FDI in a Post-Covid-19 World: A Threat to the European Project?

Author

Managing Director of Blackwell Strategic Research

In mid-April this year, arguably at the height of the Covid-19 crisis in Europe, the Chinese state-owned financial group, CITIC, became the majority shareholder in the Medea Group, the largest domestic media agency in the Czech Republic, exercising options to take it up to a 57% stake. This deal had been approved by the Czech anti-monopoly authority in 2019, yet the transfer of stock only took place months later. Medea is a dominant player in the commissioning and allocation of the advertising revenues that fund many Czech news outlets. Yet at the time there was little media commentary about the potential increase in Chinese influence over European media, probably because Europe’s attention was focused elsewhere. This transaction exemplifies the type of inward Foreign Direct Investment (FDI) to the EU that has become increasingly politicised, with concern over the power and influence wielded by external commercial and state actors in EU economies. Covid-19 may trigger an influx of FDI into the EU, thus provoking the question of how best to manage such investment.

This challenge will be complicated by the economic context. With the first wave of the Covid-19 pandemic receding and EU countries slowly emerging from their lockdowns, European governments are grappling with how to mitigate the negative impacts of the ensuing economic slowdown. They will want to increase investment to support a recovery – indeed, to this end, the European Commission has already referred to raising trillions of euros of additional financing. However, all investment is not equal. In past times, inward FDI may have been actively sought across the EU, now it needs to be treated more carefully.

The sensitivity surrounding certain types of FDI are typically managed through some form of investment screening process. Such a process would usually define certain strategic sectors, such as defence or telecoms, or be triggered when the investment involves the acquisition of a critical technology or infrastructure. An investment may require prior government approval and the screening process might consider the transaction level (for example, taking a majority stake) and the nature of the buyer, particularly when the buyer is state-owned.

China and the US have long had established screening processes in place, whereas the EU is considered to be one of the most open ecosystems for FDI.

The outcome might be a block on the transaction, or the implementation of mitigating measures, such as compulsory supply commitments. China and the US have long had established screening processes in place, whereas the EU is considered to be one of the most open ecosystems for FDI. Nevertheless, with the rise of foreign ownership of EU assets, as well as the increasing presence of state-owned enterprises and offshore investors, this openness seemed out of step with the global environment.

Concern over FDI is nothing new, but the Covid-19 pandemic has made the situation more urgent. FDI screening becomes critical when, as a result of a post-pandemic economic slowdown, European companies are systematically weakened, thus creating a one-off opportunity for foreign investors to acquire such assets at cheapened prices. Furthermore, while FDI screening is generally treated through the lens of investment in strategic sectors, Covid-19 has shown the concept of what is a strategic sector or asset needs updating, specifically in relation to medical equipment, pharmaceuticals and research. Finally, Covid-19 has so absorbed media attention that the current landscape allows potentially controversial FDI transactions to proceed without the same level of scrutiny - as perhaps was the case with the CITIC-Medea transaction in the Czech Republic.

The European Commission has long been aware of the FDI problem. While still emphasising its openness to inward investment, the Commission published a new FDI Screening Regulation in March 2019, due for full implementation in October 2020. In March this year, concerned by how Covid-19 might impact the FDI landscape, Commission President Ursula Von der Leyen highlighted the risk of Europe losing strategic assets as a result of predatory acquisitions; she encouraged Member States both to use existing powers to restrict investment in critical assets and to adopt the implementation of the investment screening regulation ahead of its formal entry into force in October. Moreover, at Member State level, nine EU leaders signed a joint letter to Charles Michel, President of the European Council, stating the need to "make sure… that no strategic assets fall prey of hostile takeovers during this phase of economic difficulties".

The problem is thus well acknowledged, but the means of resolving it is much more complicated, for three reasons. Firstly, there is the challenge of the "how to screen", posed by a lack of harmonisation of FDI screening rules across Member States. Secondly, there is the challenge of the "when to screen", as each Member State has a different assessment of what constitutes a strategic threat. Thirdly, because even if Member States agreed on the "how" and the "when", they all have very different capacities to act.

Only 14 of the 27 MS have established FDI screening mechanisms in place and each of these works differently.

Firstly, addressing the challenge of how. The EU FDI Screening Regulation provides a common framework for Member States to screen FDI on the grounds of security or public order. It also requires Member States to provide annual reports on FDI in their territories. However, it doesn’t actually harmonise FDI screening or, indeed, even force Member States to conduct such screening. In this context, it is worth remembering that only 14 of the 27 MS have established FDI screening mechanisms in place and each of these works differently. For example, the Netherlands has an investment screening process, but is limited to the telecoms and energy sectors. In France, where investment screening rules were tightened at the end of 2019, the list of sectors and transaction types triggering a formal process is much longer and includes parts of the food supply chain, research in critical technologies (nuclear, quantum, data processing, etc.) and the news media.

The nature of the EU Single Market compounds the challenge regarding FDI, because investment screening decision taken (or not) by a given Member State can have broader repercussions. Each Member State represents a potential vulnerability because once a foreign entity has foothold in the Single Market, it can move about more freely. Because of this, one action taken by France in updating its screening was to remove the distinction between EU and non-EU investors, but France has one of the EU’s most sophisticated screening processes – this approach isn’t replicated elsewhere. The new EU regulation entitles the Commission and other Member States to comment on FDI transactions, but this commentary is only guidance. Member States can choose to ignore them should they wish to.

And Member States might very well choose to ignore Commission guidance on FDI, leading us to the second challenge posed by EU level FDI screening, the "when". FDI screening can be viewed through the dual lens of trade and of national security. The problem is, whilst the Commission has expansive powers in trade, Member States take the lead on national security. Here, they have vastly different assessments of their strategic environment. In terms of security, France may include the Sahel as a priority, while Cyprus sees an existential threat in Turkey and Poland worries about Russia. This divergence is usually most visible during discussions on economic sanctions, where each Member State has different economic stakes at play, but it is also true for FDI. Here, different Member State assessments of the threat posed by Chinese FDI exemplifies the problem. Countries such as Italy and Greece argued against a stricter EU regulation out of concern that it might impede their access to external investment – but they were also signatories of China’s Belt and Road Initiative. The Chinese case is complicated post-Covid-19 because the public health crisis has demonstrated the EU’s reliance on China for certain critical products, such as masks and intensive care drugs. This fact hasn’t escaped China, which has been engaging in a worldwide Covid-19 diplomacy effort.

Leaving aside the"how" and "when" challenges, pushing the FDI issue down to Member State level creates a third problem: even if all Member States had a perfectly aligned vision of what needed to be protected and from whom, they would all have very different capacities to act. The Commission proposed several regulatory measures on offer to Member States in managing FDI, including taking "golden shares" in companies to block acquisitions.

Even if all Member States had a perfectly aligned vision of what needed to be protected and from whom, they would all have very different capacities to act.

However, the ability to do this will be wildly different in the Netherlands, which runs a budget surplus and has public debt worth 49% of GDP, versus Italy, running a budget deficit and with public debt at 135% of GDP (and, in a horrible coincidence, one of the hardest hit by Covid-19). Indeed, the Commission’s actions taken elsewhere to support EU economies during the pandemic, notably the temporary relaxation of the state aid framework, will only exacerbate such inequalities.

Under the temporary framework, Member States have more freedom to prop-up struggling companies or sectors, thereby protecting them against a foreign takeover. Quoting Germany’s economic affairs minister, Peter Altmaier, "We will not allow a bargain sale of German economic and industrial interests" – so Germany has established a EUR 100 billion economic stabilisation fund to aid German companies impacted by the pandemic, enabling the government to take equity stakes in struggling companies. The Italian Government will not have the same fiscal latitude, making Italian companies intrinsically more vulnerable. Ignoring the economic inequalities this might provoke, such divergent Member State actions make no political sense long term, as one can easily imagine the loss of national "gems" to foreign buyers provoking a populist backlash of the sort that could ultimately threaten the European Project. This raises the question of whether there should be a concerted effort to use European funds to protect systemically important companies in harder-hit Member States.

This all argues for a stronger, Europe-wide response on Foreign Direct Investment, which should, at a minimum, mandate Member States to conduct such screening whilst also aiming to harmonise their respective systems. Reaching such agreement will be arduous and, in the meantime, it may be worthwhile employing temporary FDI restrictions, such as those implemented in Australia, to minimise the risk of a fire-sale in the immediate aftermath of the crisis. However, the pandemic may also work to focus minds on the threat and, in this way, provide the call to action and opportunity the EU should seize.

Copyright: THOMAS COEX / AFP

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FDI in a Post-Covid-19 World: A Threat to the European Project?