UK Government consults on measures to protect national security in context of foreign investment

On 17 October 2017, the UK Government announced proposals to amend the UK merger control regime, aimed at improving protection of national security interests, including in the context of foreign investment.

Key points

The proposals are set out in a Green Paper entitled "National Security and Infrastructure Investment Review", and are split into two stages:

• "Short term" proposals: proposed amendments to the UK mergers regime lowering the jurisdictional thresholds for review of mergers in two sectors (the military and dual-use sector, and parts of the advanced technology sector); and

• "Long term" proposals: wider reforms intended to allow for better scrutiny of transactions that may raise national security concerns. This may include a wider "call-in" power to allow the Government to scrutinise a broader range of transactions on national security grounds, and/or a mandatory notification regime for foreign investment in certain parts of the economy which are considered critical for national security. This would include parts of the defence, civil nuclear, energy, communications and transport sectors.

Overview

The Green Paper emphasises that the Government wishes the UK to remain amongst the most open economies to foreign investment, and suggests that any steps taken will be restricted to what is necessary and proportionate. The Government states that that no part of the economy should be automatically off limits to foreign investment.

However, the Government considers that a better balance needs to be struck to ensure appropriate scrutiny of the potential national security impact of mergers, especially those involving investment from abroad. Particular areas of concern identified in the Green Paper are the risks that the ownership or control of critical businesses or infrastructure could provide opportunities to undertake espionage, sabotage, or exert inappropriate leverage.

If implemented, the long-term proposals in particular would significantly increase the scope for intervention by the Government in the UK merger control process. However, the short-term proposals are relatively modest in scope.

The Government's proposals are in addition to recent proposals put forward by the European Commission for an EU-wide foreign investment screening mechanism.

Short term proposals: Lowering merger thresholds in certain sectors

What is proposed?

The Government is concerned that there is an unacceptable risk that transactions falling outside the scope of the existing regime – in particular, those involving small innovative businesses which are not subject to the existing "special public interest" regime as defence contractors (see below) – could give rise to significant national security concerns.

The Government is therefore proposing to lower the existing jurisdictional thresholds of the Enterprise Act 2002 ("EA02") in respect of investment in businesses in two sectors:

• the military and dual use sector – this covers the design and production of military items (such as arms, military and paramilitary equipment) and so-called dual-use items which could have both military and civilian uses; and
• companies that are involved in the design of multi-purpose computing hardware or "quantum-based technology", including quantum computing and quantum communications techniques. Amongst other things, it is understood that the reference to multi-purpose computing hardware is intended to include computer chips, due to concerns that non-detectable "back doors" might be incorporated in them.

In these two sectors, the Secretary of State would be able to intervene (and potentially prohibit the merger) on national security grounds if either:

• the UK turnover of the target exceeds £1m (reduced from the normal £70m); or
• the target has an existing share of supply of particular goods or services in the UK of 25 per cent or more (this removes the requirement for an increase in market share above 25 per cent); or
• the merged entity will create or enhance a share of supply of particular goods or services in the UK of 25 per cent or more (i.e. the existing "share of supply test").

It should be noted that the wider intervention power is not premised on there being any foreign investment element: the powers would apply equally to UK acquirers.

Pending any wider reforms, the existing regime would continue to apply in all other sectors. Under the current regime, the Secretary of State can generally only intervene on national security grounds if the target has UK turnover of £70m or the transaction creates or increases a 25% share of supply.

However, the Secretary of State may also intervene on national security grounds under the existing "special public interest" regime where these thresholds are not met in cases involving certain government defence contractors in possession of classified information. The Secretary of State may also intervene on national security grounds in cases where the competition analysis is being conducted by the European Commission under the EU Merger Regulation ("EUMR"), rather than by the Competition and Markets Authority ("CMA") under EA02.

If the Secretary of State intervenes in a merger on public interest grounds, he or she assumes the role of final decision-maker in clearing or prohibiting the merger (although the CMA will remain involved in providing advice on any competition issues, and the European Commission remains the decision-maker on competition issues in cases falling under the EUMR).

What would the impact be for merging parties?

Whilst notification would remain voluntary even if the new thresholds were met (pending any introduction of a mandatory regime in certain areas - see below), the Secretary of State could choose to review the transaction even if it was not notified by the parties, and in practice parties may consider notifying in order to maintain greater control over the review timetable.

What happens next?

The consultation on the first set of proposed amendments to the EA02 closes on 14 November 2017.

Long term proposals: wider reforms to foreign investment control

What is proposed?

The Government is consulting on a range of wider longer-term proposals that are intended to make more substantive changes to the way in which the national security implications of foreign investment are scrutinised in the UK.

The Green Paper sets out various proposals which are under consideration: it is possible that only some of the proposals may ultimately be implemented.

Expanded voluntary regime with greater "call-in" powers

The Government has proposed introducing an expanded "call-in" power modelled on that contained in the existing EA02 which would allow it to scrutinise a broader range of transactions for national security concerns whilst maintaining a voluntary notification regime. As with the short-term proposals, this regime would apply to both foreign and domestic investors.

Under the proposals, the Secretary of State would be able to make a special "national security intervention" at any time within a three month "call-in" window following completion, where he/she reasonably believed that national security risks were raised by the acquisition of "significant influence or control" over any UK business entity by any investor. The Green Paper proposes that significant influence or control would cover:

• an acquisition of more than 25 per cent of a company's shares or votes; and
• "any other transaction that gives (directly or indirectly) significant influence or control". The Government indicates it would provide guidance as to what this second threshold might mean, suggesting it may draw on the existing guidance on the meaning of "significant influence or control" in the context of the Register of People with Significant Control under the Companies Act. Amongst other things, the Government says it wants to make sure it can assess transactions where an investor would obtain unrestricted access to sensitive sites or data.

The Government is also considering whether any such expanded call-in power should be extended to cover:

• new projects, in particular developments and other business activities that are not yet functioning enterprises but can reasonably be expected to, in the future, become businesses whose activities may have national security interests. An example would be a new-build nuclear power station which is not yet operational (the creation of which would not be caught by the existing EA02 regime); and/or
• sales of bare assets (for example machinery or intellectual property transferred without the other elements of a stand-alone business, which again, would not be caught by the existing EA02 regime).

If a transaction were "called-in" for review on the basis of national security concerns under this expanded power, the Secretary of State's review process would be separate from any competition review process (the detail of how the two processes would interact/run in parallel is unclear at this stage).

Mandatory notification regime for certain foreign investment

The Government is also considering introducing a mandatory notification regime for foreign investment into the provision of "essential functions" in key parts of the economy. This would cover parts of the civil nuclear, communications, defence, energy and transport sectors (and potentially emergency services and other government sectors).

Such a mandatory notification regime could potentially be extended to cover foreign investment in:

• new projects;
• specific businesses or assets (for example, businesses which supply critical services or goods to national infrastructure firms - the Government would envisage publishing a list of affected businesses and assets, except when publishing this information would give rise to clear national security threats or other public interest reasons not to do so); and/or
• plots of land in proximity to national security sensitive sites, for example, where there was a risk of espionage or sabotage.

The precise scope of any new mandatory regime remains a matter for further consideration by the Government, in light of responses to the Green Paper. However, the Government has proposed that it would only cover companies:

• which undertake, or are crucial to the undertaking of, "essential functions" which the Government views as critical to ensuring the national security of the UK;
• where foreign ownership or control could pose a national security risk which there are no other reasonable means of adequately mitigating; and
• where existing licensing or regulatory regimes are insufficient to provide the Government with the information and powers required to protect national security.

The starting point suggested in the Green Paper is to include specific activities within the following sectors: civil nuclear, defence, energy, communications and transport, as well as businesses involved in the manufacture of military and dual-use items and advanced technology (defined in line with the short term proposals outlined above), and possibly the government and emergency services sectors.

Within these sectors, the Government is proposing that a mandatory notification regime would only apply in certain parts of each sector, namely those where the Government considers national security risks are most pronounced.

Annex C to the Green Paper sets out what these would be for the sectors identified by the Government. The identified activities are quite broad in both the energy and communications sectors, for example, and apparently include (amongst others) all energy network companies (including interconnectors as well as transmission and distribution companies), large scale power generation, large energy suppliers, providers of infrastructure for voice and data networks with more than one million end users (this would cover all the major UK broadband and mobile operators) and any operator of a submarine cable. Proposed coverage in the transport sector would be less broad, comprising statutory harbour authorities, airports classified as dominant (Heathrow and Gatwick) and the provision of en route air traffic control services.

The same threshold of "significant influence or control" would apply as in the potential wider call-in power considered above.

Failure to comply with any new mandatory notification regime would be punishable by sanctions, which could potentially include criminal offences, financial penalties and/or director disqualification.

If the Government decides to introduce a mandatory notification regime, it seems likely that the Government envisages a wider call-in power operating alongside it, which would not be limited to the specified essential functions.

Any package of wider reforms would also be accompanied by additional powers to request information from companies that come within the regime's scope. The Green Paper does not provide any further details on how this might operate in practice, or what sanctions might be imposed for non-compliance/provision of incomplete or misleading information.

In terms of the powers available to the Secretary of State following his/her assessment of the national security implications of a transaction, it is proposed that he/she would have the same powers as under the existing public interest mergers regime – in other words, he/she could clear the deal unconditionally, impose conditions, or prohibit the deal altogether. Given the Government envisages a "clear separation" between the national security assessment and any competition assessment conducted by the CMA, unlike the current public interest regime, it seems a detailed Phase 2 investigation by the CMA would not be required prior to any prohibition decision. In cases where a deal had completed prior to the national security assessment (in the context of a voluntary notification regime), the Secretary of State could potentially "unwind" a deal if this were considered to be necessary and proportionate to protect national security.

The Government envisages a "clear, short timeframe" for review, but no further detail is provided.

Affected parties would be able to seek judicial review of the Secretary of State's decision through the courts, although it is unclear if limits would be set on the scope of such reviews.

How is this different from the existing regime?

Particularly if the mandatory notification regime is introduced, this would involve a very significant change from the current position. Under EA02, the Government has only intervened in seven transactions on national security grounds in almost 15 years. The Green Paper estimates that a mandatory regime covering the identified essential functions would involve "fewer than 100" transactions per year. This would be a very different world from the current "voluntary" regime, where merging parties may choose not to notify and complete a deal without first obtaining a formal merger clearance from the CMA. 

As noted above, investments in new projects are not currently covered by the EA02 merger control regime, nor are the transfer of "bare assets", specific businesses, or land.

What would the impact be for merging parties?

The Green Paper expressly recognises that an expanded call-in power within a continued voluntary notification regime would increase uncertainty for businesses and would remove the "safe harbours" currently provided by the jurisdictional thresholds in the EA02. It emphasises that the Government intends that it would only use the new powers in a small number of cases, and that it could provide informal advice to businesses about whether it has national security concerns about particular proposed investments (notably, no such comment is made regarding the mandatory regime).

Any mandatory notification regime would clearly impose an increased burden on foreign investors into affected businesses, and would be likely to catch a significant number of transactions which met the notification thresholds but did not, in practice, raise any significant national security concerns. Whilst the Government has indicated that it would seek to grant rapid approval in such cases, in practice this would no doubt have an impact on deal timetables and create additional work for the parties and their advisers.

Increased involvement of politicians in merger control (whether by means of an expanded call-in power or a mandatory notification regime, or both) is also likely to increase uncertainty and, depending on how the system works, may also give rise to question marks over transparency. Businesses will certainly be keen that the intended scope of any new regime is very clear, including the circumstances in which the Government would consider intervening in a "call-in" regime, and the circumstances in which the Government would ultimately have concerns, such that conditions may be imposed, or deals prohibited.

What happens next?

The consultation on the wider reforms package closes on 9 January 2018. The Government would then issue a White Paper before proposing any specific legislation. As a result, the new regime is unlikely to be introduced until late 2018 at the earliest.