April 18, 2022

The impacts of HFCAA on M&A: When the eagle and the dragon got divorced

The economic marriage of the West and East is on the rocks. China and the US have seen decades of – if not exactly marital bliss – then certainly mutual cooperation. Investments have flowed both ways, with Chinese firms often opting to raise capital on US stock exchanges, and US companies expanding for instance into Shanghai or Beijing.

But in recent years a political chill has been pushing these two economic giants into – metaphorically speaking – separate bedrooms. This frost has translated into policy, with potential implications for M&A practitioners.

The Holding Foreign Companies Accountable Act (HFCAA) was signed into law in December 2020. A year later, the Securities and Exchange Commission (SEC) finalized the rules. In short, the law gives the SEC powers to prohibit trading of public companies that do not submit to an audit inspection by the Public Company Accounting Oversight Board (PCAOB).

The law requires the SEC to identify public companies that have filed an annual report audited by an overseas accounting firm that is out of reach of a PCAOB inspection. China prohibits companies listed on foreign exchanges from sharing this information – putting its US-listed companies firmly in the firing line.

If a company is designated under HFCAA, it must then prove it is not owned or controlled by a government entity in the accounting firm’s overseas jurisdiction. Trading prohibition occurs when a company is flagged under the HFCAA for three consecutive years.

Who gets the kids? The fallout for dealmakers

Although the new rules focus in on listings, there could be a variety of knock-on effects for M&A professionals. The increasingly hostile environment for Chinese firms in the US could cause some buyer’s remorse for firms that splashed out in the past wave of Chinese acquisitions. If a welcoming environment becomes unwelcoming, spin-offs look more attractive. For example, a Chinese steelmaker that purchased a downstream processor in the US may no longer feel like sinking capital into this subsidiary, and start eyeing up the exit.

If US assets get caught in the new HFCAA net, then it greatly shortens the odds of Chinese companies spinning them off. If the SEC has raised official doubts about a company’s suitability to be US-listed, what does the future hold for its assets there? It’s likely that some Chinese firms will not wait to find out, and will cash out while the sun shines.

Only five Chinese companies – BeiGene, Yum China Holdings, Zai Lab, ACM Research and HUTCHMED – have so far been identified by the SEC under HFCAA. The ability to predict which other Chinese companies could fall under the spotlight of the legislation could provide an early indicator of disposal activity.

The prospect of the Chinese acquisition wave reversing gear in the US, and disposals coming more to the fore, raises the question of where potential buyers may come from. The explosion in popularity of Special Purpose Acquisition Companies (SPACs) means these deal-hungry investment vehicles are waiting in the wings in the US with roughly USD 160bn of dry powder. Private equity firms also remain hungry for deals, so will no doubt be monitoring any Chinese flight for potential opportunities.

It also goes without saying that the days are numbered for inbound buying activity from Chinese firms. Dealmakers that have benefited from Chinese expansion into the US are unlikely to see that business survive unless there is a significant change in the political environment. There are already signs that other parts of the world, such as Europe and Asia-Pacific, are the new focus for Chinese corporate expansion. Chinese firms remain hungry for overseas assets, so will direct their spending power towards other, more welcoming countries.

Bridge over troubled waters

For prospective buyers of Chinese assets, there are some innovative tools available to smooth the process. One is Datasite Acquire, which hands control of the data room to the buy side. The ability to tailor the level and style of interaction with a seller means a seamless and secure process is guaranteed. It also has an assigned views feature that helps filter content for specific roles, which can assist a buyer in preventing accidental data breaches.

Chinese companies looking to offload assets to traditional buyers or SPACS could take advantage of Datasite Outreach. This capability lets sellers market a deal to hundreds of potential buyers simultaneously with minimal effort. The seller can then filter the pool of potential acquirers for suitable candidates and conduct due diligence on past deal activity.

Then there is Datasite Diligence, a secure data room that does exactly what it says on the pack. A highlight here is the optical character recognition (OCR) search that allows quick discovery of any red flags, even in scans of hard-copy documents, so is invaluable for assessing assets being offloaded by companies with previous regulatory risk.

All these capabilities are designed to work in harmony. For example, if a deal marketed through Outreach is ready for execution, it can move forward seamlessly into Diligence.

So, despite the souring of economic relations between China and the US, there are opportunities for the more agile dealmakers to pick up the pieces – and hopefully form new, more stable alliances.

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