Prime Minister Scott Morrison’s proposed rules limiting foreign takeovers and accepting deals “on our terms” will depress takeover activity in Australian share markets, reducing the chances of big windfalls for investors receiving offers from offshore bidders.

The Federal Government wants to introduce a new security test on all foreign investments that threaten the national interest regardless of the value of investment. Foreign investors will be required to seek approval to buy a direct interest in a "sensitive national security business" – regardless of the value of the investment. The aim is to close legal gaps that leave national interest assets exposed to foreign control.

Morningstar’s head of equity research Peter Warnes says even if the rules are introduced, the federal government must closely scrutinise all deals by foreign interests.

“There is plenty of private equity money still out there sitting on a pile of cash and the government will need to scrutinise carefully who is sitting behind any bids and be very careful to find out who the bidders really are and whether or not the private equity is nothing more than a Trojan horse for perhaps unacceptable interests,” Morningstar’s Warnes said.

If introduced as law, the proposed rules could block company takeovers and investments in technology, energy, communications, ports and other sectors considered important to the national security. Many other economies — including Canada, China, the EU, Japan, New Zealand, the UK and the US — have recently updated their foreign investment rules for similar reasons.

“These reforms will ensure that our foreign investment framework keeps pace with emerging risks and global developments, including similar changes to foreign investment regimes in comparable countries,” said Treasurer Josh Frydenberg in announcing the reforms this month.

The Federal Government will release exposure draft legislation in July ahead of a six-week consultation period. Following the consultation, the legislation will be introduced to Parliament with a scheduled commencement in January 2021.

Currently, foreign bidders must seek government approval for investments above certain thresholds depending on the sector and investor’s origin. While foreign government investors such as sovereign pension funds already face a zero-dollar screening threshold, most private investments under $275 million are not screened. Under the proposed rules, all foreign investments would be screened, whether the assets sought are listed or unlisted.

Warnes believes the proposed rules could reduce takeover activity on the Australian Securities Exchange. He says they will certainly reduce the likelihood of Australian companies being sold to foreign interests.

“The Treasurer has an increased role in reviewing foreign takeovers and now, every bid over one dollar will be part of the review process,” Warnes says.

This is just another change in the way we do business in our post-coronavirus world, and he believes any assets “no matter how big or how small” should be protected.

But Drew Meredith, director and adviser at Wattle Partners, says ports, water assets, telecommunications and energy assets aren’t likely to be caught up in the changes.

“There are limited assets that fall into these sectors that remain on the ASX, many are already held by overseas investors, domestic-offshore consortiums or our own industry super funds like Australian Super or IFM investors.

“In terms of the focus on China, whilst these acquisitions get the most attention … it is actually Japanese and US companies that seem to have been the most acquisitive,” says Meredith.

“If anything, the announcement is likely to be a negative for the valuation of existing unlisted infrastructure, port and distribution network owners, as the major overseas buyers like Chinese state operated enterprises sovereign funds will be subject to more scrutiny.”

Declining Chinese investment

Chinese investment in domestic assets has already fallen, shows a report from KPMG and the University of Sydney released this month. It found that Chinese investment in Australia declined 58.4 per cent to $3.4 billion in 2019, the lowest since 2007, and down from $8.2 billion in 2018. The number of deals was down 43 per cent from 74 in 2018 to 42 in 2019.

The report was compiled before the announcement of the proposed national security test for all offshore bids for sensitive ¬assets, which could further choke investment flows from Chinese companies.

The biggest transaction in 2019 was Mengniu Dairy Company’s acquisition of Bellamy’s Australia in Tasmania for $1.5 billion. This comprised 43.7 per cent of total Chinese investment in Australia, and made food and agribusiness the largest sector recipient with 44 per cent of the annual total.

Doug Ferguson, head of Asia and international markets at KPMG Australia, says there are many reasons for the drop in Chinese investment.

“Negative Chinese perceptions on stricter investment regulations by the Australian government and worsening media narratives in both countries have all contributed to the lower levels of investment,” he says.

But Ferguson doesn’t expect such deals to suddenly cease.

“While deal activity will still continue because of the genuine complementarity between both nations and the large number of Chinese companies now established in Australia, we don’t expect to see a continuation of large-scale investment by new Chinese entrants in the short-to-medium term.”