Nigel Page
The financing of emerging-market projects on a limited-recourse basis has been a focus of attention for the past few years. Companies rarely fund such projects off their own balance sheets. Rather they will take equity stakes in special purpose project companies. Lenders only get paid back if the projects succeed.
This has been particularly so with mining projects. Weakening commodity prices have put pressure on mining companies to concentrate on developing projects in emerging markets, where extraction costs are substantially lower than in more developed economies. This trend, already much in evidence, has been exaggerated by the decreasing popularity of hedging. As a consequence of these developments, mining projects have boomed in the former Soviet Union, sub-Saharan Africa, Latin America and across South East Asia.
Emerging-market mining projects raise complex financial and legal issues. Risks proliferate in these economies and it is up to the lawyers representing the project sponsors and lenders to foresee, identify and, as far as possible, neutralize these to an acceptable degree for all concerned. Risks notwithstanding, emerging-market economies are in dire need of foreign capital and, as a result, their governments are keen to encourage investment in what is often their country’s principal resource.
Mining projects can only proliferate under these circumstances. For the lenders, these projects can be lucrative investments – but they are, by their nature, high-risk, high-return ventures. The ability of the lawyers involved to deal creatively with the issues raised is fundamental to their success.
The news in mid-October that the law firm Mayer, Brown&Platt had successfully closed the $40 million syndicated project financing of a Russian gold mine project, was noteworthy for various reasons. Above all, the Julietta gold mine project financing proved that, with adequate inter-party co-operation and a willingness to embrace and handle market and political risk, just about anything is possible. The deal represented a series of firsts, and probably heralds a more adventurous approach to limited-recourse project financing in emerging markets. The risks at the heart of Julietta are themselves an object lesson in emerging-market financing.
The deal was a long time coming. In 1996, the original bank group (led by Standard Bank London Limited, the London-based subsidiary of the South African bank) instructed Mayer, Brown&Platt to investigate the feasibility of putting together the financing for a new mine located in Russia’s far east. This was a tough proposition, even in pre-currency crisis Russia. Legal system risk can be a real issue in countries where the system of law is still embryonic and hard to interpret. All too frequently, there will be an absence of precedents covering the remedies available in the event of a default, making legal risk a key area of concern. And, in this case, because foreign exchange repatriation was tightly controlled, protracted negotiations with the Russian central bank were required to ensure that the project could remit dollars outside the country (meeting the priorities of foreign investors and lenders).
In the former Soviet Union, as in all post-Communist countries, title risk is another major concern. In this instance, the assets constituting the Julietta mine were originally owned by the Russian government, prior to their privatization. Mayer, Brown&Platt needed to verify that the sell-off had been effective and legal. In Russia, title risk is often exacerbated by the operator being unable to secure surface rights – having to make do instead with whatever rights are necessary to mine the deposit under the terms of the government’s mining licence.
The extent to which the central government has a right to retain a carried interest in the project varies from country to country. In some jurisdictions this may constitute as much as 20% of the project’s equity, while in others the government may be entitled to a royalty payment on whatever is extracted.
It took two years before the original bank syndicate, led by Standard Bank, came near to closing the transaction. But fate intervened in the shape of the Russian sovereign debt default and ensuing currency crisis. Russian borrowers were effectively blackballed from capital market funding, as well as from other credit sources and, as a consequence, the financing was unable to close. For a time, it looked as if the deal might sink without trace. But, in due course, Arian Resources, the project’s original owner, sold its interest to Bema Gold Corporation, a Vancouver-based mining company, and, by late-1999 it was clear that the Julietta deal was once again a feasible proposition.
At that point, Standard Bank restructured the lending syndicate to include Bayerische Hypo-und Vereinsbank as co-arranger. When the deal was first conceived, it was to have been completely funded by commercial banks.
However, in post-crisis Russia, the involvement of a multilateral lender assumed considerable significance. The International Finance Corporation agreed to provide $10 million of financing – and the way in which this aspect of the deal was structured represented an interesting departure from standard practice. Typically, in an emerging-market financing, the multilateral fronts the entire loan. In the case of Julietta, however, the commercial banks and the IFC had their own parallel loan agreements.
In any emerging market project financing, political risk is an important aspect of the deal – and this was particularly true in post-crisis, post-Communist Russia. In any limited-recourse project, this is something that cannot be contracted out of. Political risk must be covered either by the sponsors or by insurance. Because of balance sheet and precedent concerns, the sponsors will usually resist, making political risk insurance an integral part of many emerging-market financings. Such insurance is usually available through one of the multilateral agencies. In this instance, the Multilateral Insurance Guarantee Agency (MIGA), a World Bank operation, was approached. The fact that cover was secured was especially significnat – no previous Russian mining project loan had been guaranteed by political risk insurance.
Once insurance was in place, the lenders’ concerns were to a large degree assuaged, and by early 2000 the pressure was on to close the project in advance of the winter freeze. By the time closing was in sight, the number of lawyers involved had increased, the newcomers being two Russian firms (Padva, Rozenberg&Partners and Macleod Dixon), White&Case (as legal advisers to the IFC), two Barbadian firms and five Canadian firms (notably Blake, Cassels and Fasken Martineau).
Although Russia has substantial gold reserves, mine output has dropped steadily ever since the fragmentation of the Soviet Union. Ian Coles, Mayer, Brown&Platt’s London office managing partner, says: “We are delighted to have worked on such a significnat financing in the Russian mining sector. Although the size of the loan itself is not large, we believe this deal is the first project financing for many years in Russia to be funded by commercial banks and not solely by multilateral lenders. It provides evidence of the ability of the project-finance market to address mining deals in Russia if the structure is right.”
