Foreign investment restrictions: Looking inward

Foreign investment regulations seldom refer to China by name, but policymakers’ intentions are often implicit in the language and background briefings or obvious from recent interventions.

Australia took center stage recently with the announcement of sweeping legislative changes that include giving the treasurer license to unwind or impose conditions on deals even after the Foreign Investment Review Board (FIRB) has granted approval. Investments in “sensitive national security businesses” will be subject to heightened review regardless of the size of the transaction or whether the buyer is a state-owned entity or a private company.

Josh Frydenberg, Australia’s treasurer, noted that governments globally “are seeing foreign investment being used for strategic objectives not purely commercial ones.”

The proposed reforms – which will be released in draft form later in the year with a view to starting implementation in January 2021 – come three months after temporary legislation was introduced removing the valuation threshold below which FIRB approval is not required. The measure was positioned as a means of protecting companies that might be weakened by the COVID-19 pandemic from foreign government and corporate raiders. Since then, two deals have been nixed because they were deemed contrary to national interest. Both were Chinese investments in mining assets.

Australia’s action is not unprecedented. According to Allen & Overy, the US, Canada, the EU, France, Germany, Hungary, Italy, the Netherlands, Poland, Spain, the UK, India, Japan and New Zealand have all tightened foreign investment controls in response to COVID-19. In some cases, concerns about Chinese government entities – acting directly or through privately-owned offshore proxies – are not immediately apparent. In others they are.

Japan, for example, said that foreign investors in domestic listed companies in certain industries would require regulatory clearance to acquire stakes of 1% of more, down from 10%. This might be a counter-China measure, but the immediate response was that it would clip the wings of activist investors who are increasingly targeting Japanese corporates. India, meanwhile, specified that additional approvals would only be required for investors from countries with which it shares borders.

The legislation emanating from India also stands out in that it unequivocally – and perhaps somewhat inadvertently – drags private equity into the debate. It not only targets takeovers but also minority investments where the beneficial owners are from neighboring countries. The government may want to ensure that Chinese groups routing deals through offshore vehicles do not slip through the net. But in doing so, it is potentially placing investments by independent VC firms that have some exposure to Chinese LPs on the watchlist as well.

For the most part, private equity investors – assuming they are not secretly adhering to government-set agendas – would be most worried about the exit implications. Especially in markets like Australia, Chinese investors have become prolific buyers of PE-owned assets in recent years. As their US-based peers have discovered with the Committee on Foreign Investment in the US (CFIUS), the regulatory risks of proceeding with a Chinese buyer might not be worth whatever price premium is on the table.

More broadly, these foreign investment restrictions reflect a rise of national protectionism, and a move towards de-globalization, that was apparent before COVID-19. This sentiment might be most accentuated in China-US tensions – to the point that many now see decoupling as inevitable – but it is not limited to that axis. The UN’s trade and development body estimated in April that these policies would drive down global FDI flows by 40% in 2020-2021, with cross-border M&A also set to slump.

There will be winners and losers. Some private equity investors may find that investments in companies benefiting from a reorientation of supply chains prove highly lucrative. However, the asset class has gained far more from the proliferation of globalization than it is likely to achieve from its retraction.

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• Topics
• Australasia
• Greater China
• North America
• Europe
• Investments
• Regulation
• China
• Australia
• USA
• FDI