CFIUS

Like many disputes before it, the ongoing trade war between the US and China is being fought on many fronts. As well as the restrictions and tariffs being imposed on either side, strong regulatory protections have been installed in the US that prevent Chinese investors from acquiring companies that its government deems to be of significant national importance.

The regulation falls under the jurisdiction of the Committee on Foreign Investment in the United States (Cfius), an interagency committee with the authority to review transactions that may result in foreign persons or businesses controlling certain types of business in the US, to ascertain their impact on US national security.

The final part of this three-part series looks at steps the US government has taken to protect its most valuable assets using Cfius and how the market has reacted. For a more general overview of the committee and its rules, read our primer on the topic here. 

Developments

In the time since part one and two of this series were published there have been two major developments that greatly impact the relationship between the US and China. Firstly, on January 15 the two countries entered into an agreement called the phase one trade deal, which took steps to rein in the tariff back-and-forth that was so damaging the two economies. The deal has, for now, diffused the tension significantly.

Phase one was well received by the business community. “Securing a level playing field in China for US-based financial services firms is a long-standing goal of SIFMA. We will examine this agreement closely and are eager to learn more about its implementation,” said Kenneth Bentsen, president and CEO of the Securities Industry and Financial Markets Association.

Secondly, on January 13, the US Treasury Department issued two sets of final regulations under the Foreign Investment Risk Review Modernization Act (FIRRMA). The first related to Cfius' expanded jurisdiction over certain types of investments, including non-controlling investments in certain US businesses, while the second related to its expanded jurisdiction over certain foreign investments in real estate.

See also: Cfius takes bold move into enforcement with mitigation fine

The link between the tariff escalation and Cfius’ new powers might not be direct – but it exists.

“While Cfius is not directly related to the trade war, it is in the minds of directors and sellers. There is the general preoccupation with both,” said Randy Cook, senior managing director at consulting firm Ankura. “Because of this discussion of tension – even though it doesn't really relate to investment – people are panicky to do things at a psychological level.”

Not all parties agree that Cfius has a major impact on the trade war though. “It’s tempting to focus on the impact of the new Cfius regulations on the US-China relationship, not least because when the law underlying these regulations was passed in 2018, members of Congress and the administration emphasised the potential threat to national security posed by Chinese investment in the US," said Jeremy Zucker, partner at Dechert in Washington DC.

But US companies and foreign investors from around the globe – not just China – should recognise the impact these new regulations will have. Cfius’ jurisdiction over foreign investment transactions has expanded in a meaningful way to cover new types of investments, and filings are now mandatory for certain transactions.

Another first time inclusion in the legislation, the decision to highlight the UK, Australia, and Canada as the first “excepted foreign states”, does not come as a surprise in light of their shared security perspectives and interests.

“That said, it’s important to note that not every investor from one of these countries will be exempt from Cfius’ jurisdiction, and the exemption applies only to certain non-controlling investments and real estate transactions,” said Mario Mancuso, partner at Kirkland & Ellis. “In other words, the Cfius calculus for traditional M&A will not materially change as a result of this action.”

It is however undeniable that the impact will be most greatly felt by those in the world's second-largest economy.

Reduced investment

Cfius’ mere existence has always been highly relevant to US-China relations, but this has only deepened over the past 18 months.

“Chinese buyers have been particularly sensitive about Cfius approval – in fact practically anything to do with the US – for the last few years anyway. They have to ask the question: 'is it likely to trigger Cfius?'," said Samson Lo, head of M&A at UBS, Hong Kong SAR.

“It’s always been on people's minds, but with the trade war going on and with some of Donald Trump’s commentary about certain industries, it is getting worse,” he added.

Of late President Trump has been increasingly specific about American companies which have had dealings with certain Chinese governmental entities. “His comments are getting more extreme, so people are getting more cautious about doing deals into the US. These days we see hardly any deals into the US,” added Lo.

“People don't want to think about it. There continue to be a lot of good opportunities, but not for the Chinese now. They are usually picked up these days by Japanese or Korean investors,” said Lo.

Putting aside the spillovers from the trade frictions between China and the US – which will not go away anytime soon – changes to the policy environment governing Chinese investments into the US are conditioned by the enactment of FIRRMA and its implementing regulations. But there are other factors – more mundane perhaps, but critical – that need to be considered carefully when assessing cause and effect.

See also: PII aspects of Cfius update creating work for corporates

One way of gauging Cfius’ impact on US-China relations is the significant decrease in foreign direct investment into the US from China in recent years. Data from the Rhodium Group suggested that at one point in 2019, Chinese investment into the US had fallen by as much as 90% since President Trump took office.

But it’s not the full story. “I’m always wary of most analysts’ view of China’s FDI statistics for two reasons. First, they are largely based on signed commitments made by the Chinese side to invest; rarely do they measure actual consummation of investments on the ground,” said Harry Broadman, emerging markets practice chair at Berkeley Research Group and a former member of Cfius. "Inflows and outflows of FDI are indicative, but I am not sure they provide any hard and fast conclusion that is economically meaningful," he added.

"It’s also important to distinguish between annual flows of foreign investment and the stock, or cumulative flows, of such investment over a number of years,” continued Broadman.

In any given year, a single investment with huge fixed costs, say a purchase of a large oil refinery, will give a distorted picture – as if the investment relationship between the two countries has fundamentally changed when actually it has not, he said.

“Sometimes the people publishing or analysing these data don’t understand how investments are actually consummated and fail to take into account one-time lumpy transactions," added Broadman.

Either way, there’s little question that Chinese investors have been put off by both FIRRMA and the current administration’s Cfius approach. In meetings with Chinese investors and US firms looking to attract more capital from China, as well as US law firms advising such businesses, Broadman has heard a palpable, consistent refrain from the Chinese side that the US is closed.

“This perception is, to some extent, misplaced,” he said. “It’s typically based on the false assumption that the only US sectors worth investing in are the so-called pilot industries specified under the Cfius regulations,” he noted.

There’s no question the US policy environment for inbound Chinese investment has become tougher. But the Cfius-related advice given to clients in China, as well as to many in the US, is to first build up a positive track record as ‘good foreign investment citizens’ in the US in non-sensitive sectors. “That’s the single most important lesson from the 1980s when there were similar tensions between the US and Japan,” Broadman said.

If you're not on the list, you're not coming in

By and large, though, Chinese firms are not pursuing US deals – even in non-contentious areas.

This could be because guidelines on when a Cfius notification is triggered are quite vague. That decision is largely subject to the administration’s feeling on the specific deal – which doesn’t scream predictability.

Even minority stakes are now up for review now too, which was not the case previously. “Dealmakers just don't know how to interpret it. In the absence of better information or precedent, they think it makes more sense to just stop completely,” said Lo.

“A lawyer’s immediate reaction – in some cases before they've looked at the particulars – is that of course it will trigger a Cfius review. Then comes the recommendation for a full team of Washington lawyers,” he said.

It’s worth noting that national security concerns about Chinese investment are not unique to the US. For decades now there’s been a steady flow of capital from the country into practically every region; the high watermark probably being the ChemChina acquisition of Syngenta in 2017.

“Since then, if there have been deals, players have been quite proactive about security and regulatory concerns," the head of M&A at a major global bank told IFLR.

"Chinese outbound volume too is down 30/40%, and when you break it down further, state owned enterprise activity is down by 60-70%," said the head of M&A. "that has been mitigated by domestic activity. Significant domestic consolidation has been driven by a general restructuring need.”

"This has had some impact. It’s hard to know whether it’s solely Cfius-driven. With M&A it normally goes in flurries. We had such a big year in 2016, and the most active then also have post-merger integration amortisation, integration and reorganisation,” he added. “It’s hard to know precisely if it’s totally driven by regulatory trade considerations or where there other factors at play as well. It will be apparent in the next in the next one or two years.”

See also: South Korea update introduces Cfius-style restriction