Safeguarding Europe’s economies

In the past three years, European countries including the United Kingdom, Italy, Poland, Sweden and the Czech Republic have concluded that they need to be more judicious regarding foreign investments and have introduced stricter foreign direct investment (FDI) screening — which is welcome and much-needed.

The real challenge, though, will come with implementing such screening.

Motivated investors can hide behind layers of ownership entities, so enacting this kind of scrutiny is extraordinarily difficult. And to do so, governments will need to find ways to keep up with the volume of investments to be screened, and — most importantly — decide how to replace blocked investors. Because without thought-through execution, our economies will be no safer than before.

In 2018, a Hong Kong-based company named Mars bought a 75 percent stake in Alpi Aviation — a dual-use Italian dronemaker that supplies Italy’s armed forces — paying a staggering 90 times the stake’s value. And because Mars looked like simply a commercial outfit, the Italian government didn’t intervene. After the country’s financial police, the Guardia di Finanza, took a closer look at the investment, however, it established that Mars was ultimately controlled by a Chinese state-owned enterprise, and it had used no fewer than seven layers of ownership and 17 different entities to disguise its identity.

The country’s then-Prime Minister Mario Draghi swiftly forced Alpi to part ways with Mars, as the government would have prevented the takeover under Italy’s Golden Power FDI rules had it known about the company’s owner. But by the time of the intervention, Alpi’s Chinese owners had long had access to its technology.

Cases like these have now finally prompted Italy and others in Europe to enhance their FDI screening. In truth, many had been such strong believers in globalization, they’d had little monitoring in place. For example, just a few years ago, Chinese firms bought three cutting-edge Swedish semiconductor firms without encountering any scrutiny, simply because there was no legislation that called for it.

The Czech Republic introduced its first FDI regime in May 2021. “We had learned a lesson from our experience of having no measures we could use against toxic investors,” Ota Šimák, director of the Czech Ministry of Industry and Trade’s Department of Trade Policy and International Economic Organizations, told me. “This led to a political decision to introduce screening of investments in companies active in critical national infrastructure, defense equipment and dual-use goods.”

Companies in other areas can now proactively seek government assessment of investors above a certain percentage stake as well. “The law allows us to ask for any details of the investing company,” Šimák said. “We go deep into the ownership structures, and a few times the investor withdrew once we started doing that. That doesn’t mean it was a toxic investor — it can just be that they can’t supply the necessary information or don’t want to.”

In several cases, the trail of a prospective investor assessed by Šimák’s team has led to an entity in in an off-shore jurisdiction such as the British Virgin Islands, where firms and individuals wishing to remain anonymous are known to set up shell companies. “‘[Such] accounts are difficult for sure,” Šimák said. Indeed, even for governments — which have the power to request information — investigating prospective investors is extremely time-consuming, and it becomes even more time-consuming when prospective investors that know they’re likely to be blocked hide their identity behind layers of ownership.

That’s the paradox facing countries now seeking to protect sensitive companies through improved FDI screening. “A system that includes too many kinds of companies under its FDI screening can easily become unworkable and enable ‘bad actors’ to avoid detection because resources are diverted to processing low risk filings,” said Jenine Hulsmann from the law firm Weil, Gotshal & Manges.

“In the U.K., for example, less than 10 percent of companies that fall under the new legislation were called in for review in the first three months of the regime, which suggests that the thresholds may have been set too low.” This suggests that the U.K. government is using precious resources on investments that pose no harm, while investments by companies skilled in disguising their identity aren’t getting enough attention.

The same dilemma is true for other countries as well. The Committee on Foreign Investment in the United States — the gold standard for FDI screening — has become a victim of its own success and now struggles to keep up with demand. Italy, which strengthened its Golden Power rules in 2020, saw the number of companies notifying the government of new investors leap from just 83 in 2019 to 500 two years later, yet the number of civil servants conducting the investigations hasn’t grown accordingly.

In such cases, the civil servants regularly conducting the reviews might need help from intelligence agencies to increase their manpower. Or, to keep up, governments may need to select a few marquee cases to be thoroughly investigated — and then loudly communicate their investigators’ abilities to deter shady investors.

Politico