While governments continue to welcome foreign investment as a way to secure economic growth and to create jobs, there is, nonetheless, growing sensitivity about the potential risks of such investment in certain sectors.
In the debate about foreign direct investment controls, much of the focus in recent times has been on outbound investment by Chinese companies, particularly state-owned enterprises, but by no means exclusively.
While risks are often characterised as threats to `national security', increasingly, governments are taking a broader view on what exactly that means: it's no longer just about the defence sector; now sensitive technologies, utilities, media and `critical infrastructure' are equally under the spotlight. At the same time, governments have been arming themselves with powers to intervene in a wider range of deal types.
With heightened tensions in global trade, this is a trend we fully expect to continue.
New EU foreign investment legislation adopted in March 2019 and applying from 11 October 2020, marks the first time that the supra-national body has taken a co-ordinated approach to the vetting of investment from outside the EU on security and public order grounds across EU Member States.
It represents a significant moment in the development of mergers and acquisitions vetting in the EU.
The EU's move is part of a wider global picture, with investors facing a rapid proliferation of national interest screening across a growing number of jurisdictions around the world.
The EU's new legislation can be seen as part of this trend. So too are moves in the UK to replace the existing public interest screening regime to date used only in the context of acquisitions raising national security, media plurality and (exceptionally) financial stability concerns with a significantly expanded national interest regime that would give the UK government powers to intervene in a far wider range of transactions and sectors. Other jurisdictions, such as the U.S., France and Germany, have been strengthening their existing review mechanisms. China itself maintains strict national security controls, while increasingly opening itself to inward investment.
It adds up to an increasingly complex environment for investors. Screening approaches, though often similarly motivated, certainly are not uniform. Some, such as the Committee on Foreign Investment in the U.S. (CFIUS), apply national security tests; other countries, such as Australia, apply a broader national interest test.
Some countries have mandatory vetting schemes, obliging investors to gain clearance before a transaction can proceed; others operate a voluntary scheme enabling governments to intervene after a deal has been finalised; while others still have no screening regime at all. Some regimes operate entirely separately from competition regulation, while some are closely interlinked.
As new initiatives, like those from the EU and the UK, roll out, the risks and complexities for investors as well as providers of acquisition finance are only likely to increase.
"Increasingly, governments are taking a broader view on what exactly `national security' means: it's no longer just about the defence sector. At the same time, governments have been arming themselves with powers to intervene in a wider range of deal types."
EU legislation was initially proposed by the European Commission at the behest of several Member States, including France, Germany and Italy, who were concerned about the absence of effective instruments to combat strategic acquisitions of European technologies by non-EU investors, as well as the lack of reciprocity with EU trade partners.
Screening at an EU level is not part of the new Regulation, which instead remains the exclusive preserve of individual EU Member States. However, Member States are effectively being encouraged (although not compelled) to adopt screening mechanisms and will be required to co-operate on vetting foreign investment.
The Regulation is built around a core set of principles that try to balance investor and national interests. They include a determination to create certainty, to encourage transparency and offer the possibility of recourse against screening decisions. The Regulation also requires all third-country investors to be treated equally although, in practice, national interest concerns and security tests differ depending on the nature of the investor. Countries with screening regimes must also ensure they are robust and cannot be circumvented by investors.
The EU has drawn up a very long yet non-exhaustive list of areas where investment might pose a threat to security or public order. They include critical infrastructure, critical technologies and dual-use items, supply of critical commodities (including energy, raw materials and food), access to or control over sensitive information (including personal data) and the freedom and pluralism of the media. In practice this means that no transaction or sector is automatically excluded from the scope of the new Regulation.
In addition, Member States are explicitly allowed to take into account whether an investor is controlled, either directly or indirectly, by a foreign government.
Perhaps most significantly, a Member State probing a proposed transaction for security or public order concerns will be obliged to notify the EU Commission and other EU Member States of its review even if a specific investment is not foreseen to have effects outside the territory of the relevant Member State. Other Member States and the EU Commission will be able to comment on the notified investment and indeed on investments not undergoing screening. The views expressed are to be taken into account by the Member State where the investment is taking place. Given the sensitivity of national security concerns (both from the perspective of the Member State and the companies involved), it remains to be seen how this cross-border information sharing and co-operation will work in practice.
It also remains to be seen whether the new regime is ultimately relatively innocuous a further administrative hurdle for investors to leap, and no more or a game changer for the European investment landscape. Either way, investors will clearly need to be on their guard as the Regulation comes into force.
UK – buyer beware?
The UK government insists that changes introduced in 2018, and the more profound changes now being debated, bring its national interest merger control regime into line with approaches already in place in the U.S. and in key EU states, like Germany and France. But the extraordinary breadth of the proposals should be of real concern to investors.
The proposed new regime marks a radical departure from the past. Prior to June 2018, the UK government was able to intervene (on national security, financial stability and media plurality grounds) only where the turnover and market share jurisdictional thresholds used for competitionfocused merger control were met or the transaction fell into certain very narrowly-defined exceptional categories. In practice, these powers were used sparingly and intervention on national security grounds was limited to M&A deals with an obvious military or defence sector connection.
As an initial step last summer, the thresholds for jurisdiction were significantly lowered in three specific areas where the government believes even low value transactions could raise national security concerns: computer processing units, quantum technologies and military or dual-use technologies. These powers were used for the first time within a week of their introduction to UK law, with the government intervening in the proposed acquisition by Chinese-owned Gardner Aerospace of Northern Aerospace.
Changes now being consulted on by the UK government would create a new national interest merger control regime which would not only apply to all sectors of the economy, but would also permit intervention in any transaction regardless of the parties' revenues or market shares, provided only that the government has a reasonable suspicion that it constitutes a "trigger event". This is a broad concept designed to catch a wide range of transactions from full acquisitions of companies, to minority stakes that bestow "significant influence or control", to bare acquisitions of assets such as IP or land. Even the making of a loan could be caught.
It will be up to investors to decide whether to notify the government of a deal that might raise national security concerns (the UK government appears to have shelved earlier proposals to introduce a mandatory national security notification regime). But making that call can be trickier here than in other areas of merger control. Competition authorities tend to be transparent and apply economic principles that should generally produce predictable outcomes. Where national security is concerned, that is rarely the case. Decisions are inherently political, and governments are reluctant to publicise the substance of national security concerns for obvious reasons. That makes it hard to determine where issues might lie or to propose remedies.
The UK government has stated that it expects to conduct 100 in-depth national security reviews per year and impose remedies in 50 of these cases. To give a sense of the scale of the proposed reforms, this compares to only eight national security interventions in the nearly 16-year period since the existing regime came into force in June 2003.
Despite a growing focus on screening across jurisdictions, direct action to block transactions remains relatively rare but it is certainly not a theoretical concern.
CFIUS has attracted particular attention in recent years with high-profile blocks of Chinese investments in the technology sector. Concerns to preserve the position of the U.S. relative to China in this area even led to the prohibition of the proposed Broadcom/Qualcomm merger, which involved a Singaporean acquirer. In addition to vigorous enforcement, new legislation in summer 2018 expanded CFIUS' reach in a number of ways, with CFIUS piloting mandatory notification of transactions involving "critical technology".
Germany, like France, has tightened controls in the last two years and, in 2018, for the first time issued a precautionary order prohibiting an acquisition involving investment in a company supplying the aerospace and nuclear industries. Once again the investor was Chinese, although one that had previously been cleared to invest in another German engineering firm. In Belgium, despite no formal FDI regime being in place at the time, an investment in the energy sector was blocked following a leaked intelligence service report expressing concerns about sharing technology.
Some regimes allow for public interest considerations to work the other way, permitting deals that would otherwise have fallen foul of competition rules to proceed. This is exceptional for example, during the financial crisis, the UK government permitted the acquisition by Lloyds of HBOS on the grounds that it would promote financial stability, notwithstanding concerns raised on competition grounds.
In a fascinating twist to the national interest debate, recent weeks have seen suggestions that could allow merger control rules to be overridden in pursuit of a new goal. Following the Commission's decision to block the Siemens/Alstom rail merger, France and Germany are tabling proposals to change EU competition rules to allow the formation of EU-wide champions, including through a right of appeal to the Council that could lead to politicians overruling future Commission decisions. Europe, they argue, is at a competitive disadvantage to other countries, busily building their own champions. These suggestions are at a very early stage and it is too soon to tell where they will ultimately lead.
Investors should be in no doubt, the clear trend is towards an increased ability for governments to intervene, impose remedies and potentially prohibit deals on national interest grounds across a wider range of sectors and transaction structures. Careful analysis of national interestfocused screening of mergers and acquisitions will therefore be increasingly important in planning regulatory clearance strategies and allocating execution risk.