European Foreign Direct Investment: Practical Thoughts to Cut Through the Red Tape

Authors: Dr. Tobias Caspary, Romain Girard, Paschalis Lois, Tuula Petersen

The last 12 months have seen an unprecedented uptick in foreign direct investment ("FDI") regimes emerging in Europe (from 15 to 25 regimes). For M&A activity, the impact is potentially another layer of red tape. Investors wishing to acquire companies in the European Union ("EU") may have to obtain authorizations from a growing number of national authorities before they can close their transactions.

The uptick was, to an extent, expected for some time. In 2020, the EU FDI Screening Regulation entered into force and encouraged all EU countries to adopt national FDI screening regulations to scrutinize transactions that could negatively impact EU and national interests. In 2022, the United Kingdom's ("UK") National Security and Investment Act ("NSIA") came into force, creating a new mandatory pre-close review for entities active in one of 17 sectors[1], ranging from Transport to Military and Dual-Use.

However, in the last quarter alone, we have seen even more developments:

• In January, the European Commission announced plans for new legislation which would obligate Member States to implement, and uphold, minimum FDI regulations in their respective jurisdictions.[2]
• In April, the UK Government announced various upcoming changes to the NSIA scheduled to take place between Q3 and Q4 2024.[3]

Navigating this constantly evolving environment can be challenging. Below, we address the key considerations when it comes to FDI regimes in the context of M&A: (i) how to determine if a file is required; (ii) what is the enforcement environment; and (iii) how to accommodate FDI filings in transactions.

Europe's FDI Landscape To date, 23 out of the 27 Member States have implemented an FDI regime, and just last year, new (or extensively amended) regimes came into force in Belgium, Luxembourg, Netherlands, Slovakia, Estonia and Sweden. The only jurisdictions that currently do not have some form of FDI regime in force are Bulgaria, Croatia, Cyprus, Greece and Ireland (Ireland is expected to have its FDI regime in force in Q3 2024, while the other three jurisdictions have initiated processes to establish a regime).

A. How to determine if a filing is required

The "triggers" for European FDI regimes typically require: (1) the target having a local subsidiary in a given territory, and (2) the target's activities in that territory falling within specific sectors. There are exceptions and nuances. Those triggers will contrast the familiar and relatively uniform approach to merger control.

Indeed, European FDI regimes have a few features which set them apart from the typical merger control filing analysis:

1. Structural matters: Even subtle changes in transaction structure can potentially affect the jurisdictional analysis. This is because, while all FDI regimes look to regulate the ownership of sensitive assets, "ownership" is not uniformly defined across Europe. For all regimes, "ownership" means at least "controlling" acquisitions (e.g., >50% voting/board). However, most regimes also seek to regulate minority non-controlling stakes (sometimes as low as 10%). Additionally, most regimes in Europe capture both direct and indirect stakes, but the rules for calculating indirect stakes can vary quite sharply between regimes, ranging from a fully diluted approach (10% of 10% is 1%) to a look-through approach (10% of 10% is 10%). Lastly, non-voting stakes generally raise fewer concerns, however, there are 15 regimes in Europe which capture non-voting stakes (e.g., limited partnership stakes).
   
   
2. Target-focused analysis: FDI regimes typically require a filing only if the target has a local subsidiary. However, there are also regimes which stand out for their ability to capture pure export sales (i.e., no local presence required), such as the UK for a limited subset of very sensitive activities. For that reason, it often makes sense to have a single antitrust and FDI counsel run the analysis, as this will avoid doubling up on questions (e.g., revenue breakdown).
   
   
3. Wide sector lists and (wider) discretion by national authorities: the list of sectors captured by each FDI regime varies across Europe, from detailed lists (e.g., in the UK, Italy or Germany), to single-word descriptors such as "healthcare" or "transport"-leaving the authority with a wide degree of discretion on how to interpret what falls in scope. Adding to the legislative uncertainty is the fact that over half the FDI authorities in Europe are in their infancy (less than two years old). Such nascency translates into practical impacts for investors:
   • FDI authorities are still in "learning mode," and in some cases their guidance to local lawyer associations is simply to advise parties to file so they can develop their own views through practice;
   • Authorities often provide sparse guidance (if they provide any) to preserve their legislative discretion;
   • Definition of "sectors" is not strictly harmonized across Europe. There is some harmonization as a result of the EU FDI Screening Regulation. This is because Article 4 of that Regulation provides a non-exhaustive list of sectors[4] which should be subject to review. Many of the new regimes in the last 24 months across Europe have borrowed their list of sectors from Article 4. That said, there are still discrepancies. For example, "critical infrastructure" is nearly always a relevant sector across Europe (and is noted in Article 4), but the definitions range from: (i) by reference to a public register of companies so designated, (ii) a secret list of companies, (iii) by reference to the EU regulation on critical infrastructure, (iv) by reference to specific quantitative thresholds (e.g., number of users or amount of revenues) or (v) left undefined altogether. One of the proposed changes by the European Commission for the EU FDI Screening Regulation is to include a more detailed annex of sectors subject to review. Such a change would be welcomed, in order to curtail the residual discretion authorities have today when interpreting Article 4. That said, the proposals remain subject to legislative debates, and would not take effect before 2026.
4. Investor origin matters: unlike merger control, where the origin of the buyer is in most cases irrelevant, many FDI regimes apply a dual filtering system for their screening: namely, the origin of the investor may lessen or increase (1) filing obligations (e.g., EU investors are generally exempt from many EU FDI regimes, save for the most sensitive sectors) and (2) the scrutiny of the review (e.g., investments from China and Russia are currently heavily scrutinized in Europe, accounting for nearly all blocked transactions).

Additionally, cross-border dealmakers need to be mindful that filings decisions may have spillover effects: taking a view in one country can have an impact on other countries (discussed further in section B). Although it might appear tempting to simply file everywhere/every time, there are specific M&A risks to overcompliance: (i) not only could you put your bid at competitive disadvantage to others; (ii) but it also creates an expectation with the authority for your future deals, and (iii) it creates potential delays in the current deal.

B. Enforcement environment

European enforcement is in its infancy. Even though nearly all regimes are mandatory and suspensory, gun-jumping fines are uncommon. That does not mean that enforcement is non-existent, but rather a feature of the secret decision-making process, which is specific of FDI regimes, and reflective of the national security rationales underpinning the regimes. Both the final decision, as well as any fining practice, is unlikely to be made public.

The spare public fining/enforcement is also arguably a feature of the EU principle of legal certainty, which requires that an individual must be able to predict actions that will make him criminally liable.[5] Given the large degree of discretion afforded both legislatively, but also by each authority's practices, it is not surprising that prosecutions for breach of standstills are uncommon.

Another important feature to the European enforcement landscape is that there is still some degree of judicial oversight on defining national security. That oversight was showcased last year with the landmark case of Xella v Hungary (C-106/22), where the Court of Justice of the European Union ("CJEU") substituted the Hungarian ministry's assessment of national security with its own; concluding that gravel production was not a national security concern. The CJEU contended that, unlike ensuring the security of supply in the petroleum, telecommunications and energy sectors (where there is EU case law that these sectors serve the fundamental interests of society), ensuring the security of the local supply of gravel to the construction sector was not a 'fundamental interest of society.' The CJEU also questioned that the acquisition by Xella was also capable of giving rise to a 'genuine and sufficiently serious threat,' because (i) prior to that acquisition, the buyer was already purchasing 90% of the production of the target and (ii) those raw materials were unlikely to be exported rather than sold on the local market, given local market value and high transport costs. Although the precise ratio of that case is narrow, it nevertheless demonstrates willingness by the EU courts to set boundaries where FDI authorities are breaching fundamental EU principles.

In Europe, enforcement can also arise by way of a "call-in," where FDI authorities use their ex officio powers to initiate proceedings for deals of they were not notified. This is what happened in the UK's landmark prohibition of Nexperia's acquisition of the Newport Wafer Fab (the UK's largest semiconductor plant). Such call-ins are facilitated by cooperation mechanisms in Europe:

1. Between FDI authorities within the EU: there is a mechanism in place which (in most cases) requires a notification in one EU member state to be shared with all other EU member states. This has a few implications for investors:
   • Taking views on filing in one country may have cross-border implications: this is because filing for FDI in one EU member state drastically lowers the odds of escaping the notice of other EU member states, and it is not uncommon to receive requests for information from other member state authorities asking why no filing was made in their jurisdiction.
   • The implementation of the cooperation mechanism is still nascent: for example, some countries (e.g., Belgium) will only instigate the cooperation mechanism if they believe the case raises serious national security concerns and requires a Phase 2 investigation. That is evidently the preferred approach, especially considering the alternative implementation by certain countries, where the cooperation mechanism tacitly lengthens the review process
2. Between authorities of a country: some European countries have cooperation mechanisms between the competition and FDI authorities. For instance, certain regimes have tacit agreements that all merger control filings are forwarded on to the FDI authority. The FDI authority may then often follow up with the parties by requesting information on the transaction. It is then possible for the authority to call in the deal if they deem a notification was not made.

C. Accommodating FDI filings in transactions documents

FDI provisions are generally considered simultaneously with merger control under the transaction documents. While FDI regimes cast a wide net in terms of filing triggers, filings are oftentimes benign and can be handled with appropriate conditions precedent and filing obligations in the relevant transaction documents.

However, there a couple of unique features to FDI which are worth considering in the transaction documents:

1. Enhanced cooperation clauses to account for the target-focused nature of regimes: to cater to the target-focused nature of FDI regimes, careful attention is required to the drafting of the cooperation clauses to ensure that the target and the seller(s) both (a) are bound to provide responses expeditiously but also (b) maintain control over the description of the target's activities.
2. Effort provisions catering to different approaches to remedies: generally, behavioral remedies[7] are more likely to be appropriate to resolve FDI concerns. As such, hybrid FDI/antitrust efforts provisions are increasingly common, as behavioral remedies are currently less favored by antitrust authorities.
3. Flexible approach to reflect rapidly changing legal landscape:(i) deal conditions may need to cater to new FDI regimes arising between sign and close; e.g., with springing condition precedents; and (ii) review periods for FDI can be longer than merger control[8], meaning parties may either (1) engage with the authority before filing in an attempt to shorten the review timeline or (2) filebefore signing the transaction agreement (e.g., on a term sheet), which is permitted in some regimes.

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