Focus on the US
Scope of foreign investment review expanding in the US
The US maintains an extensive, though voluntary, foreign investment review process under the Committee on Foreign Investments in the US (CFIUS). This multi-agency review process has often been viewed as politically motivated, but at its core serves as both national security and foreign policy purposes. The underlying statute authorizes the US President to block transactions determined to be contrary to US national security interests, and further authorizes CFIUS to negotiate and agree to mitigation to address any national security concerns, while allowing the transaction to proceed.
In the last several years, the role of CFIUS focus has expanded, with a greater emphasis placed on acquisitions involving properties in any sector that are "proximate" geographically to US government or US military facilities, transactions involving critical infrastructure (such as LNG facilities, transportation hubs and energy assets), potential acquisitions of critical technologies important to defense production or raising cybersecurity concerns, and transactions that place important government supply chain assets under foreign control. While the physical proximity standard has not been defined, the use of this factor in reviewing foreign acquisitions has become increasingly relevant as a key consideration for companies seeking to acquire US commercial interests.
A related development is the expansion of CFIUS reviews to include "greenfield" investments; CFIUS reviews have included land acquisitions in the US, by foreign parties—a development with uncertain regulatory support. Following the Ralls case, in which CFIUS forced a Chinese investment enterprise to divest and terminate a greenfield alternative energy project due to the proximity to a US Naval Air facility concerns, a number of Congressional supporters of stricter investment reviews have proposed amendments to the CFIUS statute that would expressly permit review of greenfield investments. With the number of CFIUS reviews rising, increasing oversight of the CFIUS process by investors and political leaders is likely.
New legislation relating to homeland security
The US$1.1 trillion omnibus bill passed in the final legislative days of 2015 contained many homeland security provisions, including changes to the US Visa Waiver program. While not precisely tied to foreign investment, the increased scrutiny on immigration matters creates spillover effects for foreign investments in the US, particularly as scrutiny of the EB-5 visa program continues. As a policy matter, sectors such as telecommunications and energy remain subject to enhanced review by the CFIUS committee, given concerns over cybersecurity and infrastructure security.
Focus on Europe
The EU supports foreign investments as one part of its common commercial principles and has been negotiating a number of economic agreements, with the objective of improving foreign investments. Notably, the Transatlantic Trade and Investment Partnership (TTIP) with the US and the Bilateral Investment Agreement with China are the latest European external economic efforts.
Since an EU-wide comprehensive investment policy is still missing and will be introduced progressively, rules restricting and monitoring foreign investments are to be found in national laws of the EU Member States. As a result, administrative procedures and limitations on foreign investments for national security reasons may differ across the EU.
Generally, governments of each EU Member State may review the acquisition of domestic companies by foreign buyers (i.e. investors located outside the territory of the EU or the EFTA Agreement) in individual cases in order to avoid national security risks in any sector regardless of the size of the companies involved in the acquisition. Special rules apply to the acquisitions of certain defense and IT security companies. In regards to the latter, the current negotiations for selling Airbus Group's defense electronics unit in Germany are worth watching in 2016, particularly as Germany must approve this transaction under its foreign trade and investment laws.
Focus on Canada
New government, new approach to foreign investment?
As Canada's foreign investment review law, the Investment Canada Act (ICA), tends to be a law that is more political than most, foreign investors in Canada may wonder how Prime Minister Justin Trudeau's new Liberal government will treat them in 2016. Will national security reviews of foreign acquisitions or establishments of Canadian businesses continue unabated at the higher levels of the past few years or will they become less frequent? Will the new government clarify the "net benefit to Canada" test for review of foreign investments? In an uncertain economic climate, in which the Canadian economy has been devastated by plummeting oil prices, will the current policy ban on acquisitions of control of Canadian oil sands businesses by non-Canadian state-owned enterprises (SOEs) be re-considered?
Will national security reviews continue with the same frequency?
The Canadian government introduced a national security screening process into the ICA in 2009; the review applies to investments of any magnitude that could be "injurious" to Canada's national security. The federal Cabinet has wide discretion to determine the relevant risk factors and prohibit a proposed investment or require divestiture of a completed investment transaction. However, in the first few years after the review process was established, the government rarely took action to challenge foreign investments on the grounds of national security.
This changed a few years ago as the Canadian government seemingly found an increasing number of foreign transactions that raised concerns. Although there is very little transparency in the conduct of these reviews, practitioners have noted numerous reviews, including prohibitions of transactions as well as divestitures. The first formal disallowance under the national security regime was in the fall of 2013 relating to the acquisition by Accelero Capital of MTS's Allstream Division, a national fiber optic network that provides critical telecommunications services to businesses and governments, including the Canadian government.
Since 2013, there have been a significant number of national security reviews. For example, in 2015, the government rejected the establishment by a Chinese SOE of a fire alarm manufacturing facility in Québec in a location deemed to be too close to the Canada Space Agency headquarters and issued a divestiture order against a private Chinese company that had purchased a Québec company specializing in fiber components, modules, lasers and amplifier systems for applications in a number of sectors, including defence and security. Significantly, the Chinese company in the latter case has sought judicial review of the decision.
With a new government led by a prime minister who is regarded as friendlier to China and more internationalist than his predecessor, foreign investors will keenly monitor the extent to which the Canadian government scrutinizes transactions involving targets in sensitive sectors, such as telecom, defence and technology. Although the new government may have a less ideological perspective on security issues, the current global threats to security arising from terrorist attacks, cyberespionage and military aggression by certain states (or aspiring ones) suggest the government will maintain a continued close eye on foreign investments in these sectors.
Changes to "net benefit to Canada" review?
Apart from national security, the ICA provides for review of significant foreign investments under the "net benefit to Canada" test. The new government has signalled that foreign investors require greater clarity in the application of this test which involves the government's consideration of numerous factors, such as the impact of the investment on employment, capital expenditures, the participation of Canadians in senior management and governance. It is anticipated that factors such as the impact of a foreign investment on innovation, economic growth and productivity may receive greater weighting given the new government's announced priorities and the current level of economic uncertainty. It remains to be seen whether the government will issue new guidance to clarify what it has previously characterized as political decision-making under the ICA.
Apart from "net benefit," another issue to watch is whether the new government adheres to or relaxes the current policy ban on acquisitions of control by state-owned enterprises of Canadian oil sands businesses. With the devastating slump in oil prices wreaking economic havoc in Canada's oil patch, loosening constraints on foreign acquisitions of oil sands businesses may be viewed as necessary to stimulate further investment in Alberta.
In 2015, the ICA's 2009 amendments were implemented, which established an enterprise value threshold for review (replacing a simpler but cruder "book value of assets" review threshold)—currently, at CA$600 million in enterprise value of the target Canadian business. This threshold will increase to CA$800 million in 2017 and to CA$1 billion in 2019. If the Trans-Pacific Partnership is implemented in Canada, it will raise the review threshold for non-SOE TPP investors to CA$1.5 billion in enterprise value (as will the Canada-European Union Comprehensive Economic and Trade Agreement (CETA) for its members).
Focus on China
In 2015, China continued its efforts to streamline its regulations regarding foreign investment to encourage the gradual opening of China's markets. Of primary import was the release of a draft version of an updated Foreign Investment Law and a related Explanatory Note, released on January 19, 2015. The current draft represents a balance between reducing the regulatory burden on foreign investors and establishing greater control over attempts to avoid foreign investment regulation.
The major proposed changes under the draft Foreign Investment Law are as follows:
- A default principle of "national treatment" for foreign investors. This allows foreign investors to make investments on the same terms as Chinese investors without additional approvals or sector restrictions, except as otherwise required by law. Because foreign investments typically require numerous approvals at present, such a change would greatly streamline foreign investment.
- The adoption of a "negative list" approach in regulating market entry of foreign investors. China's State Council would set out industries where foreign investment is either restricted or prohibited. Sectors not on this "negative list" would be open to foreign investors on the same terms as Chinese investors. This approach has been adopted in the Shanghai Free Trade Zone.
- The principle of "de facto control" in determining whether a company should be treated as a foreign-invested enterprise (FIEs). To determine whether a domestic entity is under "de facto control" of foreign entities and should be classified as an FIE, authorities would conduct a more extensive analysis of the entities controlling an enterprise, rather than just examining its shareholders. This change is believed to target Variable Interest Entities (VIE), by which foreign investors avoided restrictions on foreign investment in certain sectors by establishing off-shore companies with contractual control over Chinese shareholders. It is unclear whether Chinese authorities would apply this change only prospectively, or also retroactively to companies that already use the VIE structure, such as Alibaba and Baidu. If adopted, this proposed change could have significant repercussions for foreign investors.
- No provisions regulating the corporate form of FIEs, whereas in past FIEs have been subject to different corporate rules and procedures than domestic enterprises. Commentators believe that this signals an intent to unify the treatment of FIEs and domestic enterprises under the PRC Corporate Law (or Partnership Law, as applicable), in terms of establishment, corporate governance, liquidation and other corporate matters. This may also imply eliminating the corporate forms unique to FIEs: equity joint venture, contractual joint venture and the wholly foreign-owned enterprise. If so, FIEs may need to convert to a corporate entity under the PRC corporate legal regime.
- Establishing a national security review system for foreign investments. Foreign acquisitions of a controlling stake in domestic enterprises have long been subject to a national security review by the State Council, but no formal statute governed this process. The draft law would seemingly provide more clarity for this process, as it is expected that implementation rules would be drafted detailing the national security review process. However, the draft law would also broaden the scope of such reviews to any investment, "where foreign investment infringes upon, or may infringe upon, national security." Current rules require a national security review only where foreign investors acquire sensitive military facilities, enterprises in the vicinity of key and sensitive military facilities, national defense, agriculture, energy and resources, infrastructure, transportation services, key technologies and major equipment manufacturing.
Though released in January 2015, the draft Foreign Investment Law has not been finalized and entered into force, and as a draft, it may undergo further changes before being finalized.
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