On 24 January 2024, the European Commission (Commission) presented five new initiatives to advance “European economic security”. One of them aiming to take effect soon: a draft for a new regulation on the screening of Foreign Direct Investments (FDI).
If this Draft Regulation becomes law, it will lead to FDI proceedings in Europe becoming more coordinated and efficient, especially in cases spanning multiple countries – but it would also make them even more far-reaching. In particular, the planned introduction of an EU-wide post-closing screening could lead to more legal uncertainty.
The EU’s current FDI Screening Regulation (Regulation) entered into force in 2019 and is mainly aimed at establishing cooperation between the Member States reviewing an investment. However, the pandemic and the Russian invasion of Ukraine elevated the importance and prevalence of FDI screening as a tool of public policy and led to significant changes in many EU Member States’ FDI laws. In addition, the Regulation has significant practical short-comings – particularly a limited scope, a lack of harmonization and unclear procedures. The Draft Regulation aims at remedying those issues. However, the Draft Regulation only defines minimum standards, and each Member State will remain free to extend its regime beyond those standards. True harmonization across EU Member States will therefore remain elusive.
Capturing investments by foreign-controlled EU companies and greenfield investments
Under the Draft Regulation, acquisitions by EU entities will be reviewable if the EU acquirer is controlled by a foreign investor. This is a marked shift from the current Regulation which only applies to direct investments by foreign investors and not to indirect investments by EU-based subsidiaries of foreign investors (as was recently confirmed by the European Court of Justice). While this is an expansion on the European framework, the approach proposed in the Draft Regulation is still more limited than that of several Member States, who subject even EU companies with minority shareholders from outside the EU to FDI screening, or who do not require any element of foreign ownership at all. Ideally, these Member States will reflect on the guidance provided by the Commission to align their national regimes with this clear-cut approach. However, given the current geopolitical climate, it seems unlikely that Member States will voluntarily materially scale back the scope of existing national regimes.
Another important expansion proposed by the Draft Regulation is to cover greenfield investments. This would mean that the mere establishment of a new company that is planning on being active in certain sectors will be covered and Member States will have to include greenfield investments in their FDI screening regimes, at least those that lead to the creation of a new subsidiary. This could have far-reaching ramifications, capturing new investments by companies that have been present in the EU already for many years which seems to go beyond what is necessary.
Mandatory, suspensory FDI screening for all of Europe – and possibility of post-closing review
The Draft Regulation contains a list of sensitive sectors that must be covered by a mandatory, suspensory FDI screening regime in all EU Member States. The list is expansive and includes military and dual-use items, critical technology, critical medicines and critical entities in the financial sector. The Draft Regulation foresees that the Commission can change the list of sectors. While almost all EU Member States have adopted some form of FDI screening, the current Regulation does not contain any obligation to do so, nor does it define a minimum scope for FDI screening regimes. This has long been a point of lament for the Commission – based on the concern that foreign investors could take advantage of “loopholes” in the FDI screening coverage in the EU.
This new mandatory regime will only apply to direct investments and not to portfolio investments (i.e. financial investments without control rights); however, the term direct investment is only vaguely defined in the Draft Regulation leaving investors wondering when their investments are in or are out of scope. It would be more helpful if the Commission were to include a specific threshold, for example by adopting the definition by the OECD (at least 10% of the voting rights).
In addition, all Member States will be obliged to introduce post-closing screening regimes for all foreign investments that are not subject to an authorization requirement independent of sectors. Member States will be able to screen and prohibit investments for at least 15 months after closing (the Draft Regulation does not provide for a maximum deadline – this will be up to the Member States). Such post-closing regimes will be a source of significant deal uncertainty – particularly as the Draft Regulation does not provide for a voluntary notification scheme (which Member States can however introduce themselves).
More “soft pressure” on Member States through more targeted cooperation mechanism
Under both the current Regulation and the Draft Regulation, Member States remain the ultimate decision makers on FDI screening. But the Draft Regulation provides the Commission with some tools to subtly nudge the Member States: they have to submit information about their current cases and invite comments from other Member States and the Commission which they have to take into account when making their decisions (the so-called “cooperation mechanism”). This mechanism will become more sophisticated: the Draft Regulation sets out clear rules about which cases need to be submitted to the cooperation mechanism – most notably investments by government-controlled or sanctioned investors into sensitive sectors, as well as any case in which a Member State has opened an in-depth (“Phase II”) investigation. This is a lot more targeted and clearer than the previous rules that required Member States to notify all cases undergoing “formal screening” – a term which Member States interpreted quite differently. The recent evaluation of the current Regulation criticized that too many unimportant cases were notified to the cooperation mechanism. With the Draft Regulation, the Commission wants to focus its resources on cases that may pose a real risk. This could reduce the length of procedures in no-issue cases as a notification to the cooperation mechanism will no longer be necessary.
In each case, the screening Member State must provide ample information to the other Member States and to the Commission. Following their decision, Member States will now also have to justify why they did not follow the recommendations of their fellow Member States or the Commission.
Moreover, Member States and the Commission can now start the cooperation mechanism on their own initiative – even in cases where the Member State in which the investment takes place did not submit to the cooperation mechanism. Essentially, comments and recommendations about potentially problematic investments can also be given uninvited and must be taken into account by the receiving Member States. Notably, this includes investments not subject to a mandatory notification; any Member State can therefore recommend the commencement of post-closing proceedings against any foreign investment.
A most welcome change is made for cross-border transactions. Now, Member States must endeavor to coordinate on procedure and decision-making in cases that are notified to multiple Member States (although this doesn’t necessarily mean that they have to agree on the assessment and the outcome). To facilitate this, the Draft Regulation foresees that the notifying investors will have to submit all FDI filings on the same day (and reference each of them). Obviously, this would lead only to a partial harmonization as review timelines vary widely among Member States.
No changes foreseen for standard of substantive review
The Draft Regulation says a lot about procedure and little about the substance of which kind of investments should actually be prohibited. This will remain up to the Member States; the Draft Regulation only lists a few general criteria. But the Commission is conscious of allegations of overreach, similar to those that were raised against some Member States’ activities in investment control. The Draft Regulation reminds Member States to observe the fundamental freedoms (as seen in the aforementioned recent ECJ judgment) and refers to the principle of proportionality; in particular, it obliges the Member States to use “other measures pursuant to Union or national law” instead of prohibitions or conditions if those are sufficient to address security concerns. The Draft Regulation also tasks the Commission with observing proceedings in Member States and to initiate infringement proceedings when necessary. It will remain to be seen whether this is an expression of a more serious commitment of the part of the Commission towards preventing arbitrary or discriminatory use of FDI regimes for political purposes.
When will this become law?
The Draft Regulation is subject to approval by the European Parliament and the Council. And presumably the Council will have a lot to say about the Commission’s draft. Many Member States consider FDI screening to be one of their key competences that is central to their strategic sovereignty. Some Member States have been reluctant to grant the Commission (and other Member States) more power over a review that they consider to be of national interest. Other Member States may consider their new obligations to screen investments an unnecessary burden that has the potential to dissuade investments. There could therefore be pressure on the Draft Regulation from both sides. However, the Commission appears to have already taken into account some of the potential concerns from Member States – for example, it is notable that the Draft Regulation does not aim at a far-reaching harmonization of FDI screening rules but rather focuses on procedural aspects which Member States might be more willing to agree to. It is likely that Member States in the Council will not begin scrutinizing the proposal immediately. For the next few months, the focus of the Belgian Presidency will be on finalizing legislative proposals that can still be agreed in the co-legislative procedure before the end of this political mandate. As for the European Parliament, we do not expect discussions to start during this term, given that the last formal session will take place in April. The appointment of lead draftspersons and allocation of the proposal to the relevant Committee will only start in September once the new Parliament is in place.
Once promulgated, the Draft Regulation will only start applying 15 months after it was published in the Official Journal of the European Union to give Member States sufficient time to adapt their national screening mechanisms. Accordingly, it is unlikely that the Regulation will apply before 2026. However, many Member States might also implement the changes proposed before the implementation deadline is over.
The bigger picture
The Draft Regulation on FDI screening is but one of five new initiatives the Commission presented today to advance European economic security. In particular, the Commission is also interested in Outbound Investment Control, meaning the control of investments by EU investors in foreign countries. The USA recently announced a narrow Outbound Investment Control (see https://www.freshfields.de/our-thinking/campaigns/foreign-investment-monitor/u.s.-outbound-investment-executive-order-focuses-on-next-generation-technologies/). However, there appears to be a lack of consensus within the Commission and among Member States whether this would be useful or not for the EU. Therefore, the Commission will launch a process to gather data and evidence on potential risks before deciding on specific steps.
To learn more about our thoughts on key FDI trends in the coming year, read our Global antitrust in 2024: 10 key themes publication.