EU M&A after One Year of the FDI Regulation

In M&A and other transactions, conditions associated with foreign direct investment (“FDI”) filings are becoming more common place, and investors are adjusting to the diligence, disclosure and time associated with obtaining FDI clearances. In the EU, the introduction of wider-ranging FDI laws has been rapid, and freshly empowered national regulators in the Member States are already demonstrating their willingness to use the tools at their disposal where they believe that is necessary. For investors, the deal execution risks are sobering in circumstances where a failure to obtain mandatory clearance may render a transaction void (in addition to other possible sanctions). Transaction costs are also rising as longstop dates lengthen to accommodate sometimes unpredictable FDI review periods, especially for deals in the most sensitive sectors.

Marking one year since the full implementation of the EU FDI screening regulation (the “EU FDI Regulation” or the “Regulation”), this alert considers the first annual report on FDI (the “Report”) published by the European Commission on 23 November 2021 and reflects on M&A in the current EU FDI landscape.

FDI Regulation in the EU

The EU FDI Regulation, which entered into force on 11 October 2020 (see our previous blogpost here), establishes an EU framework and certain baseline standards for the screening of foreign investment by Member States and provides for a degree of cooperation among the Member States when exercising their respective national powers to review foreign investment. While the Regulation falls short of creating a one-stop shop notification or establishing any decision-making powers at the EU level, the Regulation introduces cooperation through two methods: (i) regular information sharing regarding Member State FDI screening; and (ii) a mechanism through which other Member States may provide comments, and the EU Commission may deliver an opinion, regarding a transaction subject to FDI screening in one or more Member States.

The Report attests to a common trend across Europe, the United States and other Western economies towards more rigorous FDI screening and expanded mandatory filing requirements. The Commission signals in its Report that it has a “strong expectation that all 27 EU Member States will put national FDI mechanisms in place”; also, that progress in this direction will have been made prior to its next annual report. Indeed, new and amended legislation is emerging across the Member States almost monthly. The Commission notes that 16 Member States (Austria, Czechia, Denmark, France, Finland, Germany, Hungary, Italy, Latvia, Lithuania, Malta, Poland, Romania, the Slovak Republic, Slovenia and Spain) have adopted new or revised existing laws concerning the review of foreign investment and that another eight Member States (Belgium, Estonia, Greece, Ireland, Luxembourg, the Netherlands, Portugal and Sweden) have legislative procedures on-going to do so.

The Year in Focus

The Report covers the one year period since the Regulation entered into force in October 2020. In the Report, the Commission outlines M&A trends across the year and the screening statistics notified by Member States pursuant to Article 5 of the Regulation and considers those transactions that received detailed scrutiny pursuant to the EU-level cooperation mechanism. The primary conclusions are the following:

• General M&A trends have been reflected in FDI screening. In the time period covered by the Report, foreign investment into the EU remained generally robust despite a particular drop in M&A activities in the second and third quarter of 2020 due to the Covid-19 pandemic. Certain sectors, including medical supplies, pharmaceutical manufacturing, and e-commerce, saw unprecedented surges in deal-making. The Information and Communications Technology (“ICT”) sector has also generally been little affected, and M&A within this sector was a driving force for transactional activity in the first quarter of 2021.
• The national screening statistics suggest significant caution among investors finding their feet with FDI filing requirements. At the same time, Member States remain open to FDI and appear to be utilising their powers in a relatively targeted manner:
  • 80% of the transaction dossiers submitted to the Member States were not reviewed pursuant to national FDI laws, either because of an evident lack of impact on security or public order or because they fell outside the scope of the national screening mechanism.
  • Of the remaining 20% of transactions that were subject to screening:
    • 79% were approved without conditions;
    • 12% were approved with conditions;
    • 2% were prohibited; and
    • 7% were aborted for unknown reasons before FDI screening was completed.
• With regard to the notifications submitted to the Commission via the EU cooperation mechanism, a total of 265 notifications were submitted by 11 Member States pursuant to Article 6 of the Regulation. More than 90% of these cases were notified by five Member States, namely Austria, France, Germany, Italy and Spain. The value of the transactions ranged from €1,200 to €34 billion, with the majority of the transactions having a value between €10 million and €100 million. The main sectors with transactions subject to FDI review included ICT, manufacturing, wholesale and retail. The five main countries of origin for investors were the U.S., the UK, China, Canada and the United Arab Emirates. Interestingly, the Commission issued a formal opinion pursuant to the Regulation in less than 3% of the notified cases.

The View From the Member States

For the purposes of the Report, Member States were invited to share their views on any significant procedural issues encountered during investment screenings and any possible ways of addressing them.

In general, Member States found the cooperation mechanisms of the FDI Regulation “a very useful instrument […] as it challenged [each Member State] to consider the implication for itself of investment operation in other Member States.” This leads to increased cross-EU scrutiny of FDI filing requirements. Member States mentioned that the notifications under the Regulation can provide “awareness” of transactions that may not have been notified under a given national mechanism, but rightly should have been, which may prompt “ex officio” action on the part of a screening authority. The Regulation has also fostered valuable discussions among the Members States and the Commission on transaction screenings in crucial evolving industries, such as the supply of semiconductors, where it has been reported the Commission issued a formal opinion in “one or more” deals.

Having said that, the Member States reported a number of challenges observed in connection with the Regulation:

• Member States highlighted a certain degree of inconsistency when it comes to the cases notified pursuant to EU cooperation measures. Member States suggested that too many FDI transactions have been notified, including transactions with no relevance for other EU Member States or the broader interests of the EU. As such, certain Member States commented that a common set of criteria for notification would free up the resources, among Member States and the Commission, to focus on critical screenings.
• For many, the timelines established by the Regulation are too short, making it difficult to give a proper assessment to complex FDI transactions and ask and assess the relevant questions or comments. One Member State noted that the two sets of distinct deadlines, in the Member States’ national mechanisms and the Regulation, create additional complications.
• Several Member States noted that the FDI Regulation creates additional resourcing requirements that can be hard to meet, especially for the smaller jurisdictions.
• On occasion, the ability to provide comments under the framework of the Regulation has appeared superficial in nature. For example, Member States noted that there have been instances where they were simply informed that “comments had been provided” without being provided with the content, and there is no obligation for the reviewing Member State to explain how they considered comments from other Member States in their final decision.

Such comments may prove to pave the way for the future amendments of the EU screening regulation (set to be reviewed in October 2023, if not earlier) and currently appear to hint toward an outline case for additional competence in FDI screening for the Commission.

The Next Steps

For the time being, Member States requested more guidance on which transactions require notification under the Regulation in order to concentrate on the most important transactions and avoid the “overloading” of the system. Unsurprisingly for a new system, criticism also aims at some key terms/definitions: one Member State suggested that key concepts in the Regulation could be better articulated, namely the trigger date for notifications, the definition of “foreign investor” and “foreign direct investments”, and the scope of matters that could reasonably be addressed in the comments delivered by one Member State to another pursuant to the EU cooperation mechanism.

The Commission has given a favourable response to most of the proposed solutions. While the Commission remains clear that “any foreign direct investment in [a Member State] that is undergoing screening” must be notified under the Regulation (Article 6(1)), it appears supportive of the idea of introducing a joint notification for multi-jurisdictional FDI transactions. Multi-jurisdictional transactions constitute 29% of all transactions notified pursuant to EU FDI cooperation measures. The Commission remarks (and consistent with our own experience) that “such cases raise a number of challenges, including differing timelines under different national legislation which may prevent synchronisation of notification and assessment under the Regulation”. Indeed, the submission of a “Form B” notice (an EU notification form prepared by the investor; the Form A is prepared by the Member State) by investors as a supplement to each FDI filing in a Member States can create a seemingly unnecessary burden at present. Each time a Form B is submitted, Member States and the Commission have an(other) opportunity to (re)consider and raise (further) questions about a transaction, with the time periods for EU coordination set out in the Regulation also running anew. While we have not observed this process being used to purposefully create difficulty for investors, investor confidence may be gained if procedures are streamlined and provide greater legal and practical certainty. It is pleasing to see that the Commission considers that the challenges for multi-jurisdictional transactions will “warrant careful consideration in the future”. Furthermore, it may be interesting to see if such reform can be implemented through procedural and administrative changes rather than legislative measures.

The Commission also announced in the Report that it has launched a study to examine the variations between the screening mechanisms of the Member States to determine their policy consequences and the effectiveness and efficiency of the Regulation.

Practical Conclusions

In the past two years or more FDI filings have become a common feature of M&A transactions, at least in certain sectors, and are becoming more familiar to investors and target companies. The FDI landscape remains subject to change, however, and it seems likely that the numbers of FDI filings will continue to rise as additional regimes emerge (e.g. in the Netherlands) and based upon further initiatives to expand mandatory filing requirements (e.g. in Germany in relation to critical infrastructure and France in relation to R&D in renewables, in each case with effect in January 2022).

In addition, while full clearance can be expected in the significant majority of cases, for those transactions that do raise potential or actual sensitivities, detailed scrutiny can be expected. Current and developing practice suggests that, at both the Member State level and through the EU cooperation mechanism, questions raised may range across a number of topic areas and be provided in several iterations.

As investors navigate this process, a conceptual challenge also remains concerning the substantive basis for FDI screening. The Regulation uses broad language to describe the Member States’ discretion to assess the risks to public order or security: all relevant factors may be considered, including the effects on “critical infrastructure, technologies and dual use items, the supply of critical inputs and the access to sensitive information.” At present, the practice among the Member State in interpreting these provisions appears to be varied, and any court precedent is scarce. Given the economic value of the FDI for the EU, and the much-needed legal certainty for investors, it may be valuable for the Commission to comment on the substantive assessment of the risks to public order or security in its future guidance documents.

Nonetheless, after one year of FDI screening in the EU (and a little more in advance of that), a number of key considerations for M&A planning appear clear:

• FDI is not only relevant to the biggest transactions (there are few thresholds or exemptions by deal value) or only relevant to acquisitions of majority control (10% investments—and occasionally lower—may trigger filing requirements);
• FDI due diligence requires time and the review of a range of data points and facts and information regarding the target company primarily, but also investors. Transaction parties are generally aligned in the careful conduct of this review given the risk that a transaction may be rendered void if mandatory filing requirements are breached. However, that balance may shift—to the investor which usually has the filing obligation, or to the target if warranties concerning mandatory filing triggers are requested;
• FDI conditions may be numerous for transactions concerning EU-based targets and in the absence of one-stop shop filing for EU FDI. As new Member State FDI regimes continue to emerge and existing regimes expand, a sweeper condition may be an appropriate protective measure—and may also be beneficial where mandatory filing sectors are not yet clearly defined in law or practice, or for those jurisdictions where broad call-in powers are provided by law; and
• FDI review periods can be unpredictable despite statutory timeframes, not least due to information requests and other powers to stop-the-clock. However, in general and once filing preparation is accounted for, a period of approximately 3-4 months is ordinarily sufficient in standard cases. Long-stop dates may extend to up to a year or even 18 months in the most sensitive transactions.

If you have any questions concerning the material discussed in this client alert, please contact the members of our Antitrust/Competition practice.