October 21, 2019

EUFIS and Nord Stream 2: Will the Security Dog Bark?

Reuters/Scanpix
Allseas' deep sea pipe laying ship Solitaire lays pipes for Nord Stream 2 pipeline in the Baltic Sea September 13, 2019.
Allseas' deep sea pipe laying ship Solitaire lays pipes for Nord Stream 2 pipeline in the Baltic Sea September 13, 2019.

With the coming into force of the EU foreign investment screening regulation, combined with the delays to the completion of Nord Stream 2 there is now a distinct possibility that the pipeline will be fully subject to the regulation.

1.0 Introduction: Nord Stream and the Dog that now may Bark.

One of the curious features of the last four years of passionate debate and discussion in respect of Nord Stream 2 at EU level is that much of the argument has focussed on the technicalities of EU energy law. This is comprehensible from the perspective that if the EU energy acquis and in particular the Gas Directive 2009 (as amended in February 2019) applies to Nord Stream 2 Gazprom (the owner of Nord Stream 2) will have to grapple with a number of difficult questions. The application of EU energy liberalisation energy regulations would be likely to undermine some of the financial benefits of the pipeline; Gazprom would lose some control of the pipeline; there would be prospects of capacity restrictions and potential Transmission System Operator (TSO) certification problems. There has however, been no direct means at EU level of raising the public security questions that surround Nord Stream 21 so far. However, with the coming into force of the EU Investment Screening Regulation (hereafter EUFIS) on 10th April 2019, combined with the delay in the completion of the Nord Stream 2 project itself, there is now the prospect of a EUFIS investigation being opened into the pipeline. Such an investigation would permit concerned Member States to raise the public security issues surrounding the pipeline directly at EU level. The security dog would finally have barked. A major EUFIS investigation into Nord Stream 2, combined with a parallel hearings in the European Parliament would also be likely to fundamentally shape the development and direction of EU foreign investment screening in the direction of greater parliamentary involvement from the very beginning and the publication of Commission opinions.

2.0 EUFIS and Nord Stream 2

In February 2019 at the same time as the EU Institutions agreed the amendment to the Gas Directive 2009, they also agreed in trialogue a new surveillance mechanism in the form of an EU regulation for foreign investment screening2.  The EUFIS regulation may well prove to have a more decisive role in disposing of the Nord Stream 2 project than the amendment to the Gas Directive. This is because, due to recent events Nord Stream 2 is almost certain to be caught within the scope of EUFIS and because EUFIS unlike the amendment to the Gas Directive involves a security and public order assessment. EUFIS therefore unlike EU energy law in the shape of the Gas Directive permits a direct EU level assessment of the security issues surrounding Nord Stream 2.

The reason why Nord Stream 2 is faced with the prospect of being subject to EUFIS are the delays in completing the project through Danish waters. We now have had three Danish permitting applications. One through the territorial sea of Denmark and subject to a national security review. Second, a northern route application (north of Bornholm island) and a third route south of Bornholm island. The Danish Energy Agency has requested to Nord Stream 2 further information on its proposed routes and indicated that it prefers the pipeline to proceed through the permitting process for the southern route3. This southern route has become only recently available as a result of a Polish-Danish agreement to finally demarcate a long-disputed sea border on the southern route4.

The Nord Stream 2 response has been to seek judicial review of the DEA’s decision to indicate a preference for the southern route5. As a consequence the process of permitting of Nord Stream 2 in Danish waters will be further delayed providing the opportunity for the EUFIS regulation to be deployed.

Meanwhile, the EUFIS regulation, for which political agreement on the text was agreed on 20th February came into force on 10th April. It applies only to investments completed after 10th April6. It will come into full operation on 11th October 2020 (at which point the Commission and Member States can operate its provisions)7. Already a shadow transitional screening regime is operated by DG Trade as all new and incomplete investments are potentially subject to EUFIS from the April 10th date.

Even if Nord Stream 2 is complete in the next few months it still could be subject to EUFIS  investigation. Article 8(7) of the regulation provides that any completed foreign investment can be subject to EUFIS screening procedures for 15 months following completion of such an investment.

Gazprom has tried to argue that Nord Stream 2 is a complete investment already. However, It is difficult to credibly make that argument. It is actually physically incomplete and does not have all the necessary permissions which would enable it to complete the investment and bring the project to operational status8. Given the Danish delays it is now caught by EUFIS. Once it is complete which may be the second half of 20209, there will be a further 15 month period during which EUFIS can be applied. This would mean that Nord Stream 2 could be subject to EUFIS regulation until the autumn of 2021.

As Nord Stream 2 is based in Switzerland, and is incorporated under Swiss law, it constitutes a foreign investment for the purpose of EUFIS. It may also be determined by the Commission given its source of funds and ultimate beneficial ownership to be a Russian investment for EUFIS purposes10.

3.0 EUFIS: Procedure and Assessment

At first sight EUFIS appears to be merely a coordinating mechanism for the 14 Member States who have foreign investment screening procedures, with the European Commission’s DG Trade acting as co-ordinator. The only formal power of the Commission is to issue opinions11, which apparently are not intended to be published.

However, there is much more to the EUFIS process than it first appears. First it can be engaged via a number of different routes. Where an investment can have an impact on more than one Member State, a Member State can request that the Commission investigate and issue an opinion on the transaction. Probably the most politically effective option would to trigger the review mechanism would be to seek to deploy article 7(2). This provision provides that if one-third of the Member States request the Commission to undertake a EUFIS investigation even if there is no ongoing Member State investigation or even if a Member State does not have a foreign investment regime. Furthermore, under Article 7(2) the Commission must issue an opinion12. Given that there were at least 22 Member States who supported the amendment to the Gas Directive it should be possible to find 10 Member States to make such a request in respect of the Nord Stream 2 investment13.

Second, while EUFIS regulation core assessment is solely based on security and public order the factors that can be taken into account are widely drawn. They include the impact of the investment on critical technologies, supply of critical inputs, access to sensitive information and the freedom and pluralism of the media14. These factors also include investments in strategic sectors such as telecommunications and transport. Also included are the potential effects of the investment on infrastructure such as energy infrastructures15. Particularly relevant here is that EUFIS permits the Commission and the Member States to take into account whether a foreign investor is directly or indirectly controlled by the government of a third country. It also permits the Commission and the Member States to take into account whether a foreign investor has been involved in activities affecting security or public order in a Member State16.

Clearly Nord Stream 2, as a wholly owned Gazprom subsidiary is controlled by a government of a third country. Furthermore, there is a compelling case that Nord Stream 2’s owner Gazprom has undermined the public security of several Member States. There is substantial evidence notably in the work of Larsson of over the last two decades of Gazprom undermining the supply security of Member States for political ends17. In addition, in 2014-2015 in response to Hungary, Slovakia and Poland providing Ukraine with additional gas flows. Gazprom sought to reduce the amount of natural gas to those states to make it more difficult to provide gas to Ukraine18. As supply security can be part of public security these threats to supply security can be taken into account by the Commission.

Aside from the supply security questions there are a broader range of security concerns. One broader supply security concern is the extent to which European supply security is threatened by placing so much gas in one place. For the majority of the route through the Baltic Sea, the Nord Stream 1 and 2 pipes lay side by side 500 metres apart. As a result 70% of Russian gas exports to Europe will be flowing down a narrow two kilometre channel, rendering Europe far more vulnerable to supply disruption by terrorist acts and the acts hostile states. The pipeline structures in the Baltic Sea also raise other security concerns related to Nord Stream 2 becoming with Nord Stream 1 the key route for Russian gas flows to Europe. Particularly the potential for the pipelines being used as a justification to move Russian naval forces closer to the territory of Member States to protect the vulnerable and vital gas import infrastructure, permitting a more extensive operational Russian naval and marine footprint in the Baltic Sea.

An additional public security concern relates to Ukraine. It is the ostensible policy of the European Union and its Member States to support Ukraine’s territorial integrity and independence. This policy flows ultimately from a security perspective that an independent and viable Ukraine is the interests not just of that country itself but is also a security interest of the Member States of the European Union, and particularly those adjacent to Ukrainian territory. An investment such as Nord Stream 2 which will undermine Ukraine, by isolating the country from the European Union, and make it more dependent on the Russian Federation. It can therefore be compellingly argued that the pipeline by undermining Ukrainian security, also undermines the public security of several Member States if not the European Union as a whole.

Procedurally, Nord Stream 2 is subject as an incomplete investment on 10th April 2019 to EUFIS procedures. Given the delays discussed above it would be possible to wait for the full review mechanism to come into operation in October 2020 when Nord Stream 2 by virtue of the 15 month rule would still be caught by EUFIS. However, as it is already caught by EUFIS and DG Trade is already operating a shadow procedure it is open to concerned Member States to seek to follow EUFIS procedures during the shadow period. Hence concerned states could seek to operate under Article 7(2) and then request the Commission to open a EUFIS investigation.

4.0 Nord Stream 2, EUFIS and the Political Realities

Despite the scope of EUFIS and its capacity of several Member States to launch the procedure and force the Commission to issue an opinion the EUFIS process looks weak. The Commission can only issue a non-binding opinion to which a Member State where the investment will be located is required to only give ‘due consideration’19. The Commission does not intend to publish EUFIS opinions. Hence at first sight, despite Nord Stream 2 falling within the jurisdiction of EUFIS, the capacity of Member States to require the Commission to undertake an investigation and issue an opinion, the result appears minimal. The opinion is non-binding, requires the Member State where the investment is located to only consider the opinion and it remains private.

This minimalist view of EUFIS overlooks the practical political realities and US experience with their investment screening regime. EUFIS cases involve issues of public security and public order. They naturally attract the attention of media, the European Parliament and the Member States. The process of a EUFIS investigation being launched by one-third of the Member States under Article 7(2) will trigger media and parliamentary interest such that a quiet closed door process will not be sustainable. That is particularly the case of very controversial investments such as Nord Stream 2.

This view is underpinned by the experience of the US foreign investment screening process. In the United States, the principal regulatory mechanism is controlled by Committee on Foreign Investments (CFIUS) in which the central role is played by the US Treasury. The President on recommendation from CFIUS makes the final decision. Since CFIUS was created in 1975 and for most of its existence the White House made few final prohibition decisions. The very fact that a CFIUS process was under way, particularly if Congress began to engage in the process, could make an investment toxic and the deal impossible to follow through on. It was to a significant degree the process that counted in making it impossible to proceed with the investment, not whether ultimately the White House would clear the deal (in most cases the Treasury Department would be recommending that the deal be cleared). In most over the last decade years only a handful of investments would be blocked, however, the realities of the Congressional and media scrutiny encouraged many more investors throwing in the towel20. The prospect for instance of Chinese investors having to explain their connections to the Communist Party, or in other cases asking executives to explain how close the investing firm was to its domestic state apparatus was more than many executives were willing to bear in front of Congress and the media.

Whilst a Commission opinion cannot of itself block a transaction, unlike in CFIUS procedures, the process of the investigation will still able to impact heavily on a transaction. The fact that a process exists and that the Commission is engaged in an investigation will draw the attention of the media and encourage the Trade Committee of the European Parliament to hold hearings on the deal (whether the Commission or the investors wants such hearings or not). There is also nothing to stop for instance for concerned Member States in parallel with a EUFIS filing with DG Trade in publishing a non-confidential version of their filing with the Commission and encouraging the Parliament to hold hearings on the transaction.

It is also doubtful that DG Trade in such circumstances is going to be able to keep its opinion’s private in the face of questions from Parliament, the Member States and the media. There is no express obligation for opinions to remain unpublished in the EUFIS regulation. There is also no reason in principle why the Commission should not publish a non-confidential version of its opinion. In addition, there is a compelling strategic argument for the Commission to publish non-confidential versions of its opinions: Such opinions would provide guidance to Member States, investors and commercial operators on the Commission’s decisional practice in enhancing legal certainty and encouraging a common approach to foreign investment review across the Union.

A published non-confidential version negative opinion in respect of Nord Stream 2 would clearly not have the direct legal power to stop the pipeline. However, it would bring the security issues surrounding the pipeline into far greater public prominence. It would also pile on pressure on Nord Stream 2 and the German government to cancel the project faced with a negative opinion from the Commission, combined with parallel opinions from the Committees of the European Parliament.

5.0 Conclusions: Nord Stream 2 Could Re-Shape EUFIS

Within the corridors of DG Trade the understandable approach of the Commission has been to start small with this new regulatory mechanism. Begin to build up knowhow and networks to run the EUFIS mechanism and be prepared to run a small closed-door process for now. However, should sufficient Member States trigger Article 7(2) in respect of Nord Stream 2 that reasonable ‘small steps’ approach will not be sustainable. Instead DG Trade will face a much more substantial and public operation, with itself operating in tandem with committees of the European Parliament.

The process of a Nord Stream 2 EUFIS investigation with an Article 7(2) application, publication of a non-confidential version of the application to the Parliament, parliamentary hearings and pressure to publish a non-confidential version of the opinion could provide the precedents for a much more substantial and open EUFIS process than was initially envisaged in the early years of the operation of the regulation.

This should not be seen as a matter of regret. There is a compelling argument for parliament and public to be fully engaged with foreign screening review processes. A more open and substantive process is likely to have more legitimacy. An open process will also help forge a consensus across the Union on the uniform principle and effective application of the foreign screening review systems at EU and national level. In this context the publication of non-confidential versions of Commission opinions would assist in developing such a consensus.

The security dog is the dog that has not barked in the Nord Stream 2 saga so far. EUFIS may now permit that dog to bark. However, in so doing it opens up the prospect for the EU of developing a much more substantial and intensive foreign investment screening regime much earlier than had previously been thought possible. A more open, substantial and active EU regime would also provide a basis for greater EU-US cooperation on dealing with major foreign investment filings on both sides of the Atlantic and reduce the danger of the EU and US being played off against one another by third states.

______

1 It is true that Article 11 of the Gas Directive 2009 does require certification of a non-EU owner that such an owner will not put at risk the supply security of the regulating Member State or the Union as a whole. However, it would take some time to get to that assessment (the pipeline would be likely to have been constructed before certification took place) and the actual assessment would be limited to the supply security issue.

2 Regulation (EU) 2019/452 of the European Parliament and Council of 19th March 2019 establishing a framework for the screening of foreign direct investments into the Union, OJ 2019, L791/1, 21st March 2019.

3Nord Stream 2 Runs Aground in Denmark, Politco, 28th March 2019.

4 Republic of Poland and the Kingdom of Denmark reach Agreement on the Maritime Boundary in the Baltic Sea, Joint Press Statement, Copenhagen, 1st November 2018.

5Russia’s Nord Stream 2 Appeals Against Third Route Through Denmark, 30th April, 2019, S&P Global Platts.

6 Recital 21 and Article 7(10).

7EU Foreign Investment Screening Regulation Enters Into Force, 10th April 2019, trade.ec.europa.eu/doclib/press/index.cfm?id=2008

8This argument has already been raised in another context by Matthias Warnig the CEO of Nord Stream who in a letter dated 12th April to the President of the European Commission argued in respect of the amendment to the Gas Directive that Nord Stream 2 was in fact ‘completed’ for the purposes of the amendment. His argument lent heavily on the proposition that a final investment decision had been made and then a substantial investment had been made. The counter-argument however, is that a final investment decision of itself is not decisive, the actual legislation refers to completed pipelines which clearly Nord Stream 2 cannot really claim to be, and fundamentally Nord Stream 2 itself decided to proceed with the investment when all the permits to proceed with the pipeline were not in place-contrary to normal commercial practice. In September Nord Stream 2 launched a claim against the Union via the Energy Charter Treaty procedures.

9 For a discussion of the technical reasons why Nord Stream 2’s completion could be delayed into the second half of 2020 see Kubiak, Could the United States Derail Nord Stream 2? CEPA, Washington DC, 3rd October 2019.

10 Recital 10 requires Member States to also maintain anti-circumvention provisions to avoid investors holding themselves out to be domestic when they are in fact foreign entities. By analogy this anti-circumvention principle would also apply to investors holding themselves out as one third country when the economic reality that the entity is ultimately owned and controlled by a different third state.

11 For which Article 288 TFEU indicates that as with recommendations, opinions ‘shall have no binding force’.

12 Article 7(2) indicates that the Commission ‘shall issue an opinion’ ‘where justified’. Given the mandatory language here the Commission is required to issue an opinion save where there were objective practical reasons not to do so.

13 France now against Nord stream 2, Euractiv, Brussels, 8th February 2019.

14 Article 4(1)

15 Article 4(1)

16 Article 4(2).

17 Larsson, Russia’s Energy Policy: Security Dimensions and Russia’s Reliability as an Energy Supplier, FOI (Swedish Defence Research Agency), Stockholm, 2006.

18 Loskot-Strachota, Central European Problems with Russian gas supplies, OSW (Centre for Eastern Studies), Warsaw, 17th September 2014.

19 Article 7(7)

20 For the most recent statistics see Deloitte, CFIUS, a national security watchdog in M&A transactions, Paris, July 2019. See also the latest briefing of the Congressional Research Service on CFIUS, CRS, Committee on Foreign Investment in the United States (CFIUS), Washington DC, 6th August 2019.