Jurisdiction - China
Reports and Analysis
China – MOFCOM Imposes Divestiture Obligation in Approval of Private Equity Transaction.

21 November, 2011



On 31 October 2011, the Anti-Monopoly Bureau of China’s Ministry of Commerce (“MOFCOM”) cleared the acquisition of Savio Macchine Tessili S.p.A. (“Savio”) by Alpha Private Equity Fund V (“Alpha V”) subject to certain conditions. This is the eighth occasion on which MOFCOM has attached conditions to its decision approving a transaction under the Anti-Monopoly Law of the People's Republic of China (“AML”), but it is the first conditional decision relating to a private equity (“PE”) investor. The decision also sheds some light on how MOFCOM deals with minority interests under the merger control rules contained in the AML.
1. Facts
Alpha V agreed to acquire Savio, a textile machinery producer based in Italy, through Penelope S.r.l., a company specifically established for this transaction. 
Alpha V is a PE fund that generally invests in mid-size companies in Europe. According to MOFCOM, Alpha V’s main areas of investment concern non-ferrous metal recycling, home textiles and textile machinery. One of Alpha V’s other portfolio companies (with 27.9% of the issued shares) is Ulster Technologies AG (“Ulster”), a Swiss company.
Savio is a provider of winder and yarn quality control systems. It also holds all of the shares in a Swiss subsidiary company, Gebrüder Loepfe AG (“Loepfe”).
2. Procedure
After receiving the initial notification of the transaction on 14 July 2011, MOFCOM (as is its customary manner of proceeding) requested further information from Alpha V. Upon receipt and examination of the additional materials, the regulator accepted the case and officially started running the clock roughly one-and-a-half months after the date of the initial notification.
Only 10 days into phase 1 of the clearance process (phase 1 is 30 days, phase 2 is 90 days and phase 3 is 60 days under the AML), MOFCOM informed the acquirer that it had substantive concerns. Less than two weeks later, Alpha V tabled its proposal to address and remedy these concerns. Although MOFCOM ultimately accepted the remedy proposed, its decision ran over into phase 2 of the process. The regulator issued the clearance decision roughly one month into phase 2.
3. MOFCOM’s review
At the beginning of its substantive assessment, MOFCOM defined the relevant market, but did not dwell much on this aspect. It found electronic yarn clearers for automatic winders to be the relevant market. According to the MOFCOM decision, Ulster and Loepfe are the only two players in that relevant market (with worldwide market shares of 52.3% and 47.7%,respectively).
The key question for the regulator thus became whether Alpha V, one way or another, had control over Ulster. If so, the transaction would mean a move from a duopoly to a monopoly.
The difficulty with this question was, however, that Alpha V only held 27.9% of the shares in Ulster. Against this background, MOFCOM phrased the scope of its analysis in the following terms: does Alpha V participate in, or influence, the business activities of Ulster? During this analysis, MOFCOM examined Ulster’s shareholding structure, voting system at its general assembly, historical attendance records at the general assembly, and the composition and voting system at the board of directors. The stated result of the analysis was somewhat weak and inconclusive; MOFCOM simply found that it “could not exclude the possibility” that Alpha V participated in, or influenced, Ulster’s business activities.
Perhaps tacitly acknowledging the fact that its analysis was not fully convincing, MOFCOM provided two arguments to support its position that the transaction was anti-competitive. It found that not only could Alpha V engage in anti-competitive conduct through its control or influence over Ulster and Loepfe post-transaction, but it also highlighted the possibility that the two Swiss companies could – by way of coordinating their conduct “through” Alpha V – restrict competition.
In addition to the above analysis, MOFCOM also examined the barriers to entry into the relevant market, and found them to be very high. As a result, MOFCOM found the transaction to have anti-competitive effects. However, the remedy offered by Alpha V allowed the regulator to clear the transaction subject to conditions. In essence, the remedy consisted of Alpha V selling its shareholding in Ulster to an unrelated third party, subject to MOFCOM’s approvaland supervision of the divestiture process by a monitoring trustee.
The Alpha V/Savio transaction provides a number of interesting insights into the workings of MOFCOM’s merger control procedure and, perhaps, the regulator’s strategies and priorities.
Guidance for PE investors. In the first place, the MOFCOM decision is noteworthy because it is the first decision under the AML that grants conditional approval to a PE related transaction. In the past, some PE players and shareholders had taken the position that PE transactions were rarely, if ever, subject to Chinese merger control. The Alpha V/Savio decision clearly shows that this position does not reflect that of the regulator, and may herald similar decisions in the future.
The decision illustrates that MOFCOM regards PE funds or firms in much the same way as it does corporate industrial groups. For example, for the question of whether the merger filing thresholds are exceeded, MOFCOM may take the view that the sales revenues of all entities “under the control” of the same PE fund or firm need to be taken into account. 
Missed opportunity to give guidance on “control” concept. Related to the previous point, MOFCOM however missed a good opportunity to provide more specific guidance on the concept of “control” in Chinese merger control. It should be recalled that the AML requires notification of transactions only where the filing thresholds are met and a company acquires “a controlling right” or the ability “to exercise decisive influence” over another company. 
The Alpha V/Savio transaction appeared to concern the acquisition by Alpha V of the entire issued share capital of Savio. Therefore, the “acquisition of a controlling right” issue did not directly arise. However, the regulator did examine whether Alpha V had “control or influence” over Ulster, thereby using very similar terminology and (it would appear) similar logic.
In that regard, the MOFCOM decision is instructive to some degree, as it sheds light on the factors MOFCOM deliberated – namely, the shareholding structure, voting system and attendance records at the general assembly, and the composition and voting system at the board of directors. Regrettably, however, the decision did not indicate specific thresholds. For example, it is not clear whether control over a de facto majority of votes is required in the general assembly and/or board of directors, or what other level indicates “control” or “influence.” Hence, MOFCOM may continue to enjoy flexibility in subsequent cases.
Coordination and minority shareholdings. As described above, MOFCOM put forward the argument that, post-transaction, Ulster and Loepfe might restrict competition by coordinating their conduct “through” their joint shareholder Alpha V. The regulator might have resorted to this argument thinking that it provided an elegant way out of the difficulty of determining whether or not Alpha V had effective control or could exercise decisive influence over Ulster: even if it had not (so the implicit argument runs), the two Swiss companies would still have had Alpha V as a common shareholder and would have been able to somehow use this fact to coordinate their market behaviour.
MOFCOM’s concern about coordination between the two Swiss subsidiaries may be legitimate, to a certain degree. Indeed, the antitrust laws of both the United States (“US”) and the European Union (“EU”), for example, acknowledge that minority investments in competitors can, under certain circumstances, have anti-competitive effects.
However, in the US and the EU, the availability of public decisions by courts and authorities give market players some specific guidance on the legal benchmarks for this type of investments. In China, in contrast, while the Alpha V/Savio decision repeats the principle that minority shareholdings in competitors can be problematic (as, more implicitly, MOFCOM’s decisions in Inbev/Anheuser-Busch and Panasonic/Sanyo did), it does not provide any details of how exactly coordination between Ulster and Loepfe would work in practice. As a result, market players do not have clear benchmarks for the assessment of their minority investments under the AML’s merger control rules.
Timing. The timing of MOFCOM’s procedural steps, as well as Alpha V’s conduct in that regard, may be one of the most notable aspects of the Alpha V/Savio decision. For example, the regulator informed Alpha V of its concerns about the competitive effects of the transaction a mere 10 days into phase 1. This very short time scale suggests that Alpha V may havestarted discussing substantive issues in the preacceptance phase. The fact that Alpha V was able to table its “final remedy proposal” only eight days after receipt of MOFCOM’s concerns would seem to support this interpretation. To a certain extent, this development shows that MOFCOM has made progress to address concerns voiced by the legal and business community in the past, and now ensures continuity in its merger review investigation across the pre- and postacceptance phases (even though these are still led by different teams within MOFCOM).
Remedies. The remedy proposed by Alpha V and accepted by MOFCOM was relatively straightforward: the divestiture of Alpha V’s stake in Ulster to an unrelated third party. Still, it should be noted that while structural remedies are the preferred solution in other jurisdictions such as the US and the EU, MOFCOM’s past practice shows much more of a mix between structural and behavioural remedies, with a penchant for the latter.
Another noteworthy point is that the decision is the first that explicitly relies on MOFCOM’s provisional regulation on divestiture remedies adopted in 2010. In a way, this shows the growing maturity of the regulator. 
To conclude, the Alpha V/Savio decision covers new ground in various respects. As a result, not only PE firms will have a better understanding of their obligations under the Chinese merger control rules, but other companies may also have gained important insights into how MOFCOM’s carries out its substantive assessments and procedures. A particularly noteworthy aspect is how MOFCOM dealt with minority
investments in its substantive assessment. In the EU, the issue of minority investments is under review—a notice by the European Commission to gather information about minority investments was released just last week. A few months ago, the European Commissioner for Competition, Joaquín Almunia, stated that he had instructed his services to examine potential anticompetitive effects of minority shareholdings. Similarly, in the US, it is well established that minority
investments can create risks of both unilateral effects and coordinated effects. Hence, to a certain extent, MOFCOM’s conclusion on the acquisition of Savio by Alpha V – with the latter’s minority investment in Savio’s only competitor – brings Chinese merger control regulation in line with other major jurisdictions.
For further information, please contact:
Jun Wei, Hogan Lovells
Adrian Emch, Hogan Lovells
Andrew McGinty, Hogan Lovells
Henry Wheare, Hogan Lovells

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