Managing the Challenges of Food and Agribusiness Investment in China

By Bing Ho, Grace Tso and Zhenyu Wang 

[box] Editor’s Note: This is the first in a series of articles on China’s food and agribusiness sector by Baker & McKenzie. Future articles will cover the following topics as they relate to food and agribusiness: the regulatory landscape, brand protection, taxation, trade and distribution, labor and employment challenges, land, and Chinese investment in the United States. [/box]

Demand for foreign-branded foods, beverages, and other agricultural products and services is soaring in China, largely due to the rising income of Chinese consumers and their growing concerns about food safety. Here are just some of the numbers that are reshaping China’s food and agribusiness industry and driving foreign investment:

• In 2012, China had roughly 187,000 supermarkets. That number grew from just 119,000 in 2008, and experts estimate that another 100,000 new retail supermarkets will be built by 2017.
• Chinese consumers—scared away from domestic food safety scandals—prefer foreign-branded food products. China imported $35 billion worth of pre-packaged food and beverages in 2012, up from $13 billion in 2008, according to China Customs.
• In 2012, China consumed 71 million tons of meat, up from 8 million tons in 1978.

This trend affects not just the kinds of food purchased, but every aspect of China’s food industry, including retail, distribution, warehousing, and farming. It also presents an enormous opportunity for multinational agribusiness and food companies. But agribusiness remains a highly regulated industry in China, and multinational companies seeking to invest in China face a number of barriers. Regulatory challenges include restrictions on foreign investment, lengthy anti-trust reviews, and China’s new national security review process for mergers and acquisitions.

Foreign investment challenges for food and agribusiness companies

Investment in the food and agribusiness industries in China continues to see strong growth. In 2012, foreign investment in China’s food and beverage industries grew 38 percent and 28 percent, respectively, year-on-year, according to China’s Ministry of Commerce. Greenfield investments in the food and agribusiness arena continued to be the dominant form of foreign investment, with mergers and acquisitions in second place.

Despite this growth, investors in this market often find themselves frustrated by the complicated regulatory regime in China.

Agribusiness and the Catalogue Guiding Foreign Investment 

Foreign investment in China is subject to the Catalogue Guiding Foreign Investment, which classifies foreign investment projects as “encouraged,” “restricted,” or “prohibited.” Projects classified as prohibited are not permitted. Encouraged projects may receive faster approval or tax or other benefits. Restricted projects are subject to a higher level of government scrutiny. Projects not listed are permitted but receive no preferential treatment.

The catalogue also stipulates whether a foreign investor can hold 100 percent interest, in the form of a wholly foreign-owned enterprise (WFOE), or a majority or minority interest in the form of an equity or cooperative joint venture (EJV or CJV). Investment in certain highly-regulated industries or businesses must be made through EJVs or CJVs in which, in some cases, a Chinese party must hold a majority or the largest interest. For example, retail of grain, cotton, vegetable oil, sugar, pesticides, and chemical fertilizers all cap foreign shareholding at 49 percent if the enterprise has more than 30 stores nationwide selling different brands from multiple suppliers.

In recent years, revisions to the catalogue have opened some specific food and agribusiness industries to foreign investment, while narrowing the scope for foreign investment in others. For example, the revised 2011 catalogue opened some traditionally closed industries in agribusiness to foreign investment, such as carbonated drink manufacturing and hi-tech agricultural machinery. Investment in the production of natural food additives and food ingredients was no longer subject to shareholding restrictions, thereby permitting investment in the form of WFOEs for the first time.

However, the 2011 catalogue removed the storage of vegetables, dried and fresh fruits, livestock, and poultry products from the encouraged category and moved several industries into the restricted category. Newly restricted industries included the processing of rice, flour, and edible oils (from rapeseed, peanuts, cottonseed, tea seeds, sunflower seeds, and palm); grain purchasing; and building and operating large farmers’ markets.

The 2011 catalogue continues to prohibit foreign investment in the production of genetically modified plants’ seeds and—for the first time—banned foreign investors from investing in the research and development of genetically modified organisms.

Even if an industry is not listed in the catalogue and is thus permitted, other regulations and rules elsewhere may still impose restrictions. For example, the Administration of Approval and Registration of Foreign-Invested Crop Seed Enterprises issued in 1997 prohibits foreign-invested enterprises (FIEs) from distributing and selling seeds and bans WFOEs from engaging in the crop seed business. Despite the fact that these investments are not prohibited in the revised guidance catalogue, they are still subject to other rules and regulations.

Investment in western and central China

Over the last decade, China has encouraged westward expansion by implementing strategies aimed at boosting economic development in China’s central and western regions, which have lagged behind China’s more developed eastern seaboard.  China aims to promote agribusiness in western regions by establishing major agricultural production districts, promoting modern agriculture and opening up more agribusiness categories to foreign investment.

The 2013 Catalogue of Priority Industries for Foreign Investment in the Central-Western Region covers 22 out of the 31 provinces in mainland China and lists preferred industries, which can expect preferential policies for foreign-invested projects encouraged in the 2011 catalogue.

The 2013 western catalogue added 30 new agribusiness categories. Encouraged industries include production and processing of green agricultural and animal products, poultry breeding, wine and certain types of specialty foods. Some industries that are restricted or prohibited by the 2011 catalogue are encouraged in central and western regions by the western catalogue.

Shanghai Pilot Free-Trade Zone 

As a pioneer attempt to liberalize the domestic market, the Shanghai Pilot Free Trade Zone could make it easier to establish and modify an FIE established in the zone. Generally, FIEs in the zone are expected to receive national treatment with the same filing and registration requirements as domestic entities, and only foreign investment projects that appear on a special “negative list” will be restricted and require special approval. It remains to be seen how much of an impact the zone will have on investment, but this development could benefit foreign food and agribusiness companies looking to invest in China.

Mergers and acquisitions: Anti-trust and security reviews 

Anti-trust reviews 

According to the Antimonopoly Bureau, about 730 antimonopoly reviews had been conducted as of March 2014. Only once has a planned acquisition been blocked—Coca Cola’s failed attempt to acquire the Huiyuan juice business in 2009—and only 20 clearances have been conditional.

One of those conditional clearances was granted after the anti-trust review of Japanese trader Marubeni’s acquisition of US grain supplier Gavilon in 2013. MOFCOM determined that Marubeni’s acquisition of Gavilon would substantially strengthen Marubeni’s control over the import market for soybeans in China and would further weaken the bargaining power of domestic soybean pressing companies. MOFCOM issued a conditional approval requiring Marubeni and Gavilon to operate their own China soybean export businesses through separate and independent legal entities and forbade any exchange of competitively sensitive information between them. The decision hints that MOFCOM also considers the interests of domestic market players when it conducts antimonopoly reviews.

Foreign investors planning a merger or acquisition must file with MOFCOM if their firm’s annual turnover—both worldwide and in China—exceeds certain minimum thresholds. The same is true if the combined turnover of all companies involved in the proposed merger or acquisition exceeds certain minimum thresholds.

In addition, the Antimonopoly Bureau has discretion to require a merger filing even when none of the statutory filing thresholds are met. The bureau can exercise this discretion if it thinks a proposed concentration will have valid anticompetitive effects on the domestic market.

National security reviews 

Foreign investors merging or acquiring businesses involved in major agriculture products may need to go through a formal national security review. Departments under the State Council, national industry associations, enterprises in the same industry, and upstream and downstream enterprises may request that a foreign investor submit a national security review filing. A foreign investor may also voluntarily file with MOFCOM if it believes a transaction should be subject to national security review.

MOFCOM has not issued an official list of industries subject to national security review. Some unofficial guidance has been given in the form of a Security Review Industry Table, which is available on the websites of some local commerce bureaus. While not legally binding and likely not exhaustive, the table is a starting point for foreign investors in deciding whether to file a national security review for the following listed agribusiness industries:

• Cultivation of grains and other crops
• Livestock farming
• Pig farming
• Poultry farming
• Processing of edible vegetable oil
• Manufacture of starch and articles of starch
• Manufacture of mechanized agricultural and horticultural implements
• Wholesale and retail of agribusiness products

To our knowledge, MOFCOM has yet to block or approve conditionally any foreign acquisition following a national security review. However, the opacity of possible national security review requirements could affect deal time-tables and, perhaps more importantly, deal certainty.

Manageable challenges 

Foreign investors should remind themselves of the tough but manageable challenges in investing in China’s food and agribusiness industry. The industry remains highly regulated because of public opinion, vocal domestic industry interests, and national security concerns. And while the 2011 guidance catalogue loosened some restrictions on foreign investment in food and agribusiness, it tightened others. Future revisions could unpredictably alter the foreign investment landscape in this sector for better or worse.

However, the inherent and growing potential in the China agribusiness market make facing these challenges worthwhile. China has made substantial efforts to grow the number of investment opportunities and promote foreign investment in food and agribusiness, especially in the central and western regions. To identify successful investment opportunities and minimize risks when pursuing them, foreign investors should remain vigilant in analyzing the Chinese regulatory framework and monitoring changes in industrial policy.

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About the Authors

Bing Ho ([email protected]) is a partner in the Corporate Group at Baker & McKenzie and leads the firm’s North America-China M&A Practice, dividing his time between Chicago and China. His practice focuses on M&A transactions, foreign direct investment and cross-border counseling for multinational corporations doing business in China, with a particular focus on transactions related to the food, agribusiness, manufacturing, chemicals, and retail sectors.

Grace Tso ([email protected]) is a special counsel in the Corporate Group at Baker & McKenzie based in Hong Kong. Her practice focuses on cross-border mergers and acquisitions for foreign investors and foreign direct investment into China and Hong Kong. She also advises multinational companies on the planning and implementation of multi-country corporate restructuring projects.

Zhenyu Wang ([email protected]) is an associate in the Corporate Group at Baker & McKenzie based in Hong Kong. His practice focuses on mergers and acquisitions, joint ventures, reorganization and other corporate and commercial matters relating to Hong Kong and China. [/box]

(Photo by randomwire via Flickr)