CFIUS overhaul seen impacting investment practices by non-US LPs

The US government’s review of foreign investment practices risks hurting non-US LPs backing US funds, according to legal experts.

Committees in the House of Representatives and the Senate recently approved in a unanimous vote a bill which would overhaul the scope of the Committee on Foreign Investment in the United States (CFIUS), potentially dragging a greater number of private equity firms and transactions into CFIUS’s spotlight. The primary target of the reform is believed to be China, which Donald Trump and other administration officials have accused of stealing intellectual property from US companies.

“Private equity funds with non-US limited partners should be aware of Chinese exposure, and foreign government exposure more generally,” law firm Dechert said in a note drafted by partner Jeremy Zucker and associates Darshak Dholakia and Eric Auslander.

While Chinese capital is likely to come in for the greatest scrutiny, Dechert said that all non-US LPs may face enhanced examination. “A fund’s non-US LPs should expect additional CFIUS scrutiny during reviews/investigations.”

The firm said that in anticipation of potential scrutiny, “US funds may begin to restrict participation of non-US LPs on the basis of whether aspiring non-US investors are from ‘special concern’ jurisdictions and/or are subject to home country government ownership or control.”

In a separate note, law firm Paul Weiss said that if the reform passes as currently drafted “we would expect that private equity firms would have to carefully examine both the use of offshore funds and the level and nature of foreign LP ownership in a broader range of investments in U.S. companies than is currently the case (including investments that are clearly noncontrolling).”

Dechert said that the greater scrutiny applied to non-US investors could see investee companies choose to take investment from funds which would pose the least risk of being flagged for review. “The potential for CFIUS review to inject uncertainty into investments could also impact the participation of funds with non-US LPs in competitive auctions. In such a situation, a purely US investor could find itself a preferred partner compared to a non-US investor, and a private equity fund with certain non-US LPs might be preferred to one with different non-US LPs.”

The firm also said the new powers of CFIUS may cause US GPs to sideline non-US investors for fear of deals stalling. “Even if non-US investors show a continued willingness to invest, US funds may be less willing to accept capital from non-US investors – or at least some non-US investors – because of the uncertainty a thorough CFIUS review poses to a transaction.”

While China is the prime target, Dechert pointed out that deals for US companies from potential buyers based in Canada, the UK, France and Japan have also come under scrutiny in recent years.

The reform would also change the CFIUS regime from a voluntary system to one where declarations would be mandatory in certain circumstances.

In March President Trump signaled the US’s more interventionist approach on foreign investment by blocking semiconductor Broadcom’s takeover of rival Qualcomm, citing national security concerns.