September 2022

By Stephany Vargas

In late spring 2021, the European Commission released a proposal for a new Regulation on Foreign Subsidies Distorting the Internal Market. At the time, Blue Star had examined the ways in which the proposed piece of legislation would impact companies looking to invest and operate in Europe. A little over a year later, the text has made its way through the EU’s legislative process and is now expected to come into force around the middle of 2023.

EU Member States have long had strict limits placed on the amount of subsidies they can provide to companies operating in the single market in order to ensure a level playing field. The existing rules allowed subsidies granted by non-EU Governments to go largely unchecked, while subsidies granted by Member-States were subject to close scrutiny. The new regulation intends to place the same limits on subsidies provided by non-EU countries. While the measure is squarely aimed at China’s brand of state-sponsored capitalism, it will nevertheless affect all companies who benefit from public funding, irrespective of their country of origin.

The broad geographical scope of the upcoming regulation should cause all non-EU companies operating in Europe to brace for impact. In addition, Brussels’ text could potentially be at odds with the toolkit Washington is developing to maintain its competitive edge and confront an economically ascendant China.

The EU targets all subsidies

Beijing’s well-documented recourse to massive state subsidies to help Chinese companies gain global market shares clearly sparked the drafting of the new EU regulation on foreign subsidies. This is made all the more apparent by the fact that several of the European businesses who intervened in public consultations and called for stronger rules to reign in the distortive effect of foreign state aid in the European market explicitly mentioned Chinese subsidies.

However, policymakers in Brussels are keen to preserve the EU’s economic openness and remain committed to the WTO’s non-discrimination principle. As a result, the upcoming piece of legislation focuses on shielding strategic parts of the EU’s economy from any and all distortive subsidies, irrespective of their country of origin. The text makes no mention of specific sectors but industries that participated in public consultations included transportation, energy, infrastructure, semiconductors, steel, and aluminum manufacturers.

The current text differs from the earlier versions in two important ways. First, the latest iteration of the new regulation does not concern subsidies received more than five years before the date of the text’s entry into force. The Commission had initially envisaged a ten-year retroactive effect. Second, the new regulation now explicitly states that ‘financial contributions’ by state-owned enterprises can potentially constitute a distortive subsidy.

Outside of those two changes, the proposed text from May 2021 came out of the European Parliament and the Council’s back-and-forth largely unchanged. As it currently stands, the new regulation requires all companies having benefited from a state’s ‘financial contribution’ in the past five years to notify the Commission of the subsidies. Notification must take place before and after acquiring or merging with European undertakings. In the case of public procurement procedures, a notification has to accompany the request to participate and the final tender.

The regulation then empowers the European Commission to investigate whether the state’s financial contribution had a distortive effect on the internal market. It also allows the Commission to impose fines worth up to 10% of a company’s revenue, to require the reimbursement of distortive financial support, to call for the divestment of certain assets, or even to unwind an acquisition enabled by a distortive state subsidy.

The broad definition of what constitutes a ‘financial contribution’ will catch tax credits and other indirect transfers. It will also likely include Covid grants and loans. In addition, the text affords the Commission a large discretion in choosing which transactions to scrutinize. This likely means that most non-EU firms operating in the single market potentially fall under the scope of the new regulation.

The US fights subsidies with subsidies

With the upcoming piece of EU legislation having such a broad scope, US companies may be among its unanticipated collateral victims. While China’s state-sponsored capitalism causes just as much, if not more, concern in Washington than it does in Brussels, the United States has chosen a different method to confront it. Rather than targeting subsidies, the Biden Administration has decided to increase public funding to stimulate US growth, innovation, and economic competitiveness.

Over the course of the past several months, the United States have championed a series of measures to promote and strengthen critical sectors via increased public investment. Recent prominent examples of this new approach have included:

  • The Innovation and Competition Act, which plans to allocate $49 billion to foster energy development, develop telecommunications technology, and finance research on artificial intelligence.
  • The Infrastructure Investment and Jobs Act, which plans to set aside $550 billion to fund major transport and energy infrastructure projects, as well as to support the deployment and adoption of electric vehicles.
  • The recently voted CHIPS and Science Act, which plans to inject more than $52 billion into US companies producing chips and semiconductors.

These initiatives would all be potentially subject to evaluation under the EU’s new regulation on foreign subsidies.

Not getting caught in the crossfire

All non-EU companies operating in the single market should prepare for a major shift in the European regulatory environment. The new regulation is but one of several major pieces of legislation currently in the EU pipeline. The articulation of the new rules on foreign subsidies with the upcoming anti-coercion instrument or the planned directive on corporate sustainability due diligence will likely trigger transformative change in the single market.

A factor that may ease the regulatory transition is the enhanced economic coordination that has taken place between Brussels and Washington in recent years. Several bilateral formats, like the EU-US Trade and Technology Council, provide venues for both sides to better coordinate their approach vis-à-vis China and minimize externalities for companies on both sides of the Atlantic. In addition, the Commission plans to issue further guidance in the first 12 months of using the regulation, which should eventually help all non-EU firms comply with the new rules.

Nevertheless, US companies should prepare for the upcoming European regulatory shift. The rising storm over the Biden administration’s plan to offer tax credits to US consumers who buy electric vehicles assembled in North America provides a vivid illustration of lingering transatlantic disagreements over how to best adjust to changing geopolitical realities. As large US public investment programs get underway, recipients of government funds will have to comply with the regulation on foreign subsidies, for instance by including subsidy-offsetting remedies in their investment plans or by entering into ad-hoc negotiations with European regulatory authorities, in order to operate in the EU optimally.