A recent security clampdown on foreign acquisitions in China raises threat of 'tit for tat' regulation of M&A

Last month, leading Chinese networking equipment maker Huawei Technologies bowed to a recommendation by the Committee on Foreign Investment in the US (CFIUS) and withdrew its attempt to purchase $2m (£1.24m) worth of server patents from California's 3Leaf Systems.

The inter-agency CFIUS, charged with reviewing transactions for national security risks, had voiced concern about Huawei's possible ties to the Chinese military. Similar concerns killed Huawei's 2008 attempt to buy a stake in networking company 3Com, which was later acquired by Hewlett-Packard. In February, the Chinese company released an open letter asking the US Government to conduct a formal investigation to dispel the "rumours and misperceptions" that Huawei somehow posed a threat to US national security.

Other Chinese companies have faced obstacles as well. The political resistance, premised on national security concerns, that doomed China National Offshore Oil Company's (CNOOC's) 2005 bid to acquire US oil company Unocal Corp for $18.5bn (£11.5bn) is particularly etched in the memories of Chinese officials.

Well, two can play that game. The Chinese Government is currently introducing its own national security review process to scrutinise foreign investment in China. The review will be conducted by an inter-ministerial panel under the State Council that draws members from the Ministry of Commerce (MOFCOM), National Development and Reform Commission (NDRC) and other Chinese agencies.

"It's clearly modelled after CFIUS and the other foreign procedures," says Peter Wang, a Beijing partner with Jones Day. "It's hard not to see it in some ways as a tit for tat."

Of likely concern to foreign companies looking at China acquisitions is the expansive definition of 'national security' that the Chinese review will take. In addition to obvious military concerns, China also includes economic security and social stability as factors to consider. The panel's openness to complaints referred by third parties could also provide an avenue for Chinese companies to stymie potential foreign competitors by raising national security fears.

But will such a review really change much in China for foreign investors? "Most acquisitions in China already require some kind of regulatory approval," says Kenneth Chan (pictured), a Hong Kong partner with Latham & Watkins. "Even without this, the Chinese Government would be reviewing transactions for national security issues. They just would have done it secretly." Indeed, the new security review could have a more negative impact on Western lawyers than on their clients.

While a new regulatory hurdle normally means good news for lawyers, the practice restrictions placed on foreign lawyers in China complicate the picture. Foreign lawyers are technically barred from practising Chinese law but are allowed to advise more generally on the "Chinese legal environment". However, that loophole has already been tightened in recent years, and adding an explicit national security dimension to deals probably will not help.

Wang points to the example of the Chinese anti-monopoly law. Most Western law firms thought the introduction of this law in late 2008 would mean good things for them. After all, the law was based on European Union competition law, a subject about which many foreign firms possessed great expertise. But it is hard for Western lawyers in China to build on this edge when they cannot even meet with the regulators who oversee that nation's competition law.

Just a few years ago, access to regulators was easier. "There was a time when foreign lawyers met quite regularly with MOFCOM officials," recalls Chan. "There was a strong desire to attract foreign investment then. Now they feel they can afford to exclude foreigners from certain things.

"It's definitely harder than it needs to be," Wang says of China antitrust practice. As with other areas of China practice, foreign firms need to hire smaller local firms to act as their intermediaries to file documents and meet with officials. Meanwhile, the big local firms like King & Wood have steadily built large antitrust practices.

If foreign law firms feel shut out of competition practice, access is not likely to improve when it comes to national security. It is, after all, an area particularly susceptible to secrecy, paranoia and nationalist sentiment. Just ask Huawei.

This article first appeared in The Asian Lawyer, an affiliate title of Legal Week.