The implications of the UK’s proposed national security investment screening regime have been widely debated since the National Security and Investment Bill (NSI Bill) was introduced to Parliament on 11 November 2020 (see here for our previous detailed briefing).
However, as the NSI Bill progresses through the House of Lords, there has been a notable lack of public analysis of the effect of the new NSI regime on private equity, despite the significant implications for fund managers and institutional investors, whether as holders, sellers or acquirers of investments.
Poll results from our recent private capital webinar on this topic confirmed the importance of the new regime in this context:
- prior to the webinar, just 17% of webinar attendees had already considered the potential impact of the NSI Bill on their investment strategies or processes in any detail;
- at the end of the webinar, 78% of attendees expected that they would be likely to be involved in a deal requiring filings under the NSI regime in the course of the next two years.
We set out in this follow-up briefing a short re-cap of the circumstances in which notification may be required under the new UK regime, before considering in more detail:
- potential differences in the application of the new regime depending on the type of investment vehicle/structure used;
- the material impact of governance and information rights on execution risk profile; and
- other practical considerations for institutional investors and fund and asset managers, whether as holders, sellers or buyers of affected interests.
- The UK’s proposed NSI regime represents an important new execution risk factor, with a similar risk profile to merger control rules.
- Broadly speaking, the new regime will apply to any acquisition of “material influence” in a company (which may be deemed to exist in relation to a low shareholding, potentially even below 15%) and the acquisition of control over assets or intellectual property, which potentially gives rise to national security concerns in the UK.
- The additional execution risk applies not only to new investments, but also to increases in existing stakes which result in the investor gaining material influence, or crossing the 25%, 50% or 75% thresholds.
- Mandatory notification obligations (and a prohibition on completion prior to clearance) will apply to certain transactions in specified sectors (including acquisitions of a shareholding/voting rights of 15% or more).
- Whilst notification of relevant transactions in any other sector will be voluntary, in practice it may, in the interests of certainty, often be advisable to notify if there is any risk of a national security issue (broadly defined), owing to the government’s power to “call in” transactions for review in any sector and – potentially – to restructure or undo them.
- The potential application of the NSI regime should be considered on every deal completed on or after 12 November 2020. Although the NSI Bill has not yet been enacted, once in force the Government’s “call in” power may be exercised retrospectively for up to six months after the commencement of the Act or six months after the date on which the Government becomes aware of the transaction, whichever is the later (subject to a longstop of five years after completion of the relevant transaction).
- There remains a significant degree of uncertainty as to how the new rules will be applied in practice, in particular in relation to common structures used by private equity and it is important to seek advice at an early stage. The Government is encouraging parties to seek informal advice from the new Investment Security Unit (including prior to formal commencement of the new regime).
- Investments in “blind pool”, multi-asset funds seem unlikely to fall within scope of the new regime, assuming typically limited governance and information rights of institutional (limited partner or “LP”) investors over portfolio companies. The “blind pool” funds themselves (and their managers) will usually be caught in the same way as other direct investors, but the LPs should not generally expect to have to make individual filings in respect of fully discretionary investments made by the fund manager on their behalf.
- At the other end of the spectrum, directly-held investments where an institutional investor has engaged an asset manager on a non-discretionary advisory mandate (ie the LP retains control and discretion) will usually result in the institutional investor being caught by the new regime in the same way as any other direct investor.
- For more-bespoke or ad hoc investment vehicles and structures, including single-asset funds, funds of one, and separate managed accounts, the analysis becomes more nuanced and will require a detailed assessment of governance rights of LPs and information flows in relation to the underlying entity or asset.
- Key factors to consider in relation to LP governance rights in more-bespoke investment vehicles will include: influence over portfolio company-level decisions and reserved matters, no-fault general partner (GP) removal rights (particularly if exercisable unilaterally), representation on portfolio company boards or limited partner advisory committees (LPACs), and the extent to which the GP has discretion to vary governance or information rights.
- From a practical perspective, it may be possible for LPs to mitigate the impact of the new UK regime by considering the use of fully discretionarily-managed investment structures rather than making direct investments, or the use of post-acquisition syndication opportunities rather than bidding in consortium at the outset, depending on the particular circumstances.
- Parties may also wish to explore carving-out potentially-problematic components of the target for the purposes of the investment (acknowledging that this may not be an option in competitive auction processes).
- Sanctions for non-compliance with the NSI regime will be severe. In addition to the risk of the transaction being void if completed prior to clearance, non-compliance may result in fines of up to 5% of worldwide turnover or £10 million (whichever is the greater) and imprisonment of individuals for up to 5 years, as well as disqualification of individuals from serving as a director of a UK company for up to 15 years.
- Whilst the focus of the new regime is clearly on foreign investment, it applies equally to UK investors, who will be subject to the same notification obligations and potential sanctions. We note, however, the inherent probability of the regime having a lesser impact – and operating as less of a deterrent – in practice where investors of UK origin are concerned.
Please click here to read the full briefing.