EU Seeks New Powers to Address Effects of Foreign Subsidies

Background

On 17 June 2020, the European Commission (Commission) adopted a White Paper which contains far-reaching proposals for new enforcement powers against companies benefitting from subsidies granted by non-EU countries. While there are already well-developed systems of anti-trust/merger control, state aid, foreign investment control, and public procurement in the EU, the White Paper suggests that these tools are insufficient to address potential distortions of competition that are specifically caused by foreign subsidies. The White Paper therefore proposes new powers both at the Commission and Member State levels to tackle this perceived regulatory gap. At the same time, the Commission has launched a public consultation inviting comments from stakeholders that is due to run until 23 September 2020. Depending on the results of the consultation, legislative proposals may be put forward in 2021.

The White Paper comes against a backdrop of growing unease that the openness of the EU economy has left businesses in the bloc increasingly vulnerable to competition and potentially takeovers from state-owned and state-backed rivals. This led to Commission President Ursula von der Leyen tasking Vice-President Margrethe Vestager with developing tools and policies to “better tackle the distortive effects of foreign state ownership and subsidies in the internal market” as part of an EU industrial policy. Calls for an EU-wide industrial policy, which was officially unveiled in March 2020, can be traced back to the 2019 Franco-German Manifesto which highlighted the fact that EU businesses suffer from a competitive disadvantage relative to “heavily subsidised” foreign businesses.

Definition of foreign subsidy and de minimis threshold

The proposed definition of a foreign subsidy covers financial contributions by a government or any public body of a non-EU State, which confers a benefit to a recipient and which is limited, in law or in fact, to an individual business or industry or to a group of undertakings or industries. Any foreign subsidy will fall within the scope of any new legal instruments where it directly or indirectly causes distortions within the internal market. The definition covers all foreign subsidies including those granted to (i) undertakings established in the EU or third countries; (ii) undertakings established in a third country where the subsidy is used by a related party established in the EU; and (iii) undertakings established in a third country to facilitate an acquisition of an EU target or participate in public procurement procedures.

The types of financial contribution include but are not limited to the transfer of funds or liabilities; foregone or not collected public revenue (including preferential tax treatment or fiscal incentives); provision of goods or services; and the purchase of goods and services.¹

The White Paper proposes a de minimis threshold of EUR 200,000 granted to an undertaking over a three year period. Foreign subsidies falling beneath this amount will be presumed not to be distortive.

The proposed legal framework

In order to address the regulatory gaps, the White Paper proposes three legal instruments (Modules) to address the distortive effects of foreign subsidies including a general instrument to capture foreign subsidies (Module 1); an ex ante review of planned acquisitions of EU targets facilited by foreign subsidies (Module 2); a mandatory notification mechanism of foreign subsidies in EU public procurement procedures (Module 3).

Module 1: General instrument to capture foreign subsidies

This instrument is intended to capture foreign subsidies benefitting undertakings established or active in the EU where they give rise to actual or potential distortive effects in the internal market. It would have a broad scope covering all market situations including acquisitions and public procurement procedures.

From an enforcement standpoint, the White Paper draws a distinction between foreign subsidies that are most likely to create distortions and those requiring a more detailed assessment. Examples of the former include export financing (unless provided in line with the OECD Arrangement on officially supported export credits); subsidies to ailing undertakings; unlimited government debt or liability guarantees; operating subsidies in the form of tax reliefs; and subsidies directly facilitating an acquisition. For all other subsidies, a more detailed case-by-case assessment would be required. The factors which could be taken into account may include the relative size of the subsidy and beneficiary, market conditions and the conduct in question. In addition, the assessment could factor in whether the beneficiary has privileged access to its domestic market thus leading to an artificial competitive advantage. If a foreign subsidy is found to be capable of distorting the internal market, the White Paper proposes the application of an EU Interest Test whereby the distortive effects of the subsidy are weighed up against its positive impact on the EU or recognised public policy objectives. Such objectives may include job creation, environmental protection, digital transformation, security and public order.

Similar to EU anti-trust rules, the White Paper envisages a system of shared enforcement between the Commission and Member State supervisory authorities. It also suggests that EU-Member State cooperation and coordination could be modelled on existing mechanisms for anti-trust cases. National supervisory authorities would be empowered to enforce Module 1 within their respective Member States; whereas the Commission would be competent for any foreign subsidy benefitting an undertaking in the EU, irrespective of whether it concerns the territory of one or more Member State. There is however one notable exception to the competence of national supervisory authorities to enforce Module 1, namely the power to apply the EU Interest Test will rest exclusively with the Commission.

The White Paper proposes a two-step procedure consisting of a preliminary review and an in-depth investigation. Following an in-depth investigation, the competent supervisory authority may impose redressive measures or commitments to mitigate the distortive effects of foreign subsidies. In addition to redressive payments to the third country, a range of alternative structural and behavioural redressive measures are put forward where such payments are neither suitable nor feasible, e.g., divestments, blocking acquisitions.

Module 2: Foreign subsidies facilitating the acquisition of EU targets

Module 2 is narrower in scope and specifically addresses distortions caused by acquisitions of EU targets backed by foreign subsidies.

The White Paper foresees a mandatory and suspensory notification regime for potentially subsidised acquisitions, in addition to the power to initiate reviews where acquirers fail to notify acquisitions that qualify for review. It defines an acquisition as the direct or indirect acquisition of control as well as acquisitions of a specified percentage (to be defined) and material influence.² Potentially subsidised acquisitions would be reviewable where the financial contribution is made in the three calendar years preceding the notification, or up to one year following the closing of the acquisition.

Two jurisdictional thresholds are proposed: a quantitative threshold based on the turnover of the target business, e.g., EUR 100 million; and a qualitative threshold covering businesses that are likely to generate significant EU turnover in the future³ and/or a quantitative threshold set by reference to the value of the transaction. In addition, the White Paper suggests that reviewable transactions could be limited to those facilitated by a certain volume of financial contribution (e.g., the contributions received in the three years preceding acquisition exceed a certain amount/percentage of the acquisition price).

Foreign subsidies may facilitate acquisitions either directly where the subsidy is explicitly linked to the transaction; or indirectly by de facto increasing the financial strength of the buyer. Direct subsidies will be typically considered distortive. Case-by-case assessments will be required to determine whether an acquisition has been de facto facilitated by a third country. The non-exhaustive list of relevant indicators in the White Paper broadly mirror those put forward for Module 1 (e.g., size of the subsidy and beneficiary, market conditions etc.). The assessment may also take into account whether the beneficiary has privileged access to its domestic market. As with Module 1, if the potentially subsidised acquisition is found to be capable of distorting the internal market, the transaction will be subject to the EU Interest Test.

Unlike Module 1, the White Paper proposes that the Commission should be exclusively responsible for the application of Module 2 so as to enable businesses to benefit from a one-stop-shop as well as removing the need for multiple Member State regimes and complex referral systems.⁴ Module 2 envisages a two-step notification system, which would operate alongside merger control and FDI screening rules (if applicable). The first step would involve the submission of a short information notice, which would mark the start of a preliminary review, followed by an in-depth investigation. As outlined above, parties would be subject to a standstill obligation during the Commission’s review. Following an in-depth investigation, redressive measures or commitments could be imposed by the Commission if the foreign subsidy is found to be distortive. The redressive measures under Module 1 would in principle be equally available, albeit the focus of commitments is likely to be on divestment remedies.

Module 3: Public procurement

Module 3 is intended to address concerns that foreign subsidies may enable bidders to gain an unfair advantage in EU public procurement procedures by submitting bids that are less economically sustainable, e.g., bids significantly below market price or below cost.

The White Paper proposes a compulsory notification regime whereby bidders would be required to notify the contracting authority of any financial contributions received⁵ within the last three years preceding the procedure as well as any contributions expected to be received during the execution of the contract. Additional thresholds may be introduced in order to ensure that only potentially distortive subsidies are captured and that the administrative burden for public buyers and supervisory authorities is minimised. For instance, the application of the instrument could be limited to financial contributions and/or contracts that exceed a certain value.

Following the receipt of the notification, the contracting authority would transmit the information to the relevant supervisory authority (i.e., either the Commission or the national supervisory authority), which may initiate an investigation. The investigation would also consist of two steps with a preliminary review followed by an in-depth investigation, if it is found that a foreign subsidy may exist. During the investigation, the contracting authority would be barred from awarding the contract to the economic operator under investigation. In order to ensure that that there is minimal delay to public procurement procedures, strict time limits would be introduced, e.g., 15 working days for the preliminary review and three months for an in-depth review.⁶

If it is determined that a foreign subsidy exists following an in-depth investigation, the economic operator will be barred from participating in the public procurement procedure. It may also be excluded from future procedures, e.g., for a maximum of three years.

Access to EU Funding

Finally, the White Paper contains proposals to ensure economic operators compete for EU funding on an equal footing recognising that foreign subsidies may distort the process by putting recipients of subsidies in a better position to apply. The most developed policy option to prevent unfair advantages is where the funding is distributed through public tenders or grants. In such cases, a similar procedure would apply as that foreseen for EU public procurement procedures. The White Paper also underlines the importance of ensuring that international financial institutions that implement projects supported by the EU budget, e.g., European Investment Bank or European Bank of Restructuring and Development, are aligned with the Commission in their treatment of foreign subsidies.

Outlook and preliminary observations

If adopted, the proposals in the White Paper carry profound implications for the EU regulatory landscape and the business climate, despite the Commission stressing that openness to trade and investment remains a bedrock of the EU economy. This development needs to be viewed in the wider political context, notably the ever-increasing protectionist currents in the EU. Indeed, coupled with the recently enacted FDI Regulation, the number of Member States that have adopted FDI screening mechanisms continues to grow. However, FDI measures are largely focused on security or public order considerations, whereas the proposals in the White Paper are more far-reaching and support broader economic objectives, i.e., the implementation of the EU’s industrial policy.

The proposals are the subject of an ongoing consultation. At this stage, there are a number of issues and open questions which will need to be addressed including but not limited to the following:

• Administrative burden. The legal instruments are intended to work independently of merger control and FDI screening regimes which could place a significant burden on businesses. There may be different case teams or regulators involved in the application of different policy instruments. Efforts must therefore be made to ensure that the administrative burden is minimised, and that there is some degree of coordination of enforcement activities.
  
  
• Compliance burden. The White Paper underlines that the legal instruments will rely on some degree of self-assessment: identifying and managing this risk could prove challenging and burdensome, in particular if the legal test and threshold for intervention are not clearly defined (see below).
  
  
•  Overlap with other policy areas. The White Paper underlines enforcement gaps and the complementarity of the proposals with other EU policy instruments, but there are nonetheless a number of areas of potential overlap. For instance, it is suggested that where there is an overlap between the new instruments and a bilateral trade agreement, it may be more appropriate to address the distortive foreign subsidy under the dispute settlement or consultation provisions of the relevant trade agreement. It is though difficult to reconcile the Commission’s assurances that the new regime will be open, transparent and procedural rights will be respected, with the fact that dispute resolution mechanisms under bilateral trade agreements typically entail closed arbitration proceedings between contracting parties.
  
  
• Threshold for intervention. The concept of a distortion of trade will need to be clearly defined to provide some degree of legal certainty. The picture is further muddied by the wide margin of discretion that is afforded to the Commission (and national supervisory authorities), on the one hand, and the low de minimis threshold for ex post interventions under Module 1 (i.e., EUR 200,000 over a three-year period), on the other hand. This considerably widens the scope for intervention but leaves companies with little clarity as to the level of enforcement risk.
  
  
• EU Interest Test. This test will also need to be further developed and clearly defined. In this regard, the Commission could in theory draw on its experience enforcing EU state aid rules, which involve a similar balancing exercise. Moreover, the White Paper suggests that only the Commission will be competent to apply the EU Interest Test, thus raising questions over how it will be applied in practice where Module 1 is enforced by a national supervisory authority.

The wide scope of the instruments captures a broad range of market situations and covers any recipient of government funding from third countries. This undoubtedly adds a layer of complexity to the EU regulatory landscape making it tougher for foreign investors that wish to invest or operate in the bloc, not least if they also have to navigate parallel FDI and merger control reviews. There is also a risk of tit-for-tat measures by third countries which could result in EU businesses being subject to similar rules, especially in view of the significant funds that are being paid out to companies as pandemic relief. Indeed, China and Russia have cautioned against adding momentum to the ongoing protectionist spiral; and the proposals recently featured in high-level EU-China trade and economic talks.

Nevertheless, the proposals are in their infancy and the ongoing public consultation provides stakeholders with an opportunity to express their views and concerns.

1) Similar to the market economy investor principle and its derivatives under EU state aid rules, e.g., private creditor principle, the assessment of whether a financial contribution confers a benefit should take into account the usual practice in the private sector.

2) The White Paper recognises that the concept of material influence would need to properly defined, in order to avoid confusion about the need to notify. To that end, precautionary notifications are envisaged for firms wishing to have legal certainty. It is notable that the definition of an acquisition goes beyond the scope of EU merger control rules, which only cover acquisitions of control. 

3) Examples provided in the White Paper include businesses that possess critical assets or those that have high growth or technology prospects. 

4) Member States would however be kept informed during the Commission procedure and consulted on final decisions. In addition, national supervisory authorities would be able to initiate an ex post review of acquisitions under Module 1. 

5) The notification obligation extends to financial contributions received by members of a bidder’s consortium, sub-contractors and/or suppliers.

6) Where the investigation is conducted by a national supervisory authority, the Commission would exercise an oversight function. In particular, national supervisory authorities must communicate their draft decisions to the Commission. Where the Commission disagrees with the national supervisory authority’s conclusion that no foreign subsidy exists, the investigation may be extended.