If the average Canadian is left a bit bewildered by the recent debate over the proposed takeover of Nexen by China’s state-owned oil company, CNOOC, they can take solace: so are many experts. While there is generally a consensus that the government’s decision in the matter struck the best political compromise possible " approve the transaction, but keep future investments in the oil sands by foreign state-owned enterprises (SOEs) to an ”œexceptional” basis " there is wide disagreement about the merits and effects of the larger policy decision.

At the heart of this disagreement is a fundamental confusion about the question(s) under review. Was the government meant to establish the parameters of Canada’s future trade relationship with China? Pass judgement on the strategic impact of investments by SOEs? Maintain control over Canada’s energy resources? Or, more fundamentally, were they supposed to more clearly define the ”œnet benefit” test currently used to assess proposed foreign takeovers?

Because of the political uncertainty surrounding the Investment Canada Act (ICA) in recent years " particularly following the 2010 rejection of the proposed takeover of Potash Corporation and the government’s subsequent promise to provide greater clarity about the ”œnet-benefit” test " some might say Ottawa needed to answer all of these questions. And in due course, it should to a certain extent. But as much as the Nexen deal posed, as Prime Minister Stephen Harper said in October, ”œa range of…difficult and forward-looking issues,” this was never the venue for rethinking the ICA’s basic principles. Difficult cases should not, in isolation, make law.

But we need to be clear about several things.

First, Canada’s legal framework for reviewing foreign investment is among the most detailed and straightforward rulebased regimes in the world. It is not ”œrestrictive” by international standards, as some argued following the Nexen decision. In general, the Canadian commitment to an open investment environment is tempered only by considerations of net benefit, national security and any implications arising from foreign government interests in SOE investments. What ”œnet benefit” means and how it is applied in certain contexts can and should be clarified to take into account the changing international trade environment. But while the current process does favour flexibility " a necessity for all governments " it should not be viewed as an aversion to foreign direct investment (FDI).

On the contrary. With only two formal rejections in noncultural industries under the ICA over the course of nearly 15,000 investments since its inception, Canada has earned its place as a leading jurisdiction for foreign investment. Compared to some other countries, our investment review regime is both liberal and fairly predictable in practice. As such, we are not left wanting for potential investors. Since 2006 inflow of FDI to Canada as a share of GDP has consistently ranked either first or second in the G7, and well above the OECD average.

If the rules today are characterized as ”œflexible,” it is intentional. Governments require some discretion in order, over time, to properly interpret and apply the principle of national interest. Though maintaining this flexibility in the foreign investment regime is crucial for any government (and even for investors), it is not inconsistent with the need for governments to make ongoing efforts to improve clarity and transparency in the rules of the game. As contexts change and new patterns of trade and investment emerge, so too must our policies.

As will be discussed in a forthcoming IRPP paper on the topic, this is precisely the context in which Canada finds itself today. There is a need to clarify the policy and process that lie behind the investment review regime because the kinds of questions raised by recent transactions are different from those in the past. After a long period of relative tranquility, the growing number of politically sensitive foreign investment applications in the last several years " Falconbridge, Inco, MDA, Potash, Progress Energy and Nexen to name just a few " underscores the significance of FDI to Canada’s economic future.

The issues surrounding these transactions are also increasingly complex. The prospect of having SOEs buy into key industries such as technology, infrastructure and natural resources, for example, is a relatively new phenomenon facing Canada and other developed market economies.

The Canadian government has been responsive to this trend, beginning in 2007 with a new set of guidelines for transactions involving foreign SOEs. These guidelines provide an additional set of criteria that Industry Canada must weigh in evaluating the potential net benefit of a proposed investment. Among them: the governance and reporting structure of the SOE, whether the Canadian business to be acquired can continue operating on a commercial basis and now how and to what extent the SOE is owned and controlled by the state. As with other foreign investment regimes, these rules reflect a reasonable concern that some SOEs may pursue non-economic objectives that follow the interests of their own governments.

Whether or not these guidelines were sufficient to deal with the Nexen proposal, or the coincidental takeover of Progress Energy by a Malaysian SOE, Petronas, is not a useful way to look at the debate. These were always cases with the potential to set new precedents, using guidelines that had not yet been significantly tested in practice. While the 2010 takeover of Saskatchewan’s Potash Corporation gave the government some experience dealing with the issue of a ”œstrategic asset,” that proposed investment involved two private-sector firms. With Nexen, the government was being asked to apply the SOE guidelines in the context of a major Canadian oil sands producer, which raised unique and sensitive questions about domestic versus foreign ownership in this sector. This made for a highly controversial case on which to evaluate the 2007 guidelines.

Because applications made under the Act are confidential, we cannot evaluate CNOOC’s proposal in light of the specific criteria in the guidelines. Ottawa’s decision to amend the SOE guidelines, including substantial new provisions to cover investments in the oil sands and the extent an industry is controlled by an SOE, represents an important shift in some respects.

There are two policy implications to be drawn from the government’s revised approach to SOEs. First, and most important, is the special criteria provided for Canada’s oil sands: any future investments in this area by foreign SOEs will ”œbe found of net benefit on an exceptional basis only.” Although the word ”œstrategic” appears nowhere in either the revised guidelines or the government’s communications materials, by introducing the concept of an ”œexceptional” net benefit test, the government clearly sees Canadian oil sands production in this light. This is a historic precedent given that the ICA otherwise favours a microeconomic rather than an industrial approach to investment review (although by international standards it is not uncommon for countries to make special considerations for highly sensitive or important industries).

How, if at all, governments extend the scope of the ”œexceptional” net-benefit test will be a key political and policy question. While this government has limited the policy to the oil sands, it remains to be seen whether this would be applied to other industries in the future. The revised guideline also indicates that whatever broader reforms of the Act the government undertakes, the net-benefit test is likely to remain the conceptual foundation.

This brings us to the second implication: the importance of flexibility.The exceptional net benefit test, derided in some quarters for its vagueness, may strike a reasonable balance given both the larger policy context facing the ICA and the specific issues raised by the Nexen and Progress transactions. It avoids rules that might be overly prescriptive and transactional, while providing additional guidance on what is relevant to this government about the range of concerns future SOE investors need to satisfy.

We are assuming ”œexceptional basis” does not mean a full prohibition on SOE investment, given that the oil sands still require vast sums of capital for future development, as the Alberta government has pointedly noted. Ensuring there is a cost-effective and competitive global environment for capital investment, open to a broad array of market participants, is critical to the industry’s long-term competitiveness.

Because foreign investment policy can become quickly outdated or outmoded as the market changes, governments need to begin from a place of flexibility if the investment review regime is to be effective. With the changes announced in December, investors know that Canada remains open to foreign investment from all areas of the world, but that SOEs seeking control of a Canadian company will need to face a higher threshold in demonstrating how their engagement in market activity is of benefit (and not harm) to Canada. This is a good approach.

But there is still a need to continue refining the ICA and its guidelines to provide additional clarity and transparency on the remaining questions surrounding enforcement of the investment review regime. Good policy should also avoid playing catch-up. This is why, as an incremental step, the government’s response to the Nexen and Progress deals was a reasonable response to the challenges posed by SOE involvement in the Canadian economy and the oil sands specifically. But it does not put to rest larger questions that have existed for several years. If the debate is to be any clearer the next time we face a politically sensitive transaction, then Ottawa must start filling some of those gaps now.


Dany H. Assaf is a partner at Torys LLP in Toronto, specializing in competition, antitrust and foreign investment review. Tyler Meredith is a research director at the IRPP.