With uncertainty stemming from Brexit and US-China relations, Chinese investors need a geostrategy

Date: 13 Nov 2018

8 November 2018, Beijing — EY today released Geopolitical update: Brexit and US-China relations, which explores how Brexit and the increasing complexity of US-China relations is affecting Chinese enterprises’ overseas investments. Investors from China should pay close attention to the latest policy developments and develop a geostrategy to manage the risks and identify the opportunities amid this growing uncertainty.

Jon Shames, EY Global Geostrategic Business Group Leader, said: “While the world has moved into a new and unsettling geopolitical phase, Chinese businesses and investors cannot focus purely on risk mitigation. Change produces opportunities, and moving forward on value creation — with strategies and processes that factor in risks and create contingencies — is vital.”

Investors weigh challenges, opportunities posted by Brexit

Despite Brexit uncertainty and a decline in the UK’s relative attractiveness as an FDI destination in Europe, Chinese investors have continued to invest in Europe. This suggests that Chinese investors are seeking long-term opportunities with the expectation that they can manage or capitalize on near-term risks. However, it is harder to predict the long-term effects of Brexit. The EY report suggests that investors and businesses plan for a range of scenarios:

  • Moderate disruption — A partial agreement between the UK and EU on certain terms could make goods crossing borders subject to enhanced inspections and nontariff barriers, affecting supply chains and business planning. A limited agreement would likely have little or no coverage for trade in services, disrupting the services sector by leaving it without ready access to European markets. 
  • Severe disruption — If the UK and EU can’t reach an agreement, tariffs could be levied on goods exported to the EU and a wide array of nontariff barriers could be established, significantly affecting the manufacturing and services sectors.
  • Limited disruption — The most likely scenario would be a failure by the UK and EU to reach a comprehensive Brexit agreement. But London and Brussels have signaled their willingness to defer significant changes for about two years if interim terms can be agreed on. While this would reduce the near-term potential for business dislocation, it would prolong the period of ambiguity, driving up the cost of doing business in the UK.

Businesses and investors should expect Brexit to take 7 to 10 years to unfold, which makes a wait-and-see approach not feasible for most investors. The UK will have to negotiate new bilateral agreements with numerous other countries, which could take years. But trade and investment with emerging markets, including China, could become relatively more attractive. 

Rising inflation, currency depreciation, higher business costs, a lack of real wage growth, and weak consumer and business sentiment could emerge as serious impact to Britain’s economic vitality. Nonetheless, warnings about the slump of London as a global and regional business hub appear to be exaggerated, given the region’s enduring talent, infrastructure, language and business culture advantages. London has distinguished itself as a global hub for education, creativity, and innovation and this is unlikely to change in any scenario.

Greater scrutiny in the US over foreign investment amid trade dispute

Loletta Chow, EY Global China Overseas Investment Network (COIN) Leader, said: “The US is among the hottest destinations for Chinese outbound investment. For the current Sino-US trade dispute, many experts believe that the longer it lasts, the greater its impact on both China and the US. Moreover, the US has recently announced new foreign investment restrictions designed to protect itself against national security threats, adding further uncertainty and concerns for Chinese investors.”

Policy initiatives by President Donald Trump’s administration in 2017 and 2018 to spur growth, cut business taxes and reduce regulation have made the US even more attractive to global investors, with Chinese FDI into the US in 2017 totaling almost US$30b — up from nearly zero in 2009. Meanwhile, uncertainty in US-China relations has increased significantly in recent years. In addition to the ongoing trade dispute, investment from China is now subject to greater scrutiny. Therefore, as Chinese investors develop their strategies for 2019, they should pay close attention to several near-term issues that will shape the FDI landscape:

  • Domestic economic potential — The US economy is enjoying one of its longest economic growth cycles in modern history, and the trajectory has shifted upward in 2018. However, risks to watch out for in 2019 are increasing labor costs and shortages, tariffs and supply chain disruptions, and rising energy prices. Interest rates in the US are projected to continue rising, which will put upward pressure on the dollar and affect asset prices, competitiveness and growth potential. Also, economists expect the stimulative effects of the tax cut to start dissipating by 2020.
  • Political leadership — The election of Mr. Trump was a significant departure from the American political norm. His administration has pushed the US in many new policy directions regarding taxation and regulation, trade and international affairs, including US-China relations. Investors likely will have to navigate more political volatility, uncertainty and complexity in 2019. Topics of interest to Chinese investors, such as the issuance of EB-6 visas, could be affected by domestic political debates, and the next US general election in 2020 could lead to another shift in US economic and security policy.
  • CFIUS review — The Committee on Foreign Investment in the US (CFIUS) is a federal government body that reviews the national security implications of FDI in US-based companies. Scrutiny of investments from China has expanded significantly over the past seven years, and this looks likely to increase as the Trump administration has signaled its intent to use the CFIUS process to screen Chinese FDI more closely as a countermeasure to FDI restrictions in China.
  • FIRRMA rollout — The Foreign Investment Risk Review and Modernization Act (FIRRMA) of 2018 significantly expanded the legal basis for CFIUS review. Greater scrutiny will be given to transactions involving real estate in locations deemed sensitive, companies with “material nonpublic technical information” and “investment structures designed to circumvent CFIUS jurisdiction.” The new rules should start being implemented in 2019.
  • Political risks — CFIUS review is a formal process that is specified by federal laws and regulations and, in principle, should be fact-based, rules-driven and predictable. But it is also subject to many external, subjective and less-predictable political forces.

Geopolitics is a key issue for Chinese outbound investors and overseas operations. To effectively identify and manage geopolitical risks, business leaders and investors should develop a robust geostrategy.  An effective geostrategy must assess precisely how geopolitics might compromise corporate performance and investment outcomes and should include measures to mitigate risk and seize opportunity.  Investors should carry out systematic, in-depth reviews and evaluations of the local political, legal and social environment in the initial stage of overseas investment projects and monitor the environment throughout their investment horizon.

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