Merger control, investment scrutiny and foreign investor protection
Foreign investment stories have dominated media headlines in recent months. Australia-China business stakeholders will have noticed:
- the blocking of Coca-Cola’s USD2.4 billion bid for Huiyuan Juice Group (“Huiyuan”), claimed to be the leading local player in the pure fruit juice market in China, by China’s Ministry of Commerce (“MOFCOM”);
- the non-opposition of the Australian Competition and Consumer Commission (“ACCC”), Australia’s national competition law watchdog, to the proposed USD19.5 billion acquisition by Chinalco of interests in Rio Tinto;
- the blocking of China Minmetals’ AUD 2.6 billion takeover of Australia’s OZ Minerals by the Federal Treasurer of Australia, Wayne Swan, on national security grounds;
- the Australian Treasurer’s conditional approval of Chinese Hunan Valin Iron and Steel Group’s proposed acquisition of a 17.55% shareholding in Fortescue Metals Group (“FMG”); and
- the announcement that Australia’s Senate Standing Committee on Economics will inquire into Australian acquisitions by state-owned overseas companies and sovereign wealth funds.
What do these developments mean for companies operating in the Australia-China business circle in these difficult economic times? If business plans are frustrated, are there any foreign investor protection mechanisms which could be used to seek redress?
Coca-Cola and Huiyuan –competition law maturing in China, not anti-investment
China has been the world’s leading foreign investment recipient in recent years. Many multinational companies have chosen to make their China investment through mergers and acquisitions. Since China’s Anti-Monopoly Law took effect as of 1 August 2008, merger clearance by MOFCOM has become a critical issue for many large transactions.
The Coca-Cola/Huiyuan decision is the first-ever prohibition that MOFCOM has issued in a merger filing case. MOFCOM concluded that:
- Coca-Cola’s position in the market for carbonate soft drinks could be used to limit competition in the juice market, and that this may then have a negative effect on market competition amongst juice manufacturers;
- Coca-Cola’s market concentration could considerably raise market entry barriers and make it harder for potential new players to enter into the juice market; and
- the concentration may suppress the business operation space available to small and medium juice enterprises in China, and may have negative consequences for effective market competition in the Chinese juice market.
We are mindful of a question that many parties outside China could ask: is this finding a dangerous signal that the Chinese government is tightening its foreign investment policies, and will become more “nationalistic” in its attitude towards the influx of capital? We do not think that is the case.
Firstly, it must be recalled that competition approvals are a relevant and well-established aspect of any proposed merger, regardless of the source of the investment capital concerned. By introducing its Anti-Monopoly Law, China has actually adopted competition law principles which are commonplace in Western countries. If anything, the “rule of law” ought to have the effect of increasing the transparency and legitimacy of decisions reached by the relevant Chinese government agencies in their merger approval roles.
Secondly, it is unsafe to make assumptions about the location of companies operating in China, and where and how they choose to distribute their profits. Chinese companies are now becoming as multinational as many large Western companies. As Mr Chen Deming, China’s Commerce Minister pointed out, after the ruling was made:
It will be a huge misunderstanding if one views MOFCOM’s prohibition decision concerning the Coca-Cola/Huiyuan merger clearance matter as a signal that China will no longer welcome foreign investment… Huiyuan is a company registered in the Cayman Island. The proposed merger transaction between Coca-Coca/Huiyuan relates to two foreign companies and it has nothing to do with China’s foreign investment policies. MOFCOM’s role is only in regards to the product distribution circumstances of these two foreign companies. We welcome both companies to investment in China.
An increasingly sophisticated investment legal regime, both outbound and inbound, is emerging in today’s China. The Chinese government has reduced the start-up barriers for China market entrants, and improved both the protection and accountability of the on-going business operations of foreign investors in China. More importantly, the direction of this on-going reform is gradually to abandon any dual regime separating the governance of domestic and foreign investments. Such regimes are still to be observed in many other developing countries in Asia, Africa and Latin America.
There is no doubt that investment in China requires careful management of various legal issues, including intellectual property protection, land use rights, taxation, industrial relations, regulatory compliance, foreign exchange, corporate governance and dispute resolution. The recent Coca-Cola/Huiyuan decision manifests the fast-growing importance of competition law issues in China, a field of obvious significance in all developed Western jurisdictions.
Clearly, China is still “open for business”.
Chinalco and Rio Tinto – application of Australian competition control
The interest of Australia-China business people is presently focused on the outcomes of Chinese State-owned Chinalco’s USD19.5 billion bid for Rio Tinto, the biggest foreign investment in Australian history. As was the case in the Coca Cola/Huiyuan deal, merger control is an important competition law obstacle that must first be overcome. Australia’s competition policy regulator, the ACCC, has now expressed the view that Chinalco’s proposed acquisition would be unlikely to have the effect of substantially lessening competition in any relevant market in Australia in contravention of Section 50 of the Trade Practices Act 1974.
In the context of State-owned company or “sovereign wealth fund” investment, the ACCC posed a “working assumption”, in its decision, about the possible interrelationships between Chinese companies with State investment. In the final result the ACCC found that it was not necessary for it to test that assumption. That untested assumption was whether Chinalco, and various Chinese steel makers, could be treated as subsidiaries of the same parent entity, and therefore might have common commercial interests. The implication underpinning this assumption would be that the State was the parent entity. The ACCC said that it would apply such an assumption equally to the consideration of transactions involving a public sector “parent” as it does to those involving private entities. Media reporting indicates that Chinalco, for its part, would not have agreed with such an assumption, had it been reached in the ACCC’s analysis. Chinalco, while clearly having the status of a State-owned company, stressed that it operates independently from all other State-owned entities.
The question of State control of numerous companies, and the possibility that those companies might act in concert so as to cause competition concerns in a future ACCC analysis, has been left open for future consideration.
OZ Minerals and FMG – Chinese investors treated no differently to any others
Under the Australian Foreign Acquisitions and Takeovers Act 1975 (“the Act”), the Australian Treasurer may make an order prohibiting a proposed takeover if it fails a “national interest” test. The Treasurer administers his power according to the Government’s policies and regulations made under the Act. An important “set” of those policies, in the context of Chinese investment in Australia, is the Principles guiding consideration of foreign government related investment in Australia (“the Guideline”), which was released in February 2008.
On 27 March 2009 the Treasurer indicated that he was reluctant to approve China Minmetal’s bid for OZ Minerals in its then-current form. The Treasurer blocked the deal on “national security” grounds, which is specially mentioned as the fifth of the six “additional factors” within the Guideline that need to be examined when considering proposed investments by entities related to foreign governments or their agencies. Reportedly, a copper and gold mine included in the proposed acquisition is located in a weapons testing range in South Australia. Having raised his concerns, the Treasurer indicated that the Australian Government would not approve the proposal, but would be willing to consider alternative investment proposals relating to OZ Minerals’ other assets and businesses.
At around the same time, the Treasurer gave conditional approval to Hunan Valin’s bid for an interest in Fortescue Metal Group. The conditions are in the form of formal and strict undertakings required from Hunan Valin, as follows:
- Any person nominated by Hunan Valin to FMG’s board will comply with the Director’s Code of Conduct maintained by FMG;
- Any person nominated by Hunan Valin to FMG’s board will submit a standing notice under the Corporations Act 2001 of their potential conflict of interest relating to FMG’s marketing, sales, customer profiles, price setting and cost structures for pricing and shipping; and
- Hunan Valin and any person nominated by it to Fortescue’s board will comply with the information segregation arrangements agreed between Fortescue and Hunan Valin.
According to the Treasurer, these undertakings, and Hunan Valin’s reporting to the Foreign Investment Review Board on its compliance with these undertakings, will ensure the appropriate separation of FMG’s commercial operations and customer interests, and will support the market-based development of Australia’s resources. Penalties for non-compliance with these undertakings are contained in the Corporations Act 2001, and breaches of the Code of Conduct can lead to removal of the director concerned from FMG’s board. The Treasurer indicated that these conditions “would ensure the appropriate separation of Fortescue’s commercial operations and customer interests, and support the market based development of Australia’s resources”.
In both the China Minmetal and Hunan Valin approval decisions, we can see that policies were applied in ways which, in all likelihood, are independent of the Chinese nationality of the foreign investor. Having identified the fact of State ownership in the context of the China Minmetals proposal, the Treasurer then assessed the national security concerns associated with missile testing in and around land owned by a company which might have foreign government ties. The decision has been criticised by some as being overly conservative, and ultra-cautious, given the physical separation between the missile launching area and the copper and gold mine concerned. Nonetheless there was no indication that the decision would have been any different if the investment funds were not Chinese, and the Minister clearly invited a new proposal to come forward from China Minmetals in a way which overcame the problem he identified.
In the same sense, the conditions applying to the Hunan Valin approval were directed towards maintaining open pricing and supply, in circumstances where a significant interest in an Australian commodity seller was about to be acquired by a major customer. Adding to the sense of concern about the possible influence of that major customer was its level of State ownership. To guard against collusive influences on commodity pricing, by that State and by other companies having State investment, it was seen to be important to apply controls on commercial decisions at the corporate level. Again, the Chinese nationality of the investor can be seen as coincidental. A major Japanese or Korean purchaser, with shareholder connections to their own respective governments, would need to be treated similarly under the Guideline.
Australian Senate inquiry into foreign government related investment
The launch of the Senate inquiry into foreign investment by State-owned entities is another notable development. Australian Greens Leader Senator Bob Brown, who moved the motion to establish the inquiry, said that it was an occasion to ascertain whether foreign acquisitions by foreign government entities are consistent with Australia’s national interest.
As a result, the following matters have been referred to the Senate Standing Committee on Economics for inquiry and report by 17 June 2009:
- the international experience of sovereign wealth funds and state-owned companies, their role in acquisitions of significant shareholdings of corporations, and the impact and outcomes of such acquisitions on business growth and competition; and
- the Australian experience of foreign investment by sovereign wealth funds and state-owned companies in the context of Australia’s foreign investment arrangements.
Senator Barnaby Joyce, of the National Party, argued that the inquiry was not targeting Chinese investors, however almost all the major foreign investment proposals in the Australian resource sector at the present time are coming from Chinese State-owned companies. Thus the context and timing of the inquiry could have significant implications on the proposed Chinalco deal, as well as other Chinese-related acquisition transactions in the future.
Comment – certainty for international business investment
These are difficult economic times. Hardship can generate insularity and nationalism. Therefore it is understandable for commentators to fan the flames of “protectionism”, and to claim that we should have serious concerns about the openness of our markets, and anxieties about the ability to achieve deal approvals in both Australia and China. In our view, however, the fundamental legal and regulatory landscape underpinning bilateral investment activities remains unchanged. We also note the Australian and Chinese Prime Ministers’ very strong anti-protectionist stance, and the continued closeness of the Australia-China bilateral relationship. Instead, what we are seeing is a new level of Chinese investment activity which, unsurprisingly, has created its own wave of publicity and comment.
In fact, we believe that the active application of competition and foreign investment scrutiny rules by the relevant government authorities in China and Australia will create more certainty, and will make future cross-border investment transactions more accountable and transparent. These widely circulated “precedents” are telling the business community the circumstances in which deals will be supported, and the regulatory conditions which might be applied. Business can react and respond accordingly.
But it is true that companies that may wish to enter into investment transactions between China and Australia have to be more careful and considerate than at any time before now. On the China front, Australian investors will have to carefully contemplate the workings of the Chinese Anti-Monopoly Law. Here in Australia, Chinese investors have to think about the structure of their deals, and develop sophisticated commercial solutions and legal risk management strategies. Australian businesses interested in obtaining Chinese capital funding need to consider how to manage some seemingly “novel” issues incidental to State-owned enterprises and companies.
Comment – legal investment protection may be at hand
Investors of either Chinese or Australian origin who feel aggrieved by measures of either government should be mindful of redress which could be available under bilateral investment treaty law. The Agreement between the Government of Australia and the Government of the People’s Republic of China on the Reciprocal Encouragement and Protection of Investments (“Australia-China BIT”) affords investors with “fair and equitable treatment”, “most favoured nation” (“MFN”) and “no expropriation or nationalization” protections.
Importantly, the Australia-China BIT contains an interesting rule regarding the settlement of disputes between an investor and the investment host state. Article XII of the Australia-China BIT offers investors direct legal recourse against the host state to be compensated in cases of improper expropriation or nationalization. The investor concerned may either initiate proceedings through the domestic court system of the host state, or submit the dispute to arbitration under the auspices of the Washington-based International Centre for the Settlement of Investment Disputes (“ICSID”).
Literally, the subject matter of the jurisdiction under Article XII of the Australia-China BIT is quite narrow. It only covers disputes concerning the amount of the compensation payable caused by expropriation or nationalization. However, one needs to note the possibility of invoking the MFN rule (depending on the specific factual and legal circumstances), with a view to achieving a greater scope of legal protection than the Australia-China BIT offers on its face. For example, Article 10 of the Netherlands-China BIT provides that any dispute that might arise between an investor and the host state concerning an investment of that investor in the host state may be settled through the ICSID arbitration mechanism.
Likewise, Article 9 of the Australia-Romania BIT provides that in the event of a dispute between a Contracting Party and an investor of the other Contracting Party relating to an investment, the parties may resort to ICSID arbitration.
If the MFN principle can be widely applied, then there is a prospect that Chinese or Australian investors can make a variety of investment claims before ICSID arbitral tribunals which go beyond the jurisdiction of the Australia-China BIT. Important technical questions would have to be answered beforehand: for example, what amounts to an “investment”? Is there an “investor”? What are the risks of claiming ICSID’s wider jurisdiction on the MFN ground? Specialised advice and representation will be required.
As always, we are committed to helping our clients further explore and develop appropriate strategies to establish and protect their commercial interests.
This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.