October 31, 2008 / 5:39 PM / 11 years ago

UPDATE 1-China probe may curb foreign deals - sources

(Updates with details on Avon)

By George Chen

SHANGHAI, Oct 31 (Reuters) - China appears to be tightening supervision of foreign investments in the country amid a widening investigation of two senior commerce ministry officials, people with direct knowledge of the matter said.

Beijing has warned the commerce ministry and departments with power to approve foreign investments to be “increasingly cautious” when reviewing major deals, the sources told Reuters.

Chinese special investigators are also reviewing foreign investment cases involving at least two U.S. law firms with offices in Hong Kong and Beijing, part of a growing corruption probe, the sources said, declining to name the firms.

Sources said another case involved Avon Products Inc AVP.N when the U.S. cosmetics company sought direct sales licenses in China. Avon declined comment.

The clampdown came after Guo Jingyi and Deng Zhan, two senior officials in charge of approvals for foreign investments at China’s Ministry of Commerce, were detained by special investigators in August and September, according to reports by state media and confirmed by the sources.

The detentions were related to a corruption probe, but no clear reason was given, state media said.

“Initially, people thought it was just one or two single corruption cases; but step by step, Beijing apparently wanted to have a full story and thus to expand its investigations,” said one of the sources close to the commerce ministry.

“This thing makes people get nervous and will naturally slow down or even tighten deal approvals involving foreign investments before the government gets the full story,” he said.

A spokeswoman at the commerce ministry said she could not comment. The sources declined to be identified due to the sensitive nature of the matter.

APPROVALS AND LICENSES

Guo, director general of the treaty and law department at the commerce ministry, is responsible for interpreting China’s foreign investment rules, making his role particularly important when a deal is considered sensitive to China.

Deng, deputy head of the foreign investment division at the ministry, is responsible for issuing approvals and licenses to foreign investors and often works with Guo to review deals.

Avon, the world’s largest direct seller of cosmetics, won approval in 2006 to return to the direct-selling model in China. Beijing had shut the door in 1998 on direct sales in a blanket ban aimed at curtailing domestic pyramid schemes.

Earlier this month, Avon said it was voluntarily investigating its Chinese operations over an allegation of improper expenses incurred on behalf of a government official. At that time, Avon declined to give further details, including the rank of the official or the exact nature of the expenses.

Spokeswoman Jennifer Vargas reiterated on Friday that Avon was in early stages of the probe and that it was “premature” to comment further.

Foreign investors must seek approval from the commerce ministry for any deal valued at over $50 million when it involves investment in a sector that Beijing defines as a “restricted industry.”

For a deal valued at more than $100 million in a sector where the government encourages foreign investment, commerce ministry approval is also required.

The case has attracted growing concern among China-focused foreign investors, including big multinational corporations and global private equity firms fearful that the probe will lead to a crackdown on planned deals.

Foreign investors, while attracted to China’s booming economy and huge consumer market, have found it difficult to seal deals, in part because of government intervention.

Beijing has decided to expand its investigations of lawyers and other agencies, according to the sources and Chinese media.

Two lawyers specializing in helping foreign clients seek approval of deals were detained amid the corruption probe related to Guo, according to the magazine Caijing.

Both had worked at Chinese law firm Seafront, also known as Si Feng in Chinese, which has often been asked by the commerce ministry to contribute suggestions when Beijing drafts foreign investment rules, Caijing reported.

One was a Peking University classmate of Guo, and the other was a former colleague of Guo at the commerce ministry, the magazine reported. Seafront, based in Beijing, could not be reached for comment. (Additional reporting by Michael Flaherty in Hong Kong and Aarthi Sivaraman in New York; Editing by Ken Wills, Lincoln Feast and Gerald E. McCormick)

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