Earlier in the summer, the European Commission (EC) published a White Paper on foreign subsidies, proposing a regime for the evaluation of foreign subsidies that facilitate acquisitions of European companies.

The powers would be distinct from merger control and foreign investment screenings, adding another layer to the M&A regulatory process. To justify the additional regulatory burden, the EC needs to be clear on three fundamental questions of substance and scope.

The symptoms – what is the regulatory gap which the White Paper seeks to address?

The White Paper notes that “there is an increasing number of incidences in which foreign subsidies appear to have facilitated the acquisition of EU undertakings”. The White Paper seems to have its roots in a 2017 non-paper submitted by Germany, Italy and France which expressed concerns about “state-led, strategic direct investment” in European targets, “directly or indirectly subsidised by government agencies”. 

The White Paper raises (and at times seems to conflate) two different types of concerns, which are not specifically addressed by other rules.

First, a concern that foreign-subsidised acquirers may outbid rivals for investment in Europe. This is a distortion of investment opportunities upstream.

This type of harm is not currently addressed by EU State aid rules, which only apply to aid granted by governments in the EU. Nor is it addressed by merger control, which assesses whether the transaction may substantially impede effective competition on the markets affected by the transaction and where the source of the funds to acquire the target company is only relevant insofar as it may have helped the merged entity to prevent competition on those markets. Nor is it addressed by foreign investment screenings, which seek to protect certain national interests from foreign ownership irrespective of whether there was any outbidding.

Second, a concern that foreign-subsidised acquirers may benefit from an “unfair advantage” and prevent other bidders from achieving better efficiency gains or accessing key technologies, ultimately “distorting the internal market” for the downstream supply of goods or services which are affected by the transaction and where the target operates. This type of harm seems more wide-reaching than what is currently addressed by merger control (which is only concerned with protecting effective competition, not the functioning of the internal market more widely and which is otherwise agnostic as to the origin of the funds used for the acquisition), foreign investment screening (which seeks to protect certain strategic national interests rather than the internal market more generally) or State aid rules (whose goal is to ensure EU states do not “distort competition” with State-funded aid).

The diagnosis – what is the proposed legal framework?

The legal standard proposed by the White Paper is: “the distortion of the internal market through the facilitation of an acquisition by foreign subsidies” and would require the competent authorities to demonstrate that an acquisition:

• is facilitated by a foreign subsidy; and 
• results in the distortion of the internal market.

The two types of harm which we identified above are very different in nature. However, the legal standard proposed by the White Paper appears to tie them together.

Direct subsidies

For subsidies directly provided for an acquisition, the White Paper seems to suggest a rebuttable presumption of distortion, stating that “in view of the serious harm they cause to the level playing field for investments, foreign subsidies directly facilitating acquisitions would normally be considered to distort the internal market”. In other words, the White Paper suggests that an uneven playing field in the upstream allocation of capital would normally be expected to result in a distortion of the internal market on the downstream markets where the target operates.

This approach raises a number of questions.

• First, it is unclear how an “acquisition facilitated by a foreign subsidy” may distort the upstream capital allocation without necessarily establishing outbidding and its direct link to the subsidy. The White Paper does not require an examination of whether the bid ‘clearly exceeds the market price’ as per State aid rules, but only says that the existence of competing offers will be one aspect of the assessment but not determinative. It is also unclear whether the White Paper takes account of the fact that in M&A transactions, the successful bidder may be chosen based on a variety of factors, including but not only the price of the bid. 
• Second, it is unclear how an upstream distortion of capital allocation, even if established, would presumptively result in a distortion on the downstream markets where the target operates. In an EU State aid context, the parties and the EC would normally be required to assess whether the state behaved like an investor in accordance with free market conditions and whether any other private investor would have acted in the same way.

Indirect subsidies

The more detailed assessment proposed for indirect or de facto subsidies which more generally reinforce the bidder’s financial strength also raises questions. 

• First, attempting to determine whether and to what extent a foreign subsidy facilitated the acquisition of an EU company is likely to be fraught with significant complexities and may lead ultimately to a gaming of the process.
• Second, attempting to determine whether and to what extent a foreign subsidy resulted in a distortion of the internal market is also complex. The White Paper notes that “the general lack of transparency about foreign subsidies and the complexity of commercial reality may make it difficult to unequivocally identify the distortion due to specific subsidised acquisitions”. The White Paper points to various factors relevant for assessing whether the subsidy could distort the internal market, including whether the beneficiary of the subsidy has privileged access to its domestic market “leading to an artificial competitive advantage”, excess capacity in the industry, concentration levels and – unsurprisingly – the nature of the industry (high tech markets), which would exacerbate the effects of the subsidy in terms of a loss of competitiveness and innovation in comparison to non-subsidised companies.

EU interest test

Once the distortion and the foreign subsidy facilitation are established, the proposed legal framework then provides for an EU interest test which involves balancing the effects of the distortion against the positive impact in the EU or on its policy goals. The spectrum of positive impact is large, ranging from creating jobs to achieving climate neutrality or achieving digital transformation. The question arises: how would such heterogenous policy objectives be balanced in an objective way against a distorted purchase price?

Levelling the playing field between EU State aid and non-EU State aid?

If it is intended that any new legislation should seek to level the playing field between firms that have received financial support under EU State aid rules and those companies benefiting from foreign subsidies, as EC officials have suggested, then one would expect the standard to be construed in line with the State aid standard – a distortion of competition and not a broader concept of distortion of the internal market.

The circumstances in which an acquisition subsidised by a foreign state should be prohibited or subject to a remedy in the EU should ideally mirror those that apply to EU states (unless, of course, other foreign investment considerations are at play). Of course, consistent with the national treatment standard, the EU can always treat foreign subsidies more leniently than EU subsidies; but not more harshly.

However, there appear to be a number of differences with the State aid legal standard.

• As noted above, the standard is potentially wider and more open-ended.
• Assuming there was an acquisition directly facilitated by a government subsidy which originated from an EU state, there would be no presumption of distortion of the internal market. Existing merger control rules would only consider the impact of the increased financial strength of the merged entity on effective competition on the market where the target is active and assess whether there is a direct and significant link between the acquirer’s financial strength and distortion on the market(s) where the target is active. State aid rules would consider whether the aid distorted competition (not the internal market) assessing whether the state acted like any other reasonable market investor.

The cure – does the proposed remedy cure the ailment?

As well as potentially prohibiting the transaction, the White Paper envisages the potential for conditional clearance of transactions with remedies, including the divestment of assets.

A remedy must be proportional to the problem identified. In merger control, the existence of a particular competition problem informs the assessment of which assets may need to be divested to restore competition, but it is unclear which assets may be implicated by a subsidised purchase price. It might involve the divestment of the strategic assets which inspired a foreign state to help finance the acquisition – but how could this be established, and the assets identified?

As well as possible divestments, the White Paper identifies certain behavioural remedies, including the “prohibition of certain conduct linked to the foreign subsidy. A broad right to prohibit conduct linked to a foreign subsidy is concerning. Any remedy should be linked to the problem that was identified during the investigation and be relevant to resolving that distortion.

Ultimately, the uncertainties associated with the outcome of this new control regime are likely to have a significant impact on any M&A transaction, in particular in relation to auctions. Deal certainty and timing are essential to maintain an attractive European investment and innovation landscape.

Uncertainty in merger control and foreign direct investment reviews already has a significant impact on the choice of the winner in an auction process. Often the highest bidder is not chosen if its bid may cause protracted reviews or an uncertain outcome. If it is unclear when the EC will intervene, the proposed new process may disadvantage interested candidates. In this respect, competing bidders may use the process to obtain an advantage by raising foreign subsidy concerns even where such subsidies were not granted or were not material to the outcome of the bidding. In the end, the best bidder, in terms of achieving efficiencies may not prevail simply because the seller of the assets wants to avoid the hassle and uncertainty. A process intended to avoid unfair advantages for subsidised bidders may create unfair advantages for those using – or gaming – the process to create an unfair advantage for themselves. In order to avoid this outcome, the legal test will need to be very clear on the issue of what constitutes a distortion of the internal market.

If foreign acquirers are unduly restricted when seeking to invest in EU companies, or if certain types of foreign acquirers are preferred over others, this may undermine the goal of achieving a “level playing field” and lead to the same inefficient allocation of resources which the White Paper ostensibly sets out to address. Beware the risks of placing too many obstacles on one side of the playing field. After all, a level playing field is not much use with only one team playing.