High tech mergers caught by changes to UK regime for national security scrutiny

Changes to the UK regime for scrutiny of mergers on national security grounds came into force in June 2018. In this briefing, we look at why these changes were introduced and what they will mean for business.

What was the UK regime before the latest reforms?

The UK government already had some powers to scrutinise mergers on grounds of national security - but only where the following conditions were met:

as with any merger, where the target business has annual UK turnover of over £70 million or the merger would result in the creation (or the increase) of a share of supply of 25% in the UK; or
the merger does not meet the thresholds in the first bullet but involves a current or former defence contractor who has (or had) access to confidential defence-related information and at least one of the merging parties carries on business in the UK.

In both these cases, the Secretary of State for Business, Energy and Industrial Strategy (the "Business Secretary") can "call in" the merger, enabling him or her to take the final decision on whether it should be allowed to proceed. Such "call-ins" are rare. However, it is not uncommon for the Ministry of Defence to take an alternative, non-statutory approach to address any national security concerns it has by using its position as a key customer of defence contractors to secure voluntary undertakings.

What is a national security concern?

In the past, the UK authorities have invoked "national security" to "call in" mergers involving suppliers of armoured vehicles, defence-related submarine and aerospace technology and radio devices used by UK emergency services. EU law suggests that the concept may also cover, for example, security of energy supply (EU law is relevant because the UK's concept of "national security" includes "public security," as defined in the EU Merger Regulation). The new powers will allow greater scope for scrutiny of mergers relating to activities where there may not be any immediate/direct connection to the military, police, security or emergency services, notably:

certain suppliers of advanced technology and military/dual use technology (as regards the short term changes); and
critical infrastructure businesses e.g. energy, water, telecoms etc (as regards the proposed long term changes).

Why has the government changed the regime?

The UK government argues that its existing powers to scrutinise mergers on national security grounds (see above) are not broad enough. In the short term, a particular concern is that the current regime does not allow adequate scrutiny of the fastmoving technology sector.

Take the example of a small company which has developed promising new technology with potential defence or security applications. The acquisition of the company would not meet the UK merger control thresholds because its turnover is well below £70 million - and it is being acquired by a company which is not a competitor (so there would be no increase in its share of supply as a result of the transaction). Unless that company is already a supplier to the UK's defence or security services, then currently the Business Secretary would not be able to "call in" the transaction.

A key longer term concern for the government is that the concept of a "merger" in the existing regime is too narrow to allow scrutiny of some transactions with potential national security implications. An example would be if a company sold the intellectual property in technology that it had developed with defence or security applications – it is unlikely that the bare assets on their own (i.e. without staff, or customer contracts, etc.) would be regarded as an "enterprise" for UK merger control purposes, and therefore the current UK regime would not apply. This is why the government has signalled its intention to pursue a more wide-ranging reform of the UK regime.

What changes have been made?

With effect from 11 June 2018, for certain advanced technology and military/dual use businesses (see below for explanation), the UK merger control regime will apply where the business in question has:

turnover of over £1 million (as opposed to the normal £70 million threshold); or
a share of supply of 25% or more (as opposed to the normal test where a 25% share of supply must be created or increased by the merger, i.e. there must be some overlap with the acquiring party).

This will enable the Business Secretary to "call in" any such transactions raising national security concerns, just as he/she is currently able to do in relation to transactions meeting the existing thresholds for UK merger control (see above). In theory, these businesses will also be potentially at risk of scrutiny on competition grounds by the UK Competition and Markets Authority (CMA). However, the CMA has indicated that it considers it "very unlikely… that it will need to initiate investigations on competition grounds" into these transactions.

Which businesses will be caught by these changes?

The definitions of the businesses which will be caught by the changes are complex and specific advice should be sought if you are concerned that your business may be affected by these changes. In summary, the new rules apply to businesses involved in:

Military technology: in most cases, these businesses should not be difficult to identify, as they will generally be suppliers of products with obvious defence applications, such as automatic weapons.
Dual-use technology: this means technology that could have both civilian and defence applications. The export of dual use technology is subject to a licensing regime and relevant products are identified in the government's Strategic Export Control Lists (SECLs). As a result, businesses which export their products outside the EU should be aware of whether they are considered to be suppliers of dual use technology. However, although the legislation defines this category by reference to the SECLs, not all the products listed will be caught by the amended merger control regime; in particular, items on the EU and UK Human Rights export control lists are not covered, as they are not considered to raise national security concerns.
Intellectual property in computer processing units: this covers businesses which own, create or supply intellectual property relating to a particular type of hardware, namely computer processing units (CPUs). The aim here appears to be to capture businesses which own or develop the components which effectively act as the "brain" of a computing device. Software is not covered by this definition except for "the instruction set architecture for CPUs" and/or "computer code that provides low level control for CPUs".
Roots of trust in CPUs: this covers businesses which design, maintain or provide support for the secure provisioning and management of roots of trust in CPUs (and/or the computer code that provides low level control for such CPUs). "Roots of trust" are "hardware, firmware or software components that are inherently trusted to perform critical security functions." The concept includes "cryptographic key material bound to a device that can identify the device or verify a digital signature to authenticate a remote entity."
Quantum technology: this covers businesses involved in quantum computing or simulation, quantum imaging, sensing or time navigation, quantum communications or quantum-resistant cryptography. Whilst quantum technology is (at present) a highly specialised field, most businesses within that sector are likely to be caught; in addition to firms that undertake research or develop/produce anything designed for use in such quantum technologies, the definition also encompasses firms that supply services using such quantum technologies.

Apart from defence and dual use products, the main target of the changes is cutting edge computer technology.

Future changes

These changes are only intended as a temporary measure, pending the enactment of more wide-ranging reforms to the UK's regime for scrutiny of mergers on national security grounds. In contrast to these latest measures, which are relatively targeted in their scope, the longer term reforms are likely to expose mergers involving a substantially broader range of businesses to national security scrutiny.

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