This article was co-authored with Nancy Zheng.
On 5 June 2020 the Australian Treasurer announced comprehensive reforms to Australia’s foreign investment framework, marking the most extensive changes since the legislation was overhauled in 2015. See our earlier market update where we commented on the proposed changes.
The changes have been motivated, in part, to address perceived limitations in the rights and remedies available under the existing foreign investment regime to manage national security concerns.
While not framed explicitly in these terms, the changes are proposed at a time of clear sharpening of Australia’s relationship with China and may raise specific issues for Chinese investors. Tranche 1 of the exposure draft legislation proposes to introduce a number of new measures into the Australian foreign investment framework.
In this update we look at some of the more material changes in Tranche 1, in particular where the exposure legislation provides more colour on the Government’s position beyond what was previously announced in June.
A new “national security” test
The reforms prescribe a new “notifiable national security action”, which applies regardless of the value of the investment (ie. the existing value thresholds do not apply). This requires a foreign person to notify the Treasurer prior to taking an action to start or acquire a direct interest in a national security business; or to acquire an interest in national security land.
We know from the draft bill that critical infrastructure assets1, businesses that develop, manufacture or supply critical goods or technology that are for, or intended for, military end-use, critical defence services and defence information providers are all potentially captured by this proposed new notification requirement.
However, as to what’s a “critical” asset, service or good, one needs to peruse the Defence and Strategic Goods List for guidance, but it’s a non-exhaustive list and a somewhat imperfect system. Perhaps by design, this will force applications to be made where there is doubt.
Consider the acquisition of a magnesium mine or processing plant. Magnesium is used in the production of spacecraft, military aircraft and missiles, which would like be “critical” assets causing national security concerns, but it’s also used in car seats and wheels, laptops, power tools and steel. Would such an acquisition be a “notifiable national security action”? Clearly the devil is in the detail. Does this mean we will see fewer unconditional hostile bids in marginally sensitive sectors as bidders will need to first engage with a target to understand whether notification is required, thereby losing the element of surprise.
Under the new regime, foreign investors will need to consider whether a particular target business warrants notification based on the existing monetary and interest thresholds, as well as whether the proposed investment may give rise to a notifiable national security action.
With some fail-safe powers
The reforms give the Treasurer new “call in” and “last resort” powers; essentially allowing the Treasurer to review transactions, previously outside its scope, based on national security concerns. The draft bill and explanatory memorandum provide some additional colour in relation to these powers.
The call-in power will operate to capture investment proposals that may pose a national security risk but which have not been notified to, and approved by, the Treasurer. The power can only be used on actions that are taken or proposed to be taken after 1 January 2021 (ie. it doesn’t have retrospective effect). The call in power is intended to cover a broad range of actions which may give a foreign person potential influence or rights over Australian business/land and pose a national security risk. It captures some arrangements that would not currently fall within the purview of the FIRB notification requirements, for instance, significant agreements which give foreign persons rights over the assets of an Australian business.
It’s currently unclear in respect of what type of transactions the Treasurer contemplates using this power, what would be considered a “national security concern” or the extent to which the Treasurer needs to outline his concerns when exercising the power. The Government has noted that it expects that the overwhelming majority of investments will not be called in for review. How much comfort can be taken from this statement remains to be seen.
The last chance saloon
As anticipated in our last update, the last resort power gives the Treasurer the ability to review and impose conditions, vary existing conditions or, as a last resort, force the divestment of any realised investment, where new national security concerns have arisen in relation to an action previously reviewed by the Treasurer. Given the potential draconian nature of this power, there is at least a long list of proposed requirements that must be met by the Treasurer when using this power.
Notwithstanding this, the power can be triggered by a material change in the business, structure, organisation, activities or market – regardless of when the change occurs. This will give the Treasurer wide powers to manage foreign ownership of Australian assets. It also exposes investors to changes in foreign policy or domestic political concerns about foreign ownership by entities or individuals associated with specific countries.
In our view the proposed changes have the potential to affect capital flows, particularly in sectors such as energy and infrastructure, where a significant portion of capital for Australian energy comes from state owned or managed funds.
It will be particularly interesting to see the impact this power may have on investment in the tech and biotech sectors. It isn’t hard to envisage a scenario where a foreign investor seeds an Australian company to develop a highly speculative communications technology or broad super-bug antibacterial agent. If the company succeeds, does the technology or discovery create national security concerns in the hands of foreign ownership? With or without an application having been made at the time of investment, it seems the investment may not be secure. It’s also difficult to see how a foreign investor could future proof itself against this risk; and this significant uncertainty will diminish any potential upside that warrants making the investment in the first place. We wonder whether this may jeopardise important funding sources for Australia’s high-tech sectors.
This tiger has some teeth
Currently, the only existing mechanisms for penalising breaches of the FATA for investments outside of residential real estate is to initiate Court proceedings to impose civil or criminal penalties. The amendments will provide the Treasurer with the ability to revoke or alter no objection notifications or exemptions and issue directions to cure a contravention. Criminal and financial penalties for contravention of certain criminal offences and civil penalties have also been increased. In some instances financial penalties have been increased by a factor of 10. Furthermore, potential imprisonment terms have increased from 3 to 10 years.
Other notable changes
- A new register of foreign investments: the Government will maintain a non-public register of foreign interests in registrable land, being an exploration tenement (for mining, oil or gas), a registrable water entitlement or a contractual water right.
- Notification required where a foreign person’s non-participation in a share buy-back or capital reduction increases their interest: the draft bill clarifies that the action of “not participating in a share buyback” referred to in the existing legislation is an “acquisition of an interest in a security of an entity” where the foreign person’s percentage shareholding increases. The draft bill recognises that it may be impractical for the foreign person to provide advance notice to the Treasurer and permits notice within 30 days of the action. It’s unclear if a foreign person could be required to sell down any such increase where a notification is not made.
- Protected information may be shared with foreign governments for the purposes of national security, when it is not contrary to the national interest and when there is an information sharing agreement in place between the country governments.
Do you have any questions or concerns?
The Tranche 1 exposure draft legislation is open for consultation until 31 August 2020 and is scheduled to come into effect from 1 January 2021.
If you have any queries or concerns in relation to the proposed reforms and how they may affect your business or foreign investment in Australia more generally, please don’t hesitate to contact us to discuss.
We will provide further updates on the foreign investment reforms once the Tranche 2 changes are published, which is intended to occur in September.