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Chinese Direct Investment in the U.S. - The Challenges Ahead

Chinese FDI in the United States is estimated at US$5-7 billion through end of 2009.

Location USA 2010
Outward foreign direct investment (OFDI) from China is on the rise, and substantially so. In January 2010, China's Ministry of Commerce (MOFCOM) reported that Chinese companies invested a record US$43.3 billion overseas in 2009, up 6.5 percent over 2008.1 Of China's cumulative OFDI of roughly US$227 billion from 1979 through the end of 2009, 75 percent (US$170 billion) has been invested since 2001, with 19 percent invested in 2009 alone. China's strong performance in 2009 is even more remarkable given the 39 percent overall decline in global FDI flows in 2009, largely attributable to the global economic crisis.
As the global slowdown unfolded, Chinese authorities also responded quickly to ensure that momentum was not lost. In March 2009, China's Ministry of Commerce (MOFCOM) announced that as of May 1, approval authority for most overseas investments under US$100 million would reside with provincial-level officials. Effective August 1, China's State Administration of Foreign Exchange (SAFE) liberalized rules governing the source of foreign exchange for making overseas investments and eliminated the requirement for prior examination and approval of these funds. In September 2009, the State Council, China's highest executive body, issued guidance to encourage more small and medium-size enterprises (SMEs) to expand overseas. In addition to accelerating OFDI in the years ahead, these measures may also prove critical in coaxing more of China's dynamic private sector to venture abroad, largely the realm of China's large state-owned enterprises (SOEs) in past years.2
So far, Chinese investments in the developed economies of North America, Europe, and Japan represent a small percentage of the total. For a variety of reasons - not the least of which is the use of offshore holding companies - official estimates of Chinese FDI in the United States are hard to come by, but a conservative estimate would place the cumulative figure at roughly US$5-7 billion through the end of 2009.3 Clearly, the less mature markets (and ample natural resources) of neighboring Asia, Latin America, and, most recently, Africa and Australia have exerted a far stronger pull. Yet high-level buying missions to the United States and Europe during 2009 - the first explicitly organized to consider cross-border M&A opportunities - point toward an emerging shift in focus. Here the attraction is advanced technologies, brands, and other assets that would allow Chinese enterprises to ascend the global value chain and draw closer to Western end-markets.
As more Chinese companies train their sights on these huge, lucrative markets, two major, interrelated challenges will come starkly into relief: building human resource capacity and navigating overseas political environments. The former speaks directly to the readiness of Chinese companies to invest abroad, the latter to the reception they can expect to receive when they get there. Whether a "win-win" situation ultimately emerges will largely depend on how all stakeholders - public and private, U.S. and Chinese - can help Chinese executives mitigate these challenges.

Building Human Resource Capacity
At the most basic level, successfully engaging in OFDI is about managing complex, integrated cross-border production systems, consisting not only of parent companies and foreign affiliates but far-flung customers and suppliers as well. This is an extremely difficult task for well-established and aspiring multinationals alike, especially in today's competitive world market. To a great degree, success is predicated on an organization's ability to attract, develop and retain middle and top-level managers with international experience across all key corporate functions. Moreover, these managers need to be able to work in a multi-cultural environment and have a familiarity with the regulatory framework of host countries, how they function politically, and the contours of their business culture. Since a substantial portion of Chinese OFDI can be expected to use mergers and acquisitions (M&A) to enter foreign markets (estimated to account for 50-60 percent of China's OFDI in recent years), experts in making M&A work will also be in very high demand.4
Creating Sustainable Value from Cross-Border M&A
Cross-border M&As can provide Chinese companies with a short-cut to establishing or expanding an overseas footprint (and greatly enhance their competitiveness at home) but they are notoriously difficult to manage. Like their global counterparts, potential Chinese acquirers need to ask themselves five key questions during the deal process if they are to create lasting value from their overseas investments:
At what point should we walk away from a deal?
What is an acceptable price to both parties?
How should the deal be structured?
Does the deal present a compliance risk?
How can the acquisition be integrated into the global organization?
Addressing each question is deceptively difficult, requiring specialized knowledge across a wide range of functions, from finance and international tax to compensation negotiation and cross-cultural HR training. These individuals also need to be brought into a rigorous process that not only aims for success at the transactional level, but also ensures that each individual investment advances the broader strategic goals of the firm. So if their future M&A activities are to generate sustainable value, Chinese companies must make the right human resource decisions today.
Given their ambitions, Chinese enterprises will need to identify and nurture an entire generation of such managers in very short order. What are the potential tools at their disposal? Chinese enterprises are already adopting a wide range of approaches, from internalizing global best practices for developing human resources to seeking like-minded partners in the external environment. Within their own organizations, senior managers are identifying the next generation of promising managerial talent and increasing their exposure to the most international segments of their business. Once accrued, this experience can be socialized internally, formally and informally, as part of a comprehensive capacity-building program. In addition to growing their own people, the entire process can be accelerated by bringing in individuals with specialized skills and/or global experience, drawing on China's extensive diaspora population as one reservoir of internationalized talent.
Outside the organization, many Chinese enterprises are teaming up with government, academia, and other stakeholders with a similar commitment to building China's human capital base. In particular, business schools in China are beginning to embark on intensive efforts to educate internationally oriented managers - in China itself and in cooperation with well-established programs abroad. Education in the political economy of the United States, the European Union, and other major markets will need to become an important part of the curriculum if Chinese executives are to have the practical knowledge needed to operate effectively overseas.
In any case, this effort at building human resources needs to not only be massive, it also has to be fast. Chinese enterprises do not have the time, as their competitors from developed countries once had, to deepen their human resources over years or even decades of experience abroad - they need them now, lest their globalization strategies lead them to make costly mistakes or even fail. Globalization is a highly risky endeavor - second chances for market entry, especially in the United States and other mature consumer markets, are rarely an option. Fortunately, Chinese enterprises have proven time and time again to be exceptionally fast learners.

U.S. Regulatory Environment: Formal Barriers to Entry
When contemplating U.S. market entry, Chinese companies need to perform due diligence on the
evolving regulatory environment in the United States, particularly as it may apply to Chinese investors.
National security concerns can derail cross-border deals in the U.S., particularly since 9/11. The U.S. Exon-Florio Amendment (1988) to the Defense Production Act (1950) -
• Gives the U.S. president the right to review and potentially block transactions with implications for U.S. "national security."
• The 12-member, interagency Committee on Foreign Investment in the United States (CFIUS) conducts reviews, with the U.S. Treasury taking the lead role.
• The first (and only) formal block by a U.S. president was of a 1990 bid by China's CATIC for MAMCO, a U.S. aerospace parts-maker.
• July 2007 revisions presume a CFIUS review for any deal involving foreign government-controlled acquirers, and adds "critical infrastructure" as a national security criterion.
• The U.S. Treasury estimates that just 7 percent of the 24,800 cross-border deals into the United States between 1988 and 2008 filed notices with CFIUS, with just 60 deals investigated, although 23 of those investigations (38 percent of the total) came in 2008 alone.
Although it is generally deemed one of the world's most open investment environments, the United States does impose limitations on foreign investment in certain industries, for example:
• Jones Act (1936) - prohibits foreign investment in coastal and inland shipping
• Federal Power Act (1935) - restricts licenses to own, operate, or maintain certain power generation and transmission utilities to U.S. citizens or companies organized under U.S. law
• Communications Act (1934) - imposes strict corporate governance requirements on foreign companies seeking federal approval to acquire broadcasting and radio companies
U.S. anti-trust legislation can add to the compliance costs of large cross-border deals:
• U.S. Clayton Anti-Trust Act (1914) - prohibits large acquisitions if they "substantially lessen competition or tend to create a monopoly"
• U.S. Hart-Scott-Rodino Anti-Trust Improvements Act (1976) - Requires prior notification to Federal Trade Commission and Justice Department if a transaction is between large parties, transfer of voting securities is substantial, or either party is engaged in U.S. commerce
Navigating the U.S. and Other Overseas Political Environments
Globally, there are indications that the climate for FDI is becoming less welcoming just as Chinese enterprises are appearing on the global stage.5 Even before the global economic crisis, a number of developed countries - including the United States, Canada, France, Japan, and Germany - began taking a more cautious approach to cross-border M&A, by far the most important mode of entry into foreign markets by multinationals and, increasingly, for Chinese enterprises as well. Particularly since the China National Offshore Oil Company (CNOOC) withdrew its bid for Unocal Corp. in mid-2005, cross-border M&A by Chinese firms seemed to be attracting special attention, and there is ample indication that it will continue to do so for the foreseeable future.
The reasons for this nervous reaction to Chinese OFDI are mixed, but they are largely political in nature. Questions are raised about the governance of Chinese firms and the fear that Chinese acquirers, especially when they are state-owned, may enjoy financing advantages. This is less an issue for the shareholders of acquisition targets than for rival firms competing for the same assets. There is also some concern, especially in Europe, about the ability of Chinese firms to successfully manage cross-border M&A and the implication that any failures would have for host countries, especially in terms of employment and the business of key suppliers.
Most importantly, there is the suspicion that cross-border acquisitions by state-owned Chinese firms are not necessarily driven by commercial motives alone, but are rather the result of political or strategic calculations determined (or at least influenced) by the government that controls them. The formal launch in September 2007 of the China Investment Corporation, China's new sovereign wealth fund with US$200 billion in foreign exchange reserves at its disposal, has only fueled speculation about the link between Chinese OFDI and the country's wider geopolitical goals.
If this were not enough, Chinese enterprises are seeking to enter the global FDI market at a time when economic tensions between China and its major trade partners are at an all-time high. In the United States, currency valuation has emerged as a lightening rod issue in recent years, while fast-growing trade imbalances with the United States, Europe, and, more recently, Japan have increased frictions as well. In fact, many observers trace a direct link between China's trade surplus and the rapid growth of Chinese OFDI, especially its state-financed portion.6 Trade frictions between the United States and China, over products as diverse as solar panels, tires, and chicken parts, are also being exacerbated by the economic crisis. Other issues unrelated to Chinese OFDI have helped sour public perceptions of Chinese business, especially the product recalls involving Chinese-made goods in 2007 and 2008. To the average American or European, unfamiliar with even the largest Chinese companies, it becomes quite easy to allow negative associations to fill the void, with very predictable consequences in the political arena.
Given the speed at which Chinese firms are expected to "go global," and the fact that state-owned enterprises still account for a substantial portion of China's OFDI, Chinese firms are encountering a rapidly evolving political environment in the United States and other developed markets. In July 2007, the United States revised the Exon-Florio Amendment, including a presumption that filings relating to acquisitions by state-controlled foreign entities will require investigation by the Committee on Foreign Investment in the United States (CFIUS).7 Although data has yet to be released for 2009, notifications to CFIUS were up slightly in 2008 (155 vs. 147 in 2007, but up from just 65 as recently as 2005); while no deals were blocked, a record 23 were subject to investigation (after just 13 investigations in 2007 and 2006, combined). In February 2008, a filing involving a minority Chinese investment in a U.S. telecom firm was withdrawn in the face of U.S. national security concerns. In December 2009, a Chinese mining company was warned away from a acquisition deemed too close to a U.S. naval air station in Nevada, while a third Chinese company ran into CFIUS opposition to its planned purchase of a 61 percent stake in a U.S. fiberoptics manufacturer in June 2010.

U.S Regulatory Environment: Ongoing Compliance The Example of U.S. Workplace Conditions
When operating in the U.S. market, Chinese companies will need to stay in compliance with a regulatory system every bit as complex as their own, only more strictly enforced and in the context of a highly litigious society.
U.S. laws determining employment relationships and workplace conditions can be especially challenging for foreign investors, who, in many cases, have faced a disproportionately higher number of lawsuits compared with U.S. firms. Given differences in culture and business practice, Chinese companies will need to close the gap quickly in the face of close scrutiny by U.S. regulators, media, and the public-at-large for compliance with these and other federal laws:
• U.S. Occupational and Health Act (1970) - Sets minimum standards for health and safety in the workplace and empowers authorities to launch investigations and penalize violations
• National Labor Relations (1935) - Protects the right of employees to self-organization and collective bargaining
• Civil Rights Act (1964) - Prohibits employment discrimination on the basis of race, color, national origin, religion, and sex (including sexual harassment and pregnancy)
• Age Discrimination in Employment Act (1967) - Outlaws employment discrimination against individuals 40 years old or older, as well as most forms of mandatory retirement
• Americans with Disabilities Act (1990) - Prohibits discrimination against persons with disabilities and requires employers to make "reasonable accommodations" for these individuals in the workplace
Chinese companies should also keep in mind that any differential treatment afforded their own expatriate staff - whether real or perceived - could become grounds for lawsuits alleging discrimination. Lastly, many state and local jurisdictions have similar but subtly different laws on the books and are usually just as keen about enforcement.
The Way Forward for All Stakeholders
What to do in light of the vulnerability of Chinese OFDI? It is only natural that, with the reemergence of China as a major economy, Chinese firms will spread their wings and become major players in the world FDI market.8 The world needs to accept that Chinese multinationals are here to stay, and that OFDI is another aspect of China's integration into the world economy. The issue for all stakeholders is how to handle this process smoothly.
At the most basic level, it is essential that the nondiscrimination principle - which is central to the international laws governing cross-border investment - be applied by the United States to Chinese OFDI just as it is applied to the investments of other countries. If need be, this principle should be strengthened, either in the framework of the U.S.-China bilateral investment treaty currently being negotiated, in the regional context of APEC, or even through a multilateral arrangement within the WTO.
Chinese companies too need to be mindful of managing their international growth in light of the sensitivities that exist - rightly or wrongly - about the transnationalization of Chinese business. This begins, as already discussed, with the training of executives not only in matters related to the management of their firms, but also in those related to the political economy and culture of the United States and other major host countries. Furthermore, any acquisition by a state-owned enterprise and/or investments with a potential impact on national security will need particularly careful preparation. The same goes for acquisitions in sectors that are perceived to be off-limits to foreign investors in China.
On the public relations front, the message needs to get out that Chinese OFDI is fundamentally no different from that of other countries - and hence contributes to the economic growth and development of its host countries. Naturally, this message will be better received if Chinese companies behave as scrupulously good corporate citizens when operating abroad, not only by observing the laws and regulations of these countries, but by exercising exemplary corporate social responsibility as well.9
Nonetheless, in a post-9/11 world, cross-border M&A will continue to be a sensitive matter, and whatever the overall impact and perception of Chinese ODFI, Chinese firms may want to draw from the experience of Japanese firms in the United States. When Japanese companies burst onto the world FDI market in the 1980s (partly through high-profile M&A deals), there was widespread fear that they would come to dominate the world economy, and attitudes in the United States, in particular, were quite defensive.
Not coincidentally, much of the regulation that still governs foreign investment in the United States dates to this period. Some of these fears began to dissipate as Japan entered a period of stagnation in the 1990s. Yet Japanese firms also began to change their basic approach to investing in the United States. Their understanding of the U.S. market and ability to build key relationships with governments and communities grew. In addition to M&A, Japanese companies began to establish assembly facilities in the United States and, later, full production units. And as their readiness to address U.S. market-entry challenges increased, they found that the receptivity of the U.S. business environment rose as well, in a sort of virtuous cycle. Under the best of circumstances, Chinese firms will embark on a similar trajectory in a more compressed time frame, thus draining the fear creeping into the cross-border investment environment before it firmly takes hold.

What does this all add up to? Two things seem to be particularly urgent:
• Chinese companies - by themselves and/or with the help of experts - need to take a hard look at their readiness to invest overseas, especially in the United States, the world's most competitive market. Where they need to strengthen their capabilities, especially with respect to the capacity to execute cross-border M&A, they will need to do so as rapidly as possible.
• Chinese companies will also need to familiarize themselves with the regulatory and institutional environment of the United States in order to determine their receptivity and better navigate the political processes. This is particularly important now that attitudes toward cross-border M&A, especially from China, are hardening. Chinese managers can help meet this challenge by building positive social capital for their companies, including by being good corporate citizens.
To explore these and other challenges faced by globalizing Chinese companies, the Chinese Services Group of Deloitte LLP teamed with the Vale Columbia Center on Sustainable International Investment and Tsinghua University in Beijing on a year-long study to assess the readiness of Chinese firms to enter the United States and the investment environment that they are likely to encounter when they get here. Results of this research can be found online at

Research and analysis was conducted by Kris Knutsen, Senior Manager, Chinese Services Group, Deloitte LLP.

1 Figure includes Chinese OFDI in all sectors with the exception of the global financial industry, which has been tracked separately by China since 2004.
2 For example, in 2008 alone, OFDI by China's largest SOEs - the 136 companies centrally administered by China's State-Owned Assets Supervision and Administration Commission (SASAC) - came to US$35.7 billion, or 64% of China's total OFDI that year.
3 For the latest on Chinese investment activity in the U.S. - M&A as well as greenfield - see "Investing in the U.S. - A Quarterly Digest" series at
4 Even in the case of cross-border M&A by multinationals from developed countries, many, if not most, are not judged as successes, despite the fact that many of these firms have considerable experience with M&A. A recent high-profile example is Daimler's acquisition (and subsequent disposal) of Chrysler.
5 See Karl P. Sauvant, "Driving and countervailing forces: a rebalancing of national FDI policies," in Karl P. Sauvant, ed., Yearbook on International Investment Law and Policy (New York: Oxford University Press, 2009), pp. 215-272.
6 It should be noted that, while substantial appreciation of the RMB would reduce the trade surplus, it would further encourage OFDI from China as it would make U.S. and other foreign assets cheaper in terms of that currency.
7 It is worth noting that in perhaps the most famous failed deal involving a Chinese acquirer - China National Offshore Oil Company Ltd.'s (CNOOC) US$18.5 billion bid for Unocal Corp. in 2005 - it was not the CFIUS process but more generalized political pressure, including a 398-15 vote in U.S. House of Representatives demanding that the deal be reviewed by CFIUS, which ultimately caused CNOOC to withdraw its bid.
8 See Jeffrey D. Sachs, "The rise of TNCs from emerging markets: the global context," in Karl P. Sauvant, ed., The Rise of Transnational Corporations from Emerging Markets: Threat or Opportunity? (London: Edward Elgar) (forthcoming).
9 Many Chinese firms are already taking steps in this regard. As of August 2010, for example, 165 Chinese companies had associated themselves with the UN Global Compact, the voluntary code of sustainable and socially responsible business conduct launched in 1999. For a list of these companies, go to

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