Report No. 24709- KY Kyrgyz Republic Update o n the Mining Sector September 2002 Europe and Central Asia Region Country Unit VIII Document of the World Bank Currency Equivalents Local Currency: som Average Annual Exchange Rates Used 1995: 10.82 soms = US$ 1996: 12.80 soms = US$ 1997: 17.36 soms = US$ 1998: 20.77 soms = US$ 1999: 47.72 soms US$ Weights and Measures Metric System Fiscal Year 1 January - 31 December Vice President: Johannes F. Linn, ECAVP Country Director: Dennis De Tray, ECUU8 Sector Manager: Peter Thomson, ECSIE Task Team Leader: Craig Andrews, COCPD List of Acronyms BATNEEC = Best Available Technology Not Exceeding Excessive Cost CBF = Community Business Forum DFID UK = Department for International Development (United Kingdom) EAP = Environmental Action Plan EBRD = European Bank for Reconstruction and Development EIS = Environmental Impact Statement EMS = Environmental Management Systems FSU = Former Soviet Union IMF = International Monetary Fund MAC = Maximum Allowable Concentration MAD = Maximum Allowable Discharge MEES = Ministry of Ecology and Emergency Situations MME = Maximum Allowable Emission MMC = Malaysia Mining Corporation Berhad NEAP National Environmental Action Plan PSA = Production Sharing Agreement SAGMR = State Agency for Geology and Mineral Resources SCMR = State Commission for Mineral Resource Stocks TACIS = Technical Assistance Commonwealth of Independent States UNRRC = United Nations Classification System for Reserves/Resources Table of Contents 1 Executive Summary 5 2 Achieving Development Objectives through Mining Sector Reform 16 3 Economic Contribution of Mining: 1994 - 2000 23 4 The International Mining Industry and Foreign Investment 35 5 The Mining Law and Regulations 40 6 The Mining Taxation Regime 52 7 Role of Public Institutions 64 8 Enterprise Privatization, Governance and Restructuring 72 9 Environmental and Social Considerations 76 10 Proposals for an Action Plan 87 Annexes ANNEX A Kyrgyz Republic Mine Sector Statistics: 1995-1999 96 ANNEX B Economic Impacts of Selected International Mines 97 ANNEX C Selected Mine Capital Development Costs 98 ANNEX D International Standards for Institutional Organization for the Mineral Sector 1 99 ANNEX E Systems of Mineral Reserve Classification Comparisons Internationally and in Kyrgyz Republic 103 ANNEX F List of Persons Met 108 ANNEX G Applicable Taxation Regime in Kyrgyz Republic 110 ANNEX H International Mining Taxation Practices 117 ANNEX I Reform Experiences of Selected Countries in the 1990s 120 ANNEX, J Selected Principles of Mining Sustainable Development 131 List of Figures Figure 2-1 Public and Private Sector Roles 19 Figure 4- 1 Performance Mining Equity Markets 38 Figure 7-1 Basic Framework of a National Mineral Sector Lead Ministry 65 List of Tables Table 1-1 Comparison of 1994 and 2000 Mining Study Findings 11 Table 2-i Mining Reform Works 18 Table 3-1 Selected Macro Economic Indicators 23 Table 4-1 Percentage Distribution of Exploration Expenditures 1985 - 1999 35 Table 5-1 Summary of Previous versus Current Mining Legislation 50 Table 6-1 Kyrgyz Republic Mining Taxes Compared to International Practice 62 Table 7-1 Summary of Institutional Issues and Recommendations 70 1 Executive Summary 1.1 The World Bank published a Review of the Mining Sector in Kyrgyz Republic in 1994. Since the original research done for that report (July, 1993) significant developments have taken place in the sector. Accordingly, the government has requested that the present Study be undertaken to up-date the findings of the original report. This Study has been prepared by staff and consultants of the World Bank which conducted research in Bishkek during the fourth quarter, 2000. Numerous interviews and a roundtable discussion were conducted in with government officials, private companies, and members of civil society (see list in Annex F). The findings of this report are those of the staff of the Bank, though these have been thoroughly discussed with the government. 1.2 Like most other countries, Kyrgyz Republic has several development objectives in view for the mining sector. Some of these include: maintaining production and social tranquility at existing kombinats; creating competitive legal and fiscal conditions to attract and retain private investment; increasing the value added of the sector in terms of taxes, jobs and induced spin-off industries; sustaining the sector's economic social and environmental performance; providing acceptable conditions for closure of non-viable operations; and creating a professional and efficient organization of public institutions. In spite of good faith efforts on the part of the government, this Study finds that the Kyrgyz Republic is not achieving most of its objectives for the sector. 1.3 Other countries - Chile, Argentina, Peru, Ghana, Tanzania, for example - are successfully achieving these development objectives for the mining sector by carrying out a vigorous program of mining reform. The results have been highly satisfactory in terms of substantial increases in new investment, export earnings, tax revenues, jobs and spin-off industries. The central approach of the present Study, therefore, is to present international best practices and case examples to illustrate what has worked, and what has not worked, in other countries to achieve development objectives for the mining sector. The Study's recommendations will suggest how the Kyrgyz Republic might replicate this success to increase the contribution of mining to economic development. 1.4 The macro-economic indicators for the Kyrgyz mining sector, some of which have increased dramatically since 1994, are deceiving. Between 1995 and 1999 the mining s'ector's proportion of GDP has increased from 1.5% to 7.7%; exports from US$56 million to US$200 million. However, employment in the sector has decreased. More disturbingly, tax revenues of the sector as reported by the National Statistical Agency are actually negative, implying a subsidy by the central treasury to the sector. 1.5 Virtually all of the growth in the mining sector is the result of the Kumtor gold mine opened in 1997, an investment of US$450 million. This operation is owned 67% by the government through JS Kyrgyzaltyn and 33% by Cameco Corporation of Canada, the latter being the operator through the Kumtor Operating Company (KOC). This operation now contributes over 40% of total export earnings and 30% of total industrial production. While undoubtedly a technical and engineering achievement, the development impact of the Kumtor operation is mixed. Because of the fall in the international market price of gold since the original feasibility study, economically extractable ore reserves have been decreased and the mine life has been reduced. As a result, the anticipated profits of the venture have been less than expected. Additionally, the financial structure of the venture is a complicated and has not worked to the advantage of the government. A shareholder loan in the amount of US$107 million which was made by Cameco to the joint venture is being paid back from dividends which would normally would accrue to the account of Kyrgyzaltyn. The operation is perceived by some local and international observers as not contributing sufficiently to tax revenues, creating jobs for Kyrgyz citizens, and stimulating local spin-off industries. Finally, even though the operation had an unfortunate environmental incident, its overall safety and environmental record is better than industry averages. To its credit, KOC has taken some significant initiatives to address the community issues, though more could perhaps be done -to enhance the contribution to sustainable development of this mine. The mine is scheduled to dramatically curtail production in 2009 and the government faces a significant challenge to plan for the consequent decrease in export earnings and jobs. 1.6 There are other gold projects smaller than Kumtor - Dzherui, Taldy-Bulak and others - which are currently under study by private companies. But, it is unclear, given the low gold prices, when or if these can be brought into production before the Kumtor operation closes. New investment in exploration has also declined, from US$5 million in 1997 to around US$0.5 million in 1999. Much of this decline can be attributed to the fall in gold price, lack of venture capital in international equity markets to fund mining projects, and general skepticism on the part of international investors as to exploration ventures in the former Soviet Union. 1.7 Some of the existing- mining kombinats - Kara Balta (uranium oxide, molybdenum), Hyderkhan (mercury), and Makmal (gold) - are doing reasonably well under the current market circumstances. Others - Khadamdjai (antimony) and Orlovka (rare earths) are having difficulties due to a shortage of raw materials, inability to access markets, or declining reserves. These operations are still owned by the State and attempts to privatize them have not been successful. In the case of Khadamdjai, ownership and control have been transferred to Kyrygzaltin which is conducting studies to determine how production can be maintained. Studies are also underway at Orlovka with a view to resolving current difficulties. However, if these enterprises cannot be reactivated the government will eventually have to develop a program to close them in an environmentally and socially acceptable manner. 1.8 It is true that external factors outside of the control of the government, such as the price of gold, are a significant cause of the poor performance of Kyrgyz Republic mining sector. However, other countries are also subject to these international prices and their mining sectors are performing much better. The present Study finds that the poor performance is due to deficiencies in the policy, legal/regulatory, fiscal and institutional conditions pertaining to the industry. The following issues, among others, need to be urgently addressed by the government. * Government equity participation in mining ventures. The government is making a fundamental error in taking a direct equity participation ("carried interest") in mining ventures. For an economy in transition it is perhaps understandable that political sensitivities would require a direct government participation in mining ventures. However, internationally, most governments have the policy of avoiding direct equity participation in favor of a reasonable and competitive tax package. In past years, some governments have taken a "carried interest" equity participation in the capital of the mining company in the hopes of capturing dividends as well as exerting an effective control over the company and its use of the mineral resources. Experience has shown that this does not work in practice. The anticipated dividend streams may not materialize due to market conditions (as has been the case with Kumtor) and the equity participation does not necessarily imply an effective government influence over the operations. In addition, significant tax concessions are required to compensate the investor for funding the government's participation. Though there is no formal requirement in the mining legislation, the Kyrgyz Republic through Kyrgyzaltyn retains between '33% and 66% equity in the Kumtor, Dzherui, Taldy-Bulak projects. * Excessively generous tax concessions. As a direct consequence of the high level 'of government equity participation investors have required, and the government has granted, tax concessions in investment agreements which are excessively 'generous and lenient. The nature of these concessions varies by project but they !generally include a five year exemption from corporate profits taxes (in the case of Kumtor, a five year profits tax exemption plus indemnification of Cameco by Kyrgyzaltyn from taxation for an additional five years). There is no good reason to grant "tax holidays" or to otherwise exempt the mining sector from payment of normal profits taxes, subject to the dual conditions: 1) that the overall rates and methods of taxation of mining is competitive with international standards and, 2) the government does not have an equity participation in the venture, "carried" or other. * Value Added Tax. A significant challenge in Kyrygz Republic is to operationalize the application of the value added tax to the mining sector. In Kyrgyz Republic, as in most other countries, when a company exports its products it is entitled to a refund of the amount of value added taxes paid on purchases of imported equipment, supplies and materials. In practice, companies quickly build up large credits for the amount of value added taxes paid on these imports which governments have difficulty to refund. This is the case in Kyrgyz Republic where gross tax receipts are actually negative, due in large part to reimbursement of value added taxes. In order to avoid this situation, many governments "zero-rate" imports and exports for the mining industry, which means that neither credits nor debits accrue to the account of the operation. * New tax proposals. The government is to be commended for the recent initiatives to improve the general and mining taxation regimes and, specifically, the elimination of taxes based on gross revenues. These gross revenue taxes (royalties, emergency fund, road taxes, etc.) have the effect of increasing the cost of production and reducing the amount of minerals that can be economically extracted. The proposed changes include the introduction of a "property tax", "land tax" and "royalty", among others. When considering these proposals, close attention should be paid the manner in which the asset base is evaluated; for instance, it would not be appropriate to specify a value for "in situ" mineral reserves. In addition, an amendment to the general taxation law was recently passed which lowers the profits tax on legal entities from 30% to 10%. While this move will no doubt be welcomed by investors, the rate of 10% is low by international standards and it could have negative impacts on the national treasury. Additional issues which merit clarification include taxation of sub- contractors, transfer pricing rules, deduction of certain costs incurred outside of Kyrgyz Republic, and rules on depreciation of assets. Mining law. The sub-surface resources law of 1997 (as amended in 1999) is a significant improvement over the previous sub-surface resources law of 1992. However, the 1997 law still has a number of ambiguities and deficiencies which need to be remedied. The law should provide for easier access to exploration rights and mining titles. A key problem in this respect is the pre-disposition in the law to "tender" mineral properties - a practice that has not proven to be successful in other countries. Security of tenure, that is the right to pass automatically from an exploration to an exploitation license, needs to be strengthened. Requirements in the law and the powers vested in State institutions concerning the rational use of the deposit are not compatible with international standards and thus are disincentives to new investment. Finally, the law does not sufficiently deal with critical issues such as transfer of title, mine closure, and dispute resolution procedures. * New legislative proposals. Consideration is currently being given to a proposal which would establish "production sharing agreements" (PSA) for selected mineral deposits. This is an effort to stimulate the development of these deposits which have thus far attracted limited interest on the part of investors. The desire of the government to develop rapidly these resources is understandable. However, the use of a production sharing contract is highly unusual in international practice and, in the opinion of this Study, unlikely to produce the results desired by the government. As proposed, the PSA is ambiguous and leaves too much open for negotiation. It is not realistic to expect investors to fund feasibility study work and leave for negotiation the relevant details governing production sharing, rates of taxation, and management of the enterprise. * Institutional uncertainties. The mining sector review of 1994 recommended that the government designate or create a "lead agency" for the sector. To date, this has not been done, though de facto the State Agency for Geology and Mineral Resources (SAGMR) has assumed many of the functions of the lead agency. In other countries, the lead agency is responsible for policy, legislation and regulation, administration, and supervision of the sector. Importantly, the lead agency coordinates with other government departments and ministries dealing with mining to avoid duplication of functions. A degree of confusion and overlap of responsibilities exists between SAGMR, Kyrgyzaltyn, the Mvinistry of Industry, land the Ministry of Ecology. The government should move to create a "lead agency" and to define the institutional mandates and responsibilities in the sector. * 'Role of Kyrgyzaltyn. In March, 2001, Presidential Decrees expanded the role of Kyrgyzaltyn, an enterprise wholly owned by the government. The decree stipulated that Kyrgyzaltyn would hold all government equity participations in gold mining ventures. Also, Kyrgyzaltyn took ownership and management control over a holiday resort property in Issy-Kul, the Khadamdjai antimony kombinat, the Sary-Jas kombinat (tungsten) and the gold refinery at Kara Balta. It is unclear whether this expanded role for Kyrgyzaltyn signifies a major policy shift by the government to create a State owned mining company to own and operate mines. During the past fifteen years, most governments have found that State owned mining companies do not add value to the mining sector and have progressively privatized them. The role of Kyrgyzaltyn as State owner/operator of mines will present a number of difficulties for the government, particularly in respect of transparency in financial reporting and accounting, monopoly control of the sector, and possible conflicts of interest. * Professional competencies. The caliber and technical training of Kyrgyz government officials assigned to the agencies and departments supervising the sector is excellent. However, many have not been sufficiently exposed or trained in the particularities of market economy dynamics of the mining sector. The result is sometimes misunderstandings between the officials and representatives .of the private sector. * Protection of the environment Much progress has been made since the mining sector review of 1994 in matters concerning environmental protection. The :government has passed new environmental legislation, adopted a national 'environmental action plan, and reinforced the government institutions responsible for environmental protection. However, certain deficiencies remain. Inter- ministerial responsibilities for the examination and approval of environmental 'impact statements (EIS) could be better defined; regional authorities who are now responsible for environmental monitoring require training and resources; the distinction between historical and current pollution liabilities needs to be defined; 'mine closure issues need to be addressed; applicable quality standards should be re-calibrated to international standards; and requirements and practices for public disclosure by mining kombinats of environmental performance need to be strengthened. With the exception of the Kumtor mine, audits on the environmental performance of other mining enterprises are either not conducted or not publicly available, though the nature of the minerals mined and processed (mercury, antimony, uranium) gives reason for concern about past and current environmental pollution. The government and companies should be more conscious of the concept of "sustainable development". And, finally, efforts could be accelerated to mobilize international donor funds to finance the works required to clean-up and/or remediate old uranium tailings sites. l Reserve classification system. As is the case with other countries of the former Soviet Union, Kyrgyz Republic applies a reserve classification system that is not compatible with international standards. The reserve classification system does not take sufficiently into account the economic characteristics of the ore-body, nor does is re-evaluate reserves from time to time as economic and market conditions may change. This gives rise to significant points of disagreement with private companies c6nceming the quantity and value of the in situ reserves, the optimal and rational use of the deposit ("high grading"), and the cadence and overall duration of the mining operation. The present Study recommends that the government move swiftly to adopt the United Nations Reserve/Resources Classification system and to re-calibrate existing reserve estimates accordingly. Table 114 I___ Comparison of 1994 and 2000 Mining Study Findings - 1994 Findings and Recommendations 2000 Findings 2000 Recommendations Mining Policy Mining Policy - Mining Policy Govemment lacks clear vision, pohlcy Little progress has been made.- Government should prepare policy paper on and strategy for the sector. - Government still lacks clear vision, strategic objectives for the sector and how best - Recommendations- - policy and strategy for the sector; to achieve them. Paper serves as basis. for v - prepare policy statement - Bank:funded technical assistance in revisions to mining and tax law, - provide basis for new law 1994-96, but results were not satisfactory. -_ Mining Legislation Mining Legislation Mining Legislation Legislation is not internationally Good progress has been made. Revise mining law, especially: competitive. - Sub-surface law of 1997 as amended - reserves definition Recommendation: (1999) is an improvement; - optimal use of resources - law should be completely re-written. - however, several topics remain confused, - eiforcement mechanisms such as tendering and reserve definitions. - tendering of properties - dispute resolution Government Equity Ownership 1 Government EquitY Ownership Government E uity Ownership The government through Kyrgyzaltyn No progress has been made. Governinent should:- -owns between 33% and 66%. of gold - Government through Kyrgyzaltyn still - not take any equity ownership innew mining mining,ventures and 100% of other -"ownse stock in gold mines which have not ventures; kombinats. -been good investments.- -develop a program to gradually divest itself Recommendation: - Efforts to priva-tize existing kombinats- of existing equity ownership-- rlThe government should- have not been successful -l -not "own" equity ii mining ventures;. - -- - - - - privatize existing koimbnats z - - - ' = _ - _ X - Table 1-1 (continued) Comparison of 1994 and 2000 Mining StudyFu _din_ _ . 1994 Findings and Recommendations 2000 Findings 2000 Recommendations Role of Kyrgvzaltyn Role of Kyrgyzaltyn Role of Kyrygzaltin Government "owns" existing kombinats Some change but essentially the same. The government needs to assess very carefully, through Kyrygzaltin and also holds Kyrgyzaltyn control over the sector has the value added that Kyrgyzaltyn brings to the substantial equity in new mining increased: sector and be cognizant of the lessons learned ventures. - it holds equity stock in gold mines on by other governments about State owned Recommendations: behalf of the govemment; mining companies. - govemment should not have equity - it controls the Kara Balta gold refinery parficipation in projects. and the Khadamdjai antimony kombinat as - Kyrgyzaltyn should not "own" well as other operations. existing kombinats; This expanded role is contrary to - these should be privatized; international best practice and poses - if not viable, they should be closed. problems of monopoly control, 1 . transparency in accounting and reporting, _ _ _ _ _and possible conflicts of interest X | Govermnent Institutions G 1 Government Institutions Govemnment Institutions Government institutions lack clear Lize progress has been made - degignate single lead agency for sector; mandates; government role as regulator - institutions still lack clear mandates; - clarify roles of Kyrgyzaltyn and SAGMR; rather than producer is not clear, - role of government as regulator rather - clarify mandates of all government agencies administrative procedures are not well than owner/operator is still not accepted; with respect to mining sector; understood. - no "lead'7 government agency as focal - reinforce regulatory role of government Recommendations: point for the sector, - - create a single government agency to - mining title issuance and administrative be the principal focal point for the procedures still unclear, sector. - - rivalry between SAGMR and V _ _ _ _ _ _ _ _ _ - _ _ _ _ _ _ _ K yrygzaltin - L - _ - - - rable 1-1 (continued) Comparison of 1994 and 2000 Mining Study Findings 1994 Findings and Recommendations 2000 Findings 2000 Recommendatioiis Geology Database Geology Database Geology Database Good base of geology information, Some lintited progress. - emphasize role of SAGMR as provider of however it is not digitized and compiled - though SAGMR still lacks proper GIS basic earth science information, rather than according to international standards; and computer facilities; explorer for mineral deposits; Recommendations: - no attempt has been made to re-calibrate - link geology to environmental databases; - data should be digitized and computer reserves data; - introduce computerized GIS system; accessible; - exploration focus is still on deposit - introduce computenzed mining title and - reserve estimates should be re- evaluation rather than regional geological cadastre registry. calibrated according to international surveys. standards. - exploration focus should be on regional geology rather than "deposits" Mining Taxation Mining Taxation Mining Taxation Mining taxation is confused and Some limited progress eliminate gross revenues taxes (road tax, the evolving. - Better understanding of the global emergency fund payment and the concession - General taxation provisions (income competition between countnes to attract fee); tax, dividend withholding, etc.) are mining investment; establish competitive royalty rates competitive internationally. - But, this is not yet reflected in the zero-rate VAT on imports - But, concessions granted to mining applicable law and regulations. improve depreciation regime investors are excessive; - General tax reform currently under address issues such as: - Mining specific taxes (royalties, nghts consideration proposes to solve some taxation of subcontractors to use sub-soil resources, value added issues (VAT, taxation on gross revenues, transfer-pncing rules taxes, and others) are not competitive; customs regime); deduction of costs incurred outside the country Recommendation: but related to the project - Obtain advice on mining taxation. Tabl, 1-1 (continued) Comparison of 1994 and 2000-Mining Study Findings 1994 Findings and Recommehdations 2000)Findings - 2000 Reconunendations Local Mining Investment Local Mining Investment Local Mining Investment Government could do more to promote Some progress. - revise mining law to allow easier access to small scale mining as source of - Sub-surface legislation provides easier mining titles; employment. access to "common" minerals for small - create special service within existing Recommendations: scale producers; government agency to provide technical - policies and sub-surface law should be - access for other minerals is still difficult assistance to small scale mining; revised to allow easier access to mining for small scale producers; - access donor funds to support small scale titles, competitive taxation, removal of - taxation and regulations could still be mining. government monopoly on gold improved to facilitate small scale mining; purchases. - government should pay more attention to local mining as a source of employment. Environment Environment Environment - WAdequate environmental standards are Some limited progress. - government should. address "sustainability, lacking; environmental legislation and standards concept" of mining operations - Government -institutions lack capacity have been adopted, though- these are - - enhance guidelines for environmental and equipment- . inadequate in certain details; assessments and actions plans - Radioactive and toxic. waste problems; - capacity has increased at environment - develop "pro-active" environmental Recommendations: ministry, though specific experience in management system in accordance with the ISO - adopt internationally competitive mining is still lacking; 14000 series environmental legislation and standards. - pollution standards are old fashioned and - re-activate discussions with donors about - clean up of tailings and toxic dump not in line with international requirements clean-up of uranium and other toxic sites; sites; - uranium tailings and toxic waste dumps - environmental audits should be conducted of are still a problem; Kara Balta and existing enterprises in respect of - international donors have examined pollution prevention clean-up of these sites but so far no - adopt internationally competitive progress has been made. environmental legislation and standards Table 1-1 (continued) Comparison of 1994 and 2000 Mining Study Findings 1994i1ndifigsund Recommendations 2000 Recommendations -- Privatization and Corporate Governance Pnvatization and Governance Pnvatization and Governance - State owns through Kyrgyzaltyn the No progress. - Objective studces should be conducted of capital stock of mining kombinats; - In spite of good faith efforts at fundamental viability of enterprises; - Government should devise and privatization; If they cannot be made viable then they should execute plan of privatization - Some alternative forms of corporate be closed in an orderly manner; - Rules and procedures of corporate management (trust management, funds for - Deficiencies in standards of corporate governance are unclear shares, etc.), but are unlikely to be governance should be rectified. successful; - Standards of disclosure, reporting, auditing and conflicts of interest are weak 2 Achieving Development Objectives through Mining Sector Reform 2.1 Status of Achievement of Development Objectives 2.1.1 Like other countries, the Kyrgyz Republic government has many development objectives for the mining and metallurgical sector. The present Study addresses three fundamental questions concerning these objectives. Is Kyrgyz Republic achieving them? If not, or if progress is only partial, what changes are necessary to achieve them? Finally, what lessons may be learned from the experience of other countries to achieve the objectives? 2.1.2 The present Study finds that the development objectives for the mining and metallurgical sector are not, in the main, being achieved. 2.1.3 These objectives include some of the following. * Ensure continued production. employment and social tranquility at existing kombinats. Results have been mixed. Some kombinats have maintained production, others are moribund; employment has fallen, though social tranquility seems to have been maintained. * Operationalize the new role of government as regulator instead of direct investor and operator of mines. Results are confused. Continued government ownership of mines, unclear legislation, and mind-set of public institutions indicate that this new role for government is not yet fully accepted. * Attract and retain private sector investment through competitive legal and fiscal conditions. Good intentions, but results are mixed. Government has attempted to establish competitive investment conditions but there has only been one new investment: Kumtor. Other investments are in the planning stage; new exploration funding has fallen. * Use taxes and export earnings from the mining sector for overall economic development purposes. Results are unclear. Overall contribution in taxes of the sector is negative; gold exports from Kumtor dominate; reimbursement of value added taxes is a problem. * Sustain economic, social and environmental performance of sector. Results are problematic. There will be significant disruption to the economy when Kumtor closes. There are continuing environmental problems with abandoned uranium mines and at some existing kombinats. * Plan and provide for the environmentally and socially acceptable closure of operations which are no longer economically viable. This issue has not yet been addressed. The government still must devise a program for orderly closure of non-viable kombinats. 16 * Maintain an equitable balance of benefits deriving from the sector among various regions and population groups in the country. Results are unclear. Certain regions benefit from mining development, others do not. * Create a professional and efficient organization of public institutions: ensure that decisions are made in a transparent and efficacious manner. Results are mixed. The technical quality of Kyrgyz staff is good, but the government does not have clear lead agency for the sector and there is confusion of mandates of various govemment institutions. There is also some old-fashioned thinking on the part of govemment agencies and a general lack of adequate logistical support. * Enhance the scientific knowledge of the basic geology and environment to support detailed exploration by the private sector. Result: needs modernization. Basic geo- scientific data is good but new technologies are needed; regional instead of detailed exploration should be emphasized. 2.2 How Mining Reform Has Worked in Other Countries 2.2.1 Other govemments have similar objectives as Kyrgyz Republic for the development of their mining and metallurgical sectors. Many of them have been more successful than Kyrgyz Republic to achieve these objectives. They have done so by vigorously carrying out mining sector refox,ms (the "reform agenda") which typically include: * up-dating the mineral policy and strategy,. * re-writing the mining legislation (particularly in respect of mining rights), * reforming the mining taxation regime, * reinIforcing government supervisory institutions, * building greater capacity (including good governance) within the institutions to effectively carry out their tasks, and * developing a reliable and comprehensive scientific database of the earth system. 2.2.2 Countries such as Chile, Peru, Argentina, Tanzania, and Mali - to name just a few - have all undertaken within the past 15 years substantial mining reform programs. The results in terms of increased investments, production and export earnings, as well as other economic indicators, have been remarkable. The present Study argues that Kyrgyz Republic, like other countries, can achieve similar positive results through mining sector reform. 17 Table 2-1 Mining Reform Works Mining Reform 'Before and After" Results in Selected Countries | Exploration Value Production Value Exports Value Country US$ Million US$Million 11 US$Million I |Before ||After |IBefore ||After ||Before |lAfter ,Argentina 11<3 ||150 11340 |1,310 1170 1700 l |Chile 115s 1i250 J!2,400 117,500 12,300 116,900 TPeru ||io 11200 1{2,000 103,900 1,900 3,600' Tanzania ||IO,0O00bo Public Sector and Piiv ecor Roles A:OTO= fAXT 100,000 . . _ K ~~~~~~~~~PA3BEltKA) , ~~~PUBUC FUNDING l ~~~~~~~~~~~~~~DETAilED ON 100,000 s / PA3BEXtA J PRIVATH FUNDING PEr'HOHAA1bHAA1/gHAINLvo rEOJIOrH'ECKAA 3ArIACOB 10 TOHOrPAOHxECK rIOAE3HblIX AR ChEMKAx RIONALGEOlOGICAL LPOMCM ... ~~~AS5ESST M 13 2.3.6 Access to Sub-Surface Rights. In virtually every country the State owns sub-surface mineral resources. The mining laws and regulations provide that the State may grant access 19 to the sub-surface mineral resources to companies and individuals for the purposes of exploration, development and exploitation. However, in order to be successful in granting this access, the laws and regulations should take into account some fundamental principles that apply in the mining industry. 2.3.7 First, minerals exploration is a very high risk activity. The success rate of solid minerals exploration is only a small fraction of the success rate of petroleum exploration.2 Second, world market prices of ferrous and non-ferrous metals as well as other solid minerals have been declining over the past twenty years. Third, given the high risk nature of solid minerals exploration, the declining prices of mineral commodities, the general worldwide economic downturn, and the negative effects of the 1997 Bre-X scandal on the capital markets, capital available for minerals exploration is relatively scarce.3 Finally, the opening of many economies to foreign private investment since the early 1990s means that there are now a large number of countries competing for a relatively small pool of investment capital available for minerals exploration. 2.3.8 Because of the above peculiarities pertaining to mining, most governments use a simple system of licenses to grant access to minerals. This is unlike the petroleum industry which can use a system of tenders to grant access to blocks of mineral prospective ground. The licensing system grants access for exploration, development and exploitation according to clearly defined criteria and responsibilities. These include: no overlap with existing rights; availability of the area; eligibility of the applicant (eligibility requirements are not very restrictive; and in several countries, no demonstration of financial and technical capability is required); providing the necessary identification documentation and payment of the applicable fees. Geological information is made available to prospective investors by the government at low cost. This allows the investor to identify its own targets, rather than the Government selecting areas for tender. The investor then determines whether the target areas are available by consulting the public registry (cadastre) of exploration and exploitation titles. The investor then files an application for an available area. The time when each application is filed is strictly recorded. No other application for the same area is accepted unless and until the earlier application for exploration rights in the area is rejected. The requested title is granted to the first eligible applicant to apply for it correctly. 2.3.9 It is important to recognize that the mining law and regulations specify: * eligibility; * grant criteria (first come, first served - no negotiations); * obligations (maintenance vs. operating); relations with surface users; 2 "Roughly one out of every 1,000 properties passes the preliminary exploration phase and results in the discovery of economic-grade mineralization. Once discovered, the mineralized zone has a 1-2% chance of developing into an economic deposit. In other words, it takes 1,000 grassroots prospects to make a discovery and at least 100 discoveries to make a mine." Virginia Heffernan, Worldwide Mineral Exploration (1998) at p. 3. By contrast, the success rate on exploration drilling for petroleum is approximately 15%. Alexander, '"roduction Sharing Contracts and Other Host Government Contracts," presentation at the 46t Annual Rocky Mountain Mineral Law Institute, July 21, 2000, Vancouver, British Columbia, Canada. Worldwide private exploration investment increased substantially between 1993, when it totaled US$2.4 billion, and 1997, when it peaked at about US$ 5.1 billion. It subsequently declined to $2.7 billion in 1999. Metals Economic Group, Corporate Exploration Strategies: A Worldwide Analysis (1999). 20 * violations and penalties; * and recourse and dispute resolution. These terms are standard and not negotiable. This procedure not only avoids discrimination between competing applicants, but it also reduces the time necessary for processing applications from months or years to days. Moreover, the system of granting mineral rights on a strict "'first come, first served" basis through a licensing office can be - and in several countries is'- self-supporting. The initial and annual fees paid by the titleholders in order to obtain their, rights and maintain them in effect pay the costs of maintaining the licensing system. I 2.3.10 Tendering of mineral properties. As noted earlier, tendering of mineral deposits (ferrous, non-ferrous, precious metals, coal, construction and quarry materials) is not generally used in the international mining industry, even though it is used in the oil and gas industry. This is because of a number of technical and economic reasons. First, oil and gas deposits are liquid and tend to be continuous and homogenous under the surface. This means that an oil and gas investor can bid (and be willing to pay up-front) for a block which is contiguous to a known oil and gas production area because the risk is less. However, "hard- rock" mineral deposits are not necessarily continuous or homogenous underground. They tend to be fractured, deposed in veins or pockets, varied in thickness and grade, as well as many other geological variables. It is thus much riskier for the mining investor to bid (and pay up-front money) for a block of prospective ground. Second, as compared to the oil and gas industry, exploration investments in the mining tend to be smaller and invested over a longer period of time. The payback period on funds invested for mineral development and operations also tends to be longer. This means that the mining investor is at greater risk to market and!technical factors than the oil and gas investor. Third, tendering of mineral properties i$ more expensive and time consuming for investors. Investors are naturally attracted to those countries which offer not only attractive geology but also rapid, easy and transparent access to exploration rights. Rapidity and ease of title issuance are achieved through a licensing system. Finally, there is much less capital available for exploration of solid minerals than for petroleum exploration. Mining companies are thus reluctant to spend the time and funds preparing bids for mineral properties when other countries offer attractive geology without the difficulties of tendering. 2.3.11 There are some important exceptions to this negative view of tendering of undeveloped mineral properties. These are, however, exceptional cases and not the general practice. Peru, for instance, has successfully tendered a few partially developed or undeveloped mineral properties. The Peruvian government in the early 1970s nationalized the operating mines and mineral reserve holdings of the private companies then operating in Peru. These holdings were given to specific state owned mining enterprises or holding companies such as MineroPeru and Centromin. The Alberto Fujimori government reversed the previous policies of nationalism in the early 1990s. Under the new government an ambitious program of privatization of state owned enterprises was undertaken. MineroPeru and Centromin, with the advice of international advisors, sold off many mining assets, including a few highly prospective undeveloped or partially developed mineral properties. An example of a 21 successful tender of an undeveloped mineral property is the case of Antamina, described below. Tendering of Undeveloped Mineral Properties: The Case of Antamina, Peru The Antamina copper-zinc deposit was first identified by the Cerro de Pascr Corporation in the 1960s. The assets of the company were nationalized in 1974. Ln 1995/96 the Peruvian government, in accordance with the national program of privatization, decided to put out for international tender the Antamina deposit. At that time, a total of about 150 million tonnes of ore reserves had been identifi-ed; but, the govemment technicians believed that the deposit had considerable potential for greater reserves. Accordingly, an international tender procedure was devised which required a US$ 20 million cash payment and an exploration program of US$ 13.5 million. The winning bidder would have a two year option during which. tirre tre exploration program would take place and the reserves confirmed. At the end of the two year period the winning bidder could either confirm its bid, at which time the US$ 20 million would be paid to the government, or walk away from the project. The US$ 13.5 million commitment for new exploration was guaranteed by tbe company against a letter of credit. In the event that this amount was not spent in new exploration the remainder would be payable to the government. The property was awarded to the highest bid calculated according to a formula which took into account 100% of the up-front payment plus 30% of the investment commitment. The winning company was Rio Algom of Canada, later acquired by Billiton, which subsequently formed a joint venture with Noranda, Teck Corporation, and Mitsubishi. Development of this mnine is currently underway for a total in,X esFrrnert of US$ 2.2 billion. Antaniina will be one of the largest polymetallic mines in the world, producing concentrates with an equivalent metallic content of 270,000 tonnes of copper and 220,000 tonnes of zinc per year. The principal lesson to be drawn from the Antamina experience is to provide for a phased approach which will allow tnie investing company sufficient time to confirm existing reserve estimates and prove an new reserves. It should also be noted that significant reforms to the Peruvian muirng law and regulations had been taken shortly before the privatization program. This provided the investor companies with sufficient security of tenure to mobilize international financing for the venture. 2.3.12 Tenders have also been successful in Finland on a limited basis. In Finland, the Government promotes exploration and development of a small number of carefully selected mineral properties by having the Geological Survey of Finland conduct extensive exploration and then putting them up for tender. However, investors can obtain licenses to explore for minerals in most parts of the country through an application process, without going through a tender. The key to the success of the tenders in both Finland and Peru is that they have been done on a highly selective basis as part of either a privatization program or a promotional program. Neither country has attempted to rely on tenders as the main procedure for granting mineral rights. 22 3 Economic Contribution of Mining: 1994 - 2000 3.1 Macro Economic Contribution 3.1.1 The economic contribution of the mining and metallurgical sector in Kyrgyz Republic has changed significantly since the initial Mining Sector Review was prepared in 1994. These changes are both the positive and negative. On the positive side, the gross value mining and metallurgy production has increased considerably to US$367 million (7.7% of GDP) in 1999, up from US$81 million (1.5% of GDP) in 1995. Exports of mineral products in 1999 were nearly US$200 million in 1999, representing 41% of total export earnings, an increase from US$56 million in 1995. Table 3-1 Selected Macro Economic Indicators Indicator 1995 1996 1997 1998 1999 Percent of GDP 1.5 1.1 5.6 6.6 7.7 Percent of production 12.3 9.7 34.1 41.1 42.1 Value of production (soms million) 872 964 6,150 8,737 14,345 Percent of total jobs 1.1 1.0 0.9 0.8 0.7 Percent of exports 13.8 10.9 30.8 40.2 40.6 Value of exports (US$ million) 56 55 186 206 184 Percent of imports 2.7 1.9 7.9 5.5 12.4 Value of imports (US$ million) 13 16 55 46 74 Percent of tax revenues 7.2 9.0 3.2 ...... Value of total taxes (soms million) 174 118 121 -1,012 -1,154 Value of total taxes (US$ million) 16 9 7 -49 -30 Source: National Statistics Agency 3.1.2 Negative trends in the sector concern employment, environmental pollution and taxation. Overall, mining sector employment has actually decreased since 1995 and now represents only 0.7% of total employment. This is because many of the existing kombinats have had trouble adapting to the requirements of the market economy and have lost staff. Kyrgyz Republic has a legacy of environmental problems related to mining as, for example, old uranium tailings. Also, the contamination of toxic metals and chemicals caused by existing kombinats could be substantial. 3.1.3 The sector's contribution in terms of tax revenues is unclear. According to the National Statistics Office, tax revenues from the mining sector have not only decreased by are actually negative, showing a net outflow of funds from the national treasury to the sector. This is highly unusual from an international perspective and represents an implicit government subsidy to a sector which otherwise should be generating taxable profits. This is clearly not sustainable on a long terms basis. This situation is due principally to: 1) reimbursement of VAT to certain operators and, 2) errors of government policy which have retained large government equity holdings in the mining enterprises while granting excessively generous and lenient tax concessions. 23 3.1.4 A principal concern is that virtually all of the growth in the sector is due to one mine: Kumtor. The overwhelming dominance of the economy by the Kumtor gold mine represents a major challenge for the government. The mine is scheduled to dramatically curtail production around 2007 and the government must plan for the substantial economic effects, principally the loss of exports earnings, taxes, and jobs. Other gold projects in the planning stage are smaller than Kumtor and, in any event, may be difficult to bring into production due to the low gold price. 3.1.5 The performance of other mining kombinats has been mixed. Of the principal existing kombinats, the Kara Balta uranium processing facility, the Hyderkhan mercury kombinat, and the Makmal gold mine are doing reasonably well under the circumstances prevailing in the market. The Khadamdjai antimony kombinat and the Orlovka rare earths kombinat are having difficulties due to uncertainties in raw materials supply, exhaustion of mineral reserves, and difficult market conditions. Other mines, principally small coal mines, are either not operating or too small to be classified as anything but artisanal operations, though they may have infrastructure and other commitments to the communities where they are located. Studies are underway at the Khadamdjai and Orlovka kombinats as well as some of the coal mines to find remedies to the difficulties. However, at some point the government must determine if these enterprises can be made economically viable. If they cannot then it will be necessary to anticipate the social and economic ramifications of closure of the operations. 3.2 Local and Community Impacts 3.2.1 Internationally, over the past five years much attention has been focused on the economic impacts and contribution of mining at the level of the local community. Based on some recent studies4 the impacts of one mine in the local community can include: * indirect employment - for every job created directly in the mine between 2 and 25 jobs are created with suppliers, vendors and contractors to the mine; * induced economic activity - every dollar spent by the mine on operations generates an average of 2.8 dollars in the local economy in terms of induced economic activities in and around the mine site; * local employment - between 65 and 90 percent of the labor force at the mine is drawn from the local community, * social services - mines contribute directly to social services such as schools, hospitals and clinics, training centers, food security programs, water wells, small scale business development, vendor and supplier partnerships. 3.2.2 Local communities, which bear the brunt of environmental damage and social destabilization of mining activities, often complain that they do not receive their fair share of tax revenues and other benefits. The tendency at the international level is to legislate a 4 The World Bank has conducted studies (1999) of the economic contribution of mines in Latin America, Africa and Asia. The summary of the findings of these studies is in annex. 24 sharing of some of the mining taxes and other revenues directly with the local community. In Kyrgyz Republic a number of taxes are paid by mining companies to various local entities. Cumulatively, these various payments can amount to fairly large sums. However, other countries have found that this practice raises the issue of the capacity of local communities to properly administer and use the funds. Experience in several jurisdictions demonstrates that local communities (or individual political leaders of them) could simply squander the resources on projects which do not benefit the community as a whole. This, in turn, can cause significant problems for the mining company and the central government which are sometimes wrongly held to blame for the mis-use of funds at the local level. No specific evidence was brought to the attention of the study team that this is the case in Kyrgyz Republic. Nonetheless, a significant issue for all levels of government is to put into place the mechanisms to ensure that tax revenues are used transparently and to best effect at the local level. 3.2.3 Mining and metallurgical kombinats in Kyrgyz Republic, located mainly in isolated rural areas, have traditionally assumed direct responsibility for provision of infrastructure, social and support services to the local community. International companies will view their responsibilities in this regard differently. Typically, a mine operated under market economy conditions by an international company expects to undertake a much smaller role in terms of support for the local community. Costs to construct and maintain the infrastructure could substantially reduce the competitive advantage of the company's products in international markets. The; company generally does not have the required expertise to manage social infrastructure. Instead, international companies expect to pay a reasonable amount of taxes to national and local governments and leave to them the responsibility for municipal infrastructure and social services. This difference in views of their respective roles can lead to significant conflict between the mine and the local and national governments. 3.2.4 A vexing issue in Kyrgyz Republic, as in many other countries, is the extent of government responsibility to provide social support to the local community when a government owned mining operation is no longer economically viable and must close or where it has been abandoned. In Kyrgyz Republic, the government must face up to the possibility of closing some of the kombinats with the attendant social and economic consequences. International experience has shown that there are no easy solutions to these issues. The politically expedient choice, as long as funds for the purpose are available, is to continue subsidizing the mining operation to support the community. This, however, is not a viable long term strategy. Most governments, through a variety of mechanisms, prefer an orderly shut-down of operations, rehabilitation of the environmental damage at the mine site, and some form of aid to the workers and community. In most countries, this is an expensive process but ultimately cheaper than continued subsidies, provided that the political will exists to carry through with the restructuring exercise. For non-viable operations which cannot be privatized, or operations which must close due to exhaustion of reserves, the government must step in to ensure the orderly closure and shutdown of operations and provide transitional support for the workforce and local community. 25 3.3 Some Important Issues. 3.3.1 In discussions with Kyrgyz government officials and the private sector, some important issues have been raised which are discussed below. 3.3.2 Government equity participation in mining ventures. Kyrgyz Republic is making a fundamental mistake in taking an equity or shareholding position in joint ventures with private companies. Most governments over the years that have pursued such policies have found that they do not produce the dividends anticipated nor do they allow the government effective influence over corporate decisions. In Kyrgyz Republic the government, through Kyrgyzaltyn, has a 67% equity stake in the Kumtor mine; in the Dhzerui joint venture Kyrgyzaltyn 33% and in the Taldy Bulak joint venture 52%.5 3.3.3 It is entirely understandable from a public perception point of view that the nation, as owner of the natural resource, should have a majority or strong equity position in the joint venture which mines the resource. However, there are a number of problems with government equity ownership. First, it confuses ownership with operations. International practice is that the government owns of the resource on behalf of the nation and simply grants an exploration or exploitation right to the private party to for a limited amount of time. Second, dividends which are derived from equity ownership are, by their very nature, extremely risky. They may or may not be paid by the venture - depending on commodity prices, operating and other technical factors. This, in fact, is what has happened the case of the Kumtor operation: the price of gold has fallen so that the original projections of dividends streams will not be achieved. Third, the private partner is often required "loan" the government funds to purchase the equity shares ("carried interest"), to be reimbursed from future dividends. If, however, the dividends fail to materialize as originally predicted the government is left with a debt it must still reimburse. Finally, because of the "carried interest", the private partner is often required to ask for tax concessions and other fiscal inducements in order to meet its financial returns to compensate for the risk of the venture. The government then finds itself in the doubly disadvantageous position of having no taxes or dividends in return for having given exploitation rights for the deposit to the private party. 3.3.4 The lessons on government equity ownership have been learned the "hard way" by most governments. The role of the State, as explained elsewhere in this Study, has changed significantly over the past twenty years. Instead of equity shareholdings in mining ventures, most governments prefer to exercise full powers of taxation and to regulate the sector through clear, consistent, non-discretionary, and explicit rules and policies for the sector. As a result, numerous governments have privatized state owned enterprises and sold State equity shareholdings in mining ventures. This has reduced financial risks to the government and generated revenues for the national treasury. 3.3.5 Tax holidays. In addition to the issue of government equity, the government is making a fundamental error in granting excessively lenient treatment to investors, particularly in respect of exemptions from corporate profits taxation. To the extent that the government 5 The recent presidential decree stipulates that this percentage, currently held by the Kara Balta kombinat, should be transferred to Kyrgyzaltin. 26 does not take an equity percentage and the overall rates and methods of taxation are competitive with international standards there is no good reason to grant tax holidays or exemption from regular taxes. An important exception should be made to this rule, however. Many governments have recognized that exemptions from import duties during exploration and the development phase of mining operations are necessary to reduce the costs to the investor of importing necessary equipment and supplies for the investment. But, once in operation, the mine should be able to support a reasonable tax burden. It is important to recognize that the taxes should be based on profitability of the enterprise, and not based excessively on inputs (high customs duties) or outputs (ad valorem royalties on production). Studies conducted by the World Bank and the United Nations have determined that investors are not necessarily attracted to jurisdictions that offer lenient tax treatment. The controlling variables in decisions to invest are rather based on geological factors, political stability, good governance, and the overall profitability of the investment. 3.3.6 Natural disadvantages. Development of mining in Kyrgyz Republic is difficult due to a number of natural disadvantages. The country is landlocked and transportation of bulk mineral commodities must travel long distances to seaports and pass through third countries. Importation of critical equipment and consumables for mining operations is subject to the same conditions which raises the cost of these imports and could contribute to is subject to delays or other disturbances of supply. Most of the mineral deposits are located in rugged terrain at high altitude which poses a number of logistical problems. It should be noted, however, that other countries such as Peru have mines which operate in similar terrain and altitude. Finally, there are certain areas where low level guerilla infiltrations or poor demarcation of border areas make it relatively unsafe for exploration or exploitation operations. 3.3.7 High grading. An issue in Kyrgyz Republic (concerning operations at Kumtor and possibly other sites) is the problem of "rational" or "best" use of the mineral deposit. This is normally related to the perception of the government and/or local community that the mining company (foreign or local) is exploiting the best portions of the deposit (the practice known as "high grading") and will abandon exploitation once the highest grades have been exhausted. Part of this problem is caused by the reserve classification system used in Kyrgyz Republic. As explained later in this Study, because the system used in Kyrgyz Republic is different that the one used internationally, mining companies and the government could have a different estimations of the in situ reserves. Also, the plans, methods and rhythm of extraction used by the mining company to mine the ores could be different than those proposed by the government. In Kyrgyz Republic the extensive powers granted to the State Commission on Mineral Stocks to determine reserves are a significant cause for concern to private investors. Private mining companies generally exploit the best and easiest mineral reserves first in order to: a) generate substantial positive cash-flows in the early years of the project; b) quickly pay off the debts incurred for the project's development; and c) meet the expected rates of return on investment. This practice is not inherently bad or incorrect. However, governments sometimes complicate matters by assessing heavy "ad valorem" royalties which in effect increase the cut-off grade forcing the investor to mine the best ores. Another common error is to grant tax holidays during the first few years of the project in the mistaken belief that this is necessary for the investor to improve the rate of return. In reality, the tax holiday only 27 increases the temptation to accelerate the process of high grading since the investor, quite logically, will seek to maximize returns during the tax holiday period. 3.3.8 Employment of expatriate personnel. Few issues in developed or developing countries are as emotive as the issue of employment of expatriate personnel. This particularly the case in Kyrgyz Republic and neighboring countries where foreign mining companies employ large numbers of expatriates when qualified local specialists may be available. The public perception is that companies: a) do not employ enough local staff, b) needlessly spend money on expensive expatriate salaries when local and national employees are paid a lot less, and c) increase operating costs because the foreign company receives a management fee based on a percentage of total operating costs. From the company standpoint, however, it is understandable that during the project development phase and early years of operations it will want to rely on personnel which it has employed for many years or who have specialized skills which may not be available locally. However, the number of expatriate employees should diminish over the first three to five years of operations as training programs within the company develop a cadre of local specialists and managers. In some countries, Indonesia, for example, the contract of work between the government and the company specifies the phase- out of expatriate employees over a number of years. Management contracts are generally structured so that the operating company has every financial incentive to minimize the high costs employing expatriate personnel. Experience suggests that by about the tenth year of commercial operations only the very senior managers of the company should be expatriates. However, the govemment should resist the temptation to impose annual quotas on the number of expatriate employees or the vetting by government agencies of individual expatriate personnel qualifications since these have proved in other countries to be cumbersome and time consuming, both for the company and the government. 3.4 Status of Producing Enterprises 3.4.1 Kumtor Gold Mine. The Kumtor gold deposit is located in southeastern Kyrgyz Republic in the Tien Shan Mountain Range some 25 km from the Chinese border at an elevation of 3300 to 4150 meters. Kumtor is reportedly the eighth largest known gold deposit in the world and geologically similar in geology to the world class Muruntau gold deposit in Uzbekistan. Cameco, a private Canadian producer of uranium, in joint venture with State Concern "Kyrgyzaltyn", have formed the "Kumtor Gold Company" which has developed and brought the mine into production in 1997. 3.4.2 Cameco has 33.3% equity in the Kumtor Gold Company; Kyrgyzaltyn, as representative of the government has 66.6%. The "Kumtor Operating Company", a wholly owned subsidiary of Cameco, is the operator of the mine. Financing for development of the mine, which cost a total of US$ 452 million, was provided by Cameco Corporation (US$45 million equity, US$ 122 million subordinate shareholder loan) and an international consortium including Chase Manhattan Bank (US$ 155 million), the European Bank for Reconstruction and Development (US$30 million senior credit, US$10 million subordinate loan), the Canadian Export Development Agency (US$50 million export loan), and the International Finance Corporation (US$30 million senior credit, US$10 million subordinate loan). 28 3.4.3 To date, this is the largest investment in Kyrgyz Republic and one of the largest in the natural resources sector of any country of the former Soviet Union. In 2000, Kumtor produced 21 tonnes -of gold valued at US$ 230 million. Kumtor represents over 6% of Kyrgyz Republic GDP, 40% of export earnings, and 30% of total industrial production. The mine employs nearly 1,500 persons, 90% of whom are Kyrgyz citizens. The mine is clearly dominant of the national and local economies. Perhaps because it is so important the mine has been criticized on several issues. * Reduction of reserves. Previously, total reserves are around 315 metric tonnes gold metal. Because of the fall in international gold prices Cameco has reduced the amount of extractable reserves, increased in the cadence of mining, and shortened the mine life. Cameco and the State Agency for Geology and Mineral Resources have had disagreements about the exact volume and extractability of reserves, a reflection of the differences in international and Kyrgyz methods of estimating reserves. * Environmental performance. The mine has had some unfortunate environmental and work related incidents. One was the tragic loss of life in a helicopter accident during construction of the mine. A second incident occurred in May, 1998 when a truck containing granular sodium cyanide accidentally spilled into the Barskaun river. An emergency response was initiated and an expert panel initiated by the Kyrgyz Government and Cameco concluded that short term environmental impacts were limited to fish kills. The incident was audited by the World Health Organization which concurred with the panel's findings. Nonetheless, the cyanide spill generated considerable adverse reaction among local people, NGO's and in the media. Additionally, tourist revenues in the Lake Issy-Kul region were negatively effected the perception of risk to recreation areas. These incidents notwithstanding, the mine actually has an environmental and safety performance which is better than industry averages. * Lack of employment for Kyrgyz. Of the total mine workforce of 1,500 persons, approximately 10% are still expatriates. These expatriate employees are expensive: they ac6count for over 70% of total payroll, US$ 16 million/year versus only US$ 7 million for Kyrgyz employees. The company is criticized for not training Kyrgyz fast enough and for "padding" the operating costs with foreign employees since Cameco receives a management of 4% on overall costs. The company is making efforts to train locals and to reduce the number of expatriates, without sacrificing the quality or safety of the operations. * Insufficient contribution to taxes. Kumtor benefits at present from numerous tax exemptions which would be considered excessively generous by international standards. It is important to note, however, that at the time the "master agreement" was negotiated many internationally competitive tax policies, tax rates and methods of calculation were not yet in place in Kyrgyz Republic. Also, in order to compensate for the 66% government equity position effectively "carried" by Cameco relief from taxation was required. The company is exempted (for at least the first five years of commercial production), from any and all taxes with the exception of VAT, the road tax, land tax, salary and social security taxes, concession payment taxes, and payments 29 to the Issyk-Kul oblast social fund. Additionally, the master agreement stipulates that Kyrgyzaltyn will indemnify certain parties, including Cameco, from Kyrgyz tax liabilities for an additional period of five years after expiration of the original tax exemption. Project proceeds accruing to Kyrgyzaltyn (distributions, royalties, management fees) will be used to fund the indemnity. As Kyrgyzaltyn is wholly owned by the government the effects on the government treasury will not be advantageous. It should also be noted that, contrary to best practice, the taxes paid by Kumtor are not based on profits (income tax, dividend withholding taxes), but rather on inputs or outputs (royalties, concession fees, lump sum social payments, and others). This means that Kumtor paid in 1999 nearly US$ 7.5 million (about 4% of gross sales), even though the company reported an operating loss. The company estimates that as from 2003 tax payments could substantially increase, though it is unclear if this would include profits taxes. * Value added taxes. There has been considerable tension over the issue of VAT, precisely the reimbursement to Kumtor by the government of VAT paid on imported goods and services because the gold is exported. In practice, governments around the world have a great deal of difficulty finding the funds to reimburse VAT though their own legislation requires them to do so. Kumtor has last year concluded an arrangement with the government allowing the company to off-set VAT against taxes owed. Under the terms of this agreement the government must reimburse the company some US$ 2 million early next year, though it is unclear whether in fact the government will be able to do so. 3.4.4 Kara Balta Kombinat: Uranium Oxide and Molybdenum The Kara-Balta Kombinat located 60 kilometers west of Bishkek is a principal center for the production of uranium oxide (U308), molybdenum, refined gold, and other products. Kara Balta Kombinat is majority owned by the Government with some local and Kyrgyz Republic private sector participation. 3.4.5 The uranium oxide is produced from slurries and ores imported principally from Kazakhstan. The Kombinat declines to issue production figures, but published sources indicate that around 500 tonnes of uranium concentrates were produced in 1997. Concern has been expressed by some observers at the laxity of environmental controls at the Kara Balta facilities and dangers posed to the community of the dust and water contamination from tailings of processed uranium ores. According to company management, this problem has largely been solved due to the application of newer production technologies which produce much less waste. 3.4.6 Kara Balta facilities also produced in 1999 about 150 tonnes of molybdenum from concentrates and scrap imported from CIS countries. This production was originally a contract arrangement with a UK firm Micomin but now a separate company has been established in which 70% of the shares are owned by Micomin. The production has encountered a number of technical difficulties principally related to the quality standards of the final product. Additional investments have been necessary in new treatment processes and modernization of facilities. 30 3.4.7 The Kara Balta facility ailhas a gold refinery which produces refined gold from dore produced by the Kumtor and Makmal mines.6 The facility can process up to 40 tonnes, though' approximately 21 tonnes of gold are presently refined. The refinery is also accredited with the London Metal Exchange. According to recent decrees the gold refinery has been separated from the rest of the Kara Balta kombinat and control,given to Kyrgyzaltyn. This could pose a problem of "arms length" pricing of refining services' since Kyrgyzaltyn is also holds equity stockholdings in producing gold mines (Kumtor and Makmal). 3.4.8 Khadamdjai Kombinat: Antimony and antimony oxides Located on the edge of the Fergana valley, the Khadamdjai Kombinat reported production of 1,320 antimony ingots and 733.5 tonnes of antimony metals in 1999. This production is only around 15-20% of the production iri 1995. This fall in production is largely due to the shortage of slags and scrap containing antimony which must be imported from companies in Russia and Tajikistan for processing. These companies had proposed that they should acquire 90% of the capital stock of Khadamdjai in return for secure supplies of raw materials. The government was not in agreement with this approach and has initiated studies of developing local antimony and complex ore deposits to supply the plant. However, the viability of these plans has not been established. Employment has fallen by half, from 3,303 persons in 1995 to 1,796 persons in 1999. The Kombinat is "common property" but, under the terms of the recent decrees, the government has transferred its equity shares to Kyrgyzaltyn. It has been reported that Khadamdjai contracted debts with Russian banks and in return has pledged its shares or future production. Kyrgyzaltyn reports that it has cleared up these arrearages and debts of the enterprise and will pursue new investments to make the enterprise viable. 3.4.9 Hyderkhan Kombinat: mercury compounds and calcium fluoride The Hyderkhan mercury kombinat is doing better than some other enterprises. This facility processes cinnabar; (the mineral containing mercury) from near-by deposits, though these are not particularly high grade. Also, the facility processes some scraps and wastes imported from other countries to extract mercury and mercury compounds. In 1999, the kombinat produced 628 tonnes of mercury, which would make Kyrgyz Republic the third largest producer of mercury in the world (after Spain and China), and larger production than during the Soviet period. It is reported that the kombinat exported over US$3 million worth of products in 1999 (principally to Russia), an increase over previous years. Employment has remained relatively stable at the kombinat: 1,068 persons in 1999. The kombinat is "common property" meaning that the State still has a majority of the shares. A major concern at this facility should be environmental protection and control, though the Study does not have first hand information on this. 3.4.10 Orlovka Kombinat: Rare Earths (The Kyrgyz Mining & Metallurgical Plant) is located 104 kilometers east of Bishkek. The kombinat is "common property", owned by the 6 The National Statistical Agency reports the 1999 value of total Kara Balta production was 6.7 billion soms, US$ 172 million. This is a dramatic increase since 1997, due mostly to refining gold produced by Kumtor. However, this statistical reporting overstates the true value of Kara Balta production since it reflects the full market value of the gold rather than the fees the kombinat receives for refining the gold. Internationally, refiners of gold receive as service remuneration less than 1% of the market value of the gold. This "double counting" in Kumtor Company statistics and Kara Balta statistics is an anomaly which the National Statistical Agency should correct. 31 State. This Kombinat was established in 1952 to provide re earths metals to the Soviet Union's high technology industries, particularly for milit$ary hardware. In previous years, the plant has produced 14 metals and their oxides at various grades of purity. It imported ores and concentrates from Russia and Mongolia. However, since the break-up of the former Soviet Union these supplies b become unreliable and the local deposits of rare earths are poor in quality. Studies are finderway to determine whether or not it is profitable to mine and process the local ores. The plant is also in need of modernization. In spite of these difficult prospects, the Orlovka kombinat managed to manufacture products worth 50 million soms in 1999 (about the same as in 1997 and 1998), though total exports decreased from US$1.4 million in 1998 to US$0.8 million in 1999. The number of employees remained the same as in previous years: 1,000 persons. It is unclear what, if anything, could be done with this operation. The international markets for its products are small, highly specialized, and favor producers with established reputations for purity and on-time delivery. In addition, the cost of locally produced raw materials is unlikely to be competitive. 3.4.11 Makmal Gold Mine is owned and operated by Kyrgyzaltyn. Kyrgyzaltyn reports that the operation is profitable. Prior to the commissioning of the Kumtor operation Makmal was the only operating gold mine in Kyrgyz Republic. Production over the past four years has averaged about one metric tonne of gold per annum, worth approximately US$ 10 million. It was previously reported that reserves at the open pit mine were only sufficient for an additional 4-5 years of exploitation. The newest information is hat studies are underway to exploit underground reserves which will extend the life of the mine. Also, new technologies can be introduced which could lower the cut off grade and allow the processing of poorer ores. In 1999 almost 900 persons were employed by Makmalzolto, about one-half of the employment level in 1995. 3.4.12 Coal Mines. There are a number of small coal exploitation operations in Kyrgyz Republic at the following mines: Zhygalan, Kok-Yangak, Ak-Ulak, Sulyakta-Kumyr, Tash Kumyr, Tenege, Alualyk-Kumyr, and Kyzyl Kiya Kumyr. Collectively these mines in 1999 produced about 400 tonnes of coal, far below the production levels attained in 1990 (3.7 million tones). Fundamentally, under market economy conditions Kyrgyz coal mines are simply too small and lacking in requisite infrastructure to be competitive. Some discussion has taken place recently with international donors regarding funding the up-grading of transportation infrastructure to allow Kara Keche coal mines to supply about one million tones of coal to local power plants. It is unclear at this writing whether such a development would be technically or economically justified. 3.5 Status of Exploration and Proposed Projects 3.5.1 Exploration. A number of companies have showed an interest in exploration in Kyrgyz Republic since 1994. International companies such as Newmont, Teck, Normandy, Hemco, Oxus Resources, and Phelps Dodge have explored for various commodities in the country. In addition, Kumtor Operating Company has continued exploration in and around its mine site, including for underground reserves. At its peak in 1997, exploration expenditures by these and other companies totaled US$ 5 million. Due to the fall in international commodity prices (principally gold) and lack of interest on the part of international companies in minerals investments in former Soviet Union countries generally, the amount currently 32 spent by private companies, excepting Kumtor, in Kyrgyz Republic is US$0.5 million. This is clearly insufficient to discover new deposits or to further delineate known deposits. I 3.5.2 The government is not satisfied with this low level of exploration and with those companies, foreign and local, which hold under contract mineral resources without actively developing them. A government commission has been formed to examine whether or not some of these contracts should be rescinded. While the government's frustration is entirely understandable, external conditions such as, international commodity prices, overall views of investment in the former Soviet Union, perceptions of political instability and a number of other factors can presently make it difficult to raise funds in the international equity markets necessary for investment. All governments have an obligation to ensure that mineral title holders honor their contractual obligations to develop the resources in an efficient, timely and environmentally safe manner. However, mining rights and investment agreements should only be rescinded for clear violation of the specified terms and conditions of the contract, and then only after sufficient time has been allowed to the title holder to remedy the deficiency. Unilateral cancellation of contracts or forced renegotiation of its terms would be a very bad signal to the mining investment community and make it harder for Kyrgyz Republic to attract the new exploration investment it requires. 3.5.3 Dzherui Gold Deposit is located in northwestern Kyrgyz Republic at an elevation of 3600 meters, 67 kilometers southwest of the town of Talas and 230 kilometers west-southwest of Bishkek. The deposit is much smaller than Kumtor, but nevertheless could be a viable project based 'on current data. The deposit was discovered in 1969 and has been actively explored during the period 1975 to 1984 at a cost of US$12.4 million. Reserves both for the open pit and underground operations have been calculated by the State Agency for Geology and Mineral Resources on Geology: open pit reserves are 36 tonnes gold metal (at 1.5 gram/tonne cult-off ); underground reserve is 13.6 tonnes gold metal. In 1994 MK Gold, an USA mining ienterprise, explored and completed a pre-feasibility study on the deposit. Subsequently, Cameco also expressed an interest in the deposit but let its option expire. Noxus Resources, now owned by Oxus Resources (United Kingdom) 100%, set up the Talas Gold Company, a joint venture with Kyrgyzaltyn to study and develop the Dzherui deposit. Norox owns 66% of the Talas joint venture (Dzherui Mining Company), Kyrgyzaltyn 33%. The original feasibility study, based on an international gold price of US$ 300/ounce has been revised to account for the current price of US$ 270/ounce. This joint venture is currently negotiating a contract with the government to provide for certain taxation and other arrangements, 'which will permit the development of the deposit. Production is planned at around three metric tonnes of gold per year (100,000 ounces). Total production duration is scheduled for, 12 years, which includes an initial six years of open pit production with underground mining beginning in the fourth year and extending to the ninth year. Ore from stockpiles will be processed for the remainder of the project life. The total capital investment estimated as necessary to bring the mine into production is around US$118 million. 3.5.4 Taldy-Bulak Gold Deposit, which is estimated to contain reserves of 50 tonnes of gold metal, is under study by the Taldy Bulak Mining company. Previously, this company was a joint venture composed of the Kara Balta kombinat (52%) and Malaysian Mining Corporation (MMC) Berhad (48%). The Presidential decree of March, 2001 stipulates that all State interests 'in gold mining ventures should be transferred to Kyrgyzaltyn. It is, thus, 33 unclear whether Kara Balta kombinat will continue to be involved with this joint venture. It was recently announced that the European Bank for Reconstruction and Development is interested in studying the financing possibilities for this venture. However, the low price of gold will make profitable development a challenge. 3.5.5 Sary-Jas (Trudovoye tin-tungsten deposits). The Sary-Jas kombinat controls the tin and tungsten deposits at Trudovoye, located in east Kyrgyz Republic. The kombinat has had previous discussions with a Russian joint-venture partner to develop these deposits. However, the development scheme has encountered difficulties. As a result, the Presidential Decree of March, 2001 transfers ownership and management of the Sary-Jas kombinat to Kyrgyzaltyn. New feasibility studies are currently underway to determine how best to develop these deposits. 3.5.6 Other Deposits and Exploration Potential. The majority of other gold and copper- gold projects in Kyrgyz Republic are underground targets, narrow quartz-gold-sulfide veins which are too small in size to interest most foreign investors. These deposits include: Andash, Aktash, Choruz, Mirouov, Dolpran, Bozymchak, and Duru-Tegerek. However, even though the known deposits are neither large nor particularly high grade by world standards the potential for finding more attractive ore bodies is good. Some good potential may exist in areas and with respect to targets previously not considered prospective by the State Agency for Geology and Mineral Resources on Geology. The greenstone belts of northern Kyrgyz Republic are favorable for gold and gold-polymetallic deposits. The mercury-antimony mineralization in southwest and west Kyrgyz Republic, hosted by sedimentary rocks, is a prime location to search for Carlin-type disseminated gold deposits (named after the largest gold producing district in USA near Carlin, Nevada). Exploration activities should concentrate more on the discovery of bulk mine able deposits rather than narrow quartz/gold vein targets that require expensive underground mining. 34 4 The International Mining Industry and Foreign Investment 4.1 Attracting the Investor: What Do They Want? 4.1.1 Countries have become acutely aware over the past fifteen years of the necessity of attracting' international capital since the amounts of investment required to develop mineral deposits and the risks of failure are too large to be possible or justifiable from a public expenditure point of view. A survey of major international mining companies was conducted in 1991 under the auspices of the United Nations and the World Bank to determine the relative importance of certain criteria used by the companies to evaluate potential investment projects in emerging economies. In order of importance, these criteria are: 1. Good geological prospectivity and mining tradition and potential 2. Availability of infrastructure 3. Clear mining rights and title (mining legislation) 4. Attractive and competitive fiscal conditions (tax legislation) 5. Ownership and control of operations (mining legislation) 6. Political stability and transparency of governance (government institutions) 4.1.2 Experience internationally has demonstrated that if governments address these issues they can and do attract significant amounts of investment. Kyrgyz Republic has highly favorable geology and a mining tradition. The country also has reasonably good infrastructure to support mining activities, except in certain areas. However, concerning criteria 3 6 above, a significant reform program will be required to remedy the perceived deficiencies and to comply the expectations of potential investors. As explained previously in this Study,l the countries which have undertaken such a reform program have been successful in attracting new investment. For instance, Table 4-1 shows the shift in exploration expenditures which occurred between 1985 and 1999. It is noted that Latin America, a leader in the mining reform agenda, doubled its share of world exploration expenditures at the expense of traditional countries such as Canada, the USA and Australia. Table 4-1 Percentage Distribution of Exploration Expenditures 1985 - 1999 Country 1985 1999 Canada 26 11 Australia 24 19 USA 16 10 Latin America 13 29 Africa 12 15 4.1.3 Even though the total amount of exploration expenditures have fallen recently due to overall market, conditions, those countries that have undertaken effective reforms have still managed to retain significant investment while those countries in which the reforms were not as effective or undertaken seriously have lost investment. For instance, Argentina, Tanzania, and Mali - countries which are seriously undertaking reforms - continue to attract US$ 25- 35 100 million in new exploration annually. Prior to the 1990s, these countries had little or no international mining activity. 4.2 Conditions of the International Mining Industry 4.2.1 The international mining and metallurgical industry is one of the most complex industrial sectors in the world.7 Depending on the commodity, the production chain usually consists of extraction of the raw mineral commodity, beneficiation and concentration of ores, smelting and refining of product, marketing and brokerage of commodities, and fabrication into end-use products. The industry, at all stages of the production chain, but especially at the exploration, extraction and processing stage, is highly competitive and growing more so every year. Many international factors affect the decisions that companies make to invest in mining and metallurgy in emerging economies. The focus of this chapter is to explain these main international trends in general and Kyrgyz Republic in particular. For Kyrgyz Republic the over-riding issue is to attract new investment in exploration and project development, thus awareness of the international context in which private capital operates is essential. 4.2.2 First, there is significant diversity among international companies8 in terms of size, financial capacity, and strategic focus which affects the way they view investment opportunities in emerging economies. As a general proposition, these companies include: * very large international conglomerates which mine a diversified portfolio of commodities in many different countries (examples: Anglo American, Rio Tinto, Broken Hill Proprietary, Billiton); * very large international companies which focus on single commodities (examples: Newmont, Placer Dome and Barrick (gold), Alcan (aluminum), Inco (nickel), Cogema (uranium)); * state owned enterprises (such as Codelco Chile); * formerly state owned enterprises which have been totally or partially privatized in recent years (e.g. CVRD (Brazil), ZCCM (Zambia)); * medium sized intemational companies which focus on one or more commodities (Avmin (South Africa), Industrias Penoles (Mexico), Boliden (Sweden)); * local, privately owned medium sized mining companies (US$ 50+ million revenues/year) which focus on domestic operations, such as Buenaventura, Volcan, Minsur, Milpo (Peru) or Grupo Gordo, Lasinesa, Antofagasta (Chile); significantly, some of these groups are of sufficient size to have access to the intemational equity markets * junior companies which focus generally on adding value to exploration prospects * intemational companies for which mining exploration and production is not the core business but which nevertheless seek and invest in profitable opportunities in mining; 7 A major study of the international mining industry is under preparation by the Mining and Metals and Sustainable Development project funded by major mining companies due to be published in May, 2002. 8 UBS/Warburg Bank tracks over 60 ferrous, non-ferrous, and precious metals companies whose shares are quoted on international securities exchanges. This figure does not include companies active in the coal sector, numerous small "junior" companies, and privately held mining companies. 36 * smaller locally owned companies exploiting industrial and construction materials or, in some instances, deposits of non-ferrous or precious metals. 4.2.3 The second trend, and perhaps the most important, is the fierce competition among companies to raise equity riskfinance for projects in emerging economies. All companies, with the possible exception of the smaller locally owned companies, depend on access to a greater or lesser extent on the international equity, finance and risk capital markets centered principally in Canada, the United Kingdom, Australia, South Africa, and the United States. In the case of the medium and junior international companies, the equity funds raised on these markets are used principally for highly risky exploration and pre-development projects. Project finance is also raised in these financial markets for specific investment projects in emerging countries since even the largest of the mining companies will seek to off-set some of the financial and political risks involved. The financial markets as well as the performance of the companies having access to them, are highly sensitive to international commodity prices as well as competition from industrial, consumer goods, financial, and other sectors which compete for funds. For instance, the stock of global mining companies has been considerably less attractive to investors than other high technology stocks (Graph 5.1).9 This difficulty in raising equity on the financial markets has meant that companies have reduced expenditures on development projects. In 1996, international non-precious metals companies had around :US$ 30 billion capital expenditure on new project development; by 1999 this had fallen by 33 percent to around US$20 billion. This has meant that companies have become much more selective in the types of projects they will undertake and the countries in which they will undertake them. I 4.2.4 A third major trend, and directly related to the availability of risk capital, is the dramatic decrease in the funds companies spend on exploration. In the peak year of 1997, the companies surveyed by the Metals Economics Group (Canada) spent US$5.1 billion on precious and non-precious metals exploration worldwide. In 1999, these expenditures on exploration had fallen by 33 percent to about US$3 billion. The "junior" mining companies and the emerging economies have been particularly hard hit by this decline in exploration expenditures. During the mid-1990s, due to the liquidity in the equity markets, there was an explosion of activity among the juniors for exploration in the emerging economies, principally in Latin America but also Africa and Asia. Now, because of the decrease in risk capital, these companies have withdrawn from the emerging economies and are focusing their exploration efforts closer to existing mines or in their home countries. Also, some companies are concentrating on expansion of the enterprise via acquisition of other mining enterprises rather than investing in exploration. It has already been noted that investment in new exploration should be a priority for Kyrgyz Republic in order to develop new deposits. The scarcity of risk capital for exploration will make it even harder for Kyrgyz Republic to attract the exploration investment it needs. 9 Graph 5.1 shiows the performance of the Hong Kong Shanghai Banking Corporation (HSBC) global mining index relative to the performance over the same period of the NASDAQ index which is dominated by technology companies. 37 Figure 4-1 Performance Mining Equity Markets B Me.x Aye apoiHuoM macuwma6e: xaK 2opuoe deao 6utiumCA 6auKupaM International Context: How Bankers See Mining sboealoT nlH "XOPOWSe CAeRKH" B rOpHOM 6u3Hece OTHocuTenbHbl HYPOBOHbrn5 oGan bHorO rHAaKCa HSBC K MHAOKGcy Nasdaq 1200 RelatIv Performance HSBC Gobal M InIna Index va. Nasda Coa n 1000 800 600 w 400 200 0 OP l , .l. . | HSBC Global Mining Index -Nasdaq Composite Index. HCTO9HHK: SByM6epr Source: Bloomberg 4.2.5 A fourth major trend is consolidation, merger and acquisition taking place among the large and medium sized companies, such as the mergers of Grupo Mexico/Asarco (copper), Alcoa/Reynolds (aluminum), and Barrick/Sutton Resources (gold). The trend towards large companies means that these companies must find and develop very large deposits in order to meet the financial growth expectations of their shareholders and financial backers. The application of advanced technologies in exploration, extraction and processing of mineralsl has led to the relentless trend of the past 30 years to lower production costs and achieve economies of scale. These technologies are commonly available and known so it is unlikely that a single company could "corner" a mineral commodity through technology alone. It reinforces the industry's over-riding concern to find and develop "quality" or "world class" ore bodies - in terms of grade, tonnage, ease of extraction. The implication for Kyrgyz Republic is that some of the known deposits which the government may considered attractive for investment do not, in fact, meet the "quality" criteria that international companies require. An honest re-evaluation of these ore bodies according to internationally accepted reserve classification system would be a step in the right direction to determine whether particular ore bodies are attractive. Furthermore, opening up the. territory to further exploration using models and techniques which have led to world class discoveries in other countries could produce beneficial results. 10 For instance, advances in geology and the geo-sciences have made possible exploration of much larger areas of ground at reduced cost; advances in extraction technologies (larger haul trucks and mills, for instance) emphasize very large exploitation operations in order to achieve greater economies of scale and lower production cost; and instantaneous communications and computer technologies. 38 4.2.6 Fourth, increasing pressures for greater social and environmental consciousness. Companies are under increasing pressure from non governmental organizations and civil society in the countries where they operate to be more socially conscious and aware of the impacts their operations have on the national, regional and local economies. The industry in general has been heavily criticized, rightly or wrongly, for its past neglect of these issues. The industry is also more aware now than ever of the effects operations have on the physical environment and pollution of water, soils and air. Much progress has been made from a technical standpoint to apply cleaner production technologies. Yet, environmental considerations have an important effect on the decision making process companies go through to invest 'in mining projects. More recently, pressures on companies have increased regardingl the negative social impacts of mining, particularly on local communities. Companies are also attempting to do better in this respect, though there is often a wide divergence between the expectations of the local community in terms of support for social infrastructure and the economic realities of what the company can afford to spend. This is particularly relevant to Kyrgyz Republic where under the previous system mining and metallurgical kombinats accepted a wide range of social sphere responsibilities. In many cases, the kombinats have continued with these responsibilities even though they have been privatized. However, it will be difficult, though not impossible, to reconcile the expectations in terms social support of the local community or government with the expectations of private international companies. In other countries, the issue of providing social support for communities has been a point of serious disagreement between governments and private companies. I 4.2.7 Fini;ally, an interesting development in countries which have managed to attract new exploration is the emergence of private, localy owned mining companies. These types of companies were referenced in section 4.2.2 above. The growth of these small to medium sized local mining companies has been particularly evident in countries where the mining tradition is strong and which have reformed their mining laws and institutions, such as Peru and Chile. The key to success in these countries is rapid turn-over of data and the ease with which companies can obtain mining rights. International mining companies typically explore for very large mnineral deposits. During the process of exploring for these large deposits numerous smaller or medium sized deposits are discovered which do not meet the investment targets of the large company. The exploration rights to these smaller deposits are relinquished by the large company and, according to legal requirements, the exploration data is given to the national geological survey. The data is then made available at no cost to any interested party (among which could be private locally owned companies) who can then easily obtain exploration rights to the area. Given Kyrgyz Republic's strong mining tradition and technical expertise, there is good potential for the development of similar private local companies, subject to putting into place an enabling environment conducive to private sector investment in general, and significant reforms to the mining legal, institutional and taxation regimes in particular. 39 5 The Mining Law and Regulations 5.1 Since the original mining sector review was written in 1994, the Kyrgyz Republic has taken several significant steps to improve the legislation and regulations which apply to the mining industry. At the time the original review was written the operative legal framework was the Law on Sub-Soil Resources passed by the Supreme Soviet on 15 December 1992. In June, 1997, a new Law on Sub-Soil Resources entered into force; this law was amended in 1999, and a new set of amendments is currently under discussion. The 1997 Law is a significant improvement to bring the mining legislation and regulations into line with international best practices. It establishes a licensing mechanism whereby the State, as owner of mineral resources, confers upon legal and physical entities the rights to explore and exploit mineral resources. It specifies the functions of the State to issue licenses and to control and monitor such mine development. Thus, in terms of general intentions, the law resembles that in use in most countries. However, there remain in the law some provisions which provide for excessive government discretionary authority and control. In addition, the Law establishes a mechanism through which the State can tender/auction blocks of prospective minerals areas. While this practice is used in the oil and gas industry it is rarely successfully used in the mining industry. Some of these deficiencies are noted below. 5.2 Local community responsibilities. The sector review of 1994 determined that the powers and responsibilities granted to the regions and cities by the Law on Subsoil Resources (1992) should be more clearly delineated. The Law on Sub-Soil Resources (1997) clarifies some of the ambiguities by introducing some significant powers for the local governments, including powers to: issue surface land allotments to licensees; plan and implement territorial programs approved by the local Kenesh for mineral development and use; conduct environmental assessment of deposits of local importance only; exercise control over subsoil use during exploration and mining; and require protective measures when exploration or mining activities threaten lives, safety , the economy or the environment (Article 6). However, it is far from clear whether in practice the local authorities have the technical, financial and human capacity to adequately administer the environmental monitoring. In addition, the amendments of 1999 correctly introduce the concept of communal or private ownership for commonly occurring minerals (sand, gravel, construction materials) which are on the surface. However, provisions should be made, perhaps in other laws and regulations, to strengthen effective monitoring of the exploitation of these deposits, particularly from an environmental point of view. 5.3 Easy Access to Exploration Rights. The countries with the most success in attracting private investment into their mining sectors enable investors to obtain exploration rights quickly and easily, at low cost, through a transparent process. Under the Subsurface Law of 1997, however, the process whereby exploration rights for metallic minerals are made available is more time consuming, cumbersome, expensive and uncertain than in other countries. As noted in 2.3 above, most successful countries make exploration areas available on a non-competitive, first come - first served basis, founded on the principle that all areas are available unless they are taken or designated by law as off limits. An open title registry and mining cadastre enable all prospective investors to easily find out what areas are available and to show who owns what rights to any given area. Other key elements to ensure investment in exploration include: (i) rapid relinquishment of their uneconomical state 40 holdings;; (ii) promotion of investment opportunities by making geological information generally available; (iii) reducing the time and cost of acquiring mineral rights, and (iv) providing greater security of tenure for those rights. 5.4 Security of tenure. The review of 1994 determined that the right of an exploration license holder to exploit a mineral deposit in the event of discovery was not sufficiently clear in the Law of 1992. Articles 9 - 13 of the 1997 Law are an improvement but still somewhat unclear in; providing security of tenure to the investor. Customary international practice in mining codes is to provide automatic and transparent procedures to grant an exploitation license to the natural or juridical person having explored a mineral deposit, subject to the filing of a; mine and environmental protection plan. In international usage, the concept of security of tenure also includes: * clarity as to the nature and strength of available exploration and mining rights (i.e., whether they constitute property rights protected by the fundamental law of the jurisdiction, and whether those rights can be pledged or mortgaged); * exclusivity of the exploration or mining rights with respect to minerals and territory; * clear, objective requirements for the maintenance of exploration and mining rights; * appropriate term lengths (flexible for exploration and relatively long for mining); and * clear, objective criteria and procedures for the cancellation of established rights, subject to appeals to an independent adjudicator. 5.5 The Law of 1997 provides that a license for other minerals may be issued to "over- lay" an existing license (Article 10, paragraph 4). This has proved unworkable in practice in other countries and will only lead to disputes between license holders. Generally, as a matter of international best practice, exploration licenses are for all mineral substances in the surface area covered by the license. Even though the principle of exclusivity is announced in the 1997 Law, how does this work in practice? Also, is approval of the feasibility study required in order to issue the exploitation license? If so, where is this clearly stated in the Law? 5.6 Article 18 of the Law of 1997 provides that a license may be cancelled for a number of reasons. Is there a procedure to give the license holder a certain period of time in which to remedy a deficiency? And, is cancellation the only sanction available to the government or may other, lesser penalties be envisaged, such as fines? Finally, governments everywhere have an obligation to ensure that the land is worked and explored, not simply held for speculative purposes. Many of these governments use a system of escalating surface rents: the charges and fees per hectare or square kilometer of surface area of the license increase annually oyer the duration of the license. Thus, the title holder has an economic incentive to work the land or relinquish the permit. 5.7 Duration validity. In the 1992 Law the maximum duration and surface area of an exploration or exploitation permit is negotiated on a case by case basis. General international practice is 'to stipulate in the law the duration and maximum license size. Article 10 of the 41 1997 Law clarifies this question somewhat by specifying an initial exploration license period of 2 years. with automatic renewals (assuming compliance with obligations) for a total period of 10 years. This is somewhat longer than the international standard (6-8 years) but not unreasonable. However, the Law does not provide guidelines as to minimum exploration expenditures per square kilometer or hectare. These elements are generally specified in international legislation. The total term of 20 years for the exploitation license (article 11) is somewhat low by international standards (25-50 years are common for exploitation licenses). Are renewals of exploitation licenses automatic? 5.8 Use of mining title as pledge or collateral. Article 13 of the Law of Subsoil Use of 1997 provides for the use of the mining license as a pledge or collateral. This article was amended in 1999 to link the provision for transfer and collateral of the mining title to the national law "On Collateral" and other normative acts. However, under what circumstances may the State Agency for Geology and Mineral Resources refuse to authorize the transfer of title?. Is prior approval by the competent authority required for other transfers of subsurface utilization rights? The international trend has been in the direction of facilitating transfers of mining rights. Such transfers are particularly important during exploration. Most properties change hands several times before a discovery is made or developed. Extensive prior governmental review of the capabilities of transferees is usually a time-consuming process that adds nothing in the way of assurance that the transferee will be a more successful developer than the initial right-holder. Transferability of mining title should conform to the provisions governing pledges - i.e., eliminate the requirement of prior review and impose a limited check on the eligibility of the transferee at the time of registration of the transfer. 5.9 Reserve evaluation and enforcement mechanisms. The Sub Surface Law of 1992 provided that the State Agency for Geology and Mineral Resources would have extensive powers to supervise the use of the deposit by the company and its compliance with investment comrmitments. The sector review of 1994 pointed out that this could lead to endless debates between the State Agency and potential investors, excessive discretionary authority, and abusive behavior on the part of the Agency. The 1997 Sub Surface Law is an improvement, though the potential for substantial disagreement over reserves still exists. For instance, articles 33 and 35 of the 1997 Law provide for state expertise of mineral stocks before exploitation. Does this imply a warranty from the State to the investor that reserves actually exist? And, if so, is the government obligated to indemnify the investor in the event the reserves do not exist? Additionally, Article 45 of the Law of 1997 requires that the investor reimburse to the State the value of economic minerals not exploited. This is unrealistic. A better way of approaching this problem would be to insert into the license a clause to the effect that any variation +/- 20% in the original feasibility study would be subject to mutual discussions between the government and the company. 5.10 Requirements for optimal use of resources. The Law of Subsoil Resources of 1992 required complete extraction of the principal as well as associated minerals, reliable accounting of extracted and non-extracted substances, and prevention of wasteful or harmful extraction practices. Additionally, the Law of 1992 granted State bodies the right to determine mineral resources production, provision of raw materials, establishment of mineral delivery quotas, payment norms, and standards for geology investigation and rational use of the resource. The 1994 mining sector review criticized these provisions, especially those 42 concerning'production decisions, as reflecting the previous command and control philosophy. Articles 271 and 44 of the Law of 1997, as amended in 1999, would appear to soften these provisions somewhat but still provides for excessive government discretionary authority over the way in which an investor can utilize a mineral deposit. The government has a justifiable obligation to ensure that mineral resources are used in a manner consistent with economic and rational principles. However, as noted previously, there are significant differences in the way reserves are evaluated in Kyrgyz Republic compared with international practice. Also, there is a misconception regarding the feasibility study prepared by the company before mining. Companies' will not be able to commit or "promise" complete extraction of the minerals because prices and costs of production vary by year. These prices and costs are used to calculate cut-off grades and extraction rates for the minerals, thus determining how much of the mineral 'is actually extracted. The feasibility study cannot and should not be viewed as the "master" plan that cannot be changed. Rather, it is the best estimate of the company during the planning stage of exploitation operations which should be changed during the course of exploitation if market or technical factors so dictate. 5.11 Control of exploration data. The 1992 Sub Surface Use Law specified that all geological information is property of the Republic and all information obtained regardless of the source: of financing must be made available to the State under conditions of confidentiality. License holders which finance exploration may exercise a primary right to obtain the geological information gathered by them. The 1994 mining sector review strongly criticized this provision. International practice is for the information gathered through exploration funded by private companies to remain the property of the company for the duration of the exploration license. Once the exploration license is relinquished the data is turned overi to the State. The Law of 1997, as amended in 1999 (Article 32) adopts the international practice. However, it is important to note that the State Agency for Geology and Mineral Resources should specify a standardized format, type and extent of information to be supplied. This information should be integrated into the overall geology database for the country and made available a nominal cost to any potential applicant for a mining license. The information should not be sold or "tendered". l 5.12 Mine closure. The 1992 Law on Subsoil Use was silent on the responsibility of the operators to make provisions for orderly shut down and rehabilitation of mined out areas. This deficiency has been partially remedied in article 30 of the Law on Subsoil Use of 1997, as amended in 1999, which includes provisions obligating the mining operator to close the mine in an orderly manner. However, article 30 needs to be complimented by more detailed regulations which specify the exact responsibilities of the operator and the State bodies with respect to closure. Also, recent mining legislation in some countries requires operators to set aside funds, 'in some cases "guaranteed" by a performance bond, during operations for the purpose of environmental clean-up, rehabilitation of mined out areas, and protection of community benefits. It is noted that such a provision is included in the pending proposed amendments to the 1997 Law on Subsoils. 5.13 Tendering procedures and valuation of mineral deposits. The 1992 Law on Sub-Soil Use contained detailed auctioning and tendering procedures for mineral properties. Article 16 of, the Law of 1997 contains similar provisions. These are completely unrealistic and unworkable in practice. Experience in other countries is that the auctioning and tendering 43 of mineral properties has not been successful. Such a practice confuses the role of the State as a "regulatoi" (to administer the legislation on subsoil resources) with the presumed State role as a "holding company" (to evaluate and sell mineral assets). The "holding company" role is based on the erroneous assumption that auctioning procedures commonly used in the oil and gas industry can be adapted to the mining industry. As discussed in section 2.3 above, this is not the case - because of fundamental economic reasons as well as practical considerations. Because of these factors, international mining companies are not interested in bidding for the rights to acquire and/or develop mineralized areas, except in those rare cases when there is an opportunity to acquire a known, particularly high grade deposit with low production costs. The pending, proposed amendment to the 1997 Law on Subsoils (as described in section 5.18.18) would limit the tender procedure to only those known deposits that are of overall importance to the Government. Rights to explore for and develop most deposits would be granted by direct negotiation. This would be a step in the right direction; however, even a direct negotiation process has shortcomings as opposed to a standard licensing system based on objective criteria and administered according to transparent procedures. 5.14 From a practical standpoint, the experience of tendering mineral properties in Kyrgyz Republic has illuminated a number of additional problems., First international investors are reluctant to accept government valuations of reserves which are not based on intemational standards. As explained previously, Kyrgyz reserve valuations do not take into account technical, commercial, market and other risk factors which are standard practice in the international mining industry. Second, investors will not accept the government's information at face value; they will require time to confirm the validity of the data and to produce their own estimates of the mineral reserves, based on international rather than Kyrgyz technical parameters. Third, while the government should quite rightly negotiate to recover a portion of its exploration expenses, the investor will likely discount the value of what is regarded as excessive exploration work. Finally, the procedures for tendering and evaluation of the bids as stated in Article 16 of the 1997 Law are vague and unclear. Exact criteria for selection of proposals must be clear and made known to potential bidders in advance of the tender; the bids should be opened in public to ensure fairness and transparency. 5.15 Marketing of mineral products. Article 22 of the 1997 Law, as amended, provides for preferential acquisition by the government of precious and other minerals. This is somewhat of an improvement from the situation in 1994 when the Presidential Decree of 30 June 1993 required that all gold be sold to the central bank through Kyrgyzaltyn at world market prices. The 1994 mining sector review stated that this would be clearly unacceptable to investors. It is unclear whether the Presidential Decree is still in force or if it has been rescinded. In any event, even the more liberal marketing arrangements of the 1997 Law will likely pose significant problems as investors, lenders, and other project sponsors require freedom to market their products and to dispose of the sales proceeds. For instance, Article 22 does not specify that international market prices and conditions of sale and payment will be used in the event the government desires to purchase mineral production. Additionally, many companies enter into long term sales contracts or sell their production forward on the international markets. Interference in their ability to meet their market obligations will be viewed as a significant disincentive. 44 5.16 An issue related to marketing of the minerals is the use of an off-shore escrow account. Sales proceeds are directly deposited to a bank account in an intermediary financial institution outside of Kyrgyz Republic. The amounts required to service debt, pay suppliers and vendors, and satisfy other foreign currency obligations of the venture are disbursed from this account. Typically, such an off-shore account is a condition of project finance; international banks will not finance projects if the entirety of the sales proceeds are held in the country, notwithstanding the guarantees of the government in respect of repatriation of profits and foreign lcurrency. 5.17 Dispute resolution. The provisions of Article 43 of the Law on Subsoil Resources of 1997, as amended, which require that questions of subsoil use be resolved as prescribed by the legislation of the Kyrgyz Republic, will be unattractive and probably unacceptable for international investors unless a Kyrgyz law or treaty on arbitration or foreign investment enables them to resort to a neutral, international arbitral forum for the resolution of major disputes. Typically, investors require that international arbitration be available under the rules of, for instance, the International Center for the Settlement of Investment Disputes (ICSID) in Washington, D.C., or the International Chamber of Commerce in Paris, France. Sometimes, mining legislation will distinguish between: 1) "technical" disputes which can be submitted to a jury of experts chosen by both parties agreements; and 2) "investment" disputes which will require a hearing under complete arbitration procedures. It is important for governments and companies alike to be aware of the "reputational" risks associated with international litigation and the non-respect of contractual obligations. 5.18 New Legislative Proposals 5.18.1 Proposed Law on Production Sharing. A proposed law currently before the Jogorku Kenfesh would make certain sites available for development and mining on the basis of negotiated production sharing agreements (PSAs) only. The stated purpose of the proposed law is to promote the development and exploitation of economically marginal mineral deposits by providing tax exemptions in exchange for a majority share of 'profit' production after the compensation for the depreciation of capital investment and operating costs. The law would create a special legal and fiscal regime for the eligible projects that would be comprehensive and supersede any other legal provisions. 5.18.2 The production sharing regime would be applied selectively. Under the proposed law, the Government would select the sites that would be eligible for PSAs on the basis of the following criteria: * known deposits not exploitable profitably under the standard tax regime but where there is a significant economic development impact in opening the mine or keeping it open, * major deposits with respect to which there has been a settlement with miners, and as to which the discontinuance of mining could have negative social consequences; * remote areas where infrastructure is needed and could be provided by mining operations; 45 * deposits that are technically difficult to exploit; * old mine sites where lower grade ore has not been recovered; * sites. within national nature parks requiring special environmental compliance; * sites in regions in need of employment opportunities. 5.18.3 PSAs would not be available for projects that are subject to existing agreements. It would appear from the above criteria that virtually any potential mining site in the Kyrgyz Republic would qualify for the PSA regime. The provisions on selection of sites for eligibility therefore appear to have more to do with a certain ambivalence about offering tax concessions than with the nature of particular potential mining sites. 5.18.4 The sites eligible for PSAs would be offered under a tender procedure, except sites that involve national security or strategic interests, which would be subject to direct negotiations. We understand that competing bids for a site would be evaluated based on the financial resources and the relevant experience of the bidders. Participation of a Kyrgyz entity in the bid is required. We understand that the production shares of the parties would not be a subject of the bidding process, but would be determined subsequently by negotiation. Thus the tender process would be a pre-qualification procedure rather than an actual competitive bidding procedure' The essential terms of the PSA would be subject to negotiation. They would not be determined as the outcome of the tender process. 5.18.5 Royalty rates would not be a subject of the tender process either. Ad valorem royalty rates would be set by the Government either before or after the tender within a range of 0-3% of net smelter return (sales value less transportation costs). These limits are consistent with international practice, although 3 % would be high for marginal projects. 5.18.6 The proposed law requires the PSA to be negotiated and concluded within six months after the selection of the most qualified investor. The mining license would be issued upon signature of the PSA. The selected investor would have to conclude its feasibility study of the project within the six month window. That requirement assumes optimal conditions and is not realistic. Even if the quality of the data provided by the Government is very good, a company will have to conduct its own confirmation drilling in order to be able to obtain financing for the project. If the project requires the construction of infrastructure, alternative types and routes will need to be designed, cost-estimated and evaluated. An environmental assessment and consultations with local communities will be necessary so that environmental impact mitigation, site reclamation, social enhancement and sustainability issues are adequately evaluated and planned for. Their cost to the project must be taken into account in the feasibility study. Given the mountainous terrain of the Kyrgyz territory and its lack of infrastructure, completing these tasks will take longer than in less challenging environments. Six months would be close to the minimum time frame for the completion of a feasibility study under optimal conditions. The proposed law would impose that time frame as a maximum in all cases; and that is entirely unrealistic and unworkable. 46 5.18.7 The law specifies a number of the terms and conditions of the PSA that are not negotiable, including various provisions favoring the use of Kyrgyz goods, equipment, services and labor. It also provides for a steering committee to have management responsibilities over the project as agreed to by negotiation. Although these provisions are understandable, they restrict the freedom of operation of the mining company. They would likely deter some companies out of a small pool of potential investors from bidding, and therefore contradict the underlying policy goal of promoting investment in marginal projects. 5.18.8 The principal PSA terms that are subject to negotiation are the amount of production payable as compensation to the operating company and the respective shares of the investor and the state in the profit production (the amount of profit after subtraction of land fees, royalties and the compensation amount of production). Thus, the investor who prevails in a tender cannot know the profitability of the project until it has concluded the negotiation of the PSA. In our experience, investors will not be interested in tendering for the exclusive right to negotiate a PSA unless: * clear rules for the calculation of the compensation production are specified in the law so that they are assured of recovering all of their investment and operating costs; and * the law establishes a minimum share of the profit production that they will receive, and the minimum is high enough to assure profitability of the project to them. 5.18.9 The compensation for all the costs, operating and capital, incurred by the company, will be a percentage of production. This percentage will be established on the basis of the feasibility study. The investor may not be comfortable with this methodology because it leaves the geological and technical risk with him. There will be a provision in the PSA that the percentage of production dedicated to compensation may be reviewed if it is established that there is a 20% change in the amount of costs incurred in the mining operation. This provision has' two disadvantages: firstly 20% is too high a differential. If an investor faces - for example - a 12% increase in operating costs, he will need to be compensated, otherwise this increase in cost will be entirely borne by him and will represent a significant cut in his profit. This mnay be more than sufficient for the investor to decide to close the operation. The second disadvantage of this provision is that it requires a negotiation between the investor. and the tax authorities on the amount of the operating costs. This does nothing to improve the predictability of the tax regime to be applied on a project in Kyrgyz Republic and will be frowned upon by the investor. 5.18.10 Under the proposed law on production sharing, the State would offer prospective investors the opportunity to share their profit production with the State in exchange for exemption from all taxes and duties except: (a) royalties, (b) land tax and (c) subsurface use fees. Investors would be exempted from all taxes on gross revenues, all sales taxes, all value-added taxes, all customs duties for imports and exports, from profits taxes, and from all other non-enumerated taxes. This is supposed to be the big attraction of the PSA for investors., The VAT exemption would also be provided to subcontractors of the mining license holder. In addition, the PSA would allow license holders to maintain their accounts in foreign currenfcy and manage their revenues in offshore accounts exclusively for project purposes. The PSA would constitute a comprehensive investment agreement, containing 47 provisions on transfers of rights, stability and other guarantees by the Government, and dispute resolution. 5.18.11 The proposed law on production sharing agreements in the mining sector is an innovation that has not been attempted previously in the mining sector, to the best of our knowledge. However, it contains contradictory policies. On the one hand, it is intended to promote the development of marginal deposits by offering tax breaks in exchange for a share of profit production. On the other hand, it requires investors to undertake the expense of a feasibility study before establishing what production split they can obtain on their project. The best qualified investors are extremely unlikely to undertake the expense of a feasibility study without knowing in advance the terms on which they will have the right to exploit a deposit. The possibility to pre-determine tax obligations or PSA obligations is essential to any prospective investor. 5.18.12 If the investors' share of profit production is not high enough, the projects may be insufficiently profitable even with the tax exemptions. As a matter of international practice, virtually all countries outside of the transition economy countries establish clear rules on taxation and other economic issues that enable investors to pre-determine the feasibility of their projects without having to negotiate terms with the granting agency. This guarantees transparency and knowledge of the applicable rules. Because the proposed PSA law leaves essential terms to be negotiated, it does not provide a competitive advantage that would attract investment into the targeted projects. 5.18.13 In order for the proposed PSA regime to be competitive and attract investment, the Kyrgyz Republic should consider one of two options. Either: * set all the terms of a special reduced tax, customs and royalty regime for the marginal sites and put them up for tender to the bidder who offers the best development proposal and the highest bonus, if any; or * set the special reduced tax and customs provisions in the law and determine the others (e.g., royalty and bonus) by competitive bidding. 5.18.14 In both cases, there would be no need for a PSA, but rather just a standard form of agreement stating the terms that apply. Negotiation would be used, if at all, only to clarify terms. The first option would be preferred because it enables the Government to set all terms. The second option would offer investors the possibly more attractive opportunity to obtain the royalty and bonus provisions that suit them. 5.18.15 A negotiated PSA might be attractive to investors if, but only if, it is an option that they may elect in order to continue an existing project that they would not otherwise continue to operate under existing fiscal and customs terms. This would be an option available in addition to an internationally competitive general mining taxation regime available in the law. 5.18.16 Some of the fiscal provisions of the proposed law on production sharing are unnecessarily prejudicial to the State. For example, there is generally no good reason to 48 exempt any investor from income taxes at an internationally reasonable rate of around 30%. Income taxes paid to the Kyrgyz Republic can generally be credited against an investor's income tax liability in its home country. VAT exemption on imports and purchases is reasonable las long as it is limited to inputs for products that are exported and for which VAT cannot be icollected. Reduction of customs duties during development and construction promotes investment, but it should be limited to goods that cannot be procured locally and the duties should not be zero. Some low level customs revenue should be generated for all imports except those intended for re-export. A higher but internationally competitive customs duty should be maintained during production. 5.18.17 In conclusion, the proposed law on production sharing is unlikely to achieve its objectives if adopted. The Government could better achieve those objectives by making its tax regime' more internationally competitive generally and offering special tax advantages specified in advance for the targeted marginal sites. 5.18.18 Proposed Amendment to the Law on Subsoils. A proposed amendment to the 1997 Law on Subsoils is currently pending before the Government. The primary purpose of the amendment is to authorize licensing by direct negotiations without tenders in most cases, subject to strict time frames for review of applications. The proposed amendment would also introduce a requirement that licensees must provide financial guarantees for environmental rehabilitation, the details of which would be specified in a subsequent decree. The proposed amendment has the further objective of clarifying various provisions of the 1997 Law on Subsoils. l 5.18.19 a The proposed amendment would improve the Law on Subsoils. However, it does not address the several shortcomings of the law discussed above. It would not provide clear, objective terms for the grant or cancellation of exploration and exploitation rights and would not make the 1997 Law competitive with the laws of other countries that are the most successful in attracting investment into their mining sectors. 49 Table 5-1 Summary of Previous versus Current Mining Legislation a =Topic_ _ I 12 Law 1997 Law asamended Local Community and Powers and responsibilities of Significant improvement, Government local governments were not especially 1999 amendments; responsibilities defined and vague however, could have problems of capacity for local governments Security of Tenure Right of investor to progress Somewhat improved. But still from exploration to problems with,approval of exploitation not clear and not feasibility study and cancellation ' , gqaranteed ~~~~~~~~of license procedures. License duration and Negotiated on a case by case Somewhat improved. For the validity basis length of time determined in the feasibility and/or 2-10 years for an exploration license; 20 years for exploitation. license is too short. Use of mining title as Silent on this possibility ' Somewhat improved. 1997 law pledge; transferability of I and amendments provide for title transferability of title and pledging as collateral as per __________________________ - 4 Cnormative law "On Collateral" Enforcement Extensive powers of No significant improvement. mechanisms government to "supervise" The 1997 still provides for every aspect of exploration excessive government and exploitation; excessive interference in decisions of the government discretionary private company. authority Reserves definition Old "Soviet" system of No significant improvement. calculating reserves; Definition of reserves is still incompatible with incompatible with international international standards standards; should adopt United ,,_________________________________._________ Na,tions Classification System. Optimal and rational use Very strong control of Somewhat improved. The 1997 of resources government agencies over 'law softens some of the onerous reserve evaluation and use; provisions of the previous law. production and other decisions Still, problems of international versus Kyrgyz methods of reserve evaluation. 50 L _ IoPiC, XL 1992Law 7 7 1997 Law as amended 1 Control of exploration Investor basically funded Significant improvement. The data acquisition of data for the 1997 law recognizes reality: an account of the state investor should possess data gathered during exploration; the information is turned over to the State when the license is relinquished. Mine closure Silent on this topic Somewhat improved. The 1997-1 law includes some articles on mine closure but these need to be complemented and completed in __ _ 1L ___ ___ additonal regulations. Tendering of mineral Provides almost exclusively Somewhat improved. Though, properties for the tendering of mineral the 1997 Law still provides for properties. tendering of mineral properties. This practice has proven unsuccessful internationally. (Marketing of gold Presidential decree requires [Significant improvement. No sale of gold to the Central requirement to sell gold or II Bank through Kyrgyzaltyn mineal products to the State; however, State is granted preferential right of acquisition; need to specify acquisition price _______________- sued 1- Inicte I 2Infrr SMd lningmnea (3)mieal iiari T.4 2 =potentially economic 7? o ndetenmnene Explored Prspectve C~~~~~~~~~~~~~~ Geolo lcal 1- 2cMeasun eree 2l eloaa Inerredi ~~ abc1inra c32l I2 Lra W4Mcm * r5~~~~~~~~~~rsuc rsLc Source United Natons Economic and Social Council The international Classific ation of Mineral Recsotrces 106 g ] > S I 804 IC) I (Imply a ~~~_0 V Bb ~~~~~ ~ ~ ~ 7I DISCOVERMSl Inrasn Asspurance of ExiteneipaalmI ~~~ ~~~~ I2A I 3A I 4A EXISTENCEl..d CLASSES y m-d RESERVES~ ~ ~~~~~. (a da, a -ie,dmndeoi- rnou S..W.. RSOURCS RESERVES + all otbr numbOd mm RESOURCE BASE = RESOURCES + ilaflnite ama beyond tp of diagrm Source: United Nations Economic and Social Council. The International Classificadon of Mineral Resources. 107 ANNEX F List of Persons Met Roundtable Participants 1. Mr. E. Omuraliev, Vice Prime Minister, Minister of External Trade and Industry of the Kyrgyz Republic 2. Mr. U. Isaev, Chairman, State Committee on Foreign Investment and Economic Development 3. Mr. S. Murzagaziev, Director, State Agency on Geology and Mineral Resources under the Government of the Kyrgyz Republic 4. Mr. S. Sarbanov, Deputy Minister of External Trade and Industry of the Kyrgyz Republic 5. Mr. A. Makarov, Deputy Chairman, State Property Fund of the Kyrgyz Republic 6. Mr. S. Sheraliev, Deputy Chairman, State Committee on Foreign Investment and Economic Development 7. K. Ukulov, Deputy Head, Economic Policy Department, Office of the President of the Kyrgyz Republic 8. Mr. M. Ismailov, First Deputy Director, State Tax Inspectorate 9. Mr. B. Jumadylov, Head, Finance Department, Office of the Prime minister of the Kyrgyz Republic 10. Ms. D. Uturova, Head, Investment and Stock Market Development Unit, Economic Analysis and Prognosis Department, Prim Minister's Office 11. Mr. K. Kudaibergenov, President, Kyrgyzaltyn 12. Mr. Iqbal Zali, Resident Representative, IMF 13. Mr. C. Andrews, Principal Principle Mining Specialist, World Bank Group 14. Mr. Koh Naito, Mining sector Specialist, the World Bank Group 15. Dr. Allen Clark, Mineral Economist East West Center, the World Bank Group 16. Mr. I. Artemiev, Sr. Private Sector Development Specialist, the World Bank Group 17. Mr. R. Hakett, Sr. Advisor on Budget, Head of the Group, Barentz Group/USAID 18. Mr. T. Rodgers, President, Kumtor Operating Company 19. Mr. P. Wilkins, President, Norox Mining Company 20. Mr. V. Bagrov, General Manager, HEMCO Kyrgyzstan Corporation 21. Mr. B. Sinbetfl, General Director, Golden &Silver 22. Ms. G. Alybaeva, the World Bank Group 23. Mr. A. Kasymaliev, Head, Tax Policy Department, Ministry of Finance 24. Mr. K. Nadyrbekov, Head, Department on International Tax Relations, Ministry of Finance 25. Mr. I. Gorodnyanskiy, Deputy Head, State Inspectorate on Mineral Resources under the State Agency on Mineral Resources under the Government of the Kyrgyz Republic 26. Mr. Satkeev, acting Head, Investments Promotion Department, State Committee on Foreign Investment and Economic Development 27. Mr. A. Usubakunov, Head of Investment Projects Department, State Committee on Foreign Investment and Economic Development 28. Mr. A. Konukhov, Head of Geology Department, State Agency on Geology and Mineral Resources under the Government of the Kyrgyz Republic 29. Mr. K. Nuruzbaev, Ministry of Environmental Protection of the Kyrgyz Republic 30. Ms. J. Bekkulova, Ministry of Environmental Protection of the Kyrgyz Republic 31. Mr. N. Kozhomatov, General Director, Kara-Balta Mining 108 Additional Persons Met Mr. Nikolai Tanaev, First Vice Prime Minister Mr. Kourmanbeck Oukoulov, Economic Policy Department, Office of the President Ms. Jyldyz Ch. Mambetova, Economic Policy Department, Office of the President Mr. Anarkan Dzhamankulov, Prime Minister's Office Mr. Karybek Ibrayev, Expert, Prime Minister's Office Mr.: Urkaly Isaev, Chairman-Minister, State Committee on Foreign Investment Mr.! Alambek Usubakunov, Division Head, State Committee on Foreign Investment Mr.- Aidar Mokenov, Economist, Office of the President Mr., Azimbek Djoloshev, Energy and Mining Department, Prime Minister's Office Mr. Kubat A. Kanimetov, Deputy Minister, Ministry of Finance Mr.' Adylbek Kasmaliev, Tax Department, Ministry of Finance Mr. Kazybek Nadyrbekov, International Tax Relations, Ministry of Finance Mr. Almaz Kadyrkulov, Financial Department, Prime Minister's Office Mr. Tynybek M. Alykulov, Minister for Environment Protection Mr. Dilekbai Kyshtobaev, First Deputy Minister, Ministry of Ecology Mr. 'Djyparkul Bekkulove, Ecology Monitoring Division, Ministry of Ecology Mr. 'Sovetbek Sarbanov, Acting First Deputy Minister, Ministry of Industry Mr. iDjandulat Baijumanov, Deputy Chairman, National Statistical Committee Mr. 'Gani Abdrasilov, Economic Policy Department, State Comnmission for Enterprise Mr. Kamchibek Kudaibergenov, President, Kyrgyzaltyn Mr. Dilger S. Japarov, Manager of the Board, Kyrgyzaltyn Mr. Georgi Glukhov, Foreign Economic Relations, Kyrgyzaltyn Ms. Elena Evseeva, Environmental Specialist, Kyrgyzaltyn Mr. Sheyshenaly M. Murzagasiev, Director, State Agency on Geology Mr. Alexander G. Kuniukhov, Chief, Geology Department, State Agency on Geology Mr. Kadyrbek Kakitaev, Chief, Inspector on Subsoil Use, State Agency on Geology Mr. Tursun Turdumambetov, First Deputy Chairman, State Property Fund Mr. Salmorbek Asipov, Head, Department of Privatization, State Property Fund Ms. Lyudmila Lyakhova, Expert, State Property Fund Mr. Ekambek Sartov, Expert, State Property Fund Mr. Nikolai Dronov, Academy of Sciences, Kyrgyz Republic Mr. Robin M. Merrifield, Vice President, Finance, Kumtor Mr. Igor A. Kovarsky, Director, Government Relations, Kumtor Mr. Graham Sim, Chief Financial Accountant, Kumtor Mr. Barrie W. Oakes, Chief Geologist, Oxus Resources Corporation Mr. Oleg E. Kazakov, Business Development Manager, Talas Gold Mining C6mpany Mr. Kenesh B. Raimbekov, Deputy General Director, Talas Gold Mining Company Mr. Ken Arne, Norox Mining Company Mr. Valeri Minakov, AEUJA Company Mr. Jim Egan, Kyrgyz Investment and Credit Bank Various community representatives, Community Business Forum 109 ANNEX G Applicable Taxation Regime in Kyrgyz Republic (information from Tax Inspectorate) Comparative Tax Table Tax Rate Or Percentage Basis For Calculation Prospecting stage X X - land or property tax No No to central government to local government - taxes to Government for No No land use - bonus payment No No - fees collected at - for search of mineral Fees for issuance of a application for license or resources deposits - 20 license for specified types contract minimum wages; of activities are paid in - for prospecting mineral accordance with Article 13 resources deposits - 30 of the KR Law "On non- minimum wages; tax payments" (as of April - for operation of mineral 14, 1994) resources deposits - 50 minimum wages; - for the right to use Fees for issuance of a subsurface resources; license for the right to 1. legal entities - 10 times use subsurface resources minimum wages; are paid in accordance 2. individuals, which do with Article 16 of the KR not constitute a legal entity Law "On Licensing". - -5 times minimum wages. - bonus for commercial No No discovery Subscription bonus No No (Article 96) - remuneration for the No No right to have an access to geological information . - reimbursement of No No historical costs - customs taxes at No No prospecting stage - - VAT payment at 20% of taxable supplies In accordance with the KR prospecting stage Tax Code - Social insurance The tariffs for social Income tax and mandatory deductions and income tax insurance contributions are social insurance set: contributions are collected 110 Comparative Tax Table Tax Rate Or Percentage Basis For Calculation - for employers - in accordance with the Tax companies and Code of the Kyrgyz organizations, Republic and Law on irrespective of their "State Social Insurance". organizational, legal and ownership status, every months - in amount of 31 % from all types of payments made to employees for working individuals - every months - in amount of 7 % from all types of payments made to employees, irrespective of source of funding Taxable income at source of payment for an individual shall be taxed with the income tax utilizing the following rate: an income up to 5 times the minimum annual wage - 5% of the income amount; an income from 5 times up to 20 times of the minimum annual wage - the tax to be paid from 5 times minimum annual wage plus 10% of the amount which exceeds it; an income from 20 times up to 100 times of the minimum annual wage - the tax to be paid from 20 times minimum annual wage plus 20% of the amount which exceeds it; 4) an income over 100 times of the minimum Comparative Tax Table Tax Rate Or Percentage Basis For Calculation annual wage - the tax to be paid from 100 times minimum annual wage plus 33% of the amount which exceeds it. - fixed asset tax No No - tax to be paid at No No assignment of stock - other taxes No No Development stage X X land or property tax to central government No No to local government - taxes to Government for No No land use - customs taxes within the No No period of development - what could be attributed to expenditures: interest payments Expenditures related with In accordance with the non-core activities like Regulations "On ones on payment of procedure of determining interest on debentures, expenditures related with losses from selling and generation of income, retirement of fixed assets, which are deductible when and revaluation of book determining a taxable value of fixed assets down profit" approved by the to replacement value level, Ministry of Finance and losses from sale of Instruction #120-P as of securities are not Apr. 18, 2000. accounted as expenditures incurred in relation with generation of income. Deductions to be with regard of these expenditures are regulated with Articles 95, 97 and 102 of the Tax Code of the Kyrgyz Republic, respectively. costs related with Shall be attributed to the In accordance with the processing and mining expenditures in accordance Regulations "On 112 Comparative Tax Table Tax Rate Or Percentage Basis For Calculation with the Regulations "On procedure of determining procedure of determining expenditures related with expenditures related with generation of income, generation of income, which are deductible when which are deductible when determining a taxable determining a taxable profit". profit" feasibility study costs Deductions shall be made Article 78 of the Tax Code 100% of the amount of expenditures for research, design and experimental work related with income generation . costs related with Article 99 of the Tax Code prospecting and 25% of the Kyrgyz Republic preparation for operation costs related with In accordance with the development of a deposit 100 % Regulations " On procedure of determining expenditures related with generation of income, which are deductible when determining a taxable profit ". paymer6ts for services In accordance with the rendered by a foreign head Regulations " On office procedure of determining 100 % expenditures related with generation of income, which are deductible when determining a taxable profit " royalty and other tax 100 % of the amount of In accordance with the deductions only those tax and non-tax Regulations " On payments which are procedure of determining attributed to deductions in expenditures related with accordance with existing generation of income, legislation ( the land tax, which are deductible when deductions for prevention determining a taxable and liquidation of profit" emergency situations, road for using highways ) - tax stabilization X X - tax credits No No 113 Comparative Tax Table Tax Rate Or Percentage Basis For Calculation - tax holidays No No - all round defense No No - tax for using highways 0.8 % of commodities Article 32 of the Kyrgyz amount Republic Law " On taxes collected from enterprises, associations and organizations" - VAT payment at 20 % of taxable supplies In accordance with the Tax development stage Code of the Kyrgyz ._____________________ R epublic . - Social insurance tax The rates for these have The income tax and deductions and income tax been indicated above mandatory insurance contributions are collected in accordance with the Tax Code of the Kyrgyz Republic and the Law of the Kyrgyz Republic " On State Social Insurance" - Royalty ( Article 99 - No No 101 ) - tax on revenue or profit 30 % According to the Tax Code of the Kyrgyz Republic Tax on: Article 107 of the Tax Dividends No Code of the Kyrgyz Republic Interest payment 5% Article 108 of the Tax Code of the Kyrgyz Republic Foreign services 10% Article 109 of the Tax Code of the Kyrgyz Republic - losses deferred to future Losses, incurred by a Article 86 of the Tax Code incomes taxpayer as a results of its of the Kyrgyz Republic economic activities, shall be deferred over up to 5 taxation years . - losses put against past No No year incomes - tax on exorbitant profit ( No No Articles 102 - 104 ) - Bonus for certain amount No No of mining ( Article 98 ) 114 __________________ Comparative Tax Table Tax Rate Or Percentage Basis For Calculation depreciation of: capital assets From 10 % to 30 % Article 97 of the Tax Code depending on type of asset of the Kyrgyz Republic -25% costs on prospecting and Article 99 of the Tax Code development of the Kyrgyz Republic - depreciation norm used No No for reflecting deposits depletion participation of Government: free of charge This issue has nothing to do with taxation. with bought out share - rehab. ,and environment This issue has nothing to protection costs do with taxation. 115 KYRGYZ REPUBLIC TAX INSPECTORATE UNDER THE MINISTRY OF FINANCE Letter # 05-08-1-165/4328 Date: Nov.7, 2000 To: The World Bank Resident Mission According to your request the State Tax Inspectorate under the Ministry of Finance of the Kyrgyz Republic attached to this letter send you information on existing tax rates an fees in the mining sector. M. Ismailov, First Deputy Director 116 ANNEX H International Mining Taxation Practices iicone tax Dividenid Ro aity i-npol-1 d Expotl ValuLic Adcldec Tax IllCO[lle [ax ttlX Roy.llty lmport duty dutv Argentina 35% None up to 3% over the mine's exit 14%, but can None 21%, refundable if value of the extracted ore exempt attributable to export product Arizona 35% 30% None None None None Bolivia 25% 12.5% 1 to 7% of gross sale 5% for capital good None Exempt for export products (depending on international and 10% for others metal prices) Brazil 15% *) with None levied based on percentage of mostly exempt or None a state levy, maximum 10% on net invoice value (gold=1%; zero rated 18%. - tax exemption of profit copper=2%) exports of some minerals exceeding US$ 142,000 Burkina Faso 35% 12.5% base metals- 4% ad valorem; None None None gold and precious metals- 3% ad valorem . . Chile 15% 35% None 11%, but can None 18%, not subject to VAT effectively on import of government eliminated listed capital goods Ghana 35% Exempt 3 to 12% of the total revenues Exempt None Exempt of minerals Indonesia 30% 15% or US$ 235 per kg for gold; US$ exempt 10 years None 10%, effectively zero for 7.5% to 55 per tonne for copper; and and then taxed initial 10 years original US$ 12.50 per tonne for zinc around 20% _ foreign I 117 llncoc taLx .Rovaltv Ior0t dILY Ex port V1-c Acdded) Trax tllx ~ ~ ~ ~ ~ ~ ~ ______duLIy shareholders _ _ Mali 35% 12.5-18% 3% special tax on mineral 5-10% None exempt during the first products three years of production Mexico 34.0% 2/ None None 10%, but exempt None 15%, exemption for export export products oriented projects Ontario 42.62% 25.0% None 0.0% 0.0% Refundable, Peru 30% 2/ None None 12% delayed None 18%, immediate refund payment applied applies Tanzania 30% 10% 3.0% of net back value 5% is the cap limit None Exempt where products I__ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _I__ _ _ _ _ _ _ _ shall be exported Western Australia 36% 15% 5% for copper conc. Value 5% None None I__________ __ and 0% for gold value I I 1/ 15% Dividend Tax with 15% Withholding Tax foreign companies which are not representing in Kygyzstan. 2/ Mandatory workers' profit sharing: 10% in Mexico; and 8% in Peru and Brazil. 118 Fiscal Regimes for exploration and mining projects (cont.) AcceiciLitc Gov. eqCily ExchIinac coni.to Exter-.iI Dcprecaltio T.lx holidlavs Tax stahilizatioll XICCOLIMt Argentina Allowed None 30 years None None Allowed Arizona None None None None None Allowed Bolivia Allowed None None None None Allowed Brazil Allowed Ten year exemption from some local taxes may None None Allowed income tax applicable only in be stabilized by northern areas agreement Burkina Faso Allowed None During the license free 10% None Allowed ._________ ___ __ ___period Chile Allowed None 10 years None None Allowed Ghana Allowed None None Free 10% and None Allowed optional paid 20% Indonesia Allowed None 30 years provided for None None Allowed in Contract of Work Mali Allowed None Yes Up to 20% None Allowed Mexico None None None None None Allowed Ontario Allowed None None None None Allowed Peru Allowed None 10 to 15 years None None Allowed Tanzania Allowed None Full project life None None Allowed Western Australia None None None None None Allowed 119 ANNEX I Reform Experiences of Selected Countries in the 1990s a) Peru Mining Law. Peru has a long tradition in mining with diversified mineral production. The Peruvian government started a comprehensive economic reform program in 1990. Mining reform was initiated in 1992 with the enactment of the new Mining Investment Promotion Law (as an amendment to the General Mining Law) establishing mining rights as property that is freely mortgageable, transferable, and constitutionally protected against expropriation. Peru has a national grid system that limits all concessions to the shape of a closed polygon defined by the UTM coordinates of its corners, of a minimum of 100 hectares and a maximum of 1,000 hectares. There are no limits on the number and the term of the concessions. The concessions are granted on a first come, first served basis and the concession holders must pay annual surface rental fees that are significant for smalland middle size mining companies. Security of tenure is guaranteed under Peru's Mining Law because the concessions granted thereunder are for exploration and mining. Concession holders must meet minimum production requirements after 8 years or else pay escalating surface rental fees. Fiscal Regime. Peru does not impose royalties or production taxes and derives its mining revenues from the application of standard profit-based taxation. The standard corporate income tax is 30% of taxable income. Peru imposes a mandatory profit-sharing tax of 8% of pre-tax profits that constitutes a significant charge on corporate income. There are no exchange controls in Peru and mining companies benefit from VAT recovery credits for exports. Stability agreements are available under Peru's mining law. Institutional Arrangements. Peru has an independent and modem cadastre and registry system administered by a financially independent agency within the Ministry of Energy and Mines, the Public Registry of Mining. Enterprise Reform and Privatization. All of Peru's former state-owned enterprises (SOEs) have been privatized. The 10 million hectares that had been reserved for future exploration and exploitation by SOEs were released. Environmental Management. Peru has adopted a sectoral approach to environmental management. The Ministry of Energy and Mines has exclusive jurisdiction to establish and enforce environmental standards for the mining industry. The Environmental Protection Regulation requires all new mining operations to prepare an Environmental Impact Statement (EIS) and all existing mining operations to establish a Programa de Adecuacion y Manejo Ambiental ("PAMA") which bring them into compliance with international environmental standards within a fixed number of years. Mining companies are also required to engage an independent environmental firm to conduct semi-annual audits of compliance with applicable environmental standards and PAMAs. 120 Results.' Investor response to this mining sector reform in Peru has been overwhelmingly positive.' Exploration expenditures increased about twenty fold between 1990 and 1997, when it reached US$ 166.9 million (Metals Economic Group). Gold production increased rapidly to 127.7 tons in 1999 from 2.3 tons in 1992, when the Yanacocha gold project (Newmont Gold Corporation, USA and Buenaventura, Peru) started commercial production in 1992. The presence of national private companies, such as Buenaventura, Volcan, and Minsur, became more important to the national economy. b) Mexico Mining Law. Mexico has a long tradition in mining, resulting in a wide variety of operationrs in size and commodities with a significant presence of domestic private enterprises. In 1992, the new Mining Law replaced the former requirement of government control and/or majority Mexican participation both in equity and management of mining companies and opened the sector to foreign investment (Torres and Doan, 1997). Exploration concessions are granted on a first come first served basis and security of tenure is guaranteed. Although mining concessions do not confer real property riights, exploration and exploitation concessions are freely transferable and pledgeable. The concession holders have two principal obligations under the Mining Law and Regulation: (1) comply with the applicable work/investment requirements which are designed to encourage voluntary relinquishment of uneconomical concession holdings, and (2) pay escalating surface rental fees depending on the size and year in the life of the concession. Fiscal Reg me. Mexico derives its mining revenues from a profit-based taxation system and does not impose royalties. Mining companies have to pay an internationally competitiVe income tax of 34% and the rules on deductibility of expenses and carrying forward losses permit rapid recovery of capital, which encourages investment in mining. Mining companies must pay 10% of their profits to their employees annually, which represents la significant financial burden. Import duties range from 10 to 20% and exports are tax-exempt. There are no exchange controls in Mexico. Institutional Arrangements. The National Secretariat of Energy, Mines and Parastatal Industry ("SEMIP") administers the Mining Law and is in charge of a modernized cadastre. Concessions are granted under a centralized administrative system. Enterprise Reform and Privatization. In the late 1980s, the government began privatization of the mining sector. 80% of land area previously held by the State has been released for concessions. Environmental Management. There is a general approach to the environmental management of Mexico's mining sector. The Environmental Law provides for general norms that have to be complied with by all industries and requires that an Environmental Impact Assessment (EIA) be prepared and approved by the Secretaria de Desarollo Social ("SEDESOL") before the exploitation of a mine. The Camara Minera de Mexico ("CAMIMEX"), in collaboration with SEMIP and SEDESOL, developed specific 121 environmental norms for the mining sector which they have separated into three categories: (1) the legally binding norms, (2) the recommended norms, and (3) the instructions. Results. The interest that the new Mining Law generated among foreign investors resulted in about a six-fold increase in exploration investment between 1990 and 1997 when it reached US$ 184.1 million (Metals Economics Group). Minerals and metals production in the country have also increased steadily since the early 1990s, and mining is currently one of the few sectors of the Mexican economy that have grown substantially during the past decade (World Bank, 1996). c) Bolivia Mining Law. Bolivia made minor changes to its Mining Code in 1991, and then enacted an entirely new Mining Code in 1997, containing several innovative features. Bolivia adopted a system of standard sized quadrangles based on-a national grid as the component units for establishing the territorial limits of a mining concession. Under the new Bolivian Mining Code, exploration and mining rights are bundled together in a single, unified exploration and exploitation concession. Concessions in available areas are granted on a first come, first served basis without review of the technical and financial qualifications of the applicant. They are freely transferable and mortgageable, subject to registration requirements but not to prior governmental approval. There is no term limit on concessions granted under the Bolivian Mining Code, as long as the holder pays the annual surface rental fee per hectare of the concession area (the "patente") on time. The level of the surface rental fees is relatively high. Fiscal Regime. Bolivia charges ad valorem royalties on sales of extracted minerals at rates established in the Mining Code. The rate for gold varies from 0.01% to 7% of the officially established sales price (based on internationally quoted prices), depending on the value of gold. For zinc, royalty rates range from 1% to 8.43%. For tin, the rates range from 1% to 5%. Income tax paid is credited against the royalty obligation, such that taxpayers in effect pay income tax or royalties, but not both. All other taxation is pursuant to the general tax laws and regulations rather than the Mining Code. Income is taxed at a 25%, after expensing of pre-production and other costs and depreciation of capital costs over 8 years on a straight-line basis. Losses can be carried forward indefinitely. Bolivia also imposes a 25% additional profits tax on net after tax income after deduction of (1) an investment allowance of up to 33% of investments in exploration and exploitation activities; and (2) a production allowance based on 45% of annual net sales value, up to US$50 million. The withholding tax on dividends, interest and salaries paid to foreigners is 12.5%, non-deductible. Import duties are about 5%. VAT of 13% is charged on imported and locally purchased equipment, of which 55% is refunded within about four months. Institutional Arrangements. As part of its mining sector reform, Bolivia simplified and streamlined the functions of its Mining Superintendency, by modernizing and standardizing the criteria for locating concession boundaries, reducing the opportunities and incentives for private challenges to established mining rights, and limiting the 122 adjudicative aspects of its concession granting procedure. Bolivia also established a modermi, computerized mining cadastre managed by the Technical Service of Mines. Enterpirise Reform and Privatization. Between 1986 and 1994, Bolivia downsized the state-owned mining corporation, COMIBOL, from a bloated and inefficient operator of uneconbmical, aged mines - many of which were nationalized in the 1950's - into a minimally staffed holding company. In the early nineteen-nineties, it tried to promote joint ventures with COMIBOL for the development of various identified deposits, with generally disappointing results. Some properties were transferred to private investors who undertook investment commitments under Bolivia's "capitalization" program. The attraction of private capital investment into certain other state-owned properties was hampered by Constitutional prohibitions against the transfer of those properties. Environmental Management. The Mining Code contains a chapter on environmental management that clarifies how the requirements of the general Environmental Law are to be applied to the mining sector. Exploitation activities require an environmental impact assessment and an environmental permit as a condition for operations. Exploration activities do not require an EIA, but are subject to mitigation and rehabilitation norms established for the sector. Concession holders are not responsible for environmental damage caused prior to the later of (a) the effectiveness of the general Environmental Law, or (b) the grant of the concession, provided that the holder causes a complying environmental audit of the concession area as of that date to be completed at the holder's expense.: Results.l An American company, Battle Mountain Gold (now part of Newmont Gold Corporation) developed its successful Inti Raymi Project on a known gold deposit in the early 1990's, while Bolivia was in the reform process. Unfortunately, Bolivia's current Mining Code took effect just weeks before the Bre-X scandal broke, leading to a collapse of the international market for high risk exploration capital. Bolivia's investment results have been disappointing since that time. Nevertheless, the country has a well-established mining tradition dating to at least the 16th century, and several credible private national mining cbmpanies, such as COMSUR. d) Argentina Mining Law. Since the early 1990s, Argentina has undertaken a comprehensive economic reform program supported by the World Bank. Efforts to establish an enabling environment for private sector investment in mining are a major part of the reform agenda. The Mining Investment Law, which removed barriers to private investment in the mining sector, was enacted in 1993. The Mining Code of 1886 was modified in 1995 and allowed any person, whether legal entity or individual, to explore exclusively in a licensed area (Albarracin, 1997). Because Argentina has a decentralized political system under which each province administers itself under its own laws, mines are national or provincial, property depending on where they are located. Mining titles are considered property rights that are freely transferred. 123 Fiscal Regime. The Mining Investment Law No. 24.196 provides for fiscal stability for 30 years and imposes a maximum of 3 % of royalties on the "mine-head" value of the extracted minerals. Mining activities are exempted from assets tax and import taxes. There is a 5% tax credit for investment in environmental activities. Institutional Arrangements. Each Province has its own modernized cadastre and registry system. The Argentina Mining Sector Technical Assistance Project (PASMA) of the World Bank has been implemented to modernize the public mining institutions at the national and provincial level to provide more efficient public services. Enterprise Reform and Privatization. A privatization program was systematically conducted by the Government of Argentina in 1990-9.1; but there were no significant mining SOEs. Environmental Management. Argentina has a sectoral approach to the environmental management of the mining sector. The Mining Code requires the holder of a mining right to file an environmental impact report to the regulatory authority. Results. The result of Argentina's reform has been the building of a new sector in the Argentine economy. Investment for exploration - which was negligible in 1990 - reached US$ 122.1 million in 1997 (Metals Economics Group). Three new major mines have been developed - Bajo de la Alumbrera (copper), Salar del Hombre Muerto (lithium), and Cerro Vanguardia (gold). e) Brazil Mining Law. The reform of the 1967 Mining Code in the mid-nineties, the federal constitutional amendment N. 6 which removed the prohibition against foreign investor controlled mineral activities, and the privatization of the CVRD have effectively simplified the conditions for private access to mineral resources and liberalized Brazil's mining regime. A 1996 law has improved, and 1999 draft law No. 151 would further improve, the legal framework for mining by removing the requirement of financial capability and availability of funds for exploration, clarifying the functions of the issuing authorities and allowing the free transfer of mining rights during the exploration stage. The mining concessions are granted on a first come, first served basis and security of tenure is guaranteed. Although mining concessions do not confer real property rights, exploration and exploitation concessions are freely transferable and pledgeable. The concession holder must pay an annual rental fee and a share of the mining revenues to the landowner, which is 50% of the Federal Royalty. Fiscal Regime. The reform of the tax regime applicable to the mining sector has resulted in a more competitive environment for foreign investors through the application of the following measures: the reduction of the tax burden on repatriation of capital, profits and dividends, as well as on the remittance of royalties and interest; the elimination of the restrictions on foreign investors' participation in the Brazilian stock exchange; and the opening of financing lines in the BNDES System to foreign investors residing in Brazil. Mining companies are subject to the general tax law and must pay a federal royalty which 124 is no more than 3% of the net revenue from the sales of the mineral product. Under the general: tax law provisions, mining companies have to pay an income tax at the rate of 15% of the taxable income, the portion of the taxable income over R$240,000 (about USD 113,744 as of March 28, 2001) being charged an extra tax at the rate of 10%. Since 1999, mining companies must pay income tax based on the following systems which depends on the size of their total revenues: (1) Quarterly or Annual Taxable Income system for companies who have total revenues of R$ 24 million and (2) Assumed Income system for companies who have total revenues inferior to R$ 24 million. Mining companies must also pay a withholding tax on interest and royalties of no more than 15%, a social contribution tax on net income of 12% and several other social taxes. Institutional Arrangements. The two main mining authorities are the Ministry of Mines and Energy (MIME), which coordinates and formulates the Brazilian mineral policy, and the National Department of Mineral Production (DNPM), a governmental regulatory agency with decentralized offices in Brazil's regional districts which grants or recommends to the competent authorities the grant of mining rights, promotes and inspects mining activities. The Minister of MIME grants concessions for mining activities and the General Director of the DNPM issues exploration permits. Brazil has a modern cadastre and registry system. Enterprise Reform and Privatization. As part of a comprehensive National Privatization Program started in the nineties, one of the world's largest mining companies, CVRD, was privatized in 1997. Another coal mining company Companhia Riograndense de Mineracao is still under state control. Environmental Management. Brazil has adopted an integrated approach to environIental management, which is very advanced. In addition to strong constitutional provisions and Federal laws and regulation supporting the protection of the environment, the National Council for the Environment (CONAMA) has passed numerous resolutions concerning the instruments used to control the potential risks of a mining activity to the environment: the Environmental Impact Assessment Study (ELA), the Environmental License (LA) and the Plan for Recovery of Degraded Areas (PRAD). The ELA must be consolidated in the Environmental Impact Report (RIMA), which is submitted to the relevant state environmental agency in the National Environmental System (SISNAMA) for analysis and approval. The approval of the ELA/RIMA and PRAD is required before any mining company requests an LA, the approval of which is a condition to mining operation.: Results. The result of Brazil's reform efforts has been the building of a new sector in the Brazilian economy. Total private investment in minerals exploration was USD 189.6 million in 1997, but fell to USD 84.6 million in 1999. The largest mining investment planned for the coming years in Brazil is the Salobo project, a joint-venture between CVRD and Anglo-American group. The project plans an investment of nearly US$1 billion to produce copper and gold in the north of Brazil. 125 f) Tanzania Mining Law. The Mining Act, 1998 establishes transparent requirements and procedures for the grant of prospecting and mining licenses and limits considerably the scope of discretion left to the Minister. In particular, the Tanzanian law establishes a form of "first come, first served" presumption of entitlement to the grant of mineral rights, imposes no state participation in private mining projects, and authorizes stability agreements between the State and mineral rights holders or applicants. Tanzania requires an applicant to demonstrate the existence of a commercial deposit and an efficient and beneficial use of the mineral resources as a condition for obtaining a special mining license. However, it also enables an exploration license holder to obtain a retention license in order to hold onto an area for up to five years, renewable once for a like term, after expiration of the prospecting license and its renewals. Mineral rights are transferable under the Mining Act, 1998, provided that the prior written consent of the licensing authority (not to be unreasonably withheld) is required unless the transfer is to an affiliate and the latter's obligations are suitably guaranteed, or the transfer is to a financial institution to secure financing. Fiscal Regime. Tanzania lowered royalty rates to 3% of "netback value" on all minerals other than diamonds, and 5% on diamonds. Other taxes are payable in accordance with the general tax laws, and are not set out in the mining law. The income tax rate is 30% and there is no additional profits tax. For the calculation of taxable income, equipment is depreciated on a straight line basis over 8 years. Pre-production exploration and development expenses are carried forward and expensed in the first year of production., except for feasibility study expenses which are not deductible. Losses may be carried forward indefinitely. The withholding tax on dividends and salaries paid to foreigners is 10% and 3%, respectively. No import duties or VAT are levied on mining equipment. Institutional Arrangements. The mineral licensing function for mechanized mining is administered by the Ministry of Energy and Minerals. A new Office of the Commissioner of Minerals carries out geological mapping activities, develops and provides information on the geology of the country, and licenses artisanal miners through its zonal offices. The Tanzania Investment Act of 1997 created the Tanzania Investment Centre as a one-stop shop to promote, coordinate and facilitate investment in all sectors of the Tanzanian economy. Environmental compliance is regulated by the National Environmental Council created under the National Environmental Management Act of 1983. Enterprise Reform and Privatization. Historically, mining has not played a major role in the economy of Tanzania. Therefore, enterprise reform and privatization were not key components of mining reform there. The Mineral Policy of Tanzania, issued by the Ministry of Energy and Minerals in October 1997, emphasizes the role of the Government as regulator, promoter, facilitator and service provider to the private sector and not as a direct participant in operations. Environmental Management Tanzania incorporated some environmental protection requirements into its 1998 mining law. An EIA for proposed mining operations, prepared 126 by an approved independent consultant, must be submitted as part of the application for a special mining license. Acceptability of the EIA is a condition for the grant of a special mining license. The Mining Law contains provisions allowing for the amendment of ELAs and requiring the posting of a bond if and when the holder of a special mining license fails to fulfill his impact mitigation obligations. Results. An exploration boom started in the greenstone belts at the southern end of Lake Victoria from the mid-1990s. Exploration expenditures in the country rapidly increased to US$ 59.3 million in 1997 from US$ 3.3 million in 1994 (Metals Economic Group). Several exploration projects are in advanced stages, such as: Bulyanlulu Gold Prospect (Barrick Gold and Sutton Resources, Canada); Golden Pride Gold Mine (Resolute Ltd., Australia and Samax, UK); and Geita Gold Mine (Ashanti Goldfields, Ghana and AngloGold, UK). g) Burkina Faso Mining Law. A new Mining Code, which was enacted in October 1997, has improved and simplified the legal and tax regime for mining. The new law has extended the permit validitylperiods (3 years for exploration permits, 10 years for small scale exploitation permits "and 20 years for industrial exploitation permits) and provides for greater land areas. The State takes a mandatory carried 10% participation in all mechanized mining ventures. Permit holders must comply with annual spending requirements in order to maintain their rights. Mining titles are transferable subject to the government's review of the eligibility of the transferee. Fiscal Regime. The mining law provides special tax treatment for mining investors and a stabilization of the mining and tax regime for the holder of an exploitation permit during the validity of the permit. There is a fixed scale of fees for the grant of mining rights from CFA 200,000 for a prospecting authorization to CFA 5,000,000 for the grant of an exploitation permit. Surfaces rental fees range from CFA 5,000 per km2/year to CFA 500,000 per km2/year. Ad Valorem royalties are levied on the FOB value of diamond& at 7%, precious metals at 3% and other minerals at 4%. The finance and tax regime guarantees the repatriation of capital and profits, exemptions from customs duties on temporary imports of equipment, and exemptions from Value Added Tax and other taxes. The corporate income tax was reduced to 35% and the income tax on interest and dividends is 12.5%. Institutional Arrangements. The organization of the mining institutions is currently being reformed. While the Ministry of Industry Commerce and Mines grants the mining permits after negotiations, the Bureau of Mines and Geology of Burkina undertakes exploration surveys and looks for partners for exploitation, and the Burkinabe Bureau of Precious Metals purchases and sells gold and other precious metals and participates in the creation of mining companies. Enterprise Reform and Privatization. The privatization reform, which started in 1991, with the Structural Adjustment Plan, had a limited impact in the mining sector. The privatization of Burkina Shell is being considered by the Privatization Commission. 127 Environmental Management. The mining law requires the holder of an exploitation permit to submit with his permit application an EIS with a preservation and restoration program. The approval of the EIS is not a condition for the approval of an exploitation permit, however, but rather a condition for operating. Results. Burkina Faso was able to capture a significant share of the African exploration boom of the mid-to-late 1990s, even before the enactment of its new Mining Code in October of 1997. Private investment in exploration peaked in 1996 at USD 32.4 million, then fell back to USD 10.2 million in 1999 (Metals Economics Group 1999). The number of exploration permits issued grew from only one in 1990 to 137 in 1997. In 1998, gold was the country's second largest source of export revenue, after cotton. There are up to half a dozen gold projects in the pipeline that could become operating mines within the next five years. Among the companies active in Burkina Faso recently are Ashanti Goldfields, Billiton, Resolute, Semafo, High River Gold, Channel Resources and Placer Dome. Billiton took over the Perkoa zinc deposit in 1997 and was in advanced stages of drilling the deposit for pre-feasibility study purposes as of the end of 1999 (Mining Journal Annual Review 1999). h) Madagascar Mining Law. In 1999, Madagascar enacted a new Mining Code. The new code, and the implementing regulations promulgated early in 2000, include the following features: 1. All mineral rights are granted through a transparent procedure administered by the Office of the Mining Cadastre. 2. They are awarded to the first eligible person who requests a permit in an available area and complies with the applicable procedural requirements. 3. There is no requirement to demonstrate technical or financial capability to qualify for the grant of an exploration or exploitation permit 4. Exploration and exploitation permits are freely transferable, mortgageable and inheritable with no requirement of prior governmental approval. 5. Only the holder of an existing exploration permit can apply for an exploitation permit within the area covered by the existing permit. 6. An applicant for an exploitation permit is not required to demonstrate a discovery of commercially exploitable minerals; but is required to file an environmental impact statement. 7. There is no minimum work or investment requirement. 8. There is a grid system for the identification of exploration and exploitation permit areas. Fiscal Regime. Royalties have been reduced to 2% of sale price at time of sale. VAT relief is provided for exporters through an expedited refund system. A draft major investment promotion law would lower the income tax rate to 25% on the extraction business, and 10% on processing. It would also cap numerous taxes on assets. Institutional Arrangements. A new, computerized Office of the Mining Cadastre, financially autonomous but under the Ministry of Energy and Mines, was opened in 128 2000. An Environmental Cell for mining oversees the environmental protection requirements for exploration and small-scale mining. Other organizational changes in the mining administration are being implemented in response to an institutional audit carried out in 1999-2000. I Enterprise Reform. The 1999 Mining Code compelled the release of excess land areas held for future exploration by the state-owned enterprise, Office of National Mines and Strategic lIndustries (OMNIS). OMNIS continues to negotiate joint ventures with international investors. It is subject to the same regulations as private companies. The few remaining state-owned mines, which are small, have not been privatized. Environmental Management. A new decree on harmonization of investments with the environment, requiring an Environmental Impact Study and a Project Environmental Management Program (PGEP) for all mining operations except small scale mining, was adopted in 1999-2000. The evaluation of the Environmental Impact Study (EIS) for a mining project is carried out by a joint committee of representatives of the ministries involved, including the Ministry of the Environment and the semi-autonomous National Environmental Office. An Inter-ministerial Order of the Ministers of Mines and the Environment, respectively, establishes the sectoral environmental requirements for exploration and small scale mining, including guidelines and forms, while clarifying the implementation of the general EIS requirements to exploitation projects. These requirements are in turn administered by the Environmental Cell of the mining administration. Results. Madagascar, known for its gem production, has never had a major mine. However, two major investment projects by two of the world's leading mining companies are at the feasibility study stage there as of the end of 2000. Although exploration investment is currently limited, there are two advanced stage exploration projects for Toalagnaro mineral sands (Rio Tinto subsidiary QIT-Fer) and Ambatovy nickel and cobalt (Phelps Dodge) deposits. i) Mongolia Mining Law. Mongolia enacted a Minerals Law in 1997 that institutes a market-based mechanism,for access to and maintenance of mineral rights. Such rights are granted on a first come, first served basis administered by an Office of Geological and Mining Cadastre, with no required showing of technical and financial capability or required proof of discovery of a commercial deposit. Mineral rights in Mongolia are maintained in effect by payment of an annual fee per hectare, and are freely transferable. Fiscal regime. Royalties were reduced to 2.5% of market value. Mining companies in Mongolia are subject to taxation in accordance with the general tax laws, but the Minerals Law of 1997 establishes certain tax accounting rules for the sector: pre- production exploration and development costs are amortized on a straight-line basis over five years commencing with the year when production begins; fixed assets are depreciated over five years on a straight line basis; and losses may be carried forward for up to three years. Stability agreements are available under the Minerals Law. A 10% 129 excise tax on gold exports, however, enacted in' 1999, together with the current low market price of the commodity, has significantly neutralized the positive impact of the reform. Institutional arrangements. In order to implement the 1997 Minerals Law, Mongolia created the Geological and Mining Inspection Agency (OGMI) which monitors compliance with the new law, and the Mineral Resources Authority of Mongolia (MRAM). The MRAM includes the new Office of the Geological and Mining Cadastre (OGMC), which grants and administers exploration and mining rights, the Office of Geology, which functions like a geological survey; and the Mining Office, which provides relevant research and information on developments in technology, equipment, investment conditions, socio-economic impacts of mining and mineral commodity price movements. Enterprise reform. In the mid-nineties, the Government of Mongolia privatized certain assets of the state-owned copper company, Erdenet. It also restructured Erdenet and other state-owned enterprises as for-profit commercial enterprises. The SOEs continue to seek out joint venture projects with various partners. Environmental Management. Mongolia has a particularly well-developed body of environmental law, including some 13 or more statutes. The Minerals Law contains specific provisions on the application of environmental permitting and monitoring requirements to the mining industry. Environmental management plans must be submitted to the region where exploration will take place within 30 days of the grant of an exploration license. The exploration license holder must set aside 50% of the approved environmental budget in a blocked local bank account to guarantee performance. An EIA and an environmental protection plan must be submitted either before or after the grant of an exploitation license, and must be approved as a condition for operating. The mining license holder must likewise set aside 50% of the approved environmental budget in a blocked local bank account to guarantee performance. Results. Following enactment of the 1997 Minerals Law and establishment of the new mining cadastre office, Mongolia experienced an exploration boom. Promising discoveries were announced in 1998. BBIP, Rio Tinto, Phelps Dodge and numerous junior companies have all been active in exploration in Mongolia. In 1999, exploration investment rose to USD 2.5 million. The enactment of the 10% excise tax on gold exports prevented some projects from being economical, however. Nevertheless, AGR Ltd., a subsidiary of Resolute Mining of Australia, may be approaching the development stage of the Boroo gold deposit not far from Ulanbataar. 130 ANNEX J Selected Principles of Mining Sustainable Development Environmental Stewardship Principles * Comply with or exceed the requirements of all applicable environmental laws and regulations and, in jurisdictions where these are absent or inadequate, apply cost- effective technologies and management practices to ensure the protection of the environment as well as worker and community health. * Make environmental management a high corporate priority and the integration of environmental policies, programs and practices an essential element of management. l * Provide adequate resources and build requisite capabilities so that employees at all levels are able to understand and fulfil their environmental and community responsibilities. * Review and take account of the environmental impacts of exploration, infirastructure development, mining or processing activities, and plan and conduct the design, development, operation, remediation and closure of all facilities in a manner that optimises the economic use of resources while reducing adverse environmental impacts to acceptable levels. * Emnploy risk management strategies in design, operation and decommissioning, including the handling and disposal of waste. If a preliminary risk assessment indicates unacceptable risks for human health or the environment, the lack of full scientific certainty will not be used as a reason to delay the introduction of cost- effective measures to reduce environmental and human health risks to acceptable levels. . Develop approaches in the early stages of exploration projects that take into consideration related environmental and community impacts. * At the initial phases of mining or processing projects, develop closure concepts and/or plans that address both environmental and community-related issues. * Review and update closure plans in light of technological advances and operational changes * Ensure that adequate financial resources or surety instruments are in place to meet the requirements of remediation and closure plans. * Implement effective management systems; conduct regular environmental reviews or assessments and act on the results. 131 * Develop, design and operate facilities and conduct activities taking into consideration the efficient use of energy, water and other natural resources and materials, including their recycling and reuse, the minimization of waste and the responsible management of residual materials. * Develop, maintain and test emergency procedures in conjunction with the provider of emergency services, relevant authorities and local communities. * Work with governments and other relevant parties in developing scientifically sound, economic and equitable environmental standards and procedures, based on reliable and predictable criteria. * Respect legally designated protected areas and acknowledge that certain areas may have particular ecological or cultural values alongside development potential and, in such instances, consider these values along with the economic, social and other benefits resulting from development. * Contribute to the conservation of flora and fauna affected by exploration, extraction and processing activities. * Support research to expand scientific knowledge and develop improved technologies to protect the environment, promote the international transfer of technologies that mitigate adverse environmental effects, and use optimal sustainable technologies and cost-effective practices that take due account of local cultures and customs and economic and environmental needs. Product Stewardship Principles * Develop or promote mineral products and processing technologies that are safe and that are efficient in their use of energy, natural resources and materials. * Advance the understanding of the properties of minerals mined and their life cycle effects on human health and the environment. * Inform employees, the community, customers and other relevant parties concerning mineral-related health or environmental hazards and recommend improved risk management measures. * Conduct or support research and promote the application of new technologies to further the safe use of materials produced by the mining industry. * Encourage product design, technologies and uses that promote the recyclability as well as the economic collection and recovery of materials. * Private companies should work with government agencies, downstream users and others in the development of sound, balanced and scientifically based legislation, 132 regulations and product standards that protect and benefit employees, the community and the environment. Community Responsibility Principles ., Respect the cultures, customs and values of individuals and groups whose livelihoods may be affected by exploration, mining and processing. * Recognize local communities and other affected stakeholders and engage with them in an effective process of consultation and communication. * Assess the social, cultural, environmental and economic impacts of proposed activities and engage with stakeholders in the design of community development strategies. * Contribute to and participate in the social, economic and institutional development of the communities where operations are located and encourage the establishment of sustainable local and regional business activities. *i Reduce to acceptable levels the adverse environmental and social impacts on communities of activities related to exploration, extraction and closure of mining and processing facilities. * I Respect the authority of national and regional governments; take into account their development objectives; contribute information related to mining and mineral processing activities; and support the sharing of the economic benefits generated by operations. General Corporate Responsibilities * iAdhere to ethical business practices and, in so doing, contribute to the elimination of corruption and bribery, to increased transparency in government-business relations, and to the promotion of respect for human rights internationally. * Apply consistent corporate policies in all operations and encourage joint venture partners to adopt principles contained in the present Charter. * Encourage contractors and suppliers to implement practices that are consistent with corporate policies in order to improve their environmental and social performance. * Provide public reports on activities and progress relating to economic, environmental and social performance. 133 IMAGING Report No.: 24709 KG Type: SR