New Frontiers? The emerging regulatory landscape for FDI ... and what investors can do about it

In the third wave of globalisation, companies and investors experience challenges in the form of political volatility and geopolitical multipolarity, while policy makers feel increasingly powerless in the face of mighty multinationals. One of the most distinctive manifestations of political attempts to regain control and primacy are tightened regulatory measures in national investment control systems. CFIUS and AWG are merely the most prominent examples that have left investors eyeing the political stage with suspicion.

Growing uncertainty surrounding renewed calls for political veto rights on foreign direct investments (FDI) has left potential cross-border acquirers eyeing the political stage with increasing concern. The developments are manifold and the potential consequences far-reaching. A new phase of globalisation is unfolding, marked by nation states and also the EU seemingly more concerned with protecting their established industries against acquisition by foreign companies than with promoting competition and industrial rationalization. The result is that potential crossborder acquirers face an ever more complex political and regulatory environment in which to realise the undisputed economic advantages of major crossborder M&A transactions. To navigate this maze and mitigate real risks to the successful closing of a transaction, crossborder acquirers need to radically rethink their tactics, strategy and timetable in order to cope with potentially adverse public, media, political stakeholders and thirdparty influencers.

With this publication, our global team has set out to guide investors and shed some light on the convolutedlandscape of regulation and resentment.

Uncertainty is now more than a buzzword

“Say whatever you want – we will inspect this deal with extreme scrutiny.” – This was not a line the CEO of a successful German company expected when dining with a senior German government official in Berlin’s exclusive “China Club” last year. His hope that this candid statement on the planned transaction with a foreign conglomerate was owed to the excellent bottle of red wine the pair had enjoyed together soon proved futile. What came as a surprise back then is now increasingly likely to be a standard item on the menu for similar face-to-face meetings.

This anecdote is emblematic of a thriving phenomenon that can currently be witnessed on the world stage. In a global game of one-upsmanship, national governments are seemingly outbidding each other with the introduction of intervention mechanisms that give them the upper hand in deciding the fate of inbound M&A transactions that touch upon issues of actual or perceived national interest – a notion that is far broader and amorphous than traditional themes of national sovereignty, such as defence and security of supply. The ensuing uncertainty is plaguing international companies, who find it increasingly difficult to estimate the political risk surrounding their cross-border ventures.

In essence, politicians are trying to regain primacy over large global businesses, which they feel they lost in the rapid pace of globalisation. This, in turn, is translating into a very palpable new and complex environment for international foreign direct investment.

Starting most notably with a surge of CFIUS probes by the United States in 2016, Europe followed suit. Germany amended its Foreign Trade Act (AWV) in July 2017 and the EU Commission, pressured by an alliance of key Member States, published a draft act that would give it a seat at the table when Member States probe foreign investments for their compatibility with public interest.

While these outright screening mechanisms for FDI take center stage, they are part of a broader movement of tightening the screws of regulatory approval for major deals. This also involves stricter competition law vetting and calls for transparency of the buyer’s intentions regarding various target stakeholders and its post-closing performance. The latest example is the UK Takeover Panel’s consultation paper, which would require bidders to submit both detailed information at an earlier stage in the deal process, and more clarifications on the reality of post-deal implementation.

It is important to note that we are not just seeing mechanisms being sharpened, but we are also witnessing the effects of wider review discretion. While the Cadbury/Kraft saga made headlines back in 2009 as the first time in memory that the UK government aimed to protect a national favourite simply for political reasons, today direct intervention for openly political reasons is a frequent theme. Cases like GE/Alstom or AIXTRON exemplify this clearly. Beyond subjective perception, first analyses attribute a slump in global M&A deals in 2017 to growing political and regulatory uncertainty, while authorities, such as the Economics Ministry in Germany, are beefing up on staff to be able to handle a larger amount of critical cases. The implications for companies involved in cross-border M&A are likely to be severe.

A new phase of globalisation is here

Crying foul over the pendulum swinging back from free markets to blunt protectionism is, albeit understandable, far from sufficient to deal with the complex reality motivating the underlying political behaviour.
First, of course, is the general political climate which provides a fertile ground for protectionist moves. Governments trying to cope with varying forms of a new nationalism, and spurred by a well-documented public sentiment of globalisation-tiredness, are keen to deliver on election promises of protecting national interests. Impactful geo-political events, such as the election of the Trump administration (which is looking to re-negotiate a large number of major trade deals) and the mud-slinging surrounding the Brexit negotiations, put mutual trust between economic partners in jeopardy. Public justification for government intervention in otherwise economically-driven investment activity is the logical consequence.

Moreover, governments are adopting a much more sober and pragmatic approach to the opportunities and risks of globalisation and open markets in what might be dubbed as a new phase of globalisation. This is driven by two major trends:

  • First, the recognition that we are in a critical phase of transformation, where technological know-how and intellectual property will play a crucial role for the future of established economies. With observable winner-takes-all scenarios in profitable and idea-intensive industries, policy makers struggle to adapt to global competition. The fear that global behemoths like Google, Amazon, Apple and Microsoft might potentially venture into every sector or industry increases the desire for a flexible regime that protects traditional and future key industries.
  • Second, an assessment that there is an unlevel playing field, where companies in some countries are backed or even subsidised by governments in their investments abroad, and often do not face the same amount of market competition in their home markets. While Chinese state-owned conglomerates are the most widely criticised actors in this respect, the European Commission is itself actively considering legislation that provides instruments against unfair competition from the state-owned Gulf carriers in the airline sector.

Navigating rough watersFour things crossborder acquirers can do

 What cross-border acquirers are left with, is a situation in which they not only face new and more complex regulatory hurdles for their transactions, but also the need to deal with severe uncertainty stemming from the highly politicized scrutiny cross-border deals are now subjected to. Regardless of how far governments are actually willing to intervene and compromise the generally beneficial nature of FDI, this uncertainty holds a risk of its own. Predictability is diminished and costly delays will have to be taken into account.

In order to mitigate these risks and adapt to the new regulatory FDI landscape, investors need to rethink their communication processes before and during an envisaged transaction. Four key considerations can help transaction success:

Start communicating early – The announcement of a transaction is almost certainly too late a stage in which to explain to stakeholders the rationale of a deal. It is necessary to analyse the political, industrial and societal context, anticipate potential critical issues and build up (especially) political goodwill significantly in advance in order to have people listen when it counts. The longer and more uncertain the approval process for a transaction potentially becomes, the longer in advance and the wider the communication net needs to be cast.

Do not underestimate the power of public perception – Political decision-making is increasingly informed by the public’s perception of issues, which is collectively formed much quicker through new media channels. Policy-makers are under heightened public scrutiny and the resulting pressure can play a substantial role in the way they approach issues that resound in public.

Build a coherent narrative that goes beyond the pure deal logic – The societal value of a transaction will be an indispensible element of the narrative that needs to be communicated. Plain numbers and synergies convince shareholders and some regulators, but political decision-makers with intervention rights at their disposal will look much further. It is important to have a well-balanced narrative from day one, which places a transaction in the context of jobs, welfare, competitiveness and society as a whole.

Include all channels in your communication – Traditional media is losing its importance as a gatekeeper while individuals such as politicians and other influencers can garner large amounts of attention and publicize their opinions and views through their individual media presence (e.g. on Twitter). To avoid the narrative around a transaction from being hijacked by activist voices, communication must be based on a multi-channel strategy.

For further insight and information, contact our advisers:

Berlin: cbertram@heringschuppener.com

Brussels: hpeucker@heringschuppener.com

Frankfurt: pkebbel@heringschuppener.com

Washington D.C.: bobrien@gpg.com

Hong Kong: ben.richardson@finsbury.com

London: john.gray@finsbury.com