The below is the first in a series of briefings from Chris Grey, a London, UK based corporate lawyer at Clifford Chance LLP specializing in Tech M&A and venture capital, examining regulatory and governance issues for investors and companies involved in quantum computing.
‘Technology Sovereignty’ and national security concerns will likely play an increasing role as the quantum industry continues to develop. Companies, investors and founders should keep in mind not only the regulations in force today, but anticipate the broader regulatory trends and be familiar with these issues ahead of time to avoid unwanted surprises in any fundraising or acquisition process with foreign investors. This briefing introduces participants in the quantum industry to issues they should keep in consideration when contemplating cross-border transactions.
Foreign direct investment (FDI) and cross-border M&A are coming under increasing scrutiny worldwide, particularly where sensitive or ’emerging’ technologies are concerned.
In part, this is a global phenomenon stemming from governments reclaiming ‘technological sovereignty’. Quantum computing is one such technology that is now being specifically targeted by regulators and, for example, the European Commission’s Internal Market Commissioner, Thierry Breton, set out an explicit policy in 2020 of taking back ‘digital sovereignty’ with a key pillar of his policy being “Europe’s capacity to develop and produce the world’s most powerful processors, including quantum ones“.
Even before this trend got under way, quantum technology was already under the spotlight due to the national security implications of quantum algorithms and cryptography or secure communications networks.
The scope and complexity of these FDI regulations will only increase as governments catch up to each other and seek to regulate quantum computing as processing power rapidly scales up and the business use cases expand. Breaches of these regulations can already have severe financial, reputational and even criminal consequences.
Although we have not yet seen high-profile examples of quantum technology investments being specifically blocked by governmental authorities, it is only a matter of time before regulators begin to use the expanding selection of regulatory levers in their toolkit (FDI regulations, antitrust, export controls) to protect national interests in the race for quantum advantage.
Foreign investors and companies focused on the quantum computing sector should ensure they are well-advised on these rules sufficiently prior to entering into discussions to raise foreign capital in fundraising or acquire or sell to foreign investors.
Set out below is a high-level introduction to the foreign investment regulatory frameworks in the U.S., the EU and the UK, as they apply to quantum technologies:
A foreign merger, acquisition, takeover of, or (non-U.S.) minority investment in, a company that designs, produces or develops post-quantum cryptography may require mandatory filing with the U.S. Committee on Foreign Investment in the United States (CFIUS). On the advice of CFIUS, the President of the United States may block, modify or unwind the investment where it is a threat to U.S. national security interests. Approval must be obtained prior to completion of an investment and failure to notify can risk the transaction being ‘unwound’.
We are seeing more and more high profile examples of U.S. government action through CFIUS to block transactions, for example:
- the 2021 order blocking the acquisition of U.S. chipmaker Magnachip by Chinese private equity firm Wise Road Capital,
- the 2020 executive order directing Chinese company ByteDance to sell or spin-off the U.S. TikTok business on the basis that it did not seek CFIUS approval when it acquired the social media app Musical.ly in November 2017.
Foreign investment rules are in place both at the EU level and at the level of individual EU Member States. The recent EU Screening Regulation (2019/452) has put in place a coordination framework that is designed to preserve Europe’s strategic interests while keeping the EU market open to investment. These regulations apply specifically to investments in quantum technologies, which are considered to be ‘critical technologies and dual use items’.
The European Commission doesn’t have the power to block an investment or impose penalties, but can issue a non-binding opinion to the relevant EU Member State. Note that most EU Members State now have their own local foreign investment regulations.
Taking France as an example, investments in quantum technologies are subject to mandatory filing requirements where they would lead to taking ‘control’ of a French entity, acquiring a business division operated by a French entity or for non-EU/EEA investors, acquiring more than 25% of the voting rights of a French entity. Failure to obtain government approval would expose an investor to significant fines and the risk of the transaction being blocked or ‘unwound’ at the investor’s expense.
The National Security and Investment Act 2021 came into force in January 2022, allowing the UK government to scrutinise and intervene in certain acquisitions that could harm the UK’s national security. Quantum technologies are specifically targeted by this legislation.
Any investment in an activity in quantum technology that results in acquiring (a) more than 25%, 50% or 75% of the shares or voting rights in an entity, or (b) sufficient voting rights to pass or block a class of resolution governing the affaires of the entity, will now require mandatory filings and government approval before they can complete. Whether for mandatory or voluntary filings, the UK government can block or unwind the transaction and impose other remedies.
Failure to file a mandatory notification has severe consequences for the investor, with the risk of significant civil fines and/or imprisonment, as well as the transaction being declared ‘legally void’.
Transactions that are not subject to mandatory filing requirements may also be ‘called in’ by the UK government after they have already completed, during a period of up to 5 years. This call-in power broadly defined and so may also extend beyond investment and acquisitions, for example IP licensing or assignments. However, by proactively informing the UK government of a transaction it is possible to shorten the ‘call in’ period to 6 months.
The following table lists the above regulations and sets out the penalties for violations.
|Jurisdiction||Regulator||Regulations||Quantum Sector||Penalties for violation|
|U.S.||CFIUS||Defense Production Act of 1950 Executive Order 11858 Chapter VIII of title 31 of the Code of Federal Regulations||Post-quantum cryptography||Civil fine of up to the entire value of the transaction for a failure to make a mandatory filing. Un-notified transactions can be ‘unwound’.|
|EU||European Commission||EU Screening Regulation (2019/452)||Quantum technologies||No power to impose fines, however see individual EU Member State regulations.|
|UK||Department for Business, Energy and Industrial Strategy (BEIS) Secretary of State for BEIS.||National Security and Investment Act (2021)||Quantum technologies||Failure to file a mandatory transaction: imprisonment of up to 5 years for individuals and/or fines up to the greater of (i) 5% of the group worldwide turnover of the investor and (ii) GBP 10 million. Transactions that close in breach may be declared ‘legally void’.|
|France||Ministry of the Economy and Finance||Decree No. 2019-1590 of December 31, 2019; Ministerial Order of December 31, 2019||Quantum technologies||Maximum penalty is highest of (i) twice the amount of the investment and (ii) 10% of annual turnover of the target company and (iii) EUR 5 million for legal entities and EUR 1 million for individuals. There may also be criminal fines. The French government retains the ability to block transactions and issue orders to unwind them at the investor’s expense, or otherwise suspend the investor’s voting and economic rights and limiting their ability to dispose of the assets.|
As you can see, the regulations can get quite complicated and could potentially change at any time. So, for any organization that might get involved in such a transaction, we recommend they seek professional assistance from someone familiar with these issues in order to avoid any potential problems.
January 30, 2022