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Commercial Awareness: The Fortnightly Round-Up (w/b 14th August)

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About The Author

Jack Turner (Commercial Awareness Guru)

Jack is a law graduate from the University of Manchester and is currently working for as an analyst for a 'Big 4' accountancy firm. He has an interest in current affairs, business and commercial law, while also being a talented and passionate musician.

This article is part of the 'Commercial Awareness Fortnightly Round-Up' series, edited by Jack Turner.

Every two weeks, Keep Calm Talk Law will bring you an overview of main commercial stories that have occurred. Detailing the main players involved, the interesting and salient facts, and the main points of discussion that arise from each story, this round-up is intended to be vital tool for developing that commercial knowledge and awareness demanded by the country’s top law firms.

Other articles from this series are listed at the end of this article.

Conditions in China

Turbulence in the Chinese stock market in 2015 sent ripples through the global economy. Collectively, trillions of dollars were wiped off the value of stocks in global companies with exposure to the country. If the world needed a reminder of the importance of China to the global economy then this was it.

China’s thriving manufacturing industry gave it an unquenchable thirst for oil and an insatiable appetite for iron ore, lead, steel, copper and many other commodities. As growth in China’s manufacturing industry has slowed since 2014, so too has the country’s demand for these commodities. This has harmed commodity-exporting countries like Australia and Brazil and has contributed to the oversupply of oil which is pushing down oil prices globally, as discussed in a previous edition of the Keep Calm Talk Law Fortnightly Round-Up.

With GDP growth in China slowing, consumer spending in the country has fallen, damaging companies who rely heavily on Chinese consumers. Germany’s car manufacturers receive between 15 and 30 per cent of operating earnings and cash flow from Chinese sales, and luxury goods companies such as Burberry, Richemont, and Swatch have significant revenue exposure to China. 

Despite this slowdown, China still offers significant opportunities for law firms and their clients. In 2016 the country had a population of 1.379bn, an economy worth just under $18tn, a growing middle class and large and active private sector. This has enticed large global corporations to the country and, where their clients have entered the market, international law firms have followed. As China begins to transform from a manufacturing and export-driven economy to a consumer-driven one, foreign investment will follow. Lawyers in the region with an international presence are hoping to position themselves to generate revenue by facilitating this investment.

China is also a major source of investment in the US and Europe. Private Chinese investors have, as previous edition of the Keep Calm Talk Law Fortnightly Round-Up Round-Up has noted, been targeting overseas property to diversify their assets, while large corporates have been acquiring technology to increase efficiency and establish a presence in disruptive technologies such as artificial intelligence, bio pharmacy, electric cars and robotics. As this strategy has picked up pace over the past year, so too has the opposition from the US and Europe.

Two separate news stories this fortnight illustrate a growing resistance to Chinese investment strategy and business practices. These developments and their potential impact on commercial law firms are explored below.

EU Moves to Strengthen Scrutiny of Foreign Takeovers

In the past two years, China has announced over $110bn worth of tech merger and acquisition deals. Germany has seen the highest share of Chinese transactions in Europe. Most notably, Midea, a Chinese appliance maker, acquired Kuka, Germany’s largest maker of industrial robotics, for €4.5bn in 2016. The deal received significant opposition from German politicians over fears that its most advanced technology is ending up in Chinese hands and that it is being stripped of its technological know-how.

Previously, German law gave the government the power to block a company from outside the EU acquiring more than 25 per cent of a German entity if the deal endangered public order or national security. This limited its application largely to companies operating in the defence industry or involved in IT security and the processing of state-classified documents. However, under a directive adopted by the German cabinet last month, the scope of this power has been expanded to include takeovers of companies operating in “critical infrastructure”. This would include companies that produce software for power plants, energy and water supply networks, electronic payments, hospitals and transport systems. The directive allows the government to scrutinise more deals concerning important national assets and provide greater protection to Germany’s critical infrastructure.

Germany, along with France and Italy have also been lobbying the EU to adopt policies that would give Brussels similar powers to restrict foreign takeovers. Their concern is that foreign companies can set up small operations in EU countries where foreign takeover rules are relaxed and use these as conduits to gain access to the rest of the bloc. Brussels appears to have yielded to this pressure as it looks set to announce measures to tackle foreign takeovers of European companies. The particulars of the powers the European Commission will be given to scrutinise foreign takeovers are yet to be proposed. One option under consideration is the creation of non-binding guidelines to help co-ordinate member-state screening accompanied by a more comprehensive draft law for a new EU-wide screening system. If passed, this could provide an obstacle to China’s current M&A strategy.

Trump Orders Inquiry into Chinese IP Practices

In 2015 China announced the “Made in China 2025” plan. It is an ambitious plan to dominate in the production of high-tech products likely to drive economic growth by 2025. One country that stands firmly in China’s way is the US.

In order to compete, China limits American ownership of certain Chinese companies to 50 per cent or less. It also makes market access subject to entering into joint ventures with Chinese companies, and, in some cases, makes technology transfers part of product sale contracts. Chinese lawyers have also been increasingly initiating antitrust proceedings in Chinese courts to invalidate patents that they claim create illegal monopolies.

At the same time, the Chinese government and Chinese companies commonly identify US start-ups with scientific breakthroughs and make investments in these companies on better-than-market terms. China is willing to make an over-payment of a few million dollars in order to acquire new technologies; the cost are insignificant relative to its multi-billion dollar long-term objectives of technological superiority. This strategy might be controversial for some, but it is one that China is entitled to deploy in a free market. The hang-up for the US is that this free market access is not reciprocal; foreign companies seeking access to the Chinese market are subject to anti-competitive rules pressuring them into turning over their intellectual property, research, and expertise.

In response, Trump has authorised an inquiry into China’s alleged theft of US intellectual property through its rules on market access. Trump called the inquiry “a very big move.” In reality, it is more of a token gesture. The inquiry authorised by Trump will give US Trade Representative Robert Lighthizer a year to look into whether to launch a more formal investigation into China’s trade policy. Once that investigation is completed the US can then decide whether to take action under Section 301 Trade Act 1974 - a US trade tool that allows the president to unilaterally impose tariffs or other trade restrictions in retaliation to "unfair trade practices" of foreign countries. It would take years for any action to be brought under this act and some commentators believe such action will not be taken at all. After all, S.301 is a controversial tool that is not commonly used. Under a S.301 investigation, the US would be judge, jury and executioner; China would be unlikely to accept an unfavourable outcome of an investigation and the US would be in danger of triggering a harmful trade war. China also currently operates in an important position in global politics. The country’s influence over North Korea and its growing influence over Russia makes it an important ally to the US. China knows the strength of its hand and has warned that trade action will “poison” relationships.   

Talking Points

International law firms are benefiting from the booming Chinese M&A market. They are well placed to advise local Chinese companies on overseas purchases and facilitate foreign investment into China. There is a concern that new protectionist policies such as those proposed by the US and Europe could disrupt deal flow and result in less business for international M&A lawyers and less investment in new businesses and disruptive technologies. Open trade between China and the west is beneficial for both sides, however this should be based on a relationship of reciprocity. At present, China’s stringent regulations regarding foreign investment in the country, while their businesses are permitted to make significant investments elsewhere, is not a reciprocal relationship and is understandably a concern for Europe and the US.

In relation to Europe’s proposed powers to block foreign takeovers, the issue for consideration is how widely defined the scope of the powers may be. If Brussels takes a similar approach to Germany and grants itself the ability to block foreign takeovers that endanger public order and national security or involve companies that operate in critical infrastructure then its application may be narrow. For example, there is no conceivable way that such powers could limit the influx of Chinese investment in commercial property for example. Even in relation to Midea’s acquisition of Kuka, as discussed above, it is unlikely that a German industrial robotics company is considered part of critical infrastructure. For Brussels to take an effective stand against Chinese M&A practices and to protect its most advanced technology its powers of scrutiny need to be wide in scope so as to encompass the acquisition of technology that does not necessarily form part of a country’s critical infrastructure. Doing so would be conceding that its markets are not as fair and open as they are presumed to be. However, this might be the most effective solution to resist a Chinese acquisition programme that has gone too far.

International law firms with strength in China include Baker McKenzie, Skadden, Davis Polk & Wardwell, Linklaters, Clifford Chance, Allen & Overy, and Herbert Smith Freehills

The UK Sets Out Plans for a Temporary Customs Union

A government published paper sets out the UK’s wish to remain in a Customs Union with the EU for an estimated three years after the Article 50 clock expires in March 2019. Brexit Secretary David Davis says the aim is for this new relationship to be as close to the current arrangement as possible.

The customs union is an agreement between member states to charge the same tariff on imports from outside of the bloc and not to impose tariffs on goods travelling between countries in the union. Leaving the customs union could mean that UK exports to the EU – valued at around £220bn according to the Office of National Statistics – would be subject to tariffs and increased administrative costs. These costs would hit the profits of UK companies and could force them to relocate jobs and production out of the UK. However, some hard-line Brexiteers are against the customs union on the grounds that it prevents the UK from negotiating its own trade deals with non-EU countries.

The proposals will, of course, require EU approval who have maintained that first the parties need to advance on issues such as the exit bill, the rights of EU nationals living in the UK and the Irish border. Arguably, the latter cannot be decided without also deciding on the future EU – UK customs relationship. London appears to be using this link as leverage to force the customs issue on to Brussels’ immediate agenda as the government has also proposed that the Irish border remain free of physical customs posts after the UK’s exit from the EU.

Britain occupies a strong negotiating position in relation the Customs Union which is likely to end in these proposals being approved by the EU. The EU ran a £90bn goods trade surplus with the UK in 2015 – EU companies who export goods to the UK would also be damaged if no customs arrangement was reached after the Article 50 clock expired.

Talking Points

A transitional customs relationship provides greater certainty for UK businesses that rely on exporting goods to the EU. It grants the UK government more time to negotiate a future customs arrangement with the EU and will encourage spending and investment amongst these companies in the meantime.

It can also be seen as a victory for proponents of a softer transition into Brexit. There is simply not enough time to address every aspect of the UK’s relationship with the EU and negotiate favourable alternatives by March 2019. Allowing existing structures to stay in place for an extended period so that agreements can be reached will allow both parties to make the most out of Brexit. A hard Brexit resulting in no agreement will increase costs for UK businesses overnight and restrict their access to the EU market.                                                                           

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