Senate

Revised Explanatory Memorandum

Circulated by the authority of the Treasurer, the Hon Wayne Swan MP

Chapter 1 Improving the integrity of Australia's foreign investment screening regime

Outline of chapter

1.1 The Foreign Acquisitions and Takeovers Amendment Bill 2009 improves the integrity of Australia's foreign investment screening regime by ensuring that the Treasurer has the capacity to examine all substantial investment proposals that could potentially raise national interest concerns.

1.2 The screening regime is underpinned by the Foreign Acquisitions and Takeovers Act 1975 . The Act relies on the notion of control to require investors to notify investment proposals, and to trigger the Treasurer's powers to block, or place certain conditions upon, those proposals determined to be contrary to the national interest. Overall, the current provisions in the Act that deal with control have worked well.

1.3 However, the use of complex financing arrangements has highlighted that ownership and control events may potentially arise, either now or in the future, in a variety of new ways other than through traditional shares or voting power. While these types of investment arrangements may have a solid commercial basis, they can have the effect of delivering influence or control in ways that were not envisaged when the Act was being drafted.

1.4 The Bill clarifies the operation of the Act by explicitly requiring foreign investors to notify the Treasurer where there is a possibility that the type of arrangement being used will deliver influence or control over an Australian company, either currently or at some time in the future. The amendments specifically include transactions or agreements that involve instruments which eventually convert into shares or share-like interests or voting power.

Context of amendments

1.5 The Government's policy approach is to encourage foreign investment because of the potential benefits it provides to the Australian economy. It brings new job opportunities for Australians, new innovation and skills development, new technologies and the promotion of competition amongst our industries.

1.6 However, it is important to maintain the right balance between encouraging investment into Australia and ensuring that the regulatory regime is robust enough to allow the Treasurer to examine foreign investment proposals that could potentially be inconsistent with the national interest.

1.7 The procedures governing foreign investment in Australia are underpinned by the Foreign Acquisitions and Takeovers Act 1975 and Australia's foreign investment policy. The Act requires foreign investors to notify the Treasurer of their transactions in certain circumstances and provides the Treasurer with the power to block, or place certain conditions upon, those proposals that involve a foreign person obtaining control of an Australian company that would be contrary to the national interest.

1.8 The Treasurer's powers do not apply to acquisitions of interests in Australian corporations and businesses valued below the relevant monetary thresholds. Accordingly, references to acquisitions which are subject to the Treasurer's powers throughout this document refer only to acquisitions of interests in those entities valued above the relevant monetary thresholds.

1.9 The Act provides for compulsory notification of acquisitions of 'substantial shareholdings'. However, the use of innovative and increasingly complex financing arrangements that involve a component of control or influence has been a growing feature of investment activity over recent years. In such cases, the ownership interest can be held in a variety of forms other than through traditional shares and voting power. While these arrangements may have a solid commercial basis, they can have the effect of delivering influence or control in ways not originally envisaged when the Act was being drafted more than 30 years ago.

1.10 On 12 February 2009, the Treasurer announced that the Government would amend the Act to 'clarify the operation of the foreign investment screening regime ... to ensure that it applies equally to all foreign investments irrespective of the way they are structured'.

1.11 These amendments will not change the screening and examination procedure undertaken by the Foreign Investment Review Board. The screening and examination procedure is a well established process, and the decision to block or impose conditions on foreign investment proposals will continue to be exercised by the Treasurer and based on whether an investment has altered the control of an Australian business or corporation and whether the investment is contrary to the national interest.

Summary of new law

1.12 The amendments are structured to include foreign investments that have the potential, whether now or in the future, to provide some measure of influence or control over the business or assets of an Australian company.

1.13 The amendments clarify the operation of the Act by explicitly providing for compulsory notification to the Treasurer where there is a possibility that the type of arrangement being used will deliver influence or control, including transactions that involve instruments that eventually have the same effect.

1.14 The Bill also provides transitional arrangements to ensure that foreign investors will not be adversely impacted by the amendments.

Comparison of key features of new law and current law

Detailed explanation of new law

1.15 The Foreign Acquisitions and Takeovers Act 1975 provides the basis for the Treasurer to examine proposed foreign investments in Australian businesses and assets to ensure they are not contrary to the national interest. It requires foreign investors to notify the Treasurer of their transactions in certain circumstances (where the target is valued above the relevant monetary threshold) and provides the Treasurer with the power to block, or place conditions upon, those proposals involving a foreign person obtaining control of a company where it is considered contrary to the national interest.

1.16 The notion of control is a fundamental concept and described as being 'in a position to determine the policy of the corporation'. The Treasurer's powers operate according to the nature of the investment, including acquisitions of shares, acquisitions of assets, agreements relating to directorate of corporations and arrangements relating to control of Australian businesses.

1.17 While the Act specifically provides for compulsory notification of acquisitions of 'substantial shareholdings', it is unclear whether these extend to include other types of financing arrangements that involve a component of control or influence. The use of these more complex financing arrangements has been a growing feature of investment activity over recent years. In such cases, the ownership interest can be held in a variety of forms other than through traditional shares and voting power.

1.18 The amendments clarify the operation of the Act by explicitly requiring foreign investors to notify the Treasurer - and thereby trigger his condition-making powers - where there is a possibility, whether now or in the future, that the type of arrangement being used will deliver influence or control over an Australian company.

Entering into an arrangement

1.19 Section 5(4) provides that a reference to entering into an arrangement in the Act includes a reference to entering into an agreement, creating a trust and entering into a transaction. Item 7 inserts a new limb to the definition of entering into an arrangement so that it now explicitly includes acquiring an asset or a share. [ Schedule 1, item 7, paragraph 5(4 )( d )]

1.20 The reason this provision is required is to ensure that the Treasurer's existing powers to make orders in relation to 'arrangements' are clarified with respect to share and asset-type arrangements. These forms of arrangements may currently be implied, but the proposed amendment removes any uncertainty in this area.

Substantial interest and aggregate substantial interest

1.21 For the Treasurer to exercise his powers under section 18 of the Act, he must first be satisfied that a foreign person (or persons) has acquired or will acquire a controlling interest in an Australian corporation. The notion of control relies on the person (or persons) holding a substantial shareholding and being in a position to determine the policy of the corporation.

1.22 Section 9(1) currently provides that:

•

a 'substantial interest' means a person (together with their associates) holds 15 per cent or more of the 'voting power' or the 'issued shares' in a corporation (paragraph (a)); and

•

an 'aggregate substantial interest' means two or more persons (together with their associates) hold an aggregate of 40 per cent or more of the 'voting power' or the 'issued shares' in a corporation (paragraph (b)).

1.23 Item 8 expands these definitions so that they capture the concepts of potential voting power and interests that arise from a right (discussed under the headings 'Potential voting power' and 'Rights and other interests in shares' below). The 15 per cent and 40 per cent control thresholds that currently apply remain unchanged. [ Schedule 1, item 8, subsections 9(1 ) and ( 1A )]

1.24 Some rights in relation to shares are such that the actual number of shares cannot be actually ascertained until the time those rights are exercised. For example, this may be the case where a convertible note is issued in relation to shares equivalent to a specified monetary amount (see paragraph 1.27 for discussion of convertible notes). The number of shares and voting power attached to that instrument would normally depend on the value of the shares at the time of conversion.

1.25 Item 8 also provides that all rights over shares will be treated as having been exercised at a particular point in time (for example, at the time the agreement is entered into, at the time of notification or at the time a decision is made under the Act). This means that the number of shares acquired, if it cannot presently be determined from the terms of the agreement, is to be determined by assuming that the rights are exercisable in all the circumstances that exist at that time. [ Schedule 1, item 8, subsections 9(1B ) and ( 1C )]

Rights and other interests in shares

1.26 Section 11 provides what is considered an 'interest in a share'. It includes 'rights' and 'options' to acquire shares (paragraphs 11(2)(b) and 11(2)(c) respectively) but it is unclear whether these extend to include other types of financial instruments or commercial arrangements which may provide an interest in the corporation, but which are not in the legal form of a share, or which could be converted to newly issued or to existing shares in the future (such as convertible notes).

1.27 To remove doubt, item 9 clarifies the definition of an interest in a share so that it is clear that a right includes a right under an instrument, agreement or arrangement, whether the right is exercisable presently or in the future and whether on the fulfilment of a condition or not. The Bill provides a convertible note as an example of the type of arrangement that would be captured by section 11. A convertible note is a term to describe funding made available to a company with the right to be either redeemed for cash or converted into ordinary shares at a predetermined date or within a certain period. [ Schedule 1, item 9 , subsection 11(2A )]

1.28 While it is now clear that convertible notes are captured by the Amendments, item 9 has been included to ensure that the Act is sufficiently broad enough to capture all financing arrangements that involve a component of control or influence, regardless of the way they are structured. Other types of financing arrangements that would now be captured by the Act include special warrants, as well as other specialised instruments which may be created in the future.

1.29 Items 8 and 9 are key amendments in the Bill because they provide that the compulsory notification provisions in section 26 (as amended in this Bill) explicitly require foreign investors to notify the Treasurer where there is a possibility that the type of arrangement being used will deliver future influence or control over an Australian company which is subject to the Act.

Example 1.1

Company A (which is 100 per cent foreign owned) proposes to acquire an interest in Company B (an Australian corporation valued at $1 billion) by way of convertible notes which may be converted to shares in three years. Company A will not immediately acquire shares or have any voting power in Company B, but in three years' time it will have the option to convert the notes into shares. Upon conversion, Company A would hold a 15 per cent interest in Company B.

Section 11 would now treat these instruments as interests in shares. Accordingly, Company A would be required to notify the Treasurer of the proposal before acquiring the convertible notes.

1.30 It should be noted that these amendments are not designed to capture genuine money-lending agreements. Subsection 11(5) removes from the scope of the Act an interest in a share held by 'a person whose ordinary business includes the lending of money' if 'he holds the interest solely by way of security for the purposes of a money-lending agreement.' Subsection 11(5) will continue to operate as it currently does to ensure that genuine money-lending agreements do not need to be notified to the Treasurer.

1.31 However, if a money-lending agreement includes quasi-equity characteristics, such as options to acquire shares or potential voting rights, it would not be exempt under subsection 11(5) and would require notification.

Prescribed interests in shares

1.32 The concept of 'substantial interest' applies to the compulsory notification provisions in sections 26 and 26A of the Act in two ways. First, the acquirer must be substantially foreign as defined by the 'substantial interest' test (effectively a 'foreign person'). Second, the acquirer must be acquiring a 'substantial interest' in an Australian corporation.

1.33 With respect to the first component, an entity may not be aware (or be able to determine) that it is a person to whom the compulsory notification provisions apply, because with the expanded notion of 'substantial interest', the entity may not know the identity of all persons with 'potential voting power', given the characteristics of derivative instruments and the way they may be traded off-market. It is therefore possible that a company may not know whether it was required to lodge a notice based upon who may hold substantial interests in it.

1.34 Regulations are being drafted to the effect that rights to future shares and potential voting power are disregarded with respect to the first component of the compulsory notification provisions of the Act (that is, in determining whether an entity is effectively a 'foreign person'). The proposed regulation changes are not intended to affect the second component of the compulsory notification provisions (that is, in determining whether the entity is acquiring a substantial interest in an Australian corporation).

1.35 Paragraph 11(5)(c) provides for regulations to be made to disregard 'an interest of a prescribed kind in a share, being an interest of such person, or of the persons included in such class of persons, as is prescribed.' However, it is not clear whether this provision is broad enough to capture the situation described above. Item 9A clarifies that regulations can be made so that an interest of a prescribed kind may also be disregarded in relation to a prescribed provision of the Act. [ Schedule 1, item 9A, subsection 11(5A )]

1.36 This regulation making provision is consistent with the overall design of the legislation which provides for broad coverage in the Act but allows for specific exceptions in the regulations.

1.37 The relevant regulations are currently being drafted to ensure that they commence at the same time as the Bill receives Royal Assent.

Example 1.2

From Example 1.1, Company A (foreign owned) would be required to notify the Treasurer of its proposed acquisition of convertible notes which, upon conversion in three years' time, would represent 15 per cent of Company B (an Australian corporation valued at $1 billion).

Company B subsequently acquires a 15 per cent interest in Company C (an Australian corporation valued at $300 million). At that time, Company B's share register indicates 100 per cent Australian ownership (Company A has not yet converted its notes into shares). The regulations would ensure that Company B would not be considered a 'foreign person' and would not be required to notify the Treasurer of its proposed acquisition of shares in Company C under the compulsory notification provisions of section 26, before such time as any convertible notes are converted into shares.

Tracing of substantial interests in corporations

1.38 Section 12C of the Act currently provides for substantial interests to be traced back through the ownership structures of relevant entities. Although this is intended to incorporate the expanded definition of substantial interest, the existing wording in that section refers to 'voting power' and 'issued shares' as well as 'substantial interest'. Items 9B to 9E ensure that the tracing provisions fully capture the expanded definition of substantial interest (that is, not excluding 'potential voting power' and interests in 'unissued shares'). [ Schedule 1, items 9B to 9E, subparagraph 12C(b )( i ) and paragraph 12C(c )]

Potential voting power

1.39 The Act relies on interests in shares or voting power to determine whether a person has control of a company. Generally, it would be expected that the proportions of shares and voting power would be broadly equivalent. However, as this may not always be the case (the proportion of voting power may be disproportionate for whatever reason) it is necessary to have a separate limb in the substantial interest test that considers voting power.

1.40 Section 14 provides that voting power refers to the 'maximum number of votes that might be cast at a general meeting of the corporation'. Item 12 clarifies the definition of voting power so that it explicitly includes potential voting power. Potential voting power is the number of votes that could be cast if it is assumed that a future right is exercised. This means that if an agreement has the potential to provide some measure of influence or control, either now or in the future, this would be captured by the Act and the investor would be required to notify if the proposal is above the relevant thresholds. [ Schedule 1, item 12, subsection 14(2 )]

Example 1.3

Company A (which is 100 per cent foreign owned) proposes to acquire a 14.9 per cent shareholding in Company B (an Australian corporation valued at $1 billion). However, the proposal includes an agreement between the parties whereby Company A would have special voting rights (equivalent to 15 per cent) in the future upon the fulfilment of certain conditions precedent.

Section 14 would now treat this proposal as potential voting power that, at 15 per cent, would trigger the substantial interest threshold contained in the Act. Accordingly, Company A would be required to notify the Treasurer of the proposal before entering an (unconditional) agreement with Company B.

1.41 Some rights in relation to voting power are such that the actual number of votes cannot be actually ascertained until the time those rights are exercised (similar to rights over shares described at paragraph 1.24). Item 12 provides that all rights to potential voting power will be treated as having been exercised at a particular point in time (for example, at the time the agreement is entered into, at the time of notification or at the time a decision is made under the Act). This means that the level of potential voting power, if it cannot presently be determined from the terms of the agreement, is to be determined by assuming that the rights are exercisable in all the circumstances that exist at that time. [ Schedule 1, item 12, subsection 14(3 )]

Treasurer's power in relation to acquisitions of shares

1.42 The Act provides the Treasurer with the power to prohibit a proposal involving a foreign person obtaining control of a company (valued above the relevant monetary threshold) conducting an Australian business, or of the assets of a business, where he considers this would be contrary to the national interest. The Treasurer's powers operate according to the nature of the investment, including acquisitions of shares, acquisitions of assets, agreements relating to directorate of corporations and arrangements relating to control of Australian businesses.

1.43 Section 18 specifically deals with acquisitions of shares and allows the Treasurer to make an order prohibiting a proposed acquisition of shares, or where the proposal has already occurred, the power to order divestment of the shares. This section also allows the Treasurer to make an order prohibiting a person from acquiring more than a certain percentage of the issued shares or the voting power in a corporation.

1.44 Item 13 amends this section so that it also captures the concept of potential voting power. The clarification of what is considered an 'interest in a share' is already captured by the current wording in the provision. [ Schedule 1, item 13, paragraph 18(3 )( aa )]

The ability to determine the policy of the corporation or business

1.45 The notion of control relies on the person (or persons) being in a position to determine the policy of the corporation or business. To avoid any doubt, items 14 and 15 clarify that the ability to determine the policy of the corporation or business applies in relation to any matter. [ Schedule 1, items 14 and 15, paragraphs 20(5 )( a ) and 21(5 )( a )]

Compulsory notification of substantial interests

1.46 Section 26 of the Act currently provides for compulsory notification of acquisitions of 'substantial shareholdings'. To ensure that the compulsory notification provisions are broad enough to capture other financing arrangements (other than traditional shares), all references to 'shares' and 'shareholding' throughout section 26 have been replaced by references to 'substantial interest' or 'rights' as appropriate (items 16-19 and 21). This is consistent with the policy intent of the amendments of clarifying the Act to ensure that it applies equally to all foreign investments irrespective of the way they are structured. [ Schedule 1, items 16 to 19 and 21, paragraphs 26(2 )( a ) and ( b ), ( 3 )( b ), and subsections 26(5A ) and ( 7 )]

1.47 Subsection 26(6) provides that the compulsory notification requirements apply to any acquisition of shares (not just an acquisition of a substantial interest), where that acquisition would result in the foreign person:

•

increasing an existing substantial interest (paragraph (a)); or

•

holding a substantial interest (paragraph (b)).

1.48 Item 20 amends this provision to incorporate the expanded definition of substantial interest (amended at item 8). [ Schedule 1, item 20, subsection 26(6 )]

1.49 Subsection 25(4) and section 28 provide that notifications of acquisitions of options over shares or assets are deemed to include the exercise of those options, ensuring that a second notice is not required upon the exercise of those options at a later date. However, these provisions do not currently extend to other types of 'rights'.

1.50 Items 15A, 22 and 23 extend this provision to other types of rights over shares or assets so that there would be no additional requirement to notify the subsequent exercise of that right. [ Schedule 1, items 15A, 22 and 23, subsection 25(4 ) and section 28 ]

Application and transitional provisions

Commencement

1.51 The provisions contained in Schedule 1 apply from 12 February 2009. The Treasurer's Press Release indicated that these amendments would apply from the date of announcement. This ensured that proposals entered into after that time would be captured by the amendments.

Transitional provisions

1.52 As the amendments in Schedule 1 apply retrospectively from 12 February 2009, a transitional period will apply from 12 February 2009 to the date of Royal Assent to ensure that foreign investors are not adversely affected by the start date of these amendments.

1.53 During the transitional period, there will be no criminal penalties for failure to notify the Treasurer of a proposed investment of the type covered by the amendments. Retrospective criminal prosecution for an offence under subsection 26(2) is expressly excluded by the transitional arrangements. The offences excluded will not be able to be prosecuted retrospectively as they are contingent upon the Treasurer having the power to issue an order that can not be exercised until the Bill receives Royal Assent. [ Schedule 2, item 1 ]

1.54 The Treasurer will still have the power to impose conditions upon such proposals or transactions if notified following Royal Assent to the Bill, and criminal penalties will apply if the conditions are not complied with. [ Schedule 2, item 1 ]

1.55 The transitional arrangements provide that foreign investors will have 30 days to notify the Treasurer if, during the transitional period, they entered into a transaction of the type covered by these amendments and have not already provided notification to the Treasurer. Consistent with the broader approach adopted elsewhere in the Act, criminal penalties apply where investors fail to notify the Treasurer within the 30 day period. [ Schedule 2, item 2 ]

1.56 It is not expected that many investors will be caught by the transitional arrangements. The Foreign Investment Review Board has been monitoring compliance with the announced changes and it appears that, as the proposed amendments have been broadly anticipated, investors are voluntarily complying with the changes.

Consequential amendments

1.57 Items 1-6, 10 and 11 are consequential amendments related to the substantive amendments outlined above, or minor technical amendments reflecting current drafting practices. [ Schedule 1, items 1 to 6, 10 and 11, subsection 5(1 ), paragraphs 5(4 )( a ) and ( c ), and section 14 ]