Does Ukraine need investment screening?

Ukrainian government has recently started its work on introducing a foreign investment evaluation system.

On January 20, 2021, the Cabinet of Ministers approved a draft law that is broadly in line with the global trend toward the development and implementation of such mechanisms.

We analyzed this initiative in the context of other countries and found out whether Ukraine needs such investment screening.

How it works in the United States

International experience shows that the screening and monitoring of investments are carried out to avoid the concentration of foreign capital in certain sectors of the economy in line with the national security of the state.

The American equivalent of investment screening is the Foreign Investment Risk Review Modernization Act of 2018 (Foreign Investment Risk Review Modernization Act, FIRRMA). The document was drafted as a response to growing skepticism about Chinese investment in US companies.

The active expansion of Chinese companies, which began in the early 1990s and was particularly widespread in the 2000s, when Lenovo purchased the IBM Thinkpad in 2005, could not be ignored for long.

In 2011, members of Congress became worried about the potential acquisition of 3Leaf Systems by the Chinese telecommunications giant Huawei.

During 2011-2016, the number of cases reviewed by the Committee on Foreign Investment in the United States (CFIUS) increased by 55%.

During 2017-2018, such Chinese companies as Ant Financial Services Group (Alipay), China’s Hubei Xinyan Equity Investment Partnership’s, and Chinese heavy-duty commercial vehicle were denied the purchase of American MoneyGram International, Xcerra Corporation, and UQM Technologies companies.

During the same period, the Chinese conglomerate HNA Group was not allowed to invest in the SkyBridge Capital hedge fund.

Acquisitions of Lattice Semiconductor and Qualcomm were not approved as well.

Therefore, drafting a legislative act to regulate the procedure for reviewing foreign investment projects was particularly relevant and important for the United States.

The primary focus of the FIRRMA law is the investment inflow to US business related to confidential personal data, critical infrastructure and technology (big data protection, artificial intelligence, nano- and biotechnology), as well as activities related to real estate located close to seaports, airports and military facilities.

Experience of the EU Member States

The investment screening mechanism in the EU implies a procedure for preliminary consideration of requests, with a focus on checking the creditworthiness, stability, and good faith of investors.

The EU’s Foreign Direct Investment Screening Regulation (Foreign Direct Investment Screening Regulation, FDIR), which officially entered into force on April 10, 2019, defined the following sensitive foreign investment areas:

✔ critical infrastructure (energy, transport, water, health, communications, media, data processing and storage, aerospace, defense, election, or financial infrastructure);

✔ critical technologies (artificial intelligence, robotics, semiconductors, cybersecurity, aerospace, defense, energy-saving technologies, as well as quantum, nuclear, nano- and biotechnologies);

✔ supply of critical resources (energy, raw materials, food security);

✔ access to confidential information (protection of personal data, media freedom and pluralism).

When evaluating investment proposals, special attention is paid to three aspects:

✔ direct or indirect government control over a potential investor;

✔ participation in activities that affect security or public safety;

✔ risk of attracting a foreign investor to illegal or criminal activities (at the same time, a successful screening procedure is a confirmation of the investor’s good reputation as a reliable partner).

Thus, the world’s leading economies have recognized the investment screening importance for projects related to sensitive areas of national security.

Screening in Ukraine: yes or no?

The need for investment screening in Ukraine is a controversial issue.

In 2019, the volume of foreign direct investment in Ukraine amounted to only 2% of GDP and was 4 times less than remittance flows from Ukrainian migrant workers ($3.1 billion against $12 billion).

Moreover, the economy of Ukraine is characterized by a predominance of offshore foreign direct investment: in 2019, almost 30% of capital came from Cyprus, another 20% — from the Netherlands. In turn, this complicates the procedure for identifying the ultimate investment beneficiary.

For example, according to the National Bank, during 2010-2019, reinvestment in the Ukrainian economy through the round tripping investment mechanism (residents send funds abroad and then they return to the country in the form of direct investment) is estimated at $9.4 billion, which is 22.8% of the total foreign direct investment inflow in Ukraine.

The largest round tripping transactions were carried out through Cyprus, the Netherlands, Switzerland, and Austria. In 2019, the National Bank of Ukraine (NBU) estimated round tripping transactions at $1 billion, ie 34.1% of the direct investment inflow in Ukraine.

How Europeans protect themselves from the expansion of Ukrainian producers and what should we do about that?

The adoption of draft law No.5011 is extremely unfavorable to a certain group of resident companies in Ukraine, as it will require full disclosure of information on the official registration of foreign investors in the head-office country. Additionally, the ownership structure and affiliates need also to be disclosed.

Another important requirement is to disclose information on the amount of income and taxes paid for the last two years by the tax authority of the head office country of a foreign investor.

This practice will facilitate the implementation of the BEPS (Base Erosion and Profit Shifting) action plan on the implementation of measures to combat the tax base erosion and profit shifting in Ukraine. Our country joined the implementation of the BEPS action plan on January 1, 2017.

Moreover, the time limits for the submission of tax information (for 2 years) and the auditor’s report on the enterprise’s financial statements (for the previous year) make it impossible to use specially created shell companies.

All the above measures will help increase the transparency of investment projects and improve the investment climate in Ukraine.

Investors are usually indifferent to the needs of a host country, as the main goal of any business is to maximize profits within its corporate network, gain access to target, low-cost labor, technology, natural resources markets and strengthen competitive positions.

A vivid example of the negative foreign direct investment impact on the national economy is the acquisition of the Zaporizhzhya aluminum plant that was owned by the Russian group SUAL (since 2007 — RusAl) in 2004.

The ultimate goal of this acquisition was to destroy a competitor: The plant’s operation was suspended, equipment was actively exported, and the Ukrainian economy suffered significant losses — jobs, tax deductions, export potential, and so on.


Today, the government faces a difficult choice — an open market for foreign investors as a stimulus to economic growth or prudent control and the establishment of certain restrictions in certain areas of the economy.

The statutory mechanism that allows foreign investors to participate in the capital of Ukrainian strategic enterprises will help reduce corruption risks associated with the decision-making of some officials, as well as make the procedure clear, transparent, and, most importantly, sustainable.

Uniform and clear rules are the basis for avoiding compliance risks and are always attractive to investors.

After all, the introduction of a procedure for reviewing and approving investment requests in Ukraine requires using a well-structured approach and understanding that screening is needed in cases where potential foreign investment losses become secondary and are quite acceptable compared to potential threats to national security and economy.

At the same time, the introduction of a systematic approach to the protection of national interests should not create unnecessary barriers to capital inflows.