Despite recent reforms, EC Merger Regulation still generates a large and costly administrative burden, extends deal timetables and injects a further element of uncertainty into the transaction process. Joanna Gant reports.
May 1, 2004 was an historic day for the European Union. It marked not just the accession of ten new Member States but also the introduction of far-reaching reforms to EC Merger Regulation (ECMR) and radical changes to the European Commission’s working practices.
The reforms, not linked directly to the EU’s enlargement, are the result of an extensive review by the Commission launched in 2001 prompted by widespread discontent over the existing merger control system and reinforced by a series of embarrassing merger case court defeats.
In the wake of sharp criticism from the EU’s appeal court over the lack of rigour in its economics and use of evidence, the Commission has also now appointed a chief economist and set up a system of internal scrutiny. Meanwhile, the Merger Task Force (MTF) has been disbanded and integrated into the sector teams of the Directorate-General for Competition.
Any M&A or private equity (PE) transaction which constitutes a ‘concentration with a Community dimension’ must comply with the formalities of notification under the ECMR. Clearance of the proposed transaction is required before a deal can complete.
As PE funds have grown and deals become ever larger and cross-border, the risk of substantive competition concerns have increased making the ECMR ever more relevant. Firms active in Europe therefore need to be thoroughly up to speed with ECMR requirements.
The recent reforms are designed to promote greater efficiency and transparency as well as dialogue among the regulators, sectors and individual businesses involved in competition referrals. However, from the PE perspective as Elaine Gibson-Bolton, competition law partner at SJ Berwin observes, the reforms are widely seen to have not gone far enough.
The European Venture Capital Association (EVCA), for which SJ Berwin acts, was particularly disappointed that the original reform proposal did not endorse the introduction of a dedicated block exemption for certain PE transactions.
The argument for its inclusion was, essentially, that the anti-trust system hinders PE activity since the rules for the calculation of group turnover must include all companies in which PE firms have a controlling interest. In co-investments or syndicated deals it also includes the interests of their partners.
Further, PE investors are often owned by larger financial institutions whose turnover must also be taken into account in applying the threshold tests, even if the PE investor acts autonomously. Even on relatively small deals, therefore, the worldwide and EU-wide turnover thresholds are often met and a filing becomes necessary.
The revised ECMR still contains an exemption for ‘financial holding companies’, but the Commission adopts a strict interpretation of the definition of such companies and private equity firms are excluded.
Nevertheless, there are some helpful features among the ECMR reforms, notably the ability for investors to pre-clear deals with the ‘flexibilisation’ of both the timing of notifications and the triggering event for notifying a merger.
Crucially, investors are now able to notify on the basis of a ‘good faith intention’ to enter into an agreement rather than, as in the past, within a week of a ‘triggering event’, such as the signing of a binding agreement or Memorandum of Understanding.
While this is an improvement on the old system, the EVCA had been looking for the ability to complete straightforward deals prior to clearance with a proposed amendment to the ‘stand-still’ obligation. This would have allowed certain deals to complete unconditionally prior to ECMR clearance with automatic derogation from stand-still provisions for simplified procedure cases.
This would have greatly assisted in levelling the playing field between PE investors and trade purchasers by allowing investors to offer vendors completion timetables comparable to those of competing trade investors not triggering an ECMR filing.
Despite this, the amendment enabling parties to pre-notify before reaching a binding agreement will also help reduce the advantage trade buyers have over PE investors routinely caught in the ECMR net.
Gibson-Bolton explains that the possibility of seeking the Commission’s permission to close a deal prior to receiving authorisation has always existed and remains in the new regulation. “A derogation can be obtained to enable a deal to close earlier if the target is in financial difficulties, for example. And it is hoped that the Commission will now grant derogations more frequently for PE deals not raising competition concerns than it has done in the past,” she says.
Ordinarily, however, transactions still cannot be implemented ahead of competition clearance. “But because investors will be able to notify earlier in the acquisition process, regulatory approval should come through more swiftly in straightforward cases while still giving the Commission enough time to make sound judgements in more complex situations,” says Gibson-Bolton.
“Although, technically, the approval timetable is now slightly longer – 25 working days for simple cases with no issues rather than one calendar month – it could, in practice, be shorter because bidders can notify earlier and because the Commission is committed to clearing easier cases earlier. In this respect the new ECMR affords PE players a genuine advantage,” notes Paul McGeown, a competition law partner with Linklaters in Brussels.
“Industry cases can run up against the problem of publicity: is the deal in the public domain? But with PE firms ready to move on a deal and less concerned about confidentiality, then cases can be in and out of the Commission relatively quickly,” he says.
“The Commission will have longer to examine a deal and get comfortable with its ramifications during phase 1. It will then, hopefully, be less likely to bounce a deal into a phase 2 investigation simply because it has run out of time,” notes Martin Baker, competition law partner with Taylor Wessing.
“Fortunately very few PE firms will find themselves in phase 2 situations but if they do then cases can be held in limbo for some nine months from pre-notification,” warns McGeown. Previously, phase 2 referrals would take about six months to reach a conclusion.
Despite the initial enthusiasm for the new notification procedures, there are still several grey areas likely to be resolved only through experience. It is not yet clear, for example, at what stage in a transaction parties would be in a position to demonstrate a ‘good faith intention’ to the Commission. Clear rules exist only in relation to public bids.
Could participation in an auction sale be construed as sufficient ‘intention’ to allow a PE investor to pre-notify the transaction and thereby attempt to reduce the delay between exchange and completion? And outside the auction arena, does the undertaking of due diligence represent a good faith intention?
A one-stop shop
What is certain is that one of the greatest strengths of the ECMR is its ‘one-stop shop’ clearance function. But whereas under the old regime transactions with a European dimension falling beneath the ECMR thresholds automatically required notification in individual jurisdictions, the new scheme is designed to streamline the system of referrals to achieve optimal allocation of cases between the Commission and national competition authorities.
Under the new rules and where notification would otherwise have been required in at least three member states, parties are now able to make a pre-notification request to the Commission to take over the case from the national authorities. If no member state concerned opposes the application within 15 working days, the Commission has exclusive jurisdiction throughout the approval process.
“It is not yet clear how willing Member States will be to relinquish their ability to review transactions that trigger their merger notification thresholds,” says Gibson-Bolton. “So, if an acquiror elects to have a sub-ECMR threshold matter dealt with by the Commission, they may have to do quite a lot of work to ensure that none of the 25 Member States refuses a change of jurisdiction,” she continues.
“The new rules governing cases being referred to the Commission from the Member States will be interesting. It will be crucial to be able to identify those cases in which the Member States will, or will not, be prepared to give up their jurisdiction. If the target’s products or services compete in national markets then the Member States may well wish to review the case locally. If markets are wider, the Member States may be more likely to agree to a referral. But it only takes one country to veto the whole referral procedure, which could be a problem,” says McGeown.
Even so, the benefit to the PE industry of the reduced regulatory burden resulting from the ECMR’s one stop system compared with having to obtain domestic merger clearance, often in several domestic jurisdictions through multiple filings, cannot be underestimated.
Conversely, parties may also make a pre-notification request that the case be examined by a national competition authority rather than by the Commission. If the Member State does not object and the Commission agrees within 25 working days that a distinct market exists in that Member State and that competition in the market may be significantly affected by the concentration, it may refer the case to that national authority and national law will apply in that Member State.
“There is now the possibility of cases with a local product and no pan European dimension being referred from the EC to the Member State’s pre-notification,” says McGeown.
In the past PE firms have usually tried to structure deals so that they would fall inside the ECMR’s remit and benefit from dealing with just the Brussels authority. A deal not triggering the ECMR thresholds could, in a worst case scenario, require merger clearance in more than 20 jurisdictions, all of which apply different rules and substantive tests.
“As some governments can take six months or more to grant merger clearance, it is important for PE firms to consider their anti-trust strategy from the outset,” says Baker.
Gibson-Bolton suggests PE investors might want to restructure deals, use different funds or increase or decrease the controls being taken over the target to influence whether a filing is required and, if so, where. “If one part of the business being acquired is likely to present significant competition problems or delay in one jurisdiction, it may be prudent to carve the offending part of the transaction out at the beginning,” she says.
There have been cases where, due to the low thresholds set in Germany and Austria triggering domestic filings, for example, certain subsidiaries of the target have been left behind with the vendor.
McGeown, however, counsels against this type of deal re-engineering. “As a general rule, don’t let the regulatory tail wag the commercial dog. Identify and work on the deal the client wants to do, otherwise you may well end up with an unhappy client. The issues are particularly acute now when no one is quite sure how the new regime is going to operate or what the position of individual jurisdictions will be towards competition issues,” he says.
“The new rules do allow a more flexible approach to determining which is the most appropriate regulator to assess a transaction. Sometimes this will be helpful, especially since these discussions will be possible – and, indeed, encouraged – pre-notification,” says Gibson-Bolton.
Baker of Taylor Wessing points out that the pre-notification process will inevitably involve a degree of uncertainty pending the final case allocation and will need to be managed carefully if the desired result i.e. a single filing is to be achieved. “And adding that this additional stage may well increase the timescale required to obtain clearance,” he says.
“Having a choice of where the merger will be looked at will shift a lot of the filing work to a much earlier stage and inject a different dynamic into the investment process. PE houses will need to analyse competition issues very carefully and, if there is a particular issue in a Member State, deal with it at the outset,” Baker continues.
Another much-heralded change to the ECMR is to the substantive test for assessing mergers. Previously based on individual ‘dominance’ the Competition Directorate – currently headed by Commissioner Mario Monti – will now consider whether a deal ‘significantly impedes effective competition’ in the common market or a substantial part of the common market.
The Commission has emphasised the amended test applies to all kinds of mergers that may have an anti-competitive effect, including where such effects are created in oligopolistic (concentrated) markets. “This change gives the Commission more scope than previously although, in practice, it is unlikely to make any significant difference to the vast majority of PE cases,” notes Gibson-Bolton.
Preparing a filing has traditionally required the submission of copious amounts of data on the parties involved, their ownership and control, the markets in which they operate, the planned concentration, the prevailing market conditions, structure, and so on. This administrative burden has been particularly tiresome in cases where no competition concerns are actually raised.
“But again there is good news with the ECMR reforms extending short form filing to all unproblematic cases. This will make the formal notification requirements far less onerous,” says McGeown.
When it comes to dealing with the Commission itself, again things have changed with no MFT and an emphasis on individual industry sectors. “The MFT was an elite team and very good at getting deals dealt with efficiently. It will be some time before we can be sure that the new arrangement is a positive development,” says Martin Baker.
“While the direction of the organisational changes taking place is encouraging, more still needs to be done to provide clear evidence that consumer interest, procedural transparency and predictability are getting real attention. And, despite some beefing up of the size of the team assessing mergers it still compares unfavourably with its equivalent in the US,” Gibson-Bolton points out.
Martin Baker believes that while there seems to be a general awareness among PE firms of the merger control reforms the detail is not particularly well understood. “Generally the reforms are likely to improve the run of things and be good for PE investors, but more than ever firms need to be thinking about anti-trust issues as early on as possible. The better prepared they are then so the possibility of delays decreases,” he asserts.
“The ECMR reforms are workable and sensible but, inevitably, the process will take time to bed down and there are bound to be anomalies and uncertainties until some Commission precedents have been set,” says McGeown.
“Certainly for phase 1 cases the new regime is likely to be beneficial because there is now more time for the Commission to consult. But there is some disquiet about phase 2 where the time frame within which businesses have to reply to the Commission’s objections and propose remedies is quite severe,” he continues.
Gibson-Bolton agrees: “On the whole, the reforms are a good thing with increased flexibility for PE investors. This should, in principle, offer more options in terms of when to notify and the most appropriate jurisdiction. But no doubt there will be teething troubles, particularly with the inclusion of ten new Member States for whom ECMR, with its tight deadlines, will be something of a novelty.”
“But once some of the bigger pan European funds, which are best equipped to deal with merger regulation, have started to use the referral procedures and established a modus operandi with the Commission, then the reformed ECMR should mean time and cost savings. At the moment, however, firms need more guidance on how the regulations will work in practice,” she concludes.