Open for investment but not exploitation: UK foreign investment gets a v2.0 upgrade
We have previously written on whether the uptick in the UK Government’s (“Government”) intervention rate was symptomatic of the UK public interest regime being used as a means of extracting political commitments, rather than as a means of addressing genuine national security concerns (available here). We also noted that further Government reform to the regime was expected, albeit the timing was unclear.
On 21 June 2020, the Government announced reforms to strengthen its existing powers to intervene in mergers on public interest grounds under the Enterprise Act 2002 (“EA02”). The immediate changes introduce “The need to maintain in the United Kingdom the capability to combat, and to mitigate the effects of, public health emergencies” as a ground upon which the Secretary of State (“SoS”) can intervene as part of the existing merger control regime. Whether the new ground was required is debatable given the existing power of Government to intervene in deals raising “public security” concerns. Public health related concerns seem clearly within the purview of “public security”. This amendment was introduced under Covid-19 emergency legislation and takes effect from 23 June 2020.
The Government’s public health related reform is in line with comparable actions by a number of other countries worldwide to bolster their foreign investment controls in response to the Covid-19 pandemic. These include inter alia: Australia, Czech Republic, France, Germany, Hungary, India, Italy, Japan, New Zealand and Spain.
In addition, the Government announced changes to reduce the jurisdictional thresholds for three further technology sectors deemed central to national security, namely artificial intelligence, cryptographic authentication technology and advanced materials, which will be implemented once approved in Parliament; however as these are statutory instruments rather than primary pieces of legislation, debate on the second step is expected to be relatively limited (draft Statutory Instrument available here).
However, the second technology-focused aspect of the reforms reflect growing political unease over perceived national security risks posed by foreign ownership of sensitive areas of the UK economy – particularly sensitive technology sectors. These aspects of the reforms – which still need to be approved by Parliament – should be seen against a backdrop of increasing politicised interventions by the Government in recent years, most recently with the interventions in Cobham / Advent, Inmarsat / Connect Bidco and Gardner Aerospace / Impcross. Such concerns have also been demonstrated by the Government’s action to thwart an attempt by Canyon Bridge (backed by Chinese state-owned China Reform holdings) to obtain board control over UK semiconductor chipmaker Imagination Technologies, not to mention the renewed scrutiny over the involvement of Huawei in manufacturing components for Britain’s 5G networks.
These new powers are clearly a stop-gap measure, aimed at addressing the perceived risk that the Covid-19 pandemic may facilitate the “opportunistic” acquisition of UK businesses, as well as responding to the particular concern among Tory MPs about Chinese investment in the UK tech sector. As such, this is another case of the Government tinkering incrementally with the current regime, rather than implementing the long-awaited more radical reform. The Government has however reaffirmed its intention to introduce more comprehensive reforms in a forthcoming National Security and Investment Bill (“NSI Bill”).
The present national security regime
Unlike numerous other jurisdictions around the world, the UK does not currently have a standalone foreign investment regime. Specified public interest considerations (namely national security, financial stability and media plurality and, as of 23 June 2020, public health emergencies) can be considered through Government intervention as part of the wider merger regime. In such cases, the SoS can issue an intervention notice, but only where a transaction meets the jurisdictional thresholds under UK or EU merger rules (subject to limited exceptions).
Advocating for change: the Green Paper and the White 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). As a short-term measure to address “urgent” gaps in the Government’s powers, secondary legislation was introduced in 2018 to bring certain transactions involving certain small business businesses, which would not otherwise be caught, within the purview of the existing public interest regime. The UK target turnover threshold was lowered from £70 million to £1 million for transactions involving military and dual-use, multi-purpose computing hardware, and quantum technology sectors (see our Insights).
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 through a new standalone regime 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. It also envisaged reviewing many more transactions a year than are currently reviewed under the UK merger control regime.
With so much going on in since the White Paper was published in July 2018, with both Brexit and Covid-19, there has been no further public guidance or draft legislation on implementation, albeit the government has repeated its commitment to reform in this area. In the meantime, the general uptick seen in Government intervention in the last couple of years has continued.
The new reforms
The immediate reform which has come into force on 23 June 2020 adds public health emergencies as a specified public interest ground based on which the SoS can intervene. This is obviously motivated by the current Covid-19 pandemic, with Sharma explaining that “it is absolutely essential that now and in the future, we maintain our capacity to respond to public health emergencies such as Covid-19”. The amendments to the EA02 also mean the SoS will be able to impose necessary conditions in such cases. These reforms are in line with comparable actions by a number of other countries to bolster foreign investment controls in response to the Covid-19 pandemic, and Sharma indicated would cover those active in vaccine development, PPE production and, perhaps less proximate, those active in internet services and the food supply chain.
The second set of reforms proposed – which, unlike the public health amendment, will need to be approved by both Houses of Parliament before becoming law – are part of a broader trend which has been developing since before than the Covid-19 pandemic. The three specific areas which these new amendments seek to protect, namely artificial intelligence, cryptographic authentication technology and advanced materials, are described by Sharma as “critical to our national security”.
The reforms involve amending both the existing target turnover threshold and the share of supply tests for transactions in these three affected areas by:
- lowering the target UK turnover threshold from £70 million to £1 million per annum; and
- removing the current requirement for the transaction to create an increase in the share of supply of a service or product in the UK to at least 25 per cent, so that the test will be satisfied by acquiring an existing share of supply of 25 per cent (i.e. without any increment or overlap).
This follows a similar blueprint to the “emergency” measures introduced in June 2018, which likewise lowered the merger control thresholds to bring transactions involving smaller businesses in the military and dual-use, multi-purpose computing hardware, and quantum technology sectors.
These changes reflect a political unease which has been growing in the UK over the last few years around the perceived national security risks posed by foreign – and in particular Chinese – ownership of sensitive areas of the UK economy. Recent actions by the Government have demonstrated this ongoing suspicion, with the SoS intervention in Gardner Aerospace / Impcross, a transaction involving a Chinese-owned aerospace company (Gardner) seeking to acquire a British manufacturer of aerospace parts for the UK military. Despite the transaction being abandoned by Gardner following threats of a Phase 2 review on national security grounds, the SoS is still seeking undertakings (which are currently being consulted on) to ensure Gardner does not come back and try again.
Other recent interventions have also demonstrated that the Government is not afraid to use its powers for arguably political motivations, and to address concerns beyond acquisitions from “unfriendly” nations. Indeed, a number of recent PIIN cases involving acquisitions by North American private equity bidders (such as Cobham / Advent and Inmarsat / Connect Bidco) were primarily driven by considerations of national interest (i.e. protecting jobs and investment) rather than national security considerations per se. For example, in Cobham, there were clear concerns about the transaction impacting the country’s manufacturing base as much as there were national security concerns.
Sharma was however keen to emphasise, despite these arguably “protectionist” measures and this broader context, that the UK was still “open for investment” just “not for exploitation”.
Where does this leave us?
It is clear that the tech sector in particular remains high on the Government’s agenda, and deals involving UK tech companies involved in sensitive technology – such as AI and cryptography – can expect to be subject to ever increasing scrutiny. This is especially but not exclusively so for deals involving acquirers who might be seen as “hostile”, such as those with links to China. We also expect to see wider political concerns continue to be reflected in these interventions, making an already less predictable and evidence-based process (as compared to the standard merger control regime) potentially even more unwieldy.
Looking ahead, in addition to introducing these new powers, the Government has also reaffirmed its intention to introduce more comprehensive reforms in a NSI Bill. As such, we may yet still see the much anticipated broader reforms to the UK foreign investment regime, with the White Paper from July 2018 perhaps finally being brought to life in some form or other. However, given the current climate, this may have been kicked further into the long-grass, with the Government preferring instead to “plug” perceived “urgent gaps” in the existing regime for now.