Australia's foreign investment policy framework: How are we really doing and what can be improved?

While – overall – Australia's foreign investment regime is doing well, there is room for improvement. That's the conclusion of a new research paper, "Foreign Investment in Australia", from the Productivity Commission. The research paper looks at the trends, drivers and effects of foreign investment in Australia and the Australian Government’s foreign investment policy. Coming off the back of significant reforms to Australia's foreign investment review framework announced in June this year, the research paper highlights what is working well in the current system and aspects of the framework that are ripe for reform.

Australia's foreign investment regime

To balance the benefits and risks of foreign investment and ensure that it remains in the national interest, Australia regulates foreign investment through a review body known as the Foreign Investment Review Board (FIRB). FIRB's main task is to screen foreign acquisitions with values above certain thresholds, with the Treasurer being required in some cases to determine whether an acquisition is contrary to the "national interest". From an international perspective, this represents a broadly open approach towards foreign investment, yet one that is still much more restrictive compared to many other developed economies, as measured by the Organisation for Economic Cooperation and Development (OECD). For example, in the OECD's 2018 foreign direct investment restrictiveness index, Australia was placed well above the average, yet still lower than Canada and New Zealand.

The research paper notes that the balance between benefits and risks is becoming increasingly more difficult to strike, particularly in respect of risks associated with sensitive sectors and critical infrastructure assets. The focus on national security risks is certainly not unique to Australia, as policy makers around the world bolster their screening regimes on national security grounds with screening guidelines, thresholds and/or equity restrictions on sensitive sectors. Aside from national security, multinational tax minimisation strategies have also increasingly come under the purview of foreign investment policy-making, both globally and in Australia.

What is working well?

The research paper acknowledges that the following aspects of Australia's foreign investment policy are working well:

• "National interest" test overall: The research paper suggests that overall, the design of the “national interest” test and the vesting of responsibility with the Treasurer for administering the test works well, particularly in weighing up the costs and benefits of foreign investment. In particular, the "negative" nature of the test (deciding whether proposals are contrary to the national interest), helps to limit the risk of rejecting projects that are in the national interest, since the onus of proof rests with the Government to allow foreign investment unless it can determine that the proposal is against the national interest.
• Flexibility of current system: The current framework provides flexibility to quickly adapt to new domestic and international concerns, as seen in the relatively rapid policy changes enacted in response to the COVID-19 pandemic. This flexibility, evidenced by being able to restrict foreign investment in sensitive sectors while permitting foreign funding to flow in other areas, ensures that struggling Australian businesses and employers that are reliant on foreign investment have a better chance of recovering after the pandemic.
• Low rejection rate: The research paper notes that since 2015, the Federal Government has only blocked 10 out of more than 120,000 investment applications lodged with FIRB, although the low rejection rate may be partly due to the screening regime’s timing and costs discouraging some investors from applying at the outset and/or withdrawing pre-emptively.

Four areas for improvement

The research paper also suggests areas for improvement:

• Further clarity on the "national interest" test: Despite the overall success of the "national interest" test, the research paper suggests that it still lacks clarity around how it is interpreted from case to case. In particular, the research paper suggests that the Government could give more specific policy guidance and remove some risks from the test in cases where they can be regulated elsewhere (for example, competition risk, which can be mitigated through national regulations). This would assist in lowering compliance costs and improving investor certainty.
• Differentiation between low and high risk investment: The research paper highlights that a stricter foreign investment screening regime, as has arguably been proposed in light of the COVID-19 pandemic, can discourage investment from all sources, not just those against the national interest. To illustrate this, the research paper refers to various sets of modelling that the Commission undertook, which show economic costs to Australian household incomes for every foreign investment proposal blocked or discouraged. These costs are material, in the order of $0.8 to $7.1 billion per year, although it should be noted that this is not large in the context of Australia's nearly $2 trillion economy. Foreign investment policy therefore needs to strike the balance between tightly screening sensitive areas of investment, while ideally having a "fast lane" for those investments with lower risk to Australia's overall interests.
• Limited utility of conditions: The research paper argues that there are too many conditions attached to foreign investment approvals and that conditions are often of limited use in truly mitigating risks such as national security or multinational corporate tax avoidance. The research paper instead advocates that the Government should aim for more policy coherence and solutions that can progress as risks evolve, using national regulations and purpose-built and adequately-resourced regulators, such as the Australian Competition and Consumer Commission, Australian Taxation Office and Critical Infrastructure Centre. This ensures that FIRB remains an effective gatekeeper rather than a regulator with limited monitoring and enforcement capability.
• FIRB application process: In relation to the FIRB application process, the research paper recommends three concrete steps to increase transparency, enhance predictability and lower the costs of the screening regime: (1) routine publication of reasons for decisions; (2) greater certainty around timeframes; and (3) aligning application fees with the actual cost of administering the screening regime. Bidder application fees were a particular point of concern, with the research paper likening them to "taxes, not a fee for service… set at levels that are out of proportion with the cost of delivering the regulatory regime".

What's next for foreign investment in Australia?

While it remains to be seen which of the research paper's recommendations will be adopted, it is likely that Australia’s foreign investment policy will continue to shift as Australia navigates its COVID-19 recovery and global geopolitical alliances continue to change. The Productivity Commission has indicated that it intends to conduct further reviews to build on this research paper that will certainly continue to feed into the Government's response and formulation of Australian foreign investment policy.