Are countries justified in tightening foreign investment restrictions regarding their critical infrastructure?
Ross Israel, head of global infrastructure, QIC: The key word is ‘critical’. In considering restrictions in the context of the pros and cons of foreign investment, it’s important to make a distinction between critical infrastructure and the broad range of infrastructure that is not considered critical.
Importantly, there are ample investment opportunities in types of infrastructure that aren’t considered critical. In this universe, the compelling economic and other benefits of foreign investment for countries around the world argue against enacting tougher restrictions on foreign investment. In Australia, we benefit substantially, as do many other smaller countries, from open international trade and capital markets that provide the level of investment and experience needed to build companies, and whole industries, to compete in international markets.
Despite the clear benefits of foreign investment, governments are justified in ensuring that critical infrastructure, particularly assets that could impact national security, are owned and operated in the national interest. In this arena, priorities include cybersecurity, the protection of citizens’ data privacy, and the operation of essential infrastructure providing, for example, energy and telecommunications services required to operate strategic defence facilities and to keep certain functions of the economy running. In addition, crises like covid-19 and the catastrophic wildfires we have experienced recently highlight the need for essential supply chains and rapid response capabilities to protect citizens and provide a country with sovereign resilience.
Governments just need to strike the right balance between ensuring national security and obtaining the tangible benefits of accessing foreign capital.
Garry Bowditch, co-founder, Customer Stewardship Australia: Critical infrastructure concerns a nation’s energy, water, waste, transportation and telecommunication systems always being available to support people and our way of life. Their importance exceeds nearly all other government priorities. Should they fail, systemic risks are unleashed that can bring entire cities and nations to a standstill, enable wide scale theft of intellectual property and compromise national security.
While the free flow of capital, trade and people across international borders should be the ideal, it is rightly tempered where necessary with restrictions to limit threats and malicious state actors. The threshold test to justify restrictions is to ensure objective public policy criteria exists and is applied in a transparent and accountable way.
Foreign investment remains a necessity to power economic and social development. This must remain the case while also taking into account how the world is changing in terms of technology, geopolitical shifts and new national priorities in a post-covid world. Greater resilience is key, which can bring many new opportunities to invest through a more nuanced approach to adding value – not only to an investor’s portfolio but to society itself.
Is it sensible to apply restrictions to passive LPs as well?
“The ebb-and-flow of diplomatic relations shouldn’t affect foreign investment rules”
RI: It may be sensible in certain situations, depending on whether the LP is exposed to national security, land or businesses, the extent of foreign ownership, and whether it has access to sensitive non-financial information or the ability to influence decisions of the business. In cases where these aren’t met, restrictions may not be warranted. Australia recently loosened its ‘foreign government investor’ definition to provide relief to passive LP investors where they’re not able to influence individual investment decisions or the management of individual investments.
GB: It is important for government to win the confidence of industry around the integrity and rationale of foreign investment rules. Sudden changes do not help and leave government exposed to accusations of short-term expediency.
All stakeholders of critical infrastructure should prepare for greater scrutiny especially in respect of direct foreign investment and technology transfer.
Pooled infrastructure funds come with different relationship complexities, so they should be vetted on a case-by-case basis.
Depending on the sensitivity of any particular investment, passive investors may need to be vetted in case restrictions are required.
Is it inevitable that diplomatic relations between two countries will affect foreign investment rules?
RI: The ebb-and-flow of diplomatic relations shouldn’t affect foreign investment rules. Instead, the rules should be designed with key principles in mind – to protect national interests where required but also to support the inflow of foreign capital to help finance infrastructure. Consistently applying these rules helps reduce sovereign risk, allowing for cheaper financing of major projects. If the ebb-and-flow of diplomatic relations were allowed to affect foreign investment rules, it would dramatically lift uncertainty for foreign investors and, in turn, a country’s perceived sovereign risk. The higher cost of capital would then reduce economic growth, productivity and living standards.
GB: Yes. Countries use international diplomacy to fulfil their own national interest, by leveraging their own capabilities.
Diplomacy should be tightly calibrated to public policy objectives and levers. Investment and economic relationships will tend to prosper within diplomatic relations where trust, co-operation and consistency can endure; sometimes this is leading investment and other times it follows.
“Sudden changes do not help and leave government exposed to accusations of short-term expediency”
Custom Stewardship Australia
International intelligence alliances like Five Eyes (US, UK, Canada, Australia, NZ) are being touted as the new network for foreign investment, military supply chain design and trade for these nations. This smaller sphere may apply more specifically to all aspects of critical infrastructures while leaving room for less restrictions for non-critical areas.
The catch is definitions and rules can change suddenly owing to shifting threats, therefore inviting heightened sovereign risk. This may well be the new normal for accessing capital, expertise and products for critical infrastructures over the next 15-20 years.
Is this a trend you expect will intensify around the world? Why or why not?
RI: We expect governments to intensify their efforts to ensure that their foreign investment rules are fit-for-purpose. Late last year, the Australian government passed legislation on the most significant reforms to foreign investment in nearly 50 years, while other countries have also made changes or are likely to further tighten their foreign investment regimes. Rising geopolitical tensions, increased trade protectionism, and the need to protect national security assets and secure important supply chains are the key reasons for governments to re-examine their foreign investment rules. Technological advancements, including in automation and communications, have also seen governments intensify their focus on cybersecurity and associated foreign investment rules.
GB: So-called vaccine nationalism, where local production is withheld from export markets to meet in-country need, highlights the strong likelihood of an extended period of overt national self-interest. Covid-19 and other geopolitical factors may shape a more aggressive form of nationalism in key arenas like foreign investment, defence supply chains and critical infrastructures.
Institutional investors can expect a more challenging investment environment. Governments that have been emboldened to borrow more thanks to historically low interest rates and greater tolerance for public debt will place a greater onus on investors to demonstrate the value they can add if they want a bigger role in funding and managing critical infrastructures.
Active investors that have a proven and trusted track record in delivering for governments are probably most likely to gain advantage in a restricted foreign investment world. But even this may not be enough if certain capital sources or relationships within a given institution are considered by government to pose unacceptable risks.