Successful execution of cross-border transactions: managing regulatory deal risk in the EU and UK

September 2024 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

September 2024 Issue

With active merger control regimes in over 130 jurisdictions, an increasing number of foreign direct investment (FDI) screening mechanisms, and the new EU Foreign Subsidies Regulation (FSR), identifying and surmounting regulatory obstacles to cross-border transactions is becoming ever more challenging.

Each category of regime has several critical features that dealmakers should consider at an early stage in deal planning, to mitigate adverse timing and other execution risks. This will increase the chances that reviews can be avoided or their burdens minimised.

EU and UK merger control – increasing jurisdictional reach

Like many regulators, the European Commission (EC) and the UK Competition and Markets Authority (CMA) have broadened their jurisdictional tests to allow for the discretionary ‘call-in’ of deals that would have previously avoided investigation.

While the EC did not historically review transactions falling below applicable financial notification thresholds, under its revised approach to article 22 of the EU Merger Regulation, it is now actively investigating such deals by seeking referral from national EU antitrust authorities. Referrals are becoming more common in certain strategic industries, including high-tech, raw materials and pharmaceuticals. The EC confirmed that over 50 informal article 22 investigations took place in 2023.

For transactions with high referral risk, it is advisable to brief the EC proactively to avoid uncertainty and adverse timing implications later in the deal timeline. A short briefing explaining why a transaction does not warrant investigation can be prepared within one to two weeks, with the entire process capable of being concluded with the EC within three to five weeks. While a briefing paper may alert the EC to a transaction, transacting parties should also be mindful that the EC actively monitors deal announcements and may raise questions of its own initiative if no briefing paper is submitted.

Under the Digital Markets, Competition and Consumers Act (DMCCA), expected to come into force by the end of 2024, the powers of the CMA are also being significantly broadened. The DMCCA introduces a new jurisdictional threshold that can be met if one party alone has a share of supply of at least 33 percent and a UK turnover exceeding £350m, as long as the other party has a UK nexus (such as a subsidiary or customers). Accordingly, unlike the traditional ‘share of supply’ test, no competitive overlap is required between the parties’ activities. The intent behind this threshold is to analyse acquisitions of nascent competitors by well-established players that could reinforce their market position. As with the existing thresholds, parties will be advised to continue the well-established practice of submitting briefing papers to the CMA to assess if a voluntary notification is advisable.

The DMCCA also introduces an ex-ante regime to regulate digital firms whose activities have strategic market status (SMS), similar to the regulations imposed on ‘gatekeepers’ under the EU’s Digital Markets Act. Unlike the voluntary UK merger control regime that applies to all other companies, companies with SMS will be subject to a mandatory filing requirement where they acquire at least 15 percent of a target with a UK nexus for a consideration of £25m or more.

FDI screening

In recent years geopolitical tensions have resulted in a rapid proliferation of FDI regimes worldwide and particularly in Europe (24 of the 27 EU member states will have active FDI regimes by the end of 2024). As with merger control review, there is no ‘one size fits all’ approach when looking at different FDI regimes, even within the EU. For example, while in many jurisdictions a filing can be excluded where the transaction does not involve the (indirect) acquisition of a local subsidiary, in Italy a filing can be triggered without a local subsidiary if there are local assets, and in the UK, it suffices that the target ‘carries out activities in the UK’.

While there is no EU level FDI screening mechanism, there is a cooperation mechanism that requires member state authorities to notify each other and the EC of any transactions under review. In 2022, 423 notifications were shared between EU member states in this way. Transacting parties therefore need to be particularly careful not to miss a member state filing obligation when they are already filing elsewhere in the EU. The EC has also recently proposed reforms to harmonise national FDI regimes, including by establishing a common sectoral scope for mandatory FDI screening and ensuring that timelines are more similar. This move toward greater coordination and harmonisation at EU level is welcome considering the issues investors face in trying to navigate a patchwork of discrete regimes with varying scopes, processes and timeframes.

Under the National Security and Investment Act 2021 (NSIA), FDI in the UK is regulated by the Investment Security Unit (ISU). The NSIA establishes a dual mandatory and voluntary notification regime. The mandatory regime requires notifications where the target is active in one or more of the 17 broadly defined ‘sensitive sectors’. NSIA prohibition and remedies cases to date demonstrate that the ISU is closely scrutinising a range of sectors. In addition to obvious categories of military, dual-use and defence, the ISU has blocked or imposed conditions in a range of sectors, including communications (four cases), energy (three cases), computing hardware (three cases), advanced materials (three cases), and space and satellite technology (two cases). The NSIA also gives the ISU discretion to call in transactions across any sector under the voluntary notification regime where it deems that the deal may pose ‘UK national security concerns’.

Although the maximum statutory review period is approximately five months, reviews may take much longer in complex cases (such as eight-plus months), especially as information gathering can be onerous and information requests stop the review clock. Where national security concerns are identified, remedies are not negotiated with the parties, though parties do have an opportunity to make written representations. Once a decision is adopted, there is also limited scope to vary it.

Consequences for failure to comply with a notification obligation under the NSIA and other FDI regimes are typically severe. Civil penalties include a fine and most regimes also have the power to require the parties to unwind the transaction pending approval. Failure to notify can also include personal sanctions such as imprisonment or director disqualification. It is therefore important that dealmakers carry out extensive due diligence and take compliance seriously.

EU foreign subsidies regulation

The FSR aims to ensure that companies in receipt of foreign financial contributions (FFCs) from non-EU state entities do not have an unfair advantage to acquire companies or to obtain public procurement contracts in the EU. Notifiable transactions (those which meet the jurisdictional thresholds prescribed in the FSR) cannot be closed until the EC has confirmed that the initial review period has lapsed or has otherwise provided a formal clearance decision. Non-notifiable transactions (i.e., those which fall below the mandatory filing thresholds) may still be called in for review using the EC’s ex officio powers. Companies active in the EU and in receipt of broadly defined FFCs are vulnerable to scrutiny and should have systems in place to record FFCs. Such companies are also advised to proactively prepare an FSR notification so a complete and accurate filing can be submitted shortly after a filing is triggered. Sanctions for non-compliance with the FSR may result in a one-off fine of up to 10 percent of a corporate group’s global turnover.

In the first year of the regime (which came into force on 12 July 2023 with notification obligations starting on 12 October 2023), the EC received over 54 merger notifications and 350 public procurement submissions. The EC’s publicly known enforcement efforts have focused on Chinese companies (in all but one case) and FFCs granted by China, Russia and the UAE, while FFCs from countries such as Singapore, the UK and the US have attracted less scrutiny. Of the six in-depth investigations initiated under the FSR so far, three related to public procurement, one concerned an M&A transaction and two were opened by the EC on its own initiative.

Practical considerations

The growing number and scope of regulatory screening mechanisms, together with the potential sanctions that can be imposed on parties that fail to comply, necessitate engagement with potential antitrust, FDI and FSR issues at an early stage of the transaction process. Given the suspensory nature of many antitrust and FDI regimes, as well as the mandatory FSR regime, the relevant review period can have particularly acute timing implications for closing deals. Further, there is also a trend toward a stricter approach to merger control, with some regulators like the CMA showing a preference to block deals in favour of accepting remedies.

It is therefore crucial to conduct an antitrust, FDI and FSR risk analysis ahead of negotiating transaction agreements. This will put parties in a better position to consider risk allocation from the outset and inform them whether they may desire the inclusion of deal protections such as a ‘hell or high water’ clause (obliging the acquirer to proceed with the transaction regardless of obligations imposed in connection with regulatory approval), reverse termination fees, or springing conditions to cover off the risk of call-in under FSR, merger control (such as CMA and article 22), or FDI regimes (such as the UK NSI).

While the regulatory landscape is increasingly complex, prudent attention to these regulatory issues and a holistic and consistent approach across jurisdictions can minimise the negative timing and risk implications now present in cross-border transactions.

Matthew Yeowart is counsel and Andrzej O’Leary and Emma Walsh are associates at Davis Polk & Wardwell. Mr Yeowart can be contacted on +44 (0)20 7418 1049 or by email: matthew.yeowart@davispolk.com. Mr O’Leary can be contacted on +44 (0)20 7418 1042 or by email: andrzej.oleary@davispolk.com. Ms Walsh can be contacted on +44 (0)20 7418 1363 or by email: emma.walsh@davispolk.com.

Matthew Yeowart, Andrzej O’Leary and Emma Walsh

Davis Polk & Wardwell