This briefing outlines ten key features of the UK proposals which infrastructure operators and investors need to know. We then provide a more detailed analysis of the new regime and its potential impact on investments and other transactions in the UK infrastructure sector.
The new regime is not expected to be introduced until 2020. However, when implemented, the reforms will establish a comprehensive framework to scrutinise deals raising national security concerns, and will replace the current (limited) regime (including short-term reforms to the UK’s national security investment regime, which reduced merger control thresholds for deals in three specific sectors, and came into force in June 2018).
The White Paper proposals also coincide with steps being taken by the European Commission and a number of European Member States to strengthen their powers to screen foreign direct investment and/or other transactions which may raise national security concerns. Rounding out the focus on foreign investment, the US CFIUS regime was also reformed on 13 August 2018 (see our coverage of these changes here).
Ten things infrastructure stakeholders should know about the proposals
The proposed new regime is estimated to affect up to 200 transactions annually and:
- Will apply to a wide range of “trigger events”, including acquisitions of:
- more than 25% of shares or votes in an entity,
- more than 50% of an asset, or
- “significant influence or control” over an entity or an asset.
- Will have to be taken into account in the context of:
- traditional M&A activity,
- debt and equity investments (including minority investments) in both brownfield and greenfield transactions, and
- asset acquisitions, including acquisitions of real estate assets.
- May apply to acquisitions of assets or entities outside the UK where those assets/entities carry on (or are used in connection with) activities in the UK.
- Covers all economic sectors, but is likely to focus on the following “Core Areas”:
- Critical infrastructure – i.e. civil nuclear, communications, defence, energy, and transport sectors;
- Certain advanced technology sectors – i.e., advanced materials and manufacturing science, AI and machine learning, autonomous robotic systems, computing hardware, cryptographic technology, nanotechnologies, networking and data communication, quantum technology and synthetic biology;
- Critical direct suppliers to Government and emergency services sectors; and
- Military and dual-use technologies.
- Is not limited to foreign investors and could apply to any acquirer. The White Paper highlights three tiers of “acquirer risk” in descending order:
- hostile foreign states/actors,
- foreign-controlled acquirers and
- UK-controlled acquirers.
- Will introduce a formal review process which is subject to time limits, clear legal tests and judicial oversight.
- Will not be a mandatory filing. However, the Government will be able to intervene in non-notified deals up to six months from the trigger event taking place.
- Could affect deal timing, certainty and conditionality – especially in competitive auctions.
- Could ultimately lead to deals being blocked or unwound if there is an irreconcilable national security concern.
- Is expected to come into force in 2020 at the earliest. There is currently an open consultation on the White Paper, which is open until 16 October 2018.
What is the current regime and why are wholesale reforms being proposed?
Under the current regime, the Government can only intervene in deals on national security or public interest grounds for deals which trigger the EU or UK merger control thresholds*.The Government does not consider this regime is adequate given national security developments.
As an interim fix, on 11 June 2018, the Government introduced temporary changes to the UK merger control thresholds for a limited number of sectors, thereby allowing it to intervene in a broader range of deals on national security grounds.
Where the target supplies: (a) military and dual (military and civilian) use goods; (b) computing hardware; or (c) quantum technologies, the Government can now intervene on national security grounds provided that two or more enterprises cease to be distinct and:
(a) the target generated turnover in the UK in its last financial year of over £1 million (a significant lowering of the £70 million target turnover threshold for other sectors); and/or
(i) the target supplies or acquires 25% or more of particular goods or services in one of the three sectors above in the UK or a substantial part of it (note that, unlike for other sectors, this does not require an overlap in the parties’ activities); or
(ii) the target and the purchaser(s) both supply or acquire the same particular goods or services (in any sector) and together supply or acquire 25% or more of them in the UK or a substantial part of it.
There is limited guidance on the circumstances in which the Government will seek to intervene in a deal using these interim powers, or the existing powers for other sectors.
However, the White Paper proposals may provide ‘soft guidance’ for the types of transaction that may attract particular scrutiny, including the sectors and types of acquirer in which the Government is likely to be particularly interested.
* A narrow exception exists for deals involving (a) government contractors who hold or receive confidential defence-related information or (b) certain newspaper and broadcasting businesses, in which the Government can intervene on public interest grounds regardless of whether they satisfy the EU or UK merger control thresholds.
What transactions would be caught by the new regime?
A transaction will be caught by the new regime where it involves a so-called “trigger event”, i.e., the acquisition of:
- more than 25% of shares or votes in an entity;
- significant influence or control (or the right to exercise significant influence or control) over an entity. This test will be satisfied where the acquirer has a less than 25% of the shares or voted in an entity, but can direct its activities or ensure that the entity generally adopts the activities which it desires;
- further significant influence or control over an entity beyond the above thresholds;
- more than 50% of an asset; or
- significant influence or control (or the right to exercise significant influence or control) over an asset. This test will be satisfied where the acquirer does not own more than 50% of the asset, but has absolute decision rights over its operation or can ensure that the asset is being operated in the way it desires. This would result in it being able to use, sell, alter, destroy or manipulate the asset in a manner contrary to the UK’s national security.
A draft Statutory Statement of Policy Intent (the “Policy Statement”) published alongside the White Paper provides an indicative and non-exhaustive list of examples of what might constitute a trigger event. The potential scope is wide, covering traditional M&A (including minority investments), asset acquisitions, and even some debt investments.
For those active in the UK infrastructure sector, particularly notable is the fact that:
- a trigger event may occur in relation to assets or entities outside the UK where those assets/entities carry on (or are used in connection with) activities in the UK;
- assets covered by the test include intellectual property rights, real estate assets and contractual rights;
- in certain circumstances, the right to appoint or remove one Board member of an entity may be a trigger event;
- a lender or bondholder may, in some cases, exercise significant influence or control over a borrower as a result of a debt investment; and
- no “safe-harbour” for investments below a certain threshold is currently proposed.
When will the UK Government intervene in a transaction?
Notification of trigger events will be voluntary. However, the appropriate Senior Minister (i.e. a Cabinet-level minister) will have the power to ‘call in’ a transaction for review if a “trigger event” has occurred, and if the Minister has:
- reasonable grounds for suspecting that it is, or may be, the case that a trigger event has occurred or is in progress or contemplation; and
- a reasonable suspicion that the trigger event may give rise to a risk to national security due to the nature of the activities of the entity, or the nature of the asset to which the trigger event relates.
The Policy Statement outlines the three risk factors the Senior Minister will take into account when determining whether to use the call-in power:
- the target risk – the risk that the entity or asset subject to the trigger event could be used to undermine the UK’s national security. Entities or assets within the “Core Areas” described above are most likely to attract scrutiny. The target does not have to be UK-based for the deal to be caught – for example, it could apply to the acquisition of an undersea cable which serves UK energy supply or a non-UK business which delivers critical services to major UK airports. The Government expects that asset acquisitions will rarely be called in;
- the trigger event risk – the risk that the trigger event may give the acquirer the means or ability to undermine the UK’s national security through disruption, espionage, inappropriate leverage or some other means. For example, acquiring a board position could be a trigger event risk if that gives the acquirer the ability to influence the affairs of the target; and
- the acquirer risk – the risk that the acquirer may seek to use their acquisition of control over the entity or asset to undermine national security. The Policy Statement states that national security risks are most likely to arise from acquirers who are hostile to the UK’s national security. Foreign nationality may make it comparatively more likely that an acquirer poses a risk but threats may also emerge from UK-based or British acquirers. In complex transaction structures, the question of who ultimately controls an acquirer is likely to be key.
How will the review process and timetable work?
The White Paper proposes that the prescribed period in which the Senior Minister can exercise its ‘call-in’ power is six months from the trigger event having taken place.
Parties will be encouraged to engage in dialogue with the Government at an early stage, in order to decide whether to notify, and identify any substantive issues. While the White Paper is not specific on this issue, the Government is conscious of the risk of ‘chilling’ investment in the context of competitive auction bids, and so will be available to speak to bidders about any national security issues at an early (potentially pre-bid) stage.
It is not yet clear whether such discussions could provide sufficient comfort regarding the likelihood of a particular transaction being called in or ultimately raising concerns which may need to be remedied, but this is something that White Paper responses are likely to cover.
Notifications about a potential trigger event will be by way of a template form. The form and related guidance will be published in due course. Given the likelihood of consortia bids in many cases, and given the sensitivity of the information and targets involved, parties will need to take steps to minimise the risk of inappropriate disclosure of sensitive information to consortium partners (and potential competitors). This may be dealt with by separate notifications or, more practically, by careful management of confidentiality via the adviser who is preparing any notification on behalf of investors.
Once the Government receives a valid notification, the White Paper proposes that it should have 15 working days to carry out a preliminary review and inform the parties if it will be calling in the trigger event. This period will be extendable by a further 15 working days if the Government requires further time to consider specific potential risks the trigger event may pose to national security. The Government estimates that it will call in around half of the 200 notifications it expects to receive each year.
Where the Government decides to call in a trigger event, this will be made public. If the Government decides not to call in a notified trigger event, then the transaction may proceed.
Where a transaction is called in, the White Paper proposes the Government has a period of up to 30 working days, potentially extendable by a further 45 working days, to complete its assessment of the national security risks. During this time, the parties will not be allowed to complete the transaction (if they have not already done so). The Government also proposes that it will have the power to impose interim restrictions to mitigate the risk to national security pending the outcome of the investigation.
What remedies will the Government be able to impose?
Where the Government concludes that a trigger event does raise national security concerns, it will have the power to impose conditions on the transaction or prohibit it outright. If the transaction has already been put into effect, it will have the power to order for it to be unwound. The Government’s initial analysis indicates that around half of those trigger events called in for a full national security assessment are likely to require remedies.
Any remedy will have to be necessary and proportionate, the most suitable way of dealing with the issue and follow consideration of representations made by the affected parties. The White Paper includes an indicative but non-exhaustive list of the type of conditions available to the Senior Minister, which it proposes be included in the proposed legislation. This list includes both behavioural and structural (e.g. divestment) remedies.
Government decisions under the new regime will be subject to challenge by way of judicial review in the High Court.
Sanctions for non-compliance
The White Paper proposes the following sanctions are available for breaches of the regime:
- Custodial sentences of up to five years for most offences (including breach of conditions imposed on, or failure to unwind, a transaction);
- Civil financial penalties of up to 10% of a business’s worldwide turnover or, for an individual, up to 10% of their total income or £500,000, whichever is higher, for breaches other than those related to failure to provide information; and/or
- Director Disqualification Orders for up to 15 years.
The regime is unlikely to be introduced for at least 18 months. The White Paper consultation is open for comment until 16 October 2018.
If you would like to discuss the proposals and how they may affect your business, or would like to provide input into our response to the White Paper consultation, please get in touch.