The European Commission’s proposed regulation on foreign subsidies will introduce a third regulatory hurdle for M&A transactions benefitting from third-country “financial contributions”. In addition to merger review and foreign investment controls, the proposal is that in-scope deals will need to be pre-cleared by the European Commission - or risk subsequent investigation.

M&A sellers will need to undertake one additional layer in the screening of potential buyers/bidders of M&A targets. Potential buyers in the crosshairs of the new system will be at a regulatory disadvantage, and face greater deal-uncertainty, compared to rival  buyers. The EC deems this extra burden proportionate and justified. The possibility of three parallel regulatory processes (i.e. adding to the current merger control and FI procedures) with diverging substantive considerations and potential outcomes will be a real concern in some cases. But advance planning will be important in all.

A two-pronged approach gives maximum flexibility

The EC expects that a staff 60 full-time equivalents will be dedicated to this new form of M&A scrutiny.  They will review acquisitions falling within the scope of the regulation and the EC will have exclusive jurisdiction. Two mechanisms are foreseen:

1. A pre-closing notification system, under which the EC will investigate concentrations where the EU turnover of the target (or of at least one of the merging parties) is €500 million or more and the foreign financial contribution is at least €50 million (in aggregate over the preceding three years).
   
   The EC indicates that around “30 companies” per year may be affected. While that estimate is not expressed in terms of transactions, one might expect that this would produce less than the 70 – 190 transactions notifiable under the EU Merger Regulation by non-EU acquirers in recent years.
2. A general scrutiny system empowering the EC to investigate all other market situations (including concentrations not subject to pre closing notification) on its own initiative and under which it may request ad-hoc notifications.
   
   The EC expects that such ex officio investigations will be launched in “30-45 cases” per year (incl. non M&A related reviews). The second limb would in fact have implications both pre- and post-closing. Before closing, already challenging issues of managing legal certainty and deal timing would be placed under further strain by the EC’s power to call in an otherwise non-notifiable concentration before closing and impose a suspension obligation while it investigates. On top of that, post-closing, the EC will be able to initiate investigations to review (completed) transactions for a period of up to 10 years.

The jurisdictional reach of the system is wide. The definition of “financial contribution” remains broad and capable of catching a variety of financial payments or advantages conferred by foreign governments (see our State aid post on what constitutes a foreign subsidy). The jurisdictional test is also agnostic as to the recipient of the contribution and whether it is one large sum contributed by one third country or several small contributions from several countries, aggregating all contributions received by all the undertakings concerned in the three years preceding the concentration. Consequently, acquirers who contemplate targets who have received foreign subsidies would be caught even if they haven’t received a penny themselves. In addition, the regulation does not require a direct link between the contribution and the transaction, nor does it require that the parties to the concentration engage in overlapping activities in the EU. As such, potentially any acquirer may be caught by the regulation when undertaking future M&A.

The notification regime has some similarities with the EU Merger Regulation. From a timing standpoint it tracks the EU Merger Regulation process: an initial review period of 25 Working Days, possibly followed by an in-depth review period of 90 Working Days (extendable by 15 Working Days where commitments are offered). But that is largely where the similarities cease. From a practical standpoint it is noteworthy that there is no scope for the EC to accept commitments at the end of the initial investigation period. Transaction parties will thus have to endure a lengthy review process before having the ability to remedy any concerns by offering commitments.

A broad theory of harm, but do the remedies solve the problem?

The proposed regulation specifies that a foreign subsidy that directly facilitates a concentration is one of the categories most likely to distort the internal market (particularly if the subsidy covers a substantial part of the purchase price). However, it is not clear how to determine whether a “distortion” arises or what is the theory of harm. This leaves the impression that a foreign subsidy will be presumed illegal and that the EC will have a wide margin of discretion to assess possible ”distortions” that in some cases may appear far-removed from traditional competition concerns.

Where a concern has been identified, the EC will be able to impose redressive measures (or accept commitments). The types of commitments the EC may accept range from access to infrastructure on FRAND terms; capacity or presence reductions; refraining from certain investments; divesting assets or repayment of the subsidy. However, in the absence of a clear theory of harm it is difficult to ascertain which of these would be most appropriate in the M&A context. This contrasts with merger control where the existence of a competition problem informs the assessment of appropriate remedies.

If the theory of harm is that the foreign subsidised acquisition distorted the bidding process creating an uneven playing field in the allocation of capital, it is difficult to see how any commitment other than prohibition would rectify the distortion. Such an extreme outcome will have a significant impact on M&A transactions (particularly auctions) where deal certainty and timing are essential. Equally, there is significant scope for competing bidders to game the process by raising foreign subsidy concerns even where these were not material to the outcome. Bidders in scope of the new regulation may in effect be compelled to offer premium bids, to compensate for complexity and uncertainty caused by the regulation - a “Catch 22”! In the end, the best bidder, in terms of achieving efficiencies may not prevail simply because the seller of the assets wants to avoid the hassle and uncertainty.

In order to avoid these uncertainties and improve predictability of outcome, the legal test (either through further refinements to the draft text or practical guidance) needs to be clearer on the issue of what constitutes a distortion and how such distortion can be addressed.

Squaring the ledger with national interests

The EC’s decision to reserve itself exclusive jurisdiction to assess the impact of foreign subsidies stands in contrast to the current system of foreign investment controls where Member States themselves take the final decision. For transactions involving sectors in which foreign investment regimes apply at national level this raises the prospect of a parallel layer of scrutiny by both the EC and (potentially multiple) individual Member States.

Many foreign investment regimes are sufficiently wide in scope to enable consideration of the influence by foreign states. For example, the EU’s FI Screening Regulation explicitly considers whether an investor benefited from significant funding, including subsidies, by the government of a “third” country. However, the substantive tests are different as under FI rules the question is rather a matter of national security/public order than distortions in the internal market.

It should not be taken for granted that the two substantive tests necessarily lead to the same outcome. This may occur where the national interests of a specific Member State(s) are at stake and those Member States consider the transaction beneficial despite the distortive elements. The EC’s ability to undertake a balancing exercise will provide some flexibility to achieve alignment on outcomes but questions remain as to whose views will prevail if push comes to shove.