Worldwide: National Security And Foreign Investment Review

FOCUS ON THE US

Defense and national security

The 115th Congress will mark the first opportunity in a decade for a Republican-controlled House and Senate to work with a Republican president. In 2017, leading GOP defense and national security policymakers on Capitol Hill will work with the Trump Administration to craft legislation and conduct hearings in support of the President's key defense priorities, including:

  • Developing a new approach to counter ISIS;
  • Eliminating existing defense spending caps established by the Budget Control Act;
  • Increasing the strength, size and readiness of the US Armed Forces;
  • Improving federal cybersecurity infrastructure and capabilities; and
  • Identifying efficiencies and other cost-cutting mechanisms within the Department of Defense (DoD) bureaucracy
  • Leveraging DoD innovation initiatives to foster greater collaboration with non-traditional commercial interests.

Although Senate and House Armed Services Committee Chairmen John McCain and Mac Thornberry may not be in lockstep alignment with the Trump Administration across the defense policy spectrum, enough common ground exists to provide for a productive year of legislating and oversight by their respective committees in 2017.

Building on Congressional passage of defense acquisition reform measures over the past two years, McCain and Thornberry, with cooperation from Democratic members of their respective committees, will continue to champion legislation to streamline the DoD procurement process and enhance the Department's innovation programs in an effort to, in Thornberry's words, "get better technology into the hands of the warfighter faster and more efficiently." Cybersecurity will be another major policy focal point for defense lawmakers during the 115th Congress. McCain has indicated that he intends to use his committee's oversight function in 2017 to ensure that the DoD and the Armed Forces have "the resources, personnel, and capabilities necessary to defend, deter, and respond to our adversaries in cyberspace."

Cybersecurity will also take a prominent role with respect to relations with Russia. While speculation abounds regarding how the Administration will work to "reset" the US-Russia relationship, bipartisan coalitions are already forming in the Senate to pressure the new administration to maintain the sanctions imposed in late 2016. Legislation codifying those sanctions is already circulating, and while its passage might not be certain, it serves notice on the incoming executive team that Congress intends to play a role in key foreign policy and national security areas.

In the coming year, defense lawmakers will also continue to exercise their policymaking and oversight authority over matters relating to ongoing US military activities, including in Iraq, Afghanistan, Syria and Somalia.

Additionally, the congressional Armed Services Committees will continue to focus on:

  • Russia's activities along Europe's Eastern Flank and in the Middle East;
  • Iran's influence and participation in ongoing conflicts in the Middle East, as well as that nation's compliance with the Joint Comprehensive Plan of Action (aka the Iran Nuclear Deal);
  • North Korea's continued development of its nuclear weapons program; and
  • ISIS's expansion of its global footprint, with a particular focus on the continent of Africa.

Foreign investment — national security review

Foreign direct investment will likely see policy changes early in the new Administration. The incoming Commerce Secretary's views are not clear, but the role of the Committee on Foreign Investment in the United States (CFIUS) arose during confirmation hearings. A consensus is building in both houses that CFIUS must be strengthened, both as a direct national security measure and as a quid pro quo to China's restrictions on US investment. At least two measures are already circulating to add to CFIUS jurisdiction and authority. With bipartisan support forming, CFIUS changes could include mandatory reviews of certain transactions and enhanced scrutiny of transactions involving state-owned or controlled entities.

FOCUS ON CHINA

Foreign investment rules and national security review

In 2016, China continued its efforts to streamline regulations regarding foreign investment. A key development in that direction was the adoption of a filing system for foreign investment enterprises (FIEs). The current regulations encourage foreign investment by creating a more favorable investment environment as well as reducing transactional costs. Based on the current climate, it is likely that the Chinese Government will continue to modify foreign investment rules to attract more FIEs into China.

The major proposed changes under the current policies and regulations are as follows:

Creation of additional Free Trade Zones

In addition to the four Free Trade Zones (FTZs) of Shanghai, Guangzhou, Shenzhen and Fujian, the Chinese Government introduced seven additional FTZs on August 31, 2016 in the cities of Liaoning, Zhejiang, Henan, Hubei, Chongqing, Shanxi and Sichuan. The purpose of the new FTZs is to attract more foreign participation in Chinese industries, to show China's openness to foreign investments and to publicize the continued evolution of China's opening up to the rest of the world. The seven additional FTZs provide foreign investors with a greater opportunity to enter the Chinese market and likely signal that the Chinese Government will take additional steps to promote free trade and amend existing trading rules.

Replacement of approval with the filing system in the FDI regulatory regime

A major milestone in 2016 was replacing an approval regime for foreign direct investment with a simplified filing regime for FIEs that fall under the scope of encouraged and permitted sectors. Four laws were amended: the Law on Sino-foreign Equity Joint Ventures (EJV Law), the Law on Sino-foreign Cooperative Joint Ventures (CJV Law), the Law on Wholly Foreign-owned Enterprises (WFOE Law) and the Law on Protection of Taiwanese Investment in Mainland China (Taiwanese Investment Law) with effect from October 1, 2016. The amendments change the processes from approval to a "record filing" with the Ministry of Commerce (MOFCOM) or its local counterparts for the establishment of a FIE or implementing any change to an FIE. This represents a significant legal development in foreign direct investment in China and is likely to trigger a major systematic reform in China's regulatory regime. .

Draft amendment to the Foreign Investment Guideline Catalogue open for public opinion

The draft new amendment to the Foreign Investment Guideline Catalogue (the Catalogue) aims to reduce market access restrictions for FIEs and was open for public comment at the end of 2016. The updated Catalogue will retain the existing list of sectors that the government has encouraged FIEs to enter as well as add new sectors. The creation of a simplified Negative List entitled "Special Administrative Measures for Foreign Investment Access (Negative List for Foreign Investment)" will replace the existing list of restricted and prohibited sectors and will list all industries that have restricted access.

National security updates in 2016

Under the 2015 Draft Foreign Investment Law (FIL), the national security review system implemented through administrative regulations in 2011 will be replaced with a new codified national security review system (NSR) as provided in Section Four of the FIL. The new NSR system would widen the scope of the review to cover any FIEs that may endanger national security in contrast with the original system implemented under the 2011 NSR system where FIEs were only subject to NSR if they had any connection to the military or national defense or they acquired a controlling interest in an enterprise in a key industry sector. Detailed regulations under the FIL are expected to be issued in the future. The new NSR system would empower the government to block foreign investments that may be contrary to national policy and such a decision would not be subject to appeal or challenge either by administrative or judicial review. While the outlook for foreign investment in China is generally positive, the Chinese Government remains focused on protecting key industries and scrutinizing foreign investments that may affect national security.

FOCUS ON CANADA

2016 witnessed a number of significant developments in Canadian foreign investment review.

Background

Canada's foreign investment review law, the Investment Canada Act (ICA), requires foreign investors acquiring control of a Canadian business to file either a simple notification or an application for review under a "net benefit to Canada" test. Only transactions that meet certain review thresholds are subject to pre-closing ministerial review and approval. The ICA also requires notifications when a foreign investor establishes a new Canadian business. In addition, the ICA also contains a national security screening process relating to foreign investments, irrespective of size and whether or not they involve the acquisition of a controlling interest.

Fewer "net benefit" reviews as review thresholds increase

2017 will likely see a significant increase in review thresholds under the ICA, and as a result, fewer reviews.

In its Fall Economic Statement, the Canadian Government indicated its intent to raise the review threshold for investments by foreigners in Canada to CA$1 billion in target enterprise value in 2017 – two years ahead of schedule. The review threshold determines which foreign acquisitions of control of Canadian businesses are subject to pre-closing approval by the Minister of Innovation, Science and Economic Development under the ICA's "net benefit to Canada" test.

In addition, as a result of the Canada-European Union Comprehensive Economic and Trade Agreement, the review threshold for investors from the European Union will rise to CA$1.5 billion in target enterprise value. Through most-favored-national (MFN) requirements in trade agreements, other countries including the US, Mexico and Korea will benefit from this increased threshold. The precise timing for implementation of this increase in the review threshold is not clear at this point.

National security review out of the shadows?

The national security review process was used only sparingly following its introduction in 2009 but has been invoked more frequently during the past few years. Foreign investors and their legal counsel facing these reviews have complained about the lack of transparency, predictability and scope of the process.

An example of this was a challenge by a Chinese investor, O-Net Communications Holdings Limited (O-Net), of the previous Government's rejection of its acquisition of ITF Technologies Inc. (ITF), a Québec company specializing in fiber components, modules, lasers and amplifier systems. This case also represented the first time that a Cabinet decision on national security under the Investment Canada Act has been litigated.

In 2015, O-Net filed an application for judicial review of the Cabinet order seeking to have it quashed on several grounds. First, O-Net claimed that its rights to procedural fairness were breached, as the order was made without providing O-Net with any insight or basis for the national security concerns or an opportunity to respond to them. Second, O-Net claimed that the order was unreasonable, as Cabinet failed to take into account relevant considerations. More than a year later, in a consent order dated November 9, 2016, the Federal Court set aside the Cabinet order that required the divestiture and ordered a "fresh" review of the investment.

The Government has not publicly stated why it has agreed to set aside the Cabinet order and undertake a "fresh review." One can speculate that there were missteps or miscommunication in the process. Alternatively, some have argued that the agreement to re-review the transaction is related to Prime Minister Trudeau's more favorable view of China than his predecessor's government. Whatever the reason, it will be interesting and particularly telling if the result of the second review is different, as it may suggest that "national security" is a more subjective and malleable concept than one might expect.

In 2016, the Canadian Government also took measures to increase the transparency of the national security review process. In August 2016, the Director of Investments at Innovation, Science and Economic Development Canada (ISED) issued the Investment Canada Act Annual Report for 2015-16 (the Report). For the first time, the Report included a discussion of the frequency and nature of national security reviews since the introduction of the national security review process in 2009. In particular, the Government noted that there have been eight reviews, seven of which resulted in Cabinet orders and one which led to a withdrawal.

In December 2016, the Government also addressed the criticism that the national security review process generated uncertainty for foreign investors by releasing guidelines on the National Security Review of Investments (Guidelines). The Guidelines outline the types of factors the Government will consider when determining if a proposed investment in Canada will be injurious to Canada's national security. These factors focus largely on traditional security concerns, including the impact of an investment on sectors such as defence, telecommunications, technology and critical infrastructure. The Government also included a few factors that could be construed broadly, for example, a transaction's effect on the supply of critical good and services to Canadians and on Canada's international relations.

The Guidelines go beyond illuminating national security considerations to include information on how to navigate the national security review process. For example, they signal the Government's willingness to engage in early consultations with investors to assess whether there are any national security concerns. This offer of early engagement is welcome as there is no formal preclearance procedure in Canada. Although for definitive reassurance that their investments will not be challenged on national security grounds, investors must await the expiry of national security review periods set out in regulations, consultation with the Government well before closing is likely to give investors some insight into whether there is a national security risk. In addition, the Government's openness to consultation may serve to allay an investor's concerns that coming forward to the Government would be regarded as an admission that an investment poses a national security threat.

These new developments in national security review are welcome. However, it remains to be seen whether investors undergoing a national security review will feel any more enlightened about the Government's national security concerns than in the past.

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.

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