The Government’s concerns
The Green Paper cites the following as key justifications behind the proposed reforms:
- Challenges to national security exist in an increasingly complex international economic and political landscape, with greater interconnectivity of nations and greater flows of capital, and new technologies resulting in new security challenges.
- Under the current regime, the UK Government can only formally intervene on grounds of national security if cases that raise such concerns also meet either the Competition and Markets Authority’s (CMA) or the European Commission’s (Commission) jurisdictional thresholds for merger control review (subject to limited exceptions, discussed below).
- Businesses in relation to which traditional and new national security challenges could arise may undertake niche activities and/or produce highly specialised products and therefore remain relatively small and, importantly, fall below those existing merger control thresholds.
- The UK faces a continued and important need for investment in its national infrastructure, a considerable part of which will be met by private investment.
- Other states, and in particular Australia, Canada, France and the United States, have substantial and relatively consistent approaches to scrutinising foreign investment on grounds of national security and related considerations; this contrasts with the powers available to the UK Government, which the Green Paper describes as limited in places, inconsistent, possibly too reliant on voluntary notification by merging parties and potentially creating uncertainty for businesses.
The Government proposes to go about this reform in a two-staged approach, which we summarise below. It is interesting to note the contrast (in time-frame and scope) between the proposed short term and long term reforms.
Short-term reform: a reduced threshold for Government intervention in mergers in key sectors
The Government wishes to promptly plug what it considers to be a “pressing gap” in its national security defences – to examine and potentially intervene more readily in mergers involving smaller companies relating to two particular areas of the economy:
- The military and dual-use sector – in particular enterprises that design or manufacture military items or hold related software and technology subject to export controls, and possibly temporary export controls; this category may extend to businesses that design or produce items, or have technical expertise relating to activities or items, which are primarily for civilian uses but could also have military applications; and
- Parts of the advanced technology sector – in particular companies that are involved in the design of multi-purpose computing hardware and quantum-based technology.
For those businesses alone, the jurisdictional tests in the Enterprise Act 2002 (the Act) will be expanded to capture mergers and acquisitions that involve:
- a target with UK-based turnover of over £1 million (rather than £70 million as now); and/or
- a target with a 25% or more share of supply (i.e. with no need for the merger to give rise to an increase in that share of supply), or where the merger/acquisition meets the current test of creating or enhancing a share of supply of 25% or more.
Under the current merger control framework, the UK Government can only intervene on national security grounds in respect of mergers involving companies with a UK turnover of more than £70 million or where the share of UK supply increases to 25% or over, or in respect of mergers that do not meet those thresholds but which involve a party designated as a relevant Government contractor (i.e., one that has been notified by the Secretary of State of confidential information, documents or other articles relating to defence). The press release issued with the Green Paper announced that the proposals “will close these loopholes to enable greater scrutiny of foreign investment in a changing market”.
The Green Paper further states that “the amendments are intended to address only the Government’s national security concerns – the changes are not driven by any concern from it or the CMA about how competition is working in these markets”. However, the same paragraph goes on to note that the Government expects “[t]he CMA will apply the same criteria to scrutinising these smaller mergers on competition grounds as it does with other mergers”. It will be interesting to see whether the Government chooses to solve this apparent tension by formally restricting the substantive review of deals falling within the scope of the expanded thresholds (but outside existing thresholds) exclusively to considerations of national security.
The Government plans to publish guidance to help businesses and investors in their assessment of whether a merger might raise national security issues. It also encourages contact and engagement with the relevant Government department. However, the role of the CMA and the process for conducting potentially parallel assessments on competition grounds – including the CMA’s application of the “de minimis” exception to its duty to refer mergers raising substantial competition concerns for an in-depth investigation – will need clarification. However, with the Government set to take “rapid action” on these proposals, we expect revised thresholds (in some form) to be brought into force fairly quickly after the consultation period ends on 14 November 2017.
Long-term reform: a move to a mandatory regime for foreign investment?
The Government is clear in the Green Paper that it believes more needs to be done in the longer term to protect national security, in particular in the context of foreign ownership or control including of businesses operating national infrastructure and where investors obtain cumulative ownership or control within, or across sectors. However, it recognises that any changes to ensure the protection of the UK’s national security – which is “paramount” – must be made “in a manner that preserves the country’s open approach to investment and trade”. This is a difficult balance to strike and it is perhaps inevitable, therefore, that the Green Paper includes relatively little by way of specific detail of the changes envisaged to the UK merger control regime.
However, taking inspiration from other countries including the United States, Canada, Australia and France, the Government has suggested a package of complementary reforms which could include some or all of the following measures:
- Within a voluntary notification regime, an expanded version of the ‘call-in’ power (modelled on the existing power within the Act) to allow Government to scrutinise (within a three-month call-in window) a broader range of transactions for national security concerns. This could potentially include new projects and sales of bare assets (such as machinery or intellectual property transferred without the other elements of a stand-alone business) which the Green Paper notes would amount to “a significant extension of the Government’s current powers”.
- Under this proposal, the Secretary of State would be able to intervene in a transaction where she or he reasonably believed that national security risks were raised by the acquisition of “significant influence or control” over any UK business entity by any investor (whether domestic or foreign). The Green Paper strongly suggests that the concept of “significant influence” in this context would be much broader than the Act’s existing test of “material influence” for merger control purposes and could potentially include considerations such as significant involvement in the management and direction of a company, or where recommendations are always or almost always followed by shareholders with a majority of the voting rights when they are deciding how to vote.
- A mandatory notification regime (with clear sanctions for non-compliance) for foreign investment into the provision of a focused set of “essential functions” in key parts of the economy and/or in key new projects, specific named individual businesses, assets or plots of land.
- The Government’s current assessment is that the key sectors should include, as a minimum, civil nuclear, defence, energy, telecommunications and the transport sector. It is also minded to include the manufacture of military and dual-use items and advanced technology (i.e. the sectors subject to the short-term reforms) and is further open to comments on including the government and emergency services sectors. Whilst “the Government is clear that it is only parts of each of the sectors above where a mandatory regime could apply” those essential functions, provisionally set out in Annex C to the Green Paper, are in practice quite broad.
The consultation period for these longer-term reform proposals ends on 9 January 2018. The Government will then use responses to inform the precise shape and scope of its proposals, which it will progress in a White Paper planned for 2018.
A spreading concern?
While these proposals will lay many more transactions open to Government scrutiny, the Green Paper emphasises that the Government has no intention of ruling any part of the UK economy “off-limits” to foreign investment and expects that “the need to act would be relatively rare”, with fewer than 100 transactions per year requiring notification under the proposed new mandatory regime. However, whatever the balance struck between the scope of any mandatory regime and the frequency of use of a call-in power, there will be additional analysis, reporting burden and cost for businesses as well as a new (potential) investigation timeframe to consider and accommodate at the early stages of transaction planning. Ultimately, that increased Government scrutiny could result in the imposition of conditions to clearance, prohibition or unwinding of a completed transaction.
Set in a wider context, the UK Government’s proposals are part of a long-running political debate on State intervention in cross-border M&A, and reflect a trend within the European Union and individual EU Member States to expand the scope of scrutiny of foreign direct investment. Indeed, only last month the Commission proposed measures for the screening of foreign takeovers and investments by EU Member States (and the Commission itself) on grounds of security and public order (European Commission proposes common approach to foreign direct investment screening). The Commission’s proposal, in turn, came hot on the heels of Germany, which in July amended its Foreign Trade Regulation to extend screening periods and clarify the reach of government review (Foreign investment control in Germany: Berlin Wall rebuilt or storm in a water glass?). The Green Paper notes both of these developments in support of the UK Government’s view that “the UK’s current approach appears less well developed than our partners to deal with the potential risks to national security that we face, and the scale of investment our national infrastructure will require.”
Also, in September, the UK Takeover Panel announced proposals to strengthen the rules on bidders’ statements of intention regarding the business and employees of a target company. The proposals, if implemented, will require more detailed disclosure of intentions (including in relation to R&D functions specifically), at an earlier stage of a bid than is currently required, and with a requirement to report publicly on whether the intention statements have been complied with one year after the deal has closed. The proposals build on the rules in this area which were developed following Kraft’s bid for Cadbury in 2010 and Pfizer’s possible offer for AstraZeneca in 2014.
The UK Government and the Panel have coordinated their approach and the proposals will be of interest to potential purchasers considering relevant investments in the UK. The message from the UK Government is clear: foreign investment is welcome, it just needs to be accompanied by appropriate scrutiny of potential national security issues in a necessary and proportionate manner. There will be a delicate balance to be struck in the implementation and application of the new rules to ensure that any specific areas of concern are addressed without discouraging investment into the UK at this important time.
You can read the Green Paper here.
For specific advice on the proposals and their potential impact, including developments as they make their way through the UK legislative process, please contact the authors of this Alert or your usual A&O contact.