European Union: The New EU Foreign Subsidies Regulation — Key Aspects For Compliance

On July 12, 2023, the European Union's (EU) new landmark Foreign Subsidies Regulation (FSR)¹ started to apply. It empowers the European Commission (Commission) to review and remedy distortive subsidies granted by non-EU countries to companies active in the EU. The FSR significantly affects global deal making and public procurement situations in the EU, but also applies to other market situations. This advisory summarizes the main substantive and procedural rules and identifies key actions for businesses to prepare for FSR compliance.

Key Points

• The FSR closes a regulatory gap in the review of government support for companies doing business in the EU. While State aid granted by EU Member States must comply with the EU's State aid rules, there has, until now, been no comprehensive EU mechanism preventing subsidies granted by non-EU countries from providing an unfair advantage to companies doing business in the EU's internal market.
• The FSR does not prohibit foreign subsidies. It also does not introduce a review and approval mechanism for the granting of foreign subsidies. Instead, the FSR empowers the Commission to review and remedy the effects caused by foreign subsidies in the EU. To this effect, the FSR introduces three separate Commission review tools: two notification-based tools enabling the Commission to investigate both large M&A transactions defined as "concentrations" and tenders in public procurement procedures if certain thresholds are met, and a general tool allowing the Commission to investigate any situation potentially involving foreign subsidies on its own initiative ("ex officio").
• The Commission's ex officio powers came into effect on July 12, 2023 and are now fully operational. Concentrations and public procurement tenders that meet the FSR's thresholds must be notified starting as of October 12, 2023. The notification obligation applies if a transaction agreement was signed or a tender procedure initiated on or after July 12, 2023, unless the transaction is implemented or the tender contract is awarded by October 12, 2023.
• Under each of the three tools, the Commission will assess if the parties involved received a foreign subsidy that distorts the EU internal market. A "foreign subsidy" is defined as a financial contribution provided by a non-EU country that confers a benefit on a company active in the EU and is limited to one or more undertakings or industries. If the Commission establishes the presence of a foreign subsidy that distorts the EU internal market, it can prohibit the concentration or contract award and also impose a wide variety of measures to redress the distortive effects, unless such distortive effects are counterbalanced by positive effects on the development of the relevant subsidized economic activity in the EU or other positive effects in relation to the relevant policy objectives.
• The amount of information to be submitted under the required forms when notifying concentrations and public procurement tenders has been reduced compared to earlier draft forms that sparked hefty criticism from industry, but collecting the required information will still be cumbersome and time consuming.
• Best-practice FSR compliance means many companies will need to implement new internal tracking systems for financial contributions they receive from non-EU countries.
• The substantive risk and timing implications resulting from the FSR will affect the negotiation of transactions and should be assessed even for transactions that do not meet the mandatory notification thresholds.

Three Commission Review Tools Introduced by the FSR

The FSR introduces three review tools that are distinct from the EU Merger Regulation (EUMR) and other existing EU or Member State policy tools.

M&A transactions

The FSR introduces a mandatory notification-based regime for above-threshold M&A transactions that lead to a "concentration." The notion of a concentration is defined in the FSR in line with the definition used in the EUMR and notably excludes acquisitions of minority interests that do not confer joint control (by virtue of the right to approve business plans, etc.), which are therefore not notifiable under the FSR.

The first part of the notification threshold test — relating to EU presence and sales — will only be met by companies with large European operations. Importantly, in acquisitions, it is the target (on a group-wide basis, but without the seller) and, in transactions creating a JV, it is the JV (not counting the JV's parents) that must be established in the EU and generate EU turnover of at least €500 million. The second part of the test — requiring non-EU financial contributions of at least €50 million for the parties combined in the last three years — presumably will be met by a significant number of international companies that are involved in transactions that meet the first part of the test. Foreign financial contributions granted to the acquirer or the JV parent entities count for the second part of the test.

The Commission estimated that fewer than 50 concentrations per year will meet the FSR's filing thresholds. Invariably, notifiable concentrations under the FSR will also meet the filing thresholds under the EUMR or Member State merger regimes, so that parallel merger control and FSR filings and clearance procedures will be required in these cases. In many transactions, Member State foreign direct investment/national security filings will also be required.

The Commission's call-in powers for concentrations falling below the notification thresholds can be activated on mere suspicion that the companies involved have received foreign subsidies in the last three years. Even if the Commission is unlikely to call in a significant number of concentrations, the possibility of this happening in many transactions leads to timing and substantive risks that may need to be considered when drafting transaction agreements.

Public procurement procedures

The FSR introduces a mandatory notification-based tool for certain large tenders in public procurement procedures in the EU.

Ex officio investigations

The third tool empowers the Commission to investigate all other market situations in the EU on its own initiative ("ex officio"). Examples are implemented concentrations or awarded public procurement contracts, or situations where an EU subsidiary of a non-EU-country parent entity benefited from favorable State-supported financing in the non-EU country of the parent entity allowing the EU subsidiary to set up factories in the EU, thereby gaining an edge over competitors in the EU that lack such support.

With some limitations, ex officio investigations under the FSR can be carried out in parallel with, or instead of, measures available under other legal instruments that seek to protect against negative effects of subsidies granted by non-EU countries. Notably, the FSR applies separately from ("without prejudice to") Regulation 2016/1037, an established EU trade defense mechanism allowing the imposition of countervailing duties on subsidized imports of goods into the EU.

Not least due to the limited number of Commission staff available for FSR enforcement, the Commission is expected initially to focus on handling notifications and activate the ex officio investigation mechanism only in a highly selective manner.

The Commission's Substantive Assessment under the FSR

Under all three tools, the Commission's substantive assessment involves the following steps: (i) assess whether a foreign financial contribution granted to a company active in the EU constitutes a "foreign subsidy" within the meaning of the FSR; (ii) assess whether the foreign subsidy distorts the EU internal market; and (iii) if it does, balance the distortion's negative effects with any positive effects of the foreign subsidy on the development of the relevant subsidized economic activity and other broader positive effects.

A foreign subsidy is defined in Article 3(1) of the FSR as a financial contribution provided directly or indirectly by a non-EU country, which confers a benefit on an undertaking engaging in an economic activity in the EU and is limited, in law or in fact, to one or more undertakings or industries. The main elements of this definition are discussed below.

Financial contribution

The term "financial contribution" has deliberately not been defined. The FSR merely provides examples of financial contributions, which makes the concept very broad. It includes, inter alia:¹⁰

• The transfer of funds or liabilities (e.g., capital injections, grants, loans, loan guarantees, fiscal incentives, the setting off of operating losses, debt rescheduling, etc.)
• The foregoing of revenue (e.g., tax exemptions or the granting of special or exclusive rights without adequate remuneration)
• The provision, or purchase, of goods and services

Provided directly or indirectly by a non-EU country

A financial contribution provided directly or indirectly by a non-EU country includes financial contributions provided by:¹¹

• A country's central government and public authorities at all other levels
• A public entity whose actions can be attributed to the non-EU country, taking into account elements such as the characteristics of the entity and the legal and economic environment prevailing in the country in which the entity operates, including the government's role in the economy
• A private entity whose actions can be attributed to the non-EU country, taking into account all relevant circumstances

Which confers a benefit to an undertaking engaging in an economic activity in the EU

Under Recital (13) of the FSR, a financial contribution should be considered to confer a benefit on an undertaking if it could not have been obtained under normal market conditions.

The existence of a benefit should be determined on the basis of comparative benchmarks, for example:

• The investment practice of private investors
• Financing rates obtainable on the market
• A comparable tax treatment
• The adequate remuneration for a given good or service

If no directly comparable benchmarks are available, existing benchmarks could be adjusted or alternative benchmarks could be established based on generally accepted assessment methods.

Examples of situations where a financial contribution provided by a non-EU country probably leads to a benefit are:

• A state-owned bank located in a non-EU country provides a loan with preferential interest rates to a company
• An EU company invests in a new business in a non-EU country and benefits from a corporate tax exemption in that country

And is limited, in law or in fact, to one or more undertakings or industries

The benefit must be conferred on one or more undertakings or industries, i.e., it must be selective and not be available to all companies or industries.

The concepts of financial contribution, benefit, and selectivity are inspired by the EU State aid rules that include similar concepts. It can be expected that questions of interpretation will often be resolved in line with the solutions adopted under the EU State aid rules. However, the need to consider the elements of a subsidy in the context of the prevailing circumstances in a non-EU country, whose economies are often subject to significant state influence, can be expected to lead to novel questions and difficulties.

Under Article 4(1) of the FSR, a foreign subsidy is distortive where it "is liable to improve the competitive position of an undertaking in the internal market and where, in doing so, that foreign subsidy actually or potentially negatively affects competition in the internal market."

The reference to negative effects on competition should not be misunderstood as an adoption, by the FSR, of competition law concepts of anti-competitive behavior under a consumer welfare standard. Instead, the focus is on distortions of the competitive process through unfair advantages for individual companies.

When assessing the existence of a distortion of the internal market in the context of a review of a concentration, the Commission's assessment will be limited to the concentration concerned. Similarly, in public procurement procedures, only distortions affecting the public procurement procedure in question would be relevant.¹² Presumably, in an ex officio investigation, the Commission will focus on the foreign subsidy's distortive effects on the activity in question.

The Commission will consider the following indicators when establishing a distortion, but other factors can be relevant as well:

• The amount of the foreign subsidy
• Its nature
• The size of the undertaking and the markets or sectors concerned
• The level and evolution of economic activity of the undertaking in the EU
• The purpose and conditions attached to the foreign subsidy, as well as its use in the EU

The FSR characterizes the following types of foreign subsidies as most likely to be distortive (Article 5 of the FSR), so that the Commission can find a distortion to result from these types of subsidies without having to assess the indicators mentioned above in detail, unless the company provides evidence suggesting that the subsidy is not distortive:

• Subsidies to an ailing company, unless there is a viable restructuring plan that includes a significant own contribution by the company (Article 5(1)(a) of the FSR)
• Unlimited guarantees (i.e., without any limitation as to its amount or duration) (Article 5(1)(b) of the FSR)
• Export financing not in line with the OECD Arrangement on officially supported export credits (Article 5(1)(c) of the FSR)
• Subsidies directly facilitating a specific concentration (Article 5(1)(d) of the FSR)
• Subsidies enabling an unduly advantageous tender (Article 5(1)(e) of the FSR)

For subsidies that are not defined as most likely distortive, the FSR does not provide clear guidance as to how to weigh the different factors that are relevant for a finding of a distortion. In many cases, there will be no direct link between the subsidy and the situation reviewed by the Commission. For example, if a foreign parent entity receives tax breaks for an investment into a new production plant in the third country, it is unclear how the Commission will assess the effects of such tax breaks when assessing the participation of an EU-based subsidiary of that foreign parent company in an EU public procurement procedure or in an acquisition of an EU-based company. The Commission has announced that it intends to start clarifying the concepts of distortion and of the balancing test by July 2024, with formal guidelines to follow by 2026.¹³ In the meantime, companies will face significant uncertainty when internally assessing the risk that the Commission may find that a subsidy distorts the internal market.

Articles 4(2) and (3) of the FSR defines two de minimis thresholds, which are helpful in creating some degree of legal certainty:

• A foreign subsidy shall not be distortive where its total amount does not exceed €200,000 per non-EU country over any consecutive period of three years¹⁴
• A foreign subsidy is considered unlikely to be distortive where its total amount does not exceed €4 million over any consecutive period of three years

Moreover, Article 4(4) of the FSR provides that a foreign subsidy may be considered not to be distortive if it is aimed at "making good the damage caused by natural disasters or exceptional occurrences."

If the Commission establishes the presence of a foreign subsidy that is distortive, it may carry out a "balancing test."¹⁵

This test considers whether distortive effects of a foreign subsidy are mitigated by positive effects on the development of the relevant subsidized economic activity in the EU. Article 6(1) of the FSR clarifies that other positive effects may also be relevant, such as the broader positive effects in relation to the relevant policy objectives, in particular those of the EU (e.g., environmental protection, promotion of research and development, etc.).

These positive effects can completely neutralize the distortive effects of the foreign subsidy or inform the nature and level of redressive measure or commitments.

Until sufficient Commission practice evolves on these balancing factors and the Commission issues guidelines on the issue, there will remain a high degree of uncertainty as to the practical relevance of balancing factors for the outcome of a decision. This will make the outcome of a Commission investigation less predictable for companies.

The Commission's Enforcement Powers Under the FSR

Decisions and redressive measures/commitments

Following a notification, the Commission can allow or prohibit closing of the concentration or the award of the contract. If companies offer commitments that modify the notified transaction or tender, the Commission can allow the concentration or contract award to go forward subject to such commitments.

At the end of an ex officio investigation, the Commission can adopt a "no objection decision," impose redressive measures, or formally accept commitments offered by the company under investigation.

Redressive measures and commitments can be structural or behavioral. They may consist in, for example, access commitments for infrastructure acquired or supported by the foreign subsidies, reducing capacity or market presence, refraining from certain investments, the publication of R&D results, the divestment of certain assets, requiring the parties to dissolve the concentration, the repayment of the foreign subsidy to the granting country, or requiring the parties to adapt their governance structure. Commitments and redressive measures "shall be proportionate and fully and effectively remedy the distortion."¹⁶ The Commission can impose far-reaching reporting and transparency requirements in this context.

Significantly, the FSR empowers the Commission to adopt decisions "on the basis of the facts available" if companies or foreign governments fail to provide information requested by the Commission or otherwise do not sufficiently cooperate with the Commission's investigation.¹⁷ In these cases, the Commission will be able to reach substantive decisions even if the facts cannot be established with a degree of certainty that is normally required.

Implementation of the FSR is subject to the WTO rules as well as any commitments under the EU's trade and investment agreements.

Fines

Failure to comply with the FSR can lead to significant penalties, which are similar to those under the EUMR:

• Fines of up to 10% of the aggregate turnover of the undertaking in the preceding financial year for failure to comply with the notification requirements for concentrations and tenders in public procurement procedures, failure to comply with remedies imposed by the Commission, or early implementation
• Fines of up to 1% of the aggregate turnover of the undertaking in the preceding financial year for procedural faults, e.g., for submitting incorrect, incomplete or misleading information or not respecting the deadlines imposed, or not submitting to lawful inspections
• Periodic fines of up to 5% of the average daily aggregate turnover of the undertaking in the preceding financial year for each working day of non-compliance with any redressive measures or with any identified procedural fault

Preparing for the FSR — Key Takeaways for Companies

Given the requirement of new filings, companies should prepare for the possibility that they may need to file. This requires both maintaining data on financial contributions and considering the effects on transaction agreement drafting and timelines.

* Alexander Italianer, a Senior International Policy Advisor in Arnold & Porter's Brussels office, contributed to this Advisory.

Annex 1 — Commission Investigative Powers and Procedural Rules

The procedural set-up and Commission powers under the FSR have been broadly modeled after the rules that apply in the competition law context.

The Commission can gather information by issuing information requests to the parties involved, other undertakings, EU Member States, and third countries (although the FSR does not grant the Commission the power to impose fines on third countries that do not respond or provide incorrect or misleading information); interviewing persons who consent to such interview; and conducting inspections (dawn raids) at the undertaking's premises in the EU. Different from its investigative powers under competition law, the FSR allows the Commission to also carry out inspections at company premises outside of the EU but only if the relevant third country has been notified and raises no objection.

The FSR Implementing Regulation (IR)¹⁸ provides detailed rules on:

• The procedures for notifications of concentrations and foreign financial contributions in public procurement procedures
• Investigations by the Commission, including time limits for parties to submit comments following the opening of an in-depth investigation, as well as details on certain investigation tools of the Commission, e.g., interviews, oral statements, and the treatment of information from contracting authorities and others
• The procedures for the submission of commitments by companies to address preliminary concerns raised by the Commission
• The submission of observations by companies under investigation
• The procedures to be followed by the Commission for the use of information acquired pursuant to the FSR, and how confidential information is to be identified and protected
• Access to the Commission's file by companies under investigation, and rights of defense more generally
• The calculation of time limits for the provision of information and submission of commitments, as well as on the circumstances under which time limits may be suspended
• The transmission and signing of documents

Annex 2 — Notification Forms

The IR contains two annexes with template notification forms for (i) concentrations — Form FS-CO (Annex I) and (ii) foreign financial contributions in public procurement procedures — Form FS-PP (Annex II). The tables below summarize the information requirements of the Forms FS-CO and FS-PP.

Notifications of concentrations must be made directly to the Commission. Notification for public procurement procedures must be submitted to the tendering entity or authority, which will pass on the form to the Commission.

The forms must be submitted in one of the EU's official languages. For public procurement procedures, the form must be submitted in the language of the procurement procedure to which it relates; where the original language of the procurement procedure is not one of the EU's official languages, a translation into the language of the proceedings should be provided. Supporting documents must be submitted in their original language; if the original language of a document is not one of the EU's official languages, a translation of the language of the proceedings should be provided.

Where, in public procurement procedures, the €250 million threshold is exceeded but a bidding party falls below the €4 million threshold, it still must submit a "declaration" listing all non-EU financial contributions received and confirm they are under the threshold in the manner described by Section 7 of the Form FS-PP on a single form to the contracting authority or contracting entity in charge of the relevant public procurement procedure.

The Commission may agree to waive information requirements during pre-notification discussions provided the parties give adequate reasons why the relevant information is (i) "not reasonably available" (where appropriate and to the extent possible, the parties should provide "best estimates for the missing data" or indicate where the Commission could obtain this information) or (ii) "not necessary" for the Commission's examination of the case (e.g., the parties could argue that information regarding foreign financial contributions to entities not active in related markets or foreign financial contributions not directly benefiting the notifying parties or their controlling entities, is not necessary for the Commission's assessment).

The Form FS-CO, to be used for notifiable concentrations, features similarities to the Form CO that companies must use to file concentrations under the EUMR, but there are also important differences. Accordingly, there are some, but not very significant overlaps in the information requirements for transactions that require notifications under both the EUMR and the FSR.

The two forms require significantly more detailed information about foreign subsidies that belong to the categories of "most likely to be distortive" subsidies. Less information has to be provided for other types of foreign subsidies.

Footnotes

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.