30.10.2012 strategic entities foreign investment law, james a. liotta

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DISCLAIMER: The content of this presentation is intended only to provide a summary and general overview of the

SEFIL. It is not intended to be comprehensive nor does it constitute legal advice. You should seek legal or other

professional advice before acting or relying on any of the content. Your use of this presentation or the receipt of

any information from us or this presentation is not intended to create nor does it create an attorney-client

relationship between you and MahoneyLiotta. This presentation reflects the views of MahoneyLiotta and to our

knowledge and belief is factual as of the date of this presentation. No representation, express or implied, is made

as to the fairness, accuracy, completeness or correctness of information, opinions and conclusions contained in this

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be used or distributed beyond this limited audience.

Why?

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Proportional

60% Takeover

Bid29.9% Acquisition

*2 year guaranteed off-take at market price

*Infrastructure – Electricity, coal-haul highway project

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USD 250 Million pre-sold

coal to CHALCO. Market

price thereafter.

Competitors Others

The Fearful

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How? Mr. N. Enkhbold(Deputy Speaker of

the Parliament)

Ms. S. Oyun (CWG)

Mr. D. Odkhuu (DP)Mr. Kh. Narankhuu

(MPP)

Mr. R. Gonchigdorj(DP)

5 Member

Working Group

& Mr. N.

Batbayar (DP)

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Late April 2012

• First Internal Working Group Draft.

May 8-9 • Working Group Modifications.

May 10• Introduced to the Standing Committee of Parliament for its first reading.

May 10, 14, 15

• Further Modifications.

May 17• Enacted by Parliament.

June 19• Published.

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• Category I Investors – Foreign investors, their affiliated entities

or third parties who choose to “operate” in a sector of

strategic importance or conclude certain transactions listed in

the SEFIL with a business entity operating in a sector of

strategic importance.

• Category II Investors – State owned legal entities, entities with

state ownership, international organizations, their affiliated

entities or third parties who choose to “operate” in Mongolia

or “invest” into businesses, affiliated entities or third parties

carrying out any business operations in Mongolia.6

The Way it Works

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• The Catch All

Article 4.5 – Any transaction made outside the

territory of Mongolia that is relevant to the type of

transactions stipulated in Article 4.1 or 4.2 of the

SEFIL are subject to the SEFIL.

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Sectors of Strategic Importance

Resources Media & Communications Banking & Finance

Any other sectors named

by the Government of

Mongolia and approved

by Parliament

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The Regulators

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• Foreign Investment Regulations andRegistration Department of the Ministry ofEconomic Development (FIRRD),

• Government (Cabinet),

• Parliament.

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TransactionsApproving

EntityRelevant Article

Requirement

Providing the right to acquire one-third or more shares of business entity operating in sectors of strategic importance

FIRRD and Cabinet6.1.1 (subject to

4.7)Approval

Providing the right to carry out the executive management of a business entity operating in sectors of strategic importance unilaterally or to appoint the majority of the management team, or to appoint the majority of the board of directors without any preconditions

FIRRD and Cabinet 6.1.2 Approval

Providing the right to veto management decision of a business entity operating in sectors of strategic importance


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Requirement

Providing the right to exercise management functions or determine decision of the management of business entity operating in sectors of strategic importance, and carry out its business operation


That may create a buyer or supplier monopoly at international and Mongolian mining raw material and commodities markets transactions


That may affect the market and price of mining export products of Mongolia


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Requirement

Having consequences of diluting shareholding in business entities operating in sectors of strategic importance by entering into an agreement between others and itself, or affiliated entity or third party

FIRRD and Cabinet

6.1.7 Approval

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Shareholding Percentage

Trigger

Investment Trigger

Approving Entity Relevant Article Requirement

5% - 33.32% (less than 1/3)

None (no minimum or maximum investment)

FIRRD 8.1 Post Notice

33.33% - 49%None (no minimum

or maximum investment)

FIRRD and Cabinet4.7, 6.1, 6.1.1, 6.2,

7.1, 7.4 and 7.5Approval

> 49%investment at the time ≤ 100 billion

MNTFIRRD and Cabinet Same Approval

> 49%investment at the time > 100 billion

MNT

FIRRD, Cabinet & Parliament

Same Approval

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Criteria for Review by FIRRD and the Cabinet• whether any activity or nature of investment of the investor contradicts the national

security concept of Mongolia,

• whether the applicant meets conditions to abide by legislation of Mongolia and

established business codes,

• whether the investment contains elements of restraining competition in specific sector

and creates a monopoly;

• whether the investment causes a substantial effect on national budget revenue and other

policy activities of Mongolia;

• whether the investment causes a negative effect on the particular sector in Mongolia.

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Key Procedural ProvisionsTransaction agreed to with business entity operating in a sector of strategic importance

≤ 30 days

Request made to FIRRD through the business entity operating in a sector of strategic importance

≤ 45 days

FIRRD submits its proposal to the Cabinet

≤ 45 days

Cabinet renders decision and provides it to FIRRD

≤ 5 days

FIRRD notifies the foreign investor of the Cabinet's decision through the business entity operating in a sector of strategic importance

[1]Articles 6.2 and 7.1, SEFIL.[2]Article 7.4, SEFIL.[3]Article 7.5, SEFIL.[4]Article 7.6, SEFIL.

Between 5% and less than one-third requires reporting within 30 days from the

acquisition of shares.

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Other Considerations• Business entities operating in sectors of strategic importance shall:

• Give priority right to Mongolian national business entities when

procuring goods, works and services based on procedures approved by

the Cabinet.

•Defined as a business incorporated by a Mongolian citizen OR a

legal entity who is a Mongolian tax payer with more than 50% of its

shares held by a Mongolian citizen or legal entity.

• Withhold taxes of a Category I Investor who has entered into a

transaction provided for in Article 6.1.1 – 6.1.7 of the SEFIL, from any

payment made to another party in relation to the transactions, and remit

them to the state budget.

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Other Considerations• Any Category I Investor who has entered into a transaction provided for

in Article 6.1.1 – 6.1.7 of the SEFIL shall:

• Pay taxes in accordance with the tax legislation of Mongolia from

any payment made to another party in relation to the transactions

and work with the business entity operating in a sector of strategic

importance (as the withholder) to remit such taxes to the State

budget.

• The SEFIL equally applies to a Category I Investor that is incorporating a

new business entity that will operate in a sector of strategic importance.

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Non-Compliance

•Transactions will be deemed to be invalid.

•Discontinuation of the activities of the business

entity operating in the sector of strategic

importance including cancellation of any licenses

(i.e. minerals and others) held by such entity.

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Many Issues & No Regulations1. Definitional Lack of Clarity.

• No definition for “operating” which could lead to broad application (suppliers,

operating companies, license holders, etc.?). Is it tied to incorporation or a catch

all? If catchall, then overregulation. If tied to incorporation, then does it apply

only after the foreign investment threshold is met according to the Foreign

Investment Law (25% foreign shareholding)? If so, is Cabinet approval required

once the 25% threshold is met?

• No definition for “resources” in Article 5.1.1 which could lead to broad

application (petroleum, wind, energy?).

• No clarity on “relevant” in Article 4.5 for regulation of offshore transactions.

• No clarity on “continuous ties” in the Article 3.1.5 definition of third party.

•No clarity on the 100 billion MNT threshold (book value, market value, etc.?)

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Many Issues & No Regulations

2. Constitutionality of effective date of May 17, 2012 in question.

3. Severity of Punishment is significantly more extreme when compared to

non-compliance penalties associated with foreign investment rules in other

countries.

4. The timing for approval is extreme. Up to 125 days for Cabinet approval.

No indication on timing for Parliamentary approval.

5. No detail for appeals process if not approved.

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Many Issues & No Regulations6. Potential for negative impact on publically listed companies or companies

preparing to list either inside or outside the territory of Mongolia. As noted, any

transaction made outside the territory of Mongolia that is relevant to the type of

transactions stipulated in Article 4.1 or 4.2 of the SEFIL are subject to the SEFIL.

There are notice requirements to FIRRD for changes in shareholding from 5% -

33.32%, approvals required from the Cabinet for changes in shareholding from

33.33% - 100% (where the investment at the time is equal to or less than 100 billion

MNT), and approvals required from the Parliament for any changes in shareholding

from greater than 49% - 100% (where the investment at the time is greater than

100 billion MNT). As also addressed above the timing for such approvals can last for

months. Trading occurs on both local and foreign exchanges on a daily basis where

the value of shares increase or decrease at any given time. 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.

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Many Issues & No Regulations7. Limitations to Obtain Financing. The SEFIL controls a wide range of transactions

which impact share transfers, the ability to dilute shareholding, the ability to control

board or management decisions and the ability to control operations of a business

entity operating in a sector or strategic importance. In many cases financiers require,

and business entities want to offer, options, warrants, securities convertible into

shares, or similar rights convertible into securities. Lenders and financiers often

require share pledges as security and in some cases require a degree of control over

the management and operations of a business entity, control of the board of directors

and veto rights either directly by the financier or by the Category I Investor. Their

ability and willingness to finance may depend on tight timing based on their own

financing and market cycles that do not coincide with the timelines of the SEFIL. It may

become much harder for business entities operating in sectors of strategic importance

to obtain financing crucial to their ability to operate.

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8. Effective Lock-up of the Mongolian Party. A Mongolian joint venture shareholder in a

business entity operating in a sector of strategic importance would need to obtain

Cabinet, and in some cases Parliamentary, approval to sell all or a portion of its/their

shares of the joint venture, or be strictly limited to selling its shares only to other

Mongolian parties (at what is likely to be for much less than selling on a foreign

exchange or to a Category I Investor).

9. One Bad Apple Spoils the Bunch. It is not uncommon for a business entity to be

engaged in diverse sectors either directly (one company holding diverse assets) or

through a string of subsidiaries (a parent holding several companies with diverse

assets). Given the scope of the SEFIL, it may now be practically impossible to segregate

assets to remove a business entity from falling under the category of a business entity

operating in a sector of strategic importance.

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10. Potential for Burdensome, Discriminatory or Unrealistic Requirements to Give

Priority to Mongolian National Business Entities. Waiting on Cabinet regulations.

11. License Transfer. The SEFIL is silent on the transfer of licenses in sectors of strategic

importance. However, the licensing agencies have been in self-paralysis for months,

even unwilling to transfer licenses to entities already in the same sector of strategic

importance. Ad hoc rules continue. Companies cannot even segregate their own assets

for financing.

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12. The SEFIL does not Clearly Address Collective Foreign Investment (a collective

threshold). It is not clear what will happen if three completely independent Category I

Investors were to each acquire just less than one-third of the shares of a business entity

operating in a sector of strategic importance (i.e. 33.32% each and 99.96% total), or, along

the same lines, if two completely independent Category I Investors were to each acquire

up to 33.32%, and by doing so collectively pass either the one-third or 49% thresholds.

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Current Impact

While the SEFIL did prevent the CHALCO transaction from occurring, the overall

impact to Mongolia’s reputation and economy, foreign investment and the

integrity of the rule of law has been sharply NEGATIVE, costing both Mongolia

and foreign investors millions of USD and creating serious reputational damage to

Mongolia’s investment climate.

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Further Reading

For an impartial report on the Mongolian Investment Climate outlining the

overall investment climate and the impacts of the SEFIL, please see the US

Embassy’s 2012 Mongolia Investment Climate Statement at

http://mongolia.usembassy.gov/root/media/pdf/2010-mongolia-investment-

climate-statement.pdf

Also, please feel free to visit our website at www.mlmongolia.com

Thank You

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