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FI Monitor Issue 5, 2022

The UK’s national security and investment regime – key trends emerging from the first remedy cases and 10 months of experience

Since our last update in May 2022, the UK government has started publishing details of the first transactions found to raise national security concerns where remedies (Final Orders) have been imposed. Combined with our own experience of the regime in practice, these developments illustrate several important trends in terms of how the UK government is exercising its powers under the new regime, with implications for investors and target businesses.

Early indications of the types of remedies imposed

When the UK government published its first set of statistics covering the first three months of the regime, 17 deals of 222 notified had been called in for in-depth review, but none were yet subject to a Final Order (see our earlier blog). Since July 2022, the UK government has now published summaries of ten cases where a Final Order has been imposed:

  • three transactions have been blocked or ordered to be unwound: all involve Chinese acquirers of rights over, or ownership of, advanced technologies with dual-use applications; and
  • seven transactions have been allowed to proceed subject to conditions. 

As the graph below shows, in those transactions which were not blocked, the most common conditions involve restrictions on the sharing of sensitive information, technology or IP between the target and acquirer (or other third parties). Other conditions involve:

  • commitments to maintain certain strategic capabilities in the UK (e.g. government contracts, manufacturing and/or R&D);
  • restrictions over appointing staff and/or board members in the target business;
  • requirements for government approval before certain contracts are agreed or asset transfers take place; and
  • in the most far-reaching set of conditions imposed so far (Sichuan / Ligeance) a government observer being appointed to the board of the target’s subsidiary (Gardner Aerospace), despite the fact that the target has owned the subsidiary since 2017.

As expected, the types of remedies required to mitigate risks to national security are broadly in line with the UK government’s practice under the previous public interest regime, and this trend is expected to continue. 

Timely illustrations of practice under the previous regime are the undertakings accepted in two transactions where the Secretary of State intervened on national security grounds before the current regime came into force. In Cobham / Ultra, the strict conditions to clearance included creating two new “SecureCos” (UK entities which encompass the facilities that deliver sensitive capabilities to the government), placing a government appointed non-executive director on the board of each SecureCo, and giving the government strong step-in rights (similar to a “special share”). In Parker-Hannifin / Meggitt, the undertakings ensure security of supply to the UK’s Ministry of Defence and protect sensitive information and sovereign UK defense capabilities.

One notable difference, however, is that far fewer details of the specific conditions imposed on parties are published as the UK government seeks to balance the trade-off between protecting national security and providing transparency and certainty for the market. Also, unlike the previous regime, there is no public consultation on the terms of a Final Order. The UK government’s approach towards the level of detail that should be made available is expected to be subject to review as practice develops.

The types of acquirers and target businesses attracting scrutiny

The UK government’s previous statements that the regime would be “nationality agnostic” have borne out in practice. Several Final Orders, as well as transactions currently under review, involve acquirers from traditional allies including France, Germany, Australia, and the United States. One case (the acquisition by UK-based private equity firm Epiris of Sepura, from Chinese owners) demonstrated that even UK investors are not immune from the imposition of remedies. Together, these cases emphasize the regime’s focus on the nature of the target’s business and – in some sectors – the need to protect sensitive information, technology or critical infrastructure, irrespective of the acquirer’s nationality. 

A notable trend, however, is the significant proportion of Final Order cases involving Chinese acquirers (over half so far). This reflects concerns expressed by UK government ministers and security services over the threat posed by technology transfer to China. Back in July, during the contest to be the UK’s next Prime Minister, the recently appointed new Prime Minister Rishi Sunak MP set out a series of plans to tackle what he called the “largest threat to Britain and the world’s security” (China and the Chinese Communist Party), including:

  • building a new international alliance to share best practice in technology security;
  • providing more support to counter industrial espionage and help companies protect their intellectual property; and
  • preventing Chinese acquisitions of key British assets including strategically sensitive tech firms. 

More recently, at the G20 summit in Indonesia, the Prime Minister cited the UK’s national security and investment regime as a good example of the UK’s powers to defend itself against China as “undoubtedly the biggest state-based threat to our economic security”. The new Secretary of State for Business, Grant Shapps MP, is now charged with implementing those powers. His first published decision – ordering China’s Nexperia to sell the 86 percent stake in Newport Wafer Fab (the UK’s largest semiconductor manufacturer) which it acquired in July 2021 – has underscored the government’s approach.  As Nexperia has announced its intention to appeal the government’s decision, this could be a test case for the regime.

Mirroring this trend, a significant proportion of Final Order cases involve targets developing advanced or sensitive technologies (particularly those with dual-use applications), as well as those owning and operating critical national infrastructure assets (notably in the energy sector). 

A broad range of transaction types

We are also seeing the UK government using its expansive powers to review a broad range of transaction structures. That a third of the Final Order cases so far involve transactions where the relevant “change of control” falls outside the mandatory notification regime highlights the need for investors to be mindful of the government’s broader call-in powers. These include:

  • share acquisitions below 25 percent: the acquisition by UAE’s Tawazun Strategic Development Fund of shares in Reaction Engines is an example of a transaction being called in and having remedies imposed where the acquirer gained the lowest level of control for potential call-in (“material influence”) – which can arise at significantly lower levels than the (over 25 percent) minimum threshold for mandatory notification; and
  • acquisitions of control over assets: two Final Order cases involved acquirers gaining rights to direct or control how an asset is used, illustrating the broad nature of relevant asset acquisitions which again fall outside mandatory notification requirements. In the first case (Beijing Infinite Vision Technology / University of Manchester), the government blocked a license agreement that would enable the Chinese entity to use IP relating to vision sensing technology with dual-use applications. In the second case (Stonehill Energy Storage / Stonehill project asset development rights), a Chinese entity acquired development rights for an energy storage project; this transaction was allowed to proceed subject to conditions designed to protect the important electricity asset and services provided to National Grid. 

These cases illustrate the importance of assessing the risk of certain transactions being called-in – and the benefits of voluntary notification – when the criteria for mandatory notification are not met.

Lengthy review periods and a turbulent political climate

One of the stated benefits of the regime is the clear (and relatively short) statutory time periods for review. It has become increasingly clear, however, that while the vast majority of cases are cleared within these timescales, the period for review of cases raising concerns can be long and unpredictable. 

There are two main reasons for this:

  • “Clock-stopping”: if the Investment Security Unit (ISU) requires more information from the parties after a transaction has been called-in for further review (as is the case for most deals), the review clock stops until the ISU is satisfied that the information has been provided. As several notices are often served on multiple parties during the review, this can significantly extend the time period.
  • Extensions: following the initial 30 working day period after a call-in notice, the time period can first be extended by 45 working days and then for an undetermined period with the agreement of the parties. As the ISU is often finalizing remedies during this latter period (liaising with other Government departments and inviting representations from the parties), the end date for such reviews is often unclear.

The net result is that the majority of notified deals are cleared within 6–7 weeks of notification, but parties should be aware that, in the more complex cases, reviews can be on-going for over 6–7 months – and this should be anticipated in deal documents with appropriate long-stop dates and obligations on all parties to cooperate with the ISU’s review. 

Looking ahead

The UK’s new regime has now been fully operational for 10 months, but it is still relatively early days for transactions that raise concerns to undergo a full national security review and conclude with remedies. Practice is therefore still developing, and the ISU continues to monitor and update its guidance to reflect developments. The current turbulent political climate in the UK could also impact the types of deal that attract heightened scrutiny.  

To view previous versions of our foreign investment monitor, please visit our archive here.

Our team

Please get in touch with us or your usual Freshfields contact if you would like to discuss these or any other regulatory issues in more detail.