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Law360 (March 23, 2020, 6:59 PM EDT) --
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| Jing Zhao |
The outlook for cross-border transactions led by Chinese acquirers continues to dim because of the U.S. national security watchdog, the Committee on Foreign Investment in the United States, as well as COVID-19 fear and China's control on capital outflow.
CFIUS Final Rules and Proposed Filing Fees
The U.S., traditionally the largest recipient of foreign investment in the world, has in recent years shifted its accommodating attitude toward certain foreign direct investments, particularly with respect to inbound Chinese investments, toward protecting U.S. national security interests by invoking CFIUS review.
CFIUS is an interagency committee tasked with overseeing and screening foreign investment transactions that may implicate national security. According to CFIUS' annual reports, from 2015 to 2017, Chinese investors were the most active investors in the U.S., in mergers, acquisitions or takeovers, accounting for at least 26% of the total number of foreign investments.
Fear has increased over China-led foreign investments involving cutting-edge technology and sensitive data of U.S. citizens, particularly acquisitions by entities owned or controlled by Chinese state-owned enterprises. CFIUS reviewed 552 transactions involving acquirers from 36 countries between 2015 to 2017, of which 143 out of the 522 deals originated from China.
Further, President Barack Obama blocked a Chinese investment firm in 2016 from acquiring Aixtron SE, a German-based firm with assets in the U.S. In 2017, President Donald Trump blocked the acquisition of Lattice Semiconductor Corp. by the Chinese investment firm Canyon Bridge Capital Partners.
Increased concern also spurred efforts to amend CFIUS, strengthening its oversight and expanding its reach by passage of the Foreign Investment Risk Review Modernization Act of 2018. Enactment of FIRRMA in 2018 brought sweeping reform. The CFIUS pilot program concerning the critical technologies industry was adopted on Nov. 10, 2018. Proposed rules implementing FIRRMA were released on Sept. 17, 2019. On Jan. 13, CFIUS released two final sets of regulations to implement FIRRMA, which took effect on Feb. 13.
FIRRMA substantively expanded CFIUS' reach in two ways. First, before enactment of FIRRMA, CFIUS reviews were limited to acquisitions resulting in foreign control of a U.S. target that might threaten U.S. national security. Now, CFIUS reviews cover certain noncontrolling foreign investments in U.S. businesses involved in certain critical technologies, critical infrastructure or personal data of U.S. nationals — so-called TID businesses.
Under the new regulations, in addition to foreign controlling investments, foreign noncontrolling investments could now trigger CFIUS review if (1) the U.S. target qualifies as a TID business; and (2) the noncontrolling foreign investment is allowed (a) access to material nonpublic technical information, (b) observer rights on the board or equivalent governing body, or (c) substantive involvement in the U.S. target's decision-making with respect to the TID business.
Second, real estate transactions were not specifically singled out pre-FIRRMA. Now certain real estate transactions are within the reach of CFIUS, if the covered real estate is located within (1) part of an airport or maritime port; (2) close proximity of a military base and other government facility; (3) an extended range of certain military bases; or (4) part of certain military bases located within the territorial sea of the U.S.
Additionally, undeveloped lands previously exempt from review are now inside the purview of CFIUS.
Another notable change brought by FIRRMA is the mandatory filing requirement. Although the process largely keeps the voluntary filings intact, mandatory filing is now required for a number of transactions. Mandatory filing is required if (1) there is a substantial foreign government investment in a TID business; or (2) the investment is made in critical technologies within the scope of the CFIUS pilot program on critical technologies.
For voluntary filers, the proposed fee schedule is as follows:
- Under $500,000: no filing fee;
- Between $500,000 and $5 million: $750;
- Between $5 million and $50 million: $7,500;
- Between $50 million and $250 million: $75,000;
- Between $250 million and $750 million: $150,000; and
- $750 million or more: $300,000.
Beijing Kunlun Tech Co. Ltd.'s recent announcement that is was selling its 99% stake in Grindr LLC to San Vicente Acquisition LLC for about $608.5 million underscores the tough stance taken by CFIUS. Kunlun bought a majority stake in Grindr, an online dating site, for $93 million in 2016, and acquired the remaining shares two years later. In 2019, CFIUS raised concerns over Kunlun's investment in Grindr because of foreign access to the personal data of U.S. citizens. Kunlun was ordered to unwind its purchase of Grindr by 2020. Inbound Chinese investments will continue to be scrutinized in the U.S. No deal (even a closed deal) is safe under CFIUS.
COVID-19
On March 19, for the first time since the start of a crisis that sickened over 80,000 Chinese people, China announced that it had no new domestic infections of COVID-19.
While the outbreak's epicenter has shifted from China to Europe, the crippling effects of COVID-19 are likely to be felt for some time, and China could face subsequent waves of infections.
COVID-19 resulted in the mass lockdown of villages, towns and cities. With companies closing offices, stores, and factories in China, as well as suspending nonessential travel in the country, COVID-19 ground China's economy to a halt for the first two months of this year, and inevitably put at least a short-term pause on cross-border deals originated in China.
The global fear of COVID-19 spooks investors, which, in turn, delays cross-border investment. Immigration curbs and flight cancellations caused by COVID-19 deepen the shock to global demand and interfere with dealmakers' plans to meet and discuss business onsite.
Restrictions on Capital Outflow
Another factor contributing to the waning of mergers and acquisitions activity between the two economic powerhouses is China's restrictive capital-flow policy.
As mentioned above, China-led cross-border M&A activity surged in 2015 and 2016. Large amounts of capital moved out of China to finance the deals, which caused China's foreign exchange reserves to drop below $3 trillion from $4 trillion in the previous year.
The dip prompted Chinese regulators to focus on foreign investment channels and take action against rapid capital outflow to stop investors from making speculative investments overseas and thus stabilize the faltering yuan in late 2016.
Various measures had been put in place to constrict capital outflow from June 2016 to January 2018. A gradually eased monetary policy rolled out in the spring of 2018 didn't last long — the policy to curb cash outflow was reactivated in August 2018.
In August 2019, China's State Administration of Foreign Exchange pushed out new rules that allow banks to crack down on capital outflow by limiting or denying offshore remittances or transfers if SAFE declares the financial situation abnormal, with no clear criteria defining what could amount to abnormality. The control over capital flow remains strong and unpredictable.
With heightened uncertainty over CFIUS, spillovers from the slow recovery caused by COVID-19, and tight cash outflow conditions at home, challenges remain for Chinese investors doing deals in the U.S.
Jing Zhao is an associate at Saul Ewing Arnstein & Lehr LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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