National security: the UK’s new foreign investment screening regime

March 2021 | SPOTLIGHT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

March 2021 Issue

On 11 November 2020, the UK government published its National Security and Investment Bill (NS&I Bill), which introduces a new review system for transactions potentially giving rise to national security concerns. The planned regime is broad in scope, catching transactions even where there is very limited UK nexus. The UK government expects between 1000 and 1830 deal notifications each year. This is considerably higher than the 60-80 deals typically notified to the Competition and Markets Authority (CMA) annually under existing merger control rules.

The NS&I Bill is the culmination of a series of steps taken since 2017 to broaden the UK government’s discretionary powers to intervene in any transaction where there is reasonable suspicion that it might present a risk to national security. The proposals are informed by developments in other major jurisdictions, notably the European Union (EU)-level foreign investment screening mechanism (which came into full effect in October 2020), reforms to national-level screening regimes within the EU and the recent strengthening of the powers of the Committee on Foreign Investment in the US.

Although the Bill is not likely to pass into law until mid-2021, this article shows that companies need to consider its potential application now. Reviews will be managed by a dedicated 100-person investment screening unit (ISU) within the Department for Business, Energy & Industrial Strategy (BEIS), under the oversight of the secretary of state. In this article, we consider the key elements of the new regime and highlight practical considerations for dealmakers.

Mandatory notification

The NS&I Bill introduces a hybrid notification regime. Mandatory pre-closing filing obligations will arise for acquisitions of, or significant interests in, companies, assets and intellectual property (IP) in certain sensitive sectors. The 17 sensitive sectors identified in the NS&I Bill include civil nuclear, communications, data infrastructure, defence, artificial intelligence, autonomous robotics and advanced materials. The UK government recently consulted on how to define each of these sensitive sectors, with final guidance due for publication during the first half of 2021. The UK government’s proposed definition of ‘advanced materials’ alone runs to over 11 pages. It is already clear that the mandatory regime will catch a large number of cross-border transactions.

For businesses active in these sensitive sectors, any acquisition of a shareholding or voting rights of 15 percent or more by an overseas investor will be notifiable. For existing shareholders, an increase in shareholding or voting rights that passes any of the 25, 50 or 75 percent ownership thresholds will also be notifiable, as will the acquisition of any blocking powers over the passage of any class of ordinary or special resolution that governs the business affairs of the target.

Furthermore, and in contrast to competition merger control rules, there is no requirement for the transacting parties to have a certain level of UK turnover, share of supply or a subsidiary incorporated in the UK. For a filing obligation to arise, it is sufficient for the target to be supplying goods or services to UK persons or to have assets, including land and IP, located within the UK.

Voluntary notification

The NS&I Bill also sets in place a voluntary filing regime, allowing for notification of investments in businesses that are not active within any of the 17 sensitive sectors, but which nevertheless raise national security issues. Critically, this part of the hybrid notification system gives the ISU the ability to ‘call-in’ transactions for review at its discretion. Similar to current CMA practice, there is expected to be a dedicated merger intelligence team within the ISU, responsible for identifying transactions for potential ‘call-in’. Investors will need to consider the likelihood of a call-in when conducting pre-signing risk assessments and designing transaction timetables.

In addition to the ownership thresholds applied under the mandatory filing regime, the voluntary regime will also apply where an investor acquires “material influence” over a target. It is expected that a parallel will be drawn with CMA merger control, which applies the same concept and looks at whether an investor will be able to block or significantly influence a target’s commercial policy via board representation, voting rights or veto rights over such matters as approval of budget, business plan or senior executive appointments.

Notification process and review timelines

When the regime becomes fully operational, submissions will be made via a digital platform. Following formal notification, the ISU will complete its assessment within 30 working days, assuming it accepts the filing as complete. If incomplete, notifying parties will be required to collect additional information before the review clock starts running.

The UK government expects to clear the majority of transactions within this initial 30 working day review period, which compares favourably with the current public interest regime where review timetables tend to be significantly longer. However, where the ISU has questions it may issue information requests, which will pause the review clock until fully addressed. Additionally, where the ISU determines that further scrutiny is required, the review will be extended by an additional 30 working days. In the most complex cases, this can be extended by a further 45 working days.

Notifying parties may also agree to extend the review beyond this 105 working day period. As the mandatory notification regime is suspensory, assessing the likelihood of a protracted review and, where needed, building flexibility into the transaction timetable, should be a critical early consideration for dealmakers.

Retrospective reviews

Although the regime is not yet fully operational, the legislation does set in place a five-year retrospective call-in power to look at any transaction completed on or after 12 November 2020. Regarding transactions occurring before the regime becomes operational, where the BEIS has been made aware of the deal, the call-in power will only extend for six months from the date of NS&I Bill enactment. Consequently, dealmakers from now onwards will need to assess whether investments fall within scope of the regime, given the risk of a post-closing review and, if there are national security concerns, the potential for remedial action. Investors are currently being encouraged to consult informally with the UK government regarding whether planned transactions are likely to attract scrutiny.

Potential for remedies

Where the UK government does identify concerns, clearance may be subject to conditions such as restrictions on access to sensitive data or limits on the amount of shares an investor is permitted to acquire. In contrast to CMA procedure, where merging parties are generally required to table remedy proposals for the CMA to assess, under the NS&I regime the ISU is expected to take a more active role in identifying the remedies it would require to approve a deal. The UK government estimates only approximately 10 reviews a year will require a remedy. Ultimately, if no suitable remedies are available, the UK government will have the power to block a transaction or, if already closed, require that it is unwound.

The ISU will also have interim order making powers to prevent businesses from integrating while a review is ongoing or, in exceptional cases, prohibit deal closing. These powers are comparable to CMA initial enforcement orders, designed for use when a transaction falls within the voluntary regime. When imposed, these orders are likely to have extraterritorial effect, preventing integration activities outside of the UK to the extent that these impact UK operations.

Sanctions for non-compliance

The UK government will be able to sanction companies and directors that do not fully comply with the new regime. Fines of up to 5 percent of the annual global turnover of the acquirer or £10m, whichever is greater, may be imposed where there is a breach of the standstill obligation under the mandatory regime or non-compliance with an interim order. Directors responsible for these decisions may also be disqualified for up to 15 years and may also face up to five years’ imprisonment. Furthermore, transactions completed in breach of the mandatory regime standstill obligation will be legally void.

Information sharing with other regulators

The NS&I Bill permits information sharing with other UK agencies, including the CMA, and potentially with overseas regulators conducting parallel reviews. In light of the recent broadening of equivalent regimes in other major jurisdictions, notably across the EU, it seems likely some level of cooperation will be set in place among Western governments that share concerns about Chinese investors in particular. Information sharing with other members of the Five Eyes alliance also seems likely.

Practical considerations for investors

While the UK government has emphasised that the powers contemplated by the NS&I Bill will not be used to intervene in transactions for “broader economic reasons”, these UK reforms can be set against the backdrop of the sweeping reforms to foreign investment regimes in other major jurisdictions. Regulators in the UK and elsewhere have increasingly broad jurisdiction to review a range of transactions.

Regimes are not designed with legal certainty primarily in mind but rather to give governments the ability to intervene, wherever considered appropriate. The flurry of reforms are indicative of the global move toward greater protectionism, a process accelerated by the fall in asset values and economic instability resulting from the coronavirus (COVID-19) pandemic. Transactions that several years ago may have escaped regulatory scrutiny may now require notification to the ISU and equivalent authorities in other G20 states.

The rise of foreign direct investment controls has occurred in parallel with the continued increase in the number of competition merger control regimes active globally. Notably, the CMA is now able to review transactions in parallel with the European Commission, following the end of the Brexit transition period. Investors should not lose sight of the continued role of the CMA. The new UK regime, established by the NS&I Bill, is focused solely on national security. If a transaction raises competition or non-security related ‘public interest’ concerns, in addition to national security issues, parallel engagement with both the CMA and the ISU may be required and there may be a period of time until there is clarity about how two review processes will be coordinated.

Identifying notification requirements and developing clear engagement strategies with regulators is increasingly critical to ensure a smooth pathway to deal closing. Deal teams are encouraged to take account of these UK reforms (particularly given the risk of retrospective review of transactions completed from 12 November 2020 onwards), as well as the increased interventionism of the CMA at an early stage in deal planning. This will invariably assist parties in mitigating adverse timing and other execution risks.

Matthew Yeowart and Simon J. Little are counsel and Léonore De Mullewie is an associate at Davis Polk & Wardwell. Mr Yeowart can be contacted on +44 (0)20 7418 1049 or by email: matthew.yeowart@davispolk.com. Mr Little can be contacted on +44 (0)20 7418 1036 or by email: simon.little@davispolk.com. Ms De Mullewie can be contacted on +44 (0)20 7418 1070 or by email: leonore.demullewie@davispolk.com.

Matthew Yeowart, Simon J. Little and Léonore De Mullewie

Davis Polk & Wardwell