The spectre of upheaval

John Fingleton, CEO of Fingleton Associates, examines some of the key trends in the UK M&A market over 2016, and debates the impact of Brexit

The next three or four years will prove to be tricky for M&A transactions, not least in navigating regulatory uncertainty. The UK market will be dominated by its exit from the EU, with a myriad of regulatory implications. Quite aside from this, the UK has been looking at introducing a public interest test in British takeovers, but it remains unclear to what extent the government will be able to impose and monitor commitments by acquirers of British companies. John Fingleton, CEO of Fingleton Associates, which provides strategic advice in M&A transactions relating to regulatory and competition issues, examines the issues.

Because we advise on deals that may have regulatory problems, the volume of deals we see is not necessarily correlated with the greater cycles in the market. What we did see in the UK in the last six months of 2016 was more 'press pause' on transactions. Many deals that were in contemplation either did not go ahead or were proceeding a lot slower than they should. As of early 2017, we are now seeing companies becoming quite engaged in transaction planning again.

A lot of companies were, at board level, dealing with Brexit. Companies have seen an exchange rate depreciation in sterling of 10-15%. Many were expecting a falloff in consumer demand. In some sectors, companies were worried about skilled labour shortages further down the line. Some companies that suffered share price reductions may have been worried about becoming takeover targets. It is not just that the share price may have fallen but also that long term revenues may be lower or more volatile, so there is more exchange rate risk for companies buying UK assets than there was before. These concerns have caused people to slow down a bit. Some of our clients have banned the word Brexit from strategy documents in order to get back to a focus on business as usual.

At EU level, Margrethe Vestager, the commissioner for competition in Brussels, is half way through her tenure. She has shown a willingness to challenge deals that she considers anti-competitive, sometimes blocking them and sometimes watching them fall apart at the end of the process. For example, she surprised some in blocking the O2/Three merger.

In the US, it is really quite difficult to predict the direction of merger enforcement. There has been a successful run of merger challenges by the Justice Department of the Federal Trade Commission in the second Obama administration. Many mergers were challenged, often on quite novel grounds, and quite a lot of deals fell apart because of those challenges. We have seen more deals being challenged on the basis of vertical or conglomerate concerns, a new development not just in the US.

In the UK, the Competition and Markets Authority (CMA) is now three years in existence and has been refining its approach to merger control. Getting phase 1 clearance in the UK is a challenge because the legal test for phase 1 clearance is high. This increases the risk of tipping into phase 2, although some deals can then get cleared without remedies. Predicting which mergers will go to phase 2 can be extremely difficult, depending heavily on factors such as third party interventions, the preparedness of the parties, and the internal deliberations of the CMA.

The CMA has remedied many mergers at both phase 1 and phase 2 and only in one recent case, the Intercontinental Exchange (ICE)/Trayport merger, has it blocked a deal. Interestingly that was on the basis of vertical concerns. While the CMA, as with other regulators, favours clean structural remedies, we have seen the CMA experimenting with behavioural remedies in two phase 1 cases.

In a lot of big international transactions as well as UK deals, companies are getting advice earlier in the decision-making process, anticipating problems. In some cases, this involves putting in place secondary transactions that resolve them before they go to the regulator. Probably the most impressive of those deals was Anheuser-Busch InBev/SAB Miller, a huge global deal with big issues in several continents. The advisory team went through the issues with the company in advance and the deal was cleared with no serious investigation in any jurisdiction.

The CMA has recently refined its approach to retail mergers; this impacts any business where a service is delivered at a local level (for example, retail includes not just shops but other services delivered locally such as betting shops and dentists, among others). Companies looking to do deals are well advised to base their analysis and decisions on the most recent cases decided by the CMA, rather than ones from a decade ago.

Financial regulation is always a challenge as regulators are always careful and forceful about issues, such as the fit and proper person test and other prudential tests in financial services. In financial services there is always going to be an additional layer of regulatory oversight.

In the UK there is a special regime in media mergers. The Secretary of State for Culture, Media and Sport has requested a formal investigation of the bid for Sky by Twentieth Century Fox on public interest grounds. The failed Kraft bid for Unilever and other deals involving takeovers of British companies demonstrate an increased political sensitivity in the UK to foreign takeovers of British companies, not on competition grounds, but based on other issues such as employment. Theresa May, in her speech last July when she was a candidate for Prime Minister, proposed reintroducing a public interest test. There are preparations afoot for that, but even in the short term you will see quite a lot of political interest in mergers involving foreign companies taking over British companies. Even in sectors where there is no public interest test, political pressure on the companies during the process, especially if it is a longer phase 2 process, could be more damaging to the deal than the competition test.

First, companies need to control the narrative. With both Unilever and AstraZeneca, the public narrative was that a British-owned company is being bought out by a foreign company, notwithstanding the fact that the shareholder register of those companies is very international.

Second, companies need to get their stakeholders on board. If a foreign company is buying a UK company, it needs to think about all the stakeholders: the supply chain, the customers, the people around the industry, the people who are politically connected in that industry. The buyer needs to have a plan to deal with all that, and it ideally needs to lay all those preparations before they announce a deal. That smooth takeover management and political astuteness does need to be combined with a good regulatory approach.

The level of politicisation of mergers in the UK has changed in the last six months with the new prime minister. The political independence of the merger regime has been enshrined in law for over 15 years and was there for the previous decade or two as a matter of practice. The AstraZeneca merger tested that, and then so did Lloyds/HBOS; the latter more formally produced the change in law allowing politically motivated intervention in mergers in financial services.

On the other hand, the Kraft/Cadbury bid undermined confidence in the ability of the government to extract a commitment from a buyer, be it on employment or the location of the business in the UK, or in the case of pharmaceutical research on a future commitment to R&D in the UK. The government feels that there should be some mechanism by which it can turn those promises into binding commitments, and that is outside the competition bracket.

There has been an attempt to do something through the financial reporting mechanism, but I think realistically there is no legal mechanism by which the government can extract that type of behavioural commitment. Even in competition policy, where the regulators can extract behavioural commitments, they are very reluctant to do so because the market changes and behavioural remedies or commitment are quite difficult to monitor. There are a lot of practical difficulties with them, notwithstanding that the government is planning to introduce something to that effect which is currently being prepared.

Clearly with private businesses it is a little easier than with publicly quoted businesses. The same factors are to a certain extent there. If you are running a private business that is politically sensitive and a foreign company is buying it there are going to be issues that need to be managed, but it may just be a bit easier to deal with them than if it were a publicly traded company.

Brexit is impacting businesses in three main ways: first, the exchange rate depreciation of sterling; second, the tightening of the labour market in the UK regarding immigrant workers; and third, whether consumer demand in the UK will fall. Any business thinking about buying a business dependent on the UK economy, or a UK business buying one abroad, must factor these additional uncertainties and variabilities into its plans. Most businesses are used to dealing with these uncertainties, but three at once that are possibly larger in magnitude means that there is greater risk, and opportunity, in doing deals in and out of the UK right now.

Then there are sector-specific areas where future regulation matters and where we do not know the shape of future regulation. For example, if you are an airline licensed in the UK or licensed in an EU country, will you be able to fly within the UK or within the EU afterwards? Similarly, food producers will have to adapt if there are different food safety regimes.

Then there is a very specific issue around merger regulation. For deals that happen in the next 12 months the current merger control system will stay in place. Post-Brexit, many mergers that would now be decided by Brussels as a one-stop-shop will be reviewed both in Brussels and the UK. Businesses will be impacted by the higher costs, the differential process and possibly by different substantive outcomes or remedies. Subtracting UK revenue means some deals currently going to Brussels falling below the EU turnover threshold, and being reviewed by several national authorities in the EU.

Then there are some tricky transitional issues, because if you have a merger that is announced nine months before the date Britain leaves the EU, and you cannot be certain that the process will end within that nine-month period, there is a risk that you may need to run parallel procedures, if you are legally allowed to, for the CMA and European Commission as you may not know which will have jurisdiction at the end of the process. All of this may encourage regulatory gaming: is it better to do a deal now or to wait two years? We may see more deals brought forward to benefit from the predictability of the current system in the next year or two.

If a business is contemplating an acquisition, it has about a year to be certain that it will be considered under the current rules, with the caveat that the UK may change its public interest test sooner than the UK leaves the EU. Then there is a period of a year where there are a lot of transitional issues and where the UK may have introduced a public interest test which will be going through a discovery process of what the new rules really are. Then post-Brexit, there is a phase in which there will be new rules and some deals will be notified both in the UK and Brussels. That will mean a bigger burden on the businesses.

If I was a business thinking about a merger, I would probably prefer to get it done under the current rules, which are predictable and stable. My next preference would be to do it in three years' time when the UK has left and when it will be more burdensome, but probably quite stable. The least preferred would be during the transition period. This cuts across lots of different regulated sectors.

About the contributor
		John Fingleton CEO, Fingleton Associates London, UK T: 4420 3730 9094 E: info@fingletonassociates.com W: www.fingletonassociates.com John Fingleton was chief executive of the Office of Fair Trading (OFT) from 2005 to 2012, having previously run the Irish Competition Authority. As an academic economist at the London School of Economics (LSE), Trinity College Dublin and the University of Chicago, he wrote and taught game theory, economics of industry and regulation. In government, he oversaw merger regulation, enforcement of competition rules, consumer protection, and credit regulation. He has been a strong advocate for the removal of government restrictions on competition and supply side reforms to improve productivity growth. Fingleton is a member of the policy advisory board at the Social Market Foundation, a member of the advisory board at GovernUp, a trustee at the Centre for Economic Policy Research, a trustee of StepChange and a trustee at Kaleidoscope Trust.