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December 2008 - January 2009
Fortress Europe: The risk of rising protectionism in Europe and its implications for Indian Businesses
The public discussion in Europe and the US over the last months clearly indicates that protectionism, in particular regarding foreign investment is on the political agenda again. This trend has been recently reinforced by the public debate stirred by French President and current President of the European Council, Nicolas Sarkozy. He proposed in the wake of falling stock market prises that either the European Union or its member states should form their own public investment vehicles to protect the European economy against bargain purchases by non-European investors. Although this new form of protectionism has been immediately rejected by a number of European governments including the German one, it shows that even the current credit crisis might rather strengthen protectionist tendencies.
To assess the impact of this apparent trend towards protectionism, CMS, the alliance of independent law firms in Europe has commissioned a report from Oxford Analytica, an international, independent consulting firm that draws on a wide global network of experts, mainly from academia. The report considers whether protectionism is rising in Europe, the forms it is taking, and its likely effects on businesses and investors. The report can be downloaded from our website at http://www.cmslegal.com/Fortress .
Our initial thesis has been confirmed by the report. Protectionism in Europe is rising – both in terms of rhetoric as well as action. It is affecting both investment and trade, and our expectation is that this will continue to get worse. That said, there is at least some optimism that the scope for protectionism is constrained by the international nature of trade and capital, together with the impact of new technology.
The EU perspective
EU member states cannot enact national legislation that restricts the free movement of capital, whether within the EU or with non-EU members. However, some member states want to enshrine greater protectionist measures in their national legislation. Last year the European Commission launched infringement proceedings against Hungary and Poland, and this year against Portugal and Spain. Notably Germany, a country whose economic success is underpinned by its export success and international expansion by its
leading businesses, is tightening its Foreign Trade Act (Außenwirtschaftsgesetz) to further limit ownership by companies outside EU or EFTA within sensitive sectors.
The negative reactions from Brussels towards Germany’s proposals highlight the difficulties faced by member states in creating protective measures which comply with EU law. Such measures will be challengeable through the courts, but they may nonetheless
achieve, and probably exceed, their objective. This is because many overseas investors might find the prospect of uncertainty and years of protracted legislation so off-putting
that they might think twice when contemplating sensitive acquisitions in Germany or other countries implementing comparable measures.
Certainly, our experience from working on numerous deals for businesses and investors of all sizes is that what they want from governments is:
1. Clear legislation;
2. Precise and useful guidance on what investments are permitted;
3. What criteria need to be met.
Sadly such legislation is hard to find.
Existing investment protectionism across Europe
There is a minefield of legislation that investors (in particular if non-EU) need to take into account when buying stakes in European businesses. CMS has surveyed the legislation across 17 European countries. In all of these – except for the United Kingdom, and the Netherlands – rules exist which discriminate against foreign investors (although in the majority of these, investors from other EU countries are treated like national investors).
For comparison the different approaches to protectionism can be grouped into five broad categories:
Traditional “old fashioned” protectionism preventing, in particular, the acquisition of land by foreigners. Countries with such an approach are: Austria, Poland, Romania, Russia, Switzerland, Ukraine and Bulgaria.
Security protectionism preventing acquisitions of defence related companies. This is by far the largest group and includes the Czech Republic (military weapons), France (military weapons, nuclear energy, private security services and encryption technology), Germany (military weapons, encryption technology, operation of certain satellites), Italy, Romania, Russia, the Slovak Republic, Spain and Ukraine (all military weapons).
Legislation preventing acquisition in other strategic industries. This group includes industries which are not directly relevant for security purposes but which are regarded in the respective countries as being of specific national importance. These are: Energy (Italy, Ukraine, Spain), pharmaceuticals industry, (Romania, France), financial services (Switzerland).
Legislation preventing acquisition in industries to protect the public interest. Industries are protected due to fear of foreign political influence or to protect citizens against the dangers of gambling. The broadcasting industry is protected in certain countries (Austria, Poland, Slovak Republic, Ukraine) and foreign investment in the lottery and gambling industry requires public consent in several countries (Czech Republic, France, Poland, Romania, Slovak Republic).
No discrimination by law. The United Kingdom and the Netherlands do not have specific rules preventing the acquisition of shares or assets by foreigners. Nevertheless, those (
and other) countries have regulations in certain sectors that require the consent of the regulator if there is any change of control or, sometimes, a substantial investment by a third party. In the UK, the government could generally intervene in cases of national security.
Proposed new German law
After the implementation of the new law (probably from January 2009 on), the German government could intervene in all acquisitions concerning at least 25% of the shares of any German company by any entities from outside EU and EFTA if such acquisition would endanger public order or security (as defined by the European Court of Justice). There is no filing requirement but if not cleared in advance, even finalised transactions could be redone within three months after closing.
The German government claims that the change will only bring the (so far indeed very liberal) law up to international standards and that it will make use of it only under exceptional circumstances. Whether the latter holds true remains to be seen and depends a lot on the political development. In any event it will create uncertainty and put non-EU / EFTA investors at a disadvantage in time-critical situations.
Implications for European M&A by Indian Investors
We expect that the M&A regulatory minefield will get more complicated and restrictive for non-EU investors: certainly over the next few years and maybe for much longer. This will cause an inevitable lack of legal certainty as to whether a transaction will be prohibited on the grounds of national security or order. This will cause, at a minimum, delays in closing transactions and the increased need for advisory services. In particular contested or “hostile” bids for listed target companies might become more difficult for non-EU investors. Not necessarily because transactions will in the end be actually prohibited but because other interested parties (competitors or politicians likewise) might use this in the public battle to weaken the position of the bidder. It should also not be underestimated that as soon as governments have created the legal means to intervene, the public pressure to make use of it will be there regardless what the original intention of the legislation had been. Indian investors in Europe and particularly in Germany have due to their private nature and the democratic political system in India so far not seen as political threat and have not really caused political or public resistance. To a certain extent they might even profit from the new rules which are more likely to be used in defending investment from China or Russia. Much will, however, depend on how those European companies acquired already will do in the future. So far that track record of Indian investment in Europe is regarded as quite positive and we should hope that this remains the case.
As a consequence of current developments, investors must be particularly aware of political changes in the jurisdiction of the target company. Experience has shown that enhanced awareness of national interests can create resistance to cross-border M&A transactions, in some cases causing national governments to intervene. This sentiment must not be underestimated.
Sovereign wealth funds
Another element rather concerning China, Malysia and the Gulf states than India concerns the future treatment of sovereign wealth funds (SWFs). While SWFs have been around for several decades, their recent rapid growth and relative lack of transparency has generated particular hostility from many commentators who fear that they will become tools of foreign policy, perhaps also grabbing strategically important technologies to transfer to their own country.
Our report finds no clear examples of SWFs being used to further foreign policy goals, or of SWFs transferring particularly sensitive technologies. On the contrary, it highlights their importance in being able to move swiftly over the last year to give much-needed investment to troubled financial institutions, something which no doubt averted much bigger problems in the banking sector.
However, SWFs need to change quickly. Poor governance is a weakness of many large ones: typically they do not publish data about their investment portfolios; their available data is usually very out of date; and their annual reports fail to give insight into their investment strategies. Indeed, it is sometimes not clear if they are using external fund managers (most are) let alone which ones.
There is no reason why SWFs cannot provide this information in a regular and timely manner, while doing so will help to disarm their critics. If they do not change voluntarily, they will be likely to have more onerous restrictions imposed by Brussels or national governments.
Rising protectionism also includes measures to restrict the trade of goods and, to an extent, services. Following the failure of the WTO’s Doha round of talks (so called because they commenced at Doha, Qatar in November2001), aimed at achieving multilateral reductions in protectionism, governments are likely to put more effort into negotiating specific country-to-country bilateral agreements.
Sadly, the failure of Doha may encourage protectionist elements within the European Commission, traditionalists in national governments, and anti-globalisation NGOs to exert more influence on trade policy. We expect to see a rise of overt traditional trade protectionism, such as anti-dumping measures, together with tougher enforcement of product standards and intellectual property rights.
This will be supplemented with new measures. For instance, the imposition of ‘carbon border taxes’ on some imports to compensate for the disadvantage of domestic producers subject to taxes on their carbon emissions (when their foreign competitors are not).
In a worst case scenario the European Union will completely turn away from further multilateral trade integration and simply negotiate bilateral agreements. While CMS believes the overall benefits of multilateral deals far outweigh a series of bilateral ones, the benefits from bilateral agreements would be advantageous for those doing business in countries with which the EU concludes deals. India is clearly one of the most likely partners for such an agreement and talks seem to have reached already a somewhat advanced stage.
Our report finds plenty of reason to find at least some solace in the practical limits being placed on trade protectionism by our global economy. It concludes that despite rising protectionist sentiment, the barriers placed on many economic sectors run into countervailing forces. The cross-border exchange of services taking place over the internet grows steeply – despite potential protectionist measures, it has still become cheaper and easier than ever to trade across borders.
The service tier of the global economy will expand at a healthy rate, even under a worst case scenario. In this sector, the global trading system resembles the world economy of a century ago, when rapid technological advances caused trade flows to grow even as the major economies were erecting higher tariff barriers. Regardless of policy measures, and amid significant macroeconomic and political upheaval, the long-term trend is for trade to continue to grow – although at a slower pace than under a multilateral system.
In case of enquiries please contact the above. More information can also be found on http://www.cmslegal.com/Fortress