The Background: As set out in our prior White Paper, in 2020, the European Commission ("Commission") issued a draft regulation to remedy perceived internal European Union market distortions arising from subsidies provided to companies operating in the EU by foreign governments outside of the EU ("FSR").
The Development: As described in our June 2021 Commentary, FSR adoption had been on track for early 2022. The EU Council and the European Parliament have now reached a political agreement on the FSR. Formal approval is anticipated shortly, meaning the FSR rules are likely to enter into force in late 2022/early 2023, and start applying mid-2023. The FSR introduces a new notification regime for M&A and public procurement and establishes new Commission investigatory and remedial powers targeting companies receiving foreign subsidies.
Looking Ahead: The FSR will have a substantial impact on both EU and non-EU companies active in Europe. Businesses will need to develop new compliance systems to track any non-EU "financial contributions" received or committed to them globally, from outside the EU. Companies involved in M&A or public procurement in the EU may have notification obligations and require prior approvals before the closing of a deal or a public bid award in the EU. Those investigations may result in delays for deals or disadvantages in M&A auctions or public bids.
Overview of the FSR
The Treaty on the Functioning of the European Union ("TFEU") prohibits any form of public financial support selectively granted to businesses that distorts competition, absent an exception. The EU's prohibition on State aid, however, extends only to aid provided by EU Member States and existing Trade Defense Instruments (such as anti-dumping or anti-subsidy measures) address only imported products. Supporters of the FSR argue that the FSR plugs a gap and establishes a "level playing field" for EU companies to compete in Europe with their foreign counterparts that receive "unfair" government support. Critics argue that the FSR amounts to extraterritorial regulation, imposing the EU's State aid policies outside of its borders.
The FSR does not target any specific region of the world, nor companies of a specific nationality. The FSR introduces a new legal framework (and imposes a substantial compliance burden) on companies operating or investing in Europe, irrespective of origin.
The FSR provides three new opportunities for the Commission to investigate and potentially punish subsidies that non-EU governments grant to companies that operate in the EU. The FSR introduces (i) premerger notification to the Commission for certain large M&A transactions; (ii) notification to the Commission for certain public bids; and (iii) general Commission investigatory powers in all other marketplace circumstances (i.e., "ex officio" powers).
Companies are not required to track or identify whether any non-EU government support they receive constitutes a "subsidy," nor themselves establish whether such support could potentially distort competition. Rather, companies will need to track and, when necessary, report certain underlying data, or "financial contributions." The concept of "financial contribution" is broad, and can include cash grants, tax incentives, loans or loan guarantees, debt forgiveness, debt to equity swaps, the foregoing of revenue and various other benefits. It can also encompass such ordinary activities as paying public authorities for water, electricity, or employee health insurance. No de minimis threshold applies, which means that every dollar, pound, yen, or renminbi would need to be counted when assessing and complying with a filing obligation or responding to information requests from the Commission. If a company receives financial contributions in multiple jurisdictions, data from all relevant countries must be quantified. For example, a company may need to add up a federal U.S. loan guarantee, UK tax relief, credits provided by a state-owned bank in China, the benefits of a research collaboration with a Japanese public university, and financial incentives provided by a Swiss canton.
The Commission's investigative powers under the FSR will be similar to those found in the current EU competition law enforcement framework. Those powers include the authority to send requests for information, launch market investigations, and conduct on-site inspections (known as "dawn raids"). Introduction of the dawn raid authority will, however, be delayed as a some EU Member States will need to change their national laws before the Commission can launch such inspections. The Commission also will be entitled to conduct inspections outside the EU, however, only with the consent of the host country. The Commission may impose penalties for failure to comply with an inspection, or with regard to information requests: this may apply, e.g., in the provision of incorrect, incomplete, or misleading information, or if a company fails to meet a formal response deadline. The Commission has in the past fined companies nearly EUR 40 million for obstructing dawn raids and EUR 110 million for providing incomplete or misleading information in competition law proceedings.
If, after an investigation, the Commission were to confirm the existence of a foreign subsidy and concludes that it distorts competition, i.e., it improves the competitive position of a company, and is capable of negatively affecting competition in the EU's internal market, the Commission will perform a "balancing test" to weigh the positive and negative effects of that foreign subsidy. If the negative effects outweigh the positive effects, the FSR empowers the Commission to impose redressive measures or to accept commitments that remedy the alleged distortion.
The Commission's remedial authority under the FSR will include the authority to block the award of a tender, or prohibit an M&A transaction. It will be able to force asset sales, dissolve concentrations, put in place investment bans, mandate subsidy repayment, or impose licenses or access requirements to purchased assets/infrastructure, etc.
The Commission will prepare an implementing regulation, on which the Commission is likely to seek public comment. That regulation may provide more clarity around the Commission's remedial powers, among other issues.
The FSR also authorizes the Commission to investigate any company under its ex officio powers. Notification obligations for M&A transactions and public tenders, however, are likely to cause companies the more significant operational challenges, as set out in more detail below.
The FSR authorizes the Commission to investigate bids in large public procurements in which the value of the contract is at least EUR 250 million. When a company submits a bid, or a request to participate in a public tender, it must submit information to the contracting authority (i.e., the public-authority customer) about all non-EU financial contributions received in the three years preceding that notification or confirm in a declaration that it has not received any. Notifications will be transferred to the Commission for investigation and contract awards (with certain exceptions) will need to await a Commission decision.
If a company fails to provide information or a declaration, it will be disqualified from the tender, and the penalties for non-compliance with the FSR public tender notification requirements are significant. In addition to the above referenced penalties, the FSR empowers the Commission to issue fines of up to 10% of a company's worldwide revenue, if a company fails to make requisite disclosures in the context of a public procurement procedure.
According to information available from the FSR final stage negotiations, the FSR will require premerger notification for M&A transactions (or "concentrations") in which (i) at least one merging party, the acquired company or a joint venture is "established" in the EU and has EU revenue of at least EU 500 million; and (ii) all parties to the transaction, in the three calendar years prior to notification, that received aggregate financial contributions from any foreign government of a combined amount of more than EUR 50 million. Importantly, the Commission's ex officio powers provide it with a "catchall" tool to investigate sub-reportable M&A also.
As set forth above, no de minimis rule exists with respect to the calculation of financial contributions, which means that any non-EU financial contribution (no matter how small) would need to be counted and included. Any State aid received from within the EU would be excluded from this calculation. Importantly, practitioners have questioned the design of the thresholds. They have observed that the only financial contributions that should be taken into account are those on the acquiror side (as that would appropriately capture any "subsidy-fueled" acquisitions). The Commission has, however, confirmed that it has drafted the thresholds to capture financial contributions provided to all parties in an M&A transaction. That means, e.g., that a target's financial contributions need to be counted and buyers should add this item to their standard due diligence requests. The need to aggregate data likely will require early-stage engagement among parties to a transaction, transparency, and access to complex datasets so as to identify potential filing obligations or hurdles to a transaction. That work is likely to be more challenging (and involve more sensitive data) compared to revenues, asset values, or market share data that parties customarily share to identify merger control filings.
It is also worth highlighting that a notification obligation arises not only from a foreign subsidy directly facilitating the transaction itself (a measure the Commission has listed in the FSR as particularly grave). Indeed, a notification under the EU Merger Regulation ("EUMR") already today requires information with respect to any financial or other support received from public authorities. Instead, under the FSR, any financial contribution the parties have received—irrespective of its purpose and with no regard to what business activity was in receipt of, e.g., the grant, fiscal incentive, or loan guarantee—will need to be quantified and reported.
The penalties for noncompliance with the FSR's concentration notification requirements are as significant as those for public procurement. The FSR authorizes the Commission to issue penalties of up to 10% of a company's worldwide revenue, for a failure to notify a notifiable transaction, or for early implementation ("gun-jumping"). To date, the highest fine for gun-jumping issued by the Commission under the EUMR has been in excess of EUR 120 million.
In the future, transactions may be reportable to the Commission under both the EUMR and the FSR. However, it is understood that the Commission will have separate investigatory teams, keep separate files related to EUMR and FSR reviews, and will implement internal firewalls.
In practical terms, the FSR is likely to add complexity and delay to an increasing number of sometimes parallel, but sometimes overlapping, regulatory burdens related to M&A, including merger control and foreign direct investment laws.
The FSR is likely to become applicable mid-2023. However, the filing obligations under the FSR will become operational three months thereafter. Therefore, on the current timeline, we expect that companies will not have to initiate FSR notifications until fall 2023.
Four Key Takeaways
- The FSR will require significant compliance resources and attention from companies that operate in the EU and that receive "financial contributions" from any governments.
- Companies will need to establish data gathering systems to track any transactions that could constitute a "financial contribution," a broad concept capable of capturing a wide number of transactions beyond grants, state guarantees, or fiscal incentives. This is likely to pose a significant challenge for multi-national companies and private equity firms that may be active in a significant number of countries, and be active in a wide range of industries through subsidiaries and/or portfolio companies.
- Companies involved in public bids, or those with an active M&A pipeline, will need to ensure that records are kept up-to-date at all times to comply with filing obligations. Even with good record keeping, the new regulations could lead to delays in public procurement awards or M&A regulatory approvals. Incomplete records may lead to a failure to seek necessary approvals or the provision of incorrect information, which can lead to hefty fines.
- M&A advisors will need to evaluate possible delays and uncertainties resulting from the new FSR regime. Early stage negotiations may require access to, and exchange of, (potentially) sensitive data, and a new category of deal risk needs to be added to deal evaluation. Paying close attention to the Commission's forthcoming implementing regulations, guidelines, and decisional practice will help business navigate the Commission's theories of harm and chosen remedies under this new regime.