Korea-Australia Free Trade Agreement: strengthening cross-border investment

In brief

The landmark Korea-Australia Free Trade Agreement is expected to further strengthen the established complementary economic relationship between the two countries, and to provide new opportunities for cross-border investment and trade. Partner David Wenger and Senior Associate John Koshy from Allens and Partner Stephen Le Vesconte and Managing Associate Joo Hee Lee from Linklaters report on the Agreement and its implications for both Australian and Korean industry sectors.

Background

The Republic of Korea and Australia signed the KAFTA on 8 April 2014 in Seoul, Korea, following five years of negotiations and diplomacy. The KAFTA will take effect once each country has ratified the agreement domestically, which is expected to occur by the end of 2014.

Korea and Australia already enjoy a strong trading relationship, which has been growing significantly since the mid-1990s. For 2012-13, the relationship generated two-way trade of approximately A$30.5 billion.¹ Korea's key exports to Australia include refined petroleum products, automobiles, heating and cooling equipment, and telecommunications equipment and parts.² Australia's key exports to Korea include natural resources (predominantly, coal, iron ore and crude petroleum), education services and beef. Korea is Australia's third-largest export market and fourth-largest overall trading partner.³

The KAFTA follows a recent trend in Korea and Australia where the national governments of each country have sought to enter into bilateral free trade agreements to strengthen their position in international trade. The KAFTA will ensure that bilateral trade between Korea and Australia will be competitive with trade from other nations, and this will help to reinforce the ties between Korea and Australia.

Removal of barriers to trade

A critical element of the KAFTA is the reduction or removal of tariffs on trade in goods between Korea and Australia.⁴ Once the KAFTA is effective, 84 per cent of Australia's goods exported to Korea will be tariff-free, and, by full implementation of the KAFTA, that percentage is expected to rise to 99.8 per cent.⁵ Similarly, upon effectiveness of the KAFTA, 72.4 per cent of Korea's exports will enter Australia tariff-free and this will rise to 94.6 per cent over a period of 10 years.⁶

Additionally, each party agrees that it will not adopt any new tariffs on goods originating from that country,⁷ and this will provide comfort for industries that already enjoy tariff-free status. For example, coal exports from Australia to Korea are not presently subject to a tariff, and the KAFTA ensures that this position will remain.

The KAFTA also recognises that non-tariff measures can similarly impede trade and investment, and provides that the parties should not create any unnecessary obstacles to bilateral trade. The KAFTA provides that a joint committee may review alleged offending non-tariff measures, and that committee may make a recommendation that the party imposing the non-tariff measure should adopt a different measure that better facilitates bilateral trade.⁸

Implications for Australian industry sectors

Minerals and energy – Australian exports to Korea

During the consultation process on the KAFTA, the Australian Government received submissions from various Australian businesses involved in the minerals and energy sector. The importance of the Korean export market for the sector was a recurring theme expressed in those submissions. Australian businesses noted that, although many minerals and energy products enjoy tariff-free status, there remain a small number of tariffs that are an impediment to free trade.

The KAFTA addresses this concern by eliminating all remaining tariffs on Australian minerals and energy exports to Korea upon the date on which the KAFTA takes effect, or, at the latest, within a period of 10 years from the effective date. This commitment will be welcomed by Australian mining and energy companies that are currently exporting to Korea, or that may be considering exporting there. Similarly, Korean customers for minerals and energy products (eg steel manufacturers or power producers) now have further incentive to consider trade or investment in Australian mining and energy projects.

Minerals and energy – cooperation between Australia and Korea

Korean President Park Geun-hye recently commented on the significant potential for energy and resources development cooperation between Korea and Australia, by leveraging Korea's technological expertise with Australia's substantial natural resources.⁹ A good example of existing cooperation between Australian and Korean businesses in Australia's minerals and energy sector is BHP Billiton's Mining Area C project in the Pilbara region of Western Australia. This project involves a joint venture between POSCO and BHP Billiton, where POSCO contributes technological expertise, in addition to purchasing iron ore from the project. The KAFTA promotes a range of cooperation and collaboration activities between Australia and Korea that may lead to other investments of this nature, and these include:

• joint activities in areas such as research and development in the exploration, extraction, processing, transportation and use of energy and mineral resources, including energy efficiency measures and measures relating to climate change;¹⁰
• exchange of academic and scientific information relating to the minerals and energy sector;¹¹
• discuss ways to encourage investment in the minerals and energy sector, including emerging technologies and renewable energy;¹² and
• exchange of relevant information on minerals and energy,¹³ including:
  • geological data;
  • information on investment related to the minerals and energy sector;
  • information on investment opportunities in the minerals and energy sector, including related current and planned infrastructure;
  • information on respective laws, regulations and policies relating to the minerals and energy sector; and
  • information on current and future trends in the coal, oil, gas, electricity and renewable energy industries.

Agriculture

Australia's agricultural sector appears likely to reap significant benefits from the KAFTA, as a range of tariffs will be reduced or eliminated. The Australian Department of Foreign Affairs and Trade has highlighted that 98 per cent of Australia's agricultural exports to Korea will face no tariff upon full implementation of the KAFTA. These changes will be particularly helpful in assisting Australian producers to compete in the Korean market against producers from the United States who already enjoy reduced tariffs under the Korea-United States Free Trade Agreement.

The table below provides a snapshot of the tariff changes for some of Australia's key agricultural commodities:

Wine

Although the KAFTA has significant benefits for Australia's agricultural sector, there remain areas for further development. For example, tariffs over the export of Australian dairy products to Korea are to be phased out over a period of 13 to 25 years. Media reports from Australia suggest that the Australian dairy industry would prefer for these tariff reductions to be accelerated to strengthen its trade position in the Korean dairy market.

Financial and other professional services

The Australian financial services sector is expected to benefit from the KAFTA.¹⁴ Essentially, Australian financial services firms will be able to supply certain financial services in Korea without the need to first establish a full commercial presence in Korea. These services include the provision and transfer of financial information, investment advice and portfolio management services.¹⁵

Australian accounting and legal service providers will also be provided with improved access to the Korean market, being permitted to establish representative offices in Korea for the provision of international services. Within a period of five years, Australian accountants will have the right to work and invest in Korean tax or accounting corporations, while Australian law firms will be permitted to enter into joint ventures with Korean law firms.¹⁶

Implications for Korean industry sectors

Korean exports to Australia

Korea's key exports to Australia include motor vehicles and components, household appliances, industrial goods, petrochemical products and heavy construction equipment. Tariffs (imposed mostly at 5 per cent) on these commodities will be eliminated with an immediate effect upon the date on which the KAFTA takes effect, or, at the latest, within a period of 10 years from the effective date.¹⁷

Motor vehicles and components

Motor vehicles represent Korea's most valuable export to Australia and represented 20.5 per cent of Korea's total exports to Australia in 2013.¹⁸ The KAFTA will enhance trade in the automobile sector by removing the 5 per cent tariff that currently applies to Korean vehicles and components in Australia either immediately or over the three years following the entry into force of the KAFTA. The automobile products that will enjoy immediate tariff elimination include small-sized and medium-sized gasoline vehicles and tyres. This will make Korean exports more competitive, particularly against exports of motor vehicles from Thailand, which already enjoy a zero tariff rating under the Australia-Thailand Free Trade Agreement. It has been reported that the average price of a Korean car in Australia is expected to fall by A$750 as a result of the KAFTA.¹⁹

Consumer goods

Sales of electronic goods are an important part of Korea's exports to Australia. In 2012, Korea's export of household appliances to Australia amounted to US$330 million, with a tariff imposed at 5 per cent. Once the KAFTA takes effect, tariffs on most Korean household appliances (including TVs, refrigerators and washing machines) will be eliminated, with an immediate effect in Australia.²⁰

Industrial goods

Tariffs on most heavy construction equipment, steel and petrochemical products will also be removed immediately, with tariffs on certain steel and petrochemical products to be abolished progressively during the implementation period. It is worth noting that Korea's export of refined oil products (such as gasoline and diesel) to Australia, which constituted 32 per cent of Korea's total exports to Australia in 2012, was tariff-free even before the execution of the KAFTA. Korea's export of electrical goods to Australia amounted to US$2.2 billion in 2012 and the Korea Trade-Investment Promotion Agency expects to see a rise in exports of Korean electrical and other industrial goods including fibre-optic cables, electrical cables, batteries, air cleaners, aluminium materials, PVC flooring, and industrial ceramics.

Agriculture – Korean imports from Australia

In contrast to the manufacturing sector, the local agricultural industry in Korea is expected to suffer. Similar to its approach taken under the free trade agreement with the United States or the European Union, Korea will eliminate its tariffs only on 61.5 per cent of the agricultural products within 10 years, whereas Australia will abolish its tariffs on all of its agricultural products with an immediate effect following the entry into force of the KAFTA. Korean tariffs on the remaining 38.5 per cent of agricultural products (including beef) will be removed over 10 years or more (in contrast to the 12.3 per cent tariff applicable under the Korea-United States Free Trade Agreement and the 14.7 per cent tariff under the Korea-EU Free Trade Agreement).²¹ As Australian beef dominates Korea's import beef market with a 56.9 per cent share, many in the industry have raised concerns that local stock farmers will suffer significantly. The Korean Government plans to reduce the negative impacts of the KAFTA on its domestic agricultural market by creating an agricultural safeguard mechanism and imposing seasonal tariffs on certain agricultural products.

Support for cross-border investment and trade between Korea and Australia

The KAFTA contains a number of provisions to promote bilateral investment, which are generally observed in recent free trade agreements.²² The following provisions will be of most interest to investors:

• National treatment: Each party will provide investors of the other party with treatment that is no less favourable than that which it provides, in equivalent circumstances, to its own investors with respect to the development of investments.
• Most favoured nation status: Each party will provide investors of the other party with treatment that is no less favourable than that which it provides, in equivalent circumstances, to investors from a third-party nation.
• Guarantee against expropriation: Each party undertakes that it will not expropriate or nationalise an investment either directly or indirectly through measures equivalent to expropriation or nationalisation, except:
  • for a public purpose;
  • in a non-discriminatory manner;
  • on payment of prompt, adequate, and effective compensation; and
  • in accordance with the principle of due process of law.
• Free transfer: Each party must permit all transfers relating to an investment to be made freely and without delay into and out of its territory. For the purpose of this provision, a transfer may include: contribution to capital; profits; dividends; capital gains; proceeds of sale; interest; royalty payments; payments made under a contract; and payments arising from a dispute.

These provisions provide assurance and comfort to Korean and Australian investors, which should result in increased cross-border investment between the two countries.

Another key change that arises from the most favoured nation provision of the KAFTA is that the threshold for Korean investment in Australia that requires approval from Australia's Foreign Investment Review Board will increase from A$248 million to A$1.078 billion. However, the higher threshold does not apply to investment in certain sensitive sectors in Australia, including agriculture, media and telecommunications,²³ and such investment remains subject to the approval requirement at the lower threshold of A$248 million.

In Korea, Australian investors will be treated on an equal basis with US investors.

An investor's right to enforce commitments contained in the KAFTA

Australian investors in Korea, or Korean investors in Australia, may be able to pursue an action against the host country to enforce the host country's obligations under the KAFTA. Chapter 11 sets out the procedure for the resolution of such investor-state disputes. Accordingly, Korean and Australian investors who invest in Australia or Korea respectively may wish to consider structuring their investment to incorporate the Chapter 11 dispute resolution process. For more detailed analysis of Chapter 11, please see Allens Focus: Investor-State dispute settlement under the Korea-Australia Free Trade Agreement .

Conclusion

The KAFTA enhances the connection between Korea and Australia and builds upon a well-established complementary economic relationship. A key feature of the KAFTA is the removal of a number of barriers to trade across a wide range of sectors. The KAFTA is expected to lead to increased trade and investment between Korea and Australia by ensuring that such trade and investment can be conducted in an efficient manner that is internationally competitive.

Important notice

This publication is non-exhaustive, commentary only. This publication is not intended to be, and must not be, relied upon as legal advice. If you have any questions or wish to discuss this publication further, please contact any of the people below.