Tougher stance on Chinese investments comes at a cost

Next Monday, President Trump will sign the John S. McCain National Defense Authorization Act (NDAA) for Fiscal Year 2019.

Over 2,000 pages long, the NDAA includes the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), a freestanding measure that had proceeded on a separate track over the past nine months.

FIRRMA amends Section 721 of the Defense Production Act of 1950, which authorizes the president to block foreign investments in U.S. businesses on national security grounds.

Section 721 also provides the legislative foundation for the Committee on Foreign Investment in the United States (CFIUS), the inter-agency committee tasked with assessing covered transactions and determining how to mitigate national security threats CFIUS identifies.

{mosads}Passed with overwhelming bipartisan support, FIRRMA aims to modernize the processes and authorities of CFIUS to address the “national security landscape [that] has shifted in recent years,” while continuing to “enthusiastically welcome and support foreign investment.”

That shift is largely due to China. Though not named explicitly, thinly-veiled references to “a country of special concern that has demonstrated or declared [a] strategic goal of acquiring a type of critical technology or critical infrastructure that would affect United States leadership in areas related to national security,” leave little room for doubt as to Congress’ focus.

Indeed, China’s state-driven industrial policies, such as the Guideline for the Promotion of the Development of the National Integrated Circuit Industry and the Made in China 2025 program, are undoubtedly aimed at boosting Chinese self-sufficiency and leadership in advanced and dual-use technologies, such as semiconductors, artificial intelligence, virtual reality and the internet of things.

These efforts pose a real threat to U.S. national security and provide ample reason to strengthen CFIUS’ authority and resources to protect U.S. interests. It is striking, then, that much of FIRRMA’s preamble reaffirms the long-standing U.S. policy of welcoming foreign investment — a preemptive rebuttal to criticism that Congress designed FIRRMA to be a protectionist tool.

The robust debate over how to balance national security and economic objectives will now turn to CFIUS as it implements the legislation. Will FIRRMA profoundly alter the national security/foreign investment balance struck when Congress last amended Section 721 in 2007? Or will the result be merely an incremental addition to the level of scrutiny already applied by CFIUS?

FIRRMA addresses CFIUS’ jurisdiction in multiple ways: It clarifies that covered transactions include investments through which access can be obtained to material non-public technical information in the possession of U.S. businesses involved in critical infrastructure, critical technologies or maintaining personal data of U.S. citizens; and investments that create cybersecurity vulnerabilities.

FIRRMA also requires CFIUS to promulgate rules requiring short-form declarations by foreign investors in which a foreign government holds a “substantial interest,” a notable change to what has until now been a wholly voluntary process. 

While these steps are laudable, to a large extent, FIRRMA simply codifies current CFIUS practice. Over the past several years, CFIUS has asserted a regulatory reach that is hard to square with the 2007 legislation.

While Congress admonishes CFIUS in FIRRMA not to “consider issues of national interest absent a national security nexus,” in practice, the overall state of U.S.-China economic relations will surely impact CFIUS’ approach to reviewing transactions — reviews for which there is no effective check on CFIUS’ determinations of its jurisdiction or that a transaction poses a risk to U.S. national security. 

FIRRMA’s ultimate impact may be driven less by its substantive provisions than its new administrative mandates. Congress left many critical terms to CFIUS to define through rule-making. And, for the first time, FIRRMA authorized significant filing fees to support increased CFIUS headcount and resources.

The affirmation of a broad CFIUS reach, enabled by substantial new funding and personnel, unmistakably sets a tone of aggressive federal oversight of foreign investments. 

The danger is that a more expansive regulatory posture will not be cost-free. As FIRRMA acknowledges, “foreign investment provides substantial economic benefits to the United States.” Imposing restrictions on an open market that has long welcomed foreign investment may harm U.S. businesses, even if intended to protect national security.

China is the world’s second-largest economy, and access to the Chinese market is vital to achieving the global scale required for U.S. technology and industrial companies to prosper. Chinese investors are painted with a broad brush that treats all as tools of Chinese state policy.

In reality, a wide range of investors from China explore growth opportunities in the United States — the world’s largest and most financially secure market. And, many U.S. start-ups and early-stage companies look to Chinese venture capital for funding.

Unless carefully managed in accord with Congress’ strong restatement of U.S. commitment to an open investment policy, CFIUS’s expanded authority could effectively reduce not just Chinese investments, but also investments from many other foreign sources that are increasingly concerned with the direction of U.S. economic nationalism.

It is worth keeping in mind that investments from U.S. allies and other friendly countries account for the overwhelming majority of foreign investment in the United States.   

Ultimately, it will fall to Congress to determine whether CFIUS implements FIRRMA in a manner that skillfully addresses the new national security environment without diminishing the United States as the preferred destination for foreign capital.

CFIUS success in that endeavor will show how bipartisan cooperation in Congress can achieve important national benefits.

David J. Ribner is a counsel at O’Melveny & Myers LLP specializing in international trade and investment regulation.