UK investment screening: Government confirms commitment to a more pro-investment approach and sets out next steps

By Veronica Roberts and Ruth Allen, Herbert Smith Freehills LLP

On 18 April 2024 the UK Government published its response to feedback from stakeholders on the operation of the UK National Security and Investment (NSI) regime since it entered into force in January 2022, gathered via a Call for Evidence issued in November 2023 (see our previous blog post here). During that period the Investment Security Unit (ISU) has reviewed over 1,700 notifications made by businesses under the NSI regime and issued 5 prohibition/divestment decisions as well as imposing conditions in a further 15 cases (four of which we have been involved in).

The Government has concluded that the NSI regime is working well overall, but also acknowledges that it must evolve and adapt to changing realities, including the deterioration of the global security environment and developments in threats to UK national security. The Government has now committed to taking a number of steps to fine-tune the essential protections needed for UK national security, whilst ensuring the NSI regime remains as frictionless as possible for the vast majority of transactions that do not pose any concern. Between now and Autumn 2024 the Government will:

• publish an updated statement in May 2024 on how the Secretary of State expects to exercise the call-in power (the “Section 3 Statement”);
• publish updated Market Guidance Notes in May 2024 to address a range of topics, including the application of the NSI regime to academia and outward direct investment;
• undertake a formal public consultation in Summer 2024 on amendments to the definitions of the specified activities in 17 specified sectors which can trigger mandatory notification obligations under the NSI regime;
• bring forward secondary legislation by autumn 2024 to exempt the appointment of liquidators, official receivers and special administrators from the scope of mandatory notification requirements, and explore the feasibility and impact of additional targeted exemptions for certain transactions, including internal reorganisations; and
• consider further improvements to the NSI review process and ways to improve the online NSI notification portal.

We explore the key points investors need to be aware of in relation to each of these areas further below. The response emphasises that the Government intends to continue to work “hand in glove” with business to further shape the UK’s policy on screening of investments on national security grounds, in line with a “small garden, high fence” approach (i.e. focussing on the small number of investments that pose genuine national security concerns).

Unsurprisingly, the Government has rejected calls for a fast-track process for certain types of acquirer (e.g. those who have already had a prior transaction cleared through the NSI system), reiterating that some targets are considered so sensitive they will always warrant screening and so transactions need to always be assessed on a case-by-case basis. However, overall it is encouraging to see that the Government is committed to pro-business amendments to the NSI regime and has taken on board feedback from stakeholders, including many of the points made in the response we submitted on behalf of Herbert Smith Freehills (see our previous blog post here).

Publication of an updated Section 3 Statement in May 2024

The Government has committed to publishing an updated Section 3 Statement to address requests for more clarity on the areas of the economy it considers most sensitive and how it assesses the national security risks of a transaction.  Although 80% of respondents to the Call for Evidence agreed or strongly agreed that they have a good understanding of the risks the Government is seeking to address through the NSI regime, feedback indicated that greater clarity on these points, including the factors that the Government takes into account in its assessment, would be helpful for investors. The Government has however indicated (in its separate response to the Business and Trade Parliamentary Sub-Committee’s submission to the NSI Call for Evidence) that this updated Section 3 Statement will not include any express definition of “national security” (which had been called for by the Sub-Committee).

We welcome the Government’s decision to update the Section 3 Statement sooner than the five-year timeframe required by statute, drawing on its experience gained through exercise of the call-in power since January 2022. In the absence of publication of detailed decisions under the NSI regime, the Section 3 Statement is a key tool for businesses to assess the risk of a transaction being called-in for review in circumstances where the mandatory notification obligation is not triggered, and greater clarity and more detailed examples would help reassure investors.

Publication of updated market guidance in May 2024

Although the Government has published a suite of useful guidance documents for investors, there remain a considerable number of important areas in which greater clarity is needed. As we highlighted in our previous blog post (see here), these include the application of the NSI regime to fund structures and indirect investments, the potential application to outward direct investment where there is an asset transfer (most commonly a transfer of intellectual property) alongside an outbound investment, and the scope and intended application of the provisions of the NSI Act relating to the exercise of rights attached to shares held by way of security.

Many respondents to the Call for Evidence shared our desire to see further specific guidance on topics such as these, and the Government has committed to publishing updated Market Guidance Notes in May 2024 to aid comprehension and compliance, calling out the application of the NSI Act to academia and Outward Direct Investment in particular. It remains to be seen how detailed such further guidance will be, but previous updates to the Market Guidance Notes have proved useful (see our previous blog post here) and we are optimistic that the updated guidance will be helpful for investors and their advisers.

Formal public consultation on changes to the mandatory notification sectors by Summer 2024

In its current form, the UK NSI regime is catching a very large number of transactions which do not give rise to any national security concerns: 866 filings were made in the year ending March 2023 (most recent annual statistics available), yet 93% of those were cleared within the initial 30-working day review period (see our previous blog post on the NSI Annual Report here).

The Government indicated in its Call for Evidence that it was considering amending the definitions of specified activities in the 17 specified sectors which can bring a target entity within scope of the mandatory notification requirements of the NSI regime, including clarifying and narrowing some of the definitions so as to rein in the scope of the regime. We welcomed these proposals and made specific suggestions to clarify and narrow the current definitions in a number of areas, including advanced materials and critical minerals, AI, communications, energy and synthetic biology. We also cautioned against the expansion of the definitions of the mandatory sectors unless a clear risk to UK national security is identified, in particular rejecting a proposal to include “generative AI” in the definition of the AI sector.

The Government has now confirmed that it will carry out a formal public consultation on proposed amendments to the definitions in Summer 2024. As a result, the response to the Call for Evidence does not go into detail regarding potential amendments. However, it does confirm that the proposals will include separating out a standalone Semiconductor area and a Critical Minerals area (currently included as part of Advanced Materials), which was endorsed by the Business and Trade Parliamentary Sub-Committee and supported by at least some of the other respondents to the Call for Evidence (including us). In its separate response to the Sub-Committee’s submission, the Government has emphasised that the ISU will continue to work closely with the relevant experts inside and outside of Government, and that it intends to harmonise the new Critical Minerals area with the Critical Minerals Intelligence Centre’s (CMIC) latest criticality assessment.

The response also indicates that the Government is exploring the possibility of adding the water sector to the list of areas subject to NSI mandatory notification, which was not previously suggested in the Call for Evidence.

It is unclear at this stage whether the proposals in the formal consultation will also include some or all of the suggestions made by the Business and Trade Parliamentary Sub-Committee to extend the mandatory notification areas to capture, for example, transactions relating to media freedoms (although this may be addressed by separate recent amendments to the Digital Markets, Competition and Consumers Bill, expected to receive royal assent later this month) and transactions involving the UK biosecurity industry, including genomics.

Targeted exemptions to the mandatory notification requirement via secondary legislation in Autumn 2024

The response states that the Government will consider bringing forward secondary legislation in Autumn 2024 (subject to parliamentary time) to introduce targeted exemptions from the mandatory notification requirements of the NSI regime for certain transactions.

The extent of these exemptions is still being considered further by the Government. The response confirms that the Government plans to proceed with a targeted exemption for the appointment of liquidators, official receivers and special administrators. However, it considers that further work is required to consider the feasibility and potential national security impact of introducing other targeted exemptions suggested in the Call for Evidence, relating to internal reorganisations, acquisitions by public bodies and Scots law share pledges.

The Government has also rejected a targeted exemption from mandatory notification in the scenario where a lender enforces security over shares as a result of automatic enforcement provisions, in light of stakeholder feedback and the very small number of notifications the Government has received in respect of these transactions. This is disappointing, but we welcome the commitment in the response to considering where the Government can provide further guidance in this area.

We will be closely following developments in this area, in particular in respect of an exemption for internal reorganisations. We have previously advocated in favour of such an exemption on the grounds that the current approach is unnecessarily burdensome for businesses and disproportionate to the risk to national security. Even if only a certain sub-set of internal re-organisations were exempted from mandatory notification – for example, where it was clear the re-organisation would not result in any change in who ultimately controls or influences an entity which carries out specified activities – this would be a significant improvement for businesses.

Further improvements to the operation of the NSI review process and the NSI Notification Service

Both businesses and advisors have repeatedly raised concerns about the lack of transparency of decision-making under the NSI regime, and consequent difficulties in predicting how it will apply to a particular transaction. The Government has already taken a number of steps intended to improve transparency and the operation of the review process (see our previous blog post here) but it commits in the response to the Call for Evidence to consider whether additional improvements can be made (without discussing any specific measures). It does not conclude on whether this could include requesting additional information upfront through the notification forms but notes that over half of respondents opposed this suggestion.

The response also states that the Government is “aware of the issues” encountered by users of the NSI Notification Service, an online portal used for submission of notification forms to the ISU. It has already been trialling solutions to a particular problem relating to “false positive” firewall blocks that can sometimes prevent users from progressing notifications and will also consider other improvements in light of the suggestions made by many of the respondents to the Call for Evidence.

Next steps

It is encouraging to see that the Government is committed to pro-business amendments to the NSI regime and has taken on board feedback from stakeholders. However, much will depend on the detail of any changes to the scope of the regime and the extent to which updated guidance genuinely provides additional clarity for investors.

We will continue to monitor developments in this area and provide a further update when the updated Section 3 Statement and Market Guidance Notes are published next month.