Herbert Smith Freehills on foreign investment

Recent years have seen global shifts in both policy frameworks for screening inward foreign direct investment (FDI) and the way in which those frameworks are applied. The result is a more uncertain environment for foreign investment, which parties to a transaction will have to consider how to navigate earlier in the transaction process.

Veronica Roberts, Partner, Herbert Smith Freehills
An increasing number of transactions are being blocked by governments around the world. Why is that?

Some jurisdictions have always been reluctant to let overseas companies acquire their domestic businesses. However, even in jurisdictions that have traditionally been more open to foreign investment, governments are becoming more interventionist.

This change in more open jurisdictions comes against a backdrop of protectionist political and media forces and, more particularly but not exclusively, concerns about investments by China. The focus of Chinese outbound investment has moved from a focus on natural resources to a broader range of sectors, including critical infrastructure, such as utilities, and high-tech industries. This shift has raised national security concerns in many jurisdictions.

There is also a degree of discontent that companies wishing to move into China are sometimes denied equal rights and it is possible that, by taking action against Chinese companies investing in their home jurisdiction, governments may also be trying to make China reconsider its own policies.

Finally, governmental concerns are not confined to national security but extend to wider issues such as the acquirer’s intentions for the target, including any impact on employment and the economy, as well as any important research and development activities being carried out by the target.

Alex Kay, Partner, Herbert Smith Freehills

The US is a prime example of a jurisdiction where a number of transactions have recently been blocked. CFIUS (the Committee on Foreign Investment in the United States) reviews transactions that could result in control of a US business by a foreign person; its role is to assess the effect of such transactions on the national security of the US and make recommendations to the US president as to enforcement action. We have seen CFIUS intervene in more transactions recently. In line with wider global trends, these have not been confined to transactions which raise traditional national security concerns but include Canyon Bridge’s proposed acquisition of Lattice Semiconductor and Ant Financial’s proposed acquisition of MoneyGram, where the concerns were around access to technology and data.


However, the trend is not confined to the US. For example, in the UK, the government intervened in the acquisition of Sepura by Hytera Communications. Sepura provides the radio devices used by the emergency services in the UK. The government accepted statutory undertakings rather than blocking the transaction entirely; the undertakings given are designed to provide assurance that sensitive information and technology is protected and to ensure UK capability in servicing and maintaining the radio devices. It has also issued an intervention notice in connection with the proposed acquisition of Northern Aerospace by Gardner Aerospace, a subsidiary of Shaanxi Ligeance Mineral Resources.

The Canadian government has also recently blocked the sale of Canadian construction company Aecon Group to Chinese interests, citing national security concerns.

What powers do governments have to intervene?

The power to intervene inevitably varies from jurisdiction to jurisdiction but national security is well established as the key justification for public interest intervention. However, as technology evolves, national security is no longer confined to conventional forms of defence but is extending to critical infrastructure and technology.

In the UK, under the Enterprise Act, the government can intervene on the grounds of national security, media plurality/standards and financial stability.

For transactions falling within the jurisdictional scope of the EU Merger Regulation (EUMR), the scope for intervention is limited to protecting public security, media plurality and prudential rules (further interests may be invoked, but only with the consent of the European Commission).

Where a transaction meets the criteria for intervention, rather than blocking an acquisition outright, governments may seek undertakings to address the specific concerns. This was done on the acquisition of Sepura by Hytera (discussed above). The post-offer undertakings regime in the UK Takeover Code has also been used to address political concerns – for example on the takeover of ARM Holdings by SoftBank in 2016, SoftBank undertook to keep the ARM headquarters in the UK and to double the employee headcount in the UK.

It is now relatively commonplace for acquirers to give commitments on a transaction, for example in relation to domestic investment or employment. This was seen when the Italian ship maker Fincantieri took a 51% stake in French shipbuilder STX in 2017. Having initially resisted the transaction, the French government loaned a 1% stake in STX, which gave Fincantieri control of STX. The French government has however retained the option to take back that 1% stake, and therefore control, if Fincantieri fails to meet the commitments it has given, including in relation to the protection of jobs.

Caroline Rae, Partner, Herbert Smith Freehills

In France, acquirers in a wide range of sectors, impacting on the ‘integrity, security, and continuity of supply’ in the energy, water, defence, transport and communications sectors, must consult with the government on their intentions and receive a formal blessing. This obligation to consult seeks to avoid breaching EU law by simply requiring that an acquirer engages and seeks authorisation from the French state on the basis of protecting its legitimate interests and gives the French authorities significant power when it comes to scrutinising a transaction and securing commitments from the parties as part of that process.

In Australia, there have been a number of recent high-profile prohibitions under the Foreign Acquisitions and Takeovers Act 1975, such as proposed Chinese investments in a cattle business, S. Kidman and Co, and in an electricity distribution company, Ausgrid.

What steps are being taken to extend governments’ powers to intervene?

We are seeing a range of actions being taken in various countries to extend governments’ power to intervene in transactions that raise national security concerns.

In the UK, the government has lowered the thresholds at which it can intervene for transactions in certain sectors. The sectors that are subject to the new thresholds are: the development or production of items for military, or military and civilian, use; the development and production of quantum technology; and the design and maintenance of aspects of computing hardware.

Transactions generally fall within the jurisdictional scope of the Enterprise Act 2002 where the target’s UK turnover exceeds £70m and/or the transaction will create or enhance a share of supply in the UK of 25% or more. For transactions involving companies in these three sectors, however, the thresholds were lowered, with effect from 11 June 2018, so that the regime applies to transactions in those sectors where the UK turnover exceeds £1m; or one or both of the companies has a 25% or more share of supply of the relevant goods/services in the UK (ie there need not be an increase in the share of supply as a result of the merger).

The UK government has also consulted on more substantive longer-term reforms, including a possible mandatory notification regime and extending the current grounds for national security interventions to a wider category of transactions. The sectors that could fall within this wider regime include civil nuclear, telecommunications, defence, energy and transport. There are no detailed proposals relating to these options at this stage and the government will publish further proposals in due course.

Proposals to expand the CFIUS mandate in the US are also currently under consideration. As in the UK, the balance they are endeavouring to strike is between remaining open to foreign direct investment while protecting against new technologies and risks.

The EU Commission has also unveiled a set of proposals for the screening of foreign direct investments into the EU. The Commission says that, while it recognises the benefits of foreign direct investment and its importance for growth, jobs and innovation in the EU, it also wants to be in a position to take action where foreign investment may affect security or public order. The proposals are set out in a draft Regulation, which establishes a general framework with which any national screening mechanisms of member states will need to comply. The proposed Regulation does not require member states to adopt or maintain a screening mechanism, but aims to ensure that any existing or proposed mechanisms comply with a set of minimum requirements. The Commission will also carry out a detailed analysis of foreign investment flows into the EU and establish a co-ordination group with member states, in order to identify joint strategic concerns and consider possible solutions in the area of foreign direct investment.

There are also reports that Germany’s federal ministry for economic affairs and energy is concerned about Chinese takeovers of German high-tech companies and the resulting effects on employment in Germany. Minister Peter Altmaier is reportedly urging the EU to pass legislation before the end of the year to facilitate the examination of inward foreign direct investment. On a national level, Altmaier has reportedly ordered his ministry to look into whether the government’s right to veto non-welcome investments can be expanded, by tightening regulations that target in particular foreign investments in so-called ‘critical infrastructure’, and lowering the threshold for government intervention from the current 25% of the target’s equity capital to as low as 10%.

In France, the list of covered sectors and technologies in respect of which the government must be consulted is in the process of being expanded to cover artificial intelligence and data storage.

What should parties to a transaction do to address foreign investment controls?

Parties must consider early in a transaction whether it is likely to give rise to foreign investment issues and what the impact of any issues may be.

Given the trend for governments to intervene in a wider range of transactions and on broader grounds, it will not just be the obvious transactions that attract political interest. Acquisitions of businesses involved in critical infrastructure or technologies may raise concerns. As well as acquisitions of whole businesses, acquisitions of minority stakes could also give rise to issues, where those stakes confer a degree of control or influence over the target business.

Parties should establish whether there are mandatory filing or approval requirements (for example to CFIUS) and assess whether to make a notification under any voluntary regime. It can be useful, depending on the jurisdiction(s) involved, to make early contact with the relevant foreign investment authorities to start a dialogue about the purchaser’s rationale for the deal and, if appropriate, plans for the target business. Foreign investment decisions are not always published (CFIUS is the prime example of this) and so the detail of the specific objections that have arisen in previous cases is not always clear.

If there is a possibility that a transaction might give rise to issues, parties should also consider what actions they could take or commitments they could give to mitigate the risk of intervention. These could be structural (eg selling off part of the business acquired) and/or behavioural (these could include protecting the confidentiality of commercially sensitive information, committing to continue with certain research and development programmes, granting the relevant government access rights to assets, etc).

Transactions where extensive rationalisation or consolidation plans are proposed may also be subject to scrutiny – while these sorts of proposals may be attractive to investors, they are likely to cause concern among politicians. Governments may therefore seek commitments from the acquirer to address any concerns that they have.

Parties may also wish to consider measures to allocate FDI risks on a transaction, for example through the use of break fees or reverse break fees or providing that, where jurisdictions carry a high FDI risk, completion in those jurisdictions can be deferred or carved out from the transaction entirely.

It is vital to take a global approach to FDI issues, both in terms of contacts with the relevant investment authorities and positioning the rationale for the transaction with the media. We have seen examples in the past of foreign investment authorities apparently liaising with each other behind the scenes eg in 2016 the German government withdrew its informal approval of the Chinese acquisition (by Fujian Grand Chip) of German semiconductor company Aixtron, apparently after contacts with CFIUS.

We have published an interactive map on foreign investment regulation, from which you can request our country by country guide, which is available here: www.herbertsmithfreehills.com/our-expertise/services/foreign-investment-regulation.

Is this a temporary phase or a more permanent change?

Governments are balancing competing concerns, seeking to remain attractive to foreign investment while scrutinising where the investment is targeted and the terms on which it is made. This follows in part from changes in the global economy as well as the political mood. There is no suggestion that the current level of scrutiny is temporary and that attention will abate with time. In contrast, as technologies become ever more integral to our society and data ever more valuable, the focus on foreign direct investment is likely to stay and more than likely continue to increase.