How should Europe protect critical infrastructure against foreign hostile investments?
On October 11th, 2020, the “Foreign Direct Investments Screening Regulation” came into force. While such foreign direct investment (FDI) frameworks already exist in some member states, it has so far been missing at the EU level. However, we find that 12 out of 27 member states are yet to implement a national FDI screening mechanism. Therefore, the regulation mostly supplements mechanisms already being in place instead of pushing for a binding encompassing regulatory approach.
But first some facts on FDI
FDI are investments by an outward investor in the fixed assets of a company or project located abroad. This type of investment can be very helpful in fuelling a country’s economy, but it can also endanger sovereignty if it enables the investor to gain influence over the receiving country’s vital infrastructure. FDI can therefore have an impact on critical infrastructure in member states, especially when it concerns areas such as energy, transport, communications, technological know-how, and data storage. Thus, it is possible for a foreign company or a non-EU country to gain control over critical industries, supply lines, and key resources of an EU country with the help of FDI.
China, for example, is the fifth largest investor in the European Union, displaying a rapidly growing share of FDIs compared to foreign investors such as the United States. A study performed by Ernst & Young in 2019 found that China acquired 139.5 European companies annually in the period 2006-2018. One of these acquisitions has been the Greek port Piraeus, which since 2003 has been partly owned by COSCO Shipping Ports Limited, which is a subsidiary of a Chinese state-owned enterprise. In 2003, when the Greek government still had 74.5 percent ownership, COSCO started to invest in the development of a terminal. Over the years, the company won various Greek tenders which, by 2016, allowed it to acquire a 51 percent controlling stake in the port.
We have seen FDI divide the EU before, especially when it comes to China. Beijing’s investments in EU member states have caused EU statements to be weakened several times already. As demonstrated by Greece, when it decided to abstain from taking part in EU resolutions, or even ended up blocking them.
Towards an FDI screening mechanism
For the EU this means that caution is required and closer monitoring is appropriate. Especially when considering that European investors often do not have the same freedom on markets outside the European Economic Area as external investors are enjoying on the EU market. Therefore, the Commission has been proactively trying to shape a unified EU response towards FDI to prevent member states from becoming dependent on outside parties for their security, economic growth, and government stability. This includes advocating for a stronger regulatory framework. In 2017 the Commission published a Communication on FDI screening, calling for a unified approach and more restrictions in terms of FDI openness. Germany, for example, passed regulation in 2018 to prevent technological sell-off as well as foreign investments that could impair national security. This granted the German government the power to review foreign acquisitions, in specified sectors. Eventually, the EU adopted regulation (EU) 2019/452 in March 2019, following the Commission’s impetus. This regulation was bestowed with the name ‘Establishing a framework for the screening of foreign direct investments into the Union’.
FDI screening regulation
Regulation (EU) 2019/452 creates a screening framework for third country FDI into the EU where there was none before. When reviewing this framework it is worth bearing in mind that the U.S. already installed a Committee on Foreign Investment (CIFUS) in the mid-seventies with extensive centralised powers. Given that CIFUS serves as a worldwide role model for screening mechanisms it is no surprise that the EU regulation is modeled somewhat after CIFUS, although institutionally less powerful. While the final proposal ended up less powerful than CIFUS, it does represent the first step towards a unified EU-wide approach.
This includes a cooperation mechanism for the exchange of information between member states and the Commission, allowing the Commission to issue opinions on investments that endanger security, public order or EU strategic projects. It urges for international cooperation in terms of investment screening and presents prerequisites for member states looking to install such a mechanism, or to expand an already existing mechanism. Factors such as checking if a foreign investor is owned or controlled by a foreign government or has already been involved in activities affecting security or public order in a member state should be reviewed according to EU requirements. One important trait of the regulation is that the prerogative to adopt any of the opinions has been left to the individual member state.
This regulation touches upon various actors. It first involves the Commission as issuer of non-binding opinions and gives it the authority to review FDI transactions threatening public order, security or strategic projects. The Commission’s non-binding opinion should be taken to ‘utmost account’ by the respective member state, and the Commission expects an explanation if member states decide not to follow its guidance. Member states are expected to become active in peer-review, offer best practices through expert-groups, and issuing non-binding opinions. They are also obliged to report to the Commission on an annual basis.
This regulation is a first step, still it leaves – as often the case with EU regulation – quite some room to manoeuvre on whether to install a national screening mechanism or not. This is due to the fact that in the case of common commercial policy the EU has the exclusive competence to ‘adopt the measures defining the framework for implementing the common commercial policy in the field of FDI’, as mentioned in Article 207 (2) TFEU. Consequently, the EU institutions are limited to solely defining a framework, displaying a weak conferral of powers to the EU as a whole. In reverse, that means that the formulation of the framework needs to be as detailed and precise as possible in order to nudge member states into adhering to the regulation.
Currently we find 15 out of 27 member states having national FDI screening mechanisms in place. That implies that twelve member states have not adopted such mechanisms, even though the Commission advises to do so since 2017. Therefore, the regulation mostly supplements mechanisms already being in place instead of pushing for a binding encompassing regulatory approach.
Hence, a more binding regulatory framework approach would help with providing a harmonised application of the regulation instead of creating a patchwork of FDI screening regimes, considering that member states currently interpret and adhere to the EU regulation differently. Another negative effect of this patchwork approach to FDI screening is that EU countries complying with the regulation might become less attractive to third country FDI in general, as such a mechanism could act as a deterrent while lenient member states are in an advantageous position.
Especially considering that not all FDIs pose a threat to national and European security, and can be a great stimulus to economic performance. An EU-wide harmonised application of FDI screening standards is a vital asset for ensuring equality between member states and would decrease bureaucratic complexity as a positive side effect. Let’s also look at the issue of how FDI is described in the regulation. According to Article 2(2), the regulation can be circumvented indirectly by third countries, when their firm’s seat lies within an EU member state and is registered under the law of the respective EU member states. In summary, intra-EU FDIs are not covered by the regulation, which signifies that there are deficiencies in the framework.
COVID-19 calls for caution
These are not the only issues related to the FDI screening process. As we are living in times of a pandemic, the Commission calls for more caution related to investments from third countries in general. Now that EU economies are weakened, potential sell-outs of key technology and losses in other critical assets can occur. The Commission reacted to this with a communication, which highlights the need to protect vital health-care related infrastructure. The communication also requires alertness from its member states and advocates for establishing screening mechanisms, if not already in place. The COVID-19 pandemic should be reason enough for EU member states, who have refrained so far from taking protective measures against FDIs, to finally align with each other behind a common goal: the protection of EU security and public order to strengthen the stance of the EU in the world.
Food for thought
Concluding, we are facing a newly, weakly regulated policy field in the EU, entailing various questions related to legal and governance aspects. These questions arise because approximately 44 percent of EU member states do not screen FDIs according to the framework set out by the newly introduced regulation (EU) 2019/452, leaving the European economy with weak spots and possibly enabling third countries to endanger EU security and public order. We see a non-binding momentum in the new regulatory framework – leaving us with the pressing issue of how to incentivise member states that rely on FDI to implement a screening mechanism. Answers will be given over time, since this regulation has only come into effect in October last year. Still, a remaining reluctance of member states to cooperate and follow the foreign direct investment rules can be perceived as an issue that needs to be tackled in the future.
Sandra Zwick has previously obtained a degree in Economic Sciences and Japanese Studies from Martin-Luther-University Halle/Wittenberg. Currently she is pursuing her dual Master’s degree in European Governance at both Masaryk University and Utrecht University.