Key Takeaways      

• The EU institutions have reached political agreement on a new regulation or foreign subsidies regime (the “FSR”) that will allow the European Commission (“EC”) to review the effects of non-EU government subsidies given to businesses active in the EU and remedy any possible distortive effects.  This marks a decisive step towards the formal adoption of this novel and far-reaching legislative tool.  First announced in May 2021, the FSR is likely to be adopted later this year and to take effect by mid-2023. 
• The FSR establishes mandatory notification regimes for businesses that have received financial contributions from a non-EU government when participating in certain mergers or public tenders.  As such it will create a third regulatory hurdle for some M&A transactions.  In addition to merger review and foreign investment controls, the proposal is that in-scope deals will need to be cleared by the EC - or risk subsequent investigation.
• The FSR also empowers the EC to proactively investigate financial contributions to assess if there is a distortive non-EU subsidy and impose remedies (e.g., repayments, divestments, access commitments).
• The broad definition of a foreign subsidy will capture many forms of foreign state grants, incentives or forbearance (for example, tax waivers).  It will apply irrespective of the foreign country or industry involved.  And it will concern not only companies from outside the EU, but also EU companies that have received subsidies from non-EU governments.
• In an M&A context, one immediate implication of the FSR will be the need for additional due diligence regarding the nature, scope and amount of government contributions of each party to the transaction, and a detailed assessment of the potential distortive effect of those contributions, as well as of the potential delays and remedial actions that could affect the transaction.

I. Introduction

On June 30, 2022, the EU institutions reached a political agreement on the text for the FSR that will give far-reaching powers to the EC to control subsidies provided by non-EU governments to businesses active in the EU. Specifically, the FSR envisages:

(i) A mandatory notification and approval regime for mergers and acquisitions and joint ventures that involve a foreign subsidy and meet certain monetary thresholds.

(ii) A mandatory notification and approval regime for tenders in public procurement procedures where the contract and the foreign subsidy received by the participant meet certain financial thresholds.

(iii) An own-initiative investigation regime empowering the EC to request an ad-hoc notification of mergers, acquisitions, JVs and public procurement procedures that fall below the thresholds and investigate all other market situations (if the EC suspects that a distortive foreign subsidy may be involved).  

 II. Wide Definition of “Foreign Subsidy”

The FSR defines “foreign subsidy” widely, largely mirroring the EU’s state aid rules. A financial contribution will constitute a foreign subsidy if three cumulative criteria are met: the financial contribution (i) is granted by a third country, (ii) confers a benefit to a business and (iii) selective.

The broad definition is expected to give rise to uncertainty. Experience from EU state aid control shows that assessing whether a contribution amounts to an aid, or in the present context a foreign subsidy, is not always straightforward and may require extensive economic analysis.

III. New Investigative Tools

1.     M&A Notification Regime (ex-ante)

Under the FSR, transactions must be notified – and cleared prior to closing – where:

• one of the merging parties, the target or the JV is established in the EU and has generated EU-wide turnover of €500 million;

AND

• the parties involved in the transaction received a foreign subsidy (i.e., a financial contribution from a non-EU government) in excess of €50 million in the last three years.

Since the FSR does not define “established in the EU”, the threshold may be met where the merging party, the target or the JV outside the EU generates sales in excess of €500 million through exports into the EU and has a legal entity in the EU.

The €50 million foreign subsidy threshold is set relatively low, especially given that it aggregates financial contributions received by the buyer(s) and the target and covers all subsidies even unrelated to the transaction or the EU. As such, investors with multiple investments in their portfolio may need to carry out the burdensome exercise of assessing whether financial contributions received by those portfolio investments from any third country for any purpose amount to foreign subsidies. PE firms may need to carry out due diligence to confirm the source of the funds received from investors, including limited partners.

Reportable transactions must be notified to the EC which, in contrast to what is provided for in the merger control and FDI frameworks, has the exclusive power to enforce the FSR. In its review, the EC will be bound by deadlines similar to those established in the EU’s merger control regime.

(25 business days for a simple review, and 90 business days for an in-depth investigation, with possible extensions/suspensions). The FSR provides for the possibility of pre-notification consultation with the EC, but it is not clear whether such pre-notification discussions will in practice become standard as is the case in EU merger control. The FSR does not clarify whether the EC can accept redressive measures in the preliminary review period and as such conditionally clear a transaction subject to remedies as it frequently does in the merger control process.

2. Public Procurement Notification Regime (ex-ante)
 

A business participating in a public procurement tender will have to notify its participation in the tender where:

• the value of the contract exceeds €250 million;

AND

• the bidder received a foreign financial contribution of at least €4 million per third country.

The notification obligation also applies to main subcontractors and suppliers, i.e., providers of elements that are key to the contract performance and contribute at least 20% of the value of the submitted tender. 

Notified tenders will need to be suspended pending the review that may last up to 20 business days in case of the preliminary review, and additional 90 business days where an in-depth investigation is opened. At each stage, the EC can once extend the review period in duly justified cases. 

3. Own-Initiative Investigation Tool (ex-officio)
 

The FSR also includes a fallback investigation tool that allows the EC to look into (i) M&A transactions, JVs and public procurement bids that fall below the notification thresholds, and (ii) entire markets. 

The stages in the ex-officio investigation largely mirror the phases of the ex-ante regimes. The EC will investigate whether there are sufficient indications that a business received a market-distorting foreign subsidy (a preliminary assessment), and whether the EC should take any actions in relation to the subsidy, e.g., require the business to offer remedies (an in-depth investigation). Under certain circumstances the EC can also adopt interim measures at the outset of the investigation.

The EC will have the power to issue information requests to businesses concerned, third-party businesses and third-countries, and to conduct inspections within and outside the EU. The EC can adopt a decision on the basis of the facts available to it if the business concerned refuses to cooperate. 

The EC is not bound by deadlines to adopt a decision in the context of own-initiative investigations but must endeavour to adopt a decision within 18 months from the opening of the in-depth investigation. 

The EC will have the power to launch an own-initiative investigation up to 10 years from the date on which a foreign subsidy was granted (including into subsidies granted up to five years prior to the FSR taking effect). The FSR does not envisage a voluntary notification regime that would allow investors and businesses to extinguish the EC’s investigative power by proactively submitting a notification for M&A transactions, JVs or public procurement tenders that fall below the relevant thresholds.

IV. Substantive Analysis

1. Is Foreign Subsidy Market-Distorting?
 

A foreign subsidy will be deemed market-distorting where it can improve the competitive position of a business and, as a result, actually or potentially negatively affect competition on a market in the EU. The EC will have broad discretion in carrying out the assessment. Examples of factors that the EC can take into account include the amount, nature and purpose of the subsidy; the situation of the business and the markets/sectors concerned; and the level and evolution of economic activity in the EU of the business concerned.

2. Do Positive Effects Outweigh Foreign Subsidy’s Negative Effects?
 

The EC may consider positive effects of foreign subsidy in its analysis.  Positive effects may include the development of the relevant subsidised economic activity in the EU and relevant policy objectives such as a high level of environmental protection and social standards, and the promotion of research and development. Positive effects can lead to a no-objection decision if they fully outweigh the negative effects of the subsidy, or can be taken into account when designing redressive measures.

V. Redressive Measures

 Where it concludes that a foreign subsidy is market-distorting, the EC can impose redressive measures to remedy the distortion or accept commitments offered by the business concerned.

Remedies may include divestment of assets, dissolution of M&A transactions, reduction of capacity or market presence, repayment of the foreign subsidy with interest, access under fair, reasonable and non-discriminatory conditions to an infrastructure (e.g., R&D facility), publication of results of R&D, licensing on fair, reasonable and non-discriminatory terms of assets acquired or developed with the help of foreign subsidies and refraining from certain investments. The EC will also have the power to require a business to temporarily restrict its commercial activities in the EU, adapt its governance structure or to temporarily oblige a business to notify the EC of its M&A transactions, JVs and public procurement participations. 

VI. Fines

The EC will have an enforcement toolbox that mirrors itspowers under the merger control framework. Specifically, the EC will have the power to impose a monetary fine of up to 10% of the party’s worldwide turnover where the party (i) fails to notify a foreign subsidy; (ii) implements M&A or JV prior to the receipt of approval or in violation of a prohibition decision or a conditional decision with redressive measures, or (iii) circumvents or attempts to circumvent the notification obligation.

VII. What Can Investors and Business do to Prepare?

The FSR will introduce an additional layer of regulatory requirements for many businesses operating or investing in the EU. To better prepare for the FSR, companies should consider:

• The definition of "foreign subsidies" under the FSR is broad and likely to capture a wide spectrum of financial contributions. Tight timetables in M&A transactions and public procurement procedures may make it difficult for investors and businesses to determine the FSR’s applicability on an ad-hoc basis. Businesses should therefore consider compiling a record of “financial contributions” received from non-EU states over at least the last three financial years and on an ongoing basis.  They should also ascertain whether these identified contributions were received on market terms and if not assess the effects on the relevant markets and possible justifications (in terms of positive effects).
• Investors should build in sufficient time into transaction and bid timetables to obtain clearance under the FSR given the suspension obligation and the length of the EC’s review periods.
• Investors should assess the risk of a prohibition decision or conditional approval, including determining remedy packages that are likely to be acceptable to the EC to address any concerns. Where the notification thresholds are not met, the parties should determine the risk of an own-initiative investigation by the EC (e.g., as a result of a third-party complaint).       

Investors should consider appropriate contractual provisions (e.g., risk-shifting, conditions to closing, long-stop dates) in the context of M&A transactions. The FSR is expected to be formally adopted by the EU later this year and to enter into force mid-2023.  If you have any questions on the FSR, please do not hesitate to reach out to the team listed below. Our team is also available to assist in setting up an internal database and tracking system for foreign subsidies.