Testing Time For The Federal Treasurer On Chinese Investment

Key points

• 2008 and 2009 have seen a dramatic increase in Chinese investment in Australian resource companies and projects.

• During that same period, the Federal Government has twice moved to 'clarify' the operation of its screening process for foreign government investment into Australia:

• The majority of Chinese state-controlled entity investment proposals into an Australia resource company or project must therefore, regardless of quantum or structure, be submitted to the Federal Government for prior review.

• But those considering the transaction implementation issues of proposals involving Chinese state owned counterparties still retain the difficult task of assessing what weight ought to be apportioned to the various Foreign Investment Principles (of which there is little published guidance).

• The onset of the global financial meltdown and its severe impact on Australia's economy has added an additional level of complexity to the Treasurer's assessment of what is in the national interest. This is especially relevant to current investment proposals under review including Minmetals' proposed acquisition of OZ Minerals and Chinalco's transaction with Rio.

• It is therefore important in drafting any foreign investment review submissions to properly address each of the Foreign Investment Principles and the impact the investment proposal has on the national interest (in light of its impact on the effects of the financial crisis and beyond).

Recap on the last 12 months

2008 and 2009 have seen a dramatic increase in the levels of Chinese investment into Australia's energy and resource industries. From an estimated total inward investment of A$5 billion throughout 2007 (which was less than half of a percent of Australia's total foreign investment), recently released Thomson Reuters figures put Chinese commitments in the first two months of 2009 to be approximately A$33 billion.

The ever increasing number of mergers and acquisitions, together with a willingness on the part of Chinese companies to vary their style of investment into Australia (including taking controlling positions in ASX listed companies by way of unsolicited takeover bids), has fuelled public debate on whether continued foreign investment is consistent with Australia's 'national interest'.

During that period the Federal Government has twice moved to 'clarify' the operation of its screening process for foreign government investment into Australia.

On 17 February 2008 (some three weeks after the announcement of Chinalco's initial acquisition of shares in Rio Tinto), the Federal Government moved to improve the transparency of its screening process of proposed foreign government investment into Australia by announcing a set of key principles that underpin that assessment (Foreign Investment Principles). These Foreign Investment Principles assess whether:

• an investor's operations are independent from the relevant foreign government

• an investor is subject to and adheres to the law and observes common standards of business behaviour

• an investment may hinder competition or lead to undue concentration or control in the industry or sectors concerned

• an investment may impact on Australian Government revenue or other policies

• an investment may impact on Australia's national security

• 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.

The Federal Government also confirmed that every foreign government investment into Australia will be reviewed irrespective of the size of the investment. It has also indicated that it will look very carefully at proposals that see a consumer of a resource being able to control pricing and production of that resource.

While these Foreign Investment Principles have assisted the public understanding of the screening process, those considering the transaction implementation issues involving Chinese state owned counterparties still retain the difficult task of assessing what weight ought to be apportioned to the various Foreign Investment Principles (of which there is little published guidance).

On 12 February 2009 the Federal Treasurer again moved to clarify the operation of the Federal Government's screening function by announcing an intention to amend the Foreign Acquisitions and Takeovers Act 1975 (Cth) to further clarify the operation of the screening process and ensure that all foreign investments are reviewed irrespective of their structure (effective from the date of the announcement). The media release specifically stated that the amendments will ensure that investment by way of convertible notes will be 'reviewable'. Coincidently or otherwise, that same day Chinalco announced its further investment in the Rio Tinto group a key component of which included the issue by Rio of convertible bonds to Chinalco.

The Federal Treasurer has repeatedly contended that each application will be assessed on its own merits and on the basis of the Foreign Investment Principles. That, coupled with the Federal Government's response to move quickly to close perceived legislative loopholes, shows its determination to maintain control over the regulation of foreign government investment in Australia.

Impact on Chinese investment

The Federal Government has been at pains to stress that the Foreign Investment Principles are not new (they simply reflect the existing policy applied by previous governments) and are not intended to be directed at Chinese investment into Australia (in that they apply to an investment by any foreign government).

However, because of the nature of Chinese companies (the majority of the major Chinese resource investors are owned in whole or in part by the Chinese government and these companies are the major buyers of Australian resources), a significant percentage of Chinese investment proposals do require prior Federal Government approval. Accordingly, the requirement for and workings of the screening process remain an important consideration in structuring any Chinese investment proposal.

Examples of the Treasurer's involvement in a string of high profile Chinese investments proposals throughout 2008 and 2009 include:

• Chinalco's initial investment in Rio: Chinalco's initial investment in the Rio Tinto Group announced in February 2008 was by way of an acquisition of shares in the English company Rio Tinto plc (Rio Tintois a dual company structure comprising an English and Australian company). Shortly following the announcement of that transaction, the Federal Government released the Foreign Investment Principles. Approval to the transaction was eventually granted in August 2008, but it was subject to Chinalco undertaking that it would not exceed a 15% cap in Rio without a further application and would not seek a board seat.

• Murchison Metals¹ and Sinosteel: Murchison and Sinosteel were competing to acquire Midwest Corporation. During this competitive process, Sinosteel made an application to acquire all of Murchison. On 25 June 2008, the Federal Government issued an interim stop order prohibiting Sinosteel from proceeding with any transaction in respect of Murchison for 90 days. Formal approval was subsequently announced on 21 September 2008 with the approval being limited to 49.99% of Murchison (with the release indicating Sinosteel had withdrawn their application to acquire all of Murchison and resubmitted it with the 49% 'cap'). The decision was described as being able to "maintain the diversity of ownership within the Mid-West region" and permit "the development of such potentially significant new resource areas... through arrangements that are open to multiple investors".

• Shougang and Prosperity Resources: On 3 July 2008 Prosperity Resources announced that a proposed strategic alliance with Shougang had lapsed due to the failure to obtain the Federal Government's approval for the transaction prior to a specified 'drop dead' date (although it was not made clear what the cause of the delay was). Shougang at the time is understood to have held a significant interest in Mount Gibson, a company with land in the same region as Prosperity Resources.

Enter the global financial meltdown

The global financial meltdown has only made the application of this policy more difficult for the Federal Government. The pressure is on with the Federal Treasury currently considering a handful of significant investment proposals including Chinalco's proposed investment in Rio (and its assets), Minmetals' proposed acquisition of OZ Minerals and Hunan Valin Iron and Steel Group's investment into Fortescue Metals, each of which will increase Chinese control over Australian assets.

China is seen by many as Australia's greatest chance in avoiding being dragged down with other developed nations into a sustained and damaging recession. The last few years have seen the China-Australia relationship become more symbiotic. China is increasingly focused on securing resources while Australia is increasingly focused on its economic future – a future that seemingly lies with a greater dependence on its major trading partners in Asia rather than with its more traditional partners such as the US and the UK.

Chinese investment is widely touted as having the ability to preserve existing or even create new Australian jobs, stimulate a rapidly slowing economy through mine and infrastructure development, potentially prevent corporate collapses and open up investment and financing opportunities within China. These central themes are articulated in the announcements released in the last few months by OZ Minerals, Rio and Fortescue Metals in response to their respective current Chinese investment proposals. The suggestion is clearly that these are factors that ought to be considered by the Foreign Government when assessing what is in the national interest.

The counter argument is of course that the national interest test ought to balance Australia's short and long term priorities. Those opposed to increased Chinese investment often point to Australian asset values being at near 'all time lows' and champion the protectionist sentiment against 'opportunistic buying'. There is also the much touted concern over creating 'China Inc' (e.g. a centralised Chinese state owned commodity giant (or giants) with the ability to control supply and consequently pricing).

It is therefore important in drafting any foreign investment review submissions to properly address each of the Foreign Investment Principles and the impact the investment proposal will have on the national interest (in light of its potential impact on the effects of the financial crisis and beyond).

We will keep you updated on further developments in this area – particularly the nature and scope of the legislative amendments announced on 12 February 2009 and the significance of the Federal Government's response to the current applications made in respect of OZ Minerals, Rio Tinto and Fortescue Metals.

Footnote

1 Middletons' Perth office acted for Murchison in its hostile takeover bid for Midwest Corporation and subsequent merger proposal.

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