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Foreign Direct Investment Regulation: A Global Perspective - Daniel Zolinsky

In recent years, it has become clear that geopolitical tensions have transformed Foreign Direct Investment regulation (FDI) into a global and ever-growing trend. The impacts of US-China tensions as well as Russia’s invasion of Ukraine have been extensive on the screening process for FDI, with countries taking strategic measures to protect their national interests whilst balancing the demands of an open economy. This surge in FDI screening since 2020 has especially led to a significant increase in workload for competition lawyers and regulatory authorities. This article will examine the evolving landscape of FDI regulation, as well as compare notable cases, to illustrate a particular deterioration in Chinese investment.


Increased Global regulation


With governments striving to strike a balance between maintaining an open economy and protecting public security and national defence interests, a new regulatory framework to vet M&A deals in ‘red-flag’ sectors (defence, technology and infrastructure) has been adopted in the EU. After 18 of the 27 European member states embraced the framework, several other European governments, including France, Germany, Italy, and the Netherlands, have expanded their FDI screening guidelines to encompass other sectors, such as consumer goods. This reflects the evolution of FDI from what was a niche area for defence industry deals to a key part of many deal structures, timetables, and assessments of regulatory risks.


A domino effect has followed. After Germany expanded its FDI regulatory regime in October 2020, two years later France issued new FDI guidelines targeting cross-border investments within the EU. More significant, though, was the adoption by the Netherlands (3rd largest recipient of FDI in the world as at 2019) of two new FDI screening mechanisms applying to domestic and foreign investors, as this was perceived to be the country’s the biggest departure from its traditional free-trade posture. These expanded screening mechanisms set the tone for subsequent and more severe inhibitions of FDI.


Such mechanisms were soon intensified by legislative changes, such as the UK’s National Security and Investment Act (2021), which granted the UK government powers to impose conditions on FDIs or block them in sectors deemed critical to national security. Five deals were prohibited under the Act in 2022. The most high-profile instance was the acquisition of the UK’s largest semiconductor plant by Chinese-owned technology company Nexperia BV, which marked the first time the government blocked a transaction using its powers to retrospectively review deals that completed before the rules took effect.


Meanwhile in the US, the Committee on Foreign Investments in the United States (CFIUS) published its first ever enforcement and penalty guidelines. This included fines of up to $250,000 or the value of the transaction if it is higher should there be failure to file a transaction, submission of incorrect information, or breaches of CFIUS mitigation agreements. Furthermore, the committee mandates that parties involved in proposed transactions must consent to mitigation measures aimed at addressing perceived security risks.


These efforts to deter parties from non-compliant behaviour reflects a general sense of increased scrutiny over foreign investments, even if they are from traditional allies. As Freshfields note in their overview of the situation between December 2022 to April 2023, the ISU (Investment Security Unit) has come under substantial pressure to improve communication with parties during reviews and increase transparency for the market. The ISU plays a crucial role in FDI regulation as it is responsible for reviewing and assessing the potential risks and impacts of foreign investments on national security and economic stability. As has been the case with most parties, the ISU has responded by improving communication with parties and carrying out more regular calls during reviews. Additionally, the unit will aim to provide insights on overall trends of notifications and timings of reviews as well as the sectors of the economy which are generating the most interest in their first full annual report (due June 2023).


Inhibited Acquisitions and Notable Patterns


December 2022 saw the restriction of two significant FDIs. The first of which was the proposed acquisition of HiLight Research by SiLight, a Shanghai semiconductor company, which was blocked to avoid HiLight Research Limited's technology being used to present national security risks to the UK. Secondly, LetterOne’s acquisition of Upp, a regional broadband provider co-founded by Russian oligarchs Mikhail Fridman and Petr Aven, which was ordered to be unwound. These cases reflect the continuing trend of all prohibitions so far having Chinese or Russian links. This is not surprising. The Head of the UK’s National Cyber Security Centre recently declared that the UK and its allies cannot afford to be complacent over the ‘dramatic rise of China as a technology superpower’. A particular focus on Russia and China is also highlighted in the March 2023 Integrated Review Refresh. The review focuses on enhancing the UK’s internal resilience in response to China, safeguarding national security from collaborations involving Russia and Iran, and addressing their growing individual risks.


In the same month, Brussels moved to limit the ability of China and other rivals to acquire cutting-edge technology from the West, which included joining other individual member states in taking steps to block Huawei from supplying equipment to their next-generation of 5G mobile wireless technology. In addition to this, the EU prohibited companies within the single market from selling products that could help Russia’s armed forces in their war in Ukraine. It is clear that European nations are expanding their understanding of economic security in response to past vulnerabilities resulting from liberal economic policies, which made them susceptible to Russian energy blackmail and reliance on Chinese inputs for the green transition. Therefore, with changing global dynamics, states are now imposing tighter controls on capital flows involving certain hostile nations, prioritising national security over unrestricted globalisation. However, it should be emphasised that a significant factor driving the European rejection of Chinese investment is the escalating tensions between the US and China – much of these new measures come against the backdrop of Washington pressing its allies to follow its export bans on sensitive technology to China.


Decrease in Trading Volume and Direct Purchases


With increasing political tensions between China and the US, there has been a notable decline in US investor enthusiasm for Chinese stocks since their previous record-breaking levels last year.


Trading in the most liquid US-listed options that track Chinese stocks, which provides exposure to China without an overseas presence, has experienced a sharp decline of more than 50% since reaching a record high in November. Furthermore, foreign investors, who had bought a net $20 billion worth of Shanghai and Shenzhen-listed shares in the first month of 2023 (setting yet another record), have since added only $6 billion over the past three months. This dramatic slowdown in direct purchases of Chinese stocks is indicative of the waning investor confidence in this region.


Investors have responded to these market conditions by seeking alternative investment opportunities in emerging markets other than China. Christel Rendu de Lint, the Head of Investments at fund firm Vontobel, highlighted that many investors have become cautious after witnessing losses from holding Russian assets, which were subjected to Western sanctions following the invasion of Ukraine. In fact, some investors have written off these assets entirely. It is also evident that the Western world’s recent efforts to reduce dependence on China, such as in electric vehicle supply chains and semiconductors, have been motivated by the energy crisis, which highlighted the detrimental effects of relying on authoritarian regimes for critical resources. The growing interest in possible sites for lithium mines in Europe reflects such efforts, and in particular, Valdeflores in Madrid has been highlighted as a potential turning point in the race to end the West’s dependence on China for this mineral – if the plan is approved, according to estimates, the facility is projected to yield a sufficient amount of the mineral essential for rechargeable batteries, capable of powering 400,000 Tesla Model 3 cars annually.


Consequences for Investment in China


The shift in investor sentiment extends beyond individual investors to institutional investors. APG, a prominent pension fund manager, recently revealed that its pension fund clients are increasingly avoiding investments in China due to rising geopolitical risks. Other major institutional investors, such as the Caisse de dépôt et placement du Québec and Ontario Teachers' Pension Plan, have halted or paused their investments in China, indicating a broader trend.


The evolving tensions between the US and China have also impacted investment alliances. Sequoia Capital, known for its successful investments in fast-growing tech companies, faces the delicate task of its China unit's spin-off investing in priority areas like AI while navigating the increased controls on exporting sensitive information or technologies to China imposed by Washington. Moreover, AstraZeneca is considering spinning off its business in China and opting to list it in Hong Kong or Shanghai as a protective measure against geopolitical tensions, shielding the multinational company. The separation of such alliances highlights the growing difficulties in US-China investment partnerships.


Conclusion


The rise of FDI regulation as a global trend indicates a shift in governments' approach to balancing economic openness and national security. Countries are strategically expanding their screening guidelines to safeguard key sectors from foreign influence. Geopolitical tensions, especially between China and the US, have influenced investment strategies and prompted increased scrutiny. As FDI regulation continues to evolve, stakeholders must navigate the changing landscape to ensure compliance and protect national interests.


The current landscape indicates a significant shift in investor sentiment towards Chinese stocks, as the geopolitical tensions continue to mount. The repercussions are not only impacting investment decisions but also prompting a re-evaluation of risk exposure in the face of an increasingly uncertain China-US relationship.

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