Current powers and proposals for reform
The Queen's speech in December 2019 confirmed the government's intention to introduce a whole new national security regime to strengthen its powers to scrutinise and intervene in business transactions to protect national security.
It is clear that the proposals will have a major impact on investments in sensitive sectors and technologies. The new regime will be an important new risk factor to be considered when approaching deals.
We look here at the government's current powers to intervene in foreign direct investment (FDI) deals that raise national security concerns, and the likely shape of the much broader regime that is proposed to replace them.
- Current powers to intervene in FDI transactions
There are currently a number of means by which the UK government can intervene in transactions that raise national security concerns. Technically these are not limited to foreign investments; they can also apply to purely domestic transactions.
UK Merger control – public interest intervention
The UK merger control regime, contained in the Enterprise Act 2002 (EA02), applies to acquisitions of businesses (whether by share or asset purchases) and the formation of joint ventures, exceeding specified size thresholds. The EA02 gives the Competition and Markets Authority (CMA) power to review a transaction on competition grounds, but the regime also provides for government (Secretary of State) intervention in qualifying transactions on the basis of public interest concerns, such as national security, media plurality and the stability of the financial system.
The Secretary of State may also intervene in transactions that do not meet the UK merger control thresholds. Such "special public interest" cases are rare, being limited to certain mergers in the media sector and mergers in the defence sector involving a relevant government contractor or subcontractor with confidential defence-related information or other material.
Where the government intervenes on public interest or special public interest grounds, by issuing a public interest or special public interest intervention notice, the CMA investigates and reports to the relevant Secretary of State on the public interest implications of the deal. The Secretary of State is the ultimate decision maker (taking further advice as necessary from relevant government departments and officials) on whether the transaction is expected to operate against the public interest, and on the appropriate remedies to address the adverse effects.
EU merger control – intervention to protect legitimate interests
The UK remains bound by the EU merger control regime during the Brexit transition period. Under these rules a Member State can intervene in mergers subject to competition review by the European Commission and take appropriate measures to protect its legitimate interests, which include public security. In these instances the UK issues an EU intervention notice and conducts the review under the EA02; it may impose remedies to address any adverse effects even where the transaction is cleared by the European Commission on competition grounds.
In November 2019 the Business Secretary issued an EU intervention notice in relation to the proposed acquisition of UK defence company Cobham by the US private equity firm Advent International. While the European Commission cleared the transaction on competition grounds, the UK Business Secretary accepted undertakings, in late December, to mitigate the national security concerns that were identified. Advent undertook to continue to protect sensitive government information, to honour existing contracts and to give prior notice to the Ministry of Defence and the Home Office of any plans to dispose of all or part of Cobham's business.
Just as the Cobham deal was cleared, the Business Secretary issued a (UK) public interest intervention notice in the acquisition of Mettis Aerospace, a supplier of commercial and military aerospace parts, by Aerospace, a Chinese fund, a deal that falls under the UK merger control rules. The CMA delivered its report on the national security aspects of the deal to the Business Secretary on 13 February; at time of writing the report has not been published.
- Other means of limiting investments in sensitive companies/sectors
UK Takeover Code
Changes to the UK Takeover Code provide further scope for the government to extract concessions on investment deals that have possible "national interest" implications. Amendments made in 2015 to the framework for "post-offer undertakings" in the Takeover Code introduced a clear distinction between legally binding post-offer undertakings which commit a party to an offer to take (or not take) certain actions within a specified period, and non-binding post-offer statements of intent.
The new post-offer undertakings were first used in 2016 with Softbank's £24.3 billion offer to acquire UK listed technology company ARM Holdings. As part of its offer, Softbank undertook, amongst other things, to keep the global headquarters of ARM in Cambridge for five years and to maintain a guaranteed level of R&D spend. It may remain the case that, where specific national security issues are raised, the government will seek undertakings directly from the parties. In Melrose Industries plc's £8.1 billion offer for GKN plc in 2018, involving two UK companies, Melrose's binding undertakings under the Takeover Code were supplemented by additional post-offer commitments to the Business Secretary and undertakings to the Defence Secretary addressing national security aspects.
The UK government has surrendered most of the "golden shares" it once held in (mostly newly-privatised) UK companies, which had allowed it to prevent foreign investors from acquiring more than a certain level of shares in those companies. It retains a small number of golden shares in companies in the defence sector.
The use of a golden share was considered as part of arrangements for giving the go-ahead for the construction of the Hinkley Point C nuclear power plant. Ultimately the golden share was not pursued, but an agreement was reached between the largely state-owned French company EDF (as majority shareholder in Hinkley Point) and the UK Business Secretary, requiring UK government consent to any sale of EDF's interest in the Hinkley Point holding company that would result in EDF no longer holding majority voting rights prior to the second reactor becoming operational.
- UK proposals for reform of national security screening
The government's announcement on the Hinkley Point C deal also foreshadowed broader changes to its approach to the national security aspects of investments in critical infrastructure. In 2017 it began consultations on options for reform. The Green Paper on National Security and Infrastructure Investment Review outlined plans for new national security vetting requirements through a staged approach: new short-term measures for the military and dual-use sector as well as parts of the advanced technology sector and, in the longer term, an expanded call-in power.
Short term measures
The short term measures came into effect on 11 June 2018. These measures drastically reduced the jurisdictional thresholds for intervening on public interest grounds under the EA02 in acquisitions involving the development or production of military or dual-use goods, computing hardware or quantum technology. The government can now intervene in mergers in these sectors where the target's turnover is over £1 million (down from the normal merger control threshold of £70 million) or the target's "share of supply" is 25% (but with no need for the merger to bring about an increase in share of supply). The threshold changes are intended principally to enable intervention on national security grounds, but the new thresholds also apply to the CMA's jurisdiction to review on competition grounds. In July 2020 the lower thresholds were extended to cover mergers concerning artificial intelligence, cryptographic authentication technology and advanced materials. The thresholds for intervening in mergers not involving these activities remain unchanged.
The government started using its new intervention powers almost immediately. In June 2018 it called in for review the proposed acquisition of Northern Aerospace by Gardner Aerospace, a subsidiary of a Chinese aerospace and mining company.
- Longer term reforms
The short term measures were followed in 2018 by the publication of a "White Paper" consultation on the longer term options, building on the responses to the 2017 Green Paper. A draft statutory statement of policy intent was published at the same time setting out how the government expects to exercise its new call-in power.
There was no immediate follow-up on the 2018 consultation, but in December 2019 the Queen's speech confirmed the government's intention to press ahead with its longer term proposals. It announced a National and Security Investment Bill which would have the following main elements:
- a notification system, for businesses to flag transactions with potential security concerns for screening;
- powers to mitigate risks to national security – by imposing conditions or, as a last resort, blocking the deal entirely;
- sanctions for non-compliance with the regime; and
- a safeguarding mechanism for parties to appeal where necessary.
Scope of the proposed regime
The December 2019 Queen's speech (and background paper) gave few further details, but it appears to pick up on the proposals in the 2018 White Paper. According to those, the intended regime will apply to the whole of the UK and across all sectors; the government will be able to look at transactions affecting any markets which could give rise to national security risks. There will be no safe harbours or minimum target value or size thresholds limiting the scope of what the government may look at. However the new regime will be tightly focused on national security and not wider public interest or national interest issues.
Voluntary notification combined with call-in power
The White Paper proposed a voluntary notification system under which businesses and investors would be encouraged to notify "trigger events" that may raise national security concerns.
Trigger events would include investments or activities involving the direct or indirect acquisition of:
i) more than 25% of an entity's shares or voting rights;
ii) significant influence or control over an entity;
iii) further significant influence or control over an entity (whether or not the original trigger event was notified or called in);
iv) an asset (with a possible ownership level of a majority share of the asset); or
v) significant influence or control over an asset.
"Assets" would include land and intellectual property, allowing the government to scrutinise, for example, the acquisition of land that is adjacent to or overlooks a sensitive government facility, or the acquisition of software code that is protected under copyright.
"Significant influence or control" refers to the formal or practical means to direct an entity's operations or strategic direction, or to direct the operation of an asset. It would arise where the acquirer is significantly involved in the management and direction of an entity, having the ability to shape an entity's operations or strategy; in the case of assets the acquirer would be able to use, alter, destroy or manipulate the asset or its function.
National security concerns – the three risks
Only trigger events that raise national security concerns are subject to review. The intended statutory statement of policy intent would describe where and how the government considers these concerns are most likely to arise, based on three risk factors:
i) the target risk – the draft statement indicates that, while the government will be able to look at trigger events in any markets, it is expected that the focus will be core areas of the economy: certain parts of the civil nuclear, energy, communications, transport and defence sectors; some advanced technologies (including AI, computing, networking and data communication, quantum technologies, nanotechnologies and synthetic biology); critical suppliers to government and the emergency services; and military and dual-use technologies.
ii) the trigger event risk – looks at whether the trigger event would enable or enhance the ability of a hostile party to undermine national security through disruptive or destructive actions, espionage or inappropriate leverage.
iii) the acquirer risk – asks whether the acquirer is a hostile party or actor; the draft statement notes that foreign actors are more likely to pose a risk than UK-based or British acquirers.
Where a trigger event is voluntarily notified the government would undertake a preliminary screening (lasting up to 15 working days, but extendable by a further 15) to decide whether to call it in for full assessment. In the absence of voluntary notification, the government would have the right to call in transactions for assessment. It has suggested a six month window, starting from the trigger event, to exercise its call-in power.
Where a transaction is called in the government would have 30 working days (extendable by a further 45 working days) to conduct a full national security assessment. During this time the parties would not be able to complete or, if the trigger event has already taken place, the parties would not be able to take any further steps that would increase the acquirer's control or make it more difficult to unwind.
Remedies to protect national security
The White paper envisages that one Senior Minister (i.e. Cabinet Office level) would be the key decision maker for the whole national security vetting regime.
The proposed remedies include structural remedies such as blocking (or unwinding) transactions, or carving a particular division or asset from the deal, and behavioural remedies such as limiting access to certain sites. Such measures could only be imposed where the Senior Minister reasonably believes the transaction poses a national security risk and the remedy is necessary to prevent or mitigate the risk; the remedy must be proportionate to the risk.
- Impact of the new regime
Even without confirmed details of the new regime it is clear that, if it broadly follows the White Paper proposals, it will have far-reaching implications.
The government expects approximately 200 trigger events to be notified each year and that approximately 100 would be called in for full assessment (with remedies imposed in roughly 50). This compares with only a handful of mergers reviewed on national security grounds each year under the current intervention process.
The new regime introduces a new complexity into the deal clearance process, with the possibility of parallel reviews, with potentially inconsistent outcomes. A whole new set of transactions, that currently fall below merger control thresholds, will require clearance before closing. Deals that are subject to both national security vetting and merger control review (whether in the UK, EU and/or other jurisdictions) will face separate processes and timetables. This will increase uncertainties around deal timetables and the potential for further delays. These uncertainties will be all the greater for parties who choose not to notify their transaction and face a six month post-closing period in which the government might call the deal in.
The interaction between the new national security regime, the wider merger control regime, the public interest regime (which will continue to apply in respect of financial stability and media plurality) and the Takeover Code will need to be worked through in greater detail. The government's intention is to work closely with the Takeover Panel and to legislate so that the new assessment process sits as efficiently as possible alongside other regimes and processes.
Regardless of how streamlined the process can be made, however, there will remain the potential for conflicting outcomes from the merger control and national security assessments. The government will have the right to overrule the CMA (including to permit a transaction where the CMA would block it on competition grounds), but this may simply raise more questions over consistency and predictability of outcomes.