The world’s hottest destination for mining investment, Mongolia has seen its economy grow at a blistering rate, easily doubling that of its neighbour China in the last year. However, a new foreign investment law, underpinned by a surge of nationalist sentiment, as well as continuing political uncertainty could potentially derail foreign investment in the industry.
The world’s hottest destination for mining investment, Mongolia has seen its economy grow at a blistering rate, easily doubling that of its neighbour China in the last year. However, a new foreign investment law, underpinned by a surge of nationalist sentiment, as well as continuing political uncertainty could potentially derail foreign investment in the industry.Foreign investors have been keeping a nervous eye on Mongolia recently, as rapid-fire developments continue to increase investment uncertainty. First up, the recently held July elections have left more than a quarter of the government in the hands of politicians who advocate local control over the nation’s mines. Then, a tumultuous August that saw ex-Mongolian president Nambaryn Enkhbayar, jailed for four years for corruption. Given his position as the chairman of a political party that forms the current fragile ruling coalition, his sentence could easily result in developmental delays for several massive mining projects. With this most recent episode, concern continues to grow amongst investors that they may not see the returns they expect if the current trend of resource nationalism is to continue.
State of play
Reports indicate that Mongolia has over 6,000 deposits of 80 different minerals as well as possessing one of the biggest copper mines on the planet, the Oyu Tolgoi project, which is predicted to produce over 81 billion pounds of copper and 46 million ounces of gold. These resources have unsurprisingly fuelled a gold rush of investors to the landlocked country over the last year, resulting in the fastest growing economy in the world.
As expected, over the last year lawyers have seen an unrelenting stream of M&A work as well as project development matters in the mining space. Alongside, however, there are several other trends such as increased interest in coal and gas, alternative energy projects, and the growth of supporting industries. “We are seeing a lot more interest from mining services companies coming into Mongolia to support the development of the resources business there,” says David Wenger, partner at Allens. “We are also starting to see encouraging signs of infrastructure development, off the back of the intended royalties of various mining projects, so there is increased interest in airports, roads, social housing, energy, power supply etc.” Hand in hand with mining development is the need for railways, as the current lack of infrastructure hampers the development of exports. “Effectively, most of the exports are going to China," says Chris Melville, partner at Hogan Lovells, “and the government has an ambitious plan to connect with the Russian rail network to Vladivostok, in order to diversify its customer base for mineral exports.”
There are also ongoing projects to raise overseas finance; “We are currently working on the IPO of Tavan Tolgoi which is one of the largest coal mine deposits but not yet fully in production,” continues Melville, “We’re also seeing a lot of interest in the potential GDR market.”The $3 billion IPO has gone through several delays, but is now scheduled for the first quarter of 2013.
John Viverito, Singapore-based partner at Gibson, Dunn & Crutcher further details, “There’s been a tremendous amount of interest from China over the resources in Mongolia, because of the proximity in terms of location and logistics. We've also seen European, Australian and North American interest as well as a lot of interest by Indian entities in various natural resources. In that sense, it’s been a global phenomenon.”
One practice area that is heating up considerably and unexpectedly is disputes. Sparked by a conflict over the South Gobi mine (see A catalyst called Chalco), lawyers are now handling international arbitration matters, a new and potentially unwelcome addition to their previously transaction-heavy workload.
A new foreign investment law
The most momentous development by far, however, has been the recently implemented foreign investment law that came into effect in May this year. Hastily pushed through the Parliament, specific guidelines have yet to be issued, yet the general tenor of the law specifically targets foreign investor’s control over the mining industry.
Key features of the law include capping foreign investment into strategic sectors of the economy, such as minerals, communications, and banking and finance. Potential investors are required to notify the government beforehand for any transactions under which they would acquire between 5 percent and 1/3 of the shares in a strategic company. Further, if the foreign investor intends to hold more than 49 percent of the shares, and the amount invested exceeds $75 million, then approval from the Parliament must be given based on a submission from the Cabinet.
Worryingly, at the moment, the law does not specify the processes for how the request for approval should be submitted, what information should be contained in that submission and in what way, and how quickly the Parliament will respond.
“This law has created a chilling effect on new investment because people aren’t exactly sure how it is going to be implemented,” reveals Viverito. “A year ago, we were watching significant amounts of money actually flow into the country for small to medium-sized mining projects, be they silver or gold, iron ore or coal, pretty much across the spectrum. But new investment has dried up for the time being.”Another facet of the law deals with investment by foreign state-owned entities. The law specifies that foreign state-owned businesses are required to obtain consent from the Cabinet, prior to making any investment into Mongolia. However, again the definition of “state ownership” is unclear, resulting in ambiguity for investors.
“The law is vaguely drafted, but one of the effects is to specifically target state-owned enterprises that aim to gain control of key strategic sectors,” says Melville. “At the moment the government is considering underlying regulations to deal with the implementation, so the devil will be in the detail when those regulations come out".
A wait-and-see approach
Given the swift passage of the law, investors are understandably jittery about what this may mean for their current and future projects. What advice should they follow?
“There isn’t a clear path for people making investments right now as we don’t know what the application procedure will be, what information will be required by the government or what people will need to do in order to submit their applications; none of those rules or regulations have yet been announced,” says Wenger, advocating that if an investor wanted to move forward immediately they would have to negotiate with the government directly. Viverito urges a wait-and-see approach for new investments, noting that the government has announced that there may be a modification of the law to make it clearer and more favourable to foreign investors.
“Some may be scared off by the law, but Mongolia is a democracy and the government is, therefore, naturally balancing the interests of the people against the interests of the foreign investor,” says Stephen Tricks, London-based consultant at Clyde & Co. “It shouldn’t scare off those that are genuinely interested in dealing with Mongolia on a long term basis. You have to understand how the country works and what its attitude to foreign investment is, and within that framework you can expect that a lot of progress will be made over the next year.”
Corruption and other roadblocks
Besides the new investment law, practitioners highlight a few other obstacles when it comes to doing business in Mongolia. Firstly, corruption: “The new investment law is relatively draconian in a number of ways, and there are concerns that it may lead to additional corruption which is a serious problem in terms of people trying to get projects through the system there,” reveals Viverito, further noting that one of the concerns the firm has seen from investors regards the transparency of the approval process.
On Transparency International’s Corruption Perceptions Index in 2011, Mongolia was ranked 120 out of 183 countries. Not all practitioners see corruption as an insurmountable problem, however, with Melville commenting that, “Mongolia is a functioning democracy and is significantly more open and investor friendly than its neighbouring jurisdictions. Also President Elbegdorj is very keen to stamp out corruption and has made this a priority of his administration.”
Overall, lawyers highlight that the process on the ground in terms of doing business is relatively complex, but par for the course for what you would find in other developing countries. They also stress the importance of tapping into local knowledge to access local networks. The Ease of Doing Business Report 2012, in fact, showed Mongolia climbing three spots from last year, now ranked at 86 out of 183, showing a distinct improvement.
The primary impediment clearly remains the new foreign investment law, which sources in the market have labeled a potential paradigm shift for investors keen to do business in Mongolia.
Law firm frenzy
A knock-on effect of the flood of foreign investments has been the development of the legal services market in Mongolia. Several international firms have announced the launch of local offices, among them Hogan Lovells, Allens, Clyde & Co, and Minter Ellison. “Historically, given it was a Soviet satellite state, the private practice market has been small, but it is now growing and the extent of cooperation between Mongolian lawyers and foreign lawyers is also developing,” says Tricks, adding that “it’s not an easy ride; one has to be prepared to build up the relationship, and to live in Mongolia or to travel there on a frequent basis. The Mongolians are much more willing to do business with people who are prepared to meet face-to-face.”
Igor Bogdanich, partner at Allens, further remarks on the distinct yet complementary roles to be played between international firms and domestic lawyers: “International firms that come in should work closely with the local firms. It’s excellent for clients to have access to a global network, but you also need a local hand. There needs to be more local firms that are exposed to the investors’ way of doing business, and the more that the two work together, the deeper the pool will become in country, and that’s a good thing for Mongolia in terms of doing business.”
Future outlook
Given former president Enkhbayar’s recent imprisonment, the South Gobi and Chalco dispute and the new investment law, the business situation in Mongolia remains uncertain. However, sources foresee stability in the future; Bogdanich says frankly, “Most countries have a foreign investment law of some description, and it’s a legitimate sovereign matter. Once the regulations have come down in detail, I’m confident that most clients, as they do in other jurisdictions, will work through it and keep investing.”
Tricks echoes those thoughts, saying confidently that “The advice is that don’t expect anything to move quickly. It’s not a country where one can expect to get rich quick. You have to take a long view and work with Mongolians on a long term basis. But there is tremendous potential here.”
A catalyst called Chalco
The market generally concurs that triggering event that led to the hasty establishment of the foreign investment law is the dispute centred on the Aluminum Corporation of China’s (Chalco) $926 million bid in April this year for coal mining group SouthGobi Resources, in which Ivanhoe Mines has a majority share. If successful, the bid would give Chalco, a Chinese state-owned entity, up to 60 percent of SouthGobi’s shares. The Mongolian government has challenged the bid under the new foreign investment law, undoubtedly due to growing political sensitivity about foreigners profiting off the country’s natural resources. That the sale would cede control of one of the nation’s most profitable coal mines to China, Mongolia’s exceedingly powerful neighbour, has also raised concerns.
At the moment, the bid has stalled and the dispute has entered into international arbitration. SouthGobi Resources can avail itself of the international arbitration process under the Singapore and Mongolia bilateral treaty, given that one of the holding companies is a Singaporean entity. SouthGobi Resources is also listed on both the Toronto and the Hong Kong stock exchanges.
Viverito, part of the team advising South Gobi Resources, firmly says, “Unless this dispute is resolved by the government, I don’t see how foreign investors will feel comfortable investing any further money into projects in Mongolia. If this multi-billion dollar problem is not resolved, we are going to see a continued de-valuation of other companies with Mongolian assets, which are listed on stock exchanges around the world. We will see those values continue to fall because people are not convinced that the owners of these assets are going to be getting a fair shake in the country and that is really a critical issue for the new government and for Mongolia.”
It remains to be seen how this dispute will play out; but many are watching closely as it may well be a bellwether to gauge how the government will react to future foreign investment.
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