A 90% fall in Chinese investment into the US in 2018 so far could just be a blip resulting from current geopolitical tensions. Or it could be a permanent reduction, cemented in place by new laws, now finalized and set to pass the US congress in the next few weeks.
And it’s important to realize that this new law, while supported by the Trump administration, was not initiated by them. Rather it comes from agreement between Republican and Democrat lawmakers that something needed to change. And laws once made tend not to get changed very often – we should assume this new law will remain in place for at least the next decade.
So what exactly will be different?
This law – the Foreign Investment Risk Review Modernization Act (FIRRMA) to give it its full title – expands the scope of types of investment that the government must review and sign off on before an investment can be completed, and gives clear direction on the types of investment that it expects to be turned down.
These reviews are undertaken by a group called CFIUS (Committee on Foreign Investment in the United States) whose membership is made up of close to 20 branches of the US government ranging from the Department of Commerce to the Department of Defense.
Proposed investment that must be reviewed include not only investments where a foreign party acquires control of a business, but also:
1. Minority (or non-controlling) investments into:
- Critical infrastructure companies
- Suppliers to critical infrastructure companies
- Companies that develop, manufacture, or test critical technologies
- Companies that maintain or collect personal data on US citizens
2. Major real estate transactions, prioritizing any proposed transaction in the vicinity of a government facility.
Lots of use of the word “critical”. Digging in to what some of these terms mean:
Critical technology company: A business that "produces, designs, tests, manufactures, fabricates, or develops" critical technologies. Critical technologies, in turn, are those subject to certain US export and other security controls, including new export control provisions designed to protect "emerging and foundational technologies". This is likely to include companies that work in quantum computing, artificial intelligence, biotechnology and the like, as well as anything regarded as dual use, civilian and military, technology such as drones.
Critical infrastructure company: A business that "owns, operates, manufactures, supplies, or services" critical infrastructure, such as telecommunications, utilities, transportation, financial services, healthcare and government services (A very similar definition to that which China uses in its cybersecurity law). Covered suppliers to these companies include providers of technology such as servers, switches, convertors, vehicles, medical consumables and potentially anything a government department might purchase. A sweeping scope.
Sensitive data companies: Companies that "maintain or collect" data on US citizens that may be exploited in a manner that could threaten national security. This category is left rather undefined for CFIUS to work out what falls under the designation. It is likely companies in the medical sector, financial services sector, internet companies and advertisers could be covered. There is recent precedent that holding any data on military personnel or their families is automatically regarded as sensitive and will be a knock out factor.
In the past, companies making acquisitions in the US had the choice of whether or not to report the transaction to CFIUS and many chose not to. In future it will be mandatory for any investment stake of over 10%. Investors will be required to make their own ownership structure clear as part of the review process and any company with material government investment will be reviewed to a higher bar.
The extraterritorial aspect of the review process remains. More specifically this means that if a Chinese company is making an acquisition of a company anywhere in the world and that target company has operations (e.g a sales branch, a research operation) in the US, then a CFIUS review will be required for the acquirer to take control of the US part of the target business.
Many Chinese companies are already operating in the US in sectors where this new law would make it very unlikely that they could make an acquisition today. These companies must be wondering about how they might be impacted going forward – will they be able to proceed with organic investment to build a new factory or R&D centre? I assume that will be fine but can’t be certain.
Also, Chinese PhDs studying in the US and considering launching a start up in the US in a technology sector on graduation may also have questions – will their tech start up need to be approved by CFIUS if they are a Chinese citizen if they hold more than a small stake? Important detailing of the scope and process remains to be worked through.
Finally, FIRRMA reauthorizes export control laws and adds a new category of “emerging and foundational technologies” that should be controlled. This will restrict US companies from selling product and licensing impacted technology to 3rd parties or even joint venture partners without government approval. The restrictions announced last week barring sales of US technology to 44 Chinese businesses, largely ones with government shareholders, is a precedent of what potentially comes next.
Net net, FIRMMA significantly increases the risk that a proposed investment transaction from the US to China will be turned down. Most Chinese companies won’t take the risk of having that happen to them – too much uncertainty, too much loss of face if the process fails. All of this is independent of developments on trade and tariffs.
We can say goodbye to most investment from China to the US for years to come.