On 12 January 2023 the EU Regulation on foreign subsidies distorting the internal market entered into force. Among other things, the new Regulation will have a significant impact on M&A transactions and greatly increase bureaucratic red tape as well as costs for many undertakings operating within the EU internal market. The associated notification obligations and verification procedures of this new foreign subsidy control come in addition to, and are dependent on, the already known merger control instruments under antitrust law.

Background

Fair competition ensuring equal market opportunities is a cornerstone of a functioning European internal market. The EU's competition rules, regulations on public procurement and its trade protection instruments play an important role in ensuring conditions of fair competition for undertakings within the internal market. That said, these rules and regulations do not apply to financial contributions from third countries that give an advantage to their recipients when purchasing EU undertakings or when engaging in public contracts or commercial activities within the EU. Until recently, then, this has left a “regulatory gap” that has led to unfair competition conditions in the internal market. To close this regulatory gap, the European Commission in May 2021 published a proposal for a regulation on foreign subsidies distorting the internal market based on which such foreign subsidies should be controlled. On June 30, 2022 the Council of the European Union announced in the “trilogue procedure” that political agreement had been reached on the proposal for a regulation, which was followed on November 28, 2022 by the formal adoption of the Regulation on foreign subsidies distorting the internal market. Regulation (EU) 2022/2560 of the European Parliament and of the Council of 14 December 2022 on foreign subsidies distorting the internal market (“Foreign Subsidies Regulation”) was published in the EU’s Official Journal on December 23, 2022 and is now in force as of 12 January 2023. It is going to be applicable as of July 12, 2023. This adds another regulatory instrument to the European competition regime.

The background to the new Regulation is that investments by undertakings from third countries (as well as undertakings controlled by third countries) have risen sharply in recent years. For example, there has been a marked increase in the number of state-subsidised takeover bids being made by Chinese investors for European undertakings. As the bids submitted – in some cases also for geostrategically attractive or highly innovative industry areas – far exceed the market price, European countries are simply being outbid. So far neither European State aid and merger control law nor public procurement or internal trade law have provided any means of addressing this issue.

Key points of the Foreign Subsidies Regulation

The Foreign Subsidies Regulation therefore seeks to enable an adequate control of foreign subsidies having distorting effects within the EU internal market. The aim is to create equal opportunities between all – European and non-European – undertakings operating within the internal market, i.e. to ensure a “level playing field”.

1.   Review approach and procedure

The European Commission has ratione materiae competence for examining the compatibility of a foreign subsidy with the internal market to ensure the uniform adoption of the Regulation throughout Europe. Here, its scope of application extends to all undertakings operating within the EU. The Commission’s review procedure for this is two-tiered: it consists of a preliminary review procedure, which may then be followed by an in-depth investigation. The primary purpose of this in-depth investigation is (i) to determine whether a foreign subsidy exists, and (ii) whether such foreign subsidy distorts competition. If the Commission answers these questions in the affirmative, the negative effects are to be weighed up against the positive effects on the internal market (iii). In terms of form, the investigation procedure is very similar to the formal State aid investigation procedure, but is enhanced, depending on the issue under investigation, by elements of merger control and public procurement. To create competition offering equal opportunities on the internal market, the Foreign Subsidies Regulation provides for three specific review instruments: 

• Notification-based instrument for examining mergers and acquisitions
  For mergers and acquisitions, Chapter 3 of the Regulation provides new rules inspired by EU merger control. If the acquired undertaking or a merging undertaking has generated an aggregate turnover in the European Union of at least EUR 500 million during the preceding financial year, and one of the merging undertakings has received a foreign financial contribution of at least EUR 50 million in the preceding three years, the proposed merger or, as the case may be, the proposed acquisition must be notified to the Commission before it takes place. While the review by the Commission is under way, notified mergers and acquisitions may not be completed, i.e. they are subject to a prohibition on closing.
  
  The Commission has announced the drafts for such notification form drawing on the notification obligation for foreign public sector financial contributions, which is likely to be understood more broadly than the term “subsidy”. As a result, a supporting element will not be relevant when it comes to the formal-legal notification obligation. This notification obligation as a general rule comes into play if a merger is brought about by a permanent change in control. It is deemed to be detached from and independent of the obligations known in connection with EU merger control.
  
  After the transitional period of six months has expired, most of the new provisions will apply as of July 12, 2023. This application date is decisive when it comes to the application of the provisions of the Foreign Subsidies Regulation, since they apply only to M&A transactions signed after that date. 
  
  The new notification obligations and prohibitions on closing covered by fines will then apply three months from the application date, i.e. as of October 12, 2023.
   
• Notification-based instrument for examining bids in public procurement procedures
  In the case of large public procurement procedures with an estimated contract value exceeding the threshold of EUR 250 million, a notification procedure must also be conducted if the bidder has received a foreign financial contribution of at least EUR 4 million. Here too, a prohibition to close applies, i.e. bidders who are undergoing a review may not be awarded a contract in a public procurement procedure until the review by the Commission is complete.
   
• General market review instrument
  For all other market situations and for mergers and/or bids made on public tenders post-award which are below the respective thresholds, the Regulation provides a general market review instrument, similar to the counterpart under antitrust law, for those cases in which the Commission suspects the existence of a foreign subsidy. In such cases the Commission can ultimately require an ad hoc notification.        

Moreover, the Regulation includes comprehensive investigative powers and the possibility of imposing fines or periodic penalty payments to enable the Commission to enforce its investigative powers.

2.   Substantive compatibility review: When is a foreign subsidy competition-distorting?

A foreign subsidy is deemed to distort competition in the internal market if the selective direct or indirect financial support provided by a third country is capable of improving the competitive position of the beneficiary competitor to such extent that this actually or potentially adversely affects competition in the internal market. Indicators of a competition-distorting effect are deemed to include the amount, nature and purpose of the subsidy, the situation of the undertaking and the markets concerned, as well as the economic activity on the internal market. The Commission assumes the internal market is most likely be distorted in the following cases: foreign subsidies granted to ailing undertakings without a restructuring plan, export financing measures not in line with the OECD Arrangement, unlimited guarantees, unduly advantageous tenders, as well as foreign subsidies directly facilitating a concentration.

3.   Balancing test: Assessment of the effects of foreign subsidies

In the compatibility assessment of a foreign subsidy, any potential positive effects of the subsidy are to be taken into account and weighed up against the negative, competition-distorting effects. If the positive effects outweigh the negative ones, no redressive measures are to be necessary; if the negative effects outweigh the positive ones, redressive measures or commitments (taking account of the positive effects) are to be drawn up to remedy the distorting effects on competition.

4.   Suitable redressive measures to remedy the market distortions

In terms of the procedure, the undertaking benefiting from the foreign subsidy may submit to voluntary commitments to effectively remedy the distortion. Furthermore, the Commission will have the possibility of making redressive commitments binding on the undertaking concerned in a decision. In structural terms that may consist in a divestment of capacities; in terms of conduct in the reduction of market presence or access to (otherwise reserved) infrastructure, repayment of the subsidy or as ultima ratio a prohibition of the transaction, i.e. prohibition of the merger or a prohibition on participating in the public contract.

Impacts in practice

Anyone wishing to compete on the internal market in future will have to comply with the regulatory requirements of the Foreign Subsidies Regulation. With this commercial policy protective instrument regulators are seeking to counteract competition-distorting subsidies and to make them compatible with the internal market. But already now it is reasonably foreseeable that the complexity of the legal subject matter in the area of competition law is increasing and thus also could also increase for EU/national authorities: firstly, the Commission is facing mounting pressure on resources when it comes to reviewing cases swiftly but thoroughly to provide effective protection of competition. In future, national authorities or contracting authorities, when approaching the thresholds, will need to have sensitivity for these new rules.

Secondly, large globally operating companies in particular will have to rethink and adjust their market and branch strategies in light of the new rules. Especially in the case of large, globally operating groups, the threshold of EUR 50 million in foreign financial contributions will be reached relatively quickly since all contributions of any third countries are aggregated. There is moreover the risk of delays leading to commercial disadvantages, especially for those companies which are part of a transaction but which are not yet directly subject to the Regulation.

In connection with a M&A transaction above the notification threshold, it is therefore possible in the share purchase agreement to resort to the well-known antitrust game plan (conditions for closing or guarantees).

For reasons of transparency and legal certainty, the Commission has rightly been required to tie its administration practice in the interpretation of the upcoming Regulation to (yet to be created) guidelines. Such guidelines might provide insight into how the new rules might be handled and have already been announced. For reasons of flexibility, the Foreign Subsidies Regulation contains the possibility of group exemptions. This option has been used in State aid and antitrust law, and it would also make practical application of the Regulation to third-country subsidies easier. That is because the broad scope of application of the Foreign Subsidies Regulation also covers transactions to which no non-EU companies at all are party. Moreover, exemptions currently exist neither for individual non-EU countries nor for particular sectors. 

Outlook

The Commission will soon submit a draft implementing regulation in which the provisions and procedures to be applied will be explained, including notification forms for concentrations and public procurement procedures, guidelines for calculating time limits, for the right of access to the file of the Commission, and for the confidentiality of information. The market participants will then have four weeks' time to submit their comments on this draft before final adoption of the implementing provisions slated for the middle of 2023.

In the coming years, competition in the single market is likely to be shaped to a decisive extent by the new Regulation. The case practice of the Commission and the first court decisions will show whether the new provisions will be able to effectively create the desired level playing field in the single market. The term “competition-distorting foreign subsidies” must be further defined and the balancing test criteria developed to enhance legal certainty. At any event, a level playing field will be an indispensable requirement for a strong and thriving, but at the same time fair and sustainable competition on the European internal market.