UK GOVERNMENT PUBLISHES SECOND ANNUAL REPORT ON THE NATIONAL SECURITY AND INVESTMENT ACT

On 11 July 2023, the Cabinet Office published the second Annual Report on the National Security and Investment Act 2021 (NSIA), covering the period from 1 April 2022 to 31 March 2023 (the Report). As discussed in our earlier detailed briefing, the NSIA introduced a new framework for the review of transactions and investments on national security grounds in the UK with effect from 4 January 2022, updating the UK regime in line with the global trend to strengthen foreign direct investment (FDI) screening.

The NSIA requires the Secretary of State to present a report on the operation of the regime to Parliament each year. The first report, published on 16 June 2022, provided a limited overview of the first three months of the NSIA. It showed that the Government stood firmly behind the new regime but acknowledged that the data available at the time was limited and that trends would only emerge in the longer term.

The latest Report covers the full 12-month period to 31 March 2023 and offers valuable insights for investors into the work of the newly established Investment Security Unit (ISU) in enforcing the NSIA regime. Notably it includes some useful data which goes beyond the statutory requirements of the NSIA, including information relating to the origin of investments, reasons for the rejection of notifications, and the number of non-notified transactions called in for review.

We summarise below some of the key highlights from the Report and practical takeaways for investors.

Notifications

• There were 866 notifications received in the relevant period, of which 671 were mandatory filings, 180 were voluntary notifications, and 15 were retrospective validation applications.
• This figure is slightly lower than the 1,000 – 1,830 notifications which the Government estimated it would receive each year when the NSIA was making its way through Parliament. This may in part be explained by reduced M&A activity due to the global economic slowdown.
• In total, 766 transactions were reviewed during the relevant period (this differs from the number of notifications as some will have been rejected and some will still have been under consideration at the end of the reporting period). The vast majority (93%) were cleared within the initial 30 working day preliminary review period.
• 43 notifications were rejected, of which more than half (23) were rejected because they were submitted as mandatory notifications when they should have been voluntary notifications, or vice versa. This is an important point for investors to be aware of and illustrates the importance of careful consideration as to whether a target's activities fall within the definitions set out in the Notifiable Acquisition Regulations.

"Call-ins"

• 65 transactions were "called-in" for further investigation by the Secretary of State. Once again, this is lower than the number originally estimated by the Government (70-95).
• Over half of the call-ins related to mandatory filings, and around one quarter were in relation to voluntary notifications. Importantly, 10 non-notified transactions were called-in during the review period, illustrating that the Government is pro-actively monitoring deal activity and making use of its powers to call-in transactions for review on its own initiative.
• There was also an increase in retrospective validation applications: 15 compared to just one in the three month period covered by the first annual report. This is likely due to more companies becoming aware of the potential retrospective application of the call-in power to transactions which were completed prior to the entry into force of the regime.

Outcomes

• 72 called-in acquisitions were subject to final determination by the Secretary of State during the relevant period (with 11 transactions being withdrawn before the end of the review process).
• Most of the called-in acquisitions eventually received unconditional clearance, with only 20.8% resulting in a final order.
• There were 15 final orders issued by the Secretary of State during the review period (one of which was subsequently revoked due to the acquirer deciding not to proceed with the transaction). Five of these resulted in prohibition or forced divestment of the acquisition, with the rest involving conditions.
• It is notable that this figure is higher than the estimate of 10 transactions per year requiring remedies that was included in the Government's original impact assessment. Combined with the lower overall numbers of notifications and call-ins outlined above, this indicates that the rate of intervention is higher than anticipated.

Country of origin

• Whilst the foreword to the Report emphasises that the NSIA "remains country agnostic", it is clear from the data that investment associated with China attracted the most scrutiny, accounting for 42% of call-ins (despite representing only 4% of notifications), and more than half of the final orders (including all but one of the prohibition/divestment decisions).
• That said, acquisitions associated with China also received the highest number of final notifications (clearances) (40%).
• With regard to investment associated with other countries, it is notable that almost a third of call-in notices were issued to acquirers associated with the UK and a fifth to acquirers associated with the US.

Sectors

• Defence stands out as the sector with the most mandatory notifications received: at 47% this is more than double that of the next largest sector for mandatory notifications, Critical Suppliers to the Government (22%).
• In respect of voluntary notifications, it is notable that the top four sectors share designated labels with mandatory notification sectors: Advanced Materials, Defence, Military and Dual Use and Energy. This reflects the fact that deals in these sectors are being notified voluntarily when the target's activities do not satisfy the specific criteria set out in the regulations which govern when the mandatory notification is triggered, but nonetheless fall within the same sector when viewed more broadly.
• A significant number of voluntary notifications (just over 15%) are also being made in the sector labelled "Academic Research and Development in Higher Education". The Government has issued specific guidance on the application of the NSIA to the higher education and research-intensive sectors, where investment is often sought to further important research being carried out by spin-off companies or research organisations.
• The highest number of call-in notices were seen in transactions in the Military and Dual Use, Defence and Advanced Materials sectors.
• In terms of final orders, a similar list of "top sectors" emerges, with the addition of Communications: four final orders were issued in the Military and Dual Use and Communications sectors, and three in each of Energy, Defence, Computing Hardware and Advanced Materials.

Timelines

• The foreword to the Report highlights that all cases were decided within statutory timelines, which is said to provide "welcome certainty for businesses". Whilst this statement is correct, it is important to be aware that the time periods cited in the Report do not include days when the ISU has "stopped the clock" whilst parties respond to information or attendance notices requesting more information once a transaction has been called-in for more in-depth investigation (which is common practice).
• A degree of caution should therefore be exercised when drawing conclusions about how long the review process may take based on the data in the Report for transactions which are called-in. In our experience, the overall review process can take significantly longer than the statutory timelines would indicate, particularly where remedies are being considered.
• However, in more positive news, all accepted notifications were either called-in or cleared within the statutory time limit of 30 working days.
• For transactions that were called-in, only 29 cases required the "additional period" of a further 45 working days for review following the initial 30 working days for the in-depth investigation stage (of which 15 originated from mandatory notifications).
• There were 10 cases in which the assessment period was extended further to include an additional "voluntary period", with the agreement of the acquirer. In practice these will usually be cases in which a final order is ultimately imposed: 8 of the 15 final orders imposed during the reporting period were issued during an additional "voluntary period".

Key practical takeaways for investors

• The Report provides the first set of data covering a full 12-month period of the NSIA. Whilst it cannot predict with certainty how the Government will approach a particular case, it provides some interesting insights into the types of transactions which are attracting most scrutiny, and the potential impact of the review process on deal timetables.
• The number of notifications received and the number of call-in notices issued are both below the levels predicted by the Government in its impact assessment of the regime. However, the number of cases in which remedies were ultimately imposed is higher, indicating a higher rate of intervention than originally anticipated.
• Unsurprisingly, Defence, Military and Dual Use, and Advanced Materials remain the sectors of particular focus, both in terms of notifications and call-ins. Transactions in Communications, Energy and Academic Research and Development in Higher Education are also identified as more likely to attract scrutiny.
• The Report confirms that Chinese investments are more likely to be called-in and to result in a final order. However, it highlights that acquisitions associated with China also received the highest number of clearance decisions, and the Government is keen to emphasise that the regime remains "country agnostic".
• All cases were dealt with within the statutory timelines (albeit not counting calendar days when the clock may be stopped pending a response to an information request issued following a call-in notice). However, the data shows that decision-making tends to be pushed to the end of the relevant period, and in cases resulting in a final order is likely to extend into the additional "voluntary" period for review which can be agreed by the acquirer beyond the statutory 105 working days. In practice, the review process under the NSIA can have a significant impact on deal timetables and it is important to factor this in at the outset.
• The Report is the latest government effort towards greater transparency under the NSI regime (comments on the Government's previous steps can be found in an earlier post), as the Government seeks to address criticism of the NSIA regime operating as a "black box" for investors.
• The publishing of additional information and metrics beyond the Government's statutory obligations is a welcome development in this regard. However, it is notable that the Report does not include any data relating to the types of remedies being imposed, and the brief published summaries of final orders contain very limited information.
• Whilst the Report claims the NSIA's success as a light-touch, proportionate regime which provides certainty to business, the long term impact of this nascent regime, including the extent to which it may deter foreign investment into the UK, is arguably too early to tell.

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