Regulatory Challenges Arising from Sovereign Wealth Funds and National Security: Exacerbate Great Power Competition between China and the United States?

Charles Ho Wang Mak* and I-Ju Chen**

China is now a major player in some of the United States’ (US) most important sectors. China’s impact can be found through the acquisition by some of its most influential companies, which are later acquired by the sovereign wealth funds (SWFs) of China. US’ companies, for example, Apple and IBM, and their distributors, are indirectly controlled by China. This dynamic and tension of the two great economic power may play a significant role in the US-China trade war. Moreover, concerns about regulations of the SWFs and national security have never ceased in the US. While the US presidential election is in fall 2020, the foreign relationship between China and the US is an essential agenda in both Trump and Biden’s campaigns. This post examines regulatory challenges arising from the SWFs and national security under this new era of great power competition between China and the US.

National security is closely associated with the concept of state capitalism. This is because the states’ governments mostly control the enterprises that existed in states that adopted state capitalism. Therefore, investors (with political agendas) may invest in some state enterprises, which might affect national security. National security will be negatively affected by the SWFs made by state-owned enterprises. Inward SWFs might affect individual strategic firms (investing in infrastructure) and different sectors in the host countries. This is because those state-owned enterprises, which invest in those host countries by SWFs, can access sensitive information and technology of those strategic firms and then misuse that information. States investors seek to get improved access to sensitive technologies of other countries through investment. Therefore, to safeguard national interests, policies and strong regulations are necessary.

The Santiago Principle could be a reference for governments to govern international investment. Establishment of the Santiago Principle aims to depoliticise foreign investment flows and to structure and implement transparent and sound governance.[1] The Santiago Principle covers the following areas: legal framework and coordination with macroeconomic policies; institutional framework and governance structure; and investment and risk management framework.[2] Hence, the Santiago Principle is one of the most important features in reframing international perceptions of SWFs.

The balance between the protection of national security and open investment policy of SWFs is complex. In addition, SWFs raise ‘potentially controversial questions for international financial regulation and governance’.[3] China’s SWFs, such as the China Investment Corporation (CIC), have sought more access to markets in the US after Chinese deals are under more and stricter scrutiny. Chinese firms have criticized the US’ investment regulations imposing unfair restrictions on funding coming from China. Moreover, in a high-profile talk with the US government in 2015, Xi Jinping raised the issue of SWFs and relevant regulations in the US. Xi addressed that the US government should relax regulations of foreign investment in high-tech sectors.[4]

However, the investment flow of China into the US has prompted US’ concerns about the government of the People Republic of China’s influence. This is because, from the perspective of the US government, there is a potential risk of national security of SWFs. Although it is clear that the national interest ensures long-term capital availability – because much of it must come from SWFs now – several US pressure groups still urge restricting foreign investors’ choices lest they ‘steal’ technology, trade secrets or jobs.[5] On this controversial point, Bu’s research, however, indicated that China has no intention of investing in sensitive sectors pursuing the controlling stake because it has steered away from deals that would trigger any political backlash.[6]

The US has a series of critical legal regimes applicable to SWFs. The US adopted a protectionist approach towards the SWFs inward investments. Since 2000, the companies in the US that were invested by SWFs became a major issue. In the US the principal regulations that burdened SWFs are the Securities Exchange Act 1934, Foreign Investment and National Security Act (FINSA) 2007, Foreign Corrupt Practices Act of 1977 and Defense Production Act of 1950. FINSA codifies the contemporary views of the Committee of Foreign Investment in the United States (CFIUS). FINSA has dramatically strengthened the regulations introduced by CFIUS, those about inward investment, particularly for state-owned entitled such as SWFs. For instance, critical infrastructure needs to be protected against those SWFs that are invested with a political purpose, since those critical infrastructures will give rise an issue of national security. However, with respect to the unpredictability for the transaction parties, an issue arises as to whether the FINSA can strike a balance between the economic benefits of foreign investment and national security concerns about technology and critical infrastructure.[7] Nonetheless, Chinese scholar, Feng, comments that FINSA is unnecessary and even likely to be detrimental to the US capital markets and the overall economy.[8]

Furthermore, the case of Cede & Co. v. Technicolor, Inc. showed that directors and managers owe the duty of loyalty to both the company and shareholders by providing protections from SWFs’ geopolitical agendas. [9] The US government has treated inward investment by SWFs as an issue of national security. Therefore, Congress has greatly strengthened the regulations on equity investment, especially of state-owned bodies. Also, regarding the definition of strategy towards the notion of national security between the US and China, the US is the most protectionist jurisdiction. Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which predecessor (Trans-Pacific Partnership Agreement, TPP) was led by the US, pertains to regulations of SWFs. Definitions for SWFs are at the start of Chapter 17 of CPTPP.[10] In addition, SWFs must be member(s) of the International Forum of Sovereign Wealth Funds or endorse the Santiago Principles, or such other principles and practices as may be agreed to by the parties of the CPTPP.[11]

The US might adopt the European Union (EU) model in the future. To regulate foreign direct investment (FDI) into the EU within the context of SWFs, the EU and its Member States rely on the treaties and EU legislation. The free trade theory – the free movement of capital within the European Common Market is the most fundamental feature of the EU approach to regulating the SWFs. However, this fundamental freedom is restricted in a limited number of cases. This is because the Treaty on the Functioning of the European Union (TFEU) awarded the EU with the competence to adopt different measures to regulate the establishment of foreign investors within the EU. There are two ways to regulate the movement of capital. According to Article 64 of the TFEU, firstly, the EU can impose measures on the movement of capital from third countries involving direct investment, by a qualified majority; secondly, direct investments can be restricted by measures that are introduced by the EU.[12] Since the TFEU explicitly covers the relationship between the Member States and the so-called third party countries, it seems that the EU laws are favourable to the foreign investors in terms of their important rights vis-à-vis their investments in the EU. However, the principle of free movement of capital is subject to two limitations. The limitations are derogations and safeguard clauses respectively. The scope of the limitations determines the extent to which the governments could restrict FDI within their territories. The narrower these limitations are, the easier it is for SWFs to enter the EU market. On the other hand, if the limitations are broader, governments can impose more restrictions to limit access to the Common Market.

In terms of the securitisation of national security, Article 65 of the TFEU is the most important provision as it describes the power retained by the Member States to restrict the concept of free movement of capital within the European Common Market in the name of protection of public order or public security. It also sets out potential obstacles to SWFs that invest in the EU. O’Donnell acknowledged that there are several Member States in the EU which had adopted various measures to restrict investments of SWFs in the defence sector.[13] In Sanz de Lera and Others, the Court of Justice of the European Union (CJEU) produced mixed results for the development of the EU law on capital movements.[14] In this case, CJEU clarified the unconditional nature of Article 65 TFEU, that the principle of free movement of capital prohibits those obstacles between the Member States, and between third countries and the Member States. Until mid-2015, Article 65 had never been applied by any of the Member States to regulate SWFs. In October 2020, an EU regulation establishing a framework for the screening of FDI into the Union has entered into force.[15] This new EU regulation aims to better scrutinise direct investments coming from third countries on the grounds of security or public order. It enhances the European Commission’s existing powers to review foreign investments under the existing merger control rules and sector-specific legislations of the EU.

Currently, some commentators might argue that there are only a few rules that can be applied to regulate SWFs within the EU. Nonetheless, in no small extent, it seems that the legal framework of the EU has provided a comprehensive regime to tackle the phenomenon that the US can take as a reference. For instance, the US can take the new free trade agreement between the EU and, Singapore and Vietnam, and the parallel EU-Vietnam Investment Protection Agreement as a reference, to incorporate SWF provision in the future free trade agreement with China.

To conclude, it is a well-established principle of international law that sovereign immunity does not extend to a state’s commercial activities in another jurisdiction. Thus, SWFs are subject to be assessed by investment host countries’ national laws. However, too excessive scrutiny of SWFs investment is likely to fuel nationalism, and will further hamper the free foreign capital flow. Hence, it has been suggested that the potential consequence of protectionism caused by strict examinations of SWFs should be avoided.[16] Nevertheless, it has been unclear whether the Trump administration would take a tougher stance on trade and investment with China. Since the trade war between China and the US has not ceased yet, the new president of the US would have to deal with the SWFs issue for a mutually beneficial future of the two countries.

*Charles Ho Wang Mak is a PhD Candidate in international law at the University of Glasgow. He studied law at the University of Sussex in England (LL.B. (Hons.)), The Chinese University of Hong Kong (LL.M. in International Economic Law), and the City University of Hong Kong (LL.M.Arb.D.R.(with Credit)).

**Dr I-Ju Chen is assistant lecturer at Birmingham City University in the UK. She holds PhD in law from the University of Birmingham and LLM from University College London. She studied law at National Chung Hsing University in Taiwan (LLB and LLM).

  1. International working group of sovereign wealth funds: Generally accepted principles and practices, “Santiago Principles” 3, 2008. https://www.ifswf.org/sites/default/files/santiagoprinciples_0_0.pdf
  2. Id. at 5.
  3. Benjamin J. Cohen, Sovereign Wealth Funds and National Security: The Great Tradeoff 85(4) International Affairs (2009) 713, 713.
  4. Sui-Lee Wee, China’s $800 Billion Sovereign Wealth Fund Seeks More U.S. Access, Nytimes.com (2020), https://www.nytimes.com/2017/07/11/business/china-investment-infrastructure.html (last visited Aug 30, 2020).
  5. Patrick DeSouza & W. Michael Reisman, Sovereign Wealth Funds and National Security, in SOVEREIGN INVESTMENT: CONCERNS AND POLICY REACTIONS 283, 290 (Karl P. Sauvant, Lisa E. Sachs, and Wouter P.F. Schmit Jongbloed ed., 2012).
  6. Qingxiu Bu, ‘China’s Sovereign Wealth Funds: Problem or Panacea?’ 11(5) The Journal of World Investment and Trade (2010) 849, 868.
  7. Id, at 870.
  8. Zhao Feng, How Should Sovereign Wealth Funds be Regulated?, 3(2) Brook. J. Corp. Fin. & Com. L. 483, 484 (2009).
  9. Cede & Co. v. Technicolor [1988] 542 A.2d 1182.
  10. See Article 17.1, CPTPP.
  11. Id.
  12. Treaty of Lisbon amending the Treaty on European Union and the Treaty establishing the European Community [2007] OJ C306, Article 64.
  13. O’Donnell C. M., ‘How should Europe respond to sovereign investors in its defence sector?’ (Centre For Euroopean Reform- Policy Brief, September, 2010), PAGE <http://www.cer.org.uk/sites/default/files/publications/attachments/pdf/2011/pb_swf_defence_sept10-203.pdf> accessed 21 June 2020.
  14. Sideek M Seyad, European Community Law on The Free Movement of Capital and EMU (Kluwer Law International 1999) 101-102.
  15. Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March 2019 establishing a framework for the screening of foreign direct investments into the Union, OJEU, L 79I , 21.3.2019, p. 1–14, https://eur-lex.europa.eu/eli/reg/2019/452/oj.
  16. Bu, supra note 6, 871.

Book Launch: The BRICS-Lawyers’ Guide to Global Cooperation

Cambridge University Press has just published a new collective volume regarding the BRICS legal arena, suggestively entitled “The BRICS-Lawyers’ Guide to Global Cooperation”. Its editors are: Rostam J. Neuwirth (University of Macau), Alexandr Svetlicinii (University of Macau) and Denis De Castro Halis (University of Macau).

In the international trade and development arena, new and developing economies have created a block that is known as BRICS – Brazil, Russia, India, China and South Africa. Initially conceived to drive global change through economic growth, the financial crisis and reversal of fortunes of the BRICS nations have raised questions about their ability to have an impact on the governance of global affairs.

This book explores the role of law in various areas of BRICS cooperation including: trade, investment, competition, intellectual property, energy, consumer protection, financial services, space exploration and legal education. It not only covers the specifics of each of the BRICS nations in the selected areas, but also offers innovative and forward-looking perspectives on the BRICS cooperation and their contribution to the reform of the global governance networks. This is a unique reference book suitable for academics, government officials, legal practitioners, business executives, researchers and students.

The BRICS-Lawyers' Guide to Global Cooperation_Cover

See more at the publisher’s webpage.

Across the Strait: The Case for a Special EU-Taiwan Trade and Investment Partnership

 

by Horia Ciurtin LL.M., Managing Editor of the EFILA Blog*

Not Just a Bridgehead: Mercantile Reflections on EU’s Taiwan Position

 At the crossroads of global trade, Taiwan represents a hot spot that unites the flows of goods and capital from near mainland China, from the South-East Asian cauldron, as well as a bridgehead for Western transoceanic commerce and investment. Not truly an island (in the sense of isolation), but a focal meeting point between two seas and an (open) ocean, Taiwan strategically lies in one of the best positions in opening up the Asian markets to larger influxes of EU-based products and capital.

Economically speaking, the relation between the supra-national European entity and the quasi-national Taiwanese one presents quite balanced trading features and a totally asymmetric degree of FDI. Thus, according to the 2015 EU Factfile on the matter, in 2014, while Taiwan exported goods and services in value of around 26.5 billion EUR to the European conglomerate, the EU exported somewhat less to Taiwan, around 22 billion EUR. On the other hand, the FDI situation is reversed in respect to the two actors: while the investment flows originating from the EU rise to approximately 0.8 billion EUR (9.1 billion stocks), those of Taiwan going to Europe are of 0.1 billion EUR (1.1 billion stocks).

In this regard, the European Union is the most prominent investor in Taiwan, representing nearly 25% of all the FDI received by the insular entity. The striking disequilibrium between the investment flows in and out of Taiwan is paradoxical in the conditions in which this particular Asian economy invests in other parts of the world at a much higher level (for example in the Caribbean, its investments flows are 4 times higher than in the EU) or at a similar level with its EU investments, despite not receiving the same investment inputs (for example, in Vietnam or Japan). Moreover, when looking at the accumulated investments in the 1952-2014, it appears that the EU ranks first in Taiwan, while the island’s investment in the EU is only the 7th destination of its funds, ranking far below the Caribbean zone, the US, Singapore or Vietnam.

This asymmetric investment relation between EU and Taiwan takes place in the context of a European adherence to a formal strict One China policy, in line with its member states and transatlantic allies. No political or diplomatically ties are officially admitted among the two entities, in deference to China’s position toward the Taiwanese islands. The strategical factor here plays a fundamental role. It was not until the China-Taiwan relations were formalized in the cross-strait agreements in 2010 that the EU actively began to approach Taiwan in search for a bilateral arrangement.

Muddying the Waters: Hermeneutic Reflections on the EU’s Taiwan Position

Later on, in 2013, the Parliament mandated the Commission to seek ways to accommodate these geopolitical imperatives with a more economic-oriented perspective. At a first glance, a complete warming-up was appearing on the Taiwanese horizon. The rhetoric seemed to go beyond what is usually expected when dealing with Taiwan and its uncertain legal status, portraying a future relation from authority to authority (and not informal-commercial surrogates) and an institutional grounding.

However, as always, the devil is in the details. In this case, the language details of the resolution. Thus, the Parliament’s formal acknowledgement reveals the limits of such a mandate and the caveats it intrinsically implies. When confronted with the Chinese ‘elephant in the room’, the drafters feel the need to justify their decision on the PRC’s approach to enter itself into such prior agreements with Taiwan. Moreover, the resolution states that “whereas closer economic ties with Taiwan do not in any way contradict the EU’s ‘one China’ policy” and that “the decision to start such negotiations with Taiwan should be based on economic reasons, and should not be interlinked with an assessment of relations between the EU and the People’s Republic of China”.

A continuous hesitation of the EU side to assume the initiative subsists in the entire document. It heavily relies on other states’ decision to do so, on the multilateral framework of which Taiwan is already a part (WTO, for example) or – the crown-jewel of justificatory rhetoric – the normalization of China-Taiwan relation and the mainland’s prior recourse to such agreements. We did it just because others did it. Even China did it.

Hermeneutic analysis reveals an indecisive language, far below the intensity expected even in diplomatic documents. The emphasis on the purely economic dimension of the relation is relevant. No trade and investment treaty is simply economic. And everybody knows it. It is also strategic and a geopolitical statement. By formally – and vehemently – denying it such value, any future agreement is left in a mercantile limbo, deprived of symbolic – and effective – power. Among the risks of not being clear enough is not being able to settle a conflict once it occurs.

Simply economic, without a diplomatic – and, yes, political – dimension, the possibility of such a treaty appears as a rhetorical exercise. Two contracting parties with only ‘business interests’ and no identifiable political relation are not really playing the ‘great’ game of international relations. And no subsequent enforceability of their agreement might arise. Muddy (legal) waters allow no divers, no swimmers and no steady flux of boats to carry goods across them.

Beyond Sovereignty: An Interaction with Systemic Stakes

The truth is that the EU should not be afraid of institutionalizing its relations with Taiwan. From a legal point of view, none of them is truly and traditionally a ‘sovereign’. None of them can be – at the moment – perfectly circumscribed within the Westphalian system. And no actual risk exists for the individual state entities involved in the international agora. Rather, such a post-sovereign mode of interaction might open the possibilities of a different systemic configuration: supra-national entities contracting with quasi-national ones in a newly found order. Beyond the sovereign state.

On the other hand, the EU’s reluctance (as that of its member states or the US) to formally institutionalize its engagement with Taiwan is simply a historical and circumstantial position that lives on by inertia. In the post-Cold War environment where everybody rushed to admit Kosovo to the new ‘concert’ of states, Taiwan’s uncertain status lingers without any principled reason. By itself, such a decision was bound to upset major powers (i.e. Russia), even cause discord within the community of the EU member states, to trouble the fragile order of the Balkans even more. However, there was no impediment in going further in this direction and even considering the possibility of a future Kosovo accession to the EU.

In the same fashion, there is a significant support from EU institutions for the establishment of an independent Palestinian state, continuously urging for its future recognition despite vehement Israeli opposition. Of course, Taiwan’s situation is less tragic and incommensurately more complex, but it poises similar conceptual problems regarding recognition.

While understandable for classical sovereigns, such a hesitant position appears paradoxical when stemming from the EU, the self-styled postmodern entity that was to break away with Vattel’s system. In its assumed mission of using ‘soft power’ and moving away from frivolous geopolitical calculations, the EU appears as the most likely source for taking the debate a step further in the Taiwan case. Given the 2016 elections in which the DPP party won the presidential campaign, it might be possible that Taiwan’s rhetoric of autonomy rises in intensity, rather than decreases. In such conditions, it is interesting to see how the EU reacts to a legitimate desire for self-determination of a democratic community.

The post-sovereign reality of EU itself could present the Western states a chance to nuance their position towards Taiwan. The European colossus is not in any acute danger of being excluded from commerce with the discontent actors. It only faces an immediate period of diplomatic pressures (both from competitors and allies), but its irreplaceable locus is not threatened in any fundamental way. However, failing to live up to its promises as a benevolent and avant-garde hegemon might damage its reputation and the reach of EU ‘soft power’.

Moreover, the interaction of two entities that are ‘deviant’ from the classical assumptions of Westphalian sovereignty might not cause too much of a turmoil. It can – at any moment – be presented as a rather ‘exotic’ and unrepeatable manner of establishing relations in the international agora. The broad – and decoupled – mandate of the Commission might preserve the image of its member states in front of virtual Sinic dissatisfaction. The Commission did it. Not us.

On the other hand, the manner in which the EU can interact with Taiwan might not really disrupt the Westphalian status quo in an essential manner, as it is able to speak a language very different from that of sovereignty. Therefore, the established relations neither need to conform to traditional diplomatic categories of sovereign-to-sovereign parlance, nor do they have to resort to informal surrogates of such institutions. A different, post-sovereign and non-statist mode of interaction can emerge. EU can thus accommodate Taiwan’s need for recognized autonomy without bringing into discussion the notion of sovereignty or its diplomatic corollary. Such a new type of relation would appear as one that maintains EU’s rhetorical coherence and does not threaten China’s position.

The Win-Win Perspective: (Not Only) Trade and Investment

In this sense, a proper way forward could take the form of a fully-assumed trade and investment treaty, of a comprehensive instrument regulating international business flow. This would be consistent with EU’s active policy of signing expansive FTAs over the world (take, for example, the EU-Vietnam FTA, the EU-Singapore FTA or the highly-debated CETA and TTIP). Its negotiation power would be higher than with most other contracting parties, offering EU the opportunity to implement its wildest innovations in the field of ISDS and investment protection.

However, such an agreement would be of little use if the avoidant language of diplomatic-surrogates is deployed. The existing mode of interaction (for example, in the India-Taiwan BIT, the Thailand-Taiwan BIT, Vietnam-Taiwan BIT) places the agreement under the aegis of the Taipei Economic and Cultural Office/Centre and its corresponding institution from the other state. This type of ‘treaties’ serves no practical purpose when confronted with the harsh reality of cross-border investment. Take, for example, the anti-Chinese riots in Vietnam where numerous Taiwanese individuals and businesses were also strongly affected. The threat of using the Vietnam-Taiwan BIT (improperly called so) brought on no true reaction from the other side, as the Vietnamese officials knew all too well the limits of such an agreement. As did the Taiwanese side.

With no possibility of further using the ICJ if arbitration fails, Taiwan is left in a legal limbo. The ‘representative offices’ signing such agreements in a quasi-official capacity do not really create binding obligations under international law. At least not truly enforceable. And thus such ‘BITs’ are left at the will and whim – or idealistically said, at the good-will – of the other party to accept the jurisdiction of an arbitral tribunal. And then to voluntarily comply with the outcome of the arbitral proceedings.

In reality, the EU needs to move further from this existing model of interaction. But neither go in the opposite direction of engaging in an endless – and, finally, sterile – discussion about sovereignty. As a post-sovereign hegemon of global caliber, the EU is able to treat Taiwan in its ‘eccentric’ manner and establish a sui generis type of interaction. One that does not avoid direct institutional and formal relations, but also does not get entangled in the Westphalian vocabulary of inter-state connections.

From a mercantile perspective, this would also permit EU to bolster its SME focus as Taiwan presents itself as a success story of small businesses that sustain a vibrant market economy. Its democratic institutions (although quite new and imperfect, but not unlike those of some Eastern EU member states) are a guarantee for the relative degree of fairness in treating foreign investors and complying with its commitments. In addition, once allowing the access of Taiwanese investors on a more comprehensive level on the European market, the disequilibrium of outbound and inbound investment might ameliorate and help the EU diversify its sources of capital.

On the other hand, the Taiwanese subsidiaries of EU companies would largely benefit from Taiwan’s position and – in the safe harbor of a stable and free market environment – could expand in the near South-East Asian zone while avoiding some of the inherent turbulence of the area. Their double quality (of EU origin and Taiwanese operational mechanisms) would allow the European companies to take all the benefits of working from such a privileged geographic and political position, as well as circumventing the problems of being a purely Taiwanese economic entity.

And thus – symbolically – both EU and Taiwan would gain from such a bargain, allowing the European entity to advance its systemic agenda of transforming international relations and permitting Taiwan to escape its uncertain status. In this win-win scenario, the only major loser is the notion of sovereignty. A concept that seems to function rather erratically in our multipolar world. For these reasons, the sovereignty discussion would not be put under silence because it is uncomfortable, but rather because both parties – postmodern entities – regard it as irrelevant for their relation. A sui generis interaction. At the twilight of Westphalia.



 * Horia Ciurtin, Managing Editor, EFILA Blog; Legal Adviser – International Arbitration, Scandic Distilleries S.A; Editor, VERSO Journal [Romania]; Freelance researcher [see SSRN author page].