14 October 2014

Foreign investment regulation - Trends in south east Asia

This article was written by Adrian Perkins, Monique CarrollPaul Schroder and Sara Gant.

Papua New Guinea

For its size, Papua New Guinea (“PNG”) is comparatively resource rich and it is no surprise that most foreign investment in PNG involves the mining or oil and gas sectors. King & Wood Mallesons has advised foreign investors on the two largest transactions in PNG in 2014, Oil Search’s acquisition of an interest in the Elk / Antelope gas fields and Puma Energy’s acquisition of Interoil’s oil refinery and petroleum retail business. There are many considerations for foreign companies planning an investment in PNG’s resources sector, not the least of which is the extent to which Government wishes to participate in or regulate a resources project. The Government has also increased its public commentary regarding its desire to ensure that the PNG national interest is protected and promoted.

State participation in projects

Otherwise known as the State’s “back-in rights”, the PNG Government may elect to acquire up to a 30% participating interest in a mining project, and up to a 22.5% participating interest in a petroleum project. The State’s cost of acquiring its percentage interest is calculated on the seller’s unrecouped sunk costs attributable to the seller’s interest in the project. Understanding these rights and their potential impact on your project is critical to assessing a resources sector acquisition in PNG.

Certification to acquire or carry on business

The Investment Promotion Act 1992 (PNG) (“IPA”) provides that a foreign enterprise must not (1) acquire or hold a “relevant interest” in a PNG enterprise; or (2) carry on business in PNG, unless a Certificate has been granted by the Investment Promotion Authority (“IP Authority”). The concepts of “relevant interest” and “carry on business” are broadly defined in the IPA. Once a Certificate is issued, the foreign enterprise is required to carry on its permitted business activities in accordance with the terms and conditions that are set out in the Certificate. Domestic companies that are owned by foreign companies are caught by the rules. Accordingly, if a foreign company obtains control of a PNG domestic company, the domestic company needs to be “recertified” to carry on business in PNG. The Investment Promotion Regulation 1992 also sets out various business activities that are reserved for PNG citizens or domestic enterprises (i.e. foreign enterprises are restricted from undertaking them).

In our experience obtaining Certification can be a slow process and it is difficult to obtain pre-certification before a transaction closes. Also, the IP Authority’s Certification Division adopts a strict compliance approach to certification requirements. This means discussion with the Government in the early stages of the transaction is vital in order to ascertain their attitude to the potential investment (confidentiality permitting).

Takeovers of listed PNG companies

In 2013 the PNG Takeovers Code was amended to include a new and undefined “national interest” test that applies to the acquisition of any shares in a PNG listed entity (Port Moresby Stock Exchange Limited) by a foreign entity. There are no guidelines or formal requirements underpinning the test. In practice, the PNG Securities Commission (a division of IPA) has a wide discretion to decide when or if a takeover should be in PNG’s national interest. The Commission has already used its discretion in the agriculture sector by prohibiting a Malaysian company from moving to a majority position in New Britain Palm Oil Limited, one of PNG’s largest employers.

Central bank rules

The IPA provides that a foreign investor is allowed to remit earnings and repatriate capital including remittances to meet offshore payment obligations. This guaranteed right, however, is subject to PNG taxation and exchange control laws. The Central Bank (Foreign Exchange and Gold) Regulation 2000 (PNG) (“Forex and Gold Regulation”) prohibits a person from taking, sending or attempting to take or send any PNG currency (i.e. Kina) or any foreign currency (other than foreign currency obtained in accordance with authority given under the Forex and Gold Regulation) out of PNG without the authority of the Bank of PNG or an authorised dealer. For an investor to take profits made in PNG offshore, specific permission must be given and is usually given if the investor is given tax clearance by the Tax Office. Whether or not tax clearance is given depends on whether the investor has no tax liability and has a strong record of tax compliance.

Antitrust clearance

Clearance for your acquisition will be required from The Independent Competition and Consumer Commission (“Commission”) if the acquisition would substantially lessen competition in the PNG market place. However, the Commission has stated that their policy in relation to any significant acquisition is for the Commission to take into account relevant matters that are listed in section 69(5) of the Independent Competition and Consumer Commission Act 2002 (PNG) (even if there seems to be a conclusive position that the acquisition would not substantially lessen competition).

Next steps?

Call us before undertaking your next transaction in PNG.

Indonesia

Resource Nationalism

Early this year, the Indonesian Government’s ban on the export of unprocessed ore by foreign investors came into operation, requiring mining companies to process all mineral commodities (excluding coal) prior to export, or be subject to escalating export taxes. These are designed to persuade foreign investors to build smelters and perform lucrative refining processes in Indonesia. Alongside Indonesia’s recently introduced share divestment programme, which requires foreign-owned mining licences to be gradually divested to designated participants (primarily state and state-owned entities), the new laws evidence an emerging trend towards resource nationalism in Indonesia.

The new regulations have had a considerable negative impact on Indonesia’s mining sector, which prior to the ban depended heavily on raw commodity exports. Since January, oppressive export taxes, combined with a shortage of domestic processing facilities, have caused several foreign companies to drastically reduce or halt their operations, resulting in substantial profit losses. Investors are also eager to learn how Indonesia’s pending change of government will affect its investment climate.

Change of Government

Indonesia’s Constitutional Court has now confirmed Joko Widodo as the country’s next President and he will assume office on 20 October 2014. Whether the incoming President will deviate from his predecessor’s investment policies remains uncertain. However, the Energy and Mineral Resources Ministry announced in August that Indonesia’s restrictions on the export of natural resources will remain in place under the Widodo government. His commitment to the mining law reforms notwithstanding, Widodo’s assurance to investors that he will uphold the recently negotiated compromise agreements with Indonesia’s two largest foreign miners, Freeport McMoRan (‘Freeport’) and PT Newmont Nusa Tenggara (‘Newmont’), offers reason for cautious optimism.

The view of Steve Wilford, MD of Global Risk Analysis at Control Risks Asia Pacific, is “there is a plausible scenario in which the new government amends recent regulations related to the 2009 Mining Law to better incentivise investment in the sector, and acts in more consultative manner with the industry so reducing risks of future regulatory ambushes. There won’t be any great rollback of the outgoing administration’s nationalist themes in policy, however. A somewhat more restrained resource nationalist posture, with concessions in some areas such as divestment obligations, is probably the best outcome on offer.”

Compromise Agreements

Following a six month stalemate, in July US-owned Freeport signed a Memorandum of Understanding (“MoU”) with the Government, allowing Freeport to resume mineral exports. Under the MoU, in exchange for significant export tax relief, Freeport has agreed to pay higher royalties on copper and gold sales and to provide a $115m assurance bond towards the construction of a local smelter. Freeport has also agreed to make provisions to divest 30% of its share capital to the Government and its nationals at a fair value.

Newmont, meanwhile, embarked on a divergent course, suspending operation of its Batu Hijau mine in June and filing for international arbitration in July. Newmont claimed the new export duties breached its original investment contract. Newmont’s Dutch majority shareholder filed a claim against Indonesia with the Centre for Settlement of Investment Disputes (ICSID), an independent arbitral panel, pursuant to the Netherlands-Indonesia bilateral investment treaty (BIT) on the basis that the new regulations are also in breach of the protections offered under the treaty. In late August 2014, however, Newmont discontinued its ICSID claim and announced it has concluded a MoU with the Government on terms similar to the Freeport MoU (although Newmont has committed a lesser sum of $25 million towards the construction of a mineral processing facility). Newmont’s strategy underscores how contractual and bilateral investment treaty protections not only provide legal recourse to foreign investors whose agreements have been breached, but also reveals how the threat of ICSID arbitration may serve as valuable leverage to foreign investors renegotiating mining contracts.

Freeport’s and Newmont’s agreements with the Indonesian Government signal a willingness to relax the new export and divestment rules, provided foreign investors commit to developing local smelters. While such agreements suggest that foreign mining companies can remain economic (though perhaps less profitable) under the new mining regime, significant investment towards Indonesia’s limited domestic processing infrastructure will likely be required.

Investment Protections

Early this year the Indonesian Government declared its intention to terminate, or allow to expire, all 67 of its BITs. BITs provide protections for foreign investments against certain kinds of conduct by the host state. Most BITs, including the Australia-Indonesia BIT, protect against government expropriation of investments without adequate compensation and require that laws which affect foreign investments be made transparent. Importantly, BITs also usually provide investors with a vehicle through which they can enforce these protections, namely, international arbitration. Contracting States may only terminate or renew BITs during fixed periods (stipulated in the BIT), after which ‘sunset clauses’ operate to insulate existing investors against risk for a further period, usually 10 to 15 years, post-termination. Moreover, most BITs require notification of termination to be provided one year prior to the date of termination. Indonesia’s right to terminate the existing Australia-Indonesia BIT, for example, next arises in 2022, following which existing investors can rely on the BIT protections until 2037.

Even if Indonesia opts to terminate its BIT with Australia, Indonesia will remain subject to its obligations under the 2010 ASEAN - Australia – New Zealand Free Trade Area (‘AANZFTA’). AANZFTA, which provides protections similar to the Australia-Indonesia BIT as well as a guarantee that foreign investors will be treated no less favourably by the host state than domestic investors. Moreover, like the Australia-Indonesia BIT, AANZFTA, too, allows Australian investors to commence ICSID arbitration in the event of breach. Accordingly, considerable scope remains for Australian investors, depending on their circumstances, to protect their existing and future Indonesian investments through various agreement and enforcement mechanisms.

Next steps?

To come within the protections afforded under the Australia-Indonesia BIT and under AANZFTA, investors need to structure to meet the threshold requirements for protection under the two agreements. Foreign investors should also seek specific contractual protection from the Government enforceable at international law to protect their investments from dilution by future government moves towards resource nationalisation.

Laos

Emerging opportunity

We are seeing a significant increase in interest from our clients, at investing in Lao People’s Democratic Republic (‘Laos’). With US$4b of investment in the hydroelectric industry it aims to be the ‘battery of Asia’ by 2020. There are currently plans for around 100 new hydropower plants with a number of international companies expected to invest. Laos provides significant incentives for foreign investors, although the implementation is at times uncertain. The Government takes particular interest in promoting the interest of local communities and we’re seeing investors find strategic ways to structure partnerships with local communities.

Foreign investment promotion

Foreign investment in Laos is governed by the Law of Investment Promotion, 2009 (IPL). Aptly named, the IPL provides investors with rights and protections to incentivise foreign investment. Two important features are tax incentives and a legal regime that protects against seizure, confiscation or nationalisation. Tax incentives are provided for certain sectors and increase with the remoteness of the area invested in. Special Economic Zones also exist with incentives such as exemptions from leasing fees, exemptions from VAT or excise tax and ‘tax holidays’.

For ASEAN-based companies extra protections are afforded under the ASEAN Comprehensive Investment Agreement 2009. This agreement provides for ‘most favoured nation’ treatment for intra-ASEAN investors and a framework for dispute resolution for covered investors.

Realities of investing in Laos

Despite these protections and incentives in the IPL, as with all developing economies, not all legal issues are certain in Lao. Some laws are unclear as to their meaning or application and the Government makes use of decrees, regulations and directives to clarify or place interpretations on laws. Where there are not yet any implementing regulations the implementing ministry has significant discretion. This discretion is heavily influenced by community pressures.

The result of this is that regulation is particularly stringent in certain sectors, in particular those which operate by government concession. Concessions are used in the areas of mining, telecommunications, transportation, electricity and plantation agriculture. Investment approval is required for foreign investments involving concessions. There is no specific guidance on the approval process for this application. In addition to gaining special approval a foreign investor is generally required to give the government a negotiated equity stake in the project company. In some instances, local government approval is packaged together with a requirement that the investor engages with the local community. This can include building local infrastructure such as roads and power lines or an obligation to employ local workers up to a particular threshold in projects. In the mining sector the government has a statutory right to participate in up to 10% of the shareholding of a mining company. Payment for shares by the government may be made by way of deducting dividends payable to the government or in cash depending on the agreement. Recently the government has sought to claw back rights under concessions to foreign-owned mines it considers were too generous. Even though there are sometimes not specific rights to do this, onerous licensing and authority requirements imposed on foreign entities are used as leverage in such dealings.

Mining sector restrictions

In addition to the usual regulatory challenges, investment in mining faces some sector-specific hurdles. In July 2012 the Laos Government announced a 4 year moratorium on any new mining investments. For existing projects, and those already approved, companies are prohibited from transferring shares during the prospecting phase. After this phase any merger and acquisition activity requires approval from various government ministries. Critically, approval is not required where the parent company of the concession entity is subject to a change in control in a foreign jurisdiction.

At the termination of a mining operation the government has a right to the concession area and mining assets, including geology and mineral source data, vehicles, materials and equipment, without compensation. Under Laos law, land cannot be owned. Individuals and entities are granted long-term rights to use the land and upon expiration of the term, all fixtures revert to the state without compensation. However, a concession agreement for exploitation has a maximum initial term of 20 years with a maximum possible extension of 5.

Foreign exchange control

Foreign investors in Laos are subject to strict foreign exchange and capital control rules. The Bank of Laos’ approval is required for a number of transactions, including:

  • Paying or receiving foreign exchange for goods and services within Laos
  • Settling debts in foreign exchange within Laos
  • Derivative transactions
  • Payment of foreign-source loans
  • Remittances
  • Transfers into Laos
  • Use of offshore bank accounts.

Dividends to foreign shareholders are subject to a mandatory reserve of 10% of annual net profit. They are also only payable if the company’s tax and labour payments have been fulfilled and the company does not have accumulated losses.

Next steps?

We expect that with the rapid increase in investment in Laos, the regulatory environment will evolve. We are keeping a close eye on this exciting emerging market and would be delighted to discuss your interest. Please contact one of the contacts listed below.

Key Contacts

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