Geopolitics and Foreign Direct Investment: The National Security and Investment Bill
From the US government threatening Index eviction of Chinese companies from the FTSE Global Equity Index Series last week, to the UK Government’s publication of its National Security and Investment Bill last month, concerns on foreign influence are only growing. Criticised for its ‘lack of red tape’, foreign direct investment is set to go under scrutiny following the Bill’s publication, whilst the Government looks to establish a ‘UK-CFIUS’.
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In what has been described as the biggest overhaul of British takeover law in the past two decades, the National Security and Investment Bill (Bill) is set to expand the Government’s powers to scrutinise investment on national security grounds, following growing suspicions of overseas companies buying sensitive UK assets. Other nations have similarly raised concerns to tighten foreign investment, among them being Australia, Germany and France.
While Britain has long presented an ‘open-door’ for global business and expressed encouragements for international investment, the Bill’s publication signals an end to this open-door policy and represents a drastic turn to protectionism. Secretary of State for Business, Energy and Industrial Strategy, Alok Sharma, has described the new Bill as showing hostile actors that there is “no back door” into the UK.
Foreign Direct Investment
When firms or individuals are looking to expand into international markets, foreign direct investment (FDI) is one possible option to enter such markets. FDI is a process where investors from a source country acquire ownership of assets, aiming to control the production, distribution and other activities in another host country.
The key features of FDI are ‘lasting interest’ and ‘element of control’. An investment into a foreign entity is considered FDI if it establishes a lasting interest, where the investor obtains at least 10% of the voting power. The element of control represents the intent to actively manage and influence a foreign entity’s operations. FDI can be a great way to make a relatively high contribution to productivity and economic growth, through the transfer of intangible assets, such as knowledge, technology, skills and know-how.
Methods of FDI include: setting up a subsidiary in a foreign country, to get access to the country’s market; a merger or acquisition; and a greenfield investment, where a company starts operations in other countries and invests in the construction of offices, plants, sites and more. Reportedly, in 2019/20, more than 39,000 jobs were created in England through FDI projects.
The Bill’s key features
The Bill sets out to replace the regime under the Enterprise Act 2002. The Enterprise Act 2002 allowed UK authorities to intervene in deals on competition grounds, and in instances where a transaction had implications for national security, media plurality or financial stability. This applied where the target asset had an annual turnover of more than £70m, or where the potential merged business would have a market share of more than 25 per cent.
Under the Bill, the smallest of transactions are put under scrutiny, while even acquisitions of minority interests and asset acquisitions may also be checked, including buying of equity stakes and purchases of intellectual property. The Bill will set up a new Investment Security Unit for a case-by-case analysis responsible for reviewing FDI transactions, which has recently been labelled as the ‘UK-CFIUS’.
The Committee on Foreign Investment in the United States, otherwise known as CFIUS, is an interagency committee authorised to review certain transactions involving foreign investment in the United States. Its purpose is to determine risk and the effect of such transactions on the national security of the United States.
The Bill will set up a bifurcated notification system of ‘trigger events’, with a mandatory notification system, and a voluntary notification system. If a transaction subject to the mandatory regime is not notified and approved, it will be legally void. Unlike the rules under the Enterprise Act, under the proposed regime the FDI restrictions will not be dependent on certain thresholds being met.
Under the mandatory notification system, the acquirers will need to submit pre-closing notifications and obtain approval where there is an acquirement of 15% or more of the votes or shares in an entity or asset, from a list of high-risk sectors. The Bill introduces a ‘call-in’ power, which the Government has been able to use for review since last month (11 November 2020).
As for the voluntary notification system, parties have a choice to disclose. Nonetheless, the Secretary of State has the right to “call in” transactions within a 5-year window, to undertake a national security assessment. The biggest contingencies the Bill may introduce to the market are delays in the closing of deals, and where clearance was not obtained, deem a transaction as void and impose fines of up to 5% of global turnover or £10 million; whichever is greater.
Sectors to be affected include energy, data infrastructure, autonomous robotics, communications, defence, transport, AI, computing hardware, advanced materials and quantum technologies. The ‘call-in’ power is set to be exercised following a consideration of target risk, trigger event risk, and acquirer risk, and all will be under the responsibility of the Secretary of State for Business, Energy and Industrial Strategy, currently Alok Sharma.
Considering economists’ concerns that the looming end of the Brexit transition period on 31st of December 2020 will hit the level of FDI, the Bill purports to introduce an even more strenuous track for companies, making business and investor communities very sceptical. The UK’s economy is already on life support; is the Bill good news?
There has been past evidence that economic recoveries, such as the one spurred by the fiscal crisis of Covid-19, can be accelerated through two main channels: new local entrepreneurship, and increased FDI. A business environment, however, needs to align with this acceleration by being conducive to growth. Global analysis shows that countries with less stringent business regulatory processes tend to attract new business creation, and subsequently, foreign investment to remain or enter the market.
Turning to the Bill, although the Government envisioned a wide scope in order to ‘call-in’ and scrutinise transactions freely, the lack of a threshold poses risks in extensive lobbying and a wide range of issues to be considered. This could inevitably lead to massive delays, while emphasis should be put on the fact that, prior to the Bill and since 2002, only 12 public interest interventions had been made on national security grounds. The Government's Impact Assessment estimates that 1,000 to 1,830 transactions are expected to be 'called-in' per year under the new regime.
Other risks of personal interest may interfere with prospective investors’ interests. The new regime should be robust enough to prevent politicians from seeking intervention under personal interests and concerns. Fears induced from this may also lead to entrepreneurs relocating HQs outside of the UK, where regulation would be more flexible and less scrutinising.
Some have also suggested that another explanation for the proposal may be an attempt to use national security as a pretext to pursue industrial policy goals. This may primarily be the case for advancements in technological leadership, and greater domestic production for the UK.
Scrutiny of FDI is increasing on a global scale. The Bill is expected to become law in early 2021, while hopes still remain that the UK’s attractiveness as a financial destination and inflows of FDI will not be affected.