June 8, 2021
The growing global alignment in regulating Chinese trade and investment
The United States has made no secret about its efforts to prevent China from accessing US advanced technologies and know-how. As the Biden administration continues its focus on rebuilding traditional alliances and restoring multilateral remedies to global issues, early signs indicate that it will continue US efforts to bring the EU and NATO into alignment on issues relating to trade and investment with China. The upcoming G7 and NATO summits will provide the Biden administration an opportunity to signal a united front with allies in response to variety of challenges the West sees China as posing, embodied in dramatic fashion in the acrimonious US-China bilateral summit in Anchorage in March.
In so doing, the Biden administration will be building on one of the few areas of enduring bipartisan consensus in Washington. In past years, the United States has substantially tightened the requirements on commercial trade with China as well as on foreign investments (FDI) in US advanced technology firms. These efforts began in part with the Obama administration’s crackdown on Chinese attempts to acquire US semiconductor firms, kicked into overdrive with the Trump administration’s aggressive readings and expansions of its various trade and investment authorities, and, surprising some, have continued apace in the early stages of the Biden administration.
In addition to the United States’ domestic efforts, it has engaged in an extensive diplomatic effort to align its allies’ policies with its own. When Congress expanded the authority of the Committee on Foreign Investment in the United States (CFIUS) in 2018, it permitted CFIUS to give preferential treatment to investments originating from countries that themselves had implemented FDI screening processes similar to CFIUS. Tom Feddo, former Assistant Secretary of the Treasury for Investment Security, recently noted that, in crafting its policies, the United States made outreach to sixty countries to encourage them to align their policies with those of the United States. To encourage sixty nations to impede the free flow of capital into their respective private sectors was no small piece of economic statecraft.
For the Trump administration, often seen as obdurately unilateralist, this recognition that the policy goal requires multilateral implementation underscores the urgency: Preventing adversaries from acquiring advanced technologies in the United States alone simply invites them to acquire them elsewhere. Any effective response requires the United States and its allies to coordinate their approaches.
These efforts are beginning to yield their intended results. In March 2019, the European Union issued a regulation establishing a framework for screening foreign investment on national security grounds by its member states. The EU’s framework did not establish a supranational screening body, but did set a minimum threshold for member states to implement and established a process to foster information sharing and input by all member states in reviews conducted by any single member state.
Further, in recent months, two key allies, the United Kingdom and Germany, have adopted rules implementing their version of these processes. The post-Brexit UK, of course, issued its regulations independent of the EU’s umbrella regulation. Nevertheless, the similarities across the regimes are early confirmation that the United States’ policy is having its desired effect.
For comparison purposes, a brief summary of CFIUS is provided, followed by a summary of the UK’s process and Germany’s process.
United States’ CFIUS
CFIUS jurisdiction is triggered when a non-US person, or any entity ultimately controlled by non-US persons, acquires voting “control” of a US business. “Control” here is not a bright line and can be acquired when a foreign person acquires as little as 10 percent of the US business. Alternatively, for businesses with certain characteristics (e.g., they work with “critical technology,” they own, operate, or service “critical infrastructure,” or they collect personal data of US citizens), investments of any size, if they afford the investor certain governance or information access rights, trigger CFIUS jurisdiction.
With jurisdiction, CFIUS has the authority to block, unwind, or place conditions on the investment to address any risk to national security. This means that parties that trigger CFIUS jurisdiction and do not get approval remain exposed to the potential for significant adverse action by the regulator in the future. This risk extends in perpetuity, and CFIUS is now commonly reviewing transactions more than five years old. For transactions involving “critical technology,” filing before closing the transaction is mandatory. Parties that fail to make a mandatory filing can be penalized up to the value of the transaction itself. It is because its powers are so vast that CFIUS has been referred to as the “ultimate regulatory bazooka.”
The United Kingdom
In November 2020, the UK introduced reforms to its FDI screening process. Similar to the US system, the UK’s process implements a “hybrid” review model. Transactions generally above certain thresholds trigger jurisdiction, and parties can voluntarily notify the regulator to ensure no adverse consequences post-closing. A subset of transactions in any of seventeen sensitive sectors (including artificial intelligence, communications, defense, and energy) require pre-closing notification.
The UK’s system includes a number of “trigger events,” i.e., thresholds that allow for, or require, as the case may be, reporting. Similar to CFIUS, jurisdiction can attach at ownership as low as 10 percent of a company’s equity. Additionally, once notified of a transaction, the regulator has three options regarding the transaction: (i) approve; (ii) approve with conditions or (iii) prohibit.
Unlike CFIUS, whose jurisdiction exists in perpetuity, in the UK the regulator has five years to “call in” to review non-notified transactions, which is reduced to six months for transactions that the parties make the government aware of. Given the extent of recent CFIUS enforcement against transactions that have occurred more than five years prior, this “statute of limitations” of sorts is a small but notable departure from US policy.
The reforms in the UK were intended to be far-reaching. In the seventeen years prior to reforms, only twelve transactions were reviewed on national security grounds. The UK predicted that with its reforms, more than 2,200 transactions will be informally discussed with the UK government each year, and up to 1,830 transactions per year could be formally reviewed.
In 2016, following the Chinese acquisition of robotics firm Kuka, and the failed attempt by a Chinese company to acquire German semiconductor company Aixtron (after CFIUS blocked the US-portion of that acquisition), Germany embarked on a wholesale revamp of its FDI screening process.
In a series of revisions, German articulated a pre-closing “suspensory” period for investments in certain sectors, and differentiated among German, European, American, and other foreign investors, with varying requirements applying to industry and country of origin of the investor.
The most recent revisions of Germany’s system came in May 2021. In these revisions, Germany clarified the expansive scope of “high tech” companies subject to mandatory pre-closing approval and articulated new thresholds of acquisitions that trigger jurisdiction.
Notably, Germany reserves the most scrutiny for investments in the defense and encryption sector (i.e., “Category 1” companies). Any non-German investor acquiring 10 percent or more of the voting power of these companies must obtain pre-closing approval from the Ministry of Economic Affairs and Energy.
The restrictions loosen in “Category 2” companies–i.e., critical infrastructure companies. Here, non-EU or European Economic Area (EEA) companies must obtain pre-closing approval when acquiring 10 percent or more of the company’s equity.
Newly articulated “Category 3” companies are “high tech” companies, such as those involved in artificial intelligence; automated and autonomous driving; robotics; semiconductors; IT security; airlines; dual-use products and more. For these companies, acquisitions of 20 percent or more of the voting rights by a non-EU or EEA investor requires pre-closing clearance.
A catch-all “Category 4” reserves jurisdiction for acquisitions of 25 percent or more of any other company’s voting rights. These acquisitions do not require pre-closing approval. Similar to CFIUS, the Ministry reserves the right to review the investment post-closing, in the event that any particular investment in a Category 4 company gives rise to a regulatory concern.
What does this mean?
Consensus Breeds Success
A few things are of note here. First, the United States’ policy goals in this area have proven strikingly durable over three administrations that hardly see eye to eye on other matters. Moreover, Congress expanded CFIUS authorities in 2018 with overwhelming bipartisan support, and there has been bipartisan discussion of further expanding the Committee’s reach, for instance to regulate research collaboration between US and foreign educational institutions–again, primarily aimed at Chinese access to US university research labs and personnel.
Further–expansion of CFIUS authorities to regulate investment activity, as well as US diplomatic efforts to encourage similar regulation abroad, must be seen in light of significantly more aggressive regulation of commercial trade. The Department of Commerce’s ongoing campaign to restrict exports to Huawei, and its recent actions blacklisting Chinese companies that are seen to be a part of China’s “Civil-Military Fusion” program, are pillars of the same broader policy structure that seeks to prevent Chinese access to advanced technologies and know-how.
The bipartisanship in Washington is not limited to trade and investment issues. Indeed, in China, it seems both sides of the aisle have found a political scapegoat. On the right, growing Chinese militarism, its state-dominated economic system and its articulated desire to dethrone the United States as the world’s superpower invite a muscular response. On the left, its actions in Xinjiang, its labor conditions generally and its status as a larger emitter of CO2 than all other developed nations combined leaves no quarter for doves. Put another way, it is all downside for politicians in Washington to advocate for improved relations with China.
While it can be difficult for the United States to assemble and maintain coalitions when our partisan divisions infect our foreign policy, here observers should expect that the United States will remain committed to the framework it is only just beginning to establish. This unity has already proven remarkably effective in encouraging our allies to follow suit. With the EU establishing a framework, and the UK and Germany implementing systems that closely resemble CFIUS, it appears that our NATO allies are responding to US leadership on trade and investment policies.
These early successes must not obscure the difficulty of the diplomatic effort that lies ahead. Apart from our traditional NATO alliances, Japan, South Korea, Taiwan, India. and many more non-NATO allies each have tremendous capacity to create advanced technologies, and all face significantly different strategic calculations in their interactions with China, Russia, Iran, and other US adversaries.
Here, too, there are signs of momentum. Japan updated its FDI screening policies in May 2019 to adopt a system that bears striking similarity to CFIUS. Japan further tweaked its policies in April 2020, by adding advanced medical sciences as a sector that requires pre-closing notification, which has been interpreted as a rebuke of Chinese actions in the wake of COVID.
In April 2020, India announced a requirement that foreign investments from all countries that it shares a border with must receive governmental approval. This announcement notably coincided with the building hostility with China in the disputed Ladkah region, which ultimately led to fighting that left at least twenty Indian soldiers dead.
Despite momentum from non-Western allies, US policymakers must recognize that a wide swath of countries will occupy a “middle ground” in the competition between the United States and China for technology leadership. Indeed, the economic success of middle ground countries may in large part be bolstered by their skillful manipulation of the US-China relationship. In this regard, policymakers’ prescient design of a “carrot and stick” approach with CFIUS and trade policy will allow for relatively nimble (by regulatory standards) adjustments as third countries’ postures toward the US change over time.
Notwithstanding the impossibility of perfection, for US policy to succeed, we must maintain constant diplomatic engagement with middle ground countries. A tight club of NATO allies is insufficient to effect US policy goals, and the effort will not endure a superficial “with us or against us” posture.
Playing the Long Game
As countries update their FDI review processes, US policymakers should expect that their appetites for strong regulatory stances vis-à-vis China will ebb and flow based on their political and economic conditions over time. US policymakers will need to pay close attention to sector-specific conditions around the world and should expect that Chinese acquirers–often acquiring for strategic, rather than economic, purposes–will make attractive investment offers when companies (or countries) face headwinds. The economies of southern Europe, still vulnerable from the shockwaves of two economic collapses ago, and the politics of Eastern Europe, which have never fully aligned with their Western European counterparts, will continue provide reliable fissures for China to exploit in its investment diplomacy, just as it has skillfully done in its “belt and road” infrastructure projects.
An important early test for a close ally will be the UK’s willingness to hold the line as its economy adjusts to post-Brexit realities. Its long and tortured decisionmaking process regarding the use of Huawei equipment in its telecom networks portends similar difficult decisions over time. More broadly, how the EU builds on its vague “comprehensive agreement on investment” with China, signed in the waning hours of the Trump administration, will provide an early illustration of the difficulties in managing intra-EU and EU-China relations. The recent sanctions by the EU relating to China’s actions in Xinjiang, and Chinese countersanctions, have impeded EU/China progress on the CAI and may inure to the United States’ benefit as it seeks alignment with EU and NATO allies on policy vis-à-vis China.
A few pieces of obvious low-hanging fruit for the United States to build consensus are the very trade and investment regulatory regimes that it is building. CFIUS now has an inborn preference for countries that align their policy with the United States’–which has already been exercised in favor of investments originating in Canada, the UK, and Australia. Further, the Department of Commerce’s regulation of commercial trade always has been more permissive of trade with allied nations. These policies should be updated continuously to remove investment and trade barriers with partners who prove reliable. However, particular bad actors at the subnational level–for example, a UK firm that re-exports restricted technologies to China or Iran–should swiftly find itself on a blacklist, and not just a US blacklist, but a multinational one.
US policymakers should also look more broadly for tools to help strengthen ties with its allies. Perhaps an opportunity can be found in an urgent US national security risk: In seeking to mitigate defense contractors’ supply chain risks, the Department of Defense and other federal agencies should be strategic in their direct purchasing activities and in helping US prime contractors identify lower-tier subcontractors whose technologies can be integrated into Defense Department programs. One may suspect that our national security constituencies are reluctant to acknowledge that anything vital cannot be onshored. Still, the reality of supply chain complexity provides an opportunity to tighten commercial relationships between the Department and allied nations’ private sectors. This may prove beneficial in mitigating both supply chain risks and broader trade policy risks.
US policymakers would be negligent not to anticipate that China will pressure third countries to take a hard stance against US investment, thereby turning the tools we are working to create against us. While the reciprocity built into our system may help to mitigate this risk, China’s deftness in dangling access to its markets as a reward for favorable policies will make for a lot of hard decisions in third countries. Moreover, these decisions may prove less hard if the US reverts to a more abrasive and unilateralist posture in the future. One can imagine that a raft of tariffs against NATO allies in the future, or threats to abandon NATO altogether, may result in their questioning their national security interests in welcoming US investment in their countries.
Indeed, the German model already has an inborn preference for EU investors, and Germany currently reviews more US FDI transactions than Chinese. The UK, Germany, and the rest of the EU are already highly skeptical of US consumer tech companies, which led to data privacy and “digital tax” proposals, and the United States has built its China policy on the notion (more or less) that advanced technology leadership equals national security. Which is simply to say that US policymakers cannot take the current momentum and indications of alignment with the EU and NATO as givens; they can be squandered. We do not currently have a thoughtful policy for dealing with countries that implement FDI screening processes at our urging, but use them to restrict US investment.
The US private sector must be vigilant in relaying difficulties it faces investing abroad to policymakers, should such a situation come to pass.
Finally, current US efforts cannot be seen as an endgame. The most successful version of these policies, by their terms, will result in a bloc that significantly restricts trade with, and investment from, China. That outcome is only successful if used as way to encourage China to re-engage as an equal stakeholder in the rules-based international order.
Summing it up
The rapid revisions to US FDI and trade policy and the fast momentum the United States has helped to create in its diplomatic efforts reflect a near uniform consensus in the United States, and a growing consensus among our allies, that cross-border trade and investment are squarely issues of national security. Traditional US transatlantic allies appear to be serving US interests, and other countries with complex relations with China are adopting FDI screening processes that mimic CFIUS. The numerous efforts to revise statutory and regulatory regimes are an unmistakable signal that the view of China as a rival, and indeed a threat, to the established global order, is both widespread and likely to endure.
John Kabealo is the founder of Kabealo Law, a firm that specializes in CFIUS reviews.
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