After a year in power, the Labour government has published a review of the National Security and Investment Act. Will changes to the regulation help the flow of investment into the UK without compromising our security?
Almost four years after the then Conservative government introduced the National Security and Investment (NSI) Act, the Labour administration has published its review of the regulation. But despite ministers’ insistence that they want to “strengthen the takeovers regime and protect the flow of investment into the UK”, industry experts are sceptical that the reforms proposed will ease the burden on dealmakers.
The NSI Act came into force in January 2022 amid mounting concern about the number of foreign buyers acquiring British companies and assets, particularly in strategic industries and sensitive sectors. The legislation requires dealmakers to notify the UK government’s Investment Screening Unit (ISU) of transactions that might be within scope of the NSI – essentially, any transaction involving a foreign entity on a list of specific sectors and business areas. The ISU then considers whether such deals need to be investigated, with ministers having powers to impose restrictions on transactions or even to block them altogether.
While the government’s review argues that the “NSI system stays out of the way of the overwhelming majority of inward investments”, there has been a steady increase in the number of deals referred to the NSI. The latest annual report on the operation of the regulation points to a 26% rise in notifications over the year to the end of March, a period during which overall M&A activity in the UK actually fell back.
“The problem is, the legislation has created a very big net to capture a very small number of fish,” explains Paolo Palmigiano, head of the competition, trade and foreign investment practice in the UK at Taylor Wessing. “Given the consequences of failing to notify the ISU of a deal, the temptation is to err on the side of caution and to file a notification, if there is any doubt on whether the transaction is in scope.”
It doesn’t help that the ISU is not prepared to give any guidance at all, even informally
Time and money
Dealmakers and their advisers have several concerns about the escalating number of notifications. Not least, they point to the time and expense involved in reviewing transactions to decide whether they need to be referred; City solicitors routinely charge a flat fee to provide an opinion on whether a deal is in scope – £5,000 is typical – with costs to prepare the filing then potentially running into tens of thousands of pounds.
“It doesn’t help that the ISU is not prepared to give any guidance at all, even informally, about whether it needs to be notified about a specific deal,” Palmigiano adds. “In countries such as Ireland, which introduced foreign direct investment guidance at the start of the year, there is more help available.”
There is also frustration that the ISU usually takes the full 30 working days the legislation allows to issue its verdict on a notification. “The regime still captures many more transactions than it is probably intended to, which results in many more transactions having a split between signing and closing,” complains Paul Medlicott, head of private equity at law firm Addleshaw Goddard. “That then brings a number of commercial issues to the fore relating to who bears the risk of issues arising in the period between signing and closing, as well as related issues around conditionality, repetition of warranties and disclosure, termination rights and MAC [material adverse change] provisions, interim conduct provisions and price adjustments.” Contingent risk insurance cover can be taken out to cover this gap period risk. If available, its affordability is key.
Who bears the risk of issues arising in the period between signing and closing?
In theory, dealmakers aren’t required to wait until the sale and purchase agreement (SPA) has been signed to notify the ISU, which might enable them to reduce this period of uncertainty. In practice, however, the detail required in the notification will often depend on the terms of the SPA; and notifications to the ISU that lack key data will be rejected, causing additional delays.
The government says its review of the NSI could help here, since it attempts to provide more detail about the deals it expects to see notifications for, particularly in areas such as semi-conductors and critical materials. It has also loosened the scope in certain areas, notably in deals involving consumer-facing artificial intelligence technologies.
But Sarah Randall, a partner in the competition practice at Addleshaw Goddard, is cautious. “While these changes are welcome,” she says, “the detail has yet to be revealed and there may well remain sectors where it will take a great deal of time to determine whether a target’s activities are caught – for example, in advanced materials, where currently the target’s activities are defined by reference to the Strategic Export Controls List. Even with greater clarity on activities that fall with scope, the proposed changes are unlikely to significantly reduce the number of ‘non-issue’ deals caught by the mandatory notification requirement.”
The proposed changes are unlikely to significantly reduce the number of ‘non-issue’ deals caught
Plugging leaks
Critics also point out that alongside the supposed concessions made in response to the concerns of businesses and advisers, the government is adding extra provisions to the NSI. It is strengthening the rules on critical suppliers to the government and the emergency services, for example, and bringing new areas within scope of the legislation.
In particular, the government proposes to add the water sector to the list of industries where M&A acquisitions involving a foreign bidder must be referred to the ISU. The change has raised eyebrows, as water wasn’t previously considered a critical asset in the context of the legislation. And the very public issues about the running of water companies do not seem to be concerned with security as such.
However, ministers have rejected suggestions that its addition to the scope of the NSI reflects ongoing anger about levels of profitability in the sector, its record on pollution, and its significant private equity ownership. Rather, the government insists it is acting because the UK’s water infrastructure faces increasing risks to its resilience – and that malicious actors could secure sensitive information and assets through investment activity.
An early test of the change could come at Thames Water, if the heavily indebted company collapses in the coming months. China’s CKI, already a significant investor in a number of UK power and utility companies, is widely thought to be mulling over an acquisition of Thames Water, should the company enter a special administration regime.
The broader question is whether this government is minded to take a different line on foreign takeovers. So far, the evidence suggests not – while the NSI has seen more notifications over the past year, and more interventions, the proportion of deals where the government has ordered restrictions is broadly unchanged.
However, it is still early days for Labour – and ministers don’t appear to be nervous about using their powers. A decision to block the sale of a graphene business to a Chinese bidder in August (see box, Block Party, right) underlines the point.
Overseas pressure
President Trump’s return to power also has the potential to muddy the waters: within weeks of coming to office, the Trump Administration ordered the US’s Committee on Foreign Investment in the United States to take a tougher stance on restricting Chinese investments in strategic areas. There may be pressure on key US allies to follow its lead – or simply a broader reluctance to accept foreign acquirers in a pull back from globalisation.
The bottom line is that few observers expect any easing of the NSI, despite the mollifying tone of the government’s review. “It’s very sensible to review the lay of the land now this legislation has had a chance to bed in, but there’s not much sign of a recalibration here to reduce the number of filings,” says Taylor Wessing’s Palmigiano. Indeed, the government’s own preliminary impact assessment suggests the result of the changes suggested could range from a decrease of 10 notifications a year to an increase of 35.
NSI in numbers
The Investment Screening Unit (ISU) received 1,143 notifications of deals subject to the National Security & Investment Act over the year to 31 March. This was a 26% increase on the 906 notifications received in the previous year.
In 95.5% of these cases, the government notified the deal parties that it would take no further action. It issued call-in notices in relation to 56 deals (including 7 transactions the ISU had not been notified about), subjecting these deals to an in-depth review. This figure compares to 41 call-in notices in the previous year.
Of these 56 transactions, 35 were subsequently cleared without condition. In 17 cases, the government issued final orders that imposed conditions on the deals. In 5 of the cases, the parties withdrew from the deal before a final order was imposed.
The ISU identified 60 deals where the parties had committed an offence by completing a notifiable acquisition without receiving approval. No enforcement action was taken in any of these cases, despite the ISU’s powers to impose a penalty of up to 5% of turnover, up to a maximum of £10m or even further, ultimately to demand that the deal be unwound.
On average it took 29 working days for the ISU to call in a transaction, the same as in 2023-24. In-depth assessments resulting in clearance took an additional 40 working days on average, rising to 100 working days for deals where conditions were imposed.
Block party
Alternative investment market-listed Versarien had hoped that the sale of a portfolio of graphene-related assets would ease its troubles. Earlier this year, the Gloucestershire-based advanced engineering company announced a restructuring that included placing its Versarien Graphene business into administration – but a deal to sell the unit to a new joint venture looked to offer a lifeline. In August, however, the government announced it would block the acquisition.
The sale was referred to the government’s Investment Screening Unit because one of the partners in the joint venture, China’s Anhui Boundary Innovative Materials Technology was assessed to present an ‘acquirer risk’. In addition, Versarien Graphene is active in the advanced materials sector, one of 17 sectors where deals are subject to scrutiny for national security risks under the National Security and Investment Act.
Previous graphene-related deals have prompted government intervention, with ministers anxious about the military applications of the material. Potential use cases include body armour, tank armour and cooling systems in planes.
In Versarien’s case, Chancellor of the Duchy of Lancaster Pat McFadden issued orders to prevent the transfer and use of both tangible and intangible assets, including intellectual property and knowledge of potential dual-use applications, to the joint venture. McFadden described the order (in the usual way) as “necessary and proportionate to prevent, remedy or mitigate the risk to national security”.
