The European Union is moving towards uniform and stricter rules for controlling and approving foreign direct investments. This follows the trend set by national governments, among others in Germany, the UK and the USA, as we explained in our article in the September 2018 Newsletter entitled “Germany’s tighter FDI regime and the EU‘s path to uniform standards“.

Following the reflection paper on “Harnessing Globalisation“ of May 2017 and President Juncker‘s State of the Union Speech, the European Commission proposed a framework for screening direct investments in September 2017. One year later, the European Parliament, Council and Commission reached a political agreement. Article 3 para. 2 of the proposed framework allows the Commission to “screen foreign direct investments that are likely to affect projects or programmes of Union interest on the grounds of security and public order“.

The importance of FDI in the EU

The proposal is particularly important since the inward foreign direct investment (FDI) at the end of 2015 reached EUR 5.7 trillion in the EU, whereas it is lower in the US and much lower in China. The largest foreign investor in the EU is still the US; although, their share fell from 51.3 % in 1995 to 41.4 % in 2015. Likewise Japan‘s share fell; it held 7.7 % of FDI in 1995 and less than 3 % in 2015. The shares of Brazil and China, on the other hand, have increased significantly. Brazil‘s share rose from 0.2 to 2.2 % and China‘s shares rose from 0.3 to 2 % between 1995 and 2015.

Although foreign investors control only 0.4 % of EU companies, these companies are generally much larger than companies owned by EU investors. The companies owned by foreign investors represent circa 13 % of total EU turnover, 11 % of value added and 6 % of total employment in the EU.

The benefits for investors and the issue of a level playing field

Third country investors seek to make use of the benefits of the internal market. Investing in EU companies offers them access to the entire EU market. Considering the recent rise in the number of new restrictive measures adopted by foreign countries, the European Union considers the creation of a level playing field crucial. This can promote comparable investment conditions in foreign countries for EU operators. The EU‘s trade and investment policy is the best tool to ensure that third countries will offer the same level of openness for foreign investment as the EU.

The European Commission’s analysis in its “Reflection Paper on Harnessing Globalization“ issued in May 2017 showed that the European Union must allow investments in order to ensure that innovative companies have access to finance. This can be achieved by investment-friendly regulatory frameworks for investment from within and outside the EU. Investment will contribute to economic growth, jobs and innovation.

On the other hand, FDI also presents some challenges. Companies use the lower standards of other countries to their advantage and, as a result, gain an advantage over competitors that produce within the EU. Furthermore, legal immigration can cause problems if integration fails. Especially in regions with high unemployment, protectionism can be triggered.

The envisaged rules

At the core of the framework is the protection of Europe‘s strategic interests and assets, such as energy, raw materials, cybersecurity and electronic communications, while at the same time remaining open to foreign direct investments. This is to be achieved by encouraging a dialogue between the European Commission and the Member States, allowing for the exchange of information, concerns and opinions about foreign direct investments, especially if such investments have the potential to affect several Member States at the same time. According to Article 8 of the proposed framework, Member States shall inform the Commission and each other of any direct foreign investments that undergo screening under their screening mechanisms. If one Member State is concerned about the effects of a foreign direct investment to its security, it may issue a comment and request any necessary information.

According to Article 9 of the framework, the European Commission may issue opinions if projects or programmes of Union interest could be affected.

Nevertheless the ultimate decision on whether to allow any foreign operation will remain with the Member States. In accordance with Article 5 of the proposed regulation, Member States have the responsibility to decide about their own national security interests and whether to establish their own protection mechanisms or refrain from doing so. And as stated in Article 6, Member States shall define the circumstances leading to a screening as well as the reasons for a screening and the detailed procedural rules. Almost half of EU Member States have a screening mechanism already in place. While the approaches are different, there are two main systems. Some require investors to notify an investment before it is made and provide for prior authorisation, while others require ex post control of investments that have already been completed. The areas protected by these mechanisms also differ. Some Member States focus on their national security interests, especially the production or trade in arms; others also cover the protection of public security, public policy and public order. These mechanisms may infringe the freedom of capital and establishment, especially if applied to intra-EU investments. However, the Treaty on the Functioning of the European Union allows Member States to take measures of this nature if the measures to not discriminate on grounds of nationality and can be justified by the needs of public security or police or other overriding reasons in the general interest as defined by the Court of Justice. In addition, the measures must comply with the principles of legal certainty and proportionality.

As mentioned in its press release of 20 November 2018, „Commission welcomes agreement on foreign investment screening“, the Commission already analyses the foreign direct investment flows into the European Union and has set up a coordination group with Member States in order to help identify common strategic concerns and solutions.

Conclusions

The EU‘s agreement on foreign investment screening aims for higher standards regarding investment control. It will drive the harmonisation of the different systems applying (or not) in all EU countries which may over time lead to a standardized and possibly more (cost) efficient handling of FDI controls. Moreover, it will help balance foreign and European investments within the EU and thus prevent a protectionist policy in economically weaker countries. The intention is to protect the EU as a whole and to create a free, open and fair foreign investment strategy on a global level.