A look at Chinese outward investments

With political interference elsewhere on the rise, the Benelux may find itself attracting more Chinese investments in the coming years.

Amidst global economic turmoil and slower GDP growth in China, the trend towards ever-increasing outward investments from China into the world continued in 2012. A recent paper by the Asian Study Center at the American Heritage Foundation[1] provides comprehensive data and some interesting insights into the transactions behind the numbers.

The Heritage Foundation claims to offer the only public dataset of Chinese outward investment, even though it does not give a full view of Chinese outbound activity - for example, the paper excludes transactions valued at less than USD 100 million and thereby understates deal activity in smaller countries, and it also excludes bond purchases and engineering and other infrastructural contracts.

Nevertheless, the numbers of the Heritage Foundation are instructive in that they are edited numbers from the official ones given by the Chinese Ministry of Commerce. This editing was done to remove some of the statistical oddities that distort the official numbers, such as the Ministry of Commerce's habit of counting any investment out of China that was structured through Hong Kong as an investment in Hong Kong, whereas in practice Hong Kong is just as often used as a first stop on the way of a Chinese investment into other countries, in the same way as the Benelux countries are used as intermediate jurisdictions to structure investments into Europe.

The numbers for 2012 show steady growth in Chinese outbound investments, from USD 74.6 billion in 2011 to USD 79.7 billion in 2012. Top destinations for Chinese money continue to be Australia and the United States, followed by Canada, Brazil, Great Britain, and Indonesia. In 2012, the balance tipped heavily towards Canada due to the largest Chinese outbound investment up to date: CNOOC's USD 15.5 billion acquisition of Nexen.

Unsurprisingly, China has mainly been shopping for resources needed to fuel its continuous growth; accordingly, the bulk of its outbound investments goes towards securing the supply of natural resources (oil, coal, metals, and the like) and land (for agriculture).

Whilst this trend is expected to continue in the years to come, Chinese leaders are concerned about avoiding the fabled middle-income country trap (i.e., the levelling-out of a fast-developing economy's GDP growth before its having become a high-income country, a process experienced by early growth economies such as Brazil or South Africa) and will therefore continue to support Chinese companies' expansion into ever more sophisticated industries. This will translate into Chinese investments in premier brands, state-of-the art technology, and service industries, especially in the financial sector.

Such investments, especially if they are aimed at "strategic", well-known, or otherwise politically sensitive businesses, may generate host country suspicions in certain cases, especially when the proposed investment would be made by a Chinese State-Owned Enterprise (SOE).

Failed investments

In this respect, the Heritage Foundation paper provides some interesting data, detailing investments that failed not so much because the parties could not reach an agreement, but because of external factors such as a government's approval being withheld or delayed: USD 200 billion in potential Chinese investment never materialised or did not bear fruit since 2005. That means Chinese outbound investments could have been almost double the size they actually were.

Assuming the Heritage Foundation's numbers are correct, such failed investments are more than merely accidental and may indeed point towards a continuously unfavourable omen for the potential of Chinese companies to successfully investing abroad.

Even though one should be careful in trying to discern a trend given the still relatively limited pool of data, in respect of troubled Chinese outbound investments since 2005 there does seem to be the recurring themes of governmental involvement and trade protectionism as the main reasons why such investments ultimately did not go through.

In this respect, most of the literature on Chinese outbound investments tends to focus on the Chinese government's involvement in preventing certain outbound investments. However, this is not entirely justified - "host" governments are also culprits. In 2012, for instance, the United States forbade the Unocal transaction as well as a proposed investment by a company affiliated with the Chinese Sany Group in an Oregon wind farm, among other less publicised deals that were blocked.

Approval in China

Focus on the Chinese approval process is understandable because it is a considerably more elaborate and more opaque process than what most countries are accustomed to. Any outbound investment from China is likely to require the approval of several governmental agencies, including the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM), and the State Administration of Foreign Exchange (SAFE). The requirement for such approvals can delay the completion or even the signing of a transaction for several months - assuming approval is granted at all.

Regardless of the insecurity on whether or not approval will be granted, the mere passage of time itself will oftentimes prevent a transaction from happening, for example, when a rival bidder can execute the transaction more swiftly and/or the target is a distressed asset in dire need for additional funding. Accordingly, the Chinese approval process puts Chinese companies at a disadvantage when compared with their peers in other jurisdictions.

These factors, coupled with the opacity of the often political criteria for approving outbound transactions, can be reasons for the target to a transaction to prefer another candidate over its Chinese suitor, even though the latter might provide better value for the business.

Approval abroad

At the same time, foreign targets as well as their governments have often shown only lukewarm receptiveness for Chinese investments, especially where these are seen as being driven by state imperatives rather than commercial interests, as may be the case when the Chinese investor is state-owned or state-backed.

Many countries, including purveyors of free trade such as the United States and Canada, have enacted legislation making proposed foreign investments subject to governmental review or even approval. For example, the USA's Committee on Foreign Investment in the United States (CFIUS) is authorised to review transactions that could result in control of a U.S. business by a foreign person (so-called "covered transactions") in order to determine the effect of such transactions on the national security of the United States.

Although genuine concerns about national security, the safety of the public and even "general good" considerations should and will normally determine the outcome of the assessments by these governmental committees, the decision-making process can be politically tainted, even in first-world countries. For example, it is hard to avoid the impression that when the Oregon wind farm deal was blocked only a few weeks before the U.S. Presidential elections, political motives were part of the equation.

Opportunities for Europe

It is difficult to underestimate the reputational impact of such governmental interference in transactions that are generally perceived from the Chinese angle as being genuine market transactions. A few ill-chosen interferences may quickly result in a gradual shift of Chinese companies' investment focus.

Given the "herd" mentality that China outbound investments have demonstrated over the past few years (i.e., their moving together broadly from one geographical region to another), this may lead to an increased interest by Chinese companies in European targets that generally also tend to offer advanced brands, technology, and production methods, all of which are vied for by Chinese parties who are willing to bank on their country's domestic growth.

Indeed, whilst resource-rich countries such as Canada, the United States, and Australia may seem to be shielding themselves from certain Chinese investors, the European Union's free market principles generally forbid European countries from employing such methods of investment control or other governmental oversight over the M&A market.

In particular, the Benelux countries do not have governmental bodies with broad authority to examine, disapprove, or otherwise control foreign direct investment, whether by Chinese investors or otherwise.

That is not to say that any acquisition of a Benelux target will be entirely free from any sort of approval - merger control regulations may apply and certain approvals will be required for investments in certain selected sectors such as energy or the financial industry, but these are mostly limited to "fit and proper" or similar tests, are based on clearly identified criteria and do not leave much scope for subjective assessment and none for overt political interference. Regulatory market access barriers are therefore few and low.

With the China outbound trend being widely seen as irreversible and with intensified trade and investment protectionism shown by certain host countries, we expect Chinese companies to put a premium on investing in stable and predictable jurisdictions offering advanced technologies, skilled labour and a transparent legal environment: these include Belgium, the Netherlands, and Luxembourg.