Look Ma, No Hands!
Overseas Investment: Myopic Deregulation
- by Bill Rosenberg
The following is a paper prepared for a Symposium on the 2009 Report of the Regulatory Responsibility Taskforce and the Proposed Regulatory Responsibility Bill. The paper’s original title was its present Watchdog subtitle. The Symposium was held in Wellington in February 2010 at Victoria University, and was organised by the University’s Institute of Policy Studies (1). The Taskforce, an ACT initiative, “proposed major constitutional changes in the way legislation and regulations are promulgated in New Zealand”. Bill Rosenberg spoke in his capacity as the Economist for the NZ Council of Trade Unions. Other speakers, who despite a variety of backgrounds were almost unanimously opposed to the Taskforce proposals, were: Professor Paul Rishworth, University of Auckland; Tim Smith, Chapman Tripp; George Tanner, Law Commission; Dr Richard Ekins, University of Auckland; Sir Geoffrey Palmer; Professor Jane Kelsey, University of Auckland; Dr Brian Easton, independent economist; and Dr Geoff Bertram and Professor Jonathan Boston, both from the Institute for Policy Studies. Most of the papers presented will be published in a forthcoming book.
Overseas investment has long been a controversial subject both in New Zealand and elsewhere. Policy towards it has been the subject of ongoing and at times intense debates. Whatever one’s view, it is a very significant part of New Zealand’s economy. In recent years New Zealand has had one of the largest net international liabilities in the Organisation for Economic Cooperation and Development (OECD), mostly of private, not public, debt (although we are likely to fall down those ranks as a result of the global financial crisis). The income foreign investors receive from New Zealand is more than the contribution to our Gross Domestic Product (GDP) of agriculture, forestry and fishing combined. It would seem obvious that it would be in the national interest for New Zealand to ensure it is getting the greatest benefit possible from that huge outflow of resources.
Yet internationally, but particularly in New Zealand, foreign investment has been the subject of deregulation. The United Nations Conference on Trade and Development (UNCTAD) reports, for example, that since 1992, an average of 69 countries changed their regulatory settings with regard to foreign investment each year, with 89.7% of those changes making their regime more favourable to foreign investors, and just 10.3% less favourable (2). Alongside this country-specific liberalisation is a rapidly growing number of international trade and investment agreements which in general commit the parties to reducing their regulation of foreign investment and where regulation exists making it more favourable to investors. Much of the country-specific liberalisation is likely to have been mandated in this way.
New Zealand ’s regulation of foreign investment centres around the Overseas Investment Act 2005. I will outline its main provisions shortly, but apart from some fiddling at the periphery, successive governments have steadily weakened its provisions, deregulating an increasing proportion of foreign direct investment. Our regulatory regime has been further weakened by a series of international agreements, including Closer Economic Relations (CER) with Australia, certain of the agreements under the World Trade Organisation (WTO), and more recent trade and investment agreements. In what follows, I will first consider the types of overseas investment that make up New Zealand’s international liabilities, and some of the opportunities and threats of accepting them. I will then outline the history and provisions of the Overseas Investment Act. Rather than analyse the numerous and complex constraints applied by the international agreements, I will give some examples of how they affect potential policy making in New Zealand, and then conclude.
Overseas Investment In New Zealand
New Zealand ’s international liabilities are made up as follows:
New Zealand ’s International Liabilities At 30 September 2009 (3)
New Zealand ’s net international investment liabilities were equivalent to 93.7% of GDP at 30 September 2009. As might be expected in the light of the financial crisis, this is the worst figure this century with the exception of March 2009 when it leaped to 94.4% from 88.6% in the previous quarter. But for the present purposes it is important to note that net international liabilities have been rising steadily (they were around 85% in 2007 before the crisis hit) and are entirely due to the private sector: even in September 09, despite its deficit run to keep the economy moving, the Government had net international assets of $3.4 billion, not a net liability. That is likely to change, but is most unlikely to swamp the high level of private liabilities.
It is also important not to focus solely on the net position. It is largely the liabilities which have a direct effect on the New Zealand economy, and they are very high, at $309.4 billion, or 1.67 times GDP. The assets largely affect the New Zealand economy by providing a source of income (in addition to export income) to help to pay for the outgoing interest and dividends on the liabilities. It cannot be assumed that the assets reduce the vulnerability New Zealand has due to its gross liabilities, as the assets are not necessarily owned by the borrowers and are not necessarily readily available to pay off liabilities in a crisis.
The private sector liabilities are divided into two forms: equity and borrowing. Equity is either foreign direct investment (investment in a company where a degree of control of the company is intended) or portfolio investment (small shareholdings where control is not intended). Just 20% of New Zealand’s gross liabilities and 6% of net liabilities are equity investment. The bulk is financial investment: borrowing or lending (debt). Included in the debt are more complex financial instruments such as derivatives. Some of the debt is also regarded as direct investment, such as where an overseas parent company lends money to its New Zealand subsidiary. However the great bulk of the debt is owed by banks – 61.7% of overseas borrowing was by banks at September 2009 – and mainly by the big four Australian banks. Each of these types of overseas investment in New Zealand is regulated in a different way and to a different degree.
Foreign Direct Investment is regulated by the Overseas Investment Act 2005. The 2005 Act was a complete rewriting of legislation which had been in force since 1973, and had been amended on numerous occasions over the intervening three decades. There are three main forms of foreign investment that it regulates. There are relatively detailed and enforceable requirements for ownership of certain types of land (“sensitive land” – non-urban land, land on islands other than the North or South Islands, foreshore or seabed, bed of a lake, conservation and park land, and land registered under the Historic Places Act) and of fishing quota. The 2005 Act tightened requirements somewhat with regard to land, and weakened requirements with regard to ownership of fishing quota (incorporated into the Act through amended provisions in the Fisheries Act 1996). Its effect is also subject to Government instructions.
For all other direct investment (mainly business investment), requirements are minimal and there are no requirements at all for such investment if its value falls under a threshold. That threshold has been raised on several occasions over the years (it was $10 million in 1999), and now stands at $100 million, so most such business foreign investment is exempted from oversight. In October 2009 the Government announced a new Investment Protocol under CER under which it would raise the threshold for Australian companies to $477 million. It has also stated that it is reviewing the threshold as part of a current review of the overseas investment rules.
For such business investment, the only criteria are that the company investing or the individuals controlling the investment collectively have business experience and acumen relevant to that overseas investment; that the investor has demonstrated financial commitment to the overseas investment; and that all the individuals with control over the investment are of good character. The weakness of these provisions is obvious and I am not aware of them ever having been subject to enforcement decisions. It is generally assumed that business experience and acumen exist simply because the investor is making an investment. Similarly an investment can almost always be said to be demonstrating financial commitment, however small or indefinite.
Good Character Rubberstamp
The good character requirement is routinely satisfied by the individuals providing statutory declarations that they are of good character. On occasions when the regulator (formerly the Overseas Investment Commission, and since the 2005 Act the Overseas Investment Office, part of Land Information New Zealand) has been asked to investigate evidence of the bad character of an investor no action has been taken, usually on the grounds that there has been no conviction for an offence, or that a court hearing is in progress or that the person has been removed from control after being found guilty. Even for companies with established records elsewhere of large scale price fixing (such as former Canterbury Malting Company owner Archer Daniels Midland*), or bad environmental behaviour (such as Waste Management’s former and original owner Waste Management International or WMX) no action was taken because the power to act applies only to individuals, not a corporate investor. Other parent companies have documented and public records of fraud and corruption.
*For details of Archer Daniels Midland’s massive corporate criminality, see the reviews, elsewhere in this issue, of the movie “The Informant!” and the reprinted review of the book “Rats In The Grain”. CAFCA’s “not of good character” complaint about ADM to the former Overseas Investment Commission, and the OIC’s dismissal of that complaint, is in Watchdog 95, December 2000, “American Corporate Criminal Comes To NZ: OIC Happy With Its ‘Good Character’”, by Bill Rosenberg, online at http://www.converge.org.nz/watchdog/95/12ameri.htm . This is just one example of a whole series of “not of good character” complaints – of which Waste Management was another – made by CAFCA and rejected by the OIC. See Quentin Findlay’s article on that subject, “Monkeys With Rubber Stamps: The Overseas Investment Office”, elsewhere in this issue. Ed.
For land and fishing quota there are more rigorous conditions in addition to these vestigial ones. For land the Ministers must be satisfied that “benefit will be, or is likely to be, substantial and identifiable”; for fishing quota the sale must be “in the national interest”. Factors for assessing the benefit include job creation or retention of job opportunities, introduction of new technology or business skills into New Zealand, increased export receipts for New Zealand exporters, added competition, efficiency or productivity, enhanced services, and increased processing in New Zealand of New Zealand’s primary products (for land), or fish or aquatic products (in the case of fishing quota). Other factors with regard to land essentially provide leverage to push investors into making commitments such as to pest control, erosion control or covenants over the land, protecting trout, salmon and game, improving walking access to the public, or offering foreshore, sea-, river- or lake-bed to the Crown. Farmland must be first offered on the open market to buyers who are not overseas investors before sale to an overseas investor can be approved. Significantly, the Act allows the Minister to specify other factors set out in regulations, and these have included consequential benefits to New Zealand, New Zealand’s image overseas, and trade and international obligations (cited frequently by applicants), supporting significant Government policy or strategy, and New Zealand control of strategically important infrastructure (of which more below).
Business Refusals Are Very Rare
I am not aware of any refusals of consent by the Overseas Investment Commission or the Overseas Investment Office as a result of the conditions that apply to business investment. The closest was, perhaps ironically, one early in the term of this Government (in December 2008) when an investor evidently decided to pull out of an investment due to the financial crisis. However this in the end relied on the fact that land was involved so the stronger criteria could be used. The Government refused consent, but the investment was not going ahead anyway. Cheung Kong Infrastructure Holdings Limited and Ironsands Investments Limited (CKI), owned mainly in Hong Kong was refused approval to acquire New Zealand Steel Mining Limited (NZSM) for $250,000,000 from BlueScope Steel Limited of Australia. According to the Overseas Investment Office: “Originally CKI intended to carry out an expansion of the Business through its proposed investment in NZSM. However, given the reduced demand for the product produced by the NZSM mine and the deteriorating global economic conditions CKI has come to the decision that plans to expand the Business are no longer viable”. The reason for refusing approval was that “CKI did not meet the Overseas Investment Act 2005 criteria of substantial and identifiable benefit which was relevant to the acquisition of business assets which included sensitive land”.
The most public and most important refusal was that of the 2008 application by the Canadian Pension Plan Investment Board, owned in Canada, to acquire up to 40% of the shares of Auckland International Airport Limited. Significantly, as will be seen, this included 1,548 hectares at Auckland International Airport. The Government attempted to enable the refusal by creating a new regulation allowing consideration of “whether the overseas investment will, or is likely to, assist New Zealand to maintain New Zealand control of strategically important infrastructure on sensitive land”. In the event, Ministers refused the application, but not by relying on this new regulation. Rather, they found (overruling Overseas Investment Office advice) that on balance over all the relevant factors, there was not substantial and identifiable benefit (4). However note that it was crucial that there was sensitive land involved in this proposed investment. If, as for many large investments, there had been no sensitive land (or fishing quota), the Ministers would have had no power to consider the balance of benefits of the application. There have been a steady trickle of refusals of applications, all with regard to land acquisition, but these are still only a small minority of decisions – an average of five out of 181 per year, or 44 out of 1,629 decisions between 2001 and 2009 (5). Most of the 1,629 involved land: 1,304 involved freehold land and 257 other interests in land such as leases. There has been only one application involving fishing quota since 2005, which was approved.
Overseas Investment Decisions From The Overseas Investment Commission And Overseas Investment Office 2001-2009
The investor must keep to undertakings given when making an application but can also obtain retrospective consent*, and a contract is not voided by lack of consent. Complete exemptions from the requirement for approval can be given for classes of investors, usually ones deemed not to be controlled overseas even though they have more than the statutory threshold of 25% overseas shareholding. However investors can be fined for investing without consent, trying to evade the requirements of the Act, making false or misleading statements or failing to comply with conditions made on investments. Orders can be made for disposal of property and fishing quota forfeited. * See the July to October 2009 OIO Decisions, elsewhere in this issue, for examples of retrospective consents. Ed.
Attempts to enforce these Acts have occurred only on rare occasions, and again all investments involved land. Five prosecutions have occurred since 2005. In 2005, an action against a US businessman resulted in a $17,000 fine and $5,000 in costs for failing to develop a Queenstown property as undertaken to the Overseas Investment Commission. He had made more than $1 million reselling the land (6). The Overseas Investment Office stated in LINZ’s 2006 Annual Report (p9) that: “This prosecution was the first time a person was convicted of breaching the Overseas Investment Act 1973”. Another in 2005 involved a US investor who bought a share of the Benmore Station in Canterbury for $1.35 million without telling the Overseas Investment Commission about a hunting conviction in the US in which he had been fined US$15,000 and banned from hunting for a year. The Commission obtained a warrant for his arrest but not his extradition from the US. The Overseas Investment Office has successfully prosecuted three investors, involving two different investments.(7) So the Overseas Investment Act is completely ineffectual with regard to decisions which are the most important by a very long way in economic terms unless there happens to be sensitive land involved in the investment proposal. It has some teeth with regard to land and fishing quota, but it is still relatively rarely used and still attracts public criticism for its feebleness (especially on land-related decisions).
Value For Money?
Returning to that early question of value for money for all the overseas investment in New Zealand, the standard response to the observation that we are spending a huge amount of resources on foreign investment income is that it brings much wider benefits, and that it is not valid simply to look at the costs. This particularly applies to foreign direct investment (FDI). The benefits commonly are asserted to include direct effects such as the creation of employment through “greenfield” investment, transfer of technology and skills, and better access to credit and markets; and indirect effects in the form of “spillovers” in which some of the direct effects create benefits outside the foreign enterprises themselves through demonstration of new processes and skills, and through added competition.
In fact there is evidence a significant part of the foreign direct investment coming into New Zealand is of low quality. For example a Treasury paper in 2008 observed that: “Some analysts argue that New Zealand receives substantial FDI inflows but has yet to benefit from spillovers.”(8) A large proportion of FDI in the 1990s was privatisation, some of which has had to be reversed because of its problems to the wider economy, and some of which is still problematic. While there is little data to enable a clear picture to be drawn, a significant part of the more recent FDI has been in the form of leveraged takeovers for short term capital gain through private equity financiers. They are typically investing for at most three to five years and have no interest or expertise in any particular industry or sector, as long as they can see opportunities for profit. The defence made by Kerry McIntosh, the New Zealand representative of private equity investor Ironbridge, against the charge that the company had no media experience when it took over MediaWorks, the owner of TV3, C4 and one of New Zealand’s two largest commercial radio networks, RadioWorks, was: “Ironbridge did not know much about waste either before buying EnviroWaste”(9). It is questionable whether we are seeing direct benefits let alone indirect positive spillovers from such investment. Greenfield investment, considered by some experts to be more desirable than takeovers, is relatively rare: UNCTAD estimates there were only 20-30 a year in New Zealand between 2004 and 2008 (10).
There is therefore a very arguable case for much more selective policy controlling FDI coming into New Zealand. At the very least we would be sensible to keep such options open. A more selective policy for business investment is likely to ask the kind of questions that the Overseas Investment Act requires to be asked about investment in land. Yet the legislation does not allow for this because the tests apply only to investment in land or fishing quota and the vast majority of foreign direct investment in New Zealand is not concerned, except peripherally, with land. Such policies are not rare around the world. Even Australia for example has much more potent powers with regard to foreign investment.
Consistency With Regulatory Taskforce Proposals
The Regulatory Responsibility Taskforce advocated six principles for inclusion in a Regulatory Responsibility Bill. These have a long history in neo-liberal doctrine. All legislation, regulations, and rules would be interpreted by the courts subject to these principles. The Taskforce’s report(11) states that they “fall within six broad categories”. The second and third are as follows:
So what would these regulatory principles think of more effective regulation of overseas investment? It would arguably breach the second principle of “liberties” because it would reduce a person or a company’s right to dispose of an investment. Indeed this is regularly argued with regard to land sales. It could be argued in some cases that restrictions on sale of property reduces its value and therefore is a “taking” which should be subject to compensation. If these principles become law as the Taskforce proposes, they would rule out improvements in overseas investment legislation.
International Constraints Already In Place
But in fact we cannot change the legislation in this way. Under the World Trade Organisation’s General Agreement on Trade in Services (GATS), the New Zealand government in 1994 made an enforceable commitment not to change the Overseas Investment Act of that time to be any less favourable to foreign investors in services in New Zealand. Neither can we place requirements regarding international trade on overseas investors. Even though access to markets is often given as a benefit of FDI, the Agreement on TRIMS (Trade-Related Investment Measures) in the WTO requires that we do not require foreign firms to export at a certain level, or use a certain level of local content in their exports.
These provisions are repeated in most of the free trade agreements signed by New Zealand, and extended in some. In addition, some of these agreements in effect impose the “takings” principle by their very broad concept of “indirect expropriation” or “indirect nationalisation” which allows a government to be challenged for actions that significantly reduce the value of an investment. The most obnoxious of these provisions, which applies to an investment agreement New Zealand has had with Hong Kong since 1995, and is the subject of the Trans-Pacific Partnership negotiations which began in March 2010 with the US, Australia, Peru, Vietnam, Chile, Singapore, and Brunei, allows private investors to challenge New Zealand laws in international tribunals in the World Bank, United Nations, or elsewhere (depending on the agreement). There are a growing number of cases that have been made public relating to similar agreements which frequently concern privatisations which have gone wrong, or action taken by governments to protect the environment, reducing the value of an investment or even reducing the value of a prospective investment.(12) Awards against governments extend into hundreds of millions of dollars. Some trade and investment agreements try to protect government actions for public purposes against such a challenge, but for various reasons there is reason to doubt how effective they will be. In addition, it would be easy to argue that this protection of the right to regulate was contrary to the Taskforce’s “Takings” principle.
Finally I would like to turn to the other form of overseas investment: financial investment or debt, including derivatives. The global financial crisis has taught us many lessons about the difficulties brought about by New Zealand’s level of debt, and the openness of our economy to the movement of capital. Or rather, it has re-taught us lessons which had been known but dismissed as no longer a problem because of the superior skills and knowledge of economists and financial market operators. Therein lies a warning against permanent embedding of any regulatory framework.
New Zealand has escaped the worst of the crisis, but the Reserve Bank was still very concerned that the high level of short term overseas borrowing by the major banks (largely to fund mortgages) made the banking system vulnerable to a freeze of international financial markets. Regulation of financial institutions and of high risk financial instruments has risen to the top of to the agenda. The GATS agreement in the WTO contains Financial Services provisions to which New Zealand is a signatory and which require New Zealand to allow any overseas-owned financial service provider to offer any “new financial service” it wishes to offer. This prevents us refusing permission for high risk financial instruments. Market Access provisions of the agreement may also prevent us limiting the volume and value of particular types of lending. It may even prevent us taking action over the “too big to fail” problem of individual banks being so important that the Government is forced to step in and rescue them. One response suggested by an expert in the area would be to limit the size of any one bank (13). This too would be in conflict with the GATS agreement.
GATS Barrier To Capital Controls
Respected economists like Joseph Stiglitz are once again advocating forms of management of capital movement to reduce the risks inherent in open international capital markets. It is unlikely New Zealand will be able to stabilise the value of our dollar without managing capital movements. All capital controls are potentially affected by the GATS. It contains a wideranging provision which requires that foreign financial service providers present in New Zealand must be allowed to transfer capital into New Zealand without restriction (14). This would prevent management of capital in a variety of ways, most obviously when used to stabilise the monetary system or the exchange rate. However since GATS does not have a companion requirement giving foreign providers the right to transfer capital out of the country, it may be that management of outward movements could be used to impose conditions on inward movements. However the GATS does guarantee unrestricted “current” payments and transfers (such as company profits) (15), which could be used as a cover for significant movements of funds, and the investment provisions of bilateral agreements such as with China guarantee free capital transfers in either direction. Bilateral and regional agreements have a variety of provisions protecting the movement of capital.
There are prudential exceptions to some of these provisions (“including for the protection of investors, depositors, policy holders or persons to whom a fiduciary duty is owed by a financial service supplier, or to ensure the integrity and stability of the financial system”), but their effectiveness is contested. There is not clear international agreement on what is a prudential measure and what is not. What is now regarded as prudential may not have been several years ago, indicating that what is considered prudential is heavily context-specific, often involving complex political considerations. It is unlikely that some measures would be challenged in the current circumstances because the major powers are using them themselves; in other circumstances they would challenge such actions to enable market entry for their financial corporations and products. For example, Ellen Gould and Patricia Arnold, who have analysed the GATS in the light of the financial crisis, point out that the Glass-Steagall Act in the US was repealed in 1999 after becoming “a target of European Union trade negotiators who defined it as a barrier to European countries” (there was also intensive lobbying from parts of the US financial sector which hoped to benefit from the repeal). The Act “separated commercial banking (deposit taking and lending) from investment banking to ensure that depositors’ savings were not put at risk in speculative investments and to avoid conflicts of interest”. If the Act was still in place, the US financial crisis may well have been quarantined to investment banking and had a far less pervasive effect on the stability of the financial system. Yet it was apparently not protected under the prudential provisions, and certainly that protection was open to challenge (16).
The picture I have painted is one not just of deregulation, but of deregulation permanently locked into place. It leaves no room for learning from practice, let alone learning the lessons of history and the global financial crisis. It is myopic, seeing no further than the vested interests and contestable theories currently holding sway. Putting it right doesn’t necessarily mean adopting particular policies regarding foreign investment; but it does mean leaving a range of policies open in case of regulatory or market failure. This would require changes in international trade and investment agreements, but it would be made even more difficult if the regulatory principles suggested by the Taskforce were enacted. They would be a case of regulatory failure in themselves.
(1) The programme and some of the papers are at http://ips.ac.nz/events/previous_events-2010.html
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