Protecting Economic Security

Modernizing the Investment Canada Act, sort of

The Investment Canada Act (ICA) is a key, but little known, tool to protect Canadian economic security. The Act and associated regulations are designed to counter potentially harmful efforts by foreign entities to buy into the Canadian economy. It does so through giving the government the power to scrutinize categories of foreign investment and block them when they are determined to be damaging.

The ICA has two separate branches. A “net benefit” review process operates for mega investment at various (high) levels, depending on the country standing of the investor. If you are an investor from a country with which Canada has a trade agreement, the threshold is $1.711 billion of “enterprise” value (OK, I am not an economist and don’t know what that is exactly). There has only been one block of a foreign investment under these provisions since 1985. This is the “open for business” part of the ICA.

Where controls can and are applied derives from a second branch of the ICA, called national security review. This is a much newer phenomenon, dating back only to 2009. A formal process of national security review came into being after the government moved to block the takeover in 2008 of a major Canadian satellite and space company, MacDonald Dettwiler and Associates (the foreign investor was a US company). Among other capabilities, MDA was the manufacturer of the then state-of-the-art Radarsat-2 satellite, which had sensitive Arctic monitoring capabilities.

National security review of foreign investment has no monetary thresholds. It applies to all investment, no matter the scale. It moves through a series of complex stages defined in sections of the ICA, with the possibility of reaching a Cabinet-approved process of full national security review consideration for a handful of sensitive investments, in which the government can order remedies ranging from blocking a takeover, to divestiture of components of a takeover, to other compliance mitigations.

At the outset of the national security review process, China was not on the radar screens as a foreign investor of concern. That began to change after the controversial take-over of a Canadian oil sands company, Nexen, by a Chinese state-owned enterprise (SOE), CNOOC. That deal closed in 2013 after approvals by both Canada and the United States (where Nexen also had major operations). But it led to a policy decision from the Harper Conservative government that the oil sands would, in future, be “ring-fenced” against any foreign state-owned enterprise takeovers.

More recently, attention has shifted to the critical minerals sector, with the government announcing in March 2021 that it would give more rigorous national security review, what it described as “enhanced scrutiny,” to any foreign investment in the sector.

https://ised-isde.canada.ca/site/investment-canada-act/en/guidelines/guidelines-national-security-review-investments

The actual rigour of the new approach was called into question by the failure to apply full national security review provisions under the Act to a Chinese SOE takeover in the same year of an innovative, Canadian-listed mining company, Neo-Lithium, with important assets in Argentina that could serve the hot market for EV battery production. The government squirmed under media and public criticism and faced a study and report by the Industry committee in the House of Commons, released in March 2022. I gave testimony to the Industry committee and came away feeling that allowing the takeover was just plain daft.

https://www.ourcommons.ca/Content/Committee/441/INDU/Reports/RP11659786/indurp03/indurp3-e.pdf

The government then moved the goalposts further in October 2022, announcing a new policy that stipulated that “applications for acquisitions of control of a Canadian business involving critical minerals by a foreign SOE will only be approved on an exceptional basis.” This is not quite so bold as Harper era “ring fencing,” but it is pretty close.

https://ised-isde.canada.ca/site/investment-canada-act/en/ministerial-statements/policy-regarding-foreign-investments-state-owned-enterprises-critical-minerals-under-investment

To prove it was getting more serious, the Innovation, Science and Economic Development (ISED) Minister, Francois-Philippe Champagne, made an unusual announcement on November 2, 2022, regarding the decision to order the divestiture of foreign investments by three Chinese companies in the lithium sector.

https://www.canada.ca/en/innovation-science-economic-development/news/2022/10/government-of-canada-orders-the-divestiture-of-investments-by-foreign-companies-in-canadian-critical-mineral-companies.html

Usually Canadians do not learn of individual decisions to block foreign investment made on national security grounds. They are just rolled up by ISED into annual statistical reporting, unless the media uncovers the stories.

This decision was clearly designed to send a signal to various audiences, including the mergers and acquisitions folk on Bay Street, their foreign clients, including Chinese ones, and especially perhaps the United States, with which Canada is building a joint critical minerals strategy. The message was that Canada was getting tough and was intent on “friend-shoring” investments in critical minerals. Sure, the signal involved three junior miners, and was therefore low cost and low risk, but it was meant to be a portent.

The latest step in this long march towards greater protection of key sectors relevant to Canada’s future economic security came with the tabling of legislation by Minister Champagne in the House on December 7, 2022. The legislation is designed to amend the Investment Canada Act (ICA) and is described by the government as “the most significant update of the ICA in more than a decade.” While that is true, it is also fair to point out that it is the only significant update to the legislation in a decade.

Background information on the legislation is here

https://www.canada.ca/en/innovation-science-economic-development/news/2022/12/government-of-canada-to-modernize-the-investment-canada-act.html

https://www.canada.ca/en/innovation-science-economic-development/news/2022/12/an-act-to-amend-the-investment-canada-act.html

For the bill itself, see:

https://www.parl.ca/Content/Bills/441/Government/C-34/C-34_1/C-34_1.PDF

How big a deal are the proposed changes to the ICA? Perhaps the biggest deal is simply that the bill will force Parliament to pay serious attention and fix more public eyeballs (via the media) on the importance of economic security.

As legislation, it is mostly tinkering, not a major overhaul. It does provide for a better system of notifying government about foreign investment at an early stage, to replace a pretty ad hoc arrangement. This allows Canada to fall into line with practices in the U.S. under its equivalent national security review process, conducted by something called CFIUS (Committee on Foreign Investment in the United States).

To its credit, the amended Act allows for greater protection of intellectual property (IP) assets while an investment is being reviewed (to prevent any early siphoning off of tech knowledge).

The proposed legislation also gives the government more flexibility to share intelligence with foreign partners as investments are being reviewed.

However, the intelligence sharing provisions in the bill are also a reminder that Canada may be overly dependent on key foreign allies, largely from the Five Eyes intelligence partnership (the US, UK, Australia and New Zealand) for critical sources of information about foreign investment trends and players, that are not easily discoverable in the public domain (e.g. on Chinese state enterprise practices, or Russian efforts at sanctions busting, or the military-industrial complex in some other state). The Canadian national security and intelligence system lacks any real capacity for economic intelligence—by which I do not mean sending spies into overseas corporate boardrooms, but the broader practice of all source intelligence collection targeted on economic issues.

Where the Act fails, in my view, is its lack of attention to the fall-out consequences of national security review for Canadian companies, especially small and medium enterprises, that might find themselves blocked from access to foreign capital and have little chance of immediate recourse. This is particularly a problem for start-ups and tech innovators. To address the fall-out issue, the government should have considered creating a funding mechanism to substitute for blocked foreign investment through some kind of government-supported preferential access to Canadian capital, at least on a short-term basis to ensure survival.

A second missing piece concerns transparency. There should be a statutory requirement to provide public summary notification of all results of national security review under the more intensive review sections of the Act, not just meta-data in annual reports. The government has promised to continue the recent practice of publicizing decisions on Cabinet-ordered national security reviews. But in for a penny in for a pound. A promise is just a promise. Better to lay this down in statute.

What legislative change cannot guarantee is effective usage of national security review. The number of times that the ISED Minister has instituted a national security review of a foreign investment is still very small. The number has climbed over the past two years to a high of 24 (from 4 in 2017-18). Over a five year period only 2 investments have been blocked by Cabinet order, while only 7 divestitures were commanded.

As economic policy shifts away from globalized investment in Canada, under the impact of major geopolitical changes, the national security review practices under the ICA will have to shift with them. We will find more economic sectors “ring fenced” beyond the oil sands and critical minerals (quantum computing next?) Greater attention will have to be paid to data assets and innovation know-how. A fully-firing national security review system will require greater economic intelligence capacities, and a much more coordinated approach across government departments to the conduct of national security review. The cudgels will have to be set aside between the economic and national security experts, and a more streamlined system with routine higher level scrutiny and approvals in the bureaucracy will have to be established.

There is no undoing a slipshod approach in the past, but something truly more rigorous will have to be put in place, quickly.