- FIRB to update its policy guidelines to clarify when investments by foreign government owned investors need FIRB approval.
- Policy changes triggered following failure by State-owned airline, Etihad Airways, to seek FIRB approval to acquire 3.96% stake in Virgin Australia.
- FIRB Chairman clarifies national interest considerations for foreign government owned investors.
FIRB to update policy
Mr Brian Wilson, Chairman of the Foreign Investment Review Board (FIRB), speaking before a Senate Committee on 16 August 2012, said that FIRB will be updating its policy guidelines to clarify when investments by foreign governments and their related entities need FIRB approval.
Mr. Wilson’s comments were made in response to what FIRB believe was a misinterpretation of its foreign investment policy by Etihad Airways, the United Arab Emirates state-owned airline, in initially acquiring a 3.96% stake in Virgin Australia without obtaining FIRB approval. Etihad ultimately obtained FIRB approval to acquire a 10% stake.
What is a Direct Investment?
Under the policy, all foreign governments and their related entities must notify, and seek FIRB approval before making a ‘direct investment’ in Australia, regardless of the value of the investment.
The policy provides that, as a rule of thumb, investments of less than 10% are not generally considered a direct investment. However, an investment of less than 10% may be a direct investment where the investment has the objective of establishing a lasting interest in, and a strategic long-term relationship with, the target or where the state-owned investor can use that investment to influence or control the enterprise. FIRB also considers there to be certain investments below 10% to be ‘deemed’ direct investments, being: investments preparatory to a takeover bid; contractual arrangements such as offtake agreements, preferential, special or veto voting rights; the ability to appoint directors; or enforcing a security interest over a business’ assets or shares.
A direct investment can be distinguished from a pure ‘portfolio investment’ which, based on our experience with FIRB, falls outside the scope of a direct investment and does not need FIRB approval.
So what is a portfolio investment? Although the term is not defined anywhere in the policy, if an investment is less than 10% and not otherwise a direct investment (based on the tests referred to above), then it is common practice to view the investment as a portfolio investment.
FIRB’s views following Etihad / Virgin
In a rather strange admission of the apparent inadequacies of its own policy, Mr Jim Murphy (Executive Director, Markets Group, Treasury) has told the Senate Committee that ‘the policy is a little unclear in terms of direct and portfolio investment’.
Whilst Mr. Murphy did not elaborate as to why the policy is unclear, Mr. Murphy did say in relation to the Etihad case, ‘I think Virgin were mistaken. They characterised the initial five per cent investment as a portfolio investment not as a direct investment’.
The FIRB Chairman, Mr. Wilson, shed a bit more light on the issue by suggesting that Etihad may have taken the view that its initial stake was not a direct investment as it was below 10% and did not ‘establish’ a strategic long-term relationship with Virgin, as Etihad already had a 10 year strategic relationship with Virgin through a codeshare agreement it signed with Virgin in 2010.
So was Etihad’s initial investment a direct investment or a portfolio investment? It seems that, in FIRB’s eyes, the investment was a direct investment, prompting Mr. Wilson to foreshadow changes to its policy to ensure that it ‘cannot be misinterpreted’.
Presumably FIRB viewed Etihad’s initial investment (albeit below 10%) as a direct investment on the basis that it further strengthened the existing strategic relationship it had with Virgin, and was therefore not akin to a portfolio investment.
Whilst it is not entirely clear what changes FIRB will make to its policy, comments made by Mr. Murphy that ‘[FIRB] are now trying to explain to everyone that if they are a state owned enterprise they should notify FIRB of any investment in Australian entities’ has shed some doubt as to whether the portfolio investment exception will still have any relevance.
It would indeed be an unexpected and extreme reaction if FIRB were to make the portfolio investment exception redundant, as this would effectively result in an anomalous situation where a state owned investor would, in theory, have to make a FIRB application to acquire only one share in a listed Australian entity. It would also result in FIRB becoming inundated with applications which have no relevance to Australia’s national interest – a burden surely FIRB would not want.
National interest considerations
Mr. Wilson has been recently quoted as saying that ‘investment decisions should be made by investors on a purely stand alone commercial basis and that Australian businesses ….. should be run on a purely commercial basis and not as an extension of the policy, political or economic agenda of a foreign government’.
This is not really a new concept as the policy has said for over two years now that ‘The government considers the extent to which the investor operates on a transparent commercial basis and is subject to adequate and transparent regulation and supervision’.
Mr. Wilson indicated that FIRB would be concerned that foreign governments could distort markets if they made investment decisions on a non-commercial basis. These comments should not pose any concern for state-owned enterprises that can show they operate as separate stand-alone business unit, with commercial objectives separate from their foreign government owner. This will likely be the case where the state-owned investor’s decision to make the relevant investment has been led by a professional management team without intervention by the relevant government and where the transaction has been negotiated on commercial arms-length terms.
The FIRB Chairman highlighted the five broad categories FIRB considers when analysing whether a transaction is contrary to Australia’s national interest, being: the impact on the economy; national security; competition; compliance with Australian laws; and the character, nature and reputation of the investor.
Whilst these factors give some guidance to investors, Mr. Wilson then went on to reinforce the inherit opaqueness of the national interest test by saying, ‘I suppose [the national interest] is one of those things where you know it when you see it’.
Mr. Wilson also clarified that FIRB has the power to impose conditions on investors to address national interest concerns. We have seen this occur in several transactions involving state owned investors over the past few years including the recent merger by Yancoal Australia (owned by Yanzhou Coal) with Gloucester Coal Limited where FIRB required the merged business to continue its production and supply arrangements on a commercial basis and remain headquartered in Australia.
Interestingly, Mr. Wilson did flag to the Senate Committee that FIRB could impose a condition requiring an investor bring in a ‘commercial partner’ to ensure the business acquired is operated on a commercial basis. The closest we have seen FIRB coming to imposing this type of condition was when it required Yanzhou Coal to sell down its interest in Yancoal Australia to 70% as part of its acquisition of Felix Resources in 2009. However, bringing in a commercial partner goes beyond a general sell-down requirement, as it targets a particular type of investor being brought in to ensure the business is operated on a commercial basis. It remains to be seen how this condition could work in practice.
Where to now?
State owned investors should await the policy changes that FIRB has foreshadowed with interest.
Hopefully whatever changes FIRB do make to the policy ensure that its intended application is clearly expressed, so that more certainty is provided to state owned investors.
David Campbell, Graduate.