Talking Business podcast: the UK’s National Security and Investment Act 2021 – the impact on UK transactions

I guess, my first question Paul, is that given that the government's already had the ability to review transactions on certain public interest grounds for a number of years, is this new regime actually such a big deal?

Paul Cliff: Well yes, I think it is. I think the new act does give much broader powers regarding the scrutiny and intervention in acquisitions and investments on the grounds of protecting national security. There were only 13 interventions on national security grounds under the existing regime, which came to force in 2003. But, there are estimates that there could be up to 2000 notifications each year under the new regime. It's aimed at protecting key industries and targets from unwanted foreign investment, but actually catches both foreign and UK investors, so potentially quite a wide net.

Sophie Brookes: So it's something that all potential buyers or investors into UK companies or UK operating businesses need to be aware of, then.

What are the new powers, then? How's the regime going to operate?

Paul Cliff: Well, there are three key features. The first is the mandatory notification regime, which will catch some transactions in certain specified sectors. We then have the voluntary notification regime, where certain transactions which might give rise to national security concerns will be caught. And then finally, we have call in powers, where the Government can review transactions which should or could have been notified under either the mandatory or the voluntary notification regimes.

Sophie Brookes: Okay. We'll run through those three different strands, then.

First of all, let's look at the mandatory notification regime. When is that going to apply? When are we going to have to make a mandatory notification on a transaction?

Paul Cliff: Well, broadly this will apply when anyone acquires more than 25% of the shares or voting rights in an entity which is active in one of 17 specified sectors. Or, when you pass through thresholds at 25, 50 or 75 percent of the shares or voting rights in an entity in one of those sectors. There is no deal size or monetary threshold. Regardless of size, any acquisition in the sensitive sector, or in a sensitive sector, must be notified.

It's also worth noting that it only catches share purchases. The acquisition of a business and its assets is not caught by this regime.

Sophie Brookes:Okay. So it sounds like, then, the definitions of those 19 specified sectors are going to be pretty key here. What are those?

Paul Cliff: Yeah. Some are more obvious than others. If we start with the more obvious ones which are linked to national security, they would include defence, military, civil nuclear, any critical suppliers to the government and emergency services. Others are much broader, so communications, computing hardware, transport and energy where there is a link to national security. The specific definitions are still subject to consultation.

Some have sector-specific materiality thresholds built into them. So for instance, transport only catches ports or harbours that handle more than a million tons of cargo in a year, and airports that handle more than six million passengers or 100,000 tons of freight. For computing hardware, it catches any entity that makes computer processing units, regardless of size.

There's still a bit of uncertainty around and a bit more clarification needed before the act comes into full force.

Sophie Brookes:Yeah. I think the final definitions, as you say, they're still being consulted on. The final definitions are going to be included in regulations, which should be published before the act comes into force later in the year.

How do you think this mandatory notification regime is going to affect transactions in practice?

Paul Cliff: Well, first of all, it's worth noting that any transaction or investment subject to the mandatory notification regime can't complete until the clearance is given. It's effectively a standstill. So you make your notification and then wait for clearance, and your transaction will have to be conditional on clearance. Obviously, that will risk lengthening your deal timetable, and also possibly increasing the deal costs, not to mention the uncertainty.

Sophie Brookes: What happens if you don't comply? If you don't notify or you complete a transaction in a sensitive sector without getting that clearance first?

Paul Cliff: Well, there are sanctions for both the buyer or the investor and potentially its directors, so those would include a fine of up to the higher of 10 million or 5% of global turnover. There is the ability to disqualify directors and even imprison them for up to five years. And perhaps as crucially, the transaction itself would be void.

Sophie Brookes: I mean, that's really interesting, isn't it? So making the transaction void, so potentially trying to unwind the transaction that's actually already taken place. How could that work in practice?

Paul Cliff: Yes. With any conditionality of a contract, it's very difficult to unscramble something when it's already completed. For instance, you'd have third parties who've been dealing with the parties in good faith who could be affected by it. The buyer might have passed post-completion resolutions of the target using votes that it effectively didn't have because they still belong to the seller. Hopefully, we'll get more clarification on this before the bill becomes law, but I do think it's very difficult to see how transactions could be unscrambled.

Sophie Brookes: Yeah, definitely. Okay, that's the mandatory notification regime for those transactions in those specified sectors. Let's move on and look at the second element of the regime, so that's the voluntary notification regime.

When might a buyer want to make a voluntary notification?

Paul Cliff: Well, I think this is most likely to apply when you're acquiring or investing in an entity which is outside of the 17 specified sectors, but where there's a feeling that the transaction could give rise to security concerns. And here, you would make a voluntary notification to avoid the risk of the transaction being called in and investigated post completion.

And, in this part of the regime, it applies broadly to any transaction which gives rise to national security concerns, where the person acquires 25% or more of the votes or shares in an entity, acquires material influence over an entity's policy, and or gains certain rights, interests or control of a qualifying asset. That can be a piece of land, it can be tangible, movable property, or it can be intellectual property rights, depending on the type of business.

Sophie Brookes: Okay. And again, I think there's no deal size or other mandatory threshold here. So regardless of its size, the government could be interested in a transaction if there is a potential security risk. And also, you mentioned in relation to the mandatory notification regime, that that just catches share deals. But obviously here, the voluntary notification regime also catches assets or land deals, where there are national security concerns. I think the standard examples that the government have given about this is things like acquiring land opposite a military barracks or a nuclear reactor. Or, perhaps transfer of trade secrets or technology that have a national security element to it.

So the mandatory and voluntary notification regime, if you make one of those notifications then that avoids the possibility of the transaction being called in for the investigation by the government, and that's the third element of the regime. Can you explain how those call-in powers are going to work?

Paul Cliff: Yeah. Under the act, the government can call in for review any transaction that should or could have been notified under the mandatory or voluntary filing regimes, where they believe it could give rise to a risk of national security.

Sophie Brookes: Yeah. The question of what is national security there is going to be pretty key, isn't it? Do we know what that is?

Paul Cliff: No, we don't have a definition or any indication of what is a risk to national security just yet. The government said it's going to look at three key factors when deciding whether there is a risk to national security, and therefore whether to call in a transaction. They're going to look at the target risk, the nature and activities of the target business or asset being acquired. They're going to look at what they call the trigger event risk, which is the level of influence that the acquirer is acquiring. And finally, the acquirer risk, the identity and affiliations of the buyer. And here, foreign affiliations are key, but interestingly the regime will apply equally to UK and non-UK acquirers.

Right. Even when you've completed a transaction, you've still got the possibility of a review hanging over you if the government decides it wants to call it in because there's a national security concern. How long do you have that possibility hanging over you?

Paul Cliff: Well, the starting point is a transaction which should have been a mandatory notification but wasn't notified can be called in at any time. Other transactions where there was no voluntary notification, they can be called in up to five years after completion, but only up to six months after completion where the government was put on notice of the transaction. You can do that by making sure your transaction's publicized, for instance, in a national newspaper or by emailing the new Investment Security Unit, which is going to be responsible for overseeing the new regime.

Perhaps the most controversial aspect of the bill is that the call in regime is retrospective. So a transaction completed between the 12th November 2020, when the bill was first introduced to Parliament and the commencement date of the act can be called in up to five years after the commencement date. And, this is not limited just to any specified sectors, so any transaction completed after the 12th November last year could be called in for investigation if it gives rise to national security concerns.

Sophie Brookes: So that's why in particular we thought it to be a good topic to talk about because it affects people now. Although the bill has been passed, it's received Royal assent, but it hasn't yet come into force. There is this retrospective effect. And, buyers who are completing investments or acquisitions now need to be thinking about the possibility of the transaction being called in for review. Like you say, that could happen up to five years after they've completed the transaction, although you can reduce that time period down to six months if you put the government on notice of the transaction, if they become aware of it before the commencement date of the legislation later this year.

Do we know what's the risk of one of those transactions, one of those pre-commencement transactions, being called in for review after completion and after the act has been commenced?

Paul Cliff: As you said, this is very much a live issue for transactions that potentially have already completed. But, all we've got from the government so far is they say that call-in will be only in very limited circumstances but with no guarantee. They'll be particularly interested in transactions in the specified sectors. But it's likely, I think, that that threat of call in will drive an increase in voluntary notifications outside of those sectors once the regime is in full force.

And, I think as you said earlier, there is no date yet but the government is saying that the regime will be in full force by the end of 2021. I do think there will be quite a significant involuntary notifications, once that's up and running.

Sophie Brookes: Yeah, definitely. Okay, we've explained about making a mandatory notification and the circumstances in which you could make a voluntary notification.

Can you just explain a bit about the review process, either if you've made one of those notifications or if the government exercises its powers and decides to call your transaction in for review?

Paul Cliff: Yeah. Where a notification has been submitted online to the new Investment Security Unit, which is the method of making the notification, they then have 30 working days to either give clearance or to refer the transaction for phase two investigation. The government has said that the vast majority of cases will result in clearance being given, but of course, we've no certainty or track record yet.

But having said that, if the government is concerned about national security implications of a transaction, it will be referred for phase two investigation. If that's the case, we're then into another period of 30 working days, which could then be extended by a further 45 working days. So potentially, a total period here of 105 days, taking all of those periods into account. And, that assumes that there are no delays if the government, for instance, asks for further information because the notification wasn't complete or it gives rise to further questions.

And then finally, if a transaction is called in by the government rather than through a mandatory or a voluntary notification, effectively it goes straight to a phase two review, so that's 30 days from the date of call in, which is extendable by a further 45, so that could potentially be a 75 day period in total.

Sophie Brookes: So possibly quite significant delays there, and obviously if you do notify then you hope you're going to get that clearance quite early on in the initial 30 working days and not be reviewed for phase two. Sorry, be referred for a phase two review. But if you are, if you do end up in that phase two review, then what happens at the end of that?

Paul Cliff: Well, there are three possible outcomes at the end of that process. It either results in an unconditional approval, so the transaction is cleared for completion and can go ahead. Or, there's a conditional approval which means that the transaction can proceed, but subject to certain conditions which would prevent or mitigate the risks to UK national security. That might, for instance, require a disposal of some of the assets acquired, or access to certain technology to be restricted to specified individuals within the UK security clearance. Or thirdly and finally, it could result in a prohibition, so the transaction could effectively be blocked and not allowed to go ahead.

Sophie Brookes: It feels like quite a step change really here, in the UK's approach to foreign investment screening which is what this is aimed at. Although as we've said, it will also catch UK investors and buyers. It does feel like quite a step change. Although I think it's bringing the UK largely into line with other jurisdictions. In particular, I know the act is largely consistent with other foreign laws such as the EU Foreign Investment Screening regulation.

But, what do you think the practical implications are going to be for UK transactions then, once the regime is in force?

Paul Cliff: Well, I think for buyers, which is where the main impact will be in my view, I think they're going to need to review early on if there is a possibility of the transaction being called in as a risk to national security. And, whether mandatory notification is needed. I think this is going to need proper due diligence on the target's activities, to identify any national security concerns, right at the outset of the transaction. This will move up the list of priorities for buyers. In a way that anti-trust has evolved over the years, I think it'll be on a similar footing. And I think if in doubt, particularly in the early years of this regime before things settle down, people will consider voluntary notifications where there are any concerns to avoid any risk of call in after the event.

Sophie Brookes: Do you think we're likely to see more transactions being conditional on this clearance?

Paul Cliff: Yeah, I think this will become just a matter of the norm within the 17 specified sectors. I think the penalties are sufficiently Draconian, particularly the voiding of the transaction and potential criminal liabilities, that it will drive precautionary filings.

I think we'll also probably see an increase in voluntary notifications outside of the specified sectors. As I said earlier, just particularly in the early years of this regime before things settle down. There's an impact, clearly, on the transaction timetable and the appraisal of the feasibility of any deal.

Interestingly, you will be able to go to the Investment Security Unit for informal guidance, in a way that you can with other regulatory bodies on transactions. But, they will not be bound by any indication that they give without a full review, we may see some of that. But again, until there's a track record, I think, of how the ISU will deal with those approaches, I think inevitably buyers will just err on the side of caution.

Sophie Brookes: Yeah, definitely. That's been a really great summary of the new regime. So what would you say are your key takeaways?

Paul Cliff: Well, I think the key thing is to understand the 17 specified sectors. And as I said earlier, to move towards the top of the list of your early due diligence, the consideration of any national security risks, on all of your transactions. I think inevitably, we need to prepare ourselves for greater conditionality on deals and the impact that will have on deal certainty, deal timetables and costs.

The good news is, and obviously, we've got to wait and see, the government is not expecting huge numbers of transactions to be blocked. They're saying that they expect only in around 10 cases a year will there be national security concerns significant enough to require either conditional approval or prohibition. The vast majority of deals, therefore, will not be prevented or require steps to be taken, but it may take us quite a bit of pain and some patience to get to that unconditional approval stage.

Sophie Brookes: That's great. Thanks very much, Paul. That's a really useful summary, very helpful. As you said, the regime is not in force yet, it's likely to come into force later in the year, hopefully by the end of 2021 so we get a bit more certainty. But, there is that possibility now of transactions that are completed now, since the 12th November 2020, being called in for review.

I think another key point is that we're going to be watching out for the regulations that are going to be made under the act, fleshing out certain aspects of it, particularly those key sector definitions. And then finally, watching out for that commencement date, hopefully, later in the year.

We'll probably do an update once we've got all of that information so we can offer a bit more certainty. That's been a really useful review, thanks very much.

Paul Cliff: Thank you.

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