By Megan Bowman, UNSW

SYDNEY: 5 August 2014 - Speaking at the BCA-ANU Roundtable on Chinese state-owned enterprises (SOEs) and global investment last week, the Australian Treasurer, Mr Joe Hockey, made clear that “the government is very welcoming of Chinese investment, including investment by SOEs”. To support this statement, Mr Hockey provided examples of Chinese proposed investment that had been approved recently pursuant to the Australian Foreign Investment Review regulatory regime, such as the decision to lift investment conditions from Yanzhou, which I have analysed previously on the CLMR portal. Nonetheless, Mr Hockey’s words fell far short of endorsing major policy or law reform regarding approval processes for SOE investments in Australia.

The legal framework under which foreign companies can acquire Australian businesses and invest in Australian property is constituted by the Foreign Acquisitions and Takeover Act 1975 (Cth) (FATA) and the Foreign Acquisitions and Takeovers Regulations 1989. Australia’s Foreign Investment Policy (AFIP) is the key policy document that guides interpretation and application of this legal framework. It expressly states that “Australia’s foreign investment regime is concerned with investments that provide the investor with potential influence or control over the [Australian] target”. While neither the FATA nor AFIP use or define the term “state-owned enterprise”, they instead focus on “foreign government investors”, which are treated separately and differently to private investors. A “foreign government investor” is defined by section 17F of the FATA as an entity that is a foreign body politic or controlled by one. AFIP further specifies that an entity is considered to be a “foreign government investor” if a foreign government has a 15 percent or more interest in it.

Unlike “foreign persons”, who need only notify the Government if they seek to acquire a controlling interest in an Australian corporation over a certain value, a “foreign government investor” must seek approval for any proposed investment activity that comprises a “direct investment” regardless of its value. “Direct investment” comprises an investment of an interest of 10 percent or more; however, AFIP was amended on 4 March 2013 such that a direct investment may now be less than 10 percent where the “acquiring foreign government investor is building a strategic stake in the target, or can use that investment to influence or control the target”. Moreover, when assessing an investment proposal by an SOE, the government will have regard to six factors in addition to that of whether the investment serves the “national interest”. These factors, according to the 2008 Guidelines for Foreign Government Investment Proposall (the Guidelines) are:

• the degree to which a state actor is independent from their government sponsor and is observing common standards of business behaviour; and

• the degree to which an investment may impede competition in the relevant industry/sector, impact on revenue or other policies, impact on the Australian economy, broader community, and/or national security.

In the context of Mr Hockey’s professed desire for increased liberalisation vis-a-vis Chinese SOE investment last week, it is ironic to note that the Guidelines were promulgated on 17 February 2008 as a direct political response to the spectre of Chinese SOE investment in the form of Chinalco’s “dawn raid” on Rio Tinto shares on 1 February 2008.

During that dawn raid, Chinalco (a state-owned Chinese mining company) together with Alcoa (the US aluminium group)  paid a significant sum of £60 per share to secure 12 percent in Rio Tinto’s London-listed arm, giving them a 9 percent stake overall in the while company. Rio Tinto is a large supplier of iron ore, copper and aluminium to China. So from a commercial standpoint, the acquisition was a strategic move for Chinalco, as emphasised by Chinalco president, Xiao Yaqing when he said that the acquisition was “driven by a need to diversify outside China, its bullish outlook for commodity prices and… belief in the fundamental value of Rio Tinto”.

Yet media commentators offered an alternative explanation: the acquisition was more fundamentally motivated by the desire to block a planned BHP and Rio Tinto merger. Indeed, the “dawn raid” occurred just a few days ahead of the UK Takeover Panel’s deadline for BHP Billiton to formalise its takeover proposal of Rio Tinto. The Chinalco/Alcoa purchase was £10 per share higher than BHP’s original offer with the upshot that BHP Billiton’s failure to match the increased price gave Rio Tinto an excuse to reject a revised offer.

The stark appraisal of the situation by Michael Sheridan of Sunday Times illustrates clearly the political concerns regarding SOE investment activity:

“The coup was widely seen as a riposte to a bid by Australia’s BHP Billiton to acquire Rio Tinto. China is believed to fear the emergence of a titan that would be able to dictate quasi-monopoly prices for commodities vital to its interests… Chinalco is a state-owned entity and its president, Xiao, is a politically sound appointee who has the approval of the State Council, which is China’s cabinet. Funds for the Rio Tinto investment are reported to have come, in part, from China Development Bank, about whose status there is no doubt. It is a state-controlled financial institution that also answers to the State Council. “Nobody would dare to make a strategic decision like this without absolute approval from the leadership,” a Chinese investment banker commented.”

In short, the concern surrounding SOE activity is that pursuit of global capitalism is being made for political gain.

At the time of their promulgation two weeks after the dawn raid, the Guidelines purported to “enhance the transparency of Australia’s foreign investment screening regime”. However, no further guidance has been given by the government regarding how the six SOE factors might impact upon consideration of the national interest, or the extent to which the Treasurer needs to be satisfied about each of them in order to approve an investment proposal. Such lack of guidance has confounded aspirations of increased regime transparency. And regulatory uncertainty tends to dampen investor enthusiasm.

Indeed, this is the conclusion of the Business Council of Australia (BCA) Discussion Paper on Foreign Investment and State-owned Enterprises: Managing the Risks to Maximise the Benefits, which was launched at the BCA-ANU Roundtable. In that report, the BCA states that: SOEs are becoming an increasingly important source of global funds and that foreign competition for Chinese SOE investment is increasing rapidly. In terms of comparable jurisdictions for the Chinese dollar, the United Kingdom has a richer history of approving SOE and Sovereign Wealth Fund (SWF) investment in public targets, the United States has replaced Australia as the preferred destination of Chinese capital, and Canada has set its SOE screening threshold to $330 million. The Discussion Paper asserts that “Failure to respond to the moves our international competitors are making…will simply result in the capital flowing to other countries at the expense of our economy.” (p12).

Certainly the KPMG-University of Sydney August 2014 report Demystifying SOE Investment in Australia found Chinese SOEs in Australia are commercially focused and invest with similar intent to that of other foreign investors. That is, they seek “profitable growth, access to new customers, growth beyond their home markets, and securing reliable, high-quality natural resources for their own economic development objectives” (BCA, p 12). Importantly, the KPMG report found that SOE investors in Australia are increasingly displaying compliance with domestic law, employing local talent, and endeavouring to integrate with local communities.

The KPMG report highlights that when SOE investment is approved by shareholders and regulators and subject to ongoing compliance with domestic laws and regulations (including ASX minority shareholder protections), then the control of Australian companies and projects by SOEs ought not be problematic.

Nonetheless, the conclusions of the BCA Discussion Paper are ambivalent. While stating that SOE-related risks are manageable, it also provides that Australia ought to “continue to rely on the existing FIRB screening regime to satisfy community concerns” (p.15). Certainly the BCA has not endorsed a bold liberalising of Australia’s regime that would involve removing the FIRB screening regime and strengthening domestic laws. Instead, it has issued a series of options for discussion and input, which range from complete liberalisation at one end to maintaining the status quo at the other.

As discussed above, policy (not legal) changes in the foreign investment regime have only increased investor uncertainty. So at the very least, if the Australian government wishes to attract SOE investment, it will need to strongly consider raising the SOE threshold to that of private investors (being US$248 million) or even provide SOE investors with the same treatment as foreign private investors under an FTA (being $1.078 billion) (see e.g. BCA Options 2 and 3).

To this end, there may be sub-national contestation about the right regulatory balance toward SOEs, particularly from WA and NSW.

In addition to establishing the WA Trade and Investment Promotion Office in Shanghai, the WA Premier, Mr Colin Barnett, expressed clearly the WA attitude to Chinese investment vis-a-vis the federal approach: “For Western Australia, with our reliance on trade, international investment, commodities, obviously the game for us is not the Australian domestic economy. We’re interested, but we’re not going to cut our throat over it. Our focus is what’s happening internationally…For us in Western Australia, really it is Asia…”

Moreover, earlier this week the NSW ­Premier, Mr Mike Baird, stated an intention to court Chinese investors for the sale of state-owned electricity assets worth AU$20 billion if he wins the March 2015 election. Regarding Chinese SOE investment, Mr Baird was frank: ““These are issues for the [Foreign Investment Review Board] and the ­federal government. But our position is pretty clear on this: we support investment”.

These state approaches correlate with fiscal inputs. The largest recipient of Chinese investment at state level from September 2006 to December 2012 was the mining sector, which absorbed 89 percent of all WA investments and 55 percent for NSW. It is not surprising that those jurisdictions will continue to want their share of Chinese capital.

It remains to be seen how the federal approach will change, if at all, and to what extent state-federal contestation in this space will exacerbate or contract.

We acknowledge the financial support of the Centre for International Finance and Regulation (for project Enter the Dragon: Foreign Direct Investment and Capital Markets, E002), which is funded by the Commonwealth of Australia and NSW State Government and other consortium members (see www.cifr.edu.au).