Sovereign White Knights: Defensive State-Capitalism as a Gate Keeper of (EU) Economic Security?

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Geopolitical considerations have been creeping into corporate and international economic laws. Faced with rapidly increasing inbound foreign direct investment by corporations from competing economies, many countries have either strengthened existing, or developed new, investment screening mechanisms. These mechanisms enable host country governments to decide whether to admit foreign investment, and if so, whether conditions should be imposed. A key goal of the screening is to ensure foreign investments do not pose national security risks. While these mechanisms have existed in many Western countries since the 1970s, their use has increased exponentially in recent years in light of the current geopolitical situation with Russia and China leading to many investments being blocked. For example, the governments of the United Kingdom, Germany and Italy recently blocked the acquisitions of semi-conductor businesses by foreign buyers. Similar examples abound regarding acquisitions in extractive industries in particular in Canada and Australia.

The power of governments under investment screening mechanisms is, however, not unfettered. Domestically, foreign investments must meet certain thresholds (such as foreign equity, value of investment, character of investors) before the screening process can be initiated and any action taken. Furthermore, decisions made by the competent authorities can be reviewed by domestic courts to ensure substantive and procedural requirements are complied with, although judicial review may be somewhat limited when it comes to assessing whether, for example, a national security risk exists. Internationally, such mechanisms need to be applied in line with the host country governments’ commitments under free trade agreements and/or investment treaties. These commitments sometimes limit the scope of the screening mechanism and provide avenues for foreign investors or their home governments to challenge the decisions of the host country. Thus, a decision to block a proposed foreign investment on security grounds may lead to a breach of international obligations depending on the commitments made and how the security exceptions are framed, if any, in the relevant treaties.

In the European Union (“EU”), investment screening mechanisms are subject to distinctive complexities and constraints due to the division of competences between the EU and its Member States. While the EU is vested with the overarching power on matters of common commercial policy, which includes foreign direct investment (Article 3(1) of the Treaty on the Functioning of the European Union), the safeguarding of national security and essential security interests remains with the Member States (Article 4(2) of the Treaty of the European Union and Article 346 of the Treaty on the Functioning of the European Union). This means that the general screening framework established under Regulation (EU) 2019/452 only confers advisory and coordinating roles on the EU, while leaving Member States free to set up and apply their own investment screening mechanisms. Accordingly, EU Member States retain the discretion to decide whether to have such mechanisms in place, and the EU cannot screen foreign direct investment by itself in any event. This might lead to loopholes in ensuring a common EU economic security strategy, according to the European Commission.

This situation is leading to the development of what we call “sovereign white knights” to address the gaps and deficiencies of investment screening mechanisms. In investment, a white knight is a hostile takeover defence strategy whereby a friendly company acquires a corporation at fair consideration when the target is on the verge of being taken over by an unfriendly acquirer. A sovereign white knight is thus the use of the same mechanism by a government to prevent the acquisition of a domestic corporation by a foreign corporation in the context of geopolitical tensions. It entails the government’s direction of a State-controlled corporation, bank or investment fund to acquire a domestic business that is being targeted by a foreign entity. This tool can thus be used to palliate the deficiencies of investment screening. For example, in 2018, the German State-owned bank KfW bought a stake in an energy network operator to fend off an offer from a Chinese investor. In that situation, the German investment screening mechanism could not be used as the investment concerned shares below the relevant threshold. The KfW similarly invested in a biopharmaceutical company to pre-emptively prevent a foreign takeover in 2020 and the government is considering institutionalizing this process. Furthermore, the EU itself has recently touted the idea that its soon to be proposed sovereignty fund could acquire firms of strategic importance to avoid them falling into foreign hands. This use of the sovereignty fund would enable the EU to act in case a Member State does not take action to prevent foreign investments that raise security concerns.

The rise of sovereign white knights is not without risks, however. As it leads to government involvement in the economy and in corporate decisions, it tends to deviate from free market principles and increase uncertainties for both domestic and foreign businesses. Furthermore, unlike investment screening mechanisms, it comes at a cost to governments by diverting funds and resources for economic security away from potentially more commercially viable or socially important ventures. It also risks being politicized as the use of sovereign white knights is likely to be subject to less stringent review by domestic courts compared to those provided for in investment screening mechanisms. Finally, and importantly, the legal implications of this development, in particular under international investment law, have not yet been properly assessed.

Indeed, the use of sovereign white knights to prevent acquisitions by investors from specific countries could possibly result in violations of commitments regarding market access and non-discrimination under free trade agreements and/or investment treaties similarly to investment screening mechanisms. This might be so if the actions of the sovereign white knight at hand can be attributed to the host country’s government under the relevant treaty and customary international law. Furthermore, if they become involved in the absence of security concerns, their use might be more difficult to justify under the national security exceptions.

In a sense, foreign direct investment from State-capitalist economies, and China in particular, is leading to the development of a form of defensive State-capitalism in the EU which relies on traditionally State-capitalist tools (i.e. corporate vehicles under State control) to prevent economic encroachment by third countries’ entities. In the current geopolitical context where economic considerations are becoming increasingly entangled with security risks and the role of the State in the economy is growing, sovereign white knights are likely to proliferate as an additional defensive instrument in governments’ economic security toolboxes. Yet, we should not close a blind eye to the economic governance and legal questions they raise as well as to the fact that they might add fuel to the already intensified geopolitical frictions.

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