FI Monitor Issue 6, 2023

EU Foreign Subsidies Regulation poses new challenges for M&A in Europe 

As of 12 October, 2023, foreign investors will need to manage another layer of regulatory complexity to complete their investments in Europe: the Foreign Subsidies Regulation (FSR). In addition to merger control and FDI screenings, under the FSR, the European Commission (Commission) will be looking into subsidies granted by non-EU countries to companies engaging in M&A within the EU. Although the Commission will have far-reaching powers under the FSR to investigate public tenders and any other situation involving foreign subsidies in the EU internal market, the scrutiny of transactions is expected to steal the limelight under the proposed new regime. Certain types of deal-heavy companies, such as private equity (PE) firms, pension funds and state-owned enterprises (SOEs), will be especially exposed to this unprecedented tool.

The FSR aims to close a perceived regulatory gap in order to level the playing field between the EU, where in principle state aid is prohibited, and third countries. The rationale of this new tool is that companies that have received public aid from third countries may have an undue competitive advantage compared to companies that have not had access to such state support, harming competition in the EU internal market.

The enforcement of the FSR with respect to M&A will be carried out similarly to merger control and FDI – parties will be required to notify a transaction to the regulator (here, the Commission) and will not be able to close it until it is cleared. However, each assessment is different. FDI screenings identify whether a particular investment could pose a risk to national security by leaving strategic activities in the hands of foreign investors. Merger control investigates potential reductions of competition as a direct result of increased levels of concentration. The FSR also protects competition, like merger control, but from another perspective: it targets distortions of the internal market caused by “distortive” foreign subsidies. Consequently, the procedures are complementary and might lead to different outcomes.

M&A deals that will need to be notified under the new regime

Companies will need to notify transactions signed after July 12, 2023 (the effective date of the FSR) and closed after October 12, 2023 involving an acquisition of control over a company, the establishment of a jointly controlled JV, or a merger if they fulfill two thresholds:

• The target, the JV or one of the merging parties is established in the EU (by, for example, having a subsidiary or a permanent business establishment in the EU) and generates a turnover of at least €500m in the EU, and
• The transaction parties – i.e., the target and acquirer, JV and parents, or both merging parties – have received combined “financial contributions” exceeding €50m from non-EU countries over the three previous years preceding the conclusion of the agreement, announcement of the public bid, or the acquisition of a controlling interest.

While the first criterion is familiar to companies that have previously engaged with the EU merger control regime, the second is less familiar. Financial contribution is a very broad concept, catching not only direct grants, but also individual tax breaks, loans and contracts with public entities, as well as any provision or purchase of goods or services to or from any entity, whose actions are attributable to a non-EU government. 

Making the regime even more onerous, commercial relations with public bodies on market terms count towards the financial contribution threshold – a type of activity that most companies will never have monitored. Contrary to the EU State aid regime, the concept of financial contribution, which triggers the notification obligation, does not require the recipient to have received a “benefit.” Whether the recipient has received an individual benefit that distorts competition is only assessed during the Commission’s investigation, following notification. Accordingly, absent further guidance, almost any ordinary course of business financial relationship with a government of a non-EU state – or even a private entity whose actions can be attributed to such third country – can technically result in a financial contribution, triggering the notification obligation.

Companies must be ready to disclose large amounts of information

Although the final notification form has not been yet approved by the Commission, the Draft Implementing Regulation published on February 6, 2023 suggests far-reaching disclosure requirements, which go beyond those of the EU Merger Regulation notification form and have no precedents under any similar regulatory tools.

Notably, if a company has received more than €4m of financial contributions from a single non-EU country in a year, it will be obliged to list line-by-line any individual contributions above €200,000. For each one of these contributions, the name of the granting entity, country, type of contribution and its amount must be provided. Note that, even if only financial contributions above €200,000 must be reported, all of them – no matter how small – must be monitored and count towards the €50m notification threshold set out above.

The Draft Implementing Regulation also requires other potentially burdensome disclosures regarding the transaction. For instance, the Commission calls for the sharing of copies of all due diligence analyses; or – if the transaction occurs in the context of a bidding process – the number of bidders that have participated, those who expressed an interest, or how many letters of intent and non-binding offers were received. Although waivers may be granted to excuse disclosure of information “not needed for assessment” or “not reasonably available,” the decision to grant them fully lies within the discretion of the Commission. Part of this information is typically considered highly sensitive by sellers and other bidders and generally not in the possession of a winning bidder. It is unclear how the Commission will deal with this at a practical level – whether it will insist that the winning bidder procures the information from the seller after the auction process, whether it will obtain the information from the seller directly, or whether it will agree to a waiver request.

The process of assessing which financial contributions are problematic, and which are not

The submission of the notification commences an administrative procedure in two phases, aligned with EU merger control. The Commission will first assess whether a financial contribution is a foreign subsidy, i.e., whether it confers a benefit and is selective. Secondly, it will analyze whether these foreign subsidies are “liable to improve the competitive position of an undertaking on the internal market” while negatively affecting competition in the internal market. Certain types of foreign subsidies are most likely to distort the internal market. This is the case of subsidies that directly facilitate a deal, as well as those granted to ailing undertakings and those in the form of an unlimited guarantee or export financing measures not in line with the OECD. Finally, the Commission can also balance the effects on competition against the potential positive effects of the subsidy.

If the Commission considers that the reported financial contributions do not confer a benefit, are not selective, or do not distort the internal market, it will issue a clearance decision within 25 working days following the notification. Otherwise, it will open an in-depth investigation for potentially another 90 working days (or 105, if remedies are proposed), and finalize it by either clearing the transaction with or without commitments or blocking the deal altogether.

Private equity firms, pension funds and SOEs will be especially affected

Frequent investors, such as PE firms, pension funds and SOEs, might be more exposed to the FSR than other investors. For PE firms, the screening for financial contributions across broad portfolios and multiple funds will be particularly burdensome. It cannot be excluded that the state-linked limited partner’s LP investment is itself seen as a financial contribution received by the relevant PE firm, given the very broad concept described above. In addition, many portfolio companies will have arm’s length financial relationships with non-EU states.

LP investments by pension funds and SOEs from non-EU Member States could potentially constitute financial contributions. Given the low €50m monetary threshold for financial contributions, transactions involving such LP investors would always trigger the notification requirement in case of M&A in the EU that exceeds the €500m EU turnover threshold.

Key takeaways to minimize the impact of the FSR on deals

• Companies engaging in economic activity within the EU need to start monitoring financial contributions as soon as possible. The Commission also has the authority to investigate foreign subsidies even outside the M&A context, so companies should be prepared to provide such information in a timely manner.
• Due diligence questionnaires must be extended to cover financial contributions, and SPAs should include additional provisions regarding cooperation on information disclosure and condition precedents.
• Actively engage with the Commission – especially on potential waivers – in order to prepare and to minimize information gathering and compliance costs.
• Consider the timing of ongoing deals - the notification obligation applies for deals signed after July 12 and closed after October 12.

With thanks to Freshfields’ Merit Olthoff, Paul van den Berg, Andreas von Bonin and Justyna Smela for contributing to this update.