USA Inbound Acquisitions & Investments Blog : Inbound Investment Lawyer & Attorney : Sullivan & Worcester Law Firm : Mergers & Acquisitions, Cross Border Investments

If imitation is the sincerest form of flattery, then the architects of the Foreign Investment and National Security Act of 2007 (FINSA) and its regulatory agency CFIUS can be proud. The Canadian government is revising its Investment Canada regulatory scheme. The result resembles the regulatory system here south of the Canadian border.

Recent Canadian statutory enactments and proposed regulations introduced a new national security review mechanism into the screening process. In 2007, FINSA amended the then-existing U.S. statute, known as Exon-Florio, to specify that national security was to be the sole focus of U.S. regulation. The new Canadian structure authorizes the government to review, block or limit inbound investments by non-Canadians based on national security concerns. One commentator has noted that although the legislation does not define “national security,” it remains to be seen whether the regulators will also consider issues of economic security under the national security umbrella.

Under the new regime, Canada’s national security process starts with a preliminary review of the transaction. If the initial review indicates that there are national security concerns arising from the proposed deal, then the Cabinet reviews and determines whether a full review is required. The review applies the standard, “injurious to national security.” If the transaction fails that standard, then the government may order the transaction blocked, restricted or, if closed, unwound. The maximum length of the review is approximately 3 ½ months. Once the time for review has expired, the Canadian regulators cannot challenge a reviewable foreign investment on national security grounds.

Under the legislation the government retains the authority to initiate a review of non-reviewable transactions, including minority investments, at any time within 45 days after completion.

Recent statutory changes will significantly modify the monetary thresholds for review of inbound transactions. If and when the proposed regulatory changes are made, the threshold will be applied to the enterprise value of the target, not the book value of its assets as is currently the case. The threshold itself is set at enterprise value of Cdn $600 million and will increase to Cdn $1 billion over the next four years.

FINSA and CFIUS are, of course, not the only national security-based regulatory schemes in place today. China, France, Germany, Japan, Poland, Russia and the United Kingdom, among others, based their regulatory reviews of inbound deals on national security grounds.

Canada is frequently mentioned together with Australia as the leading developed, resource-rich nations that are targeted for foreign investment by China and others aggressively looking to source commodities. Australia, by contrast, recently revamped its FDI regulatory scheme to limit the range of deals subject to review. Like Canada, it raised the threshold for review. That change and others are reviewed by our recent August 13 posting in this blog.

Unlike Canada, Australia did not adopt a regulatory scheme that specifically vets national security issues.

For a discussion of the role of national security in the CFIUS review process, please access the white paper located on our firm’s Web site.

Howard Burshtein of Torkin Manes LLP, Toronto, Ontario, contributed to this post.

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Observers of the FDI scene might have come to believe that China’s outbound foreign direct investment (OFDI) program would be unequivocally welcome for its global stimulus effect.  A recent editorial in the Financial Times initially concedes that China’s investment strategy will benefit both Europe and the investing companies. It then asserts a contradictory view.

In a piece decidedly protectionist, two Dutch researchers assert that Europe needs to screen Chinese investment. 

The main issue is not the Chinese taking over European companies of great strategic importance; it is how to respond to the longer-term accumulation of economic power in Europe by a country such as China. 

The writers suggest that the EU emulate the U.S. and establish a regulatory body similar to CFIUS with jurisdiction over all of its member nations. The union-wide solution is necessary to prevent Chinese investors from playing one country against another, say the authors. The editorial then raises the Trojan Horse rationale for regulation:

What has already caused anxiety in some European countries, particularly Germany and France, is the fact that the leading Chinese companies, banks and investment funds are state-controlled. Because Europeans regard China’s autocratic political system as incompatible with their own democratic norms, the growth of Chinese influence in European companies is a highly sensitive issue.

An effective, non-politicized regulatory body that screens solely for issues of national security, and not broader issues of economic security, may or may not be beneficial to the EU. Conjuring up threats of stealth investment by Chinese state-owned enterprises is not likely to lead to a dispassionate, reasoned evaluation of the proposal. There is also the equally important question of how to insure that a regulatory screening body chartered to protect national security does not morph into a Trojan Horse for wider nationalist or protectionist agendas. 

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Last week Wayne Swan, Australia’s Treasurer, announced significant reforms to Australia's foreign direct investment (FDI) screening framework. The reforms will invite addition mergers and acquisition activity, with a view to supporting economic growth and positioning Australia for a more competitive recovery beyond the global recession. 

There are concerns that the current economic turndown may lead countries to restrict inbound mergers and acquisitions. Australia nevertheless has taken commendable steps. Swan’s steps -- clearly anti-protectionist and pro-globalization -- reflect his assessment of the best interests of Australia’s economy. The reforms upsize the investment screening thresholds, set as fixed dollar amounts.

According to Mr. Swan’s press release, Australia’s government has recognized that the health of its economy is linked to the global economy. The government seeks to eliminate certain impediments to further FDI by removing itself from uncontroversial business transactions. The announcement makes clear that “Foreign investment is vital to Australia’s future growth and prosperity.” Reasons underlying this linkage are that FDI:

• creates jobs
• increases innovation
• promotes healthy competition

The current regulatory regime has six thresholds. The proposed regulations:

• replace the four lowest thresholds with one threshold of AUD 219 million
• replace those threshold that apply to U.S. investors with one threshold of AUD 953 million
• index the threshold amounts annually against the GDP price deflator
• eliminate the notice requirement that applies when foreign investors (other than U.S. investors) make a greenfield investment of more than AUD 10,000,000

Directly on the heels of Mr. Swan’s announcement, Yanzhou Coal Mining Co. reportedly launched its cash bid to acquire Felix Resources Ltd., based in Brisbane. Talks between the companies had begun over a year ago. According to Dealbook, Yanzhou’s bid is valued at more than AUD 3.5 billion. The offer may well test Australia’s liberalized outlook. 

To put the matter in context, China's direct investments in Australia reportedly grew from US $1.4 billion in Q1 2008 to US $13 billion in Q1 2009, a staggering 830% increase.

Dr. Peter Drysdale, emeritus professor at the Australian National University, buttresses Swan’s rationale. Dr. Drysdale, a noted Australian economist, speaks out against protectionism and in favor of cooperative, bilateral frameworks. He has told Xinhua, the official press agency of the government of the PRC  that “Anxiety over the growth of foreign investment in resources by China is unfounded.” Dr. Drysdale’s premise is that increased international cooperation brings benefits to both the investor and the host country. Outbound investments secure stakes in projects that can provide long-term supplies to China’s rapidly growing markets and also bring management know-how and technology to China. The host country receives capital, know-how and access to markets. The Australian government has clearly heard Dr. Drysdale’s appeal to put market solutions ahead of regulatory solutions. 

The Australian Government’s reform is particularly courageous in light of the current controversy over China’s July 5 detention of four Rio Tinto Ltd. employees, one of whom is an Australian national. Yesterday, there were reports that Shanghai prosecutors had approved the arrest of the employees. There is a predictable home-base backlash against FDI from China into Australia arising from China’s steps to deal with alleged thefts of secrets, particularly data with great value to China’s steel manufacturers, as well as bribery of non-governmental officials. 

Our July 16 post to this blog discussed the U.S. State Department’s support for inbound FDI into the U.S. As the Australians are proving, however, actions are louder than words.

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Our latest post last week referenced the June 2009 Peterson Institute policy brief discussing China’s outbound foreign direct investment, authored by Daniel H. Rosen and Thilo Heinmann. The paper points out that global economic turbulence has made potential outbound investors in China hesitant to go abroad, citing three compelling pieces of evidence:

• The value of approved nonfinancial overseas projects announced in Q1 2009 decreased to $3.7 billion from more than $10 billion in Q1 2008.
• A recent study reported that more than 50% of Chinese firms are scaling back their overseas investment plans. 
• Chinese government has withheld approval for deals in the financial sector and chastised firms in other sectors for their overseas investment plans.

The brief predicts that despite these “short-term anxieties,” OFDI by China will increase substantially in both the medium and long terms. The key driver behind the increase is China’s need to transform its model for achieving internal growth from domestic manufacturing alone to more integrated activities carried on internationally. 

If, however, there is reluctance or unwillingness on the part of Chinese firms to make outbound direct investments, then to what extent are these attitudes attributable to changes in investment review policies of investee nations.

The issue of review policies by recipient nations is taking central stage. The brief predicts that China’s OFDI will increasingly target higher-value assets in advanced economies, such as high technology firms. As it targets these businesses, governments and businesses alike may raise national security rationales to impede the investments. In anticipation of this transformation the brief warns that potential recipients of Chinese investments may use national security inappropriately as a basis for blocking investments and requests clarity as to which business sectors are not available for OFDI investment. 

With specific reference to the U.S., the brief notes that earlier efforts to expand the U.S. investment review system to include economic security were resisted. The discussion, however, is restarting. This reaction is due to the perception that China’s government is robustly involved in its nation’s businesses. The brief argues that

• Chinese executives need clear U.S. policy to determine beforehand whether bids may be rejected on national security grounds and
• greater clarity on this issue would benefit the United States by maximizing its asset values and preventing retaliatory treatment abroad.

The brief points out that many governments have tightened investment rules in recent years in response to increased outbound investments from China and the Middle East. A chart included makes the point convincingly: 

On that basis, the brief asserts that in many countries investment protection is growing, investment rules lack transparency and domestic interest groups affect the review process. The attempted takeover of Unocal by Chinese National Offshore Oil Corporation and the involvement of Huawei Technologies in Bain Capital’s attempted acquisition of 3Com Corporation are cited as examples.  As a result, politicized reviews are an obstacle in the view of outbound investors. 

Businesses throughout OECD economies are likely to receive investment offers from Chinese firms in the near future. Consequently, the brief advises that it is imperative, in light of the many benefits to arise from China’s OFDI, that each country, including the U.S., consider the broad image of policy issues and articulate an approach conducive to that incipient inbound investment.

Last week also brought reports that Chinese security officials had detained four Rio Tinto executives on grounds that the four had stolen state secrets.  According to the Australian CEO World blog, the arrests have shocked both the business world and the Australian government.  Sources cited in the blog attributed the arrests to sensitivities in the Chinese leadership arising from economic stagnation and a search for scapegoats.  Australian press is reporting that China’s spy and security agencies have been promoted to top strategy-making positions for the purpose of managing China’s economy through the downturn.  Demonstrating that virtually every issue has an OFDI aspect, however, the China Securities Journal reported that shortly before last Thursday’s detentions the state-controlled Aluminum Corporation of China (Chinalco) bought $1.5 billion of Rio Tinto shares.  

The international reactions and press allegations are likely to make Chinese executives and officials even more reluctant to proceed with their OFDI plans and affect the receptivity of recipient economies as well. Resolution of the conflict will provide greater insight into when and in what ways expanded OFDI by China may materialize.  

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It’s well to remember that CFIUS is not the only regulator of cross-border deals that affect U.S. businesses. 

The Wall Street Journal’s Deal Journal on June 11 quoted Liu Shanwen, the CTO of Dongfeng Motor Group, who discussed Sichuan Tengzhong Heavy Industrial Machinery’s pending purchase of Hummer.  Mr. Liu estimated the transaction has less than a 30% chance of being approved by China’s Ministry of Commerce.  Hummer’s buyer does not have a high profile in China, and the Hummer product seems to be the opposite of the fuel-efficient automotive technology that the Chinese government is actively promoting.  According to Automotive News, Sichuan Tengzhong is privately owned and manufactures heavy special-use vehicles, structural components for highways and bridges and construction machinery. Hummer’s management is optimistic about an enhanced product line after the deal closes later this year, including changes to current products.

Even if it were predictable that Chinese regulators would be less than enthusiastic with Hummer’s becoming a Chinese product, there may have been another Chinese contender for the purchase of Hummer—Beijing Automotive Industry, Daimler’s China partner. According to several reliable media sources, Beijing Automotive has also expressed interest in acquiring Volvo from Ford, having been unable to capture GM’s Opel unit. Beijing Automotive and Geely Automotive Holdings are reportedly in competition for Volvo. Geely, China’s biggest private automobile maker, had been mentioned as an interested purchaser of some of GM’s models. There is no indication yet whether China’s regulators will weigh in on the Volvo transaction.

Not to be outdone, even if in Chapter 11, GM too is looking to shed its Scandinavian unit, Saab Automotive AB. According to MarketWatch, a Swedish TV station has reported that Saab has agreed to be bought by Koenigsegg Automobile AB, a niche sports-car maker that employs only 45 full-time workers and produces only a few cars a year. The deal apparently has the backing of the Swedish government, which may be prepared to issue a loan guarantee to support Saab going forward. Unlike Beijing, there do not appear to be regulatory hurdles in Stockholm.

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