On 19 August 2016, it was announced that the Hon. Scott Morrison MP, the Treasurer of the Commonwealth of Australia, had blocked the proposed acquisition of a 50.4% interest in the lessee of the network assets of Ausgrid, the New South Wales electricity transmission and distribution business, by investors from mainland China and Hong Kong. The Treasurer, on the advice of the Foreign Review Investment Board (FIRB), Government officials and departments, had concluded that the acquisition would be contrary to Australia’s national interest.
The Treasurer’s decision has received significant media attention and drawn stern comments from the parties involved and the Chinese Ministry of Commerce. The timing of the Ausgrid decision comes shortly after the Treasurer’s preliminary decision to prohibit the acquisition of an 80% interest in S. Kidman & Co Limited, a large privately owned agricultural group, by the Chinese-owned Dakang Australia Holdings Pty Ltd.
There are understandable concerns about the messages these decisions send to foreign investors, particularly Chinese investors, even though there have only been five prohibitions of foreign investment proposals since 2000.
In 2015 and 2016 there has been an increased focus by FIRB and the Government on the security issues associated with foreign ownership of critical infrastructure. This was highlighted in 2015 when the Port of Darwin was leased by the Northern Territory Government to a Chinese-owned company in a transaction that did not require FIRB approval, drawing criticism from the United States. It is understood that the relevant security authorities considered the Port of Darwin transaction and did not raise any significant concerns. Following the lease of the Port of Darwin, Australia’s foreign investment rules were subsequently strengthened so that all proposals for foreign bidders to acquire critical infrastructure now require FIRB approval.
The effect of the Treasurer’s decisions in the Ausgrid and the Kidman transactions on foreign investment into Australia is still to be seen. While the door remains open to foreign investment in Australia, including Chinese investment, it is very clear that foreign ownership of critical infrastructure and agriculture will be a sensitive issue.
Foreign investors, particularly state-owned foreign investors or investors that are perceived to be capable of being influenced by foreign governments, will face significant scrutiny before being permitted to acquire assets in these sectors.
The most surprising aspect of the Ausgrid decision is that it came so late in the transaction - after final binding bids and significant engagement by the bidders and the State with FIRB. These same bidders had been involved in the 2015 Transgrid privatisation process with no apparent concerns. The ‘surprise’ element of the Treasurer’s decision is a significant reason for the subsequent reaction.
The Ausgrid and Kidman decisions emphasise the need for particular care and consideration where foreign investors are acquiring critical infrastructure, agricultural land and other sensitive assets in Australia. All foreign investors (both government owned and privately owned) and their potential consortium members need clear guidance from FIRB at an early stage of any significant future sale processes, including any re-run of the Ausgrid auction.
Background to Ausgrid transaction
Proposed privatisation of Ausgrid
On 24 November 2015, the New South Wales Government commenced an expressions of interest process in relation to the sale of a 50.4% lease interest in the Ausgrid business.
Ausgrid is the New South Wales state-owned electricity transmission and distribution business that supplies electricity to over 1.6 million homes and businesses in Sydney, the Central Coast and Hunter regions. Ausgrid’s network predominantly comprises:
- a sub-transmission system of 33kV, 66kV and 132kV assets;
- a high-voltage distribution system of 5kV and 11kV assets; and
- a low-voltage distribution system of 240V and 415V assets.
Like the Transgrid process before it, the State would retain the legal ownership of Ausgrid’s network assets. In the case of Ausgrid, the network assets would then be leased to an entity or entities in which the private sector bidders would hold a 50.4% equity interest.1 The State would retain a 49.6% equity interest in the lessee entity or entities. The successful bidder would therefore assume effective operational control of the Ausgrid business, subject to certain “negative control” rights retained by the State in respect of major decisions.
Ausgrid’s regulated asset base (RAB) as at 1 July 2016 was approximately $15 billion. Press speculation was that the final bids received by the State for the 50.4% interest were as high as $13 billion, valuing the 50.4% interest at a multiple of approximately 1.7 x RAB.
Who was interested in Ausgrid?
The two bidders that proceeded to the final bid stage of the Ausgrid process were:
- State Grid Corporation of China (State Grid), the Chinese state-owned enterprise and the largest electricity utility in the world; and
- Cheung Kong Infrastructure (CKI), the largest publically listed infrastructure company in Hong Kong.
Both State Grid and CKI already have significant interests in electricity and gas networks in Australia, including controlling interests in some instances. For example:
- CKI and Power Assets Holdings (PAH), an entity controlled by CKI by virtue of its 38.87% interest in PAH, collectively hold a 51% interest in the South Australian electricity distribution network, a 51% interest in the Powercor and CitiPower electricity distribution networks in Victoria and Australian Gas Networks Limited.
- State Grid holds a 46.5% interest in the South Australia electricity transmission network, 20% of AusNet Services and 60% of Jemena (Jemena is the owner of the NSW gas distribution network), 50% of the ACT gas and electricity distribution networks, the Jemena electricity distribution network in Victoria, 34% of the United Energy electricity distribution network in Victoria, and various other pipeline and network assets in Australia.
Interestingly, CKI's global portfolio includes a 40% interest in UK Power Networks, which manages three of the 14 regulated electricity distribution networks in the United Kingdom, including the London distribution network.
An indicative bid was also submitted by a consortium including China Southern Power, Qatar Investment Authority and China Investment Corporation. However, this consortium withdrew from the sale process in early April 2016.
Initial FIRB engagement
It was reported that FIRB engaged with the bidders in the last week of December 2015, advising that 100% foreign ownership of the entity or entities holding the 50.4% interest in the Ausgrid lessee would be acceptable to FIRB, provided certain conditions were met.
The conditions proposed by FIRB reportedly concerned issues of data retention, maintenance works and local governance requirements (e.g. the entity or entities holding the 50.4% interest in the Ausgrid lessee needed to have an Australian chairperson and some independent directors, with key operational and management personnel to hold certain security clearances).
Timeline for the Ausgrid privatisation
The timeline below provides an overview of the Ausgrid privatisation process:
Click here to view table.
Treasurer’s decision on Ausgrid
Preliminary view of the Treasurer
On 11 August 2016, the Treasurer published his preliminary view that the foreign investment proposals put to him by State Grid and CKI were contrary to the national interest on the grounds of national security.
The Treasurer noted that the FIRB review process had identified national security issues in relation to the critical power and communications services that Ausgrid provides to businesses and governments. The Treasurer noted that as at the date of publication of his preliminary decision, the Treasurer had not identified any suitable mitigants that would address these risks.
The bidders were then given a week to make submissions to the Treasurer ahead of his final decision.
The Treasurer’s preliminary decision was particularly criticised for his comments that national security issues had been identified in connection with certain communication services provided by Ausgrid, notwithstanding that Transgrid had a much more substantial telecommunications business yet did not create the same concerns. Due to security clearance issues, the Treasurer was unable to expand on this point (or the nature of the national security concerns more generally). It is unclear whether the full extent of these national security concerns were ever made known to the State or to the bidders.
Final decision of the Treasurer
On 19 August 2016, the Treasurer made an order under the Act prohibiting both State Grid and CKI from acquiring the 50.4% interest in the Ausgrid business.
In reaching his decision, the Treasurer determined that the acquisition of a 50.4% interest in a lessee of the Ausgrid business by either bidder would be contrary to the national interest. The Treasurer particularly noted that national security concerns were paramount in the review process and were identified in relation to both the structure of the transaction and the nature of the assets to be acquired by the successful bidder. The Treasurer also noted that the national security concerns stemmed from the nature of the Ausgrid business rather than the identity of the specific bidders.
Commentators have since tried to speculate where these national security concerns would stem from for the Ausgrid business, particularly given there were no such concerns for Transgrid. Several theories have emerged, including Ausgrid’s role with the National Broadband Network, or carrying communications cables for telecommunications providers. Others have suggested that the national security concerns may relate more to what the Ausgrid business may become (i.e. the future potential of the Ausgrid business to collect data and control and use information flows in a rapidly evolving technological environment).
While few people doubt that the Treasurer’s decision was made on the basis of carefully considered advice, and reflects a genuine national security concern, it is obviously difficult for investors to react to the decision when the cause for that concern has not been made public.
Impact of the Treasurer’s decision on Ausgrid
Although there have been strong responses to the Treasurer’s Ausgrid decision from those closely involved with the transaction, reactions from commentators have been mixed.
In some circles, commentators, including the Chinese Ministry of Commerce, have foreshadowed a severe impact on the appetite for Chinese investment into Australia, and on the willingness of Chinese firms to engage in future sale processes unless the foreign investment criteria is clear from the outset. This view appears fuelled by the apparent inconsistent messaging the bidders received from FIRB throughout the process and relatedly, the delay between the bidders’ initial engagement with FIRB and the Treasurer’s final decision.
Further, it is possible that future capital allocations will be redirected from Australia for these types of transactions in light of the apparent comfort of international regulatory authorities with the foreign ownership of power networks (noting CKI’s interests in the United Kingdom).
In other circles, the view is that while the Ausgrid decisions is frustrating for those involved in the transaction, the macro effect on the China-Australia relationship is likely to be far more muted.
Statistical data shows that Chinese investment in Australia has been growing strongly since 2005, with the second highest level of inflow of Chinese investment recorded in 2015 (behind only the mining boom peak of 2008). Although some Chinese bidders may be more reluctant to participate in privatisation processes without a clearer picture on likely FIRB attitudes, we do not see the growth trend of Chinese investment in Australia being derailed by the Treasurer’s decision on Ausgrid.
We expect there will be greater scrutiny of foreign bidders for critical infrastructure, agricultural land and other sensitive assets. Further, such scrutiny is likely to be intensified where bidders are foreign government investors, such as Chinese SOEs or entities affiliated with foreign governments.
In terms of immediate impacts, it is clear that all foreign investors (both government owned and privately owned) and their potential consortium members will require clear guidance from FIRB on likely foreign investment issues prior to participating in any significant future processes.
Key messages from the Treasurer’s decision on Ausgrid
We consider the following key messages to be important ‘take aways’ for foreign investors interested in Australian transactions following the Treasurer’s decision on Ausgrid:
- FIRB: Early engagement with FIRB is imperative to ensure clarity is obtained, to the extent possible, around the conditions FIRB are likely to impose, noting that certain conditions are becoming common requirements (e.g. Australian Tax Office approval of the bidder’s acquisition structure).
- Australian advisors: Early discussion with Australian-based advisors is essential to identifying potential issues arising from the proposed acquisition structure or consortium composition.
- Consortium members: Consideration should be given to consortium composition to minimise the likelihood of FIRB related issues arising in transactions where critical infrastructure or agricultural assets are being acquired (e.g. consideration should be given to including Australian consortium members).
- FIRB guidance: Bidders should be aware of the guidance available under Australia’s Foreign Investment Policy on the issues that should be highlighted in the FIRB submission, including national security.