CFIS 24: Paris Insights – Investment Screening in Defense Sector: Promoting National Security and Neoliberalism
The CELIS Blog is launching its very first special series of blog posts ahead of this year’s CELIS Forum on Investment Screening (CFIS). Our Programme Sherpas, promising young academics and practitioners in the field, share their views on the topics we will be discussing in the various panels during CFIS.
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.
By Neil Noronha,
CFIS 24 Programme Sherpa and Law Student at the University of Virginia
A. Foreign Direct Investment: The Dark Side Revealed
Foreign direct investment (FDI), such as greenfield investments, mergers and acquisitions, or capital infusions, offer positive benefits to the receiving country in terms of employment, tax revenues, technological, and economic development.[i] However, FDI can also concentrate the market power of a host country’s industries or sectors under foreign control. In turn, a host country could become reliant on the owners of this FDI to continue thriving economically. Such dependence creates leverage that could adversely affect the host country during times of national crises involving it and those representing the nationality (or place of incorporation) of the foreign firms.[ii]
B. Birth of Investment Screening Mechanisms: Protect Hardware Industries
In response to this threat, countries have maintained investment screening mechanisms (ISMs) when examining FDI within their defense sector.[iii] While the exact procedures of ISMs differ by country, these reviews generally involve investigating the impact of the control of domestic defense industries and commercial activity by foreign citizens and/or governments.[iv] Namely, how would this FDI affect (1) a country’s capability and capacity of its domestic production to meet its national security requirements and (2) its ability to maintain a technological advantage, if one exists, that affords relative superiority to its military?[v] Traditionally, the reviews have centered on hardware, either component parts, such as semiconductors and microelectronics, or the end products themselves, like aircraft.[vi] However, as the concept of national security has expanded to meet the growing list of national interests, so too has the scope of these reviews.[vii]
C. Into the Future with the Defense Sector: Artificial Intelligence and Quantum Computing
Now, critical technologies, especially software-based applications like artificial intelligence and quantum computing, are receiving heightened attention. Namely, they can simulate physical systems and process exponentially large amounts of data, yielding solutions to complex, multivariate problems and offering interconnectivity within a relatively shorter period of time.[viii] Applications of such technologies span across multiple fields, with the promise of advances in medicine, sustainability, and engineering.[ix] Commercialization has naturally resulted over the years, with companies investing in resources to further these capabilities.[x]
At the same time, the speed, accuracy, and predictive nature of these technologies can assist countries in the defense of their security. Specifically, quantum sensing could help a country’s navy track enemies’ submarines to compromise the survivability of sea-based nuclear deterrents.[xi] Artificial intelligence can enable the development of lethal autonomous weapons systems and provide a clearer view of the battlefield.[xii] Moreover, quantum computing can enable de-encryption efforts in pursuit of signal intelligence.[xiii] Thus, whichever country is technologically superior in these spaces will have a military edge against its adversaries. In turn, ISMs have expanded to include these fields so that those lagging behind cannot erode such advantages simply through procurement, acquisition, or exploitation of firms in a host country that support the defense sector.
D. Challenges and Considerations in Screening Defense Technology
Covering both hardware and software, ISMs in the defense sector face a twofold challenge in ensuring that investment screening is not over- or under-inclusive while meeting the stated objective. On the one hand, the dual-use nature of these items and their components means that ISMs must take a holistic approach in evaluating a prospective FDI—not only investigating the acquirer or investor but also its subsidiaries, suppliers, and partners. Not doing so risks an under-inclusive review as receiving countries may require their companies to share proprietary information or technology, which they could then use for advances in military applications. [xiv] Besides increasing the breadth of the review, ISMs must also consider the risks of not pursuing depth. Namely, every step in the supply chain of an item may present a vulnerability to foreign ownership. For example, the acquisition by an adversary of a firm from a non-aligned third-party sovereign could threaten the security of an allied country, especially if the firm produces a sub-component necessary for the allied country’s military supply chain (e.g. semiconductors).[xv]
On the other hand, valid concerns exist that overregulation or enhanced scrutiny based upon capricious factors will stifle modernization and reduce profitability over synergistic efforts.[xvi] Namely, domestic politics or bilateral relations may lead to ad hoc reviews or cause delays in resolution once a review has commenced.[xvii] In turn, the resulting uncertainty over whether a country will approve an FDI within the defense sector will result in additional costs in terms of time and money for which a prospective investor or acquiring company must account.[xviii] As a result, it may be reticent to engage and shift its capital resources elsewhere to firms within countries with more permissive but capital-inefficient environments.[xix]
The forthcoming panel seeks to resolve the challenges ISMs face when reviewing transactions within the defense sector. First, it will include a brief history of ISMs within this field, comparing how such screening is done within the defense sector as opposed to the other sectors, i.e., civilian ones. Second, it will examine more closely quantum computing and artificial intelligence, specifically analyzing various approaches countries and regions have taken to “right-size” ISMs so that they mitigate security concerns across military supply chains while also promoting and incentivizing defense innovation. Lastly, it will offer a series of recommendations on these matters, specific to the European Union, which is embarking on the ambitious goal of standardizing ISMs across its Member States. As part of this discussion, panelists will discuss how ISMs should treat allies as compared to competitors when reviewing investments. Positing a balance for ISMs to strike amidst an age of great power competition and unprecedented technological advances will ensure that humanity’s progression is not a zero-sum game.
[i] Prakash Loungani and Assaf Razin, How Beneficial is Foreign Direct Investment for Developing Countries?, 38 Fin. and Dev. (IMF) (2001), https://www.imf.org/external/pubs/ft/fandd/2001/06/loungani.htm.
[ii] U.S. Gov’t Accountability Off., GAO-24-106129, Defense Industrial Base: DOD Needs Better Insight Into Risks From Mergers and Acquisitions (2023) (citing that a merger and acquisition resulting in a foreign company or commercial company owning a critical defense supplier could pose a national security risk, namely if it closed the production line supporting defense programs).
[iii] Anna Chojnowska et al., Navigating the Rise in Foreign Investment Screening, Boston Consulting Grp. (2024), https://www.bcg.com/publications/2024/navigating-the-rise-in-foreign-direct-investment-screening.
[iv] Robin Huang, China’s National Security Review of Foreign Investment: A Comparison with the United States, 57 Vand. J. Transnat’l L. 1263, 1263-1303 (2023) (comparing foreign investment screening regimes in China and the United States and highlighting similarities and differences between both).
[v] United Nations Trade and Development, The Evolution of FDI Screening Mechanisms, 25 Inv. Pol’y Monitor 1, 10 (2023), https://unctad.org/publication/evolution-fdi-screening-mechanisms-key-trends-and-features.
[vi] Toby T. Gati, Reading in the Duma, Akin Gump Strauss Hauer & Feld LLP Pol’y Alert (2008), https://www.akingump.com/a/web/1227/9VkYS/080402-new-draft-law-on-foreign-investment-russia.pdf (detailing focus of Russian investment screening regime in 2008, whose scope has grown).
[vii] Jeremy B. Zucker et al., The Evolving Global Foreign Direct Investment and National Security Review Landscape, Dechert LLP (2024), https://docs.dechert.com/view/608853383/52/#zoom=true (comparing various countries’ foreign investment screening regimes, but highlighting a common theme that concept of “national security” has expanded).
[viii] Cpt. Daniel Choi, USMC, Quantum Technology and the Military-Revolution or Hype? The Impact of Emerging Quantum Technologies on Future Warfare, Marine Corps U. (2023), https://www.usmcu.edu/Outreach/Marine-Corps-University-Press/Expeditions-with-MCUP-digital-journal/Quantum-Technology-and-the-Military/
[ix] Ling Zhu, Quantum Computing: Concepts, Current State and Considerations for Congress, Cong. Rsch. Serv. 1, 17 (2023), https://crsreports.congress.gov/product/pdf/R/R47685#:~:text=Researchers%20have%20demonstrated%20the%20potential,modeling%2C%20optimization%2C%20and%20simulation.
[x] Michael Bogobowicz et al., Steady Progress in Approaching the Quantum Advantage, McKinsey & Co. (2024), https://www.mckinsey.com/capabilities/mckinsey-digital/our-insights/steady-progress-in-approaching-the-quantum-advantage#/ (highlighting how investment in quantum technology start-ups have gone from less than $500 million just 6 years ago, to now about $2 billion).
[xi] Kelley M. Sayler, Defense Primer: Quantum Technology, Cong. Rsch. Serv. (2023), https://crsreports.congress.gov/product/pdf/IF/IF11836.
[xii] Id.
[xiii] Id.
[xiv] National Counterintelligence and Security Center, Venture Capital and Supply Chain Vulnerabilities, Off. of Dir. of Nat’l Intel. (2023), https://www.dni.gov/files/NCSC/documents/supplychain/Final%20VC.pdf.
[xv] Id.
[xvi] Vasuki Shastry, How Countries can Regulate Investment Screening, Chatham House (2022), https://www.chathamhouse.org/2022/04/how-countries-can-regulate-investment-screening.
[xvii] Dr. Andrea Pomana et al., Reform of the EU Foreign Direct Investment Screening Regulation – How Might M&A Transactions be Impacted?, Mayer Brown (2024), https://www.mayerbrown.com/en/insights/publications/2024/03/reform-of-the-eu-foreign-direct-investment-screening-regulation-how-might-m-and-a-transactions-be-impacted/.
[xviii] Kristen Eichensehr and Cathy Hwang, National Security Creep in Corporate Transactions, 123 Colum. L. Rev. 549, 555 (2023).
[xix] Boston Consulting GRP., Navigating the Rise in Foreign Investment Screening; C.f. Lorenzo Bencivelli et al., The Rise of Foreign Investment Screening in Advanced Economies, Ctr. Econ. Pol’y Rsch. (2023), https://cepr.org/voxeu/columns/rise-foreign-investment-screening-advanced-economies (quoting “the recent tightening of national investment screening mechanisms has not coincided with investors’ reappraisal of the most attractive destinations”).
