Canada: State Investors: On The Rise And Under Scrutiny

Foreign state investors are on the rise and on a buying spree. Oil-rich countries and others with unprecedented trade surpluses are moving their investment portfolios away from conservative treasury bills to higher yielding equity investments. While a global phenomenon1, these state-owned entities (or SOEs) have attracted the scrutiny of Canadians in the wake of a record-breaking rash of takeovers of Canadian icons by foreign investors, some of them SOEs. Concerns about increasing foreign state control of Canadian companies and natural resources spurred Canada's Industry Minister to announce that the Government would review this fall the need for special guidelines on Canadian investments by state-owned entities as well as consider the inclusion of a national security test in the Investment Canada Act (the "ICA"), Canada's foreign investment review legislation.

A Short Survey Of Canadian Treatment Of SOEs

While review under the ICA has been the focus of national attention with foreign (non-state) takeovers of such Canadian companies as Alcan Inc., Inco Ltd. and Hudson's Bay Co., the public or private status of the foreign buyer only became an issue in 2004 when a Chinese SOE, China Minmetals Corp., proposed to acquire Canadian mining giant, Noranda Inc. This event triggered a storm of protests on many fronts, including numerous Canadian parliamentarians who were uncomfortable with the possibility that Noranda might be lost to a foreign SOE.

While Minmetals did not ultimately acquire Noranda2, the Government proceeded to introduce Bill C-59 the following year. That legislation would have amended the ICA to give the federal Cabinet the ability to review and prohibit a proposed foreign investment on the basis that it would be injurious to "national security." This key term was not defined in the bill, an omission that generated considerable criticism. Nor did the bill address the public status of the foreign buyer.

In November 2006, the federal Department of Finance issued a report, Advantage Canada: Building a Strong Economy for Canadians3, which took a distinctly welcoming stance on foreign investment. However, Advantage Canada carefully reserved judgment on foreign investment by SOEs and acknowledged:

[T]here may be rare occasions where a particular foreign investment might damage Canada's long-term interests. For example, foreign investment by large state-owned enterprises with non-commercial objectives and unclear corporate governance and reporting may not be beneficial to Canadians. While such cases are very much the exception rather than the rule, the Government needs a principle-based approach to address these situations4.

In July 2007, the Ministers of Industry and Finance appointed a blue-ribbon Competition Policy Review Panel to review the Competition Act and the ICA, including the treatment of state-owned enterprises and the possibility of a "national security" review clause5. In particular, the Panel was asked to provide advice by June 2008 on issues related to "acquisitions by large foreign state-owned enterprises with non-commercial objectives"6.

However, on October 9, 2007, the Panel's mandate on these two issues was pre-empted by the announcement by the Minister of Industry of possible guidelines on the scrutiny of SOEs under the ICA and a proposed national security test - both of these to be delivered well before the Panel's report.

All Buyers Are Not Alike

Canadians have voiced a range of reasons for scrutinizing SOEs more than private investors, including among others: (1) national security concerns; (2) foreign control over strategic sectors; (3) a lack of transparency in governance and an adherence to non-commercial objectives; and (4) an absence of reciprocity in openness to foreign investment from the SOE's home state.

  1. National Security (Narrowly Defined)
  2. An obvious concern regarding SOEs is the possibility that they will acquire a controlling interest in Canadian defence industries that will increase the SOE's state's ability to carry out aggressive (or even terrorist) activity, gain access to confidential information relating to Canada's defence or weaken Canada's ability to marshal all available resources in furtherance of its defence policy. As a rationale for screening foreign investment by SOEs, there is little to criticize in this objective, as the risk to Canadian national security would be higher for SOEs than for private investors (unless the state and the private sector are tightly linked in the buyer's home country).

    The potential danger in reviewing SOE investments on the basis of "national security" is that this phrase may be defined expansively. For example, it is noteworthy that the Treasury Board of Canada Secretariat's Guidelines for Invoking National Security Exceptions in the context of government procurement interpret the phrase "national security" in a very broad manner, encompassing "threats to economic security, environmental security and human security".7 The potentially elastic scope of the "national security" category means a lack of predictability about which SOE investments may be subject to the review process which could, by itself, have a chilling effect on foreign investment by SOEs.

  3. Strategic Sector Investments By SOEs
  4. A frequently voiced concern is that SOEs will make purchases in strategic sectors in order to pursue political agendas at odds with Canadian national interests.

    Such fears may be well-founded in certain narrow circumstances. The recent actions abroad of Russia's state-owned gas company, Gazprom,8 exemplify this.9 In January 2006, Gazprom cut off gas supplies to Ukraine, apparently because of a price dispute, but some regarded it as Russia's punishment of the Ukrainians for voting in a government that was not friendly towards Russia.10

    Against this background, some U.K. officials and commentators were anxious when Gazprom expressed its interest in buying Centrica PLC, a major player in Britain's gas distribution business. A number of harmful scenarios could be envisaged. For example, if Centrica increased its reliance on Gazprom as a supplier, Russia could "turn off the tap" in the event of a serious diplomatic rift between the U.K. and Russia. Moreover, were Gazprom to supply Centrica with subsidized gas, it could reinforce its market position by eliminating Centrica's competitors, further increasing Russia's political clout vis-ŕ-vis the U.K.

    The Gazprom case demonstrates how SOE's may in certain circumstances be able to harm a country's national economy in order to achieve political ends. It is critical to recognize, however, that outside of the realm of defence-related industries, an SOE would probably only rarely be capable of causing significant harm to a host country. The Gazprom type of scenario is unique in that the SOE is vertically integrated downstream into the takeover target in a critical sector of the economy. State ownership might also be of concern in "critical infrastructure" industries such as banking and telecom where the stability of a system or network could be undermined by rogue SOEs.11 However, depending on the sector and risks raised by state ownership, foreign ownership limits in such sectors or domestic regulation (sector-specific or general) may be sufficient to address this issue. Moreover, where the SOE is pursuing a takeover target that merely produces a non-hazardous commodity that is exported to the SOE's home country, the strategic threats associated with such ownership are likely manageable.

    In short, screening SOE investments on the basis of the economic sector of the target is legitimate. However, like "national security", "strategic sectors" or "critical infrastructure" are elastic categories. The repercussions of SOE investments in those sectors need to be analyzed carefully before concluding that they pose an unacceptable risk to Canada.

  5. Transparency Concerns
  6. The Advantage Canada report cited concern with SOEs because of the lack of information about their governance and their opaque or non-commercial mandates.12 While the Government has not articulated this concern in any detail, some commentators worry that the lack of transparency of SOEs can, by itself, lead to unpredictability and volatility in financial or other markets. For example, if an SOE pulls out of an investment without providing disclosure about the reasons, the markets would not have anticipated such behaviour and would therefore be sent into disarray. Another worry is that so little is known about SOEs' investment policies or risk management strategies because of the lack of public disclosure that minor comments or rumours will increase volatility in the markets.13

    As a rationale for distinguishing SOE investors from private investors, this argument seems over-stated. SOEs are not the only market players about which there is not full public disclosure: private equity players and hedge funds are also less transparent than public companies.14 The rejoinder to this is that there is a higher risk that SOEs will behave in an unpredictable fashion because of unclear or non-commercial objectives than there is in the case of private equity investors, who can generally be expected to act in a way that will maximize their investment's economic value.

    Nevertheless, the ICA may be a crude instrument to address this concern. It is unrealistic to assume that the Canadian government would be able to reform an SOE through the foreign investment review process to become more transparent and disclose all of its motives for investing in a particular target. Prohibiting an SOE investment solely because the SOE is an unknown entity or may not adhere to market principles at all times would be a disproportionate response. Likely the most the Government could do is to seek specific undertakings that respond to defined concerns. In addition, much of the anxiety about possible inappropriate SOE behaviour and non-adherence to market principles in pricing (because an SOE may be subsidized or set below cost prices) could be addressed through Canada's framework regulations such as the Competition Act and trade laws, which would tend to level the playing field between private investors and SOEs receiving subsidies or engaging in predatory pricing. Furthermore, international efforts such as the OECD's Guidelines on Corporate Governance of State-Owned Enterprises promote transparency and the depoliticization of SOEs. The Guidelines recommend, for instance, that if SOEs have social and public policy purposes that go beyond "generally accepted norms for commercial activities" that these should be "clearly mandated and motivated by laws and regulations"15 and that states should avoid interference in the SOE's operational matters.

  7. Reciprocity
  8. The lack of reciprocity in openness to foreign investment rankles some commentators who argue that Canada should not allow other countries to invest in Canadian companies if Canadians cannot invest in that state's companies16. However, while a "quid pro quo" or "tit for tat" review might seem to be in Canada's self-interest, it may also fuel a spiral of retaliatory investment legislation17. Moreover, it may too readily dismiss the fact that countries at earlier stages of economic development may have justifiable reasons for controlling access to investment in certain sectors. Canada's negotiations with other countries are likely a better forum for addressing asymmetries in openness to investments than the review of individual investments by SOEs under the ICA.

Definitional Quagmires -- What Is "State-Owned"?

Another challenge is determining when a state is sufficiently implicated in an investor that the investment should be treated as state-owned. As noted by the OECD, a state may have "significant control, through full, majority, or significant minority ownership" of a SOE18 While in most cases it may be relatively easy to identify state control of an acquiring entity, there are numerous scenarios that might make the "state" status of the investor difficult to assess, including:

  • where the state holds only a small stake in the acquiror and its rights are not transparent;
  • if the acquiror were privately held by an individual who was closely linked with a government (especially an undemocratic one); and
  • if the state investor has a "golden share", giving it the ability to outvote other shareholders in the event of a takeover - a kind of state "poison pill".

While in most instances state involvement in acquisition vehicles may be readily identified, there are many potential forms of state involvement in an acquiror that would not be clear-cut and that could lead the Government either to inflate the risks and overzealously respond or to underestimate a real threat posed by an SOE investment.


Without doubt, state-owned investment may in certain circumstances raise legitimate fears on the part of the Canadian Government - namely, for defence-related reasons or because certain key sectors of the economy need to be shielded from the conduct of politically motivated foreign SOEs. However, other concerns relating to SOEs - in particular, the absence of reciprocal openness to investment or transparency of investment objectives - may be more appropriately addressed by general rules targeted at such behaviour (e.g. trade laws or multilateral codes of conduct) rather than the Investment Canada Act.

In order to avoid the material risk that the Canadian Government may exaggerate concerns relating to SOEs, either intentionally or unintentionally, any process to screen investments by SOEs must establish objective criteria. In the absence of clear rules, there is a real risk of protectionist measures that are disproportionate to the risks raised by SOEs.


1 According to Morgan Stanley, state-owned funds are estimated to hold in the range of $2.5 trillion in capital and by 2015 this figure is expected to balloon to $12 trillion. See Martin Walker, "The New Capitalism", UPI (Munich, 16 July 2007).

2 Ultimately, Noranda merged with Falconbridge in 2005 and then Xstrata, a Swiss company, bought the merged entity in 2006.

3 Canada, Department of Finance, (2006) at ("Advantage Canada").

4 Advantage Canada, supra note 3 at 87.

5 See

6 See Ministry of Industry, Canada's New Government Creates Competition Policy Review Panel (July 12, 2007).

7 See

8 Gazprom is 51% owned by the Russian government.

9 "The Big Question: Should We Fear Kremlin Control of Europe's Energy Supply", International Eurasian Institute for Economic and Political Research.

10 See also Vladimir Kovalev, "Gazprom's Power Play", Business Week (6 March 2007).

11 Recent U.S. reforms to its foreign investment review law links "national security" to effects on U.S. "critical infrastructure" which in turn may include sectors from agriculture to transportation to banking and finance.

12 By contrast, the Norwegian state fund is frequently cited as a model of good governance and accountability: it takes small positions in its investee companies, lists all of its investments on its website and votes on all shareholder resolutions. John Willman, Financial Times (7 July 2007).

13 See "Keep Your T-bonds, We'll Take the Bank; Sovereign Wealth Funds", The Economist (U.S. edition) (28 July 2007).

14 Indeed, as noted in the following Part ("Definitional Quagmires"), the German Government is introducing rules governing private equity funds and hedge funds to address these broader concerns.

15 OECD Guidelines on Corporate Governance of State-Owned Enterprises, OECD 2005 at 20.

16 See John Ivison, "Tories Eye Buyout Rule", National Post (2 October 2007) at A1.

17 Note that Canada also has its SOEs which invest abroad.

18 OECD Governance, supra note 15 at 11.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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