EU Regulation on Foreign Direct Investment Screening

The EU’s framework for the coordination of foreign direct investment (FDI) screening in the European Union (the EU) is set out in Regulation 2019/452 (as amended, the FDI Regulation), which was adopted in March 2019 and has been applied since October 2020. The FDI Regulation is the first to give the European Commission (the Commission) general powers to review private transactions since the entry into force of the EU Merger Regulation (the “EUMR”).

The FDI Regulation does not create an EU-level FDI screening mechanism, but sets out minimum requirements for EU Member States’ FDI screening mechanisms and a mechanism for coordinating FDI reviews. The Commission strongly encourages Member States to implement FDI screening mechanisms, and 24 Member States have or are in the process of establishing one (as of June 2021, and compared to 11 before the FDI Regulation’s adoption).

Under the FDI Regulation’s cooperation mechanism, Member States and the Commission itself may issue comments and opinions on transactions involving FDI in another Member State’s territory. Although the host country has the final say, the Member State in question must give those comments and opinions “due consideration.” In the case of investments deemed to be of “Union interest,” host Member States must take “utmost account” of Commission opinions and explain any non-compliance.

The Commission has published a detailed frequently asked questions document and a notification form template, which are available on the website of the Directorate-General for Trade (DG TRADE), as well as guidance (the Guidance) in response to the COVID-19 crisis, calling for particular attention to the healthcare sector. In November 2021, the Commission published its first annual report on experience with the FDI Regulation (the Report), providing valuable insights into experience under the FDI Regulation.

According to the Report, Member States reported receiving almost 1,800 FDI notifications in 2020, of which 80% required no formal screening. Of the remaining 20%, 79% were approved without conditions, 12% were approved with conditions and 2% were prohibited. After the FDI Regulation entered into force in October 2020, to June 2021, 256 notifications were subject to Commission review, of which 80% were closed in Phase 1. All 36 cases that went into Phase 2 -- mainly in the manufacturing, ICT and financial service sectors -- derived from only six Member States.

Scope

The FDI Regulation applies to screening mechanisms for FDI. “Screening” and “screening mechanisms” are defined as procedures for assessing, investigating, authorizing, conditioning, prohibiting or unwinding FDI on grounds of security or public order. The terms “security” and “public order” are deliberately vague, leaving considerable uncertainty as to the scope of Commission and Member State review.

FDI is defined as an investment of any kind by a “foreign investor” aiming to establish or to maintain lasting and direct links to an entrepreneur to carry on an economic activity in a Member State, including investments that enable effective participation in the management or control of the target. “Foreign investors” are defined as natural persons or undertakings “of a third country.” Completed investments, as well as proposed investments, are subject to review for up to 15 months.

The concept of “effective participation in management” is much broader than “control” under the EUMR and presumably includes the power to appoint representatives to the board of an EU company, even without strategic veto rights. The new mechanism is not subject to any minimum turnover or other size-based test. Thus, the FDI Regulation applies to a much broader range of transactions than the EUMR.

However, the regulation excludes “portfolio investments,” described by the European Court of Justice as the acquisition of shares “solely with the intention of making a financial investment without any intention to influence the management and control of the undertaking.”

Screening Factors

The FDI Regulation sets out a uniform set of factors to be used by the Commission and Member States. These include potential effects on, amongst other things:

• critical infrastructure (including energy, transport, water, health, communications, media, data processing or storage, aerospace, defense, electoral or financial infrastructure, as well as sensitive facilities and investments in land and real estate crucial for the use of such infrastructures);
• critical technologies and dual use items (including artificial intelligence, robotics, semiconductors, cybersecurity, quantum, aerospace, defense, energy storage, and nuclear technologies, nanotechnologies and biotechnologies);
• supply of critical inputs (including energy or raw materials, as well as food security);
• access to or the ability to control sensitive information (including personal data); and
• freedom and pluralism of the media.

In response to the COVID-19 crisis, the Guidance called for particular attention to the healthcare sector. The Guidance also encouraged Member States to intervene as needed outside of screening mechanisms, e.g. by imposing compulsory licenses on patented medicines.

In determining whether an investment is likely to affect security or public order, Member States and the Commission may take into account all relevant factors, including the effects on critical infrastructure, technologies (including key enabling technologies) and inputs that are essential for security or the maintenance of public order. Additionally, they may consider whether the foreign investor is controlled by the government of a third country, including through its ownership structure or significant funding. This clearly includes companies controlled by State entities or in which State entities are significant investors, but could potentially apply to companies that derive a significant portion of their revenues from business with State entities, such as aerospace and defense companies.

Member State Screening Mechanisms and Commission Coordination Role

As noted, the FDI Regulation does not restrict Member States’ ability to maintain or create screening mechanisms, but it requires Member States to notify the Commission of any new or existing screening mechanism, as well as any changes. Member States also submit annual reports including a list of FDIs screened and undergoing screening; screening decisions prohibiting investments or submitting them to conditions; the sectors, origin, and value of the investments; and whether an investment undergoing screening is likely to be caught by the EUMR. Based on this input, the Commission will publish annual reports on the implementation of the FDI Regulation.

Member States are required to appoint an FDI screening contact point to handle communications, whether or not they have a screening mechanism in place. Moreover, the Commission and Member States may cooperate with the relevant authorities of third countries on issues relating to the FDI screening on grounds of security and public order.

The FDI Regulation sets out minimum criteria that Member States' screening mechanisms have to meet. It also requires national FDI screening mechanisms to be transparent and not discriminate between third countries. Member States must set out the circumstances triggering screening, the grounds for screening and detailed procedural rules. Member States must establish timeframes for issuing screening decisions that allow them to take into account the comments and opinions of Member States and the Commission. Confidential information, including commercially sensitive information, made available by foreign investors and other parties must be protected, and foreign investors and other parties concerned must have the possibility to seek judicial redress against screening decisions. Screening mechanisms must also include measures to identify and prevent circumvention.

The FDI Regulation creates an elaborate cooperation mechanism for FDI undergoing screening. Member States must notify the Commission and other Member States of any FDI that is undergoing screening. Where a Member State considers that an FDI planned or completed in another Member State is likely to affect its security or public order, or otherwise has relevant information, it may provide comments to the host Member State, with a copy to the Commission. The Commission must then notify the other Member States that comments were provided and may issue an opinion itself. A Member State may request the Commission to issue an opinion or other Member States to provide comments, and the Commission must deliver such an opinion if requested by at least one-third of Member States.

Upon receipt of an initial notification that an FDI is undergoing screening, the Commission and Member States have 15 calendar days to notify the Member State concerned that they intend to provide comments or an opinion and to request additional information. Opinions and comments should be delivered within 35 calendar days of the original notice, or 20 calendar days from receipt of any additional information requested. The Commission may issue an opinion following comments from other Member States no later than 40 calendar days from the original notification. A similar process applies to FDI not undergoing screening, including FDI completed up to 15 months prior to the opinions or comments. The final decision rests with the host Member State, although it must give “due consideration” to comments and opinions from other Member States or the Commission.

The Commission drafted, together with Member State FDI screening experts, a template notification form designed to collect information required for a detailed assessment in Phase 1 to limit the need for requests for additional information and Phase 2 assessments. The notification template calls for information on the ownership structure of the foreign investor and the target and information on the investment, including its value and rationale, the source of the investor’s funds and transaction timing. The template also calls for information on the products, services and business operations of the investor and the target, the investor’s financial ability to ensure the continuity and proper operation of the target, and the Member States in which the investor and the target conduct business.

Direct Commission Review Powers

The FDI Regulation gives the Commission power to screen FDI likely to affect projects or programs of “Union interest,” in particular projects and programs involving a substantial amount or a significant share of EU funding, or which are covered by EU legislation regarding critical infrastructure, technologies or inputs. The projects or programs having Union interest are set out in the regulation’s annex, which the Commission will update from time to time. These include, amongst others, Galileo, Copernicus, Eurocontrol, and European electricity and gas transmission networks.

Where the Commission considers that an investment is likely to affect projects or programs of Union interest on grounds of security or public order, the Commission may issue an opinion to the relevant Member State or States, with copies to the other Member States. Member States shall take “utmost account” of these opinions and explain any failure to comply. Since the Commission lacks power to prohibit or impose conditions on a transaction, however, any action recommended by the Commission must be implemented under Member State laws.

Further Review and Expert Group

The FDI Regulation requires the Commission to review consider appropriate changes to the regime by October 2023 and every five years thereafter. The FDI Regulation also formalizes the role of the Commission’s expert group on screening of FDI, created by the Commission in late 2017. This group discusses issues relating to FDI screening, shares best practices, and exchanges views on trends and issues of common concern relating to FDI as well as on the FDI Regulation implementation.

Lessons from the first year

On November 23, 2021, the Commission published the Report, based on input from the Member States and other sources. According to the Report, the Commission screened over 400 transactions to November 2021.

Of 265 transactions reviewed to June 2021, five Member States (Austria, France, Germany, Italy and Spain) accounted for 90%. As noted, the Commission closed 80% of the notified investments in Phase 1; with the remaining 14% proceeding to Phase 2 (6% were still ongoing on the cut-off date). In Phase 2 cases, the Commission requested additional information to assess the criticality of the target or the potential threats posed by the investor, typically including data on products and/or services of the target company; possible dual-use classification of any products involved; customers, competitors and market shares; the target’s IP portfolio and R&D activities; and characteristics of the investor. The Commission issued opinions in less than 3% of notified cases.

For the Report, Member States were asked to comment on three subjects: (i) the value-added of the FDI Screening Regulation and the cooperation mechanism; (ii) any significant procedural issues encountered; and (iii) possible ways of addressing any such issues. All Member States considered the Regulation and the cooperation mechanism valuable tools. However, Member States also reported some issues when applying the FDI Regulation. In particular, several Member States pointed to resource constraints, as well as tight deadlines. Other Member States suggested that too many FDI transactions are notified, including those with no relevance for, or impact on, other EU Member States. Certain Member States considered some requests for additional information overly burdensome.

To address these issues, the Commission has launched a comprehensive study to ensure that the Member States’ FDI screening mechanisms, as well as the EU cooperation mechanism, are effective and efficient. The Commission is considering issuing guidelines, following public consultation, as well as ways to streamline procedures to focus on FDI transactions most likely to pose a risk to security or public order and how to handle multi-Member State transactions.

Conclusion

The FDI Regulation inserted the Commission into a hitherto jealously guarded area of Member State authority. By creating a relatively streamlined coordination framework, while leaving ultimate decision-making powers with the Member States, the FDI Regulation aimed to limit bureaucracy and reduce the risk of uncoordinated screening processes with potentially inconsistent approaches and outcomes.

The Commission’s first annual report revealed broad agreement that the FDI Regulation is a valuable tool. Likely inspired by the FDI Regulation, almost all EU Member States have already adopted or are working on national screening mechanisms in line with the FDI Regulation. The Commission anticipates that all Member States will eventually implement such mechanisms.

The Commission had limited sympathy for Member States’ complaints about the burdens of the new framework, calling on them to dedicate greater resources to FDI screening and rejecting suggestions to limit the number of transactions subject to screening. To improve the effectiveness of the screening framework, however, the Commission has launched a study seeking ways to streamline procedures and focus on FDI transactions most likely to pose a risk to the security or public order of more than one Member State or projects of Union interest.

The Commission is also considering issuing guidelines to help transaction parties to deal with the increasingly complex EU regulatory hurdles. Any such guidelines would be issued only after a public consultation, which can be expected in 2022. Meanwhile, the template notification and increased familiarity with the regime may be expected to reduce the need for information requests and the significant variation in review timelines.