The Foreign Subsidies Regulation – beware and get your data ready!

The Foreign Subsidies Regulation entered into force on 12 January 2023. This new regulatory framework provides the European Commission (the Commission) with far-reaching tools for dealing with the effects of foreign subsidies (i.e. subsidies granted by non-EU governments) on the internal market. For many years, the EU state aid control regime has been ill-shaped, covering only interventions by EU Member States and thus leaving the Commission without appropriate instruments to tackle aid (“subsidies”) granted by non-EU governments (noting that the scope of trade rules is limited and insufficient to tackle the subsidisation issue), even though such aid could result in parties being able to bid higher amounts in the M&A processes or at a lower price in a public tender. This has led to unfair advantages for certain companies and (thus) a distortion of the holy grail of the European Union: the single market. The new FSR has been adopted to close this regulatory gap and to ensure that a dynamic and competitive market is effectively preserved.

Key concepts

Foreign subsidy

The FSR applies to foreign subsidies, consisting of four cumulative elements:

1. a financial contribution – a sweeping concept, including the transfer of financial funds or liabilities (such as capital injections, grants, loans, loan guarantees, tax incentives and debt forgiveness, debt-to-equity swaps and debt rescheduling), the non-collection of income due (such as tax exemptions and the granting of special or exclusive rights to an enterprise without adequate compensation), and (even) the supply or purchase of goods or services;
2. provided directly or indirectly by a third country, through either a government, a public entity or a private entity (whose actions can be attributed to a third country);
3. conferring a benefit to an undertaking engaged in an economic activity in the internal market – a financial contribution confers a benefit if it could not have been obtained under normal market conditions; and
4. which is limited in law or in fact to one or more enterprises or industries – in other words, the aid must be selective.

Distortion of the internal market

There is no general ban on foreign subsidies, and the assessment of whether a foreign subsidy is capable of distorting the internal market will be at the core of the Commission’s enforcement of the FSR. On establishing the existence of the foreign subsidy, the Commission will have to determine on a case-by-case basis whether the subsidy distorts the internal market before it can decide to prohibit the subsidy, impose redressive measures or accept commitments.

In order to determine whether a foreign subsidy distorts the internal market, the question to be answered is how such a foreign subsidy actually or potentially affects competition in the internal market. Relevant indicators in this regard include the amount and nature of the foreign subsidy, the purpose of and conditions attached to the foreign subsidy, and its use in the internal market.

Balancing test

The FSR embodies a balanced legal framework, introducing the effects-balancing test, allowing the Commission, based on information received, to weigh the negative effects of a foreign subsidy against any positive effects arising from the development of the subsidized activity, taking into account also vast public interest considerations, such as the subsidy’s broader positive effects in relation to achieving EU policy objectives (e.g., environmental protection, digital transformation, sustainable economy, etc.). While conducting the balancing analysis is, in principle, at the Commission’s direction, the Commission will have to do so when deciding on the redressive measures or commitments.

The Commission’s toolbox

Drawing inspiration from the EU competition rules (i.e., antitrust, merger control, and state aid control), the FSR has the same enforcement setup (with ex ante and ex officio tools) and vests far-reaching investigative powers to the Commission, which will be its sole enforcer.

Notification-based tools for in-scope M&A and public procurement procedures

The two mandatory pre-authorisation tools are envisaged in the form of notifications related to the concentrations and public procurement procedures satisfying the applicable thresholds.

Notification threshold for concentrations

Under the FSR, ‘concentrations’ (a concept modelled on EU competition law) must be notified to the Commission prior to completion (read: closing) if two thresholds are met:

• turnover : at least one of the merging parties (in the case of a merger), the target company (in the case of an acquisition) or the joint venture (note: greenfield JVs do not require notification) is based in the EU and has achieved a EU turnover of at least €500 million in the previous financial year; and
• financial contribution (i.e. this is broader than the concept of a subsidy): the companies listed below together received a total of more than €50 million in financial contributions from third countries in the three years preceding the conclusion of the agreement, the announcement of the takeover bid or the acquisition of a controlling interest:

1. in the case of an acquisition: the buyer(s) and the target company;
2. in the case of a merger: the merging companies;
3. in the case of a joint venture: the joint venture partners and the joint venture.

Considering the very low amount that is required to meet this second limb of the notification threshold and the broad definition of a financial contribution, it is likely that any kind of transaction over the €500 million mark will fulfil the second criterion.

In addition, the Commission may require notification of a below threshold transaction prior to its closing if it suspects that foreign subsidies may have been granted to the parties to the transaction in the three years preceding the concentration. This theoretically allows the Commission to assess any concentration under the FSR (Note: Transitional provisions (Article 53): this Regulation shall apply to foreign financial contributions granted in the three years prior to 12 July 2023).

Notification threshold for public procurement procedures

A foreign financial contribution in the context of the public procurement procedure qualifies as notifiable if:

• tender value: the tender value is at least €250 million, and
• financial contribution: the economic operator (including its main subcontractors and main suppliers involved in the same tender) has received aggregated financial contributions exceeding €4 million in the last three years.

While the first limb of the notification threshold is significantly high to target mostly large infrastructure projects such as railway or telecommunications, the financial contribution threshold is extremely low and therefore runs a similar risk mentioned in relation to the concentration thresholds of subjecting any procurement bid with even a small international dimension to a notification requirement.

Again, the Commission may exercise its ex officio investigative powers to call in procurements below this threshold. (Note: Transitional provisions (Article 53): this Regulation shall apply to foreign financial contributions granted in the three years prior to 12 July 2023).

Reporting obligations and notification procedure

Having received a lot of criticism on the first draft Implementing Regulation’s extensive reporting obligations, the Commission has limited detailed reporting in the revised draft to the following foreign financial contributions:

• granted in the last three years prior to notification;
• worth above €1 million; and
• falling into a category most likely to cause distortions (e.g. subsidy to ailing undertaking, unlimited guarantee, subsidy enabling unduly advantageous tender or directly facilitating a concentration).

To cut the red tape and avoid the risk of receiving voluminous information concerning financial contributions which are unrelated to the transaction or public tender bid and reasonably cannot be expected to amount to subsidies, let alone distortive ones, the Commission has also exempted certain categories of non-distortive foreign financial contributions from notification, such as non-selective tax reliefs, the supply or purchase of either goods or services (except financial services) at market terms, financial contributions below €1 million and aggregated financial contributions by a particular third country in the three preceding years that stay below €45 million.

The procedure for notifying foreign subsidies is broken down into two steps, consisting of a preliminary review (Phase 1) and an in-depth investigation (Phase 2). The timeline for conducting the preliminary review is set to 25 working days for concentrations and 20 working days for public procurements. If the Commission finds that the financial contribution is not a foreign subsidy and does not distort the internal market, it may close the investigation. Otherwise, it can open an in-depth investigation, which can take up to 90 working days for concentrations and 110 working days for public procurements. As regards the latter, the FSR extends the usual timeline for awarding procurement contracts in the case of an in-depth investigation, meaning that contracting authorities may have to adapt their procedural bidding models to minimize the risk of over-extending the selection stage.

Similar to merger control proceedings, transactions falling under the scope of the FSR will require approval from the Commission before they can be completed. This creates a ‘standstill obligation’ for companies involved in M&A deals and public tenders, prohibiting the parties from closing the transaction or awarding a contract until clearance is obtained. Gun jumping or failure to notify, among other things, may result in hefty fines (of up to 10% of the aggregated annual turnover in the preceding business year) being imposed by the Commission.

Decisional powers

If the Commission finds that there is a foreign subsidy distorting the internal market, it can decide to prohibit the concentration or award of the contract to the bidder benefiting from the foreign financial contribution, or adopt a commitment decision (under which, for example, the aid must be repaid).

General ex officio tool

In addition to the notification-based tools, the FSR includes a general umbrella clause with the ex officio tool for investigations into potentially distortive foreign subsidies, covering all economic activities of undertakings receiving foreign subsidies that do not fall under the two mandatory pre-authorisation tools (such as greenfield investment or the provision of services). According to the Commission, the ex officio tool has not been designed to cast a wide net, but to focus on the most important and large activities involving foreign subsidies, and will thus be used restrictively. For reasons of legal certainty, the powers of the Commission are subject to a limitation period of ten years from when a foreign subsidy was granted.

Application Effective Date

From 12 July 2023, the Commission may use its ex officio powers but only in relation to concentrations for which the agreement has been concluded, the public bid has been announced or a controlling interest has been acquired on or after 12 July 2023 and in relation to public contracts, the contract was awarded or tender procedures initiated on or after 12 July 2023.

The notification obligations provided for in the ex ante review instruments will kick in on 12 October 2023. In the recently published Q&A, the Commission clarified that the notification obligation will apply in full to transactions signed after 12 July 2023 and not completed before 12 October 2023. This means that the deals signed or public bids announced and in relation to public procurement, contracts awarded or procedures initiated, before 12 July 2023 will escape the application of the FSR altogether.

Impact on M&A deals and public procurement: beware of the (possible) consequences and get your data ready

The FSR adds an extra layer of regulation to the existing merger control rules, FDI and trade defence instruments. Like merger clearance and FDI, the FSR will appear on the M&A checklist. On its implementation, the FSR will require companies investing in the EU to adjust their transaction and bidding processes, timelines, risk allocation and documentation in order to comply with the new requirements.

The FSR’s potential to prolong the transaction and bidding timelines and the far-reaching reporting obligations and information disclosures it imposes on the parties (sellers and acquirers alike) may result in sellers opting for a bidder whose bid will not trigger pre-notification under the FSR. A bidder who is not required to file an FSR notification is expected to have a competitive edge in that regard.

The reporting and disclosure obligations will require companies to devote additional time and resources to systematic and accurate record-keeping (which will need to be retained for ten years) in order to have the relevant information and documents readily available. Dealmakers who regularly engage in transactions or procurement bids involving EU targets and companies that often contract with public entities would be wise to start collecting the required information to be ready once the notification obligation kicks in in October 2023. However, the companies still have one week left to push the deals through the signing phase and escape the application of the FSR entirely, and until 12 October to bring those signed after 12 July to completion and at least avoid the notification obligation. For deals that will not close by 12 October 2023, the companies are also advised to kick off in pre-notification contacts with the Commission soon after 12 July 2023 to facilitate the notification process and avoid delays.

This article was published in the Competition Newsletter of July 2023. Other articles in this newsletter:

• Solace for companies seeking guidance on sustainability agreements
• Ready, set, go! The Dutch national security screening FDI regime takes off
• The era of FDI screenings kicks off in Belgium