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Business & Geopolitics: Europe’s New FDI screening regulations

On June 17 2020, ahead of a tense EU-China summit, the European Commission published a white paper on levelling the playing field as regards foreign subsidies. The white paper is the result of a yearlong inflexion in EU’s foreign policy and economic doctrine in order to adapt the European Union to the realities of a Multipolar World by promoting a model of open strategic autonomy and by acknowledging China as a “strategic competitor” and as a “strategic rival”.

On June 17 2020, ahead of a tense EU-China summit, the European Commission published a  White paper on levelling the playing field as regards foreign subsidies. This White Paper intends to launch a broad discussion on the best way to effectively address the challenges identified. As can be read in the introductory statement, the results of the consultation will prepare the ground for choosing the most appropriate way to address the distortions created by foreign subsidies, including proposals for legal instruments.

China as a strategic rival to the EU in the context of Open strategic autonomy

The aforementioned Whitepaper is the result of a yearlong inflexion in EU’s foreign policy and economic doctrine in order to adapt the European Union to the realities of a Multipolar World by promoting a model of open strategic autonomy and by acknowledging China as a “strategic competitor”, or a “strategic rival”. These expressions have been used in a joint communication of the European Commission and of the EU’s High Representative for Foreign Affairs in March 2019. For the first time, the Commission moved beyond its hyper-cautious and perfunctory style by delivering a blunt assessment of China’s state driven development model.

China’s proactive and state-driven industrial and economic policies such as “Made in China 2025″14 aim at developing domestic champions and helping them to become global leaders in strategic high-tech sectors. China preserves its domestic markets for its champions, shielding them from competition through selective market opening, licensing and other investment restrictions; heavy subsidies to both state-owned and private sector companies; closure of its procurement market; localisation requirements, including for data; the favouring of domestic operators in the protection and enforcement of intellectual property rights and other domestic laws; and limiting access to government-funded programmes for foreign companies. EU operators have to submit to onerous requirements as a precondition to access the Chinese market, such as creating joint ventures with local companies or transfer of key technologies to Chinese counterparts.

The working document outlined 10 priority actions that the European Union and its Member States should consider in their relationship with China. It served ever since as the primary guideline for shaping EU’s policy toward China.

Regulation 2019/452: Allowing the screening of FDI on the grounds of security and public order

It coincided with the release of EU Regulation (2019/452) on March 19, 2019, which established a framework for screening foreign direct investments on security and public order grounds. This Regulation will enter into force fully in October this year. It provides a list of factors that could be taken into consideration when determining whether a foreign direct investment is likely to affect security or public order based primarily on its effects on:

  1. Critical infrastructure, whether physical or virtual, including energy, transport, water, health, communications, media, data processing or storage, aerospace, defence, electoral or financial infrastructure, and sensitive facilities, as well as land and real estate crucial for the use of such infrastructure
  2. Critical technologies and dual use items as defined in point 1 of Article 2 of Council Regulation (EC) No 428/2009 (15), including artificial intelligence, robotics, semiconductors, cybersecurity, aerospace, defence, energy storage, quantum and nuclear technologies as well as nanotechnologies and biotechnologies;
  3. Supply of critical inputs, including energy or raw materials, as well as food security;
  4. Access to sensitive information, including personal data, or the ability to control such information

The preamble of the regulation also suggests that Member states and the Commission could consider whether the foreign investor is directly or indirectly controlled by the government of a third country, including through ownership structure or significant funding, or if it is pursuing State-led outward projects or programmes.

In addition the regulation allows the Commission to issue an opinion addressed to a Member State where the foreign direct investment is planned if it is likely to affect projects or programmes of Union interest on grounds of security or public order. For the first time in EU history, this regulation gives the Commission a “droit de regard” on FDI planned in EU Member States by non-EU investors, although it stops short from giving the Commission a right to block any such investment. Indeed, the regulation states that “Nothing shall limit the right of each Member State to decide whether or not to screen a particular foreign direct investment within the framework of this Regulation.”

This was a clear departure from the EU’s hitherto conciliatory tone and preference for treating trade and investment-related matters within a multilateral framework – by referring them to the WTO rule making and arbitration bodies -, or by letting Member states decide on their own what they consider to be the most appropriate policies in that regard. Indeed, prior to that U-turn the position of the EU contrasted sharply with the brash rhetoric of Donald Trump toward China. But the European Union became increasingly frustrated by the slow progress achieved on WTO reform, especially regarding industrial subsidies and forced technology transfers.

The Coronavirus pandemic as a catalyst toward a more assertive EU doctrine

Since the outbreak of the Coronavirus pandemic on EU soil, in February/March 2020, influential EU Member states such as France, Germany and Italy put additional pressure on the European Commission to translate into tangible deeds the EU’s new strategic doctrine. Indeed, move toward strategic autonomy has been reinforced by the shortcomings identified in the management of the pandemic by several Member states – as critical supplies were lacking and unavailable due to the disruption of global supply chains – and the slow response of the European Commission to the Health Emergency crisis, allegedly because it had no proper mandate and tools to intervene in such a crisis.

It seems that the message has been received. A speech delivered by EU Executive Vice-President Margrethe Vestager at the College of Bruges on March 2, 2020 illustrated the more assertive tone endorsed by the EU Member States.

Our businesses need a level playing field, to reach their full potential. And we need to be as assertive in defence of fair competition globally, as we are here in Europe. (..) In global markets, we must not put ourselves in a position where we do only good turns, and don’t expect something in return. (..) And that’s not happening, if foreign businesses can freely buy European companies, but the countries they come from don’t let our businesses do the same. Or if foreign companies use subsidies to set up business in Europe, or to buy European companies, or to bid for public tenders at artificially low prices.

Margrethe Vestager

The purpose of the recently published White paper goes further in that direction. It aims at identifying and addressing in a proper manner the unfair advantages gained by state-subsidised companies coming from outside the EU that could undermine the level playing field for EU companies. Without naming them, Chinese SOEs and state-backed private companies are clearly the main targets of this new initiative led by the European Commission.

Where a beneficiary faces no or limited competition in its domestic market, it could leverage its privileged position in other markets, thereby enjoying an undue advantage over others. Foreign subsidies originating in States where access to markets is closed or restricted may be even more likely to cause distortions.

The White paper specifically addresses three practices:

  1. Acquisitions of EU companies by foreign investors backed by subsidies granted by non-EU states
  2. Submission to EU procurement
  3. Access to funding from the EU budget

As regards acquisitions, the whitepaper states that Foreign subsidies may lead to excessive purchase prices (outbidding) and at the same time prevent non-subsidised acquirers from achieving efficiency gains or accessing key technologies.

In some cases, the granting of foreign subsidies can also be driven by a strategic objective to establish a strong presence in the EU or to promote an acquisition and later transfer technologies to other production sites, possibly outside of the EU. There is thus a specific need to ensure a level playing field for the acquisitions of EU targets. This can ensure that all companies compete on equal footing to acquire key assets and stay at the technological frontier, while preserving the benefits that international competition and inward foreign direct investments deliver.

The procedure proposed in the whitepaper to assess the distortive nature of a foreign subsidy in an acquisition process complement existing EU Merger control regulations, which sets up a system of prior notification and approval for changes of control over undertakings above certain EU turnover thresholds. Indeed, as mentioned in the Whitepaper:

Concentrations are declared compatible with the internal market only to the extent that they do not significantly impede effective competition. While subsidies may be taken into account when assessing for instance the financial strength of the merged entity relative to its rivals, the focus of the analysis of the significant impediment to effective competition is on the structure of competition in a given market, not on the existence or effects of foreign subsidies as such. A new instrument would therefore with its different objective complement the Merger Regulation. If a given acquisition has to be notified under both such a new instrument and the Merger Regulation, the notification and possible assessment would be dealt with in parallel, but separately from each other under the respective instruments.

As for EU procurement, the document acknowledges that EU companies do not always compete on an equal footing with companies benefiting from foreign subsidies. Subsidised companies may be able to make more advantageous offers, thus either discouraging non-subsidised companies from participating in the first place or winning contracts to the detriment of non-subsidised.

Finally, the whitepaper outlines the distortive effect that can occur when companies benefitting from foreign subsidies seek access to funding from the EU budget.

In some cases, foreign subsidies are granted with the express objective of enabling companies to submit bids for public contracts, at prices that are below market price or even below cost, directly “underbidding” to the detriment of competing non-subsidised undertakings.

In addition, according to the document, subsidies may also be driven by strategic goals, in order to get a foothold in strategically important markets or regions, or to get privileged access to critical and major infrastructure.

To sweeten the pill, the document states that the need to redress the negative impact of such a distortion has to be weighed up against any positive impact.

In this assessment, the EU’s public policy objectives, such as creating jobs, achieving climate neutrality and protecting the environment, digital transformation, security, public order and public safety and resilience, would be taken into account. When balancing these considerations against the distortion, the degree of distortion would play a role. (..) Moreover, the balancing needs to be based on an appreciation of the various interests, including the need to protect consumers’ interest. If on balance, the distortion on the internal market caused by the foreign subsidy is sufficiently mitigated by the positive impact of the supported economic activity or investment, the ongoing investigation would not need to be pursued further.

We concur with Yong Bai, a Partner at Clifford Chance’s Beijing Office who wrote in a commentary on the White paper that:

Should the White Paper proposals be adopted, the acquisition of an EU target by foreign investors, particularly SOEs receiving government subsidies, may be subject to three different types of mandatory filings in the EU: merger control review, foreign investment review and subsidy review. Several parallel filings with different assessment criteria, possibly at both EU and national member state levels, would significantly increase filing costs and complexity, with implications for deal certainty and closing timetables.

Indeed, from the content of the White paper, it appears that the foreign subsidy criterion overlaps somewhat with the criterion based on direct or indirect control by a foreign government, as mentioned in Regulation 2019/452, that allows the Member states to block foreign investments on the ground of national security. However, the foreign subsidy criterion is much more extensive than foreign government control. The White paper proposes to extend to the former the regulations that restrict state-aid to European companies, as a way to enforce free and fair competition and to preserve the integrity of the single market. The tools proposed seem to increase the complexity and the number of stakeholders involved in controlling FDI and Mergers & Acquisitions at the EU level. Hence, it could have a detrimental impact on the attractiveness of the European market for foreign investors without reaching its main goal.

Our take: As a way to exercise leverage and political pressure on China amid ongoing EU-China negotiations, the White paper is a timely endeavour. However, from a purely functional perspective, a more pragmatic approach based on a reduced number of well identified criteria such as national security and EU interest – as already outlined in the FDI Screening Regulation (2019/453) – would be more effective to protect the European Union from predatory and unfair market practices than a complex multilayered system with overlapping objectives, procedures and responsibilities.

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