The Regulatory Gauntlet: Dealmakers Face Increased Scrutiny

U.S. antitrust authorities have been bearing down heavily on M&A under the current administration and are becoming increasingly litigious. This emboldened approach has a significant probability of sinking deals. The Dechert Antitrust Merger Investigation Timing Tracker (DAMITT) found that 60% of significant investigations in the U.S. in 2022 concluded with a complaint or abandoned transaction. This easily eclipsed the previous year’s record of 37%. Furthermore, these investigations have become increasingly drawn out.

On June 27, 2023, the Federal Trade Commission (FTC) and Department of Justice proposed a change to the Hart-Scott-Rodino Antitrust Improvements Act rules that would essentially trigger a significant antitrust investigation for every transaction valued above the reporting threshold, which is currently US$111.4 million. This would be regardless of any substantive overlap between the parties and the deal’s potential impact on competition. Besides capturing a swathe of PE deals within its scope, under the proposal one of the key provisions expressly mentions the disclosure of any PE involvement in deals.

While the European Commission has not zeroed in on PE like the U.S. agencies, it has been heavily scrutinizing deals that it believes have the potential to undermine competition. The Commission is pushing through an overhaul of its policy and enforcement regime, the digital sector being a core focus of these changes. In April, meanwhile, the UK’s Competition and Markets Authority blocked Microsoft’s proposed acquisition of Activision Blizzard over concerns it would give the former undue control over the video games market. The regulator opened a new review of a restructured deal proposal submitted by Microsoft, and the transaction was approved on October 13, 2023.

Overall, 46% of PE fund managers globally expect such intervention to have a negative impact on their dealmaking plans over the next 12 months, and a further 25% anticipate a significant negative impact. APAC respondents are far less concerned than their peers, with 40% saying they expect no discernible impact on their future dealmaking, compared with 23% and 29% in EMEA and North America, respectively. The managing director of a U.S. PE firm concerned about greater regulatory oversight told us: “If there is a target in a region where regulatory scrutiny is greater, we might avoid investing in the region altogether. Investing in emerging countries would be more favorable under these conditions.”

As a rule of thumb, PE firms should proactively address and mitigate antitrust risk by anticipating and preparing for inquiries from regulatory authorities regarding potential competition concerns. A comprehensive understanding of the portfolio, encompassing even non-controlling minority stakes, to identify and address competition issues early in the dealmaking process is a must. Sponsors should be mindful of the presence of any interlocking directorates, avoiding any actions that could be perceived as enabling unlawful information exchange or coordination.

Consulting with antitrust counsel early in the deal process can help PE firms identify and assess potential antitrust risks and develop strategies to mitigate those risks. This year, Dechert has significantly added to its competition practice to meet client demand for advice and representation of companies facing enforcement litigation, specifically building out its high-tech expertise in light of authorities’ focus on this particular sector.

Foreign investment control

With respect to incoming foreign direct investment (FDI), the U.S. government remains as focused as ever on managing the impact of foreign investments on U.S. national security. Compared with prior years, the Committee on Foreign Investment in the United States (CFIUS) appears to be clearing fewer transactions on initial review and is requiring more investigations and more national security agreements as a condition to clearance. In addition, parties are abandoning increasing numbers of transactions after they are unable to agree to mitigation measures with CFIUS.

Of relevance to PE firms, CFIUS recently demonstrated the intense scrutiny it may apply to a transaction, including with respect to parties only tangentially involved. In an update to its frequently asked questions, CFIUS stated that it “may request follow-up information with respect to all foreign investors that are involved, directly or indirectly, in a transaction, including LPs in an investment fund.” This is the case even if there are arrangements in place to limit the disclosure of the non-U.S. person LP’s identity. Further, CFIUS can “request information with respect to any governance rights and other contractual rights that investors collectively or individually may have in an indirect or direct acquirer or the U.S. business… to facilitate the Committee’s review regarding national security risk-related considerations.” Thus, parties must know their LPs – and those LPs’ beneficial owners – and carefully consider transaction arrangements.

U.S. government scrutiny of certain inbound investments will soon be joined by scrutiny of certain outbound investments. In August, President Biden issued an executive order on “Addressing United States investments in Certain National Security Technologies and Products in Countries of Concern,” establishing an outbound investment regime that is likely to go into effect next year once the Treasury department issues final regulations. Under the regime, the U.S. government will either prohibit or require notification of certain investments by U.S. persons in companies located in China, Hong Kong or Macau that are involved in activities connected with certain advanced technologies. These include semiconductors and microelectronics, quantum information technologies and AI systems. Many details of the proposed regime are yet to be solidified and remain something to look out for in the year ahead.

In the EU, the FDI review landscape continues to evolve. A significant number of member states have adopted new national screening mechanisms or updated and expanded existing ones. 21 of the 27 member states now have FDI screening legislation in place, and the remaining member states are working on legislation.

As FDI regimes proliferate and mature, regulators are taking an ever-more expansive view of the concept of “national security” to include more than military and defense interests. In many cases, “national security” now extends to advanced technology, data, critical infrastructure and communications assets as well as healthcare, critical supply chains and public assets such as hospitals and airports. Thresholds for triggering FDI reviews are being reduced, while the definitions of investments that may prompt review are being broadened. Further, the European Commission (EC) and some member states are discussing potential outbound screening of investments, similar to the plans in the U.S.

Of relevance to PE firms and sovereign wealth funds, FDI filing requirements can be triggered in certain jurisdictions in the case of non-controlling minority investments, and even LP stakes may be reportable. Investors therefore need to factor in sufficient time to assess whether their investment triggers FDI filings around the world. They should also assess substantive FDI screening risks early on and be prepared to comply with extensive information requirements in multiple jurisdictions if the target has international operations.

New EU Foreign Subsidies Regulation

The EU’s new Foreign Subsidies Regulation (FSR) recently became fully applicable. The FSR is a novel regulatory regime designed to address perceived market distortions caused by non-EU subsidies. The FSR includes a mandatory notification regime for businesses that have received financial contributions from non-EU governments when participating in transactions that exceed certain thresholds. As such, it creates a third regulatory hurdle for some M&A transactions. In addition to merger review and foreign investment controls, in-scope deals need to be cleared by the EC or risk subsequent investigation.

For PE firms the FSR imposes an additional compliance burden, requiring investors to undertake extensive information-gathering and monitoring exercises to determine the applicability of the FSR and to fulfil potential notification obligations. To minimize disruptions to deal processes, PE firms should consider the FSR’s impact on their transactions early on and incorporate relevant considerations into due diligence and transaction structuring.

Proposed new law in Singapore for regulation of significant investments

Singapore has proposed introducing a new law regulating significant investments into entities that are designated as critical to the country’s national security interests. Under the Significant Investments Review Bill, entities that (i) are incorporated, formed or established in Singapore, (ii) carry out activities in Singapore or (iii) provide goods and services to persons in Singapore, can be designated. Such designated entities will be required to notify or seek approval from authorities for specified changes in ownership or control arising from both local and foreign investments, obtain approval for the appointment of key officers, and be subject to other provisions to ensure the security and reliability of their critical functions. For instance, designated entities cannot be voluntarily wound up or dissolved without the Minister’s consent. In addition, entities that have acted against Singapore’s national security interests may have their ownership or control transactions reviewed and have targeted actions taken against them (such as directing an investor to dispose of its equity interest in the relevant entity) under certain circumstances, even if they have not been designated as critical. At the time of this publication, no further details have been given as to when an entity may be deemed to have acted against the country’s national security interests.

While the scope of the Bill is broad, and no definition of “national security” has been provided, the intention is for the new law to supplement existing sector-specific legislation (such as those regulating entities in the telecommunications, banking and utilities sectors) by bringing critical entities not already adequately covered by such existing legislation within the scope of the government’s oversight and management. Singapore’s Minister for Trade and Industry has stated that “only a handful of critical entities” are expected to be designated under the new Bill. The government will engage with industry stakeholders to share further details of the Bill and work with them on implementation to ensure the overall impact on affected businesses will be minimized. Upon implementation, clear processes will be set up for parties that wish to seek reconsiderations for decisions by the Minister, and for further appeals to an independent Reviewing Tribunal.

The law is not expected to apply retroactively, instead applying only to entities after they have been designated.