The FIRB decision on Ausgrid.

What does the FIRB/Treasurer's knockback of the NSW Ausgrid acquisition mean? 

The decision of the Treasurer, the Hon Scott Morrison, to reject the bids of both China's State Grid (a State Owned Enterprise) and Hong Kong's CKI Group (a Privately Owned Enterprise) for a majority interest in the NSW distribution business Ausgrid has caused a good deal of concern for both domestic and international investors. Both investors already have considerable investments in Australian electricity networks (and, in the case of the CKI Group, an Australian Mobile telecommunications network).  What has led to this rejection now? 

What has changed? 

One thing that has not changed is the test for whether a foreign investment is prohibited.   An investment will be permitted (with or without conditions) unless it is contrary to the 'national interest'.  

Industry background

For many years, the Australian electricity industry was a series of state based, vertically integrated monopolies owned by the State and territory governments. However, since the 1990s, the industry has been separated into generation, retail, and networks businesses. The generation and retail businesses compete through the national electricity market. The network businesses are essentially natural monopolies, and their revenues are regulated by the Australian Energy regulator. Network businesses are divided into high voltage suppliers, called transmission businesses, and lower voltage businesses called distribution businesses. Ausgrid is an electricity distribution business.  These businesses are sometimes called ‘poles and wires’ businesses, but that title, while convenient, understates their complexity. They provide an essential service, and must manage fluctuations in customer demand and available load, in a way that keeps the lights on, and doesn’t damage our electrical equipment. To do so requires the operation of sophisticated control rooms and the collection of a lot of information about the electricity system and its customers.  

Initial FIRB expectations

The networks businesses in South Australia and Victoria were privatised in the 1990s. The partial privatisation of the NSW networks businesses were an election platform for the NSW Government in 2015. The first business to be privatised was the transmission business Transgrid.  FIRB made clear to bidders for the proposed bid for the NSW transmission network Transgrid what their expectations were early in the bid process. 

As reported in the media:

'It was late on a cold Friday night in July last year when the heads of the four consortiums bidding for the NSW transmission network, TransGrid, received an unexpected phone call from the chairman of the Foreign Investment Review Board, Brian Wilson.  He said treasurer Joe Hockey had some preferences for how the deal should be structured. Those “treasurer’s preferences” would not be put in writing or formalised as government policy but they were to rule the way the TransGrid sale would be managed, and they are understood to be governing the bids for the Ausgrid assets. They included that at least half the board had to be Australian residents and citizens, including an independent chairman. The business had to be run as an independent entity, and key data was not to be taken out of the country. Senior personnel in key technical and management roles needed commonwealth government security clearances. A single foreign private enterprise could not own 100 per cent and a state-owned enterprise could not own more than 50 per cent. …………The “treasurer’s preferences” remain informal knowledge among foreign investment lawyers and investment bankers rather than a stated policy. …..The aim of both the requirement for an independent chairman and the security clearances is to ensure that the commonwealth government can keep an eye on how the business is being conducted.'

It is understood these same expectations were relayed to potential bidders for the Ausgrid assets.  But, despite this early guidance to bidders (which presumably they heeded), the Treasurer then dropped the bombshell in August this year rejecting the FIRB applications of the two short listed (foreign) bidders for the Ausgrid assets. 

National security concerns: what does this mean ? 

In the context of the lease of a majority interest in Ausgrid, there are widespread reports that the Treasurer's concerns revolved around 'national security'. Indeed, his media statement on 19 August 2016 made this clear:

After due consideration……, I have decided that the acquisition by foreign investors under the current proposed structure of the lease of 50.4 per cent of Ausgrid ……., would be contrary to the national interest. This is consistent with the recommendation from the Foreign Investment Review Board. In making this decision, national interest concerns have been paramount. They relate to the transaction structure as currently proposed and the nature of the assets. The Australian Government has worked very closely with New South Wales to ensure that they are aware of the concerns. We will continue to work closely with New South Wales to ensure that national security requirements are met under any future transaction process.

For electricity networks those national security issues might be said to have 3 aspects. The first is the ability of a foreign operator to physically control a network from offshore. The second is the genuine ability of the State to physically step in and control a network if it was abandoned: Does the State have the resources to do that? The third concerns the ability of a foreign investor to gain access to sensitive data through the telecommunications networks operated by the networks businesses. 

One would think the first two issues could be resolved relatively easily by the introduction of licence conditions. For example, a local control room would have to be maintained at all times.

The third issue is more problematic. These telecommunications networks are an essential part of a modern networks business. They are necessary to send signals to network equipment such as transformers and switchyards to allow the increase or reduction of load, and they are physically integrated with the more conventional parts of a network. These fibre based networks are becoming increasingly sophisticated and the data they can acquire about customers is becoming more complex. However, press reports suggest that both bidders had agreed to conditions that data gathered was to be retained locally. These types of conditions have typically, in the past, been sufficient, when FIRB has examined the acquisition of businesses that collect and hold sensitive data.  

Warning signs 

There have been warning signs for a while: in 2013, there were substantial delays in the FIRB approval of China State Grid's acquisition of a 19.9% stake in the Victorian distributor AusNet. Last year there was considerable adverse publicity over FIRB's decision to approve the acquisition of the port of Darwin by a consortium including a Chinese enterprise. Sensitivities were also raised in China when the Treasurer blocked Chinese Private Group, Pengxin from acquiring the Kidman cattle empire.  For the Ausgrid transaction, it appears that bidders had agreed to a first round of conditions including local board content, the maintenance of the grid within Australia and local data retention. But according to many reports further modifications to conditions were imposed after the Federal election.  

FIRB's interactions with the NSW Government

At a macro level, the FIRB concerns would have been known to the NSW Government for a long time. The belief that these could be dealt with by the imposition of conditions may have contributed to the NSW Government's decision to allow preferred bidders to seek FIRB approval after lodging final bids. The Treasurer's finding that national security concerns 'could not be mitigated' suggests that FIRB was looking for physical means of ring fencing the communications data as well as licensing conditions. Clearly those concerns could not be overcome for the Ausgrid transaction, 2016 version.  

Impact on foreign investment

The lasting impact on foreign appetite for investing in Australia remains to be seen. Among other things, investors may be concerned at the impact of the decision on privately owned as well as state owned enterprises. The ability to find a physical solution to the data issues will no doubt test the ingenuity of the participants in the re-run Ausgrid auction. Options may include placing the relevant data network under local ownership and letting to the owner that part of the fibre network which is strictly necessary for the operation of the electricity network.  In the meantime, the Ausgrid decision is also a reminder of the importance of an effective and early engagement strategy with the FIRB process. 

The position remains: the Australian Government welcomes foreign investment, and will work with investors on proposed transactions to facilitate deals while protecting the national interest. 

Copyright (c) 2016, Minter Ellison.