A New European Commission Proposal on Foreign Direct Investment Screening: Towards Greater Harmonization?

I. Background

On June 20, 2023, the European Commission and the High Representative for Foreign Affairs and Security Policy published a Joint Communication on the European Economic Security Strategy. The Strategy was adopted to reduce risks to the European Union’s economic security amid rising geopolitical tensions and rapid technological changes. The Strategy is structured according to a three-pillar approach: promoting competitiveness, protecting against risks and partnering with like-minded countries.

It is in this context that the Commission announced five new initiatives on January 24, 2024:

  • a legislative proposal for the revision of the FDI Screening Regulation (inbound investments);
  • a white paper on potential security risks linked to EU investment in non-EU countries (outbound investment);
  • a white paper on how to make export controls more effective for export of goods with both civilian and military use (dual-use goods);
  • a white paper on enhancing support for research and development involving technologies with dual-use potential; and
  • a proposal for a Council recommendation on enhancing research security.

Although we focus in this alert on the first initiative – concerning the screening of inbound investments – it is interesting to note that the Commission is also looking at ways to reinforce the screening of outbound investments, to prevent leakage of EU technology and know-how that could be used by third countries to enhance their intelligence and military capabilities.

II. Current situation

The current FDI Screening Regulation has been applicable since October 11, 2020. One of its main objectives is to ensure that any effects of foreign direct investment on security and public order outside the borders of the Member State in which the investment takes place can be addressed. To that end, the Regulation introduced a cooperation mechanism allowing Member States and the Commission to comment on foreign direct investments in other Member States. Member States must notify the Commission and the other Member States of any FDI in their territory that is undergoing screening under their national screening regime. In addition, the Regulation makes it possible for Member States to comment on FDI in another Member State that is not undergoing screening there. 

The current FDI Screening Regulation falls short of requiring Member States to introduce an FDI screening mechanism, but it does set out some minimum requirements that all national mechanisms must respect, such as non-discrimination between third countries, transparency, protection of confidential information, anti-circumvention provisions and the availability of recourse against screening decisions. In addition, the Regulation lists some factors that Member States may take into consideration in determining whether an FDI is likely to affect security or public order, such as whether the FDI concerns a sensitive sector (e.g., critical energy, communications or transport infrastructures; critical technologies such as AI, robotics and semiconductors; critical inputs including raw materials and energy; access to sensitive information, including personal data; press and media) or the identity of the foreign investor involved (e.g., whether the investor is directly or indirectly controlled by a foreign government).

Currently, 24 out of 27 EU member States have enacted FDI screening legislation, including, most recently, Bulgaria and Ireland. In Bulgaria, the mechanism entered into force on March 12, 2024; in Ireland, it is expected to come into force during Q2 2024. Other relatively late joiners of the FDI screening club include Belgium (July 1, 2023) and Luxembourg (September 1, 2023). Croatia, Cyprus and Greece are still at various stages in the process of adopting a screening mechanism.

III. Rationale of the new proposal

The Commission carried out an evaluation of the current FDI Regulation. Overall, the evaluation report highlighted a lack of harmonization as the biggest issue of the current FDI Regulation. In particular, the following shortcomings were identified:

  • There is no obligation for Member States to have an adequate screening mechanism.
  • There are no clear guidelines as to the scope of Member States’ screening mechanisms. If the scope is defined too narrowly, some investments may not be covered.
  • Member States define key concepts differently, which results in confusion and uncertainty.
  • There are no minimum common criteria to determine which investments should be assessed.
  • The deadlines to respond are the same for the Commission and the Member States, potentially leaving the Commission insufficient time to consider any comments made by Member States.
  • The timetable for submitting comments in the framework of the cooperation mechanism is determined by the start of a formal screening procedure, and this is in the hands of the Member State concerned.

IV. What’s new

The new proposal aims to address these concerns by strengthening harmonization and enhancing cooperation and information exchange between Member States. The main proposed changes are as follows:

  • The proposal would for the first time introduce an obligation on all Member States to adopt a screening mechanism and to notify those mechanisms (or any changes to existing mechanisms) to the Commission. Existing mechanisms would have to be aligned with the requirements of the new Regulation if necessary.
  • The proposal would cover not only investments in existing EU-based targets, but also in newly established targets (greenfield investments), if they are reportable at Member State level. However, passive, hands-off investments (such as portfolio investments) are excluded.  
  • In response to the judgment of the Court of Justice in Xella Magyarország , where the Court essentially decided that an EU company with a foreign ultimate beneficiary owner (UBO) should be regarded as an EU company under the current FDI framework, the definition of foreign investment would be updated to include investments by a non-EU investor through a subsidiary in the EU (see our previous alert discussing the Advocate General’s opinion in the Xella case). However, most of the existing FDI screening regimes in the EU already cover investments by EU entities directly or indirectly controlled by non-EU investors.
  • The proposal introduces a minimum sectoral scope, which would require that Member States’ screening mechanisms impose an authorization requirement for foreign investments where the target participates either (i) in one of the 20 EU-wide projects and programs listed in Annex I of the proposal (“Annex I investments” including, e.g., the Space Program, Horizon 2020, the European Defense Fund, etc.), or (ii) is active in one of the areas listed in Annex II of the Proposal (“Annex II investments” including, e.g., dual-use items, artificial intelligence, internet of things, virtual reality, critical medicines, etc.).
  • The proposal would improve the transparency of national screening mechanisms, inter alia by requiring Member States to publish an annual report with aggregated and anonymized data on screened investments. It would also grant investors certain due process rights: notably, before taking a prohibition or conditional clearance decision, screening authorities would have to inform foreign investors of the reasons for taking such a decision, and give them an opportunity to make their views known.
  • The proposal aims to streamline the EU-level cooperation mechanism, by requiring investors who have to notify their investments in several Member States, to submit their filings to all of them simultaneously (referencing the other filings) and by requiring reviewing authorities to coordinate with each other and send notifications to the cooperation mechanism on the same day. The Commission would be involved if the investment is likely to affect security and/or public order in more than one Member State, if it affects EU projects/programs, or if it has relevant information about the investment.
  • At the same time, the proposal attempts to limit review under the cooperation mechanism to the most critical cases. While Annex I investments would always have to be notified, notification of Annex II investments would only be required if: 
    • the foreign investor (or the foreign investor’s subsidiary in the EU) is directly or indirectly controlled by a foreign government; or
    • the foreign investor is subject to EU sanctions; or
    • the foreign investor (or any of its subsidiaries) has had a previous investment blocked or subjected to conditions by a Member State.
  • The proposal tightens up the procedures and deadlines of the cooperation mechanism, while giving the Commission more time to take into account comments from the Member States. Member States would have 15 calendar days, and the Commission 20 calendar days, to inform the screening Member State(s) that they intend to submit comments or issue an opinion on an investment. Member States would then have 35 days from receipt of a complete notification to submit their comments, and the Commission would have 45 days in which to issue its opinion. The screening authority would have to give “utmost consideration” to the comments of the Member States and the opinion of the Commission.
  • The proposal also harmonizes the information that Member States should collect in notifications. The Commission would be empowered to adopt a standard form to collect such information. In addition, the proposal tightens up the exchange of information between the Member States in the context of the cooperation mechanism: each Member State would have to designate a contact point and the Commission would set up a system to enable encrypted communications with the contact points. The proposal also includes provisions on the protection of confidential and classified information.
  • The proposal would also introduce an “own-initiative procedure”, allowing a Member State or the Commission to initiate a review of a foreign investment in another Member State if the investment has not been notified under the cooperation mechanism. A Member State would be entitled to do this if it considers that the investment is likely to negatively affect its security or public order; the Commission would be able to do this if it considers that the investment is likely to negatively affect the security or public order of more than one Member State. According to the proposal, Member States and the Commission would be granted “at least” 15 months after the foreign investment has been completed to initiate an own-initiative procedure. This lack of a firm deadline could create legal uncertainty.

V. Likely impact

The new proposal addresses some key issues, such as the diverging scope of screening mechanisms and the difference in key concept definitions across Member States. Furthermore, filing in multiple Member States is at present a complex exercise because the deadlines and screening procedures do not line up. This proposal contains certain provisions which aim to fix that.

If the draft FDI Regulation were to be adopted as proposed, most EU Member States would have to significantly amend their national screening regimes to achieve the proposed level of harmonization. However, in our opinion, Member States may resist moves towards far-reaching harmonization. After all, measures to protect national security and public order touch the core of national sovereignty and are, for that reason, the preserve of the Member States under the EU Treaties. The revised FDI Regulation is therefore unlikely to usher in a common EU-wide screening regime, and the changes it brings will probably be limited to tweaks to the existing cooperation mechanism.

The proposed revisions to the FDI Regulation are without prejudice to the implementation of other instruments recently adopted as part of the EU’s economic security strategy. In particular, the proposed Regulation would not prevent the application of countermeasures under the EU’s Anti-Coercion Instrument that affect foreign investors’ access to the EU. Similarly, the proposal would not affect the Commission’s assessment, under the Foreign Subsidies Regulation, of whether an investment is fueled by market-distorting foreign subsidies.

VI. Next steps and estimated timing

The proposal still needs to go through the legislative process and will not be final until both co-legislators (the European Parliament and the Council) have adopted it. With European elections coming up in June 2024, we expect that this will be a project for the next legislature. Furthermore, the proposal provides for a transitional period of 15 months. Therefore, a new Regulation is not likely to become fully applicable before 2027. However, we expect this proposal to spur the few remaining laggards among the EU Member States into action, pushing them to finally adopt an FDI screening mechanism on a voluntary basis. Member States may also pre-emptively adapt their regimes before the new Regulation enters into effect.

Karl Stas
Cyriel Danneels
Jean-Baptiste Blancardi