Today, the EU has formally adopted its Regulation on foreign subsidies distorting the internal market (“Foreign Subsidies Regulation”). The final version of the text, which was politically agreed upon already end of June this year, remains very close to the Commission’s initial proposal of May 2021. The new rules will have a major impact on M&A transactions and will significantly increase the costs and the administrative burden for many EU and non-EU companies doing business in the EU internal market.
The Regulation is supposed to close a “regulatory gap” resulting from the fact that the EU State Aid rules strictly limit the ability of EU Member States to subsidize companies active in the EU without the Commission’s approval, whereas no similar limitation and control mechanism exists for subsidies granted by third countries.
Under the new rules, the Commission will have three far-reaching instruments to tackle distortions caused by foreign subsidies in the internal market.
- A notification-based merger control regime to investigate certain M&A transactions
- A notification-based tool to investigate certain bids in public procurement procedures
- A general tool to investigate on ad hoc basis all other market situations on the Commission’s own initiative.
Even though the new rules are focused on foreign companies, they will also lead to more red tape for EU companies.
New rules will apply soon and must be taken into consideration already now
The Regulation will enter into force 20 days after its publication in the EU’s Official Journal, so potentially still before the end of the year. Most of the new rules will start to apply 6 months after the entry into force, so most likely around mid-2023. This date of application is important, because the new rules will not apply to transactions for which the agreement was concluded, nor to public procurement procedures that have been initiated before that date. Moreover, the new notification requirements for certain M&A transactions and public procurement procedures will only apply 9 months after the date of application, i.e. most likely starting from Q4 2023.
Importantly, once the new rules apply, the Commission will also be able to scrutinize foreign subsidies granted within the last three to five years prior to the date of application. The new rules must clearly already be taken into account now when planning M&A transactions, or considering to apply for third-country subsidies.
Far-reaching notification obligations for M&A transactions and bids submitted in public tenders
The Regulation introduces new notification obligations based on certain turnover and value thresholds, namely:
- An obligation to notify certain M&A-transactions, i.e. acquisitions of joint or sole control and the creation of full-function joint ventures (“concentrations) where
- the acquired undertaking or the joint venture is established in the EU and generated in the last financial year an aggregate turnover in the EU of at least EUR 500 million; and
- all undertakings (i.e. corporate groups, including the seller group) involved in the concentration were granted from third countries combined aggregate financial contributions in the three financial years prior to notification of more than EUR 50 million.
- An obligation of undertakings participating in public procurement procedures (“PPP”) to notify foreign financial contributions, where
- the estimated total value of that public procurement is equal to or greater than EUR 250 million; and
- the economic operator participating in such public procurement procedure was granted aggregate financial contributions in the three financial years prior to notification or equal to or greater than EUR 4 million per third country.
If this threshold (b) is not met, the bidder has to submit a declaration listing all foreign financial contributions received and confirming that the foreign financial contributions received are not notifiable.
In addition, the Commission is entitled to request the ad hoc-notification of concentrations or PPP participations even if they do not meet these thresholds. In such a case, the relevant concentration or public tender bid is treated in the same way as a notifiable transaction/financial contribution meeting the above thresholds.
„EU Merger Control II“
Both notification obligations are accompanied by standstill obligations: notifiable M&A-transactions cannot be closed, and public tenders cannot be awarded to bidders that had to notify foreign financial contributions, before the Commission has concluded its foreign subsidies review. A failure to notify or to respect the standstill obligations can be sanctioned with substantial fines (i.e. up to 10% of aggregate global turnover of the undertakings concerned).
The notification and review procedures are independent from potential other reviews, e.g. under the EU Merger Regulation (EUMR), with the result that companies may have to prepare and file parallel notifications and cope with parallel proceedings under different legal instruments with different timelines and standstill obligations.
The review of notifiable concentrations is closely modelled after merger control procedure under the EUMR: There will be a preliminary investigation (“phase I”) lasting 25 working days, potentially followed by an in-depth investigation (“phase II”) of additional 90 working days (with possible extensions upon request and in case of a submission of commitment proposals). In addition, there will be an informal pre-notification stage prior to the formal notification which may easily take 6 months or more in complex cases. The review of notifiable PPP participations is subject to different timelines: the preliminary investigation can last up to 30 working days, and the in-depth investigation can last up to 130 working days from the receipt of the complete notification.
The investigation measures which will be at the Commission’s disposal (in particular RFIs and dawnraids) are also largely inspired by the instruments available under the EUMR. Importantly, the Regulation provides for far-reaching alleviations of the Commission’s burden of proof in case the undertaking under investigation and/or the third country concerned fail to cooperate with the Commission.
Notification requirement may apply even in the absence of any foreign subsidies
The notion of “third party financial contributions” that determine the notification obligations are extremely broad and include many types of transactions and measures that ultimately may not be “subsidies” at all:
- Relevant financial contributions include the transfer of funds or liabilities, such as capital injections, grants, loans, loan guarantees, fiscal incentives, setting off of operating losses, compensation for financial burdens imposed by public authorities, debt forgiveness, debt to equity swaps or rescheduling, but also any foregoing of revenue that is otherwise due and even the mere provision or purchase of goods or services, regardless of whether these transactions are conducted at market terms or not.
- Relevant “third country” originators of “foreign financial contributions” are not only foreign government authorities, but also all public and even private entities whose actions can be attributed to the third country.
Importantly, all such “financial contributions” from all third countries granted in the last three years prior to notification have to be taken into account, regardless of whether they are directly or even indirectly linked to the transaction/PPP participation at issue. The relevant “financial contributions” are not confined to contributions received by the legal entities directly participating in an M&A-project or PPP. Rather, all financial contributions received by any member of the corporate group of the participating entity have to be added together for the purpose of assessing whether the notification thresholds are met.
Given the broad scope of the notion of “financial contribution”, the identification of all such relevant contributions alone will be difficult and burdensome. In addition, it is likely that a very large number of transactions by international players will have to be notified and reviewed under the new regulation. It remains to be seen whether and how the Commission will be able to cope with this additional workload.
Ex officio tool may allow Commission to investigate M&A transactions even after closing
In addition to the two notification based instruments, the Commission will be able to investigate also on its own initiative potential distortions arising from foreign subsidies, and to adopt redressive measures. This includes even foreign subsidies granted in the last 5 years prior to the start of the application of the Regulation to the extent they continue to have distortive effects.
Under this so-called ex-officio instrument, the Commission may even decide to carry out a review on its own initiative of already implemented concentrations or awarded public contracts, notably in cases where no prior notification was required because the notification thresholds were not reached. If the distortion is substantial and cannot be remedied by behavioural or structural measures or by the repayment of the subsidy, the Commission could even decide to remedy the distortion by ordering the undertakings to unwind the concentration.
Substantive test leaves many questions open
In terms of substance, the Regulation empowers the Commission to examine whether foreign financial contributions constitute “foreign subsidies” that “distort the internal market”, and to ensure that such distortions are remedied by commitments, or by “redressive measures” imposed by the Commission. The Commission may also prohibit notifiable transactions or tender awards to subsidized undertakings if no appropriate commitments are offered by the undertakings concerned.
Foreign subsidies shall be deemed to exist where a financial contribution of a third country (i) confers a “benefit” to an undertaking engaging in an economic activity in the internal market; and (ii) is “selective”, i.e. limited to one or more specific undertakings or industries. These notions are very similar to the well-established concepts of “advantage” and “selectivity” under EU State Aid law and will likely be interpreted in line with the case law and Commission practice on the EU State Aid law concepts. Broadly speaking, this means that a “foreign subsidy” will be deemed to exist if an undertaking/industry obtains a financial contribution from foreign state resources (or resources/entities attributable to the foreign state) at terms that the undertaking could not have obtained from private actors on the market, and if that financial contribution is not made available to all other undertakings/industries in a similar situation.
If a foreign contribution constitutes a foreign subsidy, the Commission will further assess whether this subsidy “distorts the internal market”, i.e. whether it is liable to improve the competitive position of the undertaking concerned in the internal market and thus actually or potentially negatively affects competition on the internal market. The Regulation contains a non-exhaustive list of indicators factoring into this assessment, such as the amount and nature of the subsidy, the economic and competitive situation of the undertaking and the markets concerned, the purpose and conditions attached to the foreign subsidy, as well as its use on the internal market.
In addition, the Regulation specifies certain categories of foreign subsidies that will “most likely” be deemed to distort the internal market, i.e.
- Foreign subsidies granted to an ailing undertaking in absence of a viable restructuring plan;
- Unlimited guarantees for debts/liabilities of beneficiary undertakings;
- Export financing measures that are not in line with the OECD Arrangement on officially supported export credits;
- Subsidies directly facilitating a concentration or the submission of an “unduly advantageous tender” that would enable the undertaking concerned to win a public contract.
On the other hand, the Regulation clarifies that certain types of foreign subsidies should benefit from a more benevolent treatment:
- A foreign subsidy shall not be considered to distort the internal market if its total amount does not exceed the amount of a de minimis aid as defined in Regulation 1407/2013 – i.e. EUR 200,000 – per third country over any consecutive period of three financial years.
- A foreign subsidy is unlikely to distort the internal market if its total amount does not exceed EUR 4 million over any consecutive period of three financial years.
- A foreign subsidy may be considered not to distort the internal market to the extent that it is aimed at making good the damage caused by natural disasters or exceptional occurrences.
If the Commission finds that a foreign subsidy distorts the internal market, the Commission will further assess whether the distortive effects may be counterbalanced or possibly even outweighed by positive effects “on the development of the relevant subsidized economic activity on the internal market, while considering other positive effects of the foreign subsidy such as broader positive effects in relation to the relevant policy objectives, in particular those of the Union”. Regrettably, the Regulation does not contain any guidance as to how the “balancing test” shall actually be applied in practice. The Commission seems to be left with almost unlimited discretion in weighing the negative and positive effects of the foreign subsidy and in deciding on the redressive measures or commitments it deems appropriate. It is likely that the Commission will use the “balancing test” and its power to request commitments or impose redressive measures to shape foreign subsidies in a way that would ensure the equal treatment of recipients of foreign subsidies and recipients of State Aid granted by EU Member States. However, this is not guaranteed, and there remains a significant risk that foreign subsidies and their recipients may be held to stricter standards than the ones applicable under EU State Aid law.
Red tape and legal uncertainty
There is no question that the new regulation will lead to significantly more red tape for any company doing business or willing to invest in the EU. The notification procedure for planned acquisitions and PPP participations will be costly and time-consuming. The new system is to run in parallel to the merger control systems at EU and national level, as well as the national rules of foreign trade law and investment control which will also continue to apply. The standstill obligations, as well as the potential risks and uncertainties – including the possibility of ex officio investigations in cases in which the notification thresholds are not met, potentially even after closing – will also have to be addressed in M&A deal documentations.
From the perspective of a foreign investor, all these parallel regimes with different requirements and objectives create a complicated maze that will be increasingly difficult – if not impossible – to navigate without highly specialized legal advice of practitioners experienced not only in M&A-deals and merger control, but also in EU State Aid law and national FDI regimes.
The Commission has announced that it will issue draft implementing acts including notification forms by the end of the year or early 2023, with a view to be able to adopt them before the Regulation starts to apply. The Commission is also planning to adopt a simplified procedure for unproblematic transactions, but is unlikely that the simplified notification procedure will already be available from the beginning.
Detailed guidelines on the application of the new rules will probably not become available until three years after the entry into force. However, the Commission has committed to provide initial clarifications regarding the concept of a distortion on the internal market and the application of the balancing test at the latest 12 months after the date of application. Until such guidance will enter into force and will consequently bind the Commission when exercising its discretion, undertakings active in the EU and benefitting from foreign subsidies (or undertakings acquiring EU-based recipients of such subsidies) will be exposed to significant legal uncertainty when investing and/or competing in the EU.
Conclusion
The new rules will have a major impact on M&A transactions and will significantly increase the costs and the administrative burden for many EU and non-EU companies doing business in the EU internal market.The practical relevance of the Foreign Subsidies Regulation in the longer term will largely depend on the reaction of Non-EU countries. The Regulation explicitly stipulates that international agreements concluded by the EU take precedent over the proposed new regulation. The very far-reaching and ambiguous content of the Regulation may also work as a bargaining chip and a strategic attempt of the EU to demonstrate to third countries that there is a need for bilateral or multilateral trade agreements with clear rules for a fair and predictable foreign investment regime. It remains to be seen whether this strategy will succeed.
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