Building momentum: the positive outlook for a US outbound investment review regime

February 2023 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

February 2023 Issue

The Biden administration’s National Security Strategy stands out from recent predecessors in its focus on a modern industrial strategy in which US technological leadership is a key national security priority – one that promises perhaps unparalleled use of industrial and economic tools to meet the “pacing challenge” of China. The strategy reinforces the legislative and executive actions that came into effect last year to support national security objectives, including the CHIPS and Science Act, Inflation Reduction Act, National Biotechnology and Biomanufacturing initiative, stringent new export controls restricting China’s access to advanced semiconductors and supercomputing, the first-ever presidential directive defining additional national security factors for consideration by the Committee on Foreign Investment in the United States (CFIUS), and Federal Communications Commission (FCC) restrictions on the use of certain Chinese telecommunications equipment. In 2022, the US government demonstrated its willingness to aggressively utilise existing legal and regulatory mechanisms to secure US supply chains and prevent the transfer of potentially sensitive technologies to China and Russia.

However, an increasing number of US policymakers view existing national security regulatory regimes as insufficient to address these concerns. In particular, there are growing calls for the review of outbound investments to ensure American capital does not flow to support strategic competitors’ development of critical national security sectors. The strategy explicitly calls for the development of a new approach to screen outbound investment to “prevent strategic competitors from exploiting investments and expertise in ways that threaten our national security”. Colloquially referred to as “reverse CFIUS”, support for an outbound investment screening regime has steadily gained traction.

While the latest iteration of legislation that would have created an outbound investment review, the National Critical Capabilities Defense Act (NCCDA), was nixed from the CHIPS Act in the summer of 2022 and failed to make traction in other legislation, efforts persisted to make progress in the legislature and also came in the form of Congressional support for executive action. Significantly, the 2023 fiscal omnibus spending bill signed into law on 29 December 2022 includes provisions regarding an outbound investment review regime. The Senate explanations on the bill note that the Department of Treasury has 60 days to “submit a report describing such a program”, including the resources needed over the next three years to establish and implement such a programme.

The exact parameters of an outbound investment programme remain to be seen, though there are numerous ways such a programme can potentially come into existence. The NCCDA proposed the creation of a new agency, the Committee on National Critical Capabilities, that would be authorised to review and recommend presidential and congressional action on certain “covered transactions”. The original language of the NCCDA defined “covered transactions” to include those by US businesses that shift or relocate to a “country of concern”, or transfer to an “entity of concern”, the “design, development, production, manufacture, fabrication, supply, servicing, testing, management, operation, investment, ownership, or any other essential elements involving one or more national critical capabilities”, or that “could result in an unacceptable risk to a national critical capability”.

The bill defined “national critical capabilities” as those “systems and assets, whether physical or virtual, so vital to the United States that the inability to develop such systems and assets or the incapacity or destruction of such systems or assets would have a debilitating impact on national security or crisis preparedness”, including medical supplies, materials and certain services related to “critical infrastructure” and natural disaster recovery, certain supply chains, and articles related to military or intelligence operations.

The vague and broad language of the original NCCDA bill introduced in 2021 ignited criticism by industry. For example, a report by the US-China Investment Project estimated that up to 43 percent of US foreign direct investment to China over the past two decades would have been “covered transactions” under the bill’s language. Moreover, there was concern that transactions within the US or other non-strategic countries would be swept within the bill’s purview merely if people or companies from countries of concern are involved. Similarly, members of the Information Technology Industry Council (ITI) expressed strong concerns with the NCCDA in a letter to Congress in May 2022. While ITI took “seriously Congress’s and the Administration’s concerns that business transactions, investments, and transfers align with U.S. objectives for resiliency and security in critical supply chains”, ITI urged Congress that the NCCDA was premature because Congress has yet to identify concrete gaps in existing national security authorities.

In an ostensible attempt to address industry concerns, a proposal emerged to amend the NCCDA in 2022, though many argue that the proposed legislation appears just as broad as its predecessor. The 2022 proposal specifically designated China, Russia, Iran, North Korea, Cuba and Venezuela as “countries of concern”. The term “entity of concern” remained broad, covering any entity influenced by or affiliated (directly or indirectly) with a country of concern. The proposal also attempted to focus the definition of “national critical capabilities”, which includes certain supply chains, such as semiconductors, large-capacity batteries, critical minerals and materials, pharmaceuticals and active pharmaceutical ingredients, plus supply chains identified pursuant to Executive Order, technologies identified by the Director of National Intelligence as critical, including artificial intelligence (AI), bioeconomics and quantum science, sectors identified in the White House National Science and Technology Council’s Critical and Emerging Technologies List, and any other industries, technologies and supply chains identified in the future by the Committee. The 2022 bill also continues to grant broad authority to the Committee, authorising it to review “covered activities”, which includes activity that builds, develops, produces, expands, shifts, services, manages, operates, utilises, sells or relocates a national critical capability to or in a country of concern, shares, discloses, contributes, transfers or licenses to an entity of concern any design, technology, intellectual property or know-how that supports, contributes to or enables a national critical capability by an entity of concern or in a country of concern, or invests in, provides capital to, consults for, or gives any guidance relating to enhancing the capabilities or facilitating access to financial resources for a national critical capability for an entity of concern or a country of concern.

During the 14 July 2022 US Senate Banking Committee hearing with Alan Estevez, under secretary of commerce for industry and security, senator Pat Toomey acknowledged that the “rise of China presents the United States with the greatest security challenge … since the end of the Cold War”. But Mr Toomey still criticised the most recent version of the NCCDA as attempting to establish a federal agency with unchecked authority to intervene in investments, sales and business relationships, hurting US companies and economic growth. Posing questions like “what is the problem outbound CFIUS is attempting to solve?”, “[h]ow do current laws and authorities, such as export controls, address or fall short of addressing this problem?”, and “[h]ow would outbound CFIUS affect the United States as a destination for capital formation and technological innovation?”, Mr Toomey urged Congress to “take the time to properly evaluate the outbound CFIUS concept rather than rushing to enact it”.

In a 27 September 2022 letter to Congress, a bipartisan Congressional group, including representative Nancy Pelosi and senators Robert Casey, Chuck Schumer and John Cornyn, explicitly urged the administration to move forward with executive action “to safeguard our national security and supply chain resiliency on outbound investments to foreign adversaries”. The letter expressed the intent to follow executive action with statutory provisions, and included a reminder that this was the template used to establish CFIUS. This letter becomes more relevant given the failure of the NCCDA to pass in 2022. While we may see a reintroduction of the NCCDA in similar form in the 118th Congress, the potential for executive action on this topic remains a distinct possibility.

As a third path forward for the creation of an outbound investment review mechanism, the Department of the Treasury previously supported the establishment of a pilot programme in a bill called the “Sensitive Technologies Supply Chain Risk Management Act of 2022”. The programme would require US companies and individuals to submit notifications regarding certain outbound investments in China and Russia, among other designated countries, that involve sensitive technologies. The purpose of the pilot programme would be to better inform the US government’s assessment of the national security concerns arising from those transactions and, based on those findings, identify what new authorities are needed to address those risks.

While the Treasury’s pilot programme did not gain much traction, an experimental trial like the one proposed by the Treasury could strike a balance between industry concerns and proponents of a new outbound investment regime. Reports indicate that the White House has been working on an executive order that would establish a framework for outbound investment review; however, there are further reports of friction within the administration, and specifically with the Treasury Department, concerning the nature and scope of any outbound investment regime. Outreach recently conducted by the Treasury to US finance and business executives may inform further discussions.

Proponents and critics of outbound investment reviews appear to largely agree that there is a national security interest in restricting outbound investment that could facilitate strategic competitors’ military capabilities to the detriment of the US. Yet opponents collectively urge that any outbound investment mechanism should be targeted and narrow, to ensure that any review of transactions does not overlap with other national security regimes or unduly stifle investment flows.

Throughout 2022, the conversation increasingly shifted from whether there should be an outbound screening review to how that review should be designed to best achieve national security objectives while minimising the regulatory burden on US investors. As 2023 progresses, it remains uncertain whether there will be executive action, legislation or a temporary pilot programme. However, the inertia for establishing an outbound review mechanism remains strong, especially in the wake of the omnibus requiring Treasury to report on the contours of such a programme and setting aside modest funding. The efficacy of any outbound investment regime will depend in significant part on the clarity of the policy objectives to be achieved by any outbound review, including clearly identifying what gaps in existing regimes the programme hopes to address, and narrowly tailoring the scope of review in accordance with these policy objectives and in a manner that minimises the regulatory burden on US investors. Such a regime would be consistent with the National Security Strategy and bipartisan Congressional support, and be responsive to critiques, thereby gaining enough momentum to come into effect.

Stephenie Gosnell Handler is a partner and Annie Motto is an associate at Gibson Dunn. Ms Handler can be contacted on +1 (202) 955 8510 or by email: shandler@gibsondunn.com. Ms Motto can be contacted on +1 (212) 351 3803 or by email: amotto@gibsondunn.com.

Stephenie Gosnell Handler and Annie Motto

Gibson Dunn