Guest Author: Ruth Knox, Managing Associate, Linklaters LLP
Given the pace of change in the automotive industry and related technologies, combined with increasing regulatory scrutiny and recent developments in trade and M&A, there are several risks and challenges the global automotive industry can expect to deal with for the remainder of 2018 and beyond across Europe, China, and the United States.
Recently, Foley & Lardner LLP and Linklaters LLP held a roundtable on the “Future of the Automotive Sector in Europe, China and the United States.” Participants addressed four major points during the roundtable, which are summarized below.
Law and policy developments on electric and autonomous vehicles across the globe
Participants shared the most recent developments at the EU and Member State level with respect to regulation of autonomous and electric vehicles. While the EU is essentially letting Member States take the lead on regulation, a number of key documents are anticipated in the next few quarters, including some guidance on how the Product Liability Directive will apply to AVs, along with the European strategy on Cooperative Intelligent Transport Systems (C-ITS) Delegated Act, which will focus on the exchange of information between vehicles and infrastructure and the cooperation between national authorities to ensure interoperability.
Ruth Knox, Managing Associate of Linklaters, noted that while the Road Traffic Act (which took effect in June 2017) legalizes the operation of SAE Level 3 and SAE Level 4 autonomous driving functions in Germany, fully autonomous vehicles are not yet recognized under German law. From a liability perspective, the vehicle holder remains strictly liable and the maximum liability has increased to EUR 10 million (for personal injury) and EUR 2 million (for property damages).
In France, a May 2018 report sets 2022 as the deadline for the circulation of an SAE Level 3 and SAE Level 4 regulatory scheme, and a bill known as the Action Plan for Business Growth and Transformation would amend the Highway and Roads Code to say that the driver is not criminally liable when the autonomous driving system is “on”; rather, liability will sit with the holder of the authorization should a fault in the operation of the autonomous driving system be established. The driver will be criminally liable for offenses committed while driving when the autonomous driving system prompts the driver to regain control of the car or when the driver has knowledge that the autonomous driving system is not working properly.
Knox also said that incremental changes are coming to the EU, in the form of an amendment to the May 2018 Energy Performance of Buildings Directive, which requires the installation of electric vehicle charging stations in new residential and nonresidential buildings alike. In Germany, the federal government aims to increase the number of EVs to one million by 2020 and to six million by 2030. There, a 2016 law stipulates that all new charging stations must be equipped with a standard European charging plug. Germany has also developed a regulatory framework on hydrogen refueling infrastructure, where 46 hydrogen re-fueling stations have been opened, with 33 more expected to be operational by the end of the year.
The French government is predicting to have 1.9 million electric vehicles and 7 million electric charging points installed by 2030. A bill for clean mobility, which will specify the legal framework for the development of EVs, is expected to be discussed later this year in France. The bill should help define the priorities for infrastructure investments, along with proposed financing methods. The existing framework is far-ranging and harmonizes technical specifications applicable to charging infrastructure. It also requires new buildings/car parks to be equipped with charging stations and provides subsidies for the acquisition of Low Emission Vehicles.
Participants also discussed the development of the automotive sector in China, beginning in 1986, when it was asked to address emissions and climate change, to the 2016 publication of the [ASICs-3] plan, which proposed a shift to electric vehicles. Today, the production of “new energy vehicles” entitles manufacturers to a state subsidy, which ultimately results in a tax reduction for the consumer and a “new energy credit” for the OEM. Linklaters Partner Simon Meng observed that it is easier to develop electric vehicles at a lower cost in China than in Europe. Since 2015, the Chinese government has licensed 13 electric vehicle makers. While there is no industrial norm on AVs in China, three Chinese cities have published guidelines for self-driving vehicles. To some extent, China has followed the U.S. approach by not being prescriptive and by enabling cooperation between technologies.
Foley Partner Steve Hilfinger commented on how little binding regulation of autonomous vehicles there is in the U.S., though several states including California, Michigan, Florida, Arizona and Nevada, have enacted legislation or regulation permitting testing and development. At the federal level, the U.S. House of Representatives passed the SELF DRIVE Act, which would permit NHTSA to regulate the design, construction and performance of autonomous vehicles (including cybersecurity requirements). Meanwhile, similar legislation that would support the development of highly automated vehicle safety technologies is stalled in the Senate and may not be considered during the current term. To date, NHTSA has shown a preference for a cautious regulatory approach when it comes to AV’s, issuing voluntary guidance on safety/design elements, such as object detection, robust validation and determining failsafe mode, as well as the interface between human and machine.
Foley Partner Mark Aiello touched on the development of a liability regime under U.S. law, which in the end may resemble the tort liability schemes that exist under various state laws. This subject is receiving a lot of discussion, including input from the insurance industry, and is expected to receive further scrutiny and review.
What challenges has the General Data Protection Regulation created and what opportunities does it bring for the automotive industry?
Participants also spoke about the opportunities and challenges for the automotive sector presented by the EU General Data Protection Regulation (GDPR). Daniel Pauly, a technology, media & telecommunications partner at Linklaters, explained how the advent of new technologies that collect and share data (such as passenger monitoring systems, traffic flow management systems, diagnostic and preventative repair and warranty management systems) may not comply with the regulatory framework.
In 2016, a joint declaration by German data protection authorities and the German Association of the Automotive Industry (VDA) stipulated that any data generated by such systems qualifies as personal data if it includes the Vehicle Identification Number (VIN) or license plate. The GDPR prohibits the processing of such data unless expressly allowed pursuant to statutory permission or individual consent. The legislation also stipulates three principles:
- Privacy by design (any product or service needs to be designed in light of the applicable data privacy framework)
- Data minimization (any product or service which processes personal data may only process the amount of data that is required to fulfill the specific purpose for which it is designed).A privacy impact assessment must be undertaken to understand whether the processing of personal data involves a significant risk to the rights and freedoms of each individual (this will be triggered by the use of automated functions). If you think there is such a risk, you need to discuss the potential impacts with the relevant supervisory authority.
- Individuals have enhanced rights as data subjects, including the right to data portability, enabling subject access requests. Modern control units process 50,000+ categories of personal data – countless software which are not designed for GDPR, including as to the requirements for deletion of data. It is important to bear in mind that huge fines are payable for GDPR breaches, including up to 10 million EUR or 2 percent of total revenues for lesser offenses and up to 20 million EUR or 4 percent of global revenues for more serious offenses.
The future for trade in the automotive sector
Participants also addressed recent developments on Brexit, which have become “cloudier” in the past six months. According to Lorand Bartels, External Senior Counsel with Linklaters’ international trade law practice, in the event of a “hard” Brexit (Brexit without a consensual agreement on transition), there will be significant short-term disruption, which the European Commission will seek to mitigate. Mr. Bartels noted that there is no obligation under the World Trade Organization (WTO) law for customs duties to be applied. Tariffs on cars are 10 percent, which fluctuates depending on the type of vehicle. WTO law states that if you do have customs duties, you apply the Most Favored Nation principle to the same product supplied by a WTO member. There is a cap on customs duties following WTO law, which, legally speaking, should apply but tensions and disputes can be expected. Unfortunately with respect to remedies, it takes four years on average for a case to be determined; and (2) an awarded sanction calculated on an annual basis may not adequately compensate the disputing company.
If a withdrawal agreement is reached, it is expected to result in a continuation of EU law until the end of 2020 (thereby granting extra time to adapt). Post 2020, there will need to be a permanent trade relationship with the EU in the form of a Free Trade Agreement (FTA). An FTA does not deal with regulation in any sophisticated way and as such, mutual recognition would be required. This begs the question of how much the UK can and will want to diverge – otherwise what is the point of Brexit? An FTA will also not eliminate the need for border checks because of the Rules of Origin, which highlights a particularly important point: that is, on Brexit Day, regardless of the terms of the withdrawal agreement, UK products and content will all fall out of EU third-country free trade agreements. Not a single third country has publicly indicated it will say yes to continuing its existing relationship with the UK as if it were an EU Member State without some changes, and the EU will not ask third countries to do so until a withdrawal agreement is agreed to, which is not likely to happen until later in 2018.
Steve Hilfinger of Foley & Lardner also addressed the recently amended CFIUS (the Committee on Foreign Investment in the United States) regime, and the tariff environment in U.S. trade relations. According to Hilfinger, these recent changes focus on U.S. economic security as an element of national security. The reason it may be of concern is that if CFIUS concerns are raised due to a foreign investment where the process was not followed, the transaction can later be unwound. Key risk areas include transactions or targets that include defense activities, export control licenses, government contracts, access to sensitive data and critical infrastructure. As a result of these changes, a broader group of transactions need to be reviewed for CFIUS considerations.
Mark Aiello expanded on the tariff environment, explaining that most FTAs (such as NAFTA) are under negotiation. Recently, the United States, Canada and Mexico have agreed in principle to change and rebrand NAFTA, which has been renamed the U.S.–Mexico–Canada Agreement (USMCA). From a legal perspective, Foley has been examining automotive supply chain contracts in an effort to mitigate the risks of potential tariffs, including contractual terms, duty increases and how these might be addressed in the supply chain.
Key cooperation models emerging in tech M&A around the world
Participants gave an overview of M&A developments in Europe, highlighting deal flows and the novelty of seeing corporate actors investing in start-ups. The M&A processes are not necessarily plain vanilla and the targets are new people- and technology-focused businesses, sometimes involving a product and sometimes not. A minority/majority stake or full control can be purchased. The primary issue is to incentivize key staff, which can be challenging for corporates. (PE funds normally put packages in place to retain management, which is unusual for corporates.) IP is another major issue and a key area for due diligence. This must be protected and owned by the company. Linklaters Partner Pierre Tourres spoke of scenarios in which employees have asserted claims over IP rights and separate negotiations were necessary in order to consummate a transaction. GDPR is also fast becoming a due diligence issue. Employment and tax are two other major issues of interest.
Linklaters partner Simon Meng addressed M&A developments in China, pointing out that the New Energy car industry has been heavily promoted in China and represents a major economic development goal in China. He acknowledged that CFIUS is “top of mind” for many potential Chinese buyers of U.S. technologies. In terms of talent attraction and retention in transactions, some Chinese companies implement dual incentive regimes, which grant two percent of the company during its lifetime. Other companies establish another stock option pool in China, with a six-year period for vesting stock options.
Finally, Steve Hilfinger and Mark Aiello discussed the current North American automotive market, which is in the midst of one of the longest automotive expansion cycles in North American history. Currently, the industry is plateauing from peak levels and valuations have come off 2017 highs, while still attractive. Even more attractive have been valuations venture capital-backed companies in the autonomous vehicle space. In addition, corporates are setting up their own VC funds (e.g. Toyota AI) to get access to technology and talent through investments that they lead, often that include a commercial component.
Mr. Aiello spoke of seeing more customer investment in technology companies than ever before, citing the examples of Ford, Google and Intel, which is indicative of changes to the future business models of traditional automotive companies. One issue to be addressed early in negotiations is the scope of the relationship, including exclusivity asks by larger partners. This is often a tricky balance the value of establishing a key customer relationship with the potential limitations that such relationship may bring on the overall growth of the technology company.