Crisis won't alter China's foreign investment rules

When it became clear that China was not going to avoid the global economic slowdown, the government was quick to react with a stimulus package. But Beijing's decision to inject money into the economy does not mean that the regulatory environment will ease significantly to also make it easier for private or foreign firms to invest.

Maurice Hoo, partner at law firm Paul Hastings, sees tension between the long-term economic plans of the central government and the shorter-term stability goals that, while still a major concern for Beijing, are sometimes an even more immediate issue for local governments.
 
"I do not necessarily expect the central government to change its course with regard to foreign investment," says Hoo. "The central government wants to kick-start the economy, but they have not departed from the major goals for the country. The government has stated that the country has the resources internally to stabilise the economy -- it does not need a wholesale change of laws to sell assets to foreigners cheaply or open up sensitive areas for investment by foreigners."
 
What Hoo does expect is that local governments -- which are under pressure to maintain growth and employment at certain levels -- are likely to approve individual deals quicker than they would have before.
 
There are several regulatory developments anticipated: out of the 64 items on the legislative agenda of the 11th National Peoples' Congress, 11 are economic items. "To the extent that they do make changes, they are targeted towards mainly internal investments," says Hoo.
 
One proposed change that could have a significant effect on foreign investments concerns appraisals. Under current regulations, foreign investment may be made only at market value, which is usually determined through an appraisal process, and appraisers frequently simply use the historical book value as the "market" value.
 
"The appraisal process has been very much geared towards the approval process," says Hoo. "If everyone just tries to get a value that they think the regulators will approve, the process distorts what the market is supposed to be doing."
 
The regulator typically does not accept anything less than book value -- so even if a company has totally obsolete equipment on its books, it counts. This is not consistent with the cashflow-based valuation on which many investments are predicated.
 
"What I would like to see is an appraisal law that will motivate parties to arrive at a number that is going to be more reflective of the true market value," says Hoo.

Another legal theme that Hoo expects in the coming year relates to performance risks. "There is a heightened concern among private equity investors that their investee companies are not performing their obligations under the legal documents," he says.
 
Although there have been a few public cases of private equity companies getting burnt, Hoo feels this is probably the tip of an iceberg: "Not all breaches and defaults get into the press. As in any other economic downturn, more will come to the surface and there will be heightened sensitivity to risk and a flight to quality in the sense of how deals are done."
 
"There are probably a number of deals done in the past two to three years which investors, in retrospect, would have liked to have performed more thorough due diligence, designed tighter structures or drafted better documents," explains Hoo. "I think this is less likely to happen in the future because people are going to be much more careful."