Mitigating the Effects of Resource Nationalism

Businesses in the extractive industries must familiarise themselves with treaties that offer them some form of protection when they deal with countries that are displaying increasingly strident resource nationalism.

By Damian Adams, Amanda Lees & Katie Cheng, Simmons & Simmons

Resource nationalism refers to national policy changes that have the effect of reducing an economic investor’s benefit, particularly in the extractive industries such as oil & gas and mining. Although 2012 was described by the Financial Times as the “year of resource nationalism,” it is a feature of doing business in many markets, emerging and developed, that has remained consistently high on the list of risks and issues for companies and investors engaged in natural resources during the past decade.
Resource nationalism manifests in a number of ways: through direct measures, whereby foreign investors are required to divest a portion of their ownership interest to local government, government-linked companies or native commercial interests, or through indirect or ‘creeping’ expropriation through state imposition of royalties, taxes and exchange controls or suspension, termination or non-renewal of licences and permits.
Recent developments in Indonesia’s mining sector are regarded by many to be prime examples of resource nationalism, including the implementation of progressive divestment obligations and maximum foreign ownership restrictions, requirements to deposit export proceeds in Indonesian banks and, most recently, bans on the export of raw, unprocessed minerals. Conversely, others comment that such measures are legitimate to ensure that, to a greater extent than in the past, the economic benefits of Indonesia’s natural resources remain in Indonesia. Such measures are also an unsurprising response to overreaching and sometimes exploitative structures and approaches used by foreign investors to comply with the letter, but not the spirit, of the law.
Whatever one’s view may be regarding the situation in Indonesia or elsewhere, there can be no doubt that, in a climate where securing resources features more highly than before on the priority list for many governments, resource nationalism is and will continue to be a feature of doing business in extractive resources industries.
A key consideration then becomes how best to address and mitigate the effects of resource nationalism. There are a number of ways.
Beyond measures such as contractual protection or political risk insurance coverage, one way is to structure investments to take advantage of protections offered by existing multi-lateral investment treaties (MITs) or bilateral investment treaties (BITs). Focusing on South East Asia in particular, in 2012 the Member States of ASEAN entered into the ASEAN Comprehensive Investment Agreement (ACIA), which has the stated aim of creating a “free and open investment regime in ASEAN” through investment liberalisation, protection, facilitation and promotion.
The ACIA applies to measures taken by an ASEAN Member State in relation to investors of any other ASEAN Member State and their investments in the first Member State. The broad definition of ‘investors’ is significant for many in the region as it applies to individuals and so-called juridical persons (companies, corporations and the like) from outside ASEAN as well as from within, provided that those from outside ASEAN structure their investments with substantive business operations in an ASEAN Member State. This would allow, for example, a company from outside ASEAN to establish operations in Singapore, from which to invest in another ASEAN Member State and enjoy the protections of the ACIA. The similarly broad scope of ‘investments,’ which includes “every kind of asset, owned and controlled,” makes the ACIA highly applicable to many investor situations.
In terms of the protections themselves, the ACIA has provisions similar to those seen in BITs between two sovereign nations, including treatment of non-nationals no less favourably than nationals, equality of treatment of all non-national investors (so-called “most favoured nation treatment”), guarantees of fair and equitable treatment rather than arbitrary decision-making and freedom to transfer funds. In the context of resource nationalism, there are protections against unlawful expropriation and guarantees on proper compensation for direct or indirect expropriation or nationalisation.
If and when the host State breaches such investor protections, MITs and BITs, in general, allow an investor to bring a claim in international arbitration against the host State, usually with a choice as to the forum, the most popular being the International Centre for Settlement of Investment Disputes (ICSID), ICSID Additional Facility Rule and ad hoc arbitration under UNCITRAL Rules.
However, it is important to note that, before initiating arbitration proceedings under an investment treaty, there is typically a mandatory negotiation period and, in some cases, investors must first exhaust local remedies in national courts before resorting to arbitration. Thinking ahead when structuring investments to take advantage of BIT protection, investors should familiarise themselves with the dispute mechanisms.
In terms of enforcement, the ICSID Convention binds each of its contracting states to enforce an ICSID award as if it were a judgment of a court in that State. While seemingly straightforward, an investor’s ability to enforce an award may be restricted by the sovereign immunity of states. Encouragingly, most states do honour awards made against them and pay without enforcement action.
If one assumes that resource nationalism will be a continuing trend, then investors need to consider full range of protective measures that exist and structure their investments to make best use of these. Only by doing this can one hope to mitigate the unpredictability sometimes brought about by the host nation’s policy shifts.