United Kingdom | Publication | November 2023
There has been an unprecedented expansion of foreign direct investment (FDI) and national security regimes in recent years. This growth has happened in parallel with increasingly turbulent and protectionist political times, and these regimes add a layer of additional complexity to the already complex regulatory landscape for M&A. Indeed, our May 2023 Global M&A Trends and Risks 2023 report, in collaboration with Mergermarket, surveyed over 200 senior executives and found that this increasingly challenging regulatory landscape – which also includes novel and more restrictive approaches in competition/antitrust merger review – is impacting dealmakers and corporates in planning potential transactions.
In this article we briefly explore the global expansion of FDI/national security regimes, before focusing on the UK’s National Security and Investment (NSI) Act which came into force in January 2022. Approaching the second anniversary, we look back on key developments under this new UK regime and how enforcement over the past year compares to the regime’s first 12 months. We also look ahead to 2024, including potential implications of a recently launched “call for evidence” which it is hoped will lead to narrowing and clarification of the scope of the NSI regime.
A key factor in the growth of FDI regimes is that, in addition to traditional areas of concern (such as defence, energy and transport), there is now much greater appreciation of threats posed by technology and innovation, including artificial intelligence, advanced robotics and quantum technologies, and increased concern about hostile states having access to such assets or IP. Indeed, the US has gone further in this respect with the new Executive Order in relation to the Outbound Investment Program issued on 9 August 2023, limiting the ability of any US citizen or body to invest in certain technology sectors in the Chinese economy. This blurring of lines between economic security and national security is only increasing, while the COVID-19 pandemic put greater emphasis on critical vaccines and medical equipment, as well as supply chains more generally.
In any event, the growth of FDI regimes has been significant and they now sit alongside competition/antitrust approvals in considering deal viability and conditionality. While FDI screening has long been a feature of deal review in the US, Canada, Australia and certain other jurisdictions (including Russia), it has grown rapidly in the EU, following the introduction of the FDI Regulation three years ago. 21 of 27 EU Member States now having FDI regimes, and two more (Ireland and Sweden) are imminent.
The European Commission’s Third Annual FDI Report and the related Commission Staff Working Document highlight significant increases in the number of transactions being screened (almost 1,500 in 2022), with 9 per cent of those formally screened requiring a remedy or mitigating measure. Our Global M&A Trends and Risks 2023 report also found that FDI is cited as a factor impacting deal risk assessment in Asia (43 per cent of respondees) and Africa (50 per cent of respondees). In this context, how the UK operates its NSI regime is particularly important in ensuring it effectively protects national security, while not chilling foreign investment in the post-Brexit UK economy or creating a perception that the UK might be “closed to business”.
The map below gives an overview of the legislative situation in EU Member States
The UK’s NSI regime under the National Security and Investment Act 2021 (NSI Act) entered into force on 4 January 2022. This introduced a mandatory notification regime, whereby parties must notify certain transactions for approval by the Secretary of State in the UK Cabinet Office prior to completion (although the Investment Security Unit (ISU) within the Cabinet Office enforces the regime on a day-to-day basis).
Mandatory notification is required if a person will gain control of a qualifying entity active in any of 17 qualifying sectors. The definition of control is considerably broad, as it covers the acquisition of shares or voting rights of more than 25 per cent, more than 50 per cent, or 75 per cent or more, or the acquisition of voting rights enabling or preventing the passage of any class of resolution governing the affairs of the qualifying entity, with these levels of control referred to as “trigger events”. A transaction is automatically void if it is completed without required mandatory approval and parties risk penalties.
The 17 qualifying sectors under the mandatory notification regime are set out in the National Security and Investment Act 2021 (Notifiable Acquisition) (Specification of Qualifying Entities) Regulations 2021. These include advanced materials, artificial intelligence, communications, data infrastructure, defence, energy, military and dual-use, and quantum technologies – so sectors related to new technologies as well as more traditional areas of concern.
Even if a target entity is not active in a qualifying sector, the Secretary of State may still call-in a transaction for review (potentially up to five years after completion) if they reasonably suspect a risk to national security – provided there is one of the trigger events mentioned above or material influence is acquired. Acquisitions of the ability to use or control a qualifying asset (land, tangible moveable property, and ideas, information or techniques with industrial, commercial or economic value) can similarly be called-in, regardless of the sector. The NSI Act also sets out a voluntary notification regime for such transactions, so relevant acquirers may voluntarily notify if they desire certainty instead of waiting to see whether their deal is called-in.
The geographic scope of the NSI regime is also broad – entirely UK transactions can be caught (even though UK-owned acquirers are unlikely to raise substantive concerns) as well as foreign acquisitions of qualifying entities/assets in the UK and elsewhere, with relatively limited UK nexus required.
As mentioned above, the Secretary of State in the Cabinet Office is the decision-maker on NSI reviews, but this is the result of a recent change. During the first year, the ISU was part of the Department for Business, Energy and Industrial Strategy (BEIS) and the Business Secretary was the relevant Secretary of State. This changed in February 2023 when BEIS ceased to exist as part of UK government restructuring, and the ISU moved to the Cabinet Office, with the Secretary of State in the Cabinet Office taking over responsibility for NSI.
Under the new structure, the ISU is closer to the centre of government and the current Secretary of State in the Cabinet Office, Oliver Dowden MP, is also the Deputy Prime Minister. Moving the NSI regime to the Cabinet Office had some logic given the Cabinet Office has other national security functions, but prompted some commentators to raise concerns that NSI decisions might become more political.
Noticeably fewer deals have been remedied or prohibited in 2023 compared to 2022. 14 transactions received a final order in 2022 either to prohibit the transaction (five transactions) or grant clearance subject to remedies (nine transactions). In 2023, there have been only three final orders so far – all clearance with remedies. The 14 final orders in 2022 were all imposed in the second half of the year (11 during the final four months – coinciding with several changes of Business Secretary). A lack of final orders during the early months of 2022 made sense as the NSI regime bedded-in, and noting a final order can only be imposed once a transaction has been the subject of a full assessment (i.e. an in-depth review). But a low number of final orders in 2023 was less expected, especially after the uptick towards the end of 2022.
This raises the question whether NSI functions being moved to the Cabinet Office has in fact led to a substantive change in how the regime is being applied in practice. Oliver Dowden has stressed that businesses can continue to invest in the UK with confidence, and the NSI regime is being applied “in a sensible and proportionate way that allows investment to continue to flow”. Might a more business-friendly approach be resulting in fewer final orders?
Overall, it is difficult to draw firm conclusions in this regard at this stage. Fewer final orders this year could simply reflect that fewer transactions have raised concerns applying the same approach as before. Significantly, none of the final orders in 2023 (so far) are for transactions with Chinese acquirers, whereas eight final orders in 2022 (including four of the five prohibitions) concerned Chinese acquirers, and generally thought to be owned by or have links to the Chinese state. So, the low number of final orders in 2023 could be due to a decline in sensitive acquisitions by Chinese acquirers – especially absent any suggestion the UK government has softened its stance on the national security risks posed by China.
However, we will need to await the Secretary of State’s next annual report on the regime (likely to be published in summer 2024) to see whether fewer deals with Chinese acquirers have been reviewed this year. The most recent annual report published in July 2023, covering the period 1 April 2022 to 31 March 2023, shows that 42 per cent of transactions that proceeded to a full assessment during that period involved Chinese acquirers. It will be interesting to see whether the percentage is as high in next year’s report, considering the absence of final orders against Chinese acquirers this year.
There will be a UK general election in 2024, the outcome of which could lead to another change in Secretary of State for the NSI regime and potentially a change in substantive approach. “National security” is deliberately not defined in the NSI Act so the NSI regime can be applied flexibly as national security risks evolve, but this means there is scope for a Labour government (should they win the next election) to take a different substantive approach to the Conservatives, possibly putting more emphasis on a broader set of concerns, such as job losses, should they wish to do so.
All three transactions cleared with remedies in 2023 had acquirers from so-called “friendly” states (the US, Canada and France), while certain acquirers from friendly countries also received final orders in 2022. Acquirers therefore cannot simply assume their deal will be waived through unchallenged because they are from a country not perceived as hostile to the UK, especially if there are particular sensitivities about the target. But it is also important to keep in mind that only a small number of transactions with “friendly” acquirers have raised concerns – and these have been cleared with remedies, not prohibited so far.
At first glance the recent annual report suggests several entirely UK transactions raised substantive national security concerns during the period 1 April 2022 to 31 March 2023 – it shows that 32 per cent of transactions subjected to a full assessment and four final orders involved a UK acquirer. But we believe this is skewed by transactions where the immediate acquirer was a UK subsidiary of a foreign parent – meaning the investment was recorded as both from the UK and the foreign parent’s country. Our analysis indicates only one entirely UK transaction received a final order, which was an exceptional case.
As mentioned above, acquisitions of assets fall within the voluntary notification regime. The Secretary of State’s statement on use of the call-in power – i.e. their power to call-in transactions for a full assessment and the only guidance on the approach to substantive concerns under the regime – mentions that asset acquisitions are expected to be rarely called-in for a full assessment compared to acquisitions of entities. But this should not be taken to mean that asset acquisitions will never raise substantive concerns – nearly a quarter of final orders since the start of the NSI regime have been for acquisitions of assets.
The first prohibition in July 2022 was an asset acquisition (a proposed IP licence agreement regarding SCAMP-5 and SCAMP-7 vision sensing technology between the University of Manchester and Beijing Infinite Vision Technology Company Ltd), and since then three other asset acquisitions have received final orders albeit granting clearance with remedies rather than prohibition. This includes one of the final orders in 2023 – for a licence agreement thought to relate to underwater imaging technology.
A frustration with the NSI regime is that the ISU publishes relatively little information about transactions it reviews – usually nothing at all if a transaction is cleared unconditionally and only one-page notices of final orders for transactions cleared with remedies or prohibited, not the final orders themselves. Sensitivities around national security and ISU resource constraints appear to prevent publication of detailed decisions.
Since becoming Secretary of State for the regime, Oliver Dowden has said he intends to be more open and transparent about how the legislation works, although the signs so far indicate he means in respect of how the ISU operates in general – not how the regime is being applied to specific transactions. However, more information about whether/why particular transactions have been found to raise (or not raise) concerns, as well as why a review was triggered, would be useful to parties and their advisers when undertaking NSI assessments for other transactions – especially given this analysis can be complex.
Two final orders imposed in 2022 have been amended this year – not to change the substantive outcome but to clarify certain requirements. One is the final order prohibiting the licence agreement between the University of Manchester and Beijing Infinite Vision Technology mentioned above. That licence is still prohibited, but the final order was varied in January 2023 to clarify the University’s obligations regarding its employees and allow it to share the relevant technology in certain circumstances if the Secretary of State agrees. Notably, the notice of the final order published in July 2022 is silent about employees or broader sharing of the technology – reflecting that final orders may be broader than the published notices suggest.
With regard to transactions cleared with remedies, the types of requirements in the final orders made in 2023 are similar to those in 2022 (based on the published notices). Conditions include safeguarding sensitive information and physical infrastructure, government-appointed board observers, and retaining capacity and capability in the UK. The final order imposed this year regarding the licence agreement related to underwater imaging technology requires the licensee to carry out due diligence on all new customers wanting to purchase the relevant asset and to provide an annual report on those customers.
The lack of detail in the published notices of final orders means that as well as not always being easy to understand exactly why particular transactions have been found to raise concerns, sometimes the relevant sectors are also not clear. However, the recent annual report published in July sheds further light on the relevant sectors for transactions that have drawn particular scrutiny so far.
Unsurprisingly, there is a strong correlation between the sectors within the mandatory notification part of the NSI regime and relevant sectors for transactions reviewed, and especially the sectors in which transactions have ultimately raised substantive concerns. Eight transactions that resulted in a final order between 1 April 2022 and 31 March 2023 concerned military and dual-use or communications (four each), followed by energy, defence, computing hardware and advanced materials (three each), which reflects a notable concentration of scrutiny in these sectors (although transactions often concern multiple sectors).
In terms of the three transactions remedied in 2023, the published notices for the final orders imposed this year indicate that the national security concerns regarding two of these transactions are due to the target entities being important UK defence contractors, while the third (the licence agreement relating to underwater imaging technology) raised concerns about “potential military uplift”.
The UK government has committed to publish regular “market guidance notes”, based on analysis of notifications received and feedback from stakeholders. The first such market guidance was published in July 2022 with a second edition published in April 2023.
The April 2023 market guidance largely focused on steps the ISU takes during the review process, consistent with Oliver Dowden’s aim to increase transparency about how the ISU operates. While of some use that guidance is relatively brief and focuses on the full assessment stage, but most transactions are cleared at the initial review stage so do not proceed to a full assessment. Other content clarifies steps parties should take if they wish to seek an expedited review where a target is in material financial distress (there is a high hurdle) and the approach regarding possible financial assistance needed as a result of a final order being imposed (such financial assistance is likely to be rare).
This year’s market guidance also helpfully confirms parties can seek the ISU’s advice if there is significant uncertainty about whether a transaction requires notification (subject to the caveat this will not be legal advice, and parties should still seek independent legal advice – which perhaps fails to recognise parties would be seeking certainty from the ISU, probably as a last resort if their advisers have been unable to reach a firm view). The main challenge when assessing the need for a notification is determining whether the target’s activities fall within the qualifying sectors. Many of the sector definitions are complex, inter-related and difficult to apply in practice, while the published guidance on the definitions is relatively brief and does not always explain technical terms used.
The UK government launched a “call for evidence” on the NSI regime on 13 November 2023 to gather views on how the regime can be “even more business friendly while maintaining and honing the essential protections” for the UK’s national security. An important aspect of this consultation (which closes on 15 January 2024) is whether the sector definitions should be clarified. A number of sectors are flagged in particular, including advanced materials, defence and synthetic biology, while it is also suggested that activities concerning semi-conductors and critical minerals might be extracted from the current definitions to form two new sectors (reflecting their importance). Greater clarity on the scope of the sector definitions would generally be helpful.
Another enduring concern is the very broad scope of the NSI regime. 866 notifications were made from 1 April 2022 to 31 March 2023. This is less than the 1,000 to 1,830 annual notifications predicted in the impact assessment prior to the regime (although the notification thresholds were narrowed after that assessment), but still far more than the 50 to 80 transactions reviewed each year by the CMA (the UK Competition and Markets Authority) for competition concerns under the UK’s merger control regime.
93 per cent of those notified transactions were cleared unconditionally within the initial review period of 30 working days. The other 7 per cent proceeded to a full assessment, but even most of those in-depth reviews ended in unconditional clearance – 65 transactions had a full assessment during that period (including ten not notified but called-in). But there have been only 17 final orders since the start of the NSI regime. This appears a far lower proportion than the 9 per cent of screened deals where an intervention has taken place within the various EU FDI screening mechanisms.
As expected, most reviews therefore end in timely unconditional clearance, so the NSI Act will not significantly affect deal timelines for most transactions – but arguably too many unproblematic transactions are being reviewed. It appears the government broadly agrees, with one of the reasons for the recent call for evidence being to gather information on whether the scope and requirements of the regime are proportionate and effective. There are signs the regime may be narrowed, such as to exclude mandatory notifications for intra-group arrangements, and to remove certain activities from some of the sector definitions. However, the government is also “considering a small number of potential expansions” to the sector definitions. Some of the sectors may be both narrowed and expanded – for example, the government would like to hear whether any activities within the artificial intelligence definition do not present national security risks and should be removed but is also considering adding “generative AI” to that definition. The possible addition of generative AI is perhaps a good example of the challenges in reaching a settled and clear scope for the regime – there will always be new developments raising potential concerns.
The government previously announced in July 2022 it was monitoring whether exemptions from the mandatory notification requirements are appropriate, noting the NSI Act allows exemptions based on an acquirer’s “characteristics”. There would appear to be obvious benefits (for the ISU and relevant parties) in removing the burden of notification for clearly unproblematic acquirers, such as UK PLCs. However, the recent call for evidence states the government is not currently considering exempting certain types of acquirers, and instead considers the sensitivity of the target may mean some acquisitions require scrutiny and warrant remedies regardless of the acquirer.
Parties to two transactions prohibited in 2022 made known they would seek to challenge those prohibitions by way of judicial review. Given the inherent sensitivities around national security it was expected those challenges would proceed in secret, and consistent with this there has been a lack of information about whether/how those challenges may have proceeded this year.
One of those challenges concerned Nexperia BV’s acquisition of Newport Wafer Fab (the UK’s largest chip manufacturer, producing semi-conductor wafers), a deal that completed prior to January 2022 but was called-in under retrospective powers and prohibited in November 2022. Nexperia is a Dutch company, but a subsidiary of the Chinese company, Wingtech. Nexperia has now announced it has agreed to sell Newport Wafer Fab to a new US owner, Vishay Intertechnology, although it maintains it will continue its judicial review challenge against the prohibition of its acquisition of Newport Wafer Fab under the NSI regime. The outcome of this challenge will be very interesting and informative as to how much discretion the UK government has in prohibiting transactions under the NSI regime. Given the uncertain (and secretive) nature of national security concerns, it is expected that Courts will be reluctant to overturn government decisions in this respect.
As we come to the end of the second year of the NSI regime, the vast majority of transactions have been cleared unconditionally, and generally at the first review stage. However, the low number of final orders this year, especially compared to the high number of notifications, suggests too many unproblematic transactions are being reviewed. It will be interesting to see whether the current call for evidence leads to the mandatory notification regime being materially narrowed, as well as greater clarity on the sector definitions.
Other developments to keep an eye on next year include whether data in the Secretary of State’s next annual report indicates there has been a decline in transactions by Chinese acquirers, and whether this explains why the number of final orders has been lower in 2023 than 2022. The general election in 2024 is also likely to have implications for the NSI regime, potentially including whether there is time to implement changes resulting from the call for evidence before the election – although the suggestion at this stage is that the Secretary of State is not currently envisaging changes that would require primary legislation.
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