Investment Promotion


4. Legislative and institutional arrangements underpinning investment decisions and processes

The process of attracting and securing investment in the extractives sector involves a range of state and other non-state actors and requires a sound legislative and institutional basis. This section highlights some of the most significant areas that underpin investment decisions and processes, including:

  • National Investment Laws

  • The role of an investment promotion agency

  • Bilateral Investment Treaties

  • Competitive bidding processes, including bidding criteria and negotiations

  • Stabilisation

  • Conflict of Laws

  • NOC/IOC Cooperation

  • The role of International Development Banks

  • An industry Perspective

  • Best practice examples

 

National investment laws

A recent study by UNCTAD revealed that national investment laws, backed by International Investment Agreements (IIAs), either bilateral or multilateral, are the main foreign and national investment promotion tool for most countries. There is a similar structure and common provisions in the countries that UNCTAD identified as having a national investment law.

The study concluded that:

  • At least 108 countries have an investment law as a core instrument to govern investment. Investment laws are part of the overall policy framework of host countries and not the only instrument to deal with investment

  • Even though investment laws generally share the same objectives, their content and overall approaches differ strongly

  • Most investment laws have investment promotion as their main objective, while only a few also deal with investment facilitation

  • Sustainable development is an explicit goal only in a small minority of them

  • Investment laws tend to show an imbalance between the coverage of investor rights and obligations and often cover the same issues as investment treaties. More than half of the laws provide access to international arbitration

  • The importance of investment laws calls for a deeper analysis of their content and their consistency with international investment policies

  • There is a need to strengthen the coherence between investment laws and other public policies, such as trade, tax, competition, social and environmental policies

The same study reported that in most of the national investment laws, investment promotion is the main purpose of introducing the legislation followed by economic development.

Objectives referred in the national investment laws, Key findings of report on Investment Laws: A Widespread Tool for the Promotion and Regulation of Foreign Investment, Source: (UNCTAD)

The role of an Investment Promotion Agency (IPA)

National investment laws often establish an investment promotion agency whose main function is to attract foreign investment. Almost every country in the world has an investment promotion agency, each with its own distinctive capacity.

The capacity of an IPA will vary depending on externalities such as availability of funding as well as the internal management and human capital of the agency. To guide the latter, Organisation for Economic Co-operation and Development (OECD), the United Nations (UN) and the World Bank have developed various guidelines for the use of host states.

There is not however a single recipe for an IPA’s functions. Some IPAs undertake small marketing operations; a number focus on administrative aspects of inward FDI; others are part of larger economic development organisations; and some allocate and manage financial support. Yet, as their budget grows they may face challenges from the public and other governmental departments. The capability to intervene in the national economy, and the rationale for the establishment and functions of the IPA therefore needs to be defined convincingly. The UK Department for International Trade in the UK, for example, was initially set up due the misperceptions of foreign investors (from the US in particular) on investment and market frameworks in the UK. Today, the Department provides robust insights on the potential benefits of exporting and inward investment and identifies areas where the dynamic potential of the private sector needs to be complemented by Government action to address market failures.

An IPA may be globally well known, particularly if it is in a resource rich country, or has strong interactions and influence within its region, in regions where there is market integration. In the latter case, regional political instability or stability would have an impact on the role of the IPA. It is therefore important to identify these external factors and establish mitigation tools to limit the potential negative repercussions of regional circumstances on a country’s ability to attract investment. An IPA may have a mandate to only support and develop investment programmes nationally for certain industries.

In some countries, it may be appropriate to establish sub-national investment agencies for important industries. For instance, the London Development Agency (LDA) has the responsibility for promoting inward investment to London in coordination with the Department for International Trade.  

Technology linkages

Competition among different national agencies especially in neighbouring states is increasing. The maximum benefit from foreign direct investment is generally felt when the investment brings in technology transfer which can be linked and utilised in other sectors other than the one for which the investment is targeted.

For example, technology transfer in the oil sector can be utilised in the production phase or implemented via human capital – to promote development of local products. For technology transfer to non-oil sectors to be successfully achieved, the technology transferred needs to be relevant to the business sector of the host country. In particular, the potential for the transfer of technology is important in some service sectors, for example in telecommunications.

The creation of such technology linkages, however, requires the host country to have sufficient capacity to absorb and protect the intellectual property and development level of non-extractives high-technology sectors. If the technology-gap is too wide, the likelihood of local enterprises to benefit from technology transfer will be low. In Angola, for example, foreign direct investment in oil and gas sector has predominantly meant that new hardware and equipment was brought in for efficient exploitation and production, and for constructing and expanding local refineries, as well as pipelines for transportation. Other opportunities for technology transfer have however been limited.

In Azerbaijan, foreign direct investment in the oil sector has led to economic developments in other sectors such as finance, transportation and construction, as well as establishment of new projects on technology transfer.  For example, the Centre for Technology Transfer at the Azerbaijan State University of Economics was established and has organised regional seminars on technology transfer issues in conjunction with the World Intellectual Property Organization (WIPO) and Azerbaijan’s State Committee on Standardisation, Metrology and Patents.

A number of technology cooperation agreements have been signed between China and Brazil in the oil sector since 2005. However, implementation of these collaborative undertakings has not been very smooth. For example, Petrobras of Brazil rejected attempts by Chinese National Oil Companies to be involved in the development of frontier technology in pre-salt deep water development.

Local content rules may also create obstacles for bi-directional technology transfers. The successful employment of technology transfers depends on the degree of influence of the host state on the international activities of its National Oil Companies. Where this is limited, there will be less scope to achieve economic and technology development goals.

Bilateral Investment Treaties

There is a body of international investment law which evolved from the proliferation of bilateral investment treaties (BITs) and other International Investment Agreements (IIAs) that emerged to respond to investors’ concerns about protecting their investments in developing countries constrained by weak judicial systems and characterised by high political risks. Today there are around 3,000 IIAs, but their numbers are decreasing. These treaties are concluded between states for the reciprocal protection and promotion of investment by investors from either state in the territory of the other state. As such, they are part of international law.

IIAs impose legal obligations on signatory host governments and rights for foreign investors that can be enforced via commonly included dispute settlement mechanisms. They confer the right to initiate arbitration if the host state or its agencies have taken measures alleged to be inconsistent with the treaty obligations. The treaties generally cover access to arbitration, the rules applicable to the arbitration, and the enforcement of arbitral awards.

Most BITs define “investment” and “investors” and include broad and vague legal standards for the protection of foreign investors such as: fair and equitable treatment; most-favoured national treatment; and principles for the calculation of compensation in cases of expropriation/nationalisation. The challenge for host countries has been the different interpretation of these standards by different arbitral tribunals in a way that limits the host countries’ regulatory powers.

Competitive bidding processes

While statutory requirements are the typical approach to the award of petroleum or mineral rights, today there is generally more geological data available and greater interest in obtaining exploration rights than in past decades. Thus, the open door/direct negotiation approach is now under review in states which are moving towards a competitive process, particularly where more than one company is applying for a license for the same tract.

Direct negotiations will continue to be appropriate for areas that are largely unexplored. However, in areas where good geological data is available and where there are strong indications of interest from more than one potential applicant, governments should instead offer licenses on a competitive bidding basis.

Where deposits have been previously explored and new development and production rights are being offered, competitive bidding should be used. There are successful examples of this in Peru, which opened its first competitive bidding round based on weighted royalty in 1995 under its 1993 hydrocarbons law and has had success since; and in Afghanistan, which completed its first successful competitive bidding tender, in relation to the Aynak Copper Project in 2004-2008, under the auspices of the World Bank. 

Two examples of situations where competitive bidding processes are used are:

1. When land is released by a National Oil Company back to the government for licensing to private investors; and

2. When a license holder hands back land to the government (in the case of the relinquishment of exploration areas) together with more detailed geological data relating to the land.

In both cases, there may be several investors competing for the same license and in these cases only competitive bidding should be used. However, in the case that land is offered for a competitive bid and there is only one qualified bid, then that bid would of course be the winner.

Good practice calls for a transparent, competitive bidding process that can be accomplished by ensuring access to all qualified bidders and having standardised bidding documents that include: (1) all available geological information; (2) confirmation that the land is unlicensed; (3) details of the applicable legal regime and procedures; and (4) full details of the rights that will be granted to the winning bidder.

On the subject of granting mineral rights it should be noted that a comprehensive review of this topic by the Centre for Sustainability in Mining and Industry (CSMI) of the University of Witwatersrand was specifically commissioned in the form of a Good Practice Note, as are various country reports (e.g. for Algeria). This Good Practice Note contains a comprehensive Appendix with country-specific regulations that permit comparisons to be made.

Bidding criteria

Single bidding criteria (usually an upfront cash premium with staged payments) are simpler to apply than multiple bidding criteria. A single bidding criterion can be either: (1) an upfront premium; or (2) the value of the work programme to be undertaken. In either case, the winning bidder should submit a bankable feasibility study within a given time-period or risk forfeiting the license.

If a set of multiple bidding criteria are used, then factors such as upfront cash payment, conditional payment and/or minimum exploration expenditure can be combined. This can be achieved through an equation that creates a numerical value. However, any combination that includes a work program evaluation will involve subjective judgments on the part of an evaluation committee evaluating the work program. In the case that mining exploration is being competitively auctioned, it is quite rare that an upfront cash premium or a future payment is used because mining companies do not see sufficient value to bid such a payment. Typically, however, an exploration work commitment will be competitively auctioned. Relevant considerations include the following:

  • Cash bonus bidding, which is generally considered to be less efficient in frontier areas;

  • The use of area-wide licensing in which the government takes into consideration the bidders’ expressions of interest in other areas; and

  • Market segmentation, which takes into consideration the bidders’ technical and financial capability to pursue different types of exploration activities.

Negotiations

Negotiations in the extractives sector primarily focus on contracting between a government (or its agent) and the investor. However, revisions to laws, the introduction of new legislation and regulations, or laws related to local content may also be the subject of negotiation. Given the complexity of the issues involved and their consequence in terms of revenue and other benefits, governments should place a premium on the development of internal negotiation capacity and access to knowledgeable external expertise. This is especially important given the considerable information, skills, and resources generally available to investors on the other side of the negotiating table.

Stabilisation

Stabilisation clauses or agreements are provided as an investment promotion device, often because they are given by other states in the region that are also competing for investment capital. The guarantees they provide protect the investor’s contractual rights against adverse interference by the state through legislative measures. Although such provisions may not stop the government from exercising its legislative powers, stabilization clauses can mandate that a court or arbitration tribunal compensate the investor for any damage suffered. Aside from a strictly legal assessment of their value in formal proceedings, stabilisation clauses may enhance the ability of an investor to negotiate a more favourable settlement in a dispute with a host state that seeks to revise the terms of the original agreement.

Multilateral Investment Treaties: The case of the Energy Charter Treaty

The use of investment protection treaties as a promotion tool could be a value addition. While there is no evidence that investment protection treaties facilitate investment, the absence of such treaties might deter some investors.

One of the few multilateral investment treaties, the Energy Charter Treaty, has the objective of protecting, from the time of its entry into force in 1998, western investment in the resource rich Former Soviet Union (FSU) countries and Central Eastern Europe (CEE). To date, the ECT has 53 signatories from the European Union (EU) Member States, the Commonwealth of Independent States (CIS), Japan, Afghanistan, Australia, and Turkey. In 2015, a recently adopted political declaration, the International Energy Charter, was signed by more than 70 States including non-members in the Middle East and North Africa (MENA), Asia and Africa. Therefore, the ECTs provisions remain relevant in the changing global investment framework covering investment from north to south and east to west within its current and prospective constituency. The ECTs provisions are also a good-benchmark for the making of investment treaties with non-member countries.

Prior to the establishment of the ECT, there have been many attempts to conclude an international investment treaty on a multilateral level, none however have gathered the attention or reached the success that the ECT has today. The core defining features of the ECT are that its application is wide in the geographical sense, covering most of Europe, and more importantly for the energy sector, it is unique in having a subject matter that is limited to economic activities in the energy sector. Other subjects covered by the ECT are either supportive of the provisions on energy matters or have a lesser significance.

The ECT has four core areas, these are trade, transit, investment and energy efficiency. The investment regime of the ECT introduces a mechanism for the settlement of disputes between a contracting state and a foreign investor. The provision is not unique. In fact, most recent BITs and the North American Free Trade Agreement (NAFTA) provide rules enabling investors to invoke claims directly against states, which has served as precedents to the ECT. Traditionally, it was believed only states have rights and duties under international law. For this reason, foreign investors used to solve their disputes through diplomatic protection. Owing to the inclusion of “private actors” into modern BITs and especially after the establishment of the World Bank’s International Centre for Settlement of Investment Disputes (ICSID) as a neutral forum for investment-state disputes, the previous perception has changed. The ECT reflects this contemporary approach, as does its precedents. Overall, the ECT provides effectiveness to substantive investment protection provisions and serves to force states to comply with them.

According to a survey carried out by UNCTAD in 2014, in terms of the legal basis for the claims, the most-often used instruments in investor-state disputes were ECT, with 60 cases, the NAFTA with 53 cases and the Argentina-US BIT with 17 cases. The dispute settlement mechanism of the ECT ensures compliance with the investment protection obligations of member states, such as fair and equitable treatment principle. Thus, the potential political embarrassment of being condemned by an arbitral tribunal and the desire to paint a foreign investment-friendly portrait will impel host states to comply with the principles of the ECT.

The ECT, even if it cannot reach geographical areas outside its current scope by way of membership, can have a bearing upon the conclusion of future multilateral investment treaties, or at least the experience from the ECT would guide such subsequent arrangements.

Conflict of laws

Conflicts of laws between national law and international law in producing countries are often caused by investors using national and international law in such a way as to better benefit from conditions than those intended under the country’s Mining/Petroleum and tax laws. To prevent possible legal uncertainties, conflicts of law or aggressive tax planning, careful consideration should be given to the following issues:

  • Clarify if the country “Investment Law” and its incentives should apply to petroleum upstream operations. This is probably not the case because the Petroleum or Subsoil Law should be the specific Investment Law for the E&P sector.

  • Analyse the possible interaction or conflict between the Petroleum and/or Mining Code and any BITs and Regional Investment Treaties entered into by the country for the promotion and protection of investments. Thus, such conventions may contain a “fair and equitable treatment” (FET) clause not intended for the sector which may be eventually detrimental to the country in arbitration cases dealing for example with termination cases. Indonesia’s Oil & Gas Law of 2001 sets out a priority for domestic gas uses over gas exports and introduced a domestic market supply obligation.

  • Analyse the possible use by investors in order to minimize their tax liabilities in the country of the many Double Tax Treaties (DTTs) entered into by the country. Such treaties, or a combination of such bilateral treaties, may be used by some investors in an unexpected way for long-term tax planning with a possible negative impact on the country’s receipt of petroleum revenues payable by the E&P companies and their contractors and sub-contractors.

NOC/IOC Cooperation

Outside North America, remaining fossil fuels reserves are largely located in more challenging, expensive to produce geographies, and/or high political risk areas. Thus, the need for the deployment of cutting-edge technology has increased significantly. There is also greater environmental and social awareness, and more stringent standards now. Apart from new discoveries, recovery and life-prolonging activities require technically feasible and economically attractive solutions. These intensify the need for cooperation among IOCs to partner with NOCs on a long-term basis to ensure the most sustainable and efficient investments are attracted and commissioned. There are many challenges in this cooperation and uncertainties in places where host country politics are not predictable.

In many of the African and Central Asian resource rich countries, for instance, governments play combined roles as policy maker, regulator, partner and investor. The host countries remain the owners of most of the global reserves. While in some states the difference between IOCs and NOCs becomes blurred, NOCs are tied to national extractives policies and long-term socio economic planning, whereas IOCs are driven by international markets and typically often have diversified portfolios and hence world-wide experience in technology. Where the host government policies enable and promote IOC-NOC partnerships, this could have a positive impact on research and development and risk mitigation, as well as know-how exchange.
 

80 percent of world petroleum reserves are controlled by state companies and 15 of the 20 largest oil companies are state-owned (EITI).

This cooperation is also important in view of the compliance with host states’ Intended Nationally Determined Contributions (INDCs) under the Paris Climate Change Agreement. The demand for fossil fuels in the future is expected to decrease at the global level. Without coordination and effective dialogue between IOCs and NOCs towards the mitigation of future challenges and uncertainties, particularly towards new cleaner technologies, the IOCs are likely to come under international pressure which would likely have an impact on their decision to invest.

International Development Banks

The involvement of international development banks in the development of a given project, such as the African Development Bank, the World Bank, the Asian Development Bank and the European Bank of Restructuring and Development could be an effective tool for investment promotion. Among other reasons, this is because they often require compliance with international industry, health and safety, labour and environment standards.

However, as a rule, these banks do not finance early stage extractives sector activities (except through the International Finance Corporation (IFC)). This is because of the huge funding required and risk profiles associated with exploration, especially in frontier markets, and the long timelines associated with cash flows and returns on investment (there are no cash flows during exploration and appraisal stages). They would, however, provide funds for related activities including, in petroleum for example the drafting of Exploration and Production agreements, data collection, capacity building and assistance in negotiations.

An industry perspective

Overall, in any investment, and more so in the extractives sector, which is capital intensive and where returns on investment are achieved after an extended time-period, investors seek out: (a) assurances of investment protection; and (b) certainty and predictability of laws and regulations. Although an investor can seek compensation from the state or turn to investment dispute mechanisms if a licence is adversely affected by state action or a challenge to irregular procedures by aggrieved applicants, most investors would prefer to avoid using such dispute alternatives.

During the licencing process (whether by competitive bidding or direct negotiations), investors are mostly concerned about the transparency and legitimacy of the licencing procedure. Quite apart from concerns about future state actions once a licence is granted, an investor would be concerned to ensure that the licensing process is beyond reproach, and that the rights granted are not subject to challenge by other aggrieved applicants or by oversight and audit by other state agencies (such as parliamentary committees). Another emerging concern for investors is government support in obtaining a social licence to operate and community acceptance of the investment. Competitive bidding processes are preferred due to their obvious transparency. Open door/direct negotiation processes can be made more transparent when a government publishes information on negotiations and qualifying criteria.

Once a licence is granted, an investor is concerned with the licence running its full course and that there is certainty and protection of the investor’s rights under the licence. Top on the list of an investor’s goals in any negotiations with a host government is to alleviate the legal and political risks that may be associated with an investment.

The investor concerns described are evident from:

  • The inclusion of stabilisation clauses in most extractives sector contracts between host states and investors and some host state laws, which are mostly investor-focused or investor-driven;

  • The widespread conclusion of bilateral investment treaties and multilateral investment treaties by states. There are over 3,000 investment treaties that have been concluded globally;

  • The numerous investment disputes that have been commenced by investors relating to alleged breaches of stabilisation clauses and bilateral and multilateral investment treaties;

  • The increasing use in global investment of government support letters and sovereign guarantees. Some states may be reluctant to provide binding guarantees and instead provide “soft” government support letters

  • The investor involved in an extractives project in a non-OECD country would traditionally take into account political risk before its decision to invest. This would include the following: probability of disruption of the operations; currency convertibility and transfer restrictions; returns on projects; expropriation; civil unrest; war and terrorism; and breach of contract and non-honouring of sovereign financial obligations.

Political risk insurance

For foreign investors, political risk is often not that easy to be prepared and mitigated for, but a relatively recent instrument, namely political risk insurance (PRI), has gradually become commonplace for petroleum investments. Two institutions providing PRI are:

  • The World Bank’s Multilateral Investment Guarantee Agency (MIGA) which provides investment guarantees against political risk, issued a record USD 4.3bn of guarantees, up from USD 2.8bn in 2015. Of the USD 4.3bn issued in 2016, the highest percentage (USD 1.7bn) was related to Sub-Saharan Africa; and

  • The African Development Bank (AfDB) established the African Development Fund’s Partial Risk Guarantee (ADF-PRG) in 2011 for eligible projects financed by the AfDB, and has since then provided PRGs to several large investment projects in Africa (including the first PRG of € 20 million for a Kenyan project in 2013, and a USD 184 million PRG for a Nigerian project

Industry considerations are also evident in the investment rankings and indices that are produced each year by multilateral agencies and rating agencies. There are many examples, and the list below provides a few key examples:

  • The yearly World Bank Doing Business Reports provide measures of business regulations in 190 countries – these reports are increasingly used as indicators of the certainty and predictability of local laws for foreign investment. In the 2017 Doing Business Report, the World Bank added Somalia to the list, which is evidence of the country’s emergence in the global investment market

  • The World Economic Forum (WEF) also issues a yearly Global Competitiveness Report. The 2016-2017 Report measures global competitiveness based on 12 pillars, the first being institutions, which is the legal and administrative framework within which individuals, firms, and governments interact and

  • Country ratings by international credit worthiness rating agencies like Standard & Poor, Moody and Fitch Ratings also drive large investors and international financiers to consider the levels of financing and risks that should be mitigated

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-OECD fossil fuel consumption (Source IEA)

 

Best practice examples

In the mining sector, employment of the following best practices can build investor confidence and help promote local and foreign investments:

In the petroleum sector, similar guidelines can be found:


 

Guides for investment promotion (1/3)

  • Investment promotion laws: For instance, in November 2016 UNCTAD released a special issue of its Investment Policy Monitor exploring investment laws as a widespread tool for investment promotion around the world.

  • Developing new laws and regulations, and including private sector industry players in legal and policy changes (consultation as opposed to command and control). Involve experts. Technical assistance and guidelines for development of laws are available from institutions like the World Bank and AfDB.

  • Developing model contracts for certainty and predictability by investors. Institutions like the World Bank and AfDB’s Africa Legal Support Facility (ALSF) offer technical assistance. The Association of International Petroleum Negotiators (AIPN) has various model contracts. No need to re-invent the wheel. Contracts from other countries are available at the ResourceContracts.org

  • Developing mutually beneficial fiscal terms.

  • Engaging development consultants and law firms early enough in licensing rounds or earlier (when developing rounds). Poor bargaining is often due to technical capacity issues. AfDB’s ALSF offers technical assistance.

  • Developing attractive Local Content requirements, i.e. how to avoid making Local Content requirements an obstacle

Guides for investment promotion (2/3)

  • Entry into Investment Protection Treaties (Double Tax Treaties, Bilateral Investment Treaties, access to investment arbitration mechanisms like ECT and ICSID). Membership into globally recognized organizations for capacity building, training and legitimacy. For instance, the EITI.

  • Developing tools and strategies that mitigate risk, e.g. that of the mining cycle whereby overreaction to downturns may result in governments offering too much and then regretting the action later, and taking remedial measures in an upturn of the mining cycle.

  • Different strokes for different folks, i.e. targeting promotion at different sorts of investors: ExxonMobil or BP or alternatively as in Senegal, KOSMOS, Woodside and Cairn Energy, all smallish, focused and contrarian, counter-cyclical investors.

  • Overview of Online Resources on Extractives for Parliaments by NRGI.

  • Tools and Resources Investments in Extractive Industries by negotiationsupport.org.

  • African Mining Legislation Atlas Project (AMLA).

Guides for investment promotion (3/3)

  • The SADC MODEL BIT Template: Investment for Sustainable Development (2012): The South African Development Community (SADC) Model Bilateral Investment Treaty Template and Commentary, intended as a guide for member states in future investment treaty negotiations, was completed in June 2012 by Member States of the Community. This brief note discusses the orientation of the template, the drafting process, the key features, and some brief conclusions.

  • IISD Best Practices Series: The series provides both developing and developed country negotiators with state-of-the-art options and approaches to address new issues and controversies in investment negotiations. Some of the key issues addressed in 2012 include compensation for expropriation, registration and approval requirements, the definition of investor and indirect expropriation. In previous years, the series has dealt with the full protection and security standard, transparency, investment treaty and contract claims, fair and equitable treatment and the definition of investment.

  • IISD capacity building activities monitors the negotiation of investment treaties and the disputes initiated thereunder, and works with governments to develop policies on limiting negative impacts of international investment treaties on governmental law and policy making. IISD also works with parliaments and civil society to foster and deepen their understanding of the investment treaty regimes.