As China grows in stature as a world power, worries that it is using outbound FDI to further its growing economic and military ambitions is causing countries around the world to throw up roadblocks to its access to critical technologies.
Governments are increasingly revising cases where foreign companies are making potentially harmful acquisitions of domestic firms that are developing advanced technologies.
New screening mechanisms
Some countries that lack screening mechanisms are setting them up, while others that already screen are introducing new requirements. In September, the European Commission joined countries such as the US, Canada, Australia and Japan when it proposed a new regulation to establish a European framework for screening FDI.
Though FDI screening laws do not cite countries by name, it is an open secret that China is the usual focus. One reason is the fact that Western companies developing sensitive and advanced technologies are a key target of Chinese investors, including state-owned enterprises or companies with close ties to the Chinese government.
Another concern is the shroud of mystery that sometimes surrounds the identity of the true purchaser. Tracing the ultimate ownership of Chinese companies “can take you to some very strange places”, including Caribbean islands, according to an expert testifying at a recent US Senate Banking Committee hearing.
Finally, China’s lack of reciprocity is resented because the country enjoys the benefits the West’s open markets, while internally limiting the sectors it allows foreign investors to enter.
Mikko Huotari, head of the Berlin-based Mercator Institute for China Studies’ programme on China’s foreign relations, says there has been a big drop in Chinese investment this year since the Chinese government implemented restrictions on outward FDI. “There has been much less investment in soccer clubs and real estate. But the patterns of investment that might create concerns are still being encouraged. The sectors that might have critical technologies are even more encouraged than before,” he says.
Regarding inbound FDI, Mr Huotari says: “There has been some opening of sectors where the Chinese government sees the benefits of developing new industries. But it is still very evident that China is not turning into a liberal FDI market.
“It is also not doing away with joint-venture regulations. And we have heard that Communist Party organisations, even in Western companies, are becoming more prominent.”
Mercator found that Chinese companies invested €35bn in Europe in 2016 – up 77% from 2015. Advanced manufacturing assets accounted for more than one-third of the total. Still, according to the European Commission, Chinese investment in the EU represented just 2% of total EU inward FDI.
A common EU framework
The European Commission’s proposed regulation would apply to FDI that affects critical infrastructure; the security or supply of critical inputs; access to or control of sensitive information; and critical technologies. Investment controlled by a foreign government – an issue of particular anxiety – could also be subject to screening.
Twelve EU member states – including France, Germany and Italy, which pushed the European Commission to act – already have some sort of screening process, but it varies significantly among states. The proposed regulation would establish a common framework or baseline for screening incoming FDI on grounds of 'security or public order' while leaving it up to each state to establish its own rules. The European Commission would screen investments in EU-funded projects involving fields such as research, space, transportation, energy and telecommunications. It establishes a formula for co-operation between members when an investment in one state would have repercussions for another or for the EU as a whole.
The proposed regulation is not uncontroversial, says Christian Duvernoy, a partner in the Brussels office of law firm WilmerHale. He notes countries such as Estonia and Finland have objected to it, and believes the European Commission has adopted a relatively “soft” approach. Member states retain the power to accept or reject a specific investment within their borders. However, they would need strong grounds for ignoring the advice or concerns of other states, he adds.
Meanwhile, in July 2017 Germany approved an amendment to current law so that deals where a foreign investor acquires 25% or more of the voting rights in a German company could undergo a government review. It followed two controversial Chinese acquisitions of German technology companies. According to EY, Chinese investment in Germany rose from $530m in 2015 to $12.6bn in 2016.
The UK, for its part, has proposed legislation that would enable the government to take a 'special' or 'golden' share on all future new nuclear construction projects in the country where national security concerns arise, thus preventing the plant from being sold without government consent. The government also plans to review its public interest laws, and to require government approval of the ownership and control of critical infrastructure.
Caution in the US
In the US, the Committee on Foreign Investment in the United States (CFIUS ) screens FDI purely for its impact on national security and may add requirements or block a deal. In rare cases, the president may prohibit a deal from going through, as happened in September when Donald Trump barred the acquisition of Lattice Semiconductors by a state-controlled Chinese venture capital fund.
Meanwhile, the Senate is considering whether the CFIUS law needs to be updated, including expanding it to include greenfield investments. This involves a difficult dance between encouraging FDI and making sure it is the right kind of investment.
In 2016, new investment from China into the US totalled $27.6bn, up $19.8bn from $7.8bn in 2015, although it made up less than 10% of new investment, according to the Bureau of Economic Analysis. Data from CFIUS shows that China was one of the top five source countries for acquisitions of US critical technology companies in 2015, with five deals.
Expert witnesses at the Senate committee hearing described the difficulties in screening FDI. They noted that discovering the ultimate acquirer requires “resources and aggressive use of intelligence sources to do a deep dive” into financing.
CFIUS is also dealing with a growing volume of cases and an increasing complexity of deals, at a time when, experts say, the Chinese government is determined to end its dependence on foreign technology and trying to circumvent both CFIUS and US export controls, and is focusing investment on next-generation technology such as autonomous vehicles, artificial intelligence, robotics and aerospace technology.
Senators at the committee hearing voiced concern that a series of small firm acquisitions, while in themselves not threatening, could add up to a valuable resource. They also cited Chinese FDI in technology start-ups.
Clearly, there will be no easy answers to this game of cat and mouse.