LEGAL CHANGE

The National Security and Investment Act First Full Year Figures: What comfort can financiers take from them?

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About the author

Stephan Smoktunowicz is a banking & finance partner at the London office of the international law firm, gunnercooke. He helps businesses & people in the UK and across the world to achieve their commercial objectives and safely navigate issues that arise throughout any transaction lifecycle. He also provides training and mentoring to businesses, professionals and students on related topics.

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In this issue

This issue examines recent full-year statistics on the operation of the National Security and Investment Act 2021 regime and asks, what comfort can financiers take from them?

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POINTS TO NOTE

• The National Security and Investment Act 2021 regime (Regime) is potentially problematic for financiers because affected transactions may be void or unwound.
• A recent report has provided full year statistics on the Regime which indicate that it is on the whole, operating as a ‘light touch’ regime.
• This should provide some welcome comfort to financiers that the Regime is unlikely to create material repercussions on the vast majority of financing transactions.
• Nonetheless, financiers should remain alive to the potential risks under the Regime and consider having suitable screening and mitigation strategies in place throughout the financing lifecycle to address actual or potential risks, including prior to any enforcement.

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INTRODUCTION

In July 2023, the UK Government Cabinet Office published its annual report (Report) on the Regime. Its publication is of note, because it provides the first full 12-month snapshot of how the Regime has been functioning in practice.

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POTENTIAL ISSUES FOR FINANCIERS

The Regime is potentially problematic for financiers, because it requires some transactions to be notified, screened and cleared before they can complete. It also allows the Secretary of State to review certain previous transactions on national security grounds.

In worst-case scenarios, transactions will be void, or can be blocked, unwound or made conditional. For financiers, this could result in a borrower/obligor group losing the benefit of a company or asset it thought it had acquired, or being required to re-acquire something it thought it had disposed of.

Consequently, if an affected asset has been acquired using finance, relied upon as security, or is intended to generate revenues or disposal proceeds which repay a financier, a financier could find itself out of pocket.

Identifying material Regime risk before and throughout the lifecycle of a financing should therefore, be part of a financier’s risk management strategy.

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THE REPORT AND THE STATISTICS

Before looking at the Report’s main statistics, I will briefly recap on some of the Regime’s main aspects.

Main aspects

The Regime:

• requires certain acquisitions relating to 17 areas of the economy to be notified and approved by the Secretary of State, otherwise they are void if completed (see the Gov.uk guidance: National Security and Investment Act: details of 17 types of notifiable acquisitions );
• allows for some acquisitions to be called in for assessment on the grounds that they pose a risk to national security (see the Gov.uk guidance: National Security and Investment Act 2021: Statement for the purposes of section 3). Persons wishing to mitigate that risk can consider making an up front voluntary notification seeking advance clearance;
• provides the possibility that notifiable acquisitions that are otherwise void under the Regime can be cleared retrospectively via a retrospective validation application.

The statistics

The Report’s statistics consider each of those areas in terms of the:

(i) actual notifications made;

(ii) notified acquisitions called in (i.e. put under more scrutiny); and

(iii) outcome of the call-ins.

They also specify the number of call-ins relating to acquisitions which were not notified up front:

Total notifications:   866 Mandatory: 671 Voluntary: 180 Retrospective validation applications:  15

Notified transactions called in:   65 Mandatory: 37 Voluntary: 17 Retrospective validation applications:  1

Non-notified acquisitions called in: 10

Final notifications and orders:  Final notifications: 57 Final orders: 15 Acquisitions blocked/ordered to be unwound: 5

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ANALYSIS – WHAT DOES THE REPORT TELL US?

Low impact and light touch

• Most businesses in the UK had no interaction with the Regime’s screening process over the period 1 April 2022 to 31 March 2023. A total of 866 notifications equates to an average of just under 17 per week.
• Even where notifications or retrospective applications were made, the percentage of those notifications/applications then actually called in for further scrutiny amounted to just over one per week.
• 57 called in acquisitions were cleared by way of a ‘final notification’ – i.e. there was no further action taken and only 15 were subject to final orders (i.e. further requirements were imposed to mitigate national security risks).
• Of those final 15, only 5 acquisitions were blocked or made subject to an order to unwind the acquisition.
• So, on the whole, the ‘real teeth’ of the Regime have been used very infrequently.

Other trends

• The Report highlights that the highest percentages of call-ins related to military & dual use, defence and advanced materials areas of the economy, but it is important to note that the final orders issued did extend to other areas of the economy too (communications, energy and computing hardware).
• Interestingly, voluntary notifications were made in relation to 34 areas of the economy (see page 17 of the Report) which indicates that a more cautious approach has been seen as necessary by some when considering the risk of future call-in.
• The Report also looked at the origin of investment for acquisitions which attracted greater scrutiny, with China, the UK and the USA being the main sources.

Timings

• Going through the notification (and any subsequent call-in process) will take time and will need to be factored in on any financing. On average between 25 and 27 working days for a decision on whether a notified transaction will be called in for further scrutiny. Then on average a further 31 working days before issuing a final notification (or 77 working days before issuing a final order).
• This will clearly have a material impact on transaction timings.

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CONCLUSIONS & BEST PRACTICE FOR FINANCIERS

Overall risk

• The Report is broadly welcome news for financiers – even where acquisitions have been called in for further scrutiny, the number of transactions subject to final sanction is in single figures.
• Placed against the backdrop of the numerous financial transactions that occur on a daily basis, the risk of the Regime having a material detrimental effect on a financing appears to be low.

Residual risk

• Whilst the number of acquisitions actually impacted by the Regime was very low, the Regime is not a ‘no risk’ regime and ultimately which acquisitions are called in, blocked or unwound will be out of a financier’s hands.
• There is also no guarantee that the trends seen in the first full year of reporting will be the same in years to come. It merely gives the first indication of areas of most focus, which may fluctuate in future years.
• Notifiable acquisitions must still be notified as a matter of law and approved prior to completion to avoid them being void. As mentioned earlier, failure to do so could have negative repercussions.

Main focus – mandatory or voluntary notifications?

• In assessing risk, the main focus in terms of numbers in the Report was on the mandatory notification regime (37 call-ins compared to 17 under the voluntary regime).
• However, when looked at on a percentage basis, a higher percentage of notified voluntary notifications were called in than notified mandatory notifications.
• Therefore, financiers may wish to keep an eye on future news flow relating to voluntary notifications and the amount of voluntary notifications being called in.
• One of the main problems for financiers with the voluntary notification regime is that assessing whether a voluntary notification is necessary or desirable is not an exact science. A borrower or obligor may not know for certain whether or when the Secretary of State might knock on its door to review a transaction.
• That said, adequacy of security and guarantee cover are an essential part of many financings and financiers may be able to mitigate call-in risk through adequate valuations and covenants of unaffected assets within a borrower/obligor group.
• Where a material part of the security/guarantee net is potentially affected, it may be safest to ensure that a voluntary notification is made. In assessing that:
  • the Gov.uk guidance: National Security and Investment Act 2021: Statement for the purposes of section 3provides guidance on the areas of the economy in which qualifying acquisitions are more likely to give rise to a risk to national security and more likely to be called in;
  • the Cabinet Office has market guidance which is updated from time to time: *Check if you need to tell the government about an acquisition that could harm the UK’s national security* .

Monitoring

Financiers should consider Regime risk both before and throughout a financing and for example, ask the following questions:

• Has the borrower or any entity in the obligor group made or been a party to any previous acquisitions that might fall under the Regime?
• How material are those entities in terms of security cover and cash flows needed to repay the financing and service interest, fees and costs?
• Does the borrower or obligor group’s current activities bring it within one of the 17 main areas of the economy which are the focus for notifiable acquisitions (17 Areas)?
• Can the financier screen permitted acquisitions and disposals under its facility agreement terms for Regime risk before they proceed?
• How is the financier monitoring the borrower or obligor group’s customers and any post day one changes, particularly if there is an exit strategy which could involve a sale of the underlying business? Could who the borrower or obligor group is trading with bring it within one of the 17 Areas?
• Is there any perceived risk of call-in in relation to any core assets? Would it be safest to have a voluntary notification made up front, or is the ultimate risk of a transaction involving that asset being unwound mitigated commercially by other means?

Insolvency and enforcement

Notwithstanding the light touch approach highlighted by the Report, financiers should also remain aware that the appointment of liquidators or receivers may constitute a qualifying acquisition under the Regime and, in some specific scenarios, may require mandatory notification. The Cabinet Office’s market guidance provides further commentary in this respect, but financiers should consider obtaining professional advice when considering exit strategies or where there are any signs of financial distress.

Where things go wrong – financial assistance for affected transactions

Whilst the Secretary of State can give financial assistance (e.g. a loan, guarantee or indemnity) where a final order is made, none was given by the government under the Regime during the 12 months covered by the Report. So, where acquisitions are blocked, unwound, or made subject to conditions, it seems unlikely that the government will provide any material financial support to those who are out of pocket or affected as a result.

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CLOSING REMARKS

The Regime is still very much in its infancy, but on a positive note the Report indicates that the risk of transactions being materially impacted is low. However, it remains too early to tell whether financiers can dispense with considering the need for voluntary notifications in all instances.

Where there is a clear and obvious risk under the Regime, the safest route will be to make a notification. Whether failing to make a voluntary notification comes back to bite is something that is outside of a financier’s control. However, that is now a day to day risk of doing business. Commercial risk mitigation techniques may assist and financiers can take some comfort from the fact that to date, the Regime has only exercised its real muscle on limited occasions.