China officially pumps the brakes on overseas investment

China has formally implemented measures to limit and restrict what it calls extensive overseas investments made by domestic groups.

Earlier this month rumor had it that Beijing was looking to tap the brakes on flight capital. The preceding months and years have seen large overseas deals involving Chinese groups targeting U.S.-based assets and companies, especially in the hospitality sector. Companies such as Anbang Insurance Group, Dalian Wanda, Fosun International and HNA Group have all made large, debt-fuelled investments in the U.S. hotel sector. 

According to JLL, with $9.8 billion spent, investors from mainland China were the largest source of outbound capital into hotels in 2016. Across all investment classes, Chinese foreign direct investment in the U.S. totaled $45.6 billion in 2016. 

China's State Council has released a guideline "to promote healthy growth of overseas investment and prevent risks." Sectors on the restriction list include real estate, hotels, entertainment, sport clubs, outdated industries and projects in countries with no diplomatic relations with China.

Separately, and as reported by Bloomberg, the National Development and Reform Commission, the top economic planning body, "criticized irrational overseas investment in some sectors, while encouraging projects linked to the Belt and Road initiative," a massive infrastructure project initiated by China's president Xi Jinping that involves investment in countries along the old Silk Road linking it with Europe. 

Guidelines from the State Council's include the intent to drive the output of China’s products, technology and services and deepen cooperation with countries involved in the Belt and Road Initiative.

Banned Core military technology, gambling, sex industry, investments contrary to national security
Restricted Property, hotels, film, entertainment, sports, obsolete equipment, investments that contravene environmental standards
Encouraged Investments that further Belt and Road framework, enhance China’s technical standards, research and development, oil and mining exploration, agriculture and fishing

On the other hand, "Overseas investments against the peaceful development, win-win cooperation and China’s macro control policies will be restricted."

In addition, the guideline also prohibits domestic enterprises being involved in overseas investment that may jeopardize China’s national interests and security.

According to The Wall Street Journal, citing the Commerce Ministry, China’s outbound direct investment outside the financial sector declined 44.3 percent over the first seven months from a year earlier, with investment in property and entertainment down by 81.2 percent and 79.1 percent, respectively.

Yuval Tal, a partner at Proskauer Rose and head of the firm's Hong Kong and Beijing offices, is convinced that Beijing's crackdown on outbound investment will have ramifications. "These rules will have the effect of further deterring outbound investments, as they will restrict the ability of money to flow out of the PRC for the applicable categories of industries and investment vehicles," he said. "We will see much less transactions in these industries and much less headline-grabbing transactions involving outbound Chinese money." 

For instance, don't expect a Chinese buyer to swoop in and pick up the Plaza Hotel in New York, which reportedly is now inching closer to a potential sale, a sale that could be worth as much as $2 million per key.

"It will also take some time until its clear how these rules are enforced and the uncertainty will cause both Chinese investors and foreign targets to prefer other options," Tal added.

How We Got Here

Action to stymie overseas investment began in earnest last year when China began to put capital controls on outflows. Beginning in late 2016, China began making it tougher for China-based companies to move money outside the country when the country's foreign-exchange regulator instructed banks to sharply limit how much companies move out of the country and into their other operations around the world.

This came after around four years of more or less unfettered access to overseas markets. Since 2012, regulation governing Chinese institutional investors changed to allow up to 15 percent of their portfolio allocated to foreign real estate assets. Before then, these portfolios could only hold 1 percent of total assets in foreign real estate. The country is now be moving back to the erstwhile austere times. 

And companies are complying. In July, Wanda announced it was selling off $9.3 billion in hotels and tourism projects to Sunac China in a plan to lessen its debt load. Meanwhile, there are whispers that Anbang could already be shopping the Waldorf Astoria in New York, a property it acquired for close to $2 billion in 2014. 

At a time when some Chinese companies are seeking out an exit strategy, foreign sellers are becoming more and more skittish of selling assets to Chinese buyers after a spate of deals have been cancelled by Chinese buyers. Some have even turned toward accepting lower bids, knowing there will be a higher probability that the deal will close. 

"If I’m a seller of real estate and my highest bidder is a Chinese buyer, it probably adds uncertainty, an extra layer to the transaction," said Michael Bellisario, who cover the lodging sector for R.W. Baird. "The clearing price needs to be higher, because they are taking a risk to get a deal closed. You don't want a deal to break down at the 1-yard line."

So far, it appears that the measures installed by Beijing are having consequence. "[They] have already resulted in a significant downturn in the dollars and number of outbound transactions and the new rules will extend this trend, particularly in the short term, until its clear how they are being implemented," Proskauer's Tal said. "This will especially be the case in the industries designated as prohibited or restricted. We can expect to see less, if any, hotels and sports teams bought by outbound Chinese capital in the near future."