On 24 January 2024, the European Commission (the “Commission”) published its European Economic Security Package (the “EESP”), which included the long-awaited proposal to reform the EU Regulation which established a framework for Foreign Direct Investment screening (the “EU FDI Regulation”). The EESP’s proposed regulation (the “Proposed Regulation”) is one of the EESP’s five initiatives to implement the European Security Strategy (published in June 2023) – for an overview of the EESP, see our Global Policy Watch blog.

The Proposed Regulation seeks to improve the legal framework for foreign investment screening in the European Union and builds upon feedback that the Commission received during its public consultation in 2023. If adopted as proposed, it will significantly change the landscape of foreign investment screening regimes across the EU (for a full report of the public consultation see here).

This blog highlights the key changes under the proposed reform and analyses their impact on global deal making. We also provide an outlook on the next steps for the proposals.

Key takeaways and comment

• Extended scope to include indirect foreign investments through EU subsidiaries and greenfield investments.
• Minimum standards and greater harmonisation across the EU.
• Introduction of call-in powers to review all transactions for at least 15 months after completion.
• Coordinated submission of foreign investment filings in multi-country transactions.
• Focus cooperation between Member States and the Commission on cases more likely to be sensitive.
• More prescriptive guidance on substantive assessments and remedies, including a formal obligation for national screening authorities to prohibit or impose conditions on transactions they conclude are likely to negatively affect security or public order in one or more Member States.
• Increased reporting, while protecting confidential information.

The Proposed Regulation would constitute a major revision of the screening framework and it puts forward a more comprehensive and consistent set of rules and procedures for screening of foreign investments across the EU. We particularly welcome the focus on increased harmonisation of filing requirements and substantive assessment, and initiatives to improve transparency.

However, a number of key terms and concepts in the Proposed Regulation remain overly broad or without clear definitions. For example, the Proposed Regulation leaves open which standards should be applied to define ‘control’ or what ‘effective participation in the management’ means in the context of the legislation, and these terms are used in key concepts of the framework, including the definition of “foreign investment” itself. In light of existing national screening regimes with low filing thresholds, where share acquisitions of 10% (and sometimes even less) may be sufficient to trigger a filing obligation, it is unclear whether the Proposed Regulation would also capture such transactions or how the framework’s requirements apply to these aspects of national regimes. Adoption of the Proposed Regulation may therefore necessitate a further wave of revisions to national foreign investment screening legislation.

Wider scope of foreign investments and deal structures will fall under the screening framework, including indirect investments through EU subsidiaries and greenfield investments

The Proposed Regulation would extend the scope of the EU FDI Regulation to cover foreign investments that are carried out indirectly through entities established in the EU that are ultimately controlled by a non-EU investor. While many national foreign investment screening regimes within the EU already enable authorities to scrutinise such investments, the European Court of Justice held in C-106/22 Xella (2023) that indirect investments through EU entities (even if under foreign control) fall outside the scope of the current EU FDI Regulation, unless they amount to “artificial arrangements” which attempt to circumvent the screening mechanism concerned.

The Proposed Regulation intends to further broaden the scope of foreign investment screening within the EU to greenfield foreign investments if they create a lasting and direct link between a foreign investor and the European Union. Relevant greenfield investments would include the establishment of new facilities or new undertakings in the European Union by foreign investors or their EU subsidiaries.

Minimum standards and greater harmonisation for foreign investment screening regimes

Under the current framework, each Member State is free to decide whether or not to introduce an FDI screening regime. To date, 22 Member States have a screening mechanism in place, and the remaining five Member States (Bulgaria, Croatia, Cyprus, Greece, and Ireland) have pending legislation at various stages of advancement. The new regulation would oblige these Member States to introduce a foreign investment screening regime before the end of the transitional period from the current framework, to the extent they have not already done so.

The Proposed Regulation also seeks to bring greater harmonisation across the EU by imposing minimum standards on Member States to screen certain foreign investments. In particular, it would require national foreign investment screening regimes to screen ex-ante (i.e., before closing) investments in EU companies that:

• participate in the ‘projects or programmes of Union interest’ listed in Annex I of the Proposed Regulation, like the Digital Europe Programme and the EU4Health Programme; or
• are active in the specified areas of the economy ‘of particular importance’ as listed in Annex II of the Proposed Regulation. In addition to military and dual-use items, listed critical medicines, and certain parts of the financial system, the Annex II list covers ten areas of ‘critical technology’ identified by the Commission for further risk assessment (such as advanced semiconductors, artificial intelligence and autonomous systems, and advanced materials and manufacturing technologies).

Moreover, the Proposed Regulation requires Member States to ensure national screening regimes meet certain procedural requirements, including:

• providing for judicial recourse against screening decisions taken by the national authority;
• empowering authorities to retrospectively review transactions not subject to an authorisation requirement for at least 15 months after completion; and
• ensuring effective measures are in place to address non-compliance (including the power to impose mitigating measures on, prohibit, or unwind investments that were not filed).

In addition, with a view to bringing more clarity in the review process as well as improving due process, the Proposed Regulation directs Member States to inform the investor applying for clearance ahead of taking a decision that would impose mitigating measures or prohibit the investment and to state the reasons for that outcome.

Coordinated submission of foreign investment filings

The Proposed Regulation seeks to bring about a coordinated submission of foreign investment filings across the EU. In multi-country transactions, applicants would have to file their requests for authorisation in all relevant Member States on the same date and making reference to the other requests. Given the strict filing deadlines that some Member States presently apply, the Proposed Regulation would have a significant impact on transaction planning and timing.

Reduction of the procedural burden

One of the Proposed Regulation’s goals is to reduce the procedural burden for investments that are unlikely to present any concerns. To achieve this, the scope of transactions that need to be notified under the cooperation mechanism is generally narrower than the range of transactions that are covered by the minimum scope of national screening regimes (notably, transactions concerning targets active within the Annex II sectors would only be automatically covered by the cooperation mechanism if the acquirer meets certain conditions).

Under the narrowed scope, Member States would only have to report investments to the Commission and other Member States under the coordination mechanism where:

• the target participates in one of the projects or programmes of Union interest in Annex I; or
• the target is economically active in one of the areas specified in Annex II and the foreign investor (or its EU subsidiary making the investment) is:
  • directly or indirectly controlled by the government of a third country,
  • is subject to EU sanctions (restrictive measures), or
  • was involved in a transaction previously screened by a Member State that was not authorised or only authorised with conditions;
    or,
• the Member State initiates an in-depth investigation (or where they intend to prohibit or impose conditions on a transaction without an in-depth investigation).

This is intended to eliminate a significant number of low-sensitivity cases being circulated to the other Members States and the Commission, and to enable Member States to screen these cases more efficiently under their national regimes.

Own initiative procedure

The Proposed Regulation would also introduce a mechanism allowing Member States and the Commission to cooperate on foreign investments not notified under the cooperation mechanism by the Member State where the foreign investment is planned to take or took place. The Member States and the Commission would be able to open an ‘own initiative procedure’ under the cooperation mechanism from 15 months after the foreign investment’s completion date.

Substantive assessment and remedies

The Proposed Regulation sets out factors to be taken into account for the substantive assessment of a foreign investment’s likely impact on security or public order. Factors to be considered for the substantive assessment include the impact on the security, integrity and functioning of critical infrastructure, the availability of critical technologies (including key enabling technologies), the continued supply of critical inputs, the protection of sensitive information (including personal data), and the freedom and pluralism of the media.

Importantly, the Proposed Regulation would require that where the screening authority of Member State in which the foreign investment will take place concludes that the transaction is likely to negatively affect security or public order in any Member State, the authority must either prohibit the transaction or impose mitigating measures, subject to the principle of proportionality and the circumstances of the investment.

Contrastingly, if the transaction’s potential effect on security and public order can be addressed by appropriate measures available under other Union or national law, the authority must authorise the transaction without conditions.

Reporting and transparency

There is a continuing debate on the appropriate level of transparency for foreign investment review proceedings and disclosing the rationale of substantive assessments, both in decisions and reports made public by authorities and the Commission, and between screening authorities and the parties involved in a transaction. While the Proposed Regulation contains few new measures in this regard, it would require Member States to provide annual reports to the Commission concerning their screening activities and decisions by 31 March each year, which would then be used by the Commission to publish an annual report at Union level. Each Member State would also be required to publish annually aggregated and anonymised data on the transactions screened, the outcome of screening procedures, the nationalities of parties to foreign investments screened, authorised, or prohibited and the economic sectors of activity of the target.

Protection of confidential information

The Proposed Regulation proposes that all information exchanged in the cooperation mechanism is to be treated as confidential and shall only be used for the purpose for which it was requested, unless the originator of the information agrees otherwise or courts in the EU request such information for the purpose of legal proceedings. Confidential information may not be downgraded or declassified without the prior written consent of the originator. The Commission would also provide a secure and encrypted system for information exchange.

While the Proposed Regulation would provide a legal basis for Member States and the Commission to cooperate with third countries in relation to the screening of investments, the Commission suggests that this is not intended to allow the exchange of information regarding transactions that are subject to review under the cooperation mechanism.

Next Steps

The Proposed Regulation will be subject to the ordinary legislative procedure and would need to be adopted by both the European Parliament and the Council. During that procedure the Member States will participate in the discussions. While opinions on some of the obligations set out in the Proposed Regulation are likely to differ among Member States, there appears to be broad alignment on the general thrust of the legislation. With a view to the upcoming elections in the European Parliament this summer and the subsequent constitution of a new College of Commissioners, the legislative procedure is likely to involve delays and prolonged discussion.

If adopted, the new regulation would repeal the current EU FDI Regulation and enter into force after a transitional period of 15 months.

Covington’s regulatory and policy experts are closely following these developments, and are well-positioned to advise clients as to how to navigate the regulatory impact that changes to foreign investment screening regimes across Europe may have on their businesses.