On the horizon | New rules for mergers will impact the defence sector

Businesses operating in the UK defence & security sector are the focus of the UK government’s consultation on proposed new merger control rules, announced on 17 October 2017.

This article focuses upon the short-term proposals that the government has put forward that would enable it to intervene in a limited class of mergers in the defence and security sector. The government has also indicated its longer-term intention to make more substantive changes to how it scrutinises the national security implications of foreign investment in key parts of the economy, including civil nuclear, defence, energy, telecoms and the transport sector. We will consider these longer-term plans in a separate briefing.

If the rules are implemented, the UK government will have wider scope to intervene in mergers involving foreign ownership of UK businesses in the defence & security supply chain.  The government is clearly aiming to: (i) protect the UK’s domestic security and defence know-how; and (ii) reduce “brain drain” from the UK post-Brexit. 

What is the government proposing?

The proposed new rules will affect businesses that: (i) design or manufacture military or dual use products; or (ii) are involved in the advanced technology sector (i.e. computer chips and quantum technology).

At the moment, the government can only intervene on mergers that involve companies whose turnover exceeds £70m or where the merger would result in the combined business having a share of 25% or more of the supply in a particular market.

Under the proposals, the government’s net would be widened by reducing the turnover threshold to £1m for this limited class of transactions. This would let ministers scrutinise mergers involving much smaller businesses, such as manufacturers of small components that may go on to have defence applications. The proposals also remove entirely the threshold requirement relating to market share.

Comment

To date, the government’s approach to mergers, from a national security perspective, has focussed on the Official Secrets Act.  This restricts the transfer of confidential information relating to defence: i.e. the government has taken a “UK-eyes-only” approach to ring fencing security information.

The latest proposals go beyond these ideas and would allow the government to close a perceived loophole in national security, which is that foreign entities can acquire a stake in UK national security assets through investment. The government can also claim that the proposals deliver on the Queen’s Speech commitments to increase powers to protect national security.

In one sense, the proposals could strengthen the UK domestic supply chains by promoting UK ownership of know-how and technology that is important to national security.

The proposals could also go some way to reducing the risk of valuable expertise exiting the UK following a hard Brexit.  It is possible that, if Brexit leads to border friction and reduced free movement of skilled employees, Primes may decide to progress future major projects and platform developments outside the UK.  It would be a natural move for overseas companies to acquire UK businesses with desirable know-how so that they can easily extract and feed that know-how into the supply chain outside the UK.  The new rules could make it harder for overseas companies to acquire UK know-how in that way.

However, there are clearly risks to taking an overly protectionist approach:

• The security and defence supply chain is already global, and increasing barriers to sensible investment risks hampering technology growth.
• Collaboration between (i) UK businesses and (ii) companies based in countries that are allies of the UK generates both valuable technology and real economic benefit, including to the UK.  Ownership of UK-based businesses by overseas companies is part and parcel of that beneficial collaboration and any new merger rules must ensure that they are flexible to let that type of investment continue.

The consultation period for these short-term proposals is open until 14 November 2017.  If you stand to be affected by these proposals, you have an opportunity to give your views.

This article was prepared with the assistance of Sam Curtis, Trainee Solicitor at Osborne Clarke.