Chinese companies, in particular state-owned enterprises (SOEs), are a major new source of global foreign direct investment (FDI). The depth of such capital available for overseas investment, China’s obvious interest in resource assets " witness the recent bid for Calgary-based oil gas company Nexen Inc. by China National Offshore Oil Corp. (CNOOC) " and the importance of our trade with China all make this a critical issue for Canadians. We need a more informed and vigorous debate about the impact of Chinese FDI and about the behaviour of Chinese SOEs.

Among economists, there is a broad consensus that FDI, including that by multinationals from developing countries, brings economic benefits that strengthen the host country. Jobs created locally translate into stronger domestic firms and support the growth of local communities. As these firms integrate into the host country market they pull domestic firms into their supply chains and managerial networks, creating new opportunities for growth and exports.

Nevertheless, the popular debate reflected in the media suggests widespread, if not always clearly articulated, uncertainty about the purpose and operations of Chinese SOEs. Critics suggest that Chinese SOEs are at least in part directed by the Chinese state in ways that may serve to disadvantage local firms and markets. It is often assumed that their operations are funded by the state, with international acquisitions subsidized by borrowing from state banks at below-market rates and with lax repayment terms, thereby enabling them to compete unfairly against foreign rivals.

In China these assumptions are challenged by a range of business people, industry observers and government officials. Far from exerting unfair advantage over global competitors, Chinese SOEs are perceived to have faced undue resistance in OECD markets based on misconceptions of their purpose and behaviour. Both the Committee on Foreign Investment in the United States (CFIUS) and, to a lesser extent, the SOE Guidelines of the Investment Canada Act (ICA) are regarded as subjecting proposed investment from Chinese SOEs to additional investment hurdles and potentially discriminatory treatment.

The Canadian government’s 2009 approval of the China National Petroleum Corporation (CNPC) investment in Athabasca Oil Sands Corporation, and several subsequent transactions in the absence of highly polarized public debate, suggest that Canadian public opinion is evolving. However, the rancorous public debate in Australia over the attempted purchase of mining giant Rio Tinto PLC by Aluminum Corporation of China (Chinalco), followed by an uproar over the arrest of Rio Tinto executives in China, suggests a broader syndrome of misunderstanding and mistrust that remains below the surface and can erupt in the event of a commercial dispute. At the policy level, misperceptions about SOEs can influence decisions over whether proposed investments offer a net benefit to the host country. These same misperceptions can damage commercial relationships as well.

Is it true that Chinese SOEs pursue the overseas political goals of the Chinese state? Might they seek to undermine local commercial interests in response to some negative development in bilateral relations? Such claims are difficult to prove or disprove conclusively, but consider the suggestion that in a period of global scarcity of some commodity, the Chinese state might order an SOE to ship product from Canada to China at prices below the prevailing price in Canada. Canadian transfer pricing rules are designed specifically to prevent such situations. Another fear expressed is that the Chinese state might push an SOE to pursue some noncommercial objective in order to further Chinese foreign policy goals and that this would somehow disadvantage a Canadian market or a Canadian company. Again, Canadian competition and other laws are in place to guard against any such move.

Moreover, such behaviour would be contrary to the corporate interests of the SOE. Pursuing the interests of the Chinese state would require such a firm to suboptimize its own goals and performance, put at risk its corporate and financial integrity and undermine business relationships that may have taken decades to establish. Like their international competitors, Chinese SOEs are contending for global position and leadership. It seems unlikely that they would choose to act in a manner that would expose them to direct reputational damage among buyers, suppliers and service providers, to say nothing of attracting lawsuits and security investigations. Should a specific claim of such behaviour arise, it would certainly be worthy of close examination. No such claim has come to my attention to date.

In OECD countries, SOEs (Crown corporations, as they are known in Canada), are created to fulfill a range of social and/or economic objectives not being satisfied by the market. In China, SOEs are a legacy of central planning. While the role of the state in the Chinese economy is materially different than in Western economies, the key lesson learned from the country’s socialist past was that the government should not provide direction with respect to corporate strategy but rather push SOEs to compete against one another and with global rivals. Expectations that state involvement would fade as the Chinese economy matured have not materialized. However, the nature of intervention has gradually been restricted to shaping the macroeconomic environment, combined with a final, highlevel review and approval process for the largest overseas investments.

Understanding the overseas investment and operating behaviour of Chinese SOEs requires some knowledge of Chinese economic reform and the firms themselves. There are significant differences among SOEs even at the state level in size, sophistication of management and governance. The large energy SOEs (China National Petroleum Corporation, Sinopec and CNOOC) are among the largest companies in the Fortune 500 and are nationally supervised by China’s state-owned Assets Supervision and Administration Commission (SASAC). Minmetals (which is relatively small in comparison), China Non-FerrousMetalsand Chinalco are also nationally supervised, but most mining companies are owned at the provincial and township level or by entrepreneurs.

China began to move away from a planned economy toward market prices beginning with agriculture in 1978. Largely complete by 1993, this phase involved separating state ownership from the management function. The role of the Communist Party secretary within each firm shrank, while general and functional managers assumed greater control. The second phase, which involved closing, restructuring and merging noncompetitive SOEs, was more disruptive, although rapid economic growth combined with regional incentives helped to cushion the shock. At the same time, the state pushed SOEs to adopt the market approach and functional management structure of their global competitors. This phase culminated in China’s accession to the World Trade Organization (WTO), finalized in 2003. China chose an accelerated five-year, staggered grace period to fully adhere to its WTO commitments, forcing domestic firms to adapt rapidly to the demands of the international economy.

After 2003, many of China’s large, internationally active SOEs sought listings on the Hong Kong, London and New York stock exchanges, committing themselves to the disclosure and governance standards of those highly competitive markets. In all cases a portion of the SOE’s assets were retained in an unlisted SOE ”œparent.” It is these ”œresidual” companies (for example, PetroChina is the listed company while CNPC is the parent) that carry the legacy costs of the socialist era. The role of the party committee in each of these parent companies has continued to shrink as general management of the listed company has grown to resemble the functional and geographic organization of its key global rivals.

There are contending views of SOE supervision in China. The dominant one was expressed by Li Rongrong, the retired chairman of SASAC, in an interview on China Central Television in 2010. He indicated that China’s large SOEs could eventually become fully public entities, eliminating the need for SASAC’s supervisory role. The annual SASAC pruning of unprofitable SOEs and the ongoing push toward public markets suggests that Li Rongrong’s vision is indeed the prevailing model.

SASAC’s mandate is to ensure that SOEs are managed to generate an appropriate return given the size of the state’s ownership stake, and to ensure that management behaviour is closely aligned with the company’s own interests. Identifying and prosecuting corrupt officials is a role shared with the Discipline Committee of the Chinese Communist Party. Executive compensation is based on financial rewards and penalties. The criteria include ”œmarket capitalization management,” reflecting the conviction that, over time, stock price movements on the Hong Kong, London and New York exchanges are a strong indicator of managerial effectiveness. However, SASAC supervision does not involve providing guidance on corporate strategy. (The single-minded focus on profitability is the source of some popular criticism in China.)

In the West, a common criticism of Chinese SOEs is that they are subsidized bythestate, giving the man unfair advantage over their global competitors. Critics also claim that SOEs enjoy unlimited loans, either directly from the state or from state-owned banks as a matter of policy rather than a reflection of their creditworthiness. Furthermore, these loans are assumed to be at below-market rates and not subject to commercial repayment terms.

This charge first surfaced during the political furor in the United States Congress over CNOOC’s 2005 bid for California-based Unocal. Opponents of the deal spoke of a ”œChina threat” that would put at risk market-based global competition for energy resources. A number of US scholars embarked on studies to test the assumptions made by many of the witnesses who appeared before the CFIUS. The studies essentially concluded that Chinese SOEs did not have access to bank loans at below-market rates and did not benefit from export or import subsidies or other subsidies that would be actionable under the WTO.

Another area of concern with regard to the behaviour of Chinese SOEs relates to regulatory compliance. On this score, the record is uncertain but improving. China’s domestic laws are rigorous but the degree to which Chinese SOEs are perceived to be willing and able to comply with OECD-level environmental, safety and labour laws remains an issue that crystallizes popular concern both in Canada and other advanced industrialized countries. This is particularly true in cases where the investment itself is controversial (regardless of the source country). Having said that, foreign corporations must all abide by Canadian laws, and all Canadian jurisdictions have the wherewithal to enforce vigorously their own standards. Meanwhile, China’s domestic regulations have gradually caught up with OECD practice, and Chinese SOEs are rapidly establishing managerial and technical credentials in OECD markets.

To enhance our country’s interests as a global resource seller, Canada needs to adapt to new global patterns in resource supply and demand. Asian firms, particularly those from China, are acquiring equity stakes in global resources. Unduly limiting such investments would reduce Canadian access to an important source of global capital, jobs, technology and market diversification. It would also hinder the ability of Canadians to participate in the managerial networks and supply chains that these firms create.

For that reason, and in light of the degree of misperception of SOE behaviour, it is vital that Canada take steps to avoid politicization of the ICA review process for major foreign investments. To the extent that the objectives and behaviour of Chinese SOEs correspond to those of foreign investors, they should be treated in a like manner. The regulatory objective should be to achieve an acceptable threshold of protection and transparency without imposing conditions significantly more onerous than those faced by the SOE’s competitors in the Canadian market. An approach that is seen as efficient and constructive to investment by Chinese SOEs may well yield longer-term benefits by creating opportunities for both Canadian firms and individuals to access the supply chains, global projects and corporate networks that Chinese SOEs are currently developing.

Although disclosure practices vary, nonlisted parent SOEs generally do not provide the depth of information provided by their listed arms in their annual reports and are not accustomed to the same level and frequency of communication with stakeholders. Hence every effort should be made to encourage (but not require) investments in Canada by the listed arm. Where nonlisted arms invest, they would do well to address potential concerns by providing an acceptable level of visibility about the economic, environmental and safety aspects of operations so that local communities can assess the likely impact of the proposed business. In the case of acquisitions of corporate control that fall under the ICA, the investor generally undertakes to report to the government regularly on financial results, capital and research expenditures, and other relevant data. It may be appropriate to negotiate regular reporting to the ICA on an evergreen rather than three-year basis to provide assurance of extended oversight in highly sensitive cases.

Given the growing economic weight of China in global resource markets, unduly restrictive hurdles carry the risk of reduced trade and investment opportunities in the future. Canada’s continued high-level participation in global trading in energy and metals depends on strong relationships (typically based on personal and business ties). Effective interaction with Chinese resource firms in Canada and in other markets is a key foundation for these relationships. Approaches based on misperceptions of SOE behaviour are counterproductive to Canada’s own interests.