New UK defence sector merger controls proposed

January 2018  |  FEATURE  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

January 2018 Issue

In October 2017, the UK government took steps to heighten merger control in the country’s technology and defence sectors. Proposed new rules would allow the government to intervene on certain deals based on national security concerns. The proposals, set out in a Green Paper called the ‘National Security and Infrastructure Investment Review’, also launched a public consultation to seek views on how the government can “best ensure that investments and takeovers do not raise national security concerns”. The review also notes that openness to trade in the UK needs to come with “safeguards”.

As with all political issues concerning the UK since mid-2016, the impending ‘Brexit’ process looms large. While ministers and regulators are keen to exert greater control over acquisitions within the defence and technology sectors, it must be exercised in a way that communicates to would-be investors that the UK is still open for business and remains a solid investment destination for foreign capital, even as it negotiates new trade deals determining the type of relationship it will have with other nations.

The proposals

The government’s two-part proposals are aimed at tightening existing controls over investments, particularly, but not exclusively, concerning foreign investments that may have national security implications. The proposals would expand the current measures available under the Enterprise Act 2002, which stipulate that the government can intervene in takeovers on “exceptional public interest” grounds, including national security concerns, and allows the government to take action to ensure the stability of the UK financial system.

Currently, the government can rely on public interest grounds to intervene in the acquisition of control or material influence over a business in two different scenarios. The first is where the thresholds in the UK merger regime are met: either the target has a UK turnover exceeding £70m or the transaction results in an increase of 25 percent or more in the merging businesses’ combined share of supply of products or services in the UK. The second is where these thresholds are not met but the transaction is a “special merger situation” involving a defence contractor or a media company. There are currently three public interest grounds: national (including public) security, media plurality and financial security.

Under the existing framework there is no specific provision which allows the government to intervene in small transactions involving suppliers of security-related equipment, software or technology that are not defence contractors, in technologically significant investments or in investments in new projects involving critical national infrastructure. Furthermore, at present, notification is voluntary and a transaction may be completed without UK merger clearance. However, the UK Competition and Markets Authority (CMA) may intervene on its own initiative and use its power to block or unwind a problematic transaction.

Currently, the government has the ability to protect national security in certain areas, namely the water, communications, energy, civil nuclear and manufacturing industries. The Civil Contingency Act 2004 also allows the imposition of crisis measures to address any actual or threatened emergencies, though the Act has not been updated to address issues concerning advanced technology and critical infrastructure.

The government’s proposals are designed to address new national security challenges created by emerging technologies, as well as questions raised by recent transactions regarding the adequacy of the UK’s merger regime to protect the country’s national security effectively. The Green Paper specifically makes reference to foreign direct investment (FDI) in Hinkley Point C nuclear power station, which will be built by state-owned companies EDF and GCN of France and China respectively, as a particular concern.

The government has indicated its longer-term intention to make more substantive changes to how it scrutinises the national security implications of foreign investment in other key parts of the economy, including civil nuclear, defence, energy, telecoms and the transport sector. The Green Paper is likely the first stage.

Faced with the possibility of up to 100 transactions per year being scrutinised under the new plans, early preparation and consideration of potential issues will be crucial for many prospective overseas investors. UK targets are increasingly popular due to the devaluation of the pound. The total number of FDI projects into the UK’s tech sector, for example, reached a 10 year high in 2016 with 269 investments made, according to EY.

The government has also proposed that ‘change of control’ clauses be inserted into government funding to enable money to be clawed back in some circumstances if a recipient is bought.

Elsewhere, the EU is contemplating amendments to its national investment screening mechanisms. Proposals have been lodged by Germany, Italy and France which will strengthen the bloc’s existing system, as well as improve coordination between EU member countries and allow the European Commission to block takeovers in sensitive sectors. Equally, there are calls within the US to increase scrutiny of foreign investment into the country.

Foreign investment should be encouraged, given its significant contribution to national economies. While it is prudent for legislators to restrict the flow of foreign capital into sensitive industries and assets, a delicate balance must be struck, particularly in the UK where Brexit has created financial uncertainty.

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Richard Summerfield