Investments Control
Автор: Олексій Пустовіт
Джерело: Ukrainian law firms 2020, 15 вересня 2020 р.

There is an emerging conversation around foreign investments in strategically important companies — is it a path towards modernization and development or a threat to national security?

So we decided to discuss the idea of introducing a screening mechanism aimed at controlling foreign investment in particular areas of strategic importance for the economy and national security of Ukraine. In particular, the Ministry for Development of Economy, Trade and Agriculture of Ukraine has developed a draft law on such a screening mechanism. Svitlana Panaiotidi, Deputy Minister, Galyna Zagorodniuk, partner at DLA Piper Ukraine and Oleksiy Pustovit, partner at Asters, shared their views on the details and the pros and contras.

Olga Usenko (O. U.):  So what are your thoughts on attracting foreign capital into companies that are of strategic importance to Ukraine?

Svitlana Panaiotidi (S. P.): There is no doubt that attracting foreign capital into the Ukrainian economy is vitally important. Foreign investments mean modernization, development, access to new technologies and financing, they drive jobs and economic growth. However, when it comes to companies which are of strategic importance, those operating in the defense sector, telecom, infrastructure and some other sectors, it is quite natural for the state to understand and control what is happening in these industries and who those investors who enter the Ukrainian economy are.

If we consider defense, Ukraine’s desire to occupy a proper place in the international security landscape is logical and understandable for the international security community. From Ukraine’s perspective, it is not just about the development of military-technical cooperation. It is joint work on the architecture of both European and world security, and, of course, joint projects and investment cooperation.

We strive to contribute to collective defense in Europe and we understand that we must be strong inside the country: thus, we implement reforms, strengthen our defense capabilities, carry out agreements with partners, and above all, work together with G7 and NATO experts.

The screening of foreign investments in this context is one of the main components of the security architecture of Ukraine, which affects the international security environment. In our country’s case it is important to understand whether the investment does not come from the aggressor country, whether there are mechanisms to prevent technology transfer, ensure stable operation of infrastructure and so on.

Galyna Zagorodniuk (G. Z.): Mirroring Svitlana’s words, I agree that any state has a natural right to define the rules of the game on its sovereign territory and, as such, may establish various mechanisms which control the entry of foreigners up to a ban on entry. The state, therefore, may define which areas should be closely monitored and establish special rules which require transparency of information regarding an investor and planned investment as well as introduce additional barriers for entry if the state sees certain risks.

The point is that such state actions should be formalized by legislation, carried out by an authorized state agency and applied equally and fairly. Foreign investors that come to Ukraine must be informed of the existence of a special screening regime.

Oleksiy Pustovit (O. P.): The Tuzla Island conflict back in 2003 was an eye-opener, that there was a real threat advancing from a very powerful neighbor. The attempt was followed by long-term hybrid aggression which was mostly based on economic and political interference. Nevertheless, 8 years after Ukraine celebrated its 20th anniversary of independence with two gas conflicts, but even closer ties with Russian business. Ukraine still has no effective mechanism of dealing with national security issues arising out of investments, while some new threats have appeared on the radar over the course of the last decade.

By contrast, many Western countries have not only had a screening mechanism in place for years, but are now actively remodeling national legislation by introducing  stricter and more comprehensive investment control. The Ministry’s initiative is very timely, as it is obvious that control of national investment is inevitable. Investor-wise, one more bureaucratic formality, provided it is clear and easy to observe, is more attractive than the de-facto one in existence, but as yet unarticulated and enforced in an unclear manner policy, as with the well-known case of Motor Sich.

O.U.: How is the issue of capital screening resolved in other countries? Is there a “role model” for Ukraine? 

G. Z.: It should be said that the screening of foreign investments exists in many countries, both developed and developing. The screening mechanism includes monitoring, analysis, assessment, a permit which sometimes can be conditional, prohibition of investment, and sometimes even abolition of foreign investments that have already been made. The rules differ from country to country, but they are aimed at protecting national security, public order, while sometimes the purpose is protecting national production or attracting investments in high-tech or other industries. The screening mechanism exists in the US, Canada, the UK, Australia, in 14 EU countries, including France, Germany, Italy, Spain, the Netherlands, Austria and Poland. It also exists in China, Russia and other countries. Going back to Europe, the EU provides for recommendations to member countries regarding spheres and the mechanism of screening and requires annual reporting on those mechanisms which are in place and the respective practice.

The Association Agreement signed between Ukraine and EU came into force back in 2017. Under this agreement Ukraine took on a commitment to harmonize and approximate its national legislation with EU regulations in certain fields such as customs, sea transport, public procurement, competition, etc. The Association Agreement is silent about bringing the foreign investment legal framework into line with EU regulations (apparently because in the EU itself screening is a decentralized process which falls within the competence of member states). Given the political course of Ukraine, it is likely that if Ukraine introduces screening mechanism, it will be based on the EU legal framework in material respects.

S. P.: In general terms, in order to avoid the concentration of foreign capital in certain defined industries, investments are evaluated on such aspects as the country of origin of the investments, assets to which foreign investments are directed, the type of investment agreement (direct / indirect, acquisition / or partial participation), threshold values of shares acquisition of national companies by a foreign investor.

In the majority of EU member states, the Ministry of Economy is the authorized body responsible for conducting inspections of foreign investment. Thus, the decisions on approving or blocking foreign investments or agreements are made at the level of the Cabinet of Ministers or the President.

G. Z.: Screening in other countries is performed by various state bodies, such as ministries, by competition authorities (in the UK, Russia, Australia) or by specially created inter-agency commissions (in Canada and the US).

O. P.: The way in which the control is enforced abroad varies significantly, we can hardly find a system that matches Ukraine and there is no simple copy-paste solution. Special attention is required to those areas covered by investment control and the ease of approval ensured by the Law.

As in many countries, the most recent Draft Law contains a detailed list of the industries which are subject to control, which is valuable in terms of predictability. However, the idea of screening is to address the threats which, in turn, can evolve and are not easy to foresee. By way of illustration, one of the hot trends is public health. The UK recently extended its control to investments in businesses critical to combating pandemics to address COVID-19 and similar threats in the future. There are examples of non-exhaustive lists of controlled industries within the EU that can also be an option for Ukraine, since it ensures greater flexibility and more effective investment control.

S. P.: The strictest verification system by far is the one that exists in the United States. Their Foreign Investment Committee (CFIUS) is an interagency body that has the authority to evaluate investments in defense, transport infrastructure, telecommunications and technology, as well as financial services and the processing of confidential personal data. In Ukraine, however, there is currently a lack of a legally prescribed procedure for the preliminary assessment of foreign investment in terms of national security. On  the contrary, when additional control mechanisms are introduced, they usually provoke resistance.

O.U.: How do you deal with such resistance? 

S. P.: That said, the Ministry of Economy pays considerable attention to the development of a screening system in Ukraine in order to provide verification and prevention of foreign direct investment impact on national security and strategic sectors of the economy.

For this purpose experts from the Ministry analyzed the legal framework and activities of the Committee on Foreign Investment in the United States (CFIUS). We have also reviewed the measures taken in the European Union to coordinate the verification of investments from outside the EU in strategic sectors to ensure that they do not pose a threat to security and public order. Finally, we have conducted analysis of Ukraine’s current legal framework.

O.U.:  What were the conclusions? 

S. P.: As a result of the work carried out, it became clear that in Ukraine there is no special legislation to regulate the implementation of international investments that are of strategic importance for the economic security of the state. Neither is there a system for identifying, preventing and eliminating risks in the areas of national security that may be caused by foreign investment.

In order to regulate these issues, taking into account the best international practices, the Ministry of Economy has developed the Draft Law On Screening Investments aimed at:

— introducing an assessment system of the impact of foreign investments;

— avoiding in the concentration of foreign capital in areas of strategic importance;

— provide companies of strategic importance with the opportunity to cooperate with investors who have an impeccable business reputation;

— provide foreign investors with a transparent mechanism for assessing the impact of their investments and to agreed contracts with strategically important enterprises.

As mentioned before, Ukraine does not have a system for identifying, preventing and eliminating risks in foreign investments. This law is the first step towards creating such a system. In order to create an efficient mechanism for investment assessment the Law should be supplemented with proper secondary legislation.

The crucial piece of secondary legislation is a Commission for Foreign Investment Impact Assessment Mandate. On the one hand it should give enough authority to perform their duties but, on the other hand. it should provide accountability and transparency for all the Commission’s activities.

O.U.: Do you have any examples?

S. P.: For example, the Ukrainian defense industry or infrastructure are potentially attractive for foreign investors because of the scientific potential, qualified specialists, and the availability of a developed infrastructure.

Screening the impact of such investments on national security is extremely necessary. It is impossible to control the attraction of such foreign investments without a systematic approach to the issue of building a system of control over foreign investments.

We believe that we have to implement a transparent approach of verification of investments from foreign investors. We also believe that the decision of this Commission will give them guarantees that their investments will be safe in Ukraine. And we understand that it will enable us, as a country, to avoid the situations when the state needs to control certain transactions, but there is neither the proper authority which could take responsibility for it, nor the proper mechanism. It’s harmful for the economy and relationships with strategic partners. Implementation of this Law should be taken very positively in our international cooperation with strategic partners, and will pursue further development of our economy.

O.U.: Do you think now is a good time to introduce screening?

G. Z.: This is, indeed, a very important question. According to the 2020 World Investment Report published by UNCTAD for 30 years in a row, the trends regarding control of foreign investment differ radically in developed and developing countries. Developed countries like the US, Australia, Japan and others are strengthening their screening laws. For example, they increase the number of areas that are subject to screening and reduce the financial or shareholding thresholds of those transactions falling within the scope of control so that more and more transactions are caught.

At the same time, the trend is in reverse in developing countries; they aim to liberalize their laws, attracting more foreign investments to ensure further development. Developing countries compete for foreign investments trying to soften their requirements (where they exist) or refraining from introducing new restrictions and barriers.

Another important factor is COVID-19. Again, taking into account UNCTAD conclusions, the COVID-19 crisis will cause a dramatic fall in foreign direct investments throughout the world. It is forecast that global foreign direct investments flows will decrease by up to 40% in 2020. A further decrease is already being forecast in 2021 with a slight hope of recovery in 2022. The outlook is extremely negative for vulnerable economies.

Ukraine can hardly boast of large volumes of foreign investments. Careful consideration should be made as to whether this is the proper time to introduce a new law on screening of foreign investments which may affect the intention of investors to enter the Ukrainian market.

My opinion is that if the state does, indeed, aim to control foreign investments it should first introduce a properly drafted bill, empower a particular state body to deal with screening and provide for clear, transparent and non-discriminatory rules. Because we are currently observing a certain bias: Ukraine has a need to control certain investments, maybe a need to condition them with certain commitments, set restrictions or even prohibit investments. But it lacks the mechanism to do so in a civilized manner. Instead, it has no choice but to act through those authorities which are not intended to perform such functions, namely the Antimonopoly Committee and law-enforcement bodies.

O. P.: Can there be a good time for another approval procedure? Definitely not, and this initiative is likely to face opposition from business. I very much agree with Galyna. The law should provide sufficient comfort to investors by limiting the review period, setting a clear notification requirement, ensuring a transparent review and reducing paperwork. The consultations held between public authorities and foreign investors as well as an effective appeal procedure are extremely important.

It is unclear what number of investments would have to be reviewed; judging by the current Draft Law, it could trigger quite a few cases. To deal with this, the Ministry can act as a pre-screening body vested with powers to promptly clear non-problematic investments and to grant comfort letters with respect to voluntarily notified investments. The latter resolves many issues where the screening requirement is not perfectly clear or the investor simply seeks compliance comfort.

O.U.: What about your expectations as to adoption of this Draft Law?

S. P.: We are in the process of analyzing the comments which we have received from other ministries and are going to prepare the upgraded version in the course of next month. The next step is to work with Parliament.

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