Impact of the EU Foreign Subsidies Regulation

November 2023  |  TALKINGPOINT | COMPETITION & ANTITRUST

Financier Worldwide Magazine

November 2023 Issue

FW discusses the impact of the EU Foreign Subsidies Regulation with Kai Struckmann, Katarzyna Berestecka, Douglas Tyler, Joris Van Malderen and Renaud Hendricé at Deloitte.

FW: Could you outline the factors that led to the European Union’s (EU’s) Foreign Subsidies Regulation (FSR)?

Struckmann: The Foreign Subsidies Regulation (FSR) framework came as no surprise as it responds to European business’ long-voiced concerns about the lack of effective tools to counterbalance unfair competition from third countries. State aid granted by European Union (EU) member states has been subject to strict control but, at the same time, the EU had no tools to tackle the adverse effects of foreign subsidies received by operators active in the EU. As a result, for example, when European airlines were going through painful restructurings and were forced to apply compensatory measures in the form of cost cuts and capacity reductions, they could only marvel at the level of service offered by Middle East airlines benefitting from public support. EU business’ complaints and lobbying eventually coincided with a more political approach that the EU recently took in its new industrial strategy, paving the way for the adoption of tools aimed at addressing various forms of foreign financial interference in the EU market.

FW: What notification requirements does the FSR place on companies operating in the EU? What exemptions and thresholds exist?

Berestecka: While not introducing periodic notification obligations, the FSR imposes a significant reporting burden on companies carrying out M&A activities or participating in large-scale procurement in the EU, especially if they do so on a regular basis. The reporting obligation is triggered in the case of M&A transactions where one of the merging undertakings, the target or the joint venture is established in the EU and generates an EU turnover of €500m and the parties received over past three years financial contributions of €50m. In the case of public procurement, reporting is mandatory if the contract value exceeds €250m – €125m per individual lot – and the tenderer received over past three years foreign state funding exceeding €4m. In both cases, a stand still clause applies, meaning that neither can the M&A transaction be closed nor public contract awarded before the EC concludes its investigation.

Hendricé: The FSR uses the term ‘foreign financial contribution’ which is very broad and covers various forms of financial input such as grants, loans, guarantees, tax incentives, as well as preferential access to infrastructure without proper remuneration. Reporting, where required, should cover financial contributions received globally over the past three years, subject to relevant value thresholds and limitations. In particular, detailed information is expected about financial contributions considered to be most likely to distort competition in the internal market, such as unlimited guarantees or subsidies directly enabling unduly advantageous bids, but only if the value of an individual contribution amounts to at least €1m. Information about other contributions exceeding €1m is expected in an aggregated form, per country, and only if the value of reportable contributions in a given jurisdiction over the past three years reached at least €45m – €4m in the case of public procurement procedures.

Berestecka: Notifying parties may apply for a waiver from reporting information which is not ‘reasonably available’ or not necessary for the European Commission’s (EC’s) review of the notification. The discussion on the granting of waivers takes place during so-called pre-notification contacts, an informal phase preceding the submission of the formal notification. Although this phase is not mandatory, it is recommended, and in practice is a very helpful element in the process, allowing potential uncertainties to be clarified early on and speeding up the formal review.

FW: What penalties face companies that fail disclose to the EC information about foreign contributions?

Tyler: The weight of the new regime is well reflected in fines that the EC may impose on companies failing to comply with obligations under the FSR. So, for those circumventing the notification obligations or disregarding the EC’s decision prohibiting concentration or the contract award, fines may be as high as 10 percent of the global turnover of the involved undertakings. Fines for the provision of inaccurate or misleading information are limited to ‘only’ 1 percent of global turnover but they may apply both in the case of intentional and negligent misreporting. The EC also may impose periodic penalty payments of up to 5 percent of daily global turnover on companies that fail to cooperate during investigations.

Struckmann: The EC enjoys wide discretion in setting the level of fines and, at least in other areas of competition law, has not been shy in exercising it – as evidenced by the recent fine of €432m – 10 percent of global turnover – imposed on Iluminia for closing its acquisition of Grail without prior EC merger clearance. The EC sees high gun-jumping fines as an effective tool for encouraging compliance with merger notification obligations. Thus, given that EC officials have already publicly declared ex ante compliance as one of their enforcement priorities under the FSR, one cannot exclude that the EC may want to use fines to send a strong message regarding the importance of FSR compliance.

FW: In what ways does the regulation empower the European Commission (EC)? How substantive is the EC’s power to investigate foreign financial contributions granted to companies operating in the EU?

Berestecka: The EC has vast investigative powers, underscored by a broad set of remedies, as well as hefty fines for non-compliance. To address distortions in the internal market, the EC can require the repayment of subsidies but also impose behavioural or structural remedies, such as divestment of certain assets, mandatory licensing or giving third parties access to subsidised infrastructure. The EC may also prohibit certain transactions or prevent the award of public contracts. Again, the consequences of non-compliance with imposed remedies can be costly, reaching up to 10 percent of global turnover. While the EC’s practical ability to gather data or enforce discovery in third countries is far from guaranteed, it enjoys the right to take decisions based on the facts available. As such, lack of cooperation still has adverse effects as it limits the companies’ ability to submit elements in their defence and increases the EC’s discretion in assessing their case.

Hendricé: Formally, the FSR applies indiscriminately to EU and foreign companies alike. The same goes for private or public ownership or the legal form of undertakings. It also does not exclude any specific sectors. While some industries like aluminium or semiconductors have previously been named as most likely candidates for review, first reports, however, mention complaints about the allegedly unfair advantage that certain European football clubs have over competing clubs thanks to generous financing from Middle East investors. Yet, the EC has full discretion to set its enforcement priorities and deploy its powers as it sees fit in light of specific market situations. Strategically, EU companies may not be a primary target, but it cannot be excluded that the EC will also open some investigations into domestic players to showcase impartiality and discourage EU operators from unfair advantages abroad.

Struckmann: The intent behind the FSR framework is not to defer third countries from granting subsidies in general but just to better control and address the impact they may have on the EU market. As such, the FSR does not prevent players active in the EU from receiving foreign support but increases transparency by imposing reporting requirements if they do so. Further, in case of subsidies which directly or indirectly affect the EU internal market, the EC applies a balancing test and may act and impose remedies only if the negative effects of these subsidies are not outweighed by any positive effects they may have. For example, offering a cure for a rare disease at a low price may affect competition on pharmaceuticals within the EU, but the EC will also have to consider its life-saving effects and more broadly, positive implications for EU healthcare systems.

FW: How important is the FSR’s provision to investigate ex officio any other market situations where potentially distortive foreign subsidies may facilitate the operations of certain companies in the EU?

Hendricé: Ex officio investigations will lend credibility to the EU’s ambitions pursued using the FSR framework. Formal powers and their actual use are of course two different things, and it remains to be seen how often the EC will use this option. At the moment, the EC has rather scarce resources available for FSR enforcement coupled with an uncontrollable number of notifications. So, initially, it will focus its efforts on enforcing ex ante compliance with the FSR, and specifically notification and reporting obligations. However, going forward, one may expect a mix of cases triggered by both notifications as well as at least a number of ex officio cases to establish enforcement credibility and complement antidumping procedures, for the purpose of efficiently countering ‘unfair’ competition from abroad and ensuring a level playing field.

Tyler: The ‘threat’ of ex officio investigation will be a significant global policy and policing event. The notion that certain subsidies are influencing the European market will likely be subject to a longstanding philosophical question in some instances. The nature of the role of government, and the efficiency of government, as well as individual rights will likely become part of public discourse. Positions may well be echoed from distant regions of the world, both geographically and politically.

FW: What do you consider to be the most pressing challenges and issues for companies in light of the FSR?

Van Malderen: The first and foremost challenge is to identify and review foreign contributions received. This task is equally important for potential notifications as it is for due diligence purposes and it requires establishing systemic and preferably, automated tracking and recording solutions. As the relevant data is not homogenous, not precisely defined and stored in various systems and geographies within the organisation, it can be very burdensome and calls for a systemic, yet tailor-made approach. Also, the determination of whether a specific contribution is reportable or not may require complex legal and economic assessment. At least in theory, in addition to cash grants and tax incentives, all contracts should be screened to identify those which are concluded with public entities and on terms that divert from standard market terms. In the case of multinationals with millions of contracts to screen, without adequate processes it seems to be a solid candidate for the 13th labour of Hercules.

Berestecka: Lack of timely preparation for potential notifications may significantly impact the transaction timetable or even exclude the possibility to participate in public tenders. In the context of public procurement procedures, apart from pulling the company’s own data, a filing also requires the bidder to ensure that any consortium members or its suppliers have done their job thoroughly. As a result, the ability to timely compile the requisite information may become an important consideration when selecting suppliers or subcontractors for public contracts. As regards general due diligence and potential ex officio EC investigations into specific subsidies, any risk assessment requires not only identifying contributions received globally which may qualify as subsidies, but also assessing their impact on the EU internal market, which is a complex legal and economic assessment. Building awareness across the organisation is also crucial as the lack of a comprehensive approach may threaten compliance efforts.

Tyler: The FSR is accelerating transparency in the reporting of financial benefits received by global companies. The notion of reporting and publicly disclosing subsidies has been increasing over the years in different markets and jurisdictions around the world. The requirement for reporting of non-EU based contributions, however, is interesting, as it would seem to present a presumption of compliance with EU-based rules for EU financial contributions. While the ability of global companies to report financial subsidies is more of a compliance exercise, actual implementation is a far greater effort than it may first appear. Documentation is an activity that perhaps will help companies to be effective in managing their global asset deployments, which may be an unintended consequence of the regulation.

FW: With notification mandatory from 12 October 2023, what advice would you offer to companies on preparing to report foreign contributions to the EC? How should key difficulties, such as accounting for foreign financial contributions, be tackled?

Van Malderen: As each company is different, there is no ‘one size fits all’ solution for FSR compliance. Certain steps are, however, necessary to design the best approach for each company. In terms of preparatory work, first is assessing how the FSR applies to the specific company based on its business model and geographic footprint. That should help determine whether and how often the company is likely to enter in-scale M&A transactions and public procurement procedures. It also should give a preliminary view on which activities benefit from significant public support and which could potentially be subject to individual investigations. The next step is to map data sources – both databases and employees – that can provide relevant information. Based on the results of the first two steps, processes and tools allowing extraction and reporting of relevant data should be developed. This includes a central database that would allow storing and processing of tracked information.

Hendricé: The implementation phase requires a significant effort from the company and employees involved but the burden may be eased by putting in place automated processes and appropriate tools. These should allow easier identification of relevant information and reporting to the central database. Given that the relevant data is likely scattered around different geographies, systems, business units and central functions, a combination of several tools may be necessary. Creating a central database should allow automatic categorisation, filtering and processing of information relevant for threshold verification, and production of reports. Long term, reporting of FSR-relevant information and transactions should become an integral part of a company’s financial reporting and accounting systems. One should also not forget about staff training to raise awareness of FSR requirements, including allowing employees to efficiently participate in the compliance effort to limit the risks of non-compliance.

FW: Looking ahead, what impact do you believe the FSR is likely to have on companies operating in the EU? By what yardstick should its effectiveness, or otherwise, be measured?

Tyler: New reporting obligations and the risk of high fines will need to be taken in the context of planned acquisitions or bidding for public contracts, as well as business strategy more generally. In the case of M&A, verifying FSR thresholds and preparing notifications will become an additional mandatory element of the process, which already requires a number of clearances and approvals. The exact impact on transaction timelines remains to be seen, but given difficulties related to collecting data, it may – at least at the beginning – be significant. Companies will need to take this into account in their agreements and risk allocations. Contracting entities and participating bidders also need to take into account new obligations which may result in extended timelines, challenges from competing bidders and the risk of being excluded from procedures. More generally, the FSR can also affect the choice of consortium members and suppliers, since contracting with foreign partners may make notifications more complex.

Struckmann: The effectiveness of the FSR framework should be measured by taking into account its key objective – levelling the playing field in the EU. The benefits for European business cannot simply be measured by the number of notified transactions or opened investigations. Results will be less quantifiable but still tangible, in the form of removing unfair competition in specific sectors of the economy. Thus, success will depend on a number of elements, ranging from the EC’s readiness and capacity for policing any distortions to the effectiveness of its enforcement powers. In this regard, the EC will have to act cautiously but also with determination, in order to establish the credibility of what it has itself identified and ‘marketed’ as a key policy objective for strengthening the EU’s economy in a global market.

Kai Struckmann is the leader of the EU Law and State Aid Center of Excellence within Deloitte Central Europe. He has been practicing EU law at institutional level as well as private practice for more than 20 years. He advises and litigates on a broad range of questions, with a focus on competition law and state aid, and is recognised by Who’s Who Legal in its Global Elite ranking as a thought leader for ‘competition-state aid’. He frequently advises companies on the implications of the Foreign Subsidies Regulation (FSR). He can be contacted on +32 479 49 27 33 or by email: kstruckmann@deloitte.com.

Katarzyna Berestecka is a senior EU lawyer with over 10 years of experience in EU law and is a member of the EU Law and State Aid Center of Excellence within Deloitte Central Europe. She advises on a broad range of questions of EU law, with a focus on state aid, regulatory matters and competition law. She has been involved in a number of proceedings before the EU courts in Luxembourg in state aid and competition matters. She frequently advises on compliance with the FSR framework. She can be contacted on +32 489 330 254 or by email: berestecka@deloitte.com.

Douglas Tyler has over 25 years of experience in economic development and public policy that he brings to his clients and serves as the US global C&I practice leader. He has worked with global companies to report on subsidies in over 60 countries, co-developed Deloitte’s leading technology solution for global incentives tracking and assists some of the largest clients establish global subsidy governance. He can be contacted on +1 (212) 436 3703 or by email: dtyler@deloitte.com.

Joris Van Malderen is a consulting partner focusing on digital finance and multifunction global business services. He works with chief financial officers to help them outpace their competition by creating high-precision and low-touch finance operations while driving superior business outcomes. He works with chief experience officers during all stages of their shared services journey, from strategic assessment and implementation to final value realisation. He can be contacted on +32 499 567 446 or by email: jvanmalderen@deloitte.com.

Renaud Hendricé is partner of the global investment and innovation incentives department. He advises major multinational companies on their international corporate tax planning. Taking advantage of his international experience, he also assists clients with implementing and coordinating intellectual property (IP) and research & development schemes in other jurisdictions taking into consideration IP registration and funding matters. He can be contacted on +32 2 600 6721 or by email: rhendrice@deloitte.com.

© Financier Worldwide

THE PANELLISTS

Kai Struckmann

Katarzyna Berestecka

Douglas Tyler

Joris Van Malderen

Renaud Hendricé

Deloitte