By Marjorie Holmes, partner at Reed Smith, and Kohji Hayakawa, associate seconded to Reed Smith from Anderson Mori & Tomotsune

Currently, a significant number of countries are introducing new rules on foreign direct investment to strengthen measures of screening from the national security viewpoint.  In the UK, the government published the National Security and Investment Bill (‘the Bill’) in November 2020, and it has since been under discussion in Parliament.

 The Bill introduces a standalone foreign investment regime for the first time in the UK and separates the competition and merger control assessment, bringing it in line with the world’s major economies, such as the United States, France and Germany, as well as Japan.

An overview of the Bill

The Bill will expand and strengthen the government’s powers to scrutinise, investigate and intervene in investments and transactions that could threaten UK’s national security.  The scope of the proposed regime is extremely broad and covers businesses in markets as diverse as telecommunications, energy and transport, meaning that a wide range of transactions will require mandatory notification, or may be called in.

Importantly, the thresholds have now been completely removed, which allows the government to intervene where there has been a change in control.  Although the Bill is reportedly targeted towards “hostile foreign investment”, the Bill itself does not exclude national investments.

The government’s impact assessment, which accompanied the Bill, indicates an expectation of 1,000-1,800 mandatory notification events a year, with 70-95 called in for a more detailed examination, and remedies being required in 8-10 cases.  For transactions that require notification or are subject to government scrutiny, there will not only be an increased regulatory burden and cost of compliance, but also potential impact on deal timetables, deal certainty and deal execution that will need to be considered.

Concern over hostile investment is understandable, but the Bill in its current form is too broad.  Public pension and sovereign funds, for example, could be caught under the Bill, but these types of investors are much needed.  Perhaps introducing a block or individual exemption, as the Japanese have done, would achieve the object of the Bill.

In Japan, the latest amendments of Foreign Exchange and Foreign Trade Act (FEFTA), its regulations, and public announcements (collectively, FEFTAs) took effect between 2019 and 2020 and have been implemented respectively. UK Financiers concerned over the scope of the UK’s National Security and Investment Bill may gain perspective by comparing UK and Japanese legislation.

Notification/Report system

Firstly, both the UK and Japanese systems have mandatory prior notification for designated business sectors. However, the proposed UK foreign investment regulation introduces both a mandatory notification regime for those sectors which attract the greatest national interest, whilst maintaining a voluntary notification regime for all other sectors, with an enhanced call-in power.  Voluntary means that there is no fine for not filing, but the buyer takes the risk.  If the deal is investigated, the buyer can be ordered to divest or provide commitments at a loss.

On the other hand, Japan has no official voluntary notification system in the FEFTAs.

Designated business sectors as to mandatory prior notification

Secondly, in the UK, 17 ‘designated sectors’ are subject to the mandatory.  However, the mandatory notification requirement will not apply to all parts of these sectors and the scope of application may possibly be defined in secondary legislation.

In comparison, in Japan, 23 sectors are subject to the mandatory notification unless exempted.  The sectors are divided into two types according to the degree to which they affect national security: core designated business sectors and non-core designated business sectors.  As for listed companies, the Japanese authority published a list that classifies each company according to these two types.

Importantly, the Japanese list is more specific compared to the UK list; for example, it refers to different types of transport such as public, air, and maritime transport, while the UK list refers simply to transport.  This UK wide and non-specific approach is likely to result in many approaches seeking clarification as to what exactly is included in a designated sector.

Threshold for mandatory notification and exemptions including accreditation system

In the UK, the Bill provides that the government does not need to consider any turnover or market share thresholds.  The only requirement to justify intervention is that the target carries on activities or supplies customers in the UK in the designated sectors.

On the other hand, in Japan the prior approval requirement for listed companies is triggered when an investor holds 1 percent of the outstanding shares or voting rights subsequent to the investment, either on their own or together with closely related persons.  There is no threshold for non-listed companies.

There are two possible Japanese exemptions from the prior notification for foreign investors,. A blanket (block) exemption and an individual exemption.  These exemptions cannot be used by state-owned enterprises or companies that have violated the regulation in the past, and the UK government may consider drawing inspiration from these to resolve the issue of the current Bill being too broad.

• Blanket exemption – The blanket exemption is available only to “foreign financial institutions” which are subject to regulations/supervisions under financial regulatory laws in Japan or other jurisdictions, for example: securities firms, banks, insurance companies, asset management companies, trust companies, registered investment funds (including mutual funds and exchange-traded funds) and high-frequency traders.

If they fulfil certain exemption criteria, they may invest in publicly traded Japanese companies with no upper limit without having completed the prior notification.

• Individual exemption and accreditation system – the individual exemption is available to foreign investors, including sovereign wealth funds and public pension funds (SWFs) accredited by the Ministry of Finance, who will make such investments for economic reasons and without any government int

In principle, state-owned enterprises are not eligible for the exemption from the prior notification.  However, SWFs, which are deemed to pose no risk to national security, are eligible for the individual exemption if accredited by the authorities.  In contrast there are no such exemptions to foreign direct investment established by the Bill or in the UK.

For the accreditation, the Ministry of Finance will review whether investment activities of the SWFs are only for economic returns, and whether investment decisions by the SWFs are made independently of their governments.

The Ministry of Finance will sign a Memorandum of Understanding with the SWFs to grant the accreditation.  The decision on an accreditation and signing of any such memorandum will be kept confidential.

If they fulfil certain exemption criteria, foreign investors proposing to invest in non-core sector businesses may invest without any upper limit and without having to complete the prior notification process.  However, a post-acquisition notification is still required for investments of over 1 percent of the voting rights of the target company.

Where do we go from here?

Please do bear in mind that the National Security and Investment Bill is still passing through Parliament and until it comes into force as an Act it remains subject to change, which could include the criteria on which decisions on transactions are made.

Investors in the UK should be aware of these planned reforms and take advice on how to mitigate risk, especially since the government will have the power to retrospectively call-in transactions for investigation, and to curtail, block or unwind transactions where these concern UK entities or assets and a threat to national security is identified.

From our experience in seeking informal advice on the Bill and its scope from The Department for Business, Energy and Industrial Strategy (BEIS), the good news is that it has been quick and helpful whilst inevitably not definitive.  However, if Japanese style exemptions are introduced, this may minimise the resources needed to ensure appropriate screening from the national security point of view.