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HJS Report: Safeguarding our System: Chinese Investment into the UK’s Digital and Critical National Infrastructure

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Henry Jackson Society, 18 July, 2017

China’s investment into Western advanced economies – including that of the UK
– is increasing and changing in scope surging from EUR 14 billion in 2015 to EUR
20 billion in 2016, a 44% jump since 2014. More than 60% of the value of deals has been by state-owned enterprises, indicating this push is led by state strategy than commercial
interests.
• In 2016, China invested $11.15 billion into the UK. More than double the amount in
2015 and the most in any one year going back to 2005.
• China’s economic strategy, Made in China: 2025, might threaten the long-term
survival of UK businesses unless some sort of government protection is afforded to
them or unless China affords British businesses more access to China’s home market.
• Because of cyber vulnerabilities, critical national infrastructure will be at the forefront
of any future war.
• The current review system could be improved and rationalised:
– It has allowed access to the UK’s digital and critical infrastructure with elements
of China’s defence industrial concerns
– It has allowed deals that have affected the UK’s closest military allies
– It allows for domestic and foreign pressure on the government of the day
• A formal investment screening regime is both necessary and desirable to protect the
UK’s economic interests and its national security.
• A new regime should be built, which is adequately resourced to carry out the difficult
task of tracking foreign direct investment (FDI) into the sensitive parts of the UK’s
economy.
• The new regime should begin to coordinate more closely with the UK’s closet military
and intelligence-sharing allies, including the Five Eyes partners and NATO member
states.
• Any new regime should carry out its review process in a judicious but swift manner so
that foreign investment in the UK is not hampered or harmed. This report suggests
that the regime should be sufficiently able to pass its decisions within 30 days of
receiving an inquiry.
• Ideally, any regime should be overseen by a special committee in Parliament to ensure
that it is sufficiently funded and resourced to carry out its activities, and that it is
carrying them out in a legal, expedient and sufficient manner

To read the full report, please click here.

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The Times: China’s expanding economy beats all targets

The Times, Jamie Fullerton, 18 July, 2017

“Amid concern surrounding Chinese investment in UK nuclear power and parts of the telecoms network, the government should “urgently consider” a new screening office to investigate future deals, the Henry Jackson Society said in a new report.

The think tank, a critic of Chinese foreign policy, also claimed that Britain’s welcoming stance towards China’s $44 billion investment in the country since 2005 had not been reciprocated.

“The UK should, of course, welcome inward investment to feed the economy, but not at all costs,” John Hemmings, director of the Asia Studies Centre at the Henry Jackson Society, said.

“We have to ensure that foreign state-owned enterprises are not compromising our most critical infrastructure or key future technologies.”

To read the full article, please click here.


Written Evidence for Foreign Relations Select Committee Inquiry on UK-China Relations

Evidence, UK Parliament, 28 April, 2017

1.                   The UK’s China policy under the former government was based on a number of erroneous assumptions that predicate that (i) Chinese economic growth is certain and sustainable, (ii) that Chinese investment into the UK was an unalloyed good; and that (iii) there are few political risks to engagement to China; and (iv) that China is a status-quo power which desires only modest changes to the current global order.

2.                   Western debates about rising power China have long been divided between those who emphasize engagement and the transformative side of trade and those who emphasize China’s autocratic government, human rights record, and assertive foreign policy (particularly over its near maritime space). Over the past ten years, there has been a gradual shift as China watchers have begun to adopt a more critical view of China’s foreign policy behaviour, which has been particularly strong among foreign policy elites in the United States, Japan, and other regional (Asian-Pacific) powers. Despite this shift, most diplomacy seeks to hedge against the risks inherent in China’s rise, carrying out both engagement and balancing behaviours. While many in the mainstream insist that this is the best means of maintaining peaceful and stable relations with China, this ambiguity may be ultimately ineffective, and even counter-productive to both UK national interest and to defending a rules-based international order.

3.                   By this reading, the current spate of tensions between Washington and Beijing are down to the unpredictability of the new Trump administration, and the UK should not or cannot afford to become involved. While these three assumptions still define bilateral ties, they are becoming less and less valid and should be reviewed in the light of changes inside China and in China’s foreign policy behaviour. This submission examines the bilateral under the following propositions:

•         The UK cannot afford let trade define the relationship with Beijing, despite the pressures of Brexit, instilling instead a policy of “cautious engagement”

•         The UK should not develop too strong a dependency on Chinese trade, given the structural weaknesses of its economy, such as slowing growth, uncertain financial reporting methods, the property bubble, the continued dominance of state owned enterprises (SOE), and the large national debt to GDP ratio. There is a potential for sudden shocks.

•         The UK must also consider the costs and risks of Chinese investment inside the UK.

•         The UK must reconsider the proposition that economic interdependency is making China into a “responsible stakeholder”. In key ways, it has not.

•         The UK must realize that Chinese actions in the South China Sea (and Asia Pacific more widely) are bound to effect the UK. The idea that the UK can stand aside as a major power attempts to control a major Europe-Asia trade route is misguided and counter-productive to UK national interests.

To finish reading, please click here.

 

 



America, Japan and the UK: A New Three-Way Alliance?

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With Chris Bew, Researcher, Henry Jackson Society

The National Interest, 4 April, 2017

In January 2016, standing on the flight deck of the USS Ronald Reagan aircraft carrier based in Japan, the UK defence secretary, Michael Fallon, spoke of Washington’s commitment to a “three-way alliance” between the United Kingdom, Japan and the United States. He stated that the three countries would develop their commitment to interoperability by working closely together in the future. This is significant because it comes at a time when there are serious questions about stability in the region, and when the East and South China Seas may become crucial issues in relations between Beijing, Washington and Tokyo.

Putting this rhetoric into practice, on October 20, 2016, the chief of the Japanese Maritime Force and the chiefs of the British and U.S. navies sat across the table from each other at the Pentagon to sign a trilateral cooperation agreement. This agreement commits all three navies to closer cooperation, with increased exercises and joint patrols in the future. Signed at the service-level, this agreement sets forth a roadmap for what it calls “mutually desired strategic effects.”

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–>Why Team Up?
In the context of an increasingly uncertain world, we are seeing more and more states aligning with each other in non-traditional security relationships at the global level. These alignments are non-traditional in the sense that they are not formal alliances, but rather informal and ever-expanding arrangements. Covering a host of different areas, they are in many ways a reaction to the complex level of threats facing liberal democracies these days. Considering Britain’s imminent departure from the European Union, forming alliances with other powerful nations around the world is fundamental. With the United Kingdom, United States and Japan each being liberal democracies and having vested interests in the maintenance of the international rules-based system, they make natural bedfellows.

 

UK-Japan Relations
Focusing closer on the relationship between the UK and Japan, the current bastion of UK-Japan security cooperation is the 2+2 meetings. These have been held annually since 2015. At these meetings, the foreign and defence secretaries from both sides come together, usually for two days of meetings, to discuss a range of common areas of interest. The 2+2 arrangement allows both states to talk about areas of common concern, which allows them to signal both each other, and third-party states about their intentions and interests.

During the January 2016 2+2, both countries affirmed their support for the rule of law in the East and South China Seas. They also expressed a full commitment to Ukrainian sovereignty, adding their concern over North Korea’s missile and nuclear program. To those listening, the 2+2 is perhaps a hint of the security preferences of both the UK and Japan. Other purposes of the 2+2 meetings include helping to socialise each other towards common security interests and enabling both countries to create a framework for bilateral security cooperation.

In the last January 2017 2+2, both countries signed the Acquisition and Cross-Servicing Agreement (ACSA) to facilitate closer bilateral defence logistics. This agreement will enable the two militaries to cooperate abroad on combined exercises and peacekeeping operations, alongside humanitarian assistance and disaster relief missions. Ultimately, this will increase the efficiency of both country’s forces. So, for instance, British tankers will be able to refuel Japanese aircraft, or Japanese ships might be able to refuel British vessels, and so on. An ACSA is really the first step in the holy grail of interoperability for conventional militaries. This agreement improves future cooperative expediency because it removes the need for further individual case-by-case agreements.

UK-Japan Future Cooperation
The tightening of UK-Japan relations comes at a time when rising powers in Asia-Pacific are causing critical uncertainty in the region and beyond. This has led to policymakers strengthening alliances around the world. The United Kingdom and Japan are a strong example of such an alliance that has been redoubled in recent years.

Another significant area of future cooperation between London and Tokyo includes a joint research project on Chemical and Biological Protection suits and other weapons systems. In an age of shrinking defence budgets and rising threats, it makes sense to partner with other liberal democracies, sharing useful technology and pooling precious research and development funding. This follows the success of the first round of talks of a new Joint New Air-to-Air Missile. This sharing of technology is significant because it builds a framework for ever-closer collaboration between both countries for the foreseeable future in a world where nations are choosing their alliances extremely carefully. In a time of growing insecurity, such partnerships are to be welcomed.


Putting Security into Prime Minister May’s New Industrial Strategy

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The RUSI Newsbrief, 15 February, 2017

Prime Minister Theresa May’s proposed post-Brexit industrial strategy is commendable. However, the UK must avoid the pitfalls of an overly mercantilist policy, especially when it comes to dealing with China.

The UK prime minister’s Green Paper on a new industrial strategy was written ‘to provoke debate’ and ‘start a consultation’ as part of Theresa May’s commitment to make the UK a global leader in free trade. This is a commendable drive to build both post-Brexit prosperity and a post-EU identity for Britain. However, the dangers of developing overly mercantilist policies are ever present and a laissez-faire approach to inbound foreign investment should be avoided, particularly when it comes to foreign ownership of critical national infrastructure (CNI). 

A growing number of autocratic states have become global trading partners, and while this is to be warmly welcomed, it is not without risks. China is of particular note in this regard. China is predicted to surpass the US as the largest cross-border investor by 2020 and has a reputation for large-scale projects and visionary economic planning. Furthermore, the prime minister declared in a recent BBC interview that the ‘golden era’ of UK–China relations is still in place.

Much of China’s economic miracle has been built on leap-frogging technologies, achieved through a mixture of cyber espionage and pushing foreign firms with desirable intellectual property into disadvantageous joint ventures with Chinese rivals. As far back as 2007, MI5 was alerting executives in Britain to the dangers of commercial espionage from Chinese state actors. The 2016 US-China Economic and Security Review Commission asserts that ‘reports of Chinese espionage against the United States have risen significantly over the past 15 years’, noting that while the emphasis has been on ‘defence industrial companies, national security decision makers, and critical national infrastructure entities’. This article reviews three types of Chinese investment into foreign firms.

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How cautious can we afford to be about foreign investment?

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CapX, 31 January, 2017 (with Alex Manzoor)

So we all now know all about Theresa May’s industrial strategy for Britain. In addition to cutting red tape and regulation, the Prime Minister wants her Government to promote innovation, with the creation of a £4.7 billion fund to pay for research and by providing £556 million for the “Northern Powerhouse” project.

Naturally, the reception from the business community has been warm; they’re more than happy for an increase in public investment into the economy.

But the Prime Minister has yet to spell out her plan for dealing with foreign investment. And this is a key issue for her government. In an age of growing protectionism, she must carefully walk the line between encouraging inbound investment from foreign firms, and safeguarding Britain’s national security from those global companies working under state control.

As was the case with the funding for Hinkley Point, which the Prime Minister delayed over the summer, the greatest worry for many countries has been Chinese investment. This is partly because there has been a spike in Chinese investment abroad, but also because the nature of their investment tends to be in tech and critical national infrastructure sectors.

We are seeing barriers to their money going up worldwide. In August, for example, the Australian government blocked Chinese firms from bidding for a controlling stake in its largest electricity network. Then, in October, Berlin blocked a Chinese takeover of one of its largest chip manufacturers, following security concerns.

Shortly thereafter, the US Treasury took the unusual step of nullifying the part of the sale that included Aixtron Inc., an American-based subsidiary, following “credible evidence that the foreign interest exercising control might take action that threatens to impair our national security”.

It is true that an overly tough screening regime could militate against the Prime Minister’s new global objectives, particularly as we tout for business outside of the EU. But there must be some effort to screen investment in a regular and transparent manner. Only this would reassure foreign investors, British business, and our security services.

So how do we do it? Well let’s take a look at what other Western liberal democracies have done about investment security.

The best known example is the US Committee on Foreign Investment in the United States (CFIUS). Chaired by the US Treasury, this inter-agency grouping reviews transactions which might result in an American business being controlled by a foreign person or have an effect on US national security.

A transaction is first examined over a period of 30 days to ascertain its national security implications. The CFIUS then decides whether to approve the transaction or initiate an investigation.

An investigation would give the CFIUS another 45 days to decide whether to permit the transaction, impose conditions or refer the case to the President who can then prevent the transaction taking place. In 2012, President Obama cited national security risks when he blocked the Chinese-owned company Sany’s attempt to purchase wind farm projects in Oregon near the Naval Weapons System Training Facility where the military flies unmanned drones and electronic-warfare planes.

Similarly, Australia has its Foreign Investment Review Board (FIRB), which advises the Treasurer and the Government on foreign investment policy. Again, it does this largely by examining proposed investments in Australia and making recommendations.

The Treasurer can prohibit or impose conditions if there are concerns about the national interest as there were over two bids by the Chinese State Grid Corporation and Cheung Kong Infrastructure for the state-owned Ausgrid electricity company. Worth billions of Australian dollars, the bids were blocked by the FRIB citing “national security” concerns.

France also has a body to regulate inward investment. Before 2014, foreign investors in the technology, defence and betting sectors would have to notify the French Ministry for the Economy and Finance (MINEFI) before receiving authorisation. In 2014, the French government extended this oversight to the energy, transport, telecoms, water and health sectors – all areas of critical national infrastructure.

The new decree also ensured that non-EU investors’ proposals must pass muster under European Court of Justice case law, meaning that measures restricting the free movement of capital within the EU should be limited to the protection of public order and safety. The rejection of any transaction would  be on the basis of national interest, under which national security is a vital component.

It is not without irony that China has one of the most rigorous investment screening processes in the world, with a significant proportion of its economy off-limits to foreign investors.

Equally, why should the UK abandon its security or its values simply because Brexit is making growth a priority. Mrs May’s government is going to have to think carefully about its approach to economic growth and where money is going to come from.

That is why having a formal body or process, which carries out non-intrusive safeguards of investors into Britain’s economy would not be wild, suspicious, or paranoid. In fact, a brief glance around the world reveals that many other advanced economies have a process. It is just a question of common sense.

 


Foreign Investment in Critical Areas like Nuclear Power Need a Formal Vetting Process

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LSE Business Review, October 11, 2016

One of the first decisions taken by Theresa May as prime minister was to delay deciding on the £18 billion Hinkley Point nuclear power project. Because it was a centrepiece project as part of former chancellor George Osborne’s “Golden Age” of closer bilateral ties with China, the issue was instantly politicised, provoking an intense debate in Parliament and across government departments. Defenders of the deal included the Chinese embassy and foreign ministry, which came out publicly to apply pressure on May over the issue.

Meanwhile, those close to the prime minister – formerly home office secretary – pointed out the security risks to Britain’s critical national infrastructure and national security. In the end, a face-saving compromise was reached: the Sino-French consortium would go ahead with the deal with Her Majesty’s Government keeping a majority stake in the company to calm nerves within the security agencies.

The fact that it was a Chinese company which provoked the issue was not incidental: Chinese companies – private and state-owned – have become increasingly active in investing and acquiring businesses and assets in economies across the developed world, particularly in the US (no.1), Australia (no.3), and the UK (no.1 in Europe). In 2014, the FT noted that China’s outbound investment had exceeded its domestic investment and the country was on its way to becoming the world’s largest cross-border investor. As the Hinkley Point debate was flaring up here in London, Australian Treasury Minister Scott Morrison announced that two separate Chinese bids to lease Australia’s largest electricity grid would be blocked for “national security” reasons. It is obvious that May is not alone in her concerns.

To some, China’s focus on infrastructure has a nefarious side: after all, national defence and intelligence agencies depend on critical national infrastructure (CNI) to do their job. To others, China’s focus on CNI is the result of its own domestic economy, which is heavily weighted in favor of big, capital-intensive infrastructure projects. Whatever the case, it is certain that many more private and state-owned Chinese investors will seek to purchase stakes in British companies and infrastructure. Some of these – like stakes in the UK’s hotel industry are clearly benign. Others – like the bid for Global Switch, Britain’s largest data centre, may have repercussions for national security, in the wake of the UK MOD’s move to cloud computing. It may also have privacy concerns as a recent NATO report suggests that China is behind many hacks in the West and is said, by Stratfor, to have the largest domestic mass surveillance apparatus of any country.

Regardless of the answer, the need is clear in the UK for a more formal process than has taken place up until now. Australia and the United States – two of the largest recipients of Chinese investment – have long had treasury-linked agencies to deal with the foreign investment and security: the Committee for Foreign Investment in the United States (CFIUS) and the Foreign Investment Review Bureau (FIRB).

Naturally, their approach may or may not be a right fit for the UK, which has a strong culture of unregulated investment, but it would benefit both Government and business to initiate some sort of discussion on what is currently a very grey area. Such a review process would calm nerves on both sides – including those of Chinese investors who may have been riled by Hinkley Point. Clearly, Britain wants Chinese investment and even welcomes it within certain parts of the national infrastructure, but not all of its parts. What is most needed, according to Malcolm Rifkind – former Chairman of the Intelligence and Security Committee – is oversight, “This project went from consideration to contract, without ministers even hearing about it. There must be some sort of accountability with deals of this nature.” Under Rifkind, the ISC produced a strongly critical report in 2013 on the BT-Huawei deal in which BT was supplied components by a company said to have links with the Chinese military.

Prime minister May could best start this conversation in the Cabinet Office and bring members of the security community and business community together in order to hammer out the powers and processes of such a review body. One idea is to make it a committee or subcommittee within the cabinet office, with its own staff. The committee might be composed of business leaders or senior bureaucrats from within relevant ministries, Trade, Treasury, Ministry of Defence and the Home Office. Staffers could be seconded from among these same ministries. Certainly, the Treasury would have to have a large stake in any organization to give it traction, perhaps as Chair. Then there is the question of what it would do: in short, it would create guidelines for firms which operate inside Britain’s critical national infrastructure. It would also investigate adding new areas – particularly those in newly-developing technologies and computing – to areas of sensitivity. Whether it would be given teeth, or simply remain an advisory body – depends very much on whether May can rally her cabinet around the idea to pass legislation in Parliament. Either way, the committee could bring clarity to a gray area.

Creating such a committee makes sense for the UK at the moment. The number of Chinese investments into British infrastructure are only set to rise, and the UK is reconfiguring its EU-dated regulations. While the watchword of the day for many concerned British companies will be “continuity”, this process of rewriting the UK’s legal framework does provide Prime Minister May an opportunity to create a formal review process. Furthermore, a process might remind the UK of the need for investor diversity.

Winnie King, Professor of Chinese International Political Economy at Bristol University states, “The UK needs to frame its approach in terms of Brexit: “Now that we have left the bed of European supra-national governance, we shouldn’t just jump into bed with another big actor. We need to diversify.”

A recent report by the Oxford Review of Economic Policy has challenged some of the myths around Chinese infrastructure projects. The UK has had the fastest growing economy in the Group of Seven for the past four years. It deals in high value, not high volume goods, and its manufacturing includes luxury smart high-tech firms like McLaren, Deep Mind, and others. Britain has remained competitive and in the top 10 global economies by remaining open to foreign investment: a review process will not change that. But it will make future investment more open-eyed and transparent.

Jeremy S. Maxie

Energy & Political Risk Consultant

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