Outbound Investment Screening with Sarah Bauerle Danzman

In this episode, Francesca Ghiretti discusses outbound investment screening with Sarah Bauerle Danzman, Associate Professor at Indiana University and Scholar in Residence at the Atlantic Council . The episode explores the emergence of the debate in the US, the (potential) implications of the regulation that will follow the executive order, and the different ways to approach the issue. 

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SPEAKER_00 0:10

Welcome to Geoeconomic Competition. I'm Francesca Giretti, your host, and today I'm pleased to host Sarah Bowelli Densman, Associate Professor at Indiana University and Scholar in Residence at the Atlantic Council. Welcome, Sarah.

SPEAKER_01 0:24

Thank you so much for having me.

SPEAKER_00 0:26

Thank you for being here. You are an expert, especially in, you know, in geoeconomics in general, but especially in foreign investment screening, a topic you have published extensively on and a topic for which we share a bit of a common interest. But today, given recent events and developments, I would like to talk about outbound investment screening, which is a bit of a relatively newer aspect of the debate on investment screening compared to the usual foreign direct investment inbound screening. And of course, the trigger of this conversation is going to be the executive order that was published last summer. And I'm going to ask you, because we had been waiting for that executive order for a relatively long time. So I'm going to ask you, how did we get there?

SPEAKER_01 1:18

Yes, it is so interesting to take a step back and really think about how far we've come in just a few short years in terms of how much the conversation has changed around the wisdom of regulating outbound investment. When in January of 2022, there started to be rumblings that perhaps the US Congress would act on outbound. It was seen as just completely outside of the realm of possibility. And then, you know, within several months, all of a sudden we really had quite a bit of momentum. And the the window, the Overton window around this topic really shifted dramatically. So I think the best way to understand the executive order is precisely in understanding the dance between the president and Congress on this issue. So the um impetus for outbound really came out of Congress. If we step even further back to 2018 when the US was going through its updates to Cipheus, the Committee on Foreign Investment in the United States, those uh updated, that updated legislation was Firma. And in Firma, there was an early discussion that would have included outbound investment as part of Cytheus's purview. And that particular aspect of the uh initial draft legislation was stripped out. And instead, the sense of Congress was that the issues around outbound would be better dealt with through export controls. And so, along with our update to investment, inbound investment screening, the Firma bill, there was also ECRA, which is the Export Control Reform Act, which uh was trying to increase the ability of the US to use export controls in a more assertive way to deal with the issue of outbound. And that was a process that was uh really driven, I think, quite substantially by concerns in industry that an outbound um and adding outbound investment to Cyphius would just gum up the system and be a little bit too restrictive of a measure. So uh the initial uh Senate or one of the one of the senators who had um really developed the Firma legislation and the stronger FERMA legislation that included an outbound component, John Cornyn, he also was one of the main architects of the initial um congressional push towards an outbound mechanism starting in 2020. So that particular bill is oftentimes referred to as the Casey Cornyn bill because it is senators Bob Casey and John Cornyn who uh who drafted it. And so once that discussion started to gain legs, and this is also in the context of a massive push towards increasing industri um industrial policy around semiconductor um production in the United States as well, um then Treasury stepped in, tried to find a less um kind of strict version of an outbound mechanism. And finally, we got this executive order that has shifted the conversation away from a Cepheus-like case-by-case review and instead to a um concept that's focused on a narrow set of sector-based and really technical specification-based for the most part, uh, notifications around three core industries of concern, um, and then a narrower set of outright prohibitions on outbound investment that has some kind of um that has some kind of managerial or other kind of control mechanism associated with it. We're not talking about portfolio investment, but these other kinds of investments that may not be controlling but are also not patent.

SPEAKER_00 6:18

Thank you for already answering one of the questions that I was going to ask, which was, well, actually two. One was when we talk about investments in this case, what are we actually talking about? And I think you've already clarified that. And the second one was going to be, you know, what is the content? But if you could say a few more words about the content of the executive order, um, the implications, what has actually changed in the way the US treats outbound investments?

SPEAKER_01 6:46

Since the outbound investment regulation is not yet in effect, there are, for all intents and purposes, no uh regulations at all, really, in terms of outbound investment. Um, you know, as long as you're engaged with um entities that are non-criminal, you can pretty much do what you want. Um, there are no notification requirements or anything like that. Uh, once the EO is actually implemented, uh, what will change is that there are a set of sectors, um, but really even more narrowly specified than sectors. Um there, there are three of them where this um set of notifications and prohibitions will apply. The first is around high-end semiconductors and related um manufacturing equipment. The second is around quantum computing, and the third, which is perhaps the most controversial because it's hardest to really um define in a clear way, um, is uh artificial intelligence and in particular artificial intelligence with some kind of application to military, policing, surveillance type activities. And so within these three narrow sets of technologies, there will be a requirement to notify the government of um any outbound invest and any covered outbound investment in these areas so that the US government could just keep track of how much US investment is going to China into these technologies. And then within those technologies, there are a kind of narrower set of um specifications where um where any outbound investment that or covered outbound investment is prohibited. Um and in the case of quantum, all investment that is quantum is prohibited. There are no notification kind of areas, uh, and that has to do with the fact that quantum is still quite new. And so we are not starting from a base of a lot of investment. Um so it's an easier, it's easier to control now at the start of the development of that technology rather than having to reel um investments back in once the horses are out of the barn, so to speak.

SPEAKER_00 9:27

We tiptoed around a very important um issue, which is why is the US um thinking about screening and blocking outbound investments? What type of issues is it trying to tackle? And what is the role of China in Olufaze?

SPEAKER_01 9:48

Yes, well, it's 100% about China because the um the EO would not restrict investment really from any like to any other country. So this is very much China related. Um, again, going back to the conversations around updating Cipheus, which happened in 2018, but actually the discussions around um the need for updating Cipheus really started in earnest in 2017. And a big contributing factor to that conversation was a very important um a very important um research report that came out of the Defense Innovation Unit in 2017-2018. And what that report was looking at is the ways in which Chinese companies and the Chinese government were using a variety of tools, some of which were legal and some of which were illegal, uh, to uh transfer sensitive technologies to Chinese actors. And so that was really the impetus for the uh strengthening of Cepheus and why Cipheus added in very explicitly concerns over emerging technologies in a way that was not really encoded in a lot of the discussions around Cepheus previously. So previously, um the the previous time that Cepheus legislation had been updated was in 2007, and that was much more focused on issues around critical infrastructure. But Firma really focused on technology and um export controls, the export control reform act also really focused on technology and emerging technology and really tried to find ways to use export controls as the primary tool for preventing the transmission of emerging technologies that have dual use capabilities to China. But the US government's experience with trying to actually um keep up with this rapidly changing technology in a way where it could actually control these technologies in a timely fashion, um, we learned over time that this is very hard to do, especially because emerging technologies, by their very nature, you don't know their, you don't know as they're emerging what they're going to end up being used for or how much of a challenge to national security they're going to create. And so because the export control process really requires a lot of um kind of reason discussion about whether a particular technology should be controlled or not, normally by the time that you understand the technology enough to control it, it's already no longer emerging. It's out there in the world, right? And so for these reasons, there were a real concern that the US had to do something that was a little bit more proactive and that export controls themselves were not going to be the kind of panacea that we had hoped that they could be in in 2018. And so that kind of focus on the technologies, particularly the emerging technologies, and the concerns that export controls just wouldn't be um a kind of comprehensive enough tool to deal with the threat by themselves is sort of the reason why there was renewed interest in uh um outbound investment regulation.

SPEAKER_00 13:51

That is very interesting because maybe we're going to talk about it a little bit in a moment. But the debate over should it have been a development of export controls, should it have been sort of the flip side of inbound screening, inbound investment screening, or should it be his own thing, is of course something that a debate that has happened to a certain extent in the US, it hasn't fully developed entirely in Europe. But we'll get to that, uh to that in a moment. Before that, I just want to ask you, because we're talking about emerging technologies and we're talking we're talking about um preventing a tech transfer or the enabling of technologies, emerging technologies that may be used in a military application. Do you expect the very narrow sector, at least very short list, not narrow, the very short list of sectors that you mentioned at the beginning to be expanded in in the future? Do you see something like that happening or not?

SPEAKER_01 14:49

I think it is certainly within the realm of possibility. And I know that industry is concerned about the notification requirements because one of the things that is still unclear, since we don't have the final rule yet, is that when the advanced notice of proposed rulemaking um arrived uh in last the end of last August, um there was a sense that the notification requirement was going to be quite comprehensive in terms of the type of information that the government would be collecting from firms about their investments. We'll see uh what exactly in the final rules will be required from firms, but there is a real concern that this is a surveillance kind of activity that the more that the US government will collect information on these activities, the more they are going to feel pressure to do something to further restrict these kinds of investments. And so that's the real issue, right? Is that we hear over and over again from the Biden administration that the goal is to have a um small yard but very tall fence. And the issue, of course, is how likely is it that that um yard can continue to remain narrow because there are a lot of pressures um really pushing to expand that yard um more and more.

SPEAKER_00 16:43

Definitely. And speaking of that, maybe we can move geographically and talk a little bit about Europe, the role of Europe, coordination between the United States and Europe. You have been following the European uh debate as well. Um have developed together with Sophie Mounier an impressive data set, as far as I understand, of inbound investment screening mechanisms. So you are familiar with what is happening on the other side of the Atlantic, too. And just a quick recap outbound investment is not for you, Sarah, for the people who are listening, but outbound investment is a debate that is happening in Europe as well. Um, it was part of the economic security package, economic security initiative package that uh the European Commission published on the 24th of January in form of white paper, where a lot of attention was on collecting data. And I find particularly interesting, Sarah, that you mentioned that the more data the US collects, the more it may be keen to control the situation. While often some of us made the opposite argument in Europe, saying, well, the more data you collect, probably in many cases, the more you will see the need of an outbound investment screening. But it's great that it's actually a great angle, the one you provided. And then just recently last week, on the 18th of April, um the UK Deputy Prime Minister gave this economic security speech where he also talked about outbound investment, but it actually embedded it in what it is the UK's uh national investment screening mechanisms on the National Security and Investment Act. So, sort of a development of that. Um, so I put a lot on the table. So let me go, let me go in order. Um, first of all, let's talk about this data collection aspect and develop a little bit more this idea of whether collecting data first is the right step or whether we should go about it differently.

SPEAKER_01 18:45

I do think that it's important to start with data. And I didn't mean to say that in the US case, that having a notification regime uh was necessarily a bad thing. Um, my point was just that especially because there's such bipartisan support for being tough on China, um, if you do get information about particular transactions that are concerning, but that you don't have any tools to prevent, it does push in the direction of trying to find opportunities to create new tools. In the case of Europe in particular, I think that um using having as the first step a data collection um kind of phase is really important because um it is unclear how much investment is going to China in these particular uh in these particular sectors of concern. Um, it's also unclear precisely the the mechanisms through which this investment is happening. And so spending some time to just understand the scope of the problem um is important first to see if, first of all, is this an overblown concern? Um, but also if you are going to move forward with a mechanism, how much um how many how much time and resources is this going to to um take up? Um and that's a that's a real concern, especially if you have a process that requires some kind of um review or um or you know requires that an investor receive um a positive response from the government before moving ahead with their outbound investment. And so I think that this is important. And I would also just add here that my sense is in speaking to many um European um bureaucrats is that there is um more of a requirement in Europe to demonstrate the a real national security or public order um not just threat, but consequence before many Europeans are willing to make a move. Whereas I think in the US, there is less of a need um among bureaucrats to have a smoking gun because from the US perspective, they don't want to put themselves in front of the gun to begin with.

SPEAKER_00 21:37

I agree with you 100%. I think data collection is always important, but in the European case, maybe something we I should have mentioned is that even this policy would be country neutral, right? In the case of the US, there's always a strong, well, in the case of our bound, even stronger China connotation. But in the European case, it will be country neutral. Which means there needs to be a, well, either risk assessment or a national security concern that is strongly there. And on top of that, because the European Union, but also European member states, have not done much outbound screening in the past, outbound investment screening in the past, it also means there's no blueprint, which is very much different from the situation they were in when they adopted their inbound screening regulations. And something that I think we don't talk enough about, and you mentioned it already, is also capacity. A lot of member states barely have the capacity to implement the existing regulations and screening instruments, thinking about a new one needs a very strong motivation. So there need to be data that point in the direction that there is a national security concern, and so that this instrument is indeed needed. Just to say, you know, I agree with you. Which sort of brings me to the next point, which is would it make sense to have, I have my own opinion, but would it make sense to have how about investment screening as a flip side of the inbound investment screening regulations?

SPEAKER_01 23:10

Um it's a great question. It and my sense is no. I think that it is important to I I think that the fact that a lot of the discussion around outbound has been framed as, oh, we're just gonna do the reverse of inbound, right? In the US, it was discussed, it's oftentimes discussed as reverse syphys. And that makes it sound like it's pretty easy to do and that we know how to do what it is we're trying to do. And I think that that's false, and it leads to a false sense of confidence in the ability of the government to um to implement this new authority in a efficient and effective way. So I think that um I think that in particular, case-by-case review of outbound transactions is just simply unworkable. Um, there are a few reasons for this. One has to do with the time constraints. Francesca, you already mentioned that in the case of Europe, um, this that any outbound would likely have to be country neutral. And so therefore, you're talking about reviewing every single outbound transaction that any European um company would want to make, which is just an enormous uh requirement for the government to do, and it would just slow down um commerce and and industry so much. So the cost of this, uh not just implementation costs, but the the opportunity costs to firms would be immense. Um and then also in terms of collecting the data that you need in order to make uh in order to make fact-based determinations is harder in the context of outbound. In the case of inbound, um, what happens is you have, you know, both the um the target company and the potential acquirer that are trying to get um authorization for the transaction to go through. And so, and the target is in your jurisdiction. So you have far more tools around um getting those those companies to give you the detailed information about that transaction and about the target company, such that you're able to really understand what are the vulnerabilities associated with that target company and what are the potential threats associated with that particular acquirer, and then how do those threats and vulnerabilities interact to create national security or public order consequences. When we're talking about outbound, governments don't have that same sort of um kind of coercive authority because they're not talking about a target that is in their jurisdiction. And so they simply just don't have as many tools necessary to compel parties to provide the information that they need because in the end, the target is not going to kind of need the blessing of the um reviewing government in order to continue to operate. And so uh I think that this is a very big difference between inbound and outbound and one that is not discussed enough.

SPEAKER_00 26:59

Um, I mean, you couldn't have said it any clearer. Um I'm glad that you uh found perfect words to describe one of the main difficulties on top of the fact that, of course, on one hand, in many cases, we're talking about direct investments when we talk about inbound, when we talk about outbound discoveries broader, right, than just direct investments. So that on top of what you said, you know, there's also that element. Now, some people, and I'm coming to a close here, but some people um see coordination within the G7 also for data collection and data sharing as a solution. Um I'm gonna be blunt and I'm gonna say that I'm a little bit skeptical at the moment about this particular solution, but I'm wondering what you think about that in terms of the ability to share data, collect data, and then coordinate um in their approach towards outbound investment screening.

SPEAKER_01 27:54

I agree with you that I think that this will be challenging for a lot of different reasons. One might be that uh these firms that governments will be collecting data on are probably not going to want governments to share all of this information uh across the G7 because these firms are competitors with each other. And so that's a major issue. I think if we are talking about sharing information at the sector level about what types of um flows and um technological capabilities into countries of concerns do we see? That's one thing, right? And I certainly agree that um more discussions among like-minded partners is important around these issues. Um, but I don't think that you're gonna be able to across the G7 engage in a kind of landscape um kind of scoping um kind of um exercise in which you're getting into um the type of detail that you would need to be able to intervene from a policy perspective. And the more that G7 countries engage in um industrial policy that competes with each other, the more challenging that will get.

SPEAKER_00 29:25

Thank you. And well, just you know, even within the European Union, countries are not always willing to share data, and that is the European Union, so you can imagine at G7 level that would be even more difficult. I'm coming to the last question, and then I'm letting letting you go. Um, the last question is again the fulrouge of the different episodes, and it's trying to understand whether these policies are making um, well, us more competitive, in this case, the United States. I understand it is difficult to assess that from an executive order that has not become a regulation yet, but I was wondering if you can engage in a bit of speculation and think about whether this is something that will make the US more competitive globally.

SPEAKER_01 30:07

I think that the answer to this question um depends a little bit on what time frame you're thinking um of. Because clearly, in the short term, this is not helping um our competitiveness, right? That this that um by restricting firms in terms of where they're able to invest, and we didn't really kind of have time to get into the difference between kind of corporate investments that are kind of expansion um for supply chain or um or market access reasons versus venture capital. Um, but regardless of what kinds of outbound investment we're talking about, in the short term, this means that US companies will and their subsidiaries will have less um freedom of movement to make choices about how they want to allocate their assets. Um and particularly in an environment in which US companies are not always the most technologically advanced, this also reduces their ability to use um outbound investment strategically in order to gain access to new technologies that they currently don't have access to. So in the short term, I think that it's very clear that this is a cost to competitiveness that is justified as a national security imperative. Where it becomes trickier to assess is over the long term, because if you believe that in the absence of these regulations, the Chinese government will work in tandem with their firms to strip all kinds of um of IP from US firms and then use the largesse of the Chinese states to drive US companies into the ground and outcompete them in global markets, then you would say, you know, we're willing to take the short-term hit in order to protect our long-term competitiveness. If you don't believe that that is likely the uh way that you know the next 10, 15, 20 years will play out, then you're not gonna think that this short-term hit is worth the cost because you don't see getting paid out on the back end. And that's where a lot of this you know comes down to is what what type of competitor do we see China as today, but also what type of competitor will China be five years, 10 years from now. And whether you think that um restricting um US companies' ability to invest in China now is worth it or not really fundamentally depends on your answer to that question.

SPEAKER_00 33:15

Thank you, Sarah. This is going to be one of, this has been one of those episodes where I leave with more questions than answers. Uh, mostly because I would stay here and talk about investments for hours. I guess that most listeners wouldn't, so I'm gonna just let you go. And deeply thank you for your time and for sharing all this information with us. It has been a very pleasant conversation and a pleasure to have you here today.

SPEAKER_01 33:40

Well, thank you very much for having me.