01 October 2018 by Robert Bell
The UK Government is looking to extend the national security screening regime of foreign investments
At the end of July, the UK government published a white paper on its proposed national security screening regime. The regime will give the government further power to review investments by foreign parties that may have national security implications. It will radically change the way the government reviews sensitive transactions and will have implications for deal timing and the drafting of contractual provisions.
The government has invited comments on its proposals by 16 October 2018, with the implementation of the new system likely to be at least 18 months after.
Following the Chinese investment in the Hinckley nuclear power station project, the government voiced concerns it did not have enough power to scrutinise investments by foreign investors on national security grounds. Therefore it announced ‘a root and branch’ review of its existing national security vetting powers and proposed extending its ability to review transactions where foreign hostile actors acquire ownership and control in UK companies, property, intellectual property and other assets in certain key sectors of the economy.
The government’s proposals for both short and long-term reform were initially published in a green paper in October 2017, before being followed up in July’s white paper. The government’s view is 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.
The UK currently uses the Enterprise Act 2002 to review mergers on national security and other public interest grounds alongside the competition regime.
Under the existing merger control rules in the act, the Competition and Markets Authority (CMA) can review a transaction within four months of it being made public, where: the target company has an annual UK turnover of £70 million or more; or the merger creates or enhances a combined share of 25% or more of sales or purchases of goods or services of a particular description in the UK (or in a substantial part of it) – referred to as ‘a relevant merger situation’.
Where a relevant merger situation exists, the secretary of state has the power under section 42 of the Enterprise Act 2002 to intervene on certain public interest grounds, including national security.
Some immediate short term reforms to the Enterprise Act 2002 were introduced on 11 June 2018, allowing the government 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.
The effect of the new orders is to extend the definition of a relevant merger situation, for key areas of the economy mentioned above, meaning enterprises with a UK target turnover of £1 million, instead of £70 million, now qualify. A relevant merger situation will also arise if the relevant enterprise has a 25% share of supply of goods or services of a particular description in the UK before the merger.
“National security concerns could potentially arise in any sector”
Soon after the new rules came into effect, on 17 June, the government intervened in the proposed acquisition by Chinese-owned Gardner Aerospace of British aircraft parts manufacturer, Northern Aerospace. However, the acquisition was subsequently cleared unconditionally on the basis that there were no national security grounds for referring the merger for a more detailed phase two investigation.
The hallmark of the new system is 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.
The main proposals are:
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. The government can call in any relevant transaction for up to six months after the ‘trigger event’.
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 where and how it considers transactions to be covered by trigger events.
It estimates it is likely to receive around 200 notifications per year, of which 100 will raise national security concerns and 50 of those will be subject to some kind of intervention. This is likely to be at least three times the number of notifications currently made to the CMA.
For those transactions that do raise significant concerns, the government will carry out a full national security assessment.
It plans to screen out any notified transactions that do not raise 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.
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 it clear that this is not an exhaustive list and that national security concerns could potentially arise in any sector of the economy.
Trigger events will include:
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.
Sanctions for non-compliance are likely to be significant to incentivise compliance, including custodial sentences of up to five years, fines and director disqualification orders for individuals and fines of up to 10% global turnover for businesses.
Government decisions under the new regime will be subject to challenge by way of judicial review in the High Court.
If implemented, this is clearly a system that 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. There will also be consequences for the deal timetable as call in can be up to six months, as opposed to the present four. Special attention will also need to be given to the way contractual documentation deals with the new process and any potential divestitures required.
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.