Foreign Direct Investment – learning the lessons from SARs

A new Investment Security Unit (ISU) will be established to review deals involving foreign investors, across 17 ‘sensitive sectors’ which have recently been revised by Government. To provide certainty for investors, the bill requires notified transactions to be either cleared or ‘called in’ within 30 working days of the notification being given and accepted. Once called in, Government will have 30 working days, which is extendable – in cases where the specific legal test is met – by a further 45 working days, to carry out a full assessment of the transaction.

The Government hopes that this will strike an effective balance between protecting our security interests and maintaining economic competitiveness.

Parallels with the DAML SARs regime

In establishing this new FDI regime, lessons can be learned from an area with a number of similar characteristics - the Defence Against Money Laundering (DAML) regime, that sits as a subset of the wider Suspicious Activity Report (SARs) framework.

With DAMLs, organisations in the ‘regulated sector’ are obliged to submit reports to the UK Financial Intelligence Unit (UKFIU) when they suspect that property they intend to deal with is in some way criminal, and that by dealing with it they risk committing one of the principal money laundering offences under the Proceeds of Crime Act 2002 (POCA). These transactions are then assessed by the UKFIU, which has a time limit of seven working days to consider its response and the authority to direct subsequent action.

To summarise, both DAML and FDI processes are typified by proactive notifications from the private sector into government, which then has a defined time-limit to evaluate and act.

The volume problem

The numbers of SARs and DAMLs submitted has risen substantially over the last 20 years. When the original SARs database (ELMER) was built back in 2000, it was designed to hold 20,000 records – not an unreasonable starting assumption, given that 14,500 were submitted in 1999. However, fast-forward to 2019/20, and the UKFIU received 635,493 SARs of which 61,978 were DAMLs. Unsurprisingly, this has placed enormous operational pressure on the UKFIU.

The growth in submissions has been driven by a number of factors, identified by the Law Commission’s review of the SARs regime in 2019:

• The concept of ‘defensive reporting’, where institutions submit reports of minimal value to law enforcement, as there are no downsides to filing a SAR, but huge risks around failure to report – as the criminal liability of the reporter is personal.
• The lack of clarity in the definition of ‘suspicion’, where it is left to individual institutions to set out what they mean by the term, and report accordingly.
• The lack of clear guidance to the regulated sector, which would help institutions to understand what is of interest to law enforcement and what is not.
   

The risks for the Investment Security Unit

The worst case scenario for the ISU is to be inundated with ‘defensive notifications’. This is not a wholly unlikely outcome: the legislation gives Government significant powers to unwind transactions if they call them in after the event, but it cannot do this in cases where the transaction has already been approved. Therefore, investors may well seek the safe harbour of approval if there is even a marginal risk of the deal being undone.

Although statistics need to be treated with caution, a side-by-side comparison with the equivalent body in the United States (CFIUS) is potentially illuminating. In 2019 CFIUS employed 32 FTE and reviewed 231 notices. By comparison, the UK Government’s Impact Assessment indicates that they expect to receive 1,000-1,830 annual notifications, in addition to the 70-95 transactions which they expect to “call in” for an assessment, which will be assessed by ~100 officials.

This comparison indicates that the ISU might have limited capacity to process notifications, even taking into account the proposed government amendment to change the overseas stake threshold from 15% to 25%. If anticipated notifications escalate, with those caught by the regulation adopting a defensive position, the capacity of the ISU would be further constrained. In this case the implications could be:

• Transactions held up beyond the proposed time limits, causing deals to collapse and foreign investment capital to go to other jurisdictions; or
• Transactions being approved with only the lightest scrutiny, with potential ramifications for the national security interest.
   

A way forward

In learning the lessons from DAML and SARs, there are a set of steps Government can take to alleviate ‘defensive notifications’ and help to ensure that the experts in the ISU are focused in reviewing only those cases which warrant it:

• Provide clarity in its definitions, not only of the 17 sensitive sectors, but also of what constitutes ‘national security’. Establishing the appropriate postures up-front can have a huge impact on the culture of the regime, driving it to become collaborative rather than adversarial.
• Create working groups for sectors to come together and guide the development of the regime. Here, the Government can take its cues from the work of the Bank Secrecy Act Advisory Group (BSAAG) in the US, which brings together law enforcement, policy makers, regulators and the private sector, to jointly shape the development of the money laundering regime. One of the keys to its success has been for all members to corral around a shared objective – the provision of better intelligence to law enforcement – which has, anecdotally, dramatically improve the effectiveness of the relationships between public and private sectors.
• Harness the right tooling to support decision-making. There is a mature market for network analytics solutions, used not only in the major banks but increasingly in law enforcement, which will support the identification of ultimate beneficial owners and illuminate complex relationships between entities. In addition, there are emerging solutions which support the mapping of complex supply chains (e.g. for military hardware) which can identify not only the organisations which manufacture each component, but where individual factories are based. This will help to automate much of the analysis, enabling ISU resources to concentrate on the areas where human judgement is essential.
  
  

As we set out in our recent article on economic crime it is critical that there is increased collaboration across the system. The establishment of the ISU provides an opportunity for public and private sectors to develop and operate an effective regime – and it is an opportunity which must be seized.