[By Subhasish Pamegam]
The author is a student of Gujarat National Law University, Gandhinagar.
Introduction
The United States’ recent executive order (EO) regulating outbound foreign direct investments (OFDI) – also known as the Reverse Committee on Foreign Investment in the United States (CFIUS), marks a significant shift in the global landscape for outbound investment regulations. This regulatory mechanism is designed to scrutinize and potentially restrict outbound investments in critical infrastructure, particularly in “countries of concern”, to mitigate risks associated with technology transfers, the dissemination of critical know-how, and the allocation of resources that may enhance the military and intelligence capabilities of these nations. The advent of Reverse CFIUS reflects growing geopolitical tensions and a heightened focus on national security considerations that are increasingly shaping international investment policies.
In light of these developments, this article first, aims to provide a comprehensive analysis of the burgeoning trend of OFDI regulations, with a specific focus on the reverse CFIUS model of the US. Secondly, it will delve into the rationale underpinning these regulations and highlight the insufficiency of existing export control measures to capture national security risks in OFDI. Thirdly, by examining the framework, the article will explore the feasibility and implications of implementing similar outbound investment regulations in India. Finally, it will provide recommendations for crafting a balanced outbound investment regulatory framework that addresses national security concerns while fostering economic growth and international collaboration.
Reverse CFIUS on Foreign Outbound Investment Screening
The CFIUS is an independent, multi-agency governmental body responsible for reviewing foreign investments in U.S. companies and real estate to determine their potential impact on national security. The traditional CFIUS undertakes a review of inbound foreign direct investments in U.S. companies and real estate to assess potential risks to national security. Whereas the Reverse CFIUS aims to regulate OFDI by establishing a two-tier regulatory structure for its screening. Under this structure, investments in specific less sensitive sectors necessitate a notification to the Treasury Department, whereas investments in highly sensitive sectors are strictly prohibited. The objective is to prevent the inadvertent bolstering of technological and military advancement of “countries of concern” through seemingly benign economic activities such as mergers and acquisitions (M&A), joint ventures (JV), private equity (PE)/venture capital (VC), greenfield investments, and other forms of capital flows.
Historically, CFIUS focused on regulating inbound FDI to safeguard national security. However, there was growing emphasis on scrutinizing OFDI to address heightened concerns about the inadvertent transfer of sensitive technologies. The concept of monitoring OFDI was initially introduced in early drafts of the Export Control Reform Act (ECRA) and Foreign Investment Risk Review Modernization Act (FIRRMA) in 2018, specifically for certain types of intellectual property. Although this idea was dismissed at the time because CFIUS traditionally focused solely on inbound investments, recent legislative developments indicate a potential shift. The initiative to screen OFDI emerged when a report by the China Select Committee on US Investments found that firms had invested a minimum of $3 billion in PRC critical technology companies, offering expertise and other benefits to these companies, many of which support the Chinese military.
In response to these concerns, President Joe Biden issued an EO in August 2023 instructing the Department of the Treasury to create a program aimed at regulating OFDI involving the transfer of sensitive technologies in critical sectors such as semiconductors and microelectronics, quantum computing, 5G and AI in “countries of concern” which include nations like China, Russia, Iran, and North Korea. For instance, semiconductors are essential to all electronic devices and AI has vast implications for defence systems and cyber capabilities, making them vital to national security.
Contextualizing Outbound Investment Regulations in India
In India, the Foreign Exchange Management (Overseas Investment) Rules 2022 (FEM Rules) which superseded the almost two decades old framework on OFDI in India under Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 and Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations 2015, imposed certain restrictions on OFDIs into foreign entities. The restrictions were three-fold: i) OFDIs in countries identified by the Financial Action Task Force (FATF) as “non-cooperative countries and territories” were restricted and ii) OFDIs by Indian residents in any jurisdiction periodically notified by the Reserve Bank of India (RBI) or identified by the Central Government under Rule 9(2) of the FEM Rules and iii) Foreign Exchange Management (Non-debt Instruments – Overseas Investment) Rules 2021 barred Indian residents from making overseas investments in foreign entities situated in countries or jurisdictions blacklisted by the Central Government. This included regions not compliant with the FATF or the International Organization of Securities Commissions.
At present, the OFDI regulations in India are primarily driven by public policy, cross-border capital flow and exchange control considerations rather than national security concerns. Neither the FEMA regulations nor the ODI Rules govern OFDI in the context of national security risks to prevent the leakage of advanced and sensitive technologies to countries of concern, which may threaten India’s national security. However, in an increasingly interconnected global economy, where geopolitical risks are dynamic, a comprehensive legislative framework addressing OFDI in countries of concern could provide clearer guidelines and greater flexibility to adapt to emerging threats. Therefore, before implementing a similar regulatory framework like the reverse CFIUS, India needs to collect data on several fronts: (i) the OFDIs made by Indian companies in critical technologies (ii) the potential security risks arising from these transactions; and (iii) the extent to which a national-level policy response at the national level might offer an effective and proportionate remedy to the identified issues. If policy intervention is deemed necessary to address the identified national security risks, India should establish a comprehensive legislative framework. The approaches to establishing an outbound investment regulation framework will be discussed comprehensively in the next section.
Challenges in Implementing Outbound Investment Regulations in India
Implementing outbound investment regulations in India for national security considerations also presents several challenges which need to be carefully analysed.
Increased Operational Costs for Cross-Border Investments
Implementation of outbound investment regulation in India will present significant challenges, particularly regarding administrative capacity, legislative and executive tools, and effective monitoring. Such costs reflect not only the initial setup but also the ongoing operational expenses associated with monitoring, enforcement, and compliance activities. Furthermore, the financial commitment required for such regulatory efforts could entail trade-offs in other areas of public policy or defence spending. Policymakers must weigh the benefits of regulating outbound investments—namely, protecting national security against the proliferation of sensitive technologies— against the opportunity costs associated with allocating substantial financial and human resources to this effort.
The parties involved in such cross-border transactions will also face increased administrative and legal costs associated with the heightened due diligence process. The necessity for detailed disclosures and continuous monitoring of foreign partnerships may deter some investments due to the complexity and potential delays introduced into the transaction process. This could be particularly burdensome for smaller firms that lack the extensive resources of larger corporations.
Defining Jurisdictional Boundaries in OFDI Regulation
One of the foremost challenges is the clarity and scope of applicability concerning multinational corporations (MNCs) incorporated in the countries of concern. This issue encompasses questions of jurisdiction, particularly regarding which entities are subject to regulations and whether these extend to subsidiaries located in third countries, or if they apply to entities in the adversarial country which is owned by foreign companies. Such ambiguity can significantly impact the effectiveness and enforcement of regulatory measures designed to safeguard national security. For multinational corporations, the lack of clarity around jurisdictional applicability can result in legal and operational uncertainties. MNCs may face difficulties in determining compliance requirements and managing risks associated with outbound investments. For instance, does a regulation targeting tech firms of “country of concern” extend to their subsidiaries in jurisdictions like Amsterdam or the UK? This uncertainty can create regulatory loopholes and inconsistencies in enforcement.
Impact on Global Trade and Economy
Article XXI of the General Agreement of Trade & Tariffs (GATT) provides a crucial exception for measures taken in the interest of national security. This article allows World Trade Organisation (WTO) members to take any measures they deem necessary for safeguarding their essential security interests. The key issue here is the interpretation of what constitutes “essential security interests.” Outbound investment regulations that restrict capital flows to certain countries or sectors on the grounds of national security can arguably fall under the purview of Article XXI. However, this exception has been subject to limited interpretation and application, and its invocation can be controversial, as it is often perceived as a justification for protectionist policies. The self-judging nature of Article XXI—where countries can unilaterally determine what constitutes their national security interest—has led to concerns about its potential misuse to circumvent free trade principles. The challenge lies in demonstrating that such measures are genuinely necessary to protect national security interests rather than being thinly veiled economic protectionism.
Recommendations
Entity-Based Approach versus Sectoral Approach
In the ongoing debate over outbound investment regulation, there is a notable discourse between adopting an entity-based sanctions approach versus a sectoral approach. Proponents of the entity-based method argue for imposing restrictions directly on specific firms rather than entire sectors. This approach would specifically target firms involved in activities deemed critical to national security, regardless of the broader sector they operate within. Conversely, a sectoral approach focuses on restricting investments based on the industry rather than individual companies. The entity-based approach offers several advantages over a sectoral method. It allows for targeted restrictions on firms with specific ties to military or surveillance activities, thereby potentially reducing unintended economic impact on unrelated entities within the same sector. This method ensures that regulatory actions are focused on high-risk entities without broadly disrupting entire industries. However, this approach also has limitations. Implementing entity-based sanctions requires accurate and timely identification of firms involved in sensitive activities, which can be challenging given the complexity of global business operations and the opacity of certain sectors. Additionally, this method may lead to significant administrative and enforcement burdens, as authorities must continuously monitor and update lists of restricted entities.
Hence, the author suggests that a “hybrid model” could be more effective. By integrating entity-based sanctions with sectoral regulations, the policy could comprehensively address risks while maintaining flexibility. This hybrid approach will allow regulators to swiftly address immediate concerns posed by individual entities while maintaining a broader regulatory net that can catch emerging risks within critical sectors. This model allows for targeted actions against specific high-risk entities while maintaining sector-wide oversight to address emerging risks. For instance, in industries like semiconductors or artificial intelligence (AI), a hybrid model could impose sanctions on companies directly linked to military applications, while keeping a broad regulatory eye on the sector to prevent technological advancements in sensitive areas from being exploited by adversarial nations. The hybrid model thereby addresses the inherent trade-offs between precision and comprehensiveness that plague the entity-based and sectoral approaches when used independently. By integrating both frameworks, the hybrid model not only enhances the effectiveness of regulatory oversight but also ensures a more proportional and adaptable response to the multilayered challenges of outbound foreign direct investment in sensitive technologies.
Leveraging Export Control Frameworks for OFDI Regulation
The definitions of covered products and technologies under OFDI regulations for national security considerations should be precise and clear. The focus should be on the “primary” or “exclusive” use of a technology to determine its coverage. The final regulations should prioritize identifying end users rather than the specific end uses of the technologies and utilize objective criteria like export control classification numbers in India which provides the list of prohibited exports that fall under the Foreign Trade (Development & Regulation) Act 1992 and is detailed in the Indian Trade Classification (Harmonized System) [ITC(HS)] Export Policy Schedule 2. The Directorate General of Foreign Trade periodically issues notifications and public notices under the foreign trade policy to update the list of prohibited or restricted items based on national security, public interest, or international obligations. Such an adaptive mechanism can be referred to ensure that OFDI regulations remain relevant and effective over time.
Conclusion
In the coming years, national security will become the key driver in shaping international investment regulations. As geopolitical tensions rise and the global economy becomes increasingly interconnected, governments are prioritizing security over unfettered trade. National security is no longer limited to traditional military concerns; it now encompasses economic stability, technological dominance, and control over critical supply chains. Countries such as South Korea, Japan, China and Taiwan are already tightening their outbound investment regulations to prevent the transfer of sensitive technologies and to protect key industries from foreign influence that could compromise national security. This paradigm shift will likely lead to more rigorous screening processes, stricter controls on cross-border investments, and closer alignment between economic policy and national security objectives. While this shift towards stricter controls is necessary to address genuine security concerns, it also carries the risk of economic isolation and the stifling of innovation. The challenge for policymakers will be to create frameworks that protect national interests without undermining the benefits of global trade and investment.
Given the pace of change in the national security regulatory landscape, it is imperative for businesses across industries to evaluate due diligence strategies by assessing not only traditional financial and operational risks but also by including a comprehensive evaluation of the geopolitical implications, the potential for technology transfer, and the strategic significance of the target company or industry. At the same time, governments must remain mindful of the economic consequences of over-regulation, ensuring that their policies strike the right balance between protecting security and promoting global economic integration. In the years ahead, achieving this balance will require a cooperative global effort, as well as policies that are both flexible and forward-looking, capable of addressing evolving threats without sacrificing economic progress. Global collaboration is essential in ensuring that security measures are proportionate, targeted, and do not unnecessarily hinder economic growth or disrupt critical supply chains.