By Sophie Bohnert, Vienna University of Economics and Business/College of Europe

Background

The current Regulation on the Screening of Foreign Direct Investment into the Union (the “FDI Screening Regulation” or the “Regulation”) has sometimes been described as a first step towards a more comprehensive Europeanisation of investment control legislation and possibly even a supranationalisation of control and decision-making powers. The Regulation has a built-in evaluation and revision mechanism. The existence of such a mechanism can reasonably be taken as an indication that the EU legislator had in mind a gradual evolution of the FDI screening framework, or at least a certain need for improvement. On 24 January 2024, following its first evaluation of the effectiveness and efficiency of the FDI Screening Regulation, the EC tabled a reform proposal as part of its “Economic Security Package”, as discussed in a previous blog post. The volume of expertise available to the EC for the purposes of evaluation included an external study by the OECD, a Stakeholder Consultation, and a special report by the European Court of Auditors on the screening of FDI in the EU. These publications all point to the need for greater regulatory convergence in the area of FDI screening. This blog post briefly takes stock of the status quo of regulatory convergence under the current FDI Screening Regulation and undertakes to examine the extent to which the EC’s draft regulation is fit for purpose.

The Extent of Regulatory Convergence to Date

The main regulatory features of the FDI Screening Regulation have already been discussed in detail elsewhere. Nevertheless, it is useful to recall the following key aspects: First, the FDI Screening Regulation does not oblige Member States to screen FDI on their territory or to establish review mechanisms. It does not create an independent, EU-wide review system either. It only sets minimum requirements for Member States’ review procedures. Second, the Regulation’s substantive legal requirements are only rudimentary. There is an indicative list of so-called screening factors that Member States and the EC can take into account when assessing whether an FDI is likely to affect security or public order. Third, from an institutional and procedural point of view, the Regulation only lays down general procedural principles, such as non-discrimination and transparency. Finally, the regulatory core of the Regulation is the cooperation framework for the exchange of information between Member States, and between Member States and the EC. The responsibility for review and the final decision remains with the Member States. The EC has no formal veto right. Given this, and the fact that the Regulation is described as a “framework”, it is clear that it is at best a means of indirect partial harmonisation through mutual exchange of information and views.

The Potential and Need for Greater Regulatory Convergence

Comparative Perspective

As the EC noted in its analyses accompanying the reform proposal, the FDI Screening Regulation has triggered a clear trend among Member States to introduce screening mechanisms, or to reform and extend existing screening mechanisms. However, a comparative legal analysis of the Member States’ legal frameworks still reveals significant differences. While some Member States (Bulgaria, Croatia, Cyprus, Greece, and Ireland) are still in the process of adopting screening mechanisms or are not fully implementing existing legislation, the existing national frameworks differ in terms of substantive, procedural, and institutional design. For example, the scope of application (in particular the notion of covered FDI) and procedural approaches (in particular with regard to deadlines) diverge. Multi-jurisdictional transactions may require multiple filings under different investment review mechanisms, but also under other pre-notification regimes, such as merger control. This may not only give rise to different procedures but may also lead to divergent substantive decisions. Nevertheless, the potential for greater convergence in the future is high, as the systemic differences are not insurmountable as to stand in the way of further Europeanisation.

Political and Economic Dimension

In the light of proportionality considerations, a static finding of a difference in standards is not sufficient to justify further harmonisation. If a mere framework regulation is effective, further harmonisation is unnecessary. However, the information gathered by the EC points at a lack of effectiveness. First, the mechanism for taking into account the interests of the EU and other Member States is virtually toothless. In other words: Negative externalities that may result from the approval of FDI in a Member State and the interdependencies of the EU internal market are not sufficiently internalised. Member States without a control regime are potential gateways for “undesirable” investments. Second, fragmentation can also distort competition in the internal market, as the question of the existence of a control regime influences investment decisions. Third, there is a risk of protectionist solo efforts by some Member States. Fourth, fragmentation gives third country actors the opportunity to play the Member States off against each other. Finally, the lack of harmonised access requirements leads to opaqueness, unpredictability, and uncertainty for investors. As market openness decreases, transaction costs increase.

Normative Dimension

It could even be possible to identify a normative requirement for greater convergence under EU law. The basis for such an imperative could be Art 207 para. 1 TFEU, which states that the common commercial policy as regards FDI must be organised according to “uniform principles”. The objective of completing the internal market set out in Art 3 para. 3 in conjunction with para. 5 TEU could reasonably be interpreted as including uniform external EU-action vis-à-vis third countries. The spill-over problem associated with the internal market also argues for a coordinated approach to internal security. Another point of reference for the coordination of security issues could be the loyalty requirement of Art 4 para. 3 TEU. This requirement is not only addressed to the Member States. It could also reasonably be interpreted as giving the Union a coordination mandate.

The EC’s Reform Proposal

Objectives and Legal Basis

The overarching objective of the proposal is to address a number of deficiencies in the existing regime. To begin with, the reform of the FDI Screening Regulation should allow for an effective and seamless screening of FDI in the Union. Further, it should increase the convergence in the understanding of the notions of security and public order and create a level playing field. Moreover, it should enhance legal certainty and reduce the administrative burden for investors.

What immediately catches the eye is the fact that the EC decided to include Art 114 TFEU as a legal basis in addition to Art 207 TFEU. This is already an indication of greater harmonisation ambitions. It is useful to discuss separately the substantive dimension of the proposal, on the one hand, and the procedural and institutional dimension, on the other hand.

Substantive Dimension

To begin with, the EC considers that the definition of FDI is too restrictive. Therefore, the EC proposes to broaden and clarify the scope of the existing Regulation. As discussed in a previous blog post, the draft regulation seems at the very least to encourage Member States to apply their screening mechanisms to greenfield investments where they create a lasting and direct link between a foreign investor and an EU target. Furthermore, the draft regulation extends the notion of FDI to intra-EU investments where EU entities are controlled by non-EU investors, provided that the decision-making power remains with the non-EU investor (see Art 2 para. 3 in conjunction with para. 7 of the draft regulation). This situation has previously only been covered in cases of circumvention, as the relevant criterion under the existing FDI Screening Regulation is incorporation rather than control. The EC is thus trying to close the loophole revealed by the recent ECJ recent ruling in case C-106/22, Xella Magyarország. A holistic assessment of the draft regulation suggests that the extension to intra-EU investments may pose implementation challenges against the background of the case law of the EU Courts on the permissible restrictions of the freedom of establishment in intra-EU situations. This jurisprudence requires the existence of a “genuine and sufficiently serious threat to a fundamental interest of society”. Otherwise, the scope of application seems to remain unchanged, in particular as regards the non-applicability of the Regulation to portfolio investments. In any event, this “minimum harmonisation” does not prevent Member States from screening other types of foreign investments, foreign investments in other sectors, additional Union targets or economic activities that the Member States deem critical for their security or public order, provided that such screening activities comply with the Regulation.

The proposal still leaves the ultimate responsibility and decision-making power in the hands of the Member States. However, the proposal introduces an important innovation by requiring (“shall”) Member States to establish screening mechanisms in accordance with the draft regulation within 15 months of the reforms being signed into law. More precisely, the Proposal introduces a floor for the scope of application of national screening mechanisms, which also has a direct impact on Member States’ obligations under the cooperation mechanism. The approach is two-pronged. Under the first prong, Member States must screen and notify FDI in 20 projects and programmes of Union interest listed in Annex I. Under the second prong, Member States must screen FDI in EU companies active in areas of particular importance for the security or public order interests of the EU listed in Annex II (on the notification requirement, see further below). The critical technology areas listed in Annex II include those identified for additional risk assessment in the EC’s Recommendation of 3 October 2023. These areas are, amongst other things, advanced semiconductors, AI, quantum technologies, and biotechnologies.

Under the draft regulation, the likely negative impact on security and public order remains the key assessment criterion. However, the draft regulation differs from the existing FDI Screening Regulation by setting out mandatory investment- and investor-related screening factors. Member States and the EC must include these factors in their assessment. They shall consider whether the investment is likely to adversely affect the security, integrity and functioning of critical infrastructure, whether physical or virtual, the availability of critical technologies, the continuity of supply of critical technologies, the protection of sensitive information, including personal data, and the freedom and pluralism of the media, including online platforms that can be used for large-scale disinformation or criminal activities. As regards the investor-related screening factors, the draft regulation provides that Member States and the EC shall take into account, with regard to the foreign investor or any related entity, the record of previous prohibition or conditional approval decisions, the sanctions status, previous involvement in activities that adversely affect security or public order in a Member State, previous involvement in illegal or criminal activities, and the likelihood that the investment would further the political objectives of a third country or facilitate the development of the military capabilities of a third country.

Procedural and Institutional Dimension

Art 4 of the draft regulation also sets out minimum requirements for Member States’ review mechanisms. Most of these requirements aim to further procedural convergence in important areas such as due process and confidentiality. For example, Member States would be required to provide for in-depth review procedures, judicial protection, and procedures to ensure the integrity of confidential information. This should contribute to greater legal certainty and transparency in a somewhat opaque field of law. Furthermore, if implemented in its current form, the draft regulation would require Member States to provide for call-in powers for non-notified transactions, which would have to be available for at least 15 months after the completion of the FDI. Member State authorities would also need to be empowered to impose mitigating measures, and to prohibit or unwind foreign investments that raise concerns, and to detect and deter circumvention of a Member State’s screening mechanism.

As regards the scope of the cooperation mechanism, the draft regulation proposes a graduated system. Investments linked to one of the projects and programmes of Union interest listed in Annex I always fall within the scope of application of the cooperation mechanism. For the investments listed in Annex II, the proposal provides for a risk-based filter to limit the administrative burden for both authorities and investors. In particular, these investments will be subject to mandatory notification only if they meet the risk-based conditions set out in the draft regulation. Notification will be required if the foreign investor is directly or indirectly controlled by a third-country government, if the foreign investor or an associated entity is subject to sanctions, or if the foreign investor or any of its subsidiaries was involved in a previously reviewed foreign investment that was conditionally approved or was not approved. In addition, the cooperation mechanism will be triggered if the Member State where the target is established opens an in-depth investigation. This also applies if the Member State where the target is established intends to impose mitigating measures or to block the transaction without an in-depth investigation. Voluntary notification is also possible if the Member State where the target is established considers that an investment could be of interest to the other Member States and the EC from a security or public order perspective (e.g., if the target has significant operations in other Member States).

In addition, the draft regulation aims to bring some order to the maze of national timeframes, which is particularly problematic in multijurisdictional transactions. The proposal requires investors to file in all relevant jurisdictions on the same day, with cross-references to other filings. The draft regulation also obliges Member States to ensure that these filings are generally fed into the cooperation mechanism on the same day. In addition, the proposal sets deadlines for some important steps in the cooperation process, such as the submission of comments by Member States and the issuing of opinions by the EC, or the notification of screening decisions by Member States. However, there is a lack of harmonisation on one crucial point: There is no deadline for decision-making. It is therefore questionable whether the envisaged changes are sufficient to increase the effectiveness and efficiency of the cooperation mechanism.

Among the main points of criticism are the fact that the cooperation mechanism under the current FDI Screening Regulation only provides for a comply-or-explain regime and the fact that the EC’s powers have so far been limited, in particular when it comes to multijurisdictional transactions. The draft regulation recognises these problems by requiring the Member State where the foreign investment is planned or completed to give “utmost consideration” to the duly motivated comments of other Member States and the duly motivated opinions of the EC, which may be issued in certain circumstances. The EC may also address a duly motivated opinion to all Member States if it considers that the cumulative effect of several foreign investments could affect the security or public order of the Union as a whole. In such cases, the draft regulation provides for a discussion forum for the Member States and the EC to develop strategies to address cross-border risks before decisions are taken under the national screening mechanisms. A similar discussion forum will be available in cases where a Member State has received comments or opinions. Upon receipt of an opinion, the Member State where the foreign investment is planned or completed must inform the Member States and the EC of its final screening decision and explain in writing the extent to which it has given utmost consideration to the comments of the Member States and the opinion of the EC, and the reasons for possible disagreement. This will enable the other Member States and the EC to assess compliance. If the Member States or the EC conclude that the Member State concerned has failed to give utmost consideration to their comments or opinion, a discussion forum will be available ex post to develop, inter alia, strategies to avoid similar problems in the future.

Finally, the draft regulation would oblige the notifying Member State to feed into the cooperation mechanism more detailed information on the investor, the target, and the investment.

Conclusion and Outlook

The new FDI Screening Regulation would repeal and replace the existing FDI Screening Regulation. The legislative proposal will be subject to the ordinary legislative procedure. The interinstitutional negotiations in the trilogue may lead to changes in the initial proposal. Given the upcoming European elections, it is not unlikely that the legislative process will be delayed. In any case, the new FDI Screening Regulation, if implemented in its current form, would provide for a 15-month transition period for Member States to amend their national legal frameworks.

Overall, it can be argued that the draft proposal is a step towards greater regulatory convergence in the field of FDI screening. However, the proposal is somewhat conservative and still leaves some key issues largely unresolved, such as the procedural fit and substantive coherence with other (notification-based) EU procedures. Recital 48 merely states that “[t]he application of [the FDI Screening Regulation] should be consistent with and without prejudice to other notification and authorisation procedures set out in Union law”. The proliferation of unilateral trade and investment policy instruments is likely to exacerbate these coherence and coordination concerns in the future. It would therefore be desirable to develop some more specific rules.

As far as the keystone or final state of harmonisation is concerned, the last word has probably not yet been spoken. However, it is important to bear in mind that the EU’s competence to adopt harmonisation measures in the field of security and public order is subject to certain limits, as set out in the last sentence of Art 4 para. 2 TEU and Art 346 para. 2 TFEU. In this respect, it may be prudent to refrain from exaggerated expectations regarding the harmonisation of investment control legislation.