Committed Capital

Sidecar: The New EU FSR’s Impact on Private Equity Transactions

• Dechert LLP • Episode 14

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The new EU Foreign Subsidies Regulation (FSR) aims to address potential market distortions caused by subsidies from outside the EU, introducing new European Commission reporting obligations for private equity firms. In this Sidecar, Dechert partners Saira Henry, Michael Okkonen, and Clemens York discuss how private equity firms can adopt proactive strategies and thorough due diligence to effectively navigate the new regime. 

Show Notes 

“The Regulatory Gauntlet: Dealmakers Face Increased Scrutiny,” Dechert OnPoint (Nov. 5, 2023) 

Clemens York:

Music.

Intro:

Welcome to Dechert's Committed Capital. This is an episode of Sidecar, a special bite-sized discussion of the latest market issues.

Saira Henry:

Hello, and welcome to Committed Capital, Dechert's ad hoc, bite-sized podcast covering updates on developments that will affect private equity. My name is Saira Henry, and I'm a partner based in our London office, practicing EU and UK competition law.

Mike Okkonen:

Hi everyone. I'm Mike Okkonen, a partner in our antitrust group, and I'm based in our Brussels office.

Clemens York:

And I'm Clemens York. I'm a partner in our Brussels and Munich offices, and I specialize in antitrust and FDI clearance processes in the EU and globally.

Saira Henry:

In this episode, we will be speaking about the impact of the new EU foreign subsidies regulation on private equity transactions. The foreign subsidies regulation, or FSR, establishes a new regime designed to address market distortions caused by subsidies from outside of the EU, and introduced in an obligation to notify certain transactions to the European Commission. Almost a year since taking effect, the commission has reviewed a number of notifications and launched one in-depth investigation. Mike, perhaps you can address the type of transactions that fall within the scope of the FSR and the corresponding notification obligations.

Mike Okkonen:

Sure, Saira. PE firms must notify transactions involving acquisition of a target with EU-wide revenues exceeding 500 million euros and involving 50 million euros of financial contributions received from non -EU state actors in the three years preceding the deal.

Saira Henry:

Thank you. There's a second question that would be top of mind, which is whether it's necessary to notify a reportable transaction prior to closing. Could you address that question?

Mike Okkonen:

Yes. In short, it's necessary. And this is important for our listeners to know if PE firms fail to notify a reportable transaction or close before clearance, they may face a financial penalty of up to 10% of their aggregate worldwide revenues. This is a significant risk that PE firms need to be aware of.

Saira Henry:

Thank you. Clemens, perhaps you can address the issue of the significant administrative burden that results from this new regime.

Clemens York:

Sure, Sara, it is true that GPS may face more significant obstacles than strategic players under the FSR because of the typical structure of PE funds and the elements that are considered as a financial contribution. So, the FSR adopts a group-wide view to determine if jurisdictional thresholds are met, which means that a filing would be triggered. In a PE context, a group generally consists of different funds controlled by the same investment firm and portfolio companies controlled by those funds, investors are going to need to look at all of their funds, even the ones that are not involved in the transactions, and the portfolio companies in which those funds are invested. So, it's a pretty broad approach that may seem unusual to PE investors who are used to focusing on the investing fund only.

Saira Henry:

interesting. A financial contribution has been mentioned a few times, so we should cover what that means. A foreign subsidy is deemed to exist when a third country that's a non-EU country, provides, directly or indirectly, a financial contribution which confers a benefit on the recipient, and includes the following: the transfer of funds or liabilities- such as capital injections, grants, loans, loan guarantees - it can, using the language of the regulation, include foregoing of revenue that is otherwise due. So, examples are tax exemptions or granting special or exclusive rights without adequate remuneration. In the PE context, specifically, financial contributions could include, for example, commitments received by funds from certain limited partners that are non-EU government entities or from private entities whose actions can be attributed to non -EU government entities or supply agreements concluded between portfolio companies and non-EU government-related entities for goods and services. To limit scrutiny from an FSR perspective, the foregoing should be provided on arm's-length terms. Mike, perhaps you can cover investigations by the commission where transaction is not notified.

Mike Okkonen:

Sure. What PE firms should also be aware is that outside of notifiable transactions, the European Commission has two tools to investigate deals on its own initiative. First, the commission can request PE firms to notify a deal potentially involving foreign subsidies that does not meet the jurisdictional thresholds and has not yet closed. In such case, the parties will be subject to a standstill obligation and will not be able to close the deal until the commission grants its approval. Second, the commission can launch a general own initiative investigation into any transaction that has already closed, even into acquisitions of a non-controlling state or green-field investments. These two tools serve as a "catch all."

Saira Henry:

Thanks. So, it's clear that the commission has the tools at its disposal to enforce the FSR. This, together with the penalties for non-compliance, really underscores the importance of awareness and readiness. So, GPs who have done their homework will have an advantage, as they can indicate to the seller early on whether a filing is required and the consequences thereof. GPs should also keep under review the potential FSR risks, such as the potential consequences of any financial contributions and the remedial action that could be required to obtain approval for transactions

Clemens York:

That's a good point, and it leads us to in the future. another really important aspect, and that is integrating the FSR into the usual pre-closing due diligence. Now, comprehensive due diligence on potential third-country subsidies can help investors better understand the impact the FSR can potentially have on deal valuation and financing. Due diligence findings on FSR-related aspects also need to be reflected when planning the deal timeline. That way, investors can ensure that there's adequate time for filing preparation and approval process. Once the parties are ready, they should engage in pre-notification discussions with the commission to make sure that the review process is as smooth and predictable as possible. That type of dialog helps to ensure the commission has the information it needs to fully evaluate the filing during the preliminary review phase, and does not need to undertake an extended review of the transaction later on. Exchanging with the commission also provides the parties with early indications of possible substantive concerns. To ensure a smooth process, investors should have the relevant information prepared and be ready to engage with the commission prior to formal notification.

Mike Okkonen:

Those are excellent points, Clemens. And to add to that, PE firms on both the buyer and the seller side should incorporate appropriate contractual protections in the SPA to address potential FSR-related risks and remedies. Such provisions include risk-shifting provisions, conditions to closing and long-stop dates. Effective contractual structures can help parties manage the potential impact of the FSR on deal valuation, financing and post-transaction integration.

Saira Henry:

Thanks, both. Any concluding remarks?

Clemens York:

Well, Saira, it's pretty clear that the FSR is going to significantly impact many PE transactions in the EU, if their transactions are caught, GPs are going to need to navigate another regulatory hurdle that introduces additional due diligence requirements and may create risks related to timing and deal certainty. Our advice is that GPS should better manage FSR-related risks by adopting proactive strategies and carefully considering the potential impact of the FSR on their transaction as early as possible in the process.

Mike Okkonen:

I fully agree with Clemens. The key is early preparation and thorough due diligence. With these, PE firms can navigate the FSR effectively and ensure the success of their transactions.

Saira Henry:

Thank you, and thank you to our listeners for joining us on this episode of Committed Capital. If you found today's discussion interesting, feel free to reach out to us or your usual Dechert contacts with any specific questions. You can find all of our resources online, including other Committed Capital podcasts as they become available. Dechert looks forward to bringing you more updates on developments affecting private equity in our next episode.

Outro:

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