The European Commission (EC) issued its first Annual Report pursuant to Article 5(3) of the Screening Regulation on foreign direct investment (FDI) in the EU on 23 November 2021. The Report provides transparency around the implementation and operation of the EU's FDI regimes by providing information about the trends surrounding FDI in the region, legislative developments in Member States, screening activities by Member States, and how the EU cooperation mechanism on FDI screening has worked in practice. The Report confirms increased scrutiny by Member States of foreign investments over the recent years. While the vast majority of notified transactions were cleared swiftly and without in-depth investigation, foreign investors should expect a growing number of EU countries adopting FDI mechanisms and tightened scrutiny on grounds of national security/criticality of strategic assets considerations.
The EC released its first Annual Report on FDI in the EU. The Annual Report compiles key information about the operation and trends of the EU FDI cooperation system set up by EU Regulation 2019/452 of 19 March 2019 ("Screening Regulation"). The EU Regulation introduced a coordination mechanism whereby the EC may issue non-binding opinions on FDI reviews performed in Member States. "Non-reviewing" Member States may provide comments to the "reviewing" Member States. Both may ask questions as well. Member States and the EC may also provide comments on a transaction that is not being reviewed because it takes place in a Member State with no FDI regime, in a Member State in which the transaction does not meet the criteria for an FDI review by the government, or the reviewing Member State decided to waive screening of a particular investment. The Annual Report also provides an interesting overview of screening activities by Member States.
Significant Impact of the COVID-19 Outbreak
The Annual Report tracks trends in volume of FDI in EU Member States from 2019 to the first quarter of 2021 to illustrate changes in pre-COVID-19 to current data. In 2020, global FDI volume fell sharply to €885 billion, representing a 35% drop from the volume in 2019. Within the EU, the negative effects of COVID-19 on FDI amplified, with inward FDI dropping 71% from €335 billion in 2019 to just €98 billion in 2020. However, the decrease in FDI activity has been uneven depending on the nationality of the foreign investor, the EU Member State involved in the transaction, and the economic sector at the issue. All Member States saw a drop in the volume of M&A transactions. Some Member States also saw shifts in the volume and origin of key foreign investors. The US was the country from which most foreign investments in the EU in 2020 originated, followed by the United Kingdom (UK), EFTA countries, and China. As with the Member States, the economic sectors likewise were not impacted equally. Industries such as medical supplies, pharma manufacturing, and e-commerce had a remarkable increase in investment activity, whereas other industries, such as tourism, leisure, aviation, and marine-transportation dropped severely.
Prohibition Decisions are Rare
Data from the Annual Report shows that only approximately 4.2% of all transactions submitted for review last year were aborted, prohibited, or cleared with mitigation. While the Regulation establishes and encourages cooperation between Member States, the decision to screen investments still rests with those Members States operating FDI regimes. These Member States reported a total of 1,793 investment dossiers for 2020. Of this total, only 20% were formally screened, the remaining 80% being dismissed for lack of impact on security or public order. Within the 20% that were formally screened, 79% were cleared without mitigation. Of those remaining, 7% were aborted or withdrawn, 2% were blocked, and 12% were authorised, but with mitigation in place. One of the rare prohibition decisions was issued by the German FDI screening authority. In December 2020, a cabinet decision to authorise a prohibition of the planned acquisition of German company IMTS, a research-driven industrial engineering and design house specialising in radio technologies and microelectronics, by Chinese state-owned defense company Casic, active in the field of military equipment, became public.
Increasing Number of FDI Regimes
Since 2017, the number of Member States with FDI screening mechanisms that adhere to the Regulation has increased from 11 to 18. During the reporting period, the EC found that 24 out of the total 27 Member States had either adopted an FDI screening mechanism, formally initiated the legislative process to consolidate or initiate an FDI regime, or amended existing FDI mechanisms to be in more aligned with the Screening Regulation. While the Screening Regulation does not specify the particular form or content that a Member State's regime should have, it highlights the key elements that should be present in the scheme itself. Though nine Member States have not implemented an FDI screening mechanism in compliance with the Screening Regulation, the Annual Report notes that the EC expects that each remaining Member States will enact a national screening regime in the future. While the FDI regimes differ widely in several notable aspects (mandatory versus voluntary thresholds, timelines, list of strategic sectors, etc.), the implementation of the Screening Regulation in the EU led to an increase of Member States enacting FDI regimes in adherence. The EC expects that by the next Annual Report additional Member States will have adopted and strengthened national FDI screening legislation and related mechanisms for potentially risky foreign investments from non-EU countries. The ultimate vision is that all 27 Member States would have effective FDI review regimes in the short term.1
Diverse Type of Transactions Captured
Under Article 6 of the Screening Regulation, Member States notify the Commission about transactions for assessment (Phase 1) and only a limited number of transactions proceed to Phase 2, a deeper investigation. Between the enactment of the Regulation on 11 October 2020 and 30 June 2021, 11 Member States submitted 265 FDI transactions for review. Austria, France, Germany, Italy, and Spain notified accounted for more than 90% of the total submissions. Of these 265, 80% were cleared in Phase 1. The majority of the notified transactions had a valuation of €10-100 million. These notified transactions varied greatly by origin and sector. The five primary countries of origin for the notified transactions were the US, the UK, China, Canada, and the United Arab Emirates. The primary sectors under review in Phase 2 were manufacturing, information and communications technology, and financial service activities.2 The sectors with the greatest volume of transactions overall, however, were manufacturing, information and communications technology, and wholesale and retail.
Room for Improvements
The EC concludes the cooperation mechanism is functioning well, citing that, of the 265 notifications received, the vast majority were quickly closed, with only 14% of the cases proceeding to Phase 2, and a much lower number of cases resulting in a Commission opinion. More generally, and as confirmed by Member States, the Regulation and the cooperation mechanism have already proven a valuable and efficient tool. They have been reliable, with no reported leaks regarding notifications, opinions or other action under the Regulation that is vital to ensure the necessary trust and confidence between all parties involved.
Though the Annual Report identified several procedural issues Member States face, the issue of timelines is at the forefront. Some Member States argue that the procedural timeline is too short to allow for the nuanced and complex review required to effectively screen foreign transactions. Additionally, discrepancies between different Member States'timelines is said to lead to logistical issues between conflicting FDI mechanisms. Member States have found that the volume of the requests for further comments is unmanageable. The EC acknowledges that resource constraints are a pressing issue in improving the efficacy of the FDI regime and has begun to implement technical facilitation measures (e.g. electronic systems and streamlining guidelines to determine which transactions require FDI screening to preserve resources). However, Member States may define security threats differently, which makes it difficult to develop standardised filtering criteria that may be applied across the EU. Regarding timelines, the Annual Report notes that a standard iced timeline would have unforeseen consequences because of the differences that exist between the regimes and would potentially require a change to the Screening Regulation itself. In the case of multi-jurisdiction FDI transactions, there is an increased likelihood of multiple screenings amongst different member states; therefore, the EC notes that efforts for synchronisation warrant careful consideration in the future.
The EC also intend to seriously consider issuing guidelines (as it has done in other practice areas, such as merger control), in particular regarding which types of transactions warrant notification under the Screening Regulation at all, or at least in-depth scrutiny, for the benefit of Member State screening authorities and investors. The Commission would envisage consultation of the broader public with respect to any such proposed guidelines.
The EC also anticipates an increase in notifications under the Screening Regulation as a result of the new FDI regimes to be adopted. The Annual Report stresses the importance of ensuring that multi-jurisdiction FDI transactions are best handled, including possible alignment of notifications by two or more Member States.
The Annual Report already suggests potential future amendments to the Screening Regulation itself. Article 15 provides an obligation for the Commission to "evaluate the functioning and effectiveness of this Regulation and present a report to the European Parliament and to the Council" by 12 October 2023, and for the Commission to recommend amendments to this Regulation, where required. While not being specific, the EC suggests that potential future amendments to the Screening Regulation should be considered to improve the cooperation mechanism.
Practical Considerations from the Foreign Investors Perspective
While the Screening Regulation is by and large an instrument of "soft law," it does add substantial complexity and uncertainty to security reviews performed at the Member State level.
The Screening Regulation established an automatic information exchange system between all Member States on every notified transaction. From a practical point of view, foreign investors are required to fill out additional EU notification forms. They should make sure that a comprehensive multijurisdictional FDI assessment is carried out in transactions involving potentially strategic sectors and a variety of jurisdictions where the target business operates. An FDI filing in one Member State may potentially trigger one or several precautionary filings in other EU Member States that will automatically be aware of the transaction at stake based on the EU notification system. The Annual Report acknowledges that the Screening Regulation is also a source of additional administrative burden for national authorities, that are already struggling with an increasing number of notifications as a result of their broad legislative expansion of the sectors subject to FDI review, and the EU cooperation mechanism further increases the number of transactions to look at, which exacerbates the situation for the screening authorities. This impacts the timelines of review, and in turn the ability of the parties to get an early steer.
Foreign investors should anticipate a proper strategy to deal with multiple parallel EU notification processes in several Member States and to ensure a consistent approach.
Therefore, it seems indeed advisable for the EC and the Member States to explore narrowing down the notification requirements under the Screening Regulation to the most sensitive investments. In the same vein, Member States should consider narrowing down the list of sensitive areas subject to national FDI review that has been rapidly and drastically expanded over the last two years. Eventually, providing more guidance and visibility to foreign investors on the substantive review/past precedent and the procedural features of the FDI review process would be key, because the biggest practical issue for investors is the lacking transparency of the review process and the lacking predictability of timelines and outcome (especially compared to merger control reviews). Publishing guidelines, as it is currently contemplated in France, is a step in the right direction.
Brittany Henderson (Law Clerk, White & Case LLP, Washington, DC) co-authored this publication
1 Remarkably, Luxembourg ist the only EU Member State without a merger control regime, but is has announced that it will introduce an FDI screening regime.
2 Manufacturing (50%); Information and Communications Technology (17%); Financial (8%); Other (25%).
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