New takeover regulatory powers could threaten FDI

October 2020 | SPOTLIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

October 2020 Issue

During summer 2020, the UK government introduced a number of changes to merger control rules which expand its ability to scrutinise or block certain mergers or acquisitions which impact the public interest. The changes reflect an appreciation that certain industries have become of strategic importance to the UK. The takeover of UK companies active in those areas could pose a threat to the UK’s national interest, where undertaken by hostile actors, such as state actors of certain foreign governments or other entities which are subject to the jurisdiction of those governments. The changes, which run alongside the UK’s competition law regime for scrutinising mergers, are explained in more detail below.

UK merger control rules

The primary statute on UK merger control is the Enterprise Act 2002 (EA). The EA provides that the UK competition regulator, today the Competition and Markets Authority (CMA), would be the entity with jurisdiction to intervene in a “relevant merger situation”. The role of the CMA is then to consider whether the merger could realistically cause a “substantial lessening of competition” in any market.

In exceptional cases, however, the government also has a power to intervene. That power arises where there is both a public interest arising from the merger and a “relevant merger situation”, the same jurisdictional threshold the CMA must satisfy in order to investigate a deal.

Section 58 of the EA sets out the considerations which constitute a “public interest”. Originally, this included national security, media plurality (an umbrella term covering a number of media-related considerations) and the stability of the UK financial system. A further ground has now been introduced, as discussed below.

Regarding the second limb, before the 2018 Orders, a relevant merger situation under the Act was fulfilled where the acquired business had an annual UK turnover of more than £70m or the merger would result in the creation of, or increase in, a 25 percent or more combined share of sales or purchases in the UK, or in a substantial part of it, of goods or services of a particular description.

The government concluded that the thresholds, as set in 2002, were no longer working effectively as a threshold for intervention on national security grounds in certain areas of the economy. Since 2002, there had been considerable technological advances, developments in local, national and global economic structures, and changes in the national security threat facing the UK.

The EA does not require parties to a merger to pre-notify a deal before it can be completed. There is a risk, however, that in not doing so, either the CMA or the government (where it has jurisdiction) could order the integration of the parties to be suspended while it examines the effects of the deal. Ultimately, the review could culminate in clearance of the deal subject to conditions or the acquirer being ordered to sell off the target.

Changes to merger thresholds (relevant merger situation) in 2018

The government concluded that the thresholds in the EA were no longer effectively safeguarding UK national security in all areas of the economy.

There was a recognition that businesses which had low turnovers, sometimes well below £70m, or formed a small part of a particular market could nonetheless be of strategic importance. That meant that although the government may wish to intervene to prevent them being taken over, the provisions of the EA may effectively render them powerless to act.

Therefore, the government concluded in 2018 that the thresholds needed to be amended for three sectors of the economy: the military and dual-use technologies, quantum technology and computing hardware. Accordingly, it introduced two orders, the Enterprise Act 2002 (Share of Supply Test) (Amendment) Order 2019 and the Enterprise Act 2002 (Turnover Test) (Amendment) Order 2018 (2018 Orders).

The 2018 Orders amended the two threshold tests in relation to specific areas of the economy, as follows: (i) the ‘target’ business must have UK turnover over £1m, rather than £70m; and (ii) either the existing share of supply test must be met, or the target must have a share of supply of 25 percent or more of relevant goods or services in the UK, such as goods or services connected with their activities in the three defined areas of the economy. It is therefore no longer a requirement that the merger must lead to an increase in the merging parties’ share of supply to, or over, 25 percent.

Further changes to the thresholds in 2020

Since 2018, the government has been considering this evolving situation and concluded that three further sectors should be subject to the amended thresholds set out in the 2018 Orders. That prompted the government to introduce the Enterprise Act 2002 (Share of Supply Test) (Amendment) Order 2020 and the Enterprise Act 2002 (Turnover Test) (Amendment) Order 2020.

The sectors concerned are: artificial intelligence (AI), cryptographic authentication technology, advanced materials, which include materials capable of modifying the appearance, detectability, traceability or identification of objects by humans or sensors within specified ranges up to and including ultraviolet, alloys formed from chemical and electrochemical reduction of metals, polymers and ceramics in their solid state, processes taking solid state alloys in or into crude or semi-fabricated forms, or powders for additive manufacturing, and other metamaterials, not including fibre-reinforced plastics in certain applications and packaged device components for civil application.

The Explanatory Memorandum provides an insight into why these sectors have been chosen. AI refers to technology enabling the programming, or execution of, a computational process capable of undertaking complex tasks commonly associated with human intelligence. AI has the potential to have a truly transformative impact on the global economy.

AI technology deploys vast datasets to identify better ways of doing complex tasks. It also uses complex algorithms to allow for autonomous learning and is capable of interacting with the physical environment. This has led to concerns that in the wrong hands it could be programmed or deployed by a hostile actor in a manner contrary to national security.

Cryptographic technology enables information to be protected while in storage or in transit by making it inaccessible or unreadable by everyone except those who have the information needed to access or read it. The technology is integral to a well-functioning economy. The government is concerned, however, that if hostile actors gained ownership or control of such technology through a business takeover (leading to them studying or reverse engineering it), they may then be able to bypass cyber-authentication systems, enabling them to access data and programmes which are critical to national security.

Regarding advanced materials, the government explains these all stem from understanding, manipulating and exploiting the composition, arrangement and properties of matter. The UK could lose its advantage in its defence and security capability and there may be a risk of loss in this advantage if UK companies, and the intellectual property (IP) that they generate in this area, were controlled by hostile actors.

The concept of public interest and COVID-19

These changes followed moves earlier in the summer which allow the government to intervene in acquisitions of businesses which were important to fighting the COVID-19 pandemic in the UK. The Enterprise Act 2002 (Specification of additional section 58 consideration) Order 2020 entered into force on 23 June 2020.

Section 58 of the EA specifies the public interest considerations in relation to which the government may intervene in relevant merger situations. This order adds to the list an additional ground for intervention, namely the UK’s capability to combat a public health emergency.

The need for such a power has, in the government’s view, been brought into focus by the demands placed on the UK by the COVID-19 pandemic and its impact on the economy. The government may, for example, need to act if an enterprise involved in the fight against COVID-19, a vaccine research company or a manufacturer of personal protective equipment (PPE), for instance, finds itself the target of a takeover. While most mergers are carried out for business reasons, the intention or effect of such a takeover could be to diminish the resources and capacity of the UK to respond to a health emergency.

What does this mean for investors?

From the perspective of business, the rules may raise a concern. The new rules target investable businesses, in areas of high economic growth. These are also sometimes the types of business which require external investment (or an acquirer with deep pockets) to engage in activities such as R&D, manufacturing or marketing.

Investors must be alive to the potential adverse consequences of a merger investigation. There have been numerous examples of interventions leading to the forced sale of businesses after their acquisition. There has also been evidence of an uptick in the number of government intervention notices being issued on public interest grounds. Even if the purchase is ultimately cleared, being ordered to hold businesses separate can interfere with plans.

Ultimately, there is no substitute for due diligence and seeking the advice of lawyers who are not only familiar with merger control rules but also with the markets and technologies involved and provide advice on whether the rules are likely to apply. If an Intervention Notice is served by the Secretary of State (SoS), it must also be remembered that the process is governed by the usual protections of public law, including a duty on the SoS to act proportionately, rationally and within the confines of the statute. A judicial review may be brought where the Minister strays beyond those confines.

Paul Henty is a partner at Charles Russell Speechlys LLP. He can be contacted on +44 (0)20 7427 6506 or by email: paul.henty@crsblaw.com.

Paul Henty

Charles Russell Speechlys LLP