Foreign Investment and Minority Shareholdings: A Race to the Bottom
Recent years have seen a paradigm shift in the scope and intensity of regulatory scrutiny of transactions involving foreign investment. Not only has there been an expansion in the scope of foreign investment controls beyond traditionally sensitive sectors (see here), but an equally important trend has been a “race to the bottom”, whereby countries have lowered their transaction-type thresholds to capture a broader range of transactions involving non-controlling shareholdings.
The Covid-19 crisis has acted as a powerful catalyst for this shift. Whilst some of the measures currently being introduced – such as those seeking to protect the healthcare sector – are directly related to the pandemic, the accelerated rise of foreign investment control goes much further. Governments are moving fast to prevent undervalued companies from becoming targets for opportunistic foreign takeovers.
When it comes to merger control, although a number of countries globally capture non-controlling shareholdings, most jurisdictions require an acquisition of “control” in order to be reviewable. Indeed, the “decisive influence” test for control employed by the EU Merger Regulation (and equivalent tests used by other regimes globally) is generally well understood.
By contrast, there is a much greater variation in the thresholds under foreign investment screening regimes and, in many cases, even rather small minority shareholdings can trigger a foreign investment filing.
The “old guard”
Several jurisdictions have, for some time, had foreign investment rules in place which can be triggered by the acquisition of minority shareholdings, for example:
- USA - control is defined imprecisely by CFIUS as direct or indirect power (whether or not exercised) to use majority ownership, a dominant minority interest, board representation, contractual rights, or other arrangements to determine, direct, or decide important matters affecting a US business. CFIUS interprets this concept fairly broadly and has found control when an investor has sought a less than 20% voting interest coupled with only one board representative (a degree of influence which would normally not be considered “control”). For example, CFIUS reviewed the proposed 10% joint investment by NavInfo, Tencent Holdings and GIC Pte proposed in HERE International. The investment was ultimately abandoned in response to CFIUS opposition.
- Germany - for transactions in the “mandatory sectors”, a filing is required in cases where a non-EU/EFTA investor indirectly/directly acquires 10% or more of the voting rights in the target. In the wider “defence sector” the same applies to all non-German investors. This threshold was lowered from 25% to 10% in December 2018, in response to an attempt by China’s State Grid to buy a 20%-stake in German transmission grid operator 50Hertz which, at the time, escaped scrutiny. It is noteworthy that under the German regime, it is sufficient that the relevant foreign acquirer holds 10% or more of the voting rights in the acquirer – even if the acquirer in question is a company incorporated in Germany (e.g. an acquisition vehicle). If there is a more complex acquisition structure, in the view of the Ministry, it suffices that there is a link of 10% of the voting rights at each layer of the holding chain up to the foreign acquirer. This can result in even de minimis effective shareholdings in a German company being caught by foreign investment review.
- Australia / New Zealand – in Australia, a 20% interest is deemed to grant control for foreign investment purposes. However, thresholds as low as 5% and 10% apply for foreign government investors and in certain sensitive sectors (e.g. agriculture and media). Similarly, in New Zealand, obligations to notify the Overseas Investment Office may arise for an acquisition of a 25% ownership interest. Furthermore, in response to the Covid-19 crisis, both the Australian and New Zealand governments implemented (in March and June 2020 respectively) temporary measures bringing the applicable monetary screening thresholds down to zero for foreign investments into their countries. Unless extended, these temporary measures are currently expected to remain in place until January 2021, when new reforms will be implemented (assuming these are passed by the Australian government).
The “race to the bottom”
With increasingly tightened foreign investment rules being introduced globally, we are seeing new jurisdictions lowering filing thresholds to include minority shareholdings.
- France: From 6 August 2020, the threshold at which the foreign investment screening regime is triggered was temporarily lowered from 25% to 10% of voting rights for non-EU investors acquiring shares in listed companies. The French Government explained that listed companies sometimes reflect "dispersed ownership" and "minority shareholdings can be destabilizing if unfriendly."
- Italy and Spain: Recent reforms have lowered the thresholds for non-EEA investors making investments of 10% or more of the share capital of Italian and Spanish companies active in certain strategic sectors.
- Japan: In June 2020, Japan lowered the threshold at which pre-closing approval is required for any direct investment by a foreign investor in a Japanese listed company from 10% to 1%.
- India: In April 2020, India announced new foreign investment rules targeted at investments from China (and possibly Hong Kong) with “beneficial ownerships” between 10% and 25% being caught by the proposed new rules.
Other jurisdictions are expected to follow suit. Comprehensive reforms are expected to be announced to the UK in September 2020 to create a standalone foreign investment regime. The consultation issued by the Government in July 2018 envisaged a broad call-in power for transactions including shareholdings of 25% or more, coupled with a broader “significant influence” test which could be triggered by the ability to appoint a single board member. It remains to be seen whether the reforms are as expansive as the original proposals.
While the EU FI Screening regulation (which will come into force in October) does not contain any guidance as to the level at which a minority shareholding could give rise to security risks, the EU Foreign Subsidies White Paper (see here) proposed a mandatory filing system to review foreign-backed acquisitions of European businesses which would potentially also catch minority shareholdings (although the detailed triggering factors and thresholds have not yet been specified) – see our recent blog posts on the potential implications of the proposed rules for foreign investment control and merger control.
Practical implications of lower thresholds
Given the heterogeneity of foreign investment rules globally, it is harder to take a “broad-brush” approach or to structure transactions to benefit from a safe harbour at low levels of minority shareholdings. As we have seen, filings may in some cases be triggered at 10% (or lower) and may depend on the precise governance rights being acquired as well as the exact acquisition structure.
This is especially pertinent given that lower level minority stake thresholds can be linked to (i) the specific sector a target operates in; and/or (ii) the acquirer’s identity / nationality (e.g. lower thresholds apply to non-EEA acquirers in certain circumstances in Europe or to SOEs in Australia etc).
Also, we have seen instances (for example in Germany) in which governments have very quickly reacted to attempts to circumvent foreign investment control by structuring a transaction to remain below thresholds and have closed relevant loopholes. The general political desire we observe in the Western world is a comprehensive review of any transaction which is perceived as potentially critical from a foreign investment control point of view.
The “race to the bottom” creates risks and uncertainty for investors considering cross-border investments and, as a result, an early and thorough foreign investment assessment is recommended, even when only acquiring minority shareholdings.
While many of the changes noted above have been accelerated due to Covid-19, in many instances changes are not transitory in nature but will also affect M&A transactions after the pandemic. We anticipate that the global “race to the bottom” will continue post-Covid-19. Given the trends explained above, investors should take note that foreign investment controls may potentially apply to a very broad range of minority acquisitions, and in many cases there will be no difference to the intensity of regulatory scrutiny that a minority acquisition will attract, compared to an acquisition of control.