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Executive Summary

In many states foreign investors occupy a place qualitatively different from their domestic counterparts. Only with a thorough review of a country’s investment regulatory regime can a potential foreign investor hope to tailor an effective investment plan that maximises its economic benefits and ensures its legal acceptance.

This chapter discusses some of the important questions a foreign investor should consider in order to formulate that plan. Section 2 notes that the first step in any investigation is to identify the statutory instruments and regulatory authorities of a state’s foreign investment regime. Section 3 discusses the first specific, and sometimes terminal, question in deciding whether to make an investment: whether the host country may limit or even prohibit foreign investment in the sector in question. Sections 4 and 5 discuss the approval and corporate structure processes that may be involved in making a valid foreign investment. Sections 6 and 7 review ancillary issues related to incentives and continuing obligations for a foreign investor. Such issues could tip the balance in the economic assessment of whether to make a particular investment. To conclude, Section 8 provides a brief overview of the special legal protections and dispute resolution options which may be open to a foreign investor and which should be considered as part of a pre-investment strategy.

1.0 Introduction

This chapter provides a summary of some of the important issues that a foreign investor contemplating investment in a host country should consider. In some cases, especially in developed economies in North America, Europe and Oceania, there is little or no direct regulation of foreign direct investment (FDI) by a host state. Nevertheless, in many states there exists a wide range of controls and incentives for the regulation of FDI of which prospective foreign investors should be aware.

Some issues, such as competition law, and money laundering, apply to all investments, and must be considered by all investors, whether domestic or foreign. In this chapter, we focus on those issues that are specific to foreign investment. A short chapter like this cannot provide a comprehensive survey of the variety of regulations impacting foreign investment. However, below is a review of typical questions a prudent investor should ask when planning a foreign investment. Such questions, combined with advice from legal counsel and accountancy firms, will help the investor to understand the scope of FDI regulations, and the potential financial implications of these regulations:

• Is FDI permitted in the relevant economic sector?
• Are there licensing or registration requirements for making a foreign investment?
• Does the state require, or have special structures, for the involvement of domestic parties in foreign investment?
• Are there incentives for foreign investors?
• Are there continuing restrictions or obligations, such as performance requirements, for a foreign investment after establishment?
• What protections and dispute resolution mechanisms are relevant to FDI in the chosen state?

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2.0 National Investment Laws and Legal Frameworks

Before looking at these questions, the initial point to consider is: where to look for answers regarding a state’s regulation of FDI? The first step is to check whether there is a specific law covering foreign investment. Such laws are regularly amended as policy focuses shift and initiatives come and go. For example, Russia amended its investment law in 2017. China introduced modifications to its foreign investment regime in 2016 and 2017, and Egypt amended its general investment law in 2015 and 2017. It is important therefore to make sure that the general investment law being examined is the most recent one.

Whether or not created under a comprehensive foreign investment law, a central body often takes a key role in the approval, scrutiny, reporting and management of FDI.

Foreign investment regulation and approvals may also be within the province of a national trade or commerce ministry. For example, China’s Ministry of Commerce (MOFCOM) shares responsibility for approval of foreign investment with the NDRC (see Section 4.0), and in South Korea the role is performed by the Ministry of Trade, Industry and Energy.

Industry-specific licensing requirements may be handled by a separate ministry, even where there are rules for foreign investment in a specific industry. Typical examples are the energy, military, banking and telecommunications industries. As discussed in Section 4.1, in 2017 India delegated the role of foreign investment approval and registration from a central investment body (formerly the Foreign Investment Promotion Board) to individual ministries based on the proposed investment’s relevant economic sector.

The first step in a detailed review of pre-investment planning is to identify all foreign investment-related laws of a state, and its relevant regulators. Not all states have such laws. One way to begin is to study the websites of a country’s foreign, trade and commerce ministries. These in turn may direct those seeking information to other websites, including those of various regulators or committees. Investors may find that pertinent websites provide investors with access to policy documents, advice and instructions. Initial discussions with local counsel are likely to help the investor to establish a framework for further investigation.

3.0 Is FDI Permitted in the Relevant Sector?

A critical initial question when considering foreign investment is whether it is allowed at all. In many countries, some sectors — energy transmission, other utilities and the military being the most commonplace — may be exclusively operated by the state. Many states will also restrict investment within specific economic sectors to domestic investors. Some regulators publish lists of restricted sectors, often known as “negative lists”.

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Restrictions typically exist in sectors of primary importance such as infrastructure, energy, telecommunications and national security, and sometimes in sectors of moral significance (for example, the Indian FDI Policy prohibits foreign investment in lotteries, gambling and betting, and Indonesia’s Negative List bars foreign investment in alcohol and casinos). Governments frequently control the nuclear energy industry, and it is often closed to foreign investment. This industry is among the prohibited sectors in both India and South Korea.

An alternative approach is found in Australia. Instead of blanket restrictions by category, the Australian Federal Treasurer, assisted by the Federal Investment Review Board, is empowered to assess foreign investment proposals and block or unwind foreign-based take-overs and investments by non-residents that exceed certain investment transaction thresholds established for the acquisition of land, agribusiness or other company acquisitions.⁵ The Federal Treasurer has total discretion under the relevant regulations to prohibit the transaction once these thresholds are reached.

Similarly, the United States has created the Committee on Foreign Investment in the United States (CFIUS), an inter-agency committee that has the power to investigate foreign takeovers of US businesses that might affect national security. When a foreign investor intends to acquire a domestic company, the domestic company must notify CFIUS. The Committee may also investigate an intended transaction on its own volition.⁶ If it finds that there is a threat to the national security, the President has power to block the transaction. The US President has only blocked four foreign investment transactions after a CFIUS investigation, in 1990, 2012 and 2016. However, in 2015, ten transactions were withdrawn after CFIUS had launched investigations,⁷ and nine had reportedly been withdrawn in the first seven months of 2017.⁸ In most cases the would-be acquirer was Chinese. Sometimes CFIUS will approve a transaction on condition that the acquirer take steps to mitigate any risk to the national security, e.g., by requiring that only US citizens have access to sensitive data.

The most important step that a prospective investor should take is to confirm whether the host state has implemented sectoral restrictions, such as a negative list.

4.0 What Administrative Requirements Exist for Making a Foreign Investment?

Foreign direct investment regulations often establish registration and approval requirements. The process can be elaborate. In addition, some states impose minimum thresholds for foreign investment, as well as reporting requirements.

4.1 Registration and Approval

Despite its recent reforms, China remains an example of a complex FDI environment, with a multi-stage process of foreign investment approval and registration.

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There are many other examples of registration and approval requirements involving the government bodies mentioned above. For example:

• Indonesian venture capital companies are regulated by the Financial Services Authority, and foreign-owned Indonesian investment companies (PT PMAs) must be approved by Indonesia’s BKPM.⁹
• The Indian FDI Policy’s “government route” requires that approval of investments up to INR 50 billion be sought from the appropriate government ministry for the relevant sector (such as the mining, military and pharmaceutical industries).¹⁰ For larger investments, approval must be granted by the Cabinet Committee on Economic Affairs, comprising several cabinet level ministers.

4.2 Minimum Investment Thresholds

Governments sometimes establish minimum foreign investment thresholds before certain regulations and protections apply (see Section 8.2). For example, under the South Korean FIPA, a foreign share acquisition of a Korean company must exceed KRW 100 million in order to be covered by FIPA, and certain protections are activated by investment at this threshold combined with either a share purchase of 10% of a Korean company, or agreements with a domestic company involving management control, materials supply for one year or more, or technology or research cooperation.¹¹ For example, foreign investors are exempt from foreign exchange control powers (see Section 7.1) if they have invested via this FIPA mechanism and the investment exceeds the threshold.

4.3 Reporting Requirements

Reporting requirements can apply even in countries that have few FDI regulations. In the United States, anyone acquiring 5% or more of the equity in a company registered with the Securities and Exchange Commission must disclose information including citizenship and residency.¹²

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Defining the scope of administrative requirements is an important question for a potential investor to consider at an early stage. Depending upon the particular case, there may be limited or no formalities specifically regarding foreign investment (although this is a separate question from any generally applicable regulatory controls in a particular economic sector). In other cases, requirements may be inextricably linked with wider questions such as an investment’s corporate structure. An investor may be required to present detailed investment plans for state approval.

5.0 Does the State Require or have Special Structures for the Involvement of Domestic Parties in Foreign Investment?

5.1 Restrictions on Ownership or Management

Many countries allow foreign investment in certain sectors subject to restrictions on share ownership or management structures.

India’s FDI Policy, China’s Catalogue, and Indonesia’s Negative List contain similar restrictions on capital participation and management in a variety of sectors.

5.2 Corporate Structures Available for FDI

Specific corporate vehicles are sometimes required for foreign investment.

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5.3 Golden Shares

Governments occasionally use “golden shares” to restrict control over large privatised firms active in important industrial sectors. Such shares may grant a government a right of veto over activities, or deny a foreign investor the ability to complete a takeover of the company regardless of other shareholders’ views. The United Kingdom popularised golden shares during its privatisations of the 1980s, and still retains golden shares in companies such as Rolls-Royce. The Russian Federation also adopted this approach during its privatisations in the 1990s, as have many other European countries. Indonesia maintains golden shares in formerly state-owned entities including PT Telekomunikasi Tbk and PT Indosat Tbk. However, golden shares are increasingly falling out of favour in Europe. The European Commission has brought proceedings at the European Court of Justice against several European Union Member States regarding their golden share holdings, forcing governments to give up or modify golden shares in several flagship enterprises such as the UK’s BAA Systems (an airport operator), Spain’s Telefonica and Germany’s Volkswagen.¹⁸

Dealing with the particular options or requirements for structuring a foreign investment can be the most complicated stage of an investment plan. In those cases where a foreign investment requires a local partner, the foreign investor will need to identify an appropriate domestic counterpart (perhaps through industry connections or local chambers of commerce) at an early stage. This can ease the rest of the process as local experience is transmitted to the potential investor. In circumstances where a variety of investment vehicles are offered, the structures available provide different levels of risk and reward. These questions will inevitably be linked to other economic factors such as tax considerations.

6.0 Are there Incentives for Foreign Investors?

Tax incentives are often a factor in FDI regulations, usually coupled with the registration or threshold requirements discussed above (i.e., a state may give special tax treatment or other benefits to foreign investments that reach a specified threshold or are in certain economic sectors). Investors in sectors on the “encouraged” list in China’s Catalogue are granted preferential tax treatment and fast-track approval of their corporate arrangements.

As well as industry-specific or threshold triggers for investment incentives, governments frequently create special economic zones where they relax rules such as import requirements (for example tariffs), or provide tax incentives or subsidies to encourage the establishment of economic activity in specific areas. For example, the United Kingdom uses tax incentives to encourage investment in certain “enterprise zones” in England and Wales.

Special economic zones are popular in some of the Gulf states: the Qatar Financial Centre¹⁹ and the Dubai International Financial Centre (DIFC)²⁰ are examples of economic zones that have been operating for some years, and in 2015 Abu Dhabi created the Abu Dhabi Global Market.²¹ Special economic zones may offer separate legal regimes that differ from those of their host states, including the introduction of principles of contract familiar to common law jurisdictions, and special arbitration facilities separate from the main state judicial apparatus. Other incentives beyond the more common tax and import arrangements may also be available. For example, the “Emiratisation” provisions of UAE labour law do not apply in the DIFC. (See Section 7.3 below on Performance Requirements.)

Some states are willing to enter into what are known as stabilisation agreements with foreign investors, or otherwise insert stabilisation clauses into investment contracts. The purpose of such agreements is to incentivise foreign investment by guaranteeing that the investor will be protected for a certain time against changes in the law, usually regarding taxes. Investment contracts and stabilisation clauses are discussed in Chapter 7.

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Incentive structures are a less critical aspect of investment planning, but all other investment factors being equal, regulatory, tax or trade incentives can be decisive in making the final investment decision as a result of the competition between states to attract FDI. It is therefore recommended that an investor establish its overall investment plan and evaluate the general legal and financial aspects of an intended investment, then evaluate the financial implications of different incentive programmes.

7.0 Are There Continuing Restrictions or Obligations, such as Performance Requirements, for Foreign Investment After Establishment?

As well as restricting foreign investment, or at least requiring approval, states may have policies in place designed to restrict the activity of foreign investors after establishment of the investment. Some important examples are discussed below.

7.1 Minimum Investment Periods, Remittance of Profits and Exchange Controls

In some cases, foreign investors will need to be aware that repatriation of capital or profits may be restricted by the state. For example, under Venezuela’s foreign investment law, an investment, once established, must remain in the country for five years from the date of registration,²² and no more than 80% of profits and dividends of an investment company may be withdrawn from the country per annum.²³ India’s FDI Policy includes several industries for which there is a similar “lock-in”, under which an investment may not be dissolved and proceeds expatriated for a minimum term of years.

Countries may seek to protect their own currency from the vagaries of international exchange markets, and in the process restrict the activities of an investor.

Currency and cross-border transaction controls can be imposed without warning, so an investor is advised to review a state’s legal requirements and to determine whether any guarantees are in place, as in some circumstances a qualifying foreign investment may be exempted from more onerous regimes.

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7.2 Real Estate Controls

Restrictions on the foreign ownership of real estate can significantly reduce investment opportunities and can require reporting and approval procedures throughout the life of a foreign investment.

In some countries a local partner may be required. In other countries foreigners can only rent land, not own it.

7.3 Performance Requirements

Some host states impose “performance requirements” on foreign investors. Performance requirements are conditions that a foreign investor must meet in order to obtain or retain an investment licence. For example, some of the Gulf states impose “localisation” or “indigenisation” requirements which demand that a foreign investor hire a fixed number or percentage of the host states’ nationals, or hire host state nationals for certain specified positions, in order to obtain or maintain an investment licence. For example, in the United Arab Emirates, since 2004 employers must conform to “Emiratisation” under the Labour Law:³⁰ prioritising first Emirati nationals, then other Arabs, and only thereafter other nationals for employment. The Ministry of Labour may fine companies that hire foreign nationals if it believes that unemployed locals could perform the job. Some states have been known to increase their indigenisation requirements over time.

Some states have also tried to apply performance requirements in the form of local content requirements — an obligation to purchase locally-made goods in order to obtain and maintain an investment licence. These requirements almost always violate Articles III and XI of the WTO’s General Agreement on Tariffs and Trade, and the Agreement on Trade Related Investment Measures, which prohibit local content requirements.³¹ Local content requirements are also discussed in Chapter 2 of Volume I of this series (Trade).

Several recent free trade agreements (FTAs), such as the North American Free Trade Agreement (NAFTA),³² and the Canada–European Union Comprehensive Economic and Trade Agreement (CETA), limit performance requirements.³³ A growing number of bilateral investment treaties, in particular those from Canada and the United States, also seek to limit performance requirements, including in the pre-establishment phase.³⁴ The implications of these treaties for investors concerning legal protection and dispute resolution are discussed in Section 8.0.

Not only should potential investors ascertain whether the host state imposes performance requirements, they should calculate the eventual cost of any performance requirements when considering a foreign investment, and they should ascertain whether these requirements conform to the host state’s obligations under the WTO Agreement, or any applicable free trade agreement or bilateral investment treaty.

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8.0 What Protections and Dispute Resolution Mechanisms are Relevant to FDI in the Chosen State?

Businesses frequently do not pay sufficient attention at the planning stage to ensuring legal protection and the availability of effective dispute resolution. It is critical to do so in the case of FDI. States provide different levels of protection in their domestic legal systems, and are parties to a variety of treaty instruments that provide varying degrees of protection.

If an investment is not planned appropriately from the outset, a preferred forum may not have jurisdiction when the time comes to pursue remedies. Rights which could have been obtained may have been foregone, or enforcement of court judgments or arbitration awards could be more difficult than anticipated. Investors should therefore consider these issues as part of their investment planning.

This section provides a brief overview of the legal protections and dispute resolution mechanisms discussed in more detail throughout the later chapters of this book. Investors may also hedge their risk through insurance, known as political risk coverage, which is discussed in Chapter 5.

8.1 International Treaties and Investment Contracts

Historically, a foreign investor could assert rights in international law only indirectly through the mechanism of diplomatic protection — which required the investor to work through a state that agreed to espouse its claim. Diplomatic protection is discussed in Chapter 10. However, with the ratification in October 1966 of the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the “ICSID Convention”), and with great vigour from the 1980s onward, states have created systems, both bilateral and multilateral, that grant investors direct channels of redress, thus permitting them to more fully enjoy the protection of international law. The most common device is known as a bilateral investment treaty (BIT). There are close to 2,400 BITs in force.³⁵ Recent free trade agreements (FTAs), including all of the FTAs entered into by the United States, contain BIT-type protections for investors, as do international agreements such as the Energy Charter Treaty. The protections afforded to investors by these treaties, such as protection against expropriation below market value or discriminatory treatment, are discussed in more detail in Chapters 8 and 9. BITs and other instruments that include investor protections are known collectively as international investment agreements (IIAs). Chapter 6 provides an overview of IIAs.

In addition, contracts between foreign investors and governments, frequently relating to an individual project such as a dam or a power plant, usually include protections and dispute resolution mechanisms similar to those found in IIAs (see Chapter 7). These are known as “investment contracts”.

These treaties and contracts regularly offer investors an international arbitration forum and a set of arbitration rules to pursue claims against states for breach of the investment protections found therein. The most commonly-used forum is the International Centre for the Settlement of Investment Disputes (ICSID), operated by the World Bank. International investment arbitration is discussed in Chapters 13 through 26.

8.2 Domestic Laws

Domestic investment laws may also include dispute resolution mechanisms that provide a channel for foreign investors to assert their rights. It is relatively rare for investment laws to also offer international arbitration for this purpose. Some states, such as Venezuela, expressly require investment disputes arising within their jurisdiction to be heard before their own courts.³⁶

Some form of restriction on expropriation without compensation is almost always codified in the domestic law of states. In some cases domestic investors are given the

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same protection as foreign investors, but many states grant specific protections to foreign investors under their foreign investment laws. These normally include a mechanism for compensation in the event of expropriation.

As with IIAs, national investment laws may also guarantee National Treatment, i.e., that the foreign investor will not be given less favourable treatment than local investors.

8.3 Enforcement of Judgments and Awards

An investor that relies on an IIA to assert a claim will normally have to use the dispute resolution mechanism specified in the IIA. However, an investor that is negotiating an investment contract with a government may be able to influence the choice of dispute settlement. One important consideration for the investor is whether it would be easy to enforce a judgement or award.

The ICSID Convention, with 154 Contracting States as of July 2018, provides for streamlined enforcement in national courts of arbitration awards emanating from an ICSID tribunal. Enforcement of ICSID awards is discussed in Chapter 25.

International arbitration awards may also be enforced through the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, commonly known as the “New York Convention”, which had 159 parties as of July 2018. Subject to some important limited exceptions discussed in Chapter 25, the New York Convention requires the courts of Contracting States to enforce foreign arbitration awards.

State practice varies widely with respect to the enforcement of judgments from the courts of other states. There are various multilateral reciprocal enforcement instruments, such as the Brussels Regulation between European Union Member States,³⁹ as well as bilateral agreements such as those between the United Kingdom and other Commonwealth countries.⁴⁰ Often, a country requires reciprocity between its courts and the originating court of a judgment in order to grant enforcement. In some states, such as Indonesia, foreign court judgments are not enforceable at all (although in the case of Indonesia they may stand as compelling evidence if local proceedings are initiated).⁴¹

8.4 Changes in International Law Coverage

Access to international law and arbitration is in constant flux. Canada, unlike many large developed economies, only ratified the ICSID Convention in November 2013, while Iraq ratified in November 2015.⁴² Conversely, Venezuela, Bolivia and Ecuador all recently withdrew from the Convention.⁴³ Indeed, in 2017 an ICSID Tribunal ruled that it had no jurisdiction over a dispute brought against Venezuela because of its prior renunciation.⁴⁴ Mexico signed the ICSID Convention in January 2018, although ratification remains pending.⁴⁵

A number of states seeking greater regulatory and judicial control of foreign investment have reviewed, and in several cases rescinded, various BITs. At the end of 2015, South Africa enacted a new Protection of Investment Act that provides for domestic court remedies rather than international arbitration.⁴⁶ At the same time, South Africa has declined to renew many of its BITs which expired recently, so that foreign investors will have restricted dispute resolution options in the future (although South Africa did include international arbitration in its recent BIT with Zimbabwe). Ecuador cancelled its BITs in 2017.

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Nevertheless, IIAs remain popular. In the last few years, Canada, Japan and China, in particular, have signed several cross-regional BITs. Intra-regional BITs also continue to be signed, such as the Morocco-Nigeria BIT of December 2016.⁴⁷ The European Union has entered or is in the process of ratifying FTAs with investment protection chapters with South Korea, Canada and Singapore.

9.0 Conclusion

Foreign investors occupy a special place in many state regulatory regimes. It is not uncommon for a foreign investor to be forced to shoulder significant extra burdens beyond those imposed on local investors. Foreign investors may find particular economic sectors closed to them, or they may be required to accept joint ownership and management of their investments. Investment proposals may require approval from several government organs. Conversely, foreign investors may enjoy incentives or protections unavailable to their domestic competitors. Only with a thorough review of an investment regime can a potential investor hope to tailor an investment plan that maximises the investment’s economic benefits and ensures the proposal’s legal acceptance by the host state.

Notes

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