The EC publishes clarifications on the assessment whether Foreign Subsidies distort the internal market

The Foreign Subsidies Regulation¹ (“FSR”) entered into force just over a year ago (12 July 2023). Since then, the European Commission (the “Commission”) has received hundreds of FSR notifications relating to mergers and public tenders, and launched a handful of investigations with significant repercussions on targeted undertakings, amidst broader geopolitical ramifications.

In the past months Commission’s officials mentioned that they would refer to State aid rules to assess whether financial contributions obtained outside the EU constituted foreign subsidies, leaving however open the question of when and where foreign subsidies would be considered as affecting competition in the internal market.

On Friday 26 July, the Commission has finally published initial clarifications about the case-by-case assessment of whether foreign subsidies distort the internal market. The guidance is contained in a “Commission Staff Working Document” titled “Initial clarifications on the application of Article 4(1), Article 6 and Article 27(1)” (the “Working Document”) and published on the Commission’s website.²

The FSR does not prohibit all “foreign subsidies” (as defined in its Article 3(1)), but it provides that “[o]nce the existence of a foreign subsidy is established, the Commission should assess on a case-by-case basis whether it distorts the internal market.”³.

While the FSR provides a list of criteria that can be used for the purpose of that assessment (Article 4(1) FSR),⁴ these criteria are not exhaustive and they can easily be subject to divergent interpretations. This creates a situation of legal uncertainty, which makes it very difficult for undertakings to proactively evaluate the risks that foreign subsidies could be considered as distortive under the FSR.

In this update we analyse some of the key aspects of the Working Document.

The analysis of whether a foreign subsidy distorts the internal market (Article 4(1) FSR)

The Commission must establish a causal link between the foreign subsidy and the competitive position of the recipient.

The Working Document confirms that the Commission must “establish a relationship between the foreign subsidy and the activities of the undertaking in the internal market”.⁵ It provides two examples:

• First, “in the case of an interest-free loan provided by a third country directly to an EU entity active in the internal market, there is, prima facie, an apparent connection between the alleged subsidy and the activity in the internal market.”⁶
• Second, “[i]n contrast, in 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.”⁷

Based on these examples, for the purpose of establishing the causal link between the foreign subsidy and the internal market, the Commission appears to focus on the flow of a foreign subsidy to an EU entity active in the internal market, which it states would, on the face of it, evidence a connection between the foreign subsidy and activity in the internal market. In contrast, where a foreign subsidy flows from a third country to an entity active in a third country, and where that subsidy was only employed for activity in the third country, the relationship between the foreign subsidy and the activities of the undertaking in the internal market will not be apparent. As a matter of principle, that could for instance exclude foreign subsidies provided to related companies of an EU entity, insofar as those subsidies are aimed at developing an economic activity exclusively in the third country.

That said, the Working Document notes that foreign subsidies with no apparent relationships with an activity in the internal market can still be considered distortive, for instance where they are used in the group to cross-subsidise activities in the internal market.⁸ In other words, cross-subsidisations from a subsidiary outside the EU to a related EU entity may be considered as evidence of a relationship between the foreign subsidy and the activities of the undertaking in the internal market. Undertakings with entities active in the EU should be mindful of the Commission’s potential scrutiny over cross-subsidisation strategies, and establish safeguards where they are employed, if they want to mitigate the risk of adverse actions by the Commission based on the FSR.

The foreign subsidy must negatively affect competition in the internal market.

The Working Document restates that, for it to be considered distortive in the sense of Article 4(1) FSR, the foreign subsidy must “actually or potentially negatively” affect competition in the internal market.⁹

At first sight, this seems to mirror the test set out in Article 107(1) of the Treaty on the Functioning of the European Union (“TFEU”) in relation to subsidies granted by EU Member States (i.e. State aid).

However, on closer inspection, there are important differences between the State aid and FSR tests.

• In the field of State aid, the condition that the subsidy must “distort competition” does not as a matter of principle require the Commission to carry out a detailed assessment of the competitive impact of the State aid on the market. As a general rule, that condition is fulfilled insofar as the recipient has received a selective financial advantage and it operates on a competitive market. Only in very exceptional scenarios, and subject to strict cumulative conditions, the Commission will consider that State aid granted to an undertaking would not negatively affect competition.
• The same does not hold true for Article 4 FSR. The Working Document clarifies that, unlike in the State aid framework, “under Article 4 [FSR], the Commission cannot presume that the foreign subsidy distorts the internal market just because its beneficiary is engaged in an economic activity in a liberalised sector in the internal market. Rather, it will need to determine whether a distortion can be deemed to exist on the basis of indicators such as those listed in Article 4(1) [FSR]”.¹⁰ 

This is an interesting clarification. It suggests that, as a general rule, the Commission will be required to carry out an empirical and evidenced-based (economic and legal) analysis of the impact of foreign subsidies on competition in the context of FSR investigations.

However, the significance of this requirement could be limited in practice, given that, first, the Commission has a wide margin of discretion in the context of appraising actual or potential distortions based on the available evidence. Second, in relation to foreign subsidies listed in Article 5(1) FSR (i.e. the most “problematic” subsidies), the Commission will rely on presumptions and it will unlikely undertake any detailed analysis, as explained in the Working Document and outlined below (in this regard, see 2, below).

The indicators listed in Article 4(1) FSR are not exhaustive and they do not have to be mandatorily assessed in every FSR investigation.

The Working Document confirms that Article 4(1) FSR provides a non-exhaustive list of indicators to establish whether a foreign subsidy distorts the internal market. This was already clearly stated in the FSR.

The Working Document also confirms that undertakings should not expect that the Commission will assess all those criteria in each and every FSR investigation. In fact, “the Commission will assess each case on its merits and will use the relevant indicators as appropriate to assess the distortive effect of the subsidy”.¹¹ It also notes that a detailed assessment based on indicators is not required in the case of subsidies falling under Article 5(1) FSR (i.e. the categories of foreign subsidies most likely to distort the internal market) (in this regard, see 2, below). This confirms the wide margin of appreciation of the Commission in this field.

The Commission will apply a presumptive approach to the assessment of foreign subsidies most likely to distort the internal market (Article 5(1) FSR)

Article 5(1)(a)-(e) FSR provides an exhaustive list of categories of foreign subsidies which are, as a general rule, considered to distort the internal market. The Working Document notes that “[i]n practice, foreign subsidies that fall under Article 5 [FSR] will normally be considered distortive, unless the facts specific to the case show that there is unlikely to be a negative effect on competition in the internal market”.¹²

That passage confirms that the Commission will apply a presumptive approach for the purpose of assessing foreign subsidies in Article 5(1) FSR. Absent proof to the contrary, the Commission will likely presume that these categories of foreign subsidies distort the internal market. However, undertakings will be allowed to rebut this presumption by demonstrating the absence of negative effects on competition in the internal market (in the sense of Article 4(1) FSR). That said, it will likely be very difficult to rebut this presumption, until the Commission provides further guidelines on how it will practically evaluate the distortive effects of foreign subsidies.

In addition, undertakings that have received subsidies falling within the categories listed in Article 5(1) FSR can show that the balancing test under Article 6 FSR justifies the relevant foreign subsidies (albeit that, as stated in Recital 21 FSR, undertakings should be aware that “[i]n the case of categories of foreign subsidies that are deemed most likely to distort the internal market, positive effects are less likely to outweigh negative effects”).

The analysis of foreign subsidies in public procurement cases

The Working document confirms that the Commission is required to assess two key conditions when considering distortions arising from foreign subsidies related to public procurement procedures.

First, the Commission must consider whether the tender is “unduly advantageous” .¹³ These are in fact two separate criteria.

• The tender must be “advantageous”. According to the Working Document, this requires comparing the allegedly subsidized tender with the other bids submitted in the procurement procedure, as well as consideration of the documents prepared by the contracting authority showing its assessment of the competing bids. The Working Document seems to suggest that, if the allegedly subsidized tender is lower than competing bids, all other things being equal, it will likely be deemed “advantageous”.
• The advantage must be “undue”. This is likely to be the most controversial aspect of the test in public procurement cases. On the one hand, the Commission will need to consider whether the advantageous nature of the tender benefiting from foreign subsidies can be justified by other factors (than the subsidy itself). The Working Document specifies that the Commission will take into account market information, e.g. provided by competitors, and other relevant factors.¹⁴ On the other hand, the recipient undertaking will be able to provide defensive arguments, notably relying on the criteria set out by the EU procurement Directives in relation to “abnormally low tenders” to justify its tender. These criteria include, for instance, explanations related to the economics of the manufacturing process, of the services provided or of the construction method, which could potentially justify the ability to offer a lower (and more “advantageous”) tender. 

Second, the Commission must establish a causal link between the foreign subsidy and the tender, meaning that “it must be shown, on the basis of the available information, that the foreign subsidy enabled or likely enabled, the economic operator to submit the unduly advantageous bid”.¹⁵ As previously noted, also in this context the Commission will have a broad margin of appreciation.

The Working Document suggests that this will require the Commission to carry out a case-by-case assessment of all available information, including the purpose of the foreign subsidy. However, it remains to be seen whether the Commission will carry out a robust counterfactual assessment (e.g. considering whether the recipient could submit the same tender in a scenario where it did not receive the foreign subsidy) or, as it appears more likely, it will infer the existence of a causal link from a set of indices.

The analysis of foreign subsidies related to “concentrations” 

The Working Document confirms that the competitive assessment of concentrations under EU Merger Control Regulation¹⁶ and the FSR are distinct and autonomous. It states that “although the same concentration may be analysed under [the FSR] and the EU Merger Regulation, the two Regulations pursue different objectives, so that a merger may be problematic under [the FSR] but not under the EU Merger Regulation (and vice versa)”.¹⁷

The Working Document also provides some useful guidance on how to consider the effects of foreign subsidies on “concentrations”. The key points are:

• Foreign subsidies received by the acquirer appear more likely to attract scrutiny and lead to distortive effects than those received by the target or the seller.¹⁸ However, “[s]ubsidies granted to the target (or in some circumstances, even to the seller) may also be relevant.”¹⁹
• Because the effects of the foreign subsidy may be produced only after the concentration takes place, the Commission can assess whether subsidies lead to distortions with respect to the merged entity’s activities.²⁰ In particular, while the review of notified concentrations does not concern foreign subsidies granted after the concentration, when assessing whether foreign subsidies granted prior to the concentration are liable to distort the internal market, the Commission may carry out a forward-looking assessment of distortions that could materialise after the concentration has been completed.²¹

The balancing test set out in Article 6(1) FSR

Article 6(1) FSR provides that “[t]he Commission may, on the basis of information received, balance the negative effects of a foreign subsidy in terms of distortion in the internal market, according to Articles 4 and 5 against the positive effects on the development of the relevant subsidised economic activity on the internal market, while considering other positive effects of the foreign subsidy such as the broader positive effects in relation to the relevant policy objectives, in particular those of the Union”.

The burden of proving these positive effects rests primarily on the recipient of the foreign subsidy. Undertakings should be aware that it will be very difficult to establish sufficient positive grounds to outweigh the (presumed or demonstrated) distortions resulting from foreign subsidies listed in Article 5(1). However, in theory all foreign subsidies could be justified as a result of the balancing test established in Article 6(1) FSR.

The Working Document recognizes that the Commission still needs to establish a consistent approach to Article 6 FSR, but it nonetheless provides some helpful initial guidance:

• Regarding the positive effects that can be invoked under Article 6 FSR, it is possible to rely on all “positive effects on the internal market have been acknowledged under the EU State aid rules”.²²

In the context of public procurements, the Working Document notes that “the Commission should also consider the availability of alternative sources of supply for the goods and services concerned”.²³ It could be argued that this could be relevant in scenarios in which, absent the tender of the subsidized undertaking, there could be a market failure (on the relevant geographic and product market), which would lead to the inability to provide essential services, following a similar rationale to the Altmark case-law²⁴ concerning State aid in favour “services of general economic interest”.²⁵

• The assessment under Article 6 FSR requires weighing the positive and negative effects of the foreign subsidy. The Working Document notes that the Commission will rely on a broad range of evidence. In particular, “[t]he Commission will […] rely on submissions by all relevant stakeholders. Information which serves to evidence the positive effects may be submitted at any point during the investigation, but at the latest in due time to enable the Commission to adopt a decision closing an in-depth investigation in line with the procedural time limits.”²⁶
• In terms of outcomes, the Working Document confirms that the balancing test can only be positive or neutral for the undertaking. It cannot lead to a situation where the undertaking will be worse-off as a result of the test.

In practice, according to the Working Document there are three possible outcomes: (i) a “no objection decision” pursuant to Article 11(4)(b) FSR, if the test shows that the positive effects prevail over the negative; (ii) conversely, where the negative effects prevail over the positive, the Commission could use the insights from the balancing test for the purpose of deciding which redressing measures to impose and or which commitments to accept; (iii) the test can also lead the Commission to consider that the foreign subsidies “do not have any, or only insignificant, relevant positive effects, so that remedies or commitments need not be adapted or that a concentration should be prohibited or that the award of the contract should be prohibited”.²⁷

* * *

To conclude, while the Working Document is a first step in improving clarity over the FSR, it leaves many questions open and confirms the significant margin of discretion of the Commission for the purpose of assessing whether foreign subsidies distort the internal market. This creates a situation of legal uncertainty that adversely affects undertakings operating in the EU.

Please reach out to our Hogan Lovells FSR team in case you have any questions, and if you would like to learn how to mitigate the risks of adverse investigations under the FSR.

Authored by Michel Struys, May Lyn Yuen, and Francesco Pili.

References

1 Regulation (EU) 2022/2560 of the European Parliament and of the Council of 14 December 2022 on foreign subsidies distorting the internal market (OJ L 330, 23.12.2022, p. 1–45).

2 It should be noted that the Working Document is not legally binding on the Commission. It provides preliminary guidance, which will be refined and complemented by the guidelines that the Commission will adopt at the latest by 12 January 2026.

3 Recital 17 FSR, emphasis added.

4 This provides that a distortion in the internal market “shall be determined on the basis of indicators, which can include, in particular, the following: (a) the amount of the foreign subsidy; (b) the nature of the foreign subsidy; (c) the situation of the undertaking, including its size and the markets or sectors concerned; (d) the level and evolution of economic activity of the undertaking on the internal market; (e) the purpose and conditions attached to the foreign subsidy as well as its use on the internal market”.

5 See Working Document, Q&A 1, p. 1.

6 See Working Document, Q&A 1, p. 1.

7 See Working Document, Q&A 1, p. 1.

8 See Working Document, Q&A 1, p. 1.

9 See Working Document, Q&A 1, p. 2.

10 See Working Document, Q&A 3, p. 2, emphasis added.

11 See Working Document, Q&A 2, p. 3.

12 See Working Document, Q&A 5, p. 3, emphasis added.

13 See Working Document, Q&A 6, p. 4.

14 See Working Document, Q&A 6, p. 4.

15 See Working Document, Q&A 6, p. 4, emphasis added.

16 Council Regulation (EC) No 139/2004 of 20 January 2004 on the control of concentrations between undertakings (OJ L 24, 29.1.2004, p. 1–22).

17 See Working Document, Q&A 4, p. 3.

18 See Working Document, Q&A 7, p. 5.

19 See Working Document, Q&A 7, p. 5.

20 See Working Document, Q&A 7, p. 5.

21 See Working Document, Q&A 8, p. 6.

22 See Working Document, Q&A 9, p. 6.

23 See Working Document, Q&A 9, p. 6.

24 Judgment of the Court of 24 July 2003, Altmark Trans and Regierungspräsidium Magdeburg, case C-280/00. In Altmark, the Court of Justice essentially ruled that compensation for costs incurred to provide a “service of general economic interest” can be considered not to provide an “advantage” to the recipient undertaking in the sense of Article 107(1) TFEU, to the extent that four cumulative conditions are complied with. This case law was developed in the context of scenarios of “market failures”, where State intervention is required because the entrustment of a public service task to an undertaking implies the supply of services which, if it were considering its own commercial interest, an undertaking would not assume or would not assume to the same extent or under the same conditions.

25 See Communication from the Commission on the application of the European Union State aid rules to compensation granted for the provision of services of general economic interest (OJ C 8, 11.1.2012, p. 4-14), which reflects the Altmark case law and decisional practice of the Commission.