Further tightening of FDI screening: New Draft Regulation (EU) on the screening of foreign direct investments

On 24 January 2024, the EU Commission published a Draft for a new Foreign Direct Investment ("FDI") screening regulation. The current EU FDI Screening Regulation (EU) 2019/452 entered into force in 2020 and was mainly aimed at establishing a cooperation mechanism between Member States screening an investment.

As a result, numerous EU Member States introduced national screening regimes or expanded existing regulations. In several stages, Germany has, among other things, extended the scope of the investment review and tightened up procedural regulations. In practice, the coordination of transactions involving different Member States was often complex and time-consuming. With the new Draft Regulation, the EU Commission desires to address existing challenges in FDI procedures. The EU Commission carried out a public consultation in summer 2023.

Meanwhile, the German government is continuing to revise the national FDI screening regulations. In late summer 2023, the Federal Ministry for Economic Affairs and Climate Protection ("BMWK") published key points on the planned amendment of investment screening law. The German government intends to implement a new investment screening act ("IPG") before the end of this legislative period and circulated a key issues paper on this in autumn last year. The expected draft bill is likely to take the new EU regulation into account. It remains to be seen whether the reform plans (EU and Germany) will be implemented in a timely manner, not least due to the upcoming EU parliament elections and the current multitude of federal political challenges. There may still be various adjustments in the legislative process.

The main changes to the EU Commission's Draft Regulation include a notification requirement for investments of foreign-controlled EU companies and so-called greenfield investments, the obligation of Member States to implement an FDI screening mechanism, an improved, EU-wide cooperation mechanism, which is only mandatory for critical transactions.
M&A practice will be confronted with a further expansion of the review regime. In particular, the limitation of the cooperation mechanism to critical transactions and its optimization as well as the planned standardization of FDI review procedures could lead to an increase in procedural efficiency and legal certainty for multinational transactions. In view of the planned extended coordination of transactions in several countries (mandatory reporting on one day in all EU countries), it will be all the more important in future to review every transaction at the earliest possible stage with regard to a national or EU-wide FDI reporting obligation.  

Below you will find a summary of the planned changes (Draft Regulation):

Recording of investments by foreign-controlled EU companies 

One of the proposed changes is the extension of the scope of the FDI Screening Regulation to investments by EU companies whose ultimate owners are non-EU investors. According to the Draft Regulation, takeovers by EU companies are to be screened, if the EU acquirer is controlled by a foreign investor. This is a significant change to the current regulation, which only applies to direct investments by foreign investors and not to indirect investments by subsidiaries of foreign investors based in the EU. This proposal is a reaction to the Xella judgement of the Court of Justice of the European Union (“CJEU”) from last year (ECJ, judgement of 13 July 2023 - Case C-106/22). According to this ruling, the FDI Screening Regulation does not apply in principle to investments made by EU companies that are ultimately owned or controlled by non-EU investors. This only applies to situations involving artificial agreements that do not reflect economic reality and are intended to circumvent the screening mechanisms. The CJEU had ruled that Hungary's decision to block a transaction under its foreign investment screening rules violates the freedom of establishment and that Member States cannot restrict investments by an EU company without sufficient justification.

According to the Draft Regulation, investments by an EU company must be reviewed if the acquiring EU based entity company is controlled by a non-EU investor and the decision-making power over the investment remains with the non-EU investor. Companies that do not have a third country participation or only a non-controlling participation by a foreign investor (portfolio investments) are not covered. In contrast, the legal situation and practice for cross-sector FDI screening in Germany is already stricter and also covers investments by EU-based companies in which non-EU investors hold 10% or more of the voting rights.  

Greenfield investments

Another important change proposed in the Draft Regulation is the inclusion of greenfield investments in the FDI screening mechanism. This would mean that the mere establishment of a new company wishing to operate in certain critical sectors would be covered by the screening mechanism and Member States would have to include new investments (greenfield investments) in their FDI screening systems. This extension of the scope of application is also already provided for in the BMWK's key points for an investment screening law.

Obligation of Member States to adopt an FDI screening mechanism

Participation in foreign direct investment screening in the EU was previously voluntary for Member States. The original regulation only required Member States to provide the EU Commission with details of their FDI regimes. The proposed regulation now stipulates that all Member States must have an FDI screening mechanism in place within 15 months of the regulation coming into force. Since 2021, the EU Commission has repeatedly called on Member States to establish and enforce fully-fledged FDI screening mechanisms. The vast majority (22 out of 27) of EU Member States now also have an FDI screening mechanism. 

Harmonization of FDI screening mechanisms 

The Draft Regulation introduces a number of minimum requirements that national FDI screening mechanisms must meet in order to harmonize the screening of foreign investments across the European Union. In procedural terms, this includes ensuring the screening of potentially critical transactions before they are finalized, the protection of confidential information and annual reporting on screening activities. The Draft Regulation also introduces an obligation for Member States to allow legal action against FDI screening decisions. 

The Draft Regulation also contains a list of sectors that need to be reviewed. These include "critical technologies", which include, for example, semiconductors, cloud computing and bio-technologies. With regard to the substantive assessment of the impact of an investment on public security and public order, the mandatory criteria include the impact of the investment on critical infrastructure, critical technologies, continuity of supply and the protection of sensitive information. However, Member States remain free to apply stricter measures on their territory. 

Targeted cooperation mechanisms

Under both the current regulation and the Draft Regulation, the Member States remain the final decision-makers in the review of Foreign Direct Investment. However, the Draft Regulation provides the EU Commission with some tools to incentivize Member States to act on FDI procedures. Until now, Member States have had to submit information on their current cases and obtain comments from other Member States and the EU Commission, which they must consider in their decisions (so-called cooperation mechanism). This mechanism is now defined in more detail in the Draft Regulation. In previous regulations, Member States were required to provide information on all cases that were subject to a "formal review". Some Member States reported every transaction, others only Phase II cases (including the BMWK in Germany). The Draft Regulation now makes a distinction: Phase I procedures only need to be notified if the target company participates in a project or program of Union interest or is active in an area where there is a licensing requirement and the investor is either controlled by a government of a state or is subject to sanctions. In addition, all Phase II procedures must be notified to the cooperation mechanism.

Following their decision within the framework of the cooperation mechanism, the Member States must in future justify why they have not followed the recommendations of the other Member States or the EU Commission. In addition, Member States and the EU Commission can now launch the cooperation mechanism on their own initiative - even in cases where the Member State in which the investment is made has not submitted to the cooperation mechanism. In principle, comments and recommendations on potentially problematic investments can also be submitted unsolicited and must be considered by the receiving Member States. 

Cross-border transactions 

In the past, there were often complications for purchasers who needed to have the transaction authorized in several Member States. Now the deadlines and procedures within the cooperation mechanism are being harmonized. Under the new Draft Regulation, Member States must endeavor to coordinate the procedure and decision-making in cases notified to several Member States. To facilitate this, the Draft Regulation stipulates, among other things, that applicants must submit all FDI notifications on the same day (and refer to each one individually). In addition, Member States should notify the requests to the cooperation mechanism at the same time. In order to ensure efficient processing of these cross-border transactions, the Member States concerned should also coordinate on the final decision, among other things. If the Member States concerned intend to authorize the foreign investment subject to conditions, they should ensure that these conditions are compatible with each other and take appropriate account of cross-border risks.

When can we expect the new regulations to come into force?

The Draft Regulation still has to go through the ordinary legislative procedure and be confirmed by both the European Parliament and the Council of the EU. Due to the upcoming elections to the European Parliament in June, the legislative process could be significantly delayed. As the rules will apply 15 months after the regulation comes into force, the new provisions on the screening of foreign investments cannot be expected before 2026. We will keep you informed of any important developments in this area.