21st September 2018
A New Normal in the regulatory landscape for FDI
Since our report in autumn of 2017, the social, political and regulatory environment for foreign investments has become much tougher - and sometimes seems like an almost impossible Rubik’s Cube. In the US, CFIUS is being given much more power; the European Union discusses introducing a framework to allow scrutiny of FDIs across the EU; in the UK, the government is looking to dramatically expand its involvement in screening investments; in France, public authorities’ prerogatives are about to be significantly strengthened; and the German government plans to lower the threshold for intervention. And China? Is it really becoming more open? Attitudes towards foreign investments have changed from fundamentally positive to fundamentally negative in the Western Hemisphere. We call this the "New Normal". Despite these developments, our experts in Washington, Brussels, Berlin, Paris, London and Beijing still see good chances of leading a transaction to success - if the broader environment is taken into account and addressed accordingly.
Protectionism in times of globalisation – a mismatched pair
The anxieties resulting from the speed of technological change coupled with an almost incomprehensible web of globally flowing goods and capital has led to globalization fatigue. Especially industrialized Western nations have increasingly found themselves tempted to flirt with the attractiveness of demonstrative action inspired by protectionism and nationalism.
At the centre of the public debate are seemingly uncontrollable multinationals that are deemed to roam the world wielding great power and “bending the rules in their favour”. As a reaction, politicians are overcompensating for these negative sentiments by introducing measures that miss the balance between entrepreneurial freedom on the one hand, and rights of intervention on the other.
I. Seeking control over foreign direct investments becomes a weapon for economic border protection
The waning belief in borderless global capitalism has led to counter-reactions that remind of political and economic nationalism. While customs duties and border walls are obvious measures, political involvement in investment controls has become a very popular instrument to attempt to regain lost control and signal (government) determination. It promises simple and graspable solutions (“stopping the sell-off of the domestic economy”) for complex causalities, such as the shift of power dynamics through global capital flows. Investment control is intended to address one of the core concerns of protectionism – namely to cement the economic status quo – by stopping questionable capital inflow at the border. The current rules-based and open investment regime is being pushed right to the limit.
II. Investment control as an “instrument of war”
Albeit an exaggeration, the validity of this thesis becomes all the clearer the more the motive behind investment control moves away from establishing reciprocity in trade relations, to legitimising unilateral economic policy. President Trump justified the tightening of CFIUS, the US instrument for investment control, by citing the need to take action against “predatory” investments intended to “threaten” US leadership in technology, national security and future prosperity.
In a global “everyone against everyone” playing field, governments seem engaged in a retaliatory zero-sum game of introducing national intervention mechanisms. They are attempting to seek influence over mergers and acquisitions by foreign companies that threaten perceived or actual national interests. Investment control procedures – for decades only used in very exceptional cases – have become the regular instrument du jour in global political disputes.
III. Everything is software, everything is critical
Another development adds a layer of precariousness to inbound investments: Economic goods are increasingly intangible due to the global and unimpeded flow of data – and this trend is sure to grow in the future. Take for example a steel plant in Germany’s Ruhr area – the former heart of the European heavy industry – back in 2001: it had to be dismantled, placed into 4,000 freight containers, and shipped overseas only to be reassembled abroad. Nowadays, benefitting from embedded technologies and gaining access to the “heart” of another country’s economy is just a mouse click away.
Of course, the trend of digitalisation has not escaped the attention of political actors and has been cleverly leveraged in investment control stipulations. Indeed, some jurisdictions have defined software and cloud solutions as critical national infrastructure worth protecting against foreign investments. Does such a provision tee up a precedent that justifies banning almost all transactions? After all, what is not software nowadays?
Matthis Kaiser, Managing Director at Hering Schuppener Corporate Affairs in Berlin, talks about regulatory hurdles for foreign investments in Europe and how to tackle them.
A “New Normal” requires a “New Deal for Investors”
Given the above trends, investors are faced with complexities and completely changed environments in formerly predictable jurisdictions. There is a reversed burden of proof that we call the “New Normal”: the onus is on investors to justify the purpose and added value of their investments, as capital injections are increasingly accompanied by a dose of scepticism from external stakeholders.
The political winds have changed in the countries that have traditionally propagated the benefits of free trade, and governments have assumed a role in transactions that goes beyond the formalized processes of the past. The pivotal element of the debate is China, which in turn is in the process of credibly opening up to foreign trade, equal treatment of foreign companies and loosening its own very rigid FDI legislations. In light of the “New Normal”, investors in the West have to revise their approach if they want to avoid heightened political scrutiny. Not only is FDI perceived with more scepticism, but investors must also anticipate scenarios where an investment can be torpedoed. It will become increasingly difficult for foreign investors to invest in companies – let alone taking them over completely – that are deemed to be of critical interest. This will hold even more true if the exclusive rationale behind a transaction does not go beyond creating shareholder value. In China on the contrary, investing in sectors that are deemed growth and development areas will encounter less scrutiny than it used to.
When planning a cross-border transaction, it is therefore indispensable that investors take the following aspects into consideration:
1. Bid farewell to the notion that the general political attitude is overwhelmingly favourable towards any inbound FDI. Investors all over the globe will have to persuade with arguments that go beyond the strategic rationale and industrial logic, by for instance highlighting the social value of a transaction for the respective country they invest into.
2. Prepare for politicization of transactions even beyond the buyers’ control – vulnerabilities might be exposed, sensationalized and scandalized.
3. Expect prolonged scrutiny processes in the financial structure of your deal from the very beginning when investing in Europe or the United States.
Brett O’Brien, Managing Director at The Glover Park Group in Washington, D.C., explains the changing regulatory environment regarding foreign investments in the United States.