(Published in Mining Finance magazine)

The financing of projects on a limited recourse basis in the emerging markets is a subject which has received much attention over the course of the last several years. This has been particularly the case with respect to mining projects where declining commodity prices worldwide have lead to the need for mining companies to access minerals in countries where the costs of extraction are lower than in the developed markets. The recent decline in the popularity of hedging as a means to enhance the attained price with respect to any metal produced at a project has only accelerated this trend. This has led to a concentration on the development of projects in sub-Saharan Africa, the former Soviet Union, South East Asia and, although now less of an emerging market, South America.

The problems inherent in financing mining projects on a limited recourse basis in the emerging markets are well rehearsed. Some of these problems are described below:

1. Legal System Risk: The basis of the legal systems utilised in the various emerging markets are diverse. In many of the countries of the former English Commonwealth located in sub-Saharan Africa an English based common law system prevails. Thus, for example, transactions involving projects in Ghana and Zambia might be structured on the basis of traditional English law concepts of taking security and attendant filings, etc. In Francophone countries in the same region such as Mali and Mauritania French civil law systems are common, frequently based substantially on the French Civil Code. In each of these jurisdictions where the legal system is based on an established Western European model there is some certainty as to the theoretical operation of the legal system and the necessary filings, etc. However, practical operation of the legal system and remedies available upon the occurrence of an event of default, etc. may still be problematic. In South America a civil based system is common and frequently affords a very developed system of law. In the former Soviet Union the situation has evolved with far less clarity due to the uncertain nature of both the laws involved and the interpretation thereof. The developing nature of the legal system and the almost complete absence of precedents with respect to remedies available in the event of a default or similar problem compounds the problem. Practically, of course, a lender must take the legal system as it finds it. There is no way of contracting around statutory requirements. The only real method of ameliorating any difficulties presented by Legal systemic risk are by retaining sponsor support past completion for any perceived legal risk which is unacceptable from a credit perspective and by taking the benefit of political risk insurance to guard against the precipitous act of any local government or related body.

2. Title Risk: Part and parcel of legal risk is the nature of the right of the mining company in question to develop the deposit which forms the basis of the mining project. In some countries the mining company might have full legal right to both surface and sub-surface assets together with the unrestricted right to exploit those assets. However, this is unusual in the context of the emerging markets. Frequently, the ownership right in minerals is vested in the central government and all that can be obtained is a license to mine the minerals in question. In some jurisdictions, for example the Russian Federation, the situation is exaggerated by virtue of the fact that the operator will be unable to obtain even surface rights. It will merely be granted whatever attendant rights are necessary in order to effectively mine the deposit pursuant to the mining license granted by the government. In many countries, particularly in sub-Saharan Africa, the central government will have the right to retain a carried interest in the project, maybe in a proportion of up to 20% of the equity. In other jurisdictions, this interest may take the form of a royalty payment to the government in respect of minerals extracted from the ground. Whatever the format, virtually all emerging markets will require that some economic interest in the project be granted to the central government. This is clearly understandable as mineral resources may represent the most significant, if not sole, source of wealth for those countries

3. Tax Risk: Potential taxes assessable on a mining project are numerous. The local project company may be subject to a profits tax, VAT on services or other forms of local taxation. In addition, there may be withholding taxes on interest and dividend payments made offshore. Fortunately, most emerging markets recognise the economic advantages in attracting offshore mining companies to develop deposits and therefore offer tax packages for individual projects which are available to be negotiated on a project by project basis. These will frequently result in tax holidays in connection with profit and related taxes in addition to exemptions from VAT and withholding tax on both interest payments and dividends.

4. Political Risk: This, again, is something which may not be contracted out of and therefore must be covered by the sponsors or by insurance. The former will be resisted for balance sheet and precedential reasons. The latter may be available through one of the multilateral agencies (for example, MIGA), through a national export credit agency from the home jurisdiction of a participant in the project or in the commercial markets. Political risk coverage is available for the majority of the emerging markets, even those perceived to be riskier than most such as the Russian Federation. Of course, some emerging markets have now "emerged". So, for example, whereas political risk insurance for transactions in Chile may have been common several years ago that may no longer be the benchmark. Deals in certain sub-Saharan Africa countries such as Ghana have also been completed without any perceived need for political risk insurance. The insurance is frequently expensive and can add significantly to the cost of any individual project financing.

5. Insurance Risk: Comprehensive insurance for any particular project is an essential part of the package which will be required by any provider of limited recourse finance. Prima facie this should not create any difficulty as commercial insurance for a project (third party liability, construction risk, delay in start-up, etc.) should be available irrespective of location. However, a complication arises by virtue of the fact that many of the emerging markets (particularly in sub-Saharan African and the former Soviet Union) require that the primary insurance be provided by a local insurance company. This raises both performance and credit risk issues. While such local insurance will be reinsured by coverage in more traditional insurance markets such as the London market, that is not the end of the problem. For example, reinsurance is just that, it is a secondary cover with respect to the primary insurance policy. Accordingly, if the primary insurance policy is not valid then neither will the reinsurance. In those jurisdictions (such as Russia) where the primary insurance with the local insurance provider must be governed by local law then comfort must be obtained with respect to the validity and efficacy of that insurance. Note that these issues will not be circumvented by the so called "cut through" provision present in many reinsurance arrangements which provides for the reinsurers to pay beneficiaries of the primary insurance policy directly rather than being put through the necessity to pay through the primary insurer as a conduit.

6. Foreclosure Risk: The analysis of the risk inherent in any project in the emerging or other markets frequently ends, at least from a legal perspective, with the documentation. However, this is shortsighted. Enforceable documentation is obviously critical to any project lender but this does not give the whole picture. The rights available in connection with any enforcement of that documentation are paramount. The traditional common law analysis, for example, assumes that any secured party will have a self help remedy which will enable it to sell the secured asset on its own motion without the need to involve any third party. In civil law countries, and in most emerging markets other than those sub- Saharan countries with an English common law tradition, this is not possible. In those jurisdictions no self help remedy is available and foreclosure will usually need to be performed with the assistance of the court system. This usually implies an auction following some defined period and can involve lengthy delay. During a period when a project is in trouble and unable to meet the needs of its trade creditors this can be a significant issue. In addition, some auction procedures may not permit the lenders to bid in debt, rather than bidding in cash, thus potentially materially increasing the exposure of the lenders to the project as a whole if they wish to avoid defeating some wholly inadequate bid made at auction by a third party.

7. Foreign Currency and Export Risk: While governments in the majority of South American and many African countries will issue licenses with respect to any particular project which will permit the unfettered sale of metal offshore and deposit of proceeds in an offshore account this may not apply to other jurisdictions, particularly those in the former Soviet Union. In those countries and particularly in the case of projects including precious metals, the mined metal may have to be sold through a local agent which will result in the collection of domestic currency. In addition, there may be restrictions on the holding of foreign currency offshore.

This is only a summary of some of the problems which can arise in connection with the financing of mining projects in the emerging markets. Nevertheless, governments in most countries are anxious to encourage investment in the extraction of minerals and so such projects continue to form a significant part of any mining lender's portfolio. This is a trend which can only be expected to continue.