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Chinese Investments in Germany - Is FDI Control an Obstacle?
In this interview, our expert Dr Patrick Hübner talks about the increasing control of Chinese direct investments in Europe and Germany. He explains which FDI control measures exist and what influence the pandemic had on Chinese investments.
Welcome to "Article 5", the ADVANT Beiten Podcast.*
My name is Jörg Hahn and I’m a former editor and journalist for a major German newspaper. Today I’m talking to Dr Patrick Hübner about the developments in the control of Chinese investments in Europe and Germany.
Patrick Hübner is a lawyer and partner at ADVANT Beiten and is a member of the firm’s Corporate/M&A, Foreign Trade Law and China practices. He has represented numerous clients in investment control proceedings before the German Federal Ministry of Economic Affairs and Climate Action in Berlin (which we’ll refer to as just the "Ministry").
We’re looking at the increasing control of Chinese investments in Europe and Germany and explore what this means for German companies looking for foreign investors from the Far East to avert impending insolvencies, bridge liquidity bottlenecks or find a successor for the company.
Jörg Hahn: Patrick, anyone following the German media over the past few years will have seen the growing scepticism towards investments from China. The 2016 takeover of robotics manufacturer Kuka by the Chinese Midea Group was a key moment in the control of foreign investments, and it is said to have led to a change in thinking in German industry and politics. What do you think about this development?
Patrick Huebner: In my opinion, Germany and Europe are still very attractive locations for foreign investment. This is due to the good framework conditions, the predominantly stable political situation, good infrastructure and a large supply of highly qualified labour.
The takeover of Kuka by the Midea Group in 2016 was a key moment which led to a noticeable increase in the control of foreign direct investments in Germany, especially those from the People's Republic of China. Germany now looks very closely at who is investing and what is being invested in.
Still, there are only a few known cases since 2016 in which foreign investments were prohibited or prevented in some other way. This might be because FDI review procedures are not public, but it corresponds with our experience in recent years:
Most of the M&A transactions subject to German FDI review are cleared by the Ministry. This is a very good sign for Germany as an investment destination.
Jörg Hahn: Have there been any cases in the past where Chinese investments were prohibited in Germany?
Patrick Hübner: Yes. Six cases are worth mentioning.
The acquisition of Kuka by Midea was ultimately completed in 2016 after the US defence business was carved out. In the same year, there was a tug-of-war over AIXTRON, an equipment manufacturer in the semiconductor industry. A Chinese investment fund sought to take over the German manufacturer. The deal eventually fell through due to US security concerns.
Two further cases occurred in 2018. The first formal prohibition decision was imposed by the Ministry on the planned acquisition of the German special machinery manufacturer LEIFELD METEAL SPINNING by a Chinese state-owned company from the nuclear industry;
In the second case, the German Federal Government intervened indirectly and acquired shares in German grid operator 50 HERTZ, a former Vattenfall subsidiary, through the German development bank (KfW) to prevent the State Grid Corporation of China from acquiring the shares.
In 2020, the second formal prohibition decision followed. IMST is a German communications technology company active in the fields of satellite and radar communications as well as 5G technology which became the target of a takeover by the Casic-Group, a major Chinese state-owned defence contractor.
Since the beginning of this year, we have been reading about another two failed takeovers. The deadline for the public takeover bid of SILTRONICS by Taiwanese chip supplier GlobalWafers ultimately expired before the Ministry had made a decision. The takeover of German medical ventilators manufacturer HEYER MEDICAL AG by the Chinese Aeonmed-Group was vetoed by the Ministry, assumingly due to concerns for the security of the German public health care. This marked the third formal prohibition decision.**
Jörg Hahn: Who are the top investors from third countries?
Patrick Hübner: The top investors in Europe are currently the USA, followed by the UK and the PRC, which is also reflected in the number of FDI control proceedings.
Jörg Hahn: Looking at the European Commission's first Foreign Direct Investment Review Report, released in November 2021, we can see a dramatic decline in Chinese M&A transactions in 2020, falling by nearly 2/3 year-on-year. What could be the reason for the sharp decline? Is it just general uncertainty related to the pandemic?
Patrick Hübner: Our firm's China practice has also seen a general decline in M&A transactions with Chinese participation. The pandemic is certainly one reason for this, but I would say it is far from the only reason.
Before the pandemic, there was already a degree of uncertainty due to the ongoing trade disputes. The pandemic increased this uncertainty.
During the pandemic, travel restrictions were also introduced. Many investors want to "see and touch" what they intended to buy, but could not do so due to the restrictions on air travel and the quarantine requirements when re-entering the PRC. We know many investment projects have been postponed indefinitely.
And, finally, the regulatory issues already mentioned played - and still play - a particularly important role: on the Chinese side, there is the regulation of outbound investments and foreign currency outflows, and on the European and German side, there is the control of Chinese direct investments.
Jörg Hahn: At the start of the pandemic, the EU Trade Council warned of a "European clearance sale" and the former German Federal Minister of Economic Affairs announced the revision of Germany's foreign trade law. What happened?
Patrick Hübner: What happened? Over the last two years, the control of foreign direct investments in Germany and the EU picked up in speed, with Chinese investors increasingly becoming the focus of national FDI reviews, as the examples I mentioned indicate.
These protectionist efforts of the European Union against China are nothing new. However, the pandemic became acted as a "fire accelerant" in the light of the feared wave of insolvencies in Europe.
At the European level, the EU Screening Regulation was adopted in spring of 2019, well before the pandemic, incidentally at the initiative of Germany, France and Italy. Since it entered into force in autumn 2020, the EU Screening Regulation has created a uniform framework for controlling foreign direct investment in the EU.
The EU Screening Regulation can be seen as a unified European response to the increasing activities of Chinese investors worldwide and China's ambitious plans to secure global technological supremacy by 2049.
In light of the EU Screening Regulation, 24 of 27 EU member states have already either introduced an investment control regime, revised the existing regulatory framework, or launched corresponding initiatives.
In Germany, for example, there have been several amendments to the foreign trade laws that have significantly tightened up the existing FDI control regime. We’ve definitely noticed the effects in M&A transactions with foreign investors.
Jörg Hahn: What is FDI control and what specifically does the German FDI control cover?
Patrick Hübner: Generally speaking, FDI control allows the respective EU member state to examine whether a foreign investment affects national or European interests related to public security.
German FDI control covers not only the acquisition of a company, but also the acquisition of shares in a German company when certain voting right thresholds are reached, as well as the acquisition of a definable part of a business or its essential operational assets.
Jörg Hahn: What specific changes have there been in the field of FDI control in Germany?
Patrick Hübner: In the past three years, the two main sets of regulations in Germany, the German Foreign Trade and Payments Act ("Außenwirtschaftsgesetz") and the German Foreign Trade and Payments Ordinance ("Außenwirtschaftsverordnung"), have been revised several times. Some related regulations, such as most recently the German Ordinance on the Designation of Critical Infrastructure ("Verordnung zur Bestimmung Kritischer Infrastrukturen"), have also been adapted.
The amendments implement three main changes:
- First, they expand the scope of the German FDI control. The relevant voting rights thresholds were lowered so that German FDI control applies in some cases where only 10 percent of the voting rights are acquired. The cases in which the Ministry must be notified were significantly expanded in terms of both quantity and quality;
- Second, they significantly tighten the review standard of the German FDI control, i. e. where previously an actual threat to the public security or the essential security interests was required to prohibit a foreign investment, from now it will be sufficient if there is a probable impairment of the public security or the essential security interests; and
- Third, the amendments extend the review period, resulting in noticeable delays in M&A transactions with foreign investors.
Jörg Hahn: What are the specific features of the current FDI control regime in Germany?
Patrick Hübner: German FDI control distinguishes between sector-specific FDI review and cross-sectoral FDI review.
Sector-specific FDI review mainly covers cases in which a foreigner, i.e. an acquirer based outside Germany including in another EU Member State, intends to acquire an interest of 10 percent or more of the voting rights in a German company involved in the defence and armaments industry.
All other acquisitions are subject to cross-sectoral FDI review, where the acquirer is a non-EU / non-EFTA investor and the acquisition meets or exceeds certain industry-specific thresholds of 25, 20 or 10 percent.
It is important to note that, where the German target company operates within a (critical) industry sector, which is particularly relevant to security, the planned acquisition must be notified to the Ministry and may not be consummated (closed) before clearance.
Jörg Hahn: To which industrial sectors does this "mandatory notification obligation" apply?
Patrick Hübner: The obligation to notify an acquisition to the Ministry applies in all industry sectors that are – from the perspective of the German Government – particularly relevant to public security.
For sector-specific FDI review, these industries are the defence and armaments industry, certain products with IT security functions and certain defence-critical facilities.
For cross-sectoral FDI review, the mandatory notification obligation applies to classic industry sectors such as critical infrastructure, cloud computing, the media industry, and the healthcare sector, which was added to the list of sectors at the beginning of the pandemic. The mandatory notification requirement also applies to numerous, particularly promising future technology sectors, such as artificial intelligence, additive manufacturing (i.e. 3D printing), automated driving or flying, robotics, semiconductors, and network technologies (keyword: 5G), but also includes areas such as cybersecurity, aviation and aerospace, nuclear technology, critical raw materials and others.
Jörg Hahn: In light of the recent tightening of German foreign trade laws, what do German companies need to keep in mind when looking for an investor from China?
Patrick Hübner: German companies seeking investors from China or planning to sell the company or parts thereof to them should address the question of whether the planned investment or acquisition may be subject to German FDI control at an early stage.
Incidentally, this applies to all non-EU investors, including those from the US, UK and Northern Ireland. In the defence and armaments sector, it even applies to investors from other EU Member States.
In our experience, realistic timing is key. To this end, it is important to know that German FDI control is divided into two stages, the preliminary and main proceedings, and can take up to 10 months or longer for complex transactions. To obtain transaction security as quickly as possible, we recommend notifying the acquisition to the Ministry before the contract is concluded or applying for a certificate of non-objection.
Jörg Hahn: Let's assume a German company which does not belong to a particularly security-relevant (critical) industry sector is looking for an investor from the US or China to acquire shares in the company. What applies?
Patrick Hübner: Two cases must be distinguished here:
If the planned investment is below the generally applicable threshold of 25 percent for investments in non-critical industry sectors, in other words, if the US or Chinese investor does not acquire control of 25 percent or more of the voting rights in the German company, the investment is exempt from FDI approval. In this case, the acquisition does not fall under the scope of German FDI control.
If, on the other hand, the 25% threshold is reached or exceeded, the acquisition is subject to German FDI control. However, since the German target company in our case does not operate in a critical industry sector, the acquisition does not have to be reported to the Ministry and can be closed.
Since the Ministry can still review threshold-relevant investments ex officio up to five years after the conclusion (signing) of the contract, many investors decide to apply to the Ministry for a certificate of non-objection (Unbedenklichkeitsbescheinigung) as a precautionary measure, even where notification is not mandatory, to obtain transaction security at an early stage.
Jörg Hahn: What can the Ministry do if it concludes that an acquisition constitutes a risk to public security?
Patrick Hübner: The Ministry can prohibit the acquisition - as in the case of Leifeld Metal Spinning, IMST or Heyer Medical - or issue orders restricting the acquisition. In our experience, however - for reasons of proportionality – the Ministry usually tries to remedy security-related concerns primarily by creating a balance of interests in the context of negotiating public-law contracts. This is often the milder remedy compared to unilateral orders.
If a prohibition or order is issued, it does not have to be simply accepted. Prohibitions and orders are administrative acts that can be appealed. However, it must be noted that the Ministry has broad discretion when deciding whether an acquisition is likely to impair security-related interests, which can be reviewed by German courts only on limited grounds.**
Jörg Hahn: How many German FDI reviews have there been and which industries have been affected?
Patrick Hübner: According to the Ministry, there were more than 300 FDI control proceedings in Germany in 2021. This is remarkable, as it represents almost double the number of FDI reviews compared to the previous year, despite the general decline in M&A activity. This shows that the expansion of the type of cases subject to the mandatory notification obligation has significantly increased the Ministry's caseload of FDI reviews.
In total, more than half of the FDI reviews are attributable to US investments and, since BREXIT, to UK investments, too. Only a small proportion of the acquisitions reviewed involved Chinese investors. Information and communications technology, infrastructure, healthcare, and semiconductors industries have been particularly relevant for FDI control.
Jörg Hahn: Thank you very much, Patrick. Do you have a forecast for the future of Chinese investment in Germany?
Patrick Hübner: I don’t have a “crystal ball”, but I can try.
In the next one or two years, I expect we will see an increase in greenfield investments in Germany and Europe. Chinese companies will be entering the market and setting up new operations, making long-term investments, expanding existing market activities - such as in the field of electromobility - creating huge value for the German economy and offering many opportunities for German companies, for example in the context of cooperation and joint ventures.
With the end of the pandemic, Chinese direct investments should return. Despite the increased number of transactions in critical industry sectors subject to mandatory notification, there is still significant investment potential in Germany and Europe, such as in Italy and France, but also Poland, for example.
Finally, most of the investments subject to the German FDI control, whether from the US or China, are ultimately approved by the Ministry. Europe and Germany remain very attractive targets for foreign investments.