The Impact of Foreign Investment Control on Cross-Border Transactions: Charting a Course in Uncertain Times

Over the last decade or so, EU Member States and other western governments have adopted new and stricter foreign direct investment (FDI) rules, resulting in ever-increasing legal uncertainty for parties contemplating cross-border transactions. The COVID-19 crisis has accelerated this trend and has resulted in strongly-worded official statements that have caused understandable concern to potential foreign investors.

In this Update we discuss the existing landscape, the impact of COVID-19, and a number of recent developments internationally with particular reference to Europe. We also refer to the practical impact of such measures and how foreign investors can best navigate the rapidly evolving landscape.

Background

While some Western countries – in particular the United States and Australia – have had strong foreign investment control regimes in place for many years, new regimes have proliferated in the last five to 10 years, particularly in Europe. Factors that have contributed to this increase include concerns about the high level of inward investment from countries such as China, in particular in strategically important sectors, and the practical limitations of existing competition law instruments, in particular merger control, as a means of addressing such concerns.

The role of industrial policy in merger control has been hotly debated since before the introduction of the EU merger control regime 30 years ago. While the EU Merger Regulation provides for the assessment of mergers on the basis of competition criteria alone – and most national systems of merger control in the European Union follow the same approach – there have always been vocal advocates of a regime that would permit the emergence of so-called European champions. The perennial debate resurfaced in high-profile recent cases before the COVID-19 crisis, such as Siemens/Alstom and thyssenkrupp/Tata). While the existing regime permits close scrutiny of proposed acquisitions by State-owned enterprises, by reference to their ultimate ownership or control, it does not provide a mechanism for intervention in respect of proposed acquisitions of strategically important businesses, outside the scope of certain narrow exceptions in particular concerning national security and "legitimate interests" notified by Member States to the European Commission (Commission).

In recent years, France, Germany and Italy in particular have led the way in adopting and implementing ever more restrictive FDI control regimes and advocating broader European rules. Those efforts culminated in the adoption of an EU Regulation¹ in March 2019, which established a framework for the screening of foreign investment into the European Union (the FDI Regulation). The FDI Regulation, which will apply from October 2020, does not introduce a new "one-stop-shop" review mechanism, akin to EU merger control. Instead it outlines minimum requirements for FDI review mechanisms and establishes an information-sharing system that allows Member States and the Commission to provide comments and non-binding opinions to the Member States in which the proposed investment will occur. So far, only 14 EU Member States have adopted FDI regimes and many of those are limited in scope (often being restricted to only a few industrial sectors), reflecting the absence of an EU-wide consensus on the need for such regimes.

The Impact of the COVID-19 Crisis

Proponents of foreign investment control (including in Europe) are typically concerned about the impact of domestic companies falling under foreign ownership, and the resulting loss or weakening of influence over decision making that could affect the future of the business in question. Such concerns are likely in turn to reflect fears about perceived risks to a country’s security or other aspects of the public interest, for example, in relation to national security, or a potential loss of key technologies, jobs or production capabilities if a foreign investor were to decide to move production abroad or produce exclusively or mainly for export markets.

While the main focus over the last decade has tended to be on the risks referred to above, the COVID-19 crisis has dramatically highlighted the lack of existing domestic production capability for certain critical products (such as medical equipment) in many countries.

A number of western governments therefore rapidly adopted additional measures to protect domestic companies. Those measures typically aim to mitigate, in particular, the effects of:

• Disruption to supply chains serving strategically important industries (in particular the healthcare sector) and shortages of supply of critical products; and
• A severe reduction in demand affecting other critical industries, leading in turn to falls in the valuations of companies and an increased risk of opportunistic takeovers by foreign investors.

Such measures typically subject the acquisition of domestic companies by foreign investors in a broad range of critical industries to further review and to the possibility of outright prohibition or other remedies.

An illustrative list of the measures adopted by several western governments over the past year or so (including those in response to COVID-19) can be found in the overview document here. A number of recent measures are outlined below:

European Union: On 25 March 2020, the Commission issued a Communication to the EU Member States (Communication) calling upon them to use all available tools to “avoid the loss of strategic assets and technology”, especially in relation to the healthcare sector. While reiterating that the responsibility for FDI screening rests with Member States, the Communication urges them to (i) use existing FDI review mechanisms, and (ii) establish fully-fledged review mechanisms, where these are not already in place. Until such review mechanisms are in place, or where certain investments do not qualify as FDI (for example in the case of minority interests that do not confer effective influence over the management and control of the company), the Communication encourages Member States to screen investments as low as five per cent. under the EU rules on the free movement of capital. The Commission also reminds Member States of the possibility of acquiring "golden shares" in certain companies, conferring rights that might enable the Member State to block transactions in certain circumstances. It also refers to the existence of compulsory licensing powers.

Germany:The government has proposed a number of amendments to its FDI review mechanism, which are expected to be adopted soon. Among other things, the amendments would (i) expand the definition of critical infrastructure subject to filing requirements to a number of telecommunications and healthcare products and services, (ii) expand the application of the review to asset deals, (iii) lower the threshold for government intervention to “probable impairment of German public interest and security”, and (iv) extend the suspensory effect of filings to all mandatory filings.

Spain:Spain changed its liberal investment rules by introducing new governmental approval requirements if foreign investors propose to acquire at least 10 per cent. in Spanish companies in certain sectors (essentially the sectors listed in the FDI Regulation).

UK:While considering the forthcoming National Security and Investment Bill, the Parliament’s Foreign Affairs Committee requested information and received oral evidence relating to alleged attempts by Imagination Technologies to transfer technology patents to the company’s ultimate owners in China.

Australia:The government has temporarily reduced the statutory asset value thresholds for determining filing requirements to zero and extended the review period from 30 days to six months.

Pitfalls and Opportunities for Foreign Investors

Recently adopted measures and calls for heightened scrutiny of foreign investment do not mean that FDI is no longer possible or even welcome. However, more than ever, investors will need to plan carefully in the light of appropriate legal advice before making investment decisions. The following are some general considerations that might be relevant in any individual case:

1. Sectors subject to review: Most countries limit approval requirements to acquisitions in specific sectors, which now often include the healthcare sector. Certain countries, such as France, have adopted or are considering the adoption of powers to scrutinise transactions in sectors that have not traditionally been considered strategically important, e.g., the tourism sector, which the FDI Regulation does not list. While the European Union is making efforts to achieve a harmonised list of such sectors, the treatment of individual sectors differs in many cases from country to country, leading to the possibility of filing requirements in some countries and not in others.
2. EU Member States: Despite the adoption of the FDI Regulation, about half of the EU Member States have not yet adopted any review mechanism. While Member States and the Commission will be able to comment on investments in other EU countries with effect from 11 October 2020, such comments are not binding and it will often be the smaller Member States without any review mechanism in place that require foreign investment the most.
3. Nature of investment: Even low minority shareholdings can trigger the application of FDI rules, as can contractual arrangements, other rights, and acquisitions of assets.
4. Applicable substantive tests: Many FDI rules have been framed in particularly broad language, designed to confer maximum discretion on the relevant authorities. For example, the EU Communication refers to "predatory buying" of strategic assets and "over-reliance on foreign investors", without defining such concepts. The FDI Regulation refers to "public order", which is a particularly broad and fluid concept.
5. Review periods: Review periods will in many cases be significantly longer during the crisis.
6. Temporary vs. permanent changes: While many of the recent amendments to FDI screening mechanisms are likely to remain in the long term, a number of changes (such as the lowering of the thresholds in Australia) are stated to be temporary and are only intended to apply for the duration of the COVID-19 crisis.
7. Identity or origin of investors: While many of the more recent regimes and amendments were adopted with specific jurisdictions in mind, in particular China, the approval requirements apply to all third-country investors. Authorities may view investments from China more critically, but have also increasingly required commitments from investors from other countries.
8. Early remedies: While investments in certain sectors are subject to review, this does not mean they will be prohibited. However, given the aim of governments to preserve domestic capacities and prevent what they consider to be predatory acquisitions, investors should consider early in the process whether there are specific assurances that they might be willing to offer in appropriate circumstances. These might, for instance, include:
   1. Retaining, and possibly increasing domestic production capacity;
   2. Retaining domestic R&D;
   3. Protecting domestic jobs; or
   4. Providing plans for capital injections, where target companies are suffering as a result of the crisis.

The crisis has exacerbated previous calls for more protectionism in the form of heightened scrutiny of foreign investment. However, despite the political rhetoric and the shift in focus to rebuilding domestic capacity in a number of critical sectors, cross-border investments will remain crucial; the incidence of prohibition and the treatment of individual proposals do not always match the official pronouncements, and solutions that are sensitively designed to address local concerns will often be successful. Furthermore, in many jurisdictions worldwide, specific FDI regimes have not been adopted yet.

The most successful investors will therefore include those that best understand the local regulatory landscape, appreciate likely local concerns, and anticipate relevant developments; adopt a proactive approach when determining and implementing their overseas investment strategy; and take account in their transaction planning and contractual risk allocation of the inherent uncertainties resulting from the proliferation of FDI regimes.