Fortifying German Defences, published in EVCJ
Published in EVCJ (European Venture Capital and Private Equity Journal)
Are we standing on the brink of an international trade war, sparked by Germany's threat to veto foreign investments? Or is the proposed legislation from the Ministry of Economics and Technology a mere storm in a beer stein?
If enacted, the new laws would reform the existing Foreign Business Act to allow the federal government to veto any non-EU investment adding up to 25 per cent or more of a German company. The law would only be applied in an 'emergency', according to the government's parliamentary bulletin, in cases where proposed investments threatened "public order or national security".
Investors, analysts and commentators have been scratching their heads over this phrase ever since it first appeared on the bill. Since defence companies and those engaged in encryption are already off the market for investors, it is a puzzle to anticipate what other types of company or industrial sector might fall under this broad umbrella.
Energy and infrastructure companies could be included, if one considers power supplies, roads and transport to be important to national security, but these sectors have already seen significant foreign investment and it would be a peculiar volte face to remove them from consideration now.
At its most extreme, the measure could pose a serious threat to world trade, according to Simon Witney at law firm S J Berwin in London. "I think it is probably the most aggressive attempt that I've seen in Europe to legislate on investment issues," he says. "It would create a great deal of problems if it goes through as drafted."
An earlier draft of the bill had applied to all non-German investors, but the European Union caught wind of this and told Germany that it would conflict with the right to the free movement of capital permitted between all EU states. As it stands, the measure appears most targeted at sovereign wealth funds in the Far and Middle East, who now control an estimated $2.5 trillion in assets and are expanding rapidly, alongside state-controlled companies such as Russia's Gazprom. The fears raised in recent years by Russia's willingness to turn off gas supplies during its arguments with Ukraine - which affected several European Union countries - are among the factors influencing German political opinion.
Other concerns are the motivations of state-owned funds in their German investments. At the Davos economic forum in February this year, German deputy economy minister Bernd Pfaffenbach was quoted saying that the sovereign wealth funds are "welcome if they behave properly", which is an oddly patronising thing to say to a massively wealthy potential investor. Like 'public order and national security', it begs all sorts of questions. What is 'improper' behaviour? Not wearing a tie?
Judging by the internal rows that have recently broken out in Germany, the most improper thing that a foreign investor can do is to come into the country, acquire some terrific piece of technology through buying a company, then outsource production to a low-wage economy, depriving Germany of thousands of well-paid and established manufacturing jobs.
This may be what is meant by 'threat to public order', because if enough jobs are cut, people will take to the streets and riot. Nokia recently provoked an outcry when, after acquiring a research facility in Bochum and receiving around [euro]60m in subsidies, it decided to up sticks and move to Romania, where wages are a quarter of the German average.
The German Social Democrat (SDP) labour minister Olaf Scholz says that his ministry should be involved in vetting foreign investment and be allowed to veto deals if they would lead to major job losses. But this has received short shrift from the economics ministry, which fears that using job cuts as a reason to block deals would conflict with the EU's single market rules and cause the whole bill to be abandoned, through opposition from the European Court of Justice.
The whole issue is enmeshed in politics, since Germany is entering the run-up to an election in 2009 and the coalition partners of Angela Merkel's CDU and the more left-leaning Kurt Beck of the SDP are more curt than angelic. The SDP, with its popularity slipping in the polls, does not want to be seen caving in to CDU policies.
As a result, each party is trying to outbid the other in 'getting tough on foreigners', through this piece of legislation. And of course Germany is not alone. "We've had this kind of chauvinism in France and now we are getting it here," says Christian Cornett at S J Berwin in Frankfurt. "The real battle will be to what extent the law will be applied. It may be a question of the ministry deciding which industries are protected."
What is unknown is how any of the parties, ruling now or in the future, may use such powers that they receive through this legislation. The former communists, for example, might use it in a far more aggressive way than either of the two main parties. "If is it applied, we're afraid that this law will prevent other deals being completed," says Cornett. "But there is an irrational fear that sovereign wealth funds or others will come in and acquire pieces of German identity, culture or entrepreneurship." Cornett argues that it is too late to worry about such things. "When Adidas bought Reebok, everyone thought it was a national victory. But Adidas isn't a German company any more." At the very least, the effect of this legislation will be to bring "uncertainty and delay," says Cornett.
For some, the move is a nakedly political act, designed to appease disgruntled German voters who take a dim view of German assets falling into any kind of foreign hands. "If politicians can use the law, then they will use it for reasons of popularity," says Thorsten Polleit, an economist at Barclays Capital in Frankfurt.
In Munich, meanwhile, Peter Hammermann at Barclays Private Equity detects a similar window-dressing aspect to the legislation. "Some tendencies in politics are very frightening, but pragmatic experience says that a lot of things are brought up in a stringent manner, but they come down to almost nothing." Crying wolf, in other words. Although private equity has been in the spotlight in Germany (and the UK) over the past year, "a lot of rules were considered but the outcome was almost no change, just some additional support for venture capital and no change for late stage MBOs."
Hammermann agrees that some kind of protection for German interests may be worthwhile. "When you have state-owned funds transferring technology and know-how to other countries - such as all the Asian people at the Frankfurt Motor Show with cameras, trying to copy things - government regulations should cover these areas, to avoid unacceptable technology transfer."
He argues that the German government is fully aware of the benefits that private equity investment can bring. "They don't want to make our lives so unattractive that we go elsewhere."
Certain countries have very specific investment strategies, Hammermann believes, which the German government is possibly right to want to scrutinise. The German auto parts industry, for example, could become the target for investors. He can imagine the government wanting to retain a proportion of the industry rather than allow it to be sold entirely overseas. Yet Hammermann nevertheless takes issue with the vague wording of the proposed act. "I would rather it were about concrete issues rather than a widespread oversight of deals."
Simon Witney at S J Berwin in London can understand the reluctance of the German authorities to allow 'strategic' assets such as the electricity system to be taken into foreign hands, even though this has already partially happened in the UK and elsewhere. "There are legitimate concerns about having assets in the hands of foreign governments," says Witney. "But I think states can deal with these concerns in other ways, by restricting what an investor can do with an asset."
The debate has parallels with the wider issue of the credit crunch and sub-prime losses, stemming as these did from a lack of transparency in how assets changed hands and who had exposure to what level of debt. If, for example, a foreign investor acquired the German electricity system and then sold it on to another party, which then went bankrupt, Germany would be in danger of losing its electricity supply overnight. Achtung!
"The main concerns are about losing control over things which should be in state control, or at least in German hands," says Kerstin Kopp, partner in private equity at Clifford Chance law firm in Frankfurt. But she believes that, even if it is enacted in full, it will do little to change the pattern of mergers and acquisitions in Germany. "I think the law will not calm down or slow down M&A. It will be more difficult for banks, there will be more regulation and more complication. Perhaps I'm over-optimistic, but I think that no government, even if it is dominated by the left wing, would use this law to put up hurdles."
Kopp agrees that private equity has to become more transparent, to talk more to politicians and works councils, just as has begun to happen in the UK ("It has floated over from the UK to Germany," she says), but she believes the principle target of the legislation is the sovereign wealth funds.
The question of international trade and foreign investment has been in constant flux in Germany over the past few years, as the nation has attempted to liberalise its laws, attract foreign investment and maintain its role as a manufacturing base against the blandishments of Eastern Europe and the Far East. In several ways, life for foreign investors has become easier rather than harder, according to Kerstin Kopp at Clifford Chance. "There are changes under way to make it easier to register companies, making it less costly and so on," she says. The legal framework or corporate ownership has been restructured, to disentangle the mutual shareholdings in each other that characterised German corporations up to the 2000s. This has realised hidden value and prompted acquisitions that would not have been possible in the 1990s.
But after episodes such as the Nokia decampment from Bochum, the government has decided to re-regulate and to tighten up the system a little. Nobody expects the regulatory environment to return to its previous condition, but we are seeing an adjustment, as part of a response to public disquiet.
From a global perspective, it would certainly be odd for Germany to make such a unilateral and aggressive move, at a time when China and India are liberalising their economies, when the French and German-owned European Aeronautic Defence and Space Company (EADS) has just won a $35 billion contract to supply the US military with tanker planes and when the sovereign wealth funds are in discussion with the International Monetary Fund to become more transparent. Let's hope it is just electioneering bluster and not the distant thunder of war.