Overseas Investment Act – finally, the review we need to have

The Treasury-produced consultation document for the reform of the Overseas Investment Act holds out a prospect of genuine and well-directed change.

The analysis of what is wrong with the current framework, for example, is spot on, in our view.  So are many of the reform proposals. 

A significant increase is proposed in the discretion available to Ministers to decline applications and to call in investments not otherwise caught by the regime.  This may add a new level of unpredictability but a range of safeguards are contemplated, including the right to appeal decisions both on their merits and judicially.  

Submissions close on 24 May 2019.

Flaws in the current system

The problems identified in the discussion paper with the current system are:

  • the length and expense involved in applying for a consent
  • the inclusion of investments that are not likely to be high risk, or relate to land unlikely to have significant ownership value to New Zealanders – e.g., adjoining a sports field, and
  • unnecessary complexity and scope.

As a result of these issues, the New Zealand screening regime is rated the seventh most restrictive in the Organisation for Economic Development and Cooperation (OECD) and New Zealand is attracting proportionately less foreign direct investment than many other small, advanced economies – particularly greenfield investment, which is the most valuable and can make a significant contribution to economic growth.

Key reform proposals

We have grouped these under three broad categories – who we screen, how we screen and what we screen.

Who we screen

New Zealand listed or incorporated companies

The current Act is capturing listed companies which are under New Zealand control and is subjecting them to unnecessary and growth inhibiting restrictions and costs. Four options are proposed, the first three of which would raise the threshold for coverage by the Act:

  • increase the percentage of overseas ownership required for a domestically incorporated and listed company to qualify as an overseas person from 25% to 49%, or
  • target the regime at those domestically incorporated and listed companies where;
    • “substantial holdings” (5% or greater) in classes of securities that confer control rights, cumulatively totalled at 25%, are overseas owned (this is similar to the Australian approach), or
    • more than 49% of the economic returns flow to overseas owners and/or they collectively hold assets which give them 25% control.

Option four would keep the current definition of overseas person and would allow locally incorporated bodies to apply for an exemption from the Act if they have a strong connection to New Zealand and a strong record of compliance.

None of these is ideal in our view, as none acknowledges the practical realities that shareholders can change daily, making it impossible for listed issuers to confirm their ownership in real time, or which proportion is held overseas.

Our preferred approach is to exclude NZX listed entities from the definition of overseas person if no one overseas person (alone or together with associates) holds more than 25% of the voting rights.

Portfolio investors

A portfolio investor is an entity that obtains a significant minority interest (generally less than 10%) but not control, in a company, investment fund or project. These are generally passive investments by professional investors that comply with regulatory best practice. The reform aim here is to encourage such investment and – again – the options are four.

  • Establish a class exemption for entities which do not seek a controlling share of the asset, or representation on the board.
  • Establish a class exemption for entities which have at least 51% of their funds invested on behalf of New Zealanders and where control rights are 76% beneficially held by New Zealanders.
  • Create a narrower exemption which would be available only to domestically regulated superannuation funds – e.g, KiwiSaver schemes.
  • Amend the Act to allow for individual exemptions for investors beneficially owned or controlled by New Zealanders. This could operate either in isolation or in conjunction with any of the above.

We think a combination of the above options will be the best outcome here, but caution that exemptions will need to be subject to conditions which are practical for recipients to comply with.

The tipping point for requiring consent

This covers the scenario where the acquisition of a small interest in an entity which owns or controls sensitive land would tip that entity into overseas person status. The example provided in the discussion paper is where Person A applies to buy 1% of Company B and Company B is already 24% overseas owned.

The proposed options are:

  • simplify the regime by targeting the Act at deliberate attempts to gain control of sensitive land without having to satisfy the benefit to New Zealand test. This would be achieved by replacing section 12(b)(iii) with a general anti-avoidance provision, or
  • require consent where, at completion of the transaction, the acquirer will hold at least 5% of the securities in that class and the entity will be tipped into overseas person status, or
  • establish these control thresholds but limit them to publicly listed companies.
Incremental investments above 25%

Currently, additional acquisitions by an overseas person in an entity in which that person already has a 25% interest require consent. Exemptions are available but there are technical problems attached to them. The review proposes that they be expanded in a variety of ways, including removing the five year limit and opening the exemption to shareholders whose original share purchase did not require consent.

How we screen

Is the investor test fit for purpose?

Three options are offered, each of which would make the test narrower.

  • Retain the business experience and acumen criterion, remove the financial commitment and immigration criteria, simplify the good character test so that allegations are considered only for certain crimes (e.g., fraud, dishonesty, corruption or tax avoidance), and remove the requirement for decision-makers to consider “any other matter that reflects on the person’s fitness”.
  • Option One above with the additional removal of the business experience and acumen criterion and narrowing the good character test from allegations of misconduct to proven offences and contraventions.
  • Move to a bright-line, checklist assessment which would screen potential investors for: criminal convictions punishable by imprisonment, civil penalties, adverse findings from a security agency, bankruptcy, disqualification from directing a business and whether they have had a confiscation order made against them.
Should the benefit to New Zealand test be replaced by a national interest test

We think this is the defining issue of the review, and the one which will have the most far-reaching implications in practice.

It contemplates amendments to the counterfactual test – a move we would support as it would remove a lot of the frustration associated with the theoretical exercise required under the existing procedure. But other changes would substantially increase the discretion available to Ministers, which might make for opaque and unpredictable decision-making (although this is already a risk of the current system).

Option one would keep much of the current benefit to New Zealand test but would allow decision-makers to also take into account any negative effects that might arise from the acquisition (such as job losses for New Zealanders), and any implications for New Zealand’s national security.

The document notes, in what is almost certainly a coded reference to China, that the current Act does not create a distinction between government and non-government overseas investors and that government investors “may have broader political or strategic foreign investment objectives”.

Option two would overlay on Option one a substantial harm test which would give Ministers broader grounds to decline investments which posed a threat to public order, public health and safety, or essential security interests. This discretion could not be delegated to the Overseas Investment Office and would be based on OECD guidance.

To balance the additional flexibility for Ministers, the existing test applying to sensitive land would be simplified by:

  • combining factors with similar objectives to reduce the overall number
  • removing the requirement for benefits associated with non-urban land over five hectares to be “substantial and identifiable”, and
  • removing the ability to add new requirements by regulation.

Option three would supplement the simplified benefit to New Zealand test from Option two with a national interest test which would effectively allow Ministers to consider anything they felt relevant in assessing applications.

Recognising the damaging effect such licence might have on investor confidence, it is proposed that the Government would publish the factors likely to be considered and their relative importance and the reasons for declining an application (unless it would involve the release of sensitive national security information). The decisions would also be reviewable – both on the merits and judicially.

Option four would apply the national interest test in option three to all applications, except for residential land and forestry. This seems to have the inside running among officials as it is described in the consultation document as “the simplest approach…and most similar to Australia’s foreign investment screening regime”.

Option five would give Ministers the power to call in any transactions involving an overseas person, including those which would not normally come within the Act, if they raised national security or public order risks. This will require a carefully designed call-in test and notification requirements to operate effectively.

What we screen

The proposals here are mostly engaged with narrowing the scope of the Act by tightening the definition of sensitive land to avoid land being caught where it only adjoins other sensitive types of land, removing the requirement for consent for periodic leases, and excluding short fixed term leases (10 years or less for non-urban land of five plus hectares and residential land; 35 years plus for all other land).

Chapman Tripp comments

We have confined our discussion to those design elements which are fundamental to the regime. There are a number of other areas canvassed in the review which we have not covered here – e.g., relating to taking into account water extraction, tax, Māori cultural values for the benefit to New Zealand test, tidying up the rules for special land and farmland advertising.

We think the review is on the right track. It seeks to focus the screening effort where there are genuine national interest issues at stake and to recognise that some of these cases are going to be hard and will be inherently political in character so should be dealt with on those terms.

This represents something of a change in tack. Arguably the direction of recent reform has been to try to remove the politics from the process in favour of a more analytical approach. But, in the end, even then, the hard decisions finished up in a Minister’s office, with the door shut.

What is proposed now is more accepting of that reality, and also more in line with the practice in like jurisdictions such as Australia.

The important thing is that the process is as streamlined as possible and as transparent so that the prospective investor knows the tests that need to be met and doesn’t spend time and money on deals that will never be allowed to get off the ground. 

Our thanks to Brittany Reddington for writing this Brief Counsel.

For advice or assistance in preparing a submission, please get in touch with our contacts.

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Corporate & commercial; Property & real estate; Private equity; International trade & investment

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