To Screen or not to Screen? Defining the Deals that Count

Part 3 in the CELIS blogseries on the revision of FDI Screening Regulation 2019/452.

Authors:  Andrew Hill (AmCham EU, Brussels), Floor Doppen (University of Antwerp), Kaarli Eichhorn (Antitrust Partner, Jones Day)

Introduction

While most observers are eying the politically sensitive discussion of which sectors will be covered by the new Foreign Investment Screening Regulation (‘the Regulation’), many practitioners are focused on clearly defining the concepts that determine what constitutes a “foreign investment” or “control” over a targeted firm, in order to address intra-EU variation on screening legislation and practices.

If the discussions around the mandatory scope galvanised the conversation around what sectors are covered by the Regulation, the debate around definitions completes it. While the mandatory sectoral scope debate is in many ways highly intuitive and closely linked to discussions on economic security, the debate around definitions is highly technical. The significant degree of divergence, lack of meaningful case law, and in light of a myriad of security concerns related to individual cases, make negotiating clear definitions a minefield.

Despite its technicality, aligning definitions on “foreign investment” and “control” is vital for investors and Member States alike: Even with agreement on a mandatory sectoral scope, divergence on the investments covered by investment screening legislation will persist if the Regulation does not create a minimum definitional understanding of what constitutes foreign investment and control. Currently, Europe is a patchwork of different approaches to this.

The Regulation should address this issue to varying degrees. A closer examination of the changes proposed throughout the legislative process can provide better insights into the extent to which investors and lawyers alike can expect further harmonization in different areas of investment screening legislation across the EU. These changes are found in three debates related to:

1. The notion of a foreign (direct) investment in article 2(1)-(3) of the Regulation
2. The transfer of control in article 2(1)-2(7) of the Regulation
3. The establishment of control through greenfield and internal restructurings which lack the transfer of control.

This blog post aims to dive into patchwork environment of today, highlight some of the ideas which have been raised throughout the negotiations, assess to what extent they are or will be addressed in the Regulation and where actors might have to bear with continued variation.

Lost in Translation

While the minimum sectoral scope discussions are challenging due to their political dimensions, the definition discussion is exigent because it is highly technical. We will briefly discuss each of the issue areas, the varying approaches to them, and why it is important to look at them up close.

Notion of foreign investor

Currently, there is no alignment in Europe around which investors are covered by national regimes. On the contrary, Member States use a variety of tests. The first source of variation is that different Member States have different approaches to which foreign investors they screen.

The majority of Member States either require filings from investors outside of their Member State, or outside of the EU, although there are some notable outliers. Poland, for instance, aligns its screening mechanism with OECD membership – subjecting only investors from non-OECD countries to screening, a decision that was taken at the time to exclude American investors from investment screening filing obligations. There is also a clear trend of screening domestic investments. The Netherlands and Sweden, are ‘country-neutral’ and screen any investment in their predefined sectors, regardless of ‘foreignness’, subjecting domestic investors to screening as well.

The second source of divergence across Member States is the lack of a common test to define which investors qualify as foreign. Belgium and Germany use, for instance, the notion of ‘residence’ while France uses a combination of citizenship and residence (a French national residing abroad will also be considered a foreign investor). The Xella case, Xella Magyarország Építőanyagipari Kft.v Innovációs és Technológiai Miniszter, a landmark ruling on intra-EU foreign investment screening, specifically pushed the Commission and Member States to rethink the notion of foreignness and direct versus indirect foreign investment. It ruled that because the Xella company was incorporated in Hungary, it should be treated as an EU company under Article 54 TFEU on the freedom of establishment in the EU, even if it was ultimately owned by a fund in Bermuda, while the ultimate beneficial owner turned out to be an Irish national[1].

The transfer of control

Likewise, there is little commonality around what constitutes an investment that must be notified. Member States use a variety of concepts and thresholds for what they consider an investment which triggers a filing obligation.

First, there are static thresholds, which are typically related to the acquisition of ownership (shares) or voting rights (or both) that are often differentiated between sectors, types of companies or types of investors.

Hungary’s permanent mechanism, for instance, divides its static thresholds between publicly and privately held companies, with investments being subject to a 25% ownership threshold unless the investor is a publicly listed company, which is subjected to a 10% ownership threshold for screening notification. Slovakia, similar to many other states in the EU, has different thresholds for investments in critical and non-critical sectors. Germany keeps a mandatory filing obligation for investments of 10% or up for very sensitive sectors, and a 25% threshold for all sectors without a mandatory filing obligation but with call-in powers.

Second, static thresholds are often coupled with a dynamic concept of control, which is tied into the definitional discussions that we cover in this blog. For instance, Ireland includes both a dynamic provision (“acquires control…”) as well as a static provision related to “the percentage of shares or voting rights it holds…”. Control, in this sense, is defined by the legal concept of “decisive influence”.

This dynamic concept of “decisive influence” is commonly used across Europe in investment screening legislations[2] and originates in merger control and is also used in foreign subsidies screening. The Commission’s Common Jurisdictional Notice (CCJN) in combination with relevant case law provide the necessary guidance on how “decisive influence” is interpreted. For investment screening, this type of concept is helpful and necessary because Member State gain the ability to screen non-acquisition types of investment such as joint ventures or concessions, which could pose a risk to security and public order.

However, varying approaches to legislative drafting have created uncertainty about the extent to which the legal concept of “decisive influence” used in investment screening aligns with its use in merger and foreign subsidies control.

“Decisive influence” in the merger control context is principally focused on the rights and powers conferred on an acquiror during a transaction that provides the acquirer with the ability to determine the ‘strategic direction’ of a target entity. This influence is gained where a significant acquisition of shares or voting rights are amassed, and requires a broad analysis of governance rights and influence (e.g. in some case a minority shareholder may gain decisive influence through board seats or negotiated rights to veto strategic business decisions).

In the investment screening context, many Member States reference “decisive influence” but do not create crystal clear alignment with merger control by including a clear reference to the CCJN. In many cases, they couple “decisive influence” with a reference to “effective participation”, the concept of control suggested in Regulation 2019/452[3].

For instance, Belgium defines “control” as the “possibility of (directly or indirectly) exercising decisive influence, in fact or in law […]” while directly referencing the CCJN, then refers to “effective participation in the management or control […]” in its definition of “foreign direct investment”. This may indicate a margin of difference between “effective participation” and “decisive influence”. Malta, on the other hand, does not directly mention the CCJN but defines “management or control” as having the possibility of exercising decisive influence. Spain, then, explicitly links its use of “control” to its Act 15/2007 on the defense of competition, which remains close to the merger control use of “decisive influence”.

The lack of clarity of what exactly constitutes “decisive influence” and, in cases like Belgium, what lies between “decisive influence” and “effective participation”, decreases the certainty which full alignment with the CCJN would otherwise create.

Lastly, Member States not including “decisive influence” in their laws use a vast array of other idiosyncratic concepts unique to their jurisdictions, such as the “effective degree of control over the performance of” in the Czech Republic. EU case law does not provide any guidance into which concept of control is most appropriate for investment screening. The Singapore opinion -focused on foreign direct investment- sets out a definition for FDI (referred to in article 207(1) TFEU) as consisting of “effective participation in the company’s management and control”, while the Xella judgement relied on “decisive influence” as it is defined in Hungary’s laws, which varies from the definition under merger control regulation.

Greenfield investments and internal corporate restructuring

The new Regulation will also address two types of activities that are different from a typical foreign investment: greenfield investments and internal corporate restructurings. Greenfield investments establish a new company and, accordingly, do not constitute a change in control as otherwise targeted by most investment screening regimes. Internal corporate restructurings don't necessarily include a change of control: sometimes they do, sometimes they don’t.

There are Member States that screen greenfield investments and others that do not. Germany, for instance, does not require mandatory authorisation of greenfield investments, while Denmark, does as long as it is “in a particularly sensitive sector with equivalent control or significant influence”. Similarly, there is no common approach to internal corporate restructurings either. Several Member States, including Belgium, Sweden and Italy, can (and do) review internal corporate restructurings. Others, such as France and Germany, exempt certain internal corporate restructurings from review, but differ in how they define what transactions qualify, while Italy has a simplified procedure for internal restructurings.

Internal corporate restructurings are excluded from the scope of merger and foreign subsidies controls at the EU level, and are also excluded from the FDI Screening Regulation 2019/452 in the sense that they do not need to be notified to the cooperation mechanism. The absence of an EU-wide exemption of intra-group transactions under investment screening, especially if there is no change in ultimate owner/controller, results in numerous filings, even for low risk transactions that do not result in a new foreign investor acquiring ownership over an EU target. The lack of clarity across jurisdictions also makes it difficult to assess whether and where an internal corporate restructuring should be notified.

Mission Impossible?

Foreign investors have pointed out that the patchwork system currently in place leads to immense complexity, particularly for multi-jurisdictional transactions. At the same time, definitional variation creates regulatory gaps that undermines the effectiveness of the screening framework, as was pointed out in the Court of Auditors report. It is clear that there is political will to increase alignment. The question is which issues will be tackled in the new Regulation, and which debates will be saved for another day.

Notion of foreign investor

One major innovation agreed upon by both the Parliament and Council’s reports, is the extension of investment screening to certain intra-EU transactions, specifically when they involve a company incorporated under EU law (as was the case in the Xella judgement), but are controlled by an non-EU investor.

This is why the Regulation shifts its language from “Foreign Direct Investment” (Regulation 2019/452) to “Foreign Investment”. The Regulation therefore also includes reference to existing definitions of what constitutes a foreign investor’s subsidiary in the Union through Article 22(1) of Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013.

This addition provides more definitional clarity, addresses the gap that was exposed in the Xella judgement, and reflects both the common understanding that investment security concerns can arise from EU subsidiaries controlled by non-EU investors and foreign direct investment alike. The inclusion also reflects a common desire to prevent forum shopping behaviour that can result from divergent definitions of ‘foreign investor’ across Member States. Importantly, this also means that investment screening may become a regulatory checkpoint for European companies that may have to notify their own intra-EU investments if they have foreign entities in their ownership structures. The inclusion would also galvanise European firms to enter the screening-debate in following iterations of negotiations to push for more harmonization from their Member States, especially when they start facing exceptional regulatory hurdles in their investments within the Single Market.

Concept of control

Due to the complexity of creating a common concept of control, the Parliament and Council largely retain the Commission’s proposal and, accordingly, the approach taken in the 2019 Regulation. This, ultimately, does little to clarify the concept of control and its use in investments screening.

Given that divergence is a major concern for investors and the Commission, the pursuit of an aligned concept of control is certain to remain a focus as the trilogues progress. This is evident from the introduction of Article 114 TFEU as an additional legal basis, which provides for the adoption of measures to ensure the establishment and functioning of the internal market. It is proposed as “the appropriate legal basis for an intervention requiring Member States to screen certain investments within the internal market and addressing differences between Member States’ screening mechanisms” (Regulation, p10).

Attempts to create alignment can also be seen in the European Parliament, where MEPs submitted ultimately unsuccessful amendments that attempted to fully align the Regulation’s concept of control with decisive influence, clarify the definition of “effective participation”, or allow the Commission to develop guidelines on “effective participation”.[4]

Likewise, the Council’s proposal makes an attempt to softly align the Regulation with merger and foreign subsidies control by including a recital that indicates that “decisive influence” largely satisfies “effective participation” but leaves room for exceptions (Recital 16(a)). Regardless, the Council’s proposal also indicates that Member States would like to retain some flexibility to capture fringe cases while aligning with merger control, even if it does not answer the question of when “effective participation” is met but not “decisive influence”.

Ultimately, for many actors, anything short of a full alignment of the concept of “decisive influence” with existing merger regulation would effectively retain the current divergence between Member States, with each authority developing their own interpretation of the margin between “effective participation” and “decisive influence”. Important to note, the Regulation does not propose to align the static thresholds that Member States keep.

Establishing control and screening without control transfers

The Regulation does not include greenfield investments in the mandatory minimum scope, and says little about it beyond a mention in recital 17 that encourages Member States to include greenfield in the scope of transactions of their screening mechanisms. The Council seeks to retain flexibility for Member States to choose their own approach, as evidenced from the Council’s explicit exclusion of the screening of greenfield investment in the mandatory screening scope, as seen in its proposed new Art. 4(5). The Parliament, on the other hand, pushes the Member States to create national competences to screen greenfield investments (Amendment 71). On greenfield investments, the approaches are consistent with the political cleavages that we identified in our blog on the negotiations of the mandatory scope.

On internal corporate restructurings, the Council and Parliament are very aligned, as both propose to explicitly exclude these types of activities from the scope of the Regulation and from the scope of Member State screening legislation. The Council proposes to exclude in the following situation (Council mandate, Art. 2 §3(d); Parliament Amendment 52 and 56): transactions that do not result in a new foreign ultimate beneficial owner acquiring ownership or control over a Union target, where there is no increase in shares held by foreign investors, and where the transaction does not result in additional rights for foreign investors that may lead to a change in the effective participation of one or more foreign investors in the management or control of the Union target (Council mandate, Recital 16(b)). Their exclusion from investment screening review across the EU would significantly reduce the number of transactions notified and reviewed.

Conclusion

If the discussions that we outline above demonstrate anything, it is that the efforts to align investment screening across the EU are far from over. Most head-way will be made in the Regulation with respect to what constitutes a foreign investor, and the exclusion of intra-company restructurings. Divergence is likely to persist for now in relation to concepts of control, with varying static and dynamic thresholds for investment screening across the EU.

Much like the evolution of merger control, the alignment and coordination of foreign investment screening will rely on numerous negotiations in Brussels and Strasbourg, as well as judgments in Luxembourg. Divergence among definitions and, soon, the interpretation thereof, will  likely remain a source of cost and complexity for now. However, steps are being taken in the right direction, even if nothing is set in stone until the negotiations conclude and the Regulation enters into force.

Stay tuned for our next edition!

 

Footnotes

[1] it is not clear whether the Irish national was residing abroad or whether he was residing in Ireland, which is an important difference under certain jurisdictions like France.

[2] “Decisive influence” is used, for example, in Austria, France, Hungary, Ireland, Latvia, Malta, Spain and Slovakia.

[3] This may be an indication of how the Regulation would be implemented, absent a clear concept of control

[4] A variety of approaches can be seen in the amendments submitted to the draft Internal Market and Consumer Protection Committee (IMCO) opinion, including amendment 61 which describes a requirement for the Commission to publish guidelines on the concept of control https://www.europarl.europa.eu/doceo/document/IMCO-AM-767875_EN.pdf