Chinese investors with deep pockets are spreading across the world, and the lavish expenditures of Chinese tycoons have frequently dominated newspaper headlines. But this year, there has been some turbulence as regulators have stepped on the brakes of expansion. 

Statistics from the Ministry of Commerce show that China’s non-financial overseas investment halved in the first half of 2017 to $48.19 billion, and in June alone, outbound investment dropped 11.3% year-on-year to $13.6 billion. 

Regulators, from central authorities to local governments, have ramped up their scrutiny on outbound investments to prevent financial risks and stem capital flight.

In July, the China Banking Regulatory Commission asked the country’s state banks to closely review credit and financial risks posed by serial dealmakers including some top-deal-making conglomerates: HNA Group, Dalian Wanda Group and Fosun International. 

Following that, many potential bids and deals have been either dropped or are pending financing. 

In 2016, Beijing introduced tighter controls over funds moving out of the country and increased scrutiny of domestic companies’ foreign investments. 

While there are speculations on the central government’s message, last month the State Council, National Development Reform Commission, the Ministry of Commerce, People's Bank of China and the Ministry of Foreign Affairs together issued a joint statement, the Guidance Opinion to Further Direct and Regulate Outbound Investment, which sets out a clear national policy on the country’s outbound investment.

“It provides more clarity on how China will regulate its outbound investments,” says Justin Cai Junxiang, partner with Zhong Lun Law Firm. “There have been many documents issued by different authorities supervising outbound investment; however, the new guideline is addressed by the State Council, which means this will then be adopted as the basic framework.”

The new guideline, similar to that for inbound investment, further shows that China will adopt the negative-list approach when handling outbound investment projects, explains Zhang Danian, chief representative of Baker McKenzie's Shanghai office.

THREE CATEGORIES

Now, under the new framework, outbound investments made by Chinese companies are tagged with three labels: encouraged investments, restricted investments and prohibited investments.

“Such categorizing is not unexpected. We saw that outbound investments in property, hotel, entertainment and sports clubs had been mentioned by different authorities previously that they are under strict government supervision,” says Cai. 

“However, there are some other areas, like environmentally unfriendly projects, gambling and pornography, that the government in practice will very likely restrict or prohibit Chinese companies from doing investment overseas, but it has not systematically issued such policies to the public, which may create uncertainties for companies to follow. This new guideline will make it much easier for companies to execute and for authorities to supervise.” 

Restricted investments include investments in high-risk countries or countries that do not have diplomatic relations with China; investments in real estate, hotels, cinemas, entertainment and sports clubs; setting up of offshore funds or investment platforms that cannot be substantiated by projects; and projects that do not comply with the technology standards, environmental standards, energy standards or safety standards of the destination countries.

Prohibited investments include investments that could harm national interest and safety, including unapproved military-related technology and projects; prohibited technology, arts and products; gambling and pornography; and investments that are banned under any international trade pact or treaty.

In a press conference on the newly issued guidance, the National Development and Reform Commission expressed concerns that many recent investments have been made “irrationally”, and that investors focus on non-real economy investments in certain sectors, such as real estate, which poses a threat to domestic financial stability due to the significant outflow of capital involved.

“Some enterprises did not think thoroughly before going overseas and were just following the wave like blind sheep. They accumulated a large amount of debt to support their impulsive foreign investment, most of which was through banks, and ended up with a high leverage rate. Their ability to repay the debt is questionable and thus these categories cannot be encouraged by the government,” said Fang Jian, a partner with Linklaters.

“Also those investments such as excessively buying property or land overseas cannot make any contribution to the country for moving up the value chain,” said Fang. “Restructuring the economy is currently the major national strategy, and each individual policy and regulation centers on that.”

INVESTMENT ENCOURAGED

Fang’s claim can be seen to be true in the encouraged category, which includes investments related to the Belt and Road Initiative; export of advanced technology and manufacturing capability; establishment of R&D centers overseas; oil and gas, mining and natural resources; agriculture and related industries; and commerce and trade, culture, logistics and finance.

“Looking ahead, those that are technology related, including high technology in new areas, for example artificial intelligence, big data and bio medtech, and innovative technologies in traditional manufacturing sectors that can reduce the overcapacity problem that industries like mining and steel production are facing, will be the main booster for overseas Chinese deals,” says Fang.

Linklaters expects Chinese outbound direct investment in the coming decade to reach $1.5 trillion, up 70 percent from the level during 2007-2016, while Made in China 2025 and the Belt and Road Initiative are the major driving forces for the continued growth.

Zhang with Baker McKenzie agrees with the positive prediction and says that globalization has added further impetus to this trend as some Chinese companies have transformed themselves into global organizations. 

“A growing appetite for cutting-edge technology, manufacturing capabilities, consumer brands and safe haven assets in advanced economies is likely to drive the growth of China's outbound investment as Chinese companies seek to diversify their businesses and make inroads into international markets,” says Zhang. 

He adds that China has been looking to the Middle East and Russia for natural resource assets to meet its domestic energy needs. The agriculture sector, especially in areas that are conducive to modern and green agriculture development, has been another hot bed for investment activities.

Cai with Zhong Lun says that the desire and driving force of Chinese investors stepping out is still quite strong.

“Many of our companies have been developed to a stage that needs further diversification and expansion to up and down streams in order to keep a sustainable growth,” says Cai. “Such needs result in an investable trend of companies going to acquire new business and enter new markets overseas.”

Experts believe that any conclusion of whether the regulatory environment has been ramped up or loosened with policies like the guideline would be too general.

“Different regulatory approaches are taken towards different investments. In the long term, we see that the government still supports outbound investment,” says Cai.

“Under the new guideline, China does not plan to regulate outbound investment activities by way of a stringent administrative approval system. Instead, the authorities opt for a recordable system approach, which will simplify and speed up the filing process,” says Zhang with Baker McKenzie.