MCC: The robustness of the China transactional market has got to be good news for your Hong Kong office.
Puff: Yes, but it’s not without its volatility. The business climate so far this year has been affected by uncertainty in the market, particularly the stock market. In both Shanghai and Hong Kong, the swings of enthusiasm and optimism have been tempered by pessimism relating to days when the stock market fell considerably, as it did on July 27. So it’s been a bit of a rollercoaster, and I anticipate the second half of 2015 looking somewhat like the first half – some significant uncertainty as to the market and mood swings based on how the stock exchanges are trading.
MCC: It sounds like there are some similarities with the U.S. market in terms of the ups and downs. Would you expand on some of the dynamics?
Puff: To some extent, the stock market in Hong Kong is affected by the stock market in China, and both are strongly influenced by government policy. Government reports, policy and comments from senior leadership in mainland China not only have the potential to affect that market significantly but, given the importance of Stock Connect between Hong Kong and China, also have a knock-on impact in Hong Kong.
Generally speaking though, the Hong Kong market itself, and here I’m referring to the IPO market and the capital markets critical to M&A activity, and the business climate in general have been positive in 2015. Hong Kong has shaken off the effect of the protests that occurred in late 2014 and early 2015. The political situation, at least in the business community, has quieted considerably from where it was. I would characterize the mood in Hong Kong as one of cautious optimism.
Savio: In my area of international trade, I would add that trade sanctions also play a factor in influencing market activity and presenting or limiting opportunities for our clients. Most recently, we’ve seen pretty profound activity with respect to the Iran nuclear deal. The promise of some significant sanctions relief from the UN and the EU – and, albeit more limited, relief on the part of the U.S. government – has companies weighing the potential benefits of that market against the risks of engagement at this time. We’re seeing the same with respect to Cuba, in the wake of the sanctions relief by the U.S. in late 2014 and early 2015. Sanctions have also been a factor in trade with Russia. Even though the core sanctions imposed against Russia occurred in 2014, companies are still trying to understand what’s required of them under the U.S. and EU sanction regimes, respectively. All of those sanctions programs, with their various complexities, intricacies and unknown futures with respect to foreign policy, breed uncertainties among our clients in terms of their trading and investment relationships.
Moreover, China’s been very active with respect to the passage of a variety of laws relating to national security and foreign investment. While some are pending in draft form, others have passed, and global companies have expressed concern with respect to their potential impact. With the next round of bilateral investment trade negotiations between the United States and China in September, there’s some cautious optimism that China will use that forum to reassure the United States that it will continue to be a country that is receptive to foreign investment.
MCC: Has the rapid growth of China’s regulatory infrastructure made it easier to do business in Hong Kong and China or more difficult?
Puff: From a corporate point of view, every time a government adds a regulation, the business climate gets marginally more difficult, and that’s no different in China and Hong Kong. For example, Hong Kong is in the process of adopting a new anti-monopoly-type law that will come into effect in December and is certain to have some impact on business in Hong Kong, although exactly how much is pretty hard to say at this point.
Other potentially significant changes in China are the Shanghai Free Trade Zone, which has made it measurably easier for companies incorporated there to do both inbound and outbound M&A transactions, and the pending Foreign Investment Law, although the latter’s potential impact on the business climate is hard to gauge, as it is still in draft form. It’s safe to say that when new regulations come into play, they will have an impact on a business’s ability to easily navigate transactions. And, certainly, we lawyers tend to get busy when this happens.
Savio: Regarding the foreign investment law Greg touched on, that’s something I’m following closely. One the one hand, AmCham China, the U.S. Chamber of Commerce and many foreign companies have cautiously welcomed the draft law, which would replace a framework of disparate laws currently governing foreign investment, market access and the national security review process, and potentially open up certain sectors of China’s economy and bring more transparency and predictability to the investment process. On the other hand, the breadth of the national security review power has raised concerns about China’s potential to block foreign investment for reasons that do not approximate traditional definitions of national security.
China is also currently engaged in a very stringent and sweeping anticorruption crackdown that has companies – even those that have been largely unnoticed and commendably focused on compliance programs – revisiting those programs to avoid running afoul of these laws. All of these activities require resources.
Many of the laws that I deal with in my regulatory practice – the anticorruption laws, the sanctions laws, the export control laws – are extraterritorial in nature. Companies doing business in China may be subject to such laws while oftentimes also remaining subject to laws of the country in which they are based. Grappling with multiple jurisdictions and intersecting laws that are similar in substance and focus but not identical creates difficulties for companies across the board.
MCC: Akin Gump seems especially well positioned to meet these challenges given your mix of international trade, M&A, investment funds and regulatory compliance practices.
Puff: Very true. The strength of these practice areas is keeping the Hong Kong office busy. Our investment funds practice has been incredibly active this year, sometimes on fundraising but oftentimes on the regulatory compliance-type issues we’ve been talking about. Meanwhile, the general corporate environment in Hong Kong has been steady, which has been good for our M&A lawyers.
We’ve also been busy working on restructuring matters, an active business area not just in Hong Kong but for the firm overall, which has led to our hiring a number of restructuring lawyers in both Europe and Asia over the past nine months. Looking ahead to the rest of 2015 and even into 2016, I suspect that, regrettably for the companies affected, it will continue to be a component of our practice that, on any given day, may be keeping the Hong Kong office busier than they are with other types of matters.
MCC: Are you referring to restructurings of U.S. (or other non-Chinese) companies doing business in China, or of Chinese companies? Or both?
Puff: Both, but it’s more likely to be an Asia-based company going through an out-of-court “bankruptcy-type” restructuring, which is the more conventional way of dealing with things in Asia, rather than through a bankruptcy court filing. The troubled company might be in China, Indonesia, Korea, Japan or almost anywhere in Asia.
While no one at Akin Gump hopes for company failures, our restructuring practice is a countercyclical practice that flourishes in challenging economic times and tightened credit markets. Restructuring is inevitably a tough pill to swallow for the troubled company, but it is likely to continue to be an area that presents business opportunities for us.
MCC: Can you talk about some of the challenges of running an office in Hong Kong as opposed to in the U.S. or even the UK?
Puff: Number one, obviously, is that Hong Kong is a long way from New York City, where our chairperson sits. It’s a long distance across a lot of time zones, which makes it difficult to spend time with people in person or one-on-one the way you might if you were based in the U.S. or in a country that’s not so far away. There are also cultural aspects to doing business in Hong Kong that can be a challenge for those from outside the region.
But to me, the differences are not the story. The real story is how easy it’s been doing business in Hong Kong given these challenges, which is due in large part to the way Akin Gump is organized, structured and managed. I don’t lose as much sleep as you might imagine.
MCC: I understand there’s a lot of activity in the going-private area.
Puff: I think somewhere around 15 such deals were announced in the last two months. Some of that was driven by the heated market activity and the thought that coming off a U.S. exchange and relisting would be easier to do in China than it was two or three years ago. So while the special legal challenges of going private, such as the need to form a special committee, go through a committee process, file with the SEC, get shareholders to vote in favor of the transaction, etc., have not changed, the sheer volume of such transactions has been a challenge. On the other hand, the going-private path is pretty well worn at this point for Chinese companies as well as non-Chinese companies operating in China and listed in the U.S. We now have many precedents, so getting deals done is a lot easier.
MCC: What about the respite period – the easing up on government scrutiny that allows a newly private company to regroup? Has that worked out as intended?
Puff: The so-called respite period came about more by accident than design. If a company wants to delist from the U.S. but still thinks it has a business model that investors will like, its challenge is finding the stock exchange where those investors are most likely to trade its shares and give the business model and company the valuation they deserve. The respite period provides the time needed to both accomplish the corporate restructuring needed to list in Shanghai, Hong Kong or Singapore and then to market the shares.
MCC: What part have state-owned enterprises (SOEs) played in driving M&A transactions, both domestic and outbound?
Puff: While the SOE investment activity may seem more active on the outbound side, that may be because outbound activity is more widely covered by the press in the West. But there is still a fair amount of internal – internal to China anyway – corporate activity, and the empirical data suggests that it’s actually more active than someone on the foreign advisor side of M&A transactions might think.
M&A activity in 2015, and maybe also in 2014, feels slower than it was in 2012 and 2013. It’s less speculative in nature and more of a common-sense corporate activity that involves the SOE identifying sensible businesses or assets to purchase and the jurisdictions where they can be best utilized. There are a lot less of the “SOE buying mineral resources in Australia purely as an investment” type of transactions.
There’s also a trend of SOEs building platforms as a springboard for outbound activity, particularly in the banking industry, where you see important platforms in Hong Kong but also elsewhere. There’s also a lot of Chinese investment activity in Africa for example, where the Chinese think they are best situated to address market opportunities.
MCC: Where do you see the most investor interest in the last quarter of 2015 and looking to 2016?
Puff: I definitely think technology, media and telecommunications (TMT) will continue to be hot, particularly Internet and e-commerce. To my eye as a non-Chinese person, China seems to be extremely entrepreneurial, with a huge number of young, interested, well-educated engineers, programmers and e-commerce entrepreneurs. While most aren’t going to be the next Alibaba, there are a million minor examples of people with ideas they’re trying to get to the market. The action in Internet and e-commerce ranges from granular and micro in terms of dollar amount to mega companies, like JD.com, Tencent, Alibaba, Baidu and Sina.
Healthcare is also an interesting and active area in China. Like everywhere else, it’s heavily regulated and, as such, comes with its own set of challenges if you’re a foreign entrant into that market. Another sector that’s always on investors’ radar is real estate, in part because you’re always seeing real estate prices rise rapidly or fall rapidly, either of which will spur trading activity. The financial services sector, including investment banking, insurance, specialty lending and other nonbank financial services, will continue to be the steady business it has been. But none of these will approach TMT in terms of activity.
MCC: IPOs seem to have been in the doldrums, at least compared to previous years, with many companies going the back-door-listings route. Is that your sense? How are investors responding?
Puff: The IPO market tends to follow the stock market. As the stock market goes up, interest in getting one’s shares to market goes up. As it heads down, interest wanes. It’s an area requiring common sense and a knack for market timing. Are you ready at the right time? Have the underwriters you’re working with been able to build a book? It’s harder during times of huge volatility because offerors are either waiting for the market to peak or investors are waiting for the market to hit bottom before signing on to an offering. So if there’s a lot of volatility in the market, as has been the case this year, it’s very, very difficult for the underwriters to do their job, which has an impact on IPO activity. As a result, I think there’s a pent-up demand to get some of these companies to market and get capital in.
MCC: For the second year in a row, Chinese companies filed more notices with the Committee on Foreign Investment in the United States (CFIUS or the “Committee”) than companies from any other foreign country. Are the Chinese getting more comfortable with CFIUS following big deals such as the acquisition of U.S. pork producer Smithfield? What do investors need to know about CFIUS and similar reforms?
Savio: We’ve talked about foreign investment in China, but it’s important not to overlook its corollary – outbound investments from China to the United States, which are increasing and may be subject to CFIUS review. While submitting to CFIUS review is a voluntary process, the Committee has discretion to assert jurisdiction over any transaction in which a foreign person could assume control of a U.S. business. The fact that Chinese investors in increasing numbers are availing themselves of the process speaks to the increasing sophistication of the Chinese business and investor community, as well as their recognition of the need to undergo this review process in order to preempt U.S. government interest in the transaction subsequent to closing.
Chinese investors have become increasingly savvy in considering the CFIUS process in their transaction planning. Even in the preliminary phases, they are thinking about ways in which the U.S. government might perceive a particular investment and evaluating targets in terms of whether they are in sensitive sectors of the U.S. economy. They are also looking at ways to mitigate U.S. government concerns regarding certain elements of the transaction that could invoke scrutiny, such as by appointing a certain number of U.S. persons to the company’s board or spinning off parts of the company that have significant U.S. government contracts or that deal with sensitive technologies.
Chinese investors who are serious about the U.S. market recognize the importance of this national security review process, and there will be a continued focus on CFIUS in transaction planning well into the next year. Notably, the Chinese government has echoed in its draft Foreign Investment Law elements of CFIUS, such as the wide discretion to determine national security risk, the joint committee that will be formed to evaluate such transactions, and so on.
MCC: Despite the extra work, CFIUS review sounds like a win-win in that it gives the parties to a transaction the comfort of knowing that what they’re doing is not going to get them into trouble.
Savio: On the one hand, having a defined process – one that lays out the jurisdiction of a reviewing committee to both determine conditions that present a national security risk and define the protocols by which a review would take place – creates transparency and some predictability. On the other hand, things get a bit sensitive with respect to the implementation of such laws. For example, the Chinese government has been critical about how the CFIUS process has played out for Chinese investors, alleging that there has been a higher level of scrutiny in particular industries, such as technology.
The CFIUS process has also come under fire for lack of transparency. The process is confidential, which has led to criticisms that such determinations should not be taking place behind closed doors and that, at the very least, the committee’s concerns should be fully visible to those undergoing the process. Supporting this argument is last year’s Ralls Corp. decision, in which the D.C. Circuit Court of Appeals held that, at least in some instances, the U.S. government must provide access to some of the evidence relied upon by CFIUS.
MCC: Can you talk about China’s anticorruption laws and what a company operating or investing there can do to ensure compliance.
Savio: The most important thing is to have a compliance framework and infrastructure that clearly sets forth the management’s commitment to fully comply with these laws, including not just anticorruption but also sanctions, anti-money laundering and other trade control regimes, and to allocate the resources needed to implement the compliance program. Companies that are investing in China or thinking of relocating or setting up operations in China also need to recognize that Chinese anticorruption law is more expansive than the FCPA in that it prohibits commercial bribery as well as bribery of foreign government officials, so your compliance program must address its broader sweep. Also, the Chinese anticorruption regime, unlike that of the U.S., penalizes the recipients of bribes as well as the givers of bribes – another control point that needs to be worked into compliance planning. Another distinction worth noting is that while the FCPA allows for facilitation payments, the Chinese regime does not.
MCC: How can companies protect their investments in China and ensure that the returns they seek are not eaten up by penalties and legal fees?
Savio: Upfront due diligence is critical to transaction planning, as is understanding how you will manage your investments on a going-forward basis. It’s important to understand what you’re getting into, be it an investment or acquisition. You need to understand the target’s compliance program and compliance culture, and whether (and, then, how) the compliance program on the books translates at the working level. You also need to address any issues prior to closing or soon thereafter. Recognizing any compliance gaps and instituting measures to ensure that you don’t have a problem later down the line is critical to risk assessment and mitigation.
MCC: Why Akin Gump?
Savio: I relocated to Hong Kong about three months ago after spending nine years in our D.C. office. My move is a testament to the firm’s commitment to client service and being a global player. While the majority of our international trade group is in D.C., we have attorneys in Abu Dhabi, Dubai, London, Singapore and now, Hong Kong. This reflects our commitment to being in our clients’ time zones. A company dealing with an impending investigation needs to be able to pick up a phone and talk to outside counsel immediately. And I need to be able to quickly get onsite to figure out what has happened, take remedial actions and start developing appropriate procedures and policies to ensure that such issues don’t come up again.
Puff: I would add that we have 22 offices globally. While we aren’t all things to all people in all offices, we’ve created standout practices in every office, whether it’s in the U.S., Europe or Asia. Addressing client needs requires access to lawyers and others in the firm who aren’t afraid to practice in a far-flung jurisdiction and field a lot of questions that don’t fit neatly into one category or another. We’re fortunate in having brought together people who excel at such challenges.
Published September 2, 2015.