By Jennifer Lander
On the 20th of February, Rio Tinto initiated arbitration proceedings against the Government of Mongolia at the United Nations Commission on International Trade Law (UNCITRAL) through Oyu Tolgoi LLC. The escalation of the dispute over the alleged “missing millions” of tax from Rio Tinto (USD 155 million) suggests that the multinational corporation’s patience is wearing thin.
What is international investment arbitration?
In the 1990s and early 2000s, many developing countries like Mongolia were sold the idea that entering into international investment agreements (IIAs) would help them attract foreign direct investment (FDI).
It has been shown since that the FDI-attracting potential of IIAs is largely a myth.
What IIAs do certainly provide is a backstop for investors to enforce their rights and preferences against national states, drawing on international investment norms of fair and equitable treatment, non-discrimination (i.e., national treatment) and protection from expropriation and nationalization.
For states like Mongolia which are heavily dependent on FDI, IIAs incentivise governments to adopt investor-friendly policies and regulations at the expense of other national priorities. This is known among international investment lawyers as “regulatory chill”.
Baby, It’s Cold Outside
My new book – Transnational Law and State Transformation: The Case of Extractive Development in Mongolia – argues that investor perceptions of instability and risk have thoroughly chilled Mongolia’s regulatory and policy environment over the past decade. Rio Tinto’s recent arbitration proceedings are the tip of the iceberg.
If you have been following Mongolia’s mining story in recent years, you will probably have noticed a changing narrative in the international business media about investing in this country. And Oyu Tolgoi has been at the centre of it all, as the ‘litmus test’ of Mongolia’s investment potential.
According to international media sources, the former ‘darling of frontier markets investors’ became a ‘pariah’ when Mongolia, ‘the 2011 Global Growth Generator’, attempted to renegotiate the Oyu Tolgoi Investment Agreement (OTIA) in 2012 under the provisions of the allegedly “nationalist” Strategic Entities Foreign Investment Law (SEFIL).
The collapse of FDI between 2012-2016, the ensuing debt crisis and international “downgrading” of Mongolia’s investment environment resulted in a major flip-flop in the country’s investment and mining laws, as well as mining policy. SEFIL was pilloried by investors, international institutions and media outlets as an open display of “resource nationalism”, despite containing typical provisions used in most developed countries to prevent geopolitical takeovers of national resources (Scharaw 2018). These one-sided narratives hide the fact that Mongolia has capitulated to virtually every whim of foreign investors since 2014, despite election turnover.
The only thing Mongolia surely can’t afford to lose is the tax revenue owed from the country’s most significant mineral deposit.
Challenging Rio Tinto’s Victim Status
There are some good reasons to challenge the “pariah” narrative that has haunted the Mongolian government in the current tax dispute.
For a start, the OTIA reflects profoundly unequal legal expertise, knowledge and bargaining power between the parties. A 2018 report from the Centre for Research on Multinational Corporations (SOMO) details how the corporation has benefited enormously from major tax benefits and concessions, including tax stabilisation clauses, in the OTIA. Freezing tax in the face of a commodity boom was a particularly ill-informed concession by the Mongolian government.
On top of using “mailbox companies” in the Netherlands and Luxembourg to avoid tax payments to Canada and Mongolia in the past, Rio Tinto has also profited from new concessions in the 2015 Dubai Agreement, when Mongolia agreed to retroactively apply lower rates of withholding tax to the Oyu Tolgoi project (these concessions were part of an effort to restore Mongolia’s ‘lost credibility’ in the global market).
Furthermore, the OTIA makes the Mongolian government financially vulnerable in ways that they could not have predicted at the time of signing it. The framework of the agreement – with Rio Tinto holding a managing share of the Oyu Tolgoi Project – means that USD 2 billion in cost overruns incurred by Rio Tinto increases government debt alongside Rio’s “management service fee” for these “investment costs” which has to be paid by the government (see Lander, 2014). The Mongolian government’s status as a minority shareholder in the Oyu Tolgoi project further affects its ability to recoup dividends until its debts to Rio Tinto (taken out to fund the government’s stake in the project) have been paid.
If it is true that Mongolia has lost close to USD 232 million in tax as a result of the OTIA’s complex tax framework and Rio Tinto’s advantageous use of international loopholes, it certainly puts the Mongolian government’s tax bill to Rio Tinto of USD 155 million into perspective, and explains why renegotiation was on the table late last year.
International Arbitration: Time to Get the Big Guns Out
The fact that Rio Tinto has initiated arbitration proceedings shows they want to get the issues with the OTIA settled once and for all. And Rio Tinto has a pretty strong hand in technical investment law terms, on the basis of fair and equitable treatment, indirect expropriation and discrimination.
Firstly, Rio Tinto can argue that the principle of “fair and equitable treatment” has been breached because of the government’s numerous attempts to renegotiate the tax framework and the OTIA itself. In international investment law terms, this sort of “regulatory instability” undermines legal certainty and legitimate expectations for investors.
Secondly, the ongoing tax dispute could be argued to have led to an indirect form of expropriation, as delays associated with the dispute have impacted economic returns from the Oyu Tolgoi Project. Unfortunately, indirect impairment of the value of an investment can “count” as a form of nationalisation. In its 2019 Strategic Report (page 29), Rio Tinto claims that it suffered USD 1.7 billion in ‘impairments’ last year, largely from the Oyu Tolgoi Project.
Thirdly, Rio Tinto will likely argue that they are being unfairly targeted by the government amongst other domestic and foreign investors (undermining principles of non-discrimination in international investment law). Rio Tinto claims to have paid all of the requisite taxes and would likely claim that they have been subjected to particularly hostile treatment because of the government’s direct interests in Oyu Tolgoi.
Seeing the Forest for the Trees
Unfortunately, arbitration tribunals care little for the political and economic context which shapes international investment agreements like the OTIA. The parties are treated “equally”, which is to say that the actual inequalities which shape their relationship remain unaddressed.
Somewhat ironically, just one day before Rio Tinto announced its intention to pursue arbitration, SOMO published an independent report which highlights how Investor-State Dispute Settlement ‘lock[s] Mongolia into a development trajectory emphasising a safe investment climate rather than benefits for its people.’
I am inclined to agree.
While I can certainly understand why Rio Tinto is frustrated on a practical level, the Mongolian government is not just another corporate partner, and Oyu Tolgoi is not just another mining project. The management of this deal will affect Mongolians for generations to come. And if it’s a bad deal, the government need to try and change it.
Let’s just hope the UNCITRAL panel can see the bigger picture.
About Jennifer Lander
Dr Jennifer Lander is Lecturer in Law at De Montfort University in the UK, where she researches the intersections of international economic law and contemporary constitutional change. Her new book Transnational Law and State Transformation: The Case of Extractive Development in Mongolia was recently published with Routledge (2020). You can follow her for an occasional tweet about the law and politics of natural resource governance at @jennylander4.