EXPLANATORY STATEMENT

 

Select Legislative Instrument 2006 No. 286

 

Issued by authority of the Parliamentary Secretary to the Treasurer

 

Foreign Acquisitions and Takeovers Act 1975

 

Foreign Acquisitions and Takeovers Amendment Regulations 2006 (No. 1)

 

Section 39 of the Foreign Acquisitions and Takeovers Act 1975 (the Act) provides that the Governor‑General may make regulations, not inconsistent with the Act, prescribing all matters required or permitted by the Act to be prescribed, or necessary or convenient to be prescribed for carrying out or giving effect to the Act.

 

The Act provides the legislative underpinning for the Australian Government’s foreign investment screening regime to ensure that foreign investment in Australia is consistent with the ‘national interest.’

 

Further details of the legislative framework are at Attachment A.

 

The purpose of the Regulations is to amend the Foreign Acquisitions and Takeovers Regulations 1989 (the Principal Regulations) to exempt, from the operation of the Act, foreign custodian companies where they acquire interests in shares in relevant corporations and interests in Australian urban land when only acting at the direction of clients.

 

Custodians are generally performing a bare trustee or nominee role. They hold the legal interest in shares or interests in land on behalf of their client investors who hold an equitable interest. Custodians do not independently exercise rights attached to their interests. As such circumstances involving foreign custodians do not raise national interest issues, the exemption is consistent with the rationale of the Act and it will help streamline the Act’s operation. The exemption is intended to include the market practice where chains of custodian holdings are used in the provision of custodian services to clients in various circumstances.

 

The Regulations, in part, repeal a mechanism for foreign custodians to seek a partial exemption from the Act’s notification requirements in relation to proposed acquisitions of interests in shares in relevant corporations. That exemption was evidenced by a certificate of exemption which was subject to a national interest test. However, as this mechanism was narrowly cast, it was not widely taken up by industry. Further, there was no similar mechanism available for foreign custodians in relation to proposed acquisitions of interests in Australian urban land. The new exemption supersedes this partial exemption, covering interests in shares in relevant corporations and interests in Australian urban land, and is not subject to a national interest test.

 

The Act will continue to apply to any foreign person who, as a client of the custodian, is instructing the custodian and who acquires an interest in corporations or Australian urban land to which the Act applies. The Act will also still apply to foreign custodians’ relevant interest holdings where they are not acting at the direction of their clients.

 

This reform will benefit Australian corporations which otherwise could have anomalously become subject to the Act, in part due to holdings of interests in their shares by foreign custodians on behalf of Australian and foreign investors.

 

 

This reform will therefore offer substantial regulatory relief to foreign custodians and a range of Australian corporations from regulatory compliance costs with the Act. It will also create a more level playing field in the domestic market for custodian services. More broadly, this reform will help enhance Australia’s attractiveness as a destination for foreign investment which is important to Australia’s ongoing economic growth and prosperity.

 

This reform and these Regulations were developed in consultation with relevant stakeholders. A Regulation Impact Statement is at Attachment B. The Office of Regulation Review considers that this Regulation Impact Statement meets the Australian Government’s best practice processes for regulation and contains an adequate level of analysis commensurate with the significance of the likely impacts.

 

The Regulations are a legislative instrument for the purposes of the Legislative Instruments Act 2003.

 

The Regulations commenced on the day after registration.

 

 

 

ATTACHMENT A

 

Further details of the legislative framework

 

The Act provides that the Treasurer has powers to make certain orders in relation to proposed acquisitions by foreign persons of certain interests where the result of such proposals would be contrary to the national interest. Section 18 covers proposed acquisitions of interests in shares in relevant corporations. Section 21A covers proposed acquisitions of interests in Australian urban land.

 

The Act provides definitions of “foreign person” and “interests” relevant to the exercise of these powers. Section 30 of the Act provides that failure to comply with such orders is an offence. Section 25 provides that where the Treasurer is empowered to make such orders, the Treasurer may instead decide that the Australian Government has no objection to the proposal (with or without conditions).

 

Section 26 of the Act provides for compulsory notification of certain section 18 proposed transactions and section 26A of the Act provides for compulsory notification of certain section 21A proposed transactions. These sections provide that failure to notify in relation to the specified proposed transactions is an offence.

 

Paragraph 11(5)(c) of the Act provides that there shall be disregarded an interest of a prescribed kind in a share, being an interest of such person, or of the persons included in such class of persons, as is prescribed. For the purposes of paragraph 11(5)(c) of the Act, Regulations 2A to 2B of the Principal Regulations prescribe certain interests in shares.

 

Subsection 12A(8) of the Act provides that the regulations may specify that the Act, or a provision of the Act, does not apply in relation to an acquisition of a kind specified in the regulations, of an interest in Australian urban land.  Regulation 3 of the Principal Regulations provides that the Act does not apply in relation to certain interests in Australian urban land.

 

 

ATTACHMENT B

 

Regulatory Impact Statement

Proposal to Exempt Foreign Custodians in certain circumstances from the Foreign Acquisitions and Takeovers Act 1975

 

BACKGROUND

Purpose of Australia’s Foreign Investment Screening Regime

The primary purpose of Australia’s foreign investment screening regime is to ensure that foreign investment in Australia is consistent with the ‘national interest’ and takes account of community concerns about foreign ownership of Australian assets. The term ‘national interest’ does not have a precise definition. However it includes such considerations as the existing whole-of-government policy and law, national security interests, and economic development. This broad but important policy would make it very difficult to try to quantify the benefits of screening foreign investment proposals for national interest risks.

The Foreign Acquisitions and Takeovers Act 1975 (the FATA) provides the statutory basis for Australia’s screening regime and determines which proposed transactions are screened. Under the FATA the Treasurer has the power to block or unwind transactions where the outcome is considered to be contrary to national interest, or impose conditions on a proposed transaction to ensure that it would be consistent with the national interest.

The FATA allows a period of 30 days^[1] to examine transactions to determine whether they may be contrary to the national interest. For transactions that are not deemed to raise significant national interest concerns, a notice of no objection must be issued within 10 days of a decision being made. Where no decision is made on a proposal within the 40 day approval period, it will be deemed to have been approved.

Current Regulatory Framework for Foreign Business Investment

Two sets of key thresholds determine the range of business transactions that are covered by the FATA.

The first is the ‘asset value threshold’ that is used to exempt low‑value businesses from screening. Since 1999, this threshold has been set at A$50 million meaning that businesses valued below this, are not subject to the FATA screening requirements. In practice however, currently notifications relating to businesses valued at between A$50 million and A$100 million are not generally subject to any detailed examination. Typically, these proposals are simply noted and a non‑objection notice is issued.

This A$50 million threshold generally applies to all business investors, except in the case of US investors who are subject to a higher asset value threshold – currently A$831 million. The higher threshold of A$800 million (indexed to the GDP deflator) was negotiated under the Australia‑United States Free Trade Agreement (AUSFTA) and came into effect in January 2005.

Other exceptions to the A$50 million threshold apply to proposals involving: sensitive sectors^[2]; direct investments by foreign governments and their agencies^[3]; direct investments by foreign persons in the media (and proposed portfolio investments of 5 per cent or more); and establishment of new businesses involving expenditure of $10 million or more^[4].

The second set of thresholds relate to the number of shares that a foreign person or persons are permitted to hold an interest in before being subject to the FATA. This ‘FATA control threshold’ is currently set at 15 per cent for individual foreign persons or 40 per cent for groups of associated foreign persons. This means that foreign persons are deemed to hold a substantial interest in an Australian company at either 15 per cent at the individual level or 40 per cent at the aggregate level. Proposals that involve acquisitions of substantial interests (as defined by these thresholds) are subject to compulsory notification^[5] and screening if they satisfy the relevant asset value test (that is, they are valued above the A$50 million threshold).

Review of australia’s foreign investment screening regime

A Review of Australia’s foreign investment screening regime in relation to business investment was recently completed in accordance with the Australian Government’s AUSFTA commitments. Under the AUSFTA, the Australian Government undertook to conduct a review (within 18 months of entry into force of the agreement) of the treatment of several types of foreign business investment under the FATA.

The purpose of the Review was to analyse whether application of the current foreign investment screening regime to certain business transactions (including portfolio investment^[6], internal corporate reorganisations and foreign‑to‑foreign takeovers) imposes unnecessary compliance costs on investors.

The broad objective of the Review was to better focus the Australia’s foreign investment regime on transactions that are most likely to raise significant national interest concerns. Such streamlining of the regime would reduce unnecessary screening of proposed business transactions and the associated compliance costs for stakeholders, while maintaining the regime’s effectiveness.

The Review also took into account concerns about the scope of the FATA highlighted by the Taskforce on Reducing the Regulatory Burden on Business (the Banks Taskforce). This Taskforce recommended, in part, that the Government should raise the thresholds for approval of non-real estate acquisitions under Australia’s foreign investment screening regime (Recommendation 5.58(b)).

The Review consulted with relevant stakeholders including foreign investors, financial market participants, peak industry bodies and Australian business representatives. Among other issues, stakeholders questioned the appropriateness of the regime’s approach to foreign custodians.

This Regulation Impact Statement does not deal with all the issues considered during the Review. Rather, it focuses on the specific issue of the FATA’s approach to foreign custodians. However the Review’s findings on the operation of the FATA provide broader context for consideration of this specific issue.

Review’s findings on the operation of the FATA in the current economic context

The Review focussed on whether the scope of the FATA was too broad in relation to a number of business-related foreign investment proposals, imposing unnecessary compliance costs and not achieving its objective of screening foreign investment proposals only where they may raise national interest issues. The Review concluded that the FATA was too broadly cast, including in relation to its approach to foreign custodians. A key part of the problem is that the FATA regime needs updating to handle the current economic environment of increased foreign investment flows, new complex commercial structures and investment vehicles.

The review suggested that in the context of growing global economic activity and increased cross‑border investment flows, this problem is increasing in scale. These economic trends and complexity of the regime will continue to increase the already substantial FATA compliance costs for business, amplifying the risk of reducing Australia’s attractiveness as a destination for foreign investment.

There has been particularly strong growth in portfolio investment flows into Australia since 1997, partly due to the increased propensity for investors to use pooled investment vehicles. For example, the Australian Bureau of Statistics’ data shows a A$197 billion (18 per cent) increase in the level of foreign investment in Australia over the last financial year from A$1,108 billion in June 2005 to A$1,306 billion in June 2006 (ABS’ Balance of Payments and International Investment Position - June Quarter 2006). The major factor behind this increase was a A$159 billion rise in the level of foreign portfolio investment, from A$652 billion to A$811 billion. The vast majority of that investment was in the financial and insurance sectors, where the use of custodial services is increasingly popular. In June 2006, the Australian managed funds market surpassed A$1 trillion in consolidated assets. This additional source of capital enhances our financial market liquidity and helps strengthen and improve the well functioning of our domestic markets.

The following analysis demonstrates the scale and frequency of these problems.

Statistical analysis of casework – frequency of problem of regulating proposals where there are no national interest issues

In terms of the risk of national interest issues arising, the Review found that the overwhelming majority of foreign business-related proposals do not raise any national interest concerns and receive approval within the total 40 day period available. This suggests that the scope of Australia’s screening regime is currently too broad and significant scope exists for streamlining the regime.

This is reinforced by the relatively small number of non-real estate proposals that have been blocked since 1992, compared with the high volume of proposals screened. The last business investment proposal to be blocked on national interest grounds was Shell’s proposed acquisition of the North West Shelf gas project in April 2001. Between 1992-2000, nine non-real estate foreign investment proposals were blocked on the grounds that they would be contrary to the national interest. No substantive proposals have been blocked since 2001 and only a small number of approvals have been subject to conditions^[7]. As an example of the number of business-related notifications, 345 business-related proposals were notified for screening in 2005.

International comparisons – scale of problem of Australia’s regime being uncompetitive in attracting foreign investment

The Review’s comparison of screening regimes indicates that Australia screens a significantly wider range of business transactions than either Canada or New Zealand. ^[8] For example, while the FATA contains thresholds of A$50 million (general asset value threshold) and 15 per cent (individual control threshold in a relevant corporation), the Canadian regime is based on thresholds of C$265 million (equivalent to more than A$300 million) and 33 per cent and the New Zealand regime is based on thresholds of NZ$100 million (equivalent to around A$85 million) and 25 per cent.

Australia also screens categories of transactions (such as internal corporate reorganisations and offshore takeovers) that are not screened in either Canada or New Zealand. This suggests that Australia’s screening regime is relatively more restrictive and onerous than comparable regimes, which risks reducing Australia’s competitiveness as a destination for foreign investment.

Consultations – scale of business’ compliance costs

Consultations indicated that the cost of complying with Australia’s foreign investment screening regime is significant, deriving from three main sources:

·        the need for foreign persons to monitor the size of their interests in relevant companies to determine whether or not a proposed acquisition of additional shares will cause them to cross the FATA control threshold;

·        the need for foreign persons to prepare and submit a notification setting out required information in relation to a proposed transaction; and

·        the need for foreign persons to delay a proposed transaction until it has been approved.

A peak industry body and a major financial services corporate group provided an estimate of average costs per FATA notification in the range of US$25,175 to US$35,000. The following is a breakdown of the minimum aggregate costs (in terms of US$).

The legal cost for each application is between $8,000-$10,000 (ie average of $9,000). In addition, it is estimated that each application involves approximately 32 hours of compliance monitoring time, which costs approximately $16,174 per application of internal time.  This results in an average per application cost of $25,175.

A rough break down of the costs in relation to each task is as follows (per application):

·        cost of applying for/maintaining approvals: $10,046 ($9,000 legal, $1,046 monitoring)

·        notification requirements: $248

·        education requirements: $1,918

·        purchase (eg obtaining company reports and accounts): $124

·        record keeping: $9,482

·        procedural: $3,357

The above cost estimates do not take into the additional account systems related costs. One foreign custodian recently spent approximately A$330,000 on system purchase costs to assist with FATA compliance.

Consultation also indicated that these costs can be particularly significant for large foreign portfolio investors (including those that are part of larger financial services groups) and foreign custodians that hold large numbers of shares in Australian companies in the course of providing nominee and custodial services. For these investors, compliance costs can account for a substantial proportion of the total cost of carrying out a transaction.

FOREIGN CUSTODIAN ISSUE

Identification of Specific Issue

Consultations with stakeholders suggested that the FATA’s current approach to foreign custodians is not consistent with its purpose of only screening interests in foreign investments which raise national interest issues.

Custodians perform a role for their clients, similar to that of a bare trustee or nominee, in accordance with contractual agreements. The main role of custodians within Australia’s financial system is to maintain safekeeping of shares and other financial assets on behalf of institutional investors. Generally, custodian companies hold the legal interest on behalf of investors who hold the equitable interest (usually fund managers and other institutional investors). Custodians generally only exercise voting power attached to shares under the direction of the relevant beneficial owners. Foreign custodian businesses hold a 50 per cent share of the Australian market for custodial services.

Currently, foreign custodians, acting on behalf of Australian or foreign investors, are subject to the FATA, including its compulsory notification requirements, in relation to proposed acquisitions of interests in shares or Australian urban land. In addition, the relevant foreign investors are also subject to the FATA. Domestic custodians are not subject to the FATA when providing their services to foreign or domestic investors.

Consultations with stakeholders suggest that there are two unintended problems with the FATA’s current approach to foreign custodians.

The limited nature of the role of custodians suggests that the FATA is imposing an unnecessary regulatory burden on foreign custodians where they are only acting at the direction of foreign beneficiaries who themselves are subject to FATA screening. Subjecting foreign custodians to FATA screening also creates an un‑level playing field with their domestic custodian competitors who are not subject to FATA compliance costs, delays and regulatory uncertainty. This regulatory scope does not seem to be consistent with the purpose of the FATA which is to screen foreign beneficiaries’ proposed acquisitions of interests in shares in relevant corporations and in Australian urban land.

There are also unintended downstream issues with the FATA’s current application to foreign custodians. Under the FATA, an Australian corporation will be deemed to be a foreign person if another foreign person holds an interest (legal or equitable) in 15 per cent or more of its shares. Significant holdings of legal interests by foreign custodians on behalf of Australian beneficiaries can therefore result in Australian businesses themselves becoming subject to the FATA.

Size of the problem

These issues are a significant problem because as mentioned above, custodians are becoming an increasingly popular means of investing in Australian corporations for both domestic investors and foreign investors. The regulatory costs incurred by foreign custodians are passed on to investors, which impacts on Australia’s attractiveness as a destination for foreign and domestic investment. This problem is likely to amplify as portfolio investment is playing an increasingly important role in the context of ongoing growth in the investment management sector and cross‑border investment activity.

Objective

The objective of reviewing the FATA’s approach to foreign custodians is to better focus the FATA regime on business transactions that are likely to raise significant national interest. Such streamlining of the regime would reduce unnecessary screening and the associated compliance costs for stakeholders, while maintaining the regime’s effectiveness.

Options

To address these issues, three options were considered under the Review:

·        Option 1: retain the FATA regime’s current approach to foreign custodians. Under this regime, foreign custodians may seek a partial exemption from the FATA.

·        Option 2: retain the FATA regime’s current approach to foreign custodians and consider whether the problem could be addressed by other reform options such as raising the FATA’s statutory control and asset thresholds.

·        Option 3: exempt foreign custodians from the FATA in relation to proposed acquisitions of interests in shares in relevant corporations and interests in Australian urban land where they are acting at the direction of beneficiaries.

 

 

 

 

Impact Analysis

Option 1: retain status quo – FATA screens foreign custodians unless they obtain an exemption certificate

Benefits

Option 1 would provide the benefit of continuing to screen proposals for foreign custodians to acquire interests in shares in relevant corporations or in Australian urban land above the general thresholds. It is not clear what public policy benefit would be served by continuing to screen foreign custodians where they are only acting at the direction of their clients. Arguably, such screening could be considered as a way to monitor such transactions in case foreign clients, who are acquiring interests at the same time in relevant corporations or Australian urban land, do not themselves notify. This would be an indirect safeguard in the regime in addition to the safeguard that non-compliance with the FATA is an offence.

Costs

Under Option 1, foreign custodians would continue to incur FATA compliance costs and regulatory risk associated with being subject to the FATA. It is not clear what public policy interest would be served by continuing to subject foreign custodians to the FATA where they exercise the rights attached to their interests in shares only at the direction of their client beneficiaries. It would mean that both foreign custodians when acting on behalf of Australian investors or foreign investors would incur the compliance costs. In the case of foreign investors, this would suggest duplication of notification and compliance costs. In the case of Australian investors, this would not appear to be consistent with the purpose of the FATA as there is no foreign control. In both cases, it places the foreign custodian at a competitive disadvantage to its domestic competitors.

The compliance costs incurred by foreign custodians when their holdings in relevant corporations reach 15 per cent are similar to those incurred by portfolio investors. They must incur significant costs to monitor the size of their aggregate holdings in relevant corporations to determine when they may cross the 15 per cent control threshold. Foreign custodians also have to incur the costs of preparing and submitting a notification.

One stakeholder providing custodian services estimates that under the current FATA regime (without the benefit of a partial exemption) generic compliance costs with the FATA is substantial, and increases in accordance with the volume of relevant transactions.  As mentioned above, the average cost per notification under the FATA is $US30,000. This includes costs of complying with notification obligations (including legal costs), monitoring, the preparation of notices and review processes, educating staff and record keeping.  There are associated costs to support the notification process, including IT and training requirements – for example, an upfront cost would be to set up an account system which alone can be approximately A$300,000.

The problems faced by foreign custodians in relation to the FATA are further complicated because custodians do not necessarily have any advance knowledge that they will receive additional shares in a company as a result of a client transaction. This creates a significant regulatory risk for foreign custodians, as it is an offence under the FATA not to comply with its compulsory prior notification requirements. This regulatory risk for foreign custodians is particularly great in the context of their clients’ transactions on the Australian Stock Exchange which are generally settled within a period of three days.

Consultation with stakeholders also identified potentially significant downstream costs for Australian entities that would be deemed 'foreign' due to holdings of interests in their shares by foreign custodians on behalf of investors. Like the foreign custodians, such Australian entities would incur the general FATA compliance costs estimated above. In particular, large financial institutions whose business generally involves frequent transactions could incur annual FATA compliance costs of hundreds of thousands of dollars per annum along with other substantially greater commercial costs. 

For large financial institutions, the more significant commercial costs arise from the delay to transaction timetables, interference with contracts, branding and business generally and the potential lost opportunities caused by having to comply with the regime, in particular the 30 day plus approval process.  For some entities, this delay will cause business to be lost to competitors. Stakeholders suggest that it is not possible to quantify such commercial opportunity costs.

Currently the FATA regulations (2A, 2B and 2C) provide a mechanism for certain foreign custodians to seek a partial exemption from the FATA notification requirements in relation to proposed acquisitions of interests in shares in an Australian corporation.

Consultation indicates that applying for and complying with the requirements for this exemption is costly and complex. A key industry group estimates that generic compliance costs with the FATA's certificate of exemption regime is around US$10,000 to US$20,000 per annum.  This includes compiling an annual report as part of the compliance requirements. As mentioned above, setting up the technology for this would be a significant additional cost.

The practicality of this exemption mechanism has also proven to be limited because stakeholders consider its scope of regulatory relief is too narrow. In particular, the foreign custodians who obtain an exemption certificate will still be subject to FATA notification requirements when acting on behalf on foreign investors. Also, some foreign custodians may not be eligible - those who are exempt from holding an Australian financial services licence under the Corporations Act 2001. In addition to regulatory costs, this creates an un‑level playing field in the Australian market for custody services. Only one certificate of exemption has been sought and granted. Due to the limited scope of the exemption criteria, the regulatory relief does not extend to the wholly owned custodian subsidiaries of the certificate holder which continue to incur FATA compliance costs.

Option 2: retain the FATA regime’s current approach to foreign custodians and consider whether the problem could be addressed by other reform options such as raising the FATA’s statutory control and asset value thresholds

Benefits

As noted previously in the context of Option 1, it is not clear in relation to Option 2 what public policy interest would be served by continuing to subject foreign custodians to the FATA where they exercise the rights of their shares only at the direction of their client beneficiaries.

Under Option 2, other proposed reforms to the FATA (for example, raising the FATA’s control and asset value thresholds) would be of some assistance to foreign custodians. These would only reduce rather than eliminate compliance costs for foreign custodians. This is because foreign custodians acting at the direction of their client beneficiaries would still be subject to the FATA notification and compliance regime for interests in relevant corporations exceeding any new thresholds. Even if the change in thresholds better focussed the FATA on proposed transactions that are likely to raise significant national interest issues, this option would not address the fundamental policy issue here. That is, screening foreign custodians acting only at the direction of their clients does not appear consistent with the purpose of the FATA as the foreign custodian is not independently exercising ‘control’ of a relevant corporation.

Costs

In 2005, foreign custodians accounted for nearly 2 per cent of all business transactions approved in 2005. A total of six applications from foreign custodians in relation to interests of 15 per cent or more in relevant corporations were approved. In aggregate, this amounts to US$180,000 in FATA compliance costs for foreign custodians for one year (based on an estimate of US$30,000 in costs per notification and excluding the initial IT set up costs).

Under Option 2, it is likely that none of these FATA compliance costs would have been removed. In the future, the number of foreign custodian transactions is likely to increase significantly as investors, Australian and foreign, particularly portfolio investors, are increasingly employing the services of custodians and noting that foreign custodians hold a 50 per cent share at the moment of the Australian market (for custodial services).

In addition, this option would only reduce and not eliminate the potential compliance costs and regulatory risks for Australian corporations whose shares are acquired through foreign custodian services. It is not possible to estimate how many Australian corporations are likely to be affected, but there are currently a number of such corporations who are likely to approach soon the FATA aggregate control threshold, in part due to holdings of interests in their shares by foreign custodians. As noted under Option 1, the average cost per notification is US$30,000 and this would increase in accordance with the volume of transactions undertaken by the relevant Australian corporation – which would be particularly substantial for large financial institutions which frequently undertake transactions.

A peak industry body has advised that in the context of all notifications in the past 3 years in relation to proposed acquisitions of interests in Australian corporations, 19 notifications would have been avoided if the FATA individual control threshold had been raised to 20 per cent. This would have represented a saving of A$570,000 in aggregate. However a breakdown is not available of how many of these notifications were from Australian corporations who became subject to the FATA owing directly to holdings of interests in their shares by foreign custodians.

Option 3: exempt foreign custodians from the FATA in relation to proposed acquisitions of interests in shares in relevant corporations and interests in Australian urban land where they are acting at the direction of beneficiaries.

Benefits

Under Option 3, an exemption from the FATA for foreign custodians in relation to proposed acquisitions of interests in shares in relevant corporations and proposed acquisitions of interests in Australian urban land would address both problems. These proposed exemptions would apply only where foreign custodians do not exercise independent control over the shares that they hold but only deal with them in accordance with instructions of beneficial owners. As mentioned above, the role that custodians play is determined generally by contractual agreements with their clients.

This option would reduce compliance costs without undermining the integrity of the regime. This is because the FATA, in relation to such proposed acquisitions, would still screen foreign beneficiaries and also foreign custodians where they are not acting at the direction of their clients. To ensure compliance, the FATA regime relies on a compulsory notification system with non‑compliance being an offence. Rather than the regulator playing an active role in monitoring all transactions, the regime relies on the potential penalty as an incentive for compliance. If the exemption were implemented and a foreign custodian was not acting only at the direction of the beneficiary, but had contractual authority to exercise independent control, then that foreign custodian would not benefit from the exemption and would remain subject to the FATA.

As noted above in the context of Option 2, in 2005, foreign custodians accounted for nearly 2 per cent of all business transactions approved in 2005. A total of six applications from foreign custodians in relation to interests of 15 per cent or more in relevant corporations were approved. In aggregate, this amounts to US$180,000 in FATA compliance costs for foreign custodians for one year (based on an estimate of US$30,000 in costs per notification and excluding the initial IT set up costs). If Option 3 were implemented, then these compliance costs would be removed (as opposed to Option 2 where they would only be reduced). These savings are likely to be greater in the future in the context of an increasing demand for custodial services by investors, Australian and foreign, and also increasing activity by portfolio investors.

Option 3 would also minimise the potential downstream costs – that is, the extent to which Australian companies become subject to the FATA themselves as a result of the investors using foreign custodian services to acquire shares in the Australian corporation. Option 3 would not eliminate these potential downstream costs as interests acquired by foreign beneficiaries would still contribute towards the Australian corporations’ foreign control levels but this is consistent with the purpose of the FATA. As noted under Option 2 above, it is not possible to estimate how many Australian corporations are likely to be affected, but there are currently a number of such corporations who are likely to approach soon the FATA aggregate control threshold, in part due to holdings of interests in their shares by foreign custodians. Without the benefit of Option 3’s proposed exemptions, such Australian corporations face the average cost per notification of US$30,000. This would increase in accordance with the volume of transactions undertaken by the relevant Australian corporation – which would be particularly substantial for large financial institutions which frequently undertake transactions.

Costs

A perceived cost with Option 3 is the risk that the regulator would lose an additional means in the FATA regime to detect proposals by foreign investors who do not notify proposals that raise national interest issues. The FATA would continue to rely on its general offence mechanism for compliance by such foreign investors.

Monitoring compliance by foreign custodians with the conditions in the proposed exemption would not be difficult, as a custodian’s relationship with its client is defined by means of contractual agreement. Therefore this option should not impose additional public administration costs.

Consultation

The FATA regime review involved consultation with key stakeholders including foreign custodians, foreign investors, peak industry bodies, financial market participants and Australian business representatives. Two rounds of consultations were held during this process, the first in relation to the key issues or problems in the FATA business investment provisions and the second in relation to the draft proposals for addressing these issues. No new policy concerns were raised in the second round of consultations.

Consulted stakeholders were all strongly supportive of the objective of streamlining the FATA while maintaining the FATA’s focus on transactions that are likely to raise national interest implications. In particular, there were calls for urgent regulatory relief from this issue and strong support for Option 3’s proposed approach to foreign custodians.

Conclusion and recommended option

Options 1 and 2’s retention of the FATA regime’s obligations on foreign custodians and narrowly cast partial exemption mechanism do not appear to contribute to the public interest and instead impose unnecessary compliance costs. In particular, they are not consistent with the purpose of Australia’s foreign investment screening policy to screen investment proposals by foreign persons, and not to capture investments by Australians in Australian corporations through foreign custodian services. Options 1 and 2 could contribute to the risk of Australia being perceived as a less attractive destination for foreign capital. This in turn, could increase the cost of capital for Australian businesses which would create significant economic risks, particularly as Australia is a substantial capital importer.

On balance, Option 3 is the preferred option. There is strong case for an exemption from the FATA for foreign custodians in relation to proposed acquisitions of interests in shares in relevant corporations and in interests in Australian urban land where the foreign custodian is only acting on the direction of their clients. Such business transactions do not raise significant national interest issues, rather they impose substantial and unnecessary compliance costs on foreign investors as well as the Australian businesses in which they invest. Option 3 would effectively address the problems created by the FATA’s current approach to foreign custodians, while maintaining the regime’s integrity and effectiveness. This reform would help enhance Australia’s attractiveness as a destination for foreign investment, which is particularly important in the context of increasing cross‑border investment activity and economic growth.