Introduction & Background
On Friday, December 7, 2012, the Canadian government (the “Government”) issued determinations under the Investment Canada Act (the “Act”), approving acquisitions by foreign state-owned enterprises ("SOEs") of two companies with significant operations in the Canadian oil sands1. The approvals of the C$15 billion acquisition of Nexen Inc. (“Nexen”) by the China National Offshore Oil Corporation Ltd. (“CNOOC”) and the C$5 billion acquisition of Progress Energy (“Progress”) by Malaysia’s Petronas, were coupled with a clear message that further SOE takeovers of Canadian oil sands business would be curtailed. Simultaneous with the announcement of its approval of the two transactions, the Government issued: (1) revised guidelines for acquisitions by non-Canadian SOEs, which would subject such SOE investments to greater scrutiny going forward; and (2) a policy statement that limits SOE acquisitions of control of Canadian oil sands businesses to “exceptional circumstances” only.
Past Canadian Approach to SOE Investments
In 2007, following a series of high profile acquisitions by the Abu Dhabi National Energy Company, the Government published special guidelines to inform investors of policies that would be applied to proposed investments by SOEs (the "SOE Guidelines"). In a nutshell, the SOE Guidelines require the Minister of Industry (the “Minister”) to consider whether the SOE will act in accordance with Canadian corporate standards and operate in a commercial manner as part of the Government’s “net benefit” review of the transaction. The SOE Guidelines were subsequently applied in a number of energy transactions with SOE buyers, including the Korea National Oil Company, Sinopec, and, in 2011, CNOOC (in its C$2.1 billion acquisition of OPTI Canada.
It is also noteworthy that in the last two years, the Canadian Government courted Chinese oil sands investment, particularly in early 2012 after the United States rejected the proposed Keystone Pipeline, which would have brought oil from Alberta to US markets. In February 2012, Prime Minister Harper visited China with the express purpose of seeking further Chinese investment in the oil sands.2
Background: The Investment Canada Act
Under the Act, acquisitions by non-Canadians of Canadian businesses that exceed prescribed asset values3 must be approved by the Minister in the form of a Ministerial determination that the investment will be of “net benefit” to Canada. The Ministerial review is conducted during a statutory waiting period of 45 days, subject to extension. The “net benefit” determination is based on a series of economic and social criteria enumerated in the Act, including effects on the level and nature of economic activity in Canada, employment, Canadian participation in the Canadian business, competition and compatibility with government policy objectives. The deadline for review of the Nexen transaction was extended twice, a rare occurrence, while the Petronas bid was, in fact, rejected on an interim basis after the expiry of the initial waiting period and a unilateral extension by the Minister.
In order to receive a determination of net benefit under the Act, foreign investors typically provide the Minister with binding contractual undertakings that may require, among other things, maintaining Canadian employment levels and Canadian participation in management and the Board of Directors, and a prescribed quantum of capital expenditures in Canada.
Over 1,600 foreign acquisitions have been reviewed under the “net benefit” test since the Act came into force in 1985. Since that time, the Minister blocked only two acquisitions, including the 2010 high profile bid by BHP Billiton to acquire the Potash Corporation of Saskatchewan.
In 2010, a stand-alone national security test was introduced to the Act, allowing for Government review of investments that may be “injurious” to national security. To date, however, with the possible exception of one transaction, no investments have been blocked on the basis of national security.
Review of the CNOOC/Nexen and Petronas/Progress Transactions
The prelude to the Government’s announcements of December 7, 2012 was the C$5 billion bid by Malaysian SOE Petronas for Progress. This was followed in July by CNOOC’s C$15.1 billion bid for Nexen, one of Canada’s largest oil sands companies, representing the largest ever overseas acquisition by a Chinese company. Given its unprecedented size, the Nexen acquisition generated significant attention in Canada and the United States4, and forced the Canadian Government to steer a course between addressing public sentiment about investment by SOEs and its desire to promote foreign investment in Canadian oil and gas.
The Petronas bid, however, maintained a low profile until October 19, 2012, when the Minister issued an interim determination rejecting the bid, but giving Petronas 30 days to make further submissions to change the Minister’s mind. Petronas subsequently elected to undertake further negotiations with the Minister to secure approval.
On December 7, the Minister announced that both CNOOC and Petronas provided undertakings sufficient to satisfy him that the investments would be of net benefit to Canada. While Petronas has not announced the undertakings it provided, they are likely proportionate in scope to those provided by CNOOC based on the size of the transaction.
The types of undertakings agreed to by CNOOC are representative of those given by foreign investors in significant transactions. Specifically, CNOOC undertook to establish the head office of its North and Central American operations in Calgary, Alberta, retain Nexen’s current management team and employees, list its shares on the Toronto Stock Exchange, build upon Nexen’s community and charitable programs, and contribute to oil sands research.
Revised Guidelines for Investment by SOEs and the New Oil Sands Policy
Concurrently with its approvals of the CNOOC/Nexen and Petronas/Progress transactions, the Government announced revised SOE Guidelines5 and released a policy statement announcing that investments by foreign SOEs in the oil sands would be significantly restricted. In rationalizing the approval of two SOE oil sands investments while limiting similar investments in the future, Prime Minister Stephen Harper described the situation as “the end of a trend.”
The Revisions to the SOE Guidelines
As noted above, the SOE Guidelines were introduced in 2007. Although not having the force of law, the SOE Guidelines explained how the Minister would conduct a “net benefit” review where foreign investors are SOEs. They provided a definition of what constituted an “SOE”, how the Minister would consider the SOE investor’s governance and reporting structures, the plans of the SOE-investor for the Canadian business being acquired and the types of undertakings the Minister might accept to reach a “net benefit” determination.
The new changes to the SOE Guidelines introduced on December 7, 2012 add some further specifics reflective of a more aggressive approach to SOE investments. However, the basic approach outlined in the old Guidelines was left largely intact. For example, in the paragraph describing the approach to be taken for a particular SOE’s governance, the revised Guidelines specify that SOEs will be expected to “address in their plans and undertakings” their non-susceptibility to state influence. The amendments also specify that the burden of proof to obtain approval under the net benefit test rests with the foreign investor. In assessing governance, the amended Guidelines indicate that an SOE’s adherence to free market principles and whether it will likely operate on a commercial basis will be considered in the Ministerial review. In assessing whether the target will operate on a commercial basis, the Minister will also have regard to the impact of the investment on productivity and industrial efficiency in Canada.
The amendments in the Guidelines significantly expand the definition of the term “SOE” to include enterprises that are directly or indirectly “influenced” by a foreign government. Previously, the definition captured only enterprises directly or indirectly owned or controlled by a foreign government.
The New Policy Statement: Designating the Oil Sands a New “Strategic” Resource
In its policy statement regarding SOE investments in the Canadian oil sands6, the Government indicated that, going forward, such investments would proceed on “an exceptional basis only.” While the policy statement indicates that each transaction will be “examined on its own merits,” the Minister will generally not find that a foreign SOE acquisition of a Canadian oil sands business is of net benefit. The statement also identifies the rationale for the restrictions imposed on foreign SOEs: the potential undermining of private sector orientation and the potential of an inordinate amount of foreign state influence in the sector. By designating the oil sands as a semi-protected Canadian sector, it joins other protected sectors subject to different regulatory processes and tests, such as Canadian cultural businesses.
In conformity with the stated approach to SOE investments, the policy statement suggests the Government will introduce amendments to the Act. These amendments would subject investments by SOEs to review based on a target asset threshold of C$330 million, notwithstanding the planned adoption of a more liberal C$1 billion enterprise value threshold for the review of investments by non-SOE investors.
The Ministerial approvals of the two transactions were not particularly surprising. Having approved prior oil and gas acquisitions by CNOOC as recently as a year ago under the same rules, it would have been difficult to block the Nexen acquisition despite public concerns about investment by Chinese SOEs. With respect to Petronas, the assets in question were relatively minor in comparison, and the interim decision to block the transaction may have been the result of a negotiation tactic.
In releasing its revised SOE Guidelines and policy statement, however, the Government has fired “a shot across the bow” with respect to SOEs generally. The policy statement was expressly intended to discourage, but not outright prohibit, SOEs from contemplating investments in the oil sands beyond toehold interests or joint ventures. The changes to the SOE Guidelines also mean that SOEs seeking to acquire Canadian businesses in other sectors may face an uphill battle, as the Government’s expectations for commitments and compliance will be very high.
It is also worth noting that the amended SOE Guidelines also classify entities that are “influenced” by governments as SOEs, subjecting companies with strong government links to additional scrutiny. Given the concern about certain Canadian investments by Huawei, a non-SOE Chinese company which has been the subject of some notoriety over alleged ties to the Chinese government, this provision was clearly intended to permit the Canadian government to subject investments by such companies to the review standard expected of SOEs.
There are also some technical observations on the changes, including:
- the vague nature of the “exceptional basis” exception to the new SOE/oil sands policy;
- the impact of the new SOE Guidelines upon proposed SOE investments in other sectors, notably mining;
- perceived discrimination against Chinese SOEs (as opposed to SOEs from India and Korea, for example) by virtue of the new Guidelines’ additional focus on “free enterprise” compatibility, and whether this is a useful distinction in a foreign investment review context; and
- uncertainty about the scope of the SOE “definition” and circumstances in which the lower asset value review threshold would apply.
In our view, the new policy achieves a short-term solution to a political problem triggered by the Nexen acquisition – namely, that a significant number of Canadians (and part of the Government’s own caucus) are uncomfortable with increasing levels of foreign state control of Canadian assets. SOEs seeking to invest in Canadian oil sands businesses now find themselves having to consider non-controlling stakes or joint ventures in lieu of outright takeovers – and it is conceivable that caution may need to be exercised in other contexts as well. However, the Canadian government maintains that the door is not firmly shut to all forms of SOE investment.7
In conclusion, the result of the CNOOC and Petronas reviews is positive, but the content of the new SOE Guidelines and policy statement is controversial and may cause SOE investors to review their ability to navigate the Act’s review process in the context of further Canadian acquisitions.