The Investment Canada Act and Chinese Investment in Canada

  • August 15, 2012
  • Mark Katz

When it comes to foreign direct investment, China and Canada have been described as a match made in heaven. Canada has vast natural resources but not necessarily the domestic financial capacity to develop them; China has a major appetite for natural resource imports and massive levels of outward foreign direct investment.

The Canadian government has, of late, been making assiduous efforts to attract Chinese investment. However, a June 2012 report by the Conference Board of Canada suggests that Canada is still seriously lagging behind other resource-rich countries, such as Australia, which attracts approximately three times more Chinese direct investment than Canada does.

The report acknowledges that Chinese investment in Canada tends to be politically sensitive because (i) it focuses on natural resources and (ii) it frequently involves investments by state-owned enterprises. There is a lingering concern that China will use these investments to "lock-up" Canadian resources, which will then be sold at below-market prices for processing and use in China. There is also a general suspicion of the Chinese government's track record in human rights and foreign policy matters. Chinese investors are sensitive to these negative views and this may be one reason for comparatively lower levels of investment in Canada.

According to the Conference Board's report, however, the opaque and politicized nature of Canada's foreign investment review regime makes it the main culprit.

Under the Investment Canada Act, foreign investments of a certain size and nature must first be approved by the government as being "of net benefit to Canada."  There is a separate review process that can be invoked to determine if a foreign investment could be "injurious" to national security.

While the Canadian government tends to ultimately approve almost all transactions involving foreign investors, the report says the criteria for what constitutes a "net benefit" are vague and open to interpretation, and argues the ICA doesn't even attempt to define when a transaction could be "injurious" to the national security. As a result, the review process inevitably gives the Canadian government a great deal of discretion. The report argues that the difficulties in predicting how this discretion will be exercised in any given case is at the root of Chinese reluctance to increase investment in Canada.

The report offers several recommendations for improving Canada's foreign investment policies. These include:

  • organize the ICA around two clear tests – one related to Canada's "national economic interest" and the other related to national security;
  • with respect to the national economic interest test, provide that the Canadian government will only be allowed to turn down a transaction if it can demonstrate that a foreign investment will be contrary to the national economic interest. This would reverse the onus of proof under the ICA, where investors must prove a net benefit; and
  • with respect to the national security test, specify the types of security risks that are meant to be addressed.

A joint report issued by the Canadian and Chinese governments in August 2012 says that stakeholders in both Canada and China have said that problems with regulatory clarity, efficiency and predictability are impediments to foreign-direct investment in both countries. Although the ICA is not identified by name, it is clear that the ICA review process is the target of these complaints insofar as Canada is concerned.

Yet it seems to me that these criticisms are misguided.

For one, it is highly misleading to contend that the ICA process is some sort of enigma wrapped in a mystery. Lawyers who practice in the area are well aware of what the government typically demands from foreign investors in order to pass the "net benefit" test. The details will differ from deal to deal, but the template is there and known. The national security review process, on the other hand, truly is an undefined black hole. But national security issues have only rarely been raised to date and are unlikely to be of major concern for the vast majority of transactions.

Second, in my view it is not such a bad thing that ICA review is, in essence, a matter of political discretion. Countries are entitled to determine how much foreign investment they are willing to tolerate and in what sectors. No government should cede such fundamental economic questions to judicial or administrative processes outside of political control. If this means that the ICA review process will always contain a certain degree of unpredictability, that is simply part of the political nature of the beast, and one with which we as a society are comfortable in many other spheres.

All of these issues are coming to a head, again, with the recent $15.1-billion offer by China National Offshore Oil Company Ltd. to acquire Calgary-based Nexen Inc. CNOOC is China's largest producer of offshore crude oil and natural gas and one of the largest oil and gas exploration and production companies in the world. Nexen is an Alberta-based energy company that develops oil and gas resources in Canada, the North Sea, the Gulf of Mexico, Yemen and Nigeria.

The CNOOC/Nexen transaction clearly puts the Canadian government in a tight spot. On the one hand, the government recognizes the value of Chinese investment in Canada and does not want to see that investment deterred or drastically reduced. The CNOOC offer has also been crafted to maximize the likelihood of its approval under the ICA.

For example, CNOOC has publicly offered to:

  • make Calgary the site of its new North and Central American headquarters;
  • maintain Nexen's current management and employees;
  • list the company on the Toronto Stock Exchange;
  • maintain and enhance capital expenditures on Nexen's assets; and
  • enhance community and social investments.

On the other hand, the transaction has triggered concerns from both the left and right wings of the political spectrum about foreign, and particularly Chinese, control of Canada's energy sector.

This will not be an easy decision for the Canadian government, to be sure. But, in the end, if the politicians get it wrong, or enough people disagree with how the politicians exercise their discretion, they will pay the price at the polls. And that is how it should be.

Mark Katz is a partner at Davies Ward Phillips & Vineberg LLP in Toronto.