The new Foreign Subsidies Regulation (EU) 2022/2560 (FSR) is anticipated to have a major effect on large EU-related dealmaking such as mergers and acquisitions (M&A), introducing lengthy and complex screening requirements and completion risks that come on top of burdensome merger controls and foreign direct investment assessments.
Cyprus companies involved in M&A, either as acquirers, targets or merging parties must carefully consider the far-reaching implications of the new rules. This includes a very challenging process of identifying, assessing and quantifying subsidies received from third countries, the complexity of filing detailed notifications to the European Commission, the lengthy screening process involved, and the risk of an adverse commission decision.
The landmark regulation started to apply in July 2023 and seeks to ensure a level playing field for companies operating in the internal market by tackling distortions of competition caused directly or indirectly by subsidies granted by non-EU countries to companies active in the union.
Notably, “subsidies” are defined in a very broad manner to catch a whole host of direct and indirect benefits provided not just by third country governments but also by private parties with links to government. This hardened approach is accompanied by a panoply of investigatory and sanctioning tools, including the power to prohibit M&As and impose fines of up to 10 per cent of global turnover.
A foreign subsidy is deemed to exist where an undertaking involved in economic activity in the EU is granted, directly or indirectly, a financial contribution from a third country that confers a benefit on the undertaking, such as: capital injections, grants, interest-free loans, unlimited guarantees and preferential taxation.
The source of the financial contribution can be: third country governments, third country public authorities, and private entities whose actions can be attributed to the third country.
Market Distortion: A foreign subsidy will be deemed to cause market distortion where it is liable to improve the competitive position of the receiving undertaking and thereby actually or potentially negatively affect competition. In its assessment, the commission uses indicators such as the nature and amount of the subsidy and the situation, size and market/sector of the undertaking. Even where a foreign subsidy is considered as market-distorting, the commission may balance the negative effects against any positive effects when deciding whether to impose redressive measures and the nature of such measures.
Addressing market distortions
The commission may accept commitments by the concerned undertaking that, in its view, fully and effectively address the identified distortion. If so, these are made binding via a commission decision. In certain cases, the commission may also impose redressive measures to remedy the market distortion.
Commitments or redressive measures may involve, among others:
|□ Dissolving the concentration
|□ Offering access under fair terms
|□ Repaying the subsidy
|□ Reducing capacity or market presence
|□ Refraining from certain investments
|□ Divesting assets
The FSR equips the commission with the following three separate tools for examining the existence and the potentially distortive effect of foreign subsidies: ex-ante notifications for concentrations, ex-ante notifications for public procurement and ex officio procedure (All Other Market Situations)
Notifications for concentrations
A concentration is deemed to arise where a change of control on a lasting basis, results from a merger, a joint venture, or from the acquisition of direct or indirect control of an undertaking by one or more undertakings.
A notification to the commission is mandatory where:
|§ at least one of the merging undertakings, the acquired undertaking or the joint venture is established in the union where it generates a turnover of at least €500 million, and
§ any of the parties concerned were granted subsidies of more than €50 million from third countries in the three years prior to the agreement.
The notification must be made prior to implementation of the agreement. The concentration cannot be implemented pending the commission’s assessment (standstill period). The commission may also request notification of below-threshold agreements prior to their implementation if it suspects the existence of foreign subsidies.
Following a complete notification, the commission performs a preliminary review and, where it has sufficient indications of market-distorting subsidies, it proceeds with an in-depth investigation within a specific timeframe. The commission enjoys wide investigative powers such as the power to request information from undertakings, member states, and third countries and to carry out inspections of undertakings within and outside the union and impose substantial fines in case of non-cooperation (up to 1 per cent of turnover).
The in-depth investigation may result in either: a no objection decision, a decision with commitments, or a decision prohibiting the concentration. In case the concentration has already been implemented, it may require its dissolution.
Notifications for public procurement
A notification to the commission is mandatory where:
|§ the estimated value of the contract is at least €250 million, and
§ the economic operator was granted foreign subsidies in the three years prior to the notification of at least €4 million per 3rd country.
Once the complete notification is submitted to the commission, a procedure similar to that of concentrations is followed, involving a preliminary review and possibly an in-depth investigation. The investigation may result in a no objection decision, a decision with commitments or a decision prohibiting the award of the contract to the operator concerned. During the preliminary review and the in-depth investigation, the contract may not be awarded.
Other market situations
Under this general screening tool, the commission is granted the power to investigate at any time on its own initiative, any other potentially distortive market situation involving foreign subsidies, going back as far as 10 years in the past (but not earlier than July 2018). For instance, it may investigate an EU subsidiary of a third country parent that receives subsidies in the form of direct grants that allow it to crowd out competitors.
The commission can make use of information from any source, including member states, natural or legal persons and associations. It may in particular, carry out a preliminary review of the suspected case which may be followed by an in-depth investigation, employing its wide investigatory powers to request information, conduct on-site inspections, and impose heavy fines in case of non-cooperation. In-depth reviews may be followed by a decision imposing commitments or redressive measures. The ex-officio procedure, unlike the notification procedures for concentrations and public procurement, is not subject to specific triggering thresholds or assessment timelines.
The commission has already adopted Implementing Regulation 2023/1441 that contains standard forms for the submission of notifications. The regulation also sets out detailed rules on the procedures to be followed by undertakings for submitting commitments for addressing distortions, the commission’s investigation process, confidentiality issues, and the calculation and suspension of time limits.
Challenges and next steps
The Foreign Subsidies Regulation will have a significant impact, especially on large M&A transactions, adding to the regulatory burden of existing rules on merger control and foreign direct investment, and creating new challenges and risks.
- Where a Cyprus entity is involved in an acquisition as a target, the size of the company in terms of EU revenue must be assessed, as well as any subsidies the target or the acquirer have received from third countries in the last three years. Similarly, where a Cyprus entity acts as an acquirer, the target’s EU revenue must be assessed together with the existence of any foreign subsidies received by any of the parties.
- Identifying, assessing, and quantifying financial contributions that qualify as third country subsidies is an intricate procedure. Entities should consider setting up data-gathering and record-keeping systems to collect group-wide information on such contributions with a view to minimising delays in notifying and completing future M&A transactions.
- Systematic collection and recording of such data are also important because of the power of the commission to request ex-ante notification for below-threshold deals or to conduct ex officio investigations.
- Entities must also take into account the impact that the new rules may have on the timeline of M&A deals, given the high complexity involved in preparing a notification to the commission, the extensive screening period afforded to the commission for carrying out preliminary reviews and in-depth investigations, and the risk of a commission decision opposing or imposing conditions to the envisaged transaction.
- Investment funds, especially private equity, can also be caught by the new rules where foreign financial contributions have been received by portfolio companies.
- It is also notable that on the January 24, 2024 the commission published a legislative proposal for the revision of the Foreign Direct Investments Regulation. It seeks to clarify the type of investments that should be screened on grounds of security and public order (i.e, in critical technologies) as well as to bring within scope intra-EU transactions where the EU investor is controlled by a third country entity. The proposed regulation must go through the legislative process and once adopted, it should apply 15 months after its entry into force.
Stefanos Sofroniou is a senior associate at Elias Neocleous & Co LLC