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Chinese buyers seek insurance to protect against failed U.S. deals

(Reuters) - Insurers have begun offering protection for cross-border deals that might fall apart due to regulatory scrutiny, targeting Chinese companies that are aggressively pursuing acquisitions in the United States.

A Chinese man adjusts a China flag before a news conference attended by Chinese Foreign Minister Yang Jiechi and U.S. Secretary of State Hillary Clinton at the Great Hall of the People in Beijing September 5, 2012. China and the United States were divided on Wednesday over how to end the bloodshed in Syria and defuse tension in the South China Sea and other global troublespots, but stressed hope for steady ties as they navigate political transitions at home. REUTERS/Feng Li/Pool (CHINA - Tags: POLITICS) - RTR37I4L

Britain's Aon Plc AON.N in the last year became the first to offer a new type of coverage for deals that might face opposition from the U.S. Committee on Foreign Investment, insurance executives and bankers said.

Other large brokers, including Jardine Lloyd Thompson Group Plc JLT.L, are also providing insurance from CFIUS risk.

CFIUS is a wing of the Treasury Department that examines deals to determine the effect on national security. Its power to scuttle transactions or demand divestitures hovers over certain deals, especially as other U.S. authorities have raised concerns about Chinese acquirers.

CFIUS protection comes in response to sellers’ insistence that Chinese buyers promise to pay a “reverse breakup fee” if a deal is blocked, bankers and lawyers said.

CFIUS has already derailed a number of high-profile deals, and President-elect Donald Trump’s tough talk on China has made the future of that country’s investment in the United States even less certain.

Yet increased regulatory scrutiny has not deterred a large number of Chinese buyers from pursuing investments in the United States as growth at home has slowed.

Outbound M&A volume from China has more than doubled so far this year to nearly $196 billion, a record, according to Thomson Reuters data. The United States accounts for nearly 30 percent of these deals, making it the most targeted country.

Insurance is one way Chinese buyers can defend against heightened regulatory risk, said David Shine, chairman of law firm Paul Hastings’ mergers and acquisitions practice.

“We are in new and developing territory with CFIUS,” Shine said.

AWAITING CLARITY

In January, CFIUS blocked Philips' PHG.AS $3.3 billion proposed sale of lighting unit Lumileds to a consortium of Asian buyers. The next month, China's Unisplendour Corp Ltd 000938.SZ scrapped a $3.8 billion investment in Western Digital Corp WDC.O after CFIUS said it would investigate the transaction, and Fairchild Semiconductor International Inc said it was declining a takeover offer from Chinese buyers because of regulatory risks.

These risks could increase, since Trump has criticized Chinese trade policy and raised questions about the future of ties between the two countries.

That could mean premiums for CFIUS insurance will rise substantially, or the product could be put on hold until Trump’s policy agenda becomes clearer, some insurance executives said.

But Elliot Konopko, a senior managing director in Aon’s strategic advisors and transaction solutions group, said he expected demand for the product to remain high and even increase.

Policyholders typically pay a premium of 10 percent to 15 percent of the reverse breakup fee, insurance executives said. That compares with a 2 percent to 4 percent premium for other types of M&A insurance.

CFIUS coverage premiums depend on the perceived riskiness of the transaction. For example, deals in energy, aerospace and technology sectors may draw more regulatory scrutiny.

“Premiums can be higher if there is something that raises an eyebrow and it’s no slam dunk,” said David De Berry, chief executive officer of insurance underwriter Concord Specialty Risk. “But it may be lower if the insurance is just seen as a security blanket.”

BIG PREMIUMS

CFIUS insurance has been used in about a dozen deals, industry executives said.

A Chinese consortium used this insurance in April when it acquired U.S. printer maker Lexmark International Inc LXK.N for $3.6 billion, according to sources close to the deal.

The group, including Apex Technology Co and PAG Asia Capital, had agreed to pay Lexmark $95 million if the merger was terminated, according to regulatory filings. That means the buyers may have paid a premium of $9.5 million to $14.3 million.

China Resources Microelectronics Ltd and Hua Capital Management Co Ltd, which offered to buy Fairchild Semiconductor last December, had also lined up deal insurance for the transaction, according to people familiar with the matter.

But Fairchild could not get comfortable with the buyers and said in a filing with the U.S. Securities and Exchange Commission that there was an "unacceptable level of risk" that CFIUS would reject a merger. Fairchild ultimately went with an alternative bid from U.S.-based chip company ON Semiconductor Corp ON.O.

Representatives of PAG Asia Capital, China Resources Microelectronics and Hua Capital did not respond to requests for comment.

“By virtue of its nature, the relationship between the U.S. and China is complex and increasingly so,” said Mario Mancuso, a former CFIUS official who is now a partner in law firm Kirkland & Ellis LLP’s international trade and national security practice. “(It) carries risk but also carries latitude for creativity in deal terms.”

Additional reporting by Liana Baker in San Francisco and Lauren Hirsch in New York

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