Highlights:

• Chinese state owned enterprise investment into Australia’s resources sector is helping create unprecedented high-levels of M&A activity.
• In recent years, Australia’s Foreign Investment Review Board has taken steps to balance the benefits and risks created by this influx by successive revisions or elaborations of the foreign investment policy, amendments to the regulatory framework and the attachment of conditions to particular investment approvals.
• Feedback from some Chinese SOEs suggest that they view these policy changes and the foreign investment review process as confusing and discriminatory.
• The record, however, suggests that China’s SOEs have adapted to the foreign investment process and policy by changing their approach to investment and being prepared to engage with the Government earlier in the investment process.
• China is likely to continue to be a significant source of investment in Australian energy and resources, and increasingly in other areas, especially agriculture and food.

Article

In the past decade Australia has enjoyed unprecedented high rates of foreign investment.  This has been driven by a once-in-a-generation boom in investment in the country’s resources sector.  In large part, this boom has been due to the activities of China and Chinese state owned enterprises (SOEs) eager to secure reliable sources of iron ore, coal and other commodities.

This trend has presented both opportunities and challenges for Australia.  The influx of foreign capital confers obvious economic benefits.  However, for Australia’s Foreign Investment Review Board, the challenge is to balance these obvious benefits against national interest considerations.

Over the last three years, Australia’s foreign investment policy has evolved in response to this trend.  This evolution has not been smooth.  At times Chinese SOEs have referred to Australian investment policy as discriminatory, citing highly publicised rejections of deals and confusing policy and process.  Over the last twelve months, FIRB has made steps to make the process more transparent and Chinese SOEs have changed the way they look to invest to avoid some of the issues.

This dialogue may be about to begin again.  Recent media quote the Australian Government Treasurer Wayne Swan on his plans to impose a two-stage foreign approval process for investment in resource exploration and mining.[1]  This would require foreign-government-related entity investors to obtain approval from FIRB to acquire an exploration business and, if a viable discovery is made, to re-apply for permission to develop the resource.  If introduced, this would create greater uncertainty for SOE investment in new projects to add to the claims that the Australian investment regime already makes things difficult.

At this point, it is important to look back at the history of the recent evolution of Australia’s foreign investment policy to:

• provide an overview of the regime and how it applies to Chinese and other SOEs;
• examine the perception and reality behind the Government’s track record in relation to Chinese investment proposals; and
• outline the strategies that Chinese SOEs have employed to maximise their chances of obtaining foreign investment approval./li>

A closer look provides hope that while the debate rages, there are signs that the dialogue involved in the Australian foreign investment regime policy and process is shaping the structure of investment to serve the demands of investors and regulators.

Overview of Australia’s foreign investment regime

Foreign investment in Australia is regulated by a combination of legislation (the Foreign Acquisitions and Takeovers Act 1975 (Cth) (FATA)) and published government policy (the Policy).

In general terms, the FATA obliges foreign persons to notify the Australian government and obtain prior approval for the following types of proposals:

• any proposal whereby a foreign person will acquire an interest of 15% or more in an Australian business or company that is valued, or has gross assets, above A$231 million[2]; and
• any proposal whereby a foreign person will acquire an interest in certain types of Australian real estate.

In addition to the FATA, the Policy requires foreign governments and their related entities[3] to notify the Australian Government and obtain prior approval for any proposal whereby the foreign government or related entity will acquire:

• an interest of 10% or more in an Australian business or company irrespective of the value or gross assets of that business or company; or
• an interest of less than 10% in an Australian business or company irrespective of the value or gross assets of that business or company, where the foreign government or related entity will obtain special voting rights, the ability to appoint directors or contractual rights.

The aspect of the Policy regarding foreign government investment was first introduced in February 2008.

All proposals must be notified to the Foreign Investment Review Board (FIRB), which is an advisory body that examines proposed foreign investments and makes recommendations to the Australian Treasurer on whether to prohibit or approve proposals.  The Australian Treasurer is empowered to prohibit a proposed investment if it is “contrary to the national interest”.

The ‘national interest’ test

The Act does not define the concept of “national interest” nor provide any guidelines on how it is to be assessed.  However, the Policy states that FIRB reviews foreign investment proposals on a case-by-case basis with national interest considerations given to a broad range of factors.  These considerations include:

• national security – the extent to which foreign investments affect Australia’s ability to protect its strategic and security interests;
• competition – the effect that foreign investment will have on the diversity of ownership within Australian industries and sectors to promote healthy competition;
• other Australian Government policies – including the impact on Australian tax revenues and environmental objectives;
• impact on the economy and the community – including the impact on: plans to restructure the target entity, the nature of investment funding arrangements, the level of Australian participation in the target entity following the transaction and obtaining a fair return for the Australian people; and
• character of the foreign investor – the extent to which the foreign investor operates on a transparent commercial basis and is subject to adequate and transparent regulation and supervision.

The ‘national interest’ test is broadly similar to Canada’s ‘net benefit’ criteria, and both are broader than the US’ focus on security considerations.[4]

Considerations specific to SOEs

In addition to the above, the Policy contains the following considerations for SOEs:

• whether the nature of the investment is commercial and at arm’s length;
• the extent of actual or potential foreign government control, including through lending arrangements embedded in the source of the investor’s funding;
• the nature of any part-privatisation; and
• mitigating factors which may assist the Government in determining that the investment proposal is “not contrary to the national interest”, including:
• existence of external/private partners or shareholders in the investment;
• level of non-associated ownership interests;[5]
• governance arrangements;[6]
• ongoing arrangements to protect Australian interests from non-commercial dealings;[7] and
• whether the target will be listed on the Australian Securities Exchange (ASX).[8]

Observations regarding the Policy

On first read, the Policy appears to make the approval process more onerous for SOEs than for other investors.  It imposes more stringent approval thresholds (ie. approval is required irrespective of the size of the target company or business), it expands FIRB’s review power beyond that under the FATA, and applications for approval made solely under the Policy need not be dealt within in a particular time frame (whereas applications under the FATA need to be assessed by the Government within 30 days, unless extended by FIRB by an additional 90 days).

The current Policy (in place since June 2010) does represent, however, a significant improvement for SOEs compared to the previous policy.  Under the previous policy, all investments by SOEs were be subject to FIRB review, even if the proposed acquisition amounted to less than 10% of interest in an Australian company.  The current policy exempts acquisitions of less than 10% unless the SOE acquirer obtains special voting or other rights.

In addition, it needs to be recognised that most of the ‘additional’ requirements and national interest considerations are not ‘new’ in the sense that they were not previously applied to SOE investors.  The national interest considerations which FIRB may take into account are not exhaustive and were never limited to those in the previous Policy.  This was again made clear by the Australian Treasurer’s recent decision in rejecting the proposed merger between the ASX and Singapore Exchange (May 2011).

Arguably, the current Policy merely codifies some of the considerations that had already been applied to SOEs, and provides a degree of additional guidance to foreign investors.

The Australian Government has consistently stated, both in its Policy and on many occasions, that it welcomes foreign investment.  This enthusiasm has been reciprocated by Chinese investors: as of July 2011, China has invested a total of A$39 billion in Australia, making it the largest national target of Chinese outbound investment ahead of the US and Brazil.[9]  While large SOEs continue to dominate China’s outward investment by volume, the SOE share has dropped from 94% in 2010 to 89% in the first half of 2011.[10]

Given these impressive investment statistics, it can be surprising to learn that some Chinese investors (mostly SOEs) view Australia’s foreign investment approval process and its administration by FIRB to be a major hurdle to the success of their investment.[11]  The following points have been raised as ‘evidence’ supporting the perceived discrimination.

• Sensitive cases of Chinese investment – These include the widely publicised collapse of the A$24 billion Chinalco / Rio Tinto deal (2008), China Minmetals’ reduced bid for Oz Minerals (2009) and the withdrawal of China Nonferrous Metal’s offer for Lynas (2009).
• Informal FIRB position – In 2009, a FIRB representative made unofficial comments about FIRB ‘guidelines’ restricting foreign SOEs to minority equity ownership in Australian companies.[12]  The context suggested that the statement was directed at Chinese SOEs.
• Change in FIRB Policy – Whilst the current Policy applies equally to all SOE’s, it has been viewed as targeting China rather than state-backed foreign direct investments in general.
• Negative press – Chinese investors and officials have viewed the Australian media as playing a negative role in influencing popular opinion and FIRB decision-making regarding Chinese investment.  For instance, recent media attention on China’s food security concerns and its growing investment in Australia’s food and agribusiness sectors preceded the current Senate inquiries into FIRB’s handling of foreign interest in agricultural industries and rural land.
• Delays in approvals – According to policy the review process typically takes a 40 day initial review period, but it is common practice for FIRB, if their review is not completed within that time, to ask Chinese applicants to withdraw and re-submit their proposal.  Anecdotally, it is not unusual for FIRB applications for Chinese investment to take longer than the usual 30 day statutory period.  FIRB either extends the period of review for an additional 90 days as it is empowered to under FATA or requests that applicants withdraw and resubmit their applications so as to restart the statutory timeframe.

However, such ‘evidence’ of discrimination does not – to put it candidly – stack up against the evidence.  What the evidence in fact reveals is that the Australian Government has, for the most part, approved Chinese investment proposals.  In 2009-10, 1,766 approvals were granted to Chinese proposals, consistent with the 1,761 approvals in 2007-08 prior to the global financial crisis.  Where approvals were granted, FIRB has on occasions imposed conditions to ensure that the investment would comply with the ‘national interest’ test – though it is true that certain FIRB conditions (e.g. ownership caps) have had the effect of altering or blocking the proposed acquisition.[13] The table in the Schedule outlines the FIRB review outcome for major Chinese investment proposals in the last three years.

The evidence also reveals that there has been no noticeable slowdown in Chinese investments proposals since the Policy was first amended in February 2008 to refer specifically to investments from SOEs.

In many instances, the withdrawal or non-approval of Chinese SOE investment proposals have related to commercial reasons (eg. concerns about overpaying, or potentially overpaying, for a target company[14]) or reasons that are not specific to the nature of the investor (eg. two major proposals which did not receive FIRB approval in 2009 sought to acquire assets located in the Woomera Prohibited Area which is reserved for national defence purposes[15]).

Finally, it would be misguided to believe that the Australian Government is more likely to approve, or to approve on an unconditional basis, investment proposals from private enterprise than SOEs.  The Government has recently given unconditional approval to COFCO in its 100% acquisition of Tully Sugar (May 2011), and reportedly also to Bright Food’s proposed acquisition of a 75% stake in Manassen foods (August 2011).[16]  It may represent the beginning of a trend as Chinese SOEs and other investors increasingly expand their targets beyond the resources sector.

FIRB decisions and experience have provided some clues as to how Chinese investors, SOEs in particular, can (if commercially feasible) structure their investment strategically important or potentially sensitive projects to maximise the chances of receiving FIRB approval.  These strategies include:

• seek minority rather than controlling interests – aim for smaller, non-controlling stakes (eg. various share placements in ASX-listed companies of less than 20%);
• partner up with a non-Chinese investor – seek JV arrangements between Chinese and non-Australian companies to invest in Australia (eg. the acquisition of Arrow by the PetroChina/Shell JV);
• selling to the public/listing – as in Yanzhou Coal’s undertaking to sell down to 70% by 2012 and list the operating company on the ASX; and
• appropriate governance arrangements to ensure transactions are conducted on arms’ length / commercial terms.

In a recent example, two of China’s largest State-owned renewable energy businesses, China Datang Renewable Power Co and Baoding Tianwei Baobian Electric Co formed a renewable energy joint venture, called AusChina Energy Group, with Australian listed company CBD Energy Limited.  Datang Renewable is a major wind farm developer and operator.  Baoding Tianwei Baobian is the main operating company of the Baoding Tianwei Group, the largest electrical supplier in China and a producer of wind turbines and other alternative energy technology.

The new AusChina Energy Group is an important opportunity that will enable both Chinese SOEs and their Australian joint-venture counterpart to work towards a development target of approximately $6 billion worth of renewable energy projects over eight years, which would represent one third of Australia’s wind energy market.  Obviously, there are a number of commercial reasons for the joint-venture, but it highlights a successful path towards foreign investment for Chinese SOEs.

As well as an opportunity to maximise the chances of FIRB approval, this strategy could have commercial advantage for SOE investment.  With the price of acquiring Australian resources businesses at an all-time high, it is likely, going forward, that SOEs will look beyond the acquisition of operating Australian miners towards investment in exploration and development.  Joint-venture arrangements often have commercial advantages for exploration companies looking for capital and investors looking to take a more speculative investment.  It remains to be seen how the Treasurer’s recent statements about potential FIRB policy changes will impact on this investment strategy in the future.