Zero thresholds and last resort divestment powers: Protecting national security but at what cost?
The Federal Government recently announced wide-ranging reforms to Australia’s foreign investment review framework. This article focuses on two of the proposed changes and explores some associated issues and potential effects on the foreign investment and M&A market:
- the new laws will require foreign investors to obtain clearance for acquisitions in a ‘sensitive national security business’ (ie by holding a 10% or more interest or having control), regardless of the value of the investment (Zero Threshold Approval Requirement); and
- a new national security test has been introduced, which will allow the Treasurer to (among other things) require the divestment of any previously approved foreign investment in an Australian business, entity or title of land (Last Resort Power).
While it is unarguable that Australia must protect its national security concerns, one can only speculate on the extent to which the introduction of these changes will influence Australia’s foreign investment and M&A market which, by its nature, demands a level of investment certainty to thrive. Needless to say, the drafters have a lot at stake to get this right and the costs are high if they get it wrong – we eagerly await the consultation process and the release of the exposure draft legislation (expected in July) and will provide an update when it arrives to offer further clarity to the foreign investment and M&A market.
Definitions and scope
Zero Threshold Approval Requirement
For the purposes of the Zero Threshold Approval Requirement, the key definitions of ‘sensitive sectors’ and ‘sensitive national security business’ are unhelpfully not contained within the reform announcement – although the Federal Government has hinted that they will be subject to consultation and contained in subordinate legislation (regulations), akin to the current approach adopted for Free Trade Agreement (FTA) purposes.
As a potential sign of the incremental approach the Federal Government is seeking to adopt, the reform announcement refers to the existing framework definition of sensitive businesses for the purpose of monetary screening thresholds for the national interest test – that includes media, transport, and telecommunications businesses and businesses that provide vital infrastructure to these businesses. Importantly, the reform announcement also adds ‘data’ and ‘water’ as significant additions to the ‘sensitive businesses’ list.
In the COVID-19 pandemic–affected world, one could only speculate as to whether considerations relating to food, water, medicines and medical supplies, primary resources and supply chain stability will also feature.
We understand that consultation on the new definition of a ‘sensitive national security business’ will be directed towards exploring additional concepts including, but not limited to:
- any business regulated under the Security of Critical Infrastructure Act 2018 (Cth) or the Telecommunications Act 1997 (Cth);
- any business involved in the manufacture or supply of defence or national securityrelated goods, services and technologies, or any business that can create vulnerabilities in the security of Defence and national security supply chain, the Defence estate and/or other core Defence interests;
- any business or land situated in or proximate to Defence or national security installations; and
- any business that owns, stores, collects or maintains sensitive data relating to Australia’s national security and/or defence.
We encourage all businesses within these areas to remain abreast of these critical changes as there is every possibility that the scope will be widened, resulting in increased compliance, time and costs associated with M&A activity within these sectors. Once again, a key focus should be to ensure that the reforms continue to preserve the core principle underpinning the foreign investment system: that foreign investment provides ‘significant economic benefits’ to Australia.
Last resort power
It appears, at this stage, that the Last Resort Power contains significant safeguards and will be reserved for specific national security threats. Its stated purpose is to ‘address a gap in Australia’s approach to managing foreign involvement in sensitive sectors’, where:
- pointintime approvals, including conditions to protect our national security, are made redundant due to rapid technological change; or
- the nature of the security risks posed change subsequent to approval.
Although this sounds intuitive, the reform announcement unhelpfully does not define what constitutes being ‘redundant due to rapid technological change’ or provide any sort of interpretative guidance. While the draft legislation may make this clear, it raises questions such as how will the nexus between ‘redundancy’ and technological change be measured? And who determines whether the technological change was rapid or not? Unless resolved, such ambiguities may create significant impediments for the Treasurer to exercise the proposed Last Resort Power and result in unnecessary uncertainty, or (equally problematic) lack legal effectiveness. It remains to be seen whether the drafters would look to the prevailing concept of ‘material adverse change’ or similar mechanisms for inspiration.
Some uncertainty also surrounds the factors that will give rise to ‘national security concerns’ to invoke the Last Resort Power. The reform announcement does however suggest that the Federal Government, when considering whether a proposed investment gives rise to national security concerns, will consider the relevant factors as outlined within the definition of ‘security’ within the Australian Security Intelligence Organisation Act 1979 (Cth). This includes protection from:
- espionage, sabotage, politically motivated violence, attacks on Australia’s defence system; or
- acts of foreign interference, and
further includes the protection of Australia’s territorial and border integrity from serious threats.
The safeguards for the exercise of the Last Resort Power, as contained in the reform announcement, are that the Federal Government must be satisfied that:
- reasonable steps have been taken to negotiate in good faith with the foreign investor to achieve an outcome of eliminating or reducing the risk without action under the Act;
- there are no other regulatory mechanisms outside the Act that can be used to adequately address the identified risk; and
- action under the Act is reasonably necessary for the purposes of eliminating or reducing the identified risk.
Further, current foreign investors can take some comfort in the fact that the Last Resort Power will not be retrospective and will only be applicable to any future foreign investment that is reviewed under the Act – with one caveat! While the new law is expected to take effect on and from 1 January 2021, it is not clear whether one or more aspects could take effect from the date of the reform announcement (5 June 2020).
Effect on the foreign investment and M&A market
The extent to which the introduction of these changes, including the Zero Threshold Approval Requirement and the Last Resort Power, may affect the future of Australia’s foreign investment and M&A market (and the extent of economic benefits it will provide) is worthy of consideration. For instance, it is possible that the introduction of this reform could, if not drafted with sufficient precision, cause significant adverse effects on Australia’s foreign investment market through deterring foreign investors if investing in Australia is perceived as a higher-risk exercise.
Further, it is possible that such perception may extend to the way in which foreign banks and financiers price the risk in financing Australian–based transactions (with respect to the terms upon which finance is granted, if at all; eg higher interest rates and tougher covenants).
There is no question that these potential adverse effects need to be appropriately balanced against the potential sovereign risks to Australia. Rather ironically, it could be argued that the introduction of these reforms is contrary to the national interest in any event, potentially causing a substantial decline in the economic benefit brought about through Australia’s foreign investment market.
It is almost irrefutable that Australia benefits enormously from foreign investment. Even the most staunch free market advocates would agree that any reforms to the foreign investment review framework need to ensure that there is an adequate balance between protecting Australia from national security threats and maintaining foreign investor confidence to ensure the continuation of economic benefits accruing through foreign investment. The ultimate question is whether (or not) the final form of the legislation will unfavourably tip the balance. Stay tuned for the draft legislation and the consultation process…
If you have any questions about this article, please get in touch with an author or a member of our Corporate & Commercial team.
This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.