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

Will President Obama’s recent trip to China product any inbound FDI results for the U.S.? According to the U.S.-China joint statement, the November 16-18 trip produced significant agreements in five key areas of bilateral interest. There were tangential, but not explicit, mentions of FDI into the U.S. either by way of mergers and acquisitions or Greenfield investments.

Judging from the tenor and substance of the joint statement, the meetings further developed the mutual confidence and trust that are the predicates for a favorable investment climate. The five key areas of agreement were:

• The importance and productivity of regular high-level exchanges to the growth of the overall U.S.-China relationship
• The building of a bilateral strategic relationship that is positive, cooperative and comprehensive
• Strengthened dialogue and cooperation on macro-economic policies leading to global recovery
• Shared responsibility to cooperatively address regional and global security challenges
• Vigorous responses to issues of climate change, energy and environment

The joint statement implicitly references the importance of FDI at several points. There was express recognition of the importance of the U.S.-China Strategic and Economic Dialogue. “Both sides believed that the first round of the Dialogue held in Washington, D.C., in July this year was a fruitful one and agreed to honor in good faith the commitments made and hold the second round in Beijing in the summer of 2010.” The bottom line is that the U.S.-China FDI relationship appears well and growing and on track to produce results. Those results may not be evident until later next year. 

Further, while addressing the need to support the global recovery, the statement made clear that both sides are committed to open trade and to jointly fight protectionism and to resolve bilateral trade and investment disputes. The joint statement articulated the explicit promise of the U.S. and China “to expedite negotiation on a bilateral investment treaty.”

Prior to the release of the joint statement, reports had appeared in the Chinese press, notably the South China Morning Post, that a specific agreement would be reached to promote acquisitions of small and mid-size U.S. financial institutions by Chinese lenders. No such agreement or memorandum of understanding appears to have emerged from Obama’s visit.

A recent transaction involving a proposed takeover by China’s Minsheng Bank of failed California-based bank, UCBH Holdings, illustrates the formidable difficulties to be overcome if U.S. regulators intend to encourage Chinese lenders to invest in U.S. banks. Minsheng Bank had acquired a 9.9% interest in UCBH in 2007 and recently raised US$3.86 billion in its initial public offering in China. According to a report in The Wall Street Journal, Minsheng Bank also sought to acquire United Commercial Bank before U.S. authorities closed the San Francisco-based lender earlier this month. 

UCBH operated the United Commercial Bank, with several branches in California and also in other key Chinese American areas, such as New York, Boston, Seattle, Atlanta and Houston. United Commercial suffered commercial lending losses from loans to developers and home builders during the housing boom. A financial scandal led to a management shake-up. 

The Federal Reserve rejected China Minsheng's proposal to buy United Commercial Bank because of regulatory restrictions on foreign investment in U.S. banks and instead closed the bank. Soon after the closure, East West Bank, based in Pasadena, California, took over United Commercial Bank's roughly $7.5 billion in deposits, as well as $10.2 billion in assets. The Los Angeles Times reports that its takeover of UCBH will greatly expand its reach of East West, which has concentrated on Southern California and the San Francisco Bay Area. Interestingly, East West has a full-service branches in Hong Kong. 

The plain result of the regulatory actions is that a domestic bank with no interest in UCBH was permitted to acquire the business, while a foreign bank that always was a part owner of UCBH was not. The broader implication seems to be that any federal policy determined to promote inbound FDI will have to be based on a full and complete alignment of regulatory agencies at all levels. Otherwise, well-intentioned policies will be incapable of being executed. 

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China’s outbound foreign investment strategy continues to make news. TheStreet.com and other business media reported today reported yesterday that China Investment Corp. (CIC), China’s sovereign wealth fund with approximately $300 billion in assets, may be discussing an investment into, or joint venture with, The AES Corporation of Arlington, Virginia. AES operates electrical generating facilities and distribution systems across the globe, has more 25,000 employees and a market capitalization of $9.8 billion. Reuters has reported that last week a senior CIC official said that CIC is seeking minority investments in infrastructure projects as well as green energy projects. 

To view these media reports in proper context, it may be well to review a few basic facts about China’s current outbound foreign direct investment (OFDI) program, as reported by Xinhuanet on September 8. Xinhuanet based its story on a report jointly issued by China’s Ministry of Commerce, the National Bureau of Statistics and the State Administration of Foreign Exchange that same day.

• China’s OFDI added up to US$183.97 billion by the end of 2008. 
• The source of China’s OFDI is more than 8,500 domestic investors, whose overseas corporate assets in 2008 exceeded US$1 trillion. 
• Chinese overseas enterprises employed about 1.03 million people, including 455,000 overseas employees.
• China’s net OFDI in 2008 was US$55.91 billion, an increase of 111% from 2007.
• Chinese investors have established approximately 12,000 enterprises overseas in 174 countries or regions. Approximately 71% of these enterprises were in Asia and Europe.
• Among Chinese outbound investors, 50.2% were limited companies, 16.1% were state-owned enterprises and 9.4% were private companies. 
• Investment by state-owned companies declined 3.6% from 2007.

Australia is a key target for China’s OFDI, because of that continent’s abundant raw materials and other material resources. Xinhuanet also reported that Australia is seeking to attract increased amounts of Chinese investment and deepen their bilateral economic cooperation, especially in the energy and natural resource sectors. The senior trade commissioner of the Australian Trade Commission confirmed Australia’s intentions at a international trade forum held in coastal Xiamen, Fujian Province, on September 8. 

Data from Australia’s foreign review board show that Chinese investment interest in Australia is on a strong upward trend. Even so, at the end of 2008, China’s total investment stock in Australia was only $6.83 billion, and represented an increase of 26.7% from the position at the end of 2007. With this significant increase, China ranked as Australia’s 13^th largest foreign investor.

China’s surge in OFDI may be rooted in its internal $585 billion recession-fighting stimulus package. That package represented 13.2% of China’s gross domestic product for 2008. During Q1 of 2009, Chinese state-owned banks increased their lending by more than one trillion dollars, or more than half of the national GDP on an annualized basis. According to published reports, over half of the new loans went into China’s stock and property markets, generating speculation-driven increases in prices. The remainder went into the Chinese economy and is likely to be doubt a substantial factor driving China’s OFDI. Recognizing that increased China OFDI may be more than desirable for generating and maintaining its economic recovery, Australia’s recently revised foreign investment rules raised the dollar threshold for investments that require regulatory review. The change is expected to result in an increase in the number of Chinese investments in smaller Australian natural resource and energy companies. According to the Australian trade official referenced above, Chinese investment has not harmed Australia’s economic security and has enhanced the reputations of the investors. 

The U.S. is on a slower path with China. It is possible that if the AES discussions mature into a deal and if CFIUS and other regulatory review supports the deal, the pace of China’s OFDI into the United States will accelerate. Adverse regulatory responses will likely have a dampening effect when this country can least needs it. 

Updated: On September 16, in a follow-up article, Xinhuanet reported that, according to China’s Ministry of Commerce, OFDI by China's 136 centrally-administered state-owned enterprises (SOEs) in 2008 was $35.74 billion.  The investment accounted for 64% of China's total OFDI for the year.   This appears to be a significantly larger share than had been previously reported.

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How likely is it that the remainder of 2009 will see an upsurge of mergers and acquisitions or other investment activity from China?

Financial Web site 24/7 Wall St. provided its answer in a September 1 post, arguing that, in spite of China’s insatiable appetite for energy deals, that nation is more than reluctant to invest in the U.S. 24/7 Wall St. catalogued announced deals over the past year with public companies across the globe and tallied $50 billion of oil and gas purchases, as well as uncounted unannounced deals, without the merger or acquisition of a single U.S. public oil company:

As asset prices sink, it is easier for China and its central government to buy more and more of whatever it wants on the cheap. . .  . [T]he pace at which China is locking in energy supply deals seems to only be increasing. And it is effectively doing it without a single handshake taking place on U.S. soil and without U.S. oil.

The post suggests that the 2005 CFIUS action that blocked Chinese National Overseas Oil Corporation from acquiring Unocal—later acquired by Chevron—still looms as a basis for Chinese buyers to avoid U.S. deals. This view discounts the Obama Administration’s desire to turn the page on the actions of the prior Administration, as recently shown by the July Chinese/U.S. cabinet-level meetings held in Washington, discussed in this blog’s August 6 post.

As Exhibit I to 24/7 Wall St.'s position, there was the August 31 announcement from Athabasca Oil Sands Corp. of its joint venture with PetroChina International Investment Company Limited, a wholly-owned subsidiary of Asia’s largest oil and gas company. Through the venture, PetroChina has agreed to acquire a 60% working interest in AOSC's MacKay River and Dover oil sands projects for $1.7 billion. The agreements also provide for certain financing arrangements for AOSC. The projects are located in the centre of the Athabasca area in northeastern Alberta and have been independently assessed to contain approximately 5 billion barrels of bitumen resource.

Looking more broadly, however, there is a significant amount of FDI that is directed at the United States, particularly in areas other than the energy sector, and the future seems quire promising. The International Trade Administration (ITA) of the U.S. Department of Commerce recently reported that from 2004 to 2008 the FDI position of the Asia-Pacific nations in the U.S. grew at an average annual rate of 10%, exceeding the global average growth rate by 25%. The annual growth rate of FDI from China into the U.S. during that period was 23%. Although this growth rate was not as high as that of Singapore (49%) or India (48%), it approximates that of South Korea. It can hardly be considered to be negligible.

The ITA cites three motivating factors that drive FDI: access to innovation, markets and resources. The ITA makes that case that the U.S. excels in each category, noting that, "In many cases, Asian-Pacific companies do not invest in the United States solely to minimize the cost of inputs, such as . . . natural resources . . . ." Therefore, although the U.S. can offer a workforce with high productivity to offset its higher cost, a highly efficient transportation system and openness and transparency, in the natural resources sector, our assets may come with costs that compare unfavorably to Canada, Australia and other markets.

The ITA report states that "the United States should expect large increases of FDI flows, especially from China and India . . . ," the third and twelfth largest world economies. Based on trend evidence accumulated over the past 50 years for other economies such as Japan, the relative and absolute amounts of their OFDI into the U.S., ITA predicts that OFDI from those nations will increase to be in line with their rankings. The report also points to academic studies demonstrating that developing nations generally promote OFDI and eventually become net outward bound investors. Those trends cannot occur without significant investment into the US from Asia-Pacific nations in general and China in particular.

The ITA report asserts that inbound FDI will occur. Nonetheless, the predicted influx seems to not yet be occurring, as 24/7 Wall St. points out. Q4 of 2009 may reveal more as to which camp has the better argument.

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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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The Committee on Foreign Investment in the United States (CFIUS) figured prominently in the high level discussions held last week in Washington between representatives of the People’s Republic of China and the U.S. government.

According to the “The First U.S.-China Strategic and Economic Dialogue Economic Track Joint Fact Sheet,” the U.S. committed unequivocally that the CFIUS screening process would be non-discriminatory:

In addition, the United States confirms that the Committee on Foreign Investment in the United States (CFIUS) process ensures the consistent and fair treatment of all foreign investment without prejudice to the place of origin. The U.S. reaffirms its commitment to the open and non-discriminatory principles for recipients of sovereign wealth fund investment as identified by the Organization for Economic Cooperation and Development.

Two days of meetings were held among U.S. Secretary of State Hilary Rodham Clinton and U.S. Secretary of the Treasury Tim Geithner, as special representatives of President Obama, and Chinese Vice Premier Wang Qishan and State Councilor Dai Bingguo, as special representatives of President Hu Jintao.

Underscoring the importance of the meetings to the U.S. economy, President Obama addressed the opening session of the Dialogue. Twelve U.S. cabinet secretaries and heads of executive agencies also attended. The Fool’s Mountain blog carries an extended excerpt from the President’s address. There is no question but that the White House is taking substantive steps to acknowledge the importance of China’s investor status to the improvement of the U.S. economy.

Secretary Geithner’s closing statement, released on July 28, reflected the high profile that CFIUS has in these discussions. He reaffirmed U.S. commitments “to open and rules-based trade and investment” and to avoiding protectionist measures. In return, China agreed to increase its thresholds for “foreign direct investments that must obtain central government approval.” The accompanying release clarifies that China’s commitment means less regulation of inbound investment into China, particularly by its opening service markets to private investment.

The Administration seems determined to confront and allay the misgivings that Chinese investors and businesses have about the U.S. regulatory screening process. The prior experiences of Huawei Technologies and CNOOC are often cited to substantiate doubts, without equal time given to those transactions that proceeded without incident. In the conventional view of Chinese investors and businesses, any overall effort to increase investment from China requires clarity from CFIUS as to what U.S. industries, if any, are off limits. Congress has given CFIUS the gatekeeper role for inbound FDI. To keep CFIUS as far away from politics as possible, CFIUS must keep its profile low, remain nimble in its dealings and maintain intact its process for dealing with filed notices on a case-by-case basis. Pronouncements that characterize specific industries as in bounds or out of bounds will only attract the degree of attention that has been hostile to FDI in the past. Although foreign investors may genuinely desire more definitive guidance, that guidance may be better obtained from experienced U.S. advisors rather than backing CFIUS into unwelcome positions.

The net result of the meeting and the dialogue may well be that offshore buyers and investors — Chinese and other — see their way clear to proceeding with U.S.-targeted deals. This will be welcome news for private equity, venture and buyout funds with portfolio companies in need of cash. It will also be welcome news for M&A advisory firms, especially those who have built relationships in the developing world.

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Is it reasonable for U.S. businesses to expect mergers and acquisitions activity and investments from Chinese businesses?  In pursuit of a reliable answer, last week we posted Part I of our interview with Dr. Daniel H. Rosen.  Dr. Rosen is an economic advisor specializing in China’s commercial development and writes and speaks extensively on US-China economic relations. He is the Principal of Rhodium Group, a specialized practice helping decision-makers analyze and understand commercial, economic and policy trends in Greater China. He is a graduate of the Graduate School of Foreign Service at Georgetown University and the Department of Asian Studies at the University of Texas, Austin. He is a Member of the Council on Foreign Relations and the National Committee on U.S.-China Relations. He is the author of Behind the Open Door: Foreign Enterprises in the Chinese Marketplace. 

Our interview continues:

China’s State Administration of Foreign Exchange has recently announced policy changes intended to encourage OFDI, including broader access to foreign exchange to finance acquisitions.  Will these changes result in increased acquisition activity, as intended?

Rosen: Yes, but not by themselves.  Global asset price volatility is particularly distasteful to Chinese firms, which face political pressure from units of government other than SAFE if their undertakings abroad underperform.  There remains a discouraging schizophrenia in China’s policy toward investing abroad.

The July 5 detention of Stern Hu, Rio Tinto’s lead negotiator with China’s iron ore importers, was initially perceived as a step backward for both inbound and outbound investment in China.  More recently, statements by Chinese officials suggest that the government was acting to protect its legitimate interests.  Are you willing to predict the outcome of the affair?

Rosen: It is impossible to say how his will be resolved.  However the lesson learned is that China has a business planning and market transparency problem, which will poison commercial practices and create inefficiencies as long as it remains unaddressed.

How do Chinese businesses and governmental officials perceive the U.S. regulatory structure for reviewing inbound investments? 

Rosen: They are unhappy with them, and believe that the US is disingenuous when it says that we have no “no go” sectors or strategic industries apart from national security concerns.  They want clarity on US sensitivities. 

Do the CFIUS regulations provide sufficient clarity for those required to provide information to that agency?

Rosen: Not necessarily, but usually.  The system is inherently subjective, in part because the motivation of the buy side is inscrutable and yet relevant to the outcome.

Is CFIUS considered to be a fair or non-politicized regulator?  Is there a perception of bias against Chinese acquirers? 

Rosen: Generally CFIUS works ok, but CFIUS is not the only factor impacting China’s OFDI to the US.  It is the process of record, but super-regulatory forces can impede a given deal, as they did in the Unocal case.

If Chinese investors were to suggest changes to the U.S. regulatory structure, what might those changes be? 

Rosen: They have asked for a “negative list” of areas that are off-limits.  What is equally important is what they do not want to see, which is an expansion of the CFIUS mandate to include any sort of national “economic security” considerations. 

Thank you, Dr. Rosen. 

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Is it reasonable for U.S. businesses to expect mergers and acquisitions activity and investments from Chinese businesses? Our posts of July 10 and 13 highlighted a policy brief on China’s Changing Outbound Foreign Direct Investment Profile published by the Peterson Institute for International Economic and written by Daniel H. Rosen and Thilo Hanemann. Dr. Rosen agreed to respond to questions that we posed regarding China’s approach to mergers and acquisitions and other direct investments in the U.S.  Part I of our interview follows.

Dr. Rosen is an economic adviser specializing in China’s commercial development and writes and speaks extensively on US-China economic relations. He is the Principal of Rhodium Group, a specialized practice helping decision-makers analyze and understand commercial, economic and policy trends in Greater China. He is a graduate of the Graduate School of Foreign Service at Georgetown University and the Department of Asian Studies at the University of Texas, Austin. He is a Member of the Council on Foreign Relations and the National Committee on U.S.-China Relations. He is the author of Behind the Open Door: Foreign Enterprises in the Chinese Marketplace. 

Your recent policy brief addressing China’s changing outbound foreign direct investment (OFDI) makes a strong case for an expectation of increased OFDI.  In fact, you write that China’s OFDI is at an inflection point and that the geographical distribution of OFDI will shift toward the OECD countries. Do you expect OFDI into the United States to accelerate? 

Rosen: Yes.  Wherever Chinese producers are already OEMs or producers in value chains that lead to the US, they should be expected to move up and down those value chains toward US assets.

What are the characteristics of those American businesses that would be most attractive as investments for Chinese strategic investors?  

Rosen: Complementarily to Chinese capabilities, low price, non-union.

How important is the price level for those businesses?  Are distressed U.S. assets attractive to Chinese investors as an investment class?

Rosen: Price is important to Chinese firms, but not if it reflects extremely complicated situations.  China has little ability to work-out regulatory, labor or legal complexities, and so will tend to avoid them, or else have to rely on co-investors to deal with them. 

At various times in the past, both strategic and financial buyers have acquired or invested in U.S. companies.  How close are we to a time when Chinese financial buyers, as opposed to strategic buyers, will acquire U.S. businesses? 

Rosen: I think Chinese investment will be weighted toward strategic buyers who can generate value through expanded scope for a long while.  Financial investors from China have little ability to add value in the US.

You have written about the imperative for China’s firms to capture a greater share of the production chain.  The 2005 Lenovo transaction with IBM was a precursor of this type of transaction.  Do Chinese businesses and the Chinese government perceive the Lenovo transaction as a model to be followed?

Rosen: Lenovo is still considered an exceptional case, involving exceptional entrepreneurship.  Even still, it is not considered a home run in terms of performance.  It is a healthy example of the real, normal business challenges that will arise in even better Chinese forays abroad.

Part II of the interview with Dr. Rosen will be posted on August 3, 2009.

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Chinese regulatory authorities have taken an important initiative to encourage outbound FDI from China. U.S. private equity funds and other owners of businesses desiring investment should take note of these changes. These developments also are significant for investment bankers and other intermediaries, as the steps should enhance their ability to broker strategic arrangements. 

In June, China’s State Administration of Foreign Exchange (SAFE) announced that new regulations loosening its control on outbound investment procedures would take effect on August 1. SAFE will also modify its controls over foreign exchange management of domestic companies with overseas investments. The announced policy purposes of the modifications are to:

• stabilize external demand for domestic products;
• increase the efficient use of funds by Chinese enterprises; and
• support the “go global move” of enterprises “of diverse ownership” to stimulate exports.

The major changes that SAFE announced are:

•  “qualified enterprises of diverse ownerships” now can make overseas loans;
• sources of funds for overseas ownership are expanded and can include self-owned foreign exchange and foreign exchange purchased with Chinese currency;
• streamlining of procedures for overseas lending, which will be decentralized; and
•  improvements to statistical monitoring of, and risk prevention for, overseas lending.

In a related development, a former assistant professor of economics at an Indiana university has been promoted to chief of SAFE. The appointee, Yi Gang, is also a vice governor of the Peoples Bank of China. Mr. Yi taught at Indiana University-Purdue University Indianapolis from 1986 to 1994.

The changes announced by SAFE are likely connected to China’s accumulation of foreign exchange. The Financial Times reported on July 15 that China’s foreign reserve position had increased beyond $2.1 trillion. The merge results from capital inflows to take advantage of faster economic growth and inflating asset prices. These trends arise from the view that China’s economic recovery will be sustained, with GDP growth for the second quarter of 2009 expected to approximate 8%.

The Contrarian Investor’ Journal has opined that the next logical step will be towards the eventual float of the RMB, cautioning that the float will not happen imminently.  

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Last month Thomson Reuters and J.P. Morgan jointly published  "The Era of Globalized M&A: Winds of Change."  The research document points out that currently mergers & acquisition activity that is targeted at U.S.-based companies accounts for only 10% of global cross-border activity.  As can be seen from Exhibit 3.3 included in the document, this compares to levels of 20% to 30% or more during 2005 through 2007.  

The inbound activity level has not been this low since 1992, suggesting that when it returns it may show a sharp rate of increase.   

At the same time, China appears to be positioned to increase its outbound foreign direct investment. The  Reverse Mergers blog authored by noted New York attorney David Feldman recently reported that

The government has worked to encourage “ODI” (overseas direct investment) by Chinese folks. Often the level of ODI is compared to “FDI” (foreign direct investment), which is also encouraged. They expect ODI to reach $180 billion this year while FDI will probably hit around $100 billion. Watch for more Chinese takeovers of companies throughout the world as the recession continues to lower values while China has huge foreign exchange reserves.

So if there is a rebound in U.S. inbound M&A activity, it is possible to estimate how much of the anticipated increase will come from China?

Bloomberg News reported last week however that China’s direct investment abroad fell substantially in the first half of this year.  According to Chen Jian, Vice Chairman of China's Ministry of Commerce, non-financial overseas direct investment was $3.7 billion in the first quarter of 2009, a small fraction of the $170 billion invested outbound up to 2009.  From that perspective, the U.S. appears to be unlikely to receive much direct investment from China.  But the answer is simply not that straightforward.

A policy brief published last month by Daniel H. Rosen and Thilo Haneman of the Peterson Institute for International Economics, entitled "China's Changing Foreign Direct Investment Profile," provides a remarkably comprehensive and insightful view of China's programs and policies underlying outbound foreign direct investment (OFDI) . The Peterson Institute's brief describes the changing trajectory and nature of China’s OFDI toward those investments that will rebalance its economy and capture a larger share of the value chain in the manufacture and sale of its goods. It then offers six principal conclusions:

• readjustment of China’s growth model, more than political considerations, is driving the changes in the motives and targets of China’s OFDI
• currently, investment review by developed nations focuses on national security issues, and away from economic security issues; the exceptional degree of Chinese governmental involvement in China’s corporate and economic sectors will test the direction of investment reviews
• because China’s business are globalizing after OECD-country businesses have become globalized, it is in China’s interest to sustain open cross-border investment
• China’s need to accelerate its global investment presence is important for reasons beyond those narrowly related to foreign direct investment, including restoring global growth, alleviating poverty, rebalancing global growth patterns and mitigating climate change
• better statistical clarity is a prime requisite for China to maximize the benefits of OFDI
• in growing its OFDI, China will require assistance and cooperation from businesses, individuals and other governments

The brief does not single out the U.S. as being a more or less likely destination for China’s OFDI. Given the ability of U.S.-based business to enable China to achieve its OFDI goals, the inflow to our shares seems almost inevitable. There are no guarantees, however. The report itself points out:

The global financial crisis rekindled expectations that China would be buying, but lost value in the US securities and other poorly performing investment in a US financial firm .  .  . again turned the tide, prompting statements from Beijing that investment in distressed sectors abroad would be off limit. At present it again seems that political wind is blowing outward, carrying delegations to “bottom fish” the United States and Europe. Yet the callousness with which Beijing has blocked a number of inward investments in the past raises questions about its seriousness toward cross-border investments both ways.

 In a subsequent post, we will summarize those findings of the Peterson Institute brief that relate to national security reviews of inbound investment, inlcuding CFIUS. 

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