Chinese FDI Squeezed in 2017 by Regulatory Crackdowns at Home and Abroad
- Chinese FDI into North America fell 35% in 2017 to $30 billion
- FDI up 76% in Europe to $81 billion due to delayed completion of a 2016 mega deal; would otherwise have fallen 22% to $38 billion
- Changes in 2017 activity mainly driven by Chinese policies restricting outbound investment
- Record proportion of cancelled deals were blocked by foreign regulators
- Switzerland, UK, Netherlands attracted most Chinese capital in Europe
- New York, Virginia, California most popular North American investment destinations
- Investment in logistics, health and biotech, ICT and consumer services outperformed
- Pipeline for 2018 showing recovery in Europe driven partly by One Belt One Road
Chinese investment in Europe and North America stuttered in 2017 against a backdrop of the country's first fall in FDI globally since 2006, according to early data from global law firm Baker McKenzie's forthcoming annual report on Chinese FDI trends, produced in partnership with leading China analysts Rhodium Group.
Levels of investment in North America fell 35% in 2017 to $30 billion. Europe looked healthier on the face of it at $81 billion - up 76% - but solely due to the delayed completion of ChemChina's record $43 billion takeover of Swiss agribusiness company Syngenta. Without this megadeal falling into 2017, Chinese investment would have fallen 22%, to $38 billion.
These trends are in line with official Chinese data showing its global FDI flows declining by more than a third in 2017 - the first drop since 2006.
The main reason for the fall was guidelines introduced by the Chinese government imposing additional restrictions on outbound investment to address balance of payment concerns and mitigate perceived risks for China's financial system arising from rapid overseas investment.
In addition to tougher controls in China itself, growing regulatory scrutiny in many host countries also hit FDI activity, with the US Committee on Foreign Investment (CFIUS) particularly active, impacting at least seven major deals.
New deal momentum falls sharply
The number of completed deals increased 6% to 350, but more than half of these were the completion of transactions announced in 2016.
Demonstrating the impact of Chinese capital controls introduced in late 2016, the average size of deals announced in 2017 declined sharply across all industries and investor types. It fell from $626 million in North America in 2016 to $282 million last year. In Europe it fell from $346 million in 2016 to $162 million (ex-Syngenta).
"The momentum of deals involving Chinese investors dropped sharply from Q3 2016 to the first half of 2017 while the market waited for policies to be clarified," said Mike DeFranco, global head of M&A at Baker McKenzie. "Now that it is clear how the rules have changed for Chinese investors at home and abroad, activity is picking up, and 2017 was still the second-best year on record in North America and technically the best in Europe, despite all the challenges for dealmakers.""Activity has stabilised, particularly in Europe, since China clarified its foreign investment regime," said Thomas Gilles, chair of Baker McKenzie's EMEA-China Group. " But while commercial appetite among Chinese investors remains strong, political and regulatory issues mean deals must be very carefully planned and assessed. Germany has a new law on foreign investment and the EU is looking at new screening measures. This may well subdue activity in 2018 compared with recent years."
Chinese investors cancelled or withdrew 19 announced deals worth over $12 billion in North America and Europe in 2017. This is fewer than the 30 deals cancelled in 2016 and is in line with overall lower activity. Beijing’s tougher regulatory stance on outbound investment has resulted in a lower number of deals being proposed in the first place. Foreign regulators like CFIUS also played a greater role in withdrawn deals.
Our data estimates that overseas regulatory intervention was responsible for more than two-thirds of the $12 billion of formally announced and then withdrawn or cancelled deals in 2017, with Chinese capital controls and commercial decisions taking the remainder off the table. Slower and tougher security screenings mostly impacted transactions in financial services, semiconductors and other high-tech sectors. Around $5 billion of Chinese investments are currently under regulatory review in the US and Europe.
"CFIUS is busier than ever," said Rod Hunter Washington, DC-based partner focused on trade and investment regulation, who last week presented to the House of Representatives Committee on Financial Services in the United States on this topic. "In 2007 it handled 138 cases; in 2017 the number was nearly 250. Cases have also become more complex and are taking longer - in 2007 just four percent of cases moved to the investigation stage, but now it is about half. Still, while some cases get caught in ‘doom loops,’ the overwhelming majority are approved. Legislators are right to revisit CFIUS, which is straining under its workload, but should avoid handing CFIUS a broader technology control mandate, a role better filled by specialized agencies."
Trade tensions between the US and China have continued to rise in early 2018, with one deal blocked already and debate over reciprocity and technology transfer.
"No-one wins a zero sum game and cooperation between the world's largest economies is the only way to continue economic growth," said Danian Zhang, chief representative of Baker McKenzie's Shanghai office. "It may be a bumpy 2018 but the global economy needs Chinese capital to be deployed. Composure and pragmatism are essential to steer trade ties safely."
Sectors that come under China's One Belt One Road (OBOR) initiative are one brighter spot. Despite the majority of countries in this report being outside the geographic scope of OBOR, there has been an enormous increase in Chinese FDI in transport, utilities, logistics and infrastructure sectors in both regions, in particular in Europe, where investment grew from less than $1 billion in 2015 to more than $16 billion last year, primarily driven by China Investment Corporation's acquisition of Logicor Europe..
A number of countries in Europe bucked the underlying downward trend, demonstrating that Chinese investors are still keen to invest in strategic assets at a good price.
Switzerland at a stroke became the biggest European recipient of Chinese investment this century due to the completion of the mammoth Syngenta acquisition by ChemChina, which is the largest outbound Chinese investment in history. FDI into Switzerland rose 829% year-on-year.
With $20.8 billion of Chinese investment in 2017 - more than double the amount the prior year, the UK would in any other year be the biggest recipient in Europe. The Logicor deal counted for much of the total. Attractive pricing due to a weaker currency after the Brexit referendum may also have helped support activity.
The Netherlands saw (an eight-fold rise to $3.9 billion) after an unusually quiet year in 2016 and Sweden ($1.4 billion) also saw a significant increase.
The biggest year-on-year declines in Chinese investment in large economies were in Germany (down 84%), Spain (down 79%) and France (down 58%). However, these falls generally bring activity back into line with more normal levels after very active years in 2016. Activity picked up in the second half of 2017, with a number of deals pending, particularly in Germany and Spain.
The top recipient states were New York, Virginia, and California.
Chinese investment in Canada continued to remain at low levels, with the exception of Anbang’s stake in retirement home operator Retirement Concepts worth an estimated $1 billion. However, momentum clearly picked up in the second half of the year with a number of larger deals being announced.
Mega deals dominate the industry picture for 2017, but changing political reality has impacted the composition of new deals in the second half of the year, with some distinct differences between Chinese investment patterns in North America and Europe.
Agriculture and food, real estate and hospitality, transport, utilities and infrastructure, and ICT were the top sectors for Chinese investment in Europe. Toward the second half of 2017, Chinese investors shifted gears: activity in sectors deemed problematic by new Chinese government rules (certain real estate assets and hospitality assets, and entertainment) dropped, while investment in other sectors (ICT, transportation, utilities and infrastructure, and consumer products and services) held up relatively better.
Meanwhile, real estate and hospitality, transport, utilities and infrastructure, ICT, and health and biotech were the top draw for Chinese investors in North America. Similar to Europe, investments in sectors and assets singled out as problematic by Chinese regulators declined in the second half of the year. However, investment appetite in technology (ICT) and certain service sectors (health and biotech) held up well or even increased compared to 2016.
China’s regulatory crackdown has significantly changed the landscape of investors, elevating certain state-related and qualified private investors while impacting private companies with a perceived track record of aggressive overseas deal making.
Just a handful of private companies were responsible for a large share of Chinese outbound deals in the past two years. The five investors singled out by Beijing in June 2017 account for a quarter of the value of announced Chinese deals in Europe and North America in 2015 and 2016 ($63 billion or 23% of the total). This group of investors had to sharply slow down their overseas expansion.
State owned Chinese investors also faced tougher risk controls for overseas investments, but some sovereign and qualified state-owned players seem to be better able to navigate the current political environment, especially sovereign wealth funds, insurance firms and investment vehicles with a mission to advance industrial policy or geopolitical goals.
Private companies with a healthy balance sheet and without history of aggressive overseas expansion are also still able to get approval for overseas transactions in their core areas of business, especially acquisitions that allow them to modernize technology and increase competitiveness.