Over the past few years, countries around the globe have started to either implement or ratchet up their foreign direct investment (FDI) controls. Once the exclusive domain of sectors traditionally associated with national security, FDI reviews are ramping up in healthcare, high technology (especially "dual use" technology), real estate and a growing list of other sectors. Indeed, FDI considerations now reside among the top-five major issues in any cross-border M&A transaction, and have become a real string of regulatory reviews in addition to merger control.

The ongoing global expansion of FDI controls stems from many sources. Two, in particular, have come to the fore in 2020 to intensify review activity: adversarial capital and, of course, COVID-19.

Adversarial capital grabs the spotlight

Broadly speaking, adversarial capital (or adversarial investment) describes investments made by foreign rivals that buy into nascent technology or financially vulnerable companies whose work may have applications in sensitive industries but doesn't yet fall under the radar of the local national security review regime. Adversarial investments potentially position foreign adversaries to ultimately own assets in sensitive industries without having had to undergo and pass a thorough national security review.

Adversarial capital is most often framed as a US concern, particularly regarding inbound investment from the People's Republic of China (PRC). But FDI regimes worldwide are not just watching the US response but are beginning to prepare—or already have prepared and are broadening and stepping up enforcement of—their own.

In March 2020, the US Department of Defense (DoD) raised the alarm regarding adversarial investments in US companies. Ellen Lord, the US Undersecretary of Defense for Acquisition and Sustainment, told reporters, "It's critically important that we understand that during this crisis the [defense-industrial base] is vulnerable to adversarial capital, so we need to ensure companies can stay in business without losing their technology." Lord warned that struggling small businesses may be more likely to enter into problematic arrangements with foreign investors during the pandemic, when they can't count on renewal of their defense contracts.

As a hedge against adversarial capital, the DoD is steering US companies in sensitive industries and financial institutions to its "Trusted Capital Marketplace," a funding ecosystem that offers vetted opportunities to explore mutually beneficial partnerships that align with US national security goals.

In the United States, pressure from lawmakers and increased attention from the Committee on Foreign Investment in the United States (CFIUS) and its member agencies will largely foreclose any relaxation on the types of deals that will be approved or escape the attention of CFIUS. While concerns had been raised that the COVID-19 pandemic would dramatically slow the work of CFIUS, resulting in stifled investment and/or adversarial transactions slipping through the cracks, CFIUS has continued its work largely unabated, with little or no delay.

Of course, the very definition of what constitutes "adversarial capital" is not carved in stone.

Is an investment adversarial if it has no apparent goal other than financial gain? What if the investment can serve to open doors to new markets, or advocates for cutting of R&D that shows little chance of profitability? What if it is the only source of venture capital for emerging technologies that would otherwise not be funded? As governments struggle to lock out adversarial capital, they will need to ensure that they do not inadvertently shut off beneficial investment streams.

Similarly concerning is the moving target of what constitutes a "sensitive sector" forming a "greater attack surface," as the DoD has put it. The trajectory of expanding national security review regimes shows that sensitivity is no longer limited to the traditional sectors associated with national security at a macro level; the threat does not stop at defense, energy and telecommunications, but now extends to steel, sand, data and more.

While there is no substantive FDI screening at the EU level (and FDI regimes currently exist in only about half of the EU member states), in October 2020 a European FDI Screening Regulation will come into force. The new regulation will establish a novel procedural framework and give the European Commission (EC) and member states the opportunity to comment on ongoing national FDI reviews. We also expect member states to introduce their own regimes, and expect those that have a regime to further broaden and toughen them.

An intense debate has also arisen about the need for "European Champions," especially after the Siemens/Alstom merger that the EC blocked under its merger control regime, on how to deal with PRC state-sponsored competition. Also under debate are trade and market access relationships with the PRC, as well as the EU's innovation and digital, high-technology and sustainability agenda. All of these topics feed into FDI strategies across the EU.

In response to some of these concerns, on June 17, 2020, the EC published a white paper seeking views on three powerful new tools to control the acquisitions and activities of foreign subsidized companies in the EU:1 a general ex post control mechanism to review competitive distortions; a mandatory ex ante notification mechanism that would allow the EC to review foreign subsidized acquisitions, including certain minority investments; and the possibility of excluding bidders that have received distortive foreign subsidies from public contracts tendered by the EU and member state authorities.

The three new tools, if they were to result in legislative measures, would have significant implications for companies operating in the EU that receive some form of foreign subsidy as well as acquisitions of EU companies financed by foreign subsidies.

COVID-19 intensifies—and slows—oversight

Then there is COVID-19. The pandemic brought FDI restrictions into sharper focus and accelerated movement on a national level across the US, Europe and elsewhere. The US, Germany, Italy, Spain, France and additional countries have increased their FDI control measures in response to the pandemic, while others are set to do likewise.

The dependency of US companies on foreign supply chains to satisfy COVID-19 needs—such as personal protective equipment (PPE) and pharmaceuticals—has become an area of focus for US regulators, including not only CFIUS but also federal agencies such as the US Department of Health and Human Services.

In light of the pandemic, the EC recently issued formal guidelines to EU Member States that aim to ensure a "strong EU-wide approach to foreign investments screening in a time of public health crisis and related economic vulnerability," reminding Member States that they are empowered to impose measures to address identified risks to security or prohibit a foreign investor from consummating a transaction. The EC has stated, "The EU is and will remain an open market for foreign direct investment. But this openness is not unconditional." The EU's position has already been echoed by several national governments.

With the recent revisions of national FDI regimes following the outbreak of the pandemic, we would expect almost any significant healthcare deal to face FDI scrutiny now, with governments concerned about the supply security of critical products and medicines, vaccines and similar goods for their domestic populations, and to keep research and development and production capabilities in their country. Healthcare transactions will likely face lengthy reviews. (The same continues to be the case for state-owned or state-sponsored investors, especially in the high-technology sector, and even more so where a military use of the technology seems conceivable.)

For the duration of the pandemic, and surely for years afterward, parties to cross-border transactions will need to redouble their due diligence in assessing whether their transaction will require (and pass) an FDI review, either voluntary or mandatory. Given the curtailed response time of authorities, those expecting only voluntary review may be tempted to close without waiting for a government response, but doing so exposes parties to penalties and delays if their internal assessment proves too optimistic.

In any case, with FDI reviews intensifying globally and regulatory regimes presenting a fast-changing target, the watchwords for successful cross-border transactions remain caution and patience.

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