Sovereignty for sale: the FCDO’s role in protecting strategic British assets Contents

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2FCDO’s role in understanding national security risk

Technology sovereignty is fast becoming the defining issue of the century.14 —Dr Hermann Hauser, co-founder of ARM.

12.It is becoming increasingly apparent that hostile foreign involvement poses a risk to the UK’s sovereignty, freedom of action, competitive advantage and critical intellectual property (IP).15 More broadly, ensuring the UK’s domestic sovereign capability in strategically important fields is crucially important and will become more so in the coming years.16

13.During this inquiry, we have explored how well-placed the FCDO is to contribute to the Government’s understanding of the strategic, diplomatic and national security implications of foreign investments. We identified two broad (and often overlapping) categories of national security risk associated with foreign investment in the UK:

a)Investment from a hostile foreign-owned entity that may seek to use its investments to increase their influence within critical sectors of our economy, gain access to sensitive intellectual property, or otherwise undermine the UK’s security or other interests;17 and

b)Foreign investment in an asset, technology or sector that is strategically important to the UK, and the loss of UK control into foreign ownership may have implications for the UK’s technology sovereignty18 or security of supply in critical areas.19

14.This chapter outlines our recommendations for how the FCDO should contribute to the Government’s identification and understanding of risk, primarily by: enhancing understanding of the strategic intent of, and other relevant country-specific information on, foreign-owned entities; and contributing to the continuous monitoring of global investment patterns and the technology landscape. These two possible FCDO contributions to the process are explored in further detail in the following sub-sections.

Horizon scanning and continuous monitoring

15.In recent years, several UK companies have been lost to overseas buyers; the technologies produced by these companies have subsequently been found to be of great strategic importance. One prominent example raised repeatedly by witnesses throughout our inquiry was the sale of semiconductor firm ARM (described as the “crown jewel” of UK technology)20 to Japanese-owned Softbank in 2016; in 2020, US company Nvidia proposed to acquire the company. Concerns have been raised about the implications of the purchase for the company itself, as well as for the UK’s wider technological base (see Box 1). Another notable case is the purchase of DeepMind by Google in 2014. We acknowledge that this was overall a successful investment for the UK, as Google drove the company’s growth and built a successful ecosystem around it in London.21 However, in light of the critical importance of AI technology to the security, prosperity and global influence of nation-states, examining this transaction through a 2021 lens does lead us to question what the loss of a promising AI firm overseas means for the UK’s future strategic dependencies,22 and whether the deal should have warranted greater scrutiny by Government.

16.Both of these case studies highlight the need not just to scrutinise certain individual deals, but for Government to keep an eye on larger trends in foreign acquisitions. Future-proofing the NSI regime will require detailed knowledge of the global technology landscape and understanding of the types of assets that are not only important now, but are likely to become so in the future. As former National Cyber Security Centre (NCSC) CEO, Ciaran Martin, observed,

one of the challenges in terms of the regime that we have for foreign direct investment is that, for understandable reasons, it is geared towards existing companies—even in technology.23

Box 2: Acquisition of ARM by Nvidia

Identifying non-notified transactions of concern

17.On Friday 9 April 2021, the Government tabled an amendment to the NSI Bill that raised the minimum shareholding or voting rights threshold of the mandatory notification scheme from 15 percent to 25 percent.34 This means that any UK company considering an investment that would provide a foreign entity with less than 25 percent ownership of the UK company or asset is not legally obliged to notify the Government of the transaction.35 We appreciate the rationale for this decision as it will reduce the number of notifications received by the ISU (which experts have suggested will far exceed the Government’s predicted figure of 1000–1830 per annum)36 and thus reduce the risk of the ISU becoming overwhelmed. However, this will also sharply reduce the number of deals facing scrutiny.37 The Government is still permitted to intervene in a transaction that falls below this threshold if it has reasonable grounds to suspect that there may be implications for UK national security and certain other criteria like the acquisition of “material influence” are met. However, by raising the threshold for mandatory notification by 10 percent, this amendment increases the possibility of such transactions being missed by the Government. This risk increases the importance of careful proactive monitoring of the UK’s investment landscape to identify trigger events “that might not necessarily appear on the Government’s radar through monitoring of traditional databases and repositories.”38 Witnesses observed that the FCDO is well-placed to assist in this monitoring, though we question whether its existing focus reflects that; the FCDO is yet to demonstrate political leadership on this. As it can draw upon its consular activities and intelligence gathered from overseas posts, as well as its investment and trade activities it is best placed to collect such information but is yet to be tasked to do so.39

18.We have identified a number of individual case studies that point to concerning holes in the NSI Act, further increasing the imperative for multi-agency involvement in the scanning and identification process. These case studies are detailed in the box below.

Box 3: Identified loopholes in the NSI Act

The Aquind Interconnector

19.Permitting—or at least failing to examine—hostile takeovers of these companies by those linked with foreign governments who have an explicit strategy of force technology transfer appears to be short-sighted and risks undermining the UK’s security and long-term prosperity and global influence, out of preference for short-term commercial gain or a desire to avoid inconvenience. The case studies outlined in Box 3 not only highlight remaining loopholes in the NSI Act but also suggest a degree of complacency on the part of the Government. It is concerning that the Aquind deal is not covered by the NSI Act and, as far as we are aware, is not being subject to any scrutiny through a national security lens. Failure to conduct due diligence in cases such as this could put our country at risk. Similarly, the Integrated Review’s recognition of China as “the biggest state-based threat to the UK’s economic security”62 appears to be at odds with plans for deeper Chinese involvement in UK critical infrastructure through the Bradwell B nuclear plant. The prospect of a significant part of the UK’s nuclear energy infrastructure being built by a potentially hostile power—and of these sensitive operations being almost entirely reliant on Chinese-owned technology—is concerning and warrants close examination.

20.We acknowledge that we are not party to all of the information that has informed the Government’s decision not to intervene in changes to the board composition of Newport Wafer Fab. However, the revelation that NWF has now been acquired by this same Chinese-owned entity confirms our fears that the changes to the company’s board composition was only the first step towards a full takeover.

Conclusion

21.The takeover of Newport Wafer Fab by Nexperia represents the sale of one of the UK’s prized assets to a strategic competitor, at a time when global chip shortages means that the products manufactured by NWF are of vital national importance. Failure to conduct a detailed assessment of this transaction under the NSI Act would indicate that the Government continues to hold an unrealistically optimistic understanding of the Chinese government’s intentions and is prioritising short-term commercial interests over the long-term security of our country. The case of NWF may yet serve to demonstrate that, despite the stated intentions of the NSI Bill, the Government has not yet learned the lessons of previous years.

22.We recommend that the Government calls in the acquisition of Newport Wafer Fab by Nexperia for review and imposes appropriate mitigating measures, as a matter of urgency.

Understanding the future strategic importance of assets

23.Protecting the UK’s security and its businesses from hostile investments will require more than just a surface-level understanding of acquisitions and investment patterns. As highlighted by RUSI Associate Elisabeth Braw, a narrow focus on these developments (where information is typically easily accessed) may be dangerous.63 Hostile entities may seek to use other means for gaining access to strategically important technologies that circumvent, or at least may be overlooked by, the new NSI regime. For example, venture capital (VC) funding, where entities invest in start-ups at a very early stage in their development, is extremely difficult to track. Elisabeth Braw stated that

Innovation starts in early stage start-ups and that is where you can snap up the best ideas and you do not have to wait until the companies are a few years old to acquire them. If you get that knowledge early on, the home country still has it, but you can speed ahead and use it for your own purposes.64

24.Future-proofing the NSI regime will necessitate the continuous monitoring of technology developments overseas to identify technologies of strategic importance. The economist Will Hutton suggested that the Catapult Network is an important source of information in this regard and should be consulted in any proposed takeover.65 In terms of overseas information-gathering, the Science and Innovation Network (SIN) also has a valuable role to play. FCDO support would increase the Government’s institutional capacity to effectively implement the NSI Act, by contributing to this continuous intelligence function by monitoring developments overseas to identify technologies of strategic importance. This monitoring should not only cover private companies, but also universities and other research institutions. Witnesses suggested, however, that there is still work to be done to improve the FCDO’s skills and expertise in understanding the strategic implications of new technologies. Founder of podcast Exponential View and technology commentator, Azeem Azhar, suggested that we need to work out where the “common sense about the digital world” is being developed in FCDO, noting that

“I am not sure they necessarily have that muscle running that looks at the intersection between technology innovation and its commercialisation, and how it changes cultural behaviour, which is where a lot of our risks from technology currently exist.”66

25.Improving the FCDO’s capabilities in this regard will be essential not only for supporting the Government’s understanding of the implication of new investments at the point of initial transaction, but also for understanding the implications of developments after; a transaction that may have appeared benign may later prove to have security implications, for example due to the increased strategic importance of the target company or assets in question, or incremental changes within the company that may not be caught by the NSI regime but nevertheless afford hostile actors greater influence within a company.

26.We are concerned about the Government’s ability to monitor and manage foreign investments over time. The ISU is responsible for screening foreign investments at the point of the initial transaction. However, there is no legal provision for follow-up; the NSI Act has not established a mechanism for continuous monitoring of companies once the investment has taken place. The legislation does not allow for post-acquisition reviews unless a buy moves through the trigger levels requiring mandatory notification (for example, by increasing their share of ownership from over 25 percent to 50 percent). Cases such as that of ARM highlight the risk that, once a UK company is sold to even a benign foreign investor with mitigating measures put in place, this ultimately reduces the Government’s ability to intervene if the company is then sold on to another entity in a transaction that may not be in the UK’s best interests. The case of Newport Wafer Fab (see Box 3) also suggests that there is currently limited Government appetite for intervening in the event of changes to the composition of boards, which may give rise to undue influence by hostile foreign entities, including in sectors critical to UK security and sovereignty. Without accounting for these risks, the new screening regime will be very easy for foreign entities to circumvent.

Conclusion

27.It is vital that there is continuous monitoring of the investment and technology landscapes to catch non-notified transactions, as well as monitoring for changes to board compositions or ownership models, which may not serve the UK’s security interests, after the initial transaction has taken place with Government intervention if necessary. This should be additional to the notification regime established by the NSI Act and will require regular feed-in from multiple departments, including the FCDO, building on the tech ambassador we recommended in our report on the Integrated Review, Brave new Britain.

28.Ongoing monitoring of the global technology landscape by the FCDO should inform any future changes, as needed, to (a) the sectors subject to mandatory notification under the National Security and Investment Bill, and (b) the factors to be taken into consideration by the BEIS Secretary of State when assessing transactions, as set out in the Statement of Policy Intent. We recommend that the annual report outlines how this information has been taken into account in the Secretary of State’s decisions.

29.For the FCDO to add value to the NSI regime, it will be important that the Department has the necessary skills, expertise and structures to effectively support the ISU. If the Government continues to behave in the same ways and rely on the same skills base as it has previously, it will continue to see the same results—or worse, given our changing security environment.

30.The FCDO should demonstrate leadership on the foreign relations aspects of foreign investment decisions. Supporting the ISU’s work in this area is a key responsibility of the FCDO. It will be vital that the Department has the right expertise both at overseas Posts and in London to fulfil this responsibility, including through ongoing monitoring of the global investment landscape. We recommend that the Government outlines how it intends to achieve this in its response to this report.

Understanding the strategic intent of foreign-owned entities

31.The NSI Act is geography and actor-agnostic; the decision to call in transactions will not done be on the basis of flag alone. There are no countries restricted from investing in UK companies under the Act, nor is there any current green list of friendly countries who would be permitted to undergo less rigorous scrutiny.67 We understand the rationale for such an approach. The evidence we have received supports the importance of a case-by-case approach to assessing foreign transactions as it would not be possible to decide with absolute certainty that an investment can be trusted simply because it originates from a friendly state.68 This is all the more imperative given the security implications of losing strategically important assets overseas, including to friendly countries (see paragraph 11). This is not a binary issue; the country of ownership is only part of the answer.69 As one witness noted, “If we choose our technology supplier on the basis of flag, we will not necessarily end up with a well-run, resilient network.”70 Undoubtedly, however, various factors relating to the country of origin are crucial to understand when assessing the security implications of any given transaction.

32.Understanding the long-term strategic ambitions of the UK’s competitors, and the different means by which they may use investments in UK companies to achieve these, will be vital in order to understand how foreign activities in certain UK sectors can feed into broader state strategies, including activities that may appear benign or insignificant. This includes, for example, patterns of very small minority investments by one company (or companies with shared foreign ownership) across a strategically important UK sector. Such patterns can be observed, for example, across the UK’s AI and semiconductor industries, where companies with reported links with the CCP often hold 0.5–1% stakes in these companies.71 While large and very public investments are, for the most part, likely to be called in and examined for possible security risks under the new regime, the same will not necessarily be true of small or medium-size investments, particularly those in “less obviously critical” sectors.72 Such transactions, or small investments in important assets, are more likely to fall under the Government’s radar.73

33.Witnesses suggested that potentially concerning transactions that perhaps merit significant attention rarely make their way into public debate.74 Dr Ashley Lenihan from the London School of Economics referred to the example of Huawei’s investments in the UK’s ICT and technology sector, which she described as “very small stakes… seed money… [and] acquisitions of incredibly small companies.”75 This pattern of investment has received very little public attention in the UK. This suggests a need for further reflection on what a non-controlling investment of concern might look like, and what risks these could present, in order to avoid overlooking important transactions, particularly investments from the UK’s strategic competitors.76 These issues highlight the need for “redundancy” in the monitoring process; in other words, continuous monitoring of the investment landscape and involvement by multiple organisations with different sets of expertise and knowledge who are able to identify issues that may be missed by other teams.77

34.As well as understanding strategic intent, the FCDO has an important role to play in improving the Government’s understanding of the commercial and cultural environment of other countries, as well as relationships between commercial entities and foreign governments. The FCDO’s overseas networks should make it well-placed to contribute this knowledge and the Department should be seeking to developing its capabilities in this vital area. As Martin Thorley warned in written evidence,

There is a risk of over-projection of liberal democratic values when assessing linkages in other territories… given the Chinese Communist Party’s (CCP) “rule by law” (rather than “rule of law”) governance within the PRC, PRC organisations (including companies) form part of a “latent network”. Though many have a degree of autonomy in day-to-day affairs, they remain within the gravity of the CCP’s influence and on matters the CCP considers important, they are subject to its will, either by legal means or otherwise.78

35.The importance of a foreign department’s contribution to a government’s understanding of these factors cannot be understated. In order to obtain information about an entity’s intentions and its relationships with other parties with potentially malicious intents, witnesses emphasised that it is crucial for the UK to have a presence, and a useful network of contacts within, the country of ownership and tasks representatives to collect the information relevant to the decision-making required.79 Former National Security Adviser (NSA), Paddy McGuinness, told us that it is important to think of the FCDO as being “in a unique position” to inform the Government about what is happening in markets overseas and among enterprises overseas, and the ultimate intent of foreign entities which might have an effect on the UK.80

36.Inadequate monitoring for relevant transactions below the mandatory notification threshold, coupled with incomplete understanding of how these smaller investments may fit into the foreign government’s broader strategic objectives, risks creating vulnerabilities for the UK. Crucially, the Government will need to weigh up the economic benefits of investment from specific foreign-owned entities with the possible security implications. Detailed knowledge of the long-term ambitions of the acquiring state will be essential to achieving this; as the department with detailed knowledge of these matters, the FCDO should have a significant voice in these discussions and should develop its capabilities in this area accordingly.

Conclusion

37.We support the Government’s decision to keep the NSI Act agnostic of geography or type of actor, so that investments are judged on a case-by-case rather than country-specific basis. The FCDO has a vital role to play in communicating to other parts of government its assessment of the broader strategic intent of foreign governments in their investment decisions, and this information should be a primary consideration when considering specific transactions. The FCDO should be responsible for advising BEIS on these matters and we intend to hold the Department to account for any failure to do so.