The changes introduced in June 2018 were designed to fill a gap and cover those cases with the greatest potential to raise national security concerns but which were not caught by existing legislation.
Over the past year, there have been a number of important changes (actual and proposed) to legislation permitting intervention by the UK Government in transactions that may raise national security concerns. Unlike many other jurisdictions, acquisitions in the UK in potentially sensitive industries do not, as a matter of course, require parties to seek approval from a regulator or the Government.
Following a Government consultation designed to "strengthen powers for scrutinizing the national security implications of particular types of investment" the notification regime remains voluntary. However, a number of changes have been implemented to strengthen the Government's powers and allow for intervention in a wider range of cases.
The Government adopted some changes in June 2018, and is also proposing more wide-reaching changes that will require a new Act of Parliament. The changes introduced in June 2018 were designed to fill a gap and cover those cases with the greatest potential to raise national security concerns but which were not caught by existing legislation.
These short-term changes amended the Enterprise Act 2002 to reduce the thresholds at which interventions could be made in cases involving a target active in one of three areas: the development or production of military or dual-use goods; the design and maintenance of computing hardware; and the development or production of quantum technology.
The Government can now intervene in an acquisition in any of these areas if the annual UK turnover of the target is £1 million or more (reduced from £70 million, which remains the threshold for all other cases), or if the target alone accounts for 25 percent or more of purchases or sales of any goods or services in the UK. Previously, the parties had to overlap such that there was an increment leading to a combined share of supply of 25 percent or more. This requirement no longer exists for cases in the three identified sectors, and a deal can be caught even if there is no overlap with the purchaser.
The Government anticipates between five and 29 additional cases per year will be caught by the amendments that came into force in June 2018.
The Government's long-term objective is to more comprehensively reform its powers of scrutiny over investments that may pose a risk to national security. The intention is to implement this regime with a new piece of primary legislation.
Under the proposed changes, notification will remain voluntary but parties will be encouraged to notify their transaction. As with the UK's general merger regime, transactions that are not notified may be subsequently investigated and remedies imposed if found to be problematic. The Government expects approximately 200 notifications a year under the new national security regime and that approximately half of these will progress to a full assessment. Of those, the Government estimates that 50 will result in a remedy of some sort, which could vary from implementing some ring-fencing (e.g., of individuals and/or information) to outright prohibition.
Where parties choose not to notify, the Government may still decide to "call in" transactions that result in a "trigger event." It is proposed that these trigger events will include the acquisition of more than 25 percent of an entity's shares or votes, significant influence or control over an entity, or further acquisitions of significant influence or control over an entity beyond these thresholds. Acquisitions of assets will also be covered, which is not always the case under the existing rules. The timescale for post-closing intervention in national security cases will be increased to six months after the details of the transaction are in the public domain (the current time limit is four months).
The Government has indicated that it will consider three factors when determining whether a trigger event could lead to a national security risk: "target risk," whereby the entity or asset in question could be used to undermine national security (i.e., where the nature of the target's business could pose a potential risk); "trigger event risk," whereby the acquisition itself gives someone the means to undermine national security (e.g., by affording greater opportunity for disruptive actions or espionage); and "acquirer risk," where the acquirer itself has the potential to use its control over the target to undermine national security (e.g., where acquisitions are carried out by entities controlled by hostile states or other hostile parties).
The new legislation will provide that all national security considerations be assessed by the Government. Therefore the existing role of the Competition & Markets Authority (CMA) —the UK's main antitrust agency—to investigate and report to the Government when an intervention is made will be removed. The proposed legislation will also introduce civil and criminal sanctions to deal with non-compliance with any remedies that might ultimately be imposed.
The Government is expected to publish draft legislation in 2019, following its assessment of comments received as part of the current consultation process. As a degree of uncertainty still surrounds details of the proposed new regime and the fact that any new legislation is unlikely to take effect until 2020 at the earliest, the remainder of this article focuses on the existing law.
As there are currently no specific requirements relating to deals that may raise potential national security issues, strictly speaking no person needs to file an application. Rather, if the UK Government considers that a deal raises national security issues, the Secretary of State (SoS) may issue an "intervention notice."
The procedures for the SoS to issue an intervention notice, and—if considered appropriate—ultimately block a deal, are set out in the Enterprise Act. If an intervention notice is served, then the acquirer (and others as appropriate) will be required to provide information.
TYPES OF DEALS REVIEWED
The Enterprise Act currently allows the SoS to intervene when specified public interest considerations arise. In addition to national security, the other specified public interest considerations relate to media plurality, quality and standards, and the stability of the UK's financial system. These powers have been bolstered by the June 2018 amendments mentioned above if the target is active in military or dual use goods, computing hardware or quantum technologies.
Prior to the June 2018 amendments, there was no guidance as to what industries were relevant to national security, although in all but one case national security intervention notices involved defense considerations. The lowering of thresholds for transactions involving targets active in computing hardware and quantum technology in June 2018 indicates that there is potential going forward for a greater number of non-defense-related transactions to be scrutinized on national security grounds.
The first Government intervention under the new thresholds was in the aerospace sector, with a target active in the manufacture of dual-use goods. That case—the proposed acquisition of Northern Aerospace Limited by Gardner Aerospace Holdings Limited, a Chinese company—was ultimately cleared by the Government (although the intervention caused the deal to be abandoned).
In cases to date, the Ministry of Defence on several occasions raised concerns about the maintenance of strategic UK capabilities and the protection of classified information, including when the acquirers have been from the US or other NATO allies. In these cases, the deals have been approved following undertakings provided by the acquirer to address the concerns, often involving the ring-fencing of sensitive information.
SCOPE OF THE REVIEW
When an intervention notice on national security grounds is issued, the CMA must investigate and report to the SoS—but, as noted above, the legislative proposal is to remove the CMA from all national security reviews. Under the current system the CMA will consult on the national security issues and its report will summarize any representations received on the matters specified in the SoS's intervention notice and, where relevant, will also deal with any competition issues.
The SoS will consider the CMA's report and decide whether the transaction should be subject to a more in-depth "Phase 2" review by the CMA, or whether to accept any undertakings the acquirer may have offered to address public interest concerns, or indeed—which has never happened to date—whether the public interest concerns are not warranted or do not require any remedial action.
If there is an in-depth review by the CMA, it is required to report whether the transaction operates or may be expected to operate against the public interest, and make recommendations as to the action the SoS or others should take to remedy any adverse effects. The SoS will make the final decision on the public interest issues and any remedial steps to address the public interest issues.
TRENDS IN THE REVIEW PROCESS
The specific focus in the recent reforms on military and dual-use technology, quantum technology and computing hardware reflects the fact that national security risks are increasingly likely to arise in the technological and cyber spheres. As general concerns about cybersecurity and control of critical infrastructure networks become more commonplace, it would not be surprising to see more SoS interventions on national security grounds.
HOW FOREIGN INVESTORS CAN PROTECT THEMSELVES
Potential issues should be considered as early in the planning process as possible, and increasingly in any case—not just defense-related deals—that might be considered to touch on national security. State-owned acquirers, or those with material links to (or financing by) state-owned enterprises, should be particularly well prepared, and consider what undertakings they might be prepared to give, if concerns are raised.
To date, such undertakings have tended to relate to ensuring the protection of classified information and ensuring UK capabilities. Early engagement with the relevant Government departments would also be sensible, especially if an auction process is likely, because the target will want to ensure that the acquirer is able to complete any proposed deal. The collapse of the Gardner/Northern deal may have been due, in part, to inadequate planning and preparation on the potential national security issues.
REVIEW PROCESS TIMELINE
Under the current regime, the CMA typically reports to the SoS within four to six weeks of the intervention notice, with the SoS's decision following shortly thereafter. If the SoS decides the CMA should conduct a Phase 2 investigation, it will take up to a further 24 weeks (followed by the time for the SoS to reach a final decision).
2018 UPDATE HIGHLIGHTS
- The thresholds at which Government interventions can be made have been lowered in cases involving targets active in one of three areas: the development or production of military or dual-use goods; the design and maintenance of computing hardware; and the development or production of quantum technology
- The Government can now intervene in an acquisition in any of these areas if the annual UK turnover of the target is £1 million or more (reduced from £70 million, which remains the threshold for all other cases), or if the target alone accounts for 25 percent or more of purchases or sales of any goods or services in the UK. Previously, the parties had to overlap such that there was an increment in their combined share of supply resulting in a share of 25 percent or more. This requirement no longer exists for cases in the three identified sectors
- Under the lower thresholds in these three specific sectors, the UK Government anticipates an additional 5 to 29 mergers will be captured annually by the new rules
- More wide-reaching changes to the national security landscape are planned. New legislation is proposed, which will cover a wider range of transactions that may pose a risk to national security (including acquisitions of assets). The revised regime will remain voluntary, meaning that there will be no obligation to notify deals that may affect national security. However, non-notified deals will be susceptible to review for up to six months after details become public
- No deal has been blocked by the SoS on national security grounds
- All national security cases to date have resulted in behavioral remedies (e.g., ring-fencing information and ensuring strict controls are in place) in lieu of a detailed Phase 2 investigation. No divestments have been required
- Intervention on national security grounds is no longer limited only to defense-related transactions
- The radical changes proposed by the Government to the rules for reviewing deals potentially affecting national security are likely to have a material impact on M&A in the future
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