Digital Trade And Investment Screening: Friends Or Foes?

By Murilo Lubambo, University College London

Entry of Foreign Investments and Digital Trade 

This blog post discusses how investment screening activities by states may have an impact on digital trade. In other words, to what extent does investment screening constitute a restriction that affects the integration of digital trade between countries on a global basis? 

For the purposes of this blog post, the term digital trade is understood to refer to transactions in goods and services that are enabled through digital means, regardless of how they are delivered.i  In fact, digitalisation increases the speed and scale of global trade. Digital trade integration represents an increase in the pace, level and amount of those transactions, backed by flows of data and capital.  

The entry of foreign investments into countries is subject to domestic controls of various kinds. Screening of foreign investments generally refers to all domestic procedures and mechanisms by which a state analyses, or is notified of, a particular proposed foreign investment in order to assess whether and, if so, under what conditions it should be allowed to proceed. The outcome of the review may, as noted by the OECD Secretariat in a Research Note, lead to the prohibition of the implementation of certain proposed foreign investments, the requirement that they be unwound, or the imposition of mitigation measures 

Most states do not require formal authorization for a foreign investment to be made. In fact, individual screening mechanisms were getting rarer and forthright prohibitions are becoming less common in light of investment liberalisation trends.ii As recent developments have shown, revived concerns as to mergers and acquisitions by foreign companies from certain states have led to tighter control with a special emphasis on digital products and services. In fact, investment screening mechanisms have recently been mushrooming in the European Union. The proliferation of these mechanisms has attracted the attention of experts and has encouraged the creation of epistemic communities, such as the CELIS Institute. 

Technology Diffusion and Investment Screening

Recent government decisions prohibiting the acquisition of technology companies by certain foreign investors are a clear example of the new trend. More specifically, one can mention the rejection of bids by foreign investors to acquire companies that use certain key technologies in the semiconductor manufacturing sector. Other examples include the imposition of restrictions on the acquisition of controlling interests in telecommunications companies on national security grounds and the prohibition of the use of certain telecom equipment. The ICSID case of Global Telecom (GT) v Canadaiii dealt with Canada’s undue delay in a national security review of GT’s, an Egyptian-incorporated integrated telecommunications services company, application to take control of its investment in a Canadian company. Reports mention that authorities were concerned over GT’s ownership structure, which ultimately involved a Russian individual. Besides, the Huawei ban from the 5G auctions has been extensively analysed by commentators. 

Technology-based type of investment screening generally falls within the remit of national security. A focus on know-how and technology in areas deemed critical is part of recent approaches, which may include concerns about research and development activities, including in the biotechnology sector. Cases where a foreign government has a substantial interest in investments in critical digital infrastructure, or sensitive data, may be of greater concern to reviewing authorities. For example, investments by state-owned companies and sovereign wealth funds are more carefully reviewed by the Committee on Foreign Investments in the United States.iv 

The rationale for these state measures is to safeguard the domestic technological and industrial base. Some investments screening regimes even seek to induce technology transfer. As noted by some commentators, government authorities may impose requirements to force technology transfer in exchange for investment approval. In such situations, investment screening mechanisms may produce counterintuitive results. Indeed, the host country may benefit from a greater technology diffusion thanks to investment screening procedures, which deepens digital trade integration. 

Restrictions of Digital Trade

In assessing the extent to which investment screening is a barrier to the integration of digital trade between countries, a number of factors need to be taken into account. It is important to consider the objective needs for and policy goals of investment screening measures, and the differences between screening for economic and national interest purposes. There are different levels of restrictions, such as whether an investment screening process has been established and whether it affects digital products and services. The levels of analysis are also important for this assessment: whether the screening process is merely formal, whether it has ever been used, or whether it is frequently used against investments in digital products and services. 

It can always be argued that restrictiveness is relational: the more countries impose similar restrictions, the lower the perceived restrictiveness and its impacts will be. The mere existence of FDI control is unlikely to affect digital integration. On the other hand, only if it is focused on digital products or services that actually require investment in the country then can it amount to a restriction on digital trade. This is clearly the case when the focus of FDI screening is on FDI-intensive sectors, such as telecommunications, as the main backbone of the digital trade infrastructure, and on the manufacturing of digital components.  

Chilling and anticipation effects on companies also need to be considered. Chilling and anticipation effects occur when digital companies faced with FDI restrictions, actually refrain from investing in a particular country or reduce their investments. Chilling and anticipation effects will be higher if the mechanism is effectively used. Publicity is likely to increase these effects. This is the case when measures are actually implemented (law in practice), either through blocking or mitigating measures that are imposed on a specific investment in the digital sector.  

A standard national security regime, which many countries have now adopted, is horizontal (i.e., cross-sectoral) and may not always be unduly burdensome or trade-distorting. However, there may be a generally wide margin of discretion in this regard, which, as the OECD notes, creates uncertainty. Apart from the increasingly blurry lines between defense and commercial technologies, commentators observe that cross-sectoral horizontal review mechanisms allow countries to keep the definition of national security quite vague. 

As this author has noted in previous research, there are multiple layers of screening mechanisms. For example, a transaction may be subject to merger control proceedings, environmental impact assessments applicable only to foreign investments, procedures for the analysis of economic interests and needs, or the evaluation of impacts on job creation. Some commentators have argued that countries with a higher level of technological development have been more supportive of investment screening because of concerns about unreciprocated technology transfer. In any case, countries that have established mechanisms mainly in response to the recent trend, but have not used them to block any transactions in key digital sectors, will be less affected by digital trade disintegration. 

Friends of Foes?

To sum up, investment screening measures have some impact on digital trade integration. Investment screening can have an impact on digitally-enabled transactions in goods and services and on the speed and scale of trade on a global basis. An in-depth analysis of the impact of investment screening procedures on digital trade integration needs to focus on the practical use of investment screening powers in digital sectors, rather than on the toolkit of potentially applicable powers. The analysis should also take into account the specific effects of investment screening mechanisms compared to more general investment restriction measures affecting digital trade integration. The conclusion might even be that the impact is neutral, as positive and negative effects balance out. This thorough assessment will help us to properly frame them as allies or enemies, or perhaps just colleagues.

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