This week the UK Government introduced before Parliament its much anticipated National Security and Investment (NS&I) Bill – setting out proposed legislation for major reform of the UK’s foreign investment control regime which would significantly increase the Government's ability to scrutinise investments in the UK on national security grounds.
In summary, here’s what you need to know:
- New stand-alone regime for national security vetting
- Expanded category of transactions that are within the new regime’s scope
- For certain sectors, mandatory notification of such transactions
- For other investments, voluntary notification where they potentially raise national security concerns
- No jurisdictional thresholds preventing smaller transactions from being caught
- Operation of certain provisions retrospectively and thus potentially affecting deals completed prior to the new regime’s introduction
- Significant fines and other legal consequences for non-compliance (including criminal sanctions and transactions being void)
Unlike many countries, the UK has hitherto not had a specific regime for review of foreign investments. Currently national security concerns can be tackled by the Government through a process allowing it to intervene on public interest grounds in the UK merger control regime under the Enterprise Act 2002 (EA02). However Government intervention to date on national security grounds has been relatively rare; it has intervened in only 12 mergers since the current regime came into force nearly two decades ago.
Nevertheless, intervention under the existing regime has been on an upward trend, with the Government in recent years becoming increasingly concerned about the need to deal more effectively with corporate takeovers of UK companies and other investments in the UK by foreign players, in particular by those perceived to be potentially hostile to UK interests – and in relation to sensitive sectors involving advanced technologies as well as sectors more directly concerned with military or defence matters.
The Government has therefore been considering the steps it might take to widen the variety of transactions that it can review on national security grounds. To this end, it published a White Paper on the topic in July 2018 and, as something of a stop-gap in anticipation of the introduction of a NS&I regime, it lowered the jurisdictional thresholds for review of transactions in certain technology sectors to facilitate easier intervention where national security issues may arise (see our previous briefing note).
The proposed new NS&I legislation will replace these provisions with a stand-alone regime covering all national security considerations arising as a result of investments/acquisitions involving UK businesses or assets. In the interim between the NS&I Bill’s introduction and the entry into force of a new Act, the existing national security powers of the Secretary of State (SoS) under the EA02 will continue to apply.
It is worth noting two features of the proposed regime which distinguish it to some extent from similar regimes in other jurisdictions. First, its application is limited to national security concerns rather than broader national interest issues. Secondly, the new regime applies not only to foreign investors; in principle, it could also apply to transactions involving domestic acquirers where national security issues arise. However, in practice it can be expected that the focus will more be on overseas players looking to invest in the UK.
How the new regime will work
The Bill sets out provisions for the “making of orders in connection with national security risks arising from the acquisition of control over certain types of entities and assets and for connected purposes”. More details on the key features of this new screening for investments in the UK economy are set out below.
Stand-alone FDI regime: the NS&I regime sits alongside but is separate from the UK’s current competition and public interest intervention regime under the EA02.
Broader scope: the NS&I regime expands the type of transaction that could be reviewed, as compared with the EA02 regime, with designated trigger events defined as gaining control over qualifying entities or assets.
Control of an entity for these purposes arises with:
- Acquisition of more than 25%, 50% or 75% of the shares or voting rights in the entity (i.e. including moving from a lower level of interest to a higher band). The lower threshold is reduced to 15% for acquisitions falling within the mandatory notification regime;
- Acquisition of sufficient voting rights to pass or block resolutions governing the affairs of the entity; or
- Acquisition of material influence over the policy of the entity (this is only relevant to acquisitions falling under the voluntary notification regime).
Control of an asset arises upon the acquisition or increase of a right to use the asset or to direct or control how it is used.
As for what constitute qualifying entities or assets, unlike the EA02, which requires a transaction to involve two or more ‘enterprises’ (i.e. businesses), the proposed NS&I regime also permits scrutiny of acquisitions consisting only of an asset or assets falling short of a going concern. This includes land and tangible property and also ideas, information or techniques such as databases, algorithms, formulae and software.
Mandatory notification sectors: there is a requirement for parties to notify and obtain pre-closing clearance from the SoS for acquisitions of qualifying entities in certain sensitive key sectors (this does not currently extend to qualifying asset deals – although this may be provided for in secondary legislation). The Government has launched a consultation paper on the key sectors which will be subject to the mandatory notification regime. The provisional list of 17 sectors is follows: advanced materials, advanced robotics, artificial Intelligence, civilian nuclear, communications, computing hardware, critical suppliers to government, critical suppliers to the emergency services, cryptographic authentication, data infrastructure, defence, energy, engineering biology, military/dual use, quantum technologies, satellite/space technologies, and transport.
Voluntary notification: the NS&I Bill also introduces a voluntary notification process for trigger event transactions (in relation to qualifying assets as well as qualifying entities) which are not in a key sector but where there may still be a national security issue to consider. As with the current EA02 merger control regime, transacting parties will have the option of not notifying the SoS but, if they chose not to do so, they risk a call-in for review by the SoS subsequently. Specifically, the NS&I Bill provides the SoS with the power to call in anticipated or completed transactions where the SoS reasonably suspects that there is or could be a risk to national security as a result of the transaction.
No jurisdictional thresholds: there will not be any thresholds relating to the size of the deal or the target which allow smaller transactions to escape scrutiny (unlike under the EA02 merger control regime, where there are thresholds based on the target’s UK revenues or the parties’ share of supply/consumption in UK markets).
Strong sanctions for non-compliance: the NS&I Bill has significant penalties for parties who complete a transaction which is subject to the mandatory notification requirement without prior SoS approval, including fines of up to £10 million or 5% of an offending company’s annual revenue (whichever is higher) and/or prison sentences of up to five years. Further, such transactions will be deemed legally null and void.
Long window for intervention: notably, the NS&I Bill gives the SoS an extended period to intervene in trigger event transactions which were not notified to him/her at the time, although once the SoS is aware of the transaction he/she will have a short window to act. Specifically, as regards trigger event transactions occurring after the commencement date of the new legislation:
- Those which were subject to voluntary notification but not notified will be open to review by the SoS at any point in the five years subsequent to their occurrence – but once the SoS becomes aware of the transaction he/she will be subject to a six-month deadline to intervene.
- Those in the sectors subject to mandatory notification which were not duly notified will remain exposed indefinitely to review by the SoS, subject again to the application of the six-month deadline once the SoS is aware of them (the transaction will be void from the outset pending any subsequent decision by the SoS to clear it, and the parties will also be exposed to sanctions for failure to file, as explained above).
Perhaps most controversially, the legislation, as it currently stands in draft before any Parliamentary scrutiny, will in addition have retrospective effect in relation to trigger event transactions which take place in the period between the introduction of the NS&I Bill earlier this week and the new regime coming into force. Whether in a mandatory notification sector or not, any trigger event transactions occurring between 12 November 2020 and the commencement date of the new legislation will be open to review by the SoS at any point in the five years running from the commencement date, but subject again to the six-month deadline for the SoS to act once he/she is aware of the deal.
The Government will provide a statutory Statement with more details on how the SoS expects to use the power to issue a call-in notice and how the NS&I voluntary notification regime will apply. A draft of this Statement has already been published (available here).
How transactions will be assessed
Where a transaction is notified, the SoS will have 30 working days to decide whether to call it in for a national security assessment or take no further action.
Following a call-in (whether after a notification or upon the SoS’s own initiative), the national security assessment must be undertaken within a 30 working day review period, although this may be extended by an additional 45 working day period where the SoS believes that a national security risk has arisen that warrants further investigation, with the possibility of a further extension by agreement with the parties.
The SoS will have broad power to obtain information where it is necessary for assessing the national security implications of the notified transaction, including from third parties. The SoS will also be able to issue interim orders to prevent pre-emptive action that might prejudice his/her ability to undertake the review.
Any subsequent clearance may be subject to conditions or undertakings which could include altering the level of shareholding that an investor is allowed to acquire, restricting access to sensitive information, or controlling access to certain operational sites or works. The Government will have the power to block or unwind transactions as a last resort.
It should be noted that the broad wording in the draft legislation and the absence of a definition in it of ‘national security’ would provide the Government with a significant margin of discretion to intervene in transactions.
Impact of the new regime
The Government believes that this new regime will give investors and businesses certainty and predictability when doing business in the UK. The provisions of the NS&I Bill, in particular the mandatory notification requirements, also bring the UK more into line with the FDI regimes seen in many other countries (in Europe and beyond).
However, certain aspects are anticipated to be contentious and may create concerns for business – particularly given the UK’s historically open stance towards foreign investment. Some of the proposed measures may be seen as creating a risk of deterring inbound investment at a time when the UK is keen to be seen as ‘open for business’ following Brexit.
The Government estimates that the NS&I regime could result in over 1000 transactions being subject to the new notification requirement annually. Of these, it is anticipated that close to 100 transactions will be called in for further scrutiny and that approximately ten will be subject to remedial measures.
The new regime will increase the regulatory burden for business, particularly for SMEs. Although there will be no fee charged by the Government where a transaction is reviewed (unlike under the EA02 merger control regime), the Government in its impact assessment notes that the cost to companies involved in a review could be significant (as high as £300,000 for a transaction involving a large company). The assessment also indicates that the overall cost to businesses could be as high as £40m a year.
The regime will also create legal uncertainty for trigger event transactions that proceed without a prior review by the SoS. This potentially includes deals that would legitimately have fallen outside UK merger control jurisdiction under the EA02.
Transaction parties are therefore well advised to consider whether they may be subject to notification obligations and/or exposed to Government review as a consequence of the new NS&I Bill. For trigger event deals subject to voluntary notification, the pros and cons of filing the transaction with the SoS, and so closing off the five-year intervention risk, will need to be weighed up.
Similar considerations arise in relation to trigger event deals which take place in the period between 12 November 2020 and the commencement date of the new legislation: these transactions will also be exposed to the possibility of being called in by the SoS in the five years following the commencement of the new legislation, unless the parties choose to make the SoS aware of the transaction and thereby start the clock on the six-month deadline for the SoS’s intervention.
The Government has launched a public consultation on the types of transactions that may require mandatory notification under the NS&I Bill. Responses to the consultation must be submitted by 6 January 2021.
In addition, and ahead of the legislation coming into force, the Government is welcoming informal engagement from businesses about transactions which may fall within the scope of the new regime (representations to be sent to firstname.lastname@example.org).
As for when the new regime will come into force, if the NS&I Bill is approved by Parliament largely in its current form and without any delays, the new regime could enter into law as soon as the end of this year or early next.
Authored by Mark Jones, Christopher Peacock and Matt Giles.