On 24 July 2018, the Government published its proposals for increased national security review of foreign investment in the UK. This consists of (i) proposed legislative reforms and (ii) a draft statement of policy intent providing greater detail on how the powers will be exercised (the "Proposals").
The Proposals are the second set of measures to come out of the Government's National Security and Infrastructure Investment Review (see here for our briefing on the Green Paper), published in October 2017. Initial measures, which took effect in June 2018, reduced the jurisdictional thresholds for certain transactions in specified sectors (military, quantum technology and computing hardware). As a result, these transactions were brought within the general UK merger control regime, giving the Government (through the Secretary of State) the ability to intervene to address any national security related issues. There has been one Governmental intervention under these rules so far: the acquisition by Gardner Aerospace of Northern Aerospace from Better Capital. Both parties manufacture and supply parts used in the manufacture of aircraft. We acted for Gardner Aerospace (which is ultimately controlled by a Chinese listed entity) in obtaining clearance for the deal on 19 July 2018.
The Proposals now indicate that these measures were only a temporary step until the new national security regime takes effect, and that the changes to the turnover and share of supply thresholds will be reversed.
The latest Proposals set out legislative changes to create a distinct regime and standalone powers for the Government to scrutinise transactions on the grounds of national security interests. The Government says that the reforms will bring the UK closer in line with other countries' foreign investment regimes: see here for our briefing on the global shift in foreign investment regulation. It is important to note that the existing public interest regime under the UK merger control rules will remain unchanged (covering media plurality and financial security), although national security considerations will be removed from the public interest assessment process.
- The new powers for the Government to call in transactions that may give rise to national security risks are not limited to specified sectors but will apply on an economy-wide basis
- The key decision-maker will be a Cabinet-level minister
- The national security review is a distinct regime with no turnover or share of supply requirements and therefore has the potential to capture smaller strategic/innovative transactions
- The Government estimates that it will receive on average 200 relevant notifications per year. Of these 200 notifications, it expects 100 will qualify for further investigation and 50 may raise national security issues requiring remedies to address concerns
- The new regime will apply to the acquisition of assets, such as IP rights, as well as businesses. In limited circumstances, even loan agreements may be a relevant trigger, where an asset secured as collateral could itself give rise to national security concerns in the event of a change of ownership
- The new legislation will focus on protecting the UK's national security and, although the activities and assets of UK-based entities are therefore most likely to be relevant, certain trigger events that take place outside the UK may also threaten the UK's national security. The Government therefore proposes that its powers to call in a trigger event will extend to assets or entities outside the UK where they carry on (or are used in connection with) activities/supply taking place in the UK
- Transactions that are caught by both regimes (competition and/or public interest review by the CMA and national security review by the Government) are likely to face dual regulatory processes
- Much of the detail is still to be finalised: the Government is inviting comments by 16 October 2018.
What investments could be subject to review?
Transactions will be subject to the national security review where two thresholds are met: the jurisdictional (called "trigger events") and the substantive.
Jurisdictionally, the Proposals for trigger events are wide ranging and focus on the degree of influence rather than the form of investment. The thresholds will capture (i) share acquisitions of 25% or more (including of voting rights), (ii) control or significant influence over an entity or asset and (iii) any acquisition (including through contractual arrangements) of control or significant influence beyond the above thresholds. As such, the Proposals are not restricted to transactions, mergers and acquisitions – they have the potential to capture (i) a breadth of alternatively structured arrangements and (ii) a range of tangible and intangible assets.
The Government proposes to adopt a definition of asset to encompass real and personal property, contractual rights and intellectual property. Although money is not captured, other property or rights are caught. The Proposal goes some way to delineate the intellectual property rights that would be treated as assets, including patents, database rights, design rights and copyright. Recognising the wide-ranging definition of asset, the Government has provided a clear indication that it expects to exercise its power to intervene in asset sales relatively rarely: the power is viewed as a backstop to prevent circumvention of the regime.
Whilst the final definition of control and significant influence is likely to turn on feedback from the consultation, the Government has provided some guidance in the Proposal:
- Control and significant influence are unlikely to arise unless there is some degree of direct or indirect ownership: preferential access, for example, would not be sufficient;
- Acquiring a licence related to an asset (whether physical or intellectual) will be captured if it creates a means of using/manipulating the asset; and
- There will be a carve out for "excepted persons" such as employees/directors who would generally not be deemed to have control or significant influence.
Substantively, the risk assessment to establish whether there is a national security concern will take the following three considerations into account:
- Nature of the target and sector - does the entity/asset pose a risk to national security;
- The trigger event – does the nature of the rights acquired or the structure of the investment made create an ability to undermine national security (e.g. through potential disruption, leverage etc.); and
- The acquirer – is the acquiring person/entity one that could seek to undermine national security.
The sectors most likely to give rise to national security concerns are grouped into "core areas" and include national infrastructure, advanced technologies, direct suppliers to Government/emergency services and "dual use technologies". Sectors, entities or assets involved in supplying "core area" persons/operators are also identified as more likely to raise concerns, as are wider advanced technologies.
The review process
The Government is proposing a voluntary notification system, reserving the right to intervene where parties choose not to notify, with a six month call-in period post-completion. Unlike for merger control notifications, there will be no fee. Informal discussions with the Government will be available in order to assist the parties in deciding whether or not to notify. A dedicated team will monitor the market for potentially relevant developments and the Government will have powers to request information in order to determine whether further screening may be required. Further guidance and a template for notification will be published at a later stage.
Once a valid notification has been received the Government will have a short period, currently suggested to be 15 working days, to carry out a preliminary review and decide whether or not to call-in the trigger event. For complex cases this period may be extended by an additional 15 working days. Notified trigger events that do not raise any national security concerns will be 'screened out' and will be able to proceed.
National security assessment
The Government is proposing a two-limb test in order to determine whether a trigger event should be called in for a national security assessment:
- There must be reasonable grounds for suspecting that it is or may be the case that a trigger event has taken place or is in progress or contemplation; and
- There must be a reasonable suspicion that, due to the nature of the activities of the entity involved in the trigger event or the nature of the asset involved, the trigger event may give rise to a risk to national security
Once a trigger event has been called in for national security assessment, the Government will have a further 30 days to make its assessment of the national security risks. This could be extended by 45 working days where a more detailed analysis of the extent of the risk and the appropriate remedies are necessary.
What remedies could be imposed for transactions creating a national security risk?
Where the Government concludes that national security is at risk, it will be able to impose such remedies as are necessary and proportionate to address its concerns. Remedies can only relate to identified national security concerns and not to any wider considerations (eg protecting employment), and can be structural or behavioural in nature.
The proposed legislation will include an indicative but non-exhaustive list of the type of remedies that can be imposed, without limiting the Government's powers to adopt other measures. The purpose of the remedies could typically be to ensure maintenance of a strategic capability, protect confidential or sensitive information or ensure economic viability of an entity providing essential services and Annex B to the Proposals provides a list of corresponding remedies.
Where it is not possible to address or mitigate the risk to national security with other remedies, the Government will be able to block a deal or require it to be unwound if it has already been completed.
Sanctions for non-compliance with the regime
In order to ensure compliance with the regime the Government is proposing to introduce sanctions ranging from custodial sentences (of up to five years) for most offences, financial penalties both for the businesses (up to 10% or worldwide turnover) and individuals concerned (up to 10% of total income or £500,000 whichever is higher) and director disqualifications for up to 15 years.
How will the national security review work alongside existing merger control?
The new national security regime, enforced by the Government, will be separate from the UK merger control regime and the assessment of a transaction on competition and public interest grounds by the CMA. The Government is keen, however, to ensure that both regimes interact in an efficient manner and coordinate where possible. The proposed legislation will design a new procedure for interaction where a national security issue has been identified for a trigger event that is also being scrutinised by the CMA.
The Government will also work closely with the Takeover Panel to consider how the proposed reforms would interact with the Takeover Code and whether any updates to the timetable and process for the completion of takeovers are necessary in light of the proposed new regime.
In relation to transactions falling within the jurisdictional scope of the EU Merger Regulation, the scope for intervention is currently limited by Article 21 EUMR which allows Member States to intervene to prohibit or impose conditions on such transactions to protect narrow legitimate interests only. As long as the UK remains bound by the EU Merger Regulation the proposed reforms will need to work alongside and in compliance with the Merger Regulation. If the Commission clears a transaction under the EUMR, the Government could still impose its own conditions on the basis of national security. If the Commission was to block a transaction that the Government considered to be in the interests of the UK's national security, the Government will not be able to override the block while the EUMR applies in the UK. The Government's proposals may also need to work alongside the proposed EU-wide FDI screening Regulation which provides for cooperation between Member States and requires them to share information on their screening activity, depending on the timing of the entry into force of both regimes.
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2018