The U.S. government has been increasing its scrutiny of inbound foreign investment for national security risks and concurrently is establishing a new program that would prohibit certain outbound investments. Both developments directly affect private equity funds. In contrast, the EU’s regulatory response is nascent, with concrete proposals not
expected before fall 2025.
Foreign Investment into the United States
The Committee on Foreign Investment in the United States (CFIUS) continues to be aggressive, maintaining a high volume of reviews and more frequently taking action to address identified national security risk. In particular, the following developments affect funds:
Foreign Limited Partners
CFIUS is closely examining the rights of foreign limited partners to determine if CFIUS has a basis for asserting jurisdiction and to determine if these rights could cause national security risks.
Third-party Ties
CFIUS also has been increasingly scrutinizing “thirdparty ties” to countries of concern—that is, commercial or investment ties that investors from lowrisk countries have with countries such as China.
Mitigation
CFIUS has been increasingly requiring mitigation conditions to clear transactions, including to address risk associated with third-party ties.
Enforcement
CFIUS has made enforcement a top priority, including calling in transactions that parties have not voluntarily filed with CFIUS and becoming stricter with respect to mandatory filings.
Mandatory Filings
Where filing 30 days in advance is mandatory, CFIUS has taken the position in its guidance that it no longer allows “springing rights.” That is, parties cannot satisfy the mandatory filing requirement by closing a funding round and holding rights that trigger CFIUS jurisdiction (such as board membership or observer rights) until CFIUS clearance is obtained post-funding. Rather, parties must wait until the 30-day post-filing period has lapsed before funding such transactions.
Areas of Focus
Technology and personal data continue to be particular focus areas. Even acquisitions of sensitive technology that is not state of the art could be considered a national security structures and thirdparty relationships, and factor CFIUS review into their timeline risk if it would allow a country of concern to close a technological gap.
In light of these developments, private equity funds must increasingly conduct diligence on the business activities of U.S. targets, consider their own ownership structures and third-party relationships, and factor CFIUS review into their timeline. U.S. Investment into Chinese Companies On August 9, 2023, President Biden issued a long-awaited Executive Order on outbound investment to China (including Hong Kong and Macau) that will prohibit or require notification of certain investments by U.S. persons into certain Chinese or Chinese-affiliated entities, namely those that develop or produce semiconductors, quantum computers or certain artificial intelligence (AI) applications. The Executive Order is being implemented through a new rulemaking process, and the U.S. Department of the Treasury issued an Advanced Notice of Proposed Rulemaking for public comment, laying out proposed parameters for the new program. Private equity firms are squarely in the crosshairs.
Key Takeaways
- General Partners. Treasury has stated an intention to cover funds with U.S. general partners regardless of the country of formation. These funds will need to undertake additional due diligence and ensure compliance with both prohibitions and notification requirements. Non-U.S. managers may not be directly targeted by these rules, but ties to U.S. persons
(e.g., investors or employees) could impose compliance obligations.
- Limited Partners. Treasury has proposed an exception for some but not all indirect investments by U.S. limited partners. Where a limited partner invests over a certain monetary or percentage threshold or has assets under management over a certain threshold (in each case, still to be determined), these indirect investments may be covered under the new program even if passive. Therefore, non-U.S. funds will need to take measures to ensure compliance for their U.S. limited partners.
- Knowingly Directing. If U.S. persons sit on the management committees or boards of foreign funds or entities, they would need to recuse themselves from certain investment decisions.
We expect draft regulations to be published in the first part of 2024 with a final opportunity for public comment. Final rules will likely become effective in the second half of 2024.
Congress also continues to debate restrictions and notification requirements relating to outbound investment to China and other countries of concern. Some of these proposals would cover more types of passive investment than Treasury’s proposed approach and could potentially have a more significant effect on funds.
Outside of the U.S., we are seeing some other governments consider the necessity of rules on investment in China and elsewhere. The British government has been conducting a study to analyze the need for new measures to regulate outbound investment, particularly in relation to China following President Biden’s Executive Order.
More recently, the European Commission (EC) published its White Paper on Outbound Investments. That said, rather than provide details of a concrete proposal—as had been originally anticipated when the Commission published its European Economic Strategy in June 2023. The White Paper instead proposes further steps for gathering information before any more concrete proposals are made.
While the EC already restricts the export of dual-use technologies and provides a legislative framework for Member States to screen inbound investments, there is currently no monitoring of outbound investment flow. In its White Paper, the Commission emphasises the complex and sensitive nature of the field of outbound investments, and the tentative steps it must take to ensure that the EU’s response is proportionate and targeted.
Despite having already gathered information from Member States, and the EC Expert Group on Outbound Investment having met thrice last year, more reliable data is needed. Over the next couple of years the Commission has committed to running a public consultation on the proposed monitoring and review of existing outbound investments, and expects to issue a Recommendation to Member States this summer.
After another year of monitoring and reviewing risk assessments, the Commission’s assessment of the need for policy responses and possible proposals are currently expected to be announced in fall 2025.
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