The expansive scope of foreign investment regulations: A look at ‘unexpected’ transaction types
Governments around the world have enhanced their screening of inbound foreign investment (FI). The Covid-19 pandemic, geopolitical uncertainty, and increased rivalry with respect to advanced technologies have acted as a catalyst for governments to rethink the level of protection afforded to domestically important industries and accelerated the trend towards expanded powers to examine foreign investments.
This trend has resulted in a significantly broader array of transaction structures, acquisition targets, and investors being brought within the scope of FI regulations internationally. The expanded remit of FI rules can create unexpected pitfalls for investors, particularly given the potentially severe consequences (including both civil and criminal sanctions) for failure to notify in many jurisdictions. This blog post highlights some of the most notable transaction types that may give rise to ‘unexpected’ issues from a FI perspective, which investors should carefully consider as part of their transaction due diligence.
Non-controlling minority shareholdings
With a view to mitigating opportunistic foreign takeovers of domestic targets, several countries have expanded their jurisdiction over non-controlling minority acquisitions to capture much lower levels of equity and governance rights. Indeed, shareholdings of as low as 10% (or even less) may commonly be caught by FI rules, regardless of whether the foreign investor will have the ability to actually determine or influence the strategic decision-making of the target.
Notable examples are Austria, Denmark, and Spain, which have lowered the filing thresholds for investors acquiring at least 10% in target entities active in certain strategic sectors. Japan has gone even further - catching direct investments in Japanese listed companies of 1% or greater.
As a result, even passive minority acquisitions, such as investments by limited partners in fund structures (whose rights are limited to corporate and tax requirements with no controlling influence over the target entity), may nonetheless trigger a FI notification. This is contrary to most global merger control regimes, which typically require pre-closing approvals only for acquisitions conferring control to the acquirer.
Licence agreements
FI review powers often stretch beyond the acquisition of an interest in corporate entities to capture purchases of standalone assets. However, in addition to tangible assets such as production and distribution facilities, assets may also include contracts or intellectual property rights connected to sensitive activities.
This is evidenced, for example, by the UK National Security and Investment Act (NSIA) which captures IP licences within the scope of its far-reaching jurisdiction. Indeed, the first prohibition decision (issued in July 2022) since the introduction of the NSIA related to a licence agreement for certain vision sensing technology between the University of Manchester and a Chinese company, Beijing Infinite Vision Technology Company Ltd.
The UK is not the only country catching contractual arrangements. Other jurisdictions, such as France and Italy, apply equally broad rules.
‘Friendly’ or domestic buyers
Regulators have also made clear that they are not solely interested in investors based in countries considered as ‘hostile’ from a geopolitical perspective, as was historically the case.
Although a more targeted approach based on the buyer’s identity still applies in many jurisdictions (e.g. EU countries may exclude EU-based acquirers from the scope of the applicable screening mechanisms depending on the sector of investment), regulators now routinely extend their focus to acquirers originating from theoretically ‘friendly’ countries – particularly for transactions involving so-called ‘national champions’. A recent example of this shift includes the blocked takeover of Carrefour, the French food distribution group, by the Canadian company Couche-Tard in 2021.
Certain FI rules go a step further and apply ‘nationality neutral’ regimes which apply, in principle, to both foreign and domestic investors alike (e.g. in Norway and the UK). Although domestic acquirers may inherently be unlikely to attract heightened scrutiny, this does not mean that domestic investors can refrain from making a filing.
Limited local presence
FI rules typically apply to acquisition targets with subsidiaries, branches or assets located in the relevant jurisdiction. The ‘local presence’ test is indeed employed by most jurisdictions globally. Yet, investors may see their deals attract FI scrutiny even in the absence of permanent target presence, such as in instances where the target entity solely generates domestic turnover from supplying local customers or government entities. Currently this applies at least in the US, Czech Republic, and the UK, but remains to be seen whether other countries enacting new regimes (e.g. Romania) will follow the same far-reaching jurisdictional approach.
Extraterritorial reach
Recently, in what may be the first action of this type, the Committee on Foreign Investment in the US (CFIUS) demonstrated its willingness to intervene in transactions involving non-US entities with no impact on the US economy. Concerned that sensitive technology fostered domestically would be transferred to China, CFIUS ordered the dissolution of an Asian-focused joint venture between the US firm Ekso Bionics Holdings Inc. (Ekso Bionics) and its Chinese partners. Under the joint venture arrangement, Ekso Bionics would contribute its technology to develop exoskeletons for sale in China and other Asian markets. Yet, given that the exoskeleton technology is not used solely in the medical sector but may also have military applications (Ekso Bionics had indeed in the past developed exoskeleton projects for the US military), CFIUS extended its review powers and asserted jurisdiction over the ex-US deal on the basis of national security concerns.
This intervention may prompt other countries to reconsider and flex the territorial scope of their FI rules to protect critical technologies or infrastructure developed locally from transferring to foreign countries. In this vein, the economy ministry in Germany has recently proposed screening all company investments going into China.
Focus on broader industry sectors
There is a clear trend across jurisdictions to expand regulators’ powers to review transactions in sectors previously considered irrelevant from a FI perspective. In redefining what ‘national security’ entails, regulators have stretched sectoral coverage to unprecedented levels, now including everything from national defence and critical infrastructures to healthcare, critical technologies, and food security.
While enforcement priorities vary by jurisdiction, we have seen regulators investigating transactions in industries that are not generally sensitive from an economic or political view (such as standard industrial products and services). This primarily occurs where the target is a supplier to the government, or has access to government information or sensitive personal data. Several regimes (such as the French and Italian regulations) include broad and often ambiguous rules that allow regulators a significant discretion to assert jurisdiction if they are concerned that national interests may be at stake.
Internal corporate reorganisations
Internal corporate restructurings – even where there is no change to the ultimate controlling entity – can be subject to mandatory FI screening. In fact, a number of major jurisdictions (including Australia, China, Germany and the UK) capture transactions that do not lead to a substantive change in the ultimate ownership. This may happen, for instance, where a holding entity sells its stake in a target company to an existing or newly created subsidiary within the same group or increases its shareholding in the target company above a specified threshold. While the review of internal reorganisations can often be concluded more swiftly, given that they are typically unproblematic from a substantive perspective, this does not negate the need for a FI filing.
Plan for the ‘unexpected’
With FI regimes expanding globally to catch a very wide range of transactions which may not present ‘obvious’ national security concerns, but also business-as-usual transactions (such as licensing arrangements) and internal restructurings, companies are faced with increased uncertainty and complexity when planning cross-border investments.
It is more important than ever that prospective investors assess the potential applicability of FI screening regulations at an early stage and ensure that FI aspects are integrated into their deal timeline and strategy. In this fast-evolving regulatory environment, planning early and identifying ‘unexpected’ filing requirements is key for the successful execution of transactions.