UK Government Publishes Third Annual Report on UK National Security and Investment (NSI) Act

Introduction

On 10 September 2024, the UK Government published its third annual NSI report, the second to cover a full annual reporting cycle. Undoubtedly delayed by the General Election (the previous report was published in July 2023), the report’s contents are an indicator of how the NSI regime functioned during the final year of the Conservative Government.  With the recent changes in the UK political and defence environment and expected upcoming reforms to the NSI regime, investors and businesses are watching developments closely – keen to understand whether the new Government’s approach will change in any way and, for example, align more closely with a more active industrial strategy and the Government’s broader economic and foreign policy objectives.

What does the report show?

Key takeaways from the third annual report are:

1. The regime continues to capture a large number of transactions with the total number of notifications remaining steady (906 over the reporting period 2023-24 (‘this year’) vs 865 over the reporting period 2022-23 (‘last year’)).  A helpful indicator is the lower number of notifications rejected by the Investment and Security Unit (ISU) (24 vs 42 last year), perhaps due to parties gaining a better understanding of some of the regime’s ambiguities. 
2. Slightly fewer call-in notices than last year (41 vs 65 last year) and, although call-ins following mandatory notifications were stable, a higher proportion of voluntary notifications were called-in (37% vs 26% last year).  This increase illustrates how acquisitions falling outside the mandatory notification regime can – and do – give rise to national security risks.  It underlines the importance and complexity of risk assessments surrounding the use of voluntary filings. 
3. Fewer final orders (remedies) (five this year vs 15 last year) and no blocks which more likely indicate the nature of the transactions reviewed rather than a more open approach.  Although we’d expect the number of final orders to vary year-on-year, it is notable that no final orders were imposed on investors with links to China (in contrast to eight out of 15 last year).  This trend may indicate greater reluctance from Chinese investors to acquire ‘high risk’ targets where unpalatable remedies or even a block are likely.  The Government’s focus on the UK’s bilateral relationship with China and, in particular, the UK’s dependence on Chinese supply chains could well shape its approach to future investments from China in sensitive and strategic sectors – the Government’s findings from its reviews will be watched closely.
4. The “military and dual-use” sectors continue in the spotlight, while “critical suppliers to government”, “academic research in higher education, advanced materials and communication” and “communication” are also closely scrutinised.  This year, “military and dual-use” faced the most call-ins, whereas last year it was “defence”.  However, “defence” still made up the most final orders (four), followed by “military and dual-use” (two) and “communications” (two) (NB notifications may be associated with more than one sector).
5. The NSI regime remains nationality-agnostic with a wide range of countries representing call-ins and final notifications.  Transactions involving investors with links to China, the UK and the USA were most commonly called-in.  Final orders were imposed on acquirers from the UK (two), USA (two) and Canada, France and the UAE (one each).
6. Non-notified acquisitions will not necessarily escape scrutiny as the ISU continues to scan and investigate non-notified acquisitions, with four being called-in and of these, one resulting in a final order.  Based on these statistics, there is a higher likelihood of remedies being imposed if a non-notified acquisition is called-in compared to a notified transaction (25% vs <1% for mandatory and voluntary notifications combined).

What is missing?

Aware of past criticism, the ISU has gone out of its way to emphasise that it has included “additional information [in the report] to aid understanding and transparency” (e.g. average times from a transaction being called in to a final order).  However, there are still areas where investors and their advisors are currently unsighted:

• how voluntary notifications are being used and which types of voluntary notifications are most frequently called-in.  For instance, whether this route is most commonly used for deals involving assets or acquisitions of material influence over targets, or companies with activities outside (but closely linked to) the mandatory sectors; 
• the impact of “clock stops on timing (including statistics on how long they lasted for, information notice response deadlines and ISU confirmations when information notices were considered complete);
• the ISU’s use of interim orders (including contents, regularity and fact patterns most likely to prompt one’s imposition); and
• penalties – when and in what circumstances the ISU will begin using its statutory powers to impose fines when parties proceed with a notifiable transaction without notifying or waiting for clearance.

More information on all these points would help investors make more informed decisions about the NSI risks and implications of (potentially lengthy) reviews for their deals.

Past behaviour a predictor of future practice?

The continuing relevance of the third annual report’s findings will depend on the outcomes of recent and imminent developments including:

• The new Labour Government – the Labour Government has been clear that, like the Conservatives, protecting national security is a top priority, whilst openness to trade remains a key driver of economic growth.  However, clear linkages already being made between “national security”, “economic security” and “national resilience” could colour how the Labour Government both shapes and deploys the NSI regime.  Over the next few months, investors will be keen to understand whether, for example, investment screening may be used more actively to defend and encourage growth in key industrial sectors, drive greater domestic ownership of critical industries and/or secure more national resilience in essential supply chains.
• Strategic Defence Review – the Prime Minister launched the Strategic Defence Review on 16 July 2024 to identify – among other points – regulatory gaps, including in the NSI regime.  A call for evidence is currently open and due to finish on 30 September 2024.  The Government has stated that “the Review will ensure that Defence is central both to the security, and to the economic growth and prosperity of the UK” underlining Labour’s view that the UK’s security is intertwined with its economy. 
• Pending NSI reforms – following an initial consultation earlier this year.  In April 2024, the Conservative Government trailed:
  • a formal consultation on the mandatory sectors “by the summer” (the Government has a statutory obligation to publish a report on these sectors by 4 January 2025) – the consultation was due to cover topics including: clearer definitions for “advanced materials” and “artificial Intelligence”; standalone definitions for “semiconductors” and “critical minerals”, aligning with the UK’s latest strategies for those sectors; the potential addition of water as a new sector;  and additional/clarified guidance for defence and critical suppliers to government areas; and 
  • legislation relating to limited NSI technical exemptions (e.g. the appointment of liquidators) underpinned by an ISU national security risk assessment in the Autumn King’s Speech. 

However, neither of these events has occurred yet, derailed by the July General Election; they’re awaited imminently, potentially in a different guise. 

These factors are likely to shape the legal framework and operation of the NSI regime over the next 6-12 months. If you want to know how they might impact any NSI process for your company – whether now or in the future - please get in touch.