Regulation 2019/452 (as amended, the FDI Regulation) inserted the European Commission (the Commission) into a hitherto jealously guarded area of EU Member State authority – screening of foreign direct investment (FDI) for threats to security and public order. In spite of its limited formal powers, the Commission now plays a key role in setting FDI screening policy in Europe, and its importance is set to increase further.
M&A practitioners may be concerned by the additional complexity of navigating the FDI Regulation in addition to FDI rules at Member State level.
Under the FDI Regulation, Member State authorities, not the Commission, have the final say over proposed FDI. The FDI Regulation merely set out minimum requirements for Member States’ FDI screening mechanisms and a mechanism for Member States and the Commission to ask questions and share views on proposed (or even already implemented) investments throughout the EU. Coordinating these communications, however, the Commission sits in the centre of an EU network of FDI screening authorities and has considerable practical power.
One striking effect of the FDI Regulation is the proliferation of FDI screening mechanisms in the EU. The regulation does not require Member States to implement screening mechanisms, but the Commission now publically urges all Member States to do so such that by June 2021, 24 (out of 27) had or were in the process of adopting such regimes.
In late 2021, the Commission published its first annual report on experience with the FDI Regulation (the Report), providing valuable insights into the regulation’s practical impact and likely next steps.
The FDI Regulation: Hybrid enforcement, EU style
Scope. The FDI Regulation applies to screening mechanisms for FDI, defined as investments of any kind by a “foreign investor” aiming to establish or to maintain lasting and direct links to an economic activity in a Member State, including investments enabling “effective participation” in management or control of the target. The concept of “effective participation” is much broader than “control”, and the new mechanism is not subject to any minimum turnover or other size-based test.
The FDI Regulation sets out a uniform set of factors for FDI screening, including potential effects on:
- critical infrastructure (including energy, transport, water, health, communications, media, data processing or storage, aerospace, defense, electoral or financial infrastructure, as well as sensitive facilities and investments in related real estate);
- critical technologies and dual use items (including artificial intelligence, robotics, semiconductors, cybersecurity, quantum, aerospace, defense, energy storage, and nuclear technologies, nanotechnologies and biotechnologies);
- supply of critical inputs (including energy, raw materials, and food security);
- access to or the ability to control sensitive information (including personal data); and
- freedom and pluralism of the media.
In response to the COVID-19 crisis, the Commission also published guidance calling for particular attention to the healthcare sector.
Minimum requirements. As noted, the FDI Regulation sets out minimum criteria for Member States' screening mechanisms. National mechanisms must be transparent and not discriminate against third countries. Member States must set out the circumstances triggering screening, the grounds for screening and detailed procedural rules. Member States must establish timeframes for issuing screening decisions that allow them to take into account the comments and opinions of Member States and the Commission. Confidential information must be protected, and foreign investors and other parties concerned must have the possibility to seek judicial redress against screening decisions.
EU coordination. The FDI Regulation creates an elaborate cooperation mechanism for FDI undergoing screening. Member States must notify the Commission and other Member States of any FDI that is undergoing screening. Where a Member State considers that an FDI planned or completed in another Member State is likely to affect its security or public order, or otherwise has relevant information, it may provide comments to the host Member State, with a copy to the Commission. The Commission must then notify the other Member States and may issue an opinion itself. A Member State may request the Commission to issue an opinion or other Member States to provide comments, and the Commission must deliver such an opinion if requested by at least one-third of Member States.
Upon receipt of an initial notification that an FDI is undergoing screening, the Commission and Member States have 15 calendar days to notify the Member State concerned that they intend to provide comments or an opinion and to request additional information. Opinions and comments should be delivered within 35 calendar days of the original notice, or 20 calendar days from receipt of any additional information requested. The Commission may issue an opinion following comments from other Member States no later than 40 calendar days from the original notification.
The Report: Lessons from the first year
The Regulation requires Member States to notify the Commission of any new or existing screening mechanism, as well as any changes. Member States also submit annual reports including a list of FDIs screened and undergoing screening; screening decisions prohibiting investments or submitting them to conditions; the sectors, origin, and value of the investments; and whether an investment undergoing screening is likely to be caught by the EUMR.
On November 23, 2021, the Commission published the Report, based on input from the Member States and other sources. Considering that the FDI Regulation was only applied from October 2020, the Report includes data from two periods; “investment dossiers” for calendar year 2020 and transactions reviewed between the regulation’s entry into force and June 2021.
According to the Report, inward FDI into the EU fell 71% between 2019 and 2020, compared to a global reduction of 35%. The U.S., Canada and the UK accounted for over half of foreign investments into the EU, with China accounting for only 2.5% (down from 4% in 2019). This reduced level of inward investment nonetheless generated almost 1,800 notifications under Member State FDI regimes, of which 80% were not formally screened either because of the evident lack of interest or because they did not meet the notification criteria. Of those that were screened, 79% were approved without conditions, 12% were approved with conditions and 2% were prohibited.
Following implementation of the FDI Regulation, 265 transactions were notified to the Commission by 11 Member States through June 2021, originating mainly from the US (45%), the UK (9%), China (8%), Canada (4%) and the United Arab Emirates (3%). 80% were closed in Phase I and 14% in Phase II, with the Commission requesting additional information.
The average delay before the Commission received the requested information was 31 days, but there was a very large range, from 2 to 101 days. The information requested typically included data on products and/or services of the target company; possible dual-use classification of any products involved; customers, competitors and market shares; the target’s IP portfolio and R&D activities; and characteristics of the investor. In April 2021, the Commission published a notification template designed to upgrade the information submitted and speed up reviews.
The Commission’s role under the FDI Regulation, on its face, appears quite limited. Final decision-making power rests with the Member States, who can choose whether or not to create a screening mechanism and 24 Member States have now done or are doing so.
Although the Commission has no power even to adopt implementing measures, it took a major step to harmonize EU notification processes by publishing a notification template, as well as detailed discussions of key concepts in a frequently asked questions document and guidance on how Member States should adapt their screening practices in light of the Covid-19 pandemic.
In 2022, the Commission’s role is set to increase further. A study that may lead to proposed amendments to the FDI Regulation, as well as formal guidelines, is under way. A post-pandemic recovery of FDI levels, combined with the growing number of EU screening regimes, will significantly increase the number of cases passing through the review and comment process.
The FDI Regulation is the first to create a general EU framework for reviewing private transactions since the EU Merger Regulation (the EUMR) in 1989, but it is unlikely to be the last. For example, another new screening mechanism will likely be created under the EU’s anti-subsidy regulation proposed in May 2021. Meanwhile, a new approach to EUMR referrals adopted in March 2021 gave the Commission effectively unlimited jurisdiction to review M&A transactions whether or not they met the EUMR’s “Union dimension” thresholds effectively abandoning the EUMR’s (formerly) fundamental ‘one-stop-shop’ principle.
M&A Outlook 2022: W&I insurance | a resilient factor in M&A transactions
Although the first ever Warranty & Indemnity insurance (better known in the US as Representation & Warranty insurance) (W&I insurance) policy was written more than twenty years ago, it is only in the past five to ten years that W&I insurance has become a mainstream and widely applied M&A solution for larger and smaller M&A transactions.