Germany to Tighten Rules on Foreign Investment…Again

Key Takeaways

Germany’s cabinet has approved draft legislation designed to tighten the country’s foreign investment control (“FDI”) regime. The draft bill pre-dates the coronavirus crisis but comes amid growing fears that non-EU investors will take advantage of depressed valuations to snap up strategically important German companies in the current environment. This will be the third time Germany has amended its FDI regime since 2017. 

The impact of the planned amendments on Germany-related M&A activity is expected to be substantial:

• The German government will have broader discretion to intervene in transactions that have a German nexus. This may lead to increased uncertainty for international deals that impact Germany, even where Germany is not the center of gravity of the transaction. 
• The notification and standstill obligations, which currently only apply in very limited circumstances, will be extended to additional categories of transactions. This means that, in certain cases, foreign investors will need to notify transactions that would not have been reportable in the past and will need to wait for clearance before closing their deals.
• In its review the German government will in the future be able to consider not only German interests but also those of other EU member states and the EU as such. Review procedures will therefore likely take longer to complete.

FDI reviews in Germany could thus become a major factor in certain transactions. Companies should therefore carefully consider Germany-related FDI risks when structuring deals and planning for regulatory review.

On April 8, 2020, the German cabinet, on the initiative of the German Ministry for Economic Affairs and Energy (BMWi), approved a draft bill to amend the German Foreign Trade Act (AWG) that sets out the rules for FDI screening in Germany. The approval paves the way for the reform to be passed through the parliamentary procedure. It is expected that the amendments to the AWG will take effect in late 2020¹. The draft bill comes in the wake of the EU’s new Foreign Direct Investment Regulation (EU FDI Regulation) that will enter into full force in October this year. The EU FDI Regulation – which is intended to enhance transparency and cooperation on FDI matters within the EU – leaves the decision-making powers in relation to FDI with the member states and grants the European Commission no more than advisory powers (Dechert OnPoint: EU to Enhance National Security Screening of Foreign Direct Investment, December 4, 2018).

While the draft bill has been in circulation since January of this year, the topic has become particularly relevant in the context of the ongoing coronavirus crisis. Most notably, the perceived risk of a foreign takeover of German vaccine company CureVac received prominent coverage in the German press. The German minister for economic affairs, Peter Altmaier, introducing the FDI reform legislation, noted that “the current situation shows that Germany and Europe need their own competences and their own technologies in certain areas”.

This will be the third time Germany has tightened its FDI regime since 2017 (Dechert OnPoint: Germany: Foreign Investments Under Increased Scrutiny, August 14, 2018). While Germany traditionally takes a liberal stance on foreign investment, the acquisition of German robotics company Kuka by a Chinese company (Midea) in 2016 marked a turning point in German FDI control. At the time, there was widespread political concern that existing FDI rules were insufficient, given that the German government was unable to block this highly sensitive transaction. In consequence, Germany tightened its FDI rules for the first time in 2017: investments into businesses operating a “critical infrastructure” became reportable, and review timelines were extended. 

In July 2018, State Grid Corporation of China tried to purchase a 20% stake in 50Hertz, the electricity transmission system operator. At the time, FDI rules only applied where a stake of 25% or more of the voting rights was being acquired. As such, the government was unable to block the acquisition. Instead, it instructed German state-owned bank KfW to acquire the stake. In reaction to that transaction, Germany tightened its FDI rules again. In August 2018, the BMWi was authorized to block a sensitive transaction under the FDI regime for the first time, when Chinese Yantai Taihai Corporation attempted to acquire Leifeld Metal Spinning, a company that produces high-tech materials for the nuclear sector.

Current FDI Rules 

Under current rules, the BMWi has jurisdiction to review the following categories of transactions:

• The acquisition by any foreign investor (including those from other EU member states), of 10% or more of the voting rights in a German company active in a “sensitive security area” (e.g. weapons, ammunition, military equipment such as tank motors and gears, and any technology used for processing classified government information). This category of transactions is subject to so-called “sector-specific screening”. Transactions falling within this category are subject to a notification obligation and may not be closed before clearance has been granted.
• The acquisition by a non-EU investor of 10% or more of the voting rights in a German company operating a “critical infrastructure” (e.g. energy, water, information technology and telecommunications, infrastructure used for finance or insurance, healthcare, transport or food; as well as software used for the operation of such infrastructures). A transaction pertaining to a critical infrastructure must be notified, but the transaction can be consummated prior to any decision by the BMWi. However, a buyer who closes prior to clearance bears the risk that the BMWi blocks the transaction and orders it to be unwound.
• The acquisition by a non-EU investor of 25% or more of the voting rights in any German company where the transaction poses a threat to public order or security in Germany (so called “cross-sectoral screening”). There is no obligation to notify but the BMWi may initiate a review on its own initiative within five years after the signing of the relevant agreements. In order to obtain legal certainty investors often apply for a certificate of non-objection confirming that the BMWi has no objections to the deal.

As far as the substantive appraisal is concerned, the BMWi will block a transaction or clear it only subject to specific conditions or commitments from the investor if it “poses a threat to public order or security in Germany”. This is the current legal standard for the cross-sectoral screening including transactions pertaining to critical infrastructures².

Expected Changes 

The draft bill includes the following key elements:

• A change in the review standard: instead of an actual threat to public order and security, in the future, it will suffice that an acquisition is likely to affect public order or security. As such, the BMWi no longer needs to identify a concrete and severe risk to public order and security. Instead, an abstract and lower level of risk will be a sufficient basis for the BMWi to intervene.
• An extension of the scope of the standstill obligation: in the future, the standstill obligation will apply not only to transactions relating to “sensitive security areas”, but also to transactions relating to “critical infrastructure”. As such, any transaction subject to a mandatory filing will be suspended pending clearance by the BMWi. 
• Consideration of EU-wide factors: while the review was previously focused solely on Germany, the BMWi will now also take into account the public order or security of other EU member states as well as projects and programs of EU interest. 

In addition to the changes envisaged in the draft bill to amend the AWG, the German government is also seeking to amend the German Foreign Trade and Payments Ordinance (“AWV”). The AWV sets out the details with respect to the legal framework contained in the AWG. It is expected that the planned amendments will be heavily influenced by the current crisis. Based on information that is currently available, the key changes to the AWV will likely include in particular: 

• The inclusion of a list of “critical technologies” including artificial intelligence, robotics, semiconductors, biotechnology, and quantum technology. Any direct or indirect acquisition of 10% or more of the voting rights in German companies active in those technologies will require a notification to the BMWi and will be subject to a standstill obligation. 
• An increased focus on the identity of the investor. The new rules are expected to formalize the BMWi’s practice of looking closely at the identity and recent activities of the investor (and not just the target).

It is expected that changes to the AWV will take effect in late 2020 along with the amendments to the AWG.

Context and Outlook

The envisaged FDI reform is part of a broader series of measures designed to protect German economic interests in what is perceived to be an increasingly hostile economic climate. In a recent strategy paper entitled “Industrial Strategy 2030”, the BMWi devotes an entire chapter to “maintaining technological autonomy”. Other envisaged measures include tightening technology transfer to third countries and the possibility for the German state itself to step in and acquire shares in sensitive sectors.

The impact of the FDI reform on transactions involving German companies is expected to be substantial. The new rules will give the German government broader discretion to intervene in inbound transactions and will thus lead to increased uncertainty for foreign investors. For many deals the reform will also have repercussions on timing. Foreign investors will need to notify transactions that would not have been reportable in the past and will need to wait for clearance before closing their deals. While the formal review periods will not change, reviews may on average take longer than they have in the past as the BMWi intensifies its scrutiny of foreign investment and considers broader European interests along with German ones. In case of an in depth investigation reviews can last 7 months (or longer if the BMWi deems submissions to be incomplete) as from the moment the BMWi becomes aware of a transaction. 

It remains to be seen whether the BMWi, in light of the increasing administrative burden on foreign investors, will follow the example of competition authorities and issue practical guidance to help investors better understand the process and the substantive analysis it performs. Irrespective of this, it will be essential for foreign investors considering transactions involving German companies to identify and plan for regulatory challenges posed by Germany’s FDI regime at an early stage in order to avoid unpleasant surprises later on in the process.

Footnotes

1) After the first reading of the draft bill on April 23, and the 2nd and 3rd readings which are expected at the end of May, a public hearing by the Economic Committee of the German parliament is expected to follow.

2) The review standard differs with respect to transactions relating to “sensitive security areas”.  This standard will not change in the context of the proposed reform.  Such transactions may be blocked by the BMWi if the transaction poses a threat to Germany’s “material security interests”.