Corporate Law Update

This week we focus on the Government’s proposals to modify the UK’s domestic merger control regime, and to make other potential changes to expand its power to intervene in acquisitions of businesses in sensitive sectors. We also look at the FRC’s Annual Review of Corporate Reporting and note that ESMA has issued an updated Q&A on prospectuses.

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Government consults on national security investment

As mentioned in last week’s Corporate Law Update, the Government has published a consultation on ways to ensure that investments and takeovers do not raise national security concerns in the UK.

The consultation is split into separate proposals for the short term and the long term.


Broadly speaking, a merger of two or more enterprises is subject to the UK’s domestic merger control regime if one of two “jurisdictional thresholds” is met:

  • The target’s UK turnover exceeds £70 million (the “turnover test”)
  •  The transaction results in a 25% or more combined share of sales or purchases of goods or services of a particular description in the UK (or a substantial part of the UK), or it increases a combined share that already sits above 25% (the “share of supply test”)

UK domestic mergers are scrutinised by the Competition and Markets Authority (CMA). The merger parties do not have to notify the CMA. However, not doing so means the parties cannot obtain advance clearance and will risk the consequences of the CMA investigating the merger on its own initiative.

In addition, the Government can intervene in mergers that affect national security, media plurality or the stability of the UK financial system, provided one of the jurisdictional tests is met. In theory, it can also intervene on other public interest grounds and (in limited cases) where the jurisdictional tests are not met. In practice, interventions are infrequent – there have been only 12 since 2007.

The Government is concerned about the limited extent of these powers. For example, it cannot intervene in a transaction that is not a merger (such as a strategic investment) and is concerned that the current regime relies too heavily on voluntary notifications.

Short-term proposals

In the short term, the Government is proposing to alter the jurisdictional thresholds for certain sectors:

  • The turnover test threshold would be reduced from £70 million to £1 million.
  • The share of supply test would be modified so that a merger will satisfy the test if the target’s existing share of supply is 25% or more. In other words, the test would be conducted by reference to the target’s existing business, not the effect of the merger itself.

The modifications would apply only to mergers in the following sectors (which may overlap in areas):

  • Military and “dual-use” products. These are items with both a military and civilian use. In the UK, these kinds of products are specified in the Government’s Strategic Export Control Lists.
  • Advanced technology involving multi-purpose computing hardware or quantum-based tech.

This would bring smaller transactions and those where the acquirer has no or little UK market presence within the Government’s purview. (It would also bring them within the CMA’s remit, although the paper says the proposals are driven by national security, not competition, and the CMA would continue with its current approach.) Notification would remain voluntary.

Longer-term proposals

In the longer term, the Government proposes to expand its existing power to intervene. The proposals divide into two concepts: extent of the power and mandatory reporting.

The proposals would allow the Government to intervene in the following kinds of transaction:

  • The acquisition of significant influence or control over a UK business that gives rise to national security risks. It would not matter whether the acquirer is domestic or foreign.

    This would happen where someone acquires more than 25% of a company’s shares or voting rights or enters into a transaction that gives significant influence or control over a company or its assets. This is similar to the tests set out in the UK’s persons with significant control (PSC) regime; indeed, the consultation refers to statutory guidance produced under that regime.

    Critically, the concept of a “relevant merger” based on turnover or share of supply would not apply. Instead, the test would be based on the type of business and the level of control acquired.
  • Sales of assets. This would represent a significant expansion of the existing regime, which is limited to company mergers. It would prevent businesses from circumventing interventions by selling plant, machinery or intellectual property, rather than a fully-fledged company.
  • New projects, including activities that are not yet functioning but have the potential to develop into national security interests. Again, this would significantly expand the Government’s existing powers and does not appear to require an initial national security dimension.

To assist with interventions, the Government is proposing mandatory reporting for the following:

  • Transactions involving an “essential function” in the following sectors: civil nuclear, defence, energy, telecommunications, transport, manufacture of military and “dual-use” items and advance technology, and (possibly) government and emergency services.

    The proposed “essential functions” are listed in the consultation. For example, operating radio or television broadcast infrastructure is given as an essential function in the telecoms sector
  • Transactions involving individual businesses. The Government could designate an individual business for mandatory reporting even if it does not carry out an “essential function”.
  • Transactions in plots of land designated by the Government, where the land is close to a “national security-sensitive site”. This would be designed to prevent espionage or sabotage.

The Government has requested comments on its short-term proposals by 14 November 2017 and on its longer-term proposals by 9 January 2018.

FRC publishes Annual Review of Corporate Reporting

The Financial Reporting Council (FRC) has published its Annual Review of Corporate Reporting 2016/2017. The review of just over 200 companies’ accounts focused on listed companies.

The review found that the standard of corporate reporting in accordance with the Companies Act 2006 and applicable standards, in particular by the largest listed companies, remains generally good. However, there is room for further improvement in the clarity and completeness of explanations companies provide. Although there have been some improvements in strategic reports, for example in respect of Alternative Performance Measures (APMs), findings in respect of financial statements are “broadly consistent” with last year.

The FRC asked companies to pay particular attention to the following areas:

  • Properly explaining and quantifying key judgments and estimates.
  • Providing a fair and balanced assessment of performance and prospects that covers both positive and negative aspects.
  • Ensuring the links between the financial statements and discussions of strategy, performance (including Key Performance Indicators or KPIs), financial position and cash flows (including the use of APMs) are clear.
  • Providing information that is company-specific and material to an understanding of the business, its performance and prospects.

The report notes that despite improvements, the strategic report continues to be one of the areas that is most frequently the subject of challenges by the FRC, for example, where there is insufficient balance or where not all key aspects of performance have been considered.

Amongst other things, the report also calls for further improvements to the viability statement and more focused company-specific Brexit disclosures as the economic and political effects of the referendum result develop and become more certain.

The report provides important information for those with responsibility for preparing annual reports and accounts. As well as looking back over the last financial year and highlighting aspects of good practice and common areas for improvement, it emphasises areas of future focus for boards in the upcoming reporting seasons.

The FRC has also published an accompanying presentation setting out the technical findings of the review.

ESMA issues updated Q&A on prospectuses

The European Securities and Markets Authority (ESMA) has updated its Q&A on prospectuses. In the updated Q&A, Q&A 27 has been deleted and four other questions have been amended (Q&A 29, 31, 32 and 44). The changes are not substantive and relate to the Prospectus Regulation becoming applicable on 20 July 2017.