The EU Foreign Subsidies Regulation Update: How The New Implementation Rules Will Impact Private Equity Deals - Contracts and Commercial Law

1. The EU Foreign Subsides Regulation: Where are we now?

Whilst the EU Foreign Subsidies Regulation ("FSR") came into force back in January 2023, the long awaited Implementing Regulation ("IR") now provides key guidance on how the M&A reporting regime will operate in practice.¹ The IR, adopted by the European Commission ("Commission") on 10 July 2023, sets out the procedures for notifying deals under the FSR, including the content of the notification form (a "Form FS-CO") and the procedural rules for preliminary reviews and in-depth investigations in cases of suspected distortive foreign subsidies. In this briefing we outline the key reporting obligations in the Form FS-CO and how these will apply, in particular, to M&A deals in the private equity space.

As explained in our earlier briefing, M&A activity will be subject to mandatory notification to the Commission, with an associated stand-still obligation, where:

The target (one of the merging parties or the joint venture) is established in the EU and generates aggregate turnover of at least Euro 500 million in the EU; and
All deal parties were granted combined financial contributions of more than Euro 50 million from non-EU 'state bodies', in the previous three financial years.

Whilst the notification thresholds were set by the text of the FSR back in January, there has been much debate in the intervening months as to the applicable reporting obligations, in particular for financial investors. The concept of a "financial contribution" is very widely drawn: prompting calls from the private equity industry for disclosure concessions in order to render the regime workable. The final IR makes some welcome improvements to the mechanics (as compared to the draft IR consulted upon in February): both limiting the disclosure obligations applicable to all M&A activity, as well as introducing new concessions for private equity-led deals.

2. Headline concessions, applicable to all investors

In relation to all deals (regardless of the type of investor), the IR sets an increased de minimis threshold for the financial contributions that need to be reported in the Form FS-CO, focuses in on the types of support that the Commission considers are most likely to distort, and removes certain 'benign' categories of support from disclosure completely.

De minimis threshold

Whereas all financial contributions are counted in order to ascertain whether the Euro 50 million threshold is met, contributions now only need to be reported in the Form FS-CO where they individually exceed Euro 1 million in the three years prior to the deal. (This is a welcome increase from the Euro 200,000 proposed in the draft IR).

Focus on those financial contributions most likely to distort

Once above the Euro 1 million threshold, detailed information is only required for the following four types of financial contribution that the Commission considers are "most likely to distort" the internal market:

Support granted to ailing companies;
Unlimited guarantees for debts or liabilities;
Contributions that directly facilitate a transaction; and
Non-OECD-compliant export financing measures.

For these four categories, the Form FS-CO requires detail on the purpose and rationale of the financial contribution, any conditions attached to it, and an analysis of whether the contribution actually confers a benefit on the recipient.

For any other financial contribution (i.e. that does not fall within the four most 'risky' categories), a summary table is provided in the Form FS-CO. Reporting is limited to the Euro amount of the contribution (provided it is above the Euro 1 million threshold), together with a brief description of the measure. Furthermore:

Rather than needing to list each contribution individually, data can be grouped by country and by type (e.g. according to whether it is a direct grant, loan/financing instrument, tax advantage, guarantee, equity intervention, debt write-off etc.); and
Only those countries where the estimated aggregate amount of all financial contributions (granted in the three years prior to the deal) is Euro 45 million or more need to be included (a marked increase from the Euro 4 million level proposed in the draft IR).

The Commission does, however, reserve the right to request additional information where necessary.

Exemption for ordinary course dealings

The scope of financial contributions covered by the FSR is wide: on its face including contracts made between a state-linked body and a private entity (including a portfolio company anywhere within a PE firm's wider structure) for the purchase/provision of goods or services, even if they have been negotiated on arm's length, commercial terms or were subject to a competitive, transparent and non-discriminatory tender procedure.

Importantly, the IR now introduces a more pragmatic approach. It excludes from disclosure contracts for the provision/purchase of goods or services (except for those in financial services) where they are on market terms in the ordinary course of business. (This does, however, means that any such contracts in the financial services field will still need to be reported).

Also excluded from disclosure are certain tax measures (including deferrals of tax/social security contributions and reliefs for the avoidance of double taxation).

3. Carve-out for investment fund reporting

As noted above, the private equity industry has been calling for narrowed reporting obligations, appropriate to the particular structures of PE firms. Given the group-wide concept to calculating the notification thresholds under the FSR, financial contributions to portfolio companies wholly unrelated to the deal in question were, under the draft IR text, subject to disclosure. Indeed, Commission officials have previously acknowledged that private equity firms face a higher notification burden than other types of investor.

The Commission has gone some way to addressing these concerns in the final IR. In the case of M&A deals by an investment fund (or by a legal entity controlled by or via that fund), financial contributions granted to other investment funds managed by the same investment company (but with a majority of different investors) do not need to be disclosed, provided two conditions are met.

First, the fund controlling the acquiring entity (the 'Acquiring Fund') must be subject to the Alternative Investment Fund Managers Directive (2011/61/EU) or to an equivalent third country legislation in terms of "prudential, organisational and conduct rules, including requirements aimed to protect investors".

Second, the economic and commercial transactions between the Acquiring Fund and the other funds/portfolio companies managed by the same firm are "non-existent or limited". On this point, the Commission will require evidence of any of such economic and commercial transactions which may have taken place in the three years prior to the deal.

4. What next?

The M&A notification regime kicks in on 12 October 2023. This means that all transactions that sign on or after 12 July 2023, but which do not complete before 12 October 2023, will require mandatory notification to the Commission where the thresholds are met. From 12 July 2023, even though the notification provisions will not yet apply, the Commission will be able to use ex officio powers to review M&A activity on its own initiative, where it considers this to be appropriate given a deal's impact in the EU.

Given notifications will not be accepted before 12 October, deals (involving upwards of Euro 500 million targets) signing within the three month (July to October) window should factor in the potential impact of the FSR on deal timelines. Pre-notification discussions are actively encouraged, including prior to 12 October, and the Commission aims for these to be "extremely valuable" in determining, amongst other things "the precise amount of information required in a notification".

Whilst the concessions outlined in this briefing are welcome, there remains a weighty reporting burden under the IR. Investors will therefore need to consider how best to collate and manage data on financial contributions in time for kick-off . Investors should also be aware that the IR provides a continuous reporting obligation: after notification, any relevant information must be communicated to the Commission without delay where it would have been subject to notification if known (or ought to have been known) at the time. Having appropriate data systems in place before a notification requirement arises will therefore be important for streamlining the review process so far as possible.

Footnote

1. The FSR also provides a regime covering public procurement processes. This note focuses on the separate M&A regime.

Originally published by 19 July, 2023

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