Draft EU Foreign Investment Screening Regulation sets out more comprehensive screening regime

EU foreign investment regime – key proposed updates:

• Mandatory for all EU Member States to have a foreign investment screening regime in place
• EU screening extended to investments by EU investors that are ultimately controlled by individuals or entities from a non-EU country
• Minimum sectoral scope of national foreign investment screening (and other standards)
• Requirement for national screening before investments are completed
• Enhanced cooperation, information sharing and reporting between Member States and the EC

Background

The current EU Foreign Direct Investment Screening Regulation (FDI Regulation) provides a cooperation framework for the screening of foreign investments into the EU by the EU Member State authorities for their impact on security and public order. The FDI Regulation has been in full operation since October 2020.

Although there has been a significant increase in FDI screenings each year (see our alert on the EC’s latest report), the EC’s experience with the current framework has shown that “a number of issues could be improved”. For example, the EC flagged insufficient cooperation within the network of screening authorities as well as substantial differences between screening mechanisms across the EU, particularly in terms of timing, coverage, and notification procedures. In June 2023, the EC launched a public consultation on a replacement FDI Regulation.

A pillar of the European Economic Security Package

The proposal for a new Regulation on the screening of foreign investments in the EU (Draft FI Regulation) has been published with four other legislative initiatives, forming a so-called “European Economic Security Package” (ESP). This includes White Papers on (i) export controls, (ii) outbound investment, (iii) options for enhancing support for research and development involving technologies with dual-use potential, and (iv) a Proposal for a Council Recommendation on enhancing research security. The proposals aim to enhance and protect EU economic security “at a time of growing geopolitical tensions and profound technological shifts” and help the bloc stay competitive in core industries. All initiatives are in line with the European Economic Security Strategy published in June 2023.

Our alert discusses the key aspects of the Draft FI Regulation as well as a brief description of the other ESP initiatives.

Wider scope of application

Extension to indirect investments

The current FDI framework covers EU investments made by EU companies directly owned or controlled by non-EU entities. The EC now proposes to also capture investments from EU companies whose ultimate owners/controlling entities are non-EU investors. The EC believes that investments made by foreign investors through a subsidiary established in the EU potentially create the same risks to security or public order as direct investments made from third countries.

This proposal comes as a response to the European Court of Justice (ECJ)’s July 2023 Xella judgment that confirmed that the FDI Regulation does not apply to investments in the EU made by EU companies ultimately owned or controlled by non-EU investors, except for situations involving artificial arrangements that do not reflect economic reality and that circumvent screening mechanisms.

However, Member States are entitled to adopt national FDI screening mechanisms covering indirect/intra-EU investments, subject to compliance with EU fundamental freedoms. Many have done so. It therefore remains to be seen to what extent and how this extension will practically change national regulatory frameworks.

Greenfield investments

The Draft FI Regulation encourages Member States to bring greenfield investments within their screening regimes. Scenarios where a foreign investor, or its subsidiary in the EU, sets up new facilities or a new undertaking in the EU would be caught. If Member States decide to include greenfield investments in their regimes, it will inevitably have a major impact on investments made by non-EU investors in, for example, solar, wind, electric vehicle (EV) and semiconductor sectors.

A lot remains unclear at this stage. Crucial will be the criteria national authorities apply to determine whether certain greenfield investments qualify for review (eg turnover thresholds, assets value) and the point at which an investment in such a project should be notified. 

More harmonisation

Obligatory screening mechanisms in all Member States

Although the EC has been strongly encouraging Member States to adopt national FDI regimes, the FDI Regulation does not require them to do so. Five (Ireland, Croatia, Cyprus, Greece and Bulgaria) are still developing a screening mechanism.

The new framework will oblige all Member States to introduce screening regimes conforming with the revised minimum standards, within 15 months from the entry into force of the proposed reforms. It may be that we see all 27 Member States needing to update their legislation. Indeed, Germany may well have been holding off publishing a draft of announced changes to its regime to allow it to incorporate revisions required under the EU proposals.

Minimum standards for screening mechanisms

The proposal sets out the minimum criteria for screening mechanisms across the bloc. In terms of procedure, this includes ensuring that potentially critical transactions are screened before they are completed, in-depth investigations, protection of confidential information and annual reporting on screening activities.

The draft also introduces an obligation on Member States to establish judicial recourse against screening decisions. This change will certainly be welcomed by many investors and may feed into an increasing willingness to challenge foreign investment decisions in court.

The Draft FI Regulation provides a list of sectors that must be screened. This includes “critical technologies”, which encompass eg advanced semiconductors, AI language processing, cloud computing, quantum computing, biotechnologies, the Internet of Things and virtual reality. In terms of the substantive assessment of an investment’s impact on security and public order, mandatory criteria include the effects of the investment on critical infrastructure, critical technologies, the continuity of supply of critical inputs, the protection of sensitive information and the freedom and pluralism of the media.

However, Member States will remain free to apply stricter measures within their territories. Indeed, the proposed minimum harmonisation still leaves much space to decide which specific types of transactions should fall within the scope of screening mechanisms or whether additional sectors should be included. We expect to see Member States continue to focus on additional jurisdiction-specific sectors of concern. In addition, the Draft FI Regulation also does not align crucial aspects of the screening procedures such as deadlines for approvals. Ultimately the review of a particular foreign investment will remain exclusively with the specific Member State in which the investment is notified.

It therefore remains to be seen whether the degree of harmonisation proposed will adequately address concerns over the current fragmented regulatory framework across the EU and increase certainty for dealmakers.

Harmonisation with other EU instruments

The EC sets out some proposals to ensure alignment with other EU instruments such as eg the EU Merger Regulation (EUMR) or WTO rules. For example, when a foreign investment constitutes a concentration under the EUMR, the application of this Draft FI Regulation should be without prejudice to the application of Article 21(4) EUMR allowing Member States to take appropriate measures to protect legitimate interests. Both instruments should be applied consistently and coherently. This may come as a response to the Vienna Insurance Group (VIG)/AEGON case where the EC found that Hungary's decision to veto the acquisition by VIG of AEGON Group Hungarian subsidiaries under its national foreign investment regime breached Article 21 EUMR.

Enhanced cooperation across the EU and the EC’s coordinating role

In addition to harmonisation, the EC proposes various measures to strengthen cooperation and information exchange between Member States.

First, foreign investors notifying their investment in several Member States will have to submit notifications to all of them on the same day, referencing other states involved. Second, the draft imposes a cooperation obligation on screening authorities in cross-border investments, eg authorities reviewing such investments need to coordinate with each other and send notifications in cooperation mechanisms on the same day. Finally, the authorities will have to collect the same types of information in FDI notifications and align some of the deadlines (for example, there will be uniform deadlines for providing comments and opinions on notified investments, see below).

The draft also proposes tightening up information sharing among authorities when they believe that the investment might “negatively affect security or public order” in their Member State or have information relevant for the screening of that foreign investment. The EC would be involved in discussions if the investment is likely to negatively affect security or public order of more than one Member State, EU projects/programmes or if it has relevant information related to that foreign investment. In such cases, a Member State would have 15 calendar days (EC would have 20 calendar days) to inform other states that it intends to issue comments/an opinion on an investment and then can seek more information if necessary. A screening authority then would have to “give utmost consideration” to the opinions of other Member States or the EC before issuing a final decision.

The obligation to file with all screening authorities on the same day will create a significant obstacle for the notifying investors given the significant divergence in national screening rules. It remains unclear how the obligation will be imposed or what changes will be required at the national level. There is also potential for the enhanced cooperation to increase review timelines.

Own initiative procedure

The EC also proposes introducing an "own initiative" procedure, which would allow the EC or a Member State to initiate a review of a foreign investment in another EU jurisdiction if the investment has not been notified to the cooperation mechanism and is likely to negatively affect security or public order of the Member State(s).

The EC would be able to open an own-initiative procedure when it considers that a non-notified investment is likely to negatively affect security or public order of more than one Member State, EU projects/programmes or if it has relevant information related to that foreign investment.

Notably, the EC or the Member State would be granted ‘at least’ 15 months after the foreign investment has been completed to open own-initiative procedure. Such proposal would introduce uncertainty for investors and may pose new post-closing risks.

Other ESP initiatives

EU outbound investment screening under consideration: “gradual” step-by-step analysis set out

The EC first indicated that an EU outbound investment review mechanism was on the cards in its June 2023 European economic security strategy. It continues to suggest that the current lack of any specific or systematic monitoring at EU or Member State level raises concerns in relation to “a narrow set of advanced technologies that could enhance military and intelligence capacities of actors who may use these capabilities against the EU or to undermine international peace and security”.

At this stage, a new outbound investment control regime is still by no means certain. However, a White Paper now outlines a plan of action that broadly involves the EC working with Member States to assess the level and destination of outbound investments and the potential risks linked to them. The work will build on that already undertaken by an expert group set up last summer.

First, a public consultation will run until April 2024 to gather views on the monitoring and subsequent risk assessments that Member States would have to undertake.

An EC recommendation will then prompt EU governments to carry out a 12-month review of outbound EU investments completed since 1 January 2019. This could be limited geographically as well as to four sensitive technology areas: advanced semiconductors, artificial intelligence, quantum technologies and biotechnologies. The data and information would be shared with other Member States and the EC through the expert group.

The results will feed into a joint EU security risk assessment report, and the EC and Member States will together determine the need for and formulation of any policy response. Risks could be mitigated through existing tools or new action at national and/or EU level. We can expect a further EC communication in Autumn 2025. 

The U.S. is in the process of implementing its own outbound investment regime. Our alert sets out details regarding the Biden Administration’s August 2023 Executive Order (EO) directing certain U.S. government agencies to develop a programme prohibiting (or requiring notice of) certain outbound investments to certain countries of concern (at this stage, the People’s Republic of China), as well as related developments in the UK. Importantly, the U.S. Government’s technology and product sectors covered by the EO are similar to those covered in the EC’s White Paper: semiconductors and microelectronics; quantum information technologies; and AI. 

Uniform export control rules for dual-use goods

The EU export-control regime (in place since 2009) largely implements multilateral export-control arrangements (including the Wassenaar Arrangement on export controls for conventional arms and dual-use goods and technologies).

The regime underwent a major upgrade in 2021, enhancing coordination between the Member States. However, EU governments still have sole authority to control the export of items not subject to multilateral arrangements. This has led in recent years to divergence in the scope of controls across the bloc (see, for example, here).

The EC aims to overcome this challenge by amending the current EU export-control regime to introduce new items that had been supported by EU Member States but were not adopted by the multilateral export control regimes after being blocked by certain members, in particular Russia. Also, the White Paper envisages the establishment of a senior level forum for political coordination and a mechanism for better coordination of new national control lists. Finally, it proposes that the evaluation of the current dual-use regulation should be brought forward to the first quarter of 2025 from 2026 – 2028. That evaluation may result in more radical changes being proposed and subsequently adopted.

Will the screening landscape be changed?

It will be interesting to see whether the Draft FI Regulation marks a step towards a common EU-wide foreign investment regime, or whether EU Member States will resist and use Article 346 TFEU to protect their “national security sovereignty” against the EC. In his opinion on the Xella case, Advocate General Ćapeta described the current FDI Regulation as “a kind of a platypus, a strange creature when compared to the ‘ordinary’ type of regulations”. In any case, it seems that the Draft FI Regulation will become an even more important tool allowing the EU to safeguard its interests at a time when the ideas of globalisation and liberalisation are under political, economic and legal pressure.

The foreign investment landscape will however unquestionably remain dynamic in the foreseeable future. To achieve the proposed level of harmonisation, most of the Member States will have to significantly amend their national screening regimes.

Next steps

The Draft FI Regulation will have to follow the ordinary legislative procedure, with scrutiny from both the European Parliament and the Council of the EU. Given the regime could take effect 15 months after its entry into force, these new foreign investment screening provisions could become fully effective as soon as 2026. However, with the upcoming European Parliament elections in June, the legislative process may well be delayed. We will keep you posted on implementation timing and any changes in substance.