We previously wrote that “Winds of Change” were sweeping across Europe, with both the European Union and its individual Member States, tightening their rules on foreign direct investment (“FDI”) with an increasing focus on matters of national security.
Since then, on an EU level – and especially in the context of COVID-19 – the European Commission has singled out the issue of FDI screening. In their guidance to Member States on 25 March 2020, it was made clear that foreign investment needs to be balanced by appropriate screening tools. Pursuant to the EU Regulation (2019/452) on Screening of Foreign Direct Investment, commencing from 11 October 2020, Member States will be empowered to review investments within their scope on the grounds of national security or public order, and to take measures to address specific risks. Notably this applies to all sectors and is not subject to any minimum thresholds.
As set out in our review, the German government has initiated a process to amend the German foreign investment control (“FIC”) regime in line with the EU Regulation and with the intention to close existing lacunas and improve the effectiveness of their FIC procedure.
The current position in the UK
To assess what further changes might be introduced in the United Kingdom to address the EU-lead measures, it is important to recap the current legislative position.
Under the Enterprise Act 2002 (the “Act”), the Competition and Markets Authority has jurisdiction over mergers where either:
the target business had a UK turnover of £70 million in the last financial year (“Turnover Test”); or
both the buyer and the target supply the same category of goods or services in the UK (or a substantial part of it accounting for at least 25% of such supply) (“Share of Supply Test”).
If a transaction does not satisfy the above thresholds, the power to intervene is limited to transactions involving certain public interest and security issues (notably relating to defence), media plurality covering certain newspaper and broadcasting companies and financial stability. However, following amendments which came into force on 11 June 2018 to address particular concerns regarding foreign access to:
the development or production of military items and “dual-use” items;
the design and maintenance aspects of computing hardware; and
the development, design, manufacturing or production of goods for use in, or supply of services based on, quantum technology,
the Turnover Test was lowered to more than £1 million per annum and the Share of Supply Test was amended to apply where the same category of goods or services is being supplied in the UK (or a substantial part of it accounting for 25% or more of such supply, even if the share of supply does not increase as a result of the merger). As a result, this brought ever closer scrutiny of these sectors within the remit of the UK Government.
Further sectors targeted
On 21 June 2020 it was further proposed that the new lower thresholds for the Turnover Test and Share of Supply Test described above be extended to the following sectors, (i) artificial intelligence; (ii) advanced materials; and (iii) cryptographic authentication technology. This expansion of categories will need to be debated and approved by Parliament before it can come into effect.
For transactions caught by the amended thresholds, notification will continue to be voluntary. Those involved in transactions can choose to notify the transaction to the CMA or take the risk that the CMA or Secretary of State will decide to initiate an investigation up to four months after completion of the transaction (or completion of the transaction is made public, if later).
New legislation to intervene in matters of public health
The UK Government also recently passed with effect from 23 June 2020 new legislation to intervene in certain deals of substance involving businesses critical to the UK’s ability to combat, and to mitigate the effects of, public health emergencies such as the COVID-19 pandemic. This potentially wide categories of businesses covered includes targets that are directly involved in a pandemic response, such as pharmaceutical companies and research bodies involved in vaccine research, as well as companies involved in the manufacture of personal protective equipment (PPE) and other essential medical supplies.
This new legislation is also wide enough to cover companies active in the food supply chain, logistics companies that play an essential role in keeping supply chains moving in exceptional circumstances or private healthcare companies that may offer resources to relieve the NHS.
The Government may intervene where each of the following tests are met:
Acquisitions of minority or controlling stakes - investments giving the acquirer materially influence over the target, which may occur at shareholdings as low as 10-15 %, (or even lower due to the wide discretion of the CMA which may consider other factors such as the size of other shareholdings, veto/consent rights and other negative controls, board representation, commercial agreements and the investor’s industry expertise). Joint ventures and deals which allow the investor to move from a position of material influence to control may also be caught.
The target is an ‘enterprise’ – it must comprise an activity or assets capable of generating revenue. An enterprise usually includes assets, contracts and employees necessary to carry on a business, but assets alone will sometimes suffice where they enable a business activity to be carried on.
The ‘turnover’ or ‘share of supply’ tests are satisfied, being either:
the target’s UK turnover exceeds £70 million; or
the acquisition creates or enhances a share of supply of goods or services in the UK of at least 25% (a test which the CMA interprets increasingly widely).
We expect the Government will use its wide discretion for a period during which the concerns surrounding the current COVID-19 pandemic remain more heightened. As a result market participants should take advice before proceeding with transactions in these sectors.
Proposed new legislation in the UK
Despite the measures recently brought in or that are being debated, the current legislative position on FDI in the UK is expected to undergo further significant overhaul. Following public consultation on the Government’s White Paper on “National Security and Investment” published in July 2018 (the “White Paper”), on 19 December 2019, the National Security and Investment Bill 2019-20 (the “Bill”) was announced in the Queen’s Speech. The Bill will replace the Act when passed.
The Bill intends to create “a notification system whereby businesses flag transactions with potential security concerns to the Government for quick, efficient screening”, providing “powers to mitigate risks to national security by adding conditions to a transaction or blocking the transaction as a last resort” and a “safeguarding mechanism for parties to appeal where necessary”.
Alignment with the “Five Eyes”
The stated intention is to align the Government’s powers with the approach of key allies such as the “Five Eyes” partners (including the United States and Australia), and others such as Germany and Japan, who have recently strengthened their powers to scrutinise and intervene in business transactions to protect national security.
Despite the UK’s imminent exit from the EU (the so-called “Brexit”), expected in 2021, international alignment of this nature would be welcome to those seeking firmer restrictions and scrutiny of FDI. Notwithstanding, this is also likely to raise concerns for those hoping for a more open investment climate and may make it more difficult for the UK Government to secure favourable trade deals in a post-Brexit world.
UK to remain a global champion of free trade and investment
Under the Bill, the Government’s intends to strengthen its powers to scrutinise and intervene in business transactions to protect national security whilst at the same time provide businesses and investors with the certainty and transparency they need to do business in the UK. The Bill also seeks to ensure that the UK remains a global champion of free trade and investment and remains one of the most open countries in the world for innovative and dynamic investment.
There is a delicate balancing act at play here and it may not always be possible for the Government to adhere to apparent competing interests.
Scope of the Bill
In keeping with the White Paper, the scope of the Government’s powers under the Bill are intended to be more expansive than before, as the scope will cover any form of transaction, investment, or other commercial activity, regardless of the sector, revenue and market share. With no minimum threshold the proposed powers are potentially far-reaching, save that the scope is limited to “national security” concerns.
On first reading, “national security” may appear extremely broad and subjective, however, it is a well understood term in national and international law, narrower than a subjectively broader interpretation of a “national interest” or “public interest”.
The Bill is intended to cover national security risks from investment in entities and assets, acknowledging that national security concerns will change over time, especially given advances in technology and the reliance on data. The "trigger events" that may be reviewed on national security grounds, include the acquisition of:
more than 25% of the shares or voting rights of an entity,
significant influence or control over any entity,
further influence or control of an entity beyond the above thresholds,
more than 50% of an asset, including land and intellectual property and
significant influence or control over an asset.
The Government has provided extensive guidance on the above triggers, whilst retaining ultimate discretion.
Broadening of coverage to assets and intellectual property and anti-circumvention
It is worth highlighting that a key new feature of the Bill is to upgrade the Government’s powers to scrutinise investments and consider the risks that can arise from hostile parties acquiring ownership of, or control over, not only businesses or other entities, but now also assets that have national security implications, particularly intellectual property.
As a result of broadening of the triggers (as described above) to include assets and intellectual property, the Government is seeking to ensure that hostile parties cannot circumvent the law by other means, for example, asset only transactions or intellectual property licencing deals.
Examples of target assets that could give rise to national security concerns
The Department for Business, Energy and Industrial Strategy (“BEIS”) has provided detailed guidance on their proposed approach to “target assets” that could give rise to a national security concern if acquired or controlled.
A non-exhaustive list of examples from BEIS guidance, include:
assets that could be used to cause an emergency;
dual military and civilian use assets, covering entities with advanced manufacturing or technology capabilities;
intellectual property used in cyber security;
an entity or asset integral to UK defence;
assets that could be manipulated or controlled to cause detrimental harm or to extract sensitive information;
access to healthcare databases; and
civil nuclear and chemical sites.
Critical infrastructure is also covered
In addition, the new powers under the Bill are intended to cover a wider remit of UK infrastructure, with the guidance covering “critical national infrastructure which are necessary for the UK to function or for daily life” and will include energy networks and major airports and other “core” infrastructure. The BEIS guidance provides further detail as to the core areas of infrastructure that are expected to fall within the remit of the Bill.
Focus on advanced technologies
Other key areas covered include certain aspects of advantaged technologies, such as AI and machine learning, autonomous robotic systems, computing hardware, cryptographic technology, materials and manufacturing technology, nanotechnologies, network/data technologies, quantum technology and synthetic biology. This is not an exhaustive list but a guide at present.
Focus on suppliers and dual-use products or businesses
The Bill will also cover critical suppliers to the Government or the emergency services sector (expected to cover PPE and other essential supplies during and post COVID-19) as well as dual-use products and technologies. However, in all cases the final discretion as to whether an area falls within the remit of national security for the Government to intervene will remain.
Most acquirers do not pose a risk
The Government states 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. However, of some concern is the ambiguity as to what the Government of the day will determine as a “hostile party”, potentially opening the scrutiny process to subjective will and politics. There will be some known “hostile states” but it is not always clear-cut as to which nation state is on the Government’s list of the day.
To assist in further scrutiny of what constitutes a hostile party, BEIS guidance states that a “hostile party is an acquirer that may seek to use their acquisition of control to undermine national security through disruption, espionage, inappropriate leverage or other means”. The former terms tend to conjure “Cold War” themes and one would think would rule out most legitimate corporate or commercial undertakings, but there remains an unhelpfully wide remit and subjectivity in the determination process.
Notification and screening
If future FDI will be more firmly in the hands of Government and the market at large, how will this work in practice? The Bill proposes widening the powers of the Government to intervene and further seeks to more actively involve market participants in the screening process by “encouraging notification of investments and other events that may raise national security concerns”, rather than imposing any strict obligations to do so. However, the Government reserves the right to call-in transactions or other events before or even after a transaction completes. We would expect there to be a long-stop date for the latter to allow for more certainty in the market, but this has not yet been determined.
When considering whether to exercise their call-in powers, the Government is expected to take into account the following factors:
the areas of the economy where the Government considers national security risks are more likely to arise in relation to trigger events;
how trigger events can give rise to national security risks; and
circumstances in which acquirers may raise national security concerns.
Timing and impact on transactions
It is important to note that the Bill contemplates that the vast majority of transactions will raise no national security concerns and the Government expects to quickly rule out national security risks in most cases that it considers, allowing parties to proceed with certainty.
If required, an initial assessment is expected to be carried out within 15 business days with the potential for a full national security assessment that could take up to 75 business days, potentially causing significant delay to completion of transactions. Sufficient time will need to be incorporated into deal documentation to allow for this condition to be satisfied, potentially giving more time for MAC clauses or even force majeure to be triggered and terminate deals.
Imposition of remedies and ability to appeal
If the Government finds that national security is indeed at risk following their assessment of the transaction, it will impose such remedies as are considered by the Government to be necessary and proportionate. Typically the Government could impose certain behavioral conditions to the transaction (such as refraining from certain activities), or it may insert certain structural and oversight features, such as granting the Government a “golden share” in the capital structure, with step-in rights and certain vetoes. The Government may also limit access to certain information to persons with the requisite security clearances. Of course, the Government may ultimately block a transaction.
Such decisions made by a Senior Minister in the Government with oversight of the transaction are 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 10% of worldwide turnover and director disqualification orders. 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.
Recent developments and deeper Parliamentary involvement
Notwithstanding Brexit and the national focus on the COVID-19 situation, there have been recent statements that the Government intends to press ahead with the Bill. It remains to be seen whether this can be achieved this year, although there appears to be heightened rhetoric and action within Parliament of late.
Parliamentary inquiry into the role of the FCO
A parliamentary inquiry has been opened by the Foreign Affairs Committee (“FAC”) to assess in what circumstances the UK Foreign & Commonwealth Office (“FCO”) should be given powers to intervene in the review of transactions under contemplation of the Bill.
Whilst typically other Government Ministries play a more active role (in consultation with the Ministry of Defence), this inquiry seeks to ensure that the FCO will, under the new Bill, have a full role in the decision-making process in relation to interventions.
Irrespective of the outcome, it appears that there is a desire for more Parliamentary scrutiny of the Bill and a more interventionist approach to FDI by many functions of the Government.
As further evidence of Parliamentary manoeuvrings regarding the Bill, take the recent reported alleged attempt of a boardroom takeover of a high-profile English-based semiconductor and software design company (“Target”), by a foreign state-owned private equity fund (“Investor”).
Investor, as the largest investor in an overseas-based private equity firm, acquired indirect control of Target in 2017 for a large sum and delisted it from the London Stock Exchange. Subsequently, at a board meeting scheduled for early April 2020, it was understood that Investor was planning to appoint four directors on to the board of Target to take further control.
In advance of the board meeting, Conservative MP Tom Tugendhat, Chair of the FAC, along with three other MPs who Chair the Committee for BEIS, the Digital, Culture, Media and Sport Committee and the Defence Committee, penned a letter to Prime Minister Boris Johnson, expressing their concerns.
The letter states that the MPs had been under the impression that Target was owned by the private equity firm, and “not under the control of [a foreign] government, with Investor remaining a passive investor”. The letter continues that in light of the “importance of the UK tech sector for self-sufficiency in the UK industrial base”, the MPs made strong recommendations for action by the UK Government to intervene as well as seeking assurances for a “stronger legal framework” to be put in place to scrutinise and deal with foreign investments and acquisitions that could pose a “threat” to national security.
Target was reportedly summoned to answer questions by MPs, who were concerned with potential risks to UK critical digital infrastructure, national security concerns and the commitment of Target to remain a UK-headquartered business. Other MPs made stern public statements on the matter which were widely covered in the national press, stoking further public interest.
The board meeting was later cancelled (reportedly at the request of the UK Government) and no further action was taken by the private equity firm or the Investor. However, the affair shows how key MPs and their committees, will raise the temperature and demand UK Government intervention when they perceive national security is at risk.
Given its stated benefits and purpose, the Bill does not appear to be a full “pulling up of the drawbridge” moment for the UK, but rather a new targeted power for the UK Government to act in serious cases of national security concern within key sectors of the economy. Despite the overriding objectives, the risk remains that the application of the Bill, when passed, will be subject to a political agenda at any time, with commensurate uncertainty for market participants.
As a result, market participants are advised to consult their legal advisers early in any process if they are considering transactions in the United Kingdom, particularly if there are concerns as to whether the target entity or assets, or even the acquirer, could be considered as raising national security concerns.
King & Wood Mallesons is following the development of the Bill through Parliament and is able to advise its clients on their transactions where required. If you have any queries relating to matters raised in this article, please do contact the authors or your usual KWM contact partner.
For a review of the latest position on CIFIUS in the United States, click here.
For a review of the latest position on FIRB in Australia, click here.
If not already the case and you wish to be added to our email distribution list for future articles, please contact Isabel Stewart.