1. Introduction

On 24 January 2024, the European Commission (“Commission) published a proposal to reform the current Regulation on Foreign Direct Investment Screening (Regulation 2019/452) (“FDI Screening Regulation). The proposed draft of the revised FDI Screening Regulation (“Draft FDI Regulation”) is part of five initiatives to strengthen “European economic security” and can be seen as a response to the Commission’s evaluation report on the functioning and effectiveness of the FDI Screening Regulation. To better identify and address security or public order risks related to foreign direct investments (“FDI”) that affect at least two EU member states (“Member States”) or the EU, the reform aims at ensuring that all Member States have appropriate screening mechanisms in place and at addressing existing shortcomings in the effectiveness and efficiency of the current cooperation mechanism.

If the Draft FDI Regulation enters into force, FDI proceedings in Europe should become more coordinated and efficient. However, the scope of the review could be broadened and the envisaged introduction of an EU-wide post-closing screening regime could cause more legal uncertainty.

2. Background

The current FDI Screening Regulation, which came into force in October 2020, created a cooperative framework for the screening of FDIs by the respective authorities of Member States with regard to the impact of such investments on security and public order. Since the initial discussions about the FDI Screening Regulation, several Member States have either strengthened their already existing national control systems or introduced control systems where non existed so far. According to the Commission’s Draft FDI Regulation, the number of Member States that have introduced screening mechanisms has risen by eight additional Member States up to 21 Member States since 2017. However, the Draft FDI Regulation also highlights that a significant share of FDIs in the EU goes to Member States which do not have a screening mechanism in place (22.7% of foreign acquisitions and 20% of greenfield projects), leaving vulnerabilities because potentially critical FDIs remain undetected. Although, accord-ing to the explanatory memorandum to the Draft FDI Regulation, the Commission and relevant Member State authorities have reviewed more than 1,100 transactions since the cooperation mechanism was introduced, the management of multi-jurisdictional notifications has been challenging and raised efficiency issues. Examples include insufficient cooperation between screening authorities and significant differences between screening mechanisms across the EU, particularly in terms of timing, coverage and notification procedures.

3. Key aspects of the Draft FDI Regulation

The proposed reform provides for a more harmonised and coherent application of the various FDI regimes in place in individual Member States. It aims to close gaps which might arise by screening FDIs only at the national level, as compared to screening at the EU level. Changes are envisaged in particular in procedural aspects and, to a lesser extent, in substantive aspects of FDI screening. Key aspects of the reform include:

• Obligation for all Member States to establish a screening mechanism

• Obligation to comply with certain minimum screening standards

• Obligation to review FDIs in certain sensitive sectors

• Obligation to apply a screening mechanism to indirect investments by foreign investors

• Obligation to introduce a post-closing screening mechanism

• Extension of reporting obligations, the right to comment and own-initiative procedures

• Introduction of basic guidelines for a harmonised audit standard

3.1 Obligation to establish a screening mechanism

The current FDI Screening Regulation does not require Member States to introduce or implement a screening mechanism, nor does it define a minimum scope for FDI screening regimes. Currently, it is the right of individual Member States to decide whether or not to screen an FDI in accordance with the requirements of the FDI Screening Regulation. The Draft FDI Regulation changes this by requiring Member States to establish a screening mechanism that meets its requirements (Art. 3 para. 1 of the Draft FDI Regulation). Member States will have 15 months after the entry into force of the Draft FDI Regulation to comply (Art. 3 para. 3 of the Draft FDI Regulation). This obligation is intended to address the increased security concerns of recent years and to close the protection gap for security and public order in the internal market, as a significant number of investments take place in Member States with no or only inadequate screening mechanisms.

3.2 Obligation to comply with certain minimum screening standards

In addition to the obligation to set up a screening mechanism, Art. 4 of the Draft FDI Regulation imposes minimum screening requirements. In procedural terms, a two-stage system is envisaged. As a first step, the screening authority has to check whether it has the jurisdiction to screen the FDI filed for authorisation and, if so, carry out an initial review (Phase I). Where necessary, and as a second step, the authority is then authorised to conduct an in-depth investigation to determine whether the FDI in question is likely to negatively affect security or public order (Phase II). The notification and review of the FDI must now be carried out in a uniform manner prior to execution. To that end, the Draft FDI Regulation provides for several mandatory procedural rules, including (i) the right to be heard before the screening authority takes any measures, (ii) the obligation of the authority to provide reasons for its decisions and to ensure confidentiality and (iii) the possibility to seek judicial recourse against any screening decisions.

3.3 Obligation to review FDIs in certain sensitive sectors

Art. 4, para. 4 of the Draft FDI Regulation specifies certain sensitive sectors in which FDIs must be examined by the national screening authorities. Member States may exceed the proposed minimum standards but must in any event require authorisation where the target company (i) is part of or participates in projects of Union interest (Annex I of the Draft FDI Regulation) or (ii) is active in one of the areas listed in Annex II of the Draft FDI Regulation. The list in Annex II is expansive and includes inter alia military and dual-use items, critical technology (e.g. certain semiconductor technologies; AI technologies; quantum technologies; biotechnologies; connectivity, navigation and digital technologies incl. the “Internet of Things” or “virtual reality”; sensing technologies; space & propulsion technologies; energy technologies; robotics and autonomous systems; advanced materials, manufacturing and recycling technologies), critical medicines and critical entities in the Union’s financial sector. Given the vagueness of many of the items contained in Annex II, it is hoped that this list will be further refined in the legislative process.

All Member States must introduce standstill obligations for the duration of FDI screening. This means that a transaction must not be closed without prior clearance of a mandatory FDI filing. Since not all Member States currently have such standstill obligations in place, national regimes will need to be adjusted accordingly. Transaction planning will need to take these standstill obligations into account.

3.4 Obligation to apply screening mechanism to indirect investments by foreign investors

The current FDI Screening Regulation only applies to direct investments by foreign investors and not to indirect investments by EU-based subsidiaries of foreign investors. This interpretation of the current legal situation was recently confirmed by the European Court of Justice in its “Xella”-ruling (European Court of Justice, 13 July 2023 - C-106/22 - Xella Hungary). The proposed Draft FDI Regulation now extends the scope of the FDI Screening Regulation to investments made by a European acquirer that is controlled by a non-EU investor. While this is an extension in scope of the European screening regime, the approach proposed in the Draft FDI Regulation is still not as far reaching as that of several Member States which have regimes in place that subject even EU companies with minority non-EU shareholders to FDI screening. It remains to be seen if Member States with stricter regimes implement the approach of the Draft FDI Regulation, which considers indirect control by a foreign investor as the relevant criterion.

Greenfield investments are now also covered by the Draft FDI Regulation. While the proposal refrains from establishing an obligation to review greenfield investments, the Commission recommends that Member States at least include them in the scope of application if they are made in sectors that are important for the security and public order of the Member State.

3.5 Obligation to introduce a post-closing screening mechanism

Member States will be required to introduce post-closing screening regulations for foreign investments that are not subject to any authorisation requirement where the screening authority has grounds to consider that the FDI may affect security or public order (Art. 4 para. 2 lit (c) of the Draft FDI Regulation). In this context, the screening authority will be authorised to open proceedings by its own initiative at least 15 months after completion of the transaction in question.

By requesting the introduction of a post-closing review mechanism for a minimum period of 15 months post closing, the Draft FDI Regulation substantially threatens deal certainty for parties to M&A transactions. If this provision comes into force, Member States should ensure that voluntary notifications of FDIs and voluntary initiations of screenings are permitted to enable investors to secure transaction certainty. In the current draft proposal, the provision on post-closing screening procedures would even allow opening review proceedings where a transaction has already been approved. This is probably not the intention, but should be clarified in a revised draft.

3.6 Extension of reporting obligations, right to comment and own-initiative procedures

The Draft FDI Regulation extends the reporting obligations of Member States to include notifications to other Member States and the Commission (Art. 5 of the Draft FDI Regulation).

Phase I procedures only have to be notified under certain conditions. A notification requirement for Phase I reviews arises if the target company is involved in a project or programme of Union interest (Annex I of the Draft FDI Regulation) or is active in an area in which there is an approval requirement (Annex II of the Draft FDI Regulation) and the investor (i) is controlled by a non-EU government, (ii) is subject to sanctions or (iii) was involved in a foreign investment that was previously screened by a Member State and not authorised or only authorised subject to conditions.

Phase II procedures must always be notified.

Where a transaction is subject to simultaneous screenings in more than one Member State (“multi-country transaction”), notifications to the relevant authorities shall occur on the same day. This requirement underscores the need for cooperation in the planning and timing of M&A transactions (for details on content and procedures in these cases, see Art. 6 of the Draft FDI Regulation).

Art. 7 of the Draft FDI Regulation continues to allow Member States to submit comments to another Member State on planned foreign investments in that other Member State. The Member State must also forward these comments to the Commission, which continues to have the right to issue opinions.

Art. 8 of the Draft FDI Regulation goes into more detail than the current FDI Screening Regulation in setting out the deadlines and procedures for providing comments and opinions on notified foreign investments and extends a number of existing deadlines.

Art. 9 of the Draft FDI Regulation allows a Member State to open its own procedure in relation to a foreign investment on its own initiative (so-called “own initiative procedure”) if it considers that such foreign investment in the territory of another Member State which has not been notified to the cooperation mechanism is likely to negatively affect its security or public order. The initiating Member State has 15 months to do so after the investment has been made.

3.7 Introduction of basic guidelines for a harmonised audit standard

While the Draft FDI Regulation addresses procedural aspects in detail, it provides only limited guidance on the substantive criteria for determining which investments should be prohibited or subject to restrictive measures. Hence, it only provides a minimum standard for a harmonised assessment.

Art. 13 of the Draft FDI Regulation lists various criteria for the assessment of a potential threat to security and public order. The assessment must take into account, in particular, the potential negative impact on (i) the security, integrity and functioning of critical infrastructure, (ii) the actual availability of critical technologies (as well as relevant enabling technologies), (iii) the steady supply of critical inputs for security or public order, (iv) the protection of sensitive data, or (v) freedom of expression or pluralism of opinion. When assessing a potential threat to security or public order, the circumstances or context of the FDI should also be taken into account. This includes, for example, whether the investor is directly or indirectly controlled by the government of a third country or is involved in the pursuit a third country’s policy objectives, or the development of a third country’s military capabilities.

4. Commentary and outlook

The introduction of an obligation for all Member States to establish screening procedures for foreign investments, including certain harmonised minimum standards, is certainly to be welcomed as a means to close existing protection gaps for security and public order at the EU level. In addition, the introduction of clearer, more detailed procedural rules and the higher degree of harmonisation throughout the EU (e.g. minimum standards with regard to deadlines and procedures) should increase the ability of M&A deal teams to plan ahead. In terms of material audit standards, however, many questions remain unanswered, such as the key concept of “control” and the specifics of the sector groups listed in Annex II. In this respect, it remains to be seen whether and to what extent the further legislative process, which requires the approval of the European Parliament and Council, will bring changes to the Draft FDI Regulation. The process should resume after the selection of committees in autumn 2024 following the election of the European Parliament in June 2024. As the new regulations must be implemented 15 months after they have come into force, the new provisions are unlikely to come into effect prior to 2026 or 2027.

In the meantime, businesses and advisors that are actively involved in M&A transactions are well advised to keep track of further developments, at both the European and national levels.