CMS comments on proposal for EU foreign investment screening regulation

CMS is an integrated, multi-jurisdictional organisation of law firms that offers full-service legal and tax advice. With 80+ offices in more than 40 countries and 5,800+ lawyers worldwide, we combine deep local market understanding with a global overview. Advising on more transactions in Europe than any other law firm, our FDI group has vast experience with the foreign investment screening mechanisms in the EU and worldwide.

We welcome the opportunity to provide feedback on the Commission’s proposal for a new regulation on screening of foreign investments in the Union (the “Proposal”). We recognise the political desire to further improve the effectiveness of the EU foreign investment screening framework for protecting security and public order from risky foreign investment in the EU. Accordingly, our comments will focus on those aspects of the Proposal which, in our experience as legal advisors in hundreds of transactions involving Union targets, threaten to place an additional and potentially disproportionate burden on economic operators.

We encourage the co-legislators:

• to carefully consider the interests of economic operators,
• to further harmonise national frameworks, including by clarifying the requirements of national screening regimes and reducing scope for divergent interpretations of the Proposal,
• to only introduce rules that further burden economic operators if they offer a clear, risk-based improvement to the effectiveness of the screening mechanism and
• to incorporate more specific rules protecting the legal rights of economic operators, including to transparency, and expand on their procedural rights and entitlement to judicial recourse. 

Extension of EU foreign investment screening framework to indirect foreign investments

The Proposal extends the scope of the EU foreign investment screening framework to indirect foreign investments, i.e. intra-EU investments, where investments in EU targets are made by EU entities which are directly or indirectly controlled by a foreign shareholder (Recital 10 and Articles 2(1) to 2(3) and 2(7) of the Proposal).

The Proposal does not only extend the scope to such indirect foreign investments where the foreign investor intends to circumvent foreign investment screening mechanisms in the EU (i.e. by creating an EU subsidiary as an investment vehicle in the EU which will then invest in the actual EU target or other artificial arrangements), but also to investments where the acquiring EU subsidiary is a full-function undertaking which intends to invest in another EU entity.

While we tend to believe that the latter cases are less likely to pose significant risks for security and public order, and that extending the scope of the EU foreign investment screening framework to bona-fide intra-EU investments might not strike the appropriate balance between security interests and the fundamental freedoms of the EU (establishment, capital), we recognise that this is ultimately a political question.

However, it appears that the current Proposal does not define key terms sufficiently clearly and does not address crucial jurisdictional concepts concerning such indirect foreign investments at all. In particular, the notion of “effective participation in the management or control of a Union target” (Article 2(1) of the Proposal), and the definition of “investment within the Union with foreign control” remain unclear, ultimately leaving the meaning of ‘indirect foreign investment’ open:

• The definition in Art. 2(1) clarifies that “investments within the EU with foreign control” are only within the scope of the Proposal if the investment “enables effective participation in the management or control of the Union target”. However, the Proposal does not provide any additional guidance, and case-law from the European Court of Justice (from which the notion of this Proposal appears to be derived) does not provide guidance which is conclusive enough to ensure uniform application of the notion within the EU foreign investment screening framework.
• The definition of “investment within the Union with foreign control” in Article 2(3) seems contradictory in itself. Article 2(3) is intended to define the concept of indirect foreign investments via EU subsidiaries, i.e. investments characterized by the lack of direct links between the foreign investor and the Union target. However, Article 2(3) defines such indirect investments as investments which aim at establishing “lasting and direct links between the foreign investor and a Union target […], and to which target the foreign investor makes capital available” [emphasis by us].

This leaves significant scope for divergent interpretations between Member States, which makes a uniform application of the proposed EU foreign investment screening framework by individual Member States unlikely. It also threatens to render obsolete the intended harmonisation of the approach across Member States to intra-EU investments, which is where consistency in approach arguably matters most.

The potential for differing interpretations by Member States also creates the risk of the new framework significantly increasing the overall number of screenings, which not only puts substantial additional burden on EU investors with foreign shareholders but also appears to run counter to the Proposal’s aim, which is to reduce the number of low-risk cases reported to the cooperation mechanism.

As a result, the new framework as proposed, or its implementation by Member States in practice, may also raise questions as to its legal basis and consistency with the provisions of the Treaty on the Functioning of the European Union (TFEU) on the freedom of establishment, as set out in Articles 49 to 55 TFEU, or with the provisions on the free movement of capital, as set out in Article 65 TFEU.

We recommend that the co-legislators carefully consider whether extending the scope of the EU foreign investment screening framework to bona-fide intra-EU investments by full function EU entities which are controlled by a foreign shareholder is indeed appropriate. In any event, we urge the co-legislators to unambiguously state under which circumstances indirect foreign investments are within the scope of the EU foreign investment screening framework, e.g. by providing specific voting rights thresholds. 

Obligation to introduce authorisation requirements in national screening mechanisms

The Proposal includes a new obligation for Member States to introduce authorisation requirements for foreign investments, if the Union target is active in areas of the economy listed in Annex II (Article 4(4)).

While we recognise that authorisation requirements are a means to render the EU foreign investment screening framework more effective, we submit that authorisation requirements should be limited to cases which are sufficiently likely to have a negative effect on security or public order. We further note that economic operators should be able to swiftly and clearly identify potential authorisation requirements in the individual Member States – which is not the case under the current EU foreign investment screening framework, where the significant differences in scope and approach between screening mechanisms in individual Member States create legal uncertainty and substantial compliance costs for businesses.

We therefore welcome the Proposal in that it aims at harmonising the national screening mechanisms by introducing a common “minimum standard” and focussing authorisation requirements on Union targets which are active in areas listed in an Annex to the Screening Regulation.

However, we submit that under the current Proposal the scope of Union targets which would be subject to an authorisation requirement is excessively wide and would in practice include almost any legal entity in the EU:

• Annex II of the Proposal appears to be overly generic when it includes items such as “processors” or “batteries”. We submit that Annex II does not yet provide the desired level of clarity and specificity. In its current draft it could even force Member States whose rules are currently formulated more clearly to make their rules more vague in order to comply with the Proposal’s standards.
• The definition of “active in an area listed in Annex II” in Article 2(9) of the Proposal appears to be too wide, as it would capture cases where companies merely own, use or supply items listed in Annex II.

By combining an overly generic list in Annex II, which includes for example “processors”, “photovoltaics” or “batteries”, with the extremely broad definition of “active in” in Article 2(9) of the Proposal (according to which merely using or owning items listed in Annex II qualifies as being “active in”), any entity in the EU which owns or uses processors, photovoltaics or even batteries would qualify as a Union target which is “active in one of the areas listed in Annex II” and therefore fall within the scope of Article 4(4). In fact, given that under the definition in Article 2(9) of the Proposal “active in” includes “intending to be active in”, even an EU entity only intending to purchase a battery falls within the scope of Article 4(4) of the Proposal.

The above examples demonstrate that a list such as Annex II which identifies sensitive areas, items, technologies or services:

• should be limited to those areas, items, technologies, and services which are indeed of particular importance for the security or public order interests of the Union, and should define these on the basis of a risk-based approach as precisely as possible, and
• should additionally specify, for each area, item, technology, and service separately, the exact economic activity which is considered sensitive. For most of the items, technologies and services listed in the current Annex II, mere ownership, supply or use of such items typically would not be relevant to security and public order interests of the Union, and the sensitive activity could be limited to development and production.. In contrast, when considering items on the Common Military List of the European Union (Annex II 2. of the Proposal), not only their development, production or supply but also the mere ownership of these items could be relevant.

In the context of this review of the EU foreign investment screening framework, achieving a mutually agreed list of sensitive areas, items, technologies and services which is sufficiently specific would be a major breakthrough, and would assist economic operators enormously in their handling of EU foreign investment screening. We therefore call upon the co-legislators to prioritise agreeing such a list. 

Obligation to report foreign investments into the cooperation mechanism

The Proposal introduces an obligation for Member States to report certain foreign investments into the cooperation mechanism (Article 5).

We recognise that introducing criteria which help identify the cases to be reported into the cooperation mechanism should ensure that the most relevant cases are reported. However, the current Proposal in our view runs the risk of not contributing to this goal and might even lead to the mechanism being overloaded with irrelevant cases.

While in principle Union targets which are part of or participate in projects or programmes of Union interest should be of higher-than-average relevance to the security and public order interests of the Union, this may not be the case in practice if no de-minimis or materiality threshold applies. In particular, where the amount of funding received is only marginal, security interests or public security are unlikely to be affected. We therefore recommend introducing a materiality threshold to Article 5(1)(b)(i) or Article 4(4)(a) of the Proposal, which could filter likely irrelevant de minimis cases. This would help both screening authorities and economic operators.

We further submit that requiring Member States to report into the cooperation mechanism all cases where the investor (or any of its subsidiaries) was involved in a screening and where the investment was not authorised or only authorised with conditions (Article 5(1)(b)(iii) of the Proposal) is also likely to direct unwanted cases into the system. In particular, in our experience from past cases, it is very often the Union target’s business which determines whether mitigation measures are required whereas the identity of the foreign investor is rarely decisive in cases where the Union target’s business is relevant to the interests of national security and public order. We accordingly suggest this filter be reconsidered. One option could be to require Member States to notify all investments relating to a Union target that was involved in a screening and where the investment was not authorised or only authorised subject to conditions. 

Obligation to introduce call-in right for 15 months post-closing / Right to open own initiative procedure

The Proposal introduces an obligation for Member States to empower their screening authority to initiate – at its own initiative – screening for at least 15 months post-closing for foreign investments which were not subject to an authorisation requirement under Article 4(4) of the Proposal (Article 4(2)(c)).

The Proposal further introduces a right for the Commission and for Member States to open own-initiative procedures in relation to foreign investments in other Member States which have not been notified to the cooperation mechanism (Article 9(1) and 9(3); see also comments below).

As a result, unless the Member State where the investment occurs has already terminated its own screening, the Commission and other Member States can – via the cooperation mechanism – ask the Member State where the investment occurs to screen the foreign investment post-closing, and the respective Member State is then empowered to initiate a screening for at least 15 months post-closing.

We submit that an obligation on all Member States to introduce such post-closing screening powers would have very serious consequences for the transaction security of foreign investments. The negative impact on all economic operators concerned (investors and sellers) would, if implemented as proposed, in our view be disproportionate.

We acknowledge that several Member States already provide for post-closing call-in powers, sometimes for periods substantially exceeding 15 months. However, these Member States recognise that parties have a legitimate interest in obtaining legal certainty before the call-in deadline expires. They allow investors to actively trigger screening e.g. by means of voluntary applications, thereby enabling them to obtain legal certainty within the timeframe of regular screening.

Should the co-legislators pursue the idea of obliging Member States to introduce post-closing call-in rights, we consider it imperative that the EU foreign investment screening framework allow the foreign investor to obtain legal certainty prior to the 15-month period. This is necessary to (1) ensure both protection of the rights of the economic operators concerned and (2) mitigate the negative effects caused by such a post-closing call-in right. This would require the EU foreign investment screening framework to entitle the foreign investor to:

• actively trigger screening for the investment in the Member State where the investment occurs and
• request the respective Member State to notify the Commission and the Member States through the cooperation mechanism.

As a result, however, the cooperation mechanism could be flooded with non-problematic cases. In our experience, investors and in particular financial investors tend to be risk-averse and, in the face of regulatory uncertainty, will prioritise transaction security. We would expect investors to trigger screening and request notification through the cooperation mechanism as a matter of precaution, even if the investment were not subject to a strict authorisation requirement and therefore, prima facie, is less likely to have any negative impact on security or public order interests of the Union. 

Right to open own initiative procedure

As mentioned, the Proposal introduces a right for the Commission and for Member States to open own initiative procedures in relation to foreign investments in other Member States which have not been notified to the cooperation mechanism (Article 9(1) and 9(3);

It is not entirely clear what consequences an own initiative procedure in the meaning of Article 9 of the Proposal could potentially have. We understand that those Member States where the investment occurs cannot be required, as a result of own initiative procedures of the Commission or other Member States, to re-open screenings which they have already terminated, but we recommend that the co-legislators clarify this point.

The own initiative procedure as provided for in Article 9 of the Proposal also widens the material scope of the Proposal substantially. In case of a suspected or alleged threat to security and public order, the Member States and the Commission will have a basis to intervene whenever a transaction has not been notified to the cooperation mechanism, irrespective of whether there was an obligation on the transacting parties to do so. In this regard, the areas of the economy in which the Union target is active are also irrelevant. In view of this widening of the scope, ensuring foreign investors have rights to actively trigger screening and to have their investment notified through the cooperation mechanism in order to obtain legal certainty quickly (see above) becomes even more important. 

Greenfield investments

Under the current framework, Member States have taken divergent positions on greenfield investments. In some national screening mechanisms, greenfield investments are in scope, in others they are out of scope. The Proposal remains somewhat unclear with regard to how greenfield investments should be treated.

According to recital 17 of the Proposal, greenfield foreign investments occur where the foreign investor or a foreign investor’s subsidiary in the Union sets up new facilities or a new undertaking in the Union. The recital states that these investments should fall within the scope of the Proposal to the extent they are considered relevant by a Member State, and the recital encourages Member States to include greenfield foreign investments in the scope of transactions covered by their screening mechanisms.

While the definition of “foreign investment” in Article 2(1) of the Proposal does not take any position on greenfield investments, the definitions of “foreign direct investment” in Article 2(2) and “investment within the Union with foreign control” in Article 2(3) refer to an “existing or to be established” Union target, which suggests that greenfield investments are in scope.

In contrast, according to the definition of Article 2(8) of the Proposal, “Union target” means “an undertaking established” under the laws of a Member State, which could be understood to exclude greenfield investments, as these undertakings still need to be established.

Finally, Article 4(4) of the Proposal reads that Member States shall ensure that their screening mechanisms impose an authorisation requirement for foreign investments where the Union target is established in their territory and already is part of projects or programmes or active in one of the areas in Annex II, which could be understood to exclude greenfield investments.

A possible interpretation is that greenfield investments are within the scope of the EU foreign investment screening framework and qualify as foreign investments under Article 2(1) to 2(3), but are not subject to an authorisation requirement under Article 4(4) of the Proposal.

We recommend that the co-legislators clarify this.