Screening of Chinese investments intensifies[1]*
In recent years, the “screening” of proposals for inward foreign investment has proliferated.[2] More countries around the world have introduced processes for the review of such proposals, often in particular sectors or above particular thresholds in terms of value or proportion of shares, with the potential to reject investments or permit them subject to conditions. The basis for review is increasingly linked to national security, although broader public interest issues are also at play. Several countries with existing screening mechanisms have revised or replaced them, typically widening the scope of reviewable investments to additional areas or lower thresholds. The “return of investment screening as a policy tool”[3] has legal, political, and economic implications.
Screening remains largely the province of developed countries — with mechanisms first introduced in Australia, Canada, the United Kingdom, and the United States in the 1970s — although shifts are also occurring among developing countries. UNCTAD lists 29 jurisdictions with “FDI screening laws,” including the European Union, whose regulatory framework governing (and encouraging) FDI screening by member states took effect in 2020. The European Commission recently identified 18 of 27 EU member states with screening mechanisms in place, three of which mechanisms were introduced in 2021, and five of which countries do not appear on the UNCTAD list.[4]
Developing countries with recently introduced screening mechanisms include India (2017),[5] South Africa (2019, although the relevant amendment has not yet taken effect), and the Philippines (2022). Established mechanisms exist in Mexico, Russia, and China (since 2011, with a formal national security-specific review system—replacing existing laws—created more recently in 2020). Many other countries, including Viet Nam, have proposals to introduce screening.
Targeting of Chinese Investments
Recent screening developments and actions appear to have been directed disproportionately at Chinese investment, which has spread worldwide in the last two decades, with Europe the recipient of the largest share. From 2000 to 2021, China’s outward stock of FDI increased 93-fold compared to a 5.6-fold increase in global FDI stocks over the same period. Countries such as Australia, Canada, and the United States all saw huge increases in the stock of inward Chinese FDI, with inflows peaking over 2016–2017.
Alongside the large volume of Chinese investment, the significance of foreign investment by Chinese enterprises that are owned or controlled by the state has raised foreign policy concerns in other nations, especially in sectors such as energy, resources, and telecommunications.[6] These concerns have been heightened by the enactment of China’s National Security Law in 2015 and National Intelligence Law in 2017, as well as the enhanced Military–Civil Fusion strategy that was also set out in 2017. Collectively, these may allow individuals and corporations to be co-opted into supporting national security and intelligence objectives of the state. These initiatives, undertaken under the leadership of Xi Jinping, have contributed to the growing perception of China as a strategic threat to Western democracies and thus to the increased screening of Chinese investments in Australia, Canada, Europe, and the United States. In particular, they have driven innovations in screening policy that focus on investments in so-called critical technologies, infrastructure, and personal data-intensive sectors.
Domestic screening laws and policies do not typically identify China by name. Thus, for example, a recent U.S. Presidential Executive Order refers instead to “investments directly or indirectly involving foreign adversaries or other countries of special concern” as possibly posing an “unacceptable risk to United States national security.” More specifically, the order reiterates the indication in the Foreign Investment Risk Review Modernization Act of 2018 that “[o]ne factor for the Committee on Foreign Investment in the United States [CFIUS] to consider … is that ‘national security risks may arise from foreign investments involving “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 United States leadership in areas related to national security.”’
The blocking of Chinese investments, whether within formal screening mechanisms such as CFIUS or through other legislative contexts, is nevertheless becoming commonplace in multiple countries. In June, Italy reportedly used its FDI screening mechanism to oppose an investment by a Chinese robotics company in Italian company Robox. In August, the United Kingdom used its recently revamped screening law to prevent Hong Kong company Super Orange from acquiring electronic design company Pulsic. In November, Canada ordered three Chinese companies to divest themselves of certain investments in critical mineral companies, following national security reviews pursuant to updated guidelines under the Investment Canada Act. Also in November, Germany reportedly blocked Chinese investments in two semiconductor companies.
Economic Implications of Screening
The economic impacts of screening become crucial to understand against the background of these ostensibly political reasons for enhanced screening of inward Chinese investment. While difficult to test, one hypothesis is that a host country’s screening may chill FDI by adding to financial costs (e.g., associated with applying for approval), delays, and uncertainty, potentially eliminating the commercial viability of a proposal.
Slightly easier to observe than such a chilling effect are the effects of blocking transactions, which involve not only the foreign investor but also the local investment target. Stopping a proposal by a foreign investor in a domestic company may lead to that company having to raise funds on less favourable terms, at the expense of existing shareholders. Such an effect was seen after the Australian Treasurer rejected a proposal by Baogang, a Chinese investment group, to take a minority stake in Northern Minerals Limited.
Another possible outcome is that an alternative buyer/funder may not be found, leading to liquidation, loss of jobs, and disruption of valuable projects, as occurred after a Chinese state-owned enterprise withdrew its planned acquisition of Probuild, apparently due to national security concerns raised by the Australian Treasurer. This example highlights transparency difficulties in that studying the rate of blocking is complicated by the fact that proposals are often withdrawn before the screening process has led to a formal rejection but after the investor has received indications of that likely result.
The perceived challenge of Chinese investment is not the only motivation for the tightening of screening policies. Other reasons include digitalization and related privacy concerns, the increasing importance of global value chains, and the continuing COVID-19 pandemic. Countries’ responses to Chinese investment and other economic and political developments, through screening, may also have been modulated by their different obligations under international investment law.
Potential for Investment Treaty Claims by Chinese Investors
According to UNCTAD, China has in force 106 BITs and 23 other treaties with investment provisions (collectively, 128 IIAs). These include, most recently, a preferential trade agreement (PTA) with Cambodia, and the RCEP—between the 10 member states of the Association of Southeast Asian Nations (ASEAN) and five of ASEAN’s six PTA partners (Australia, China, Japan, New Zealand, and the Republic of Korea)—both of which entered into force in 2022. In addition, the European Union concluded negotiations with China for a Comprehensive Agreement on Investment at the end of 2020.
This large volume of IIAs, beginning with China’s first BIT with Sweden (signed and entered into force in 1982), provides potential for Chinese investors to bring investment treaty claims against countries screening Chinese investment proposals. The coverage of screening by different investment provisions is not straightforward, for example, depending to some extent on whether a given obligation extends beyond the pre-establishment stage (not generally the case for provisions on expropriation and fair and equitable treatment; not often the case for non-discrimination disciplines, for example).[7] However, while screening might be expected to occur most often with respect to prospective investments, it may also arise for an existing investor seeking to make a new transaction, such that post-establishment obligations will apply. Moreover, countries such as Australia, the United Kingdom, and the United States have relatively recently allowed for “retrospective” screening, in the sense that existing investments might be screened (for example where new information arises or material circumstances change), increasing the risk of conflict with post-establishment investment obligations.
Canada’s BIT with China excludes from both ISDS and state−state dispute settlement Canadian decisions regarding admission of an investment pursuant to review or national security review under the Investment Canada Act. However, the arbitration in Global Telecom Holding v. Canada demonstrates that even an IIA that appears to exclude foreign investment (i.e., screening) decisions from the scope of ISDS (as does the BIT between Egypt and Canada) may be held to apply to such a decision: in that case, a refusal to allow the acquisition by an Egyptian company of voting control of a joint venture with a Canadian company.[8]
The application to screening of Australia’s various investment-related agreements with China is subject to further jurisdictional uncertainty. Although RCEP has no ISDS mechanism, both the BIT signed between the two countries in 1988 and the PTA signed in 2015 allow for ISDS in certain circumstances. The latter agreement (known as “ChAFTA”) contains few substantive investment disciplines and restricts ISDS to national treatment. However, under the BIT, some debate exists as to whether the allowance for ISDS regarding “the amount of compensation payable” under the expropriation provision in Article VIII may encompass a determination of whether an expropriation has actually occurred. Moreover, on one reading of the BIT, Chinese ISDS claims against Australia pursuant to the ICSID Convention could extend to alleged breach of a range of provisions.[9]
Countries such as the United States that have no IIA with China obviously face minimal risks of an investment treaty claim with respect to screening of Chinese investments. The 2020 “Phase One” agreement between the United States and China does not affect either party’s screening of inward foreign investment. However, other international obligations such as those arising under WTO agreements (e.g., with respect to commercial presence under the General Agreement on Trade in Services [GATS] or performance requirements under the Agreement on Trade-Related Investment Measures) could create concerns for WTO members’ screening, including as regards China. The potential for a WTO dispute might depend, for example, on the scope of the Member’s relevant GATS commitments and MFN exemptions.
Conclusions
The rise of China as an important outward investor in the 21st century, the transformation of its global political and economic status, and the escalation of its policy under the leadership of Xi Jinping have been significant—though not the only—drivers of the spread and tightening of investment screening, especially among developed democracies. These policy responses to the perceived challenge from China, in turn, have extensive political, economic, and legal implications. Politically, they have been perceived in China as part of a wider, coordinated attempt to “keep China down”; in specific cases, they have contributed to sharp deteriorations in bilateral diplomatic relations with China. Economically, although measuring the impact of raising barriers to Chinese investment in critical infrastructure, technology, and personal data-intensive sectors is challenging, critics argue that the costs have been disproportionately high and that there are more effective ways of managing the risks associated with Chinese FDI. Legally, while screening mechanisms generally avoid explicit discrimination based on investor origin, the legacy of an extensive network of international investment agreements creates growing risks of international litigation on increasingly controversial matters of vital national interest.
Authors
Phillip McCalman, Professor of Economics, University of Melbourne. Laura Puzzello, Associate Professor of Economics, Monash University. Tania Voon, Professor of International Economic Law, University of Melbourne. Andrew Walter, Professor of International Relations, University of Melbourne.
Notes
[1]* This piece is developed in part from our longer article, “Inward Foreign Investment Screening Targets China: Interdisciplinary Perspectives,” forthcoming in the Cambridge Journal of International Law (2023). Underlying research was funded by the Australian Research Council pursuant to Discovery Project DP200100639. For valuable research assistance, we thank Marlene Caudillo, Clementine Girard-Foley, Diane Hu, Dean Merriman, Thi Nhung Nguyen, and Helen (Hui) Pang. All opinions expressed here and any errors are ours and do not necessarily reflect those of any employer or other entity.
[2] See, for example, Gertz, G. (2021). Investment Screening before, during, and after COVID-19. Global Perspectives, 2(1). https://doi.org/10.1525/gp.2021.24538
[3] Bonnitcha, J. (2020, December 19). The return of investment screening as a policy tool. Investment Treaty News. IISD. https://www.iisd.org/ITN/en/2020/12/19/the-return-of-investment-screening-as-a-policy-tool-jonathan-bonnitcha/
[4] European Commission. (2022, September 1). Report from the Commission to the European Parliament and the Council: Second Annual Report on the screening of foreign direct investments into the Union, p. 9. https://EC.europa.eu/transparency/documents-register/detail?ref=COM(2022)433&lang=en The five missing countries are the Czech Republic, Malta, the Netherlands, Slovenia, and the Slovak Republic. Unlike UNCTAD, the European Commission does not include Belgium in the list of countries with screening mechanisms.
[5] Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations 2017 (since amended and now superseded).
[6] See generally Knight, T., & Voon, T. (2020). The evolution of national security at the interface between domestic and international investment law and policy: The role of China. Journal of World Investment & Trade, 21, 104–139. https://doi.org/10.1163/22119000-12340169
[7] See Voon, T., & Merriman, D. (2023). Incoming: How international investment law constrains foreign investment screening. Journal of World Investment & Trade, 24, forthcoming. https://doi.org/10.1163/22119000-12340253
[8] See Paine, J. (2021). Global Telecom Holding v. Canada: Interpreting and applying reservations and carve-outs in investment treaties. Journal of International Arbitration, 38(4), 533–548.
[9] See Voon, T., & Merriman, D. (2022). Is Australia’s foreign investment screening policy consistent with international investment law? Melbourne Journal of International Law, 23(1), 62–113. https://law.unimelb.edu.au/__data/assets/pdf_file/0004/4360072/Voon-and-Merriman-unpaginated.pdf