May 15, 2019

Chinese Investment and the Security of EU Member States

Õhtuleht/Scanpix
A drawing of the Helsinki–Tallinn tunnel, which may be built with Chinese investment.
A drawing of the Helsinki–Tallinn tunnel, which may be built with Chinese investment.

EU governments need to be aware of the potential downsides of Chinese funding.

The prospect of huge Chinese investment in Europe, such as the proposed 15 billion US dollar financing of the Helsinki–Tallinn tunnel project, is understandably likely to receive an initially positive welcome. However, EU member state governments need to be aware of the potential downsides of such investment. No major Chinese investment is likely to be made in Europe or elsewhere without the explicit support of the party-state apparatus. Furthermore, the obligations that the Chinese state imposes through its structures—which extend into most of the country’s major businesses—and via the law raise serious security concerns for all Europeans. This is not to say that such investments should be prohibited, rather that at least remedies are necessary to protect core member state and EU public policy and security interests. Fortunately, in March the EU Council approved a draft regulation on screening foreign investment, which member states will be able to deploy in cooperation with the European Commission to protect themselves against undue interference by the Chinese party-state in their internal affairs.

On the surface, China looks like a modern market economy. It has banks, a stock market, a commercial code and a complex court system, and is obligated to operate under WTO rules in respect of market access. It now has dozens of firms in the Fortune Global 500 list. However, the reality is much darker, and as far removed from a modern market economy as it is possible to be. Whilst China observes the forms of a market economy, the substance is very different. Take the Shanghai Stock Exchange. Superficially, it looks like any other, with shouting traders, screens and price movements. But in reality it is not like any stock market in the West. Eighty per cent of the traded stock is in state-owned enterprises (SOEs) and not one of these firms has 100% of its stock traded on the exchange; at best, only around 20% is traded. As a consequence, the fundamental role of a stock market—to assess value and reward and discipline company management—is lost. At most it acts as a mechanism for raising some cash. It may in fact amount to no more than corporate gambling on stock prices unlinked to any real commercial considerations.

More fundamentally, the Chinese party-state maintains substantial surveillance and control over the Chinese economy. It is able to maintain this control via a series of measures. First, via its central organisation department (literally the Organisation Department), the Chinese Communist Party (CCP) appoints the senior managers of all major SOEs, the senior judiciary and heads of regulatory agencies. Regional CCP offices carry out a similar function at that level. These coordinating offices also appoint the heads of newspapers, think-tanks and universities. Second, every major entity, public or private, will have a party committee that oversees its operations. Third, virtually all Chinese banks are controlled by the party-state at regional or central government level. If you do not toe the line, you will not get any finance.

These measures are reinforced by central and regional government shareholding entities that can direct about 40% of the economy controlled by SOEs.  The State-owned Assets Supervision and Administration Commission, a central government entity with a couple of dozen Fortune Global 500 companies on its books, is probably the largest shareholder in the world. Even private businesses are not just subject to internal party committees and the need to kowtow to banks controlled by the party-state, but are also subject to local, regional and national chambers of commerce in every sector. These bodies represent the interests of the party-state in every sector rather than those of business, providing another means to ensure its guidance and direction over private business.

Party-state control has been further strengthened under President Xi with a battery of new laws, including on cybersecurity and national security, both of which extend the reach of the security forces into the operations of businesses both domestic and foreign. However, the most extensive and controversial is the National Intelligence Law (NIL) of 2017. Like the other two laws, the NIL imposes extremely broad and open-ended obligations; but, unlike the first two, it imposes obligations without regard to any geographical limit. Article 7 provides that

All organisations and citizens shall support, assist and cooperate with national intelligence work according to the law, and keep secret their knowledge of national intelligence work.

The NIL reinforces those obligations with Article 14, which grants the intelligence agencies authority to insist on cooperation:

… state intelligence work organs, when legally carrying out intelligence work, may demand that concerned organs, organisations and citizens provide necessary support, assistance and cooperation.

This law applies to foreign nationals and companies in China and to Chinese citizens, companies and NGOs operating abroad. It also appears to apply to foreign subsidiaries of Chinese companies operating outside the country.

Furthermore, the scope of the legislation is not restricted to traditional security concerns. Article 2 gives a very broad definition of national security, which could bring within the law’s scope any matter, economic, cultural and technological, included in the concept of intelligence for the purpose of this legislation.

For the member states and European institutions that have traditionally been very open to inward investment from third countries, investment from China raises serious and legitimate security concerns, given the party-state’s control over and influence on any investments made.

The EU has moved to deal with this issue through its new foreign direct investment regulation, which has been dubbed EUFIS (for EU Foreign Investment Screening, comparing it with the US equivalent, CFIUS), which will come into force on 10 October 2020. In brief, EUFIS formally creates a cooperation mechanism through which member states and the Commission will be able to exchange information and raise concerns related to specific investments. The Commission will be able to issue opinions when an investment threatens the security or public order of more than one member state, or when an investment could undermine an EU project or programme of interest to the whole EU. The Commission, supported by the European Parliament, is therefore likely to play a decisive role in cases of controversial major foreign investment.

The regulation also lists several EU-funded projects and programmes which may be relevant to security and public order, and which will receive particular attention from the Commission. The list includes Galileo, Horizon 2020, Trans-European Networks and the EU Defence Industrial Development Programme, and will be updated as necessary.

The regulation establishes an indicative list of factors to help member states and the Commission determine whether an investment is likely to affect security or public order. These include the effects of the investment on critical infrastructure and critical technologies, the supply of critical inputs such as energy and raw materials, access to sensitive information or the ability to control information, and the freedom and pluralism of the media.

Member states and the Commission may also consider whether the investor is controlled by the government of a third country, whether it has previously been involved in activities affecting security or public order, and whether there are serious risks that it engages in criminal or illegal activities.

In key critical cases, it is likely that the Commission will take the lead in making an assessment of the proposed investment. The Commission may formally only be able to issue an opinion, but politically its opinion is likely to prove decisive, particularly when backed up by the European Parliament.

Given that virtually any Chinese investment raises concerns that it is ultimately controlled by “the government of a third country”, the Commission will have to produce guidance for member states on how to deal with the influence of the Chinese party-state. In critical cases, the Commission is likely to investigate issues in some detail in order to come to a definitive opinion.

In many more cases, it is likely to be involved in negotiating remedies with the EU member states involved and the third-country investor. In respect of Chinese investors, it is likely that a series of remedies will be developed. Given the role of the Chinese party-state in the economy and the existence of restrictive legislation such as the NIL, remedies are likely to include: prohibition of Chinese nationals occupying management positions; removal of direct or indirect influence over management boards; appointment of security trustees to maintain oversight over the operation of key infrastructure; and physical separation of key assets from ownership and control by Chinese entities.

As for the proposed Chinese investment in the Helsinki–Tallinn tunnel project, one option for Estonia and Finland would be to ask the European Commission to carry out an initial investigation based on the new regulation, give its opinion and propose remedies. Any assessment would consider the scope of the investment, access to key infrastructure such as telecommunications, potential for resale to a hostile buyer, the role of Chinese nationals on any management board, and options to split the investment to minimise security concerns.

Finland already has its own foreign investment screening law. Estonia, like 13 other member states, does not. Perhaps it is time for Tallinn to consider adopting its own law?

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