FDI control challenges in cross-border M&A transactions
9 March 2020
The international rise of protectionism has brought about an exponential increase in worldwide Foreign Direct Investment ("FDI") control regimes. According to the latest UNCTAD World Investment Report, over the past eight years at least eleven states have introduced new FDI control regimes. In addition, over 41 amendments, mainly of a restrictive nature, have been made to pre-existing legislation on FDI. This means that in an increasing number of jurisdictions governments have the power to prohibit or change transactions and often have significant discretion in doing so. While merger control notifications are normally on the radar of the acquirers' and sellers' corporate lawyers, the awareness of the increasing FDI-related transaction risks is often limited.
How to define FDI control?
It may be difficult in cross-border M&A transactions to clearly define the scope of an FDI control review. While many differences exist between jurisdictions, FDI control essentially entails discrimination between national and foreign acquirers. FDI review may take various forms, among which we distinguish (i) dedicated FDI review procedures, (ii) merger control combined with FDI review, (iii) sector regulations or government contracts, and (iv) informal types of FDI control.
(i) The most common form of FDI control are dedicated FDI review procedures. Such procedures are normally triggered by explicit thresholds and apply only to specified industry sectors. If the thresholds are met, a foreign company must often submit a notification to the relevant authority before effectuating the investment. FDI review procedures may be triggered by the acquisition of as little as 10% of the shares or assets in a local target company. Often, thresholds in EU jurisdictions distinguish between non-EU and EU investors (for example Germany and France).
(ii) In several jurisdictions FDI review is an integral part of the merger control procedure. This means that an FDI review may be triggered when the 'regular' merger filing thresholds are met. Under such regimes national competition authorities may impose measures in merger control procedures on the basis of public interests (for example UK and South Africa).
(iii) Some governments use sectoral regulation or government contracts to control foreign investments. These regimes may be difficult to detect during a cross-border transaction. For example, Dutch regulations in the electricity, natural gas, and financial sectors include mandatory approval by the government of any change of control irrespective of the identity of the acquirer. In addition, the acquisition of companies which supply the Dutch defence forces must be notified on a contractual basis.
(iv) Finally, some governments exert their discretion without a set legal framework. Such informal FDI control is widespread and hard to detect and predict. Informal FDI control may range from public criticism of foreign investments by government officials to using any contractual power the government may have to block or alter foreign investments. For example, governments may possess 'golden shares' in vital companies which they can use to control or prevent acquisitions of shares by foreign investors.
Practical challenges for cross-border transactions
It is a challenge to identify cross-border transactions that involve potential FDI complications in an ever-changing landscape. Even after the identification of FDI-related risk in one or more jurisdictions, it may be difficult to determine whether the notification to the local authorities is required and whether such notification will lead to material objections. Below is a short overview of practical challenges that may arise in this respect:
- Fast developments: A critical and challenging element in FDI review is ensuring that the knowhow of multi-jurisdictional FDI thresholds is up-to-date. Major jurisdictions such as the UK, Germany, China, and the US have recently adopted amendments to their FDI regulations.
- Lower thresholds: Notification obligations are often more easily triggered than in merger control, especially in sectors that authorities have noted as sectors that are critical to their economies. Which sectors are captured, varies greatly from jurisdiction to jurisdiction. While some governments prioritise the defence and energy industries, others may be focused on protecting fisheries and tourism industries.
- Political involvement: FDI legislation often gives significant leeway to authorities: not just on issues such as procedural deadlines, thresholds and material assessments. Thus, the most challenging task for lawyers are identifying material risks upfront. This is due to the politics involved but also by a lack of precedents as decisions by national authorities are rarely made public.
We are still in uncharted territory; however, it's safe to say that FDI control will likely become more extensive and sophisticated in the next few years. The President of the European Commission, Ms von der Leyen stressed the need for "tools and policies to better tackle the distortive effects of foreign state ownership and subsidies in the internal market. On the other side of the Atlantic, the US have adopted extensive regulations to implement the Foreign Investment Risk Review Modernisation Act of 2018 ("FIRRMA"). In particular, FIRRMA will enable the Committee on Foreign Investment in the United States ("CFIUS") to block certain transactions involving non-controlling foreign investments in critical technologies, infrastructure, and sensitive personal data.
Against the backdrop of increasing protectionism in the West, some states that are historically very restrictive towards FDI are trying to stem the tide by creating more favourable conditions for foreign investments. For example, liberalisation of national FDI legislation has recently taken place in China, where the negative list has been simplified whilst the endorsed catalogue amended. In addition, the new law has significantly improved the security of foreign investments due to the Chinese government committing to the protection of foreign intellectual property rights. It may take a while before a new equilibrium is found.