Key Takeaways: The European Union Foreign Subsidies Regulation

A new regime tackling foreign subsidies has begun to take effect in the European Union (the “EU”): the Foreign Subsidies Regulation (the “FSR”).

The FSR introduces a new set of rules for M&A transactions that have a nexus to the EU.¹ It will have a significant impact on businesses active in the EU, particularly with respect to increased compliance obligations and potential delays in obtaining the required regulatory approvals in M&A transactions.

In the M&A context, as of October 12, 2023, the new regime will introduce mandatory obligations on contracting parties who meet certain thresholds under the regime to notify the European Commission (the “Commission”) before closing their transaction. The filing obligation will rest, in an acquisition scenario with the acquirer and the target; in an outright merger scenario with both merging entities; and in a joint venture (“JV”) constellation with all JV parents exercising “control” (within the meaning of EU antitrust law) over the JV company and the JV company itself. It has already been the case since June 12, 2023 that the Commission can “call in” and review any M&A transactions ex officio if it finds sufficient evidence that a foreign subsidy distorts the EU market.

The Q&A below provides more detail of the FSR, with a focus on implications on M&A transactions.

What is the New FSR About?

The FSR introduces a new regulatory layer that parties to M&A transactions need to comply with in the EU—in addition to the already existing merger control and foreign direct investment rules.

The FSR aims to combat the effects of potentially distortive subsidies granted by non-EU (i.e., “foreign”) countries to companies operating in the EU. Through this new regime, the Commission seeks to ensure that subsidized companies do not enjoy what it views as an unfair advantage when participating in M&A transactions. Transacting companies implicated by the FSR may need to repay the subsidy or offer other remedies to obtain clearance before closing their deal.

The EU already has in place rules that screen subsidies granted within the EU (i.e., the EU State Aid regime), as well as rules combatting injurious subsidies granted to foreign imports (i.e., the anti-subsidy trade defense regime). However, prior to the FSR, no rules existed to effectively deal with distortions in the EU market caused by foreign subsidies in the context of M&A transactions.

Who is Subject to the FSR?

All international companies, irrespective of their country of origin or primary location, will be subject to the FSR if they (i) receive a foreign financial contribution (“FFC”) from non-EU government entities (see further discussion on what constitutes a subsidy below) and (ii) engage in M&A deals that impact the EU (see the relevant thresholds below).

What is a Subsidy?

A foreign subsidy exists where a non-EU country provides, directly or indirectly, a financial contribution that confers a benefit on an undertaking engaging in an economic activity in the EU and that is limited, in law or in fact, to one or more undertakings or industries.

The most common types of subsidies are cash grants, interest-free loans, unlimited guarantees, capital injections, preferential tax treatment, purchases from the government or sales to the government.

The FSR will ensure that acquisitions of an EU target are not supported by a foreign government providing, for example, a preferential loan or an unlimited guarantee to the acquirer, thus enabling it to outbid potential competitors.

When Will the FSR Apply?

The FSR entered into force on January 12, 2023, but has applied partially as of July 12, 2023 and will be in full effect beginning October 12, 2023.

As of July 2023, the Commission has had the power to examine any foreign subsidy in any sector of the EU economy in its sole discretion (so called ex officio investigation power), regardless whether the thresholds mentioned below are met or not.

As of October 12, 2023, the Commission must be notified of all M&A transactions that meet the relevant thresholds. All M&A transactions signed after July 12, 2023 and which both close after October 12, 2023 and meet the FSR thresholds will need to be notified to the Commission.

What are the Filing Thresholds?

For M&A transactions, a mandatory notification is required when the following two cumulative thresholds are met:

• at least one of the merging parties, the acquired party or the joint venture, is established in the EU and generates an aggregate revenue in the EU of at least EUR 500 million; and
• the parties to the M&A transaction solely or on a combined basis were granted financial contributions of more than EUR 50 million from non-EU countries in the three years preceding the conclusion of the agreement or the acquisition of a controlling interest.

The notification thresholds are not based on the level of subsidies (i.e., grants) that are liable to improve the competitive position in the EU of a party to the transaction. Rather, the notification requirement is based on a much wider concept of FFC, as described above.

Are Private Equity Companies also Affected?

Yes. “Financial contributions” are broadly defined and can be made by a wide variety of entities. Investments by a private equity (“PE”) fund are included within the definition of a relevant “financial contribution”, depending on whether such PE fund’s actions can be attributed to the non-EU country in question. All relevant circumstances are taken into account in determining whether a PE fund’s actions can, in fact, be attributed to a non-EU country.

The Commission has acknowledged that PE funds potentially within the scope of the FSR would need to gather information from multiple portfolio companies, which can be more burdensome than M&A transactions that do not involve PE investors. As such, the Commission has lightened the notification burden applicable to PE funds by limiting their disclosure requirements for FFC to only the acquiring fund (or funds)—including its investors and portfolio companies—under certain conditions. However, in the case of foreign subsidies that fall within those categories identified by the Commission as most likely to distort the EU internal market, all funds and portfolio companies need consideration.

In any case, the analysis of FFCs for the purpose of determining the EUR 50 million notification threshold should still be carried out across all funds and portfolio companies.

It is also worth bearing in mind that in the case of non-compliance with the new rules, the Commission may look at the wider group structure to calculate a fine (see further discussion of fines below).

The Commission has acknowledged that more guidance on how these concepts apply in the PE context is required. It has indicated that this will soon be forthcoming.

Are Joint Ventures Implicated by the FSR?

It depends. The JV needs to hit a certain gross revenue (also called, “turnover”) number and to act like an independent market player for the FSR rules to be triggered.

More specifically, in the case of the creation of JVs performing on a going-forward basis all the functions of an autonomous economic entity, the gross revenue threshold of the FSR will be met if the JV is established in the EU and the JV’s gross revenue in the EU is at least EUR 500 million. However, in the case of the creation of a newly set-up JV (i.e., a “greenfield JV”), as it does not have any gross revenue of its own, this threshold is not met, and therefore a notification under the FSR is not required.

The analysis may be different when the JV is created via the change from sole to joint control of a pre-existing business or subsidiary or where there is a change in control in a joint control structure due to the entrance of new controlling equityholders or in the case where entities newly acquire joint control of a pre-existing entity or business. This is a complex area, and it is facts and circumstances dependent.

What Needs to be Reported?

The FSR requires the notification of FFCs.

A FFC is a measure taken by a non-EU government—including public entities and private entities acting under control of, or under entrustment or direction of that non-EU government—that transfers economic resources to a notifying company.

FFCs are widely defined and can include, for example, capital injections, grants, loans, loan guarantees, exclusive rights and tax incentives as well purchases from the non-EU government or sales to the government, including those made on market terms. They can also include, under certain circumstances, measures such as export taxes, for example on oil exports that depress domestic oil prices.

The FSR has not issued a finite list of FFCs that should be reported. The list is intentionally left open to cover all possible forms of financial contributions and to avoid circumvention

Such notification should cover financial contributions granted not only to the legal entities directly involved in a transaction but to all group entities of the companies concerned (except for investment funds, which benefit from a specific limitation under certain conditions).

The FSR and its Implementing Regulation further distinguish between FFCs that should be (i) notified in detail or (ii) declared through a simplified overview table.

Detailed notification is required for FFCs that, in the last three years, individually exceed EUR 1 million and are considered to be the most distortive subsidies (“high-risk” FFC). Examples of high-risk FFCs are unlimited guarantees for the debts or liabilities, export financing measures that are not in line with the Organisation for Economic Co-operation and Development arrangements, a subsidy directly facilitating a M&A transaction as well as a subsidy granted to a bankrupt undertaking.

All other FFCs need to be declared by means of an overview table if the individual FFC is above EUR 1 million and granted by a non-EU country that granted in aggregate FFCs of at least EUR 45 million in the three years prior to the concentration.

However, note that all FFCs granted in the three years prior to the conclusion of the agreement or the acquisition of a controlling interest (including the sale of products or services to a public entity at market terms) count for determining whether the EUR 50 million threshold is met that triggers the notification obligation.

Substantive Assessment?

The Commission will focus in its assessment on foreign subsidies that distort competition in the EU.

The FSR explicitly lists categories of foreign subsidies that are most likely to distort the internal market, such as a subsidy directly facilitating a M&A transaction. Foreign subsidies are also likely to cause distortions if granted in markets characterized by overcapacity, or leading to overcapacity, by sustaining “uneconomic assets” or by encouraging investment in capacity expansions that would otherwise not have been built. Under the FSR, a foreign subsidy granted to a beneficiary that shows a low degree of activity in the EU (measured in terms of EU revenue) is less likely to cause distortions than a foreign subsidy granted to a beneficiary that has a more significant level of activity in the EU.

The Commission will particularly focus on sizeable subsidies (i.e., subsidies in absolute terms or in relation to the size of the market or to the value of the investment). In addition, the Commission is likely to focus primarily on subsidies granted by China, Japan, the United States and, in some cases, South Korea and Saudi Arabia due to these economies having a large enough budget to grant sizeable subsidies. The Commission has already explicitly identified subsidies granted under the U.S. Inflation Reduction Act as a major area of concern and is expected to follow its extensive existing practice under the EU anti-subsidy trade defense rules when considering distortion under the FSR.

What is the Review Timetable?

The FSR review timetable is similar to the one under the EU Merger Regulation. As such, parties are encouraged to speak to the Commission early on, at the “pre-notification” stage before the formal phase 1 review period of 25 working days. In case of substantive concerns, the Commission may open a phase 2 review, which will last up to 90 working days (with a possible extension).

The Commission must approve the notifiable transactions under the FSR before the closing of the affected M&A deals.

It is not currently clear when remedies can be offered and accepted, especially at phase 1. As a practical matter, early engagement with the Commission on this point, as well as the review timetable more generally, is encouraged.

Does the analysis run in parallel to merger control and other regulatory filings?

Yes. The FSR creates an additional layer of regulatory compliance and deal conditionality for sizeable transactions separate and apart from potential merger control and foreign direct investment clearance. However, the FSR and merger reviews at the Commission level have aligned timeframes, allowing the two notifications to run efficiently in parallel. Parties and their advisors should speak to the Commission as soon as possible to ensure that both regulatory regimes–FSR and merger control–are synched up in terms of timing, data requests and analysis.

Note that a M&A deal may require an FSR filing with the Commission while the same deal may undergo merger control scrutiny only at the EU member state level in cases where the Commission has no merger review jurisdiction. In addition, the same M&A deal may require foreign direct investment scrutiny in one or more EU member states.

Do Fines Apply?

Yes. Fines of up to 10% of the preceding financial year’s turnover apply for companies that fail to notify a transaction, implement a notified merger or acquisition before the lapse of the review periods or who try to circumvent the notification requirements.

As under the EU Merger Regulation, the Commission is authorized to impose fines on the entities for breaching certain procedural requirements, such as supplying incorrect information or failing to supply required information. The fines for infringements of procedural requirements may reach 1% of the aggregate turnover in the preceding year or 5% of the average daily aggregate turnover in the preceding year for each day of the violation.

What Should Parties Consider in M&A Deals Specifically?

Parties should specifically consider the following in M&A transactions:

• Deal planning: If the deal requires FSR clearance, the transaction will also be subject to a “standstill obligation” under the regime, meaning that the transaction cannot close until the notification process has cleared. This time frame needs to be built into the deal timeline and corresponding agreement terms.
• Include FSR provisions in corporate documentation: All transactions signed after July 12, 2023 and that will not be closed by October 12, 2023 will need to be notified under the FSR procedures if the thresholds are met. All such deals should include provisions relating to FSR clearance (and potentially commitments with respect to what must be done in order to seek clearance) in their conditions precedent and other relevant corporate documentation.
• Adopt stringent data collection mechanisms: Under the FSR, the data collection burdens on parties to a relevant merger are significant (see further discussion below). Parties need to consider how to best to collate records of the required data on FFCs received from their investors, and by their portfolio companies and other group investments, in order to assess their likely exposure to filing obligations under the FSR.
• Carefully consider whether the FSR applies to financial contributions from countries where loans, utilities and land-use rights are provided at non-market terms: This is especially relevant when such conditions have been found in past European decisions, such as in the area of anti-subsidy investigations. The same applies to manufacturing inputs sourced from sectors with a significant state ownership or those acting under entrustment and direction from a foreign government (e.g., batteries, steel, aluminum, chemicals). Such contributions are unlikely to benefit from a waiver for the less-detailed summary reporting.

The FSR regime is new, and the Commission itself has acknowledged that it will need some time to work out how to operate the new rules in practice. There may be, for example, some flexibility by the Commission regarding the timeframe during which commitments can be offered. Businesses should plan their engagement with the Commission strategically and consider what waivers they can offer the Commission in terms of protection of confidential information to speed up both the FSR and merger reviews.

It is also critical for parties to keep up to date on the adoption of the FSR into practice. The Commission has emphasized that the applicable rules and regulations in the FSR field will evolve as practice and experience grow so it will be important to closely follow developments as this new regime goes into effect.

How should companies collect the required data?

Businesses will need to gather information on their group-wide receipts of non-EU State financial contributions over a rolling three year period for three main reasons:

• to check whether they trigger the thresholds for mandatory notification of M&A transaction under the FSR;
• to be able to fill in the required notification forms if the thresholds are met; and
• to be able to respond to any ex officio investigation carried out by the Commission.

Parties will need to gather, on an on-going basis, an extensive amount of information on FFC. This is similar to the process many companies follow to comply with EU merger control—corporates collect data on an on-going basis and know their geographic group-wide breakdown of turnover, so that they can assess to the relevance of merger control when they enter into M&A deals. With respect to the FSR, companies need to collect information on FFCs in order to determine whether the regime applies; and if it does, then the information will need to be further refined.

In terms of putting into place internal mechanisms to help with the necessary data collection under the FSR, companies should generally be able to combine an annual turnover breakdown request from its internal teams with a request for FFC data. The list of operating subsidiaries and controlled JV investments should generally be the same for both data collection exercises. It follows that the identification of the relevant corporate “group” for FSR purposes should follow the same approach used for the group-wide turnover breakdown—meaning, the ultimate parent, all subsidiaries and all interests in JVs where the group is able to exercise control and/or material influence for merger control purposes.

To assist in putting into place such internal processes, we have developed a template that is designed to capture, in a single place, the information required to assess whether a notification triggered for the relevant M&A transaction, as the case may be. The template is intended as a basis to capture the necessary FSR data from potentially extensive numbers of group entities. In any given M&A transaction, as with merger control, there will be a need for some dialogue and follow-up questions with the Commission, during which process, the parties can benefit from the advice of counsel who have experience working with the Commission.

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Note: The authors co-lead the FSR practice within Mayer Brown.

¹ The FSR also applies to public procurement procedures that are not further discussed in this paper.