China's hand in risk arb spreads

Ecolab Inc.'s $5.2 billion acquisition of Nalco Holding Co. received antitrust clearance in China after shareholders approved the deal Nov. 30. The China nod was the last condition that had to be met to get the deal done, a factor that is increasingly a concern for how the arbitrage community gauges deal risk.

China has joined the ranks of countries that companies need to deal with for regulatory approvals, and the uncertainty of the process has created a betting opportunity for arbs. Ecolab's acquisition by Nalco received early termination from the Federal Trade Commission in late August. The European Union's competition commission cleared it in early November. But with the shareholder approval, the deal still traded at a spread of 86 cents, or 2%. That spread equaled an annualized return of about 50%.

What that spread represents is the uncertainty China's regulatory process has introduced into many U.S. mergers. Previously, predicting antitrust approvals involved measuring the risk associated with reviews by the U.S. Department of Justice Antitrust Division or the Federal Trade Commission and the European Commission. In rare cases, the German federal trade office or the U.K.'s resident trade bureau could come into play. But by and large, the Hart-Scott-Rodino process and the EU were gatekeepers for mergers when it came to antitrust scrutiny. Now China has become a third factor with an approval process that remains murky. The result: Trading deals exposed to a China review can be tricky.

China's review process is not as transparent as those in the U.S. or the EC, so it's hard to tell if protectionism plays a part in its decisions. As one arb says, there is no information flow.

The Chinese government enacted an anti-monopoly law in 2008 under the Ministry of Commerce, or Mofcom. The core of the law on merger reviews is a chapter relating to concentration of business operations. The review process is not unlike that of the U.S. HSR process or the EC. The requirement to file before Mofcom is uncertain, but increasingly, deals with business ties to Asia include the possibility of a China review in their timetables. The anti-monopoly law provides for an initial 30-day review once a filing has been deemed complete.

This, according to a report by K&L Gates LLP, is not as cut and dried as it appears. The process for determining whether the application to Mofcom is complete is not part of the statutory timeline and can take weeks or even months, depending on the complexity of the transaction, K&L says. Mofcom has published few decisions since the antitrust process was revamped, but it has revealed that the Anheuser-Busch Cos.-InBev NA/SA review required six weeks before the application was considered complete, according to K&L. The Panasonic Corp.-Sanyo Electric Co. Ltd. transaction in 2009 required four months before the 30-day review began.

Once the initial 30-day waiting period expires, Mofcom can extend the review for 90 days. Another extension into a Phase 3 period of 60 days is also possible, so the review can extend to 180 days after the application is deemed complete.

In 2010, 62% of cases filed to Mofcom went into the second phase, and this year almost all have gone to extended review, says K&L. The prime reasons for extended reviews are a lack of resources at the agency and Mofcom's reliance on other ministries and trade associations for input, which often is slow to arrive.

The uncertainty has hit spreads in deals over the past year or two, beginning with Caterpillar Inc.'s acquisition of Bucyrus International Inc., which received U.S. and EC approval in May but didn't clear China until July.

Arbs were concerned that the Bucyrus deal was being delayed in China, but to a large degree that was inaccurate, says Baker Botts LLP's Sean Boland, who advised Caterpiller. The Bucyrus deal appears to have been delayed because the U.S. approval came sooner than anticipated, he says. Boland notes that there are lots of deals undergoing reviews in China, and Mofcom is both understaffed and feeling its way; concerns over the government protecting Chinese companies has not been his firm's experience, he says, and appear overblown.

Still, the Mofcom process does require attention, and companies should file in China expeditiously even if it is not clear that there are competition issues. Holding back on the filing process is a mistake, Boland says.

In June, Mofcom published a draft of provisional rules relating to its review process including the adoption of the Herfindahl-Hirschman index, which measures market concentrations. The HHI is a staple of U.S. antitrust analysis.

In July, Mofcom entered a memorandum of understanding with the FTC and the DOJ to foster cooperation between the agencies.