The EU’s Foreign Subsidies Regulation: implications for M&A

November 2023 | EXPERT BRIEFING | MERGERS & ACQUISITIONS

financierworldwide.com

The European Union’s (EU’s) Foreign Subsidies Regulation (FSR) represents one of the biggest regulatory changes in recent years. Under the FSR, the European Commission (EC) can investigate, and remedy subsidies received from non-EU countries that distort the EU internal market, both in the context of M&A and beyond.

The FSR

The FSR introduces a new mandatory notification requirement to the EC, applicable from 12 October 2023, for M&A deals involving companies that have received financial support from non-EU governments. It also includes a new screening regime for public tenders involving foreign-subsidised entities, and a broad investigation tool enabling the EC to investigate any commercial activity in the EU (deal-related or not) where foreign subsidies may distort the internal market.

Types of non-EU financial support caught by the FSR

The FSR introduces a very broad notion of a foreign financial contribution (FFC), capturing almost any financial flow between a company and any non-EU public body (or private body acting on behalf of a public body).

FCCs include: (i) the transfer of funds or liabilities, e.g., capital injections, grants, loans, loan guarantees, fiscal incentives, setting-off operating losses, compensation for financial burdens imposed by public authorities, debt forgiveness, debt-to-equity swaps and rescheduling; (ii) the foregoing of revenue that is otherwise due, e.g., tax exemptions, the granting of special or exclusive rights without adequate remuneration; and (iii) ordinary course arm’s length transactions including the supply and purchase of goods and services.

However, this extremely broad notion of FFCs is only relevant to determine if a filing is required. The substantive assessment will focus on FCCs that are selective, i.e., which confer a benefit on one or more specific companies or industries – a subset of FFCs defined by the FSR as “foreign subsidies”.

Notifiable transactions

A mandatory filing is required for transactions that signed on or after 12 July 2023 and that have not closed by 12 October 2023 if (i) the target (in an acquisition), one of the merging parties (in a merger) or a joint venture has EU turnover of at least €500m and is “established in the EU” (i.e., has a subsidiary or permanent establishment in an EU member state), and (ii) all parties combined have been granted at least €50m FFCs from non-EU countries in the three years prior to signing of the transaction agreement or the announcement of the public bid.

Note that the establishment of a greenfield joint venture (i.e., a newly established joint venture), which does not involve the transfer to it of any existing business activities, will not require notification under the FSR.

In practice, the €500m turnover threshold and the requirement for the relevant party to be “established in the EU” act as useful initial filters, and only if these requirements are met will there be a need to assess FFCs. The relatively low €50m threshold for FFCs, however, means that as soon as an M&A transaction meets the €500m EU turnover threshold, it will likely be notifiable under the FSR.

However, the EC may also call-in a below-threshold transaction for review (automatically triggering the bar on closing) if it believes the parties may have been granted distortive foreign subsidies.

Impact on deal timetables

Like the EU Merger Regulation (EUMR), the FSR imposes a bar on closing. Gun-jumping may result in fines of up to 10 percent of global turnover.

The review process is also modelled after the EUMR, with pre-notification and a Phase I review of 25 working days. If the EC has substantive concerns, it may open a Phase II in-depth review of up to 90 working days (with possible extensions), at the end of which the EC can conditionally clear the transaction with remedies, prohibit the transaction or clear it unconditionally. Note, though, that unlike under the EUMR, the EC can close a Phase I review merely by “informing” parties without the need for a formal clearance decision, but if substantive concerns arise, parties can offer remedies only in Phase II.

Disclosure requirements

In addition to the typical requirements of the merger control process, the EC’s filing form (the Form FS-CO) requires significant additional information (detail on transaction financing and valuation, disclosure of FFCs, description of the bidding process and other bidders, if applicable) and supporting documents.

The biggest disclosure burden is in relation to FFCs. The FSR filing form requires information to be provided on all FFCs valued at €1m or more that have been granted in the three years prior to signing of the transaction agreement or the announcement of the public bid, even if not linked to the transaction, including: (i) detailed reporting for specifically defined types of foreign subsidies granted to any party that are assumed most likely to distort the EU internal market (aid to companies in difficulties, unlimited guarantees, certain export financing, or aid directly facilitating a transaction); and (ii) an overview of all other FFCs received by the buyer (or the parents in a joint venture or the merging parties in a merger), unless the total amount received over the three years from a country is less than €45m.

There are exceptions to the disclosure requirements. Information is not required in relation to FFCs in the form of arm’s length supply and purchase relationships (except in relation to financial services) or generally applicable tax measures.

The level of disclosure required in each notification will be determined on a case by case basis. The EC allows parties to discuss and seek waivers from the disclosure requirements for information that is not reasonably available and not necessary for the assessment of the case. Waivers can be negotiated during pre-notification. An effective pre-notification strategy will therefore be crucial to ensure a swift and effective review process without imposing unnecessary information burden on parties.

Impact on private equity firms and other financial sponsors

The FSR results in a particularly extensive burden for private equity firms and other financial sponsors, which need to assess FFCs at both the level of the fund and across portfolio companies.

Following significant industry pushback during the legislative process, the EC limited FFC disclosure requirements to just the acquiring fund (or funds), including its investors and portfolio companies, under the three conditions outlined below.

First, the acquiring entity is subject to the EU Directive on Alternative Investment Fund Managers or equivalent legislation in non-EU countries.

Second, the other funds have a majority of different investors measured according to their entitlement to profit.

Third, there are no or only limited economic or commercial transactions between the fund that controls the acquirer and other funds managed by the same investment firm (or their controlled portfolio companies), including sales of assets, ownership in companies, loans, credit lines or guarantees.

However, this limitation does not apply to those types of foreign subsidies that are assumed most likely to distort the EU internal market. Investment firms must look across all funds and portfolio companies to identify such foreign subsidies for disclosure, regardless of the acquiring fund.

Also, the assessment of whether the €50m filing threshold is met will also require consideration of FFCs received across all funds and portfolio companies. However, in practice, if the disclosable FFCs from the acquiring funds and portfolio companies exceed the threshold, there will be no need to continue this assessment across other funds.

The EC’s assessment

The EC will assess whether any foreign subsidies granted distort the EU’s internal market (i.e., improve the relative competitive position of the receiving company in the internal market). This will be a case by case assessment, with the EC having broad discretion. Unlike merger control, the EC may also consider any “positive effects” in line with the EC’s broader policy goals.

The EC has not yet issued any guidance on how it will assess distortions, and balance any distortions against “positive effects”. Any guidance is not expected until next year at the earliest. That said, the EC’s assessment will likely focus on those types of foreign subsidies which the FSR assumes most likely to distort the EU internal market.

Potential remedies to address potential distortion are also likely to be broader than typical merger control remedies. For example, the EC may require a company to reduce its manufacturing capacity or market presence, refrain from certain investments, make changes to its governance structure, or repay any allegedly harmful foreign subsidy (with interest).

How to prepare

For every deal, additional due diligence will be needed to determine whether an FSR notification is required and for the risk assessment of any FFCs received by all the parties involved. This is important even if a filing is not required given the EC’s power to call-in transactions below the notification thresholds.

Where a filing is required, or there is a risk of the EC calling-in a transaction for review, early engagement with the EC should be considered to minimise disclosure obligations and related delays.

FSR risk should also be properly addressed in deal documentation and deal timetables.

Businesses should also consider establishing internal processes to map FFCs on an ongoing basis, to make sure they can hit the ground running in relation to future M&A opportunities as they arise.

Giorgio Motta is a partner, Niels Baeten is counsel and Simon Dodd is a professional support lawyer at Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates. Mr Motta can be contacted on +32 2 639 0314 or by email: giorgio.motta@skadden.com. Mr Baeten can be contacted on +32 2 639 0321 or by email: niels.baeten@skadden.com. Mr Dodd can be contacted on +44 (0)20 7519 7416 or by email: simon.dodd@skadden.com.

Giorgio Motta, Niels Baeten and Simon Dodd

Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates