Back to Corporate and M&A Law Committee publications

Carlos Alexandre Lobo
Veirano Advogados, Rio de Janeiro
carlos.lobo@veirano.com.br

Vitor Rozenthal
Veirano Advogados, Rio de Janeiro
vitor.rozenthal@veirano.com.br

 

In the last few decades, China has become one of the main engines of global economic growth. According to the International Monetary Fund (IMF), China has accounted for 28 per cent of all growth worldwide in the five years from 2013 to 2018 (more than twice the share of the United States in the same period). Before the Covid-19 pandemic outbreak, expectations were that the Chinese contribution to the global economy in the five years between 2019 and 2024 would be roughly the same.^[1]

The Chinese ‘growth miracle’ has made it a leader in international trade and in foreign direct investment (FDI). Between 2005 and 2019, Chinese overseas investment and construction combined exceeded $2tn.^[2] In 2013, the Chinese government launched the Belt and Road Initiative (BRI), a development strategy aiming to build connectivity and cooperation across parts of Africa, Asia and Europe. Between 2013 and 2018, BRI investments were of $114bn in the energy industry alone.^[3] Outside the BRI region, China also invested heavily in Western countries. In the European Union, Chinese FDI grew steadily until 2016, peaking at €37.3bn.^[4] In the US Chinese FDI peaked at $46bn in 2016.^[5]

However, after reaching a record level of $196.16bn in 2016, Chinese investments throughout the world began to decline sharply. In 2017, Chinese FDI dropped by 19.3 per cent, the first decline on record.^[6] In 2018, the volume of Chinese international overseas investments was slashed by 9.6 per cent, reaching $143bn,^[7] and by 2019 investments had fallen back to 2014 levels. In 2019, Chinese direct investments in the US barely exceeded $5bn.^[8]

There are several reasons for the decline in the volume of Chinese FDI worldwide, such as:

• the resurgence of protectionism following the election of a series of nationalist leaders across the globe;

• certain key geopolitical disputes between the West and China; and

• a general fear that China may be gaining too much control over Western companies.

Some say that the world is on the verge of a new war focused on technology. The most glaring evidence of the change in the economic and political landscape has been the 2016 election of Donald Trump, a president whose campaign slogan was ‘America First’, who has vocally defended that China was ‘ripping off America’ and who has launched an extensive worldwide campaign against Chinese company Huawei.

In the years following Trump’s election, a trade war coupled with a series of geopolitical disputes have laid the ground for a significant downturn in the relations between the top Western economies and China. Matters have only been made worse by the global Covid-19 pandemic and criticism about how the Chinese government has handled the situation. Clashes between China and the West have had a direct effect on China’s popularity abroad. Following the Covid-19 pandemic, an internal report by the Chinese government concluded that anti-China sentiment is at its highest level since the 1989 Tiananmen Square protests.^[9]

In the current environment, it is not surprising that the recent nationalist-oriented trend of curtailing foreign investments has affected China disproportionally. According to United Nations Conference on Trade and Development (UNCTAD), at least 20 transactions between 2017 and 2019 with a total value of more than $162bn were blocked or suspended ‘by reasons of national security’.^[10] While not all of these transactions involved Chinese investors, a significant number of high-profile Chinese deals in the West have been blocked over the last few years.

In the US, the Committee of Foreign Investments (CFIUS) has become increasingly active since Trump came into office. CFIUS recently blocked Broadcom’s proposed $117bn takeover of Qualcomm, which would have been the biggest deal in the history of technology, due to concerns that it could hand the leadership of chip and wireless technologies to Huawei. Following the 2018 Foreign Investment Risk Review Modernization Act (FIRRMA), CFIUS has been running with an expanded mandate, allowing it to review a larger number of transactions including real estate and land rights deals as well as non-controlling investments in US businesses involved in critical technologies and infrastructure.

The US has not been the only country imposing new restrictions on FDI, especially from China. In 2018, Germany blocked an attempted acquisition by the Chinese utility company State Grid of a 20 per cent stake in 50Hertz Transmission GmbH, and the United Kingdom, long regarded as the most open country in Western Europe, has launched a series of investigations into potential asset stripping of UK high-tech firms following an aborted Chinese boardroom takeover of Imagination Technologies.^[11]

Fears of international takeovers (most notably from China) have been impacting policy decisions throughout the world; the Covid-19 pandemic has only accelerated this movement by raising concerns that important assets can now be acquired with depressed prices. Several countries, such as Australia, Canada, France, Italy and Japan have taken steps to limit foreign investments in critical industries, and India has stepped up scrutiny of investments from companies in ‘neighbouring countries’, which was widely seen as a move to stave off takeovers by Chinese companies. The EU, in its turn, is reported to be currently working on a draft legislation to allow European regulators to intervene in deals where foreign state-backed companies were involved.

What about Brazil?

From 2007 to 2018, Chinese investments in Brazil amounted to approximately $58bn. During this period, Brazil’s political and economic ties with China were at an all-time high following the creation of the BRIC (Brazil, Russia, India, China) bloc in 2006. Chinese investments peaked in 2017, with around $8.8bn invested in Brazil – largely a result of the acquisition of CPFL Energia by State Grid. Between 2015 and 2017, approximately 30 per cent of FDI in Brazil came from China. Over the last ten years, Chinese investments in Brazil were mainly directed to four industries:

• until 2010: commodities;

• from 2010 to mid-2013: industrial;

• from mid-2013 to 2014: services; and

• from 2014: electric power and infrastructure.^[12]

However, Chinese investments in Brazil went into a downward spiral in 2018, when they plummeted to $1.8bn, remaining at roughly the same level in 2019. In addition to global factors, this decline was a response to the political turmoil in Brazil, which began with the impeachment of President Dilma Rousseff and continued with the ascent of Jair Bolsonaro – a nationalist president with a pro-US and anti-China rhetoric.

Following the election of Bolsonaro, and notwithstanding the continued anti-China rhetoric of certain members of the government, most experts believed Chinese investments were set to soar in 2020, with expectations of investments of up to $7bn. Part of the reason for the renewed interest in Brazil was the pro-market stances of the Bolsonaro government, which included the adoption of a comprehensive pension reform and the passing of many pro-business laws such as the Economic Freedom Act. The Brazilian government also launched an ambitious plan for privatisations and concessions in the hopes of raising between $125bn and $250bn, and started to open key strategic industries, such as airlines, to foreign investors.

Hence, when the Covid-19 pandemic hit, Brazil was moving in the opposite direction compared to the other top Western economies. While the EU and the US were already taking steps to protect companies in critical industries against international takeovers, Brazil was opening new industries to foreign investment and selling state-owned enterprises – which, unsurprisingly, ended up in the hands of state-owned companies from abroad in many instances. The depressed value of Brazilian assets amidst the pandemic, combined with the global shift towards protectionism, has left Brazil positioned to become a preferred destination for international (particularly Chinese) capital. However, there are also growing calls for the Brazilian government to start using the tools it has at hand to protect critical industries and infrastructure from falling into the hands of foreign investors.

While Brazil does not have general FDI screening procedures in place,^[13] Article 172 of the Brazilian Constitution allows the government to regulate foreign investments ‘based on national security’. There are currently several industries that are, at some level, subject to restrictions to foreign capital, such as:

• banking;

• real estate (in rural areas and land borders);

• broadcast;

• money transport;

• mail services;

• nuclear; and

• aerospace.

Airlines and cable companies were only recently taken off this list. Moreover, Brazil also has a National Security Council, which, among others, has the power to ‘authorise the incorporation or development of industries that are of national interest’. While the National Security Council historically has not been used to review foreign investments (except in rural areas or land borders), the expansion of its role could also be an alternative to implementing an FDI screening process should the Brazilian government decides to implement one.

Other than blocking international takeovers – or nationalising companies, as has recently happened in other Latin-American countries such as Argentina and Venezuela - the Brazilian government has other options at its disposal to reduce the influence of foreign investors, particularly in the case of state-owned companies.

Firstly, the government can make use of non-voting shares to raise capital without entirely giving up control. When giving up control of state-owned companies, the government can cause such companies to issue golden shares, which were used in the privatization of Embraer (Brazil’s aeroplane maker, recently involved in a failed M&A transaction with Boeing), Vale (Brazil’s largest mining company), and IRB (the federal government’s reinsurance company), and are also expected to be used in the privatization of Eletrobras (the largest power generation and transmission company in Brazil).

Golden shares are ‘special shares’ that allow its holder (the federal government) to veto certain decisions, such as (in Embraer’s and IRB’s case) change of control. Another option that the Brazilian government has adopted in the past when selling state-owned companies was to limit voting rights by foreign shareholders. This structure was used in the privatisation of Embraer, where the bylaws originally provided that votes by foreign shareholders were limited to 40 per cent.

While privatisations have always been a sensitive topic in Brazilian politics – with politicians on the left claiming that they represent the sale of Brazil’s ‘crown jewels’ to foreign investors – concerns were also raised in the last few years in respect of sales of non-state-owned enterprises. President Bolsonaro publicly criticised the sale of private niobium mines to Chinese investors (following an acquisition made by Chinese CMOC), and many candidates in the last presidential election promised to veto the Boeing-Embraer transaction if elected. After the transaction with Boeing fell through, there have been proposals in Congress for Embraer’s immediate nationalisation. On the other hand, since Brazil currently has a liberal Secretary of Treasury (Ministro da Economia), calls to protect Brazilian companies in critical industries from attempted international takeovers have been mostly ignored.

It is clear that political risks have now become a crucial aspect of international M&A transactions, which requires a prior review of each country involved internal regulation. Such new trend may also impact the levels of M&A activity going forward. In the case of Brazil, for a country with a historic deficit in private investments, an increase in FDI would certainly have a positive impact on the Brazilian economy, with the added benefit of helping in the development of much-needed infrastructure. With additional restrictions to foreign capital being adopted throughout the world, Brazil is positioned to become a premiere destination for foreign investments, especially from China. However, while the liberal stance of the Brazilian government is still holding firm, it is difficult to predict whether the resurgence of protectionism in the West, a nationalist President and an anti-China sentiment in some segments of the government will be enough to change Brazil’s course in the near future.