On July 10, the U.S. Senate Committee on Agriculture held a hearing on the proposed $7.1 billion acquisition by China’s Shuanghui International of Smithfield Foods – the largest Chinese acquisition to date of a U.S. company, which was recently cleared by U.S. regulators. Although the hearing focused on food safety concerns relating to foreign acquisitions of U.S. firms, it publicly underscored a key emerging phenomenon in US-China relations: rising Chinese investment in the United States and related national security considerations.
Much as Japan Inc. caused a sensation with its buying spree in the eighties, acquiring prominent U.S. companies and landmarks, including Rockefeller Center, Chinese companies are making their presence felt. Acquisitions range from AMC cinemas to IBM’s personal computers unit. Prominent Chinese bids reportedly in the works include One Chase Manhattan Plaza in New York City and select assets of smartphone maker Blackberry in neighboring Canada.
Far from the Congressional spotlight, the little-known Committee on Foreign Investment in the United States (CFIUS) housed within the U.S. federal government reviews select inbound investments on national security grounds. CFIUS review seeks to balance free market principles that would keep the U.S. market open for business against national security considerations, specifically averting or mitigating foreign control of U.S. companies that are operating in potentially sensitive sectors.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
CFIUS reviews are confidential, but what is public suggests that the record of Chinese companies investing in the United States is more robust than it may seem. Often eclipsed by those transactions that have unraveled, such as the failed $18.5 billion bid for Unocal by the China National Offshore Oil Cooperation (CNOOC) in 2005, in many cases investments have been approved. As the investment relationship between the world’s two largest economies evolves into “a two-way street,” China Inc.’s interface with CFIUS will be increasingly important for policymakers to understand and to insulate from politicization, to allow for careful and considered review by the regulators.
Coming to America
China’s investment profile is rapidly changing. The Economist Intelligence Unit projects that China will be a net global investor within four years. This investment is steadily diversifying. Whereas in 2010, energy deals made up 30 percent of outbound deal activity, they accounted for only 24 percent in 2012. While the top destination last year was the European Union, 2012 witnessed record Chinese investment in the United States: $6.7 billion worth of deals. This record will prove short-lived. In the first nine months of 2013 alone, Chinese firms spent nearly $12.2 billion on projects in the United States.
Chinese state-owned firms are not the only players. Private Chinese firms spent more on U.S. deals in the past fifteen months as of April 2013 than in the last eleven years combined. As of September 2013, private Chinese firms led by Shuanghui accounted for 84 percent of deals and 74 percent of total investment value this year. State governments are actively competing for this investment and the derivative jobs (California, New York, Texas, Illinois, and North Carolina are in the lead) with Chinese investment reportedly currently providing 33,000 U.S. jobs – expected to touch 70,000 with the close of the Smithfield deal.
Congress has tasked the executive branch with weighing the value-add of such inflows against their risks. As a result, unsurprisingly, a key issue in the U.S.-China investment relationship from the Chinese perspective has become the CFIUS review process. According to China’s Commerce Minister, the review process needs to be “more open and transparent, because companies never know whether their bid meets the requirements or not…We need clearer guidelines on what conditions might violate U.S. security, to reduce risk for companies that want to invest.” Such comments highlight the important if largely unknown role CFIUS plays in US-China relations.
What Is CFIUS?
Established in 1975, CFIUS is an inter-agency committee in the federal government that includes the heads of the following departments and offices: Department of the Treasury (chair); Department of Justice; Department of Homeland Security; Department of Commerce; Department of Defense; Department of State; Department of Energy; Office of the U.S. Trade Representative; and Office of Science & Technology Policy.
CFIUS operates pursuant to the 1988 Exon-Florio Amendment to the 1950 Defense Production Act – an amendment prompted largely by concerns regarding Japanese acquisitions in the United States. Exon-Florio authorizes the president to suspend, block, or otherwise modify transactions prior to closing that could result in foreign control of U.S. businesses engaged in inter-state commerce in the United States – if such control threatens to impair U.S. national security. It also authorizes the president to seek divestment or other relief in the case of concluded transactions.
To avert the risk of a transaction being blocked, both the potential foreign acquirer and the U.S. “target” company generally assess with legal counsel at the onset whether CFIUS might view the latter’s activities as sensitive. If so, they file a joint voluntary notice with CFIUS, which reviews the transaction as a “covered transaction” over a 30-day period followed by, if need be, a 45-day investigation. Importantly, CFIUS can also initiate a review of a transaction on its own accord.
A key determination in the review is what level of foreign control and areas of activity raise national security concerns. Exon-Florio and subsequent legislation and regulations only provide a number of non-exclusive risk factors. This ambiguity is double edged: it provides needed room for evolving concepts of national security, such as cyber, at the cost of the predictability that the private sector requires. Like other foreign companies, Chinese firms have had to navigate this ambiguity – albeit in the context of the overarching strategic dynamic in U.S.-China relations.
The Case of China Inc.
No complete picture is possible of how Chinese firms are faring under CFIUS review as CFIUS discloses neither whether specific firms have filed for review nor the outcome. Analysts and practioners rely largely on disclosures by the parties through press releases or corporate filings. The perception is that Chinese firms attract considerable CFIUS scrutiny. Based on generalized CFIUS statistics, however, topping the list for review are companies not from China but from the United Kingdom. Between 2009 and 2011, U.K. firms accounted for 26 percent of notices filed with CFIUS involving transactions subject to CFIUS review; Chinese investors accounted for only 7 percent. According to the CFIUS CY 2011 Report to Congress, the latest such report, Chinese firms were involved in 10 covered transactions in 2011 – behind those from France (14) and the U.K. (25).
To be sure, the report has significant gaps. For example, it does not and cannot account for Chinese companies dissuaded from investment due to apprehensions regarding Congressional scrutiny and a potentially negative review outcome. The trend, however, is for companies – including Chinese firms – to increasingly file notices out of an abundance of caution. Just as overall notices filed with CFIUS have increased from 65 to 111 over the 2009-2011 period, so too have notices from Chinese companies – up two percentage points from the 2008-2010 period.
This slice of the data will become more important as the volume and sophistication of Chinese firms looking to enter the U.S. market increases. So far it suggests that Chinese firms are not being grossly singled out. China, however, is not the U.K.; should the U.S.-China trust deficit deepen, further hurdles may arise, as may an aversion to investing. For now, Chinese companies are faring better than even they seem to think in entering the United States.
Another way to come at the question of how Chinese companies are faring is to look at the issue from the bottom up. Below are five illustrative transactions involving Chinese firms that reflect a range of issues and experiences when it comes to CFIUS review of Chinese investment.
1) Mitigate and Acquire
One example of a successful Chinese acquisition this year involved Wanxiang USA, a unit of the Chinese auto parts giant Wanxiang Group. In January 2013, Wanxiang USA was cleared to acquire the assets in bankruptcy of U.S. lithium-ion battery maker A123. The complicating factor was that the U.S. Department of Energy had previously provided $250 million in grants to A123 in 2009. The company had drawn down nearly $133 million in grants before filing for Chapter 11 bankruptcy in October 2012. To mitigate concerns relating to Wanxiang potentially acquiring A123’s contracts with the U.S. defense sector and taxpayer funded core battery technology that could be used to develop military applications, A123 excluded from the transaction A123’s military contracts, which were sold separately to Illinois-based Navitas Systems for $2.25 million.
The Wanxiang experience underscores the role of mitigation agreements in enabling Chinese firms to proceed with investments in a manner that balances investment and security imperatives. From 2009-2011, 8 percent of cases (22) resulted in the use of legally binding mitigation measures. CFIUS is increasingly requiring parties to enter mitigation agreements or otherwise imposing mitigation requirements as a condition for closing, accounting for only two cases in 2008, yet eight and nine cases in 2011 and 2010, respectively. The ability to craft and consent to such mitigation measures and agreements will become a key element for Chinese firms seeking to invest in the United States
2) If at first you don’t succeed…
The leading example of an unsuccessful Chinese bid in the United States remains energy giant CNOOC’s bid for Unocal in 2005 – an experience that still gives pause to many Chinese firms. The year the deal collapsed, volume for China-inbound deals fell from $2 billion and eleven deals to three deals totaling less than $1 billion. CNOOC’s bid triggered a Congressional storm regarding Chinese influence over U.S. energy supply; an acquisition’s “potential effects on U.S. requirements for sources of energy…” is, indeed, one of the risk factors explicitly identified in Exon-Florio. CNOOC withdrew its bid and Chevron later acquired Unocal with a lower bid.
In February 2013, however, CFIUS cleared the U.S. component of the $15.1 billion acquisition by CNOOC of Nexen Inc., a Canadian energy company with a modest amount of assets in the United States. Although CFIUS scrutinized the transaction closely (CNOOC had to withdraw and refile its voluntary notice), its ultimate clearance is notable given opposition from certain quarters in Congress; the target sector, energy, being one of identified national security sensitivity; and CNOOC’s prior blocked bid. CNOOC’s experience underscores the case-by-case nature of CFIUS review where even a firm with a fraught history involved in sensitive sectors may clear the CFIUS process in a subsequent go-around, lending credence to the review process.
3) Location, Location, Location
In contrast to Wanxiang and CNOOC, a bid by Ralls Corp., a Delaware corporation owned by two Chinese nationals, failed and ended up in unprecedented and ongoing litigation. Ralls sought to acquire four wind-farm projects in Oregon without initially filing a notice with CFIUS. The acquisition was halted by CFIUS and, later, by a rare presidential order mandating divestment due to the farms being “all within or in the vicinity of restricted air space at Naval Weapons System Training Facility Boardman in Oregon.” On at least two prior occasions, Chinese investments in the mining sector in Nevada similarly failed due to the targets’ proximity to U.S. military installations.
In the first-ever direct challenge to the validity of a CFIUS order, Ralls brought a lawsuit against CFIUS and U.S. President Barack Obama in the U.S. District Court for the District of Columbia. A ruling was issued on February 22 largely upholding the U.S. government’s motion to dismiss the case, yet allowing Ralls to proceed with a limited due process claim regarding the process that led the Obama administration to issue its divestment order. On October 9, however, the court dismissed Ralls’ due process claim on the grounds that it failed to substantiate it; the court took particular note of Ralls’ failure to initially file a voluntary notice with CFIUS. In its holding, the court noted that no statutory conditions were placed on the president’s discretion to block a transaction, according deference to the executive branch on a matter of national security. Ralls has since filed an appeal with the U.S. Court of Appeals for the District of Columbia.
The Ralls case has implications for all investors relating not just to the limited nature of legal recourse vis a vis CFIUS review but also to the proximity issue of the target’s assets to sensitive facilities. Given that at least three Chinese investors have run afoul of the proximity issue, Chinese firms will have to contend with this factor – no matter how seemingly benign the actual target of their investment – for scrutiny derived from U.S. concerns regarding espionage.
4) “Not Interested in the U.S. Anymore”
If Ralls’ unsuccessful bid had an unspoken undercurrent of espionage, Chinese telecommunications giant, Huawei, has had to deal with the issue upfront. In addition to having withdrawn its bid for 3Com, a network equipment manufacturer, in 2008 and having had its 2011 acquisition of 3Leaf, a cloud computing company, blocked, Huawei has had to respond to targeted Congressional scrutiny for its founder’s alleged links with the Chinese military.
In October 2012, the House Permanent Select Committee on Intelligence issued an “Investigative Report on the U.S. National Security Issues Posed by Chinese Telecommunications Companies Huawei and ZTE” recommending that CFIUS “must block acquisitions, takeovers, or mergers involving Huawei. Overseas, a UK Parliamentary body has expressed similar concerns regarding how Huawei is “embedded” in the country’s critical national infrastructure, although it did not find evidence of specific problematic activities.
Huawei’s troubles underscore how mounting U.S. concerns regarding Chinese cyber activities and critical infrastructure protection are spilling into the investment domain. Consider the recent acquisition of Sprint, the third-largest U.S. mobile carrier, by Japan-based SoftBank. As part of securing Congressional support for the transaction, both parties had to assure members of Congress that they would not integrate Huawei equipment into Sprint systems. CFIUS approval was conditioned on a National Security Agreement that required the appointment of an independent member to the Sprint board of directors to serve as a security director – a position since filled by retired Admiral Mike Mullen. In the aftermath of the Sprint-SoftBank deal and on the heels of various derailed transactions, Huawei’s Executive Vice President announced at the company’s annual analyst summit: “[w]e are not interested in the U.S. market anymore.”
What is notable in the Sprint case is not just the parties’ agreeing to “mitigation measures” at the request of Congress – not CFIUS itself – but also that Huawei was not a party to the transaction under review. Thus, foreign firms seeking to invest in the United States will have to assess the target, as well as perhaps look over their shoulders to gauge how their suppliers are perceived in the United States. In addition to Congressional opposition, Chinese and other foreign firms will also need to be prepared for media campaigns by local competitors. In the Sprint deal, Dish, the U.S. satellite broadcaster, launched a full-throttle campaign, placing ads in the Washington Post and even launching a website citing the national security risks associated with the transaction.
5) “These are pork chops.”
As the tempo of Chinese investment increases, the highest note to date has been the acquisition by China’s biggest meat producer, Shuanghui International, of Virginia-based pork producer Smithfield Foods. Following the announcement of the deal, the question of whether CFIUS review was merited quickly arose. Smithfield’s CEO, Larry Pope publicly made his company’s case: “[we]’re not exporting tanks and guns and cyber security…These are pork chops.” Nonetheless, both parties prudently left little to chance. In addition to submitting to CFIUS review up front, the transaction was reportedly structured such that if the deal fell apart, Shuanghui would pay Smithfield a $275 million reverse break-up fee – a payment that would not have applied had CFIUS blocked the transaction.
Although CFIUS ultimately approved the deal, probing the key considerations it may have assessed is illustrative. Three potential CFIUS angles on the transaction may have arisen in a sector that, once again, does not fall in an explicitly identified sector of national security concern. First, food security might have been seen through the prism of critical infrastructure. The Department of Homeland Security, which sits on CFIUS, has defined 17 critical infrastructure sectors, including “Food and Agriculture;” CFIUS, however, has stated that it will assess which target assets fall within the critical infrastructure sector on a case-by-case basis, denoting only the energy sector as definitely constituting critical infrastructure. Second, Smithfield reportedly had been a direct supplier to the U.S. Department of Defense and civilian government agencies, perhaps drawing scrutiny as a vendor with access to potentially sensitive information regarding the locations and staffing of government facilities. Third, the proximity of any Smithfield facilities to military installations would likely have raised concerns.
In addition to CFIUS review, however, both parties had to navigate a restive Congress where a bi-partisan group of senators wrote a letter to the U.S. Secretary of the Treasury calling for the Department of Agriculture and Food and Drug Administration to participate in the review given that “food supply is critical infrastructure that should be included in any reasonable person’s definition of national security.” Smithfield’s response was that “the combined company will not import any product from China into the U.S. As a result, the proposed combination does not have any implications for the U.S. food supply.” Following on the letter, the Senate Committee on Agriculture announced its July 10 hearing in which Smithfield’s CEO testified as to why the investment was not detrimental to U.S. interests and mollify Congressional concerns.
Interestingly, the hearing occurred the same day as the Fifth US-China Strategic & Economic Dialogue. The treatment of Chinese investments in the United States arose not just in the confines of the Dialogue but in an op-ed published in the Wall Street Journal that same week by Chinese Vice Premier Wang Yang who pointedly noted that “expanding business ties have also led to disagreements and doubts” between both countries and that “some Chinese wonder why their country’s corporate investments in America have suffered setbacks time and again, even as the U.S. is actively trying to expand employment.”
Although the approval of the Shuanghui deal cuts against such concerns, a long-term source of confidence may prove to be a US-China bilateral investment treaty – negotiations for which were announced by U.S. Treasury Secretary Jacob Lew during the Dialogue. The treaty, according to the Wall Street Journal, “would give China a lot more clarity about the rules of the road, give it a way to appeal for compensation if a deal is blocked, and provide China something of an overall seal of approval.” For now, perils aplenty lie ahead in the negotiations.
Open For Business
While the above cases demonstrate a process that is largely working, room for debate exists on transparency, due process, and the scope of national security considerations. Some contend that the scope of CFIUS review should be expanded beyond national security; others are pressing for explicit new criteria relating, for example, to intellectual property. Still others have cautioned about “Washington’s tendency to define American national security interests unreasonably broadly.” The scope of review and what poses a national security risk will need to be continually calibrated yet more tailored guidance can help reduce misunderstanding and Chinese perceptions of discriminatory treatment and establish a standard by which U.S. companies will want to be treated given China is reportedly studying CFIUS in creating its own security review mechanism.
For now, the Smithfield deal weaves together key themes derived from the recent experiences of Chinese firms seeking to invest in the United States in potentially sensitive sectors: the mitigation considerations of Wanxiang; the proximity issues of Ralls; the Congressional opposition that CNOOC encountered; and evolving areas of national security concern as seen in Huawei’s experience. These factors are leading Chinese firms like Shuanghui to adapt their transactions and to proactively engage CFIUS and Congress to make the case for the merits of their investment, providing important transparency and inflows. While considerations unique to Chinese firms exist and friction will likely rise in tandem with Chinese investment and an evolving strategic dynamic, the United States is and should remain open for business.
Ziad Haider is an attorney specializing in CFIUS matters and Director of the Truman National Security Project’s Asia Expert Group. He served as a White House Fellow in the U.S. Department of Justice and as a national security aide in the U.S. Senate. Follow him on Twitter @Asia_Hand.