Asia IP

Chinese outbound foreign direct investment (OFDI) has dramatically veered towards Europe over North America in the first six months of the 2018. The value in that period of newly announced Chinese M&A in Europe (US$22 billion) exceeded that in North America (US$2.5 billion) by a factor of nine, while the value of completed Chinese investments was six times higher in Europe (US$12 billion) than in North America (US$2 billion).

The numbers were revealed in new research from global law firm Baker McKenzie with leading independent research provider Rhodium Group.

Globally, the half-yearly value of newly announced global M&A activity by mainland Chinese companies has stabilized. It dropped from a peak of US$145 billion in 1H 2016 to an average of US$70 billion in 1H and 2H 2017. In 1H 2018 it reached US$50 billion – a further 32 percent drop compared to 2H 2017, but still significantly above the 6-month average of US$39 billion seen in 2013-2015.

North America’s small 1H 2018 investment total continued a downtrend that started more than a year ago. Chinese OFDI in the region peaked at US$28 billion in 2H 2016 before falling to US$24 billion in 1H 2017, US$6 billion in 2H 2017 and a nine-year low of only US$2 billion in 1H 2018 (a 92 percent year-over-year decline). Deal activity is depressed in both the United States and Canada.

Europe has also seen a drop in Chinese investment over the last year, but this decline came from a higher base and has been much less pronounced. Completed Chinese OFDI peaked in 1H 2017 (thanks to ChemChina’s US$43 billion Syngenta acquisition) before falling to US$22 billion in 2H 2017 and US$12 billion in 1H 2018. Excluding Syngenta, Chinese investment in 1H 2018 actually increased 4 percent year-on-year.

The industry composition of Chinese investment has also shifted remarkably in 1H 2018 in both Europe and North America. “Real economy” sectors such as automotive, health and biotech, and consumer products and services became top recipients for Chinese FDI in both regions. The real estate and hospitality sector lost its top spot but still remained a sizeable attractor for Chinese capital.

Chinese companies have also divested assets at an unprecedented pace in North America so far in 2018, with several prominent investors during the 2015-2016 boom forced to sell holdings as part of a financial clean-up and tightening campaign back home in China. In total there were US$9.6 billion of completed divestitures in North America by Chinese firms in the first half of 2018, with another US$4 billion pending. Similar to North America, Chinese companies started to divest assets in Europe, with nearly US$1 billion of assets sold in 1H 2018 and another US$3 billion pending.

“The scale and speed of the diverging trends revealed by these figures is remarkable,” said Thomas Gilles, chair of Baker McKenzie’s EMEA-China Group. “At the same time, no-one should be surprised by the direction of travel – China is actively courting the EU with offers of reciprocal market access in an attempt to show foreign investment is not a one-way street, while trade relations with the US continue firmly on a downward path.”

“After five years of similar investment levels in Europe and North America, Chinese investors are now clearly favouring Europe,” said Thilo Hanemann, director of Rhodium Group’s cross-border investment practice. “Regulatory hurdles remain lower, political relations are more predictable, and Europe offers a great base if industrial high-tech assets, which is a good match with Chinese regulators’ outbound investment priorities.”

“Policy is weighing on deal making,” said Rod Hunter, international trade partner in Baker McKenzie’s Washington office. “For all the noise about CFIUS the past two years, we have recently seen more predictable reviews, and upcoming CFIUS legislation should not represent a major departure for Chinese buyers. Still, it is no surprise that escalating Sino-US trade disputes are impacting Chinese investments in the United States.”

“China plays a vital role in driving the global economy and it’s clear outbound investment is continuing at a more measured and sustainable pace, even if the geographic mix is changing,” said Danian Zhang, chief representative of Baker McKenzie’s Shanghai office. “What is important for Chinese investors is that the deals that do progress involve real economy sectors with sound business planning and objectives, that can be operated in a safe business and regulatory environment. It is normal that there is a mix of buying and selling activities for outbound investment projects as corporate health after all requires acquiring as well as disposing of assets.”

The initial decline in Chinese OFDI was primarily caused by Chinese regulatory tightening over outward investments. Facing large capital outflows, Beijing began to crack down on outbound FDI in the second half of 2016.

This has been then compounded by the actions of foreign regulators. In the United States, Congress is in the final stages of toughening national security investment screenings and stricter scrutiny of outbound technology transfer developed in the United States. The Trump administration also strongly considered additional restrictions for Chinese investors in late 1H 2018 as part of the Section 301 investigation into Chinese intellectual property practices but backed off at the last minute.

Driven by concerns about Chinese acquisitions, Europe is also expanding its toolkit to review foreign inbound investments. Negotiations start in July on an EU-wide investment screening mechanism, with a view to agreement by December for a new mechanism for information sharing between EU member states on investments with potential national security impacts. Individual EU governments including Germany, Italy, the UK and France have also recently revised their investment screening frameworks or are in the process of doing so.