The new EU Regulation on the screening of foreign direct investments: A tool for disguised protectionism?

Prof. Nikos Lavranos, Secretary General of EFILA

In December 2018, the EU institutions agreed on the text for an EU Regulation establishing a mechanism for screening all foreign investments into the EU.

In just over a year the EU institutions adopted this Regulation, which is unusually fast and reflects the apparent political will of the institutions involved to deliver something tangible that would address the fear against Chinese investments that would essentially take over the European economies.

The Regulation is in particular noteworthy because it introduces an EU-wide screening mechanism at the EU level as well as at the Member States’ level, which in many ways is similar to the US screening mechanism (CFIUS) whose scope of application was recently also significantly expanded. (The revised CFIUS text is part of the very extensive National Defense Authorization Act for Fiscal Year 2019, sections 1701 et seq.)

The EU Regulation is also significant in that it gives the Commission and other Member States the power to directly interfere in the screening of FDI in a particular Member State.

At the Member States’ level, it should be noted that there is a disparity among them regarding their approach of whether or not to screen FDI, and if so, under which conditions and procedures.

According to the Commission, about half of the Member States have currently no screening mechanism at all, while the other half does have one. In addition, the conditions and procedures of the existing screen mechanisms differ.

Accordingly, the Regulation aims to harmonize this situation by grandfathering all existing screenings mechanisms and by encouraging all Member States, which have not yet one, to establish such a mechanism. In addition, common basic criteria for the screening of FDI are laid down in this Regulation. Indeed, all Member States are required to register all incoming FDI and to report them to the Commission and to all other Member States. In fact, the Member States and the Commission are required to set up a dedicated contact point for that purpose.

At the European level, the Regulation gives the Commission – for the first time – the power to actively screen FDI – not only those that are “likely to affect projects or programmes of Union interest on grounds of security or public order”, but also those that are “likely to affect security or public order in more than one Member State”.

The Commission may issue opinions, which the Member State concerned is required to duly take into consideration. Similarly, Member States can comment on the screening of FDI in other Member States.

However, what is most interesting is the wide scope of the sectors that may be screened, which covers, inter alia, the following areas:

(a) critical infrastructure, whether physical or virtual, including energy, transport, water, health, communications, media, data processing or storage, aerospace, defence, electoral or financial infrastructure, as well as sensitive facilities and investments in land and real estate, crucial for the use of such infrastructure;

(b) critical technologies and dual use items as defined in Article 2.1 of Regulation (EC) No 428/2009, including artificial intelligence, robotics, semiconductors, cybersecurity, quantum, aerospace, defence, energy storage, nuclear technologies, nanotechnologies and biotechnologies;

(c) supply of critical inputs, including energy or raw materials, as well as food security;

(d) access to sensitive information, including personal data, or the ability to control such information; or

(e) the freedom and pluralism of the media.

Also, noteworthy is the fact that there is no minimum threshold of the amount of the FDI for screening, which means that potentially any FDI from 1 to 100 billion euros could be screened.

While the fear against a Chinese takeover of the European economies is widespread and understandable, it is not supported by facts. Indeed, as a recent study by the well-respected Copenhagen Economics institute shows that countries other than China invest much more into the EU.

According to this study the US is by far the largest investor in the EU and accounted for 51.1% of the M&As by third country investors, followed by Switzerland (10.8%), Norway (4.6%) Canada (3.8%), while China comes only fourth with a meager 2.8%.

When it comes to investments by State Owned Enterprises (SOEs) from third states, Russian investors accounted for 16.6% of M&As, followed by Norway (15.8%), Switzerland (11.8%), while Chinese SOEs account only for 11% of the M&As.

In other words, the amount of Chinese FDI are far lower than from several other third countries, but which seemingly are considered friendlier and thus approached with less hostility.

Be that as it may, the real risk of this Regulation is not so much the screening of FDI but that it could be abused as a tool for disguised protectionism and classic state-governed economic nationalism.

This is so because the big Member States will be able to force smaller Member States to block FDI, for example from China, in order to give preference instead to French, German or Spanish investors.

Similarly, the Commission may force a Member State to block an FDI for unrelated more important geopolitical reasons.

This can also raise the tension among EU Member States which are competing for FDI. For example, if the Rotterdam harbour wants to attract Chinese investments for upgrading and expanding its facilities in order to be able to better compete against the harbour of Hamburg, Germany might very well use the argument of “security or public order” in this Regulation to force the Netherlands to block the Chinese investor and rather accept a European investor instead, or forget about the whole project altogether.

This is not to say that one should be naïve about Chinese, American or Russian investments, which are often connected with geopolitical aims or potentially (business) espionage. The example of Huawei, which has been restricted in developing the 5G network in some Western countries, is telling. At the same time, one should not forget that EU Member States are competing with each other to attract FDI and have the vested interests of their national champions always in mind.

Thus, the line between genuine protection of “security and public order” and disguised protectionism is very thin and tempting to cross for short term political and/or economic gains. However, this Regulation – unsurprisingly – does not contain any effective mechanisms to mitigate this risk.

Therefore, when this EU Regulation enters into force, foreign investors are well-advised to seek proper in-depth advice prior to investing into the EU.

EFILA 2019 Annual Conference: The EU and the future of international investment law and arbitration

Description

4th Annual EFILA Conference

The EU and the future of international investment law and arbitration

With the entering into force of the Lisbon Treaty 10 years ago the EU has become a dynamic policy actor in international investment law and arbitration. In particular, within the context of the increasing public concerns against TTIP, BITs and ISDS, the European Commission has been active in “reforming” and “reshaping” the investment law and arbitration landscape, for example with the EU-Singapore and EU-Vietnam FTAs, which contain many “innovative” features such as the investment court system (ICS). Another area in which the increasing influence and interaction between investment law and EU law is particularly visible is the Energy Charter Treaty (ECT).

The 2019 Annual Conference will take stock of these developments by discussing the EU’s external investment policy generally, by focusing specifically on the EU’s approach towards Asia and by analysing the EU’s impact on the ECT. In addition, a high profile key-note speaker will address the Conference.

As was the case in the previous very successful Annual EFILA Conferences, this Conference will again showcase many distinguished and experienced scholars and practitioners in the area of investment law and arbitration. As always, the Conference will be very interactive and allow for sufficient time for discussion between the speakers and the audience.

Click here for the detail draft programme.

Tickets can be purchased here: https://www.eventbrite.co.uk/e/the-eu-and-the-future-of-international-investment-law-and-arbitration-tickets-48123937994

Date And Time

Thu, 31 January 2019

09:00 – 18:00 GMT

Add to Calendar

Location

Herbert Smith Freehills London

Exchange House, Primrose St

London

EC2A 2EG

United Kingdom

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The Pre-Establishment National Treatment Obligation: How Common Is It?

Vrinda Vinayak*

Introduction

The national treatment obligation in international investment agreements (IIAs) is a double-edged sword – while it may attract foreign investment by guaranteeing equal access to and treatment in the domestic market, it has the potential to limit autonomy and sovereignty of nations in formulating domestic policy, and opens these measures up to challenge before arbitral tribunals. In this light, one of the most important aspects of the national treatment obligation is whether it applies only when investments have been admitted into the host country according to the latter’s rules and regulations (post-establishment obligation), or also before or during the admission stage (pre-establishment obligation).

Exclusively post-establishment obligations allow host states to retain autonomy over the kind and quantum of investment it wants to permit. An obligation to offer pre-establishment national treatment limits the ability of the host state to impose government approval requirements or sectoral caps for foreign direct investment (FDI). There is also a restriction on favourable treatment being granted to infant industries, imposition of performance requirements on foreign entities, requirements of mandatory partnership with local firms as a condition for establishment etc. Owing to these factors, pre-establishment obligations have traditionally been seen only in a small minority of agreements. However, this trend seems all set to change.

Pre-establishment obligations can be incorporated in IIAs in a variety of ways. They can either be embodied expressly in the national treatment clause, or gathered from the definitions of ‘investor’ and ‘investment’. IIAs containing broad, asset-based definitions of ‘investment’ (without reference to the asset having already been admitted in accordance with national law) and defining ‘investor’ as someone who “seeks to make, is making or has made an investment” or that “attempts to make, is making, or has made an investment” usually offer pre-establishment protections.

Treaty Practice – United States and Canada

The United States (US) and Canada have been at the forefront of the pre-establishment national treatment obligation. Early examples of some relevant bilateral investment treaties (BITs) include the US – Jordan BIT (1997)[1] and the Canada – Latvia BIT (1995)[2]. The model BITs of the US (2004 and 2012) and Canada (2004) were also the first models to feature such an obligation. The most prominent example of a provision embodying the pre-establishment national treatment obligation is Article 1102 of the North American Free Trade Agreement (NAFTA) (1992)[3], which reads: “1. Each Party shall accord to investors of another Party treatment no less favorable than that it accords, in like circumstances, to its own investors with respect to the establishment, acquisition, expansion, management, conduct, operation, and sale or other disposition of investments…” (clause 2 speaks of treatment accorded to ‘investments’ very similarly). ‘Investor’ is defined in terms of an entity that “seeks to make, is making or has made an investment”, and the agreement contains an asset-based definition of ‘investment’.[4] The NAFTA’s national treatment obligations have also been incorporated in the newly concluded Agreement between the US, Mexico and Canada (USMCA) (2018)[5], but ‘investor’ is now defined in terms of an entity that “attempts to make, is making, or has made an investment”, with a clarification as to the meaning of “attempts to make”.[6]

The IIAs concluded by the US and Canada with emerging economies display a varying practice – while the Canada – China BIT (2012)[7] does not include pre-establishment national treatment, the Rwanda – US BIT (2008)[8], the Canada – Senegal BIT (2014)[9] and the Canada – Mongolia BIT (2016)[10] contain such obligations worded similarly to the NAFTA. The practice of emerging economies will be examined in more detail below.

Treaty Practice – European Union

The European Union (EU) has recently become open to extending national treatment to the pre-establishment phase, as demonstrated by the EU – Montenegro Stabilisation and Association Agreement (2007), which provides for establishment of companies pursuant to the national treatment standard[11]. The EU’s agreements with Georgia[12], Moldova[13] and Ukraine[14] concluded in 2014 also admit pre-establishment national treatment. The most prominent manifestation of this trend is the newly concluded EU – Canada Comprehensive Economic and Trade Agreement (CETA) (2016)[15], Article 8.6 of which reads: “1. Each Party shall accord to an investor of the other Party and to a covered investment, treatment no less favourable than the treatment it accords, in like situations to its own investors and to their investments with respect to the establishment, acquisition, expansion, conduct, operation, management, maintenance, use, enjoyment and sale or disposal of their investments in its territory…

Similarly, Article 8.8(1) of the EU – Japan Economic Partnership Agreement (2018)[16] states particularly in the context of establishment that, “each Party shall accord to entrepreneurs of the other Party and to covered enterprises treatment no less favourable than that it accords, in like situations, to its own entrepreneurs and to their enterprises, with respect to establishment in its territory,” where “entrepreneur of a Party” means a “natural or juridical person of a Party that seeks to establish, is establishing or has established an enterprise…in the territory of the other Party.

Treaty Practice – Emerging Markets

It is interesting to examine the trend in emerging market states. Initially, most IIAs entered into by such states did not contain pre-establishment national treatment obligations. A typical formulation of such an exclusively post-establishment obligation is seen in the Indonesia – Turkey BIT (1997), which stated that “each party shall, in conformity with its laws and regulations, accord to these investments, once established, treatment no less favourable than that accorded in similar situations to investments of its investors or to investments of investors of any third country, whichever is most favourable.[17] Language facilitating only post-establishment obligations is also seen in the Korea – Qatar BIT (1999)[18], and the South Africa – Turkey BIT (2000)[19].

While the practice of emerging market states is still varied, pre-establishment obligations are becoming more frequent than before. One of the earlier examples of this trend is the BIT concluded by Korea with Japan in 2002[20] which defines investor broadly, provides a wide, asset-based definition of investment, and includes ‘establishment’ within the fold of the national treatment obligation. Around the same time, the ASEAN Comprehensive Investment Treaty (CIT) (2009)[21] also provided pre-establishment national treatment to its members, under the ‘mutual national treatment’ model.

In the next decade, regional agreements such as the Pacific Alliance Additional Protocol (PAAP) (2014) between Chile, Colombia, Mexico and Peru[22], and the ASEAN – India Investment Agreement (2014)[23] also provided such treatment. The Economic Partnership Agreement (EPA) concluded by Mongolia with Japan in 2015 states that:  “Each party shall in its area, accord to investors of the other party and to their investments treatment no less favourable than the treatment it accords in like circumstances to its own investors and to their investments with respect to investment activities,”[24] where ‘investment activities’ is defined as “establishment, acquisition, expansion, operation, management, maintenance, use, enjoyment and sale or disposal of an investment[25] – this formulation very clearly includes pre-establishment obligations. The terms ‘investor’ and ‘investment’ are also defined broadly.[26]

There are several recent examples of emerging market IIAs encompassing pre-establishment obligations. A case in point is the China – Hong Kong Closer Economic Partnership Arrangement (CEPA) Investment Agreement (2017), which defines ‘investor’ broadly as, “one side, or a natural person or an enterprise of one side, that seeks to make, is making or has made a covered investment,[27] and contains a national treatment obligation phrased very similarly to the NAFTA[28]. Another example is the Central America – Korea Free Trade Agreement (FTA) (2018) between Costa Rica, El Salvador, Nicaragua, Panama and Korea, which also extends national treatment to the pre-establishment phase[29] and incorporates an obligation phrased like the NAFTA.

On the other hand, some emerging economies still prefer to limit their national treatment obligation only to the post-establishment phase, exercising full investment control. Brazil is a prime example of this – for the longest time, it attracted investment without IIAs, and has only recently started entering into Cooperation and Facilitation Investment Agreements (CFIAs), which may explain its cautious and relatively more protectionist approach. The Brazil – Suriname CFIA (2018)[30] contains a national treatment obligation worded similarly to the NAFTA. However, an ‘investor’ must already have “made an investment”, and an ‘investment’ must be “established or acquired in accordance with the laws and regulations of the other Party”, thereby seemingly excluding pre-establishment national treatment obligations and allowing domestic law to discriminate. This is also clarified by Article 14(a) which clearly states that all investments must conform to domestic law in matters including establishment. Brazil’s CFIA with Ethiopia (2018) also contains an explicit admissions clause, stating that investments of investors of each party shall be admitted in accordance with domestic law,[31] and does not include ‘establishment’ in its national treatment clause[32]. Admissions clauses have been a common trend among countries wishing to retain autonomy over enacting domestic legislation stipulating specific criteria to admit foreign investment. Examples of older IIAs containing such clauses are the Ethiopia – Russia BIT (2000)[33] and the Bahrain – Thailand BIT (2002)[34]. More recently, the South Africa – Zimbabwe BIT (2009)[35] and the Rwanda – UAE BIT (2017)[36] have also adopted such clauses.

India’s 2016 Model BIT also clarifies through the definitions of ‘investor’, ‘investment’ and ‘enterprise’, coupled with non-inclusion of ‘establishment’ in its national treatment obligation, that such obligations are excluded at the pre-establishment stage. Uniquely, the model in Article 2.2 also states that: “…nothing in this Treaty shall extend to any Pre-investment activity related to establishment, acquisition or expansion of any Enterprise or Investment, or to any Law or Measure related to such Pre-investment activities, including terms and conditions under such Law or Measure which continue to apply post-investment to the management, conduct, operation, sale or other disposition of such Investments.

Restrictions on the Pre-Establishment Obligation

It is but natural that IIAs offering pre-establishment protections also contain restrictions on such a broad obligation, over and above general exceptions. Many IIAs of this kind contain ‘negative lists’ of sectors to which the obligation does not apply, such as those involving national interest or security, like telecommunication, transport, defence etc. The NAFTA, EU – Canada CETA, China – Hong Kong CEPA, Japan – Mongolia EPA, PAAP, ASEAN CIT, Central America – Korea FTA etc. are all found to contain such lists. There may also be a narrower approach, that of a ‘positive list’ enumerating sectors wherein national treatment will be granted, such as in the India – Singapore Comprehensive Economic Cooperation Agreement (CECA) (2005)[37]. Most IIAs analysed above also contain provisions making the national treatment obligation inapplicable to existing non-conforming measures and reasonable amendments thereto, while prohibiting the enactment of new discriminatory measures. Article 9 of the China – Hong Kong CEPA, Article 8.15(1) of the EU – Canada CETA and Article 9.13(1) of the Central America – Korea FTA are good examples of such provisions.

Another measure to restrict a broad interpretation of the pre-establishment obligation is to define the meaning of “seeks to make…an investment” or “attempts to make…an investment” in the definition of ‘investor’. Footnote 12 of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) (2018) clearly states that, “For greater certainty, the Parties understand that, for the purposes of the definitions of “investor of a non-Party” and “investor of a Party”, an investor “attempts to make” an investment when that investor has taken concrete action or actions to make an investment, such as channelling resources or capital in order to set up a business, or applying for a permit or licence.[38] Footnote 14 of the Central America – Korea FTA also contains such an understanding.

Explanations ‘for greater certainty’ have also been added in several agreements to explain ‘like circumstances’, so as not to allow arbitral tribunals too broad a discretion. For example, the USMCA in Article 14.4(4) states that, “For greater certainty, whether treatment is accorded in “like circumstances” under this Article depends on the totality of the circumstances, including whether the relevant treatment distinguishes between investors or investments on the basis of legitimate public welfare objectives.” Article 3(4) of the ASEAN-India provides detailed guidance in this regard by clarifying that, “A determination of whether investments or investors are in “like circumstances” should be made, based upon an objective assessment of all circumstances on a case-by-case basis, including, inter alia: (a) the sector the investor is in; (b) the location of the investment; (c) the aim of the measure concerned; and (d) the regulatory process generally applied in relation to the measure concerned. The examination shall not be limited to or biased towards anyone factor.

Further, in response to jurisprudence that discriminatory intent is not a requirement for a finding of violation of national treatment, IIAs offering pre-establishment national treatment in the future may consider including such a requirement in the treaty itself. India’s 2016 Model BIT, despite not offering pre-establishment national treatment, clarifies the need for discriminatory intent in the following words: “A breach of Article 4.1 will only occur if the challenged Measure constitutes intentional and unlawful discrimination against the Investment on the basis of nationality,” and similar wording may be adopted in the future by countries offering a pre-establishment protection. Furthermore, for countries that have chosen not to afford pre-establishment national treatment, it may be beneficial to clarify that such treatment cannot be imported from other IIAs either. The Brazil – Colombia CFIA (2015) in Article 5(3) adopts this method.

Adopting a more extreme measure, some countries are also seeking to renegotiate treaties which had earlier offered pre-establishment guarantees, to retain autonomy over regulation of foreign investment. An example of a domestic measure which would ordinarily violate pre-establishment national treatment obligations is India’s foreign direct investment (FDI) policy, which mandates government approval for foreign entities seeking to invest in certain sectors in India. Moreover, the percentage of foreign investment allowed in these sectors is also limited. These restrictions placed on foreign entities in the pre-establishment phase accords them less favourable treatment than that afforded to domestic entities. India had previously adopted two distinct approaches while concluding IIAs – first, to undertake only post-establishment obligations, which was seen in a majority of agreements, and second, to undertake pre-establishment obligations but either only in certain agreed sectors (the ‘positive list’ approach was adopted in India’s IIAs with Singapore[39]) or by excluding certain sectors from the purview of pre-establishment national treatment (the ‘negative list’ approach was adopted in the IIA with Japan[40] and Korea[41]). Since the FDI policy is a pre-establishment regulatory procedure pertaining to sectors other than those agreed upon, or concerning those expressly excluded, India believed its FDI policy to be in compliance with its obligations under all international agreements. However, in its 2016 model BIT, India has specifically clarified its intent to undertake only post-establishment obligations henceforth, and is renegotiating its investment agreements according to this model.

Conclusion

It can be concluded safely that while countries continue to enter into treaties offering only post-establishment national treatment protection, the trend reflected in many recently concluded IIAs is towards inclusion of pre as well as post-establishment obligations. This trend could in part be attributed to intense liberalisation and globalisation. Countries and regions such as the US, Canada and the EU choosing to adopt pre-establishment protections is unsurprising, given that these developed economies do not fear competition from counterparties to their IIAs. Further, while emerging market economies were initially almost exclusively offering only post-establishment national treatment to protect their domestic economies, pre-establishment protections are now being offered among parties whose economic power is more equal.

There are political factors at play here as well. At the pre-establishment stage, there is strong impetus to the host state to strengthen the economy by attracting foreign investment. However, the same motivation to uphold national treatment may not remain in the post-establishment stage, when the investor has already invested large amounts of capital and other factors of production, and is unlikely to exit easily.[42] Political parties have more to gain from favouring domestic investors, which secures votes for them. In light of this, it will be interesting to see whether countries uphold the obligation with equal commitment in both phases.


*Vrinda Vinayak, Student, 5th Year, B.A. LL.B. (Hons.), National Law University, Delhi (India)


[1] Treaty Between the Government of the United States of America and the Government of the Hashemite Kingdom of Jordan Concerning the Encouragement and Reciprocal Protection of Investment, art. II.1, Jul. 2, 1997.

[2] Agreement Between the Government of Canada and the Government of the Republic of Latvia for the Promotion and Protection of Investments, art. II.3, Apr. 26, 1995.

[3] North American Free Trade Agreement between the United States, Canada and Mexico, Dec. 17, 1992.

[4] Id., art. 1139.

[5] Agreement between the United States of America, the United Mexican States, and Canada, art. 14.4, Nov. 30, 2018.

[6] Id., art. 14.1 read with footnote 3.

[7] Agreement Between the Government of Canada and the Government of the People’s Republic of China for the Promotion and Reciprocal Protection of Investments, art. 6, Sept. 09, 2012.

[8] Treaty between the Government of the United States of America and the Government of the Republic of Rwanda Concerning the Encouragement and Reciprocal Protection of Investment, art. 3, Feb. 19, 2008.

[9] Agreement Between Canada and the Federal Republic of Senegal for the Promotion and Protection of Investments, art. 4, Nov. 27, 2014.

[10] Agreement Between Canada and Mongolia for the Promotion and Protection of Investments, art. 4, Sept. 08, 2016.

[11] Council and Commission Decision on the conclusion of the Stabilisation and Association Agreement between the European Communities and their Member States, of the one part, and the Republic of Montenegro, of the other part, art. 53, March 29 2010.

[12] Association Agreement between the European Union and the European Atomic Energy Community and their Member States, of the one part, and Georgia, of the other part, art.79, June 27, 2014.

[13] Association Agreement between the European Union and the European Atomic Energy Community and their Member States, of the one part, and the Republic of Moldova, of the other part, art. 205, June 27, 2014.

[14] Association Agreement between the European Union and its Member States, of the one part, and Ukraine, of the other part, art. 88, June 27, 2014.

[15] Comprehensive Economic and Trade Agreement between Canada, of the one part, and the European Union (and its member states) of the other part, Oct. 30, 2016.

[16] Agreement between the European Union and Japan for an Economic Partnership, July 17, 2018.

[17] Agreement Between the Government of the Republic of Turkey and the Government of the Republic of Indonesia Concerning the Promotion and Protection of Investments, art. II(2), Feb. 25, 1997.

[18] Agreement Between the Government of the Republic of Korea and the Government of the State of Qatar for the Promotion and Protection of Investments, art. 3(2), Apr. 16, 1999.

[19] Agreement Between the Republic of Turkey and the Republic of South Africa Concerning the Reciprocal Promotion and Protection of Investments, art. II(3), June 23, 2000.

[20] Agreement between the Government of the Republic of Korea and the Government of Japan for the Liberalisation, Promotion and Protection of Investment, art. 2(1), Mar. 22, 2002.

[21] ASEAN Comprehensive Investment Agreement, art. 5, Feb. 26, 2009.

[22] Additional Protocol to the Framework Agreement of the Pacific Alliance, art. 10.4, Feb. 10, 2014.

[23] Agreement on Investment Under the Framework Agreement on Comprehensive Economic Cooperation Between the Association of Southeast Asian Nations and the Republic of India, art. 3, Oct. 8, 2003.

[24] Article 10.3, Agreement Between Japan and Mongolia for an Economic Partnership, art. 10.3, Feb. 10, 2015.

[25] Id., art. 10.2(e).

[26] Id., arts. 1.2(k) & (l).

[27] Investment Agreement of the Mainland and Hong Kong Closer Economic Partnership Agreement, art. 2(2), June 26, 2017.

[28] Id., art. 5.

[29] Free Trade Agreement between the Republic of Korea and the Republics of Central America, art. 9.3, Feb. 21, 2018.

[30] Cooperation and Facilitation Investment Agreement between the Federative Republic of Brazil and the Republic of Suriname, art. 5 read with art. 3(1.3) and art.3(1.5), May 02, 2018.

[31] Agreement Between the Federativo Republic of Brazil and the Federal Democratic Republic of Ethiopia on Investment Cooperation and Facilitation, art. 3(4), art. 4(1), Apr. 11, 2018.

[32] Id., art. 5(1).

[33] Agreement between the Government of the Federal Democratic Republic of Ethiopia and the Government of the Russian Federation on the Promotion and Reciprocal Protection of Investments, art. 2(1), Feb. 10, 2000.

[34] Agreement between the Government of the Kingdom of Thailand and the Government of the Kingdom of Bahrain for the Promotion and Protection of Investments, art. 3(1), May 21, 2002.

[35] Agreement between the Government of the Republic of South Africa and the Government of the Republic of Zimbabwe for the Promotion and Reciprocal Protection of Investments, art. 2(1), Nov. 27, 2009.

[36] Agreement between the Republic of Rwanda and the United Arab Emirates on the Promotion and Reciprocal Protection of Investments, art. 3(1), Nov. 01, 2017.

[37] Comprehensive Economic Cooperation Agreement between India and Singapore, art. 6.3, Jun. 29, 2005.

[38] Comprehensive and Progressive Agreement for Trans-Pacific Partnership, Mar. 08, 2018.

[39] Supra note 37.

[40] Economic Partnership Agreement between Japan and India, art. 90(2), Feb.16, 2011.

[41] Comprehensive Economic Partnership Agreement between India and the Republic of Korea, art. 10.8(2), Aug, 07, 2009.

[42] Jurgen Kurtz, The WTO and International Investment Law: Converging Systems 90 (2016).

Chinese SOE Investment: An Economic Statecraft

Bashar H. Malkawi*

China’s rising economic preeminence has been stunning, firmly ensconcing China as the second most powerful world economy replacing previously second-ranked Japan. In a remarkably short span, less than 15 years, the US economy has experienced a relatively huge decline vis-à-vis China on a nominal GDP basis.

China’s remarkable economic juggernaut has been fueled by an opening of markets, globalization and booming free trade which has provided immense financial benefit to Chinese companies. The free market open rules trading system led to the establishment of China as a major global exporter. As China’s economy has boomed, China has looked increasingly abroad for investment opportunities to both employ its cash hoard and provide long-term growth for its citizens.

In China, many large companies are state-owned enterprises (SOEs), and are the most common form of entity that are involved investment. Chinese SOEs receive preferential treatment in terms of access to capital and obtaining regulatory approvals[1] and are employed in the advancement of Chinese governmental aims “serv[ing] political goals, including fostering indigenous innovation, supporting social stability and crisis response in China, and advancing economic initiatives abroad such as ‘One Belt, One Road.’”[2]

By definition, all SOEs raise concerns because of their connection to their home states. These anxieties over state-owned businesses are not unique to China and relate to all SOEs in general. Investments made by states trigger different regulatory sensitivities compared to considerations raised by private companies because of the possibility that in conducting business government owned or controlled entities may utilize non-profit motivations and substitute political ambitions instead of or in addition to profit-making.

Thus, these concerns are tied to any government-owned business which potentially subjugates (or at a minimum is an additional motivation) private market interests to the political interests of the state.[3] Indeed, such concerns are not entirely new. As an illustration of prior concerns with respect to government-owned businesses and their investment decisions was the opposition over Dubai Ports’ attempt to invest in the U.S.  In 2007, the Dubai government-owned Dubai Ports World sought to acquire port terminals located in the U.S.  Members of the U.S. Congress, concerned about a foreign government controlling the flow of goods and people into the U.S. voiced strenuous opposition on national security grounds.[4] In this respect, Chinese SOEs are no different than other state-owned businesses.

However, there are additional factors with respect to China’s SOEs which increase national security concerns of FDI recipient nations; China’s political structure and unique state dominance/control of SOEs presents a different type of investor.  China is a communist economic order and the state is purposely directly involved in all critical economic sectors. “The way that the Chinese government exercises ‘state capitalism’ is that it directly or indirectly controls a large number of powerful SOEs, especially in the strategic and key sectors.”[5]

The raison d’être of the Chinese SOE is the advancement of the CCP’s objectives thus amplifying the general “state-ownership” concerns. China is ruled by one political party, the CCP, and its domination of Chinese SOEs is of critical importance.  The CCP wields near total non-financial control over its citizenry; singularly legislates the law of the land and CCP appointed judges rule on the interpretation of law in courts. These facts are not meant as a criticism of China which has expressed no intent of aggressively advancing such goals. Nevertheless, Chinese SOEs may have motivations that align with CCP goals and those aims may not necessarily correlate with other countries’ national interests.

While the U.S. government also wishes to advance its geo-political goals, the key distinction is that the U.S. government’s pursuit of policies is not part of private U.S. company investment decision making.  In evaluating FDI from U.S. companies, the presumption is the decision to invest is 100 percent profit motivated; but the same cannot be said of Chinese SOE investment. It is thus crucial to internalize that Chinese SOEs related investments may very well harbor an agenda to advance strategic goals for the CCP. These concerns can be expected to grow.  The CCP is apparently strengthening its control over SOEs.

The potential motivation to further the goals of an alternative vision of global governance by a private entity investing and buying companies is a very different context for review than traditional corporate acquirers. In addition, investments and joint ventures from SOEs may not be an efficient allocation of resources or be a profit-generator.[6] If investments are not based upon pure economic motivations, the investments may prove to be less than stellar performers or at a minimum, fail to achieve the potential return. Crucially, such motivations bring potential economic risk/loss of potential into the calculus for a recipient nation.

China has acknowledged the crucial need to reform its inefficient SOEs and doing so would lend confidence to recipient nations and lower concerns.[7]  However, economic considerations have not trumped political considerations. Rather than utilizing pure economic factors as the benchmark for SOE reform, political factors are considered which may impinge on the profit-making calculus private sector companies engage in.[8] In terms of enacting reforms to China’s SOEs, economic performance is surely a factor but not the controlling factor as it would be in a private sector business. This demonstrates that SOE investment in other countries may potentially be made based at least in part upon non-economic factors.  The fact that some SOEs investments may not have pure economic profit as the driving factor may constitute an inefficient allocation of financial resources and economic potential in addition to raising security concerns.

Although FDI is acknowledged as beneficial and an important enabler of economic vitality, many governments are concerned about national security implications of FDI. Chinese FDI has come under more stringent scrutiny in recent years sparked by political. concerns about foreign ownership in Europe and the U.S. Some in the U.S. have urged a complete ban on Chinese SOE investment. It is not only the U.S. that has signaled a reassessment is being considered. The EU has also expressed concerns regarding China’s FDI into the EU and the associated national security risks of OBOR-driven investment.  EU diplomats gave expressed “suspicions ran deep over China’s geopolitical intentions in Europe, particularly with its massive trade and infrastructure plan, the ‘Belt and Road Initiative’.

In the U.S., CFIUS is the primary vetting mechanism and wields power to review a “covered transaction,” defined as any merger, acquisition or takeover … by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States.  The term “national security” is not strictly defined and CFIUS focuses on certain strategic national security spheres such as energy, defense and technology.[9]  The U.S. President is specifically empowered to “suspend or prohibit any covered transaction that threatens to impair the national security of the United States.” In every other country, a CFIUS style review mechanism is an option that should be examined as a potential solution to the upcoming challenges of increasing Chinese investment worldwide.


* Bashar H. Malkawi is Dean and Professor of Law at the University of Sharjah, United Arab Emirates. He holds S.J.D in International Trade Law from American University, Washington College of Law and LL.M in International Trade Law from the University of Arizona.


[1] See Wendy Leutert, China’s Reform of State-Owned Enterprises, 21 ASIA POLICY 83, 86 (2016).

[2] Id.

[3] See Sovereign Wealth Fund Acquisitions and Other Foreign Government Investments in the United States: Assessing the Economic and National Security Implications: Testimony Before the Comm. on Banking, Housing, and Urban Affairs, 110th Cong. 4 (2007) (testimony of Edwin M. Truman, Senior Fellow, Peterson Institute for International Economics), available at http://
banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_
id=e4fe589e-90aa-46e0-afe9-lefb57fcd69c.

[4] See Bashar H. Malkawi, Balancing Open Investment with National Security: Review of U.S. and UAE Laws with DP World as a Case Study, 13 The University of Notre Dame Australia Law Review 153, 161 (2011).

[5] Julien Chaisse, Demystifying Public Security exception and Limitations on Capital Movement: Hard Law, Soft Law and Sovereign Investments in the EU Internal Market, 37 U. Pa. J. Int’l L. 583

[6] See, e.g., Debt risk for main state-owned enterprises is controllable: China, THE ECONOMIC TIMES (India) (Jan. 27, 2017), http://economictimes.indiatimes.com/articleshow/56806126.cms?utm_source=contentofinterest&utm_medium=t ext&utm_campaign=cppst (“While many state companies are bloated and inefficient, China has relied on them more heavily over the past year to generate economic growth in the face of cooling private investment.”)

[7] For an excellent discussion of SOE reforms see Wendy Leutert, supra note 1.

[8] See id. Wendy Leutert, China’s Reform of State-Owned Enterprises, 21 ASIA POLICY 83, 86 (2016), available at https://www.brookings.edu/wp-content/uploads/2016/07/Wendy-Leutert-Challenges-ahead-in-Chinas-reform-ofstateowned-enterprises.pdf.

[9] See https://www.wsgr.com/CFIUS/pdf/section-721.pdf (noting the list of factors CFIUS will consider include defense, energy and technology). Note there are calls to expand the list of areas.  See https://www.agriculture.senate.gov/newsroom/dem/press/release/senators-stabenow-and-grassley-introduce-bipartisan-legislation-to-protect-american-agricultural-interests-in-foreign-acquisitions (proposal to add food security to list).