Current Issues Brief no. 7 2003-04
Foreign investment and the Australia United States Free Trade
Agreement
David
Richardson
Economics Commerce and Industrial Relations Group
8 March 2004
Contents
Introduction
On 8 February 2004 the Minister for Trade,
Mark Vaile, announced that Australia had entered a free trade
agreement with the US, the Australia
United States Free Trade Agreement (AUSFTA). There was a
simultaneous announcement by
the US of a free trade agreement with Australia. The full
text
was released on 4 March 2004. Most of the discussion since the
announcement has focused on issues to do with access for goods and
services in the respective markets. However, there were also
important announcements made with respect to foreign investment
matters. Included here were the lifting of the automatic approval
thresholds from $50 million to $800 million for takeovers of
Australian companies in non-sensitive areas.
Agreements among countries on foreign
investment have become more common in recent years. In a special
chapter on foreign investment in a recent
OECD Economic Outlook the OECD noted that formal agreements on
foreign investment are far less extensive than agreements on
international trade despite the importance of foreign investment to
the world economy. The agreements that the OECD cites as treating
foreign investment include the North American Free Trade Agreement
and recent agreements reached by Singapore and the European Fair
Trade Association, Japan and
Australia, the European Community and Chile, and among European
countries under the European Union. Since that was written,
Australia and Thailand concluded a free trade agreement that
included some investment provisions. In addition mention should be
made of the 1980s Australia
New Zealand Closer Economic Relations agreement which includes
investment facilitation and promotion measures.
The OECD also gives some
quantitative research on the restrictiveness of the various
regulatory regimes that deal with foreign investment in the 28 OECD
countries. The OECD ranks countries in terms of their
restrictiveness and, on that basis, suggests that Australia is much
more restrictive than the US. For example, the US with a rank of 0.
17 is the 15th most restrictive of the 28 while
Australia with a rank of 0. 27 is the 5th. (Ranking goes
from least restrictive at zero to most restrictive at one. ) This
research suggests that Australia, being the heavier regulator, may
well have more obligations to make concessions. However, to a large
extent the OECD exercise compares apples and pears. The US comes
out with a higher score on absolute limits on foreign ownership but
lower on screening and restrictions on foreign personnel and
operational freedom. Australias screening could be seen as hardly
worth worrying about compared with absolute limits on foreign
ownership in communications and other sectors of the US
economy.
The OECD itself has been particularly active
in promoting investment agreements. For example, the OECD sponsored
the Code
of Liberalisation of Capital Movements under which countries
bind themselves to agreed measures liberalising capital movements.
However, the individual country reservations in this document
suggest that most existing restrictions were retained by member
countries. Earlier attempts by the OECD to promote the Multilateral
Agreement on Investment (MAI) failed as a result of international
protest, from groups such as Friends of the
Earth, suggesting the MAI was undemocratic and would erode
environmental safeguards. On 2 November 1998 the Assistant
Treasurer, Senator Rod Kemp, announced that the MAI would not go
ahead and cited
a number of serious concerns with the draft text of the treaty as
it stood. Against this background it is important to examine
the present provisions in further detail.
Each party to the agreement gave different
emphasis on the content of the agreement. The United States side,
through the Office of the US
Trade Representative, has said that the agreement will
establish a predictable framework for US investors operating in
Australia. All forms of investment are protected under the
Agreement, including enterprises, debt, concessions, contracts and
intellectual property. The Australian side is silent on exactly
what is protected and how.
The
Australian statement says the Agreement successfully preserves
the main features of Australias foreign investment policy and
refers to the lifting of the screening threshold from $50 million
to $800 million. Screening presently applies to all types of
foreign investment, the creation of new business and the takeover
of existing companies. The US side refers to those limits as
applying just to acquisitions in nearly all sectors and also
says:
All U. S. investment in
new businesses is exempted from screening under
Australias Foreign Investment Promotion (sic) Board (FIRB).
(emphasis added)
The exemption of all US investment in new
businesses seems inconsistent with a press release put out on
Sunday 8 February 2004 by the Minister for Trade, Mark Vaile, who
said:
In relation to
foreign
investment,
Australia has protected sensitive areas, it has protected its
national interest test, but it has liberalised the overall
prospects for US
foreign
investment in Australia. We have liberalised
it in relation to new investments and we have liberalised it
outside sensitive sectors for existing areas up to a limit of $800
million, where we will not apply a screening test.
The Treasurers response can be seen as
consistent with the position put by the US although the statement
is slightly opaque. Now the agreement is available it is apparent
that there are no saving provisions that would allow screening of
new businesses by US investors.
Australian and US
objectives
The Australian Government had recently
published its objectives for the free trade agreement generally and
the foreign investment objectives included:
However, it would appear that the Australian
Government was not able to win any concessions for Australian
investment in the US, or at least none that it thought worthy of
announcing. That may seem unfortunate given the problems
experienced by foreign investors in the US. For example, the
European Commission (EC) publishes an
annual report on US barriers to trade and investment. In that
report the EC has expressed concern about the current significant
restrictions to foreign investment. The EC mentions the
Exon-Florio Amendment to the Defence Production Act that
authorises the President to investigate any takeover or merger that
could result in foreign control of an entity engaged in interstate
commerce. The screening is carried out by the Committee on Foreign
Investment in the US (CFIUS) in the Department of Treasury. The EC
cites lengthy processes and legal costs connected with such
investigation and, while the US concern is national security, that
term is open to wide interpretation. Moreover, there is no
provision for review or compensation.
According to Washington based law firm,
Gardner
Carton & Douglas LLP:
Every transaction that results in foreign
ownership, control or influence over a U. S. company, or that
results in a change in foreign ownership, control or influence, is
potentially reviewable by CFIUS.
To take just one illustration, ASML Holding
(ASML), a Dutch company, was blocked in its acquisition of Silicon
Valley Group (SVG) until it agreed to numerous conditions imposed
by the CFIUS. According to Gardner Carton and Douglas LLP, ASML had
to:
-
agree to divest itself of a subsidiary that
supplied satellite parts
-
commit that it would not relocate operations
offshore, and
-
agree that it would maintain its technology at
cutting edge.
While the first condition appears to have
something to do with US national security, the next two seem
problematic.
Apart from the Exon-Florio Amendment
the EC expresses concern about many US laws that give rise to
conditional national treatment which refers to treatment of
foreign-owned firms that is less favourable than the treatment of
domestic firms. In addition the EC expresses concern about
restrictions in particular industries such as shipping, power and
communications.
While the present set of US restrictions on
foreign investment remain, Australia successfully resisted pressure
for further concessions to foreign interests in Australia. American business
interests were pushing for investor-state dispute settlement
which is described as a mechanism for redressing unfair treatment
by governments. In other free trade agreements signed by the US
American companies have the right to take the host government to a
neutral tribunal and gain compensation in the event of
nationalisation or expropriation of US interests or measures having
equivalent effects to nationalisation or expropriation. Depending
on how the agreement is written investor-state arbitration can
imply that there are remedies available for US owned businesses in
Australia that are not available to any other business in
Australia. Moreover, there was concern that the tribunals may give
a wide interpretation to phrases such as measures having equivalent
effects to nationalisation or expropriation. The Australian
Conservation Foundation for example was concerned that the
agreement might have provided unprecedented rights to US
corporations to challenge existing Australian laws that are
designed to protect the environment and other matters of public
interest.
Despite the apparent victory for the
Australian side, the
Office of the US Trade Representative noted that while the two
countries agreed not to adopt investor-state dispute settlement
measures, the issue will be revisited if circumstances change. The
present draft of the agreement does include an article on
expropriation and compensation (article
11. 7 on page 11-3) and measures equivalent to expropriation
and compensation. While there are no investor-state dispute
settlement mechanisms in the agreement as it stands there is
provision for developing such procedures in the event of a change
in circumstances.
Article 11. 16 par 1 says:
If a Party considers that there has been a
change in circumstances affecting the settlement of disputes on
matters within the scope of this Chapter and that, in light of such
change, the Parties should consider allowing an investor of a Party
to submit to arbitration with the other Party a claim regarding a
matter within the scope of this Chapter, the Party may request
consultations with the other Party on the subject, including the
development of procedures that may be appropriate. Upon such a
request, the Parties shall promptly enter into consultations with a
view towards allowing such a claim and establishing such
procedures.
That seems to be saying that if Australia were
to change its approach to US investors and a US corporation had a
complaint, the US Government may press the Australian Government to
agree to a procedure for the US corporation to put its claim.
Against that, however, there is only a commitment for Australia to
consult under those conditions.
One of the major questions raised by the
investment clauses is how important this would be in practice and
how many Australian businesses might be subject to potential
takeover by US companies without FIRB screening. According to the
Australian stock exchange there were 1472 companies listed on the
stock exchange on 30 December 2003, of which 66 were foreign owned
and 1406 were domestic companies. The AUSFTA would exempt US
interests from FIRB examination for companies with assets worth
under $800 million. Based on market valuations on Friday 6 February
2004, all but 147 companies would no longer need to be examined in
the event of a takeover. Of course, many of those 147 companies are
already foreign owned or controlled, including News Corporation,
Rio Tinto Ltd, Singapore Telecom, Telecom Corp NZ, AXA Asia Pacific
(formerly National Mutual Life Association of Australasia Limited),
Lion Nathan Ltd, and so on. The ownership status of Australias
biggest company, News Corporation, depends on whether or not its
Chairman and Chief Executive, Mr Rupert Murdoch is regarded as a US
citizen for these purposes. He owned and/or controlled 33. 5 per
cent of News Corporation at 30 June 2003, according to the latest
News Corp annual report.
Another other important factor is whether or
not the present screening by the FIRB is effective or not.
According to the latest
FIRB annual report, in 200203 there were 361 foreign investment
proposals by US investors that were approved. The total value of
the investment was $30 460 million, or an average of $84 million
per investment. Proposals from the US are only 7 per cent of all
proposals but represent 33 per cent by value of the proposals. Less
is known about the proposals that were rejected or accepted subject
to conditions. However we know that all of the
rejected proposals related to real estate. However, there were 44
proposals outside the real estate sector that were approved subject
to conditions and the main type of condition was environmental. The
annual report mentions that the low rejection rate reflects the
consultative approach taken in the administration of foreign
investment policy. What this means is that there tends to be an
informal discussion of the proposal that indicates its likely
rejection or approval and those likely to be rejected never make it
to a formal application. In addition, problematic proposals can be
modified before formal application. Of course, no informal
screening would take place without the requirement for
approval.
At this point it is useful to canvass some of
the analytical arguments surrounding foreign investment. In the
case of goods and services the arguments in favour of free trade
are well known and tend to be widely accepted, at least in
principle. While there are qualifications and conditions under
which the arguments are valid, the case has been strongly debated
for many years. The case for free foreign investment or free
capital movements generally does not have the same tradition and,
at best, is an argument by analogy with that for goods and
services. Indeed, following the Asian currency crisis of the late
1990s, there is now a strong recognition that free capital
movements may be dangerous unless host countries have sufficient
institutional and policy strengths.
The term foreign investment includes a
continuum of transactions from short-term speculative capital
investments of the type that were implicated in the Asian crisis
through direct investment by foreign interests that contributes to
the Australian capital stock. Examples of the latter would be a
foreign-owned car manufacturer tooling up to produce a new model or
a foreign-owned mining company developing a mineral deposit.
A more problematic example of direct foreign
investment is the case of a foreign takeover of an Australian
company. Such a takeover could be argued to involve benefits for
the company concerned. Its operations may be improved by better
access to management, technology or overseas markets. Indeed, it
could be argued that there would be no incentive for any takeover
unless the acquiring management thinks it could earn additional
profit by utilising the assets of the target company better than
the incumbent management. In principle we can think of a market in
corporate ownership and control and, subject to certain conditions
there will be a competitive equilibrium in which ownership and
control will go to those who are in the best position to most
effectively manage the corporate assets. However, this is
complicated in the real world because generally the businesses
involved are large players with some influence in their market. The
company initiating the takeover may well be motivated by a desire
to better manage the assets of the target company. However, there
may also be an aim to dominate the market at the expense of
customers, suppliers or some other group. If the parties to the
takeover are in the same country then at least the winners and
losers will offset each other. However, when the winners and losers
are in different countries then one country can be said to gain at
the others expense. In order to really determine whether or not
there are merits in a takeover some knowledge of the economic
environment is required, including some idea of the incentives
facing the actors involved.
A case study of a foreign takeover was
provided by the recent attempt by Shell to mount a hostile takeover
against Woodside Petroleum Ltd. This attempted takeover was
rejected on national interest grounds and it is important to
consider what might have been the result had the Governments
discretion been removed as a result of a treaty arrangement.
Woodside is a large Australian resources
company, exceeded in value only by BHP Billiton Ltd and Rio Tinto
Ltd. Woodside has major interests in the North West Shelf and other
offshore petroleum and gas interests. Ultimately the Treasurer,
Peter Costello, rejected the Shell bid on national interest
grounds, basically on concerns that Shell would be motivated to
operate Woodside as part of its global strategy rather than in the
interests of the Australian business. In rejecting the bid
Mr Costello said:
It is in the national interest for the operator
of this project to develop the resource to its maximum and for
sales from the NWS [North West Shelf] to be promoted in preference
to competing sales from projects in other parts of the world.
Whilst there have been positive discussions with Shell on steps to
secure the independence of the operator and marketing functions I
have not been able to see that enduring conditions which are fully
enforceable could be put in place in advance, as such conditions
would require action after the approval and require the consent of
joint venturers which cannot be guaranteed.
Shell has expressed indignation over the
suggestion that it might operate in a manner inconsistent with
Australias interests. However, it is highly unlikely that Shells
interests and those of Australia will always be identical. Shell is
in the textbook position of a multi-plant producer:
-
with considerable market power
-
aiming to maximise returns to shareholders (via
the maximising of its own profits), and
-
in a position to bring capacity on stream so as
to fit in with its profit maximising objectives.
None of this should be taken as singling out
Shell in particular. It has to be said that an Australian based
multinational may also act against the Australian national
interest. If Woodside had Shells international portfolio of assets,
we would have to admit that it would be tempted to act exactly the
same as Shell in similar circumstances. It is not the character or
identity of Shell that is at question but the incentive structure
facing any powerful multi-plant company.
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