National Security and Investment Bill (Second sitting)

Matt Western Excerpts

Committee stage & Committee Debate: 2nd sitting: House of Commons
Tuesday 24th November 2020 Public Bill Committees

[The Parliamentary Under-Secretary of State for Business, Energy and Industrial Strategy (Nadhim Zahawi)]

Q It is a pleasure to serve under your chairmanship, Sir Graham. Dr Ashley, considering your experience of other countries—we talked about the US at length in the first couple of questions—such as Japan and Germany, what are your views on the retrospective powers under our Bill?

Dr Lenihan: Personally, I think they are fine. I know that might not be a popular answer with some. Germany, France and even parts of the EU framework set up this five-year retroactive for cases. I think that that is at minimum important. Other countries, such as China, Russia and the US, do not place any limit on retroactivity. I would have to check up on Australia and Canada, but there have been cases that have gone beyond a year there. Under the original Government White Paper, the idea of having only a six-month period, whether or not you have been notified, is quite dangerous, because there have been cases that were well known where they have been caught after that point.

Some of my examples are from the US. The reason for that is that it is one of the longest-standing and most institutionalised regimes. It is also one of the most transparent, from which we know most about the cases that have gone through it. I have looked at over 200 cases of this type of investment over a seven-year period in the US, UK, Europe, China and Russia. One case that stands out in the US is the 3Leaf acquisition by Huawei, which was caught almost at the year mark. Another good example that went over the one-year mark would be the review in 2005 retroactively of Smartmatic, which was a Venezuelan software company, and its purchase of Sequoia Voting Systems, which was a US voting machines firm. Smartmatic was believed to have ties to Chavez. However, that acquisition completed without knowledge of CFIUS and it was not actually able to be unwound until 2007. At that point, you worry about what has happened, but at least you do not have the ongoing concern.

You do need flexibility. With the volume of notifications and the learning curve that the investment security unit will have to undergo, or whatever the final regime truly looks like, it will take time to get the team in place and get the knowledge and systems down, to accurately catch even the most obvious investments that are of concern. Dealing with the kind of evolving and emerging threats we see in terms of novel investments from countries such as China, Russia and Venezuela needs the flexibility to look at retroactively and potentially unwind transactions that the Secretary of State and the investment security unit were not even aware of.

One thing is that for mergers and acquisitions transactions, which are historically what have been covered under these regimes, across Europe, Australia, Canada, Russia, China and the US, all the systems that have been used—the M and A databases: Thomson ONE, Zephyr, Orbis—take training, but they only cover certain types of transaction. They do not cover asset transactions; they do not cover real estate transactions, which are of increasing concern, especially for espionage purposes.

It is going to take time, and I believe that flexibility really needs to be there. It can always be reviewed in the future, but I do not think that so far foreign investment has been deterred in any way in countries that have that retroactive capability. To limit the UK’s capacity to protect itself for some kind of strange feeling that we need to be perceived as being even more open than everybody else when under threat is not really wise at this time.

[Matt Western (Warwick and Leamington) (Lab)]

Q It is a pleasure to serve under your chairmanship, Sir Graham. Dr Lenihan, I am keen to know more about whether, other than in the US, you have seen good exemplar approaches to screening investments into these sectors; we spoke about Japan and Germany a moment ago. Can you give examples which we might learn from?

Dr Lenihan: I do think the US system is the most institutionalised that we have, and the best at the moment. That being said, Germany’s system is very good; it has caught quite a bit. The German system has also been very good about regularly updating, changing and adapting its regulations as it sees new emerging threats to itself. They seem to have good feed-in across Government and they are exceptionally good at co-ordinating with other states in terms of information of concern.

In terms of national security review, Canadian and Australian systems are quite good. The problem with those systems is that they tend to do national interest reviews at the same time or in tandem with their national security reviews. Over the long term, including national interest in the regime has had an impact on how they are perceived in terms of their openness to foreign direct investment abroad. In the OECD’s FDI restrictedness index, Canada and Australia rank far lower than the US, the UK, Germany and France, and I think this is because of their inclusion of national interest concerns. Similarly, on the World Economic Forum’s global competitiveness index, they rank far lower. That does not provide investors with the type of clarity that they need. In general, we see that investors tend not to be dissuaded from investing just because there is a new foreign direct investment regime, as long as that regime is seen to have clear regulatory guidance, is transparent, and is applied consistently over time.

France sometimes gets quite a bad reputation for economic nationalism, but its review mechanism is also quite good at catching potential threats to national security. Japan is an interesting case. It has been so restrictive for so long that it is a little harder to compare with the other western countries. Its system has been tied in again to an overarching inward investment regime that has been restrictive towards foreign investment for other means beyond national security, so I find that country to be less of a comparator for these purposes. I hope that answers the question.

[Simon Baynes (Clwyd South) (Con)]

Q It is a pleasure to serve under your chairmanship, Sir Graham.

I have found your comments particularly interesting, Dr Lenihan. My own background is in the financial world, where I was involved in cross-border M and A and quoted equity transactions. I fully accept the premise of the Bill, which I think is important and has to be put into effect, and I draw encouragement from what you are saying about other regimes, but I am still left wondering a little bit whether, in practice, it will be really quite difficult for us to put into effect. Your point about the necessity of expertise among staff is crucial. Having sat at the centre of the process, I recognise that the point you make about a huge amount of information flowing across, especially in respect of unquoted companies, is very important; often, there is not much established information in the public domain. That first point is very important. The second point is that there is a very complex mechanism of market sensitivity as well. I do not quite know how this system intervenes with that. Also, within the UK itself there is a culture of openness, which has been touched on before, and in some respects we are a very different country from the others, particularly given the strength of the City of London. We therefore have the ability to transact in a way that some other countries do not, and a different culture.

The other point I wanted to raise and to hear your comments on is that there is a danger of political interference. I know that that is not the intention, but it must be a hazard in this process. What happens if the Government get it wrong about a company? Could not that be interpreted as political interference rather than seeking to establish a security risk?

Dr Lenihan: I started my career in mergers and acquisitions in aerospace and defence M and A, in London. I think you make an important point: the UK has historically been the most open country to foreign direct investment on most indices and indicators. That perception is strong, and I do not think that that culture of open investment will or should change with the introduction of the regime. To the contrary, it actually gives you one of the best starting points that any country has to do this.

As I said, on the whole, in the Bill as written, and in the statement of policy intent behind it, it is very clear that the powers for review and intervention should be used only for an identified risk of national security, and not on the grounds of national interest. Regimes that are based only on national security, like that in the US but also Germany and France—even with a very different culture in many ways—have not seen a lowering of levels of foreign direct investment over time, because they have introduced, modified or kept these regimes up to date. It is because, on the one hand, the stable environment that they provide and that the UK will definitely provide for foreign investors, is far more attractive than any uptick in cost from having to get up to speed on a new regime; also, they are able to retain these global perceptions of openness to foreign investment and ease of doing business because of the way in which the rules are applied. As long as the rules are applied consistently, and with clear reasons behind their use, and applied consistently and transparently over time, it should be okay.

The Bill provides for a lot of regulatory guidance, which needs to come forward in a clear and very easily comprehensible and understandable manner. As long as that happens, it should be okay. Global Britain should still be the proponent of liberal economic values that it always will be, while also being able to demonstrate to itself and to its allies that it is able to protect itself from this type of investment.

Going forward, Britain’s relationship with many of its Five Eyes allies is going to depend on having a comprehensive regime of this nature that is used well. Under FIRRMA, under US law, for example, the UK is an exempt foreign investor in certain categories—one of three with Canada and Australia. It has been stated that for that to continue––it is going to be reviewed––it needs to have a regime to protect itself. We can talk about this later, but part of that is about the potential concern about not just the ability to share intelligence on these issues, but about acquisition laundering, export controls and all these issues that tumble on behind that can affect investment, trade and intelligence-sharing relationships over time. That is important.

The research evidence shows that foreign investment is not deterred unless there is a problem in how this is applied. There has been politicisation of cases; demonstrated proportionality of response is also extremely important. There are many cases in which a threat to national security can be mitigated by agreements and undertakings without needing to block a deal. When you look at the modern history of foreign direct investment intervention across Europe and the US––even if you look at Russia and China and how they behave––the preference is, where possible, to mitigate national security concerns through comprehensive agreements, and that can be done in a host of ways. It can be that you have a board of directors that is only UK nationals, or that you require divestment of a certain black box technology company to another UK company or a friendly allied country. Whatever it may be, historically, there has been a preference for that type of action to be taken. Vetoes of cases are actually quite rare since world war one, when we first really saw this type of issue pop up.

The concern is if we see the UK blocking deals where it could mitigate because a deal has become a political hockey puck. In today’s world, where this is something that is constantly discussed in the Financial Times and The New York Times, whereas it was not 15 years ago, any case has the potential to be discussed widely in the political debate. The question is how it is treated by Government and how other countries perceive that treatment. I know that I have used US examples quite a bit, but if you look at US-China investment, China still invests a lot in the US, even though it complains every time a deal is blocked or mitigated. The reason behind that is because this is a sovereign right under customary international law, and China does the same thing when it has the same concerns. It is only if a case becomes truly politicised that there is an issue.

To give you an example, in 2005 in the US, the case of Dubai Ports World and P&O, which was a takeover of a UK company, became overly politicised in the US system. It is one of the only real examples where it has happened, and that was because there were a few US lawmakers who had a completely different view of the risk and relationship of the US vis-à-vis the United Arab Emirates than the Department of State or the Department of Defence. That is quite rare but what ended up happening was US lawmakers seeking to block a deal when most reasoned professionals in the industry and in various Government Departments thought that any risk could be mitigated simply in a host of other ways.

In the case of overuse, overbalancing, misuse, politicisation, whatever you want to call this tool of economic statecraft, there was a momentary blip in relations between the US and the UAE. There was a momentary stalling of trade talks, change in the currency basket and some uncomfortable months, but the relationship was strong enough to survive and it usually is. This is not really an aspect of going to war. I think the key is proportionality in response, how it is applied, and it is about consistency and transparency. The Bill is well written in many ways, but how it is used can go any number of ways, so it is about how the UK uses it going forward.

--- Later in debate ---

[The Chair]

In that case, the last question will come from Matt Western.

[Matt Western]

Q Thank you, Sir Graham. Mr Leiter, I would like clarification on the point about disguised takeovers, and perhaps you can use CFIUS as an example. What happens if a benign country or an organisation in a benign country, such as Canada or wherever, takes over a business and then that gets sold on to a state actor or a non-obviously state actor? How does CFIUS respond to that, and do you think that this Bill covers it?

Michael Leiter: I think your Bill does cover it. CFIUS would cover it in two ways. First, to the extent that a non-benign actor was behind the first transaction, CFIUS looks at the ultimate parent and whether it has been structured to evade review, so I think there is robust authority there. Secondly, the follow-on transaction itself would of course also be subject to CFIUS review, so I think you could catch it in the first instance or the second instance.

I think your Bill covers that. I will say also that I think the Bill is quite expansive and potentially problematically so. The US regime looks to see if there is a US business that is being acquired or invested in. That is a broad definition, but it still requires, generally, some physical presence, some people or the like. Your Bill does not seem to contemplate that, and specifically it says, “If the business simply provides supplies and goods to the UK or from the UK”. That is a very broad definition. It fundamentally means that if someone in London is buying something from a US business and it sends that to London—well, I read that as being covered by the Bill. That would actually be more expansive than CFIUS. It might, in that sense, give you greater national security protection, but I think it also may implicate a far more significant scale of transactions.

[The Chair]

Thank you very much, Mr Leiter. We are grateful to you for giving of your time so generously to assist the Committee.

Examination of Witness

David Petrie gave evidence.

--- Later in debate ---

[Simon Baynes]

Q There is a fairly fine line in smaller companies in which an investment manager takes a major stake. There is a fairly fine line between having an active role in its management and having very close scrutiny of its management. From my own experience in the business, the investment manager keeps a very close eye on it in those cases. If they do not, quite a lot of risk is involved. That is quite a crucial grey area, and it therefore makes me think that a blanket exclusion would create problems. It might be viewed by private equity companies or whatever as being an unfair advantage to investment managers.

Chris Cummings: Certainly, we are keen to see those smaller and medium-sized companies get access to as much growth capital and investment as they need. Part of our enthusiasm for this piece of legislation, and indeed others, is that it is an opportunity to re-excite the UK public about the opportunities for equity—for shareholder participation in fast-growing companies. That is partly why we are so keen to work with your Committee and others to communicate the message.

Perhaps a clearer distinction could be found for the difference between listed and unlisted companies. That is perhaps where we could focus our attention more, on explaining—I am not sure that “blanket exception” is quite the right language for me to use because that seems to be a one-and-done exercise and perhaps there would be more to it than that—but focusing the attention on the listed sector, where it is much more obvious that we as investment managers are investing for the long term rather than seeking control over the company. I hope that would allay some of the concerns that you rightly mention.

[Matt Western]

Q Thank you, Mr Cummings, for being a witness today. I want to come back to the point about capacity in terms of the mandatory notifications. As described, do you think it is going to be able to cope with that, and just how opaque are some business organisations and ownership? With that opacity, will they realistically get to that within 30 days? That is my first question. Secondly, in terms of many transactions, the Government have no legal powers over retaining jobs or research and development in the UK—thinking about SoftBank, Arm and many others. Do you think there is a need to plug those sorts of gaps or deficiencies?

Chris Cummings: You rightly raise the question of scale and resources. It is one of the things we have been consulting our members on, and having discussions with others, to try and get a better view of what the notification process would be, who would notify, who would then respond, the scale of the team in the Department that would be exercising due diligence in the applications and whether the system could cope. Bluntly, what would concern us deeply is having a 30-day notice or turnaround period that the Department regularly missed, because that would then create a shadow over this particular piece of legislation. It would gum up the works and, frankly, none of us would wish to see that.

Looking at how the regime works at the moment, with very few notifications, there seems to be a scale difference between where we are today and what the legislation proposes. We would like to hear more from Ministers on how they are going to address that and what the processes would be. There have been discussions about a portal, a very brief form of five pages or so that would be easy to complete, but I think a degree more of reassurance on that point would not go amiss—as would the confidentiality. There is so much around any investment process and the acquisition process that has to remain entirely confidential, that investors would require and would be looking for reassurance that these conversations could be held in the strictest of confidence and that nothing would appear until the right time. In terms of scale and resources, it is a point that we share your interest in.

I was making a note of the point you raised on transactions, but could you repeat that part of the question? Apologies.

[Matt Western]

Q No problem. It was just about various deals, with the example of, say, SoftBank and Arm, and the protection of jobs, research and development and pensions in the UK, and whether the Government need to plug that gap to give assurance and protection here in the UK to those elements.

Chris Cummings: Thank you, and apologies again for omitting that. This is something that we, as the investor community, have been observing for the last few years at least, looking at the different requirements that Governments have tried to put on acquiring companies—Kraft Cadbury and so on, through to SoftBank—and seeing what has happened there, and the role that the takeover panel has been asked to play to police or report on those activities.

The intent behind the Bill at the moment seems to be for national security to preserve intellectual property in that R&D capacity here in the UK. If that is going to be seen through, transparent and accountable mechanisms need to be clarified in the Bill, on how that will work in practice, what resources will be in place to measure, monitor and report it, to whom it would report, and any sanctions that would be applicable afterwards. Those are definitely areas that we feel deserve further scrutiny.

From our point of view, as investors, the last thing we want is to invest in companies where we feel the IP is protected and the R&D facility is well known to us, but where within one, two or three years there has been either a change of management or further changes that mean that IP has been moved or duplicated elsewhere. That is a very legitimate concern.

[The Chair]

If there are no further questions, I thank you very much on behalf of the Committee for giving your time and assistance, Mr Cummings.

Ordered, That further consideration be now adjourned. —(Michael Tomlinson.)