The UK government has assumed an increasingly interventionist approach to foreign takeovers in recent years. In June 2018, the UK adopted new powers to review deals on national security grounds, extending the scope and breadth of its control regime. In July, the UK went a step further and published a White Paper on a new and significantly extended foreign investment notification regime, which likely will lead to wider and closer scrutiny of many transactions, including private equity deals.
The government’s jurisdiction over transactions is expanding with most areas of the economy within scope, new information-gathering powers, longer review periods, and stricter penalties for noncompliance. Changes could come into effect as early as next year, and deal teams must assess the implications for private equity deals.
National security review anticipated to catch more deals than current merger control regime
The new regime is intentionally broad and has the potential to catch almost all deals. Indeed, the government has made it clear that no sector is off limits. Energy, communications, transport, and nuclear likely will receive the most focus; however, national security concerns can arise in any deal.
The government anticipates reviewing up to 200 transactions per year under the new regime, with 100 full investigations, and 50 cases expected to lead to some form of remedy. In contrast, just eight transactions have been fully investigated on national security grounds since 2003, and the Competition and Markets Authority reviews around 60 to 65 deals annually under current UK merger control rules.
“Trigger events” sparking a review under the new regime include acquisitions, minority investments, property deals, contractual rights, and intellectual property transactions, with no threshold for government intervention. Furthermore, all investors, foreign or UK-based entities, are subject to the regime. While Chinese buyers have been a global focus, the new regime is more expansive — specific jurisdictions or closed deals that the government would have liked to prevent have not been published. However, the government must be considering other jurisdictions as a cause for concern — there have not been 50 Chinese deals in the UK raising national security concerns.
Further, if the government “calls in” a transaction, this automatically stops the deal from closing until approval is granted. Reviews can last up to 75 days, far longer than under the current regime. Penalties for non-compliance are severe, indicating how seriously the government is taking national security. Civil penalties — such as financial penalties (up to 5% of worldwide turnover) or director disqualification — can be imposed, while serious breaches can result in criminal penalties of up to five years’ imprisonment.
How should PE deal teams respond?
The new control regime raises unique concerns for PE firms. Limited partners in a PE fund currently fall under the regime’s scope, meaning sovereign wealth funds linked to foreign powers could be considered a national security threat in the context of a PE buyout. Limited partners that co-invest alongside a GP would also face scrutiny. PE firms should consider their investor base and co-investment partners as they approach deals in sensitive industries, and think about how they would react to an investigation. If national security issues are flagged or risks are identified, PE deal teams should consider additional closing conditions in deal documents.
The new regime likely will necessitate a bedding-in period and careful regulator navigation by legal counsel. Overall, dealmakers may prefer to pre-notify the regulator of contemplated deals, as they plan for life under the new regime.
In our view, the government views national security as a priority, given the numbers of deals discussed and the potential penalties. The changes could come into effect as early as next year, and deal teams must ensure investments and exits are compliant.