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Coordinated foreign direct investment screening proposed for EU Member States

Screening by EU Member States of foreign takeovers and investments is the subject of proposed new EU legislation. The proposals are important for financial institutions, in particular those involved in financing takeovers or investments by non-EU entities, and also those which are potential foreign investors in EU businesses in their own right. The new screening system aims to improve coordination between Member States when vetting transactions affecting security or public order. It also enables the EC to issue opinions and to screen investments targeting businesses supported by EU funding. The legislative process should start soon and critical developments are expected in the coming months as Member States gear up for potentially controversial procedures.

FDI in the State of the Union speech

There has been growing concern in some European Union (EU) Member States (primarily France, Germany and Italy) over what has been perceived as a recent surge in investment across Europe by non­EU investors with strong financial ties to their home governments. To date, this investment has often targeted businesses or infrastructure in sectors of the economy deemed to be of strategic significance (such as energy, telecommunications and technology).

Speaking in front of the European Parliament in Strasbourg on 13 September 2017, President Juncker confirmed that the EU would remain open to foreign direct investment (FDI). It should, however, devise "vigorous and effective policies" to ensure a level-playing field with the rest of the world, and to "protect critical European assets against investment that would be detrimental to legitimate interests of the Union or its Member States".

In parallel, on 14 September 2017, the EC published a detailed proposal for a new EU Regulation in this area. It also published a staff working document and announced a Communication providing additional context on the proposal.

Current approach to FDI screening in the EU: responsibility at Member State level

The EC has not been directly involved in FDI screening to date; instead FDI screening is the exclusive responsibility of individual EU Member States, albeit subject to certain EU-level restrictions.

Article 21 of the EU Merger Regulation (EUMR) recognises the right of Member States to take appropriate measures in relation to transactions requiring notification to the EC under the EUMR to protect legitimate interests other than maintaining competition in the relevant markets. These include, in particular, public security, plurality of the media and 'prudential rules' (in effect, financial stability). Article 21 also leaves open the possibility that other public interests may be recognised by the EC as 'legitimate', at the request of a Member State, after an assessment of their compatibility with general EU law principles. Individual EU Member States have used this provision to protect national interests in the context of acquisitions of businesses operating in the defence, media and financial services sectors that would otherwise fall within the exclusive jurisdiction of the EC under the EUMR. For instance, the UK has a well-established framework for public interest interventions under Article 21 in its national merger control rules (see below for more information on the UK position). Importantly, however, these provisions are not expressed as applying specifically or exclusively to acquisitions or investments by foreign entities (and indeed have been used to review domestic mergers in addition to takeovers by foreign entities).

FDI screening – national measures

Nearly half of EU Member States already have a mechanism for formal FDI screening (which may apply to transactions that do not require notification under the EUMR). The most recent example of a Member State updating its FDI screening legislation is Germany where an amendment to the Foreign Trade Regulation (Aussenwirtschaftsverordnung) entered into force in July this year, establishing a list of sensitive industries and extended timelines for review by the German Federal Ministry of Economic Affairs and Energy.

An uncoordinated approach

There is a wide variety of approaches and procedures to FDI screening across Member States. For example, the screening can be mandatory or voluntary, ex ante or ex post, applicable across all sectors or limited to specific sectors, applicable to investors coming from specific geographic areas or covering the entire world.

There is also no formal mechanism to coordinate FDI screening between different Member States. This increases the risk of a burdensome process for foreign investors and their targets, inconsistent timelines, and potentially divergent outcomes.

A European-wide FDI framework

The EC's proposal aims to provide legal certainty by giving a firm legal foundation for national FDI screening mechanisms under EU law and by ensuring compliance with international trade laws (such as the World Trade Organisation rules). It is also designed to achieve EU-wide coordination and cooperation between Member States.

An enabling framework

The EC's proposal creates an enabling framework for Member States to screen FDI on grounds of security and public order, even in cases where the EUMR does not apply. It confirms that Member States may continue to maintain and amend existing FDI screening measures, or adopt new ones, taking into account their national circumstances. Importantly, however, Member States are not required to adopt an FDI screening mechanism.

Increased collaboration

A key aspect of the proposal is the creation of channels for communication and collaboration between Member States and the EC, in order to facilitate the sharing of information about planned or completed FDI in the territory of one or several Member States. Through these channels Member States will also be able to comment on investments that may affect their security or public order. Moreover, the EC (presumably through its Directorate-General in charge of trade) may itself issue an opinion on an investment that may affect the security or public order of one or more Member States. However, the final decision on the appropriate response to any particular FDI rests exclusively with the specific EU Member State(s) in which the investment is planned or completed – they must give "due consideration" to the comments and/or opinion received, but are not bound by them.

Basic substantive and procedural requirements

The proposal is clear that every EU Member State which has an FDI screening mechanism will have to ensure that it complies with basic substantive and procedural requirements.

In terms of substance, the EC lays out a non-exhaustive list of effects that may be taken into consideration by EU Member States when screening FDI. These include effects on critical infrastructure (including financial infrastructure), technologies, sensitive information, and inputs which are essential for security or the maintenance of public order. The EC has said that this list of factors is intended to provide clarity to investors considering making or having made FDI in the EU. Crucially, the proposal states that, when assessing these effects, Member States and the EC should also be able to take into account whether a foreign investor is controlled directly or indirectly by the government of a third country, including through significant funding.

The EC has also outlined the essential elements of a proposed procedural framework. In particular, the proposal stipulates that national FDI screening regimes should have clear timeframes, which allow them to take into account comments by other EU Member States and the opinion of the EC. The proposal also provides that individual investors should have the possibility to seek judicial redress.

More scope for intervention by the EC?

Importantly, the proposal also gives the EC the power to screen FDI affecting projects or programmes "of Union interest" on grounds of security or public order – in particular those funded by the EU (the proposal cites by way of example the 'Galileo' satellite navigation system or the 'Horizon 2020' European framework programme for research and innovation). Under the proposal, where the EC identifies concerns in this respect, it may address an opinion to the Member States in which the investment is planned or completed.

While Member States will have no obligation to follow such an opinion, the proposal makes clear that in cases where an investment is screened under national FDI rules, Member States have to "take utmost account" of the EC's opinion in.

their analysis and provide an explanation to the EC in cases where that opinion is not followed (this requires a greater degree of consideration than FDI which does not have a "Union interest").

Perhaps more surprisingly, the EC considers in an explanatory memorandum (but not in the text of the proposal itself) that an individual EU Member State in receipt of an opinion from the EC – even if that Member State is not conducting a screening – should nonetheless consider ways of taking that opinion into account either through its national FDI screening mechanism or, in the absence of such a mechanism, its broader policy making.

In all cases, however, the final decision on the appropriate response will rest with the relevant EU Member State, and not the EC.

When might the proposed law come into force?

Given the sensitivities, we expect that the EC's proposal will be subject to intense scrutiny throughout the legislative procedure. As such, while it is still too early to predict with confidence when the final text may be adopted (if at all), this is unlikely to be before the end of the year.

Curbing FDI or controlling the Member States?

The key question for the international business and finance communities is whether the EC's proposal will constitute an obstacle to investments in Europe. The EC strongly believes that openness to FDI is a key principle and a major source of economic growth. Yet, at first sight, it may appear that the EC is effectively putting in place – or at least facilitating – an FDI screening system comparable (albeit on a decentralised basis) to those existing in other jurisdictions such as the U.S., Canada, or Australia. There is no doubt that the EC is keen to ensure a level playing field in international business and that, in its eyes, the acquisition of European technologies or infrastructures (in particular if they were funded by the EU) by foreign companies is a potential concern.

At the same time, the proposal allows the EC to get a much better grasp of national FDI screening procedures. Through the proposed information exchange and coordination mechanisms, the EC is also expecting coordination gains in the assessment of risk related to security and public order. Further, it will be very interesting to see how the EC makes use of its powers to issue FDI-related opinions, which may eventually come to set a de facto benchmark for individual EU Member States screening FDI.

For investors and lenders

In practical terms for international investors and their lenders, and for European businesses looking for new sources of capital, it is hoped that the proposed legislation will contribute to harmonising the various EU Member State national FDI screening procedures. As with any significant change to the EU legislative landscape, however, the devil will very much lie in the detail of the final text of the Regulation.

Brexit – UK set to chart its own course?

The UK has a well-established framework for public interest interventions in its national merger control rules (both in relation to transactions notifiable to the EC (ie under Article 21 EUMR) as well as transactions falling outside the EC's jurisdiction). The current grounds for review are, broadly, national security, plurality of the media and maintaining the stability of the UK financial system. However, last year the UK Department for Business, Energy and Industrial Strategy (DBEIS) announced its intention to "impose a new legal framework for future foreign investment in Britain's critical infrastructure". Just before this statement, the Prime Minister signalled, referencing both the Kraft/Cadbury deal and the attempt by Pfizer to acquire AstraZeneca, that going forward the UK Government would be more inclined to intervene in cross-border takeovers to protect UK interests.

As it stands, while the UK remains part of the EU, the ability of the UK Government to expand the scope of intervention to protect national interests is constrained by EU laws (including the EUMR and the EC's FDI proposal (if adopted)). Post-Brexit, these restrictions are likely to fall away, leaving the UK free to chart its own course in respect of screening FDI. As yet though, no detail has been published on what form this screening may take. However, it is expected that even if the UK does introduce a new framework for FDI screening in respect of "critical infrastructure", it will seek to remain, as acknowledged by DBEIS, "one of the most open economies in the world".

Post-Brexit, if the EC's proposal is adopted and the UK Government's intentions to further scrutinise FDI are realised, the impact on UK­based entities will be twofold. On the one hand, UK companies or financial institutions investing in EU businesses or assets may find their investments subject to FDI review by the remaining EU Member States and possibly also the EC. On the other, UK businesses active in "critical infrastructure" (and possibly also other sectors of the UK economy deemed to be of 'strategic significance') and seeking overseas capital may see an additional layer of Governmental scrutiny applied to their would-be investors.

For more information on the UK position and the impact of Brexit, see our note.1 You can read the EC's proposal here.2



2 regdoc/rep/1/2017/EN/COM-2017-487-F1-EN-MAIN-PART-1.PDF

Further information

This case summary is part of the Allen & Overy Legal & Regulatory Risk Note, a quarterly publication.  For more information please contact Karen Birch –, or tel +44 20 3088 3710.

Legal and Regulatory Risk Note