National security: a review of the first year of the UK’s foreign investment regime

April 2023 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

April 2023 Issue

Under the UK National Security and Investment Act 2021 (NSIA), the Investment Security Unit (ISU) started to accept filings on 4 January 2022. One year on, the ISU has blocked four transactions and imposed conditions in a further 11 transactions on the basis that they pose a risk to UK ‘national security’ – a concept not defined in the NSIA.

In February, the government moved the ISU to sit within the Cabinet Office, with ultimate decision-making power now resting with Oliver Dowden, secretary of state and chancellor of the Duchy of Lancaster, a close ally of the prime minister. This signals the increasing importance with which the new NSIA regime is regarded by the current government and foreshadows a potential uptick in intervention rates with greater risk of political considerations determining outcomes.

In the 14 months since the NSIA regime became operational, it has demonstrated its ability to disrupt cross-border deals and prohibit or condition approval on far-reaching remedies. In this article, we consider the key enforcement trends and process issues that dealmakers should consider early in deal planning.

Filing requirements not limited to traditional M&A

The NSIA casts a wide net, with reviews potentially required not only for traditional M&A but also a range of other transactions, including minority share acquisitions of more than 25 percent, internal reorganisations, grant of a licence agreement, lending transactions that involve the transfer of legal title or control and appointment of a liquidator where it gains voting rights over a solvent subsidiary of the liquidated entity. A filing may also be triggered by incremental acquisitions that cross the 50 percent or 75 percent ownership thresholds and the ISU even has the discretion to call in acquisitions of less than 25 percent if they confer ‘material influence’ over a target’s commercial strategy.

Potentially lengthy timelines

While the NSIA sets out statutory review timelines – the review period can run for a maximum of 105 working days – its practical application is less predictable once a deal is called in for in-depth review. That is a result of stop-the-clock information notices – of which there can be several rounds – that can prolong reviews considerably. In complex cases, the ISU may also seek a voluntary extension.

In practice, complex reviews may run for six to eight months and potentially longer. Deals that do not get called in are typically cleared within one to two months of notification.

Range of sectors and acquirer types in focus

The NSIA prohibition and remedies cases to date demonstrate that the ISU is closely scrutinising a range of sectors. In addition to military and dual-use matters, where three cases have been subject to prohibition or remedy, the ISU has also blocked or imposed conditions in a range of other sectors, including energy (three cases), communications (two cases), satellite and space technology (two cases), quantum technology (three cases) and industrial engineering (one case).

Although there is a clear focus on acquirers with actual or potential links to China and Russia, which accounted for all publicly known prohibition decisions in 2022, acquirers domiciled elsewhere are not immune from scrutiny. In 2022, remedies were imposed in deals involving acquirers with actual or potential links to China and Russia, as well as acquirers from the United Arab Emirates (UAE), the US and the UK.

In fact, the true number of deals that collapsed due to NSIA scrutiny is unlikely to yet be clear. In contrast to antitrust processes, the secretary of state is not obliged to publish a prohibition decision or notice of deal withdrawal where transacting parties decide to terminate a deal prior to a decision deadline.

UK industrial policy

Under the NSIA, the ISU is required to consider “target risk” (the activities of the target), “acquirer risk” (the extent to which the acquirer poses national security risk) and “control risk” (the type and level of control being acquired).

In the majority of cases, the ‘target risk’ will be the primary driver of the assessment. However, there are certain categories of acquirers that are viewed as problematic, even if the target they are seeking to acquire only has limited UK-sensitive activities. Where a potentially problematic acquirer is looking to buy a business that may have sensitive activities in the future (e.g., Nexperia/Newport Wafer Fab) or where the UK concludes its infrastructure is already overreliant on an acquirer and any incremental increase in that reliance would be problematic, that may be sufficient to prohibit a deal on ‘acquirer risk’ grounds.

Throughout reviews, the ISU is typically unwilling to provide insights into its analysis. ISU commentary during calls with notifying parties will focus almost exclusively on process. Guidance on whether there are ‘national security’ concerns under consideration will not be shared until the latter stages of a review.

Decision making can also be driven by other government departments. For example, in telecommunications-related transactions, ISU questions and the outcome of a review are likely to be influenced by the views of the National Cyber Security Centre and Department for Culture, Media and Sport. The outcome of defence-related reviews will rely on feedback provided by the Ministry of Defence. Notifying parties should therefore design engagement strategies to make sure that deal rationale is clearly understood by all government stakeholders in order to allow for as quick and efficient a review as possible.

Relatedly, NSIA outcomes are potentially influenced by broader political dynamics. Members of the US Congress actively petitioned the Biden administration to engage with the UK regarding Nexperia’s acquisition of Newport Wafer Fab, a deal which the government ultimately determined should be unwound. The recent move of the ISU into the Cabinet Office is likely to increase the ability of politicians and administrations in allied countries to influence outcomes. It is therefore prudent to have advisers look across filing jurisdictions and design engagement strategies to take account of parallel reviews and the prospect of the ISU cooperating with its counterparts elsewhere.

Interim order powers

The mandatory regime suspends closing until the ISU has reached a decision. However, under the voluntary regime, the ISU has demonstrated its willingness to impose restrictive interim orders, pending the outcome of its review. These may impose restrictions that go even further than the standstill obligation under the mandatory regime and prohibit any communications between the parties altogether. It is therefore important to consider deal timing implications, long-stop dates and integration planning mechanisms, even for matters that may be subject to discretionary call-in under the voluntary regime.

A preference for behavioural remedies

In contrast to antitrust regulators, the ISU regularly imposes behavioural remedies. These may include keeping certain strategic capabilities within the UK, information restrictions, security measures and government oversight through approval of board members, auditors and security officers.

As ISU conditions to clearance tend to be loosely drafted behavioural remedies, continuing post-clearance dialogue between parties and authorities may be required. Whether this trend will continue remains to be seen, as the ongoing monitoring required by such remedies may stretch the ISU’s resources as it takes on more cases over time.

Unilateral remedy design

Where ‘national security’ concerns are identified, remedies are not negotiated with the parties. Imposing remedies or blocking a deal entirely is a unilateral decision taken by the secretary of state considering the recommendations of the ISU.

Parties do have an opportunity to make representations with regard to the ISU’s remedy analysis. However, as the ISU will only provide a high-level and non-exhaustive list of the remedies it is considering, and the parties have limited insights into the concerns that those remedies are designed to address, the ability to make representations that influence outcomes is typically limited.

Once a ‘final order’ is adopted, there is also limited scope to vary it. While the parties can request variation of the final order, the ISU will tend to grant it only if there is a material change of circumstances. To date, there has only been one variation (Beijing Infinite Vision Technology Company Ltd./The University of Manchester).

Judicial review?

Although parties have limited influence over the contents of a final order, they do have the right to apply for judicial review on (albeit relatively limited) grounds of illegality, procedural unfairness or irrationality.

To date, Nexperia/Newport Wafer Fab is the only NSIA case which has led to a judicial review application. Nexperia has lodged an application on the basis that the final order was disproportionate and therefore illegal, as the ordered divestment of Newport Wafer Fab puts hundreds of jobs at risk and other remedies had been offered but rejected. The outcome of the application is pending, but will set a precedent for future deals and may prompt refinements to ISU review processes.

Looking ahead

The ISU is expected to continue to be very active in the year ahead, particularly as it now sits within the Cabinet Office with reviews closely scrutinised by high-ranking political decision makers. The current government appears broadly approving of outcomes to date and a change in enforcement practices therefore seems unlikely. As the regime continues to develop, transacting parties are encouraged to consider risk allocation at an early stage in deal planning to reduce commercial uncertainty and to seek the views of legal counsel when navigating the complexities of an ISU review.

Matthew Yeowart is counsel and Sara Moshfegh and Dylan Jones are associates at Davis Polk & Wardwell. Mr Yeowart can be contacted on +44 (0)20 7418 1049 or by email: matthew.yeowart@davispolk.com. Ms Moshfegh can be contacted on +44 (0)20 7418 1084 or by email: sara.moshfegh@davispolk.com. Mr Jones can be contacted on +44 (0)20 7418 1028 or by email: dylan.jones@davispolk.com.

Matthew Yeowart, Sara Moshfegh and Dylan Jones

Davis Polk & Wardwell