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Protecting mining investors’ rights

25 June 2012

Resource nationalism, a doctrine that advocates asserting state control of natural resources, often to the exclusion of incumbent foreign investors, is increasing and poses particular threats to investors in the mining sector.

Mining activities call for large up-front capital investments, with often considerable delay prior to seeing any return, and comparatively smaller investments later once production becomes profitable. These conditions create a ‘hostage effect’ to future intrusive regulation. Additionally, rising commodity prices incite governments to seek an increased share of mining profits. Profit-generating assets in the mining sector are therefore particularly vulnerable. 

Pursuing resource nationalism

Regulation affecting ownership of resources:
A state may enact regulations to control or seize profits generated by a foreign investor’s exploitation of a natural resource. These regulations often take the form of “windfall taxes” that deprive investors of a substantial portion of production, or the proceeds of its sale.
For example, in October 2011, Peru introduced a mining tax regime requiring mining companies to pay higher royalties on their earnings before interest and taxes, as well as a windfall profits tax on their net profits.
Similarly, in March 2011, South Africa introduced a royalty regime that levies a charge on foreign mining companies calculated as a percentage of gross sales. Reports are that Ghana plans to double royalties on mining. Australia has proposed a Minerals Resource Rent Tax, to apply from July 2012, that levies a 30% tax on the profits of iron-ore and coal extractors.
Alternatively, regulations might impose restrictions on foreign ownership or impose a degree of domestic participation. Both China and India have introduced legislation limiting foreign ownership of mining companies and have stated their intention to prohibit company structures used to circumvent these restrictions.
India has approved a bill obliging mining companies to pay an amount equal to the royalty they already pay to the government to displaced local people. Such regulations – often attempts to swell the state treasury – could render mining investment commercially unviable.
Interfering with exploitation rights:
States may also refuse to grant, or renew, a foreign investor’s authorisation to use an area or resource, often after the investor has invested a large amount of capital to develop the site. Similarly, some governments are perceived to interfere with the process of obtaining licences in favour of domestic mining companies.
Social empowerment movement:
States may take measures that affect mining companies in order to empower historically disadvantaged sections of the population. Zimbabwe requires targeted businesses to cede 51% of their equity to black Zimbabweans. South Africa’s government is coming under increasing domestic pressure to do the same.
Excluding international arbitration:
A state may give local courts exclusive jurisdiction over miningrelated legal conflicts, making the neutral forum of international arbitration unavailable to foreign investors. States may also withdraw from agreements beneficial to investments such as the ICSID Convention (which establishes a neutral and internationally protected forum for the resolution of disputes between foreign investors and states) or investment-protection treaties. Ecuador, Bolivia, and Venezuela have recently withdrawn from the ICSID Convention, thus reducing foreign investors’ recourse to international arbitration.
Protections for foreign investors:
There are two principal types of protection available against resource nationalism: contractual protections, such as stabilisation and arbitration clauses, and investment protection treaties between the host state and the investor’s home state.
Stabilisation clauses:
A significant change in the law of the host state affecting investment conditions can affect the financial viability of a project. A stabilisation clause is a contractual mechanism that attempts to protect foreign investors from such risk.
This is done either by attempting to “freeze” the investment conditions in place at the time an investment is made, or by allowing regulatory change, but imposing an obligation on the host state to maintain “economic equilibrium” with the investor through negotiations.
In order to benefit from favourable changes in the law, such clauses can provide for the application of more favourable subsequent legislation.
International arbitration:
It is undesirable to litigate a dispute between a foreign investor and a host state in local courts if the host state might improperly influence the process. Inserting a contractual provision that provides for international arbitration reduces that risk. Such arbitration clauses ensure disputes are resolved in a neutral forum by an impartial tribunal, and result in a binding, enforceable award. Alternatively, it may be possible to grant jurisdiction to the courts of a neutral country.
Investment treaty arbitration:
While states generally have a margin of appreciation to manage their natural resources and to make good faith use of their sovereign powers in the public interest, there are circumstances where resource nationalism will amount to a breach of a state’s investment treaty obligations.
First, if a state takes a foreign investor’s assets for public use, the investor is entitled to be paid adequate compensation. This is most often measured as the ‘fair market value’ of the investments. Not all expropriations involve a formal taking. An indirect expropriation does not affect any legal title held, but instead deprives the investor of the economic benefits of investment in a meaningful way, for example, through price caps or the unreasonable revocation of permits. Second, the obligation to treat investors fairly and equitably requires the host state to act in a consistent, transparent and non-discriminatory manner, in accordance with the investor’s legitimate expectations, and not to act arbitrarily or unreasonably towards a foreign investor. Thus, if a state arbitrarily and unreasonably revokes an investor’s exploration licence, the investor could invoke this protection in order to obtain compensation. Third, ‘national treatment’ provisions oblige the host state to treat foreign investors no less favourably than local competitors. Such clauses ensure that foreign investors can operate on a level playing. A ‘most favoured nation’ treatment clause requires the host state to treat the foreign investor at least as well as foreign investors from other states. This means a host state cannot treat more favourably a competitor from another friendly state, ensuring other foreign investors are not disadvantaged.

Act early


Risks arising from resource nationalism in the mining sector continue to increase. To maximise protection, tools such as those set out above should be considered from the earliest stages of the investment process. Only then can one negotiate contractual protections, or structure the investment to benefit from investment treaty protection. While resource nationalism risks may seem remote initially, early planning can bring significant benefits once mining assets become profitable – and potential targets of resource nationalism.

This article was published in Mining Journal on 2 March 2012.