On 17 October 2017 the UK Government released a Green Paper entitled "National Security and Infrastructure Investment Review", asking for comments on proposed new structures for reviewing foreign investments (available here).
The proposals would result in a radical change in the UK investment environment and could subject a broad range of transactions to potentially onerous and lengthy reviews.
In the short term, there are significant proposals allowing for increased review of transactions in the dual-use / military and technology sectors.
For the longer term, the government is consulting on broader reforms including proposed mandatory approval requirements for foreign investments in a number of sectors (including civil nuclear, communications, defence, energy, and transport, amongst others).
These UK proposals follow a growing global trend towards foreign investment review, including recent proposals for a new EU framework for screening foreign investment, and increased intervention around foreign investments in Germany (see here for our recent alert on this). The Green Paper also includes a useful summary of the current approaches to foreign investment review taken by the US, Canada, Australia and France.
The Green Paper, issued by the UK Department for Business, Energy & Industrial Strategy, poses 30 questions and asks for comments. The time limits for response are short, being 14th November 2017 for the short-term proposals and 9th January 2017 for the long-term proposals.
The UK Export Control Organisation issued a simultaneous notice to UK exporters (available here) welcoming comments on the proposals, given the potentially significant impact on the broad range of UK businesses which deal with items subject to dual-use or military export controls.
The consultation questions are set out at section 9 of the Green Paper, with a helpful table at Annex C setting out how the longer term mandatory notification proposals could be applied to "essential functions" within various sectors. Responses should be submitted via the Citizen Space website: https://beisgovuk.citizenspace.com/ccp/nsiireview/.
Given the potential impact of these proposals across a wide range of sectors, and the many questions and issues open for debate, businesses are advised to review the proposals and consider responding to the consultation by the relevant deadlines. Baker McKenzie's combined team of leading UK and EU trade and competition law experts are uniquely placed to assist companies on this.
Summary of key proposals
Under the short term proposals:
- The Government proposes to lower the jurisdictional threshold for UK merger review from £70 million to £1 million, and amend the current 25% share of supply test, better allowing the Government's review of investments in "(i) the dual-use and military use sector, (ii) parts of the advanced technology sector".
- In particular, this is aimed at broadening the scope of review for transactions beyond defence contractors to capture "enterprises that design or manufacture items or hold related software and technology specified on the UK Military List, UK Dual-Use List, UK Radioactive Source List and EU Dual-Use Lists (i.e. not just those enterprises that currently export these)". Given the breadth of these controls, this could impact a wide range of businesses.
- Review of foreign investments in the technology sector would relate to those enterprises which design, develop, own, create IP etc. related to "multi-purpose computing hardware" or "quantum-based technology", again broadly defined.
The longer term proposals include the following:
- An expanded version of the "call-in power" within the voluntary merger notification regime, to allow the Government to scrutinise any transaction where it reasonably believes that national security risks are raised; and/or
- A mandatory notification regime for foreign investment into:
- a focused set of "essential functions" in key parts of the economy (such as in the civil nuclear, defence, communications, energy and transport sectors);
- new projects that could reasonably be expected to provide essential functions; and/or
- specific businesses or assets, potentially capturing businesses which supply critical services or goods to national infrastructure firms.
The proposals focus on transactions which are currently classified as mergers or acquisitions falling within the jurisdiction of the Enterprise Act 2002, and do not appear to affect national security mechanisms found in other UK statutes.
The Green Paper states its objective to be to balance the current open UK market for investment against a need for new tools to limit problematic behaviour. The Executive Summary states:
"Britain's rightly-praised openness to foreign investment also needs to be accompanied by appropriate scrutiny of the potential national security impacts of deals [. . .]. The vast majority of investment into the UK's economy raises no national security concerns. However, we need to be alert to the risk that having ownership or control of critical businesses or infrastructure could provide opportunities to undertake espionage, sabotage or exert inappropriate leverage. This is an issue already recognised by other developed and open countries in their equivalent regimes."
Following a review of the stock of national security measures that could be used to examine investments, the Green Paper concludes that UK powers appear:
"inconsistent – in some sectors, this means that the Government can rely only upon emergency or 'backstop' powers; and
may be too reliant on voluntary powers – given the national security threats [outlined] , it may be insufficient to rely on business voluntarily notifying potential transactions involving foreign actors taking significant influence or control over key parts of our critical national infrastructure; and
potentially uncertain for businesses – by solely relying on voluntary or 'call in powers', businesses cannot be certain in which transactions Government may, or may not, have national security interests."
The Green Paper then concludes that some form of amendment is necessary, but that "All reforms that the Government makes in this area will only be the necessary and proportionate steps to protect national security." It then sets out two broad proposals based on short term and long-term measures.
As to the short-term measures, the Green Paper proposes that the jurisdictional thresholds found in the Enterprise Act 2002 are amended by secondary legislation to allow the Government to review investments in "(i) the dual-use and military use sector, (ii) parts of the advanced technology sector". The suggested amendment would (i) lower the turnover threshold from £70 million to £1 million and (ii) remove the current requirement for the merger to increase the share of supply to or over 25%.
As to the long-term measures, the Green Paper notes that the objective is to bring the UK into line with many other developed economies in implementing an investment review process that can focus on national security issues. The main proposals are:
"an expanded version of the 'call-in power', modelled on the existing power within the Enterprise Act 2002, to allow Government to scrutinise a broader range of transactions for national security concerns within a voluntary notification regime and/or;
a mandatory notification regime for foreign investment into the provision of a focused set of 'essential functions' in key parts of the economy. Mandatory notification could also be required for new projects that could reasonably be expected in future to provide essential functions and/or foreign investment in specific businesses or assets."
Looking at these two proposals in more detail, as to the short-term proposal, the Green Paper notes that under the Enterprise Act's special public interest regime, HMG can intervene in relevant mergers of defence contractors which fall below that Act's jurisdictional thresholds. However, "not all businesses that design or produce military items are defence contractors or hold confidential defence material, so they are not subject to the special public interest regime. As well as military and defence businesses, there are also businesses that design or produce items, or have technical expertise relating to activity or items, which are primarily for civilian uses but could also have military applications." This is a reference to so-called "dual-use" items (goods, software and technology) which are controlled on export from the EU under Regulation 428/2009, implemented in the UK through the Export Control Order 2008. The Green Paper notes that these "dual-use" items may raise national security implications even though they do not trigger the market share or turnover threshold in the Enterprise Act, and so "the Government therefore proposes that enterprises that design or manufacture items or hold related software and technology specified on the UK Military List, UK Dual-Use List, UK Radioactive Source List and EU Dual-Use Lists (i.e. not just those enterprises that currently export these) would be in scope of the amended thresholds."
The Government believes that "the well-established nature of the Strategic Export Control Lists (which have existed in something like their present form since the 1990s) will ensure businesses are aware whether they are in scope of the amended thresholds."
In addition to these military and dual-use items, the Green Paper would extend the national security review to:
- "Multi-purpose computing hardware" provisionally defined as being produced by "Enterprises that: (i) own or create intellectual property rights in the functional capability of multi-purpose computing hardware; or (ii) design, maintain or support the secure provisioning or management of roots of trust of multi-purpose computing hardware"; and
- "Quantum-based technology" provisionally defined as being produced by "Enterprises that research, develop, design or manufacture goods for use in, or supply services based on, quantum computing or quantum communications technologies. This would include the creation of relevant intellectual property or components."
In relation to these sectors, the Enterprise Act would be amended to:
a) Reduce the GBP70 million turnover threshold to GBP 1 million; and
b) Amend the "share of supply" test to apply to any situation where items in the combined undertaking have a share of supply of 25% or more, but specifically not requiring the transaction to result in any increment. Currently the Enterprise Act would only apply to a situation where the transaction resulted in an increase in the share of supply to or in excess of 25%. This would capture transaction where the acquirer is not currently operating in the relevant market in the UK.
As to the possible process by which the review would be undertaken in the short-term, the Green Paper states:
"The Government has established a cross-Government forum to bring together relevant departments and agencies to consider the implications of foreign investment for national security and ensure that Ministers are provided with timely advice on such investment, as required. Chaired by the Deputy National Security Adviser, the Investment Security Group ensures that the Government takes a joined-up and co-ordinated approach to scrutinising transactions for national security concerns."
The long-term proposal is more complicated, and it is not clear as to whether the proposals for the long-term process would be a replacement for, or in addition to the short-term process.
The proposals are:
"• an expanded version of the 'call-in power', modelled on the existing power within the Enterprise Act 2002 to allow Government to scrutinise a broader range of transactions for national security concerns within a voluntary notification regime, including potentially new projects or assets;
• a mandatory notification regime for foreign investment into the provision of a focused set of 'essential functions' in key parts of the economy, for example the civil nuclear and defence sectors. Mandatory notification could also be required for new projects that could reasonably be expected in future to provide essential functions and/or foreign investment in specific businesses or assets."
The Green Paper states that the two approaches might be mutually exclusive, or combined.
As to the new "call in power", the Green Paper notes that there are advantages to having a voluntary system into which the Government can intervene where relevant. The new "call in power" would allow the Government to review any transaction where it reasonably believed that national security risks were raised by the acquisition of significant influence or control over any UK business entity by any investor (either domestic or foreign). "Significant influence or control" would be acquisition of at least 25% of a company's shares or votes, supplemented by a second limb allowing review of "any other transaction that gives (directly or indirectly) significant influence or control over that company or over its assets or businesses in the UK."
Finally, the Green Paper envisages two further "backstop" extensions of the "call in power", these being:
"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"
"sales of bare assets (i.e. assets such as machinery or intellectual property transferred without the other elements of a stand-alone business). This would be a significant extension of the Government's current powers but would ensure that Government had comprehensive backstop powers to prevent national security risks arising from ownership and control from being realised."
As to process "The Government envisages that this would be a separate process from the existing competition process, given its sole focus on national security"
As to the proposed "mandatory powers", the Green Paper proposes that:
"all foreign investors in specified sectors would need to secure the Government's approval before the transaction could take legal effect, and would therefore be required to provide information on the investment to be reviewed within an agreed timeframe. It is expected that for the majority of transactions, the Government would give rapid approval."
The Green Paper states that the new mandatory measures would be "proportionate" for certain critical infrastructure sectors including, "as a minimum, civil nuclear, defence, energy, telecommunications, and the transport sector". However, the impact of the new regime would be limited to "essential functions" in these sectors, which are set out in Annex C of the Green Paper. The Green Paper also lists other critical infrastructure sectors where, at the moment, it does not believe mandatory notifications would be proportionate.
The Government also intends to extend mandatory to the sectors established in the short-term amendments i.e. the manufacture of military and dual-use items and advanced technology, but these do not appear to be limited to "essential functions".
Further, the Green Paper notes that:
"There may also be a case for certain individual businesses or assets to be included in the scope of the mandatory notification regime, even though the wider sector that they operate in is not in scope (i.e., no "essential functions" have been defined). Such a power may be particularly useful in the case of businesses which supply critical services or goods to national infrastructure firms – by specifying individual businesses as subject to mandatory screening rather than an entire supply chain, the Government can ensure the tightest possible focus for its regime while still giving certainty about where its national security interests lie."
In the interests of transparency, these individual entities would be named at the time of the extension of the power to them, unless to do so would itself create a national security risk.
Again, as to mandatory process, the Green Paper notes: "The powers within the regime would only be exercised where necessary and proportionate. Under a mandatory regime, it would be likely that the vast majority of proposed transactions notified would proceed as planned. The Government recognises that investors and businesses will wish to be clear about the process it will follow and the timing of the scrutiny procedure. The Government would aim to set out a clear, short timeframe within which investors would receive a decision."
The Green Paper also proposes new information-gathering and penalty powers.
Issues for debate
The Green Paper as well as including 30 questions that the Government are seeking comment on, raises many key issues including:
- On the short term proposals:
- The extent to which companies know they are dealing in dual-use items and will be subject to the short term controls, given the length, complexity and breadth of UK and EU military and dual-use controls; in particular, unless companies export such items outside the EU, they would ordinarily have no need to engage with the EU/UK dual-use export rules.
- Likewise, the extent to which those engaging in "multi-purpose computing hardware" or "quantum-based technology" will be aware that transactions relating to these items could be subject to review, given the breadth of these terms.
- Based on the current proposals, there will need to be significant outreach to these sectors.
- On the longer term proposals:
- Clarity on the precise processes that will be followed in relation to the proposed "call-in powers" and mandatory notification requirements.
- Given the sensitive nature of the review, the controls could add lengthy delays to some transactions.
- There are also significant questions as to which agencies will implement the controls and how they will be resourced. Given the sensitive nature of these new procedures, it may be that the CMA is not the most appropriate agency to undertake the reviews, and would need to draw on the Export Control Organisation and other agencies.