13 November 2020

Cross border M&A comment - New UK government review powers over foreign direct investment

Foreign investors seeking acquisition or business expansion opportunities in the UK must, with effect from 11 November 2020, be mindful of new government measures to review such transactions in certain circumstances. The legislative position on FDI in the UK has now been overhauled following the Governments’ publishing of the National Security and Investment Bill 2020 (the “Bill”) for a second reading in Parliament.  

Investors and market participants ought to have already been aware of the Government’s 2018 White Paper pre-empting the Bill that was announced in the 2019 Queen’s Speech, its June 2020 plans to lower transaction thresholds in certain sectors deemed to be of national security importance and its measures adopted in the summer to protect parties involved in the COVID response.  

The provisions of the Bill remain substantially in line with the 2018 draft although there are some key new provisions announced together with the launch of a consultation process to further clarify business sectors that the Bill, when passed, will seek to target. Despite the Bill not being formally ready to be enacted into law these provisions are actually now in effect through a retrospective review process – a means to prevent fast tracking deals to circumvent the rules.

What is clear is that despite the impending Brexit, a need for new trade deals, the pandemic response and other significant national and international priorities, the Government was eager to announce these new powers to bring it in line with the approach of key allies such as its “Five Eyes” partners (including the United States and Australia), and others such as Germany and Japan, who have all strengthened their powers to scrutinise and intervene in business transactions to protect national security. 

The Bill gives the Secretary of State for Business, Energy and Industrial Strategy (“BEIS”) powers to screen investments and to address any national security risks in specified circumstances.  The policy statement accompanying the Bill shows that the Government has moved more towards a risk-based approach that is on the face of it narrower than the previous national or public interest approach but given the broad review criteria over target assets and trigger events, call-in powers, ability to block or unwind deals and potential sanctions for breach the rules are rather heavy handed for those familiar with the previous system in the UK. 

The Government has, however, done away with minimum target turnover and market share thresholds for areas of concern but is seeking to capture any activity in the UK that could be a risk to national security. 

Risk based approach to assessing notifications

Acquiring “control” of an entity will typically start at 25% of the shares (or similar) of a target entity (or increases through 50% and 75% levels) but could apply if a person will acquire shareholder blocking rights (or similar) or a deal enables a person “materially to influence” the policy of the entity by other means. There are also provisions covering where a person acquires a right or interest in an entity over 15%. For assets, control will change if a person is able to use the asset or use it more than before or otherwise is able to direct or control how the asset is used. 

Once a trigger event has been notified or called in on the basis described in further detail below, BEIS will carry out a full assessment of the potential risks and may impose remedies to address such risks. During its review BEIS will consider three levels of risk, being (a) the target risk covering the nature of the target and whether it is in an area of the economy where the Government considers risks more likely to arise, (b) the trigger event risk derived from the type and level of control being acquired and (c) the acquirer risk – the extent to which the acquirer raises national security concerns. 

As a result acquirers, sellers, and target entities will need to adopt similar review criteria in assessing deals and formally notifying BEIS if there are trigger events involving them which they consider could give rise to a national security risk on the basis of the new laws.  

Target risk

To identify target risk, the Government recommends that the UK economy is approached based on three levels as below:

1. Core areas

The core areas are the headline sectors in which national security risks are more likely to arise and where mandatory notification applies for relevant trigger events. These are certain national infrastructure sectors, advanced technology, military and dual-use technologies, and direct suppliers to Government and the Emergency Services that were principally covered by previous legislation. If a trigger event transaction is in contemplation the Government expects a mandatory notification to be made that will be subject to BEIS review.

2. Core activities

Acquisition of entities involved in core activities will also be subject to mandatory notification. Core activities are primarily within the core areas although BEIS has identified 17 key sectors that it is consulting upon until January 2021 to develop detailed definitions and sub-sectors to be adopted in secondary legislation. 

The current key sectors are (a) Advanced Materials, (b) Advanced Robotics, (c) Artificial Intelligence, (d) Civil Nuclear, (e) Communications, (f) Computing Hardware, (g) Critical Suppliers to Government, (h) Critical Suppliers to the Emergency Services, (i) Cryptographic Authentication, (j) Data Infrastructure, (k) Defence, (l) Energy, (m) Engineering Biology, (n) Military and Dual Use, (o) Quantum Technologies, (p), Satellite and Space Technologies and (q) Transport.  The Government’s consultation paper contains far more detail to give one a very good idea as to what it is expecting to be covered and its reasons for covering them.

Asset acquisitions will not be subject to mandatory notification although will more likely be called in if in these core activities. The Government remains focused on intellectual property and know-how, described in the Bill as ideas, information or techniques which has industrial, commercial or other economic value, such as trade secrets, databases, source code, algorithms, designs, plans and software. Transactions to acquire these outright or by licence or other commercial arrangement will now be caught as was not previously the case under the past regime. Land is now also covered in certain circumstances. 

3. The wider economy

Trigger events occurring in the remaining areas of the UK economy are unlikely to pose risks to national security, so such transactions are only expected to be called in on an exceptional basis.

The trigger event risk

As mentioned, the Bill now includes a power to call in acquisitions of control over entities or assets, based on ‘trigger events’, where there is a reasonable suspicion of risk to national security. 

The Government states that trigger event risk is the potential of the underlying acquisition of control to undermine national security or to position one to do so. This might involve gaining control of a crucial supply chain, or obtaining access to sensitive sites, with the potential to exploit them.  The Government will itself (and will expect market participants to do so) make an assessment of potential from the transaction to increase the risk of disruptive or destructive actions, espionage activities such as the ability to have unauthorised access to sensitive information or the use of inappropriate leverage to exploit an investment to influence the UK.

This line of enquiry poses a greater burden on market participants than was previously the case, and will necessitate extensive front-loading of information to allow views to be taken. There is a risk that some transactions will be delayed or ultimately derailed if an assessment is not able to be quickly made. Although in line with some international jurisdictions that have adopted similar approaches for some time, such a review is new to the UK and we expect considerable impact on the previously free-flowing UK M&A markets in these areas.

If a party is unsure as to whether a trigger event may pose a risk, the Government’s position is that it is required to consider how a hostile actor with control might act to the detriment of national security. 

The acquirer risk

Assessing acquirer risk currently carries the most uncertainty at this stage due to the lack of guidance from the Government other than stating that it expects parties to do their due diligence on acquirers and notify BEIS if they have concerns. Apart from being able to make attempts to identify ultimate beneficial owners or controllers (that UK market participants will be accustomed to carrying out in controlled or regulated transactions), in order to effectively satisfy this requirement it will be more onerous for sellers than they are currently accustomed to. 

Therefore, to proceed swiftly through the early stages of a transaction the onus will be on the acquirers to be forthcoming with information. We expect to see sophisticated acquirers pre-empting enquiries and preparing information packs for this purpose. However, without knowing the prevailing Government policy it will be difficult to second-guess whether there will be national security concerns. 

In our view, detailed assessment of acquirer risk will only really be able to be effectively discharged by BEIS once notifications are made.  There are also new powers to require the provision of information ("information notices") and to require the attendance of witnesses ("attendance notices"). The issuance of these notices will stop the clock pending confirmation  that the requirements of the requests have been met.

Helpfully, the Government states that even where an acquisition of control may have the potential to undermine the UK’s national security, it expects that the vast majority of acquirers will not seek to use it in this way (for example, pension funds that may be long-term investors with no incentive to interfere). 

Assessment factors to consider

Factors which will be considered by BEIS when assessing acquirer risk and in deciding whether to exercise its call-in power are stated to include and assessment of (a) those in ultimate control of the acquiring entity, (b) the track record of those people in relation to other acquisitions or holdings, (c) whether the acquirer is in control of other entities within a sector or owns significant holdings within a core area, as this increases their potential leverage and (d) any relevant criminal offences or known affiliations of any parties directly involved in the transaction.

The Government has not yet given clear indication as to the types of persons or entities that will give rise to concern once the ultimate controller is identified. Past criminality will be a factor – the consultation lists serious organised crime and cyber-criminals alongside hostile state actors without any indication as to which states the Government deems (or will deem) hostile. 

Consideration of States 

No individual states have been named to date and there are no express criteria to determine what makes a state hostile. Clearly the Government is giving itself maximum discretion to make an appropriate assessment at any given time, although the ambiguity as to what the Government of the day will determine, is potentially opening the review process to subjective will and politics of the day.

Statements to date provide some indication that the Government does not currently regard state-owned entities, sovereign wealth funds – or other entities affiliated with foreign states – as being inherently more likely to pose a national security risk. If it can be shown that there is full operational independence in pursuing long-term investment strategies with the object of economic return, one can expect no national security risks associated with them. Mere existence of a relationship with a state will not be enough – there will need to be an affiliation with a hostile party. 

However, until there is more guidance or precedent on the issue the market will remain in the dark as to what constitutes a hostile actor or state. Will this be confined to states where the UK does not have diplomatic relations or those with which it is currently at war, or will there be other factors at play? What about entities connected with States that already operate and/or own interests of national significance in the UK (or have committed to do so)?

Ultimately the Government has stated that, in its assessment, most acquirers do not pose a risk to national security – most parties acquiring assets do so purely for financial or commercial gain. This should rule out most legitimate corporate or commercial undertakings, but there remains an unhelpfully wide remit and subjectivity in the process. No doubt, as with any new regime, greater clarity will develop over time and the hope is that a consistent, transparent and commercial approach will be discerned in due course.

Call-in powers

Whether or not the parties have given voluntary notification of a proposed transaction, BEIS has the power to call in a trigger event which has taken place up to 6 months after they became aware of it (such as via press) so long as it is done within 5 years of the trigger event occurring. Where the acquisition was subject to mandatory notification, the 5-year time limit does not apply.  

Given the uncertainties in the practical application of the rules we expect an initial cautious approach by acquirers in the form of more detailed expert consideration of the need for a mandatory notice. We also expect to see more voluntary notifications to achieve more transaction certainty.  The Government is offering informal guidance and prompt feedback in any consultations so over time we expect that the market view of transactions at risk will settle, although each transaction should always be considered on its own facts. All of this will require immense new manpower and technical capability to cope.

Notwithstanding, by comparison with a 4-month potential review period by the CMA under the old rules, under the Bill there is an initial 30 working day assessment period for BEIS to review a transaction. This may not be overly burdensome if the parties wish to go for better deal certainty or are prepared to sign conditional deals and wait for the outcome of a review. However, the initial period may be followed by an additional period of 45 working days or an even a lengthier voluntary period if agreed with the acquirer.  

If sufficient time is incorporated into the deal documentation to allow for a “national security” condition to be satisfied, there is more time for MAC clauses or even force majeure to be triggered, putting deals at risk when not previously the case. These issues are already well-considered in transactions subject to regulatory or anti-trust clearances.

Blocking actions, conditions and remedies

If BEIS finds that national security is indeed at risk following its review of the transaction, it is expected to impose necessary and proportionate remedies or potentially void the deal if it has already occurred. Typically, it could impose certain behavioural conditions (such as refraining from certain activities), or it may insert certain structural and oversight features, such as has been seen in the past, granting the Government a “golden share” in the capital structure, with step-in rights and certain vetoes. It may also limit access to certain information to persons with the requisite security clearances. 

Such decisions will be subject to judicial appeal, although such appeals may only be brought to review the way in which a decision has been made, not the merits of the decision reached.

Failure to comply and penalties

Where there is a failure to comply with this new regime, necessary sanctions will be imposed, such as criminal sanctions of imprisonment up to five years or fines up to 5% of worldwide turnover or £10 million (whichever is higher). Clearly, transactions should not proceed if there are national security concerns, and early consultation is highly recommended to seek to avoid any abortive transaction costs and time delays.  

There are also criminal penalties for failure to comply with information or attendance notices, the intentional or reckless alteration, suppression or destruction or information or the provision of false or misleading information. For failure to comply with an order by the Government on a particular transaction there are also various monetary daily rates that could apply.

Conclusion 

In a post-Brexit and post-pandemic era we expect that it will take some time for the Government to strike a good balance between the UK’s free market approach and with its perceived “national security” concerns. Eventually market practice will develop to alleviate uncertainty and concerns with delays, with the UK remaining “open for business” and attracting legitimate corporate and commercial players as has been the case for centuries.

For further consideration of the key aspects of the Bill, please contact the partners listed here.

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