This article was written by Malcolm Brennan, Paul Schroder, Jin Xiong and Michael Ting.
The Foreign Acquisitions and Takeovers Legislation Amendment Bill 2015 (“FATLA Bill”) is currently before the Australian Senate as part of a package of reforms to Australia’s foreign investment framework set to be introduced on 1 December 2015. The broad aim of the reform package is to modernise the Foreign Acquisitions and Takeovers Act 1975 (“FATA”) and strengthen the enforcement of the foreign investment system, while remaining consistent with the Government’s approach to welcoming foreign investment.
We have issued a separate article on the broader reforms, but looking into the detail of the FATLA Bill there are some significant changes specifically for foreign government investors that will increase the compliance burden of investing in Australia and, more importantly, send a message to our foreign partners that is inconsistent with current practice and recent positive developments in Australia’s trade relationships.
The New Rules Broaden the Net of FIRB’s Screening Process
Under the new regime, all foreign government investors from a single country will be deemed to be associates. Therefore, the holdings of all investors from a single foreign country will be aggregated for the purpose of determining whether the Australian Foreign Investment Review Board (“FIRB”) will need to be notified in respect of a potential investment.
For the majority of cases, this aggregation should not be an issue as it is uncommon for multiple government related entities from one country to have investments in a single Australian entity. Where the new rules will likely have most impact will be on private equity interests, particularly from the United States, where there is often a number of state government related interests invested in funds. Many US private equity investors are considered to be foreign government investors due to state government interests. The newly released draft regulations provide a measure of assistance for limited partnerships, however, the issue remains that otherwise unrelated entities that have government related ownership from a single country will now be required to aggregate their interests when determining if the Australian regime applies to their investments.
FIRB’s position is that the new rules codify current practice and that FIRB has always assessed applications on the basis that government related investors from the same country are considered to be related. However, deeming association at the notification stage (which is the effect of the expanded associate definition) is a subtle, but important deviation from current practice, where FIRB considers any association relationship at the assessment stage.
In effect, the new rules place the burden on foreign government investors to investigate the Australian target’s register and to make a FIRB notification on the basis of any deemed association found. In some instances, this will present significant practical difficulties as interests in the target may be hidden behind multiple layers of ownership, or will simply not be available. For example, identifying less than 5% interests in listed target companies will often not be possible.
These practical difficulties present substantial compliance risks for foreign government investors. It is possible that a foreign government investor will fail to make an application in circumstances where it is required to do so as information regarding the holdings of other foreign government investors for the same country will not be available to it. In these circumstances, the foreign government investor may be in breach of FATA even though it did not have the information available to it to comply with the relevant provisions. In other circumstances, where an investor lodges an application, it may not take into account the holdings of its deemed associates and may again inadvertently breach FATA for failing to disclose these in its application.
With the introduction of new increased penalties for contraventions of FATA, the deeming provisions become a major concern. Investors looking to invest in Australia and take advantage of the passive interest threshold (ie, less than 10%) may be forced to look elsewhere as they may not want to run the risk of a compliance issue as well as the time and cost of a FIRB application which, going forward, will have fees attached as well.
The New Rules Bring a Changed Approach
More significant than the administrative burdens imposed by the new rules is the message it sends to potential foreign government investors. By deeming all foreign government investors from a single country as associates for the purpose of notification, it makes the blanket assumption that each state-backed entity acts in concert with each other. This is an inappropriate assumption for many foreign government entities and is inconsistent with views held by the Australian business community.
The premise (or perhaps fear) that foreign government investors act in concert in respect of Australian inbound investment is also not borne out in recent transactions. On the contrary, in recent years we have seen fierce competition amongst foreign government investors (especially Chinese state-owned enterprises (“SOEs”)) for investment opportunities in Australian companies. A recent example was the sale for Swisse Wellness, in which a number of Chinese SOEs submitted bids in a highly competitive process. Another example is the proposed sale of NSW’s electricity distribution network (poles-and-wires), which has attracted government-backed bidders from around the world, including competing Chinese State-funded bidders (State Grid and China Investment Corporation).
Australian regulators have historically recognised that Chinese sovereign wealth funds and SOEs are operated and managed independently of each other and of government. This includes FIRB, which previously stated that it does not consider Chinese sovereign wealth funds and SOEs as all one related entity. This understanding has been a significant point of difference between Australian regulators and those in Europe or North America, who have typically considered Chinese SOEs as related entities in the context of anti-trust, takeovers and securities regulation. The message that Australia has a stable and apolitical regulatory framework for foreign investment is fundamental to Australia’s relative success in attracting foreign investment.
In addition, FIRB has an opportunity to build upon the momentum of recent trade deals signed with Korea, Japan and China to reform the foreign investment regime to align with those positive developments. In particular, following the signing of the China-Australia Free Trade Agreement (“ChAFTA”), the Australian business community was optimistic that it would open opportunities for reform to encourage foreign investment, including by Chinese SOEs and sovereign wealth funds. One suggestion would be to carve out certain foreign government investors (including identified sovereign wealth funds and SOEs) from those countries from the presumption of association.
A More Nuanced Approach
Australia’s foreign investment framework requires a clear and consistent approach to screening foreign investment. There are legitimate policy concerns which need to be addressed in the drafting of the FATLA Bill to ensure that foreign government investors who act in concert are aggregated for the purpose of FIRB’s screening procedures. However, we do not agree that the solution is to implement the blanket assumption that all foreign government investors are associates when assessing the notification requirements.
It must be remembered that only an interest of 20% needs to be held by government related investors from a single country to make an entity a “foreign government investor”. It is not just wholly state owned enterprises that are impacted by this change. FIRB’s approach of assessing applications as if they were associated is a very different proposition to requiring notifications to be made based on a deemed association.
Consider that if the same approach was adopted in Canada, and what its effect would be on Australian investment. The new rules would imply that the Queensland Investment Corporation colludes with the Australian Future Fund in respect of its investments. Clearly that implication is incorrect and the suggestion otherwise would call into question Investment Canada’s understanding of Australian sovereign investment.
A more nuanced approach might be to adopt an associate test based on effective control or actual acting-in-concert as is currently used in the Australian Corporations Act 2001 (Cth). Other options would be:
- to exclude entities that are not wholly state owned;
- to exclude entities from different levels of government from being associated. That is, state or provincial level government entities are not associated with Central/Federal entities.
- to make the deemed association under the FATLA Bill a rebuttable presumption giving investors the opportunity to demonstrate their commercial orientation, freedom from political influence or independence from other government entities. Foreign investors backed by state funds who can demonstrate these qualities would not automatically be deemed an associate of other foreign policy investors.
These alternatives would acknowledge the reality of many foreign government investors that act commercially and independently of their government shareholders (including wholly State owned enterprises). It would also send a message to our foreign partners and regulators in other jurisdictions that Australia is taking a lead in developing a sophisticated and fair foreign investment regime.