National security reviews 2018: A global perspective
What's inside
A guide to navigating the rules for investing in countries that require national security approval
Navigating national security reviews worldwide
As governments in various countries tighten their grip on national security reviews of foreign direct investment, the need for better assessment and calibration of the associated regulatory risk in cross-border transactions is greater than ever before
Nowhere is this trend more evident than in the United States, with the August passage of the Foreign Investment Risk Review Modernization Act (FIRRMA), which expanded the range of transactions that are subject to review by the Committee on Foreign Investment in the United States (CFIUS), and the more recent release of a pilot program under FIRRMA that instituted mandatory declarations for a broad range of transactions and put in place penalties—up to the full value of the transaction—for failure to comply. With CFIUS set to clamp down still further in coming months, CFIUS compliance is rapidly moving to the very top of the due diligence list for cross-border transactions involving US businesses.
The US is far from alone. As you will read in the pages that follow, the European Union, United Kingdom, Germany, France, China and other nations are also incrementally ratcheting up their reviews. In the UK, for instance, the government is proposing radical new legislation to allow it to intervene in cases that raise potential national security concerns. The UK government itself estimates that, under the new law, approximately 50 cases a year may end up with some form of remedy to address such concerns. In France, the new PACTE law is likely to strengthen the sanctions mechanism, extend the list of sectors subject to review and introduce some transparency into the process through annual reporting on a no-name basis of reviewed cases.
The pages that follow offer a common-sense guide to investing in major jurisdictions, a snapshot of recent regulatory changes in each, and guidance on making sound investment decisions in a time fraught with regulatory uncertainty.
United States
Deals are generally approved, but a new law increases the number and types of deals reviewed.
New legislation has been proposed to expand the scope of French national security reviews, especially in the technology sector, and to strengthen the powers of French authorities to impose sanctions
Deals are generally not blocked by the Italian government. However, in connection with the clearance process, conditions may be imposed that can have a significant impact on the investment
New amendments potentially require foreign investors to disclose information about beneficiaries, beneficial owners and controlling persons as part of pre-clearance
China is attempting to implement a more structured and comprehensive system to keep a closer eye on economic deals that might have security implications
In September 2018, the BMWi announced its intention to further tighten the regime for foreign direct investments.
Pursuant to the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz; AWG) and the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung; AWV), the German Federal Ministry for Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie; BMWi) is entitled to review inbound transactions by foreign investors based outside the European Union (EU) or the European Free Trade Association (EFTA). The BMWi may prohibit or restrict a transaction if it poses a threat to the public order or security (öffentliche Ordnung oder Sicherheit) of the Federal Republic of Germany.
In August 2018, the BMWi for the first time threatened to veto a China inbound transaction after the new investment control rules had come into force in July 2017, which brought about significant changes to the landscape of German investment control reviews. In September 2018, the BMWi announced its intention to further tighten the regime for foreign direct investments in Germany with new legislation currently expected to be passed by the end of 2018.
SCOPE OF REVIEW AND TYPES OF DEALS REVIEWED
The AWV distinguishes between a cross-sectoral review for all industries and a sector-specific review that applies only with respect to certain highly sensitive industries. The scope of the latter includes arms and military equipment and encryption technologies as well as other key defense technologies such as reconnaissance, sensor and protection technologies.
As part of the cross-sectoral review, an intervention by the BMWi requires the investment to pose a threat to public order or security. Such threats are assumed for investments into the following (non-exhaustively listed) technology assets:
Operators of critical infrastructure that is of particular importance for the functioning of the community
Companies developing or changing industry-specific software for the operation of critical infrastructure
Companies entrusted with organizational monitoring measures for telecommunication facilities
Companies providing cloud computing services above a certain volume
Companies engaged in the area of telematics infrastructure
The BMWi is entitled to review all acquisitions, whether by way of asset or share deal, by non-EU based investors. This applies to acquisitions reaching or exceeding directly or indirectly a 25 percent threshold in the target's equity and/ or voting rights. The calculation of voting rights will take into account certain undertakings that may be attributed to the ultimate owner, such as an agreement on the joint exercise of voting rights. Asset deals require a comparable test for the respective asset values, whereby 25 percent of the total assets of the acquired business are deemed relevant. In contrast to the sector-specific review, which is applicable to all foreign buyers, the general review process only applies to non-EU/EFTA-based investors.
PROCESS CONSIDERATIONS AND TIMELINE
The completion of the investment review process is by law not required for the consummation of a transaction. However, following the AWV amendments in 2017, the obligation to notify the BMWi of a transaction is no longer limited to a sector-specific review but extends to the cross-sectoral review if the transaction fulfills the criteria mentioned above. Even if the relevant criteria are not fulfilled, foreign investors often decide to initiate the review process by submitting an application to the BMWi for a non-objection certificate (Unbedenklichkeitsbescheinigung) in order to obtain legal certainty.
As a response to international transactions becoming increasingly complex and sensitive, the review periods were extended significantly as part of the 2017 reform. This leaves the BMWi with considerably more time to perform its review process, which has a significant impact on the overall transaction timetables.
The sector-specific reviews will be completed with a review period of three months (formerly one month). The review process for crosssectoral reviews is typically initiated by the parties applying for a non-objection certificate. After complete submission of the application, the BMWi has two months to decide whether to issue such certificate or open the formal review procedure. Upon expiration of this period, the non-objection certificate is deemed to have been issued.
The period available to conduct the formal review measures is four months starting upon receipt of all necessary documentation; it is suspended for as long as negotiations on mitigation measures are conducted between the BMWi and the parties involved.
In order to safeguard public order or security, the BMWi may prohibit the transaction or issue "instructions" (taking the form of mitigation measures). Except for acquisitions in sensitive industry sectors, such measures require the approval by the German Federal Government.
RECENT DEALS REVIEWED BY THE BMWI
Since the 2017 amendments to the AWV, 80 transactions have been subject to BMWi investment reviews, more than a third of them directly or indirectly involving a Chinese acquirer.
The first transaction reviewed by the BMWi following the 2017 reform was the acquisition of the German aerospace composite fiber components manufacturer Cotesa by a Chinese consortium.
In August 2018, a Chinese investor dropped its attempt to acquire German toolmaker Leifeld ahead of an expected veto by the German Federal Government, which had indicated its intention to block the transaction but had not yet issued its veto. This decision would have been the first prohibition of a transaction under the revised AWG/AWV.
In July 2018, the German state bank Kreditanstalt für Wiederaufbau– KfW acquired a 20 percent stake in high-voltage grid operator 50Hertz, denying China's State Grid the acquisition after the transaction had been announced. The government officially confirmed that the acquisition by KfW was aimed at protecting critical infrastructure for energy supply in Germany. The necessity for the intervention of the KfW (according to public sources) arose as the transaction did not fall within the scope of the BMWi's review competences, given that the stake was below the 25 percent entry threshold.
TRENDS IN THE REVIEW PROCESS
The current market climate is characterized by the BMWi's substantially increased awareness and persistent efforts toward enhanced scrutiny. Having said that, the overall number of approved transactions (despite recent vetoes) clearly shows that the investment climate in Germany remains liberal for the overall majority of transactions.
The BMWi announced that it is working on further amendments to German investment control laws, which are currently discussed by the relevant governmental bodies. These amendments will include the lowering of the intervention threshold for selected industries. The changes are currently expected to come into force in late 2018.
HOW FOREIGN INVESTORS CAN PROTECT THEMSELVES
Parties to M&A transactions— whether public or private—should carefully consider the risk of foreign investment control procedures as typically being part of the due diligence process. If AWG/AWV rules apply, it may be appropriate that the acquirer initiate discussions with the BMWi even before the signing of an SPA, or, in case of a public deal, the announcement of the transaction. Depending on the timing and the type of offer, the purchase agreement or the public takeover offer and a related business combination agreement will contain corresponding condition precedents and covenants.
In sensitive sector transactions, foreign investments meeting the above-mentioned thresholds must be communicated to the BMWi and should not be closed before the acquisition is approved or deemed to be approved by the BMWi. Any BMWi decision may be challenged before a German court.
OUTCOMES
-Despite recent interventions by the BMWi and the German Federal Government on two Chinese inbound transactions, the overall number of deals approved shows the continuous openness of Germany toward foreign direct investment
-The threshold for a prohibition of a transaction by the BMWi remains high in the current legislative environment, requiring an actual and sufficiently serious danger to public order or security
