On March 25, 2020, the European Commission (EC) published its first official guidance (the Guidance) on the application of Regulation 2019/452 (the FDI Regulation), which created a new framework for screening foreign direct investments (FDI) into the European Union (EU). The EC noted that, in the context of the COVID-19 emergency, there could be an increased risk of attempts to acquire healthcare capacities (for example for the production of medical or protective equipment) or related industries, such as research establishments (for instance developing vaccines).
The FDI Regulation must be applied by EU Member States only as from October 2020. The Guidance’s issuance more than six months early may have been inspired by widespread reports that the U.S. government tried to acquire a German company working on a COVID-19 vaccine. In any event, the Guidance is a useful reminder that the FDI Regulation applies not only to acquisitions by buyers from countries such as China or Russia, where State ownership or influence has often given rise to concerns, but also to acquisitions by U.S., UK and other foreign companies.
The Guidance calls on EU Member States to:
- “Make full use already now of its FDI screening mechanisms to take fully into account the risks to critical health infrastructures, supply of critical inputs, and other critical sectors as envisaged in the EU legal framework.
- “For those Member States that currently do not have a screening mechanism, or whose screening mechanisms do not cover all relevant transactions, to set up a full-fledged screening mechanism and in the meantime to use all other available options to address cases where the acquisition or control of a particular business, infrastructure or technology would create a risk to security or public order in the EU, including a risk to critical health infrastructures and supply of critical inputs.”
The Guidance’s call for the 13 Member States without an FDI screening mechanism to adopt one is a significant departure for the EC. The Guidance also reminds Member States of the availability of other tools, such as imposing compulsory licenses of prescription medicines or taking “golden shares” in local companies. These tools, notably, are also available to Member States that already have FDI screening procedures.
This article reviews the background to the FDI Regulation, summarizes the FDI Regulation’s main provisions and discusses the relationship between the new FDI screening framework and EU merger review. This article also notes ways the Guidance helps interpret the FDI Regulation.
The FDI Regulation stems from concerns among EU Member States about the growth in foreign investment in strategic sectors and the proliferation of foreign investor screening mechanisms among EU Member States. In a May 2017 reflection paper on “Harmonising Globalisation,” the EC noted that openness to foreign investment remains a key principle for the EU and a major source of growth, but also noted concerns about foreign investors, notably State-owned enterprises, taking over European companies with key technologies and the lack of reciprocal access for EU investors. The EC published its proposal for the FDI Regulation in September 2017. In a communication accompanying the proposal, the EC noted the risk that foreign investors may seek to acquire control of or influence in European undertakings whose activities have repercussions on critical technologies, infrastructure, inputs, or sensitive information, especially but not only when foreign investors are State-owned or State-controlled, including through financing or other means of direction.
The FDI Regulation creates a new cooperation mechanism in which Member States, and the EC itself, may issue comments and opinions on transactions involving FDI in another Member State’s territory, and the Member State in question must give those comments and opinions “due consideration.” In the case of investments deemed to be of “Union interest,” the EC will have greater authority, as Member States in which an FDI is planned will have to take “utmost account” of EC opinions and explain any non-compliance.
While not requiring EU Member States to create an FDI screening mechanism, the FDI Regulation set out uniform factors to be applied by those that do, as well as a framework for sharing information and opinions on relevant transactions. As noted, the COVID-19 crisis has inspired the EC to go further, expressly calling on Member States without an FDI screening regime to adopt one and meanwhile reminding them of the availability of other tools, such as imposing compulsory licenses on prescription medicines and Member States taking so-called “golden shares” in relevant companies.
Implementation of the FDI Regulation will be the responsibility of the Directorate-General for Trade’s (DG TRADE’s) Investment unit, led by Carlo Pettinato. Unusually for a measure of this type, the FDI Regulation includes no provisions instructing the EC to adopt more detailed implementing rules. Although the Guidance provides little clarity in this respect, the Guidance confirm that the EC can and will take a leading role in setting policy on FDI screening in the EU.
The FDI Regulation applies to so-called screening mechanisms for FDI. “Screening” and “screening mechanisms” are defined as procedures for assessing, investigating, authorizing, conditioning, prohibiting or unwinding FDI on grounds of security or public order. The terms “security” and “public order” are deliberately vague, leaving considerable uncertainty as to the scope of EC and Member State review. The Guidance specifies that the FDI Regulation applies to all sectors of the economy and is not subject to any thresholds, since even small start-ups may be of strategic importance on issues like research or technology.
FDI are defined as investments of any kind by a “foreign investor” aiming to establish or to maintain lasting and direct links to an entrepreneur to carry on an economic activity in a Member State, including investments which enable effective participation in the management or control of the target. “Foreign investors” are in turn defined as natural persons or undertakings “of a third country.” The term “of a third country” arguably limits the new framework’s scope to buyers incorporated under the laws of a non-EU jurisdiction. It is not clear whether transactions by EU-incorporated buyers whose ultimate parent is a non-EU entity would be caught; if not, this would seem to be a significant loophole.
The concept of “direct participation in management” is much broader than “control,” and presumably includes the power to appoint representatives to the board of an EU company, even if they do not have strategic veto rights. The Guidance notes that acquisitions of qualified shareholdings that confer certain rights under national company law (e.g. 5 per cent) might be of relevance in terms of security or public order.
The FDI Regulation applies not only to proposed investments, but also to investments that have already been completed. Under the EC’s original proposal, the framework could apply to past transactions without limit in time, but the final text limits ex post facto screening to 15 months. The Guidance notes that “a foreign investment completed now (March 2020) could be subject to ex post comments by Member States or opinions by the Commission as from 11 October 2020 (date of full application of the Regulation) and until June 2021 (15 months after completion of the investment).”
The FDI Regulation sets out a uniform set of factors to be used by the EC and Member States. These include potential effects on:
- Critical infrastructure, including energy, transport, water, health, communications, media, data processing or storage, aerospace, defense, electoral or financial infrastructure, as well as sensitive facilities and investments in land and real estate crucial for the use of such infrastructures.
- Critical technologies and dual use items, including artificial intelligence, robotics, semiconductors, cybersecurity, quantum, aerospace, defense, energy storage, and nuclear technologies, nanotechnologies and biotechnologies.
- Supply of critical inputs, including energy or raw materials, as well as food security.
- Access to or the ability to control sensitive information, including personal data.
- Freedom and pluralism of the media.
In determining whether an FDI is likely to affect security or public order, Member States and the EC may take into account whether the foreign investor is controlled by the government of a third country, including through ownership structure or significant funding. This will clearly include companies controlled by State entities or in which State entities are significant investors, but could potentially apply to companies that derive a significant portion of their revenues from business with State entities, such as aerospace and defense companies.
Direct EC review powers
The FDI Regulation gives the EC new powers to screen FDI that are likely to affect projects or programs of “Union interest,” in particular projects and programs involving a substantial amount or a significant share of EU funding, or which are covered by EU legislation regarding critical infrastructure, technologies or inputs. The projects or programs having Union interest are set out in the regulation’s annex, which the EC will update from time to time. These include Galileo, Copernicus, Eurocontrol, and European electricity and gas transmission networks. The Guidance highlights the Union interest in EU undertakings that have received funding under the EU Research and Innovation programme Horizon 2020 (and presumably other EU programmes).
Where the EC considers that an FDI is likely to affect projects or programs of Union interest on grounds of security or public order, the EC may issue an opinion to the relevant Member State or States, with copies to the other Member States. The EC’s opinions will not be legally binding, but Member States will have to take “utmost account” of them and explain any failure to comply. Since the FDI Regulation does not create any new legal powers for the EC to prohibit or impose conditions on a transaction, any action recommended by the EC will have to be implemented under Member State laws.
Although the FDI Regulation does not contemplate adoption of a standard notification form, the EC can request information from the relevant Member State, in particular on the ownership structure of the foreign investor and the target; the value of the investment; the products, services and business operations of the investor and the target; the Member States in which the investor and the target conduct business; the funding of the investment; and the date on which it is planned to be or has been completed. These information requirements are likely to create bottlenecks in some transactions, particularly in view of the tight timelines summarized below. More detailed guidance would be helpful, but no such guidance is contemplated in the FDI Regulation.
Although the FDI Regulation does not provide any right to communicate directly with the EC regarding transactions under review, interested parties will no doubt seek out possibilities to do so. Although the FDI Regulation does not give the EC decision-making power, its opinions are likely to be influential, and the EC will play an important coordinating role with Member State authorities. If DG TRADE’s Investment unit does not provide a mechanism for interested parties to have input in the process, they will likely seek such possibilities through other EC Directorates-General. It would be preferable for the EC to formalize its procedures and to give interested parties an opportunity to provide input.
Member State Screening Mechanisms and EC Coordination Role
As noted, the FDI Regulation will not restrict Member States’ ability to maintain or create screening mechanisms, but it will require Member States to notify the EC of any new or existing screening mechanism, as well as any changes. Member States will also submit annual reports including a list of FDIs screened and undergoing screening; screening decisions prohibiting investments or submitting them to conditions or mitigating measures; the sectors, origin, and value of the investments; and whether it considers that an investment undergoing screening is likely to be caught by the EUMR.
Member States will be required to appoint an FDI screening contact point to handle communications, whether or not they have a screening mechanism in place. Rather than creating a contact point with no powers, some Member States that currently have no FDI screening mechanism will likely choose to introduce new mechanisms of their own. Indeed, the Guidance expressly urges them to do so.
The FDI Regulation will set out minimum criteria that Member States' screening mechanisms will have to meet. They will have to be transparent and not discriminate between third countries, and Member States will have to set out the circumstances triggering the screening, the grounds for screening and detailed procedural rules. Member States will have to establish timeframes for issuing screening decisions that will allow them to take into account the comments and opinions of Member States and the EC. Confidential information, including commercially sensitive information, made available by foreign investors and other parties will have to protected, and foreign investors and other parties concerned will need to have the possibility to seek judicial redress against screening decisions of the national authorities. While these procedural protections are welcome, they offer far less transparency and protection for investors than, for example, the EC’s merger review procedures.
The FDI Regulation creates an elaborate cooperation mechanism for FDI undergoing screening. Member States must notify the EC and other Member States of any FDI that is undergoing screening. Where a Member State considers that an FDI planned or completed in another Member State is likely to affect its security or public order or otherwise has relevant information, it may provide comments to the Member State where the FDI is planned or has been completed, with a copy to the EC. The EC may also issue an opinion where it considers that an FDI is likely to affect security or public order in one or more Member States or otherwise has relevant information, irrespective of whether other Member States have provided comments. A Member State may request input from the EC or other Member States, and the EC will have to deliver an opinion if at least one-third of Member States consider that the investment is likely to affect their security or public order. Member States where an FDI is planned or has been completed will have to give due consideration to such comments and opinions, but they will not be legally binding.
Upon receipt of an initial notification that an FDI is undergoing screening, the EC and Member States will have 15 calendar days to notify the Member State concerned that they intend to provide comments or an opinion and to request additional information. Opinions and comments should be delivered within 35 calendar days of the original notice, or 20 calendar days from receipt of any additional information requested. The EC may issue an opinion following comments from other Member States no later than 40 calendar days from the original notification.
The Guidance notes that Member State concerns need not lead to prohibition of a proposed transaction. In the context of the COVID-19 crisis, potential mitigating measures may include commitments to supply medical products/devices, including beyond the predicted needs of the host Member State.
Relation Between EU FDI and EUMR review
As mentioned, the FDI Regulation will create the first new framework for EC review of transactions since the EU Merger Regulation (EUMR) entered into force in 1989. Although the FDI Regulation is not limited to mergers, acquisitions or joint ventures that constitute concentrations caught by the EUMR, many investments triggering the FDI Regulation will often be reviewed under both laws.
Under the EUMR, EC review is a “one-stop shop,” meaning that a concentration notified under the EUMR is exempt from review under Member State merger review laws. Article 21(4) EUMR allows Member States to take measures in respect of EUMR-notified transactions on grounds of other legitimate interests, provided these measures are compatible with other EU laws. Except for decisions based on the protection of public security, plurality of the media and prudential rules, Member State decisions on a transaction subject to the EUMR must be communicated to the EC, which must decide whether the proposed decision is consistent with EU law within 25 working days. The EC has invoked this procedure in cases concerning a variety of sectors, including the energy, telecommunications, transport and construction sectors.
The FDI Regulation did not amend Article 21(4) EUMR, which differs in many ways from the proposed new screening mechanism. Article 21(4) applies only to transactions meeting the EUMR thresholds and only empowers the EC to intervene to strike down Member State impediments to a transaction approved under the EUMR (if the EC finds that those impediments violate EU law); Article 21(4) does not empower the EC to review or impose restrictions on a transaction for any reason except the transaction’s impact on competition.
The EC’s powers under the FDI Regulation will be broader than its powers under Article 21(4) EUMR in some respects, but narrower in others. The EC’s powers will be broader, because it can intervene in transactions not caught by the EUMR, and it can raise public-interest objections on non-antitrust grounds, whether or not the transaction is approved under the EUMR. On the other hand, the new screening mechanism applies only to investments from non-EU countries and to a narrower range of public interests, and the EC’s opinions under the new regulation will not be legally binding. The EC will also be dependent on Member States for information, lacking the extensive investigatory powers granted by the EUMR. Although the Commission has promised to ensure consistency in the application of the FDI Regulation and Article 21(4) EUMR, many practical questions can be expected to arise on a case-by-case basis. Parties notifying transactions under the EUMR will likely seek to coordinate the processes to avoid delays and the risk of inconsistent outcomes, and they may be frustrated by the lack of transparency and procedural protections under the FDI Regulation.
As the first new framework for a general EC review of private transactions since 1989, the EU’s new FDI screening mechanism represents a bold step and inserts the EC into a hitherto jealously guarded area of Member State authority. By leaving ultimate decision-making powers with the Member States, the FDI Regulation aims to reassure Member State governments about the EC’s limited role, while still reducing the risk of uncoordinated screening processes with potentially inconsistent approaches and outcomes.
The EC’s issuance of the Guidance over six months before the FDI Regulation is due to be applied by Member States highlights the potential security and public order implications of the COVID-19 crisis and suggests that the EC may take a larger role in setting FDI screening policy than originally expected. The EC’s recommendation that Member States without an FDI screening mechanism should adopt one is a departure from the EC’s previously neutrality. The EC’s endorsement of tools, such as compulsory licenses and “golden shares,” is also striking because these measures would be outside the EC’s coordination regime. While the Guidance does not target any particular country or type of investor, the EC may be as or more concerned about potential acquisitions by U.S. or UK companies than by acquisitions by Chinese or Russian-led transactions.
|Jay Modrall, Partner, Norton Rose Fulbright LLP|
|James R. Modrall is an antitrust and competition lawyer based in Brussels. He joined Norton Rose Fulbright LLP in September 2013 as partner, having been a resident partner in a major US law firm since 1986.A US-qualified lawyer by background, he is a member of the bar in New York, Washington, D.C., and Belgium.
With 27 years of experience, he is a leading advisor for EU and international competition work, in particular the review and clearance of international mergers and acquisitions.
Mr Modrall also has extensive experience with EU financial regulatory reform, advising the world’s leading private equity groups in connection with the new EU directive on alternative investment fund managers and leading banks and investment firms on EU initiatives including EU regulation of derivatives, EU reforms in financial market regulation and the creation of a new EU framework for crisis management, among others.Mr. Modrall’s native language is English, and he is fluent in Italian and proficient in Dutch and French.