On 11 June 2018, the UK government (“UK Govt”) revised its merger control thresholds to allow it to review smaller mergers that have the potential to raise national security concerns.
The new thresholds allow the UK Govt to review a merger in certain sectors, where the target's UK turnover is £1m (down from £70m), or where the target has a share of supply in the UK of at least 25% (even where there is no overlap between the acquirer and target's activities).
The sectors for review cover military/dual-use goods, and aspects of computing hardware and quantum technology, demonstrating a potentially very large remit. Although the UK Govt and the UK’s competition authority (the Competition and Markets Authority, or “CMA”) currently expect the actual impact on caseload to be limited (at up to six cases a year), this is a significant expansion of the jurisdictional thresholds. It remains to be seen how businesses, and the CMA, will handle the new scope, in particular with the expected uptake in caseload following Brexit.
The revised thresholds come in the wake of an increasing focus on national security matters, and a global rise in protectionism. Other jurisdictions, such as Germany, have revised their powers to review transactions in what they deem critical infrastructure sectors, and the European Union is currently working towards adopting its own rules on screening foreign investment into critical infrastructure.
Background – the current rules
The UK has historically had one of the most relaxed regimes worldwide when it comes to reviewing inbound foreign direct investment (“FDI”), and is in turn one of the major global recipients of foreign investment. Unlike with the United States, foreign investors into the UK face no CFIUS-equivalent hurdles to their transactions.
Likewise, the UK has a voluntary regime for competition matters, and the parties to a transaction are not required to notify. However, the UK (through the independent competition authority, the CMA) can of its own volition review a transaction where the UK jurisdictional thresholds are met. These are:
- The target’s UK turnover exceeds £70 million (the “turnover test”); or
- The parties’ activities overlap and they have a combined UK share of supply or purchases of at least 25% (the “share of supply” test).
Where the jurisdictional thresholds are met, the CMA can “call in” the transaction for review for up to four months after it closes or is made public. The CMA will review the transaction on narrow competition grounds.
The UK’s public interest regime
Only in three types of transaction can the UK Govt review the transaction on broader political grounds, as well as competition grounds; these are “public interest” cases, and cover transactions that concern (i) national security, (ii) plurality of the media, or (iii) the stability of the UK financial system.
Outside of the jurisdictional thresholds the government can only intervene under the “special public interest regime”, which applies to a narrow remit of certain “government contractors” holding confidential information related to defense and certain mergers in the media sector.
Since the introduction of the Enterprise Act in 2002, use of the public interest regime, or special public interest regime has been relatively uncommon. The government has to date only intervened using these powers 12 times, of which seven were on grounds of national security.
The process for public interest mergers remains unchanged by the new legislation. Should the UK Govt decide to intervene in a merger on public interest grounds, the process is broadly as follows: The Secretary of State issues a public intervention notice requesting review of the transaction on public interest grounds, which leads to a phase 1 report from the CMA. The transaction can then proceed, result in remedies, or lead to a phase 2 investigation. After the phase 2 investigation, the Secretary of State decides on whether the transaction can go ahead, or on suitable remedies. No public interest review on national security grounds has yet gone to phase 2.
What are the changes?
The changes that came into force on 11 June 2018 broaden the jurisdictional range in the UK where cases of national security are concerned by lowering the turnover test amount and the amending share of supply test.
(1) The Enterprise Act 2002 (Turnover Test) (Amendment) Order 2018 reduces the turnover threshold: the target now needs to achieve just £1m in the UK, down from £70m.
(2) The Enterprise Act 2002 (Share of Supply Test) (Amendment) Order 2018 eliminates the need for the parties to have overlapping activities in the UK. Whereas previously the share of supply test required (i) the parties to have a combined share of at least 25% in the UK and (ii) an incremental increase in share to arise as a result of the transaction, now the target is just required to have a 25% share.
This amendment to the share of supply test is significant, nullifying the need for the acquiring party to have any activities in the UK market in the same sector as the target, which has traditionally formed the basis of the initial competitive assessment in the UK.
Importantly, the changes only apply to certain sectors identified by the government as having a nexus with national security: being a “relevant enterprise sector”. These are described in detail in the legislation cited above, but in essence cover:
(i) the development and production of items for military or dual military/civilian use;
(ii) the development and production of quantum technology; and
(iii) the design and maintenance of aspects of computing hardware.
The definitions of these sectors are complex and potentially broad. We do not go into the complexities of the definitions in this Alert, other than to note the inclusion of dual-use items as within the scope of review. Dual-use items are products that can be used for both civilian and military applications, and the scope of the items considered dual-use is therefore necessarily broad, including items from nuclear materials, to electronics, computers, lasers, propulsion, marine, and others. Putting such items within the remit of the government’s review is likely to put UK merger control on the radar of many a company that to date had only been concerned with export control rules. The Government advises concerned companies to check the Goods Checker Tool1 on its Export Control Organisation website in the first instance to determine whether they might fall into scope.
Why have the new rules been introduced?
The UK Govt has made it clear that the changes coming into force are designed to address national security concerns, noting that the new thresholds come “in light of technological advancements, economic developments and changes in the national security threat” 2 , and as a result, “the Government needs to be alert to the risk that having ownership or control of critical businesses or infrastructure could provide opportunities to undertake espionage, sabotage or exert inappropriate leverage”.3
The removal of the share of supply increment reflects the UK Govt’s concerns about non-UK buyers, with no presence in the UK market, buying up UK enterprises that present a national security angle.
While presently the focus of the changes are limited to the context of national security, the UK Govt has suggested that more sweeping reforms may be implemented in the longer term, potentially including a mandatory notification regime for “essential functions” of the economy, which alongside defence, could include such sectors as civil nuclear, energy, telecoms, and the transport sector.
This is not surprising when seen in wider context of global developments, in particular the rise in protectionism we are witnessing throughout the world. Last year notably saw Germany tighten its FDI regime by expanding its definition of industries deemed to be “critical infrastructure”, in particular IT security related industries.4 The new regime also strengthens the authorities’ power to call in transactions that have not been notified by extending the period to five years, and unlike the UK, this time period only starts running from written notification to the authority of completion of the transaction.
At the same time the European Commission has proposed a framework for the review of FDI, which would allow the Commission and Member States to screen FDI in critical infrastructure sectors (including energy, transport, and communications) on the basis of security and public order. The proposal is currently going through the EU’s parliamentary procedure.
What does this mean for you?
Despite the breadth of the changes, in practice the UK Govt expects only 5 – 29 additional mergers to be brought into its jurisdictional reach, of which it estimates just 1 – 6 to raise concerns. 5 In line with this, while the CMA has issued guidance stating that more transactions will now technically come within its jurisdiction, “it does not expect to change how it will assess mergers within these sectors from a competition perspective", and in particular it does not anticipate opening investigations of its own accord where the share of supply test is not met.6
Some comfort may be drawn from this, and from the UK merger regime’s traditionally open approach to trade and investment, which continues to be underpinned by a voluntary merger regime.
However, while the CMA’s current position is promising, it should not be overlooked that this is a significant expansion of the jurisdictional thresholds in the UK. Potential purchasers of businesses acting in the relevant enterprise sectors, in particular in the wide and varied realm of the “dual-use” sector, will need to consider an extra layer of due diligence in the analysis of the merits of the transaction in the UK.