FI Monitor Issue 6, 2023

An expanded Australian screening process placing FDI under greater scrutiny 

Contributed by Geoff Hoffman and Kirsten Webb at Clayton Utz, which is part of the Freshfields StrongerTogether network.

With a strong economy, stable political environment and proximity to key regional markets, Australia is highly attractive to foreign investors. Indeed, foreign investment is critical to the country’s long-term economic success. Nevertheless, in recent years Australia has introduced a number of reforms that have resulted in a foreign direct investment (FDI) regime that is much more extensive in reach than ever and covers a broader range of transactions.

This expansion is partly due to concerns over a global socio-economic environment that is less stable than in previous years. Further, rapid technological advancement coupled with geopolitical and security challenges have seen heightened concern around cyber-attacks, which potentially affect not just defense assets but also major transport infrastructure, the banking system and a range of other sectors. In this respect, the Australian approach towards FDI reflects the wider global landscape in which many countries have reviewed and strengthened their FDI frameworks.

Crucially, amendments to the Security of Critical Infrastructure Act 2018 have expanded the scope of what is considered a “national security business” while simultaneously lowering the threshold for coverage under the Act. Previously, the definition only covered large electricity, gas, water and port infrastructure assets, as well as traditional defense assets. The new definition now covers industry sectors such as telecommunications, food and grocery, financial services and banking, and higher education and research to name a few. As a result, investments of 10 percent or more in the newly expanded list of industries are subject to a mandatory, suspensory filing requirement, regardless of the value of the investment. Foreign investors seeking to acquire businesses in these newly covered sectors will need to evaluate – and factor into their transaction timelines – the potential need to obtain Foreign Investment Review Board (FIRB) approval and, if so, when to approach FIRB. 

Australian reforms have introduced significant changes to the filing fee regime, which is complex and subject to multiple exceptions and rules for specific situations. For foreign investors looking to acquire an interest in Australian entities, assets or land, the application fees have doubled and can reach over A$1m for acquisitions of more than A$2bn. There is also a more assertive enforcement function within FIRB with significantly increased penalties for failures to notify and obtain required approvals, and investment in an expanded enforcement capability.

Unsurprisingly, the impact of these reforms has been significant. The broadened definition of national security business and the accompanying reduction in investment threshold for triggering the FIRB approval requirement have resulted in an increase in applications to FIRB for transaction approval. The effect is that the regime now requires review and approval of even very small and non-substantive transactions involving national security businesses, including indirect changes of ownership arising from offshore transactions. According to FIRB statistics, in the six months to December 2022, newly covered transactions subject to the mandatory regime accounted for nearly 10 percent of all notifications. The average value of those marginal transactions was approximately A$58m, or about 40 percent of the average value for all other transactions for which approval was sought (which is about A$150m).

Merger Control Interplay

The expanded scope of coverage also highlights the interplay between FIRB and the Australian Competition and Consumer Commission (ACCC), which administers the merger control regime. If a transaction is likely to face antitrust scrutiny, investors and companies must think very closely at the outset of the transaction about whether FIRB approval is mandatory or merely advisable. The ACCC cannot block transactions on its own authority (as the European Commission can), yet it can apply to the court to do so (as the US agencies also must). However, if a transaction is subject to FIRB approval, FIRB will not approve the transaction if the ACCC has concerns. This results in FIRB approval becoming a de facto instrumentality for the ACCC to block transactions without ACCC approval.

In global M&A deals where the target has an Australian subsidiary or business, it is possible that the transaction will fall within the voluntary (as opposed to mandatory) FIRB notification regime. This regime provides that parties can complete the transaction without prior approval but gives the Treasurer the right to unwind a transaction if they subsequently determine that the transaction is contrary to the national interest. Therefore, where the parties are seeking regulatory approvals in various jurisdictions for such transactions, it is generally considered prudent to also file in Australia under the voluntary notification regime.

However, if a transaction falls into the voluntarily notifiable category, once the parties have notified FIRB, they cannot complete the transaction until approval is provided – and, as explained above, if the ACCC has concerns with the transaction, they can effectively block the transaction unless they are satisfied.

Therefore, when subject only to the voluntary regime, companies may wish to consider not notifying FIRB and completing the transaction, leaving them free to pursue any strategy they wish from an ACCC perspective.

Eyes on Chinese investors as data security concerns mount

In line with developments elsewhere in the world, Australia’s FDI reforms have occurred in parallel with the perceived shift in China’s position, leading to increased scrutiny of Chinese investors. Ordinarily, transactions which will not obtain approval are withdrawn rather than publicly blocked. Nonetheless, in recent years, we have seen some public prohibitions by FIRB of acquisitions by entities with Chinese interests, such as a lease over the electricity transmission network in New South Wales and South Australia. While the government is careful not to overtly single out individual countries as the subject of scrutiny, companies perceived to be the subject of some form of state ownership or control draw the most scrutiny. China has many state-affiliated companies, and it remains one of the top five foreign investors in Australia.

Strategic investors are subject to closer scrutiny by FIRB than financial investors if they already have a presence in Australia. By contrast, financial investors are perceived as being more friendly than strategics from a foreign investment perspective. That said, private equity funds with large foreign government investors, including sovereign wealth fund investors, are effectively treated as foreign government investors and draw corresponding scrutiny from FIRB. Australia’s regime reserves the closest scrutiny for investments by foreign government investors.

Data security has been a longstanding concern for the Australian government when reviewing foreign investments. This trend continues to be a significant factor in the government's scrutiny of offshore transactions. For example, if a target Australian business has databases containing personal details of Australian citizens, or government contracts with access to sensitive government data, the transaction will be subject to more stringent scrutiny. As a condition of approval, FIRB may impose conditions concerning the handling of that data and require independent audits to monitor compliance.

Further changes on the way

The Australian government is introducing the new Register of Foreign Ownership of Australian Assets from 1 July 2023. We expect the new register to impact foreign investors both directly and indirectly. The new reporting regime will both require companies to have new internal systems to enable compliance and require reporting of disposals of interests, necessitating a significant change in the approach to FIRB and requiring significant investment in processes and systems.