Investing in the EU? Tighter foreign investment control is on its way as the new EU foreign investments control scheme takes shape while national governments adopt and enforce stricter rules.
Recent EU foreign investment control reforms have demonstrated the impact that foreign investments screening processes can have on the timing and outcome of foreign investment transactions in the relevant key industries. Where national security and public order are at stake, it is becoming increasingly likely that foreign investments into the EU may be limited or prohibited by the national governments.
It is expected that the volume of transactions subject to foreign investment control will further increase, particularly as the relevant national governments are considering lowering the applicable thresholds, therefore opening up minority investments, e.g. acquisitions of 10% of shares in EU businesses, for review, similar to the CFIUS regime in the United States.
The EU is taking a lead on harmonising the approach to the screening of foreign investments into the EU. The new scheme is expected to be finalised at the EU level by the end of 2018, introducing a new competence of the EU Commission to screen, and opine on, foreign investments, along with a cooperation mechanism between national governments and the EU Commission.
At the Member States level, following the reforms in Germany and Italy, a number of countries, in particular the UK, Germany and France, are working on (further) amending their foreign investment control regimes, which will broaden the scope of the rules, allowing regulators to intervene more often, in particular, in cases of investments in the 'critical infrastructure' and 'key industry' sectors.
Below, we discuss the proposed EU framework, as well as the national regimes in the UK, Germany and France, in more detail.
New Screening Mechanism Allows for Comments, but Member States Will Still Decide
The EU Parliament and the EU Council have recently suggested amendments to the initial proposal issued by the EU Commission in September 2017 for the "Regulation establishing a framework for screening of foreign direct investments into the European Union" (the "Draft Regulation"), currently reviewed in the EU trilogue procedure. The EU legislative process therefore still appears to be on track for the new rules to be adopted by the end of 2018.
The current discussions suggest that the national governments would remain independent in deciding whether a specific transaction should be cleared. Other than under the EU Merger Control Regulation, no centralised decision mechanism will be established at the EU level, even in cases where multiple Member States are affected by a particular investment into the EU. The Draft Regulation does not, in fact, require Member States to establish a screening mechanism at all.
Once the foreign investment control schemes are established, Member States will, however, be required to share information regarding any screenings undertaken at the national level with the other Member States and the EU Commission.
EU Commission Opinion to Be Considered if EU Programmes, Subsidies or Infrastructure Are Involved
The EU Commission will be able to provide comments to the Member States concerning foreign investments that may affect EU interests; the Member States have, however, specifically emphasised that such comments may only be provided by way of non-binding opinions.
The Draft Regulation enables the EU Commission to issue such opinions where:
- it considers that a direct foreign investment is likely to affect projects or programmes of the EU interest on the grounds of security or public order.
- the relevant projects and programmes need to involve a substantial amount or a significant share of EU funding or should be subject to the EU legislation regarding critical infrastructure, critical technologies or critical inputs.
- the relevant EU projects and programmes are listed in the Annex to the regulation and include projects in the transport, energy and telecoms sectors such as Galileo, Horizont 2020 and the Trans European Networks (TEN).
The EU framework does not specify a threshold an acquisition has to exceed to fall within the EU level screening regime. This, again, will be defined by EU Member States under their respective national control regimes and may therefore vary depending on the jurisdiction.
Key Sectors Where Security and Public Order May Be Affected
The EU seeks to establish certain minimum standards for review procedures (including timeframes and protection of confidential information), coordination between the EU Commission and the Member States and, most importantly, further determination of the areas where, in line with the EU law, (national) security or public order may be affected.
These ongoing discussions include analysis of the following areas:
- critical infrastructure, including energy, transport, communications, (aero)space, data storage, sensitive facilities and, upon the EU Council's suggestion, media, defence and real estate crucial for the use of such infrastructure;
- critical technologies, including artificial intelligence, robotics, semiconductors, technologies, dual-use items, cybersecurity, nuclear technology and, upon the EU Council's suggestion, defence, nanotechnologies and biotechnologies;
- the security of supply of critical inputs, including energy, raw materials, components and semi finished products;
- access to sensitive information or the ability to control such information; and
- the plurality of the media.
This list is non-exhaustive, and other sectors may potentially become subject to screening. The EU framework will have direct and immediate effect in the Member States. Therefore, where screening mechanisms exist at the national level, this list will have to be taken into consideration to determine the areas where national governments may intervene.
It is currently unclear whether, when adopted, the EU framework would be immediately applicable or delayed by 18 months, as currently suggested by the EU Council. Also, there remains much uncertainty around the list of areas where the EU and the relevant national governments may consider that security or public order may be affected, and, in the absence of any case law, foreign investors should carefully consider the tightened foreign investment regimes at the EU and the relevant national governments levels to assess possible timing implications and regulatory risks, as the case may be, including multijurisdictional foreign investment control analysis, in addition to similar prior filing requirements and risk assessments under merger control laws.
The UK Government Is Moving Forward on the National Security Reform
Following the announcement in September 2016 of the UK Government's intention to reform its powers in the sphere of national security and the publication of the Green Paper in October 2017, in July 2018, the U.K. Department for Business, Energy and Industrial Strategy published its National Security and Investment White Paper (the "White Paper") setting out the more detailed proposals on the reform of its powers in relation to protecting national security from hostile actors' acquisition of control over entities or assets.
The overriding intention set out in the White Paper is that the UK Government's powers under the reform will be proportionate and focused it their application, with each case following a clear and predictable process, and will be used to protect national security from hostile actors using ownership of, or influence over, businesses and assets to harm the country. It is also made clear that the UK Government views foreign investments and an active and competitive economy as the key to the UK's growth and development, and that the UK warmly welcomes the contribution that foreign investment makes and seeks to increase international partnerships in areas such as research and innovation.
It is the UK Government's view that only a small number of investment activities, mergers and transactions in the UK economy pose a risk to the UK national security. However, for these cases, it is vital that the UK Government is able to intervene in order to prevent and mitigate these risks.
The White Paper is a consultation, and, as such, it invites the market and the relevant professional bodies to respond to the specific questions on the proposed reform before the final policy statement, and related legislation, is published.
The White Paper Sets Out Detailed Screening Procedure
Currently, the UK Government's powers to intervene in relevant transactions in order to prevent and mitigate the risks to national security derive from the Enterprise Act 2002, which was amended in early 2018 to allow more interventions in certain key areas of the economy. However, the UK Government has concluded that these powers are still limited in places – particularly in contrast to other countries' regimes – and is therefore suggesting that a full reform requires primary legislation to introduce a new regime.
The proposed new regime
The new regime proposed for the consultation, at a very high level, will comprise the following key stages:
- Notification: The UK
Government will encourage voluntary notification of investment and
other events that may raise national security concerns (the
Trigger Events: Currently, these are proposed to be defined as the acquisition of control or significant influence over an entity or asset. This will normally be in the form of a merger, investment or other commercial activity. However, a Trigger Event may also arise through any other means by which someone acquires significant influence or control. It also captures acquiring any additional or further means of exerting significant influence or control over an entity.
- As regards the range of assets in
scope, the amended Enterprise Act 2002 currently lists the
following asset classes:
- dual-use export-controlled technology, i.e. enterprises that develop or produce export controlled items with dual military and civilian uses, or that hold information concerning the development, production or performance characteristics of such items;
- computer hardware and software, i.e. enterprises that own, create or supply intellectual property relating to computers, their instruction set architecture and their low-level control code, as well as enterprises that design, maintain or provide support for the secure provisioning of computer security hardware, software, firmware and encryption keys; and
- quantum computing, i.e. enterprises that conduct research and development of, produce components used in or provide services employing quantum computing and its applications in simulations, imaging, sensing, timing, navigation, communications or quantum-resistant cryptography.
To prevent the reforms being subverted or evaded, the proposed legislation would also allow the UK Government to scrutinise the acquisition of control over real and personal property, intellectual property and contractual rights when this might raise national security concerns.
Further guidance on the interpretation for 'control or significant influence over an entity or asset' will be set out in the UK Government's statement of policy intent.
The UK Government also expects to publish a detailed statement to describe where and how it considers the Trigger Events most likely to arise, which should allow the parties to determine whether to discuss the activity informally with the UK Government and/or whether to submit a formal notification to the UK Government.
The UK Government also reserves the right to 'call in' transactions and other events, including after they have taken place, even in the circumstances where there are no Trigger Events.
It is therefore not currently clear how broadly the policy will apply and what industries it is expected to apply to.
- Screening: The UK Government expects there to be around 200 notifications made each year. It also expects to be able to quickly screen out those that do not pose any national security concerns, allowing it to identify the Trigger Events requiring further analysis.
- Full national security assessment: For those notifications that the UK Government expects will raise national security concerns each year (the initial analysis indicates this may be around half of those notified), the UK Government will subject these to a full assessment. It will do so following a prescribed and transparent process.
- Imposition of remedies: If,
following its assessment, the UK Government concludes that national
security is at risk, it will impose such remedies as necessary and
proportionate. The initial analysis indicates that this will arise
in around half of those cases subject to a full national security
assessment having been called in per year.
The remedies are expected to include conditions the UK Government will impose to prevent or mitigate national security risks, following its assessment. As a last resort, this might mean blocking the Trigger Event or unwinding it if it had already taken place.
Consultation timetable and next steps
The consultation on the White Paper closes on 16 October 2018. The UK Government will then work on the responses to the proposals received during the consultation period, and will publish its finalised Policy Statement along with the proposed legislation in due course. The timing for the rules to be finalised is expected to be confirmed later in this process.
Stricter Enforcement Following 2017 Reform, Lower Thresholds May Follow
The Federal Government was recently close to formally prohibiting a foreign investment by Chinese investors into a German machine tool building company that offers products for the aerospace, air transport and nuclear industries. The required approval by the cabinet of ministers was, however, obtained on 1 August, 2018, while the Chinese investor abandoned the deal at the eleventh hour to avoid a formal prohibition decision. It could be argued therefore that, at least de facto, the Federal Government did prohibit the transaction, and, were the acquisition formally prohibited, it would have been the first prohibition under the German foreign investment control regime. This comes a year after Germany tightened its foreign investment rules, in part due to the Federal Government's inability to control certain Chinese investments under the prior regime.
Following the German foreign investment control regime reform in July 2017 (on which, please see our client alert here), a thorough review of procedures was undertaken in an increased number of cases. As a result, several public law agreements were concluded between the Federal Government and foreign investors as a condition for approval of certain transactions and in order to protect the interests of the German Government.
Even where the Federal Government was not able to intervene because the applicable 25% investment threshold was not met, it still managed to prevent a Chinese investment into a critical energy infrastructure provider 50Hertz, whereby the state-owned bank KfW purchased a 20% stake in 50Hertz, not allowing the Chinese state-owned infrastructure service provider to complete the acquisition. This intervention demonstrates that the Federal Government is considering the need to protect critical infrastructures where non-controlling minority investments are being proposed.
While the number of screenings has increased and the Federal Government is now adopting a more thorough approach to screenings, the criteria have not changed, and the Federal Government is still only able to prohibit foreign investments in individual cases.
It is being reported that the Federal Government plans to lower the currently applicable threshold of 25%, or even to switch to the concept of "control or significant influence over an entity or asset" as proposed in the UK, to be able to initiate screenings of similar investments. Most recent reports indicate that the current threshold will be lowered to direct or indirect acquisition of 15% or more of the voting rights of a German company and that the Federal Government aims at adopting the amendments during the remainder of this year.
Reform Proceedings Underway to Further Protect Key Industries and High-Tech Sector
The French Government is also about to adopt an amended set of foreign investment control provisions designed to further protect key industries, especially in the high-tech sectors. The draft legislation was introduced in June 2018 and is currently under review by the competent legislative bodies.
In addition to the control of the sectors already included in the regime in 2014, e.g. fuel supply, electricity, natural gas, public transport and telecoms networks, the new rules include sectors similar to those listed in the EU framework, including production of semiconductors, space relevant products and research, drones and – if related to national security – artificial intelligence, cyber security, robotics and massive data storage.
In order to protect national security and public order interests, the French Government will receive additional powers, including:
- suspending voting rights;
- limiting or prohibiting dividend payouts;
- prohibiting any transaction with shares and assets; and
- imposing a public commissioner to the company with powers to interfere with any decision made by the company's bodies.
Failure to comply with the foreign investment control rules or with an obligations imposed by the French Government with respect to a specific transaction may result in a fine of up to the double of the investment or 10% of the annual revenues of the investor.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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