The National Security and Investment Act 2021 – Insights from Australia
Forsters LLP and Arnold Bloch Leibler discuss how the Australian Foreign Acquisitions and Takeovers Act 1975 might help to put the UK’s new National Security and Investment Act 2021 into perspective.
What is the National Security and Investment Act 2021?
On 29 April 2021 the National Security and Investment Act 2021 (the ‘UK Act’) received Royal Assent before the UK Parliament. Broadly, the UK Act grants the UK Government authority to review, add conditions to, and potentially ‘block’ any transaction involving national security interests.
For more in-depth information on the UK Act, see Forsters’ previous commentary:
- Draftsmen statute books national security and investment act 2021
- National security and investment bill basics
How the UK Act will work in practice is yet to be seen, as secondary legislation is still required to be enacted to enable the new regime to take full effect. Fortunately, there is nothing new under the sun. Australia has had a similar regime in place since 1975, and a comparison between the UK Act and that already in force in a similar jurisdiction can provide hints as to what we can expect when the UK regime becomes fully operational.
For a summary of the key practical takeaways which Australia can offer the UK, please skip ahead to the section titled ‘Insights’.
Why is Australia a useful point of comparison?
Unlike the UK, Australia has had a system in place for quite some time that operates in much the same way as the UK Act intends to. Foreign investment into Australia is governed by the Foreign Acquisitions and Takeovers Act 1975 (Cth) (the ‘FIRB Act’). Under the FIRB Act, transactions above certain monetary thresholds (varying for different industries and investor origin) require the approval of the Australian Treasurer, who is a Minister of the Crown and equivalent to the UK’s Chancellor of the Exchequer. The Treasurer is advised by the Foreign Investment Review Board (the ‘FIRB’), a non-statutory body which provides advice on foreign investment related matters. It is common to talk about transactions requiring ‘FIRB approval’, although approval is technically sought from the Treasurer.
Arnold Bloch Leibler and other Australian lawyers have therefore had many years to finesse their interactions with regulators to ensure that clients’ investments and deal opportunities are not curtailed by bureaucracy. Even more fitting, Australia’s established FIRB-review process was reformed on 10 December 2020 via the Foreign Investments Reform (Protecting Australia’s National Security) Regulations 2020, which has a very similar focus to the UK Act, i.e. investments affecting national security.
Promisingly for the UK, the Australian framework illustrates that transactions and investment – even foreign investment – need not dry up by virtue of the UK Government’s new review function.
Which deals are affected?
The UK Act threatens to capture an incredibly broad array of transactions and subject them to regulatory oversight (in addition to any other regulatory oversight already in place, e.g. the City Code on Takeovers and Mergers).
Any deal which may trigger a ‘risk to national security’ (undefined in the UK Act) could be caught – whether the reason for that risk is the underlying business, specific property, the identity of the purchaser, or potentially even the rationale behind a given transaction. Most importantly, in the UK Act there is no distinction made between foreign and domestic investments. This is distinct from the Australian context, where only transactions with a foreign nexus are captured.
Australian vs UK frameworks
Under the Australian regime, approval for foreign acquisitions is required when:
- a foreign person proposes to acquire an interest in Australian land, an Australian business or Australian securities;
- the proposed acquisition is above the relevant percentage ownership threshold; and
- the proposed acquisition is above the relevant monetary threshold.
The relevant thresholds depend on, among other things, the type of foreign person (e.g where they are from or if they are a foreign government investor) and the type of investment (e.g whether the land is residential or agricultural, or the business is a sensitive business). The FIRB regime does not just capture direct investments such as the direct acquisition of Australian land, businesses or securities, but also indirect investments such as the acquisition of securities in a foreign entity that ultimately owns Australian assets. The UK Act applies in the same way.
The level of detail required to be disclosed as part of the application process and the follow-up questions asked by FIRB are usually commensurate with the risk and value of the transaction. It may be necessary to disclose, for example, details about the ultimate legal and beneficial owners of the proposed acquirer, the amounts and sources of equity and debt funding and any national security or critical infrastructure owned or operated by the target interest. The UK regime, on the other hand, allows the UK Government wider information-gathering powers – for example, parties may be required to disclose ‘any information in relation to the exercise of the Secretary of State’s functions under’ the UK Act.
Practically speaking, applications for FIRB approval are submitted via an online portal, and low-value or low-risk investments are rubber stamped by one of the Treasurer’s delegates. Only high-value or high-risk investments are considered by the Treasurer, after they receive advice from FIRB. The UK Secretary of State has suggested that a similar process will operate in the UK – but this will need to be evaluated in time.
Recently, some sensible changes have been made to the Australian regime. For example, private equity funds may now apply for a certificate to operate within certain parameters without FIRB approval, however the Treasurer may reconsider transactions after they are completed where the investment raises national security concerns. The UK Act does not provide for any “safe harbours” but the Secretary of State is able to consider transactions post-completion (a “call-in” right is available for five years post-completion, or six months from the Secretary of State becoming aware of a transaction) and could potentially unwind a transaction if it is considered to be a national security risk.
In terms of volume, FIRB receives in excess of 11,000 applications a year. Although only a handful of applications are rejected each year, many more are withdrawn when it becomes clear (through delay or multiple rounds of questions from FIRB) that approval is unlikely to be forthcoming. It remains to be seen how the UK will compare on this front although the UK Government’s National Security and Investment Bill’s Impact Assessment dated 9 November 2020 suggests that up to 1,830 notifications will be received each year. This seems to be on the low side and we, as well as many other commentators, expect the figure to be much higher.
In Australia, it is mandatory to apply for approval for investments in “national security land” or a “national security business”, irrespective of the value of the proposed investment or the nature of the investor. These concepts go beyond businesses that supply goods or services directly to defence or intelligence agencies and includes:
- businesses which hold direct interests in critical infrastructure assets;
- businesses which develop or manufacture goods or technology for military or intelligence use; and
- businesses which provide critical services to defence and intelligence personnel, the defence force of another country, a foreign intelligence agency or store or have access to information that has a security classification.
As such, it is critical to seek to understand the target’s product and customer lists at the early stages of the transaction in order to determine whether approval is required by virtue of these factors.
Similarly, the UK Act requires that acquisitions of voting rights and/or shares in entities (companies, limited liability partnerships, partnerships, trusts, etc.) involved in certain sectors will require mandatory notification if they will result in the acquirer holding above 25%, 50% or 75% of the votes or shares in the target entity.
However, there are a number of other possible transactions – including simple asset sales – where mandatory notification is not required but where the Secretary of State may “call-in” the transaction. In those cases, voluntary notification is available to the parties; in such circumstances, it may be prudent to make a notification to resolve any potential issues sooner rather than later.
Insights – How are deals affected?
Timing: Timing of the deal will necessarily need to be flexible. While there is a stipulated statutory period that will require the UK Government to respond to deal notifications within a specific period, this can be extended if more information or time is needed. Timing of completion therefore, cannot be known until Government approval (or no objection) is obtained – and completion may need to happen very quickly thereafter. Deal documentation will therefore need to provide clarity on what completion timing is acceptable to all parties – for example, two business days after receipt of Government approval. To enable these completion timescales to be met on a practical level, all parties and their advisors will need to ensure that key mechanics such as fund flows are in place in plenty of time.
Documentation and Negotiation: Given that the UK Government may impose certain conditions on a deal for it to proceed, parties will need to consider two threshold issues:
- Should parties seek Government approval before executing a contract at all, or should it simply be a condition for completion?
- What will happen if (unknown) conditions are imposed: will the parties wear that risk, or will any imposed conditions entitle a party to rescind the contract?
Depending on the deal circumstances, these two questions could be answered in any number of ways. For example, a deal under a bidding process would be expected to have a conditional completion. The parties will need to negotiate around these questions and crucially understand whether the commercial rationale for the deal relies on no conditions being imposed by Government review.
Internal Resources: Part of the UK Government review process will routinely involve requests to provide further information from all or some parties to a transaction. Often this will require internal resources from the parties themselves to satisfy – collating data on financing, corporate structures, business plans and so forth. For smaller parties who primarily use professional advisors – this will undoubtedly increase costs as those advisors will need to factor in this additional workload to their fees.
Legal Costs: Whether legal costs will increase for a given transaction will depend heavily on circumstances. Presuming that Government review doesn’t request a substantial amount of additional information which requires legal advice – then the impact should be minimal (and this is often the case in Australia). The likely increases in transaction costs may stem from situations where conditions are imposed on a transaction which alter the commercial efficacy of entering into it. If documents need to be redrafted, deals restructured and so forth in response to the UK Government’s review, then clients can expect transaction costs to increase. This is another reason to – where circumstances permit – have discussions between the parties on the ‘Documentation and Negotiation’ points outlined above earlier rather than later.
Unwinding transactions: Although not all transactions require notification to the UK Government under the UK Act, there is an option to voluntarily notify a transaction to the Secretary of State. Clients should be aware that where transactions are not sanctioned at the time of completion, the UK Government retains the power to investigate any transaction after it has completed for up to five years and could require the parties to unwind the transaction. Parties and their advisors should be aware, then, that this is a possibility and either seek authorisation at the time of the transaction as a precaution (once the Government has been made aware of a transaction, this “call-in” period reduces to six months from notification), or ensure that deal documentation is robust enough to set out how the parties will cooperate to respond to an investigation by the Government post-completion.
Filing Fees: Neither the UK Act or supporting documentation suggests that any fees will be imposed on notifications, but the UK Government has retained powers to make amendments to the regime in the future as it deems fit. In Australia, the level of fees for FIRB applications generally depend on the value of the consideration for the target, and the type of acquisition that is taking place. For example, the fee for acquisitions for general businesses, entities and commercial land are AUD $2,000 for acquisitions below AUD $10 million, AUD $26,200 for acquisitions above AUD $10 million but below AUD $1 billion, and AUD $105,200 for acquisitions above AUD $1 billion.
Takeaways and expectations
An important distinction between the Australian and UK regime is that the UK Act does not currently differentiate between the value of different transactions, nor whether a transaction is foreign or domestic. This means that a substantial number of smaller-value transactions are likely to be caught.
While it will take some time to gain an appreciation of how the Secretary of State will implement the review system in practice, the vast majority of transactions should hopefully have minimal impact – both in time and cost. Deals that have minimal or a borderline connection with national security interests ought to be reviewed and consented to in short order (which in turn will minimise any increase in transaction costs).
The following additional points should be noted by prospective investors in the UK as a result of the UK Act:
- Investors operating in the UK should anticipate similar flexibility problems and idiosyncrasies to those that are experienced with the Australian regime, particularly while the regime is finding its footing.
- Investors looking to acquire interests in UK entities or assets will need to proactively turn their minds to the need for approval, and factor this into transaction timelines and costs.
- If the UK regime follows a similar path to Australia in terms of national security concerns, it will be critical to engage with the target in terms of the target’s product and customer base at the early stages of a transaction in order to ascertain whether approval may be required – and whether the parties’ advisors can assess at an initial stage whether approval is likely to be obtained or rejected.
- Applications that are ultimately submitted should be prepared on a completely transparent and fulsome basis in order to minimise delay in processing of applications and reduce overall ancillary costs.
It will be interesting to see, once the necessary secondary legislation has been enacted in the UK to fully implement the regime, whether any of the suggestions from our Australian counterparts have been implemented:
- The Secretary of State should think carefully about the types of transactions that should trigger the need for approval. At present, for example the acquisition of non-voting shares requires approval – but should it? What about a single preference share that amounts to all of the economic interest in a company? Under what circumstances (if any) should foreign investors taking up pro-rata entitlements in publicly listed companies require approval? Should amending a put / call option arrangement trigger the need for re-approval?
- The regime should set appropriate monetary thresholds and introduce an exemption certificate type system. The system could permit known acquirers (for example, private equity firms who regularly do business in the UK) to acquire interests within certain parameters without needing transaction specific approval. The exemption certificate system should be flexible enough to cover all manner of collective investment vehicles.
- In considering the need for approval, the FIRB Act looks both to ultimate ownership and control, but somewhat inconsistently and sometimes with perverse outcomes. For example, each beneficiary of a discretionary trust is deemed to have a 100% interest in that trust (therefore satisfying the relevant percentage threshold test) even though they have no control. The UK Act does not specifically contemplate beneficiaries – and this may be a quirk to be ironed out in practice moving forward.
This note reflects the opinion and views of Forsters LLP and Arnold Bloch Leibler as of 13 May 2021 and is a general summary of the legal position in England and Wales and Australia. It does not constitute legal advice.