FIRRMA: sharpening scrutiny of FDI
January 2019 | FEATURE | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
January 2019 Issue
In security-driven manoeuvres designed to reverse a decades-long trend toward increasingly open markets, western nations, the US in particular, are introducing stronger measures to vet foreign direct investment (FDI) and foreign takeovers of strategic economic assets.
One such measure is the recently enacted Foreign Investment Risk Review Modernization Act (FIRRMA).
Passed by Congress and signed into law by president Trump in August 2018 as part of a $717bn defence spending bill (the National Defense Authorization Act (NDAA)), FIRRMA seeks to address the range of threats to US national security, such as the contention that certain foreign governments, particularly China, are deploying FDI as a tool to access sensitive US technology and infrastructure.
Also a key factor in the introduction of FIRRMA is the perception that the US government’s existing foreign investment review authority – the Committee on Foreign Investment in the United States (CFIUS) – lacks the authority to review and potentially block investments of the type being attributed to China. FIRRMA, therefore, broadens the authority of CFIUS (last amended by Congress in 2007) to block transactions which threaten national security, as well as significantly expanding the scope of investments CFIUS scrutinises.
Concern over the ulterior motives of countries such as China has certainly intensified in recent years, with an increasing number of US, as well as European, companies being targeted by Chinese investment intent on gaining a foothold in key western industries.
“FIRRMA should be viewed in both a commercial and geopolitical context,” says Joyce Lee, a senior consultant at FTI Consulting. “It responds to bi-partisan anxiety over foreign investment in sensitive sectors such as artificial intelligence (AI), robotics and semiconductors, as well as technology transfers that could advance non-US entities ahead of their US counterparts. It also follows a pattern of protectionist statements made by president Trump, who has promised to safeguard ‘the crown jewels of American technology and intellectual property (IP)’.
“The legislation is also symptomatic of an emerging power rivalry between the US and China, which has been displaying greater military and commercial clout around the world,” she continues. “The combined pressure of China’s increasing interconnectivity with the West, coupled with its potential long-term strategic threat to Western actors, gave rise to FIRRMA and the ongoing US-China trade war.”
The provisions of FIRRMA broaden the operational mandate and authority of CFIUS, as well as codifying a number of its practices. Furthermore, many FIRRMA provisions became effective upon enactment, while others will come into effect over the next 18 months.
“FIRRMA expands the scope of transactions subject to CFIUS review in a number of ways,” says Priya R. Aiyar, a partner at Willkie Farr & Gallagher LLP. “Under prior law, CFIUS jurisdiction was limited to investments that would result in foreign control of a US business. Under FIRRMA, CFIUS has jurisdiction to review non-controlling investments in US businesses that own or maintain critical technology, critical infrastructure or sensitive personal data of US citizens, unless the investments are purely passive.
“FIRRMA also creates a new category of real-estate transactions that are subject to CFIUS review, involving property situated in proximity to sensitive facilities,” she continues. “In the new law, Congress reaffirmed the importance of foreign investment to the US economy, but sought to provide federal agencies with new tools to review investments in sensitive areas that could provide foreign entities with access or influence even if they do not rise to the level of control.”
Another consequence of FIRRMA is that it is likely to force both US entities and potential foreign investors to involve CFIUS at an earlier stage in the deal planning process. “Although the expanded scope of CFIUS does not automatically mean that transactions will involve mitigation, it does, however, mean that CFIUS now has the authority to review more transactions,” explains Kara M. Bombach, a shareholder at Greenberg Traurig, LLP. “US entities and their counsel, therefore, will need to pay particular attention to deal timelines in order that transactions reported to CFIUS will have enough review time to assuage concerns.”
Another notable aspect of FIRRMA is that for the first time CFIUS submissions are no longer voluntary, as under the new legislation, certain transactions will be subject to mandatory short-form declaration requirements.
“The Act is designed to make the US foreign investment control regime fit for purpose in an age of offshore joint ventures (JVs) and licensing deals, rising cross-border collaboration and investor influence and access that falls outside a majority stake or seat on the board,” adds Ms Lee.
While FIRRMA does not explicitly identify nationalities of concern (earlier drafts of the legislation did, however, differentiate investor risks by nationality), it is generally perceived that China is the main target of expanded US FDI oversight.
“Chinese investment is significantly and necessarily impacted given the history and magnitude of Chinese investment in targeted industries, such as aerospace manufacturing, semiconductors, industrial metals, power generation, high-end computerised machines, new-generation information technology, and bio- and nano-technologies,” says Ms Bombach. “Additionally, foreign investment by governments or government-owned or controlled entities faces increased scrutiny in light of the significant role of Chinese government ownership in even publicly traded companies in China.”
In the view of Ms Lee, many of the critical technologies and industries being protected by the US through FIRRMA are the same targeted for development by China through its ‘Made in China 2025’ industrial strategy. “Although FIRRMA does not single out China, it alludes to the Chinese as the main US competitor in areas which have the potential to yield vital industrial and military advantages and enormous datasets of personal information,” she asserts.
How, then, is China responding to the FDI measures contained in FIRRMA, not to mention dealing with the perception that it is the country being specifically targeted by the US?
“Chinese investors – and their US partners – may respond with creative deal structures that mitigate a perceived threat to national security,” suggests Ms Lee. “But given the broadened definitions of influence and national interests, it is not clear whether post-FIRRMA transactions could skirt regulatory scrutiny through corporate gymnastics, as seen with the US-based chipmaker Advanced Micro Devices brokering licence deals with its own JVs with Chinese companies. Whether state-affiliated or not, Chinese investors may also begin to seek friendlier markets for their capital.”
Also of concern to potential investors is how FIRRMA may impact future non-control investment deals in the US, e.g., minority investments that obtain sensitive information but do not deliver control of a US entity to a foreign investor. Such investments have generally been outside the scope of CFIUS, a blind spot that FIRRMA is intended to address.
“Fears exist that the wider jurisdiction of CFIUS under FIRRMA will discourage Chinese private firms from investing in industries that are traditionally non-national-security-related, such as life sciences,” says Ms Bombach. “There is also a possibility that, should CFIUS’ decisions prove unfavourable, China may take steps to deny or further inhibit US investment.”
FDI scrutiny in Europe
In terms of Europe, the continent’s four largest economies – Germany, the UK, France and Italy – are considering proposals for a framework to enable EU-level scrutiny of FDI (only 12 of the current 28 EU Member States have national legislation regulating FDI).
“There is a definite trend toward closer alignment on the part of the EU and its Member States as regards FDI,” observes Gillian Sproul, a shareholder at Greenberg Traurig, LLP. “The EU and nearly all EU Member States operate merger control regimes that have tended to be strictly focused on the impact of M&A transactions on competition, subject only to limited exceptions enabling Member States to block transactions impacting national security and other interests.”
While there is no formal mechanism for scrutinising FDI at EU-level currently in place (national policies generally favour FDI), this scenario is poised for change, with proposals for an ‘enabling framework’ for FDI scrutiny at an advanced stage.
When implemented, this framework will: (i) establish minimum standards for FDI screening across all EU Member States; (ii) create a mechanism for the EU and Member States to cooperate and share information; and (iii) empower the EU to review FDI transactions on grounds of security and public order where they affect ‘union interest’, e.g., involving substantial EU funding or subject to EU legislation on critical infrastructure, critical technologies or critical inputs.
Like FIRRMA, the EU proposals are not specifically aimed at China. However, a recent surge in inbound investment by Chinese state-backed companies has provided additional impetus to introduce uniform scrutiny of FDI across Europe.
“Generally speaking, these measures are likely to lead to closer global alignment in FDI scrutiny,” says Ms Sproul. “However, there remains clear potential for diverging outcomes for specific mergers & acquisitions – both globally and within the EU – given the different focus of each national FDI regime and differing national economic and political drivers. This is likely to be exacerbated by the UK’s imminent departure from the EU.”
Tread a fine line
The enactment of FIRRMA, as well as the proposals to tighten FDI scrutiny across the EU, serves as a notice that the attitude of western nations toward FDI is hardening – by no means an easy shift in approach given the fine line that governments are required to tread when it comes to investments originating overseas.
“In the future, investors considering transactions in sensitive sectors in the US and Western Europe will require insight into FIRRMA and other FDI-focused legislation as a central aspect of due diligence and capital-raising efforts,” suggests Ms Lee. “And as national security considerations are constantly evolving alongside industrial and geopolitical shifts, it is imperative that investors look beyond procedural requirements to seek expertise from those with experience in political risk analysis and cross-border investment trends.”
For Ms Bombach, the exact impact of FIRRMA on FDI remains to be seen. “It is likely that the changes will mostly impact the industries that have, in the past, operated for the most part outside the scope of traditional national security concerns,” she says. “Businesses operating in these areas and the foreign acquirers need to understand as quickly as possible the potential national security ramifications.”
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