The Perils of Down Under:

Chinese Investment in Australia

Hong Kong University of Science and Technology

Hong Kong September 2011

2

Who is Clive Palmer and why is he saying these things?

“The Australian government has racially discriminated against (China) and stopped them from investing in Australia…They've brought in things like the Foreign Investment Review Board in Australia, which is an outstandingly racist legislation designed to slow down Chinese growth, and it's a national disgrace”

Clive PalmerThe Australian

29 September 2009

3

The facts do not support a racist policy which discriminates against Chinese investors

In the past 4 years the FIRB has approved around 230 Chinese investments worth some $60 billion, one outright rejection and six with conditions

Over the last decade there were three high-profile rejections of which one was Anglo-Dutch, one Singaporean and one Chinese

4

Chinese investors believe that Australiadiscriminates against them Survey by Australia’s Lowy Institute found Chinese

believe investment discrimination by Australia is driven by: Media driven nationalism Perception that state related investors are not

focused on commercial objectives Concerns about China as both owner and customer Concern with China’s growing geo-political clout

Such perceptions stem largely from the failure of a series of high profile resource deals

5

A serious policy debate, but we can

still laugh

The topics and structure of this presentation

1

•Anal

yze

the

mag

nitu

de

and

struc

ture

of

Chin

a’s

over

seas

direc

t

inves

tme

nt in

gene

ral

and

to

Aust

ralia

in

parti

cular

2

•Expl

ain

the

work

ings

of

the

FIRB

and

detai

l its

track

reco

rd in

appr

ovin

g

and

rejec

ting

inves

tme

nt

prop

osals

3

•Cons

ider

char

acter

istics

that

mak

e

Chin

ese

inves

tme

nt

diffe

rent

to

othe

r

forei

gn

inves

tme

nt to

Aust

ralia

4

•Disc

uss

the

Chin

alco

Rio

Tinto

trans

actio

n as

a

case

stud

y to

bett

er

unde

rstan

d

Aust

ralia’

s FDI

polic

y

7

Key facts relating to China’s overseas direct investment

1

•Chi

na’s

ODI

has

incr

eas

ed

in

rec

ent

yea

rs,

but

is

still

mu

ch

sma

ller

tha

n

FDI

(big

ger

reci

pie

nt

tha

n

inv

est

or)

2

•Aus

trali

a is

the

larg

est

ben

efici

ary

of

Chi

na’s

ove

rse

as

dire

ct

inv

est

me

nt

3

•Min

eral

res

our

ces

are

the

larg

est

part

of

Chi

na’s

Aus

trali

an

ODI

,

but

this

is

not

the

cas

e

ove

rall

4

•Chi

na

has

enc

oun

tere

d

pro

ble

ms

in

cou

ntri

es

oth

er

tha

n

Aus

trali

a

and

usu

ally

wit

h

nat

ural

res

our

ce

inv

est

me

nts

Over time, China has attracted far more FDI than ODI

2003 2004 2005 2006 2007 2008 2009 2010$0

$20

$40

$60

$80

$100

$120

FDI ODI

Valu

e (

US$ b

illio

n)

9

Official data would suggest Australia is a very minor beneficiary of China’s ODI

2003 2004 2005 2006 2007 2008 2009 20100%

1%

2%

3%

4%

5%

Share

of

Chin

a’s

OD

I

10

Australia is ahead of all other countries in attracting Chinese overseas direct investment

Australia USA Nigeria Iran Brazil Canada Other$0

$100

$200

$300

$400

FDI (U

S$ b

illio

n)

Heritage Foundation 2005-10

11

Mineral resources are a significant,but not the largest part of China’s ODI

2003 2004 2005 2006 2007 2008 2009 20100%

20%

40%

60%

Share

of

Chin

a’s

OD

I

12

Iron ore and copper make up 60% ofChina’s mineral resource sector ODI

Iron ore

Cu Al Pt C Au Other0%

20%

40%

60%

80%

100%

13

The Heritage Foundation has identifieda further US$122 billon of troubled investment

Agricu

lture

Ener

gy

Fina

nace

& p

rope

rty

Met

als

Tech

nology

Tran

spor

t$0

$40

$80

$120

2006 to 2010

14

Australia not the only difficult destination,but natural resources are mostly a problem

Total value(US$ billion)

Most troubledsector

Most troubled destination

2006 34.5 Energy Iran

2007 13.7 Agriculture Philippines

2008 33.2 Finance Germany

2009 33.1 Metals Australia

2010 7.6 Metals USA

15

Summary of key issues relating to China’s Australian bound ODI

1

•Whi

le

its

leve

l of

inv

est

me

nt

is

gro

win

g,

Chi

na

is

still

a

min

or

pla

yer

in

Aus

trali

a’s

FDI

2

•Alm

ost

all

the

pro

pos

als

sub

mitt

ed

to

the

FIR

B

are

app

rov

ed,

tho

ugh

so

me

hav

e

con

diti

ona

l

obli

gati

ons

3

•Min

eral

s

res

our

ces

acc

oun

t for

56

%

of

Aus

trali

a’s

FDI,

but

alm

ost

all

of

Chi

nes

e

inv

est

me

nt

4

•Min

eral

res

our

ces

diff

er

sign

ifica

ntly

fro

m

oth

er

for

ms

of

inv

est

me

nt

16

FIRB statistics not a reliable indicator of Australia’s foreign investment inflows Data do not cover investments below legislated

thresholds

Includes proposals that are approved in a given year, but may not be actually implemented or could be implemented in a later year or over a number of years

Can include approvals for multiple acquirers of the same target asset

Because of time, I have not been able to access additional data published by Australian Bureau of Statistics

17

Its Australian investment is growing, but China is still a relatively small investor

2007 2008 2009 2010

USA 29% 26% 22% 28%

UK 9% 17% 11% 21%

China 2% 4% 15% 12%

Japan 3% 3% 12% 4%

Singapore 12% 6% 1% 3%

Europe 27% 34% 24% 31%

Asia (other) 7% 7% 18% 10%

No of transactions not value

18

Even on a value basis, China is asignificant but not the largest investor

USA UK China Japan Switzerland Other$0

$40

$80

$120

$160

Share

of

FDI (A

$ b

illio

n)

A sample of China’s biggest Australian dealsDate Target Acquirer Value (US$

m)

March 10

Arrow Energy Petro China A$3,500

April 09 Felix Resources

Yanzhou Coal $2,755

April 09 Mining assets Minmetals $1,386

Feb 09 Fortescue Hunan Valin $765

March 08

Oil & gas assets

China Petrochemical

$560

March 09

Mining assets China Metallurgical

$515

Feb 08 Soco Yemen Sinochem $465

Feb 08 Mining assets China Metallurgical

$370

Aug 08 Mining assets Shenhua $261

Aug 09 Aquila Resources

Baosteel $237

20

FIRB approvals involving mineral resources represent 56% of all approvals

Miner

al re

sour

ces

Real e

stat

e

Resou

rce

proc

essin

g

Serv

ices

Man

uf.

$0

$6,000

$12,000

$18,000

FIR

B a

ppro

vals

($ b

il-lio

n)

21

About half of China’s FIRB approvals involve mineral resources

Miner

al re

sour

ces

Real e

stat

e

Resou

rce

proc

essin

g

Serv

ices

Man

uf.

Agric

ultu

re

Fina

nce

Tour

ism$0

$30,000

$60,000

$90,000

$120,000

$150,000

FIR

B a

ppro

vals

($ b

illio

n)

22

Mineral resources differ significantly from other forms of investment Usually associated with economic rents

Involve a wasting resource

Capital intensive and asset specific investment

In many countries, including Australia, minerals are owned by the people

Transfer pricing is an issue: Opaque global prices Intermediate products and integrated companies

23

Analysis of FIRB annual reports revealsthe vast majority of proposals are approved

2007 2008 2009 2010

Rejected totally

0.03% 0.10% 0.03% 0.04%

Approved 99.97% 99.9% 99.97% 99.96%

Unconditionally

90.00% 85.0% 75.0% 90.0%

With conditions

10.oo% 15.00% 25.00% 10.00%

24

Australia does not rank too badly on the OECD FDI restrictiveness index, but China…

China Non OECD

Aus-tralia

Brazil World USA OECD0.000

0.125

0.250

0.375

0.500

1=

Clo

sed,0

=O

pen

25

Summary of key issues relating to the administration of Australia’s FDI

1

•Aus

trali

a

has

a

lon

g

trad

itio

n of

acc

epti

ng

fore

ign

inv

est

me

nt,

esp

ecia

lly

in

the

res

our

ces

sect

or

2

•A

clea

rly

defi

ned

app

rov

al

pro

ces

s,

wit

h

the

fina

l

deci

sion

ma

de

by

a

poli

tici

an,

how

eve

r

reje

ctio

n is

rare

3

•Enti

ties

wit

h

>1

5%

fore

ign

gov

ern

me

nt

own

ers

hip

are

subj

ect

to

low

er

thre

shol

ds

and

add

itio

nal

crit

eria

4

•Inv

est

me

nts

are

app

rov

ed

if

the

y

are

fou

nd

to

be

in

Aus

trali

a’s

nati

ona

l

inte

rest

26

Because of the benefits, Australia has always welcomed foreign investment From settlement in 1788, the development of

Australia’s mineral resources have depended on foreign capital and technology

Almost all of the great Australian mines have been developed because of the availability of foreign capital and technology

Foreigners own 50 to 70% of Australia’s mining industry

While Australia now has the technology, it still is very dependent on foreign capital AND markets

Foreign investment must ultimately benefit Australia’s long term interests i.e. National Interest Test (Net benefit in Canada)

Beijing’s own restrictive FDI policy confirms that, like Australia it has a national interest test. (Coca-Cola and Carlyle).

27

Understandably, the national interestis an opaque standard that changes over time Introduced in 1986

Burden of proof rests with the Government NOT the investor

According to Treasurer Swann, reasons include: Preserving national security Preserving government revenue Investor will not respect Australian law and business

practice Reduce competition or result in excessive

competition Consistent with government policies Character of investor

Rarely used but basis for rejecting Shell, Lynas, WISCO and SGX

28

Current regulations regarding foreign investment are detailed in the FAT Act (1975) Foreign Acquisitions and Takeovers Act (1975) requires

investors obtain approval to acquire > 15% of a company worth > $219 m

FTA with US means higher thresholds for US companies Irrespective of size, entities owned >15% by a foreign

government require approval Sensitive areas include media, banking,

telecommunications, civil aviation and real-estate for which there are special rules

Decision made by Treasurer (political decision) on FIRB advice

30 days to make a ruling but can be extended to 90 days

Process seems to be flexible with each case examined on its own merits while consultation is welcomed

29

Applications are becoming more complex and require more than the maximum 90 days If likely to exceed 90 days applicants are asked to

withdraw and resubmit applications

No comprehensive data on withdrawn applications nor withdrawn and resubmitted, but FOI fillings show no obvious bias against Chinese investment Between November 2007 and January 2011, 349

proposals withdrawn of which 66 were from China (15 government) and 35 from USA

During 2010, 10o withdrawn of which 6 from China (5 government) and 11 USA

High proportion of withdrawals in early years could reflect lack of familiarity with the process

30

Not in the national interest, but very reasonable grounds for outright rejections 2001: Shell additional stake in the Woodside LNG JV

rejected by Treasurer (sic.) because of the belief that further development could be sacrificed for other Shell projects

2009: China Nonferrous Metal Mining Group proposed 51.66% stake in rare earth hopeful Lynas rejected unless reduced to <50% and minority board representation. China controls >95% of market and acquisition would reduce competition Withdrawn

2009: WISCO’s planned purchased of Western Plain Resources iron ore project rejected because of close proximity to Wommera

2011: SGX takeover of much larger ASX rejected because of perceived loss of economic and regulatory sovereignty. 23% non-voting Singapore Government ownership in SGX

31

Applications from foreign government entities are judged on additional criteria Entities include companies as well as sovereign wealth

funds

The extent an investor’s operations are independent from the foreign government

Whether the investor is subject to adequate regulation in other jurisdictions

That the investment not hinder competition or lead to undue concentration or control in the relevant industry sector

Investment taxed same way as other commercial entities

Investment will not impact Australia’s national security

Whether the investment impact Australian exports, research etc

32

Summary of key arguments fortreating Chinese entities differently

1

•Mos

t

Chi

nes

e

inv

est

me

nt

inv

olve

s

SOE

s

whe

re

no

clea

r

disti

ncti

on

bet

wee

n

co

mm

erci

al

and

poli

tical

obj

ecti

ves

2

•Chi

nes

e

enti

ties

incr

eas

e

the

pos

sibil

ity

of

tran

sfer

pric

ing

bet

wee

n

rela

ted

enti

ties

3

•Reci

pro

city:

fore

ign

co

mp

ani

es,

incl

udi

ng

Aus

trali

an

can

not

inv

est

in

Chi

na’s

res

our

ce

ind

ustr

y

4

•SOE

s

etc

hav

e

littl

e

exp

erie

nce

in

ope

rati

ng

wit

h

ope

n

soci

ety

mul

ti-

stak

eho

lder

and

stro

ng

insti

tuti

ons

33

Chinese companies are different frommost other enterprises investing in Australia Vast majority (95%) of Chinese investment involves

SOEs where there is no clear line between commercial and political objectives

Many Chinese investors have little experience with the administrative processes associated with rule of law jurisdictions so have difficulty working with the FIRB process

Transfer pricing is a problem in the mining industry and more so with integrated companies and state owned enterprises

34

Reason to believe that SOEs sacrifice commercial efficiency for political imperatives NDRC selection of Chinalco to thwart BHP move on Rio

confirms political interference and suggests that Beijing does not want companies to compete with each other outside of China

Party secretary is the most important position in an SOE and it is usually a joint appointment with the enterprise chairman.

Party personnel department controls political and commercial appointments

35

There are many cases where the Partyrotates people between industry & government Wei Liucheng from CNOOC to Hainan Governor Zhang Qingwei from Aerospace to Minister of

Technology

Guo Shengkun from Chinalco to vice-governor Guangxi (now Party General Secretary)

Xiao Yaqing from Chinalco to State Council where he is secretary to Vice Premier, Zhang Kejiang

Li Xiaopeng from Huaneng to vice-governor Shanxi

Fu Chengyu from CNOCC to Sinopec

36

Even the largest Chinese companiesare not experienced at operating outside China When operating in China, SOEs really have only one,

but very powerful stakeholder

The large number of Chinese projects withdrawn from the FIRB system in 2007 and 2008 suggests a learning process

Chinese companies seem to have shifted from criticizing the FIRB to complaining about compliance over environment, heritage and labor regulations

Overseas problems (Ramu, Chambishi etc) can be traced to attempts at replicating the China model i.e. confining negations to political elite while ignoring local stakeholders

37

Even outside China, national strategic objectives seem to trump commercial objectives Hanlong chairman (Liu Han) reported as saying Beijing

backs his takeover of Sundance Resources (ASX) as it would give China an opportunity to influence the price of iron ore

Similar statements by Shen Heting regarding MCC’s involvement in the Sino Iron project in WA

Representatives of government organizations ranging from CISA to the NDRC supported Chinalco’s move on Rio because it would lower the price of iron ore

The mining industry affords ample opportunity for transfer pricing and it is hard to police infringements

A Chinese SOE increases the risk of transfer pricing

38

Sino Iron project demonstrates Chinesecan bring their own perils with them CITIC Pacific purchased Cape Preston project from

Palmer in 2006 for $200 million

Planned cost of $1.4 billion and 2009 delivery blown out of the water because CITIC’s partner, MCC has no Australian (developed country?) experience

Problems being solved by employing more labor and MCC critical of Australian Government for not approving import of laborers from China

MCC has suggested that problems with their project stem from Australians managing Australians

39

Lack of reciprocity is a reasonableargument against Chinese resource FDI Much of China’s mining industry is out of bounds to

foreign investors, including Australians

Outside the resource sector, China is also very tough on foreigners wanting to invest in its local companies. Coca-Cola and Huiyuan Juice, Carlyle and Xugong

China’s discrimination is a powerful rallying point for nationalists

Because China discriminates against foreigners, does this make China racist?

Rosen and Hanemann argue that China has grown stronger by opening its doors wider FDI and US should do the same. But is Australia different? Are resource investments different?

40

Chinese perceptions are driven by

several high profile failures

41

Summary of the key issues surrounding the Chinalco transaction with Rio Tinto

1

•Rio

Tint

o

und

er

sign

ifica

nt

fina

ncia

l

pre

ssur

e

foll

owi

ng

disa

stro

us

pur

cha

se

of

Alc

an

2

•Chi

nacl

o’s

(an

SOE

)

initi

al

pro

pos

al

to

incr

eas

e

its

Rio

stak

e

was

app

rov

ed,

subj

ect

to

so

me

con

diti

ons

3

•Pro

pos

al

wit

hdr

awn

whe

n

bail

out

pla

n

coll

aps

ed

und

er

sha

reh

old

er

opp

ositi

on

and

imp

rov

ed

fina

ncia

l

mar

kets

4

•Trea

sur

er

nev

er

had

to

deci

de

on

vari

ous

stra

tegi

c

allia

nce

s

42

The Rio Tinto-Chinalco transaction is widely known but not well understood During GFC Rio came under significant financial

pressure because it overextended to purchase Alcan Rio’s circumstances compounded by a hostile bid from

BHP In a daring and well executed share market raid,

Chinalco snapped up 9% of Rio to become its largest shareholder.

Chinalco (an SOE) and NOT Chalco the listed subsidiary Chinalco threw Rio a lifeline in exchange for additional

shares, board representation and strategic stakes in a number of key operations

Chinalco permitted to grow to 14.99%, subject to not raising it again without fresh approval and not seeking a board position

43

Chinalco’s planned alliance with Rio

Tinto failed because the deal was unsound Fierce opposition from Rio shareholders who were

annoyed with their management and were positioning to vote it down

Improved financial climate confirmed that Rio could improve its balance sheet with shareholder equity

Proposal withdrawn so FIRB did not have to make a decision, but approval given to Chinalco increasing its stake in Rio up to 14.99% and not seeking to appoint a director

44

Urandaline Investments

PO Box 100, Biggera Waters

Queensland 4216

Australia

Phone+61-7-5528-5595 Cell +61-409-198-173

ChinaMetal@Urandaline.com.au

www.Urandaline.com.au

45

Minemtals’ legally enforceable conditional approval protects national interest Operate as a separate business with commercial

objectives, HQ in Australia and managed locally

Sales team based in Australia with arm’s length pricing

Maintain or increase production at nominated mines subject to economic conditions

Comply with Australian IR laws and honour employee entitlements

Maintain and increase levels of indigenous employment

46

Hunan Valin share holing in FMGalso has enforceable undertakings

Hunan’s Board nominees will comply with FMG’s director’s code of conduct as well as submitting a standing notice on potential conflict of interest relating to marketing, sales, pricing, costs etc

Hunan and any person nominated to FMG Board will comply with information segregation arrangements

47

Yanzhou Coal’s purchase of FelixResources is another conditional transaction Acquisition through Yancoal, an Australian subsidiary

Two Australian directors

Yancoal to list in 2012 at which time Yanzhou to reduce stake to 70%

Arm’s length dealing on coal sales to China

48

Process

Confidentiality can be justified on basis that some applications seek advance approval for possible investments that have yet to be revealed to the stock market

49

Chinese companies have come a longway since the failed Noranda deal 2004 Minmetals US$4 billion bid for Noranda which

foundered on Canadian opposition and decision paralysis by NDRC

Acquisition completed in September 2005 by Xstrata for US$19.2

In past 4 years FIRB has approved 230 Chinese investments worth $60 billion, no outright rejections, but 6 with conditions

Foreign exchange reserves are no longer an issue and decisions made by NDRC and not State Council

50

Australian companies have not beenactive investors in China Australian investment in China is a paltry $11 million

Services make up 70% of the Australian economy and China has yet to open this area to foreign investors

51