Two years on… notable enhancement in the EU foreign investment screening landscape, but shortfalls remain

Two years on since the EU FDI screening mechanism came into effect, the OECD has now released its report assessing the effectiveness and efficiency of the framework. This report comes a few months before the EC starts reviewing and adjusting the mechanism (planned for 2023) and will certainly serve as inspiration for further proliferation and harmonisation.

While the report highlights the benefits that information exchange has brought for investment screening within the EU (in particular, a more comprehensive level of screening), it also considers numerous limitations of the current mechanism; including the procedural difficulties faced by investors notifying in multiple Member States. 

This post considers these findings and the possible solutions the report suggests for improving coordination and screening within the EU.

What the EU FDI Screening Mechanism does

The EU FDI screening regime (the Regulation) (see our previous blog posts here and here) has created a framework of cooperation for the exchange of information among Member State authorities and the EC in respect of foreign investment screening. It aims to promote awareness and allow interested stakeholders (i.e. other Member States and the EC) to ask questions and issue opinions on FDI processes. It also endeavours to promote “best practice” for the relevant legal standard for review, on which sectors can be considered sensitive and when an investment might be deemed to be against public interest considerations.

Stronger FDI regimes, more comprehensive FDI screening 

In assessing the Regulation, the OECD interviewed a wide range of stakeholders, including government actors and legal representatives. Some of the key changes identified by the OECD – and the benefits of those changes - are set out below.

Enhanced knowledge has ultimately strengthened EU FDI screening

The OECD’s report finds that there is improved recognition by Member State authorities of the benefits of FDI screening and a better understanding of EU investment trends. 

Member States who had previously been sceptical about the benefits of investment screening reported that detailed information on investment projects in the EU has “opened their eyes to investment patterns and the implications of certain investments”. Similarly, in Member States with longer traditions of investment screening, additional transparency about investment patterns has reportedly sharpened authorities’ overall awareness and understanding, allowing adjustment of their approach to screening individual transactions. 

The report finds that this has strengthened EU FDI screening in three main ways:

  • It has helped make the case for the introduction of FDI regimes, as can be seen with the proliferation of FDI regimes in the EU. To date, 18 Member States have screening mechanisms in place, with new regimes due take effect in Belgium, the Netherlands and Luxembourg early next year.
  • It has led to a better understanding of investment patterns, which has helped authorities adjust their approaches to screening individual transactions.
  • It has made it easier for Member States’ authorities to explain and defend having more robust FDI screening
… and has also resulted in more comprehensive FDI screening

Enhanced knowledge is considered a core contributor to the effectiveness of the Regulation. Member States officials can benefit from others’ expertise by sharing knowledge and best practices. They can also engage in transaction-specific information exchanges with the broad network of peer authorities and the EC, resulting in better informed, and more comprehensive, FDI screening. 

This has also reportedly led to slightly longer processing times for transactions.

Despite promising results, the mechanism is not without blind spots

However, despite the benefits felt by Member States, the Regulation is not without blind spots. Two years of practice has brought to light a number of shortcomings which diminish the effectiveness and efficiency of EU FDI screening. 

The OECD report identifies twelve key issues and suggests how these issues could be remedied, summarised below.

Issue Remedy proposed
Absence of screening in some Member States. Member States that have no screening mechanism have few or no effective means to manage foreign investment risk, do not build institutional capacity, and cannot benefit fully from information exchanges with their peers in other Member States and the EC. Revise the Regulation to require all Member States to have an investment screening mechanism that covers at least some core areas.
Limitations of the coverage of investment screening mechanisms in Member States. Member States that exclude important areas from the application of their screening mechanisms, including through narrow definition of their sectoral scope and extensive whitelisting of certain investor classes, have limited effective means to manage risk related to foreign investment into the EU. Revise the Regulation to require Member States cover a core of transactions by a screening mechanism, or recommend standards in this regard.
Weak political impetus to sustain reform and thorough implementation of investment screening in Member States. Lack of peer pressure among Member State governments slows progress in introducing investment screening mechanisms and upgrading existing frameworks and reduces resources allocated for screening by Member States. The review of the Regulation could be a catalyst for renewed attention, especially on the slow pace of advance in several Member States. Also, the Regulation could be revised to require cyclical conversation on investment screening at leadership level.
Many Member States are unable to produce information upon request from other Member States or the EC. This is especially important where the transaction in question is not undergoing screening in their territory. Member States could establish powers to allow them to gather information independent of an ongoing screening process and complement these powers with mechanisms to enforce the provision of timely and truthful disclosure.
The capacity of Member States and the EC to discover reviewable, non-notified transactions is limited. The current cooperation mechanism is unlikely to reveal all transactions that would need to be screened. Member States would need to resolve their respective resource constraints. The EC could play a greater role in investigating transactions, reducing the burden on Member States. The bar could be lowered to allow the EC to issue an opinion to a non-screening Member States, even where only one Member State was affected.
Not all Member States have explicit competencies to act on comments from other Member States. There is no accountability mechanism that would require a Member State to assist another in preventing adverse security or public order outcomes beyond the duty of sincere cooperation. Amend domestic rules to give greater prominence to other Member States’ security and public order interest and the interests of the EU. Amend the Regulation to require Member States to establish competencies to intervene in transactions, or to require Member States to give an explanation of its course of action when they have received comments or opinions.
Accountability in the context of comments and opinions received from Member States and the EC is low. The receiving Member State is not required to inform the Member States that have provided comments or indeed any Member State about its course of action. Explicitly require Member States that have received comments or opinions to share feedback on their use.
Timelines for screening decisions in some Member States are too short to effectively incorporate input from the cooperation mechanism. These may elapse before comments, opinions and other information provided under cooperation mechanisms have arrived. Member States should adjust domestic rules on screening decision timelines.
The Regulation limits the flow of transaction-specific information among Member States. As a result, informal exchanges among Member States’ screening authorities have arisen which, while convenient, may exclude certain Member States’ authorities. Change the Regulation to lift conditions on available information channels or create options for voluntary sharing of information.
Information that is irrelevant for the security and public order interests of other Member States or the EU is fed into the information exchange mechanism, while some relevant information is not required to be shared. The criterion “undergoing formal screening” does not always correlate with whether a transaction is likely to affect a Member State’s security or public order, and so (sometimes) feeds irrelevant information to other Member States. Amend the Regulation to exempt notification where transaction has no implications beyond a Member State’s borders, and to require notification where a transaction potentially affects the security or public interest of other Member States.
The availability of the Regulation’s instruments is limited and uncertain when a third country investor invests via a company established in the EU. The Regulation only applies to foreign direct investment, and there are differing interpretations of “foreign investor”. Amend the Regulation to clarify the scope of application.
The processing of multi-jurisdictional FDI transactions is inefficient. It currently results in repeated, asynchronous, and uncoordinated triggering of the information exchange mechanism, even if the investor submits complete information simultaneously to all concerned Member States. Procedural aspects of investment screening in Member States could be harmonised or a specific procedure applicable solely to multi-jurisdiction FDI transactions could be established.

What next?

The Regulation is subject to an evaluation by the EC by 12 October 2023, following which a report will be presented to the EU Parliament and Council. The recommendations in the OECD’s report (which was co-funded by the EU) are likely to trigger some further thinking in advance of this, and we may expect some of the suggestions to appear as concrete proposals for modifying the Regulation and/or individual Member States’ FDI rules. 

Time will tell whether such recommendations can be put in place easily and effectively. Certainly, suggestions for improving the processing of multi-jurisdictional FDI transactions within the EU may be welcomed by investors.

However, other recommendations in the report may strain tensions over Member States’ authority in screening FDI – in particular, suggestions that Member States be required to have an investment screening mechanism that covers certain transactions, or that the EC plays a greater role in scrutinising non-notified transactions (and Member States have an “obligation” to respond to promising leads which follow, to justify the investment by the EC). In addition, the suggestion that timelines for review should be further extended is clearly critical for many M&A-transactions. Rather, authorities should be equipped with adequate resources to carry out investment screening in an efficient manner.

In the meantime (and, certainly, in the next few months) we can expect the current proliferation and expansion of FI regimes across Europe to continue.