This September, the Trump administration moved to block the proposed acquisition of a US semiconductor company by a state-backed Chinese investment fund, citing a number of concerns that the deal posed for US national security. This move was the latest in a series of signs that national security reviews are becoming an increasingly important part of M&A regulation in a number of jurisdictions. This article will explore the latest regulatory developments in this area in the US and China context, considering their implications for both immediate M&A activity and broader economic relations between the two countries.
The Committee on Foreign Investment in the United States (CFIUS) is a federal government agency authorised to review any investment deals that result in a foreign entity acquiring control over any US company in order to determine whether such a deal might affect American national security interests. Since a legislative amendment in 1988, the President has possessed the authority to block any covered transaction that might impair US national security interests. Subsequently, further changes to legislation in 2007 have expanded CFIUS powers by broadening the definition of ‘national security’ and creating a presumption that the committee would further investigate any cases that involved ‘critical infrastructure.’
The Lattice Ruling and Its Implications
Earlier this year, President Trump followed a recommendation from CFIUS to block the $1.3bn acquisition of Lattice, an American semiconductor manufacturer, by a state-backed Chinese investment fund. The CFIUS report cited a number of national security concerns including the risk of transferring sensitive intellectual property to China, the ‘importance of semiconductor supply chain integrity’, and concern about the Chinese government’s support for the acquisition. Patrick Moorhead, a chips analyst, said that the ruling could be explained by the fact that programmable silicon chips are often incorporated into weapons and defence systems operated by the US military, thus highlight the US’s concern that sensitive military technology would potentially have been transferred to the Chinese government.
The Lattice ruling highlights the growing scrutiny being applied by the US to Chinese inbound investments and the political momentum behind national security reviews. The ruling comes in the wake of a decision by the Obama administration late last year to block the Chinese acquisition of Aixtron, a German semiconductor company, after a similar recommendation by CFIUS. Like the Lattice ruling, the committee had cited concerns relating to the military application of the technology held by Aixtron.
Meanwhile, there is a strong lobbying effort by members of US Congress to increase the powers of CFIUS even further. Some legislators are pushing for a wider definition of ‘national security’ to include considerations of media control and ‘soft power’ after one of Hollywood’s biggest production companies was purchased by a Chinese conglomerate. There are also hopes to expand CFIUS’s jurisdiction beyond M&A to cover other transaction structures such as minority investments and joint ventures.
As a report by law firm Kirkland & Ellis outlines, these latest developments have a number of implications for how US companies should conduct overseas deals. Firstly, it has become clear that if a deal has any direct or indirect link with a Chinese entity, this immediately elevates the deal’s risk. While CFIUS has jurisdiction to review controlling transactions from any country, all four deals that have been blocked by a US president after following its recommendations have concerned a Chinese company.
Secondly, companies will have to take account of new ways in which CFIUS will perceive a deal to contain national security concerns: this will include the use of lower-tech technology that is nonetheless sensitive if widely used by US government customers. And thirdly, companies may have to be prepared to have a wider scope of transactions, such as minority investments and joint ventures, scrutinized by CFIUS in light of calls to expand its jurisdiction.
National Security Review in China
Coinciding with the development of CFIUS and its growing importance to the US M&A market, the Chinese government has instituted its own system of national security review for its own economy. In 2011, pursuant to a notice issued by the State Council, the Ministry of Commerce (MOFCOM) established a panel responsible for conducting national security reviews of foreign investments in domestic Chinese companies. Like CFIUS, the MOFCOM panel has the statutory authority to investigate foreign M&A deals and to recommend that the transaction be blocked or subject to modifications in order to make it compliant with national security concerns. The MOFCOM panel’s scope of review and powers were then further clarified in the the 2015 PRC national security law.
It can be tempting to characterise the MOFCOM panel as ‘China’s version of CFIUS’. Arguably, the very formation of the panel can be seen as a political reaction to CFIUS, as its formation came immediately in the wake of a decision by CFIUS in 2011 to block a merger between Huawei and 3Leaf.
However, as outlined in academic literature and law firm reports, there are a number of substantial differences between the two systems that the business community must take into account. Firstly, China’s definition of what constitutes a ‘national security’ concern is much broader. While CFIUS is able to review control over assets constituting ‘critical infrastructure’, it excludes ‘economic security’ as a consideration.
In contrast, the 2011 NSR notice explicitly grants MOFCOM the power to include economic concerns, such as the impact on domestic capacity, ‘basic social order’ and domestic R&D capabilities, as part of its analysis. Secondly, MOFCOM panel rulings have more powerful implications. While CFIUS can only make non-binding recommendations to the President, the Chinese panel has authority to take its own action, including the power to divest the transaction.
In theory, this suggests that MOFCOM will develop to become a more interventionist regulatory body as compared to its American counterpart, reflecting China’s continuing evolution as a mixed economy. Nonetheless, there is certainly an element of ‘wait and see’ with the institution. There are yet to be measures taken by the Chinese government to implement its rulings. So far, MOFCOM has not moved to block any transaction on national security grounds.
Implications of Developments for US-China Business Relations
In the short-term, we can expect national security reviews to be a significant hurdle for US-China M&A deals that some companies will not be able to clear. This is proving to be the case for many high-profile potential takeovers by Chinese investors seeking to buy American companies. For example, a former affiliate of Jack Ma’s Alibaba Group, Ant Financial, is expected to initiate a third attempt for CFIUS approval of its takeover of MoneyGram International after the panel rejected its two previous proposals. The outcome of this case will set an important precedent for the regulatory approach to US-China financial services deals.
In the longer-term, we may see the merger review process become only further politicised, especially if the Chinese MOFCOM panel moves to block acquisitions by US companies. It is not hard to envisage a ‘tit-for-tat’ exchange between the two countries. In light of the ever-increasing protectionist sentiment being signalled by the Trump administration and some members of Congress, national security review may grow to become a significant point of contention between these two world powers on matters of economic policy.
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