Has Canada shut the door on foreign SOEs?

February 2013 | FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Following months of speculation, and a great deal of anxiety among business leaders and politicians, in early December the Canadian government finally announced its controversial new policy guidelines regarding the proliferation of foreign direct investment (FDI). The new policy focuses primarily on imposing new, more restrictive controls on any foreign state-owned enterprises (SOEs) wishing to purchase Canadian businesses. Most notably, the new directive is designed to check the progress of SOEs into the valuable Canadian oil sands in Alberta – an area which boasts the third largest oil reserves in the world. In light of the new guidelines, those oil sands have now become a semi-protected sector in their own right.

Minister of Industry Christian Paradis and Prime Minister Stephen Harper announced the government’s new stance alongside the decision to approve the proposed takeovers of global energy companies Nexen Inc and Progress Energy Resources Corp by CNOOC Ltd and PETRONAS – Chinese and Malaysian SOEs, respectively.

The deals for Nexen and Progress will be the final two acquisitions by foreign SOEs to be considered and approved under existing FDI policies. The government’s approval, however, was overshadowed by the accompanying, wide ranging caveats related to SOEs.

The government’s decision to create a more onerous policy regarding future SOE investment has been a contentious one, applauded and castigated in almost equal measure. Speaking at a press conference for the announcement, Mr Harper declared that the decisions to allow the two protracted takeovers to be completed represented “not the beginning of a trend, but rather the end of a trend”.

Under the existing Investment Canada Act (ICA), in order for a foreign investor to complete an acquisition of a Canadian business with a minimum of C$330m worth of assets, it must first gain the approval of the Minister of Industry by proving that the deal would be of net benefit to Canada in areas such as employment, resource processing, exports, productivity and Canadian participation.

The new policy guidelines state that the C$330m threshold will remain, but for private transactions it will rise to C$1bn. SOEs may still acquire minority stakes in Canadian businesses, where they will be subjected to the same level of scrutiny as private investors. The definition of SOEs will also be amended within the new guidelines; entities influenced directly or indirectly by foreign governments will now be classified as SOEs.

Furthermore, before any kind of ministerial approval is granted, the government must now determine the degree of control or influence a state-owned enterprise would likely exert on the Canadian business that is being acquired; the degree of control or influence that a state-owned enterprise would likely exert on the industry in which the Canadian business operates; and the extent to which the foreign government is likely to exercise control or influence over the SOE purchasing the Canadian business. It would appear that the government’s new policy direction is designed to discourage SOEs from attempting to invest in the oil sands, but not necessarily prohibit them from doing so.

Despite approving the CNOOC deal, and strengthening links between Canada and China in recent years, the Harper government has decreed that any future bids by foreign SOEs would only be considered in exceptional circumstances. “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,” said Mr Harper.

The proposed $15.1bn takeover of Nexen would be the largest ever foreign investment by a Chinese firm. At the time of writing, the deal has yet to be completed. Authorisation has not yet been obtained from the Committee on Foreign Investment in the United States (CFIUS). US approval is required before completion as Nexen has assets in the Gulf of Mexico. The company also has assets in the UK, although regulatory approval is not required there. It is expected that the acquisition will be completed in the first quarter of 2013.

Delays and rejection

The approval of the deals for Nexen and Progress had been a long time coming. CNOOC and Nexen announced they had agreed a deal on 23 July 2012 and PETRONAS’ acquisition of Progress was announced on 28 June. Although shareholders of both firms had approved the takeovers, the Canadian government, under the terms of the ICA, was able to extend the timeframe in which it could approve or reject the deals.

This issue was particularly pertinent for the Nexen deal – CNOOC being a Chinese SOE gave cause to Mr Harper and his government to review the transaction in greater detail. In addition to the usual net benefit tests which must be satisfied, the Harper government needed to be sure that the Nexen deal would not allow the Chinese government to exert an undue degree of control over the company and its assets. When discussing approval of the deal, Mr Harper said “To be blunt, Canadians have not spent years reducing the ownership of the economy by our own governments only to see them bought and controlled by foreign governments instead.”

The Canadian government also needed to be sure that the acquisition of Nexen by a Chinese SOE would not represent a threat to national security. The compromise of national security was brought into sharp focus in October 2012, when the US House of Representatives Intelligence Committee suggested that US firms should not be allowed to do business with Chinese telecommunications firms Huawei Technologies Co Ltd and ZTE Corporation. The report postulated that both firms posed a security threat in the US due to their ties to the Chinese state and military.

As for the Progress deal, PETRONAS’ acquisition was initially rejected by Mr Paradis under the ICA, as it was felt that PETRONAS had not demonstrated that its proposed acquisition of Progress would be of net benefit to Canada. This was only the second deal to have ever been rejected under the ICA, following the rejection of BHP Billiton’s highly controversial $39bn bid for the Potash Corporation of Saskatchewan Inc in November 2010. Once approval of the PETRONAS/Progress deal was received, the transaction was quickly finalised. It was completed on 12 December for $5.2bn.

Is Canada open for business?

The government’s decision to approve the deals, particularly with regard to Nexen, has sparked great debate throughout the country. Some analysts have praised the decision, believing that agreeing to the Chinese takeover will afford the Harper government a better position when discussing a proposed, broader free trade agreement. The Chinese firm was also required to make a number of concessions in order to complete the deal. CNOOC pledged that it would make Calgary its North and Central American headquarters; it would retain Nexen’s current management team and employees; and it would list CNOOC shares on the Toronto Stock Exchange.

The Nexen decision came in the same year that the two nations signed the Canada-China Foreign Investment Promotion and Protection Agreement (FIPA). The agreement was signed in September 2012 and it continued the strengthening of relations between the countries. FDI between the two increased by more than five times between 2005 and 2011, rising to $15.4bn. Equally, bilateral trade between the countries has increased six-fold, increasing from $11bn in 2001 to $65.6bn in 2011.

While designed to help protect a valuable sector of Canadian industry, the policy also plays nicely with public sentiment. Increasingly, more Canadians are concerned with rising levels of foreign SOE control of valuable assets. Seventy-eight percent of Canadians polled by Angus Reid in October 2012 believe that foreign governments should not be able to control Canadian resources. The tough new stance adopted by the Harper government will help placate those concerned.

The CNOOC takeover, therefore, represented a something of a puzzle. Having openly courted China and invited investment into Canada, a rejection of the Nexen deal would have been a very public slight of high profile Chinese investors. However, by accepting the deal, the Harper government has also opened itself up to allegations of weakness in the face of the more powerful, capital-rich Chinese.

Criticism of the government’s decision over the Nexen deal has been fierce. Thomas Mulcair, leader of the opposition New Democratic Party (NDP) declared that the government had sold out the country’s natural resources and that Mr Harper had failed to recognise the difference between selling a Canadian company to a Chinese company and selling a Canadian resource to the Chinese state. In a statement, Peter Julian, the NDP’s spokesman on natural resources said the Nexen deal was a “farce”. Furthermore, the government’s own natural resource minister Joe Oliver suggested that the Nexen deal would not have been approved under the new SOE rules.

The vague nature of the new policy has also drawn the ire of analysts and politicians. Mr Harper and his government have noted that, although each case will be considered on its merits, future SOE acquisitions would only be accepted in “exceptional circumstances”. Unfortunately, the minister did not clarify the nature of those circumstances. When questioned further regarding those circumstances, Mr Paradis would not be drawn.

It is not known whether this new policy will cool interest from foreign investors looking to make inroads into Canadian industry, particularly the natural resources sector. The government has stated previously that it requires $657bn worth of investment in the next 10 years to develop and exploit the sector to its full extent. The hazy terms of the new policy may deter investors from looking to Canada in the future. That said, in lieu of outright takeovers, joint ventures and minority interest, non-controlling stakes will still be viable, less regulated options for SOEs going forward. How attractive those propositions will be remains to be seen.

The future of FDI in Canada remains as ambiguous as the government’s new policy. In his press statement Mr Harper noted “When we say that Canada is open for business, we do not mean that Canada is for sale to foreign governments.” But if the Canadian government was hoping to open up the notoriously closed off Chinese markets with a free trade agreement and increase the flow of significant foreign capital into Canada, following the new SOE guidelines, it may find those routes remain closed off for the foreseeable future.

Richard Summerfield