The impact of Brexit on UK M&A
Against a background of legal and commercial uncertainty in the period immediately following the United Kingdom’s decision to leave the European Union in June 2016 and, subsequently, its announcement that it would leave the EU Single Market, there were significant concerns that Brexit would have a chilling effect on M&A activity and, in turn, threaten the UK's leading global position in M&A.
In June 2016, just prior to the referendum, the Financial Times reported that the volume of deals involving UK targets that year, was down “almost 70%…compared with the same period in 2015” amid uncertainty of the UK’s membership of the EU.1 In fact, while some M&A transactions were delayed, put on hold or terminated altogether as a result of the legal and political uncertainties immediately following the Brexit vote in June 2016, there was little tangible evidence of a significant slowdown in M&A activity, in particular once the EU-UK Withdrawal Agreement was finalised in November 2018.
Indeed, the substantial depreciation in the value of Sterling following the Brexit referendum may have had a positive impact on M&A activity in the UK. Notwithstanding the political deadlock and consequential legal uncertainties that followed the May Government’s unsuccessful attempts to incorporate the Withdrawal Agreement into UK domestic law, UK business generally continued to transact in the knowledge that, absent a “no deal”, there would almost certainly be a transitional period and, at least until the end of that period, EU laws and regulation would continue to apply in the same manner as previously; therefore, very much a case of “plus ça change, plus c'est la même chose”.
As a result, few M&A transaction documents involved a Brexit termination right, and there was little evidence of buyers introducing deferred consideration or non-cash consideration specifically to cater for Brexit concerns, as some had anticipated.
The EU-UK Trade and Co-operation Agreement (TCA), which established the new trading relationship between the EU and the UK at the end of the transition period post-January 2021, again raised the spectre of a negative impact on levels of UK M&A activity. The TCA contained little to maintain existing levels of convergence or continuity in key legal areas relevant to M&A, such as financial services and investment. Coupled this with the wide powers given to ministers to amend, disapply or modify retained EU law under the European Union (Withdrawal) Act 2018, it seemed increasingly likely that divergence would increase, to the detriment of UK business activity.
Despite these concerns, data based on actual experience of investment and M&A activity following the referendum indicates that Brexit has in fact had little impact on the nature and extent of UK M&A transactional activity, both during and after the transitional period.
Over the past two years, it has been difficult to disentangle the effects of Brexit UK M&A activity from those of the Covid-19 pandemic. However, available data show that, while there may have been a modest decline in European inward investment into the UK since June 20162, overall levels of inward investment from all sources continued to flourish in 2019 prior to the onset of Covid-193, with US investment into the UK particularly strong. The Office of National Statistics notes that US companies controlled the highest levels of inward foreign direct investment (FDI) on both an immediate and ultimate (i.e. ultimate beneficial owner of the funds) basis in 20194. Despite Covid-19, for the most recent financial year alone, the US provided 389 FDI projects, more than any other country.5
Within Europe, France has now pinched the UK’s accolade of the top European destination for FDI, according to the EY Europe Attractiveness Survey 2021 published on 7 June 2021.6 According to EY, in 2019, France saw the largest increase in new projects, up 17% year on year, with 1,197 new projects, but investment in the UK remained strong, increasing by 5%, with 1,109 projects. EY cites a reduction of investor concerns about Brexit as a driver of growth, noting that only 24% of survey respondents cited Brexit uncertainties as one of their top three risks to attractiveness across Europe, compared with 38% of respondents in 2018. "In a wider international context between 2016 and 2020, direct US investment into the UK has grown from US$747.43bn to US$890.09bn”7. According to Channel Futures, more UK companies were bought by foreign companies in the last eight months of 2021 than in the previous five years altogether8.
However, while Brexit may not have dampened the level of UK M&A activity, it has led to greater complexities for M&A transactions and in particular additional burdensome regulatory changes due to the UK no longer being an EU Member State or part of the Single Market. For example, mergers with both an EU and UK dimension no longer benefit from the “one-stop shop” anti-trust clearance regime established by the EU Merger Regulation. As a result, many transactions will now require clearance from both the European Commission and the UK’s Competition and Markets Authority (CMA) (as well as any relevant competition authorities in other jurisdictions, such as the US and China). While there are similarities between the EU and UK merger control regimes, there are also material differences that can cause significant procedural impediments and delays to complete a merger or acquisition, including differences in substantive outcomes that can, under certain circumstances, prove terminal.
The full impact of these changes was not experienced during the transition period. Provided the European Commission initiated proceedings before 31 January 2021, the merger would remain within its jurisdiction alone. However, after that date, double exposure for merging parties began, resulting in the CMA now reviewing most multi-jurisdictional mergers in parallel with the Commission. It has been estimated that this will result in a 60-78% increase in the CMA’s workload,9 much higher than the 50% increase that the CMA itself had been predicting.
Early evidence suggests the CMA will be adopting an expansive approach to the exercise of its jurisdiction. This may, on occasion, result in mergers which are cleared by the European Commission being delayed, blocked or subjected to conditions by the CMA. Unlike the EU, the UK can use a “share of supply” test to establish jurisdiction; if a merger may result in a share of supply of 25% in any candidate market, or may increase further above that threshold, the CMA can step in. The CMA has used this jurisdictional test to examine mergers even where the merging parties generate little or even no revenue in the UK. The recent Sabre-Farelogix merger is a vivid illustration of this. The transaction involved the merger of two undertakings based in the US. The only nexus with the UK was indirectly through an agreement concluded in the US which was supported through an interlining agreement with British Airways. The merger was blocked in the UK, even though it would have been allowed to proceed (following judicial intervention) under US merger control legislation. The Competition Appeal Tribunal has subsequently confirmed the wide discretion of the CMA in application of the jurisdictional test.
Undoubtedly, a similar conflict of outcomes will occur in the future between the EU and the UK. This is particularly so, given differences in the CMA’s and the European Commission’s approach to substantive assessment of mergers and the remedies required to address any lessening of competition. Post-Brexit comments by the CMA (for example, criticising EU decisions in the technology sector) suggest that the prospect of divergence in approach and outcome is more than merely academic. For example, Andrea Coscelli, chief executive of the CMA, has stated that the CMA is sceptical of the complex, long-running behavioral remedies accepted by the European Commission (for example, in the Commission’s assessment of the Google-Fitbit transaction)10.
Despite its expansive approach to jurisdiction, Colin Raftery, Senior Mergers Director for the CMA, noted during a webinar on 4 November 2021 that the CMA had seen a smaller increase than expected in post-Brexit merger case-load, with the number of merger reviews conducted at the lower end of CMA’s post-Brexit workload forecasts. (This may be attributed, in part, to a greater proportion of acquisitions in the last 18 months being led by financial or private equity investors, rather than industry or trade buyers, with the result that substantive competition concerns did not arise to the same extent). This is borne out by recently published CMA data for the post Brexit year which shows that the CMA launched only 12 merger reviews parallel to EU reviews, two of which went to a CMA second phase review.
Further post-Brexit regulatory challenges to M&A continue to emerge from new legislative initiatives that are, at least in part, a result of the UK’s expanded jurisdictional autonomy post-Brexit, or the EU’s concerns over how the UK will exercise that autonomy. In the UK, the National Security and Investment Act 2021 (NSIA) provides the UK Government with retrospective powers (back to 11 November 2020) to screen acquisitions and investments that may give rise to a risk to national security through its new “Investment Security Unit”. Since 4 January 2022, there are mandatory notification requirements for transactions within 17 sensitive economic sectors, ranging from defense and energy to synthetic biology and transport. Qualifying entities to which the NSIA applies include both UK entities and overseas entities that carry on activities, or supply goods or services to persons, in the UK, potentially impacting acquisitions that take place entirely outside the UK. The scope of the new powers granted by the NSIA and the range of the 17 economic sectors involved will without doubt prove to be a further irritant in the progress of M&A transactions in the future and, in some cases, the ability to close those transactions.
The impact of this significant UK regulatory “creep” should be seen against the backdrop of the enactment in October 2020 of the EU Foreign Direct Investment Screening Regulation11, which provides for an EU co-ordination network concerning FDI into the EU. Among other things, it allows the European Commission to issue opinions where an investment into the EU may pose a threat to the security or public of one or more Member States or to an EU project or programme. It also establishes certain minimum requirements for Member States who maintain (or adopt) their own FDI screening process at a national level.
Of even greater potential significance is the draft EU Regulation on the control of subsidies by third countries12, which creates a mechanism to review within the EU subsidies granted to undertakings by third countries. The Regulation would grant the European Commission power to investigate mergers above a threshold and involving a non-EU government where there is a financial contribution exceeding €50m from a non-EU government. Following Brexit, this includes the UK. There would be a requirement to notify the Commission of the transaction, and parties would be prohibited from completing the transaction pending the Commission’s review. The Commission would be able to impose fines for failure to notify a transaction, and would gain general market investigation powers to pro-actively investigate markets where it suspects foreign subsidies may be at play. With no equivalent power available to UK public authorities, this too raises the prospect of diverging outcomes in the EU and the UK of assessments of M&A transactions.
Finally, the UK has also lost access to some of the benefits under EU Directives that facilitate cross-border M&A within the EU. For example, the EU Cross Border Mergers Directive allows mergers between companies established in different European Economic Area (EEA) member states. Before the end of the UK/EU transition period, this included the UK but, following its expiry, UK companies can no longer participate in EU cross-border mergers. Any merger of a UK and EEA company must now take the form of a share or business transfer, followed by a dissolution/liquidation of the transferor entity. Similarly, in a taxation context, UK companies have now lost the benefit of the EU “Parent-Subsidiary Directive”13 and “Interest and Royalties Directive”14. UK companies in receipt of dividends, interest and royalties from companies established in the EU/EEA will no longer be able to rely on those Directives to eliminate withholding taxes that would otherwise be imposed under the domestic laws of EU/EEA member states. Taking dividends as an example, where a double tax treaty with the UK does not entirely eliminate domestic withholding taxes, any withholding tax will create an additional cost to repatriating profits from subsidiaries, particularly given that most dividends received by UK companies are exempt from UK corporation tax.
A recent agreement between the UK and US seeks to address the impact of Brexit on the UK/US double tax treaty, which has historically referred to the EU/EEA when limiting access to its beneficial provisions. This agreement brings a welcome end to a period of uncertainty on the availability of treaty benefits. It is not, however, a comprehensive solution, as EU/EEA counterparties will need to agree on a bilateral basis that references to the EU/EEA should be interpreted as including the UK.
So, almost one year on in the post-Brexit world, what does this all point to for M&A transactions going forward? While any predictions are fraught with uncertainties, it appears unlikely we will see the feared significant chilling effects as a result of the UK leaving the Single Market and resulting divergence, and it seems probable that activity from the US will continue to grow.
The general view is that UK stocks have underperformed during the last five years, suggesting that there are some good value M&A opportunities for both domestic and foreign investors.
It is suggested that the real message is likely to turn on the increasingly challenging regulatory environment in the UK and duplication of regulatory hoops that must be jumped through both at EU and UK levels.
1 Brexit jitters drag UK’s share of M&A to record low | Financial Times (ft.com)
2 In 2018, the UK accounted for 23% of the EU’s total inward FDI flows, down from 30% in 2017 and a high of 35% in 2016 (Foreign investment in UK companies in 2018 and the effect of Brexit (parliament.uk)).
3 In its Europe Attractiveness Survey 2021, EY reported that the United Kingdom remained attractive in 2019 as investment increased by 5%.
6 Foreign investment into Europe set to rebound in 2021, following 2020 downswing | EY - Global
7 On an historical cost basis. Source: STATISTA, 4 August 2021
8 https://www.channelfutures.com/emea/uk-attracting-record-levels-of-us-companies-investment
9 See written evidence of the CMA (CMP0002) reported in the House of Lords European Union Committee’s 12th Report of Session 2017 – 19, Brexit: competition and State Aid, paper number 67.
10 UK competition watchdog warns big tech firms of investigations | Technology sector | The Guardian
11 Regulation 2019/452
12 https://ec.europa.eu/commission/presscorner/detail/en/ip_21_1982
13 Directive 2011/96/EC
14 Directive 2003/49/EC