EU’s pending foreign subsidies rules put PE deals in the spotlight

The EU’s co-legislators are currently in the process of finalising the FSR as the European Parliament (EP) is slated to vote on the proposal in its plenary session in November.

The regulation will introduce a suspensory control regime that will task the European Commission (EC) with screening acquisitions of European targets that meet certain thresholds to determine whether the subsidies the parties are in receipt of are “distortive” to the EU internal market.

The EC has proposed thresholds for the merger control module of EUR 500m in target revenues and EUR 50m in financial contributions from foreign governments. The proposal also allows the EC to call in deals, including retroactively, that do not meet the thresholds.

The regulation is expected to impose an additional regulatory burden on financial sponsors active in Europe, including sovereign wealth funds, private equity funds and asset managers that may already require sign-off on deals under merger control and European foreign direct investment (FDI) screening rules, lawyers told this news service.

“Sovereign wealth funds may well be in scope of the regulation, but it gets trickier when the role of the state in the activities of the fund is more remote – for example, passive investment by public pension schemes into privately managed funds,” said Stephen Whitfield, partner at Travers Smith.

“Any multinational that is likely to trigger the revenue thresholds certainly triggers the financial contribution threshold,” said Jay Modrall, lawyer at Norton Rose Fulbright.

Given the industrial policy background to the proposal, the EC’s primary focus in terms of enforcement will probably be on funds and investors from China and the Middle East, said Yvo de Vries, partner at Allen & Overy. “If you’re a US investor or an investor from the UK, you’re likely to aim for strict compliance with the notification and information requirements,” he said.

There are certain scenarios that could escalate the EC’s interest, noted several lawyers. The presence of competing buyers in bids for European assets could lead potential complainants to approach the EC to raise subsidy issues of their competitors, said Andreas Reindl, partner at Van Bael & Bellis.

Joint ventures between state-owned enterprises (SOE) and local governments that create a fund that is intended to finance investments in the EU could also likely trigger the EC’s interest, said Reindl. Rescuing aid for a failing company and subsidising operating costs would also be considered rather problematic, he added.

Demanding task
The most significant practice concerns for financial investors will likely be related to compliance preparation and in particular tracking whether transactions meet the EC’s thresholds, said two of the lawyers.

There is no de minimis threshold or exclusion of financial contributions, so almost any receipt or disbursement of funds in any non-European jurisdiction could go towards meeting that threshold, said Modrall.

Collecting that information will be a difficult and demanding task, added Modrall. Determining whether a contribution is attributable to a government will be complicated in many cases, he said, adding that the EC’s assessment under state aid control involves examining the capital structure, board composition and participation in shareholder meetings.

“It’s very in-depth – it’s not something you can do if you’re looking at thousands of contracts in [dozens] of jurisdictions all over the world,” said Modrall, noting that compliance will likely require parties to collate information that could be scattered across multiple databases and CRM systems.

For private equity firms that may be consistently acquiring and disposing of acquisitions in portfolio companies, compliance might be a challenge, said Modrall. Acquisitions of stakes in new portfolio companies, even if they do not meet the thresholds, may add to a fund’s overall amount of financial contributions, and will require a separate assessment, he noted.

Regime coming in 2023
For the time being, many aspects of the FSR remain unclear, and the further guidance that the EC plans to provide should give some clarity on how the regime will work. The EC is currently consulting on further procedural rules, including notification forms.

The notification forms in particular should give a strong indication of what information will be required, and thus what information companies and funds should start collecting and what compliance systems they should have in place, said Modrall.

The extent to which the EC opts for a process akin to that of EU Merger Control, with a distinction between a normal notification and a short-form CO, as well as an informal pre-notification process, will also be important, said de Vries. It would be helpful to have a shorter form, less demanding of information, for cases where there is less likelihood of distortion, he said.

One area where investors may find predictability will be in the limited margin for manoeuvre that the EC will have in interpreting the regulation, vis-a-vis other instruments.

“The FSR is a sort of Frankenstein construct because it takes bit of merger control, state aid, public procurement and trade law, borrowing a lot of terms and terminology,” said de Vries.

The EU courts, which will oversee its implementation, have always tried to interpret those concepts between different instruments consistently, he added, citing the definitions of undertakings concerned and subsidy as examples.

“I think that the EC has very little leeway to interpret that differently when they have engaged with the related areas of law, which does give some level of predictability,” he said.

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