UK National Security and Investment Act

August 2021  |  TALKINGPOINT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

August 2021 Issue

FW discusses the UK National Security and Investment Act with Nicole Kar, Christian Ahlborn, Christoph Barth, Jonathan Gafni and Mark Daniel at Linklaters LLP.

FW: Could you provide an overview of the actual or perceived national security threats facing the UK, which led to the introduction of the new National Security and Investment Act (NSIA)? What does it aim to achieve?

Kar: Although it has historically been a very open economy with little in the way of national security screening in place – with only 13 national security reviews in around two decades – concerns around national security have been growing for some time in the UK. In 2015, the Theresa May government published its ‘National Security Risk Assessment’, which concluded that national security threats were increasing in scale, diversity and complexity. It highlighted the resurgence of state-based threats and the transformative impact of technological developments – driving, for example, the evolution of new cyber threats. In 2017, the then UK government published a Green Paper, which concluded that its existing enforcement toolkit was inadequate to address these evolving national security risks. The UK was not alone in this: a recent Organisation for Economic Co-operation and Development (OECD) paper noted that 2016 seemed to mark a turning point in national security screening, with many OECD member countries reconsidering whether their former essentially unconditional openness to foreign investment was making them increasingly vulnerable in a changing geopolitical environment.

Ahlborn: The National Security and Investment Act (NSIA) reflects a UK backdrop of domestic political concerns over technological sovereignty and opportunistic acquisitions of undervalued UK businesses – which have only been exacerbated by the coronavirus (COVID-19) pandemic. These concerns were highlighted in guidance published by the UK government in late 2020, aimed at British technology companies, particularly those working with China. The aims of the NSIA are to strengthen the UK’s ability to intervene in transactions to protect UK national security, but at the same time to ensure the approach to screening is proportionate and efficient and that the UK remains a “global champion of free trade and an attractive place to invest”. In practice, given that the NSIA will subject investments in companies with UK activities to stringent new levels of scrutiny with the government anticipating that between 1000 and 1830 transactions will be notified each year, the experience and efficiency of the newly created Investment Security Unit will be key if the government is going to balance these objectives.

Gafni: Until now, the UK has been almost unique among major Western economies in not having a standalone foreign investment regime. The UK’s introduction of the NSIA is consistent with the trend toward strengthened foreign investment control in a significant number of major economies worldwide following the COVID-19 pandemic and the newly introduced EU Investment Screening Regulation. It will subject foreign investment in the UK to some of the most expansive levels of scrutiny of any regime globally. The NSIA is expected to have the added benefit of helping certain UK investors continue to qualify for preferential US treatment by the Committee on Foreign Investment in the United States (CFIUS).

FW: Could you outline the scope of the NSIA and its key provisions? What considerations need to be made with regard to mandatory vs voluntary filings?

Daniel: The NSIA provides for a hybrid system involving mandatory pre-closing notification for transactions in 17 of the most sensitive sectors from a national security perspective and a voluntary/call-in system for all others. The NSIA will capture a very broad range of transaction types. Under the mandatory regime, transactions involving in-scope entities will require notification where they involve an acquisition of 25 percent or more, 50 percent or more or 75 percent or more of votes or shares – or moves through these thresholds in relation to an existing investment – in an in-scope entity or where a person acquires the ability to block or pass resolutions. The NSIA has no turnover, monetary value or other de minimis thresholds, applies equally to UK and overseas investors and will also apply to many international transactions with limited UK nexus.

Kar: Parties are encouraged by the government to proactively notify investments that may be of interest from a national security perspective that fall below the 25 percent share threshold for notification, or which are not in one of the 17 sensitive sectors. This applies to transactions where a purchaser acquires “material influence” – a concept familiar to us as UK merger control lawyers – which can be triggered by acquisitions of shareholdings as low as 10 percent or involving acquisitions of a broad range of assets, including land, moveable property, intellectual property and ideas. The voluntary notification system will be accompanied by an expansive ‘call-in’ mechanism. This means the UK government will be able to review non-notified transactions up to five years after they have completed – reduced to six months if the UK government has become aware of the transaction, for example through informal notification. This time period for call in greatly exceeds that available to merger control authorities, which is a maximum of four months post-closing or facts becoming public, whichever is later.

Barth: In practice, parties planning investments that may fall within the UK NSIA regime will need to consider, ahead of signing, the issues that they consider for regimes that are already in force. These include whether their transactions raise any substantive national security issues, considering both the target and the acquirer’s profile. How the notification and review process, or even informally consulting with the Investment Security Unit, will affect the deal timetable. And how potentially burdensome information requirements for the notification will be managed, and whether co-investors will be willing to disclose potentially sensitive ownership information. Additional transaction costs will also need to be considered.

Ahlborn: Even though the NSIA regime has not yet commenced, transaction parties already need to factor it into their plans. The NSIA contains retroactive provisions that give the government the power to ‘call in’ transactions that completed after 12 November 2020 – when the NSI bill was introduced to parliament – and before the regime comes into force. For transactions completing in this gap period, the new Investment Security Unit is already actively providing informal guidance on transactions that may fall within the scope of the regime, and parties should consider whether to proactively engage in order to achieve a level of informal comfort their deal will not raise concerns and in order to reduce the otherwise five-year call-in period to six months, following commencement of the Act.

FW: What are the sectors most likely to be impacted by the NSIA? Do you anticipate a particular focus on the tech sector?

Ahlborn: There are 17 sectors that are specifically identified as sensitive from a national security perspective. These cover a broad range from defence, energy and transport to artificial intelligence (AI), quantum technologies and satellite and space tech. Of the 17 sectors around half relate to technology and this reflects the government’s political concerns around technological sovereignty and concerns around cyber attacks. So, tech is certainly one of the key focus areas. But the NSIA was amended in parliament to increase the threshold for mandatory notification from 15 percent, as originally proposed, to 25 percent. This amendment was intended to screen out certain type of investments, such as venture capital investments below 25 percent, which have been vital for the development of some industries in the UK, including tech, demonstrating that the government is clearly trying to strike a balance.

Barth: The focus on technology is one that we see across the globe. In the EU, the Foreign Investment Regulation, which has recently come into force, increases the level of scrutiny over transactions relating to companies active in AI, robotics, semiconductors, cyber security, nanotechnologies and biotechnologies. And in Germany, a further reform introduced in 2021 has materially expanded the scope of transactions that need to be reviewed in the tech sector. Other jurisdictions including the US and China are also focused on foreign investments in the tech sector.

Gafni: As well as pure tech deals, the NSIA and other foreign investment regimes will enable governments to look closely at deals involving ownership of and control over data. For example, CFIUS reviewed a Chinese entity’s investment in PatientsLikeMe, a US health technology start-up offering a network where patients connect to track and share their experiences. The result: a forced divestment of the acquirer’s stake due to national security concerns related to patient data. A similar outcome under the NSIA would not be unlikely.

Kar: For all that tech is very much in the spotlight, it does not mean that other sectors will get light touch treatment. The COVID-19 pandemic has acted as the catalyst for foreign investment reform in a number of countries and this was one of the factors which was front of mind as the NSI bill passed through the UK parliament. This means that the UK government, as well as other governments, will be active in protecting domestic healthcare resources so transactions involving life sciences, pharma and healthcare can expect significant scrutiny. Similarly, transactions in the energy sector will come under review to safeguard domestic energy supplies.

Daniel: The UK government has also recognised that national security concerns can shift over time. The NSIA includes provisions for the 17 sensitive sectors to be kept under review with additional sectors being added or expanded as needed. The government resisted calls during the parliamentary process to define what is meant by “national security” under the NSIA, preserving flexibility for interpretations of this concept to evolve over time.

FW: To what extent does the NSIA provide businesses and investors with a clear, predictable process, allowing them to plan their UK-focused strategies with confidence? How do you think the new regime will impact deal timelines?

Ahlborn: The UK government has claimed that the new regime will enable the fastest and most proportionate foreign investment screening in the world. But the reality is that a period of uncertainty, at least at first, is inevitable for a new regime combined with a high number of deals to be reviewed – the government has estimated up to 1830 per year. There are no safe harbours on the basis of turnover, transaction value or asset values. Given the expansive jurisdictional scope of the NSIA, a broad range of investments in UK companies – and indeed international companies with UK activities – could be called in for review and deal parties will need to build this into both deal timelines and the allocation of risk in deal documents.

Kar: The NSIA does provide a legal safeguard that a transaction may only be assessed on “national security” grounds. There is no broader power to review the transaction for reasons of economic interests, for example. However, the concept of “national security” is not defined. The Foreign Affairs Committee’s report raised several concerns resulting from the lack of clarity over what constitutes national security, including a lack of transparency, the risk of politicisation of the review process and uncertainty for investors and businesses. Two amendments to the NSI bill aimed at clarifying the concept of “national security” were tabled by various members and debated at the report stage in the House of Commons, with cross-party support. Both amendments proposed a non-exhaustive range of factors that have to be considered when assessing the national security risk posed by a transaction. These amendments would have given an additional level of comfort to businesses and investors, particularly as other political parties have seen the Act as an opportunity to advance industrial strategy ends, but did not ultimately pass as part of the NSIA.

Daniel: In terms of impact on deal timelines, the formal timetable under the NSIA regime has been perceived as an advantage compared to the more flexible and uncertain process under the current Enterprise Act 2002 rules. Transactions will be reviewed with a definitive outcome within 105 working days of being notified, although most reviews are expected to be considerably shorter. The Investment Security Unit has 30 working days after it receives a notification – whether mandatory or voluntary – to decide whether to call in a transaction. It then has 30 working days to clear the transaction, clear it subject to remedies or to initiate a full national security assessment of the transaction. This review period can be extended by a further 45 working days for transactions raising national security concerns.

Barth: Companies should build in flexibility to avoid deals failing for procedural reasons. This is particularly important in the early days of the new regime. But we expect, in line with our experience in other jurisdictions, that a relatively predictable timeline will quickly emerge for less problematic transactions. For those transactions raising complex national security issues, review periods will be significant, with parties needing to prepare for prolonged and detailed scrutiny. However, from experience in more established regimes, preparation and the right approach to disclosure is key in bringing the review period down to the minimum possible.

FW: What are the potential consequences for entities that fail to comply with requirements outlined in the NSIA? What new enforcement powers are proposed?

Daniel: The NSIA is backed up by a robust enforcement toolkit and underpinned by both civil and criminal sanctions. Non-compliance with statutory obligations may result in fines of up to 5 percent of worldwide turnover or £10m – whichever is higher – and up to five years imprisonment for individuals. These sanctions will apply to breaches of the mandatory notification obligation by an acquirer, and also instances of non-compliance with interim orders and information requests. In addition, a transaction that falls within the mandatory regime and which takes place before clearance is granted will be legally void. This is important given it represents a shared risk for both the buyer and seller.

Gafni: Failure to submit a required CFIUS filing can subject the parties to a civil penalty up to 100 percent of the value of the transaction. Notably, CFIUS regulations do not specify which party would be liable for this fine, so the expectation is that CFIUS is prepared to enforce it against either or both parties. Separately, there have been two reported instances in which CFIUS assessed fines – $1m and $750,000 – against parties that failed to comply with CFIUS-imposed risk mitigation requirements.

Barth: We have seen regimes across the EU introducing severe penalties for non-compliance with respective local foreign investment regimes. Such sanctions range from fines reaching a multiple of the transaction value, including in Italy, to criminal sanctions with potential imprisonment, such as in Germany and Poland. Given most of these sanctions were only introduced recently, we are not aware of many enforcement cases, however the sanctions have to be interpreted as a clear signal to the market to not treat foreign investment control lightly.

Kar: Of course, there is no practice to date on how the Investment Security Unit will use its enforcement powers. But, drawing the parallel with merger control, both in the UK and more widely, we see increased willingness on the part of regulators to sanction procedural breaches, for example issuing fines for provision of incorrect or incomplete information. This makes preparation before engagement with regulators crucial to ensure that it will be possible to comply with information requests within the relevant time frames. Automatic share transfer invalidity will also pose a host of problems for financing of deals, for example. Finally, the potential for criminal consequences will mean that senior executives will be very focused on the risk to themselves and not only the consequences to the corporate of getting it wrong.

FW: What advice would you offer to businesses and investors evaluating UK prospects in light of the NSIA? What steps do they need to take in connection with any UK-targeted investment?

Kar: Businesses and investors should treat foreign investment like other regulatory conditions and plan well in advance of signing. Foreign investment rules, in the UK and internationally, are now a deal-critical consideration for investors and transaction parties. For those planning to invest in UK companies – both international and domestic investors, as the NSIA does not distinguish – the NSIA will need to be factored into deal feasibility, contractual conditionality and transaction timetables at an early stage of the process.

Ahlborn: There are some key questions that need to be thought about upfront. For non-mandatory notifications, parties will need to decide whether to notify or at least to informally engage. While there are immediate downsides in terms of timing, the benefit of notifying the Investment Security Unit proactively of a deal and thereby reducing the period in which the transaction can be called in from five years to six months, offers longer term legal certainty. Parties will also need a strategy to enable them to deal quickly and accurately with information requests which can be extensive. Putting in place a process to identify and review relevant documents is a must.

Barth: Parties that are familiar with dealing with more established regimes, such as CFIUS in the US and the German regime, will already understand well the processes to go through. The UK is now stepping up alongside these regimes as a jurisdiction where foreign investment scrutiny will become a routine part of the transaction process. Careful consideration of the global foreign investment strategy will be needed – while interagency cooperation is not yet as well established as it is for competition agencies, the ability to present consistent advocacy across jurisdictions will be a crucial element of success for global transactions.

FW: What short-, medium- and long-term impact do you expect the NSIA to have on the UK market? What has been the initial reaction by investors so far?

Kar: The NSIA represents a radical overhaul in the UK’s approach to foreign investment screening. It sees the UK move from having one of the most permissive approaches to foreign investment in the world, to one of the most expansive regimes globally: catching deals that may have no obvious UK nexus and which may involve very limited sales into the UK. We do anticipate that in the short term this might be off-putting to investors reluctant to blaze the trail with a fledgling agency. But the UK government has been clear: its aim is to implement a highly efficient and effective review process that does not deter investors from doing business in the UK. The Investment Security Unit will, therefore, be under pressure to move quickly, especially on the vast majority of non-problematic deals.

Ahlborn: While not yet in force, the NSIA has retroactive effects. Transactions that have closed since November 2020 can be called in for review by the Investment Security Unit. But so far, this does not seem to have acted as a significant deterrent, with public and private M&A markets in the UK remaining active in the first half of 2021.

Daniel: Now that the NSIA is in final form, investors and corporates are watching closely to find out more detail about how the NSIA will work in practice. We expect more detail on a number of matters, including the exact scope of the 17 sensitive sectors, the timelines and procedure for detailed review and more information on how pre-notification procedures will work. We expect that the UK government will be keen to engage with investors between now and the NSIA coming into force to provide reassurance that the UK is still open for investment and more certainty about the review process. This will be very welcome.

Gafni: Over the longer term, as the UK regime beds in, we would not expect a significant deterrent effect on investments in the UK. In a way, the surprising thing is that it has taken until now for the UK to bring in a foreign investment regime. Compliance with the NSIA will be just one factor in determining whether to go ahead with a transaction, as factors in assessing timing and deal certainty risk. There will be some deals where the new regulatory regime could act as a very significant deterrent, but for most the NSIA review process will be factored into the process along with merger control regimes and foreign investment requirements in other countries.

FW: Are other jurisdictions taking similar steps to introduce new FI rules or is the UK an outlier? How does the NSIA regime compare to FI screening regimes in other jurisdictions?

Gafni: The UK is very much moving in line with other jurisdictions around the world by introducing new foreign investment rules. Over the past three years more that 60 percent of OECD countries have introduced new rules or strengthened existing foreign investment regimes – widening the range of sectors which are affected or lowering thresholds to catch more transactions. This is a trend that has been accelerated by COVID-19 which saw many countries move quickly to introduce rules focused on protecting pandemic-related supply chains and avoiding opportunistic investments seeking to benefit from the economic downturn. This regulatory environment has resulted in a spike in the number of foreign investment notifications globally, adding complexity to many transactions. This is particularly true of investments in multinational companies in which parties need to navigate engagement with numerous merger control and foreign investment authorities.

Ahlborn: The UK has clearly been informed by existing regimes in drafting its legislation. The hybrid mandatory/voluntary regime and potential for criminal sanctions is similar to the German regime. It is also common for the foreign investment rules to capture low levels of minority shareholdings and small transactions. However, if the government’s estimates of the number of transactions to be reviewed or businesses and lawyers’ even larger estimates is accurate, then the regime will quickly become one of the busiest in the world.

Barth: In terms of big differences with other regimes, one significant difference is that UK acquirers are treated in a similar way to overseas investors. This is very unusual both from an EU perspective – where domestic and EU investors often receive favourable treatment – and an international perspective, such as in the US where CFIUS does not review investments by US acquirers. The NSIA also has a very broad jurisdictional reach. In many countries, though not all, some form of safe harbour or local nexus test applies, for example reviewing only transactions where there is a local subsidiary company, local assets or relevant local business activities or applying a turnover or transaction value threshold. This is not the case under the NSIA, so it will capture international transactions with limited nexus to the UK.

Nicole Kar is head of Linklaters’ UK antitrust & foreign investment group. With over 20 years of European and UK regulatory experience, she has led on over 40 significant merger investigations and also advises corporates, pension funds, private equity and sovereign wealth groups on complex national security reviews. She is a specialist adviser to the foreign affairs committee of the UK parliament on foreign investment law. She can be contacted on +44 (0)20 7456 4382 or by email: nicole.kar@linklaters.com.

Christian Ahlborn is the global practice head of Linklaters’ antitrust & foreign investment group. He is a market-leading lawyer qualified in England & Wales as well as in Germany. He is also a trained economist and his clients rate highly that he is among a very small group of practitioners who can bring both a legal and economic perspective to a case. He can be contacted on +44 (0)20 7456 3570 or by email: christian.ahlborn@linklaters.com.

Christoph Barth is a partner in the global antitrust & foreign investment group, based in Germany. He has a particular focus on global merger and foreign investment control proceedings. Besides his competition practice, he advises clients from a wide variety of backgrounds on foreign investment proceedings before the German Federal Ministry of Economics and Energy and coordinates foreign investment reviews at European and global level. He can be contacted on +49 211 2297 7306 or by email: christoph.barth@linklaters.com.

Jonathan Gafni is the head of Linklaters’ US foreign investment practice, representing domestic and international clients before the Committee on Foreign Investment in the United States (CFIUS) and other US government authorities responsible for cross-border investment controls. He previously served as the US Intelligence Community representative to CFIUS and as chief CFIUS strategist of a private sector consultancy. Mr Gafni was named a top adviser for 2020 and 2021 by Foreign Investment Watch. He can be contacted on +1 (202) 654 9278 or by email: jonathan.gafni@linklaters.com.

Mark Daniel is a managing associate in the antitrust and foreign investment group, with extensive experience advising clients on a variety of complex competition and regulatory matters, with a particular emphasis on merger control and foreign investment investigations. He advises on a range of competition law matters across all sectors, with particular experience in the pharmaceutical, retail and utilities sectors. He can be contacted on +44 (0)20 7456 5445 or by email: mark.daniel@linklaters.com.

© Financier Worldwide

THE PANELLISTS

Nicole Kar

Christian Ahlborn

Christoph Barth

Jonathan Gafni

Mark Daniel

Linklaters LLP