While state aid from EU member states is scrutinised on its compatibility with the internal market, there is no corresponding review framework for financial support provided by non-EU states to undertakings that are active in the EU. This can cause certain undertakings to receive foreign subsidies from third countries while others may be prohibited from getting financial aid from EU member states. Foreign subsidies could, for example, allow undertakings to offer lower sales prices in the EU or outbid competitors in M&A transactions. The European Commission has responded with a proposal to level the playing field. The proposal contains a standstill obligation, meaning companies which received foreign subsidies will have to notify the Commission and await clearance before bidding in an M&A deal. Contracting authorities that encounter participants which received foreign subsidies in their public procurements must also notify. Financial thresholds have been set for both types of notification procedures. However, even where cases fall below the threshold, they might still attract scrutiny if the Commission believes their potential impact in the EU so merits.

If the proposed regulation is adopted, companies should prepare for an increased regulatory burden. And as there will also be other coinciding ex-ante screening regimes, careful planning and deal management are essential.

Background

In terms of trade policy, the EU is consciously positioning itself as one of the most open global economies. Yet, there is a growing perception that some of its trading partners liberally grant subsidies which selectively give the beneficiaries a competitive advantage in the EU’s internal market. According to the European Commission’s Impact Assessment accompanying the proposal for a foreign subsidy regulation (FSR), the US, China, the UK and Russia together have more than 1700 subsidy measures in place. Recently, the European Court of Auditors concluded that certain foreign subsidies would constitute state aid if granted by a member state and that this differential treatment could distort competition in the EU’s internal market.

The economic crisis precipitated by the Covid-19 pandemic will only lead to a proliferation of similar foreign subsidies, making the issue of market distortion more pronounced. To address this asymmetry, the European Commission’s FSR proposal aims to authorise the Commission to investigate foreign subsidies benefitting companies in the EU, as well as to remedy any resulting market distortions.

Furthermore, this proposal is part of a broader increase of ex-ante controls throughout the EU, such as Foreign Direct Investment control (FDI) by EU member states (see our previous article here), and increased control of mergers below notification thresholds (see our previous article here). All these measures together aim to protect the internal market and simultaneously mirror the increase and tightening of ex-ante control in other large economies around the world.

Subsidies caught by the proposal

The overarching rationale driving the proposed FSR regime is to maintain a level playing field in the internal market between companies receiving foreign subsidies and those that do not. However, unlike under EU state aid law, foreign subsidies will not generally be prohibited. Instead, the focus will be on redressing the effects of “distortive foreign subsidies”. The definition of a foreign subsidy under the proposal – inspired by the World Trade Organization (WTO) Agreement on Subsidies, and by EU state aid law and practice – is comprehensive and capable of capturing all different types of foreign financial support. Such support is considered distortive if it augments the competitive position of the recipient undertaking to the detriment of effective competition in the market.

Market distortion will be determined based on certain indicators, including the amount, nature, and purpose of the relevant subsidy being investigated. Moreover, certain categories of foreign subsidies, such as grants to an ailing enterprise, unlimited debt guarantees, and those directly subsidising an M&A transaction or enabling an unduly advantageous tender, are presumed most likely to distort the internal market. As under EU state aid law, a noteworthy de minimis-style presumption is equally in play: a foreign subsidy below EUR 5 million granted over any consecutive period of three fiscal years is considered unlikely to distort the internal market. Nevertheless, depending on each specific case, the factors suggesting distortion, as well as the presumption ruling it out, may be refuted.

Mandatory notification for subsidised transactions

Undertakings receiving foreign subsidies and party to a merger or acquisition might trigger a mandatory notification. The parties involved, whether within or beyond the EU, may not implement the transaction prior to receiving clearance.

Under the FSR, a transaction would become notifiable to the Commission if

• it qualifies as a “concentration” under the EU Merger Regulation (EUMR) resulting in a change of control between two or more previously independent undertakings on a lasting basis;
• the target or at least one of the merging undertakings is established in the EU;
• the parties concerned generate an aggregate EU-wide turnover of at least EUR 500 million; and
• any of the undertakings concerned received from one or more non-EU states an aggregate financial contribution of more than EUR 50 million in the three preceding calendar years.

Joint ventures operating wholly outside the EU may still fall within the FSR’s scope if one of the parent undertakings is established in the EU.

When the Commission completes its review, it may issue an approval (either conditionally or unconditionally) or prohibit a deal if it is deemed to distort competition. The FSR’s proposed notification procedure and review periods are closely aligned with their counterparts in the EUMR, as are fines for “gun jumping” when the deal is executed before the mandatory notification has been made or before approval has been granted.

A remarkable feature of the proposal is the Commission’s power to “call in” a deal when it considers that the case merits ex-ante review even though it does not meet the thresholds as such. This non-restrictive approach to assuming jurisdiction is reminiscent of the Commission’s recently published guidance on Article 22 EUMR (see our previous article here), which empowers it to review transactions not meeting the EUMR’s thresholds.

Mandatory notification of subsidised public procurement bids

For public procurement, the FSR proposal contains no minimum foreign financial contribution that must be met to trigger a review. As long as the estimated value of the procurement is equal to or higher than EUR 250 million and the bidder has received some foreign financial contribution, the Commission has jurisdiction to review it. Companies participating in public procurement procedures that meet or exceed a value of EUR 250 million will need to disclose to the contracting authority concerned all foreign financial contributions received in the preceding three years. If they have not received any foreign financial support, they must provide a declaration to that effect. The contracting authority must forward all information received to the Commission.

Without a disclosure or declaration, it will not be possible for the participating undertaking to be awarded the procurement contract. Moreover, failure to notify can lead to fines. The Commission must complete its preliminary review within 60 days from the date of notification, and any in-depth review within 200 days. The assessment of bids by the contracting authority may continue unabated during the assessment periods, but the undertaking may only be awarded the contract if this statutory review period lapses and the Commission has not reached a decision or if the Commission has issued a no-objection decision. In practice, such an ex-ante screening in public procurement might affect the chances of a bid under review being awarded the contract or may discourage recipients of foreign subsidies from submitting a bid in the first place.

Investigations of below-threshold cases and other market situations

The FSR proposal aims to protect the EU internal market by granting investigative powers to the Commission for remedying the distortive effect of foreign subsidies in other market situations, too. Those include below-threshold transactions and public bids which are already completed, and the Commission might order the parties to unwind a transaction if it concludes that it led to a distortion of the internal market that cannot be remedied. Greenfield investments by companies from non-EU states might also fall within the scope of these investigations where a non-EU parent company creates a subsidiary or branch in the EU and builds its operations from the ground up.

Under the proposed FSR, the Commission may ex officio investigate any economic sector or activity to identify and rectify the distortive effects of foreign subsidies. The powers of the Commission are subject to a limitation period of ten years from when a foreign subsidy was granted.

Multiple notification regimes for one M&A deal

Merger control by the Commission, as a system for reviewing transactions meeting certain turnover-based quantitative thresholds, has been in operation since 1990. Now, it will be complemented by a parallel review system targeting transactions fuelled by foreign subsidies. At this moment, it is unclear whether the same case team at the Commission would review a deal that has also been notified under the EUMR and the FSR. In addition, if a merger is not notifiable to the Commission under the EUMR but is notifiable only in certain member states, it could still be covered by the proposed FSR. This could subject the same deal to review at the member state and the EU level. In addition, the EU is undeniably a major destination for Foreign Direct Investment and a growing number of EU member states have introduced or are in the course of introducing FDI screening mechanisms, including some with retroactive application for M&A in vital sectors and sensitive technology (see also our previous article on the proposed Dutch FDI regime here).

What to expect next

If the FSR proposal is adopted, companies should prepare for an increased regulatory burden. Another key consideration is how the FSR will interact with the chapter on subsidy control under the EU-UK Trade & Cooperation Agreement (see our previous article here). Bearing in mind the far-reaching implications of the proposed FSR regime, we expect extensive further debate and changes to the proposed regulation during the legislative process.