Foreign direct investment: what is the impact of the new EU FDI screening regulation on investments in Europe?

May 2021 | EXPERT BRIEFING | MERGERS & ACQUISITIONS

financierworldwide.com

EU Regulation 2019/452 of 19 March 2019 establishing a framework for the screening of foreign direct investments into the European Union (EU FDI Regulation) became applicable on 11 October 2020, introducing several changes to the way FDI is addressed at EU level. The EU FDI Regulation is not intended to introduce a ‘one-stop-shop’ in relation to foreign investments into the EU. While it seeks to increase legal certainty for EU member states’ screening mechanisms and to enhance EU-wide coordination on the screening of FDI, member states have sole responsibility to decide whether to set up a screening mechanism, or to screen a particular FDI in their territory notably on security or public order grounds.

The European Commission (EC) and member states are already cooperating in this regard to ensure the smooth implementation of the regulation at EU and national levels. Currently, 17 member states have an FDI regime in place. This number seems to be growing steadily, considering that several member states, including Austria, Poland, Slovenia, Finland and Czech Republic, have introduced new screening mechanisms within the last year, and others, including Belgium and Sweden, are considering implementing new FDI frameworks.

The global outlook for FDI in 2021 suggests that this trend is expected to continue, however it has also highlighted the need for companies planning to invest in the EU to be aware of the potential impact of the EU FDI Regulation on their transactions.

Growing scrutiny of foreign investment across the EU

In recent years, in response to changing investor profiles and investment patterns, there has been a shift in the importance of foreign investment reviews. Globally, several countries have become alert to the fact that they need to introduce new regimes or strengthen their existing screening mechanisms on FDI. In the EU, this has been translated as a need to foster cooperation between the member states and with the EC by establishing common standards for national screening mechanisms, including information sharing between various stakeholders.

The COVID-19 pandemic has also been a catalyst for this transition. Very early on, it became clear that the pandemic could be used as leverage for investors to acquire or invest in target companies that have been impacted by the crisis. To deal with these exceptional circumstances, many countries were required to revisit their FDI screening mechanisms, including restricting FDI in strategic assets, as a matter of urgency. To tackle concerns regarding inbound investments, the EC issued guidelines on 25 March 2020, designed to ensure an EU-wide approach to FDI screening during a public health crisis and related economic vulnerability.

In particular, the EC guidelines encouraged member states that have FDI screening mechanisms already in place “to make full use of tools available to them under EU and national law to prevent capital flows from non-EU countries that could undermine Europe’s security or public order”. At the same time, member states that did not have such mechanisms in place were urged “to consider all options, in compliance with EU law and international obligations, to address potential cases where the acquisition or control by a foreign investor of a particular business, infrastructure or technology would create a risk to security or public order in the EU”.

Developments since the application of the EU FDI Regulation

The EU’s approach to the crucial role of FDI in creating an investment-friendly environment has not changed. FDI is still considered an element of paramount importance, which could accelerate the EU’s growth by enhancing its competitiveness, creating economies of scale, bringing in capital, technologies, innovation and opening new markets for EU exports. Yet, certain types of investors and investments are expected to be at the centre of increased scrutiny with additional regulatory obligations.

More generally, the EU FDI Regulation’s main objective is to promote the creation of a cooperation mechanism, under which member states and the EC will be able to exchange information and maintain a minimum level of transparency regarding rules and procedures related to screening mechanisms, including relevant time frames. Furthermore, it introduces the obligation for member states to report on the application of their screening mechanisms on an annual basis.

This is the first time that the EC will be involved in FDI screening, which has, until recently, been the prerogative of member states. The EU FDI Regulation does not impose an obligation on member states to adopt an FDI screening regime. However, if member states choose to adopt or maintain mechanisms to screen FDI in their territory on the grounds of security or public order, they are required to notify the EC and all other member states. Member states may then comment on the FDI where they consider that their security and public order may be affected. Similarly, the EC may issue a non-binding opinion if it considers that the FDI is likely to affect security and public order in more than one member state, or when it could affect a project or programme of EU interest.

The final decision in relation to any FDI in any member state’s territory lies with the state itself. However, while the opinions of the EC and of the other member states are not binding, in practice, their competence to intervene may prove to have an impact on the final outcome and could result in more complex and longer FDI procedures.

What could be expected to raise investors’ attention in 2021?

The EU FDI Regulation adds a layer to the regulatory FDI framework in the EU. However, it is still too early to anticipate how member states will implement the new rules. National screening mechanisms still vary, both from a procedural and from a substantive review perspective. Accordingly, businesses need to strategically review their ongoing or contemplated transactions to have a better understanding regarding the timing and economics of their investments.

First, member states may approve reforms to their FDI legislation to include the elements that have been identified in the EU FDI Regulation as relevant in the assessment of an investment on security and public order grounds. This can be determined by looking into the latest trends, which indicate that member states are inclined to accelerate changes in their regimes and tighten FDI screening.

Second, companies must be well placed to carefully assess the specifics of their transactions in parallel with existing competition and trade rules. While the EU FDI Regulation is a significant step toward establishing common requirements among the national screening mechanisms, the FDI review framework is not harmonised. Some member states have adopted fully-fledged mechanisms to screen FDI. However, there are still several member states, which solely rely on their competition framework and antitrust instruments to review acquisitions in their territory.

At the same time, companies should be ready to review a potential investment from different jurisdictional angles. Indeed, the EC’s and other member states’ involvement may add further hurdles during the review process. Foreign investors that are interested in a target located in the territory of a certain member state, are now called to examine whether their investment may raise security or public order concerns within the country in which the investment takes place, but also to consider the impact of their investment in other member states as well as across the EU.

Third, targeting assets or infrastructure in strategic sectors is likely to receive additional scrutiny. The EU FDI Regulation provides a non-exhaustive list of sensitive sectors that member states may take into consideration when reviewing an FDI filing in their territory. Critical infrastructure, critical technologies, supply of critical inputs, access to sensitive information including personal data, and the freedom and pluralism of the media are examples that would typically fall under this scope. It is interesting to follow developments in the member states’ approaches in this regard, as this particularly concerns FDI in booming industries, including energy, transport, health, communications, media, financial infrastructure, defence, artificial intelligence, cyber security and biotechnologies.

Finally, the EU FDI Regulation reflects concerns regarding FDIs that are controlled directly or indirectly by the government of a third country, or which are pursuing state-led outward projects or programmes. Under the new framework, in determining whether an FDI is likely to affect security or public order, member states and the EC may also consider the ownership structure of the foreign investor and the financing of the planned or completed investment, including, when available, information about subsidies granted by third countries. This may result in more stringent reviews of deals pursued by governmental entities.

This is also in line with the EC’s White Paper dealing with the distortive effects caused by foreign subsidies, which was published on 17 June 2020. In the months to come, further action can be expected at EU level, as the EC is actively looking into various instruments and options to address distortions caused by foreign subsidies facilitating the acquisition of EU companies.

Melanie Bruneau is a partner, Antoine de Rohan Chabot is a senior associate and Antonia Rountou is a legal consultant at K&L Gates. Ms Bruneau can be contacted on +32 (0)2 336 1940 or by email: melanie.bruneau@klgates.com. Mr de Rohan Chabot can be contacted on +32 (0)2 336 1941 or by email: antoine.derohanchabot@klgates.com.

Melanie Bruneau, Antoine de Rohan Chabot and Antonia Rountou

K&L Gates