EU Foreign Subsidies Regulation brings significant compliance burden for private capital firms
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The advent of the EU Foreign Subsidies Regulation (FSR) presents a challenge for sponsor-driven M&A. In essence, the regulation is the EU’s attempt to take its concerns over state aid beyond Europe’s borders by introducing a new notification regime for deals involving parties that have received financial contributions from foreign governments (the logic being that this can distort competition within the EU single market).
The filing obligation will apply from 12 October and will operate in parallel to merger control and foreign investment/national security reviews. Like most of these regimes, the FSR notification will be mandatory and suspensory – meaning parties will need to receive clearance before closing a deal.
Transactions have to be notified to the European Commission (EC) if one or more of the merging parties, the target or the JV is established in the EU, generates sales of at least EUR500 million within the EU, and, together with all other parties to the transaction, has received combined “financial contributions” from a non-EU country of more than EUR50m in the previous three years.
Concept of ‘financial contribution’ is extremely broad and would apply to any relevant acquisition by a sovereign wealth fund
The concept of “financial contribution” is extremely broad and includes loans, guarantees, capital injections, non-ordinary-course tax benefits, fiscal incentives, debt forgiveness or the purchase of goods and/or services by public authorities.
By being cast in this way, the regulation captures financial investments by third countries into investment funds, and would therefore apply to any acquisition of a controlling interest in a company by a sovereign wealth fund, where the revenue thresholds are met. Private capital firms that have state-affiliated investors will also be in scope, and because the rules cover all parties to a deal, a filing is also required where the target has received such financial contributions, even if the acquirer has not. We expect contributions from countries that operate subsidy regimes deemed similar to Europe’s (e.g. the UK) to be viewed more leniently than those that don’t, as will contributions received on “market terms”, but a notification and suspension of closing pending clearance will still be necessary.
Review timelines will be similar to the EU merger control process. After a period of “pre-notification”, formal filing of a notification will start the clock on a 25 working-day “Phase 1” review period, after which the EC will either provide clearance (expected in the vast majority of notifications) or can launch an in-depth “Phase 2” investigation (lasting up to 90 working days, subject to extensions). If it doesn’t like what it sees, it can block a deal or request the parties to submit remedies, which could be structural (i.e. divestments), behavioural, or both.
The EC also reserves the right to investigate deals it believes distort the EU market even where they fall below its thresholds, and could also review transactions post-completion.
And if parties should notify but fail to do so, they could be fined up to 10% of their aggregate turnover.
The FSR extends across all investments controlled by funds, and will require sponsors to track (at fund level) the financial contributions they or their portfolio companies have received in the three years prior to a deal.
Commission’s notification form seeks detailed, confidential financial data
The relevant three-year look-back period applies from deal signing or announcement, requiring firms to implement systems to monitor financial contributions across the entire fund in real time (or at the very least on an event-driven basis) rather than relying on yearly updates (as is normal for merger control reporting). We expect this to be a formidable task.
The notification form also reveals that, in addition to detail on financial contributions, the EC is looking for granular, confidential data on the sources of finance used to fund transactions, as well as a comprehensive breakdown of how the target has been valued, among other things.
There is some potential for respite, with the EC limiting disclosure obligations in the notification form for foreign financial contributions granted to other investment funds managed by the same investment company but with a majority of different investors, provided certain conditions are met.
The Commission is encouraging parties to initiate early contact to discuss exactly what is required before submitting their filing.
Having a clear overview of a fund and its portfolio companies’ financial contributions will be critical to determine regulatory positions on deals, and will give a competitive advantage in auction processes. Some funds are rumoured to be considering creating “clean funds” free of foreign financials contributions at the fund level to gain a further edge.