Investors are paying more attention to Sensitive Industries requirements and discovering a complex web of rules
By Jeanette Turner; Jean White, SEI
Published: 20 September 2021
Shareholding rules, such as long and short shareholding disclosures and position limits, are well known to professional investors such as investment fund managers and institutional investors. Sensitive Industries, another category of shareholding rules, has traditionally received less attention. That is now changing.
Sensitive Industries is a common term used to describe shareholding rules for industries considered critically important or 'sensitive'. A rule might be from a large regulator or a small government agency, it might cover listed or unlisted issuers, and it might apply to all shareholders or just foreign ones. It might require that a shareholder seek pre-trading approval before crossing an ownership threshold, or it might have a simple 'hard stop', outright prohibiting a shareholder from owning a certain percentage of a company or industry.
The commonality is that the rules are based on geopolitical sentiment and are focused on protecting critical industries from unwanted controlling interests, but without stifling investments. Accordingly, ownership limits have traditionally been set high enough that non-activist investors can trade without concern about crossing thresholds.
Two recent trends, however, are causing more investments to be in scope, and more investors to take note. First, governing bodies are expanding the scope of industries considered 'sensitive'. Second, thresholds are tightening, especially with foreign investors.
Shareholders paying closer attention to Sensitive Industries are discovering overwhelmingly complex rules that are difficult to monitor and that come with little guidance on how to comply. Here are five reasons these shareholders are turning to experts for help.
1. A complex web of rules
The number one challenge with Sensitive Industries is the breadth and complexity of coverage. There are more rules to manage than investors are used to with standard shareholding disclosure requirements—as of mid-2021, SEI’s Global Regulatory & Compliance team covers more than 800 Sensitive Industries rules across nearly 100 jurisdictions, versus approximately 600 shareholding disclosure rules. There are (1) rules related to specific industries, (2) rules related to specific issuers, and (3) rules based on the investor. For each of these three categories, there are additional complexities—a seemingly endless matrix of sub-categories, with different rules for each. A single investment can be subject to more than one rule. See the table below for a simple example of the complexity involved.
- Rules by industry –Classic sensitive industries include defense, banking, energy, transportation, aerospace, telecommunications, and media. What is deemed 'sensitive', however, varies by jurisdiction. For example, some jurisdictions have rules for fishing industries. In some jurisdictions, industries are broken down into sub-categories. For example, 'Utilities' might include different rules for nuclear generation versus electricity transmission, gas, or water. Even more challenging, some rules focus on an activity, regardless of industry. For example, a rule might apply to any company that handles sensitive personal data. In these situations, investors must have a clear understanding of a company’s activities in order to determine applicable restrictions.
It is up to the investor to determine whether a company—listed or unlisted, public or private—operates in a protected industry. Some industries, such as banking, will have a well-defined list of issuers that are in scope. But others may have no such list and also offer no guidance. In these cases, many investors turn to industry codes, such as the Global Industry Classification Standard (GICS). But mapping issuers to industries in this way has limitations, as companies can fall within more than one industry. For example, the GICS code will code an automobile manufacturer as 'automobile', but the company might also have a financial services subsidiary that is not captured by the GICS code. It is the obligation of the investor to research how individual rules apply to complex corporate structures.
- Rules by Issuer – Some rules set ownership limits on specifically named companies. For example, some apply a 'hard stop' on investing in specific banks or defense companies. It’s important for the investor to remain vigilant as the lists may change as geopolitical conditions change.
- Rules by Investor – There are two ways that rules are linked to investor type. First, some rules are for all investors, while others are for just foreign investors. 'Foreign' can be defined in different ways. For example, for European jurisdictions it can mean non-EU, non-EEA, or non-national.
Second, a restriction might apply per individual investor, or to investors in the aggregate (e.g., a rule that foreign ownership in the aggregate cannot exceed 40% of voting shares). If it is per individual, the investor needs to understand what is included (e.g., does it include entities in the investor’s control?). If it is in the aggregate, the investor needs to know the current status of foreign investment before trading.
To illustrate the complexities noted above, this table sets out South Korea Sensitive Industries rules for the utilities sector.
|SUB-INDUSTRY and SCOPE||RULE|
(Overriding rule under the Foreign Investment Promotion Law (FIPL))
|Pre-acquisition reporting obligation for 10% individual foreign ownership|
(any Korean nuclear generation issuer licensed in South Korea, whether listed or unlisted, public or private)
|Foreign direct investment rules apply.|
ELECTRICITY(any Korean electricity transmission issuer licensed in South Korea, whether listed or unlisted, public or private)
1. 50% aggregate foreign ownership restriction
2. A foreign investor cannot own more voting shares than the largest domestic shareholder
3. Additional issuer-based rule for Korea Electric Power Corporation:
(no specific restrictions, except for an issuer-based rule for Korea Gas Corporation)
Issuer-based rule for Korea Gas Corporation:
WATER(no specific restrictions, except for an issuer-based rule for Korea Water Resources Corporation)
Issuer-based rule for Korea Water Resources Corporation:
2. The rules are hard to find
With shareholding disclosure, there are one or two known authorities at whom to look. But with Sensitive Industries, oversight is not centralized. Investors may find rules by canvasing individual governing bodies, such as a ministry of agriculture or a ministry of defense. This is a challenging 'you don’t know what you don’t know' exercise, as one might research classic protected industries and miss a nuanced rule that is buried in a resolution about something else.
3. The rules change
Sensitive Industries rules are based on geopolitical sentiment, and governments can quickly change course. As the COVID-19 pandemic intensified in 2020-2021, some jurisdictions lowered thresholds with little warning, some set limits on foreign investments in health care and technology, and some implemented temporary thresholds, set to expire at a later date.
4. What is the requirement and who must report?
Investors need to determine what is required for each threshold. For example, do they need pre-trade approval before crossing a threshold, or is disclosure to the regulator enough? Is the disclosure before or after the threshold is crossed? Who must report—the fund manager? In some cases, the investor discloses its holding to the issuer, and it is the issuer that reports to the regulator.
5. Lack of instructions to calculate the thresholds
A rule might limit ownership to X% but not state X% of what. It can take substantial work for the investor to determine the appropriate calculation. For example, for the numerator (the investment), should all shares be included, including derivatives and indexes? For the denominator, is the threshold a percentage of voting shares outstanding, total shares outstanding, or some other figure? Should the information be calculated at month end, or must the investor check shares outstanding in the interim during the month? Too often, the rule does not provide this information. Some investors run different calculations and set a trading alert for the most conservative result.
Given recent trends in Sensitive Industries, investors can no longer assume that the rules will not apply to them. The rules are complex, complying can be a drain on resources, and the sanctions range from fines to criminal penalties. As such, investors are increasingly turning to service providers to map holdings to applicable requirements, monitor for rule changes, and to provide accurate and timely reporting to all relevant parties.
Global Regulatory & Compliance is part of the Investment Manager Services division, an internal business unit of SEI Investments Company. This information is provided for education purposes only and is not intended to be relied upon as legal or regulatory advice, and information is subject to change. SEI does not claim responsibility for the accuracy or reliability of the data provided. Information provided by SEI Global Services, Inc.
 The GICS methodology, developed by S&P Dow Jones Indices and MSCI, “assigns each company to a sub-industry, and to a corresponding industry, industry group and sector, according to the definition of its principal business activity. Since the classification is strictly hierarchical, at each of the four levels a company can only belong to one grouping.” See Guiding Principles and Methodology for GICS, available on both S&P Global and MSCI websites.