The new EU Regulation on the screening of Foreign Direct Investments
The new EU Regulation on the screening of Foreign Direct Investments
The new EU Regulation on the screening of Foreign Direct Investments: Moving towards a CFIUS review framework for the EU?
On March 19, 2019, the European Union (EU) formally adopted Regulation (EU) 2019/452 of the European Parliament and of the Council establishing a framework for the screening of foreign direct investments (FDI) into the EU (the Regulation). The Regulation, which covers a broad category of foreign investments affecting “security or public order” came into force on April 10, 2019 and will apply broadly from October 11, 2020. To date, there has been no general EU-wide framework relating to the screening of foreign direct investment into the EU. While certain mergers, acquisitions and joint ventures (including those involving foreign investors) may be subject to review by the European Commission (the Commission) under the EU Merger Regulation, that review is limited to ensuring that a transaction would not significantly impede effective competition in the EU (or in a substantial part of the EU). The introduction of the new Regulation marks an important first step by the EU towards an EU-level foreign investment screening framework similar to the review process of the Committee on Foreign Investment in the United States (CFIUS) in the US. While the Regulation stops short of introducing any form of CFIUS style blocking mechanism or suspension powers at EU-level in relation to foreign investment, it does introduce a comprehensive cooperation and information-sharing framework between the Commission and EU Member States, which will have a material procedural (and timing) impact for European deal-making falling within the Regulation's scope in the years ahead. The adoption of the Regulation may also embolden individual EU countries that do not currently have foreign investment controls in place to introduce new CFIUS-style review processes and screening mechanisms at the national level. Essentially, this will mean a more complex procedural environment for certain categories of foreign investment activity in Europe going forward.
The initial proposal for the Regulation was published by the Commission in 2017 amid growing concerns from European countries around the impact of certain foreign acquisitions (in particular, certain Chinese acquisitions) on security and public order in the EU. In publishing its initial draft of the Regulation, the Commission emphasized the EU's commitment to remaining an attractive location for foreign direct investment, noting that “openness to foreign investment” is “enshrined in EU treaties”. However, it also expressed concerns that certain foreign investments could be detrimental to the EU's interests, in particular, acquisitions by foreign state-owned or controlled companies of strategic assets that are critical to public order or security. The adoption of the Regulation is an attempt by the EU to balance these competing concerns. This move by the EU is in line with a global trend towards increased scrutiny of foreign investments. Within the US, 2018 saw the introduction of the Foreign Investment Risk Review Modernization Act (FIRRMA) which expanded and strengthened CFIUS's review powers with respect to foreign investments into the US. At Member State level within Europe, the Commission recently reported that 14 EU Member States (namely, Austria, Denmark, Finland, France, Germany, Hungary, Italy, Latvia, Lithuania, Netherlands, Poland, Portugal, Spain and the UK) currently have foreign investment screening mechanisms at national level and that several are in the course of reforming them or adopting new ones.
What does the Regulation do?
As a starting point, it is worth noting what the Regulation does not do:
It does not give the Commission or any other EU body or agency the power to suspend or block foreign investment into the EU (although the Commission can issue non-binding “opinions” on certain FDI as detailed below).
It does not require EU Member States to introduce or implement foreign investment screening mechanisms at the national level. Under the Regulation, each Member State remains primarily responsible for screening foreign direct investment in its own territory in accordance with its national laws. However, the Regulation sets out certain minimum requirements that must be incorporated into national screening processes (where they have been adopted), including transparency obligations, the rule of equal treatment among foreign countries, confidentiality obligations and the obligation to ensure adequate redress possibilities with regard to decisions adopted under these review mechanisms. The Regulation also provides for a cooperation and information-sharing mechanism between Member States and between Member States and the Commission for certain foreign investments falling within its scope (discussed further below). In addition, it imposes annual reporting requirements on Member States in relation to foreign direct investment taking place in their territory.
What type of investments fall within the scope of the Regulation?
The Regulation applies to foreign direct investments into the EU that are likely to affect security or public order.
Foreign direct investments
“Foreign direct investment” is defined broadly in the Regulation to include “investments of any kind” by natural persons or undertakings from non-EU countries, which aim to establish or maintain “lasting and direct links” between the foreign investor and an economic activity in an EU Member State. This definition could potentially incorporate a wide range of transactions by foreign investors involving EU assets or targets (including, for example, indirect acquisitions of EU assets or targets, where the lasting and direct link is established). Indeed, the recitals indicate that the Regulation is intended to extend to foreign direct investment through “artificial arrangements that do not reflect economic reality” – presumably to deter the use of local strawman entities or other complex structuring arrangements which could otherwise be put in place to circumvent the Regulation or any related national rules. The recitals do however clarify that the Regulation is not intended to cover portfolio investments.
Security or public order
Similar to the CFIUS review framework, the new EU framework is focused on foreign direct investments which raise security or public order concerns. In determining whether an investment is likely to affect “security or public order”, a Member State or the Commission may take into account its potential effects on a broad (and non-exhaustive) range of factors set out in the Regulation, including:
critical infrastructure, whether physical or virtual, including energy, transport, water, health, communications, media, data processing or storage, aerospace, defence, electoral or financial infrastructure, and sensitive facilities, as well as land and real estate crucial for the use of such infrastructure;
critical technologies and certain dual items, including artificial intelligence, robotics, semiconductors, cybersecurity, aerospace, defence, energy, storage, quantum and nuclear technologies, as well as nanotechnologies and biotechnologies;
supplies of critical inputs, including energy or raw materials, as well as food security;
access to sensitive information, including personal data, or the ability to control such information; and
the freedom and pluralism of the media.
In making their assessment, Member States and the Commission may also take into account (i) whether the foreign investor is directly or indirectly controlled by the government of a third country; (ii) whether the foreign investor has already been involved in activities which affect the security or public order of a Member State; and (iii) whether there is a serious risk that the foreign investor engages in illegal or criminal activities.
What is the cooperation mechanism and how does it work?
The Regulation establishes a cooperation framework which allows a Member State to request information and to issue comments on an investment in another Member State where the investment is likely to affect the national security or public order of the first Member State.
It also allows the Commission to request information and to issue opinions on investments that impact public order and security in more than one Member State. In particular, the Commission has the ability to issue opinions in scenarios where the foreign direct investment may affect projects or programs of EU interest (ie projects which involve substantial EU funding and which relate to critical infrastructure, technologies or inputs which are essential for security and public order). This includes certain projects in the areas of research (e.g. Horizon 2020), space (e.g. Galileo), transport (e.g. Trans-European Networks for Transport, TEN-T), energy (TEN-E) and telecommunications.
If more than one-third of EU Member States consider that an investment affects their security and public order, then the Commission is required to intervene and issue an opinion.
The final decision on how to treat an investment ultimately rests with the Member State in whose territory the investment is taking is place. However, that Member State must give “due consideration" to any comments from other Member States and/or any opinion issued by the Commission. Where the Commission issues an opinion taking the view that a proposed investment is likely to affect projects or programs of EU interest, the Members State must take “utmost account” of the opinion, and provide an explanation if the opinion is not being followed.
Controversially, the Regulation allows Member States and the Commission to provide comments and/or an opinion (as appropriate) on a foreign investment for a period up to 15 months after its completion. While these comments/opinions are not binding on the Member State in which the investment has taken place, there is nevertheless a risk for foreign investors that a completed transaction may be challenged under the Regulation for a significant period post-completion.
So is this the EU's answer to CFIUS?
Not quite. While FIRRMA imposes direct obligations on the parties to a transaction, the Regulation imposes obligations on EU Member States. For example, it is Member States (rather than the parties to a transaction) who are responsible for responding to an information request from another Member State or the Commission.
Ultimately, however, depending on how Member States react to the Regulation, we may in due course see more CFIUS-style review boards and related screening and blocking mechanisms appearing at national level in EU jurisdictions. It may, for example, be difficult for Member States to comply with their own obligations under the Regulation (particularly around the provision of information and reporting) without putting some kind of foreign investment controls and/or reporting mechanisms in place at national level.
How will this Regulation impact deal activity in the EU?
To fully evaluate the potential impact of the Regulation on foreign investments into the EU, we will need to wait and see how many EU Member States take steps to introduce national screening mechanisms and, ultimately, we'll need to see what those screening mechanisms look like. Notably, since publishing the initial draft of the Regulation in 2017, two additional EU countries (Hungary and Netherlands) have introduced national screening mechanisms. The formal adoption of the Regulation may well embolden and prompt other EU countries to do the same.
However, irrespective of whether a Member State introduces its own screening regime at national level, all Member States will be subject to the cooperation provisions (including the information-sharing requirements) outlined above. This adds an additional procedural layer, and related timing implications, for EU deal-making falling within the scope of the Regulation.
US deal-makers report that the CFIUS review process adds approximately 4-6 months to deal timelines. The EU merger control process (where applicable) can have a similar impact for EU deal-timelines where competition issues arise in seeking approval for the deal from the Commission. While the Regulation sets out specific timeframes that must be met when making and responding to information requests and it emphasizes that “undue delays” must be avoided, time delays for transactions falling within its scope are inevitable. Foreign investors will need to factor these potential timing implications into European deal planning going forward where a transaction potentially falls in the “security and public order” category.
On the positive side, for any EU countries that may currently operate opaque or complex rules around foreign investment screening, the Regulation may lead to more streamlined processes and greater transparency. As mentioned above, the Commission recently reported that 14 Member States currently have screening frameworks in place. All of these Member States will need to review their national frameworks to ensure they comply with the broad principles and requirements set out in the Regulation, including relevant timeframes, and the requirements of transparency and non-discrimination. Moreover, the ability to seek recourse against negative screenings may be a useful mechanism in the future for foreign investors who believe they have been subject to an unjust decision in a particular Member State.
The new EU framework adds an additional layer of procedural complexity to foreign investment activity in the EU that could potentially impact “security and public order”. While the new Regulation is a far cry from FIRRMA, it is indicative of a trend in Europe (and globally) towards an increased focus on national security concerns when it comes to foreign investment. As EU Member States consider and assess the impact of the Regulation for their national laws and frameworks, we may see more European countries adopting CFIUS-style review processes and screening mechanisms in the years ahead. This will inevitably mean a more complex transactional environment for foreign investors targeting European acquisitions, in particular those involving “critical infrastructure” and “critical technologies”.
While the Regulation will not fully apply across the EU until October 2020, US acquirers and investors that are assessing European targets should nevertheless be considering the potential impact of the Regulation, and identifying and considering applicable national screening regimes, early on in European deal-planning going forward. State-owned acquirers and investors with links to foreign governments should be particularly mindful of the new framework. Given the emphasis in the Regulation on “critical infrastructure” and “critical technologies”, investors in European utilities, as well as in European technologies, should also be particularly mindful.