Rio Tinto Says Oyu Tolgoi Remains on Track

Representatives at Rio Tinto denied reports today that they were planning to suspend construction at Mongolia’s US$6.2 billion copper-gold mine at Oyu Tolgoi. The firm reiterated that it is on course to start production by the middle of this year.

The comments came in response to reports that Rio was considering halting construction in response to the government’s demand to renegotiate the ownership of the mine and impose new royalties.

“The power is secured, first ore produced and the concentrator switched on and we are on schedule for first commercial production in the first half of the year,” Rio said, speaking on Thursday, “we continue to work together with all stakeholders including the government of Mongolia to bring the benefits of Oyu Tolgoi to all parties.”

The mine, which accounts for a third of Mongolian GDP, has been subject to much controversy of late, as the Mongolian government has twice attempted to renegotiate the terms of the contract in the last two years.

Currently, the Mongolian government owns 34% of the mine, with the remaining 66% being owned by Canadian listed Turquoise Hill Resources, itself controlled by Rio Tinto.

The move by the government to attempt to renegotiate the terms of the contract is further evidence of the resource nationalist sentiment that had been persistent throughout 2012. During the election campaign last year, some members of parliament promised to not allow foreign miners to exploit Mongolia’s tremendous mineral wealth.

In October 2012, Rio Tinto rejected Mongolia’s request to renegotiate the contract signed in 2009, after several years of negotiations.

Despite the uncertainty, Rio is adamant that it is on track to start production in the first half of this year. The mine is expected to produce 74,000 tons this year, accounting for 1.1% if Rio’s forecast net profit. Given this, the conclusion from analysts is that a delay would not trigger a profit warning for the mining giant.

No IPO for Erdenes-Tavan Tolgoi in 2013

The giant Mongolian coking coal deposit will not list this year due to financial difficulties, according to its chief executive of development.

Speaking to Reuters, Batsuur Yichil, the head of the state-owned firm controlling the project said  “E-TT (Erdenes Tavan Tolgoi) is facing ... financial difficulties. That's why we stopped our coal transportation and export,” He then added that the government would provide assistance to help the firm repay its debts.

Along with the copper and gold mine Oyu Tolgoi, the 7.5 billion ton coking coal deposit has been a key factor in Mongolia’s recent headline grabbing growth figures. Mongolia was planning to list the eastern section this year however, Batsuur confirmed yesterday that these plans have been suspended.

Batsuur cited poor market conditions as another reason to delay the listing process. “We have decided to wait until the market recovers, the price of coal increases and until E-TT starts regular construction of its wash plant. Plus, we need to increase our exports”

It also emerged that E-TT are trying to renegotiate the cost of sales deal with Chinese state owned Chalco, after the project was forced to suspend shipments to China this month due to high transportation costs.

The Mongolian government has pledged to provide a $355 million loan to E-TT, which he said might be used to help it exit an agreement to supply to China.

E-TT main creditor Chalco, is owed $180 million by the project as part of a supply contract signed in 2011. Within the terms was an agreement that E-TT could pay the $250 million lent to them by Chalco in coal or cash.

The mine’s financial troubles stem from the government’s pledge to issue each Mongolian citizen with 1,072  shares in the mine in an effort to allow the public to participate in the mining wealth. 

Last year, amid numerous delays in listing and a fast approaching election, the government initiated a buyback scheme in which citizens could trade their shares for MNT 1 million ($760).

In a country where per capita income is around $3,000, the buyback program saddled the government with a $1 billion bill, at a time when E-TT itself was unlisted and barely breaking even. In an effort to recoup the losses the government forced E-TT to front most of the cost.

As well as negotiating with Chalco, E-TT is in discussions with the government of Mongolia over a sizeable loan, which would ensure that the mine is able to continue its development.

Investment Funds in Mongolia

A great way to invest into the burgeoning Mongolian economy is through a fund. In this blog I will assess the legal and economic environment of investment funds in Mongolia.

Investment funds provide a means for investors to aggregate their savings of relatively small sums of money for investment by professional asset managers. In countries with developed financial markets, there are usually hundreds if not thousands of investment funds. This may be the best way for ordinary individuals who are not financial and securities market experts to invest their savings in the capital markets and participate in Mongolia’s economic growth. For intelligent investment in some securities, minimum amounts must be invested which are larger than ordinary individuals could invest or should invest to be able to diversify their investments in different asset classes which is a fundamental principle of investments in securities

Available assets for investment

The key issue for the feasibly of establishment of investment funds in the near term in Mongolia is eligible assets for investment fund investment. The availability of investible assets in the near term is problematic. There are an insufficient number and volume of liquid equity securities listed on the Mongolian Stock Exchange and there is no real market in the few listed corporate bonds. There are government bonds that could be bought by investment funds, but this would have a more limited benefit to the economy than corporate finance.

There are attractive investment opportunities in non-listed companies. However, the interest of such companies in having investments from the new investment funds and the liquidity of such investments are not apparent. Regarding the interest of the companies, investment funds could not bring the indirect business opportunities of many other investors. Regarding liquidity, some unlisted companies by their charter or a shareholders’ agreement require that their shares be held for a number of years or that they may be sold in the first instance only to existing shareholders. If the shareholders are not interested in acquiring more shares when they have intimate knowledge of the company, it would be difficult to find other investors to purchase the shares of that company held by an investment fund or at an attractive price. 

There is also much competition by private equity funds with foreign investors for equity investment in and lending to profitable non-listed companies so the opportunities for investment fund investment in such companies would be limited for this reason as well. Investment funds would be permitted to invest some portion of their assets in equity and fixed income securities listed on major foreign stock exchanges but this would have limited benefit for the Mongolian economy.

Regulation and supervision

The Law provides for investment fund sponsors, which are banks or securities brokers, to organize investment funds. Investment fund investment portfolios would be managed by banks or securities brokers that have an assets management capability and are not affiliated with the fund sponsor. Investors would invest in investment fund “units” which are a type of security and would be sold pursuant to the issuance of a prospectus containing comprehensive information about a fund’s administration, governance, risk factors, and how investors may sell their units.

The Law contains general provisions for the regulation and supervision of investment funds. In addition, since investment fund units are securities and at least some funds will have securities brokers as sponsors or investment fund portfolio managers, the administration and management of investment portfolios of investment funds will be supervised under the securities law by the Financial Regulatory Commission (FRC) since securities brokers are licensed under that law. In addition, the central securities depository and sub-custodians of investment fund assets will also be subject to FRC supervision.

The Law is consistent with the IOSCO Principles for Collective Investment Schemes. The IOSCO Principles have three general objectives: the protection of investors; ensuring that markets are fair, efficient and transparent; and the reduction of systemic risk. The Principles for Collective Investment Schemes, which the Law includes as well as many others, include:·        
 -         Segregation of investors’ assets
·         Disclosure of information to investors
·         Suitability for investors of investment fund investments
·         Rules for redemption of investment fund investments


Legal form of investment fund

With respect to the form of an investment fund, a new legal entity of a fund is recommended as the entity which has the least cost of administration since investors pay for the administration expenses of a fund and such costs reduce the return on their investment. However, Article 33 of the Civil Code provides:

33.1. Profit-making legal persons shall be established in the form of partnership or company.
33.2. Non-profit juristic persons shall be established in the form of association, foundation or cooperative.

These provisions are at variance with international practice and reflect inappropriate central planning. Reportedly in Mongolian “foundation” and “fund” is the same word although the meaning can be quite different since there are many types of funds but foundations usually have a charitable or public benefit connotation. The basic formalities for the administration of limited partnerships or companies are relatively costly and can be very costly if shareholders or partners challenge the administration of these entities. In addition for companies, certain provisions of the Companies Law are unsuited to investment funds or could considerably complicate the business of an investment fund. These are in Articles 5, 15, 17, 30, 62, 87, and 88. Thus, these forms of business for an investment fund should be avoided.

There are three alternative possibilities to consider to overcome the obstacle of Article 33:

·         The law could provide that Article 33 of the Civil Code is not applicable to investment funds for which there reportedly is precedent in exemption from certain articles of the Code in other laws. The Civil Code could also be amended to remove the arbitrary provisions of Article 33.
·         A fund could be a contractual relationship between investors and fund sponsors by which the fund sponsor would arrange for the management of common investment portfolios on behalf of investors. Different portfolios would have different investment strategies.
·         A fund could be in the form of a trust, a new type of legal entity. This would require the enactment of a trust law but by the time market conditions are conducive for investment funds in Mongolia for investment in Mongolian debt and equity securities, a trust law could be enacted. Trusts are also useful for development of the financial sector in other areas—pension funds, insurance, and securitization of financial assets. Trusts are the form of investment funds in several common law jurisdictions and some civil law jurisdictions have authorized trusts.

A possible fourth form for a fund would be an investment cooperative but this would be well beyond common practice and would not enhance the reputation of the Mongolian financial sector.

Foreign Direct Investment

Extraction of Mongolian mineral wealth, fueling impressive export performance, has been funded by aggressive foreign direct investment over recent years, which looks set to continue well into the future.

With the exception of 2009, where conditions were weakened due to international financial instability, total FDI flows to Mongolia, and the percentage of the country’s GDP they represent, have increased consistently on a yearly basis.

Inflows of $1.6 billion (representing 39% of Mongolian GDP) look set to be exceeded in 2012; World Bank data based on the first quarter results suggesting around $4.4 billion dollars (roughly half expected GDP) of internationally sourced funds are set to finance Mongolian enterprises.

Mongolia’s desirability as an investment location originally stemmed from interest in its under-utilized mineral wealth, combined with its reputation for democratic and stable politics, an investor friendly legal system, and an attractive tax environment. The OECD FDI Regulatory Restrictiveness Index measures statutory restrictions on foreign direct investment in 55 countries worldwide, based on data drawn from across 22 sectors. Mongolia’s rank of 0.096 represents an economy considerably more open for FDI than in many comparable macro investment cases; its score being lower than Russia’s 0.189, China’s 0.408, and both the Non-OECD and World averages.

The Oyu Tolgoi project, finalized after six years of negotiation in 2009, has spearheaded the development of Mongolia’s capital inflows. The single mine’s complex construction budget for 2011 alone is $2.3 billion (over 1/3 of the country’s 2010 GDP), as completion nears. The operations assembly is to be responsible for an estimated $7 billion of foreign capital inflows in order to bring it to completion; the single investment being accountable for an estimated 30% of Mongolia’s GDP. The example set by OT has whet investors’ appetites for high quality Mongolian mineral assets around the world, as inflows funding a diverse range of mining operations have begun to materialize from a range of international sources.

What are FDI inflow forecasts (by any body in both absolute terms and as a percentage of GDP) for 2012, 2013, and 2014?

APIP research estimates predict a stabilization of FDI flows over the coming years. Capital flows to the mining sector are set to decrease somewhat, as the first stage of Oyu Tolgoi is completed in Q3 2012 and the financing of operational equipment for the open pit mine begins to drop off. Despite this, investment in the country’s foremost mining project looks set to support growth well into the medium term. Development of the mines two capital intensive, high tech block cave mines are set to be in development until 2015 and 2017 respectively, whilst the financing of considerable infrastructural expansion if the capacity constraints currently limiting the mines efficiency are to be eased.

Any reduced FDI flows to mining operations are likely to be replaced by funds destined for a range of Mongolian industries extending well beyond the scope of the mining sector. Mongolia’s resource led growth has begun to spillover across the economy, stimulating the GDP generated by many industries.

As real GDP expanded by 17.3% in 2011 Mongolia’s financial services industry experienced double digit output growth, as credit requirements became increasingly sophisticated, demand for advisory services flourished, and the Mongolian Stock Exchange (MSE) grew by 57.8%. The APIP research department forecasts that these forces will continue driving growth over the coming years, alongside the development of the country’s fledgling insurance industry (which will need significant capital investment if it is to support the insurance of the country’s mines once they become operational).

Real wage growth across Mongolian society and the creation of something akin to a middle class fueled rapid growth in consumer based industries in 2011; GDP of the manufacturing sector increased by 16%, whilst the retail trade increased revenues by a staggering 42.3% (an increase on the 2010 growth rate of 39.3%). Changes in Mongolian consumer’s budget constraints appear to have been accompanied by rapid transformations in consumer preferences. As Mongolia’s population becomes more affluent, they increasingly desire Western branded goods as symbols of their personal wealth. These consumer conditions have seen foreign investment in Mongolia’s consumer sector draw in brands from across the mid-to-luxury global market including: Hugo Boss; Louis Vuitton; Coca Cola; Porsche; Timberland; Monte Blanc; Yves Saint Lauren; Calvin Klein; Swatch; Swarovski; Burberry; Emporio Armani; L’Occitane; Emenegildo Zegno; Tommy Hilfiger; Adidas; Shishedo; Dior; Samsonite and BMW. With Mongolia’s growth forecast to continue at a similar, if not a greater rate than has been witnessed at present, the APIP research team are in consensus is that the retail industry will at the very least continue on the same trajectory, potentially gathering even more momentum as the country’s mines become operational.

As increased information concerning the Mongolian growth story filters through investors worldwide, FDI flows to increasingly diverse industries are to be expected. The FDI gap created by the completion of the first stage of OT production looks set to open in the short term, however APIP believes that an increase in the quantity of viable investments across the Mongolian economy, in combination with an increased investor appetite for exposure in the country should keep overall foreign capital flows at the very least constant in the medium term.

A Breakdown of Mortgage Policy in Mongolia

Overview:

As Mongolia continues to experience rapid GDP and population growth, the availability of affordable mortgage financing for people seeking proper accommodation in Mongolia is in high demand. Similarly, as Mongolia’s financial system deepens, housing finance emerges as an increasingly important part of the maturation of its financial system. In emerging markets, the maturation of financial systems appears to lead to the development of housing finance, and this deeper, more extensive financial system, in turn, contributes to higher rates of growth.

However, while the need for housing finance in Mongolia is obvious, the 40,000 homes project illustrated the country’s lack of a fully developed and reliable mortgage system. Many banks in Mongolia simply do not have the financial expertise to offer attractive mortgage loan packages or even provide the liquidity and the necessary legal framework to deliver the loans. Consequently, Mongolia’s mortgage market faces a variety of structural and procedural issues that must be resolved before ordinary Mongolians can have access to financing for house purchases and in turn contribute to Mongolia’s economic growth.

A Brief History:

The institutional structure of the present Mongolian housing finance market has been under development since 1997, when the Asian Development Bank and the Government of Mongolia initiated a drive to create legal and policy frameworks and standardized documentation for mortgage loans in Mongolia. However, the first loans were not offered until May of 2003 under the ADB’s Housing Finance Sector Program. Since then, the Government of Mongolia has enacted legislation such as the Mortgage Collateral Law and the Asset-Backed Securities Law as a means of regulating Mongolia’s mortgage market and more recently, has undertaken action to simplify origination processes and lower origination costs. In 2007, the Bank of Mongolia partnered with the National Statistic Committee (NSC) to develop a methodology for computing a Housing Price Index in Mongolia, which is computed on a quarterly basis.

Current Issues:

In order to support an efficient primary mortgage market, an incredible amount of progress needs to be made to improve the current mechanisms for property appraisal and credit risk assessment. Lack of information continues to hamper efforts to expand mortgage lending in Mongolia. For example, credit history information, which is stored by the Bank of Mongolia is extremely limited and is often out of date, making it hard for banks to measure the risk of their loans accurately. The Bank of Mongolia only carries information about the current status and not about loan performance and information from non-banking financial institutions is not stored, making it impossible to observe the history of a creditors utilities or telecom payment history. The debt to income ratio (ratio between monthly mortgage repayments including insurance and taxes and gross monthly income) is used to analyze a borrower’s capacity to repay a mortgage loan, yet there is no uniform method of calculating this. For foreign citizens, housing finance in nearly impossible to find, as the majority of commercial banks have policies that explicitly restrict lending to foreign citizens.

Before mortgages can become affordable the real estate market must also adapt by developing professional surveying and valuing services that will underpin a market undergirded by fundamental property values as well as supply and demand dynamics to provide extra security for lending institutions. Furthermore,  the sanctity of property rights should be reviewed to make it easier for banks to foreclose on property attached to defaulted loans. Without the assurance of being able to foreclose on immovable property most commercial banks are unwilling to risk lower interest rates as in the event of default they presently have little certainty of obtaining a collateralized property asset. Although great breakthroughs have been made in recent years, much work is still need in order to make foreclosure a simple and dynamic process.

The Secondary Mortgage Market:

The development of the secondary mortgage market through the establishment of the Mongolia Mortgage Corporation (MIK) in 2006 is one way the Government of Mongolia is attempting to provide increased access to housing finance. By issuing bonds on foreign and domestic markets, MIK will provide long-term funds to the Housing Finance Sector (HFS). The current shareholders of the Mongolian Mortgage Corporation are Bank of Mongolia and nine commercial banks. In 2009 MIK was approved to issue 25 Billion MNT in securitized mortgage bonds, 6.3 billion of which were sold between 2009 and 2010.

The market for MIK bonds is small since the main investors are all banks and there is a distinct lack of institutional investors. There is also an absence of rating agencies and a market based yield curve, as well as no constant issuance of government bond. The premise of mortgage securities in on the existence of supportive legal and regulatory framework, sizable and standardized primary mortgage markets, and well-developed bond markets. Specialized lenders can create efficiencies; however they need an external funding source such as a government lending window or secondary market. Their viability will ultimately depend on the willingness of investors to buy mortgage-backed securities and provide short-term funding, which in turn depends on their confidence in the credit quality of the underlying assets.

The potential benefits of a highly successful secondary mortgage market are many. Primarily, the MIK has the ability to raise large funds for subsidized housing finance, such as the 100,000 Homes Project, as well as increase the liquidity and efficiency of the housing finance system. If executed correctly, a thriving secondary mortgage market can even lower interest rates by encouraging the development of a new industry of loan originators.

Conversely, a major challenge for MIK in the next two or three years will be to preserve and enhance its private-sector-led status. Given the failure of government-created agencies to promote housing, MIK may become an attractive target for GOM investment and control. Current shareholders will have to decide whether to move more aggressively to enhance MIK’s current preeminent market position by, among other things, developing and issuing investment- grade mortgage-backed securities or losing control.

Conclusion:

The experience of the 1990s suggests that the provision of housing finance can exacerbate macro volatility. The volatility of housing prices and the potential for a boom-bust is higher if the housing supply is severely constrained by land access and urban regulation problems, which is an issue considering the short supply of land in UB with access to critical infrastructure. Going forward, the Government of Mongolia must also enact mechanisms to ensure the transparency of housing finance processes as well as create a more elastic supply of housing in order to reduce the probability of adverse real estate cycles and sharp run-ups in house prices. A strong but nimble and delimited public role in sector development is critical for the deployment of the measures.

Certainly, the extension of mortgage markets also relies upon a well functioning secondary market, which will rely on the ability of MIK to prepare and sell mortgage backed securities. The regulatory framework governing mortgage providers must also improve drastically if commercial banks are to eliminate some of the risks that push up interest rates on mortgages. These requirements are presently being worked through by the Government of Mongolia in cooperation with several multilateral organizations in order that Mongolia’s mortgage market can fuel growth in the property sector and contribute a solution to Ulaanbaatar’s housing shortage.

A stable, growing economy will encourage the growth of the housing finance system through lower inflation, lower interest rates, and lower systemic risk. In this evolutionary perspective, beyond a certain level of per capita income, housing finance will emerge with household demand for it; that is, as long as the macro, legal, and housing-market regulation environments are conducive to its emergence. In such cases, a virtuous circle can emerge as growth if the financial system promotes overall economic growth, and this higher growth, in turn, will encourage both further financial-sector and housing-finance development.


If you’d like to learn more about news in Mongolia, visit Mongoliana, Mongolia’s premier news source for all things Mongolia. If you’re interested in investing in real estate in Mongolia, check out Mongolian Properties, Mongolia’s leading property developer and real estate agency.

Village @ Nukht Construction Update

Construction at the Village @ Nukht site is underway. Rapid progress is being made on the new buildings, located 500 meters south of Nukht's gated community. The development will feature 10,000 sqm of retail, dining, entertainment, and office space and is set to be completed by the beginning of 2013. Check out the pictures of the site below:

The Mongolian Properties agents pose for a picture

Josh Haines, APIP's new COO is overseeing the construction

On the existing building, the doors and windows have been set and the exterior facade is underway

Excavation is underway for the 3rd building

The footings have been set here

The footings have been finished and the columns are being set

If you’d like to learn more about news in Mongolia, visit Mongoliana, Mongolia’s premier news source for all things Mongolia. If you’re interested in investing in real estate in Mongolia, check out Mongolian Properties, Mongolia’s leading property developer and real estate agency.

Assessing the Coalition Government

With large resource projects set to go live in the near future, the new Mongolian government is to oversee the most crucial period in Mongolia’s post-communist history.

After winning 31 out of 76 seats in the Mongolian parliamentary elections on June 28, the Democratic Party has announced that it has successfully formed a majority coalition with a number of smaller parties. The Democratic Party was formed as a unification of many pro-democracy factions in the early 1990s, after the fall of the Soviet influenced socialist state. Despite this recent election triumph, the Democratic Party is historically seen as the weaker of the two major parties with its pro-business ideology.

The next biggest party in the coalition is the controversial Mongolian People's Revolutionary Party (MPRP), a splinter group from the old communist party, led by Nambaryn Enkhbayar. Enkhbayar was arrested before the election on corruption charges and is scheduled to be tried at the end of July, although this date has already been subject to a series of delays. In contrast to the Democratic Party, the MPRP holds an aggressive stance on Mongolia’s resource ownership, believing that deposits should be nationalised. This will undoubtedly worry investors that the new government will not be as welcoming to foreign investment especially as, according to analyst forecasts, the MRPR are set to take control of four or five of the eighteen ministries on offer, most notably the Finance Ministry, which would see them overseeing the country’s investment agenda.

Although these two parties seem an unlikely fit for collective rule, the Democratic Party has made it clear that the coalition partners must follow their lead. Despite this statement of intent to make the new government their own, much heated debated can still be expected on how to govern the country over the coming years. Most of this will be centred on managing the country’s vast mineral wealth and appropriately investing the money that comes in as the deposits are extracted.

As with all coalitions, there is a threat that the decision-making process will be fragmented. The Democratic Party itself is comprised of many different factions, some more radical than others, and the coalition partners could pose problems. The opposition Mongolian People’s Party (MPP), on the other hand, enjoys a consolidated, experienced group of political veterans ready to pounce on the Democratic Party should they falter over the next four years. 

At present, Mongolia is still heavily dependent on foreign investment however, when the mining projects at Tavan Tolgoi and Oyu Tolgoi are running at capacity, it is thought that they will be able to run independently. The next four years will undoubtedly set the precedent for the coming decades and thus determine the success of the transition to financial independence. In order to achieve success, the Democratic Party must prove that they can spend mining revenues responsibly in order to address important campaign issues such as education, infrastructure and wealth distribution.

The new prime minister, Norov Altanhuyag, an ex-physics professor-turned-revolutionary in 1989, speaks calmly and confidently with well-rehearsed words; "In the last four years we have just started to use our mining resources, but the coming four years is a tipping point," says Altankhuyag. "We have huge discussions on how to use the mining wealth." 

Strong, pragmatic decision making from the coalition will be crucial in securing a period of sustained growth and a bright future for Mongolia.

If you’d like to learn more about news in Mongolia, visit Mongoliana, Mongolia’s premier news source for all things Mongolia. If you’re interested in investing in real estate in Mongolia, check out Mongolian Properties, Mongolia’s leading property developer and real estate agency.