Attracting foreign investment to Mongolia the motivation for new laws

With the dramatic decrease of foreign direct investment (FDI) over the past year or so, Mongolia’s lawmakers have done much – including consulting with various stakeholders – to kick-start the economy. A number of new laws and regulations have been passed in the hope of creating a legal framework that will be more appealing to foreign investors.

As may be expected in a fast-growing emerging market, Mongolia’s legal framework – like many other aspects of Mongolian society – is in a constant state of flux. Because foreign investors tend to crave legal certainty, this may initially appear to be a weakness of the country’s legal system.

However, investors should take comfort in the fact that over the long term, changes to Mongolia’s legal system tend to be in the right direction, i.e., towards more stability, predictability and openness in order to attract a greater amount of FDI.

Mongolia’s constitution was enacted in 1992 and is the primary source of Mongolian law. The country’s private law is largely based on the Germanic Civil Law model, and those who are familiar with the German BGB (or the civil codes of other jurisdictions which are based on the German model) will find numerous similarities in both style and substance to Mongolia’s Civil Code. The Civil Code of Mongolia, which was enacted on January 10, 2002 (as amended from time to time), is the cornerstone of Mongolian private law. The Civil Code is the primary source of private law norms, and contains the rules on property, obligations (including contract law), inheritance and private international law.

Much of Mongolia’s Civil Code contains principles which will be familiar to jurists elsewhere. The concept of freedom of contract is enshrined in Article 189 of the Civil Code, and specific rules governing nominate contracts, such as the sale of goods, services for hire, loans and leases, are covered therein.

Because the country’s legal system is based on the Civil Law tradition, strictly speaking case law does not form a primary source of law. However, decisions from Mongolian courts – and particularly the Supreme Court – are being used more frequently to explain and elaborate on specific provisions of the Civil Code and other statutes. In this way, rulings from judges are becoming more predictable, thereby increasing legal certainty.

Companies & Investment Vehicles

The Company Law of Mongolia, enacted on October 6, 2011, outlines two forms of companies which have full legal capacity: the limited liability company (LLC) and the joint-stock company (JSC).

Shares in an LLC tend to be privately held, whereas those in a JSC are either listed publically on the Mongolian Stock Exchange (an Open JSC) or deposited for private trading at a securities depositing organisation (a Closed JSC). The LLC has far fewer requirements mandated by law in terms of corporate structure or governance and, as such, tends to be the preferred vehicle for foreign investors.

A foreign company that wishes to have a full-time presence in Mongolia may also establish a representative office. The key distinction between an LLC and a representative office is that the former has a distinct legal personality (meaning, among other things, that it may enter into contracts in its own name), whereas the latter is simply the representative of the parent company.

Representative offices work well in certain industries, such as insurance and banking, but are more limited in other sectors, as they cannot generate revenue in their own name.

Land Ownership

Ownership of land is restricted to citizens of Mongolia and the state. Foreign citizens or foreign-invested companies can own immoveable property (other than land), so long as the land on which it sits is subject to a valid land possession or land use certificate.

Business entities with foreign investment can obtain land use certificates outlining the purposes and conditions of the land use. Further, each Mongolian citizen is entitled to ownership of a plot of land for family usage, the size of which depends on its location, which is to be granted by the state.

Currency Controls

The Law of Mongolia on Conducting Settlements in the National Currency (the National Currency Law) requires all domestic transactions to be expressed and settled in Mongolian tugriks (MNT).

Transactions in which one of the parties is located abroad are not affected by this law, and certain additional transactions carried out by banks and non-banking financial institutions are also exempt from this requirement. In addition to settlement being made in MNT, purely domestic contracts must also express figures in MNT.

The biggest impact the National Currency Law tends to have on foreign investors occurs when employing expatriate staff, as salaries must lawfully be expressed and paid in MNT. Mongol Bank, the Central Bank of Mongolia, as well as the Financial Regulatory Commission (FRC), are charged with enforcing the National Currency Law.

Adoption of the Investment Law

In November 2013 the Mongolian Parliament adopted the long-anticipated Investment Law, which replaced the former regime in place for foreign investors operating in Mongolia.

In the same act of Parliament, the former Foreign Investment Law and Strategic Entities Foreign Investment Law (SEFIL) were both repealed. The SEFIL in particular had been widely blamed for the drop in FDI since its inception in May 2012.

Although the Investment Law cut out much of the red tape which had been in place during the previous regime, it has yet to bear fruit in the form of an increase of FDI. This has less to do with any particular weakness in the law itself than a reflection of other factors which are presently damaging the Mongolian economy, such as weaker global commodity prices, and the ongoing dispute between the Mongolian government and Rio Tinto over the Oyu Tolgoi project. The jury is still out regarding whether the Investment Law will prove to be an effective legal platform on which to facilitate FDI.

Mining Legislation

As mining continues to be the driving force of Mongolia’s economy, the legal framework in the mining sector is of vital importance. The most significant piece of legislation in the mining sector is the Minerals Law of 2006 (as amended from time to time).

The Minerals Law was amended on July 1, 2014, bringing a number of positive changes which should eventually help in attracting further investment. The amendments to the Minerals Law will be discussed in greater detail below.

The Minerals Law lays out the framework whereby companies, both domestic and foreign, can obtain exploration and mining licences.

Pursuant to the Minerals Law, a holder of an exploration licence is granted the exclusive right to obtain a mining licence if the holder deems the mineral deposit to be commercially viable.

Exploration licences are granted for an initial term of three years, with the possibility of extending the term for an additional three years three times, with the exception of exploration licences for radioactive minerals. Mining licences are valid for an initial term of 30 years, with the possibility of extending the term for an additional 20 years twice.

The Minerals Law outlines rules concerning what are deemed “strategically important deposits”, and allows the state the ability to acquire certain ownership interests in companies that are exploiting such deposits. If state funding was used during the exploration phase, the state may purchase up to 50% of the shares in a company exploiting the deposit. If no state funding was used, the government still has the right to acquire up to a 34% interest in the company conducting the mining activities.

After a great deal of deliberation and consulting with various stakeholders, the country’s parliament, the State Great Khural, adopted certain amendments to the Minerals Law on July 1, 2014. Many of the amendments to the statute were based on the State Minerals Policy, which was adopted prior to the passage of the amendments to the Minerals Law. The important amendments to the Minerals Law adopted on July 1, 2014 include the following:

• The amendments to the Minerals Law establish a National Geological Office, which is charged with conducting “geological cartographic, geophysics, geochemical and hydrogeological and geoecological mapping and research on the territory of Mongolia”. (Article 11 of the Minerals Law);
• The maximum geographical size of an exploration licence was reduced from 400,000 ha to 150,000 ha (Article 17.4 of the Minerals Law);
• The maximum term for exploration licences (including all possible renewals) was extended from nine years to 12 years, with the exception of exploration licences granted for radioactive materials (Article 21.1.5 of the Minerals Law); and
• Mining Licence holders are now required to give priority to domestic taxpayers when procuring goods and services (Article 35.9 of the Minerals Law). Also on July 1, 2014, Parliament adopted the Law of Mongolia on the Repeal of the Law on the Prohibition of Granting Exploration Licences.

Until this law was passed, there had been temporary moratoria on the issuance of new exploration licences since 2010, stemming from investigations into corruption at the Minerals Resources Authority of Mongolia.

Repealing the prohibition on the granting of exploration licences is certainly a welcome move for the investment community, as it demonstrates the Mongolian government’s willingness to take steps to encourage economic growth.

Adoption of the Petroleum Law

On July 1, 2014, the State Great Khural adopted the long-awaited Petroleum Law, which governs both upstream and downstream activities.

The previous petroleum law was enacted in 1991 and had been seen as too anachronistic to attract meaningful investment in the oil and gas sector. Since Mongolia currently imports all of its finished petroleum products, improvements to the legal framework in this area are a welcome development.

The Petroleum Law outlines the process to be taken by companies seeking to obtain exploration and exploitation licences, as well as outlining the relevant licensing and royalty fees. Exploration licences can be issued for up to eight years (including extensions), and extraction licences can be issued for up to 25 years (including extensions).

Additionally, the Petroleum Law requires companies engaged in exploration works to set aside 3% of their yearly investment in exploration works annually into an escrow account. Companies engaged in extraction are required to set aside 1% of their yearly profits in escrow annually.

The Budget Transparency Law, or the Law on Glass Accounts

On July 1, 2014, the Budget Transparency Law, or the Law on Glass Accounts, was initiated and submitted to the State Great Khural by the president of Mongolia, Ts. Elbegdorj. The Policy and Action Programme of the President of Mongolia for 2013-17 set out, among other things, the objective of establishing transparency in accounting and financial practices of governmental ( budgetary) organisations and agencies by introducing a concept of a “glass account”, a transparent system of reporting on financial transactions of governmental organisations and agencies.

The Decree of the President of Mongolia of September 19, 2012, endorsed a National Mid- and Long-Term Policy Paper on Decentralisation through Direct Democracy and Citizen Participation. One of the policy goals of this document was to develop and adopt the Budget Transparency Law.

The Budget Transparency Law became effective from January 1, 2015. The provisions of this law apply to all governmental organisations, which includes ministries, governmental organisations, agencies, public educational and health institutions of all levels, state-owned press and media, companies and enterprises with state participation, as well as all companies and entities that are implementing state funded projects valued over MNT10m ($6000).

Pursuant to the Budget Transparency Law, all governmental organisations and agencies are required to deliver to the public all of its accounting and financial information, information on disbursement and disposal of budget/fiscal funds that are not related to state secrets or national security through its web page and/or noticeboards.

Prior to adoption of this law, governmental organisations and agencies tended not to divulge information related to disbursement and disposal of budget funds, using the excuse that such information is related to organisational secrets, despite the fact that disclosure to the public of financial and accounting information by governmental organisations was required under the “Law on the Information Transparency and Right to Information”. The Budget Transparency Law prohibits such actions.

The Budget Transparency Law enables citizens to control and monitor the spending of taxpayers’ money. By publicly reporting the financial decisions and stances on disbursement and disposal of fiscal funds, Mongolia will have established an effective financial prudence and accountability system. The law should not only help prevent corruption, bribery, abuse and misuse of public funds from those in official positions, but also increase public trust in the government and its officials, and help build a smarter, more responsible and accountable government.

Banking & Finance

As LLCs tend to be the preferred form of business entity, for both foreign and domestic investors, raising funds through the sale of a company’s equity has been somewhat limited in practice. In order to obtain financing, firms often resort to the more traditional forms of raising funds, such as asset-based secured debt financing. This is more time-consuming and costly for companies, and therefore raises a barrier to entry for organisations that wish to operate in Mongolia.

The only security interest over physical or intangible assets under Mongolian law is the pledge. Currently, there are only three forms of pledge which can be registered and therefore perfected: pledges over mining licences, immoveable property and shares in a JSC. For other pledges (e.g., over moveable assets), the timing of when the contract was concluded will determine priority ranking.

The need for a developed legal framework for secured transactions involving security interests over moveable property has been present for some time, although legal reforms have yet to materialise. In 2013 the Ministry of Justice formed a working group comprising academics, judges and other professionals to examine how to implement changes in this area and propose a draft law to be considered by Parliament. Although Parliament did consider the above proposed law, at time of press no new statute has been adopted in the area of moveable property pledges. For the immediate to short-term, conventional debt financing remains the lone option for many businesses. The adoption of a law on the registration of moveable property pledges would have a significant positive impact on the ability of Mongolian firms to obtain financing.

Securities Market

In May 2013 the Parliament adopted a number of amendments to Mongolia’s Securities Law, which came into force at the beginning of 2014. To date, Mongolia’s securities market has been limited by the legal framework necessary to monitor and regulate the trading of securities.

The revised Securities Law introduces a legal regime which will provide greater transparency for investors, as well as granting more authority to the FRC to enact regulations and oversee the securities market generally. Pursuant to its authority under the Investment Law, the FRC adopted a regulation on custodial licensing and custodial services in July 2014.

Although the Securities Law is generally seen as being a positive development, additional rules, regulations and legal concepts need to be adopted and further developed in order to make additional improvements to securities markets.

Investment Fund Law

In addition to the revisions to the Securities Law, Parliament adopted the Investment Fund Law in October 2013 which also came into force at the beginning of 2014.

The Investment Fund Law lays out the obligations on professional investors operating investment funds within Mongolia. As with the amended Securities Law, the purpose of the Investment Fund Law is to provide more transparency and predictability for investors, in the hope of providing a better regulatory framework for Mongolia’s capital markets.

Dispute Resolution

Although Mongolia’s rules on private international law specifically indicate that Mongolian courts can and will interpret foreign law, in practice, Mongolian judges are often quite reluctant to apply foreign law to disputes when seized. Moreover, given that cross-border disputes are a relatively recent development in Mongolia, many judges lack the experience necessary to rule on complex international commercial transactions.

Mongolian courts will generally not recognise judgments rendered in foreign jurisdictions unless a treaty has been concluded with the state where the judgment was rendered. While parties to trans-border contracts may wish to select the courts of their home state to have exclusive jurisdiction over any dispute, if that state does not have a treaty with Mongolia on the mutual recognition of judgments, any judgment rendered in that state would be difficult, if not impossible, to enforce in Mongolia.

For the above reasons, parties to international transactions tend to favour arbitration as the method of dispute resolution. Although Mongolia’s current arbitration law is somewhat rudimentary, it does include the competence-competence principle, meaning Mongolian courts will generally decline jurisdiction in disputes where the parties have an agreement to arbitrate.

Furthermore, Mongolia is a party to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958, meaning arbitral awards rendered abroad will generally be recognised and enforced in Mongolia unless one of the grounds for non-recognition as laid out in the treaty are met.

Presently, Mongolia’s Ministry of Justice is in the process of developing revisions to Mongolia’s arbitration law and the Code of Civil Procedure in order to incorporate international best practices.