By Genevra Forwood & Axel Schulz[i]

1. Introduction

The Covid-19 pandemic has focused the attention of the European Union (“EU”) and its Member States on the risk of foreign investment in critical European assets jeopardising security and public order. The pandemic has highlighted the importance of strategic industries – the production of medical supplies, personal protection equipment (PPE) and a potential vaccine come to mind but many other assets could be relevant to ensuring public security and order. At the same time, struggling European companies could become an attractive target for foreign investors. While the EU and its Member States, traditionally very open to foreign investment, may see foreign investors with increased skepticism, distressed companies may see foreign investors as a last hope for survival. Balancing the different interests will become one of many challenges for foreign investment control in Europe.

The possibility for EU countries to control foreign investments – either foreign direct investments (“FDI”), where the investor has a controlling stake in a company, or portfolio investments, where the foreign investor does not acquire control – for public policy and security reasons has always existed under the EU Treaties. Over the years, more countries have adopted rules to screen foreign investment and the new EU-level coordination mechanism under the FDI Screening Regulation[ii] will be effective from October 2020.

During the Covid-19 pandemic, the European Commission (“Commission”) gave new impetus to this trend, publishing guidelines on 25 March 2020 (“Guidelines”)[iii] urging Member States to more actively scrutinise foreign investments in European strategic assets. Several Member States have already tightened up their foreign investment screening mechanisms, at the same time as ramping up public support measures to European companies, facilitated by special State aid rules.[iv]

This article sets out the risks the Covid-19 outbreak entails for EU strategic assets (2.) and will explore the legal framework by which Member States and the EU can control foreign investments(3.): first, the national screening mechanisms and the EU FDI Screening Regulation (3.1.); second, restrictions on the free movement of capital (3.2.); and, third, the (partial) nationalisation of strategic EU companies (3.3.).It concludes with an outlook on future developments (4.).

2. How the pandemic exposes EU strategic industries to potential risks

For many years, Member States have been concerned about non-EU investors taking over European companies with key technological competences for strategic reasons.[v] After failed attempts to adjust competition rules to enable the emergence of ‘European champions’ able to compete more effectively with foreign companies,[vi]the focus turned to a more interventionist approach, to directly protect strategic

pandemic, and the resulting economic pressure, has highlighted the importance of strategic goods and technologies. Member States experienced shortages of medicines (with some active ingredients manufactured outside the EU) and PPE, due to their dependence on third countries. In response, the Commission imposed a temporary export authorisation for such products manufactured in Europe and encouraged European businesses to diversify their supply chains for critical goods.[vii]

At the same time, tensions arose in relation to allegations that the United States was seeking exclusive access to potential vaccines developed in Germany.[viii] Both issues reflect the susceptibility of integrated global supply chains to crises and political arbitrage.[ix]The pandemic also made the EU strategic industries an attractive target for foreign investors due to plunging asset prices across all sectors.^[x]The Commission notes in its Guidelines that “ among the possible consequences of the current economic shock is an increased potential risk to strategic industries, in particular but by no means limited to healthcare-related industries.”[xi]In fact, the MSCI Europe Index, which tracks the return of stocks within 15 European developed markets, has collapsed by 23% this year.[xii]Against this background, foreign companies and funds are gearing up for acquisitions in the EU.[xiii]

3. Scaling up the tools to protect the EU’s strategic industries from foreign investment 

Due to the impact on national security and public order created by such economic exposure of strategic industries, both the EU and its Member States are implementing additional measures to protect strategic assets from foreign investments.This ranges from full-fledged FDI, whereby the foreign investor establishes or maintains a lasting and direct link between the foreign investor and the entrepreneur, enabling it effective participation in the management or control of a company,[xiv]to portfolio investments, involving the acquisition of shares with no control rights, or the buying of IP rights. 

• Tightened (or new) national screening and a new EU-level review

Although FDI is an ‘exclusive competence’ of the EU,[xv] Member States retain sole responsibility for their national security and have the right to protect their essential security interests.[xvi] As a result, foreign investment screening currently takes place at the national level, with a patchwork of regimes, some Member States with no specific controls at all.[xvii]The recent Commission Guidelines urge Member States that already have a screening mechanism in place to make “full use” of it, and for those Member States that do not to adopt one quickly and in the meantime “use all other available options”.

The EU FDI Screening Regulation establishes an additional level of scrutiny, giving other Member States and the Commission the possibility to comment on foreign investments in all sectors, whether or not they are subject to national FDI screening. The host Member State must “give due consideration” to the views of the other Member States and the Commission and, where FDI is likely to affect projects or programmes of Union interest, must “take utmost account of the Commission’s opinion” and explain why if they don’t.  However, where there is a national screening mechanism, the host Member State has the final say as to whether the investment is allowed, and any conditions attached.[xviii]

It remains to be seen how the EU-level mechanism will work in practice. Complexities could arise where the European target has subsidiaries in numerous Member States. Although the ‘direct’ investment would typically only be made at the level of the European parent, this could trigger screening in the Member States where subsidiaries are located, since many national screening rules are also triggered by indirect control. If the national screening of ‘indirect’ investments is covered by the FDI Screening Regulation (and this can be questioned, given that it applies only to foreign ‘direct’ investment), there would be multiple ‘host’ Member States notifying the same investment, giving rise to multiple, and potentially contradictory, screening procedures.

The mechanism comes into operation on 11 October 2020, but the recent Guidelines note that even where a foreign investment is completed before that date without undergoing a national screening process, other Member States and the Commission may provide ex post comments and opinions from 11 October 2020 and until 15 months after the foreign investment has been completed.

It is unclear what impact any negative comments could have on completed investments. The regulation only requires the host Member State to “give due consideration” to the views of other Member States and the Commission (or, where there is a potential impact on projects or programmes of Union interest, to “take utmost account of” the Commission’s opinion). The Guidelines envisage the host Member State adopting “necessary mitigating measures”, giving the example of conditions guaranteeing the supply of medical products/devices. In view of the Union interest, such commitments might extend beyond the predicted needs of the host Member State.

The Guidelines also recall that Member States can intervene outside of screening mechanisms, for instance by imposing compulsory licences on patented medicines in the case of a national emergency. However, the FDI Screening Regulation is silent on the particular mitigating measures that might be imposed or how these could be enforced. Ultimately, these matters will be driven by national law and policy, but also increasingly influenced by the interests of other Member States and the EU.

Various countries have already tightened up their FDI screening mechanisms and provided further protections from potentially hostile foreign takeovers. In early March 2020, Spain lowered the screening threshold for foreign share acquisitions to 10% and expanded the FDI review to several sectors including critical infrastructure, healthcare, and technology.[xix] In April 2020, the German Government initiated a reform of the Foreign Trade and Payments Act. A potential deal can now be reviewed if there is a ‘probable harm’ to public order or security as opposed to ‘actual harm’. The effect of the transaction on other Member States and projects of EU interest will then be assessed and the affected transaction put on hold pending a final decision.[xx]

On 27 April 2020, the French Government announced a lowering of the screening threshold for foreign share acquisitions from 25% to 10%, while expanding the screening to the biotechnology sector.[xxi] Similarly, the Italian Government extended the State’s veto power to block or set limits to certain types of foreign investments in a certain company to the sectors of financial services, infrastructure and critical technology, energy, transport, water and health, food, data elaboration, AI, robotics, semiconductors, cybersecurity, nanotechnology, and biotechnology. In addition, the Italian Government introduced a notification requirement for EU investors acquiring control and for non-EU companies acquiring a stake of 10% or higher and above EUR 1 million in an Italian company.[xxii] Poland is planning similar steps.[xxiii]

• Enhanced screening of non-FDI capital under free movement of capital rules

Foreign investment that does not constitute FDI[xxiv], such as portfolio investment, falls outside the scope of the FDI Screening Regulation. Nevertheless, the Guidelines also calls on Member States to scrutinise such investments. It recalls that the EU free movement of capital rules,[xxv]which generally prohibit restrictions on capital movements and payments between Member States and between Member States and third countries, allow derogations to be invoked by the EU – “[w]here, in exceptional circumstances, movements of capital to or from third countries cause, or threaten to cause, serious difficulties for the operation of economic and monetary union”,[xxvi] or by Member States – inter alia, “on grounds of public policy or public security”.^[xxvii]

The Guidelines consider“ portfolio investments, which do not confer the investor effective influence over management and control of a company [and] are generally less likely than FDI to pose issues in terms of security or public order.” However, “where they represent an acquisition of at least a qualified shareholding that confers certain rights to the shareholder or connected shareholders under the national company law (e.g., 5%), they might be of relevance in terms of security or public order.”[xxviii] In other words, while small portfolio investments into EU companies seem less problematic to the Commission, it may be relevant to screen (and block) minority acquisitions when certain rights are attached.

The Guidelines also recall that EU law permits Member States to acquire ‘golden shares’ in companies, retaining special rights, such as the right to block or set limits to certain types of investments, although such an action must be necessary and proportionate to achieve a legitimate public policy objective.

Indeed, according to the case-law of the CJEU, “[g]rounds of public policy, public security and public health can be relied on if there is a genuine and sufficiently serious threat to a fundamental interest of society”.[xxix] The Guidelines point out that in situations “of ‘predatory buying’ of strategic assets by foreign investors (e.g. with a view to limit supply to the EU market of a certain good/service)”, these grounds could justify “restrictive measures necessary to ensure security of supply (for instance in the energy field) or the provision of essential public services if less restrictive measures (e.g. regulatory measures imposing public service obligations on all companies operating in certain sectors) are insufficient to address a genuine and sufficiently serious threat to a fundamental interest of society”.[xxx] Interestingly, the Commission stresses that “ restrictive measures may also be taken to address threats to financial stability.”[xxxi]

In relation to stock-quoted companies deemed to be under-valued, the Guidelines indicate that restrictions could be considered, taking into account the true value of these companies to society and the risk dependence if they fall into foreign hands. The Guidelines also suggest that, as concerns investments from a non-EU countries, “additional grounds of justification may be acceptable” and “the permissible grounds of justification may also be interpreted more broadly”.[xxxii]

It should be noted, however, that the CJEU has traditionally taken a restrictive view of the derogations to the free movement principles, whether the investment is intra-EU or from a non-EU country. If the public policy can be achieved through other means (e.g., regulatory measures imposing public service obligations), then a restriction on the foreign investment would be deemed disproportionate.

• (Partial) nationalisation of strategic companies to prevent foreign takeovers

Member States may also protect European assets by directly acquiring a controlling stake in them and thereby averting foreign takeovers. In principle, the EU Treaties are neutral regarding the system of property ownership – either private or public.[xxxiii] EU law does not prohibit full or partial nationalisation. However, a Member State nationalising a private undertaking must act like a ‘private market economy operator’ regarding the purchase price and the management of the nationalised undertaking, to avoid being caught by State aid rules.[xxxiv]

In response to the Covid-19 crisis, the Commission adopted a special set of State aid rules,[xxxv] giving Member States further flexibility to support the economy. In May 2020, the Commission amended the Temporary Framework by empowering Member States to recapitalise companies in distress, under a number of conditions relating to the necessity, appropriateness and size of intervention, the State’s entry in the capital of companies and remuneration, the State’s exit from the capital of the companies concerned, various conditions regarding governance (including a ban on dividends and share buybacks), and a prohibition of cross-subsidisation and acquisition.[xxxvi]Thus, companies in distress may have to renounce a future take-over possibility where they have accepted public capital injections under the State aid rules.

4. Conclusion

The Covid-19 pandemic has undoubtedly accelerated the trend towards more foreign investment controls, with Member States widening the scope of their screening mechanisms. A further tightening of the conditions and implementation of new national screening mechanisms by other Member States will likely follow. The Guidelines also encourage Member States to consider other measures to curb non-FDI third country investments, potentially testing the limits of the derogations to the capital movement rules, and to consider ‘golden shares’, recapitalisation and even nationalisation.

Announcing the recent Guidelines, European Commission President von der Leyen stated that: “The EU is and will remain an open market for foreign direct investment. But this openness is not unconditional.”  While foreign investment flows will be as important as ever in rebuilding the European economy after the Covid-19 crisis, it is clear that foreign investors looking towards the EU will need to navigate these emerging rules, at national and EU level.