Newly effective EU rules impose another layer of review for acquisitions in Europe. They empower the European Commission to investigate whether either the acquirer or target has received non-EU government subsidies that distort the EU internal market. While the new regulatory regime may not ultimately lead to many blocked deals, it could result in delays, and companies considering M&A in Europe will need to create comprehensive systems to track any government support they receive anywhere in the world. Skadden M&A partner Ann Beth Stebbins discusses the impact of the review process with Brussels-based partner Giorgio Motta.
Episode Summary
Companies now face an additional regulatory hurdle when making acquisitions in the European Union. In addition to merger control and foreign direct investment (FDI) filings, they will be subject to the EU’s new Foreign Subsidies Regulation (FSR), Giorgio explains. The law, which took effect in July, allows the European Commission to look into acquisitions of, and investments in, businesses in Europe by non-EU companies that have received some sort of financial support from a non-EU government.
The FSR’s reach is broad. For example, it is not limited to targets based in the EU. If a non-EU company buys another non-EU company and the target has substantial European operations, the companies may be required to report their transaction under the FSR, Ann Beth points out.
There are two economic thresholds: First, does the target have EU revenue of at least €500 million in the EU? Second, have the companies together received more than €50 million in non-EU government support in the past three years? The latter is quite a low threshold, so most companies that meet the revenue threshold will likely be required to notify the EC of the transaction and disclose government support they have received, Giorgio says.
Foreign financial contribution encompasses almost any financial flow between a company and any non-EU public body or private body whose actions can be attributed to a non-EU government. Even purchases of goods or services by or from a public entity on market terms count toward the €50 million threshold. For the types of financial contributions that the EC considers the most distortive — support to a failing business, unlimited guarantees, export financing or the funding of an M&A transaction — the EC will require more detailed disclosure.
The filing requirement applies to transactions signed on or after July 12, 2023, which have not been completed by October 12. No filings will be accepted before October 12, but the EC is inviting companies to come in and discuss the form and details of any potential notification before then.
The EC is likely to be concerned about transactions where the buyer may have been able to outbid other interested parties because of state ownership or subsidies, Giorgio says. That might also apply to private equity funds with sovereign wealth fund investors that provide advantageous financing, he adds.
Both acquirers and targets will want to perform additional due diligence on their counterparties to determine if there are risks the transaction could be blocked or delayed because of the FSR, and their merger agreement will need to provide for those risks, Ann Beth and Giorgio say.
Today virtually no companies systematically compile comprehensive information about all types of government support, Giorgio says. Because the FSR considers financial support globally, companies considering acquisitions in Europe will need to create systems to collect this type of information and keep it updated so they can respond quickly to M&A opportunities.
The best approach, Giorgio says, is to prioritize data on the types of support that the EC is mostly likely to fear will have the most distortive effect on competition in the EU, and/or support to strategic industries that the EC may want to protect. If your company is near or over the thresholds, we also generally recommend discussing with the commission how to narrow the disclosure required, he adds.
We do not expect many transactions to be blocked or be subject to remedies, Giorgio says. In most cases, the FSR filing will likely be just one additional layer of red tape for M&A deals. But companies will want to make sure in the due diligence phase that there is nothing that would trigger a more in-depth review that could affect the outcome or timing of the transaction.
Voiceover (00:00):
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Ann Beth Stebbins (00:35):
The EU has recently introduced a new regulatory notification requirement that’s aimed at non-EU acquirers that receive subsidies. I’m Ann Beth Stebbins, a partner in Skadden’s M&A practice. I’m joined today by my partner Giorgio Motta from our Brussels office. Giorgio specializes in merger control and state aid, and we’re here to talk about the new Foreign Subsidies Regulation. Hello, Giorgio.
Giorgio Motta (01:01):
Hey, Ann Beth.
Ann Beth Stebbins (01:02):
Thanks for being with us. Let’s start with the basics. What is the new Foreign Subsidies Regulation?
Giorgio Motta (01:09):
M&A transactions as of the 12th of July of this year face an additional regulatory red tape in Europe, that is in addition to merger control and to FDI approvals, and that is the Foreign Subsidies Regulation, or FSR.
Ann Beth Stebbins (01:27):
Why was this law enacted?
Giorgio Motta (01:29):
The FSR is essentially a new tool that will allow the European Commission to look into acquisitions of, or investments in, businesses in Europe that are made by companies that have received some sort of financial contribution from a foreign government. The EU already has quite detailed rules to monitor how EU governments fund and subsidize companies and industries in the EU.
Ann Beth Stebbins (02:06):
This new regulation doesn’t impact any European subsidies of European companies?
Giorgio Motta (02:13):
That’s exactly right because the EU already has in place a system to actually monitor and control these kind of subsidies given by EU national governments.
Ann Beth Stebbins (02:25):
But this regulation is going to target non-EU investors into EU companies if those acquirers receive non-EU subsidies.
Giorgio Motta (02:34):
That’s right, and that’s because the European Commission before the FSR was enacted had no means to monitor similar types of subsidies that were granted by foreign governments. What the FSR is designed to do is exactly to fill that perceived regulatory gap.
Ann Beth, if helpful, I can give you some background because I think this may help everyone understand which companies and which M&A deals are most likely to be subject to this new regime.
The lawmakers in Brussels started to think about this new law a few years ago, and the idea was to go after acquisitions and investments in Europe made largely by Chinese state-owned and state-backed companies. And the concern was to prevent China Inc. from using its state economy, from taking over European businesses in important industries.
Ann Beth Stebbins (03:37):
So this isn’t all that different than the thinking behind CFIUS, and CFIUS is focus on China Inc. in recent years.
Giorgio Motta (03:44):
I think that there is a slight difference with CFIUS, which is this new regime doesn’t really distinguish or focus on particular industries, companies or nationalities. It focuses on any companies that are investing in Europe that are supported by foreign governments in a way that the European competitors are not getting.
And going back to the history of this, I think it’s fair to say that the focus has somewhat expanded in the last couple of years from looking only at China state-owned companies to more broadly at foreign subsidies given by non-EU governments. And why is that? Because when you look at what has happened in the last couple of years, first, the COVID pandemic, then Russia’s invasion of Ukraine, what they have triggered is the largest-ever flow of government subsidies. And actually, when you look at the most recent statistics from the World Bank, the largest contributor of government subsidies around the world has been the United States of America, most recently through the enactment of the Inflation Reduction Act.
Ann Beth Stebbins (05:01):
So Giorgio, even though China Inc. might’ve been the initial impetus for the regulation, the impact will be felt most significantly by U.S. companies because of recent legislation in the U.S. — the CHIPS Act, the Inflation Reduction Act — that all gets picked up when we think about what constitutes a subsidy for purposes of triggering this regulation. Is that right?
Giorgio Motta (05:30):
That is right. While the FSR does not distinguish or focus on particular industries, when you look at the industries and technologies that are being supported by the U.S. administration through the IRA, those are industries that are somewhat strategic in Western economies, where many governments are pouring money. So I think if U.S. companies have received some sort of support from the U.S. administration or from local governments through the IRA or through other subsidy measures, they may get the attention of the EU through the FSR review process.
Ann Beth Stebbins (06:18):
We already have merger controls, we already have foreign direct investment approvals. How is this assessment under the FSR, the Foreign Subsidies regime, different?
Giorgio Motta (06:30):
First of all, different thresholds. To summarize them in short, first of all, the FSR applies to all transactions that have signed after the 12th of July of this year, but will not be completed by the 12th of October of this year. Second, the target in an M&A deal or the merging parties, they must be established in the EU. And just to be clear, this requirement, it’s quite broad. So this would potentially also cover companies that have non-EU headquarters, but that have subsidiaries and operations in Europe.
Ann Beth Stebbins (07:12):
So if you’re a non-EU acquirer and you’re acquiring another non-EU target, if that target has significant operations in Europe, this regulation will require a notification.
Giorgio Motta (07:26):
That’s right. But then there are some financial thresholds. Does your target in your M&A deal generate more than €500 million in revenues in the EU? And that is a relatively high threshold. And then there is a fourth threshold, which is that the merging parties have received in the last three years more than €50, 5-0, million in financial contributions in subsidies from a foreign government. It’s a relatively low threshold. And so we anticipate that if the 500 million revenue threshold in Europe is met, many companies will meet the 50 million threshold.
Ann Beth Stebbins (08:17):
Just to be clear, it’s 50 million for both parties. So if one party receives 30 million in subsidies over the measurement period of three years and the other party received 25 million in subsidies, even though that other party is the target, the two subsidy levels are combined to see if that 50 million, 5-0, over three years.
Giorgio Motta (08:41):
That’s correct. It’s the combination of a low threshold and the broad definition of financial contribution under the FSR.
Ann Beth Stebbins (08:51):
Let’s spend some time talking about that. What is a subsidy? What does foreign financial contribution pick up?
Giorgio Motta (08:58):
The law introduces a very broad notion of foreign financial contribution that counts towards the filing threshold. This notion would essentially capture almost any financial flow between a company and any non-EU public body, or even a private body that is acting on behalf of a government. So to give an example, the sale or purchase of goods or services from a foreign government or government entity, even if it’s done on market terms, would count for the determination of the threshold.
There is a subset of this category of financial contributions, which the commission defines as the most distortive type of financial contributions that will not only count for the threshold, but that will require some detailed disclosure. To give you an example of that, support to a failing business, unlimited guarantees, export financing measures, or the funding of M&A transaction, so contributions that directly facilitate a transaction. These are the most typical forms of subsidy the commission will take a close look at.
Ann Beth Stebbins (10:26):
So let’s drill down. You mentioned the purchase of goods and services. So take COVID for example, when governments were procuring masks or procuring PPE, those types of purchases, even if on arm’s length terms would be picked up as part of the €50 million threshold.
Giorgio Motta (10:42):
That is correct. They would be picked up by the 50 million threshold, and that is why most companies would probably meet this threshold.
The commission during the consultation process received a lot of comments from businesses pushing back on this broad definition of foreign financial contributions. And so what the commission did in the final implementing regulation is to tone down the disclosure requirements for this type of arms length transactions. So, while companies still will need to count financial flaws with governments, they will not need to disclose detailed information in the filing about this.
Let me maybe add on that. This is a new regulation. There are no precedents, there are no guidelines. So I think it’s going to be essential for companies to go in early and have an open and frank discussion with the commission to possibly get waivers.
Ann Beth Stebbins (11:52):
Well, let’s talk about the process. I know it’s new, have there been any filings made or notifications made yet?
Giorgio Motta (11:58):
The filing obligation will only kick in as of the 12th of October of this year. However, the commission is inviting companies to come in and discuss the form and the details of any potential notification in pre-notification discussions. The FSR review process will be quite similar to the one under the EU merger regulation. It will involve a pre-notification period and a phase one review of 25 working days.
Ann Beth Stebbins (12:32):
And that can run concurrent, Giorgio, with the merger control time periods, with any foreign direct investment review period?
Giorgio Motta (12:40):
It can be run concurrently, whenever you have a merger control filing approval for your deal and you also have an FSR approval, it’s quite important for companies to be able to run this process in parallel.
The FSR teams and the merger control teams that will look at your transaction sit under the same director general of the commission, which is the director general for competition, and they will talk to each other. They will share information. So it becomes very important to ensure a consistent approach and strategy in your FSR and merger control filing process.
Ann Beth Stebbins (13:24):
Would you anticipate that there would be sharing of this additional disclosure that’s required under the FSR among the regulators so that the merger control people, for example, are seeing due diligence reports that are provided to the FSR team?
Giorgio Motta (13:42):
There is some overlap in terms of the documents that are required under the two filing processes, but there are some additional document disclosure requirements under the FSR, like due diligence reports, valuation analysis, analysis regarding potential alternative acquisitions — materials that are specific to the foreign subsidies that are being assessed under the FSR. And because the two teams, the FSR team, the merger control team will speak to each other, I think it is important for companies from now on to take a close look at this type of due diligence reports, valuation analysis, and the content of it because that content may impact also the outcome of your merger control view.
Ann Beth Stebbins (14:35):
How will the FSR team assess the merits of a transaction? What gets their attention and what are the remedies if it’s something that they determine influences or distorts the internal EU market?
Giorgio Motta (14:50):
The commission will assess whether foreign subsidies or selective financial contributions distort the EU internal market. When reviewing subsidies in the context of an M&A deal, these assessment will be limited to the context of the transaction. The assessment under the FSR will not look at the overall impact of the transaction on competition, but at the specific effect that a foreign subsidies has on competition in Europe, particularly on the market in which the transaction is taking place. That means that the commission could raise, for example, concerns even in markets that are not particularly concentrated, which is the test you have in a merger control system. And a good example is a competitive M&A bidding process. The typical merger control regime would not worry about which bidder wins a particular acquisition of a particular business, as long as sufficient competition remains after the transaction.
(16:03):
Under the FSR, the commission could instead intervene if he believes that, for example, the winning bidder was able to outbid competing companies with the help of some foreign subsidies. If you want to think about some examples, the most typical one is state-owned or state-backed Chinese companies that may be able to outbid competitors because of the backup that they get from the Chinese government. But also you might think in the context of a PE transaction of limited partner investments that are made by sovereign wealth funds or pension funds to participate in the acquisition of a business in Europe.
Ann Beth Stebbins (16:51):
So what should U.S. companies who are considering acquisitions of targets with significant business in Europe be doing now to prepare? It sounds like there’s quite a bit of tracking that companies who are inquisitive should be doing on a regular basis. How are we advising clients to change their practices in anticipation of this rule?
Giorgio Motta (17:20):
There are maybe two practical elements that will be relevant. First, filing requirements or the risk of investigations by the commission in most deals, the deals that have an EU angle. We talked before about filing thresholds, however, under the FSR the commission will also have a below-threshold investigation tool that will allow the commission to go after acquisitions that may be less material in size if the transaction relates to specific industries or, for example, if they get a complaint.
So what does this mean in practice? I think it means some additional work during the due diligence phase of an M&A deal, because company will need to get smart on the type and on the amount of foreign subsidies that are being received from foreign governments. In a pre-signing phase, could my deal be blocked or delay because of the amount and focus of subsidies that I’m receiving?
Ann Beth Stebbins (18:27):
And that goes both ways since both parties are considered in whether or not the 50 million threshold is met. So it’s diligence that the acquirer is doing on the target, but also reverse diligence from the acquirer similar to how we exchange information for merger control filings?
Giorgio Motta (18:43):
Absolutely. Absolutely. It’s going to be both ways.
Related to that, companies will need to reflect the FSR risk in their merger agreements. Do we need to have a condition precedent for FSR approval? What are the cooperation provisions to reflect the disclosure requirements from all the parties involved? Do we need to adjust the long stop date to reflect potentially lengthy reviews? Do we need to look at the effort covenants to reflect the very diverse nature of potential remedies that may be triggered here, divestments or behavioral commitments, the repayment of a subsidy. So that’s I think the first element.
But back to your point on tracking this kind of information, most companies contacted by the commission expressed a concern that they are simply unprepared to this process. Virtually no company has a systematic way of collecting this type of data.
Ann Beth Stebbins (19:48):
Because this data would be in various pockets of a typical corporation. What are you getting as a tax credit for having a facility in a particular location? Procurement, what are you buying from a government source? Do you have a loan where the lenders might be funds that have LP money? I think the information is probably very-
Giorgio Motta (20:16):
Dispersed.
Ann Beth Stebbins (20:17):
... distributed throughout a typical organization. So just to collect that from the various pockets seems onerous.
Giorgio Motta (20:23):
And there is also on that the geographic element. If a U.S. company is essentially multinational with subsidiaries and operations around the world, you need to do that due diligence exercise for your non-U.S. operations.
Companies, I think, should start thinking now about setting up a system for the mapping, collection and gathering of this type of information, and keep this updated so that they can quickly assess FSR notification requirements for their M&A opportunities. But also because the European Commission will have this below-threshold investigation tool under the FSR. So your investments or your M&A deals that fall below the FSR funding threshold could still be caught by the commission.
(21:14):
And how do you in practice try and address that? The best option here is to prioritize the collection of these type of subsidies, focusing on those that we know are the most likely to potentially have a distortive effect on competition that may relate to some strategic industries that the commission may be interested in. If you are above the threshold already, then my advice would be go in and try to discuss with the commission pragmatic, practical ways to get waivers and to narrow the disclosure to really the type of subsidies that are most likely to be relevant for the assessment.
Ann Beth Stebbins (22:04):
Giorgio, do you anticipate that many transactions will be blocked or be subject to remedies, or do you see this more as a notification process, and the vast majority of transactions will be approved without any second request? Is this just another regulation and not something that will block M&A transactions?
Giorgio Motta (22:24):
The commission actually has been pretty clear. When they introduced the FSR, the competition commission did say this tool is designed to go after the big fish. I would anticipate that in most transactions, the FSR filing is going to be just one additional red tape, together with merger control and with FDI. But I think companies, they just want to make sure, and that’s why I always focus on the due diligence phase. They want to make sure in the due diligence phase that they’ve done a sufficient risk assessment to make sure that this is nothing more than just a red tape. There is nothing in terms of foreign subsidies that could have an impact on the outcome or timing of the review. But in general, I think very few transactions eventually are going to be blocked or subject to significant remedies under the FSR.
Ann Beth Stebbins (23:24):
Well, Giorgio, thank you very much for joining us from Brussels. I think we will need to have you back in a few months to see how this is actually playing out in practice, once the rules are fully implemented
Giorgio Motta (23:38):
With pleasure. I think in a few months we will have a bit more cases and guidance.
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