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More countries are scrutinising inward investments by foreign investors (including PE firms and financial sponsors, particularly those with Chinese investors) and those with existing regimes are strengthening their application. There is a perception that national security issues may arise in industries not traditionally thought to be sensitive (notably in the technology space) and also wider industrial policy concerns.
In the US, the powers of the Committee on Foreign Investment in the United States (CFIUS), which conducts national security reviews of M&A activity involving a foreign investor, have been enhanced recently with the enactment of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). FIRRMA is bipartisan legislation responding largely to investments from China by expanding CFIUS’ jurisdiction and mandating CFIUS filings for certain transactions involving critical technologies, critical infrastructure, and sensitive personal data of US citizens. The timeframes for review are longer so a single complete CFIUS review process could potentially take 120 days or longer. FIRRMA does allow parties to submit short-form “declarations” subject to a more accelerated (but less definitive) process, but declarations submitted under a pilot program for critical technology transactions have been largely inconsequential.
One benefit of FIRRMA for US-managed investment funds is the creation of a new “safe harbour” for passive foreign investments made via such funds. Implementation of the safe harbour has been uncertain, with interim regulations and draft regulations failing to clearly define when an investment fund is “US managed” in a way that reflects how PE, venture capital, and other funds are often structured. Final FIRRMA regulations, preferably with greater clarity on this issue, should be in effect by February 2020.
Investments by Chinese and Russian-backed PE funds and financial sponsors, like other investments from those countries, have faced the greatest resistance from CFIUS. In 2017, President Trump, on the advice of CFIUS, blocked the acquisition of Lattice Semiconductor by Canyon Bridge-managed fund in which the sole limited partner was indirectly owned by Chinese state-owned enterprises. In 2019, following a post-closing review, CFIUS required Pamplona, which is partially backed by Russian billionaire Mikhail Fridman, to divest its minority interest in cybersecurity firm Cofense.
In the UK, the government has taken on additional powers to block takeovers of companies in the defence and technology sectors (and is proposing to introduce a far-reaching standalone national security regime). Concerns can arise even in relation to investors who were previously not deemed “high risk”. As a recent example, the proposed acquisition of Inmarsat, a global mobile satellite communications company, by a consortium comprising of Apax Partners, Warburg Pincus, Canada’s CPPIB and Ontario Teachers’ Pension Plan Board, required the consortium to offer voluntary undertakings to the Secretary of State for Digital, Culture, Media and Sport to address the national security concerns raised by the UK Government.
The legally binding undertakings require that for the three-year period following completion, the consortium will ensure that:
Similarly, US-based PE firm Advent International’s proposed takeover of Cobham, a UK aerospace and defence supplier, prompted an intervention by the UK government based on national security grounds. The UK Government is currently consulting on the concessions offered by Advent, which focus on the governance of and services provided by the business in the UK to remove public-interest concerns.
In Germany, the acquisition of a technical ceramics manufacturer by a consortium of PE funds joining as co-investors was subject to foreign investment approvals and closely scrutinised by the regulatory authority. Likewise, in France, investments made by funds managed by PE firms and financial sponsors have come under close scrutiny by the French Ministry of Economy (notably, in relation to the rationale for the investment and the contemplated commercial strategy).
The need for a filing and the outcome of a foreign investment review is already much harder to predict than merger reviews because: (i) there is no standardised turnover or asset-based test (tests look to acquirer risk and target risk); and (ii) reviews are highly political. Going forward, PE firms and financial sponsors (including those based in western countries such as the US and Canada) can expect their cross-border deals to take longer to complete if called in for review, and they will need to consider foreign investment issues upfront to mitigate any potential unexpected delays. In addition, the various reforms and proposals will mean potentially increased scrutiny and execution risk for a broader range of deals in a number of jurisdictions. It is vital, therefore, for deal teams to consider the practical considerations for managing this uncertainty and addressing individual transaction challenges upfront by conducting appropriate foreign investment screens and by building in deal protections in deal documentation.