Main Image Credit Risky business: a model of Hinkley Point C nuclear power station, which is being built with Chinese investment. Image: gov.uk / Wikimedia Commons / CC0 1.0
A little over four months after it came into force, it is timely to assess whether the UK’s National Security and Investment Act is delivering on its intended purpose.
The UK’s National Security and Investment Act (NSIA) came into force on 4 January 2022. It was designed to deliver the intentions behind a range of recent national security and economic policies by preventing inappropriate foreign ownership of, or control over, key areas of the UK economy and infrastructure, as well as intellectual property theft. The Act was conceived to guard against foreign actors with potentially malign intent (such as China’s planned investment in Hinkley Point C and Huawei’s planned involvement in the UK’s 5G network) or commercial entities who might intend to asset-strip UK businesses (such as Advent International’s acquisition of Cobham). New machinery has been established in Whitehall to implement the Act.
Four months after it came into force, there are concerns about the potential reach and commercial implications of the Act. There are questions about whether the machinery of government can operate with the agility needed to ensure a proportionate balance between imperatives of national economic security and the legitimate freedoms of national and international business that make the UK an attractive destination for foreign direct investment (FDI). And there are some concerns that the policy reflects a growing protectionist approach among leading economies around the world, most notably the US, which shifted dramatically under former president Donald Trump and has changed little under Joe Biden.
This article provides an initial assessment of how widely the new legislation is being applied and how effectively the new machinery is operating; it offers some initial views from the business, legal and financial investment sectors about their experience of the new Act; and it suggests a checklist of issues against which the continuing implementation of the legislation could be assessed.
Provisions of the NSIA
The NSIA marks a step-change in the UK government’s ability to intervene in commercial contracts to which it is not itself a party. The Act gives the government powers to scrutinise and intervene in business transactions, including mergers and acquisitions and FDI, to protect national security, while providing businesses and investors with the certainty and transparency they need to do business in the UK.
This brings the UK government’s toolkit more closely into line with key international partners – most notably the US with its Committee on Foreign Investment and Australia with its Foreign Investment Review Board.
The NSIA defines 17 ‘sensitive areas of the economy’ for compulsory notification of significant transactions. It places the responsibility for notification on the company controlling the entity concerned – radically modifying the requirements of the Enterprise Act 2002 and its subsequent amendments. Guidance issued in July 2021 and updated in March 2022 sets out how the process will work and the timescales investors and businesses should expect once notifications have been made.
The Act introduces compulsory notification of significant transactions in very broadly defined circumstances. Failure to notify a qualifying transaction renders the transaction voidable, with power for the government to intervene for up to five years following completion of the transaction in question. There are criminal and civil sanctions for completing a transaction without gaining the necessary approval.
The scope of what counts as ‘significant’ under the NSIA is wide. The 17 sensitive areas include ‘military and dual use’, ‘transport’ and ‘communications’. It would cover, for example, the purchase of a company operating an advanced robotics manufacturing plant, a company acquiring a functioning national port, or a company making mobile phone components.
Finally, the reach of the Act is extra-territorial. Even if a deal is transacted in another jurisdiction, it is still subject to the NSIA if the company or companies concerned provide goods or services in the UK or use UK supply chains.
The consequences for commerce are clear. The NSIA has the potential to interrupt or end transactions which may be critical to the parties involved, and to those who have invested in them. Any significant delays in the scrutiny process could have major consequences for the enterprises concerned.
The government has sought to clarify in guidance issued in November 2021 the circumstances in which call-in powers might be used to guard against immediate or future harm to UK national security, and the risks it will weigh when deciding whether to exercise call-in powers.
For some companies, the requirements of the Act will add another layer of costs at a time when they already face high inflation and tighter purse-strings
This guidance is helpful. It implies that the NSIA will be used thoughtfully and discerningly – and solely to safeguard the UK’s national security. This stated intention is important. The UK is currently the fifth-largest recipient of FDI, and there is some risk that the NSIA could discourage prospective international investors.
Challenges Presented by the Act
First, unlike its US counterpart, the NSIA is less specific about which international partners are deemed to be suitable investors and which are not. This means that all inward investment is potentially subject to scrutiny under the Act. For example, although the acquisitions by Cobham of Ultra and by Parker-Hannifin of Meggitt preceded the NSIA, the governent’s approach displayed its willingness to call in such deals – in these cases both involving US firms.
Second, there is a risk that this approach could deter or at least delay foreign investment in specialist sectors in defence and other hi-tech areas, especially for smaller deals where the costs of the deal going through the NSIA process, compared to the price to be paid, could be material. For firms reliant on angel or early-stage investment to support cashflow, this could prove fatal. The absence of any financial value threshold for transactions under the Act will be of concern to small- and medium-sized enterprises (SMEs) who are looking for investment and access to new markets. With many SMEs involved in the 17 sectors specified in the Act, and with greater interest in the defence and security market in ‘dual-use’ technologies and applications, the legislation could have the unintended consequence of discouraging SMEs from seeking new investors, or investors/acquirers being put off investments or acquisitions in the UK.
Third, businesses and investors will be expected to have a much clearer understanding of the UK government’s national security priorities. This may be straightforward for firms already involved in the UK’s traditional national security sector, but will be less easy (and more expensive) for newcomers. This is particularly true for those operating in the communications, computing hardware/advanced materials, and artificial intelligence sectors, where dual-use technologies are less easily defined and increasingly prevalent.
A combination of these factors could introduce greater barriers to doing business in the UK, making it a less attractive – or at least less straightforward – place to invest. The legislation should provide safeguards against potentially malicious investors. But for some companies, the requirements of the Act will add another layer of costs at a time when they already face high inflation and tighter purse-strings.
It follows that the greatest possible clarity on the government’s intentions on a sector-by-sector basis will be useful to ensure that the Act serves its intended purpose. At the very least, a greater sense of which security concerns are paramount would be useful. This will need to include the best possible guidance for companies considering significant mergers and acquisitions, and for investors considering direct investment in the UK. A good dialogue between government departments, industry, investors, and the lawyers and others advising them will be vital.
The New Machinery
The Investment Security Unit (ISU) within the Department for Business, Energy and Industrial Strategy (BEIS) is the lead unit set up to process and respond to NSIA notifications. Built around a hub and spoke model, the ISU engages with other relevant government departments and agencies to confirm whether or not there are concerns over a particular transaction. Other departments with key stakes include the Ministry of Defence (for obvious reasons) and the Department for Digital, Culture, Media and Sport (due to the prevalence of digital and telecommunications sectors in the Act).
These and other ministries and agencies are establishing between them the capacity to process the several thousand notifications a year that were originally predicted. There is not yet any publicly available data on the number of cases that have been notified during the first four months of operation, but we understand that they have been lower than expected. Triage systems are being developed to ensure that departments are not swamped by surges of cases and that important cases are not missed. While the majority of cases may pass through without problem, hi-tech, specialist companies – where value propositions may be uncertain or have dual-use potential – are likely to be subject to stricter scrutiny. Many companies, particularly start-ups, will be concerned by the additional costs they will incur under this new regime.
We expect the government to publish the results of a review of the initial implementation of the Act in summer 2022, when case numbers and the government’s assessment of how its triage system is working should become clearer.
Private Sector Experience to Date
The private sector has primarily relied upon its legal advisers, as experts in competition and regulatory issues, to advise on NSIA requirements and implementation. However, in various conversations with corporates, lawyers and investment funds, we have heard some concerns about government methodology – especially given the close proximity between legal issues (generally close to being a ‘known known’), policy (‘a known unknown’) and political agendas (‘an unknown unknown’). These challenges make legal advisers nervous about giving high-percentage predictions to clients about the prospect of deals being called in or blocked by government.
While the NSIA defines the 17 sensitive areas of the economy, it remains difficult to interpret the government’s national security concerns and priorities as they relate to these sectors. The very breadth of the categories creates challenges for businesses, who want as clear a picture as possible when making significant, sometimes make-or-break financial decisions. The cost of the collapse of the ARM/Nvidia deal is the most recent example of the risks involved.
How businesses and investors perceive the government’s approach to enacting the legislation will be important. The policy goals behind the firmer regulation of mergers and acquisitions and FDI could be construed by risk-averse company boards and investors as a disincentive to doing business in the UK. To counter this risk, the government will need to build confidence in both the legislation and its policy execution, by permitting decisions to be made at appropriate levels in departments, and by publishing decisions to provide awareness of where it is setting the bar, and why. This should be done in parallel with regular engagement with businesses and investors.
Some entities are choosing to take the risk of not notifying planned deals on the basis that they believe the government will only be focused on the complicated cases
As things currently stand, without clarity about the types of deals that are being closely scrutinised, we understand that some entities are choosing to take the risk of not notifying planned deals on the basis that they believe the government will only be focused on the complicated cases. We have also heard that, in private equity cases, some sponsors are proactively and voluntarily notifying transactions to try to remove the risks of retrospective call-in and of transactions being unwound. As implementation proceeds, a balance will need to be struck between these approaches.
Another challenge comes from intergroup restructuring, which could, in principle, establish a requirement for mandatory notification. All this creates an additional hurdle for venture capital and private equity investors as they consider their risk appetite for early-stage investments. In some cases, investors who are not the deal’s counterparties could face the challenging scenario of holding significant stakes in both of those counterparties. They will wish to have the clearest possible visibility of relevant departments’ thinking to inform their choices and decisions.
Further difficulties could arise from sudden and dramatic shifts in the international security landscape. The Russian invasion of Ukraine and the rapid shift in the government’s position on Russian investment and assets in the UK is a case in point. The scope of required referrals is bound to change, sometimes as fast as the news.
Finally, the requirement under the recently passed Economic Crime Act (ECA) for the foreign beneficial owners of UK property to identify themselves in a register adds further complexity. The enforcement architecture of this legislation will presumably be aligned with that of the NSIA, given that national security considerations may also arise under the ECA – as well as important questions about legitimate requirements for privacy.
All this has left a much wider net of businesses wondering about their notification requirements and the potential risk that their sector could be added to the mandatory notification list in the not-too-distant future.
A Checklist to Assess Progress with Implementation
We believe that the NSIA represents a pragmatic approach to protecting the UK’s national and economic security interests in the more competitive and adversarial decade in which we are living. It is sensible to have created a regulatory framework that brings the UK more closely in line with some of its key allies.
The headline goals of the policy which the legislation and new machinery are intended to enact are clear. The model designed by the government and the new Whitehall structures appear to provide a generally sound basis for managing the process and ensuring that enforcement can be achieved in a manner that limits the risk to the UK’s leading position as a destination for FDI. The published guidance on how the Act will work, the timescales investors and businesses should expect, and the risks the government will be weighing when assessing whether or not to call in individual cases provides solid foundations.
However, based on a range of discussions with businesses, legal firms and investment houses, we have heard various concerns about the depth and clarity of the available guidance and how the machinery is operating in practice. We suggest that the following simple checklist could be useful both to government and to those interacting with the NSIA to assess initial experiences of working with the new Act and ways in which the next phase of implementation could be improved:
- Is the policy and practical guidance on the Act clear enough in aggregate and detail, including in relation to each of the 17 sensitive areas of the economy, so that businesses and investors understand which mergers, acquisitions and inward investments the government is encouraging or would discourage/block? Is it being applied consistently?
- How could acquiring companies be more thoughtful and thorough about what information to provide government in their notifications, regarding themselves and the target company, to help officials more quickly assess their case?
- Is there a clear mechanism with simple communication channels to enable businesses and investors to interact effectively with the relevant departments, beyond the ISU in BEIS?
- Are industry concerns being dealt with fairly and promptly? Is there a need for a simple forum to bridge any gap that currently exists?
- Is the machinery that has been established to operate the NSIA proportionate to the number of cases now in train? Are any adjustments required to the machinery based on the first few months of its operation?
We look forward to seeing the government’s report in the summer on the initial phase of the Act’s implementation, and hope that this article and the suggestions we have made will inform debate about the further development of guidance and procedures for the future operation of the NSIA.
The views expressed in this Newsbrief are the author’s, and do not represent those of RUSI or any other institution.
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Lord Carlile of Berriew CBE, QC
Will Jessett CBE
Senior Associate Fellow