What Chinese Investors Must Know About the CFIUS New Rules

What are the main take-away lessons of the new CFIUS rules?

With the passage of the Foreign Investment Risk Review Modernization Act (“FIRRMA”), CFIUS will undergo the following changes:

  • Control over the acquired target is no longer the threshold consideration. In certain sensitive sectors, even minority interests with no de facto control may now be under CFIUS jurisdiction.
  • Foreign government-backed investments in sensitive sectors must be reported to CFIUS.
  • “Countries of special concern” such as China will undergo greater scrutiny.
  • Investment structures designed to evade or circumvent CFIUS review will be scrutinized. Investment by fund structures has already been watched closely under current practice and closer scrutiny is expected as they are suspected of being used to evade or circumvent review.
  • Real estate investments of certain kinds near sensitive areas may now be covered.
  • Review duration will be extended.

What is CFIUS? How does it work?

CFIUS stands for the Committee on Foreign Investment in the United States. CFIUS reviews the national security implications of economic transactions involving transfer of control to foreign entities, including acquisition of U.S. assets or investment in U.S. businesses.

When parties believe a transaction may be covered by CFIUS, they may file for CFIUS review. If CFIUS determines that there are any risks to the U.S., it can (i) negotiate changes to the deal to resolve the issues, or (ii) recommend that the president intervene to stop the deal [1]. On the other hand, if the transaction is cleared, the parties receive a “safe harbor,” meaning CFIUS declines to intervene.

What are CFIUS “covered transactions”?

A “covered transaction,” which CFIUS has the authority to review, is any deal (merger, acquisition, takeover, restructuring, etc.) that would result in foreign control of a U.S. business. However, with the passing of the FIRRMA, all deals involvingcritical technology or infrastructure companies and sensitive personal data in the U.S., regardless of foreign control, will now come under review. Real estate acquisitions are also covered transactions now, if the land sold to a foreign entity may serve as a port or is close to military or government facilities [2].

The notion of a “U.S. business” also includes the U.S. subsidiaries, assets, or operations of international businesses, so a deal between non-American companies may still be subject to CFIUS review. “Foreign control” means the power to direct important matters of the acquired business, such as the sale of the company’s assets or the relocation of facilities, not necessarily related to the percentage of shares owned. Therefore, a minority investment could still count as a covered transaction [3] . However, if a transaction results in 10% or less ownership of the US business and is deemed entirely “passive”, it is exempt from review.

In the past, what are key lessons on how CFIUS affects Chinese inbound investment into the U.S.?

CFIUS scrutinizes deals that involve U.S. businesses in defense, technology, infrastructure, or utilities. China, as a growing investor in these industries, is a key target in CFIUS reviews. The concept of national security is gradually expanding to include long-term technological prowess, long-term economic and financial health, and the privacy of citizens’ medical, financial, and other data. [4] This means tighter regulation of Chinese investments and more aborted deals.

  • The proposed acquisition of Lattice, a U.S. chipmaker, by Canyon Bridge Capital, a semiconductor investment fund sponsored by a Chinese state-owned asset manager, was blocked in September 2017.
    Lesson : There are concerns about the U.S. semiconductor supply chain and potential transfer of intellectual property to a Chinese acquirer. The deal was further complicated as the U.S. government used Lattice products and the Chinese public sector was backing the acquisition.
  • The proposed acquisition of Xcerra, a semiconductor testing company, by Sino IC Capital, which manages China Integrated Circuit Fund, was blocked in February 2018.
    Lesson: Aside from the red flag that comes with a state-backed fund buyer, the result reveals a trend that even the upstream sector (service providers) in the semiconductor industry are coming under CFIUS scrutiny.
  • Ant Financial’s proposed acquisition of Moneygram, the second largest money transfer provider in the United States, failed in January 2018. The acquisition of an insurance company, Genworth Financial, by China Oceanwide Holdings Group finally passed in June 2018 after two years of review and multiple refilings.
    Lesson: CFIUS reviews are paying more attention to protecting the data of U.S. citizens from foreign exposure. The failed Ant Financial-Moneygram deal was perceived to threaten the financial data of U.S. soldiers and government employees abroad, who use the target company’s transfer services. The China Oceanwide deal gained CFIUS approval after agreeing to use a U.S.-based third-party service provider to manage the data of its U.S. policyholders.

What are the expected changes to future CFIUS review of Chinese investment into the U.S.? [5]

FIRRMA is bringing many key changes that would heavily impact Chinese investment in the U.S., including:

  • Increased scrutiny of transactions involving “countries of special concern,” including China, deemed to pose significant risks to U.S. national security.
  • Authority to review any foreign investment in any U.S. critical technology company or U.S. critical infrastructure company . Also put under review are investments in businesses that maintain or collect sensitive personal data of U.S. citizens . The tougher regulations are largely targeted at preventing Chinese companies from acquiring U.S. technology and data, especially as many Chinese deals are subsidized by the Chinese government. [6]
  • Crackdown on deals designed to evade or circumvent the CFIUS review process, e.g. use of a shell company to conceal true ownership. Proponents of FIRRMA were “particularly concerned that China was exploiting loopholes in the CFIUS process to acquire U.S. technology with military applications.” [7]
  • Mandatory, despite abbreviated, CFIUS filing (rather than voluntary under the status quo) for transactions where a foreign government-backed entity would acquire a substantial interest in U.S. businesses involving critical technologies, infrastructure, or sensitive data.
  • Lengthened time for review (initial review period extended from 30 to 45 days, with possibility of a 45-day extension at the request of a federal agency).
  • Formally confirmed the authority for CFIUS to suspend transactions, impose conditions, and implement mitigation agreements prior to the completion of the review or after the transaction has been abandoned.

As China is a key economic and military rival to the United States, FIRRMA is largely supported by China hawks hoping to restrict potentially harmful Chinese investments amid the trade war. [8] Most of these changes are aimed at putting Chinese deals under tighter scrutiny than ever before. The added bureaucracy, extended review period, and increased scrutiny over deals involving countries of special concern, including China, are likely to lengthen the timeline for deals and increase the cost of Chinese investments .[9]

What can Chinese investors considering U.S. investment do to meet these challenges?

Chinese investors are advised to inform themselves and plan in advance for increased scrutiny and regulation, possibly with the guidance of professional counsel to navigate the new CFIUS requirements. For more information on CFIUS and how Pamir can help maximize the success of your transactions in the face of these changes, please contact us at info@pamirlaw.com.