Elisabeth Braw is a Senior Fellow at the American Enterprise Institute. She is also a consultant for Gallos Technologies.
Over the past three years, European countries, including the UK, Italy, Poland, Sweden and the Czech Republic, have come to the conclusion that they need to be more cautious about foreign investment and have introduced stricter foreign direct investment (FDI) screening – which is welcome and much needed.
However, the real challenge will be the implementation of such a screening.
Motivated investors can hide behind layers of ownership units, so conducting this type of scrutiny is exceedingly difficult. And to do that, governments must find ways to keep up with the volume of investment under scrutiny and, most importantly, decide how to replace blocked investors. For without thoughtful execution, our economies will be no safer than they were before.
In 2018, a Hong Kong-based company called Mars bought a 75% stake in Alpi Aviation – an Italian manufacturer of dual-use drones that supplies the Italian armed forces – paying a staggering 90 times the stake’s value. And because Mars just looked like a commercial enterprise, the Italian government didn’t intervene. However, after the country’s financial police, the Guardia di Finanza, took a closer look at the investment, they discovered that Mars was ultimately controlled by a Chinese state-owned company and had no fewer than seven layers of ownership and 17 different entities to establish its identity disguise.
The country’s prime minister at the time, Mario Draghi, was quick to force Alpi to divest itself of Mars as the government would have prevented Golden Power’s takeover under Italy’s FDI rules had it known of the company’s owner. But at the time of the intervention, Alpi’s Chinese owners had long had access to its technology.
Cases like these have finally prompted Italy and others in Europe to step up their FDI screening. In truth, many had believed in globalization so firmly that they had hardly been monitored. For example, just a few years ago, Chinese companies bought three state-of-the-art Swedish semiconductor companies without any scrutiny, simply because there was no legislation to do so.
The Czech Republic introduced its first FDI regime in May 2021. “We had learned from our experience not to have any measures that we could use against toxic investors,” Ota Šimák, director of the Department of Trade Policy and the Czech Ministry of Industry and Trade, said International Economic Organizations told me. “This led to a political decision to introduce screening of investments in companies involved in critical national infrastructure, defense equipment and dual-use goods.”
Companies in other sectors can now also proactively seek a government rating from investors above a certain percentage. “The law allows us to ask for all the details of the investing company,” said Šimák. “We go deep into ownership structures, and a couple of times the investor pulled out when we started. That doesn’t mean they were a toxic investor – it may just be that they can’t or won’t provide the necessary information.”
In several cases, the trail of a potential investor evaluated by Šimák’s team has led to a company in an offshore jurisdiction such as the British Virgin Islands, where companies and individuals who wish to remain anonymous have been known to set up shell companies. “‘[Such] Accounts are certainly difficult,” said Šimák. Even for governments — who have the power to request information — investigating potential investors is extremely time-consuming, and it becomes even more time-consuming when potential investors, knowing they are likely to be blocked, hide their identities behind layers of ownership.
This is the paradox faced by countries now trying to protect sensitive companies through enhanced FDI screening. “A system that includes too many types of companies in its FDI screening can easily become unusable, allowing ‘bad actors’ to evade detection because resources are diverted to processing low-risk applications,” Jenine said Hulsmann of the law firm of Weil, Gotshal & Manges.
“In the UK, for example, less than 10 per cent of companies covered by the new legislation were asked for screening in the first three months of the regime, suggesting the thresholds may have been set too low.” This suggests that the UK government is diverting valuable resources to non-harmful investments, while not paying enough attention to investments by companies that disguise their identities.
In 2021 alone, Mario Draghi vetoed three Chinese takeovers of sensitive Italian firms | Sean Gallup/Getty Images
The same dilemma applies to other countries as well. The US Board of Foreign Investments — the gold standard for screening foreign direct investment — has fallen victim to its own success and is now struggling to keep up with demand. In Italy, which tightened its golden power rules in 2020, the number of companies reporting new investors to the government rose from just 83 in 2019 to 500 two years later, but the number of officials conducting investigations has increased , has not increased accordingly.
In such cases, the officials who regularly conduct the checks may need help from intelligence agencies to bolster their staff. Or, to keep up, governments may need to select a few cases to thoroughly investigate — and then loudly communicate their investigators’ skills to deter shady investors.
Meanwhile, the question governments have not asked themselves is: if they block an investor, who will replace him?
For example, in the late 1970s, the Iranian government wanted to buy a larger stake in Germany’s Daimler-Benz. But as then-Chancellor Helmut Schmidt later explained: “I found it inappropriate that the pearl of German industry, which was Daimler-Benz, ended up in Iranian hands. I thought this had to be prevented.” So he asked Deutsche Bank to buy the stake: “I said it’s in the patriotic interest that you buy this stake. You may need to keep the insert for many years. . . but you have to do it. And because they were good patriots, they did.”
Today’s European political leaders would struggle to receive similar appeals – but they must try. If a company is sensitive enough to have an investor blocked, it’s sensitive enough to stay alive. In 2021 alone, Draghi wisely vetoed three Chinese takeovers of sensitive Italian firms, and in the 12 months since the new UK review came into effect, the UK government has blocked three takeovers. For its part, Germany came up with its own solution when Berlin instructed the state-owned KfW bank to buy a German energy company when a Chinese company wanted to take a stake in it in 2018.
In the longer term, FDI legislation is only the first step. Truly protecting our economies will require sophisticated investigations by cadres of officials – as well as the willingness of other companies or governments themselves to step in for a suspect investor.
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