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US China Trade War and No-deal Brexit: the combined economic effect



US protectionism and trade war with China

Since President Trump took office, the US has increased protectionist economic measures and has been embroiled in a trade war with China. The US has imposed 25% tariffs on Chinese goods entering the US and imposed stricter CFIUS reviews on Chinese deals. In relation to the world at large, the US has withdrawn from international trade deals such as Trans-Pacific Partnership (TPP), renegotiated the North American Free Trade Agreement (NAFTA) and cut corporate tax using the TCJA.


Tax Cuts and Jobs Act (TCJA)

Under President Trump’s direction, the TCJA has cut corporate tax from 35% to 21%. Additionally, deductions for business interest will be limited to 30% of EBITDA (earnings before interest, tax, depreciation and amortisation). This Act is likely to have great effect on M&A decisions in US firms.


The TCJA will change how M&A deals are structured and financed. Cutting corporate tax by 6% increases the attractiveness of business being done in the US. This makes it less attractive to shift deals abroad since US tax levels are now more similar to other countries; so there will also be increased foreign direct investment (FDI) into US, since many US companies will bring back their cash reserves which are currently held offshore in tax efficient regimes.


Currently, the US market takes up 44% (the bulk) of global M&A activity, with a higher liquidity, inorganic growth and stronger domestic market. Therefore, international firms with a strong US connection would stand in good stead to tap on the booming US domestic market.


Broadened CFIUS review

The Committee on Foreign Investment in the United States (CFIUS) reviews transactions involving foreign investment in the US and can block any transactions which it deems may threaten the national security of the US. Previously, CFIUS focused on reviewing acquisitions by foreign buyers for national security risks. However, under Trump’s direction, it can now review transactions by both foreign buyers and US companies.


CFIUS review has recently gained media attention for blocking numerous deals where China is involved. Unsurprisingly, technology has been epicentre to this strategic rivalry between the US and China, since Chinese companies have made highly accelerated progress in technology and Artificial Intelligence (AI). Most recently, Huawei is suing US government for banning its technology (5G). Trump has argued that Huawei will give the Chinese government a backdoor into tapping on communications. 5G will enable faster and larger data flow, by connecting more devices to the internet which services can allegedly spy on. As such, the US has banned Huawei and other Chinese telecoms as national security threats.


However, since a bulk of funding often comes from Chinese investors. Therefore, the legal challenge is to see how Chinese investors can get integrated into private-equity funds. Another issue for businesses regarding CFIUS review is its arbitrariness and lack of transparency on its assessment criteria. As such, this could make the Europe and Asia a less risky more attractive option for Chinese investors and private equity funds.


No-deal Brexit

Threats to businesses in UK

A key reason why no deal has been reached is the Irish backstop problem of a hard border to check on goods. Custom checks and difficult border control can increase costs to businesses. For instance, lorries that used to be waved through now have to be checked, possibly creating long queues at the border. This poses some uncertainty for businesses and investors.


The UK leaving the single market with no deal would subject it to the most rudimentary trade tariffs under the World Trade Organisation (WTO). Since the UK currently depends on the EU for half of its exports, it may stand to lose demand for trade exports.


Most importantly, business face a change of law risk. Of course, Brexit has never happened before, so there is no precedent. According to a recent survey, ⅔ of UK firms have not yet assessed and tackled the risks of Brexit. Therefore, firms which have done so will stand out from competitors by being able to adapt to this new situation.


Opportunities

In the short term, however, inbound deals have increased by 20% in the UK, demonstrating that British firms are out to acquire foreign firms to expand internationally. International firms with a strong EU presence will be better poised to stay involved in transactions outside the UK after Brexit takes place.


Combined effect of the US-China trade war and no-deal Brexit on the UK economy

Threats

With increased US protectionism, US firms may be inclined to acquire firms within trade barriers to avoid higher costs of cross border trade. This could worsen prospects for the UK economy which will be more dependent on non-EU trade after no-deal Brexit.


Opportunities

Alternatively, the negative effect of Brexit on the UK economy may be alleviated by the trade war between US and China. Since the trade war, Chinese FDI into the US has fallen by 90%. This FDI could be redirected towards the UK and emerging markets in South East Asia.


This creates an opportunity for law firms in the UK to work on these cross-border deals, especially if they have expertise in international jurisdictions. As a result, M&A is likely to become more complex in terms of deciding what markets to prioritise and deciding where the acquisition vehicle should be situated. Firms will need to decide which legal jurisdiction and tax regime will be best suited to carry out the transaction in light of Brexit and US protectionist measures.



Su-Ann Cheong

Politics Section Editor

23 March 2019


 

Bibliography

'No-Deal Brexit' (The Independent, 2019) <https://www.independent.co.uk/topic/no-deal-brexit-0> accessed 9 March 2019

Edward Malnick, 'Public Swinging Behind No Deal Brexit, As Tories And DUP Urge May To Invoke Plan B' (The Telegraph, 2019) <https://www.telegraph.co.uk/politics/2019/03/09/support-no-deal-brexit-backed-public-poll-finds-growing-number/> accessed 9 March 2019

'The Truth About A No-Deal Brexit' (The Economist, 2019) <https://www.economist.com/leaders/2018/11/24/the-truth-about-a-no-deal-brexit> accessed 9 March 2019

'Trade War - BBC News' (BBC News, 2019) <https://www.bbc.co.uk/news/topics/ce25yderw6pt/trade-war> accessed 9 March 2019

'US-China Trade War' (The Independent, 2019) <https://www.independent.co.uk/topic/us-china-trade-war> accessed 9 March 2019



Disclaimer: The views expressed are that of the individual author. All rights are reserved to the original authors of the materials consulted, which are listed in the bibliography above.

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