Building walls seems to be in vogue right now, whether a physical barrier or a legal one to keep others out. Many Western countries are busily employed in the latter strategy, hoping to exclude Chinese companies hungry to acquire the West’s advanced technologies through mergers, acquisitions or insider access.

The US has had a mechanism to screen inbound investment for national security threats since 1975, when the Committee for Foreign Investment in the United States (CFIUS) was established. But amid growing sensitivity about rising Chinese investment, in a rare bipartisan effort Congress passed the Foreign Investment Risk Review Modernisation Act of 2018 (Firrma), which expands the scope of CFIUS’s review and the range of foreign investments it can block.


Firrma focuses on whether a transaction “involves a country of special concern that has a demonstrated or declared strategic goal of acquiring a type of critical technology or critical infrastructure” that would affect US national security leadership. Red flags are raised by deals that reveal a “pattern” or “cumulative control” related to a critical technology that could expose sensitive information about US citizens or create cybersecurity vulnerabilities. Sales, leases or concessions of developed or undeveloped land near sensitive US government facilities are also covered.

Firrma's tight grip

Firrma became effective in August 2018, to be implemented in stages. Though the scope of CFIUS’s review is now much broader, in most cases foreign investors can still decide whether to file a voluntary request for CFIUS approval as under the old law. However, ‘short-form declarations’ are now mandatory under a two-year pilot programme governing foreign acquisitions of ‘critical technologies’ in 27 defined industry sectors. CFIUS can then take further action. Guidelines on ‘emerging and foundational technologies’ and others are awaited.

The pilot programme applies to all direct and indirect investments in a US critical technology, whether controlling or non-controlling, if the buyer would gain access to material non-public technical information, a seat or observer rights on the board of directors, or decision-making powers regarding its critical technology.

The problem, says Antonia I Tzinova, a partner in the Washington, DC office of law firm Holland & Knight, is that there’s no “bright-line” test (such as a percentage of equity held) to determine whether a foreign investor has control or decision-making influence. “You have to perform a functional, granular analysis,” she adds.

As foreign investors consider a US acquisition or investment, the key question they now ask is: “Does the mandatory filing apply to me?” according to Ms Tzinova. Especially challenging to classify are “dual-use” technologies intended for commercial use that could have a secondary military or security application. If the deal does fall under the pilot programme, her clients often ask: “Do I want to go through with it?” – especially since there is now a $300,000 filing fee.

Ms Tzinova’s colleague, Ronald A Oleynik, says from a US seller’s perspective the question becomes: “Is the deal going to go through? They want to know the risks before they go down that road.” Firrma does make an exception for indirect foreign investment made through US-based investment funds, managed by a US general partner, with foreign participation that is strictly passive, Mr Oleynik notes.

EU moves

The EU has also woken up to this potential threat. A regulation published in March that will apply 18 months later aims to deter FDI that “may affect security or public order in the EU”.

The regulation sets up the first EU-wide screening mechanism so the European Commission and member states can share information and concerns about specific investments. Currently, only 12 of the 28 states have domestic laws regulating FDI, and these vary widely. Those of Germany, France and England are among the most stringent.

The regulation does not displace national legislation, but is intended to establish common criteria that states can consider in domestic law, such as the effects of an FDI project on critical technologies and infrastructure, supply chains, sensitive information, and “whether the investor is controlled by the government of a third country”.

The EU “co-operation mechanism” involves a multi-step process. It begins with the member state screening the investment, then informing the European Commission and other states. Affected states can comment and the European Commission can issue an opinion. But the final decision on approving FDI remains with the host state. Portugal and Italy have resisted attempts to force compliance.

“It makes it more burdensome at the national level,” says Tilman Kuhn, a partner in the Düsseldorf and Brussels offices of the law firm White & Case. “There will be more red tape and more opportunities for competitors and sceptical member states to stir up opposition.”

The EU has not set up an agency similar to CFIUS to screen deals, he notes. He expects the director-general for trade to be in the lead role, with others called on as needed.

Target China?

Though China is the primary, if unnamed, target of the EU rule, Mr Kuhn says FDI from the US may also be viewed with some suspicion following revelations in 2015 that the National Security Agency was conducting wiretaps in Germany. What EU politicians and companies want, he says, is a level playing field where companies have access to the markets, reciprocity and the absence of state influence in the private sector. 

Indeed, in March 2019 China passed a new law to ease inbound FDI. It establishes a “negative list”, opening China’s market to FDI in all sectors not specifically listed, but has been criticised as insufficient.

Both the US and EU have stressed they remain open to and welcoming of FDI. However, Chinese FDI into these locations has plummeted due to strict capital controls in China and new limits on overseas investment by its companies, along with Western countries’ tighter scrutiny of deals.

PwC’s 2019 global CEO survey found just 17% of Chinese chief executives viewed the US as key to their company’s overall growth in 2019, compared with 59% in 2018. In 2018, the Rhodium Group concluded, Chinese FDI into the US slumped 84% from $29bn in 2017 to $4.8bn in 2018 – and actually turned negative if $13bn of divestitures is considered.

Similarly, Rhodium found Chinese FDI in Europe fell 40% from €29.1bn in 2017 to €17.3bn in 2018 – the bulk of it going to Germany, France and the UK. State-owned enterprises’ share of that investment fell to 41% from 71%.

Whether the baby has been thrown out with the bath water remains to be seen.