Focus: Regulating foreign investment in Mongolia
12 June 2012
In brief: In response to increasing growth in foreign investment (especially in the mineral resources sector), the Mongolian Government has moved to regulate foreign investment in sectors of the economy of strategic national importance. Partners Igor Bogdanich (view CV) and David Wenger (view CV) , and Senior Associates Anthony Lepere and John Koshy, look at the newly enacted legislation, and its significance for foreign investors.
How does it affect you?
- Foreign investors are now required to obtain permission where a proposed investment in Mongolia involves the acquisition of one-third or more of the shares in an entity involved in a 'sector of strategic importance'.
- Sectors of strategic importance comprise minerals, banking and finance, and media and communication.
- For investment by foreign state-owned legal entities or entities with foreign state ownership, permission must be obtained for any investment in Mongolia.
- Permission is granted based on various factors that broadly concern Mongolia's national interest.
- If a foreign investor intends to hold more than 49 per cent of shares in a strategic entity and the amount of investment exceeds 100 billion togrogs (approximately US$75 million), then the investor must obtain the approval of the Parliament, based on a Cabinet submission.
Over the past several years, Mongolia has experienced tremendous growth in foreign investment, which has largely been directed towards its mineral resources sector. During this period, there has been no generally applicable regulatory regime under which foreign investment in Mongolia might be refused on national interest grounds.
The new Law on Regulation of Foreign Investment in Business Entities Operating in Sectors of Strategic Importance (the Law) was developed and passed quickly, having been introduced into the Mongolian Parliament (the Great Khural) as a Bill in late April 2012 and subsequently passed on 17 May 2012. There appear to be two primary reasons for the apparent urgency of the Law. First, there was Ivanhoe Mines' proposed sale of its equity interest in SouthGobi Resources Ltd to Chalco, a subsidiary of Chinese state-owned entity Chinalco, in April of this year, in a deal reportedly worth US$950 million. SouthGobi Resources Ltd owns four significant coking and thermal coal projects in Mongolia. On 16 April 2012, in response to the proposed sale, the Mineral Resources Authority of Mongolia announced that it was requesting the suspension of exploration and mining activity on certain licences owned by SouthGobi Sands LLC, a wholly-owned entity of SouthGobi Resources Ltd. Shortly thereafter, a draft version of the Law was put before the Mongolian Parliament.
The second reason may be that Mongolian elections are due to be held on 28 June 2012, which meant that the most recent parliamentary sitting when the Law was passed was the final opportunity to pass new legislation ahead of the election.
Broadly speaking, the Law classifies and regulates foreign investment into two categories: foreign investment into sectors of strategic importance, and foreign investment by foreign state-owned entities.
Foreign investment into sectors of strategic importance
Under the first category, the Law applies to entities engaged in sectors of 'strategic importance'. These sectors are minerals, banking and finance and media and communication. Foreign investors are required to give notice of (but not obtain permission for) certain transactions under which they would acquire between 5 per cent and one-third of the shares in a strategic entity.
If a foreign investor intends to hold more than 49 per cent of shares in a strategic entity and the amount of investment exceeds 100 billion togrogs (approximately US$75 million), then the investor must obtain the approval of the Parliament, based on a submission from Cabinet. The Law, however, does not prescribe the procedure for how approval is requested, who must request it, what information is required or how and when Cabinet and Parliament may respond. A process that exposes a proposed foreign investment to open Parliamentary debate would presumably be commercially unpalatable for most foreign investors. It is not yet clear as to the stage of the transaction at which the resolution should be sought. Investors may be required to seek a resolution before entering into any contract.
Foreign investment by foreign state-owned entities
Under the Law, foreign state-owned legal entities or businesses with foreign state ownership are required to procure consent from the Mongolian Government (Cabinet) to make any investment in Mongolia. There is some uncertainty as to what entities are caught by this provision, as the meaning of 'with state ownership' is not clear.
When is permission required and what are the criteria for granting permission?
Transactions requiring permission are listed in Article 6.1 of the Law. In summary, foreign investors must obtain permission to acquire more than one-third of the shares in, or obtain control of, a strategic entity. Permission is also required if a proposed transaction may:
- create a buyer or supplier monopoly in the international and Mongolian mining raw material and commodities markets; or
- affect the market and price of mineral export products; or
- have the consequence of diluting a shareholding in business entities or companies of strategic importance.
The touchstones for granting permission resemble (to some extent) the national interest guidelines applied in other countries. The regulatory authority will consider the following factors:
- whether the activity or nature of the proposed investment contradicts Mongolia's national security;
- compliance with Mongolia's legislation and established business codes;
- impacts on competition in the specific sector and the likelihood of creating a monopoly; and
- whether the proposed investment would have a negative effect on the relevant sector.
How is permission obtained?
The procedure for seeking permission is to be prescribed by the Mongolian Government.
The regulatory authority is required to submit its recommendations on acceptance of investment applications to the Mongolian Government within 45 days of receipt of the application. With the exception of applications for the acquisition of more than 49 per cent of shares in a strategic entity where such investment exceeds 100 billion togrogs, the Government must make its decision within 45 days of receiving the recommendation, and the regulatory authority must notify the applicant of the outcome within a further five days. As noted above, there is no guidance in the Law in respect of the Parliament's timeframe to review an acquisition of more than 49 per cent of shares in a strategic entity where such investment exceeds 100 billion togrogs.
The timeframes for responses are not investment friendly, particularly when compared to the timeframes that apply in other jurisdictions. In addition, there is little transparency or certainty of the review process. It is hoped that further clarity on the review process will be provided in the regulations that are to be developed to administer the Law.
Foreign investment under international treaties
Article 2.2 of the Law provides that, if an international treaty to which Mongolia is party is inconsistent with the Law, then the provisions of the international treaty shall prevail, while Article 4.3 provides that the Law shall not apply to foreign investment made within the scope of an international treaty to which Mongolia is a party.
Article 2.2 is a fairly common provision found in most Mongolian legislation. Articles 2.2 and 4.3 potentially insulate some foreign investment from the requirements of the Law. For example, Mongolia has entered into bilateral investment treaties with more than 24 other states and such treaties provide various investment protection such as the obligation to treat national investors and investors of the 'other contracting state' in the same way, without discrimination. This could mean that most of the provisions of the Law will not affect investors of other contracting states. Although this is the literal interpretation of the Law, the extent to which the Government may seek to apply the Law to foreign investment made under international treaties remains to be seen.
Article 6.3 provides that the payment to the seller made by a foreign investor when it acquires one-third or more of the shares of a strategic entity will be taxed under applicable Mongolian tax law. The application of this Article, however, is also unclear.
Scope of the Law
The Law also applies to transactions made outside Mongolia and appears to cast a very wide net.
Other features of the Law
- The definition of 'making foreign investment' in Article 3.1.7 is not clearly worded and, as references to the making of foreign investments are not generally expressed in exactly that way, it is not clear what is included.
- The Law provides that when procuring goods, works and services, strategic entities must give a prevailing right to Mongolian national business entities registered in Mongolia, in accordance with procedures to be approved by the Mongolian Government in consultation with the strategic entity. This requirement does not appear to be limited to the procurement of goods, works and services within Mongolia. Again, there is no guidance as to how the consultation process is to be conducted.
- Transactions in breach of the Law are invalid and the regulatory authority is empowered to act in response to breaches and invalidate associated licences that have been granted. This is a potentially severe consequence.
Mongolia has welcomed foreign investment in recent years as its economy has developed and expanded. The Law is intended to protect and preserve Mongolia's naturally legitimate national interest in connection with the regulation of foreign investment. From a foreign investment perspective the question is: can the Law be administered efficiently and in a transparent manner to provide investors with certainty and clarity before making an investment decision in relation to Mongolia? The restriction on foreign ownership above 49 per cent in sectors of strategic importance, combined with the inherent uncertainty in some of the concepts of the Law, may weaken foreign investor confidence.
In this regard, it should be noted that, according to Mongolia's president in recent press, the Mongolian Government is willing to reopen negotiations on the content of the Law after parliamentary elections at the end of this month.
This note is non-exhaustive legal commentary only. It has been prepared by international lawyers (who are not Mongolia qualified) based upon an unofficial English translation of the final edition of the Law.
This note is not intended to be, and must not be relied upon for the purposes of, legal advice. If you require legal advice, then please contact us.
- Igor BogdanichPartner,
Ph: +61 3 9613 8747
- David WengerPartner,
Ph: +852 2903 6256
Ph: +976 7711 0231
- Erin FerosPartner, Sector Leader - Mining,
Ph: +61 7 3334 3313
- Nic ToléPartner,
Ph: +852 2903 6237
- Anthony LepereSenior Associate,
Ph: +852 2840 6206
- John KoshySenior Associate,
Ph: +852 2840 6253
- Kate AxupPartner,
Ph: +86 10 8515 0250