26 September 2017

Government should beware building a ‘fortress Britain’

By David Chmiel

Theresa May’s speech in Florence has come and gone and many questions remain about Brexit’s ultimate form and substance. Will the UK have to pay a “divorce settlement” into the EU’s coffers and how much will it be? What rights will be granted to EU citizens in a post-Brexit UK?  How much protection will critical industries such as financial services secure? Only time will tell which of Mrs May’s positions are inviolable and which fall prey to the cut and thrust of negotiation.

While these and a host of other issues are likely to remain unresolved for some time, another policy initiative will start wending its way through the parliamentary process this autumn. And while it is unrelated to Brexit, it may actually provide a substantive indication of just how open the UK will be to foreign investment in a post-Brexit world.

Last September, in connection with its decision to approve construction of the Hinkley Point C nuclear power station, the Government announced that future foreign investments in the UK’s “critical infrastructure” would be subject to review for national security purposes. That policy was reiterated in the Conservative manifesto for this year’s general election and ended up being one of the few policies in that document to make it into the pared-down Queen’s Speech.

However, few details have been revealed about how the regime will operate, the criteria against which investments will be assessed, or even how “critical infrastructure” will be defined. Will it be limited to areas such as sensitive defence technology and key utilities such as the national power grid, or will it also include transportation infrastructure such as airports and railways? Could it even be extended to other essential services such as healthcare? The term can be defined in a host of different ways.

What we do know is that the UK is a relative latecomer to this type of legislation. Canada, Australia, the United States and New Zealand, among others, have all had foreign investment review regimes in place for decades, with each geared to particular sectors of national interest.

Germany introduced a similar regime this year and the European Commission recently published proposals for a framework to screen foreign investments on an EU-wide basis after President Macron called for the same during his election campaign. All of these measures are driven by concerns that foreign acquisitions can be used as cover to gain access to sensitive technologies or critical intellectual property.

We also know that foreign investment into the UK is not without its critics. Concerns about Chinese investment in the Hinkley Point C project served as the catalyst for this new policy. That debate was recently reignited by the announcement that Canyon Bridge, a private equity fund with Chinese state-owned investors, would acquire Imagination Technologies, a UK-based chipmaker. Earlier this month, a proposed acquisition by Canyon Bridge of a technology company in the United States was blocked by President Trump on national security grounds.

But criticisms of foreign acquisitions of UK-headquartered companies extend beyond high technology sectors. When Theresa May launched her campaign for the Conservative Party leadership last year, she openly questioned certain aspects of Kraft Foods’ post-acquisition management of Cadbury. Efforts earlier this year by Kraft Heinz to acquire Unilever caused a brief flurry of debate in the media before the deal collapsed.

These criticisms demonstrate that concerns about foreign investment extend beyond national security to questions of whether all investments should be reviewed to determine their broader net benefits to the UK. In fact, the Conservative manifesto included pledges to toughen up takeover regulations to introduce such a concept. Interestingly, however, it was only the national security review component which was expressly referenced in the Queen’s Speech.

Even when confined to a national security-based review, foreign investment laws remain open to politicisation and can serve as cover for more basic protectionism if they are not structured correctly. Ambiguously drafted laws can make foreign investors reluctant to make bids for companies if they fear incurring millions of pounds in banking and legal fees, only to have the transaction rejected in the review process at the last minute.

Equally, unless review criteria are closely defined, interest groups can generate political pressure on an ad hoc basis to expand their scope.  This is a particular risk in the US system, where proposed acquisitions in industries such as agriculture, food, steel production and even hotels have come under scrutiny amidst lobbying of Congress by those opposed to such investments on a host of grounds – but who couch their objections in the language of national security.

Of course, every government has an obligation to ensure that vital national security interests are protected from interference by foreign investors, but as Britain prepares to look to the world beyond the EU for new trade and investment partners, it is equally important to recognise the benefits brought by foreign investment to the UK’s economy and its overall competitiveness.

For decades, UK plc ventured out into the world as an acquirer. The UK is the largest single investor in the United States, with the Confederation of British Industry estimating that UK companies had 449 billion dollars invested in that country at the end of 2014.  It would be somewhat hypocritical to adopt a contrarian approach to the benefits of cross-border investment simply because a weaker pound is making UK businesses more attractive to foreign buyers, instead of allowing UK companies to continue their acquisitions overseas.

Equally, two Bank of England economists published research in August which demonstrates that foreign-owned firms are more productive than domestic firms and that foreign ownership can boost labour productivity. They attribute this to a number of factors, not least of which is significantly higher investments in R&D activity by foreign-owned companies.

As Brexit forces the UK to venture out and compete in the wider world, it would be counterproductive to introduce a policy which was indirectly making the economy less productive and competitive. A badly drafted or overly protective foreign investment review law could do just that.

It is also worth noting that whatever proposal does enter the statute books is likely to come under future scrutiny when the time comes for the UK to negotiate bilateral free trade agreements with countries ranging from the US and Canada to China and India. Such agreements often include variations or exclusions to the applicability of foreign investment review laws.

Even if there are concerns about the motives behind investments from certain countries – and China is often at or near the top of that list – the Government might find itself in the difficult position of having to decouple such concerns from demands from trading partners to waive such restrictions as a condition to new free trade agreements.

The immediate challenge comes from the fact that foreign investment is not an issue which typically garners headlines. When it does, media coverage quickly loses sight of the broader benefits brought by such activities. Yet the form and substance of the UK’s nascent foreign investment review regime will send a very clear message about the approach which this country intends to take as it opens itself up to the world.

There are benefits – both actual and symbolic – to subjecting certain types of investment activity to greater government scrutiny. However, that cannot be used as cover for building some artificial “Fortress Britain” in which UK companies are, unless truly vital national interests are at stake, effectively rendered immune from acquisition and, by default, competition.

Doing so would send the wrong message at the wrong time. The bill implementing the new foreign investment review regime must, as a result, be exposed to as much scrutiny and debate as is being devoted to the shape and form of Brexit.

David Chmiel is Managing Director of Global Torchlight. @DavidJChmiel