2015 is looking set to be the year the European Commission significantly expands its powers to investigate minority, non-controlling investments. Such a move would bring the Commission’s powers into line with several other major authorities – including those in Austria, Brazil, Germany, Japan, the UK and US. It is also likely to lead to similar extensions of power elsewhere in the world, where merger control practice tends to be heavily influenced by the Commission’s approach.
Many antitrust authorities take a close interest in minority stakes because of their potential to change how companies compete, either through changed financial incentives, co-ordinated behaviour through information flow or influence over commercial behaviour through blocking rights.
Acquisitions of minority interests have long been scrutinised by the US Federal Trade Commission and Department of Justice. In particular, the US authorities have focused on cross-holdings by competitors and third party (private equity) investments in competing firms. These cases show us that in certain instances, regulatory risk may be mitigated by limiting the acquirer’s degree of control in the target and access to target competitively sensitive information
EU merger control – changes ahead
Following publication of detailed proposals in July 2014, the Commission is moving towards legislative change, despite considerable opposition from corporate and financial investors who have argued that regulatory intervention in such deals could stifle investment and economic growth.
The Commission’s proposals, as currently drafted, will impose filing obligations on parties making acquisitions that meet certain prescribed thresholds. Closing will need to be suspended for at least three weeks, and possibly much longer if competition issues are identified that merit investigation. Even if a transaction closes without a full notification being required, there remains a risk of subsequent intervention and divestment orders for up to six months. The impact on timing and completion risk for such deals will be significant.
Helpfully, the Commission has recognised that the regime should only apply to the minority of deals that potentially raise competition concerns. Officials have stated that they are expecting only around 30 notifications each year (with annual notifications under existing rules currently numbering around 280). However, most experienced investors and advisers agree that this number is unrealistically low, unless the current proposed thresholds are both raised and more clearly defined.
The proposed new regime
Acquisitions of non-controlling stakes that meet EU turnover thresholds must satisfy two cumulative tests in order to fall within the new regime: (1) they must be significant enough to allow the acquirer to influence the target’s commercial policy; and (2) the acquisition must be in a competitor or vertically related company.
Currently, significance will be presumed at around 20 per cent due to corporate rights and changes in financial incentives that accrue (or are deemed to accrue) at such a level. However, links may be deemed significant at much lower levels (even as low as 5 per cent), if the investment is combined with additional factors such as a de facto blocking minority (through low shareholder attendance at general meetings), board representation or access to commercially sensitive information.
Experience in other regimes where jurisdiction may be determined by, for example, shareholder attendance at general meetings, supplier and other key commercial relationships, debt finance arrangements or potentially wide concepts such as “commercially sensitive information” suggests that the decision whether a deal should be notified will be far less clear-cut than international best practice on clear and objectively quantifiable criteria demands.
Competitors and vertically related companies
Under the second limb of the test, the concepts of ‘competitor’ and ‘vertically related company’ have also raised concerns, given their potential for wide and subjective interpretation.
Could, for example, a ‘competitor’ include a potential competitor, or a company active in the same sector but different geographic market? How will the Commission assess different views and evidence on closeness of competition between particular companies? Could the concept of vertical link capture all supplies into a product or service, or will it be limited to those links where realistic concerns over input or customer foreclosure could arise? What happens if a competitor relationship develops over time?
In the UK, where the same ‘share of supply’ test has been in place for over 40 years, and where a long line of cases and detailed guidance should provide sufficient legal certainty, the question whether a 25 per cent ‘share of supply’ is created or enhanced by an acquisition is still often debated over many months.
In Germany, uncertainties created by a jurisdiction test that relied on market definition and quantifying market size recently led to the abolition of an exemption for mergers in small (‘de minimis’) markets.
It is clear that, in a mandatory filing regime with significant financial penalties for breach, filing thresholds should be capable of determination by the acquiring party at the time the transaction is being contemplated, without the need for in-depth market analysis. In the case of minority acquisitions, detailed information about the target’s portfolio companies is likely to be even more limited than in some cases of acquisitions of control. Experience in other regimes which incorporate similar concepts that rely on categorising markets, market shares or commercial relationships emphasise the need for objectively clear thresholds.
These changes will have major implications for financial and corporate investors looking to invest in companies, and build portfolios, with limited regulatory interference or risk. Now is the time to assess whether you have adequate systems in place to assess filing requirements and avoid serious financial penalties being imposed
Recent cases have highlighted the importance of establishing clear thresholds, and the risks of getting it wrong: in July 2014, the Commission imposed a €20 million fine on salmon farmer and processor Marine Harvest for acquiring a 48.5 per cent stake in its rival, Morpol, without clearance.
The German authority has demonstrated a pragmatic approach to pure financial investments and minority stakes not raising concerns. However, it has taken strong action to prevent cross-shareholdings between competitors and vertical integration in markets where competition may be impeded. Intervention to limit vertical integration in the energy sector, in particular, has been a key area of focus
Looking ahead to 2015
It currently looks fairly certain that these major changes to the EU merger regime will come into force, although the timing and the details are still to be worked out. In the meantime, corporate and financial investors looking to acquire minority stakes should be anticipating a number of changes to deal timing and completion risk ahead:
- Deal planning
Parties will need to anticipate likely regulatory intervention and the impact on overall deal certainty in their:
- due diligence – asking the right questions to identify potential overlaps and assess risk early on;
- transaction documents – ensuring adequate protection through regulatory conditions, long-stop dates and co-operation agreements to help ensure the conditions are satisfied; and
- financing - anticipating potentially higher costs involved in a longer and less certain transaction timetable.
- Competition assessment and evidence
The Commission plans to apply the same substantive assessment that it applies to acquisitions of control – whether the transaction will lead to a significant impediment of effective competition – with theories of harm tailored to the specific circumstances of the minority holding. Experience in other regimes (notably Germany and the US), however, suggests that the Commission may conduct its review as if control is being acquired, despite the fact that the parties will remain competitors. In practice, it will be important for parties to be able to advocate the impact a lower level of influence should have on the substantive assessment, through economic and market-based evidence.
- Upfront planning
More upfront time will be needed to assess whether a deal is caught and prepare the notification, if needed. Current levels of uncertainty around the jurisdiction tests, and the penalties involved in failing to notify a notifiable deal, suggest that more investors will choose to notify transactions – or make a full, voluntary filing – than the Commission currently anticipates.
- Overall timetable
For deals that are caught, closing may need to be suspended for several weeks or months, depending on the issues at stake and the authorities involved. Parties will need to consider whether they should commit the time and cost involved in a lengthy review, and agree fall-back positions if necessary.
The Commission will publish details of filings, and will circulate the notification to authorities in all 28 member states, resulting in significantly increased publicity – and flow of information around – minority investments. Companies should anticipate much more transparency across their portfolio interests and investments.
To prepare for these changes, there are a number of steps companies could take now:
- Knowledge of portfolio interests
Investors will need to be able to check for competitive overlaps and vertical links in minority stakes across all investor holdings, including aggregating positions held by different funds or divisions (e.g. debt finance, equity investment, broking). Acquisitive investors should ensure they have the systems in place to enable them to make these checks both accurately and efficiently.
- Understanding how the new regime will operate in practice
The Commission’s approach, and how it interprets its potentially broad powers in practice, will need to be monitored closely in order to identify notifiable deals and understand the impact on completion risk and timing. At least until detailed guidance and reliable case law is established, investors are strongly advised to involve antitrust advisors, who have regular experience with the regime, early on in any deal discussions.