By King & Wood Mallesons – Neil Carabine and Stephanie Courtice
China’s outbound foreign direct investment (FDI) has increased substantially over the past decade. China’s 13th Five Year Plan has also encouraged acquisitions and investment by Chinese organisations in a wider range of sectors (e.g. fintech, high-end manufacturing and real estate).
With the implementation of the BAR initiative, Chinese investors will continue to play an increasingly significant role in global markets. In this publication, we look at some of the central steps investors can take to mitigate their risks and take advantage of the legal protections available to safeguard their outbound investments.
Tip 01: Understanding the key risks for outbound foreign investment
As well as providing opportunities, large-scale foreign investment projects face numerous risks. Understanding how to assess, navigate and mitigate these risks is key to project success. Key risks associated with outbound FDI include:
- Country operational risk – risks associated with corruption, national security, political stability, government effectiveness, the legal and regulatory environment, the macroeconomic situation, foreign trade and payments, local labour markets, tax policy and the standards of local infrastructure;
- Political risk – the risk of policy changes on exchange rate and interest rate controls, international sanctions, changes of regime and economic changes, controls on prices, outputs, currency and remittances, labour quotas and, in some cases, nationalisation or expropriation. Political risk may also result from events outside of government control, such as war, revolution, terrorism, labour strikes, extortion, and civil unrest; and
- Credit risk – one of the major risks of outbound FDI is the potential for the host country to default on foreign lending and / or investment projects. This risk is particularly high in a number of BAR countries, which lack sound creditworthiness. The graph below sets out the overall country credit risk of certain BAR countries. Investors should also be aware that during periods of financial crisis, governments may be excused from providing the substantive protections granted under bilateral investment treaties (BITs).
Tip 02: Mitigating corruption risk
Anti-corruption due diligence
Given the penalties under certain investor state laws and the huge commercial risks of investing in a corrupt entity, it is essential that adequate anti-corruption due diligence is undertaken into:
- the entity’s control environment: policies, procedures, employee training, audit environment and whistle-blower issues;
- any ongoing or past investigations (government or internal), adverse audit findings (external or internal), or employee discipline for breaches of anti-corruption law or policies;
- the nature and scope of the entity’s relationship with the government (both family and corporate relationships) and the history of significant government contracts or tenders;
- the entity’s important regulatory relationships, such as key licenses, permits, and other approvals – with a focus on employees who interact with key regulators; and
- the entity’s relationships with distributors, sales agents, consultants, and other third parties and intermediaries, particularly those who interact with government customers or regulators.
Tip 03: Factoring in the ongoing cost of foreign investment regimes
Foreign investors often face unpredictable approval regimes. Navigating government decision-making processes can result in delay and increased costs. Even in historically investor-friendly jurisdictions, foreign investors can face challenges and political opposition when the privatization of public assets is involved.
Foreign investment rules
It’s not just caps on ownership. For example, some BAR countries (e.g. the Philippines) prevent foreign nationals from holding executive roles in locally incorporated companies, leading to excessive executive costs associated with engaging a local CEO and a ‘real’ CEO to shadow their local counterpart.
Additionally, some jurisdictions allow initial foreign ownership but require the foreign investor to sell down to a local partner over time, which can lead to a fire sale of assets and depressed pricing. For example, Indonesia requires foreign companies to sell down stakes in local mining operations and increase domestic ownership to 51% by the 15th year of production.
Effective planning and management of outbound FDI projects is key to allowing investors to mitigate risks and maximize the protections available. In particular, investors should:
- engage external advisors at an early stage to help evaluate and navigate the risks associated with potential investments;
- structure investments to maximise the protections available under BITs; and
- ensure effective deadlock and exit mechanisms are incorporated in joint venture agreements to allow for a smooth exit in the event that things do go wrong.
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