Sovereign Wealth Investment in Germany

Sovereign wealth funds (SWF) are state-owned investment funds composed of financial assets or other financial instruments. They are created for a variety of purposes, ranging from the purely economic, such as binding excess liquidity to reduce inflation or securing national wealth, to purely strategic aims such as creating war chests for uncertain times.

While the concept is not new, the number and wealth of these funds has increased dramatically over the last few years, making them a powerful tool. That is why state-controlled investment from abroad is a topic under fierce discussion in the media. The major concern is the underlying intent of these funds and the potential threat that they may pose to the domestic industries in which these market players might invest. One example discussed is the intention of China Investment Corporation to acquire a share in the German Railway.

With this in mind, the German Federal Ministry of Economics and Technology has initiated changes to the law on foreign trade, potentially affecting foreign investors' possibilities of investing in German companies. Possible restrictions on acquisitions by foreign investors, in its draft bill, have attracted much attention abroad as well as in Germany. Some commentators regard it as vesting the ministry with powers to veto foreign takeovers, of German companies targeted by SWFs and other cash-rich overseas buyers. But it would be a deep misunderstanding to consider the envisaged legal amendments as a gateway for protectionism and state interventionism.

The impact of the new legislation remains to be seen but there will most likely be very few scenarios of investments being prohibited under the new legislation. Nevertheless, there will be some cases and investors that think their investments may be affected should seek expert advice and clearance up-front before proceeding with any transaction.

The bill, which has just been approved by the German Federal Cabinet prescribes amendments to both the Foreign Trade and Payments Act, as well as to the Foreign Trade and Payments Regulation. It will be read by the German Parliament after the summer recess. Once Parliament has considered it, the chances are good that the legislative changes will take effect this year.

Without giving away too much of an analysis in advance, in order to be on the safe side, investors intending to acquire at least 25% of the voting rights in German companies operating in sensitive areas will be well advised to request a review of their envisaged investment by the ministry. To do so, they will need to submit the complete documentation before or immediately after signing the sale and purchase agreement, or in the case of a public takeover, the announcement of a take-over bid. Within a one-month period the Ministry must provide feedback, otherwise the acquisition will become effective.

Military matters

In particular, the coming legislation will add to the already existing control of the military industry.

Already, the acquisition of 25% or more of the voting rights by a non-resident investor (from outside the European Community) in a company that aims to develop or produce military weapons, related materials and crypto systems requires the notification of the Federal Ministry of Economics and Technology, which can prohibit the transaction.

This regulation contained in is an elaboration of a general clause, according to which, any legal transactions the subject of which is the purchase of domestic companies or shares in domestic companies, which produce or develop military weapons or other military equipment or cryptographic systems, may be restricted in order to guarantee the vital political and security interests of the Federal Republic of Germany.

The new legislation aims to create a more flexible instrument that will not only serve the interests of security policy in a narrow sense but also include the protection of the infrastructure and security of supply. The draft bill therefore provides for the criteria of public law and security of the Federal Republic of Germany.

Also, as any influence by the state in this area can affect the freedom of capital movement according to Article 56 of the Treaty of the European Community, which is also afforded to third countries, the entire regulation including the terms public law and security must be interpreted in this context and in line with the rulings and understanding of the European Court of Justice. It was for this reason that the legislator saw a need to make the present legislation more precise and less discretionary.

It is worth mentioning that both direct and indirect acquisitions by so-called Community non-residents which, under the definitions of the Foreign Trade and Payments Act are all natural and legal persons except for Community residents are affected by this new legislation. Voting rights of other shareholders are legally attributed to the Community non-resident, provided that it holds 25% or more of the voting rights in the other shareholder. Voting rights of third parties are also legally attributed if they are subject to a voting agreement.

Acquisitions affected in this way will be pending for a three-month period after the signing of a take-over bid. Strictly speaking, only the contractual part of the acquisition, which is subject to the law of obligations, is pending. It is subject to the condition that the Ministry will prohibit the acquisition within the three-month period. If the Ministry does not prohibit it in this timeframe, the mutual obligations of the parties under the acquisition agreement – assignment and transfer of the object of the purchase (e.g. shares) against payment of the purchase price – are fulfilled.

According to a German legal peculiarity called 'principle of abstraction', the transfer and assignment of, for example, shares to fulfill the purchase agreement, is abstract in the sense of being legally independent from the underlying obligation. Thus, the transfer and assignment agreement remains in effect, even though the underlying (obligatory) relationship is not. As a consequence, if a share purchase agreement is implemented but later on prohibited, the need arises to unwind the agreement. However, this is evidently difficult if not impossible in the case that 25% or more of voting rights were not acquired as a whole but successively. Most of the former shareholders will not be known by name. It is also unclear whether it will be sufficient to reduce the shareholding to 24.99% in such case.

Playing the percentages

In this context it is debatable whether or not the 25% threshold makes any sense at all. On many occasions, possession of as little as 10% of the voting rights put a shareholder in the position to block resolutions in general shareholders' meetings of listed corporations because decisions are taken with a majority of the votes of the shareholders attending the meeting. On average, the attendance at shareholders' meetings is between 50–80%. German corporate law prescribes a 75% majority for the passing of special resolutions compared to a simple majority of votes cast for ordinary resolutions. However, the required 75% majority relates to the share capital present at the shareholders' meeting.

In case the right to request documents within the three-month period is exercised, the purchaser must provide the Ministry with the complete documentation of the acquisition and the involved companies and their business activities. Only after the expiration of a further one-month period, and if no prohibition or limitation order is made, will the acquisition become effective.

The acquisition can only be prohibited or limited or instructions be issued, if this measure is necessary to guarantee public law and security of the Federal Republic of Germany. In light of the referenced jurisdiction of the European Court of Justice only direct and serious endangerment to the protection of the interests of the public in Germany will justify a prohibition or limitation. A prohibition of an acquisition can only serve as a last resort and the question will always arise whether the available mechanisms of market control under the existing competition law or according to the existing trade law are sufficient.

As it is often stressed, a common European approach, ideally in common with the United States, would be desirable.

It is to be welcomed as a step in the right direction that the International Monetary Fund is aiming to encourage more transparency in foreign investors and has plans for a code of conduct. And also the International Working Group of Sovereign Wealth Funds did not remain active and has just reached a preliminary agreement on a draft set Generally Accepted Principles and Practices, known as the Santiago Principles.