Australia's foreign investment regime has undergone significant and widespread change in 2020.
Not only have there been material changes in the law itself, 2020 also saw changes to FIRB's policies and guidance to, approval conditions and to FIRB's administration practices. Plus, FIRB has also effectively restructured its department resulting in a more than 4 times increase in the number of Treasury staff in FIRB. You would be forgiven for thinking that in 2020 there has been a constant moving of the goal posts in Australia's foreign investment regime.
And the change is set to continue in 2021, with material reforms to Australia's foreign investment legislative regime permanently coming into effect on 1 January 2021.
Here is what you need to know:
1. Thresholds and critical infrastructure sectors
The pre-coronavirus monetary thresholds for notifiable actions under Australia's foreign investment regime will be reinstated on 1 January 2021 (with the usual indexed uplift). However, the zero dollar threshold will remain permanently in place for "national security businesses" that is, those in a 'critical infrastructure section' as defined as intelligence-community related. In addition, there will be a new 10% investment threshold at which an investment in a national security business becomes a notifiable action under the foreign investment legislation (rather than the 20% that applies, after industries).
Whereas previously the foreign investment legislation and FIRB's policy had its own list of sensitive sectors, the FIRB reforms will align the definition of critical infrastructure in the new national security component of the FIRB legislation with the meaning of the term in the amended Security of Critical Infrastructure Act. That legislation has not yet been finalised (and won't come into effect on 1 January 2021), so we don't yet know exactly what it will classify as 'critical infrastructure'. The guidance from Parliament to date suggests that it will be very broad and capture whole industries which have never been classified as infrastructure nor critical to the national interest, including food and grocery, science, education and research and transport.
In short, this means that the thresholds will be almost back to normal on 1 January 2021, but there will be a permanent new normal when the amended national security legislation commences. Once the definition of critical infrastructure is broadened in line with the security legislation, transactions of all sizes in potentially many sectors will be subject to mandatory approval requirements.
2. 10 years review power
Under the reforms, the Treasurer will have:
- a new power to 'call-in' for review, for up to 10 years, investments in national security sectors which are not required to be notified under the mandatory notification process; and
- everlasting 'last resort' powers to make prohibition and disposal orders if the circumstances of a foreign investor or the market change materially with the 'material change' element being focussed on the potential national security impact the change. To exercise the power, the Treasurer must be satisfied that the use of other options under the existing regulatory systems of the Commonwealth, States and Territories would not adequately reduce the national security risk.
These changes mean that far greater caution will be needed from foreign investors when investing in national security sectors. With the penalties for non-compliance increasing, it will be a brave call for a foreign investor to decide that a transaction is not in a national security sector and therefore does not require FIRB approval. Whilst most exemptions will continue to apply, investors should nevertheless test proposals until a working knowledge of what is to be caught is built up. FIRB is offering a voluntary notice mechanism for this purpose.
3. New passive foreign government investor exemption
A long overdue, new passive foreign government exemption will be introduced from 1 January 2021.
This means that a fund vehicle will no longer be classified as a foreign government investor solely as a result of having more than 40% foreign government ownership provided that:
- there is less than 20% aggregate ownership from foreign government entities in a single country. There will be an ability for financial sponsors to seek a discretionary declaration that the exemption applies where the 20% single country threshold is breached but conditions 2 and 3 below are satisfied;
- no foreign government investor may access non-public information about the fund's investments that may affect the financial metrics of the underlying investment; and
- the relevant foreign government investors are truly passive and have no ability to influence individual investment decisions or the management of individual investments. Those investors can still have a say over the fund's broad investment strategy or serve on advisory committees.
The new passive foreign government exemption is a welcome relaxation, but ultimately its utility is likely be restricted by its conditions. We see many fund vehicles with more than 20% of their investors from a single foreign government. Whether the Treasurer is willing to grant a declaration that the exemption applies in those circumstances is likely to depend on the jurisdiction of the relevant foreign governments and ultimately, whether the Treasurer wants to see each individual investment application from that fund vehicle. The non-public information condition may also limit the usefulness of this exemption, as it is common for LPs to be provided with information that relates to the financial performance of individual fund investments.
4. New investor-specific exemption certificate
As part of the reforms, the prospect of individual financial sponsors and other foreign investors potentially being able to apply for their own specific exemption has been put forward.
Our understanding from consultation with FIRB, is that this class of new individual investor exemption certificates will be created in 2021. However, to date, no specific guidance has been given by FIRB as to the criteria for qualifying to get one. We are hopeful that the carve-outs and reporting obligations, as well as the fees, won't mean the certificates are of little utility.
5. Exemption certificates for bolt-ons
From 1 January 2021, there will be 4 exemption certificates which give a foreign person pre-approval for multiple investments as part of a planned acquisition strategy in a sector – business and land exemption certificates for non-national security investments, and business and land exemption certificates for acquisitions which raise national security concerns, including in critical infrastructure sectors.
These new exemption certificates do not appear to add much to the existing exemption certificate regime. Whilst the idea of not having to approach FIRB for multiple acquisitions is very appealing, the multiple limitations placed on the grant of exemption certificates make them less helpful in reality and the extra time taken to process them makes them even less attractive. Until now, FIRB has been reluctant to pre-approve sensitive acquisitions and we expect that the new national security interest exemption certificates will be similarly difficult to obtain.
All exemption certificates will also become costly, with the application filing fee moving from a flat fee to 75% of the aggregate filing fees that would be payable if the proposed program of acquisitions was completed. In circumstances where all of the proposed acquisitions don't all go ahead, this could result in an investor wasting money on filing fees.
The reforms to the foreign investment legislation will unfortunately bring a substantial increase in filing fees for larger deals.
The current fees are $2,100 for acquisitions below $10 million, $26,700 for acquisitions above $10 million but less than $1 billion, and $107,100 for acquisition values more than $1 billion.
These fees will be updated next year to:
- $2,000 for acquisitions below $75,000;
- $6,600 for acquisitions below $50 million;
- $13,200 per $50 million of consideration for acquisitions above $50 million; and
- capped fee of $500,000 for acquisitions above $1.9 billion.
The increased fees will likely drive changes in competitive auction processes for larger deals. Whereas it has become common for sellers in those processes to require that FIRB applications are submitted by the start of the binding bid phase ('phase 2'), the significant fees are likely to be unacceptable to bidders where they have no certainty of securing the deal.
7. Approval timing
With the lifting of the COVID-19 temporary measures on 1 January 2021, FIRB's statutory deadline will return to 30 days at least in theory. The 30 day deadline has not been met for some time, other than in the case of the most urgent applications where there are jobs or businesses on the line.
8. Ever-increasing conditions and compliance
Alongside the increased scrutiny of foreign investment under the prism of national security, it is inevitable that 2021 will see increasing probing reviews from FIRB (as well as the government agencies it consults with as part of its review process) of the data implications of an investment. Unsurprisingly, where a target holds government data, especially Federal Government data, that will give rise to the most concerns. Significant concerns can also arise in situations where the target holds data for a third party who provides services to government agencies, such as a bank, telco or health care provider.
Over the last few years, FIRB has been evolving a set of conditions in relation to access and storage of data. That evolution process has resulted in an onerous set of conditions that are effectively physical and cybersecurity protocols covering an extensive range of requirements from more customary and basic good data management requirements, to micromanagement of IT systems and software management (including managing end user devices, maximum timelines for deploying software patches, requirements for regular data penetration testing and specific staff training requirements on a number of aspects).
The evolution has also resulted in number of inconsistent sets of conditions and a lack of certainty in the application of conditions to different business.
We expect to see a standard set of data conditions put forward by FIRB in 2021, much like the standard tax conditions which financial sponsors have come to expect. Whilst these conditions will hopefully have consistency in their application and terms, they will likely be more onerous.
It is also worth noting that in 2020 some of our financial sponsor clients have had new tax conditions imposed which are specifically directed at private equity firms. It is too early to say if these conditions will become routine, taking us back to post-Myer days – we definitely hope not.
Finally, compliance with conditions will inevitably be a focus by FIRB, with a large part of its increased staff numbers being dedicated to compliance and enforcement work. Investors will need to ensure systems are in place to attend to compliance with conditions and reporting.
9. Money-lending exemption
In July, as part of the initial announcement of the reforms, the Federal Government announced that national security land and national security business would be carved out of the moneylending exemption, meaning that financial sponsors and other financiers providing debt financing to businesses in those sectors (independent of an equity investment) would no longer be able to rely on the exemption.
Following substantial negative feedback, the money-lending exemption amendment has changed. Whilst entry into a security will continue to benefit from the exemption, the new regulation as it applies to national security business / land will only exempt enforcement of a security where the enforcement is undertaken by appointment of a receiver. In effect it means that if a lender wishes to take physical possession or forfeiture, FIRB approval will be required for such enforcement.