Caught between China’s growing economic expansionism, the erratic fluctuations of US trade policy and the weakness in its global supply chains exposed by the Covid-19 pandemic, the EU has declared its “open strategic autonomy” on trade. 

“To reap the full benefits of global trade, Europe will pursue a model of open strategic autonomy,” an EU white paper published in June reads. 

“This will mean shaping the new system of global economic governance and developing mutually beneficial bilateral relations, while protecting ourselves from unfair and abusive practices.”

The white paper focuses particularly on foreign subsidies, labelling them as an example of “state-sponsored unfair trading practices, which disregard market forces and abuse existing international rules” to dominate various economic sectors and distort markets, it reads. 

Ongoing tensions

While the white paper does not name any specific wrongdoers, and applies to any non-EU counterpart, China is the elephant in the room. 

“There’s a political idea behind the tightening of the foreign investment rules,” says Clemens Graf York von Wartenburg, a Brussels- and Frankfurt-based partner in the global law firm Dechert. “There’s a concern about Chinese investment and them snapping up assets at low prices from weakened EU companies.”

BusinessEurope, a business association representing companies in 35 European countries, also drew attention in its comments on the white paper to the “extensive subsidisation programmes” of China.

A foreign subsidy is defined as “a financial contribution by a government or public body of a non-EU state which confers a benefit to a recipient”, the white paper says. 

The contribution could consist of a transfer of funds in various forms — including to a subsidiary within the EU, foregone public revenue (such as preferential tax treatment or tax credits), or the provision or purchase of goods and services.

The white paper contends that subsidised buyers may be able to pay higher prices for EU assets and outbid unsubsidised domestic purchasers, preventing local companies from achieving efficiency gains or accessing key technologies. Worse, the goal of the subsidised buyer may be to establish a strong position in the EU market, or to transfer the technology it acquires with the purchase out of the EU. Finally, since EU public procurement markets are open to third-country bidders, a company backed by a foreign subsidy may be able to submit the low bid to win a contract, while EU companies are barred from bidding in that country’s procurement process.

Level playing field 

At the moment, the EU’s options for dealing with foreign subsidies are limited in terms of scope. And an FDI screening mechanism in effect in Europe only screens inbound investment for issues that raise security or public order concerns. 

To address the issue of unfair competition, the white paper proposes three options, known as modules. Each begins with a preliminary review of the transaction in question, followed by an in-depth investigation, if market distortion seems likely, and an EU interest test to determine whether its benefits outweigh any market distortion. There will be penalties for companies that fail to disclose relevant information, and remedial actions to redress the harm caused by the subsidy, including repayments, asset divestiture and prohibiting acquisition. 

• Module 1 addresses subsidies over €200,000 ($234,000) provided to a beneficiary already established or active in the EU, and would allow authorities to review its acquisitions or public procurement actions.
• Module 2 focuses on distortions caused by foreign subsidies that facilitate the purchase of EU targets — acquirers would have to notify authorities in advance.
• Module 3 applies to public procurement and would bar companies that have received distortive foreign subsidies from bidding. 

This last module is especially significant, says Mr York. EU spending on public procurement amounts to €2tn ($2.3tn) annually, or 14% of its GDP, EU statistics show. Bidding on EU public procurement contracts has historically been open to third-country bidders, while China’s markets are generally closed to EU companies. 

How best to move forward

Mr York thinks Module 1 could prove the most troublesome in practice for foreign investors, because it applies to companies that are already active and competing in Europe. In contrast, investors know what to expect in advance with Modules 2 and 3.

The hoops that companies will have to jump through to get approval will make the process of FDI more complex, and will require more preparation by an investor, Mr York continues. Furthermore, he notes, investors could find themselves undergoing three investigations at the same time: anti-trust, FDI screening and foreign subsidy scrutiny. 

Nikolaus von Jacobs, a partner in the Munich office of the international law firm McDermott Will & Emery, says the proposed rules would have a heavy impact on the transaction security of foreign mergers and acquisitions, affecting the probability of a closing and delaying it. They could even reduce competition because they could hinder market players from participation and lead to depressed prices.

The China Chamber of Commerce to the EU reacted negatively to the white paper’s conclusions, contending new legislation was unnecessary and that the options presented lacked a legal basis. The Chinese Mission to the EU also weighed in, warning the EU not to “send negative signals” to the outside world and to “refrain from creating new trade barriers under the pretext of subsidies”. 

The American Chamber of Commerce to the EU said the EU’s concern about unfair subsidies is legitimate. However, it recommended adapting the EU’s existing state aid rules and avoiding unnecessary new levels of administration, prolonged procedures and discretionary decisions not capable of judicial review. It called for changes “that allow the EU to remain an attractive investment environment to the greatest possible extent”. 

While welcoming the white paper as a good basis, BusinessEurope called for “a more focused and consistent instrument”. It added: “The European Commission needs to communicate clearly to partner countries that the instrument is not protectionist, does not seek to exclude FDI and only aims to level the playing field.”

The public comment period for the white paper has closed and the Commission hopes to have a law in place by mid-2021. Lawyers say the issue is not yet on most companies’ radar. But start preparing, they warn.

This article first appeared in the October - November print edition of fDi Intelligence