits”.123 The takeover regulations in China also favour takeovers, which are regarded as an efficient tool for market structuring and promoting the national economic reform plan.124 China’s state-led restructuring of industries through scaling up industrial

118

The State Council of China (2014) Opinions on further Optimising M&A Market Conditions. SASAC (2013). 120 Report on China’s Corporate Governance 2009: The Market for Corporate Control and Corporate Governance. Fudan University Press. 121 Ibid. 122 Chi et al. (2009). 123 The State Council (2010). 124 Ibid. 119

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concentration and cultivating globally competitive champions plays an essential role in favouring takeovers to optimise the market structure.125 The “Interim Provisions on the Management of the Issuing and Trading of Shares” was the first experiment under the Chinese Securities Law. The takeover regulations of these provisions were substantially incorporated into the Securities Law of 1999, which provided a framework for takeover law in China.126 Although the Securities Law of 1999 provided substantial provisions about takeovers, it was still not precise enough in practice to guide the takeover of listed companies.127 Subsequently, the CSRC established the “Measures for the Administration of the Takeover of Listed Companies (Measures for Takeovers) 2002” to provide a preliminary, workable regulatory regime for takeovers to improve the efficacy of takeover regulations. Subsequently, the “Measures for Takeovers” were revised by the CSRC in 2006, 2012, 2014 and 2020.

3.4.1

Non-frustration Rule

Under the Chinese takeover regulations, takeover defensive tactics should not be adopted without shareholder approval at a general meeting. However, a defensive tactic could still be adopted without shareholder approval, if it “does not have a crucial impact on asset and liabilities of target or those defensive tactics are parts of ordinary business operation of the target, or adopted before the takeover bid announcement”.128 Hence, compared with their UK counterparts, under China’s board neutrality rule, there is considerable room for adopting ex post defensive tactics by the target management. In practice, there are various types of defensive tactics adopted by Chinese listed companies, though the legality of such tactics is unclear.129 Anti-defence rules under China’s takeover law are vague about providing guidance for the practice.130 The law provides that the target board “shall not erect any improper obstacles to the takeover by misusing its authorities”.131 However, the question of what kinds of obstacles should be regarded as improper obstacles is unclear.132 In terms of ex post-defensive defences, the rule of board neutrality in China follows the board neutrality principle in the UK Takeover Code. Various defences could effectively deter hostile bidders and delay the development of the market for corporate control. In addition to takeover defences adopted by the listed

125

Xi (2015). Huang and Chen (2018). 127 Cai (2011a, b). 128 Measures for the Administration of the Takeover of Listed Companies, Article 8 & 33. 129 Cai (2011a, b). 130 Ibid. 131 Xi (2015). 132 Lin et al. (2017). 126

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companies, the company law revision in 2018 eases the conditions for allowing listed companies to buy back shares, and this can be used as a defence by targets.133 A cross-shareholding structure could also effectively impede unsolicited takeovers, as shown in Japan.134 The increasing number of hostile takeovers is one result of the crucial decline in institutional cross-shareholding of listed firms in Japan.135 Even if the company law does not explicitly address the issues of crossshareholding, the “Anti-monopoly law” together with several administrative regulations restrict the scope of cross-shareholding in listed companies to protect consumers’ interests and prevent market manipulation.136 In addition, there are several rules restricting the cross-shareholding structure of financial institutions and companies that invest in financial institutions.137 Although lawmakers may have negative opinions of cross-shareholding structures, there are as yet no uniform laws and regulations restricting cross-shareholding structures in listed companies.138

3.4.2

Mandatory Takeover Bid Rule

Although there is a UK-style mandatory takeover bid rule in China’s takeover law, an empirical study suggests that the majority of mandatory bid obligations have been exempted by the CSRC, and the mandatory bid rule exits in name only in China.139 Before the revision of “Measures for Takeovers” in 2020, if bidders were under any of the circumstances prescribed in article 62 or 63, bidders and their concerting parities may apply to the CSRC for the exemption of mandatory bid obligations.140 The CSRC is responsible for reviewing if the bidder’s meets the exemption requirements. A research revealed that from 2004 to 2010, the total number of takeovers triggering the mandatory bid obligation was 733; 706 of the mandatory bid obligations were exempted by the CSRC, which accounted for 96.32% of the total number of takeovers triggering the mandatory bid obligation.141 There is a suggestion that the mandatory takeover bid should be abolished.142 Unlike the mandatory bid rule in the UK, proportional takeover bids are allowed in China when the bidder triggers the mandatory bid obligation.143 If the shares tendered by the target shareholders exceed the scheduled purchase amount, the bidder can carry out the acquisition on a

133

Bagwell (1991). Lee (2017). 135 Milhaupt (2015). 136 Qiu (2017). 137 People’s Bank of China and the CSRC (2018). 138 Zhang (2008). 139 Cai (2011a, b). 140 Measures for Takeovers 2014, Art. 61. 141 Ibid. 142 Ibid. 143 Measures for Takeovers 2014, Article 24. 134

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proportional basis (or the pro rata basis).144 Furthermore, if a bidder purchases the shares of a listed company by means of a takeover bid, the proportion of shares to be purchased shall not be lower than 5% of the issued shares of target in accordance with “Measures for Takeover 2014”.145 The revision 2020 did not change the proportional partial bid rule in essence. Prohibiting the adoption of takeover defensive tactics together with frequent exemptions of mandatory bid obligations has significantly relieved the financial burden of bidders.146 In the 2020 revision of the “Measures for Takeovers”, the requirement to apply to the CSRC for exemptions from mandatory bid obligations has been removed, and bidders are exempted automatically if they meet the requirements under article 62 or 63 of the “Measures for Takeovers”.147 In addition, compared to the previous version, the revised one sets out the circumstances in which bidders are exempted from mandatory bid obligations.148 As will be discussed in great detail in the next section, there is empirical evidence supporting the argument that the exemptions that CSRC granted in the past were biased in favour of the interests of SOEs.149 The revision in 2020 allows bidders to be exempted from their mandatory bid obligations without CSRC’s approval, and therefore the scope for CSRC’s bias is reduced. Furthermore, the Securities Law 2019, as the superior law of the “Measures for Takeovers”, introduced several new rules on M&A activities. In particular, the mandatory bid obligation under the Securities Law is now triggered when bidders acquire 30% of the voting shares of the targets.150 However, in the revised “Measures for Takeovers 2020”, the threshold for the mandatory bid obligation is when bidders acquire more than 30% of the issued shares of the target, rather than 30% the voting shares.151 Hence, the threshold for mandatory bid obligations under the “Measures for Takeovers” is lower than that set under the Securities Law. The “Measures for Takeovers”, as a CSRC’s departmental regulation that provides detailed practical M&A rules based on its superior law, i.e. the Securities Law, should be consistent with the Securities Law. The current divergence can cause misunderstandings in practice. Although the revised Securities Law152 and Corporate Governance Code153 attempt to improve the corporate governance of listed companies and to promote the development of the market for corporate control, the essence of the rules on takeovers remains unchanged. The proportional partial bid rule is still effective and

144

Cai (2011a, b). Measures for Takeovers 2014, Article 25. 146 Cai (2011a, b). 147 Measures for Takeovers 2020, Art. 61. 148 Measures for Takeovers 2020, Art. 62 & 63. 149 Xi (2015). 150 Securities Law (2019 Revision), Art. 65. 151 Measures for Takeovers 2020, Art. 24. 152 Securities Law (2019 Revision). 153 Code of Corporate Governance for China’s Listed Companies (2019 Revision). 145

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considerable room remains for listed companies to adopt draconian takeover defences without shareholders’ approval.154

4 The Institutional Arrangements of the Takeover Law Framework 4.1

Policy Based Regulatory Model

The UK model facilitates a smooth and orderly takeover market with the financial services industry controlling the drafting, administrating, and enforcing of takeover law. The state has very limited power to control takeovers. The legitimacy issue remains a moot point, although it did raise some issues in the negotiations of the Takeover Directive at the EU level. There is no plan in the UK to change this selfregulatory model to a statutory model. Even though the UK courts can, both in terms of expertise and resources, deal with takeover law issues, there is no immediate plan to give the adjudicatory function to the courts, i.e., the financial list of the commercial court. The Takeover Code contains principles that are developed into detailed rules and guidance notes. Although parties should observe both the spirit of the general principles and rules, the spirit of the general principles is paramount. The Panel can prevent a transaction that, although the transaction complies with the letter of the Code, breaches the underlying purpose of a particular provision.155 The Panel has the ability to grant a dispensation from the rules where the transaction adheres to the spirit of the general principles. Such a principle-based governance provides flexibility to takeover governance, which also allows the Panel to issue guidance to supplement the rules. Furthermore, the Panel can also embody the practices—the rulings of the Panel—through amendments to the Code following the consultation process. The constitution of the Panel and the processes to amend the Code are not regulated by law. The courts and parliament have limited roles in the rule-making, decision-making, and adjudication processes.156 To date, the legitimacy of the Panel and Code has not been questioned by the legal community. Neither has there been any attempt to reform the Takeover Panel or to introduce a statutory Takeover Code. The self-regulation of the takeover market remains the cornerstone of the regime.157 The legitimacy of such a self-regulatory takeover regime can be justified on the basis of resources and expertise.158 It is recognised that the takeover market focuses on the interests of investors and those who facilitate market transactions. In the UK, the 154

Huang and Chen (2018). Lee (2017). 156 Ibid. 157 Kershaw (2016). 158 Ogowewo (2007). 155

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majority of these entities are financial intermediaries. Hence, the resources for law making, adjudication, and administration of the takeover market should be provided by the market players. Taxpayer money should not be spent on the takeover market, which is not relevant to non-market players.159 Equally, the courts—especially the Commercial Court and the Chancery Court, should deploy their resources to hear cases that are of wider societal implication. Regarding expertise, the Panel, represented by the players in the financial markets, has insight into the trading practices, corporate governance issues, and dynamics of the markets. Some of the issues are not immediately apparent to non-market players, such as the fact that the announcement requirement falls on the target management. As London is a financial centre with great economic significance to the UK, expertise is important to ensure the competitiveness and stability of the London financial markets.160 Such a de-centralised and professionalised governance regime minimises direct state intervention and the impact of lengthy court cases on financial stability. However, other stakeholder interests, such as employee job prospects, employees’ pensions, community development, and long-term investor commitment, can be overlooked.161 These stakeholders’ interests are not enshrined in the general principles of the Takeover Code.162 Despite some rules designed to protect these interests,163 they give measurably less protection than the protection given to investors in the market, such as asset funds.164 Many jurisdictions, such as Hong Kong and Singapore, have modelled their takeover laws on the UK Takeover Code, but neither Hong Kong nor Singapore follows a similar institutional arrangement in terms of their constitutions. To avoid appeals cases being reviewed by the courts, senior ex-judges sit as members of the Appeal Panel.165 Such an arrangement substantially removes the legal risk of cases being argued in the courts.166 There is no evidence to suggest that government agencies have direct influence over the law-making processes, appointment of members, and decisions of the Panel.167 Although the Financial Conduct Authority (FCA) has the power to impose sanctions on parties for transgressing the Takeover Code, the FCA does not have the power to amend the rules or enforce the Code. Other departments, such as the Department for Business, Energy and Industrial Strategy, which oversees the development of company law, do not have formal power to interfere with Takeover Code enforcement.168 The recent Green Paper on corporate governance reform published

159

The Takeover Panel (2020). Kershaw (2016). 161 Nyombi (2015). 162 Ibid. 163 Department for Business (2012). 164 Kershaw (2016). 165 Lee (2017). 166 Ibid. 167 Kershaw (2016). 168 Lee (2017). 160

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reviews of the impact of takeover law on other stakeholders. Although the paper suggests the implantation of heightened protection for stakeholders other than employees, there is very little momentum to extend the power of government or to provide more power to stakeholders to control the outcomes of a takeover.169

4.2

China: The Late Comer to Adopt a Takeover Market

The Shanghai and Shenzhen Stock Exchanges were established in 1990, and at that time, there were no unified regulations for the capital markets. Instead, various rules, regulations, measures, notices and guidelines applied.170 After the “Fourteenth National Congress of the CCP” agreed to create a socialist market economy in 1992, takeovers of listed companies were first regulated by the “Interim Provisions on the Management of the Issuing and Trading of Shares” promulgated in 1993. These provisions established the initial framework for takeovers in China and were mainly disclosure rules for takeover bids and competitive bids.171 During the early 1990s, the Hong Kong stock market was the essential channel through which SOEs could raise financing.172 Thus, Hong Kong financial experts had the opportunity to suggest that China adopt Hong Kong’s takeover law173 at a time when Hong Kong’s legal framework and laws were mainly based on the UK legal regime. Thus, many of the “the Measures for Takeovers” in China were borrowed from the UK Takeover Code via the Hong Kong Takeover Directives. Mandatory bid rule was transplanted into China and initially codified in article 88 of the Securities Law,174 which was introduced as part of the protection of the principle of the equality of opportunity.175 Before the amendment of the Measures for Takeovers in 2006, the 2002 version of the mandatory bid was transplanted from the UK Takeover Code in all its material aspects:176 the CSRC had full discretion to exempt mandatory bid obligations;177 the consideration paid by the bidder followed the highest price rule;178 and the acquisition of 30% of target shares triggered the mandatory bid obligation.179 In addition, the 2002 Takeover Measures were strongly

169

Ibid. Guanghua and Minkang (2001). 171 Hui (2014). 172 Ibid. 173 Guanghua (2005). 174 Huang and Chen (2018). 175 Ibid. 176 Xi (2015). 177 Measures for Takeovers 2002, Article 49. 178 Measures for Takeovers 2002, Article 34. 179 Measures for Takeovers 2002, Article 13, 14 and 23. 170

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antipathic to partial bids.180 According to the 2002 Measures for Takeovers, the acquisition of 30% or more would trigger the mandatory bid obligation, and partial bids were not allowed.181 However, in the 2006 version, the general bid rule was amended to the proportional partial bid rule.182 The rationale behind the amendment of the mandatory bid rule in 2006 reflects competition between different interest groups. Although China and the UK shared broadly similar takeover law, the interest served by the takeover laws in the two regimes are completely different. The UK Takeover Code is influenced by financial intermediaries and serves the interest of promoting financial services in the UK. However, in China, the Takeover Law mainly serves to facilitate industrial restructuring and the goal of creating globally competitive national companies, which was re-emphasised by President Xi Jinping on the “19th Congress of the CCP”. This policy has also been reflected in the Takeover Law in China, for example in the existence of proportional partial bids, non-frustration rules and reduced disclosure requirements. Authorities regard solicited takeover as an efficient tool for promoting China’s goal of deepening the reform of SOEs in order to develop a mixed ownership economy and to cultivate globally competitive, world-class companies.183 In 2010, the state council announced guidance opinions on promoting takeovers and restructuring activities to “optimise the industrial organizational structure, accelerate the transformation of the economic development mode and structural adjustment and improve the development quality and benefits”.184 In the context of promoting an active market for corporate control, the rationale behind frequent exemptions of mandatory takeover bid obligations by the CSRC and the existence of proportional partial bids are aimed at promoting the development of a takeover market to facilitate the national economic reforms.185 Strict enforcement of the mandatory bid rule would frustrate takeovers. As a result, proportional partial bids were allowed in the 2006 Takeover Measures, and the non-frustration rule was introduced.186 In addition, the Takeover Law in China has also clearly expressed that if the bidder acquires the target company in order to bail out the target from financial difficulty, the bidder may apply to the CSRC for an exemption from the mandatory bid obligations.187 An empirical study revealed that between 1993 and 2005 approximately 80% of the listed companies undergoing takeover and reorganisation survived rather than becoming delisted because of poor performance.188

180

Xi (2015). Measures for Takeovers 2002, Article 13. 182 Measures for Takeovers 2006, Article 24 and 25. 183 The State Council (2014b). 184 Ibid. 185 Cai (2011a, b). 186 Measures for Takeovers 2006, Article 8 and 24. 187 Measures for Takeovers 2006, Article 49. 188 Hua (2007). 181

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Under the 2002 Measures for Takeovers, a UK-style general bid rule was adopted, and shareholders can be protected by the enforcement of mandatory bid obligations.189 The CSRC has full discretion to decide whether a takeover is valuecreating or value-destroying in order to determine whether an exemption to the mandatory bid obligation will be granted.190 Due to the exceedingly high cost of a mandatory bid for all the remaining shareholders of the target company, the waiver of a mandatory bid could greatly lighten the financial burden of the bidder. In other words, the CSRC uses its power to reduce the costs for bidders for the purpose of facilitating corporate restructuring. Although the Measures for Takeovers of 2006 still allow the grant of exemptions to the CSRC, the allowance of a proportional partial bid makes exemptions from the mandatory bid obligations less crucial than before because, even if no exemption is granted, the bidder can still continue the acquisition process by launching a proportional partial bid.

4.2.1

CSRC Approaches to the Non-frustration Rule and De Facto Defensive Tactics

As mentioned in the last section, there are several types of defensive tactics that have been adopted by various listed companies to impede unsolicited bids, though the legality of anti-takeover provisions remains unclear under current regulations.191 These defensive measures aim to provide protection against possible unsolicited takeovers.192 Defensive tactics may stop the bidder from gaining actual control of the target, even if the bidder has gained a controlling block of the target’s shares.193 One study shows that, among the sample of 150 listed companies in China, 73 adopted defensive tactics, and over three-quarters of the remainder were controlled by the dominant shareholders.194 These existing defensive tactics can make hostile takeovers costly and difficult to conduct successfully.195 A case study revealed that Chinese listed companies have established a range of defensive tactics in their articles of association, such as restricting the voting rights of hostile bidders, staggering the board regime and the provision of golden parachutes. The CSRC and courts have failed to provide guidance on the validity of such defensive tactics.196 Some scholars have argued that the ‘letter of concern’ issued by stock exchanges, a non-binding regulatory

189

Measures for Takeovers 2002, Article 13. Measures for Takeovers 2002, Article 49. 191 For the detailed discussions, see Sect. 3 of this chapter. 192 Cai (2011a, b). 193 Ibid. 194 Ibid. 195 Ibid. 196 James (2019). 190

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measure (soft law), has positive effects on regulating takeover defences.197 However, the letters of concern issued by exchanges as a soft-law normally express concerns in specific cases, rather than providing a universal guidance to the whole industry. More importantly, the implicit permission for defensive tactics given by laws and by the CSRC shows that the regulator prefers friendly takeovers to hostile takeovers198 to achieve the goal of optimising the market structure. This could be one reason why hostile takeovers are rare in China.199 Financial regulators are also frequently involved in hostile takeover battles in China. In the Vanke case, for instance, the Chairman of CSRC publicly commented harshly on the bidder’s (Baoneng) high-leverage strategy and described the hostile share purchasing as “barbaric”.200 The CIRC, the national insurance watchdog, also called such share purchasing “risky” and suspended a product issuance of certain insurance companies through which Baoneng raised most of the capital to acquire Vanke’s shares. Following the financial regulators’ intervention, Baoneng announced that it would not seek control of Vanke and reduced its shareholding in Vanke incrementally to 15% as of September 2018.201 Baoneng’s announcement was also related to the actions taken by two other major shareholders of Vanke: China Resources, a state-owned enterprise, and Evergrande, a real-estate developer. They announced that they would transfer their shares entirely to Vanke’s white knight Shenzhen Metro, a SOE at the local level. China Resources and Evergrande shareholdings were 15.3% and 14.1% respectively before the start of the bidding process, compared with Baoneng’s 25.4%.202 As a result, Shenzhen Metro replaced Baoneng as Vanke’s largest shareholder. The decision of China Resources to transfer its shares in Vanke may have been influenced by SASAC’s view that “the Central SOE should not compete for benefits with local enterprises” and that China Resources was required to cooperate with the Shenzhen city government.203 Such SASAC requirements may have pressured China Resources to transfer its shares in Vanke to Shenzhen Metro which backed target management fully.204 Shenzhen City Government also encouraged Evergrande to transfer its shares to Shenzhen Metro.205 The result was that this hostile takeover attempt was ended by state intervention. In this case, the state acted as a “white knight” by blocking Baoneng’s unsolicited bid. As mentioned, amendment to takeover law in China is part of the programme for national economic reform and corporate restructuring. This means that the law does

197

Ibid. Huang and Chen (2018). 199 Ibid. 200 Caixin (2017). 201 Huang (2019). 202 China Daily (2017). 203 An Ran (2017). 204 Ibid. 205 Sheng (2017). 198

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not have the same logic as the UK’s non-frustration rule, which was adopted to maximise shareholder value. Based on CSRC’s implicit permission for takeover defences206 and frequent administrative interventions into takeover battles,207 one could reasonably infer that regulators prefer friendly to hostile takeovers.

4.2.2

Lack of Independent Market Players and the Role of SOEs and SASAC

Under the UK takeover market, takeover law is driven by the interests of financial intermediaries. However, the situation in China is significantly different. As mentioned, the main goal of takeover law is to facilitate state-led national economic reforms in China, and SOE reform is one of the crucial parts of this reform.208 Thus, SOEs are important market players in China that own and control the majority of securities companies, insurance companies, commercial banks, pension funds and social security funds. Larger numbers of professional and independent institutional investors can be expected after the introduction of the new set of asset management rules. Before the regulation of asset management industries, asset funds, which were not independent, were the channels through which commercial banks were able to evade regulatory restrictions to provide bank loans to restricted industries and unqualified borrowers. Asset funds frequently enabled commercial banks to whitewash their balance sheets, which is the main type of shadow banking business that increases systemic risk in China’s of the financial system.209 The role of the independent external monitoring mechanism cannot be fulfilled effectively. Several cases such as the takeover of Vanke (by Baoneng) and Sunriver (by Longwei Media) indicate that commercial banks offer loans to bidders in order to take over listed companies through such channel-type businesses. Asset funds are the ideal professional institutional investors to fulfil the gatekeeper role in the financial market and should not be used as channels or tools for commercial banks to evade regulatory restrictions on the provision of loans. Lawmakers have therefore begun to regulate such channel-type businesses with the hope of creating more professional institutional investors and managing systemic risks. The newly announced regulation requires commercial banks to separate their asset

206

Empirical studies revealed that, in many listed companies’ articles of associations, an array of draconian takeover defences has been adopted, which harms shareholders’ interests. However, these defences are regulated by a soft-law approach, rather than prohibited by the securities regulatory authority (CSRC), i.e. stock exchanges issue ‘letters of concern’ to listed companies. For detailed discussion, see James (2019); also see Hui (2019). 207 Such as hostile takeover battels between Nanbo Float Glass Co., Ltd., v. Baoneng Investment Group (bidder), Yili Industrial Group v. Sunshine Insurance Group (bidder), and Gree Electric Appliances Industrial Group v. Foresea Life Insurance (bidder). 208 Xi (2015). 209 Guofeng and Junyi (2015).

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management departments from the rest of the bank in order to establish an independent subsidiary and prevent the asset management department from becoming the tool through which banks whitewash their balance sheets. Additionally, the regulation requires that asset management subsidiaries of banks perform the duties of faithfully and diligently managing the property on behalf of investors upon commission.210 Most importantly, the law releases the restriction on banks’ asset management subsidiaries to directly invest in the equity market.211 In addition, although the percentage of foreign institutional investors is insignificant at this stage, regulators, such as the state council, the CSRC and the CBIRC, have gradually begun to open the capital market to foreign institutional investors, as mentioned in the previous section. SOEs play an active role in the takeover market in China, and takeovers are regarded as an efficient way to promote SOE restructuring under the guidance of the mixed ownership structure reform. At the same time, SOEs are also responsible for bailing out some private companies that face financial difficulties and assisting in the development of private enterprises. According to the announcement of the SASAC, as of 2018, 32% of mergers were conducted by SOEs taking over private companies with the intention of diversifying the state investment portfolios and assisting in the development of private enterprises.212 On the other hand, in the situation involving an SOE as a bidder, approval by the relevant department of the state, such as different levels of state asset supervision and administration organs, is needed before such transactions can be launched.213 Although under the mixed ownership structure reform, SOEs welcome private investors, thus fulfilling the requirement of a mixed ownership structure, transactions involving state-owned shares can be executed only with administrative approval in most occasions.

5 Looking Forward China is in an equivalent historical position to that of the UK over the last few decades in terms of the privatisation of some SOEs and the liberalisation of its capital market. However, the UK and China are in different stages of their economic development and have different legal and political structures. China’s takeover regulations were mainly transplanted from UK Takeover Code via Hong Kong Takeover Directives in the early 1990s.214 Hence, there are some similarities. To be specific, both China’s Takeover Measures and UK Takeover Code apply the

210

CBRC (2018). Ibid. 212 Ibid. 213 Measures for Takeovers 2020, Article 4. 214 Weilin et al. (2017). 211

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shareholder primacy governance model and the board neutrality rule to allocate powers between target shareholders and management. The adoption of defences is in principle restricted, albeit with significant differences between the two jurisdictions, and a mandatory bid obligation will be triggered if the acquirers hold a certain percentage of the target shares. Neither country relies on the development of the concept of the fiduciary duty of management to control the takeover process. The CSRC and other policy markers play more decisive roles in the development of takeover policy and law than do the courts; policy plays the most important role in takeover law development in both countries. In the UK, the takeover market forms part of the UK’s international financial services market so shareholder democracy and equal treatment go hand-in-hand in supporting the development of the industry. In China, takeovers are mainly used to facilitate corporate restructuring and courtmade norms may not be put in place sufficiently quickly to accommodate the requirements of state policy. Although the takeover regulations in China were initially translated from the UK Takeover Code, China’s approach has gradually deviated from the UK model as it seeks a regulatory model that fits in with the nature of its political system. For now, the two largest world economies are experiencing major geo-political challenges—Brexit and the US-China Trade War. The UK’s Brexit politics will require the UK to seek new global trading partners and, more importantly, to find ways to maintain its leading status as a global financial centre.215 Leaving the EU is unlikely to have a major impact on takeover law in the UK. Rather, the UK may relax some of its rules to attract incorporation in the UK, listing on UK exchanges, and asset funds domiciled in and managed from the UK. These measures can increase inbound M&A. For outbound M&A, China remains an attractive market for UK companies. The mixed ownership policy and the new FIL provides an opportunity for foreign companies to enter the Chinese capital market by either buying controlling stakes in Chinese companies or in some of the subsidiaries of SOEs.216 The recent measures cracking down on shadow banking, and the new FIL may also encourage UK financial services firms to start providing financial and advisory services to the parties in the takeovers. Some funds may also participate in the takeovers. However, the regulatory regime for asset funds is still in the developmental stage in China. The regulatory risk of a UK fund launching a direct, unsolicited takeover would be difficult to mitigate as regulatory attitude towards foreign funds operating in China is still unclear.217 For the foreseeable future, the UK will continue to be open for foreign takeovers. It is possible that a Chinese company may launch an unsolicited bid to acquire control of a UK company.218 Since the UK does not apply reciprocity rules in

215

Sheffield Political Economy Research Institute (2017). Foreign and Commonwealth Office (2017). 217 Ibid. 218 For example, the contest between Chinese Company China National Offshore Oil Corporations (bidder) and US Unocal was the first big unsolicited takeover, which occurred in 2005. 216

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takeovers, UK listed companies can be taken over more easily by Chinese companies than Chinese companies by UK companies. The UK Takeover Code does not contain reciprocity clauses as permitted by the EU Takeover Directive to allow UK companies to use defences. Hence, regulatory alignment can level the playing field. China has committed to open up its capital market to foreign investors, as it has with the London-Shanghai Stock Connect, QFII and the Shenzhen-Hong Kong Stock Connect Regime. In this context, the role of the takeover market should be expanded to include the function of serving market restructuring, such as providing an efficient external monitoring mechanism, attracting inbound investments and promoting the development of the financial market. To achieve these goals, the UK model may have some lessons for China.

5.1

Takeover Laws and Regulations

In the UK, the non-frustration rule and mandatory bid rule are the cornerstones of promoting the smooth development of the market for corporate control and protecting investors’ opportunities to receive abnormal returns when there is a hostile bid.219 However, as established in Sect. 4, in order to achieve the goal of establishing world-leading champions, the non-frustration rule and mandatory bid rule in China’s takeover law have deviated from their originally intended purpose. The CSRC grants implicit permission to listed companies to adopt defensive tactics, although whether such defenses comply with the law and regulations is unclear. Proportional partial bids are also allowed in China, unlike the UK where the mandatory bid rule is strictly enforced. With China’s commitment to opening up the capital market and to deepening reforms to mixed ownership structure, the takeover law should grant enhanced protection to investors and promote the development of the market for corporate control. In doing so, takeover law in China should strike a fair balance between the contestability of takeovers and shareholder protection in order to attract inbound investment and promote the development of an active market for corporate control. In the UK, the mandatory bid rule is effective in enhancing the opportunity for shareholders to share control premiums and thus attract inbound investment.220 However, proportional partial bids and excessive exemptions from mandatory bid obligations granted by CSRC have meant that the mandatory bid rule exists in China in name only.221 UK-style strict enforcement of the mandatory bid rule should be instigated in order to attract inbound investment and to protect shareholders’ interests. Proportional partial bids and CSRC’s exemptions of mandatory bid obligations of bidders may be allowed, but only in exceptional cases. Draconian anti-takeover

219

Lee (2017). Ibid. 221 Cai (2011a, b). 220

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defensive tactics harm the interests of investors because they prevent investors from obtaining control premiums222 so China’s takeover regulations should restrict them severely. Even if defensive tactics are allowed, the power to make decisions should be vested in the shareholders meeting, rather than the board of directors, in order to avoid a conflict of interests.

5.2

Market Players

As established in Sect. 2, the market for corporate control in China could be an efficient external monitoring mechanism which is especially important when internal monitoring mechanisms are weak in China. To develop such an active market for corporate control, the role of financial intermediaries should not be overlooked. Under the UK model, financial intermediaries perform an independent gatekeeping, financing and advising role but in China, non-bank financial intermediaries mainly act as the channel for commercial banks to conduct off-balance deposit-taking and loan-making business (regulatory arbitrage), which comprises the main part of China’s shadow banking system.223 Hence, to establish an active market for corporate control as an external monitoring mechanism, it is imperative for financial intermediaries to be able to operate independently. Introducing a fiduciary duty regime into the asset management industry in order to emphasise financial institutions’ duty towards their clients is a possible way of promoting independent operation of non-bank financial intermediaries in China.

5.3

Regulatory Models: CSRC Centralism and Self-Regulation Model

In the process of the state-led scaling-up of industry in China, administrative orders are applied to mergers more frequently than is takeover law.224 This is because when the reform of market structure began, the majority of market shares were held by SOEs, but takeover law is applied only when corporate control is transferred in the capital and securities markets.225 However, under the mixed ownership structure, an increasing number of takeovers could be expected in the capital and securities market because of an increasingly dispersed shareholding. This means that a comprehensive takeover law and an effective and unbiased regulatory model are essential. 222

James (2019). Cai (2011a, b). 224 Xi (2015). 225 Ibid. 223

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In an effective market for corporate control, the regulators should ensure a level field for market players and counteract the greater ability of SOEs to lobby for the adoption of their favoured regulations.226 An empirical study revealed that “the CSRC appeared to be systematically more responsive to the waiver applications of mandatory bid obligations from SOEs than from private individuals. Within the generic grouping of SOEs, the higher the level of government that ultimately controls the acquirers, the speedier the approval process was”.227 Hence, the UK’s principles-based self-regulatory model which limits the function of the state and judiciary, can serve as a blueprint for developing an independent regime under the supervision of the CSRC. This deserves further research.

6 Conclusion Regulatory alignment can level the playing field in cross-border M&A activities. However, the UK is an open market for foreign takeovers while there are still many restrictions against foreign investors launching unsolicited bids in China. Although China is committed to a gradual opening of its capital market, the establishment of an active takeover market is still at an early stage. There are distinct differences between the UK and China in both takeover regulations and policy, due to differing economic models, ownership structures and institutional arrangements. Structural differences between China and the UK dictate different policies with regard to takeovers in these two countries. The UK operates a self-regulatory model while China has opted for a command-and-control model. In the UK, the takeover market offers major revenue to the financial services industry’s financing, advising, brokering, and asset management sectors. The self-regulatory model ensures the smooth development of the takeover market. At the same time, financial intermediaries in the UK perform an independent gatekeeping role in that market. However, the takeover market in China mainly functions to serve the domestic economy. China’s state-led restructuring of industries through scaling up industrial concentration plays an essential role in using takeovers to cultivate globally competitive national champions. In terms of ownership structures, the UK enjoys a high degree of dispersed ownership and is less constrained by government controlling stakes and crossshareholdings. Hence, institutional investors have more opportunity to realise their investment returns. The dispersed ownership structure in the UK is linked to its policy of developing London as a centre for international financial industry and the hub of the global fund management industry. By contrast, China’s ownership structure is relatively concentrated, despite the various ownership structure reforms have been adopted to release state controlling stakes. As a result, it is difficult to

226 227

Ibid. Ibid.

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conduct unsolicited takeovers at present. Nevertheless, as the mixed ownership structure is progressively reformed in China, there is room for developing an active market for corporate control. The UK model also facilitates the development of the takeover market since the financial services industry is involved in the drafting, administration and enforcement of takeover law. The state has limited power to intervene and control takeovers. In China, however, takeovers are mainly used for corporate restructuring and market optimization and the proportional partial bid rule, the low level of information disclosure requirements, and a Chinese-style board neutrality rule have been introduced to realise this goal. This chapter shows that differences in policy goals make regulatory alignment currently not achievable. However, the UK’s experience provides some lessons for China’s continuing corporate reform, for the development of China’s takeover market, and for its goal to develop Shanghai or Shenzhen into an international financial hub.

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Koty A (2019) China’s new foreign investment law. Dezan Shira & Associates Lee J (2017) Striking a fair balance in UK takeover law: market interests, power of regulation, and enforcement. Eur Bus Law Rev 4:840–852 LEX (2012) Roche/Illumina: take a Chill Pill Lin W et al (2017) The Vanco takeover – revisiting the takeover defences regulation in China. Company Lawyer 38:153–154 Liu Y, Lou J (2016) Asset managing plans in corporate mergers. Tsinghua Law Rev 6:64 Loubere N, Zhang H (2015) Co-operative financial institutions and local government in China. J Co-operative Organ Manag 3:32–39 Milhaupt C (2015) In the shadow of Delaware? The rise of hostile takeovers in Japan. Columbia Law Rev 105:2171–2216 National Bureau of Statistics of China (2018). http://data.stats.gov.cn/easyquery.htm?cn¼C01. Accessed 20 May 2020 National Statistics (2016) Ownership of UK quoted shares. https://www.ons.gov.uk/economy/ investmentspensionsandtrusts/bulletins/ownershipofukquotedshares/2016. Accessed 20 May 2020 Nyombi C (2015) A critique of shareholder primacy under the UK takeover law and the continued imposition of the board neutrality rule. Int J Law Manag 57:235–264 OECD (2011) The role of institutional investors in promoting good corporate governance. OECD Publishing Office for National Statistics (2018a). https://www.ons.gov.uk/economy/ investmentspensionsandtrusts/bulletins/ownershipofukquotedshares/2018#rest-of-the-world. Accessed 20 May 2020 Office for National Statistics (2018b) Ownership of UK quoted shares 2018. https://www.ons.gov. uk/releases/ownershipofukquotedshares2018. Accessed 20 May 2020 Ogowewo T (2007) Tactical litigation in takeover contests. J Bus Law:589–619 Opinions on Promoting Enterprise Merger and Restructuring, Article 1 Paul D (1993) Institutional investors in the United Kingdom. In: Theodor B, Richard B, Klaus H (eds) Institutional investors and corporate governance, 1st edn. de Gruyter, Berlin People’s Bank of China and the CSRC (2018) Guiding opinions on strengthening the regulation of non-financial enterprises investing in financial institutions, Article 9 Qiu Z (2017) The dilemma of the cross-shareholding structure and the proposal for regulatory improvement. Legality Vision 3:100 Reisberg A (2015) The UK Stewardship Code: on the road to nowhere? J Corporate Law Stud 12:217–253 SASAC (2013). http://finance.people.com.cn/n/2013/1220/c70846-23901072.html. Accessed 20 May 2020 Schaub M et al (2019) China signals improvements for foreign investors. Paper posted on Foreign Investment, King & Wood Mallesons Sender H (2011) Monetary tightening by China to be felt across globe. Financial Times Servaes H, Zenner M (1996) The role of investment banks in acquisitions. Rev Financ Stud 3:787–815 Shahid Y et al (2005) Under new ownership: privatising China’s state-owned enterprises, 1st edn. World Bank and Stanford University Press, p 5 Sheffield Political Economy Research Institute (2017) The political economy of Brexit and the UK’s national business model. Research Paper No. 41 Shen W (2014) The risk of China’s shadow banking and selection of regulatory tools. China Legal Sci 4:151–177 Shen W (2016) Regulating wealth management products. In: Shadow banking in China: risk, regulation and policy, 1st edn. Edward Elgar, p 104 Sheng H (2017) Control and governance with Vanke Style, 1st edn. Oriental Publishing, p 148 Steinitz M (2012) The litigation finance contract. William Mary Law Rev 2:455, 518 Tella S (2019) Optimal regulation of financial intermediaries. Am Econ Rev 109:271–313

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The Investment Association (2017) Asset management in the UK 2016–2017: the Investment Association Annual Survey The Investment Association (2018) Asset management in the UK 2017–2018: the Investment Association Annual Survey The Investment Association (2019) Investment management in the UK 2018–2019: the Investment Association Annual Survey The State Council (2010) Opinions of the State Council on Promoting Enterprise Merger and Restructuring The State Council (2014a) Notice on issuing the guidelines for the risk management of merger and acquisition loans granted by commercial banks. Article 1 The State Council (2014b) Opinions of the State Council on Promoting Enterprise Merger and Restructuring The State Council of China (2014) Opinions on further optimising M&A market conditions The Takeover Panel (2020). http://www.thetakeoverpanel.org.uk/structure/panel-membership. Accessed 20 May 2020 Weilin W et al (2017) The Vanco takeover – revisiting the takeover defences regulation in China. Company Lawyer 38:153–154 WFE data in 2016; also see OECD Survey of Corporate Governance Frameworks in Asia 2017 Wolff L (2004) Making perfect corporate governance rules: mission impossible? Corporate Governance Int 7:21 Xi C (2006) Institutional shareholder activism in China: law and practice. Int Company Commercial Law Rev 17:1–35 Xi C (2015) The political economy of takeover regulation: what does the mandatory bid rule in China tell us? J Bus Law 12:142–164 Xianchu Z (2003) Globalization of corporate governance and lessons from emerging economies. In Zhipan W, Michiyo H (eds) Corporate governance and capital markets supervision, 1st edn. Peking University Press, pp 82, 109 Xin Hua News (2018). http://www.xinhuanet.com/politics/2018-04/10/c_1122660064.htm. Accessed 20 May 2020 Zhang Z (2008) Studies in the regulation of corporate takeover defences. PhD thesis, China University of Political Science and Law Zhu H (2004) Replacement of senior managers and firm performance. Econ Sci 4:91

On the Supply Side of Western Hostile Takeover Law and Its Implications for China Ciyun Zhu and Linyao Tang

Abstract The battle for corporate control may ultimately lead to the improvement of corporate governance, or the plunder of corporate wealth. The goal of hostile takeover regulation is to promote merit-adding takeovers while decreasing as much as possible the agency costs between corporate insiders and shareholders. Different practices in the US, the UK and the EU all have their merits and inadequacies. This research examines the western practices from a path dependence perspective, and offers insights for future Chinese hostile takeover legislation. For complex reasons and institutional factors, amendments to the law would be of little use in improving the hostile takeover regulations in China, and the main priority should be to discard the “CSRC centralism” dependency path that has been active for decades.

1 Introduction To regulate hostile takeovers within its regime, the U.S. adopted a Fiduciary Duty Centered Mode to combine the court trial on directors’ behavior with federal formality examination on tender offers; the U.K. adopted a Self-Regulatory Mode where the non-governmental Takeover Panel had replaced the ex post adjudications with fair and swift ex ante conciliations; the E.U. adopted a Free Choice Mode that allowed the Member States to transpose the takeover law according to their needs based on a seemingly “unified” European Directive. These are the three original models that existed and shaped subsequent regulatory models world-wide.

This research is supported by National Social Sciences Fund of China (Grant No. 20CFX006). C. Zhu (*) School of Law, Tsinghua University, Beijing, China e-mail: [email protected]; [email protected] L. Tang Institute of Law, Chinese Academy of Social Sciences, Beijing, China © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_3

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The formation of the three above regulatory frameworks had gone through special historical contexts, political manipulation and institutional evolution; in turn, these factors together shaped legal schemes with varying path dependence features with regional characteristics. The top-down two-tier U.S. regulatory framework has distinctive Board Centrism features: the fiduciary duty review system established through a series of legal precedents was nothing more than an intermediate standard between the Business Judgement Rule and the Substantive Fairness Principle. Instead of judicial review, it in fact produced the effect of judicial deference to the directors’ anti-takeover actions. In comparison, the bottom-up single-pattern U.K. regulatory framework was obviously shareholder supreme: institutional investors, being the major shareholders of the companies, reflected rational apathy in corporate governance, but maintained convenient oversight of their managers by lobbying the industrial elites to make private laws that favored them. The Takeover Panel is competing with public legislators, unifying the interests of the panel committee with the yields-first investors honoring traditions. The bottom-up drafted European Directive had all the characteristics of Shareholder Centrism, but the top-down transposition process of it had given Member States the chance to adopt director primacy laws and promote trade-protectionism. Interestingly, the E.U.’s dilemma mirrors China’s status quo in regulating hostile takeovers—a seemingly shareholder-oriented Company Laws failed to guarantee shareholders’ legitimate rights and decision power in takeover-related issues, and corporate insiders could easily elbow out dissenting stockholders and utilize management tools for selfpromotion. Originally, China had crafted its hostile takeover law from the U.S., the U.K. and the E.U. After over two decades of local practice, China had formed a unique regulatory framework (and path dependence) in its semi-market economy. On one hand, the target board has very limited ex post takeover defensive measures under the current law, they then introduced various ex ante anti-takeover provisions into the articles of associations utilizing their de facto controlling powers. The duty of care and duty of diligence in Chinese law are stipulated through a series of positive and negative lists; this parody of the U.S. fiduciary duty review system fails to provide a comprehensive and fair standard to review the board’s ultra vires. On the other hand, facing unruly managements, the acquirers also have gone wild and frequently undermine the assumptions of the Securities Law. Breaches of the tender offer procedural requirements, violations of information disclosure rule and other questionable behaviors are common practices. Previous hostile takeover cases illustrated that, these loopholes come from over-complicated legislations that are vague and obscure. Almost every pending dispute has been solved by the China Securities Regulatory Commission’s administrative intervention; the intentions of the “above” have outweighed the substantial law to decide the outcomes of hostile takeovers. With this in mind, it can be seen how actual amendments to the law would be of little to no use in improving the hostile takeover regulations in China. That is why the main priority should be to discard the “CSRC centralism” dependency path. To find an applicable alternative path under the current regime, we first draw suggestions from the established approaches of the U.S., the U.K., and the E.U.; future reform in

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China must take the contextual and complicated local factors into consideration, such as the economic needs, capital market development, supply side reform and other imperative political appeals. Despite the fact that the E.U. practice was falling victim to pork-barrel politics and interests exchange between the Member States, the Directive itself is an exemplary paradigm that successfully and accurately codified some of the advantages of the U.S. and U.K. approach. At the macro level, China should adopt a U.K. alike regulatory approach referring to the E.U.’s codification technique to gradually reform the current pro-U.S. regime. Our research then reviews China’s peculiar capital market history, extra-ordinary political particularities and systemic inertia in law, and provided detailed suggestions at the micro level for future improvement taking all these social and institutional backgrounds into account. First, the supervisory power needs to be redistributed. The Chinese Securities Law acknowledges two self-regulatory entities in the Chinese securities market—the Stock Exchanges and the Securities Association of China. However, both of them lack the substantial punitive power to regulate; the CSRC maintains strict vertical control of them. The modernization of China’s securities market cannot be fulfilled without the development of inner-industry self-supervisory authorities that truly represent the interests of the participants. Therefore, despite the fact that the CSRC is the highest regulator in China, power should be delegated little by little to selfregulatory entities in order to achieve higher supervisory efficiency. Second, after approximately 20 years of growth, institutional investors in China are not as well-organized as their Western counterparts. Experiences from the U.K. demonstrates that, strengthening the scales and rights of the institutional investors could ultimately push China’s relatively primitive takeover regulatory regime into a modern one. Moreover, in order for the limited self-regulation to be effective and long lasting, the motives of the regulators must be compatible with those of the institutional investor shareholders—the overall profitability of the listed companies should always be the prior concern. Third, the ultra vires actions on the part of the management should be restrained especially in conflict-of-interests situations. The Administrative Rules on Acquisition of Listed Company should make it clear that without shareholder approval, the board of directors should not take any defensive measures. This is not to suggest a blanket ban on all takeover defenses, but rather, to allow the shareholders the ability of having the final say of adopting ex post defenses. Fourth, considering the severity of the insider control and the absence of a functional proprietor of the state-owned shares in Chinese listed companies, the agency costs among minority shareholders and controlling shareholders are especially high in China. As a result, the direct application of the Board Neutrality Rule proves to be inadequate. We will suggest a “modified” Board Neutrality Rule that stipulates that when takeovers are imminent, directors should not take any actions that may frustrate the offer bid unless the majority of minority shareholders say otherwise. This would make it imperative for the shareholders’ assembly to establish criteria that empowers ?? the “minority shareholders” in the company bylaw.

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Fifth, the fundamental rights of shareholders stipulated in the Company Law should be respected in takeover activities. Shareholders’ right to vote on major issues, to elect and nominate directors of the board and to call on interim meetings should not be violated by any means. In light of this, some of the anti-takeover provisions in the articles of associations should be nullified; it is also important to ensure that the proper procedures of shareholder assembly’s resolution are correctly fulfilled. Sixth, current Chinese Mandatory Bid Rule has a trigger so low that hostile takeovers can hardly happen; beyond that, partial offers instead of general offers are too frequently allowed in takeovers that the interests and lawful rights of the minority shareholders are ignored. A higher trigger, combined with a stricter general tender offer requirement is optimal and imminent for Chinese securities market. Likewise, considering the state-owned shares percentage varies from company to company, and almost every listed company in China has its unique equity distribution, a flexible trigger is very important. Seventh, the current threshold of the sell-out right in public acquisitions is too low. Drawing knowledge from the experiences of the Member States of the E.U., 90% is an optimal line for shareholders’ sell-out right to ensure a buy back of their shares by the 90% controller. In addition, it is rational that when minority shareholders exercise the sell-out right, all majority shareholders (according to their shareholding ratio) are together responsible for the remnant shares, but the acquirer reserves a preemptive right to acquire all the remnant shares. Accordingly, the introduction of a Squeeze-out Right is also necessary in China. Eighth, the law should allow moderate discriminative treatments to acquirers of different funding sources and leverage ratio. The management should be allowed to have the discretionary power of adopting defensive measures when faced with intruders funded by high-leverage ratio capital or insurance funds. Additionally, the supervisory body should meticulously define the parameters of leverage ratio, in other words, what could be regarded as “high” leverage ratio. Ninth, increasing the speed and transparency of takeover activities could help to ease the uncertainties in the market. Some of the efficacy clauses in the U.K.’s City Code largely increase the efficiency of tender offers and takeovers, which are of great referential value to China as well.

2 Retrospect of the Original Regulatory Models The battle for corporate control may ultimately lead to the improvement of corporate governance, or the plunder of corporate wealth—the key of hostile takeover regulation for the legislators is to set fair and stable rules for the participants.1 During this process, the hostile takeover laws could reveal certain level of “priorities”: the 1

Fu (2017), p. 227.

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tradeoff between empowering the board or the shareholders’ assembly seems unavoidable. In structuring their securities markets, the U.S., the U.K. and the E.U. had adopted three completely different models and regulatory patterns. They are displayed in the Chart below. The U.S.: “Fiduciary Duty Centered Model” ¼ Formality Examination of Tender Offers by the SEC + Modified Judicial Review of Target Board’s Fiduciary Duty of the State Court The U.K.: “Self-Regulatory Model” ¼ Ex Ante Involvement of the Takeover Panel + Ex Post Cooperation with the Industrial Associations The E.U.: “Free Choice Model” ¼ United European Directive Codifying the City Code of the U.K. + Member States’ Flexible Transposition of the Directive

Chart I: Three Original Models of Hostile Takeover Regulation How did the divergence of the regulatory frameworks happen? The traditional ownership structure theory was widely adopted to explain the diversity of the hostile takeover regulatory framework of the U.S., the U.K. and the E.U.2 The logic behind the ownership theory is as follows. The listed companies in the U.S. had more dispersed ownership structure than their counterparts did in the U.K. or the E.U. Meanwhile, the controlling minority structure widely existed in the listed companies of Germany, Finland and the Netherlands—some powerful families controlled the companies firmly with only a small portion of shares. As a result, it was easier to takeover listed companies in the U.S. than companies in the U.K. or E.U. Therefore, the boards in U.S. listed companies were allowed to take anti-takeover defensive measures, while the boards in the U.K. or E.U. were prohibited from warding off unfavorable takeovers.3 However, recent empirical studies showed that, the ownership structure in U.S. listed companies was not as diffused as expected and a dual-ownership structure and share pyramiding was very common in the U.S.4 As we will explain in detail, the situation of t listed companies was much more complicated. In sum, the traditional ownership structure theory was flawed, and was insufficient to explain regulatory differences between the regulation of hostile takeovers in the U.S., the U.K. and the E.U.

2 See Demsetz and Lehn (1985), pp. 1155–1177. See also Jensen and Meckling (1976), pp. 305–360. See also Demsetz (1983), pp. 375–390. 3 Ventoruzzo (2006), p. 171. 4 See Carter et al. (2003), pp. 33–53.

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History Retrospect

The reasons behind the divergence of the models are comprehensive. Path dependence theory implies that, historical factors and localities had set the basic tones for the hostile takeover regulatory frameworks long ago, even though some of the past circumstances are now no longer relevant. The history of the U.S. hostile takeover regulation could trace back to the early 1920s. The failure of the Blue Sky Laws and the financial crisis of 1929 resulted in President Roosevelt’s aggressive reform and reconstruction of the banking and securities’ industry. The populist-dominated U.S. congress consecutively passed the Securities Act of 1933, Securities Exchange Act of 1934, Glass-Steagall Act and the Banking Act of 1935,5 federalizing the regulation of the securities market and establishing a tradition of separate management of commercial and investment banks.6 Since 1960s, the U.S. corporations were established exclusively through general incorporation statutes.7 Proxy contests first appeared in 1954, and battles for corporate control became pervasive with the invention of the tender offer.8 Cunning corporate raiders designed coercive offers like the “Saturday Night Special”, pressing stockholders to rush to tender.9 On account of this, the Williams Act in the 1968 imposed stricter information disclosure and procedural requirements on acquirers. Along with federal legal reforms, the commercial law of Delaware has undergone huge changes since the late 1960s as well—it largely expanded the liability exemptions for directors, established a loose accreditation criterion for self-interested transactions,10 narrowed the use of appraisal rights of dissenting shareholders and upheld the Business Judgement of the board of directors.11 In a sequence of landmark trials of hostile takeover conflicts in the 1980s, the court recognized that the directors were “of a necessity” confronted with a conflict of interest as they may very possibly lose their job if the takeover succeeds, therefore, the direct application of the Business Judgement Rule was inappropriate. In Unocal Corp v. Mesa Petroleum Co. of 1985, a scientific interim standard—the Unocal test—came into being. However, as the directors of the board were repeat players in case trials and could utilize company resources to cope with litigation, it was extremely hard for the acquirers to obtain injunctions from the court against the anti-takeover defenses of the target company. Eventually, the ostensible mature fiduciary review system established in a series of cases was nothing more than an interim standard in between the rigorous Substantive Fairness Principle and loose Business Judgement Rule. In

5

Hoover and Roosevelt (1952). See Benston (1973), pp. 132–155. 7 Hurst (2010), pp. 1–20. 8 See Ikenberry and Lakonishok (1993), pp. 405–435. 9 See Bebchuk (1982) pp. 23–50. 10 See Arsht and Stapleton (1967), p. 75. 11 See Nourse (1996), p. 1331. 6

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sum, the Fiduciary Duty Centered Mode of the U.S. was more of a judicial deference to the directors’ anti-takeover actions than a stringent judicial review. In sum, “oldfashioned politics mattered” in the formation of the distinctive characters of the large U.S. firms as we see today.12 The legislation preference of the U.K. hostile takeover regulations can at least be traced back to the mid nineteenth century, when the great Board of Trade championed a laissez faire approach in regulating market-related affairs. Yet the picture was actually a little complicated, as the impluse of such a laissez faire impulse was not always so stable in the U.K. through the 19th to the early 20th.13 Intermittent governmental interferences were also critical in shaping U.K.’s hostile takeover regulation. At the end of the Second World War, high inflation rate elevated the price of fixed assets,14 making companies with land and real estates extraordinarily appealing to astute investors that were not intimated by high risks. Government-imposed dividend restrictions in the 1950s led to the hoarding of cash by many companies,15 gave rise to the outburst of hostile takeovers, for example, Charles Clore’s takeover of the Shoe Retailer J. Sears and Harold Samuel’s takeover of the Savoy Hotel Group. Interestingly, institutional investors and commercial groups in the U.K. were more outraged by the management’s ultra vires conduct in taking defensive measures without approval from shareholders than the hostile takeover attempt per se.16 Such discontent arose in the takeover contests between the U.K. Tube Investments, the U.S. Reynolds Metal Company, the Aluminum Company of America and the British Aluminum.17 To try to manage the increasing merger activities within the industry, the Bank of England formed a private legislation committee and drafted the first self-regulatory law on takeovers—the Notes on Amalgamation of British Businesses, and did so in close cooperation with the Issuing Houses Association, the Accepting Houses Committee, the British Insurance Association and the London Stock Exchange.18 This private law evolved into its more mature version - the City Code on Takeovers and Mergers of 1968, and the Panel on Takeovers and Mergers was established based on this code.19 The Panel initially had nine committee members, representing the banks, large corporations, business associations and industrial unions. To those commercial elites, ex ante interference was more efficient than ex post adjudication. The inchoate performance of the Takeover Panel was not as successful as expected, as it was overwhelmed by the steady flow of cases. Fearing governmental and public

12

Roe (1996), p. 3. See Robert (2009), pp. 1–362. 14 See Benati (2004), pp. 691–717. 15 Id. 16 See Sheppard (2013). 17 Armour and Skeel (2006), p. 1739. 18 See Roberts (1992), pp. 183–200. 19 See Johnston (1980). 13

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interference, the Takeover Panel acted swiftly and sought to improve itself in the 1970s.20 Moreover, the Board of Trade supported the Takeover Panel by agreeing to impose administrative punishments on undisciplined bidders and the London Stock Exchange also expressed its a willingness to work alongside the Takeover Panel to delist companies that misbehaved21 Since then, the Takeover Panel’s sanction and penalty powers had been inexorably on the increase. With the whole industry behind it, the Takeover Panel and its City Code finally became the ultimate authority in takeover disputes. Despite the left-leaning Labor Governments in the 1970s, the Takeover Panel proved irreplaceable through its strong performances and proactive self-improvement efforts . All in all, the history of the Takeover Panel and the City Code was the history of a self-regulatory system racing against imminent governmental statutory intervention.22 In order to survive, the Takeover Panel had to constantly improve itself to better cater for the need of the market; at the same time, it had to keep its good reputation as the pressure for legislative intervention could resurge at any time. Even in the Global Financial Crisis afterwards, Sir David Walker argued in his report for the government that there was no need for new legislation. He fell back upon the old mantra, recommending new soft law codes such as a stewardship codes for the involvement of institutional investors in corporate governance. His report led to the cosmetic revision of the old UK corporate governance code and the tradition of self-regulation remained stable and strong in the securities sector. The E.U. hostile takeover regulation came into being much later than that in the U.S. or the U.K. The notion of “a united European takeover law” started from the middle of the 1970s, when the European Council intensely discussed how to integrate its internal market. In a landmark document—Completing the internal market: white paper from the commission to the European Council of 1985, the European Committee mentioned the necessity of improving the tender offer procedure. In 1989, the European Committee drafted the Proposal for a Thirteenth Council Directive on Company Law Concerning Takeover and Other General Bids. This proposal contained a basic equal treatment rule for shareholders and delineated the rudiments of the general duty of the acquirers as well as the target management.23 Despite the fact that it was based primarily on the City Code, this proposal had been severely criticized by the U.K. The Department of Trade and Industry feared that codifying the non-statutory self-regulation code might impair the Takeover Panel’s speed and flexibility. Proposals made in 1996, 2000 and 2002 by the European Council led to several innovations. For example, in order to improve the efficiency of a united market in Europe and to establish a “level-playing field” among all Member States, Professor Jaap Winter and his drafting team

20

See Deakin et al. (2002). Armour and Skeel (2006), p. 1769. 22 Id. 23 Linyao Tang (2017c), p. 129. 21

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invented the Breakthrough Rule.24 However, these proposals ignited even more controversies and debates between Member States, and achieving “a united European takeover law” seemed almost impossible. After continuous negotiations and compromises, the Italian Representative proposed the idea of the “Optional Arrangements Rule”, which gave each member state the freedom to apply or not apply the controversial Board Neutrality Rule and Breakthrough Rule. In 2004, The European Directive on Takeover Bids was finally passed and came into effect afterwards—it “harmonized” takeover regulation in all E.U. Member States by giving up the most important essence of the notion of “a united European takeover law”—unification.

2.2

The Impact of Path Dependency

The above historical sketch has explained the movement toward the formation of three different hostile takeover regulatory models, yet it did not fully reveal the path dependent nature of the takeover regulation. How did the regulatory systems entrench themselves? What then accounts most for the systemic inertia of these three regulatory regimes? Professors John Armour and David A. Skeel Jr. found that differences in U.S. and U.K. takeover laws were mainly due to the fact that institutional investors in the two countries had played “very different roles”.25 Enlightened by their theory, we attribute the discrepancies and formation of the path dependency of hostile takeover regulatory frameworks in the U.S., the U.K. and the E.U. to the different roles of different interest groups, and the contests between them. These interest groups included the institutional investors, industry associations, labor unions, large conglomerates and so on. Before the establishment of the Securities and Exchange Commission, the financial industry of the U.S. had undergone more than 100 years of incomplete selfregulation. Between the Buttonwood Agreement of 1972 to the Constitution of the New York Stock Exchange Board of 1863, industry self-regulation was the principal constraint on the securities market, and the New York Stock Exchange was effectively the most important supervisor.26 However, “greedy Wall Street” was often blamed for the causing the financial crisis of 1929, and the public (represented by furious labor unions) and the government (represented by the populist Congress) no longer believed that self-regulation was an optimal method of supervision,27 which led to drastic legal reforms that shifted power to the SEC. The emergence of hostile takeovers from the 1950s further raised the rifts and frictions among the general public and Wall Street capitalists who were referred to as “corporate raiders” and 24

See Edwards (2004), pp. 416–439. Armour and Skeel Jr (2006), p. 1763. 26 Hart (1992), p. 843. 27 See Sorkin (2010). 25

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“white collar pirates”.28 In 1968, Senator Williams Harrison spoke candidly that he wanted to ensure that the management of a company had enough “gunpowder” to fight back the “barbarians at the gate”.29 The State Courts (mainly the Delaware Courts) had to tolerate deferring to the requests of directors of the board, as directors could decide where to incorporate their companies.30 As a result, the legal climate in the U.S. was never pro-acquirers. Restrained by these factors and circumstances, future corporate lawmaking in the U.S. could hardly shift to shareholder supremacy. Today’s U.S. regulatory framework is already well-entrenched; it is a pro-management system with no room for self-regulation. The UK chose the opposite regulatory preference—there, institutional shareholders had influenced the legal climate of the U.K. since the very beginning of capitalism practices. The punitively high rates of marginal taxation applied to investment income for individuals after the World War II completely destroyed the investment enthusiasm of independent citizens.31 The Mutual Investment Scheme then promoted the wild growth of institutional investors.32 These stockholders of U.K. listed companies were famous for being passive and generally indifferent to corporate governance concerns,33 whenever the performance of the company was not satisfactory, they would “vote with their feet” by dumping all their shareholding. Meanwhile, institutional investors were inclined to exert their influence on legislations directly to ensure laws were in their favor,34 but they could not achieve this without the cooperation of the industrial associations that represented their interests. When hostile takeovers first emerged in the U.K., the management’s ultra vires conduct provoked institutional investors and their associations; they were brought together by the Bank of England to promulgate the first self-disciplinary takeover rules in the 1950s. During this process, the Institute of Directors and the Association of British Chambers of Commerce were completely excluded from participating.35 As the institutional investors and their associations continued to lobby politicians and the government thereafter, the doctrine of “active shareholders, passive directors” under the self-regulatory rules became deeply engrained.36 At last, a shareholder-supremacy self-regulatory takeover law became unshakeable. In the E.U., the protests and indignation by institutional investors, large consortiums and labor unions ultimately led to the compromises in the European Directive. The formation of a “united” European Directive was not only the contest between the Member States, but to battles between the interest groups, institutional investors and

28

Keller and Gehlmann (1988), p. 329. Brown (1970), p. 1637. 30 See Mitchell and Netter (1994), pp. 545–590. 31 See Steinmo (1994), pp. 9–17. 32 See Dong and Ozkan (2008), pp. 16–29. See also Khan (2006). 33 See Goergen and Renneboog (1998). 34 Armour and Skeel (2006), pp. 1760–1770. 35 Id. 36 See Deakin et al. (2002). 29

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large conglomerates as well.37 Although their influences were not easy to penetrate the Member States’ shell frame, but their discontent and objections inevitably would influence the transposition process of the final European Directive, causing even larger divergences under a “uniformed” European Directive; Prominent cases included the Volkswagen’s protests against the Board Neutrality Rule and the Wallenberg Family’s severe Condemnation of the Breakthrough Rule, which more or less contributed to the introduction of the Optional Arrangements Rule and the Reciprocity Exception Rule as a compromise. In sum, the European Council was immersed into a web of cyclical dependencies—whenever it wanted to move one step ahead, it ended up falling two steps behind—the endless contests among Member States and the uncoordinated interests between conglomerates had largely constrained its legal progress.

2.3

Implications So Far

The path dependent nature of hostile takeover regulatory frameworks is a doubleedged sword: on the one hand, it may restrict future legal reforms; on the other hand, it could awake the “internal vigor” and turn institutional inertia into an endogenous force of growth. Having strong confidence in their court system, the U.S. takeover regulation relied heavily on ex-post judicial review as the U.S. had high confidence in its court system. Indeed, the U.S. courts, especially the Delaware court, is quite capable. Such special infrastructure may not be present in other jurisdictions. The U. K., on the contrary, gave its non-judicial Takeover Panel an unprecedented opportunity to pursue self-regulation, and precluded court participantion in takeover issues. Both systems are regarded as the most efficient and refined regulatory frameworks for hostile takeovers. One very important reflection from the U.S. regulatory framework is that, the US judicial-review system would inevitably lead to the structural prejudice that favors the interest of the board; the judge could only review cases that are put in front of them, and repeat players in trials—the directors, are more likely to win.38 Previous trial practices in the U.K. also displayed the tendency of judges to tolerate directors’ entrenching behaviors. Another insight from the U.S. approach is that, shareholder activism of institutional investors could improve the overall corporate governance in U.S. listed companies, but it was almost impossible for them to bring about big changes to the currently hostile takeover regulatory framework.39 When compared with the U.S. and the E.U. model, the self-regulatory takeover framework of the U.K is clearly more efficient in terms of cost and time, offering

37

See Schneper and Guillén (2004), pp. 263–295. Bainbridge (2005), p. 1735. 39 See Karpoff et al. (1996), pp. 365–395. 38

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more certainty to the capital market.40 Both the acquirer and the target board do not have to afford far-flung litigation costs and expensive legal service fees as the Takeover Panel tackles issues in takeover disputes with little delay. Moreover, the Takeover Panel could proactively amend the City Code to tackle the needs of the market. In contrast, US judges in Delaware and legislators in the E.U. are relatively passive and lagged behind in their ability to upgrade the law. However, the formation of a self-regulatory framework requires institutional investors, bankers and industrial associations to work in concert—and an important prerequisite for them to achieve this is the geographical proximity they had in London. Moreover, in order for the UK self-regulatory model to be effective and long lasting, the motives of the regulator must be compatible with those of the stockholders of the company—to increase the overall profitability of the company by cutting unnecessary costs. Indeed, institutional investors in the U.K. have various motives, but the overall profitability of the company was always their mutual concern, as they had to be responsible for investors who put their money into the institutions. The failure of self-regulation in the U.S. was also due to conflicting motivations of the participants. For example, the brokers and traders had very different self-interest motives; they might freeze any deals that would delist the target company,41 even if the deal were beneficial to both the offeror and the offeree. The European Directive had little impact in shaping a “united European takeover law”. The Board Neutrality obligation could be waived in reciprocity situations, and extremely few companies had adopted the Breakthrough Rule. The Optional Arrangements Rule let some directors on the board, who had been accustomed to staying neutral, now asked for larger discretionary powers in building takeover defenses.42 The Mandatory Bid Rule provided shareholders with a fair opportunity to exit the company with a share premium, however, many of the Member States set the trigger of such a Mandatory Bid Rule so high that it was nothing more than a legal decoration.43 Future lawmaking in China must draw lessons from the E.U.’s practice, and try to avoid the internal contradictions in legal clauses. Moreover, the E.U. model, though designed to be based on the U.K. model, yielded a legal effect similar to the U.S. in the transposition process from the E.U. level to its Member States. In a cognitive aspect, the unpleasant transition process of the European Directive mirrors the failure of many Asian countries transplanting their takeover law from abroad, notably, China. So much so, the European Directive itself offered a paradigm of codifying both the merits of the U.K. City Code as well as the pioneer practices of the Delaware court, which could be regarded as an excellent template for other Asian countries. In other words, the transposition of the European Directive might be a completely failure, but the European Directive was merely a victim of pork-barrel politics. Its articles and

40

Armour and Skeel (2006), p. 1727. See Michie (2012). 42 Tang (2017c), p. 113-197. 43 Tang (2017a), pp. 68–76. 41

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clauses were so carefully and articulately trimmed that if all of its core rules were completely mandatory for the Member States, it could fulfill its original goal to construct an integrated market with a level-playing field within the E.U. and at the same time promote prosperity of the market for corporate control. Most importantly, the European Directive was given thorough consideration and protection to shareholders, especially minority shareholders, setting an exemplary excellent example for countries whose agency costs between the corporate insiders and minority shareholders were high.

3 The Chinese Regulatory Model Some scholars believed that, the Chinese takeover laws were mainly transplanted from the U.K.44 The Audit Committee of Mergers and Acquisitions under the CSRC was regarded as the counterpart of the Takeover Panel in the U.K., and the Administrative Rules on Acquisition was the Chinese version of the City Code. However, the ACMA is obviously not a self-regulatory entity; it only had very limited authority in takeover disputes. Moreover, Chinese courts every now and then also took part in takeover related case trials; it is too farfetched to consider the Chinese model as being similar to the U.K.’s.45 On the other hand, the Chinese hostile takeover regulatory framework bears resemblance to the U.S. mode as well. The CSRC has the ultimate authority with oversight over the securities market; it functions in a similar to that of the SEC to some extent.

3.1

Reflections of the Substantive Law

In terms of legal clauses and provisions, China has transplanted its takeover law from the U.K., U.S and the E.U. First, in parallel with the City Code and the Companies Act of the U.K., the Chinese Company Law is ostensibly “shareholder centered”—the general assembly seems to be the highest authority in corporate issues, and the board of directors are responsible for carrying out the general assembly’s resolutions.46 In theory, as all defensive measures, no matter ex ante or ex post, more or less concern corporate issues which need majority approval from shareholders—hence in theory, it is the general assembly not the board of directors that should have the right to order defensive measures.

44

See Bai et al. (2004), pp. 599–616. See also Cai (2012), p. 901. Tang (2017c), p. 164. 46 2014 Company Law, Article 98. 45

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Second, just like the takeover laws of the U.K. and E.U., the Chinese Company Law has directly banned certain takeover defenses such as poison pills, dual ownership structure47 and so on. Equal treatment of shareholders has become a basic principle in Chinese law.48 In addition, the Chinese Securities Law has rigorous merit-review requirements49 for the target board to issue shares and bonds, making share repurchase schemes,50 share issuance schemes and convertible securities issuance plans51 impossible to defend hostile takeovers.52 Third, in tender offer regulation and investor protection, the Chinese Securities Law has learnt a lot from the Securities Exchange Act of the U.S.; insider trading, market manipulation, false statements and fraud behavior were strictly prohibited. Chinese Securities Law and the Administrative Rules on Acquisition also have similar information disclosure and its tender offer procedural requirements are similar to the US William’s Act.53 Disgorgement Statute and share transfer restrictions for corporate insiders could also be found in the Chinese Securities Law.54 Fourth, Chinese law placed considerable attention on the board’s fiduciary duty in takeovers. The Administrative Rules on Acquisition require directors to “assume the duty of loyalty and duty of care” in takeovers.55 The Chinese Company Law explained what “duty of loyalty” is through a series of prohibitive stipulations.56 The Guidelines on Articles of Association has suggested the meaning of the “duty of care”.57 Fifth, the Chinese Securities Law has borrowed the Mandatory Bid Rule from the City Code and the European Directive, mandating that acquirers who reaching 30% shareholding threshold of target company shares to send out tender offers, either partial or full, to all shareholders of the target company.58 As in most of the Member States within the E.U., the Chinese Securities Law has also left abundant room for the exemption of tender offers.59

47

Id, at Article 126. Some originally-born-in-China companies achieved the ownership structure by re-incorporating in the Cayman Islands and having their IPO either in HKSE or NYSE, for instance, Alibaba. 48 Id, at Article 103. 49 2014 Securities Law, Article 13. 50 2014 Company Law, Article 142. 51 2014 Securities Law, Article 16. 52 2014 Securities Law, Article 22 and Article 24. 53 Administrative Rules on Acquisition, Article 75. 54 2014 Securities Law, Article 47. 55 Administrative Rules on Acquisition, Article 8. 56 2014 Company Law, Article 147. 57 Guidelines on Article of Associations, Article 98. 58 2014 Securities Law, Article 88 and Article 96. 59 Administrative Rules on Acquisition, Article 62.

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Sixth, the Administrative Rules on Acquisition borrowed the Board Neutrality Rule from the U.K. and the E.U., but modified the original rule into a less rigorous one. This also arose with the Selling-out Right60 from the European Directive. However, China’s seemingly comprehensive, conclusive law is more problematic than thorough, not only did it fail to provide explicit answers in certain conflicts; it also failed to divide the work clearly between the court and the CSRC. Apparently, the articles and clauses were contradictory with each other, and the goal of the Chinese law was therefore blurred—should the law give primacy to shareholders protection, or should the law respect company directors business judgement? In summary, it is necessary to amend the present hostile takeover related laws in order to provide more certainty for the participants and players in the Chinese capital market.

3.2

Reflections on Supervisory Practice

The “Shareholder Centrism” over “Board Centrism” debate in corporate law is always an interesting topic in takeover research. Chinese Company law has a long history of empowering shareholders rather than directors, but most minority shareholders remain rationally apathetic in corporate governance, which has led to the “Majority Shareholder Centrism” in the past few decades. The Company Law endows shareholders who “individually or collectively hold 3% of the company share” the right to bring an interim proposal for discussion on the general assembly;61 in comparison, minority shareholders’ appeals and opinions seem insignificant. Yet, this scenario has undergone rapid change, but not in a positive direction. When hostile takeovers began to rise in China, the focus on “Majority Shareholder Centrism” began to decline. The emergence of the agency cost between management and shareholders in China inevitably blurred the original legal pattern of “Shareholder Centrism” or “Majority Shareholder Centrism” promoted by the Chinese Company Law. This is especially true in corporate control transfer situations. Hostile takeovers manifest the divisions and discord inside the target company: usually, most shareholders regard hostile takeovers as an ideal way to get away with their shares with a considerable premium, but once the takeover succeeds, directors of the board will lose the whole empire that they have been building for years. From this perspective, the hostile takeover is not only a battle between potentates of the company and covetous bidders, but a fierce skirmish between the board of directors and the shareholders assembly as well. From the fact that most hostile takeovers eventually fail in China, the management and the board of directors seem to have gained an upper hand. Consolidation of the board’s control gradually challenges the general assembly’s

60 61

2014 Securities Law, Article 51. 2014 Company Law, Article 102.

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authority, and the vested interests group seeks to further solidify their power. Associations is now the new battlefield for the management and the shareholders of the company. Lack of the necessary knowledge and information being one cause, lack of unity being another, shareholders in China seldom give constructive suggestions in hostile takeovers, and the board usually takes the lead in major resolutions. Failing to distinguish the boards’ deeper intentions from its rhetoric and glorified jargon, shareholders usually vote in favour of issues that eventually may have an adverse effect on them.

3.3

Chinese Fiduciary Duty: A Comparison with the U.S.

As we have mentioned above, the Article 8 in 2014 Administrative Rules on Acquisition provides the general rule on directors' fiduciary duty. The Article 148 of 2014 Chinese Company Law defined fiduciary duty as duty of loyalty and duty of care. The duty of loyalty is enumerated in several prohibitive stipulations in Article 148 and Article 149 in Company Law. The Company Law does not elaborately define the “duty of care”, it only reveals the consequence when directors, supervisors or senior managers fail to obey Article 150. The Article 98 of 2016 Guidelines on Articles of Association provides certain examples of how directors could fulfill their duty of care to the company. Despite so many words and paragraphs used to clarify what fiduciary duty is in Chinese corporate governance, the fiduciary duty is still too vague and fuzzy for legal practitioners. All these articles in Chinese law have used general terms such as “treat all the purchasers. . . in a fair manner”, “protecting interests of a company and its shareholders”, “should not. . .cause improper obstacle to takeovers” or “should not cause damages to the lawful rights of the said company or its shareholders”. Those general terms are necessary, especially for emergencies and new situations. However, without detailed, definitive and deterministic clauses to support them, those general regulations alone have left many critical questions in takeovers unsolved, and thereby cause massive uncertainty in Chinese takeover markets.62 For instance, what manner is “fair” and what is not? What obstacle is proper and what is not? How do you define the lawful rights of a company? In addition, how do you define the lawful rights of the shareholders? The answers to these questions are critical, in order to eliminate uncertainties in the Chinese market. Nevertheless, another even more important question is to ask who is responsible for the ultimate answers to those questions in China, the courts, or the CSRC? From the U.S. experience, we know that clarifying fiduciary duty is never easy. The court had realized that the directors of the board inevitably face conflicts of interest in hostile takeovers; therefore, the traditional Business Judgement Rule

62

See Huang (2008), pp. 153–175.

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could not apply in such cases. Instead of writing down simple principles of fiduciary duty one by one, the Delaware court employed a two-part reasonableness-based tests, to determine whether it is legitimate for the board to take defensive measures. Under this test, the defendant—directors of the board, was required to prove that: first, they had reasonable grounds to believe that a danger to corporate policy and effectiveness existed because of another person’s stock ownership, and; second, that the defensive measure that they were taking was reasonable in relation to the threat posed.63 Compared to Chinese practice, this two-part reasonableness-based test is definitely better because: first, it is more flexible in defining fiduciary duty; second, it is more stable and produces more certainty. In the Revlon case, the court understood that fiduciary duty might require the board to take different actions under different circumstances: when the sale of a company become inevitable or had already begun, the duty of the board switches from protecting the company into obtaining the highest price for the benefit of the shareholders. Later, the courts strengthened the Unocal test in the Revlon case. The court realized that, whether the board had breached their fiduciary duty when adopting anti-takeover defenses was an objective problem that should be determined on a case by case basis, or, as in the Revlon case, defense by defense. The Court found that, the defenses of the Unitrin board was so “draconian” that no shareholders could obtain control of the company through normal proxy contest. Since then, a Unitrin test became prepositive before the application of the Unocal test—defensive measures should first not draconian, and should not be coercive to its shareholders, and then could be put under review of the proportionate test applied in Unocal. Over the years, the Delaware court had formed the inclination to favor the primacy of the board of directors over the will of shareholders. This inclination continued from the early 1980s to today, and will probably last forever. During this process, such a well-known inclination had provided a high level of certainty to the target company and the acquirer as well. The board had been accustomed to adopt anti-takeover measures as responses to unfavorable takeovers; and the acquirers usually struck the target company under very well preparation. In China, expressions and interpretations in Chinese Law on fiduciary duty are too general and too simple; as a result, all takeover defenses adopted by the management were regarded as “controversial” with different “reasons”,64 even when hostile takeovers per se in China were usually deemed “immoral”. The Delaware courts had for years practiced in interpreting the essential meaning of the fiduciary duty. China, apparently, lacks the infrastructure of the Delaware courts in reviewing directors’ behaviors in takeovers.65 Moreover, as the essence of the duty of case and the duty of loyalty is constantly changing with the market and situations, the fiduciary duty is not something that could be described and defined

63

Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). Huang (2008), pp. 153–175. 65 See Lee (2006), p. 897. 64

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accurately merely by resort to paragraphs of words or (negative) standard lists.66 China is a civil law country in nature, it is almost impossible for it to establish a fiduciary review system, as the Delaware courts did, therefore, the U.S. mode is not an optimal model for China to imitate..

3.4

Chinese Self-Regulation: A Comparison with the U.K.

If the U.S. mode is not suitable for China, how about the U.K. mode? The hostile takeover regulatory framework of the U.K. is a self-regulatory one, which was formed during its distinctive commercial history. The early institutional investors, financiers and bankers of England all used to live in the City of London, where they could see each other almost every day in their daily transactions. Being geographically close to each other brought many conveniences for the formation of the self-regulatory system; these repeat traders in London gradually developed a low-cost way of management for them—reputational penalties among the circle were more preferable in the first place than expensive litigation and complicated administrative procedures. The city of London had acted as a coherent force shaping the new commercial legal order until such role was significantly undermined by the Big Bang,67 yet the promintent status of a selfregulation shaped by institutional investors had been well-entrenched by then. Comparably, China did not have such a solid background and long history for self-regulatory supervision; individual investors are still the mainstream participants in China.68 Indeed, the institutional investors largely account for the formation of the UK self-regulatory system. U.K. institutional investors were very passive in relation to corporate governance, but were extremely active in shaping the law through lobbying and protest. After several takeover disputes in the 1950s and 1960s, the spirit of “Passive Directors, Active Shareholders” became well entrenched in the U.K., and this principle was elaborated through shareholder-oriented laws such as preemptive rights, the prohibition of anti-takeover defenses and so on. In addition, the Takeover Panel successfully proved its irreplaceability by constantly improving itself. Most importantly, other major industrial associations and commercial groups, such as the Board of Trade, the Council of Stock Exchange, the Association of Unit Trust Managers, the Association of Investment Trust Companies and so on, consistently supported it, which helped the Takeover Panel to head off governmental intervention in takeover regulation. This history illustrated that, self-regulatory entities and industrial associations in the U.K. were at all times more independent than their counterparts in China.

66

See Nikkel (1995), p. 503. See Augur (2000), pp. 1–16. 68 See Christmann and Taylor (2001), pp. 439–458. 67

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According to the Securities Law, there are only two self-regulatory entities of the Chinese securities market—the Stock Exchanges and the Securities Association of China.69 However, in practice, neither the Stock Exchange nor the Securities Association in China has substantial self-regulatory power.70 Let us talk about the Stock Exchange first. Both Shanghai Stock Exchange and Shenzhen Stock Exchange lack the independence to effective supervise the market. Historically, the Stock Exchanges in China were not established by the traders, investors or participants in the securities market; instead, they were established and developed by the government in the first place. According to the Securities Law, the council is the decision-making organ of the Stock Exchanges71; however, the law allows the CSRC to designate up to half of the council members.72 Moreover, the general manager of the Stock Exchange is also appointed by the CSRC,73 and any revisions to the Stock Exchange Articles74 or operational rules need to obtain administrative approval from the CSRC.75 Therefore, the Stock exchange is in fact under strict control of the CSRC. The self-regulation by the Securities Association of China is even weaker than that by the Stock Exchange. The former presidents of the Securities Association of China all held positions simultaneously in the CSRC, and approximately half of the council members were appointed directly by the CSRC. Therefore, the Securities Association could not really represent the well-being and interests of its members, but in reality it represented the will of the CSRC. Compared with the UK Takeover Panel, what the self-regulatory entities in China lack the most is the substantial punitive power that could effectively discipline the participants in the securities market.76 The Securities Law did not specify the punitive measures that the Stock Exchange could impose when its members broke the rules. In practice, the Stock Exchange could suspend or terminate the transactions of misbehaving investors. As punishments this severe response could trigger turbulence and lead to a chain reactions in the market, more moderate measures are needed. However, apart from the above severe penalties, all other measures that the Stock Exchange could adopt, such as public criticism, are either too light or have no inhibitive effect. On the other hand, the Securities Association of China has almost have no punitive power at all, it at best has the right to mediate between its members and inspect its members’ activities that may violate its articles of association. Both the Stock Exchange and the Securities Association of China lack the investigation power and means necessary to constraint their members’ behavior. Despite

69

2014 Securities Law, Article 8, 102, 174. See Jordan and Hughes (2007), p. 205. 71 CSRC. Administrative Measures of Stock Exchanges, Article 22. 72 CSRC. Administrative Measures of Stock Exchanges, Article 23. 73 2014 Securities Law, Article 107. 74 CSRC. Administrative Measures of Stock Exchanges, Article 19. 75 CSRC. Administrative Measures of Stock Exchanges, Article 28. 76 See Wei (2005), p. 479. 70

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self-regulation not being a tradition in the U.S., the National Association of Securities Dealers could do much more than their counterparts in China.

3.5

Chinese Board Neutrality Rule: A Comparison with the E. U.

The Board Neutrality Rule in the European Directive was mainly borrowed from the No Frustrating Action Principle in the City Code—the board should remain neutral and take no actions that may frustrate the bid unless authorized by the shareholders. Therefore, almost all ex post takeover defenses are violations of the Board Neutrality Rule. The Board Neutrality Rule was equivocally clear in the European Directive, but during the transforming process, several Member States played literal games to reduce the impact of the Board Neutrality Rule. The Chinese Board Neutrality Rule is even worse, in that it is not equivocally clear per se.77 The Article 33 of the 2014 Administrative Rules on Acquisition provides substantive guidance for the Board Neutrality Rule. “[d]uring the period after the announcement of a takeover bid and before the completion of the takeover bid, target company management. . .without the ratification of the general shareholders’ meeting, should not cause major impacts on the assets, liabilities, entitlements or business performances of the target company by disposing of assets, engaging in external investments, adjusting the main businesses, providing guarantees or loans and others.”78 The principle underlying this term was supposed to be “for management of the target company, without shareholders approve, no defensive measures should be taken”. However, from the literal meaning of the article, there are lots of things the board actually could do before and during the takeover bid. First of all, “During the period after the announcement of a takeover bid and before the completion of the takeover bid. . .” means this article does not apply to defensives measures employed “before the announcement of a takeover bid”. Second, “should not cause major impacts on the assets, liabilities, entitlements or business performances of the target company. . .” means that this article does not apply to takeover defenses that “do not cause major impacts on the assets, liabilities, entitlements or business performances of the target company”. In other words, under Article 33, as far as defensive measures do not cause major impact on the target company, or such measures were taken before the announcement of the bid, then the management does not need shareholders’ approval for using such defenses.79 Therefore, instead of preventing management from taking defensive measures, Article 33 provides the board with a loophole, through which the board could 77

Tang (2017c), p. 170. 2014 Administrative Rules on Acquisition, Art.33. 79 Tang (2017c), p. 171. 78

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circumvent shareholder approval and adopt certain types of defensive measures allowed by the law. While fiduciary duty in Chinese law seems to be too broad and too general, the Board Neutrality Rule is over specified. The No Frustrating Action Principle in the City Code clearly forbids the board from taking any actions that may frustrate the bid; its key elements were clear and unequivocal, almost with no exceptions. Despite the flawed transposition process, the Board Neutrality Rule in the European Directive was also thorough. According to the Article 9 in the EU Directive, once the board is aware of the offer bids, it should not take any actions that may frustrate the acquisition activity before obtaining authorization from shareholders, except for finding an alternative potential offeror to join the bid.80 Article 9 (1) through (6) have thoroughly considered the time span and different kinds of situations, and deal with the procedure for obtaining authorization. If China is to embrace the Board Neutrality Rule, the City Code and the European Directive are good examples, while the Member States’ malpractices are negative examples formit to follow. In summary, takeover laws should be clearcut enough so that the participants can adjust their behaviors towards a more shareholder oriented direction.81

3.6

Chinese Mandatory Bid Rule: A Comparison with the U. K. and the E.U.

Through whatever means of acquisition, when an acquirer or investor holds 30% of the issued shares of a listed company, further acquisition of company shares must occur via a tender offer.82 China transplanted this Mandatory Bid Rule from European countries to protect the lawful rights and interests of minority shareholders. In the U.K., the City Code clearly mandates that “any person, or together with persons acting in concert with him, acquires shares carrying 30% or more of the voting rights of a company whether by a series of transactions over a period of time or not”, shall launch an overall tender offer for all the outstanding shares of the target company.83 In the E.U., the European Directive has a similar clause. When a natural or legal person holds securities of a listed company to a certain level, a mandatory bid through tender offer “shall be addressed at the earliest opportunity to all the holders of those securities for all their holdings”.84 In the U.S., the Williams Act has no such Mandatory Bid Rule, it only requires all the shareholders to be treated

80

Council Directive 2004/25, art. 9, 2004 O.J. (L142) 8 (EC). Tang (2017c), p. 172. 82 See 2014 Securities Law, Article 88. 83 See the City Code, Part F1, Rule 9. 84 Council Directive 2004/25, Art. 5, 2004 O.J. (L142) 8 (EC). 81

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equally in a fair manner, and acquirers are required to purchase shares on a pro rata basis if the preliminary accepted shares exceed their estimation.85 In the U.K., once the acquirer obtained 30% of the voting rights of the company, the Mandatory Bid Rule applies. The European Council allows every EU Member State to determine the “percentage of voting rights which confers control” according to their own circumstances,86 thus the trigger of the Member States varies from the lowest threshold of 25% to the highest 66%.87Interestingly, in Denmark and Estonia, there is no fixed number for the Mandatory Bid Rule to be triggered, the rule applies whenever the acquirer “holds the majority of voting rights in the company or becomes entitled to appoint or dismiss a majority of the members of the board of directors”88. Despite the minute threshold difference between the U.K. and the E.U. Member States, once the Mandatory Bid Rule is triggered, the acquirer has to bid for all the company shares through a general tender offer; no partial tender offer is allowed except under extreme conditions. In contrast with the U.K. and the E.U., partial tender offer is an important part of the current Chinese Mandatory Bid Rule. Only in rare situations do the acquirers have to send out a general tender offer: the Chinese Mandatory Bid Rule requires acquirers holding 30% of the issued shares and acquirers holding 30% of the total shares sending out either a partial tender offer or a general tender offer under different circumstances, for part or all outstanding shares of the company. In other words, whenever an acquirer or investor, individually or collectively, steps over the 30% issued shares line, a tender offer seems to be the only legitimate pathway to acquisition; but whether a general tender offer is compulsory varies from case to case.89 Obviously, a partial tender offer is more cost-efficient than a general tender offer.90 After all, general tender offer is way too money consuming and would usually lead to the failure of whole takeover attempt. On the other hand, the general tender offer can provide shareholders with far more certainty and convenience by ensuring that all shareholders have an equal chance to sell their shareholdings at a

85

The 90th United States Congress, Williams Act (82 Stat. 455), Section 14d, Section 14e. Council Directive 2004/25, Art. 5(3), 2004 O.J. (L142) 8 (EC). 87 Hungary and Slovenia have a triggering point of 25% voting rights; Austria, Belgium, Cyprus, Germany, Finland, Ireland, Italy, the Netherlands, Spain and Sweden have a triggering point of 30% voting rights; Greece, France, Luxembourg and Slovakia have a triggering point of 1/3 voting rights (33.33% voting rights);Czech Republic and Lithuania have a triggering point of 40% voting rights; Latvia, Malta and Portugal have a triggering point of 50% voting rights; Poland has a triggering point of 66% voting rights. See COMMISSION OF THE EUROPEAN COMMUNITIES. Report on the implementation of the Directive on Takeover Bids. Brussels, 21.02.2007.SEC(2007)268. Annex 2. 88 Id. 89 Tang (2018), pp. 47–48. 90 Easterbrook and Fischel (1981), pp. 1161–1204. Partial offer is definitely cheaper, the acquirer only have to acquire as much shares as he needs. 86

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premium.91 Under current Chinese law, stepping over the 30% threshold or trigger point, through normal security trading or tender offer provides acquirers in China with the legitimate right to send out a partial offer in takeovers instead of making a bid for all the outstanding shares. From this aspect, the Chinese Mandatory Bid Rule is more acquirer-friendly than shareholder-supreme; it promotes hostile takeovers from happening at the cost of minority shareholder protection. In reality, in partial tender offers, when preliminarily accepted shares exceed the purchasers’ original plan, certain percentage of shares are detained in the hands of shareholders, the price of which may very possible plummet after the takeover. In addition, the minority shareholder further may suffer a heavy toll once an acquirer chasing short-term gain consolidates its control power of the target company, as repeatedly observed in the Chinese security market.92 In summary, the current Mandatory Bid Rule in China is very problematic and urgently needs modification.

4 Future Legal Improvements Merely amending the articles and clauses of the law is of very limited use in improving the Chinese hostile takeover regulatory framework; the most important thing is to get rid of the “CSRC centralism” path dependence. Drawing experiences from the U.S., the U.K., and the E.U., future legal reform in China must take its contextual and complicated local factors into consideration. There are several facets critical to future lawmaking. First, the institutional investors are weak in China. The Chinese institutional investors had undergone several phases. The embryonic stage began from 1990 and ended in 1998, when securities companies were almost the only player in the securities market. The growth period began from 1999 and ended in 2008, during which the government allowed state-owned and state-controlled listed companies enter the stock market.93 Since December 2002, the State Council began carrying out the institution of Qualified Foreign Institutional Investors, and foreign capitals poured into China since 2004. From October 2004, insurance funds were allowed to enter the stock market. After 2008, mainstream institutional investors in the capital market are securities companies, different types of funds, large enterprises, financial companies, commercial banks and Qualified Foreign Institutional Investors. However, comparing to the institutional investors in the Western countries, Chinese institutional investors are not mature enough to bring substantial changes to the takeover laws. Psychologies of herd instinct and great fool exert strong influence on the institutional investors’ decisions, which give rise to myopic behaviors that corrode the market. First, individual investors still account for the majority in the

91

Id. Compare with partial offer, general offer provides minority shareholders more protection. Tang (2017b), pp. 106–114. 93 See Li et al. (2009). 92

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stock market, and they are too dispersed to become investment communities. Second, current established institutional investors are not strong enough to form political associations that have the power to lobby the legislators. Third, the market infrastructure and legal supports for institutional investors are grossly inadequate. Second, self-regulation in China is still in the nascent period. Chinese Securities Law acknowledged two self-regulatory entities of the Chinese securities market— the Stock Exchanges and the Securities Association of China.94 However, in practice, neither the Stock Exchange nor the Securities Association in China has substantial self-regulatory power and the supervisory effects were virtually none.95 Historically, these two self-regulatory institutions were not established by the traders, investors or participants in the securities market; instead, they were established and developed by the government in the first place. Current law allows the CSRC to designate up to half of their council members, including their general managers. Under the vertical control of the CSRC, neither of them could truly represent the well-being and interests of its members, but the will from above. Moreover, the reputational punishment mechanism is not established yet in Chinese capital market, there is still a long way to go for the self-regulation to be really effective.

4.1

Modifications of the Board Neutrality Rule

There are at least four benefits to the market and shareholders of takeovers above: better allocation of resources, synergy effects between cooperation, better corporate governance and more precise market estimation. Then, why should the law intervene in takeovers? One reason is that the naturally existed conflicts of interests, or in other words, agency costs between different participants in takeovers, are to some extent avoidable sometimes. Previously we revealed those agency costs in detail. The first agency cost exists between the management and shareholders. When takeover emerges, it brings premiums for shareholders, which is good for them. However, this is definitely a nightmare for the incumbent management, who will almost absolutely be replaced if takeover succeeds. Therefore, instead of thinking what is best for the company and shareholders, the management intends to think for themselves at this time and they would find every possibility to outmaneuver the acquirers by adopting various defensive measures. If the management successfully frustrate the offer bids, the shareholders would not be able to enjoy the premiums of the offer and if the takeover is really a value-adding one, the board of directors are entrenching their control at the cost of better management and long-term revenue of the company.

94 95

2014 Securities Law, Article 8, 102, 174. See Wei (2005), p. 479.

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Another type of agency cost exists between the dominant shareholders and minority shareholders. There are two kinds of agency costs among dominant shareholders and minority shareholders. The first one is, when a company has a controlling shareholder, this shareholder usually also controls the board using his overwhelming voting rights. Hence, when takeovers are imminent, this dominant shareholder can cut deals with the acquirer, offering them his portion of the total shares to save the trouble of public offering, by doing so the controlling shareholder could enjoy the premiums of share prices alone and do not necessarily have to share with other shareholders. There are even worse situations, too, when a dominant shareholder had get used to exploit the company resources at the expenses of minority shareholders. When takeover happens, this dominant shareholder and the board representing this shareholder does not want to lose control of the company, and together they hit back those potential reformers of the company who may eventually bring good to shareholders of the company as whole. In addition, by frustrating the acquirers' attempt because of personal reasons, the dominant shareholder closed the gate for minority shareholders to cash out at a reasonable market price, or to have a better management of the company in the future. In sum, the ultimate goal of the Company Law is to reduce the agency costs that come with opportunism. Those agency costs usually come into being between: first, shareholders and the management; second, minority shareholders and controlling shareholders. In fact, different jurisprudence has different types and levels of agency costs. In countries where share ownership structure is dispersed, the agency costs between minority shareholders and controlling shareholders are almost non-existent, but the shareholders and management agency costs are relatively high. On the contrary, in countries where share ownership structure is concentrated, the agency costs between shareholders and the management are low, but minority shareholders and controlling shareholders' agency costs are high.96 In light of this, the Company Law in different countries have different goals and systematic design. When the U.S. law are designed to mitigate the agency costs between the shareholders and the management board through a Business Judgement Rule centered legal system, countries with concentrated ownership structures like China and most Member States of the European Union have to deal with the agency costs between minority shareholders and controlling shareholders more. We illustrated that China should take an U.K. alike regulatory path using E.U.’s codifying technique, therefore, the Board Neutrality Rule must become the center of the future takeover regulatory framework. However, the naturally high agency costs among minority shareholders and controlling shareholders determined that a “broad” Board Neutrality Rule is grossly inadequate—at least not good enough for China. Based on the E.U. and the U.K.’s terminology, a “modified” Board Neutrality Rule should be applied in China. In the normal Board Neutrality Rule, when takeover happens, directors of the board should not take any actions that may

96

Jensen (1986), pp. 323–329.

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frustrate the offer bid unless the general meeting of shareholders say otherwise. In this “modified” Board Neutrality Rule, when takeovers are imminent, directors of the board should not take any actions that may frustrate the offer bid unless the majority of minority shareholders say otherwise. As individual investors are widespread and they thereby need the protection from the law most, it is better to let the minority shareholders, instead of the general assembly, to have the conclusive power of taking takeover defenses. In China, minority shareholders are scoffed with the nickname of “chives”, because they are easily “harvested” by majority shareholders in the Chinese stock market. The knotty problem behind is the much poorer corporate governance environment in China compared to its counterpart in the U.K or E.U. Another important question arised with this modified Board Neutrality Rule: who, or what kind of shareholders should be labelled as “minority shareholders” in the Chinese listed companies? As ownership structure is different from company to company, only the general assembly could judge the upper limit of shareholding of the “minority shareholders”. Therefore, every companies’ corporate charter should have the clear standards of “minority shareholders” according to the companies’ ownership structure, and such standards should be subjected to change on a yearly basis. On the other hand, if the minority shareholders really only make up an extremely small portion of company shareholders, then it is not appropriate for a group of people this small to decide the major issues in takeovers; instead, it should be the non-controlling shareholder, as well as the minority shareholders together to decide whether takeover defenses should be adopted. In this situation, the corporate charter only have to define the shareholding threshold of the controlling shareholders, and exclude them in the resolution.97 This “modified” Board Neutrality Rule has three advantages. First of all, it largely mitigates the agency costs between minority shareholders and controlling shareholders. Second, it encourages takeovers from happening, as the adoption of defensive measures are more difficult than before. Third, it benefits the shareholders as a whole by empowering them with real decisive power. Indeed, the disadvantages of this “modified” Board Neutrality Rule is also obvious. First, the minority shareholders are usually much dispersed, and it is very hard to gather them together to vote. In addition, the minority shareholders have little knowledge and information about the company business; it is difficult for them to make really splendid decision. Vote proxy mechanism through internet those days could to certain degree mitigate these two disadvantages, but it also brings new agency costs between the minority shareholder and the proxy entity as well. In sum, the “modified Board Neutrality Rule” is an ideal solution to mitigate the agency costs, but to what degree is it effective largely depends on other factors as well, the “legal infrastructures” in Chinese capital market being the most important ones.

97

Tang (2017c), p. 171.

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4.2

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Improvements of the Mandatory Bid Rule

The Chinese Mandatory Bid Rule has an initial trigger of 30% issued shares, while the U.K. and most E.U. Member States set the threshold at 30% shares carrying voting rights. Considering the non-tradable state-owned shares account for a proportion impossible to ignore in total shares of most listed companies, the initial trigger point of Chinese Mandatory Bid Rule is much lower than the U.K. and major E.U. Member States. For wide range minority shareholders, it might be a good thing; but such a low-threshold Mandatory Bid Rule inevitably hinder takeovers from happening in the first place. Fewer takeovers means even fewer exit channel for minority shareholders, thus it is hard to say such a low-threshold of Mandatory Bid Rule is at the interest of minority shareholders. Even from the aspect of the policy maker, setting the trigger low was trying to protect minority shareholders, but allowing partial tender offers overflow the security market is definitely not. In the U.K. and all the E.U. Member States, once the acquirers trigger the Mandatory Bid Rule, general tender offer becomes compulsory while partial tender offer is strictly prohibited. This is to ensure equal and fair treatment for all shareholders without any omission. From the experiences of the U.K. and the E.U., when obtaining shares to the extent of triggering the Mandatory Bid Rule, the acquirer usually holds sufficient voting rights that may confer control, and the minority shareholders are in a weaker position. Therefore, the compulsory requirement of general tender offer only has very little inhibiting effect on takeovers, but can improve minority shareholders’ well-being significantly. In sum, current Chinese Mandatory Bid Rule has a trigger so low that hostile takeovers can hardly happen; beyond that, partial offers instead of general offers are too frequently allowed in takeovers that the interests and lawful rights of minority shareholders are ignored. A higher trigger, combined with a stricter general tender offer requirement is optimal and imminent for Chinese securities market. Likewise, considering state-owned shares percentage varies from company to company, and almost every listed company in China has its unique equity distribution, a flexible trigger is crucial. Denmark and Estonia has set a good example for China: “[w] henever an acquirer holds the majority of voting rights in the company or becomes entitled to appoint or dismiss a majority of the members of the board of directors, he shall launch a general tender offer for all the outstanding shares of the target company.”98 As when the acquirer could be deemed as “holding the majority of voting rights in the company or becoming entitled to appoint or dismiss a majority of the members of the board of directors”, it is optimal for the general assembly of shareholders to decide, instead of a fixed standard from CSRC.

98 COMMISSION OF THE EUROPEAN COMMUNITIES. Report on the implementation of the Directive on Takeover Bids. Brussels, 21.02.2007.SEC(2007)268. Annex 3.

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Advices for the Limited Self-regulation in China

Compare with the U.K., China lacks the soil of inner-industrial self-regulation. However, this is not to say that limited self-regulation is impossible or not important for China. Currently, both Stock Exchange and the Securities Association of China did not achieve very good autonomous supervision result, but they both have abundant rooms for improvement. There are several things to do in order to improve the self-supervision of the Stock Exchange. First, the law should acknowledge the independent legal person status of the Stock Exchange and stop regard it as an administrative appendage of the CSRC or the State Council. Currently, the Stock Exchanges are more of state-owned public institution than independent commercial entity; the CSRC has vertical control over almost all the major issues of the Stock Exchanges, not to mention it controls firmly the power of appointment and approval. The completely corporate governance structure of the Stock Exchanges should be changed, starting from decreasing the number of designated directors and council members. In addition, the Stock Exchanges should be given the right to elect its own chairman and vice-chairman. Second, the division of labor between the CSRC and Stock Exchanges should be clear-cut, and the Stock Exchanges should be given more substantial supervisory rights, especially the rights closely related to its members. For example, the right of mediation, the right of investigation and the arbitration right are all extremely crucial for the Stock Exchanges if they want to establish unshakable authority in a selfregulation manner. Moreover, the Stock Exchanges do not necessarily have to obtain approval from the CSRC on issues like amendment of the articles of associations, amendment of its business rule, accepting new members and so on. In these occasions, all that the Stock Exchanges should do is to record and report those changes to the supervisory authority for future possible legal review. Third, there should be more investigation methods and punitive measures available for the Stock Exchanges so that the Stock Exchanges could punish misbehaving listed companies; for instance, fine penalty is always a better option than having to suspend the trade. The autonomous supervision of the Securities Association of China could also be improved in the following ways. First, the law should recognize the Securities Association as an autonomous organization rather than a dispatched institution of the CSRC. The CSRC should avoid administrative interference to the Securities Association, and should only keep abstinent right of supervision. Second, the Securities Association should be given more duty and rights. Currently, the Securities Association has the right to conciliate in-between its members, it should also be given the right of arbitration, too, as court trial might be the worst solution for disputes among securities companies. Third, the Securities Association should represent the interests of its members, not the official government. Memberinterests-supreme could tie the Securities Association more closely with its

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members, mitigating the barriers the Securities Association would face when implementing its policies.99 The highest realm for self-regulation is when reputational punishment replaces punitive measures. Maybe, only the U.K. have reached this condition over its long history. However, for China, even limited self-regulation, should it be effective, could reduce the misbehaviors in the securities market to an incredibly lesser extent than they use to be. Without doubt, there is a long way to go.

4.4

Empowering the Institutional Investors in China

In the preceding parts, we illustrated how interest groups such as institutional investors, industry associations, labor unions, large conglomerates and so on accounted for the differences of the takeover regulatory models between the U.K and the U.S. Indeed, strengthening the scales and rights of the institutional investors could ultimately push China’s relatively primitive takeover law into a modern one. In contemporary China, the institutional investors in the capital market are securities companies, different types of funds, large enterprises, financial companies, commercial banks and Qualified Foreign Institutional Investors (QFII). The social security funds, investment funds, insurance funds and private equity are relative active funds in Chinese market, and large enterprises involving in security transactions are mainly state-owned enterprises and listed companies. The Chinese institutional investors had undergone three phases. Phase I—the embryonic stage began from 1990 and ended in 1998, when securities companies were almost the only player in the securities market.100 Phase II began from 1999 and ended in 2008, during this period the government allowed state-owned and statecontrolled listed companies enter the stock market, symbolizing the growth of the institutional investors parallel with individual investors. Since December 2002, the State Council began carrying out the institution of Qualified Foreign Institutional Investors, and foreign capitals poured into China since 2004. From October 2004, insurance funds were allowed to enter the stock market.101 Phase III began from 2008, when institutional investors grew rapidly, and formed the prospects as we see today. The year of 2016 saw a series of hostile bids for old industrial corporations launched by insurance funds in the open market. The Insurance funds were so active that the China Insurance Regulatory Commission put a sudden restraint order on Insurance Funds in the end of 2016. Generally speaking, the Chinese institutional investors are not as mighty as their counterparts are in the Western countries.

99

Changxing Sun (2009), pp. 28–30. See Li et al. (2009). 101 See Kling and Gao (2008), pp. 374–387. 100

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Relying on institutional investors to aggressively shape the Chinese takeover law is not possible in the for seeable future. First of all, in China, the individual investors still account for the majority in the stock market, and they are too dispersed to become investment communities. Second, current established institutional investors are not strong enough to form political associations that have the power to lobby the legislators. Third, the market infrastructure and legal supports for institutional investors are grossly inadequate. Currently, the Chinese institutional investors faced several share transfer limit when they want to dump their shareholdings. Psychologies of herd instinct and great fool exert strong influence on the institutional investors’ decisions, which give rise to myopic behaviors that corrode the market.102 Rather, we should realize that, this is not to say that the growth of the institutional investors in China is not important for future law making. The U.K. experience illustrated that, the development and expansion of the institutional investors were the foundation for the improvement of the self-regulatory framework. In light of the U. K.’s practice, before we talk about how to promote the limited self-regulation under the current regulatory framework, the importance of the institutional investors must be correctly recognized; China must continue encouraging institutional investors emerge and grow.

5 Ending Remarks It has been 27 years since the first hostile takeover attempt in China. From indiscriminately imitating the law from the Western countries to drafting the Administrative Rules on Acquisition with regard to the local conditions, this 15-year marked the spiral progress of the Chinese securities market. Despite several amendments and revisions, the Chinese hostile takeover regulatory framework is still insufficient in terms of legislative technique and dispute resolution. These defects might be temporarily masked in government-leading legal reforms, as the CSRC and the State Council have extremely powerful controlling power over the capital market. However, with the intensification of the hostile takeovers and the prosperity of the market of corporate control, these defects would eventually manifest and even cause disastrous consequences. As we have mentioned above, merely literal adjustment of the law could no longer improve the hostile takeover regulation anymore—China is in desperate need of changing its legal climate and should construct necessary legal infrastructure for future takeover law making.

102

See Bailey et al. (2009), pp. 9–19.

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The Role and Future of Self-Regulation in the Market for Corporate Control: A Comparative Narrative of the Two Models in the UK and China Zhaohui Shen, Linyao Tang, and Charlie Xiao-chuan Weng

Abstract There are three different modes of market regulation for corporate control. The US adopts a court-centered mode based on the fiduciary principle which combines court trials of directors’ behaviour with formal federal examination of tender offers. The UK has adopted a self-regulatory mode where the non-governmental Takeover Panel has replaced ex-post adjudication with fair and swift ex-ante conciliation. China operates government CSRC centralism. With the emergence of a series of hostile takeovers in China, CSRC centralism is problematic because the government has a natural bias in favour of state-owned listed companies. The Chinese courts are neither independent, efficient, nor sophisticated enough to handle corporate control disputes. Although the formation of China’s regulatory frameworks has gone through unique historical contexts with political manipulation and institutional evolution, these factors have together shaped legal schemes with different path dependence features and regional characteristics. The result is that the self-regulation institutions have great potential in China. China should learn something from the UK model, it should force considerable change to the institutional environment and make the self-regulatory institutions work in the market for corporate control.

We thank the participants in the UNSW-Tsinghua Workship, 30 April 2019 at UNSW Law Boardroom. Also thank the participants in the Tsinghua-Toronto-HKU 2019 Annual Forum in Beijing. Especially thank Emma Armson, Deborah Healey from the UNSW, Edward Iacobucci from University of Toronto, Richard Wu from the University of Hong Kong, Simin Gao from the Tsinghua University for their valuable comments. Z. Shen (*) School of Law, Tsinghua University, Beijing, China e-mail: [email protected] L. Tang Institute of Law, Chinese Academy of Social Sciences, Beijing, China C. X.-c. Weng Law Faculty, UNSW, Sydney, NSW, Australia e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_4

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1 Introduction The contest for corporate control is a continuous thread in every corporate governance regime. Associated with wealth transfer, ambitious investors and their capitals behind are challenging the existing order of modern Company Laws, bringing new opportunities as well as risks and conflicts to the securities market. Intrinsically, the regulation of hostile takeover is just like any other laws—it shall strike a subtle balance between efficiency and equity—and shall maintain the beautiful equilibrium in-between every participant. A series of changes recently in China awaked adventurists for corporate control. In 2015, the Supreme People’s Court called off the 10-year ban on private loans between non-financial institutes,1 and the China Banking Regulatory Commission (CBRC) removed its prohibition for merchant banks to fund takeovers.2 Since then, P2P lending and internet insurance instruments began to thrive for the first time in Chinese history.3 Meanwhile, the Shanghai Securities Composite Index of Chinese stock market plummeted from its peak of 5178.19 on 12th June 2015 to under 3000 in 2016, during which most listed companies in China lost more than 30% of their market value.4 The stock market is still in distress in 2017 and 2018, with no sign of imminent recovery.5 During this process, the cumulative stock price of some ST-companies6 are approaching their bust-up value.7 The concentrated ownership structure in Chinese listed companies was once the biggest obstacles for barbarians to knock at the gate. However, the Share Split Reform beginning in 2005 made the non-tradable shares of the State tradable8 and gradually reduced the level of ownership concentration in Chinese listed companies9 which paved the way for hostile takeovers to emerge on a large scale. Indeed, the end of 2015 saw the outbreak of hostile takeovers (or, to a lesser extent, disputes for corporate control) in Chinese capital markets.10 The Baowan

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See Garnaut et al. (2014). See Jiang and Yao (2017), pp. 15–17. 3 See Huang (2013), pp. 757–758. 4 See CSRC, Annual Report of the CSRC (2014); CSRC, Annual Report of the CSRC (2015); CSRC, Annual Report of the CSRC (2016). 5 See Carpenter et al. (2017). 6 “ST-companies” in China are listed companies that are labelled with “Special Treatment” by the Stock Exchange because of bad performances over the past years. 7 See CSRC, Annual Report of the CSRC (2017). 8 See Sun et al. (2017), pp. 186–199. 9 For various reasons, a large portion of the State shares in Chinese Listed Companies was still restrictive from the sale even after the Share-split Reform. These shares are entering the market very slowly (and yearly) until they are fully released. See Liu et al. (2014), pp. 339–342 and 345. 10 See Shi (2016). 2

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Disputes had drawn the whole nations’ attention.11 Since then, Kingkey Group’s bid for Shenzhen Kondarl, Shanghai Bao Yin Chuang Ying Investment Management Corporation’s bid for Xinhua Department Store Corporation, Hu Brothers’ bid for Tibet Tourism, Kainan and its concerted parties’ bid for ST Xinmei, and Baoneng and its concerted parties’ bid for Nanbo A Share and Gree Electric Appliances Inc. subsequently entered the public consciousness,12 however, this is just a small tip of the hostile takeover iceberg. The once rare corporate control battles are becoming everyday routine in China, pressuring the supervisory authorities to upgrade the contemporary regulatory framework. Acquirers in China are repeatedly challenging the bottom line of the law; breaches of the tender offer procedural requirements, violations of information disclosure rule and other misbehaviours are standard practices.13 However, current law and administrative rules are more problematic than thorough, not only did it fail to provide specific answers in inevitable conflicts, some of the articles and clauses are contradictive with each other, which need official judicial interpretation urgently. All the legal vacuums are left for the China Security Regulatory Commission (hereinafter “CSRC”) to fill, yet this supreme regulator’s decisions are somewhat inconsistent and capricious in different cases. As a result, both the acquirer and the target company are facing considerable uncertainties in takeover activities.14 On the one hand, the target management feels constrained by various vague prohibitive clauses; they usually hesitate before adopting ex-post anti-takeover defences. As a result, they tend to abuse their management power and introduce anti-takeover provisions into their articles of associations. On the other hand, the bidders usually have to hide their intentions of a hostile takeover, and they even have to break the law to circumvent the coercive ex-ante defences in the target companies’ articles of associations.15 As substantial law and stipulations cannot provide clear solutions to pacify the disputes and conflicts between the acquirers and the target boards, both sides of takeover activities have to probe the supervisory authorities’ standing before taking another move. Such contexts leave many questions to academia. How to reform the Chinese “CSRC centralism” regime, and what is the direction of the Chinese takeover

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From July to December 2015, Baoneng and its affiliations acting in concert one share after another acquired Vanke—A Share from the stock market. By 17th December 2015, Baoneng group collectively held approximately 24% of total shares of Vanke, exceeded the China Resources Corporation and became the largest shareholder. Baoneng funded its acquisition through issuing corporation bond and the highly-controversial Universal Life Insurance. Baoneng’s sudden attack has shocked the whole securities market. See The driving force behind Baoneng’s assault on Vanke, available at http://www.scmp.com/business/article/1990310/driving-force-behind-baonengsassault-vanke (last visited 24th July 2019). 12 There are, of course, more hostile takeovers than those listed above. However, these are the ones that drew the most attention. See Fu (2017), p. 227. 13 Id, p. 226. 14 See Chen (2014). 15 Id, p. 20.

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regulation reform? Which one, the courts, government, or the self-regulatory institutions, should play the principal role in the Chinese market for corporate control? The primary purpose of the paper is to explore the role and future of the selfregulation institutions in the takeover markets by the comparative narrative of the linkage and divergence of the English and Chinese law development regarding the takeover law.

2 The Three Modes of the Takeover Regulation In order to set an order for hostile takeovers and protect the lawful rights of the participants, the US, the UK and China had adopted three completely different regulatory frameworks in the hostile takeover domain.

2.1

Courts: e.g. “Fiduciary Duty Centered Mode” of the US

The first model of the takeover law is that the courts play a primary role in the takeover markets. The courts would review the takeover disputes ex-post mostly based on the fiduciary duty of the directors and the controlling shareholders. The judicial decisions interpreting the directors’ fiduciary duty are the core of the US hostile takeover regulation. Since our paper is about the role of self-regulation, we just simply brief the US model.

2.2

The Self-Regulatory Model: e.g. the UK

Comparing to the US hostile takeover regulatory framework, the UK mode is quite different. The shareholders’ assembly has the primary power over all significant corporate issues, and the board shall not take any defences unless authorized by the shareholders’ assembly.

2.2.1

The Takeover Panel and the City Code

The City Code on Takeovers and Mergers governs all the takeover activities in the UK. It is drafted, revised and carried out by the Panel on Takeovers and Mergers. The Takeover Panel consists of full-time professionals from different industries, representatives of commercial institutions and specialists on secondment from Banks and Industry Associations. Unconstrained by the legal precedents and procedural limitations, the Takeover Panel and its City Code could solve takeover disputes in extremely high efficiency.

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No Frustrating Action Principle

The core of the City Code is the famous “No Frustrating Action Principle”: “[D] uring the course of an offer, or even before the date of the offer if the board of the offeree company has reason to believe that a bona fide offer might be imminent, the board must not, without the approval of the shareholders in general meeting, take any action which may result in any offer or bona fide possible offer being frustrated or in shareholders being denied the opportunity to decide on its merits.”16 Moreover, the board are strictly prohibited from taking the following measures that may have a particular effect on the tender offer: “1. issue any shares or transfer or sell, or agree to transfer or sell, any shares out of treasury or effect any redemption or purchase by the company of its shares; 2. issue or grant options in respect of any unissued shares; 3. create or issue, or permit the creation or issue of, any securities carrying rights of conversion into or subscription for shares; 4. sell, dispose of or acquire, or agree to sell, dispose of or acquire, assets of a material amount; or 5. enter into contracts otherwise than in the ordinary course of business.”17 Except for these direct bans on issuing new shares, the Companies Act of the UK also requires the board to obtain approval from the shareholders before allotting(issuing) any shares.18 In share issuance situations, the shareholders are entitled to the Right of Pre-emption: “[A] company must not allot equity securities to a person on any terms unless it has made an offer to each person who holds ordinary shares in the company to allot to him on the same or more favourable terms a proportion of those securities that is as nearly as practicable equal to the proportion in nominal value held by him of the ordinary share capital of the company, and the period during which any such offer may be accepted has expired, or the company has received notice of the acceptance or refusal of every offer so made”.19 Any attempt to circumvent the right of pre-emption is under the regulation of the Association of British Insurers and its Directors’ power to allot shares and disapply shareholders’ pre-emption rights.20 These rigorous rules directly forbid the management, or the board to take any defensive measures without the approval from the shareholders. Most importantly, “[t]he Panel must be consulted in advance if there is any doubt as to whether any proposed action may fall within this Rule (No Frustrating Action Principle).” From the literal expression, the “No Frustrating Action Principle” only works “during the course of an offer, or even before the date of the offer”, is it possible for the target company to take some precautionary measures? For example, dual-

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The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part I18, Rule 21.1(a). 17 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part I18, Rule 21.1(b). 18 Companies Act, 2006, Part 17, c.2, §549–551. 19 Companies Act, 2006, Part 17, c.3, §560(1). 20 Association of British Insurers (1995 & Updated 2009).

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ownership structure, staggered boards, severance agreements or anti-takeover provisions are all common proactive defences in Anglo-American countries. Ex-ante defences appear much less frequent in the UK than in the US. Let us address the common ex-ante defences one by one. The UK Companies Act did not directly ban the use of dual ownership structure, but such arrangements may disfavour the institutional investors in the first place, which directly give rise to depressing share price and difficulties of refinancing in the capital market.21 As for the staggered board, the UK Companies Act entitles the shareholders’ assembly to remove directors even before his term due: “[A] company may by ordinary resolution at a meeting remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him.”22 Therefore, the staggered board provisions have no use at all in the UK under this context. Besides, the directors of the board are under intense surveillance by the people for whom they are working. The directors of a company must prepare a directors’ report for each financial year of the company, and this report must record in detail the director’s principal activities of the year. Moreover, “[u]nless the company is subject to the small companies’ regime, the directors’ report must contain a business review. . .The purpose of the business review is to inform members of the company and help them assess how the directors have performed their duty under section 172 (duty to promote the success of the company).”23 The Large and Medium-sized Companies and Groups (Accountant Reports) (Amendment) Regulations 2013 replaced the old Directors’ Remuneration Report Regulation, imposing an even stricter disclosure requirement on the directors’ expenditure.24 The Combined Code on Corporate Governance of the Financial Service Authority (FSA) explicitly limit the directors’ term to one year, and the renewal of the term is one-year maximum as well.25 Because of these stipulations, severance agreements like the golden parachutes are practically not applicable in the U26

2.2.3

Principle of Equal Treatment of Shareholders

The nature and purpose of the City code are to “[e]nsure that shareholders in an offeree company are treated fairly and are not denied an opportunity to decide on the merits of a takeover and that an offeror affords shareholders in the offeree

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See Armour and Skeel Jr (2006), pp. 1756–1765. Companies Act, 2006, Part 10, c.1, §168(1). 23 Companies Act, 2006, Part 15, c.5, §415, §417. 24 The Large and Medium-sized Companies and Groups (Accountant Reports) (Amendment) Regulations 2013. 25 Financial Reporting Council. The UK Corporate Governance Code. D1.5 (2012). 26 Armour and Skeel Jr. (2006), pp. 1756–1765. 22

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company of the same class equivalent treatment.”27 Three substantial rules are supporting this general principle. Section E11 Rule 6 sets the bottom price of an offer: “[a]n offeror or any person acting in concert with it acquires any interest in shares at above the offer price (being a then-current value of the offer), it shall increase its offer to not less than the highest price paid for the interest in shares so acquired.”28 Section H1 Rule 14 ensures that the same class of shares are to be treated the same:“[W]here a company has more than one class of equity share capital, a comparable offer must be made for each class whether such capital carries voting rights or not; the Panel should be consulted in advance. . .In the case of offers involving two or more classes of equity share capital, prices for all of which are published in the Daily Official List, the ratio of the offer values should typically be equal to the average of the ratios of the middle market quotations taken from the Daily Official List for the six months preceding the commencement of the offer period.”29 Section H3 Rule 16 forbids the acquirers to reach any superior agreements with any third party: “[E]cept with the consent of the Panel, an offeror or persons acting in concert with it may not make any arrangements with shareholders and may not deal or enter into arrangements to deal in shares of the offeree company, or enter into arrangements which involve acceptance of an offer, either during an offer or when one is reasonably in contemplation if there are favourable conditions attached which are not being extended to all shareholders.”30 The shareholders, as mentioned earlier protection rules are quite similar to the Securities and Exchange Act of the US. However, the UK went even further and introduced the Mandatory Bid Rule: “[a]ny person acquires, whether by a series of transactions over a while or not, an interest in shares which (taken together with shares in which persons acting in concert with him are interested) carry 30% or more of the voting rights of a company,” a mandatory offer is required.31 Indeed, the Mandatory Bid Rule offers all shareholders with a fair opportunity to exit without any omissions, but it mostly increases the cost for the acquirers. Hence it hinders takeovers from happening. To sum up, the UK hostile takeover regulatory framework leans mostly to the shareholders’ side, which is very much the opposite to the US practice. The shareholders have the primary power over takeover issues, and directors of the board must remain passive.

27 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Introduction, 2(a). 28 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part E11, Rule 6. 29 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part H1, Rule 14. 30 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part H3, Rule 16. 31 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part F1, Rule 9.

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The Governmental Regulation Regime: e.g. The CSRC Centralism Regime of China

As discussed below, the government, which the CSRC represents, plays the primary role in the market for corporate control. The CSRC has broad power over the takeover. The CSRC stipulates the rules of the takeover, 2014 Administrative Rules on Acquisition of Listed Companies, albeit according to the Securities Law. The CSRC is responsible for the administrative regulation of the securities markets, including the takeover activities. When significant takeover transactions happen, the CSRC tends to exert considerable influence upon the bidders and the targets beyond its jurisdiction.

3 The UK’s Self-Regulatory Model and the Takeover Panel: History, Path Dependence, and Reflections 3.1

From Shareholder Centric to Self-regulatory System

Now let us have a historical review of the UK’s approach. Just like the US, hostile takeovers first emerged in the UK in the 1950s. After World War II, the high inflation rate elevated the price of fixed assets, especially the land.32 As the financial information of companies was not as transparent as today, the investors could only judge the value of the shares through the number of dividends. In other words, the value increase of the companies’ assets was not reflected directly at the share price. The government-imposed dividend restriction in the 1950s led to the hoard of cash of many companies, and acute investors sniffed profitable opportunities.33 In 1953, the Russia-immigrant businessman Charles Clore realized that the value of the Shoe Retailer J. Sears was severely undervalued. J. Sears owned plenty of commercial houses and land in central London, and their values were not reflected in the share price. Charles Clore then launched a tender offer for all outstanding shares of J. Sears at the open market, and the tender offer price was much higher than the market price. The J. Sears management was horrified, they immediately promised to increase its dividends and reevaluate the company assets so that the share price could truly reflect its value, but such promises came too late. Charles Clore then successfully obtained the control of the Shoe Retailer J. Sears.34 In the same year of 1953, the England Financier Harold Samuel announced his hostile takeover attempt over the Savoy Hotel Group. As the price of the fixed assets

32

Benati (2004). Id. 34 Armour and Skeel Jr. (2006)//City Notes: The J. Sears Offer, TIMES (London), Feb. 5, 1953, p. 10. 33

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skyrocketed in the past few years, Savoy’s share price did not fully reflect its actual value. Harold Samuel intended to transform Savoy’s Berkeley Hotel into commercial office premises for better profit. The Savoy’s board began taking defensive measures against Harold’s attack. The board sold the Savoy’s Berkeley Hotel to a new business entity—the Worcester Limited, who later rented the Savoy’s Berkeley Hotel back to the Savoy’s Group, on condition that the buildings and constructions associated with Berkeley could only be used as hotels. As the Savoy board was the de facto controller of the Worcester Limited, this Assets Lock-up Strategy was directed wholly by the Savoy Board.35 At that time, the hostile takeover was not a decent way for corporate control, and the previous hostile takeover attempts of both Charles Clore and Harold Samuel had drawn controversies nation-wide. However, in the Harold case, an even more considerable controversy aroused around the board’s self-trenching behaviours when facing takeovers—they deployed defensive measures without seeking approvals from their general assembly. The shareholders contested continuously, which led to the investigation from the United Kingdom’s Board of Trade, who later ruled that the board’s ultra vires had breached their fiduciary duty.36 However, it was until the end of the 1950s was the regulation on hostile takeover officially put on the agenda. At the end of 1958, the Tube Investments of UK, the U.S. Reynolds Metal Company and the Aluminum Company of America all publicly announced their acquisition attempt of the British Aluminum. Without thorough discussions with the general assembly, the British Aluminum board reached a cooperative intention with the Aluminum Company of America and directly rejected the other two companies. The board agreed to issue a large number of new shares to the Aluminum Company of America so that it could hold 1/3 shares of the British Aluminum. The shareholders were kept unknown from this deal until the Tube Investments of the UK and the U.S. Reynolds Metal Company bypassed the British Aluminum board and sent out a general tender offer for its all outstanding shares. The board then intended to exclude the Tube Investments of UK and the U.S. Reynolds Metal Company’s tender offer by publishing the fait accompli deal. The shareholders were outraged by the board’s behaviour, and the board tried to bribe the shareholders by mainly increasing the share dividends. However, this could not stop the irritated shareholders selling their shares to the “hostile” tender offerors. At last, the board completely lost control of the company very fast.37 The mal-practice of the British Aluminum board shocked the whole industry, and the call on stricter regulations on the board’s behaviour was overwhelming. As the mergers and acquisitions appeared much more frequently than in the past few years, the major players in the game felt obliged to take actions before the congress would. In July 1959, the Bank of England quietly formed a legislation committee, members

35 Armour and Skeel Jr. (2006)//Battle for the Savoy, Economist, 12th December 1953, pp. 831–832. 36 See Sheppard (2013), pp. 1880–1966. 37 Armour and Skeel Jr. (2006), p. 1739.

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of which were representatives from commercial banks, investment organizations, significant commercial associations and the stock exchange. In October 1959, under the close cooperation with the Issuing Houses Association, the Accepting Houses Committee, the British Insurance Association and London Stock Exchange, the Bank of England released the Notes on Amalgamation of British Businesses—the first hostile takeover law in the UK history. As the Marquess of Queensberry mainly wrote it, it was also referred to as the Queensberry Rules.38 “Active shareholders, passive directors,” was the quintessence of the Note, and it was divided into two parts—principle and procedure. The four fundamental principles were: “1. There should be no interference with the free market in shares and securities of companies. 2. It is for a shareholder to decide for himself whether to sell or retain his shares. 3. To enable him to come to a considered decision, the shareholder should have in a suitable form, and at the right time, all relevant information and the Board of his company must make every effort to ensure that such information is provided and to give him their advice. 4. Every effort should be made to avoid disturbance in the normal price level of shares until the relevant information has been made available.”39 The Bank of England released this self-supervisory rule just before Prime Minister Harold Macmillan announced the intention to revise the Companies’ Act in November 1959.40 Even though the Notes on Amalgamation of British Businesses was in many aspects flawed, it was commonly accepted in the UK in the following years.41 The lack of a law enforcement agency was the Notes’ biggest weakness, and some people began to deem a governmental institution with regulatory authority— just like the Securities and Exchange Commission in the US—was the only solution for a stable market for corporate control. Luckily, in July 1967, Prime Minister Harold Macmillan expressed clearly that: currently, imperative law was not the best solution for England.42 When the US Congress was trying to carry out the Williams Act, the investors and their associations in the UK drafted and released the City Code on Takeovers and Mergers at the end of March 1968. Based primarily on the Queensberry Rule, the newly released City Code had explicitly addressed all the issues unable to solve by the Note.43 Also, it specified the shareholders’ absolute authority in takeover related issues. Most importantly, the Panel on Takeovers and Mergers was established on 27th March 1968 based on the City Code. The Panel had nine committee members initially, representing the banks, large corporations, business associations and industrial unions. For those commercial elites, ex-ante interference was more efficient than ex-post adjudication. 38

See Roberts (1992), pp. 183–200. Bank of England et al. (1959), p. 4. 40 Armour et al. (2011), p. 219. 41 See Wardley (1991), pp. 268–296. 42 Armour and Skeel Jr. (2006), p. 1760. 43 See Johnston (1980). 39

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The inchoate performance of the Takeover Panel was not as good as expected; it was overwhelmed by the steady flow of cases. The bidders were repeatedly challenging the bottom-line of the City Code that even if the Takeover Panel was always kept on the run, it could not babysit every aspect in various transaction deals.44 In November 1968, the Prime Minister expressed his confidence in the City Code, but at the same time pointed out that if the Takeover Panel failed to reform immediately for better working flow and higher efficiency, the government would have no choice but solve the problem through public legislation.45 The Takeover Panel acted swiftly to evolve itself. In 1968, Lord Shawcross46 was invited as the non-executive chairman of the Takeover Panel, and more full-time conciliation professionals were hired to solve the complicated cases. An Appeal Committee was introduced into the dispute solving procedure, paralleled with the Common court. Lord Pearce47 was invited as the chairman of the Appeals Committee of the Takeover Panel; he served on this position until 1976. Most important, the sanction and penalty power for the Takeover Panel had been inexorably on the increase. The Board of Trade supported the Takeover Panel’s back by agreeing to inflict administrative punishments on undisciplined bidders. The London Stock Exchange also expressed their will to work along with the Takeover Panel to delist companies out of line. Soon, the Council of Stock Exchange, the Association of British Insurers, the Association of Unit Trusts Managers, the Association of Investment Trust Companies all unanimously agreed to endorse the Takeover Panel. With the whole industry as its back, the Takeover Panel and its City Code successfully became the ultimate authority in takeover disputes. Despite the leftleaning Labor Governments in the 1970s, the Takeover Panel proved its irreplaceability through its impeccable performances and proactive self-improvements.48 All in all, the history of the Takeover Panel and the City Code was the history of a selfregulatory system racing with the administrative legislation. In order to survive, the Takeover Panel had to continually improve itself to cater to the need of the market better. Meanwhile, it must keep its excellent reputation as legislative interventionism may resurge at any time. In the end, this thoroughly hammered-regulatory framework has blended itself into the UK’s capital market, outmatching any possible regulators established by a parliamentary system.

44 In the first year after the promulgation of the City Code, there were near 600 takeover cases for the Takeover Panel to decide. Excluding the public holidays, that would be approximately two cases per day. 45 See Deakin et al. (2002). 46 Hartley William Shawcross, barrister, politician and businessman. He was the Chief U.K. Prosecutor of the International Military Tribunal in Nuremberg from 1945–1946 and was the President of the Board of Trade since 1951. 47 Edward Holroyd Pearce, a reputable British Judge, born in February 1901, he was the Lord of Appeal in Ordinary from 1962–1969. 48 See Armour and Skeel Jr. (2006), p. 1769.

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Understanding the UK Self-Regulatory Model The Path Dependence: Formidable Institutional Investors and Unfading Takeover Panel

Institutional investors, industrial associations and unions played a much more critical role in the formation of the UK hostile takeover law.49 Institutional investors such as pension bund, unit trust and alike, were the most important players in takeovers. Most importantly, their growth had never suffered any political resistance; some of the policies even fostered the growth of the institutional investors. For instance, the punitively high rates of marginal taxation applied to investment income for individuals after the World War II, and the marginal tax rate rises from 90% in the 1950s to 98% at the end of the 1970s; these factors destroyed the investment enthusiasm of independent citizens.50 Despite the Thatcher Government pushed a tax cut since 1979, the marginal taxation applied to investment income for individuals in the 1980s was still at a high level of around 40%. The Mutual Investment Scheme, on the other hand, largely reduced the institutional investors’ tax rate. The insurance funds enjoyed half of the individual investment tax rate, and the pension fund was almost tax-free at the end of the 1990s as the government intended to promote private senior-care institutions. Under these contexts, mutual investment behaviours had replaced all individual investment, and the institutional investors had grown wildly—the average shareholding of institutional investors was rocketing from 1950 until the early 2000s.51 Although the institutional investors were the mainstream in the UK capital market, those stockholders were famous for passive and indifferent to the management and development of the Company.52 They never interfere with the corporate issues, and once the performance of the company was not excellent, they “vote with their feet”. The UK government always had the intention to encourage institutional investors to take part in corporate governance, but they refused to do so because of the “free-rider” problem.53 In fact, in order to maintain sustainable growth, most institutional investors held only a tiny portion of shares of each company they invested—the overall performance of the portfolios were the fund managers’ primary concern, not each companies’ income status. Moreover, the cost of cooperation was so huge that, only in extreme situations would the shareholders united together to overturn the incumbent management. Rebellions of the institutional investor shareholders were sporadic in UK history.54

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Armour and Skeel Jr. (2006), pp. 1750–1760. See Steinmo (1994), pp. 9–17. 51 See Dong and Ozkan (2008). See also Khan (2006). 52 See Goergen and Renneboog (1998). 53 Id. 54 Id. 50

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It does not mean that the hands of the institutional investors were completely tight in front of the board and managers of the company. To ensure their supremacy in the companies, the institutional investors exert every influence they have on legislations directly. In other words, they strongly preferred the laws at their favour to unnecessary participation in corporate governance. The preemptive rights, the ban on non-voting shares, the prohibition of taking takeover defences without the approval from the shareholders, the approval rights of major corporate issues and the limitations on board structures and directors remunerations were all optimal rules for the institutional investors in the UK In conclusion, the institutional investor shareholders put their energy on things that they were good at—lobbying and persuasion. They avoided being forced to take part in things they were not familiar. Although the freerider problem still exited in lobbying, it was much more efficient and cost-saving than having to involve deeply in corporate governance. Moreover, frequently withdrawing investment from companies with poor performance and reinvesting the money into potentially better ones were extremely costly, too; cultivating a shareholder-oriented law was the most convenient solution that could once for all let the investors rest easy. After all, the agency cost was the source of the problems. Over the past decades, the institutional investors actively participated in the formation of the self-regulatory laws, and the labour unions, directors associations, were excluded out of this process.55 By effectively lobbying the politicians and legislators, the glorious tradition of self-discipline was retained almost integrally. For example, in the 1950s, the institutional investors, industry elites, associations and unions were united together by the Bank of England, and they managed to adopt a self-discipline rule—the Notes on Amalgamation of British Businesses just before the official revision of the Companies Act. The institutional investors even managed to retain the independence and authority of the City Code after Britain joined the EU. The “political proximity” between the Bank of England and the British government offered convenience for the institutional investors, fund controllers and financiers’ demands and appealed to be noticed by the prime minister and his cabinet. After all, the forefathers of these real owners of the listed companies originally all lived in a square mile London city, and they shared the same anxiety when modern enterprises had to separate ownership and control for the economics of scale.56 When Charles Clore successfully took control of the Shoe Retailer J. Sears, the industry was shocked, referring Charles Clore to as an “asset striper”. Nevertheless, the shareholders benefited a lot from this takeover. In the takeover disputes between Harold Samuel and the Savoy Hotel Group, shareholders were outraged not because of Harold Samuel’s “hostility”, but because of the board’s ultra vires, which was the same situation in the takeover battles of the British Aluminum. The Bank of England conveniently took advantage of these momentums, and formed a draft committee for the Notes on Amalgamation of British Businesses; the Institute of Directors and 55 56

See Cheffins (2001). See Jenkins and Nations Unies (2001).

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Association of British Chambers of Commerce were not invited at all. In 1968, when the Bank of England invited the elites and representatives to draft the City Code, this time, they cannot exclude the Confederation of British Industry, who represented the interests of the management of the large corporations.57 However, the doctrine of “Active shareholders, passive directors” of the previous Queensberry Rule was so deeply ingrained that no one could shake its status.58 In summary, from the perspective of the public choice, a shareholder-supreme self-regulatory takeover law was formed as a result of (1) mighty institutional investors constantly lobbying the legislators; (2) Bank of England’s proximity with the British Government; and (3) weak labour unions and directors associations being unable to change the distaste for ultra vires behaviours and alike. Hence, the self-regulatory tradition first became a fashion and ultimately became a consensus foundation for the hostile takeover law in the UK.

3.2.2

Special Background of Self-regulation

The formation of a self-regulatory framework required the institutional investors, bankers and industrial associations to work in concert—and one of the essential prerequisites for them to achieve so was the geographical proximity they had in the UK. Most investors, bankers and officials lived in the commercial areas of London since the nineteenth century. Over the years, they formed close ties and relationships with each other. These commercial elites later developed different associations and social groups that best reflect their interests. The associations and groups then promoted the laws that were favoured them. The management class who worked for those people and get paid from those people, unfortunately, did not form any groups or associations that were strong enough to challenge the institutions established by bankers and investors.59 Even today, the financial and economic centre of the UK is still London alone. Larger banks, financial institutions and industry associations are all located in the London city, providing great convenience for the Takeover Panel to borrow professionals from other institutions and switch information with them. In the US, the situation is just the opposite. Even though bankers, investors were once gathered in Wall Street, they are now dispersed everywhere in different States. Even in the past, the political centre of the US—Washington was 380 km from New York. As a result, it is more difficult for investors and bankers in the US to affect legislation than their counterparts in the UK; only federal securities laws could better oversee every state across the nation.60

57

Armour and Skeel Jr. (2006), p. 1775. See Deakin et al. (2002). 59 Armour and Skeel Jr. (2006), pp. 1730–1745. 60 See Fox and Sklar (2009). 58

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Incomparable Advantages of Self-regulatory Mode

Comparing with the US and the China model, the self-regulatory framework of the UK is incredibly more efficient in terms of cost and time, offering more certainty to the capital market. Litigations are costly in every country. In the US where the takeover disputes were solved in the court, the acquirers and the target boards have to afford far-flung litigation costs and expensive legal service fees; but in the UK, the necessary funding to support the Takeover Panel comes from service charges in tender offers and the sales of the City Code.61 Of course, legal professionals more or less have to participate in takeovers in the UK, too, but their primary jobs are to offer legal consultations or to draft legal documents. As a result, takeover participants do not have to bear sky-high price disputes resolutions costs. The Takeover Panel tackles with takeover disputes with no delay: the professional councils respond to appeals very quickly and involve almost immediately. Forasmuch, deliberate and tactical suits became unnecessary. The English Court of Appeal forbids anyone using litigations to interfere with the real-time decisions from the Takeover Panel. In the R.v.Panel on Take-Overs and Mergers case of 1986, the Data Fin Company was unhappy with the decision from the Takeover Panel, and the Master of the Rolls Sir John Donaldson decided that the Takeover Panel’s decision was so vital that it must withstand judicial review. Nevertheless, even the Takeover Panel’s decision was overturned in the future in judicial reviews; it only could have influences on future cases.62 As a result, takeover disputes were always solved within a week in the UK. On the contrary, and in the US, takeover disputes could last for years. For instance, in 2003, Oracle launched a hostile takeover of People Soft, and the antitrust review alone took 18 months.63 Most importantly, the Takeover Panel could proactively amend the City Code to cater to the needs of the market. The council members would gather together every month to discuss challenging cases and the newest financial innovation. In comparison, the Delaware court is relatively passive and lagging, as the judges could only rule and discuss the cases in front of them. In order to overcome such procedural flaws, the Delaware judges would frequently refer to the latest academic findings and articles; moreover, the steady flow of takeover cases also compensate the courts’ lag in takeovers. Still, it could not match the speed with the UK hostile takeover regulatory framework, as the Takeover Panel could directly add or adjust the contents in the City Code to reflect the market changes.

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Armour and Skeel Jr. (2006), p. 1727. R.v.Panel on Take-Overs and Mergers [1987] Q.B. 815, 841, 842. 63 Armour and Skeel Jr. (2006), p. 1750. 62

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Functional Premise of Self-regulatory Mode

In order for the self-regulatory model to be active and long-lasting, the motives of the regulator must be compatible with those of the stockholders of the company— increasing overall profitability and cutting unnecessary costs.64 The US securities market had undergone a self-regulatory history for more than 100 years. The Stock Exchange itself was the most prominent self-regulatory entity before 1933, as all the listed companies were its members and were bound by the constitution and listing rules of the NYSE.65 Until the enactment of the Securities Act, the self-regulatory rules of the New York Stock Exchange were the most critical legal resource of the federal securities law. However, the brokers and traders had very different self-interest motives; they might freeze any deals that would delist the target company, even if the deal were beneficial to both the offeror and the offeree. With the rise of the NASDAQ and AMEX, the NYSE had every reason to make their members happy; it always compromised whenever its listed companies threatened to leave. Therefore, the overall profitability of the company was not the self-regulator’s primary concern from the beginning to the end.66 Indeed, the self-regulatory system of the UK was shaped by institutional investors with various motives. However, the overall profitability of the company was always their mutual concern, as they had to be responsible for investors who put their money in the institutions. In summary, only when regulators are focusing solely on increasing the overall profitability of the listed companies could a self-regulatory hostile takeover framework function well.

4 China’s CSRC Centralism Takeover Regime: Linkage with and Divergence from the UK 4.1

The Hostile Takeover Regulatory Law of China

Our discussion on Chinese hostile takeover regulatory framework begins from here. Before talking about the social and historical accounts of Chinese regulation, let take a close look at China’s takeover law first. The Chinese Securities Law of 2005 established the China Security Regulatory Commission, a technocrat just like the SEC in the US, as the primary regulator in Chinese Securities Market. The CSRC has more considerable power than the SEC does—in the takeover domain, it has the highest and almost exclusive authority, despite small equity disputes went to the court occasionally.

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Armour and Skeel Jr. (2006), pp. 1756–1770. See Michie (2012). 66 Armour and Skeel Jr. (2006), p. 1765. 65

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In 2006, enlightened by the Takeover Panel of the UK, the CSRC established a particular unit to address takeover relative affairs specifically—the Mergers, Acquisition and Restructuring Committee (the MAR Committee). The MAR Committee consists of legal experts and commercial professionals borrowed from other institutions, banks and stock exchange. Opinions on takeover issues from the MAR Committee represent the state-of-art conclusive views of the CSRC. In recent years, the CSRC has lowered its administrative intervention in mergers and acquisitions, partly by eliminating administrative approval requirement and entitling oversight power to the stock exchange and CSRC dispatched offices.67 Except the administrative regulations from the CSRC, current Chinese takeover activities are also governed by the People’s Republic of China’s Company Law (hereinafter 2014 Company Law as it came into effect on 1st March 2014),68 the People’s Republic of China’s Securities Law (hereinafter 2014 Securities Law as its last amendment is in 2014),69 and the Administrative Rules on Acquisition of Listed Company (hereinafter 2014 Administrative Rules on Acquisition as its last amendment is in 2014).70 Moreover, although not functioning as a substantive rule, the Guidelines on Articles of Association of the Companies Listed in China (hereinafter 2016 Guidelines on Articles of Association as its last amendment is in 2016)71 also provides useful guidelines for takeover disputes, especially those associated with corporate charters of Chinese listed companies.

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Huang (2005), p. 145. Adopted at the Fifth Session of the Standing Committee of the Eighth National People’s Congress on 29th December, 1993; amended for the first time in accordance with the Decision on Amending the Company Law of the People’s Republic of China adopted at the 13th Session of the Standing Committee of the Ninth National People’s Congress on 25th December, 1999; amended for the second time in accordance with the Decision on Amending the Company Law of the People’s Republic of China adopted at the 11th Session of the Standing Committee of the Tenth National People’s Congress on 28th August, 2004; Revised at 18th Session of the Standing Committee of the Tenth National People’s Congress on 27th October, 2005; and amended for the third time in accordance with the Decision on Amending Seven Laws Including the Marine Environment Protection Law of the People’s Republic of China adopted at the Sixth Session of the Standing Committee of the 12th National People’s Congress on 28th December, 2013. 69 Adopted at the 6th Meeting of the Standing Committee of the Ninth National People’s Congress on 29th December 1998; amended in accordance with the Decision of the Standing Committee of the Tenth National People’s Congress on Amending the Securities Law of the People’s Republic of China adopted at its 11th Meeting on 28th August, 2004; and revised by the Standing Committee of the National People’s Congress on 2005 and 2014. 70 First promulgated by CSRC in 2002, then its newer edition was promulgated by CSRC on 31st July 2006 and effective from 1st September 2006, amended in 2008, 2012 and 2014. 71 Promulgated by CSRC in December 1997, amended in March 2006, May 2014, October 2014 and September 2016. 68

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The Dilemma of Chinese Takeover Regulation

China’s seemingly comprehensive, particular law is more problematic than thorough; not only did it fail to provide clear answers in specific conflicts; it also exacerbated the internal contradictions of the provisions. As the target board had relatively limited ex post takeover defensive measures under the current law, they then take advantages of their de facto controlling powers to introduce self-trenching ex-ante anti-takeover provisions into the articles of associations. On the other hand, facing the target board ignoring the duty of care and duty of diligence in takeovers, the acquirers also went wild and frequently broke the bottom line of the Securities Law. Breaches of the tender offer procedural requirements, violations of information disclosure rules and other questionable behaviours are standard practices.72 When acquirers and the target boards were nearly a draw, the China Securities Regulatory Commission usually engaged and “hosted” the tiebreaker. The prominent hostile takeover cases in this section will illustrate that the CSRC’s administrative intervention solved almost every pending dispute—the intentions of the “above” has replaced the contradictive clauses and become the only decisive factors in hostile takeovers. As the corporate charter has to be approved in the general meetings of shareholders, theoretically, the shareholders have the review and absolute power of such provisions. However, due to the inherent agency costs exist between management and shareholders, directors of the board usually use their position to affect the corporate charter in favour of their interests.

4.2.1

The Board Centrism Anti-takeover Provisions

Lack of the necessary knowledge and information is one cause, lack of unity being another, shareholders in China seldom give constructive suggestions in hostile takeovers, and the board usually take the lead in significant resolutions. Falling to distinguish the boards’ deeper intentions from rhetoric persuasion and glorified jargons, shareholders usually vote for yes on issues that eventually may have an adverse effect on them. The self-binding anti-takeover provisions (hereinafter the “ATPs”) in articles of associations are good examples. In late 2015, a series of takeover conflicts emerged in China, including the famous “Baowan Dispute”. The tense atmosphere in the Chinese capital market resulted in numerous A-share listed companies scrambling to add ATPs in their corporate charters. Official data indicates that, in 2016 alone, more than 600 A-share

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companies revised their corporate charters to adopt ATPs.73 Until June 2017, more than 620 Chinese A-share companies have adopted ATPs.74

4.2.2

The “CSRC Centralism” Path Dependence

Excessive administrative interventions from the supervisory authority could be observed in several takeover cases in the past three decades. Typical were the Shenzhen Baoan Group Co., Ltd takeover Shanghai Yanzhong Industrial Co., Ltd case and the Dagang Oilfield Group Ltd takeover Shanghai ACE Co., Ltd. case. In conclusion, deficient and contradictory laws gave rise to uncertainties in the capital market. On the one hand, the target board had minimal ex-post takeover defensive measures under the current law; they then introduced various ex-ante antitakeover provisions into their articles of associations utilizing their de facto controlling powers. The duty of care and duty of diligence in Chinese law was stipulated through a series of positive and negative lists; this parody of the US fiduciary duty failed to provide a comprehensive and fair standard to review the board’s behaviours. On the other hand, facing unruly managements, the acquirers also went wild and frequently broke the bottom line of the Securities Law. Breaches of the tender offer procedural requirements, violations of information disclosure rule and other questionable behaviours are standard practices. Such loopholes came from overcomplicated legislations that were vague and obscure. Previous hostile takeover cases illustrated that much pending dispute was solved by the China Securities Regulatory Commission’s administrative intervention; the intentions of the “above” have outweighed the substantial law to decide the outcomes of hostile takeovers. CSRC’s intervention may temporarily ease the disputes and conflicts, but this would form even heavier reliance on administrative interference in hostile takeovers.

4.3

Linkage with the UK: Reflections of the Substantial Law

Some scholars believed that the Chinese takeover laws were mainly transplanted from the U75 The MAR Committee under the CSRC was regarded as the counterpart of the Takeover Panel in the UK, and the Administrative Rules on Acquisition was the Chinese version of the City Code. However, the MAR Committee is not a selfregulatory entity; it only had minimal authority in takeover disputes. Moreover,

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Sangtong (2016) 600 A-share Companies Revised Their Bylaw: Shareholders Became Outsiders Due to Over Defenses. Xinhua News Agency. 2016-09-26. Available at http://news.xinhuanet.com/ fortune/2016-09/26/c_1119625379.htm. 74 Wen (2017). 75 See Bai et al. (2004). See also Cai (2012).

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Chinese courts now and then also took part in takeover related case trials; it is too farfetched to consider the Chinese mode similar to the UK’s.76 On the other hand, the Chinese hostile takeover regulatory framework bears a resemblance to the US mode as well. The CSRC has the ultimate authority oversight the securities market; it functions similarly, just like the SEC to some extent. In terms of legal clauses and provisions, China has transplanted the takeover law from the UK, and the US. First, in parallel with the City Code and the Companies Act of the UK, the Chinese Company Law is ostensible “shareholder centred”—the general assembly seems to be the highest authority incorporate issues, and the board of directors are responsible for carrying out the general assembly’s resolutions.77 In theory, like all defensive measures, no matter ex-ante or ex-post, more or less concern corporate issues which need the majority approval from the shareholders—hence in theory, it is the general assembly, not the board of directors who should have the right to order defensive measures. Second, just like the takeover laws of the UK, the Chinese Company Law directly banned certain takeover defences such as poison pills, dual ownership structure78 and so on. Equal treatment of shareholders has become a fundamental principle in Chinese law.79 Besides, the Securities Law had rigorous merit-review requirements80 for the target board to issue shares and bonds, making share repurchase schemes,81 share issuance schemes and convertible securities issuance plans82 impossible to defend hostile takeovers.83 Third, in tender offer regulation and investors’ protection, the Chinese Securities Law has learnt a lot from the Securities Exchange Act of the US; insider trading, market manipulation, false statement and fraud behaviour were strictly prohibited. Chinese Securities Law and the Administrative Rules on Acquisition also have similar information disclosure, and tender offers procedural requirements similar to the William’s Act.84 Disgorgement Statute and share transfer restrictions for corporate insiders could also be found in the Chinese Securities Law.85 Fourth, Chinese law put considerable attention on the board’s fiduciary duty in takeovers. The Administrative Rules on Acquisition requires the directors to

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Tang (2017b), p. 164. 2014 Company Law, Article 98. 78 Id, at Article 126. Some originally-born-in-China companies achieved the ownership structure by re-incorporating in the Cayman Islands and having their IPO either in HKSE or NYSE, for instance, Alibaba. 79 Id, at Article 103. 80 2014 Securities Law, Article 13. 81 2014 Company Law, Article 142. 82 2014 Securities Law, Article 16. 83 2014 Securities Law, Article 22 and Article 24. 84 Administrative Rules on Acquisition, Article 75. 85 2014 Securities Law, Article 47. 77

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“assume the duty of loyalty and duty of care” in takeovers86 The Chinese Company Law explained what “duty of loyalty” is through a series of prohibitive stipulations.87 The Guidelines on Articles of Association has suggested the meaning of the “duty of care”.88 Fifth, the Chinese Securities Law borrowed the Mandatory Bid Rule from the City Code, mandating acquirers reaching 30% shareholding of the target company to send out tender offers, either partial or full, to all shareholders of the target company.89 Sixth, the Administrative Rules on Acquisition borrowed the Board Neutrality Rule from the UK,90 but modified the original one into a less rigorous one. It is the same case with the Selling-out Right91 from the European Directive. However, China’s seemingly comprehensive, particular law is more problematic than thorough, not only did it fail to provide specific answers in inevitable conflicts; it also failed to divide the work clearly between the court and the CSRC. The articles and clauses were contradictive with each other, and the goal of the Chinese law was therefore blurred—should the law give primacy to shareholders protection, or should the law respect the directors of the boards’ business judgement? In summary, it is urgent to amend the present hostile takeover related laws in order to provide certainties for the participants and players in the Chinese capital market.

4.4

Divergence from the UK: China’s MAR Committee

The self-regulation model of the UK has a high impact on the HKEX. Borrowed from the HKEX, the CSRC (Chinese Securities Regulatory Commission) established the Mergers, Acquisition and Restructuring Committee (“the MAR Committee”). China’s MAR Committee was established and modelled indirectly from the UK through HK. We know that the Panel on Takeovers and Mergers in the UK was established on 27th March 1968 based on the City Code. Hong Kong Exchanges learned from the UK Takeover Panel and established the Listing Committee in the Hong Kong Exchanges. The Listing Committee (HK) acts both as an independent administrative decision-maker and an advisory body for the Exchange. It has four principal functions: to oversee the Department (to the extent practicable given the Committee’s mode of operation); to provide policy advice to the Department on listing matters and to approve amendments to the Main Board Rules and GEM Rules; to

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Administrative Rules on Acquisition, Article 8. 2014 Company Law, Article 147. 88 Guidelines on Article of Associations, Article 98. 89 2014 Securities Law, Article 88 and Article 96. 90 Administrative Rules on Acquisition, Article 33. 91 2014 Securities Law, Article 51. 87

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take decisions of material significance for listing applicants, listed issuers and the individuals concerned. These include approvals of listing applications and cancellations of listing and disciplinary matters; and to act as a review body (in its role as the Listing (Review) Committee) for decisions made by the Department and by the Listing Committee.92 Both of them are the model of self-regulatory institutions worldwide. The CSRC established the Issuance Review Committee before the MAR committee. In 1993, The Issuance Review Committee inherently in the CSRC was established. The Issuance Review Committee applies the IPO regulation of the CSRC and vote to decide whether to approve the share issuance applications. The CSRC makes the final decisions based upon the results of The Issuance Review Committee Meetings. The Issuance Review Committee was the rudiment of the MAR Committee. The particular capital market context promoted the birth of the Chinese MAR Committee. The CSRC found that the listed Companies substantially change the assets and business. The listed companies issue new shares with buying the new assets and business from private companies, also called Backdoor Listing. However, no rules were there to cover these transactions that hurt the interests of listed companies and public shareholders. In order to govern the transactions between listed companies and private companies ensuring the fairness to the listed companies, the CSRC stipulated the Administrative Regulation of the Substantially Assets Restructuring of Listed Companies in 2007. At the same time, inspired by the Issuance Review Committee of the CSRC, in about 2007, the CSRC established another committee, i.e. the first session of the Mergers, Acquisition and Restructuring Committee (the MAR Committee). The member of the MAR committees consists of three types. One comes from the government, including the CSRC, stock exchanges, other government departments. The other comes from the intermediaries, including securities firms, Venture Capital, Private Equity, Mutual Fund, lawyers, Accountants, asset evaluators. Moreover, the last one type comes from universities. These members are divided into five groups by the CSRC, convener group, law group, accounting group, institutional investor group and finance group. In each case to be reviewed, five members selected randomly from the respective group would review the case, and vote independently. The application would be approved, rejected or approved with conditions based upon the majority vote of the five members hearing process. The CSRC would issue the final approval resolution based upon the voting results of the Committee. In 2018, the CSRC decided that the membership of the MAR Committee is no more than 40 and the membership from the CSRC no more than 11. The cases that the MAR committee of the CSRC reviews are about the substantial assets restructuring of listed companies, rather than takeovers of listed companies. The difference of them is demonstrated in Fig. 1. Notably, the restructuring of the

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https://www.hkex.com.hk/Listing/How-We-Regulate/Listing-Committee?sc_lang¼en, last visited 26th July 2019.

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Fig. 1 The comparative jurisdiction of the takeover panel of the UK and the MAR Committee of China (Source: The Authors)

substantial assets of listed companies, including two types of transactions. The first type is that the listed companies want to buy new assets and business from a private company and in order to pay, the listed companies would issue new shares, which is so-called the restructuring of the substantial assets of listed companies. The second type is the reverse mergers of the listed companies, which is also called Backdoor Listing and comprises two steps. The corporate control of listed companies changes from old controllers to new controllers through share purchase and in turn, the new controllers sell assets to the listed companies. All those restructuring transactions are friendly, not hostile, which is different from the takeover of listed companies covered by the UK Takeover Panel. We know that “The self-regulating Panel, though a private body performing a public function, ensure its constitutional legitimacy by adhering to the principle of separation of power and principle of a fair trial. There are the Executive Committee (executive), the Code Committee (legislative) and the Hearing Committee (judiciary).”93 However, first, the MAR Committee does not have authority to make rules. It just applies the rules made by the CSRC and decides to approve or reject the application of the listed companies. The Takeover Panel of UK has the authority to make rules about the takeover markets. Second, the MAR Committee does not adjudicate the disputes among acquirers, target companies, board, public shareholders. The Takeover Panel of UK solves the disputes among the takeover markets. Third, the MAR Committee does not have the supervisory authority. Fourth, the primary function of the MAR committee is to evaluate the fairness of the transaction between the listed companies and the counterparties and ensure that the transactions comply with the regulation and rules about the substantial assets restructurings of listed companies. The Chinese MAR committee is an institutional innovation and supports the development of the securities market. First, the MAR Committee consisting of members from the public and private sectors are more professional than the government officials. The MAR committee is diligent. As Table 1 shows, in 2017, the MAR committee have reviewed 144 cases; 2018, 176 cases. On average, the Mar

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Deal Backdoor listing Issuing shares to buy assets Mergers Total Backdoor listing Issuing shares to buy assets Mergers Total

Cases 4 137 3 144 7 167 2 176

1. Approval 4 116 3 123 6 153 2 161

Rate of approval 100% 84.67% 100% 85.42% 85.71% 91.62% 100% 91.48%

Source: Based on the information disclosure of the MAR committee

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Table 1 The case number of the Chinese MAR Committee reviews Rate of rejection 0 12.41% 11.87% 14.29 6.59% 6.82%

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committee would review and complete one case every two working days. Secondly, the MAR Committee can protect the CSRC from the firm pressure of rent-seeking or corruption. There are also some adverse effects of the Chinese MAR committee. Significantly, the Chinese MAR committee fails to achieve the goal of the self-regulation. Rather than, the Chinese MAR Committee is a useful tool for the CSRC. There are many reasons that the government likes it. First, the CSRC has substantial control over the MAR Committee. Who could be the CSRC decides the member of the MAR Committee? The CSRC member of the MAR Committee may have more substantial power over other outside members. Secondly, the MAR Committee serves the regulatory purpose of the CSRC. The MAR Committee has to apply the Administrative Regulation of the Substantially Assets Restructuring of Listed Companies stipulated by the CSRC and comply with the policies of the CSRC. Lastly, the most important is that the MAR Committee can protect the CSRC from the judicial review of the administrative decisions. The MAR Committee is affiliated with the CSRC and does not have independent legal status, although each member can make judgments and vote independently based upon their expertise and judgments. The MAR Committee does not have independent legal status. It is not actionable. Considering the CSRC decisions are based upon the MAR Committee, there is little room for the courts to play if the procedures of the Committee and CSRC are fair. The reasonable choice for the listed companies which fail to get the approval from the CSRC is to modify or revise the transaction proposals and apply again. That is why so many listed companies have been rejected since 2007. Nevertheless, none sues the CSRC in the court for remedies regarding the substantial assets restructuring deals.

5 The Future of China’s Takeover Regulatory Regime: Learned Self-regulation from the UK Experiences Although China securities regulators involve deeply in the market for corporate control, that does not mean that self-regulatory institutions have no role to play in China. Instead, we argue that self-regulatory institutions should play a significant role in the future Chinese market for corporate control. Firstly, the CSRC would tend to be biased in favour of the state-owned listed companies and cannot make neutral decisions regarding the takeover disputes. Secondly, the Chinese courts are slow, inefficient and not professional to handle the takeover cases. Ruling out the two possibilities, we can find out that self-regulation is a viable option for the Chinese market for corporate control, deserved to be considered seriously.

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Optimal Choice of Modes of China: Learn Something from the Self-regulatory Regime in the UK

Law that intends to please every side of the participants, without doubt, leads to uncertainty. Consistency is the foremost merit in hostile takeover regulations. A proper hostile takeover regulation should be consistent and bring certainty to the capital market. Over time, the participants could adjust their behaviours according to the established preference of the law. In order to achieve so, the law has to take sides; more specifically, good takeover law must take sides between the board of directors and the shareholders’ assembly. The US regulatory framework chose the side of the directors, while the UK regulatory framework worshipped the shareholders’ power. The formation of the different original regulatory framework had its historical inevitability. In other words, every incumbent law and system had its uniqueness and unique background. We illustrated that the non-repeatability of the UK’s selfregulatory framework. Pondering that China is a civil law country, the US’s trialdominant mode is also not an imitable option. That leaves the European Directive being the nearest paradigm for Asian countries to learn from the practice of the Anglo-American countries. In above, we demonstrated that the different roles of institutional investors and the contests between different interest groups counted mainly for the nuance of the different regulatory frameworks. In the formation of any law, market evolution and economic appeals are also crucial background factors. Similarly, future China’s hostile takeover lawmaking must consider several local and contemporaneous factors, for example, the relatively short history of China’s capital market, the status quo of large companies’ corporate governance, the aftershock of the share split reform, the practical need to normalize the insurance funds and debt-equity, the call of a nationwide supply-side reform and the sustainable growth of the economy. In China, the corporate governance problem is especially severe compared to its counterparts in the US or the UK The No. 1 corporate governance problem in China is the agency costs because of the controlling block holder and insiders’ control because of no functional proprietor of the state-owned shares. A considerable proportion of shares in Chinese listed companies are state-owned shares. However, the State-owned Asset Supervision and Administration Commission performed severely over the past two decades. As a result, the state-owned largest shareholder as the supervision entity of the management is virtually non-existent; insider control problems are serious as always.94 Moreover, the supervisory board and independent director system functioned awfully in China.95 Due to reduced institutional transplantation, it is almost impossible for the supervisory board to “supervise” the

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management, and independent directors in China are nothing more than “rubber stamps” of the board of directors.96 Under these circumstances, takeover, especially hostile takeover, maybe a cure to Chinese corporate governance, especially when China gradually open its capital markets. In order to sustain growth, the Chinese government adopted the supply-side reform to vitalize Chinese enterprises. As a result, the whole industries are in desperate need of takeovers and reorganizations to better utilize social resources. In other words, a legal framework which facilitates takeovers is more optimal for China. The UK approach in nature better facilitates takeovers than the US approach, from this aspect, China should adopt a “board neutrality rule” centred takeover regime and discard the “fiduciary duty” centred regulatory approach, in order to stimulate takeovers from happening.97 Considering China is not a case law system country, and the UK’s self-regulatory framework is impossible to form through any institutional innovation or reform, Chinese takeover regime could only step by step evolve into an investor-friendly hostile takeover regulatory framework. Initially, China had transplanted its hostile takeover law from the US and the UK. After 15 years of local practice, China had formed its unique regulatory framework (and path dependence) in its semi-market economy. On the one hand, the target board had minimal ex-post takeover defensive measures under the current law; they then introduced various ex-ante anti-takeover provisions into their articles of associations utilizing their de facto controlling powers. The duty of care and duty of diligence in Chinese law was stipulated through a series of positive and negative lists; this parody of the US fiduciary duty failed to provide a comprehensive and fair standard to review the board’s behaviours. On the other hand, facing unruly managements, the acquirers also went wild and frequently broke the bottom line of the Securities Law. Breaches of the tender offer procedural requirements, violations of information disclosure rule and other questionable behaviours are standard practices. Such loopholes came from over-complicated legislations that were vague and obscure. Previous hostile takeover cases illustrated that almost every pending dispute was solved by the China Securities Regulatory Commission’s administrative intervention; the intentions from the “above” have outweighed the substantial law to decide the outcomes of hostile takeovers. With this in mind, it can be seen how actual amendments to the law would be of little to no use in improving the hostile takeover regulations in China. That is why the main priority should be to discard the “CSRC centralism” dependency path. To fulfil this goal, first of all, the Administrative Rules on Acquisition of Listed Companies should make it clear that without shareholder approval, the board of directors should not take any defensive measures. It is not to suggest a blanket ban on all takeover defences, but rather, to allow the shareholders the right of having the final say of adopting ex-post defences. 96 97

Tang (2017c), p. 4. See also Wang et al. (2006). Tang (2017b), pp. 179–182.

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Second, the fundamental rights of shareholders as stipulated in the Company Law should be respected in takeover activities. Shareholders’ right to vote on significant issues, to elect and nominate directors of the board and to call on interim meetings should not be violated by any means. Third, the self-regulation from the Stock Exchange and Securities Association of China should be primarily strengthened. Although the public authority of the CSRC shall not be challenged, the CSRC could delegate more power to the self-regulatory entities to achieve higher supervisory efficiency.

5.2 5.2.1

Make the Self-Regulatory Institutions Work in China The Problems of the Chinese Takeover Law in the Mirror of the UK’s Success

If the US mode is not suitable for China, how about the UK model? The hostile takeover regulatory framework of the UK is a self-regulatory one, which was formed under unique commercial history. The early institutional investors, financiers and bankers of England all used to live in the London city, where they could see each other almost every day in their daily transactions. Being geographically near had brought many conveniences for the formation of the self-regulatory system; these repeated traders in London gradually developed a low-cost way of management for them—reputational penalties among the circle were preferable in the first place than expensive litigations and complicated administrative procedures. Comparably, China does not have such a solid background and long history for self-regulatory supervision; individual investors are still the mainstream participants in China.98 Indeed, as we mentioned in the previous sections, the institutional investors account primarily for the formation of the self-regulatory system. The UK institutional investors were very passive in corporate governance but were extremely active in shaping the law through lobbying and protesting. After several takeover disputes in the 1950s and 1960s, the spirit of “Passive Directors, Active Shareholders” became well trenched in the UK, and this principle was elaborated through shareholder-oriented laws such as the preemptive rights, the prohibition of antitakeover defences and alike. Besides, the Takeover Panel successfully proved its irreplaceability by continually improving itself. Most importantly, other significant industrial associations and commercial groups, such as the Board of Trade, the Council of Stock Exchange, the Association of Unit Trusts Managers, the Association of Investment Trust Companies and alike, consistently supported its back, which helped the Takeover Panel to win the race with the public authority.

98

See Christmann and Taylor (2001).

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This history illustrated that the self-regulatory entities and industrial associations in the UK were at all times more independent than their counterparts in China. According to the Securities Law, there are only two self-regulatory entities of the Chinese securities market—the Stock Exchanges and the Securities Association of China.99 However, in practice, neither the Stock Exchange nor the Securities Association in China has substantial self-regulatory power.100 Let us talk about the Stock Exchange first. Both the Shanghai Stock Exchange and Shenzhen Stock Exchange lack the independence to supervise the market adequately. Historically, the Stock Exchanges were not established by the traders, investors or participants in the securities market; instead, they were established and developed by the government in the first place. According to the Securities Law, the council is the decision-making organ of the Stock Exchanges;101 however, the law allows the CSRC to designate up to half of the council members.102 Moreover, the general manager of the Stock Exchange is also appointed by the CSRC,103 and any revisions to the Stock Exchange Article104 or operational rules need to obtain administrative approval from the CSRC.105 Therefore, the Stock exchange is under the strict control of the CSRC. The self-regulation of the Securities Association of China is even weaker than the Stock Exchange. The former presidents of the Securities Association of China all held positions simultaneously in the CSRC, and approximately half of the council members were appointed directly by the CSRC. Therefore, the Securities Association could not represent the well-being and interests of its members, but the will of the CSRC. Compare with the Takeover Panel, what the self-regulatory entities in China lack the most is the substantial punitive power that could effectively discipline the participants in the securities market.106 The Securities Law did not specify the punitive measures the Stock Exchange could impose when its members broke the rules. In practice, the Stock Exchange could suspend or terminate the transaction deals of misbehaving investors. As for punishments, this severe could trigger turbulence and chain reactions in the market, and more moderate measures are needed. However, except the above severe penalties, all other measures the Stock Exchange could adopt, such as public criticism, are either too light or have no inhibitive effect at all. On the other hand, the Securities Association of China almost have no punitive power at all, it at best has the right to mediate between its members and inspect its members’ activities that may violate its articles of association. Both

99

2014 Securities Law, Article 8, 102, 174. See Jordan and Hughes (2007), p. 205. 101 CSRC. Administrative Measures of Stock Exchanges, Article 22. 102 CSRC. Administrative Measures of Stock Exchanges, Article 23. 103 2014 Securities Law, Article 107. 104 CSRC. Administrative Measures of Stock Exchanges, Article 19. 105 CSRC. Administrative Measures of Stock Exchanges, Article 28. 106 See Wei (2005). 100

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the Stock Exchange and the Securities Association of China lack the investigation power and means necessary to constraint their members’ behaviours. Although selfregulation is not a tradition in the US, the National Association of Securities Dealers could do much more than their counterparts in China.

5.2.2

Pieces of Advice for the Limited Self-regulation in China

Compared with the UK, China lacks the soil of inner-industrial self-regulation. However, this is not to say that limited self-regulation is impossible or not necessary for China. Currently, both the Stock Exchange and the Securities Association of China did not achieve excellent autonomous supervision result, but they both have ample rooms for improvement. There are several things to do in order to improve the self-supervision of the Stock Exchange. First, the law should acknowledge the independent legal person status of the Stock Exchange and stop regarding it as an administrative appendage of the CSRC or the State Council. Currently, the Stock Exchanges are more of a stateowned public institution than independent commercial entity; the CSRC has vertical control over almost all the significant issues of the Stock Exchanges, not to mention it controls the power of appointment and approval firmly. The completely corporate governance structure of the Stock Exchanges should be changed, starting from decreasing the number of designated directors and council members. Also, the Stock Exchanges should be given the right to elect its chairman and vice-chairman. Second, the division of labour between the CSRC and Stock Exchanges should be clear-cut, and the Stock Exchanges should be given more substantial supervisory rights, especially the rights closely related to its members. For example, the right of mediation, the right of investigation and the arbitration right are all extremely crucial for the Stock Exchanges if they want to establish unshakable authority in a selfregulation manner. Moreover, the Stock Exchanges do not necessarily have to obtain approval from the CSRC on issues like amendment of the articles of associations, amendment of its business rule, accepting new members and so on. In these occasions, all that the Stock Exchanges should do is to record and report those changes to the supervisory authority for future possible legal review. Third, there should be more investigation methods and punitive measures available for the Stock Exchanges so that the Stock Exchanges could punish misbehaving listed companies; for instance, a fine penalty is always a better option than having to suspend the trade.107 The autonomous supervision of the Securities Association of China could also be improved in the following ways. First, the law should recognize the Securities Association as an autonomous organization rather than a dispatched institution of the CSRC. The CSRC should avoid administrative interference to the Securities Association, and should only keep the abstinent right of supervision. Second, the

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Sun and Qin (2009).

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Securities Association should be given more duty and rights. Currently, the Securities Association has the right to conciliate in-between its members. It should also be given the right of arbitration, as court trial might be the worst solution for disputes among securities companies. Third, the Securities Association should represent the interests of its members, not the official government. Member-interests-supreme could tie the Securities Association more closely with its members, mitigating the barriers the Securities Association would face when implementing its policies.108 The highest realm for self-regulation is when reputational punishment replaces punitive measures. Maybe, only the UK has reached this condition over its long history. However, for China, even limited self-regulation, should it be useful, could reduce the misbehaviours in the securities market to an incredibly lesser extent than they use to be. Without a doubt, there is a long way to go.

5.3

Empowering the Institutional Investors in China

As discussed above, we illustrated how interest groups such as institutional investors, industry associations, labour unions, large conglomerates and alike accounted for the differences of the takeover regulatory modes between the UK and the U109 Indeed, strengthening the scales and rights of the institutional investors could ultimately push China’s relatively primitive takeover law into a modern one. In contemporary China, the institutional investors in the capital market are securities companies, different types of funds, large enterprises, financial companies, commercial banks and Qualified Foreign Institutional Investors (QFII). The social security funds, investment funds, insurance funds and private equity are relative active funds in the Chinese market, and large enterprises involving in security transactions are mainly state-owned enterprises and listed companies. Chinese institutional investors had undergone three phases. Phase I—the embryonic stage began in 1990 and ended in 1998 when securities companies were almost the only player in the securities market.110 Phase II began in 1999 and ended in 2008. During this period, the government allowed state-owned and state-controlled listed companies enter the stock market, symbolizing the growth of the institutional investors parallel with individual investors. Since December 2002, the State Council began carrying out the institution of Qualified Foreign Institutional Investors, and foreign capitals poured into China since 2004. From October 2004, insurance funds were allowed to enter the stock market.111 Phase III began in 2008 when institutional investors proliferated and formed the prospects as we see today.

108

Sun and Qin (2009). Armour and Skeel Jr. attributed the differences to the different roles of the institutional investors played in the formation of the law. 110 See Li et al. (2009). 111 See Kling and Gao (2008). 109

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The year of 2016 saw a series of hostile bids for old industrial corporations launched by insurance funds in the open market. The Insurance funds were so active that the China Insurance Regulatory Commission put a sudden restraint order on Insurance Funds at the end of 2016. Generally speaking, Chinese institutional investors are not as mighty as their counterparts are in Western countries. Relying on institutional investors to aggressively shape the Chinese takeover law is not possible in the foreseeable future. First of all, in China, individual investors still account for the majority in the stock market, and they are too dispersed to become investment communities. Second, current established institutional investors are not strong enough to form political associations that have the power to lobby the legislators. Third, the market infrastructure and legal supports for institutional investors are grossly inadequate. Currently, the Chinese institutional investors faced several share transfer limit when they want to dump their shareholdings. Psychologies of herd instinct and great fool exert a strong influence on the institutional investors’ decisions, which give rise to myopic behaviours that corrode the market.112 Instead, we should realize that this is not to say that the growth of institutional investors in China is not essential for future lawmaking. The UK experience illustrated that the development and expansion of the institutional investors were the foundation for the improvement of the self-regulatory framework. In light of the UK’s practice, before we talk about how to promote the limited self-regulation under the current regulatory framework, the importance of the institutional investors must be correctly recognized; China must continue encouraging institutional investors to emerge and grow.

5.4

Borrowing Efficiency-Adding Clauses from the City Code

We compared the three original hostile takeover regulatory frameworks of the US, the UK and China. Further, we found that the self-regulatory framework of the UK was of incredibly high efficiency in terms of not only dispute resolution but also legal improvement. The Takeover Panel responds quickly to takeover issues, and the City Code refreshes itself yearly to cope with the needs of the market. Some of the articles in the City Code could primarily increase the efficiency of tender offers and takeovers, which are of great referential value to Asian countries, especially China. Increasing the speed and transparency of takeover activities could help to ease the uncertainties in the market. Rule 30–35 of Section M1–N3 stipulated in detail the timetable for the acquirers in tender offers.113 The acquirer who had the intention of taking over must send out a

112

See Bailey et al. (2009), pp. 9–19. The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part M1–N3, Rule 30–35.

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formal tender offer within 28 days after the announcement of the takeover proposition: “[T]he offeror must, normally within 28 days of the announcement of a firm intention to make an offer, send an offer document to shareholders in the offeree company and persons with information rights, in accordance with Rule 30.2 and must make the document readily available to the trustees of the offeree company’s pension scheme(s)”.114 Most important of all, the target company have the right to ask a potential bidder to either confirm or deny its intention of obtaining corporate control.115 Estoppel is a universal principle in any law system. Once the bidder waived its intention of corporate control, he shall keep this promise for at least 12 months.116 These rigorous articles could ensure that the bidder cannot take advantage of information asymmetry and thereby increase the efficiency of the market.

6 Conclusion It has been 15 years since the first hostile takeover attempt117 In China. From indiscriminately imitating the law from the Western countries to drafting the Administrative Rules on Acquisition concerning the local conditions, this 15-year period marked the rugged path of the slow growth of the Chinese securities market. Despite several amendments and revisions, the Chinese hostile takeover regulatory framework is still insufficient in terms of legislative technique and dispute resolution. Currently, Chinese takeover law has borrowed from the US and the UK. However, this seemingly comprehensive, conclusive regulatory framework has not only failed to provide clear answers in corporate control conflicts, but also exacerbated the internal contradictions of the provisions. In the 15 years of regulatory practise, China has formed the “CSRC centralism” path dependence in its semi market economy. The defects of the law might be temporarily masked in government-leading legal reforms, as the CSRC and the State Council have extreme controlling power over the capital market. However, with the intensification of the hostile takeovers and the prosperity of the market of corporate control, these defects will eventually manifest themselves and even cause disastrous consequences. Even though the old supervisory pattern in China is in urgent need of change; the twenty-first century has seen reforms. The graduate dispersion of shares in Chinese listed companies, the expansion of the institutional investors, and the endless 114

The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part J2, Rule 24.1 (a). 115 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part M1, Rule 30.1. 116 The Panel on Takeovers and Mergers, The City Code on Takeovers and Mergers (12th ed. 2016), Part N1, Rule 35.1. 117 In September 1993, China Baoan Group initiated a takeover attempt of Yanzhong Industrial Ltd, which is the first hostile takeover in China.

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emergence of financial innovation are some of how Chinese regulation began to shift. This research aims to look for solutions in the history and evolution process of the three Western hostile takeover regulatory frameworks and put forth locally applicable suggestions and opinions for future lawmaking. The top priority for future legal reform is to get rid of the reliance of the CSRC in hostile takeover disputes. In order to do so, policymakers must draw lessons from previous attempts, and take contextual factors in China into consideration, such as the economic needs, capital market inertia, supply-side reform and other political appeals. One thing is for sure—the transformation process is going to be long and arduous.

References Armour J, Skeel DA Jr (2006) Who writes the rules for hostile takeovers, and why-the peculiar divergence of US and UK takeover regulation. Geo Law J 95:1727–1794 Armour J, Jacobs JB, Milhaupt CJ (2011) The evolution of hostile takeover regimes in developed and emerging markets: an analytical framework. Harv Int Law J 52:219–285 Association of British Insurers (1995 & Updated 2009) Directors’ power to allot shares and disapply shareholders’ pre-emption rights (UK) Bai C-E et al (2004) Corporate governance and market valuation in China. J Comp Econ 32 (4):599–616 Bailey W et al (2009) Stock returns, order imbalances, and commonality: evidence on individual, institutional, and proprietary investors in China. J Bank Financ 33(1):9–19 Bank of England, Issuing Houses Association, British Insurance Association, London Stock Exchange (1959) Notes on amalgamation of British businesses Benati L (2004) Evolving post-World War II UK economic performance. J Money Credit Bank 36 (4):691–717 Cai W (2012) Hostile takeovers and takeover defences in China. Hong Kong Law J 42:901–938 Carpenter J, Lu F, Whitelaw R (2017) The real value of China’s stock market. Work. Pap., Stern Sch. Bus., NY University Cheffins BR (2001) Does law matter? The separation of ownership and control in the United Kingdom. J Leg Stud 30(2):459–484 Chen J (2014) Legal transplantation theory: a theoretical framework for examining Chinese takeover law. regulating the takeover of Chinese listed companies. Springer, Heidelberg Christmann P, Taylor G (2001) Globalization and the environment: determinants of firm selfregulation in China. J Int Bus Stud 32(3):439–458 Deakin S et al (2002) Implicit contracts, takeovers and corporate governance: in the shadow of the City Code. University of Cambridge Dong M, Ozkan A (2008) Institutional investors and director pay: an empirical study of UK companies. J Multinatl Financ Manag 18(1):16–29 Fox J, Sklar A (2009) The myth of the rational market: a history of risk, reward, and delusion on Wall Street. Harper Business, New York Fu Q (2017) Legal standing of hostile takeover. China Leg Sci 3:227 Garnaut R et al (2014) Private enterprise in China. ANU Press Goergen M, Luc Renneboog (1998) Strong managers and passive institutional investors in the UK. SSRN: 137068 Huang RH (2005) China’s takeover law: a comparative analysis and proposals for reform. Delaware J Corp Law 30:145–198 Huang RH (2013) Private enforcement of securities law in China: a ten-year retrospective and empirical assessment. Am J Comp Law 61(4):757–798

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Disclosure Rules in Takeovers: Making Sense of Fragmentation in German Law Maren Heidemann

Abstract Disclosure rules serve the acquirer to prepare a formal bid or acquisition and the formation of the price. Financial markets regulators have a range of interests in receiving accurate data from listed and unlisted companies and other market players. Presently, legislatures also seek to react to inbound foreign investment reflecting a perceived need to protect domestic industry from foreign takeovers. This involves a flurry of problems ranging from policy formulation to implementation and application of the relevant rules. In this chapter, the author argues that German takeover law suffers from historic fragmentation and a poor formulation of industrial policies and legislative objectives. She suggests a method of reorganising the methodology of legal classification of such rules in four layers. The chapter explains these issues by drawing on a prominent recent example of inbound foreign investment as well as an industrial scandal, both testing the current legislative landscape in Germany.

1 Introduction Traditionally, the law relating to takeovers of public limited companies through acquisition of their listed stocks is classified according to the dichotomy of private and public law. Regulatory law is expected to be public law and classic commercial law is generally regarded as part of the private legal order.1 This classification also

Dr Maren Heidemann is Associate Research Fellow at the Institute of Advanced Legal Studies, School of Advanced Studies and Visiting Lecturer at the Centre for Commercial Law Studies at Queen Mary, University of London. Assessor Iuris (Germany), PhD, LLM (Nottingham). She is also a director of The London Centre for Commercial and Financial Law, London. 1 See for instance Oetker (2019), p. 9. This may look distinctly oversimplified when considering the historic evolution of commercial law, see for instance Horn (2005). Nevertheless, academic debate

M. Heidemann (*) University of London, London, UK e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_5

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entails a distinction as to the types of enforcement mechanism that can be used to give effect to each of these rules. Rules of a public law nature are commonly enforced by public authorities while those of a private law nature confer enforceable rights, usually of a contractual or monetary nature, to contractual partners, tort victims or third parties. Public authorities have a wider choice of enforcement mechanisms at their disposal than private parties have. They can for instance impose penalties, withdraw licences and prevent or reverse transactions which are found to infringe regulatory norms. The mere descriptive and academic application of this dichotomy post factum to the lex lata is often not sufficient in modern financial and securities market law, however, to achieve effectiveness of regulatory norms and give market participants clarity regarding their rights and obligations.2 It is therefore attempted here to highlight some flaws that have accumulated through several rounds of reform—often prompted by updated EU legislation—with a view to contributing to academic debate on future reform taking a more structured and comprehensive approach. This paper therefore describes the German rules relating to takeovers according to an alternative and more diversified classification in four layers. These four layers are distinguished by their aims and objectives which the rules created within them are meant to serve and achieve. The aims and objectives pursued by the rules in question range from the protection of individual interests at one end to serving the public interest at the other.3 It is submitted here that a lack of clarity as to the nature of each rule at the point of legislative conception leads to unnecessary confusion and subsequently to a negative public perception of this area of market activity as well to avoidable transaction costs. This phenomenon in the specific context of German law is explained using two recent examples from the German business world which attracted high media interest and led to a re-evaluation of existing laws by the courts and the regulator. The first example is the case of the emissions manipulation by German car maker Volkswagen (VW).4 The second example is the acquisition of just under 10% of the shares in German car maker Daimler by Chinese businessman Li Shufu and his car maker company Geely.5

has focussed more on the distinction of commercial law from general civil law than on the role of the public/private dichotomy in this area of law. See on this also Heidemann (2016). Petra BuckHeeb emphasises the interlaced nature of German capital markets law in particular with rules of a civil, public and criminal law nature, see Buck-Heeb (2014), p. 7. 2 See on this Andenas (2018), Cherednychenko (2015), Deipenbrock (2018a), Bridge and Braithwaite (2013). 3 See Buck-Heeb (2014), pp. 3–7, 14. 4 See below Sect. 3. et seq. 5 See below Sect. 5.

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Complexity

The law regulating securities in Germany is spread over a number of enactments and therefore not easily appreciated at a glance. Other than in the UK, there is no compact legislation such as the UK Financial Services and Markets Act 2000 or the UK Companies Act 2006.6 Instead, the German rules governing securities and financial markets can be found in the general civil code, the Buergerliches Gesetzbuch (BGB), the general commercial code the Handelsgesetzbuch (HGB), the stock corporations act, (Aktiengesetz, AG), the stock exchange act, (Boersengesetz), the securities act, (Wertpapierhandelsgesetz, WpHG), the securities acquisition act (Wertpapiererwerbs- und Übernahmegesetz, WPÜG), the stock market admissions regulations (Boersenzulassungsverordnung, BoersZulVO), the prospectus regulation, (Prospektverordnung) and many more.7 Disclosure rules in particular are to be found in all of these laws and also in the publicity act (Publizitaetsgesetz, PublG). They consist of reporting, publication and notification obligations some of which are enforced by way of criminal law sanctions as contained for instance in §331 et seq. HGB as well as in each of the above.8

1.2

Evolution of Regulation

Historically and functionally, the rules governing disclosure and takeovers of public limited companies have arisen from both national legal traditions as well as from European Union (EU) regulatory law. Directives and regulations adopted by the EU had to be implemented into domestic German law. In this way, a degree of uniformisation has been achieved across the whole of the Common Market that EU member states share. The so called passporting or single licence effect (as part of the capital market union) has been achieved by this method of legislation where stock companies can list their shares on all EU stock exchanges using only one licensing procedure in their EU country of choice.9 However, the fact that the listing rules are similar or identical in each EU country does not mean that there is exactly the same legislation in each jurisdiction.10 Therefore Germany has continued to maintain its complex web of legislation where each rule has to be detected by the user in its ‘natural habitat’ as described above. This will pose an additional hurdle to foreign investors when compared to UK law with its more compact legislative (statutory) tools in this area of law. It is also a source of potential misconception, 6 See for a concise overview of UK law in this area Moore and Petrin (2018), especially Chapters 3 and 10 on takeovers. 7 An extended overview can be found in Buck-Heeb (2014), pp. 7–14. 8 See below Sect. 3.1 for more detail. 9 See below Sect. 3.2. 10 See further below Sect. 1.3.

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misinterpretation and misapplication of the rules ex ante and ex post by investors, their advisers, regulators and the courts as explained in this chapter.

1.3

The Area of Takeover Laws

The law relating to corporate takeovers also operate of on all four of these levels. It is not sufficient to look at only a section of them, such as the EU derived laws only, in order to describe the transaction performed in a takeover fully from the point of view of a legal adviser or scholar. The full range of legal aspects covers contractual issues as well as corporate governance decisions but it will also require engagement with public regulatory laws in employment law as well as competition law for instance. This chapter does not seek to cover all these aspects fully. Aspects of competition law are covered elsewhere in this book.11 The EU has legislated extensively on this issue and on other stakeholder interests within takeover laws. The result is of course that there are similarities in all EU Member States’ (MS) laws, so that some of the issues covered here may be found in other European jurisdictions.12 However, as far as the EU has acted in the form of directives, leeway remained for the MS to implement the new rules into their existing domestic laws according to their preferences. This means that in Germany, for instance, the general ‘blueprint’ of fragmentation in this area of law has remained. As described above13 the relevant legal rules are scattered across a number of codifications but still have to be read together as governing one and the same transaction.

2 Layers of Regulation Counteracting the above described development, I propose to distinguish four layers of regulation—two in private law and two in public law. Each one of the rules relating to disclosure in connection with a takeover or significant acquisition is intended to operate on a particular level of regulation. These levels can be distinguished by their specific aims and objectives. Rules of private and public law, contained in these layers can further be distinguished by the enforcement mechanisms available for each of them, as mentioned above.14 So, what are these layers, aims and objectives? Traditionally, rules of private law have been designed to ensure the functioning of the market as a whole. The regulator wants to preserve the market for the traders

11

See Cole in this volume. See Meijers in this volume. 13 Section 1.2 above. 14 See above Sect. 1. 12

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using it. Self-regulation also contributed to this through large parts of history. This type of regulation is not necessarily derived from typical state acting in the traditional forms of prescriptive public law. The aims of this general type of market regulation are transparency, truthful representation of commercial facts and generally integrity in order to keep the market place usable and attractive for merchants and customers. In this sense, there is certainly a public policy both supporting and driving this objective, that of the functioning and success of a state’s national economy.15 Self-regulation (or self governance) is typical for a so called market economy as opposed to other forms of economic acting as explored in the twentieth century, such as a planned economy based on the absence of private property. This type of basic market regulation through private law often occurs spontaneously and has an ability to determine the equilibrium among the market actors. Where these rules are breached or ignored, market distortions can occur, be it on a small or large scale. An example is the great stock market crash of 1929 in the US and the ensuing world wide economic depression.16 This is not the only but possibly the most devastating example of the self defeating potential of a market place left to its own devices.17 It shows clearly where the public and political regulator has its place and its function. Public regulators in the EU have been particularly active to counteract the effects of the 200718 and 200819 events and ensuing economic crisis which was also triggered by persistent disregard of rules of commercial savvy and caution, some resorting to downright fraud (such as in the case of Enron)20 or simply ignorance and incompetence such as the handling of the subprime mortgage derivatives by bankers worldwide. So, regulators ramped up prudential regulation, such as increased minimum capitalisation of banks, higher diligence levels in regard to financial products and staff training as well as disclosure and reporting.21

15

Buck-Heeb (2014), p. 3. The events are being referred to as “Black Tuesday” after the stock market crash beginning on Tuesday, 29 Oct 2019 at the New York stock exchange leading to panic selling and ensuing total loss of value to the extent of over 400 billion dollar in today’s money. See also below Sect. 3.2. 17 A lack of relevant regulation had been one cause for this catastrophic event which led to a world wide economic crisis which itself supported political instability and unrest in Europe which is considered to be one cause of World War II. 18 The Northern Rock crisis, triggered by a mishandling of derivative financial instruments based on so called subprime mortgages taken out by customers on properties predominantly situate in the US. 19 The collapse of Lehman Brothers. 20 See below. 21 These changes were agreed by a number of regulators including the “Basel Committee” and the Bank of International Settlement (BIS) in Basel, Switzerland, who adopt the “Basel Accords” on a regular basis in a traditional form of transnational industry self regulation. The EU had reformed its regulatory framework establishing the European System of Financial Supervisors (ESFS) consisting of three sectoral supervisory bodies at EU level, the European Securities and Markets Authority, (ESMA) according to Regulation (EU) No 1095/2010; the European Banking Authority (EBA) according to Regulation (EU) No 1093/2010 and the European Insurance and Occupational Pensions Authority (EIOPA) according to Regulation (EU) No 1094/2010. 16

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At this point, the aims, objectives and legal nature of regulation become less easily distinguishable and complexity takes hold. We can distinguish two effects of market distortion: on the one hand, private actors (investors and merchants) damage themselves and their interests by disregarding and violating the market order and market rules. On the other hand, the effect reaches beyond those market participants and affects the general public as an object of state responsibility. The state regulator then finds itself in a multi-functional role which may be impossible to neatly keep apart so that the resulting rules of regulation serve multiple aims in blurred categories. This is how the perception of a disintegrating free market can arise where businesses feel stifled by over protective regulators while at the other end of the spectrum customers may even wish for more state based assistance and protection in dealing with anonymous overbearing businesses in the modern global mass market.22 In this perception, the traditional assumption of free and equal market participants acting within the parameters of contract law may not hold water any longer.23 The state regulator always serves both the market players and the wider public. Therefore, its regulation is enabling and restrictive at the same time. This oscillating nature of state emanating regulation, in both domestic and EU regulation is most visible in the enforcement of these rules. Private actors often find themselves without a remedy for the breach of such rules in respect of their contractual counterpart of a financial transaction. This is so because often, the rules of prudential regulation and conduct rules have been designed with only the relationship between regulator and regulated business in mind, not with the relationship between the business and its client, i.e. the private law based end of the commercial activity.24 This is a typical scenario arising from legislative activity without the necessary reflection on the role of such regulation within the market place.25 Examples can be found in EU regulation such Art 35 (a) of the EU Credit Rating Agencies Directive26 and information duties in the Markets in Financial Instruments Directives as well as the Transparency Directive.27 Traditional private law rules of tort or delict do not provide enough protection to clients, business partners and third parties in financial and capital markets due to the difficulty in attributing damage to a particular behaviour by the business subject to a particular rule of regulatory law (to prove causation).28 Private

22

See further Alexander et al. (2018). Tilman Repgen has reflected on this problem extensively in his analysis of the creation of the present German civil code adopted in 1900, Repgen (2001). See also Bydlinski and MayerMaly (1994). 24 See on this in the area of EU banking regulation and business conduct rules Andenas (2018); Della Negra (2020). 25 This phenomenon is often exacerbated by the choice of legislative organ as in the case of EU institutions with their limited treaty derived competences as opposed to state legislatures who have a full range of options as to how best to approach a given problem. 26 VO (EU) Nr. 462/2013. 27 See on this in detail Deipenbrock (2018b), Andenas (2018), Cherednychenko (2015), Veil (2014). 28 Buck-Heeb (2014), p. 7. This difficulty is due to the nature of the regulations which constitute a general duty, not a specific duty of care towards the individual as well as the nature of the capital 23

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law in the area of securities law uses other tools which are more closely tailored to the interests of the right holders and the nature of the rights acquired. As a typical rule, §44 WpHG provides for a ban on exercising voting rights arising from acquired shares if the prescribed notification duties are not met. Monetary compensation comparable to tort liability arising from shareholder s’ fiduciary duties or the corporate contract is not at the forefront of remedies in this area of law.29 This is due to the close vicinity and intermingling of corporate governance rules and the rules governing securities and financial products.

2.1

Layer 1

The first layer has already been mentioned above. This is a private law layer which aims to protect the market place as a whole. Its object is the market place and its aim the integrity and stability of the market as a place for trading. Rules in this layer have often evolved over many centuries and have often morphed from private self regulation into formal legislation such as the rules contained in the general civil code or the commercial code of a country.30 A lot of rules can be counted into this type of legislation including rules governing the sale of goods, such as rules about quality standards of goods and related remedies for defective performance. Enforcement mechanisms are indispensable for the functioning of the markets, too, in order to provide a level playing field where an orderly exchange of goods and services can take place, and most importantly, genuine price formation will occur.

2.2

Layer 2

The second layer consists of another type of private law rules—rules which actually constitute a market player or a marketed product. Rules governing corporations as well as rules governing financial products, securities and payment methods form part of this layer. Again, while these have properties that might be assigned to the public legislator many or most of these rules have also been formed over centuries and have often arisen from merchant custom and only been formally adopted and enacted as

market (price formation) and its double function in corporate law and financial markets law. The German supreme court, Bundesgerichtshof (BGH) has accepted that a breach of information duties can lead to liability under §826 of the civil code (BGB) where the intentional or reckless infringement of a regulatory norm constitutes an immoral act, see e.g. the decisions in BGHZ 160, 134 and 149 (“Infomatec”); BGH NJW 2005, 2450 (“EM.TV”) and BGH WM 2007, 486 (“ComROAD III”). 29 See for instance a recent decision of the German Federal Supreme Court on acquisitions of private limited companies: BGH 6.11.2018, II ZR 199/17. 30 See Oosterhuis (2018), D’Alvia (2018).

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public legislation in (continental) civil codes or special statutes such as the UK Companies Act 2006 typically within the past 150 years.31 Commercial registers support the operation of this layer of law. Companies are actually creatures of law and more specifically of national law.32 Financial products are also largely created by rules which both enable and limit their reach and function within the market place. These rules are primarily needed to protect the market participants and regulate their interaction with each other.

2.3

Layer 3

The third layer is a layer of public law rules or rules in the public interest. It is arguable that rules in this layer may even be identical to layer 2 but play a different or additional role.33 They may be designed by private market participants to protect the integrity of the market but at the same time fulfill an important function beyond the individual contract between merchants or providers and their clients or customers. As was mentioned above, the integrity of the market is a value itself and is considered to constitute a public good by Western legislatures. This is one of the aims and objectives of competition law for instance. Competition is a defining characteristic of the marketplace and its preservation therefore equals upholding the markets themselves. Competition rules, however, serve both the market players and the wider public who benefit from intact markets as cornerstones of Western market economies. Rules about fair competition, the avoidance of collusion in price building (prohibition of cartels) and the avoidance of the abuse of a dominant market position are essential ingredients of sustained success of individual competitors but at the same time require an umpire and a regulating force to enforce them. It is therefore not always straightforward to define the nature of competition rules as public or private. In the EU, however, enforcement of competition rules is clearly allocated to the public sphere and state acting.34 In the US, private enforcement35 together with criminal law provide this infrastructure regulating the markets.36

31

See on this Oosterhuis (2018). See Andenas and Wooldridge (2009). 33 Some consider that such rules may be subject to a so called split interpretation according to their ‘split’ legal nature as Petra Buck-Heeb explains, Buck-Heeb (2014), p. 15. 34 Through the EU Commission and the national competition authorities. 35 Through the distinctive civil litigation channels such as class actions and punitive damages. 36 See comprehensively on this Furse (2012). 32

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Layer 4

The fourth layer displays rules which are more clearly of a public law nature and serve public aims and policies. These objectives regularly go beyond contractual business parties’ interests and aim to benefit the public as a whole in the long run. Examples are the stability of a currency, the growth of the “Gross Domestic Product” in order to build a strong state budget to be able to pay for social and public services, increases in jobs and tax revenue. Other policies may be more explicitly pursuing specific industrial policies such as building an independent national energy sector, controlling inbound foreign investment, decreasing dependency on imports, achieve cleaner air, promote certain domestic industries such as coal mining, steel, cars, electronics, or promote innovation, expand the military sector and so forth. It is easy to see that the range of these public policies are not only rather random and susceptible to fashions and changing times but also bear a strong potential of impacting on the markets and distort them and in this way possibly even achieve the opposite of the rules in layers 1, 2 and 3.

3 The Layers in Context In practice, these layers are often not identified by users of the law and sadly even by regulators. Commentators often argue exclusively within the traditional public/ private dichotomy of law and fail to see the penetration of the traditional law merchant which is clearly private law with public law derived rules and the effect thereof.37 These latter ones can be better described using the more sophisticated system of layers suggested here. Where market distortions and failed application of the rules happen, the resulting perceived injustice increases the detrimental effect both on the markets themselves and onto the perception of the law and its users. A recent and indeed ongoing and current example is the scandal triggered by the discovery of manipulation software in diesel engine cars by a number of car manufacturers in the US and the ensuing prosecution and private litigation. This affair offers the opportunity to appreciate the applicable legal rules in their different layers and how they disappoint users. In a latest development, a German court dismissed the joint damages claims by a group of Volkswagen (VW) diesel car owners for the breach of the rules governing emissions standards. The court found that the company (VW) had not breached any rules which were meant to protect the car owners, the buyers of those wrongly labelled cars.38 This decision reinforces an

37

See for instance Oetker (2019), p. 8. See also generally Brinktrine (2010). A supreme court judgment in these cases has not yet been reached because the disputes have eventually mostly been settled. Arguments were based on contractual rights and established case law on misrepresentation rather than on defective performance. See Oberlandesgericht (Upper Regional and Appeal Court) Bamberg – 6U 5/17 – decision of 20 September 2017. 38

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important doctrine in German law. It is called the Schutzzwecktheorie, a doctrine that asks who or what is a rule meant to afford protection. This doctrine has its main origin and function in administrative and constitutional law.39 But it also constitutes the barrier between the above mentioned regulatory rules and the private actors in the market place in rules of the levels 2, 3 and 4. Parties affected by the breach of those rules of regulation cannot rely on the very rules to recover the loss suffered from such breach because the rule was not intended to protect them, the Schutzzweck der Norm. This begs the question of whom or what the rule was in fact intended to protect. Many regulatory norms are intended to serve the “greater good” in general, such as the integrity of the market, the environment. They define an exclusive relationship between the regulator and the regulated business, not between the business and its customer. These are public goods and public policies as described above for the rules in layers 2,3, and 4. It is not always obvious though which rules belong to which one of the above described four layers. Some are open to interpretation in more than one way. This is of course done by the courts in each case. If a rule can be understood to operate in several of these layers, or if it is even designed to be ‘multifunctional’ there is room for legal uncertainty and misunderstanding. It is then up to the courts to specify exactly what the rules are supposed to protect. A well explored area of this legal phenomenon is so called private enforcement of competition law within the EU. A more recently emerging field is the private enforceability of norms of EU financial regulation. Here, the above described discrepancy between the remedies available to private parties and those that can be meted out by regulators is acutely felt in cases where regulatory norms are breached. In the specific context of German law, this difficulty can be illustrated by way of the example of the recent emissions litigation. In these cases, rules of public law used to issue licences to car manufacturers are sought to be relied on by private purchasers of cars which were fitted with illegal software to downplay the amount of pollution caused by the engines. The private parties sought to claim damages or rescind contracts, relying on the rules relating to defective performance, such as § 434 (1) second sentence, No. 2 of the German Civil Code (BGB) against the car manufacturers and car dealers. The German federal supreme court (Bundesgerichtshof, BGH) issued a decision in January 2019 in case VIII ZR 225/17 stating that it is the court’s legal opinion that a breach of the emission rules constitutes a defect of the car. This was in spite of the fact that the above mentioned EU regulation does not protect the individual buyer but serves the completion of the EU Single Market.40 The defendants had argued that no rule was breached that was intended to protect the buyer.

39

It could be understood to serve as a kind of limitation of state liability. See BGH Decision of 8 January 2019, VIII ZR 225/17, available at http://juris.bundesgerichtshof. de/cgi-bin/rechtsprechung/document.py?Gericht¼bgh&Art¼pm&Datum¼2019&nr¼92892& linked¼bes&Blank¼1&file¼dokument.pdf (last accessed 21 March 2019). The reason for this conclusion is the fact the licensing authority is entitled to revoke the licence of the car at any point due to the breach of emission rules—a device which had been installed in contravention of Art 5 (2) first sentence of Regulation 715/2007/EC—which renders the car unfit for the contractually agreed purpose. Cf. section I Lit. 1 (c) of the underlying judgment of the Regional Court in 40

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Prior to this decision, however, claimants have successfully relied on rules of contract law eventually, invoking unconscionability rules.41 This area of litigation demonstrates well the closeness of public regulation and private law and the difficulty to argue successfully in favour of an aggrieved private party where the damage arises out of the breach of a norm of public law.

3.1

Disclosure Rules in Layers 1 and 2

In a planned takeover, the first items of disclosure an interested party or enterprise would look for in its target would be those documents that are published and disclosed periodically, such as the annual statements and reports. Public limited companies have a duty to publish their balance sheet once a year in addition to other annual reporting duties. These rules are contained in the German Commercial Code (Handelsgesetzbuch, HGB) as well as in the Stock Corporation Law (Aktiengesetz, AktG) and the Publizitaetsgesetz (PublG). According to §325 (2) HGB the relevant reports have to be published within the calendar year following each business year to be reported on. The audited reports are to be submitted in electronic form to the Federal Gazette, the Bundesanzeiger, §325 (1) 2nd sentence HGB who will publish the information. For public limited companies §§ 150 et seq. of the AktG contain the specific content and structure of the annual operational and financial reports and the non-financial report according to the ‘soft law’ (non-binding) corporate governance code (§ 161 AktG).42 Non-compliance with the reporting duty is a criminal offence under the German Commercial Code (HGB) which carries a prison sentence of up to 3 years or respective fine according to §§331-333a HGB. §400 AktG complements the HGB rules as a lex specialis. Breaching the rules relating to publication of the annual reports carries a fine and constitutes an offence, §§334-335 HGB. The fines are more severe if the company in breach is stock market listed or “capital market oriented” according to §264 lit. d HBG. In this case, the fine can be up to two million

Bayreuth, LG Bayreuth 21 O 34/16, available at https://files.vogel.de/infodienste/smfiledata/1/0/3/ 7/.../191127.pdf, (last accessed 21 March 2019). 41 See Regional Court of Cologne, judgment of 12 April 2018, Az. 24 O 287/17 damages paid upon return of the used car relying on §826 BGB confirmed on appeal by Upper Regional Court OLG Cologne with decision of 3 Jan 2019, Az. 18 U 70/18 available at https://www.justiz.nrw.de/nrwe/ olgs/koeln/j2019/18_U_70_18_Beschluss_20190103.html (last accessed 21 March 2019). See also judgment of 14 Nov 2018 by the Regional Court of Augsburg Az. 021 O 4310/16 where for the first time the buyer was granted a right to return the car for a full replacement of the purchase price with interest and no deductions were made for the actual use of the car. Text of the judgment available at http://www.gesetze-bayern.de/Content/Document/Y-300-Z-BECKRS-B-2018-N-33801?hl¼true& AspxAutoDetectCookieSupport¼1 (last accessed 21 March 2019). 42 This rule is operated on a ‘comply-or-explain’ basis.

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Euros (§334 (3) No.1 HBG) or double the amount which was gained (or loss avoided) by way of the breach, (§334 (3) No.2 HBG).43 The Publizitaetsgesetz (PublG) extends these reporting and publication duties to enterprises which reach a certain threshold in their balance sheet, turnover or number of employees for three consecutive years, §1 and § 9 PublG. This serves to counterbalance the selectiveness resulting from the traditional attachment of the reporting and publication obligations to certain types of companies in the HGB. Enterprises of a certain size are thereby forced to publish their reports even though they would not have to do so under the general rules of the HGB. These rules serve to give participants in the market an opportunity to inform themselves about potential business partners (e.g. suppliers or customers) and of course potential investors, i.e. lenders to carry out due diligence tests ahead of investment decisions. We can highlight here public limited companies because these will be typically subject to takeovers carried out by purchasing shares. Private companies usually prevent takeovers by adopting respective clauses in their shareholder agreements which restrict the fungibility of the shares or other interest in the company. Private companies typically exclude third parties from entering the company by clauses relating to inheritance, bankruptcy and sale or pledge of a shareholder’s interest in the company. Public companies, by contrast, seek to benefit from funding opportunities that fungibility and stock market trading of its shares provide. This entails the risk that the company will become a victim of its own success and be bought up leading to a change of the original owners or controllers of a company. The objective of disclosure rules on this regulatory layer is to provide a sound investment. Layer 2 serves to actually establish material properties of a public limited company. Filing and publication of information in the commercial registers actually incorporates this type of company and establishes limited liability. It also establishes the fungibility of the shares and makes them a commodity. The relevant vehicle to do this is the domestic commercial register.44

3.2

Corporate Governance and Capital Markets at the Interface Between Private and Public Interest: Disclosure Rule in Layers 3 and 4

In a second step, shares in public limited companies can be listed at stock exchanges and traded freely. This makes them a financial instrument in addition to a fungible asset. In order to list its shares, the company will have to disclose more information in a compact way to provide a prospectus. Prospectuses in Germany are subject to EU regulation which has been emulated in German law. The 43 See in detail Veil (2014), chapter 4, who gives an overview of scholarly debate on the subject of enforceability and liability for breaches of the disclosure rules. 44 See on this Heidemann (2019).

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Wertpapierprospektgesetz (WpG) contains most of the rules about what needs to be disclosed in a prospectus. The actual listing is then subject to the listing rules of the stock exchange where the titles are to be listed. Germany has a general stock exchange act, the Boersengesetz (BoersG) as well as the Boersenzulassungsverordnung, (BoersZulV), the stock exchange admissions regulations containing the detailed listing rules. Due to the creation of the single market and the integrated capital markets across the European Union, once a German public limited company is listed at one stock exchange in an EU member state, the shares can be listed at any of the other EU country’s stock exchanges without having to undergo more listing applications. This is called the passporting system.45 A third factor subject to disclosure is the ownership structure of any company. This is where corporate governance law meets capital markets laws. Private companies and partnerships must file changes to their ownership structure with the commercial register. In the case of public companies, accumulations of ownership have to be disclosed. If shares are concentrated in the hands of one investor to a certain degree, this has to be disclosed and notified in the prescribed way. Again, there is a distinction between the corporate governance rules and specific rules serving the financial market: Under §20 AktG accumulations of 25% of the share in a public limited company in the hands of an enterprise has to be notified to that company. § 20 (8) AktG clarifies the relationship of this rule to §33 WpHG which governs securities traded in the organised financial market. Under §33 WpHG various thresholds have to be notified to the regulator and published in the companies register.46 §33 WpHG reads: Mitteilungspflichten des Meldepflichtigen; Verordnungsermächtigung (1) Wer durch Erwerb, Veräußerung oder auf sonstige Weise 3 Prozent, 5 Prozent, 10 Prozent, 15 Prozent, 20 Prozent, 25 Prozent, 30 Prozent, 50 Prozent oder 75 Prozent der Stimmrechte aus ihm gehörenden Aktien an einem Emittenten, für den die Bundesrepublik Deutschland der Herkunftsstaat ist, erreicht, überschreitet oder unterschreitet (Meldepflichtiger), hat dies unverzüglich dem Emittenten und gleichzeitig der Bundesanstalt, spätestens innerhalb von vier Handelstagen unter Beachtung von § 34 Absatz 1 und 2 mitzuteilen. (. . .) (Section 33 Notification requirements applicable to the party subject to the notification requirement; power to issue statutory orders (1) Any party (the party subject to the notification requirement) whose shareholding in an issuer whose home country is the Federal Republic of Germany reaches, exceeds or falls below 3 per cent, 5 per cent, 10 per cent, 15 per cent, 20 per cent, 25 per cent, 30 per cent, 50 per cent or 75 per cent of the voting rights attaching to shares belonging to that party by purchase, sale or other means must notify this to the issuer and simultaneously to BaFin

45 46

According to §17 of the Wertpapierprospektgesetz (WpPG). §40 WpHG. See also below Sects. 4 and 5 for more detail.

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without undue delay, and at the latest within four trading days, in compliance with section 34 (1) and (2).) (. . .)47

For whose benefit are these rules? As described above, the foremost and oldest objective of disclosure rules is to provide a level playing field and a basic reliability of the information given to the market place for the sake of its integrity. Meaningful commercial acting is only possible if there is a basis of good faith in merchants and truthfulness in book keeping and accounting.48 Merchants have been operating on this unwritten basis for centuries even where no state legal system was present to protect them. However, events which occurred during the last century have brought the fact home that the private dealings of merchants can have effects on such a large scale that state intervention became necessary in a growing and constantly evolving way. The 1929 stock market crash in the US can certainly be described as the mother of all modern crises as well as the mother of our modern system of capital markets law. The tension between self regulation and public governance was increasingly exacerbated by the events leading up to the 2002 Worldcom49 and Enron50 scandals which were followed by the 2007 sub prime mortgage crisis and subsequently the 2008 crisis which cost the investment firm and bank Lehman Brothers its existence. Globalisation led to worldwide effects of these spectacular market failures. Especially the sub prime crisis had shown that prudent self protection of the market players could no longer be taken for granted. Factors such as a lack of staff training, so called short-termism, employment culture51 and generally a tendency by banks to engage in risky business which eventually triggered a general and prolonged banking crisis. Long established self-governing mechanisms such as practiced by the central bankers issuing the Basel Accords52 no longer seemed sufficient to guarantee minimum standards in the EU but also in world wide financial markets. States assumed their responsibility to ensure the welfare of their citizens by engaging in

47 Quoted from the English version of the German Securities Trading Act as published by BaFin available at https://www.bafin.de/SharedDocs/Veroeffentlichungen/EN/Aufsichtsrecht/Gesetz/ WpHG_en.html;jsessionid ¼5831AFCE61BB352696FD170F1CE42687.1_cid390? nn¼8379954#doc7856864bodyText39 (last accessed 2 Aug 2019). 48 See Oetker (2019), p. 7. 49 See Tran (2002). 50 The facts can be reviewed at a glance on the news website of the BBC: BBC News (2002) and CNN: CNN (2019). 51 Excessive bonus payments, a hire-and-fire-culture, lack of oversight were all made out to be reasons for spectacular failures such as the demise of Barings Bank and the sub prime mortgage crisis which started with the crisis of the British bank and building society Northern Rock in 2007. 52 The Basel Accords are guidelines, recommendations of good governance and a transnational industry standard in the financial sector adopted by an international committee of central bankers (the Basel Committee) meeting periodically at the Bank for International Settlement (BIS) in Basel, Switzerland. The guidelines are an example of industry self governance and have acquired an increased significance in the wake of the financial crisis of 2008 informing regulators, especially in prudential regulation for banks. The relevant set of principles is referred to as “Basel III”. The text of these as well as the history of the Basel Committee can be found on the Committee’s website https://www.bis.org/bcbs/history.htm. (last accessed on 28 July 2019.).

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policies to support stable currencies and the prevention of further market failures. The integrated European financial market architecture of the present day is one of the results. This system of EU wide market organisation in the capital markets is designed to provide opportunity but also to uphold standards of transparency, compliance and organisation. As can be seen from this, the current system of capital markets law consists of a complex web of rules which have been derived from a number of legislatures (EU, international organisations, domestic) and traditions. Basic and traditional disclosure rules such as accounting and reporting standards are enforced by way of typical state reserved means including criminal law. False accounting and reporting amounts to a criminal offence according to §§331 et seq. HGB and in respect of public limited companies according to §400 AkG. Offenders can receive prison sentences of up to 3 years or 5 years in more severe cases. Equally sanctioned is the divulging of trade secrets or certain confidential information. The HGB is thereby setting a limit to disclosure. It delineates both sides to disclosure, desirable and undesirable disclosure, striking the balance between transparency on the one hand serving the market and a loss of control by the business owner on the other, or a type of predatory intrusion into the private business sphere and interference with legitimate private commercial interests. Due diligence and a duty to observe confidentiality is also ensured by way of §§ 21 and 22 WpHG which also regulate the procedures for the routine reporting of ongoing trading of financial instruments to the supervisory authority which in Germany is the Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin), § 4 WpHG. Any interested party in a takeover of a target company will therefore study the publicly available information in the first place which is the result of the above described general disclosure duties. Part of this information is also collated and provided by credit rating agencies. These, too, have been subject to stricter and more comprehensive regulation in the wake of the 2008 crisis. The EU adopted Regulations CRA-I (VO (EU) Nr. 1060/2009), CRA-II (VO (EU) Nr. 513/2011) and CRA-III (VO (EU) Nr. 462/2013) in an attempt to discipline the conduct of rating agencies, optimise their influence on the markets and counteract market distortions arising from misinformation or manipulation emanating from their service.53 Up to this point, the interested party in a takeover is therefore no different from any other investor in the marketplace, relying on available information in order to assess the target as suitable for the intended purpose.

53

See on this Deipenbrock (2018a), Sergakis (2018), chapter 13.

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4 Modes of Acquisition and Types of Interest Once the target is considered to be suitable, the interested party has a number of options to increase its ownership or control. In the case of a stock market listed company the easiest way is to simply acquire stock. Certain milestones (thresholds) in the accumulation of percentages of shareholdings in a listed or non-listed public limited company need to be reported, though, according to §33 WpHG within the time limit mentioned on §33 (1) WpHG which is within four trading days.54 This rule serves to achieve market transparency. It is however not immediately obvious whose benefit this rule serves or, to remain in the classification attempted here, which of the four layers it operates in.55 An answer might flow from taking a closer look at the bidder or acquirer. Investors come in many different shapes and forms and have equally numerous interests and objectives driving their investment decisions. Investors can be business owners, as such holding and trading shares, they can be private savers or they can be institutional professional market players such as public or private pension fund managers, sovereign wealth funds, large merchant banks or insurances. The diverse interests of these different types of investors can be determined by their spending power. A private saver may be perceived as not normally having the means to acquire large shareholdings in for instance a ‘blue chip’ business listed at the stock market to reach a threshold that needs reporting under §§ 21 and 22 of the WpHG as well as under §§29 and 30 (2) of the Wertpapieruebernahmegesetz (WpÜG). However, these assumptions cannot be generalised and so the question remains with whom or what in mind the reporting and disclosure rules in respect of reaching the thresholds were made. The EU Takeover Directive of 21 April 200456 mentions foremost the protection of the interests of the target company’s shareholders as an objective. Another declared aim of the Directive is the harmonisation of the laws relating to takeovers across the EU so that there are no negative effects of regulatory competition arising from the differences in the laws of the MS. The latter objective does nothing to describe the interest of potential investors and the nature of the interest of the target company. Indeed, both are not straightforward to define as they vary as much as the potential motivations for each shareholder to actually want a particular share in a particular company. The interest can range from a mere transitory financial interest of an occasional speculator to a much closer bond and long term view interest such as that of an employee to his or her workplace where he or she might be given shareholdings as part remuneration, pension or performance incentive. The latter type of shareholder will be more unequivocally 54

This time limit runs from the time when the purchaser or seller becomes aware of the circumstance giving rise to the reporting duty. It is presumed that this will be the case within two trading days, § 33 (1) 3rd sentence WpHG. 55 See generally on this Brinckmann (2014). 56 Directive 2004/25/EC, OJ L 142/12 (30 April 2004).

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part of the ‘real economy’ than the transient speculator who might even invest indirectly as part of a derivative financial product with varying degrees of remoteness. This latter interest is reflected in §37 WpHG which exempts certain acquisitions from the above mentioned reporting duty. Another interest on the part of the acquirer or offeror as the case may be could, however, be very much connected with the real economy. An investor may have an interest not just in improving financial positions but in furthering business interests connected with another business that they already own. This could be the emulation of a competitor which in turn could be in order to eliminate competition or in order to achieve synergies by pooling resources in Research and Development (R & D) or by vertical integration or the building of a conglomerate. This type of interest evokes decidedly public policy based responses from legislatures. It is here where we must be looking to competition law to apply but also to a range of industrial policies. The desire to protect ‘key industries’ and national infrastructure from inbound foreign investment has received fresh momentum. Examples are discussions about the merits of selling stakes in utility companies such as water works to foreign investors or leave strategic infrastructure projects such as railways, airports and nuclear power stations under the control of foreign entities. Most recently, a discussion has erupted whether the Chinese technology company Huawei should be taking part in public auctions of newly released high speed mobile transmission frequencies (“G5”) and whether their products may double up as channels of influence by the Chinese government. Classic protectionism may also be a policy of choice in certain segments of a market or in certain economies and their stages of evolution. These may serve the protection of public health (“chlorinated chicken”) or the environment. Disputes like this have been subject to the WTO Dispute Settlement Body over the past decades.57 It is clear that they play out at the interface of private takeover laws and public regulation and international trade negotiations.58 Against this background the difficulty of attributing a rule of law to one or more of the above defined layers of legislation becomes visible.

57 See for instance the ‘Shrimp/Turtle caseʼ (United States—Import Prohibition of Certain Shrimp and Shrimp Products) WTO Dispute DS58, materials available from, http://www.wto.org/english/ tratop_e/dispu_e/cases_e/ds58_e.htm. [last accessed 28 Aug 2019]. 58 Current negotiations where such policies are publicly debated include the (now suspended) Transatlantic Trade and Investment Partnership (TTIP) between the EU and the USA as well as the Comprehensive Economic and Trade Agreement (CETA), the recent EU-Canada trade agreement.

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5 Application of the Layers in Practice The recent example of the acquisition of a 9.69% percent stake of the German company Daimler by Chinese entrepreneur Li Shufu and his car manufacturer Geely shows how private securities law, industrial policy and indeed public perception can get conflated.

5.1

The Threshold Rule of §33 WpHG

Businessman Li Shufu published his ideas about the importance and opportunity of global co-operation in car manufacturing and technological development in the German national newspaper “Frankfurter Allgemeine Zeitung” on 16 April 2018. At the time of writing, these plans have in fact materialised in the form of a joint venture to co-produce a well known model owned by Daimler in China.59 The public and political discussion centres around the significance of the nationality of private individual actors and companies in the markets. It concerns the essence of the nature of the company, whether it can actually have a nationality or whether it has any political significance. Both public and academic debate has engaged in the question how inbound investment has to be characterised. It is very complex to distinguish the interests playing out in investment decisions. Their effect is measurable in economic terms as well as in terms of market strategy and to an extent also in political terms. By contrast, the underlying motivations and their relevance to political and economic decisions tend to escape measurability. It is therefore equally complex to both design and interpret the applicable rules of disclosure in securities and capital markets law as in this German case centering around §33 WpHG. The disclosure rules of the WpHG are complemented by the Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz—WpÜG) which provides for disclosure rules in cases where an acquirer has actually obtained control over a target company, for instance by buying over 50% of the voting shares. In such a case the acquirer has to produce a formal offer according to §§ 35 et seq. WpÜG and follow the comprehensive procedures and interaction with the target company. This law is the implementation of EU Directive 2004/25 EC. So, while the law does not prohibit the actual acquisition of the shares it forces the acquirer to observe certain procedures to ensure standards relating to the rights of the remaining shareholders as well as the employees. At first, the authorities were quick to publicly state that they saw the time limits for the reporting of threshold acquisitions of the Daimler shares by Li Shufu’s

59

Manager Magazin (2019).

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businesses under the WpHG exceeded and the notification rules breached.60 On closer inspection of the facts and evaluation of the legal norms, however, the competent national supervisory authority BaFin had to admit that the acquisition was carried out lawfully and that the investigation was closed.61 This episode poses two questions: are the rules fit for purpose? and is it sufficient to impose fines upon infringement in order to achieve this purpose? The first question was posed by the political parties and also by the Federal business minister at the time of the Daimler-acquisition, Ms. Zypries.62 The minister is quoted by the political magazine “Der Spiegel” as saying Man müsse den Einstieg des Investors “besonders aufmerksam betrachten”, sagte Bundeswirtschaftsministerin Brigitte Zypries (SPD) und sprach sich gegen den möglichen Einzug eines Geely-Vertreters in den Daimler-Aufsichtsrat aus. (The [acquisition of Daimler shares by] the investor must be “extra attentively observed” said federal business secretary Brigitte Zypries and expressed her opposition against a membership of a Geely representative on Daimler’s supervisory board”)63

The federal government was concerned at the time about the effect the current rules had or rather lacked as it were. The federal parliamentary party “Die Linke” (The Left) filed a parliamentary information request in the matter.64 In its response the government explained that it was considering options to amend the notification rules in order to prevent further surprise accumulations of shareholdings.65 In fact, the eventual acquisition and notification of 9.69% of Daimler shareholdings by Geely Ltd. had followed earlier acquisitions which had not been notified, so that the 3% and 5% thresholds had not been notified and recognised neither by Daimler nor the supervisory authority. The initial viewpoint was that this constituted a breach of §33 (1) WpHG.66 This initial analysis was eventually dropped by the authority on closer inspection as mentioned above.

“Nach Auffassung des Bundesfinanzministeriums hätte der Investor sein Engagement einen Tag früher bekannt geben müssen”, (“The federal ministry of finance is of the opinion that the investor would have had to announce his investment one day day earlier”), Handelsblatt (2018). 61 Handelsblatt (2018), Kroener (2018), Manager Magazin (2018). The detailed steps of the acquisition are described by Jourdan and Shirouzu (2018) and Wilk (2018). 62 Manager Magazin (2018). 63 Bartz et al. (2018). 64 Deutscher Bundestag (2018a, b). 65 Response of 15 June 2018 published in the Parliamentary Gazette Bundestagsdrucksachen BT-Drs. 19/2771. Kroener (2018). 66 See Wilk (2018). 60

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Industrial Policy and Capital Market Law: The Challenges of Layer 4

The example shows clearly the significance of the four layers described above. The compliance duty of the acquirer is towards the regulator, in this case BaFin. A breach of the notification rules can be sanctioned with the imposition of a fine issued by the regulator.67 In addition, §44 WpHG prevents the acquirer from exercising the rights contained in the acquired shares for the duration of noncompliance with the notification duty of §33 WpHG including voting rights and, in case of an intentional breach which has not been remedied, the right to collect the dividend or share of the proceeds after dissolution respectively.68 It is less clear whether an infringement of the notification rules has any bearing on the contractual relationship between the target company and the acquirer. Should the shares purchase be annulled for instance if the prescribed procedure was not observed? Should the shares be delisted upon a breach of the notification obligations? An examination of the nature of the rules as to the four layers may help to answer these questions. Is it straightforward to determine what the actual purpose of the notification rules is? Are the rules designed to protect the target company? Are they designed to protect the interests of the existing shareholders? It would seem that it may not be the notification rules but rather the more specific rules of the WPÜG which deal with actual open takeover offers. The rules relating to share acquisitions in the open market do not deal with takeovers. Therefore, why would the interest of the target company need protecting? The problem with this question is of course that there cannot be a particular hypothetical interest of the remaining shareholders in a public limited company in the case of the acquisition of shares in their business amounting to the regulated thresholds. The regulator much rather pursues the prime interest of observing the market and documenting acquisitions and disposals in order to evaluate these with a view to detecting and preventing harmful practices, market distortions and other threats to the integrity of the market place as a public policy. This is a policy derived from the experience of the financial crisis where it was perceived as an oversight that the degree and market penetration of certain complex financial products were not known to the regulators so that the scale of the domino effects that were triggered by the Northern Rock crisis for instance was unexpected and hit the markets unprepared. Over 10 years on, comprehensive reforms have been passed. However, rules of regulation of the capital and financial markets are still largely of a public law nature and concern the relationship between the market player and the regulator, not that

67 In fact, in late 2018, the German Federal Financial Supervisory Authority, short BaFin, imposed a fine on Morgan Stanley for infringing §§ 33 and 34 WpHG, see Bundesanstalt fuer Finanzdienstleistungsaufsicht (2019): “On 3 December 2018, BaFin imposed administrative fines amounting to 2.4 million euros against Morgan Stanley & Co. International plc.” The investment firm was also involved in helping Li Shufu’s business acquire the desired amount of shares in Daimler which allowed the transaction certain exemptions from the disclosure rules. 68 §44 (1) second sentence WpHG, §§58 (4) and 271 AktG.

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between market players directly. The private law governed contractual relationship between the parties to the transactions is not directly affected by these rules. This means that an injured party cannot generally rely directly on a breach of regulatory norms to claim damages or enforce compliance. A company cannot reject the acquisition of publicly traded shares on the ground that notification rules were breached. The breach does not give the company a contractual right arising form the contract of sale. Does this mean that the regulatory norms are dysfunctional? This brings us back to the above question of the purpose of these norms. It depends very much on the viewpoint any particular shareholder might have regarding a threshold acquisition. The management of a public limited company might have yet another viewpoint and interest. In the case of the acquisition carried out by Mr. Li Shufu, the management might anticipate an influence on their managerial decisions as to the business strategy of the company along the lines of the newspaper article referred to at the start of this section. Shareholders may or may not share the same concerns and may derive both positive and negative conclusions from the transactions and the public announcement of a strategic interest. There is not one particular judgement that can be made regarding the threshold acquisition. This is why the norm most likely is not designed to have any direct effect on contractual obligations between the company and its shareholders or shareholders among each other. It is therefore not a rule of layer 1 and not of layer 2 either. The rules may be attributed to layers 3 and 4. The monitoring of the market definitely forms an important cornerstone of modern regulatory oversight. The rules therefore fit into layer 3. Whether they also fit into layer 4 is less clear. The takeover of a domestic enterprise by a foreign investor has received revived interest within the last decade. One case that made the headlines and caused emotional reactions in Germany was the takeover of the traditional Mannesmann group by the British telecommunication giant Vodafone AirTouch plc 2000.69 This shows that as much as the perception of an industry or an individual company or brand name as “national” can lead to an irrational resistance to a foreign takeover the commercial rationale behind a takeover equally has inherent weaknesses. Economic projections may be flawed and not entirely free of irrational elements of zealousness. A more rational concern may however arise in the area of foreign investment into national public services, utilities, infrastructure and military equipment such as airports, water works, road and rail networks, power stations and digital components. The merits of proposing legislation to control foreign

69 See for instance the news coverage by the BBC (BBC News, 11 Feb 2000, available at http:// news.bbc.co.uk/1/hi/business/630293.stm;even, last accessed 30 July 2019); even 10 years later it has been referred to as “The mother of all takeovers” (Deutsche Welle, the international German radio station, “Mannesmann: The mother of all takeovers”, 3 Feb 2010, available at https://www. dw.com/en/mannesmann-the-mother-of-all-takeovers/a-5206028). The deal produced no lasting economic success (The Telegraph lists it under “top 5 worst merger deals ever” on 29 July 2019, see https://www.telegraph.co.uk/finance/newsbysector/banksandfinance/10973243/Top-5-worstmerger-deals-ever.html?frame¼2933243, last accessed 30 July 2019). Nevertheless, it was felt in the public perception as a painful loss to German traditional industry. It also prompted the adoption of the WPÜG in 2000.

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investment in these areas has been debated for a while at EU level most recently resulting in the Screening Regulation.70 It is in this extended context that the Daimler case has to be seen. The extent to which countries can or should pursue industrial policies varies over time. Libertarian views prefer a free market order where foreign investment is judged only by its economic benefit for the parties involved. Countries use tax incentives and other legislative measures to attract foreign investment. They may focus on specific branches of industry such as electronics, coal and steel or car manufacturing. Businesses are supposed to benefit from “regulatory competition.” In the area of tax incentives, however, this has caused significant resentment among EU member states as well as OECD member states who criticise the practice as endangering the soundness of state budgets as well as a breach of rules of competition law such as those relating to state aid as well as opening themselves up to an influx of illicit flows of money through so called letterbox companies. In this context, it appears to be a complex task for states to protect certain industries which are seen as relevant to public services, infrastructure and administration from foreign investment. The rules discussed here, relating to the disclosure of certain threshold shareholdings, are clearly unlikely to be suitable tools for the control of foreign investment. They are located in a piece of legislation which is foremost an instrument to help shareholders to maintain the value of their investment and to enable the individual owners of public limited companies (shareholders) and their management to make informed decisions about managerial, operational and investment decisions for their enterprise. With the choice of instruments, the WpHG and WPÜG, the legislator has still not made it clear whether these legal rules serve the real economy or the regulator’s supervisory tasks.

6 Conclusions This example shows very clearly the problematic effects of fragmentation of disclosure rules in German law. It shows the difficulty of achieving regulatory aims with the means of private law. One important guideline for the legislature therefore ought to be the conscious classification of norms, for instance according to above described layers, and ensuing assignment of a suitable legislative vehicle. The CJEU has attempted to resolve this problem by pointing to the requirement of effectiveness of EU law, thereby implicating that the private investor ought to have a means to enforce regulatory norms against a contractual partner.71 The difficulty is in my view 70 Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March 2019 establishing a framework for the screening of foreign direct investments into the Union, OJ 21 March 2019, L 79 I/1, See also the earlier contributions on this subject made for the International Federation for European Law (FIDE)’s congress 2010 collated in Rodriguez Iglesias and Ortiz Blanco (2010). 71 CJEU, case C-604/11, Bankinter, para 57. See also CJEU, case C-222/02, Peter Paul, ECLI:EU: C:2004:606; Moeslein (2015), Andenas (2018).

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a lack of prior consideration by the legislator as to what the aims of the rules are, whether they can be achieved at all and if so by what legislative means. Concerning the disclosure rules in EU and German takeover law, it seems that none of these considerations have been sufficiently dealt with prior to implementing the present legislation. The result is an unclear situation from the viewpoint of both the investor and the regulator which in my view results from the confusion about the nature of the rules in question. This creates a situation marked by over regulation and futile attempts to prevent measures which may or may not be detrimental to the market, the industry or the individual enterprise. It is also useful to reflect on the question of what makes a takeover, merger or significant acquisition successful. The acquirer may be successful in completing the acquisition by discharging all necessary regulatory requirements as well as achieve consent among the original shareholders. However, the legal success ought to be followed by economic success. This is not guaranteed as was briefly mentioned in the context of the 2000 Mannesmann-Vodafone takeover. Another example has to be the recent takeover of US company Monsanto by the German Bayer AG which has led to a significant loss in share prices and a financial threat from law suits which may not have been factored in by the acquirers.72 This shows clearly how important disclosure rules in all the above described layers are for the market players to make informed decisions upon due diligence. It is not clear, however, to what extent market players are aware of the legal nature of the rules they comply with in terms of these layers and whether it might be beneficial for them to be aware of this. Certain disclosure rules may serve different ends in different jurisdictions and a poor understanding of the interplay of these norms within the different layers may lead to a detrimental outcome post factum following the acquisition. At first sight, the above explained Daimler acquisition is a clear example of legal practice having successfully played the system. The economic success of the newly formed business or the new cooperation, however, depends on a multitude of factors including local business culture and will only transpire over time. Most importantly, acquirers, regulators and legislators should be aware that aims in one layer of regulation may not be achievable with rules operating in another layer. In the area of corporate acquisitions the close interplay of corporate governance norms with the law relating to financial transactions adds to the complexity of the classification of norms. This classification should not be dismissed as irrelevant while a persistent lack of awareness of the origin and effect of norms leads to an increase of wasteful litigation, poor corporate governance and missed opportunity.

72

Dohmen et al. (2019) and Hoffmann (2018).

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“The Takeover Mirror” On the EU Side of the Looking Glass, Most Regulatory Checks Are Ex Post, Not Ex Ante Victor Meijers, Ailin Song LL.M, and Renée Otten

Abstract When two jurisdiction both have public legal instruments such as merger control, how does their practical implementation affect outcomes? Two real cases of substantial investment by Chinese companies in Europe are introduced and then mirrored as an imaginary test case to see what would be the outcome if the European targets had been investors in China, with the Chinese investors now as targets. The cases are CTG/EDP and Geely/Daimler. The tentative conclusion is that practical implementation of legal instruments such as the timing of required approvals (before closing the deal) versus own responsibility (accountable after closing the deal if requirements are not met) result in the difference between “cannot do” in one jurisdiction versus “may not do” in the other.

1 Introduction Cross-border trade has become an inevitable trend all over the world. In the past, outbound M&A transactions were made to access abundant resources. Later, more and more companies became increasingly interested in acquiring state-of-the-art technology, knowledge and experience through M&A deals. Now, Chinese companies also use outbound M&A to develop opportunities to help them acquire synergy in selected industries overseas, thus enhancing core competence both at home and abroad. Between 2015 and 2017, outbound M&A conducted by Chinese companies showed an uptrend, and China represented more than 40% of the deals in the AsiaPacific region.1 Since Chinese companies had become more experienced in M&A transactions, they were increasingly critical and cautious when seeking global expansion in 2018. During 2019, the share of outbound investment from China to

1

Phil Leung et al. (2018) More Rigor Means Better Results in China’s Global Pursuit.

V. Meijers (*) · A. Song LL.M · R. Otten DeHeng Civil Code N.V., The Hague, The Netherlands e-mail: [email protected]; [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_6

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Europe has increased compared to steeply declining investment from China to the USA, also as a result of American trade restrictions. With this development, one significant concern appears, namely the lack of reciprocity between China and Europe as regards investment relations. While Chinese investors enjoy the same rights and privileges as other participants in the EU market, China still imposes more restrictions on foreign investors in its own market. Although China has promised to gradually remove barriers against free trade, this action remains to be fully implemented. Unlike the ex-ante pre-authorisation mechanism set in China to strictly control the market access, the EU puts more emphasis on ex-post measures such as imposing fines on high-risk investment after investigation of specific M&A deals. Ex-post measures are more prone to being circumvented compared to ex-ante measures. Now the EU has proposed establishing a mechanism for screening foreign direct investment among EU member states, filling the gap before M&A deals occur. In this article we will investigate the different situations and mirror specific examples.

2 Developments in 2018, 2019 2.1

Developments in the First Half-Year Report of 2018

The value of China M&A in the first six months of 2018 was US$ 348 billion,2 with a slight increase in the volume of transactions. In the PwC review of M&A 2018 in the first half of 2018, PwC declared the information regarding the China M&A came from three sources: ThomsonReuters, ChinaVenture and PwC analysis. According to the PwC review, the value of China M&A in the first half of 2018 fell by 18% during this period compared to the second half of 2017 (see Fig. 1). From the trend of the mid-year values, there appears to be an approximate increasing tendency in China M&A before the first half-year of 2018 (from 2016 to 2017). Thus it can be seen that something is changing, which is affecting cross-border mergers and acquisitions. With regard to the ThomsonReuters review, the M&A transactions involving China reached. US$ 322.7 billion at the end of the first half in 2018, a 13% increase in value compared to the first half of 2017.3 But compared to the second half of 2017, the value of M&A in the first half of 2018 had decreased (see Fig. 2).

2

The value in the source of Thomson Reuters is US$ 322.7 billion, see https://www.thomsonreuters. cn/zh/reports/MA-China.html. Accessed 30 November, 2020. The value in the source of China Venture is US$ 205.15 billion, see https://www.chinaventure. com.cn/cmsmodel/report/detail/1432.shtml. Accessed 30 November, 2020. 3 ThomsonReuters review (2018) 2018 Thomson Reuters H1 M&A Report. https://max.book118. com/html/2018/1105/5103130334001324.shtm. Accessed 30 November, 2020.

Fig. 1 Developments of China M&A market in PwC review. *Financial buyer-backed China mainland outbound deals are also included in private equity deals, but they are not double counted in the total deal volume and deal value in the table above. Source: ThomsonReuters, ChinaVenture and PwC analysis (PwC (2019) M&A 2018 review and 2019 outlook. https://www.pwccn.com/en/deals/publications/ma-2018-review-and-2019-outlook.pdf. Accessed 30 November, 2020)

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450 400

427

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250 200 150 100 50 0

1H16

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Fig. 2 Trend of the Value of China M&A (Ibid)

$816.6

Rank Value US$ Billions

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2006

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Fig. 3 Recent Developments of China M&A market in ThomsonReuters review (ThomsonReuters review (2018) 2018 Thomson Reuters H1 M&A Report. https://max.book118.com/html/2018/ 1105/5103130334001324.shtm. Accessed 30 November, 2020)

ThomsonReuters does not reveal the specific figures of each half-year period in its review. The figure above (Fig. 3) presents a steady trend from 2016 to 2017 in the value of China M&A transactions. Another source—ChinaVenture also presented its review (see Fig. 4). Although the value is less than that in the PwC and ThomsonReuters reviews, it shows a similar trend from 2016 to 2017 in value of China M&A. And the value of the first half of 2018 is US$ 205.15 billion.

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Fig. 4 Recent developments of China M&A market in ChinaVenture review (ChinaVenture (2018) Investment Central Statistics: M&A market picks up in July 2018, with large deals recurring in cross-border M&A. https://www.chinaventure.com.cn/cmsmodel/report/detail/1446.html. Accessed 28 December, 2020) Table 1 Comparison of Value (US$bn)a

2016 2017 1H2018

PwCb 798.3 713.3 348.3

ChinaVenturec 608.78 566.79 205.15

ThomsonReutersd 737.0 604 322.7

a

ThomsonReuters review (2018) 2018 Thomson Reuters H1 M&A Report. https://max.book118.com/html/2018/1105/ 5103130334001324.shtm. Accessed 30 November, 2020., ChinaVenture (2018) Investment Central Statistics: M&A market picks up in July 2018, with large deals recurring in cross-border M&A. https://www.chinaventure.com.cn/cmsmodel/report/detail/ 1446.html. Accessed 28 December, 2020, and PwC (2019) M&A 2018 review and 2019 outlook. https://www.pwccn.com/en/deals/ publications/ma-2018-review-and-2019-outlook.pdf. Accessed 30 November, 2020 b PwC (2019) M&A 2018 review and 2019 outlook. https://www. pwccn.com/en/deals/publications/ma-2018-review-and-2019-out look.pdf. Accessed 30 November, 2020 c ChinaVenture (2018) Investment Central Statistics: M&A market picks up in July 2018, with large deals recurring in cross-border M&A. https://www.chinaventure.com.cn/cmsmodel/report/detail/ 1446.html. Accessed 28 December, 2020 d ThomsonReuters review (2018) 2018 Thomson Reuters H1 M&A Report. https://max.book118.com/html/2018/1105/ 5103130334001324.shtm. Accessed 30 November, 2020

Although the figures in these three reviews from the various sources vary significantly, the trends of the values do look similar. From 2016 to the first half of 2018, the value of China M&A represents a declining trend (see Table 1 and Fig. 5).

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900 800 700 600 500 400 300 200 100 0 2016

2017 PwC

ChinaVenture

1H2018 ThomsonReuters

Fig. 5 Value of China M&A in different sources (Ibid)

2.2

Developments in the Annual Report of 2018, Most Recent Developments

In February of 2019, PwC released their 2018 M&A report. The total value of China M&A deals remained flat compared to the data from 2017. In 2018, the total value of China M&A deals was US$ 678.3 billion, almost the same as the total value of US$ 676.6 billion in 2017 (see Fig. 6).4 On January 21, 2019, ChinaVenture released the 2018 review of China M&A. In the review, the value of the whole year of 2018 was US$ 576.84 billion, therefore the value of the second 6 months of 2018 was US$ 371.69 billion. Compared to the value of 2017 (US$ 587.78 billion), 2018 displayed a slight decrease but largely remained at a similar level (see Fig. 7). In summary, it is clearly shown there was no significant growth in 2018 compared to the previous years, especially compared to 2017. Many factors may have led to this situation, such as the complex economic environment, rigorous supervisory system, anti-takeover measures and the like. More and more intervening factors now are influencing cross-border M&A. The most recent figures show a very significant decrease in global outbound M&A from China so far in 2019, with Bloomberg reporting a total of US$ 35 billion

4 PwC (2019) M&A 2018 review and 2019 outlook. https://www.pwccn.com/en/deals/publications/ ma-2018-review-and-2019-outlook.pdf. Accessed 30 November, 2020.

Fig. 6 Developments of China M&A market in PwC 2018 review (Ibid)

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Fig. 7 Developments of China M&A market in ChinaVenture review (ChinaVenture (2019) 2018 China Corporate M&A Market Data Report. https://max.book118.com/html/2019/0204/ 6220040044002005.shtm. Accessed 28 December, 2020)

in the first six months. Of this, only US$ 6.8 billion accounted for US acquisitions, with increasing tariffs and trade tensions seeming to have a detrimental effect. Joseph Gallagher, head of Asia Pacific mergers and acquisitions at Credit Suisse Group AG, said: “The trade war sentiment continues to weigh on overall outbound China M&A activity, and we expect this to particularly impact China-US deals in the near future.”5

5 Manuel Baigorri and Vinicy Chan, Outbound M&A Plummets as Trade War Keeps Companies at Home. https://www.bloomberg.com/news/articles/2019-07-04/china-outbound-m-a-plummets-astrade-war-keeps-companies-at-home. Accessed 30 November, 2020. It should be noted that this Bloomberg-compiled data presumably only takes M&A by companies and individuals registered in China into consideration, not M&A via shell companies in other territories ultimately owned by Chinese companies or individuals.

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3 Analysis of Megadeals6 As stated in the PwC review, Europe replaced Asia as the primary outbound destination in terms of value. However, two deals accounted for 80% of the eurozone total. The two megadeals in question are China Three Gorges’s US$ 10.8 billion acquisition of EDP Energias de Portugal and Geely’s US$ 9 billion investment in Daimler. This paper will illustrate these two cases in detail.

3.1 3.1.1

China Three Gorges’s Failed US$ 10.8 Billion Acquisition of EDP Energias de Portugal Introduction of the Companies in Question

EDP Energias de Portugal S.A. ranks among the world’s major electricity operators, as well as being one of Portugal’s largest business groups. It is a public company with its headquarters in Lisbon listed in Euronext Lisbon. The company is the main energy-related investor in Portugal and one of the engines driving the economy and national development, being the largest producer, distributor and supplier of electricity in the country. The production of energy takes place through EDP Produção’s activity (water, coal or combined cycle natural gas) and EDP Renováveis7 (wind energy). EDP Distribution is the distribution network operator in mainland Portugal. The commercialisation of energy is effected through EDP Universal Service (regulated market) and EDP Commercial (free market).8 CTG China Three Gorges Corporation was founded in 1993 with the approval of the State Council and is a state-owned company. CTG positions itself as a clean energy group focusing on large-scale hydropower development and operation. Its main area of business covers the construction, international investment and contracting, and development of wind power and solar energy, among other renewable energies, in addition to comprehensive development and utilisation of water resources, as well as providing relevant professional technical services.9 In and outside China, a subsidiary of CTG, China Yangtze Power, is known as owner of the Three Gorges Dam.

6

In the PwC review, megadeals mean a deal value of more than $1 billion. CTG also concluded an acquisition of this subsidiary in 2014, see https://www.edpr.com/es/ noticias/2015/05/19/edpr-concludes-sale-minority-stakes-wind-farms-brazil-ctg-0. Accessed 30 November, 2020. 8 EDP official website, see https://portugal.edp.com/pt-pt/edp-em-portugal. 9 CTG official website, see http://www.ctg.com.cn/english/text_qry_menuId_equ_ 2e9dcfc56cd440d692961a27c59e8430_and_page_equ_1.html. Accessed 30 November, 2020. 7

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Overview of the Offer

China Three Gorges (CTG) announced a takeover bid for shares of EDP Energias de Portugal (EDP) on May 11, 2018. The offer was ultimately held by China Three Gorges Corporation through its wholly-owned subsidiaries China Three Gorges International Corporation and China Three Gorges Company Limited (Hong Kong). CTG was offering a cash consideration of € 3.26 per share, representing a premium of 4.8% over the closing share price of EDP on the day of the announcement (€ 3.11) and a premium of 10.8% and 7.9% respectively over the Volume Weighted Average Price (VWAP) of the six and twelve months prior to the day of the announcement (€2.94 and €3.02) on the Euronext Lisbon regulated market.10 In order to complete the transaction, CTG would need to obtain authorisations and approvals from some administrative and regulatory bodies in different markets and segments, such as the European Commission, the Portuguese Government, CADE and ANEEL in Brazil, CFIUS and FERC, among others.

3.1.3

Shareholder Structure and Voting Rights

“One share, one vote” is a general rule in the Portuguese Companies Code (Código das Sociedades Comerciais), but there can be derogation under certain circumstances. Unless provided in the company’s articles of association, each share will correspond to one vote in principle.11 However, the Code also stipulates that voting rights may not be proportional to the economic value of the shares in order to maintain the stability of the company’s management and supervisory authorities. For example, in a listed company, voting rights can be granted to a certain minimum share capital such as giving at least one vote for every 1000 euros of share capital.12 Besides, a system of “voting ceiling” can be applied according to the Code, which means once a sole shareholder holds shares exceeding a certain threshold, regardless of the actual shares obtained by the shareholder, the voting rights above the threshold will not be taken into consideration.13 In the offer, CTG expressed the ultimate intention of acquiring control of EDP. The offer would be subject to the fulfilment that CTG eventually obtains at least 50% of EDP voting rights plus 1 voting right.14 If no special derogation is stipulated in the articles of association, the general rule will enable CTG to have the final say on company decisions. The offeror holds, at the date of announcement, 850,777,024 shares in the target company’s share capital, representing approximately 23.27% of the share capital of

10

Report of the executive board of EDP, 8 June 2018, 6. Portuguese Companies Code (2006), Article 384 .1. 12 Portuguese Companies Code (2006), Article 384.2(a). 13 Portuguese Companies Code (2006), Article 384.2(b). 14 Report of the executive board of EDP, 8 June 2018, 5. 11

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Table 2 Shareholder Structure and Voting of EDPa Shareholders China Three Gorges CNIC Co., Ltd Oppidum Capital, S.L. BlackRock, Inc. Mubadala Investment Company Grupo BCP + Fundo de Pensões do Grupo BCP Sonatrach Paul Elliott Singer Qatar Investment Authority Remaining shareholders Norges Bank EDP (Treasury Stock) a

EDP official website, 30 November, 2020

see

No. of Shares 850,777,024 182,081,216 263,046,616 182,733,180 148,431,999 88,989,949

% Capital 23.27% 4.98% 7.19% 5.00% 4.06% 2.43%

% Exercisable votes 23.27% 4.98% 7.19% 5.00% 4.06% 2.43%

87,007,433 83,827,873 82,868,933 1,586,904,281 78,097,245 21,771,966

2.38% 2.29% 2.27% 43.40% 2.14% 0.60%

2.38% 2.29% 2.27% – 2.14% –

https://www.edp.com/en/shareholder-structure-1.

Accessed

the target company, holding the entirety of the voting rights inherent to such shares (see Table 2). From Table 2, we can assume EDP adopts the general rule—one share, one vote. However, according to paragraph 3 of article 14 of EDP’s by-laws, votes from a shareholder on their own account or on behalf of another shareholder, shall not be cast in the event that they exceed 25% of the total votes corresponding the total share capital. This is a measure to prevent major shareholders from abusing their rights. The cap on voting rights can be lifted by a two-thirds majority of shareholders. Hence, CTG’s bid, with its precondition that it can obtain an absolute majority of voting rights, hinges on the shareholders voting to abolish the voting rights limit. China Three Gorges Corporation is a state-owned enterprise of the People’s Republic of China. The voting rights held by CTG are attributable to the People’s Republic of China, in accordance with the provision of number 1 of article 20 of the Portuguese Securities Code.15 It is noteworthy that there are also 182,081,216 shares, corresponding to 4.98% of the share capital and voting rights of the Target Company, held by another state-owned enterprise of People’s Republic of China, “CNIC Co., Ltd.”. Overall, the total voting rights attributable to the People’s Republic of China thus amount to 1,032,858,240, corresponding to 28.25% of the voting rights in EDP at the time of announcement. In the offer draft, the offeror “recognises that investors’ interest in listed companies is directly linked to the adoption of corporate governance best practices and the prompt disclosure of material information to shareholders. The offeror is committed

15

Portuguese Securities Code (2006), Article 20.

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to the target company continuing to adopt the highest corporate governance standards in accordance with international practices and applicable law”.16 The Executive Board of Directors notes that European Corporate Governance standards include critical mechanisms to protect minorities’ interests. They furthermore believe that the offeror should express its views on whether a professional management team will be maintained and if a related party committee will continue to exist. This related party committee is particularly relevant to implement the offeror’s intentions to execute asset contributions. European officials may also raise concerns about China’s growing influence over Portugal’s power generators and grids. The State Grid Corporation of China17 already holds partial ownership of the operator of Portugal’s electricity and natural gas grids, REN-Redes Energeticas Nacionais SA. On that level, China already counts as a partial owner with State Grid, the largest Chinese enterprise, which owns 25% of REN in Portugal.18 China Three Gorges’s offer was also linked to a simultaneous bid for a renewable-energy business, EDP Renovaveis SA, which is 83% owned by EDP. It is said China Three Gorges, the Portuguese firm’s biggest single shareholder, is concerned that American regulators could stymie efforts to gain control of the U.S. portfolio of the renewables business, which is of particular interest as the Chinese group tries to build a global alternative energy powerhouse. China Three Gorges is discussing various structures and divestments that would facilitate approval from the Committee on Foreign Investment in the U.S. (CFIUS), but would allow it to retain large parts of the business. On the official website, EDP mentions ADR holders. ADR holders are granted the same rights as common shareholders. The voting rights of ADR holders are calculated in such a way that each ADR represents 10 common shares.19 But after checking the shareholder structure of EDP, we did not find any shareholders relating to ADR holders.

3.1.4

Present Situation

The offer remained on hold for some time. The Executive Board of Directors was of the opinion that the price offered did not adequately reflect the value of EDP and that the implied offer premium was too low considering what is customary for European utilities where the offerors have gained control.20 Therefore they could not

16

Report of the executive board of EDP, 8 June 2018, 55. State Grid Corporation of China is a Chinese State-owned company, whose core business is the investment, construction and operation of power grids. 18 Takeover bid from CTG to EDP is put on hold(2018), see https://econews.pt/2018/09/03/ takeover-bid-from-ctg-to-edp-is-put-on-hold/. Accessed 29 November, 2020. 19 EDP official website, see https://www.edp.com/en/voting-and-shareholder-rights. 20 Report of the Executive Board of EDP, 8 June 2018. 17

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recommend that shareholders tender their shares at the offer price. They also did note that there are merits in the strategic intentions of the offeror. However, given the uncertainties regarding the implementation of the plan and potential impact on EDP, the Executive Board of Directors sought more information from the offeror in order to be in a position to form a more considered view regarding the value of the project.21 Notwithstanding the merits in the plan to be formulated by the offeror based on stated intentions, the Executive Board of Directors was of the view that shareholders who wished to tender their shares needed to be appropriately compensated for giving up control of EDP, and for enabling the implementation of such a plan.22 Eventually in late April 2019, the take-over bid seemed to definitively collapse when 56% of EDP shareholders voted against lifting the cap on EDP voting rights, which was a prerequisite of CTG’s bid. Despite the bid falling through, António Mexia, EDP’s Chief Executive, said “our strategic partnership [with CTG] will continue.”

3.2 3.2.1

China’s Geely’s US$9 Billion Acquisition of Stake in Daimler Introduction of Companies Concerned

Geely Zhejiang Geely Holding Group (ZGH), is a global automotive group based in the city of Hangzhou in south-east China’s Zhejiang Province. The group was established in 1986 and launched its automotive business in 1997. The following figures show the management structure and the total structure of the Geely Group (Fig. 8). Geely also holds one listed company in Hong Kong; the others are all private companies. Daimler Daimler AG is a German multinational automotive corporation with its headquarters in Stuttgart, Germany. It is one of the biggest producers of premium cars and the world’s biggest manufacturer of commercial vehicles with a global reach.23 Daimler owns or has shares in a number of car, bus, truck and motorcycle brands as follows:

21

Ibid. Ibid. 23 Daimler official website, see https://www.daimler.com/company. 22

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Fig. 8 Management structure and total structure of the Geely Group (Geely website, see http://zgh. com/our-business/?lang¼en)

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161

Overview of the Offer

The billionaire founder of Zhejiang Geely Holding Group Co. has accumulated a stake worth about 7.3 billion Euros (US$ 9 billion) in Daimler AG, marking the biggest investment in a global automobile manufacturer by a Chinese company. Chinese businessman Li Shufu acquired the 9.7% holding through Geely Group, a company owned by him and managed by the carmaker he controls.24 By using Hong Kong shell companies,25 derivatives, bank financing and carefully constructed share options, Li Shufu kept the plan under wraps until he could, at a stroke, become Daimler’s single largest shareholder. The result was a US$ 9 billion investment that skirted disclosure rules requiring investors to notify German authorities if their share of voting rights in a company passed 3%, and then 5%. Because of the way the stake was built, there is no indication that Geely breached those rules.26 Table 3 shows that Li was obliged to disclose the equity changes on February 23, 2018. How he circumvented the disclosure rule in Germany and when he reached the threshold of 3% or 5% still remains unclear. If the relevant European and German regulatory authorities do not impose any sanctions on Li, or on relevant companies directly or indirectly owned by him, it means that he obtained all the equity on February 23, 2018. Many people are wondering how Li processed this deal. One assumption is that he utilised the help of banks, shell companies and financial derivatives. In order to achieve shares in Daimler, Geely founded three shell companies in Hong Kong. After their proposal of acquisition was rebuffed by Daimler, Geely began to acquire shares through a secondary market (See Fig. 9). Li Shufu is not named in any of the documents seen by Reuters, but he has openly said he is the owner of the stake held by Tenaciou3.27 The three figures (Fig. 10) show the dates when these three shell companies were founded, and that they still exist. (May 2018) Investment bank Morgan Stanley was also involved in this case. As part of the Geely deal, German regulator BaFin asked Morgan Stanley to complete a disclosure filing, according to a letter from Germany’s finance ministry, which was seen by Reuters. Germany’s finance ministry, which oversees BaFin, declined to

24

China’s Geely Buys $9 Billion Daimler Stake (2018), see https://www.bloomberg.com/news/ articles/2018-02-23/china-s-geely-is-said-to-be-buying-9-billion-stake-in-daimler. Accessed 30 November, 2020. 25 Tenaciou3 purchased some shares on its own, but not enough to require disclosure. 26 Michael Nienaber, Edward Taylor, Arno Schuetze, China’s Geely raid on Daimler reignites German know-how fears, 26 February 2018, https://www.reuters.com/article/us-daimler-geelyidUSKCN1GA048. https://www.reuters.com/Article/us-daimler-geely-shell-insight/how-geelys-li-shufu-spentmonths-stealthily-building-a-9-billion-stake-in-daimler-idUSKCN1GD5ST. 27 Ibid.

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Table 3 Notification of major holdinga

a

Daimler official website, see https://www.daimler.com/investoren/berichte-news/ stimmrechtsmitteilungen/stimmrechtsmitteilung-330308.html

Fig. 9 Timeline (Reuters News, How Geely’s Li Shufu spent months stealthily building a $9 billion stake in Daimler, 1 March 2018, https://www.reuters.com/article/us-daimler-geely-shellinsight/how-geelys-li-shufu-spent-months-stealthily-building-a-9-billion-stake-in-daimleridUSKCN1GD5ST)

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Fig. 10 Corporate information (Hong Kong trade register, see https://www.icris.cr.gov.hk/ preDown.html)

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Fig. 11 Response from the German Bundestag (Detscher Bundestag (2018) Kleine Anfrage Einstieg der chinesischen Geely Group Co. Ltd bei der Daimler AG, http://dipbt.bundestag.de/ extrakt/ba/WP19/2359/235901.html. Accessed 28 December, 2020)

comment on this specific case.28 The Frankfurter Allgemeine Zeitung was the first to report on the existence of this letter.29 (June 2018) According to the request answered by the German Bundestag (see Fig. 11), “according to BaFin, Li Shufu’s aggregate holdings of equities and financial instruments were initially only slightly above 3%.30 With this stock several participation thresholds were exceeded at the same time. On February 23, 2018, Li Shufu exercised the financial instruments within the aggregate holdings of just over 3% and simultaneously acquired the remaining 6.19% in a total package. The

28 Reuters News, German regulator says Geely’s Daimler stake needed earlier disclosure, 12 May 2018, https://www.reuters.com/article/us-daimler-geely-shell-disclosure/german-regulator-saysgeelys-daimler-stake-needed-earlier-disclosure-report-idUSKCN1ID0BR. 29 The letter is not available to the public. The report in Frankfurter Allgemeine Zeitung, “Li entry at Daimler was reported too late”: http://www.faz.net/aktuell/wirtschaft/unternehmen/hat-li-shufuseinen-einstieg-bei-daimler-zu-spaet-gemeldet-15585055.html (in German). 30 Securities Trading Act (Securities Trading Act—WpHG) §33 Notification obligations of the reporting party; statutory authorisation (1) If anyone acquiring, selling, or otherwise disposing of shares reaches, exceeds or falls below (declarant), any of these: 3%, 5%, 10%, 15%, 20%, 25%, 30%, 50% or 75% of the voting rights in an issuer for which the Federal Republic of Germany is the country of origin, they must notify the issuer immediately and at the same time the Federal Agency, at the latest within four trading days in accordance with § 34 paragraph 1 and 2.

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different input thresholds were no apparent impediment to Li Shufu’s ability to rapidly increase his stake to 9.69%.”31 The German Federal Parliament is examining whether the regulation of investment disclosure has loopholes and whether these can be closed appropriately and proportionately, if required. The extent to which it would be expedient to extend disclosure obligations or take other measures that counteract the formation of transactions such as that which led to the acquisition of shares by the Chinese investor Li Shufu to the amount of 9.69% in Daimler AG, requires careful consideration. In doing so, the Transparency Directive Amendment (Directive 2013/50/EU), which implements the notification obligations in the German Securities Trading Act, considerably limits the member state legislator’s room for manoeuvre, since it pursues a basically fully harmonised approach. In addition, the Federal Parliament is considering a change in foreign trade law. At this point, the Federal Parliament can prohibit unwanted participation of foreign investors in German companies only from a segment of 25%. It is regularly checked whether adjustments are necessary, according to the statement by the Federal Parliament. “This includes the test entry threshold.”32 In December 2018, Geely announced that German financial supervisory authority BaFin had ended its investigation of the purchase of Daimler’s stake by Geely and decided not to impose any fines against Geely over its disclosure practices.33 That is to say, what Geely did strictly speaking followed the German and European laws. We have not been able to find any announcements either with regard to the start or the end of investigation on the official BaFin website. But after the news revealed by Geely, BaFin does not appear to deny the news, which to some extent can reflect BaFin’s attitude towards the authenticity of this piece of news.

3.2.3

Follow-up

In October 2018, Daimler and Geely announced their intent to establish a ridehailing service in China.34 They planned to establish a 50-50 joint venture headquartered in Hangzhou. The financial terms and investment plans of the venture

31

Deutscher Bundestag, request of entry of the Chinese Geely Group Co. Ltd at Daimler AG, http:// dipbt.bundestag.de/extrakt/ba/WP19/2359/235901.html. 32 Andreas Kröner, Raffinierter Geely-Einstieg bei Daimler ruft die Bundesregierung auf den Plan, 21 June 2018, https://www.handelsblatt.com/finanzen/maerkte/boerse-inside/geely-und-daimlerraffinierter-geely-einstieg-bei-daimler-ruft-die-bundesregierung-auf-den-plan/22719272.html? ticket¼ST-7721263-rtFc4xieXQdZGnYZhVd7-ap3 (in German). 33 Xinhua News, Geely says not subject to fines over Daimler stake disclosures, 15 December 2018, http://www.xinhuanet.com/english/2018-12/15/c_137676980.htm. 34 Daimler official website, Daimler and Geely form ride-hailing joint venture in China, 25 October 25 2018, https://www.daimler.com/innovation/case/shared-services/daimler-and-geely.html.

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have not been disclosed yet.35 “The joint venture will play a significant role as we continue to enlarge our portfolio and global presence and solidify our strong position in the mobility market,” said Klaus Entenmann, CEO of Daimler Financial Services AG.36 The joint venture will provide ride-hailing mobility services in several Chinese cities using premium vehicles including, but not limited to, MercedesBenz vehicles.37 In January 2019, Bloomberg reported that Geely’s holding of Daimler had been cut in half but Geely denied this report.38 Geely released a statement on its website stating they have no plans to cut the holding in Daimler as a long-term investor and the largest single shareholder.39 Bloomberg reported the news on the basis of a notification disclosed on Daimler’s website, which showed Morgan Stanley’s voting rights increasing from 0.02% to 5.39% (see Fig. 12). Therefore, Bloomberg considered the possibility Geely had sold a 5.4% stake to Morgan Stanley, since Morgan Stanley had previously assisted Geely in acquiring stakes in Daimler.

4 EU Legislation 4.1

Disclosure

According to Directive 2004/109/EC (amended by 2013/50/EU) article 9, when a shareholder acquires voting rights exceeding the thresholds of 5%, 10%, 15%, 20%, 25%, 30%, 50% and 75%, they must notify the issuer.40

35 Ouyang Shijia, Geely, Daimler in ride hailing JV, China Daily, 25 October 2018, http://www. chinadaily.com.cn/a/201810/25/WS5bd126b7a310eff30328476b.html. 36 Geely official website, Geely Group Co., Ltd. and Daimler Travel Service Co., Ltd. form a highend car travel joint venture, 24 October 2018, http://www.zgh.com/zh-hans/news/5247. 37 Automotive World, Daimler Mobility Services and Geely Group Company form premium ridehailing joint venture in China, 24 October 2018, https://www.automotiveworld.com/news-releases/ daimler-mobility-services-and-geely-group-company-form-premium-ride-hailing-joint-venture-inchina/. 38 Bloomberg News, China’s Geely Denies Report It Cut Daimler Stake, 11 January 2019, https:// www.bloomberg.com/news/articles/2019-01-11/china-s-geely-is-said-to-cut-daimler-stake-bymore-than-half. 39 Geely, Statement on Geely Holding Group’s non-reduction of Daimler shares, 11 January 2019, http://www.zgh.com/zh-hans/news/5430?from¼timeline&isappinstalled¼0. 40 Directive 2013/50/EU, Article 9.1, The home Member State shall ensure that, where a shareholder acquires or disposes of shares of an issuer whose shares are admitted to trading on a regulated market and to which voting rights are attached, such shareholder notifies the issuer of the proportion of voting rights of the issuer held by the shareholder as a result of the acquisition or disposal where that proportion reaches, exceeds or falls below the thresholds of 5%, 10%, 15%, 20%, 25%, 30%, 50% and 75%.

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Fig. 12 Notification of the change of Morgan Stanley voting rights (Daimler official website, see https://www.daimler.com/investors/reports-news/voting-rights/voting-rights-announcement373248.html)

Before the 2013 amendment, the notification requirements did not apply to investors who acquired voting rights relating to financial instruments held directly or indirectly. Article 13a of 2013/50/EU corrected this.41 41

Directive 2013/50/EU, Article 13a, The notification requirements laid down in Articles 9, 10 and 13 shall also apply to a natural person or a legal entity when the number of voting rights held

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Jurisdiction When must disclosure be made? Germany

3%, 5%, 10%, 15%, 20%, 25%, 30%, 50%, 75% of voting rights. 5%, 10%, 15%, 20%, 25%, 30%, 50%, 75% for derivatives with similar economic effect.

When must a mandatory offer be made? At least 30% of the voting rights.

Fig. 13 Threshold of disclosure and mandatory offer (Practical Law, Stakebuilding, mandatory offers and squeeze-out comparative table, https://uk.practicallaw.thomsonreuters.com/1-518-5074? transitionType¼Default&contextData¼(sc.Default)&firstPage¼true&comp¼pluk&bhcp¼1)

Currently, the regulatory thresholds under German law for investment disclosure are 3% and 5% of voting rights.42 However, these do not apply to all types of financial instruments,43 some of which were used by Geely in the acquisition of Daimler shares.44 Different jurisdictions apply different thresholds for disclosure, among other guidelines.

4.2

Mandatory Offer

According to Directive 2004/25/EC, where a natural or legal person, as a result of his/her own acquisition or the acquisition by persons acting in concert with him/her, holds securities of a company as referred to in Article 1(1) which, added to any existing holdings of those securities of his/hers and the holdings of those securities of persons acting in concert with him/her, directly or indirectly give him/her a specified percentage of voting rights in that company, giving him/her control of that company, Member States shall ensure that such a person is required to make a bid as a means of protecting the minority shareholders of that company.45 The percentage of voting rights which confers control for the purposes of paragraph 1 and the method of its calculation shall be determined by the rules of the Member State in which the company has its registered office (see Fig. 13).46

directly or indirectly by such person or entity under Articles 9 and 10 aggregated with the number of voting rights relating to financial instruments held directly or indirectly under Article 13 reaches, exceeds or falls below the thresholds set out in Article 9(1). 42 Securities Trading Act (WpHG)(1994, last amendment in 2019), section 40, para 1. 43 Securities Trading Act (WpHG) (1994, last amendment in 2019), section 38. 44 Zachary Ho, The Effects of Geely Buying A Stake in Daimler, 5 March 2018, http://autoworld. com.my/news/2018/03/05/the-effects-of-geely-buying-a-stake-in-daimler/. 45 Directive 2004/25/EC, Article 5.1. 46 Directive 2004/25/EC, Article 5.3.

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EU Investment Screening Regulation

On Tuesday, 20 November 2018, the Council of the EU and the European Parliament reached a provisional agreement on a future EU-wide coordination mechanism and information exchange for the screening of inward foreign direct investments (FDI) in the fields of EU strategic interest. The new regulation (“Regulation (EU) 2019/452 of the European Parliament and of the Council establishing a framework for screening of foreign direct investments into the Union”47) entered into force in April 2019 following its formal adoption by the Member States and by Parliament.48 Some EU member states already have legislation on FDI screening mechanisms. The new regulation does not aim to harmonise the formal FDI screening mechanisms previously adopted by these member states. Instead, it aims to enhance the coordination of FDI screening between the Commission and member states.49

4.3.1

Some Features of the Proposed Legislation

1. Member states can choose to maintain, amend or adopt mechanisms to screen FDI. 2. Minimum requirements: There is no obligation to introduce a screening mechanism, but if a Member State decides to do so, the competent authorities will need to fulfil minimum requirements (such as the principle of non-discrimination and transparency,50 the protection of confidential information51 and the right to judicial review52) and comply with time limits for national FDI review procedures.53 3. Other EU member states are also competent to provide comment to the Member State where an FDI is planned or completed. The comment shall be forwarded to the Commission in parallel.54

47

(EU)2019/452 https://eur-lex.europa.eu/eli/reg/2019/452/oj. EU foreign investment screening regulation enters into force, https://europa.eu/rapid/pressrelease_IP-19-2088_en.htm. 49 (EU) 2019/452 Article 1.3 “Nothing in this Regulation shall limit the right of each Member State to decide whether or not to screen a particular foreign direct investment within the framework of this Regulation.” 50 EU foreign investment screening regulation (EU) 2019/452 Article 3.2 https://eur-lex.europa.eu/ eli/reg/2019/452/oj. 51 EU foreign investment screening regulation (EU) 2019/452 Article 3.4 https://eur-lex.europa.eu/ eli/reg/2019/452/oj. 52 (EU) 2019/452 Article 3.5, “Foreign investors and the undertakings concerned shall have the possibility to seek recourse against screening decisions of the national authorities”. 53 EU foreign investment screening regulation (EU) 2019/452 Article 6. 54 EU foreign investment screening regulation (EU) 2019/452, Article 6.2. 48

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4. Sensitive areas, such as critical infrastructure, critical technologies and access to sensitive information need to be considered.55 5. In determining whether a foreign direct investment is likely to affect security or public order, Member States and the Commission may take into account whether the foreign investor is controlled by the government of a third country, including through significant funding.56 6. Member States shall give due consideration to comments or opinions.57

5 China M&A Legislation 5.1

Fundamental Regulation of Foreign Mergers and Acquisitions of Domestic Enterprises

MOFCOM order no.658 plays an essential role in regulating mergers and acquisitions of domestic enterprises by foreign investors (See Fig. 14). In China, one company can acquire another in several ways, including purchasing some or all of the company’s assets or buying up its outstanding shares of stock.59 For share acquisitions, investors can acquire the equity or subscribe additional registered capital of a domestic company and convert it into a foreign investment enterprise (FIE). For asset acquisition, investors can either establish a new FIE and acquire the assets of a domestic company, or directly acquire the assets of a domestic company and then inject those assets as registered capital into an FIE. Recent developments show a practical opening-up: Dutch bank ING is setting up a joint venture with Beijing Bank in China for tech clients, with the Dutch holding a majority 51% in the new Chinese bank of RMB 3 billion.60

5.2

Limits on Industries Entry

The Catalogue of Industries for Guiding Foreign Investment (2017) is the basic piece of market entry legislation relating to all foreign investment in China. According to article 4 of Order No.6,61 company acquisitions cannot result in: 55

EU foreign investment screening regulation (EU) 2019/452, Article 4.1. EU foreign investment screening regulation (EU) 2019/452, Article 4. 57 EU foreign investment screening regulation (EU) 2019/452, Articles 6.9, 7.7. 58 Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009). 59 Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009), Article 2. 60 Dow Jones Newswires, 21 March 2019. 61 Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009), Article 4. 56

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Fig. 14 Provisions on merger and acquisition of domestic enterprises by foreign investors (Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009))

(1) Foreign investors holding 100% of shares of the acquired company in industries that are not encouraged in the Catalogue; (2) Foreign investors becoming the controlling party of the acquired company in industries that are restricted;62 (3) Foreign investors acquiring companies in industries where foreign investment is prohibited.63 In the case of mergers and acquisitions of domestic enterprises by foreign investors and the obtaining of control of domestic enterprises which involve national or economic security or which own well-known trademarks or time-honoured China brands, the parties involved shall submit a declaration to the Ministry of Commerce. Where the parties involved do not submit a declaration, but the merger or acquisition has or may have a significant impact on national and economic security, steps will be taken to eliminate the impact of the merger or acquisition on national and economic security: the Ministry of Commerce may, together with other relevant authorities,

62 63

The Catalogue of Industries for Guiding Foreign Investment (2017), restriction part. The Catalogue of Industries for Guiding Foreign Investment (2017), prohibition part.

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require the parties involved to terminate the transaction or adopt a transfer of the relevant equity or assets or take other effective measures.64 Additionally, if the target company of the acquisition deal is located in Central or Western China, investors may refer to the Catalogue of Priority Industries for Foreign Investment in Central and Western China (2017 revision),65 which grants incentives to foreign investment in these areas. Special rules also apply to foreign investment in certain sectors, including, but not limited to, real estate, the commercial sector and advertising. Encouraged projects in the Catalogue of Industries for Guiding Foreign Investment with a total investment (including capital increase) of 300 million US dollars or more and requiring that the Chinese party has a (comparatively) controlling share shall be subject to confirmation by the National Development and Reform Commission.66 Such projects with a total investment (including capital increase) of less than 300 million US dollars shall be subject to confirmation by local governments.67 Restricted projects (excluding real estate projects) in the Catalogue of Industries for Guiding Foreign Investment with a total investment (including capital increase) of 50 million US dollars or more shall be subject to confirmation by the National Development and Reform Commission.68 Real estate projects falling under the restricted category in the Catalogue of Industries for Guiding Foreign Investment and other restricted projects in the same Catalogue with a total investment (including capital increase) of less than 50 million US dollars shall be subject to confirmation by provincial governments.69

5.3

Regulations on Security Review and Anti-Monopoly Investigations

The Chinese government has been careful in weighing the risks against the benefits of foreign enterprises acquiring domestic companies, particularly in what are considered to be key sectors. In addition to the anti-monopoly investigations stipulated 64

Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009), Article 12. 65 Official website of National Development and Reform Commission, http://www.ndrc.gov.cn/ fzgggz/wzly/wstz/wstzgk/201702/t20170228_839515.html. 66 Measures for the Administration of Approval and Filing of Foreign Investment Projects(Decree of the NDRC No.12, 2014), Article 4. 67 Official website of National Development and Reform Commission, http://www.ndrc.gov.cn/ zcfb/zcfbl/201405/t20140520_612252.html. 68 Measures for the Administration of Approval and Filing of Foreign Investment Projects(Decree of the NDRC No.12, 2014), Article 4. 69 Official website of National Development and Reform Commission, http://www.ndrc.gov.cn/ zcfb/zcfbl/201405/t20140520_612252.html.

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in the PRC Anti-Monopoly Law and the Order No.6, an additional security review by the joint Ministerial Conference has been required since March 3, 2011, as indicated in “Notice on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (Guo Ban Fa [2011] No. 6)”. More details can be observed in another legal document released later in 2011, the “Provisions on Implementation of Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (Ministry of Commerce Announcement [2011] No. 53)”.

5.3.1

Security Review

The scope of M&A Security Review is as follows: foreign investors’ mergers and acquisitions of domestic military industrial enterprises and enterprises associated with military industry, enterprises based in the peripheries of important or sensitive military facilities, and other enterprises that have a bearing on security of national defence; foreign investors’ mergers and acquisitions of domestic enterprises that have a bearing on national security in areas such as important agricultural products, important energy and resource services, important infrastructure, important transportation services, key technologies, key equipment manufacturing etc., with the possibility of foreign investors obtaining actual control.70 Foreign investors’ acquisition of actual control includes:71 (1) After M&A, the foreign investor, its parent holding company and/or its holding subsidiaries possess more than 50% of the total shares. (2) After M&A, the shares held by several foreign investors exceed 50% of the total shares. (3) After M&A, the total shares held by the foreign investor, albeit less than 50%, represent sufficient voting rights to exert material influence over the resolutions of the general meeting or shareholders’ meeting and the board of directors.72 (4) Other situations that lead to the shift of actual control of a domestic enterprise, including operational decision making, finance, human resource management, technology etc., to foreign investors.

70 Notice on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (2011), Article 1(1). 71 Notice on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (2011), Article 1. 72 Company law of the People’s Republic of China (2013), Article 43 “Unless it is otherwise provided for by this Law, the discussion methods and voting procedures of the shareholders’ meeting shall be provided for in the bylaw. A resolution made at a shareholders’ meeting on revising the bylaw, increasing or reducing the registered capital, merger, split-up, dissolution or change of the company form shall be adopted by the shareholders representing 2/3 or more of the voting rights.”

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Outcomes of the Review Findings If it is deemed a transaction may have, or has already had an impact on national security, the transaction is terminated and measures taken to eliminate the impact.

5.3.2

Anti-Monopoly

Pursuant to the provisions of the Anti-monopoly Law, where the merger and acquisition of a domestic enterprise by a foreign investor meets the declaration standard stipulated in the ‘Provisions of State Council on Declaration Threshold for Concentration of Business Operators’,73 a declaration shall be made to the Ministry of Commerce in advance; no trading shall take place unless the declaration has been made.74 Where the accumulation of undertakings reaches any of the determined thresholds, the undertaking(s) concerned shall file a prior notification with the competent commerce department of the State Council, and no such accumulation may occur without the clearance of prior notification.75,76

5.4

Transfer of State-Owned Property Rights and Equity

M&A of domestic enterprises by foreign investors which involve transfer of stateowned property rights of an enterprise and management of state-owned equity of a listed company shall comply with the relevant provisions on administration of stateowned assets.77 The transfer of state-owned assets shall be decided by the body performing the contributor’s functions. If a body performing the contributor’s functions decides to transfer the full (state-owned) assets or transfer partial (state-owned) assets which will cause the state to lose the controlling position over the enterprise, it shall report such a decision to the corresponding people’s government for approval.78 If the state-owned assets are transferred to any overseas investor, the relevant state

73 Provisions of State Council on Declaration Threshold for Concentration of Business Operators (2008). 74 Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009), Article 51. 75 Provisions of State Council on Declaration Threshold for Concentration of Business Operators (2008), Article 3. 76 Ibid. 77 Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009), Article 5. 78 Law of the People’s Republic of China on the State-owned Assets of Enterprises (2008), Article 53.

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provisions shall be observed, and the national security and public interest shall not be compromised.79

5.5

Listed Company

Foreign investors may undertake strategic investment in accordance with regulations upon approval from the Ministry of Commerce.80 Foreign investors who want to conduct strategic investment must meet stringent criteria as regards governance, financial status and minimum assets81 and fulfil all legal obligations in accordance with the Securities Law of the People’s Republic of China and the related provisions of China Securities Regulatory Commission.82 According to Securities Law of the People’s Republic of China, when an investor, through securities trading at a stock exchange, comes to hold (individually or with any other person) 5% of the shares as issued by a listed company the investor shall, within 3 days as of the date when such shareholding becomes a fact, submit a written report to the securities regulatory authority under the State Council and the stock exchange, notify the relevant listed company and announce the fact to the general public. Within the aforementioned prescribed period, the investor may not purchase or sell any shares in the listed company. The investor must report each 5% increase or decrease in the proportion of the issued shares.83 Where an investor holds (individually or with any other person) 30% of the stock as issued by a listed company through securities trading at the stock exchange and continues the purchase, he/she shall issue a tender offer to all shareholders of said listed company to purchase all or some of the shares of the listed company.84

5.6

Foreign Exchange Control

Foreign investors shall comply with relevant Chinese laws and administrative regulations on foreign exchange control, and promptly complete various foreign exchange approval, registration, filing and registration-modification formalities with the foreign exchange control authorities.85

79

Law of the People’s Republic of China on the State-owned Assets of Enterprises(2008), Article 57. 80 Measures for strategic investment by foreign investors upon listed companies(2018), Article 3. 81 Measures for strategic investment by foreign investors upon listed companies(2018), Article 5. 82 Measures for strategic investment by foreign investors upon listed companies(2018), Article 8,14. 83 Securities Law of the People’s Republic of China (2014), Article 86. 84 Securities Law of the People’s Republic of China (2014), Article 88. 85 Foreign Investment Law of the People’s Republic of China (2019), Article 21.

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Fig. 15 General procedure for company acquisitions (Ibid)

The registration administration authorities are the State Administration for Industry and Commerce of the People’s Republic of China or the local administration for industry and commerce authorised by the State Administration for Industry and Commerce; the foreign exchange control authorities are the State Administration of Foreign Exchange of the People’s Republic of China or its branches.86

5.7

Approval and Filing

Foreign investment project management is divided into two categories: approval and filing.87 Upon signing the acquisition agreement, investors should apply for the “Certificate of Approval for Foreign Investment” from MOFCOM (Ministry of Commerce) or its local level branches according to the investment amount, type of enterprise, and the industry to be invested in.88 Several requirements must be met to get the approval from MOFCOM,89 and a multitude of specific documents are required to be submitted (see Fig. 15).90

86 Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (2009), Article 10. 87 Measures for the Administration of Approval and Filing of Foreign Investment Projects (Decree of the NDRC No.12, 2014), Article 3. 88 Measures for the Administration of Approval and Filing of Foreign Investment Projects (Decree of the NDRC No.12), Article 8–9. 89 Measures for the Administration of Approval and Filing of Foreign Investment Projects (Decree of the NDRC No.12), Article 16. 90 Measures for the Administration of Approval and Filing of Foreign Investment Projects (Decree of the NDRC No.12), Article 10.

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177

QFII (Foreign Investment in Securities Products)

The Qualified Foreign Institutional Investor (QFII) Scheme is a transitional arrangement that allows institutional investors who meet certain qualifications to invest in a limited scope of cross-border securities products, in the context of incomplete free flow of capital accounts. Foreign investments in China are restricted due to foreign exchange control. The quota, products, accounts, and fund conversions are strictly monitored and regulated.

5.8.1

Qualification Procedures

1. A qualified investor shall entrust a domestic commercial bank with managing the assets as the custodian (only one custodian to be appointed) and entrust the domestic securities company with handling the securities trading activities in the territory.91 This custodian must meet stringent conditions92 and must be approved by the China Securities Regulatory Commission and the State Administration of Foreign Exchange. After receiving the complete application documents, the China Securities Regulatory Commission will sign the State Administration of Foreign Exchange for an escrow licence.93 2. Applicants can submit documents through the custodian to apply for qualified investor qualifications (China Securities Regulatory Commission) and investment quotas (the State Administration of Foreign Exchange). After obtaining the qualification from the China Securities Regulatory Commission, a qualified investor may obtain a certain amount of investment quota (the base amount); The application for investment quota must be approved by the State Administration of Foreign Exchange.94 ※ (1) qualified investor qualifications—China Securities Regulatory Commission. If the decision is approved, the securities investment business licence shall be issued.95 ※ (2) investment quotas—the State Administration of Foreign Exchange. 91 Provisions on the Foreign Exchange Administration of Overseas Securities Investment of Qualified Domestic Institutional Investors is the law governing QFII, Article 3. 92 Measures for the Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors, Article 11. 93 Measures for the Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors, Article 12. 94 Provisions on the Foreign Exchange Administration of Overseas Securities Investment of Qualified Domestic Institutional Investors, Article 5. 95 Measures for the Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors, Article 8.

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The applicant shall, within one year from the date of obtaining the securities investment business licence, submit an application for investment quota to the State Administration of Foreign Exchange through the custodian.96 If the decision is approved, a written approval shall be issued and a foreign exchange registration certificate shall be issued. The State Administration of Foreign Exchange may adjust the criteria by considering factors such as balance of payments and capital market development.

Open Accounts A qualified investor shall, on the basis of the information on the investment quota of the State Administration of Foreign Exchange, or the approval document, and analysis of the contents of the relevant control information table of the capital project information system, open a corresponding foreign exchange account with the custodian for its own funds, client funds. A qualified investor who has opened a foreign exchange account shall open a special RMB deposit account corresponding to the foreign exchange account in accordance with the relevant regulations of the People’s Bank of China on the management of the domestic RMB settlement account of the overseas institution.97 Funds in qualified investor accounts may not without approval be used for purposes other than domestic securities investment.98 If the CSRC revokes qualification, the State Administration of Foreign Exchange cancels the investment quota of qualified investors, or other circumstances occur as stipulated by the State Administration of Foreign Exchange,99 the assets shall be realised within one month and the foreign exchange account shall be closed, and the corresponding investment amount shall be void at the same time.

Custodian’s Obligation Aside from keeping custody of all assets of qualified investors, custodians must also perform tasks such as supervising the investment operation of qualified investors and reporting to the China Securities Regulatory Commission and the State Administration of Foreign Exchange whether the investment instructions are legal or illegal,

96

Measures for the Administration of Domestic Securities Investment by Qualified Foreign Institutional Investors, Article 9. 97 Provisions on the Foreign Exchange Administration of Overseas Securities Investment of Qualified Domestic Institutional Investors, Article 11. 98 Provisions on the Foreign Exchange Administration of Overseas Securities Investment of Qualified Domestic Institutional Investors, Article 12. 99 Provisions on the Foreign Exchange Administration of Overseas Securities Investment of Qualified Domestic Institutional Investors, Article 13.

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reporting on purchase and sale of foreign exchange, income and expenditure, accounts etc.100,101

Additional Condition The State Administration of Foreign Exchange may implement macro-prudential management of remittance of qualified investor funds in accordance with the national economic and financial situation, the relationship between supply and demand in the foreign exchange market and the state of international payments.102 If a qualified investor fails to comply with regulations, the State Administration of Foreign Exchange shall impose penalties in accordance with the relevant provisions of the Regulations on Foreign Exchange Control and may reduce the amount of investment.103 Equally, if the custodian fails to carry out its duties, the State Administration of Foreign Exchange shall impose penalties; if the circumstances are serious, the relevant business may be terminated.104

6 Mirror Case 6.1 6.1.1

Daimler Acquires Geely Geely’s Profile

Profile of Zhejiang Geely Holding Group Co., Ltd (see Fig. 16). Legal Representative: Shufu Li. Shareholders: Shufu Li (91.08%); Xingxing Li (8.92%). Registered Capital: RMB 930 million. Business Scope: Automobile sales, industrial investment, investment in mechanical and electrical products, education, real estate investment, investment management, technical development of automobile vehicles, auto parts, automobile shape design, automobile model design, business import and export business.

100

Provisions on the Foreign Exchange Administration Qualified Domestic Institutional Investors, Article 14. 101 Provisions on the Foreign Exchange Administration Qualified Domestic Institutional Investors, Article 15. 102 Provisions on the Foreign Exchange Administration Qualified Domestic Institutional Investors, Article 16. 103 Provisions on the Foreign Exchange Administration Qualified Domestic Institutional Investors, Article 24. 104 Provisions on the Foreign Exchange Administration Qualified Domestic Institutional Investors, Article 25.

of Overseas Securities Investment of of Overseas Securities Investment of of Overseas Securities Investment of of Overseas Securities Investment of of Overseas Securities Investment of

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Fig. 16 Structure of Geely Group. Ultimate actual controller: Shufu Li (Geely website, see http:// zgh.com/our-business/?lang¼en)

6.1.2

Limits on Industries Entry

Automobile Manufacturing: Except for special vehicles and new energy vehicles, the proportion of Chinese stock in automobile manufacturing shall be more than 50%. The same foreign company can establish no more than two joint ventures producing similar vehicle products in China.

6.1.3

Different Ways of Carrying Out M&As

Direct Negotiation First, Daimler will negotiate with Geely about the offer. Usually, foreign investors will draft either a “letter of intent” (LoI) or a “memorandum of understanding” (MoU) after initial investigation of and negotiation with the targeted company, outlining the matters that the two parties are going to discuss and laying out the complete procedures for doing so. To better understand the targeted company and to avoid potential risks, it’s very important for investors to conduct a comprehensive due diligence investigation. Approval and Filing Upon signing the acquisition agreement, investors should apply for the “Certificate of Approval for Foreign Investment” from MOFCOM (Ministry of Commerce) or its local level branches according to the investment amount, type of enterprise, and the

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industry to be invested in.105 We can assume that in a case of a foreign enterprise attempting to acquire a stake in a company such as Geely, the investor would have to apply for approval from MOFCOM itself. For the approval process with MOFCOM, certain documents are required to be submitted depending on whether the transaction is an equity or asset acquisition.106 MOFCOM announces its acceptance or rejection of the application within 30 days of receipt of the application documents.107 Where successful, MOFCOM will present a certificate of approval. Business Licence Upon receipt of the approval certificate from MOFCOM by foreign investors engaged in equity acquisitions, the acquired domestic company will be responsible for the modification of its registration with the original registration authority and for obtaining an FIE business licence. If the original registration administration authorities do not have jurisdiction for registration, the application documents are forwarded to the relevant authorities within 10 days from the date of receipt of the application documents. Within 30 days of receiving the FIE business licence, the investors need to complete subsequent registration with the tax, customs, land administration and foreign exchange control bureaus. Payment Requirements The foreign investor should pay the full amount as stated in the Equity Purchase Agreement within three months of the receipt of the FIE business licence. Under special circumstances and subject to the approval of the Ministry of Foreign Trade and Cooperation (MOFTEC), or the relevant provincial examination and approval authority, the foreign investor can pay a minimum of 60% of the price within six months, with the full balance to be paid within one year of the issuance of the FIE business licence. If the foreign investor conducts the acquisition through subscription to the capital increase of a domestic enterprise, they will pay no less than 20% of the amount of registered capital to be increased at the time of application for the FIE business licence.

105

Measures for the Administration of Approval and Filing of Foreign Investment Projects (Decree of the NDRC No.12, 2014), Article 8–9. 106 Measures for the Administration of Approval and Filing of Foreign Investment Projects (Decree of the NDRC No.12, 2014), Article 10. 107 Measures for the Administration of Approval and Filing of Foreign Investment Projects (Decree of the NDRC No.12, 2014), Article 15.

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Anti-Monopoly As we saw in Sect. 5.3.2., under the Anti-Monopoly Law, where the merger or acquisition of a domestic enterprise by a foreign investor attains the declaration standard stipulated in the ‘Provisions of State Council on Declaration Threshold for Concentration of Business Operators’, a declaration must be made in advance with the Ministry of Commerce; no trading can take place if this declaration is not made. Where a concentration of undertakings reaches any of the turnover thresholds described in Sect. 5.3.2., the undertaking(s) concerned shall file a prior notification with the competent commerce department of the State Council, and no such concentration may be implemented without the clearance of prior notification.108 Again, it is safe to assume a company such as Geely easily meets these thresholds, meaning prior notification would have to be filed. Security Review The scope of M&A Security Review, as shown in Sect. 5.3.1., includes foreign investors’ mergers and acquisitions of domestic enterprises that have a bearing on national security in areas such as important infrastructure, important transportation services, key technologies, key equipment manufacturing etc., with the possibility of foreign investors obtaining actual control.109 On top of this, the legislator has left room for specific circumstances: in China, NDRC and the Ministry of Commerce have the power to conduct a security review if they deem any company part of a key industry which may affect national security. The review is conducted by an Inter-Ministerial Panel led by the National Development and Reform Commission and the Ministry of Commerce under the leadership of the State Council, which work with relevant government agencies to carry out M&A security reviews, in accordance with industries and sectors where the foreign investors’ M&As take place.110 If the transaction is expected to have an impact on national security it is terminated. Geely Group is a big company which is of great significance to China, so it is to be expected a security review would be conducted if any foreign investor attempted to acquire a sizeable number of its shares.

108

Provisions of State Council on Declaration Threshold for Concentration of Business Operators, Article 3. 109 Notice on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, Article 1. 110 Notice on Establishment of Security Review System Pertaining to Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (2011), Article 3.

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Table 4 Main shareholders of Geely Automobile Holdings Limiteda Name Proper Glory Holding Inc. Zhejiang JiRun Automobile Co., Ltd Shufu Li Zhejiang Geely Group Co., Ltd a

Shares 3167.79 million 796.56 million 23.14 million 0.08 million

% of shares 35.29 8.87 0.26 0.0010

HKEXnews, see https://www.hkexnews.hk/index.htm. Accessed 21 December, 2018

Indirect The parent company—Zhejiang Geely Holding Group Co. Ltd—is a non-listed company, so Daimler cannot acquire the shares through secondary market. The only listed company in the group of Geely companies is Geely Automobile Holdings Limited. On May 10, 2014, Geely Group officially revealed to the public that it has successfully listed in Hong Kong Exchanges and Clearing Limited (HKEX). Geely Automobile Holdings Limited is a company incorporated in the Cayman Islands with limited liability (see Table 4). Companies listed in Hong Kong are also subject to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited or the Rules Governing the Listing of Securities on the Growth Enterprise Market of The Stock Exchange of Hong Kong Limited (as the case may be), as well as the Codes on Takeovers and Mergers and Share Buy-backs (which apply to public companies). Securities and Futures Ordinance Disclosure Part 15 of the Securities and Futures Ordinance (the ‘SFO’) requires an acquisition of an interest of 5% or more of the voting shares of a Hong Kong listed company to be disclosed to the HKEx and the company within 3 business days.111 An ‘interest’ in shares includes an interest in the underlying shares of equity derivatives. Disclosure is also required if a notifiable interest increases or decreases across a percentage level (e.g. from 6.9% to 7.1%). Once the 5% threshold is reached, the acquisition or disposal of a short position of 1% or more in the voting shares of a listed company and a change in the percentage level of a short position must also be disclosed. Disclosure must be made to all offerors and the offeree or their respective financial advisers and to the Executive and, in the case of listed securities, to the HKEx. In Hong Kong, any takeover, merger, privatisation and share repurchase activities affecting public companies are regulated by the Codes on Takeovers and Mergers

111

Securities and Futures Ordinance, Part 15.

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and Share Buy-backs (referred to as the Codes) which are issued by the SFC in consultation with the Takeovers and Mergers Panel. Mandatory Offers Under the Hong Kong Codes on Takeovers and Mergers Under Rule 26 of the Codes, the Securities and Future Commission (SFC) requires a mandatory offer to be made to all the shareholders of the offeree by the offeror in the following circumstances, unless a waiver is granted by the Executive:112 1. when any person (or two or more persons acting in concert) acquires, whether by a series of transactions over a period of time or not, 30% or more of the voting rights of a company; and 2. when any person (or two or more persons acting in concert) holding not less than 30% and not more than 50% of the voting rights of a company, acquires additional voting rights that increase his or their holding of voting rights by more than 2% from the lowest percentage holding by that person (or the concert group) in the preceding 12-month period. This is commonly referred to as the ‘creeper provision’. The Minority’s Right to be Bought Out Alternatively, the holder of any shares to which the offer relates may require the offeror to acquire their shares. Section 700 of the Companies Ordinance provides that where the offeror has by virtue of acceptances of the takeover offer acquired or contractually agreed to acquire at least 90% in number of the shares in the offeree before the end of the offer period, a holder of shares who has not accepted the offer may by letter addressed to the offeror require it to acquire his shares. Where shareholders are entitled to require the offeror to acquire their shares under section 700, the offeror must give notice to relevant shareholders of their rights under that section and of the period during which those rights are exercisable. This notice must be given within one month of the section 700 rights arising. A shareholder must exercise their right to require the offeror to purchase their shares within 3 months after the later of: (i) the end of the offer period; and (ii) the date of the offeror’s notice. Where the shareholder exercises their right to be bought out, the offeror is entitled and bound to acquire the shares on the terms of the offer or on such terms as it may agree. Suppose Geely is listed in Shanghai, then we should refer to the Securities Law of the People’s Republic of China. Where an investor, through securities trading at a stock exchange, comes to hold or holds with any other person 5 % of the shares as issued by a listed company by means of agreement or any other arrangement, the investor shall, within 3 days as of

112

Hong Kong Code on Takeovers and Mergers, Article 26.

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Table 5 Restricted period of different waysa Ways Securities trading at a stock exchange By agreement a

Threshold of reporting 5% 5%

Restricted period of disposing of shares Within the reporting period Within the reporting period as well as two days after the relevant report and announcement are made

Ibid

the date when such shareholding becomes a fact, submit a written report to the China Securities Regulatory Commission and the stock exchange, notify the relevant listed company and announce the fact to the general public. Within the aforesaid prescribed period, the investor may not purchase or sell any further shares of the listed company. In case an investor holds or holds with any other person 5% of the shares as issued by a listed company by means of agreement or any other arrangement, they shall, pursuant to the provisions mentioned above, make report and announcement of each 5% increase or decrease in the proportion of the issued shares of the said company they hold through securities trading at a stock exchange. Within the reporting period as well as two days after the relevant report and announcement are made, the investor may not purchase or sell any further shares of the listed company (see Table 5).113,114 Where an investor holds or holds with any other person 30% of the stock as issued by a listed company by means of agreement or any other arrangement through securities trading at a stock exchange and if the purchase is continued, they shall issue a tender offer to all the shareholders of the said listed company to purchase all of or part of the shares of the listed company. It shall be stipulated in a tender offer as issued to a listed company that, where the share amount as promised to be sold by the shareholders of the target company exceeds the scheduled amount of stocks for purchase, the purchaser shall carry out the acquisition according to the relevant percentage.115 Before any tender offer is issued pursuant to the provisions in the preceding paragraph, the relevant purchaser shall submit a report116 on the acquisition of a

113

Securities Law of the People’s Republic of China, Article 86. Securities Law of the People’s Republic of China, Article 87. 115 Securities Law of the People’s Republic of China, Article 88. 116 Securities Law, Article 89: The report shall include such items: (1) The name and domicile of the purchaser; (2) The decision of the purchaser on acquisition; (3) The name of the target listed company; (4) The purpose of acquisition; (5) The detailed description of the shares to be purchased and the amount of shares to be purchased in schedule; (6) The term and price of the acquisition; (7) The amount and warranty of the funds as required by the acquisition; and (8) The proportion of the amount of shares of the target company as held by the purchaser in the total amount of shares of the target company as issued, when the report on the acquisition of the listed company is reported. A purchaser shall concurrently submit to the stock exchange a report on the acquisition of the relevant company. 114

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listed company to the China Securities Regulatory Commission. A purchaser shall, after 15 days as of the day when the report on the acquisition of a listed company is submitted pursuant to the preceding paragraph, announce its tender offer. Within the aforementioned term, where the China Securities Regulatory Commission finds that any report in the acquisition of a listed company fails to satisfy the provisions of the relevant laws and administrative regulations, it shall notify the relevant purchaser in a timely manner not to issue the offer.117 In an acquisition of a listed company, the stock of the target company as held by a purchaser may not be transferred within 12 months after the acquisition is concluded.118 Supervision The China Securities Regulatory Commission shall carry out supervision and administration of the securities market according to law so as to preserve the order of the securities market and guarantee the legitimate operation thereof. A stock exchange shall exercise a real-time monitoring of securities trading and shall, according to the requirements of the China Securities Regulatory Commission, report any abnormal trading to them. A stock exchange shall carry out supervision over the information as disclosed by a listed company or the relevant obligor of information disclosure, supervise and urge it/them to disclose information in a timely and accurate manner according to law. A stock exchange may, if it requires so, restrict the trading through a securities account where there is any major abnormal trading and shall report it to the China Securities Regulatory Commission for archival filing.119 Where an issuer, a listed company or any other obligor of information disclosure fails to disclose information, submit the relevant reports according to the relevant provisions, or where there is any false record, misleading information or major omission in the information or any report as disclosed, the securities regulatory body shall order it to be corrected, give a warning and impose a fine. The person in charge and any other person directly responsible, as well as any controlling shareholder or actual controller of an issuer, a listed company or any other obligor of information disclosure which instigates any irregularity shall also be subject to these punishments.120 Where a purchaser fails to perform their obligations such as announcing the acquisition of a listed company, issuing a tender offer or reporting the acquisition report of a listed company or unlawfully alters their tender offer according to the present Law, they shall be ordered to correct this, given a warning and fined. Before any correction, for the stock that constitute more than 30% of shares of the target

117

Securities Law of the People’s Republic of China, Article 90. Securities Law of the People’s Republic of China, Article 98. 119 Securities Law of the People’s Republic of China, Article 115. 120 Securities Law of the People’s Republic of China, Article 193. 118

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company as held by them or held with any other person through an agreement or any other arrangement, their voting right may not be exercised. The person in charge and any other person directly responsible shall be given a warning and fined.121 Where a purchaser or any controlling shareholder of a purchaser takes advantage of the acquisition of a listed company to injure the legitimate rights and interests of the target company as well as the shareholders thereof, they shall be ordered to correct this and given a warning. Under serious circumstances, a fine can be imposed. Where any loss is incurred by the target company or its shareholders, they shall be subject to the liabilities of compensation according to law. Again, the person in charge and any other person directly responsible shall be given a warning and a fine can be imposed.122 If the information disclosure obligor in the acquisition of the listed company and the related information disclosure activities fails to perform the report, announcement and other related obligations in accordance with the provisions of the present measures, the CSRC shall order the correction, perform a supervisory talk, issue a warning letter, order the suspension or stop the acquisitions. The relevant information disclosure obligor shall not exercise voting rights on the shares held or actually controlled by them before correction.123

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EDP Acquires CTG

CTG is a state-owned company in China and is not listed on any stock exchange market. If EDP wants to acquire equities from CTG, it could only be a private offer. EDP would need to negotiate with CTG; however, Chinese state-owned companies are unwilling to sell any shares to external shareholders. The transfer of state-owned assets shall be decided by the body performing the contributor’s functions. If a body performing the contributor’s functions decides to transfer the state-owned assets, partially or in full, which will cause the state to lose the controlling position over the enterprise, it shall report such a decision to the corresponding people’s government for approval.124 If the state-owned assets are transferred to any overseas investor, the relevant state provisions shall be observed, and the national security and public interest shall not be compromised.125

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Securities Law of the People’s Republic of China, Article 213. Securities Law of the People’s Republic of China, Article 214. 123 Administrative Measures for the Takeover of Listed Companies, Article 75. 124 Law of the People’s Republic of China on the State-Owned Assets of Enterprises, article 53. 125 Law of the People’s Republic of China on the State-Owned Assets of Enterprises, article 57. 122

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Conclusion

While Chinese state-owned corporations are able to buy shares in foreign companies, there is no option for any external shareholder to buy into a Chinese stateowned company. Even when it comes to Chinese private companies the options for foreign investors to gain control are strictly limited. If a foreign investor such as Daimler were to attempt to buy a significant number of shares in a company like Geely, there would be a fair few hurdles before such a transaction could go ahead: First, they would need a Certificate of Approval from MOFCOM. They require an FIE business licence and must file a prior notification with the competent commerce department of the State Council to comply with the Anti-Monopoly Law. On top of this they would likely face a security review. At any of these stages during the prior approval process, the transaction can be terminated. It is therefore unlikely that any foreign party would ever be able to, suddenly and unexpectedly, acquire a serious stake in a major Chinese company, the way Li Shufu managed to do with the German Daimler.

7 New Development in China On March 15, 2019, China approved its new foreign investment law which will come into effect on January 1, 2020. The action of rush approval is regarded as a signal to ease complaints from foreign countries about unfair trade practices. The law attempts to address outstanding concerns raised by foreign investors, comprising protection of commercially confidential information,126 adoption of pre-establishment national treatment and a negative list system.127 The “pre-establishment national treatment” will offer foreign investors investment treatment no less favourable than that offered to Chinese domestic investors. Meanwhile, the Chinese government will implement a special list to restrict free investment in certain important industries and fields.128 It is significant that China is signalling to foreign investors that the Chinese government is willing to open its domestic markets to foreign businesses. It is worth noting that some people hold the opinion that China has adopted this measure in view of the ongoing serious and much-publicised trade dispute with the US. There are some important notable points in this law:129

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Foreign Investment Law of the People’s Republic of China (2019), Article 23. Foreign Investment Law of the People’s Republic of China (2019), Article 4.1. 128 Foreign Investment Law of the People’s Republic of China (2019), Article 4.2. 129 China Briefing, https://www.china-briefing.com/news/chinas-new-draft-foreign-investmentlaw; Foreign Investment Law of the People’s Republic of China (2019). 127

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(1) Essentially, governments will be prohibited from using administrative ways to force foreign investors to transfer their technology; (2) Foreign investors will be permitted to enjoy equal treatment as domestic counterparts in China apart from derogation specifically listed in the negative list; and (3) China reserves the right to retaliate against countries that discriminate against Chinese investment with “corresponding measures”. Although China has published the new law to ease foreign investment restrictions, the effect remains to be seen in the long run. However, it appears to be good news for European investors intending to conduct business there. No matter which party, China or Europe, both are in the process of changing and altering, trying to make a more adapted environment. Everyone is stepping out of the mist and gradually looking through the mirror to see what is happening on the other side.

Mergers and Competition in Digital Markets: Learning from Our Mistakes Matthew Cole

Abstract This paper analyses two particular merger decisions; the EU Commission’s Facebook/WhatsApp decision and the UK OFT’s (now CMA) Facebook/ Instagram decision. In analysing these two cases common flaws are discovered. First, a poor or superficial assessment of the relevant market and second, the assumption that rapid growth of entrants in these new product or geographical markets is an indication of low barriers to entry. These miscalculations lead to a mistaken belief that the markets in which the proposed mergers were to be conducted were competitive. It is argued here that once account is taken of these mistakes it becomes clear that the markets had far fewer competitors than originally thought and that they were not characterised by low barriers to entry on an ongoing basis. Policy recommendations are made to remedy these issues for the benefit of global competition enforcement authorities.

1 Introduction In April 2018 Senator Lindsey Graham asked the founder of Facebook, Mark Zuckerberg, to name a single competitor of Facebook’s social network. He struggled.1 How has the market for social media reached a stage where it appears that a single company has so few genuine competitors? Both in the UK and in the EU at large there exists competition laws that are designed to protect competition within markets and that includes in relation to mergers. Nonetheless, it appears that in new markets such as social media, markets that only 20 years ago did not exist in any meaningful form, the authorities have not found their feet in protecting consumers

1

https://www.washingtonpost.com/news/the-switch/wp/2018/04/10/transcript-of-markzuckerbergs-senate-hearing/?noredirect¼on&utm_term¼.56bc29d3fd0b (Accessed on 21/06/ 2019).

M. Cole (*) School of Law, University of Exeter, Exeter, United Kingdom e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_7

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through market competition. Instead of protecting competition they appear to have allowed huge technology companies to acquire their competitors, leading to a situation where there is a lack of alternatives for consumers and a lack of competition generally in these new markets. What can be seen from current academic literature on the subject of digital markets (not least most antitrust conferences) is that digital market developments are in an early stage of maturity and without prior experience competition authorities are still at the stage where they are trying to understand how to apply the law.2 The focal point of these developments includes online platforms3 but has also to some extent focused on the importance of ‘big data’.4 Some authorities and institutions have suggested that current case law, legal tools and economic theory may need to be adapted in order to properly target online platforms.5 Further, a number of competition authorities are either setting up groups or have set up groups seeking to review competition law and the tools with which it is equipped in order to ensure that they are prepared and able to deal with the new challenges presented by digital markets. This has happened in Germany,6 the UK7 and within the EU institutions

2

Mandrescu (2017), p. 353. See Commission Staff Working Document on Online Platforms SWD (2016) 172, https://ec. europa.eu/digital-single-market/en/news/commission-staff-working-document-online-platforms [Accessed 08 July 2019]; Commission Decision of 26.4.2018 on setting up the group of experts for the Observatory on the Online Platform Economy, C (2018) 2393 final. Auer and Petit (2015), p. 426. 4 Kupčík and Mikeš (2018), p. 393; Stucke and Grunes (2016); “Big Data: Bringing Competition Policy to the Digital Era” OECD Report ref. no.DAF/COMP(2016)14 published on 27 October2016. Consider also: Viktoria Robertson, H.S.E., Excessive Data Collection: Privacy Considerations and Abuse of Dominance in the Era of Big Data (June 24, 2019). Available at SSRN: https://ssrn.com/abstract¼3408971 (Accessed on 08/07/2019); Kathuria, Vikas and Globocnik, Jure, Exclusionary Conduct in Data-Driven Markets: Limitations of Data Sharing Remedy (February 18, 2019). Forthcoming in: Marco Botta (ed.), EU Competition Law Remedies in Data Economy, Springer 2019; Max Planck Institute for Innovation & Competition Research Paper No. 19-04. Available at SSRN: https://ssrn.com/abstract¼3337524 (Accessed on 08/07/ 2019); Although also consider Dirk Auer, Geoffrey Manne, ‘The Antitrust Dystopia: The Case of Big Data Competition’ (presented at ASCOLA conference 2019, forthcoming). 5 Mandrescu (2017) notes the following: rapport of the German national competition authority, http://www.monopolkommission.de/images/PDF/SG/s68_fulltext_eng.pdf; see also the rapport from the DG for internal policy on online platforms, http://www.europarl.europa.eu/RegData/ etudes/STUD/2015/542235/IPOL_STU(2015)542235_EN.pdf; and the OECD Round table on two sided markets DAF/COMP/WD/(2009)69, https://www.oecd.org/daf/competition/44445730.pdf [Accessed 08 July 2019]. 6 Kommission Wettbewerbsrecht 4.0, Bundesministerium für Wirtschaft und Energie, https://www. bmwi.de/Redaktion/DE/Artikel/Wirtschaft/kommission-wettbewerbsrecht-4-0.html [Accessed 10 July 2019]. 7 https://www.gov.uk/government/consultations/digital-competition-expert-panel-call-for-evi dence/digital-competition-expert-panel [Accessed 10 July 2019]. 3

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themselves.8 While this is well received by some such as Jean Tirole, the Nobel Prizing winning economist,9 others, such as Jung and Sinclair, suggest that the desire to change the law is based on ‘politically fuelled interventionism’ and the reappearance of the ‘big is bad’ philosophy which they link to a ‘wider populist, anti-elitist movement’.10 Jung and Sinclair consider that there should be no wide reaching reform without detailed consideration of empirical evidence.11 They, although listing a number of apparent ‘type 2’ errors,12 are concerned that should the law change this would potentially cause ‘type 1’ errors that could deprive consumers of greater innovation and competition.13 There is also a debate around the procedural aspects of mergers in digital markets. In particular, there is concern that traditional filing thresholds, usually based on the revenue generated by the merging parties, are no longer effective. This has caused some countries to amend their competition law.14 This is not the focus of the present work however, which instead focuses on the substantial aspects of the law. This chapter however is not concerned with changing regulation. Rather, this chapter argues that the greatest flaw that has undermined the present system is a reliance on the dynamism of the technology sector to ensure that competition survives. As far back as 2015 Weitbrecht noted that although some observers had criticised the EU Commission’s clearance of major technology mergers on ‘superficial analysis’,15 he hoped that ‘it may well be that the constantly moving innovation in the digital world will ultimately prove the Commission’s laissez-faire approach to be correct.’16 Which has been reiterated by others since.17 The fundamental crux of this chapter is to argue that a focus on the initial dynamism of digital markets by competition authorities can lead to a situation where competition is undermined. This is because competition authorities can and are placing too much emphasis upon the initial dynamism of a market that has been disrupted by technology and are not accounting for the following stagnation of that market due to network effects once it has become more mature. This is to say that they have not accounted for the

8

Jacques Crémer, Yves-Alexandre de Montjoye and Heike Schweitzer (European Commission), Competition Policy for the Digital Era (4 April 2019), http://ec.europa.eu/competition/publications/ reports/kd0419345enn.pdf [Accessed 10 July 2019]. 9 Jean Tirole, Competition Policy in the Digital Age (Shaping competition policy in the era of digitisation, Brussels, January 2019). 10 Jung and Sinclair (2019), p. 266. 11 Jung and Sinclair (2019), p. 267. 12 Jung and Sinclair (2019), pp. 268–270. 13 Jung and Sinclair (2019), p. 270. 14 Consider Germany’s new § 35 1a in the Gesetz gegen Wettbewerbsbeschränkungen 1957 and Austria’s new § 9(4) in the Bundesgesetz gegen Kartelle und andere Wettbewerbsbeschränkungen 2005. Also consider as a solution to this issue Andrew McLean, “Futurity and the Future of Competition: The Case of Killer Acquisitions” (15th ASCOLA conference, online, June 2020). 15 Weitbrecht (2015), p. 153. 16 Weitbrecht (2015), p. 153. 17 Mandrescu (2017), p. 353.

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significant first mover advantages these markets can engender. This is not to say that this will be a concern in every market subject to significant digital disruption, but that authorities must no longer be dazzled by disrupted markets because they are initially subject to a remarkably quick transformation, but rather must carefully analyse whether each market is of the sort likely to stagnate quickly after an initially period of rapid change and enforce the law accordingly. To do this, this chapter will analyse two separate decisions; one by the EU Commission and the other by the United Kingdom’s Office of Fair Trading (what is now the Competition and Markets Authority). Through analysis of these decisions it will be shown that a significant error has occurred in the way the authorities have analysed digital markets. It will then be suggested how the authorities can reform their approach in order to properly take into account the difficulties of the situation and provide effective protection of competition and implement an effective merger policy in digital markets. There are other decisions of value in this area,18 but in the present case it is only necessary to consider these two to demonstrate both the mistakes made and the fact that they are not restricted to either one decision or even one jurisdiction.19 This, will provide a valuable contribution, not just for the UK or the EU competition authorities, but further abroad, in markets that have less established competition systems that are similar to or related to EU competition law, such as China. The structure of the chapter will be as follows: First the law will be set out, focusing mainly on the European Union Merger Regulation (EUMR) and the Guidelines on the assessment of horizontal mergers. This first part will show the framework in which the Commission and the UK OFT has worked, showing the matters that the law and the Guidelines directs the authorities to consider. This section will not broadly evaluate the law, but will focus on those aspects of the law that relate to the matters in hand. Second, the WhatsApp decision will be considered. Here it will be argued that the Commission incorrectly evaluated the state of the market by considering several apps to be interchangeable. As a result of this mistake the Commission believed that consumers were happy to ‘multi-home’, that is, that consumers are willing to use several apps all of which perform the same function. This led to the erroneous belief that the markets concerned were actually competitive, rather than a duopoly. It will also be argued that there was a fundamental flaw in the decision: the Commission equated the explosive growth in consumer messaging apps with a dynamic market with low barriers to entry and easy access for

Consider for example OFT, ‘Motorola Mobility Holding (Google, Inc.) of Waze Mobile Limited’ (2013) ME/6167/13; OFT, ‘Anticipated acquisition by Amazon.com Inc. of the Book Depository International Limited’ (2011) ME/5085/11; Commission, ‘Case No COMP/M.4731 - Google/ DoubleClick’ C(2008) 927 final; OFT, ‘Anticipated acquisition by Expedia of Trivago’ ME/5894/13 (the OFT elected not to assess this merger due to failing the market share test); and most recently Facebook/Giphy although whether this will be challenged in the US jurisdiction is open to question. 19 In the sense that one comes from the UK and the other from the EU, even though UK and EU law shares the same fundamental principles. 18

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competitors and potential competitors. It will be argued that the Commission, by not realising that there are actually significant first mover advantages in consumer messaging apps, misinterpreted the explosive growth of first movers as ease of entry, when actually mature markets are beset by significant barriers to entry for later entrants. Third the Instagram decision will be analysed. This will reinforce the same point in relation to explosive growth and the fallacy that this indicates low barriers to entry and therefore a low risk of restricted competition. Fourth this flaw will be expressed in more broad terms with reference to the economic and business literature on the subject and finally the implications of all this for competition law and policy will be set out. It will be recommended that the Guidance is amended to make specific reference to the differences between rapid entry and growth in new undeveloped markets and how this should not be assumed to be representative of low barriers to entry in the same markets once they have matured. A more narrow recommendation will also be made in relation to competition authorities regarding digital networks; that they are careful not to assume that similar functionality within apps is proof of their interchangeability when delineating markets. Rather, in digital markets at least, it will also be important to consider the significance of the audience to which the network is directed and whether from a consumer point of view, their similar functionality is used to address different audiences for different reasons, making them to all intents and purposes, separate markets.

2 The Law The European Union Merger Regulation sets out that mergers are to be ‘welcomed to the extent that they are in line with the requirements of dynamic competition’20 and increase the competitiveness of European industry. This is subject to the requirement that they avoid lasting damage to competition.21 The crucial test that is implemented by the EU Commission to achieve this balance is whether a merger would ‘significantly impede effective competition’22 (the SIEC test). This phrase is rather vague and therefore it is not surprising that the EU Commission (the Commission) has published guidelines on how this test will be applied. There are Guidelines both on vertical mergers23 and horizontal.24 Of particular relevance here are the Horizontal Guidelines. These Guidelines provide factors that indicate the likelihood that a merger would have anticompetitive effects in the relevant markets,25 this is largely dealt with in section 4 of the Guidelines. The Guidelines state that when considering

20

The European Union Merger Regulation (EUMR) preamble para 4. EUMR preamble para 5. 22 EUMR Article 2. 23 Vertical merger guidelines. 24 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5. 25 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 11(b). 21

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possible anti-competitive effects they will consider, inter alia, if the merger is taking place between potential competitors.26 It is here the Guidelines that are crucial to the analysis below are found. The Guidelines consider a number of possible anti-competitive effects caused by horizontal mergers,27 one of these is non-coordinated effects. On this the guidelines state that: A merger may significantly impede effective competition in a market by removing important competitive constraints on one or more sellers, who consequently have increased market power. The most direct effect of the merger will be the loss of competition between the merging firms. For example, if prior to the merger one of the merging firms had raised its price, it would have lost some sales to the other merging firm. The merger removes this particular constraint.28

The difficulty in many respects for services provided by firms such as Facebook and Google is that they are ostensibly free. Therefore the likelihood of price rises is low, however, quality deterioration is also another harm that can be caused where there is a lack of competition. Other competition issues may also arise including higher barriers to entry due to the volume of data gathered by the merged entity and the possibility of higher prices in the advertising market, as these ‘free’ products are essentially just one side of a double sided market.29 The Guidelines also state that: When entering a market is sufficiently easy, a merger is unlikely to pose any significant anticompetitive risk. Therefore, entry analysis constitutes an important element of the overall competitive assessment.30

When considering the likelihood of entry the Guidelines note that barriers to entry should be taken into account, where they are high the likelihood of entry is lower and vice versa.31 In reference to this the Guidelines recognise the importance of network effects in making entry more difficult.32 The Guidelines also recognise the importance of switching costs making customers more vulnerable to price increases, or in this context quality degradation.33

26

Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 58–60. Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, Section IV. 28 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 24. 29 Although interesting, discussion of these issues will remain outside the ambit of this work as the harm caused by a lack of competition in ‘free’ product and service markets constitute a formidable topic in itself. 30 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 68; similarly in the UK Merger Guidelines it states: ‘Where entry barriers are low, the merged firm is more likely to be constrained by entry; conversely, this is less likely where barriers are high.’ Merger Assessment Guidelines CC2 Revised, OFT 1254, Sept 2010, para 5.8.4. 31 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 70. 32 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 71. 33 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 31. 27

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What will be argued here is that the major flaw that has occurred in both the UK and EU jurisdiction and both the WhatsApp decision and the Instagram decision is the flawed assessment of network effects and switching costs. The guidelines state in order to assess the level of barriers to entry ‘historical examples of entry and exit in the industry may provide useful information about the size of entry barriers’34 and similarly in reference to customer switching ‘Evidence of past customer switching patterns . . . may provide important information in this respect.’35 It is in the application of these points that the clearest mistakes were made by the Commission and the OFT respectively. By calculating the ease with which a new entrant may enter the market and considering that as representative of the ability of a new entrant to enter the same market in a more mature state the authorities grossly underestimated the barriers to entry and thus overestimated the potential competition that existed. They also mis-construed the theoretical ability (rather than the practical desire) of customers to multi-home and mistook the movement of a few WhatsApp users as indicative of a larger pattern of low switching costs between competitors, rather than the behaviour of a small number of users that was in no way significant enough to provide real competitive pressure.

3 The WhatsApp Decision The WhatsApp decision36 reveals two major flaws in the approach of the Commission to identifying a genuine threat to competition from the concentration. The first point is that it the Commission misconstrued the numerous consumer messaging apps in the market as a competitive market, when actually this is not the case and secondly, because of that misinterpretation, it undervalued WhatsApp as a challenger to Facebook in a sphere it dominated. These matters will be considered in turn. Beginning with the first mistake: In relation to consumer messaging the view of the Commission was that it did not suffer from high barriers to entry. The Commission stated that post-transaction there would remain a number of alternative consumer communications apps37 and that there were no significant costs preventing consumers from switching between different apps.38 The Commission found that: there were no significant traditional barriers to entry,39 that the market was dynamic and fast growing,40 that developing and launching a consumer communication app

34

Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 70. Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5, para 31. 36 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final. 37 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 108. 38 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 109. 39 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 117. 40 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 118. 35

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did not require a ‘significant amount of time and investment’,41 was not subject to important intellectual property rights42 neither did either party have particular hardware, software or other advantages that would hinder expansion of competitors in future.43 This all sounds like the ingredients for a competitive market. The Commission went so far as to use the explosive expansion of WhatsApp itself, along with its competitors Telegram, Line and Kik Messenger to show how easy it was to enter the market and grow a substantial body of users in very little time. This is an odd belief to hold, not least because if it really was that inexpensive and quick to establish a consumer communication app, one should ask why Facebook was choosing to pay $19 billion for WhatsApp, instead of expanding their own consumer messaging service. Consider, that $19 billion is actually more than Facebook itself was valued at when it undertook its IPO.44 The issue of network effects was dealt with using virtually the same facts to suggest that they were not sufficient to shield the merged entity from competition.45 The Commission referenced the tendency and ease with which consumers could ‘multi-home,46 the lack of any control of hardware or software infrastructure to control the market47 and the dynamism of the market, again placing weight on how other consumer communication software platforms, in particular LINE and WeChat, had after 3 years acquired more than 400 million active users worldwide48 and the fact that after the announcement of Facebook’s acquisition of WhatsApp ‘thousands of users downloaded different messaging platforms with better privacy protection’.49 The foundation of the Commission’s error can be found in these two points; network effects do not restrict competition because (1) consumers can multi-home and (2) the market is dynamic and expanding as shown by the expansion of competitors. Both points are flawed. While it is true to say that users can multi-home and that various platforms have managed to obtain significant market share in short periods of time, to suggest this establishes a lack of barriers to entry is to ignore the nuance of the market. It is argued below that customers do not in fact multi-home in a way that maintains competition and the market is not as dynamic as the statistics presented suggest.

Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 119. Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 120. 43 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 121. 44 https://www.reuters.com/article/us-whatsapp-facebook-idUSBREA1I26B20140220. 45 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 135. 46 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 133. 47 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 134. 48 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 132. 49 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, footnote 79. 41 42

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Multi-Homing

The Commission decision states that ‘the EEA market for consumer communications apps features a significant degree of “multi-homing”, that is, users have installed, and use, on the same handset several consumer communications apps at the same time’.50 It is probably true that many consumers in the EU will have Twitter, Facebook, WhatsApp, LinkedIn and perhaps another networks on their smartphone or other internet enabled device. The functions of these apps appear similar, all have, for example, a messaging function and allow you to connect with other users of the network, but not all are interchangeable for consumers. If a consumer wants to contact a member of their family or close friends, they are extremely unlikely to use LinkedIn. LinkedIn is a professional network for making professional connections. They are also unlikely to use Twitter, since this is more for engaging with celebrities, politicians, companies and others who are not really personal contacts or for obtaining news. This helps explain why 97% percent of all 193 UN member states have an official presence on Twitter51 and why LinkedIn, unlike other platforms, has restrictions on how many messages you can send and to whom52 and allows you to know who has looked at your profile, while others do not. These differences make sense because although the basic functions of the different platforms are very similar, they are in fact distinct from the consumers’ point of view. Each platform is used for a particular type of communication that is not interchangeable. Consider, by way of analogy the following: a university campus coffee shop, an airport lounge coffee shop and a local independent café. Each may serve hot beverages and provide a place to sit and relax, but the purpose of visiting each and to whom you would suggest each as a meeting place is probably completely different. Consequently a user may appear to multi-home and have a number of apps on their phone that they use simultaneously but this does not mean those apps are in competition, rather it means the user has apps with similar functionality that are used for different purposes. After all, most people have a work profile on their employer’s webpage, but realistically no one would suggest that that would be a substitute for a MySpace page, their intended audience render them to all intents and purposes, wholly separate services despite the functionality being almost completely overlapping.

Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, 105. https://twiplomacy.com/blog/twiplomacy-study-2018/. 52 https://www.linkedin.com/help/linkedin/answer/192 (Accessed 03/04/2019); https://www. linkedin.com/help/linkedin/topics/6073/6089/437 (Accessed 03/04/2019). 50 51

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Explosive Growth ≠ Dynamic Market

Some apps that the Commission considered are genuine substitutes however. Consider LINE and WeChat, both of which started as simple consumer messaging services that provide the same features for the same purpose and the same possible groups of people. These are, of course, interchangeable. As the Commission stated they also achieved huge growth in users in a short period of time, so are these genuine competitors with WhatsApp? The answer is still ‘no’. The Commission in part acknowledges this stating: ‘certain consumer communications apps enjoy a greater reach than others in certain world regions. For example, WhatsApp is widespread in the EEA, but not so much in the USA; LINE and WeChat are particularly popular in Asia.’53 This is then backed up by the Commission’s data setting out the market shares within the EEA54 as follows: • • • • • • • • • •

WhatsApp: [20–30]%; Facebook Messenger: [10–20]%; Android’s messaging platform [5–10]%; Skype [5–10]%; Twitter [5–10]%; Google Hangouts [5–10]%; iMessage [5–10]%; Viber [5–10]%; Snapchat [0–5]%; other market players with a share of [0–5]% or less.55

Notably the two platforms that the Commission identifies as examples of consumer communication apps that have successfully entered the market and are genuinely interchangeable with WhatsApp (LINE and WeChat) are completely absent from the market. If LINE and WeChat were able to build up a user base of 400 million users in just 3 years, why are so few users to be found within the EEA? It is argued that this phenomenon can be explained by the lack of genuine multihoming that has already been described. If users do not really have more than one app for the same purpose, but actually have several apps for several different realms of communication (professional, intimate friends, broader public) and they don’t use more than one app for any one group then the market may be close to tipping while, on the Commission’s analysis, it looks competitive. Therefore, what is seen in the consumer messaging app market is not a dynamic market, but rather several geographic markets that are initially subject to explosive expansion as a new app becomes popular, then stagnation as network effects cause that particular geographic area to settle on one particular app. This explains why LINE has a strong user base in Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 38. Data provided by the Parties for their market share in the EEA market for consumer communications apps on iOS and Android smartphones between November 2013 and May 2014. 55 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final 96. 53 54

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Japan, (where it started) Taiwan, Thailand and Indonesia, which accounts for 67.3% of its monthly active users and is struggling to grow elsewhere.56 WeChat has around 700 million users, however of those 700 million only 70 million are outside of China.57 Despite an ambition to do so, WeChat’s plan to expand outside of China ‘is not considered to be a success’.58 Consequently competition is limited to those apps that target similar social interactions, in geographic areas that have substantial user populations for more than one of these apps. Only these are genuinely contestable markets. The next question that must be answered is: at the time of the WhatsApp decision were there any contestable markets and if so, which apps were in contest? A ‘virgin’ market with no real up take of consumer communication apps could be contested by any market entrant, but a market where 50% of the smartphone owning population uses platform A and 50% uses platform B is unlikely to be contestable by any other platforms other than platform A and platform B. In the EEA (at the time of the decision) there was a contestable market for consumer messaging services for personal contact between WhatsApp and Facebook messenger. Both are oriented towards personal communication and both have significant market shares in overlapping countries, consequently, they were two platforms that were genuinely in competition. This becomes all the more obvious when it is considered that other messenger services noted in the Commission’s market share analysis are proprietary messaging systems that are set as default on particular mobile Operating Systems (iMessage for Apple, Skype for Windows Phone and Android Messenger for Android) and are not always available on other platforms. Given the fact that markets tend to tip when there are strong network effects, WhatsApp and Facebook messenger could have been considered to be competing strongly against each other, each seeking to tip the market sufficiently so that they become the singular dominant platform in the EEA. Astonishingly, the Commission comes to the reverse conclusion. The Commission notes that Facebook Messenger and WhatsApp offer similar products, neither having features that are unique to them.59 The Commission notes that a significant overlap exists between the WhatsApp and Facebook network.60 The Commission expressly states ‘[i]n particular, WhatsApp and Facebook Messenger have been reported as being the two main consumer communications apps simultaneously used by the majority of the users in the EEA’,61 and strangely this draws the conclusion that ‘[t]his fact suggests that the two consumer communications apps are to some extent complementary, rather than being in direct competition with each

56

https://www.techinasia.com/line-annual-revenue-2015 (Accessed 03/04/2019). https://www.businessinsider.com/wechat-breaks-700-million-monthly-active-users-2016-4? r¼US&IR¼T (Accessed 03/04/2019). 58 http://www.businessofapps.com/data/wechat-statistics/ (Accessed 03/04/2019). 59 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 104. 60 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 104. 61 Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 105. 57

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other.’62 This could not be further from the truth. In order to demonstrate this consider the following hypothetical scenario based on the evidence provided to the Commission: Facebook represented that 60% to 70% of Facebook Messenger’s active users already used WhatsApp.63 This would mean in likelihood that without any change of behaviour an average user of both Facebook Messenger and WhatsApp would have between 60% to 70% of their contacts in Facebook Messenger also on WhatsApp. If a hypothetical event then occurs where, for example, Facebook degrades the quality of their product, perhaps by allowing significant breaches of data privacy or some other degradation, the users of Facebook Messenger can switch to communicating through WhatsApp with virtually zero switching costs. Their network is largely present on both systems, they already have both systems available, all that is necessary is to use one app instead of the other. This could lead to a substantial loss of customers that would provide significant competitive pressure on Facebook. In contrast, switching from Facebook Messenger to LINE or WeChat would require users convincing the majority of their contacts to download the new app, which may take a significant period of time, since each contact would be unlikely to switch unless they were confident that a majority of their contacts would do the same within a reasonable space of time. This leads to not so much as a chain reaction, but a continuous chain of friction, each user not switching because they need to get all their contacts to switch as well for the switch to be successful. On the facts then, the Commission made a significant mistake, interpreting the only genuine competitor to Facebook Messenger as a complement rather than a competitor. It is worth noting that some recognise the WhatsApp shut down in Brazil as evidence of the contestability of WhatsApp’s market.64 In December 2015 it was reported that 1.5 million users joined WhatsApp’s competitor; Telegram65 in just 48 h. But this was only after a court-ordered shut down of WhatsApp’s service. This was not a competitive event such as a competitor’s product launch or new price or function being implemented by a competitor. It was not even a system failure by WhatsApp, it was a court mandated shut down. There was only a significant change in users because users had no access to their usual service, meaning no ‘switch’ was actually necessary. There was no chain of friction because users did not need to convince each other to switch. They all had no service, so they all needed to seek out a new app. This shows that only an event that forces all users of a service to find a new provider simultaneously leads to a newly competitive, genuinely dynamic environment. In other words, one that returns the market to an almost ‘virgin soil’ state.

Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 105. Commission, ‘Case No COMP/M.7217 - Facebook/ Whatsapp’ C(2014) 7239 final, para 140. 64 Mandrescu (2017), p. 353. 65 http://money.cnn.com/2015/12/17/technology/telegram-whatsapp-brazil-suspension/ [Accessed 10 July 2019]. 62 63

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4 The Instagram Decision The Instagram decision66 is dealt with in a concise 3015 word document. The product scope of the decision is broken down into three relevant services; the provision of a camera app, social networking services and advertising space for advertisers.67 The competition concerns are split into two sets of issues, horizontal68 and vertical.69 The matters relevant here pertain to the horizontal issues. The discussion of horizontal issues is a little strange, it explains that two unilateral effects theories of harm were considered, the first being ‘actual competition in the supply of photo apps’ and then the second is ‘potential competition in the supply of social network services’.70 These are both perfectly valid aspects to consider, and yet, the following paragraphs go on to describe theories of harm titled ‘Actual competition in the supply of photo apps’71 and ‘Potential competition in the supply of online display advertising’.72 The latter of which is clearly different to that which is described as the second theory of harm that would be investigated. Whether this was just some sort of typographical error or actually some sort of greater mistake where the wrong facet of the acquisition was considered is not clear. What is clear is that the error becomes all the more salient when it is considered that analysis of the harmful effects on potential competition in the supply of social network services would have been an excellent point of consideration, which is unfortunately omitted. Instead all that is provided on this topic is found at the end of the decision under the heading ‘assessment’, where a terse summary is given: The OFT examined this merger on the basis that the parties overlap in the supply of social networking services . . . In the social networking space, the OFT has no reason to believe that Instagram would be uniquely placed to compete against Facebook, either as a potential social network or as a provider of advertising space.73

This analysis seems surprisingly short on detail. Instagram would not be uniquely placed to compete against Facebook as a potential social network. Who are Facebook’s other potential competitors? This is a question that has even caused Facebook’s own founder to struggle.74 Why are these other social networks equally well placed to compete with Facebook? What is their user base? While the decision explains who Facebook’s competitors are in terms of advertising space (Google, OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12. OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 7. 68 OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 14. 69 OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 30. 70 OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 14. 71 OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 15. 72 OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 22. 73 OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 43–44. 74 Maija Palmer, Are there any viable alternatives to Facebook? The difficulties of leaving a social media platform with two billion users (25 April 2018) Financial Times. 66 67

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Yahoo, and Microsoft)75 discussion of social media competitors is notably absent. Later however, social media is considered under vertical issues, if it is assumed that this discussion applies equally within the horizontal sphere this does provide some answers. It is noted in the decision that, according to one third party: Google is the strongest constraint to Facebook because it has a social network, Google+, and because its combined services allow it to gather large volumes of information on users making it an attractive proposition for advertisers. Google has an additional ability to constrain Facebook through its Adsense subsidiary which matches advertisers to online advertising space.76

This could be one of the other social network competitors that the OFT considers to show that Instagram is not ‘uniquely placed to compete against Facebook’. If that is the case Google+ provides a cautionary tale of why competition authorities should pause for thought when considering the ease with which incumbent, dominant undertakings can be dislodged from their position. Google, as a company would appear to be ideally placed to launch a social network. It has significant resources, unrivalled expertise in terms of human resources for programming, large amounts of data on individuals to understand their target market, one of the most visited web portals in the world through which they can advertise their product and an established and respected brand in Information Services. Despite all this their foray into social networks, in the form of Google +, was a failure77 and has been shut down.78 This is despite the fact that they used tactics such as requiring users to hold a Google+ account to be able to use their exceptionally successful online video platform; YouTube.79 While the exact reason Google+ failed is subject to speculation80 what is useful to note is that a new entrant, with established services and astonishing resources available to support their new social network can still fail, some would say, catastrophically. Therefore, if the OFT considered Google+ as an example of a how Instagram was not uniquely placed to compete against Facebook in the social network space, this assumption is seriously flawed. Why the OFT thought there was an abundance of potential competitors to Facebook’s social network is not explained explicitly in the decision, however it appears that the same mistake was made as has already been explained in relation to WhatsApp. This mistake is to believe that because apps expand extremely quickly, OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 28. OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 34. 77 https://www.theverge.com/2019/4/2/18290637/google-plus-shutdown-consumer-personalaccount-delete (accessed on 12/06/2019). 78 https://support.google.com/plus/answer/9217723?hl¼en-GB (accessed on 12/06/2019). 79 https://www.theverge.com/2019/4/2/18290637/google-plus-shutdown-consumer-personalaccount-delete (accessed on 12/06/2019). 80 https://www.businessinsider.com/what-happened-to-google-plus-2015-4?r¼US&IR¼T (Accessed 12/06/2019) https://economictimes.indiatimes.com/news/et-explains/heres-why-googlefailed (Accessed 12/06/2019) https://www.forbes.com/sites/stevedenning/2015/04/17/five-reasonswhy-google-died/ (Accessed 12/06/2019). 75 76

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because up take of apps can reach hundreds of millions within months, that competition can also appear within that timeframe. Take for example the following statement in the Instagram decision: In terms of whether other apps or social networks could replicate Instagram’s success, it is relevant that Instagram grew rapidly from having 1.4 million users in January 2011 to around 24 million users in February 2012. Whilst this indicates the strength of Instagram’s product, it also indicates that barriers to expansion are relatively low and that the attractiveness of apps can be “faddish”.81

The implication is clear, Instagram added 22.6 million users in a single year, there is no reason why the OFT should not allow the acquisition, because if Instagram can grow that quick, so can a competitor. The problem here is clear: there is a ‘virgin soil’ effect in apps. Apps are indeed extremely easy to download and they require only a little social momentum to grow into customer groups that companies would traditionally take decades to accrue, but this is not a constant. An imperfect analogy could be drawn with a pioneer settling a new country. Initially the acquisition of land, once the process of discovery has been completed, is almost cost free. However, once land is claimed then any settlers arriving after the initial pioneer will then have to pay for the land driving up the costs and slowing down any intended expansion. Only app markets that are virgin either geographically or in terms of product scope are conducive to rapid expansion. So, for example, a messaging app might not be new in terms of product scope, there may be other messaging apps in the world, but if they are relatively unknown in a particular geographic market then an app may spread quickly. Equally if there a geographic market with many different types of apps available, if a new app is developed that provides a new function, clearly distinct from the other apps that are available, then this too may spread very quickly. Once this is done however any app coming after that performs a similar function, even if it does so better, will be subject to significant barriers to entry due to the network effects caused by the earlier entrant. This is a first mover advantage, a concept well established in economic literature,82 which suggests that those who first enter a market, tend to have higher market share.83 This ipso facto tends to mean that those first movers also tend to have higher profitability.84 However what is of greater contention is how first mover advantages apply to internet related markets.

OFT, ‘Anticipated acquisition by Facebook Inc. of Instagram Inc’ (2012) ME/5525/12, para 36. Consider early empirical study of such advantages present in 1977; Ronald Bond, David Lean, ‘Sales, promotion and product differentiation in two prescription drug markets’ (1977) Staff Report to the Federal Trade Commission, economic report. Consider further study and comment such as: Robinson et al. (1994), p. 1; Aoki (1998), p. 284; Lean (1994), p. 177; Scherer (1994), p. 173; Tufano (1989), p. 213; Gal-Or (1985), p. 649. 83 Robinson and Fomell (1985), p. 305; Robinson (1988), p. 87. 84 Pan et al. (1999), p. 81; Shepherd (1972), p. 25; Ravenscraft (1983), p. 22. 81 82

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5 First Mover Advantages in Internet Markets There has been much debate regarding the implications of first mover advantages in internet enabled markets. However, much of it has come to seemingly contradictory conclusions. Some argue that internet based competition erodes first mover advantages85 while others argue the reverse.86 In terms of the empirical evidence87 while evidence does exist, it is difficult to apply universally since different markets are characterised by different levels of network effects and other facets that will mean a study in one market will not necessarily be broadly applicable to all internet based commerce. The lack of clarity in the area can be illustrated by the following studies: Lieberman88 found that first-movers benefited only when they were established in markets characterised by network effects and when they entered with innovations subject to patent rights. However, in software markets where innovations may easily be replicated by competitors this leads to further complications.89 Likewise whereas Srinivasan et al90 use empirical methods to establish that network effects have a negative impact on the survival of a first movers product, Qi Wang et al,91 by focusing more on the order of entry find that in markets with strong network effects, first mover survivability increases where there is cross-generational compatibility92 but within-generation incompatibility.93 This is particularly salient to our current examples of social media and messaging applications where an account on one platform is generally incompatible with another platform. Crucially for the present analysis, Varadarajan et al94 break down the broad concept of first mover advantage into a number of clearly defined, sub-advantages. They then analyse which of these advantages become less important, and which become more important when moved from the context of a traditional market to one 85

Porter (2001), p. 63; Suarez and Lanzolla (2007), p. 377. Downes and Mui (1998); Tapscott (2001), p. 1; Amit and Zott (2001), p. 493. 87 M. Lieberman, ‘Did first-mover advantage survive the dot-com crash?’ (2005) Working Paper, Anderson Graduate School of Management, University of California, Los Angeles; Nikolaeva (2007), p. 560; Geyskens et al. (2002), p. 102; Dewan et al. (2003), p. 1055; Lee and Grewal (2004), p. 157. 88 B. Lieberman, ‘Did first-mover advantage survive the dot-com crash? (2005) Working Paper, Anderson Graduate School of Management, University of California, Los Angeles. 89 For a study on where easy replication of innovations can actually stymie innovation consider; Rasmusen and Yoon (2012), p. 374. 90 Srinivasan et al. (2004), p. 41. 91 Wang et al. (2010), p. 1. 92 Cross-generational compatibility is where one generation of products is compatible with the next. 93 Intra-generational compatibility is where the products are now compatible within a particular generation. The example given by the authors is ‘DVD players are cross-generation incompatible with previous-generation VCR players but are within-generation compatible with each other’; Wang et al. (2010), p. 2. 94 Varadarajan et al. (2008), p. 293. 86

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that is internet enabled. They find, compared to traditional markets, first mover advantages in internet enabled markets are less important in relation to consumers’ choice behaviour under conditions of information and consumption experience asymmetry, spatial resource positions and installed capacity. While aspects of first mover advantages such as network effects, consumers’ non-contractual switching costs, and technological leadership and innovations take on much greater significance.95 It is these very market characteristics, in particular network externalities and consumers’ non-contractual switching costs that are so important in determining the error made in the WhatsApp and Instagram decisions. What can be summarised from the literature then, is that while there is some disagreement about how first mover advantages apply in internet enabled markets, those studies that do exist, particularly those that break down first mover advantages into constituent elements, tend to emphasise the importance of the advantages that are possessed by firms such as Facebook. These include non-contractual switching costs and network effects.

6 The Flaw What can be seen from the analysis of these cases is that there is a fundamental appreciation of digital competition that appears to be flawed. In both WhatsApp and Instagram, the competition authorities appear to have bought into the idea that ‘competition is just a click away’96 as propounded by Google’s Larry Page, but this is not necessarily correct. What is actually true of software markets subject to significant network effects and an established incumbent, is that competition is just a click away, assuming you can get your entire network to simultaneously make the same click. . . which they are likely to do only if their whole network also makes the same click. This is certainly not as catchy as the original phrase but more accurate. An often-cited rebuttal to the suggestion that these markets are difficult to penetrate and that incumbents are extremely difficult to dethrone is Facebook overtaking Myspace in social media. Myspace, once a very successful social media company, was overtaken by Facebook and it is now worth a fraction of what it was previously and has a fraction of the active users. The difficulty with this example is that Myspace and Facebook were founded in 2003 and 2004 respectively. They were genuine competitors. This is exemplified by the following statistics from ComScore, an analytics provider that assesses unique visitors to various websites each month in order to provide market data on users interacting with various media. Myspace at its peak attracted 75.9 million monthly unique visitors, this occurred in December 2008. The point at which Facebook overtook

95

Varadarajan et al. (2008), p. 293. https://www.forbes.com/sites/davidwismer/2012/10/14/googles-larry-page-competition-is-oneclick-away-and-other-quotes-of-the-week/#33caa3125ea1 (Accessed on 12/06/2019). 96

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Myspace as the leading global social network is April 2008. The dates of Myspace’s peak, coincide with the point that Facebook overtook the platform as the leading social network. This is very important. In the 4 years running up to 2008 Myspace was expanding alongside Facebook. It was not that it had peaked years before and was dominant in an established, mature market. Neither was it the case that Facebook started after Myspace was well established and managed to overtake the company despite the barriers to entry caused by network effects, both Facebook and Myspace were founded around the same time, expanded rapidly in a fledgling market and over time Facebook managed to out compete Myspace on the merits. Once again this points back to the idea that digital markets, contrary to the understanding of competition authorities, lend themselves to massive growth early on, during which time they are indeed contestable, but are far more challenging to expand into after the market has matured. Further, while multihoming would suggest that there is no reason why groups must be users of either Myspace or Facebook, it is notable that once Myspace visitor numbers peaked and was over taken by Facebook, Myspace’s visits did not continue to increase but at a slower rate, neither did they remain stable, but instead they shrank. If MySpace’s visits remained stable while Facebook’s increased this could indicate that users were loyal to MySpace, but MySpace was no longer adding users, or it could indicate that users were continuing to use MySpace but also getting Facebook accounts. The fact that users stopped visiting the site suggests that users either lost interest in social media as a whole, which would be difficult to explain, or that they were gradually stopping using MySpace and using Facebook instead. This is very important as it strongly suggests once again that although multihoming is possible, users are not interested in using more than one network. They could maintain their presence on both networks, visiting both each month to communicate with different groups of friends, but they do not. The statistics instead suggest users ceased visiting the one and began visiting the other.

7 Implications for Competition Law and Policy There are two main insights that are yielded from the analysis above. The first is that prior decisions have produced incorrectly defined markets and the second is that high growth markets have been taken to represent competitive markets and contestable markets when this is not the case. These two points will be summarised below:

7.1

Market Definition

Previous decisions in this area reveal a lack of careful analysis of product/service interchangeability. A focus on the functionality of apps rather than their

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substitutability or interchangeability97 has led to outcomes where important aspects of a digital service, such as its user audience, have been ignored and led competition authorities to assume that digital services are interchangeable from the point of view of the customer, when they are not.

7.2

Virgin Markets and Established Markets

The stunning growth of consumer apps has led competition authorities to believe that digital markets are highly dynamic and highly contestable when they are not. There appears to have been an implicit assumption in competition authorities’ practice, where rapid expansion in digital markets was considered to mean that digital markets are highly contestable and therefore mergers between competitors or potential future competitors in those markets are not a cause of concern since new competitors can arise quickly and easily. This has been countered with the argument that markets that are subject to network effects and non-contractual switching costs may be initially highly contestable, but once they have matured they become extremely difficult to enter successfully. This has significant implications for the competitive process and equally means that competitors or potential competitors that exist during the initial period of rapid and fierce competition should be seen as an important source of competitive pressure, even if there is eventually a single competitor that ‘wins’ overall through organic growth. What implication does this have for competition policy, both in the EU, the US and in markets seeking to avoid the same mistakes such as those in China? The implications are clear, competition authorities, whether in China, the UK, the EU or the US should consider the following: The functionality of an app or digital service should not replace the traditional rigorous assessment of interchangeability of a service from the perspective of a customer or user. Rapid growth of a service, app or product for a first mover or even an early second mover should not be confused with low barriers to entry for competitors generally. Instead where a market is likely to be subject to network effects once settled, competition authorities must look beyond the experience of first movers (whether in new product markets or new geographic markets) in order to evaluate potential strategic advantages (such as network effects) that could make later entry more difficult for potential competitors. Finally, and contrary to intuitive thinking, rapid growth of first movers in digitally disrupted markets may actually make future entry more difficult. This is because the window of opportunity for imitators to enter the market before network effects make entry more difficult is smaller.

97

The legally appropriate test in such circumstances, as set out by Case 6/72 Continental Can v Commission EU:C:1973:22, para 32 and Case 27/76 United Brands v Commission EU:C:1978:22, para 22.

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In short, when a genuine rivalry exists between competitors in a digital market, such as that which existed between Facebook Messenger and WhatsApp, it should be preserved. In the event, two apps that competed in the same geographic and product spaces were unfortunately and inappropriately allowed to merge.98 This should not be allowed to happen in future. The Guidelines of competition authorities should be amended to reflect this consideration by adding the following: In markets characterised (or upon maturity likely to be characterised) by network effects, exceptionally rapid growth of first movers should not necessarily be taken as indicative of low barriers to entry or an absence of strategic advantages. Such growth is likely to benefit only the first mover in a particular product or geographic market. Once the market has matured network effects are likely to prevent later entrants from obtaining the same rapid growth, even when supplying a desirable product.

8 Conclusion This chapter has analysed two previous decisions, one from the European Commission and one from the UK OFT. These two digital mergers provide an excellent insight into the manner in which digital mergers have been evaluated in the recent past. It has found that two main flaws are present in these decisions. The first relates to the way market definition is analysed and the second relates to how barriers to entry have been assessed. The application of the law and the Guidelines in these two areas show where competition authorities are making mistakes when applying merger regulations in digital markets. In relation to market definition, the Commission has used a focus on functionality to assess the market for social networking sites and consumer messaging apps. By not paying attention to the user audience the Commission has erroneously come to the conclusion that consumers can and do multi-home. That is that they have multiple accounts on multiple apps for the same purpose. This error means that the market, from the Commission’s view point was divided between a number of competitors, each with a comparable market share. As a result of this, the Commission failed to identify that it was actually approving a merger between the only two comparable competitors in the EEA, resulting in significant damage to the competitive process. The OFT, in the Instagram decision, likewise did not carefully analyse the market situation, claiming that there were many competitors who were equally well placed to challenge the merged entity. Few details were provided on who those competitors were however. This also meant that the level of concentration in the market was either not calculated or if it was, may have been misunderstood. In relation to the assessment of barriers to entry another flaw has been discovered that is common to both decisions. The Guidelines on mergers state:

98 Although it is fully accepted that this is easier to see with hindsight, nonetheless the aim here is to improve enforcement for the future.

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When entering a market is sufficiently easy, a merger is unlikely to pose any significant anticompetitive risk. Therefore, entry analysis constitutes an important element of the overall competitive assessment99

This Guideline was applied too simplistically. It has been argued that evidence of easy entry into new product or geographic markets was taken as an indication of ease of entry generally. This mistake meant that competition authorities underestimated the difficulty in entering the market at a later stage in the market’s development. As a result, competition in digital markets has been weaker than desirable. While this chapter analyses two decisions from two different authorities (albeit with linked jurisdictions) this analysis and the implications thereof should be considered more broadly. The implications are likely to apply to all markets where there are significant network effects and rapid expansion following the initial disruption of the market. It has been suggested that global competition authorities should amend their practice to take these issues into account. Newer competition authorities, such as those in China, are well placed to take advantage of this situation by learning from the mistakes made in other jurisdictions, where competition authorities have had to try to apply competition law effectively to new situations that at the time were difficult to analyse and interpret. To do this, a minor modification of merger Guidelines is desirable, but largely the main change necessary is to apply the law that already exists as thoroughly to digital markets as in any other market, because, while digitisation has changed the rate of change in many markets, the principles of network effects and non-contractual switching costs are just as important as ever.

References Books Downes L, Mui C (1998) Unleashing the killer app: digital strategies for market dominance. Harvard Business School Press, Cambridge Kathuria V, Globocnik J (2019) Exclusionary conduct in data-driven markets: limitations of data sharing remedy. In: Botta M (ed) EU competition law remedies in data economy. Springer (forthcoming) Stucke ME, Grunes PA (2016) Big data and competition policy. Oxford University Press, Oxford

Journals Amit R, Zott C (2001) Value creation in e-business. Strateg Manag J 22(6/7):493 Aoki R (1998) Strategic complements with first mover advantage. Metroeconomica 49(3):284

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Auer D, Petit N (2015) Two-sided markets and the challenge of turning economic theory into antitrust policy. Antitrust Bull 60(4):426 Dewan R, Jing B, Seidmann A (2003) Product customization and price competition on the internet. Manag Sci 49(8):1055 Gal-Or E (1985) First mover and second mover advantages. Int Econ Rev 26(3):649 Geyskens I, Gielens K, Dekimpe M (2002) The market valuation of internet channel additions. J Mark 66(2):102 Jung N, Sinclair E (2019) Innovation theories of harm in merger control: plugging a perceived enforcement gap in anticipation of more far-reaching reforms? Eur Compet Law Rev 40(6):266 Kupčík J, Mikeš S (2018) Discussion on big data, online advertising and competition policy. Eur Compet Law Rev 39(9):393 Lean D (1994) First-mover advantages from pioneering new markets: comment. Rev Ind Organ 9:177 Lee R, Grewal R (2004) Strategic responses to new technologies and their impact on firm performance. J Mark 68(4):157 Mandrescu D (2017) Applying EU competition law to online platforms: the road ahead - part 1. Eur Compet Law Rev 38(8):353 Nikolaeva R (2007) The dynamic nature of survival determinants in e-commerce. J Acad Mark Sci 35(4):560 Pan Y, Li S, Tse DK (1999) The impact of order and mode of market entry on profitability and market share. J Int Bus Stud 30(1):81 Porter M (2001) Strategy and the internet. Harv Bus Rev 79(63) Rasmusen E, Yoon Y-R (2012) First versus second mover advantage with information asymmetry about the profitability of new markets. J Ind Econ 60(3):374 Ravenscraft D (1983) Structure-profit relationships at the line of business and industry level. Rev Econ Stat 65:22 Robinson W (1988) Sources of market Pioneer advantages: the case of industrial goods industries. J Mark Res 25:87 Robinson W, Fomell C (1985) Sources of market Pioneer advantages in consumer goods industries. J Mark Res 22:305 Robinson W, Kalyanaram G, Urban G (1994) First-mover advantages from pioneering new markets: a survey of empirical evidence. Rev Ind Organ 9:1 Scherer F (1994) First-mover advantages from pioneering new markets: comment. Rev Ind Organ 9:173 Shepherd W (1972) The elements of market structure. Rev Econ Stat 54:25 Srinivasan R, Lilien GL, Rangaswamy A (2004) First in, first out? The effects of network externalities on Pioneer survival. J Mark 68:41 Suarez F, Lanzolla G (2007) The role of environmental dynamics in building a first mover advantage theory. Acad Manag Rev 32(2):377 Tapscott D (2001) Rethinking strategy in a networked world. Strategy Bus 24:1 Tufano P (1989) Financial innovation and first-mover advantages. J Financ Econ 25:213 Varadarajan R, Yadav MS, Shankar V (2008) First-mover advantage in an internet-enabled market environment: conceptual framework and propositions. J Acad Mark Sci 36:293 Wang Q, Chen Y, Xie J (2010) Survival in markets with network effects: product compatibility and order-of-entry effects. J Mark 74:1 Weitbrecht A (2015) From cement to digital industries - EU merger control 2014. Eur Compet Law Rev 36(4):148

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Webpages https://www.washingtonpost.com/news/the-switch/wp/2018/04/10/transcript-of-markzuckerbergs-senate-hearing/?noredirect¼on&utm_term¼.56bc29d3fd0b (Accessed on 21/06/ 2019) https://www.reuters.com/article/us-whatsapp-facebook-idUSBREA1I26B20140220 https://twiplomacy.com/blog/twiplomacy-study-2018/ https://www.linkedin.com/help/linkedin/answer/192 (Accessed 03/04/2019) https://www.linkedin.com/help/linkedin/topics/6073/6089/437 (Accessed 03/04/2019) https://www.techinasia.com/line-annual-revenue-2015 (Accessed 03/04/2019) https://www.businessinsider.com/wechat-breaks-700-million-monthly-active-users-2016-4? r¼US&IR¼T (Accessed 03/04/2019) http://www.businessofapps.com/data/wechat-statistics/ (Accessed 03/04/2019) http://money.cnn.com/2015/12/17/technology/telegram-whatsapp-brazil-suspension/ [Accessed 10 July 2019] https://support.google.com/plus/answer/9217723?hl¼en-GB (accessed on 12/06/2019) https://www.theverge.com/2019/4/2/18290637/google-plus-shutdown-consumer-personalaccount-delete (accessed on 12/06/2019) https://www.businessinsider.com/what-happened-to-google-plus-2015-4?r¼US&IR¼T (Accessed 12/06/2019) https://economictimes.indiatimes.com/news/et-explains/heres-why-google-failed (Accessed 12/06/ 2019) https://www.forbes.com/sites/stevedenning/2015/04/17/five-reasons-why-google-died/ (Accessed 12/06/2019) https://www.theverge.com/2019/4/2/18290637/google-plus-shutdown-consumer-personalaccount-delete (accessed on 12/06/2019) https://www.forbes.com/sites/davidwismer/2012/10/14/googles-larry-page-competition-is-oneclick-away-and-other-quotes-of-the-week/#33caa3125ea1 (Accessed on 12/06/2019)

Working Papers See Commission Staff Working Document on Online Platforms SWD (2016) 172, https://ec. europa.eu/digital-single-market/en/news/commission-staff-working-document-online-plat forms [Accessed 08 July 2019] Max Planck Institute for Innovation & Competition Research Paper No. 19-04. Available at SSRN: https://ssrn.com/abstract¼3337524 (Accessed on 08/07/2019) Lieberman M (2005) Did first-mover advantage survive the dot-com crash? Working Paper, Anderson Graduate School of Management, University of California, Los Angeles Viktoria Robertson, H.S.E., Excessive Data Collection: Privacy Considerations and Abuse of Dominance in the Era of Big Data (June 24, 2019). Available at SSRN: https://ssrn.com/ abstract¼3408971 (Accessed on 08/07/2019)

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Conference Papers Auer D, Manne G (2019) The Antitrust Dystopia: The Case of Big Data Competition. Presented at ASCOLA conference, Aix-en-Provence 27–29 June 2019 Tirole J (2019) Competition Policy in the Digital Age. Paper presented at Shaping competition policy in the era of digitisation, Brussels, 17 January 2019 McLean A (2020) Futurity and the Future of Competition: The Case of Killer Acquisitions. Paper presented at 15th ASCOLA conference, online, 25–27 June 2020

Reports Crémer J, Yves-Alexandre de Montjoye and Heike Schweitzer (European Commission), Competition Policy for the Digital Era (4 April 2019), http://ec.europa.eu/competition/publications/ reports/kd0419345enn.pdf [Accessed 10 July 2019] “Big Data: Bringing Competition Policy to the Digital Era” OECD Report ref. no.DAF/COMP (2016)14 published on 27 October2016 Rapport of the German national competition authority, http://www.monopolkommission.de/ images/PDF/SG/s68_fulltext_eng.pdf See also the rapport from the DG for internal policy on online platforms, http://www.europarl. europa.eu/RegData/etudes/STUD/2015/542235/IPOL_STU(2015)542235_EN.pdf The OECD Round table on two sided markets DAF/COMP/WD/(2009)69, https://www.oecd.org/ daf/competition/44445730.pdf [Accessed 08 July 2019] Kommission Wettbewerbsrecht 4.0, Bundesministerium für Wirtschaft und Energie, https://www. bmwi.de/Redaktion/DE/Artikel/Wirtschaft/kommission-wettbewerbsrecht-4-0.html [Accessed 10 July 2019] https://www.gov.uk/government/consultations/digital-competition-expert-panel-call-for-evidence/ digital-competition-expert-panel [Accessed 10 July 2019]

Newspapers Maija Palmer, Are there any viable alternatives to Facebook? The difficulties of leaving a social media platform with two billion users (25 April 2018) Financial Times

Commission Decisions Setting Up Expert Groups Commission Decision of 26.4.2018 on setting up the group of experts for the Observatory on the Online Platform Economy, C (2018) 2393 final

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Guidelines Vertical merger guidelines OJ [2010] C 130/1 Guidelines on the assessment of horizontal mergers OJ [2004] C 31/5 Merger Assessment Guidelines CC2 Revised, OFT 1254, Sept 2010

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The Amendment of Anti-Monopoly Law of Merger Remedies: Based on the Empirical Analysis in China Chenying Zhang

Abstract Since the implementation of the Anti-Monopoly Law in 2008, China has implemented a review system for the eligible concentration in which structural remedies or behavioral remedies are imposed when certain concentrations are reached by way of restrictive conditions. This is a common principle in almost every jurisdiction, but China’s practice shows that behavioral remedies are used more often than structural remedies, which is different from EU or US practice. Based on the interpretation of the Chinese system and the logic of remedy rules, this article analyses all the remedy cases in China, and makes suggestions for improvement.

1 Background The concept of Concentration of Undertaking comes from EU competition law and refers to the process in which an undertaking acquires the control over other undertaking(s) or becomes possible to exercise a decisive influence on other undertaking(s) through merger, acquisition of equity or assets, by contract or by any other means. The crucial point to define a Concentration of Undertaking lies in whether there is a market competition disorder due to change of the relevant market structure caused by change of control. The meaning of the Concentration of Undertakings is broader than that of merger and acquisition in commercial law. A concentration occurs when an undertaking acquires control over or is possibly able to exercise a decisive influence on other undertaking(s) by various means. The Concentration of Undertaking has a doubling effect. On the one hand, economies of scale brought by Concentration of Undertaking may achieve huge economic This article is a result of research under the 2018 Beijing Social Science Fund’s major project “Research on the Merger remedies from the View of antitrust” (project number: 18FXB013). C. Zhang (*) School of Law, Tsinghua University, Beijing, China e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_8

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efficiency; on the other hand, in the context of decreased number of competitors in the market due to the concentration, it might be convenient for the undertaking to engage in abusing market dominance or collusion. Therefore, for the purpose of anti-monopoly law, if the conclusion of a specific deal will lead to a substantial change in control among the undertakings under the original market structure and thus bring structural impacts on the market and eliminate or restrict competition, a Concentration of Undertaking will be deemed as occurring. Therefore, antimonopoly law enforcement agencies in various jurisdictions regulate1 the mergers among the undertakings with a certain size or above.2 In China, as from the effectiveness and implementation of the Anti-monopoly Law on August 1, 2008 till December 31, 2019, 2998 Concentration of Undertakings cases have been concluded, with a total amount of more than 50 trillion yuan, which makes a great contribution to preventing potential anti-competition practices in the market. When a Concentration of Undertakings might eliminate or restrict the competition, the anti-monopoly law enforcement agencies, instead of simply and directly prohibiting or permitting the concentration, permit the concentration on certain conditions, to avoid potential competition-related problems that might arise from the Concentration of Undertakings.3 In the merger remedy system, the imposed restrictive conditions are proposed by the undertakings involved in a concentration, which are subject to the approval and will be supervised and implemented by the law enforcement agencies. By the categorization currently and generally accepted in foreign theoretical circles and by foreign practical voices, the imposed conditions are divided into structural conditions and behavioral conditions.4 In China, both theoretical circles and legislative agencies divide the restrictive conditions into structural conditions, behavioral conditions, and synthetic conditions, namely a combination of both structural conditions and behavioral conditions.5 By the type of imposed conditions, the merger remedies can be divided into behavioral remedies, structural remedies, and synthetic remedies.

An exception is Hong Kong, where, in principle, no deal other than those in the field of telecommunications is subject to operator concentration review. 2 The thresholds for regulating the mergers among the undertakings are different among various jurisdictions, dynamic or static. Even though taking the sales in the previous year as the criterion, the baselines vary significantly among the jurisdictions. Although this is an important consideration in amending the Anti-monopoly Law in China, it is not of focus of this Paper, so it is not discussed in detail herein. 3 See Wu and Liu (2012), p. 430. 4 See Davies and Lyons (2007), pp. 13–17; Kwoka and Moss (2012), pp. 979–1011. 5 See Article 3 of Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation) promulgated by MOFCOM. 1

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Generally, the structural remedies place their focuses on the disposal of the property rights to specific types of assets of the absorbed entity upon merger, mainly by divesting part of the assets involved in the concentration and assigning such assets to an independent third party, thereby bringing a new and effective competition. While, the behavioral remedies impose certain constraints on the behavior of the surviving entity upon merger. Such constraints can manifest as active actions or passive omissions. Instead of a disposal of the property rights to the assets of the absorbed entity, such constraints only impose restrictions on the property rights. Quite different from the EU and the United States, far more behavioral conditions are imposed than structural conditions in the law enforcement in China, which raises a question about the effect of the law enforcement in China, and, once again arouses the heated discussions on which remedy should be given preferential application, behavioral remedies or structural remedies. As at the time of the amendment of the Anti-monopoly Law and formulation by the State Administration for Market Regulation of the Interim Provisions on Review of Concentrations of Undertakings, the author responds to the questions in connection with the restrictive conditions in this Paper, based on the theory of remedies and combining with the practice rationality, especially by comparing the merger remedies in China and in other jurisdictions in light of globalization, and with an exploration on the trends of merger remedies.

2 Legal System for and Rules on Merger Remedies in China In this section, the author introduces the Chinese government agencies that are responsible for enforcing the AML and provides a brief description of the antitrust system in China, then and merger remedy. I conclude the legal foundation of merger remedy.

2.1

AML Enforcement Agency

From the AML became effective on August 1, 2008 till the March of 2018, antitrust enforcement in China was shared by three agencies: National Development and Reform Commission (NDRC), Ministry of Commerce (MOFCOM), and State

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Fig. 1 China’s Antitrust Enforcement Agency Structure as of May 2018 (See Shang Min, the Director of the Anti-monopoly Bureau of the Ministry of Commerce, talking about “Promoting Anti-monopoly Law Enforcement and Maintaining Fair Market Competition”, http://www.gov.cn/ zxft/ft155/)

Administration of Industry and Commerce (SAIC).6 The division of antitrust responsibilities is illustrated as follows (see Fig. 1):7 MOFCOM is the agency responsible for the antitrust review of mergers and acquisitions. It has the authority to issue fines based on Article 48 of the AML. The fines are against two main types of violations: failure to notify8 and violation of remedies.9 In March 2018, as part of the Chinese government’s plan to reform institutional structure, a new agency, known as the State Administration for Market Regulation (SAMR), was established combining the antitrust functions of NDRC, MOFCOM and SAIC. One of the consequences is to unify the jurisdictions. The new agency is named as Antitrust Bureau, which is responsible for not only public enforcement, including cartel, abuse of dominance, merger control and administrative monopoly, but also administrative legislation which the following regulations belongs to.

6

These three are ministry-level administrative agencies. Each has a broad range of mandates in performing other functions. Antitrust reviews and investigations are carried out by their respective antimonopoly bureaus, i.e., the Price Supervision and Antimonopoly Bureau of NDRC, the Antimonopoly Bureau of MOFCOM, and the Antimonopoly and Anti-Unfair Competition Bureau of SAIC. As is commonly done in antitrust writings relating to China, we use NDRC, MOFCOM and SAIC as the acronyms for their antitrust enforcement bureaus. 7 This Figure is drawn from The US-China Business Council’s report, “Competition Policy and Enforcement in China,” (2014), p. 4. 8 See “Interim Measures for Investigating and Handling the Failure to Report the Concentration of Undertakings,” (2011). 9 See “Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation)” (2014).

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Legal System for Concentration of Undertakings

Several rules and regulations have been formulated under PRC legislation system and review system of the Concentration of Undertakings at multiple levels. At legislative levels, Chapter 4 of the Anti-monopoly Law contains general provisions on the concept of Concentration of Undertakings, notification and reviewing procedures of concentration, and review criteria. In order to implement the relevant provisions of the Anti-monopoly Law, the State Council and anti-monopoly law enforcement agencies have successively promulgated a series of laws and regulations, forming a legal system consisting of one law, one administrative regulation, seven departmental regulations, and a guide. Specifically, it covers four aspects: notification of Concentration of Undertakings, review of Concentration of Undertakings, special treatment of simple cases, and imposing of restrictive conditions. Applicable laws and regulations currently in effect are detailed in the table below (in chronological order) (see Fig. 2): During the period from August 1, 2008 till December 31, 2019, 2,998 concentration cases were decided, in which 44 are conditionally approved, 2 are prohibited, and 98.5% are unconditionally approved, a similar proportion to other jurisdictions. With respect to the remedy system to be discussed in this paper, the author sorts out the legal hierarchy and logical relationship from the perspective of the legislation as follows: Firstly, the basis of the superior law is Article 29 of the Anti-monopoly Law, “Where the concentration is not prohibited, the Anti-monopoly Enforcement Agency under the State Council may make a decision of approval with restrictive conditions, the imposition of which will reduce the adverse effect brought by the concentration on competition”. Secondly, the Ministry of Commerce (“MOFCOM”), the administrative law enforcement agency responsible for reviewing the Concentration of Undertakings, introduced the Measures for Review of Concentrations of Undertakings, which elaborated the relevant rules on imposing restrictive conditions. Article 11 of these Measures specifies three types of restrictive conditions: (1) Structural Conditions. Structural conditions refer to the divestiture of part of assets or businesses of the undertakings concerned, including tangible assets, intellectual property and other intangible assets, or relevant interests therein or thereto. Taking tangible assets as an example, in MOFCOM Announcement No. 77 of 2009 on Anti-monopoly Review Decision on the Concentrations of Undertakings of Pfizer’s Acquisition of Wyeth, the deal got a conditional approval. One of the conditions is the divestiture of Pfizer’s mycoplasma suis pneumonia vaccine business under the brand of “Respisure” and “Respisure One” in China, including the tangible assets and intangible assets necessary to ensure its survival and competitiveness.10

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MOFCOM Announcement No. 77 of 2009.

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Date of Promulgation

Date of Effectiveness

Anti-monopoly Law

2007.8.30

2008.8.1

NPC Standing Committee

Provisions of the State Council on Thresholds for Prior Notification of Concentrations of Undertakings

2008.8.03

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Title

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(Amended on 2018.09.18)

Guideline on Definition 2009.5.24 of Relevant Market

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2009.11.21

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Measures for 2009.7.15 Calculation of Business Turnover for the Notification of Conce ntrations of Undertakings in the Financial Sector

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MOFCOM, People’s Bank of China, China Banking Regulatory Commission, China Securities Regulatory Commission, China Insurance Regulatory Commission

Interim Rules on the Assessment of the Effects of Concentrations of Undertakings on Competition

2011.8.29

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Interim Rules on the Criteria for Simple Cases of Concentrations of Undertakings

2014.02.11

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Provisions on Imposing 2014.12.04 Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation)

2015.01.05

MOFCOM

Guiding Opinions on Notification for Simple Cases of Concentration of Undertakings

2018.9.29

State Administration for Market Regulation

2018.9.29

Fig. 2 Current effective laws and regulations related to concentration of undertakings (Source: The author)

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(2) Behavioral Conditions. Behavioral conditions refer to the conditions that undertakings concerned should include opening networks, platforms or other infrastructures, licensing key technologies, and terminating exclusive agreements. The cases having been reviewed by anti-monopoly enforcement agencies illustrated that, behavioral conditions include, but are not limited to, the prohibitions on increase in shareholding, on launch of specific product into certain market, on substantive change in current business model, and on sales of any product at an unreasonably high price and on tie-in sales. For example, in the review decision on Novarti’s Acquisition of Alcon, MOFCOM prohibited Novarti from selling Infectoflam in China market and requested Novarti to terminate the Sales and Distribution Agreement entered into by and between CIBA Vision, Novarti’s wholly-owned subsidiary, and Hydron.11 Such restrictive conditions are more convenient and efficient in the implementation, with no need to divest the assets of the undertakings and no significant influence on the normal operations of the undertakings, and are conducive to the rapid adjustment of the undertakings concerned to seize business opportunities. At the same time, behavioral conditions also have their disadvantages. For example, the weakening effect of the behavioral conditions against the competition is not sufficient, and the implementation of restrictive conditions shall be subject to the ex-post supervision of anti-monopoly enforcement agencies, which inevitably increases the cost of law enforcement.12 (3) Synthetic conditions combining structural and behavioral remedies. In the review decision on Panasonic’s acquisition of Sanyo, in response to the elimination and restriction effect on competition in the coin-type rechargeable lithium battery market brought by the concentration, MOFCOM requested Panasonic and Sanyo to simultaneously perform the structural remedy of divesting Sanyo’s all coin-type rechargeable lithium battery business then currently ran by Sanyo, and the behavioral remedy that relevant business units of Panasonic and Sanyo should operate independently and not disclose price of products, customer data or other competitive information to each other.13 In addition, these Measures also contain general provisions on general requirements for providing comments to restrictive conditions, the amendment of restrictive conditions, supervision on implementation of restrictive conditions, and penalties. On July 5, 2010, in order to further regulate the implementation of divestiture of assets or business, the restrictive conditions on Concentration of Undertaking, MOFCOM promulgated the Interim Provisions on Implementation of Divestiture of Assets or Business in Concentration of Undertaking (MOFCOM Announcement No. 41 of 2010, hereinafter referred to as these “Divestiture Provisions”). These Divestiture Provisions predominantly focus on the qualifications, rights, and

11

MOFCOM Announcement No. 53 of 2010. Qiu (2009), pp. 96–100. 13 MOFCOM Announcement No. 82 of 2009. 12

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obligations of the supervision and divestiture trustee in a structural remedy, and on the qualification of the purchaser of the divested assets or business. Moreover, these Divestiture Provisions also clarify certain requirements on the maintenance of the divested assets or business and division administrator. In addition, MOFCOM promulgated the Interim Rules on the Assessment of the Effects of Concentrations of Undertakings on Competition in August 2011. The restrictive conditions are imposed based on assessment of the effects of Concentrations of Undertakings on competition and the assessment on the anti-competition effects of a specific case often directly determines the potential restrictive conditions applicable to the case. In view of the above, these Interim Rules are also of positive significance to the improvement of the system of imposing restrictive conditions on Concentration of Undertakings in China. In addition, MOFCOM promulgated in December 2014 the Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation) (for Trial Implementation) (hereinafter referred to as these “Remedy Provisions”) as supporting the Anti-monopoly Law and abolished these Divestiture Provisions at the same time. The main contents of these Remedy Provisions are taking the behavioral conditions as the remedies, which expanded the application scope of the relevant remedies under these Divestiture Provisions.

2.3

Rules Under Merger Remedy System

In reviewing an merger, if the restrictive conditions are required to be imposed to prevent the anti-competitive effects upon the merger, the restrictive conditions shall be imposed in following logical order: imposing restrictive conditions on the Concentration of Undertaking—implementing restrictive conditions and supervision thereon—modifying or removing restrictive conditions. Step 1: Determination of Imposing Restrictive Conditions In terms of basic ideas and rules, the concentration requiring restrictive conditions are the mergers where the concentration has a relatively material adverse effect on competition, on which the ordinary procedures have to be applied. According to the law, the review procedures for ordinary notification of Concentration of Undertakings are as follows (see Fig. 3): The restrictive conditions will only be imposed on the concentration where the Concentration of Undertakings has or might have an effect of eliminating or restricting competition, which can be dispelled by imposing the restrictive conditions. If a concentration is not in compliance with the above, such concentration should be prohibited. Articles 5 to 9 of these Remedy Provisions specify the process of making a determination in imposing the restrictive conditions. The restrictive conditions are imposed in the following procedures:

The Amendment of Anti-Monopoly Law of Merger Remedies: Based on the. . .

Phase

Phase 1

Period

within 30 days

Type of Decision

Approved or not

decision to conduct further review

unknown

decision not to conduct further review

restrictive conditions imposed

conditionally approved

No restrictive condition imposed

approved

no decision made

approved

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within 90 days

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extendable by no more than 60 days in special circumstances

decision not to prohibit

restrictive conditions imposed

conditionally approved

No restrictive condition imposed

approved

no decision made

approved

Fig. 3 The review procedures for ordinary notification of concentration of undertakings (Source: The author)

(1) The MOFCOM shall promptly inform the notifying party of adverse effect brought by the concentration on competition and explain the reasons; (2) The notifying party shall propose a remedy plan within the specified period. As mentioned earlier, a conditional approval over the Concentration of Undertakings is given to eliminate potential anti-competitive effects caused by the Concentration of Undertakings without declining the benefits generated from involving in the Concentration of Undertakings. The proposals on imposing restrictive conditions raised by the notifying party shall meet three requirements: first, the restrictive conditions shall be effective to eliminate the adverse effects of the concentration on competition; second, the restrictive conditions shall be feasible, which means being operable in practice; third, the restrictive conditions shall be timely and able to quickly resolve the competition-related issues caused by the Concentration of Undertakings. (3) After receiving the proposals from the notifying party, MOFCOM shall consult with the notifying party, assess the potential effect on eliminating the anticompetition effects arising from imposing the restrictive conditions proposed, and inform the notifying party the assessment result. The assessment is usually conducted by surveying by questionnaires, holding focus group interview, hearing, seeking comments from government departments, industry associations, related enterprises, and so forth.

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(4) If, upon assessment, it is believed that the imposition of the restrictive conditions could not eliminate the adverse effects of the concentration on competition, the notifying party will usually propose a new remedy plan. In such case, the above 2nd and 3rd procedures will be taken until the restrictive conditions pass the assessment. Upon approval by the competent administrative authority of the restrictive conditions proposed by the notifying party, the competent administrative authority will issue an announcement on conditional approval over the concentration. Then the procedures are finished. For example, in the acquisition by NXP of all equity of Freescale,14 due to the horizontal market overlap between the parties in the sectors of general-purpose microcontroller, analog integrated circuit dedicated for power supply (applied in automotive applications) and RF power transistor, the acquisition would strengthen NXP’s control in relevant markets and eliminate the competition between the two leading competitors close with each other in the RF power transistor market. Based on that, MOFCOM finally decided to accept the restrictive condition proposed by NXP, that is, to completely divest its RF power transistor business and sell it to Beijing Jian’guang. If the restrictive conditions proposed by the notifying party could not eliminate the anti-competition effects, the concentration shall be prohibited. After 11 years since the Anti-monopoly Law came into force, there are two prohibited mergers: acquisition by Coca-Cola of Huiyuan Juice,15 and establishment a network center by Maersk16, MSC and CMA CGM. Step 2: Implementation of Restrictive Conditions The implementation of restrictive conditions is an important step to rectify the damage to competition. For example, in a concentration involving structural remedy, how to define the purchaser of the divested assets? Is the purchase price the preferred or even the sole criterion? In the aforementioned NXP case, could a pure financial investment company be a qualified purchaser? For another example, in a case involving behavioral remedy, it is required that the patent royalty charged by the intellectual property right holder shall be at a reasonable rate. How to identify a reasonable rate? These all depend on the specific implementation of the restrictive conditions. Chapter III of Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation) specifies thereon. The main mean to making a structural remedy is to divest, that is, sale by the divesture obligor of the divested business to an independent purchaser other than the undertakings involved in a concentration. The divested business includes tangible assets, intangible assets, equity, key employees, and interests in the agreements with customers, agreements with suppliers, etc., and may be the subsidiary, branch, or business division of the undertakings involved. In case of a conditional approval, the law enforcement agencies would designate a divesture obligor. For example, in the

14

See MOFCOM Announcement No. 64 of 2015. See MOFCOM Announcement No. 22 of 2009. 16 See MOFCOM Announcement No. 46 of 2014. 15

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acquisition by NXP, NXP is designated as the divesture obligor. In addition, these Remedy Provisions address the following issues: the type of divestiture; the assets (business) of the divesture obligor and its duties and obligations; the requirements for the supervisory trustee and the divesture trustee; the requirements for the purchaser of the divested business; the period of divestiture; the duties of law enforcement agencies in the divesting process. A divestiture will be implemented in two cases. The first is the self-arranged divestiture, in which case, the divesture obligor shall be obliged to identify a purchaser and signs relevant agreement. According to the first paragraph of Article 12 of these Remedy Provisions, the divesture obligor shall inform the anti-monopoly law enforcement agencies of the purchaser designated by it and the sales agreement signed by and between it and the purchaser within the period specified in the review decision. In the review decision, the law enforcement agencies may specify a divestiture period as the case maybe. If no self-arranged divestiture period is specified, the divesture obligor shall identify a qualified purchaser and sign a sales agreement with such purchaser within 6 months from the date of the review decision. Based on the specific circumstances of the case, upon the explanation of the reasons by the divesture obligor, the anti-monopoly law enforcement agency may extend the self-arranged divestiture period at its discretion, provided that the extension period may not be more than three months. The second is entrusted divestiture, in which case, if the divesture obligor fails to complete the self-arranged divestiture on time, an independent third party, i.e., the divesture trustee, would identify a qualified purchaser, sign a sales agreement with such purchaser, and obtain the approval from MOFCOM within the period specified in the review decision. If the divestiture period is not specified in the review decision, the divesture trustee shall identify a qualified purchaser and sign a sales agreement within 6 months from the date of commencement of the entrusted divestiture. Then, the divested business or assets shall be transferred. According to Article 15 of Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation), the divesture obligor shall transfer the divested business to the purchaser within three months as from the date of the sales agreement and complete relevant legal procedures required, such as, the transfer of the ownership. However, based on the specific circumstances of the case, upon the application made and explanation of the reasons by the divesture obligor, the anti-monopoly law enforcement agency may extend the period for business transfer at its discretion. Step 3: Supervision on Implementation and Removal of Restrictive Conditions The anti-monopoly law enforcement agency will supervise and inspect the implementation of the restrictive conditions. The implementation of the restrictive conditions is a highly specialized task, which shall be carried out by an independent third party other than the undertakings involved in concentration. Such independent third party is called the supervisory trustee. The supervisory trustee shall, upon confirmation of the anti-monopoly law enforcement agency, sign an agreement with the undertakings, and regularly report the implementation to the law enforcement agency within the validation period of the restrictive conditions. The undertakings

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are obliged to abide by the restrictive conditions. So far, there have been three cases in which the obligor is subject to administrative penalties for violating the restrictive conditions. Western Digital and Thermo Fisher Scientific were imposed administrative penalties for violating the restrictive conditions.17 If the objective circumstances based on which the restrictive conditions are imposed changed significantly after the effectiveness of an anti-monopoly review decision on Concentration of Undertakings, MOFCOM may re-review, modify or remove the restrictive conditions, or the surviving undertaking upon concentration may file a written application for the same and explain the reasons thereon. The MOFCOM may assess the following factors in making the determination on modifying or removing the restrictive conditions: whether there have been significant changes in the involved party in a merger; whether there have been substantive changes in the competition structure in relevant market; and whether it has become unnecessary or impossible to implement the restrictive conditions. As for various restrictive conditions, some may be automatically removed, generally in case of structural remedy, where the restrictive conditions are removed upon completion of the divestiture, e.g., the acquisition by Pfizer of Wyeth and the acquisition by Novartis of Alcon; some are removed upon assessment, where upon the application of involved undertakings, the law enforcement agency may assess whether it is necessary to continue to implement the original restrictive conditions based on the competition in the relevant market and the situation of the undertakings.

3 Basic Logic of Restrictive Conditions The anti-monopoly review made by the anti-monopoly law enforcement agencies in the merger constitutes an essential part in the anti-monopoly law enforcement in various jurisdictions over the world and the system of imposing restrictive conditions is one of the key contents of the control system over the Concentration of Undertakings set forth in anti-monopoly laws and regulations.

3.1

Value and Positioning of Restrictive Conditions

It is a rationale that a free trade can improve the welfare of the parties involved is also a prerequisite for anti-monopoly enforcement agencies to issue administrative permits in respect of the merger. The review of the concentration of undertakings is not intended to prohibit the mergers. The law enforcement agencies must protect free 17

The Ministry of Commerce issued three administrative penalty decisions, including two against Western Digital, i.e., S.F.H [2014] No.786 and S.F.H [2014] No.787, and one against Thermo Fisher Scientific, i.e., S.F.H [2018] No.11.

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trades as much as possible on the one hand, and prevent potential adverse effects of the mergers, that is, obstructing the market order and ultimately harming consumer benefits. The criteria for assessing a concentration is that if a concentration will not bring seriously effect against the competition, or if the benefits outweigh its adverse effects, such concentration shall be permitted; if the concentration seriously hinders competition, such concentration shall be prohibited. These criteria are anticipative. In other words, the review of concentration of undertakings is a preventive measure which may prevent the potential monopoly leaded by over-concentration of the market power. The main forms of the monopoly, if occurs, are unilateral abuse of market dominance or collusive cartel. In order to avoid such possibility, the review of Concentrations of Undertakings should be implemented to prevent the risks in advance when making the merger. According to experience and analysis, if a high risk concentration is prohibited, false negative errors or false positive errors might occur. In Frank H. Eastbrook’s 1984 paper, The Limits of Antitrust, he pointed out that the anti-monopoly enforcement agencies could not make a 100% accurate identification on a monopoly behavior. Mistaken decisions are unavoidable, which can be divided into: positive error (also known as Type I error, false positive error), in which case an effective competition behavior is mistaken identified as anticompetition and is therefore prohibited by the anti-monopoly enforcement agencies, and; negative error (also known as Type II errors, false negative error), in which case a monopoly behavior is mistaken identified as a normal business behavior by the anti-monopoly enforcement agencies.18 In other words, in case of a positive error, a behavior is wrongly judged as guilty, and therefore being subject to an “excessive deterrence” and overcharged, while in case of a negative error, a behavior is wrongly judged as innocent, and therefore being subject to an “insufficient deterrence” and undercharged.19 Therefore, in addition to prohibiting a concentration and approving a concentration with condition, the anti-monopoly enforcement agencies are presented a third option, i.e., imposing restrictive conditions on a concentration. In particular, it is necessary to clarify that the restrictive conditions imposed are proposed by the undertakings involved in the concentration,20 approved and implemented by competent authorities. From this perspective, the determination of the restrictive conditions to be imposed is a game between law enforcement agencies and the undertakings, and an important legal means to balance the effectiveness of market competition and the healthy development of enterprises. Imposing restrictive conditions on concentration may prevent the effective competition from being

18

See Easterbook (1984), pp. 1–40. Hylton (2009), p. 105. 20 See Article 5 of Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation): The MOFCOM shall, in a timely manner, put forward that a concentration might preclude or restrict competition and give the reasons. Based on this, the reporter may propose additive restrictive conditions. 19

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serious damaged by the merger and, at the same time, safeguard the interests of the enterprises in their development to the maximum extent. The system of imposing restrictive conditions belongs to the field of “remedies system against anti-competition effects”, with a goal to ensure that, upon imposing restrictive conditions, a specific merger will not have serious anti-competition effects. Such system focuses on protecting “free competition”, “economic efficiency” and “public interest”. Conditional approval is an important legal instrument for the law enforcement agencies to implement anti-monopoly control over the Concentration of Undertakings. The imposition of “restrictive conditions” by the law enforcement agencies is in fact a deal and market intervention, involving the relationships between anti-monopoly review agencies and undertakings involving concentration, anti-monopoly review agencies and third parties, and undertakings involving concentration and third parties.21 So, the extent of intervention and its methods thereof reflect the law enforcement philosophies in different jurisdictions at different times. By the categorization currently and generally accepted in foreign theoretical circles and by foreign practical voices, the restrictive conditions are divided into structural conditions and behavioral conditions.22 According to the Merger remedies review project: report for the fourth ICN annual conference in 2005, by imposing structural conditions, the anti-monopoly enforcement agencies deal with the possible damage to competition caused by a merger through direct intervention with the market structure, and by imposing behavioral conditions, the anti-monopoly enforcement agencies deal with the possible damage to competition caused by a merger by changing the behaviors of the parties to the deal or other entities.23 Behavioral conditions set constraints on the behaviors of the surviving entity upon merger. In the Chinese academic community, restrictive conditions are generally divided into structural conditions, behavioral conditions, and synthetic conditions, namely a combination of structural conditions and behavioral conditions. This categorization has been adopted in the relevant legislation regarding the Concentration of Undertakings in China. In the existing departmental rules, restrictive conditions are accordingly divided into the abovementioned three categories.24

3.2

Structural Remedy and Behavioral Remedy

In fact, the classification of the merger remedies is different in various jurisdictions. For example, a mandatory license is generally deemed as a behavioral remedy, but in

21

Li and Ma (2016), pp. 37–39. Davies and Lyons (2007), pp. 13–17; Kwoka and Moss (2012), pp. 979–1011. 23 Merger remedies review project: report for the fourth ICN annual conference (2005). 24 See The Ministry of Commerce of the People’s Republic of China, Article 3 of the Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings (for Trial Implementation). 22

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the EU, an irrevocable, permanent, and royalty-free mandatory exclusive license is deemed as a structural remedy.25 The key to distinguish the behavioral remedy and structural remedy is on whether the obligor could meet the requirements of the law enforcement agencies at one time. If yes, it is a structural remedy; or otherwise, it is a behavioral remedy. The immediate reasons of this classification of the merger remedies are cost control of implementation and supervision. The law enforcement agencies place a higher value on the cost control of implementation will prefer structural remedy; the law enforcement agencies think more of cost control of implementation will prefer behavioral remedy.

3.2.1

Structural Remedy

Generally, structural remedies place their focuses on the disposal of the property rights to specific types of assets of the absorbed entity upon merger, mainly by divesting part of the assets involved in the concentration and assign such assets to an independent third party, thereby bringing a new and effective competition. The divestiture has two main purposes: to weaken the market control acquired by or strengthened by the undertakings involved upon the merger; and, to enhance the ability of the purchaser of the divested business to impose competitive pressure on the undertakings involved in concentration. To this end, it is necessary to divest all the elements required by the undertakings to compete in the relevant market effectively, including the obligor’s tangible assets, intangible assets, equity, key employees, and interests in its agreements with customers, agreements with suppliers, etc. In practice, the divested business is usually that the undertaking has been basically running independently, including the operator’s subsidiary, branch or business unit. A typical structural remedy is the divestiture of an existing independent business unit of the absorbed entity, including the divestiture of intellectual property rights or shares in other entities held by the absorbed entity or the waiver of particular shareholder equity in other entities. Structural remedies have very distinct advantages: (1) having obvious effect—once the assets are divested, the market control of the purchaser and the original disadvantaged competitors can be strengthened, and the market structure caused by the concentration can be changed; (2) being definite and with targeted object—a divesture will be taken against a specific business or proportion of equity with no ambiguousness; the constituents and term of the portfolio are definite and enforceable; (3) being able to be quickly enforced and easy for supervision—the structural remedies are active obligations, so that it is easy to judge whether such obligations have been fulfilled. And in the light of the characteristics of the structural remedies, a structural remedy may be fulfilled all at one time, so that no continuous supervision is required.

25

European Commission, Commission Notice on remedies acceptable under Council Regulation (EC) No. 139/2004 and under Commission Regulation (EC) No. 802/2004, OJ C 267, 22, October 2008.

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Structural remedies are more taken in horizontal concentration, which refers to the concentration having direct competitive relationship, in which case, by means of business and asset divestiture, competition problems in overlapping areas can be eliminated quickly and accurately.

3.2.2

Behavioral Remedy

Behavioral Remedies impose certain constraints on the behavior of the surviving entity upon merger. Such constraints can manifest as active actions or passive omissions. Instead of a disposal of the property rights to the assets of the absorbed entity, such constraints only impose restrictions on the property rights. Behavioral remedies are open-ended. By direct purpose, behavioral remedies can be divided into “behavioral remedies that promote horizontal competition” and “behavioral remedies that control the results of merger”. For example, opening-up commitments, non-discrimination provisions, purchase commitments, firewall provisions, transparency provisions, anti-retaliation provisions, and restrictions on rehiring key employees are typical examples of behavioral remedies. Behavioral remedies have the following advantages: (1) being in various forms—depending on the specific case and competition concern, behavioral remedies can be in various forms, as long as they protect the competition; (2) strong adaptability—behavioral remedies are directed against post-concentration behaviors which requiring necessary flexibility to cope with the structural change in the market after the completion of the concentration. MOFCOM requested a change of behavioral conditions in Western Digital’s Acquisition of Hitachi [Three years after the conditional approval over the Concentration of Undertakings in March 2012, at Western Digital’s application for lifting the restrictions, MOFCOM mainly assessed the impact of lifting the restrictions on the competition in the market, pointed out the changes of market competition status, such as SSDs have significantly stronger competitive constraints over the traditional hard drives, and the overdue capacity of the traditional hard drives has significantly increased, and thus concluded that the restrictive conditions should be changed, that is, it should be partially released from the obligations to keep independent in production, research and development, but it was still required to maintain the competitions between the two independent sales team and two independent brands in the market].);26 (3) being more suitable instruments can be continuously created— the 2004 Guide of the U.S. Department of Justice only set out firewall, fair deal and transparency provisions,27 and with the accumulation of experience and as needed by law enforcement, its 2011 Guide added prohibitions on certain contracting

26

MOFCOM Announcement No. 41 of 2015. See U.S. Department of Justice Antitrust Division, Antitrust Division Policy Guide to Merger Remedies, October 2004, pp. 22–26. 27

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practices, non-discrimination, mandatory licensing, anti-retaliation, and other provisions.28 The open-endedness of behavioral remedies gives the undertakings and law enforcement agencies sufficient flexibility to create and choose remedies that meet actual needs, while eliminating the possible damage to competition, minimizing the interference with business behaviors and maximizing the expected efficiency of concentration.

3.3

Debate Over Whether Structural or Behavioral Remedy Is Preferred

There has been a long-running debate worldwide over which type of the two remedies are preferred. The United States and the European Union have clearly stated that structural remedies take precedence over behavioral remedies. All seven parts of the Statement of the Federal Trade Commission’s Bureau of Competition on Negotiating Merger Remedies issued by the U.S. Federal Trade Commission (FTC) in 2003 are related to the divestiture rules of structural remedies,29 and behavioral remedies are not mentioned therein. In the Antitrust Division Policy Guide to Merger Remedies issued by the U.S. Department of Justice in 2004, the position is that law enforcement agencies shall give priority to structural remedies, with the belief that structural remedies can maintain competition, and are concise, highly certain, and easy to implement, and can avoid government’s intervention in the market, which can be costly. In contrast, behavioral remedies are difficult to design, require long time to implement, are easy to circumvent, and cost more.30 For a fairly long time, in the law enforcement practice in the United States, behavioral remedies are rarely applied, and in almost all cases where they are applied, they are applied to industries regulated by the government.31 In 2011, the U.S. Department of Justice revised the Guide(hereafter referred to as the 2011 Guide), by deleting the expression to the effect that structural remedies are preferred, and asserting that effective remedies should include structural remedies, behavioral remedies or a combination of both. Some scholars believe that this move has put behavioral remedies and structural remedies on an equal footing.32 In 2018, Makan Delrahim, the U.S. Assistant

28 See U.S. Department of Justice Antitrust Division, Antitrust Division Policy Guide to Merger Remedies, June 2011, pp. 12–18. 29 Bureau of Competition of the Federal Trade Commission, Negotiating Merger Remedies, https:// www.ftc.gov/system/files/attachments/negotiating-merger-remedies/merger-remediesstmt.pdf. 30 See U.S. Department of Justice Antitrust Division, Antitrust Division Policy Guide to Merger Remedies, October 2004. 31 Ibid. 32 See Fazio (2013), pp. 5–7.

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Attorney General, announced the revocation of the 2011 Guide and the resumption of the 2004 Guide, noting that behavioral remedies “are inherently regulatory, which is to say that they substitute central decision making for the preferred free market”.33 In practice, of all the remedies applied in the United States from 2009 to 2011, 13% are behavioral remedies, 78% are structural remedies, and 9% are synthetic remedies.34 In the Commission Notice on Remedies acceptable under the EU Merger Regulation issued by the European Commission in 2001 and revised 2008, it is stated that structural remedies are preferred.35 Of all the remedies applied from 2007 to 2009, 42% are structural remedies, 12% are behavioral remedies, and 46% are synthetic remedies.36 In the Merger Remedies: Competition Commission Guidelines issued by the U.K. Competition Commission in 2008, it is stated that the Competition Commission prefers structured remedies.37 In practice, more than 95% of the remedies in the cases concluded in Phase 1 review are structural remedies, while 81% of the remedies in the cases going into Phase 2 review are structural remedies.38 The discussions of Organization for Economic Co-operation and Development (OECD) show that the major developed economies stand very differently on this issue. Law enforcement agencies believe that each has their own advantages and disadvantages, the design of remedies plan requires the consideration of different competition issues involved in horizontal and vertical concentration: structural remedies are usually chosen against horizontal concentration, and behavioral remedies or synthetic remedies are usually chosen against vertical concentration. Many law enforcement agencies believe that structural remedies are more effective because they directly target the source of damage to competition and can be implemented at a low cost of supervision.39 However, in Australian practice, since 2002, only 10% of the cases applied just structural remedies, and 15% of the cases applied synthetic remedies.40 It can be inferred that behavioral remedies are applied in most cases. The reasons why structural remedies are more popular are as follows: 1. the notified cases accepted by law enforcement agencies are mainly on horizontal concentration, which is exactly the type of concentration against which structural remedies work. So, it is normal that structural remedies are preferred, which is

33

See Makan Delrahim (2018), p. 7. See Wang et al. (2013), p. 10. 35 See Commission Notice on Remedies acceptable under Council Regulation (EEC) No. 4064/89 and under Commission Regulation (EC) No. 447/98, 2001/C 68/03; No. 139/2004 and under Commission Regulation (EC) No. 802/2004, OJ C 267, 22 October 2008. 36 See Sorinas and Jorns (2009), pp. 9–13. 37 Competition Commission (2008), Merger Remedies: Competition Commission Guidelines, pp. 14–15. 38 See OECD (2011), p. 207. 39 See Han (2014), p. 192. 40 See OECD(2011), p. 46. 34

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shown by statistics. 2. The academic community and law enforcement agencies prefer free competition and its outcomes. After asset divestiture, the law enforcement agencies do not need to continue to interfere with the enterprises’ market behaviors, but allow them to compete freely. Structural remedies are obviously more consistent with the philosophy of free competition, compared with behavioral remedies, which continuously correct enterprises’ business behaviors and require continuous supervision. 3. Behavioral remedies are implemented by the concentration participants under the supervision of a trustee. Due to resource and professional knowledge constraints, law enforcement agencies are unable to effectively monitor concentrated operators’ behaviors. In sum, the awareness, philosophy, and level of law enforcement of the law enforcement agencies have led to the preference for structural remedies. However, behavioral remedies are applicable to most Concentrations of Undertakings in China.

4 Practice and Reflection on Merger Remedies in China 4.1

Practice of Merger Remedies

From August 1, 2008 to December 31, 2019, there were 44 cases of conditional concentration, including 8 cases involving structural conditions, 26 cases involving behavioral conditions, and 10 cases involving synthetic conditions, accounting for 18.2%, 59%, and 22.7% respectively, quite different from the distribution in the United States, the European Union and the United Kingdom. (see Fig. 4).

synthetic conditions, 10, 23%

structural conditions, 8, 18%

behavioral conditions, 26, 59%

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Structural remedies %

Jurisdiction

Behavioral remedies %

Synthetic remedies%

China

18.2

59

22.7

United States

78

13

9

European Union

42

12

46

United Kingdom

81

——

——

Fig. 4 Structural, behavioral and synthetic remedies in main jurisdictions (Source: The author)

In practice, by the undertakings’ position along the industrial chain, the concentration can be divided into horizontal concentration and vertical merger. Horizontal concentration refers to a concentration of two undertakings located in the same relevant market, such as acquisition by Inc. of AB; vertical concentration refers to a concentration of undertakings at different industrial links for a product or service, such as the concentration between automobile manufacturer and component manufacturer. The specific distribution is as follows (see Fig. 5): In all the 44 cases, 33 cases are horizontal concentrations, accounting for 75%. All 8 cases applying structural remedies are horizontal concentration cases. All vertical concentration cases apply behavioral remedies. And 15 horizontal concentration cases apply just behavioral remedies.

Type of Serial conditions No. imposed

Parties involved

Date of Filing

Date of Decision

Types of Acquisition

Type of Merger

Overseas Notification

1

Acquisition by Pfizer of Wyeth

2009.06. 15

2009.09. 29

Equity acquisition

Both EU and USA impose structural Horizontal conditions for approving the acquisition

2

Acquisition by Penelope of Savio Textile Machinery Co., Ltd.

2011.09. 05

2011.10. 31

Equity acquisition

Horizontal

Structural Remedy

Fig. 5 Specific distribution of merger remedy cases (Source: The author)

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Acquisition by 3 UTC of Goodrich

2012.02. 26

2012.06. 15

Equity acquisition

Internationa l Inc. of Gambro AB

5

Acquisition by NXP of all equity in Freescale

6

Acquisition by AnheuserBusch InBev of SAB Miller

Both EU and USA impose structural Horizontal conditions for approving the acquisition EU imposes structural conditions for approving the acquisition

Acquisition by Baxter 4

237

2013.03. 12

2015.05. 15

2015.03. 29

2013.08. 08

2015.11. 25

2016.07. 29

Equity acquisition

Horizontal approves acquisition without additional structural condition

Equity acquisition

All of USA, EU and Japan impose Horizontal structural conditions for approving the acquisition

Equity acquisition

All of USA, South Africa, and EU impose Horizontal structural conditions for approving the acquisition

Fig. 5 (continued)

4.2

Reflection on Precedence of Remedies

The effect of a horizontal concentration is mainly that after the merger, the undertakings’ competitors in the relevant market will decrease, or its share will increase significantly or even takes a dominant position, with a high possibility of cartel or abuse of dominance. Therefore, structural remedies against horizontal are often taken by transferring the property rights to specific assets of the absorbed entity, namely asset divestiture, a typical remedy. Vertical concentration could contribute to integration. The surviving entity upon merger is motivated to develop policies more

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7

Acquisition by Abbott of St. Jude Medical Inc.

2016.09. 06

2016.12. 30

Equity acquisition

Both USA and EU impose Horizontal structural conditions for approving the acquisition

2017.07. 12

2017.12. 27

Equity acquisition

Horizontal

Equity acquisition

USA imposes structural Horizontal conditions for approving the acquisition

Equity acquisition

Both EU and USA impose no condition for approving the acquisition

Merge of Becton, Dickinson and 8 Company and C. R. Bard, Inc.

9

10

Acquisition by In of AB

Acquisition by GM of Delphi

2008.10. 27

2009.08. 31

2008.11. 18

2009.09. 28

Vertical

Behavioral Remedy

11

Acquisition by Novartis of Alcon

2010.07. 20

2010.08. 13

Equity acquisition

Both EU and USA impose structural Horizontal conditions for approving the acquisition

12

Consolidati on Merger by Uralkali of Silvinit

2011.03. 14

2011.06. 02

Equity acquisition

Horizontal

Fig. 5 (continued)

favorable to its upstream or downstream enterprises, while other enterprises (unabsorbed entities) in the original market are restricted or blocked or have to accept unfavorable trading terms. For example, in the aforementioned Case No. 10: Acquisition by GM of Delphi, the two companies were in an upstream-downstream vertical relationship: GM was an auto manufacturer, while Delphi was an auto parts

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Acquisition by GE of China Shenhua Coal to Liquid and Chemical Co., Ltd.

14

Acquisition by Seagate of the hard drive business of Samsung Electronics

2011.06. 13

2011.12. 12

Asset acquisition

15

Henkel HK and Tiande Chemical Holdings Limited

2011.09. 26

2012.02. 09

Joint venture

16

Acquisition by Western Digital Corp. of Viviti Technologie s Ltd.

2011.05. 10 2011.11. 07

17

Acquisition by Google of Motorola Mobility

2011.05. 16

2011.11. 21

2011.11. 10

2012.03. 02

2012.05. 19

Joint venture

239

Vertical

Both USA and EU impose no Horizontal condition for approving the acquisition

Vertical

Equity acquisition

Both EU and USA impose structural Horizontal conditions for approving the acquisition

Equity acquisition

Both EU and USA impose no condition for approving the acquisition

Vertical

Fig. 5 (continued)

supplier and the exclusive supplier of many auto manufacturers. Since both parties occupied a large share in their respective markets, GM might purchase less or no auto parts from other suppliers, or Delphi might refuse to supply auto parts to other auto manufacturers (including those previously purchasing auto parts exclusively from it), for the benefit of both parties, after the merger. In the review of the concentration of undertakings, it is necessary to impose behavioral remedies to eliminate the adverse effects on the industry. GM and Delphi made four commitments including non-discriminatory supply, core information protection, and cooperation with clients with smooth replacement of suppliers.

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C. Zhang

18

Acquisition by Wal-mart of New Height Co., Ltd.

19

Joint Venture among ARM, Giesecke & Devrient and Gemalto

20

Acquisition by Marubeni Corporation of Gavilon

21

Consolidati on merger by MediaTek of MStar Semiconduc tor Inc.

22

Acquisition by Microsoft of the devices and services business of Nokia

2012.02. 16

2012.06. 28

2013.07. 13

2012.09. 04 2013.03. 12

2013.10. 10

2012.08. 13

2012.12. 06

2013.04. 22

2013.08. 26

2014.04. 08

Equity acquisition

Joint venture

Horizontal

Vertical

EU imposes behavioral conditions for approving the acquisition

Equity acquisition

Both EU and USA impose no condition Horizontal for approving the acquisition

Equity acquisition

Korea imposes behavioral Horizontal conditions for approving the consolidation merger

Asset acquisition

Both EU and USA impose no condition for approving the acquisition

Vertical

Fig. 5 (continued)

In this case, a behavioral remedy applied may constrain the behaviors of the surviving entity upon merger. This constraint can consist in active or passive obligations. Instead of disposal of the property rights to the assets of the absorbed entity, it only entails the restriction on the property rights. A structural remedy can also be applied, for example, through asset divestiture, re-creating an independent third party upstream as a competitor, so as to open up resources to the unabsorbed downstream, and offset the blockade effect.

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Acquisition by Merck KGaA of AZ Electronic Materials

2014.01. 29

2014.04. 30

Equity acquisition

24

Joint venture incorporate d by Corun, TMCI, PEVE, and Toyota Tsusho

2014.03. 04

2014.07. 02

Joint venture

25

Acquisition by Nokia of the equity in AlcatelLucent

26

Acquisition by Broadcom Limited of Brocade Co mmunicatio ns Systems, Inc.

27

Acquisition by HP Inc. of partial business of Samsung El ectronics C o.,

2015.06. 15

2015.10. 19

241

Approved by USA, Germany, Horizontal Japan, and Taiwan District

Vertical

Equity acquisition

Both EU and USA impose no condition Horizontal for approving the acquisition

USA imposes behavioral conditions for approving the acquisition

2017.03. 06

2017.08. 22

Equity acquisition

Vertical

2016.12. 23 2017.06. 21

2017.10. 05

Asset acquisition

Horizontal

Fig. 5 (continued)

From the analysis above, it seems that the structural remedies represented by asset divestiture are effective for both horizontal and vertical concentration. So, should the principle of “preference for structural remedies” be followed? The advantages of structural remedies have been discussed earlier in this paper. In 1999, the U.S. Federal Trade Commission published the A Study Commission's Divestiture Process, which was conducted by return visit to 37 purchasers in the cases of asset

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C. Zhang

28

Acquisition by Maersk Line A/S of HSDG (Hamburg Südamerika nische Dampfschif ffahrts Gesellschaft KG) Acquisition by Advanced S emiconductor

29

Engineering , Inc. of Siliconware Precision I ndustries C o., Ltd.

30

Merge of Essilor Internationa l and Luxottica Group SpA

31

Acquisition by KLATencor Corporation of Orbotech Ltd.

32

Fig. 5 (continued)

Acquisition by CargotecOy j of TTS Group ASA

2017.04. 27 2017.10. 24

2016.12. 14 2017.06. 06

2017.08. 17 2018.03. 07

2018.4.2 8 2018.12. 20

2018.7.2 6 2019.1.1 4

2017.11. 02

Equity acquisition

Brazil imposes no condition for approving the acquisition Vertical EU imposes structural conditions for approving the acquisition

Equity acquisition

Both Taiwan District and USA impose Horizontal no condition for approving the acquisition

2018.07. 25

Equity acquisition

Vertical

Both EU and USA impose no condition for approving the Merger

2019.02. 13

Equity acquisition

Vertical

2019.7.1 2

Asset acquisition

Horizontal

2017.11. 24

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Acquisition by 33

II-VI of Finisar

34

Joint venture incorporateed by Zhejiang Garden Biochemica l High-Tech Co., LTD and Royal DSM

35

Acquisition by Mitsubishi Rayon of Lucite

36

Acquisition by Panasonic Corp of Sanyo

2019.02. 20 2019.8.2 0

2019.9.2 3

Equity acquisition

Horizontal

2019.10. 18

Joint venture

Horizontal

2018.5.2 2019.4.3 0

2009.01. 20

2009.04. 30

2009.04. 24

2009.10. 30

Equity acquisition

EU imposes no condition Horizontal for approving the acquisition

Equity acquisition

Both EU and USA impose structural Horizontal conditions for approving the acquisition

Synthetic Remedy

37

Fig. 5 (continued)

Acquisition by Glencore In ternational plc of Xstrata plc

243

2012.05. 17 2012.11. 23

EU imposes structural conditions for approving the acquisition 2013.04. 16

Equity acquisition

Horizontal & vertical USA imposes no condition for approving the acquisition

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38

Acquisition by Thermo Fisher Scientific of Lifei Technology

2013.08. 27

2014.01. 14

Equity acquisition

EU imposes structural Horizontal conditions for approving the acquisition EU imposes behavioral conditions for approving the acquisition

39

Merge of DOW and DuPont

2016.05. 06 2016.11. 17

2017.04. 29

Equity acquisition

Horizontal USA imposes no condition for approving the acquisition Approved by Brazil

40

Merge of Agrium Inc. and Potash Corp oration of S askatchewa n Inc.

2016.12. 05 2017.06. 02

2017.11. 06

Horizontal

Equity acquisition

EU and U.S. Department of Justice impose Horizontal structural conditions for approving the acquisition

Acquisition by BAYER

41

AKTIENG ESELLSCH AFT, KWA INVESTM ENT CO. of Monsanto Company

2017.02. 24 2017.09. 19

2018.03. 13

Approved by the Federal Trade Commission

Equity acquisition

Fig. 5 (continued)

divestiture from 1990 to 1994. The study affirmed the effectiveness of asset divestiture as remedy: about 75% of the cases were successful.41 At the same time, it has objective disadvantages. Some scholars argue that asset divestiture as remedy has

41

See Baer (1999), p. 4.

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Chile, Argentina, Russia, and Mexico impose no condition for approving the merger

42

Merge of Linde AG and Praxair, Inc.

2017.09. 29 2018.04. 04 2018.09. 29

2018.09. 30

Equity acquisition

USA, EU, India, Korea, Horizontal and Canada & impose vertical structural conditions for approving the merger Brazil imposes synthetic conditions for approving the merger

43

Acquisition by United 2017.12. Technologies 13 2018.06. Corporation 08 of Rockwell Collins, Inc.

44

Acquisition by Novelis Inc. of Aleris

2018.12. 13 2019.6.1 2

2018.11. 23

Equity acquisition

Both U.S. Department of Justice and EU impose Horizontal structural conditions for approving the acquisition

2019.12. 20

Equity acquisition

Horizontal

Fig. 5 (continued)

three shortcomings, namely “composition risks”, “purchaser risk” and “assets risks”, so that the asset divestiture might not be the optimal remedy.42 Specifically, asset divestiture may involve risks such as risk of insufficient divestiture, risk of

42

See Rey (2004), pp. 129–134.

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purchaser’s eligibility, risk of asset preservation, and risk of transitional competition.43 The purpose of asset divestiture is to enable new and independent competitors to compete effectively with the concentrated undertakings in the relevant market by finding eligible purchasers. Therefore, the divesture obligor might deliberately create barriers to divestiture for its own interests. Such as the following two: (1) Portfolio constituents. Although it has approved the divestiture of certain assets, the law enforcement agency could not take the initiative to obtain valid information due to lack of expertise. So, the specific constituents of the portfolio are determined by the divesture obligor or the divesture trustee. (2) Eligible purchaser. If there is such option, the undertakings are motivated to divest assets to weaker purchasers, so as to weaken their future competitiveness in the relevant market. Asset divestiture as remedy is more suitable for horizontal merger. The key to application of such remedy is to clarify the scope of divestible assets, select the assignee, and select an eligible divesture trustee and an eligible supervisory trustee. Structural remedy is a major modification to a concentration, because the divestiture is a one-shot deal and thus is “irreversible”. A material deviation from any of the requirements for the divested assets, the assignee, and so on will reduce the efficiency expected to be brought by the concentration. As mentioned earlier, Concentration of Undertakings is an autonomous action of the undertakings proposing to make a merger, and also a common business practice that might lead to scale effect. Divestiture, which is aggressive, might cause excessive intervention by the administrative authorities, resulting in inefficiency of the markets. In contrast, behavioral conditions are flexible and diversified. Where a structural remedy will eliminate the efficiency expected to be brought by concentration and the competition will be seriously damaged if no remedy is implemented, a behavioral remedy is an effective option.44 However, its implementation costs are higher than that of a structural remedy. According to the law enforcement experience of China, behavioral remedies are widely applicable where the aim is to, after merger, restrict the undertaking from blocking trades, trading at unfair prices, or causing other anti-competition consequences with its advantages. For example, in the aforementioned Case No.22, Microsoft/ Nokia Corporation, in order to prevent the patentees from abusing their rights after the merger, the law enforcement agency required Microsoft and Nokia each to undertake to grant non-exclusive licenses of non-standards essential patents to smartphone manufacturers in China and to trade with them on fair, reasonable, and non-discriminatory terms (FRAND). It can be seen that, due to different rules and methods, a structural condition and a behavioral condition each has its own characteristics, application scope and application scenarios, which should be taken into full

43

See Papandropoulos and Tajana (2006), p. 443. See U.S. Department of Justice Antitrust Division (2011) Antitrust Division Policy Guide to Merger Remedies, pp. 5–7. 44

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consideration. In addition, it is necessary to consider the different applicability of the same type of remedy to different types of deals, such as horizontal concentration and non-horizontal merger. The choice from different types of remedies should be made based on the specific circumstances of a case, and no particular type is absolutely preferred. This is fully illustrated by the international review and approval in the 44 cases mentioned as above.

5 Improving the System of Imposing Restrictive Conditions In the cases of Concentration of Undertakings, the absolute number of cases of conditional approval is not large, but such cases are of great significance to undertakings participating in concentration and affect competition patterns in relevant markets and adjacent markets. Therefore, law enforcement agencies in various jurisdictions are very prudent in imposing restrictive conditions, which are imposed after complicated and time-consuming procedures. Based on past experience of eleven years in anti-monopoly law enforcement, China's system of imposing restrictive remedies shall be improved in the following aspects.

5.1

Basic Principles for Remedy

Anti-monopoly enforcement agencies implement merger remedies for the purpose of maintaining effective competition in relevant markets while realizing the efficiency expected to be brought by merge and acquisition. To this end, anti-monopoly law enforcement agencies shall balance the competition damage mitigating effectiveness of and the collective benefits from merger remedies.

5.1.1

Principle of Necessity

A merger remedy is a precautionary measure against possible competition concerns in the future market. Therefore, a remedy shall be only applied to the concentration which might cause damage to the market, in line with the principles of prudent enforcement and limited intervention, with respecting the operator’s right to operate autonomously. For this reason, in respect of any proposed merger, comments shall be sought in a centralized manner from multiple parties, including industry associations, competent authorities, competitors, and upstream and downstream undertakings. In particular, competitors’ opposing views shall be treated cautiously and objectively. During the above-mentioned competition effect assessment, it is necessary to conduct economic analysis on market power and efficiency evaluation.

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Principle of Minimum Intervention

In adding remedy measures, under the premise of ensuring effective elimination of damage to competition, the law enforcement agency shall choose the option that imposes minimum burden on the undertakings, so that the undertaking bears the lowest costs while exercising its right to operate autonomously and realizing the benefits from merge and acquisition. These costs include both substantive contents, such as reasonable and effective coverage of portfolio, which may not be expanded arbitrarily to unduly increase the obligations of the divesture obligor; and procedural contents, such as adoption of reasonable and effective supervision mechanism to improve transparency. When designing a remedy, the law enforcement agency shall conduct a trade-off between appropriate cost and effectiveness so that the remedy is effective in both procedure and practice and cheap to manage, with main considerations including: the risk of failure of remedy, the possible losses and costs, and whether the efficiency expected to be brought by the concentration can be realized.45

5.1.3

Principle of Effectiveness

Remedies shall enable effective elimination of the damage to competition and be easy to be implemented and supervised.46 Once a restrictive condition is determined, the accurateness, promptness and effectiveness of its implementation will become the important factors in achieving expected works. As the potential change of objective circumstances, the change of the restrictive conditions, if necessary, could ensure that in addition to preventing the competition in the market from being damaged, the value of anti-monopoly regime will protect the interests of the undertakings as much as possible. For example, in the case of acquisition by Seagate of Samsung, MOFCOM issued a conditional approval. During the implementation, Seagate proposed to the law enforcement agency to lift the restrictive conditions. After assessment and consultation with Seagate and based on the circumstances, the restrictive condition was not lifted, but changed.47

5.2

Expertise and Neutrality of Divesture Trustee and Supervisory Trustee

You can see that structural remedies and behavioral remedies each have their own characteristics and are applicable to different types of merger. In addition, there is an increasingly obvious trend that synthetic remedies are first choice in practice. 45

See Dong (2008), p. 63. See Wu and Liu (2012), p. 437. 47 MOFCOM Announcement No.43 of 2015. 46

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Therefore, research on imposing restrictive conditions will evolve from type comparison to effectiveness evaluation. The effect of a remedy is determined based on two factors: the reasonableness and feasibility of the remedy; the effectiveness of its implementation. Both two factors will be evaluated relying on professionals’ independent judgment from the perspective of market competition. Most previous researches have focused on substantive issues, such as the “crown jewel clause”, “asset division”, and sales without floor price in a divestiture.48 However, what kind of portfolio is reasonable and effective? How to determine which of the three bidders in an auction would compete effectively in the future market and thus become an eligible purchaser, and whether a contract clause meets the FRAND standards? Different cases involve different market conditions and different industries, and require high expertise. Law enforcement agencies obviously lack such expertise. At this moment, divesture trustees’ and supervisory trustees’ advantages in expertise are highlighted. Moreover, in respect of many issues arising during the implementation, the judgment criteria from the perspective of anti-monopoly law are different from those from the traditional perspectives of civil law and company law. For example, in respect of the above-mentioned issue of purchaser, when all bidders are eligible, it is not necessarily the bidder offering the highest price should be selected. Instead, the selection must be made by judging which one would realize an “effective competition”, upon comprehensive considerations. At this time, the commercial criteria are abandoned, and the ultimate goals are to maintain order of market competition and protect consumer welfare. The goals of law enforcement agencies are somewhat transferred to divesture trustees and supervisory trustees. So, in designating divesture trustees and supervisory trustees, law enforcement agencies shall be careful about the potential problems with their ability and willingness. There is a paradox in China’s current mechanism of remedy implementation. According to Article 18 of the Provisions on Imposing Restrictive Conditions on the Concentration of Undertakings, the supervisory trustee, divesture trustee and divesture obligor shall enter into a written agreement to set out their respective rights and obligations, that is, a mutual contract. In addition, the divesture obligor shall pay remuneration to the supervisory trustee and the divesture trustee, and provide necessary support to and convenience for the implementation of restrictive conditions. On the other hand, according to Article 20 of these Provisions, such two trustees shall be selected and appointed by relevant administrative law enforcement agency, and are obliged to report it on, among others, the obligor’s compliance with the review decision, implementation of the divestiture, and performance of related agreements. In view of the basic rationale for designing the mechanism, system and other arrangements of merger remedy, the interests of law enforcement agencies are not consistent with those of operators, with the former being supervisor and the latter being implementor, not necessarily antagonistic, indeed not on the same side somewhere sometime. In the circumstances where the trustee not only has an

48

See Cary and Bruno (1997), p. 875.

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agreement with the obligor but also supervise the obligor on behalf of the law enforcement agency, it is difficult for the trustee to position itself and perform its duties. It is a paradox that in practice, if the trustee performs its duties diligently, its workload will increase, so will its remuneration, resulting in an increase in the burden on the obligor. A possible way is that, due to their expertise, the trustees are entrusted by law enforcement agencies to supervise obligors, and receive remunerations according to consistent standards. Unlike the current way, after such correction, such remunerations shall be collected by law enforcement agencies from obligors on behalf of trustees and then paid to trustees. In this way, the relationship between law enforcement agencies, trustees, and obligors can be straightened out, and the effectiveness of remedies can be maximized.

5.3

Increasing Negative Consequences of Illegal Concentration

Adding remedy measures limit undertakings’ business practices and competitive advantages to a certain extent, so they are motivated to evade restrictive conditions. Specifically, there are three possibilities: The first is to conduct concentration without notification, in order to avoid restrictive conditions. So far, there have been more than 30 notifiable but unnotified concentrations in which the undertakings are punished by the law enforcement agencies, and the number of such cases and the intensity of punishment have increased significantly since 2018. According to Article 48 of the current Anti-monopoly Law, if an undertaking conducts an concentration illegally, the anti-monopoly law enforcement agencies shall order it to cease the merger, dispose of relevant shares or assets within a specified period, transfer relevant business within a specified period, and take other necessary measures to restore the status before merger, and may impose it a fine up to 500,000 yuan. In practice, in those notifiable but unnotified mergers, none of the undertakings are forced to restore the status quo ante, and in all such mergers, the undertakings are fined. However, the upper limit on the fine, 500,000 yuan, is obviously too low making the risk from such practice is controllable, causing the undertakings to “reasonably violate the law”. In response to this, the cost of violation shall be increased, and a fine amounting to 1–10% of the violating undertaking’s sales in the previous year shall be imposed, like the fines for other monopoly acts.49 The second is that the undertaking would not notify due to uncertain review period. Since the market is changing rapidly, the certainty of deal is very critical. The longer the time taken by administrative authorities to review, the greater the impact is on the undertakings involved. So, in practice, many cases have not been reported due to such uncertainty. According to Articles 25 and 26 of the PRC Anti-monopoly Law, the review on a Concentration of Undertakings shall be completed within no 49

See Articles 46 and 47 of Anti-Monopoly Law of China currently in effect.

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more than 180 days. Unlike in other jurisdictions, in China, the review period is counted as the number of calendar days, instead of working days, from the date of notification and case filing, without interruption. As for the concentrations imposing restrictive conditions, the undertakings and law enforcement agencies shall negotiate repeatedly, as well as go through hearing, announcement, and other procedures. Therefore, objectively, some cases cannot be concluded within the statutory period, and thus are filed repeatedly. In all 26 concentration cases imposing behavioral conditions, 10 are refilled upon supplementing supporting materials for notification, accounting for 38.5%; in all 10 concentration cases imposing synthetic conditions, 7 are refilled upon supplementing supporting materials for notification, accounting for 70%, in which Case No. 42, Merger between Linde AG and Praxair was filed for three times. According to China’s review procedures, each time a case is filed, the period must be re-counted, allowing time for the law enforcement agency to review on the one hand, and increasing the uncertainty of the time of completing the review on concentration on the other hand. For this reason, it is required to be practical and realistic in the event of a restrictive condition to be negotiated, and such negotiation shall be considered as a statutory cause for suspension of timing, in order to eliminate the uncertainty caused thereby. The third is that the undertaking would violate the remedy taken. According to the statutory procedures, the restrictive conditions shall be proposed by the undertaking, and upon approval and announcement by the law enforcement agency, shall become an obligation legally binding on the undertaking. A violation of the obligation of remedy not only constitutes a violation of administrative obligation but also causes damage to market competition, so the violating undertaking shall be punished. Under the current legal rules, the maximum fine is 500,000 yuan. In the only three cases mentioned above, Western Digital was fined 300,000 yuan for each of its two violations, and Thermo Fisher Scientific was fined 150,000 yuan for its violation. The fine is not high enough to punish the violating operator. Conclusion With the development of the global economy, Concentration of Undertakings, as a common business practice, has an irreplaceable positive effect. At the same time, reviewing and imposing conditions on Concentration of Undertakings is also a means for law enforcement agencies in various jurisdictions to maintain market competition status. The reasonableness and effectiveness of a remedy are the keys to realize the positive effect of Concentration of Undertakings. The research conclusions suggest that, for structural and behavioral remedies, it is hard to judge which is superior, each have their own advantages or disadvantages and are applicable to different individual cases. The fact that structural remedies are more applied in some jurisdictions represented by the United States and the European Union cannot be used as counterevidence, or what’s more, as a predictor of future law enforcement trends. One reason is difference in philosophy of law enforcement. For example, Chinese law enforcement agencies tend to apply prudent behavioral remedies, in order to avoid excessive damage to competition caused by one-shot and irreversible divestiture. Of course, they have to pay the high cost and sacrifice the flexibility of behavioral remedies. The other reason is the imprint of the era. At

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present and in future, the competitive advantages held by an undertaking arising from intellectual property rights are more uncertain in a fast-changing market with rapid technological development. Compared with divestiture, intellectual property licensing might better accommodate such uncertainty. At present, China is amending its Anti-monopoly Law and SAMR has also issued ministerial-level administrative regulations on concentration of undertakings. It is believed that the opinions in this paper will be useful for the revision and supplement to relevant rules in China.

References Cary G, Bruno M (1997) Merger remedies. Adm Law Rev 49:875–888 Davies S, Lyons B (2007) Mergers and merger remedies in the EU. Edward Elgar Publishing Limited, Cheltenham Dong H (2008) Remedies in the anti-monopoly review on concentration of undertakings. Price Theory Pract 7:63–64 Easterbook F (1984) The limits of antitrust. Tex Law Rev 63:1–40 Fazio C (2013) Merger remedies: the greater use by the DOJ and FTC of an expanding toolkit. Aspatore Books Han W (2014) Introduction to and comment on 2011 merger remedy forum of OECD. Econ Law Rev 1:191–207 Hylton E (2009) Antitrust law: economic theory and common law evolution. Translated by ZHAO Ling. Peking University Press, Beijing Kwoka J, Moss D (2012) Behavioral merger remedies: evaluation and implications for antitrust enforcement. Antitrust Bull 57(4):979–1011 Li J, Ma X (2016) The composition of operation mechanism of operator concentration remedies Price Theory Pract 12: 37-39 Makan Delrahim (2018) “Life in the Fast Lane”, Antitrust in a Changing Telecommunications Landscape. https://www.justice.gov/opa/speech/file/1108606/download OECD (2011) Policy Round tables: Remedies in Merger Cases. http://www.oecd.org/daf/ competition/Remediesinmergercases Papandropoulos P, Tajana A (2006) The merger remedies study: in divestiture we trust? Eur Compet Law Rev 8:443–454 Qiu C (2009) Discussions on the system of conditional approval over operator concentration in the anti-monopoly law. Res Rule Law 10:96–100 Rey P (2004) ‘Economic analysis and the choice of remedy’, merger remedies in American and European Union Competition Law. Edward Elgar Publishing, Cheltenham Shang M, the Director of the Anti-monopoly Bureau of the Ministry of Commerce, talking about “Promoting Anti-monopoly Law Enforcement and Maintaining Fair Market Competition”, http://www.gov.cn/zxft/ft155/ Sorinas S, Jorns C (2009) European Union: EU merger remedies. Int Financ Law Rev: 9–13

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The Staff of the Bureau of Competition of the Federal Trade Commission, William J. Baer, Director (1999) A Study of The Commission’s Divestiture Process. https://www.ftc.gov/sites/default/ files/documents/reports/study-commissions-divestiture-process/divestiture_0.pdf The US-China Business Council (2014) Competition Policy and Enforcement in China. https:// www.uschina.org/reports/competition-policy-and-enforcement-china. Wang EX-R, Tsai J, Chan S (2013) Merger remedies with Chinese characteristics. CPI Antitrust Chronicle 8(2):1–13 Wu Z, Liu X (2012) Theory and practice of the anti-monopoly review system for mergers and acquisitions. Law Press, Beijing

Evaluating the Mandatory Bid Rule for Takeover Law in China: An Empirical and Comparative Analysis Joseph Lee, Yonghui Bao, and Jinlin Li

Abstract This paper discusses the purpose and practice of the mandatory bid rule in takeovers in the UK. A literature review looks at the impact of the mandatory bid rule in a takeover on both bidders and target companies. The origin and evolution of the mandatory bid rule in China are described and cumulative abnormal returns (CAR) used to measure its impact on bidders and target companies. The results show that shareholders of target companies receive a better return when bidders acquire more than 50% of the shareholding in target companies. This suggests that China should reform its mandatory bid rule by restricting the use of proportional partial bids to increase returns to the target shareholders. The results also show that in making a proportional partial bid to take a company over, bidders receive a better return when they aim for corporate restructuring that adheres to the state-led industrial policy. The authors recommend that the law should strike a balance between following the state-led policy of corporate restructuring and protecting the interests of target companies.

The authors thank Prof Zhu Ciyun & Prof Tang Xin, Tsinghua Law School; Dr Beat Reber, Sheffield University Management School, and Mr Jiannan Lin, Legal Counsel, Coscoshipping-Cinda Asset Management Co Ltd, for their feedback on earlier drafts of this article. J. Lee (*) · Y. Bao School of Law, University of Exeter, Exeter, United Kingdom e-mail: [email protected]; [email protected] J. Li Business School, University of Exeter, Exeter, UK e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 J. Lee (ed.), Takeover Law in the UK, the EU and China, https://doi.org/10.1007/978-3-030-72345-3_9

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1 Introduction The mandatory bid rule is one of the cornerstones of the UK Takeover Code, that provides protection to minority shareholders when corporate control is transferred, based on the principle of equal treatment.1 China introduced a UK-style mandatory bid rule in its Securities Law in 1999. However, since that time the takeover market regulator has allowed frequent exemptions to mandatory bid obligations in takeovers, so that today the mandatory bid rule exists only in name. This paper uses both empirical and comparative methods to examine the effects of China’s mandatory bid rule on target and bidder companies’ market value shortly after a takeover bid. We use ‘cumulative abnormal returns’ (CARs) to measure stock performance of both target and bidder companies before and after the announcement of a takeover. Because the bidder’s acquisition ratio in target shares directly relates to abnormal returns for both target and bidder, the percentage of the bidder’s acquisition is chosen as the first parameter in observing the changes in CARs. The takeover market in China has been regarded by the state as a tool for promoting industrial transformation so the bidders’ purpose in conducting a takeover is selected as the second parameter. This comparative and empirical analysis leads to suggestions for improving the mandatory bid rule in China. In Sects. 1 and 2, we examine the nature and origins of the mandatory bid rule, and its effects on the market value of targets and bidders. Section 3 presents the corresponding evidence from the UK and US literature. Sections 4 and 5 set out the evidence from China on the effect of takeovers and mandatory bids on target and bidding companies. Section 6 discusses the policy objectives and current problems of the mandatory bid rule in China and we give suggestions for improvement based on both the empirical evidence and comparative analysis.

2 The Nature and Origins of the Mandatory Bid Rule The mandatory bid rule originated in the UK Takeover Code. It provides that a bidder is required to offer a bid to all remaining shareholders if he acquires a specified percentage of voting shares or interests in voting shares.2 In reality, the bidder is fully aware of when the mandatory bid threshold is crossed and although this rule is called ‘mandatory’, the bidder voluntarily crosses the threshold to trigger the obligation. In this respect it is indistinguishable from a voluntary bid.3 In accordance with the UK Takeover Code, if a bidder crosses the threshold inadvertently, the Takeover Panel will waive the mandatory bid obligation, subject to certain

1

Kershaw (2016). Rule 9.1, The UK Takeover Code. 3 Kershaw (2016). 2

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undertakings.4 The reason that a bidder triggers the mandatory bid obligations voluntarily lies in the strategic advantage of announcing mandatory bids.5 Triggering a mandatory rather than a voluntary bid brings the advantage that the bidder may be able to acquire a block of shares before the bid announcement. As a result, the bidder may acquire a block of shares before the bid announcement, and thereby increase the chance of successfully acquiring de jure control of the target company. Even de facto transfer of control may have happened before the bid announcement, especially when, as in the UK, there is a highly dispersed shareholding structure.6 In hostile takeover battles, this is advantageous to an unsolicited bidder. If the bidder acquires such a block of shares without announcing a possible bid, the cost of acquisition is lower than when making a voluntary bid, because bidding companies normally offer a control premium above the market price.7 Because it is a cornerstone of takeover regulation, the design of the mandatory bid rule should be consistent with the regulatory attitude towards takeover law as a whole. If regulators intend to develop an active market for corporate control, takeover law, including the mandatory bid rule, will encourage takeover activities, and vice versa. Although, in theory, takeover has the function of amalgamating resources to create synergy and also to play the role of the ‘Sword of Damocles’ on slack corporate managers, the evidence is that the effect of takeovers varies from country to country.8 If takeovers create value, then regulation is more likely to support and foster takeover activity. On the other hand, if takeovers destroy value, then takeover regulation may aggressively police takeover activities to deter potential bidders.9 Even though the mandatory bid rule could in theory provide protection to minority shareholders, it should not be the sole factor to be considered by the regulator when designing it. The mandatory bid rule should be consistent with the spirit of the whole system of takeover regulation, either to encourage or deter takeover activities. Hence, this paper assesses the operation of the mandatory bid rule in order to understand the regulatory attitude towards takeover activities.

3 The Policy Goal of the Mandatory Bid Rule in the UK Takeover Code 3.1

Protecting Minority Shareholders

The General Principles of the UK Takeover Code stipulate that ‘if a person acquires control of the company, the other holders of securities must be 4

Notes on Dispensations from Rule 9 (Note 4), The UK Takeover Code. Kershaw (2016). 6 Ibid. 7 Borges and Gairifo (2013). 8 Kershaw (2016). 9 Ibid. 5

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protected’.10 The mandatory bid rule offers minority shareholders an opportunity to avoid future exploitation by the new controller of the company, when control is transferred.11 Under the UK Takeover Code, proportional partial bids are not allowed, so that shareholders in the target companies are able to share the control premium in takeover transactions.12 In China, however, the mandatory bid rule has deviated from its UK origins. The existence there of proportional partial bids and frequent exemptions from mandatory bid obligations mean that the mandatory bid rule exists in China only in name. In accordance with the Measures for Takeover 2020, ‘if a bidder acquires the shares of listed company by means of takeover bids, the proportion of shares to be acquired shall not be lower than 5% of the issued shares of the said listed company’.13 Compared with general bids, proportional partial bids very much reduce the opportunity for target shareholders to share control premiums because the right of shareholders to exit from the target companies is restricted. Hence, the mandatory bid rule in China offers weak protection to minority shareholders.

3.2

Equal Treatment

In accordance with the general principles of the UK Takeover Code, all holders of the securities of an offeree company of the same class must be afforded equivalent treatment . . . . the holders of securities of an offeree company must have sufficient time and information to enable them to reach a properly informed decision on the bid.14

In addition, target boards are not allowed to deny the holders of securities the opportunity to decide the merits of a bid.15 The highest price rule gives target shareholders the chance to share the control premium to the maximum. All these rules protect target shareholders as they participate in control transactions and also increase the possibility of their sharing the control premium. Hence, under the UK Takeover Code, the mandatory rules are in place to protect target shareholders’ interests and to safeguard equal treatment. Although there are several circumstances in which bidders are allowed to avoid the mandatory bid obligation, such exemption is exceptional under the UK Takeover Code.16 By contrast, although the highest price rule has also been introduced into Chinese takeover regulation, the frequent

10

General Principle 1, The UK Takeover Code. Kershaw (2016). 12 Ibid. 13 Art. 25, Measures for Takeover 2020. 14 The General Principles, The UK Takeover Code. 15 Ibid. 16 Cai (2011). 11

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exemptions allowed and the existence of proportional partial bids have made the highest price rule less applicable in China.

4 Creating and Destroying Value Through Takeovers: Theoretical and Empirical Evidence 4.1

Value Creation and Destruction in Theory

The market for corporate control promotes the combination of assets in order to create value.17 This added value is the combined result of many causes, referred to as ‘synergies’, which include the effects of economies of scale and cost savings.18 Normally, the way in which assets are combined is specified in contracts between sellers and buyers. However, when contracting parties fail to agree on valueenhancing combinations, the market for corporate control may offer solutions.19 On the other hand, takeovers may also destroy value. For instance, if two companies have combined their assets, but then find that their operational and governance culture are incompatible, value may be destroyed.20 Empire building is another motivation for managers to pursue takeovers; managing a larger company may increase managers’ remuneration and enhance their business profile,21 but this may come at the cost of destroying corporate welfare. Hence, there are potential pros and cons of takeovers.

4.2

Value Creation and Destruction in Practice: Empirical Evidence from the UK and US

Evidence about the performance of companies after takeover can be divided into two groups: short term and long. In the former, studies reported in the literature have tracked the stock price of companies before a bid announcement and for up to two months afterwards. For evidence of the long-term effect of takeovers on target and bidder companies’ performance post-merger, the most frequent observation periods are between three to five years.

17

Coffee (1984). Manne (1965). 19 Kershaw (2016). 20 Deakin and Singh (2008). 21 Davidoff (2009). 18

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Short-Term Effects of Takeovers on the Value of Companies

Normally, ‘abnormal returns’ are used to reveal short-term effects of takeovers on company value. The most widely accepted definition of abnormal returns is ‘the difference between the realised returns and an expected return, i.e. the difference between actual returns and benchmark returns’.22 The expected return is the return that would have been generated had the takeover bid not taken place.23 There is a consensus in many jurisdictions, including the UK, US and EU, that shortly after a bid, target companies witnessed significantly positive abnormal returns.24 But the majority of studies have shown that there were no significant abnormal returns for bidder shareholders, even though they may be slightly negative in the short term.25 When the abnormal returns of both target and bidder shareholders are combined, all studies found the results were positive.26 (1) Short-term effects of takeovers on targets The research conducted by Frank and Harris on the UK takeover cases found that from 1955 to 1985 there were 23% of abnormal returns for target companies and 2.4% for bidders.27 The research also revealed that, on bid announcement day, the cumulative abnormal return was 21.3% and was 8.4% four months before the bid announcement day.28 Jensen and Ruback reviewed 13 studies in the US on the effects of takeovers and concluded that there were cumulative abnormal returns of between 20 and 30% around the bid announcement period.29 Andrade et al., found that target companies’ cumulative abnormal returns were 23.8% shortly before and on the bid announcement day.30 Clements et al. reported results that are consistent with these findings, with cumulative abnormal returns of 19.9% on the bid announcement day, compared to 6.9% before the bid announcement day.31 Bidders have various intentions and approaches as they conduct takeovers. These include differences in the structure of the deal (merger or contractual offer),32 the attitude of the target board (hostile or friendly),33 industry segmentation of bidders and targets (conglomerate merger or industry merger), and the payment methods of consideration (cash offer or share for share merger).34 The research showed that

22

Martynova and Renneboog (2008). Ibid. 24 Franks and Mayer (1996). 25 Martynova and Renneboog (2008). 26 Ibid. 27 Franks and Harris (1989). 28 Ibid. 29 Jensen and Ruback (1983). 30 Andrade et al. (2001). 31 Clements et al. (2007). 32 Davidoff (2009). 33 Elliott (1998). 34 Eckbo (2008). 23

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target companies had positive abnormal returns under all these categories in the short term and that there were higher returns from a hostile takeover compared to a friendly one.35 A study conducted in the UK revealed 30% abnormal returns for target shareholders through hostile takeovers, compared to 18% for friendly takeovers.36 (2) Short-term effects of takeovers on bidders Shareholders of bidders do not always get positive returns from takeovers. Martynova and Renneboog’s research found that in the UK, US, Continental Europe and Asia, bidders’ returns were on average, indistinguishable from zero.37 However, one to two months after the completion of takeovers, the return of bidder shareholders varied over time: in the 1960s the return was 3 to 5% while in the 1990s it was indistinguishable from zero.38 The return obtained by bidder shareholders in the UK between 1980 and 1990 was slightly negative on bid announcement day and for the following forty days.39 Sudarsanam and Mahete found that between 1983 and 1995 in the UK, regardless of whether takeovers were hostile or friendly, the one-day returns for bidders were negative,40 but in the following forty days after the bid announcement day, there were slightly positive returns for bidders in hostile takeovers.41 On the other hand, there was a negative return for bidders conducting friendly takeovers.42 However, due to the significant positive return for the targets, the combination gave a significantly positive return in the short term, although the short-term return for bidders was indistinguishable from zero.

4.2.2

Long-Term Effects of Takeovers on the Value of Companies

Compared to the short-term effect of takeovers on the value of companies, the results of observations on the long-term effect (the long-term post-merger return) are more variable.43 This is because in order to observe the effects of takeovers on the value of a company in the long-term, all other company-specific factors should be controlled, leaving the takeover as the sole variable in influencing the company’s’ performance. However, the variables that affect a company’s performance increase over time so, because governing policies and investment environments change, it becomes increasingly difficult to control the variables. In addition, there is no consensus on what time horizon is appropriate for measurement of the long-term effects of

35

Franks and Harris (1989). Franks and Mayer (1996). 37 Martynova and Renneboog (2008). 38 Ibid. 39 Ibid. 40 Sundarsanam and Mahate (2006). 41 Ibid. 42 Ibid. 43 Bhagat et al. (2005). 36

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takeovers on a company’s performance.44 Companies may be merged in order to achieve strategic goals rather than to achieve cost savings.45 The length of time taken to achieve these goals is variable and may take several years which means that it is difficult to make direct comparisons between cases. In addition, Betton et al. showed that the results from empirical studies on the long-term effects of takeovers on the value of companies vary widely according to which empirical technique is applied.46 Although there are conflicting results on the long-term effects of takeovers on the value of companies, there are several widely cited research findings. Kennedy and Limmack’s research suggests that between 1980 and 1989, the return of UK companies after takeover was indistinguishable from zero one year after the completion of the takeover, but after two years there was a significantly negative return.47 In other words, takeovers eventually destroy a company’s value. Sudasanam and Mahate’s research findings are consistent with this conclusion.48 In their analysis, taking all the cases together, for successful takeovers in the UK conducted between 1983 and 1995 the long-term return was negative, although hostile takeovers brought positive returns more frequently than friendly takeovers.49 To be specific, three years after the completion of a takeover, for hostile takeovers the negative abnormal return ranged from
1 to
6%, while the abnormal return of friendly takeovers ranged from
10 to
16%.50 Powell and Stark’s research, by contrast, found a positive improvement in the operating performance of companies which experienced takeovers from 1985 to 1993.51 In Cosh’s research, friendly takeovers did not generate an improvement in profitability, but hostile bids brought a significant improvement.52 To summarise, there is no consensus on the long-term effects of takeovers on company value, but hostile takeovers are more likely to bring positive returns.

5 The Mandatory Bid Rule in China 5.1

Initial Introduction and Later Reforms to the Mandatory Bid Rule in China

China was early in introducing the mandatory bid rule in 1993 through the ‘Tentative Regulations on the Administration on Takeovers of Companies Listed in China’ (the Tentative Regulations). Even in the EU states, whose jurisdictions have more 44

Ibid. Kershaw (2016). 46 Schoenberg (2006); Eckbo (2008). 47 Kennedy and Limmack (1996). 48 Sundarsanam and Mahate (2006). 49 Ibid. 50 Ibid. 51 Powerll and Stark (2005). 52 Cosh and Guest (2001). 45

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developed capital markets than China, less than half had adopted the mandatory bid rule by 1995.53 In the 1990s, Hong Kong’s capital market was the place for mainland China to raise finance for state-owned enterprises (SOEs) and as a result, financial experts from Hong Kong persuaded China’s authorities to adopt some of Hong Kong’s laws and regulations including the mandatory bid rule.54 As a former British colony, the mandatory bid rule in Hong Kong is based on the UK Takeover Code55 so initially, China’s mandatory bid rule mainly followed the UK format.56 For instance, the Tentative Regulations established that ‘any legal person whose acquisition of 30% of the total outstanding common shares of the targets should make a takeover bid to all target shareholders’,57 which is almost identical with the mandatory bid rule under the UK Takeover Code. In addition, the highest price rule was also introduced in China from 2002.58 This states that the offer price should be the higher of: I, the highest price paid by the bidder in the preceding 12 months for the target shares, or 2, the average market price of the target shares in the 30 trading days prior to the announcement of the bid.59 However, the Tentative Regulations failed to guide the implementation due to the absence of a clear procedure for acquiring listed companies, and takeover bids were rare at that time.60 The Securities Law 1999 and the ‘Measures for the Administration of the Takeovers of Listed Companies 2002’ (Measures for Takeovers 2002) were then introduced to guide the practice of takeovers, but the UK-style mandatory bid rule established by the Tentative Regulations was not replaced. The Measures for Takeovers 2002 established that when the acquirer obtains 30 per cent of all the outstanding shares of the target company, he is obliged to make a bid to all the remaining shareholders for further acquisition of shares in the target company or enhancement of his control.61

Measures for Takeovers 2002 is much clearer than previous regulations,62 and established that the mandatory bid obligations could be exempted by the China Securities Regulatory Commissions (the CSRC), the watchdog of China’s securities market. The CSRC was granted unfettered discretionary power63 to grant or refuse

53

Cai (2011). Lin (2012). 55 Ibid. 56 Xi (2015). 57 Art. 48, Tentative Regulations on the Administration on Takeovers of Companies Listed in China. 58 Art. 48 & 49, Tentative Regulations on the Administration on Takeovers of Companies Listed in China. 59 Ibid. 60 Cai (2011). 61 Art 23, Measures for Takeover 2002. 62 Cai (2011). 63 Xi (2009); Cai (2011). 54

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an application by bidders to waive the mandatory bid obligation.64 For instance, Measures for Takeovers 2002 established that: to satisfy the needs to adapt to the development and change of the securities market and to protect the investors’ lawful rights and interest, the acquirer may apply to the CSRC for exemption of the mandatory bid obligation.65

Although Measures for Takeovers 2002 provided clear guidance for takeover practice, they were revised in 2006 and again in 2008 thus moving away from the UK-style mandatory bid rule. The Securities Law 2006 established that where an investor holds 30% of the shares in the target company, individually or with any concerting party, he must issue a takeover bid to all shareholders to purchase ALL or PART of their shares.66 If the number of shares that the shareholders of the target company would like to sell exceeds the number of shares intended to be acquired, the bidder must carry out the acquisition on a pro rata basis.67 This amendment allows bidders to make a bid to all remaining shareholders to acquire only a portion of the target shares, if they trigger the mandatory bid obligation. Allowance of such a partial bid significantly reduces the financial burden on bidders compared with a general bid.68 Subsequent revised laws and regulations, such as Measures for Takeovers 2006, 2008 and 2014 maintain the proportional partial bid rule established by the Securities Law 2006. The newly revised Securities Law 2020 still accepts the existence of proportional partial bids,69 although the amendments in Measures for Takeovers 2020 removed the CSRC’s unfettered discretionary power to accept or deny applications for waiving mandatory bid obligations.70 Before the revision of Measures for Takeovers in 2020, even if a bidder fulfilled the requirements for exemption from the mandatory bid obligation, he still needed to submit an application to the CSRC for approval.71 An empirical study revealed that the CSRC’s processing time for dealing with the waiver applications made by the State or provincial government-controlled acquirers is shorter than for applications made by private entities.72 The average approval time for state-controlled acquirers was 149 days, compared with 177 days for provincial-level governments and 204 days for private entities.73 In the 2020 revision of Measures for Takeovers,

64

Art. 48, 49, and 50, Measures for Takeover 2002. Art. 48, Measures for Takeover 2002. 66 Art. 24, Measures for Takeover 2006. 67 Ibid. 68 Cai (2011). 69 Art. 65, Securities Law 2019. 70 Art. 61, 62 and 63, Measures for Takeover 2020. 71 Art. 62, Measures for Takeover 2014. 72 Xi (2015). 73 Ibid. 65

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under certain circumstances,74 bidders are automatically released from mandatory bid obligations and do not have to apply to the CSRC for an exemption.75 This amendment shortens the takeover process. Furthermore, the amendments in Measures of Takeovers 2020 promote a level playing field between private enterprises and state/local government-controlled enterprises by waiving mandatory bid obligations.

5.2

Regulatory Attitude Towards the Mandatory Bid Rule

Measures for Takeover 2002 was strongly against partial bids made after a bidder has triggered the mandatory bid obligation.76 If bidders’ acquisitions surpass the threshold, the general mandatory bid obligation is invariably triggered, unless bidders were granted an exemption by the CSRC.77 However, in the 2006 revision of Measures for Takeovers and the Securities Law 2006, proportional partial bids were allowed, which was another amendment to the UK-style general bid rule. The rationale for this was that in China, takeovers were regarded as a tool for industrial transformation.78 The State Council published guiding opinions on promoting takeovers and restructuring activities to ‘optimise the industrial organizational structure, accelerate the transformation of the economic development mode and structural adjustment and improve the development quality and benefits’.79 Before the Split Shareholding Structure Reform, two thirds of shares were not allowed to be traded privately,80 but after that reform, all the shares of listed companies could be freely traded on the secondary market.81 In addition, the

74 For instances, Measures for Takeover 2020 (Art. 62) established that: ‘under any following circumstances, the bidder is exempted from a mandatory bid: (1) the purchaser and the transferor can prove that the transfer of shares is between different parties under the control of the same actual controller, which will not cause the change of the actual controller of the listed company; (2) The listed company is confronted with serious financial difficulty, the restructuring plan offered by the purchaser to save the company has obtained the approval of the shareholders’ meeting of the company, and the purchaser undertakes not to transfer its equity in the company in the future three years; (3) Other circumstances as determined by the CSRC for adaptation to the development and changes of the securities market or for protection of the lawful rights and interests of investors.’ 75 Art. 62 & 63, Measures for Takeover. 76 Cai (2011). Art. 65, Securities Law 2019. Art. 23, Measures for Takeover 2002. 77 Ibid. 78 Art. 24, Measures for Takeover 2006. 79 ‘Opinions of the State Council on Promoting Enterprise Merger and Restructuring’ (The State Council, 2010). 80 Zheng et al. (2015). 81 Ibid.

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mixed ownership structure reform was implemented by the state and SOEs began to welcome private capital to hold their shares and the state decided to diversify its investment portfolios by investing in various private entities.82 According to information released by the State Assets Supervision and Administration Commission, the state continues to diversify its investment portfolios and could accept a non-controlling status in their portfolio companies, unless the SOEs are related to national security or to pillar industries of the national economy.83 China’s relatively concentrated ownership structure is gradually becoming dispersed, although not to the extent of its UK counterpart. Takeovers are seen in China as an efficient tool for promoting state-led transformation, which is the reason that the mandatory bid rule was amended from the UK-style general bid rule to a proportional partial bid rule.84 It may also be a partial explanation for the increase in the number of control transactions through takeovers. Research also found that the CSRC has exempted the majority of mandatory bid obligations (96.32%) between 2004 and 2010.85 As a result, the mandatory bid rule reduces the obstacles to bidders in the takeover process compared with the UK-style general bid obligations, and this has encouraged potential bidders to take over listed companies. The mandatory bid obligation is a huge financial burden on bidders in the UK compared with their counterparts in China today.86 The mandatory bid rule in China has gradually deviated from its original purpose of supporting regulation to one in which the takeover market is used as a tool to promote state-led industrial reorganisation.87 At the same time, however, the opportunity for target shareholders to share control premiums has been reduced by the frequent exemptions to the mandatory bid obligation and the proportional partial bid rule.88

6 Evidence from China 6.1

Aims and Scope of the Study

What is the evidence of short-term effects of takeovers on the returns for targets and bidders in China? Although the empirical studies of this paper start with the effects of takeovers, the main emphasis is providing evidence to justify the mandatory bid rule in China. To seek control of a company in China, a bidder normally needs to

82

SASAC (2013). Ibid. 84 Lee and Bao (2020). 85 Cai (2011). 86 Ibid. 87 Xi (2015). 88 Ibid. 83

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surpass the threshold of the mandatory bid obligation (30% of acquisitions in target shares) because, as will be discussed in Sect. 6.3, the mean and median of holdings of the largest shareholders in China are 32.64% and 30% respectively. Hence, we exclude from our dataset M&A cases in which the bidders’ acquisition is below than 30%. Most of the evidence suggests that abnormal returns for bidder shareholders through takeover activities is slightly negative or indistinguishable from zero. By contrast, there is a consensus that takeovers generate significant positive abnormal returns to target shareholders and to the combined entities in the short term. The reason for this is that bidders offer a higher than market price (control premium) to incentivise the target shareholders to sell their shares. The participation of financial intermediaries, such as buyout funds and hedge funds, greatly contributes to this result.89 A typical strategy used by these funds during a corporate takeover is to long shares of target companies and short shares of bidder companies.90 This paper focuses on the short term rather than long term effects of takeovers, because the average holding period of shareholders in China, whether institutional or retail, is relatively short. In 2019, 71.7% of retail investors in China held shares for less than 1 year and 89.1% for less than 3 years.91 The figures were 66.1% and 86.7% respectively for institutional investors.92 To measure the long-term effects of takeovers on the value of companies would need observation of their companies’ performance for at least three to five years.93

6.2

The Source of Data

Our sample of M&A transactions between 2004 and 2019 comes from the China Stock Market & Accounting Research Database (CSMAR), the China Listed Firms’ M&A and Restructuring Research Database, and the Wind Database. To get daily stock price and return data of target and bidder companies listed on the Shenzhen and Shanghai Stock Exchanges, the selected sample of M&A transactions from CSMAR was matched with the China Stock Market Trading Database (CSMT). Applying the filters, the sample consists of 673 successful transactions.

89

Rozwadowski and Yong (2005). Ibid; The long security position is in the expectation that the share price will rise in value in the future, and a short position is the opposite of a long position. 91 SAC (2020). 92 Ibid. 93 Kershaw (2016). 90

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Fig. 1 The Distribution of Holdings of the Largest Shareholders in Chinese Listed Companies

6.3

The Sample for Data Analysis

The mandatory bid rule is a regulatory device for protecting the interests of shareholders when there is a transfer of control. ‘Control’ is defined by the UK Takeover Panel as when a bidder acquires more than 30% of the voting shares, i.e. a de facto control percentage.94 Because the control threshold varies in different companies, the Takeover Panel has acknowledged that this is an arbitrary figure selected for the trigger point.95 In our dataset, there are 673 cases in which target and bidder companies are both listed companies, and they all experienced corporate takeovers from 2004 to 2019. In China, the threshold chosen by the Measures for Takeover for triggering mandatory bid rule is also 30%. Looking at the holdings of the largest shareholders in Chinese listed companies, Fig. 1 shows that among 3926 companies listed on Shanghai or Shenzhen Stock Exchanges, the mean and median holdings of the largest shareholders are 32.64% and 30%, respectively. Acquisitions taking place with less than 30% of acquisitions in target shares have been excluded from our dataset, because they are less likely to result in a transfer of control in China. In our dataset, 57 target companies are listed companies taken over by bidders between 2004 and 2019. However, over the same period, 616 bidders conducted takeovers to seek control of target companies. The discrepancy arises because in most M&A cases, bidders choose to take over private companies, so there are fewer cases where the target company is a listed company.

94 95

Rule 9.5, Takeover Code. The Takeover Panel (1973).

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269

Methodology

We have used the standard event study method established by Brown and Warner in 198596 to examine the effect of a takeover bid on the value of a target company. Cumulative abnormal returns (CARs) are used to measure stock performance after subtracting a benchmark return based on beta risk. The abnormal return is the actual ex post return of the security over the event window minus the normal return of the company over the event window. The normal return is defined as the expected return without the event taking place. For company ‘i’ and in the event date ‘τ’, the abnormal return is ARiτ ¼ Riτ
E ðRiτ jX τ Þ where ARiτ, Riτ, and E(Riτ| Xτ) are the abnormal, actual, and normal returns respectively for time period ‘τ’. Xτ is the conditioning information for the normal return model. To get the predicted return, the company’s recent performance track record, i.e. αi, and its sensitivity to general market movements, i.e. βi, should be considered, and obtain the αi and βi by running a regression model of the company’s returns onto the market returns during a pre-event period. Rit ¼ αi þ βi Rmt þ εit We use the CSMT Current-Value-Weighted return as the market return, Rmt. With the parameter estimates for the normal performance model, the abnormal returns can be calculated as: c iτ ¼ Riτ
b AR αi
b βi Rmτ The cumulative abnormal return (CAR) of the sample from τ1 to τ2 is the sum of the abnormal returns: d iðτ ,τ Þ ¼ CAR 1 2

6.5

τ2 X τ¼τ1

c iτ AR

Two Parameters of Empirical Study

The percentage of the bidder’s acquisitions in the target shares directly relates to the target shareholders’ abnormal return. If bidders only acquire small portion of the 96

Brown and Warner (1985).

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shares, even though a control premium is offered, target shareholders may not be able to obtain or share the control premium from such a small portion of shares. The mandatory bid rule sets the threshold for triggering mandatory bid obligation, so it is worth examining whether trigger points are appropriate and whether proportional partial bids could create value. Hence, the percentage that bidders intend to acquire is a parameter to examine the efficacy of the mandatory bid rule and the effects of takeovers on the interests of target shareholders. The takeover market in China is currently developing very quickly. The aggregated volume of control transactions through M&A in China ranked second in the world with just below 5000 billion USD between 2010 and 2015, compared to approximately 3000 USD in the UK.97 One driver for this substantial growth in takeovers is likely to be state-led industrial reorganisation which suggests that the purpose of takeovers is a significant factor in China. There are two main approaches of takeovers in China: takeovers by takeover bids (tender offers) and takeovers by private agreement.98 Because of the difficulty in accessing the data related to takeovers by private agreement, this paper focuses on the effects of acquisitions by takeover bids.

6.6 6.6.1

Results from Data Analysis The Relationship Between Cumulative Abnormal Return and Holdings

Takeovers create some positive returns for target companies in China. For bidder companies, the slightly negative abnormal return that bidders receive in the UK and US were also apparent in China, although the positive return for target companies in China is less significant. We recognize four categories in our data set according to the acquisition ratio of the bidder: in the first group, bidders acquired more than 30%99 of target shares; in the second, more than 32.64%100; in the third, between 30 and 50%; and in the fourth, over 50%. As Table 1 shows, the CARs of target companies’ market value created by takeovers (Group 1) is significantly positive (210 basis points101 of returns). That is to say the mandatory bid rule could protect target shareholders in China because once a bidder acquires more than 30% of target shares, he is obliged to make a bid to all shareholders. However, the takeover cases in Group 3 indicate that the returns are

The figure only calculates the share acquisitions surpassing 30% of shares in target companies. Kershaw (2016). 99 The median of holdings by the largest shareholders in China’s listed companies is 30%. 100 The mean of holdings by the largest shareholders in China’s listed companies is 32.64%. 101 1 basis points ¼ 0.01%. 97 98

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Table 1 CAR for Target Companies Holdings CAR (%) t-statistic Number of Cases

Group 1 [30%, 100%] 0.021** 2.15 57

Group 2 [32.64%, 100%] 0.018** 2.14 55

Group 3 [30%, 50%) 0.008 0.3 14

Group 4 [50%, 100%] 0.026** 2.6 43

Note: This table presents the mean target returns (CAR) over the ten calendar days event window around the deal completion date for the sample of 57 completed takeovers between 2004 and 2019. ** stands for statistical significance at the 5%, and 10% level, respectively

statistically insignificant if the bidder’s acquisition ratio is between 30 and 50% of the target shares, i.e. the CARs are indistinguishable from 0. Conversely, if bidders acquire more than 50% of the target shares, there are significantly positive CARs for target companies (260 basis points). Therefore, in the overall positive CARs (Group 1), the cases with an acquisition ratio of 50% or above (Group 3) contributed to the vast majority of abnormal returns. Table 2 shows that Group 1 bidders witnessed significant negative returns (
260 basis points). Compared with Group 4 in Table 2, the bidders in Group 3 suffered more losses (
660 basis points). In other words, if bidders acquire more than 50% of target shares, they suffer less loss than those bidders who acquired 30 to 50% of target shares. To sum up, as the acquisition ratio in target shares increases, the CARs of target companies become more positive, especially when the ratio is over 50%. If a bidder acquires 30 to 50% of the target shares, the CARs for the target companies is indistinguishable from 0. Although bidders experienced negative CARs because of takeovers, as the acquisition ratio increases to over 50%, the bidders’ losses decrease from
660 to
230 basis points. This result could also explain why the majority of bidders shown in Table 1 (43 out of 57) and Table 2 (579 out of 616) acquired more than 50% of the target shares. Unlike the UK’s strict enforcement of the mandatory bid rule (general bids), China’s mandatory bid rule allows bidders to make a proportional partial bid.102 For instance, if a bidder acquires 30% of the target shares and triggers the mandatory bid obligation, he is allowed to fulfill his mandatory bid obligation by acquiring an additional 5% of the target shares. The evidence is that acquisition of 35% of the shares fails to create a statistically significant positive CAR. However, if a UK-style general bid rule were in place, the bidder would have to acquire all remaining shares and when the acquisition surpasses 50%, then the target shareholders can obtain a significantly positive CAR. This means that in China, the existence of the proportional partial bid rule reduces the likelihood of the target shareholders sharing a control premium.103

102 103

Art. 24 & 25, Measures for Takeover 2020. Cai (2011).

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Table 2 CAR for Bidder companies Holdings CAR (%) t-statistic Number of Cases

Group 1 [30%, 100%]
0.026***
2.9 616

Group 2 [32.64%, 100%]
0.026***
2.92 612

Group 3 [30%, 50%)
0.066*
1.94 37

Group 4 [50%, 100%]
0.023**
2.52 579

Note: This table presents the mean bidder returns (CAR) over the twenty calendar days before and after event window around the deal completion date for the sample of 616 completed takeovers between 2004 and 2019. ***, **, and * stand for statistical significance at the 1%, 5%, and 10% level, respectively

6.6.2

The Relationship Between Cumulative Abnormal Return and Bidders’ Aims

When the intention of bidders in making a takeover is to obtain corporate control, does this affect target and bidder companies’ abnormal return? In our dataset, 57 target companies and 616 bidder companies were involved in takeover bids in the past 15 years. As in most M&A cases, bidders choose to take over private companies, and therefore there are fewer cases where the target companies are listed. This explains why in our dataset there are only 57 cases where target companies are listed, while there are more than 600 cases where the bidders are listed companies. The reasons that bidding companies seek control of target companies include: i. They wish to diversify their business into unrelated industries (conglomerate acquisitions); ii. They wish to merge or consolidate companies that operate in the same industry (horizontal acquisitions); iii. They are looking for an appreciation of their initial investments (financial investment); iv. They seek to reorganize assets by bailing out targets through takeover; and v. Other purposes, such as obtaining qualifications and brands held by targets or acquiring ‘shells’ of targets’ listing status. Table 3 below shows that if the aim of takeovers is to diversify holdings by conglomerate acquisition or merger by horizontal acquisition, the target companies obtained a significantly positive CAR of 390 and 290 basis points respectively. By contrast, according to Table 4, bidders attempting conglomerate acquisition suffered CAR losses with a reduction of 370 basis points on average shortly after conducting a takeover. There was, however, a significantly positive CAR for bidders Table 3 CAR by aim (target companies) Purposes CAR (%) t-statistic Number of Cases

Group 1 Conglomerate Acquisitions 0.039** 2.79 11

Group 2 Horizontal Acquisitions 0.029** 2.63 33

Group 3 Financial Investment
0.024
1.4 6

Note: ** stands for statistical significance at the 5% level

Group 4 Reorganisation of Assets 0.053 0.39 3

Group 5 Other Purposes -0.047 -2.19 4

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Table 4 CAR by aim (bidding companies) Purposes CAR (%) t-statistic Number of Cases

Group 1 Conglomerate Acquisitions
0.037
1.59 92

Group 2 Horizontal Acquisitions
0.026**
2.09 344

Group 3 Financial Investment
0.016
0.15 3

Group 4 Reorganisation of Assets 0.110* 2.19 12

Group 5 Other Purposes
0.031*
1.83 165

Note: ** and * stand for statistical significance at 5% and 10% level respectively

whose aim was to reorganise corporate assets (110 basis points) and in this way, through the state-led industrial reorganisation, takeovers have created value for bidding companies. Although proportional partial bidding to facilitate the state-led industrial reorganization considerably decreases the financial burden for bidders, it also reduces the opportunity for shareholders to share the control premium. Takeover law should therefore balance takeover contestability and shareholder protection.104 This is especially important when China is committed to opening its capital market to attract inbound foreign investment.105 Figures 2 and 3 suggest that the proportion of shares acquired by bidders is characteristically above 50%. This is consistent with the conclusion in Sect. 6.6.1 (above) that the CARs of target companies become significantly positive and that of bidder companies become less negative if the bidders’ acquisition is greater than 50% of the target shares.

7 The Mandatory Bid Rule in China: Looking to the Future It has been argued that the mandatory bid rule in China exists today in name only, and it should therefore be abolished.106 However, despite any shortcomings, it is an effective regulatory device for protecting the interests of minority shareholders in target companies and ensuring equal treatment. China has committed to opening its capital market to foreign investors,107 so it needs an effective mandatory bid rule to attract inbound investment, as happens in the UK. The results reported here show that takeovers create value for the shareholders of target companies when bidders acquire more than 50% of the shares.108 Hence, instead of abolishing the mandatory bid rule, we believe that it should be amended in order to facilitate industrial 104

Ibid. Lee and Bao (2020). 106 Cai (2011). 107 Reuters (2017). 108 See Table 2. 105

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30

Number of Cases

25 20 15 10 5 0

[30%,50%]

[50%,100%]

100%

Holdings of Bider Companies Other Purposes

Conglomerate Acquisitions

Horizontal Acquisitions

Financial Investments

Reorganisation of Assets Fig. 2 Number of Takeover Cases by aim (Target Companies)

transformation while at the same time as protecting minority shareholders’ interests, and thereby attracting more investment and developing an active market for corporate control. Although the proportional partial bid rule should be amended, strict enforcement as demanded by the UK Takeover Code may not be appropriate for China’s situation. As it is national policy that state-owned enterprises should take the lead in guiding the development of the national economy, state ownership of the pillar industries will not be changed.109 Although, under the Mixed Ownership Structure Reform, private capital is able to acquire shares of companies in pillar industries, state policy does not allow the private sector to control such enterprises, even if the acquisition surpasses the threshold of the mandatory bid rule.

7.1

Amendments to the Proportional Partial Bid Rule

The mandatory bid rule still exists in China, but its operation has changed in practice because currently the CSRC often allows proportional bids. Although acquisition of 30% of target shares still triggers the ‘mandatory bid rule’, the partial bid rule requires a bidder who has triggered it to acquire at least an additional 5% of the target shares.110 However, the data presented above show that target shareholders 109 110

The 14th National People’s Congress (1992). Art. 24, Measures for Takeover 2006.

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450 400

Number of Cases

350 300 250 200 150 100 50 0

[30%,50%]

[50%,100%]

100%

Holdings of Bider Companies Other Purposes

Conglomerate Acquisitions

Financial Investments

Reorganisation of Assets

Horizontal Acquisitions

Fig. 3 Number of Takeover Cases by aim (Bidder Companies)

can obtain positive abnormal returns if bidders acquire more than 50% of the target shares and, at the same time, the bidder’s abnormal return becomes less negative. If bidders acquire between 30 and 50% of the target shares, target shareholders fail to obtain abnormal returns. We therefore suggest that the takeover regulations should require a bidder who triggers the mandatory bid obligation (30% of the target shares) to make a bid to all the remaining shareholders for at least an additional 20% of the shares. For industries in which state policy does not allow control by the private sector, the CSRC has the power to exempt bidders from the mandatory bid obligations, but any exemptions should only exceptionally be granted, in order to strike a fair balance between takeover contestability and shareholder protection.

7.2

Trigger Points

The UK Takeover Code specifies two circumstances for triggering the mandatory bid obligations, unless the Takeover Panel allows exemption. Anybody who acquires shares in a target company which carries 30% or more of the company’s voting rights is obliged to make a general bid to all the remaining shareholders. Concerted groups of shareholders who together hold between 30 and 50% of the

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voting shares should also make a general bid to all remaining shareholders if they acquire any additional voting shares.111 The mandatory bid rule under the UK Takeover Code applies when a bidder acquires not merely the specified proportion of shares, but the proportion of interests in shares that provide voting powers.112 When applying the mandatory bid rule, the critical factor should be whether a bidder has potentially or actually obtained control of the target company, i.e. the substantial voting powers, rather than merely considering the percentage of target shares acquired. However, the trigger point in China’s Measures for Takeover is set as the acquisition of 30% of issued target shares, rather than 30% of interests in voting rights. The mandatory bid rule in China’s revised Securities Law 2020 incorporated a definition of ‘interests in voting shares’ for the first time. It established that: where an investor continues to purchase shares when the voting shares offered by a listed company as held by an investor through securities trading on the stock exchange or jointly with others through agreements or other arrangements reach 30%, the investor shall, in accordance with the law, make a takeover bid to all shareholders of the listed company for acquiring all or part of the shares of the listed company.113

This Securities Law, however, merely provides the structure of takeover regulations in China, while the detailed rules are established by the Measures for Takeovers. As far as the threshold for triggering the mandatory bid obligation is concerned, the revised Measures for Takeovers 2020 remain unchanged from the previous version, i.e. the bidder is obliged to make a partial or general bid when his holding reaches 30% of the company’s issued shares.114 Thus the Securities Law 2020 and the Measures for Takeovers 2020 differ in their definition of the trigger point. In the majority of situations, there is no difference between the ‘interests in voting shares’ and ‘issued shares’. However, from 2018, companies listed in China by the Sci-Tech Innovation Board are allowed to apply a dual-class share structure.115 There is an argument that this dual-class structure should also apply to companies listed on other Boards. Under the dual-class share structure, interests in voting shares and interests in shares are not always identical, which means that in practice there may be confusion between the mandatory bid trigger points of the Securities Law and of the Measures in Takeover. These should be brought into line with each other, bearing in mind that in Chinese law, Securities Law takes precedence over the Measures for Takeovers. In addition and more importantly, the standard of ‘interests in voting shares’ needs to be consistent with the original intention that the mandatory bid rule should protect securities holders when there is a transfer of control. 111

Rule 9.1, The UK Takeover Code. Rule 9.1, The UK Takeover Code. 113 Art. 65, Securities Law 2020. 114 Art. 24, Measures for Takeover 2020. 115 Zhang and Shen (2019). 112

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Parties Acting in Concert

There may be conflict between the definition of ‘parties acting in concert’ when set in a broad way, and shareholder activism. Collaborative action taken by shareholders to intervene in the governance of their portfolio companies is a common approach taken by institutional shareholders who wish to influence corporate decisions or to replace inefficient incumbent directors.116 Shareholders acting in this way can provide a useful mechanism for improving corporate governance. However, if ‘parties acting in concert’ is defined in such a broad way that it could cover any collaborative action taken by shareholders and therefore trigger mandatory bid obligations, groups of active shareholders may not be able to monitor company governance in this way.117 In order to avoid shareholder activism being caught up in a broad definition of acting in concert, the UK Takeover Code and Takeover Panel make it clear that ‘group activist activity that merely seeks to or threaten to remove or replace directors in a requisitioned general meeting is insufficient to amount to seeking to obtain control’.118 Active participation of shareholders in monitoring their companies is as important in China as it is elsewhere. But there has long been criticism that listed companies in China lack efficient internal monitoring mechanisms and that supervisory boards and independent directors are ineffective at monitoring the activities of boards of directors there.119 China’s revised Corporate Governance Code also emphasises the positive role that institutional investors need to play in their portfolio companies’ corporate governance.120 In order to avoid deterring the active participation of shareholders, the takeover regulations in China need to be worded in such a way that collective activity by shareholders is clearly excluded from the definition of parties acting in concert, unless their collective action is taken with the intention of taking control of a company.

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Tactics for Circumventing Mandatory Bid Obligations

The tactics that can be used to circumvent the mandatory bid obligation have been acknowledged by the UK Takeover Code and regulations put in place to prevent them. However, China’s takeover regulatory system has not so far taken similar steps. The Notes on Rule 9.1 (the mandatory bid rule) of the UK Takeover Code emphasise that when shareholders sell part of their holdings (block selling), especially when a purchaser wishes to acquire shares carrying just under 30% of the 116

Kershaw (2016). Ibid. 118 Practice Statements No. 26 of the Takeover Panel: Shareholder Activism (2008). 119 Kang et al. (1984). 120 Arts 78, 79, 80, 81, 82, Corporate Governance Code of China’s Listed Companies. 117

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voting rights in a company, ‘the Panel will be concerned to see whether in such circumstances the vendor is acting in concert with the purchaser or has effectively allowed the purchaser to acquire a significant degree of control over the shares retained by the vendor’.121 If the vendor allows the purchaser to acquire a significant degree of control over the retained shares, a mandatory bid is required, even if the individual shareholding is less than the threshold for the mandatory bid obligation.122 The Takeover Code lists circumstances in which the Panel should consider that transactions have triggered the mandatory bid obligation. These circumstances include very high considerations paid by the purchaser, or when the purchaser is an insider shareholder of target companies.123 These rules prohibit the parties acting in concert to use tactics designed to circumvent the mandatory bid obligation. The Notes on the Takeover Code also cover a situation in which a bidder obtains indirect control of the target company by acquiring over 50% of shares in its parent company thereby obtaining control of the subsidiary. In such a case, the Code stipulates that the mandatory bid obligation is triggered, subject to some exceptions. This is known as the ‘Chain Principle’ in the Takeover Code.124

8 Conclusion Takeovers in China can create value for the shareholders of target companies if bidders acquire more than 50% of the target shares. Since the market for corporate control in China is regarded as a tool for industrial re-organization, the evidence is that takeovers motivated by the aim of reorganising assets create value for bidding companies. For this reason, the mandatory bid rule should be amended to support the state policy of optimising market structure and to offer more protection to shareholders when there is transfer of control. The mandatory bid rule in the UK Takeover Code offers some lessons for China. There are some conflicting or vague definitions in China’s mandatory bid rule that need to be addressed. For instance, the unclear scope of the definition of ‘parties acting in concert’ may deter potential effective shareholder engagement. The different criteria for assessing the conditions of triggering mandatory bid obligations in the Securities Law 2019 and Measures for Takeover 2020 can cause confusion. The proportional partial bid rule and frequent exemptions of mandatory bid obligations by the CSRC prevent the mandatory bid rule from operating in the way that was originally intended. We therefore argue that the proportional partial bid rule should be amended so as to strike a fair balance between takeover contestability and shareholder protection. Although the CSRC should continue to

121

Notes (Note No. 6) on Rule 9.1, The UK Takeover Code. Ibid. 123 Notes on Rule 9.1, The UK Takeover Code. 124 Notes (Note No. 8) on Rule 9.1, The UK Takeover Code. 122

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have the power to exempt bidders from the mandatory bid obligations, such exemptions should only exceptionally be granted.

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