By Christian Cornett(partner)，Sandra Link(Partner)，Tilmann-Becker(Counsel). King & Wood Mallesons’ Frankfurt office.
“In 2017, various elements of neo-protectionism have materialised globally, some of which have directly influenced China-outbound investments. While in the US, the committee on foreign investments in the US (CFIUS) has undergone some changes, in the European Union, plans for a new regime on foreign investment in strategic European targets is under consideration (CFIEU). Meanwhile, motivated also by a substantial discussions in the Germany press following the acquisition of some German targets by Chinese investors such as Midea’s acquisition of KUKA – and a few months ahead of the upcoming German election – the German minister of economics has decided to implement a first step by tightening the administrative proceedings regarding foreign investment control. The attached paper sheds some light on these changes.”
This week, the German government published an amendment to the German regulation (AWV, a regulation by the German Minister for Economy in accordance with the authorizations under the German foreign investment act, AWG) on foreign investment control. The changes to this regulation, which sets out the administrative approval procedure for foreign investments in Germany, are expected to come into force after their announcement in a few weeks. Although the German regime varies considerably from the corresponding US regime, recent German changes can to some extent be compared to similar suggested changes to the Committee on Foreign Investment in the United States (CFIUS) framework.
“Level playing field” and areciprocity” – or simple protectionism?
Many observers see the changes as part of recent global trends towards protectionism. In February 2017, the German, French and Italian Ministers for the Economy called for more effective defense instruments at the European level to review politically motivated takeovers of highly technical firms by a non-European country. On 19 June 2017, the European Parliament’s Committee on International Trade (INTA), which deals with issues in European trade policy, published its proposal for the screening of foreign investments in strategic areas. Additionally, on 23 June 2017, the European Council agreed to reinforce Member States’ ability to effectively tackle unfair and discriminatory trade practices and market distortions, and to enhance reciprocity in the fields of public procurement and investment, while adding that it would “revert to this issue at future meetings”. And recently, on 7 and 8 July 2017, G20 leaders in Hamburg reached a compromise on international trade by acknowledging both free trade and “legitimate trade defense instruments.” With regard to foreign direct investment, the G20 emphasized the importance of a reciprocal and mutually advantageous trade and investment framework, and affirmed its unequivocal commitment to “identify[ing] strategies to facilitate and retain foreign direct investment” in their communiqué.
Present German foreign investment regulation (referred to as AWG and AWV) grants the German Ministry for Economic Affairs the option to intervene in or prohibit transactions which are deemed to constitute a threat to public policy or security.
This German regime follows a double approach: in general, it applies to all transactions where an acquirer is located (or controlled by a shareholder ultimately situated) outside of the European Union. The restriction applies if at least 25 percent of the voting rights in a German company are to be acquired. Moreover, there are specific regimes tailored to specific sectors (e.g. targets producing military goods). Particularly following Midea’s acquisition of German robotics producer KUKA, many observers and politicians in the German market have raised their voices and deemed the existing German regime insufficient to protect “vital” or “strategic” German interests. Without changing the existing regime, against the backdrop of an intensive discussion amongst the German press and politicians, and ahead of the German election in September 2017, the new changes to the German regime will at least result in tighter scrutiny of Chinese investments in German enterprises, and prolong the required administrative procedures.
Increased scrutiny to specific sectors
Said to be the result of new “security concerns,” certain new requirements have been stipulated in the revised regulation with respect to “security relevant technologies”. They focus in greater detail on critical infrastructures including transport and traffic, as well as telecom-surveillance technologies, telematics infrastructure, cloud computing-services, sensor technology, and electronic equipment that could be used in warfare in any way. For example: under the new regulation, a threat to public policy and security can be said to exist if the target company develops or amends software that is required for these so-called critical infrastructures, which – e.g. in the sector of transportation and traffic – will now include software used in the operation of premises or systems for road transportation.
Review period extended from three (1+2) to six (2+4) months
The recent changes moreover have a significant impact on the timing of investments by Chinese investors: while so far, a so-called certificate of non-objection (i.e. de facto: an advance clearance) was either granted or deemed to be granted one month after the filing (in cases where no formal procedure is initiated), going forward the so-called certificate of non-objection and thus the (typical) advance clearance will only be granted or be deemed to be granted two month after the filing. Correspondingly, the period for the formal proceedings (in the few cases where no advance clearance is obtained) has been prolonged from two months to four months, thereby increasing the potential investigation period from three to six months. Materially, we expect that in the future the vast majority of transactions will be cleared. The Ministry is permitted to scrutinize past transactions up to five years after the relevant agreement has been entered into, thus the potential consequence is that agreements can be held void. Under the new regime, the waiting period will be prolonged to obtain clearance, all else being equal.
Extended filing periods cause delays and constitute competitive disadvantages
According to official statements by the German Ministry for Economic Affairs, the new regime is supposed to lead to very few additional formal proceedings; the Ministry estimates that roughly an additional ten proceedings will take place per year. Formally, this may be accurate. De facto, however, the number of informal pre-proceedings will increase somewhat, and the effect will be much wider, in particular for Chinese investors. From a seller’s perspective, the increased uncertainty will reduce deal certainty and may thus make Chinese bidders less attractive, particularly in auction processes. Moreover, the German Ministry has predicted that the recent changes will merely result in two additional cases becoming subject to detailed negotiations involving the Ministry. However, even if – materially – we share the view that only very few (if any) future transactions will be caught by the new regulations, all else being equal, the increased administrative burden for all filings, combined with the increased scrutiny and longer procedures for all filings, will inevitably result in a (procedural) disadvantage for Chinese bidders in comparison to European bidders, which may become particularly tangible in auction processes.
Procedural elements reduce deal certainty
While fortunately, KWM in Germany has dealt with both general and specific procedures for Chinese and other clients in the past, and while so far, no transactions we have been mandated to handle have been prohibited, our partners should communicate the new situation to clients investing in Germany. In general, very few formal proceedings have been conducted in the past. Thus, we will be able to deal with this and expect only minor changes in the long run. In the medium- and long-term we expect a situation similar to that in the US: an additional procedural layer which Chinese investors will have to deal with, a limited but residual increase in deal uncertainty, and thus an unfavorable effect on Sino-German deals.