Global foreign investment flows have bounced back over the past two years, and now exceed pre-pandemic levels. On cross border transactions, governments continue to demonstrate their increasing appetite to monitor foreign investment, as seen in the increasing number of transactions subject to regulatory approvals prior to completion. While some of the most onerous restrictions imposed as a result of the COVID-19 pandemic in jurisdictions such as Australia and New Zealand have been relaxed, there is still a global trend towards increased intervention stemming in large part from the current geopolitical context.
In addition to 2022 being the first year of operation of the UK's new national security regime under the National Security and Investment Act 2021 (NSI Act), we are also seeing an increasing number, and scope, of FDI regimes applicable and enforced across the EU and globally. A new EU Foreign Subsidies Regulation (FSR) came into force at the beginning of 2023, operating essentially as another form of foreign investment screening. Under the FSR some M&A activity, if it involves target businesses with activities in Europe, may need to be notified to the European Commission for clearance prior to completion. This will be the case if certain financial thresholds are met, including a minimum level of financial contribution received by the acquiror from non-EU state entities. The mandatory (and suspensory) notification regime for M&A deals will take effect from 12 October 2023. However, the European Commission will have powers to investigate deals on its own initiative from 12 July 2023.
Foreign direct investment update
The global trend towards increased government intervention in M&A transactions involving overseas investors is continuing. Governments across the world are increasing the scope of their monitoring of foreign investments in target businesses which either sit within, or have significant operations in, their jurisdiction. In 2022 we saw nearly a quarter of transactions subject to approval from a foreign investment decision making body, including in the UK under the NSI Act.
CFIUS in the United States and FIRB in Australia will be familiar hurdles to most. For the private equity industry in particular, sponsors with sovereign wealth investors can face more onerous FDI requirements (for example under the Australian system). Although, at the UK level, the Secretary of State has said that it does not regard state-owned entities, sovereign wealth funds or other entities affiliated with foreign states, as being inherently more likely to pose a national security risk.
At the EU level, the European Commission has actively encouraged individual Member States to introduce, or expand, their national FDI regimes. By the end of 2021, 25 out of 27 EU Members States either had a national FDI screening mechanism in place, or had initiated a process expected to result in the adoption of one. This includes the adoption of new national screening mechanisms in the Czech Republic, Denmark and Slovakia. We have also seen existing regimes amended to widen their scope (for example, in France, lowering the thresholds at which investments of non-EU investors are screened and, in Germany, widening the scope of applicable sectors). The EU has also introduced a new notification regime aimed at combatting the effect of potentially distortive subsidies granted by third countries to companies operating in the EU (the Foreign Subsidies Regulation, or FSR). Amongst other matters, the FSR includes a mandatory notification regime for M&A activity meeting certain financial thresholds, including a minimum level of foreign contribution received from third countries. Financial contributions may, for example, include investment from a government aligned pension provider or sovereign wealth fund. The notification requirement (and standstill obligation) for M&A deals meeting the FSR thresholds will apply from 12 October 2023. However, the European Commission's powers to investigate deals on its own initiative will apply earlier, from 12 July 2023.
FDI filing requirements are now routinely assessed, similarly to merger control, on all potential cross-border transactions (and even some domestic transactions in the UK). However, in most cases, FDI screening remains a procedural rather than a substantive challenge on transactions, but the potential civil and sometimes even criminal penalties for non-compliance mean that this will inevitably remain a key focus at the early stages of transactions.
The UK National Security & Investment Act
On cross border transactions, governments continue to demonstrate their increasing appetite to monitor foreign investment, as seen in the increasing number of transactions subject to regulatory approvals prior to completion. Indeed perhaps one of the biggest shake-ups of the UK's regulatory landscape in recent years has been the introduction of the UK's new National Security and Investment Act, which came fully into force in January 2022.
The National Security & Investment Act
The UK NSI Act is now one full year into its operation, having introduced a hybrid mandatory and voluntary regime to strengthen the UK government's powers to scrutinise and intervene in transactions on grounds of national security. Unlike foreign direct investment regimes in other jurisdictions, the UK regime does not include any requirement for the acquirer to be a foreign person and instead the mandatory regime focuses on the sector in which the target business operates.
Relevant transactions which fall within any of seventeen mandatory sectors, including data infrastructure, energy, and suppliers to the emergency services, need to be notified and cleared in advance of completion. A mandatory notification can be triggered both by a majority acquisition and by any other transaction (including any restructuring transaction) where a party increases its stake through any of the 25%, 50% and 75% ownership thresholds.
Acquisitions of entities active in any other sectors or acquisitions of qualifying assets, which give rise to UK national security concerns, may be called in for review by the Secretary of State (acting through the Investment Security Unit (ISU)) or voluntarily notified by the parties. As announced on 8 February 2023, the ISU has relocated from the Department for Business, Energy and Industrial Strategy (BEIS) to the Cabinet Office. The current Secretary of State in the Cabinet Office is Oliver Dowden, who will be the primary decision maker on matters of UK national security including NSI notifications.
According to the UK government’s inaugural report on the operation of the NSI Act (covering the first three months of the regime), 222 notifications were received between January and March 2022, across the whole range of sectors. This number was close to the government's expectation of between 1,000 and 1,830 notifications a year. In our experience, given in particular that failure to make a mandatory notification results in a transaction being void, parties are aligned in taking a cautious approach to the question of notification and therefore notifications across the first full year of the regime are likely to have remained at a similar level.
Where UK national security concerns arise, the first year of the NSI Act demonstrates the government’s appetite to take strong action. To date there have been 15 deal interventions. The prohibition of transactions, at least in the case of acquirors linked to politically sensitive states and sectors that are key to the UK’s national security, are happening and can be expected to continue. However, the UK government has also demonstrated a pragmatic stance when considering the appropriateness of remedies packages, even where politically sensitive states are involved. The government’s action also reflects the focus of the NSI Act on the activities of the target, rather than purely the nationality of the investor. UK-based investors and acquirors based in politically friendly nations have faced in-depth probes into their deals, in some cases resulting in remedies.
Four out of the five deal prohibitions to date have related to acquirors with Chinese links and transactions that either pose risks to the UK defence sector (in two cases) or to the UK's semiconductor industry (in two cases), each raising defence concerns of some kind. In the fifth case, the deal prohibition related to a Russian-backed fund acquisition in the UK broadband sector. It is only a matter of time before the scope of sectors in which action is taken broadens. Indeed, clearances subject to remedies have now been seen in the emergency services, energy, satellite communications, critical national infrastructure (specifically for quantum timing and atomic clocks), aerospace, defence (specifically where the deal involved the acquisition of an industrial gearbox manufacturer), and mobile telecoms spheres. A broad range of remedies have been imposed, typically including restrictions on the sharing of information and maintenance of strategic capabilities in the UK.
At the other end of the spectrum, i.e. deals which do not raise material national security issues, the new system appears to be working efficiently. Filings are generally accepted by the government within a small number of days, with clearance received within the initial review period without significant requests for further information. As anticipated, on the basis of our discussions with the ISU leading up to the new regime, the NSI Act generally operates as a timing and process issue on the typical private equity transaction rather than a more substantive concern.
UK merger control thresholds to be revised
The government confirmed in its Autumn Statement that it will legislate in this Parliament to amend, amongst other matters, the Competition and Market Authority's (CMA) jurisdiction to review M&A activity in the UK. In addition to strengthening the CMA's ability to review M&A in the digital sector (requiring firms with 'strategic market status' to notify their most significant transactions), the government also proposes to introduce a new merger control threshold to catch so-called 'killer acquisitions'. The existing turnover threshold is also expected to be increased, from £70 million to £100 million, to reflect inflation.
