David M. Sassoon
The World Bank Group has advanced $721 million for mining ventures in the developing countries since it began extending financial assistance for such purposes in 1957. Of this amount $609 million was lent by the Bank and the International Development Association (IDA) and the balance has taken the form of investment and lending by the International Finance Corporation (IFC). An increasing amount of Bank Group loans to the mining sector can be expected in the decade ahead, as capital requirements grow and as known resources are depleted and demand rises.
The Bank’s limited involvement in the mining sector up to now (slightly less than 2½2 per cent of total Bank Group lending) is due to a number of factors.
Mining operates at levels of physical, commercial, and political risks that are normally significantly higher than those of other industries. Mining projects require extremely heavy investments, not only in physical and social infrastructure facilities, but also in preinvestment expenditures on exploration and metallurgical testing, which, because there is no certainty of discovery, will often be written off as a loss. In addition, much of the requisite technical expertise has been, and still is, concentrated in the hands of a relatively small number of multinational corporations with free access to the capital markets of the world on their own account. The investment climate was, until recently, more stable, and nationalization and expropriation of foreign-controlled mines less customary than now. Mining was thus more readily financeable without Bank participation. And finally, the Bank itself used to be reluctant to finance governmentally owned and managed industrial enterprises, further curtailing its limited involvement in the sector.
A commitment to the member country
As a rule, mining projects have been financed on a project-by-project basis, rather than in the framework of a balanced sector approach. Most projects were referred to the Bank from the outside, generally after the bulk of the contractual arrangements between the foreign private participants and the host country had been at least substantially completed. If arrangements for financing a project appeared unfair to the member country, the Bank simply refused to participate. The Bank’s policy in this area has been very clear.
Where the safety of the Bank’s own investment was concerned, the Bank was duty bound to influence the terms and conditions of the transaction between the private foreign investors and the host government. Beyond that, however, it did not act as the advocate of the government in its negotiations with foreign investors, but it did make sure that the government had competent legal and business advice. When necessary, the Bank has made the retention of outside legal and other counsel a requirement for its participation in mining projects and, where appropriate, has been willing to include the cost of such services as part of its loan. Whether the Bank’s attitude in this area will change and become more active, and if so, what particular form this involvement may take, remains to be seen.
The Bank’s procedure with mining projects, irrespective of the portion it was asked to finance, was first to be satisfied that the whole project was fair to the Bank member country where it was located, that the allocation of benefits and risks was properly balanced, that the project made economic sense, and that the investment was secure. The Bank would be unwilling, for instance, to participate in financing a railway, port facility or township which depended on a mine for its justification, without being satisfied with the project as a whole, and vice versa.
This was Bank practice in the Falcon-bridge ferro nickel mine in the Dominican Republic, where the Bank financed the power facilities as well as in the Miferma iron ore project in Mauritania, where the Bank financed the railway and port facilities. In these cases the loans were made to the mining company directly, which of course was the project entity. But the same total project appraisal was made for the Burfell power project in Iceland, serving the Alusuisse aluminum smelter, and the Volta power project in Ghana, serving the Valco aluminum smelter. Here the loans were made to the member country’s government or to one of its agencies responsible for the operation of the infrastructure facilities in question. These two forms of financing—direct financing of the project entity and indirect financing of the supporting outside infrastructure facilities—involve different legal and financial problems and techniques, but the choice of the form is essentially irrelevant to the Bank’s evaluation of the project as a whole. In all cases, the companies operating the mining facilities were the real parties to which the Bank looked for assumption of the risk and for security of its loan repayment. The Bank has, therefore, financed infrastructure facilities as well as production facilities proper, and depending on the particular circumstances, has lent money to a private corporation which was the project entity, as well as to a member country’s government or to one of its agencies.
Choice of borrower
Of the 26 projects financed by the Bank Group to date, 4 financed infrastructure, 11 production facilities, and the remainder both. Lending by the IFC was, of course, exclusively for private enterprise, while Bank loans went about equally to the private and government sector, although in the majority of projects control of the mines was in private hands. The Bank of course has certain preferences in this area. It prefers to lend directly to the entity or enterprise that will be responsible for the construction and operation of the project, so that any problems are attended to immediately. If the project is to be carried out by a private corporation, or if any of its infrastructure facilities are to be controlled or operated by the private corporation, the guarantee of the member country (a requirement of the Bank’s Articles of Agreement) will normally be confined to the payment of the debt service of the loan. The member country will not be required to ensure the full performance of all of the borrower’s undertakings, nor to agree to provide all of the funds and other facilities required to complete the project, which is the case where the government is the borrower or where the loan is made to a state corporation or enterprise. All that the guarantor government will usually be requested to covenant in this case is: “not to take, cause, or permit to be taken any action which would prevent or interfere with the construction and operation of the project or with the performance of the borrower’s obligations.”
The choice of borrower under each loan will be resolved by reference to the particular portion of the project which the Bank is asked to and is willing to finance. Under the Articles of Agreement, the Bank would normally finance the foreign exchange cost of projects; financing local costs in these types of projects is exceptional. The Bank’s participation in projects which require large foreign exchange expenditures-and mining projects in the less developed countries almost invariably fall into this category—are therefore on the whole confined to the financing of imported equipment and materials. This may have a bearing on the portion of the project that the Bank is willing to finance, and it is also a factor to keep in mind in the choice of borrower.
The terms of the loans
In the past, where the borrower was privately owned, a commitment of substantial shareholder equity or subordinated debt was required, and shareholder guarantees for cost overruns and repayment were normally sought. These usually included financial commitments to provide all funds necessary to complete and operate the project, and to repay the loan, quite apart from other more customary types of security such as mortgages of plant. In the case of the Shashe project in Botswana, the private party, a subsidiary of Roan Selection Trust, was even made to assume one half of the cost of the engineering studies of the infrastructure, financed by the IDA under a $2.5 million credit to the government, in case it did not proceed with the project.
In addition, because the Bank’s practice is to charge as low a lending rate as is consistent with its own financial condition (currently 8½ per cent), and because there is no reason to give the benefit of this low rate to a private investor, the Bank has insisted that the member country’s government, which must guarantee the Bank loan, charge the private party a guarantee fee equal to the difference between the Bank’s and the market interest rates. On the other hand, where the loan was made to the government or to one of its agencies in support of a mining venture, the lending rate was of course the Bank’s usual uniform low lending rate. But this does not mean that the government was seen as the real provider of the funds to cover the debt service of the loan. In all these cases, as the infrastructure facilities were designed to service the mining operation or enterprise, the Bank insisted on adequate arrangements to ensure that the government receive sufficient guarantee from the private participants in the mining venture to repay the debt to the Bank.
Forms of security
Security arrangements in these cases have taken different forms. The Bank has occasionally insisted on obtaining liens or pledges which could be enforced directly against third parties who were, for example, to be the purchasers of the mining product. Shareholder guarantees running directly to the Bank are also in this category because the Bank can enforce them by being a party to the contract. When the Bank is not a party to the arrangement, the security will run directly from the consumer or from the shareholders to the borrower, not involving a right that the Bank can enforce directly, but in effect producing a somewhat similar financial guarantee for the borrower.
From the legal point of view, a distinction can clearly be made between arrangements which give the Bank direct rights and remedies against a third party (other than the borrower), and those which do not establish a direct contractual relationship between the Bank and a third party. Financially, that distinction is perhaps less significant, because the latter arrangements, by aiming to strengthen or safeguard the financial position of the borrower, also contribute, though more indirectly, to the protection of the Bank’s investment.
“Take or pay” long-term purchase contracts are a frequently encountered form of security arrangement in this type of loan. They consist, broadly speaking, of the obligation of a third party to purchase a product or service or to pay for it, even if it is not purchased—and this third party undertaking is often assigned to the Bank. In some cases, the obligation to pay exists, even if the product involved has not been produced. The third parties involved may be the shareholders of the borrower, as in the Falconbridge project. In other instances, they are outsiders interested in a steady supply of the product, for example, an Argentinian state agency as a buyer of gas transported through a Bank financed Bolivian pipeline. In some cases payments for the service or product are made to a trustee who must earmark and apportion the receipts between the various creditors, and often the government also, in accordance with priorities agreed upon before transferring any money to the private producer. There is no established pattern.
No matter what form the particular security takes, the infrastructure, if publicly owned, has to be secured by the mining operation and its sponsors. The obligation of the government as a borrower or guarantor in these cases will protect the Bank’s loan, but this protection is in addition to, and not in lieu of, the security which the private investors must furnish. The specific security arrangements are in effect designed to protect the government as guarantor (or as borrower) as much as they are designed to protect the Bank as lender. There is less likelihood of the Bank having to invoke the government’s direct obligation in these circumstances, and it is for this reason that such projects can receive Bank rather than IDA financing, though the country itself may normally have access to IDA funds only. Even in the unlikely circumstance of the Bank enforcing the government’s direct obligation, the government will usually be subrogated to the rights and benefits of the security arrangements.
Although World Bank Group lending since 1957 accounts for less than 1½ per cent of the total investment in mining in the developing countries, this has been estimated to represent a 6-8 per cent involvement in total mineral expenditures, and a contribution of between 20-25 per cent of costs. The discrepancy arises because the object of requesting the Bank’s financial participation in the past has frequently been not lack of money, but the inability to raise it without the World Bank’s presence in the deal, sought for what might be termed its stabilizing influence.
However, private parties furnishing security want to be free from their commitment if government interference causes enforcement of the security, and insist on limiting their obligations to cover technical or commercial but not political risks. The subject is known in Bank parlance as the “forcemajeure” exception. Many security arrangements contain forcemajeure exceptions, releasing the private parties from their obligations to supply funds (irrespective of the technique used) for cost overruns or repayment of the loan capital in the event of political interference.
Loans to governments vs. loans to private companies
Many covenants found in loans to private parties will not apply in cases where the borrower is a government or a governmental agency providing infrastructure or production facilities for mining with the assistance of Bank financing. Where the borrower is a private corporation, its debt/equity ratio will normally be subject to limitations imposed by the Bank. So, too, a restriction on dividends to shareholders or on interest on shareholders’ advances, and a commitment to keep working capital at adequate levels will be necessary. And there will normally be some real or personal security required. With governments, or governmental agencies, liens on specific revenues or assets as security for loans valid against third parties will not generally be sought, unless they are obtained by another creditor or lender participating in the financing, or where specific unencumbered assets may be seized by another creditor outside the member country. As already noted, a typical form of security that the Bank seeks in lending to a private investor in the mining sector is precisely of this kind—namely a shareholder’s commitment or an assignment to the Bank of a contract to take or pay for the mining product or both.
It is the Bank’s usual policy not to require specific security for its loans to governments or governmental agencies, and to permit the government in these cases to borrow on the basis of its general credit. Regarding mining projects in what would otherwise be IDA countries, the Bank relies on the security the government has—directly or indirectly—obtained from the beneficiaries of the particular project. The Bank does not, however, wish other lenders to take specific security or to acquire preferences or priorities of payment which could put the Bank in a subordinate position, or make payment to the Bank by a member country (either as borrower or as guarantor) more difficult than payment to another creditor. The Bank, therefore, includes in its agreements with members (whether as borrower or as guarantor) a “negative pledge” provision which assures it of equal and paripassu treatment if specific security or preference is later given to another lender. To be sure, the Bank has sometimes agreed to waive the right to participate in a security by virtue of the negative pledge undertaking if the circumstances justified it; but it would be less than prudent and it could weaken its position in the capital markets of the world if it did not pursue the practice of including a negative pledge covenant in its agreements with governments.
What of the future?
A growing Bank role in lending to the mining sector can be expected. There is likely to be more emphasis on local participation and on the fairness and openness of agreements governing the relations between the foreign and local participants. This would probably involve different legal and financial problems from those the Bank has been accustomed to, but these should not pose any real difficulties. It will, however, also entail the assumption of greater risks on behalf of already overstrained economies. It would be irresponsible to focus attention only on the profits of successful ventures without taking into account the potential for losses and failure. The bargaining power, and the geological and relevant technological knowledge of the producing countries must be strengthened, and adequate mineral policies and exploration techniques established so that the economic and social benefits of successful operations might be realized more quickly.
If the problems which now beset the industry are to be solved—and many of them are essentially political in nature—as everyone is well aware, a closer partnership between the mineral producing and the mineral consuming countries must be forged. The need for this is very urgent now because the balance of mineral reserves is gradually expected to shift toward the developing countries in the future. As a healthier country/corporate relationship is a precondition to any progress in the exploration and exploitation of new resources, governments as well as corporations will have to moderate some of the positions which have in the past led to conflict between them. Corporations will have to be more receptive to local demands (financial, economic, social, and political), and governments will have to minimize the political risks to attract the capital required for the development of new sources of supply.