FDI screening: EC proposes regime reform

June 2024  |  FEATURE | FINANCE & INVESTMENT

Financier Worldwide Magazine

June 2024 Issue

The European Union (EU) is an attractive destination for foreign direct investment (FDI). Transactions come from a multitude of sectors and geographies, and are a major source of growth and jobs.

Given the significant level of investment involved (over €1.2 trillion of FDI flowed into the EU in 2022, for example), screening FDI is a formidable task – one that falls within the purview of the EU FDI Screening Regulation, an FDI cooperation framework between the European Commission (EC) and EU member states.

Entering into force in October 2020, the objective of the regulation is to ensure the EU is better equipped to identify, assess and mitigate potential risks to security or public order, while remaining among the world’s most open investment areas.

“Since the mechanism came into effect, the result has been more comprehensive FDI screening across the EU, with 23 of 27 member states now having screening mechanisms in place,” observes Christoph Barth, a partner at Linklaters LLP. “However, despite promising results, divergences between national screening mechanisms remain, particularly with respect to timing, sectoral coverage and notification requirements.

“There has also been a significant increase in formally reviewed cases – 55 percent in 2022 compared to 29 percent in 2021 – with most authorised without conditions, use of remedial measures decreasing, and very few, just 1 percent, being prohibited cases. This suggests that a significant proportion of FDI reviews in the EU were unnecessary,” he adds.

Keen to tackle divergence in national FDI regimes across the EU, the EC has assisted member states with technical and policy guidance, meetings and information exchange, particularly with regard to best practices, culminating in proposals to reform the EU FDI regulation.

Proposals for reform

While the EC contends that that the EU FDI regulation has largely been successful in shielding member states from ‘risky’ FDI, shortcomings in the framework remain.

Thus, in a bid to boost the ability of member states to identify and adequately respond to transactions that could give rise to security and public order concerns, in its January 2024 report ‘Advancing European economic security’, the EC proposed several reforms to the EU FDI regulation, as outlined below.

First, in response to concerns that the regulation’s effectiveness was being undermined by the absence of a national screening regime in some member states, the EC has recommended that it be mandatory to do so – rather than voluntary, as is currently the case. If enacted, member states will have 15 months to adopt a national screening regime.

Second, in order to address concerns relating to differences between the procedural and substantive operation of national screening regimes across member states, the EC has proposed “minimum requirements” that national regimes must satisfy in order to ensure harmonisation across the EU.

Third, the EC has proposed that the scope of the regulation be expanded to capture investments between member states where the investor in one member state is controlled, directly or indirectly, by a foreign entity, regardless of whether the ultimate owner is located in the EU or elsewhere.

Fourth, the EC proposes an ‘own initiative’ procedure, whereby a member state can open an investigation into a foreign investment in the territory of another member state which has not been notified via the cooperation mechanism if it considers that the investment is likely to affect security or public order in the member state.

Lastly, the EC is proposing reform in relation to multijurisdictional transactions, such as requiring such transactions to be filed in all member states at the same time, requiring the same minimum level of information to be collected for such transactions and imposing additional cooperation obligations.

According to the EC, the reforms are necessary if the EU is to reflect the evolving geopolitical landscape and governments’ changing approaches to protecting national security and other national interests.

Timetable for enaction

At the time of writing, the EC’s proposed reforms are being discussed between the EC and EU member states. However, due to EU elections in June 2024, it is expected that results from such discussions will not become public before autumn and – in view of the long timeframe for legislative processed in the EU – the EC does not currently expect an entry into force before 2026.

“I expect to see expanded scope and reach but also some degree of harmonisation within the EU,” says Mr Barth. “It is unlikely, however, that there will be a central competence with the EC in the near or mid term, and divergence between member states will remain in place.

“The sectoral focus will be more aligned and settle on a ‘minimum standard’,” he concludes. “This broader reach means a further boost in the number of FDI screenings while the share of interventions will decline further, posing a material burden on regulators and investors.”

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Fraser Tennant