Following years of negotiation, speculation has been building that Prime Minister Abbott and President Xi are likely to shake hands on a free trade agreement (FTA) after President Xi addresses a joint sitting of Federal Parliament next Monday.
Australia has participated in FTAs with the United States of America and New Zealand for a number of years, and more recently with Japan and South Korea.
The signing of an FTA with China will present unique opportunities for both countries. One of the opportunities anticipated for Australia is the relaxation of the rules around in-bound investments by Chinese investors, specifically by Chinese state-owned enterprises (SOE) which make up the overwhelming majority of in-bound Chinese investments. In-bound investments under Australia's already existing free trade agreement which are less than AUD$1.08 billion are not subject to notification to and approval from the Foreign Investment Review Board (FIRB).
In this Alert, Senior Associate Lea Fua discusses recent trends relating to inbound investments into Australia by Chinese investors. Chinese government officials have publicly stated that they would like to see as part of the FTA negotiations the removal of the requirement that all investments by Chinese SOEs receive prior FIRB approval. This alert will briefly identify some of the suggestions in a recent report by the Business Council of Australia (BCA) of ways in which the investments of SOEs in Australia can be treated.
Current regulatory regime in relation to inbound SOE investments
The current regulatory regime in Australia requires all in-bound investments by foreign SOEs to be notified to the FIRB. There are limited exceptions to this general rule such as an investment of less than 10% (referred to in FIRB’s policy as a direct investment). While the regime applies to all investments by foreign SOEs regardless of country of origin, it is believed that there is a perception in China that Australia’s investment regime regarding SOEs is primarily targeted at Chinese SOEs. This regulatory compliance not only applies to Chinese SOEs but also to Australian companies where Chinese SOEs control at least 15% of the voting shares as such companies will be deemed to be SOEs under the FIRBs foreign investment policy. This primarily impacts on the Australian entity’s ability to acquire assets in Australia (which will require prior approval from FIRB).
Chinese leaders have publicly stated that they would like to see under an Australia/China FTA that all Chinese SOE investment be subject to the same FIRB approval requirements as private foreign investors.
Outbound Chinese investments
The following trends are noteworthy in relation to outbound Chinese investments into Australia:
- In 2013, Australia attracted 8% of Chinese accumulated global outbound direct investment (down from 12% in 2012);
- At the end of 2013, China is Australia’s sixth largest foreign investor with an accumulated USD $58.8 billion in investments from 2007 to 2013;
- Of the total investments of USD $58.8 billion from Chinese investments in that period, 89% of the investments came from Chinese SOEs;
- There is a growing trend for Chinese SOEs to implement a clearer separation of government from enterprises, the intention being a shift away from the current state-owned asset management system to a model management system similar to that employed by the Singaporean sovereign wealth fund, Temasek;
- In April 2014, the National Development and Reform Commission in China released the “Administrative Measures on the Approval and Registration of Outbound Investment Projects”. In this document the NDRC announced that overseas projects below USD $1 billion will only be required to register with the NDRC or local government agencies in charge of overseas investment, while overseas investments greater than USD $1 billion will still need approval from the NDRC;
- Previously, any Chinese company wishing to invest greater than USD $300 million in overseas natural resources sector or greater than in USD $100 million in other overseas sectors were required to obtain approval from the NDRC.
While there has been a drop in Australia’s overall proportion of Chinese accumulated global outbound direct investment, this does not detract from the overall trend that Chinese investment in Australia, especially by Chinese SOEs will continue to grow. The signing of the Australia/China FTA would also likely impact on the levels of such investments.
The increasing trend in China towards separation of government from enterprises in respect of certain Chinese SOEs should also be reflected in the compliance requirements for in-bound investments in Australia by Chinese SOEs which can prove that they are run on a commercial basis and independent of the government despite their designation as a SOE. It is anticipated that this trend will be reflected in the Australia/China FTA.
Options proposed by the BCA
In its discussion paper titled “Discussion Paper on Foreign Investment and State-owned Enterprises” released in August 2014, the BCA put forward a number of options for dealing with inbound foreign investments by Chinese SOEs. The BCA discussion paper arose as a result of the joint report by KPMG and the University of Sydney titled “Demystifying SOE Investment in Australia” and also released in August 2014.
In its paper, the BCA looked at the issues around the regulation of foreign direct investment into Australia by foreign SOEs and proposed the following models as options to liberalise the regulatory environment surrounding investment:
- Domestic Regulation Model: Remove the FIRB screening regime and strengthen domestic laws to ensure SOE’s operating in Australia behave like private enterprises.
- FTA Model: Provide SOEs with the same treatment as foreign private investors under a free trade agreement. The FIRB screening threshold would be raised to $1.078 billion.
- Private enterprise model: Provide SOEs with the same treatment as foreign private investors and raise the threshold for SOEs to the existing general threshold for private enterprise of $248 million.
- Historical accreditation Model: Establish an accreditation scheme that operates in parallel with current FIRB processes, and provide SOE’s who have a proven track record of investing in Australia with the same investment thresholds afforded to foreign private enterprises at $248 million.
- Operational accreditation model: Establish an accreditation scheme that operates in parallel with current FIRB processes, and assess SOEs against operational criteria guided by standards expected of private enterprises operating in Australia. Once awarded accreditation, the SOE would be afforded the same threshold as a foreign private enterprise ($248 million).
- Minimalist model: Raise FIRB’s screening threshold for SOE’s by a small amount ($54 million). The amount reflects the same screening investor threshold for foreign commercial real estate by a foreign private individual investor.
- Existing model: Maintain the status quo. Screen all SOE investments.
While the Federal Government has not formally released any details of the upcoming Australia/China FTA, according to recent media reports:
There is likely to be a change to the treatment of in-bound investments by Chinese SOEs;
- Certain sectors in Australia such as agriculture are set to gain from the proposed FTA.
Based on recent media statements from Prime Minister Abbott and Trade Minister Robb, it appears likely that the treatment of in-bound investments by Chinese investors and more critically by Chinese SOEs will change. While the details are at this stage unknown, it is likely that the change may include elements of one or more of the options which the BCA has recommended. In particular, it will be noteworthy how the Australia/China FTA will treat Chinese SOEs that operate on a commercial basis with little involvement by the state in their operations other than as a shareholder. In our view, this will be critical given that in-bound investments by Chinese SOEs make up the bulk of Chinese investments in Australia.
With the increased speculation that the Australia/China FTA will be agreed and announced on Monday 17 November following the address by Chinese President Xi to the joint sitting of Federal Parliament, we will closely monitor any developments and provide further analysis and comments in relation to an announcement.