EU FSR – the notification regime begins; what does it mean for private equity investors?

The Foreign Subsidies Regulation (FSR) establishes a new regime, enforced by the European Commission (EC), to regulate such subsidies. Importantly, it introduces a suspensory notification obligation for certain M&A transactions and joint ventures – including transactions that have not received any subsidies from foreign governments. This new notification regime applies from 12 October 2023. Outside the notification regime, under the FSR the EC is able to investigate subsidies that may distort the EU internal market, and to intervene if it finds they do.

Parties should now be considering the application of the FSR alongside merger control and/or foreign investment control. If notification is required under the FSR, it will need to be a condition to closing alongside any other required merger control and/or foreign investment control approvals.

Transactions in scope

Under the FSR, certain M&A transactions and joint ventures must be notified to the EC before completion. For private equity investors this will be where:

• the target (in the case of an acquisition) or the joint venture entity (in the case of a non-greenfield JV) is established in the EU and generated an aggregate group-wide turnover in the EU of at least EUR500 million in the previous financial year; and
• the parties (ie target and acquirer(s) in the case of an acquisition and, in the case of a JV, the undertaking creating the JV and the JV itself) received combined aggregate financial contributions from non-EU countries of more than EUR50m in the three years preceding the conclusion of the agreement, the announcement of the public bid or the acquisition.

Even if these thresholds are not met, the EC may request a notification (at any time before closing) where it suspects that foreign subsidies may have been granted to the parties in the three years before the transaction. If it requests a notification, the transaction cannot close before the EC’s review is complete. While use of this tool is expected to be rare, particularly in the early years of the FSR, the EC’s approach to enforcement is by no means clear.

As under EU merger control rules, all investments controlled by an investment firm (ie all investments by funds ultimately controlled by the same firm) are taken into account for the purposes of these thresholds.

The meaning of “foreign financial contribution” is extremely wide. It includes capital injections, transfers of funds or liabilities, grants, loans, guarantees, debt to equity swaps, certain tax benefits or reliefs and other forms of forgoing revenue otherwise due, and even the provision or purchase of goods and/or services. In each case, the provider of the “contribution” just needs to be any public authority of a non-EU country at any level of government, or even any other private entity whose actions can be attributed to a non-EU country. It therefore captures financial commitments (eg by way of limited partner interests) by entities affiliated with non-EU governments into investment funds, as well as a broad range of transactions by businesses controlled by investment funds (including, for example, the mere provision of goods or services on arm’s length terms to non-EU public authorities).

Most notifications under the FSR will be non-problematic and cleared in phase 1 processes (see timing below). But the more significant impact on most investment firms is likely to be the burden of having to collate and track data on foreign financial contributions across the entire group, both to identify if a filing is required and to make the required disclosures if a filing is required. Failing to do so in an efficient manner could have timing implications for filing and clearance processes, and ultimately lead to a possible competitive disadvantage in auction processes (see more on this below).

Impact on timing

The notification process has three possible stages. In the pre-notification period, the EC comments on a draft and requests further information for the filing. During phase 1 (25 working days) the EC assesses whether any foreign subsidy distorts the internal market. If that is likely to be the case, the EC can open an in‑depth phase 2 investigation (90 working days). These timeframes are similar to those under the EU merger control rules.

A notifiable transaction cannot be implemented before the EC issues a no-objection decision or accepts commitments to remedy any concerns. As with EU merger control filings, a failure to notify or completion before approval can result in fines of up to 10% of parties’ global turnover.

Prohibition and remedies are possible

If at the end of phase 2 the EC concludes that parties have received foreign subsidies from a non-EU country that could distort the internal market, it can block the transaction or impose redressive measures. The parties to the transaction can also submit commitments to remedy the distortion.

Complying with the notification requirements

Depending on the size of an investment firm and its investment strategy, some firms may well never need to make an FSR notification – for example, because they would never take a controlling interest in a business with EU turnover of EUR500m.

However, if the FSR regime is potentially relevant to an investment firm, then it needs to identify: (1) whether or not it has received “foreign financial contributions” over the threshold for making notifications; and, if it has, (2) keep track of what “foreign financial contributions” it has received over a three year period that are potentially disclosable in a notification, in each case including any controlled businesses throughout the investment firm’s wider group. Unlike the EU merger control rules, the FSR does not allow calculations of financial contributions to be based on the last financial year, so this will need to be regularly updated and maintained.

This means that an investment firm potentially subject to the notification regime should think about the best procedure to put in place to allow for this data to be collected and reported.

Some firms may consider it feasible to wait until a particular transaction arises, and only then start an information gathering exercise. This may make sense if a firm expects FSR notifications to be rare and is confident that it will be straightforward to gather the information from in-scope investees. However, the risk is that, when a notification is required, gathering the required information proves more time-consuming than expected and places the firm at a competitive disadvantage in an auction process.

On a positive note, while investment firms will need to collect information on foreign financial contributions to determine whether a notification is required (that is, for step (1) above), the EC has significantly limited the scope of foreign financial contributions that need to be disclosed on the notification form (step (2) above).

Among those limitations that apply for step (2) only, there is a carve-out on information disclosure for investment firms, whereby they will not need to list foreign financial contributions granted to other investment funds managed by the same investor but with a majority of different investors measured according to their entitlement to profit (or granted to portfolio companies controlled by the other funds) if each of the following conditions are met:

• the fund must be subject to Directive 2011/61/EU of 8 June 2011 on Alternative Investment Fund Managers (or to equivalent legislation in terms of prudential, organisational and conduct rules, including requirements aimed at protecting investors); and
• the notifying party is able to prove that the economic and commercial transactions (eg sale of assets/shares, loans, credit lines, guarantees) over the last three years between the fund that controls the acquiring entity and other investment funds (and the companies controlled by these funds) managed by the same investor are non-existent or limited.

This tightly framed carve-out does not dispense with the need for single-fund investors to monitor, collect and disclose information about foreign financial contributions received by their portfolio (group) companies.

For investors with multiple funds, the carve-out is helpful for information disclosure when it is clear that the foreign financial contribution threshold under (1) is met, and where only some funds managed by an investment manager will potentially engage in transactions giving rise to the notification requirement. This will allow the information gathering for disclosure purposes to be limited to those funds or closely linked funds. However, the second limb concerning economic and commercial transactions between funds may limit the ability of this exemption to apply in practice for those funds that have carried out frequent continuation fund raises and/or fund-to-fund deals in recent years.

Uncertainties remain

Much uncertainty remains around the application of the regime, including how the EC will determine whether a subsidy has or is likely to have distortive effects and, critically, the nature of remedies required by the EC to address any such distortions. The EC’s short- and long-term appetite for opening “ex officio” investigations into potentially distortive foreign subsidies that are not caught by the notification requirements is also unclear. We will keep you updated as the regime beds in and EC practice is clarified.

In the meantime, our FSR publications provide more detail on how the overall regime will work and the important procedural rules. You can also read about proposed amendments to the U.S. merger control notification form to require information on subsidies received from certain foreign governments and related foreign entities in our Global M&A Insights publication.