The growth in foreign investment regimes and its impact on international M&A

September 2020  |  SPECIAL REPORT: PRIVATE EQUITY

Financier Worldwide Magazine

September 2020 Issue

One of the impacts of the COVID-19 pandemic has been to accelerate an expansion of foreign direct investment (FDI) controls which had already been in progress. Countries which previously did not have FDI regimes are increasingly adopting them, and those with pre-existing regimes have been expanding their scope. The result is that financial investors, particularly when investing in sectors which may be viewed as sensitive or strategic, increasingly need to factor into deal timetables and processes the need to obtain FDI clearances, in much the same way as they have long factored in the need for merger clearances.

In this article we will explore the factors driving the expansion in FDI regimes pre-COVID-19, the impetus given to that trend by COVID-19, some of the key changes (and potential changes) which have resulted and the impacts for financial investors.

Factors behind the expansion of FDI regimes pre-COVID-19

Some countries, such as the US, Canada and Australia, have had well-established FDI regimes for many years. Other regimes, such as China, limit or prohibit FDI in certain sectors, but allow it in others.

Until quite recently, many Western countries, including many in Europe, either had no specific FDI regime, or had regimes which were narrow in scope. They instead pursued a policy of being open to foreign investment but reserving the right to intervene in limited circumstances critical to national security.

Over the last few years, however, there has been a clear trend for countries to expand the scope of FDI regimes, or to introduce them. A number of factors have driven this, including: (i) a belief that the risks to national security have increased significantly as a result of the growth in powerful technologies, such as quantum computing, artificial intelligence (AI), advanced encryption technologies and materials which are capable of concealing objects or altering their appearance; (ii) concerns that certain countries seek to expand their global influence through acquisitions by state-owned companies, or other entities backed by state subsidies, while not allowing foreign investors the equivalent freedom to invest in their domestic economies; (iii) a perceived risk of ‘crown jewel’ businesses falling into the hands, or under the influence, of potentially hostile states; and (iv) a claimed increase in state-sponsored attempts to influence policy covertly and steal sensitive commercial information.

China is frequently cited by politicians as a driver of many of the increased concerns, with the current controversy surrounding the involvement of Huawei in the UK 5G telecoms network being one example of this.

The impact of COVID-19

The COVID-19 pandemic has accelerated the pre-existing trend for two main reasons. First, there has been a realisation that a wider range of businesses may be important for fighting pandemics. For example, many countries’ regimes would not previously have captured, at least clearly, companies working on vaccines or producing personal protective equipment. Second, there is a belief that businesses that are important to a country, either because of the products or services they supply, or the number of jobs they provide, may be picked up by opportunistic foreign investors ‘on the cheap’, while they are temporarily weak due to COVID-19.

Some key recent developments

As a result of these factors, there has been a significant growth in FDI regimes in recent years, particularly over the last few months.

In the European Union (EU), an FDI Screening Regulation was adopted in 2019 and will come into force in October 2020. The regulation provides for the exchange of information, comments and opinions between member states and the European Commission (EC) on specific FDI. The decision of whether an investment should be permitted will remain with the member states, rather than be taken at EU level, however.

In March 2020, the EC issued guidelines encouraging member states to use their screening mechanisms to block transactions that would pose a risk to critical health infrastructures, supply of critical inputs and other critical sectors as a result of COVID-19. It also urged member states which did not have a screening mechanism to establish one.

In the US, rules adopted in February 2020 expanded the scope of investments subject to review to include non-controlling investments in critical technology, critical infrastructure and sensitive personal data businesses, and certain real estate transactions. Mandatory filing was also introduced for certain transactions.

In France, in April 2020, the ownership percentage of French companies for which prior authorisation may be required (depending on the sector and the investor’s location) was reduced from 33 percent to 25 percent and the list of sectors to which the regime applied was extended. The sector list was extended again in May 2020. Further, the ownership threshold is in the process of being temporarily reduced to 10 percent for non-EU investors investing into French listed companies.

In Japan, in June 2020, the threshold for notification where a foreign investor invests in a Japanese listed company was reduced from 10 percent of the voting rights or number of shares, to 1 percent. However, certain types of investment, such as portfolio investments, were also exempted from the filing obligation.

In Germany, in June 2020, the regime was extended to cover asset deals, and reviews now explicitly consider whether an acquirer is directly or indirectly controlled by a non-European Economic Area (EEA) government. The list of specially protected sectors was also extended. Additional amendments are planned to further expand the sectors covered, and to introduce a ban on closing pre-clearance.

In Italy, the ‘Golden Power’ decree has been extended to cover additional sectors. Extended screening also applies temporarily to acquisitions of controlling interests by EU entities, and acquisitions by non-EU entities representing 10 percent or more of share capital, where the investment value exceeds €1m, in companies owning assets with strategic relevance.

In Canada, it was announced in April 2020 that for the duration of the COVID-19 pandemic there would be enhanced scrutiny of FDI of any value, controlling or non-controlling, in Canadian businesses related to public health or involved in the supply of critical goods and services to Canadians or the government by state-owned enterprises or private investors closely tied to foreign governments.

In Spain, new restrictions entered into force in March and April 2020 under which FDI resulting in the acquisition by non-EU/ European Free Trade Association (EFTA) investors of 10 percent of the shares of Spanish companies active in certain broadly defined strategic sectors are subject to authorisation. Authorisation is also required if the foreign investor is directly or indirectly controlled by a third country government or is involved in sensitive activities in another EU member state.

In Australia, the monetary threshold for notification has been temporarily reduced to zero for all FDI. The timeframe for reviews has also been extended from 30 days to up to six months. On a more positive note for financial investors, as part of proposed reforms intended to take effect in 2021, foreign investors will be able to obtain exemption certificates once they are assessed as not posing a national security risk. In addition, investment funds in which foreign government enterprises have invested will no longer be treated as ‘foreign government investors’ (to which enhanced scrutiny applies) if the foreign government enterprises have no influence or control over the investor’s investment or operational decisions.

Although there is no specific foreign investment regime in the UK, in 2018 the government’s powers to intervene in merger control assessments to protect national security were expanded by lowering the thresholds for deals in the defence, computing hardware and quantum technology sectors. In July 2020, this was expanded further to cover AI, encryption technology and certain advanced materials. In June 2020, the government also introduced a new public interest ground on which it can intervene in merger control processes: to protect the UK’s ability to combat and mitigate the effects of public health emergencies. Finally, the government plans to introduce a National Security and Investment Bill to parliament imminently. This will introduce a separate notification regime aimed at protecting national security.

Impacts for financial investors

Most financial investors are unlikely to be viewed as ‘undesirable’ acquirers and are therefore likely to be approved under FDI regimes in a large majority of cases. Nevertheless, the growth in FDI regimes has significant repercussions for financial investors.

Deals are more likely to trigger FDI controls than previously, at least where an investor is investing outside its home state (or outside the EU in the case of EU investors). This is likely to have an impact on transaction timetables as additional regulatory approvals may be required. Even financial investors from countries that are unlikely to be viewed as hostile may see remedies imposed on them more frequently, for example to preserve domestic capability.

Investors will need to consider not only their own position, but also that of any investment partners. This could have an impact on the attractiveness of sovereign wealth funds and state-owned enterprises as co-investors. It may also increase the extent to which foreign investors look to work in tandem with local investors.

Investors which require FDI approval may find themselves at a competitive disadvantage in auction processes if they are up against rival bidders which do not require such approvals. They may also need to work hard to convince the vendors that FDI approvals will be obtained in a timely manner.

We are also likely to see an increase in the extent to which transaction agreements impose onerous obligations on buyers that need FDI approval, such as obligations to offer whatever remedies may be required to obtain clearance (‘hell or high water’ provisions) or indemnities in case FDI approval cannot be obtained.

Although some of the recent changes in FDI regimes may be temporary COVID-19 measures, the factors driving the general expansion of these regimes are not short term. Accordingly, financial investors need to ensure that they are factoring FDI approvals into acquisition strategies to manage risks in the most effective way.

Neil Cuninghame and Michael Burns are partners at Ashurst LLP. Mr Cuninghame can be contacted on +44 (0)20 7859 1147 or by email: neil.cuninghame@ashurst.com. Mr Burns can be contacted on +44 (0)20 7859 2089 or by email: michael.burns@ashurst.com.

© Financier Worldwide

BY

Neil Cuninghame and Michael Burns

Ashurst LLP

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