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.