The tightening of controls on foreign direct investment (FDI), on national security or national interest grounds, is having a significant impact on technology transactions – a trend that is only likely to grow.
In many countries, investigations into proposed acquisitions ballooned in 2021, and in some instances, an increasing number of transactions were subject to FDI screening in addition to merger control filings.
It is a considerable shift in the regulatory landscape and one that dealmakers increasingly need to take account of in a growing number of markets.
The shift towards greater intervention
Regulatory controls on FDI have become a powerful tool for governments looking to take a more interventionist stance to protect what they regard as vital assets, from a national security or national interest perspective.
The trend towards greater regulation has only been exacerbated by the pandemic, which has underlined the importance of technology and exposed weaknesses in vital supply chains, from food security to semi-conductors.
Indeed, the European Commission took the unprecedented step at the onset of Covid-19 of warning EU member states to be alert to acquirers exploiting the crisis to snap up assets that could be of great national importance.
Some countries are bucking the trend of greater scrutiny and intervention.
Indonesia has taken steps to relax controls on foreign investment in key sectors of the economy.
But elsewhere the trend is in one direction: greater and more time-consuming and resource– intensive scrutiny, even if the ultimate outcome is rarely intervention. For example:
- the U.S. Foreign Investment Risk Review Modernization Act (FIRRMA), enacted by President Trump in 2018 and taking effect from February 2020, has strengthened and modernised the role of the Committee on Foreign Investment in the U.S. (CFIUS);
- China introduced a new regime for vetting national security issues in early 2021;
- the EU has launched its first ever framework for assessing FDI across the bloc. This became operational in October 2020 and encourages member states to share details of FDI investigations. Member states, however, apply FDI controls at national level and some have strengthened these independently, including Germany, France, Italy, Spain and Denmark;
- there has been a dramatic expansion of the UK Government’s ability to review transactions on national security grounds with the introduction of the National Security and Investment Act 2021. For the first time, there is a mandatory notification regime for acquisitions (by UK or foreign entities) in 17 sensitive sectors (which include, among others, AI, communications, advanced robotics, computing hardware and data infrastructure) and a wide “call-in” power that allows the UK Government to scrutinise the acquisitions of entities or assets across the UK economy even where a mandatory notification is not required. The regime commenced on 4 January 2022;
- in Australia the Foreign Investment Review Board is increasingly imposing data conditions on technology deals. Separately, the government has armed itself with last-resort and call-in powers to vet non-notified deals with national security concerns and has just effectively lowered the ownership threshold at which deals must be notified from 20% to 10% for an additional 14 categories of critical infrastructure; and
- in France, R&D activities in certain critical technologies (cybersecurity, robotics, artificial intelligence, additive manufacturing, semiconductors, quantum technologies and energy storage) have been added to protected sectors since April 2020. As of 1 January 2022, R&D in renewable energy technologies is also protected. In the meantime, the triggering threshold for vetting procedures has been lowered from 33% to 25% of voting rights in sensitive French businesses and even to 10% for listed companies.
Investigations rise sharply in some jurisdictions
The number of FDI cases has risen sharply, partly exacerbated by the pandemic.
Germany cleared some 450 cases in 2021, sharply up from around the 40 we were seeing in 2016. In France, where the last available statistics date from 2020, 275 dealings were cleared in a year, representing an increase of 50% in two years. In Italy there were more than 200 notifications in 2020 compared with 69 the year before. Meanwhile, the European Commission has seen around 265 cases dealt with under its co-operation mechanism from October 2020 to June 2021.
The intensification of activity, of course, takes place against the backdrop of trade tensions between the U.S. and China, which remain fraught despite the arrival of a new U.S. administration.
However, latest figures show that CFIUS reviewed 313 cases in 2020, slightly fewer than in 2019. This reflects the decline in M&A activity during the early days of the pandemic but also the sharp decline in Chinese investment since the outbreak of trade hostilities.
Dealmakers are facing a new set of complexities in completing deals that might spark national security concerns.
Reviews are possible irrespective of the size of the transaction. Megadeals, such as the proposed USD40 billion takeover of UK chipmaker Arm by the U.S. group Nvidia, is being investigated by the UK government as is the much smaller transaction involving the takeover of Newport Wafer Fab by Dutch-headquartered, but Chinese-owned, Nexperia.
Reviews apply to both direct and indirect acquisitions. A merger between two U.S. companies might prompt an investigation by German regulators if one of the companies has a German subsidiary. Some regimes (eg the UK) also catch acquisitions of foreign entities when there is no local subsidiary but the entity carries on activities or supplies goods or services to persons within the territory.
Reviews have targeted investors from all angles, as the Nvidia/Arm case shows. France has also blocked the proposed takeover of Photonis, a photo-sensor imaging company that supplies night vision cameras to the French military, by Teledyne from the U.S. as well as the takeover of Carrefour, the leading French retailer, by Canadian group Couche-Tard.
Priorities for investors
Dealmakers need to address a number of key priorities. These include:
- considering early engagement with authorities if a proposed deal looks likely to raise national security concerns. Investors involved in bilateral processes might have greater opportunity to have in-depth discussions with relevant regulators on potential national security concerns in advance (with the assistance of the target business). In auction processes, this may be more difficult and, in the case of regimes that only apply to foreign investors, domestic investors may have a natural advantage;
- preparing for the likelihood that deal timetables will be extended;
- considering possible remedies. Regulators may look favourably on commitments to build manufacturing or R&D capacity in their territories, or to ring-fence certain information from investor groups, for instance;
- being aware that authorities are increasingly scanning the market for deals that might raise concerns and are increasingly likely to use call-in powers where they exist (and potentially post-closing);
- presenting a consistent argument to regulators across jurisdictions, particularly as the EU FDI regulation encourages data and information-sharing across EU Member State FDI regimes; and
- considering the sequencing of national filings from a timetabling perspective and whether it might be possible to leverage approval in one country to help make the case elsewhere.
The direction of travel appears firmly set. A growing number of deals will be assessed on national security grounds (often alongside merger control review). Although that does not necessarily mean more deals will be blocked or other conditions imposed, dealmakers will increasingly find these seas more difficult to navigate.