Hot Topic: Investments In Defense And Dual-Use Assets In Germany

Overview

In view of the geopolitical developments in recent months and years, there is increasing interest from (domestic and foreign) investors, including private equity and venture capital funds, in investments in the defense sector in Germany. At the same time, high-profile start-ups are looking for investors.

This interest is expected to continue to grow in the coming months, in view of the political course set in Germany and the EU and as a result of the recent decisions to increase defense spending by NATO member states. The upcoming order security from the public sector will make it even more attractive for investors to invest in defense or dual-use assets.

At the same time, however, investments in the defense sector in Germany are subject to strict (national and European) regulatory requirements designed to ensure that investments in security-relevant areas are controlled and monitored in order to protect national security interests. Particularly (private equity / venture capital) funds aiming to attract foreign investors need to be structured carefully to ensure compliance with all regulatory requirements enabling an investment in defense assets.

Key Regulatory Frameworks

Funds may invest in companies in the defense sector (or companies in the dual-use sector) in Germany subject, in particular, to the following regulatory requirements and conditions:

1. Foreign Trade and Payments Act (AWG) and Foreign Trade and Payments Ordinance (AWV)
   • AWG and AWV: These laws govern foreign investments in Germany, particularly focusing on sectors critical to national security, including defense and dual-use goods:
     • Section 4(1) AWG grants the Federal Ministry for Economic Affairs and Climate Action (BMWK) the authority to review and restrict foreign investments that may pose a threat to public order or security
     • Section 55 AWV specifies the sectors subject to sector-specific review, including defense and dual-use goods
   • .Sector-Specific Review: Investments in companies producing military goods or dual-use items are subject to a sector-specific review by the Federal Ministry for Economic Affairs and Climate Action (BMWK). This applies to acquisitions of 10 percent or more of the voting rights by non-EU/EFTA investors, i.e. if a foreign investor reaches or exceeds the threshold of 10 percent of the voting rights, either directly or indirectly (via the investment in the fund). Transactions falling within this category may not be closed before clearance has been granted.
   • For these purposes, voting rights of affiliated companies or companies that are deemed to exercise voting rights jointly on the basis of an agreement are aggregated.
2. Federal Ministry for Economic Affairs and Climate Action (BMWK
   • Notification Requirement: Investors must notify the BMWK of any planned acquisition that meets the threshold criteria
   • Review Process: The BMWK conducts a review to assess potential threats to public order or security. This process can take up to four months, extendable under certain conditions.
3. European Union Regulations
   • EU Screening Regulation (2019/452): Provides a framework for EU member states to screen foreign direct investments (FDI) on grounds of security or public order. It encourages cooperation and information sharing among member states, and sets out a uniform set of factors to be used by the EU Commission and member states for screening. These include potential effects on, inter alia, critical technologies and dual use items (including artificial intelligence, robotics, semiconductors, cybersecurity, quantum, aerospace, defense, energy storage, and nuclear technologies, nanotechnologies and biotechnologies).
   • These rules, currently still in place, are planned to be tightened in accordance with a proposal of the European Commission made on 24 January 2024.

Conditions for Investment

1. Approval Requirement
   • If the proposed investment in the defense and dual-use sectors requires explicit approval from the BMWK based on the AWG and AWV, the transaction subject to review cannot proceed and be completed without such approval (section 15(1) AWG).
   • Careful structuring of a specialized fund taking into account the acquisition thresholds for foreign investors may prevent the fund from a rejection of the required approval.
2. Mitigation Agreements
   • In some cases, the BMWK may impose conditions or require mitigation agreements to address security concerns. These can include restrictions on information access, governance changes, or operational limitations.
3. Compliance with Export Control Laws
   • Companies in these sectors must comply with German and EU export control regulations, particularly the EU-Dual-Use Regulation (2021/821). Investors must ensure that their activities do not violate these laws, which govern the export of military and dual-use goods.
   • Particularly, the export of military goods requires a license from the Federal Office of Economics and Export Control (BAFA).
4. Transparency and Reporting, ESG Criteria
   • Investors may be required to provide detailed information about their ownership structure, business activities, and strategic intentions. Regular reporting and audits may also be mandated to ensure ongoing compliance.
   • While not strictly mandated by law, ESG criteria play an important role in investment decision-making and compliance with internal policies and ethical standards. The relationship between the defense industry and financing is complex, especially with regard to sustainability.
   • The EU Sustainable Finance Disclosure Regulation (SFDR), which aims to channel capital flows into sustainable investments and economic activities, also applies to fund investments and obliges funds to make a statement as to whether they pursue ecological or social aspects or even sustainable investments with their investments. If they do not pursue such objectives, funds must explicitly disclose this. However, since May 2024, so-called "ESG funds" have also been able to invest up to 20 percent of their capital in non-sustainable areas.
5. Additional Requirements under the German Investment Code
   • Once a fund's voting rights in a non-listed company reach or cross the 10 percent, 20 percent, 30 percent, 50 percent, or 75 percent threshold - or if the fund (alone or jointly with other funds) gains control - the fund manager must notify both the Federal Financial supervisory Authority (BaFin) and the non-listed company. The fund manager must also notify the company's shareholders, where feasible, and ensure that the company's management board promptly informs the workforce or employee representatives about the acquisition of control.
   • All such notifications must be made within 10 business days after the relevant threshold is reached or exceeded, or control is acquired.

Conclusion

Investing in German defense and dual-use sectors involves navigating a rigorous regulatory environment designed to protect national security. Both German and foreign investors must comply with the AWG, AWV, and EU regulations, and obtain necessary approvals from the BMWK. Understanding these requirements and conditions as well as structuring funds properly to ensure compliance is crucial for successful investments in these sensitive sectors.

Originally published on https://ebs.publicnow.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.