FDI And FSR Enforcement Trends in Europe: July and August 2024 – Hard Times For Chinese Investments In Europe?

By Paul Johnson, Pavlo Prokhorov and Beau Maes, all Baker McKenzie

This summer was marked by a particular focus and scrutiny by authorities on transactions involving investors from China, which is typically considered a "risk" jurisdiction from an EU FDI and FSR perspective.

The four decisions highlighted below are an important reminder for companies to carefully assess the FDI and FSR risks when engaging with and receiving investments from Chinese investors. It shows that authorities can and do scrutinize the same transaction using different regulatory frameworks.

• On 3 July 2024, in its first prohibition decision this year, the German Federal Ministry for Economic Affairs and Climate Action (BMWK) prohibited an acquisition of a Volkswagen subsidiary by a Chinese state-owned company under its official FDI powers.
• On 11 July 2024, the German Federal Ministry of the Interior and Community (BMI), having no official FDI powers,[i]announced that it agreed with three mobile network operators to restrict their reliance on critical components made by Chinese suppliers Huawei and ZTE in their 5G mobile network in Germany, thereby de facto imposing national security measures.
• On 12 August 2024, the EU General Court rejected a request for interim measures related to the European Commission ("Commission")'s first ever dawn raid under the Foreign Subsidies Regulation (FSR). The decision is significant in strengthening the Commission's push for enforcement of the FSR.
• On 28 August 2024, the UK Cabinet Office conditionally approved the construction of a battery storage facility led by a JV involving KX Power, a UK-registered asset management company led by a former Chinese diplomat with links to Chinese investors.

In recent years, FDI authorities have increasingly scrutinized investments from investors from 'friendly' jurisdictions. A UK decision dated 25 July 2024 exemplifies this trend: the UK Cabinet Office approved the acquisition of a UK radiation detection and device manufacturer by a French company but imposed commitments due to national defense interests.

The political context and potential close ties of friendly jurisdictions to risk jurisdictions are a further factor to be considered when undertaking a risk analysis. For example, a recent prohibition of a bid by the partially Hungarian state-owned consortium Ganz-Mávag to acquire the Spanish train manufacturer Talgo was reportedly influenced by Hungarian Prime Minister Viktor Orbán's close ties with Russia.[ii]

What are the practical takeaways?

• Investments from traditional "risk jurisdictions" such as China are subject to strict scrutiny. To mitigate risks, companies operating in more sensitive domestic sectors should carefully consider their investors' nationality and, together with their legal counsel, assess the potential scrutiny and likelihood of prohibition or commitments imposed by FDI authorities. Authorities will probe any possible connection to China, even if those connections are remote and ambiguous.
• In the current context of political tensions with China, countries in Europe may go beyond their national security instruments to address national security concerns. Authorities may enact new targeted non-FDI legislation or negotiate contracts with key national companies, such as telecom infrastructure operators, to exclude investors from "risk" jurisdictions. This approach creates legal uncertainty for both foreign investors and companies that benefit from foreign investment and face challenges in defending their interests due to a potentially ambiguous legal framework, unclear procedural rights and limited avenues for contesting these actions.
• Companies must recognize that investments from "friendly" jurisdictions, including the US and EU member states such as France, are also scrutinized by FDI authorities and can result in prohibitions or commitments. Legal advisers should not dismiss risks solely on this basis but should instead consider the sensitivity of the sector in which the target company operates (e.g., whether it is defense-related) and the current bilateral and European-wide political tensions.
• In cases where investments by companies from friendly jurisdictions are prohibited without adequate justification or approved under unreasonable commitments, investors should consider seeking redress in national and European courts. Under the current Xella case law,[iii] an EU member state imposing such restrictions on foreign investments from another EU member state may violate EU internal market rules.
• With respect to FSR enforcement, the judgment of the EU General Court demonstrated that the same high standards are applicable to requests for interim measures related to FSR proceedings as to any other requests for interim measures. The affected parties cannot claim without sufficient evidence that the requested documents contain state secrets and that their disclosure will infringe the domestic law of their country of origin.

The first prohibition decision in Germany in 2024 confirms a tougher stance against transactions with a Chinese nexus.

On 3 July 2024, the BMWK, the German FDI authority, prohibited the proposed acquisition of the gas turbine business of Volkswagen subsidiary MAN Energy Solutions, a supplier of large engines, turbomachinery and turbines for marine and stationary applications.

Although the decision is not public, public sources report that it was prohibited because the investor, CSIC Longjiang GH Gas Turbine (GHGT), a subsidiary of state-owned China State Shipbuilding Corporation (CSSH), allegedly had links to China's army industry and military shipbuilding.

This is the first prohibition decision by the BMWK in 2024, and it confirms its tougher stance against transactions with a Chinese nexus. As reported in our previous FDI updates, Germany has prohibited a significant number of acquisitions by entities with Chinese links in recent years.[iv] This decision implies that such scrutiny will continue and that companies should therefore be aware of the risks associated with engaging with investors from China.

The UK government has also kept a watchful eye on investments from foreign investors with Chinese links. On 28 August 2024, the UK Cabinet Office imposed commitments before approving a joint venture between a US investment management company and KX Power to build an 80-megawatt battery storage facility. Concerns were raised because KX Power, led by a former Chinese diplomat, has connections to Chinese investors and entities that have strategic partnerships with Chinese sovereign wealth funds and state-owned enterprises. The commitments included notifying any changes in the party buying power from the station and restrictions on data sharing.

Germany going beyond FDI rules to target Huawei and ZTE

In the same month, Chinese companies Huawei and ZTE were also targeted. On 11 July 2024, the BMI announced that after "extensive investigations," it had negotiated and agreed on contracts with mobile network operators Deutsche Telekom, Vodafone and Telefónica, requiring them to stop using critical components from Huawei and ZTE in their 5G mobile networks.[v]

The BMI is not an official FDI authority in Germany and does not have the authority by itself under FDI rules to impose commitments on foreign companies. Foreign investors should, therefore, be aware that authorities acting under EU and national political pressure[vi] may go beyond their legal set of national security instruments. This includes enacting targeted non-FDI legislation[vii] or contractually negotiating with companies of national interest, such as telecom infrastructure operators, to exclude the involvement of companies from "risk" jurisdictions.

This arguably raises legitimate questions about how unique this situation is, given the current political context and pressure from the Commission to remove Chinese suppliers from European 5G mobile networks, and how foreign investors can adequately defend themselves against this, given that the national authorities are not acting under the standard FDI framework and are instead imposing restrictions through different methods.

Investments from "friendly" jurisdictions are not entirely risk-free

On 25 July 2024, the UK Cabinet Office conditionally approved the acquisition of Centronic, a UK-based radiation detector and device manufacturer, by Exosens, a French high-tech optical devices manufacturer. To address defense-related concerns, the commitments require Centronic to maintain its presence in the UK in order to fulfill UK defense contracts.[viii]

The new UK government's first conditional approval decision demonstrates that the UK FDI authority will not only scrutinize risk jurisdictions such as China but will also assess potential risk from investors based in "friendly" jurisdictions, including the United States and EU member states such as France. The Centronic deal follows a similar case where the UK government imposed commitments for a transaction involving a defense-related target, even when the investor was from France. In August 2023, the UK government only authorized the French-state company EDF's acquisition of General Electric's nuclear steam business after it agreed to retain capacity for critical UK Ministry of Defense programs.

This scrutiny of "friendly investors" applies not only to scrutiny between different regions, such as the UK and the EU, but is also noticeable among EU member states.

On 27 August 2024, the Spanish government prohibited a takeover bid worth EUR 619 million for Talgo, a Spanish train manufacturer, by Ganz-Mávag Europe, a consortium 45% owned by the Hungarian government and 55% owned by the Hungarian train manufacturing group Magyar Vagon, due to national security grounds.[ix] The prohibition is believed to be motivated by potential links between the consortium and (i) Hungary's pro-Russian Prime Minister Viktor Orbán and (ii) Magyar, a former subsidiary of Transmashholding, the largest manufacturer of trains and railway equipment in Russia.

The prohibition decision is unprecedented, as it is the first time that Spain, an EU member state, has invoked national security grounds to block an investment from Hungary, a fellow EU member state.[x] It raises many questions: Will all investments by Hungarian state-owned companies now be subject to increased FDI scrutiny? Might the same scrutiny be extended to other countries where the current government is pro-Russian (such as Slovakia)? Is it possible that other EU member states besides Spain will start applying such a strict approach?

For now, reactions from Ganz-Mávag Europe in public sources set out its intention to challenge the prohibition before the Spanish Supreme Court and, if needed, to appeal via the European Courts. In the long run, this may prove to be a useful development for any foreign investor from an EU member state, as it may give the European Court of Justice, following the Xella decision in 2023, another chance to further clarify the ways in which national enforcement of FDI by an EU member state in relation to another EU member state may violate EU law.

Interim measure applications must be sufficiently substantiated under the FSR.

In April 2024, the Commission launched its first dawn raid under the FSR, targeting the Dutch and Polish premises of Nuctech, a Chinese state-owned company supplying various security inspection systems.[xi] During the inspections, the Commission requested Nuctech to provide information from the mailboxes of its employees, including those whose data was stored on the Chinese servers, among other things.

On 29 May 2024, Nuctech filed with the General Court an appeal as well as an application for interim measures seeking the annulment of the decision initiating the dawn raid and any subsequent acts or requests by the Commission, including requests for information. On 12 August 2024, the President of the General Court issued an order dismissing the application for interim measures, mainly due to Nuctech being "extremely laconic" in its arguments.

There are several important takeaways from the General Court's order:

• The established EU case law that interim relief may be granted only in exceptional circumstances also applies to FSR enforcement. That is, the undertaking must prove the serious and irreparable harm to its interests by presenting sufficient supporting evidence, not just referring to "mere general assertions." As this case proves, references to damage to reputation and financial viability or claims that the information request would breach domestic law are unlikely to find support in court if unsubstantiated.
• Incorporation outside the EU provides no protection from the Commission's enforcement actions against undertakings under the FSR (as is the case with respect to merger control or antitrust rules). As long as the undertaking operates in the EU, the Commission can conduct dawn raids at its EU premises and request information from it (including from the group entities outside the EU).

This ruling will bolster the Commission's powers of FSR enforcement, especially with respect to carrying out dawn raids. While Chinese companies will likely continue to be the primary target of the FSR tool in the short term, other companies (including those based in the EU) receiving foreign subsidies should be mindful of the General Court's ruling and its implications.

---

[i] The BMWK has been designated as the exclusive body to review transactions under German FDI rules. The BMI only has a consulting role in the FDI screening processes.

[ii] This development warrants close monitoring, as a legal challenge could lead to a ruling by the European Court of Justice having broader implications (e.g., under a request for preliminary ruling as part of a legal appeal before the Spanish Supreme Court). Such a ruling might further clarify the rights of foreign investors against unreasonable and disproportionate decisions by national FDI authorities under EU law.

[iii] Please refer to our previous blog post about the Xella judgment for more detail.

[iv] In the past, Germany has often taken a strict approach toward investors with Chinese ties. As reported in our previous updates, in September 2023, the German government prohibited the Chinese majority shareholder of Kleo Connect, a Berlin-based satellite company, from acquiring an additional 45% stake (here). In November 2022, the German government also blocked Silex Microsystems, the Swedish subsidiary of Chinese chipmaker Sai MicroElectronics, from taking over a domestic semiconductor production facility.

[v] The German government's official press release can be found here. The contracts obligate the mobile network operators to stop using all critical components by the end of 2026 and replace the critical functions by the end of 2029.

[vi] In 2020, the EC introduced an EU toolbox on 5G cybersecurity that advised EU member states to diversify their supply chains and exclude high-risk vendors, including Huawei and ZTE, from 5G network infrastructure. In June 2023, EU Commissioner Thierry Breton urged EU member states to use the 5G toolbox to restrict or exclude high-risk vendors. The Commission considered imposing a mandatory ban to EU member states in response to concerns that national governments were delaying action on the matter.

[vii] Some EU member states have enacted legislative measures to allow themselves to remove "high-risk" suppliers from their 5G mobile network infrastructure (e.g., Estonia, see here).

[viii] The UK Cabinet Office's notice of its decision can be found here.

[ix] The press release of the Spanish government can be found here.

[x] This is only the second time the Spanish government has blocked a transaction since the FDI regime entered into force in March 2020. Since decisions are completely confidential in Spain, it is not known which investor from which jurisdiction was involved in the first prohibition decision.

[xi] Please refer to our previous blog post for more detail about this dawn raid.