The problem of divergence in EU Foreign Investment review: will the proposed EU FDI Screening Regulation close the gaps?

Changes to the EU FDI Screening Regulation have been under consideration behind the scenes since June 2023, when the European Commission (EC) published its Joint Communication on a European Economic Strategy (which we covered in an earlier blog post). In a meeting of the European Parliament in November, Denis Redonnet, Deputy Director-General and Chief Trade Enforcement Officer at the EC, outlined what these potential reforms might look like, including: FDI screening rules to cover investments by EU entities whose ultimate owners are not EU-based; harmonising national screening regulations within the EU; and filtering out non-critical cases.

As anticipated in our earlier post, the EC has now published its proposed reform of the EU FDI Screening Regulation, which focuses on the key areas previously highlighted, along with Annexes detailing the types of projects, programmes, and sectors (including military technology and equipment, dual-use items, and critical technologies) the regime is concerned with. While these proposals largely follow what was outlined by the EC in November, the devil is in the detail – and the reforms might not quite do everything the EC planned, especially when it comes to reducing the number of unnecessary reviews.

This post details the key features of the reform to the Regulation, considers whether they address the issue of significant divergences between screening mechanisms, and highlights some of the main impacts that investors need to be aware of going forward. We will cover the Commission’s White Paper on outbound investments soon.

Extended scope

Perhaps one of the most contentious proposed reforms involves widening the scope of the Regulation to capture investments from EU entities whose ultimate owners are non-EU investors. 

This reform comes in response to the Court of Justice’s judgment in Xella, where the Court ruled that Hungary’s decision to block a transaction under its foreign investment screening rules breached the freedom of establishment because – although EU-company Xella was ultimately owned by non-EU shareholders – Xella was not established as a means of circumventing the filtering mechanism.

The proposed reforms would do away with any requirement to show that an EU company controlled by non-EU entities is an “artificial arrangement”, and the Regulation would instead be capable of capturing all foreign investments made through EU subsidiaries controlled by non-EU investors, including those legitimately established in the EU. While it is proposed that the review of foreign-owned EU entities be limited to situations where the investment has the “aim of establishing a lasting link between the foreign investor and the EU target”, this proviso set out in the explanatory memorandum to the proposals is somewhat vague - and could arguably cover many situations where an EU entity with foreign ownership would seek to invest.

Given this vague and potentially far-reaching expansion of the Regulation, we expect to see a significant increase in precautionary filings being made by EU entities with foreign ownership. This appears to be a step away from the EC’s stated aim of filtering out non-critical cases, and is particularly concerning in light of the EC’s third annual assessment of the EU FDI screening mechanism, which indicated that a significant proportion of the reviews already being undertaken were unnecessary. Also, the devil may be in the detail when it comes to transposing this broader scope into national laws in light of the Court of Justice’s long-standing case law on the freedom of establishment and the higher hurdle which an intervention needs to comply with (whereas this hurdle for intervening is significantly lower for direct foreign investment by non-EU investors, as not all of the EU’s four freedoms apply to them).

Key takeaway: EU entities controlled by non-EU shareholders may soon see their investments within Europe being subject to foreign investment screening requirements.

Requirement on Member States to enact FDI legislation

Participation in foreign investment screening has, to-date, been voluntary, with the original 2019 Regulation merely requiring Member States to share details with the Commission of their FDI regimes, where applicable. The proposed reforms see a complete turnaround on this, and provide that all Member States must have a screening mechanism within 15 months of the reforms being enacted into law.

This change is not surprising, as the investment screening landscape has changed beyond recognition since 2019. Growing technology-based security threats, geopolitical shifts, and the breakdown of globalism - as well as a greater focus on onshoring supply chains and building domestic resilience in strategic industries - have all contributed to this trend. 

Since 2021, the EC has repeatedly called on Member States to set up and enforce fully fledged FDI screening mechanisms, and now the vast majority (22 out of 27) of EU Member States have done so. Ireland, Croatia, Cyprus, Greece, and Bulgaria are working on enacting legislation, and the proposed reforms can be expected to apply further pressure on them to bring in screening mechanisms, too. 

Key takeaway: Expect FDI regimes to come into force in all EU Member States. However, given the very long timeline which the reform of the EU Screening Regulation is likely to be subject to, Member States may not need to rush.

Harmonisation of national screening mechanisms

The problem of discrepancies between the Member States’ handling of transactions was identified in the OECD’s latest report – and Denis Redonnet had cited concerns that critical cases were being “missed” because of a lack of alignment between Member States with respect to sensitive sectors. 

Procedural harmonisation

Responding to these concerns, the proposed reforms introduce a set of minimum requirements that national screening mechanisms must meet, to harmonise foreign investment screening across the Union (Article 4). Many of the requirements relate to how the mechanism operates, such as having procedures to carry out an in-depth review, providing for judicial oversight, and protecting confidential information (Article 4(2)). The procedural alignment – and the uniform protection of areas such as due process and confidentiality in investment screening – are welcome reforms that will provide more certainty for applicants navigating processes that are often opaque. 

Substantive harmonisation

The minimum requirements also extend to the types of transactions which need to be screened (Article 4(4)), requiring authorisation for foreign investments where the target is involved in a specific type of project or programme (Annex I) or sector (Annex II). 

Included in the long list of sectors (Annex II) are dual-use items, military technology and equipment, critical technologies, critical medicines, and financial infrastructure. In particular, advanced semiconductors, AI, quantum technologies, and biotechnologies (amongst others) are listed as critical technology areas. Given these technologies were the areas listed for further risk assessment in the Commission’s Recommendation of 3 October 2023, explicitly including them within the scope of the EU’s inbound screening mechanism is of little surprise.

While including a more prescriptive list of areas captured by the screening mechanism will help address the concerns raised with respect to different sector definitions resulting in varying sector coverage, the Annexes are extensive. This will likely expand the scope of many national screening regimes, and in turn, lead to an increased number of notifications under the Regulation.

Key takeaway: Expect the economic activities captured under certain national screening mechanisms to expand.

Alignment of multi-jurisdictional transactions

More requirements on timelines, but not enough

The lack of synchronicity in the screening of multi-jurisdictional deals was also identified in the latest OECD report, with concerns raised about procedures starting at different times and insufficient predictability regarding individual and cumulative timelines.

The reforms seek to address this by (i) requiring applicants in multi-jurisdictional transactions to file in all Member States at the same time (with the aim of ensuring procedures start at the same time); and (ii) imposing deadlines on Member States for key steps in the foreign investment process, such as Member States sending notifications to the EC, or Member States providing comments and the EC issuing opinions on notified investments, or Member States notifying other Member States and the EC of their screening decisions (Article 8). 

However, the proposals do not impose a uniform deadline for Member States to issue their screening decision, meaning that while there might be uniformity for the start date and key steps in the process, there is no uniformity in the end date, so timelines are still likely to be unpredictable in multi-jurisdictional deals. Also, adjustments will be required to national laws in many Member States to make this proposal workable – for instance, Austria currently runs the screening mechanism before the national review period even starts (since its national review period is too short to accommodate the EU screening mechanism) while Germany only initiates the screening mechanism in a Phase II review (thereby effectively filtering out cases that are sufficiently straightforward and unproblematic).

Additional (mandatory) cooperation requirements specific to multi-jurisdictional deals

Criticism of the Regulation in the OECD report noted the lack of rules catering for multi-jurisdictional FDI transactions, alongside ambivalence as to what was expected by Member States when it came to pursuing collective security. This lacuna is particularly noticeable in light of the EC’s third annual report on EU FDI Screening, which highlighted that 20% of all cases notified in 2022 were multi-jurisdictional transactions.

To address this, the proposal details several reforms that would see the EC taking a more active role in multi-country transactions, providing for the EC (alongside Member States) to attend meetings to address cross-border risks and discuss whether the intended outcomes are compatible across borders. In addition, Member States will be required to give “utmost consideration” to comments from other Member States or opinions from the EC, and the Commission will set up a secure central database accessible to Member States detailing the reviews under the screening mechanism and the outcomes at national level (Article 7).

These reforms can be expected to lead to increased coordination, which should in turn lead to improved certainty in cross-border transactions. It may also create more of a “common house” in which all Member States contribute to collective security by reacting to and commenting on investments in other Member States. However, given the deadlines that Member States and the Commission have to comment or opine on a notification (35 calendar days after receipt of a complete notification for Member States, or 45 calendar days for the Commission – extendable if additional information is requested), we can see this having an impact on transaction timelines. 

Information requirements mean more disclosure for investors

While the EC already requires Member States to ensure that the information provided in a notification includes certain information, the proposal expands on this, requiring significantly more detail about investors and the investment (Article 10). It also envisages the EC creating a standardised form to be used by Member States when collecting information. The stated purpose of this is to ensure the effective functioning of the cooperation mechanism, by requiring Member States to provide a minimum level of information in a set format, and to address concerns of asynchronous information on multi-jurisdictional transactions. 

Requiring Member States to collect uniform information is a step in the right direction. However, even if investors submit complete information simultaneously to all concerned Member States in a multi-jurisdictional deal, there is still the issue that new information (for example, provided to one Member State in response to an information request) could see timelines and decision-making falling out of step - leading to delays in decision-making and uncertainty for investors. 

Key takeaway: Investors in multi-jurisdictional deals may be under a requirement to notify in all jurisdictions at once, and provide more detailed information, but should still be aware of variable timings in decision-making.

Own initiative procedure

The proposals introduce an “own initiative” procedure, which would enable a Member State to open an own initiative procedure when it considers that (i) a foreign investment in the territory of a Member State hasn’t been notified to the cooperation mechanism, and (ii) the transaction is likely to affect its security or public order. Similarly, the EC may also open an own initiative procedure where it considers a foreign investment in a Member State has not been notified (Article 9). Member States and the Commission will be granted ‘at least’ 15 months after the foreign investment has been completed to open an own-initiative procedure.

This likely responds to concerns that more needed to be done for the Regulation to enhance collective security, rather than envisaging a situation where Member States intervene on behalf of other Member States, or the EC. These measures should contribute to collective security, by deterring delayed notifications to the EU’s screening mechanism. 

Key takeaway: Investors will need to consider the impact their deals could have on different EU jurisdictions and be aware that, if a deal is not notified, there are different avenues through which it could be called in.

What’s next?

The proposed revision of the EU FDI Screening Regulation will have to follow the ordinary legislative procedure and be amended by both the European Parliament and the Council of the EU. This process will likely be delayed due to upcoming elections in June and there is a very high likelihood that the proposals will need to be revisited after the EU elections. We will be watching this space and will update you on any major developments.