Greater scrutiny of foreign ownership is here to stay

While stricter regulations surrounding foreign investment in infrastructure have coincided with a rise in populism around the world, we find the root causes lie elsewhere.

Before the German government intervened in July to prevent China State Grid from acquiring a 20 percent stake IFM Investors was looking to sell in 50Hertz, a transmission system operator that supplies electricity to roughly 20 percent of the German population, Australia had tended to be the poster child of a more restrictive foreign-ownership regime.

“The Ausgrid transaction was a very high-profile one that sent a signal, but I wouldn’t want to overstate it,” Brett Himbury, the Australian fund manager’s chief executive, tells Infrastructure Investor.

The 2016 transaction, to which Himbury refers, involved the sale of a 50.4 percent stake in a 99-year lease for New South Wales’s largest electricity distribution business, which had initially attracted two Chinese bidders. The government blocked both bids, citing national security concerns, and the stake ended up in Australian hands – those of IFM and Australian Super – for A$16.2 billion ($11.5 billion; €10.0 billion).

“The Ausgrid transaction was a very high-profile one that sent a signal, but I wouldn’t want to overstate it.” – Himbury

“In the period preceding the Ausgrid deal, there were roughly 10,000 foreign-investment applications into Australia, and only three were declined. Unfortunately, one of those three was the second-biggest deal in the world that year.”

But, the “real catalyst” according to Himbury, was the 99-year lease for the Port of Darwin awarded to China’s Landbridge Group in December 2015.

That transaction led to criticism both domestically and internationally. At home, many saw the long-term lease in a highly strategic asset to the Chinese as not being in the country’s best interests. The US also expressed displeasure, given that the port is a hub of military co-operation between the two countries.

“So, we as a country, post the Port of Darwin transaction, increased the level of focus and resources that we put into the Foreign Investment Review Board to consider national security issues,” Himbury says.

Since then, Australia has also launched the Critical Infrastructure Centre, tasked with developing a register of critical infrastructure assets, tracking who owns and operates them and working in partnership with the FIRB on reviewing foreign investments in the sector.

A ‘confluence of trends’

But over the past two to three years, populist sentiment has also risen around the world – the UK’s decision to leave the EU and Donald Trump winning the US presidential election being two obvious examples. Could the rise of populism and protectionism then be the cause behind greater restrictions on foreign ownership?

“I think it’s all of that and yet, I think it’s more,” Mario Mancuso, a partner at Kirkland & Ellis who leads the firm’s International Trade & National Security practice, remarks.

“There are macro trends – the rise of China; global structural shifts in power; liquidity moving East. These macro changes have contributed to a scepticism about certain foreign investment in the West,” he explains.

“But, in addition to that, 10 years after the Global Financial Crisis, large parts of the Western publics have yet to recover from its effects and that has helped fuel political populism and challenges to established political orthodoxies.

“So, between larger trends that are driven by macro, structural changes in the global economy and political trends, I think the confluence of those trends has contributed to where we are today, not just in the US, but broadly in the West,” Mancuso asserts.

Anish Butani, director of infrastructure at advisory firm bfinance, adds to that list of causes. “I think there’s a greater appreciation and awareness of the risks associated with the technologically connected, interconnected global economy that we live in today,” Butani points out. “In addition, we’ve seen from recent cyber-attacks over the past two to three years, that cyber risk and technology risk are rising up the agenda, as far as defence and national security are concerned.”

Indeed they are, as witnessed by the legislative initiatives currently under way in several jurisdictions.

Reinforcing legal frameworks

“I think the US legislation is the most restrictive national security investment clearance regime in the West and perhaps in the world – with the exception of China.” – Mancuso

Within the past five months, several jurisdictions have either presented draft bills or passed into law measures aimed at broadening existing foreign direct investment regimes or establishing them for the first time.

In August, the US passed the Foreign Investment Risk Review Modernization Act as part of the National Defense Authorization Act of 2019.

FIRRMA, according to a note by law firm Bryan Cave Leighton Paisner, “contains the first significant revisions to the process and jurisdiction of the Committee on Foreign Investment in the US in more than a decade”.

The new law expands CFIUS’s jurisdiction, lowers the threshold for a transaction to trigger a review and broadens the definition of critical infrastructure to include the energy, transportation, communications, utilities, water and wastewater sectors.

Asked whether the US law – much of which will be clarified further once implementing regulations are written – is comparable with other countries’ regulatory frameworks, Kirkland & Ellis’s Mancuso replies: “I think the US legislation is the most restrictive national security investment clearance regime in the West and perhaps in the world – with the exception of China, which is more opaque.

“But, that’s not surprising given the US’s global security profile which is unique and broader than most other countries’,” Mancuso continues.

“But in this regard, the US is increasingly serving as a bit of a model to other countries that are either thinking about implementing or upgrading their own regimes.”

France is one example of a country upgrading its measures. While in 2014, under the Montebourg Decree, it added the energy, transportation, telecoms, water and public health sectors to the scope of the foreign investment screening regime – the French Prior Authorization Regime – it is now looking to expand it further by adding such sectors as artificial intelligence and robotics.

What’s more, through its proposed PACTE [Action Plan for Business Growth and Transformation] draft bill, it is also looking to expand the ministry of economy’s remedial powers.

If passed into law, “the Ministry of Economy will have a varied range of sanctions for non-compliance with Regulated Foreign investments conditions such as withdrawing the authorisation of the investment, suspending the foreign investor’s voting rights or preventing him from receiving dividends,” Ardian head of infrastructure Mathias Burghardt explains. “This is much more effective than the current regulation which is not very dissuasive and is difficult to enforce.”

An EU-wide framework

But France is not just looking to overhaul its legislation at a national level. In February 2017, it – alongside Germany and Italy – submitted a proposal for a foreign investment screening mechanism at the EU level.

“If someone invests in an asset that is strategic in the heart of Europe, it may have an impact on all of Europe.” – Burghardt

This past June, the EU Council said the proposal had been identified as “a legislative priority” by the Council, the European Commission and European Parliament.

“The EU is the number one destination for FDIs and is a very open market,” the EU Council said in a statement at the time. “However, in recent years, there has been a surge in investments relating to critical EU assets which are not the result of normal market forces.

For example, opaque state-owned enterprises or private firms with close government links are buying EU firms using cutting-edge or dual-use technologies (such as artificial intelligence, robotics or nanotechnologies) or strategic infrastructure assets which could have a potential impact on the EU’s security or public order.”

The proposed legislation, which will be tabled in the EU parliament by the end of this year, would establish a co-operation mechanism, which would require EU member states to notify other member states as well as the Commission of any FDI under review at the national level.

“I think it’s an excellent initiative,” Ardian’s Burghardt says. “It will be more efficient to adopt this type of regulation at the European level, because if someone invests in an asset that is strategic in the heart of Europe, it may have an impact on all of Europe,” he remarks.

According to Bryan Cave Leighton Paisner, the EU proposal was the result of a series of takeovers of European companies that involved foreign investors with strong ties to their home governments. “The most notable of these was the acquisition of Kuka, a German robotics technology company, by Midea Group of China,” the law firm said in a note.

China emerging as the common denominator in many of the transactions that have led governments to reconsider their foreign investment review laws raises an inevitable question: Are these stricter laws about foreign ownership or about Chinese ownership?

“I think China is in ‘a category of one’ for these issues,” Mancuso says. “First, it’s a huge global economy, so by virtue of its size and global activity it will be a more significant and impactful investor. Second, the transparent nature of its political system, as well as the nature of its ambitions – at least, its recent ambitions – makes this issue largely about China.”

“Increased regulation around the world does worry us, but not directly related to stricter foreign investment screening.” – Himbury

IFM’s Himbury concedes that China’s size and the amount of capital it looks to deploy overseas is a factor but offers the following caveat: “Other countries that would also probably raise equivalent national security concerns might not have the capital to invest,” Himbury explains. “So, I’m not sure it’s just a Chinese issue. They obviously have an excess of capital, whereas many other countries do not have an abundance of capital they’re looking to export. If they did, they, too, would probably raise national security concerns.”

Given the current state of affairs worldwide, all those interviewed for this story believe the trend of increased scrutiny will continue.

“But, my hope is that over time, governments will get better about striking the right balance between attracting foreign investment and creating suitable restrictions on deals which truly raise national security concerns,” Kirkland & Ellis’s Mancuso comments. “That way, nations and their publics can have the best of both worlds – the maximum benefits of cross-border investment with the minimum impacts on their own national security.”

IFM’s Himbury agrees that increased scrutiny of foreign ownership will continue, but it should be done “prudently”. Asked whether this has affected investor sentiment, he replies: “I don’t think so. But, what I believe has affected investor sentiment is one of the things we’re seeing as a result of this – the increased regulation of existing assets and sometimes over-regulation to meet what we might call more popular demands at the expense of long-term equity returns.

“Increased regulation around the world does worry us, but not directly related to stricter foreign investment screening.”

This is one of a series of features in our Future of Infrastructure report. Keep an eye out for the report’s full online publication next week.