The FSR is driven by anxiety that foreign governments are subsidising their industries to the detriment of EU companies. Originally motivated by Chinese competition, this issue has become very prominent in the last six months as energy costs have increased sharply and the U.S. Inflation Reduction Act has introduced large subsidies for domestic U.S. production.
The EU is also responding by increasing the subsidies it is prepared to permit, but it is difficult to take this much further without undermining the EU’s single market. This is because the EU itself has a tiny “federal” budget. Almost all public spending is controlled by Member States which have very different levels of fiscal capacity. If the EU loosens its internal rules on subsidies too much, it will suck what economic growth there is towards the already wealthy Member States, undermining internal cohesion.
The entry into force of the FSR disclosure requirements precedes similar developments in other jurisdictions. Notably, the U.S. Congress recently passed the Consolidated Appropriations Act, 2023, which includes significant changes in merger control and state enforcement of antitrust laws and also adds disclosure requirements to the Hart-Scott-Rodino Act (HSR) notification forms for companies receiving subsidies from particular foreign entities, though the details and implementation of such disclosure requirements are subject to further rulemaking, including public comment. These requirements are very different from the FSR and focused on national security threats rather than protectionist concerns that motivate the FSR.
These developments mean companies in receipt of foreign subsidies—even things often not considered subsidy, like tax credits or state R&D partnerships—and doing business in the EU may face substantial additional red tape and risk of regulatory intervention. This is especially true of companies engaging in M&A.
The companies that are likely to be most severely impacted by the new regimes are state-owned entities, global conglomerates, large private equity firms and companies in receipt of known subsidies should prepare for the implementation of these laws now in order to avoid delays and issues further down the line.
Entry Into Force of the FSR
The FSR applies to companies that have received “financial contributions” from non-EU countries. The definition of foreign contribution is extremely broad and encompasses any direct or indirect financial contribution to a company engaging in an economic activity in the EU internal market. This includes: (i) the transfer of funds or liabilities (e.g., capital injections, grants, loans, guarantees, etc.); the foregoing of revenue otherwise due (e.g., tax emptions or the granting of special or exclusive rights without adequate remuneration); or (iii) the provision or purchase of goods or services. While only foreign contributions that qualify as “foreign subsidies” (i.e., selective benefits that could not have been obtained on market terms) may have a distortive effect and be subject to remedies, this judgment is for the Commission to make. The jurisdictional reach of the FSR is determined by “financial contribution.”
Monitoring tools – the FSR creates two ex ante notification obligations as well an ex officio market inquiry power:
- Transactions – companies must notify transactions to the Commission where: (i) the acquired company, one of the merging parties or the joint venture is established in the EU and generates an EU turnover of at least €500 million; and (ii) the companies to the concentration received, in the previous three years, aggregate financial contributions from foreign countries of at least €50 million.
- Public procurement procedures – companies must notify to the Commission participation in public procurement procedures, where (i) the estimated contract value is at least €250 million (and, if applicable, the aggregate value of the lots for which the company bids is at least €125 million); and (ii) the bidding company (including its main subcontractors and suppliers in the tender) received foreign financial contributions in the previous three years of at least €4 million per non-EU country.
- Catch-all review tool – the Commission can start investigations on its own initiative if it suspects that distortive foreign subsidies may be involved. This includes the possibility to request ad-hoc notifications for concentrations and public procurement procedures below the mandatory notification thresholds.
Sanctions – for the two ex ante tools, failure to notify (or early implementation prior to clearance) may result in a fine of up to 10% of aggregate worldwide turnover in the preceding financial year. Where a company supplies incorrect, incomplete or misleading information, it may be subject to fines of up to 1% of global turnover and periodic penalty payments up to 5% of the average daily aggregate turnover for each working day of delay.
Balancing test and remedies – Phase 1 will determine if there is a subsidy that could distort the market, while Phase 2 looks at whether the subsidy will distort competition and applies the balancing test. The Commission claims it will “balance”—in a way it hasn’t yet explained—the positive effects of the subsidy (for example on environmental goals or R&D) versus the negative effects on the single market. In out view, this will mean that should a foreign government award a subsidy that is larger than the Commission would have permitted under its own State aid rules, it will find the “balance” is negative. In this way, the EU will attempt to push trading partners to follow its own subsidy rules—or else it will restrict access to the EU’s single market via redressive measures. These include structural measures such as acquisition bans or reduction of market presence, or behavioral measures such as repaying the foreign subsidy, making adaptations to governance structure, etc. The Commission can also block deals or public awards and even unwind M&A transactions that have already been implemented.
The FSR has now entered an implementation phase in which the Commission will present in the coming weeks a draft implementing regulation to clarify key procedural rules (including the types of information which must be submitted when notifying a qualifying transaction or participation in a public procurement). The implementing regulation will then be open to feedback before its rules are adopted by mid-2023. The Commission will be able to launch ex officio investigations since July 2023 and the notification obligations for companies will be effective as of 12 October 2023.
US Disclosure Obligation in HSR Notification Forms
Like the FSR, the U.S. Congress adopted a broad definition of the notion of subsidies. This notion captures direct subsidies, grants, loans, loan guarantees, tax breaks, preferential government procurement policies and government ownership or control.
Any person submitting an HSR filing that received a subsidy from a “foreign entity of concern” must disclose information about those subsidies during the HSR notification process. Foreign entities of concern include:
- Entities owned by, controlled by or subject to the jurisdiction or direction of China, Russia, Iran or North Korea;
- Entities designated as foreign terrorist organizations;
- Entities on the list of specially designated nationals and blocked persons maintained by the Office of Foreign Assets Control of the Department of the Treasury (commonly known as the “SDN” list);
- Entities alleged by the U.S. Department of Justice (DOJ) to have been involved in activities for which a conviction was obtained under the Espionage Act, the Arms Export Control Act, the Atomic Energy Act, the Export Control Reform Act or the International Emergency Economic Powers Act; and
- Entities determined by the U.S. Secretary of Energy, in consultation with the U.S. Secretary of Defense and the Director of National Intelligence, to be engaged in unauthorized conduct that is detrimental to the national security or foreign policy of the United States.
The rulemaking on the scope of the disclosure obligation includes the U.S. Federal Trade Commission and DOJ consulting with several U.S. agencies and involves publication in the U.S. Federal Register, a public comment period and a period of no less than 30 days before its effective date. This process can take months or even years before final implementation. Unlike the FSR, no specific powers are contemplated for the U.S. antitrust agencies to act upon beyond their inherent powers under the U.S. antitrust laws.
Key Practical Takeaways
A company, for example, which benefits from the Inflation Reduction Act in the U.S. may need to notify the aid amount to the Commission prior to acquiring an EU-based company and or risk being subject in future to an ex officio Commission investigation.
In practical terms, companies should start “mapping” any financial contributions received on a group-wide basis regardless of whether these distort competition (as this is for the Commission to assess). Data collection is likely to be burdensome since direct and indirect foreign contributions fall within scope.
Notification of a concentration or a public tender procedure will require submission of information on financial contributions received over the last three years. If such financial contributions from foreign countries are on market terms, parties should ensure this is appropriately captured in contemporaneous documentation to avoid evidential issues further down the line.
Foreign governments have started to consider how they will respond so as to put pressure on the Commission to use its powers carefully. For example, bringing WTO or FTA arbitration complaints, introducing ex officio investigation powers so that EU companies can be targeted in response to FSR investigations, or introducing blocking statutes to prevent documents etc. being disclosed by companies to the Commission under the FSR.
For M&A deals, the entry into force of the FSR will also add an additional layer of complexity and legal uncertainty that will need to be factored into deal documents:
- Deal timetable – procedural rules for concentration notifications under the FSR are similar to those under the EU Merger Regulation (EUMR). The FSR envisages a Phase I review of 25 working days and a Phase II of 90 working days. A concentration which may be otherwise unproblematic from a competition perspective may still be delayed because of a long FSR review. This risk must be assessed and reflected in the long stop date. “Stop the clock” risk as a result of failure to provide information is likely to be particularly severe, given that foreign governments may resist companies providing the requested information.
- Risk shifting allocation – sellers and buyers will need to assess the risk that a concentration may only be cleared subject to remedies, or even be prohibited. This will have an impact during the due diligence process as information on foreign contributions will need to be provided. As with merger control risk assessments, the parties will need to negotiate the appropriate FSR risk allocation in their deal documents.
Finally, the FSR opens a new pathway for companies active in the EU to target foreign competitors with allegations of having received foreign subsidies. Such companies may want to explore the opportunity to lodge a complaint to the Commission or otherwise intervene as a third party during a concentration review. Third-party complaints are expected to be an important and useful tool of detection for the Commission to open ex officio investigations.
Special thanks to trainee Jade Tinslay who contributed to this publication.
