Mongolia’s reputation as a suitable destination for foreign investment suffered in 2012, as mining companies along with those in other sectors came under a new and restrictive legal regime: the Strategic Entities Foreign Investment Law of Mongolia, which passed in May. This legislation, combined with a high-profile merger, the government’s cancellation of some double-taxation agreements in order to win more revenue from existing deals, and multiple attempts at reopening the investment agreement that governs the country’s flagship mine, Oyu Tolgoi, have resulted in a recalibration of what it means for multinationals to invest in Mongolia.
SLOWING ACTIVITY: The opportunities have always been clear – some of the world’s last great untapped mineral deposits are to be found here. Mongolia’s authorities remain focused on getting the best deal for their country, and as such are aware of the leverage these massive deposits provide.
As of early 2013, however, new foreign investment was on hold in the mining sector, and had been for most of the previous year. The pace of mergers and acquisitions has also slowed. One in particular, an aborted attempt by Turquoise Hill Resources to sell a producing coal mine to Aluminium Corporation of China (Chalco) is seen by many as a potential catalyst for the new law as well as a cautionary tale for other potential investors. Turquoise Hill is owned by Rio Tinto, and also developed Oyu Tolgoi.
CATALYST: The mine in question is at Ovoot Tolgoi in the southern Gobi Desert, where South Gobi Resources had become one of the country’s largest exporters of coking coal. The company’s shares trade on stock exchanges in Hong Kong and Canada. Chalco agreed in April 2012 to pay $8.28 per share, or about $926m, for a 58% stake in South Gobi; a 28% premium to the market value of stock at the time.
Mongolia’s government at the time opposed the deal, which was not a surprise. One of the country’s top priorities is to avoid an overreliance on China, and this merger would have given made a single Chinese state-owned company both the owner and the buyer of the mine’s resource.
Mongolia is sandwiched between China and Russia, and foreign policy and trade policy for the country is primarily the art of balancing interests between these two giants. Often cited is the country’s “third neighbour” policy – the development of political, commercial and cultural ties with other countries in order to widen the mix of international partners Mongolia has. Third neighbours include Japan, Korea, the US, Canada, Germany, Australia and France.
REDUCING RELIANCE: In the specific context of mining, Mongolia’s concern about developing an overreliance on China relates in large part to the issue of prices paid for its mineral exports. It is widely expected that China will be the main customer for Mongolia’s coal, copper, and other ores and metals.
However, Mongolia wants to court other customers to reduce its reliance on its southern neighbour and give it and its miners more bargaining power when setting purchase prices. A key objective, for example, is to build a rail link to a deep-sea port, which would add new potential export markets.
Because of these issues, the Mongolian authorities opposed Turquoise’s South Gobi Resources sale to Chalco. Officials at the mining regulator, the Mineral Resources Authority of Mongolia (MRAM), fielded a request from government to revoke or suspend South Gobi’s licence, but the regulator told OBG that the licences remain active. Production, which was already lower in the second quarter of 2012 because of reduced Chinese demand for coking coal, stopped and had not resumed as of November 2012.
Chalco walked away from the deal in September.
FOREIGN INVESTMENT LAW: Though that ended Mongolia’s short-term concern about controlling its own resources, the government felt the need to impose a long-term solution to secure its influence over foreign investment. The new law on foreign investment is just 64 paragraphs long and has yet to be tested. The government body that was to implement it, the Foreign Investment and Foreign Trade Agency, was also changed shortly afterward the law’s passage. The agency was moved into the Ministry of Economic Development and renamed the Foreign Investment Regulation and Registration Department. This change required an amendment to the law, which was subsequently passed in August.
Since then, investors have declined to invest in Mongolia in part because of a lack of clarity on some issues in the law. Terms such as “investor’’, “resource’’ and “operational’’, among others, lack legal definitions specific enough to meet the standards foreign investors are comfortable with.
THE SCOPE OF THE NEW LAW: All expectations are for the law to target the mining sector, but it could also perhaps affect any businesses dealing in other natural resources, or even be used in a wider interpretation, according to research from the Ulaanbaatar-based law firm MahoneyLiotta.
Under the new law, projects valued beyond MNT100bn ($70m) require parliamentary approval if they are in the three strategic sectors: mining, financial services or media, and cannot be more than 49% owned by a foreign entity. Drafts of the law also included real estate as a strategic sector, although it was dropped before the vote. Foreign state-owned entities must get approval for any acquisition of any size in any sector in Mongolia at the cabinet level.
The law also grants the government the right to influence the operations of foreign companies whose investments it approves in accordance with the law, down to day-to-day operational issues. Sales of stakeholdings in strategic sectors larger than 5% of an asset or company require approval, as do increases in ownership above several further thresholds.
QUESTIONS & CONCERNS: One of the first questions raised once the law was passed was whether it would apply retroactively to current projects, as the law itself does not address that question. The government has said it will not, but that has not quelled all concerns. Another issue investors want further details on is parliament’s capacity to review proposed deals and further corporate activities that do not fall above the threshold.
The concern is summed up by a July 2012 report on Mongolia’s investment climate published by the US embassy in Ulaanbaatar: “Specifically, they wonder how the government will deal with the innumerable stock purchases and financial transactions, management decisions and the other aspects affecting investments.” The report continues to ask “where they, the cabinet of ministers, and parliament will find the time and resources to review the scores, if not hundreds, of investment requests envisioned.’’ Another issue is that the law allows up to 125 days for such approvals to be made. That could mean too much uncertainty for publicly traded investors, according a presentation given by James Liotta, a partner at MahoneyLiotta, at the Mongolia Investment Summit at the end of October 2012 in Hong Kong. “Trading occurs on both local and foreign exchanges on a daily basis where the value of shares increase or decrease at any given time,’’ he said. “Given the complexity of stock markets, it will not be possible for a listed company to comply with the notice and approvals of the SEFIL [Strategic Entities Foreign Investment Law].’’ NEW GOVERNMENT: Amidst the uncertainty, parliamentary elections in June 2012 brought in a new government, which is pledging to soften the law to an extent. As of October 2012, with the new government’s parliamentary session under way, the stated intent was to revisit the law to make it more favourable for investors, but by early 2013 this had yet to happen. According to O. Chuluunbat, the deputy minister of economic development, the most likely change would be a boosting of the monetary threshold that triggers parliamentary approval.
The new government’s approach, according to Chuluunbat, is not designed to fully avoid Chinese investment, or to scare off investors. The priority is to ensure that Mongolian resources are not owned by and purchased by the same foreign entity, he said. In the case of Ovoot Tolgoi’s coal, making Chalco the owner as well as the buyer would leave Mongolia with less revenue from the project that it is entitled to. “We wanted to provide tighter regulation, not to block investment,’’ Chuluunbat said. “If Chalco owned South Gobi without any approval from the Mongolian government that’s a catastrophe for us. We would lose our ability to set the price of our own coal.’’ If the standard for Chinese involvement is to be based on being either a seller or a buyer but not both, that may represent perhaps a better investment climate for Chinese interests and their potential business partners than in the past. In 2010 Canada’s Khan Resources attempted to sell a controlling stake in a uranium mine at Dornod to a Chinese state company and later had its licences revoked as a result.
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