Increasing national security by controlling inward investment
The UK government’s National Security and Investment Bill and its Investment and Security Unit seeks to control acquisitions of sensitive industries by hostile overseas parties. David Prosser examines the consequences for all M&A involving foreign investment.
Market wags dubbed it the “great haul of China”. But as Chinese interests, often with links to the state, have made a spate of investments in British businesses – including providers of critical infrastructure ranging from nuclear power to telecommunications – concern has mounted about a threat to the UK’s national security. The government’s response came in November, with new legislation that will give ministers sweeping powers to stop hostile actors making acquisitions in the country if they believe national security could be compromised.
The National Security and Investment (NSI) Bill mirrors legislation adopted by many of the UK’s major geopolitical allies, but the scale of its reach and potential implications for inward investment have surprised many practitioners.
“This could result in a real step-change in the way the UK conducts M&A and corporate finance,” says David Petrie, ICAEW’s head of corporate finance. While the UK’s security must be paramount – and concern about international interest in sensitive British industries is not limited to Chinese acquirers – there is anxiety about the potential impact of the legislation on valuable inward investment.
Philip Robert-Tissot, a Corporate Finance Faculty board member and former director-general of the Takeover Panel, another public body with powers to intervene in M&A activity, warns it will be challenging to manage these conflicting imperatives: “A number of other countries have long-standing regimes to regulate foreign investment that function relatively smoothly and do not prevent deals getting done,” he says. “But this sort of legislation adds complexity, with additional processes for bidders to navigate, so the detail of these processes needs to be carefully considered. Companies and advisers will want the new rules to be clear, simple and transparent.”
Devil in the detail
The UK’s new rules will apply to 17 industries that the government deems sensitive, including nuclear, communications, data infrastructure, artificial intelligence and computing hardware. Would-be overseas investors in these sectors must notify their intentions to a new government agency, the Investment Security Unit (ISU). The Secretary of State for Business will then decide whether such deals merit further investigation and, ultimately, whether they are blocked or allowed to proceed.
On 24 November 2020, in a parliamentary debate about the bill, Minister for Business and Industry Nadhim Zahawi said: “Any action the Secretary of State takes under the proposed regime would be to protect national security and not for wider economic or industrial reasons.”
While the UK’s Enterprise Act already gives ministers powers to intervene in deal-making for reasons of national security, this applied only to deals that were relatively large in size or market share. The new legislation includes no such thresholds. The government’s own assessment is that the ISU may receive as many as 1,830 notifications a year – 30 times the number of deals as are currently reviewed for competition or national security reasons – at a cost to business of £40m a year.
For those who worry about the potential detrimental impact on overseas investment in Britain, those figures are alarming. But the government also says it expects only 70 to 100 referrals to the ISU to result in fully fledged national security assessments, and an even smaller number to face any kind of remedy. This is, after all, a critical moment for the inward investment that many of the businesses in the 17 sectors named in the legislation need so badly to grow.
While the UK has a strong record of attracting foreign investment – second only to the US over the past decade – the COVID-19 crisis has seen activity drop sharply as the pandemic has hit all cross-border business. The first 10 months of 2020 saw a 28% decline in the number of overseas companies buying UK businesses.
Brexit represents a further complication for cross-border M&A in the months ahead. Petrie warns: “The UK government recognises the importance of open markets, but there is still some confusion about what this legislation seeks to achieve and how it will operate. Investors require a regime that is transparent, proportionate and provides certainty.”
How, then, to get to such a regime? The first step, says David Collins, head of the UK corporate department and co-chair of the global M&A group at Dentons, is that the NSI should be more precisely defined. “Without greater clarity ahead of the bill being passed into law, there will inevitably be a significant and disproportionate number of deals being notified,” he argues. “Parties are likely to err on the side of caution and notify deals for review in cases where they perceive doubt or ambiguity.”
In practice, question marks remain over which targets will fall within the ISU’s remit and also about which acquirers the government is concerned about, and which transactions trigger events.
Ministers have promised to provide further guidance on the activities within the 17 sectors that it regards as most sensitive. Otherwise, they concede, the mandatory disclosure regime will be too broad. Advanced materials, to take just one example, covers everything from components used in sophisticated weapon systems to the high-tech fibres in clothing designed for cyclists and runners. It is difficult to see the latter as relevant to national security.
The government is understandably reluctant to publish a list of the nation states that it regards as most risky – hence the need for the legislation to cover all acquirers. But some nations are clearly going to cause more concern than others. And ministers have yet to set out detailed guidance about how they will define ‘overseas’. UK-based private equity funds, for example, may find themselves caught up in the regime if their investors are international.
One major concern is that, unlike the Enterprise Act, the new regime will apply to even the smallest transactions, including investments and acquisitions in unquoted companies. Often, these businesses, in sectors such as technology, will be those that have the greatest need for new funding and the fewest resources with which to deal with complicated new legislation.
The other worry, argues Petrie, is mission creep. “It was very clear from the second reading of the bill in Parliament that there are those who want to extend the scope of the legislation from national security to national interest.” In which case, the argument about whether a particular transaction genuinely poses a security risk could also become one about protecting British jobs or even pride, in Petrie’s opinion.
Political influence on major decisions that have a public or national interest is of course a vital aspect of democratic government. But Robert-Tissot explains how the new legislation marks a significant policy shift: “The narrower remit of the Enterprise Act meant politicians did not have the ability to review many high-profile transactions, even if there was a high level of public interest,” he says.
“Most stakeholders will not want to move to a regime where politicians call in deals for review due to external pressures. The criteria for deciding which deals are to be reviewed need to be clear.”
Will the bill slow down or even stop some M&A? Petrie says: “If the ISU really is going to look at so many deals, it has to have both the culture and the resources that make it possible to resolve these cases quickly. It’s especially important that its officials are able to engage with market participants in a non-bureaucratic way to provide meaningful guidance at an early stage.”
About the article
This is extracted from the full cover story in the Corporate Financier February 2021 edition - exclusively for Corporate Finance Faculty & Faculties Online members - who can access our award winning magazine in its originally designed form, and our extensive archive brought to you by the ICAEW Corporate Finance Faculty.