The new FSR regulation changes the landscape for M&A transactions and high-value procurement procedures.
The FSR in a nutshell
On 12 January 2023, the EU Foreign Subsidies Regulation (the "FSR") entered into force. The FSR aims to address distortions in the internal market caused by foreign subsidies to create a level playing field for companies operating in the EU. Unlike state aid granted by EU Member States, which is subject to stringent EU state aid rules and in many cases approval by the European Commission ("EC"), foreign subsidies from third countries have previously escaped the EC's control. The FSR intends to close this regulatory loophole through filing requirements imposed on market participants and gives the EC a toolbox to tackle competitive advantages market participants operating in the EU obtain through foreign subsidies from non-EU Member States. The proposed information requirements in connection with the filings are extensive. The FSR regulatory regime is separate from and comes in addition to EU and national merger control/anti-trust filing regimes.
The FSR broadly provides the EC with three wide ranging tools to investigate, assess and endorse the compatibility of foreign subsidies with the internal market:
- examination of mergers and acquisitions exceeding certain thresholds (based on both turnover and size of financial contributions from third countries), entailing a standstill obligation and with the possibility for the EC to block transactions and in certain cases require the parties to reverse transactions that are not notifiable.
- examination of financial contributions in the context of high-value public procurement procedures with the possibility to suspend awards, require the successful bidder to offer commitments, and block award decisions.
- ex officio review of foreign subsidies, with the possibility to order interim measures, request information and carry out inspections within the EU.
Failing to notify transactions exceeding the thresholds (turnover and financial contributions) or implementing notifiable transactions in breach of the standstill obligation can result in fines up to 10 % of the aggregate turnover the preceding financial year. The same applies in the case of failure to notify foreign financial contributions during a public procurement procedure or in case of attempts at circumventing notification requirements in the FSR.
In the following, we will look closer at the impact of the FSR on M&A transactions.
A game changer for larger M&A transactions
The FSR will have a significant impact on larger M&A transactions going forward. All transactions which are signed on or after 12 July 2023 (when the FSR starts to apply) and are not closed before 12 October 2023 (when the filing obligation starts to apply) will be subject to prior notification and a standstill obligation if meeting the notification requirements. This means even ongoing M&A processes (not signed before 12 July) may be affected, particularly in two ways.
- Firstly, dealmakers will have to cater for an increased risk of deals not being completed as it may be blocked by the EC, together with delays of completion pending approval.
- Secondly, the information that needs to be provided to the EC are particularly extensive and yet unclear, which needs to be taken into account in the very early stages of the transaction, particularly in auction processes and the due diligence phase.
Even though the filing requirement applies at EU level, with the EC as the sole enforcer, it will become relevant for Norwegian and other deals with a connection to the EU. In the case of acquisitions, for the FSR to become applicable it suffices that the target is established in the EU, for example through subsidiaries or branches, provided the notification thresholds are met.
Notification thresholds
Whether a transaction is subject to a filing obligation depends on the turnover and financial contribution provided to the companies involved in the transaction.
A transaction will be subject to a filing obligation when
- At least one of the merging entities, acquired companies or joint venture established in the EU generates turnover exceeding 500 mEUR; and
- The entities involved have been granted a combined financial contribution of more than 50 mEUR from third countries in the past three years.
The thresholds capture many transactions and foreign contributions which may at the outset not appear to have a close link to the EU. For instance, if a buyer established outside the EU has been granted a financial contribution of 60 mEUR from non-EU Member States in the past three years and acquires a target established in the EU which generates a turnover exceeding 500 mEUR, a filing will be required.
The filing requirement applies for transactions involving a change of control and the filing obligation lies with the buyer in case of an acquisition and with both parties jointly in case of a merger or establishment of a joint venture.
The FSR also provides the EC with an extensive competence to investigate transactions falling below the thresholds on an ex officio basis. The EC may also impose filings in case it suspects that foreign subsidies may have been granted in the three years prior to the transaction.
What qualifies as a financial contribution?
The FSR stipulates that a foreign subsidy shall be deemed to exist where a third country provides, directly or indirectly, a financial contribution which confers a benefit on an undertaking engaging in an economic activity in the internal market and which is limited, in law or in fact, to one or more companies or industries. This has clear similarities with the notion of state aid under EU law. The notification thresholds refer to financial contributions from third countries. The concept of a financial contribution it is wide-reaching, and encompasses all types of direct or indirect financial contributions from third countries , including grants, loans, guarantees, compensations, tax exemptions, exclusive rights and the provision of goods and services. In addition to contributions by central governments and authorities, contributions from public and private entities whose actions can be attributed to a third country government may also be covered, giving rise to difficult assessments in practice.
The FSR does not make any exceptions for the treatment of financial contributions from the EFTA states Norway, Iceland and Liechtenstein, or other countries covered by EU external agreements which include provisions on state aid. This entails that interactions with public authorities from Norway will have to be included in the calculations of financial contributions when assessing the notification threshold. It is yet unclear whether the draft FSR Implementing Regulation ("Draft IR") will require the parties to report financial contributions granted from EFTA-countries under the notification form for concentrations, and whether the EC will take into account state aid from EFTA-countries that have already been subject to state aid control by the EFTA Surveillance Authority ("ESA") in its material assessment of the concentrations distortive effect.
Calculation of turnover and financial contributions
For acquisitions, only the EU target's turnover (and its subsidiaries) will be relevant for the assessment of turnover, but both the Buyer's and the Target's turnover will have to be included in the calculation of the combined financial contributions. For mergers, both the seller's and buyer's turnover will be relevant, and both parties' financial contributions will have to be included in the calculation of the combined financial contributions. Note that in the creation of a newly set-up joint venture (greenfield joint venture), the turnover threshold will not be met, as it cannot have any turnover of its own.
Timeline, standstill and fines
The time limits and review process after filing a notification to the EC mirror those of the EU Merger Regulation. The EC has 25 working days to review the transaction before deciding whether to open a Phase 2 investigation. In Phase 2, the EC has 90 days to conclude (extended by 15 working days if commitments are offered to remedy the concerns). The EC will have the power to impose fines of up to 10% of the total revenue of the companies involved if a transaction is not notified or implemented prior to the EC's decision (as under the EU merger regime).
Extensive information requirements
For transactions that meet the filing thresholds, the Draft IR sets out the form, content and procedures of the filing process. The regulation is expected to be finalized and enter into force by the summer.
In addition to the information that normally must be provided in a notification under the EU Merger Regulation, all foreign financial contributions for the past three years exceeding 4 mEUR in total per third country per year must be notified. This implies that companies must provide information on the name of the receiving and granting entity; the third country to which the financial contribution is attributable; the type of financial contribution; if the financial contribution results from a tender; the amount; and the date of granting. Contributions below 200 000 EUR are exempted from being notified specifically, but must nonetheless be included in the calculations of notification thresholds.
As the Draft IR currently stands, more detailed information is required for financial contributions that are considered "most likely to distort competition" pursuant to Article 5(1) of the FSR. This applies for aid to ailing firms, unlimited guaranties, export financing not in line with the OECD rules, subsidies that directly facilitate a transaction or gives an unlimited guarantee for debts and liabilities. For these types of subsidies, the companies must submit information on the purpose and economic rationale for granting the contribution, conditions attached to the contribution and whether it confers a benefit. Where the transaction occurs in the context of a structured bidding process, the buyer will have to submit a detailed description of all other candidates contacted or who expressed an interest in the bidding process, including who and when the bidders withdrew. In the case of an acquisition or merger, all companies who expressed an interest must be listed with contact details.
These information requirements will likely cause significant challenges for M&A processes.
- To provide the required information about financial contributions, both the target but also all potential buyers will need to gather substantial information already early in the transaction process to allow for assessments on the whether the filing requirement becomes applicable.
- The further transaction-related information that is required, such as information about other (unsuccessful) participants in an auction, is usually not available to a buyer and often not even to the seller/target. This will likely require amendments to established M&A transaction procedures and will need to be considered very early in transaction processes, already in the early planning phase, as well as through cooperation procedures in transaction agreements.
It remains to be seen whether these requirements will be upheld when the Implementing Regulation is adopted (adoption is expected Q2 2023).
Material assessment of the transaction
In its assessment of the transaction, the EC will assess whether the foreign subsidy is likely to have distortive effects on the internal market by improving the competitive position of the relevant undertaking. The FSR states that the EC will take into account the nature and amount of the foreign subsidy, the situation of the company, the level and evolution of the economic activity of the undertaking on the internal market and the purpose and condition of the subsidy and its use on the internal market.
The FSR sets out when foreign subsidies will likely not distort the internal market. In cases where the total amount of a foreign subsidy over the last three years to one undertaking does not exceed 4 mEUR, that subsidy will be considered unlikely to distort the internal market. In addition, the regulation sets out a de minimis exemption for subsidies not exceeding 200,000 mEUR per third country for the last three years, where the foreign subsidy shall be considered not to distort the internal market. The de minimis threshold coincides with the de minimis rules under the EU state aid rules. Despite certain contributions falling outside scope of control, companies should nonetheless ensure that all financial contributions from third countries are reported and kept on record to provide for a correct calculation under the notification thresholds.
The FSR also black-lists certain subsidies that are considered most likely to distort the internal market (aid to ailing firms, unlimited guarantees, subsidies directly facilitation a transaction, enabling an undertaking to submit an unduly advantageous tender, export financing not in line with OECD rules)
In line with the approach under the EU state aid rules, a potential distortion may be counterbalanced by positive effects on the relevant subsidised economic activity and broader positive effects in relation to the relevant policy objectives. The EC also has the possibility to accept commitments or order redressive measures that mat remedy the distortions in the internal market (i.e. divestment of assets, dissolvement of concentrations, repayments of foreign subsidies, amendments to governance structures). It remains to be seen how this will play out in practice.
Key takeaways
Market participants involved in M&A should already now if signing is expected to occur from 12 July 2023 onwards be aware of the following:
- The FSR implements an additional regulatory approval requirement with amongst others a filing and stand-still obligation, which may lead to further deal uncertainty and completion risk/delays. This comes in addition to filing obligations under the EU Merger Control regime, national merger control regimes and FDI rules. As a consequence it will be ever so important for the market participants to carefully consider the need for additional conditions and mitigating measures in the transaction agreements. A delayed completion may also effect considerations with respect to whether a "Locked Box" or "Closing Accounts" pricing mechanism should be used for the transaction
- Information requirements under the FSR can be extensive. Thus, it is advisable that companies that are active or plan to invest in the EU, put in place routines to ensure that relevant information is collected and constantly updated. This ensures efficient transaction preparation.
- As the FSR applies to both the buyer and target group, review of financial contributions should be implemented as part of the transaction process for both the target (and therefore be part of the due diligence and information sharing process) and the buyer. The mapping should include relevant information on financial contributions subject to FSR, as well as an assessment of their potential impact on the transaction to ensure a realistic timeline and risk assessment.
- Given the sensitivity of much of the information that will need to be shared between the parties to fulfil the FSR's requirements, the information sharing process and necessary measures protecting the parties' sensitive information can be expected to be complex and cumbersome.
- Extensive information requirements, particularly for auction processes, need to be considered early in the M&A processes and for the transaction agreements.
Originally published 17 April 2023
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.