In a world characterized by geopolitical shifts and heightened national security concerns, the realm of foreign investments is undergoing a profound transformation. Disruptive events, evolving alliances and strategic recalibrations are increasingly influencing how nations perceive the risks and opportunities associated with foreign investment. As international power structures continue to evolve, the rise of new global players, coupled with technological competition in sectors such as artificial intelligence (“AI”), quantum computing and 5G, underscore the need for nations to reassess their foreign investment strategies in alignment with broader geopolitical goals.

Globally, investments in critical infrastructure, supply chains and emerging technologies are now subject to increased scrutiny. Governments across the world are grappling with the intricacies of safeguarding national security against an expanding array of threats that extend beyond traditional military concerns, including techno-economic vulnerabilities. In this note, we discuss some of these trends along with future implications.

The US

CFIUS

In the United States in particular, the concept of ‘national security’ has shaped the evolution of the foreign investment regime, primarily overseen by the Committee on Foreign Investment in the United States (“CFIUS”). The Exon-Florio amendment in 1988 had granted the President authority to block foreign transactions that compromised national security, particularly in defense-related sectors. Subsequent legislative developments, such as the Foreign Investment and National Security Act of 2007 (“FINSA”), expanded CFIUS’s scope to address threats from foreign governments and state-controlled entities.

However, it was the surge in national security discourse related to China – especially with respect to technology transfers – that spurred additional reforms. Accordingly, the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) expanded CFIUS’s authority further, reflecting an increased focus on safeguarding critical technologies and industries.

‘Reverse CFIUS’ and outbound foreign investment

Recently, an additional development in the US is the idea of ‘Reverse CFIUS’. In August 2023, President Joe Biden issued an executive order (“EO”) along with an advance notice of proposed rulemaking directing the Department of the Treasury to establish a program for the purpose of regulating certain types of US outbound investment in semiconductors and microelectronics, quantum information technologies and AI in ‘countries of concern’ – i.e., places where such investments may pose a threat to US national security.

Although unlikely to come into effect for several months, outbound investments from the US into listed countries may now be subject to notification rules or remain prohibited altogether. The reason behind this measure seems to be the fear that US investments into certain foreign entities can result in “enhanced standing and prominence” and other “intangible benefits” for such entities, which may ultimately create national security risks for the US – especially when sensitive technologies are involved. In fact, the Biden Administration’s 2022 National Security Strategy had announced its proposed approach to screen outbound FDI for the purpose of preventing strategic competitors from exploiting US investments.

While CFIUS has historically focused on reviewing inbound investments, the idea of scrutinizing outbound FDI reflects new US concerns over inadvertent transfers of sensitive technology. Accordingly, the US program on outbound investment seeks to prevent foreign adversaries from exploiting US intellectual property for the purpose of increasing their own economic competitiveness and military capabilities. As of now, the list only targets China (along with Hong Kong and Macau). Meanwhile, the European Union is pondering a similar initiative, while countries such as China, Japan, South Korea and Taiwan already have such rules in place.

The review and screening of outbound foreign investment could become more prominent in the future, as the US and its allies continue to face global supply chain crises, exacerbated by their dependence on foreign actors for pharmaceuticals, semiconductors and technology. Previously, the idea of adopting an explicit mechanism for outbound foreign investment review had arisen in early drafts of FIRRMA for certain types of intellectual property. However, the idea was rejected because CFIUS had historically regulated incoming foreign investments only. Nevertheless, a revised National Critical Capabilities Defense Act (a preliminary version of which had proposed the review of US business transactions that might result in unacceptable risks to national critical capabilities, including by authorizing the President to suspend or prohibit such transactions), if and when enacted, may create outbound review processes similar to existing CFIUS procedure for inbound investments.

The EU

An FDI screening regulation already allows the European Commission (“EC”) to review incoming investments that are likely to affect the security or public order of multiple EU countries. This regulation covers critical infrastructure, technologies, inputs, food security and information control – thus demonstrating a broad spectrum of national security concerns. Individual countries, such as France, Germany, Italy and Spain, have strengthened their domestic regimes, including by interpreting ‘national security’ broadly. The EC’s guidance on FDI from Russia and Belarus further exemplifies its commitment to safeguard critical assets.

Further, in 2023, the EC announced an initiative for controlling certain outbound investments as well. Stemming from similar concerns about the potential use of European capital, expertise and knowledge “to enhance the military and intelligence capabilities of those who are also systemic rivals”, the EC is now considering whether and how Europe should develop a targeted instrument on outbound investment that “would relate to a small number of sensitive technologies where investment can lead to the development of military capabilities that pose risks to national security”. Examples such as quantum computing, AI, 6G, biotechnology and robotics have been cited. Indeed, the EU and the US have committed to align their respective approaches in this regard, to the extent feasible.

While individual member states of the EU do not screen outbound FDI yet, countries like Germany are already contemplating it as part of a new ‘China strategy’. The strategy suggests that controlling outbound investment is an effective risk-mitigation tool, including for the purpose of protecting state-of-the-art technologies and R&D from being used to advance military capabilities that compromise national and international security. Accordingly, outbound FDI control regimes may proliferate across the EU soon.

India

India’s Press Note 3 of 2020 presents its perspective on balancing economic growth with security imperatives. With a focus on scrutinizing inbound investments from neighboring countries with which it shares land borders, India sought to strike a measured balance for the purpose of curbing opportunistic takeovers/acquisitions of Indian companies during times of economic uncertainty, including to protect domestic sectors such as defense, telecom and information technology. For a discussion on such press note, see our previous analyses here and here.

Meanwhile, the erstwhile framework in India did contain restrictions on overseas direct investment (“ODI”) into foreign entities (i) that are located in countries identified by the Financial Action Task Force (“FATF”) as “non co-operative countries and territories;” or (ii) as notified by the Reserve Bank of India (“RBI”) from time to time. Similarly, draft rules from 2021 also prohibited overseas investment by Indian residents into foreign entities located in countries/jurisdictions that are blacklisted by the Central Government, including those which are not in compliance with the FATF or the International Organization of Securities Commissions (“IOSCO”). However, current regulations simply provide that an Indian entity will require prior approval for making any financial commitment in Pakistan or any other jurisdiction specified by the Central Government. As of date, the Central Government has not specified any jurisdictions in addition to Pakistan.

In addition, current Indian regulations restrict overseas investment in certain sectors such as (a) real estate, (b) gambling, and (c) financial products linked to the Indian Rupee. However, these sector restrictions are evidently based more on public policy and exchange control considerations rather than national security.

Striking the right balance between fostering innovation and regulating cutting-edge, technology-based industries will remain a global challenge in the future, including for India. Accordingly, policymakers, governments, businesses and investors need to navigate a complex geopolitical terrain.

Proliferation of Restrictions on Outbound Investment

Reverse CFIUS may inspire the creation of similar regulations in other jurisdictions, particularly among key US allies. If regulations on outbound FDI proliferate among peer nations – similar to the proliferation of inbound review regimes in recent years, new barriers to foreign investment may emerge worldwide. According to an UNCTAD report from last year, almost 40 countries introduced a regulatory framework for investment screening on national security grounds since the mid-90s – a trend that has accelerated after the global economic crisis, peaking around 2020-2021 in the aftermath of COVID-19, including for the purpose of protecting sensitive sectors from foreign takeovers. More than half such countries are developed economies in Europe.

Interestingly, China is one of the major countries with a regime that systematically screens outbound investment. However, Chinese law also addresses investments in areas that should not be sensitive from a national security perspective, such as the hotel, real estate, film and sports sectors. Thus, it appears that the main goal of the Chinese regime so far has been currency regulation.

Elsewhere in Asia, South Korea restricts outbound investments by companies that develop critical technology through government subsidies. In Japan, outbound investments in specified sectors, such as weapons, are subject to approval. On the other hand, Taiwan regulates outbound investments into China based on industry, with a general prohibition on high-tech industries.

Conclusion

Over the past few years, the world has witnessed several disruptive events involving issues which may continue to cause disruption. It is important to appreciate such geopolitical risks, including the growth of economic nationalism that restricts or prohibits foreign investment in sensitive sectors. Since these factors directly impact investment decisions, investors need to develop strategies to address such new dynamics.

Further, understanding where the main assets of a target are located, or where the target’s activities are the most exposed to political change, remains fundamental to developing appropriate FDI strategies. The implications of national security, strategic industries and/or geopolitical factors need to be duly considered.

In the future, businesses may be expected to not only navigate multiple FDI regimes, but different outbound screening regulations too. Although the final scope of outbound investment review regimes is still being decided, both the US and the EU have indicated that critical technologies that have the potential to advance military and dual-use capabilities, especially in respect of outbound investment into strategic adversaries such as China, will be additionally scrutinized. Accordingly, investors may need to integrate such factors in their due diligence and risk management processes.