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In 2018, new measures were introduced to expand the scope of government intervention in mergers. This year, the government's briefing note accompanying the Queen's Speech proposes new rules on investment screening. What does this mean for business?

Our experts examine the existing UK foreign direct investment rules, and explain what any expansion of investment screening may mean in practice.


Bernardine Adkins: Well good morning, here we are on a cold wet Friday morning where we are still tittering on the edge of are we going to get a deal will all be revealed tomorrow Saturday and, in the meantime, Sean and I thought we would try something completely different.

Something that, Brexit or no Brexit, is not going anywhere and is an issue. It's the issue of foreign direct investment regimes and what the UK does to screen investment on the basis of national security. Indeed we will have a peep at what other people are up to in other jurisdictions as well.

I thought it would first be interesting to just review what is the background to how foreign direct investment has been regulated (or not) in the UK. Old hands will recall back in the day we used to have the Secretary of State on any merger, who would be the final decision maker and people probably will recall that when the then Office of Fair Trading issued its report there would be a mad scramble to get the ear of the Secretary of State as to what the remedies would be ordered or not or would the deal be blocked or not. And, then enter Thatcherism the wonderful freehand of the market whereby the various Secretaries of State said 'I will only decide mergers on pure economic grounds, pure competition grounds I am not going to intervene on political bases' and that was described as the Lilley doctrine and then became the Tebbit doctrine. That sort of situation of policy was maintained for a number of years until it was eventually transcribed into law in the wonderful Enterprise Act 2002 as amended by what competition lawyers affectionately call the "ERRA" Act - The Enterprise and Regulatory Reform Act. [The Enterprise Act] put into law what had already happened, as a matter of fact, the de-politicisation of the process whereby the Secretary of State had very limited powers of intervention where it could only intervene in a merger where:

  1. the merger meets the jurisdictional requirements which we will come onto and
  2. also raised a public interest consideration.

In that Act tactic it was only national security that was initially marked out as being a specified consideration and only later on through parliament did we add such matters as plurality of the media (although some people would question whether actually we would be very effective in intervening in that front) and also the stability of the UK financial system.

But, Sean, I think I can turn to you now and explain how these wonderful expressions of the PIIN notice and the SPIIN notices - how does this intervention actually operate in practice?

Sean Giles: Yes, it is nice to talk about another type of government 'spin' I suppose, with two I's, so the 'PIIN' is the Public Interest Intervention Notice and the SPIIN is the Special Public Interest Intervention Notice. They are essentially two separate jurisdictional bases on which the Secretary of State may intervene in a merger. For PIIN it more broad, I guess, than a SPIN on the basis that SPIIN – since a SPIIN is special there is some extra requirements which I will talk through shortly.

So on a PIIN, there are several grounds that the Secretary of State can intervene so, as mentioned by Bernardine earlier, that was the plurality of media, stability of the financial system and defence - it is "national security". The process for SPIINs and PIINs is broadly the same whereby the Secretary of State refers a transaction (or a transaction that is in contemplation and there is a media announcement about it and that is how the government find out about it) to the CMA or, in the case of media mergers, that might also go to OFCOM.

The CMA then produces a report to identify whether (a) there has been what is called a relevant merger situation so where there is something that would satisfy the normal jurisdictional test for the CMA to intervene. It then [(b)] looks at whether the public interest concern raised by the Secretary of State exists so the phrase they use in legislation is it "operates contrary to the public interest".

The CMA then recommends in its report to the Secretary of State what action, if any, the Secretary of State should take to address either the competition concerns, if there are any, and the national security or other public interest concerns, if there are any. But the actual decision maker itself is the Secretary of State. The Secretary of State is bound to follow the CMA's decision on whether there is, in fact, a merger situation and the Secretary of State also follows the decision in respect of competition analysis.

But it is ultimately the Secretary of State's decision whether the government should intervene and whether the transaction should be then referred to a phase two in-depth investigation following that initial phase one report. So, it operates quite similarly to the ordinary merger regime where you have the phase one, initial investigation and the phase two, in-depth investigation if there is a potential substantial lessening of competition.

Bernardine: Yeah, and just to make things even more complex and more fun it was last summer wasn't it that the government introduced another threshold with respect to issues again which will arise in and around national security?

Sean: Yeah, that is right, so last year the government changed the law - introduced a new piece of legislation - that added the definition of "relevant enterprise" to the Enterprise Act. A "relevant enterprise" is defined as a company (or a business) that is involved in the design and maintenance of aspects of computing hardware, the development and production of quantum technology or the development or production of military and militaries within use i.e. dual use goods and services. Dual use goods and services means items that can be used for military application or civilian application and the UK has several lists of what these goods are so there is the UK military list, the UK dual use list, the UK radioactive source list and there is also the EU dual use list which sets out a variety of goods that, if an enterprise deals with those goods, is caught within this definition of relevant enterprise. If you are a relevant enterprise the jurisdictional tests are lowered so the turnover tests is reduced from £70 million to £1 million and on the share of supply test there is a change there that you no longer need an increment you just need to acquire 25% of goods and services of a particular description.

Bernardine: We have experienced that this has really caught people on the hop, it does not seem to have gone into the thinking of the corporate world when these deals are happening. The other thing people do not realise is this £1 million turnover test so, in fact, there could be just one ball bearing within a deal that it falls under that list and the rest can be, you know, making sandwiches, you are still within that turnover, so it is deliberately set incredibly low to give a huge amount of flexibility for the government to intervene.

But nonetheless we are still in this voluntary system where people decide whether or not they want to inform the authorities but mercifully both BEIS and the CMA have issued parallel guidance.

Sean: Yeah, so that guidance, so the BEIS guidance is sort of on behalf of the Secretary of State, I suppose, and that talks about what the definition of a relevant enterprise is, the kind of goods it expects relevant enterprises to be involved in, and when it would expect a notification [by the Secretary of State] to be made to the CMA on the basis of this revised jurisdictional test.

The CMA guidance, again, very helpfully talks through those various lists. It does not talk through the Secretary of State intervention side so much it more talks about the delimitation of who does what in terms of that investigation. That reads on again to this PIIN (public interest intervention), and when the Secretary of State may intervene if the CMA is not looking at a transaction concerning a relevant enterprise, the Secretary of State may issue a PIIN if these relevant enterprise jurisdictional basis are met. So that is, again, a massive lowering from £70 million to £1 million and that affords the Secretary of State the ability to intervene.

Bernardine: Yeah but, I think, everybody is at pains to say it will not be that many deals that are caught by that but what they do encourage is people to come proactively approach the authorities, approach the relevant government body that they may be selling into - the Ministry of Defence is the obvious one - and have that dialogue and upfront to perhaps get yourself that security, that comfort, as to whether the authorities are going to be interested in a particular deal (and whether or not they are going to be interested to issue a PIIN). I think, in the vast majority of cases, that should be reassuring for people and it is better that people get that reassurance early on prior to completion.

Sean: Yeah, and the guidance focuses on that dialogue aspect of it rather than the government wanting to intervene frequently, it is more about taking a risk-based approach.

Bernardine: Yes, because there is always that tension in any regime of this nature between wishing to encourage foreign direct investment but at the same time wanting to be cautious to ensure that the hostile authorities, hostile countries, do not have an undue interest in our economy.

So keen observers of the Queen's speech would have noticed that, in the background paper to the speech, the government have said that they are going to be bringing forward legislation to create a discrete regime around foreign direct investments. What we know is that essentially this national security oversight is actually going to be removed from the merger control regime and it will no longer be the CMA which will be carrying out that screening. What we understand is proposed (or will be proposed) is based on a green paper on this issue, then a white paper back in July of last year looking at proposals for a national security regime - we have also had consultation and now we are waiting for the issue of this proposed legislation. What we do know is that it is going to create a discrete system, we are going to be removing the screening of investments on the basis of national security, it is going to removed completely from the merger jurisdiction and put into its own standalone system.

But still we are going to remain with this quite uncertain voluntary regime, voluntary notification with the same time the government having a so called call-in power which will be backed with sanctions if people do not start to co-operate in terms of notification and [the government] will be able to examine transactions and investments for review.

What is interesting is what they are saying the call-in power will happen where you have got a "trigger event", which reads quite similarly to what a merger would look like and it can be done if it is some sort of indirect [investment], some sort of form of material influence. But it will also apply to acquisition of assets and, again, this is probably going to have people unaware so it could be acquisition of an infrastructure, acquisition of intellectual property, acquisition perhaps of a piece of land even if that is of strategic interest.

So: does a trigger event occur? Then the second question will be "is this trigger event posing a risk to national security?"

So it is going to a very, possibly deliberately, a very fluid test and so there is going to be a need for people to engage in dialogue with the government to ascertain whether there is a chance that the government will intervene. I think the government is aware that they do not want this new system to operate so as to create too much uncertainty and stifle foreign direct investment, so they are also going to issue a statement of policy which will set out when it expects such national security concerns to arise.

But they also say they expect that intervention will be exceptional and they expect that only 200 transactions a year to be affected. But, that said, if it is your transaction that is affected and you have not seen this coming - that is pretty major.

Sean: And that contrast currently because the "trigger event" at the moment is effectively a 'relevant merger situation' under the existing merger review regime on national security grounds. So this will broaden that definition of a trigger event, and create a new set of trigger events for review?

Bernardine: Yeah, absolutely.

Sean: As distinct from a merger review?

Bernardine: Yes, correct. Also it would include transactions which were structured as a loan as well. So it is very much a desire to intervene, and if people try and circumvent it those powers of intervention, [the regime] will still apply. But this is not isolated - this sort of reshaping the legislation, reshaping the screening is not isolated to just the UK. We are seeing it across the globe in this new trading environment that we are seeing. We have seen at an EU level, we have EU Regulation 2019/452 establishing a framework for the screening of foreign direct investments into the Union. This was largely promoted as a sort of Franco-German initiative which a Cecilia Malmström [EU Commissioner for Trade] also ran with.

It is an interesting one because, ordinarily the issue of an EU Member State intervening on the basis of national security, very much falls within the competence of the Member State, that is an exception to the so-called Common Commercial Policy, which falls within the exclusive competence of the EU. It is interesting there has been this desire to have a regulation across the board to apply to whole of the EU It is one of these early regulations, basically trying to establish some common rules, some common ground, a co-operation mechanism as between various Member States to create a learning as to how and on what basis a country should intervene to inhibit or screen foreign direct investment.

On its face, you can say "oh this is dreadful", there is increased oversight of transactions but my view is that actually that could be a good thing. One of things [the regulation] is trying to do is ensure that there is certainty put into the regime, that people have proper rules and procedures, that these rules and procedures are transparent and there is no discrimination and so on.

To my mind, it actually guards against a Member State behaving in an arbitrary fashion - and that is good for business because it gives them certainty, transparency, predictability and those are the circumstances that encourage, quite frankly, foreign direct investment.

So, I think, it is an interesting spot to watch, it should be coming fully into force October of next year. We are seeing this happening across the globe, it is an uneasy balance that countries need to manage - the balance between fear and greed. Fear of what is happening in terms of where is this foreign investment coming from, is it coming from a hostile regime? And greed - which is basically you want to encourage foreign direct investment into a country because it creates employment and it is a good thing. It is a difficult balance as to how Member States do it. I n the UK, a very UK-orientated approach, it is a voluntary system but that has its own dangers because people can be caught unawares.

Sean: That is right Bernardine, I mean, Japan just this morning has announced that they are introducing legislation for screening of foreign direct investment. I would love to disclose more detail about it but, unfortunately, the announcement is in Japanese and my Japanese is slightly rusty. But also one thing just to note on the regulation is that it actually creates a common framework across the EU because, at the moment, only 14 Member States have legislation for foreign direct investment screening. So, at least, now there should be some single regime or some co-ordinated regime across all 28, soon to be 27, Member States.

Bernardine: Indeed, because it puts in place a co-operation mechanism and also the Commission has an involvement and engagement in it and at times [the Commission] actually can intervene where there is a community project that is possibly being compromised as a result. I suspect that the role of the Commission in this may well grow over time.

I think that probably about wraps it up Sean.

I think the last point we need to make is to say we really have just touched on these issues but as you can hopefully hear this is very much an evolving landscape and it is one to watch because, I think, it just not getting the traction or the noise that one would expect. Maybe it will at some point, but it does mean that we are seeing it as a bit of trap for the unwary because it really has just risen up for the last couple of years and business, the corporate world, is not yet used to that level of oversight but from what we can see we expect it to increase and it needs to managed accordingly.