20 4월 2023 Christoph Barth  -  Ann-Christin Käser ForeignInvestmentLinks

Chip War: Foreign Investment Control at Arms

Semiconductors (also known as “chips”) are omnipresent in everyday life and are the driving force behind many of today’s industries. They are an essential component not only in computers and smartphones but also in cars and planes, as well as critical infrastructures, data, communication, and military use cases. 

While today’s semiconductor value chain is the result of true globalisation and an optimal use of economies of scale and production cost advantages, the entire industry - including design, front-end, and back-end processes - is at the centre of a trade war between China and the US and its allies. Foreign investment control is a key tool for many Western governments in managing these geopolitical tensions. 

Aspects of this trade war include not only the deployment of extensive export control restrictions, but also the very intense scrutiny of transactions featuring the semiconductor value chain, particularly when they involve Asian investors. China - a particular target of this activity - has fought back by tightening its merger control regime, providing its authority with more tools to screen M&A transactions in critical industries like semiconductors (which was already one of the most scrutinised sectors in China by deal volume). More recently, it has been reported that China is consulting on adding three new categories to its list of restricted exports - including wafers, which are essential for manufacturing semiconductors. The potential introduction of outbound foreign investment control, which is currently being considered both in the US and the EU, could also be a further escalation of this conflict in the future. 

Background

The global semiconductor industry is estimated to have reached, in 2022, a global sales volume of more than USD 600 billion and the top 10 global chips companies have achieved a market capitalisation of around USD 2 trillion. Semiconductors play a vital and ever-increasing role in modern life as leading-edge chips are crucial for future technologies and economic development. Demand in advanced semiconductors is expected to double worldwide by 2030.

However, Europe accounts for less than 10% of semiconductor manufacturing globally, with the vast majority being produced in the United States and Asia, in particular in Taiwan and South Korea and, increasingly, in China. All of the world’s most advanced semiconductor manufacturing capacity is currently located in Asia (92% in Taiwan and 8% in South Korea) and it will take several years until additional capacities come to market in the US and Europe, where they are currently being built with significant public funding.

A global semiconductor shortage since 2020 has made this discrepancy even more apparent and exposed the risks present in the world’s supply chains. This has led to extended delivery periods for life-saving equipment and consumer electronics, as well as a decrease of around 30% in car production in some EU Member States. At the same time, 2022 was marked by significant geopolitical tensions, including the ongoing tensions around Taiwan, and an increasing rivalry between China and the US.

As a result, Western governments have turned to protecting and expanding their national semiconductor capacities in order to strengthen their competitiveness in a new global economic order. The European Union has proposed the European Chips Act to boost its future technological sovereignty and resilience, and announced a EUR 43 billion investment programme. In light of their political sensitivity, negotiations on the European Chips Act have evolved at a faster pace than previously expected, and a provisional political agreement was reached between the Council of the European Union and the European Parliament on 18 April 2023. 

Similarly, the US introduced the CHIPS and Science Act in August 2022, which aims to strengthen the US semiconductor industry and mobilises approximately USD 280 billion. In October 2022, the US also introduced new export restrictions on semiconductor manufacturing equipment and high-performance semiconductors for Chinese companies, affecting not only US-made equipment and semiconductors, but those made in other countries using technologies controlled by the US. The Dutch government recently followed suit, introducing new restrictions on overseas sales of semiconductor technology based on national security grounds, which will affect a key Dutch supplier to China’s semiconductor industry. Japan is expected to announce similar measures shortly.

Regulatory framework and practical implications

Alongside export control, foreign investment screening mechanisms are an important tool for governments to implement their semiconductor agendas. All key Western foreign investment control regimes now feature some form of chips protection. For example:

  • There is an issue with the language in the EU Screening Regulation, however, in that it does not distinguish between different types of semiconductors. In fact, almost all production capacity that is currently located in the EU (in particular, for Complementary Metal Oxide Semiconductors) relates to rather old technology, that is anything but cutting edge. Considering “Moore’s Law” - the observation that the number of transistors in an integrated circuit doubles about every two years - it is surprising that foreign investment laws do not make any distinction between technologies. By contrast, tools such as the EU Chips Act recognise the different relevance of different generations of semiconductor technology.
  • Further, the EU Screening Regulation does not consider the additional value chain of the semiconductor industry, which is highly complex across design, front-end and back-end. Much like the production of traditional newspapers, the process steps are numerous and include the design of a chip, the printing of large-scale integrated circuits on silicon wafers in the front-end process, and the cutting of those wafers into individual chips during the back-end process. The EU rules do not even consider which of these steps - thin-film deposition, lithography, etching in front-end processes and dicing, wire bonding, moulding, inspection in back-end processes - are actually sensitive (and, for each of these processes, which technology generation they belong to).
  • Some EU Member States have introduced seemingly narrower provisions. In Germany, the development, manufacturing, or processing of specific semiconductor products, such as integrated circuits or processing tools, including etching equipment, became subject to the mandatory and suspensory German foreign investment control regime in 2021. Since then, acquisitions of 20% or more of voting rights by non-EU/EFTA investors in a German target carrying out such activities trigger a mandatory filing requirement and non-compliance is subject to criminal sanctions. Similarly, in France, acquisitions of 25% or more of voting rights by non-EU/EEA investors in a French target carrying out R&D activities in relation to critical technologies trigger a mandatory filing requirement and non-compliance is subject to criminal sanctions. However, again, the national rules barely consider the actual complexity of the semiconductor value chain. Even the German rules, which are the most specific within the EU, simply refer “in particular” to certain types of semiconductor products, thereby leaving open which tasks and technologies are actually viewed as sensitive.

In the UK, the National Security and Investment Act 2021 (NSIA) took effect in January 2022 and introduced a mandatory pre-closing filing obligation for transactions in 17 sectors of key national security risk set out in separate schedules. Semiconductor businesses are likely to fall under at least one of these 17 mandatory sectors, notably the “advanced materials” schedule. The NSIA has a very wide jurisdiction, and the mandatory notification regime captures non-controlling minority stakes as low as 25%. There are, unfortunately, no detailed guidelines or similar materials that currently allow for some way to distinguish between technology generations and/or process steps. Rather, as in the EU, an entire industry and the full value chain is “pulled” into mandatory review.

In the United States, pre-closing filings with the Committee on Foreign Investment in the United States (CFIUS) are required in connection with certain investments in critical technology businesses, broadly defined as those that develop or produce items subject to certain categories of US export controls. The relevant export control categories were recently expanded to include advanced computing integrated circuits (ICs), computer commodities that contain such ICs, and certain semiconductor manufacturing items. In addition, CFIUS has jurisdiction over certain noncontrolling investments in such businesses. The expansion of US export controls associated with semiconductors and semiconductor manufacturing technologies therefore expands the scope of mandatory filings and CFIUS jurisdiction for related transactions.

Governments tend to apply the rules quite broadly, by including upstream and downstream activities. In addition, it has become clear that investors from China, in particular, are subject to heightened scrutiny. This combination has led to an increased number of high-profile cases, as well as prohibition decisions, in recent months - for example:

  • In the UK, the Secretary of State recently blocked the acquisition of the UK’s largest semiconductor manufacturer, Newport Wafer Fab, by China-backed Nexperia. It is reported that the Welsh plant produces transistor-style chips (which are commonly found in more rudimentary items such as charging cables and hairdryers). This prohibition decision - the first taken under the NSIA’s “look-back” provisions - was subject to significant media and political scrutiny (including pressure from US Congress). Nexperia offered “far-reaching remedies” to address the concerns identified, including undertakings not to conduct the compound semiconductor activities of concern, and to provide the UK Government with direct control and participation in the management of Newport. The parties argued this had been “entirely ignored” without any “meaningful dialogue”. In addition, it should be noted that 3 out of the 5 prohibition decisions to date under the NSIA have involved companies active in the semiconductor supply chain.
  • In Germany, there were 7 cases in the semiconductor industry that were filed for foreign investment control review in 2022, and another 10 cases in 2021. At the beginning of 2022, the attempted takeover of German hyper-pure silicon wafer manufacturer, Siltronic, by Taiwanese GlobalWafers failed as the German government did not grant approval within the deal’s longstop date. In addition, at the end of 2022, the German government blocked the acquisition of a wafer fab by a China-backed Swedish company and an investment in a company manufacturing wafer probing equipment. Based on what is known about other cases that were prohibited under the German foreign investment rules, it appears that at least the majority of the other cases were approved, possibly subject to some mitigation measures.
  • In Italy, in April 2021, the Italian Government exercised its so-called “Special Powers” by vetoing the acquisition by the Chinese company, Shenzhen Investment Holdings Co., of a controlling stake in LPE, an Italian firm active in the production of semiconductor equipment, and in particular - based on publicly available information - in the design and manufacture of epitaxial reactors that allow the realisation of connections between various devices on a chip.

Overall, it is very challenging to identify - from the existing case law - a pattern as to which technology and which process steps are ultimately viewed as highly sensitive under foreign investment rules. In fact, some of the cases suggest that factors such as short-term political views may well trump considerations relating to technology.

Key takeaways
  • Semiconductor products fall within the scope of all key foreign investment control regimes and regulators generally apply the rules expansively. So, for any investment with links to the wider semiconductor industry, foreign investment control filing requirements should be considered carefully - and there is a high likelihood of a mandatory filing being required.
  • The devil often lies in the detail, and not all semiconductor products should be viewed as sensitive from a foreign investment control perspective. Unfortunately, relevant laws do not currently consider technological differences to the extent they should, and we hope that the ongoing evaluations of both the EU and the German rules will be an opportunity for a greater focus on technologies which are actually capable of triggering a security interest (as opposed to being on the list of industry policy considerations by politicians). There are examples, such as the EU Chips Act, which may - despite certain shortcomings - serve as a good starting point for such considerations.
  • Heightened scrutiny of certain investors (in particular, the Chinese) can lead to an increased risk of a Phase II review and remedies. Foreign investors should also be prepared for heightened public interest and political involvement should semiconductor deals become public. It will be critical in each case to assess in great detail - and at an early stage of a deal - which concessions may ultimately be necessary to secure foreign investment clearance, how such concessions interact with the deal rationale, and to adopt appropriate contractual protections.