This article was first published in the Australian Private Equity & Venture Capital Journal on May 7, 2020.
Temporary changes to Australia’s foreign investment approval regime will affect deal-making for local private equity firms. Firms with significant overseas investment in their funds are often regarded as foreign investors. With all deals by foreign investors now coming under the scrutiny of the Foreign Investment Review Board, these firms are advised to prepare in advance of deals emerging.
What changes have been made?
As part of the Federal Government’s response to the COVID-19 pandemic, the federal government recently announced temporary changes to Australia’s foreign investment regime. The main change is reducing the monetary screening thresholds to nil for any transactions which are classified as ‘significant actions’ or ‘notifiable actions’ for the purposes of the Foreign Investments and Takeovers Act 1975 (Cth) (the Act) – the main pillar of Australia’s foreign investment regime. Relevant monetary screening thresholds prior to the recent changes were set at:
- $1,192 million for acquisitions in non-sensitive businesses by foreign investors from free trade agreement partner countries such as the US, China and New Zealand; and
- $275 million for acquisitions in non-sensitive businesses for other foreign investors,
except for acquisitions in the media or agribusiness sectors and acquisitions involving interests in land where lower thresholds apply.
These temporary changes were announced and effective from 29 March 2020 and are explained in detail in a guidance note (Guidance Note No. 53) issued by the Foreign Investment Review Board (FIRB) on 24 April 2020. The Foreign Acquisitions and Takeovers Amendment (Threshold Test) Regulations 2020 introduced these temporary changes. In this article, we discuss some of the changes of particular relevance to acquisitions of Australian businesses or companies by private equity (PE) funds.
Why were these changes introduced?
FIRB explained the rationale for the changes as follows: “Australia is being fundamentally disrupted by the coronavirus, including potentially threatening economic security and the viability of critical sectors. Businesses are increasingly under pressure. There will likely be a rise in debt restructuring transactions for Australian businesses, along with opportunities to invest in distressed assets. Without these changes, it is possible many normally viable Australian businesses would be sold to foreign interests without any government oversight, presenting risks to the national interest.”
The tightening of the FIRB process will allow the Australian government to oversee all foreign investment in Australia while the impact of the coronavirus on Australian businesses plays out and allow it to prioritise foreign investment which supports Australian jobs and businesses.
What is the main impact of these changes?
These changes will mean the Australian government will, for the foreseeable future, treat all foreign investors as ‘foreign government investors’ (FGIs). Prior to these changes being introduced, all FGIs (including some PE funds with significant offshore government and government employee pension fund investors) were already subject to a $0 monetary screening threshold.
While the temporary measures are in effect, a large number of transactions by ‘foreign persons’ (including many PE funds in the mid-market or below) which previously would not have required notification to FIRB because they fell below the monetary screening thresholds, will now require notification to and approval of the Australian Treasurer before those acquisitions are undertaken, regardless of the monetary value of the investment.
As a result of these changes and the additional scrutiny of inbound foreign investment into Australia, there will be a significant influx of first-time applicants to FIRB that (until recently) have only made investments which fall below the relevant thresholds. This expected surge in applications explains why FIRB also decided to extend its approval processing times from 30 days to up to six months for applications involving notifiable actions.
In Guidance Note No. 53, FIRB announced that the Treasury and the Australian Taxation Office (ATO) will triage cases using a risk-based approach and have taken on additional staff to help manage the additional workload. FIRB have also advised that “priority will be given to processing application for investments that protect and support Australian businesses and Australian jobs. In particular, the potential impact on the community and employment will be considered when screening applications.”
When is a PE fund deemed a ‘foreign person’?
The term ‘foreign person’ is central to Australia’s foreign investment regime as, under the Act, FIRB is only required to be notified of any actions taken or proposing to be taken by foreign persons.
Broadly speaking, a PE fund would be classified as a foreign person if either:
a) A limited partner in the fund, together with its associates are foreign companies or foreign trustee entities hold 20 per cent or more of the total interest in the partnership (a substantial interest); or
b) Two or more of its limited partners, together with their associates are foreign companies or foreign trustee entities that hold an aggregate interest of 40 per cent or more in the partnership (an aggregate substantial interest).
The above is sometimes referred to as the 20/40 rule and applies to not only interests in limited partnerships, but also through shareholdings in foreign corporations or through beneficial interests in the income or property of a trust.
To consider whether a foreign person requires FIRB approval, there are tracing of interests provisions in the Act which have the effect that a foreign person classification of an entity is determined by the status of the ultimate legal and beneficial interest holders of that particular entity.
If a PE fund is not deemed to be a foreign person then they will not be impacted by these changes as only foreign persons are captured by the Act.
How will these changes impact PE funds which are deemed ‘foreign persons’?
The extent to which any PE fund is affected by the changes will ultimately depend on whether the fund is also deemed to be an FGI for the purposes of the Act and whether they hold a valid Business Exemption Certificate (Business EC).
As it is common for PE funds to raise a substantial portion of their funds offshore including from foreign governments, government employee pension funds or sovereign wealth funds, many PE funds operating in Australia as well as offshore managed funds are deemed to be an FGI for the purposes of Australia’s foreign investment regime and therefore already subject to the same level of scrutiny. Any potential investments made by a fund deemed to be an FGI already required FIRB approval prior to the recent changes and FIRB approval will continue to be required unless the investment is covered by a Business EC held by the fund – as detailed below.
The only significant change for funds that are deemed to be FGIs is that the time it will take to obtain FIRB’s approval to an investment could take up to six months as compared to the previous usual one- to two-month timeframe. This could put such funds at a competitive disadvantage to other bidders if an investment opportunity was hotly contested and a quick deal was a key criterion.
The impact on all other PE funds (i.e. those that are deemed to be foreign persons but are not classified as an FGI) is that they will now be required to notify and seek approval of the Australian Treasurer before those acquisitions are undertaken, irrespective of the monetary value of the investment. However, this will not be the case if the fund has obtained a Business EC issued by FIRB prior to 10:30 pm AEDT on 29 March 2020 and the acquisition falls within the ambit of investments permitted by the Business EC.
Business Exemption Certificates – a competitive edge?
To the extent that any proposed acquisitions to be made by a PE fund fall within the scope of an existing Business EC held by that fund, then the changes to Australia’s foreign investment regime will not only not impact those funds, but is likely to give those funds a competitive edge over competitors. Not only would any offer the fund makes not need to be subject to a FIRB approval condition but they would be in a position to move quickly to complete a transaction without a delay of up to six months faced by bidders requiring FIRB approval. In a competitive process for a distressed business where an administrator is seeking a quick sale to preserve value, this could be a critical factor.
Overview of Business Exemption Certificates
The Foreign Acquisition and Takeovers Regulations 2015 (the Regulations) sets out a number of exemptions, including those related to acquisitions of interests in businesses or land, where FIRB approval is not required for specific acquisitions by foreign investors. The Regulations were amended in July 2017 for the purposes of introducing a new general Business EC for programs of acquisitions of interests in the assets of an Australian business and / or securities in an Australian entity.
As stated above, many PE funds (even locally managed PE funds) are deemed to be FGIs because of the extent of interests in the fund held directly or indirectly by foreign government entities, sovereign wealth funds or government employee pension funds. Under Australia’s foreign investment regime, all notifiable investments by those funds in Australia including bolt-on acquisitions by their portfolio companies in Australia, require FIRB approval regardless of value. This has meant that FIRB’s resources have been tied up reviewing a high volume of investments that are routinely low risk.
Business ECs were introduced by FIRB for the purposes of minimising the regulatory burden of foreign investment screening that would typically be required for such investments. Business ECs allow foreign persons (including FGIs, such as certain PE funds) to undertake multiple acquisitions of Australian businesses and securities in Australian entities without having to obtain separate approvals from FIRB for each transaction. Although Section 42 of the Regulations – which gives the Treasurer powers to grant a Business EC – is intentionally broad, the more specific an applicant looking to obtain a Business EC can be in terms of the nature and scale of the intended acquisitions (including target businesses or industries) and duration, the more likely the Treasurer will grant a Business EC.
Applications for Business ECs are considered by FIRB on a case-by-case basis, but are perfectly suited to PE funds, particularly those looking to make low risk investments. The Business EC is also suited to funds and other investors who may not have exact target acquisitions in mind when they seek FIRB approval though intend to make a number of investments in sectors or industries that are typically not considered “sensitive” from a national interest perspective.
Conditions attached to Business ECs
Typically, Business ECs are granted subject to a number of conditions which include conditions regarding the target business proposed to be acquired and a financial limit on the value of exempt investments permitted without notification to FIRB for the duration of the Business EC. If conditions of the Business EC are not met and a notification is not made, the Treasurer has the power to issue divestment orders or impose conditions on acquisitions made under the Business EC.
Other examples of conditions typically imposed include specific exclusions of target businesses that provide services to the Commonwealth or a State government and which provide access to bulk holdings of sensitive government data or businesses which provide services to the Australian Department of Defence.
Even PE funds holding Business ECs may be impacted to some extent by the changes. FIRB’s latest Guidance Note No. 53 on the temporary measures, makes specific reference to Business ECs which impose a financial limit on the value of all investments exempt from the need for approval under the Business EC. As a result of the temporary changes, certain acquisitions may now give rise to significant and/or notifiable actions where this would not have previously been the case. Such acquisitions may be covered by Business ECs that are already held by a PE fund and, where this occurs, those acquisitions may now be taken into account in determining whether the holder of the Business EC has exceeded the financial limit specified in their Business EC. Prior to making any future acquisitions, funds with a Business EC in place should carefully assess whether any financial limits or other conditions on their Business EC are impacted by the temporary changes referred to in Guidance Note No. 53.
Who can apply?
Any foreign persons can apply for a Business EC, however they are intended for entities who have a good track record of compliance in Australia (including tax and company laws as well as foreign investment laws).
Transactions which may be covered
There is no limit on the types of acquisitions that can be covered by the Business ECs but they are intended to only cover transactions that are unlikely to raise significant national interest issues. Business ECs will typically exclude any investments in ‘sensitive businesses’ such as defence, media, telecommunications, transport and critical infrastructure etc.
Any PE fund that holds a Business EC must consider before making an investment whether the proposed investment comes within the ambit of its exemption and whether the target business satisfies relevant conditions of its Business EC. If not, and the investment is notifiable by virtue of the new $0 monetary threshold, the PE fund would need to provide notice to and obtain clearance from FIRB.
Duration of Business EC
Although the preferred duration of the Business EC can be specified in an application to obtain one, most Business ECs remain valid for anywhere between 12 months and five years from the date of issue. FIRB has noted that it will only consider granting Business ECs with duration of five years or more in special circumstances. As a rule of thumb, FIRBs guidance is that the longer the duration of a Business EC, the more likely the Business EC will be restricted to extremely low risk transactions.
Application timeframe and fee
FIRB advises that the usual processing times to apply for a Business EC is the same as for general applications of notifiable actions. This means applications for Business ECs made after 29 March 2020 my take up to six months.
Consistent with FIRB’s previous timeframes, factors that may delay the application process include where applicants pay the incorrect fee or do not include sufficient information in their application. The applicable FIRB application fee for applying for a new Business EC is currently $36,200. Taking into account that the Business EC may last several years and cover multiple investments and that the fee payable for most FIRB approval applications for investment of more than $10 million is not less than $26,200, significant cost savings should be made if a Business EC is obtained.
Similarly, although this has not changed since the new measures were introduced, it is important to note that the statutory application timeframe for making a decision will not commence until the correct fee has been paid.
How can funds gain a competitive edge?
Any PE funds which hold valid Business ECs are ideally placed to take advantage of investment opportunities arising from the fallout of COVID-19. In the current economic climate more than ever, those PE funds will have a competitive edge over other PE funds or other foreign acquirers which need FIRB approval. This will particularly be the case if the target business is either in administration, receivership or liquidation because for businesses in distress, a quick sale with minimal conditionality is often of paramount importance.
The appointment of administrators to Virgin Airways is the first high profile casualty of the economic impact of the lockdown. In the next six months, it is expected that a large number of businesses will not be able to weather the impact of the COVID-19 lockdown on their operations and will follow Virgin into administration. Sales or re-financings by administrators, receivers and liquidators will be inevitable and PE funds holding Business ECs will be ideally placed to move quickly to take advantage of these opportunities.
As the impact from the COVID-19 pandemic and the resulting economic fallout could be felt for a number of years, PE funds deemed to be foreign persons should consider applying to FIRB for a Business EC as soon as practicable to give themselves the best chance to remain competitive in the current landscape, even though from application a Business EC could take up to six months to obtain.
Richard Lewis is a partner and leads the firm’s private equity practice in Australia and the Asia Pacific region. Christian McMahon is a senior associate in the firm’s private equity team.