Canada's Foreign Investment Reforms Create A More Open

UNCLAS SECTION 01 OF 03 OTTAWA 000581

SENSITIVE
SIPDIS

STATE FOR E, EB/DCT, WHA/EX, WHA/CAN

STATE PASS USTR (SULLIVAN)

COMMERCE FOR ITA/MAC (WORD AND BARRAGAN)

TREASURY FOR IA (NEPHEW)

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV EIND PREL CA
SUBJECT: Canada's Foreign Investment Reforms Create A More Open
Market But Do Not Spare U.S. Steel from Canadian Court Action

SENSITIVE BUT UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY


1. (SBU) Summary: Canada's July 17 federal court action against U.S.
Steel attempts to force the company to meet the production and
employment commitments it made to the Federal Government in 2007 in
exchange for permission to take over Canada's Stelco. At that time,
the GOC exercised its legal right make foreign acquisition of
Canadian assets conditional on the fulfillment of certain
performance requirements. However, at the same time as the Federal
Industry Ministry is cracking down on investor behavior, the
Conservative government is also implementing changes to the national
investment regime that would make Canada a more open and transparent
investment destination for foreign investors. Although most of the
proposed regulations are not controversial, some foreign investors
will be dismayed that Canada's new security requirements demand
increased disclosure of confidential information and increase the
possibility that the government might disallow an investment on
security grounds even after the transaction has been completed. End
summary.

U.S. Steel
--------------


2. (U) On July 17, Minister of Industry Tony Clement announced that
the Government of Canada was launching an action against U.S. Steel
in the Superior Court of Canada to remedy an alleged breach of
Canadian investment law. The American steelmaker's 2007 acquisition
of Ontario-based Stelco was predicated upon the company maintaining
minimum levels of Canadian employment, capital expenditures and
production. In May 2009, the industry minister threatened legal
action after U.S. Steel cut production and laid off employees at its
Canadian operations in tandem with the global economic recession.

ICA Undertakings
--------------


3. (U) Canada's Investment Canada Act (ICA) permits the Industry
Minister to bind foreign investors to obligations on matters such as
local production and employment levels in order to ensure that the
investment provides a 'net benefit' to Canada. Following a recent
exchange of letters with the company, Clement stated, "I remain of
the view that U.S. Steel is not complying with its undertakings, and
I am not satisfied by its explanations for non-compliance." If the
Canadian court finds that an investor has breached an ICA
undertaking, remedies include curing the breach, fines or forced
divestiture of the investment. In this case, the Industry Minister
has asked the courts to levy a C$10,000-a-day fine against U.S.
Steel, retroactive to the November 2008 Canadian layoffs.


4. (SBU) Although the terms of the undertakings a company makes to
the government are generally confidential, the Canadian media is
reporting that when U.S. Steel bought the bankrupt Stelco in 2007
for C$1.16 billion, it promised to boost production at Stelco mills
by 10 per cent in each of the first three years of ownership and to
maintain 3,105 full-time employees. Today, some 2,400 workers have
either retired or been laid off by U.S. Steel, and the company has
halted steel output in Hamilton and Nanticoke, Ont. In its court
filing, the government alleges that the company has defaulted on 77
percent of its employment commitment. (Comment: Since U.S. Steel
Qpercent of its employment commitment. (Comment: Since U.S. Steel
has not responded publically to the GOC court action it is not known
whether the company's undertakings included any exemptions for
exogenous economic downturns. End comment.) This is the first time
the Canadian government has taken a foreign company to court over
promises made as part of an acquisition (although it has threatened
similar action against the Brazilian mining company Vale Inco which
has laid off approximately 400 workers).


5. (SBU) Some Canadians are criticizing the government's move for
the negative message it will send to other potential foreign
investors. A Globe and Mail editorial argues that although Ottawa
may be legally entitled to its actions, Stelco's 2007 commitments
are unreasonable in today's volatile economic climate. The paper
speculates that Canada's hard line against Stelco may be intended as
a warning to General Motors and Chrysler that they will be similarly
held to the employment commitments they made in exchange for federal

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bailout funds. Nevertheless, the Globe concludes, "Ottawa should
refrain from intervening in future foreign takeovers. In a world
where economic volatility can render hard-won promises
impracticable, it simply isn't worth it."


6. (SBU) Christopher Sands, a senior fellow at Washington's Hudson
Institute, notes that the Canadian action puts U.S. Steel in the
difficult position of having to sideline one government's policy in
order to comply with another's. The steel industry has been hit
hard by the slump in construction and one of U.S. Steel's best
customers is the U.S. government, which has imposed strict Buy
American rules. This means that U.S. Steel has a stronger incentive
than usual to cut Canadian production to maintain higher volumes at
U.S. mills. Consequently, Sands suggests, the future decisions of
U.S Steel "will be determined by which government they fear more."


Changes to ICA
--------------


7. (U) In spite of the actions regarding Stelco, the Harper
Government is moving forward with commitments to open up the
Canadian economy to more foreign investment. In March 2009
preliminary changes to the Investment Canada Act (ICA) were
introduced as part of the government's budget legislation. These
were followed on July 11, 2009 with a number of proposed regulations
to give effect to the investment changes contained in the budget.
Among the most important amendments are increased investment
thresholds -- to determine which foreign investments will be subject
to a full governmental review -- and the imposition of a new
national security screening mechanism. Canada also plans to
eliminate differential review thresholds for transportation and
financial services and uranium production. The proposed regulations
will take effect after a 30-day comment period and do not require a
vote in the House of Commons.

Higher thresholds, new formulas, same cultural barriers
-------------- --------------


8. (SBU) The ICA requires that direct foreign takeovers of large
Canadian companies be reviewed and approved based on whether or not
the investment constitutes a "net benefit to Canada." (Comment:
The net benefit criteria are not spelled out in legal terms and are
open to a range of interpretations depending on the disposition of
the government in power. End comment.) Frequently, the government
will ask the foreign investor to provide negotiated undertakings
such as those assumed by U.S. Steel. Under the old rules, an ICA
review is required for any direct takeover by foreign investors from
a WTO country of a Canadian company with more than C$312 million in
gross assets. The new regulations will increase the review
threshold, first to C$600 million and ultimately to C$1 billion by
the end of four years.


9. (SBU) Although the higher thresholds mean fewer foreign
investments will likely be subject to full review, all foreign
investments must be notified to the government. Also the
methodology for determining the review threshold will be expanded
from considering only the asset value of the proposed acquisition to
a broader evaluation based on a company's market capitalization,
assets, and liabilities. Despite the new regulations, Canada's
Qassets, and liabilities. Despite the new regulations, Canada's
pre-existing regime banning virtually all foreign investment in
cultural industries remains unchanged, even though the 2008
government report Compete to Win recommended reforms in this area.


Enhanced national security requirements
--------------


10. (U) Under the proposed regulations, a foreign investor will have
to disclose the names of directors, the five highest paid officers,
any person or entity holding more than ten percent of the investor's
equity or voting rights, and the name of any foreign state that
holds a direct or indirect ownership interest in the investor, even
minor shareholders. The security disclosure requirements apply to
all foreign investments (including acquisitions and the
establishment of new businesses),even those that fall below the

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review threshold.


11. (SBU) The new regulations set out time frames for the government
to invoke the national security screening process - generally within
45 days after a notice of investment or review application has been
filed. However, in cases of investments valued below the applicable
review threshold, the government has up to 45 days after an
investment has been implemented to determine whether it should be
submitted to a full security screening. (Comment: Presumably, this
longer period exists to prevent smaller acquisitions that are not
subject to other forms of review from slipping under the radar and
to provide adequate time for the government to obtain more
information about the proposed investment and investor. End
comment.)


12. (U) The security review could take as long as four months and
will be conducted primarily by Canada's security and intelligence
agencies. If an investment is found to be a threat to national
security then the investment can be unwound or restricted.


Implications of Canadian changes for US investors
-------------- --------------


13. (SBU) Although the subjective net benefits test has not been
eliminated from Canada's foreign investment review process, the
higher review threshold means that fewer investments will be
subjected to it. As well, the addition of a more transparent
process to ensure that investments are not injurious to national
security brings Canada's policy more closely into alignment with
that of the United States. The clarification of Canada's security
requirements comes too late to affect the failed 2008 attempt by
US-based Alliant Techsystems, Inc. to take over the space-assets arm
of Canada's MacDonald Dettwiler and Associates Ltd (MDA),which
Ottawa vetoed on national security grounds. However during a
meeting with Embassy officials last week, a senior Industry Canada
official speculated that if the new security framework had been in
place at the time of Alliant's bid, the outcome could have been
quite different.