Attractiveness to foreign investment is a key principle for the EU, as well as a major source of economic growth. However, concerns about foreign investors, notably state-owned enterprises from third countries (which could pose a threat to national security), strategically taking over EU companies which own or use key technologies has resulted in a more critical stance towards foreign investment and closer scrutiny. This reasoning led to the Commission’s proposal[1] for and adoption of the EU FDI screening Regulation 2019/452[2] (the “FDI Regulation”) on 19 March 2019.
Scope
The FDI Regulation does not create a directly applicable EU-wide foreign direct investment screening regime (unlike the EU Merger Regulation). Rather, it creates a framework and establishes a mechanism to coordinate national FDI reviews and sets out minimum conditions for Member State’s FDI screening regimes (noting that FDI is a reserved matter for national authorities).[3] It provides, for instance, that foreign investors and the companies concerned shall have the possibility to seek recourse against screening decisions of national authorities. Similarly, the Commission may bring infringement actions against Member States whose screening mechanisms do not comply with the FDI Regulation. Other key aspects include a requirement for Member States to notify the Commission and other Member States about foreign direct investments that are under review.
Aside from an understanding of the FDI Regulation, investors may wish to familiarise themselves with the FDI regime of the country in which they wish to invest, as local national law determines the substantive rules, the exact screening mechanism, and which sectors and sensitive technologies will be covered.
This ambiguous distinction between the merely, high-level monitoring duties of the Commission and the actual executive powers of the Member States is based on the regulatory competence derived from EU law. Pursuant to Article 207 of the Treaty on the Functioning of the European Union (“TFEU”), the EU has the exclusive power to regulate foreign direct investment (through the means of a ‘Regulation’).[4] However, the rationale behind regulating foreign direct investment stems from protecting national security interests, which is not an EU competence and thus remains at the sole discretion of the Member States.[5]
Recently, the Advocate General (“AG”) to the Court of Justice of the European Union (“CJEU”) delivered its opinion on the scope of the FDI Regulation. The AG held that EU law does not, in principle, preclude national legislation, which allows for the screening of foreign direct investment of third country provenance even if implemented indirectly via an EU-based company.[6] Furthermore, the AG points out that national screening mechanisms are nevertheless subjected to respect the four fundamental EU freedoms – in particular, the free movement of capital, which also grants rights to third-country undertakings – and the principle of proportionality.
The development of national FDI screening mechanisms
Four years after the entry into force of the FDI regulation, most of the Member States have adopted or amended their FDI regimes or are in the process of doing so. Most recently, in the Netherlands, the Investment, Merger and Acquisition Safety Test Act (“Vifo Act”) is expected to enter into force before 1 July 2023. In Germany, the act amending the pre-existing German FDI law entered into force on 17 June 2020, followed by various further amendments and we comment on recent developments below. Finally, the United Kingdom adopted its National Security and Investment Act 2021, which came into force on January 4 2022; we also take a look at the evolution of the UK’s regime.
I. Foreign direct investment screening in the Netherlands – It is finally coming
Initiatives for sector-specific FDI laws (i.e., in telecoms, energy, and defence) in the Netherlands pre-date the FDI Regulation. However, following the entry into force of the FDI Regulation, the Dutch legislator proposed a general FDI Act, namely the ‘Investment, Merger and Acquisition Safety Test Act’ (Wet veiligheidstoets investeringen, fusies en overnames or “Vifo”). The Vifo introduces an ex-ante FDI screening in all other sectors that are deemed vital to Dutch society. Thus, the Vifo is complementary to other sectoral regulation. In the situation where an investment falls within the scope of both the Vifo Act and a sector-specific review mechanism, the Vifo expressly provides that it will not apply, and the sector regulations take precedence.[7]
Enforcement
The competent national authority responsible for enforcing the Vifo is the Ministry of Economic Affairs and Climate Policy (“Ministry”), whose enforcement powers are delegated to the Bureau for Investment Screening (Bureau Toetsing Investeringen or “BTI”).
Scope
The Vifo applies to all kinds of investments (e.g., direct investments, mergers, demergers, the creation of a full-functioning joint venture, and acquiring assets), which result in obtaining control or significant influence over an undertaking which:
- provides vital services;
- administers a business campus; or
- owns sensitive technology or extremely sensitive technology.
‘Services’ are considered vital when they are deemed crucial to the national interests of the Netherlands, such as services in relation to Schiphol Airport and the Port of Rotterdam. Furthermore, business campus administrators fall within the scope of the Vifo if they facilitate public-private partnership initiatives which procure, or develop, vital technologies or applications within the economic and strategic interest of the Netherlands. The term ‘sensitive technology’ covers products which are suitable for dual use (civil and military use) or have a military use and are on the EU Common Military List. Technologies within quantum mechanics, photonics, semi-conductors, and high assurance information also qualify as sensitive.
Finally, ‘control’ has the same meaning as in competition law (which is inter alia presumed when at least 50% of the voting rights are acquired). However, lower thresholds apply to undertakings which own extremely sensitive technology where reference is made to ‘significant influence’. Depending on the extremely sensitive technology in question, the acquisition of either 10%, 20%, or 25% of the voting rights may lead to significant influence.
Filing & Substantive test
Both the investor and the target are obliged to obtain the BTI’s approval. In principle, this notification is based on ‘self-notification’ but the BTI can also assess transactions on its own initiative and/or order both parties to notify the transaction concerned.
The Vifo notification process consists of two phases. For both phases, eight weeks is the normal decision period. These periods can be extended only once and for up to six months in total. Consequently, the extension period for one phase will be automatically withdrawn from the extension period of the other phase to make sure that the six months in total are not exceeded. In addition, this period can be extended by three months if the transaction concerned is subjected to screening advice from the Commission (together with views from other Member States), pursuant to Article 6(3) FDI regulation.
Therefore, the entire process, including Phase 2, can take, in principle, no longer than 13 months (given that the BTI does not suspend the period to request additional information, which “stops the clock”). This leads to the following structure:
- Phase 1
The BTI decides whether the notified transaction can proceed without any further investigation (a decision for no further review) or is subjected to a more in-depth investigation. Pursuant to the Dutch General Administrative Law Act (Algemene wet bestuursrecht), the BTI has 8 weeks to determine its decision. This period can be extended by six months. In case the transaction requires additional in-depth research, the BTI issues a Phase 2 decision; - Phase 2
The BTI must decide, following an in-depth investigation, whether the notified transaction can carry on or should be prohibited. Again, the BTI has eight weeks to decide, which can be extended by a period of six months, minus the extension period that was used in Phase 1.
From the moment the BTI is asked to approve the investment, a standstill obligation applies, i.e., the transaction cannot be closed. The BTI will assess whether the investment poses a threat to national security. Such a threat is deemed present when the investment:
- distorts critical processes;
- distorts the integrity and exclusivity of knowledge and information; or
- results in an undesirable dependency.
If the BTI considers such a threat present, it will explore the possibility of remedies before it forbids the investment altogether. However, these remedies can entail far-reaching obligations, such as installing a security commission or handing over specific knowledge, technology, source codes, and genetic codes to third parties, including a body of the state.
Entry into force
The Vifo enters into force upon enactment of subordinate legislation, which is the following: the ‘Investments, Mergers, and Acquisitions Decree’ (Besluit Veiligheidstoets voor investeringen, fusies en overnames) and the ‘Further Specifying Sensitive Technology Decree’ (Besluit toepassingsbereik sensitieve technologie). These Decrees are expected to be enacted before 1 July 2023. Finally, the Vifo will have retroactive effect, allowing the BTI to look back as far as 9 September 2020. However, given the principles of legal certainty and legality, it will be reluctant to do so, which has been informally communicated by BTI representatives.
Final comment
Companies active in vital industries which made substantial investments or received such investments after 9 September 2020 or are planning to do so are advised to investigate whether their investments are subject to the Vifo. Failure to comply with the Vifo may result in fines. Investments contrary to the Vifo can also be legally void (ultimum remedium) and could be subjected to far-reaching measures, such as an obligation to undo or prohibit the proposed transaction, as well as its voidability.
II. The strict German approach on foreign direct investment screening
Few regimes are as broad, strict and tested as the German FDI regime – it includes both a cross-sector review mechanism and narrower but more onerous sector review process (limited to military and defence activities or entities that hold government-classified IP or information). It dates back to 2009 and, today, may catch economic activities including in sectors as diverse as AI/machine learning, quantum computing and cloud computing, critical infrastructure & raw materials, (software for) automated and autonomous driving, robotics, unmanned aerial vehicles, essential medicines and biotech, (social) media, and gaming platforms, etc.
Cross-sector review
Most cases (262 of 306 total in 2022) fall within this so-called cross-sector review regime which scrutinises direct or indirect investments from as low as 10% of voting rights in Germany companies by a non-EU (EU including EFTA) buyer operating in one or more of the sectors listed in Sec. 55a Foreign Trade & Payments Ordinance (FTPO). Different from merger control, the German system operates no turnover or control test, meaning that pure financial investments including into SMEs can be caught even absent strategic veto rights for the buyer – it’s a ”national security” rather than a ”size of transaction” or ”control” test.
However, as in merger control, there is a suspension obligation i.e., the transaction must not be closed prior to FDI clearance. In practice, this means investors need to ensure that the SPA (or APA, as the case may be) includes FDI clearance as a closing condition. The competent authority to obtain clearance from is the Ministry for Economic Affairs and Climate Action (BMWK) and the standard waiting period (phase 1) is two months from filing. The transaction will be deemed cleared by law if the two-month waiting period has elapsed without the BMWK having opened a main (phase 2) investigation (or communicated phase 1 clearance), although this is rarely ever seen in practice.
If there is uncertainty about whether the target’s business is, or may be considered, security-relevant, we typically recommend obtaining a so-called certificate of non-objection (CNO) to obtain deal certainty. This is particularly relevant for future-oriented technologies, which may not (yet) be listed but may nevertheless (or all the more so) be deemed relevant by the government. The list in Sec. 55a FTPO is non-exhaustive, and the regime is highly political – meaning that the government can call-in a case even if they sit outside the sectors listed in Sec. 55a FTPO. The process for obtaining a CNO is very similar to that of a (formal) clearance application and the waiting period is also two months.
Sector-specific review
In addition, there is a sector-specific review scheme governing investments into domestic targets that are active in military and defence or hold government-classified IP or information. In 2022, only 44 of 306 cases in total (see above) were subject to sector-specific review. The entry threshold is 10% and waiting periods are equally two months for phase 1 and up to eight months in phase 2 (main investigation). The main difference to the cross-sector review is that the sector-specific review regime catches all foreign (i.e., non-German) investors including from within the EU (or EFTA).
Latest developments
2022 has seen the investor-relator criteria gaining greater attention. Not to say that Chinese investments carry a higher prohibition risk per se, but the risk of being called-in is greater. We have seen this happening lately, including in sectors as remote as waste recycling and for what appeared to be just an internal restructure at group level in China with no immediate impact on the German subsidiary. We expect this trend to carry on well into 2024 at least, given the ongoing geopolitical tension.
With 37 cases in 2022, China-outbound investments have maintained rank three in the statistics, right after the UK (40 cases) and the US (110 cases). Not surprisingly, information and communication technology cases are in the lead sector-wise (87 cases), followed by biotech (34 cases), mechanical engineering (29 cases) and energy (18 cases). Most cases (54%) were closed within 40 days from filing.
In the four-year period from 2018 to 2022 alone, the total number of German national cases has close to quadrupled (rising from 78 in 2018 to 306 cases in 2022) which alone demonstrates the ever-increasing importance of FDI compliance in M&A transactions. Investors want to avoid being called-in post-closing and, worst case, having to unwind the transaction. Close connections to the regulator are key, and so is maintaining consistency with the information provided to other governmental bodies including in e.g., merger control and working hand-in-hand with the deal team.
III. A look at the evolving UK National Security regime
Whilst the focus of this article has been on the EU regime, with insights from Germany as well as an introduction to the new Dutch regime, we now take a look back at the development of the UK’s National Security and Investment Act 2021 (“NSIA”) regime which has been operational since January 2022 (and also even been applied to transactions concluded prior to that).
Background
A quick recap: the NSIA regime introduced a mandatory notification and clearance requirement for certain transactions involving in one of 17 “sensitive” sectors and where the buyer proposes to acquire greater than 25% of the shares or voting rights in the target entity which has activities in the UK (there are other transactional thresholds not discussed here). Acquisitions of lower shareholdings, assets or IP as well as transactions in other sectors can also be captured by the regime, but are only subject to a voluntary notification requirement notwithstanding that they can be called in for review for up to 5 years from the date of the transaction. More detail on the nature of the regime and a procedural flow chart can be found here.
The NSIA regime is administered by the Investment Screening Unit (ISU) which was initially located in the Department for Business, Energy and Industrial Strategy (BEIS) – now the Department of Business and Trade (DBT), but the Government announced on 7 February that it would move to the Cabinet Office (moving it a little closer to Prime Minister which could result in greater oversight of transactions).
Whilst we are still waiting for the second NSIA annual report to be published later this year (which will provide a greater level of detail on the number of: notifications made, transactions called in for review, and details of acquisitions subject to final orders), there have been a number of final decisions that can be looked at to consider if any trends have been emerging as well as to identify any key takeaways.
Limited transparency to date and room for improvement
However, before looking at those decisions, one of the key frustrations with the NSIA regime has been the lack of or perhaps limited transparency available to both advisers and investors. It is also common for decisions to be made regarding “call in”, and remedies proposed with limited or even no engagement with the parties, which also makes it difficult to assess whether transactions may raise national security concerns. This is, in part, to be expected, given the regime is about national security. Notwithstanding this, more could be perhaps be done to improve this and we await the outcome of the ongoing BEIS (now DBT) inquiry which was launched on 1 February 2023 and is looking at this very issue – Inquiry into Government’s investment security watchdog opens – Committees – UK Parliament. The Government committee is looking at:
- How, and how effectively does the ISU communicate with the firms involved in transactions? How could this improve?
- What metrics and information should be used to assess the impact and effectiveness of the investment screening systems, and over what time frame?
- What can the UK learn from the way other countries report on the work of their investment screening systems?
Further, it is also worth noting that on 23 March 2023 a Memorandum of Understanding was also agreed between the Government and BEIS. This will enable the BEIS Committee to access the information it needs to scrutinise the work of the Investment Security Unit (ISU) and the UK’s new system of screening investments for security risks, providing independent oversight of the process, increased transparency, and accountability. It should be noted that only completed cases will be reviewed to minimise any risk of political influence. National Security and Investment Act: Scrutiny deal agreed between Committee and Government – Committees – UK Parliament
Lessons learnt
Now turning to the decisions to date. There have been 15 published final orders since the regime took effect with five prohibitions and 10 conditional clearances where remedies were imposed.
These cases have involved a number of the 17 sectors as follows:
- Communications Sector – 2
- Satellite Sector – 2
- Energy Sector – 3
- Advanced materials – 2
- Quantum technology – 1
- Suppliers to the emergency services – 1
- Military/Dual Use – 3
- Defence – 1
In terms of the final orders, it is clear that transactions involving links to China have been closely scrutinised, with four of the prohibition decisions involving links to China (Silight (Shanghai) Semiconductors/Hilight Research, Nexperia BV/Newport Wafer Fab, Super Orange HK Holding/Pulsic Ltd and Beijing Infinite Vision technology Company Ltd/University of Manchester), although it is worth noting that the acquisition of Flusso Limited by Shanghai Sierchi Enterprise Management Partnership was cleared without remedies following a call in. The other prohibition decision had ties to Russia (LIT FM Holdings UK/UPP). It is also notable that a number of these deals involved the semiconductor supply chain which falls within the advanced materials “sensitive sector” which is not entirely surprising given the global focus in this area. A further deal was abandoned following the imposition of remedies (Electricity North West Limited by Redrock Investment Limited).
It is also worth noting that the Beijing Infinite Vision technology Company Ltd/University of Manchester decision did not concern an acquisition of shares or voting rights but involved an IP licensing arrangement and was not even subject to a mandatory notification. It clearly shows that the Government will scrutinise acquisitions of assets and licensing arrangements carefully.
Notwithstanding this, transactions involving “friendly” countries have also been looked at, with remedies imposed in the Viasat Inc/Inmarsat Group Holding Ltd deal in the satellite sector, where controls were put in place to protect information from unauthorised access and ensure that strategic capabilities continue to be provided by Inmarsat and Viasat to the UK Government.
The extent of political involvement in decisions is also a little opaque; the prohibition in the Nexperia BV/Newport Wafer Fab case could be seen to have resulted from political pressure given the reversal of the original decision that there were insufficient grounds to launch a review. In relation to the timing of this deal, it is worth noting that the trigger event took place prior to the entry into force of the NSIA regime in January 2022. Further, with the move of the ISU to sit within the Cabinet Office, going forward we can perhaps expect closer oversight too.
On the remedies side, whilst five cases resulted in prohibitions, the other 10 final order involved a range of remedies, including:
- Information barriers
- Imposing limits on non-UK control (board composition/oversight);
- Requirement to maintain UK capabilities;
- Information security measures; and
- Requirements for Government approved operators.
Finally on the process side, our experience is that it has been fairly straightforward in the vast majority of cases, with the ISU typically confirming an application is complete within a few days and reaching its decision on whether to “call in” a transaction for detailed review within 25 or so working days instead of the full statutory 30 working days. This may change depending on the number of deals subject to review. If a deal is “called in” for review, there is then a further 30 working day period which can also be extended by a further 45 working days, so parties need to allow sufficient time to obtain clearance in deals that may raise national security concerns (total review time is up to 105 working days). An update on the process side will likely be provided in the second NSIA annual report expected soon.
Overall, the development of the NSIA regime in the UK has been relatively smooth; the vast majority of transactions have not been called in for review and, of those that have been called in. only 15 have been the subject of final orders. The notification process has been straightforward but there could be scope for greater dialogue and transparency with the ISU. Over time we will also see more decisions which can help to inform advisers and investors on the factors that that may raise national security concerns as well as the type of remedies that may be imposed.
As we get ready for the introduction of the new Dutch FDI regime in the Summer of 2023, we can perhaps see by reference to the German and UK regimes that Chinese investments are likely to be closely scrutinised. Notwithstanding this, investments across multiple sectors will be reviewed and investors will certainly need to carefully consider FDI screening requirements in the EU and the UK as part of any transactional due diligence.
For more information, please contact Janneke Kohlen, Stephan Waldheim and Anthony Rosen.
VISIT OUR COMPETITION & EU HOMEPAGE
For further information, please contact:
Dr. Stephan Waldheim, Partner, Bird & Bird
stephan.waldheim@twobirds.com
[1] Proposal for a Regulation of the European Parliament and of the Council establishing a framework for screening of foreign direct investments into the European Union (COM/2017/0487 final – 2017/0224).
[2]Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March 2019 establishing a framework for the screening of foreign direct investments into the Union.
[3] Commission, List of screening mechanism notified by Member States.
[4] A Regulation within the meaning of Article 288 TFEU.
[5] Article 4(2) of the Treaty on the European Union (“TEU”).
[6] Opinion AG T. Ćapeta 30 March 2023, C-106/22, ECLI:EU:C:2023:267 (Xella).
[7] Article 5(1)(b) Vifo.
