Outbound Investment Screening

By Dr. Leonard von Rummel, BLOMSTEIN  

With the “Executive Order on Addressing United States Investments In Certain National Security Technologies and Products In Countries Of Concern“, the USA has drafted a regulation for outbound investment control. This article deals with the question of whether a comparable project could also be transferred to Europe or Germany and, if so, what such a mechanism could look like.

A. Projects in the USA 

On 9 August 2023, US President Joe Biden signed a decree, the Executive Order on Addressing United States Investments In Certain National Security Technologies and Products In Countries Of Concern, which is the first step towards a so-called outbound investment control, i.e. a review of national investments in foreign countries. 

The Executive Order authorises the US Treasury Department to prohibit or require reporting of investments in companies involved in sensitive technologies critical to national security (including semiconductors, microtechnology, quantum information technology and artificial intelligence) that are located in countries listed in the Annex to the Executive Order. The only country currently listed in the Annex to the Executive Order is China. The so-called “small yard, high fence” approach is intended to prevent China from exploiting US investments in technologies that are critical to the development of military and intelligence capabilities.

The US Treasury Department, which is tasked by the Executive Order with issuing a corresponding regulation, has already published an Advanced Notice of Proposed Rulemaking. The regulation is intended to address U.S. persons and affect transactions such as the acquisition of equity interests, greenfield investments, joint ventures and certain debt financing transactions. The US Treasury Department is considering exemptions for investments that do not pose a threat to national security (e.g. transfer of funds from a US parent company to a subsidiary). The Advanced Notice also specifies the technologies that are categorised as critical. 

B. Projects in the EU 

The EU Commission is currently looking into the question of whether a European instrument for controlling foreign investments should be introduced. On January 24, the EU Commission is said to unveil a package of economic security measures, including thoughts on an outbound investment screening mechanism. A week later, senior EU and US officials will meet in Washington for the fifth edition of their Trade and Technology Council. It is likely that the EU Commission will introduce some kind of mechanism to align itself with the US, be it a separate regulation or an extension of export control law to sensitive investment sectors. 

The German government also assures the EU of its support in this endeavour and intends to play a constructive role in the process. From a German national perspective, Chinese investments should be subject to stricter controls, particularly for reasons of national security. This is particularly supported by Minister Habeck, who publicly advocated the introduction of outbound investment controls. This was met with headwinds – including from within his own organisation. In this respect, a solo effort by Germany seems out of the question.  

In line with the Executive Order, the aim of a European regulation could conceivably be to prevent the strengthening of military and intelligence capabilities abroad. The regulation could relate to investments in states that are considered systemic rivals. Such a “list approach” is not alien to foreign trade law (e.g. Annex II of the Dual-Use Regulation). However, one principle of inbound investment control is that it is country-agnostic. It is therefore unlikely that the EU will break with this position. 

There are two possible ways to organise an outbound screening regulation: either the EU takes over the control itself or it leaves the control to the Member States under certain conditions. The latter is more likely. On the one hand, a procedure carried out by the EU that affects the national security of its Member States is hardly politically feasible and legally problematic (Art. 4 para. 2 TEU, Art. 346 TFEU). Secondly, investment control requires a lot of staff and information from secret services, which the EU, unlike its Member States, does not have at its disposal. An independent investment control would therefore most likely exceed the EU’s capacities. 

Furthermore, it is questionable whether implementation is covered by the EU Treaties (see I.) and whether investors can invoke fundamental freedoms and fundamental rights of the Union vis-à-vis the Union legislator (see II.).  

I. Authorisation Basis 

According to the principle of conferral (Art. 5 para. 2 sentence 1 TEU), legislative action by the EU is dependent on a transfer of competence from the Member States. According to Art. 207 TFEU, the common commercial policy is part of the Union’s competence. Foreign direct investment is listed as an associated subject of regulation in Art. 207 para. 1 sentence 1 TFEU. In addition to the screening of domestic investments (see the EU Screening Regulation), the EU can therefore also adopt an instrument to control foreign investments. 

However, a restriction may be necessary due to the case law of the CJEU. According to this, foreign direct investments are only those that “offer the possibility of actually participating in the management or control of a company carrying out an economic activity.” This would include strategic acquisitions, mergers, takeovers and, according to the EU Commission, greenfield investments. Portfolio investments, on the other hand, would not be covered.

II. Fundamental Freedoms 

Both the EU legislator and the EU Member States are bound by the fundamental freedoms. The regulation could affect investors’ freedom of capital and freedom of establishment. The freedom of establishment under Art. 49 TFEU applies in the context of foreign investments with regard to controlling interests. The free movement of capital under Art. 63 TFEU also covers direct investments, as is already apparent from Art. 64 (1) TFEU. 

The necessary distinction between the two fundamental freedoms is generally made according to the subject matter of the regulation: if this (exclusively) concerns direct investments or controlling interests, only the freedom of establishment is applicable. In third country cases, however, the freedom of establishment cannot be applied, as Art. 49 TEU requires the establishment of a Union citizen in the territory of the Union. However, the subject of a possible regulation would be establishment in a third country. 

The CJEU has also ruled out recourse to the free movement of capital in its case law to date. This is intended to prevent economic operators located outside the territorial scope of the freedom of establishment from being able to invoke it. However, the instruments for controlling investments are or would only be applicable to controlling interests. In the case of inbound investment control, the case law of the CJEU “merely” means that third-country nationals cannot invoke the fundamental freedoms. In the case of outbound investment control, however, this means that EU citizens cannot invoke the fundamental freedoms. The serious interference of an investment ban could therefore not be scrutinised against the standard of the fundamental freedoms. This is highly questionable. 

However, even if the free movement of capital were to apply, the restriction could be justified on the basis of the legitimate purpose of national security (cf. Art. 65 para. 1 lit. b TFEU).

III. Charter of Fundamental Rights 

In any case, the EU legislator must respect European fundamental rights in accordance with Art. 51 para. 1 CFR. Article 16 of the European Charter of Fundamental Rights guarantees the freedom to conduct a business, which protects not only the establishment of a company but also trade within the EU and with business partners in third countries. Prohibitions, orders, authorisation or reporting obligations with regard to an investment in a third country constitute an encroachment on the freedom to conduct a business. However, restrictions may be imposed in accordance with Art. 52 para. 1 sentence 2 CFR. In the explanations on the interpretation of the Charter, Art. 346 TFEU is cited as an example of an objective serving the common good recognised by the Union. Art. 346 para. 1 lit. b TFEU protects the “essential security interests” of the EU Member States (in relation to the production of or trade in arms, munitions and war material). An interference with the freedom to conduct a business in accordance with Art. 16 CFR could therefore be justified. 

IV. Outlook 

It should therefore be legally possible for the EU Commission to introduce a regulation on outbound investment control. However, the fundamental question arises as to its necessity. Firstly, the situation in the USA and Europe is not directly comparable. The USA has a large market for private equity and venture capital with an often complex corporate law structure. In this respect, there is a need to know who is investing in which areas abroad. In Europe, however, especially in Germany, it is more about investments in certain industrial sectors. It is often clear who is investing in which area. In this respect, there is no protection gap. The question also arises as to whether investment control is the right place to regulate any gaps in the national security toolbox. Export control law appears to be closer to the issue by prohibiting the export of critical goods and technologies. An extension of export control to goods that cannot necessarily be used for both military and civilian purposes could be considered. In addition, it should be possible to link not only the export of goods or technology, but also an investment. In this way, the objective of outbound investment control could also be achieved without the introduction of a new instrument. The EU Commission has at least reported that experts from investment control and export control law are currently reviewing the need for a set of instruments. We will hopefully know more by the end of January 2024.  

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