Lucy McNulty, Asia editor Additional reporting by Ashley Lee
Frontier markets are best defined by the rule of law, or the lack of
it. The simplest way to view this ever-expanding class of developing
countries is as a chaotic fourth world, open to foreign investors but
without readily-enforced market rules.
These are the emerging markets' younger, less-experienced siblings. A
state of semi-lawlessness makes them unpredictable lands of huge risks.
And yet they are capturing the interest of investors worldwide. One
look at the numbers explains why.
Frontier markets are home to one billion of the world's six billion
people, but they account for just 5% of global GDP and 0.5% of global
investment. In 2010 economic growth rates ranged from a high of 20% in
Ghana to a low of 2% in Serbia, compared to the much narrower range in
big emerging markets, from 9% in China to 3% in South Africa. The
frontier stock markets magnify those gaps, ranging in 2010 from a gain
of 80% in Sri Lanka to a loss of 20% in Bulgaria. The major emerging
markets, however, produced a maximum gain of 20% in India and no gain in
In a global economic climate where there is little else to get
excited about - and in which even the man who coined the Bric [Brazil,
Russia, India, China] acronym, Jim O'Neill of Goldman Sachs, has
admitted that their best days are behind them - frontier markets present
a very enticing business opportunity.
Despite positive noises around the opening up of Myanmar, market
participants in the country have branded the significance of proposed
changes to its foreign investment law as over-hyped. Investors should
enter with a healthy scepticism.
Among a series of changes proposed to the investment law are
provisions allowing foreigners to set up businesses in Myanmar without
Reforms also include a five-year tax exemption for foreign companies,
government guarantees against nationalisation, easing of restrictions
on private land use, and repatriation of profits.
Following months of delay, the foreign investment law was finalised
in early May after ,being approved by parliament and signed into law by
president U Thein Sein.
One Yangon-based partner questions the international reaction to the news.
"Many are saying this is a huge change, but to me it is not
game-changing at all," he says. "The changes proposed are not
drastically different to Myanmar's Foreign Investment Law of 1988."
"With so much else changing in Myanmar it is hard to say if these changes will make much difference," he adds.
Thura Soe-Paing, managing director of All Myanmar Investment &
Development Partners, an affiliate of Singapore-based investment company
Frontier Investment and Development Partners, agrees that the reported
changes are only cosmetic.
"The common perception is that reforms in Myanmar are happening very
fast, but people here are complaining it is going too slowly," he says.
"Economically things haven't changed that much. Banking laws are
still antiquated and there is still little transparency as to what the
reform agenda or timeframe is," he adds.
DFDL Mekong's James Finch says the draft foreign investment law was
consistent with earlier laws, but represented a liberalisation of
provisions in the Myanmar Foreign Investment Law of 1988.
However Derek Tonkin, chairman of foreign investment development
organisation Network Myanmar, believes the fine print and follow-on
reforms would prove important.
"This will mushroom in the coming months and years as it did in
Vietnam from a single document to literally volumes of decrees,
notifications, instructions on all sorts of matters related directly or
indirectly to foreign investment," says Tonkin, who is also the former
British Ambassador to Thailand, Vietnam and Laos.
It pays to prepare
But what do we actually know about these markets? Or more pertinently, what do we need to know?
Leopard Capital's founder Douglas Clayton is a man well placed to
answer. As head of investment fund managers specialised in the world's
overlooked frontiers, he has years of experience guiding on-site teams
to opportunities in pre-emerging economies. It is, he says, an
impossible task without good advice.
"Frontier markets are full of guys who got rich quick, but even more
who lost their shirts," says Clayton. "The learning curve for newcomers
can be pretty steep."
The main hurdles are inexperienced policy makers and a lack of legal
precedent. Of course, weak regulatory systems can be an advantage for
some investors looking for markets into which they can pump money
without dwelling on details; but it's a disadvantage for other smaller
With time and practice frontiers will change laws, as priorities
evolve from simply attracting investors to protecting their own
interests. In the meantime, however, potential foreign investors should
hire a consulting company or lawyer who is aware of local laws and
practice, and thereby better able to ensure investments are protected.
Local business partners can also play a critical role in this
respect. But sourcing a viable and, most importantly, honest partner
presents its own share of problems.
"Frontier markets are long on opportunities and short on human
resources," says Clayton. "Execution is everything so you have to really
focus on management team quality."
According to Hogan Lovells' Ulaanbaatur-based partner Michael
Aldrich, success comes down to common sense. "Don't be tempted to
dispense with the same common sense approach you would bring to a
transaction in Ohio or New South Wales simply because you are investing
somewhere exotic," he says.
"Before a law firm bills a single dollar to a local law firm, they
should be comfortable with its reputation as a local partner," he adds.
"It's always better to anticipate something going wrong, rather than
learning behind the curve."
Private investigators should be hired to verify the practices of
business partners that investors are unfamiliar with, he says. They can
help identify the investment risks, as well as any potential reputation
problems that might not be recognised by prospective investors.
And in markets where recourse to a free and fair legal system is by
no means guaranteed, investors should not chance their hand in the local
courts because of something that could, and should, have been
identified early on.
Ben Rowse, the Asia practice head at investigative firm Nardello
& Co, believes it is critical for companies entering a joint venture
to carry out proper due diligence beyond business's books and records.
The partner's reputational integrity, as well as the political
connections and principles of senior management and shareholders, should
also be looked into.
"All too often I see instances where supposedly fantastic investments
turn sour after a year or two," he says. Investors should wait until
they have a thorough understanding of legal regimes, especially in
relation to foreign exchange, labour, foreign equity caps and methods of
"Understanding the operating environment, including its political,
social and economic conditions is just one part of the due diligence
process," he adds. "In emerging frontiers, business and politics can be
very intertwined. It is critical to determine what side of the fence a
company or business is sitting on and how that may impact business."
|Fools rush in
Myanmar's banking sector is not prepared for a flood of foreign
investment, according to the deputy chairman at the country's largest
A landslide victory by opposition leader Aung San Suu Kyi's National
League for Democracy party in April's by-elections, as well as a series
of political and economic reforms, led the US, EU, Japan and Australia
to announce plans to relax sanctions against the Southeast Asian
country. This prompted a rush of foreign investors eager to profit from
the opening up of the country.
But KBZ Bank's U Than Lwin told IFLR that foreigners should, for the moment, hold-off from taking advantage of the investment opportunities available in Myanmar.
"I advise potential investors to wait for the various regulatory revisions currently being enacted to be finalised," he says.
Although Myanmar's new Foreign Investment Law has been finalised,
work is still underway to revise outdated banking laws ahead of the
country's integration with ASEAN in 2015. Discussions are being held as
to whether updates should be made to foreign exchange control laws.
"There's a lot of change on the cards," Lwin says. "Wait for these
regulatory amendments and the incentives provided under these reforms to
The floating of Myanmar's currency, the kyat, on April 1 after 35
years pegged to IMF's special drawing rights unified seven different
rates used by business, government and consumers to a new reference
rate, set at 818 kyat per US dollar.
As the most dramatic economic reform yet by the country's
one-year-old civilian government, it is hoped it will transform trade,
banking and public finances.
According to presidential economist Set Aung, it marks the first step
towards the full internationalisation of Myanmar's banking sector. He
expects foreign banks to be allowed into Myanmar by 2018, but thinks
joint ventures between foreign and domestic banks are likely much
U Than Lwin says the domestic banking sector would struggle to
compete with its larger international counterparts once the market fully
opens up. It would be better for global banks interested in entering
the market to consider joint ventures with local financial institutions
instead, he says
Myanmar has a basic banking system in place, he says. But work was
underway to train domestic banking staff in international practices and
technology. Senior staff at KBZ Bank have been participating in training
with global banks such as Japan's Bank of Tokyo-Mitsubishi UFJ and
Home country rules
Evaluating the impact of, and risk of exposure to, breaches of the US
Foreign Corrupt Practices Act and UK Bribery Act is also critical.
"Claiming you didn't know about a companies' problematic relationship
with corrupt senior officials or dodgy government connections simply
isn't going to cut it when you are being investigated for FCPA breaches a
few years down the line," according to Rowse.
"Identifying these factors early on in the deal will enable you to
ringfence certain areas of a business or simply walk away if an
investment becomes too high-risk," he says.
Informal business practice should also be avoided. Foreign investors
are often encouraged to take this more relaxed route. But to Aldrich, it
is critical that informal practices are reserved for locals. "Full
compliance with the law is the only way to protect investments in the
event of a dispute with business owners or the government," he says.
It is also important for investors to make clear from the outset if
they are uncomfortable with any business practices. If, for example, a
foreign investor makes an exception for corrupt or unclear working
methods in order to win a contract or have a transaction processed
faster, they have set themselves up for repeat overtures. "If that means
a deal takes much longer then so be it," says Aldrich.
International companies should take a stand from the start and make
it clear that they have their own obligations to abide by laws in their
home country. "That is harder for small to medium enterprises without
the gravitas to make that statement effectively, but it is imperative
that a position is taken," he adds.
Relying on a local partner's political capital to get you out of
problems is also unwise. "Invest in your own reputations and political
capital with the relevant authorities," says Aldrich. "It's
overly-optimistic to assume your partner's influence will protect you if
things go wrong."
Investors need more than just a leading knowledge of a jurisdiction's
culture and history. The more one is conversant with local customs,
laws, history and culture, the more one takes on the role of being a
respected guest as opposed to someone who has come for short-term profit
or for hardship pay. "Such people will soon cultivate an image of being
a carpetbagger and won't be welcome," adds Aldrich.
Where to invest and why
It is, according to Clayton, important to focus on poor countries in
rich neighbourhoods, especially the ones that seemed more successful 40
to 50 years ago than they are now. Here is a rundown of the best
Middle East and north Africa
In response to the Arab Spring of 2011, the White House announced an
initiative focused primarily on the economic development of the Middle
East and north Africa. This initiative was complemented by the Deauville
Partnership, which saw the promise of a $35billion facility by the IMF
and a pledge by the G-8 to increase the region's trade and inbound
foreign investment. The region presents enormous growth opportunities.
But money laundering and terrorism, bribery, cronyism and gender
discrimination remain challenges to involvement.
By 2020 Africa is projected to have a collective GDP of $2.6 trillion
and consumer spending power of $1.4 trillion. Sub-Saharan Africa will
lead this growth with an average regional economic growth forecast of
5%. In Ghana alone, which is projected as the fastest growing in the
region, the economy grew by 13.5% between 2010 and 2011, and is expected
to grow at a rate of 7.3% in 2012.
South Sudan also offers significant potential. Its foreign
investor-friendly common law background and resource-rich climate
contribute to a society open to international investment. Political
instability and risk of clashes between Sudan and South Sudan
governments will prove an ongoing challenge for market participants.
Even so, increasing international attention is likely in the short term.
With a projected growth rate of 5.6% over the next four years,
Southeast Asia emerged from the global financial crisis relatively
unscathed. Growth in the region will be led by emerging markets such as
Indonesia and Vietnam.
But frontiers such as Myanmar (see box) should not be overlooked.
Positioned in an unusually strategic location between China, Thailand
and India, Myanmar has recently catapulted from an impoverished pariah
state to the darling of the global investment community, thanks to a
series of sweeping regulatory reforms.
Rich in natural resources, and with a population of 55 million it
offers both an untapped consumer market and a substantial labour pool.
Extractive industries such as mining, oil & gas, and hydropower have
seen the most concentrated investment over the last decade, but there
are opportunities too in the tourism sector, financial services and
telecommunications. Its common law system is also nicely familiar for
those coming from English-speaking jurisdictions.
Mongolia follows close behind (see box). But without Myanmar's large
population, and therefore the cheap labour force to support extensive
manufacturing facilities, investment here is purely a mining,
infrastructure and construction play.
| Maldives modernisation
The Maldives is to modernise its commercial laws in a bid to attract
sophisticated foreign investment outside the tourism sector.
Most of the country's commercial laws were passed in the late 1980s
and early 1990s amid an influx of foreign investment. Subsequent
amendments have often been stymied by the Majlis (parliament), but
despite recent political unrest in the country, the government has
reiterated its commitment to encouraging investment.
An arbitration bill was debated in parliament on April 9. Subject to
revision, it is expected to incorporate United Nations Commission on
International Trade Law (UNCITRAL) rules. It is a direct result of the
Maldives' recent accedence to the New York Convention to enforce awards
from international arbitration.
According to Mohamed Shahdy Anwar, senior partner at Suood Anwar
& Co, the bill outlines the framework of a Maldives body similar to
the Singapore International Arbitration Centre and the Kuala Lumpur
International Arbitration Centre.
Practitioners say the arbitration bill has broad support and will
encourage the arrival of investors who have been reluctant to resolve
disputes in Maldivian courts.
Additionally, the country's 1996 Companies Act will undergo broad
revisions. The Act lacks provisions for public disclosure, terms and
conditions for company directors and establishing a company with only
one shareholder or director. A draft was debated in parliament last
October, and a revised version will return sometime this year.
Lawyers hope that the amendments will also establish a clearer means
to register foreign companies, which is regulated by the 1979 Foreign
Investment Act. Mohamed Fizan, a partner at Shah, Hussain & Co,
says this iteration of the Act has been a major complaint for lawyers
and investors. It requires foreign companies to register with the
Ministry of Trade and Industries, long considered an unpredictable
regulatory body. A proposed solution is for foreign companies to
register with the relevant sector's government authority.
Tax laws introduced last year are also subject to changes. The
proposed Corporate Tax Act and the Personal Income Tax Act, if passed,
will repeal and replace the 2011 Business Profit Tax Act, which the
first to levy taxes on business profits.
Further legislation to be debated in parliament this year includes
the Trust Act, to provide for the establishment and regulation of
trusts, and the Central Securities Depository Bill to further expand the
country's stock exchange.
The next generation
Although admittedly a long way behind, North Korea could well join
the growing ranks of frontier markets, thanks to a decreasing
regimentation in society and China's increasing economic impact on
"North Korea is much more than a goose-stepping population," says
Aldrich. "Thanks to China's growing influence in the country, North
Koreans are increasingly abandoning their ideological foundation of
reliance on the state. They now accept they need to know how to conduct
business and be more entrepreneurial," he says.
Such change may seem minute, but over time the country could present
huge opportunities for pioneer investors in manufacturing, construction
and private enterprise.
China will be best placed to take advantage of the country's
shockingly low skilled labour costs. But increased involvement by
private equity firms in jurisdictions that do not abide by UN sanctions
is also likely. "It is a little like talking about China in 1977,"
Aldrich says. "Clearly at that time, few would have forecast the country
would develop as it has. I sense North Korea might be in a similar
The opportunities within the Russian far east and Siberia are also
frequently overlooked. The region offers similar opportunities to
Mongolia, and potential for successful investment from professional
service providers, but is too often dismissed. "Foreign investors tend
to think of Russia as no more than Moscow but the east of the country is
definitely one to watch," according to Aldrich.
Populated by descendents of those exiled from Soviet and Tsar Russia,
or by pioneering spirits, who relocated to build a better life less
influenced by reliance on the state, the eastern Russian population is
more progressive from businesses perspective than their less-reactive
counterparts in the west. Elsewhere, Haiti and Cuba have also been
flagged by frontier-focused private equity houses.
Most economists believe that the frontier shares of the economy and
money flows will grow. Certainly, in frontier nations leaders can
unleash explosive growth just by instigating a few well-timed reforms.
In nations emerging from bouts of ethnic strife or civil war merely the
absence of conflict can unleash growth.
But it will be a rollercoaster ride. Investors need to choose wisely
and quickly. "Move to a frontier and join its business community, or buy
in through a country fund," says Clayton. "Either way you want to buy
into the best companies before others show up."
|Tips for Mongolia
Investor appetite for Mongolia's rich natural resources has grown
rapidly over the past year. However, as with most frontier markets, new
legislation must be navigated carefully.
On May 17, Mongolia's parliament passed a new foreign investment law
ahead of the country's June 28 elections. Mongolian parliament members,
anxious to retain their seats ahead of the highly-anticipated 2013
opening of the Oyu Togloi mine, are introducing extensive legislative
reforms, including the foreign investment law titled the Law of Mongolia
on the Regulation of Foreign Investment in Business Entities Operating
in Sectors of Strategic Importance.
The law was proposed in a bid to curb China's increasing investment
and influence in the country, after speculation that Chinese aluminum
company Chinalco planned to acquire a majority stake in Canadian coal
miner SouthGobi Resources.
Mongolia has long promised an open foreign investment regulatory
scheme, but the foreign investment law proposed would introduce
regulation on a variety of industries.
Michael Aldrich, managing partner at Hogan Lovells' Ulaanbaatar office, told IFLR
the draft law was very complex. "It makes the foreign investment
approval process in China and Russia appear relatively straightforward,"
Early drafts included provisions that a foreign entity could not own
more than 49% of any company worth MNT 100 billion ($76 million), as
these would be classified as a business entity of strategic importance
(BESI). The BESI designation applies to companies operating in banking
and finance, media and telecommunications, and minerals including oil
The new law stipulates that there is a reporting requirement to the
Foreign Investment Agency of Mongolia (FIA) if a foreign investment
totals more than 5%, but less than a 33% interest, in a BESI. If a
foreign entity owns more than a 33% stake, there will be a FIA review
process. Parliamentary approval will be required if a foreign entity
wishes to acquire a 49% or greater stake in a BESI worth more than MNT
100 billion. Non-compliance could result in the revocation of the
offending company's business license.
The changes will leave broad and discretionary authority in
government hands. Violation of the law may result in the rescinding of
the business registration of the strategically important company.
Stephen Tricks, head of Clyde & Co's Mongolia practice, says
investors are growing increasingly concerned about the wide range of
industries potentially subject to the law, and the level of state
ownership of ventures operating under the law. "There is a danger that
an over-zealous approach in the draft law could frighten foreign
investors and choke off the rapid expansion in the economy," he says.
The law's cumbersome procedures could significantly slow processes.
It also does not specify how the 49% foreign investment threshold for
parliamentary approval is calculated.
Though there were rumours of a retroactive clause, the plenary
session has since clarified that there will be no retrospective
application of the law. At the time of going to press, the law was set
to take effect on May 27, 10 days after it was passed. The president,
however, can veto the law.
Given Mongolia's history of quickly repealing legislation, such as
the Windfall Profits Tax, many suggest that the law will be repealed
after the new parliament takes office. However, Aldrich thinks that
patience is critical. "The bedrock of Mongolia's political system is a
participatory democracy," he says. "There is an element of popular
sentiment in the political process: resource nationalism and populism
can play a significant role. And there is a tendency for people to dwell
on its faults, but Mongolia's political system is very much to be