The European Commission unveiled a proposal on 24 January 2024 aimed at revamping the current European framework for screening foreign direct investments (FDI), signalling new requirements for member states. The initiative is part of a package of five measures seeking to strengthen the EU's economic security at a time of growing geopolitical tensions and profound technological shifts. The Proposed FDI Screening Regulation is in a more advanced stage than the remaining four initiatives. These include white papers – on export controls, outbound investment and enhancing R&D support for technologies with dual-use potential – and a proposal for a Council recommendation on enhancing research security. Businesses and investors entering or expanding in the EU market must take heed of the rapidly changing regulatory environment, especially regarding investments in critical infrastructure, sensitive technology and other areas that are important to the EU's economic security.

Increased protectionism through Proposed FDI Regulation

Since October 2020, EU rules have provided a framework for FDI screening through the current FDI Screening Regulation, which encourages member states to review FDI and impose mitigation measures, such as conditions to guarantee the supply of products and services, as necessary. The current FDI Screening Regulation provides member states a large margin of discretion regarding the breadth and depth of their FDI screening mechanisms. The decision on whether to set up a screening mechanism or to screen a particular transaction also remains the sole responsibility of the member state concerned (see our March 2020 update here).

Under the current regulation, the Commission has reviewed over 1200 foreign direct investment transactions notified by member states over the past three years. The Commission identified the following shortcomings, which it seeks to address with its new proposal.

Quasi-mandatory rules

Whereas the current regulation allows EU member states a large degree of flexibility to "maintain, amend or adopt" national FDI screening mechanisms, the Proposed FDI Screening Regulation requires those states with no screening mechanism to adopt one. Member states with existing screening mechanisms will need to ensure that theirs are up to par. If adopted, the regulation enters into force after a transitional period of 15 months, and any changes to national law will need to be implemented in fairly short order. The proposal seeks to harmonise FDI screening procedures within the EU, and mandates that all national authorities tasked with screening foreign investments must have the authority to investigate, assess, decide on, and monitor foreign investments. The proposed regulation will have a significant impact in countries which do not yet have an FDI screening regime, including Croatia, Cyprus, Greece and Portugal. In Bulgaria, an FDI screening mechanism expected later this year may find itself outdated before it even has a chance to get off the ground.

A defined sectoral scope

Unlike its predecessor, which left the scope of screening entirely up to national law, the Proposed FDI Screening Regulation now gives member states a shopping list of sectors and industries that must, at a minimum, be included. The list includes certain projects of EU significance as well as:

• critical technologies, including advanced semiconductor technologies, AI technologies, biotechnologies, and advanced materials, manufacturing and recycling technologies;
• listed medicines, if they are considered innovative or critical for human use. Factors such as therapeutic indication, the availability of appropriate alternatives, and the vulnerability of their supply chain are relevant to ascertain whether a given medicine is innovative or critical. Known examples include vaccines against hepatitis and rabies, and medicines like paracetamol and diazepam;
• critical entities and activities within the EU's financial system, such as payment systems and institutions, operators of a multilateral or organised trading facility, and other large institutions, among others.

Member states with robust FDI screening regimes may still need to update their laws to meet the proposal's minimum sectoral scope. For example, France provides screening for investments concerning sensitive sectors such as defence; activities relating to essential services such as energy, water and transport networks; activities relating to certain research and development; and, as of December 2024, activities affecting critical raw materials, security of prison establishments, and certain critical technologies. While it is clear that critical technology is covered, whether investments affecting the EU's financial systems and each of the listed critical medicines will be caught, remains to be seen.

The same may hold true for countries such as the Czech Republic, which screens for "critical infrastructure", but does not define this specifically with regard to either medicines or financial institutions. Finland's mandatory notification requirement applies only to transactions involving companies in the defence sector, while voluntary notifications are possible for investments in companies critical for securing vital functions of society. Changes may be required to address the voluntary nature of the regime as well as to broaden its scope, which does not explicitly cover critical technologies, critical medicines or financial systems.

Capturing indirect investments

The Proposed FDI Screening Regulation clarifies that national screening mechanisms must be wide enough to capture investments made indirectly by foreign investors through EU-based investment vehicles. If an EU company is ultimately either controlled or beneficially owned by a non-EU investor, its investment activities within the EU will be subject to screening. Member states are also encouraged

to include greenfield foreign investments in the scope of transactions covered by their screening mechanisms.

This application to indirect investments comes in response to the Court of Justice's position of 13 July 2023 in Case C-106/22 (Xella Magyarország), where it held that the 2020 FDI Screening Regulation applied only to direct investments by non-EU investors. EU-based investors with non-EU ownership or control were not caught unless there was evidence of active attempts at circumventing screening. As a result, also with a view to the freedom of establishment and the free movement of capital enshrined in the TFEU, Hungary was not able to block investments made by an Austrian company with Belize ownership. Under the proposed regulation, these indirect investments will be caught. While many member states do screen indirect foreign investments (including the Netherlands, Austria, the Czech Republic, Denmark, Germany and Slovenia), some do not. For example, Polish screening applies to all non-EEA/non-OECD nationals or entities, but not to indirect investments where the dominant undertaking is under an obligation to file. In the Netherlands, the problem is avoided in its entirety since the Dutch FDI Act applies to Dutch, EU and non-EU investors alike.

The proposed regulation applies to non-EU investors with "effective participation in the management or control of a target", including investments which establish "lasting and direct links" between the foreign investor and an EU-based target, or those carried out through a subsidiary with the same effect. However, control is not defined by reference to any specific minimum shareholding or voting rights. This can be contrasted with many member states' screening rules, which provide either 10% in their most sensitive sectors and 25% in other listed sectors, such as Austria, Belgium, and Slovakia, among others.

Stricter timelines

Under the Proposed FDI Screening Regulation, member states will continue to coordinate FDI screening efforts through a central cooperation mechanism. One change from the current mechanism is that the Proposed FDI Screening Regulation imposes strict deadlines for member states to inform the Commission of national investment notifications. The deadlines, which depend on the character of the investment and range from 15 to 60 days of receiving a request for authorisation at the national level, are designed to ensure a more streamlined and expedited process for investors, especially those who trigger notifications in multiple member states. Similar to the current regime, after notifying the Commission, the member state hosting the investment can provide comments before the Commission issues an opinion. What is new under the proposed regulation is that the Commission puts forward that all member states should have a legal basis to take into account the security concerns of other member states and the Commission and, where necessary, take measures that can address these concerns. This process can increase uncertainty and procedural challenges if a national screening authority in one member state is requested to address national security concerns of another member state.

Outbound investment screening for sensitive sectors on horizon

The increased scrutiny of transactions involving FDI in EU-based undertakings put forward by the Proposed FDI Screening Regulation is complemented by a second proposal unveiled by the Commission, this time concerning outbound investments. Though still in the early stages of development, the White Paper on Outbound Investment is highly relevant for businesses active in the EU in the four technology areas identified by the Commission as most likely to present sensitive and immediate risks related to technology security and leakage:

• advanced semiconductors
• artificial intelligence
• quantum technologies
• biotechnologies.

The white paper foreshadows the possibility of there being a national or European mechanism for screening outbound investments in third-country targets by EU-based companies active in these sectors. At this early stage, the Commission's proposal would require member states to set up a monitoring mechanism with the purpose of collecting data and assessing the risks associated with outbound investments. The Commission casts a very wide net, which captures any direct or indirect outbound transaction by an investor based in the EU, such as investments made through a third-country investment vehicle. Gradual investments made over a period of time would also be in scope, as would investments which result indirectly and passively from previous investment activities. Portfolio investments not granting control would be excluded. The Commission does not exclude the possibility that monitoring could have retroactive effect and cover past transactions.

The white paper does not require or empower the Commission or national authorities to actually screen or block outbound investments. Currently, the EU already has mechanisms in place to screen, restrict or block commercial and investment transactions involving dual-use and sensitive technologies.

• Exports of items with both civil and military uses are controlled by member states under an EU framework dating from 2021. However, there are growing concerns that the effectiveness of export control rules may be undermined if some sensitive technologies and know-how could nevertheless wind up in the wrong hands, not directly through trade but indirectly as a result of outbound investment transactions.
• Similarly, the EU's existing framework for screening inbound foreign direct investments also covers sensitive technologies and its recently Proposed FDI Screening Regulation would only bolster the power to review transactions involving companies active in the field. However, while investors could be restricted from buying into target companies operating sensitive technologies, there is currently no mechanism preventing EU companies from making those same technologies available to foreign entities through outbound investments.

The EU is not alone in thinking about regulating outbound investment screening. Some countries already control outbound investments, such as Japan and China. Others, like the US, are developing a framework to do so. The white paper maps out the first policy initiative which the Commission is taking in the field of outbound investments. A public consultation allows stakeholders to submit views until April 2024, and the Commission will consider the need to take concrete regulatory steps later in 2025.

Implications for businesses

For entities operating within or looking to enter the EU market, the new initiatives signal a pivotal shift. The broadened scope and heightened scrutiny mean that a wider range of investments may in the future require careful examination and compliance with the new framework. This includes investments by foreign entities through subsidiaries within the EU and those investments between member states in subsidiaries controlled by non-EU investors.

On a national level, the extent of the changes varies according to member state. For instance, in the Netherlands, very little will change, as the recently adopted Vifo Act (see our previous article here) already applies to transactions involving both Dutch and foreign investors and to a wide set of business sectors. Rather than specifying sectors where investment must be screened, the Wet Vifo instead introduces screening of investments where target companies are involved in vital processes, active in sensitive technologies, or operate or manage business campuses. This may already encompass each of the three areas to be screened under the Commission's proposal, as it was subsequently clarified that vital providers include any company carrying out a vital process, including payment transactions, drinking water supply and data traffic. As the proposed regulation purports to impose investment screening in critical technology areas, listed medicines and financial infrastructure, we can expect an expansion of the Dutch FDI screening regime.

Businesses must stay abreast of these changes to navigate the complexities of investing in the EU and avoid potential legal and operational hurdles. Aligning investment strategies with the evolving regulatory environment involves a thorough review of current and planned investments to identify any that may fall under the expanded scope of the screening mechanisms. Early engagement with legal and compliance teams can facilitate a smoother adaptation process, ensuring that investments remain viable under the new rules.

Looking ahead

The proposed changes underscore the EU's commitment to safeguarding its security and public order while fostering a predictable and harmonised investment environment. However, times of uncertainty still lie ahead as implementation of the Proposed FDI Screening Regulation may come as late as 2026 (assuming it passes European Parliament scrutiny following elections in June). The public consultation for this proposal is open until 16 April 2024. As the proposal moves through the legislative process, staying informed and engaged with these developments is key for businesses and investors aiming to thrive in the EU market. The dialogue between policymakers, industry stakeholders and legal experts will be instrumental in shaping a regulatory framework that balances security concerns with the need for economic openness and investment facilitation.