Swan's iron will

Wayne Swan may want to defuse the latest bout of concern about investment by China's state-owned enterprises in Australian resource companies but there is no doubt that the Australian government is becoming deeply concerned about how to deal with it.

The government appears frozen on the issue and is choosing to buy time while it tries to develop a policy response in the face of what appears to be a concerted attempt by the Chinese state-owned entities (SOEs) to gain control of the mid-west iron ore region in Western Australia.

If they are successful the strategy, if that is what it is, it could give China the ability to influence the spot market for iron ore and therefore depress the prices Australian producers receive in both the spot and contract markets.

Swan tried to discreetly warn the Chinese off in February with a diplomatically-worded re-statement of the government's foreign investment screening policies. He made it clear that any proposal for investment by a foreign government or their agencies – not those above the normal 15 per cent threshold for foreign investment review – had to be reviewed by the Foreign Investment Review Board.

Swan said the government had singled out foreign government agencies and sovereign wealth funds because they might not operate solely in accordance with normal commercial considerations and might instead pursue broader political or strategic objectives that might not be in Australia's national interest.

Since then, Sinosteel, a state-owned enterprise that had received FIRB approval to bid for Midwest Corp, has applied, not for the first time it seems, to also acquire Midwest's neighbour and prospective merger partner, Murchison Metals.

It is said that Sinosteel, at the FIRB's behest, initially withdrew the application but subsequently appears to have re-submitted it, given that the FIRB was forced to formally gazette a 90-day extension to the 30-day period the board and the Treasurer usually have to consider the application. That has deferred, but not resolved, a potential flashpoint in the government's relationship with the Chinese.

A report in The Australian yesterday suggested the government was considering a new foreign investment regime that would cap – it said at 49.9 per cent – holdings by sovereign wealth funds in Australian companies.

The view in Canberra appears to be that it is possible to send conflicting signals to Beijing (although any new regime couldn't and wouldn't be presented as a set of China-specific rules but would apply to any and all SOEs and agencies).

The government wants to say that Chinese investment in Australia is welcome, as long as the Chinese don't want to control anything. A 49.9 per cent ceiling would, of course, allow effective control of a listed company but would ensure the companies' operations remained transparent and its directors would be bound to act in the company's interests and that of its shareholders.

If control were a sticking point, however, it would be cleaner to limit holdings in listed companies to 15 per cent, or 20 per cent, but allow direct interests of up to 49.9 per cent in resource projects, where the presence of a corporate partner or partners would ensure the project was managed for commercial outcomes.

Direct investment by Japanese companies and other foreign sources of capital in resource projects have been very important to the development of the sector. It makes sense for the Chinese to gain hedges against soaring commodity prices and lock in secure access to supply and it's in the national interest to access their capital and maintain good commercial relationships.

The delicate balance between encouraging the Chinese and other sovereign wealth funds to invest while protecting the national interest isn't confined to Australia.

The US has toughened its foreign investment rules, Europe is developing a policy response and Canada revised its regime earlier this year. Canada's "net benefits” test allows its Industry Minister a lot of discretion, including the ability to consider the destination of any exports amid concern that SOEs would direct exports to their home country rather than to where value would be maximised.

The Australian government can't, and shouldn't, target the Chinese. Singapore's state-owned Temasek, for instance, has been able to invest quite freely in relatively sensitive parts of the economy, as have other "Singapore Inc” companies.

The land grab by the Chinese in the mid-west does, however, present a particular challenge. Chinese SOEs have strategic stakes in virtually all the significant players in the region. There's said to be a veritable queue of Chinese applications to go above the 15 per cent trigger point for a review that have been made and then withdrawn at FIRB's request in order to defer the decision.

Allowing foreign customers, particularly SOEs, to gain control of strategic resources that could be used to reduce the value of our major exports would be unpalatable policy.

Portfolio holdings by SOEs and government agencies are fine; controlling shareholdings are not. Swan just needs to find a way to say that without unduly offending the Chinese and he needs to say it quickly.

Chinese investment in Australia ...see what readers and experts are saying in The Conversation.