After brisk movement through the EU legislative process, the proposed EU Regulation on Foreign Direct Investment Screening (the “Regulation”) was approved by the European Parliament on February 14, 2019. This development comes amidst a global sprint to strengthen and establish foreign direct investment laws, including in France, UK, Germany, and Hungary, as well as the US and China.

Although individual Member States retain their authority to screen (i.e., investigate, condition, prohibit, or unwind) foreign direct investments (“FDI”), the Regulation introduces and formalizes numerous procedures and criteria for cooperation among Member States and with the Commission.  Specifically, it sets out an EU-wide framework on this process and grants competence to the European Commission (“EC”) to intervene with an official opinion on the grounds of “public order and security”.  Additionally, it provides an official forum for Member States to weigh in and potentially affect the course of foreign investment activities across the European Union.

The Regulation targets FDI in particular, (it does not apply to portfolio investments), capturing any type of investment by a foreign investor which aims to establish or maintain “lasting and direct links” between the investor and the other party receiving the funds.  The ambit of the Regulation has expanded substantially since it was first proposed by the EC in 2017 (see our post here).

Increase in Affected Sectors and Enhanced Scrutiny of Transactions

In sum, the revised Regulation now:

  1. Expands the scope of “strategic sectors” specifically captured by the new screening mechanism (Article 4):
    • Critical infrastructure previously included: energy, transport, communications, and data storage; it now also covers: water, health, media, data processing, aerospace, defense, electoral infrastructure, and investments in land and real estate crucial to that use.
    • Critical technologies is now joined by “dual use items”; this category, which previously encompassed artificial intelligence, robotics, semiconductors, cybersecurity, and nuclear technologies, has now been expanded to include quantum aerospace, defense, energy storage, nanotechnologies, and biotechnologies.
    • Critical inputs now includes energy or raw materials, as well as food security.
    • Sensitive information now emphasizes personal data.
    • Media freedom and plurality is a new delineated sector of interest.
  1. Requires Member States to Report FDI and to Request EC Involvement (Articles 6 and 7):

Member States will be required to notify the EC and all other Member States of an FDI undergoing screening.  The Regulation also explicitly empowers a Member State to comment on any planned or completed FDIs in other Member States if it considers that its security and public order may be affected, and to request an opinion from the EC.  This subsumes FDI that are undergoing screening, as well as those that are not.

Although the EC’s power to issue opinions is discretionary, if at least one third of Member States consider the FDI likely to affect their security or public order, it must set out its views on the transaction.  While the opinion does not technically have binding force, Member States are required to “take utmost account” of it and provide an explanation if the opinion is not followed.

This enhanced level of scrutiny on foreign acquisitions adds an additional layer of uncertainty to FDI activities in the EU—investors will need to analyze potential impact beyond the borders of the actual transaction based on the very broad concept of “public order and security”.  In considering this concept, Member States and the EC are free to take account of “all relevant factors”, including effects on critical areas and inputs essential to this purpose and disruption or failure thereto, control by a foreign government, and the pursuit of “State-led projects”.

Arguably, the new system also creates a level of pressure on a Member State to conform to the views of the EC (and one-third (or more) of concerned Member States) and to justify its decisions.

  1. Amplifies the definition of “foreign-government controlled direct investment”:

There is greater precision in the new definition, which defines government control as direct or indirect, and includes state bodies and armed forces.  It also allows authorities determining whether the FDI could affect security to consider whether the investor “has already been involved in activities affecting security or public order of a Member State”, and whether “there is a serious risk that the foreign investor engages in illegal or criminal activities”.

Implications for Businesses

Businesses involved in M&A transactions in the EU will need to carefully consider the impact of the new legislation for several reasons, including:

Deeper Scrutiny.  The new system creates an EU-wide cooperation mechanism.  As explained above, the obligation on Member States to report an FDI undergoing screening, as well as to request EC review, coupled with information sharing requirements between authorities will potentially subject transactions to additional layers of assessments.

TimingOnce a Member State notifies an FDI, the EC and other Member States may request further information and indicate if they have concerns within 15 days.  After that, a Member State will have 35 additional days to provide their comments.  The EC should issue its opinion within that 35-day timeframe, but is allowed an additional five days.  (Article 6).

This process means that Member States will likely try to align the timing of their decisions with the Commission’s opinion, as well as possibly engage in deliberations with other Member States and the Commission.  Given the additional layers of review, this may lead to delays in completing the review process at national level.

Clarity.  As the new framework sets out a list of factors that could underpin FDI review, this will provide a baseline guide to investors in the EU as to potential EU concerns.  The heightened transparency anticipated in the intra-EU screening system will also lead to a better understanding of investment activity, as well as the positions of Member States and the EC towards certain types of investments.  This could have the positive effect of greater consistency in approach.

Notably, the Regulation also allows Member States and the EC to set out any concerns within 15 months after completion of a transaction if it had not previously been subject to review.  Although there are no legal provisions permitting post-transaction challenges, such views will be informative as to potential risks for future investments across the EU of similar nature.

To sum, the Regulation makes it more difficult for investors to bypass screening in the EU.  While there are presently only 14 EU Member States with FDI screening mechanisms (Austria, Denmark, Germany, Finland, France, Latvia, Lithuania, Hungary, Italy, Poland, Portugal, Spain, United Kingdom, and Hungary), this Regulation anticipates a higher level of monitoring across the EU by each Member State, as well as by the EC.  In addition, the requirement on Member States which currently have screening mechanisms to ensure that measures are in place to identify and prevent circumvention (Article 3(7)) will likely lead to tightening of new and existing regimes.

Entry into Force

The European Council is expected to formally endorse the Regulation on March 5, 2019.  The new law will then enter into effect 20 days after publication in the Official Journal. Member States and the Commission will subsequently have 18 months to implement the new mechanism.

If you have any questions regarding the above, do not hesitate to contact François-Charles Laprévote or your usual firm contact.