2020 was a trying year for dealmakers and cross-border M&A. Foreign direct investment ("FDI") has been one of the more notable casualties in the pandemic. Companies are approaching transactions with greater caution, and dealmakers have been reassessing investment decisions, particularly where they involve other countries.
At the same time, there has been a general trend towards greater FDI regulation in some places. The Committee on Foreign Investment in the United States, or CFIUS, continues to see its jurisdiction expand and its funding increase. In the EU, a regulation and mechanisms have been introduced that apply directly in member states and that allow one member state to make submissions where foreign investments in another member state are likely to have an impact on national security in that member state. While Asia and, in particular, Southeast Asia seem to be bucking the trend and continue to attract FDI from China and Japan, the pandemic is expected to suppress some of that early promise.
In France, Germany and the United Kingdom, we are seeing a growing emphasis on investment control and, consequently, a need to navigate related legal and regulatory challenges.
Since its introduction in 2005, the FDI regime in France has expanded and developed apace, especially in relation to sensitive sectors and in respect of transactions and investors falling within the scope of the regime. The evolution of the French FDI regime has often echoed wider economic or technical developments, e.g. the inclusion of artificial intelligence and cloud computing in the list of relevant sectors in 2018. Several changes to the regime were implemented following major foreign investments in the country, e.g. the acquisition of Alstom by General Electric in 2014. Decisions have also often had a political component, as in the proposed takeover of supermarket chain Carrefour by the Canadian group Couche-Tard. The Ministry of Economy and Finance rejected it in January 2021, even before a formal filing for approval had been made.
The French FDI regime was fully reformed in 2019, consolidating the amendments made since 2005, as well as additional modifications recently introduced in response to the Covid-19 pandemic. The key aspects of the reformed regime are set out below.
First, the former distinction between EU and non-EU foreign investors (whether persons or entities) was abolished and entities in the chain of control included in the definition. This amendment, together with the requirement that investors disclose any interest held by or financial support received from a state outside of the EU or its agencies in the preceding five years, have significantly increased the information to be provided in an FDI filing.
Second, the reform harmonised the list of transactions that qualify as investments under the regulation. These are 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. Since the pandemic, the threshold was temporarily lowered to 10% for listed companies until the end of 2021, thereby mirroring the applicable rules in Germany and Spain.
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, goods and services in ten economic sectors considered vital to the national interest. Research and development activities in critical sectors are on the list as is the biotechnology sector which was added during the pandemic.
Unlike the rules for merger control filings and similar to the reforms proposed 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.
The decisions of the Ministry on FDI filings are not made public. When reviewing a request for approval, the Ministry may require the investor to make certain commitments, including reporting, operations, or divestments. Such commitments can be negotiated with the Ministry, therefore, outright refusals are rare. 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 Ministry 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. In light of the continuous move towards greater protectionism, thorough preparation and anticipation of FDI restrictions are key for the success of transactions in any of the protected sectors.
Recent amendments to German foreign trade laws (the Foreign Trade and Payments Act (Außenwirtschaftsgesetz, "AWG") as well as the Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung, "AWV") have imposed on foreign investors a new layer of bureaucratic requirements and restrictions. In general, under the new rules, if a foreign investor directly or indirectly acquires at least 10% of the voting rights in a German company, the Federal Ministry of Economics may determine the acquisition to represent a threat to public order and security and, if necessary, restrict or prohibit the acquisition.
The main changes to the AWG and AWV introduce a significantly broader screening standard. The key question now 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 Ministry 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 approval is obtained.
Like its counterparts in France and the UK, German government introduced new FDI restrictions in response to the pandemic. The 15th regulation amending the AWV is directed at the healthcare sector, introducing 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.
To safeguard German know-how and technology in critical areas, the Ministry has also proposed an updated regulation which will either further restrict investment in the areas of artificial intelligence, robotics, biotechnology and quantum technology or extend the scope of investment control to these areas.
The extended scope of regulation and the need to consider EU interests are likely to have significant impacts on FDI in this country. We expect the changes in German foreign trade law to lead to longer examination phases of up to several months to account for EU considerations. This is likely to have a deterrent effect on FDI transactions as investors consider the pros and cons of investing in Germany (and other EU countries). Some commentators suggest that there will be a slight decline of about 6.6% in FDI volumes for 2020 (from EUR 64.7 billion in 2019), but the effect of the new regulations, as well as the government's efforts to promote the country as an investment-friendly jurisdiction, remain to be seen.
Given the new legal standards for FDI transactions, dealmakers should plan ahead, conduct any appropriate risk analyses and prepare to engage with the EU Commission and other EU member states. For M&A transactions, parties will have to examine closely the reporting obligations under foreign trade law and whether the transaction should be reported or an application made for a clearance certificate. Parties may also wish to consider the inclusion of a condition precedent in the transaction documents that the Ministry approves the transaction. Contractual amendments to account for the possibly more intensive and longer examination of the acquisition by the authorities might also be a good idea.
The United Kingdom remains one of the top destinations for FDI globally and has historically shied away from policing FDI in the way that some other countries have. Indeed, existing FDI controls have been addressed as part of the UK's voluntary merger control regime for years. The UK government has the power to intervene in transactions on certain specified public interest grounds.
In November last year, the government published draft legislation to reform the current FDI screening regime, introducing a framework similar to CFIUS and closer to those adopted in France and Germany. These measures are expected to give the government increased powers to block, impose conditions to, delay the closing of, or unwind FDI transactions, including joint ventures, in 17 key sectors, including communications, defence, data, energy, transport, artificial intelligence, computing hardware and robotics.
The National and Security Investment Bill introduces a broad package of reforms to the existing FDI framework. The Bill contemplates a hybrid system of mandatory and voluntary notifications. The former would apply when a transaction occurs in relation to any of the 17 key sectors. The latter would be deployed when parties observe any defined "trigger event" which may be of interest from a national security perspective. 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. As with the FDI regulations in France, the Bill envisages that certain transactions would, regardless of market share or sales thresholds, fall within the scope of review.
The lack of safe harbours and the danger of having completed transactions being unwound means that a greater number of transactions are now susceptible to either intervention or pre-emptive and voluntary notification. Failure to make notifications where required will void a transaction. Non-compliance could attract fines of up to 5% of worldwide turnover or £10 million (whichever is higher) and up to five years imprisonment for directors.
Whilst seeking to maintain its reputation for being open for business, the UK is clearly moving towards engagement with FDI on levels and in ways more akin to its US and European counterparts. Dealmakers and companies looking to invest in British companies, particularly in the sectors described above, will need to focus on early due diligence, careful transaction structuring and pre-emptive engagement with advisers and the government.
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. We expect issues like persons with significant control or influence, board rights, director appointments, shareholder voting rights, and reserved matters to come to the fore. 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.
These developments reflect the general approach taken in other countries as part of a global trend towards greater protectionism. Despite the role that FDI could play in supporting business and economic recovery, we are likely to see increasing government intervention in areas of strategic value and sensitivity. We believe these new FDI regimes will survive and continue to be relevant regardless of COVID-19 and any near-term outcomes. Investors and dealmakers would be well-advised to plan their transactions accordingly, particularly where there are concerns around the identity of the acquiring or investing entity or where the target operates in a sector of national or strategic importance.
Previously published in The World Financial Review.
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