The Canadian government has announced revisions to Canada's foreign investment guidelines, which are intended to clarify the review process for investments by foreign state-owned enterprises ("SOE"s). In back to back announcements on December 7, Prime Minister Stephen Harper and the Minister of Industry outlined new guidelines for investments by SOEs ("SOE Guidelines") and also announced the approval of two controversial SOE acquisitions of Canadian businesses. The approval of these transactions was regarded as a welcome sign of Canada's openness to foreign investment. That said, the new SOE Guidelines signal an increasing concern about investments by SOEs, particularly in the Canadian oil sands.
The Canadian government has significantly altered the landscape for SOE investors in Canada. A potential consequence of these revisions will be an increased appetite for joint ventures between Canadian and foreign entities, including SOEs. A joint venture structure may allow SOEs to invest in Canadian industry without engaging the new SOE Guidelines, which is of particular interest in the context of the amendments targeting foreign acquisitions in the Canadian oil sands. Joint ventures enable foreign enterprises to benefit from the experience of long-time oilpatch operators and open the door to a more diverse set of partners. Encana Corp.'s $1.18 billion joint venture agreement to develop Canadian oil and gas fields with PetroChina Co., an SOE, announced on December 13, might serve as a model.
Summary of the Canadian Government's Announcements
1. The Minister of Industry has approved the $15.1 billion acquisition of Nexen Inc. by China National Offshore Oil Co. ("CNOOC") and the $6 billion acquisition of Progress Energy Resources Corp. ("Progress") by Malaysia's Petronas.
2. The new SOE Guidelines for evaluating proposed investments by SOEs set out:
(a) an expanded definition of an SOE;
(b) a more detailed list of key factors for determining whether an investment by an SOE will likely be of net benefit to Canada; and
(c) notice that investments by SOEs in the Canadian oil sands will, going forward, only be found to be of net benefit to Canada on an "exceptional basis".
3. The previously announced increasing threshold for review of proposed takeovers by WTO non-SOE foreign investors under the Investment Canada Act (the "Act") from $330 million to $1 billion will be implemented imminently.
4. The Minister of Industry has been given broad powers to extend the timeline for conducting a national security review of a proposed investment.
Approval of the CNOOC/ Nexen and Petronas/ Progress Transactions
The Canadian government has approved two takeover bids by Asian SOEs for Canadian oil and gas companies.
In a $15.1 billion takeover bid, China's CNOOC will be acquiring Nexen Inc., which has substantial developments in the Alberta oil sands. Notably, these developments comprise only 30% of Nexen's production globally.
In a $6 billion takeover bid, Malaysia's Petronas will be acquiring Progress, which is developing natural gas lands in northern B.C.
These takeover bids were approved under the former SOE Guidelines. Natural Resources Minister Joe Oliver speculated that if Nexen and CNOOC had sought approval under the new rules, the transaction would have been rejected.
The approvals of these takeover bids come in the context of a protracted public discussion about the perceived increase of SOE acquisitions in Canada. This, combined with the Canadian government's rejection in 2010 of the proposed acquisition by BHP Billiton PLC of PotashCorp had left many investors with the impression that Canada was growing increasingly hostile to foreign investment.
The Canadian government's announcements were intended to send a strong message that, in the words of the Prime Minister, "Canada is open for business". However, future acquisitions by foreign SOEs of controlling interests in the Canadian oil sands will be off limits except on an "exceptional basis", and in the case of other industry sectors, may be subject to a more stringent review, as discussed below.
The Investment Canada Act SOE Guidelines
Under the Act, large foreign investments that involve the proposed takeover of a Canadian business automatically trigger a review to determine whether the transaction is likely to be of "net benefit to Canada". The Act sets out six, largely economic, factors that the Minister must review in determining whether a proposed acquisition will be of net benefit to Canada.
In addition to the review factors enumerated in the Act, the new SOE Guidelines outline key considerations in determining whether a proposed investment by an SOE will be of net benefit to Canada. While the "net benefit to Canada" test will still apply, the government will look at such factors as the governance and commercial orientation of the acquirer, the degree of foreign state control or influence over the acquirer, the extent to which the acquirer conforms to Canadian standards of corporate governance (such as transparency and disclosure), adherence to free market principles, and the likelihood that the new enterprise will operate on a commercial basis.
These clarifications were motivated by two factors. First, previous failed bids had led to mounting criticism that the former SOE Guidelines were too vague to provide certainty to foreign investors. Secondly, the Canadian government was responding to growing public concern about the implications of SOEs playing a major role in Canada's natural resources sector.
The major changes to the SOE Guidelines are set forth below.
1. New Guidelines for Proposed SOE Transactions
In the SOE Guidelines, the definition of an SOE has been expanded to include not only entities owned by a foreign state, but also entities that are directly or indirectly owned, controlled, or influenced by a foreign government. The new broader definition of an SOE is likely to create uncertainty as to when the new SOE policy regime applies.
The Minister of Industry will monitor SOE transactions throughout the Canadian economy, with a specific focus on three factors:
(a) the degree of control or influence a state-owned enterprise would likely exert on the Canadian business that is being acquired;
(b) the degree of control or influence a state-owned enterprise would likely exert on the industry in which the Canadian business operates; and
(c) the extent to which a foreign state is likely to exercise control or influence over the state-owned enterprise acquiring the Canadian business.
These factors are designed to address what the Canadian government perceives as the inherent risks of SOE investment in the Canadian economy. One such perceived risk is that SOEs are inherently susceptible to foreign government influence, which may be inconsistent with the national, industrial and economic objectives of Canada. Another is that the acquisition of Canadian companies by SOEs may have adverse effects on the efficiency, productivity and competitiveness of those businesses, negatively impacting the Canadian economy in the long term.
Finally, the new SOE Guidelines target investments in the Canadian oil sands. Going-forward, acquisitions by foreign SOEs of Canadian oil sands companies will only be found to be of net benefit to Canada on an "exceptional basis". In justifying this position, the Canadian government stated that the Canadian oil sands are of "global importance and immense value to the future economic prosperity of all Canadians... If the oil sands are to continue to develop to the benefit of all Canadians, the role of private sector companies must be reinforced." This approach marks a departure from the former SOE Guidelines, which did not identify specific industries or assets that are considered more sensitive than others.
2. Implementation of Increased Threshold for Review Under the Act will not Apply to SOEs
The threshold for review of proposed takeovers by WTO non-SOE
foreign investors under the Act will be progressively increased
from $330 million to $1 billion over four years. Additionally, the
basis of evaluation will be changed from the asset value to the
enterprise value of the Canadian business. This change will better
reflect the market value of businesses and capture the increasing
importance of service and knowledge based industries to the
However, in a departure from the amendments (which were previously announced but have yet to be implemented), the threshold for review of proposed takeovers by SOEs will remain at $330 million, adjusted annually to reflect changes in nominal gross domestic product in the previous year. This threshold will not be raised to $1 billion. The basis of evaluation for SOEs will remain the book value of assets.
3. Ministerial Authority to Extend Timelines
The Minister of Industry will now have the ability to extend the timelines for conducting a national security review of a proposed foreign investment in a Canadian business. This will give the Minister the ability to conduct careful and thorough reviews of complex proposed investments that could be injurious to national security. At the same time, it injects a level of deal uncertainty, where a national security concern is identified, in terms of transaction timelines.
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