This April, the new EU foreign investment screening regulation entered into force, with terms scheduled to become applicable on October 11, 2020. The regulation was conceived and designed to provide member states with a valuable tool to employ in defending their strategic interests. We spoke to several experts in the region to learn more.
Context: Foreign Investment in the EU
The European Union is one of the most open investment regimes in the world, with around EUR 6.295 billion in foreign direct investment stocks in the EU held by third-country investors in 2017, directly correlating to about 16 million jobs, according to the European Commission.
Nonetheless, concerns about insufficient oversight of foreign investments remain, and EC President Jean-Claude Juncker has claimed that “we need scrutiny over purchases by foreign companies that target Europe’s strategic assets.” As a result, a new FDI Screening Mechanism was adopted, based on a proposal put forward by the European Commission in September 2017, and which the EC claimed “will be instrumental in safeguarding Europe’s security and public order in relation to foreign direct investments into the Union.” According to Juncker, the regulation – (EU) 2019/452 – means that, “when it comes to defending Europe’s interests we will always walk the talk.”
The regulation was created to establish a lowest-common-denominator type of groundwork; a starting position for all member states and potential investors. The regulation provides a stronger sense of predictability, establishes clear lines between what falls under the direct jurisdiction of EU bodies and what is left to member states, and creates a strong foundation for greater communication between all players involved. It also allows the European Commission to issue opinions on how member states should deal with investments they wish to screen.
What the regulation does not do, however, is harmonize the national screening regimes of the member states that have them. Foreign investors that seek to invest in companies that operate in multiple EU countries will still need to deal with an eclectic tapestry of different legal frameworks, some of which may be greatly divergent due to cultural and political differences between each member state.
What the New FDI Regulation Is
In essence, the FDI screening regulation is designed to enable Member States and the European Commission to exchange information and raise concerns related to specific foreign investments. It:
Creates a cooperation mechanism for the EC and the member states, allowing them to communicate information and raise red flags regarding specific investments
Allows the EC to issue non-binding opinions when it believes an investment poses a threat to the “security or public order” of more than one member state, or when an investment could undermine a project or a program of interest to the entire EU
Sets certain requirements for member states that elect to adopt or maintain a national-level screening mechanism – although member states retain the ultimate right for final approval or denial of each specific investment impacting their territories;
Takes into account the needs of a fast-paced business environment that often uses short deadlines and has strong confidentiality requirements
Encourages cooperation on an international level when it comes to investment screening, which includes sharing best practices and information on issues of common concern.
The regulation does not require that member states create a screening mechanism. However, should they choose to do so, it sets a baseline for what must be included. Specifically, the regulation asserts that takeovers in the areas of “critical infrastructure, raw materials, sensitive information, or important technology” are valid reasons for a member state to screen an investment. Currently, around half of all member states have a national screening mechanism in place (see table), with several either in the process of reforming them or adopting new ones. All member states with screening mechanisms in place are required to notify the EC of their existence.
In practice, any barriers, checks, or remedies imposed on a foreign direct investment will remain under the direct control of each member state’s screening regime. It will be the criteria of that state’s legal framework that will specify which transactions are impacted, including, for example, the relevant thresholds of control that would trigger governmental scrutiny.
Because the rate of informational exchange between the member states is likely to increase, it could lead to greater scrutiny of transactions on the grounds of public interest or national security, or, some claim, simply allow greater meddling into sectors that states consider to be of strategic importance to them.
At the same time the Regulation explicitly states that the “rules and procedures related to screening mechanisms … shall be transparent and not discriminate between third countries” and that “foreign investors and the undertakings concerned shall have the possibility to seek recourse against screening decisions of the national authorities.”
In addition to this, the regulation requires that member states inform the EC of any investments that are to be screened under their national mechanisms, as well as any other member states whose public order or security may be affected by the investment. The notification must include details about the business activities and the ownership structure of both the foreign investor and the target company, the funding, and the timing of the investment. Foreign investors and targets will be obliged to provide this information without delay, if requested.
Finally, the FDI regulation creates a feedback procedure that allows member states to comment if they feel that a foreign investment in another member state may create security or public order concerns in their own country.
What Is the European Commission’s Role in All of This?
The European Commission will also be empowered to review certain foreign investments – primarily those that the EC considers likely to affect endeavors of “Union interest” (defined as those that “enjoy a significant level of EU funding or are covered by European Union legislation and are related to critical infrastructure, technologies, or inputs essential for security or public order”), but only on grounds of public order or public security. It will not have any direct power to limit or block such transactions; the EC may only issue a non-binding opinion to the member state in which the foreign investment is either planned or has been completed. Member states, on the other hand, need only “take the utmost account” of this opinion, and if they don’t follow it, provide an explanation why.
The FDI screening regulation contains a list of the programs which qualify as of “Union interest,” including those involving “a substantial amount or a significant share of Union funding.”
What Does This Mean in Practice?
The definition of “foreign direct investment” under the FDI regulation is quite broad and covers any investment by a non-EU country. Essentially, this will impact all investors who seek to maintain or establish direct links with a prospective target in order to carry out an economic activity in a member state.
“The regulation is the EU’s lowest common denominator when it comes to investment control,” says Rastko Petakovic, Managing Partner of Karanovic & Partners in Serbia. “Rather than challenge investments from certain countries and in certain sectors, it sets out a platform for cooperation between the member states, and standardization by the Commission. It will make some foreign investments more visible, which will in turn lead to more scrutiny, if not from authorities then from the public. That in turn means its ultimate impact will depend on the economic outlook and public support more than the regulation’s mechanisms.”
This increased spotlight on such investments will ultimately make them more viable, says Janos Toth, who heads the Corporate/M&A practice of Wolf Theiss in Budapest, as it will “clarify the playing field” and incentivize capital flow both between member states themselves and between them and outside investors.
Ultimately, few believe it will cause any real problems. Cobalt Lithuania M&A Partner Juozas Rimas concedes that “the regulation may theoretically be used to limit outside investments,” but he says that additional safeguards to prevent this will eventually evolve and be put in place. Ultimately, he says, the regulation “may be a very useful tool to review investments of questionable nature – say, if a data privacy breach is a possibility.”
What About CEE?
CEE, of course, is made up of both EU and non-EU countries, making the regulation’s effects more complicated to parse. Still, many believe that the region’s history may work to its benefit. Toth explains that “CEE has, ever since the fall of Communism, been very open to investment,” and he believes that the regulation should “encourage more FDI, and have it go at a faster speed.” He also trusts that the regulation will prompt member states to both protect their national interests and to be more open to investments coming from outside of the EU, because “a roadmap exists now; there is more predictability.”
Petakovic suggests that it “will make the distinction within the CEE countries between the EU and non-EU members more obvious, and there will be a lag time before the non-EU countries implement adequate FDI control tools.” According to him, non-EU countries such as his own – Serbia – may thus benefit, at least in the short term. “This lag time, together with bilateral and multilateral treaties which some of these countries have, may direct some of the investments into the Western Balkan region. We are already seeing an increase in inbound investments from China, Russia, and Arab countries, and if anything, the regulation can affect it only positively.”
“In 2018, Serbia was the second largest recipient of foreign direct investment among the transitioning countries – including the former Soviet countries of Eastern Europe,” Petakovic continues. “EU companies invested almost 70% of the cumulative FDI inflows to Serbia over the past nine years – amounting to over EUR 13 billion in total. This makes the EU by far the largest investor in Serbia. Considering this, and the attractiveness of the CEE region in general, we could see an increase in FDIs in Serbia coming from both the East and the West.”
Toth believes that EU member state Hungary, too, is pre-positioned to benefit. “The Hungarian Government has pre-empted this wisely,” he says. “A national mechanism was put in place just before formal talks at the EU level ended in 2017 – this allowed Hungary to position itself in this area before other countries,” providing it, he says, with a more predictable framework, and thus a safer situation for investors.
Juozas Rimas, in Lithuania, is more blasé about the effects of the regulation on his part of the world. “Yes, it will lead to more information and best practice experience being exchanged,” he says, “but this is a very small market and it won’t be as exposed as other CEE countries like Poland or the Czech Republic.” Still, he concedes that the regulation may allow some countries to “defend against what they perceive to be a threat, such as aggressive Russian companies.”
Because Ukraine is not a member of the EU, the screening regulation does not apply to the country directly, although of course investments from Ukraine into the EU will fall within the scope of review that the regulation sets out. Mykola Stetsenko, Co-Managing Partner of Avellum in Ukraine, believes that the screening regulation “should not negatively affect these investments, because such investments, even though quite rare, are made by public companies that have been cleared by EU banks and stock exchanges in the past.” To the contrary, Stetsenko says; the country will actively benefit from the regulation: “When transparent national investment screening mechanisms are established in each EU member state, they will create more predictability for Ukrainian investors to the EU in such areas as agriculture and IT.”
While outgoing investment from Ukraine into the EU may not be significantly impacted, some countries may not be so lucky. Rastko Petakovic believes that “the new EU investment screening framework could particularly impact Chinese investors.” According to him, “the EU regulation encourages member states to specifically review state supported investments in sensitive technologies and critical infrastructure. This could include most Chinese M&A activities in Europe. It is estimated that approximately 82% of Chinese M&A transactions in Europe in 2018 would fall under at least one of those criteria.”
“More complex regulations for investments are probably only the first step in a broader overhaul of EU’s policy toward trade and investment with China,” continues Petakovic, who notes that “EU leaders are considering reforms in other sectors as well, including export controls for dual use and critical technologies, data security and privacy rules, procurement rules and competition policy.”
Ultimately, though, few believe that the regulation will have a significant affect one way or another. “It is not a discriminatory framework in and of itself,” says Juozas Rimas. “Even if discrimination arises in some cases it may be simply due to a lack of information about an investment or where there is a perceived security risk.”
Still, the FDI screening regulation does have some risks. For instance, the inevitable increase in informational exchange between member states regarding foreign investments means sensitive data is likely to pass through a greater number of hands, which may result in information leaks. In addition, there is at least the theoretical possibility that member states – benefitting from an increased certainty about where the boundaries between their internal screening mechanisms and the European Commission’s exclusive jurisdiction under the EU Merger Regulation are, may become more trigger-happy about initiating proceedings under their national screening mechanisms.
But, on balance, response is positive. “The general intention of the regulation is to create a seamless and predictable set of rules,” says Janos Toth, who believes that, as a result, any discrimination that occurs will not be “on the EU level” but only on a national one. And he’s not worried about that in his part of the world, at least. “The CEE region is not typically a discriminatory one.”
This Article was originally published in Issue 6.6 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.