French Bourse © Wikicommons
The United Nations Conference on Trade and Development, which exists under the ugly acronym UNCTAD, is not often given to hyperbole. So people tend to sit up and take notice when, in its latest Investment Policy Monitor report, it highlights “at least twenty instances of planned foreign takeovers with a value exceeding $50-million (€45-million) that were blocked or withdrawn for national security reasons in the period from 2016 to September 2019.” The report says the aggregated value of these transactions amounts to more than $162.5-billion (€146.47-billion), a not insignificant amount and one to make those seeking inward investment nervous. “For example, in 2018 the value stood at $150.6-billion (€135.74-billion) – which represents 11.6% of global FDI (Foreign Direct Investment) flows in that year.”
Yes, governments are getting picky where FDI is concerned. It’s one thing to attract a much-needed basket of development cash, quite another to find, like Cleopatra, an asp hiding there. That’s why, according to UNCTAD, a number of countries have either introduced or else reinforced existing mechanisms and procedures dedicated to screening proposed inward investments as an acknowledgement of and answer to national security or rising political concerns. According to Joseph Nguyen, writing about emerging markets in Investopedia: “Investing internationally has often been the advice given to investors looking to increase the diversification and total return of their portfolio. The diversification benefits are achieved through the addition of low correlation assets of international markets that serve to reduce the overall risk of the portfolio.” Nguyen writes that the biggest barrier to investing in another market is often very high transaction costs. And that’s not all: “on top of the higher brokerage commissions, there are frequently additional charges that are piled on top that are specific to the local market, which can include stamp duties, levies, taxes, clearing fees and exchange fees.” As the saying goes, caveat emptor.
For US investors looking for somewhere overseas to invest, there are ways to minimise these expenses, such as “through the use of American depositary receipts (ADRs),” writes Nguyen. “ADRs trade on local U.S. exchanges and can typically be bought with the same transaction costs as other stocks listed on U.S. exchanges.” However, he also points out that the cost can be affected by currency fluctuations. But what if investment coming the other way hits snags because of its origins? “From January 2011 to September 2019, at least thirteen countries introduced new regulatory frameworks,” according to the UNCTAD report. “In addition, at least forty-five significant amendments to existing screening systems were recorded in fifteen jurisdictions in this period.”
The Website ‘ConnectUS’ lists a number of the advantages FDI can bring: it stimulates economic development, it simplifies international trade, it can boost employment and it helps to develop human resources as workforces learn skills from each other, spreading knowledge and expertise. It can also boost productivity and, of course, profit. But on the other hand it can dilute the funds available for investment at home, there is a risk of political change or instability and often a fear on the part of the country in which the investment is being made that it’s an attempt to expropriate the company itself, a fear especially felt in developing countries. Many third-world countries, or at least those with history of foreign conquest and rule, worry that foreign direct investment would result in some kind of modern day economic colonialism, which exposes host countries and leave them vulnerable to foreign companies’ exploitations.
WHO, WHY and WHERE?
But it’s not only developing countries that are concerned about interest from abroad. UNCTAD cites the case of an attempt by Shanghai Fosun Pharmaceutical Group in 2017 to take over Gland Pharma of Hyderabad. After national security concerns were raised by India’s Cabinet Committee on Economic Affairs, Shanghai Fosun reduced its investment to a 74% stake. The following year, the German government blocked the acquisition of a 20% minority share of the German grid operator ‘50Hertz’, which boasts 18-million connected users, by the State Grid Corporation of China, even though the intended stake was below the level needed to trigger automatic screening. The government helped ensure that the stake went instead to the state-owned Kreditanstalt für Wiederaufbau. German concern over Chinese inward investment has heightened since the takeover in 2016 of German tech manufacturer Kuka Robotics by China’s Midea Group.
State interference in FDI bids is on the increase. In Italy, screening for security reasons rose from 2015 to 2018 by 255%; in the United States over the same period the number of cases rose by 160%. Natalie Regoli, Editor-in-Chief of ConnectUS, adds a caution: “Remember that we live in an increasingly globalized economy, so foreign direct investment will become a more accessible option for you when it comes to business. However, you should weigh down its advantages and disadvantages first to know if it is the best road to take.” And, of course, assuming the country where you want to invest sees no security risks in letting you in in the first place.
A report by the World Bank Group in 2017, the ‘Global Investment Competitiveness Report, 2017-2018’ speaks encouragingly of the opportunities out there for overseas investment but it has words of caution, too: “A business-friendly legal and regulatory environment – along with political stability, security, and macroeconomic conditions – are key factors for multinational companies making investment decisions in developing countries,” according to Anabel Gonzalez, Senior Director of the World Bank Group’s Trade & Competitiveness Global Practice. “Combining a survey of global investors with analysis of investment policy issues makes this report a powerful contribution to our understanding of how developing countries – including fragile states – can de-risk their economies and unlock FDI.”
The problem is that the volume of FDI is raising concerns in a number of countries. The European Union has now introduced a screening system, as the European Commission announced: “The new EU framework for the screening of foreign direct investments has officially entered into force on 10 April 2019. The new framework is based on a proposal tabled by the European Commission in September 2017 and will be instrumental in safeguarding Europe’s security and public order in relation to foreign direct investments into the Union.” The former President of the European Commission, Jean-Claude Juncker said at the time: “This new framework will help Europe defend its strategic interests. We need scrutiny over purchases by foreign companies that target Europe’s strategic assets. I want Europe to remain open for business, but I have said time and again that we are not naïve free traders. The adoption and entry into force of this proposal in an almost record time shows that we mean business and that when it comes to defending Europe’s interests we will always walk the talk.” Walking the talk sounds somewhat confusing, but I think he meant we mean business, in both senses of that phrase.
As of the April 2019 launch date, EU Member States have been required to notify their national investment screening mechanisms to the Commission. At the time, 14 Member States already had national screening mechanisms in place. Several Member States were in the course of reforming their screening mechanisms, or adopting new ones. Since then, the European Commission and individual member states have been seeking to ensure that the EU can apply in full the new Investment Screening Regulation as of 11 October, 2020. Member states will be expected to notify each other of any concerns about specific foreign investments.
WATCHING OUT FOR FREEBOOTERS
Let’s not be ambiguous about this: foreign direct investment is important to the EU, as the European Commission discovered when investigating the issue before drawing up its plans: “While only 3% of European companies in the sample considered in 2016 were owned or controlled by non-EU investors, they represented more than 35% of total assets in the sample and around 16 million jobs.” In fact, the report produced by the Commission raised no concerns about the origins of FDI with the EU at that time: “the ‘traditional’ main investors in the EU – i.e. advanced economies such as the US, Switzerland, Norway, Canada, Australia, Japan – remain well ahead and still control more than 80% of all foreign-owned assets. They started investing a long time ago and have kept their acquisition rates constant over time. Their investments are diversified across sectors, with a particularly high level of diversification for the US.” So far, so reassuring. It’s the investments from other more ambitious or less predictable countries that cause concern, and a lot of countries have taken steps to address the issue through adopting a screening process, not unlike the one the European Commission is putting in place: “UNCTAD has identified 28 jurisdictions that have such a mechanism. These countries are: Australia, Austria, Belgium, Canada, China, Denmark, Finland, France, Germany, Hungary, Iceland, India, Italy, Japan, Latvia, Lithuania, Mexico, New Zealand, Norway, Poland, Portugal, the Republic of Korea, Romania, the Russian Federation, Spain, South Africa, the United Kingdom and the United States.” All of this, of course, in addition to the EU’s new mechanism.
The UNCTAD report also says that countries that have not established an FDI screening mechanism for reasons of national security may control inward investment by other means, such as restrictions on foreign land ownership or complicated licencing procedures. The European Commission notes that although it is widespread across virtually all sectors of the EU economy, foreign ownership is remarkably high in a number of sectors that are at the heart of the economy, such as oil refining (67% of total assets of the sector), pharmaceuticals (56%), electronic and optical products (54%), insurance (45%) or electrical equipment (39%). The database also makes it possible to identify the types of entities owning or controlling EU companies. While state-owned companies represent only a small proportion of foreign acquisitions, their share in the number of acquisitions and their assets have grown rapidly over the most recent years. The Commission report starts that: “Russia, China and the United Arab Emirates stand out in this respect with a total of 18 acquisitions in 2017, three times more than in 2007.Another noticeable development is the ‘financialization’ of FDI, in the sense of foreign investment funds and private equity firms accounting for an increasing number of acquisitions (from 102 in 2007 to 194 in 2017).” You may not be surprised to learn that: “This segment is heavily dominated by the US, followed by the Cayman Islands and Switzerland. Finally, a rise of individuals as ultimate owners in an increasing number of acquisitions is also found. These hold mainly Swiss, US, Russian, Norwegian and Chinese passports.” And there’s another factor: “Albeit these represent only 5 percent of the total number of deals, between 2007 and 2017, the number of acquisitions involving individuals or families has increased from 31 to 197.” We are left to imagine what sort of individual beneficial owners we’re talking about here. The number of new owners or would-be owners giving the Cayman Islands as an address suggests they are among those who would rather not face taxes or any kind of scrutiny.
BUILDING SUBTLE BARRIERS
The foreign presence is greatest in mining and oil refining as well as in high tech sectors like the manufacture of computer, electronic and optical products, the Commission report states, where 54 percent of all assets of the sector and 7 percent of all firms are controlled by non-EU nationals. That is also the case in services sectors such as security and investigative activities (48% of all assets and 2% of all firms of the sector). This gets complicated; we are referring here to firms controlled by non-EU citizens, and it turns out that this is the case for 45% of all assets and 3% of all firms that are auxiliary to the financial services and insurance industries, and 45% of all assets and 15% of firms engaged in insurance, reinsurance and pension funding, except compulsory social security. The higher proportion of assets relative to the number of firms indicates that, on average, foreign-controlled companies tend to be bigger than domestic ones. These are arguably slightly alarming figures, given the relative importance strategically of the extractive industries, IT, electronics, financial services, insurance and pensions. Who owns your pension?
Given all of this, it’s hardly surprising that many countries want to screen and take a very careful look at the sorts of inward investments on offer. Oddly, they tend to do it in different ways. In terms of sector-specific screening, Austria targets defence and military manufacturing, security services, energy production and distribution, water supply, transport and aviation, telecoms and communication and health provision, while Hungary looks at Defence and military manufacturing, intelligence and cryptology, dual-use products, energy and water but also gas or petroleum production, storage and distribution, telecoms, financial services and governmental or infrastructure IT system and software development. Russia looks at virtually everything except dual use products, energy and financial services. If you look carefully at the areas in which individual countries are most concerned it tends to reflect their politics and general outlook to a certain degree.
The EU, being a trading bloc rather than a country, is keen to ensure that exchanges of information and mutual wariness and circumspection provide a barrier that is permeable to those with good intentions but tough against others. The former Commission President Jean-Claude Juncker said it would be: “proof the EU is able to act quickly when strategic interests of our citizens and economy are at stake. With the new investment screening framework, we are now much better equipped to ensure that investments coming from countries outside the EU actually benefit our interests. I committed to work for a Europe that protects, in trade as in other areas; with this new legislation in place we are delivering on a crucial part of our promise.” All well and good and doubtless important, but UNCTAD does sound a warning: “Concerns have been expressed that an overly broad interpretation of these interests could create new investment barriers.” Nobody wants global industry to become sclerotic out of mutual fear. The EU, after all, is the world’s leading source and destination of foreign direct investment. In 2015, the EU attracted €5.7-trillion in inward investment. The United States attracted €5.1-trillion and China (including Hong Kong) just €1.5-trillion. So everyone stands to lose if an atmosphere of protectionism and worry were to slow things down.
How about the United States? It remains the largest single investor overseas (the EU invests more but it is not a single country, of course) and FDI both inwards and outwards is important, according to the US Council on Foreign Relations (CFF): “Washington has traditionally led international efforts to bring down barriers to cross-border capital flows with the goals of expanding investment opportunities for U.S. multinational businesses and creating a more stable and efficient international system.” The CFF doesn’t want to see FDI discouraged: “The United States relies greatly on foreign inflows to compensate for a shortage of savings at home, and it routinely ranks among the most favorable destinations for foreign direct investors.” However, although the Organisation for Economic Cooperation and Development (OECD) has introduced rules to ensure that all companies and commercial enterprises are treated in the same way, regardless of who has beneficial ownership, this is a less confident world. In 2017, a fall in corporate restructurings led to an 18% drop in global FDI flows to $1411-billion (€1276-billion) and in the fourth quarter of 2017, flows reached their lowest levels since 2013. The inflow of investment into OECD countries was down a remarkable 37%, largely because of decreases in the United Kingdom and US. There was also a decrease in outflows from the OECD, but only of 4%. FDI inflows to non-OECD G20 economies increased by 3% while FDI outflows decreased by 33% as FDI outflows from China declined for the first time since 2005. FDI flows into EU countries decreased by 45%, from $531-billion (€480-billion) to $290-billion (€262-billion), and dropped to negative levels in the last quarter of 2017, due to widespread decreases and large net disinvestments recorded in Ireland and Luxembourg (excluding resident SPEs) in that quarter. SPEs (special purpose entities) are bodies with little or no physical presence or employment in the host country but that provide important services to the MNE (multi-national enterprise) in the form of financing or of holding assets and liabilities.
GOING DOWN, WARILY
In 2017, according to OECD figures, the major FDI recipients worldwide were the United States at $287-billion (€260-billion) followed by China with $168-billion (€162-billion). Brazil received $63-billion (€57-billion), the Netherlands got $58-billion (€52.5-billion) excluding resident SPEs, France $50-billion (€45-billion), Australia $49-billion (€44-billion), Switzerland $41-billion (€37-billion) and India $40-billion (€36-billion). The OECD figures, compiled in cooperation with the IMF, make for interesting reading. The 37% decrease in OECD inflows of FDI was driven by large decreases in the United Kingdom and in the United States from very high levels in 2016. The decrease was also widely spread among twenty other OECD countries but was particularly large in Belgium, where FDI fell from $30-billion (€27-billion) to $0.8-billion (€0.72-billion), Luxembourg from $45-billion (€40.7-billion) to $7-billion (€6.3-billion) excluding resident SPEs (a decrease that is more than twice the size of Luxembourg’s economy), the Netherlands from $86-billion (€77.8-billion) to $58-billion (€52.5-billion) excluding resident SPEs and Spain from $32-billion (€29-billion) to $6-billion (€5.4-billion). Interestingly, in contrast, FDI flows increased by almost $20-billion (€18-billion) in Austria, France, Germany and Ireland. The EU’s Eurostat statistical body confirms the fall-off in FDI: “Since 2008, the EU-28’s outward investment position has been positive. In other words, the value of the EU-28’s outward stocks of FDI has exceeded the value of inward stocks. In 2017, the ratio of the EU-28’s stock of FDI (relative to GDP) was 48.3 %, while the stock of inward investment in the EU-28 (relative to GDP) was 41.0 %.”
The threat of a trade war between China and the United States has certainly caused some worry in FDI circles, reducing China’s FDI in November by 27.6% to $13.6-billion (€12.3-billion). It happened before the 90-day trade truce announced between Trump and Xi Jinping over fears of a possible tariff battle. According to the South China Morning Post, Beijing was quick to play down the latest figures: “The monthly decline is due to the high base of comparison in the same period of last year,” commerce ministry spokesman Gao Feng told the media at a regular briefing. And, of course, one month’s figures don’t mean the figures will continue to fall. Shao Yu, chief economist at Orient Securities in Shanghai, quoted in the South China Morning Post, said it was too early to say if the slump in the November FDI figures was solely due to the tariff dispute. “It may have something to do with the trade war, but data for a single month doesn’t represent a trend,” he said.
In Britain, the fall in FDI is being blamed on Brexit. Figures released by the Department of International Trade, says the Politics Home website, revealed that “1,782 Foreign Direct Investment (FDI) projects were secured in 2018-19, down 14% to a five-year-low. The report also found a 24% slump in new jobs being created – 57,625 compared to 75,968 in the previous year.” But it’s not all doom and gloom, says the website. “Out of the year’s total investment projects, expansions – including retentions – took the biggest hit of 22%, while new investments saw a 12% decline. Mergers and acquisitions however, including joint ventures, went up by 8%.” So that’s a bit of good news at least. But security concerns are rising, and with them the scrutiny reviews being applied to inward FDI by a number of countries.
The global law firm White and Case, in a report on FDI trends, points out that the United States is getting especially tough with its Foreign Investment Risk Review Modernisation Act (FIRRMA) but that it’s not alone: “the European Union, United Kingdom, Germany, France, China and other nations are also incrementally ratcheting up their reviews. In the UK, for instance, the government is proposing radical new legislation to allow it to intervene in cases that raise potential national security concerns. The UK government itself estimates that, under the new law, approximately 50 cases a year may end up with some form of remedy to address such concerns.” The EU’s decision to harmonise the way in which FDI schemes are reviewed follows massive investment from China in European technology assets.
CHOOSE YOUR THREAT LEVEL
So just what sort of threat does FDI pose to a country? According to the Peterson Institute for International Economics, a research institute based in Washington DC, there are three main areas of concern. Firstly, there’s a fear that the proposed acquisition of a domestic company could make the recipient country dependent on a foreign-controlled supplier for goods or services vital to that country’s economy. That is especially the case where defence industries are involved. The second category of threat is that it could allow the transfer of technology to a foreign-controlled entity in a manner that could prove harmful. The third category is the fear that the acquisition could facilitate the insertion of “some capability for infiltration, surveillance, or sabotage – through a human or nonhuman agent – into the provision of goods or services” that may be crucial to the functioning of the economy of the country receiving the investment, whether or not that involves companies engaged in defence.
Certainly, fears have been expressed that China has wound down its cyber attacks and corporate espionage in favour of buying up (or at least buying an interest in) the companies whose expertise and knowledge Beijing wants to acquire. Writing in Raconteur, Sharon Tiruchelvam says: “In recent years, Europe has received record levels of Chinese inward investment, with minimal barriers to Chinese-led mergers and acquisitions. China, by contrast, has maintained extensive restrictions on inward FDI.” Tiruchelvam says that most of the concern is over technology advances that could have potential defence applications: “It is widely thought that countries possessing the technological edge in artificial intelligence, chip-making, quantum computing and aerospace will have an economic and defensive advantage. Indeed, the Pentagon warned in 2017 that state-led Chinese investment in US firms working on facial-recognition software, 3D printing, virtual reality systems and autonomous vehicles is a threat because such products have blurred the lines between civilian and military technologies.”
Spying on China, on the other hand, is a dangerous and deadly game. In 2011, employees of a government ministry in Beijing were forced to watch the execution of a colleague who had been caught spying for the CIA. The case is highlighted in a new book by Peter Mattis and Matthew Brazil, ‘Chinese Communist Espionage: An Intelligence Primer’. According to the book, the man executed was one of twenty rounded up as part of a network of spies. His pregnant wife was executed, too. Both writers have backgrounds in the US military and intelligence services. Western security services regularly highlight the dangers posed by Chinese espionage, as they have done for decades. People are more inclined to listen now that Russia is no longer seen as China’s and the West’s common enemy. China is a major user and developer of face recognition technology and several Chinese telecoms companies have sought approval at the International Telecommunication Union, a UN body responsible for technical standards, to agree a common set of rules so that different countries’ surveillance technology will be inter-operative, including in the field of facial recognition. And Companies that help shape standards are sometimes able to help draft regulations to suit their own goals and specifications.
Facial recognition technology is extremely valuable. The Chinese company specialising in it, Face++, recently raised $750-million (€678-million) taking its total valuation to more than $4-billion (€3.62-billion). Human Rights Watch claims that the company’s technology is being used by China’s security services to spot potential ‘terrorists’ and that the technology was directly involved in the detention of well over a million Turkic Muslims, including Uyghurs and ethnic Kazakhs, living in China’s north west Xinjiang region, although Beijing claims the places of detention are just “re-education” camps. However, it seems that inmates are forbidden to practice Islam, forced to swear allegiance to China and to learn Mandarin. Presumably, they will be encouraged to speak it rather than their own Turkic language. The Nazis occupying France’s Alsace region during the Second World War imposed language restrictions on the locals, making the speaking of French an offence punishable in law. According to a report on China by Human Rights Watch: “Authorities increasingly deploy mass surveillance systems to tighten control over society. In 2018, the government continued to collect, on a mass scale, biometrics including DNA and voice samples; use such biometrics for automated surveillance purposes; develop a nationwide reward and punishment system known as the ‘social credit system’; and develop and apply ‘big data’ policing programs aimed at preventing dissent.”
Xi looks like remaining ruler of China for the foreseeable future, the restriction on terms of office having been removed. He has ambitious plans for his country, which include FDI. His diplomats at the UN have shown themselves more willing to use outright coercion to get China’s views approved, such as getting support from various undemocratic countries to see off criticism of what is happening in Xinjiang. Austria was even warned that it wouldn’t obtain the land it wants for its new embassy in Beijing if it joined in criticism of how the Uyghurs have been intimidated and interned. Austria signed anyway, which was rather courageous. So it’s hardly surprising when approaches from Chinese companies to invest in the West get looked at with suspicion. It is why Trump is suspicious of Huawei and other Chinese tech companies. As the UNCTAD report explains: “First, cutting edge technologies and know-how have become a key factor for the international competitiveness of countries. States in possession of such assets may therefore have a strong interest in ensuring that they remain in domestic hands.” The report goes on to say that many countries “may find it necessary or desirable that other companies of strategic importance and critical infrastructure are not foreign controlled. Third, governments may consider FDI screening as a necessary counterweight to earlier privatizations of State-owned companies and infrastructure facilities.”
Or to put it simply, in general terms FDI is good for the global economy. It interweaves the interests of different countries and ensures a spread of technical and other skills and knowledge, supposedly to the advantage of humankind. But like so many activities, it requires careful consideration. China’s bullying tactics at the UN may make other countries wary of letting Beijing get too firm a foothold in their territory. Everybody would like to have China as a friend, but as the 18th century poet and playwright John Gay wrote in 1727:
“An open foe may prove a curse,
But a pretended friend is worse.
Robin Crow
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