Screening FDI – Economic and Political Risk

It is often stated that IC (Investment Canada), and FIRA before it, approved over 90% of applications, with some implying that the agency was an easy sell for the foreign investor. In practice this result is not surprising given the process used to meet and negotiate with the foreign investor and its Canadian legal advisors. The foreign investor and its lawyer meet with the agency officials to discuss its written application. From previous decisions, it is known what conditions are likely to be acceptable. Bargaining may take place with the investor aware that the agency may want something which it is prepared to give. The agency can then show that they have obtained better conditions for Canada. The Canadian legal adviser will advise the investor of how to play this game. No investor wants a rejection and has the ability to withdraw the application if failure is apparent. The result of this process is that the approval rate is high, maybe over 90%.

The foreign investor may be asked to meet certain conditions in order to pass the net benefits test. This is similar, but with one significant difference, to a patient being told by her doctor to eat certain foods, exercise daily, and get eight hours of sleep. These can be monitored and corrections made if necessary. If the foreign investor agrees to employ a certain number of Canadians, perform R and D in Canada, and export a certain percentage of production, these commitments suppose that market conditions are known in the future. If a recession occurs, it may be difficult or impossible to keep them, whereas the patient normally can comply when warned.

Commitments can be made for a certain point in time but not necessarily kept in the future. They could be exceeded in a growth situation, or not reached with a downturn. One then has to inquire about the monitoring procedure of the screening agency. I am unaware of the details, but pretty sure the agency does not have the staff to monitor in detail all previous approved investments. Foreign investors may disinvest for economic reasons but there is no record of investors being thrown out of Canada.

 Political Risk

Quantification is not possible. There are a series of issues to examine and these are clearly outlined in a study by Professor Ted Moran (Georgetown University) where he sets out current practice in other countries and by the OECD, and suggests how they might be applied in Canada,

“The first category (which I will refer to as “Threat I”) consists of proposed acquisitions that would make the home country dependent upon a Chinese foreign-controlled supplier that might delay, deny, or place conditions upon the provision of goods or services crucial to the functioning of the home economy.  The second category (“Threat II”) is a proposed acquisition that would transfer, to a foreign-controlled entity, technology or other expertise that might be deployed by the entity or its government in a manner harmful to the home country’s national interests. The third category (“Threat III”) is a proposed acquisition that would enable the insertion of some potential capability for infiltration, surveillance, or sabotage into the provision of goods and services crucial to the functioning of the home economy.”

http://www.ceocouncil.ca/wp-content/uploads/2012/03/Chinese-Foreign-Direct-Investment-in-Canada-Theodore-H-Moran-March-2012.pdf

Ted Moran has been an expert on this general subject area since the 1970s with a large number of publications. In Canada, the only comparable person would be Professor Ed Safarian, Professor Emeritus at the University of Toronto.

Since each case is different and political risk non-measurable in a precise way, the decision, on this dimension, becomes one which the cabinet must make with the best advice from officials. In this instance the issue of reciprocity needs to be considered. Canada is reported to have a stock of $4.5bn invested in China and China has $10bn invested in Canada. No doubt there will be more on its way, depending in part on the Nexen decision.

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