New reforms have given the UK government the power to intervene in acquisitions, with a view to maintaining in the United Kingdom the capability to combat and mitigate the effects of public health emergencies. The UK government has also proposed lower thresholds to intervene in acquisitions in the artificial intelligence, cryptographic authentication, and advanced materials sectors, which are considered relevant to UK national security. Longer term the UK government is planning to pass further legislation to obtain additional powers of intervention in mergers impacting UK national security.
Two amendments to the UK merger control regime will grant the UK government important powers to scrutinise certain acquisitions in the UK:
Although not expressly targeting foreign direct investment, the UK government is likely to focus on non-UK investors when using these new powers. The UK government has stated that “the UK is open for investment, but not for exploitation” and that “these powers will send an important signal to those seeking to take advantage of those struggling as a result of the pandemic that the UK government is prepared to act where necessary to protect our national security.”
Longer term, the UK government has announced its intention to enact the National Security and Investment Bill, giving the UK government further powers to scrutinise and intervene in transactions impacting UK national security. The National Security and Investment Bill is expected to be brought before the UK Parliament in the next few weeks.
Non-UK investors in these sectors in particular should be mindful of the increased risk of intervention by the UK government on public interest grounds, which now also include public health emergencies. Investors should consider engaging in early informal discussions with any relevant UK government departments and the UK antitrust authority, the Competition and Markets Authority (CMA). Where relevant, investors may also wish to consider potential remedies such as divestments, behavioural undertakings or restructuring transactions in such a way as to allay potential UK government concerns (e.g., by including UK investors or by reducing the level of control of non-UK investors).
These reforms are part of a wider trend towards greater screening of foreign investment by European governments that is likely to last beyond the COVID-19 pandemic (see our LawFlashes addressing this: LawFlash: COVID-19: EU Commission Issues Guidelines to Protect Against Predatory Buyers ; Potential UK Reforms Could Increase Screening of Certain Foreign Takeovers; LawFlash: COVID-19: Control of Foreign Direct Investments in France; and LawFlash: Germany to Tighten National Foreign Direct Investment Screening Regime in Light Of COVID-19).
The UK has a voluntary filing regime for mergers. Parties may decide to notify a merger and the CMA may decide to investigate a merger on its own initiative when the enterprises cease to be distinct (this can be when one enterprise obtains “material influence” over another) and when certain notification thresholds are met. These are discussed in greater detail further below under the section titled “Conditions for a Merger to be Notifiable in the UK”.
There is currently no standalone UK foreign direct investment regime (although the UK government is envisaging further legislation in this space (see further below)). Instead, the UK government has the power to intervene in transactions on certain specified public interest grounds as part of the general merger control regime.
Currently, such interventions by the Secretary of State, depending on the circumstances, may take the form of a Public Interest Intervention Notice (PIIN), a Special Public Interest Intervention Notice (SPIIN), or a European Intervention Notice (EIN). As discussed further below, there are also lower thresholds for CMA interventions in mergers in certain specified sectors relevant to national security. In public interest mergers, the Secretary of State will assess the public interest issues raised by the transaction and decide whether the merger operates or may be expected to operate against the public interest (the “public interest test”).
Under the Enterprise Act 2002 the UK Secretary of State is able to intervene via a PIIN in transactions where (i) enterprises cease to be distinct; (ii) the jurisdictional thresholds are met; and (iii) one or more specified “public interest considerations” are present. Until 23 June, such public interest considerations consisted of: (a) national security; (b) media plurality; and (c) financial stability. The reforms that came into force on 23 June 2020 now add a fourth public interest consideration (d) maintaining in the UK the capability to combat, and to mitigate the effects of, public health emergencies to this list of specified public interest consideration. These criteria are discussed in more detail below.
Enterprises ceasing to be distinct. The Secretary of State may find that a proposed investment giving the investor “material influence” over a target, for example, a 15% shareholding (although this level can be flexible and is assessed on a case-by-case basis), board representation and/or other factors (such as agreements enabling the investor to materially influence the target’s policies), may result in the enterprises ceasing to be distinct.
Merger Control Thresholds. The CMA has jurisdiction to review a merger if (i) the UK turnover of the target business exceeds £70 million (the turnover test); or (ii) as a result of the transaction, a share of 25% or more in the supply or purchase of goods or services of a particular description in the UK (or in a substantial part of the UK) is created or enhanced (the share of supply test). Lower thresholds apply to mergers in respect of transactions in certain specified sectors relevant to national security. As discussed further below, proposed reforms will mean that mergers in the artificial intelligence, cryptographic authentication and advanced materials sectors will also be subject to these lower thresholds for potential intervention.
Voluntary merger control filing regime. The UK has a voluntary merger control filing regime under the Enterprise Act 2002. The parties are not legally obliged under the Enterprise Act 2002 to notify the Secretary of State or the CMA of their intention to enter into the transaction and would not be fined or otherwise penalised under the Enterprise Act 2002 for not doing so. However, where the relevant jurisdictional thresholds are met, notification to the CMA may be advisable depending on the circumstances of a specific merger, particularly considering that the CMA may decide to investigate an unnotified transaction on its own initiative and may ultimately impose hold-separate orders preventing and unwinding any integration until it has cleared the transaction. The CMA has the power to unwind a completed merger should it decide to following its review that it should be blocked.
The reforms to the Enterprise Act 2002 that came into force on 23 June adding a further public interest consideration with regard to public health emergencies mean that the Secretary of State may intervene on his or her own initiative if, for example, a takeover approach is made for a business that is involved in a pandemic response (e.g., in the manufacturing of personal protective equipment or vaccine research), although as we described above, these powers may also be applied more broadly, beyond acquisitions in the healthcare sector. In order for the Secretary of State to intervene in such transactions, the transactions must meet the jurisdictional requirements discussed above (i.e. they must involve enterprises ceasing to be distinct and they must meet the relevant merger control thresholds).
In determining whether or not to intervene on this new specified public interest ground, the Secretary of State will likely consider inter alia the degree to which the acquirer has the ability and incentive to reduce in the UK the capability to combat a public health emergency. An important factor in any such assessment is likely to be whether the acquirer is ultimately controlled by non-UK persons.
The Secretary of State may in limited cases intervene via a SPIIN where the UK turnover or share of supply jurisdictional thresholds (discussed above) are not met, provided that:
An intervention from the Secretary of State can significantly extend the review process beyond the normal merger control timeframes.
The Secretary of State will first either be notified by the CMA of a Phase 1 merger case that the CMA believes raises public interest considerations or, the Secretary of State will issue on his or her own initiative an intervention notice to the CMA requesting that it prepare a report in relation to the specified public interest considerations.
The CMA will then request third-party comments on the public interest considerations (and competition issues if relevant) and will consult other government departments, sectoral regulators, industry associations and consumer organisations regarding the public interest considerations. The CMA will then prepare a report for the Secretary of State considering jurisdictional issues and summarising any representations received in relation to public interest issues. The Secretary of State will also receive input from relevant government departments or public bodies (e.g., the Ministry of Defence for defence mergers).
The Secretary of State will then decide whether to (i) refer the transaction for a Phase 2 in-depth investigation on public interest grounds; (ii) accept undertakings from the parties in lieu of a reference to a Phase 2 investigation; or (iii) not to make a Phase 2 referral.
There is a low threshold for making a Phase 2 referral and the Secretary of State has wide discretion in making this decision; it is enough for the Secretary of State to believe that there is a risk that the merger might be expected to operate against the public interest.
If the Secretary of State refers the case to a Phase 2 review, then the CMA will conduct an in-depth review of the public interest considerations. The CMA will prepare a detailed report for the Secretary of State within 24 weeks (extendable by a further eight weeks); although the CMA also has the ability to stop the clock, thereby extending the review period further, in circumstances in which the parties have not provided requested information. The CMA’s report will include the CMA's conclusion as to whether the merger operates or is expected to operate against the public interest and recommended remedies.
The Secretary of State must then decide whether to make an adverse public interest finding. The Secretary of State must accept the CMA's conclusions regarding the transaction’s impact on competition and regarding jurisdiction. The Secretary of State will consider but is not bound by the CMA's recommendations for remedies or in respect of the wider public interest issues.
The UK government has intervened on public interest grounds on only 20 occasions in total over the last 17 years (12 on national security grounds, seven on media plurality grounds, and once on financial stability grounds). No transaction has yet been blocked on specified public interest grounds, although in 2018 the Chinese-owned company Gardner Aerospace abandoned its planned acquisition of Northern Aerospace after a UK government national-security intervention. Given the perceived risk of foreign acquisitions of important UK businesses, it will be interesting to see whether the UK government will make use of this new grounds for intervention or indeed the other existing grounds in the short term.
For transactions subject to the EU merger control regime, the EU merger regulation permits member states (including the UK during the Transitional Withdrawal Period)[2] to investigate a transaction to protect its “legitimate interests” (in which case the European Commission will conduct the competition review (unless jurisdiction is transferred to a member state under the EU Merger Regulation)). Under EU law legitimate interests include public security, media plurality and prudential rules. Any other legitimate interest a Member State wishes to protect must be communicated to the European Commission, which then has 25 working days to assess whether that interest is compatible with EU law before the Member State can take measures to protect that interest.
To trigger this review process, the UK Secretary of State will issue an EIN. In order to do so, the Secretary of State must have reasonable grounds to suspect that it is or may be the case that the relevant UK and EU merger control thresholds are met and that it is or may be the case that a public interest consideration is relevant to the review of the transaction.
Following the issuance of an EIN, the CMA will investigate and report to the Secretary of State on UK and EU merger control jurisdiction, and give a summary of representations from parties of a public interest nature and its views on whether the transaction will or is likely to operate contrary to the public interest. Other UK government organisations or sectoral regulators may be consulted, such as Ofcom in media mergers or the Ministry of Defence in defence mergers. The CMA will then investigate and report to the Secretary of State decide on whether to make a finding that the transaction would be adverse to the public interest. At the end of any Phase 2 review, depending on the outcome, the Secretary of State will have powers to take enforcement action.
Proposed Lower Thresholds for Intervening in Transactions in the Artificial Intelligence, Cryptographic Authentication, and Advanced Materials Sectors, and the possible application of these to direct foreign investments
Prior to the new proposed reforms, reforms to the Enterprise Act 2002 in 2018 lowered the thresholds for intervention in transactions in the following sectors relevant to national security: (i) the development or production of items for military or dual-use; (ii) the design and maintenance of aspects of computing hardware; and (iii) the development and production of quantum technology. The lowered thresholds for intervention in these sectors are:
Under the current proposed reforms, these lower thresholds will also apply to transactions in the artificial intelligence,[3] cryptographic authentication,[4] and advanced materials sectors. These current proposed reforms were tabled before the UK Parliament on 22 June 2020 and must first be debated and approved by UK Parliament before coming into force.
It is also worth noting that, whilst the 2018 reforms were not expressly premised on there being a foreign investment element, since the powers apply equally to UK acquirers, the UK government indicated when it adopted the reforms that in practice, foreign investments are more likely to raise national security concerns. A similar approach can be expected with respect to artificial intelligence, cryptographic authentication, and advanced materials sectors.
The amendments discussed above are intended to mitigate risks in the short term ahead of more comprehensive powers in the forthcoming National Security and Investment Bill which the UK government announced as part of its legislative programme in December 2019. The National Security and Investment Bill, when enacted, will establish a new screening regime for acquisitions of UK businesses and assets (including intellectual property) with national security implications. The UK government’s stated objective is that the new regime will provide businesses with certainty and transparency, while at the same time ensuring that the UK remains open to foreign investment.
The new regime will involve a notification system for businesses to identify transactions raising potential national security concerns for UK government approval. The UK government has previously indicated that its preferred approach would be for a voluntary (rather than a mandatory) notification regime, with the UK government having the ability to call in relevant transactions for review, and for such reviews to be quick and efficient.[5]
No date has yet been set for the next stage of the legislative process of the bill, although it is expected to be brought be the UK Parliament in the coming weeks. The UK Parliament's Foreign Affairs Committee has issued a “call for evidence” and is seeking third party views on the role of the Foreign Office in such a review.[6]
In order to address similar concerns arising out of the COVID-19 pandemic, the European Commissionhas issued guidelines to EU member states in relation to foreign direct investment screening and free movement of capital from non-EU countries with regard to foreign investments likely to affect the security and public order of EU member states.[8] The European Commission has asked EU Member States with national screening mechanisms to actively apply them or, if they do not have such screening mechanisms in place, to introduce them in order to avoid “a loss of critical assets and technology”. In order to address such concerns arising out of the COVID-19 pandemic, both France[9] and Germany[10] have recently tightened their foreign investment screening regimes.
The European Commission is also consulting until 23 September 2020 on how it and European national authorities can inter alia assess and limit the distortive effects of non-EU government subsidies on the acquisitions of EU companies.[11]
Governments in Europe and worldwide are increasingly focussed on the risks associated with foreign acquisitions in their strategic sectors. We are likely to see greater government intervention and a stricter application of foreign investment regimes for the duration of the current COVID-19 crisis, and potentially over the longer term. Even though to date the United Kingdom does not have such a standalone regime in place, this is expected to change in the short term. Accordingly, if you think that a proposed merger may give rise to the issues addressed here, it would be advisable to seek specialist advice.
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If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
London
Frances Murphy
Omar Shah
CFIUS Contacts
Washington, DC
Giovanna Cinelli
Kenneth Nunnenkamp
Ulises Pin
Katelyn Hilferty
Christian Kozlowski
Boston
Carl Valenstein
[2] The UK exited the European Union on 1 January 2020. However, EU laws continue to apply in the UK during the Transitional Withdrawal Period. Accordingly, the European Commission will continue to review mergers that are notifiable both at the EU and at the UK level until the end of the UK’s Transitional Withdrawal Period from the European Union (currently set for 31 December 2020).
[3] Relevant enterprises active in artificial intelligence include those that produce, develop and design digital AI and machine learning technologies (excluding physical robotics), including components and service providers and all relevant intellectual property. (see Explanatory Memorandum)
[4] Relevant enterprises active in cryptographic authentication include enterprises producing solutions, researching technology, or providing services relating to cryptographic authentication.
[5] To date, the UK government has stated that it envisages a 15 working day review period, extendable to a total of 105 working days for in-depth reviews. Transactions giving rise to concerns would be subject to divestment or behavioural undertakings or could even be blocked, with parties anticipated to have the right to appeal. The UK government also anticipates penalties for noncompliance.
[7] For further background on the Commission’s guidelines please see: LawFlash: COVID-19: EU Commission Issues Guidelines to Protect Against Predatory Buyers
[8] The UK exited the European Union on 31 January 2020, however EU law continues to apply in the UK as if the UK continues to be an EU member state during the transition period until 31 December 2020 (unless extended).