In response to a significant increase in acquisitions of companies in the EU by Chinese buyers in recent years, the foreign (i.e., non-EU) investment review legal framework in the EU is currently undergoing a change towards stricter scrutiny. Germany this summer tightened its national foreign investment review regime, and the European Commission recently at the initiative of France, Germany and Italy tabled a proposal for an EU Regulation for a framework for review of foreign investments into the EU. These developments are from a political perspective driven by fear of a “sell-out of European expertise,” notably to investors which due to state subsidies are able to offer an extraordinarily high price that is hard to match by other potential investors. Another factor in the political debate concerns the lack of reciprocity when it comes to investments of companies from the EU in China. The President of the European Commission announced the proposed EU Regulation by stating “we are not naïve free traders.”
The substantive criteria under which investments of non-EU companies in targets in the EU may be scrutinized and ultimately even be prohibited are determined by international law. On that basis, such investments may only be prohibited in case they pose a threat to the public order or the national security. However, it is up to each individual EU Member State to decide whether to review foreign investments in its territory at all, and, if so, how to interpret and apply the substantive review criteria and how to organize the formal procedure for review of transactions which fall within the scope of the foreign investment review regime.
The acquisition of 25% or more of the voting rights in a German target by a non-EU acquirer may be reviewed by the German government to assess whether it creates a threat to the public order or the national security. The relevant regulation, the Foreign Trade Regulation (Außenwirtschaftsverordnung – AWV), was tightened earlier this year. The change came in the wake of last year’s acquisition of Kuka, a German manufacturer of industry robots, by the Chinese white goods manufacturer Midea. The transaction at the time sparked a debate in Germany about acquisition of strategic German know-how in key industry sectors by foreign investors notably from China pursuing industry policy aims of the Chinese government.
Scope of Application: Introduction of Non-Exhaustive List of Sensitive Civil Sectors
From a substantive point of view, the government introduced a non-exhaustive list of civil business activities which are deemed particularly relevant for the national security and therefore fall within the scope of the regulation. The revised regulation for the first time defines concrete business areas in the civil sector which are considered relevant for the national security. While the general substantive test (threat to the public order or the national security) remains unchanged, it can be expected that acquisitions of German targets active in any of these areas will in the future be subjected to particular scrutiny, notably if the proposed acquirer is a state-owned or state-funded company from a non-EU state which supposedly pursues strategic industry policy aims with the proposed transaction.
The relevant business sectors are: (i) operators of so-called Critical Infrastructures which are relevant for the security of supply of Germany, including the sectors energy, water, nutrition, IT and telecommunication, health, finance and insurance, and transport and traffic, (ii) suppliers of dedicated software to operators of Critical Infrastructures, (iii) companies that are obliged to implement measures to monitor telecommunication, and companies which produce respective technical devices, (iv) certain cloud computing service providers relevant for the national security, as well as (v) key companies of the telematics infrastructure in the public health sector.
Further, the scope of the specific foreign investment review regulation for military products was extended to include certain additional key technologies that are crucial for defense applications, inter alia, encryption technology and sensor technology.
Introduction of Notification Obligation For Acquisitions in Sensitive Civil Business Sectors
The acquisition by a non-EU investor of a German target active in any of the civil business sectors defined by the new non-exhaustive list is under the revised regulation to be notified to the German government. In practice, this extension of a statutory notification obligation from targets in the military sector to targets in sensitive civil sectors is, however, unlikely to bring about significant changes, as prudent non-EU investors in case of doubt have usually already previously submitted a voluntary notification anyway in order to obtain a so called Certificate of Non-Objection. The German government consequently does not expect the extended formal notification obligation to give rise to a significant increase in applications.
Extension of Initial Review Period to Two Months
From a procedural point of view, the key change is the extension of the review period in cases where the acquirer applies for a Certificate of Non-Objection, which is available in case of acquisitions in a sensitive civil business sector (not in case of acquisitions in the military sector). In practice, any prudent investor would file such an application if there is a remote risk that the transaction may be taken up for review. The relevant review period was extended from one month to two months. This extension may generally tend to delay closing of relevant transactions since a transaction for which a Certificate of Non-Objection has been requested will for reasons of precaution not close prior to expiry of the review period or the granting a Certificate of Non-Objection. While there is no statutory standstill obligation the acquirer will usually not want to run the risk of having to unwind the transaction if the government raises concerns after closing. On the other hand, the change in practice resulting from the extended review period may not be that significant, taking into account that the government could extend the review period already previously by initiating a formal investigation.
Extension of In-Depth Review Period to Four Months
If the government during the review period for the request of a Certificate of Non-Objection comes to the conclusion that an in-depth investigation is required, it has now four (previously two) months from the point in time when the notification is deemed complete by the government to conclude the in-depth investigation.
Another procedural change concerns circumvention of the foreign investment review. Under the revised regulation it will become much more difficult to escape the scope of the regulation by setting up an acquisition vehicle within the EU as direct acquirer. In particular, the revised regulation expressly extends to cases where the direct acquiring entity does not pursue any appreciable business activity or does not maintain an own presence within the EU on a continuing basis in the form of business premises, staff or equipment. Further, it is in such cases no longer possible to rebut the assumption that the arrangement was chosen in order to escape foreign investment review by demonstrating that there were also other objective reasons, for example tax reasons, for the arrangement.
Proposed EU Regulation on Foreign Investment Review
No Foreign Investment Review Procedure at EU Level
The proposed EU Regulation does not stipulate the introduction of a foreign investment review procedure entirely operated at the EU level, which would likely not have been approved by all Member States. The proposed EU Regulation limits itself to stipulating the right of the Commission to issue comments or opinions on proposed transactions to the reviewing Member State, notably in cases where a foreign investment may affect projects or programmes of European Union interest, including projects and programmes involving a substantial EU funding. Moreover, the principle that each Member State decides independently whether to implement a foreign investment review regime will remain unchanged. At the moment, 12 out of 28 EU Member States have a foreign investment review regime in place. A number of Member States consequently currently do currently not subject foreign investments in their territory to any scrutiny. These Member States will not be obliged to introduce a foreign investment review regime in the future either. To the extent the relevant Member States stick to their current approach, a Chinese company could for example acquire a target in Greece, in the Netherlands, or in Sweden without foreign investment review.
For those Member States who have a foreign investment review regime in place, the draft EU Regulation aims at harmonizing the application of the substantive criteria and introducing procedures for coordination of reviews between Member States and between Member States and the European Commission.
From a procedural point of view, the draft Regulation proposes to give Member States and the European Commission the possibility to submit comments or an opinion to the reviewing Member State(s).
As regards the substantive review, the draft Regulation proposes to apply a broad approach to assessing a potential threat to the public order or national security, stipulating a non-exhaustive list of relevant activities, notably an array of examples of “critical infrastructure” and of “critical technologies,” as well as “security of supply of critical inputs” and “access to sensitive information or the ability to control sensitive information.”
Generally speaking, the proposed Regulation follows a similar approach as adopted in the revised German regulation described above, by defining concrete sectors of potential concern. Importantly, however, the EU proposal goes further than the revised German regulation particularly in stipulating expressly that a factor to be taken into account should be “whether the foreign investor is controlled by the government of a third country, including through significant funding.”
Convergence With US Standards?
The proposed criterion whether the foreign acquirer is state-controlled may be perceived as bringing foreign investment review in the EU closer to the standard applied to foreign investment review in the US by the Committee on Foreign Investment in the United States (CFIUS). Factors that CFIUS considers include, inter alia, whether the transaction could result in the control of a US business by a foreign government or by an entity controlled by or acting on behalf of a foreign government, and the relevant foreign country’s record of adherence to non-proliferation control regimes and record of cooperating with US counterterrorism efforts. Similarly, the European Commission in the context of the presentation of its initiative for an EU framework for reviewing foreign investments pointed out that acquisitions by foreign state-owned or controlled companies in strategic areas “may allow third countries to use these assets not only to the detriment of the EU’s technological edge, but also to put our security or public order at risk.”
From a procedural point of view, it will remain to be seen how far the proposed EU Regulation, in case it will be ultimately adopted, would align the triggering investment threshold to US standards. In the US, CFIUS reviews cover acquisitions or investments that result in a transfer of control over a US business to a foreign person. The concept of “control” is applied in a very broad sense in practice and may even include, depending on the circumstances, acquisitions of relatively small non-controlling minority stakes. Germany, as noted, applies a strictly formal approach and covers only acquisitions of 25% or more of the voting rights in the target. The proposed EU Regulation appears to be closer to the US approach. It does not define a particular formal threshold of investment as triggering event but relates to a “broad range” of “investments of any kind…aiming to establish or maintain lasting and direct links…, including investments which enable effective participation in the management or control…” but not covering “portfolio investments.”
If the EU Regulation comes into force as proposed, which requires consent of the European Parliament and EU Member States, and consequently would be binding on Member States, the envisaged broad interpretation of the terms public order and national security would likely be a step towards a stricter assessment in the future in all Member States which have a foreign investment review in place. Another practical impact of the EU initiative may be the introduction of foreign investment review regimes in additional Member States. Whether the new approaches in Germany and at EU level, which leave the general substantive test—threat to the public order or the national security—unchanged, may in the future prevent further “sell-out of European expertise” remains to be seen. It will in particular still not be possible to block transactions simply on industrial policy grounds if no threat to the public order or the national security can plausibly be demonstrated.
Nevertheless, non-EU acquirers contemplating the acquisition of a target in Germany or in other Member States of the EU with foreign investment review regimes will in the future need to pay increased attention to potential transaction risks resulting from foreign investment regulation in the EU. A diligent analysis at an early stage of the process is required to identify potential transaction risks. While it would be premature to draw parallels to the CFIUS procedure in the US, which as is well known may pose significant hurdles to acquisitions notably by Chinese companies not only of US targets but also of targets outside the US with significant US operations, the climate in the EU for acquisitions by non-EU, particularly Chinese, companies in industries perceived as strategic from an industrial policy standpoint, such as the high-end computer and electronics sectors, can be expected to get rougher.
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