Watch this space: how merger clearance is evolving

Several countries want to increase national security reviews of foreign buyers, and have set plans in motion to implement investment clearance reforms

From Brussels to Canberra, policymakers continue to weigh the benefits of traditional open investment frameworks against growing anxiety over increasing investment from China and other economic and strategic competitors in sectors that are considered critical. The EU is considering adopting a region-wide investment screening mechanism for the first time. Australia, for its part, recently tightened restrictions on foreign acquisitions of agricultural land and electricity infrastructure. Likewise, in the US, the Committee on Foreign Investment in the United States (Cfius) continues to make headlines. To date this year, at least four transactions involving Chinese parties have been frustrated and abandoned due to failure to achieve Cfius clearance.

These developments are generally consistent with the heightened scrutiny of foreign direct investment that characterised the latter half of 2017. Nevertheless, they reflect a profound shift in the historic Western commitment to the free flow of capital across national borders. This profound change is evident in the broad political support for clearance reform.

We summarise below several noteworthy developments to watch in global national security reviews and offer some related takeaways for cross-border dealmakers to consider.

Meaningful international cooperation and information sharing among national security regulators in the US and its allies is on the horizon. As a result, parties to cross-border transactions will likely encounter increased regulatory headwinds, which may result in deal delays and uncertainty.

Ongoing European Parliament discussion of the draft EU legislation have emphasised the critical importance of collecting data and exchanging information regarding inbound investment. Initially previewed in a speech by Jean-Claude Juncker in September 2017, the EU screening framework would not supplant investment review processes in individual member states, but would instead 'enhance cooperation on FDI screening between the [European] Commission and Member States, to increase legal certainty and transparency'. Public reports indicate that EU officials hope to reach agreement on the framework by the end of 2018.

In the United States, Cfius reform legislation introduced on November as the Foreign Investment Risk Review Modernization Act (Firrma) would direct the US President to encourage other countries to adopt Cfius-like regimes to screen foreign investments for national security reasons. Firrma would similarly incentivise other countries to adopt investment screening mechanisms by enabling such countries to undergo less demanding Cfius reviews. The Assistant Secretary of the Treasury for International Markets underscored the Trump administration's strong support for cooperation with US allies in recent testimony before the US-China Economic and Security Review Commission:

'[I]t is essential to our national security that our allies maintain robust and effective national security review processes to vet foreign investments into their countries.'

Notably, the Trump administration's openness to international coordination in national security reviews echoes longstanding US policy and political support for multilateral regulations in the export control space.

Takeaway: Transaction parties must ensure consistency in what they disclose to regulators in different countries as well as in any press releases or public filings. Parties should assume that, in a base-case scenario, public filings made in one jurisdiction will be seen and reviewed by all other relevant regulators.

National security regulators will continue to forcefully exercise their authorities to review transactions that fall within their jurisdictional ambit. Pre-transaction planning and transaction due diligence should include targeted inquiries regarding the target company's national security risk profile in any jurisdiction where a national security review could be required or advisable.

In July 2017, presumably responding to growing anxiety over rapid increase in Chinese investment, Germany amended the Foreign Trade and Payments Regulation strengthening the German Ministry of Economics' (BMWi) authority to scrutinise acquisitions of German companies, with a focus on those operating in critical infrastructure sectors (eg energy, IT, transport or telecommunications).

As of February 2018, about 30 transactions had reportedly been audited under the new regime. In late December 2017, the BMWi announced that it would investigate the acquisition of Cotesa, a manufacturer of parts for aircraft manufacturers, by a subsidiary of China Iron and Steel Research Institute Group, a state-owned enterprise. The deal is now on hold, pending the results of the BMWi's investigation.

In the United States, Cfius' decision to intervene in Broadcom's $122 billion hostile bid for Qualcomm–which came just two days before Qualcomm's shareholder meeting to vote on the takeover proposal–is emblematic of the vigorous approach that Cfius has generally adopted in the Trump administration. Following a voluntary filing submitted by Qualcomm and several weeks of public calls from certain members of Congress to investigate the transaction, CFIUS issued an interim order on March 4 2018, prohibiting Qualcomm from convening its annual shareholder meeting until Cfius had conducted its review. Days later, Cfius advised Broadcom that it would need to provide Cfius with advance notice of any steps taken to carry out Broadcom's plans to re-domicile in the United States. On March 12 2018, after Cfius notified Broadcom that it had failed to provide sufficient advance notice and additional information as requested, President Trump issued an executive order prohibiting the transaction from proceeding. Broadcom has since announced it was abandoning its bid for its US rival.

While the Cfius process is still currently voluntary, a decision not to notify Cfius of a transaction in which it may be interested carries risk. The risk may be especially acute in transactions where the acquirer intends to take the target company public: an inquiry from Cfius during the lead-up to an initial public offering could have significant collateral market consequences for the acquirer.

Takeaway: Acquirers should ensure that they understand how national security regulators would view their fitness as buyers of assets in the relevant country or countries. In the private equity context, this assessment often requires a more granular evaluation of evaluation of the regulatory DNA of the fund, manager or advisor, and any co-investors in play.

Complex transaction structures elevate risk. Dealmakers involved in transactions with complex ownership chains should build into their timelines sufficient time for regulators to fully understand beneficial ownership of the acquiring party.

In January 2018, the European Parliamentary Research Service released its report on an EU foreign direct investment screening framework. Among other things, the report highlighted concerns regarding acquisitions of companies with cutting-edge or dual use technologies and strategic infrastructure assets by foreign investors, including opaque state-owned enterprises.

Similarly, in the US, complex ownership chains frequently prompt Cfius requests for additional information about the ultimate beneficial ownership of the acquirer–including, for private equity sponsors, information about minority ownership interests held by limited partners.

Notably, these growing concerns about direct and indirect beneficial ownership are not restricted to the investment screening context; they dovetail with recent enhancements to customer due diligence (CDD) and other related requirements among EU, US and Canadian anti-money laundering and sanctions regulators.

China remains in a 'category of one' for perceived national security risk, but it is not the exclusive source of national security risk. Evaluating an acquirer's national security profile often requires a bespoke evaluation taking into account all relevant factors as well as the policy and political context in the relevant jurisdictions.

It is no secret that acquisitions involving Chinese investors have garnered significant political and media attention, particularly over the last 18 months. This trend holds true not only for transactions involving 100% buyouts of companies by Chinese parties, but also in transaction scenarios that contemplate minority investments with more limited governance rights that do not involve a corporate traditional change of control. For example, in November 2017, CEFC China Energy Co. abandoned a planned $100 million investment in US asset management firm Cowen, under which CEFC would have acquired a 19.9% stake in Cowen, after the investment failed to achieve Cfius clearance.

However, this focus on China may well distract dealmakers from recognising latent risks in transactions without a nexus to China, certain of which have encountered similar regulatory turbulence. For example, participation by Russian investors frequently elevates deal risk, even if the target company does not operate in a sector that has traditionally been considered sensitive. The shifting Russia sanctions landscape in the US and Europe is likely to heighten risks around Russian investment in the near term.

Similarly, Cfius frequently considers in its assessment of a foreign buyer's national security fitness the buyer's record of compliance with applicable economic sanctions and export controls–regardless of the buyer's country of origin. If enacted, Firrma would make this evaluation mandatory.

According to the draft EU regulation, the Commission and the EU countries may take into account whether the foreign investor is controlled by a government of a third country, including through significant funding. This addresses the fact that EU member states are subject to EU state aid rules, whereas third countries are often only subject to WTO-level subsidy rules, which are subject to much looser scrutiny.

Mario Mancuso, PC Partner Kirkland & Ellis (Washington DC)

Anna Schwander Partner Kirkland & Ellis (Munich, Germany)

Lucille Hague Associate Kirkland & Ellis (Washington DC)