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UK foreign investment law under review after two years
2024 PRINDBRF 0130
• Practitioner Insights Commentaries
• March 12, 2024
(March 12, 2024) - Matthew Hall of McGuireWoods London LLP discusses proposed reforms to the UK National Security & Investment Act and implications for U.S. private equity investors and others regarding control investments in the UK.
UK foreign direct investment (FDI) rules1 were significantly strengthened when the UK National Security and Investment Act 20212 (NS&I Act) came into force in January 2022. The act, which controls FDI into the UK on national security grounds3, introduced a mandatory notification and pre-closing clearance regime for certain acquisitions of companies and the right for the government to review a wide range of other transactions. Transactions can be cleared subject to conditions or even blocked or required to be unwound if closed without clearance.
There has been significant criticism from businesses and private practice lawyers about the scope of the new regime and how it operates in practice. Against the background of that criticism, in January 2024, the UK government concluded a call for evidence on "how the [NS&I Act] regime can be even more business friendly while maintaining and honing the essential protections we need for our national security"4.
Broadly, the aim as expressed in the foreword to the call for evidence is now to follow a "small garden, high fence" approach which protects the UK against the "small number" of deals that could be harmful to national security while leaving most transactions unaffected.
Wide scope of the UK NS&I Act
FDI regimes around the world are often very expansive in scope. In common with controls in other countries, the UK's NS&I Act includes no value-based jurisdictional thresholds, but the act is in other ways an outlier. It is one of the broadest worldwide.
The NS&I Act applies regardless of the location of the purchaser. This means that, as well as "foreign", even UK-based acquirers are potentially caught. This is the case even where the ultimate owner of the acquirer is a UK company or individual or it is UK-listed.
The mandatory notification rules can only apply where the target company itself carries on activities in the UK which are on the list of sensitive activities. That list is however wide and uncertain and the threshold control level for a review is low. Acquisitions of more than 25% of the shares or of voting rights which allow the investor to secure or prevent the passage of any class of resolution governing the affairs of the entity are caught.
In addition, where mandatory notification is not required, the act can still be applied to review investments in entities which either carry on activities in the UK or simply supply goods or services to people in the UK. This is provided the government sees potential national security concerns and at least "material influence" is gained. "National security" is not defined for this purpose and material influence is a wide concept.
In addition to investments in companies, the NS&I Act can be applied to acquisitions of or investments in a wide range of assets. These include land, tangible moveable property and intellectual property rights (IPR). A license to IPR gave rise to the first decision and first block of a transaction under the act5.
For an asset acquisition to be caught, all that is needed is that the buyer is able to use the asset, or direct or control its use, or is able to do so more than it could prior to the acquisition. This can include acquiring a right or interest that gives the buyer the ability to use, or to direct or control the use of an asset, even if it does not acquire the asset itself.
An asset acquisition can be reviewed if the asset is used in connection with activities carried on in the UK or used in connection with the supply of goods or services to people in the UK. For example, this would include an asset such as machinery located overseas used to produce equipment that is used in the UK. It would also include an offshore wind farm used to generate electricity which is supplied to the UK.
Less obvious types of transactions can also be caught as entity or asset acquisitions. Internal corporate reorganisations within corporate groups can be acquisitions for this purpose and may even give rise to a mandatory notification requirement. The appointment of liquidators and receivers can be caught and again may require mandatory notification.
There is also a long period of potential jeopardy under the act. The government can assess an acquisition up to five years after it has taken place (reduced to six months after the government becomes aware, including through notification). In a recent case, the transaction was announced in May 2023 and the NS&I Act decision was not made until January 20246.
Concerns in practice
Even before the NS&I Act was adopted, there were concerns about these issues and others. The first two years of practical operation of the regime have not allayed those concerns.
In particular, the mandatory notification part of the regime applying to certain acquisitions of companies active in sensitive sectors has proven to be too broad and ambiguous. It captures many transactions that clearly do not raise genuine national security concerns and gives rise to precautionary filings where there is uncertainty as to its application.
This unnecessarily wide scope is shown by the figures in the 2022-2023 annual report on the operation of the NS&I Act7. During that year, 766 transactions were reviewed and of these around 93% were unconditionally cleared without a detailed investigation. Therefore, only around 7% were even "called-in" for a detailed investigation.
This compares unfavourably with the U.S. In 2022 under the CFIUS regime only 440 notices and declarations were reviewed8. The U.S. economy is around eight times larger than the UK's (OECD data for 2022, based on total GDP9).
In addition, the operation of the decision making process has been opaque even for the parties to a transaction and is commonly described as a "black box". The parties have limited if any transparency on the state of a review and the reasoning for decisions and the conditions that are required to permit some deals to proceed. Purchasers caught by the mandatory filing obligations are often subject to a long and drawn-out process.
Investors and potential investors into the UK are aware of the issues. Vishay Intertechnology, Inc. commented10 in January 2024 that "we had hoped [the procedure] would conclude before the end of 2023" and "… the length of the [ongoing review] process can create challenges for businesses looking to invest in the UK." Vishay is a U.S.-based and NYSE-listed company which was at the time waiting for clearance of its purchase of a UK semiconductor wafer fabrication facility, which has now been obtained subject to conditions11.
There is a clear risk that the FDI regime will act as a disincentive to investors. This is not helped by the view of the UK's parallel merger control regime, which is often conflated with FDI. The merger regime operated by the UK Competition and Markets Authority (CMA) is already seen as amongst the most difficult in the world following Brexit.
The review and proposals
The UK Government's call for evidence on the operation of the NS&I Act was aimed at considering many of these issues. The call for evidence makes it clear that the government is concerned about the impact of the system on investors and "their experience interacting with the process". In addition, the government wanted to consider "whether the scope and requirements of the system are proportionate and effective".
The evidence received will therefore be used to inform a review of the list of sensitive activities, hone the scope of the mandatory notification rules, improve procedure and develop the government's guidance. Potential changes include the introduction of exemptions, improved clarity and simplicity in the definitions of the sensitive sectors and changes to the operation of the regime.
The government's expressed wish for "a small garden, high fence" approach, increasing legal certainty for prospective investors, has been generally welcomed by stakeholders. The influential Business and Trade Committee of the UK House of Commons (elected lower chamber of the UK Parliament) commented in response to the call for evidence that the large number of transactions caught means the government risks "losing sight of the wood for the trees" and missing key transactions with security implications12.
At the same time, the committee identified particular issues which in its view need to be covered more comprehensively and clearly. These include risks relating to media freedoms, access to UK persons' sensitive data, cybersecurity, critical supply chains and data relating to the UK biosecurity industry. The committee further suggests that "national security" as used in the NS&I Act is defined in order to increase the predictability of the regime.
The committee also emphasised the importance of improving business awareness and transparency of the regime. It commented that "awareness amongst industry of the [NS&I Act's] coverage appears to be low." It suggested there should be an online tracking portal available to parties in live cases and greater engagement with stakeholders including venture capital and private equity firms.
These comments are important and will probably cause the government to adjust its approach in some areas. The overall result is likely to be that the act will be more workable and targeted and this is welcome. This would be good for investors in UK businesses and assets and for owners and founders of UK companies and assets which could be targets.
Continue to beware the Act in any deal relating to the UK
The NS&I Act was a step change in UK control of FDI on national security grounds. For the first time, it introduced mandatory pre-closing notification and clearance of certain full or partial acquisitions of companies. It also allows the government to review a very wide range of other investments into and acquisitions of companies and assets.
Purchasers considering transactions involving assets or investments with a UK link, however limited, need to consider the potential application of the act. This often leads to uncertainty and at least additional cost. In some cases the application of the NS&I Act is crucial to the prospects for a transaction.
The investigation procedure itself does not work satisfactorily from the point of view of the companies and other stakeholders. Reviews can be extremely drawn out and parties do not have visibility as to any concerns. The House of Commons' Business and Trade Committee noted that it "has heard repeated concerns from stakeholders concerning the 'black box' nature of the review process and a lack of communication from the [UK government] during the review period".
The recently-concluded call for evidence by the UK government on the scope and operation of the act, to which the committee was replying, indicates that the act may be narrowed and made more investor friendly. The government will now consider whether more detailed consultation on specific measures or legislative changes are necessary. Any additional consultations will probably take place in the second half of 2024, as the government will be working towards publishing its review of the sensitive sectors before 4 January 2025.
Until the next steps and any changes are made clear, parties have to continue to work with the current very wide scope of the NS&I Act and its procedural limitations. They should in particular note the wide range of entity and asset acquisitions potentially caught, the limited local nexus needed and the lack of any value thresholds limiting its scope. Where it does apply, timing issues should be considered right at the outset because reviews can be extended.
Some transactions are subject to mandatory notification, but even where this is not the case the government may be able to investigate. In all cases, following a detailed review, the government can impose conditions if it sees national security concerns. It is even possible for a deal to be unwound or blocked.
Acquisitions can be assessed for a significant period after closing, which is reduced if the government becomes aware of the transaction for example through a notification. Where mandatory notification does not apply, but there could be national security issues, parties will therefore need to consider whether a voluntary notification should be made. That may be a difficult decision, but often acquirers will prefer the certainty of that review over a long period during which intervention could come.
Notes
1 Article contains UK public sector information licensed under the Open Government Licence v3.0.
2 https://tinyurl.com/mrbsmnw
3 Public interest issues relating to media plurality, financial stability and public health are subject to separate legislation.
4 https://tinyurl.com/4b3cbepf
5 Acquisition of know-how related to SCAMP-5 and SCAMP-7 vision sensing technology by Beijing Infinite Vision Technology Company Ltd, Final Order available at https://tinyurl.com/2s3k67rd
6 Strategic Relationship Agreement between Vodafone Group PLC and Emirates Telecommunications Group Company PJSC, Final Order available at https://tinyurl.com/3z3hedpp
7 https://tinyurl.com/2uy3f23n
8 https://tinyurl.com/2a77safe
9 OECD (2024), Gross domestic product (GDP) (indicator). https://tinyurl.com/56xcbpcz (accessed on 11 March 2024).
10 "Written evidence submitted by Vishay Intertechnology Inc", accessed via Internet search on 5 March 2024.
11 Acquisition of Neptune 6 Ltd by Siliconix Inc., Final Order available at https://tinyurl.com/bdebkw97
12 https://tinyurl.com/3ftcnah2
Matthew Hall, a partner in McGuireWoods London LLP's London office, is an England, Wales and European Union-qualified lawyer whose practice focuses on all aspects of EU and UK merger control, antitrust/competition, and foreign direct investment law. He has substantial experience in notifying mergers and joint ventures in the EU and UK under merger control and FDI law, as well as coordinating the notification of international transactions. He advises on all aspects of competition law, including cartel enforcement, collaborative arrangements, vertical agreements and unilateral conduct, and provides compliance programs and training. He can be reached at [email protected].
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