China braces for rough seas in global M&A

But the landscape is changing. Increasing capital outflows have prompted the PRC authorities to step in. The nation's policy makers have announced restrictions on certain overseas investments, potentially curbing all mega deals worth over $10 billion and scrutinizing any transactions over $1 billion that are outside the buyer's core business.

Meanwhile, Chinese acquirers are facing taller regulatory hurdles and stricter national security reviews overseas, particularly in the U.S. and Germany. Despite a record $94.2 billion Chinese investment into North America and Europe in 2016, the year also saw the highest ever number of canceled transactions. Thirty Chinese FDI deals into the two regions were canceled last year—abolishing nearly $80 billion in deal volume, according to Baker & McKenzie—with some affected by overseas regulators.

One notable example was the proposed €670 million takeover of German chip equipment maker Aixtron by a group of Chinese investors led by Fujian Grand Chip Investment Fund in May 2016. The deal progressed until October, when the German economics ministry withdrew its initial approval for further review, citing concerns over security-related technologies owned by Aixtron. The U.S. dealt the final blow when former President Obama issued an order prohibiting the U.S.-related part of the deal due to national security issues. The entire deal was subsequently withdrawn.

That deal's release came shortly after Midea announced an attempt to purchase Kuka AG, a German robot manufacturer leading the nation's drive to digitize industrial processes and create automated factories, for €4.5 billion, the largest ever acquisition of a German business by a Chinese buyer. It was completed in January this year after months of controversy in the European nation. Midea won over shareholders by offering commitments to 2023 to allow Kuka to operate independently, to preserve jobs, management and existing headquarters. It said also that it would keep the public listing, and ring-fence data in response to security concerns, Clifford Chance, which represented Kuka, wrote in its report.

On the U.S. side, the election of Donald Trump may spell trouble. His campaign was largely fueled with anti-China rhetoric, such as accusing Beijing of devaluing the renminbi to put American companies at a disadvantage and stealing U.S. trade secrets, as well as promising to brand China a currency manipulator and slap 45% tariffs on Chinese goods (neither of which he has done yet).

In November, the U.S.-China Economic and Security Review Commission, a panel that monitors trade and security links between Washington and Beijing, urged Congress to change the mandate of the Committee of Foreign Investment in the United States (CFIUS) to ban Chinese state-owned enterprises (SOEs) from acquiring or gaining control of American companies, alleging that the PRC government had used SOEs to advance its own national security agendas. (Investments by Chinese acquirers have represented the largest percentage of CFIUS filings for the past three years.) While the suggested changes aren't mandatory, the recommendations carry weight now that a number of confirmed cabinet members of Trump's administration have criticized China and could take a tougher stance against inbound deals from the Asian nation. Rex Tillerson, the nominee for U.S. Secretary of State, has publicly condemned China's controversial island-building in the South China Sea, for instance. Trump will also have the final discretion on deciding to block or allow transactions sent to him for review.

Earlier in the year, state-owned Tsinghua Unigroup terminated a $3.8 billion plan to acquire a board seat and become the largest shareholder in data storage group Western Digital after the deal was flagged for a CFIUS probe. Chinese telecom equipment maker Huawei Technologies' proposed investments into the U.S. have repeatedly been blocked because of the company's alleged ties to the PRC military.

This change in pace and uncertain outlook have some investors retreating from the global deal stage.

Clifford Chance London partner Simon Clinton said, “Last year saw a big uptick in Chinese outbound M&A, but plans have largely been put on hold as companies and investors wait to see how the new caution of governments and regulators plays out.”

Practical tips from the firm for Chinese cross-border M&A parties included engaging early with foreign regulators, including CFIUS on inbound American security concerns, as well as the PRC authorities regarding the new capital outflow approval process. Sellers are also increasingly asking Chinese buyers to take on the risk of regulatory intervention such as by confronting them with reverse break fees at rates of 3% to 6% of deal value (and sometimes higher in certain cases).

Foreign sellers have also been expressing wariness regarding the certainty of funds promised by Chinese investors—a domestic bidder backed by debt financing from local banks must be able to convince the seller that the funding is certain to materialize. Some sellers may request letters of credit from debt financiers or cash escrows to support the payment obligations in addition to break fees, the Clifford Chance report said.

Investors should also monitor political and trade developments in China's ties with the U.S. and Europe. Export controls and sanctions may indicate how CFIUS may interpret its review process, though recent developments do little to suggest that CFIUS' investigation priorities for Chinese deals will shift any time soon.

By Katherine Jo

Armed with the world's largest currency reserves and among the biggest trade surpluses, China has become a force to reckon with in global M&A.

Global outbound investments by Chinese entities topped $208.6 billion in 2016—a 114% increase from the previous year—led by industrials and chemicals ($72.2 billion) and TMT ($39 billion) deals in Europe and North America, trends compiled by Clifford Chance show. (ChemChina's $45.9 billion acquisition of Swiss Syngenta, the largest outbound deal of the year, pulled significant weight into these figures.)

An abundance of capital and cheap debt, pursuit of growth outside a slowing economy and efforts to meet the standards of a more affluent and brand-conscious middle class, are largely driving the momentum for outbound M&A, the report said.

But the landscape is changing. Increasing capital outflows have prompted the PRC authorities to step in. The nation's policy makers have announced restrictions on certain overseas investments, potentially curbing all mega deals worth over $10 billion and scrutinizing any transactions over $1 billion that are outside the buyer's core business.

Meanwhile, Chinese acquirers are facing taller regulatory hurdles and stricter national security reviews overseas, particularly in the U.S. and Germany. Despite a record $94.2 billion Chinese investment into North America and Europe in 2016, the year also saw the highest ever number of canceled transactions. Thirty Chinese FDI deals into the two regions were canceled last year—abolishing nearly $80 billion in deal volume, according to Baker & McKenzie—with some affected by overseas regulators.

One notable example was the proposed €670 million takeover of German chip equipment maker Aixtron by a group of Chinese investors led by Fujian Grand Chip Investment Fund in May 2016. The deal progressed until October, when the German economics ministry withdrew its initial approval for further review, citing concerns over security-related technologies owned by Aixtron. The U.S. dealt the final blow when former President Obama issued an order prohibiting the U.S.-related part of the deal due to national security issues. The entire deal was subsequently withdrawn.

That deal's release came shortly after Midea announced an attempt to purchase Kuka AG, a German robot manufacturer leading the nation's drive to digitize industrial processes and create automated factories, for €4.5 billion, the largest ever acquisition of a German business by a Chinese buyer. It was completed in January this year after months of controversy in the European nation. Midea won over shareholders by offering commitments to 2023 to allow Kuka to operate independently, to preserve jobs, management and existing headquarters. It said also that it would keep the public listing, and ring-fence data in response to security concerns, Clifford Chance, which represented Kuka, wrote in its report.

On the U.S. side, the election of Donald Trump may spell trouble. His campaign was largely fueled with anti-China rhetoric, such as accusing Beijing of devaluing the renminbi to put American companies at a disadvantage and stealing U.S. trade secrets, as well as promising to brand China a currency manipulator and slap 45% tariffs on Chinese goods (neither of which he has done yet).

In November, the U.S.-China Economic and Security Review Commission, a panel that monitors trade and security links between Washington and Beijing, urged Congress to change the mandate of the Committee of Foreign Investment in the United States (CFIUS) to ban Chinese state-owned enterprises (SOEs) from acquiring or gaining control of American companies, alleging that the PRC government had used SOEs to advance its own national security agendas. (Investments by Chinese acquirers have represented the largest percentage of CFIUS filings for the past three years.) While the suggested changes aren't mandatory, the recommendations carry weight now that a number of confirmed cabinet members of Trump's administration have criticized China and could take a tougher stance against inbound deals from the Asian nation. Rex Tillerson, the nominee for U.S. Secretary of State, has publicly condemned China's controversial island-building in the South China Sea, for instance. Trump will also have the final discretion on deciding to block or allow transactions sent to him for review.

Earlier in the year, state-owned Tsinghua Unigroup terminated a $3.8 billion plan to acquire a board seat and become the largest shareholder in data storage group Western Digital after the deal was flagged for a CFIUS probe. Chinese telecom equipment maker Huawei Technologies' proposed investments into the U.S. have repeatedly been blocked because of the company's alleged ties to the PRC military.

This change in pace and uncertain outlook have some investors retreating from the global deal stage.

Clifford Chance London partner Simon Clinton said, “Last year saw a big uptick in Chinese outbound M&A, but plans have largely been put on hold as companies and investors wait to see how the new caution of governments and regulators plays out.”

Practical tips from the firm for Chinese cross-border M&A parties included engaging early with foreign regulators, including CFIUS on inbound American security concerns, as well as the PRC authorities regarding the new capital outflow approval process. Sellers are also increasingly asking Chinese buyers to take on the risk of regulatory intervention such as by confronting them with reverse break fees at rates of 3% to 6% of deal value (and sometimes higher in certain cases).

Foreign sellers have also been expressing wariness regarding the certainty of funds promised by Chinese investors—a domestic bidder backed by debt financing from local banks must be able to convince the seller that the funding is certain to materialize. Some sellers may request letters of credit from debt financiers or cash escrows to support the payment obligations in addition to break fees, the Clifford Chance report said.

Investors should also monitor political and trade developments in China's ties with the U.S. and Europe. Export controls and sanctions may indicate how CFIUS may interpret its review process, though recent developments do little to suggest that CFIUS' investigation priorities for Chinese deals will shift any time soon.