The Canadian government’s approval of the takeover of Nexen by CNOOC is yet another step in the evolution of Canada’s policy on takeovers by state-owned enterprises. This author, with significant experience in academia, government and the private sector, reviews that evolution and considers what it will mean for practitioners. He also addresses questions that have arisen in light of the government’s most recent announcement.
The issue of investment in Canada by foreign state-owned enterprises has been a hot topic in the Canadian media since last summer. On December 7, 2012, the Prime Minister personally announced that the Chinese National Oversees Oil Corporation’s (CNOOC) purchase of Nexen Inc. and the Petronas (the Malaysian state-owned oil company) purchase of Progress Energy Resources would be approved. He also announced that these would almost certainly be the last takeovers in the oilsands by foreign state-owned enterprises (SOEs). The political importance of this announcement was underlined by the fact that the Prime Minister himself took over lead of the file from the Minister of Industry.
This latest announcement represents a further evolution of the Canadian government’s approach to investment by foreign SOEs. After a good deal of public debate regarding the issue, the government gave Canadians further clarity around how these large pools of capital will be treated in the future. In this article, I review the evolution of the government’s approach, consider what that evolution means for practitioners, and look at some [un?]answered questions that arise in light of the government’s most recent announcement.
The evolving approach to investments by foreign SOEs
The issue of foreign ownership of Canadian business has been hotly debated in the past. Walter Gordon, a leading economic nationalist (and later, Liberal finance minister) chaired a Royal Commission in the 1950s that raised questions about growing foreign ownership of Canadian business. In 1972, the government created the Foreign Investment Review Agency (FIRA) to oversee foreign investment in Canada. Further, in 1975, the government created Petro-Canada (a SOE), in part, to increase Canadian ownership in the oil and gas industry.
After the Conservative government took office in 1984, FIRA was replaced with the Investment Canada Act (ICA), legislation that was generally regarded as more pro-foreign investment. In the early 1990s, the government began selling off portions of Petro-Canada, a process that was completed by the Liberal government in 2004. Despite periodic flare-ups, there was relatively little public debate over foreign ownership until the latter half of the last decade when the ‘hollowing out’ issue (loss of Canadian-headquartered companies) came to the fore. A number of relatively large transactions by SOEs took place in the energy sector, but these attracted little attention at the political level until the offer by CNOOC for Nexen Inc. in the summer of 2012.
To understand what changed as a result of the CNOOC-Nexen transaction, it is useful to review how the ICA worked before the transaction was approved. If investors come from a World-Trade-Organization (WTO) member country, the threshold for review is currently $330 million (destined to rise over time to $1 billion). Investments below the threshold are subject to notification only, as are Greenfield investments.
Investment Canada officials review transactions to determine whether the purchase will constitute a ‘net benefit’ to Canada. The final decision to approve a transaction rests with the Minister of Industry. To determine net benefit, officials consider such factors as the effect on the level of Canadian economic activity, employment, resource processing and exports. The criteria are flexible, reflecting the need to address the particular circumstances of each transaction and the value of the Minister retaining some flexibility to exercise judgment in reaching his or her decision. The assessment of Investment Canada officials is based on the business plans submitted by the investor. In particular, investors are encouraged to translate plans into binding commitments called “undertakings,” for which they can be held accountable by the minister.
If the investor is an SOE, Investment Canada officials will seek to determine whether the investor acts on a “commercial basis” i.e. not as an instrument of its state owner’s foreign policy. To make this determination, officials will look to the investor’s governance practices to determine the extent of government influence as well as their public disclosure policies. Listing on a Canadian stock exchange provides some guidance regarding reporting and the treatment of minority interests. Additionally, officials will look to the involvement of Canadians in the management and on the board of directors.
On December 7, 2012, while announcing the approval of purchases by CNOOC and Petronas, the Prime Minister outlined important changes to the government policy surrounding investments by foreign SOEs. Significantly, the government resisted the temptation to change the rules retroactively for CNOOC and Petronas, recognizing that one of the most important pillars of investor confidence in a country is the knowledge that the rules of the game won’t be changed while the game is under way.
In the future, however, SOEs will face a substantially changed foreign investment review regime. In a statement that made clear the government’s antipathy towards SOEs, the Prime Minister stated: “Canada has decided to have a free market economy.” Specifically related to investments in the oil sands, the Prime Minister said:
“In light of growing trends, and following the decisions made today, the Government of Canada has determined that foreign state control of oil sands development has reached the point at which further such foreign state control would not be of net benefit to Canada. Therefore, going forward, the Minister will find the acquisition of control of a Canadian oil-sands business by a foreign state-owned enterprise to be of net benefit, only in an exceptional circumstance.”
Finally, the Prime Minister announced that future increases in review thresholds would not apply to transactions proposed by SOEs, including those in other sectors of the economy. The Minister of Natural Resources later clarified that SOE portfolio investments (i.e. those that represent an minority share and do not constitute control) would still be acceptable.
Implications for practitioners and questions to be resolved in the future
By stating that no more takeovers of oilsands operations by foreign SOEs would be approved, the PM signaled a clear change of direction in Canada’s foreign investment regime. Further, by exempting all acquisitions by foreign SOEs from the rising threshold for review, the PM reinforced the Government’s general antipathy to public sector involvement in the private sector.
The change in policy direction will create winners and losers in the oil and gas sector. Clear winners are the existing management and boards of Canadian-controlled oilsands companies. They have been awarded protection from takeovers (and potential changes in management) by some of the largest global pools of investment capital. Clear losers are the shareholders of the same Canadian-controlled companies. They have been deprived of potential purchasers who are, based on recent history, willing to pay a large premium on current trading values. Large private sector firms looking to make acquisitions in the oilsands may benefit from the disqualification of some key SOE competitors.
Other things equal, prohibiting these large global pools of capital from owning oilsands companies may mean that the pace of development of the oilsands will be slower than it otherwise would be, with a corresponding effect on employment and government revenue in Alberta.
As with any change in policy direction, a number of practical questions will need to be answered as time goes on. The first is: What would qualify as an “exceptional circumstance?” Commentators are already starting to speculate, but the definition will likely only be revealed as the guidelines are tested in practice. This will lead practitioners to develop so-called “creative” deal structures in an attempt to comply with the new regulations. The assessment of joint ventures will take Investment Canada into the area of determining who actually controls, perhaps indirectly, a post-transaction business. For example, suppose an existing Canadian operation offers a 33 percent share to an Asian SOE in the energy business and a 33 percent share to a Middle Eastern sovereign wealth fund. How would such a transaction be treated under then new guidelines?
Another question to be clarified is how the government will view expansions of existing oilsands operations by their current SOE owners. Will the government move to limit development of existing properties by CNOOC, Petrochina, Sinopec or Statoil in order to maintain the participation of state-owned investors at existing levels? What new legislative instruments would be required to monitor and maintain shares of oilsands production by SOEs at current levels? The same set of questions applies to Greenfield investments in the oilsands by SOEs.
By refraining from raising the review threshold for SOEs in line with the rising threshold for private investors, the government signaled that its antipathy towards SOEs extends beyond the oilsands. Does that mean we may be reaching an overall cap of SOE participation in other sectors, such as mining? If so, is the cap approximately ten percent as in the oilsands or some other, sector-specific figure? Further, how will the government make investors aware that a cap is being approached so as to promote investor certainty and to avoid diplomatic embarrassment?
Some commentators have suggested that these tougher rules for state-owned enterprises will provide leverage to increase access for Canadian firms abroad. Does this mean that the government would be prepared to revisit the prohibition for specific countries if Canadian firms were provided with liberal access to investment opportunities in those countries? Based on the Prime Minister’s statement of the government’s general aversion to state-owned firms operating in the oilsands, this possibility appears unlikely.
Finally, it is worth noting that a number of Canadian SOEs operate in spaces occupied by private sector firms both at home and abroad. The Canada Pension Plan Investment Board, the Ontario Teachers’ Pension Plan, the Ontario Municipal Employees’ Retirement Fund, the Caisse de Depot et Placement and the Alberta Investment Management Corporation are examples of Canadian sovereign wealth funds that sometimes take active roles as investors in private sector companies.
Canadian Crown Corporations like Hydro Quebec, Ontario Power Generation, SaskTel, SaskPower, SaskEnergy, Alberta Treasury Branches and BC Hydro are active providers of services that, in other jurisdictions, are provided by the private sector. With these obvious examples of Canadian SOEs already at work at home and abroad, it is hard to see how the prohibition on future acquisitions of control by foreign SOEs provides much leverage in trade and investment dealings with foreigners. Indeed, the government’s clear statement regarding investment in Canada by SOEs may have an effect on the treatment of Canadian SOEs in their foreign dealings.
The government has established a new policy regarding what types of investors are welcome in developing the oilsands that is based on a clearly framed political ideology. In the process, they resisted the temptation to change the rules for transactions that were already under way. Commentators can debate the effect this decision will have on various stakeholders in the industry and on resource-owning provinces. However, the government has provided what a number of commentators sought: more clarity around the determination of net benefit and how a class of investors will be judged in the process.
As with any policy change, a number of questions related to implementation remain to be resolved. Further, it remains to be seen how broadly the new approach will be applied in other sectors of the economy. For these reasons, the ICA will likely continue to be an area of focus for practitioners and policy analysts alike for some time to come.