Germany expected to tighten grip on FDI

Germany will likely see some significant changes to its existing foreign direct investment (FDI) regime in 2025, further tightening its grip on foreign direct investments. Whether for the good or detriment of the German economy, which is currently in decline, investors will need to adapt. Likely, this will lift FDI considerations even higher up on the priority list of risk factors that investors will consider when looking to invest in Germany.  

Background

FDI is about national security – and national security is a highly political, flexible term. Since 2017, the German FDI regime has seen some significant changes, partly in response to crises (take the COVID pandemic or the war in Ukraine, for example), partly for geo-strategic reasons (take the national China strategy, for example), or simply to catch up with a world that is being rapidly changed by technology such as quantum computing and AI. As a result, the existing regime is scattered across various laws and regulations, in parts inconsistent and subject to interpretation, which leads to legal uncertainty for investors, sellers and founders looking to raise capital. 

The new German Investment Control Act (“ICA”) (Investitionsprüfgesetz) is set to change this. A first draft, which was originally expected to pass parliament in the first half of 2024, is yet to be seen, probably owing to the current turmoil within the German government. However, the ICA will come – in one form or the other. And it will include some significant changes. Without speculating, from what we know to date[1] likely these will include one or more of the following:

Extended scope

The ICA will likely extend the scope of application of the German review mechanism to more sectors and more transactions. The existing rules[2] distinguish between two review mechanisms: 

• A sector-specific review mechanism limited to investments (including by EU/EFTA nationals) into military & defence and IT security software and products; and 
• A cross-sector review mechanism, catching all sorts of investments provided that the ultimate beneficial owner (“UBO”) of the investor is non-EU/EFTA and the domestic target company is active in critical infrastructure or any other sector of national security concern (see list in Sec. 55a FTPO). 

The new ICA is expected to include a third, fallback mechanism. The details are unclear at present, but we expect this to be a “catch-all” law targeting any business activity that the government may show an interest in. While such an approach may raise concerns over legal certainty, in practice, investors investing in areas such as new or emerging technologies will likely opt for a voluntary filing from 2025 onwards, to avoid a government call-in post-closing (similar to the existing practice of obtaining a certificate of non-objection in borderline cases, see Sec. 58 FTPO). 

Internal reorganizations

In return, it looks as if internal reorganizations may be treated more leniently. Under the current rules, internal reorganizations are exempt only if all parties to the transaction reside in, and are managed out of, one and the same third country. The position paper of 2023 suggests looking at whether a previously uninvolved jurisdiction (notably from an unfriendly state) comes into play instead. While this clarification is generally welcomed (and in line with the government’s existing best practices), it remains to be seen whether the analysis will be done at UBO level only or would need to include any previously uninvolved jurisdiction down the corporate chain. Take an internal reorganization, for example, by which a German subsidiary of a US group (UBO) is relocated within the group from a US to a Swiss subsidiary, both of which are 100%-controlled by the US group (directly or indirectly). In this case, Switzerland (being the home jurisdiction of the direct buyer) is a “previously uninvolved jurisdiction” but the German target entity remains 100%-controlled by a US group before and after the internal restructure, so the transaction should not be caught. 

Greenfield investments

Today, greenfield investments are not caught by the current regime (for lack of a domestic target business). The only exception is existing domestic assets that are (or may be viewed as being) security relevant and will be moved into the newly created company. This will most likely change under the new ICA, although it remains to be seen whether greenfield investments will be caught per se or only if in particularly sensitive sectors such as quantum technology, advanced semiconductors, AI and critical infrastructure. The rationale being that national security can be harmed either way. 

Outbound investment screening

The same is true for outbound investments, which are equally not caught by the current regime. Following the example of the US, as part of its Economic Security Strategy, on 24 January 2024 the EU Commission released a White Paper introducing a set of instruments aimed at monitoring and, if necessary, restricting EU companies' equity investments and their accompanying intangible outflow of expertise, networks, and management skills in highly sensitive sectors abroad (see separate article on the EU regime in this newsletter). The ICA is expected to adopt the Commission’s proposal at national level and, possibly, go beyond. The details are unclear to date. 

IP transactions

The position paper of 2023 also identifies IP transactions as a potential security gap in Germany’s existing investment screening regime. Similar to outbound investments, the logic here seems to be that technology transfers from within the EU/Germany to foreign investors may equally lead to an outflow of security relevant know-how and information. IP transactions are not currently caught. The ICA will likely change this. The position paper explicitly mentions the pharmaceutical sector as an example. Notably, this is not only with a view to a transfer of ownership of an entire IP portfolio to a foreign investor (which may potentially qualify as an asset deal even under the existing rules) but may equally cover a simple patent licence agreement. 

Reversal of the burden of proof

Some investments are less critical, from a national security perspective, than others. For the latter, the ICA intends to introduce a reversal of the burden of proof, meaning that investors will need to show why the proposed transaction does not pose a threat to national security (as opposed to the government showing why it does). Sectors under discussion are the usual suspects i.e., quantum technology, advanced semiconductors, and AI. Practically, this will lead to yet additional powers for the German government, who can limit or, in the worst case, prohibit any investment into the abovementioned sectors without giving reason why, simply by reference to a legal presumption. This is even more frustrating as FDI is a political concern and investors do not necessarily enjoy insights into the current (geo-) political agenda of the German government, which makes it even more difficult for them to rebut the legal presumption working against them. Whether this is limited to investment screening or pure economic protectionism remains to be seen.

Jurisdictional thresholds and timeline

The jurisdictional thresholds (10%, 20% or 25%, depending on sector) will likely remain unchanged. However, it appears that de facto majorities based on the attendance rates of past general meetings (of listed companies with a large proportion of shares in free float) will suffice under the new ICA regime to trigger an investment screening. The standard (“phase 1”) review period for uncritical investments will likely be shortened to 45 calendar days from filing (as opposed to 2 months under the current regime).

Final remarks and outlook

The new German ICA is a welcome consolidation of what is currently a patchwork of rules. Abbreviated waiting periods will help streamline the FDI workstream in M&A transactions with other regulatory approval processes such as merger control. However, ever more sectors and transactions will be caught, as the government retains the right to classify additional sectors as being security-relevant by administrative order as before, and the burden of proof will (partly) be on the investors. In effect, inbound and outbound FDI will be less attractive under the new ICA, restricting significantly the free movement of capital. 

The new rules were originally expected to enter into force in 2024. With the national elections coming up in the fall of 2025, it is currently unclear whether the incumbent Scholz administration will succeed at all in passing the new law. However, investors should not count on a potential Merz administration necessarily taking a more lenient approach to FDI, particularly with the social democrats and Chancellor Scholz as a junior partner in the new government.

If you need more information or further guidance in this area, please contact Stephan Waldheim and Tamy Tietze.

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[1] See e.g., a position paper of 2023 by the German government leaked on LinkedIn, the government’s response to a parliamentary query of September 2023 (available at Drucksache 20/8384 (bundestag.de) as well as various press reports, e.g., by Legal Tribune Online. 

[2] Governed mainly by Sec. 55, 55a and 60 Foreign Trade and Payments Ordinance (“FTPO”).