Updated guidance on the UK’s investment screening regime: key takeaways

By Veronica Roberts, Andre Pretorius and Ruth Allen, Herbert Smith Freehills LLP

On 21 May 2024 the UK Government published updated versions of two key documents for investors seeking to assess how the UK National Security and Investment (NSI) screening regime may apply to a proposed transaction:

• an updated statement on how the Secretary of State intends to exercise the power to call-in a transaction for in-depth investigation (the “Section 3 Statement”); and
• updated Market Guidance aimed at improving comprehension of and compliance with the NSI regime.

This is the first step in the UK Government’s stated plan to fine-tune the NSI regime in response to feedback from stakeholders on the operation of the NSI regime since it entered into force in January 2022, gathered via a Call for Evidence issued in November 2023 (see our previous blog posts here and here).

We highlight below the key takeaways for investors, drawing out the areas in which new guidance and helpful clarifications have been added.

Updated statement on the exercise of the power to call-in transactions for in-depth review

The NSI regime empowers the Secretary of State to issue a call-in notice to undertake an in-depth investigation of potential national security concerns arising from transactions which involve the acquisition of “control” (which can arise with a very low shareholding, potentially even lower than 15%) over a target which has the requisite UK-nexus.

The so-called “Section 3 Statement” sets out guidance on how the Secretary of State will exercise this call-in power. 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 investors would welcome greater clarity on the areas of the economy the Government considers most sensitive and how it assesses the national security risks of a transaction.

The updated Section 3 Statement includes a number of helpful clarifications and areas of expanded guidance for investors. In particular:

• The guidance on what the Secretary of State is seeking to protect by using the call-in power has been expanded to provide further detail and examples of the potential national security risks that the Secretary of State may consider. For example:
  • a new reference to supply chain risks and risks associated with the creation of dependencies that could lead to national security risks;
  • reference to the risk of disruption, erosion or degradation to critical national infrastructure, rather than referring solely to the impact of a qualifying acquisition on the security of such infrastructure; and
  • consideration of the potential impact of an acquisition on the UK’s military, intelligence, security or technological capabilities, not just the building of such capabilities by actors with hostile intentions towards the UK.
• New hypothetical examples have been included to illustrate how the assessment of whether to use the call-in power will be carried out in practice, with a total of 7 examples in the updated guidance (compared to 5 in the previous version), of which 5 are new scenarios. Of particular note:
  • two of the new examples involve artificial intelligence technology, illustrating the increasing importance of considering the potential application of the NSI regime to transactions in the AI sector – where the definition of the target activities which can trigger a mandatory notification obligation is currently very broadly drafted; and
  • helpful new hypothetical scenarios include consideration of licencing agreements to transfer intellectual property, joint ventures involving sub-contractors to the Government, transactions involving fund structures and acquisitions of particularly sensitive targets (even where the risks associated with the acquirer are low).
• The fundamental principle of not making judgments based solely on an acquirer’s country of origin is retained, but expanded guidance is included in respect of the overall approach to the assessment of “acquirer risk” and the characteristics of the acquirer which will be taken into account. For example:
  • emphasis that in some cases a target may be considered to be so sensitive that it will need to be investigated regardless of the acquirer risk;
  • consideration of the intent of the acquisition and past behaviour of the acquirer and any linked parties – including taking into account the source of funds, including individual members of investment consortiums, fund managers and the ultimate beneficial owner – and investigating whether actors with hostile intentions may be “seeking to obfuscate their identity by funnelling investment through other companies or corporate structures“;
  • consideration of the impact of cumulative acquisitions across a sector or linked sectors by a particular acquirer; and
  • confirmation that the Government 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, but with the additional clarification that where these entities have ties or allegiances to states or organisations hostile to the UK, this will inform the assessment of acquirer risk.
• The updated statement now includes a short paragraph highlighting that there are certain situations where outward direct investment may constitute an acquisition under the NSI regime, including for example the transfer of technology, intellectual property and expertise as part of the investment or when forming joint ventures overseas. This is an area which is also picked up in the updated Market Guidance published alongside the updated Section 3 Statement.

Updated Market Guidance

In line with the approach taken when publishing updated Market Guidance in April 2023, the Government has incorporated various amendments and additions into its suite of guidance documents for investors, intended to aid comprehension and compliance with the NSI regime.

The amendments address a number of areas highlighted by respondents to the Call for Evidence. By way of overview of some of the most important changes to be aware of:

• new guidance (albeit still fairly limited) clarifying how the NSI regime can apply to scenarios involving outward direct investment where the acquisition leads to a party gaining control over a qualifying entity or asset that is outside the UK but the relevant UK-nexus criteria are met;
• new and clarified practical “top tips” for completing notification forms correctly, comprehensively, and without sending any classified information;
• more detailed guidance on how long the NSI review process will take in practice, including how statutory timelines are calculated and the (rare) circumstances in which timeframes may be expedited where parties are suffering from material financial distress; and
• substantial amendments and additions to the guidance for the higher education and research-intensive sectors, including in respect of determining whether a particular transaction or collaboration will amount to a “qualifying acquisition”, how to contact the Research Collaboration Advice Team, new guidance on the interaction between the NSI regime and the UK’s export controls system and some useful new and adapted examples of how the NSI Act can apply to certain academic collaborations.

The amendments made in this latest Market Guidance update provide welcome clarifications for investors. However, they do not address all of the requests for clarification made by respondents to the Call for Evidence. For example, in our response we highlighted the need for more detailed guidance on the application of the NSI regime to fund structures and indirect investments, 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. These issues have not been addressed in the updated Market Guidance, and it remains to be seen whether further clarifications will be forthcoming in future updates.

Next steps

The Government’s response to the Call for Evidence on the operation of the NSI regime indicated that it will also take a number of further steps in the coming months as it continues to fine-tune the operation of the regime:

• a formal public consultation is due to be published 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;
• secondary legislation is due to be brought forward by autumn 2024 to exempt the appointment of liquidators, official receivers and special administrators from the scope of mandatory notification requirements, with the Government also exploring the feasibility and impact of additional targeted exemptions for certain transactions, including internal reorganisations; and
• further improvements to the NSI review process and ways to improve the online NSI notification portal are being considered.