Identifier
Created
Classification
Origin
09ULAANBAATAR119
2009-05-01 04:58:00
UNCLASSIFIED
Embassy Ulaanbaatar
Cable title:  

2009 MONGOLIA INVESTMENT CLIMATE STATEMENT

Tags:  ECON EINV KTTB MG OPIC USTR 
pdf how-to read a cable
VZCZCXRO4958
RR RUEHCN RUEHGH RUEHVC
DE RUEHUM #0119/01 1210458
ZNR UUUUU ZZH
R 010458Z MAY 09 ZDK CTG RUEHSD 0008 1221630
FM AMEMBASSY ULAANBAATAR
TO RUEHC/SECSTATE WASHDC 2808
RUEHOO/CHINA POSTS COLLECTIVE
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCPCIM/CIMS NTDB WASHINGTON DC
UNCLAS SECTION 01 OF 24 ULAANBAATAR 000119 

SIPDIS

STATE FOR EAP/CM AND EEB/IFD/OIA
STATE PASS USTR

E.O. 12958: N/A
TAGS: EINV, ECON, OPIC, KTTB, USTR, MG
SUBJECT: 2009 Mongolia Investment Climate Statement

REF: 08 STATE 123907

ULAANBAATA 00000119 001.4 OF 024


UNCLAS SECTION 01 OF 24 ULAANBAATAR 000119

SIPDIS

STATE FOR EAP/CM AND EEB/IFD/OIA
STATE PASS USTR

E.O. 12958: N/A
TAGS: EINV, ECON, OPIC, KTTB, USTR, MG
SUBJECT: 2009 Mongolia Investment Climate Statement

REF: 08 STATE 123907

ULAANBAATA 00000119 001.4 OF 024


1. As requested ref, post provides the 2009 Mongolia Investment
Climate Statement.

A.1 OPENNESS OF GOVERNMENT TO FOREIGN INVESTMENT

In its specific policies, laws, and general attitude, the Government
of Mongolia (GOM),supports foreign direct investment (FDI) in all
sectors and businesses. Its industrial and economic strategies do
not discriminate actively or passively for or against foreign
investors. Mongolia screens neither investments nor investors,
except in terms of the legality of the proposed activity under
Mongolian law.

Mongolian law does not discriminate against foreign investors.
Foreigners may invest with as little as US$100,000 cash or the
equivalent value of capital material (office stock, structures,
autos, etc.). In both law and practice, foreigners may own 100% of
any registered business with absolutely no legal, regulatory, or
administrative requirement to take on any Mongolian entity as a
joint venture partner, shareholder, or agent. The only exceptions
to this flexible investment regime are in land ownership, petroleum
extraction, and strategic mineral deposits.

Limitations on Participation in Real Estate, Petroleum Extraction,
and Strategic Minerals Deposits

Only individual Mongolian citizens can own real estate. Ownership
is currently limited to urban areas in the capital city of
Ulaanbaatar, the provincial capitals, and the county seats, or
soums. No corporate entity of any type, foreign or domestic, may
own real estate. However, foreigners and Mongolian and foreign
firms may own structures outright and can lease property for terms
ranging from three (3) to ninety (90) years.

Mongolian law also requires oil extraction firms to enter into
production sharing contracts with the government as a precondition
for both petroleum exploration and extraction.

In 2006, the Mongolian Parliament (State Great Hural, or SGH)
amended the 1997 Minerals Law of Mongolia. In doing so, it enacted
the concept of the strategically important deposit. The amendments
gave the Government of Mongolia (GOM) the right to obtain up to a
50% share of any mine on such a deposit. The 1997 law had no concept
of "strategic deposits" or state equity in mines.

The 2006 amended law defines "mineral deposit of strategic
importance" as "a mineral concentration where it is possible to
maintain production that has a potential impact on national
security, economic and social development of the country at national
and regional levels or deposits which are producing or have
potential of producing above 5% of total GDP per year." Ultimately,
the power to determine what is or is not a strategic deposit is
vested in the State Great Hural (SGH). For practical purposes, the
GOM currently seems to define these deposits as world class copper
and coal reserves and all deposits of rare earths and uranium.

If a mineral deposit is determined to be strategic and if the state
has contributed to the exploration of the deposit at some point, the
GOM may claim up to 50%. This applies to all exploration conducted
during the socialist era, primarily by Soviet geologists. If the
deposits were developed with private funds and the GOM has not
contributed to the exploration of the deposit at any time, it may
acquire up to 34% of the deposit.

State participation (or share) is determined by an agreement on
exploitation of the deposit considering the amount of investment
made the state; or, in the case of a privately-explored strategic
deposit, by agreement between the state and the firm on the amount
invested by the state. The SGH may determine the state share using
a proposal made by the government or on its own initiative using
official figures on minerals reserves in the integrated state
registry.

It is important to note that the state equity provision does not
seem expropriatory on its face as the GOM has committed itself to
compensating firms for the share it takes at fair market value.
Although experience is limited with the new law, so far the GOM has
honored this commitment.

ULAANBAATA 00000119 002.2 OF 024



Windfall Profits Tax on Copper and Gold

The Windfall Profits Tax Law of 2006 (WPT) has drawn criticism
regarding the GOM's commitment to creating an open, predictable, and
fair environment for foreign direct investment. The speedy
legislative process for passing the WPT was unprecedented. This
bill was passed in six days without any consultation with outside
stakeholders on any its provisions. The entire process has raised
concerns among investors about the stability and transparency of
Mongolia's legislative and regulatory environment.

In May, 2006, the SGH the WPT in an effort to: 1) assuage
wide-spread public fears that Mongolia was being stripped of its
mineral assets and 2) to increase revenues for new social spending
on pensions and children.

The WPT imposes a 68% tax on the profits from gold and copper mining
respectively. The WPT for gold originally kicked in when gold the
price for gold hit US$500 per ounce; however, in late 2008
Parliament raised the threshold to US$850. For copper, the
threshold is US$2,600 per ton. Mining industry sources claim that
the 68% tax rate, when combined with other Mongolian taxes, makes
the effective tax 100% on all proceeds above the copper threshold
price. In theory, the WPT proceeds are set aside in a special fund
for a combination of social welfare expenditures and a reserve fund.


Revisions of the Mongolian Tax Code

Problems with the WPT aside, major reforms to the Mongolian Tax code
in 2006 were designed to improve the business environment in
Mongolia for both foreign and domestic investors. Before the
reforms, a World Economic Forum survey of Mongolian business
executives cited tax rates and the complexity of tax regulations as
two of the top five problems for doing business in Mongolia. The
tax reforms benefited from two years of technical assistance from
USAID's Economic Policy Reform and Competitiveness Project (EPRC).
The reforms affected the Personal Income Tax (PIT) and Corporate
Income Tax (CIT) codes, as well as the VAT and excise tax codes.
(EPRC has a number of useful and informative guides on their
website: http://www.eprc-chemonics.biz.)

The old corporate income tax system's lack of a loss carry-forward
provisions as well as arbitrary caps on deductions for business
expenses discouraged investment; businesses could easily end up
owing tax, even if they lost money. The old law was so at variance
with world norms that it was a prime reason why foreign investors
sought tax holidays under stability agreements.

The new laws became effective January 1, 2007. In general, the new
laws reduce tax rates, flatten the tax schedule, remove
discriminatory loopholes and exemptions, and introduce appropriate
deduction opportunities for corporate investment.

The new corporate income tax law allows firms loss carry-forward for
two years after incurring the loss, potentially encouraging
investment and accommodating firms experiencing temporary negative
shocks. While most businesses approve of this provision, many note
that the two year carry-forward limit is insufficient for projects
with long development lead times, as is typical of most large-scale
mining developments. The new law allows firms to deduct more types
of legitimate business expenditures: training, business travel,
cafeteria expenses, etc. The new law levels the playing field
between foreign and domestic investors, eliminating the majority of
discriminatory tax exemptions and holidays (most of which favored
international investors).

Unfinished Business (Including Customs Rates)

There is unfinished business, however. Parliament was scheduled to
take up additional tax reform measures in 2007 but has not done so
and has made no substantive progress since. These measures include
revisions to the law on customs and customs tariffs. While the
exact nature of the proposed changes in the customs law has been
murky, the GOM states that changes will be consistent with
Mongolia's WTO obligations and investment climate enhancement
goals.

Despite overall solid, positive changes, international financial

ULAANBAATA 00000119 003.2 OF 024


institutions warn that last year's tax reforms by themselves are
insufficient to improve Mongolia's business environment. They
report that reform efforts need to go beyond changes to the tax code
to restructure the operations of the key agencies - the tax
department, the customs administration and the inspections agency -
that directly interact with private firms and individuals.

2006 Amendments to the Law on State Procurements

Amended in late 2006, the revised Law on State Procurement (LSP) has
two provisions that raise investor concerns. First, the new LSP
bars international competitors from participating in government
procurements under US$10 million, which covers 999 of the 1,000
projects budgeted for fiscal year 2007. The old law set a much
lower bar for participating in state procurements of about US$1
million. In addition, the amended law specifically exempts power
and transport projects from competitive procedures, as they were
under the terms of the old law. In these two sectors, ministries
may procure the services for the GOM by direct contracting for
projects under US$10 million and where local capacity is lacking.
Issues in the Telecom and Aviation Sectors

While the Mongolian government supports FDI and domestic investment,
domestic and foreign investors report that individual agencies and
elements of the judiciary often use their respective powers to
hinder investments into such sectors as meat production,
telecommunications, aviation, or pharmaceuticals. Investors report
similar abuses of inspections, permits, and licenses by Mongolian
regulatory agencies.

Abuses in Mongolia's telecom and information technology sector have
raised public and business concerns. The state-owned telecom
company, Mongol Telecom (MT) uses its regulatory and technical clout
to forestall or attack competition. As the monopoly supplier of
land-based lines through which much internet traffic flows, MT
charges predatory rates for access to all other Internet Service
Providers (ISPs) at a rate 10 times the charges assessed to the
state-owned ISP. These per-minute charges add up and are hard for
competitor ISPs to absorb. In addition, the GOM, in an effort to
make Mongol Telecom more attractive for privatization, is inclined
to make MT the sole portal for all telecommunication into Mongolia.
The apparent intent here is to require licenses for both
telecommunication services and technology, which only MT could
satisfy. There has been significant lobbying against this policy by
ISPs, voice-over IP providers, cellular rights holders,
multi-lateral organizations, and diplomatic missions as contrary to
Mongolia's own competition law and long-term interests. So far
these efforts have delayed the passage of any damaging legislation.

Compounding these problems are the non-transparent activities of the
Mongolian Information and Communication Technology Agency (ICTA),
which is charged with providing policy guidance to the Communication
Regulatory Commission of Mongolia (CRC). Companies report that this
agency routinely embarks on maneuvers that seem to have no basis in
law or regulation but that have hurt American interests, not to
mention those of other investors. For example, ICTA has attempted
to order internet service providers to charge set access prices,
without recourse to the market. Most recently this government
intervention has taken the form of setting floor prices for hook up
charges on wireless, voice over IP, etc., but without setting
ceiling prices for charges. The four big cellular providers
dominating the market favor this approach because it protects their
respective market shares. However, competitors cannot offer similar
services at a price that might undercut the market leaders, harming
and limiting consumers' rights to low cost communication
alternatives.

ICTA has justified these acts by claiming that these low-cost
providers would have offered services at such low prices that the
dominant Mongolian cellular providers would have been driven out
business, thus depriving the state of the benefits of cellular
service.

The state also involves itself in the domestic aviation sector.
Mongolia has two domestic service providers, the privately owned
Aero Mongolia and EZNIS. Government regulation recommends maximum
ticket prices that airlines may charge for all domestic routes, but
the law does not strictly forbid airlines from charging fees higher
than the state carrier. However, the GOM frowns on domestic
airlines that charge more for service. These state prices are well

ULAANBAATA 00000119 004.2 OF 024


below operating costs and inhibit the private carriers from charging
a break-even fee. However, the private carriers seem to have
decided to shake off GOM prohibitions and are charging rates that
might yield profits and support safe and efficient flying
arrangements.

State-owned MIAT formerly ran domestic operations which were heavily
subsidized, primarily through its foreign routes. This
state-subsidized competition with private carriers has inhibited
investors from participating in the provision of private domestic
service; and consequently limited the aviation products and services
that U.S. firms might sell into the Mongolian market. . However,
MIAT and the GOM have failed to upgrade the domestic air fleet,
letting it slowly wither. This tacit policy seems to have opened
the field for private investment into the aviation sector.

The Mongolian Judiciary and the Sanctity of Contracts

We find no concerted, systematic, institutional abuse specifically
targeted at foreign investment. In the case of the
judiciary-corruption aside (see A. 11 Corruption)-most problems
arise from ignorance of commercial principles rather than antipathy
to foreign investment. In principle, both the law and the judiciary
recognize the concept of sanctity of contracts. However, the
practical application of this concept lags, with both foreign and
domestic investors reporting inconsistent enforcement of contracts
by the judiciary. This inconsistency comes from the slow transition
from Marxist-based jurisprudence to more market oriented laws and
judicial practices. Recent decisions in banking and land use cases
in which contract provisions were upheld reflect a growing
commercial sophistication among Mongolia's judges. As more judges
receive commercial training and as Soviet era (1921-1990) jurists
retire, we expect to see the gradual improvement of the entire
judicial system.

Privatization Policies and Resistance of Mongolian firms to Foreign
Investment

Privatization policies have actually favored foreign investment in
some key industries, including banking and cashmere production. The
bidding processes for privatizations and other tenders have
generally been transparent, and after some legal disputes among the
winners and losers lasting from late 2006 through mid-2008, most
participants have accepted the results.

Foreign companies and investors are subject to the same legal regime
imposed on Mongolian domestic firms regarding incorporation and
corporate activities For example, casinos are illegal under
Mongolian law, and so, neither Mongolians nor foreigners may own or
operate them (except in one specifically designated free trade
zone).

Generally, Mongolian private businesses want foreign participation
in all sectors of the economy. They seek foreign partners and
equity. That said, some Mongolian businesses use Mongolian
institutions to stop competitors, if they can. These activities
represent no animus against foreign investment as such; rather, they
reflect individual businesses desire to keep competitors, Mongolian
or foreign, at bay.

Key Investment Laws

The Foreign Investment Law of Mongolia (FILM) transformed the
anti-business environment of the Soviet era into today's
investor-friendly regime. Under the old system, everything not
provided for in law was illegal. Because such economic activities
as franchising, leasing, joint venture companies were not
specifically mentioned in earlier Mongolian statutes, they were
technically illegal. In 1993, the GOM enacted FILM to legalize all
manner of foreign investment in Mongolia (amended in 2002 to allow
for representative offices and franchises). This law and subsequent
amendments define broad ranges of activity that would otherwise have
limited validity under Mongolian law. It also defines the meaning
of foreign investment under the civil code without limiting
activities that foreign investors can conduct. FILM also establishes
registration procedures for foreign companies. Specifically, the law
requires that any investment with 25% or more of foreign content
must register as a foreign-invested firm with the government. The
law creates a supervisory agency, the Foreign Investment and Foreign
Trade Agency (FIFTA),that runs the registration process, liaises

ULAANBAATA 00000119 005.2 OF 024


among businesses and the Mongolian government, and promotes in- and
out-bound investments.

In 2008, the Parliament of Mongolia amended the FILM. The stated
intent of the revision was to improve FIFTA's ability to track
foreign investment and to enhance the services provided by FIFTA to
foreign investors. The amendments apply only to investments
registered after the new law came into force in summer 2008. The
new law has raised the minimum level for new foreign investment from
US$1,000 to US$100,000 and imposed a series of requirements on
foreign investors seeking registration. Registered foreign
companies must now have FIFTA certify that their by-laws,
environmental practices, their technologies, etc., comply with
standards determined by FIFTA.

FIFTA officials admit that procedures are still under development
and that because they lack specific expertise in most of these
areas, they will have to consult with the relevant ministries and
agencies as they assesses each firm's request for investment
registration. FIFTA has also not clearly defined what the precise
processes it will use to evaluate investments, what the exact
standards will be for any given investment, how it will determine
those standards, and how an investor might seek redress if FIFTA
denies a registration request. Foreign investors have expressed
concern over what they perceive as FIFTA's broad and seemingly
un-transparent regulatory authority; however, we have not received
any complaint of abuse of these new powers to date.

New Ministerial Structure Impacts Foreign Investment
In early 2009, the Parliament re-organized the government structure
by combining various ministries and agencies in an effort to
streamline government functions. Relevant to foreign investors,
Parliament took trade policy and trade promotion functions that had
been vested in the former Ministry of Industry and Trade and FIFTA
respectively and merged them with the Ministry of Foreign Affairs.
The new Ministry of Foreign Affairs and Trade (MOFAT) has assumed
direct control all formulation and execution of trade policies and
promotion efforts, which includes export promotion and in-bound
investment efforts. FIFTA is now under MOFAT's direct supervision.

Ministry officials have stated that the government will concentrate
on promoting Mongolian exports and foreign investment into Mongolia.
They want FIFTA to resemble counterpart agencies in South Korea,
Japan, or the U.S.; and have told both us and businesses that they
plan to get FIFTA out of the regulatory business. The intent is to
limit FIFTA's activities to supporting business in their efforts to
work in Mongolia and to registering in-bound investment for purposes
of investment tracking only.
A.2 CONVERSION AND TRANSFER POLICIES

The Mongolian government employs a limited regulatory regime for
controlling foreign exchange for investment remittances and
maintains exceptionally liberal policies for these transactions.
Foreign and domestic businesses report no problems converting or
transferring investment funds, profits and revenues, loan
repayments, lease payments into whatever currency they wish to
wherever they wish. There is no difficulty in obtaining foreign
exchange, whether the investor wants Chinese Renminbi, Euros,
English Pounds, Rubles, or U.S. Dollars. The ongoing global
financial crisis has made dollars scarcer, with banks and
individuals reporting difficulties in exchanging into the currency.
This currency shortfall, however, appears to have occurred because
of challenging economic circumstances rather than policy changes.

The Mongolian government wants funds to flow easily in and out of
the nation, with one exception. Foreign-held interest bearing
dollar accounts remain subject to a 20% withholding tax. The bank
retains 20% of all such interest payments sent abroad, and remits
this withholding to the Tax Authority of Mongolia. Otherwise,
businesses report no delays in remitting investment returns or
receiving in-bound funds. Most transfers occur within 1-2 business
days or at most a single business week.

Ease of transfer aside, foreign investors criticize Mongolia's lack
of sophisticated mechanisms for converting currencies and parking
money. Letters of credit are difficult to obtain, and legal
parallel markets do not exist in the form of government dollar
denominated bonds or other instruments for parking funds in lieu of
payment. Many Mongolian financial institutions lack experience with
these arrangements. Moreover, Mongolian banking law currently

ULAANBAATA 00000119 006.2 OF 024


provides no secure statutory grounds for the activity to take place.
Banks may hesitate to use instruments that may be technically
illegal under Mongolian law. The immediate impact has been to limit
access to certain types of foreign capital, as international
companies resist parking cash in Mongolian banks or in local debt
instruments.
A.3 EXPROPRIATION AND COMPENSATION

Mongolia respects property rights as they apply to most asset types.
We detect no changes in policies, statutes, or regulations related
to the use and ownership of private property. Foreigners face no
legal bias in asset ownership (except that only citizens of
Mongolian may own land) or how they structure ownership. Foreign
investors need not seek local partners or share ownership of most
assets or endeavor as a condition of doing business. However, in
the crucial mining sector, with extensive foreign participation,
some note governmental actions that might represent "creeping
expropriation" coupled more broadly with some renewed "statist
tendencies," meaning gradual increases in government ownership of
and participation in Mongolia's economy.

Security of Ownership

Mongolia and the United States signed and ratified a Bilateral
Investment Treaty (BIT) which entered in force in 1997, and which
specifically enjoins both signatories from expropriatory acts
against private property and investments. In addition, both
Mongolian law and the national constitution recognize private
property and use rights and specifically bar the government from
expropriation of such assets. To date, the government of Mongolia
(GOM) has not expropriated any American property or assets. Thus,
we have no precedent from which to assess how the Mongolian system
would respond to seizure and compensation.

As can most governments, the Mongolian government can claim land or
restrict use rights in the national interest. Currently, this means
little, as most land outside Mongolia's urban centers remains
government property, as provided in Mongolia's constitution. The
government has no plans to privatize these vast countryside
holdings, but it leases parcels for such economic activities as
mining, pasturage, timbering, etc. This practice remains in flux
because the government must still determine how to let these rights
and what fees to charge. Except for mining, most foreign firms
remain inactive in these sectors.

Since May 2003, land in the urban areas has been privatized to
citizens of Mongolia or leased to both citizens and foreigners for
periods ranging from 3-90 years. The legislation and implementing
regulations are evolving, but so far investors believe that the GOM
generally respects recently enacted property rights and leases.

I: Implications of the Current Minerals Law

We closely watch the key mining sector, Mongolia's major foreign
exchange earner. The 2006 amendments to the Minerals Law have
several provisions that raise red flags for investors and observers
alike. The law does not allow the GOM to usurp rights to explore
and exploit natural mineral, metal, and hydrocarbons resources per
se. Instead, the amended law has imposed new procedural
requirements and extends new powers to central, provincial, and
local officials - new powers that, if abused, might prevent
mineral's license holders from exercising their exploration or
mining rights. The current law has the potential to deny the rights
holder access to his rights without formally revoking use rights. .

An example is the new tender process for apportioning some
exploration rights. The old law awarded exploration rights on a
"first come, first served" basis, a process that gave little
discretion to government officials to intervene. The new law lays
out a different procedure for obtaining exploration rights on land
explored with state funds or lands where the current holder has
forfeited exploration rights. The Mineral Resources Authority of
Mongolia (MRAM) will tender such exploration rights only to firms
technically qualified to conduct minerals work. The new tender
procedure neither requires nor allows for a cash-bid. Only the
technical merits of exploration proposals will determine who gains
exploration rights. MRAM staff has the authority and responsibility
to assess the merits of proposals to determine who wins the
tenders.


ULAANBAATA 00000119 007.2 OF 024


Both MRAM and its supervising authority, the Ministry of Mineral
Resources and Energy, now have broad discretionary authority to
select who will get tenements. This authority disturbs miners, who
fear this power will be the source of corruption and arbitrary
decisions by MRAM. Evidence suggests that local mining guilds will
define an expert in Mongolian mining as a person who received a
degree from a Mongolian institution, such as the National
University, rather than an internationally recognized institution.
While this enforced employment program for Mongolian geologists
would be an annoyance, the discretionary power MRAM now has
generated the most concern. If MRAM rejects a firm's experts and
mining plan as unqualified, no recourse is spelled out under the new
law, and the firm will in effect lose its rights.

The concept of "expertise" allows another potential avenue for
expropriation of rights by denying or preventing their use. The law
has the potential to limit the ability of rights holders to seek
financing, because it forbids transfer of mining licenses and
exploration rights to non-qualified individuals. Consequently, a
miner will not be able to offer his licenses as secured collateral
to banks or to any lender lacking the professional qualifications to
receive these rights if the miner defaulted on his debt obligations.
A given bank is unlikely to set up a "qualified" mining firm just
to receive a pledged license offered as collateral. Thus, the law
limits the investment pool that a mining firm might tap to finance
its mine, which might prevent bringing a property into production,
again denying licensees access to their legal economic rights.

The amended law removes the Mongol word for exclusive from the grant
of exploration rights. The old article read, "To conduct exclusive
exploration for minerals within the boundaries of an exploration
area in accordance with this law." The new article reads, "To
conduct exploration for minerals. . . ." It is unclear what, if
anything, this deletion means. However, the deletion would seem to
allow the government to apportion mineral rights per metal or
mineral rather than as a whole, which has been the standard
practice. The deletion was done intentionally, as the word appeared
in earlier drafts, right up to the passage of the law.

Investors and observers are also concerned about new authority
granted to the MRAM Chairman to approve transfers of existing and
new licenses. The law grants final approval authority to the MRAM,
without specifying any check or balance on this official's
authority. This power is not a revocation but if abused would
certainly prevent exercise of economic rights.

Complicating matters is that in early 2009 MRAM had been moved
under the direct authority of the Ministry of Mineral Resources and
Energy in a sweeping re-organization of the government. Prior to
this restructuring, MRAM had been a quasi-independent agency, the
acts of which did not require ministerial approval. In the new
structure, the ministry can intervene in the registration and
transfer of exploration and mining licenses. The ministry seems to
have only intervened in cases where the license involves a
"strategic" deposit. (See A.1 Openness to Foreign Investment for
explanation of strategic deposits.) In this specific category,
ministerial officials have ordered MRAM to freeze all transfers and
transactions involving properties near or in strategic deposits,
which includes uranium deposits of any size and massive coal and
copper deposits near the Chinese border. Further, these same
officials have indicated that the government may then revoke the
rights of those holding exploration rights or mining licenses in or
near strategic deposits. Although the law seems to allow for
compensation, the ministry has not presented formal compensation
packages to those potentially affected by its actions.

Acts of Provincial Administrations:

With regard to the issuance of both exploration permits and mining
licenses, provincial officials increasingly appear to use their
authority to block arbitrarily access to mining rights legally
granted under the current law. For example, reports regularly
circulate that some provincial government officials abuse their
authority to designate land as "special use zones" to usurp mining
exploration tenements. In a common technique, provincial governors
often reclassify property that has never felt the touch of the plow
or felt the tread of a tourist for agricultural use or cultural
tourism respectively, although the central government has legally
granted exploration rights to miners. In one case, a miner could
not gain access to the subsurface resources because the provincial

ULAANBAATA 00000119 008.2 OF 024


government claimed that doing so would damage a potato farm that had
suddenly appeared over the site.

Other miners harshly criticize the misuse of the local officials'
rights to comment on permits for water use and mining licenses.
Comments are advisory, and have limited legal force regarding
disallowing activity, but the central government routinely hesitates
to reject a governor's negative comment no matter the motives behind
it. The effect has been to stop progress for months, limiting
access to the resource and costing rights holders' time and money.

Whatever the motives, these provincial actions are often seen as a
creeping bureaucratic expropriation through denial of access and use
rights. The 2006 Minerals Law provides no clear limit on provincial
control of permits and special use rights or guidance on how to
apply these powers beyond codifying that the provincial and local
authorities have some authority over activities occurring in their
provinces and soums (counties). Faced with these unclear boundaries
of authority, the central government often interprets the rules and
regulations differently from the provincial authorities, creating
administrative conflicts among the various stakeholders. The
central government acknowledges the problematic ambiguity but has
yet to definitively clarify the situation in law or practice, even
though the situation threatens accessing one's rights. Mongolian and
foreign permit holders have advised the government that letting this
problem fester raises perceptions among investors that they may risk
losing their economic rights, which can scare away inbound
investors.
A.4 DISPUTE SETTLEMENT

The GOM consistently supports transparent, equitable dispute
settlements, but executing good intentions has proven problematic.
These problems come from a lack of experience with standard
commercial practices rather than from any systemic intent by public
or private entities to target foreign investors. The framework of
laws and procedures is functional, but many judges who adjudicate
disputes remain ignorant of commercial principles.

Problems with Dispute Settlement in Mongolia's Courts

The court structure is straightforward and supports dispute
settlement. Disputants know the procedures and the venues.
Plaintiffs bring cases at the district court level before a single
district judge or panel of judges, depending on the complexity and
importance of the case. The district court renders its verdict.
Either party can appeal this decision to the Ulaanbaatar City Court,
which rules on matters of fact as well as matters of law. It may
uphold the verdict, send it back for reconsideration or nullify the
judgment. Disputants may then take the case to the Mongolian
Supreme Court for a final review.

Problems arise for several reasons. First, commercial law in
Mongolia and understanding of it are in flux. New laws on
contracts, investment, corporate structures, leasing, etc. have been
passed or are being considered at both the ministerial and
parliamentary levels. Mongolian civil law does not work on
precedents but from application of the statute as written. If a law
is vague or does not cover a particular commercial activity, the
judge's remit to adjudicate can be severely limited or non-existent.
For example, until recently leasing did not exist in the Mongolian
civil law code as such, but seemed to be covered under various
aspects of Mongolian civil law regarding contracts and other
agreements. But judgments on leasing made under these laws might
not have applied to an arrangement not otherwise specifically
recognized under its own exclusive law. Further, because precedents
are not legally relevant or binding on other judges and Mongolian
courts, decisions reached in one case have no legal force in other
suits, even when the circumstances are similar or even before the
same court and judges.

Trained in the former Soviet era, many judges lack training in or
remain willfully ignorant of commercial principles. They dismiss
such concepts as the sanctity of the contract. This is not a
problem of the law, which recognizes contracts, but of faulty
interpretation. In several cases courts have intentionally
misinterpreted provisions regarding leases and loan contracts.
Judges regularly ignore terms of a contract in their decisions. If
someone defaults on a loan, the courts often order assets returned
without requiring the debtor to compensate the creditor for any loss
of value. Judges routinely assert that the creditor has recovered

ULAANBAATA 00000119 009.2 OF 024


the asset, such as it is, and that is enough. Bad faith and loss of
value simply do not enter into judicial calculations of equity.

Replacing old-school judges is not an option. It is politically
impossible-if not functionally impractical-for the Mongolians to
dismiss this cadre of Soviet-era judges. There is a realistic hope
that young justices, trained in modern commercial principles by
American and European experts, will gradually improve judicial
protections for commercial activities in Mongolia. Lately, we have
seen better decisions in several cases involving Americans seeking
to recover on debts and contractual fees and to hold Mongolian
government entities to the terms of their respective contracts and
regulations, but these results tend to be limited to courts where
modern-educated judges preside.

Bankruptcy and Debt Collection

Mongolia's bankruptcy provisions and procedures for securing the
rights of creditors need serious reform. Mongolian law allows for
mortgages and other loan instruments backed up with securitized
collateral. However, rudimentary systems for determining title and
liens and for collecting on debts make lending on local security
risky. Banks frequently complain that onerous foreclosure rules are
barely workable and unfair to the creditor.

Although a system exists to register immovable property-structures
and real estate-for the purpose of confirming ownership, the current
system does not record Qting liens against immovable property
has. In addition, no system exists to record ownership of, and liens
on, movable property. Consequently, Mongolian lenders face the
added risk of lending on collateral that the debtor may not actually
own or which may have already been offered as security for another
debt.

Overall, the legal system does recognize the concept of
collateralized assets provided as security for a loan, investment
capital, or other debt-based financial mechanism. The legal system
also provides for foreclosure, but this process has proved
exceptionally onerous and time consuming. A 2005 change to
Mongolian law simplified the process by allowing creditors to
foreclose without judicial review. Prior to the new law, all
creditors had to go to court to collect on securitized collateral,
thus adding months to the entire collection process. However, the
Constitutional Court of Mongolia voided the law on constitutional
grounds, slowing down debt collection to pre-2005 levels. Waits of
up to 24 months for final liquidations and settlement of security
are not uncommon.

Once a judgment is rendered, the disputant faces a relatively
hostile environment to execute the court's decision. For example, a
bank collecting on a debt in Mongolia must allow debtors to put
forward assets for auction and set the minimum bid price for those
assets. If assets do not sell, a second round of auctions occurs in
which a reduced minimum bid is put forward. The State Collection
Office (SCO) supervises this process but does not set the price.
However, the SCO receives 10% of the sales price, or of the second
auction minimum price even if there is no sale.

The SCO does not allow collateralized assets to be valued by neutral
3rd parties. Because it derives income from the forced sale of
assets, the SCO has a conflict of interest; and, anecdotally, seems
to have failed as an impartial arbiter between debtors and
creditors. For banks, this has meant that forcing a company into
bankruptcy may be the safest way to recover rather than forcing
piecemeal sales of assets. This approach automatically puts all
assets into play rather than those selected by the debtor. However,
it is an onerous procedure without a clear process behind it.

Purchase financing is also tricky. For example, a local car dealer
financed an auto for US$20,000 down and US$60,000 in credit,
complete with a local bank guarantee. The buyer subsequently
defaulted on the loan, the bank refused to honor its guarantee, and
the dealer took the buyer to court. Under current Mongolian law,
interest payments are suspended for the duration of the case, from
first filing to final appeal before the Supreme Court of Mongolia.
Possibly months of interest-free time can pass while the asset rusts
in an impound lot. In this case, the dealer simply reclaimed the
car and dropped the lawsuit, swallowing the lost interest payments
and loss in value on the car. Domestic and foreign businesses often
respond by requiring customers to pay in cash, limiting sales and

ULAANBAATA 00000119 010.2 OF 024


the expansion of the economy.

Binding Arbitration: International and Domestic

The Mongolian government supports and will submit to both binding
arbitration and international settlement procedures. However,
glitches remain in local execution. Mongolia ratified the
Washington Convention and joined the International Centre for
Settlement of Investment Disputes in 1991. It also signed and
ratified the New York Convention in 1994.

To our knowledge, the government of Mongolia has accepted
international arbitration in four disputes where claimants have
asserted the government reneged on a sovereign guarantee to
indemnify them. In all cases the government has consistently
declared that it would honor the arbitrators' judgments. However,
this resolution has not been put to the test, as Mongolia has won
each case.

More widely, Mongolian businesses partnered with foreign investors
accept international arbitration, as do government agencies that
contract business with foreign investors, rather than avail
themselves of the Arbitration Bureau operated by the Mongolian
National Chamber of Commerce and Industry. They seek redress abroad
because they perceive that domestic arbitrators are too politicized
and self-interested to render a fair decision.

Although arbitration is widely accepted among business people and
elements of the government, support for binding international
arbitration has not penetrated local Mongolian agencies responsible
for executing judgments. In two cases, the Mongolian-state-owned
copper mine lost two international arbitral cases. The awards were
certified and recognized as valid and enforceable by Mongolian
courts. But the local bailiff's office has consistently failed to
execute the collection orders. Local business people routinely cite
the failure of SCO and the bailiffs to enforce court-ordered
foreclosures and judgments as the most common problem threatening
resolution of debt-driven disputes.
A.5 PERFORMANCE REQUIREMENTS AND INCENTIVES

Mongolia imposes few performance requirements on, and offers few
incentives to, investors. The few requirements imposed are not
onerous and do not limit foreign participation in any sector of the
economy. Performance requirements are applied somewhat differently
to foreign investors in a limited number of sectors.

2006 Amendments to the Tax Law of Mongolia did away with most tax
incentives and exemptions. (Certain staples, such as flour, and
sectors targeted for growth, most recently, the agriculture sector,
have and continue to receive exemptions on import duties and on
Mongolia's value-added tax.) The GOM seems willing to let current
agreements run their course. Foreign investors have accepted phasing
out of tax incentive provisions since the amendments bring other
world-standard practices to the tax code. These include provision
for loss-carry-forwards, five-year accelerated depreciation, and
more deductions for legitimate business expenses including but not
limited to marketing and training expenses.

Few Restrictions on Foreign Investment

The government applies the same geographical restrictions on both
foreign and domestic investors. Existing restrictions involve border
security, environmental concerns, or local use rights. There are no
onerous or discriminatory visas, residence, or work permits
requirements imposed on American investors. Generally, foreign
investors need not use local goods and services, local equity, or
engage in substitution of imports. Neither foreign nor domestic
businesses need purchase from local sources or export a certain
percentage of output, or have access to foreign exchange in relation
to their exports.

Although there remains no formal law requiring the use of local
goods and services, the GOM encourages firms to do value-added
production in Mongolia, especially for firms engaged in natural
resource extraction. Certain senior officials and politicians have
made in-country processing a consistent feature of their public and
private policy statements regarding the development of mining. For
example, the 2006 windfall profits tax on copper and gold applies
the tax to copper concentrate, but exempts metallic copper produced
in Mongolia. Recent negotiations on strategic copper deposits in

ULAANBAATA 00000119 011.2 OF 024


the Gobi between the GOM and private Western firms ended with
commitments by the companies to explore copper smelting in Mongolia.
Government talks on coal production constantly feature discussions
of power generation and coals-to- liquid processing in Mongolia.
The recently-passed Government Action Plan also calls for increased
investment in businesses and activities that keep the "value" of a
resource in Mongolia. As a result, firms should continue to expect
the GOM to aggressively press them for value-added production in
Mongolia.

Generally, foreign investors set their own export and production
targets without concern for government imposed targets or
requirements. There is no requirement to transfer technology. As
a matter of law, the government imposes no offset requirements for
major procurements. Certain tenders may require bidders to agree to
levels of local employment or to fund certain facilities as a
condition of the tender, but as matter of course such conditions are
not the normal approach of the government in its tendering and
procurement policies.

Investors may finance as they see fit. Foreign investors need sell
no shares to Mongolian nationals. Equity stakes are generally at
the complete discretion of investors, Mongolian or foreign.
Investors, not the Mongolian government, make arrangements regarding
technology, intellectual property, etc.

Regarding employment, investors can locate and hire workers without
using hiring agencies-as long as hiring practices are consistent
with Mongolian Labor Law. However, Mongolian law requires companies
to employ Mongolian workers in certain labor categories whenever a
Mongolian can perform the task as well as a foreigner. This law
generally applies to unskilled labor categories and not areas where
a high degree of technical expertise not existing in Mongolia is
required. The law does provide an escape hatch for all employers.
Should an employer seek to hire a non-Mongolian laborer and cannot
obtain a waiver from the Ministry of Labor for that employee, the
employer can pay a fee of around US$140 per employee per month.
Depending on the importance of a project, the Ministry of Labor may
grant an employer a 50% exemption of the waiver fees as an
incentive.

Limited Performance Requirements

Performance requirements are sparingly imposed on investors in
Mongolia with the exception of petroleum and mining exploration
firms. The Petroleum Authority of Mongolia (PAM) issues petroleum
exploration blocks to firms, which then agree to conduct exploration
activities. The size and scope of these activities are agreed upon
between PAM and the firm in writing and are binding. If the firm
fails to fulfill exploration commitments, it must pay a penalty to
PAM based on the amount of hectares in the exploration block, or
return the block to MPPAM. These procedures apply to all investors
in the petroleum exploration sector.

The 2006 amendments to the Minerals Law of Mongolia made receiving
and keeping exploration licenses contingent on conducting actual
exploration work. Under the terms of the 1997 Minerals Law, mining
companies holding exploration tenements or extraction licenses
needed neither explore nor mine so long as they paid annual fees
associated with their holdings and provided annual reports of their
activities to the government of Mongolia.

The amended law imposes more stringent work requirements. Each year
and subject to annual verification by the Minerals Authority of
Mongolia (MRAM),exploration firms must submit a work plan and
report on the execution of the previous year's performance
commitments. Commitments expressed in terms of US dollar expenses
per hectare per year:

--2nd and 3rd years miners must spend no less than US $.50 per
hectare on exploration

--4th to 6th years miners must spend no less than US $1.00 per
hectare on exploration

--7th to 9th years miners must spend no less than US $1.50 per
hectare on exploration

MRAM has the authority and right to inspect the exploration sites to
verify that work is being done. Failure to comply with work

ULAANBAATA 00000119 012.2 OF 024


requirements may result in fines, suspension, or even revocation of
exploration rights.

In addition to these performance requirements, the law also requires
holders of mining licenses for projects of strategic importance to
sell no less than 10% of company shares on the Mongolian Stock
Exchange. Vaguely presented in the statute, there is still no formal
clarification in law or regulation of what this provision means in
practical terms or how it is to be implemented.

All foreign investors must register with the Foreign Investment and
Foreign trade Agency (FIFTA). The Foreign Investment Law of
Mongolia requires all foreign investors to show a minimum of
US$100,000 in assets (cash, working stock, property, etc.)
registered in Mongolia as a precondition for registration. In
addition to this particular requirement, all foreign investors must
pay an initial processing fee of some 12, 000 Mongolian tugriks or
about US$8.00. Foreign Investors must then pay a yearly
prolongation fee of 6,000 Mongolian tugrik or about US$4.00.

In addition to these fees, foreign investors must annually report on
their activities for the coming year to the government through
FIFTA. Businesses need not fulfill plans set out in this report,
but failure to report may result in non-issuance of licenses and
registrations and suspension of activities. This requirement differs
from that imposed on domestic investors and businesses. Local
investors do not have a yearly reporting requirement. Mongolians
pay lower registration fees, which vary too much to say with any
precision what the fees actually are.

FIFTA explains that the higher registration costs for foreign
investors arise from the need to compensate for the services it
provides to foreign investors, including assistance with
registrations, liaison services, trouble-shooting, etc. The
different reporting requirements provide the government with a
clearer picture of foreign investment in Mongolia. Foreign
investors are generally aware of FIFTA's arguments and largely
accept them, but they question the need for annual registrations.
Investors recommend that FIFTA simply charge an annual fee rather
than require businesses to submit a new application each year.

Regarding reports, foreign businesses are concerned about the
security of their proprietary information. Several foreign
investors have claimed that agents of FIFTA routinely use or sell
information on business plans and financial data. We have yet to
verify these claims, but FIFTA acknowledges that data security
largely depends on the honesty of its staff, as there are few
internal controls over access to the annual reports.

Tariffs

Mongolia has one of Asia's least restrictive tariff regimes. Its
export and import policies do not harm or inhibit foreign
investment. Low by world standards, tariffs of 5% on most products
are applied across the board to all firms, albeit with some concerns
about consistency of application and valuation. However, some
non-tariff barriers, such as phyto-sanitary regulations, exist that
limit both foreign and domestic competition in the fields of
pharmaceutical imports and food imports and exports. The testing
requirements for drugs are extremely unclear and onerous. When
companies attempt to clarify what the rules for importing food or
drugs into the country are, they receive contradictory information
from multiple agencies.

WTO TRIMS Requirements

Mongolia employs no measures inconsistent with WTO TRIMs
requirements, nor has anyone alleged that any such violation has
occurred.

A.6 RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT

Mongolia has one of Asia's most liberal ownership and establishment
regimes. Unless otherwise forbidden by law, foreign and domestic
businesses may establish and engage in any form of remunerative
activity. All businesses can start up, buy, sell, merge; in short,
do whatever they wish with their assets and firms.

Diminishing Competition from the State-Owned Sector


ULAANBAATA 00000119 013.2 OF 024


Mongolia passed and implemented a competition law applying to
foreign, domestic, and state-owned entities active in Mongolia. As
a practical matter, competition between state-owned and private
businesses has been declining for the simple reason that most
parastatals have been privatized. The exceptions are the
state-owned power and telecom industries, an airline, the national
rail system, several coal mines and a large copper mining and
concentration facility.

Currently, three firms -- one a Mongolian company and the others
Chinese state-owned entities -- are actively seeking opportunities
for power generation. Few want to enter the power generation field
until the regulatory and statutory framework for private power
generation firms up and tariffs are set at rates allowing profits.
In the railway sector, a recent law allows private firms to build,
operate, and transfer railroads to the state. Under this new law
several private mining companies have proposed rail links from their
respective coal mines to the Chinese border or to the currently
operating spur of the Trans-Siberian Railroad. Mongolia has no
plans to privatize railroads jointly held with the government of
Russia.

Although the trend has been for the GOM to extract itself from
ownership of firms and other commercial assets, the current Minerals
Law of Mongolia lets the state back into mining. Under this law,
the GOM gained the right to acquire equity stakes of up to 50% in
certain deposits that it deems of strategic value for the nation.
Once acquired, these assets are to be placed with a state-owned
management company, Erdenes MGL, that will invest them for the
benefit of the Mongolian people. The role of state as an equity
owner, in terms of management and operation of the mining asset, is
unclear at this point. There is some concern that the GOM will
have to deal with conflicts of interest arising from its dual
position as regulator and owner of these strategic assets.
Specifically, firms are worried that the GOM's desire to maximize
returns in order to provide a revenue stream to the Mongolian people
may comprise the long term commercial viability of any mining
project.

A.7 PROTECTION OF PROPERTY RIGHTS

The right to own private, movable and immovable property is
recognized under Mongolian law. Regardless of citizenship (except
for land which only citizens of Mongolia can own),owners can do as
they wish with their property. One can collateralize real and
movable property. Should a debtor default on such secured loans,
the creditor does have recourse under Mongolian law to recover the
debt by seizing and disposing of property offered as security. The
only exceptions to this liberal environment are recent changes to
the mining law that prevent transfer of exploration and mining
licenses to third parties lacking professional mining
qualifications.

Mongolia's Current Regime to Protect Creditors

The current protection regime for creditors is functional but needs
reform. The legal system presents the greatest pitfalls. Although
the courts recognize property rights in concept, they have a
checkered record of protecting and facilitating acquisition and
disposition of assets in practice. Part of the problem is ignorance
of, and inexperience with, standard practices regarding land,
leases, buildings, and mortgages. As noted in A.4 Dispute
Settlement, some Soviet-trained judges, largely out of ignorance of
the concepts, have failed to recognize these practices. Newly
trained judges are making a good faith effort to uphold property
rights, and need time to learn how to adjudicate such cases.

Mongolia's bankruptcy provisions and procedures for securing the
rights of creditors need serious reform. Mongolian law allows for
mortgages and other loan instruments backed up with securitized
collateral. However, rudimentary systems for determining title and
liens and for collecting on debts make lending on local security
risky. Banks frequently complain that onerous foreclosure rules are
barely workable and unfair to the creditor.

Although a system exists to register immovable property-structures
and real estate-for the purpose of confirming ownership, the current
system does not record if immovable property has any liens against
it. In addition, no system exists to record ownership and liens of
movable property. Consequently, Mongolian lenders face the added

ULAANBAATA 00000119 014.2 OF 024


risk of lending on collateral that the debtor may not actually own
or which may have already been offered as security for another debt.


Overall the legal system does recognize the concept of collaterized
assets provided as security for a loan, investment capital, or other
debt-based financial mechanisms. The legal system also provides for
foreclosure, but this process has proven exceptionally burdensome
and time consuming. A September 2005 change to Mongolian law
simplified the process by allowing creditors to foreclose without
judicial review. Prior to the new law, all creditors had to go to
court to collect on securitized collateral, thus adding months and
expense to the entire collection process. However, the
Constitutional Court of Mongolia voided the law on constitutional
grounds, slowing down debt collection to pre 2005 levels where waits
of up to 24 months for final liquidations and settlement of security
were not uncommon.

Debt Collection Procedures

However, even with the delays, getting a ruling is relatively easy
compared to executing the court's decision. The problem is not the
law but the enforcement. A judge orders the State Collection Office
(SCO) to move on the assets of the debtor. The SCO orders district
bailiffs to seize and turn those assets over to the state, which
then distributes them to creditors. However, foreign and domestic
investors claim that the state collection office and the district
bailiffs frequently fail in their responsibilities to both the
courts and the creditors.

In some cases, bailiffs refuse to enforce the court orders (see the
Erdenet case mentioned in A.4). The perception is that they do so
because they have been bribed or otherwise suborned. Bailiffs are
often local agents who fear local retribution against them and their
interests if they collect in their localities. In some cases,
bailiffs will not collect unless the creditor provides bodyguards
during seizure of assets. Creditors also have reason to believe
that the state collection office accepts payments from debtors to
delay seizure of assets.

Protection of Intellectual Property Rights

Mongolia supports intellectual property rights in general and has
protected American rights in particular. It has joined the World
Intellectual Property Organization (WIPO) and signed and ratified
most treaties and conventions, including the WTO TRIPS agreement.
The WIPO Internet treaties have been signed but remained un-ratified
by the State Great Hural, Mongolia's Parliament. However, even if a
convention is un-ratified, the Mongolian government and its
intellectual property rights enforcer, the Intellectual Property
Office of Mongolia (IPOM),make a good faith effort to honor these
agreements.

Under TRIPS and Mongolian law, the Mongolian Customs Authority (MCA)
and the Economic Crimes Unit of the National Police (ECU) also have
an obligation to protect IPR. MCA can seize shipments at the
border. The ECU has the exclusive power to conduct criminal
investigations and bring criminal charges against IPR pirates. The
IPOM has the administrative authority to investigate and seize fakes
without court order. Of these three, only the IPOM makes a good
faith effort to fulfill its mandates.

Part of the problem is ignorance of the importance of intellectual
property to Mongolia and of the obligations imposed by TRIPS on
member states. Customs has been particularly hesitant to seize
shipments, saying that their statutory mandate does not allow
seizure of such goods, but Mongolian statutory and constitutional
law recognizes that international treaty obligations take precedence
over local statutes and regulations. A clear legal basis exists for
Customs to act, which has been recognized by elements of the
Mongolian Judiciary, the Parliament, and the IPOM. In any case,
Customs officers do occasionally seize fake products, but it seems
that Mongolian customs law will have to be brought into compliance
with TRIPS before Customs will actively fulfill its obligations.
The ECU has also been lax. The ECU hesitates to investigate and
prosecute IPR cases, deferring to the IPOM as the lead agency.
Anecdotal evidence suggests that ECU officials fear political
repercussions from going after IPR pirates, many of whom wield
political influence.


ULAANBAATA 00000119 015.2 OF 024


The IPOM generally has an excellent record of protecting American
trademarks, copyrights, and patents. However, its small budget
limits the scope of its actions. In most cases, when the U.S.
Embassy in Ulaanbaatar conveys a complaint from a rights holder to
the IPOM, the IPOM quickly investigates the complaint. If it judges
that an abuse occurred, it will (and has in every case brought
before it to date) seize the pirated products or remove faked
trademarks, under administrative powers granted in Mongolian law.

We note two areas where enforcement lags. Legitimate software
products are rare in Mongolia. Low per capita incomes have given
rise to a thriving local market for cheap, pirated software. The
IPOM estimates pirated software constitutes at least 95% of the
market. The Office enforces the law where it can but the scale of
the problem dwarfs its capacity to deal with it. The IPOM will act
if we bring cases to their attention.

Pirated optical media are also readily available and subject to
spotty enforcement. Mongolians produce no fake CD's, videos, and
DVD's, but import such products from China, Russia, and elsewhere.
Products are sold through numerous local outlets and sometimes
broadcast on private local TV stations. The IPOM hesitates to move
on TV stations, most of whom are connected to major government or
political figures. Nor does the IPOM raid local ("street") DVD and
CD outlets run by poor urban youth; IPOM argues that such action
would not halt sales and only alienate the public. Again, when an
American raises a specific complaint, the IPOM acts on the
complaint, but IPOM rarely initiates action on its own.

2006 Amended Mining Law Restricts Transfer of Licenses in Certain
Cases

The current Minerals law of Mongolia would seem on its face to
prevent transfer of exploration or mining rights to any third party
lacking professional mining qualifications as determined by the
Mineral Resources Authority of Mongolia (MRAM).

Under the Minerals Law, the concept of mining expertise can either
qualify or disqualify any entity from acquiring, transferring,
securitizing exploration and mining rights. The law has the
potential to limit the ability of rights holders to seek financing,
because it forbids transfer of mining licenses and exploration
rights to non-qualified individuals. Consequently, a miner might
not be able to offer his licenses as secured collateral to banks or
to any lender lacking the professional qualifications to receive
these rights if the miner defaulted on his debt obligations.

At a stroke the law seems to limit the investment pool that a mining
firm might tap to finance its mine, which might prevent bringing a
property into production, again denying licensees access to their
legal economic rights.

A.8 TRANSPARENCY OF THE LEGISLATIVE AND REGULATORY PROCESS

Generally, Mongolia's problem is not lack of laws and
regulations-Mongolia has passed more than 1,600 laws since
undertaking its transition to a market economy over 18 years ago-but
a lack of knowledge on the part of the lawmakers on what is needed
and a history of not consulting with affected and potentially
affected communities. Corruption aside, the fact that laws and
regulations change without much consultation creates a chaotic
situation for all parties. Many laws and regulations, as well as
behavior, still require amendment and adjustment; but, overall, the
trend is positive. We have seen definite improvement in the mining
sector and in the foreign investment statutes.

Problems with the Drafting Process for Legislation and Regulations

Normally, laws can be crafted in two ways. Once rare but now more
common, Members of Parliament and the President of Mongolia may
draft their own proposals for direct submission to the Parliament.
Such bills need not be submitted to the Cabinet of Ministers but can
be delivered directly to the Speaker of Parliament for consideration
by the relevant Standing Committee. The relevant Standing Committee
may either reject the bill (in which case it dies in committee) or
pass it on to the Parliament's plenary body, unaltered or revised
for a general vote. More common is when Parliament or the Cabinet
of Ministers requests legislative action. These institutions send
such requests to the relevant ministry. The Minister relays the
request to ministerial council, which in turn sends the request to

ULAANBAATA 00000119 016.2 OF 024


the proper internal division or agency within the respective
ministry, which in turn forms a working group. The working group
prepares the bill, submits it for ministerial review, makes any
recommended changes, and then the bill is reviewed by the full
Cabinet of Ministers. Relevant ministries are asked to comment and
recommend changes in the legislation.

Prior to a final vote by the Cabinet of Ministers, the National
Security Council of Mongolia (NSC)-consisting of the President of
Mongolia, the Prime Minister, and Speaker of Parliament-can review
each piece of legislation for issues related to national security.
Although the legal and constitutional authority of the NSC to veto
entirely, or to recommend changes to, draft legislation has not been
clarified to outside observers, the Cabinet to our knowledge will
not and has never overruled NSC recommendations.

Once through NSC and Cabinet reviews, the bill goes to Parliament.
In Parliament, the bill is vetted by the relevant Standing
Committee, sent back for changes or sent on to the full Parliament
for a vote. The President can veto bills, but his veto can be
overcome by a two-thirds (2/3) vote of Parliament.

For regulations, the process is truncated. The relevant minister
assigns the task of writing the regulations to the working group
that wrote the original law. This group submits their work to the
minister who approves or recommends changes.

The Ministry of Justice and Home Affairs (MOJHA) plays an important
role in drafting both laws and regulations. MOJHA vets all statutes
and regulations before they are passed for final approval. In the
case of legislation, MOJHA is supposed to reconcile the language and
provisions of the law with both existing legislation and the
constitution of Mongolia, after which the law is supposed to pass to
the Cabinet and then Parliament. In the case of regulations, MOJHA
vets the regulations to ensure consistency with current laws and
provisions of the constitution. In either case, MOJHA can, in
effect, veto legal or regulatory provisions that it finds
inconsistent with the statutes and constitution.

Absent from these drafting processes is a statutory, systematic,
transparent review of legislation or regulations by stakeholders and
the public. Ministerial initiatives are not publicized until the
draft has passed out of a given ministry to the full Cabinet.
Typically, the full Cabinet discusses and passes bills on to
Parliament, without public input or consultations. Parliament
itself issues neither a formal calendar nor routinely announces or
opens its standing committee or full chamber hearings to the public.
While Parliament at the beginning of each session announces a list
of bills to be considered during the session, this is very general
and often amended. New legislation is commonly introduced,
discussed and passed without public announcement or consideration.
For example, in 2006, Parliament passed the Wind Fall Profits Tax
Law bill in six days without consulting any business, NGO, or other
entity about the impact and desirability of the bill. In 2007,
Parliament significantly amended the Law on State Procurement within
thirty days without any public notification or comment regarding new
limits competitive, transparent bidding practices and limits on
access tender opportunities to foreign bidders. In 2008 and 2009,
key mining agreements were negotiated by the government and simply
presented to Parliament for quick votes without formal public
comment and review.

The U.S. Embassy in Ulaanbaatar and foreign and domestic investors
have repeatedly urged the Mongolian government to utilize the
government's Open Government web site to post draft and pending
legislation for public consultation and review before it is
finalized and sent to Parliament. Over the past couple of years, we
have noticed some improvement in the timeliness and completeness of
the postings.

To supplement this effort, the U.S. Embassy and local business
organizations have jointly created an informal system to identify
legislation and regulations under review. Once identified, we meet
with working groups, provide information on how other nations have
handled such legislation, share stakeholders' points of view, and
widely distribute publicly available draft bills, preferably before
they reach a minister's desk. Should a piece of vital legislation
pass on to the Minister, Cabinet, or Parliament, these organizations
are prepared to lobby at the appropriate level. Over the last three
years we have found that many agencies and Members of Parliament

ULAANBAATA 00000119 017.2 OF 024


welcome our advice and information, particularly if given in a
non-confrontational way that respects Mongolia's political process
and right to deliberate.

Regulators also resist consultation when it comes to implementation.
Bureaucrats are only slowly becoming comfortable with the concepts
and practices of broad, public consultation and information sharing
with their own citizens, let alone foreigners. Many times
businesses ask for a clear copy of the current regulations, only to
be met with blank stares or outright refusals. The government has
acknowledged that the Soviet-era State Secrets Law requires
substantial amendment. Currently, most government
documents-including administrative regulations affecting investments
and business activities-are technically classified and cannot be
released to the public. This gives both bureaucrats and regulators
a convenient excuse to deny requests for information or, more
commonly, to demand extra-legal fees to provide documents. The
legacy of secrecy has also resulted in cases where government
officials themselves cannot get up-to-date copies of the rules.
Mongolia is considering a freedom of information law, but it is only
in its formative stages.

High officials acknowledge the value of and need for a more open,
transparent system. While laws are easy to fix, the behavior of
individual bureaucrats, Members of Parliament, and the judiciary
will only gradually change, with training and experience. Already a
younger generation of professionals, many trained abroad, is
beginning to take hold and to move into senior positions of
authority. This bodes well for Mongolia's continuing transition to
a private sector-led, open, market economy underpinned by good
government and corporate governance.

The Role of NGOS and Private Sector Associations in relation to FDI

The Mongolian government actively protects its prerogatives to
legislate, regulate, and administer economic activities in its
domain. While NGOs and private sector associations are given wide
latitude to run their activities, the government of Mongolia has
never allowed any non-governmental entity-be it business, civil
society, trade union, etc.-to have anything more than an advisory
role over the formulation and execution of the both laws and rules,
which also applies to setting standards for various industries.
Based on recent experience, the GOM routinely resists any expanded
role for civil society and NGOs. This tacit but unarticulated
policy of the government of Mongolia applies to both domestic and
foreign entities.

Laws, Regulations, and Policies that Impede FDI

While the GOM supports FDI and domestic investment, individual
agencies and elements of the judiciary often reportedly use their
respective powers to hinder investments into such sectors as meat
production, telecommunications, aviation, or pharmaceuticals. Both
domestic and foreign investors report similar abuses of inspections,
permits, and licenses by Mongolian regulatory agencies. However,
we have noted no consistent, systematic pattern of abuse
consistently initiated by either government or private Mongolian
entities aimed against foreign investors in general or against US
investment in particular. The impediments more often than not are
opportunistic attempts by individuals to misuse contacts to harass
U.S. and other foreign investors with whom the Mongolian entity is
in dispute. Alternatively, other reports suggest that they induce
well-placed regulators at all levels to extract extra-legal payments
from both foreign and domestic businesses or otherwise hinder their
work. In the latter case the general approach is to demand some
sort of payment in lieu of not enforcing work, environmental, tax,
health and safety rules, otherwise imposing the full weight of a
contradictory mix of Soviet Era and the current reformed rules on
the firm. Most foreign businesses refuse to pay bribes, and in turn
accept the punitive inspections, concede to some of the violations
found, and contest the rest in the City Administrative Court. In
our experience companies that show resolve against such predatory
abuse of statutory and regulatory power will face impediments at the
start; but these usually ease over time as state agents look for
easier targets.

A.9 EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT

Mongolia currently lacks experience and expertise to sustain
portfolio investments. It has no regulatory apparatus for these

ULAANBAATA 00000119 018.2 OF 024


activities, and both the state and private entities are just
beginning to engage in them. However, Mongolia has active capital
markets. The Mongolian government imposes few restraints on the
flow of capital in any of its markets. Multilateral institutions,
particularly the IMF, find the regime too loose, especially in the
crucial banking sector. Although the government has clear rules
about capital reserve requirements, the Mongol Bank, Mongolia's
central bank has historically resisted restraining credit flows at
commercial banks. In response to the current global financial
crisis, however, Mongol Bank has responded to the decreasing
availability of capital and liquidity in Mongolia by tightening
reserve requirements and the interest it charges to local banks for
funds, and currency controls. That said, most foreign businesses
have approved of the ease with which they can access financial
resources.

Capital and Currency Markets

Although liquidity is quite high in Mongolia, affordable capital
remains scarce. Local credit interest rates for customers range
from 12% for the most credit worthy to perhaps 90% per annum (or
more) for the least, with inflation peaking at around 40% in 2008
before settling at 24%. Foreign investors can easily tap into
domestic capital markets. However, they seldom do, because they can
do better abroad or better locally by simply taking on an equity
investor, Mongolian or otherwise.

Mongolia's currency, capital, and equity markets took major hits in
2008. Over the last three years the currency had proved resilient,
holding its value against most international currencies. This
resiliency has largely been attributed to the commodities boom,
which saw Mongolia selling such raw materials as copper, gold, and
coal, primarily to China. In mid 2008, the commodity markets began
to cool and Mongolia's foreign trade began to fall, leading to
growing trade deficit as imports no longer balanced or exceeded
exports. Subsequently, the once strong tugrik has begun to slide
and by March 2009 had lost 40 % of its value relative to the U.S.
dollar, affecting all import-related trade. Complicating matters,
major banks and other institutions that formally had access to
international capital flows (in the form of dollars, yen, renmimbi,
Euros, etc, which were parked in high-interest yielding tugrik
accounts),found international in-flows reversing as foreign
depositors repatriated their funds, either because these entities
needed the money to weather their own financial crises or they fear
that the tugrik's collapse would eat away the value of their
deposits. Banks no longer had access to easy capital and liquidity,
and began to restrict lending to almost all clients, who in turn
found they lacked funds to finance construction projects, trade, and
other activities.

After several months of tapping reserves to slow the tugrik's
decline, Mongol Bank has curtailed such infusions. Instead, the
Bank will sell dollars into the system via an auction to the local
commercial banks and will let the market decide the value of the
exchange rate rather than attempt to set the rate or artificially
support it.

Equity Markets

Investors do not use stocks to raise equity for investment but to
gain control of companies listed on the exchange. As most of the
firms have been bought up, the market sees little trading.

Mongolian firms do not use shareholding relationships to restrict
foreign investment at this point. Part of this arises from lack of
experience with such devices. It also arises from the fact that
Mongolians prefer to concentrate ownership in their own hands,
rather than disperse it through complicated shareholding
relationships. They perceive such devices as weakening their
ability to control the companies, which is more important than
safeguarding the firm from foreign or domestic raiders. If a
foreign company wanted to purchase a Mongolian firm, the foreign
entity would have to contact the shareholders and buy them out.
These could not be hostile takeovers, because few outstanding shares
remain on the market to buy. Eager to take on equity partners or
sell businesses entirely, the Mongolians would employ few defenses
beyond sharp negotiating.

The current Minerals Law of Mongolia recently imposed a provision
that requires that holders of mining licenses for projects of

ULAANBAATA 00000119 019.2 OF 024


strategic importance must sell no less than 10% of the resulting
entity's shares on the Mongolian Stock Exchange. Vaguely presented
in the statute, what this new provision means in practical terms and
how it is to be implemented has yet to be spelled out in regulation.


The Banking Sector

Weakness in Mongolia's banking sector concerns all players,
including the International Monetary Fund (IMF: http://www.imf.org).
Small by American standards, the total assets of Mongolia's sixteen
(16) banks adds up to just over US$2 billion. The system has been
through massive changes since the Soviet era, during which the
banking system was divided into several different units. This early
system failed through mismanagement and commercial naivety in the
mid-90s, but over the last decade has become more sophisticated and
better managed.

Mongolia has three large, generally well-regarded banks owned
primarily by Japanese and, Mongolian interests respectively. They
follow international standards for prudent capital reserve
requirements, have conservative lending policies, up-to-date banking
technology, and are generally well managed. If a storm should
descend on Mongolia's banking sector, these banks appear
well-positioned to weather it.

However, concerns remain among these bankers about the effectiveness
of Mongolia's legal and regulatory environment. As with many issues
in Mongolia, the problem is not of lack of laws or procedures but
the will and capacity of the regulator, Mongol Bank, to supervise
and execute mandated functions, particularly in regard to capital
reserve requirements and non-performing loans.

From 1999 through late 2008, Mongol Bank had consistently refused to
close any private Mongolian bank for insolvency or malpractice. In
late 2008, Mongol Bank took Mongolia's fourth largest bank into
receivership. Most deposits were guaranteed and their depositors
paid out. Mongol Bank survived the crisis, which cost it around
US$150 million -- not an inconsequential sum in an economy with a
US$5 billion per annum GDP. However, most observers noted that the
bank in question had shown signs of mismanagement, non-performing
loans, and ill-liquidity several years before the central bank moved
to safeguard depositors and the financial sector; and they argued
that that Mongol Bank had not shut any bank, fearing that closure
would signal weakness to the general public or because regulators
within the Mongol Bank, as Mongolia's central bank, have financial
interests in the troubled banks that would be threatened by
regulatory action. The latest crisis led to a new Mongol Bank
governor, and the institution has tightened some but not all of the
reserve requirements and formally indicated to banks that it will
not indemnify them for deposits they park in any bank which
subsequently goes bankrupt.

No accurate figures exist on non-performing loan (NPL) rates.
American and foreign bankers and the IMF believe that central bank's
methods for tracking NPLs understate the rate, and as such are
concerned that several banks may teeter near insolvency.

A.10 POLITICAL VIOLENCE

Mongolia is peaceful and stable. Political violence is rare.
Mongolia has held eight peaceful presidential and parliamentary
elections in the past 15 years. However, a brief but violent
outbreak of civil unrest followed disputed parliamentary elections
on July 1, 2008. Accompanied by some property destruction and
bodily injury, the unrest was quickly contained and order restored.
There has been no repeat of this civil unrest since July 1.

Mongolia has an ethnically homogenous population: 97% of the
population is Khalkh Mongol. The largest minority, numbering an
estimated 90,000 people, is Kazakh (Muslim),concentrated in the far
western part of the country.

There have been no known incidents of anti-American sentiment or
politically motivated damage to American projects or installations
in at least the last decade. However, there has been a gradual and
perceptible level of rising hostility to Chinese and, to a lesser
extent, Russian nationals in Mongolia. This hostility has led to
some instances of improper seizure of Chinese-invested property; and
in more limited cases acts of physical violence against the persons

ULAANBAATA 00000119 020.2 OF 024


and property of Chinese nationals resident in Mongolia. Other
Asians living in Mongolia have expressed concern that they may
inadvertently become victims of this hostility.

A.11 CORRUPTION

In mid 2005, the USAID Mission to Mongolia, in collaboration with
USAID/Washington and The Asia Foundation (TAF),funded a corruption
assessment conducted by Casals & Associates, Inc. (C&A).(the
complete report is available at http://www.usaid.gov/mn). Follow up
surveys of the problem show that the results of this assessment
remain valid in 2009. The study found that opportunities for
corruption have and continue to increase in Mongolia at both the
"petty" or administrative and "grand" or elite levels. Both types of
corruption should be of concern to Mongolians, but grand corruption
should be considered a more serious one because it solidifies
linkages between economic and political power that could negatively
impact or ultimately derail democracy and development, as it has in
other post-Communist countries. Several inter-related factors
contribute to Mongolia's corruption problem:

--A profound blurring of the lines between the public and private
sector brought about by endemic and systemic conflict of interest
(COI) at nearly all levels;

--A lack of transparency and access to information, stemming in part
from a broad State Secrets Law that surrounds many government
functions and undermines nearly all aspects of accountability by
contributing to an ineffective media and hindering citizen
participation in policy discussions and government oversight;

--An inadequate civil service system that gives rise to a highly
politicized public administration and the existence of a "spoils
system;"

--Limited political will and leadership to actually implement
required reforms in accordance with the law, complicated by
conflicting and overlapping laws that further inhibit effective
policy implementation;

--Weak government control institutions, including the Central Bank,
National Audit Office, parliamentary standing committees, Prosecutor
General, Generalized State Inspection Agency, State Property
Committee, and departments within the Ministry of Finance.

The aforementioned systemic shortcomings have allowed for an
evolution of corruption in Mongolia that "follows the money,"
meaning that graft on the most significant scales generally occurs
most often in the industries and sectors where there is the most
potential for financial gain. During the early 1990s, opportunities
for increased corruption emerged during the transition toward
democracy and market economy and process of reconnecting to the
international community. Two areas that offered particular
opportunities for grand scale corruption at that time were foreign
donor assistance and privatization of state-owned enterprises.
Later, as Mongolia embarked on further policy changes to install
capitalistic practices, corruption reared its head in the process of
privatizing public land. Now that most of the small amount of
high-value land has been doled out and the overall economy continues
expanding, based in part on extractive industries, emerging areas
for corruption include the banking and mining sectors. As in many
developing countries, there also are several areas that provide
stable and consistent opportunities for corruption, both grand and
administrative in nature, such as for procurement opportunities,
issuance of permits and licenses, customs, inspections, the justice
sector, among high-level elected and appointed officials, and in the
conduct a variety of day-to-day citizen- and business-to-government
transactions, notably in education, health care, and city services.

Despite the fact that few of the conditions to prevent corruption
from getting worse are in place, the situation has not reached the
levels that are evident in many other countries with contexts and
histories similar to that of Mongolia. Perhaps more importantly,
there are a number of nascent and rudimentary efforts underway to
actively combat corruption, including:

--Government commitments to international anti-corruption regimes
and protocols, such as the Anti-Corruption Plan of the Asian
Development Bank/Organization of Economic Cooperation and
Development (ADB/OECD) and the United Nations Convention Against

ULAANBAATA 00000119 021.2 OF 024


Corruption (UNCAC);

--Development of a National Program for Combating Corruption and
formation of a National Council for coordinating the Program and a
Parliamentary Anti-Corruption Working Group;

--Implementation of an anti-corruption law that has included the
formation of an independent anti-corruption body;

--Short- and medium-term anti-corruption advocacy and "watchdog"
programs initiated by civil society organizations, often with
international donor support.

There is, in fact, time for Mongolians and the international
community to nurture these efforts and take further action before
the corruption problem gets out of hand. In general, the main need
in Mongolia is for effective disincentives for corrupt behavior at
both the administrative and political level. In its broadest
configuration, this implies a strategy of increasing transparency
and effective citizen oversight, as well as intra-governmental
checks and balances. Without these major changes, administrative
reforms may provide some small improvements, but they are unlikely
to reverse current trends. Specifically, the report makes several
strategic recommendations, including:

--Diplomatic engagement focused on keeping anti-corruption issues on
the policy agenda, promoting implementation of existing laws related
to anti-corruption, and highlighting the need for further measures
to promote transparency and improved donor coordination;

--General programmatic recommendations to address conflict of
interest, transparency/access to information, civil service reforms,
and the independent anti-corruption body, with a definitive focus on
engaging civil society and promoting public participation utilizing
UNCAC as a framework;

--Specific programmatic recommendations to address loci of
corruption, such as citizen- and business-to-government
transactions, procurement, privatization, customs, land use, mining,
banking, the justice sector, and the political and economic elite

In addition, the reputable international anti-corruption NGO
Transparency International (TI) opened a national chapter in
Mongolia in 2004. (See: www.transparency.org) U.S. technical
advisors are working with TI to train Mongolian staff to monitor
corruption and to advocate on behalf of anti-corruption legislation
and, TI first included Mongolia in its annual "Perceptions of
Corruption" survey in September 2004. In that initial survey,
Mongolia ranked 85 out of 145 countries and its score of 3 on the
Corruption Perception Index was "poor." (TI's CPI Score relates to
"perceptions" of the degree of corruption as seen by business people
and country analysts and ranges between 10 (highly clean) and 0
(highly corrupt). TI's 2005 Survey ranked Mongolia 85 out 158; and
again Mongolia earned a "poor" score of 3. In TI's 2006 survey,
Mongolia had dropped to 99 out of 163 countries, being on par with
Mali, Mozambique, and the Ukraine, receiving a score of 2.8-poor.
In 2007, Mongolia was still 99 but out of 179 nations and had
achieved a score of 3.0, slight uptick but still poor. 2008 saw
Mongolia drop to 102 out 180 nations, maintaining its poor score of
3. In short, Mongolia has become neither more nor less noticeably
corrupt.

2006 Anti-Corruption Law

In 2006, Parliament passed an Anti-Corruption Law (ACL),a
significant milestone in Mongolia's efforts against corruption. The
legislation had been under consideration since 1999.

The ACL created an independent investigative body, the Independent
Authority Against Corruption (IAAC). The IAAC has four sections.
The Prevention and Education Section works to prevent corruption and
educate the public on anti-corruption legal requirements. The
Investigation Section receives corruption cases and executes
investigations. The third section collects, checks, and analyzes the
legally required property and income statements of government
officials. The fourth section, the IAAC's Secretariat, handle s
administrative tasks. The IAAC formally began operations in August
2007. (For a review of the IAAC's activities from its inception
through late 2008 and a general assessment of the public's current
views of corruption in Mongolia see the series of Mongolia

ULAANBAATA 00000119 022.2 OF 024


Corruption Benchmarking Surveys prepared for USAID Mongolia:
http://www.usaid.gov/mn; and The Asia Foundation:
http://asiafoundation.org/publications)

U.S. Foreign Corrupt Practices Act (FCPA)

The U.S. Embassy in Ulaanbaatar reminds U.S. entities and citizens
active in Mongolia that both they and their agents are subject to
the provisions of the FCPA. For information about the FCPA visit
the U.S. Department of Justice web site at
http://www.usdoj.gov/criminal/fraud/fcpa/.

A.12 BILATERAL INVESTMENT AGREEMENTS

(For Agreement list see UNCTD: http://www.unctad.org)

Taxation issues of Concern to American Investors

Taxation remains an area of key concern for American, other foreign
investors, and Mongolian domestic investors and businesses. 2006
saw major reforms of the Mongolian tax system, most of which, with
the exception of the windfall profits tax on gold and copper, were
greeted positively by most foreign and domestic investor in
Mongolia.

Windfall Profits Tax on Copper and Gold

The Windfall Profits Tax Law of 2006 (WPT) drew sharp criticism of
the GOM's commitment to creating an open, predictable, fair
environment for foreign direct investment. (See Section A.1 for
discussion of the WPT.)

Revisions of the Mongolian Tax Code:

Problems with the WPT aside, major reforms to the Mongolian Tax code
in 2006 greatly improved the business environment in Mongolia for
both foreign and domestic investors. Before the reforms, a World
Economic Forum survey of Mongolian business executives cited tax
rates and the complexity of tax regulations as two of the top five
problems for doing business in Mongolia. The tax reforms benefited
from two years of technical assistance from USAID's Economic Policy
Reform and Competitiveness Project (EPRC). The reforms affected the
Personal Income Tax (PIT) and Corporate Income Tax (CIT) codes as
well as the VAT and excise tax codes. (EPRC has a number of useful
and informative guides on their website:
http://www.eprc-chemonics.biz. See Sections A.1 and A. 5 for
description of these tax reforms.)

Unfinished Business (Including Customs Rates)

There is unfinished business, however, as Parliament continues to
consider additional tax reform measures. These include revisions to
the law on customs and customs tariffs. While the exact natures of
the proposed changes in the customs law have been murky, the GOM
states that changes will be consistent with Mongolia's WTO
obligations and investment climate enhancement goals.

Institutional Impediments Remain a Concern

Despite these solid, positive changes, international financial
institutions and other observers warn that these recent legislative
changes by themselves are insufficient to improve Mongolia's
business environment. Reform efforts need to go beyond changes to
the tax code, requiring fundamental reform in how such key agencies
as the tax department, the customs administration and the
inspections agency directly interact with private firms and
individuals.

Specifically, tax authorities charged with enforcing the tax codes
require a more customer-based approach to dealing with their
business clientele and a more detailed and rigorously enforced
regulatory framework under which to audit company accounts. Many
foreign and domestic investors argue that the lack of such a clear,
implementable code of ethics and enforceable set of guidelines leads
to arbitrary, capricious, or predatory tax audits.

A.13 OPIC AND OTHER INVESTMENT INSURANCE PROGRAMS

Recently OPIC (www.opic.gov) has become more active in Mongolia.
OPIC has issued and plans to issue direct loans to American firms

ULAANBAATA 00000119 023.2 OF 024


providing a variety of services in Mongolia. Loans and political
risk insurance to American investors involved the banking, tourism,
mining, and equipment sectors are in process. Because the amounts
required are relatively small, OPIC seems willing to make direct
loans rather than provide loan insurance to projects.

In 2006, the U.S. Export-Import Bank (EXIM) opened in Mongolia for
short-, medium-, and long-term transactions in the public sector and
for short- and medium-term transactions in the private sector.
(www.exim.gov).

Mongolia is a member of the Multilateral Investment Guarantee Agency
(MIGA: www.miga.org).

A. 14 LABOR

The Mongolian labor pool is generally well educated, relatively
young, and adaptable, but shortages exist in most professional
categories requiring advanced degrees or training. Only time and
investment in education and training will remedy this deficit of
trained skilled labor. Unskilled labor is sufficiently available.
Shortages exist in both vocational and professional categories
because Mongolians who obtain such skills frequently go abroad to
find higher wages. Why stay in Mongolia if one cannot recover the
outlay on the training from a Mongolian-based job? Foreign invested
companies are dealing with this situation by providing in-country
training to their staffs, raising salaries to retain employees, or
hiring expatriate workers to perform functions not available
locally. In addition, the USG funded Millennium Challenge
Corporation (MCC) is underwriting a five-year training and
vocational education program (TVET) to develop sustainable programs
to help Mongolia meet its needs for skilled blue- collar workers
(http://www.mca.mn or http://www.mcc.gov).

Mongolian labor law is not particularly restrictive. Investors can
locate and hire workers without using hiring agencies -- as long as
hiring practices are consistent with Mongolian Labor Law. However,
Mongolian law requires companies to employ Mongolian workers in
certain labor categories whenever a Mongolian can perform the task
as well as a foreigner. This law generally applies to unskilled
labor categories and not areas where a high degree of technical
expertise nonexistent in Mongolia is required. The law does provide
an escape hatch for all employers. Should an employer seek to hire
a non-Mongolian laborer and cannot obtain a waiver from the Ministry
of Labor for that employee, the employer can pay a fee of US$140.00
per employee per month. Depending on a project's importance, the
Ministry of Labor can exempt employers from 50% of the waiver fees
per worker.

Foreign and domestic investors consistently argue that they bear too
much of the social security costs for each domestic and foreign hire
under the amended 2008 Social Insurance Law enacted in July 2008.
Foreign employees became liable for social insurance taxes if they
reside within Mongolia for 181 days within a 365 day period. Under
this law, foreign and domestic workers pay up to 108,000 tugrik (US$
67) for this tax, no matter their respective rates of pay.
Employers must pay a tax equivalent to 13% of the annual wage on
both domestic and foreign workers. Given that state pensions have
yet to broach even US $100, Employers argue that pensions are not
commensurate with worker contributions, especially those of
highly-paid ex-patriot employees. In addition, workers must pay in
for twenty years in order to be vested, highly unlikely for many
ex-patriot employees, who reside in Mongolia for less than three
years on average. Local and foreign business associations are
working with both the government/Parliament to address perceived
inequities.

Regarding ILO conventions See ILO at http://www.ilo.org

A. 15 FOREIGN TRADE ZONES/FREE PORTS

The Mongolian government launched its free trade zone (FTZ) program
in 2004. Currently there are two FTZs located along the Mongolia
spur of the trans-Siberian highway: one in the north at the
Russia-Mongolia border town of Altanbulag and the other in the south
at the Chinese-Mongolia border at the town of Zamyn-Uud. Both FTZs
appear moribund, with no development at either site. The port of
entry of Tsagaan Nuur in Bayan-Olgii province is being considered as
the site of third FTZ.


ULAANBAATA 00000119 024.2 OF 024


Management for the Zamyn-Uud Free Trade Zone (ZUFTZ) was originally
tendered to a Chinese firm. In 2006, the GOM voided the agreement
for non-compliance of the terms of the tender. The GOM re-tendered
the management contract in 2006, but later voided the contract,
alleging that the current holder of the management rights in the
ZUFTZ had failed to live up to the terms of the tender.

So far, there are no indications that government will not keep
promises to open the zone to any who satisfy the relevant legal
requirements. However, there are concerns about the Mongolian free
trade zones in general and Zamyn-Uud in particular. In April 2004,
the USAID sponsored Economic Policy Reform and Competitiveness
Project (EPRC: http://www.eprc-chemonics.biz/) made the following
observations of Mongolia's FTZ Program. In 2009, these issues
remain concerns:

--Benchmarking of Mongolia's FTZ Program against current successful
international practices shows deficiencies in the legal and
regulatory framework as well as in the process being followed to
establish FTZs in the country.

--Lack of implementing regulations and procedural definitions
encapsulated in transparency and predictability quotient required to
implement key international best practices.

--A process of due diligence, including a cost-benefit analysis, has
not been completed for the proposed Zamyn-Uud FTZ.

--Identifiable funding is not in place to meet off-site
infrastructure requirements for Zamyn-Uud and Altanbulag sites.

--Deviations from international best practices in the process of
launching FTZs risks repeating mistakes made in other countries and
may lead to "hidden costs" or the provision of subsidies that the
government of Mongolia did not foresee or which will have to granted
at the expense of other high priority needs

A. 16 FOREIGN DIRECT INVESTMENT STATISTICS:

Comment on the data sources for foreign direct investment in
Mongolia. The Foreign Investment and Foreign Trade Agency (FIFTA)
provides most of the data for tracking FDI in Mongolia. However,
the data has limitations:

A. Incomplete reporting and data collection:

--Many foreign firms provide FIFTA with inaccurate or incomplete
data on their annual investment amounts. FIFTA's registration
regime requires companies to document business plans and total FDI
for the coming year. FIFTA uses these amounts to determine FDI for
the year. However, firms reportedly believe FIFTA may not be able
to guarantee the confidentiality of proprietary business
information, and so they withhold complete data on their actual
activities.

--Mongolia also suffers from promised investment that does not
materialize or which comes in at a lower level than originally
stated. FIFTA does not update reports to account for these or
other changes to investments during the year. (See Chapter 6,
Section A.5: Performance Requirements and Incentives).

--In addition, many of Mongolia's largest foreign- owned or
foreign-invested entities are in the mining sector, which because of
a quirk of the current Minerals Law of Mongolia are not necessarily
defined as foreign-invested firms. The current minerals law
specifies that only domestically registered mining firms can have
mining licenses registered in their names, which means that foreign
investments associated with mining may not be recorded by FIFTA,
even though the investment is demonstrably foreign. For example,
the investment by Ivanhoe Mines Mongolia (a Canadian company) into
Mongolia has reached at least US$ 800 million, yet this investment
is not recorded among the data provided by FIFTA.

B. Data not Available: Neither FIFTA nor any other Mongolian agency
to our knowledge tracks Mongolia's direct investment abroad.

MINTON