By Mukesh Ralhan 1

Cross-border direct investment flows have been increasingly influenced by mergers and acquisitions, which continue to change the landscape of ownership and control of enterprises, as well as production and financing. We investigate the dynamics of Foreign Direct Investment (FDI) Mergers and Acquisitions (M&As) for Canada in the context of Canadian Balance of Payments (BOP) framework. 2 INTRODUCTION

 First, M&As tend to be both increasing and significant transactions with impacts on money flows, investors, and domestic employment.  Second, and more importantly over the medium to long term, they represent a substantial and fundamental re-structuring of operations of multinational enterprises, which is both a cause and effect of globalization. This, in turn, translates into a re-structuring of domestic and worldwide economic activity with resulting impacts on countries’ aggregate production, trade and investment. Given these effects, it is important to understand cross-border M&As 3 SIGNIFICANCE M&As

 The International Monetary Fund (1993) defines foreign direct investment as the category of international investment that reflects the objective of obtaining a lasting interest by a resident entity in one economy in an enterprise resident in another economy.  4 Definition

 Under Canadian direct investment abroad (CDIA), the foreign entities in which a Canadian enterprise holds at least a 10% voting equity ownership are referred to as related parties of a Canadian direct investor; they include foreign subsidiaries (enterprise more than 50% owned), foreign associates (enterprise between 10% and 50% owned) and foreign branches (wholly-or jointly-owned unincorporated enterprises).  Similarly a foreign entity investing in a Canadian entity is referred to as Foreign Direct Investment in Canada (FDIC) and similar provisions are applicable. 5

 Statistics Canada disaggregates Foreign Direct Investment (FDI) flows into three broad categories:  (i) Cross-border mergers and acquisitions (M&A);  (ii) Greenfield investments or other long-term flows (i.e. injections of new capital), and  (iii) reinvested earnings and an extension of the capital of established direct investment enterprise . The first two categories are generally the largest and M&A activity can be quite volatile. When Canadian firms acquire foreign companies, the transaction is classified as “outward” transaction; while foreign firms acquiring Canadian companies is categorized as “inward” transaction. 6

 There are no guidelines in the manuals in regard to treatment of M&A and the definition and coverage of the data vary across different countries. Statistics Canada reports data on M&A as a sub-head under direct investment.  At Statistics Canada, the data on direct investment are compiled from a variety of sources viz.  Survey Control System (SCS), including annual and quarterly surveys and administrative data, supplemented by public financial information.  Financial information published in the financial press (for example, Globe and Mail, National Post and Les Affaires) is systematically analyzed and processed against quarterly survey results. The importance of the financial press is evidenced by the fact that this source often accounts for more than half of the preliminary quarterly estimate of the net inflow of inward foreign direct investment in Canada; for outward-bound Canadian direct investment abroad, the proportion has reached up to half the preliminary quarterly estimate. 7 METHODOLOGY AND DATA SOURCE

The OECD Benchmark Definition of Foreign Direct Investment (Benchmark Definition) and the IMF’s Balance of Payments Manual do not provide for the separate delineation of flows associated with merger and acquisition activity from other direct investment flows. Direct Investment Technical Expert Group (DITEG) set up by the IMF Committee on Balance of Payments Statistics and OECD has recommended that cross-border M&As be shown as a separate item in the BOP framework in view of the following concerns: 8 DEVELOPMENTS AT OECD

 (a)Analytical shortcoming considering the significant share of M&As in FDI activity worldwide. The impact of M&As on home and host economies differs from the impact of other types of investments, in particular of Greenfield investments;  (b) There is no agreed coverage and definitions of M&As;  (c) There are no (or very few) M&As data comparable to and consistent with FDI statistic;  (d) Lack of guidance for recording individual transactions and their classification. 9 DEVELOPMENTS AT OECD …contd..

 Since 1985, the basic legal framework for foreign investment in Canada (for inward transactions) is provided by the Investment Canada Act (ICA), which replaced the more restrictive Foreign Investment Review Act, introduced in  As per the regulatory framework, the Government of Canada can review large-scale foreign investments in Canada, which exceed a designated financial threshold.  The threshold for notification of large-scale foreign investment from WTO countries is currently $281 million. For non-WTO countries, it is $5 million. 10 LEGAL FRAMEWORK

 Review of foreign investment at a lower financial threshold is required in financial services, transportation services (including pipelines), uranium and culture. The threshold for review of foreign investment in these sectors is $5 million for direct investment and $50 million for indirect investment.  Foreign investments involving Crown corporations as well as foreign investment involving financial institutions regulated under the Bank Act and the Insurance Companies Act are exempt from review under the ICA. 11 contd…

 Approval of the acquisition is granted when the Minister is satisfied that the investment is likely to be of “net benefit to Canada”. The Minister of Industry grants approval of an acquisition. In 1999, responsibility for administration of the ICA in the cultural sector (music, film and video, books, magazines and newspapers) was transferred to the Minister of Canadian Heritage.  Schedule IV of the Regulations to the ICA contains precise wording to determine whether a business activity is cultural or not. 12

 The interested readers are referred to the consultation paper issued by the Competition Policy Review Panel (2007) for a detailed overview of guidelines relating to FDI.  Also Canada has a sectoral investment regime in place for foreign investment in six sectors of the Canadian economy viz. telecommunications, cultural industries, broadcasting, transportation services and uranium production. The investment in these sectors is subject to lower thresholds. 13 ……

 Also, the financial services sector is subject to ownership restrictions of general application but not specific foreign ownership restrictions. For the outward transactions, a majority of the countries have mechanisms in place to block any mergers or acquisitions on the basis of national interest or security considerations.  In addition to the Investment Canada Act, there is other legislation governing FDI in Canada. At the international level, foreign investment is governed by a number of multilateral agreements, conventions, treaties etc., and the prominent among them being under the umbrella of the World Trade Organization (WTO). 14 contd…

15  In addition to data from Statistics Canada, we looked at data from some other sources viz. World Investment Report, 2007 (Thomsons Financials) and Financial Post Crosbie.  The sales (FDIC) and purchases (CDIC) have stayed close to each other for most of the years except some notable exceptions in 2002 and The sales exceeded purchases by a wide margin for these two years. Both sales and purchases have shown a constant upward trend for the period in terms of absolute number of takeovers. However, the situation is not similar if we look at the value of M&As.  The M&As transactions in terms of value are marked by wide fluctuations for both sales and purchases. These swings are, however, more visible in the case of sales as a result of some of the largest takeovers recorded in recent times.

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 Economists have used a variety of tools using state of the art statistical and econometric methods to identify drivers of Cross-Border M&As for Canada such as Ordinary Least Squares (OLS), ARCH and GARCH etc.  The findings of these research studies are based on data compiled by Statistics Canada and other international sources.  The findings suggests that in order to attract foreign investment, it is important that the fundamentals of financial markets are strong; as is shown by the statistical significance of the variables associated with TSE, NYSE and DJII in some of the studies.  Economists have used a variety of tools using state of the art statistical and econometric methods to identify drivers of Cross-Border M&As for Canada such as Ordinary Least Squares (OLS), ARCH and GARCH etc.  The findings of these research studies are based on data compiled by Statistics Canada and other international sources.  The findings suggests that in order to attract foreign investment, it is important that the fundamentals of financial markets are strong; as is shown by the statistical significance of the variables associated with TSE, NYSE and DJII in some of the studies. 19

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