Harmonizing Inbound Investment Screening

Commentary by David Korn, Thibault Denamiel, andWilliam Alan Reinsch

Published August 16, 2024

Introduction

The Committee on Foreign Investment in the United States (CFIUS) commanded extensive attention last month amid a Senate hearing and the release of its 2023 annual report. Yet, the real story might lie in what went unsaid. Notably absent from CFIUS officials' testimonies and public statements was a meaningful summary of CFIUS-led international engagement efforts, which are mandated by statute and critical amid a proliferation of diverse inbound investment screening regimes across advanced economies.

The recent outburst of inbound investment screeners among U.S. allies and partners provides an opening for CFIUS to devise a new approach to international coordination. Engagement through an expanded G7+ framework may provide an optimal starting point, as may NATO and new and existing initiatives with key trading partners. Plurilateral frameworks, bilateral free trade agreements, sectoral arrangements, and working groups are four potential pathways. CFIUS should concurrently determine priority areas for engagement, potentially encompassing information sharing, review exemptions, and common standards, while maintaining a watchful eye on partners' efforts. Balancing economic security imperatives with economic growth will demand more coordination and scrutiny among like-minded countries' screening authorities.

CFIUS Coordination with Like-Minded Counterparts

Broadly understood as a process through which national governments review incoming foreign investments to determine their potential impact on national security and potentially block their execution, inbound investment screening regimes have proliferated since the U.S. government's enactment of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). Aside from expanding the jurisdiction of CFIUS to cover a wider range of transactions, FIRRMA called on the U.S. president to "conduct a more robust international outreach effort to urge and help allies and partners . . . to establish processes" similar to those of CFIUS.

As chair of CFIUS, the Department of the Treasury has since supported over 30 countries' proposals, revisions, or enactments of inbound investment screening mechanisms. Adopters now include virtually every U.S. ally and key partner, such as Australia, Japan, India, Israel, New Zealand, the Philippines, South Korea, and Taiwan, as well as 22 out of 27 European Union member states. The remaining states have all initiated procedures to create such a mechanism, and a European Commission proposal promises to mandate their establishment. Such a rapid embrace suggests that CFIUS has successfully conveyed the economic security imperative for inbound investment screening.

However, a patchwork of different review processes has emerged among the inbound investment screeners of U.S.-aligned countries, many of which may diverge from those adopted and presumably supported by CFIUS abroad.

Definitional Triggers

The establishment of an inbound foreign direct investment (FDI) screener for national security purposes requires criteria by which a government can identify proposed transactions that pose risks and therefore necessitate review. Many national governments have understandably sought to improve the effectiveness of their screeners by adding additional criteria, particularly by roadening the definition of foreign investment subject to review. Most definitions sensibly require investments with a clear connection to "national security," "defense," or "public safety" to be reviewed.

However, several governments have also adopted screening criteria beyond core security-related concerns, with some focused on economic considerations, such as Japan's criteria on the "smooth functioning of Japanese economy" and the Investment Canada Act's "net benefit" threshold, which considers, among other things, an investment's potential impact on employment, exports from Canada, industrial efficiency, technological development, product variety, and competition. Beyond the Canadian regime's consideration of a transaction's compatibility with cultural policies, many regimes now bleed into matters of social policy as well. New Zealand evaluates if an investment is in "alignment with New Zealand's values and interests," while South Korea similarly evaluates if "social morals and customs are threatened" by an investment. Likewise, Poland's criteria include "health and life of the population" and "the protection of the environment." By contrast, Australia embraces a catchall term-"national interest"-that covers everything from "employment and prosperity" and "impact on the economy and the community" to potential effects on biodiversity and the "character of the investor."

Coverage of Investment Types

Another common strategy to expand (or minimize) the breadth of an inbound investment screener is to specify the type of financial investments covered. One such example is the coverage of loans, bonds, and other non-equity-based investments-in some cases referred to as "indirect" investments-that, aside from conferring shares, may provide foreign investors of domestic firms with "control," "material influence," or access to data and intellectual property. Several countries' screening regimes, such as those of Denmark, Japan, Spain, and South Korea, explicitly cover many such transactions; however, those of several U.S. allies such as Sweden and France do not.

Another area of notable divergence among inbound investment screeners lies in their coverage (or lack thereof) of "greenfield" investments. Distinct from traditional foreign acquisitions of existing acquisitions, greenfield investments are a type of FDI in which a parent company invests in operations in a foreign country from the ground up, starting with new facilities and infrastructure. These investments are often coordinated by fully operating subsidiary companies and can account for significant shares of FDI. In the European Union, for example, inbound FDI originating from China and Hong Kong conducted via EU-based subsidiaries reached 38 percent of total FDI in 2021. The European Union has sensibly responded by incorporating greenfield investments into a draft of a new FDI screening regulation, though the United States explicitly excludes such investments from coverage-and CFIUS subsequently lacked jurisdiction to block one greenfield investment that posed a clear national security concern.

Treatment of Foreign Government Investors

Some, but far from all, national governments with new or expanded inbound FDI screening regimes have implemented additional screening provisions to specifically target investments by foreign state-owned enterprises (SOEs) or state-backed investors. Some of this increased scrutiny has emerged in response to the Russia-Ukraine conflict, including in the European Union and Canada, though most is attributable to concerns over Chinese firms and investors with ties to the Chinese government gaining additional control over critical infrastructure and advanced technologies. For example, May 2024 reforms to the inbound screening regime of Australia, which accumulated over $113 billion worth of investments by Chinese firms between 2006 and 2023, stipulate that reviews of proposed investments involving a foreign government investor will additionally consider if the investor "may be pursuing broader political or strategic objectives that may be contrary to Australia's national interest."

Likewise, 2019 amendments to Japan's Foreign Exchange and Foreign Trade Act prevent most SOEs from taking advantage of filing exemptions otherwise intended to avoid unduly burdening foreign private sector investors. CFIUS has adopted a more expansive approach to covered transactions that involve "foreign government control." Before it approves such a transaction, CFIUS must find that its execution "will not impair" the national security of the United States, a higher standard than "no unresolved national security concerns," which is applied to other transactions under the jurisdiction of CFIUS. That said, the screening regimes of several treaty-bound allies, including those of Hungary and Poland, include no such SOE-specific regulations, suggesting that they do not adequately regulate SOEs' foreign investments or, perhaps, that they maintain sufficiently broad catchall criteria to cover those investments.

Screening Procedures

The United Nations Conference on Trade and Development categorizes investment screeners into three main groups: sector-specific (20 countries), cross-sectoral (21 countries), and entity-specific (4 countries). As its name suggests, a sector-specific approach lists the sectors wherein screening of inward investment is required. Targeted sectors often fall within the defense industry and critical infrastructure, though they in some cases extend to the technology industry. Notable adopters of this approach include Germany, India, and Mexico, with Taiwan promulgating a "positive list" of industries in which Chinese investors can invest. The second (and sometimes complementary) approach, cross-sectoral screening, is reliant on broadly defined review criteria related to specific risks, not sectors. These criteria, as discussed above, can differ significantly among regimes, such as those of Japan, South Korea, and the United States. Last, entity-specific screening mechanisms designate investments in identified domestic companies, presumably in sensitive sectors, as subject to review.

The Importance of Coordination and Consistency

Consistency in inbound investment screenings among partner countries should be embraced wherever possible. Policy convergence and communication can help allies better identify and prevent potential vulnerabilities. Conversely, divergent and uncoordinated screening regimes can produce enforcement gaps whereby acquisitions of critical infrastructure, supply chain chokepoints, and emerging technology approved under one, perhaps less stringent, jurisdiction pose indirect security and resiliency risks to allies and partners. Divergent criteria may impose extensive and, arguably, unnecessary burdens on foreign investors, especially from "friendly" countries. One such example is the Biden administration's scrutiny of the proposed acquisition of U.S. Steel by Nippon Steel, whose national government (Japan) is one of the United States' closest allies. Moreover, if compliance with inbound investment screening policies is further differentiated among allied nations, private sector legal costs will rise and overcompliance may take hold, thus dampening investment and long-term growth. At the same time, countries with stringent screeners may be less economically competitive than those with less restrictive ones, thus incentivizing countries to impose less restrictive regimes that provide insufficient consideration to national security imperatives. Harmonization efforts among U.S. partners make for sound economic security policy.

A Path Forward

The apparent lack of effective coordination among U.S.-aligned countries' screeners does not mean that CFIUS is short on initiative. Beyond its 300 engagements with foreign counterparts in 2023, CFIUS has recently established working groups with Mexico and the European Union to foster greater coordination. Little is known about their precise nature and outcomes, but based on the relevant public announcements and the extent of CFIUS engagement with Japan via the newly forged Critical Minerals Agreement, the sharing of best practices is the focus. Engagement with the Five Eyes allies may be more expansive, with its four non-U.S. members-Australia, Canada, New Zealand, and the United Kingdom-the only countries designated as "excepted foreign states" by CFIUS as of January 2022, meaning their investors are subject to less scrutiny.

These new efforts aside, other plurilateral forums may enable a more sustainable and effective approach, with options including enhanced engagement via the G7-or an expanded G7+ framework. By working on a group-wide basis, the United States and its key partners could further institutionalize cooperation on economic security strategy beyond ad hoc arrangements established under the Biden administration-such as the EU-U.S. Trade and Technology Council, the Quad, and the Chip 4 Alliance. Inbound investment screening can be one focus of either grouping, as can other "offensive" tools for economic security, like export controls and sanctions. Collaboration on the deployment of "defensive" tools, such as tariffs and national security guardrails associated with subsidies, is another consideration.

The United States may also consider historically defense-oriented structures, such as NATO, as forums to coordinate these economic security disciplines with its treaty-bound allies. The establishment of a new planning group under the purview of the alliance's Resilience Committee or Security Committee is one such opportunity. Members could establish formalized information-sharing mechanisms and cooperation agreements, as has been embraced on an EU-wide basis, as well as a renewed commitment to-and potential updates of-common standards. CFIUS may also consider integrating select NATO allies that are key trading partners into its excepted foreign states program.

The Biden administration's new regional international economic arrangements-the Indo-Pacific Economic Framework for Prosperity and the Americas Partnership for Economic Prosperity-could also provide flatforms to engage governments on investment screening. Many of their members, as well as most emerging markets and developing economies (EMDEs) in the Global South, require significant volumes of FDI to fund infrastructure development but lack the instruments and bureaucratic capacity necessary to manage the security implications of such FDI inflows. As a result, these arrangements' minimal oversight of SOEs, many of which are Chinese, and the subsequent dominance of SOEs in providing funding for critical infrastructure in EMDEs risk exacerbating economic security vulnerabilities and jeopardizing their potential gains from U.S. de-risking policies.

Lastly, whitelists and new trade agreements-including sectoral arrangements-may help the United States incentivize heightened investment in critical sectors while strengthening economic security. As recommended by Peter Harrell, a former official on the Biden administration's National Security Council staff, in remarks last year, CFIUS can create a "whitelist of companies based in critical sectors and either eliminate or expedite CFIUS screening for cross-border investments in these sectors." Along those lines, the United States can forge new agreements that ensure companies from allied nations like Japan can invest in sectors critical to national security-such as semiconductor manufacturing or biotechnology research and development-without risk of CFIUS intervention. Harell also suggests that the United States should use "trade deals to lock in commitments by foreign governments to restrict Chinese acquisitions of strategic companies in their countries" through CFIUS-like mechanisms. The 2026 review of the U.S.-Mexico-Canada Agreement, for instance, is a fitting pilot opportunity.

Conclusion

The growing complexity of inbound investment screening mechanisms across U.S. allies and partners highlights both the challenges and opportunities for CFIUS in enhancing international coordination. The fragmented landscape of screening criteria and procedures among allied nations underscores the need for a more harmonized approach to protect economic security while fostering investment growth-doubly so for U.S. partners in the Global South, which urgently need increased investment yet lack sufficient economic security protections.

As countries adopt varying standards and definitions, CFIUS must leverage its existing relationships and new frameworks-such as the G7, bilateral agreements, and sector-specific arrangements-to promote consistency and effective collaboration. Whether it be through enhanced information sharing, the exchange of best practices, or the establishment of common standards, CFIUS can play a pivotal role in aligning inbound screening regimes, thus ensuring that common national security concerns are addressed without stifling economic progress. The path forward involves not only strengthening existing partnerships but also innovating new mechanisms for engagement, ultimately creating a more cohesive and secure economic environment.

David Korn is an intern with the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Thibault Denamiel is an associate fellow with the Scholl Chair in International Business at CSIS. William Reinsch holds the Scholl Chair in International Business at CSIS.

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