The Overseas Investment Amendment Bill (No 2) ("Bill") was introduced on 20 March 2020 and sets out the proposed Phase II amendments to the Overseas Investment Act ("Act"). This is the second in a series of articles discussing the changes introduced by the Bill, the first having covered the new national interest test and call in powers.
While the new national interest and call-in powers provide the Government with greater power to manage risks associated with overseas investment, the Bill also makes liberalising changes to the regime intended to better encourage overseas investment in New Zealand.
The changes covered in this article are those that exclude "lower risk" investments from the scope of the regime. Specifically, the Bill (and associated regulations, once introduced) will:
- Amend the definition of "overseas person", such that majority New Zealand owned and widely held NZX-listed New Zealand companies are no longer caught by the Act.
- Extend the exemption process, to allow exemptions for New Zealand controlled entities. Associated regulations are expected to use this as a basis for exempting Kiwisaver funds and providing criteria for exemptions for non-listed entities and managed investment.
- Further limit the extent to which incremental securities transactions in NZX-listed entities and increases in shareholdings in listed and unlisted entities by previously consented overseas, persons require consent under the Act.
- Exclude interests in low risk adjoining land from the definition of "sensitive land".
- Increase the term of leases of sensitive land (that are caught by the Act as a qualifying "interest") from three years to 10 years (including unexercised rights of renewal).
The Government has estimated, based on historical statistics, that these changes will result in a 14% reduction in applications. This may not seem like a lot, but it is our expectation that many of the applications that will make up this 14%, are those that have caused overseas investors to question New Zealand's status as a welcoming destination for offshore capital on the basis the regime is disproportionate and/or misdirected.
In our view, these changes will be effective in addressing aspects of overreach that are unnecessarily deterring beneficial and low risk investment in New Zealand, and have an associated positive impact. However, we have also identified some areas where, in our view, the changes have not gone far enough in achieving the objectives of the reforms, and where the detail to be included in new regulations (where the draft regulations have not yet been made available) will be critical to ensure the success of the reforms.
This alert will be followed by:
Article 3: Simplifying the existing investor and benefit tests
Article 4: Application processing times, penalties, new enforcement tools, and new tax information requirements.
Excluding some fundamentally New Zealand entities from the scope of the Act
Under the Act, a New Zealand company is treated as an "overseas person", and is subject to the consent regime, if it is subject to 25% or more overseas ownership or control.
During the consultation process for the reforms, many submitters noted that the 25% overseas ownership threshold seemed arbitrary and did not correlate to an ordinary person's understanding of what would categorise an overseas owned and controlled company. Furthermore, widely held NZX-listed issuers had significant practical difficulties determining whether they were an overseas person or not at any point in time,1
which could result in either inadvertent breach or over compliance (seeking consent when it is not required, through an abundance of caution).
In addition to arguable overreach for New Zealand listed and non-listed companies, the current regime also captures fundamentally New Zealand entities such as Kiwisaver funds and managed investment funds where these are managed by managers that are overseas persons, despite the funds being operated solely for the benefit of New Zealanders.
We note that there was previously provision under the Act to seek exemptions for New Zealand controlled businesses and portfolio investors, which were then listed in Schedules 3 and 4 of the Regulations. In practice, exemptions were rarely granted. Further, changes in the Phase I reforms meant that this exemption was no longer available.
What the Bill does
Change to definition of "overseas person" for New Zealand incorporated and NZX-listed companies
Under the Bill, companies that are both incorporated in New Zealand and listed on the NZX will no longer be an "overseas person", unless they are either of the following:
- more than 50% beneficially owned by one or more overseas persons; or
- one or more overseas persons who each own 10% or more of the company's securities either:
- individually or together control the composition of 50% or more of the company's governing body (board of directors); or
- exercise or control the exercise of more than 25% of the voting power at a meeting of the company's security holders.
These changes will mean that a number of New Zealand's most well-known listed companies that are fundamentally New Zealand businesses will no longer be treated as "overseas persons", and will therefore no longer be restricted in transacting in sensitive New Zealand assets by the requirements of the Act.
New exemption process for other fundamentally New Zealand entities
The Bill also introduces a new exemption process that is intended to be used to exempt fundamentally New Zealand entities that are not listed companies. The Bill does this by introducing a new category in the exemption purpose in the Act, which will allow exemptions to be made by way of regulation or application for persons that the Minister considers to be "fundamentally New Zealand owned or controlled or to have a strong New Zealand connection". We understand from Treasury that regulations will be made pursuant to this new purpose that will:
- remove KiwiSaver funds from the definition of an overseas person by way of a class exemption; and
- set out a process and criteria for exempting non-listed companies and managed investment schemes.
It is expected that criteria for exemptions under the new regulations will mirror the exemption criteria for listed companies set out in the Bill, but with some additional requirements, recognising that managed investment schemes and other non-listed entities are subject to less stringent regulation and disclosure obligations that apply to NZX-listed companies. These changes are therefore likely to benefit non-listed companies that are majority New Zealand owned and controlled and relatively widely held. The application of the new exemption category to managed investment schemes and portfolio investors is discussed further below.
Treatment of managed investment schemes and portfolio investors
Specifically in relation to managed investment schemes, the Bill amends the definition of "overseas person" in the Act by introducing a new provision that clarifies when managed investments schemes will be "overseas persons". These changes mean that managed investment schemes will be overseas persons if their manager or trustee is an overseas person or if more than 25% of the value of the investment products in the investment scheme are invested on behalf of overseas persons. This does not materially change the current position under the Act.
As noted above, the new exemption process for fundamentally New Zealand entities will allow managed investment schemes to apply for an exemption from the definition of "overseas person" (and therefore from the Act). The Regulatory Impact Statement on the Bill (RIS) indicated the exemption will apply where:
- 50% or more of the scheme’s funds are invested on behalf of New Zealanders;
- overseas persons that each hold 10% or more of voting power do not collectively control more than 25% of voting power at a meeting of scheme participants;
- less than 10% of the scheme’s funds are invested on behalf of a foreign government; and
- the Minister is satisfied with the scheme’s compliance with the law and, where relevant, the degree of control that a foreign government or its associates has in the scheme.
In relation to portfolio investors, the general exemption is not intended to apply (so the previous Schedule 4 exemption for portfolio investors will not be replaced). As noted in the RIS, this is because portfolio investors are expected to benefit from the changes to the tipping point rules discussed below.
Does the Bill address the problem?
The change to the "overseas person" definition for New Zealand listed companies is a welcome reform, and will be gratefully received by a number of our listed clients and other well-known NZX-listed issuers who have, until now, been burdened by compliance costs in respect of their obligations under the Act. It should encourage investment by these entities, by reducing their compliance costs and allowing them to compete more effectively for domestic assets, particularly against foreign buyers.
The new class exemption for KiwiSaver funds is also welcome, and the new exemption process for "fundamentally New Zealand entities" has the potential to be beneficial for managed investment schemes and other non-listed entities, depending on the final criteria and application process included in the regulations and the manner in which it is implemented by the OIO. We hope for an opportunity to engage on the detail of the regulations before they are finalised. In particular, it will be important that the criteria used to determine whether an entity is 'fundamentally New Zealand owned' are clear and available to a range, and material number of, fundamentally New Zealand businesses and entities. A key issue for managed investment schemes will be to ensure the criteria focuses on New Zealand ownership of the investment products and not overseas ownership or control of the manager or trustees – if the latter position is adopted, the exemption process will not resolve the current issue.
Finally, we do not agree with the position under the Act that negative control (the rationale for the 25% threshold) equals control in and of itself, and argued in our submissions that the threshold, for all entities and regardless of whether listed or unlisted, should be 50% or more overseas ownership or control. The Government has come some way towards this position, but clearly was not comfortable doing away with the 25% negative control proxy threshold altogether. This is disappointing, as there is (clearly) very limited control afforded to an overseas person that holds between 25% and 50% of the ownership or control rights in an entity.
The "tipping point" and incremental investment in NZ listed issuers
Currently, if an overseas investor in a New Zealand entity acquires an ownership or control interest in that entity such that the entity becomes 25% or more overseas owned or controlled, that overseas investor who caused the target entity to "tip over" the 25% threshold is required to obtain consent under the Act regardless of the size of the ownership or control interest that the investor acquires.
In our submissions we argued, among other things, that this approach is arbitrary and disproportionate. In sensitive land cases, it requires the incremental investor to obtain a sensitive land consent from the OIO (at a cost of approximately $150,000 including the application fee and legal fees), including showing a benefit to New Zealand from the incremental investment (in most cases where the investor tipping the target entity over the 25% threshold has no means of actually delivering any such benefit through its investment). Clearly, this either operated as a block to overseas persons undertaking such transactions, or meant that such transactions occurred regardless of the restriction in the Act because the incremental investor was not aware that their investment had tipped the target entity over the 25% threshold, thereby triggering the consent requirements in the Act. We refer to this below as the "tipping point problem".
In addition, there is limited relief under the Act from the consent requirement for incremental investments by overseas investors that had previously been granted consent to acquire a 25% or more ownership or control interest and where the additional investment did not cross any accepted control threshold (eg, 50%, 75%, 100%). This issue was partially addressed by a new "shareholding creep" exemption originally introduced by regulation in 2009 and amended again by regulation in October 2018. The exemption currently allows overseas persons with existing consents to increase their shareholdings by up to 10% of the total number of shares in the same class within five years of the original consent, so long as the increased shareholding doesn't cross a key control threshold (25%, 50%, 75%, 90%). However, this exemption has been of limited relief to investors, and has been the subject of ongoing criticism, on similar proportionality grounds as those raised above in relation to the tipping point. Overall there appears to be a limited policy basis for screening incremental transactions that do not give the investor any increased degree of control in practice. We refer to this issue below as the "incremental investment problem".
What the Bill does
The Bill seeks to deal with the tipping point problem, in relation to New Zealand incorporated and NZX-listed issuers only, through amendments to the "overseas person" test and the tipping point provision in section 12 of the Act. As a result of these amendments, investments will now only require consent if the incremental investor (i) acquires a 10% or more stake in the listed entity, and (ii) the incremental investor and other 10% shareholders together hold greater than 25% of the listed issuer's shares as a result of the transaction.
In relation to the incremental investment problem, it appears that the new reforms will do little to assist here, contrary to the recommendations of Treasury. Treasury recommended to Cabinet that the 90% control threshold should be removed and there should be no restriction on previously consented overseas investors increasing their ownership level within the other accepted control thresholds (50%, 75%, 100%). This change would have meant that a previously consented investor could, for example, move from a 25% or more holding to up to a 49% holding, or from a 50% or more holding to a 74% holding. However, the RIS states that this option was not preferred and instead the regulations will merely tweak the existing shareholding creep exemption (which allows a maximum 10% increase in shareholding within the control limits) by removing the 90% control threshold and five year time limit and allowing holding companies of previously consented entities to rely on the exemption.
Does the Bill address the problem?
The tipping point changes are a welcome amendment which materially improves what is currently an untenable position for incremental investors in widely held New Zealand incorporated and NZX-listed companies. In effect, as long as the New Zealand listed issuer remains widely held within the terms of the Act (one or more shareholders each holding 10% or more of the shares and shareholders do not together hold 25% of more of the shares), an incremental investor will not require consent under the Act. We do note that this change is unlikely in practice to materially reduce the number of OIO applications that are currently made, because, as noted above, tipping point transactions often either do not proceed or proceed without an application being made under the status quo.
In relation to the proposed amendments by regulation to the shareholding creep exemption for previously consented investors, we are disappointed (as will be the investment community) that the Treasury's recommendations, which we had supported in our submissions, has not been adopted by Cabinet. The exemption will remain of limited assistance to such investors, and could preclude them from funding additional growth by target entities through equity injection, where such injection would cause an incremental increase in an overseas owner's shareholding.
Certain adjoining land no longer "sensitive land"
Currently under the Act, OIO consent is required for an acquisition of an interest in land that adjoins land of the type listed in Table 2 of Schedule 1. This captures a wide variety of land and is generally considered unnecessarily broad. One type of land, the "section 37 list" of reserves, is determined based on district plan classifications, meaning the treatment of the same kind of land may vary across different regions of New Zealand.
The classification of land adjoining low level "reserves" as "sensitive land" under the Act has been particularly problematic for overseas investors seeking to undertake offshore or onshore transactions where some or all of the target business is conducted in New Zealand. All too often, the target business would include a warehouse or industrial property that happened to adjoin a "reserve", meaning that the entire transaction (often major international mergers or acquisitions) would be subject to an OIO consent process that could delay the transaction for six months and often longer. This was clearly not a proportionate outcome for the risk being addressed, and operated to bring New Zealand into disrepute as an investment destination and place to do business. The Government recognised from the outset of the consultation process (and previously) that this issue needed to be addressed.
What the Bill does
Under the Bill, OIO consent will only be required if the target land adjoins a marine or coastal area, lakebed, conservation land, national parks, certain regional parks, and certain land significant to Māori. The OIO is no longer responsible for maintaining a list of other sensitive reserves or areas.
The changes ensure that the new categories of sensitive adjoining land are readily identifiable through public registers (such as a search of the record of title or the New Zealand Heritage List) or definitions of land in statute (for example, the Te Urewera Act 2014). Land which adjoins road or esplanade reserves that in turn adjoins the foreshore will no longer be treated as sensitive land.
Does the Bill address the problem?
In our view, these changes appropriately address the issues referred to above and are welcome. They eliminate one of the main issues that overseas investors and their advisers have had with the Act, and more appropriately reflect what should constitute "sensitive land" in line with the overarching purpose of the Act.
Shorter lease terms no longer a qualifying interest in sensitive land
Under the Act, an acquisition by an overseas person of a 25% or more direct or indirect interest in a lease of "sensitive land" which has an unexpired term of three years (including unexercised renewals) is caught by the Act. This three year lease threshold has been raised as an issue for a number of years, with arguments made that it falls well short of ownership or control of the relevant land, which is what the Act is intended to target. Further, it is more difficult for investors to meet the benefit to New Zealand test under the Act when acquiring a leasehold interest, as a lease generally will not give the lessee sufficient control over the property to, for example, invest development capital in the property or create additional jobs at the property, sufficient to satisfy the test (particularly when the remaining term of the lease is short, and does not provide the investor with sufficient time to justify a return on investment). Perversely, these anomalies also incentivise overseas persons to own sensitive land, rather than lease it.
What the Bill does
Under the Bill, leases of a "total term" of less than 10 years will now not be caught by the Act. The "total term" includes not only the term (or the balance) along with rights of renewal but any prior lease of that land (including any "holding over" periods) held by the overseas person or their associate. This is clearly an improvement on the status quo.
Does the Bill address the problem?
In our view this change does not go far enough to address the concerns raised by many submitters and recognised by Treasury during the consultation process with leasehold interests. Submitters and Treasury acknowledged that lease terms could be long enough to transfer effective control of the land out of the hands of the freehold title owner, such that the lease equates to freehold ownership, in which case the acquisition of the leasehold interest would justifiably require consent. But, as we understand it, few submitters thought that 10 years was the right place to draw the line, with many favouring 20, 30 or 35 years, to reflect the life of an investment and address concerns that shorter leases are too uncertain.
The 10-year term is the more restrictive of the two options put forward in the consultation paper, the other option being a split test of a 10-year term limit for leases of non-urban land greater than 5 hectares and a 35-year term limit for leases of any other "sensitive land". According to the RIS on the Bill, Treasury recommended an increase to a 15-year term limit, but this was not accepted by Cabinet.
We also note that at no point prior to the issue of the Bill did the Government suggest that prior interests held by the same overseas person would be included within the limit. It is likely that these prior interests were required to be included during the Cabinet approval process, to prevent parties from granting back-to-back 10-year leases, which was a concern raised in the consultation paper. The inclusion of previous interests (prior leases of the same land) means that any re-grant or extension of a lease so that the overseas person (or an associate of theirs) has been in possession of the land for more than 10 years, even where the extension is for a short period, will (unless the re-grant exemption applies) require a sensitive land consent. It will undoubtedly be difficult for a lessee to demonstrate benefits arising from short-term occupation.
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