Tug of war continues… changes to the EU FDI Screening Regulation could find Member States restricting investment by EU-based companies with third-country ownership, among other changes

Earlier this year, the Court of Justice ruled in the Xella decision that Member States cannot, without sufficient justification, restrict investments by an EU company on the grounds that it is controlled by a non-EU entity – unless it involves a transaction structure being used as a means of circumventing foreign investment rules. This decision certainly took many European FI regulators by surprise with its far-reaching potential implications. 

However, this – and other features of the EU FDI Screening Regulation – may soon be revised. 

Before the summer, the European Commission consulted on possible revisions to its screening mechanism. This week, it published the results of that consultation, providing an insight into respondents’ views on the regime:

• Continued relevance of foreign investment screening: 83% of respondents considered that protecting security and public order from the risks posed by certain FDI is still relevant, and generally agreed that EU-level action had increased the protection from those risks beyond what would have been achieved by Member States operating individually.
• Effectiveness of the EU FDI Screening Regulation: most respondents agreed that the regime had “significantly helped” to identify risky FDI transactions. But most responses also expressed a strong preference for maintaining Member States’ primary role in evaluating and resolving cases, in cooperation with other Member States and the Commission.
• Reforms to increase the effectiveness of FDI screening in the EU: “considerable support” was reported for scrutinising transactions where the direct investor is EU-based but is ultimately owned by a non-EU person or entity, and for a minimum set of sectors that Member States must screen. Further, most respondents called for a requirement for national authorities to notify transactions to the cooperation mechanism only if the transaction meets certain criteria – as opposed to the current requirement to notify all FDIs undergoing screening. Considerably less support was expressed for a system that would allow Member States to pre-screen and notify only those FDIs that they had identified as posing a potential public order / security risk.
• Burden of FDI screening: respondents overall agreed that the administrative burden placed on transacting parties by the cooperation mechanism was reasonable, and that neither national nor EU FDI screening rules deterred EU-bound FDI.
• Improvements to the regime’s efficiency: a significant number of respondents flagged the lack of harmonisation of timelines for screening notifications as one of the hindrances to efficiency (as noted in our previous blog posts here and here).

Potential changes

While the EC has not yet put forward proposals for reform of its screening mechanism, it plans to do so in the coming weeks and Denis Redonnet, Deputy Director-General and Chief Trade Enforcement Officer at the EC signalled in a recent hearing of the European Parliament that the EC is considering a number of potential changes to the EU FDI Screening Regulation, namely:

• Covering transactions where the direct investor is established in the EU, but ultimately controlled by a non-EU investor. This change would seek to address the limitations identified by the CJEU in the Xella decision, in particular the point that, absent “circumvention” of the FDI rules, direct investments made by e.g. an EU-based portfolio company of a private equity investor or even by EU-based companies controlled by a Chinese investor are not in scope of the FDI regime. However, any such change would need to comply with the restrictions set by the EU’s free movement of establishment and the free movement of capital (depending on the magnitude of the investment made and the governance rights afforded). A potential consequence may be a somewhat narrower scope of the FDI rules compared to those applicable to genuine foreign investors for which only the free movement of capital is applicable in certain cases.
• More power to the EU governments to block transactions on the basis of information provided by other EU countries or the EC. 
• Addressing divergence between national screening mechanisms. We may see a tightening of the rules to cover all investments in sensitive EU sectors and improvements in the functioning of the cooperation mechanism. In particular, Redonnet has cited concerns that critical cases are being “missed” because of a lack of alignment by Member States with regard to sensitive sectors. Currently the approach adopted by Member States is very heterogeneous and it will be interesting to see whether the Commission will issue more concrete guidance in terms of the particular activities, in specific sectors, which it views as critical.
• Filtering out non-critical cases. Finally, as noted in the EC’s third annual report, there has been a “significant increase” in formally reviewed cases, but a decrease in mitigation. As we commented in our earlier blog post, this would suggest that a significant proportion or reviews were unnecessary, and Redonnet has commented that too many “non-critical cases” may indeed be being screened. Currently many Member States initiate the EU Screening Mechanism for all cases notified to them, which adds considerable “red tape” to the process – a potential role model could be Germany, which only notifies cases for which it initiates an in-depth review. But implementation of such a “filter” may be challenging while EU Member States have very different review periods for their FDI assessments, and with some simply not allowing for the review under the EU Screening Mechanism to be conducted in parallel to a national review.

What next?

The EC is expected to present its report to the European Parliament and Council on the functioning and effectiveness of the EU FDI Regulation in the coming weeks and by the end of 2023, alongside proposed revisions to its scope and operation. We may also see proposals relating to an EU outbound investment screening mechanism. We will of course be reporting on these developments – watch this space!