As the world's two largest economies continue discussing a Bilateral Investment Treaty (BIT), which could be a key potential talking point during the upcoming visit of President Xi Jinping to the U.S. in October, it is noteworthy to consider how national security considerations may impact the entry of foreign investments. One of the goals of the BIT is to expand the frontiers for investments for both contracting parties, as well as ensure reciprocal treatment and protection.
National security concerns have been used by several states to bar certain types of foreign investments. Most jurisdictions maintain a list of sectors wherein foreign investments are prohibited or restricted. While the definition and extent of “national security” may vary across states, there is a general inclination towards keeping key strategic sectors within domestic control, whether through actual state ownership or through ownership by local private companies. Foreign control over important sectors of the economy may erode a state's economic sovereignty, limit its capacity to plan for its future, and put it in peril in times of tensions or conflict with the foreign party who assumes such economic control.
However, while such restrictions surely have their valid and legitimate merits, they are also prone to abuse, as states can expand its application or interpretation to constitute protectionist measures to favor local homegrown companies over more efficient and competitive foreign firms. As more and more sectors are being opened up to foreign capital, states also have to guard against the unchecked exercise of national security reviews (NSR), as this may discourage the much needed international participation in certain key sectors they intend to boost or develop, such as infrastructure and energy. Thus, there is a need to balance national security with the maintenance of a vibrant economy conducive to the entry of foreign investment.
As the economic and political interests of the U.S. and China continue to grow, so do their national security concerns. The evolution of their legal frameworks governing the regulation of foreign investments and review of the same on grounds of national security reflect this. The 2007 U.S. Foreign Investment and National Security Act (FINSA) contains salient national security review provisions. On the part of China, the 2015 Draft PRC Foreign Investment Law (FIL) also has the same. While it remains to be seen when the Draft PRC FIL will finally be passed into law, it is worthwhile to consider how its national security review (NSR) provisions fares when compared to that of FINSA's.
FINSA: Robust and tested
FINSA had amended relevant provisions of Sec 721 of the U.S. Defense Production Act of 1950 to enhance national security review. It inserted new definitions such as “covered transactions,” “foreign government-controlled transaction,” and “national security,” as well as “critical infrastructure” and “critical technology” investments – all areas subject to national security review. It also established the Committee on Foreign Investment in the United States (CFIUS), an inter-agency body headed by the Secretary of Treasury, which undertakes the review. FINSA laid out the review and investigation process, the considerations for review, and the mitigation and monitoring of the threat to national security posed by the covered transaction. Finally, it also outlined actions that the President can undertake in relation to NSR, as well as the increased oversight role given to Congress.
Under FINSA, the U.S. President may suspend or prohibit any covered transaction that threatens to impair U.S. national security (Sec 6). In relation to enforcement, the President may also direct the Attorney General to seek appropriate relief, including divestment relief in U.S. district courts (Sec 6). However, such actions can only be exercised under the following circumstances: “a) there is credible evidence that leads the President to believe that the foreign interest exercising control might take action that threatens to impair the national security; and b) provisions of law, other than this section and the International Emergency Economic Powers Act, do not, in the judgment of the President, provide adequate and appropriate authority for the President to protect the national security in the matter before the President” (Sec 6). FINSA also increased the oversight function of Congress in the review process. The Law states that CFIUS shall “upon request from any Member of Congress … promptly provide briefings on a covered transaction for which all action has concluded under this section, or on compliance with a mitigation agreement or condition imposed with respect to such transaction, on a classified basis, if deemed necessary by the sensitivity of the information” (Sec 7). This involvement of the President and Congress is not present in the national security review provided for in China's Draft FIL.
FINSA covers proposed and pending M&A or takeover transactions, which would result to foreign control of a local entity engaged in U.S. interstate commerce. The review can be initiated by parties to the transaction, or unilaterally by the President or CFIUS. The Law provides a long list of considerations for the review process, including those that affect the country's military defense/security, weapons proliferation, energy, and other critical resources and materials. There is also a catch-all phrase included in the considerations, leaving the option for the President or CFIUS to undertake review as they deem appropriate. The Law also allows a repeat review of transactions already reviewed should it be found that false or misleading information or important information were omitted by the parties. Re-review can also be done if there is a breach of the mitigation agreement or condition. FINSA provides for a 30-day national security review which depending on the result can trigger a 45-day national security investigation. Mitigation agreement and imposition of conditions may be made to address the threat posed to national security of a covered transaction and a monitoring, tracking, and enforcement mechanism has been put in place to facilitate this.
Draft PRC FIL: Sound and comprehensive
Chapter 4 of China's Draft Foreign Investment Law (FIL) deals with national security review of foreign investments. It establishes a Joint Conference composed of reform and development authorities and foreign investment regulatory authorities under the State Council, which would undertake such review. While FINSA specified the role of the President and Congress in the review, Draft FIL only mentioned authorities under the State Council. In terms of scope of application, both FINSA and FIL can be considered broad enough, but FINSA arguably is more expansive, since it can look into transactions involving foreign control of any person engaged in interstate commerce in the U.S. The Draft Law provided a list of the application materials to be submitted by a foreign investor, which was not explicitly stated in FINSA. FIL did not come up with a definition of “national security,” but browsing through the factors to be reviewed would reveal that the concept covers a wide range of aspects. While FINSA has a longer list, there are many similar items, such as impact on national security, sensitive and dual-use assets, key infrastructure, China's position on national security-related technologies, and demand for energy, food, and other resources and control from a foreign government. FIL lists the impacts on information and network security, economic stability, and public order, among others, making the notion of “national security” very comprehensive.
The Law goes beyond FINSA in terms of the actors that can initiate the review. More than the parties to the transactions and concerned government authorities, it also allows trade associations and enterprises to propose for such review, which the Joint Committee would then receive and evaluate. Similar to FINSA, FIL also provides for a re-review of previously reviewed transactions if some vital information were withheld by parties during the first review, or if parties violated restrictive conditions applied based on the review decision made. Like FINSA, FIL also has 2 review phases – the 30-day general review phase and, depending on its outcome, the 60-day special review. After the review has been done, the Joint Conference can either approve the transaction since it poses no danger to national security, disapprove the same, or provide conditional approval meaning that certain actions have to be done to eliminate the danger posed by the transaction. The Law allows the foreign investor to propose restrictive conditions before the review decision is reached. FIL also provides for provisional and compulsory measures that can be exercised while the review is ongoing.
The draft FIL creates an obligation to cooperate on the part of foreign investors—something not expressly stated in FINSA. It outlines the legal liability of foreign investors for failure to implement the agreed conditions, which could come in the form of fines. The Law also states that government will not be responsible for losses sustained by the foreign investor for failure to apply for national security review.
Towards a prudential exercise of NSR
China's drafting of a consolidated Foreign Investment Law may signal the country's sincere interest and willingness to continue undertaking the necessary reforms to further attract foreign capital. At the same time, it may also suggest the emerging confidence and capacity of local companies, including state-owned enterprises, to compete with their foreign counterparts in the domestic market. In addition, as Chinese companies expand their global footprint and actively engage in outbound mergers and acquisitions, they may need to relax restrictions to foreign investments at home and open more sectors for foreign capital, so that Chinese firms will receive similar treatment abroad.
At the present, the U.S. has more investments in China than the other way around, but in line with the “Go Global” or “Go Out” policy, more and more Chinese companies are expected to invest in the U.S. in the future. Chinese firms seem to have learned lessons from such setbacks as the botched CNOOC-UNOCAL transaction. A string of successful equity acquisitions across sectors from energy, finance and food, among others, demonstrate the growing sophistication and confidence of Chinese firms in navigating the U.S. legal landscape. These cases are encouraging and may inspire China to adopt similar measures at home in keeping with reciprocity and fairness. However, the threat of abusing or misusing NSR to block foreign investments especially in a climate of tension or mistrust still lingers. Subjecting a legitimate commercial deal to arbitrary and abusive exercises of NSR may only invite a similar action by the affected state, thus creating a potential spiral adverse to foreign investments. As such, both states should make genuine efforts to ensure transparency and consistency in the application of NSR.
