The FSR Guidelines: M&A Implications and Unanswered Questions

Under the European Union’s (EU’s) Foreign Subsidies Regulation (FSR), the European Commission (the Commission) can block a merger if it finds that foreign (meaning non-EU) subsidies “distort the [EU] internal market.”  This power isn’t limited to mergers meeting mandatory notification thresholds; the Commission can “request” notification of any merger if it suspects that the parties may have received foreign subsidies in the three previous years.  The Commission can also approve even distortive mergers if it finds that foreign subsides’ positive effects outweigh the negative ones.

The Commission’ approach to identifying foreign subsidies that “distort” the EU market, identifying sub-threshold mergers it will call in for review and balancing foreign subsidies’ positive and negative effects is of critical importance to merging parties and their advisers.  The broader the Commission’s approach, the more transactions the Commission can challenge.  Indeed, large global corporate groups, especially those operating in sectors with significant public-sector involvement, commonly receive numerous foreign subsidies.  The Commission has now published FSR guidelines (the Guidelines), claiming extraordinary flexibility on all three issues.

Do the Guidelines foreshadow a new wave of increasingly aggressive FSR enforcement in merger review?  Probably not.  Out of hundreds of notified concentrations, the Commission has only opened in-depth investigations into two, and even in these the Commission has focused on only a few subsidies.  The Commission is facing political pressure to scale back, not expand, the regime.  The German government advocates scrapping the mandatory merger notification system completely, replacing it with a call-in system limited to very large transactions “to focus [the Commission’s] limited resources on cases with genuine potential for market distortion, while freeing businesses from costly and time-consuming notifications that yield no regulatory benefit.”

Any major changes to the FSR merger regime must await the results of the Commission’s separate review of first three years of FSR enforcement.   Meanwhile, the Commission will likely continue focusing on a very small number of mergers, but exercising considerable discretion in those cases, for instance by imposing apparently policy-driven sustainability remedies.  Unfortunately, while making its case for maximum flexibility in the Guidelines, the Commission missed an opportunity to address practical questions that will continue to challenge merging parties and the antitrust community.

Distortion

The Guidelines take an expansive approach to foreign subsidies that can distort the EU market for FSR purposes, including all foreign subsidies “liable to benefit, directly or indirectly, the economic activities in which that undertaking engages in the internal market, regardless of whether that benefit has actually materialised.” The Guidelines break the analysis into several steps.

First, the Commission determines whether foreign subsidies are liable to improve the parties’ “competitive position” in the EU.  Second, the Commission assesses whether the improvement is liable to distort competition in the EU.

Improving competitive position.  In discussing which foreign subsidies are liable to improve the beneficiary’s competitive condition, the Guidelines distinguish between “targeted foreign subsidies,” meaning foreign subsidies that support, directly or indirectly, a company’s EU economic activities, and others, described as “non-targeted foreign subsidies.”  (Treating foreign subsidies only indirectly benefiting EU activities as “targeted” creates an unfortunate ambiguity between the two terms.)

Targeted foreign subsidies.  The Guidelines explain that targeted foreign subsidies are considered to improve the beneficiary’s competitive condition without the need for further assessment.  Examples include foreign subsidies granted to directly support activities in the EU, such as EU manufacturing or distribution of goods or the provision of services to EU customer; foreign subsidies conditional on events related to EU activities, such as EU investments or acquisitions; foreign subsidies supporting non-EU activities that may indirectly benefit EU activities, such as R&D;  and financial insurance or risk management tools that may lower financing costs and/or prompt more risk-taking in the EU.

Non-targeted foreign subsidies.  Non-targeted foreign subsidies do not directly or indirectly support a company’s EU economic activities but may nonetheless improve the beneficiary’s EU competitive position.  Examples include general subsidies that can be used for any economic activities but where there is no clear indication as to how the beneficiary uses or intends to use them, as well as subsidies supporting non-EU activities, such as building a manufacturing plant or incentivizing employment in a non-EU country, if those subsidies free up resources the company could use in the EU.

For non-targeted foreign subsidies, the Commission needs to assess whether a company is liable to use the resources provided (or freed up) to cross-subsidize its EU activities.  If no credible legal or economic factors exist which prevent or render unlikely that transfer or use, the Commission may consider that the foreign subsidy is liable to improve the beneficiary’s EU competitive position.  The Guidelines list several factors to be considered, including the beneficiary’s shareholding structure (for example whether other shareholders in joint ventures may prevent or disincentivize cross-subsidization); functional, economic and organic links (such as joint or overlapping management); and other links, such as centralized management or support functions, common or coordinated strategies, the need for central authorization of important decisions. Economic links such as group-level financial synergies, centralized or interconnected financing, economic interdependence and industrial or vertical integration may point towards distortion.

In a typical corporate group acting globally through wholly or nearly wholly owned subsidiaries, many of these criteria will often be met.  The Guidelines discount the effectiveness of restrictions on cross-subsidization in corporate by-laws, guidelines, policies or management practices (unless amendments would require third parties’ consent), as well as transfer pricing rules requiring group members to interact on arm’s-length terms.  Thus, if the Commission identifies foreign subsidies received by a group that is currently or potentially active in the EU, those subsidies are likely to be found to strengthen its competitive position in the EU.  Exceptions include subsidies that would qualify for authorization under EU State aid rules and those for non-economic purposes, such as the inclusion of minorities or persons with disabilities, or compensating for natural disasters or “exceptional occurrences” (such as the Covid-19 pandemic). 

The Commission’s approach appears to presume distortion unless the parties can point to specific factors preventing cross-subsidization, even if there is no evidence that cross-subsidization has occurred or is planned.  Indeed, the Commission recently found evidence of distortion (in an ex officio context) due to “the absence of any credible legal or economic factors preventing or rendering unlikely the transfer of resources.”  This approach is arguably contrary to a July 2024 Staff Working Document (the Staff Working Document), which noted that “[I]n the case of a foreign subsidy that has been granted to a subsidiary not active in the Union, where that subsidy has been granted and effectively used in order to develop the local activity of the subsidiary in a third country, the relationship with the internal market is not apparent” (para 7).

Distortion of competition.  If a foreign subsidy is liable to improve the beneficiary’s EU competitive condition, the next question is whether those subsidies are liable to alter or interfere with competition in the EU.  Again, the Guidelines take a broad approach.

An alteration of or interference with competition may relate to any activity the beneficiary engages or may engage in in the EU or any downstream, upstream, related or otherwise indirectly affected sectors. Although it is “in principle” up to the Commission to show the alteration or interference to competition, the foreign subsidy need not be the sole reason for the impact, and the Commission need not show an actual impact.  Moreover, while the actual or potential negative impact needs to be “appreciable,” there is no need to prove that such distortion is of a “serious nature.”

Thus, the concept of distortion of competition is broad, and the standard for showing an “appreciable” effect is low.  Once a foreign subsidy is found to improve the beneficiary’s competitive position in the EU, the Commission will have little difficulty finding a distortion of competition.

Distortion of the acquisition process.  The Guidelines briefly discuss the concept of distortion specifically in the acquisition context (paras. 60-64).  The Guidelines state that “whether foreign subsidies may have facilitated an acquisition by the undertaking under investigation that otherwise may not have taken place, or may not have taken place in the same way (for example, only on a smaller scale or scope, or on different terms) had it not been for the foreign subsidies. Secondly, the Commission will consider whether, by improving the competitive position of the acquirer, the foreign subsidy actually or potentially negatively affects competition in relation to the acquisition process”.

The Guidelines list ways foreign subsidies may facilitate the offering of more attractive terms, such as a higher purchase price, an improved financing structure or transaction perimeters more desirable to the seller.  Foreign subsidies may also allow the beneficiary to crowd out other investors, either by outbidding them or by deterring them from participating in an acquisition. The assessment relies on several indicators, including comparisons with competing offers.  Where this isn’t possible, the Commission may benchmark the price offered with the prices of comparable past acquisitions or rely on internal documents, including valuation models.

The foreign subsidies discussed in paragraphs 60-64 appear to qualify as “targeted foreign subsidies” (as discussed above) or even foreign subsidies directly facilitating a concentration (per Article 5(1)(d)) FSR).  But the Guidelines’ discussion of ways foreign subsidies can distort competition in the M&A context indicate that “non-targeted foreign subsidies” can also be caught.

Distortions in general.  The Guidelines explain that competition in the EU market may be distorted where a foreign subsidy actually or potentially affects the beneficiary’s behaviour in the internal market, and second, potentially alters or interferes with competitive dynamics to the detriment of other economic actors. The scope, purpose or conditions of the foreign subsidy may suffice to determine that a foreign subsidy actually or potentially affects the beneficiary’s behaviour, for instance (though the Guidelines don’t use the term in this context) in the case of targeted foreign subsidies.

Where foreign subsidies do not have a specific purpose or conditions indicating their potential impact, the Commission can rely on indicators such as the nature of the foreign subsidy, its frequency or periodicity, and the characteristics, competitive dynamics and evolution of the relevant sectors.  For example, subsidized financing may affect pricing or output decisions. Alternatively, a subsidy could prompt strategic decisions such as investments in capacity, innovation, expansion into new products/services or geographies, or acquisitions.  Financial support, such as guarantees, may alter the beneficiary’s attitude towards risk, inducing it to take higher risks either in the ordinary course of business or in its investment decisions.

The Commission provides examples of how foreign subsidies may distort subsidy beneficiaries’ operating or investment decisions. Foreign subsidies may also affect behavior by lowering investment costs and facilitating investments that a beneficiary may not otherwise have undertaken. Similarly, some foreign subsidies, such as unlimited guarantees, may enable the beneficiary to undertake higher risk investments by mitigating the negative consequences of such risk-taking behavior.  Foreign subsidies may affect the beneficiaries’ behavior in ways that negatively impact other levels of the value chain.  For instance, the expansion of the subsidized activity may increase demand for a certain input, which could limit competitors’ access, increase their costs or even crowd them out. The resulting reduction of rivals’ operations may negatively affect other suppliers of that input.

Improvements in a subsidized company’s competitive position can negatively impact rivals by reducing their sales and profits, resulting in their potential downsizing, marginalization and/or reduction of their incentives to invest and, at the extreme, their exit. The negative impact on competition may vary depending on the type of investment. For example, investments leading to increased production or an improvement and/or diversification of the beneficiary’s products/services may contribute to lowering the expected profits of rivals, or to discouraging future investments on their part.  Investments in excess capacity may deter rival’s entry or lead to their exclusion, especially in stagnating or declining industries. To evaluate the potential distortion, the Commission will also examine how rivals would likely react.

The Commission uses different indicators depending on the specific distortion being analyzed. Relevant indicators include the amounts involved, as well as the degree of vertical integration across the value chain.  The characteristics of the relevant sector and other stakeholders are also relevant.  For instance, the Commission may pay particular attention to the presence of economies of scale or scope as well as dependencies across the supply or value chain.

Call-in Powers

Recital 36 FSR notes that the Commission should exercise its powers to “require the notification of potentially subsidised concentrations that were not yet implemented . . . where it considers that the concentration or the bid would merit ex ante review given its impact” in the EU, although the mandatory thresholds are not met.  The Guidelines explain that the notion of “impact in the Union” includes both actual and potential impacts including on the production of goods or the performance of services in the EU, access to technology or intellectual property rights, or the availability of services.

In making its determination, the Commission will consider whether the target’s turnover does not reflect its actual or future economic significance; the strategic or important character of the current or future economic activity concerned, supply or value chains, and the strategic or important character of the target and the acquiror, notably when they own strategic assets such as critical infrastructure or innovative technologies; patterns in investments, acquisitions or participation in public procurement procedures throughout which influence or economic presence is built up in those sectors; and previous findings that the acquiror has received distortive foreign subsidies.

The Guidelines do not discuss how the Commission determines which economic activities, parties or assets are strategic or important.  The Guidelines recall, but are less specific than, the Commission’s (now withdrawn) communication on application of the EUMR’s Article 22 referral mechanism (e.g., para. 19).  The Commission may be expected to favor cases involving sectors referenced in the forthcoming foreign direct investment regulation (e.g., dual-use items and military equipment, artificial intelligence, quantum technologies, semiconductors, critical raw materials, energy, transport and digital infrastructure, electoral infrastructures and financial services).  The German government, however, has warned against mixing FSR and FDI review.

The Balancing Test

Under Article 6 FSR, the Commission may balance negative effects from distortive foreign subsidies against potential positive effects, potentially leading to the approval of a transaction that would otherwise be prohibited or cleared subject to commitments.  The Guidelines “provide guidance on the methodology that the Commission will typically apply in performing the balancing test, including concerning positive effects that the Commission can take into account, and the procedure that the Commission will follow when performing the balancing test in individual cases” (para 100).

In line with Article 6(1) FSR, the positive effects to be taken into consideration include both positive effects in the EU and positive effects on “other policy objectives,” including benefits outside the EU.  Positive effects in the EU could include making it possible for subsidized activities to exist at all or changing the development of the activities.  Of course, subsidies granted and used outside the EU are commonly intended to achieve benefits outside the EU.  Positive effects arising outside the EU may nonetheless be taken into account, for instance where foreign subsidies contribute to global welfare improvement or the preservation of global public goods, such as climate change mitigation in a third country or biodiversity, social standards (including human rights protection), or the promotion of R&D relating to innovative products or technologies.

In performing the balancing test, the Commission must take account of the nature, purpose, conditions, use and amount of the foreign subsidy, as well as factors such as the sectors affected.  Positive effects are less likely to outweigh negative effects of foreign subsidies deemed most likely to distort Article 5(1) FSR, such as subsidies directly facilitating a concentration. The significance of positive effects depends inter alia on the nature of the effects; their relation to the relevant policy objectives; their intensity; and their timing.

Relevant positive effects should be “merger specific”; i.e., absent the foreign subsidies, the positive effects would not occur at all or to the same degree.  These effects must be verifiable, and the distortive effects should not go further than required to generate the resulting positive effects.  It is up to the acquiror to provide information that establishes their existence, although other interested parties and Member States may also submit such information.  The more precise the positive effects, and the more convincing the evidence submitted, the better the Commission can evaluate the claims. Vague, general or theoretical claims, or claims which rely exclusively on the person’s own commercial interests, are not sufficient.

The Guidelines do not discuss the similarities and differences between the FSR balancing test criteria and the EUMR efficiency defense, as outlined in the Commission’s 2004 horizontal merger guidelines.  The Commission has never relied on the efficiencies defense to approve a transaction under the EUMR, a fact that has drawn criticism in the Commission’s ongoing merger guidelines review.  With so few in-depth FSR merger investigations, the FSR balancing test may remain similarly dormant.

Takeaways and Unanswered Questions

The Guidelines tackle three important issues for merging parties, but by far the most significant is the concept of distortion of the EU internal market.  The Guidelines adopt a confusing distinction between targeted and non-targeted foreign subsidies to identify those that can improve beneficiaries’ competitive position, then abandons the distinction when discussing which foreign subsidies can distort competition.  But the bottom line is clear; even subsidies granted and used entirely outside the EU by sister companies of the merging parties can be found to distort the EU internal market unless notifying parties can show that “credible legal or economic factors” prevent resources freed up by those subsidies being transferred, directly or indirectly, into the EU.

In principle, the Commission could use its broad interpretation of distortion to aggressively expand FSR merger review.  In practice, the high volume of notifications, limited resources and political pushback would likely rein in such an effort even if the Commission wanted to ramp up FSR merger reviews.  Instead, the Commission seems likely to continue focusing on a small number of foreign subsidies in a few key deals – potentially using its call-in powers for the first time – pending completion of its FSR review next summer. 

Nonetheless, it is regrettable that the Commission did not use the Guidelines to address some of the practical questions that have arisen in FSR merger review.  These include the interpretation of foreign subsidies “directly facilitating a concentration” (Article 5(1)(d)), the only M&A-specific foreign subsidies considered most likely to be distortive.  In 2024, Commission staff indicated in an FSR Brief that foreign subsidies not intended to be used in a specific transaction could nonetheless be counted as directly facilitating it and called for extensive information on sources of financing, in particular for private equity limited partners.  Subsequently, the Commission clarified on its Questions and Answers page that investments from entities attributable to non-EU sovereigns are not problematic if they are “passive” and on “pari passu” terms (question 26).  But a more comprehensive and official treatment of foreign subsidies directly facilitating a concentration would be welcome.

Another set of questions relates to the treatment of foreign subsidies to the target, as opposed to the buyer.  Buyer subsidies seem more likely to distort the acquisition process, but the FSR does not make a distinction.  The Commission’s Form FS-CO requires more information regarding buyers’ subsidies, but still calls for information on target subsidies presumed to be distortive under Article 5(1) FSR.  More information on when the Commission will need more information on target subsidies, and how it assesses potential distortions from such subsidies, would also be welcome.

A third set of questions relates to the timeframe for distortions in the M&A context, as opposed to the ex officio context.   Article 19 FSR provides that “Only foreign subsidies granted in the three years prior to the conclusion of the agreement, the announcement of the public bid, or the acquisition of a controlling interest shall be considered in the assessment.”  This clearly rules older foreign subsidies out of bounds, but it is less clear about distortions arising post-closing.  The Staff Working Document observed that “it is not excluded that foreign subsidies lead to distortions with respect to the merged entity's activities” where the effects of foreign subsidies “granted in the three years prior to the conclusion of the agreement” “may not have materialised at the time that the concentration is completed.”  Guidance on how the Commission assesses the risk of distortions materializing after closing, and for how long, would be especially relevant to remedy design.

In less than three years, FSR review has emerged as a key regulatory obstacle for large transactions, sometimes the last standing between the parties and closing.  In the Guidelines, the Commission addresses three key issues for merging parties and their advisers.  The Guidelines stake out broad interpretations, preserving maximum flexibility.  But for practical guidance, the antitrust community will continue to turn to other sources.