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Foreign investment by state owned entities

CHAIR —I welcome our next witnesses, from the ACCC. Thank you very much for appearing here tonight. Do you wish to make an opening statement and perhaps outline the ACCC’s role in foreign investment, if any?

Mr Grimwade —I had not planned to make an opening statement, unless you would like me to make a statement to that effect.

CHAIR —It might be helpful if you did, I think—just to outline the ACCC’s role.

Mr Grimwade —Okay. We do not have any role at all in relation to the Foreign Acquisitions and Takeovers Act. Our role in relation to acquisitions is restricted to purely competition assessment under section 50 of the Trade Practices Act, which prohibits, in effect, anticompetitive mergers.

CHAIR —Thank you very much. Have you at times been invited to review a proposal for foreign investment in, say, a minerals or other business in Australia?

Mr Grimwade —Yes. We review a large number of acquisitions by foreign acquirers of Australian or other interests. Of the, say, 400 mergers that we review each year, a fair number are actually referred to us by the Foreign Investment Review Board, and we will often conduct assessments in relation to those. Separate to those, where there are particularly major transactions that involve a foreign acquirer, we are directly notified, or clearance is sought from us. So it is not uncommon at all. Of interest to this inquiry is the fact that we have looked at at least three major Chinese acquisitions of mining interests in the last six to 12 months, and there have been a much larger number of smaller acquisitions that we have been notified of by the Foreign Investment Review Board where we have conducted some form of assessment.

CHAIR —Given your interest is in competition and preserving competition, what dimension of an investment in a mining venture triggers your attention? Could you explain that. Is it because you think competition might be lessened between Australian miners? What is it exactly?

Mr Grimwade —For acquisitions in the mining sector, there are two particular theories of competitive harm that we will examine when we are looking at a merger in terms of our assessment of whether or not there is a breach of section 50 of the Trade Practices Act. We are looking at the likely effect on competition, and there are several different types of theory of competitive harm that we will explore to see whether there is an anticompetitive effect.

On the one hand, we will look at any horizontal aggregation of interests that the acquirer might already hold in addition to its acquisitions. For instance, if an acquirer already has some interests in Australia that compete with the target that it is intending to acquire, then we will look at the extent to which there might be some chilling or a diminution of competition in the market as a result of that acquisition. Separately—and this was an issue we explored particularly in the mooted Chinalco acquisition of Rio Tinto—we look at the vertical relationship as well, where you have an acquirer who does not necessarily have an interest that competes with its target head-to-head but it is a purchaser or has a related entity that is a purchaser of the product—the ore, for example—that is being produced by the target it is acquiring. The theory of harm we will examine there is the extent to which there can be any foreclosure of competitors through the vertical integration that might result or ensue from that acquisition. So they are two different anticompetitive effects that we will examine when we are looking at mergers generally and some of the acquisitions of mining interests in particular.

CHAIR —Thank you. Senator Joyce or Senator Hurley?

Senator HURLEY —I just want to go on to sovereign wealth funds. My understanding is that usually they invest in companies in Australia or if they invest in foreign companies that they do not necessarily form part of the management of the company. Is that right? And can you comment on the role of sovereign wealth funds in Australia in the context of your considerations of mergers and acquisitions?

Mr Grimwade —I cannot really provide any general comment. I am better answering questions that relate to particular transactions that we have examined. I will do my best. We will have regard to the interrelationship between the various interests that the sovereign wealth fund might have in competing entities and those of the target that it is going to acquire. We have not had to address the issue head-on yet, particularly in relation to Chinese acquisitions, but it is something that we have given a bit of thought to. Indeed, in relation to the Chinalco-Rio matter, if there was going to be a problem a number of conditions had to be met. One of them would have been that there was some relationship, say, between the Chinese steel mills and the entity that was proposing to purchase Rio, which was going to supply the ore to those Chinese steel mills. Ideally we will have regard to the sorts of relationships that do exist between companies. That might go to the level of ownership, control or influence that they might hold over each other.

Senator HURLEY —Last year, I think it was, I went to a briefing by a US sovereign wealth fund manager. They were talking about the range of investments they had in Australia but they were not necessarily 100 per cent owners or even a substantial owner of some of those businesses. When you are looking at mergers or acquisitions, how far down do you take the ownership? If a sovereign wealth fund or another investor entity were investing in, say, an area of property, would any alarm bells ring once they went to a certain percentage of ownership of that company?

Mr Grimwade —There is no bright red line, really. In fact, the provision that prohibits anticompetitive mergers does not require an element of control or ownership to be assessed in reaching a view of whether or not there is an anticompetitive effect. What we focus on is the effect on competition. To get to that point, to determine whether or not there is an effect on competition, you have to have regard, essentially, to incentives. There are a whole lot of factors that might come into play to determine whether or not the incentives will change after an acquisition. The level of ownership might be one of those factors, but there might be factors like board representation or other mechanisms of influence.

It might be that there are particular assets of a target. Senator Joyce raised this point before with the previous witness: in Chinalco-Rio there was a proposal to move from nine to 18 per cent of the shareholding of the Rio entity. As part of that acquisition there were other assets that were being acquired with a much greater degree of ownership. There were various committees where there was a greater representation by Chinalco to govern the management of that particular asset. So there are a lot of complicating factors in reaching a conclusion as to whether or not competition might be affected. There is interplay of a whole degree of different factors.

Senator HURLEY —I have not been here to listen the whole time, but it seems as though there has been a lot of discussion about Chinese investment. My understanding is that there have been waves of investment by all kinds of countries, by sovereign wealth funds and other large companies. Have you ever seen a particular country creating a particular problem?

Mr Grimwade —We do not really focus on the nationality of the acquirer, except to the extent that there might be some impact on competition. We are focusing more now on Chinese acquisitions because there is a trend and there are a large number of acquisitions in a particular sector. But it is fair to say that there are a large number of acquisitions in different sectors by companies that are based in countries all around the world and some of those companies have other interests here. Often they are a new entrant and raise no competition issues at all.

Senator HURLEY —That competition issue is clearly important to you. Often investment or a company coming in creates more competition. Sometimes it enables Australian companies or Australian originating companies to reach a critical size so that they can go out and work in other countries or create more competition by going interstate. That is a factor that you consider when you are looking at mergers and acquisitions, I presume ?

Mr Grimwade —Yes. Often we are confronted with sale processes where there are a number of competing bidders. Often there will be several bidders who are foreign companies who do not have a presence here. Often they will be the acquirers that pose the least competitive problems for us under section 50, particularly in oligopolistic markets, of which there are quite a few in Australia, where there are very few players.

Senator HURLEY —I worked in the investment banking industry in the mid-eighties. There were a lot of mergers between foreign banks going on there later on in the period. I guess at that time that played a role in keeping the sector alive, because they were experiencing difficulties and it might have collapsed altogether otherwise, even following the deregulation of the banking sector. Is that sort of injection of a stimulus into a struggling industry also something you take into account?

Mr Grimwade —In a way, yes. It might influence our thinking if you are comparing that acquirer with another acquirer that is not going to engender such a procompetitive outcome. But it is interesting to note that, at least in the banking industry, where there were quite a few international entrants, like HBOS with BankWest, there has been a departure of some of those interests from our shores.

Senator HURLEY —Thanks.

Senator JOYCE —Do you have a working knowledge of the Foreign Investment Review Board guidelines?

Mr Grimwade —I am not sure I would say it is a working knowledge.

Senator JOYCE —Do you have any knowledge of it?

Mr Grimwade —I have a little bit of knowledge. It is a different decision-making process.

Senator JOYCE —We used the analogy of a fictitious place, similar to Antarctica, to say if there was an issue with that country, would it concern you. I want to run through a couple of situations. Would the ACCC have any concerns if Iran in its current form under Ahmadinejad were to make substantial investments in Australia?

Mr Grimwade —Our focus in looking at an acquisition is on whether or not it is going to have an effect on competition. Whether or not there are national interest issues and implications is the role of the FIRB to advise the Treasurer on under the FATA. We would not have regard to the political dimensions of the country.

Senator JOYCE —Do you have any knowledge whether the Foreign Investment Review Board gives any consideration to the political dimensions of the country that is investing?

Mr Grimwade —That is a question that you should put to the FIRB.

Senator JOYCE —How do you deal with the issue of shelling out? Let’s say that you have a company that is now the owner of the resource in Australia and the purchaser of the resource overseas. The logical thing is that it will buy from itself and affect all the companies around it trying to also supply that sector. Take the example of uranium. If you have one major purchaser of uranium that is also one of the major owners of uranium in the ground in Australia—I am not saying this has happened but if it did—surely that would affect all the other uranium mines which are trying to supply the same market. Would that be the case?

Mr Grimwade —In a hypothetical scenario, if you have one buyer of the product and it integrates with one of a number of competing suppliers then that transaction would enable foreclosure of those competing suppliers.

Senator JOYCE —If it was a substantial buyer of a resource and it was also a substantial owner of a resource in Australia would that also have effects?

Mr Grimwade —It may. You have to remember the prohibition on anticompetitive mergers is an acquisition that is likely to have a substantial lessening of competition in a market in Australia. If the market is overseas and there is no market in Australia, it may well not be anticompetitive.

Senator JOYCE —My favourite area is the substantial lessening of competition test! Can you please for the purpose of the Hansard tell us the section of the Trade Practices Act which pertains to the substantial lessening of competition test then give the briefest description of how it works.

Mr Grimwade —Section 50 of the Trade Practices Act proscribes acquisitions that would have the effect or would be likely to have the effect of substantially lessening competition in a market.

Senator JOYCE —What is the test for that?

Mr Grimwade —Other provisions explain what a market is. Under section 50(3) the commission must have regard to a number of factors in assessing whether or not there is a breach of section 50. In that subsection the commission must have regard to things like import competition, concentration, barriers to entry, the likelihood of the removal of a vigorous and effective competitor, degree of substitutability and a few others.

Senator JOYCE —What is the general test? For me to get the keys to the court, to wander in the door, under section 50, the substantial lessening of competition test, what do I need to actually prove? Can I just prove that it is a big player in the market or do I have to prove more than that?

Mr Grimwade —You have to prove more than that.

Senator JOYCE —A lot more than that?

Mr Grimwade —I do not want to focus solely on concentration. That is one of the factors which the court must have regard to.

Senator JOYCE —I think the substantial lessening of competition test is a complete and utter furphy that is impossible to prove. I will cut to the point. I am going to try to clarify that point because I really have to prove that that person has almost a complete domination of a market before I can really get anywhere. To prove that point I will ask you this question: what was the last company that you succeeded in proving the substantial lessening of competition test on?

Mr Grimwade —As I mentioned this morning I think in response to a question you posed to the commission in Senate estimates, we have opposed at least 10 mergers this year. None of those have been challenged in court, so we have not had to go to court to establish—

Senator JOYCE —From your long history in the ACCC, your knowledge since you have been in that culture and your knowledge of everything to do with the substantial lessening of competition test, tell me a case where they said, ‘We took that one to court and they failed the substantial lessening of competition test’?

Mr Grimwade —In my time in Mergers, in the last five years, there has not been one, except for AGL-Loy Yang and that preceded me. In that case we were not successful.

Senator JOYCE —In all seriousness, would the Rio-Chinalco deal have failed the substantial lessening of competition test?

Mr Grimwade —No, it would not have failed the competition test. In fact we cleared that transaction.

Senator JOYCE —How much ownership of the iron ore or coal market would Rio and Chinalco have to have held, do you believe, before they would have a chance of failing the substantial lessening of competition test?

Mr Grimwade —In our view that was a clear-cut case of not a breach of section 50. If we look at, for instance, the iron ore market, Chinalco did not have a presence in iron ore and so the theory of competitive harm was one purely of a vertical nature. So our inquiries focused on the extent to which Chinalco, through its ownership of 18 per cent and its other interests in Rio, would have had the ability and incentive to influence the pricing and supply by Rio of its iron ore to Chinese steel mills.

For us to establish an SLC in such a circumstance, there were a number of conditions that would have to have been met. One we decided to conduct a working assumption of—namely, that the Chinese steel mills and Chinalco were related. Two, there would have to have been an establishment of the proposition that Chinalco would have been able to control Rio and influence Rio in making a decision to actually increase the supply of iron ore so as to lower the price of iron ore to the Chinese steel mills. Thirdly, we had to establish that Rio would have had the ability and incentive to actually increase supply and lower the price of iron ore. That third condition was simply not met, because the only way that competitive harm could have resulted from a vertical nature was if Rio was to oversupply iron ore and lower the price of iron ore to the Chinese steel mills to the detriment of others.

Senator JOYCE —And there was no way you were going to be able to prove that. How would you ascertain these facts? You would have to have a thorough knowledge of the workings of the market in China and that knowledge is precluded from you because you are dealing over there with state owned enterprises and they are just not going to let you know how their pricing mechanism or their costing mechanism works. That information is just not available to you.

Mr Grimwade —I think that question is pertinent to the first condition I mentioned, which was the extent to which different Chinese owned entities compete with each other. But, no, that is not relevant to the key issue for us, which was the ability and incentive of Rio to influence the pricing that Chinese steel mills would have paid for iron ore. We did not need to delve into the workings of the Chinese corporate mind because Rio would not have been able to exercise that ability and it would not have had the incentive. We established to our satisfaction that should Rio have increased its supply—that is, it brought forward its various production programs—then the reaction of its competitors would have been to hold off their production programs and minimise or reduce their supply so that there could not have been a change to the international pricing of iron ore in that transaction. So there was no ability or incentive for Rio to engage in the sort of competitive harm that we would have needed to establish for it to breach section 50.

Senator JOYCE —There are two issues here. Look at all oil, for instance. Oil comes out of the ground and can be converted into diesel, so it can arrive on the streets of Iraq at a cost of about 7c or 8c. It is not very much. By the time it gets over to Australia, the terminal gate price for it is about $1.10. That is 38.186c in excise and the rest is transport. But the rest is just what they call control of the market. That is how they manage to make a quantum of money. Surely that is going to work in the other direction to the detriment of Australia when the ownership is in such places as China and there are miners in Australia and we are relying on the transfer pricing on the way through. Since all these entities are related, because they are all owned by the Chinese government, their primary source and their preferred source will be from the entity they own and control in Australia. Then we just have to rely on some sort of honesty and transparency in what becomes a completely and utterly different transaction—that is, a transaction to themselves.

Mr Grimwade —We did not consider that that level of concern arose in the Chinalco-Rio transaction because Rio simply would not have been able to act in a way that advantaged the Chinese customer over any other customer of Rio for iron ore. We did not even need to get to the point where of establishing that Chinalco would have had some degree of strong influence over Rio’s pricing decisions.

Senator JOYCE —Let us say, Mr Grimwade, that the ACCC, despite your best efforts and with the greatest sense of diligence and honesty in the way you acted, got it wrong. Can you please refer me to the divestiture powers that you would use to break the arrangement up?

Mr Grimwade —There is a divestiture power for acquisitions. I think it is under section 81.

Senator JOYCE —There is a very temporary one after mergers and acquisitions, but it has no longevity in it.

Mr Grimwade —Three years after the date of the acquisition, the commission—only the commission, not a private party—has the power to seek divestiture in court.

Senator JOYCE —So after three years you are sort of stuck, aren’t you? There is no power. You would have to introduce a bill to get the divestiture power beyond that date. Even then, divestiture powers in Australia are extremely limited in their operation in comparison to those of other countries. You would have to say that, wouldn’t you?

Mr Grimwade —I am not that familiar with other countries’ divestiture powers. There are certainly some jurisdictions that would have a broader divestiture power that extends to monopolisation. Our divestiture power is restricted to acquisitions.

Senator JOYCE —Mergers and acquisitions, in a temporary form after the event. How would you deal with the problem if you found out later on it had all gone pear-shaped? Say an entity, by reason of its vertical integration, was shelling out the marketplace? How are you going to deal with it?

Mr Grimwade —The divestiture power is rarely used. I think it might have been used once years ago.

Senator JOYCE —That is interesting. When was the last time divestiture power was used?

Mr Grimwade —It might have been in the Australia Meat Holdings case, which was in the nineties, I think.

Senator JOYCE —Who owned Australia Meat Holdings at that stage?

Mr Grimwade —Not Swift.

Senator JOYCE —Was it ConAgra?

Mr Grimwade —I cannot remember.

Senator JOYCE —I will just declare for the record that I was an accountant for Australia Meat Holdings.

Mr Grimwade —Okay. Hopefully not at the time we took action against them.

Senator JOYCE —I am going to inform you that the trick is to rip you off.

Mr Grimwade —Just going back to your question, one of the complications in convincing a court to grant the remedy of divestiture in a merger case is that we would have to establish that the acquisition was the cause of the competitive harm. The longer you wait after an acquisition, the murkier it is gets as to what might be the actual cause of any anticompetitive effect, because there might be changes in the marketplace. There might be another acquisition. There might be some other change that has been somewhat responsible for the anticompetitive effect that might result. It is not an issue that we have faced in recent times, I should say.

Senator JOYCE —So really we are looking at the fact that the substantial lessening of competition test under section 50 has not got a history—if you actually look at the court history of it, it is extremely limited and almost non-apparent. If you look at the divesture powers, it virtually is non-apparent. Does this not give us a concern about what happens if things go wrong? And what do you think your capacity is in the ACCC to haul into court a foreign entity which—to be completely frank—is far more powerful than Australia?

Mr Grimwade —Can I just address the first part of your question because I do not agree with you. I think the substantial lessening of competition test is quite satisfactory. You seem to be judging its effect on the basis of the lack of court actions that have been taken. I would say that the great success of the substantial lessening of competition test is that we have engendered at the commission and through the informal clearance process a great degree of compliance with section 50. There are often companies that I will speak to that say, ‘We thought about this transaction, but we are not going through with it because we know that we could not get it past you or we know it would breach section 50’.

As I mentioned before, there are a number of transactions that we will oppose each year and the companies are sufficiently satisfied with our analysis and that we have reached the correct result that they are not going to challenge us in court. They can go ahead with the merger and then we have to prove our case in court. They chose not to because, invariably we consider that we have a strong case under section 50. In addition to those mergers that we oppose under section 50, there is a lot of engagement that we have confidentially with firms that come in with proposals. They will walk away before we even reach a final view.

Senator JOYCE —What percentage of mergers go through?

Mr Grimwade —90 to 95 per cent of the mergers that we would review we would clear.

Senator JOYCE —There is more than that, though, isn’t there? So there are 90 to 95 per cent that go through and then there are a few more with conditions.

Mr Grimwade —There are those that we would have opposed otherwise.

Senator JOYCE —How many are actually opposed and do not go through?

Mr Grimwade —I would say we opposed 10 this financial year.

Senator JOYCE —As a percentage?

Mr Grimwade —That is three or four per cent.

Senator JOYCE —That is what I thought—97 per cent ultimately end up going through. If I had a 97 per cent strike rate in darts, I would be the king of every pub in town.

Mr Grimwade —You have to look at it in context. I could reduce the number of mergers that we look at in the commission by a couple of hundred and increase our strike rate—double it.

Senator JOYCE —I am not saying you should reject. I am just saying that from an outsider looking in it looks like you are really doing something crazy if you get rejected. Internally in Australia, I suppose we can handle the problem domestically. We have got real problems when the jurisdiction goes outside our borders because it makes it twice as difficult when you are dealing with an organisation in which there are diplomatic issues and a whole range of issues that are pertinent to that issue.

Mr Grimwade —If the acquisition by a foreign acquirer is going to give us competition concerns, invariably that acquirer is going to be carrying out some business in Australia, so there will be an entity that we will be able to enforce a finding against. There is a section of the act, section 50A, which has never been used—do not asked me to cite it, because I do not think I could—which essentially deals with acquisitions that occur overseas and have some effect in Australia.

Senator JOYCE —Which is a form of quid pro quo. China is now looking at that with Rio and BHP—or a type of act similar to 50A. There would be a Chinese version looking at those.

Mr Grimwade —Something like that.

CHAIR —Senator Joyce, we are a little bit beyond time. I do not know what other questions you have.

Senator JOYCE —I understand. It gives us something to go on. Thank you very much, gentlemen.

CHAIR —With that, I thank the witnesses for appearing tonight. I thank the secretariat and Hansard.

Senator JOYCE —I just have one question. Stephen, what are you doing here tonight?

Mr Bordignon —Moral support, I think!

Senator JOYCE —You did a very good job of moral support; you were very moral and very supportive.

Mr Bordignon —Thank you, Senator.

CHAIR —Thank you for being here.

Committee adjourned at 9.50 pm