On December 7, 2012, the Canadian Minister of Industry announced decisions under the Investment Canada Act (ICA) to allow acquisitions by two foreign state-owned enterprises (SOEs): of Nexen Inc. by China National Offshore Oil Corporation (CNOOC) and of Progress Energy Resources Corp. by Malaysia’s Petroliam Nasional Berhad (PETRONAS). Immediately following this announcement, the Prime Minister of Canada announced changes to how the government will review acquisitions by foreign SOEs.
The importance placed on the December 7 announcements by the federal government is evident from the fact the policy announcements were made by the Prime Minister in a formal news conference. Following his speech, the Prime Minister answered several questions from Ottawa-based journalists, which is something he does not normally do. The Prime Minister stated that the CNOOC and PETRONAS decisions are not the beginning of a trend, but rather the end of a trend, by which we believe he intended to foreshadow the changes in policy regarding investments by foreign SOEs.
While the Prime Minister stated that the government continues to encourage foreign investment in Canada, the government has also determined that “Canadians have not spent years reducing the ownership of sectors of the economy by our own governments, only to see them bought and controlled by foreign governments instead.” The policies announced by the Prime Minister are intended (i) to address inherent concerns regarding foreign state influence, (ii) to stress that the burden of proof continues to be on the foreign investor to demonstrate that proposed investments will likely be of net benefit to Canada, (iii) to emphasize the importance of free market principles and the economic and other impacts of the proposed investment and (iv) to highlight productivity and industrial efficiency considerations. While one of the policy changes applies specifically to investment in the oil sands, most of the changes apply to foreign investment in all industries and economic sectors, and some apply to both foreign SOEs and other foreign investors.
The changes announced by the Prime Minister on December 7 are as follows:
the SOE definition will now include an investor that is influenced by a foreign government, whether or not it is also owned by the foreign government;
the financial threshold for review for investments by foreign SOEs will not rise from the C$330-million GDP-indexed book value number to the enterprise value calculation (which for other foreign investors will start at C$600 million and rise over four years to C$1 billion);
a foreign SOE investment to acquire control of oil sands businesses will be approved only in an exceptional circumstance;
the examination of foreign SOE investments will now look at the degree of control or influence the SOE would likely exert on the target Canadian business and the relevant industry as well as the extent to which a foreign state is likely to exercise control or influence over the SOE;
the burden of proof continues to be on all foreign investors to satisfy the Minister that the proposed investment is likely to be of net benefit to Canada.
How the ICA Works
Part IV of the ICA provides that an acquisition is reviewable if a non-Canadian investor proposes to acquire control of an existing Canadian business, where the book value of the assets of the target business exceeds C$330 million. If the business is a cultural business, the threshold is C$5 million. This general foreign investment review process is in addition to a national security review process under the ICA that is applicable to any investment by a non-Canadian and also industry-specific legislation, such as that relating to transportation and telecommunications.
In broad terms, control of a Canadian business may be acquired through the acquisition of all or substantially all of the assets used in carrying on a Canadian business, the acquisition of a majority of the voting securities or interests of the entity that owns the business or the acquisition of more than one-third of the voting shares of a listed corporation in certain circumstances. An acquisition by an existing minority non-Canadian owner may be reviewable if by the incremental acquisition that owner acquires control of a Canadian business.
A non-Canadian investor is an entity that is ultimately controlled outside Canada, or an individual who is not a Canadian citizen ordinarily resident in Canada or a permanent resident of Canada. Jurisdiction of incorporation is not relevant.
Following the release in 2008 of the Compete to Win report by the Competition Policy Review Panel, the federal government announced that the C$330-million threshold would rise to C$600 million and thereafter to C$1 billion over a four-year period and would be calculated with reference to enterprise value as opposed to the book value. The purpose is to limit review under the ICA to those investments that are more financially significant, in the belief that foreign investment in Canada is generally beneficial to Canada. Regulations to enact these changes were circulated for public comment in June 2012, four years after the initial recommendations, but are not yet in force. These regulations will require amendment as a result of the December 7 announcement.
If a proposed investment is reviewable under the ICA, the foreign investor cannot complete the investment until the Minister has approved it. The review process is undertaken by the Investment Review Division of Industry Canada. The legal test for approval is whether the Minister is “satisfied that the investment is likely to be of net benefit to Canada.” In determining whether an investment is likely to be of net benefit, the Minister considers the following assessment factors:
the effect on the level of economic activity in Canada, employment, resource processing, the utilization of parts and services produced in Canada and exports from Canada;
the degree and significance of participation by Canadians in the Canadian business or new Canadian business and in any Canadian industry of which the Canadian business forms a part;
the effect of the investment on productivity, industrial efficiency, technological development, product innovation and product variety in Canada;
the effect of the investment on competition within any industry in Canada;
the compatibility of the investment with national industrial, economic and cultural policies; and
the contribution of the investment to Canada’s ability to compete in world markets.
The Minister can also take into account undertakings given by an investor, and will make undertakings a condition of the approval of all significant investments. The undertakings relate to the assessment factors mentioned above. For example, undertakings will generally commit the investor to specified levels of capital expenditure and employment and to participation by Canadians in management and operation of the business. They are contractual commitments by the investor and are generally enforceable for up to five years from closing, except in the case of additional specific undertakings required in situations where an SOE is the investor, which can be in effect as long as the SOE owns or controls the Canadian business that it acquired. The investor is also required to report to the Minister periodically as to the status of its compliance with its undertakings.
Undertakings are explicitly recognized to be based on projected circumstances. Where the investor’s inability to fulfill a commitment is clearly the result of factors beyond the investor’s control, the Minister may not make the investor accountable to comply with all its undertakings.
If the foreign investor is an SOE, as part of the net-benefit-to-Canada assessment, the Minister will examine the corporate governance and reporting structure of the SOE in the context of Canadian standards of corporate governance and Canadian laws and practices. The Minister and the Investment Review Division will also assess whether the business to be acquired will continue to have the ability to operate on a commercial basis in regard to matters such as exporting, processing, participation of Canadians in its operations, support of ongoing innovation, research and development and the appropriate level of capital expenditures to maintain the Canadian business in a globally competitive position.
Length of the Review Process
The length of the review process can vary dramatically from case to case, from as little as 35 days in very simple cases to as long as several months, as evidenced by the CNOOC and PETRONAS applications.
National Security Review
All foreign investment that could be injurious to national security, whether or not reviewable under the net-benefit test, is subject to a separate review process under the ICA. Part IV.1 of the ICA authorizes the government to review investments that threaten to impair national security and provides that the federal cabinet may take measures that it considers advisable to protect national security. The regulations to implement these new provisions are presently undergoing a public consultation process.
Amendments Earlier in 2012
The government introduced ICA amendments earlier this year that will permit the Minister to accept security for the performance of undertakings, which is aimed at improving compliance, and to permit the Minister to disclose his reasons publicly, if the Minister makes an interim determination that he is not yet satisfied that a proposed transaction will likely be of net benefit to Canada. The Minister has been able, for some time, to release reasons for final decisions, but has thus far chosen not to do so.
The December 7 Announcements
Themes and Rationale
In the interest of predictability, the CNOOC and PETRONAS decisions were made under the ICA and government policy as they existed at the time the transactions were announced. The revised policy announced by the Prime Minister will apply to future acquisitions by non-Canadians and address the following themes:
clarifying how investments proposed by foreign SOEs will be reviewed under the ICA, including releasing revised SOE guidelines;
changing and increasing the financial threshold for review applicable to non-SOE investments; and
amending the ICA to give the Minister flexibility to extend the timelines for national security reviews.
The government’s expressed rationale for these changes is as follows:
the purposes and objectives of foreign SOEs may go well beyond the commercial objectives of privately owned companies and may be inconsistent with Canadian national industrial and economic objectives;
over the past two decades or so, the ownership of sectors of the Canadian economy by Canadian SOEs has been reduced, and the government does not believe that it is in Canadian interests to see foreign SOEs buy and control economic sectors; and
fairness and Canada’s national interest require clarity in regard to how Canadian law will apply to future proposed SOE investments in Canada.
While foreign SOE investments in Canada in the past five years have concentrated on acquisitions in the Western Canadian oil and gas industry, the government’s policy changes will generally apply to foreign investment in all industries and economic sectors.
Expansion of the SOE Definition
The SOE definition has been expanded to include not only entities that are owned or controlled by a foreign government but also entities that are influenced, directly or indirectly, by a foreign government. The change in the definition of an SOE may cause uncertainty as to when a foreign investor will be characterized as an SOE, where the investor is thought to be influenced by a foreign state. This expanded definition may apply, for example, to Lukoil, which although not owned by a foreign government is thought by some observers to be subject to significant control by the government of the Russian Federation. The US House Intelligence Committee has suggested that Huawei and ZTE, while not state-owned, are influenced by the Chinese government. There are many other examples. Whereas determining ultimate voting share ownership and resulting control is generally a relatively straightforward process, determining whether a foreign government influences an investor could be a somewhat more difficult question to answer.
Factors to be Considered in Reviewing Investments by Foreign SOEs
The examination of foreign SOE investments will now include an examination of (i) the degree of control or influence the SOE would likely exert on the Canadian business it proposes to acquire, (ii) the degree of control or influence the SOE would likely exert on the industry in which that Canadian business operates and (iii) the extent to which a foreign state is likely to exercise control or influence over the SOE.
The investor will need to satisfy the Minister (i) that its investment is commercially oriented, (ii) that it is free from political influence, (iii) that it will adhere to Canadian laws, (iv) that it will implement standards and practices that will promote sound corporate governance and transparency and (v) that it will make contributions to the Canadian business’ productivity and industrial efficiency.
These changes to the SOE guidelines (as well as other statements in the Prime Minister’s speech) show that the government will be more overtly taking an incremental approach in reviewing particular transactions to determine the extent to which that investment might add to foreign SOE control in the Canadian economy or in a particular industry, something that was not so explicitly addressed in the process prior to the announcements. The government stated that: “[w]here due to a high concentration of ownership a small number of acquisitions of control by SOEs could undermine the private sector orientation of an industry, and consequently subject an industrial sector to an inordinate amount of foreign state influence, the Government will act to safeguard Canadian interests.” However, while the government has not provided guidance as to when such foreign state influence may become inordinate, it has clearly come to that conclusion in regard to the oil sands industry.
Foreign SOE Investment in the Oil Sands
The Prime Minister stated that the acquisition of control of a Canadian oil sands business by a foreign SOE would be found to be of net benefit only in an exceptional circumstance. No explanation of what would be considered to be exceptional was provided by the Prime Minister or by the Minister of Industry. Examples could include that the target is in financial distress or that a particular project will not proceed absent the SOE investment.
This new policy regarding oil sands businesses likely renders companies that are entirely or mostly focused on oil sands operations (such as Suncor) off limits for foreign SOEs; however many observers would have considered Suncor to have been in that category prior to this announcement. Questions are left open with respect to how proposals to buy oil and gas businesses with mixed asset portfolios, which include both oil sands assets and other assets, would be treated. One possibility is that, in some circumstances, a foreign SOE proposing to acquire such a company would be required to sell some or all of those oil sands interests to a third party as a condition of approval.
Little insight was given as to why the oil sands were singled out in the government’s policy statement, other than that these policy changes were considered during the Minister’s review of the CNOOC and PETRONAS investments and that Canadian public and political opinion was quite divided on whether or not the Minister should approve the transactions. However, it is significant to note that the government believes “foreign state control of oil sands has reached the point at which further such foreign state control would not be of net benefit to Canada.” This conclusion was made in light of the government’s assessment that the vast majority of global energy deposits are state-controlled, that there are roughly 15 major oil sands developers in Canada and that the role of private-sector companies must be reinforced.
Development of the oil sands is a particular focus of concern for those interested in the impact of hydrocarbons on the environment. It is possible that the government believes, for example, that a better case can be made for the regulatory approval of new oil sands projects, or of export pipelines such as Northern Gateway and Keystone XL, if the degree of foreign SOE ownership and control is kept at a relatively low level. This distinction may also reflect a government view that the oil sands are a particular object of resource nationalism in Canada and ownership by foreign governments must therefore be kept to a minimum.
The Financial Threshold
The financial review threshold is currently C$330 million, based on book value. Regulations were published in July 2012 for public comment, which would increase the dollar threshold and base it on enterprise value rather than book value.
The Prime Minister announced that the increased financial threshold will apply only to non-SOEs; foreign SOE investments, however, will continue to be subject to the lower C$330-million threshold, which will continue to be based on book value. This threshold is subject to annual adjustment based on GDP growth.
The government’s intention in modifying the financial threshold is to limit review of investments by non-SOE investors to more financially significant investments, while ensuring that many foreign SOE investments continue to be subject to review at the current lower threshold. However, there is the potential for unintended consequences: the market value of a business may be lower than its book value (e.g., companies with significant gas assets, given the fall in the price of gas in the past year), and, at the other extreme, the sale of Nortel’s patents for $4.5 billion in 2011 was not subject to review under the ICA, because the book value of the assets was less than the financial threshold.
Burden of Proof
The government has emphasized that the burden of proof continues to be on foreign investors, whether they are SOEs or not, to satisfy the Minister that the proposed investment is likely to be of net benefit to Canada.
One significant issue with respect to which many observers had advocated changes was the addition of clarity and transparency around the net-benefit test and undertakings given by foreign investors. The government did not offer up any changes in policy or law in regard to these matters.
While the December 7 policy changes are significant in regard to future foreign SOE investment in Canada, particularly in the oil sands, it should not be forgotten that business as usual continues to a large degree, even for foreign SOEs: many significant investments by foreign entities are not reviewable under the ICA, and that whether or not an investment is subject to review depends not only on the value of the Canadian business, but also on the structure of the investment.
For example, in many circumstances, the establishment or acquisition of a joint venture, where the foreign investor is acquiring 50 percent or less of the underlying assets, or the acquisition of 50 percent of less of the voting interests of a partnership will not be reviewable—no matter how large the investment. Similarly, the acquisition of 50 percent or less of the voting securities of a corporation will not be subject to review, subject to an exception: the acquisition of one-third or more but less than a majority of the voting securities will be deemed to be reviewable unless the foreign investor can establish that it will not control the Canadian business through the ownership of those securities. For example, the acquisition of a 100-percent interest in a corporation whose only asset is a minority interest in an oil sands mining joint venture would be reviewable assuming that the financial threshold is met, however, the direct acquisition of that minority interest in the joint venture may not be reviewable if the acquisition would not result in the acquisition of control of a Canadian business.
There are already several public examples of significant foreign investments, including those by foreign SOEs, through joint venture and partnership structures, particularly in unconventional gas exploration and development, which have not been subject to review under the ICA. The announced changes to the SOE review process and new SOE financial threshold would not affect a finding that those transactions are not subject to review.