Update: The Harper government has approved both CNOOC Limited’s $15.1-billion acquisition of Nexen Inc and Petronas’ $5.2-billion acquisition of Progress Energy Resources Corp. Read the full story here.
The Harper government has until Dec. 10 to allow or block the proposed $15-billion takeover of Calgary-based energy oil and gas producer Nexen by China National Offshore Oil Company. In September, Nexen shareholders approved CNOOC’s bid by an overwhelming 99-per cent margin. The government is reviewing the deal under the Investment Canada Act, which mandates public scrutiny of foreign takeovers worth over $330 million. Normally, the decision would sit with the minister of industry, who is charged with assessing whether the investment is of “net benefit” to Canada. CNOOC’s case, though, is more complicated than that, for two reasons. First, the Chinese energy behemoth is a so-called “state-owned enterprise,” for which the government has set out additional guidelines. Second, earlier this year, the Canadian Security Intelligence Service warned that firms “with close ties to their home governments have pursued opaque agendas or received clandestine intelligence support for their pursuits here.” So the Nexen takeover might also have triggered review under national security parameters, even though CSIS never specifically mentioned CNOOC. Under the Investment Canada Act, a national security review would be in the hands of the cabinet, not just the Minister of Industry.
Below is our Q&A on the matter with Debra Steger, a law professor at the University of Ottawa and senior fellow at the Centre for International Governance Innovation. Steger, a former senior WTO official and trade negotiator for the Canadian government, explains what we do and don’t know about the ongoing review, how our process stacks up to that of the U.S. and other countries and why all this matters:
How much do we know about the review process through which Ottawa is assessing the CNOOC/Nexen deal? Is it about “net benefit,” national security or both?
The Investment Canada Act provides for two types of reviews: one that looks at whether a foreign investment is “likely to be of net benefit to Canada” and one that looks at whether it could pose a threat to national security. In this case, we don’t know if the federal government is conducting a “net benefit” or a “national security” review or both. It could very well be conducting a combination of both types of reviews and requiring undertakings from CNOOC to respond to the economic and national security concerns raised in these reviews. The time periods may have been extended to give the government and CNOOC more time to negotiate undertakings as conditions for approval of the acquisition. These undertakings, if the acquisition is approved, will be enforceable in the Canadian courts.
A “net benefit” review, conducted by Industry Canada and decided by the Minister of Industry, is required for any direct acquisition of a Canadian business by a foreign enterprise of a member of the World Trade Organization where the asset value of the Canadian business is $330 million or greater. The test is whether the acquisition is “likely to be of net benefit to Canada” based on different factors specified in the Investment Canada Act including: effect on economic activity in Canada, employment and resource processing; degree of participation by Canadians in the business; the effect of the investment on productivity, product variety, industrial efficiency, technological development, innovation and competition in Canada; compatibility of the investment with Canada’s industrial, economic and cultural policies; and contribution of the investment to Canada’s ability to compete in world markets. In assessing the likely net benefit relating to an acquisition by an state-owned enterprise (SOE), such as CNOOC, guidelines issued in 2006 provide that additional factors must be taken into account including: the corporate governance and reporting structure of the SOE (for example, whether it follows Canadian standards of corporate governance), the degree to which the SOE is owned or controlled by the state, and whether the Canadian business being acquired will have the ability to operate on a commercial basis in the future.
A “national security” review applies to a broader range of investments than a “net benefit” review. It can apply to any investment to establish a new business, to acquire control of a Canadian business, or to acquire, in whole or in part, or to establish an entity carrying on all or part of its operations in Canada. If he has reasonable grounds to believe that the investment would be injurious to national security, the minister of industry will send a notice to a non-Canadian investor that a review may be ordered, and after consultation with the minister of public safety, ask the Governor-in-Council to determine whether a national security review should be ordered. If the Cabinet orders a review, it will be carried out by the Minister of Industry (in consultation with other government departments) who will submit a report to the cabinet. The Governor-in-Council will ultimately decide whether to take any measures necessary to protect national security. As in a “net benefit” review, an applicant can be required to make undertakings as a condition of approval of its investment. Decisions of the G-in-C are final and cannot be appealed, but they can be subject to judicial review.
What about the Foreign Investment Promotion and Protection Agreement Canada and China ratified just a few weeks ago, does that apply to the CNOOC/Nexen takeover?
No, Annex D.34 of the Canada-China FIPA provides that any decision whether or not to approve an investment that is subject to review under the Investment Canada Act is excluded from both state-to-state and investor-state dispute settlement. In other words, no decision under the Investment Canada Act to approve or not approve an investment can be subject to dispute settlement under the Canada-China FIPA.
The CNOOC/Nexen case appears to be quite different from BHP’s proposed purchase of Potash, which was turned down in 2010. Is there a prior review that could be seen as precedent for the CNOOC deal?
No, each review is based on information provided by the applicant, the Canadian business being acquired, and any interested Canadian province, and the decision is made on the basis of the specific facts of that case. There is no formal, transparent, judicial or quasi-judicial process. Rather, the process is an internal investigation conducted by Industry Canada officials in the case of a “net benefit” review. If Industry Canada officials take the view that there is a concern with the investment under one or more of the factors in the Act, they will advise the applicant and give the applicant an opportunity to provide written undertakings as to how it will resolve the issues raised. The Act was amended in 2009 to require that written reasons be given for “net benefit” review decisions. There is no appeal from a “net benefit” review decision, although judicial review may be available.
In the case of a “national security” review, the process is even less transparent, although it would appear that more government departments are consulted for their input. There are no criteria defining what constitutes a “threat to national security” in the Act or regulations, and no written reasons are published. As the decision is ultimately taken by the Governor-in-Council, the national security process is shrouded in secrecy, there is no appeal, and it would be difficult for any decision to be treated as a precedent as no one knows what happened in a particular case or even if a national security review was conducted. In this case, for example, we do not know whether or not a national security review has been carried out.
Should the government block the takeover, can CNOOC appeal? And should Ottawa approve the deal, can the government impose additional conditions on how CNOOC conducts its business in Canada at a later date if new security concerns arise?
There is no appeal from either a “net benefit” or a “national security” review under the Act. However, CNOOC could seek judicial review of either decision if there are grounds for review. This would be difficult given the non-transparent nature of the internal government investigation process for both types of reviews. In the case of a “net benefit” review, the government must provide reasons for its decision, so there may be a basis, in some cases, on which to ground a judicial review application. However, given the opaque and highly secretive nature of a “national security” review, and the fact that the decision is ultimately taken by the G-in-C, it would be highly unlikely that a judicial review application would succeed.
A more likely scenario is that the government has been negotiating undertakings with CNOOC to ensure that the new Canadian business will operate in a commercial, transparent manner adhering to Canadian corporate governance standards and allaying concerns with respect to national security. These undertakings could include commitments to retain a certain number of Canadian directors on the board of the Canadian company, a number of Canadian employees in senior managerial positions, shares on a Canadian stock exchange, and/or a Canadian office or headquarters.
The deal also triggered review in the U.S., the U.K. and the E.U., where some of Nexen’s assets are located. Just today, it was approved by the European Commission, whereas the judgement is still out in Washington and London. Would the takeover be implemented in Canada if it is blocked elsewhere?
If the investment is approved under the Investment Canada Act, it could proceed in Canada with respect to the Canadian assets and operations of Nexen. However, if the investment is not ultimately approved in other jurisdictions, Nexen and CNOOC may have to restructure their overall deal relating to Nexen’s assets in those countries.
How does our review process compare to that of the U.S. and other countries where China has been eager to invest?
When it comes to whether a foreign acquisition will be reviewed or not, Canada treats SOEs like any other investor: only investments that would establish foreign control of a Canadian business valued at or over $330 million in assets are reviewable under the “net benefit” procedures. However, if an acquisition is reviewable, there are specific guidelines on SOEs meant to ensure that the governance and commercial orientation of the SOE is of “net benefit” to Canada. In the U.S. and Australia (another country that has seen a heavy influx of Chinese investment) any direct acquisition for control of a national company by an SOE is reviewable regardless of the value of the company. In other words, all three countries have specific factors they consider when reviewing SOEs, but Canada does not review direct acquisitions by SOEs below the $330 million threshold. On the other hand, when it comes to “national security” reviews, Canada can potentially review a broader range of investments than the other countries.
The U.S. could potentially review more SOE investments than Canada given its rules. All transactions involving a “foreign entity controlled by a government” acquiring control (which includes a dominant minority interest) of a U.S. company must be reviewed. Also, all transactions that “threaten to impair national security” must be notified pursuant to regulations which list twelve specific factors that include economic security as well as national security. An interagency Committee on Foreign Investment in the U.S. (CFIUS) decides whether to conduct a review “only if” there is “credible evidence” that the foreign investment will impair national security. In the past, CFIUS has rarely conducted reviews, few cases have been ultimately sent to the President for decision, and he has rarely prohibited an investment, but that could change. The process is very secret, cases are often resolved through negotiations between the applicant and officials, in some cases, the applicant may decide to withdraw and not proceed with the investment (as in the Dubai Ports case).
In Australia, any direct acquisition by a foreign government or a related entity regardless of the value must be notified to the government and prior approval must be obtained. For non-SOEs, interests of 15 per cent or over in an Australian business valued above $231 million must be notified. There are also special rules relating to real estate, banking, shipping, airlines and airports. The test is whether the investment is not contrary to Australia’s national interest. Factors taken into consideration are: national security, competition, other government policies (including tax and environmental impact), impact on the general economy and the community, and the character of the investor. For SOEs, in particular, considerations include whether it operates on a transparent, commercial basis, is subject to adequate and transparent regulation and supervision, and has good corporate governance practices.
Compared to the U.S. and Australia, Canada’s Act, with the two review processes for “net benefit” and “national security,” is confusing and difficult to apply in practice, as in this case involving CNOOC. The “national security” process is also highly non-transparent in that there are no criteria specified for a review and no decisions are ever made public. The U.S. has one test for direct acquisitions: national security, with a list of 12 factors. These are wide-ranging and include: domestic production for national defence requirements, potential effects on U.S. technological leadership in areas affecting national security, potential effects on critical infrastructure in the U.S., long term projection of U.S. requirements for energy and other critical resources and materials. The U.S. approach is more specific, transparent, and integrated than the Investment Canada scheme. The U.S. CFIUS model also requires nine agencies to work together to carry out reviews. This would appear to allow for a broad range of views and better decision making than the Canadian approach in which Industry Canada plays the lead role.
What impact would a rejection of CNOOC’s bid have on Chinese investment in the oil patch?
Chinese investment in the oil sands as well as in other natural resource industries in Canada is on the rise and will continue to increase regardless of the outcome of this review. In 2011, CNOOC made a major move into the oil sands by purchasing 100 per cent of OPTI Canada for $2.1 billion. Sinopec acquired Daylight Energy in 2011, and made a $4.65 billion investment in Syncrude in April 2010. China Investment Corporation (CIC), a sovereign wealth fund with an office in Toronto, made an investment of $817 million in a new oil sands joint venture with Penn West Energy Trust in May 2010; it also made a $1.5 billion investment in Canadian mining company, Teck Resources, in 2009. Petro China invested $1.9 billion in Athabasca Oil Sands Corp. in late 2009.
Some of these investments by Chinese enterprises were not reviewable because they were minority investments in Canadian businesses (even though these investments may have been significant in terms of dollar value). But a new trend has begun to emerge whereby Chinese SOEs are making acquisitions for direct control of Canadian companies, as in the cases of Daylight Energy, OPTI Canada, Athabasca Oil Sands, and Nexen. To date, around five acquisitions by Chinese SOEs have been reviewed and approved without fanfare.
My prediction is that the government will allow the investment, albeit with a requirement for undertakings designed to ensure that the resulting business operates in a transparent and commercial manner in accordance with Canadian corporate governance norms and is likely to provide net benefit to Canada.