On 11 July 2023, the UK Government published its second annual report on the UK’s national security and investment screening regime but its first report which provides statistics on a full year of the regime’s operation. The report covers the year from 1 April 2022 to 31 March 2023, a period when four different Secretaries of State assumed the role of decision maker under the regime. It provides some interesting insights on the types of deal attracting Government scrutiny and when investors should prepare for in-depth reviews and potentially intrusive interventions.
1. The volume of notifications is slightly below original expectations – but the rate of intervention is higher
During the reporting period, the UK Government received 866 notifications, which is lower than the number originally expected (1,000 – 1,830 per year). Similarly, the number of deals called-in for further assessment (65) is lower than original expectations (70-95).
However, the proportion of notified deals called-in for further review (over 7%) is towards the upper end of the expected rate. This is significant given the delays often caused by a decision to call in a deal and the unpredictability of review times and outcomes post call-in (see further below).
Despite the lower overall volume of notifications, the number of deals where the UK Government issued orders to block, unwind or impose conditions on deals was higher than originally expected: the reporting period saw 15 remedy cases compared to an original estimate of around 10 per year. Five of those deals were blocked or ordered to be unwound. The remaining 10 were subject to conditions – such as information barriers, government observers on boards and commitments to maintain certain capabilities in the UK – which can be onerous and intrusive in practice for both the target business and investors.
During the same period, the Government agreed national security remedies for two other transactions that were reviewed under the previous regime (Cobham / Ultra Electronics and Parker Hannifin / Meggitt). This followed an uptick in national security interventions in the last few years of the previous regime – a trend we are now seeing under the new, more expansive regime.
2. Targets active in defence-related sectors dominate the deals that are called-in – but tech, communications and infrastructure sectors feature heavily too when it comes to remedies
Of the 65 deals called-in for further assessment, 66% were associated with the military, dual use and defence sectors and 29% with advanced materials (which includes semiconductors). However, of the 15 cases where final orders (remedies) were imposed, the sectors are more evenly spread: targets with activities in the military and dual use and communications sectors received four each, and three went to targets active in each of the energy, defence, computing hardware and advanced materials sectors (note that deals can relate to more than one sector).
It is not surprising that more traditional defence-related sectors have dominated the deals called in for further assessment given the focus of the previous national security regime on defence deals, but it is notable that a broader range of sectors have seen deals with remedies imposed. Investors should take note: firstly, a decision to call-in a deal does not necessarily indicate that remedies will be imposed (nearly 80% of the called-in deals put to the Secretary of State for final determination during the period were cleared unconditionally); and secondly, the UK Government is identifying national security risks in a broader range of sectors and imposing (often onerous) remedies on the businesses involved, particularly those in advanced technology or critical infrastructure sectors.
3. The regime catches investors from all countries including the UK – but deals involving investors from China are attracting the most scrutiny and intervention
The UK regime is unusual compared to international counterparts in that it is nationality agnostic when it comes to origins of the investment. This is borne out in the annual report which shows that the majority of accepted notifications (58%) related to investments associated with the UK. These were closely followed by investors from traditional allies including the US, France, Canada and Germany. Investments associated with China represented less than 5% of notified deals.
However, the picture is reversed when looking at Government interventions: 42% of deals called-in for further assessment involved investors associated with China (compared to 32% associated with the UK and 20% with the US), and eight of the 15 final orders (remedies) involved investors with links to China (note that deals can be associated with more than one country).
These statistics are not surprising given the UK Government’s position, restated by the regime’s current decision maker, the Secretary of State in the Cabinet Office and Deputy Prime Minister, Oliver Dowden MP, that “China represents the largest state-based threat to economy security”. The Government is keen to emphasise that this does not mean “decoupling” the UK from China’s economy, but it should be seen as de-risking that engagement. Investors with links to China, wherever they are in a consortium or chain, should be alert to this heightened risk of intervention and plan for how that risk can be mitigated.
4. The UK Government is using its broader powers to intervene in deals falling outside the mandatory notification regime
During the reporting period, over three quarters of notified deals (77%) fell within the mandatory regime (which catches deals involving targets carrying on certain specified activities in the UK within 17 sensitive sectors). However, the Government has broader powers to call in deals which fall outside the mandatory regime where national security risks may arise, and parties may choose to notify deals voluntarily in order to achieve business certainty.
The annual report throws some light on the types of deal that parties are choosing to notify voluntarily, and the deals falling outside the mandatory regime that are being called in for review.
Firstly, a large proportion of deals being notified voluntarily involve targets with activities within the same broad sector as the 17 mandatory sectors, but which do not satisfy the specific criteria set out in the regulations. Notably, the top four areas of economy for voluntary notifications share the same labels as the mandatory regime: advanced materials, defence, military and dual use and energy. However, parties have also used the voluntary notification regime for a broad range of sectors that are not linked to the mandatory sectors, including finance, insurance, construction, accommodation and food.
Secondly, although voluntary notifications made up 21% of total notifications in the reporting period, of the 65 deals called-in for review, 17 (26%) followed a voluntary notification and 10 deals were called-in having not been notified at all. Moreover, of the 766 notifications reviewed during the period, 6% of mandatory notifications were called-in and 12.4% of voluntary notifications were called-in. This pattern was also seen in final orders, where several deals which were blocked or had conditions imposed clearly fell outside the mandatory regime (eg because they were asset deals or fell below the mandatory change of control thresholds).
These statistics illustrate some important points for investors: the rate of call-in for voluntary notifications was double the rate the call-in for mandatory notifications; and the Government’s Investment Security Unit is actively monitoring and calling-in unnotified deals. Investors should not assume that their deals will go unnoticed and, if the Government identifies potential national security risks arising, it will call-in the deal (and potentially impose remedies) whether or not the target’s activities fall within scope of the mandatory notification sectors.
The Government is clearly using its broader call-in powers to intervene when it considers it necessary or appropriate, and a case-by-case assessment of national security risks arising from the acquirer and/or the target’s activities remains key.
5. A light-touch and proportionate regime for most – but deals called-in face a lengthy review and uncertain outcome
The Government is keen to emphasise that the regime is “light-touch” and “proportionate” and, with 93% of notifications being cleared with 30 working days of the filing being accepted as complete (which takes on average 4 working days), the statistics support those claims for the vast majority of cases. However, the published statistics do not provide a clear picture for the cases that are subject to in-depth review.
Firstly, in terms of timing, following a call-in the Government has an initial 30 working day assessment period, which can be extended by an additional 45 working days and extended again for a voluntary period with the agreement of the acquirer. However, during each of those assessment periods, the clock is stopped whilst parties respond to information or attendance notices requesting further information, which are common. In practice, the clock can stop for several weeks (or even months) at a time.
The annual report shows that, of the 65 acquisitions called-in during the reporting period, 25 used the additional 45 working day period and 10 used the voluntary period. It also states that the Government took an average of 81 working days from calling in an acquisition to issuing a final order. However, these time periods do not include days when the clock was stopped. Investors should therefore be cautious about drawing conclusions from these time periods: experience is showing that, for those deals that are called-in and particularly those where remedies are being considered, the time taken to conclude the review can be long and unpredictable.
Secondly, in terms of outcome, the annual report is focused on statistics and does not provide further details of the types of remedies being imposed or why certain deals have been called-in. Published details are confined to short notices that are published with final orders which provide only very high level summaries of the national security risks and conditions imposed. The Government is balancing the need for transparency for the market with protecting national security risks, but the lack of detail provided of the reasons for extended reviews and the imposition of conditions will continue to be a source of debate.
The UK Government’s desire to increase transparency and predictability for investors and target businesses is welcome. It is also clear that the Government is achieving its objective of fast reviews and clearances for the vast majority of deals that are notified under the regime. However, the picture for deals which raise potential concerns – either because of the nationality of investors and/or the sensitivity or strategic nature of the target’s business – is less clear.
Early assessments of potential concerns remain key – and parties involved in deals that could attract scrutiny should prepare for potentially lengthy reviews and understand the scope and nature of remedies which could be imposed. The risks of intervention and the impact on deal timing and outcome should be anticipated upfront in deal documents – conditions, obligations on the parties to cooperate with the Government during reviews, long-stop dates and financing. And finally, investors should take note: because a deal falls outside the scope of a mandatory filing obligation does not mean the UK Government will not exercise its broad powers to intervene.
For further information about developments in foreign investment and national security regimes globally, please see our Foreign investment monitor or get in touch with one of the Freshfields team.