Foreign direct investment can be hugely beneficial for host countries, providing jobs, knowledge exchange and technological innovation that can foster economic growth. Since the 1970s, most countries have loosened their regulations towards foreign direct investment and actively seek to attract it. However, foreign investments may entail risks, especially for national security.

For example, when critical infrastructure, such as a major energy provider, is owned and controlled by foreign investors, it could be vulnerable to politically motivated disruption in the event of a conflict with the home government of the foreign investor. Where investment exists for online products, the investor has the potential to acquire sensitive personal data, which could be abused by a foreign government. These kinds of concerns are especially acute if the foreign investor is owned or substantially influenced by its home government.

To mitigate these risks, many countries have developed procedures to screen foreign investment. Investment screening involves governments reviewing inward transactions and denying entry to investments that are deemed too risky. The rejection of investment normally occurs where it is believed that there are dangers to national security.

Investment screening is not new – it wasn’t unusual in the 20th Century for countries to evaluate whether investment would provide beneficial economic growth. However, as part of the general shift towards liberalised and open markets in the 1980s and 1990s, many governments in Europe and elsewhere removed these processes. Economic benefit-oriented investment screening was not seen as compatible with the internal European market, which emphasised openness and multilateralism.

In recent years, however, the geopolitical landscape has changed, and investment screening is back with a vengeance. China continues to use market-distorting industrial policy and substantially limits foreign investors’ ability to acquire Chinese enterprises; the US has pursued increasingly protectionist economic policies; and supply chain disruptions – either due to political events such as Russia’s military aggression in Ukraine or due to exogenous shocks such as the Covid pandemic – have demonstrated the potential risks of having critical supply chains concentrated in a few foreign countries.

By the end of 2017, the EU had announced that it was taking a major strategic shift towards a more assertive, unilateral trade and investment policy.

A screening framework for foreign direct investment was introduced, in parallel with the creation or reinforcement of national investment screening mechanisms in EU member states. These screening mechanisms are novel in that they focus on security, rather than economic benefits. In 2020, the first pan-European investment screening framework began operating. This provides mechanisms for review and national cooperation, but does not replace national screening processes. Today, 26 member states have an investment screening regime in effect or being drafted, but there are substantial variations across countries in how they work.

In their recent study, Professor Bauerle Danzman and Professor Meunier analyse how the different features of investment screening mechanisms in EU countries can be explained and why there are still variations in how, and how much, countries screen foreign investment.

The researchers highlight that are many key similarities between the investment screening mechanisms introduced in different member states. Most fundamentally, most states have newly adopted or strengthened their screening processes, and increased the number of sectors they review. All review investments in critical infrastructure and defence, with a high number reviewing critical technology sectors and acquisitions of media companies.

There has also been a decrease across countries in the equity thresholds necessary to trigger reviews. Reviews of 10 to 20% acquisitions are now becoming standard, whereas 25 to 50% was previously more common.

However, the team also identify substantial differences. There is no screening mechanism template in the EU, and member states have not agreed on a harmonised approach to screening across several different areas. Firstly, reviews vary in scope. Some countries only grant government authority to screen in specific industrial sectors, whereas others allow review of transactions regardless of sector.

Professor Bauerle Danzman and Professor Meunier also highlight variations in screening thresholds. While transactions over 10% are reviewed in most EU member states, there are important exceptions, such as Portugal, which still only screens majority-owned transactions. At the other end of the spectrum, some countries review transactions in sensitive sectors at thresholds even lower than 10%.

Countries also vary substantially in who oversees reviews and instances in which transactions are blocked. Most EU member states designate the economic ministry as the authority on reviews, but some require cross-ministry participation. This has implications in how investment screening mechanisms weigh the risks of investment.

Furthermore, while Portugal and Slovenia require ‘actual and sufficiently serious threats’ to public order and security to prohibit a transaction, other countries allow for blocks based on the ‘likelihood’ of an effect or the ‘potential’ endangerment of national security. This significantly affects the standards of evidence required.

So, what explains this? Professors Bauerle Danzman and Meunier identify several factors that could affect these differences: public debt, Chinese investment, research and development expenditures, and geographic groupings.

Their results show that the rise of China as an outwards investor has directly prompted the tightening of investment screening worldwide. However, there is less evidence that patterns of Chinese foreign direct investment explain variations in the implementation of screening mechanisms. They found the strongest correlations between screening mechanisms and research and development expenditure. Specifically, countries with large research and development expenditures were both more likely to have screening mechanisms and more likely to have cross sectoral review authority.

They also show that countries bordering Russia are more likely to enact investment screening mechanisms. This is consistent with the long history of concern amongst bordering economies regarding Russian influence, especially in relation to energy and critical infrastructure. This also challenges the idea that investment screening mechanisms are entirely a reaction to the growth of China.

Professors Bauerle Danzman and Meunier conclude by making some key policy observations about the use of investment screening mechanisms in the EU. They argue that, while the recent spread of investment screening is often perceived as a global shift towards protectionism, screening mechanisms are not necessarily designed to be protectionist instruments. On the contrary, given the potential for ‘coercive’ capital to undermine democratic institutions, European integration and economic liberalism, some level of investment screening may be necessary to prevent full economic protectionism.

They also posit that the strengthening of investment screening mechanisms across member states represents a shift from market logic to security logic in investment policy discussions. Finally, they discuss how the shift towards seeing foreign investment as a security issue has the potential to alter how competences are distributed within the EU. By ‘commercialising’ the various policies linking investment and security, the EU may be able to centralise its power over foreign direct investment and security.

Ultimately, the changing geopolitical landscape has highlighted foreign direct investment as an emerging security threat. It will be key to observe how the EU handles this moving forward, and how this changes its role on the world stage.