The EU Foreign Subsidies Regulation: what does it really mean?

The EU Foreign Subsidies Regulation: what does it really mean?

In March, we held a roundtable event on the subject in Brussels, hosted together with Norton Rose Fulbright. In this article, drawing from our own insights and the discussion at the roundtable event, we take a look at its origins and outline the main considerations from an economic point of view.

The EU’s new Foreign Subsidies Regulation (FSR) entered into force at the start of this year and started to apply from 12 July. It is a significant development in EU competition and trade law, which aims to address distortions of competition in the EU internal market caused by foreign subsidies.

But as Margrethe Vestager, European Commissioner for Competition, said recently on the topic, ‘it’s complicated’ - the regulation was first proposed ‘in a simpler time’. And there are uncertainties surrounding how it will be implemented and what it will mean for businesses and practitioners.

The origins of the FSR

The genesis of the FSR does not lie primarily in competition policy concerns, but rather in a desire to plug a perceived gap in trade policy. The FSR forms part of the EU’s push for ‘strategic autonomy’, which aims to correct perceived distortions to international trade and investment by state-led models of investment and economic activity – particularly in China. In the case of foreign subsidies, the concern is that behaviours by China (and other economies with heavy state intervention) might create distortions that damage EU industries.

The EU’s approach has historically been to deal with matters like these within the framework of multilateral rules, particularly under the WTO. But gaps in these rules, and concerns that they are unfit for purpose, have led to the introduction of the FSR.

In addition, the western world has itself shown an increased appetite for subsidising domestic industry in recent years. This in turn reflects a confluence of factors: recovery from the Covid-19 downturn, the pursuit of decarbonisation objectives coupled with green-reindustrialisation objectives, and a desire to reconfigure global value chains in response to concerns about geopolitical rivalry. So while the original impetus for the FSR lies in an attempt to deal with the ‘Chinese model’, an increased appetite for granting subsidies among major industrial nations means the FSR now potentially targets a wider range of jurisdictions.

The spotlight on industrial subsidies and policy activism serves to highlight an important distinction between competition policy and trade remedies. The focus of EU competition policy is to enable the proper functioning of the EU’s internal market as a key driver for the well-being of EU citizens, businesses, and society as a whole, while the focus of trade remedies is primarily to avoid damages to particular industries. As we discuss later in this article, the tension between these two objectives, may complicate the enforcement of the FSR.

How to define a 'benefit'?

To qualify as a ‘subsidy’, and thus to come under the scope of the FSR, a financial contribution by a foreign state must ‘confer a benefit’. This phrasing seems to draw from the WTO Agreement on Subsidies and Countervailing Measures (SCM). In essence, this is a counterfactual test: is the recipient better off than they would have been without the financial contribution? 

This is similar to the concept of ‘advantage’ in state aid, which involves assessing whether a private operator, acting in its own commercial interests, would have made a transaction on similar terms as the public authority – i.e. whether the transaction was struck on market terms (also commonly referred to as the ‘private investor test’). It is a notion that economics is frequently involved in assessing, also for example, in transfer pricing cases (where a relevant question is whether profit allocation methods agreed with local tax authorities are in line with market outcomes).  

In some cases, identifying a benefit will be straightforward. For example, a state guarantee (given by a foreign government) for bank loans to foreign companies would clearly confer a benefit. 

Other cases will be less clear. For example, does a long-term contract for power purchases between an aluminium company and a state-owned power plant, at prices more favourable than other contracts, confer a benefit? Or is it just consistent with the sort of commercial arrangement any power utility might implement, given the benefit to the power plant of having a long-term contract in place with a large load that provides it with security to cover its fixed costs? The example points to the more general challenge of framing the counterfactual. 

How does a subsidy lead to harm to competition?

This would seem a central question, although there is no clarity on how the FSR would actually answer it. 

Under the FSR, the test for distortions in the single market requires two conditions:  

  1. The subsidy is liable to improve the competitive position of an undertaking. 
  2. In doing so, the subsidy negatively affects competition in the internal market.  

Formally, article 4 of the FSR says both conditions are relevant. But most of the FSR seems to focus on condition 1, which would ‘make it more like state aid’, where in practice, the competitive impact is often not analysed in great detail. 

A focus on condition 1 would also underscore the conceptual proximity between FSR and trade remedies, where the test is whether the subsidy or dumping causes adverse effects to domestic industry.  

Regardless of the relative weight assigned to conditions 1 and 2, however, it is unclear how one would actually formally demonstrate condition 2 (i.e. that a subsidy harms competition).

The text of the regulation seems to suggest that a subsidy can be treated a bit like an agreement or a concentration. But once you think more about it, it is not immediately obvious that that’s the case.

Mergers, for instance, tend to weaken competition, so showing a negative impact on competition in the internal market is just a question of materiality (however complex to assess in practice). However, foreign subsidies will tend to reduce companies’ costs and thereby strengthen competition in the markets in which they are active. While their competitors may perceive this to be unfair, foreign subsidies can be to the advantage of domestic downstream users or consumers whose interests competition policy seeks to protect.

So how could we go about establishing a negative impact on competition in the internal market under the FSR? 

One possibility would be to draw on theories of harm based on concepts of entry deterrence or predation. This would imply raising the potential concern that the foreign financial contribution received by Firm A could allow it to drive its competitors out of the market or deter entry, thereby adversely affecting competition in the long run.

This could be consistent with some of the examples given in the text of the regulation – for instance when it references lowering operating costs, allowing to maintain overcapacity in a market, or raising barriers to entry – and would be a framework DG COMP has experience dealing with. However, this type of theory of harm has been notoriously hard to prove and would therefore impose a very high bar for demonstrating that a subsidy negatively affects competition in the internal market.

By comparison, in the context of trade remedies, the bar for action is lower since it only focuses on adverse effects to domestic industry and establishing a causal linkage to the subsidy provided, rather than on competition in a market. Indeed, jurisdictions have flatly refused to countenance any parallel between trade remedies and predation and similar theories of harm, precisely for fear this will hamper their ability to implement trade remedies.

This tension between trade remedies, on one hand, and competition policy on the other is not new. What is new is that the FSR brings these tensions under one institutional roof.

The Commission has stated that they are actively thinking about potential theories of harm under the FSR. But with guidelines due to arrive within three years, we’ll have to see what we can distil from Commission’s case practice in the meantime.

The balancing test

Another interesting question is how important the balancing test will be: the balancing of a potential adverse effect on competition brought about by a subsidy against potential offsetting benefits. Such tests are included in some jurisdictions (the UK, notably) in the implementation of trade remedies.

Some read the balancing test as more secondary, which is usually the way similar public interest tests (where they are present) operate in trade remedies cases. But Margrethe Vestager’s words at a Concurrences event in March made it sound more central. She highlighted it as one of the major remaining uncertainties of the FSR (next to the definition of potential distortions to competition), saying that while the balancing test would have similarities with merger and Article 101 regulation, the test would also aim to estimate the balance between distortions of the internal market versus ‘other’ policy objectives. That seems more in line with state aid.

Whether taking into account these other objectives is likely to lead to a more or less restrictive application of the FSR depends on what these objectives are and how they are taken into account. For example, suppose that United States producers of technologies used in renewables benefit from large-scale subsidies under the Inflation Reduction Act and are able to invest and expand in the EU, to the benefit of downstream EU renewables businesses, and to the EU’s decarbonisation agenda more generally. How would these competing matters be addressed?

Reading between the lines – and awaiting the guidelines

For economists assessing cases under the FSR some of the problematic areas are already clear. The FSR’s complexity stems from the intermingling of concepts from the world of trade remedies and competition policy, which have had different motivations and have not happily coexisted in the past. Trade remedies are essentially a political economy construct. They have long been viewed with suspicion by economists who see them as back-door protectionism, and whose main justification is a “second-best” political economy one: namely, that they help to provide temporary safety valves when political pressure against trade liberalisation mounts, and in turn allow progress to be made on a broader trade liberalisation agenda.  

By contrast, competition policy concepts have traditionally had a much stronger grounding in mainstream economics: the aim is to ensure safeguard against a lessening of competition, on the grounds that this in turn harms consumers.

The FSR reflects the broader EU concern around strategic autonomy, which is an explicitly political economy concept, and therefore it is not surprising that concepts and approaches that diverge from the standard ways in which competition authorities approach matters now intrude on the work of such authorities. For businesses, and indeed the authorities, this introduces greater uncertainty, and consequently a greater need for analytical rigour to ensure that suboptimal outcomes do not occur.

That’s our reading for now, but like everyone else interested in the FSR, we’ll be keeping an eye on upcoming cases ahead of the arrival of more formal guidelines from the Commission in three years.