The European Parliament and Council of the EU have agreed on a draft text for the upcoming Foreign Subsidies Regulation (FSR). The FSR is intended to fix a regulatory asymmetry: state aid granted by EU member states is subject to strict checks, but there is no equivalent scrutiny of financial contributions by third countries to companies active in the EU. The FSR will make M&A deals or public procurement bids fuelled by foreign financial contributions notifiable to the European Commission if they meet certain thresholds. Notified M&A deals will remain suspended, and procurement contracts cannot be awarded, until there is a clearance decision from the Commission. Even when the notification thresholds are not met, the Commission might "call in" M&A deals before their implementation or bids before the award of the public contract. Under a general market investigation power, the Commission may also review implemented concentrations or awarded public contracts. In practice, this means dealmakers will have to navigate a variety of regimes and jurisdictions as an M&A deal could be subject to national or EU merger control, national security/foreign direct investment (FDI) control, and now also, EU foreign subsidy control.
Within the EU common market, stringent state aid rules govern financial contributions by member states. Financial contributions granted to market participants by third countries, however, have remained unscrutinised. This regulatory gap has unlevelled the playing field by giving companies benefiting from foreign subsidies an unfair advantage over their rivals.
Foreign subsidies could, for example, allow recipient undertakings to offer lower sales prices or lower bids for public procurement in the EU or outbid competitors in M&A transactions. Only EU member states are bound by state aid rules while third countries are not. Unequal treatment between companies not benefiting from state aid and their competitors that do benefit from foreign subsidies, distorts competition in the internal market. This regulatory gap is further widened by the pandemic which resulted in subsidisation markedly increasing across the globe.
The FSR aims to regulate subsidies granted by a state to companies that are also operating beyond its jurisdiction, specifically in the EU. Within only 14 months of the FSR proposal being introduced by the Commission, on 30 June 2022, the European Parliament and Council of the EU achieved consensus on the final text.
Foreign financial contributions
According to the FSR, a subsidy exists where a third country provides a financial contribution conferring a benefit specifically to one or more companies or industries. This requirement of specificity or selectivity is borrowed from state aid. Similarly, just as in state aid, the notion of a financial contribution under the FSR is quite broadly defined. It should not be understood in the narrow sense of direct payment of public money to an undertaking. According to the FSR, a financial contribution may not only include interest-free loans, unlimited guarantees, capital injections, preferential tax treatment, pandemic-related support, but even the provision or purchase of goods and services. The FSR thus targets several forms of financial state support.
Furthermore, state-owned enterprises that often benefit from subsidies are explicitly covered by the FSR. High on the radar will be M&A activity of sovereign wealth funds, investments by public enterprises or enterprises otherwise backed by state funding. That does not, however, mean that the FSR is limited to foreign companies – it equally covers European companies benefitting from foreign subsidies. It is noteworthy that a de-minimis style presumption applies to subsidies of less than four million, which are considered unlikely to be problematic.
Distortion of competition
Market distortion caused by subsidies will be determined based on certain indicators, including the amount, nature, and purpose of the relevant subsidy being investigated. Moreover, certain categories of foreign subsidies – such as grants to an ailing enterprise, unlimited debt guarantees and subsidies directly subsidising an M&A transaction or enabling an unduly advantageous tender – are presumed most likely to distort the internal market.
If screening by the Commission reveals that a foreign subsidy distorts the internal market, the Commission may conduct a balancing test to determine if any possible positive effects outweigh the negative effects caused by the distortion of the internal market. It is rather unclear when and how exactly a foreign subsidy has positive effects on the internal market. Since the balancing test is largely borrowed from EU state aid rules, the guidelines applicable to state aid might shed some light on identifying justified subsidies (such as aid for environmental goals or R&D and innovation, and rescue and restructuring aid for companies in financial difficulties).
When the Commission completes its review, it may issue an unconditional or conditional approval. In the latter case, the Commission can impose structural or non-structural redressive measures to remedy the distortion or accept commitments from the parties. These may include divestment of certain assets, or the prohibition of certain market behaviour or of a deal.
Screening of subsidised transactions
When foreign financial contributions exceed the applicable thresholds, they will be evaluated under two different prior authorisation screening tools, one for large deals and another for public procurements.
When to notify?
If any of the undertakings that are involved in an acquisition, merger or joint venture have been granted foreign subsidies, a mandatory notification to the Commission will be triggered. Under the FSR, a transaction must be notified to the Commission if:
- it qualifies as a “concentration” under the EU Merger Regulation (EUMR);
- the target, at least one of the merging undertakings or the joint venture is established in the EU;
- the undertakings concerned generate an aggregate EU-wide turnover of at least EUR 500 million; and
- one or more third countries have granted to any of the undertakings concerned an aggregate financial contribution of more than EUR 50 million in the three preceding calendar years.
Different from the Commission's original proposal, a notifiable joint venture is one that is established in the EU, and it is not notifiable if only its parent entities are established in the EU.
The notion of an "undertaking" is aligned with the EUMR and includes parents, subsidiaries and covers all economic sectors where the said undertaking is active. Consequently, conglomerates will have to take into account all foreign subsidies which any of their business divisions have been granted, even if the division active on the EU internal market is different from the one that has received a third country subsidy. Similarly, investment funds must take into account all foreign subsidies which any of their constituent investments and portfolio companies have been granted. However, a financial contribution provided exclusively for non-economic activities of an undertaking will not be considered a foreign subsidy, unless used to cross-subsidise that undertaking's economic activities. More clarity should be expected when the Commission issues guidance in the future based on the initial enforcement of the FSR.
Aggregate financial support
Furthermore, in assessing if the FSR's foreign financial contribution threshold for notifying M&A deals is met, all financial support granted by any number of third countries will be considered together. It is therefore imperative that companies institute robust reporting systems for each third country in which they operate. For instance, a tax exemption received in a third country and an unrelated subsidy from another third country may be added up. This sum, in turn, may have to be added to the turnover realised by the sale of goods to yet another third country.
Standstill and call-in power
Similar to EU merger control, before receiving clearance, a transaction cannot be implemented, whether within or beyond the EU as the parties are subject to a standstill obligation.
Interestingly, the Commission may “call in” a deal if it considers that the case merits ex-ante review, even if the deal does not meet the FSR's thresholds. The Commission may call in a deal any time before implementation. This non-restrictive approach to asserting jurisdiction is in sync with the Commission’s guidance on Article 22 of the EUMR (see our previous article), which empowers it to review transactions not meeting EUMR thresholds. The General Court has just confirmed the Commission's approach in the Illumina/Grail case.
The FSR is another layer of screening control that must be cleared. It establishes a concurrent form of merger control, although one that aims at remedying a different form of distortion of competition in the internal market than merger control under the EUMR or national merger control rules of the member states. Moreover, most EU member states have by now introduced, or are in the course of introducing, FDI screening mechanisms including some that apply retroactively to M&A in vital sectors and sensitive technology (see our previous article on the new Dutch FDI regime). The current geopolitical crisis adds to this regulatory vortex. The pace and severity of EU sanctions against Russia, Belarus and the Crimea, Donetsk and Luhansk regions make it practically impossible to engage in any ongoing or future transactions with a nexus to these jurisdictions (see our coverage on economic sanctions and export controls). As such, dealmakers must come to terms with an increasingly crowded regulatory landscape.
Screening of subsidised procurements
The second prior authorisation screening tool under the FSR is activated where
- the estimated contract valuation for tenders in public procurement procedures is EUR 250 million or more, and
- a particular bid involves a foreign financial contribution of EUR 4 million or more per third country.
Companies taking part in these large public procurement procedures must notify the contracting authority of any foreign financial contribution received in the preceding three years. In turn, the public authority must notify the Commission. Alternatively, companies must confirm that they did not receive any foreign financial contributions in the last three years. Companies which do not submit this information or confirmation cannot be awarded the contract. A foreign financial contribution that allows a company to submit a bid that is unduly advantageous in terms of the works, supplies or services offered, will be viewed as being distortive, although the assessment will be limited to the public procurement at stake.
Similar to the call-in power for subsidised transactions, the Commission may also request that it be notified of foreign financial contributions granted to an undertaking in any public procurement procedure which is not notifiable under the above threshold, at any time before the award of the contract.
Only foreign subsidies granted during the three years before the notification will be taken into account in the assessment. Furthermore, the maximum period for the Commission's assessment of potentially distortive foreign subsidies in public procurement has been shortened compared to the original proposal, largely at the insistence of the European parliament. This is a commendable revision in view of legal certainty.
General power of investigation: ex officio
The FSR additionally bestows on the Commission a comprehensive ex-officio power of investigation for other market situations, including below-threshold transactions and public bids. The Commission may also conduct a market investigation in any sector or economic activity or into the use of any subsidy instrument to identify and rectify the distortive effects of foreign subsidies. Therefore, even outside the context of M&A and procurements, companies must be aware of any subsidies they receive and carefully assess if these may be distortive.
The European Parliament and Council must formally vote on and adopt the final text before the FSR is published in the EU official journal and enters into force. The FSR will become applicable within six months of entering into force. Notification obligations will kick in nine months after it enters into force. Regardless of that transition period, the Commission's general investigative power exists as of the date of application. The FSR proposal states that at least 145 dedicated full-time staff will be needed, so we can expect a substantial number of notifications to be made. The Commission will also need to issue guidelines on how it assesses distortive foreign subsidies. These guidelines will help to minimise legal uncertainty and any added administrative burden on companies and public bodies.