A year of EU rules on foreign grants

One year after it entered into force on July 12, 2023, the Foreign Subsidies Regulation (FSR) continues to make headlines. The FSR allows the European Commission (EC) to investigate financial contributions granted by non-EU governments to companies operating in the European Union and to impose measures to address any undetected distortive effects.

Contrary to expectations, the EC quickly implemented this new investigative tool to address distortions caused by the allocation of foreign subsidies in the internal market. You can read more in our previous post here.

Furthermore, it is highly likely that FSR-based controls will be strengthened in the coming years as domestic protectionism increases. For example, the Inflation Reduction Act (IRA) adopted by the US in 2022, introducing a nationwide support plan including production subsidies and tax incentives, will likely impose FSR notification obligations on US companies and possibly strengthened ex officio European Commission investigations.

Although recent examples of FSR implementation have allowed for a better understanding of the EC’s priorities, many questions still remain for economic entities, and even more so for private equity (PE) investors.

Private Equity and Merger Control | Walking lightly

Investment funds are also subject to EC control under the FSR regulation. In addition to large Chinese companies, the EC’s “usual suspects” include sovereign wealth funds (SWFs), and in particular Middle Eastern SWFs.

As evidence, the European Commission recently announced on June 10, 2024, that it had opened a formal investigation into a €2.2 billion telecommunications contract involving a United Arab Emirates (UAE) buyer suspected of receiving distortive subsidies from the United Arab Emirates government. In particular, it is alleged that the buyer received subsidies in the form of an unrestricted guarantee from the United Arab Emirates and a loan from UAE-controlled banks directly facilitating the contemplated transaction. It should also be noted that the unlimited guarantee is considered by the EC to be one of the most likely subsidies to distort the internal market.

As a result, investment funds must be particularly vigilant in enforcing the FRS, particularly in the case of mergers exceeding the notification thresholds, i.e. where the target company, one of the merging parties or the joint venture generates a turnover in the EU of EUR 500 million or more and in over the last three years, the parties have been awarded foreign financial contributions (FFC) of over EUR 50 million.
Such vigilance is necessary because one of the reporting thresholds can easily be exceeded, given the broad interpretation of the concept of FFC by the EC. As the EC reminded in its questions and answers, a financial contribution made by a private entity may be attributed to a third country when, for example, the private entity receives an order or entrustment to the private entity by the third country to take a specific action. As a result, an investment by a state-linked limited partner (LP) may ultimately be considered an FFC.

In this context, PE firms should establish systematic monitoring and quantification of FFCs to assess whether applicable reporting thresholds have been achieved. You can read more in our previous post here. They should also ensure that the structure of their funds can be easily described to the EC.

For the purposes of this Commission assessment, the FSR and its Implementing Regulation provide for certain exemptions for PE funds and firms. In particular, Form FS-CO, which describes the information to be disclosed about a proposed transaction, provides that in the event of an acquisition of control or creation of a joint venture by an investment fund or by a legal person controlled by or through an investment fund, it is not necessary to take into account the FFC granted to other investment funds managed by the same investment company, but with a predominance of different investors provided that the following two conditions are met: :

• The fund controlling the acquirer must be subject to the EU AIFM Directive or equivalent third country legislation on prudential, organizational and behavioral rules, including requirements designed to protect investors; AND
• Economic and commercial transactions (e.g. sales of assets, including ownership in companies, loans, credit lines or guarantees) between the fund controlling the acquiring entity and other investment funds (and companies controlled by these funds) managed by the same investment company do not exist or are Limited.

Regarding the first condition, it should be noted that in April 2024, the EC specified in its questions and answers that investment companies should provide evidence that the provisions in question contain sufficient guarantees to prevent cross-subsidies between funds, including their portfolio companies .

In this context, given the wide scope of the FSR and the practical difficulties that may be encountered in collecting the appropriate level of information required by the EC, it is worth considering entering into pre-notification discussions with the EC (namely the Directorate-General for Competition) well in advance of notification in order to prepare for the initial review the FFC and negotiate waivers to limit information collection and disclosure efforts.

How will the IRA impact the conduct of bid investigations in public procurement procedures?

As regards EC investigations into tenders submitted in public procurement procedures (PPPs) involving financial contributions from non-EU governments, the notification thresholds can be even more easily exceeded as FSR notification is required where the estimated contract value is at least EUR 250 million and the bidder has been awarded a total FFC of at least EUR 4 million per third party country in the three years preceding notification. If the contract is divided into lots, the value of that lot or the total value of all the lots for which the company bids must also be at least EUR 125 million, in addition to the above two criteria.

In this context, companies operating in the EU that have benefited from FFCs granted under an IRA are likely to be subject to notification requirements if they decide to participate in a European tender. Indeed, in the response provided by the Executive Vice-President, the EC confirmed that FFCs granted under IRAs to companies doing business in the US (primarily in the form of tax breaks) will need to be assessed on a case-by-case basis under the FSR.

The IRA raises some concerns among investors, EU operators and contracting authorities. The EC pointed out, for example, that some IRA provisions may raise serious doubts as to their compliance with the rules of the World Trade Organization and have an unfavorable impact on non-US companies.

Finally, it should be noted that, in addition to the FSR, the EC also recalled that in accordance with the EU anti-subsidy regulation (Regulation (EU) 2016/1037), if an EU industry suffers injury as a result of importing a subsidized product from a non-EU country, the Commission may impose countervailing measures if it is in the EU interest (e.g. the ongoing investigation into China-based producers of battery electric vehicles).