We now move to the next session. David Petrie is from the Institute of Chartered Accountants in England and Wales. Mr Petrie, would you be so kind as to enough introduce yourself for the record?
Good afternoon, Sir Graham, and thank you very much indeed for inviting me to give evidence to the Committee. My name is David Petrie, and I am head of corporate finance at the Institute of Chartered Accountants in England and Wales. My background is in corporate finance and mergers and acquisitions, for 10 years or so now in my current role at the ICAEW and prior to that with PwC. My experience includes advising on transactions, principally in the mid-markets, including private equity buy-outs, company sales and some infrastructure transactions. Prior to that I had a career in industry as well, so I have seen all sides of the fence on this, I suppose.
Q Welcome, Mr Petrie, and thank you very much for placing your expertise at the disposal of the Committee. You have experience of mergers and acquisitions, and I am sure you will be aware that we have seen several transactions in this country—I will name GKN and Melrose, SoftBank and Arm, and indeed I will include the failed Pfizer-AstraZeneca case—where it appeared that the Government had no legal powers to secure jobs, pensions, research and development and key UK industries, relying instead on behind-the-scenes soft power. That created uncertainty and lack of clarity for investors. Do you think that is a problem for both Government and investors, and how do you think we could effectively tackle that gap?
The Government have been very clear that the purpose of this legislation is to focus on protection of national security. The guidance notes they have issued, which accompany the Bill and are intended for market participants, are very clear on that aspect. I would suggest that probably all the factors you listed in your question extend beyond a simple matter of national security—if national security can be a simple matter; no doubt that this Committee has heard this afternoon about the difficulties associated with defining national security. Many of the factors that you set out there, important elements though they are to all stakeholders in a company, are not necessarily matters of national security.
I would also say that that for some of the companies that you mentioned there, while certain of their activities might well be included within the scope of this new Bill, it would be very difficult in certain instances to suggest that they had a direct impact on our national security. Of course, that would be up to the new investment security unit to determine, based on a full representation of the facts. If that unit was at all concerned, a procedure is set out in the Bill whereby it would be able to call for as much evidence as it felt was necessary in order to be able to reach a balanced determination on whether investment by an overseas entity did indeed constitute a real threat to our national security. I think that is the point here.
Q Thank you for your response. If we look at GKN-Melrose and, indeed, even SoftBank-Arm, we could consider that they had national security implications. I suppose the point is that there are essential industries that are directly critical for our economy, but that at first may not seem directly critical for national security because they are evolving technologies, as in the case of Arm and the ongoing takeover by Nvidia, or because they are indirectly critical as suppliers to downstream industries that support national security. Indeed, in the response to the Government’s consultation for this Bill, an example is given of the undermining of the functioning of an airport by a software manufacturer, which would be within the transport sector but would not necessarily immediately appear to be directly concerned with national security. Economic security and national security end up being linked. Do you think that should be reflected in the Bill, and how do you think it can be reflected?
I have read the impact assessment, which included that example. It is a difficult situation, as described in the example. In accordance with the way that this new legislation is drafted and the number and extent of the sectors that are regarded as mandatory—the sectors in scope such that their operating activities would require a notification of the unit—the example set out in the impact statement would indeed require screening by the investment security unit. The Government would likely have the opportunity to review a potential acquisition in that software company.
I was struck by that example, in that it suggested that service had failed, or a malign actor had decided not to provide the necessary services to the airport. I think a broader question here is what might happen in reality. Those services would be procured through a commercial contract, which in turn would, presumably, be backed by insurance. If it were an absolutely critical service, I would expect that the airport would have a back-up system, whether power supplies or a parallel running system, as they do for air traffic control. There are commercial protections for the actual operating activities of critical infrastructure, which should work. It is difficult to protect against the actions of malign actors, but critical infrastructure already has systems and processes, and invests heavily in capital equipment, to ensure that there is not an interruption of supply. The question would be the extent to which ownership of that asset physically gave the owners of the shares the ability to get in and interrupt supply. That almost implies mechanical breakdown or some deliberate and malign disconnection. Again, companies have cyber-security systems in place to ensure that critical infrastructure does not fail.
The point you made was about whether suppliers of that sort of service to our critical infrastructure and their ownership should be subject to review. As the Bill is set out and as the sectors in scope are drafted—of course, the Government will consult over the next month or so on those definitions and whether they should be adjusted or whether they are as wide-reaching as they should be—a business like that would be captured. The investment security unit and, presumably, the security services would have an opportunity to review whether or not to allow that to go ahead.
Q Mr Petrie, you will understand better than most that businesses will want to ensure information is being treated sensitively in any transaction. I want to capture your view of the closed material procedure for judicial review under the Bill and what you think of it in terms of that sensitivity of information.
I think a quasi-judicial review is really important and a part of the process, and then, if necessary, there is judicial review. I think the question cuts back to how many times that is likely to happen. We have to step back a little bit and recognise that that would be a situation where the parties to the transaction are challenging the Secretary of State’s decision as to whether or not this is in the interests of national security.
I would assume that if the sellers are British companies, they will probably have received what they feel are adequate assurances that it is okay to sell to an overseas acquirer, but the Secretary of State takes a different view, presumably based on evidence provided by our national security services. Ultimately, if there is a compelling body of evidence to suggest that a transaction should be modified or adjusted or, in extremis, blocked, it would be quite an unreasonable group of shareholders to disagree with that if the if the Secretary of State was applying the test as set out in the Bill, and indeed in the guidance note, that intervention is to be limited only to matters where the national security of this country is at threat.
That is quite different from the national interest. It is tempting—or possible, rather—in this debate to get sucked into questions about what we should and should not be doing in this country. That is not what this is about. The Government have been very clear to the investment community, and to British business more generally, about the purpose of this legislation. That is why, although markets and investors recognise that it will take a certain amount of time and effort to comply with a mandatory regime—the Government have been very clear about their purpose in introducing that—the market is generally favourably disposed towards it. We can see that it is unfortunately necessary in these modern times.
Q Thank you, Mr Petrie, for your answers so far. I just have a couple of straightforward points for you to address. We discussed the timeframe in earlier sessions, in relation to the five years of retrospectivity, the six-month call-in and the potential 75 days. Do you have any concerns about the impact that that might have on potential investors into the UK? On a similar note, in terms of the fact that there will potentially be in excess of 1,800 notifications annually, an entirely new body will have to be set up, possibly working across Departments and involving the security agencies. A lot of detail will need to be put behind that, and again, that will take time. Do you think any of that will cause any uncertainty among investors and perhaps lead them to look elsewhere?
Perhaps I could deal with the second part of your question first, if I may, on the potential number of notifications that the new legislation is going to necessitate. The first point I make about that is that this new investment security unit will need to be very well resourced. A thousand notifications a year is four a day; I am just testing it for reasonableness, as accountants are inclined to do. That is quite a lot of inquiries. I note from the paperwork that the budget allocated to the new unit is between £3.7 million and £10.4 million. I do not know and cannot comment yet as to whether that is likely to be adequate. What I can say is that the impact statement also suggests that of those 1,000 or so transactions which are going to be subject to mandatory notification, only 70 to 95—the numbers set out in the impact statement—are likely to be called in for further review by the Secretary of State, where a very detailed analysis of those businesses and the potential target is going to be necessary.
As, I hope, has been echoed by other witnesses, it is going to be extremely important that this new unit can engage in meaningful pre-consultation with market participants—with British companies, finance directors, and investors and their advisers—so that they can get a pretty clear steer at an early stage as to whether or not this is likely to be subject to further review. If the unit operates in a way where it can give unequivocal guidance to market participants at an early stage and is open to dialogue—I understand from discussions with the Minister that this is the way the unit is being asked to operate—that would be extremely helpful.
I would say that that is about process, certainly, but I think it is also about culture. It has to be a balance, which is well achieved by the Takeover Panel, for example, in this country. You do not tend to approach the Takeover Panel unless you are well-informed and have done your homework—"Don’t bother us with stuff you ought to know” is the unwritten rule. But at the right time and place, I think it is important that there is an opportunity for market participants to be able to engage in a dialogue. The guideline where we put this “Don’t bother us with stuff you ought to know” question is going to shift. At the moment, we really do not know a lot about the way the Government are going to look at certain transactions. We do know which sectors and operating activities are in scope, but, again, we are not quite sure at what stage it will be right to consult and try and get clear guidance. This process will evolve.
I note that the Bill includes provision for the new unit to issue an annual report as to the number of transactions called in and the sectors they are in. That will be extremely helpful for market participants. An issue here, I think, is potentially asymmetry of information. In order to resolve potential asymmetry of information amongst the investment and advisory community, it would be very helpful that the unit is well resourced and able to engage in meaningful pre-consultation, but, by way of a third recommendation, it would also be extremely useful if it was able to issue meaningful market guidance notes, similar to the notes that accompany the takeover code. That would again be extremely helpful so that we can understand. It would help the market to be better informed. If, for example, the unit is receiving a lot of notifications that are not correctly filled in or with important details as to ownership missing, then it would helpful to have guidance notes as to what we can do to make sure this process works with more certainty, speed, clarity and transparency—these are the things financial markets need to see—to help us with that, beyond what has already been issued, which is very helpful, I have to say. As the market evolves, that would be extremely helpful.
Q May I follow on from that question about the resources? There is talk about 1,800 companies coming forward and voluntarily disclosing that this transaction is going on, but I am just as interested in what happens with those companies that do not disclose this? I am not for a moment suggesting that there are a huge number of dishonest actors involved in the corporate finance market, but given the fact that the threshold was reduced to £1 million a year under the recent review, there are an awful lot of small businesses with turnover of about £1 million a year that are not very well resourced for their corporate governance functions and that could easily miss the requirement to disclose, should a transaction come through that is enticing for the shareholders, who are presumably offered the same as the directors. Are you confident that the Government have in place sufficient resources to be able to police the whole sector, to make sure that we are not missing out on a number of transactions that are going through? Even if we do, are we getting in there quick enough to make sure that the intellectual damage is not done by the time we have found out what is going on?
That is a very difficult question. We will find out—that is the answer to that. I think businesses working in sectors where there is a real threat to national security know that. They know that they are involved in weapons design or designing software that could have a dual use. In advising companies over the years, I have found that no one knows better than the company directors about the value of their assets and their business, both from a market perspective and to competitors or others seeking to gain access to their technology.
The Bill has been in discussion for some years now, and the advisory community is well aware of its existence and of the Government’s desire to put this legislation on the statute book, so I do not think there will be many corporate finance advisers for whom the Bill emerging last week was a surprise. I am very sympathetic to the points made about small companies falling under the provisions of the Bill, but I hope that it will be possible for them to complete what, in the first instance, is a five-page questionnaire—when completed, it could run to 20 pages or more—at a relatively low cost.
To my earlier point, I hope they are able to engage in formal and meaningful dialogue with the unit at the earliest possible opportunity by saying, “This is what we do, and this is what we are worried about.” They have to say, “We’re concerned about this. These are the people from whom we are hoping to attract investment to take the business to the next stage. How do you feel about our business, and how do you feel about the people we are talking to? How does the Government feel about xyz corporation?” I think that kind of steer would help remove a great deal of uncertainty from the circumstances that you have set out.
Q Thank you, Mr Petrie, for a very interesting presentation. I want to look at two areas. One was touched on by the previous witness: the inclusion of not only businesses, but tangible and intangible assets. That is one issue. The second is the acquisition of material influence over qualifying entities’ policy being another trigger point. I would have thought that these are more subjective—perhaps I am wrong—in terms of how you define them, whereas the other trigger points are obviously very clear cut. There are different levels of voting shares in the qualifying entity. I think the previous witness was somewhat surprised to see the tangible and intangible assets element of it and said that this goes further than other similar regimes in other countries. Can you comment first on whether you are surprised or whether you think it makes perfect sense? Secondly, is it easy to define the material influence and the assets, either intangible or tangible?
On the question of tangible assets, it really depends on what we are talking about. Again, it was trailed in the White Paper and the Green Paper that assets would also be within scope, so it is not going to be a surprise. It depends very much on the nature of those assets. In a relatively small country, the ability to acquire land or other buildings—strategic assets—immediately next to a sensitive military installation is, presumably, now included within scope because people who know about these things think it ought to be. I think the investment community will have a degree of sympathy there.
With intangible assets, that is a much more difficult question. It depends on the extent to which ownership of those assets is necessary in order for a malign actor to have the control or the information that they might need. It is possible to gain access to intellectual property through means other than ownership, so the question here is, how might those intangible assets be applied in ways that might prejudice our national security in some way? Again, that is something that the unit is going to have to assess on a case-by-case basis.
It makes sense to include assets that could be sold separately, without the sale of shares in a business. Companies often do that. They may well sell a parcel of patents, or parcel up a division and sell it on because it is no longer core to their operating activities. That is understandable. The investment community will understand that. In short, it is not a surprise, and we are going to have to find our way through this on a case-by-case basis.
That would be the most obvious example. There are things like industrial designs, blueprints or chemical processes that may not be subject to patents. It is typically those aspects of production and design that it is necessary to ensure would be in the scope of this kind of legislation.
Much of the discussion that has led to the publication of the Bill has been around the ownership of shares or of the business—as to whether that is actually the bit that malign actors might want to get hold of. That may not be what really interests them with the business. It may well be intellectual property or these other assets, which it is necessary to separately define. If they are able to get hold of those without buying the company, then it seems to follow that it makes sense to include that within the scope of this Bill.
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.
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?
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.
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?Q
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.
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?
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.
Q How do you think the mandatory notification framework could impact small and medium-sized enterprises in particular, which are obviously having a difficult time, given the consequences of the pandemic?
Yes, that is an important consideration. I hope that if small businesses have limited resources, that is recognised by the new unit, and that smaller businesses are able to have an open dialogue with it, and can say, “This is what we do, and this is what we need the money for. We are going to need it quite quickly because we are running out of money.” If the unit is able to give unequivocal guidance very quickly, that would be very helpful.
I would also say that the new unit should not treat the 30-day turnaround for a mandatory notification as the target. The target should be to respond as quickly and efficiently as it can, and in such a way that does not cause difficulty or distress for small and medium-sized companies. A five-page form for a small or medium-sized company seeking investment for a UK or a relatively straightforward overseas entity is not a terribly burdensome obligation. I hope that it will be possible for them to find their way through that at relatively low cost.