Walking a tightrope- M&A and national security

On 24 July 2018, the UK government published its proposed new regime for the scrutiny of foreign investments with potential national security implications.

Similar in approach to the US regime, CFIUS (Committee on Foreign Investment in the United States), and now under consultation until 16 October 2018, the Proposals would replace the entire existing national security public interest regime for mergers, including the reforms introduced in June 2018, and apply to a much wider range of transactions.

They would include the acquisition of assets that do not amount to an enterprise, such as a piece of land or a patent, and extend to all sectors of the economy. Property situated outside the UK that meets a UK nexus test would also be caught.

The only material limiting factor would be that the government must have a “reasonable suspicion” that a transaction may pose a risk to national security before it can launch an investigation.

Unlike the current regime, a transaction would not need to reach a particular turnover or share of supply threshold to generate government interest. Although there would be no mandatory filing requirement, parties would be encouraged to make voluntary notifications to the government if they believe a transaction might raise national security concerns.

Potential risks

The government’s proposal identifies three risk factors for review when determining whether a transaction requires closer scrutiny:

Target risk: The acquisition of control over entities, assets and suppliers within specific areas of the economy, including businesses involved in national infrastructure; advanced technologies, including artificial intelligence and machine learning, computer hardware and nanotechnologies; critical direct suppliers to the government and emergency sectors; and military and dual-use technologies.

Trigger event risk: The risk that the acquisition may give the acquirer the ability to undermine the UK’s national security, for example through disruption, espionage or inappropriate leverage; and

Acquirer risk: The risk that the acquirer could use its control over the asset to undermine national security, i.e. that it may be a so-called “hostile party”.

Informal discussions with officials would be available to help parties decide whether or not to notify, after which the government would have 15 working days (extendable by a further 15 working days in complex cases) to decide whether to call in the transaction for a full national security assessment.

The impact of the proposed new regime is expected to be significant: whereas typically only one transaction a year has been subject to a national security review under the current system, the government anticipates that around 200 notifications would be made each year under the new regime, of which 100 are likely to raise national security concerns and 50 would require remedies. By comparison, only 62 transactions were reviewed under the UK’s current merger control regime in the year 2017/2018.

The government is proposing severe sanctions for non-compliance, including a maximum custodial sentence of five years for most offences and civil financial penalties (up to 10% of a business’s worldwide turnover or, for an individual, up to 10% of their total income or £500,000, whichever is higher) and director disqualification for up to 15 years.

Once the proposed legislation is enacted, a transaction’s impact on competition may be assessed by the UK Competition and Markets Authority (CMA), and simultaneously by government ministers for national security risks. The government will also work with the Takeover Panel to consider how the proposed reforms would interact with the City Code on Takeovers and Mergers.

The reforms will have to work alongside the EU Merger Regulation, so long as the UK is bound by it. This will constrain the government’s ability to take action against acquisitions by companies or individuals from other Member States, until the EU Treaties no longer apply to the UK (likely to be either 29 March 2019 or 31 December 2020). The proposals will also need to sync with the Commission’s proposed EU-wide foreign direct investment screening regulation, which requires information sharing between Member States for such reviews.

Fortunately, the Proposals will require ministers to review transactions on national security grounds alone, rather than applying a broader ‘public interest’ test for acquisitions that could lead to deals being challenged simply because they involve a foreign acquirer.

Future uncertain

The main impact of the reforms is likely to be a degree of uncertainty and potential delay for transactions that come within its scope. A transaction that was caught by the June Reforms provides a good proxy. Just days after they came into force, the government intervened in the proposed acquisition of civil aerospace components manufacturer Northern Aerospace by Gardner Aerospace, a subsidiary of China’s Shaanxi Ligeance Mineral Resources, on national security grounds. The intervention was resolved after approximately 30 days when the transaction was permitted to proceed.

Ultimately, the Proposals show that the government is walking a tightrope. On the one hand, it is seeking to address legitimate concerns that acquisitions by foreign investors have the potential to expose the country to national security threats and their potential consequences.

In particular, the technology sector is an increasingly important part of the nation’s security infrastructure and, at the same time, a sector in which the UK has a growing number of attractive acquisition targets. On the other hand, the government clearly recognises that the UK needs to continue to encourage foreign investment and to maintain an open trading environment, which is particularly important as the security provided by the UK’s membership of the EU draws to an end. Whether it can maintain this delicate balance remains to be seen.

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