German protectionism

(This article is taken from Private Equity Europe, the pan-European publication from the publishers of unquote")

In the spirit of the infamous locust debate that dominated public opinion in 2005/6 and fuelled by the often-voiced fear that Germany is being sold to foreigners, the Federal Government has recently passed amendments to its foreign trade and payments legislation. The new measures enable the Government to prohibit the purchase of German companies by entities outside of the EU or the EFTA (European Free Trade Association) to safeguard Germany's 'public order or public security'.

The moves have brought criticism from many within the advisory community, who have condemned the amendments for their protectionist spirit (an embarrassing accusation given the Government's anti-protectionist rhetoric in recent months). Moreover, the changes have been slated on technical grounds, with one leading lawyer calling it a 'shoddy piece of work'.

Breadth not depth
The new provisions are broadly perceived to be largely levelled against certain Sovereign Wealth Funds, with one industry source suggesting that Russian funds were specifically being targeted following the recent turmoil that was caused when Russia shut off its gas supply to Europe. With EON and Vattenfall's energy networks due to come up for sale, the German government to thought to be creating a legal basis on which to intervene.

However, some are warning that private equity funds may become targets as well. While the management companies of private equity funds are usually domiciled within the EU or EFTA, they have historically gone to great lengths to make clear that they are separate entities from funds domiciled in off-shore locations. Legislators may therefore claim that an investment made via a vehicle domiciled for example in the Cayman Islands is just such an entity that the amendment applies to.

And the new law is also troublesome in its definition of what constitutes a German company. "The law would also apply to a company that is not headquartered in Germany per se, but has 'substantial holdings' in Germany - such as regional headquarters," Peter Memminger of Milbank, Tweed Hadley & McCloy explains.

Advisers are therefore warning private equity buyers not to assume that a transaction will not be subject to the new amendments, as they are imprecise and the political situation could potentially shift to greater protectionism in the future. "We warn our clients against assuming that the law will not apply to their transaction, because the way it is phrased that assurance is simply not there," Memminger comments.

Indeed, the focus on 'public order and security' could theoretically be applied far beyond business engaged in basic supplies, the arms industry, and telecommunications - for which it was originally envisioned. Any company that delivers a crucial service for any of these could be subject to the law, as well as those in the infrastructure sector or core industries such as cement or steel.

In fact, concerns have been raised that any sufficiently large company that might be the dominant employer in a region (such as a large automotive company or a shipbuilder) could be seen as a crucial asset for public order and safety.

Red tape
Under the new law, a transaction is examined by the BaFin, which requires a three month assessment period and an additional two months decision period. The main result of the amendments, therefore, seems to be an increase in bureaucracy in a country seen as already overly bureaucratic - an ironic move given the Grand Coalition's stated aim of attracting foreign capital, a pledge that now looks like lip service at best.

However, according to Dörte Höppner of German private equity trade body BVK things could have been worse. Indeed, the first draft of the legislation gave the Government the power to retroactively prevent transactions from going through and contained no provision for protecting investors involved in a sales process. "We have now established the possibility for receiving pre-emptive clearance by the Ministry of Economics that will not impact negatively on the bidding process and gives our members greater legal security."

But despite these undoubtedly positive amendments, and while regulation is bound to lag significantly behind market developments, the measures remain contentious - appearing anachronistic at best and harmful at worst. Now that the economy is suffering from illiquidity on all levels, any protectionist measures that further damn up capital and present a disincentive to foreign investment are clearly counter-productive.

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• UK / Ireland