In March, the European Union passed a regulation, the most binding legal instrument at its disposal, to strengthen foreign-investment screening processes throughout the union. The law came into force in April, and member states have until October 2020 to comply with its requirements. From the moment the issue was first raised by a handful of member states, it only took the EU two years to approve the regulation — and by 26 out of 28 of them, with only Italy and the United Kingdom abstaining from the final vote. However, the text was substantially watered down to ensure its speedy approval in the face of significant internal debates. As a result, the framework set up by the regulation will require substantial strengthening if it is to achieve its intended objectives. To do this, the EU could emulate some aspects of the U.S. screening mechanism, the interagency Committee on Foreign Investment in the United States (CFIUS).
Why the EU needs foreign-investment screening
The EU prides itself on its openness to foreign direct investment (FDI). In 2017, it was the top destination for FDI in the world. Yet certain member states have grown concerned that political and strategic, rather than economic, considerations have guided FDI from certain foreign authoritarian regimes, most notably China. Over the past decade, Chinese FDI into Europe increased tenfold, with a peak of €37.2 billion in 2016. And with Beijing exercising tight, and growing, control over Chinese companies, the investments and acquisitions made by those companies very often have political motives. The Made in China 2025 plan states explicitly the country’s ambition to become a dominant player in several key sectors of the 21st century’s economy, such as aeronautics, biopharmaceuticals, or intelligent manufacturing. This led German leaders to see the 2016 purchase of the German robotics firm Kuka by a Chinese conglomerate as part of Beijing’s national strategy.
The Kuka case prompted Germany’s government to strengthen its national screening mechanism. In its wake, European policy makers realized the necessity of an EU-wide approach. Indeed, not all EU member states have the capacity and expertise to identify, restrict, or block politically motivated acquisitions. In addition, having 28 different screening mechanisms creates a heavy burden on legitimate investors. Finally, the high degree of integration between EU economies means that it only takes one country refusing to screen investments or, intentionally or otherwise, setting up a loophole-ridden mechanism to create vulnerabilities for the whole union. The risks created by Italy’s recent economic re-alignment toward China illustrate this last point.
Where the EU Stands and how it got here
In February 2017, conscious of the need for a more unified European approach, France, Germany, and Italy wrote an official letter to the European Commission enjoining it to look into the matter. The commission’s leadership was immediately on board, and President Jean-Claude Juncker declared that same month that Europeans were “not naïve free traders.” However, monitoring and blocking foreign investments on the basis of the geostrategic risks they may pose lies at the junction of trade and national security. The EU institutions have broad powers on the former while member states have the final say on any issue pertaining to the latter. This explains why the European conversation around foreign-investment screening has been driven by the trade authorities. It also may explain why the new regulation does not explicitly carve out a role for the European External Action Service, the EU’s foreign policy arm, in the new screening framework.
The national security dimension of the issue also means that any EU-wide decision on foreign-investment screening requires agreement, or at least no explicit opposition, from all 28 member states. However, the proposal for the regulation ran into strong resistance from several EU countries. Southern European countries, most notably Portugal and Greece, were concerned that it would hamper their access to investment their economies have come to rely on. Meanwhile, northern European states, most notably in Scandinavia, saw EU-level foreign-investment screening as protectionist and incompatible with the union’s commitment to open markets. Lastly, in Italy, one of the three initial supporters of the initiative, a populist coalition that called for strengthening commercial ties with China swept to power shortly before the text’s adoption in 2018.
The new regulation establishes a screening framework that is binding on member states, but its content has been significantly watered down from what was initially envisaged as a result of these internal debates. Except for foreign investment pertaining to projects of “union interest” (such as the European satellite navigation system Galileo), the Commission can only issue opinions at the request of a member state. In addition, its opinions are non-binding. This means that member states have the final say on approving a foreign acquisition, even when the investment touches on projects of union interest.
Since the European Commission was granted only limited powers under the regulation, the EU must still rely on each member state to set up its own national investment-screening mechanism in order to defend effectively the union from politically motivated acquisitions. And the decision to do so rests entirely with member states. To improve expertise sharing and coordination between member states, the regulation does require them to issue yearly reports about foreign investment in their territories and about the application of their screening mechanisms, when applicable. The regulation also lays out criteria all national screening mechanisms must respect.
As of July, 15 member states had some form of investment screening in place, with Sweden about to follow suit. Not only does that leave close to half of the EU without any form of mechanism in the works, all existing ones are not equally effective. For instance, only foreign investment in the energy sector is subject to scrutiny in the Netherlands. In Hungary, a seemingly strict screening process may be undermined by a lack of political will. Considering that in March 2019 the country’s parliament granted de facto diplomatic immunity to a Russian bank strongly suspected of conducting intelligence operations in Europe, there is ground to question the extent to which Hungary’s government will make use of the large discretion the screening mechanism affords it.
Lessons from the United States
The establishment of an EU-level screening mechanism is an important, if modest, first step. The adoption of the regulation brings oversight of foreign investments—and their national security implications—within the European Commission’s purview. The non-binding opinion process will inform the public, the commission, and member states as well as provide a channel for political debate about the potential risks from certain acquisitions. The EU should continue to build on the new screening framework and strengthen it over time. For now, though, the real responsibility remains with the member states. They must take immediate steps to close loopholes and, in some cases, put screening frameworks in place.
European policymakers can learn from the history of CFIUS in the United States, its enhancement over time, and its successes and limitations as they work to expand the new EU mechanism or strengthen national-level screening.
CFIUS does several things well. It completes hundreds of reviews per year, using an interagency process led by the Treasury that that includes foreign policy, national security, law enforcement, and other officials. Its ability to review foreign acquisitions for threats to national security is not limited to certain sectors. It has shown a willingness to block or restrict transactions, or to force sales of sensitive assets to appropriate buyers before allowing an acquisition to proceed.
CFIUS was also enhanced under the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). The law allocated more money and staff to the committee and gave it the ability to review foreign acquisitions that threaten national security, under certain circumstances even if the foreign stake is non-controlling. This September, the Department of Treasury proposed new permanent rules that, upon adoption, would fully implement FIRRMA. Finally, under a pilot program, CFIUS now requires prior disclosure in 27 priority areas related to critical technologies, prohibiting completion of the transaction without initial CFIUS review.
CFIUS also has several weaknesses that the EU and its member states should avoid. It does not cover “greenfield” investments (that is, an investment in which the investor constructs new facilities from the ground-up), only acquisitions of existing businesses, operations, or plants. This is not a problem under the new EU regulation. There are also limitations on what is construed as a foreign investor for CFIUS purposes under FIRRMA. Controlling and certain passive positions are now reviewable. However, there is an exception for foreign investors that are limited partners in U.S.-based private investment funds such as private equity or hedge funds, unless they have access to certain information or decision-making authority. While the assumption that purely passive limited partners would have no influence seems reasonable, this will be tested in coming years. CFIUS will need to monitor this provision closely to ensure that it does not became an attractive loophole facilitating evasion of appropriate review.
More broadly, the lack of detailed information about foreign investment in the United States, means that CFIUS may miss certain transactions. While it is likely that mergers and acquisitions involving a major multinational will generate a lot of press reports and securities filings, smaller investments may go undetected. Better information collection by the government is necessary to build out a comprehensive survey of the landscape of foreign investment, which would inform CFIUS review and the allocation of resources to priority areas. Similarly, better understanding of the profile of foreign investment flows in the EU, especially through private funds, would help inform Europeans’ screening processes.
While CFIUS has its flaws, Europeans would do well to emulate its levels of staffing and resources as well as its seamless integration of economic and national security considerations. The investment screening framework put in place by the March regulation can only be the first step. Strong, independent authorities at the national level, as well as far more extensive monitoring and enforcement powers for the EU-level are needed if Europe is going to effectively protect itself from strategically motivated investments from foreign authoritarian states.