National Security and Investment Bill (Second sitting)

Peter Grant Excerpts

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

[Nadhim Zahawi]

Q Thank you, Mr Leiter. That is really good feedback. Building on the point made by my colleague the shadow Minister, the CFIUS regime in the US obviously operates successfully, in the sense that the US remains an incredibly attractive place for inward investment. How have the US regulators balanced those two things? Does the Bill as drafted provide us with a similar opportunity to strike that balance?

Michael Leiter: I am honoured to have worked with the UK Government for 20-plus years on security issues, and over the past 10 years on economic issues. I certainly think you have the potential to strike that balance. In the US, traditionally, the CFIUS structure was a balance between the security agencies, which tended to want to restrict investment, and the economic and commerce agencies, which tended to want to encourage that investment. Certainly, in the case of China, we have seen massive decline in direct investment because of both Chinese controls and US controls: a tenfold decrease from 2016 to 2018. But as you said, the scale and strength of the US economy mean that global investors look to the United States no matter what.

I do not mean to make less of the UK in any way but, from a UK perspective, one has to be a bit more careful, because you simply do not have the scale that inevitably will attract investment. The US could be a rather poor place to invest, with lots of regulation, but people would still come because of the scale of the market. You don’t have quite that luxury. That is not to say that the UK has not for generations been an incredibly attractive magnet for investment, but whereas the US can err on the side of security, from my perspective, admittedly an American one, the UK might want to be a bit more careful about restrictive measures, because the size of the market is not in and of itself so inherently attractive that companies and investors must be in it. We have a bit of an advantage over you on this one.

[Peter Grant (Glenrothes) (SNP)]

Q Good afternoon. I do not know whether your saw much of the previous witness’s evidence, but she commented on how countries such as the United States have a limited number of excluded or exempt countries—including the United Kingdom—that are not covered by their equivalent legislation. What are your thoughts on how the Bill does not have any provision to exempt entire countries from its scope?

Michael Leiter: I was able to see part of Dr Lenihan’s excellent testimony, which was quite informative and good. First, to clarify, although the US does make distinctions for exempted countries—obviously those are the UK, Australia and Canada right now—that exemption is extremely narrow. It limits those countries only on mandatory filings, and only if investors from those countries fulfil a fairly rigorous set of requirements. So, although Canadian, UK and Australian investors were quite excited before CFIUS reform, when the regulations about excepted investors were promulgated, that has had a minimal effect on those countries. It is not a significant advantage. Those countries are still subject to CFIUS review in the vast majority of investments they make. Now, that gives only half the story, because clearly investments from those nations go through a much less rigorous review, and come out with much better results than those from countries where the US has a more strained security relationship.

On what I see in the Bill, I would say a couple of pieces about the excepted possibility. First, as I read the Bill right now, it covers investments from other UK investors—not even simply those outside the UK. If my reading is correct on that front, I have to say that is probably not wise. We have already talked about the significant increase you could have, based to some extent on mandatory transactions as well as some other factors, and I think trying to take a slightly smaller bite of the apple and not including current UK businesses in the scheme would be well advised.

To the extent one has open trade and security relationships with certain countries, lowering the bar for review to exempt them, or including things such as dollar limits and getting rid of the de minimis exemption, might well make sense. That is another way of making sure that the Secretary of State can focus on those areas you think are the most sensitive from a security perspective. Whether we like to do so or not, that can be aligned to some extent with the country of origin of the investor. It is not always perfect—one must often look below that, especially when dealing with limited partners and private equity—but it is a relatively easy way to reduce the load you may experience if all these measures were implemented.

[Nickie Aiken (Cities of London and Westminster) (Con)]

Q There are 17 sectors included in the Bill, but are any sectors missing? Is there scope for future-proofing?

Michael Leiter: Right now, it is a very robust list. In fact, I would probably err on the side of going in the other direction. I think this is a good list of 17, but what is critical is that these sectors gain further definition about what this actually means. Let me give you a quick example: artificial intelligence. I invite you to go online and try to find more than 10 companies in the world right now who are doing well and do not advertise their use of artificial intelligence in one way or another. It is one of the most commonly used marketing terms there is: artificial intelligence and machine learning, all to serve you in your area of work. If one interprets artificial intelligence as encompassing all those businesses, there will be a flood of reviews. Now, if one focuses on those companies not using artificial intelligence but actually developing artificial intelligence, I think the definition of the mandatory sector will make much more sense. That is an area where I think the US is still finding its way. As Dr Lenihan noted, the US began with a set of listed sectors where transactions were more likely to be mandatory. They eliminated that and now focus purely on export controls, but again, it is not that a company uses export control technology; it is that it produces export control technology.

That may be too narrow for your liking, but if one mapped out your 17 sectors as currently described to their widest description, I think there would be very little left in the UK economy, except for some very basic manufacturing and some other services that would not be encompassed. This is a very broad list and, again, I think it will take some time to tune those definitions so they are not overly encompassing. Again, if you look at data infrastructure, communications, transportation —at their extreme, that is quite a broad set of industry descriptions.

--- Later in debate ---

[Simon Baynes]

Q But they would be quite difficult to police, would they not? How would you know—

David Petrie: Yes. I don’t think anyone is suggesting that the job of this new investment security unit is going to be straightforward. In fact, we are absolutely not suggesting that. It is going to be absolutely essential for Government Departments to work together and, going back to my original point, for this unit to be extremely well resourced, to be able to respond quickly and appropriately to what is put before it.

[Peter Grant]

Q Good afternoon, Mr Petrie. There will be some entities that try to take over British businesses where the warning flags are flown immediately, because it is well known that either it is a foreign state, or a company controlled by a foreign state. Often, it is difficult or even impossible to know who the ultimate controlling party of a business is if they have arranged to have their ultimate ownership registered somewhere offshore, where that information is not made public. Does the Bill, as presently worded, provide enough protection against a hostile power trying to infiltrate the system by going through a secretive intermediary state? If it does not, what more should be done in the Bill to protect us against that scenario?

David Petrie: This is an issue that is well recognised by the investment and advisory community. I think that, as you say so rightly in your question, the warning flags, flares or whatever they might be will already be going off if this is a particularly sensitive military asset that is being considered for acquisition. I think that the unit will be able to look first at the nature of the asset, and it will be apparent very quickly as to whether this is a very sensitive issue. If the acquirer is not a British public limited company, a British private company or one invested in by private equity, if the ultimate ownership is structured in a way that is not conventional—many companies are held through offshore companies for entirely conventional, obvious and transparent reasons for the investment community—and if there is something strange about that ownership structure that makes it extremely difficult to trace the ultimate ownership, it feels to me as though that would be one of the 70 to 90 cases that the Secretary of State would want to review in a lot more detail. Then, due and diligent inquiries would be made to try and understand the ultimate ownership of those holding companies. There would be lots of complicated diagrams drawn, no doubt, showing who owns which bit of what and who are the key individuals and shareholders. The answer would be that, I am afraid, this unit is going to have to keep digging until they get to the bottom of who are the ultimate shareholders.

The Bill is drafted in such a way that you do not need to own much in the way of shares—or there are provisions included within it such that if an entity or individuals, or individuals reporting elsewhere, have control or influence over those holding companies, that in itself would be something we would be concerned about. The Bill includes provision for that because we know, and I believe the security services are well aware, that the equivalent of layering is used for acquisition of these sorts of businesses, or people have certainly tried to do that. So, it is going to be a matter of hard work and digging to get to the bottom of who really owns and controls those entities.

[Peter Grant]

Q When you talk about a lot of hard work and digging to get to the bottom of it, does that include potentially gaining information that is not in the public domain and from a jurisdiction where that information is not allowed to be disclosed? Does that potentially mean having to rely on information that is gained covertly by British intelligence, which then cannot be shared in open court if the case is challenged?

David Petrie: I suspect that would be the corollary of that, yes. We are probably dealing with a relatively unusual set of circumstances here. It rather assumes that the shareholders of the British company are absolutely determined to sell or take investment from an entity where its ultimate ownership is quite difficult to identify. We are dealing with quite an unusual situation—not unprecedented, certainly, but relatively unusual. I do not know what resources the new unit will have at its disposal, but given that this is relatively rare and is a question of national security, I would expect that the Secretary of State would ask it to use whatever resources are necessary to gain the information it needs.

I hope—again, we will see—that the closed doors process for the judicial review, should it come to that, would enable national security to be protected, so that if there were some other breaches as a result of the investigation, or if explaining how we found out what we know caused a breach in national security elsewhere, that problem could be resolved. I am comfortable—I think that would be the right expression—that those difficulties can be dealt with in circumstances in which the absolute preferred option for the company is to take investment, but I have to say that I think those circumstances would be relatively rare.

[Sam Tarry]

Q How have you found your engagement with Government so far, and what processes are you looking for, in terms of how the Government engage with you and the industry—whether it is with your organisation or more widely? Do you have any comments on that?

David Petrie: Yes, I have. The Government have been very clear about the need to bring this legislation on to the statute book, and they have done so through the Green and White Papers. When consulting on the White Paper, they sought opinion from a very broad spectrum, including business groups, businesses, the investment community and so on. They have set that out in the response to the consultation.

The next consultation is the one on the sectors within the scope of the mandatory regime, and the next month or so is going to be a very important stage in this process. Defining those sectors in a way that market participants understand and that does not trigger manifestly unnecessary notifications is going to be very important, and we look forward to engaging in that process, as does the legal and investment profession and British business.

--- Later in debate ---

[Nickie Aiken]

Q On the 17 sectors that were included in the Bill, do you think there are too many or do you think any sectors are missing?

Chris Cummings: That is something we are looking forward to engaging with. When you first hear it, 17 sectors sounds like quite a lot, but having worked through the 17 sectors and looked at some of the draft definitions, I think that each one is justifiable.

We would be keen to point out a few things to the Government. First, the greater the specificity around the definitions, the better. Secondly, we should not rush to change the sectors by adding to them too quickly. Investment needs a degree of stability, and legislative stability most of all.

Thirdly, in consulting with industry and thinking about the operations and practice, I would ask to have industry expertise around the table. We found time and again working with officials—they are hugely valuable, talented individuals, but do not come from a commercial background, almost by definition, although some do—that having the commercial insight, we can play a role in nudging in the right area, to ensure that nothing is hard-coded that would prevent a deal because the nuance has not been appreciated. Having that industry insight would be a big step forward, if it could be accommodated.

[Peter Grant]

Q Good afternoon. The Government’s impact assessment expresses the view that a national security regime such as this does not have much of an impact on overseas investors and their investment decisions, as long as they are comfortable that any interventions are appropriate and the regime is predictable. Do you share that view?

Chris Cummings: With any new piece of legislation, and certainly one of this character and this far-reaching, investors will always want to understand the motivations that led to it being introduced, how it will work in practice and whether we can give case studies as quickly as possible to prove that it does work in this way.

The important thing—I cannot stress this enough—is how it gets spoken about by Ministers. That enduring political support for investment carries such weight with investors. More than the words on the page, what matters is how it is presented—how Ministers then talk about the desire to continue to attract investment and how they make themselves available to investors.

All major economies, because of the covid-19 crisis, are seeking new levels of investment, whether for individual corporates or infrastructure investment, let alone Government debt. We feel very strongly that the UK has a tremendous story to tell. Introducing new legislation such as this at a time when, bluntly, we are looking for more investment to come into the UK, will require a degree more explanation. The way it has been phrased so far, as national security and almost as a catch-up activity with other developed jurisdictions, is fine. However, if Ministers make themselves very much available to investors to explain how this will work, and make a bonus of the pre-authorisation facility, so that if investors are troubled that an investment they are considering could attract attention, there is an ability within 30 days —that is a really important point: within 30 days—to have it pre-approved and then stood by, that will go a long way in the investment community.

As you can tell, we will have to paddle a little bit harder, but that has the potential to be a short-term explanation for a long-term gain. Potentially, that is fine, but I say again that we hope Ministers will seize the opportunity to explain this to investors, the course will be set and we will not see further iterations or scope creep from national security to other sectors, which then becomes a little more worrisome.

[Peter Grant]

Q Thank you. Decisions under this legislation will initially be taken by the Secretary of State. In the United Kingdom, the way that Ministers exercise the authority given to them by legislation, and indeed the way that Governments or Prime Ministers exercise the authority that comes down through the concept of the royal prerogative, is governed as much by tradition, convention and understanding as it is by hard legislation. Recently, we have seen an increasing number of occasions when Governments have chosen to do things that are allowed but are completely unprecedented and not according to the usual traditions and conventions. There are some notable examples here, and clearly a number of examples from the outgoing President of the United States. Does that give you a concern that legislation might be passed giving a Minister power under certain understandings, but that the understandings themselves might have no legal force, so a future Minister might exercise that power in a way that is very different from what had been expected or intended when the legislation was passed?

Chris Cummings: Forgive me, but it is obviously not my role to advise future Ministers on attitudes they may take. I can simply say, from an investor’s point of view, that we prize stability, predictability and accountability beyond all things. Making sure that the rule of law applies and that there is no handbrake turn in policy direction matters hugely. Investment is being sought by every economy around the world, and it would be a very rash Minister indeed who decided to unpick something that is a great strength of the UK and one of our global competitive advantages: a system based on the rule of law and an approach to policy making that is entirely transparent and accountable to Parliament, which gives the investment community great confidence that the UK retains its position as being one of the safest places in the world to invest in.

From our perspective, that accounts for one of the reasons why our investment management industry here in the UK is globally pre-eminent. The UK is not only the largest investment centre in Europe; we are bigger than the next two or three added together. Only the US is a bigger market, and that is because of its substantial domestic scale. When it comes to international investment, the UK is streets ahead of its competitors. We would very strongly urge any parliamentarian, and certainly any Minister, to think twice before taking actions that would have a lasting consequence for our international reputation.

[Simon Baynes]

Q Thank you, Mr Cummings, for a very good presentation. I just want to go back to your point about the blanket exclusion for investment managers. First, you say that is the situation in Japan, but maybe you could say where else it exists. Secondly, why is it needed? I totally accept that, on the whole, the investments being made by your members will not fall within the trigger points, because they will not be taking over 25% of Shell or even some small companies, but they might do in certain circumstances.

Thirdly, to what extent do hedge funds represent members within your organisation? Obviously, they have greater capacity, or greater natural affinity, for investing in smaller companies—not always, but in certain cases. They might actually fall within the remit of the triggers, so I do not quite see how we could implement the blanket exclusion, if from time to time there are exceptions to the exclusion.

Chris Cummings: Thank you for asking me to clarify; I apologise that I was not as clear as I should have been. The hedge fund community has a representative organisation. It is a splendid one that can do a tremendous job in speaking for them, and I would not put myself in that position; I would not try to speak for them. We have members that invest substantially through private markets into smaller and unlisted companies. Again, it comes down to intention. The intention is not to invest in such a way as to take over the company and to seize the reins; the intention is to make an investment that is in the strategic direction of the company, to support its growth.

I am trying not the use the term “passive investment”, because we are anything other than passive when it comes to investing, but it is an approach that is designed to support the company, rather than to change dramatically the company’s ownership or direction, or to land one of our members on its board—in effect, they would then be part of the management and governance of that company. I hope it is more than a subtle definition; it is a distinction with a real difference. That is part of why we think it is an important distinction to make.

Other jurisdictions have been through similar experiences. The Japanese example is so relevant, because it is only a year or so ago that the Japanese Government were considering very similar legislation. As a result of consultation, they came up with the approach that we are suggesting: to exclude the activities of investors, insurance companies and so on, because it is around the intentionality—not wanting to take an active role in the management or to change the company’s direction, but to support through investment rather than to seek control.

The US has a similar modus operandi. It is not quite as framed in the legislation as it is in Japan—again, just through history. The approaches that we have seen in Germany and France also nudge in the direction that I am describing, so there are parallels. The Japanese experience is the closest match that I can offer the Committee, but we will continue to do further investigations and to feed in ideas through the Bill’s stages and through the consultation on individual sectors.