Q&A: Chinese Firms’ Overseas Deals Fail Because They Underestimate Political Risk, Veteran Lawyer Says

Chinese companies seeking outbound deals have increasingly looked to emerging markets amid a tightening regulatory environment in the developed world, exacerbated by ongoing trade tensions between China and the U.S.

However, even in emerging markets ranging from Southeast Asia to Africa, areas covered by Beijing’s signature Belt and Road Initiative, the success rate of companies’ deals is generally low, said Robert Lewis, a partner at the Beijing-based Zhong Lun law firm, in an interview with Caixin late last week.

This is due to a series of misperceptions and miscalculations commonplace among many state-owned and private companies, especially their lack of political risk awareness.

“They have to understand that there is now a natural and growing level of concern about Chinese activities around the world,” said Lewis, who is the author of the recently published “Why So Many Chinese Outbound Investments Fail.”

Lewis has more than 25 years of experience working on cross-border commercial transactions in China, where he was a managing partner with law firm Lovells (now Hogan Lovells) in Beijing before joining Zhong Lun in 2011, becoming the firm’s first foreign lawyer. Lewis is also the co-founder of Beijing-based think-tank China Going Global, which is now developing the docQbot online automated contract tool to facilitate China-related cross-border trade and investment transactions.

Lewis said working at a local law firm has given him advantages and more freedom in a country where foreign law firms still face restrictions.

Below are edited excerpts from Caixin’s interview with Lewis.

Caixin: There has been a general decline in Chinese outbound investments. Can you tell us the changes over the last two years?

Robert Lewis: We saw that there’s almost no outbound investment in the first half of 2017. But in the second half of the year, there was a big increase again. The overall decrease from 2016 — which was the highest ever — to 2017 was not as big a drop as originally we may have expected. For the second half of 2017, most of outbound investment went to the Belt and Road countries.

What are the factors that lead to the decline?

There are a couple of factors. Firstly, the Chinese government’s policy change at the end of 2016. The objective of that policy was not to stop all outbound investments, but was to try to focus on areas that are thought to be more helpful to the overall development of the Chinese economy. So as we see, there are certain outbound investments that were restricted in entertainment, in hotels, property, football and soccer clubs, things like that.

The other pressure is coming now from foreign governments. Everyone is now talking about the U.S.-China trade disputes. But these are symptomatic and are representative of the overall tension between the developed Western world and China in recent years. That is not just a question of short term, but there will continue to be some resistance and push-back from many Western countries. The reason for that — most of what we read around the world are reports from foreign governments — is this concern about reciprocity policies. It’s referring to the fact that there’s a fundamental difference between the investment environments in major Western countries and the investment environment in China.

The mistake that a lot of Chinese business people make is that they say, in China, “we are so open, we welcome foreign investment, but when we go to a foreign country, sometimes we face resistance or obstacles or restrictions.” And they think that that’s unfair. But actually their understanding is completely the opposite of reality. There are more restrictions on foreign investment coming into China than there is on Chinese investment going out to other countries.

By shifting to the Belt and Road countries, will Chinese companies face fewer risks?

Actually, they’re swapping one set of risks in these other higher risk industries for a higher risk region because the investment environment in most of the Belt and Road countries is much higher risk than many other parts of the world. If they don’t properly manage the process and do the proper evaluation of the investment target, the investment environment, and manage the process in the right way, they’re going to still face problems.

Do you think there should be a different strategy for Chinese companies doing deals in emerging markets and the developed ones?

Yes and no. When I talk about how Chinese companies do not manage the cross-border M&A process effectively, that applies to emerging markets as well as to developed markets.

But the other thing that Chinese investors need to recognize is that each market has a different investment and operating environment. So in more developed countries, the infrastructure will be better, the economies will be stronger, the legal system will be more complete, and there’ll be a lot more certainty. But there’s a lot more competition.

In the less developed areas of the world, it’s a lot more open, not as much competition, but there’s a reason there’s not as much competition — it is because some elements of the investment environment are higher risk. So the legal system is not as complete, the government policies are less certain. There can be problems with corruption. The infrastructure perhaps is not as developed. So these are all things that investors have to take into account. You do have to choose slightly different variations on the main process, but it’s still the same process. You apply that process in the different environments that have different types of risks.

For the Chinese government, by focusing on the Belt and Road countries and developed countries, the motivations can be different: the latter is more for technology, while the former is more for markets. Is it the right move for China, which is still heavily dependent on Western technologies, to focus so much on the less developed countries?

My view is that the Belt and Road is an important initiative, but it’s not exclusive. From the perspective of the Chinese government, I still see that there is significant emphasis by Chinese companies to invest in technology sectors in developed countries. But this is where we’re seeing more and more concern and resistance on the part of Western countries.

I think this reflects two things. One is that China is much stronger than it was 20 years ago. So, many of the rules relating to China’s relationships with the countries around the world need to be adjusted.

The other thing is because of the change over the same period of time in the nature of the global economy. Twenty years ago, China was weak and the internet was just starting; now China is strong and the internet is a dominant part of the economy. So foreign companies are now seeing their internet economy as an important asset, and they want to protect that. And they’re not going to make it as easy for China to acquire technology assets and bring them back to China and then have China compete on that basis.

But that doesn’t mean that China has to always be in a secondary position. Actually, I think that even without acquiring advanced technology from foreign countries, China has the capability to develop, not only equally good technology, but in some cases, better technology.

I think the strategy the government is pursuing is more balanced than sometimes we think — there’s a lot of emphasis on the Belt and Road, but there’s also equal emphasis on Made in China 2025. I think both are equally important.

Caixin: When it comes specifically to the political risks, like we’ve seen in Malaysia, where they suspended the China-funded railway project, what’s your advice for private enterprises?

First of all, Chinese outbound investors need to have a better understanding of the entire investment environment in each country, and that includes political risk. They have to know that and do more research.

Actually, they’ve been going in a little bit blind sometimes.

The other thing is that each Chinese company has to understand that the other party or the business leaders or political leaders in the target country do not see the Chinese company only as the Chinese company. They see it as representing China in many respects. That’s particularly true with state-owned enterprises. Many people around the world have the view that a state-owned enterprise acts on behalf of the government.

Sometimes I believe that is true, but that’s not always the case. State-owned companies have their own business plan, but when they go out, they have to recognize that people on the other side, view them as being part of China. So if there are any concerns or questions or suspicions about China and China’s policies, then the Chinese companies will feel that resistance.

That’s a key thing. They have to understand that there is now a natural and growing level of concern about Chinese activities around world. It’s not because China is doing something wrong. It’s just a China is now so much stronger, so much more influential that people have to stop and think — “is this going to be good for China, but not good for me?” That’s a natural thing.

And so there are more questions, more suspicions. It’s something they have to do a better job of assessing in advance. And then they have to have a plan to say, “We understand what your concerns are, here’s how we propose to deal with this.”

Contact reporter Mo Yelin (yelinmo@caixin.com)