The EU Foreign Subsidies Regulation (FSR) entered into force on 12 January 2023 and will start to apply from 12 July 2023. Any business wanting to do business in the EU after July could be affected and should prepare now to understand its impact, which could be significant.

The FSR aims to protect the EU's internal market from foreign subsidies which distort competition and create a level playing field. The European Commission (EC) is to be given extensive powers to intervene against such potential distortions in relation to any economic activity, and a new notification regime for certain M&A transactions and public tenders, which is independent from current EU/national merger control and foreign direct investment (FDI) notification requirements, is to be introduced. This will add significantly to the administrative burden faced by businesses, not only in relation to specific deals and tenders if notification is required, but also on an ongoing basis as maintaining data on subsidies/financial support received will be vital.

With less than five months to prepare for the FSR (and slightly longer for the new ex ante notification obligation, which starts to apply from 12 October 2023), the key implications, risks and steps that need to be taken by companies in order to hit the ground running are set out below.

Who is affected by the FSR?

The FSR will affect foreign companies operating in the EU, as well as EU-domiciled companies.

It applies to all companies (private or public), including state funds and state-owned enterprises (SOEs), that are engaging in an economic activity in the EU internal market and which have received any form of direct or indirect financial contribution from a non-EU country.

What is a foreign subsidy?

Foreign subsidy is defined very broadly in the FSR. It includes any form of direct or indirect financial contribution from a non-EU country (which includes contributions from governments, public bodies/entities and such contributions provided via a private entity). It may include, for example, direct grants, tax breaks, public support (e.g. support for COVID-19 or green initiatives), state loans or guarantees granted below market value, and government contracts.

As the definition of a foreign subsidy appears intended to be wider than state aid under EU law, a conservative approach to identifying subsidies will likely need to be taken, at least initially.

The FSR covers all foreign subsidies regardless of their size and whether they have an EU nexus.

The FSR applies only where there is a foreign subsidy that may have a distortive effect on the internal market. It provides the following examples:

What are the practical implications?

Ex ante mandatory filing regime

A filing to the EC will be required if the following thresholds are met by a transaction or tender bid:

Notification triggers a standstill obligation. This means that a notifiable M&A transaction cannot be implemented before the EC has concluded its investigation. Similarly, in public tenders, the public contract cannot be awarded to the notifying undertaking before the EC has concluded its investigation. However, the undertaking can submit its final tender during the investigation, provided that it submits an updated notification to the EC together with the final tender.

Companies should be aware that the EC also has powers to request parties to M&A transactions which are below the specified filing thresholds to notify their transactions prior to their implementation, if the EC considers these transactions to be supported by distortive foreign subsidies. The same applies to public tenders. It is not clear how actively the EC will seek to use this power. It clearly introduces significant uncertainty.

Ex officio investigations

The EC also has powers to investigate on its own initiative all potentially distortive foreign subsidies. This sweeping provision covers any economic activity where the EC suspects the existence of a distortive foreign subsidy. It includes, but is not limited to, M&A transactions and public tenders that have already been concluded.

The EC can investigate foreign subsidies up to 10 years after the date when they were given, including subsidies granted in the five years before the FSR starts to apply (i.e. 12 July 2023).

The EC, upon finding distortive foreign subsidies, can order the dissolution of an M&A transaction. It cannot cancel a public award, but could, for example, order the repayment of a foreign subsidy.

Procedure

The investigation by the EC follows a two-tier structure that is similar to the existing Phase I and Phase II merger investigation regime. Following an in-depth investigation, the EC can adopt: (i) a no objection decision; (ii) a commitments/redressive measure decision; or (iii) a decision prohibiting a concentration or the award of a public contract.

The EC published the draft implementing regulation (including procedural guidance) on 6 February for public consultation. Any interested parties are actively encouraged to participate and express their views by 6 March.

Be aware of the risks!

• Fines: A failure to notify a notifiable M&A transaction or public tender can result in fines of up to 10% of aggregate worldwide turnover of the parties concerned.
• Timing of transactions: Although the EC's time limits for reviewing a notification are similar to those under the EU merger regime, it is not guaranteed that the review periods will run concurrently. Further complications in relation to deal planning will arise when the merger and FDI notifications are reviewed by various EU national authorities, while the FSR notification is reviewed separately by the EC.
• Potential remedies imposed by the EC: The redressive measures include, for example, the unwinding of a transaction/prohibiting the award of a public contract, reducing capacity/market presence, publishing R&D results, repaying foreign subsidies with interest and/or adapting the governance structure. These may significantly undermine the commercial rationale of a transaction or tender bid.
• Extensive enforcement powers: The EC has powers to carry out dawn raids in relation to its investigations. It can even do so outside the EU with the approval of the relevant third country. It is not yet clear how often the EC will rely on its extraterritorial investigation powers and the enforceability will be dependent on the law of the respective third country.
• State funds and SOEs: There is uncertainty surrounding what the FSR means for state/sovereign wealth funds and SOEs. As these may be recipients of extensive foreign subsidies, many (if not all) of their transactions could potentially be caught by the mandatory notification regime.

How to mitigate risks?

Businesses need to be alert to the extensive administrative burden that will be imposed by the FSR.

Now is the time to start implementing data collection systems for group-wide information on any foreign subsidies received. For any notifiable transaction or public tender, information on foreign subsidies from the past three calendar years is required. The EC can launch an ex officio investigation into any foreign subsidy granted in the past 10 years before the start of the investigation (but cannot look back further than five years before the application of the FSR).

Therefore, detailed records of any foreign subsidies received in the five years prior to 12 July 2023 should be maintained. Going forward, data should be updated on an ongoing basis and retained for 10 years. Having a data system in place prior to the application of the FSR will avoid any delays caused by an extensive information-gathering exercise.

Finally, once the notification obligation starts to apply from 12 October 2023, companies need to factor in FSR assessment in relation to all M&A and tenders. Due diligence will need to focus more rigorously on subsidies received. If relevant, the notification and investigation period under the FSR regime will need to be factored into the timetable for completion of the transaction/public tender process and transaction documents.

More generally, businesses will need to weigh up the risks of receiving significant subsidies in countries outside the EU against its ability to invest and compete within the EU.