Foreign Involvement in the Defence Supply Chain Contents

Legislation limiting Foreign Involvement

The Enterprise Act 2002

33.Our inquiry assessed the Government’s ability to intervene in mergers and acquisitions. The current powers are set out in the Enterprise Act 2002, with the related competition regime overseen by the Competition and Markets Authority. Paul Everitt, Chief Executive of ADS Group, told us that this current regulatory regime is “very non-interventionist” and is “very lightly used”.55

34.We were told that, having reviewed these powers, the Government had concluded that they needed to change in order to address the evolving national security threats the UK faces, with the introduction of a new regime necessitated by technological, economic and geopolitical changes.56 A staged approach was adopted by introducing short-term amendments to the Enterprise Act 2002 aimed at closing existing gaps, while preparing a new National Security and Investment Bill.57 The MOD’s written evidence provides a comprehensive overview of powers within the Enterprise Act 2002.58

The National Security and Investment Bill

35.The National Security and Investment Bill was introduced to the House of Commons on 11 November 2020.59 The Bill passed its third reading in the House of Commons on 20 January 2021 and is currently under consideration by the House of Lords.60 The responsible department for the Bill is the Department for Business, Energy & Industrial Strategy (BEIS). Nadhim Zahawi MP, the Minister for Business and Industry, is responsible for the Bill’s progress. Minister Zahawi acknowledged that the Bill was a long time in the making, with a Green Paper in October 2017, a White Paper in July 2018, and a public consultation.61

36.The Bill will introduce, for the first time in the UK, a distinct regime and standalone powers for the review of foreign direct investment in the UK and will replace the scrutiny of mergers which give rise to national security considerations under the Enterprise Act 2002.62 Commentators have argued that the Bill goes beyond earlier consultation drafts, such as the White Paper, and also goes beyond “a number of peer regimes” in other countries.63 Analysis from Bryan Cave Leighton Paisner LLP stated that the Bill will:

37.The impact assessment for the Bill suggested that there could be 1,000 to 1,830 transactions notified under the new system each year, and that around 70 to 95 transactions of these would progress to full substantive review , with around 10 transactions being subject to remedial orders or prohibition.65 The Bill provides for an annual report to Parliament detailing the number of transactions called in and the sectors they are in.66

38.The reaction from industry to the Government’s plans to strengthen its powers to scrutinise and intervene in business transactions has been positive. ADS Group Limited supported the plans.67 Francis Tusa told us that the Bill was just “the UK catching other people up”.68

39.The UK is not alone in making changes to its foreign investment screening arrangements, with “like-minded partners” including the US, Australia, Japan and some European governments having strengthened their own investment screening regimes.69 Dr Ashley Lenihan, a fellow at the Centre for International Studies at the London School of Economics, argued that the introduction of this Bill was in line with international trends surrounding strengthening of foreign investment screening legislation with seventeen countries having made changes to foreign investment screening in the past couple of years.70 Minister Zahawi echoed these remarks telling us that the new approach brings the UK into line with “other open, free market economies” including the Five Eyes group.71

40.The MOD told us that the development of the National Security and Investment Bill included scrutiny of the regimes applied by others and related experiences, with BEIS having engaged extensively with other countries, particularly within Five Eyes.72 The MOD provided an outline comparison of the current international investment screening regimes by country.73 The Minister for Business and Industry told us that the UK had indeed learnt from others, such as the US regime, and have talked to colleagues in other countries “to make sure that we try to take the best ideas that we think will work sensibly in the United Kingdom”.74

41.The UK previously lacked foreign direct investment screening legislation which left the defence supply chain, alongside other sectors of the UK’s economy, vulnerable to influence from hostile foreign investors. The National Security and Investment Bill, once law, will change this situation and offer greater protection to the UK’s economy. Alongside industry and many expert commentators, we support the introduction of this Bill and the planned regime.

The role of the Ministry of Defence in the new system

42.The Bill places the ‘Investment Security Unit’ within BEIS, with no mention of the role that the MOD or the Defence Secretary would perform in the new system. Under the Enterprise Act 2002 the Defence Secretary could provide formal advice if any transactions raised national security concerns for the MOD.75

43.Some commentators have questioned the placement of this Unit, with Charles Parton, Senior Associate Fellow at RUSI, questioning the Bill “putting everything in the hands of the Department for Business, Energy and Industrial Strategy”, arguing that it “probably does not have the expertise on China–certainly not in the defence, security and surveillance realms”.76 Dr Chris Mackmurdo, Director at Legatus and former Head of National Security Research at the Foreign Office, argued that the Foreign, Commonwealth and Development Office should instead be taking the lead in strategic assessments.77

44.However, both Francis Tusa and Elisabeth Braw agreed that BEIS was the most suitable department within the UK Government for the powers within the Bill.78 They suggested that other government departments and agencies should instead “feed into” the unit. The “feed in” model is exactly what was described by the Minister for Business and Industry. He said:

“The unit will sit in BEIS, and it is obviously up to the perm sec at BEIS, working with the Treasury, to make sure it is resourced adequately. It is able to pull in any expertise from across Government and the agencies. It is a sort of hub and-spoke model.”79

45.The Minister for Defence Procurement confirmed to us that he was content with BEIS’ lead role under the regime.80 Huw Walters said:

“The current arrangement gives us freedom to pull together a very robust national security assessment because we are advisers who do not have to balance all the other issues that BEIS must consider. We can give an unfettered national security perspective.”81

46.Some commentators have questioned the placement of the ‘Investment Security Unit’ within the Department for Business, Energy and Industrial Strategy, suggesting that it does not have the necessary expertise and knowledge. We are content, however, that the unit will be able to draw on experience across Whitehall. The Ministry of Defence, alongside other departments and agencies, should proactively feed into all relevant assessment processes.

Venture Capitalism

47.Innovation in defence and associated industries is often led by small start-ups, frequently within universities.82 These small start-ups are often subject to investment through venture capitalism (VC) in order to scale up. Andy Sellars, Strategic Development Director at Compound Semiconductor Catapult, told the Foreign Affairs Committee that:

“The UK has the second highest number of start-ups outside the US and attracts the second highest level of venture capital outside the US. There is a lot of evidence that a lot of these companies come out of universities. They attract VC, they scale up, they de-risk over a short period, and they then sell out.”83

48.There are concerns that VC funding represents an area of focus for foreign involvement in defence innovation. Elisabeth Braw told the Committee that VC funding is incredible hard to track or measure and that few countries have been able to address foreign involvement in VC in legislation.84

49.The Minister for Business and Industry told us that venture capitalism was covered by the Bill, explaining:

“Where early funding or venture capital amounts to a trigger event, that will be absolutely covered by the Bill. I believe very strongly that it is only right to ensure that we can scrutinise acquisitions of control over national security-sensitive entities, some of which may happen at a very early stage.”85

50.Venture capitalism helps to drive innovation in defence and associated industries. However, we heard concerns that venture capitalist funding could represent an avenue for hostile foreign investors to gain entry into the UK defence supply chain. The Minister for Business and Industry told us that the National Security and Investment Bill legislates in this area to protect national security-sensitive entities.

Impact on Foreign Direct Investment

51.It is unclear how the Bill’s provisions will impact on levels of foreign direct investment into the UK, particularly in sectors such as defence and security. Michael Formosa, a Partner at Renaissance Strategic Advisors, told us that the UK has been an “incredibly open FDI destination”, behind only the United States and Hong Kong in terms of levels of foreign direct investment.86 This high level of foreign direct investment is illustrated in the defence supply chain by the volume of foreign involvement in top tier suppliers, as described in the MOD’s written evidence.87

52.Skadden, Arps, Slate, Meagher & Flom LLP stated that the new regime will be a significant factor for overseas investors to consider in planning investments in the UK and that “the Bill represents a very significant departure from the past as far as inward investment into the UK is concerned”.88 Baker McKenzie suggested that “investors into the UK should be prepared for additional regulatory burdens, more complex risk assessments and allocation as well as delays to anticipated deal timelines”.89

53.Roger Barker, Director of Policy and Corporate Governance at the Institute of Directors, told the Foreign Affairs Committee that the Bill could negatively or positively impact the ease of foreign investment in the UK depending on how it is implemented. He explained that if the process is “slick”, “efficient” and “transparent and predictable” it could provide a competitive advantage; however if it were not implemented correctly it “could become a bureaucratic nightmare for companies”.90 Michael Formosa was more positive and predicted that foreign direct investment is likely to rise on the back of this Bill as it is a “significant commitment which makes the UK more attractive”.91

54.When we asked about the impact of the new regime on the UK’s attractiveness for foreign direct investment, the Minister for Business and Industry said that the new regime will strike a balance between protecting national security and sending “a very clear message to the world that we are open to good, positive inward investment”.92 Specifically on the defence and security sectors the Minister said that the only investment that the new regime will lose the UK “is malign investment by hostile actors - that is business we probably would not want here anyway”.93

55.The new regime’s impact on foreign direct investment is, as yet, uncertain. If implemented efficiently the new regime should have little to no harmful impact on foreign direct investment to the UK defence supply chain, only preventing investment that is undesirable. This will require HMG to ensure rapid efficient turnaround of decisions.

55 Paul Everitt, Chief Executive, ADS Group (Q12)

56 Written evidence submitted by the Ministry of Defence (FSC0001), 30 September 2020, paragraph 25

57 Written evidence submitted by the Ministry of Defence (FSC0001), 30 September 2020, paragraph 12

58 Written evidence submitted by the Ministry of Defence (FSC0001), 30 September 2020, paragraph 13–19

61 Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q96)

66 National Security and Investment Bill (Second Sitting), 24 November 2020, Column 54

67 Written evidence submitted by ADS (FSC0002), 1 October 2020, paragraph 1.2; Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q112)

68 Francis Tusa, Editor, Defence Analysis (Q64)

69 Written evidence submitted by the Ministry of Defence (FSC0001), 30 September 2020, paragraph 26

70 National Security and Investment Bill (Second Sitting), 24 November 2020, Column 33

71 Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q96)

72 Written evidence submitted by the Ministry of Defence (FSC0001), 30 September 2020, paragraph 28

73 Written evidence submitted by the Ministry of Defence (FSC0001), 30 September 2020, Table 1

74 Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q104–105)

75 Written evidence submitted by the Ministry of Defence (FSC0001), p4

76 National Security and Investment Bill (First Sitting), 24 November 2020, Column 7–8

77 Foreign Affairs Committee, 1 December 2020, The FCDO’s role in blocking foreign asset stripping in the UK (Q262)

78 Elisabeth Braw, Visiting Fellow, American Enterprise Institute and Francis Tusa, Editor, Defence Analysis (Q85)

79 Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q111)

80 Jeremy Quin MP, Minister of State (Minister for Defence Procurement), Ministry of Defence (Q126)

81 Huw Walters, Director Economic Security and Prosperity, Ministry of Defence (Q127)

82 Francis Tusa, Editor, Defence Analysis (Q64) and Elisabeth Braw, Visiting Fellow, American Enterprise Institute (Q62)

83 Foreign Affairs Committee, 24 November 2020, The FCDO’s role in blocking foreign asset stripping in the UK (Q237)

84 Elisabeth Braw, Visiting Fellow, American Enterprise Institute (Q62; Q93)

85 Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q116)

86 Michael Formosa, Managing Partner, Renaissance Strategic Advisers (Q59)

87 Written evidence submitted by the Ministry of Defence (FSC0001), 30 September 2020, pages 12–13

88 Skadden, Arps, Slate, Meagher & Flom LLP, 11 November 2020, UK Government Introduces New Regime for Screening Foreign Direct Investment

90 Foreign Affairs Committee, 24 November 2020, The FCDO’s role in blocking foreign asset stripping in the UK (Q230)

91 Michael Formosa, Managing Partner, Renaissance Strategic Advisers (Q91)

92 Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q108)

93 Nadhim Zahawi MP, Parliamentary Under-Secretary of State (Minister for Business and Industry) Department for Business, Energy and Industrial Strategy (Q109)




Published: 14 February 2021 Site information    Accessibility statement