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Aerial view of winding roads
Aerial view of winding roads

Evolving foreign direct investment regimes add yet more hurdles for M&A

Navigating the international foreign direct investment (FDI) landscape is becoming ever more complex. In 2022 we saw a proliferation of new FDI regimes, a stream of revisions to existing rules and unprecedented levels of enforcement. 

Of the jurisdictions surveyed, 23 of 26 have an FDI regime in place. Across the globe, over 100 jurisdictions now have some form of investment screening rules.

Last year we saw governments continuing to use FDI rules to intervene in transactions, in particular targeting semiconductor and critical infrastructure deals.

Rules and enforcement practices are evolving rapidly. The scope and focus of regimes varies widely and there is often a lack of transparency over jurisdictional tests, processes and substantive concerns. Considering FDI early in the transaction process is therefore vital. A clear global FDI analysis and filing strategy will help to assess risk and ensure consistency of notifications.

UK national security screening regime makes an impact

The UK’s National Security and Investment Act is now one year old and having a significant impact on deal making.

Five deals were prohibited under the regime in 2022.

One of the most high-profile was the acquisition of the UK’s largest semiconductor plant by Chinese-owned technology company Nexperia BV. This marked the first time that the UK government blocked a transaction using its powers to retrospectively review deals that completed before the rules took effect. It has since done the same in a second deal.

Nine other transactions were cleared subject to conditions.

More broadly, there remains uncertainty over many aspects of the regime. The scope and application of the 17 sensitive sectors (which trigger mandatory notification) are often hard to determine. There is a particular lack of transparency and dialogue in the review process.

What is clear, however, is that parties to any deal with a UK nexus – even one that does not obviously raise national security concerns – should consider very carefully the possible application of the regime.

Elsewhere governments intervene in M&A

In addition to UK enforcement activity, we saw a stream of government intervention under FDI rules throughout 2022.

In Germany, for example, the government blocked two Chinese investments in the semiconductor sector, as well as a completed deal in the medical sector. In a port acquisition case, the Ministry restricted the Chinese investor to a 24.9% stake. GlobalWafers was forced to abandon its purchase of Siltronic after failing to get German FDI clearance within the deal deadline.

Deals in the defence, energy and robotics sectors were blocked following FDI scrutiny in Italy.

Across the Atlantic, the Committee on Foreign Investment in the United States (CFIUS) recently required a global technology provider with offices in China to fully divest its ownership interests and rights in a U.S. solar energy storage supplier. The Canadian government ordered the divestiture of three separate Chinese investments in Canadian critical mineral companies.

Remedies/conditions are (sometimes) more predictable

While concerns under FDI regimes can be extremely wide-ranging, some issues arise frequently. Access to sensitive information, IP or sites and/or the need to maintain national capabilities are often cited by governments when intervening in transactions.

In such cases, the remedies required to address the concerns are relatively well established. They include information barriers, appointment of government representation on the board and commitments to maintain national activities/capabilities.

This gives a welcome degree of predictability for merging parties. However, parties should not get too comfortable. With the introduction of new FDI rules and an evolution of approach in many existing regimes, the emergence of new concerns, or at least different ways of addressing common issues, cannot be ruled out.

For example, last summer we saw the UK government impose novel conditions in its approval of Cobham/Ultra. The government took “step-in rights” (similar to a golden share) enabling the transfer of ownership of the target business on national security grounds, either to a third party or to the UK government itself.

Regimes continue to appear in the EU

At EU level, the European Commission (EC) is still encouraging Member States to adopt and adapt national screening mechanisms to ensure the collective security of the EU and its Member States. It has named and shamed those that have not done so.

­18 Member States now have an FDI regime in place and several more have new or revised rules in progress. The Netherlands, for example, adopted a revised screening bill in April, which is set to take effect in the first half of 2023. New rules will enter into force in Slovakia in March and in Belgium in July. In Ireland, too, we expect a new regime to commence in the coming year.

The EU FDI Regulation, which ensures that the EC and Member States are informed of all FDI notifications made in the bloc, continues to prompt merging parties to make precautionary filings across Member States.

Finally, adding yet another layer of regulatory scrutiny and complexity to deal making in the EU, a new foreign subsidies regime will take effect in July 2023. Find out more below.

CFIUS guidelines suggest uptick in enforcement action

In October 2022, CFIUS published its first ever enforcement and penalty guidelines. Violations of the mandatory filing requirement (such as failure to file or submission of incorrect information) or breaches of CFIUS mitigation agreements can result in heavy penalties – up to USD250,000 or the value of the transaction, whichever is higher. We expect CFIUS to pursue more enforcement action going forward.

In other developments, CFIUS continues to use its powers to require parties to agree to mitigation measures to address perceived national security risks posed by proposed transactions.

CFIUS is also increasingly monitoring non-notified transactions and contacting parties that have not submitted a filing to inquire about the circumstances of deals and, in some cases, to request or even demand a notification.

A recent Biden executive order may result in even closer CFIUS scrutiny for certain transactions. The order introduced an expanded range of national security factors that CFIUS must consider when evaluating inbound investments into the U.S. These factors include the effect of the deal on the resilience of critical U.S. supply chains or on U.S. technological leadership, industry investment trends, cybersecurity risks and risks to U.S. persons’ sensitive data.

EU foreign subsidies regime adds to deal risk and administrative burden

The Foreign Subsidies Regulation (FSR) aims to regulate subsidies granted by non-EU countries so that they do not distort competition in the EU internal market.

Significantly, the new rules impose mandatory notification requirements for transactions. From 12 October 2023, companies must notify the EC if at least one of the merging parties, the target or the joint venture is established in the EU and has an EU turnover of at least EUR500m, and the parties received combined "financial contributions" from non-EU countries of more than EUR50m in the three calendar years prior to notification.

The definition of financial contribution is deliberately wide. Transfer of funds or liabilities, the foregoing of revenue that is due (eg non‑ordinary course tax benefits), or the purchase of goods and/or services by public authorities of a third country could all fall within scope.

The EC can block deals or accept remedies. Failure to notify can result in fines of up to 10% of turnover.

The EC also has the power, on its own initiative, to investigate suspected distortive foreign subsidies. This could include requesting notifications of transactions falling below the notification thresholds.

The FSR will operate alongside existing merger control and foreign investment control regimes, adding an additional filing and review requirement for acquisitions falling within its scope.

In order to ensure compliance, businesses will need to carefully monitor any foreign contributions received in the preceding three years, a task which could be particularly burdensome for investors with multiple portfolio companies.

There is considerable uncertainty about how the FSR will work in practice and how the thresholds for notification will be applied. We should get more clarity as the regime starts to operate.

The EU is not the only jurisdiction focused on policing foreign subsidies in M&A.

In the U.S., recently passed legislation will, once implemented, require merging parties to disclose the involvement of certain “foreign entities of concern” in the transaction or its funding. This includes entities controlled by the governments in China, Russia, Iran and North Korea. We will keep a close watch on whether other similar developments emerge across the globe.

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