2010 Mongolia Investment Climate Statement, Part 1 of 3

UNCLAS SECTION 01 OF 15 ULAANBAATAR 000027

SENSITIVE
SIPDIS

STATE PASS USTR, USTDA, OPIC, AND EXIMBANK
STATE FOR EAP/CM AND EEB/CBA
USAID FOR ANE FOR D. WINSTON
USDOC FOR ZHEN-GONG CROSS

E.O. 12958: N/A
TAGS: EINV ECON OPIC KTTB USTR MG
SUBJECT: 2010 Mongolia Investment Climate Statement, Part 1 of 3

REF: 09 STATE 124006

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1. As requested ref, post provides the 2010 Mongolia Investment
Climate Statement. This cable, Part 1, contains sections A.1 through
A.3. See septels for sections A.5-A.16.

A.1 OPENNESS OF GOVERNMENT TO FOREIGN INVESTMENT

In its specific policies, laws, and general attitude, the Government
of Mongolia (GOM),has tended to support foreign direct investment
(FDI) in all sectors and businesses. However, some 2009 regulatory
and legislative acts in the areas of environmental law, taxation,
and mineral rights effectively narrow Mongolia's openness to FDI.
While most Mongolian industrial and economic strategies do not
discriminate actively or passively for or against foreign investors,
specific governmental acts regarding foreign involvement in
Mongolia's nascent uranium sector have spurred public criticism that
the government is curtailing the rights of foreign investors in
favor of the Mongolian state. These criticisms also concern that
changes to the uranium law have created a precedent for further
restrictions on FDI.

In general, Mongolian law does not discriminate against foreign
investors. Foreigners may invest with as little as USD100,000 cash
or the equivalent value of capital material (office stock,
structures, autos, etc.). In both law and practice, foreigners may
own 100 percent 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. Mongolia
pre-screens neither investments nor investors, except in terms of
the legality of the proposed activity under Mongolian law. 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
rights are 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.

Passed in 2006, Mongolia's current Minerals Law enacted the concept
of the strategically important deposit, which empowers the GOM the
right to obtain up to either a 34 percent of 50 percent share of any
mine on or abutting such a deposit. The prior 1997 law had no
concept of "strategic deposits" allowing the state to take equity in
mines.

The current law defines "a 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 percent 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 or Parliament. To date, the GOM has only
identified world class copper and coal reserves and all deposits of
rare earths and uranium as reaching this threshold.

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 percent. If the deposits were developed with
private funds and the state has not contributed to the exploration
of the deposit at any time, the GOM may acquire up to 34 percent of

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that 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. Parliament 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.

Importantly, the state equity provision is not expropriatory on its
face, because the GOM has committed itself to compensating firms for
the share it takes at fair market value. Although experience is
limited with the law, so far the GOM has honored this commitment, as
experience with the recently signed agreement for the mega Oyu
Tolgoi copper-gold mine project confirms.

In addition, the current Minerals Law restricts the access of
petroleum and mineral licenses to entities registered in Mongolia
under the terms of the relevant company and investment laws. A
foreign entity, in its own right, cannot hold any sort of mining or
petroleum license. Should a foreign entity acquire a given
license as either collateral or for the purpose of actual
exploration or mining, and fail to create the appropriate Mongolian
corporate entity to hold a given license, that failure may serve as
grounds for invalidating the license. In essence, the foreign
entity may lose its security or its mining rights. We advise
investors with specific questions regarding the current status of
their respective licenses to seek professional advice on the status
of those licenses.

Reaching Agreement on the Oyu Tolgoi Project

In October 2009, the GOM, Ivanhoe Mines of Canada, and Rio Tinto
jointly negotiated an investment and development agreement for the
Oyu Tolgoi (OT) copper- gold deposit located in Mongolia's South
Gobi desert. The OT agreement vests the government of Mongolia with
34 percent ownership of the project and provides guarantees for
local employment and procurement. With estimated development costs
in excess of USD seven (7) billion, this 40-year plus mine is
conservatively expected to double Mongolia's annual GDP when it
becomes fully operational around 2020.

Observers of Mongolia's investment climate consider passage of this
agreement an unambiguously positive sign for foreign investors.
Although the deal took about six years to craft and several
conditions must still be met before implementation begins, nearly
all observers conclude that it shows Mongolia can say "Yes" to key
projects undertaken with foreign involvement and investment. In
addition, the agreement confirms the GOM's commitment to
compensating private rights holders of most deposits considered
strategic under the current minerals. Finally, the OT deal shows
that the GOM and Parliament are willing to amend laws and
regulations to enhance the commercial viability of mining projects
in Mongolia. As other projects of varying scales have been waiting
for OT to pass, the positive impact and message of the OT deal for
investors should not be underestimated.

2009 Laws Negatively Affecting Investor Rights

Although the OT deal was the big positive story for foreign
investors in 2009, the impact has been moderated by the passage of
two key laws that many foreign and domestic investors think detract
from Mongolia's claims to being a competitive, safe, and predictable
destination for investment.

The 2009 Uranium Law of Mongolia

In 2009 the Parliament imposed significant new controls on mining
and processing uranium in Mongolia. The law creates a new
regulatory agency, the Nuclear Regulatory Authority of Mongolia

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(NRA),and a state-owned holding company, MonAtom, to hold assets
that the government will acquire from current rights holders. The
law imposes several conditions:

--Immediately revokes all current uranium exploration and mining
licenses and then requires all holders to register these licenses
with the NRA, for a fee.

--Requires investors to accept that the Mongolian state has an
absolute right to take -- without compensation -- at least 51
percent of the company that will develop the mine -- as opposed to
just the deposit -- as a condition of being allowed to develop any
uranium property.

--Creates a uranium-specific licensing, regulatory regime
independent of the existing regulatory and legal framework for
developing mineral and metal resources. Prior to the Uranium Law,
exploration licenses gave their respective holders the rights to
discover and develop any and all mineral and metal resources
discovered within that license area (this did not include petroleum
resources, which are governed separately). According to GOM
officials, this new law means that the state can issue a distinct
license for uranium exploration on a property otherwise dedicated to
other mineral and metals exploration.

The Law on the Prohibition of Minerals Exploration in Water Basins
and Forested Areas of 2009

In 2009, the Parliament passed a law prohibiting mining in water
basins and forested areas of Mongolia. The stated intent was to
limit environmental damage caused primarily by placer gold mining in
and around forests and watersheds. The law imposes the following
restrictions on exploration and mining rights:

--Revokes or modifies licenses to explore for or mine any and all
mineral resources within an area no less than 200 meters from a
water or forest resource.

--Requires the government to compensate rights holders for
exploration expenses already incurred or revenue lost from actual
mining operations.

--Empowers local officials to determine the actual areas which can
be mined. In effect, the local official can extend the 200 meter
minimum at his discretion.

Both foreign and domestic investors have unambiguously criticized
these new laws and their respective implementations as both
non-transparent and potentially expropriatory. They argue that
these laws radically change the rules for investing in Mongolia's
vital minerals sector quite late in the game, raising the question
of Mongolia's reliability as an investment destination.

Further, observers note that these laws also raise the specter of
outright expropriation, which heretofore has not been present in
Mongolia. Although the Water Law requires compensation, the
government of Mongolia has not devised detailed plans for
indemnifying rights holders. In regards to the Uranium law, the
legislation explicitly rejects any obligation to compensate
investors for loss of economic rights and property; hence,
generating credible investor fears of government of expropriation.


Investors note that both laws passed without sufficient public
review and comment; and that the subsequent regulatory drafting
process occurred with little participation of the affected parties.
The resulting regulatory regimes do not generally specify how and on
what basis licenses will be revoked, nor do these new process detail
how investors might appeal non-renewals. The open-ended powers
seemingly granted Mongolian officials seem to give central,
regional, and local officials broad discretionary powers to curtail
rights without apparent limit.

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Pending Elimination of the Windfall Profits Tax on Copper and Gold

Since passage in 2006, the Windfall Profits Tax Law 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: The law passed in six days with no consultation on
any of its provisions with stakeholders. The entire process raised
concerns among investors about the stability and transparency of
Mongolia's legislative and regulatory environment, which three
intervening years of legislating have done little to alleviate.

The WPT imposes a 68 percent tax on the profits from gold and copper
mining respectively. For gold, the tax originally kicked in when
gold price hit USD500 per ounce; however, in late 2008 Parliament
raised the threshold to USD850. For copper, the threshold is USD
2,600 per ton. Mining industry sources claim that the 68 percent
tax rate, when combined with other Mongolian taxes, makes the
effective tax 100 percent 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,
although that fund, too, was modified in late 2009.

The recent OT Investment Agreement entailed further amendment to the
WPT as a condition precedent to its passage. OT's private investors
successfully argued that they would not be able to run a
commercially viable OT operation when faced with the WPT.
Consequently, Parliament amended the WPT Law: The WPT will
officially end for all copper concentrate and gold products in 2011.


Revisions of the Mongolian Tax Code

Effective since January 1, 2007, the current tax code reduces tax
rates, flattens the tax schedule, removes discriminatory loopholes
and exemptions, and provides for appropriate deduction opportunities
for corporate investment. The current code allows firms to deduct
more types of legitimate business expenditures: training, business
travel, cafeteria expenses, etc. The law also imposes a level
playing field between foreign and domestic investors. Specifically,
the current code eliminates the majority of discriminatory tax
exemptions and holidays (most of which favored international
investors).

As with the WPT, the OT Agreement had a salutary effect on key tax
provisions long-desired by foreign and domestic investors alike.
Before OT, firms could only carry-forward losses for two (2) years
after incurring the loss While most businesses approved of this
provision, many, especially those requiring large and long-term
infrastructure development, 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. As a
condition precedent of passing the OT Agreement, Parliament extended
loss-carry forward to eight (8) years.

On the down side, Mongolia's Parliament revoked an exemption
available on value-added tax (VAT) taxes of 10 percent on equipment
used to bring a given mine into production, except on equipment to
be used in the production of highly processed mining products. For
example, if the OT project decides to smelt copper, imported
equipment supporting production of metallic copper might qualify for
a 10 percent reduction on VAT. However, in a effort to promote
value-added production in Mongolia, the GOM defines the production
of copper concentrate -OT's likely copper product - as
non-value-added output; and so, equipment imported to develop and
operate this sort of operation would not qualify for the 10 percent
VAT exemption.

Most jurisdictions, recognizing that most mines have long
development lead times before production begins, either waive or do
not tax such imports at all. Parliament, with no consultation with

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investors, international advisors provided by donor organizations,
or even of its own tax officials, chose to impose the VAT, which
immediately makes Mongolian mining costs 10 percent higher than they
would otherwise be, impairing competitiveness and dramatically
varying from global practice.

Whether any mining output qualifies for this exemption seems
completely at the discretion of the GOM, which has not set out in
regulation or statute a process by which it will regularly
adjudicate such VAT exemption requests.

Unfinished Business (Including Customs Rates)

Both the GOM and Parliament continue to intend to debate additional
tax reform measures. Discussed since 2007, no substantive progress
has been made since. Proposed measures include revisions to the law
on customs and customs tariffs. While the exact nature of the
proposed changes in the customs law remains 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
institutions warn that the 2007 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.

Issues in the Telecom and Aviation Sectors

While the Mongolian government supports FDI and domestic investment,
both foreign and domestic 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 has
traditionally flowed, 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,
some observers believe that 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, Communication Technology, and Post Agency
(ICTPA),which is charged with providing policy guidance to the
Communication Regulatory Commission of Mongolia (CRC). Companies
report that these agencies routinely act in ways that seem to have
no basis in law or regulation and which have harmed American
interests, not to mention those of investors from Mongolia and other
countries. For example, ICTPA has attempted to order internet
service providers to charge set access prices, without recourse to
the market. The CRC routinely tenders licenses for frequency and
information technology service allocation through a completely
non-transparent process that invariably seems to favor certain
domestic interests over other Mongolian companies and foreign

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investors. While agreeing that the GOM has an interest in
allocating frequency, domestic and foreign investors question why
either the ICTPA or CRC need to interfere in the provision of ICT
services, which they believe should be left to the consumers to
decide.

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 (which does not currently operate
domestically). However, the GOM frowns on domestic airlines that
charge more for service. These state prices are well below
operating costs and inhibit the private carriers from charging a
break-even fee. However, private carriers 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. Apart from a
brief and no-longer operating domestic service in 2009 using
aircraft from their international fleet, MIAT and the GOM have
failed to upgrade the domestic air fleet, which is effectively
non-existent. This 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.
Concerns over Exit Visa's
Although not strictly a judicial issue, in 2009 a trend intensified
involving abuse of the country's requirement for exit visas by both
Mongolian public and private entities to exert pressure on foreign
investors to settle commercial disputes. The required valid exit
visas are normally issued at the port of departure (e.g. the
international airport),but may be denied for a variety of reasons
including civil disputes, pending criminal investigation, or for
immigration violations. If denied for a civil dispute, the visa may
not be issued until either the dispute is resolved administratively
or a court has rendered a decision. Neither current law nor
regulations establish a clear process or time-table for settlement
of the issue. Nor does the law allow authorities to distinguish a
criminal and civil case when detaining a person. In fact, the
Mongolian government maintains the right to detain foreign citizens
indefinitely without appeal until the situation has been resolved.

Research into issue has revealed that investors from countries other
than the U.S. are being affected by abuse of the exit-visa system.
All cases have a similar profile. A foreign investor has a
commercial dispute with a Mongolian entity, often involving assets,
management practices, or contract compliance. The Mongolian
entities respond by filing either civil or criminal charges with

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local police or prosecutorial authority. It is important to note
that at this point there need be no actual arrest warrant or any
sort of official determination that charges are warranted: Mere
complaint by an aggrieved party is sufficient grounds to deny exit.
We should note that Mongolian investors are not subject to similar
detention when involved in commercial disputes. Mongolian citizens
do not require exit visas to depart Mongolia and can only be denied
exit with if an actual arrest warrant has been issued.

An investor in this situation is effectively detained in Mongolia
indefinitely. Some foreign investors have resolved the impasse by
settling, allowing them to depart Mongolia. If unwilling to settle,
the foreign investor will have to undergo the full investigatory
process, which may lead to a court action. Investigations commonly
take up to six months, and in one case an American citizen has been
denied an exit visa for two years pending a criminal investigation
into a failed business deal. In addition, even if a dispute seems
settled, it can be filed in the same venue again -- if the local
police and prosecutors are willing -- or in a different venue.

Privatization Policies and Resistance of Mongolian firms to Foreign
Investment

Privatization policies have 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.

Although the GOM routinely announces that it plans to privatize its
remaining assets, we have seen little real movement to privatize
state holdings in the aviation, telecommunications, power, and
mining sectors. Recent moves by the GOM to acquire assets in the
minerals sector - especially in uranium and coal -suggest to some
that, to the contrary, the GOM has no intention to extract the state
from ownership.

That said, the GOM has recently discussed initial public offerings
(IPO) for certain state-owned power, infrastructure, and mining
holdings. To date, the IPO discussion has developed at the
conceptual level, with little focus on the details.

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,
although no casino has been established there).

Generally, Mongolian private businesses seek foreign participation
and equity in all sectors of the economy. That said, some Mongolian
businesses use Mongolian institutions to stop competitors, if they
can. These actions 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 generally
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 its
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.

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FILM also establishes registration procedures for foreign companies.
Specifically, the law requires that any investment with 25 percent
or more of FDI 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 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
USD 1,000 to USD 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 late 2008, 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 (MIT) and
FIFTA respectively and merged them with the Ministry of Foreign
Affairs. The new Ministry of Foreign Affairs and Trade (MFAT) 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 MFAT's direct
supervision. Other units of MIT were absorbed by the now-named
Ministry of Food, Agriculture, and Light Industry and Ministry of
Nature, Environment, and Tourism.

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, or 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.


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In regards to domestic transactions, the Parliament of Mongolia in
2009 closed a loophole that allowed local transactions to occur in
any currency desired. Now, all domestic transactions must be
conducted in Mongolia's national currency, the Tugrik, excepting
those entities allowed specific waivers as determined by the
Mongolian central bank, the Bank of Mongolia.

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 percent withholding tax. The
bank retains 20 percent 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
provides incomplete statutory grounds and regulatory support for the
activity to take place. 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.
In 2009, we detected no wide-scale 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 endeavors as a condition of doing business.
However, in foreign-investor dependent crucial mining sector, 2009
saw the government of Mongolia (GOM) cross from actions that might
represent "creeping expropriation" to what many consider explicitly
expropriatory acts sanctioned through force of law, especially in
the uranium mining sector.

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.

Like 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 few 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

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generally respects recently enacted property rights and leases.

I: Implications of the Current Minerals Laws

Minerals Law of 2006

We closely watch the key mining sector, Mongolia's major foreign
exchange earner and chief engine for economic and commercial growth
and development. The current Minerals Law has 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 law imposes procedural requirements and grants powers to
central, provincial, and local officials - powers that, if abused,
might prevent mineral 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.

Both MRAM and its supervising authority, the Ministry of Mineral
Resources and Energy, now have broad discretionary authority to
select who will get tenements. Under the current system, it is
possible for a company to prospect virgin territory, and scope out a
potential exploration site, only to risk losing the site should MRAM
decide to grant the rights to another exploration company. 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 generates 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 current law removed from its predecessor 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

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rights per metal or mineral rather than as a whole, which has been
the standard practice. The deletion was apparently 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 2008 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 or even
issued compensation guidelines to those potentially affected by its
actions.

Expropriatory Aspects of the 2009 Law on Uranium Mining

In 2009 the Parliament passed a new law imposing significant new
controls on mining and processing uranium in Mongolia. The law
created a new regulatory agency, the Nuclear Regulatory Authority of
Mongolia (NRA),and a state-owned holding company, MonAtom, to hold
assets that the government will acquire from current rights holders.
The law imposes several key policies:
--Immediately revokes all current uranium exploration and mining
licenses and then requires all holders to register these licenses
with the NRA, for a fee.

--Requires investors to accept that the Mongolian state has an
absolute right to take -- without compensation -- at least 51
percent of the company (as opposed to the deposit) that will develop
the mine as a condition of being allowed to develop any uranium
property.

--Creates a uranium-specific licensing, regulatory regime
independent of the existing regulatory and legal framework existing
for mineral and metal resources. Prior to the Uranium Law,
exploration licenses gave their respective holders the rights to
discover and develop any and all mineral and metal resources
discovered within that license area (this did not include petroleum
resources, which are governed separately). According to GOM
officials, this new law means that the state can issue a distinct
license for uranium exploration on a property otherwise dedicated to
other mineral and metals exploration.

To many foreign and domestic investors, this law is outright,
statutorily sanctioned expropriation, which heretofore had not been
present in Mongolia. Although the Minerals Law of Mongolia and
other pieces of legislation officially state that the GOM must
compensate rights holders for any taking, the Uranium Law gives the
GOM the unfettered right to take uranium holdings from whomever it
will with no obligation to compensate the rights holders.
Complicating the issue is that the law seems to conflate the deposit
and company mining the deposit, allowing the GOM to claim an
uncompensated share in any entity that might mine the deposit. In

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effect, the GOM is demanding a free-carried, non-compensated
interest of no less than 51 percent of any uranium mine.

Acts of Provincial Administrations:

With regard to the issuance of both exploration permits and mining
licenses, provincial officials reportedly routinely use their
authority arbitrarily to block access to mining rights legally
granted under the current law. For example, reports regularly
circulate that some provincial government officials use 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
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 current 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.

Expansion of License Revocation Powers to the Soum Level

The recently passed Law on the Prohibition of Minerals Exploration
in Water Basins and Forested Areas of 2009 represents a considerable
extension of unregulated authority to Mongolia's 320 soum (county)
administrations in regards to mining activities within their
respective jurisdictions.

In 2009, the Parliament prohibited mining in water basins and
forested areas of Mongolia. The stated and laudatory intent was to
limit environmental damage caused primarily by placer gold mining in
and around forests and watersheds. The law imposes the following
restrictions on exploration and mining rights:

--Requires the government of Mongolia to revoke or modify licenses
to explore for any and all mineral resources within an area no less
than 200 meters from a water or forest resource.

--Requires the government to compensate rights holders for
exploration expenses already incurred or revenue lost from actual
mining operations.

--Empowers local officials, the soum or county governors, to
determine the actual areas which can be mined. In effect, the local
official can extend the 200 meter minimum at his discretion.


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Current rights holders are concerned that the power of local
governors to curtail mining in their respective jurisdictions seems
unlimited and unregulated. Although the governor cannot allow
mining within the 200 meter limit, the law sets no upper limit on
mining near water courses and forests in the respective soum. The
local administration has full discretion to prohibit operations 400
meters, 600, 1000, or more. Mining companies have to work out the
issue with the local governor; and should any company disagree with
a given soum administration's ruling, the law makes no provision for
administrative appeal. A company would then have to pursue redress
through a lengthy case in Mongolia's courts. In either case, the
rights holder would lose access to their economic rights for a
protracted period or permanently.

A.4 DISPUTE SETTLEMENT

The GOM consistently supports transparent, equitable dispute
settlements, but executing good intentions has proven problematic.
These problems largely stem 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 remain ignorant
of commercial principles.

Problems with Dispute Settlement in Mongolia's Courts

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. Matters regarding the constitutionality of laws and
regulations may be taken directly before the Constitutional Court of
Mongolia (the "Tsetz") by Mongolian Citizens, Foreign Citizens, or
Stateless Persons residing legally in Mongolia.

Problems arise for several reasons. First, commercial law in
Mongolia and broad understanding of it remain in flux. New laws and
regulations on contracts, investment, corporate structures, leasing,
banking, 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 ignorant of commercial principles, in some cases willfully.
They dismiss such concepts as the sanctity of the contract. This is
not a problem of the law, which recognizes contracts, but what most
conclude is faulty interpretation. In several cases courts have
misinterpreted provisions regarding leases and loan contracts,
allegedly intentionally in some cases. 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 the asset, such as
it is, and that is enough. Bad faith and loss of value simply have
no formal standing in judicial calculations of equity.

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Replacing old-school judges is not an option. It is politically
impossible-if not functionally impractical-for the Mongolians to
dismiss its cadre of Soviet-era judges. There is a realistic hope
that young justices, trained in modern commercial principles by
international 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 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 creditors.

Although a system exists to register immovable property-structures
and real estate-for the purpose of confirming ownership, the current
system does not record existing liens against immovable property. In
addition, no system exists to register 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.
It is hoped that a project sponsored by the Millennium Challenge
Corporation to create a more modern and efficient property
registration system will help improve the ability of creditors and
debtors to prove ownership. For program details go to
http://www.mca.mn.

Overall, the legal system does recognize the concept of
collateralized assets provided as security for loans, investment
capital, or other debt-based financial mechanisms. The legal system
also provides for foreclosure, but this process is exceptionally
onerous and time consuming. A 2005 change to Mongolian law
attempted to simplify the process by allowing creditors to foreclose
without judicial review. Prior to this law, all creditors had to go
to court to collect on securitized collateral, 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 were 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 percent from the sales price or from
the second auction minimum price even if there is no sale.

The SCO does not allow collateralized assets to be valued by neutral
third 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,
this procedure is onerous without a clear process behind it.

Purchase financing remains tricky. For example, a local car dealer
financed an auto for USD 20,000 down and USD 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

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the dealer took the buyer to court. Under current Mongolian law,
interest payments are suspended for the duration of such a 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 of value on the car. Domestic and
foreign businesses often respond by requiring customers to pay in
cash, limiting sales and 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 five 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. In the four cases
where a decision has been rendered, Mongolia has won each case; and
so, its commitment to imposing a negative international arbitral
decision remains untested.

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. These entities tell us
that they seek redress abroad because they perceive that domestic
arbitrators are too politicized, unfamiliar with commercial
practices, and too self-interested to render fair decisions.

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.

ADDELTON