Counterbalancing distortions in the internal market

From 12 July 2023, the Regulation[1] on foreign subsidies distorting the internal market (Foreign Subsidies Regulation, hereinafter: „FSR”) has become applicable, as previously mentioned in our year opening article. The practical relevance of the FSR is that the European Commission may already start proceeding investigations into certain incoming subsidies from foreign countries. In the following article, our experts summarise the main factors for the application of FSR in practice.

The FSR aims to ensure the EU's internal market and a level playing field while preventing foreign subsidies from distorting the internal market. To this end, the European Commission is investigating subsidies granted by non-EU countries to companies operating in the internal market, which may have a distortive effect on the harmonised market. The FSR establishes a notification obligation for economic activities above a certain threshold, giving the European Commission the tools to investigate subsidies and correct any possible distortive effects.

It is important to note that any transaction can trigger the application of the FSR by the European Commission, although the notification obligation for companies described below will apply from 12 October 2023. Nevertheless, the European Commission may also open ex officio investigations into transactions signed on or after 12 July 2023, but not closed by 12 October 2023. This right of the Commission, however, not apply to transactions signed before 12 July 2023.

The scope of the FSR and thus the notification obligation covers all economic activities within the EU, in particular mergers and public procurement.

Therefore, the following must be notified to the European Commission:

• a merger if one of the merging undertakings is established in the EU, generates a total turnover in the EU of at least EUR 500 million and has received a total financial contribution of more than EUR 50 million from third countries in the three years preceding the transaction;
• a public procurement, if the estimated value of the agreement in question reaches EUR 250 million and the amount of financial contributions from third countries to an applicant in a public procurement procedure is at least EUR 4 million;
• in addition, the European Commission may open an ex officio investigation into alleged foreign subsidies distorting the internal market, which consists of two phases: first, a preliminary review and, second, in case of sufficient evidence, an in-depth investigation.

In the light of the above, the key affected parties include large private equity firms, which are frequently involved in M&A activity, and multinational companies active in major European public procurement tenders. The FSR pays special attention to strategic sectors such as energy, health, infrastructure and telecommunications. In these sectors, subsidies may have a particularly sensitive impact on competition and innovation.

Notifiable concentrations are subject to notification to the Commission prior to their implementation and following the conclusion of the agreement, the announcement of the public bid, or the acquisition of a controlling interest.

The economic activities subject to the notification obligation shall not be carried out or the notified transactions shall not be closed while the investigation is pending. The penalty payments for failure to notify may reach up to 10% of the total turnover of the undertaking in the preceding financial year.

It is qualified as a foreign subsidy, when a non-EU country provides directly or indirectly a financial contribution, which contribution provides benefit for the undertaking in the internal market and which is limited in law or in fact, to one or more undertakings or industries. A financial contribution shall be considered as a benefit providing contribution for the undertaking if it could not have been obtained under normal market conditions.

Within the framework of the FSR a financial contribution is the transfer of funds or liabilities. This can include capital injections, subsidies, loans, loan guarantees, budget incentives, financial compensation, debt relief, etc.

A distortion in the internal market exists, where a foreign subsidy is liable to improve the competitive position of an undertaking in the internal market and where, in doing so, that foreign subsidy actually or potentially negatively affects competition in the internal market. When the European Commission examines the extent of the distortion it takes into consideration among others: the amount of the foreign subsidy, the level and evolution of the undertaking, the purpose and conditions attached to the foreign subsidy as well as its use on the internal market. In public procurement procedures those foreign subsidies, which enables undertakings to submit their tender that is unduly advantageous in relation to the works, supplies or services concerned shall be understood as a risk causing a distortion.

The following categories of foreign subsidies are most likely to distort the internal market:

• a foreign subsidy granted to an ailing undertaking, which will likely go out of business in the short or medium term in the absence of any subsidy;
• a foreign subsidy in the form of an unlimited guarantee for the debts or liabilities of the undertaking;
• export financing measure;
• a foreign subsidy directly facilitating a concentration;
• a foreign subsidy enabling an undertaking to submit an unduly advantageous tender on the basis of which the undertaking could be awarded the relevant contract.

In order the properly investigate the potential distortive effect, the Commission has the following instruments:

• order interim measures;
• request information;
• conduct inspections within and outside the European Union;
• measures against non-cooperation and
• impose fines and periodic payments.

If the Commission concludes that the foreign subsidy distorts the internal market, it may impose redressive measures or – if it has accepted commitments offered by the undertaking under investigation - adopts a decision, in which it obliges the undertaking to fulfil the commitments offered by the undertaking under investigations.

One last and interesting fact is that on 29 December 2022 a similar regime was adopted in the United States regulating the transactions involving “foreign entities of concern”. The legislation from overseas requires lower threshold for the notification therefore, it will be worth observing which of the parallel developed systems will be more successful in monitoring the targeted transactions.

[1] Regulation (EU) 2022/2560 of the European Parliament and of the Council of 14 December 2022 on foreign subsidies distorting the internal market