By Andrew Lumsden, Corrs Chambers Westgarth, Sydney

The national interest test has always been an opaque standard. The test was introduced in 1986 and was intended to reflect a changed bias towards foreign investment, but it has been the subject of substantial criticism.

In a sense, the test is both a strength and the weakness of Australia's foreign investment policy. The recent decision by the Treasurer to reject the takeover of ASX Limited by the Singapore Exchange emphasises the difficulty of pinning down what is “the national interest”.

The decision of the Treasurer to publish his reasons is an unusual but welcome step towards transparency in the FIRB process.

Background

Australia is a subscriber to the OECD Declaration on International Investment and Multinational Enterprises. Australia’s regulatory regime sits in the mid-point of OECD

countries in terms of its relative level of restrictiveness. Australia’s score is held back by the fact that the national interest test is seen as a “discriminatory screening requirement”, even though the onus of proof that a foreign investment proposal is “contrary to the national interest” rests with the Government and not with the investor. Indeed the OECD’s annual Going for Growth found that screening might create uncertainties that limit foreign direct investment. The review suggested that:

Transparency would be enhanced by more information on the criteria applied in government decisions and by involving specialist agencies (e.g. national securities) in the review process of FDI approval. Australia’s investment policy is decidedly pro-investment. Australia rarely invokes the national interest test to reject foreign investments.

In the case of the ASX–SGX deal, an inherent problem was that the transaction was never seen as a merger of equals. It was always characterised as an SGX takeover. In this sense no

matter what concessions were made, there were deep seated concerns that the deal would not give ASX a sufficient voice. This point is expressly acknowledged in the Treasurer’s reasons:

To diminish Australia's economic and regulatory sovereignty over the ASX could only be justified if there were very substantial benefits for our nation, such as greatly enhanced opportunities for Australian businesses and investors to access capital markets. Given the size and nature of the SGX – which is a smaller exchange with a smaller equities market than the ASX – the opportunities that were offered under the proposal were clearly not sufficient to justify this loss of sovereignty.

The Government and FIRB have consistently been reluctant to approve foreign acquisitions which might result in parties who have lower levels of interest in developing Australian assets ahead of other global interests. In the case of Woodside Petroleum in 2011 there were substantial concerns that the proposed new owners (Royal Dutch Shell) would not have an interest in developing the Australian asset ahead of their other global assets. Again the Treasurer’s reasons point to this feature:

It is in the national interest for Australia to maintain the ongoing strength and stability of our financial system, and ensure it is well placed to support the Australian economy into the future. It is important that we continue to build Australia's standing as a global financial services centre in Asia to take best advantage of the benefits of our superannuation savings system. I had strong concerns that the proposed acquisition would be contrary to these objectives.

While there have been calls for the national interest test to be more precisely defined and for the role of the Treasurer to be replaced with an independent body that would not achieve the same functional purpose as is provided by the existing test. What is then the existing test and how is it applied?

So What is Australia’s National Interest?

In many respects the national interest is “a bit like an elephant” – hard to describe but you know one when you see one. As Ashton Calvert commented in 2003, "The Australian national interest is something that is defined by the Australian Government and the Australian people. It is not static and cannot be defined in a mechanical way."

The legislation does not provide a mechanical definition or guidelines against which to measure the national interest. FIRB as the advisory body to the Treasurer is not obliged to reveal either how it arrived at a decision or its recommendation to the Treasurer. That is entirely consistent with usual general principles of advice from Treasury to its minister. The Treasurer is not compelled to provide justification or clarification for the reasons for his or her decision. This has resulted in accusations of political expediency and of failing tests of transparency and openness that no one would expect in a democracy like Australia.

In the case of the SGX merger it is helpful that the Treasurer has provided insight into his thinking in prohibiting the acquisition of ASX by SGX. In March 2009 the Treasurer issued

statements in connection with the Oz Minerals takeover and has issued details of conditions attaching to transactions but he has not previously issued formal reasons. The national interest includes the following:

• preserving of national security;

• preserving of Government revenue;

• evidence that the participant will respect Australian law and business practices;

• avoiding inappropriate levels of competition or excessive concentration;

• consistency with Government policies; and

• the character of the investor.

Of these, the most ambiguous is the national security test. This test has on occasions been applied to prohibit acquirers from purchasing mining assets that were considered too close to the Woomera prohibited area and in the SGX transaction it was considered by reference to the systemic security of the Australian financial system. That said, the Treasurer’s decision took into account the “importance of maintaining the effectiveness of Australia’s regulatory framework and the Government’s objective of building Australia’s standing as a regional financial services centre.”

The SGX decision was also apparently based on “the importance to Australia and its long term economic wellbeing of the development of the ASX as a primary equities and derivatives exchange and sole clearing house.”

There is no doubt that the Treasurer formed the view that the role that ASX played in the Australian financial system was such that the takeover by SGX may have meant a loss of “full regulatory sovereignty” that might have a negative effect on Australian regulatory authorities' capacity to protect the system from financial crisis.

The ASX also operates infrastructure that is critically important for the orderly and stable operation of Australia's capital markets. Both the Reserve Bank of Australia (RBA) and the Australian Securities and Investments Commission (ASIC), carefully review the operations of the ASX on an ongoing basis and have been satisfied that it is meeting its obligations and remains a robust operation. However, FIRB's recommendation, which incorporated advice from ASIC, the RBA and the Australian Treasury, was that not having full regulatory sovereignty over the ASX-SGX holding company would present material risks and supervisory issues impacting on the effective regulation of the ASX's operations, particularly its clearing and settlement functions. Australia's financial regulators have advised me that reforms to strengthen our regulatory framework should be a condition of any foreign ownership of the ASX to remove these risks.

This analysis is not surprising. The Australian clearing and settlement system has been the subject of a number of enquiries following the global financial crisis, including the Review of

Settlement Practices for Australian Equities in May 2008. The Treasurer found that the clearing and settlement system operated by ASX was critical to the smooth functioning of

the Australian financial system. FIRB advised him that there was a genuine concern that the wider role of Government as a regulator meant that he ought to be careful before he agreed to give up flexibility over the market mechanism. In part this is an acknowledgement that the rules are never going to be perfect and they do not necessarily anticipate all the consequences or “externalities” that may arise.

The Treasurer asked the Council of Financial Regulators to establish a working group to consider measures to protect the interests of Australian issuers, investors and market participants. Clearly there was a perceived need to preserve the ability of our financial supervisors to maintain “robust oversight in all market conditions, including in the event of a future commercial arrangement between the ASX and another exchange”.

Conclusion

In 2005 the Financial Times described the national interest test as a “protectionist relic” that does not fit with the Australian Government’s free market principles. The Times argued that screening foreign investments was common among countries but that few countries “operate regimes that are more opaque, unaccountable or open to political and bureaucraticmanipulation”.

While some of the criticism meted out by the Times is warranted, this ought not be a reason to abandon the test. The test serves a useful function for the Government as a macro economic regulator of the economy.

The Government ought to retain the flexibility to be able to deal with the consequences or externalities that may arise from a foreign takeover. That said, as noted by the OECD there is great merit in increased transparency around the process and this would be enhanced by a regular process of providing detailed decisions by which others could judge how the process operated.