DAY 1: February 28
A guide to Chinese capital controls and the future of outbound M&A
- In 2017, outbound deal activity dropped by 40% in H1, 10% in H2, and 30% overall year-on-year;
- Technology, advanced manufacturing, renewables and natural resources continue to be strong sectors - Belt and Road Initiative projects are also encouraged but buyers need to ensure they stay within their core business;
- New outbound investment rules (Administrative Measures for Enterprise Outbound Investment) started March 1: capital controls previously focused on onshore financing/guarantee but new rules focus on monitoring vehicles. Sellers should pay attention to see if they have a legitimate structure/enough assets to ensure the deal can close properly, and need to mobilise sufficient funds; offshore/onshore, check what are regulatory approvals are needed;
- The US Foreign Investment Risk Review Modernisation Act 2017 poses a threat to deal activity with an increased review period of up to 45 days, and mandatory filings for the acquisition of a 25% share or more of voting interest in a US business by a foreign entity;
- Cfius has broadened the application of covered transactions, sectors such as technology, big data, robotics, artificial intelligence (AI), fintech data and records, health electronic medical records, and digital health draw increasing attention.
Investment trends in Asia outbound M&A into Europe
- China was one of the main drivers in the region (2010-2016) though activity slowed down in 2017. China and Japan make up half of deals into Europe: areas such as industrials, high tech, materials are popular because they are highly correlated to the China 2025 strategy which focuses on robotics, rail, marine transport, new energy vehicles and advanced medical product development;
- There are big opportunities in eastern European countries as domestic consumption rises and countries converge to western Europe: the region is still subject to scarcity of capital but has attractive asset prices, making it easier to negotiate compared to western Europe where there is overpricing and potential cultural backlash for Chinese buyers;
- An EU security review draft proposal will review investments into Europe affecting security/public order, those involving substantial amount of EU funding or those involving critical infrastructure, technologies or critical inputs. Some sectors draw a specific focus such as AI, robotics, semiconductors, cybersecurity, space or nuclear tech.
Managing antitrust risks in Asian M&A
Different requirements for merger control filings in different countries can cause confusion, especially with over 130 thresholds globally;
- Merger control notifications usually refer to sales/revenue but technology startups increasingly raise questions when revenues are non-traditional, such as Uber/Didi model which triggered an investigation from the Ministry of Commerce of China (Mofcom);
- Competition authorities increasingly feel there is an accumulation of power in the tech sector by conglomerates and nobody is there to exercise checks and balances: there is an ongoing debate as to whether thresholds are well defined for acquisitions of a new kind;
- Structural remedies are applied in more than 60% of transactions in China – traditional remedies include forcing a company to make a divestment. Behavioural remedies require more involvement from the government such as forcing parties to maintain a pricing system and looking for evidence that customers are not discriminated against after the merger has closed;
- There is increasing focus on gun jumping: authorities are sanctioning companies for getting too close too soon before getting clearance from the regulator(s);
- Parties often underestimate jurisdictions that mandate merger control filing: the time needed for notifications and the volumes of information involved, arrangements in sale negotiations for who will take responsibility if something goes wrong.
Navigating corruption risk, due diligence and enforcement in Asia
- A recent trend had been to move away from jurisdictional focus towards an industry specific enforcement, honing in on special purpose vehicles, platform investments, and the amalgamation of different assets;
- Information exchanges between regulators is also increasing: for instance, the US Securities and Exchange Commission is increasing its relationship with Hong Kong’s Securities and Futures Commission and the China Securities Regulatory Commission;
- Investigations into counterparty government/military linked regulatory problems and data privacy increase sensitivity;
- Companies need to pay attention to sanction lists, for instance the US Treasury’s Office of Foreign Assets Control list.
- There’s been a trend towards the privatisation of state-owned enterprises, eight-10 privatisations expected for 2018;
- Resolution No.42 and its pilot programme for handling credit institutions’ bad debts especially in the real estate sector are encouraging more M&A activity;
- Some pre-deal considerations include business scope, licensing process, expectations of buyers/sellers on pricing, payment terms, funding, timing and transaction complexity;
- It’s important to do due diligence on capital structure, construction permits, land rental fees as well as internal labour rules;
- Common issues in transactions: lack of experience in international transactions which creates a large gap in expectations on both commercial terms and drafting agreements; negotiating styles can be challenging especially for state-owned enterprises where there is multi-level decision making, leading to deadlock situations.
Developments in technology M&A in the region
- More venture funds, minority shareholders and corporates are willing to put money to find targets that are leapfrogging disruptive technologies;
- Because of increased scrutiny from Cfius, it’s challenging for China to get involved in US tech deals;
- China’s cybersecurity law comes into effect on January 1 2019, so companies have to comply before then;
- In the context of M&A, companies need to consider how transactions can add value in terms of data, relocalisation costs, IP rights, data transfers and processing, whilst balancing data governance and process controls;
Shareholder activism: the state of play in Asia and beyond
- Opportunities for shareholder activism are beginning to increase with stewardship codes being implemented in Asia, including Japan, Hong Kong and Korea;
- But with weighted voting rights in place, shareholder activism will be even more challenging;
- Many companies in Hong Kong are still family owned, so shareholder activism activity can be limited;
- Hong Kong courts are sympathetic to shareholder activists but any solution is difficult without a class action regime in place;
- For companies, good strategies for handling activists include being open and honest with investors, having a good understanding of the shareholder base, identifying longer term strategies, building relationships and having regular dialogues.
DAY 2: March 1
Lessons learned from post-closing claim studies
- The use of reverse break fees to tackle deal and funding uncertainty is on the rise, especially with China regulatory approvals and Cfius issues;
- A combination of escrows and representation and warranty insurance is also on the rise to fill gaps, though not so much in China;
- The US practice of placeholder claims is not as prominent in Asia: outside of the US, fewer meritless placeholder claims could be due to the 'loser pays costs; principle and ambulance chasing for contingency fees in US.
The art of non-price bid sweeteners to win M&A auctions
- Reverse break fees are on average three to five percent, sometimes up to 10%;
- Representation and warranty insurance is one of the most important tools for acquirers, and is becoming more common in Asian markets;
- It's rare for Chinese companies to understand and entertain the idea of representation and warranty insurance;
- Whether this type of insurance is enforceable in Chinese courts is a whole different matter.
The art of distressed M&A
- Distressed opportunities are growing in India, Vietnam, South Korea andJapan;
- There's been a strong focus on sectors such as energy, shipping, real estate. Strong growth in private lending for distressed debt especially with capital adequacy constraints for banks is also expected;
- A new bankruptcy regime in India has provided huge scope for distressed assets;
- Non-performing loans in China are still being managed by asset management companies, making it difficult for international companies to get in.
Games people play: lessons learned from purchase price disputes
- Companies must think about dispute resolution clauses, as these will impact the course of action if something goes wrong;
- They also need to consider court or arbitration processes, especially which jurisdiction arbitration should take place in;
- Transactional documents, including emails are important to look at, and may be used against a party in price adjustments;
- The use of representation and warranty insurance can be a negotiation tactic: buyers can use representation and warranty insurance to enhance bids.
- Representation and warranty insurance can work to minimise disruption by government approval processes, including by Cfius.
Practical impact of
representation and warranty insurance on the M&A process
- While there's been growing interest in representation and warranty insurance in Asia, it's still a nascent practice compared to the US, the EU and Australia;
- Chinese buyers are interested in getting assurance about the capacity of insurance companies to pay, especially when it comes to domestic insurance companies;
- Insurance costs depend on the jurisdiction and sector: they are lower for sectors such as real estate, consumer retail but higher for higher risk sectors such as infrastructure, mining, financial services. They are also higher for higher risk for jurisdictions such as China;
- In 2017, an AIG study on claims made based on 2016 data found that financial warranties topped the list followed by compliance breach, material contracts, tax.
See alsoPRIMER: the Committee on Foreign Investment in the United States (Cfius)
PRC focuses on continuous monitoring of offshore deals