|
Policy Objectives and Options
In 1987, the Government of Canada justified the imposition of foreign ownership restrictions on telecommunications common carriers by arguing that they “ensure our national sovereignty, security and economic, social and cultural well-being.” In 2003, this committee is reviewing this contribution, and the need for foreign ownership restrictions in realizing this public policy objective. At the outset, the Committee would like to reaffirm the objectives of the Telecommunications Act, in particular that “telecommunications performs an essential role in the maintenance of Canada’s identity and sovereignty.” Telecommunications uniquely contribute to our identity and sovereignty as a nation by enabling Canadians to build the social and commercial networks upon which a country can develop and grow, particularly important in an increasingly knowledge-based economy. The Committee is also committed to the Government of Canada’s objective of encouraging FDI as a means of maintaining modern telecommunications infrastructure and services. In the interest of balancing these two objectives, the Committee will evaluate foreign ownership restrictions and other policy instruments in the context of the following five policy options;12 it will then recommend one option.
Status Quo: Canadian Control
Currently, the Telecommunications Act stipulates that to operate in Canada, a telecommunications common carrier must be “Canadian-owned and controlled” in that: (a) 80% of the Board of Directors of the corporation must be Canadian; (b) Canadians must beneficially own, directly or indirectly, not less than 80% of the corporation’s voting shares; and (c) the corporation must not be otherwise controlled by persons who are not Canadians. Foreigners are permitted to own not more than 46⅔% of the voting shares of a telecommunications common carrier (including both direct holdings and indirect holdings through a holding company). The rules apply only to voting shares, based on the assumption that only voting shares permit control; however, many other factors may contribute to control.
BCE Inc. has proposed a variant on the status quo. It recommends that the Government of Canada consider reducing the current 66⅔% minimum Canadian ownership requirement of a holding company to 51%. This alternative would permit foreigners to own, directly and indirectly, up to 59% of the voting shares of a telecommunications common carrier. Since the Canadian status of a holding company is determined by regulation, the Government of Canada would not need to seek formal Parliamentary approval for such a change. However, this proposal would not address the issue of de facto control, an important consideration deserving further study.
Another alternative that is similar to the status quo would be to: (1) lower the minimum requirement for direct ownership in a telecommunications common carrier from 80% Canadian to 51% Canadian; (2) discard the indirect ownership regulations; and (3) introduce limits, e.g., 10%, on individual ownership of voting shares. Canadian majority ownership and control would thus be preserved. This variant on the status quo might require a “grandfathering” clause for a number of existing operations, if adverse financial impacts are to be avoided. It would also be more restrictive and might pose a greater barrier to FDI than the current rules. Some OECD countries have, in fact, adopted similar rules (see Appendix 4).
Some witnesses suggested that one advantage of the current Canadian ownership and control rules, as well as the above two proposals, is their simplicity. Limiting foreign involvement to a non-controlling status makes it easier to ensure sovereignty over such considerations as maintaining a head office in Canada, performing research and development (R&D) in Canada and favouring Canadian facilities, thereby indirectly favouring Canadian jobs, commerce and economic development. Other policy instruments that would address these sovereignty issues involve some amount of discretion and uncertainty, and would be more cumbersome and costly to administer.
Other witnesses suggested that the primary disadvantage of any foreign ownership regime involving restrictions is that it is a very blunt way of achieving sovereignty objectives; and that restrictions on shareholdings have adverse impacts on the Canadian economy. By limiting the investment pool from which to draw, foreign ownership restrictions raise the cost of capital and slow the rate of capital investment for companies seeking outside equity financing. Moreover, foreign ownership restrictions disproportionately affect new entrants or CLECs relative to incumbents or ILECs because the former disproportionately finance their investments using outside sources of capital relative to the latter. New entrants, therefore, respond to higher-cost equity capital by shifting more towards debt capital as a means to finance their investments, thereby raising their debt-equity ratios. Higher debt-equity ratios across the industry translate into a less financially stable industry, particularly evident in periods of economic downturn; in such circumstances, debt-servicing charges can sometimes overwhelm a company’s liquidity position and force capital restructurings, including bankruptcy. For all these reasons, competition is held in check, which leads to slower integration of the newest infrastructure and services into the Canadian marketplace. This situation occurs even when the FDI does not entail any changes to the operating company’s strategic direction (e.g., maintaining a head office in Canada, performing R&D in Canada, or favouring Canadian facilities).
Canadian Majority Ownership: The 51%/49% Rule
A relatively easy way of significantly modifying the current foreign ownership regime would be simply to discard the Canadian control rules while maintaining the requirement for Canadian majority ownership. The most widely used majority ownership rule today is the 51%/49% rule, which would permit foreigners to directly acquire as much as 49% of the voting shares in a corporation.
This policy option would increase the foreign ownership permitted for a telecommunications common carrier only slightly, but possibly cede control of the company to foreign interests. If foreigners were more concerned about acquiring control of the carrier, rather than achieving majority ownership of it (to lower financial risk of their investment), then FDI would be more likely to flow to the Canadian telecommunications sector, in particular its new entrants, bringing with it new ideas, innovation, jobs and a more competitive environment than the current regime.
Some witnesses believe that the downside to this option is that the sovereignty objective might be more difficult or administratively costly to achieve. The takeover of an incumbent Canadian telecommunications common carrier by foreigners might be followed by a move of its head office and R&D facilities to the foreign owner’s home base, taking many high-paying jobs with them. Foreign owners might also assign a lower priority to rural and remote regions than do Canadian owners. However, evidence suggests that the CRTC has the authority and the means to maintain the cross-subsidy of services across the country, as well as to maintain an incumbent provider’s commitment to universal service. Moreover, the Minister of Industry, under the Investment Canada Act, can address head office and R&D concerns in the “public interest.”13 These alternative measures, while not a perfect substitute for foreign ownership restrictions, may in fact be superior policy instruments when addressing sovereignty concerns.
Incumbent Provider Restrictions: Tiering
Another easy modification to the current restrictions would be to simply change the rules’ scope of application. Instead of applying the current foreign ownership restrictions to all telecommunications common carriers operating in Canada, one could adopt a tiered approach. Under this approach, current foreign ownership restrictions would continue to apply to incumbent telecommunications common carriers (ILECs) but would be removed from all other industry participants. A variant would be to remove the indirect ownership regulations and lower the direct ownership requirement from 80% to 51% for the Canadian companies that remain subject to the restrictions; this is indeed the preferred option of some OECD countries.
Since the history of telecommunications in Canada involves many provincially and territorially based monopolies, complemented by many very small municipal telecommunications companies (which also meet the definition of an incumbent), the companies that would be subject to the restrictions might be further refined to include only “large” incumbent telecommunications common carriers. Under tiering, which could only be a transitional option, legislators would be challenged to determine when a large incumbent ceased to be dominant, after which the restrictions could be safely removed. What competitive or market share “milestone” would have to be reached for the removal of the foreign ownership restrictions imposed on large incumbents? Or would a behavioural condition, such as some level of customer defection to rivals in response to a price change by an incumbent, be more appropriate? A periodic legislative review of this issue would be advisable.
The primary advantage of this option is that it would alleviate new entrant firms’ concerns regarding access to capital and the cost of capital, while retaining sovereignty safeguards that are a greater concern when it comes to large incumbents. Second, once a proper definition of a large incumbent telecommunications common carrier was adopted, little or no administration would be required.
There are three main disadvantages to this approach. First, tiering creates an “unlevelled playing field.” Since the ultimate objective of the regulatory forbearance approach to deregulation is a competitive marketplace, it may be unwise to tilt the underlying market conditions in favour of any industry participant, or class of participants. There is no evidence to suggest that artificial rules designed to bolster one class of competitors (or handicap another class) can create anything but artificial competition. A truly competitive marketplace offers the promise of the best combination of product selection, service quality and prices. An artificially constructed competitive marketplace offers something less.
Second, any definition of a large incumbent would likely include, among others, Bell Canada and TELUS Corporation. Bell Canada is dominant in Central Canada, but it is not the dominant player in Western Canada. By the same token, TELUS Corporation is a large incumbent in Western Canada, but it is a new market entrant in Central Canada. What would be the point of shackling both these potential rivals from competing aggressively with each other? Although neither Bell Canada Enterprises nor TELUS Corporation is currently constrained by the current foreign ownership restrictions, this might not continue to be the case. Moreover, this type of competition is just as important as competition with new entrants and it may become even more so in the near future.
Finally, it is conceivable that a new entrant or CLEC could be taken over by a large foreign telecommunications company and could gain access to capital at lower cost than its large incumbent competitor. Such a takeover would defeat any attempt to level access to capital among industry participants and could result in a greater imbalance in the opposite direction.
Licensing with “Public Interest” Conditions: The Discretionary Approach
Licensing telecommunications common carriers would allow the CRTC or the Minister of Industry to permit foreign control of providers without sacrificing Canadian control over their operations (i.e., sovereignty). Licence conditions could include R&D targets or the development or maintenance of services to rural and remote regions. Failure to abide by the conditions of a licence could result in any number of sanctions, including, as a last resort, the revocation of the licence.
It is important to bear in mind that a foreign takeover of a Canadian telecommunications provider is a concern only when the target of the takeover is an incumbent. The concern is that if a U.S. company, for example, were to take over a Canadian incumbent, then the U.S. company could move its head office and R&D facilities to its home base, taking high-paying jobs with it.
While licensing would address sovereignty concerns, it would likely discourage the free flow of capital. Licensing places a great deal of discretion in the hands of the licensing authority, which introduces a degree of uncertainty in the investment climate stemming from concerns about possible political interference. Uncertainty is something investors prefer to avoid and, in a global capital market, investment capital would tend to flow to jurisdictions where the investment climate is more predictable. Licensing also involves a degree of continuing government oversight and involvement, and runs the risk of distorting markets — a phenomenon that frequently occurs when government regulators impose controls on the operation of markets and the flow of capital investment. Additionally, in terms of administrative costs, licensing is the most expensive option of the five approaches considered by the Committee.
The problem of uncertainty in the investment climate could be improved (although not completely solved) by clearly setting out, in regulations or guidelines, the factors governing licensing decisions. A transparent decision-making procedure would be less prone to becoming “politicized,” and would permit potential foreign investors to better assess the risks and costs of investing and operating in Canada.
Three basic models of licensing could apply to the telecommunications sector:
1. All telecommunications common carriers would be required to have a licence to operate.
2. All telecommunications common carriers would be required to have a licence, but different classes of licences would apply to different types of industry participants.
3. Only incumbents (ILECs) would be required to have a licence.
With the removal of the foreign ownership restrictions, the cost of capital could be expected to decline across the industry. However, if the licensing system that replaced these restrictions were not transparent and not predictable, licensing would once again raise the cost of capital to those subject to it. The net effect on the cost of capital thus cannot be ascertained.
In models 2 and 3, non-incumbents are favoured over their incumbent rivals. This favouritism could be expected to translate into a more balanced cost of capital structure across the industry. In effect, the free cash flow advantage enjoyed by incumbents, which translates into a cost of capital advantage over non-incumbents, would be attenuated by the burdens inherent in the conditions of licence(s) in models 2 and 3.14
In the absence of other business considerations, new market entrants would be better able to access capital (both equity and loan capital), invest more, and more quickly establish a viable market presence. Over time, such investments will erode the ILEC’s dominance, at which point the restrictions could be removed for all operators. As noted above, in the discussion of tiering, the challenge for legislators would be to determine at what point an incumbent ceases to be dominant; what competitive or market share “milestone” is appropriate? Or would a behavioural condition, such as some level of customer defection to rivals in response to a price change by an incumbent, be more appropriate? A periodic legislative review of this issue would be advisable.
No Foreign Ownership Restrictions: The Free Entry Approach
The free entry approach would place no restrictions on foreign ownership. Foreign takeovers would, however, remain subject to review by the Minister of Industry under the Investment Canada Act. There are several advantages to this approach. First, it would tend to make Canada more attractive to international capital. Second, it would permit capital markets themselves to determine the most efficient allocation of resources. Moreover, some witnesses suggested that free entry might, over time, encourage the private sector to bring new services to remote and rural communities, since, of all five options considered by the Committee, free entry results in the lowest capital cost structure across the industry. Other advantages of this approach are that it is simple and avoids administrative costs (which eventually get factored into existing price or tariff structures or tax burdens).
It has been argued, on the other hand, that this approach might pose an unacceptable risk to Canadian sovereignty, since it could allow foreign entities to control dominant telecommunications providers. Moreover, it would not permit the government to have a strong role in mandating the development of new services to rural and remote communities. However, these concerns could be addressed through CRTC regulation and/or initiatives such as Industry Canada’s Broadband for Rural and Northern Development Pilot Program.15
Some of these concerns about foreign takeovers of ILECs under a free entry approach could be addressed in large measure by the provisions of the Investment Canada Act, which is administered by Industry Canada.16 The Act prescribes thresholds which, if passed, make the acquisition17 of a Canadian business subject to a “net benefit” review by the Minister. For WTO investors, the threshold for direct acquisitions in 2003 is set at $223 million. An indirect acquisition by or from a WTO investor is not reviewable. The threshold for non-WTO investors is $5 million for direct acquisitions and $50 million for an indirect acquisition; however, the $5-million threshold also applies to indirect acquisition if the asset value of the Canadian business being acquired exceeds 50% of the asset value of the global transaction.
The Act provides for the review of investments in Canada by non-Canadians in order to ensure a “net benefit” to Canada. The “net benefit” is determined according to the following factors:
| · | | the effect on the level of economic activity in Canada, including the effect on employment, on resource processing, on the utilization of parts and services produced in Canada and on exports from Canada; |
| · | | the degree and significance of participation by Canadians in the Canadian business or new Canadian business and in any industry or industries in Canada; |
| · | | the effect of the investment on productivity, industrial efficiency, technological development, product innovation and product variety in Canada; |
| · | | the effect of the investment on competition within any industry in Canada; |
| · | | the compatibility of the investment with national industrial, economic and cultural policies; and |
| · | | the contribution of the investment to Canada’s ability to compete in world markets. |
Objectives and Instruments: Striking a Balance
The Committee has carefully considered the advantages and disadvantages of the policy options presented during the hearings. We recognize that the best policy must strike a balance between two primary objectives: removing or reducing impediments to foreign investment in Canadian telecommunications in order to stimulate competition and innovation within the sector while, at the same time, maintaining Canadian sovereignty and security.
The Committee is of the view that removing or reducing impediments to foreign investment can best be accomplished by removing entirely the current foreign ownership restrictions on telecommunications common carriers. We are aware of the concerns expressed by many Canadians about the possibility of a foreign takeover of an incumbent Canadian carrier. These concerns are related to the potential for the Canadian carrier’s head office, R&D facilities and associated jobs to be moved to the foreign owner’s home country subsequent to the takeover. However, the Committee shares the views of some industry experts who have assessed this potential and determined it to be very limited. In fact, these experts estimate that, because of its modern telecommunications infrastructure, Canada is very likely to attract more jobs and R&D work in the telecommunications services sector than it will lose. Furthermore, we are confident, however, that the Investment Canada Act provides the government with the tools it needs to ensure that substantial foreign investment will be carried out in a way that is consistent with the public interest. Finally, the CRTC has the authority and means to ensure that telecommunications services are provided at affordable prices to rural and remote regions of the country. Accordingly, the Committee recommends:
2. That the Government of Canada prepare all necessary legislative changes to entirely remove the existing minimum Canadian ownership requirements, including the requirement of Canadian control, applicable to telecommunications common carriers.
|
|
[W]e need to keep in mind the appropriate role of two quite distinct sets of policy instruments. Foreign ownership on the one side and … regulation [on the other side]. If restrictions on foreign ownership are relaxed or eliminated, this does not mean that associated policy goals cannot be better achieved by regulation without depriving us of the benefits of an infusion of foreign capital, outside new ideas, new sources of technology and management efficiency. [Hudson Janisch, University of Toronto, 16:15:55]
We believe that the complete liberalization of the foreign ownership regime in Canada is inevitable and we believe that Canada cannot act like, you know, the mythological King Canute trying to roll back the wave here. This doesn’t work. … We believe that these changes are also highly complex because of changes in technology, and they’re given. Like King Canute, we can’t roll those back either. [Michael Sabia, Bell Canada Enterprises, 20:9:30]
Canadians don’t want further foreign ownership. There’s a Decima poll out that suggests that 72% of Canadians are opposed to the kinds of changes that are potentially being contemplated and advocated by others. [Brian Payne, Energy and Paperworkers Union of Canada, 21:15:35]
Canada could increase foreign ownership rules at the holding company level, from the current 33% to 49%, for both telecom companies and cable distributors. The 20% threshold that exists on the books today would remain unchanged at the operating company level … and none of that would require any legislative changes. [Michael Sabia, Bell Canada Enterprises, 20:9:25]
Say what you will about investment restrictions, they at least provide certain knowledge of the degree of foreign investment penetration permitted. [Gerald Shannon, International Trade Consultant, 24:16:10]
[W]e can already stack the per cents and get 46.7%, I doubt that 49% would make any appreciable difference. [Robert Yates, Lemay-Yates Associates Inc., 26:10:20]
[W]e … recommend immediate removal of these restrictions for new entrants even if it is deemed appropriate that the restrictions stay in place for incumbent players for a period of time or upon the achievement of certain competitive milestones. [André Tremblay, Microcell Telecommunications Inc., 13:16:05]
[A] tiering approach will not, it cannot … deprive incumbents of the benefits of foreign capital and business know-how. [Richard Schultz, McGill University, 21:16:10]
[W]e believe that … the foreign investment restrictions should be fully liberalized symmetrically, meaning that no company should be placed at a competitive disadvantage by liberalizing the rules for some companies but not others competing in those markets. [Michael Murphy, The Canadian Chamber of Commerce, 17:15:50]
It has been suggested that it might be appropriate to adopt an asymmetrical tiered ownership regime … To deprive incumbents … of the benefits of foreign capital, technology and business know-how in order to give new entrants who would have access to foreign capital technology and business know-how would simply lead to a less dynamic market overall in which the public at large would lose out in order to satisfy the private interests of new entrants. [Hudson Janisch, University of Toronto, 16:16:00]
Tiering … is arbitrary and it’s discriminatory. … Today we [Bell Canada] operate in western Canada. Our company in western Canada is a new entrant. Today, TELUS, based in western Canada, operates in our core market. In our core market they’re a new entrant. Well, how do they get placed? How do we resolve that from a tiering point of view? [Michael Sabia, Bell Canada Enterprises, 20:9:20]
We find that the fundamental flaw … if you allow a special category of regulation for a new entrant, then a foreign company could buy that new entrant and all of a sudden you’ve got a foreign company with access to large pools of capital; that new entrant which may have been small, which may have been fledgling, develops into a competitor under a privileged set of rules ... [Francis Fox, Rogers AT&T Wireless Inc., 13:16:20]
Canada could remove its foreign investment restrictions while implementing a licensing system in the context of a policy stating that the transfer of licences of major companies would require government approval. Proposed mergers could be denied or approved, subject to conditions reflecting the public interest such as location of head office, levels of R and D, etc. [Peter Harder, Industry Canada,
12:9:40]
Licensing, frankly licensing is about uncertainty. By its nature, it creates discretion. It adds burdens and all of that we believe rather than being a positive move in enhancing investment can become a negative move. [Michael Sabia, Bell Canada Enterprises, 20:9:20]
Regulatory oversight should remain in the hands of regulators. Review of licence transfers or of mergers and acquisitions should be done by those agencies or bodies currently in place. Case by case ministerial approval or the creation of new regulatory entities would generate uncertainty for the international investment community and would deter, rather than spur, both foreign investment in Canadian companies and innovation. [Michael Murphy, The Canadian Chamber of Commerce, 17:15:50]
Now it has been suggested … that if foreign ownership restrictions were relaxed or eliminated there should be a residual government discretion to block or modify any investment deemed not to be in the public interest. This type of unstructured public interest test is dangerously vague and non-transparent and will lead to excessive delays and under the table bargaining. [Hudson Janisch, University of Toronto,
16:15:55]
[A]n integral part of full liberalization of foreign investment restrictions would … maintain a transparent and predictable regulatory framework. This means that no new licensing measures should be introduced that would counteract the benefits that may be accrued through lessening of foreign investment restrictions … [Michael Murphy, The Canadian Chamber of Commerce,
17:15:50]
We believe that the rules should be changed for all carriers large and small. We recommend a complete elimination of the rules ... [Francis Fox, Rogers AT&T Wireless Inc., 13:16:20]
We think that to have a sustainable, competitive model you have to have access to a pool of funds at the best possible price. We think that lifting the foreign ownership restrictions means that we’ll have larger access of funds and would probably decrease, by at least 100 basis points, the cost of debt funding for us. [Francis Fox, Rogers AT&T Wireless Inc., 13:16:55]
[M]any of the goals of restrictions on foreign investment can be more effectively achieved if you look to regulation rather than to restrictions on foreign investment. [Hudson Janisch, University of Toronto, 16:16:55]
[T]he issue of research and development is not really the issue of telecommunications investment. It’s true that telecommunications carriers do some adaptation of technology, but the real technology know-how is in the equipment companies and they are not subject to the regulations under the Telecommunications Act. [Hudson Janisch, University of Toronto, 16:17:20]
I’d like to see this committee recommend the removal of the foreign review restrictions … it’s one step on what is apparently a tough and long journey. But it would be a strategic step. [Vic Allen, Upper Canada Networks, 14:16:45]
[I]t seems to me that reliance on such a blunt instrument is a rather sad comment on the effectiveness of the range of alternative government instruments such as regulation, competition policy, taxation, and departmental scrutiny. [Richard Schultz, McGill University, 21:16:00]
Replacing foreign investment restrictions with new regulations would not increase the attractiveness of Canada as a place to invest in telecommunications and, in fact, could prove to have the opposite effect. [Michael Murphy, The Canadian Chamber of Commerce, 17:15:50]
[A]ny framework that’s developed to change the foreign ownership regime must be predictable with discretion kept to a minimum. … Any change in the foreign ownership regime that expands uncertainty, enhances discretion, will again chill investment. [Michael Sabia, Bell Canada Enterprises, 20:9:20]
[F]oreign ownership limits must be symmetrical for all Canadian telecom companies. [James Peters, TELUS Corporation, 16:15:40]
The foreign ownership regime should be technologically and competitively neutral and the rules of the game should not be changed in midstream by economically disadvantageous some competitors by adhering to obsolete labels such as traditional carrier. [James Peters, TELUS Corporation, 16:15:45]
|