Given the increasing importance of foreign direct investment review in M&As, Marc Israel and Farhad Jalinous provide an overview of recent changes and potential deal impacts
Even without the impacts of the covid-19 outbreak, there is a discernible global trend towards the strengthening of foreign direct investment regimes made perhaps most clear in the 2018 adoption by the United States of the Foreign Investment Risk Review Modernisation Act (FIRRMA).
This is not a US-only trend by any means, however. The coronavirus has, if anything, further exacerbated awareness by governments of national economies' perceived vulnerability to foreign takeovers with respect to critical industries and companies, notably in the national security and health sectors.
FDI regimes operate by placing certain restrictions on, or allowing enhanced scrutiny of, deals that involve foreign investors. Just who will qualify as a foreign investor, however, varies by regime."
Who is a ‘foreign' investor?
Certain countries are more sensitive to potential investors from particular countries over others. The US and Australia, for example, have enacted regulations aimed at protecting certain assets that are deemed critical to national security or other national concerns from foreign investors. In some instances this has even led to scrutiny of existing investments by foreign investors.
FDI regimes operate by placing certain restrictions on, or allowing enhanced scrutiny of, deals that involve foreign investors. Just who will qualify as a foreign investor, however, varies by regime.
European regimes, for example, regularly distinguish between European Economic Area (EEA) investors and non-EEA investors. The approach, however, does vary. France, for example, has a very broad interpretation of the concept. Officially, anyone will qualify as a foreign investor where they fall into one of the following categories:
any natural person of foreign nationality, any natural person of foreign nationality or any natural person of French nationality who is not domiciled in France
any foreign entity, or
any entity governed by French law controlled by one or more persons or entities mentioned at (i) or (ii).
In practice, these definitions operate to define any entity as a "foreign investor" if its chain of control involves one single non-French entity, whether intermediate or ultimate.
The UK regime, by contrast, has no qualifying criteria for the nature of the investor to which the regime will apply. The focus is strictly sectoral and has been used to scrutinise investment by US or European investors, as well as those from other countries. India, on the other hand, restricts its FDI regime to foreign investors from countries that have a land border with India.
Most regimes operate on the basis of subjecting deals in certain sectors of the economy to review. Unsurprisingly, there is a discernible global focus on national security. Canada, China, France, Germany, Hungary, Israel, Italy, Japan, Poland, and the UK, among others, all make reference to national security or other defence or military operations in their delineations of the sectors that will be subject to FDI review.
Indeed, the nature of the activities of a target that are deemed to fall within the scope of national security-based review has recently been expanded in a number of jurisdictions.
For example, in June 2018, the UK government lowered the thresholds at which it can intervene in a number of sectors including the development or production of military or dual-use goods, as well as to the design and maintenance of computing hardware and the development or production of quantum technology.
Those lower thresholds were further expanded in June 2020 to include artificial intelligence, advanced materials and cryptographic technology.
The covid-19 outbreak has also led to various jurisdictions enhancing their rules to focus on the criticality of certain sectors to supporting the ability to combat the virus and mitigate its effects. In the UK, a new ‘public interest consideration', which is the gateway to permitting intervention by the government, was added to the list of sectors subject to public interest review in the form of the "need to maintain in the UK the capability to combat, and to mitigate the effects of, public health emergencies."
Italy also expanded its regime in response to the outbreak by adding a number of additional sectors targeted at safe-shoring its ability to respond to the crisis, specifically amending its rules to include: (i) critical infrastructure (including water and health) and (ii) supply of critical inputs.
Germany also adopted a proposal to extend the list of ‘critical activities' under its regime to include additional healthcare sectors, including developing or manufacturing protective equipment, certain medicinal products, medical devices and in vitro diagnostic medical products
These are by no means the only sectors that attract scrutiny. In the UK, for example, media plurality and the stability of the financial system are both sectors that meet the ‘public interest' test; in New Zealand there is a particular focus on acquisitions of entities that have holdings in ‘sensitive land'; and in many other jurisdictions have rules that cover investments in energy, water supply, transportation, telecommunications.
Others, such as Austria, also include the education sector as one that is relevant to ‘public security and order' and so potentially subject to FDI review. In certain jurisdictions, including South Africa for example, only transactions in regulated sectors are subject to FDI scrutiny, whereas Germany focuses very much on ‘critical infrastructure' in particular sectors.
FDI: impact on deals and future outlook
It is certainly the case that the direction of travel in terms of FDI review is towards more, rather than less regulation. This involves countries introducing rules to cover FDI for the first time, as well as jurisdictions with an existing FDI regime tightening them up and subjecting certain deals to increased scrutiny. Even countries that have traditionally been very open to foreign capital have seen something of a change in direction, with countries such as Canada and the UK amending their laws and ramping up scrutiny.
In terms of the impact of transaction timelines, it should be borne in mind that many of these regimes require prior-approval from the relevant authorities before a change in control may be effected. Even in regimes without notification requirements, such as the UK (where there is no obligation to seek approval even if the government can intervene), FDI scrutiny has the potential to seriously impinge upon transaction timelines.
For example, in the UK, if the government decides to investigate by issuing a ‘public intervention notice', this has the capacity to delay closing by an extended period. Likewise, in Australia, the Foreign Investment Review Board has extended the statutory timeline for review to six months (although clearance can be shorter in practice).
Regulators will be most interested in the deal rationale, particularly any plans to relocate or diversify existing businesses in the case of companies with a contribution to make to the coronavirus response, and in the identity of investors and any associated security concerns when it comes to reviews based on national security considerations.
Further changes on the horizon
FDI regulations are currently in a constant state of flux, and investors should also be aware of new rules coming into force in various jurisdictions. For example, although the European Union does not have competence over issues relating to national security (which remains in the power of the individual Member States), in October a new EU foreign investment screening regulation takes effect.
This requires Member States to keep the Commission and other Member States informed of cases they are reviewing on FDI grounds who may provide comments. Whilst a Member State does not need to accept the opinion of the Commission, in practice it is likely to have to justify why it has not done so, and the new regime will create a more holistic European FDI review system.
Other jurisdictions are also keeping their rules under review, or plan to introduce changes. This includes Poland, as well as the UK, which is expected to introduce a new National Security and Investment Bill later this year.
This will create a standalone FDI review mechanism for the first time in the UK that will focus exclusively on national security considerations; currently it is closely intertwined with merger control procedures.
The bottom line for investors is, then, to plan early and consider the potential impact of FDI rules on investments - which will be particularly relevant depending on the nature of the target's activity and the jurisdiction in which the investor is based.
Marc Israel and Farhad Jalinous are partners and Kate Kelliher an associate at law firm White & Case