New rules for a new international security environment: Ongoing reform to Australia’s foreign investment review framework

On 31 July 2020, the Australian government released the exposure draft legislation for its proposed reforms to the foreign investment review framework and has commenced a four-week consultation inviting public submissions on the draft legislation before 31 August 2020. 

The exposure draft legislation that has been released includes the Foreign Investment Reform (Protecting Australia’s National Security) Bill 2020 (Cth) (FIRB Reform Bill), which will amend the Foreign Acquisitions and Takeovers Act 1975 (Cth) (FIRB Act) to provide the framework for the new regime and the first part of the government’s proposed amendments to the Foreign Acquisitions and Takeovers Regulation 2015 (Cth) (FIRB Regulation).

The exposure draft legislation deals with:

• the new national security test, including:
  • the definition of a “national security business”, foreign investment in which will be subject to the national security test
  • the framework for mandatory notification of investments in sensitive national security businesses and the ability to “call in” investments for review
  • the government’s powers to impose conditions on or block such investment and the “last resort” power to require divestment of a realised investment where national security risks emerge.
• the new monitoring and investigative powers to be granted to the Federal Government to monitor and investigate investor compliance with the reformed FIRB Act and FIRB Regulations
• the additional regulatory powers, including the issuing of directions and infringement notices and the imposition of increased civil and criminal penalties, that the government will be granted to enforce the FIRB Act and FIRB Regulations
• various amendments relating to the integrity of the existing foreign investment review framework, including:
  • requiring further FIRB approval for creep acquisitions and proportional increases in interests beyond those previously approved
  • extending tracing rules to unincorporated limited partnerships.
• certain new information collation and sharing mechanisms, including arrangements for a new Register of Foreign Ownership and increased ability to share information across government agencies and with international counterparts.

Further reforms to the FIRB regime will be released in September 2020, which will address:

• the time limit applicable to the government’s “call in” power
• the process intended to streamline the review and approval of investments by foreign private equity, institutional fund and similar investors with passive foreign government investors
• the detailed regulations applicable to a number of the framework changes provided for in the first tranche exposure draft legislation
• various other technical and consequential amendments.

New national security test

The Explanatory Memorandum for the FIRB Reform Bill explains that risks to Australia’s national interest, particularly national security, have increased as a result of a confluence of developments – including rapid technological change and changes in the international security environment. The Explanatory Memorandum refers to the challenge of attracting foreign capital that supports the economy, while at the same time protecting Australia’s national interest.

According to the Explanatory Memorandum, in order to avoid overlap between the new national security test and the existing national interest test, where the broader national interest test would apply to a particular action, only that test will be used in an assessment. This is because national security is already a relevant factor that the government considers when assessing the national interest.

Notifiable national security actions

The FIRB Reform Bill creates a new category of actions, called “notifiable national security actions”, that from 1 January 2021 will be required to be notified to the Treasurer for review, regardless of the value of the investment or whether those actions would be “significant actions” or “notifiable actions” under the existing foreign investment review framework.

A “notifiable national security action” involves a foreign person starting, or acquiring a direct interest in, a “national security business” (which we will define below) or an interest in national security land, which, broadly, is land:

• that is defence premises
• in which a national intelligence agency has an interest
• which the Treasurer declares to be national security land.

In relation to acquisitions of interests in a “national security business”, a “notifiable national security action” requires satisfaction of the existing threshold for a “direct interest”, that is, the foreign person must be acquiring either an interest of 10 per cent or more in the “national security business” (or 5 per cent or more if the foreign person has a legal arrangement between its business and the target business) or any interest that provides it with the ability to influence or participate in the central management, control of the business or to influence, participate in or determine its policies.

A “notifiable national security action” where a foreign person “starts” a “national security business” is taken to exist when the person starts to “carry on” the business by taking actions that are required for commencing the business (rather than making plans or acquiring information about starting the business). Such actions may include taking out a lease, engaging employees or entering into business contracts in respect of the national security business.

Given the wide definition applied to characterise what will be a “national security business” for these purposes and the various powers of the Treasurer in relation to foreign investment in them, we expect to see a material increase in foreign investments being notified to the Treasurer for review, once the government’s reforms are implemented.

National security business

The proposed amendments to the FIRB Regulation set out the definition of a “national security business” in respect of which the new national security test will apply.

Two elements need to be satisfied:

• the business must be carried on wholly or partly in Australia, whether or not in anticipation of profit or gain
• the business must fall within one of the categories of businesses that are national security businesses as specified in the legislative amendments.

Broadly, the legislative amendments provide that a business will constitute a national security business where it falls into one of the following categories:

• critical infrastructure – it is a responsible entity for an asset or a direct interest holder in relation to a critical infrastructure asset for the purposes of the Security of Critical Infrastructure Act 2018 (Cth); or
• telecommunications – it is a carrier or carriage service provider to which the Telecommunications Act 1997 (Cth) applies; or
• critical military-use goods or technology – it either develops, manufactures or supplies, critical goods or critical technology, that are for (or intended for) a military end-use by Australian defence and intelligence personnel in activities relating to Australia’s national security or another country’s defence force that may affect Australia’s national security; or
• critical defence services – it provides, or intends to provide, critical services to Australian defence and intelligence personnel in activities relating to Australia’s national security or another country’s defence force in activities that may affect Australia’s national security; or
• defence information – it stores or has access to information that has a security classification or stores, has access to or collects personal information of Australian defence and intelligence personnel which, if accessed or disclosed, could compromise Australia’s national security.

The national security test focuses on businesses that are concerned with critical Australian infrastructure assets or the provision of telecommunications services or that are involved in arrangements with the Australian defence or the national intelligence community, including their supply chains and management of their sensitive information.

Each of these categories (in particular, those relating to goods, technology and services for defence force and national intelligence use) are scoped broadly, and will therefore afford the government a fairly extensive ambit for review of foreign investment on national security grounds across a range of businesses under the national security test.

National security in a changing international context

As noted above, the Explanatory Memorandum for the FIRB Reform Bill refers to changes in the international security environment. It goes on to explain that, in recent years, many countries have updated their foreign investment regimes to manage a range of new risks. In particular, both advanced and emerging economies have introduced changes to their foreign investment screening rules to strengthen the powers of the government to scrutinise investment in sensitive sectors.

In addition to advising on FIRB matters, we have been involved in advising clients on how to navigate national security issues affecting investments in the U.S. and in China.

In the U.S., the Committee on Foreign Investment in the U.S. (CFIUS) has recently introduced new rules to expand the jurisdiction of CFIUS to cover certain investments in critical technologies, critical infrastructure and sensitive personal data. The new CFIUS rules permit investors from certain states (such as Australia) who meet certain requirements to be an “excepted investor”. Importantly, countries like Australia who are on the list of excepted foreign states were given two years to ensure that their national security-based foreign investment review process and bilateral cooperation with the U.S. on such a process meet the requirements of the new CFIUS regulations. This is likely to be a key driver of the proposed changes to the FIRB regime.

In China, the 2011 Notice of the General Office of the State Council on Establishing a Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, the 2015 National Security Law and the 2019 Foreign Investment Law have enhanced the Chinese government’s oversight of foreign investment. Relevant Chinese rules focus on a list of key industries circulated by China’s Ministry of Commerce, including agriculture, energy, infrastructure, technology and equipment manufacturing. Where a foreign person is seeking to control (for example, obtain ownership - sole or combined - of an equity interest of 50 per cent or more, or obtain sufficient voting power to materially influence the decisions of shareholders or board meetings, or otherwise actually control) an entity in a key sector, China’s comparatively opaque national security review process will be triggered.  

We will continue to provide updates of the ongoing reforms to Australia’s foreign investment review legislative framework. In the meantime, we would be delighted to assist with any queries that you may have on how these changes may affect you.

Author: Carl Hinze

Disclaimer
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.

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