Why Mongolia's investment law amendments disappoint

Author: Ashley Lee | Published: 25 Apr 2013
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  • Amendments to the Strategic Entities Foreign Investment Law are less significant than what’s been widely reported;
  • Private companies will not be exempt from an approval process altogether, but must now obtain approvals from the cabinet instead of parliament;
  • Continuing uncertainty over the Sefil and the corresponding investment freeze due to lack of regulations could affect the stability of the banking sector;
  • Investors are beginning to look to other resources-rich frontiers where it is easier to do business.

Mongolia’s amendments to its controversial foreign investment law may not make a difference to investors looking to enter the market.

It has been widely reported that mendments to the deeply unpopular Strategic Entities Foreign Investment Law (Sefil) eliminates approval for private investment.

But lawyers told IFLR that the amendments represent minor changes rather than a complete overhaul. Further, a lack of clarity in the Sefil is beginning to prompt investors to look to other resource-rich frontiers in which it is easier to do business.

MahoneyLiotta’s Darin Hoffman said that the official text of the amendment has yet to be published, but changes to article 4.7 are narrow in scope and have limited benefit for investors.

He clarified that the amendment only eliminates the requirement for non-state-owned entities (SOEs) and entities without state ownership to obtain parliamentary approval for investments above MNT 100 billion ($71,000) in business entities operating in sectors of strategic importance, such as resources, media and communications, and banking and finance.

But full cabinet approval for transactions involving private sector investment is still required – the same as before.

"This has always been seen as one of the major impediments brought on by Sefil," he said. "It is in sharp contrast to reports that the Sefil was amended to no longer apply to private sector investments – that reporting is in error."

"The high hurdle for potential state-owned foreign companies effectively blocked investment inflows from China, which is by far Mongolia’s biggest importer of its mineral resources and nearly 90% of its total exports," analysts stated in an article titled Mongolia’s Amended Foreign Investment Law Credit Positive in today’s issue of Moody’s Credit Outlook.

Further, analysts noted that the vagueness of the law and absence of implementing regulations has prevented planned and new investments from moving forward.

Banking sector

The effective halt on inbound investment has had a substantial effect on the stability of Mongolia’s banking sector.

In Moody’s first report on Mongolia’s banking sector, the agency gave the sector a negative outlook. But it maintained stable bank ratings outlooks for the four Mongolian banks it rates; all four banks are rated B1.

The report summary said that its outlook reflects the challenges that banks face in managing what will likely be a period of rapid loan growth in an economy that is increasingly exposed to commodity-driven boom-bust cycles.

"Further underpinning our negative banking system outlook are structural features, such as high loan concentrations, weak risk-monitoring systems and the developing nature of the regulatory framework," the report added.

Moody’s analyst and report author Hyun Hee Park told IFLR that Mongolian banks experienced 73% year-on-year loans growth in 2011 and 24% growth in 2012. These paces, if attained, will likely offset even the strong internal capital generated by their earnings in 2013.

However she noted that fresh additional capital from external sources will be needed in the coming one to three years. "An uncertain process of the Sefil risks fresh capital injection from foreign investors," she added.

She highlighted the banks’ loan book composition chart (below), in which the mining sector represents 12.4% of total bank exposure. That number does not include ancillary industries related to mining, such as transportation, construction and wholesale and retail trade.

EXHIBIT 4: Loan Book Composition as of September 2012
Source: Bank of Mongolia Loan Report
Note: Loans to Individuals include small business loans and personal loans.

If there is a decrease in foreign investment in this sector, it will hurt the banking system indirectly but will not be material in the near future; there may be an indirect impact with time lag, she added.

"However, if a prolonged decrease in foreign investment in mining sector adversely affects the cash flows of companies in this sector and undermines their credit positions, it could heighten credit stress in this sector and could hurt banks’ asset quality," she said.

Further, uncertainty regarding the Sefil is discouraging foreign banks from considering investing in Mongolian banks.

Park said that one of the positive aspects of the Mongolian banking system is that foreign investors remain interested in investing in Mongolia banks given their high mid-to-long-term growth prospects.

Foreign investors had started to become active in the banking sector before the Sefil was passed. Goldman Sachs Group’s investment to acquire a 4.8% stake in the Trade and Development Bank of Mongolia is an example.

"Once the details and processes of the foreign investment law are disclosed – and if they are positive – it will be good for Mongolian banks," Park said.

What to expect

Hoffman told IFLR that prime minister N. Altankhuyag and the Ministry of Economic Development seem committed to proposing new and improved legislation to create a more workable foreign investment regime in Mongolia.

"Sources indicate a draft has been proposed that has more reasonable controls on foreign investment," he added.

But the lack of resolution regarding the Sefil may damage Mongolia’s ability to repay its debt. The Moody’s article on the Sefil noted that a particular credit risk is the threat to the government’s debt repayment capacity from a restrictive and unpredictable credit regime.

It said that the Sefil, coupled with the government’s efforts to renegotiate its investment agreement with the owners of the Oyu Tolgoi project, which only became effective in March 2010, jeopardises future budgetary revenues from the mining sector.

The revenue is necessary to repay the government’s external debt. Further the article noted that last year alone, the government took on $5.5 billion in direct and guaranteed global capital market debt obligations, equal to about 55% of GDP in 2012, $2 billion of which has been drawn down so far.

"The rise in external debt compared with current account export, income and service receipts has been sharp, to 252% in 2012 from about 64% in 2008," it said.

Further, some of the investors that left Mongolia may not return.

Gibson Dunn partner John Viverito and of counsel Myles Hankin are seeing natural resources investment move from Mongolia to other jurisdictions due to the lack of an investor friendly environment.

"We’re seeing a fair number of African deals coming through, and a couple of people who do business in other frontier markets around the world have said that it’s easier to do business legally in the Congo and many other African countries than it is in Mongolia," the added.

Related links:

Asia-Pacific: Mongolia: Investment darling no more http://www.iflr.com/Article/3158018/Asia-Pacific-Mongolia-investment-darling-no-more.html

Investors hope for clarity on Mongolia foreign investment law http://www.iflr.com/Article/3182769/Investors-hope-for-clarity-on-Mongolia-foreign-investment-law.html

Legal impasse threatens Mongolia FDI http://www.iflr.com/Article/3155429/Legal-impasse-threatens-Mongolia-FDI.html

Mongolia foreign investment reform: what to expect http://www.iflr.com/Article/3098391/Mongolias-foreign-investment-reform-what-to-expect.html

Mongolia’s new foreign investment law explained http://www.iflr.com/Article/3028715/OPEN-ACCESS-Mongolias-new-foreign-investment-law-explained.html

Mongolia sovereign bond first explained http://www.iflr.com/Article/3133749/Mongolia-sovereign-bond-first-explained.html