Updates To The UK National Security And Investment Act

Key Points

Following our Alert last month addressing the United Kingdom Government's intentions to improve the workings of the National Security and Investment Act 2021 (NSIA), the U.K. Government has now published two new sets of guidance - an updated "Section 3 Statement" and updated Market Guidance - designed to enhance comprehension of and compliance with the NSI regime, including:

• Expanded Risk Clarifications. Greater insight into the potential security risks the Secretary of State considers likely to trigger a call-in.
• New Hypothetical Scenarios. Especially helpful for funds and fund sponsors, this includes examples and guidance for complex fund structures where it is unclear who the ultimate beneficial owners are.
• Acceleration in financial distress cases. In acquisitions involving parties who are suffering material financial distress, it may be possible to expedite the government's decision on whether or not to call in an acquisition.
• Enhanced guidance on assessing acquirer risk. For funds and fund sponsors, it is important to note that the Secretary of State will want to consider the source of the funds (including individual members of investment consortia, the fund managers and the ultimate beneficial owner(s)). For state-affiliated entities, the Secretary of State emphasised that where entities have ties or allegiances to states or organisations hostile to the U.K., this will inform the Secretary of State's assessment of acquirer risk.
• Outward Direct Investment. The updated guidance provides some clarification on the application of the NSIA to scenarios involving non-U.K. investments (provided the necessary UK-nexus criteria are satisfied).
• Detailed advice for the higher education and research-intensive sectors. including examples how NSIA applies to certain academic collaborations.
• Improved guidance on completing forms and timelines. Top tips when completing a notification form.

These are just the first of many steps the current U.K. Government is taking to streamline the NSIA Regime. We are still expecting the Government to (i) consult on changes to the mandatory notification areas¹; (ii) consider certain technical exemptions to the mandatory notification requirement; and (iii) make further improvements to the operation of the NSIA system, including the NSIA Notification Service. In particular, we continue to encourage the U.K. Government to implement an exemption for intra-group transactions, as well as a fast-track 20 working day review period for straightforward cases, including those involving institutional investors with a strong track record of responsible investing the U.K. (which may also include intra-group reorganisations, should no formal exemption materialise).

An updated statement on how the Secretary of State intends to exercise the power to call in a transaction

The new Section 3 Statement "gives as much detail as is possible on how the Secretary of State expects to use the call-in power, given the sensitivity of national security". This is intended to result in greater clarity over the sectors the Government considers most sensitive and how it assesses the national security risks of investors as well.

Expanded Risk Clarifications

The updated statement provides an insight as to the potential security risks the Secretary of State could consider. This includes:

• The risk of 'disruption, erosion or degradation of critical national infrastructure'. The previous guidance simply referred to 'the security of critical infrastructure', so the new additions here are the "disruption, erosion or degradation" of critical national infrastructure. While critical national infrastructure has not been exhaustively defined in the regulations, it includes at least the civil nuclear sector, public communication networks, all space-based services, synthetic biology, Government buildings and military bases.²
• The 'risks to related supply chains'. We understand that this relates to ensuring that transactions do not create a dependency, or create a vulnerability, that could lead to a national security risk.
• The risk of 'any potential disruption or erosion of the U.K.'s military, intelligence, security or technological capabilities' (including acquisitions which enable 'those with hostile intentions to build defence, intelligence, security or technological capabilities' that could present a national security threat to the U.K.). This could be through, but is not limited to, the acquisition of goods, technology, sensitive information (including data), intellectual property, know-how or expertise.

New Hypothetical Scenarios

The updated Section 3 Statement also helpfully provides new and updated hypothetical scenarios to provide greater clarity on the assessment process when determining whether to exercise call-in powers. There are now a total of seven examples in the updated Section 3 Statement (as opposed to five in the previous version). The scenarios consider a range of sectors including the licensing and sublicensing of intellectual property (IP), acquisitions of a sensitive part of a business and interestingly, artificial intelligence (AI) technology (emphasizing its growing importance). The scenarios also consider joint ventures involving sub-contractors to the Government (the U.K. Ministry of Defence in the provided Example 3).

Importantly for funds, the updated statement discusses transactions involving complex fund structures. The statement refers to scenarios where "it is unclear who the ultimate beneficial owners are from the complex fund structure" – meaning that in such circumstances it will be more likely that the Government will need to issue Requests for Information (RFIs) to obtain this information or to carry out an in-depth investigation.

Acquirer Risk Assessment

The updated statement also contains enhanced guidance on assessing acquirer risk. The Secretary of State may consider the characteristics of the acquirer to a greater extent, paying particular attention to the 'past behavior of the acquirer and the intent of the acquisition, the sector of activity the acquirer operates in and its existing capabilities (e.g., technological and security capabilities), whether it has cumulative acquisitions across a sector or linked sectors, and any ties or allegiance to a state or organization which may seek to undermine or threaten the national security of the U.K., considering the intent and cumulative sector acquisitions'.

Importantly for funds, the updated statement also notes that they are interested in the intent and past behaviour of any linked parties. For example, the Secretary of State may consider the source of the funds (including individual members of investment consortia, the fund managers and the ultimate beneficial owner) and whether actors with hostile intentions are seeking to obfuscate their identity by funneling investment through other companies or corporate structures. This could mean that funds and fund sponsors may have to provide more information/documents to the Secretary of State going forward.

Significantly for state-owned entities (or state-affiliated entities), the Secretary of State clarified that it does not "regard all state-owned entities, sovereign wealth funds or other entities affiliated with foreign states, as being inherently more likely to pose a national security risk". However, the Secretary of State emphasized that "where these entities have ties or allegiances to states or organisations hostile to the U.K., this will inform the Secretary of State's assessment of acquirer risk" (but this does not automatically mean that the deal will be called in).

Finally, the updated statement notes that in some cases, the target is so sensitive that the Secretary of State will want to be investigate it regardless of the acquirer risk. In other cases, risks may arise through a target company's structures or security processes, regardless of the acquirer. For example, the acquisition of a sensitive part of a business by a U.K. company with poor information security may result in risks to national security. Parties to transactions involving U.K. companies with even potentially sensitive activities should therefore be carrying out a careful due diligence process to ensure that the target company's internal structures or security processes are robust.

Updated Market Guidance

The second piece of guidance released on 21 May 2024 is the updated Market Guidance. Essentially, the new guidance seeks to clarify the factors the Government will take into account when assessing the national security risks posed by a prospective transaction. The main changes are highlighted below:

• Outward Direct Investment: The updated guidance provides some clarification on the application of the National Security and Investment Act 2021 (NSIA) on scenarios involving non-U.K. acquisitions (provided the necessary U.K.-nexus criteria are satisfied). This can be, for example, with regard to the transfer of technology,³ intellectual property and expertise as part of the investment or when forming joint ventures overseas. When deciding whether to call in, the Secretary of State will consider whether the asset or entity is linked to any activities potentially subject to a mandatory notification.
• Practical Tips for Notifications: Improved guidance on completing forms and timelines including helpful information on 'how the statutory timelines for the "review period" and "assessment period" are calculated and how information notices and attendance notices affect these timelines'.
• Higher Education Sector: Detailed advice for academic collaborations and detail on how the NSIA applies to 'higher education and research-intensive sectors' as well as further 'guidance to help higher education institutions decide whether to notify the Government of certain academic collaborations'. Examples of notifiable acquisitions can be found here.
• Acquisitions involving parties who are suffering material financial distress. In exceptional circumstances, it may be possible to expedite the government's decision on whether or not to call in an acquisition. The scope to expedite later stages of the process during the "assessment period", after an acquisition has been called in, is more limited, as a call-in means that the Secretary of State has already established that there is reasonable suspicion that the transaction has given rise to or may give rise to a risk to national security. Relevant evidence of urgent financial distress is likely to include, but is not limited to:

1. Restructuring and insolvency advisor confirmation of engagement, along with their analysis and advice to the company supporting the claim that an insolvency event is imminent
2. 13-week cash flow statement, clearly showing a deficit and breach of facilities
3. Current balance sheet and profit and loss account, including projections
4. Evidence of non-support from lenders and shareholders, including evidence of breaching banking facilities
5. Correspondence with suppliers/creditors of the company evidencing debt demands (and therefore non-support).

Concluding remarks

By publishing the two pieces of guidance discussed above, the Government has demonstrated a solid start to actioning its stated plan to fine-tune the NSIA to ensure that the U.K. investment screening regime is as "business friendly as possible". We can expect further updates this Summer, with the Government planning to launch a formal public consultation on updating the definitions for the 17 sensitive areas of the economy that are subject to NSIA's mandatory notification requirements. With the General Election now called for July 4, it remains to be seen how any change of Government may alter these plans.

Footnotes

1. In this regard we note the proposed updated European Union (EU) Foreign Direct Investment FDI Regulation "Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on the screening of foreign investments in the Union and repealing Regulation (EU) 2019/452 of the European Parliament and of the Council" which features an expanded Annex II of technologies, assets, facilities, equipment, networks, systems, services and economic activities of particular importance for the security or public order interests (see here).

2. https://www.gov.uk/government/publications/national-security-and-investment-act-guidance-on-notifiable-acquisitions/national-security-and-investment-act-guidance-on-notifiable-acquisitions.

3. See the Secretary of State's final order with regard to Beijing Infinite Vision Technology Company and the proposed licence agreement that enabled Beijing Infinite Vision Technology Company to use the University of Manchester's intellectual property relating to SCAMP-5 and SCAMP7 vision sensing technology to develop, test and verify, manufacture, use, and sell licenced products.

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