The UK Government published on 24 July 2018 its long awaited White Paper on the proposed new national security screening regime to review investments by foreign investors which may have national security implications. In this article we review the Government’s proposals and ask what it means for foreign investment in the UK.
The UK currently uses the Enterprise Act 2002 to review mergers on national security and other public interest grounds alongside the competition regime.
Following the Chinese investment in the Hinckley Nuclear power station project, the Government voiced concern that it did not have enough powers to scrutinize properly investments by foreign investors on national security grounds.
Therefore it announced “a root and branch” review of its existing national security vetting powers and made certain proposals to extend its powers to review transactions which result in foreign hostile actors acquiring ownership and control in UK companies, property, intellectual property and other assets in certain key sectors of the UK economy.
In October 2017, the Department for Business, Energy & Industrial Strategy published for consultation a Green Paper to seek views as to whether the Government’s current powers were sufficient to ensure that national security risks receive the appropriate level of scrutiny. The Green Paper set out some immediate short term reforms to the Enterprise Act 2002 but also canvassed stakeholders’ opinions on the shape of a new CFIUS style regime in the longer term. The Government’s view contained in the paper was that there should be a substantial extension of its powers, with the formation of a vetting system entirely separate to the existing merger control system similar to other countries’ foreign direct investment (FDI) regimes.
Short term reforms
On 11 June 2018, the Government introduced reforms allowing it to intervene in a broader range of transactions where the target is active in either the military or dual-use sector, the computer hardware sector or quantum technology. Details of those reforms were provided in our previous blog ‘Greater national security scrutiny at the heart of new UK merger control reforms’.
Soon after the new rules came into effect, the UK Government took advantage of the new lower thresholds for such interventions. On 17 June 2018, it intervened on national security grounds in the proposed acquisition by Chinese-owned Gardner Aerospace of British aircraft parts manufacturer, Northern Aerospace. However, despite invoking the new rules to vet this transaction, it was subsequently cleared unconditionally on 19 July 2018 on the basis that there were no national security grounds for referring the merger for a more detailed Phase 2 investigation.
New FDI Regime
As the Government had intimated in its Green Paper, it wanted to establish a specific regime similar to other countries’ regimes entirely separate from the competition based merger control regime. Its proposals for that system and its longer term reforms were set out in the White Paper published in July. The object of the consultation on the White Paper is to seek respondents’ views about those trigger events that parties consider they would notify to the Government, or which they would seek further advice about. The consultation will remain open until 16 October for responses from stakeholders.
Following the consultation responses to the Green Paper, the Government now wishes to press ahead with its plans. It wants to introduce a standalone FDI system which protects national security from hostile actors using ownership of, or influence over, businesses and assets to harm the country. These reforms will bring the UK closer in line with other countries’ regimes, and are taking place as many other governments are also updating their powers in light of the same technological, economic and national security-related changes. The new regime is only related to national security which will be assessed by the Government. The proposals also involve removing the existing national security considerations from the Enterprise Act 2002 . National security is distinct from public interest issues. Public interest issues (namely plurality of the media and ensuring financial stability) will remain within the Enterprise Act 2002 merger control regime. The Green Paper concluded that no changes were needed to the wider public interest regime.
The main proposals contained in the Government’s new national interest regime are as follows:
Notification of relevant transactions covered by the regime will be voluntary, with the Government having the option of calling in non-notified transactions for a national security assessment. There will be a prescribed period in which the Government can call in any relevant transaction. This is most likely to be up to six months from the “trigger event” having taken place. The Government states it will encourage notification of investments and other events that may raise national security concerns and it will publish a detailed statement of policy intent to set out more fully where and how it considers transactions will be covered by so called “trigger events”. This will assist parties to determine whether to discuss the transaction informally with government officials and/or whether to submit a formal notification to the Government.
It estimates that it is likely to receive about 200 notifications each year of which 100 will raise national security concerns and of which 50 will be subject to some kind of intervention. This is a considerable workload. To put this into context, this is likely to be at least three times the number of UK merger notifications currently made to the CMA. There will also be powers to request information in relation to specific trigger events that the Government is aware of in order to inform its decision as to whether to call in a trigger event for screening.
For those transactions that do raise significant concerns, the Government will carry out a full national security assessment. A clear and circumscribed legal test would need to be met in order for the Government to exercise this power and the screening process would be subject to a clear and transparent process subject to appropriate judicial oversight. The national security assessment will be conducted within set time periods. The Government plans to screen out any notified transactions which do not, in fact, raise any national security concerns quickly and confirm its views within a prescribed period. The White Paper suggests the Government has 15 working days to consider whether a notified deal will be subject to a full national security assessment. If it so decides it then has a period of up to 30 working days, potentially extendable by a further 45 working days, to complete its assessment.
3. Trigger Events
The new regime will extend the range of circumstances where the Government has powers to address national security risks. The areas covered include activities in the energy, communications, transport and nuclear sectors but the White Paper makes clear that this is not an exhaustive list and that national security concerns could potentially arise in any sector of the economy. So the areas covered are likely to go even beyond those set out in the short term reforms.
Transactions by which a hostile actor can acquire the ability to undermine national security in the short or long term will be deemed “trigger events” susceptible for investigation by the Government. The Government proposes to publish more detailed policy guidance as to what transactions are likely to be covered by the new regime. This will include a description of the entities and assets where the acquisition of control can be used to undermine national security, and details about the sectors of the economy where the Government expects risks are more likely to arise as well as detailed guidance as to what constitutes trigger events. These cover those areas already subject to enhanced scrutiny under the Enterprise Act 2002 but are likely to be much broader.
In summary, however, trigger events will at least include:
- any investment or activity that involves the acquisition of more than 25% of an entity’s shares or votes;
- acquiring significant influence or control over an entity;
- increasing the quality of existing control beyond the above thresholds;
- ownership of more than 50% of an asset including ownership of intellectual property rights and real estate; and
- significant influence or control over any of the above assets.
Where the Government concludes that a transaction does pose a risk to national security, it will have the power to impose conditions on the transaction or prohibit it outright. If the transaction has been put into effect it will have the power to order for it to be unwound. There are also likely to be powers to impose interim enforcement orders where a transaction has been called in and has already been completed to mitigate the risk to national security pending the outcome of the investigation. The Government’s initial analysis indicates that around half of those trigger events called in for a full national security assessment are likely to require remedies.
Sanctions for non-compliance are likely to be significant to incentivise compliance. The following sanctions could be imposed upon the companies involved and /or individuals who authorised or were instrumental in the breach:-
- Custodial Sentences:- prison sentences of up to five years will be available for most offences (including breach of conditions imposed or failure to unwind a transaction). Lesser prison sentences of up to two years are available for less serious offences (e.g. for failure to provide information or providing false information);
- Civil Penalties:- substantial civil financial penalties for failure to provide information (up to £30,000 or maximum daily fine of up to £15,000) and for all other breaches (up to 10% of a business’s worldwide turnover or for an individual up to 10% of the higher of their total income or £500,000); and/or
- Director Disqualification Orders:- director disqualifications for up to 15 years.
Government decisions under the new regime will be subject to challenge by way of judicial review in the High Court.
Lessons from the US
Indications are that the Government’s reforms will take the US CFIUS regime as their inspiration.
In the United States, in addition to competition/antitrust review, certain transactions that result in foreign control of a U.S. business may be subject to review by the Committee on Foreign Investment in the United States (“CFIUS”), an interagency group tasked with determining whether a particular transaction could impact U.S. national security. CFIUS review is not triggered by the size of a transaction, but rather by the nature of the U.S. business and the potential foreign acquirer.
Under federal law, if a covered transaction poses a national security concern that cannot be mitigated, or if the parties are unwilling to agree to the mitigation required, CFIUS may recommend that the President prohibit the transaction or, if the transaction has already been finalized, order steps to prevent the potential threat, including divestiture
Implications for Investors
So the Government is going to roll out a UK version of the CFIUS regime under which notification is voluntary but compliance is incentivized by substantial penalties.
The Government has stated that it expects 200 transactions to be caught by the regime in any given year with 50 or so of those deals subject to conditions or even outright prohibition. If implemented, this is clearly a system which means “business”. It will represent a substantial uptick in enforcement activity in UK merger policy. For inward investors it will provide additional complexity to the merger clearance process in the UK especially if they are in one of the high risk categories of the economy highlighted by the White Paper.
All investors will need to grapple with the new rules but, for those investors from countries with friendly relations with the UK, it is not likely to be a cause for concern.
Those foreign investors engaged in auction processes for sensitive assets or companies may find their bids marked down if there are potential foreign investment risks.