National security or political insurance? UK Government intervention in M&A
There is concern amongst businesses and stakeholders that the merger regime rules allowing for government intervention on national security grounds are being increasingly used in a political context.
With the general election looming, change is inevitable. Against this background, we consider the perceived politicisation of national security reviews, and the background to reform proposals.
In the past five months there have been two Government interventions on national security grounds. This is a significant uptick: prior to 2019 there have only been 8 such interventions since 2003, when the current merger rules came into force – a rate of roughly 1 every 1-2 years.
As a result of the commitments obtained by the Government in relation to Melrose’s 2018 takeover of GKN, there is increasing concern that the national security regime is being used as a means of extracting political commitments, rather than as a means of addressing genuine national security concerns.
Indeed, both Labour and the Liberal Democrats have included commitments on broadening the public interest test in their general election manifestos. The Labour Party manifesto promises the introduction of “a broader ‘public interest test’ to prevent hostile takeovers and asset-stripping weakening our industrial base and destroying treasured home-grown companies.” The Conservative manifesto does not make a specific reference (in contrast to the 2017 manifesto). But senior government minister Michael Gove recently referenced the need for reform and a strengthening of the Investment Security Group (which coordinates cross-department policy to sensitive transactions).
The present national security regime
Unlike countries such as the U.S., Australia, Canada, Germany and France, the UK does not currently have a standalone foreign investment regime. National security (and other public interest considerations: financial stability and media plurality) can be considered as a result of Government intervention as part of the wider merger regime. In such cases, the Secretary of State will issue an intervention notice, governed by the Enterprise Act 2002 (EA02). The Secretary of State’s responsibility is discharged in a quasi-judicial capacity, and so regard must be had to statute and other public law duties, such as the principle of proportionality.
Advocating for change: the Green Paper
In 2017, the Department for Business, Energy & Industrial Strategy published a Green Paper setting out proposals to give the Government greater scope to intervene in takeovers that raise national security concerns (see our Insights).
The Green Paper concluded that foreign ownership of critical businesses and infrastructure comes with the risk of espionage, sabotage or the ability to exert inappropriate leverage. In addition, technological developments meant that Government powers needed updating. The review also highlighted that Government powers were limited in places.
As a short-term measure to address “urgent” gaps in the Government’s powers, secondary legislation was introduced in 2018 to bring transactions involving certain small businesses, which would not otherwise be caught, within the purview of the existing public interest regime. The turnover threshold was lowered from £70 million to £1 million for transactions in the military and dual-use, multi-purpose computing hardware, and quantum technology sectors (see our Insights).
In addition, the Government advocated for longer-term reforms, and the creation of a standalone national security regime, more in line with regimes in the U.S., Australia and Canada.
Addressing concerns: the White Paper
The Government’s White Paper, published in July 2018, proposed a sea-change in the review of deals from a national security perspective, with expansive powers to call transactions in for review. It proposed to cover a wider set of transactions, including minority shareholdings, “bare” assets, property (including property outside of the UK) and, in certain circumstances, loans.
The proposal arose because of concerns that the UK faces hostile activity from foreign intelligence agencies. This view had been reinforced by the 2015 national security risk assessment. In relation to M&A, the Government considered that foreign ownership could be used to disrupt processes or systems (for example, a so-called “kill switch” in the National Grid or transport systems). It could also be used to conduct espionage via access to sensitive information or technologies.
The White Paper, eye-catchingly, projects around 200 notifications a year, with 100 deals resulting in reviews and 50 in remedies, including prohibition. These numbers are in stark contrast to reviews under the UK merger regime – currently around 60 a year, with around 10 raising remedial issues.
In common with the approach under the U.S. CFIUS regime, and other foreign investment regimes, “national security” is not defined in the White Paper. However, the White Paper does emphasise that national security is separate and distinct from the national interest.
What has happened since?
Political turmoil since the White Paper was published in July 2018 has meant that there has been no further public guidance or draft legislation.
However, there is a pressing need for clarity, with advisers and companies attempting to apply the principles of the White Paper in the interim, given that its principles are already understood to be informing current enforcement priorities.
Intervention in practice
Under the EA02, there have been 17 public interest interventions in total, with a large number relating to media or newspaper mergers. There have been 10 interventions on national security grounds (including the recent Cobham review). No deal has ever been blocked on national security grounds; nor has an in-depth review been opened. The majority of decisions, 8 of the 9 taken, involved acquirers (largely of UK defence contracting businesses) giving undertakings. For example, to keep existing strategic capabilities within the UK, to protect sensitive technology and information, or to comply with governance requirements. The Cobham intervention is also likely to result in undertakings, with the Secretary of State currently consulting on proposed undertakings in relation to the acquisition, and being “minded to accept” them.
Despite the apparently immediate need for such rapid changes to its powers, the Government has intervened using its expanded capabilities, under the short-term reforms, on only a single occasion (in the acquisition by Gardner Aerospace of Northern Aerospace).
Political concessions on the rise?
The turning point in UK Government intervention in M&A on political grounds came with the Government’s approach to Melrose’s hostile acquisition of GKN in 2018. Melrose and GKN were UK businesses, both engaged in manufacturing. Calls for the Government to intervene came from a number of quarters, including the unions which sought assurances on job security and investment. It was unclear, however, what defence concerns could credibly arise, given that, for GKN, defence, as an activity, made up a relatively small part of GKN’s engineering business.
Ultimately, the Secretary of State did not formally intervene on national security grounds by issuing a PIIN. But it did obtain commitments from Melrose – none of which related to national security. These included to:
- maintain its UK listing
- maintain its UK headquarters
- ensure a majority of its directors are resident in the UK
- ensure the Aerospace and Driveline divisions retain the rights to the GKN name
- maintain GKN’s current level of R&D investment for the next five years
Similar themes can also be seen in some of the undertakings provided in Inmarsat, and being consulted on in Cobham, with both involving undertakings for at least 50% of their boards to be UK/British nationals, and for the Chairman to be a British national. These cases bring into question whether the insistence that “national security does not mean national interest” holds true.
Pending the outcome of the UK general election, it is unclear what will become of the Government’s White Paper. But, given the recent general election manifestos of both Labour and the Liberal Democrats, and very recent comments by a UK minister, it is clear that greater government intervention in M&A is inevitable. This is in line with a global trend of legislative reforms aimed at enabling greater government interventions following reforms to CFIUS in the U.S., and German legislation. Additionally, a proposal for the German Government to temporarily take stakes in tech companies, to prevent them from being sold to non-EU investors, was announced by Germany’s economy minister late last week.