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Allens Arthur Robinson

Focus: Mergers & Acquisitions – March 2008

Chinese translation

Increased transparency for foreign investment screening process

In brief: Federal Treasurer Wayne Swan has announced a set of six principles that are to be applied by the Federal Government when it considers applications to invest in Australia by foreign governments and their agencies. The announcement follows the recent high-profile investments by State-owned or State-controlled enterprises and sovereign wealth funds in iconic global corporations. Partner Alex Ding (view CV), Senior Associate Mark Malinas and Articled Clerk Magnus Mason report.

How does it affect you?

  • State-owned or State-controlled enterprises and sovereign wealth funds must deal with this set of six principles in investment applications or notifications to the Foreign Investment Review Board.
  • The principles will apply across the board to all investments by foreign State-owned or State-controlled enterprises and sovereign wealth funds (but with some exception to certain US government entities).
  • Key factors the Federal Government will consider when determining whether an investment by a foreign State-owned or State-controlled enterprise or sovereign wealth fund is in the national interest will include:
    • independence;
    • adherence to the law and common standards of business behaviour;
    • the impact on competition;
    • the impact on Australian government revenue and other policies;
    • national security; and
    • the impact on Australian business, the economy and the broader community.
Background

The Foreign Acquisitions and Takeovers Act 1975 (Cth) (the FATA) provides for the government screening of transactions where such transactions would see foreign persons potentially controlling Australian businesses or assets. The FATA empowers the Federal Treasurer to block such transactions on national interest grounds. The FATA must be read in light of the Federal Government's foreign investment policy.1 This policy provides that all direct investments by foreign governments or their agencies, irrespective of the size of the investment, are required to be notified for prior approval.2 The notification requirement applies regardless of whether the investment is made directly or through a company in which a foreign government owns at least a 15 per cent stake.3 Applications must be submitted to the Foreign Investment Review Board (the FIRB) for:

  • acquisitions of interests in companies or business assets of any amount or value;
  • the establishment of any new business activity, regardless of investment value; and
  • acquisitions of real estate of any value.

The Treasurer, who usually relies on the advice of FIRB, may deny approval where the investment would be contrary to Australia's national interest.

In recent times, foreign State-owned or State-controlled enterprises and sovereign wealth funds have been actively investing in iconic global corporations. Recent notable investments include:

  • China Investment Corporation's US$5 billion capital injection in Morgan Stanley by way of convertible securities for up to 9.9 per cent of the shares by 2010;4
  • Qatar Investment Authority's substantial acquisition of a stake in Credit Suisse;5
  • Temasek Holding's US$4.4 billion acquisition of new Merrill Lynch shares, with an option to invest a further US$600 million;6 and
  • Government of Singapore Investment Corporation's investment of approximately € 9 billion in UBS by way of convertible bonds (convertible into a 9 per cent stake in the company).7  

In addition, a recent significant investment in the Australian natural resources sector was made by Aluminium Corporation of China (together with Alcoa) in Rio Tinto.8

Whether by coincidence or otherwise, Federal Treasurer Wayne Swan announced on 17 February 2008 a set of six principles to be applied in assessing whether proposed investments by foreign governments or their agencies in Australia are contrary to Australia's national interest. Although these principles are not new to the Treasurer's consideration of such investments, the publication of the principles does increase the transparency of the foreign investment review process.

One of the key issues for the Treasurer is balancing foreign investment (and, in particular, foreign government investment) in Australia's natural resources. The Federal Government has historically adopted the policy position that Australian natural resources assets should be controlled by publicly listed companies that are subject to rigorous continuous disclosure and financial reporting regimes. It will be a balancing exercise for the Treasurer as moves are made by foreign State-owned or State-controlled enterprises and sovereign wealth funds into the Australian natural resources sector. From the perspective of foreign governments, the balancing exercise is made more transparent by the release of the principles.

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What are the principles?

By way of summary, the factors that the Federal Government will consider when examining proposed investments by foreign governments are:

  • that an investor's operations are independent from the relevant foreign government;
  • that an investor is subject to and adheres to the law and observes common standards of business behaviour;
  • whether an investment may hinder competition or lead to undue concentration or control in the industry or sectors concerned;
  • whether an investment may impact on Federal Government revenue or other policies;
  • whether an investment may impact on Australia's national security; and
  • whether an investment may impact on the operations and directions of an Australian business, as well as its contribution to the Australian economy and broader community.

While all factors will need to be dealt with by foreign government investors in their submissions to FIRB when seeking approval, the first two factors are critical in establishing the independence and good corporate governance of State-owned or State-controlled enterprises and sovereign wealth fund investors.

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An investor's operations are independent from the relevant foreign government

One of the most important considerations announced by the Treasurer is the independence of a potential investor's operations from the relevant foreign government. The commentary to the Principles states:

In considering issues relating to independence, the Government will focus on the extent to which the prospective foreign investor operates at arm's length from the relevant government.

  

From our experience, specific examples of the ways an applicant can demonstrate independence from the relevant government include:

  • appointing an independent board of directors and an independent chief executive officer;
  • demonstrating the absence of government involvement in the decisions of the organisation; and
  • demonstrating independence in the setting of chief executive officer and executive remuneration.

To the extent that such matters are enshrined in legislation, for example, in legislation establishing the entity, the greater the perception of independence of that entity from the relevant government.

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Investors adherence to the law and observance of common standards of business behaviour

Adherence to the law and the observance of common standards of business behaviour is another important consideration for the government when assessing foreign investments. The commentary to the principles states that:

Proposals by foreign government owned or controlled investors that operate on a transparent and commercial basis are less likely to raise additional national interest concerns than proposals from those that do not.

  

An investor's ability to meet this criteria can be demonstrated in a number of ways, including:

  • strong public sector accountability;
  • compliance with rigorous disclosure requirements and accounting requirements;
  • regular audits by an independent external audit firm;
  • tabling of annual reports in parliament;
  • the holding of public meetings; and
  • various publicly available charters, codes of conduct and policies.

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The other principles

The Treasurer does not provide much guidance on the other principles. This is most likely because they are well known and point clearly to the national interest test. For example, the consideration of the impact of competition (which may also be assessed by the Australian Competition and Consumer Commission) and national security concerns are obvious considerations.

Based on our experience, FIRB will also consider whether the foreign investor intends to seek representation on the target's board of directors. Passive investors or investors seeking the appointment of nominee directors that would not result in a majority of the target's board being nominees of the foreign investor are less likely to give rise to objections by FIRB in comparison to the scenario where the foreign investor seeks to control the target's board and, ultimately, the relevant Australian business and assets.

In addition, FIRB's screening of investments by State-owned or State-controlled enterprises and sovereign wealth funds will be heightened where the investment is in a 'sensitive sector'. Sensitive sectors include investments in residential real estate, banking, telecommunications, shipping, civil aviation, airports and the media. We have found that, when considering the national interest test, FIRB will also look closely at other sectors, such as uranium (which may have national security concerns). In the case of assets in such sensitive sectors, FIRB may seek undertakings that certain sensitive assets are quarantined from foreign government control (eg that they be divested from the entity that the foreign government investor seeks to control). Whether such action would be sought by FIRB is likely to depend on, among other things, the extent of the interest sought by the relevant foreign government investor.

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Conclusion

Foreign State-owned or State-controlled enterprises and sovereign wealth funds seeking to invest in Australia will need to satisfy FIRB that their investment is in Australia's national interest. The Treasurer's publication of the principles, while not new matters, highlights some of the more important issues under consideration and which should be addressed in FIRB applications. Accordingly, it is prudent to deal with each principle in any FIRB submission.

Footnotes

  1. Summary of Australia's Foreign Investment Policy dated April 2007, issued by the Treasury, Foreign Investment Policy Division.
  2. Paragraph 8 of the Summary of Australia's Foreign Investment Policy dated April 2007.
  3. Certain exceptions apply in accordance with the Australia-US Free Trade Agreement.
  4. New York Stock Exchange, 19 December 2007.
  5. Bloomberg, 18 February 2008.
  6. www.ml.com, 24 December 2007.
  7. Bloomberg, 10 December 2007.
  8. ASX announcement dated 4 February 2008.

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