Chinese outbound merger and acquisition (M&A) activity has surged in Europe during the last decade. Chinese companies, particularly state-owned enterprises (SOEs) were the key drivers of this surge, amounting to 70% of these investments in Europe.
This paper, available here, argues that the way the European Commission looks at mergers involving Chinese state-owned enterprises (SOEs) suffers from several flaws. These arise primarily from inconsistency in how the single economic entity doctrine has been applied to these companies – sometimes a single Chinese SOE is taken to be the relevant economic unit, sometimes all SOEs active in a specific industry were said to comprise the acquiring undertaking. The author argues that a more systematic application of the single economic entity doctrine is required to restore consistency to the case law, address the realities of China’s State capitalism and protect the principle of competitive neutrality at the core of EU competition law.
Section two reviews how the single economic entity doctrine applies to SOEs.
Merger review under the EU Merger Regulation builds on the concept of undertaking, which corresponds to the relevant economic corporate group, independently of how it is legally structured.
For SOEs, the concept of undertaking has had to be adapted. The Commission has done so in light of wider EU competition law, which focuses on whether subsidiaries can freely choose their own course of action when assigning liability for anticompetitive conduct. The determination of whether there is a single economic entity or not rests on an assessment of the control exercised by the parent company over its subsidiaries. Control rests on two conditions: on one hand, ownership as proof of possible control and, on the other hand, the exercise of actual influence. For SOEs, ownership is irrelevant, since a SOE is owned by the state; the analysis thus focuses almost solely on the exercise of actual control by the State. In short, the European Commission will look at SOEs by focusing on the relevant ‘economic unit with an independent power of decision’, irrespective of the way in which their capital is held or of the administrative supervision rules applicable to them. A SOE will qualify as an independent entity as long as it can decide its own strategy, business plan and budget autonomously.
SOEs of the same State will form a single common undertaking if there is a common centre of commercial decision-making, i.e. when a superior entity makes a commercial decision for them. When the state exercises its ownership control only in relation to its basic rights as a shareholder – such as the sales of shares, the listings or the dividends – and state-owned companies have separate and independent managements, it has been straightforward to find that the individual SOE is the relevant undertaking. However, when a SOE is susceptible to direct supervision and control by a State or its government, that SOE will be part of a wider undertaking comprising also state-controlled entities even if the State has not intervened in its management in practice.
In practice, the analysis of whether the state exercises a potential power of control rests on whether certain de jure criteria are met – who nominates the board, whether there are interlocking directorships, who decides, control and supervises the governance of the SOE, business plans as well as business operations, and whether there are elements or structures of coordination between SOEs – regardless of whether they are fulfilled in practice.
Sections three and four discuss common misconceptions regarding corporate governance in China.
The relationship between the Chinese state and its companies, especially SOEs, is the result of a long and painful process of reform that began in the late 1970s, when SOEs were parts of a larger centrally planned system. In this system, SOEs were completely dependent on the government.
When introducing competition into the market, the government implemented Western corporate structures for its SOEs and created a trustee, the State Asset Supervision and Administration Commission (SASAC), to act as a management firewall between the government and the companies. This reform sought to limit the ability of the government to intervene in corporate decisions, decoupling ownership from control with the purpose of introducing some level of flexibility and competition between SOEs.
SASAC’s declared goal is ‘to separate the government’s social and public management functions from the role as investor of the state-owned assets in terms of institutional framework’. It is supplemented by local and regional SASACs to manage investments at lower level. SASAC’s responsibilities and obligations are comparable to that of a board of directors. SASAC may, among other things, reform SOEs, dispatch supervisory panels to SOEs, appoint or remove management, evaluate their performance, reward or punish them, and even undertake specific tasks assigned by the government. Subject to the supervision of the State Council, SASAC is also to assume the functions of shareholders, which empowers it to decide on business policies and investment plans, to elect and replace directors and supervisors, and to consider and approve the board of supervisors’ reports and corporate accounts. It has been shown that SASAC makes wide use of these powers, in particular to appoint and remove senior management.
On the other hand, the government maintained its grip over SOEs through the Chinese Communist Party, which acts as a parallel governmental structure and the centre of real power. Party bodies are included within all SOEs, where they are empowered to implement the policies of the party and to support shareholders, board of directors, board of supervisors and managers in the exercise of their functions. The role of the party is set out in law and was institutionalised by a joint opinion between the Communist Party’s Central Organization Department and the SASAC Party Committee that required the appointment of prominent party members to senior management positions in SOEs. This allows these members to hold dual leadership roles, the Communist Party to participate in decision-making by SOEs and, ultimately, the tight monitoring of the operations of SOEs by the party.
Such conclusions are supported by robust data. 80% of CEOS of SOEs are party members. Party leaders and senior managers of SOEs regularly swap positions in what has been described as a ‘common rotation’.
While the Communist Party clearly controls and influences Chinese SOEs, this has been overlooked in western analyses of Chinese corporate governance. Instead, the focus has been on the formal similarity in Western and Chinese corporate models. Chinese company law – including as regards SOEs – provides for corporate forms that mirror the fundamental characteristics of Western companies, such as independent legal personality, limited liability, transferable shares, and centralised management by a board that responds to capital owners. From this perspective, SASAC is supposed to ensure professional management detached from the interests of the Chinese state, in line with the role of control trustee that is advocated for Western SOEs. However, the institutional environment in China means that these similarities are merely superficial. In particular, such an approach overlooks the control exercised by infra-state bodies such as the Chinese Communist Party, which controls both the Government and the operations and management personnel of SOEs. A comprehensive analysis of Chinese SOEs necessitates, then, a two-level analysis of corporate governance: a legal one where the power is exercised by state entities such as SASAC, and a political one where the Communist party assumes an essential role.
Section two contains a discussion of how the single economic entity doctrine has been applied to Chinese SOEs.
Until recently, EU merger control did not delve into the nature of the control exercised by SASAC over Chinese SOEs. The European Commission merely noted, without discussing, the notifying SOEs’ submissions that SASAC had a mere oversight function, and that each SOE maintained its decision-making autonomy. While SASAC has the power to nominate the top management of Chinese SOES, this management would then have complete autonomy as regards a SOE’s strategic decisions, business plan and budget. Furthermore, Chinese SOEs submitted that, when SOEs are controlled by different SASACs (central or local), these SASACs are not in a subordinate relationship to one another, and are independent and autonomous entities.
The situation changed with the notification in 2016 of a joint venture between China General Nuclear Power Corporation (CGN) and EDF Group concerning, among other things, an investment in the planned Hinkley Point nuclear power plant in the United Kingdom. When reviewing the competitive effects of this merger, the EU had to assess whether these submissions were truthful and accurate. Following its traditional formalistic approach, the Commission focused exclusively on the 2008 Law of the People’s Republic of China on State-Owned Enterprises. The Commission stressed the role of SASAC in the appointment and the removal of senior management, and concluded that the influence exercised by SASAC was sufficient to conclude that CGN was part of a wider economic entity that comprised other SOEs. Nonetheless, the Commission stopped short of concluding that all relevant companies managed by SASAC were part of the relevant undertaking; instead, it limited its review to the energy sector.
Section four provides an analysis of how merger control of transactions involving Chinese SOEs should be pursued.
The coexistence of two forms of corporate governance operating in parallel as regards Chinese SOEs has a number of implications for competition policy. First, one cannot simply assume that the power of the State is limited to the companies the State effectively owns – on the contrary, the State’s reach can extend to private entities as well. Secondly, one must not approach Chinese entities solely on the basis of the legal rules to which they are subject. Western antitrust law focuses exclusively on legal governance, but this ill-suited to and ignores the political and institutional environment in which Chinese companies operate.
While the CGN merger review was welcomed as the first time the European Commission acknowledged the peculiarities of Chinese State-capitalism, it suffers from two failings. First, it is inconsistent with the criteria developed and deployed by the European Commission by failing to undertake a comprehensive analysis of the regulatory framework so as to identify who effectively controls CGN, the merging Chinese SOE. In particular, the focus on the Chinese energy sector seems to be unprincipled and lack any basis on the Commission’s prior practice. A second failing of this decision is that it fails to take into account the institutional context in which Chinese SOEs operate. The analysis focuses solely on the system of legal governance of SASAC. In doing so, it fails to grasp the central role played by the Chinese Communist in practice, and how the party pervades all levels of government in China. These failings, when taken together, lead to an arbitrary limitation of the number and type of SOEs that are taken into account in the context of a competitive assessment.
To remedy these inconsistencies, the single economic entity doctrine should be applied in a consistent manner, and even extended to take into consideration de facto control. The Commission should focus not only on legal criteria, but also on how control is effectively exercised. In the case of Chinese SOEs, this would lead to a strong presumption that they are all controlled by the Chinese State / Communist party. While rebuttable, defeating such a presumption would require meeting a high standard of proof.
I believe this paper could have been structured differently, and that would have made it easier to follow – and that is reflected in my review below.
Despite this, I consider that this piece provides a very interesting analysis of how companies operating in economic systems other than Western capitalism are able to evade the strictures imposed by the regulatory framework in place in the West. Personally, I found that the piece also provides some interesting insights into the assumptions that underlie competition law and corporate governance – and of how an awareness of them permits one to try to circumvent them – which is something that the author could have explored in greater detail.
On the other hand, I am not sure I agree with the authors proposals to address these problems – which broadly amount to adopting a functional approach to the corporate structure of Chinese SOEs. I think that any effective solution will need to address all instances where there is a lack of connection between the legal structures and economic realities underpinning a transaction, regardless of the jurisdiction from which the merging party hails. Lastly, I would suggest that a possible reason why the Commission adopted the approach it did regarding the acquisition of the Hinckley power station is not obliviousness on its part to the problems that the author identifies, but because such a limited approach sufficed to enable it to pursue the required competition assessment. Of course, this may ran athwart past practice, but, sometimes, pragmatic considerations prevail when deciding individual cases – particularly in matters as sensitive as what principles should govern the evaluation of acquisitions by Chinese SOEs.