CFIS 2024: Issue Notes (Part 2/2)
A Note from the Editors
The CELIS Blog is launching its second special series of blog posts ahead of this year’s CELIS Forum on Investment Screening (CFIS). The Issue Note series provides analyses which are published to elicit comment and to further debate. The series is written by our Programme Sherpas, promising young academics and practitioners in the field.
CFIS is the flagship event of the CELIS Institute and is now in its 6th year. It is Europe’s first and foremost forum for the discussion of investment control and economic security issues. Thought leaders in investment control and economic security from Europe, the US and beyond will discuss current practical challenges and influential ideas to outline geo-economic strategies for Europe. Participation is by invitation only. If you are interested, please contact events@celis.intitute.
Strategic Considerations for Sovereign Investment and Investment Control
By Simon Shargi-Erdmosa, CFIS 24 Programme Sherpa and MA International Security Student at Sciences Po Paris
The liberal world order is in flux. While financial and economic integration have for a long time been considered the basis for peace, democracy and freedom, pro-liberal market principles such as the optimal allocation of capital are under pressure by national and economic security considerations. The introduction and strengthening of investment screening mechanisms on grounds of national security and public order in EU member states exemplify this evolving repositioning vis-á-vis unconditioned financial integration.
State-led investments, such as those channelled through Sovereign Wealth and Pension Funds, has increasingly been associated with the potential to pursue geo-political agendas. Given their capacity to move substantial capital on a global scale across industry sectors, the rapid advancement of these government-owned funds since the Financial Crisis of 2007/08 presents unprecedented challenges for investment regulation authorities. While increasingly being perceived as a risk to national security, state-owned funds also offer significant benefits. Their substantial resources and long-term investment horizons benefit host states by providing essential capital and fostering sustainable growth, as they typically avoid the need for a quick exit unlike some private equity funds. This dual nature of sovereign investment highlights the need for a focused discussion on the most pressing strategic issues at the intersection of sovereign investment and investment control during CFIS 2024.
I. All red but not the same: lumps apples, lobsters, and bliss potatoes
Issue: Sovereign Wealth and Pension Funds differ in their purpose, management structures, and investment strategy.
Why it matters: Sovereign investment vehicles serve different purposes. Some are designed to function as intergenerational saving mechanisms. Others, however, also serve the purposes of stabilisation, regional or economic development. Yet others fulfil political objectives for the home country.
Increasingly, investment screening frameworks establish state ownership as a criterion for screening transactions. While sovereign investment vehicles are essentially state-owned entities, their management structures vary in terms of control exercised by national executives over the fund’s daily operations. Accordingly, state-owned investment vehicles may be in possession of a sovereign state but not state controlled.
Sovereign investors employ various strategies, including portfolio, controlling, and mixed approaches. The investment profile can serve as an indicator of a fund's broader motives. While majority investments often prioritize strategic gains over financial returns, non-controlling or portfolio investments typically focus on maximizing financial returns. However, it remains highly difficult to distinguish financial from political objectives.
The rapidly evolving landscape and differences of sovereign investors appear to require investment screening/controlling authorities to qualify the individual risk profiles of individual investment vehicles and transactions. To ensure market openness and the essential security interests of investment-hosting countries, a dialogue is necessary to clarify how such qualification is done when screening sovereign investments. Sovereign investors should explore designs and management structures of investment vehicles that reduce the perception of pursuing objectives beyond financial returns on investment.
Points for discussion:
- According to which criteria is governmental control of sovereign investment assessed in investment screening decisions?
- How can screening mechanisms differentiate between strategic and non-strategic investments by sovereign funds?
- What measures can ensure transparency in the operations of sovereign investment vehicles?
II. Third wheeling: The sovereign investors, the host country and the strategic competitor
Issue: The financial relationship to China of several sovereign investors that seek investment in Europe and the US has raised national security considerations.
Why it matters: Sovereign investment vehicles have become an essential instrument of global financial integration. In particular, the relationships of Gulf Arab sovereign investment vehicles with Beijing—exemplified by their involvement in the Digital Silk Road—are increasingly seen as potential channels for the transfer of data and technology to China.
Points of discussion:
- How can screening mechanisms address the risks posed by the financial integration of individual sovereign investment vehicles
- What measures can be implemented to monitor and regulate the relationships between sovereign investors and third-party countries?
- What frameworks can be established to ensure transparency and accountability in the operations of sovereign investment vehicles?
Investment Screening in Defense Sector
By Neil Noronha, CFIS 24 Programme Sherpa and Law Student at the University of Virginia
I. Introduction
The panel related to investment screening within the defense sector seeks to navigate with a diverse group of panelists the thorny and seemingly irreconcilable issues inherent in a sector where the chief objective is protecting against foreign threats. Particularly, there are three strategic issues that stand out and which require CFIS 24’s attention:
- What defines a country’s defense sector?
- How comprehensive must investment screening reviews and mitigation plans be to de-risk foreign influence within supply chains?
- How can countries promote innovation amidst this increasingly expansive regulatory environment?
II. Scope: Defining a Country’s Defense Sector
Understanding the trajectory of investment screening in the defense sector requires a definitional scoping of the subject matter. Namely, a country must decide which types of transactions, in terms of nature and industry, fall under the specter of its defense sector. This determination becomes challenging when products and services surrounding a foreign merger and acquisition have dual-use purposes. As mentioned in the background paper, quantum computing and artificial intelligence offer promising civilian applications. For example, at Texas A&M University in the United States, researchers used quantum computing to map gene regulatory networks.[i] In turn, the knowledge gained from knowing which genes will affect other ones will help scientists look for ways to stop harmful cellular processes, such those related to cancer growth.[ii] At the same time, there are military applications, such as tracking enemy submarines, that can yield a country a decisive advantage in a future conflict.[iii]
While the public can understand why critical technologies, such as the example provided, fall under a country’s defense sector, other items may have less intuitive dual-use applications. Namely, the U.S. Bureau of Industry and Security’s Commerce Control List requires licenses for parachutes.[iv] With each country having the purview to define the scope of its own defense sector, discrepancies may likely exist among investment screening regimes, in which a transaction occurring in one sovereign jurisdiction may elicit concern whereas it would not in another.
Consider investment screening regimes in France. It is one of a handful of advanced European economies that take a liberal, broader view regarding defense.[v] For example, in the context of investment screening, French legislation recently amended the definition of public security sector to cover prison security services, a perspective that other European nations, like Germany, do not hold.[vi] Normally, such dissimilarity is banal—a reality of independent nations operating within the international system. However, the European Union is different. Each member state has voluntarily ceded some of its own sovereignty in pursuit of the group’s collective interests. Thus, the lack of harmonization among members’ investment screening regimes when it comes to defining the “defense” sector impedes achieving the collective goal of protecting against malign influence threats from foreign ownership control.
Arriving at a near-universal understanding of what constitutes the “defense” sector involves informal conversations and formalized consultations within multilateral organizations, such as the European Union. Undoubtedly, tensions will arise between countries oriented to a trade-first agenda and those prioritizing security matters. However, not addressing this issue fundamentally suspends investment screening regimes proverbially in a cryogenic stasis, unable to adapt to emerging technologies that modify or even redefine security relationships. In turn, CFIS 24 offers the perfect forum to discuss how to properly scope what constitutes the defense sector given the various government officials attending, each of whom can offer a unique perspective on resolving this issue.
III. Means: Mitigating Foreign Influence Risks in Supply Chains
Independent of scope, how to conduct an investment screening review deserves its own consideration. Specifically, countries have come to terms with their own threshold for determining when a sufficient review has been conducted and the proper mitigation actions have been implemented. Namely, full certainty that a malign actor cannot gain influence or leverage into a domestic company via the foreign merger or acquisition is an unattainable goal. The multiple layers and networks comprising of a supply chain provide capable adversaries with access to data and information at multiple points, establishing advanced, persistent, and multifaceted threats related to control, subversion, and corporate espionage for nearly any goods or services company.[vii]
At the same time, without full knowledge that an investment screening regime can sufficiently mitigate the national security risks of a foreign investment transaction, governments must balance security and economic growth. On the one hand, an underinclusive review and/or mitigation plan would expose critical sectors to foreign influence threats. For example, a government that gained foreign ownership control of a company, even if small and indirect, could manipulate the necessary components intended for a particular defense system.[viii] Such exploitation can degrade the other country’s defense capabilities and effectiveness during potential conflicts.[ix] On the other hand, an overinclusive review and/or mitigation plan may ward off a prospective investor, hurting the economic growth of the inbound investment country. For example, in 2022, 57% of the notices (up from 48% in 2021) filed with the Committee on Foreign Investment in the United States involved an extended review (e.g. the second 45-day “investigation” phase).[x] Correspondingly, there was an increase in the number of withdrawals from companies that did not end up refiling a notice (from 9 in 2021 to 20 in 2022).
Determining the level of comprehensiveness that investment screening reviews should assume or the obligatoriness of the mitigation steps the prospective acquiring company should take requires dialogue among governments, multinational companies, law firms, and academics. Without a shared understanding of each participant’s perspective, an investment screening approach and mitigation plan would be fully biased in favor of what the government, who owns and operates this apparatus, wants—naturally predisposed toward national security. If this issue is not resolved, the private sector faces uncertainty as to how long an investment screening will take or even whether an investment screening regime will approve a transaction (or subject it to remedies). In turn, investors are likely to change the mix of which countries as well as what to invest.[xi] With government, academia, and the private sector taking part in CFIS 24, this conference can shine a spotlight on how countries have adapted the depth and breadth of investment screening reviews and mitigation to meet the growing expansion of transactions with national security implications.
IV. Effects: Promotion of Innovation in Defense Sector Amidst Regulation
Enhanced investment screening reviews and mitigation plans within the defense sector likely puts innovation at risk. Notably, mergers and acquisitions within the defense sector reduce the barriers to invest in research and development (R&D) projects and allow for companies to enhance their capabilities by partnering with others that offer complementary or supplementary competences. In fact, the U.S. Chamber of Commerce found that such investments positively correlate to an average increase, over three to four years, in industry-level R&D expenditure of between USD 299 million and USD 436 million in R&D intensive industries, such as the defense sector.[xii] Without long-term, sustainable R&D, maintaining technological advantages that afford military superiority for a nation state becomes difficult. At the same time, this concern becomes moot if foreign adversaries utilize foreign transactions to gain control and thus access to patented technologies. In turn, they would become the ones who reap the benefits of R&D while only incurring minimal costs.
Encouraging innovation amidst this regulatory regime requires industry firms and government officials to find common ground in their positions and use those similarities to navigate and resolve points of contention. Since both actors value innovation, albeit for different reasons (firms for profits and governments for military superiority), any disagreement in the economic growth-versus-security debate should center around whether the investment regime promotes innovation. If it does not, then the government should refine the process and/or requirements. CFIS 24 can highlight the necessity of innovation in the defense sector and participants can discuss about the collaboration that occurs between government officials and the private sector when approaching investment screening reviews.
V. Conclusion
CFIS 24 offers a unique opportunity to advance the debate about how a country’s investment screening regime within the defense sector evolves in this current era so that the country can meet the rapidly changing threat landscape, which over the last few years has moved from non-states being the focus to countries as the driver of competition and conflict. Hosting this panel will allow for various perspectives to be heard and consensus to be built on how to resolve these strategic issues within the next two to five years.
[i] Courtney Price, Researchers Use Quantum Computing To Predict Gene Relationships, Tex. A&M Today (Nov. 20, 2023), https://today.tamu.edu/2023/11/20/researchers-use-quantum-computing-to-predict-gene-relationships/.
[ii] Id.
[iii] See Kelley M. Sayler, Defense Primer: Quantum Technology, Cong. Rsch. Serv. (2023), https://crsreports.congress.gov/product/pdf/IF/IF11836.
[iv] “9A018 Equipment on the Wassenaar Arrangement Munitions List” in Commerce Control List: Category 9—Aerospace and Propulsion, U.S. Bureau of Indus. & Sec. (Dec. 08, 2023), https://www.bis.doc.gov/index.php/documents/regulations-docs/2340-ccl9-4/file
[v] See footnote 5 in Lorenzo Bencivelli1 et al., Who’s Afraid of Foreign Screening?, Banque De France (Working Paper No. 927, Oct. 2023), https://www.banque-france.fr/system/files/2023-11/DT927.pdf.
[vi] Aline Doussin et al., French Government Extends the Scope of Application of the French Foreign Direct Investment Screening Regime, Hogan Lovells (Jan. 16, 2024), https://www.engage.hoganlovells.com/knowledgeservices/news/french-government-extends-the-scope-of-application-of-the-french-foreign-direct-investment-screening-regime.
[vii] See page 1 of Supply Chain Risk Management, Nat’l Counterintelligence and Sec. Ctr. Supply Chain Directorate (Mar. 17, 2017),20170317-NCSC--SCRM-Background.pdf (dni.gov).
[viii] See page 1 of Exploitation of Global Supply Chain, Def. Sec. Serv. & Nat’l Counterintelligence and Sec. Ctr.,Exploitation_of_Global_Supply_Chain.pdf (odni.gov).
[ix] Id.
[x] David N. Fagan et al., CFIUS Annual Report Shows Transactions Facing Longer Road to Approval,
Covington & Burling LLP (Aug. 7, 2023) https://www.cov.com/en/news-and-insights/insights/2023/08/cfius-annual-report-shows-transactions-facing-longer-road-to-approval#layout=card&numberOfResults=12 (referencing CY 2022 Annual Report to Congress, Comm. on Foreign Inv. in the United States, https://home.treasury.gov/system/files/206/CFIUS%20-%20Annual%20Report%20to%20Congress%20CY%202022_0.pdf).
[xi] Tim Figures et al., Navigating the Rise in Foreign Investment Screening, Boston Consulting Grp. (Jan. 05, 2024), https://www.bcg.com/publications/2024/navigating-the-rise-in-foreign-direct-investment-screening.
[xii] Mergers, Industries, and Innovation: Evidence from R&D Expenditure and Patent Applications, U.S. Chamber of Com. (Feb. 07, 2023), https://www.uschamber.com/antitrust/mergers-industries-and-innovation-evidence-from-r-d-expenditure-and-patent-applications.
