A new regulation to control foreign subsidies could result in more complex, costly, and time-consuming M&A clearance processes.
By Richard Butterwick, Carles Esteva Mosso, Beatrice Lo, Elisabetta Righini, Gillian Bourke, Natália Solárová, Werner Berg, France-Helene Boret, and Catherine Campbell
European M&A is set to become more complex after the European Parliament and European Council agreed the Foreign Subsidies Regulation (FSR), a new regime introduced to control foreign subsidies that distort the EU internal market. This new regulatory layer will apply in addition to existing merger control and foreign direct investment scrutiny of M&A, and comes at a time of heightened regulatory intervention in deals across multiple jurisdictions.
The FSR, agreed in June 2022, is unprecedented in the global regulatory landscape and grants the European Commission (EC) additional powers to intervene in M&A and joint venture (JV) transactions. Under the regulation, the EC will have the power to review a wide range of M&A transactions involving a company that has received a subsidy from a non-EU country, and may impose remedies against any market distortion created by such subsidies.
The aim of the FSR 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. While the FSR will lead to increased scrutiny of subsidies from countries accustomed to state intervention in the economy, such as China, it captures subsidies from all territories, including the US and UK.
Due to the conservative nature of the thresholds and wide-reaching investigatory powers, a broad range of corporate deals will likely be captured. In our view, the new regime has the potential to increase deal complexity and dealmakers must assess how best to tackle the implications and minimise the impacts of this new regulatory regime.
What Types of Deals Are Captured?
The EC can conduct suspensory reviews of M&A and joint venture deals, and deal teams will be required to notify before a transaction closes if:
- the turnover of the target (in respect of acquisitions), the JV (in respect of a JV 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.
For the second financial contribution threshold, the FSR takes into account any transfer of resources from a non-EU country to a company, including grants and tax exemptions, as well as trading arrangements with government related customers.
In addition to meeting the thresholds, a transaction will only be notifiable if it constitutes a “concentration”, i.e., leads to a change of control on a lasting basis arising from a merger, acquisition, or the creation of a JV. The FSR borrows the definition of a concentration from the EU Merger Regulation — only transactions resulting in the acquisition of sole or joint control will be notifiable. Similarly, in line with the 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.
Are There Exemptions?
While there are no exemptions from notification if the thresholds are exceeded, not every form of state support is expected to be treated as a subsidy by the EC. For example, 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 company a strategic advantage. Similarly, while there are no exemptions for COVID-19-related loans and furlough payments, given the wide distribution of such payments across jurisdictions, including within the EU, the EC may consider such payments as permissible. Wide-ranging due diligence will be needed to assess and determine impacted entities based on the factual matrix of each deal.
What Is the Anticipated Impact on M&A?
For acquirers, the transaction analysis and notification 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 agreements, ensure adequate time to complete regulatory obligations, and align the share purchase agreement long stop dates with approval timetables.
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, which can be extended further. Acquirers should expect intense scrutiny in second-phase investigations. The EC has powers to conduct in-depth reviews of M&A transactions, and investigate whether a company has gained an unfair advantage from its non-EU subsidies.
If the EC concludes a deal will distort the internal market, it can impose various 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. 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.
Aside from its far-reaching investigative powers, the EC can impose fines of up to 10% of a company’s 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.
The FSR is expected to be formally adopted later this year. The publication of an implementing regulation for public consultation, expected in December 2022, will provide further details about the new regime, including the notification process. The FSR will start to apply six months after entry into force, and acquirers’ obligations to notify will begin nine months after the entry into force, in autumn 2023.
Deal teams can improve their chances of a successful transaction by planning ahead and conducting an assessment of their relationships with governments and related entities across jurisdictions and corporate structures. Acquirers will need to engage upstream with specialists to prepare their notifications, which may be particularly challenging and time-consuming for global corporations.
The FSR presents a fresh challenge for deal teams. Although it is expected to result in more costly and time-consuming deal processes 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. The FSR is certainly a new hurdle for corporate acquirers to contend with, but it is not seen as an insurmountable one.
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