In the latest in a series of legislative steps taken globally that have been designed to allow governments to exercise tighter rules over foreign investments, the UK Government has published proposals to enable it to intervene in a broader range of foreign investments that may raise national security concerns:
- Military and dual use products and advanced technology: investments in these sectors will no longer need to meet UK merger control thresholds to fall under review. The UK Government will be able to intervene if the target business has UK turnover of over £1 million (instead of £70 million) or a share of supply of 25% or more (with no need for an increase). The UK Government intends to make these changes as a matter of urgency by way of secondary legislation; and
- Broader powers to review deals on national security grounds: two options are being considered for long-term reform that will require primary legislation: first a ‘call-in’ power to allow the UK Government to review a broader range of transactions within a voluntary notification regime and, second, a mandatory notification regime for foreign investments in certain key sectors, businesses or assets. These powers will catch a much wider class of transactions in key sectors than those caught by the existing UK merger control regime, including new projects and asset deals.
Faced with the possibility of up to 100 transactions per year being scrutinised under the new plans, early preparation and consideration of potential issues will be crucial for many prospective investors into the UK.
The proposals come as no surprise to many. They were announced in the Queen’s speech in June 2017, and follow several statements by Theresa May and her Government on the importance of scrutinising foreign investments in strategic sectors. They are, however, notable given the UK’s long track record of open investment and its comparative lack of political intervention in deals to date. To some, they look more like a blast from the past, when the UK reviewed mergers under the broad public interest test that was replaced by a competition-based assessment for the majority of deals in 2003.
Nevertheless, the UK is not alone in tightening up its approach to the screening of foreign direct investment. These proposals follow the unveiling last month of the European Commission’s draft proposed regulation on foreign direct investments, while Germany has recently updated its own rules in this area. On a similar note, the Trump Administration last month blocked Chinese-backed private equity fund Canyon Bridge’s acquisition of Lattice Semiconductor, following a unanimous vote from the CFIUS committee, amid calls from some quarters for a broadening of CFIUS’s role.
The UK Government has stated that it wishes to provide as much clarity as possible about national security assessments going forward. For this reason it has established a cross-government forum to bring together relevant UK Government departments and agencies. Businesses and investors who wish to engage with the UK Government about transactions that may have a national security dimension are therefore invited to contact the UK Government department that has responsibility for their sector. In addition, a public consultation period is now open on the specific proposals. If you would like to discuss the proposals with us, please get in touch.
The proposed new regime
The UK Government has proposed a set of measures aimed at giving itself a broadened scope to intervene in foreign investments and acquisitions that raise national security concerns. The proposed measures would significantly expand the UK Government’s existing powers in this area.
The UK merger control regime currently enables the Secretary of State to review deals on the basis of specified public interest grounds: national security, plurality and quality of the media and stability of the UK financial system. However, (with some limited exceptions) intervention is only permitted if a transaction falls above certain turnover and share of supply thresholds.
The UK Government’s stated policy objective is to ensure that it has a clear and consistent means available to take necessary and proportionate steps to protect national security where required, both in the short and long term.
Short-term reforms: military and dual-use and advanced technology
The UK Government believes that there are certain “gaps” in existing legislation that require immediate action in order to protect national security. It is proposing to amend the existing turnover threshold and share of supply tests under the UK Enterprise Act 2002 to allow it to examine and potentially intervene on a national security basis in much smaller transactions in two specific sectors: (i) the dual-use and military sector; and (ii) parts of the advanced technology sector. For these two sectors only, the proposal is to reduce the turnover threshold so that certain small and medium sized businesses are brought into scope for review (i.e. those with a UK turnover of greater than £1 million) and to amend the share of supply test to remove the requirement for the merger to result in an increase in share of supply (the test is met if the target business has an existing share of supply of 25% or more of the relevant goods or services). A knock on effect would be that mergers in these two sectors that meet the new thresholds would also be subject to competition review by the UK’s competition authority.
The dual-use and military sectors cover the design and production of military items and “dual-use” items which could have both military and civilian uses. To provide clarity as to the basis for which businesses in this sector would be subject to the amended thresholds for intervention, the UK Government intends to rely on the Strategic Export Control Lists, proposing that enterprises that design or manufacture items or hold related software and technology specified on the UK Military List, UK Dual-Use List, UK Radioactive Source List and EU Dual-Use Lists would be in scope.
Parts of the advanced technology sector are included on the basis that mergers involving certain categories of advanced technology, which are often developed by small businesses, have the potential to give hostile actors knowledge or expertise that could be used to undermine national security. The key areas set out in the proposal for the amended thresholds to apply are:
- Multi-purpose computing hardware - enterprises that: (i) own or create intellectual property rights in the functional capability of multi-purpose computing hardware; or (ii) design, maintain or support the secure provisioning or management of roots of trust of multi-purpose computing hardware; and
- Quantum-based technology - enterprises that research, develop, design or manufacture goods for use in, or supply services based on, quantum computing or quantum communications technologies. This would include the creation of relevant intellectual property or components.
In relation to both sectors, the UK Government is seeking feedback on, amongst other items, the appropriateness of the proposed definitions concerning which types of business should fall into the scope of the amended thresholds for intervention.
In terms of timing, the UK Government plans to put this amendment into effect “as a matter of urgency”, and the relatively short consultation period (all feedback must be made by 14 November 2017) seems to confirm this intention.
Long-term reforms: an expanded ‘call in’ power or mandatory notification
These short terms reforms will likely eventually be subsumed by the UK Government’s proposals for more far-reaching reforms that it intends to pursue in order to protect national security while maintaining an open approach to trade and investment. Reforms currently under consideration include a combination - or all - of the following proposals:
- An expanded version of the ‘call in’ power within the UK’s existing voluntary merger control regime allowing the UK Government to scrutinise a broader range of transactions for national security reasons, including new projects and bare asset sales. This power appears to cover both foreign and domestic investors.The UK Government envisages using this “call-in” power when more than 25% of a company’s shares or voting rights are acquired (i.e. in line with the current approach under UK merger control rules) but also when a transaction gives (directly or indirectly) significant influence or control over that company or its assets or businesses in the UK. This “second limb” therefore encompasses a much broader range of transactions than those currently covered by UK merger control rules. In line with its existing “call-in” powers, the UK Government is indicating that there would be a similar three month “call-in window” for it to intervene under the new regime.
- A new mandatory notification regime for foreign investment into the provision of a focused set of “essential functions” in key parts of the economy which would likely include, as a minimum, the civil nuclear, defence, energy, telecommunications and transport sectors, and probably also the manufacture of military and dual-use items, advanced technology, government and emergency services sectors. The UK Government states that it intends the mandatory regime to only apply to parts of these sectors, i.e. to an identified set of “essential functions.” Annex C of the document summarising the proposals sets out draft definitions of the essential functions within each key sector. While only parts of sectors are identified, they are still in some instances extremely broad, for example mandatory notification would appear to be required for all telecommunications providers with more than one million customers and retail energy suppliers with a “significant customer base”. Mandatory notification could moreover potentially be required for new projects that could reasonably be expected in future to provide essential functions as well as certain specifically identified businesses or assets even though the sector in which they operate is not in scope, for example if they supply critical services or goods to national infrastructure firms. The UK Government is also seeking views on the merits of including particular plots of land in the UK into the scope of review, where that land is in proximity to a national security-sensitive site. Given the breadth of sectors potentially caught by the mandatory regime, investors may well try to structure deals in two phases to try to carve out essential functions that would be subject to mandatory review. Whether such structuring would be possible is not yet clear. The UK Government refers to the mandatory regime addressing parts of sectors where “foreign ownership or control” could pose national security risks. At this stage no definition is provided as to which levels of “foreign ownership” would trigger a mandatory notification, but it could well be that non-controlling interests are covered. Unlike the voluntary “call-in” regime, this system does appear to be limited to foreign investors.
How the reforms are expected to operate
The UK Government has emphasised its wish to retain the independence of the UK’s Competition and Markets Authority and a clear separation between competition and national security related assessments, and that it does not intend for the proposed reforms to affect the way in which other public interest assessments (i.e. on the grounds of financial stability or media plurality) operate. However, what is not clear is how such a regime will operate in practice, for example the duration of reviews and what form any review body would take. Interestingly, no extra budget appears to have been allocated to assist with the review of what could be up to 100 transactions per year.
In terms of enforcement, as under the existing regime, the UK Government foresees itself as being able to approve, impose conditions on or – in extreme cases – prevent or unwind a transaction. This would be subject to a judicial review mechanism, which brings the proposals more in line with those unveiled recently by the European Commission than for example the US CFIUS regime, and may provide investors with some comfort that purely political reviews would face some degree of checks and balances. Given the seemingly broad reach of the mandatory regime, investors in a wide range of sectors, potentially acquiring interests equating to less than control, will need to be acutely aware of their notification obligations as sanctions for non-compliance include criminal offences, financials penalties and/or director disqualification.
The UK remains open for business
The introduction of a mandatory notification regime would be a hugely significant step for the UK, which currently operates a voluntary merger control regime and has long held itself out as a favoured destination for foreign investment and champion of free trade. This apparent change in direction is particularly notable in some of the mooted long-term proposals, including the wide range of sectors potentially covered by the mandatory notification regime and the possibility of the UK Government having the power to include certain individual businesses or assets in the scope of the mandatory regime even though the wider sector in which they operate is not in scope (i.e. no essential function would need to be identified). If drafted broadly, such a provision could in theory allow the UK Government to review and even block any transaction that it wishes. While the UK Government emphasises the need to ensure that such a provision still provides clarity to businesses, it is difficult to see how this could be squared with the names of businesses or assets on this list only being published upon the exercise of the power, and in some cases not at all.
Nevertheless, the Business and Energy Secretary Greg Clark stated upon the release of the proposals that “no part of the economy is off-limits to foreign investment and the UK will continue to be a vociferous advocate for free trade and a magnet for global talent”. Whilst the sentiment is clearly consistent with the UK’s over-arching message as a champion of foreign investment, the interpretation and implementation of this new regime (like all laws) has the ability to evolve over time to reflect the then current political mood of the nation.
To allow interested parties to put forward their views on aspects of these proposals, a public consultation is now open:
- comments on the lower threshold for military and dual use products and advanced technology must be made by 14 November 2017; and
- comments on the broader powers must be made by 9 January 2018.