April Insight - The Door Half Open

In the absence of China’s own proactive investment strategy in the energy and mining sectors abroad, the nature of how open China’s own resource sector to foreign participation may well have gone largely unnoticed.  But the more crucial question is really what is in China’s own medium- to longer-term interest?.  The fact is that expanding over time the level of international participation in the development of mineral resources within the People’s Republic of China is consistent with a robust and sustainable best practices mining industry within China.  Officially Chinese governments have proclaimed such investment is welcome; in practice, they have retained significant hurdles.

The author respects that each government has to factor in the short and long term capacity of its economy to absorb off-shore capital and ownership in its domestic resource sector.

A fundamental tenet of global investment in the resource sector must be that resource projects facilitate the transfer of knowledge, technology, management experience, environmental and labour practices and assist with the development of a rational flow of capital within the host country.

The author advocates that all governments should commit to concrete measures to develop and or maintain policies that are friendly, adhere to the rule of law and are committed to the sustainability of inbound and out bound trans-border investment flows of capital and services in the resource sector. A key factor in ensuring the sustainability of such investment flows is that all foreign investment reviews should adhere to a spirit of and international norms of reciprocity transparent approval process by all participants in the regulatory process.

This overview of the potential benefits to China of improving the conditions for international players to invest in its minerals sector is written with the knowledge that in the most recent ranking of resource investment climate, China's resource investment environment was ranked in the lower tiers on the Fraser Institute’s mining Policy Potential Index.

As China integrates further into the world's economy via offshore investments, there are a critical number of potential benefits to China's corporations and its economy if China expands foreign investment in the mining sector.  Furthermore, there are substantial number of potential domestic benefits to the resource industry within China that can be obtained through permitting the same access to resource development projects for foreign mining companies as are granted to both domestic public and private sector capital.

With respect to China's integration into the global economy, a firm commitment to an open door policy towards investment in the resource sector would provide comfort to the government agencies outside of China that are reviewing Chinese equity investment applications for projects within their own countries. It is important for these approval agencies to demonstrate to their political leaders, the mining industry and the public that China is committed to the spirit of reciprocity.  Access to resource projects worldwide on objective terms without any political barriers assists China's own resource investment strategy off-shore. It also creates the best political environment for China's sovereign funds and also leading non-resource focused SOE's under China’s State-owned Assets Supervision and Administration Commission (SASAC) to make direct and indirect investments abroad.

There is a critical commitment to continue to defend the principle of national treatment as prescribed under the WTO by offering an even playing field. What is dynamic and impressive about the development of mineral projects within China today is that there are state agencies, state owned companies, private sector companies and also publically traded companies in Shanghai, Shenzhen and Hong Kong that are actively involved in exploration and development of new mineral deposits. According to statistics released during China Mining 2007 by the Ministry of Land and Resources (MOLAR), there were 300-600 foreign funded exploration projects in China.  A significant portion of these companies have now ceased exploration in China. It is not difficult or unreasonable to suggest that all these various sources of mineral exploration and development capital deployed within China should be treated equally under the principle and spirit of national treatment. Fair treatment of international capital will also foster confidence in the Chinese private sector that its investment rights in new mineral exploration and development are also protected.

Prior to the current economic downturn, there had been a surge of protectionism worldwide in the resource sector. It is important, now that prices are far off peak levels, to return to the original rationale and repeat the goals that led to the liberalization of foreign investment in the mineral sector in China. These goals include new sources of high risk capital, increased access to technology and open-mindedness towards exploration, introduction of new mine design and metallurgical processing technologies, introduction of the Equator principles regarding the environment and international practices on labor safety, tailings design and reclamation -  simply defined as "sustainable mining".  Finally, there is the goal of increasing recovery rates on deposits, and also an improvement via international benchmarking on return on mining and exploration capital.

Most international companies in the minerals sector are publicly traded or listed companies regulated by securities legislation in developed countries. Their management are required by law to present financial reports quarterly, to present geological and metallurgical information according to legally recognized scientific principles, to adhere to the labor safety and environmental standards of their own jurisdiction as well as China's, and to support the anti-corruption goals of China's government through strict adherence to OECD guidelines and the respective laws of their country of origin including China’s own off-shore corruption law passed in 2011.  If projects are to obtain project financing for the development of a mining project, they must also meet Equator Principle. International companies will ideally introduce new practices to Chinese companies that will lead to better corporate governance and the adherence to international operational standards and return on capital.

The most important benefit to China's economy of having diversified sources of capital and of having international companies involved in the identification and development of new mines is, through the technologies and processes they introduce, access to zinc, copper, iron and precious metals from within its borders.  There are those who argue that resources fall under the category of "national resource security" and should not be developed by foreign firms. This is a simplistic argument.  In almost all cases, due to economic factors, export controls, and the legal requirement to sell metals to the Shanghai Metals Exchange or the Shanghai Gold Exchange, the resources stay within China unless the government wishes to export them. The tax rates for foreign companies and domestic companies are now at parity. The only downside to China of foreign ownership of successful resource projects is repatriation of dividends that are only declared at the end of a large risky investment.  

For a number of years, Chinese authorities have publicly promulgated interest in having foreign operators to invest in China's resource sector, but in practice, foreign firms rarely have the same access or benefits in the market that Chinese bureaus and exploration firms do.  In recent years many international and private Chinese companies have discontinued exploration activities in China for that very reason.

The philosophical principle of national treatment for international resource companies operating in China was part of the motivation for tendering and promoting investment in exploration in China from off-shore players. This same principle has created many opportunities and benefits for Chinese firms whom have invested abroad since 1979.  As alluded above, to continue to scientifically develop the potential of its resources, China must attract significant investment in exploration, mining equipment and services, which will in turn introduce new management and resource technologies, benefitting the entire industry, as well as the people of China.

Without national treatment being extended to foreign resource firms that wish to operate in China, moreover, there are potential negative implications for China's offshore resource investment strategies. Therefore, given current financial market trends, this is an opportune moment to shift away from protectionist sentiments. Instead, China should consider the overall benefits to its people and industrial development and continue to attract foreign investment in exploration and mineral development, China should permit properly qualified, foreign-invested mines to be permitted, developed and operated.

China should not shut the door to foreign investment in the mining industry as this will create untold losses for the mineral sector and China's economy.  Opening the sector, on the other hand, will facilitate its globalization and modernization – and thereby strengthen its value added to China’s own ongoing development.

John Gruetzner is the Managing Director of Intercedent. Intercedent is an investment and business advisory firm focused on Asia.

This Insight is reprinted with the permission of the University of Alberta, China Institute.

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