EU to screen outbound investment in sensitive markets and sectors

In a hard-hitting speech on EU-China relations on 30 March 2023, European Commission President Ursula von der Leyen declared that the EU is preparing to screen outbound investments as part of a new economic security strategy. The speech was made in advance of her visit on 5 to 6 April to China with France's President Emmanuel Macron.

The announcement follows a period of introduction of new, and tightening of existing, foreign direct investment (FDI) controls across the EU and in the UK as a result of both the Covid-19 pandemic and geopolitical risks such as China and the war in Ukraine.

Her speech details the threats the EU views China as posing as well as confirming that, given the importance of China on the world stage politically and economically, the aim is for the EU to remain a key trading partner of China but that the EU needs to "rebalance this relationship on the basis of transparency, predictability and reciprocity."

We explore below what the EU's outbound investment screening is likely to cover and how European governments are tackling the challenge of striking a balance of protecting their national security while at the same time being open to inwards investment and trade.

We also consider the impact of regulation on the M&A landscape and cross-border deals.

What will be in scope of the EU screening of outbound investments?

President von der Leyen's speech gives some indication of the likely scope of any EU outbound investment screening regime.

The proposed screening measure was described as "a targeted instrument on outbound investment" which would, "relate to a small number of sensitive technologies where investment can lead to the development of military capabilities that pose risks to national security." The speech set out the areas where Chinese trade and investment could pose a risk to economic and national security in the EU, highlighting "China's explicit fusion of its military and commercial sectors." Von der Leyen made it clear that the "EU needs to define its relationship with China and other countries in sensitive high-tech areas such as microelectronics, quantum computing, robotics, artificial intelligence, biotech and where dual-use purposes cannot be excluded or human rights might be implicated", and to set "a clear line on whether investments or exports are in our own security interests."

The intention with any new EU screening would be to ensure that EU companies' capital, expertise and knowledge are not used to enhance the military and intelligence capabilities of those who are also systemic rivals.

The push for European outbound investment screening is coming from Berlin, where China hawks in the Green party are responsible for foreign affairs and the economy. The German government released a statement which stated that they "are examining the creation of a legal basis for scrutinising foreign investments by German and European companies in 'security-critical' areas.”

It is anticipated that the EU may initially go for a proof-of-concept approach, with an extremely limited set of industries (possibly high-tech sectors which tend to receive a large amount of government financial support) in scope, widening the scope over time.

US review of outbound investments

The EU is not the only trade block looking at this issue. Reports have recently been published by the US government on outbound investment review that confirm that (like the EU), the US will take a very targeted approach to any policy implemented, focussing on investments that could result in the advancement of military and dual-use technologies by countries of concern. The report states that: "The Administration is considering restrictions or notification requirements on US investment in certain entities involved in a sub-set of certain key advanced technologies that are critical to US national security." It is likely that, with implementation expected later this year in the US, the EU will study the US rules when designing its own.

What is the timing for the EU's screening instrument?

The EU Commission will present some initial ideas as part of a new economic security strategy to be launched later this year.

However, it could be a slow process for the EU to adopt an outbound investment measure because investment policy is still governed at Member State level, unlike trade matters, and EU countries are likely to clash over where to set the boundary between a free-market economy and national security. They also have varying views of how to work with China.

EU FDI and foreign subsidy controls

While the new screening measure will target outbound investment from EU Member States, the EU has in recent years also enacted a law to protect national security in relation to foreign inward investment and a second to protect against market distortion from foreign subsidies in relation to transactions.

EU FDI Regulation

In 2019, the EU adopted a regulation (the EU FDI Regulation) setting out minimum requirements for Member States regarding FDI controls, requiring notification to all Members States and the EU of a filing, and providing for cooperation, information sharing between Member States and the European Commission. It does not create an EU-level FDI screening regime.

The EU FDI Regulation has applied since October 2020. Member States have been adopting and updating FDI control measures both in pursuance of the regulation and also in reaction to the general global trend of tighter controls to protect national security (see further below under European FDI regimes).

The EU FDI Regulation only applies to FDI by a foreign investor of a third country aiming to establish or maintain lasting and direct links to an entity in a Member State that may raise concerns relating to security and public order (both intentionally left vague). It sets out a list of sensitive sectors including critical infrastructure (including energy, water, health, transport, media, data processing and storage, aerospace, defence), critical technologies and dual use items (including artificial intelligence (AI), robotics, semi-conductors, defence, energy storage and nuclear, nano- and bio-tech, supply of critical inputs – energy, food and raw materials, the access and control of sensitive data and freedom and plurality of the media). The effect of the transaction on these should be considered, as should whether the foreign investor is controlled by a third country government (through ownership or significant funding).

The duration and complexity of national FDI screening processes has increased as Member States are obliged to consider the European Commission's and other Member States' opinions and comments. The EU FDI Regulation puts additional pressure on Member States to consider a broader range of security interests, which is likely to facilitate lobbying efforts from other stakeholders taking an interest in a transaction. As review remains under the control of the Member States, investors can face multiple national FDI notifications in transactions where the target has a multi-jurisdictional presence in the EU; the terms and processes of the applicable regimes vary considerably. Any FDI clearance needed is likely to require a condition precedent, due diligence and warranties.

The European Commission is considering revising the current regulation to strengthen its effectiveness. The next review date is October 2023.

The Commission also has the power to screen FDI likely to affect projects of "Union interest" – mainly projects that receive a substantial amount of EU funding or which are covered by EU legislation regarding critical infrastructure, technologies or inputs.

EU Foreign Subsidies Regulation

On 28 November 2022, the EU adopted the far-reaching Foreign Subsidies Regulation (FSR), giving the European Commission broad powers to intervene where there is a risk of foreign subsidies (for example, grants, interest-free or low-interest loans, tax incentives, state-funded R&D or government contracts) distorting competition in the EU internal market.

The FSR, due to apply by mid-2023, will have a major impact on parties that engage in M&A in the EU, and which have received financial contributions (other than of a de minimis amount) from non-EU governments or any public or private entity attributable to a non-EU country.

If the target company is established in the EU, has an aggregate EU turnover of at least €500m in the previous financial year, and the parties to the transaction have received combined foreign financial contributions exceeding €50 million in the three years prior to the conclusion of the acquisition, a filing will need to be made to the Commission. Notification triggers a standstill obligation; the transaction cannot be implemented before the Commission has concluded its investigation.

Deal execution will be more complex where the FSR applies. Due diligence will need to look at subsidies received and clearances may need to be conditions precedent to the acquisition. The sale and purchase agreement may need specific FSR warranties.

The Commission also has ex officio (call-in) powers which can result in the unwinding of an M&A transaction.

European FDI regimes

The majority (24) of the EU Member States have already enacted laws, or are in the process of doing so, to protect their national security.

Below is a high-level summary of the scope of current FDI regimes in the European jurisdictions in which Osborne Clarke operates. The regimes across Europe vary considerably in terms of government intervention and decision-making powers, sectors covered and the definition of those sectors, percentage share capital/voting thresholds for investments triggering a filing, types of transaction in scope and identity of investors caught, the penalties for non-compliance and the processes involved, including whether a standstill applies.

Belgium

On 30 November 2022, Belgium agreed the final text of a co-operation agreement to establish a single screening mechanism for FDI in Belgium. The agreement is expected to come into force at the beginning of July 2023.

The regime, once in force, will screen investments by non-EU investors of voting (share acquisitions and subscriptions and public takeovers) in Belgian entities (which includes investments in foreign entities controlling Belgian entities) which establish or maintain lasting direct relations between investor and company and could have negative consequences on national security, public order or the strategic interests of Belgium.

The sectors covered include critical infrastructure, supply of critical inputs (energy, raw materials, food security), freedom and pluralism of media, technologies and materials of essential importance to safety, public health, defence or public order. The percentage interest of the investment triggering screening depends on the sector involved and has turnover conditions attaching in some cases.

France

The French FDI control rules are set out in the French Monetary and Financial Code (Code monétaire et financier).

The rules mandatorily require prior approval if the investment is carried out in a French entity by a foreign investor, the investment is a share deal whereby control is acquired, an asset deal or (in the case of investors outside the EU and EEA only) an investment crossing a percentage threshold, relating to a French entity, and the activity of the target is within one of the sensitive sectors including energy, critical infrastructure, food security, transport, print press, defence, space, AI, robotics, cybersecurity and public health.

A foreign investor includes an entity or person in a chain of control.

In recent times, the rules were amended to include strengthened enforcement powers, a larger scope of review, lower review thresholds and a larger list of strategic sectors.

Germany

The Foreign Trade and Payments Act (Aussenwirtschaftsgesetz) and the Foreign Trade and Payments Ordinance (Aussenwirtschaftsverordnung (AWV)) provide for the mandatory filing of FDIs into German companies via a share of asset deal or an investment of a specified percentage of voting rights, where the company operates in a specified sector (and in the case of certain sectors where specific conditions are met) and the acquisition could have a likely effect on public order or security in Germany, another EU Member State or an EU project.

There are a large number of specified sectors and subsectors. In recent years, the types of sectors covered by the rules have been widened to include companies producing personal protective equipment (PPE), medicines and health diagnostics during the pandemic, and also to cover innovative technologies such as AI, quantum technology, robotics and autonomous driving.

Factors to be taken into account as to whether there is a risk to public order or security include where the acquirer is controlled by a foreign government, is or has been involved in a crime, or has previously impacted public order or security.

The regime only captures non-German investors, but the exact definition of foreign investor depends on the sector; sometimes including investors (or their parent, direct or indirect) outside the EU and EFTA, other times including all investors (or their parent, indirect or direct) resident outside of Germany (defence and IT security).

Recent amendments to the law lowered the percentage share capital thresholds which trigger a filing (these differ by sector but range from 10-20%, and latest amendments also dealt with the acquisition of shares above those initial acquisitions. A standstill obligation was also introduced. The current coalition government is looking at whether the rules sufficiently protect critical infrastructure.

German authorities have ex officio (call-in) powers where there is no filing obligation. This includes the right to review where voting right control is not acquired, but material influence is acquired through management control (such as board seats or veto rights).

Italy

In Italy, FDI is controlled by the so-called Golden Power Law.

A filing must be made:

• by a company which adopts a resolution in relation to a transaction (such as an asset sale, merger, demerger, transfer of headquarters outside of Italy, or change of corporate purpose) which would result in a change of ownership, availability or use of strategic assets; and
• by a purchaser and the target in relation to an acquisition (direct or indirect) of a prescribed debt or equity interest or voting rights in a company holding strategic assets. The Italian government has ex officio powers to review transactions not notified.

The strategic assets sectors in scope include defence and national security, energy, finance and insurance, media, critical technologies, health and pharma, supply of critical inputs and 5G technologies.

Investments in defence or national security are subject to review irrespective of whether the investor is in the EU (including Italian) or not. For other sectors, originally only investments by non-EU entities were in scope, but since the pandemic, direct or indirect acquisition of a controlling interest by EU (including Italian) and non-EU investors in sectors, and acquisitions of certain minority stakes by non-EU investors (where the investment exceeds €1m) were also brought into scope.

The test applied is whether the transaction under scrutiny will "entail a threat of serious prejudice" to the essential national interests in any of the relevant sectors. Any links between the investor and a risky foreign government are considered. 

The Italian government has ex officio powers to review transactions not notified.

Poland

In Poland, FDI control of investments by non-EU/EEA or OECD investors came in in 2020, initially as a temporary response to Covid-19, but now extended until mid-2025.

An investor which is within the EU/EEA or OECD but which has a parent from outside those regions will also be a foreign investor for the purposes of the rules.

The direct or indirect acquisition of control of an in-scope entity, the acquisition of a qualifying holding in a Polish entity or the acquisition of an in-scope entity's assets, together with buybacks and redemptions and mergers are within the rules' scope.

A transaction may be opposed where it poses a threat to public order, public security or public health. In-scope companies include publicly listed entities, those holding property classified as critical infrastructure, those developing software key to infrastructure or security and those operating in a specified sector (for example, energy, medicine, IT software, transport and food processing).

The law is considered to be quite vague and there is currently little established practice in relation to it.

Poland also has an investment control regime under the Act of 24 July 2015 on the Control of Certain Investments; this involves a limited number of strategic entities and is applicable regardless of an investor's nationality.

Spain

The FDI control regime in Spain is mainly governed by the Spanish Act on the legal regime of capital movements and economic transactions abroad (the Spanish Act 19/2003) and Royal Decree 664/1999, of 23 April 1999, on foreign investments which established the Defence Screening Mechanism.

Urgent measures were also passed during the Covid-19 pandemic and included the introduction of the General Screening Mechanism.

The Spanish government intends to adopt a new Royal Decree soon to clarify the transactions, thresholds and exemptions in relation to the General Screening Mechanism and the definition of strategic sectors; a draft is currently available which is instructive.

The General Screening Mechanism applies to FDIs in Spanish companies or assets conducted by foreign investors in a list of strategic sectors (including critical infrastructure, dual use technologies, energy, personal data and media) in which activities may have implications for national security, public order and public health, provided that one of the following two criteria are met: (i) the investment is for at least 10% of the capital of a Spanish company or (ii) control of a Spanish company is acquired.

There are three definitions of foreign investor – residents outside the EU and EFTA, residents in the EU and EFTA with ultimate ownership outside the EU/EFTA, residents in the EU/EFTA (for target companies that are listed in Spain or with a value in excess of €500 million).

The General Screening Mechanism also covers transactions regardless of sector due to specific characteristics of an investor, for example: controlled by a government of a third country, have invested in activities impacting security in another Member State or pose a serious risk of illegal or criminal activities.

The regime contemplates a simplified process and exemptions for de minimis investments.

The Defence Screening Mechanism covers foreign investments in Spain in activities relating to national defence. Lower share capital percentage thresholds apply than for the General Screening Mechanism. EU investors are foreign investors for these purposes.

For either mechanism, a filing is mandatory.

Sweden

There are proposals for a new FDI regime to be introduced in Sweden in December 2023. This is expected only to cover investments in companies domiciled in Sweden which operate in sensitive sectors. The list of sectors is wide and encompasses sectors of both military and civil importance. Further orders will be issued providing further details of the sectors.

The Act is nominally applicable to any investor irrespective of nationality, though the government has said Phase II investigations will not be initiated where the ultimate owners are not citizens of any non-EU Member State.

Investments of specified percentages trigger a filing, as do smaller investments where the investment results in non-shareholding influence.

Sweden also has the Protective Security Act which stipulates that ownership changes in so-called security-sensitive businesses are subject to prior authorisation. That Act will apply in parallel to this new regime.

The Netherlands

On 17 May 2022, the Cross-Sector Foreign Direct Investment Screening Act (Wet veiligheidstoets investeringen, fusies en overnames) was adopted by the Dutch Senate. The Act is expected to come into force in the first half of 2023, applies equally to Dutch and non-Dutch investors and EU and non-EU investors and will apply to investments in an undertakings based in the Netherlands (not just incorporated there) that are a vital supplier, or active in the vital field of (very) sensitive technology, or the operator or manager of a high-tech business campus. It is therefore relatively limited compared to other Member States' regimes.

Where the investment is in a business of a type mentioned above, the following types of transaction will need to be screened:

• acquisition of a controlling interest;
• a merger of two entities where the surviving entity's activities will continue to be in scope;
• asset acquisitions;
• demergers;
• other actions that result in the acquisition of control of an entity; and
• the acquisition of certain other interests in or significant influence over an in scope entity.

The regime also covers indirect acquisitions, for example where an investor acquires control of a company that has a subsidiary which falls within the scope of the regime.

The Netherlands has separate sector specific screening regulations for energy, telecoms and infrastructure and is working on further legislation relating to investments in defence.

UK

The National Security and Investment Act came into force in January 2022, creating a new standalone regime for the government to intervene in a broad range of transactions on national security grounds with substantial implications for the UK M&A landscape. Please see our recent Insight on the NSIA.

More aggressive enforcement

Von der Leyen's speech stated that in future EU Member States and the EU should be more aggressive in their use of existing measures such as existing FDI and foreign subsidy controls, "We now need the unity at EU level for a bolder and faster use of those instruments when they are required and a more assertive approach to enforcement." This will raise questions about bandwidth and resources to do this. Transactions may be more likely to be affected.

Osborne Clarke comment

It is anticipated that increased regulation and a more bullish approach to enforcement will impact transaction timetables and deliverability, and may function as a deterrent to cross-border transactions.

As regards the proposed EU instrument trailed in President von der Leyen's speech, businesses will need to wait and see the details later in the year when the full economic security strategy is published. Getting any policy agreed across the EU will be challenging where views differ strongly. If policy is agreed, and becomes law, it will no doubt have an impact on the deliverability of transactions in limited sensitive sectors where the investor is based in the EU.

We expect the trend of the strengthening of FDI and outbound investment controls to continue for the foreseeable future, while the global economic and political outlook remains unpredictable, though EU and domestic lawmakers will need to strike a fine balance between protecting national security, fostering good international relations and encouraging trade and dealmaking to stimulate the bounce back of their economies following Covid-19, the war in Ukraine and other underlying causes of current economic weakness.

Governments will need to pay heed to the IMF blog post warning against too much friend-shoring of foreign direct investment (investment between countries that are geopolitical allies rather than those that are geographically close): "rising geopolitical tensions have triggered a reshaping of global investment that threatens to depress growth and raise the risk of financial instability".

Given investment control is a landscape that is constantly changing, frequent deal-doers would be wise to monitor further developments as they arise and take counsel from their advisers on rules. Newer regimes will gain clarity of reach and process over time.

Acquirers, sellers and other deal makers should be aware that FDI or outbound investment controls may impact their transactions, particularly where there is a risk to national security, and prepare, plan and protect themselves accordingly.