Identifier
Created
Classification
Origin
10ULAANBAATAR28
2010-01-27 08:10:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Ulaanbaatar
Cable title:  

2010 Mongolia Investment Climate Statement, Part 2 of 3

Tags:  EINV ECON OPIC KTTB USTR MG 
pdf how-to read a cable
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RUEHOO/CHINA POSTS COLLECTIVE
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RUEHKO/AMEMBASSY TOKYO 3656
RUEHMO/AMEMBASSY MOSCOW 2825
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RUEHBY/AMEMBASSY CANBERRA 0506
RUEHTA/AMEMBASSY ASTANA 0262
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC
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UNCLAS SECTION 01 OF 14 ULAANBAATAR 000028 

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 2 of 3

REF: 09 STATE 124006

ULAANBAATA 00000028 001.2 OF 014


UNCLAS SECTION 01 OF 14 ULAANBAATAR 000028

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 2 of 3

REF: 09 STATE 124006

ULAANBAATA 00000028 001.2 OF 014



1. As requested ref, post provides the 2010 Mongolia Investment
Climate Statement. This cable, Part 2, contains sections A.5 through
A.9. See septels for sections A.1-A.4 and A.10-A.16.

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.
Formally quite generous to foreign investors, the current Tax Law of
Mongolia (amended in 2006) offers few incentives and exemptions.
While preferential tax agreements made with most foreign investors
have been allowed to run their courses, the government of Mongolia
(GOM) has attempted to limit both exemptions and incentives and to
make sure that tax preferences offered are available to both foreign
and domestic investors.

Current exemptions are granted for imports of staples as flour and
for imports in certain sectors targeted for growth, such as the
agriculture sector. Exemptions apply to both import duties and
Mongolia's value-added tax (VAT). In addition, the GOM will extend
a 10percent tax credit on case by case basis to investments in such
key sectors as mining, agriculture, and infrastructure.

Foreign investors have accepted phasing out of tax incentives,
because the amendments have brought some needed best practices to
the tax code. These include provision for 8-year
loss-carry-forwards, five-year accelerated depreciation, and more
deductions for legitimate business expenses including but not
limited to marketing and training expenses.

Revocation of the VAT Exemption

Investors view 2009's changes into the tax code's treatment of
exemptions as something of a mixed bag. On the down side,
Mongolia's Parliament revoked an exemption available on value-added
tax (VAT) taxes of 10percent 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 Oyu Tolgoi
(OT) copper-gold project were to smelt copper, imported equipment
supporting production of metallic copper might qualify for an
exemption from the VAT. However, 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 10percent 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
investors, international advisors provided by donor organizations,
or even with its own tax officials, chose to impose the VAT, which
immediately makes Mongolian mining costs 10percent higher than they
would otherwise be, impairing competitiveness and dramatically
varying from global practice.

Pro-Investment Changes to the Tax Code

On the plus side, Parliament revised both the Windfall Profit Tax
(WPT) and loss-carry forward provisions. Under the old regime, the
WPT imposed a 68percent tax on the profits from gold and copper
mining respectively. (For more details on the WPT see Chapter A.1:
Openness of Government to Foreign Investment.) 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 operate OT
commercially if burdened with the WPT. Consequently, Parliament
amended the WPT Law: The WPT will officially end for all copper

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concentrate and gold products in 2011.

Regarding the granting of more generous loss carry-forward
provisions, as a condition precedent of passing the OT Agreement,
Parliament extended the provision from two (2) years to eight (8)
years after incurring a loss. Most investors find eight years
sufficient for many Mongolian investments that require impose long,
expensive development horizons before producing any sort of profit.

Few Restrictions on Foreign Investment

The government applies the same geographical restrictions to 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, services, or 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. All Mongolian senior officials and politicians
make in-country processing a consistent feature of their public and
private policy statements regarding the development of mining. For
example, the current but soon to sunset WPT applied the tax to
copper concentrate, but exempted metallic copper produced in
Mongolia. Recently concluded negotiations on the OT copper-gold
project 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. Government plans also call for
increased investment in businesses and activities that keep the
"value" of a resource in Mongolia. Consequently, firms should
continue to expect the GOM to press aggressively 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, not the Mongolian government, make arrangements regarding
technology, intellectual property, and similar resources and may
generally 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 -- with one
key exception for strategic mining assets (For more detail on what
constitutes a strategic mining asset see Chapter A.1: Openness of
Government to Foreign Investment). Although Mongolia imposes no
official statutory or regulatory requirement, the GOM, as a matter
of foreign policy, sometimes negotiates restrictions on what sort of
financing foreign investors may obtain and with whom those investors
might partner or to whom they might sell shares or equity stakes.
These restrictive covenants will most likely be imposed in certain
sectors where the investment is determined to have national impact
or national security concerns, especially in the key mining sector.


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

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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 USD140 per employee per month.
Depending on the importance of a project, the Ministry of Labor may
grant an employer a 50percent exemption of the waiver fees as an
incentive.

Limited Performance Requirements

Requirements in the Petroleum and Mining Sectors

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 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
PAM. These procedures apply to all investors in the petroleum
exploration sector.

Under the current Minerals Law of Mongolia, receiving and keeping
exploration licenses depends on conducting actual exploration work.
Each year exploration firms must submit a work plan and report on
the execution of the previous year's performance commitments, all of
which are subject to annual verification by the Minerals Authority
of Mongolia (MRAM). Failure to comply with work requirements may
result in fines, suspension, or even revocation of exploration
rights. Work commitments expressed in terms of US dollar expenses
per hectare per year:

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

--4th to 6th years miners must spend no less than US D1.00 per
hectare on exploration

--7th to 9th years miners must spend no less than US D1.50 per
hectare on exploration

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

In 2009 the Parliament passed a new law imposing significant new
controls on mining and processing uranium in Mongolia. This 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 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 50percent
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

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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

Requirements Imposed on Foreign Investors Only

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 USD
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 tugrik or about USD 8.00.
Foreign Investors must then pay a yearly prolongation fee of 6,000
Mongolian tugrik or about USD 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 have no 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 5percent 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 imported drugs, food products, chemicals,
construction materials, etc., are extremely nontransparent,
inconsistent, and onerous. When companies attempt to clarify what
the rules for importing such products 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


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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, with exceptions
in the mining and petroleum sectors.

Competition from the State-Owned Sector

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 many
parastatals have been privatized. The exceptions are the
state-owned power and telecom industries, a national airline
(international only at present),the national rail system
(half-owned by Russia),several coal mines, and a large copper
mining and concentration facility (also half-owned by Russia).

Currently, firms from Mongolia, China, Japan, Europe, Canada, and
the U.S. are actively seeking opportunities for renewable and
traditional power generation in Mongolia. However, few want to
invest in the power generation field until the regulatory and
statutory framework for private power generation firms up and
tariffs are set at rates allowing profits.

Regarding its railway sector, Mongolia has no plans to privatize its
existing railroad jointly held with the government of Russia, but
current law does allow private firms to build, operate, and transfer
new railroads to the state. Under this law several private mining
companies have proposed rail links, and obtained licenses to
construct these new lines from their respective coal mines to the
Chinese border or to the currently operating spur of the
Trans-Siberian Railroad. However, because landlocked Mongolia and
its neighbors have yet to resolve transnational shipping issues,
companies may not be able to access rights granted under these
licenses.

Although the trend had been for the GOM to extract itself from
ownership of firms and other commercial assets, both the current
Minerals Law of Mongolia and the 2009 Uranium Law bring the state
back into mining. (See Chapter A.1: Openness of Government to
Foreign Investment for fuller discussions of both the 2009 Uranium
Law and Minerals Law) Under both laws, the GOM granted itself the
right to acquire equity stakes ranging from 34 percent to perhaps
100 percent of certain deposits deemed strategic for the nation.
Once acquired, these assets are to be placed with one of two
state-owned management companies: Erdenes MGL, for non-uranium
assets; or MonAtom for uranium resources. These companies are then
mandated to use the proceeds from their respective activities for
the benefit of the Mongolian people.

The role of state as an equity owner, in terms of management of
revenues and operation of the mining asset, remains unclear at this
point. There are some concerns over the capacity of the GOM to
deal with conflicts of interest arising from its position as both
regulator and owner of these strategic assets. Specifically, firms
are worried that the GOM's desire to maximize local procurement,
employment, and revenues may comprise the long term commercial
viability of any mining project. In addition, discussions are
underway to set up three new state-owned holding entities to manage
assets in three priority areas -- mining, energy, and infrastructure
-- then take the companies public to raise investment revenues
through the capital markets.

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. If debtors default on such secured loans,

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creditors do have recourse under Mongolian law to recover debts by
seizing and disposing of property offered as security. The only
exceptions to this liberal environment are current mining laws,
which either bar transfer of exploration and mining licenses to
third parties lacking professional mining qualifications or status
as a Mongolian registered entity, or which threaten to expropriate
without compensation certain mineral holdings outright.

Mongolia's Current Regime to Protect Creditors
The current protection regime for creditors functions 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 Chapter A.4 Dispute
Settlement, some judges, largely out of ignorance of the concepts,
have failed to recognize these practices. Some newly trained judges
are making a good faith effort to uphold property rights, but need
time to learn how to adjudicate such cases.

Mongolia's bankruptcy provisions and procedures for securing the
rights of creditors need 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 on immovable property; nor
does the current system record ownership and liens on movable
property. Consequently, Mongolian lenders risk 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
go some way to improving the ability of creditors and debtors to
prove ownership. For details: http://www.mca.mn.

Overall, the legal system recognizes the concept of collaterized
assets as security for loans, 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. Current law bars creditors from non-judicial
foreclosure, requiring them to submit all contested foreclosure
actions for judicial review through Mongolia's court system. This
approach slows debt collection substantially: Waits of up to 24
months for final liquidations and settlement of security are not
uncommon.

Debt Collection Procedures

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 courts
and creditors.

In some cases, bailiffs refuse to enforce the court orders. 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.

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Protection of Intellectual Property Rights

Mongolia supports intellectual property rights (IPR) 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 remain
un-ratified by 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, the IPOM makes the most
consistent good faith effort to fulfill its mandates.

Problems stem from ignorance of the importance of intellectual
property to Mongolia and of the obligations imposed by TRIPS on
member states. Customs still hesitates to seize shipments, saying
that their statutory mandate does not allow seizure of such goods,
but Mongolian statutory and constitutional laws clearly recognize
that international treaty obligations in this area 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. Customs officers
may occasionally seize fake products, but it seems that Mongolian
customs law will have to be brought into formal compliance with
TRIPS before Customs will fulfill its obligations. The ECU has
also been lax. The ECU hesitates to investigate and prosecute IPR
cases, deferring to the IPOM. Anecdotal evidence suggests that ECU
officials fear political repercussions from going after IPR pirates,
many of whom wield political influence.

The IPOM generally has an excellent record of protecting American
trademarks, copyrights, and patents; however, tight resources limit
the IPOM's ability to act. In most cases, when the U.S. Embassy in
Ulaanbaatar conveys a complaint from a rights holder to the IPOM, it
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 95percent 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 its attention.

Pirated optical media are also readily available and subject to
spotty enforcement. Mongolians produce no significant quantities of
fake CD's, videos, or 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 broadcasters, most of which are
connected to major government or political figures. Rather the IPOM
raids local ("street") DVD and CD outlets run by poor urban youth
who lack the political and economic clout of the TV broadcasters.
Again, when an American raises a specific complaint, the IPOM acts
on the complaint, but IPOM rarely initiates action.

Restrictive Aspects of Current Mining Laws

Minerals Law of 2006


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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.

In addition, no foreign entity, in its own right, can hold any sort
of mining or petroleum license; only entities registered in Mongolia
under the terms of relevant company and investment laws may hold
exploration and mining licenses. Should a foreign entity acquire
a license as 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 mining rights. We advise investors with
specific questions regarding the current status of their respective
to seek professional advice on the status of those licenses.

Uranium Law of 2009

The Uranium Law of 2009 dramatically curtails property rights
protection regime protecting most exploration and mining licenses.
The law imposes the following conditions upon investors in the
uranium mining sector:

--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 51percent
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 both investors and observers, this law statutorily sanctions
expropriation, a concept heretofore alien to Mongolian law.
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 allows the GOM unfettered
power to seize holdings with no obligation to compensate rights
holders. Complicating the issue, the law conflates deposits with
the companies developing those deposits, letting the GOM claim an
uncompensated share of any entity that might mine the deposit. In
effect, the GOM demands a free-carried, non-compensated interest of
no less than 51percent of any uranium mining firm in Mongolia.

Affected uranium rights holders contested the constitutionality of
these provisions before Mongolia's Constitutional Court, and lost
the case. The Court upheld the law, asserting that the all minerals
in the ground are the property of the Mongolian state even if
separated from the ground. Legal experts with whom we consulted

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explained that the Court seems to make the extraordinary and
unprecedented claim that Mongolia's ownership extends to products
created with the ore; hence the state has a "legitimate" claim on
both the ore body and any company mining the resource. This theory
appears to undermine the property rights of uranium investors and
chips away at property rights protections granted both under the
constitution and Mongolia's Minerals, Company, and Foreign
Investment Laws.

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 20 years ago-but
rather, the problem is that legislators lack knowledge on what
foreign and domestic investors need from the state when investing;
and that they do not consult with those affected by their
legislative actions. Corruption aside, the fact that laws and
regulations change with little consultation creates a chaotic
situation for all parties.

Problems with the Drafting Process for Legislation and Regulations

Normally, laws can be crafted in two ways. Once rare but now
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 typically, 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 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 government has never clarified the legal and
constitutional authority of the NSC to veto or recommend changes to
draft legislation, 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
tasks the working group that wrote the original law to draft
regulations. This group submits their work to the minister who
approves or recommends changes. In most cases, regulations require
no Cabinet approval, and become official when the relevant incumbent
minister approves them. When legislation crosses inter-ministerial
boundaries, the Cabinet will authorize the most relevant ministry to
supervise an inter-ministerial approval process for regulations.

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 reconciles the language and provisions of
the law with both existing legislation and the constitution of
Mongolia, after which the law passes to the Cabinet and then

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Parliament. In the case of regulations, MOJHA vets the regulations
to ensure consistency with current laws and provisions of the
constitution. In effect, MOJHA can either modify or even veto legal
or regulatory provisions that it finds inconsistent with the
statutes and constitution.

System lacks Transparency

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 passes 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 committees 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
list 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
(since-amended) 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 on competitive,
transparent bidding practices and limits on access tender
opportunities to foreign bidders. In 2009, Parliament passed
legislation threatening property rights in the mining sector that
many view as expropriatory and revoked key tax exemptions affecting
major mining and construction projects, all with no formal or
informal 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
non-government organizations are prepared to lobby at the
appropriate level. Over the last three years we have found that
many agencies and Members of Parliament welcome our advice and
information, particularly if given in a non-confrontational way that
respects Mongolia's political process and right to deliberate.

Regulators 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
long acknowledged that the Soviet-era State Secrets Law requires
substantial amendment. Currently, most government
documents-including administrative regulations affecting investments
and business activities-can be technically classified as "state
secrets" not for release to the public. This technicality allows
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 for
several years, but it remains in its formative stages.

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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 or during
Mongolia's democratic era, is taking hold and moving 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 Impact of NGOS and Private Sector Associations on GOM Policy

The Mongolian government actively protects its prerogatives to
legislate and regulate economic activities in its domain. While
NGOs and private sector associations have 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 serve more than an advisory role over the formulation and
execution of both laws and rules, which also applies to setting
standards for various industries. Based on experience, the GOM will
routinely resists any expanded role for civil society and NGOs.
This unarticulated but tacit 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 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
generally note no consistent, systematic pattern of abuse
consistently initiated by either government or private Mongolian
entities aimed against foreign investors in general or against U.S.
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 Mongolians use connections
to 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.

Although we have note no systemic and routine abuse of Mongolia's
legal system to hinder FDI and investors, a worrisome trend
affecting implementation of Mongolia's requirement for exit visas by
both Mongolian public and private entities to exert pressure on
foreign investors to settle commercial disputes.
Required, valid exit visas are normally issued pro forma 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. The law does not
allow authorities to distinguish a criminal and civil case when
detaining a person. 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 resolution. In fact,
the Mongolian government maintains the right to detain foreign
citizens indefinitely without appeal until the situation has been

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resolved.
Research into issue has revealed that investors from countries other
than the U.S. are 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 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.

An investor in this situation is effectively detained in Mongolia
indefinitely. Some foreign investors have resolved the impasse by
settling, thereby 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. In one case, an American citizen has been denied
an exit visa for over two years pending a criminal investigation
into a failed business deal with the Government of Mongolia.

We note that Mongolian investors are not subject to similar
impositions of their immigration codes when involved in commercial
disputes. Mongolian citizens do not require exit visas to depart
Mongolia and can only be denied exit with a pending arrest warrant.


A.9 EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT

Mongolia currently lacks the experience and expertise needed to
sustain portfolio investments. It has no regulatory apparatus for
these activities, and both the state and private entities are just
beginning to engage in them. However, Mongolia has active capital
markets. The government of Mongolia (GOM) imposes few restraints
on the flow of capital in any of its markets. Multilateral
institutions, particularly the International Monetary Fund, have
typically found the regime too loose, especially in the crucial
banking sector.

Although the government has clear rules about capital reserve
requirements, loan practices, and banking management practices, the
Bank of Mongolia (BOM),Mongolia's central bank, has historically
resisted restraining credit flows and interfering with operations at
Mongolia's commercial banks, even when the need to intervene has
been apparent. However, in response to the severe impact of the
ongoing global financial crisis on Mongolia's banking sector, the
BOM is striving to improve it capacity to deal with those insolvent
banks and improperly managed banks that have impaired the health of
Mongolia's financial system. To illustrate, two (2) of the
country's 16 banks are currently in receivership, and additional
consolidation under BOM supervision is likely.

Capital and Currency Markets

The global economic crisis savaged Mongolia's currency, capital, and
equity markets. While the currency had proved resilient, holding
its value against most international currencies, it fell some 40
percent against the U.S. dollar from late 2008 into spring 2009, as
the worst of the crisis hit. It has remained relatively stable and
even resilient since then. The currency's 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, once
the tugrik began to slide relative to the U.S. dollar,
import-related trade was affected as well.

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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 in-flows reversing as
foreign depositors repatriated their funds, either because these
entities needed the money to weather their own financial crises or
feared 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 and continue 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 curtailed such infusions. Instead, the Bank
sells dollars into the system by auction to the local commercial
banks and lets the market decide the value of the exchange rate
rather than attempting to set the rate. . In addition, Parliament
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 move was intended to
bolster the value of the Tugrik by increasing demand for the
currency. Overall liquidity is sufficient but affordable capital
remains scarce. Local credit interest rates for customers range
from 12percent for the most credit worthy to perhaps 90percent per
annum (or more) for the least. Foreign investors can easily tap
into these 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.
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 or raising
capital for investment. 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 contains a provision that
requires that holders of mining licenses for projects of strategic
importance must sell no less than 10percent 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
remaining fourteen (14) commercial banks (down from 16 in 2008) adds
up to just around USD2 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 somewhat
better managed.

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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. As the global financial
storm has descended on Mongolia's banking sector, these banks have
weathered it well - so far.

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

From 1999 through late 2008, BOM consistently refused to close any
commercial 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 at a
cost of around USD 150 million -- not an inconsequential sum in an
economy with a USD 5 billion per annum GDP. In 2009, Mongolia's
fifth largest bank went into receivership, and three (3) other
mid-tier banks are at the center of widespread discussion of future
consolidation.

The BOM and Mongolia's financial system have so far endured the
crisis. However, most observers note that the insolvent banks had
shown signs of mismanagement, non-performing loans, and
ill-liquidity for several years before the BOM moved to safeguard
depositors and the financial sector. They argue further that the
BOM withheld effective supervision fearing that closure would signal
weakness to, and spur panic among, the general public; and because
of interference on the part of those whose financial interests in
the troubled banks would have been threatened by regulatory action.

The latest crisis has spurred the BOM to develop a short run plan to
identify and close insolvent banks while preserving the integrity of
financial system. Reserve requirements will be raised to deal with
the on-going non-performing loan problem, too. Beyond this triage,
the BOM is in the process of instituting long-term reforms to
enhance its ability to supervise the banking system; however, such
reform depends on Parliament to amend both Mongolia's banking and
banking supervision laws, a process that may be completed by
mid-2010.

ADDELTON