Mining fears of Chinese invasion

TONY Abbott was at his pugilistic best as he worked through a tight schedule of meetings on his visit to Beijing last month.
Nanjing Night Net

Shaking hands with Chinese dignitaries with the iron-grip confidence of a man who believes he should be the next prime minister, his eyes bulged and veins popped with the adrenalin of meeting senior officials who will set the course of arguably Australia’s most important trade and diplomatic relationship.

His Chinese counterparts were well briefed on our opinion polls; a more senior than usual line-up of party officials and ministers were summoned to have an audience with the opposition leader. When it came to his keynote speech at the Grand Hyatt in Beijing, Abbott had already raised eyebrows by noting that for all of China’s recent economic strides, its people ”still can’t choose their government”.

But then he moved to the crux of his speech – the emotive issue of sovereign investment. While he welcomed foreign investment in principle, he said, Chinese investment ”is complicated by the prevalence of state-owned enterprises”.

”It would rarely be in Australia’s national interest to allow a foreign government or its agencies to control an Australian business,” Abbott said. ”That’s because we don’t support the nationalisation of business by the Australian government, let alone by a foreign one.”

On his return, Abbott launched a policy discussion paper espousing tighter scrutiny on foreign investment in Australian farmland and agribusinesses – including a national register of foreign-owned land and lower trigger levels requiring Foreign Investment Review Board approval. The review board’s chairman, Brian Wilson, has also weighed in, saying Australian businesses, however they are owned, should be run on a purely commercial basis and ”not as an extension of the policy, political or economic agenda of a foreign government”.

Foreign Minister Bob Carr called Tony Abbott’s remarks in Beijing ”dangerously dumb”, and the official Chinese news agency Xinhua characterised Australia’s foreign investment debate as our ”economic xenophobia” on display.

To say no to Chinese SOEs is to say no, effectively, to China. Of the 116 deals involving China in the past six years, 92 of them were made by 45 state-owned enterprises.

Based on transaction value, 95 per cent of Chinese investment into Australia in the same period came through SOEs, according to a recent joint study by consulting firm KPMG and the University of Sydney.

Chinese SOEs have invested nearly $50 billion in Australia in the past five years, with almost all of it in the sensitive sectors of mining and energy. The acceleration has been marked – total Chinese investment in 2007 was just $1.5 billion. And with our traditional sources of foreign investment, the US and Europe, struggling to pull themselves out of their economic funk, signs are China will continue to provide a larger share of our capital needs.

The investment is also highly concentrated. Just 11 SOEs account for 80 per cent of all Chinese investment stock in Australia.

But what are Chinese SOEs and what is behind their push into Australia? Are SOEs driven purely by commercial interests, or are they merely an extension of the Chinese Communist Party? Should they be viewed as an emerging threat to our security, industry and even sovereignty?

”There’s a fear of SOEs and when I say fear, I mean a fear of their real motive and their modus operandi,” says Jason Chang, the chief executive of EMR Capital, a China-focused private equity investment manager. ”It’s very logical, because when you think about SOEs they’re controlled by one shareholder and that’s the Communist Party.

”It’s different ideology, different language, different culture, so when you think about that, it’s not that easy for a Western nation to understand it quickly.”

The rhetoric of the debate has invariably been black or white. There has been political point-scoring from those keen to feed off fears of ”selling the farm” and negative perceptions surrounding China-backed investment. And yet the defence has largely come from business leaders whose corporate profits depend on, or at least are boosted by, healthy levels of investment from China.

One frequent cheerleader for Chinese investment is ANZ chief executive Mike Smith, who is pursuing an aggressive Asian expansion strategy for his bank, and the internationalisation of the Chinese currency, the yuan.

”What is a state-owned institution? The obvious target here is China,” he says. ”I think you have to look at China and say, of its state-owned institutions, what are truly controlled for the interests of the state or, actually, what are run as businesses that happen to be owned by the state.”

Regardless of the size of the transaction, any investment from a state-owned enterprise automatically triggers a Foreign Investment Review Board review. Where a proposal involves a foreign government or a related entity, the review board must consider whether the investment is commercial in nature or if the investor could be pursuing broader political or strategic objectives that may be contrary to Australia’s national interest.

So with the FIRB rules already providing a safeguard against foreign investment which may be against our national interest, why has there been so much debate?

”There’s this underlying assumption when you read the public commentary that there is a conflict of interest between the national interest and that of the SOE,” Chang says. ”I put to you that they can be highly complementary because we have resources and intellectual property which is what China needs to sustain their growth. And they have … financial capital to assist us in developing what we need.

”Australia was built on foreign capital; now foreign capital is just coming from a different time zone than in the past … [but] the concept is exactly the same.”

Tim Murray, an investment analyst who has been based in Beijing for the past 18 years, said conservative politicians were engaging in cheap political point-scoring.

”At the core of it is actually a racist debate and I think the Liberal Party under John Howard and now Tony Abbott, they’re still following the same sort of course,” he says.

”It’s nothing to do with whether they’re state-owned or not, I think it’s a furphy.”

FOR David Lamont, revealing his occupation often proves a show-stopper at barbecues and other social gatherings.

”I work for a company that’s listed in Hong Kong and 72 per cent-owned by a SOE in China, and people go: ‘Why are you doing that?’

The chief financial officer at Minmetals Resources, which is controlled by China Minmetals Corporation, says the common perception was that he was at the beck and call of his Chinese minders. ”That [is] so far from the truth,” Lamont, a former BHP Billiton and PaperlinX executive, says. ”It’s not as though on day one when Minmetals acquired OZ Minerals there was a [Boeing] 747 that arrived from Beijing and unloaded a whole bunch of people who took over the office.”

He says his experience of China Minmetals’ management style was ”no different to any Western company I’ve worked for”. ”Are they tough in certain instances? Yes. Are they sensible and rational? Yes.”

Minmetals Resources launched a takeover for OZ Minerals in 2009, but was blocked by the Australian government due to concerns over the proximity of the Prominent Hill mine to a military site. But a deal excluding Prominent Hill was approved, and Minmetals retained the management of OZ Minerals, including Lamont and chief executive Andrew Michelmore.

Despite a common perception that Chinese investors are put off by an unwieldy FIRB process, or suspect it as an excuse to single out Chinese investment for exclusion, Lamont says China Minmetals ”is no way perturbed” about needing to go through FIRB for every transaction.

”They don’t sit there and take it as an affront,” he says, pointing to subsequent acquisitions in Havilah Resources and Anvil Mining, and a failed play at Equinox, as evidence that China Minmetals were not rendered gun-shy by perceived regulatory hurdles.

Lamont is keen to emphasise that the Australian operations are run autonomously and that the Chinese parent company has not interfered with where the resources its mines produced would go. But ultimately approval for large projects and acquisitions, as with any state-owned enterprise, needs to be cleared with China’s all-powerful National Development and Reform Commission. ”It’s quite clear that the strategy at its broadest is that China growing the way it is … clearly needs to be able to get exposure into the underlying base metals that we produce,” Lamont says.

SOEs are the leading force in China’s offshore investment push. State-owned enterprises are an important instrument of government policy. The government uses SOEs to facilitate structural change in the Chinese economy, to acquire technology from foreign firms, and to secure raw material sources from beyond China’s borders. As of 2010, SOEs held 2.66 trillion yuan ($402.5 billion) in assets outside mainland China, a 50 per cent increase on the previous year.

China’s total outbound direct investment flow reached $US68.8 billion, or 5.2 per cent, of the world’s total in the same year. Seventy per cent of this outbound investment was made by SOEs, according to official statistics.

But despite promising that the government would not influence the commercial decisions of SOEs when it joined the World Trade Organisation in 2001, China does not appear to be keeping this commitment, according to a report prepared last October for the American government’s US-China Economic and Security Review Commission, which found SOEs were likely to retain a critical role in China’s economic make-up. ”If anything, China is doubling down and giving SOEs a more prominent role in achieving the state’s most important economic goals,” the report, by Capital Trade Inc, says.

The report finds the question as to whether state-owned enterprises are acting on their own or merely as a proxy for the Chinese government is moot: most state-owned enterprises, by definition, are either wholly or majority-owned by the state and therefore their actions must be a de facto proxy for their shareholder’s interest.

The influence the Communist Party and the State-owned Assets Supervision Commission exert over the executives of state-owned enterprises mean they face two possibly conflicting sets of incentives. ”You don’t always understand why they’re doing [things], sometimes its not 100 per cent a financial part of the project, but it could be that the government wants him to do it, so he’ll be rewarded for doing it,” Chang says. ”So there’s this strategic element that is not purely financial. But do we have something to fear? I don’t think so, we just need to understand why they’re doing certain things.”

On the one hand, the entities they control are supposed to be profitable, and they are rewarded accordingly based on financial performance. On the other hand, it is also in their best interests to follow the Chinese government’s central policy guidelines, given their career paths are determined by the party’s Central Organisation Department.

”The tricky thing with understanding state-owned enterprise is the role of the top person, who is a Communist Party appointee,” says Geoff Raby, the former Australian ambassador to China.

One of the biggest controversies in Raby’s time at the helm was when Chinalco was trying to increase its stake in Rio Tinto in early 2009. The Australian government’s decision to block the move and the subsequent Chinese backlash is widely considered the low point in recent Australia-China relations.

”I was saying to Canberra: ‘Sure, this is what a state-owned enterprise is, the party secretary runs the show’,” says Raby, who now runs a private consulting firm and is a non-executive director at Fortescue Metals. ”I know party secretary, chairman Xiao Yaqing, very well, he talks to me and he’s very focused on the business dimensions of Rio.

”So there was a very strong and convincing story and I think I convinced Canberra that this was a class-A firm that behaved and operated like a private sector firm – which I believe it still does.”

In the middle of negotiations, the Communist Party’s Central Organisation Department – a powerful and secretive government organ which decides who does what within the party machine – asked chairman Xiao to resign from Chinalco and appointed him deputy secretary-general of the party’s State Council: its equivalent of the government’s parliamentary cabinet.

”People in Canberra were like: ‘What? He goes from running the world’s second-biggest aluminium corporation to being the deputy secretary-general of the State Council?”’ Raby recalls. ”It’s a case of the left hand and the right hand not knowing what it was doing.

”But it certainly set me back in my attempts to persuade people that this was basically a commercial enterprise.”

Raby says the reform of China’s SOE sector is ”the single most important economic challenge” that China’s new leadership faces because of the inefficiencies the state-owned model brings to its economy.

Former Treasury secretary Ken Henry, now the Prime Minister’s special adviser charged with leading the preparation of the Asian Century white paper, says Australians had a similarly adverse reaction when the Japanese ramped up their investment in Australia in the 1980s. But, he says, it goes back even earlier than that.

”Very few people in Australia seem to know that the Foreign Investment Review Board was set up because of concerns in the community about American investment in Australia,” Henry says.

”That was really the first wave of foreign investment to challenge Australian policymakers … and the history is that we will find a way of bringing ourselves to a position of comfort with a significant level of Chinese investment in Australia.”

Much of the negative sentiment around SOE investment stems from its close ties with the ruling Communist Party government and its authoritarian rule, and its chequered record with human rights, social equity and sovereign disputes in the South China Sea.

But Chang says China’s track record with foreign investment has proven it did not want to assert its authority.

”If government’s involved, [people think] they must have a different motive behind it, but bear in mind what they’re trying to do is preserve China’s growth and prosperity, they’re not there to figure out how to conquer Australia,” Chang says.

But the Capital Trade report says the system in place means that despite the autonomy afforded to SOE executives in most circumstances, it must consider the strategic objectives of the Chinese government. Put differently, it says, as long as SOE executives are beholden to the Communist Party, they will have an incentive to choose state goals over financial goals when the two conflict.

But with much of the developed world in the economic doldrums, signs that Chinese economic growth is slowing, and evidence firming that our historic mining boom is running out of puff, perhaps beggars can’t be choosers.

”In the past, whatever we dug up and put on a boat somebody would pay a higher price for that, and if we dug more they’d still buy it. It’s going backwards now,” Murray says, adding that the power dynamics in the region are shifting. ”Prices are going to fall back and when that situation happens, people will be glad to have any investment they can get and that’s when things will naturally change.

”Maybe then, certain enterprises aren’t so bad any more.”

This story Administrator ready to work first appeared on Nanjing Night Net.