Sow a character, reap a destiny

12 December 2012

Canada’s recent announcement about SOE investment serves as a timely reminder that there is no monopoly on securing Chinese capital. Promoting Australia’s competitive advantage for foreign investment is an important element of our engagement with China. In the words of the Chinese proverb “Sow a thought, reap an action; sow an action, reap a habit; sow a habit, reap a character; sow a character, reap a destiny.”

Four months after China National Offshore Oil Corporation (CNOOC) applied for foreign investment approval for its CA15.1 billion bid for Nexen Inc, and following two delays, the Canadian Government has finally approved the acquisition.  At the same time and in a stunning reversal the Canadian Government also approved Petronas’s bid for Progress which had previously been rejected by it.  In an interesting and clever decision, the Canadians have effectively grandfathered foreign investment in its extensive oil sands assets and set out the rules of engagement in relation to future acquisitions of significant Canadian assets by SOEs.  Two noteworthy features of the announcement are the reversal of the onus of proof (which requires applicants to demonstrate to the satisfaction of the Minister that proposed investments are likely to be of net benefit to Canada) and the explicit comments by the Prime Minister that "...Canadians have not spent years reducing the ownership of sectors of the economy by our own governments, only to see them bought and controlled by foreign governments..." – a statement vaguely reminiscent of the leader of the opposition’s comments that it would “rarely be in Australia’s national interest to allow a foreign government or its agencies to control an Australian business”.

Concurrent with the CNOOC approval, the Canadian Government announced its new and more stringent updated policy guideline for foreign investment by SOEs (Guideline).  Under the Guideline any future acquisitions of oil sands by SOEs are effectively banned other than in exceptional circumstances.  While the threshold for SOE acquisitions remains at CA330 million (the threshold for private sector bidders will move to CA1 billion over the next five years), the extension of the definition of SOE to include entities that are “influenced directly or indirectly by a foreign government” is likely to result in the review of more acquisitions by Chinese entities. New factors that an SOE applicant seeking approval will need to address are – the degree of control or influence that a SOE would likely exert on the Canadian business and the industry in which that business operates and most importantly the extent to which the foreign government in question is likely to exercise control or influence over the SOE acquiring the Canadian business. 

In particular, the Guideline provides that when assessing an acquisition the Minister will examine the corporate governance and reporting structure of the SOE including, whether the SOE adheres to Canadian standards of corporate governance (including, for example, commitments to transparency and disclosure, independent members of the board of directors, independent audit committees and equitable treatment of shareholders), and to Canadian laws and practices.  The Guideline notes that specific undertakings related to these matters may assist an applicant, including the appointment of Canadians as independent directors on the board, the employment of Canadians in senior management positions, the incorporation of the business in Canada, and the listing of shares of the acquiring company or the Canadian business being acquired on a Canadian stock exchange.

These principles announced by Canada on Friday may seem more than a little familiar to Australian practitioners where such arrangements have been de rigueur for the past five years.

In 2008 the Commonwealth Government released its re-vamped Foreign Investment Policy, which explicitly introduced corporate governance practices of foreign investors as an element in assessing how their proposed FDI impacts on Australia’s national interest.  In particular, the 2008 Foreign Investment Policy set out six national interest criteria to be applied to SOE investments which included whether:

  • the investor’s operations are independent of the relevant foreign government
  • the investor is subject to and adheres to the law and observes common standards of business behaviour
  • the investment hinders competition or leads to undue concentration or control in an industry
  • the investment impacts on Australian government revenue or other policies
  • the investment impacts on national security
  • the investment impacts on the operation or direction of an Australian business, including its contribution to the economy and wider community.

On 30 June 2010, the Commonwealth Government updated the Foreign Investment Policy to provide more certainty about what constitutes a foreign government or related entity, namely where the government holds a 15% stake, guidance about direct foreign investment and a reframing of the six principles encapsulated in consideration of the “character of the investor”.

Since 2008, the Commonwealth Government has consistently managed concerns about “the character of an SOE investor” by the imposition of behavioural conditions on SOEs.  These market based behavioural conditions are designed to ensure SOEs operate in ways that are more akin to normal commercial players and mirror the corporate governance requirements imposed on any Australian operation.  These legally binding conditions which have been readily accepted and complied with by SOEs, require SOEs to operate Australian assets as separate business units on an arm's length basis and are supported by governance conditions.

For example, in the case of Minmetal’s acquisition of the majority assets of OZ Minerals and Yanzhou’s acquisition of Felix, investment approval was granted on the following conditions:

  • that offtake be sold on an arm’s length basis with reference to international benchmarks and in line with market practice
  • that the Australian business be incorporated, headquartered and managed in Australia under a predominantly Australian management team, with the CEO and CFO to have their principal place of residence in Australia
  • that the boards of the Australian businesses have at least two directors whose principal place of residence is Australia and that the majority of all regularly scheduled meetings of those boards be held in Australia.

Most recently in the approval of Shandong RuYi Scientific & Technological Group Co Ltd and Lempriere Pty Ltd’s acquisition of Cubbie Group Limited, the Commonwealth Treasurer imposed conditions on the Consortium including that:

  • Shangdong RuYi sell down its interest in the Cubbie Group from 80% to 51% to an independent third party (or parties) within three years of completing the proposed acquisition, and investigate the possibility of publicly listing Cubbie Group in order to achieve this sell down
  • the Cubbie Group be managed and operated by a wholly-owned subsidiary of Lempriere, including the marketing and sale of its cotton production on arm's length terms in line with international benchmarks and standard market practices
  • the Consortium establish and maintain a board of six members comprising two independent directors who are Australian residents with relevant commercial and/ or agricultural experience and one director appointed by Lempriere.

The Australian foreign investment regime is a permissive and flexible regime and has to date enabled Australia to develop a foreign investment framework which is open to foreign investment and can mature as investment into Australia also develops.  Consistently the Commonwealth Government has managed concern about the possible strategic intentions of SOEs through the imposition of behavioural undertakings – conditions which are readily identifiable and predictable.

However, Australia should be under no illusion that it is in a race for capital.  China's direct investment in Canada reached 14.1 billion Canadian dollars (about 14.69 billion US dollars), up from 12.9 billion Canadian dollars in 2009 and 5.7 billion in 2008.  If Australia is to derive the immense benefits from the Asian Century, then we need to work at being seen to welcome foreign investment in Australia and promote Australia as an investment destination, including by investors and investing nations like China. 

Markets for resources are competitive and adverse policy responses will encourage Chinese investors to seek more willing recipients of their capital.  Any initiative to strengthen and deepen our engagement with China should extend beyond mere platitudes.  Continued transparency and consistency are fundamental to an effective foreign investment policy. Corporate governance of SOEs is evolving towards a system of market disciplines driven by profit. Appreciation of the dynamic nature of SOE reform and the drivers for SOE investment through engagement and analysis will serve Australia well.  Australia has sown a seed, it is now time to sow its character as a place welcoming to Chinese capital.

This article originally appeared online at the University of New South Wales’ Centre for Law, Markets and Regulation.

The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.

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Andrew Lumsden

Partner. Sydney
+61 2 9210 6385


Lizzie Knight

Partner. Sydney
+61 2 9210 6437