​​Outbound Investment Regime Should Capture 'Smart Money' Flows to China, Former NSC Official Says

Kilcrease, in written testimony before the U.S.-China Economic and Security Review Commission this week, said the regime shouldn’t capture “passive capital flows” that don’t include management expertise, because China can easily obtain that capital from other sources. It should, however, screen transactions that may provide China with expertise on how to “orchestrate complex supply chains, attract and retain skilled workers, and operate efficiently in a cost-competitive environment.”

“These skills, which can be broadly characterized as ‘management expertise,’ are critical to the success of a sector but are not possible to capture through export controls,” Kilcrease said. It is “this precise gap that an outbound investment mechanism can address.”

Kilcrease’s comments come amid reports that the Biden administration is close to issuing an executive order that would create an outbound investment screening tool (see 2301120035 and 2302280011), although it remains unclear what types of investments the tool would capture. Kilcrease argued that focusing on “indigenous technology development, complementarity to export controls, and smart money can provide an overarching framework for designing an outbound investment mechanism.”

She also said the administration should introduce any new regime through a “phased approach” to allow it time to “build institutional capacity and coordinate policies with allies and partners.” The first phase would include a “mandatory notification regime” by requiring U.S. companies to report certain investments in China, with that reporting exempt from Freedom of Information Act disclosures.

This phase should capture a “broad” range of investments to give the U.S. better “visibility into the full scope of investments occurring” in China. Although specific outbound investment controls “should be implemented on the basis of the smart money principle noted above,” Kilcrease said the government “may not have sufficient visibility into investment flows at present to determine where to draw the line between smart money and passive investments.” This first phase could aid the U.S. in narrowing its focus.

Kilcrease also said notifications shouldn’t be required for all U.S. investments in China -- only investments in a Chinese firm that “produces, designs, tests, manufactures, fabricates, or develops” any item or items that would normally be subject to U.S. export controls. But, over time, the mechanism would expand to implement “sector-based screening” and would allow the U.S. to negotiate mitigation terms with a U.S. company to address national security risks arising from their outbound investment, similar to the process carried out by the Committee on Foreign Investment in the U.S. The president would also have the authority to block an investment.

“These reviews will therefore be inherently more time intensive and consequential [than] a notification regime,” Kilcrease said, “and the jurisdiction should be scoped accordingly to permit effective administration of a screening process.”

She also said the Treasury Department is “best situated” to lead the process given its experience overseeing CFIUS and implementing sanctions. Congress should create a new office to lead an interagency outbound investment process under the leadership of Treasury’s Assistant Secretary for Investment Security, Kilcrease said, adding that the Commerce Department also should have a “leading role.”

She also said there is an “unresolved question” about whether the new regime should be implemented through an executive order or by Congress. Some lawmakers last year hoped to get ahead of the White House unilaterally creating a regime (see 2209290043 and 2210040025). However it’s implemented, Kilcrease said, “no new authorities should be established prior to a rigorous public debate,” and any outbound screening regulations should first be issued as proposed rules.