Swiss Investment Control: Preliminary Draft Published
On May 18, 2022, the Federal Council published its preliminary draft for a new law on the control of foreign direct investment (FDI). The FDI control regime pursuant to the preliminary draft is intended to protect public order and security in the event of takeovers of domestic undertakings by foreign investors.
The preliminary draft focuses (i) on takeovers by state-owned and state-related foreign investors and (ii) on takeovers in certain security-critical sectors. Minor cases are not to be subject to investment control.
The consultation will last until September 9, 2022. Thereafter, parliament will discuss the introduction of investment control in Switzerland.
Federal Council Publishes Preliminary Draft of an Act on Swiss Foreign Direct Investment Control
As a small, open economy, Switzerland has traditionally been liberal in allowing foreign direct investment (FDI). It does not yet have a general mechanism for systematically reviewing FDI projects (investment control), but only individual special rules in regulated markets (e.g. for banks). Such mechanisms for systematically reviewing FDI projects already exist in other countries. Internationally, there is a trend toward investment controls in the area of key technologies and industries.
With the Rieder Motion (18.3021), the question of investment controls has also become a point of political debate in Switzerland. Parliament approved the Rieder Motion against the will of the Federal Council (i.e. the Swiss federal government). It instructed the Federal Council to create a legal basis for a control regime of FDI in Swiss companies. On August 25, 2021, the Federal Council presented the key points of its proposal (see the Homburger Bulletin).
On May 18, 2022, the Federal Council published its preliminary draft of a new, independent Federal Act on Foreign Investment Control (the PD-FDI) together with its Explanatory Report. At the same time, the Federal Council opened the consultation period, which will last until September 9, 2022. After the consultation, the deliberations in parliament will follow.
The PD-FDI essentially follows the key points published last year, but also differs from them in some respects. At present, it is not possible to estimate whether the PD-FDI will be able to gain a majority in parliament and whether the parliamentary deliberations will lead to any changes.
This bulletin provides an overview of the PD-FDI and the key proposed changes it contains as well as an analysis of their significance.
FDI control caught between conflicting interests
The Federal Council continues to oppose the introduction of a FDI control regime. It believes that the existing legal framework is sufficient and that the costs of FDI control outweigh the benefits.
The future of the proposed FDI control is caught between concerns relating to the national economy on the one hand (i.e. the inflow of foreign capital and knowledge to promote value creation and secure jobs) and, on the other hand, national security policy (i.e. the prevention of threats to public order or security from foreign takeovers). While proponents of FDI controls emphasize the danger of (industrial) espionage and the infringement of intellectual property, critics see FDI controls as a protectionist and bureaucratic measure.
In this context, the PD-FDI is a compromise. The Federal Council intended to present a targeted, effective and administratively lean regulation, which would enable transparency, predictability and legal certainty for companies. Accordingly, the PD-FDI focuses on (i) takeovers by state-owned or state-related foreign investors and (ii) takeovers in certain safety-critical sectors. At the same time, minor cases are not subject to investment scrutiny due to a de minimis threshold.
Contents of the PD-FDI
The purpose of the PD-FDI is to prevent takeovers of domestic undertakings by foreign investors that endanger or threaten public order or security (Art. 1 PD-FDI). The control regime is therefore limited to security-related aspects, which also includes the safeguarding of critical infrastructure.
However, promoting or preserving certain industries or technologies is not a purpose of FDI control under the PD-FDI. The same is true for preventing distortions of Swiss competition which is no longer a basis for investment control under the PD-FDI – in contrast to the Federal Council’s key points published in August 2021. At that time, the Federal Council still intended to use FDI control to prevent significant distortions of competition by foreign state-related actors and to enforce competitive neutrality internationally. Due to concerns about compatibility with international law, the Federal Council has since refrained from examining such distortions of competition as part of FDI control. Nevertheless, Art. 5(2)(g) PD-FDI does allow significant distortions of competition to be taken into account if the distortion endangers or threatens public order or security.
(ii) Transactions subject to reporting and approval requirements (pick-up thresholds)
According to the PD-FDI, FDI should only be subject to control (i.e., subject to a reporting obligation and approval requirement) if it is a matter of a «takeover» of a «domestic undertaking» by a «foreign investor». The three terms are defined in Art. 3 PD-FDI:
- «Takeover»: According to the legal definition in Art. 3(a) PD-FDI, a takeover requires that the foreign investor directly or indirectly acquires control over the domestic undertaking. According to the Explanatory Report, the threshold for the acquisition of control in the case of corporations with few shareholders is «as a rule» a share of 50% of the voting rights, whereas in the case of publicly traded corporations 20% or 30% of the voting rights would suffice. Thus, compared with thresholds imposed abroad, which are often 10% or 20%, the PD-FDI sets the take-up threshold rather cautiously.
- «Domestic undertaking»: The Federal Council has left open how the term «domestic undertaking» is to be defined. In Art. 3(c) PD-FDI, it has put forward two variants for discussion during the consultation process. They differ according to whether targets that are Swiss subsidiaries of foreign groups should be considered as domestic undertakings or not.
- «Foreign investor»: 3(d) PD-FDI defines when an investor is foreign. At the same time, according to Art. 2(3) PD-FDI, the Federal Council is intended to have the power to exempt investors from certain countries from the control regime. Art. 3(d)(1) PD-FDI stipulates that for companies, both the statutory head office and the place of the actual head office must be abroad. According to the Explanatory Report, a group-wide approach applies vis-à-vis groups of companies. Accordingly, an acquisition of a domestic undertaking by the Swiss subsidiary of a foreign group is subject to FDI control, but an acquisition by a foreign subsidiary of a Swiss group is not. According to Art. 3(d)(2) PD-FDI, foreign-controlled companies, such as investment companies, are also foreign investors. Art. 3(d)(3) PD-FDI differentiates between natural persons from the EU/EFTA and those that are not.
Under the PD-FDI, different rules apply depending on who the foreign investor is:
- Takeovers by state-owned or state-affiliated foreign investors are per se subject to FDI control. The PD-FDI classifies such transactions as fundamentally problematic for public order and security.
- Takeovers by private foreign investors, on the other hand, are subject to FDI control only if the domestic undertaking (i) operates in a sector that is critical to public order and safety and (ii) meets the turnover threshold, if any.
b) Takeovers subject to FDI control
Specifically, pursuant to Art. 4(1) PD-FDI, the following takeovers are subject to FDI control:
- Takeovers by state or state-affiliated investors: First, takeovers of domestic undertakings are generally subject to approval if the foreign investor is «directly or indirectly controlled by a state body» (Art. 4(1)(a) PD-FDI). The FDI control requirement thus exists per se in the case of participation by a foreign state, irrespective of sectors and turnover thresholds (apart from the de minimis threshold pursuant to Art. 4(2) PD-FDI).
- Takeovers in certain particularly critical sectors: Secondly, takeovers of domestic undertakings are to be subject to approval if they are active in sectors that are particularly critical for public order and security. The undertakings that qualify as being particularly critical are listed in Art. 4(1)(b) PD-FDI. The list includes undertakings in the defense industry (no. 1-2), undertakings in the energy and water supply sector (no. 6), and undertakings that supply central security-relevant IT systems to domestic authorities or provide such IT services (no. 7). In all cases, the undertaking must be relevant to security policy; accordingly, undertakings that provide IT systems for the ordinary business administration of public authorities are not covered. The FDI control requirement is independent of any turnover threshold (apart from the de minimis threshold pursuant to Art. 4(2) PD-FDI).
- Economically significant takeovers in certain critical sectors: Thirdly, takeovers of domestic undertakings are subject to approval if they (i) operate in critical sectors and (ii) generate an average annual turnover of at least CHF 100 million or (in the case of banks) gross earnings in the past two financial years. The relevant sectors, which are listed in Art. 4(1)(c) PD-FDI, include general hospitals (no. 1), undertakings in the pharmaceutical and medical products industry (no. 2), certain undertakings in the field of goods and passenger transport and logistics, such as operators or owners of airports, railroad infrastructure or food distribution centers (no. 3-5), telecommunication network operators or owners (no. 6), and systemically relevant financial market infrastructures as well as systemically relevant banks (no. 7-8). Again, the undertaking must be relevant to security policy. Art. 4(1)(c) PD-FDI and the Explanatory Report do not specify whether the turnover threshold refers to the undertaking’s domestic or worldwide turnover; although elsewhere the PD-FDI specifies which should apply (cf. Art. 4(2) PD-FDI). In keeping with the law relating to competition merger controls, it seems likely that Art. 4(1)(c) PD-FDI refers to the turnover in Switzerland, but the point should be clarified.
Art. 4(2) PD-FDI provides for a de minimis threshold. According to this threshold, takeovers of domestic undertakings that have had on average less than 50 full-time employees in the past two financial years and have generated worldwide annual turnovers of less than CHF 10 million are not subject to FDI control. This de minimis rule is intended to avoid overburdening the competent authorities.
Using these benchmarks, and depending on the definition of domestic undertaking, between 2016 and 2020, between 20 and 45 takeovers per year would have been subject to FDI control, which is within the range of merger control notifications to the Competition Commission.
Pursuant to Art. 4(3) PD-FDI, the Federal Council will have authority to apply the FDI control regime for a maximum period of 12 months to other categories of domestic undertakings if necessary to ensure public order or security. According to the Explanatory Report, the Federal Council should also be allowed to lower the turnover thresholds that the PD-FDI stipulates. From a constitutional and democratic perspective, it would be desirable if the PD-FDI expressly granted the Federal Council competence to alter the PD-FDI by measures contra legem.
(iii) Assessment/intervention criteria
According to Art. 5(1) PD-FDI, a takeover subject to FDI control is approved if, viewed ex ante, «there is no reason to assume that public order or security is endangered or threatened by the takeover.» According to the Explanatory Report, endangerment and threat refer to the probability of occurrence and the extent of damage: If the probability is close to zero that a takeover will damage or endanger Switzerland’s security, the takeover must be approved.
To assess whether the takeover is likely to endanger public order or security, the authorities will consider the non-exhaustive list of factors in Art. 5(2) PD-FDI, which are explained below.
- Letters a-d relate to foreign investors and require them to «guarantee impeccable business management» (according to the Explanatory Report). It is clear from Art. 5(2)(a) PD-FDI that any threat to foreign states must also be included. However, the purpose of the control regime according to the PD-FDI is not the protection of foreign states. Rather, it is an indication that a threat to Swiss security is more likely if a foreign investor has endangered other states in the past.
- Letters e-f concern domestic undertakings, or their facilities, that are critical for public order and safety. These provisions allow for an assessment of the potential extent of damage likely to arise from the takeover. If the target’s services, products or infrastructure cannot be substituted within a reasonable period of time, this is a factor that weighs against approval (Art. 5(2)(e) PD-FDI).
- Letter g concerns distortions of competition that have a connection with public order and safety.
Art. 5(3) PD-FDI provides that the foreign investor’s willingness to cooperate may be taken into account in the decision. Whether this is a suitable criterion for assessing the danger or threat to public order or security remains to be seen. In any case, persons subject to the reporting obligation have a duty to cooperate under administrative law.
All in all, Art. 5 PD-FDI appears to be relatively vague. It contains a large number of indeterminate legal terms the interpretation of which is unlikely to be predictable for businesses. It is therefore questionable whether the PD-FDI can fulfill its promise of enabling legal certainty from a substantive point of view. Conversely, FDI control laws must be kept open to a certain extent to permit the authorities to react to unforeseeable circumstances in security-sensitive areas. If the proposed law enters into force, it is to be hoped that the State Secretariat for Economic Affairs (SECO) will engender (more) legal certainty as quickly as possible by publishing detailed reports of its decisions and not keep them secret, which is done in other countries.
(iv) Review procedure
The review procedure provided for in the PD-FDI resembles the merger control procedure under competition law. The foreign investor must notify the SECO of the takeover before it is completed (Art. 6(1) PD-FDI). Until approval is granted, completion of the takeover is suspended under civil law (Art. 8(5) PD-FDI). There is a prohibition against execution of the takeover without approval. This prohibition can be enforced by administrative measures (Art. 17 PD-FDI) and violations can be sanctioned up to 10% of the transaction value (cf. Art. 18 PD-FDI). This potential sanction is considerably more drastic than the corresponding provision under merger control law, which is capped at CHF 1 million.
The PD-FDI entrusts the SECO with the implementation and coordination of FDI control. SECO makes its decisions in consultation with the so-called co-interested administrative units, which each have a de facto veto right. Pursuant to Art. 10 PD-FDI, SECO designates the co-interested administrative units of the central federal administration on a case-by-case basis. The State Secretariat of the Federal Department of Foreign Affairs and the General Secretariat of the Federal Department of Defence, Civil Protection and Sport are deemed co-interested in all cases. The Federal Intelligence Service (FIS) only has a right to be heard by SECO.
Art. 6 et seq. PD-FDI provide for a two-stage examination procedure:
- Phase I: Within one month, SECO decides, in agreement with the co-interested administrative units and after hearing the FIS, whether the takeover can be approved directly or whether a review procedure must be initiated (Art. 7(1) PD-FDI). SECO and the co-interested administrative units, but not the FIS, each have a veto right: if no agreement is reached among them, a review procedure must be initiated (Art. 7(2) PD-FDI).
- Phase II: In the course of an in-depth examination, SECO decides, in consultation with the co-interested administrative units and after hearing the FIS, within three months of the initiation of the examination procedure, whether the takeover is approved (Art. 8 PD-FDI). In cases concerning Art. 8(2) PD-FDI, decision-making authority is escalated to the Federal Council. Only the Federal Council can decide not to approve a takeover (Art. 8(2)(a) PD-FDI).
The two-stage procedure seems appropriate and has proven its worth in merger control law. The time limits stipulated in the PD-FDI are appropriate in order to avoid undue delays in merger projects. A formal completeness check of the application is not foreseen (unlike in merger control proceedings), so that complex pre-notification procedures prior to the start of the deadline will probably not form part of the examination.
Art. 16 PD-FDI provides for the possibility of an appeal to the Federal Administrative Court against the Federal Council’s non-approval decision. Art. 16(2) PD-FDI stipulates that only the foreign investor and the domestic undertaking have standing to appeal. This paragraph probably means that the investor and the undertaking are each entitled to appeal alone and do not have to appeal jointly. Neither third parties nor SECO or other interested administrative units may file an appeal. Pursuant to Art. 16(3) PD-FDI, judicial review in cases of considerable political significance (cf. Art. 8(2)(b) PD-FDI) is limited to procedural guarantees and abuse of discretion. This provision satisfies the guarantee of legal recourse.
Significance for practice
With the PD-FDI, the Federal Council has shown a sense of proportion, as it did before with its key points. The description of when a project is subject to FDI control appears to be concrete and predictable for businesses. In contrast, the Federal Council has remained rather vague regarding the assessment criteria, which contains a number of undefined legal terms. Thus, the PD-FDI also brings with it certain legal uncertainties as to whether, for certain transactions, a significantly more time-consuming in-depth examination or even non-approval is to be expected. It is to be hoped that, by publishing its decisions comprehensively, SECO will help to reduce the legal uncertainty as quickly as possible.
If Switzerland introduces FDI control, foreign investors will have to take into account merger law risks and investment control law risks relating to the time between signing and closing of the takeover and whether the takeover may be completed at all. Until sufficient time has passed for a pattern of practice to emerge, a period of legal uncertainty must be expected. In the case of potentially problematic takeovers, contractual provisions should account for a possibly longer review period or non-approval.
This Homburger Bulletin expresses general views of the authors at the date of the Bulletin, without considering the facts and circumstances of any particular person or transaction. It does not constitute legal advice. This Bulletin may not be relied upon by any person for any purpose, and any liability for the accuracy, correctness or fairness of the contents of this Homburger Bulletin is explicitly excluded.