Chinese direct investment in Europe continued to decline in 2018, amidst heated debates in Europe about Chinese influence and growing awareness that some investments from China - for instance in hi-tech sectors or infrastructure - might need closer scrutiny.

These are the findings of a recent report titled “Chinese FDI in Europe: 2018 Trends and impact of new screening policies”, by Thilo Hanemann and Agatha Kratz at Paris-based Rhodium Group, and Mikko Huotari at Berlin-based think-tank Mercator Institute for China Studies (MERICS).

The authors indicated that the decline in Chinese foreign direct investment (FDI) in the European Union (EU) was in line with Chinese investments globally. Though this was mainly a result of continuing capital controls and lower liquidity in China’s financial system, another contributing factor is the growing political and regulatory backlash against Chinese commercial presence in advanced economies, including new and updated investment screening mechanisms in various EU member states.

For the time being, the EU remains an attractive region for Chinese investors. At the start of 2019, more than 15-billion-euros worth of proposed transactions were pending. The expansion of the US investment screening regime, and the deterioration of US-China relations, might at least temporarily boost Chinese investment in Europe.

Nonetheless, the new European investment screening framework, which was presented in November 2018 and passed the European Parliament in February 2019, is likely to reinforce the current trend of falling Chinese investment in Europe.

The new EU regulation encourages member states to specifically review investment in sensitive sectors including critical technologies and infrastructures, as well as transactions by state-controlled entities or those backed by state-led programmes (such as the Made in China 2025 strategy). The authors estimated that 83% of Chinese mergers and acquisitions in 2018 would have fallen into at least one of these three categories.

"As current debates in Europe about the risk of economic engagement with China progressively extend beyond FDI reviews, additional policy action in areas like export controls for dual-use and critical technologies, data security and privacy rules, procurement rules, and competition policy is becoming more likely," they argue.

In 2018, Chinese firms completed FDI transactions worth 17.3 billion euros, a decline of 40% from 2017 levels and of over 50% from the 2016 peak of 37 billion euros. The lion’s share of the investment continued to go to the three biggest economies in Europe: the UK (4.2 billion euros), Germany (2.1 billion euros) and France (1.6 billion euros) received 45% of Chinese investment in Europe – down, however, from receiving 71% in 2017. All three nations have updated their screening regimes in the last two years.

Significant investment in Sweden (3.4 billion euros) and Luxembourg (1.6 billion euros) contributed to an increase in Northern Europe and the Benelux’ respective weight, to 26% and 13% respectively, thereby eroding the share of Europe’s Big Three.

Compared to previous years, Chinese investment was spread more evenly across a greater variety of sectors. The absence of mega-deals led to a more balanced distribution of capital, with no single sector accounting for more than 20% of overall Chinese investment. Investment by state-owned enterprises fell to a five-year-low of 7.1 billion euros, while state-owned enterprises’ share of total Chinese investment fell to 41% from 71% in 2017, the second-lowest level on record.

One of the common complaints from the EU is that, while Chinese firms seek to invest in Europe, access to the Chinese market remains highly restricted for foreign companies.

FDI has been high on the agenda at the National People's Congress which is currently holding its plenary session in Beijing.

According to MERICS, the foreign direct investment law would be a clear signal to the US - and also to Europe - that Beijing is taking further steps towards opening its markets to foreign enterprises. The speed at which this project has recently been pursued is clearly a reaction to the trade dispute with the US.

But, far from being a purely symbolic gesture, the law should bring substantial improvements in market access, and mark a step towards the equal treatment of foreign and Chinese companies in China. The law would pre-establish national treatment for foreign investments, improve the protection of intellectual property and prevent technology transfer as a prerequisite for investment.

At the same time, the government is defining criteria under which foreign companies can continue to be denied access to certain sectors. There will still be a so-called negative list of areas that remain closed to foreign investors. Beijing also reserves the right to intervene directly where national security interests are concerned. In that spirit, the foreign direct investment law stipulates the establishment of a security review mechanism to examine foreign investments. In addition, it requires an antitrust review for mergers and acquisitions.