A new regulation to control foreign subsidies could entail more complex, costly, and time-consuming deal clearances.

By Carles Esteva Mosso, Tom D. Evans, Elisabetta Righini, David J. Walker, Gillian Bourke, Natália Solárová, Werner Berg, France-Helene Boret, and Catherine Campbell

European M&A is set to become more complex after the entry into force of the Foreign Subsidies Regulation (FSR), a new regime introduced to control foreign subsidies that distort the EU internal market. This unprecedented new regulatory layer will apply in addition to existing merger control and foreign direct investment scrutiny, and comes at a time of heightened regulatory focus on deals across multiple jurisdictions.

Agreed in June 2022, the FSR introduces a new suspensory notification regime and grants the European Commission (EC) new powers to intervene in M&A and joint venture transactions. The goal is to ensure a level playing field by extending the principles of the state aid regime applicable to subsidies from EU countries to subsidies from third countries. “Subsidy” is interpreted significantly more broadly than government grants and exemptions — and may encompass a wide range of payments, reliefs, trading arrangements, investments, and other commercial transactions involving governments and entities connected with governments. Deal teams should plan ahead now by assessing relationships with government entities across jurisdictions and group structures.

What Types of Deals Are Captured?

Due to the conservative nature of the thresholds (see below) and wide-reaching investigatory powers, a broad range of deals will be captured.

The FSR borrows from EU merger control rules, and dealmakers will encounter familiar concepts — only transactions resulting in a “concentration” (i.e., the acquisition of sole or joint control) will be notifiable. Similarly, in line with EU merger control rules, a minority acquisition that does not allow the acquirer to exercise decisive influence over a target will not need to be notified. Diligence will be needed to assess and determine impacted entities based on the factual matrix of each deal.

While there are no exemptions from notification if thresholds are exceeded, not every form of state support is expected to be treated as a subsidy. Sovereign wealth fund investments made on the same terms (and with the same level of risk and rewards) as comparable benchmark investments made by other private investors, are unlikely to be considered subsidies as they do not give a strategic advantage. Similarly, there are no exemptions for COVID-19-related loans and furlough payments, but given the wide distribution across jurisdictions — including within the EU — the EC may consider such payments as permissible.

The FSR does not formally target any particular country or jurisdiction. Financial contributions from countries accustomed to state economic intervention (such as China) are likely to be heavily scrutinised but the FSR captures all territories, including the US and the UK.

What Is the Impact on PE?

The clearance process is expected to be similar to existing merger control procedures, and will run in parallel. Deal teams will need to include appropriate FSR conditions in sale and purchase documents, ensure adequate time to complete regulatory obligations, and align the share purchase agreement and financing long-stop dates with clearance timetables. Further, the application of hell or high water undertakings is also likely to be heavily negotiated, as parties seek to allocate risk and uncertainty around obtaining clearances under the new regime.

During the first phase of review, the EC has 25 days to examine whether a transaction is problematic. If the deal is not cleared at this stage, the review moves to a second phase, lasting 90 days (or longer if extended) during which acquirers should expect intense scrutiny. If the EC concludes that a deal will distort the internal market, it can impose remedies including blocking deals, forcing divestitures, or forcing a company to open up access to its facilities or data. The impact of such remedies on deal value and rationale will require careful consideration.

Aside from its far-reaching investigative powers, the EC can impose fines of up to 10% of the parties’ global turnover in the event of a breach, and periodic penalty payments of up to 5% of daily turnover for procedural infringements. It also has the power to order the dissolution of a closed transaction or prohibit a pending transaction.

Planning Ahead

Formal adoption is expected later this year, with notification obligations beginning in autumn 2023. The FSR is certainly a new hurdle for PE acquirers to contend with. Although more costly and time-consuming notifications are expected, there is no suggestion that the EC intends to use the regulation to block all deals involving a company that receives a state subsidy from outside of the EU.

What Does the FSR Do?

Under the FSR, deal teams will be required to notify before a transaction closes if:

  • the turnover of the target (in respect of acquisitions), the joint venture (in respect of a joint venture creation), or one of the merging parties (in respect of mergers) in the EU is equal to or exceeds €500 million; and
  • the undertakings concerned (e.g., the acquirer and the target, the merging entities, or the joint venture) and/or its parent company(ies) received a combined financial contribution of more than €50 million from non-EU countries in the three calendar years before notification.

The FSR also includes a general market investigation tool that the EC may use ex officio in a wide range of market situations, giving it powers to intervene in smaller transactions that fall below the stated thresholds.

See Worker Windfalls Bring Benefits for PE.