UK national security screening in the political crosshairs

UK Conservative Government looks at refining the NSI regime – but, ahead of a 2024 election, Labour objects to any watering down

On 13 November 2023, the UK Government announced a consultation on the UK’s national security and investment (NSI) regime.  The wide-ranging review is driven by the Government’s desire to make the regime as “pro-business and pro-investment as possible” - also one of the drivers behind the Investment Security Unit’s (ISU) move into the heart of the Government (the Cabinet Office) in February 2023.  It comes at a time when the UK’s merger control authority (the CMA) has attracted attention for intervening in deals cleared elsewhere (e.g. the CMA’s original decision in Microsoft/Activision), which has fuelled a public debate on the impact of regulatory uncertainty on investors’ appetite to invest in the UK.

The consultation makes a number of suggestions to improve, and potentially narrow, the regime and has been well-received, particularly as stakeholders have been calling for many of the consultation’s proposals since the regime came into force in January 2022.  As the 2022/23 ISU Annual Report demonstrated, the regime is relatively light touch for the vast majority of investors. However, there are still areas for improvement – all of which the consultation aims to address:

• the NSI regime is capturing a high volume of deals with no conceivable national security concerns, thereby creating avoidable friction for dealmakers.  Although the regime is not catching as many transactions as originally anticipated (866 compared to 1,000-1,830), 93% of notifications in 2022/23 were cleared within 30 working days of the filing being accepted as complete (i.e. were unproblematic);
• the regime is unclear, particularly the mandatory sector definitions - the ISU’s Annual Report reflected the uncertainty surrounding the regime’s interpretation, particularly the mandatory sector definitions.  In 2022/23, 43/849 notifications (~5%) were rejected, 11 mandatory notifications because they should have been voluntary and 12 voluntary notifications because they should have been mandatory.  A significant number of these “wrong track” notifications were likely rejected because the mandatory sector definitions had been misapplied/misunderstood due to inherent ambiguities; and
• the ISU is a “black box” with poor communication and opaque processes – the ISU has previously come under substantial pressure from all quarters to improve its processes and increase transparency including via evidence given to the Business, Energy and Industrial Strategy (BEIS) Select Committee during its inquiry into information sharing by the ISU (February/March 2023), parties and their advisors, and thinktanks including the Tony Blair Institute for Global Change. 

Given the above, perhaps the consultation’s most surprising elements were therefore its timing and scope – a full review of the mandatory sector definitions was already expected as the Government prepares to publish its statutory report by January 2025.

The consultation mirrors broader global national security trends in the regulatory space, specifically:

• protectionist tools moving up governments’ agendas, including the use of outbound investment screening (OIS) mechanisms (e.g. the US introduced an OIS mechanism covering China this summer, while the European Commission is due to publish its OIS proposals by the end of this year);
• FDI regimes being revisited after an initial bedding-in period (e.g. the European Commission is due to publish proposals to update/amend the EU FDI Screening Regulation by the end of 2023); and
• an increased focus on semiconductors and critical materials in FDI regimes, reflecting domestic policy and concerns relating to over-reliance on hostile states for these technologies and materials.

It was notable that the UK Government’s NSI decision-maker, Oliver Dowden MP, used remarkably similar terminology – “a small garden, high fence” – to describe the Government’s approach to investment screening, as the “small yard, high fence” term used by U.S. officials to describe the Biden Administration’s approach towards its new OIS restrictions.

The Consultation

The consultation (deadline 15 January 2024) – a large part of which is structured as multiple choice questions - covers three main areas:

• the impact of the NSI regime on businesses and investors, and their experience interacting with the process;
• whether the scope and requirements of the regime are proportionate and effective; and
• how well stakeholders understand the NSI regime, how it is likely to be used, and what national security risks may be posed by investments.

The Government aims to achieve three primary goals with the consultation:

• inform its review of the 17 mandatory sector definitions, including ultimately: (i) clarifying the scope of the Advanced Materials, Critical Suppliers to Government and Synthetic Biology definitions; (ii) refining the scope of the Artificial Intelligence and Communications definitions; (iii) clarifying and expanding on the Data Infrastructure and Suppliers to Emergency Services definitions; (iv) refining and clarifying the Defence definition; (v) updating the Energy definition; and (vi) creating separate definitions for semiconductors (currently captured by the Advanced Materials and Computing Hardware definitions) and critical minerals (currently captured by Advanced Materials definition);
• improve and streamline the NSI notification and assessment processes to minimise business burdens as far as possible, without compromising the Government’s ability to conduct proper scrutiny.  For example, the Government is proposing improved communication between the Investment Security Unit (the relevant UK authority) and notifying parties (via routine calls, named contacts etc), as well as adding potential exemptions from mandatory notification requirements including for: (i) acquisitions by non-crown public bodies, liquidators, official receivers and special administrators; and (ii) internal corporate restructurings; and
• develop the Government’s public guidance and communications on how the relevant legislation works and where the Government tends to see risks arising.  The Government has asked for input on where additional guidance would be useful and suggested updates to the Section 3 Statement (which sets out at a high level how the Government conducts its risk assessment), the mandatory sector definitions and outward direct investment specifically, while asking for stakeholders’ suggestions on other areas where guidance could prove helpful.

Next steps

Getting the balance right, in terms of intervening to protect national security and not stifling investment, will continue to be high on political agendas as the regime evolves.  The UK’s main opposition party, Labour, has already promised to oppose any dilution of the NSI regime, stating that it would put the UK at odds with key allies, as well as the Labour Party’s belief that the UK must “prioritise strength and resilience in the face of an uncertain world”.  Ahead of a likely UK General Election in 2024, emerging differences of approach between the main political parties towards foreign investment, national security and economic resilience will become increasingly salient.  

This is an important opportunity to help shape the regime for the future.  Please get in touch with us or your usual contact in our Antitrust, Competition and Trade team if you would like to discuss the Government’s review and the UK’s developing approach to NSI screening.