"The bravest are surely those who have the
clearest vision of what is before them, glory and danger alike, and
yet notwithstanding, go out and meet
Thucydides, History of the Peloponnesian War
To say we live in uncertain times is an understatement. A new epoch is upon us – where national security prevails over economics.
At the apex of an extraordinary confluence of events comprising the rise of China, the Fourth Industrial Revolution, global supply chain instability and net zero transitions, industrial policy is in the ascendency and the great homecoming is accelerating. The re-mooring of the national interest means business will be forced to make choices about with whom they do deals, particularly in strategic sectors. Patriotic capitalism is problematic – but a growing inevitability.
Those with the clearest vision as to what is before them will be in the best position to address the challenges and capitalise on the opportunity.
Key trends in foreign investment regulation
The key trends for foreign investment regulation in 2024 will be:
- Lock step. The Five Eyes members cooperate by
exchanging information on foreign investment activities and
encouraging the coordination of foreign investment screening
We expect the ongoing international convergence of foreign investment regulation and increased sharing of information about vulnerabilities in foreign investment between the Five Eyes with the Five Eyes moving in lock step.
Following a review of the Australian and New Zealand regulations, the proposed expansion of of the scope of CFIUS to review real estate transactions associated with national security-related facilities is a case in point. With the US and Canada in particular having demonstrated greater intervention in the critical minerals space, we can expect that sector to have a heightened focus in Australia.
While for the majority of acquisitions foreign investment approval will be a process, investments in critical supply chains, digitalisation, infrastructure and decarbonisation will be the subject of heightened interest from security services and accordingly long review periods.
- Friend-shoring. Although certain acquirers
from China have tended to bear the brunt of prohibition decisions
under foreign investment regimes in the past, they are no longer
the sole focus. Bidders and targets alike will need to choose their
friends wisely in an increasingly fragmented world.
It is just over a year since the US Treasury secretary launched a new buzz word, 'friend-shoring', an industrial policy of building redundancies and resilience in supply chains both at home and in "friendly" destinations to reduce the impact of potential conflict and economic coercion.
But friend-shoring is more than statements of intent – the numbers are in, with IMF economists concluding that foreign direct investment data are splintering between politically aligned blocs and the trend of geoeconomic fragmentation is accelerating.
- National security prevails over economics.
Consistent with global trends, we expect to see a continued primacy
of national security over economics and the ongoing imposition of
conditions on most transactions and a more bespoke application of
the framing of those conditions.
The statistics in the latest FIRB Quarterly Report support this position with conditions imposed on 122 of the 297 applications for the April to June quarter and 72% of applications year to date including the imposition of conditions.Transactions involving sensitive technology, including semiconductor development and production, and energy, continue to be seen as posing higher risk. We also expect to see an ongoing focus on compliance and an increased risk of enforcement action.
- Foreign investment laws provide the
'in'. We expect the ongoing use of foreign
investment laws by consult agencies to gain greater access to
information and an opportunity to impose conditions under a more
flexible legislative regime.
Bidders will need to have information to hand as part of the foreign investment process to address, at least, competition and tax requests for additional information.
- The impact of filing fees in 'borderline' transactions. The steady escalation of filing fees for FIRB is becoming an issue for some bidders, especially in transactions involving multiple bidders where the seller's expectation is that FIRB applications will be lodged by multiple bidders at an early stage in the process (to avoid delays in completion). We have seen this issue "frightening" offshore bidders from being involved in the process.
- Evolving FIRB conditions. We expect to see
evolving market practice on formulation of FIRB conditions from
'acting reasonably' to specifying types of conditions and
acceptance of those conditions, including if previously accepted by
the bidder, with a material adverse impact carve out on the
bidder's governance of the operation of the business.
In a dynamic geopolitical paradigm, these modifications will become increasingly common (particularly for sensitive targets or bidders which may be sensitive) and reflect a compromise to bridge the gap for the bidder (concerned about the unpredictability of geopolitics and the response of regulators) and the target not wanting to take regulatory completion risk, particularly where no reverse break fee is otherwise forthcoming.
The key areas of focus
In September 2022, President Biden issued Executive Order 14083 reflecting the evolving national security threat landscape and underscoring the critical role of the Committee on Foreign Investment in the United States in responding to new and emerging threats and vulnerabilities in the context of foreign investment. The Executive Order – the first of its kind since the inception of CFIUS – elaborates and expands on the existing list of factors that CFIUS is to consider when reviewing transactions for national security risks.
The factors identified in the order are similarly concerns of the Australian foreign investment regime and we expect the focus in the coming year to be on:
- Supply chains. Reflecting the rise of
friend-shoring, the security and resilience of supply chains
relating to manufacturing, artificial intelligence, critical
mineral and material resources, advanced clean energy and climate
adaptation technologies, microelectronics and other key sectors
relevant to key supply chains will be a focus.
In a new policy paper – Raw Materials for the Green Transition: Production, International Trade and Export Restrictions issued by the OECD in April of this year, the OECD noted that over the last decade, export restrictions on critical minerals have increased more than fivefold. From January 2009 to December 2020, the total number of export controls on industrial raw materials surged to 18,263 from 3,337. Now roughly 10% of the global value of critical raw material exports face at least one export restriction measure.
In October 2022 the Canadian Government Guidance that applications for acquisitions of control of a Canadian business involving critical minerals will only be approved on an exceptional basis. The Guidance noted that the participation of foreign state-owned enterprises (SOEs) or entities linked to or subject to influence by hostile or non-likeminded regimes or states will support a finding that there are reasonable grounds to believe the investment poses a threat to national security. Following the policy guidance, the Canadian Government ordered three Chinese SOEs to divest their investments in Canadian listed critical minerals companies. The stakes held by these Chinese SOEs was not necessarily high and the mines were not necessarily Canadian. The Minister of Innovation, Science and Industry, François-Philippe Champagne, stated "[these] investments pose a threat to our national security and critical mineral supply chains". In the same month Australia said it will more assertively review whether foreign investment proposals are in the national interest, particularly critical minerals investments.
In March 2023 British MP Alexander Stafford, vice-chair of an all-party parliamentary group on critical minerals stated "[The UK should] follow the example set by the US and, more recently, Canada in limiting foreign investment in UK critical mineral activities...we already have the legislative powers to [limit foreign investment] under the National Security and Investment Act; all that remains is to use these powers to ensure investment primarily from Five Eyes countries".
In July of this year the Treasurer issued a prohibition order to block the takeover of lithium miner Alita Resources by a China-linked company.
The Five Eyes convergence shows foreign investment regulators are increasingly concerned to ensure that critical minerals and their processing remains onshore or within friendly shores and owned by like-minded investors. We would not be surprised to see the next focus of these agencies to be on off-take arrangements especially where facilities have long term arrangements for supply to non-Five Eyes destinations.
- Cumulative effects of multiple transactions.
Anti-trust and national security are increasingly tied
Australia's foreign investment policy which sets out the national interest was recently updated to note that the Government may also consider the impact that a proposed investment has on the make-up of the relevant global industry, particularly where concentration could lead to distortions to competitive market outcomes. A particular concern is the extent to which an investment may allow an investor to control the global supply of a product or service. This harks back to the proposed acquisition of Ashton Mining by de Beers in 2000.
Acquisitions by the same bidder, or related parties within the same sector or involving similar technologies, particularly in certain sensitive sectors or technologies, can expect greater scrutiny even where the particular transaction under review may not give rise to national security concerns when considered by itself.
Considerations include the degree of diversification through alternative suppliers across the supply chain, including suppliers located in allied or partner countries, supply relationships and the concentration of ownership or control by the foreign person in a supply chain.
China supplies about 80% of the world's separated rare earth elements, giving it a hold on an industry that is essential for defence applications like drones and decarbonisation equipment like wind turbines. Following decisions in 2020 prohibiting investments in Australian-listed rare earths companies, the Treasurer prohibited the Yuxiao Fund from increasing its stake in Northern Minerals from 10% to 19.9% on the basis it is "consistent with other decisions taken by other governments in the past".
Expect greater consideration of the impact of an investment on global supply from the perspective of the Five Eyes.
- Tech, cybersecurity and sensitive data. A
strengthening of Australia's high-tech ecosystem in support of
advanced capabilities will be fundamental to the success of AUKUS
and investment in that ecosystem and its adjacencies is likely to
attract more attention.
Whether a transaction could result in the exploitation of information in a manner that 'threatens national security' will remain a focus with the concept of what constitutes sensitive data continuing to expand.
With the ongoing Government and regulator concerns with cybersecurity following high profile attacks, along with fears of coercion, we expect to see the ongoing imposition of conditions on bidders relating to data including:
- requirements to implement enhanced security controls to protect sensitive information and technology from unauthorised access;
- requirements that certain key personnel or Board members hold particular security clearances; and
- restrictions on the sharing of certain information.
What it means for M&A – choose your friends wisely
The problem, as Lord Palmerston keenly observed in 1848, is that states "have no eternal allies and... no perpetual enemies".
How do you assess with any certainty what constitutes a friend? The Russian invasion of Ukraine demonstrated, if nothing else, the need for 'what if' scenarios to be particularly imaginative.
With lines in the sand drawn, choosing your friends wisely becomes increasingly important.
Joint bids might present bidders with flexibility to manage the optics of a bidder who may be considered non-likeminded. A consortium can be used to manage potential foreign investment approval issues through using the consortium structure to manage the economics and governance arrangements.
Bidders, including PE, should be mindful of the increasing requests for information from FIRB about the truly passive nature of investors. Consistent with the CFIUS announcement in May of this year that CFIUS has the authority to make inquiries "with respect to all foreign investors that are involved, directly or indirectly, in a transaction, including limited partners in an investment fund" and "with respect to any governance rights and other contractual rights that investors collectively or individually may have in an indirect or direct acquirer", FIRB is increasingly requesting information about governance and contractual rights of investors in funds.
To allay concerns about regulatory risk, foreign bidders may be more likely to have to offer ticking fees to manage delays to implementation as a result of any drawn-out regulatory approvals process. For example, the Brookfield Origin Scheme includes a 4.5 cents per month ticking fee, accruing on a daily basis, will be payable if implementation of the Scheme is delayed beyond 30 November 2023.
Know your bidder
One of the issues a target board will need to consider when assessing a bid by a foreigner is FIRB completion risk – this will be particularly important in contested takeovers. This task is all the more complex in a world of geoeconomic fragmentation, and where who constitutes a friend is not necessarily straightforward.
With Five Eyes focus on ultimate beneficial owners, it is increasingly important for target boards to interrogate a bidder's upstream investors and any other sources of equity that will fund the bid. A failure by a bidder to provide sufficient information to enable a target board to effectively assess FIRB risk could result in challenges to the adequacy of disclosure as a tactic to challenge the merits of a bidder's offer or in challenging a competitor's offer.
Target boards may look to additional contractual protections in the implementation deed to address the later introduction of investors in a bid structure (increasingly common for private equity bids with further syndication) that may impact the FIRB risk of the transaction.
We expect target boards to increasingly require FIRB conditions which provide further guidance about what constitutes a bidder acting reasonably in accepting FIRB conditions to include matters relating to:
- notification of operational and ownership changes;
- restrictions on access to sites and data; and
- operational involvement of investors.
While signalling to FIRB the conditions a bidder is essentially willing to accept may be of concern to the bidder, from a target board's perspective, a rapidly evolving foreign investment environment means certainty about what conditions a bidder will accept will be important.
Reverse break fees
Reverse break fees have been becoming an increasing feature of this market. Could this extend to the risk of 'regulatory failure'?
This year BHP agreed to pay an A$95 million or 1% of the equity value reverse break fee to OZ Minerals if it failed to obtain certain regulatory approvals required for the transaction (albeit Brazilian and Vietnamese competition approvals).
With the growing focus on foreign investment approvals and the heightened scrutiny, we expect to see reverse break fees relating to regulatory conditions having a greater prominence in negotiations, particularly where the bidder is from or has investors from a politically sensitive region or where the target operates in a sensitive sector.
While the reverse break fee for Newcrest and Newmont was extraordinary, we expect the quantum to mirror bidder break fees, i.e. 1%.
We expect to see the evolution as to what is market for a FIRB condition, from the standard formulation of 'the bidder acting reasonably in the acceptance of conditions' (which may include a reference to standard tax conditions and, in more sensitive deals, a side letter of agreed conditions) to a FIRB condition which:
- specifies types of conditions which must be accepted e.g. PE tax conditions, governance including Australian directors, residency, headquarters and security clearances, and data and access conditions;
- requires acceptance of conditions previously accepted by a bidder (particularly relevant for repeat FIRB customers); and
- with a material adverse impact carve out.
The broad construction of conditions as types and the move from the reliance on side letters reflects the lack of standard conditions as FIRB's practice evolves and the growing unpredictability as to conditions which may be imposed as the geopolitical paradigm moves at pace.
The simultaneous takeover of lithium exploration company Azure Minerals Limited by Chilean firm SQM is a case in point, with a FIRB condition of the bidder obtaining FIRB approval either unconditionally or subject only to standard tax conditions and conditions that SQM or its Affiliates has had imposed in relation to prior notifications under the and/or conditions which would not reasonably be expected to result in an adverse material financial impact on the value SQM could reasonably expect to derive from the Scheme.
The concern of bidders about hell or high-water formulations suggested by targets in US deals is equally seeing material adverse effect carveouts and/or that mitigants are not inconsistent with mitigants previously imposed by CFIUS.
Protect your capital
Foreign investment regulation will also need to be considered as part of any capital raise where even small holdings in a company by non-likeminded investors may pose risks for a company to access Australian Government approvals.
Boards will need to do what they can to ensure a company's shareholder make up does not impact on its ability to transact in Australia or elsewhere. For example, it is unclear whether Commonwealth agencies like Export Finance Australia would be willing to fund a rare earths miner that plans to sell most of its product to China at a time when billions of taxpayer dollars are being spent developing a non-Chinese supply chain for rare earths.
A listed entity may prescribe ownership or control of its securities in its constitution with the agreement of the ASX. Drafting changes to a constitution, which enables sufficient liquidity for existing and future capital, while giving the company sufficient flexibility, will need to be a careful exercise which supports the interests of the stakeholders as a whole. If pursued, a careful and considered narrative which demonstrates the imperative of any change will be important to securing both stakeholder and ASX support.
It remains essential that the application of the foreign investment regime is taken into account in deal planning and execution.
Appreciating the politics, respecting the process and having a clear strategy to proactively manage concerns will be critical to M&A in 2024.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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