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Chinese outbound deals raise flags for US regulators

Investors on the hunt for US deals are coming under increasing pressure from regulators to reveal ownership and corporate governance.

Chinese firms are coming under increased pressure for greater transparency with regard to ownership structure, funding sources and corporate governance, says Farhad Jalinous, partner and practice head of the national security and Commission on Foreign Investment in the United States (CFIUS) practice at law firm White & Case.

“At the end of the day, it comes down to the control of the business. How is it allocated in terms of governance rights? What authority and how much of it does the private equity backer have?” he said.

“Even if there is private equity backing from US firms, if the centre of decision-making comes from China, CFIUS will follow the threat component of the analysis. That will affect how CFIUS views the role of the private equity backer.”

Chinese overseas acquisitions in the first half of 2016 was at a record $305 billion, surpassing last year’s total of $120 billion, according to data from Thomson Reuters.

CFIUS plays a decisive role in national security reviews of foreign direct investments in the US. Some of its high-profile members include the Secretaries of Treasury, Homeland Security and the US Attorney General.

Latest published data from CFIUS showed that in 2014, overall deal flow picked up, with a high of 147 reviews. This represented a 52 percent increase over the number of notified transactions in 2013 and a 33 percent increase over 2012. For the third consecutive year, China had the highest number of inbound transactions; 24 transactions were reviewed in 2014, up from 21 in 2013.

Among successful big-ticket deals this year are ChemChina’s $44 billion bid for seeds and pesticide maker, Syngenta; real estate and leisure conglomerate Dalian Wanda’s $3.5 billion acquisition of Legendary Entertainment for $3.5 billion; and Chinese hardware company, Apex Technology’s, $3.6 billion purchase of US printer company Lexmark alongside private equity firms PAG Asia Capital and Legend Capital.

The buying spree in the US comes amid a slowing economy in China, which is expected to slow to 6.5 percent this year. Chinese companies shopping abroad are also encouraged by the simpler outbound deal-making rules and speedy approvals, drafted by the country’s regulators in April.

The draft rules, compiled by the National Development Reform Commission (NDRC), will no longer require Chinese companies involved in deals of $2 billion or more to get approval from the State Council, the country’s central government, or to provide proof of financing. Chinese buyers will also be allowed to pursue deals involving sensitive industries such as media, telecommunications and infrastructure.

However, in recent years, CFIUS has generally shown particular sensitivity regarding transactions involving cyber security and other information technology issues, Jalinous said. Data from the commission showed that the types of transactions which required mitigation in 2014 included those involving US target companies in the software, services, and technology industries.

Jalinous added that parties interested in buying US companies should be prepared to disclose the identity of the buyer, the buyer’s affiliates, sources of financing, and relationships to foreign government entities.

Early this year, the CFIUS blocked Phillips’ $3.3 billion sale of its lighting business, Lumileds, to Beijing-based fund GSR GO Scale Capital, due to “unforeseen concerns”.

Financial regulators in New York had also asked China’s Anbang Insurance Group to withdraw its $1.57 billion bid for US insurer Fidelity & Guaranty Life after it failed to submit more detailed documentation about its ownership and shareholder structure. Anbang, together with private equity firms Primavera Capital and J C Flowers & Co, had in March pulled out from a $14 billion bid for Starwood Hotels & Resorts, due to “various market conditions”.

In the same month, the US Department of Commerce added Chinese state-owned telecommunications equipment makers ZTE and Huawei to a sanctions-related blacklist for allegedly violating American export sanctions.