Impact of the Foreign Subsidies Regulation on Private Equity firms and other institutional investors

Evaluation of the consultation on the Implementing Regulation


Notifications of M&A transactions that are signed on or after 12 July 2023 and have not been closed by 12 October 2023 will have to be filed with the European Commission (“Commission”) if they exceed the thresholds under the new EU Foreign Subsidies Regulation (“FSR”) (see our article here).

In order to clarify the formal requirements for such notifications for the companies concerned, the Commission published a draft Implementing Regulation (“IR”) in February 2023 which sought to resolve procedural issues (see our article here). As part of a consultation process, stakeholders and other interested parties were given the opportunity to submit comments on this draft IR to the Commission by 6 March 2023. The Commission received 74 responses to this consultation, in particular from businesses (32) and business organisations (29).

In the following, we address some of the criticisms and proposals for change made by private equity firms and other institutional investors such as sovereign pension funds. Overall, their submissions make it clear that the FSR will have a significant administrative impact, especially for these investors.

I. Criticism and proposals for change from institutional investors

1. Term “financial contribution” defined too broadly

Institutional investors invariably criticised the fact that the term “financial contribution” under the FSR is unclear and defined too broadly. All of the other participants in the consultation shared this criticism.

The broad definition of the term “financial contribution” is problematic because the term is pivotal for the obligation to report an M&A transaction.

Whereas under EU State aid law, only “aid” must be reported to the Commission, under the FSR “financial contributions” are sufficient to trigger the obligation. The main difference lies in the fact that “aid” is only available if a financial contribution also confers a selective advantage on the undertakings concerned. The FSR however takes this into account only during the substantive examination, i.e. after notification.

The broad definition of “financial contribution” is particularly evident in the following examples: on the one hand, any tax advantage granted by a third country can be understood as a “financial contribution”. On the other, the mere purchase of goods and services from or their sale to a third country can also provide companies with a “financial contribution”, even if this occurs on regular market terms.

This means that companies will face the challenge of having to effectively monitor and record any economic interaction with a third country (and affiliated entities, see point 4. below). In principle, this would also include investments and contributions to funds of limited partners, which (like pension funds) could be regarded as state actors. This is because a company can only check whether it has an obligation to report an M&A transaction if it knows which “financial contribution” came from a third country.

For this reason, the solution uniformly proposed by institutional investors is to limit the definition of “financial contributions” under the FSR to those that also constitute a selective advantage for certain companies and to significantly increase the de minimis threshold for financial contributions.

The EU legislature intentionally defined the term “financial contributions” broadly so that it would be possible to carry out extensive reviews of any third countries’ influence  on the EU internal market. Restricting the scope of the term would risk allowing the opportunity to review financial contributions to be circumvented. The Commission therefore has to balance the legislative interest in investigating financial contributions with the practical needs of companies.

One possible option for the Commission would be to establish exemptions for “financial contributions” that would otherwise have to be taken into account. For example, it could exempt interactions with third countries resulting from competitive tender procedures from the definition. This means that arm’s length transactions with third countries could be disregarded.

2. Understanding of the term “notifying party” too broad

Institutional investors also criticised the Commission’s broad understanding of who should be regarded as a notifying party. This is related to the question of who the recipient of a financial contribution is and therefore what information the parties have to disclose when making their notification.

At present, the entire group of companies (“economic unit”) is considered the notifying party and, simultaneously, the recipient of the contributions. Put simply, all companies that are jointly controlled count as one enterprise (one economic unit).

This understanding has particularly far-reaching consequences for institutional investors because different funds and the portfolio companies held by them are often controlled by a single investment firm (general partner). This makes it necessary for each fund and each portfolio company to treat financial contributions from other funds and portfolio companies controlled by the same  investment firm as its own. As a result, all the “financial contributions” of all of the funds and portfolio companies would always have to be regarded for the threshold calculation and listed with each application.

In order to limit their administrative burden, institutional investors are proposing that the term “notifying party” be restricted to the acting portfolio company itself or at least the relevant fund(s) making the investment.

This would lead to a different understanding of the term “notifying party” in the case of investments from institutional investors than in other cases. Commission representatives themselves have already shown a willingness to allow exceptions for institutional investors such as private equity firms and accept that the FSR’s administrative burden could otherwise prove a barrier to investment. It is thus to be expected that the Commission will take this criticism from institutional investors into account in the final version of the IR.

3. Dispensing with disclosure requirements in respect of M&A auctions

Another point of criticism raised by institutional investors is the obligation to disclose information about the auction process that led to the transaction to be notified. The Commission’s draft notification form for M&A transactions requires the acquirer to disclose details such as the number of participants in the auction process, the number of potential acquirers contacted by the seller and to give a detailed description of the other participants in the auction process.

The main problem for institutional investors is that the auction participants themselves usually do not have such information. This has led to suggestions that the information should have to be disclosed (if at all) by the seller.

However, the disclosure of such information could influence the results of (future) auctions. Sellers could be incentivised to exclude potential bidders who fall within the scope of the FSR from auctions in order to avoid the problem. This could lead to disadvantages for institutional investors. Furthermore, the disclosure of such information could also raise antitrust issues.

It is likely that these criticisms will prompt the Commission to review its notification form as it would not wish the FSR to hinder M&A auction procedures or create antitrust problems for itself.

4. Ambiguities in attribution to third countries

Finally, institutional investors complained of the effort involved in attributing a financial contribution to a third country due to the difficulty of identifying the payee behind an investor.

For this reason, some institutional investors have proposed including exceptions in the IR, for example, for contributions from (state) pension funds to the relevant third country and for interactions with investors based in jurisdictions with which the EU has concluded a free trade agreement (such as Canada).

The problem of exceptions for investments which can only be indirectly attributed to third countries poses a particular challenge for the Commission since it could lead to third countries structuring their affairs in a way that is designed to deliberately circumvent the FSR. On the other hand, it can be very time-consuming for institutional investors to have to identify  the state a contributionoriginates from. It remains to be seen whether the Commission will be able to solve this problem in the IR or whether a solution will only emerge through practice.

II. Outlook

The amendments proposed by institutional investors are aimed essentially at avoiding administrative burdens and thus potential delays in M&A transactions, and, of course, the risk of heavy fines for breaches. Unsurprisingly, these organisations are calling for clear and easy-to-manage requirements.

The Commission, however, must reconcile meeting the FSR’s objectives with ensuring that the EU internal market offers good investment conditions. As a result, it will not be able to accede to every request from institutional investors.

Nevertheless, the Commission has itself acknowledged that FSR notification requirements will create a considerable amount of extra work. The likelihood of this pushing the Commission’s personnel capacities to its limits cannot be ruled out.

It would be desirable if the Commission were to deal with the bulk of the criticisms in the final version of the IR, whose adoption is planned for Q2 2023. Due to the FSR’s far-reaching impact on the investment climate in the EU internal market, it would also be highly beneficial if it were to quickly clarify the approach it will take in practice. This would help realise the goal of a “level playing field” for all companies operating in the EU internal market.