The regulation of foreign direct investment, or FDI, has been in the spotlight for most of 2022 and will likely remain a key issue for dealmakers and cross-border M&A in 2023.
Globally, we continue to see a trend towards greater FDI restrictions. The degree of regulation, however, varies significantly across different jurisdictions.
Navigating the rapidly developing legal and regulatory FDI landscape will remain a challenge for both sellers and buyers. In addition to FDI regimes, dealmakers will have to take into account other customary investment barriers, including merger control and regulated sectors for which specific licenses may be required e.g., defence, insurance, infrastructure, and energy.
It is crucial, at the time of planning a new transaction, to consider the application of any such investment restrictions. Dealmakers and investors will need to focus on early due diligence, careful transaction structuring and pre-emptive engagement with advisers and the government.
With careful transaction management and deal structuring, we believe investors can successfully navigate many of these regulatory and legal challenges. The alternative is the very real risk of having a transaction blocked from closing or, worse, unwound after closing.
The global trend towards greater FDI regulation shows no sign of slowing down, as governments continue to balance the contrasting demands of an open, welcoming economy with protectionist policies around public security and national defence interests.
United States – The Committee on Foreign Investment in the United States, or CFIUS, continues to see its jurisdiction expand and its funding increase. The CFIUS 2021 annual report reflected a nearly 40% increase in declaration and notice filings in 2021 from 2020.
Europe – An FDI screening mechanism was adopted in the European Union to ensure cooperation and exchange of information across member states, with 18 jurisdictions now fully operational. However, FDI regulations remain largely a national matter and so requires a country-by-country analysis. The United Kingdom, which is no longer part of the European Union after Brexit, recently implemented a comprehensive set of FDI laws for the UK government to review and intervene in M&A transactions where they raise national security concerns.
Asia – China continues to develop its FDI regime under the PRC Foreign Investment Law, which came into effect on 1 January 2020. Hong Kong remains a popular investment hub and, while the adoption of the Hong Kong National Security Law has raised concerns, its impact at this stage remains political rather than economic. Other jurisdictions in Asia have introduced new licencing regimes and regulatory restrictions in certain sectors. However, certain governments, particularly in Southeast Asia, appear to be prioritising foreign investment and economic growth.
United Arab Emirates – The UAE federal government and the governments of the seven separate Emirates that comprise the UAE (being Abu Dhabi, Ajman, Dubai, Fujairah, Ras Al Khaimah, Sharjah and Umm Al Quwain) have, in recent years, introduced various measures to liberalise their FDI regimes. The current position is that non-UAE nationals may own 100% of a UAE limited liability ‘onshore’ company, but sector-specific FDI restrictions remain in place.
The US remains one of the top recipients of FDI inflows worldwide. The US Bureau of Economic Analysis reports that, from 2020 to 2021, FDI in the US increased by more than $500 billion to approximately $5 trillion. This was primarily driven by foreign investment from Europe. The corollary was that CFIUS, an interagency review committee for foreign investment transaction, saw a nearly 40% increase in declaration and notice filings in 2021.
Some transactions require mandatory filings with CFIUS but, even if no mandatory filing requirement applies, a voluntary notification may be advisable. CFIUS regulations permit parties to file a short-form “declaration” as an alternative to the traditional voluntary notice, which is typically reviewed within 30 days. If CFIUS identifies national security concerns, it will follow with a 45-day investigation and may impose certain mitigation measures. These measures include guidelines for the transfer or sharing of sensitive information, ensuring that certain operations are located only in the US, and divesting all or part of the US business. Failure to comply with CFIUS can result in civil penalties up to the value of the transaction, and, in certain circumstances, a block on pending transactions or unwinding of completed transactions.
In response to evolving US national security risks, CFIUS authority and involvement in reviewing foreign investment in the United States has expanded over the past several years. The Foreign Investment Risk Review Modernization Act of 2018 and regulations passed by the US Department of Treasury in 2020 modernized and broadened the authority of CFIUS over certain foreign investments in “TID US businesses”. These are businesses involved in critical technologies, critical infrastructure and sensitive personal data of US citizens, as well as certain real estate transactions.
Most recently, on September 15, 2022, US President Joe Biden signed an executive order intended to provide guidance for CFIUS in conducting national security reviews. While the executive order does not expand or change the regulatory requirements under CFIUS, it does provide additional guidance on whether to make a voluntary filing, including more context as to whether a transaction may be subject to post-closing review. Given the continued broadening of CFIUS involvement, we anticipate 2023 will see an increase in the volume of voluntary CFIUS filings, as well as post-closing inquiries.
Since its introduction in 2005, the FDI regime in France has expanded and developed apace. The French FDI regime was fully reformed in 2019, consolidating amendments made since 2005, as well as additional modifications recently introduced in response to the Covid-19 pandemic and the EU screening mechanism. Notwithstanding these developments, France remains one of the most active European countries for FDI. In 2021, it attracted a total of 1,600 FDI transactions (18% from Germany, 15% from the US, and 9% from the UK) and 328 FDI applications for approval, an increase of 31% from 2020.
The reform in 2019 largely abolished the former distinction between EU and non-EU foreign investors and required investors to disclose any interest held by or financial support received from a state outside of the EU. The reform also harmonised the list of qualifying transactions, being the acquisition of control of a French entity, the acquisition of a business unit of a French entity or, except for EU investors, the acquisition of 25% of the voting rights of a French entity. During the pandemic, the threshold was temporarily lowered to 10% for listed companies, extended until the end of 2022, thereby mirroring the applicable rules in Germany and Spain. Approval timelines have been clarified and the government recently issued some guidance to frequently asked questions. Unlike the rules for merger control filings and similarly to the rules in the UK, the FDI regulation in France does not set any economic or financial conditions for its application. The size of the target will, however, be taken into consideration when a filing is reviewed.
Finally, the reform clarified the list of sectors considered sensitive and into which an investment by a foreign investor would require prior approval. The list covers not only activities directly related to defence and national security, but also infrastructure, biotechnology, goods and services in ten economic sectors considered vital to the national interest, as well as research and development activities in critical sectors.
Decisions on FDI filings are not made public. When reviewing a request for approval, the government may require the investor to make certain commitments, including reporting, operations, or divestments. Such commitments can be discussed with the government and, therefore, outright refusals are rare. Since the 2019 reform, it has been possible for both the investor and the target to submit a preliminary inquiry to determine whether the target’s activities fall within the scope of the FDI regulation. The investor will generally prefer to abandon a transaction before a formal refusal is issued (as was the case with the proposed acquisition by Couche-Tard for Carrefour). However, the government does not consider itself bound by its own precedent decisions, notably as regards its definition of the precise scope of the sectors covered by the regulations.
Recent amendments to German foreign trade laws (the Foreign Trade and Payments Act (Außenwirtschaftsgesetz) as well as the Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung) have imposed on foreign investors a new layer of bureaucratic requirements and restrictions. In general, under the new rules, if a foreign investor acquires 10% or more of the voting rights in a German company, the government may determine the acquisition to represent a threat to public order and security and, if necessary, restrict or prohibit the acquisition.
Under the new, broader screening standard, the key question is whether an acquisition or investment leads to an “expected impairment of public order or security”. Before this amendment, a “genuine threat” was required before any intervention. The change is therefore likely to lead to greater scrutiny of FDI transactions. In addition, the government will consider whether the transaction affects other EU member states or EU programs and projects, thus introducing a further layer of complexity and uncertainty to the review process. During the screening period, any acquisition subject to reporting requirements will be provisionally invalid until otherwise approved.
Like other EU member states, Germany has also introduced the EU-screening directive 2019/452, which establishes, amongst other things, a new information and cooperation mechanism between EU member states for the examination of foreign direct investment.
Other specific areas that have attracted FDI restrictions include healthcare, artificial intelligence, robotics, biotechnology and quantum technology. In healthcare, the government introduced stricter regulations on companies that develop or produce goods that are essential for the long-term maintenance of a functioning health care system. For this purpose, manufacturers of vaccines, antibiotics, medical protective equipment and medical goods for the treatment of highly infectious diseases have been added to the list of protected companies. Foreign non-EU or EFTA investors are not only obligated to notify the government of certain transactions, but are also prohibited from proceeding with the transaction until clearance is obtained.
As one of the top destinations for FDI globally, the United Kingdom had historically shied away from policing FDI in the way that some other countries have. That changed recently with the introduction of the National Security and Investment Act 2021, which from January 2022 introduced parameters for the UK government to review and intervene, including on an extraterritorial basis, in M&A transactions where they raise national security concerns.
The Act establishes a framework for scrutinising FDI in a manner similar to CFIUS and closer to the regimes adopted in Europe. Broadly speaking, the Act applies to transactions that gives an acquirer control over UK entities or control over foreign entities that carry on activities in the UK or supplies goods or services to persons in the UK, even if that entity holds no assets in the UK. Where the Act applies, the government has powers to block, impose conditions to, delay the closing of, or unwind transactions, including joint ventures, in 17 key sectors. These include communications, defence, data infrastructure, energy, transport, artificial intelligence, computing hardware and robotics. Non-compliance may result in fines of up to 5% of worldwide turnover or £10 million (whichever is the greater) and imprisonment of up to five years.
The Act contemplates a hybrid system of mandatory and voluntary notifications. The former applies when a transaction occurs in relation to any of the 17 key sectors, in which case the transaction must be notified to and cleared by the Secretary of State. The latter applies when parties observe any defined “trigger event” which may be of interest from a national security perspective, notwithstanding that it may fall outside of the mandatory notification regime. This hybrid system is supplemented with a “call-in” ability that allows the government to review any transaction that has completed but that has not been notified to the authorities. Conversely, there is also a prescribed process by which a transaction that should have been notified is retrospectively approved and validated by the Secretary of State.
The lack of safe harbours and the danger of having completed transactions being unwound or being found to be legally void mean that a greater number of transactions are now susceptible to either intervention or pre-emptive and voluntary notification. The government estimates there could be between 1,000 to 1,830 transactions notified under the Act each year.
FDI in mainland China is primarily regulated by the PRC Foreign Investment Law and its implementation rules, which came into effect on 1 January 2020.
Under these laws, the PRC government maintains a list of industries in which investment is either prohibited or otherwise regulated. Foreign investors are not permitted to invest in prohibited industries, while regulated industries require foreign investors to meet various criteria, including restrictions on ownership ratio and the composition of the management team. Prohibited industries include tobacco, domestic postal services, PRC law legal services, religious and mandatory education and news and media. In recent years, the PRC government has been revisiting the list of industries on an annual basis and reducing its size, indicating a greater willingness to open up the Chinese market for foreign investment.
In addition to the list of industries in which investment is either prohibited or otherwise regulated, the PRC government has also adopted a national security review regime for FDI. The Measures on National Security Review on Foreign Investment, which came into effect on 18 January 2021, identifies several areas where foreign investment would be subject to national security review. These include military facilities or related businesses, agriculture, infrastructure, energy and resources, the manufacture of certain equipment, and cultural products and services. Given the broad language used in these measures, we expect the PRC government will exercise discretion in determining whether an FDI transaction is subject to national security review.
As a special administrative region of the PRC, Hong Kong maintains a legal system separate to that of mainland China. As one of the world’s most open economies, Hong Kong generally does not restrict foreign investment into any sector, except a 49% voting control restriction in respect of local broadcasting companies and residency requirements on the directors in such companies. Foreign investors generally enjoy the same national treatment as domestic investors. There are no statutory laws that specifically address FDI, and there is no foreign exchange control regime in Hong Kong. Profits and capital can be freely remitted into and out of Hong Kong without any restrictions.
While there is a national security law that came into effect on 30 June 2020, that law does not contain any direct restrictions on foreign investment. It does require all institutions, organisations and individuals in Hong Kong to comply with various laws and regulations regarding the maintenance of national security.
The PRC government is expected to further strengthen the ties between Hong Kong and mainland China both politically and economically. This poses both challenges and opportunities for foreign investors that intend to invest or continue to invest in the Greater China area. We anticipate that Hong Kong will continue to act as an intermediary jurisdiction for investors hoping to enter the mainland China market.
Singapore remains committed to its long-standing economic development policy to promote the city-state as an attractive global FDI hub in the longer term. As such, Singapore does not have any specific umbrella legislation governing FDI. Instead, FDI is governed by sector-specific laws and regulators.
The main structural barriers to entry for foreign investors lie in the key sectors where foreign investment controls are imposed. These include financial services, professional services, media, telecommunications and real estate transactions. The government maintains a level of oversight and control over FDI in these sectors with legislative restrictions and licensing regimes that apply both qualitative and quantitative criteria. Each investment application is assessed on a case-by-case basis, with a view to encouraging co-operation and commercial partnerships with local companies.
To encourage FDI, the government offers incentives in the form of tax breaks and grants if international companies base their regional headquarters or other key production facilities in Singapore. Grants include the Financial Sector Technology and Innovation Scheme, which provides up to 70% co-funding for various qualifying expenses, as well as the Research and Innovation Scheme for Companies, which provides co-funding to support the development of research and development capabilities in science and technology. In addition, the government grants permanent residence status to foreign individuals who intend to drive their businesses and investment growth from Singapore.
Much of the FDI inflows to Singapore is accompanied by FDI outflows to other Southeast Asian, South Asian and North Asian markets. The Regional Comprehensive Economic Partnership, a free trade agreement involving all Association of Southeast Asian Nations member countries, China, Japan, South Korea, Australia and New Zealand, is expected to accelerate trade and investment in the region. Singapore is likely to remain a key regional hub for foreign investors seeking an entry point to deploy their capital across the region.
Until recently, the UAE had longstanding restrictions in place that prevented non-UAE persons from owning more than 49% of any UAE company. Efforts to liberalise this regime began with the introduction of free economic zones in 1985 and which now number nearly fifty separate zones. These include the Dubai International Financial Centre (established in 2004) and the Abu Dhabi Global Market (established in 2013), each of which has its own common-law based legislative systems, courts and financial regulators and which allow 100% foreign ownership. In 2020, the UAE federal government took further steps to open up the market, issuing a new decree that, in essence, permitted non-UAE nationals to own 100% of a UAE limited liability “onshore” company.
That ownership is subject to the business activity to be performed falling within a prescribed list of activities issued by the economic department of each relevant Emirate. Current practice indicates that these lists are subject to continuous review and extension, including, for example, by reference to “new” activities requested by applicants.
In addition, like other jurisdictions, sector-specific exceptions remain. These are codified in what is referred to as the “strategic impact” list, and includes security and defence, banking, foreign exchange, financing, insurance, telecommunications, Hajj and Umrah services, Holy Quran memorisation centres, and services associated with fisheries. In broad terms, any non-UAE investor wishing to conduct any activity falling within this list is required to apply to the relevant authorities in the relevant Emirate, which will determine, on a case-by-case basis, the required percentage of Emirati ownership (as well as any other restrictions, such as board composition).
These developments reflect the general approach taken in certain countries as part of a global trend towards greater protectionism. While there are jurisdictions, particularly in Asia, that continue to liberalise and open up their economies to foreign investment, we are likely to see increasing government intervention in areas of strategic value and sensitivity. We believe FDI restrictions will survive and continue to be relevant regardless of global political and economic tensions and any other near-term outcomes.
Broadly speaking, the burden of compliance with FDI restrictions tends to fall on the investor. This means sellers are likely to push for “hell or high water” undertakings from investors regarding FDI. When planning a transaction, we expect issues like control or influence, board rights, director appointments, shareholder voting rights, and reserved matters to come to the fore. Deal structure and timetable will be affected, as well as the way in which a target company is controlled. The use of commitments (e.g., as to the safeguarding of intellectual property rights, or divestments of certain assets) will continue to be relevant. In certain jurisdictions, regulators may be open to providing some level of comfort before a transaction closes, either formally through a prescribed process or informally.
Assembling an organised transaction team will be important, particularly where a project has cross-border elements and requires careful coordination across FDI and other investment restrictions in multiple jurisdictions. Given the often severe sanctions on breach, the transaction documents will need to reflect the risk allocation as between the parties to the transaction, any conditions to closing and the impact on execution risk, as well as the timetable and process for fulfilling the requirements of regulators.