The Government has announced changes to the Overseas Investment Act (Act). This is the second phase of the reforms to the Act, following public consultation and, we would expect, negotiations with NZ First and the Greens (the proposals are referred to as "agreed" changes). The Government intends to introduce legislation early next year which would see it on track to pass before the next election. There will be opportunities to make submissions at the Select Committee stage (although, given the extent of consultation to date and Government agreement, it could be difficult to achieve substantive change at that point).
As expected, the Government will introduce a national interest test, as well as a call in power where national security or public order is at issue. This is key focus in the statements and documents released so far (despite the intention that these powers will be rarely used).
However, this emphasis plays down a number of other important changes that will address long-standing problems with the interpretation and implementation of the Act, and should result in a more targeted and streamlined process for overseas investors. The issues with the current Act should not be understated; they risked deterring (and, anecdotally, have deterred) the quality overseas investment New Zealand needs.
Summarised below is our assessment of the proposed changes, based on information released on Tuesday, 19 November. The proposed changes are largely based on options, or combinations of options, set out in the Treasury's consultation paper issued in April 2019. The information is relatively high level and, for these changes, the "devil will be in the detail". We will provide a further update once more information is available.
National interest test and call in power
The national interest test will apply to both significant business asset transactions and sensitive land transactions, and in relation to sensitive land will sit alongside a simplified benefits test. The call in power will apply to transactions otherwise not caught by the Act. The proposed approach is demonstrated in the figure below taken from the consultation paper:
National interest test criteria
The national interest test will apply to three categories of investment: (1) where a foreign government or its associates would hold a 10% or greater interest; (2) that are found to present national security risks; (3) that involve specified strategically important industries and high-risk critical national infrastructure, listed as follows:
- significant ports and airports;
- electricity generation and distribution businesses;
- water infrastructure (broadly, drinking, waste, and storm water networks, and irrigation schemes);
- telecommunications infrastructure;
- media entities that have an impact on New Zealand’s media plurality;
- entities with access to, or control over, dual-use or military technology;
- critical direct suppliers to the New Zealand Defence Force, Government Communications Security Bureau and the New Zealand Security Intelligence Service;
- systemically-important financial institutions and market infrastructure (for example, payments systems); and
- other investments that pose material risks (it is stated that this would be in rare cases).
It is unclear how the decision-making Ministers' discretion will be constrained, for example by criteria to be included in the Act. The consultation paper states that, to support investor confidence, the Government would provide guidance on the factors likely to be considered and their relative importance. The consultation paper went on to indicate that risks to national security, public safety and international relations would be relevant factors. Environmental and cultural implications were flagged as possible considerations. The Minister will likely consider the extent to which conditions can mitigate risks.
We note that the test can be applied not only to the listed industries and infrastructure, but to any other investments "that pose material risks" which suggests a broad discretion could be applied. Saying that, the consultation paper suggests that other investments would only be subject to the national interest test where a risk to national security has been identified by security services.
Overall, it will be critical, in our view, to give clarity on the factors to be considered, and how and when the test will be applied, including to provide investor confidence that the test will be rarely used (as the Government asserts).
As we understand, the proposed national interest test has been modelled off the national interest test applied by the Foreign Investment Review Board (Australia's equivalent to the OIO). We will run a separate alert on how the proposed national interest test compares to the Australian version.
Call in power
The call in power will apply to strategically important investments not caught by the Act and only for national security and public order reasons. Documents released by Treasury state that the call in power will be able to be used for the same categories of strategically important assets that the national interest applies to (as listed above), with the exception of irrigation schemes and the addition of transactions that grant access to sensitive data. Sensitive data was not specifically mentioned as a category in the consultation paper. It is also unclear what "sensitive data" covers. However, we would expect it is intended to be limited to situations where security services have identified significant national security or public order concerns. Again, a clear understanding of how and when the call in power would be applied to this category is important for investor confidence.
It will be mandatory to notify the government of some transactions (relating to military, defence and security services) with an option to notify in relation to other types of transactions.
Other changes
Majority listed companies removed from the Act / others can apply for exemptions
Proposed change
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Status quo
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Comment
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KiwiSaver funds and listed entities that are majority owned and wholly controlled by New Zealanders will not be caught by the Act.
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A body corporate is captured by the Act if it is 25% or more owned by overseas persons (meaning fundamentally NZ entities were captured by the Act).
The consultation paper referred to a well-recognised problem with the status quo - where listed companies with widely held shares face real difficulty in accurately assessing beneficial ownership at any one time.
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This change shifts the ownership threshold from 25% to 49% for NZ listed companies, recognising that the concept of 25% negative control was too restrictive.
Reference to "wholly controlled" by New Zealanders was not mentioned in the consultation paper and may be unnecessarily restrictive (depending on how it is defined).
It is disappointing, however, that the changes have not included a further option put forward in the consultation paper to address issues with identifying beneficial ownership. The option proposed was that shareholdings of less than 5% would be excluded from counting towards the overseas ownership percentage (similar to the position in Australia). The move to 49% will not address this costly and unworkable issue for those companies that sit close to the percentage.
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An exemption from the Act can be applied for by non-listed entities and managed investment schemes that: are majority owned and wholly controlled by New Zealanders; do not have significant foreign government backing; and have a record of compliance with New Zealand’s and foreign laws.
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There is a process in the Act for an exemption for NZ controlled companies (which are then listed in Schedule 4). However, this was narrowly applied (where ownership was close to 25%), guidance covered only companies and (since that last reforms) the Overseas Investment Office (OIO) consider the exemptions could no longer be used in any event.
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This change should enable a broader range of NZ controlled / connected entities to obtain an exemption (for example, limited partnerships). It will be important to see further detail on what criteria will be applied. The consultation paper suggests it could apply where an entity is headquartered and incorporated in NZ and is at least 51% owned by New Zealanders. Again, "wholly controlled" could be too restrictive meaning the exemption process has limited application – this will depend on how it is defined.
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Transactions removed from the Act
Proposed change
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Status quo
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Comment
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Leases of less than 10 years will not be caught by the Act.
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Leases of not less than 3 years are caught by the Act.
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While this is an improvement on the status quo, some submitters argued for a 20 or 30 year limit, to reflect the life of an investment and address concerns that shorter leases are too uncertain, which (perversely) incentivises buying freehold land over leasing.
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In relation to adjoining land, consent will only be required if land adjoins the foreshore, lakebed, conservation land and certain regional parks, and some land significant to Māori.
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Consent is required for land adjoining land listed in Table 2 Schedule 1 referred to as sensitive adjoining land. Classifications were confusing and varied across different district plans.
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This will address overly broad adjoining land requirements which were costly and complex in situations where the land had limited sensitive value.
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Incremental increases in shareholding will not require consent.
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Further applications for consent are required for often small changes in shareholdings.
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This change will avoid unnecessary applications where the overall control enjoyed by the controlling entity is not materially impacted.
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Simpler investor test
Proposed change
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Status quo
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Comment
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Investor test - good character test: a simplified bright line test will cover only serious convictions / civil contraventions and proceedings.
It appears it will not be applied to New Zealanders.
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The scope of the good character test is very broad: it includes any offences or contraventions of the law or any other matters that reflects adversely on a persons fitness, and can extend to unproven or untested allegations.
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This change should considerably reduce cost and uncertainty associated with current scope of inquiry.
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The good character test will include an assessment of corporate character for entities that have substantive control over the investment.
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Corporate entities are only tested where an individual with control has a 25% interest in the asset.
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A different test will apply to which corporate entities are tested (those with substantive control), but the clearer test should the limit the impact of any additional administrative burden.
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Sensitive land benefit test
Proposed change
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Status quo
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Comment
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Relevant benefit factors will be reduced in number and broadened to encompass a range of benefits.
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21 different factors can be considered. These are, in certain areas, relatively narrow and means that broader benefits cannot be claimed as arising from the transaction.
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This shift simplifies the number of benefit factors that need to be considered (although numerous factors could be helpful when identifying benefits). Clear guidance on what benefits the OIO will consider will be essential to ensure that the new benefits are not too narrowly construed.
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Only positive impacts can be considered (except for extraction of water for bottling).
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Arguably, the current position is that only positive impacts can be considered (but this was tested in the Oceania Gold decision, where negative impacts were taken into account).
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This change clarifies what was generally understood to be the correct position. Note that negative impacts can be considered under the national interest test.
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Investors in sensitive land will not need to demonstrate that that benefits are "substantial and identifiable". Instead, the OIO will apply a proportionate approach (except for farmland investments, which will be required to demonstrate a "substantial point of difference").
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Most sensitive land applications must demonstrate benefits are "substantial and identifiable". The application of this test has been increasingly problematic, resulting in expectations of benefits that were simply not possible and / or not proportionate to the sensitivity of the asset and the interest being acquired.
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This is a significant improvement, which should allow for a more flexible, sensible and targeted approach. For example, it is unrealistic / disproportionate to expect large benefits where a well-managed asset is changing hands between overseas fund managers. The extent to which the new test will address unintended impacts under the current regime will depend on the direction provided to the OIO.
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The relevant counterfactual will be the current state of the sensitive land and the activity on it.
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The counterfactual requires comparison with what is likely to happen if the investment does not occur. This is highly theoretical and tended to require complex and costly assessments – with the OIO starting point being a well funded alternative New Zealand investor (often, in reality, the least likely scenario).
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This is a significant improvement which removes the requirement for speculative assessment of future scenarios. However, we note that there may some circumstances where the new test is less helpful, for example where a business will likely do better in the future with the overseas investor than with the current owner (the "failing firm" scenario).
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Other changes will include requirements for applications to processed within specified timeframes (depending on the type of application). This is a significant change. Currently, the OIO regime is out of step with international foreign investment regimes, the vast majority of which have statutory timeframes within which a consent or approval is required to be delivered. The introduction of decision timeframes will provide all parties to a transaction with much greater certainty as to when a decision will be received and when a transaction can be expected to close, thereby reducing uncertainty and hopefully minimising (or at least mitigating) disruption to business operations.
It is not clear from the information released to date whether there will be any other changes as canvassed in the consultation paper or whether this is a complete list. Officials will now work toward drafting legislation for introduction to Parliament, where we expect to see the detail of the reform teased out. We will provide further updates once more information is available and, of course, are available to discuss the potential implications on your business or assist in submissions on the next stage of the reform.
You can find the Minister’s press statement here. Further information can be found on the Treasury website.