DealMakers - Q1 2022 (released May 2022)
Proposed national security considerations may complicate foreign investments into South Africa
by Ziyanda Ntshona, Burton Phillips and Lwazi Mthembu
Over the last few years, amendments to the Competition Act which introduce national security considerations for foreign acquisitions have been pending enactment. Although there is no exact indication of when these amendments will come into effect, we are likely to see some movement on this front in 2022.
South Africa receives the largest amount of foreign direct investment (FDI) on the continent, followed by Morocco and Nigeria. Although South Africa saw a decline on FDI in 2020 (in line with the decline of FDI in the broader continent), there was an uptick in 2021, led by the financial services, technology, online retail and healthcare industries. The increase is likely to be sustained in 2022, with additional potential opportunities in renewable energy, agriculture and education sectors.
In line with the growing global trend towards protectionism, South Africa plans to introduce the long-awaited national security provisions by way of amendment to the Competition Act (in terms of section 18A) (FDI Amendments). Although the exact timing remains unclear, there is an expectation that these amendments could be enacted in 2022, and that they will result in FDI mergers facing an additional regulatory hurdle. Here is what FDI investors will need to know…
At a high level, the FDI Amendments introduce a mandatory regime which will consider FDI mergers from a national security perspective. The national security interests will be considered by a committee to be established by the President of South Africa (President), comprising cabinet members and other public officials. The mandate of the committee will be to determine whether the implementation of a merger involving a foreign acquiring firm may have an adverse effect on the national security interests of South Africa. Due to its mandate, the committee is likely to include the Ministers of Defence; Health; Agriculture and Land Reform; and Trade, Industry and Competition. The committee will be empowered to prohibit or impose conditions on mergers which may have an adverse effect on South Africa’s identified national security interests.
Although the FDI Amendments will involve an additional review process for FDI mergers, they do not expand the scope or nature of FDI mergers to be scrutinised, as the committee will only consider those mergers that meet the same thresholds already applicable under the Competition Act. Therefore, the committee will only have jurisdiction to assess a merger if the acquiring firm is a foreign entity, the merger relates to one or more national security interests, and satisfies the applicable financial thresholds for notifiable mergers. Applications for FDI approvals will need to be filed at the same time as applications for competition approvals, and are likely to follow a similar timeframe (currently, the proposed review period for the committee is 60 business days – which is the same as the maximum review period for an intermediate merger). However, considering that the anticipated members of the committee are officials in other capacities, there is a concern around their capacity to reach decisions timeously.
National security and public interest considerations
The list of national security interests to be considered by the committee is yet to be published. However, the draft FDI Amendments list several factors that the President must consider in determining national security interests. These include South Africa's defence capabilities and interests, the use of sensitive technology or know-how outside South Africa, the security of infrastructure, and the supply of critical goods and services. The President must also publish a list of the markets, industries, goods and services or regions in respect of which mergers involving foreign acquiring firms would require the approval of the committee.
As part of their substantive assessment of mergers, the South African competition authorities are already required to assess the impact of mergers on certain public interest factors. This involves an assessment of the effect a merger may have on (i) a particular industry or region, (ii) employment, (iii) the ability of small/black owned firms to compete, (iv) the ability of national industries to compete internationally, and (v) the promotion of a greater spread of ownership, in particular to increase the levels of ownership by historically disadvantaged persons (HDP) and/or workers.
Given the nature of the interests to be considered by the committee when assessing FDI mergers, there are likely to be overlaps with respect to the public interest factors currently considered by the competition authorities. A merger may be prohibited on public interest grounds, even if it does not have an anti-competitive effect in the relevant market. This has the impact of propelling the importance of public interest considerations in FDI mergers.
Transparency and accountability
The decisions of the committee may have serious consequences for FDI mergers across the board, as the FDI Amendments prohibit the South African competition authorities from approving a merger that has been prohibited by the committee.
It would, therefore, be important for parties to have an avenue of recourse against decisions made by the committee. However, the provisions relating to the committee are brief, and do not include any provisions that deal with the accountability of the committee. The only requirement is for the Minister of Trade, Industry and Competition to publish the committee's decisions in the Government Gazette and inform the National Assembly of the decision (in appropriate detail, although not necessarily the committee's reasons).
Notably, the FDI Amendments in their current proposed form also do not provide a dispute resolution mechanism. Arguably, a foreign investor could use the South African Promotion and Protection of Investments Act, which provides for a dispute resolution mechanism for foreign investors (essentially entailing international arbitration). This process could be used to challenge decisions of the committee (although this approach is yet to be tested). Unlike the South African competition authorities, the committee is not an independent body. The broad nature of the factors to be considered by the committee also leaves room for interpretation and disputes. Greater clarity in the drafting and accountability in decision making is critical if South Africa hopes to remain an attractive destination for FDI. In 2020, Nigeria passed investor friendly legislation and experienced an uptick in FDI deal activities, especially in the technology, financial technology, automotive and construction industries. As a continent, we need to ensure an investor friendly regulatory environment if we are to retain the continent's already low share of FDI (at just 4% on a global scale), and even more so to attract greater FDI and increase the investor base beyond developmental financial institutions.
Considerations for merger parties
Public interest has been considered by many jurisdictions in the merger application process, including the United Kingdom, Russia and India and, therefore, should not be a foreign concept to FDI investors. While a global trend, the national security provisions will add another layer of regulation that an investor must contend with and creates a level of uncertainty across a large number of FDI mergers. In the current climate of stringent merger control regulation in South Africa, and even more so when the national security provisions come into effect, merger parties have to carefully assess the potential impact of transactions on public interest (e.g. employment, dilutions in HDP ownership), as well as the potential national security concerns. Depending on the nature of transactions and timing, merger parties may want to deal with these issues upfront as part of their application for merger approval. In global transactions with timing sensitivities, the South African competition authorities could also be consulted on whether ring-fencing arrangements are possible. Such arrangements are not specifically provided for and are generally considered by the competition authorities on a case-by-case basis.
It would also be prudent to anticipate the nature of conditions that may be imposed from a public interest (and going forward, national security) perspective, so that they are priced into transactions, and the economic rationale for transactions is assessed. As has been seen in recent merger approvals, the competition authorities often seek to impose conditions in pursuance of its public interest mandate. Conditions range from establishing employee ownership schemes, introducing HDP shareholders, to undertakings relating to local procurement and/or supply. In some transactions, it may even be preferable to negotiate conditions upfront, rather than to seek approval without conditions, particularly in transactions where onerous conditions are likely to be imposed. Although the right time to engage with the competition authorities depends on the circumstances of each case, parties may want to consider the possibility of more formal, proactive engagements early in the process. The South African competition authorities are generally receptive to such engagements with parties.
Ntshona and Phillips are Partners and Mthembu a Trainee Attorney | Webber Wentzel.