Resource nationalism in Mongolia’s draft Minerals Law and the lack of action on the Strategic Entities Foreign Investment Law (SEFIL) are threatening the country’s investment environment.

Mongolia used to be an investor darling; a democracy located between China and Russia with enormous natural resources potential. But recent political developments and their subsequent legal implications have severely impacted sentiments.

The shift occurred in May 2012 following China Aluminum Corporation’s (Chalco) bid to buy SouthGobi. Fearing China’s influence on Mongolian resources, the Parliament passed the SEFIL.

Tensions were exacerbated when Mongolia banned SouthGobi president Justin Kapla and counsel Sarah Armstrong from leaving the country in November. In January, Chalco threatened legal action against state-owned Erdenes Tavan Tolgoi (ETT) for its failure to abide by its contract.

In addition, sources say that the much-hyped ETT triple-listing on the Mongolia Stock Exchange, London Stock Exchange, and Hong Kong Stock Exchange is on hold until at least 2014. Even at that point, its listing may not be on the same scale.

Laws aggressively targeting foreign investors means many are now checking their bilateral investment treaties rather than actually making investments.

Darin Hoffman of Ulaanbaatar-based MahoneyLiotta told IFLR that many emerging markets go through a “two steps forward and one step back” process on the road to joining the global economy.

“Bumps in the road are understood as part of the economy’s maturation process and investors will take this in stride so long as it isn’t one step forward and two steps back (or worse),” he added.

Foreign investment uncertainty

Mongolia’s foreign investment law was adopted and became effective on 17 May last year, following a quick but opaque legislative process.

But the Foreign Investment Regulations and Registration Department (Firrd) has not yet promulgated the SEFIL regulations as required by law.

This has paralysed foreign investment. A way to get around this to draft a share purchase or subscription agreements that transfer less than one-third of a business entity of strategic importance (Besi) with no other control or direction prongs triggered. This means no approval is required, other than post-closing notification.

“We can move money to escrow if necessary but we’re uncertain when or if such transfers may be completed,” said Hoffman. “We have had many clients reach the long stop date (breakaway point) and had the transaction fall apart and the money returned to the potential acquirer because the registration could not occur.”

Moreover, if someone were to go to Firrd to obtain the requisite approval, the Department’s clerks will not approve the transaction as they have no guidelines by which to abide. The clerk at Fiird to whom the application is presented will simply hand the paperwork back to the applicant and tell them to come back after the regulations have been promulgated.

Foreign investment has therefore been at a standstill since the law was passed and adopted. Although politics – namely a June parliamentary election – can be partially blamed for the delay, it is becoming increasingly difficult to justify to the market.

Hoffman added that the SEFIL has had a devastating impact on the equity capital markets, particularly initial public offerings, but he does not think the full effect has yet trickled down to the entire economy.

Resource nationalism

A new development is even more worrying to foreign investors: Mongolia’s draft Minerals Law. Released in December 2012, investors agree that if passed in its draft form, it would have a devastating impact on inbound investment.  

The law is calamitous for foreign investors, who previously came to Mongolia for its friendly so-called Third Neighbour investment policy. A lawyer who has undertaken significant work in Mongolia told IFLR that licences will generally be issued via a tender process instead of today’s first-come-first-served system, which is a disincentive for companies to try to locate potential deposits.

Moreover, the State will be allowed to take over land or licences while only paying compensation for incurred expenditures, the lawyer said. This is not sufficient because it does not account for lost opportunity costs.

But resource nationalism is most evident in provisions that require a strategic deposit mining licence-holder to enter into a ‘deposit development agreement’ if required by the government. The agreement would allow the government to take an equity stake for no consideration.

“This is clearly expropriatory, especially since it applies to shares in mining companies – which are clearly private property – rather than deposits, which arguably belong to the state,” the Ulaanbaatar-based lawyer said.

Further, state-owned entities appear to have preemptive rights over any transfers of licence. The lawyer said this will discourage licence sales and purchases between private parties, since they would be concerned with the state stepping in at the last minute and buying the licence for itself. This means the time and expense by the parties entering into the deal would go to waste.

The draft Minerals Law also has a minimum ownership threshold for Mongolian citizens for mining licence-holders. It is a provision seemingly modeled after those seen elsewhere in resource-rich Asian countries like Indonesia.

“At least 34% of the equity in a mining licence-holder must be owned by a Mongolian citizen, and in some cases this percentage is even higher: 51% in some instances and 75% in others,” the lawyer said.

Stipulations for obtaining prospecting, exploration or processing licences in areas other than special border zones do not require minimum ownership by Mongolian citizens. Therefore this provision essentially forces foreign investors to divest shares once they reach the mining stage.

But the lawyer noted it will be impossible for Mongolian citizens to finance such a large shareholding percentage in every mining licence-holder in the country. There are only 2 million Mongolian citizens, while Mongolia has $2 trillion in untapped natural resources.

It is, however, encouraging that this law was released before passage. Hoffman said that it is a positive sign that open forums have been conducted on the draft Minerals Law, which is a marked departure from past practice. The legislative process in Mongolia is usually quite opaque and laws are generally adopted with little or no public commentary.

Hoffman added that while the President reportedly intended to have the draft Minerals Law adopted by Parliament prior to the scheduled June 2013 Presidential election, there has been some indication that the President may be willing to delay adoption to open a more detailed dialogue with the industry.

But he warned that in any case, whether adopted sooner or later, there is a strong probability that a minimum Mongolian ownership component will remain in the final law as adopted.

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