West won’t sell…
The blocking of the Ant Financial-Moneygram deal by the Committee on Foreign Investments in the United States in January was declared as the death of the “China deal”, at least from a US sellside perspective. The recent nixing of Broadcom’s bid for chipmaker Qualcomm upped the ante by showing how America’s national security concerns can be extended to any overseas company perceived as simply being within China’s sphere of influence. Meanwhile stricter legislation to reinforce CFIUS’s powers – the Foreign Investment Risk Review Management Act or FIRRMA – is winding its way through Congress.
US is not alone. Other governments, from Europe to Australia, have also signalled sharper official scrutiny will be applied to attempts by Chinese corporates to acquire in their respective geographies. For example, in Germany, where China struck deals at a pace of almost one per week in 2016, government officials have called for increased national powers within the EU to screen takeover transactions, and to be able to block them when necessary. German legislation was introduced in the summer of 2017 following Midea’s acquisition of Kuka, a leader in applied robotics.
Chinese outbound investors thus face a much more challenging environment abroad today. However, this is only one half of the story. China’s own policy announcements have independently raised the bar for ambitious corporates, even before considering the reception that their advances may receive from foreign regulators.
…while China clamps down
In an effort to further alleviate stress on foreign reserves, and to keep active investment capital within its own borders, China has introduced additional measures to restrict – but most importantly regulate – domestic companies’ outbound M&A activities. The goal is to improve the quality of deals, following a period where expansionist corporations such as HNA and Anbang embarrassingly over-reached themselves in pursuit of trophy assets.
The first moves on this front were made in December 2016. Three key agencies – the Ministry of Commerce, the National Development and Reform Commission and the State Administration of Foreign Exchange – were handed powers to assess all outbound deals greater than US$5m, with broad discretion under the new legislation to block “irrational” overseas investments.
Unsurprisingly, this led to questions seeking clarification on exactly how the new rules were to be enforced. In an effort to increase transparency and to help investors make more informed decisions, the ‘New ODI Guidelines’ were published in August 2017. These guidelines classified investment activities into three main categories: Encouraged, Restricted and Prohibited.
New ODI Guidelines
- Encouraged ODI: Investments that further the One Belt One Road initiative, or enhance China’s technical capabilities, or that are related to research and development, oil and mining exploration, agriculture, or fishing;
- Restricted ODI: Investments in real property, the entertainment industry, sports clubs, obsolete equipment, private equity, investment platforms established offshore without actual business or investments that contravene environmental standards;
- Prohibited ODI: Investments involving the export of core technologies and military assets, investments in the gambling or adult entertainment industry or investments contrary to national interests/security.
Two further regulatory announcements along the theme of avoiding overseas embarrassment were released in the pre-holiday period. The first was the 36 point ‘Code of Conduct’ for private firms, announced December 18, 2017. This initiative’s stated its goal is to reduce “fraudulent overseas deals”, highly-leveraged deals and investments into offshore financial derivatives by mandating Chinese private enterprises must follow a new set of regulations to ensure that deals abroad are “in line with their own conditions and capabilities”. This was followed by the Streamlined Reporting but Expanded Oversight, announced on December 23, 2017, which called for additional scrutiny on deals in terms of financing, valuation, and rationale and introduced a nationwide online platform to make management and services for outbound investment more convenient and transparent.
These measures further enhance China’s examination of proposed outbound deals. Currently implemented exchange controls effectively limit mainland firms’ ability to finance overseas acquisitions with their own onshore currency reserves. In trying to work through these challenges in the context of an M&A process, publicly listed would-be acquirers can also be “timed out” on significant transactions. China’s Securities and Regulatory Commission requires deal-related trading suspension of shares be limited to a few months. If the deal takes too long to conclude then it can be back to square one for both buyer and seller.
Tilting the dealflow
The latest data on historic deal values for China inbound and outbound M&A has been anything but stable, the question is, given the recent social and economic developments in the region, what is 2018 likely to hold?
2017 saw a significant decline in China outbound M&A deal value and volume, especially for transactions involving the US. However, overall figures should remain more stable through 2018 as Chinese investors alter their investment goals and behavior and adapt to both domestic and foreign policy objectives.
In contrast, China’s inbound M&A activity finally rebounded after experiencing a declining trend over the last three years. This increase is supported by new regulations designed to make the domestic market more attractive to foreign investors.
We expect to see robust levels of M&A activity within China’s borders over 2018 as foreign investors capitalise on new subsidies, tax incentives, and other favourable legislation.
Mark Webster and Jeffrey Wang are managing directors at cross-border investment bank BDA Partners.