January 20, 2023
The EU Foreign Subsidies Regulation (FSR) entered into force on 12 January 2023. It represents a massive expansion in the European Commission’s power to investigate inward investment to the EU. This new regulation—the first of its kind in the world—attempts to assert control over subsidies granted by non-EU countries.
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.
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:
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 behavioural 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.
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:
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.
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:
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.