Europe, regulator of the world

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The aims of the European Union are set out in Article 3 of the Lisbon Treaty. Within its boundaries these include ensuring the peace and well-being of citizens; providing freedom, security and justice without internal borders; creating a highly competitive market economy; and enhancing economic, social and territorial cohesion.

The EU AI Act brings opportunities because people want trustworthy systems. If European developers are required to build them, they can be at a competitive advantage.

The E.U. also has a purpose that extends beyond its own borders: to uphold and promote its values and interests, contribute to sustainable development, and protect human rights on the global stage.

The primary levers used to achieve these goals have been regulation and enforcement. Indeed, regulatory development can be viewed as one of the E.U.’s main outputs. Some business groups have seized on this as a cause of the E.U.’s sluggish economy, calling for “regulatory breathing space” to boost growth and jobs. French President Emmanuel Macron picked up on the theme when he presented his national green industrial policy.  

The E.U.’s regulatory reach is increasingly extraterritorial, in part because of the competitive impact of European regulation on its domestic businesses. 

As an example, E.U. state aid rules prevent Member State governments from offering certain types of support to businesses (such as preferential tax breaks or grants) that would distort competition within the single market, yet businesses from third countries are not bound by the same restrictions at home. 

Europe suffers from a positioning problem. Its regulation is framed as a compliance exercise, as bureaucracy, rather than as a roadmap through which your business can become a world leader.

Europe’s global agenda has a domestic objective

During the 2019-2024 mandate, the EU institutions introduced rules to redress this balance, including the Foreign Subsidies Regulation – designed to identify and mitigate distortive subsidies from outside the bloc – and the Digital Markets Act and Data Governance Act, which were introduced to help European companies access the digital resources they need to compete on the global stage. State support could prove a key focus area during the next EU mandate if calls grow for more powers to be returned from Brussels.

The Carbon Border Adjustment Mechanism was similarly calibrated to support decarbonisation and counter the impact of the EU’s own sustainability rules by imposing an emissions tariff on imports of goods from third world countries that carry a high risk of carbon leakage.

The General Data Protection Regulation aims to safeguard the fundamental rights and freedoms of citizens – including the right to a private life – while allowing data to flow freely across borders.

The forthcoming EU AI Act is intended to apply similar safeguards to the development of artificial intelligence, while the Corporate Sustainability Due Diligence Directive (CSDDD, based on corporate duty of vigilance laws introduced in countries such as France) is designed to confer on large businesses a responsibility to identify – and address – any negative impacts of their activities on the environment and human rights across their global operations. 

The Regulation on Deforestation-free products is also built around the imposition of supply chain obligations on businesses, this time to ensure the goods that EU citizens consume do not contribute to deforestation or forest degradation.

The regulation focuses on seven key commodities and the products derived from them – cattle, cocoa, coffee, oil palm, rubber, soya and wood – and will require organisations to conduct due diligence and risk mitigation across their entire supply chains before being allowed to distribute across the European market.

While European regulations invariably set a high bar that requires extensive investment in disclosure and risk management, there is also a predictability to the way EU frameworks are constructed that aligns with the general shift towards a more purpose-driven, responsible corporate environment.

It is perhaps no surprise therefore that almost half of respondents to our survey (43%) viewed the EU’s regulatory structures as “very favourable”, far higher than those of other global jurisdictions.

Supply chain due diligence is hard. You face the choice of going back to suppliers where you have more of a handle on how they operate or with whom you have greater cultural affinity, and that means businesses in certain geographic areas. But that may put your costs up and potentially lowers profits if you can’t pass them on to your customers, which in turn makes you less attractive to investors and less able to innovate.

Despite the positive signals from our survey, our in-depth interviews painted a more nuanced picture of the EU’s regulatory structures. While some business leaders we spoke to viewed EU regulations as positive – particularly where they worked for larger organisations – others described them as burdensome, even where they as individuals supported the regulations’ intentions.

For example, there was a sense that European sustainability rules are significantly more difficult to navigate where they are overlaid on commercial operations in emerging markets.

The proposed EU social taxonomy – which would increase transparency around the “S” of ESG in a bid to drive investment towards activities that improve living and working conditions – was specifically called out as a concern by leaders of businesses with activities in developing countries which have different social structures to those in mature markets.

Given the prevailing sentiment around over-regulation it’s questionable whether the social taxonomy will be introduced any time soon (“It’s perceived as a very high political capital endeavour right now given the debate around gas and nuclear under the EU green taxonomy,” said E3G’s Jurei Yada), but the prospect of EU regulatory overreach was a consistent theme in our conversations.

We see a lot of regulation especially coming out of the EU which can be on balance positive for the larger companies because the barriers of entry may go up.

There is also a scale point. Greater compliance requirements are more difficult to absorb for smaller organisations, financially and from a skills and resource perspective. This confers an advantage on bigger businesses, and while the European Commission has looked to rectify this through the principle of proportionality, there was a sense among our interviewees that EU regulation has the potential to drag on innovation and growth.

The EU itself has recognised that its structures need to adapt to a fast-changing world. European state aid rules for example were reformed to counter the effects of the U.S. Inflation Reduction Act, while the European Commission has signalled its willingness to engage with businesses to discuss the potential antitrust risks of collaborations focused on decarbonisation. There is also debate among countries including France and Germany over whether to raise the minimum threshold of employees for a business to qualify as an SME from 250 to 500, which would cut at a stroke the number of businesses in scope of certain rules. Commission President Ursula von der Leyen herself has acknowledged the need to reduce regulation in order “to make business easier in Europe”.

Some of our interviewees were positive about the EU’s regulatory frameworks as a potential driver of innovation, pointing out that requiring businesses to track granular emissions data across their operations would potentially involve a technological solution, which in turn could improve risk monitoring and agility.

Thierry Breton, the EU’s Internal Market Commissioner, made a similar point following political negotiations on the EU’s AI Act. “The Act is much more than a rulebook,” he said. “It’s a launchpad for EU startups and researchers to lead the global AI race.”

Considered regulation establishes a level playing field that protects domestic players from being colonized by multinationals. But where that regulation is indiscriminately applied to smaller companies it can put them at a disadvantage against bigger players who can afford the cost of compliance.

EU Commission focuses on antitrust enforcement to protect economic growth and innovation

As the volume of new E.U. regulation continues to rise, so does the risk of enforcement. Nowhere is this more apparent than in the antitrust space, where the European Commission is increasingly focused on protecting growth and innovation – and ensuring that the pursuit of other priorities such as the Green Deal doesn’t become a cover for collusive behavior. In this environment, while we have seen antitrust theories of harm evolve to reflect changing market dynamics, more classic allegations of anticompetitive information-sharing remain just as relevant as in years past.

There is broad acceptance among economists that information exchanges between businesses can be pro-competitive, for example where they lead to efficiency gains that benefit consumers. But where the information relates to a company’s market strategy, there is potential for co-ordination and collusive behavior that could act in the opposite direction.

Increased risk of infringements as pace of regulatory and market change increases

The likelihood of competitively sensitive information being exchanged is greater where there is a significant volume of new regulation, as companies will often engage with their rivals to discuss how to adapt to or implement the new rules. The same is true in a world where more businesses are launching R&D collaborations with their competitors to develop new technologies. 

Where these partnerships align with the E.U.’s strategic objectives, for example in relation to electric vehicle batteries or other low carbon systems, the Commission is willing to engage upfront and provide informal comfort on how to de-risk the relationship. But where the gap between safe conduct and cartel behavior is increasingly slim – and with the Commission now using cutting-edge AI tools to enhance its investigative capabilities – companies need a sophisticated understanding of the enforcement landscape and robust compliance frameworks to stay on the right side of the line.

E.U. Damages Directive generates significant private enforcement in a claimant-friendly legal landscape

The E.U. Damages Directive, which makes it easier to bring follow-on claims in the wake of a cartel (or abuse of dominance) infringement decision, adds an additional layer of complexity. Before the Damages Directive was enacted, the primary decision for companies alerted to possible misconduct was whether to apply for leniency. 

(In Europe, the first company in any cartel to submit a leniency application receives full immunity from any administrative fine if the information it provides is enough to warrant a Commission investigation or find an infringement and the company complies with the other conditions of the leniency notice. Any company that applies for leniency afterwards can also have its fine reduced if it offers information that adds “significant value” to the evidence in the Commission’s possession). Any granting of leniency by the Commission will be followed by an infringement decision against the company and other participants in the collusive behavior, which will then become the reference point for private enforcement action. 

But today, the scale of private damages claims is so large that leniency is a less appealing option, particularly when factoring in the complex, costly and lengthy co-operation obligations that come with it. It is critical that companies consider the full lifecycle of a cartel case, and the related risk, when deciding whether to self-report potential collusive conduct.

Settlement discussions require careful consideration

Settling with the Commission is also a tricky process; in theory it’s possible to contest the legality of a Commission decision that underpins a settlement, but in practice the margin to do so is very limited. Companies, therefore, face a dilemma – settle to conclude the administrative process quickly and receive a lower fine (even if it means accepting an infringement decision that goes beyond what the business is comfortable with and potentially exposes it to increased risk of private damages claims), or fight on, prolonging the uncertainty and increasing the possibility of a bigger regulatory penalty? 

While the Damages Directive entered into force in 2014 and all Member States had implemented it into their legal systems by 2018, only recently have the first cases resulted in rulings by the Court of Justice of the European Union in Luxembourg on questions referred to it by national courts. As a result, the procedural issues involved – and indeed the scope of the rules themselves – have only begun to be clarified over the past 18 months or so. 

Court of Justice decisions clarify rules and procedures

Guidance coming out of the Court of Justice for example essentially now means that claimants in many E.U.-wide cartel cases can sue for damages in whichever Member State they choose. At a high level, the Court’s broad interpretation of the scope of corporate liability implies that where an infringement decision is made against a parent company, claims can be brought in any EU jurisdiction in which one of its national subsidiaries active in the same market operates, due to the degree of decisive influence presumed to flow down from the parent to other group entities. 

The influence of the Representative Action Directive – which allows consumers impacted by a breach of E.U. legislation to bring group claims – adds a further challenge. Recent cartel cases have led to significant private enforcement activity in Germany and the Netherlands for example, both of which have implemented the Directive into their national legal frameworks. But the same conduct has also sparked follow-on claims in Spain, which has not. As a result, defendants may find themselves tackling large group cases in some jurisdictions and literally thousands of smaller ones in others. 

Against this backdrop – market changes that raise the possibility of information exchange and anticompetitive coordination amid heightened threat of E.U. antitrust investigations, and the rise of claimant-friendly private enforcement rules that complicate the decision-making process for senior executives looking to manage antitrust risk– businesses must ensure they can construct a coherent response strategy that minimizes their exposure across the E.U. as a whole. 

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This content was originally published by Allen & Overy before the A&O Shearman merger