The Indonesian Government has implemented laws prohibiting the export of raw minerals by foreign investors or subjecting their export to progressive export taxes and requiring the divestment of foreign held mining licenses. These laws are expected to cause foreign investors to suffer significant loss.
Recently, Indonesia's ban on the export of unprocessed ore, Regulation No. 1 of 2014 ("MEMR 1/2014"), came into effect meaning that all mineral commodities (excluding coal) must now be processed or refined domestically prior to export. MEMR 1/2014 forms part of the 2009 Mining Law, an initiative that was introduced to increase Indonesia's exploitation of its own natural resources.
MEMR 1/2014 aims to increase the domestic processing of ore and stimulate investment in Indonesia's limited domestic smelting infrastructure.
While a 3 year exception has been made in relation to semi-processed materials including iron, copper, titanium, lead, manganese and zinc, Indonesia's Ministry of Finance has imposed new export taxes on these minerals that increase each year for the term of the 3 year exception, as part of the plan to encourage the processing of materials domestically.
Not only will the regulations affect foreign investors' current business models, Indonesia's onshore processing capacity is also in question. Many investors are therefore unsure of how to proceed in the new market climate and the ramping up of Indonesia's divestment program.
Late last year, the Indonesian Government's Minister of Energy and Mineral Resources issued the procedure for implementing the 2009 Mining Law. This requires that, upon 5 years of operation, foreign owned shares in an IUP Company (companies holding Production Operation Mining Permits, formerly known as Mining Authorisations, that permit the commencement of a production operation stage upon completion of an Exploration IUP stage) to be offered for sale to a list of Indonesian participants comprised primarily of state or state owned entities. The offers are to be made in stages so that by the 10th year, at least 51% of the shares are owned by the Indonesian Participants ("Divestment Program"). Unlike MEMR 1/2014, the Divestment Program applies to coal mining interests.
Regulation No. 27 of 2013 on Procedures for Divestment and Share Pricing and Changes to Investment in Mineral and Coal Mining Business ("MEMR 27/2013") provides guidance on how the Divestment Program will be implemented. IUP companies are required to begin divesting shares 90 days after their fifth year of production.
MEMR 27/213 requires that investors divest their shareholdings at a price equal to replacement cost being: investment cost - (accumulation/amortization + liabilities). It is possible that this pricing mechanism will result in a price below market-value. This pricing mechanism may also be inconsistent with Indonesia's Investment Law pursuant to which the Government can acquire investments upon payment of market price.
If IUP Companies fail to comply with the Divestment Program, their mining activities may be suspended or their IUP or production operation permit revoked.
What Can Investors Do?
Foreign investors are seeking to mitigate the fallout of MEMR 1/2014 and the Divestment Program and implement strategies to manage political risk going forward. For many, this will mean either accepting the losses resulting from the introduction of MEMR 1/2014 and the Divestment Program or attempting to fight the regulations in Indonesia's courts. It is unclear whether local courts will provide effective and just remedies to foreign investors.
However, Australian investors have additional rights of protection. This is because the Australian and Indonesian Government have agreed that the Indonesian Government will provide certain additional protections for Australian investors. Pursuant to this agreement, Australian investors can seek compensation from the Indonesian Government for losses suffered if the Indonesian Government does not abide by the promised protections.
These additional protections and rights have been provided under the Bilateral Investment Treaty between Indonesia and Australia ("Australia-Indonesia BIT") and under the 2010 ASEAN - Australia - New Zealand Free Trade Area ("AANZFTA"). Australia and Indonesia are both parties to this multilateral treaty.
What rights do Investors have?
Between the Australia-Indonesia BIT and the AANZFTA, Australian investors with investments in Indonesia can require Indonesia to:
- pay adequate compensation (assessed at market values) if it "expropriates" (or takes) the investment
- accord fair and equitable treatment to the investment
- encourage and create favourable conditions for investors to invest in its territory
- submit disputes to independent arbitration (enforceable in a similar manner as international commercial arbitration)
- give 'most favored nation status', so that any protections granted to foreign investors of other States must also be offered to Australian investors. Indonesia is a party to numerous bilateral and multilateral treaties with other countries and these may be a source of further protections.
Depending on your circumstances, any number of these protections might be breached by the Mining Law or the Divestment law. If so, as a protected investor under Australia's treaties, it will be possible to claim compensation from the Indonesian Government. Before doing so, the investment treaty rights will provide a good background within which negotiations with the Indonesian Government can be conducted.
How can Australian Investors enforce their rights?
These treaties provide for recourse against Indonesia for Australian investors affected by MEMR 1/2014 and the Divestment Program. Unlike claims commenced against the state in that host state's local court system, claims brought under the Australia-Indonesia BIT or AANZFTA, are determined by an independent panel appointed by the parties or by an impartial arbitral institution.
The Australia-Indonesia BIT provides for disputes to be resolved by ICSID Arbitration at the International Centre for the Settlement of Investment Disputes, a member of the World Bank Group in Washington. A recent decision of an ICSID tribunal, however, held that under the specific terms of the Australia-Indonesia BIT, Indonesia is not required to submit disputes to arbitration. So unless the Indonesian government has separately agreed to submit investment disputes to arbitration, investors are likely to have stronger rights under AANZFTA. The AANZFTA provides a choice of ICSID or United Nations Commission on International Trade Law arbitration.
Importantly, the enforcement process is effective. If an ICSID tribunal grants an award in favour of an investor, the amount of that award may be enforced against assets located in any of the 158 countries party to the 1965 Washington Convention. For most other tribunals, awards may be recognised and enforced against assets located in any of the 149 countries that are a party to the 1975 New York Convention on International Commercial Arbitration.
If you are concerned about the impact of these laws on your investment, please contact us. We can help you develop a risk management and dispute resolution strategy.
Comments on the scope and impact of Indonesian laws were prepared with the assistance of ABNR Law (IFLR 2013 Indonesian Law Firm of the Year).
Who does this effect?
Those who hold mining interests in Indonesia.
What do I need to do?
Consider the impact of the Mining and Divestment Laws on your investment and your strategy to protect the value of your investment.