The COVID-19 pandemic and the resulting market volatility have led several governments to amend law and regulation in the context of sensitive industries. Much of the regulatory response has been directed at tightening foreign investment restrictions by lowering shareholding thresholds as well as expanding the sectors caught by a foreign investment review. As a result of the recent regulatory changes, more investments are now subject to regulatory scrutiny, accelerating an existing trend of reform in this space.
CSS’s Regulatory Guidance expert Marye Cherry answers the most common questions she’s seen around sensitive industries and investment monitoring. With more than 15 years of legal and compliance experience, Marye specializes in transparency and regulatory reporting issues in the financial services industry. At CSS, Marye focuses on financial regulations that affect fund managers and their operations worldwide and helps translate regulatory requirements into automated reporting solutions.
How has COVID and market volatility impacted sensitive industries?
MC: This is a question I have been asked a lot, and there has indeed been a lot of activity in this area in the last few months. Most prominently, foreign investment scrutiny, either under foreign direct investment (FDI) review regimes or national security reviews, have been expanded to deal with the perceived increased threat to critical national assets. The recent market volatility has raised an alarm with regulators who are concerned that some important assets could become distressed and then easily acquired cheaply by foreign investors.
To address that concern, regulators have done a number of things, including: 1) expanding foreign investment review regimes to include certain healthcare related sectors (e.g. in France and Germany); 2) expanded existing review regimes to bring more investment activity within scope of the review process (e.g. in Italy, new sectors were added and in Australia and New Zealand, previous monetary thresholds were temporarily eliminated) and 3) created an FDI review system in some countries where one previously didn’t exist (e.g. Spain and Slovenia).
What are the typical challenges in monitoring sensitive industries?
MC: The number one challenge in monitoring sensitive industries is the breadth of coverage. The sheer number of industries that can be regulated and that have restrictions around for all investors, or particular foreign investors, is challenging. The classic industries are defence or military, along with banking, media, energy (including both utilities and extractive industries such as oil and gas), transportation and technology. Recent legislation, especially in Europe, includes activities like the handling of sensitive personal data.
What that means for monitoring developments is that a wide range of laws are relevant, and there is no one consolidated place to go for information regarding sensitive industries. This is in contrast to shareholding disclosure or position limit monitoring, where there is often a single relevant piece of legislation that, while very detailed and nuanced, is manageable to monitor for developments. However, for sensitive industries, staying on top of developments in a particular country requires consulting several different pieces of legislation that are likely under the purview of several different regulators, or many different ministries. There are as many laws as there are industries to monitor, which means there are as many government bodies as there are industries to pay attention to. That is ultimately the number one challenge in monitoring sensitive industries.
Another challenge in this context is that we have this definitional issue with sensitive industries. For example, which issuers and activities fall within the scope of a particular industry restriction? Banking and other financial sectors are well-defined in most jurisdictions, especially in well-developed markets. But for other industries, and in most jurisdictions, there is often no definite list of issuers that are within scope of a particular industry regulation. That is the challenge. In these situations, we are relying on market practice and market data, namely industry codes classifications. However, these of course have not been validated by any regulator.
How are firms typically caught off guard by the complexity of sensitive industries?
MC: Where some can get caught off guard is that there are some very low thresholds in this sensitive industry context. Now, it is true that in this area we often see quite high thresholds. For example, reviews that are triggered when acquiring control or 50% shareholding in a company, and even the commonly found restrictions in the financial sector, such as the EU qualifying holding approvals, often start at 10% shareholding. But there are some notable exceptions in the financial sector such as the 1% post-notification requirement in China, for listed banks. Another example is the low thresholds in Italy. Shareholdings in certain types of bank are restricted to 1% and acquisitions in the defence sector are reviewable as from 3% shareholding.
How best can firms stay ahead of sensitive industries?
MC: As sensitive industries cover such a broad scope and is a rapidly changing area, it is wise to have monitoring tools and resources in place to stay on top of the fast-moving changes. That can be in the form of a dedicated compliance or regulatory team that are monitoring these changes around the world and have set up internal alerts. Firms can do it internally with their own team, manually setting up alerts to track these changes in different industries around the world.
Also, there are automated tools and platforms that are available to help you stay on top of these changes in real-time.
What do firms need to understand about the EU FDI Screening Regulation?
MC: There are a few important issues to note.
First, is to understand the nature of the regulation. It is a coordination mechanism; it does not create any new obligations directly for investors. This contrasts with other regulations, for example the Short Selling Regulation.
The EU FDI Screening Regulation obligates the member states to exchange information about certain foreign investments coming into their countries and also to inform the European Commission. Even though the regulation does not create a direct legal obligation upon investors, investors will feel impacts of this regulation. For example, in March of this year, the European Commission issued guidance to member states about how they can best use their foreign investment screening rules to protect critical assets in the context of COVID-19. That is, in fact, what prompted the changes I mentioned in response to the first question. In Germany and France, the governments expanded their foreign regime to include certain healthcare sectors such as biotechnology and vaccines.
Investors can also be impacted as EU countries move to align their foreign investment regimes with the sectors identified in the FDI Screening Regulation. In addition to the tweaks made by France and Germany, we’ve seen a broader expansion of the existing FDI review system (Italy), and the creation of a brand-new investment screening regime, as in the case of Spain.
I expect that we will see more EU countries reviewing their national rules to better align them with the FDI Screening Regulation which means that investors should monitor national FDI rules to identify any shifts in scope and application of the national review system.
Are there any sensitive industries blindspots firms need to be aware of?
MC: From my research, I have seen certain industries pop up repeatedly across jurisdictions even though they are not as significant as some of the larger ones such as banking and media. A good example would be the lottery or gambling sector. I have also noticed that not every legal service provider covers that type of industry to the same extent, and I think it is important to be mindful of the less common industries that can show up.
What are your key considerations firms need to be aware of regarding sensitive industries?
It’s important to remember that with sensitive industries, you have all the complexity and nuances from the long shareholding situation, but then multiplied by the number of industries and legal rules per industry given that there are multiple laws and regulations laying down these restrictions. All the tricky issues around securities within scope, voting shares vs. shares outstanding, aggregation and other distinctions exist for sensitive industries.
For more information on CSS’s Investment Monitoring solution, including Sensitive Industries, please email us at info@cssregtech. Our automated platform and our team of regulatory experts can help your firm stay ahead of regulatory changes across global jurisdictions, reduce risk and optimize operational efficiency.
*This article includes content derived from Rulefinder Shareholding Disclosure, the online legal service from aosphere LLP. We work with aosphere to source legal content for our rules engine.
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