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1 almdms #2033587-v1 Mongolian Mining Investment - Selected Legal Considerations John Connors Managing Partner, Central Asia [email protected] June 2010 Mongolia Mining investment 2010 21 -22 June 2010 Amora Hotel Jamison, Sydney 2 Addressing A. Foreign Mining Investment in Mongolia B. Mongolia’s National Circumstances, Development Goals C. Competing Pressures on Government D. Mongolia’s Approach to Mining Regulation E. Mining Taxation F. Oyu Tolgoi and Tavan Tolgoi G. Uranium Sector Policy, Regulatory Developments H. Risk Factors and Risk Mitigation I. Future Directions J. Summary and Conclusions

2010, PRESENTATION, Mongolian mining investment selected legal considerations, Mr. John Connors

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almdms #2033587-v1

Mongolian Mining Investment

- Selected Legal Considerations

John ConnorsManaging Partner, Central [email protected] June 2010

Mongolia Mining investment 2010

21 -22 June 2010 Amora Hotel Jamison, Sydney

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Addressing A. Foreign Mining Investment in MongoliaB. Mongolia’s National Circumstances, Development Goals C. Competing Pressures on GovernmentD. Mongolia’s Approach to Mining RegulationE. Mining TaxationF. Oyu Tolgoi and Tavan TolgoiG. Uranium Sector Policy, Regulatory DevelopmentsH. Risk Factors and Risk MitigationI. Future DirectionsJ. Summary and Conclusions

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A. Foreign Mining Investmentin MongoliaA. Foreign Mining Investment in Mongolia

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Foreign Mining Investment in Mongolia• Mongolia unique in former Soviet Union/satellites in having

significant foreign mining presence (approx 200 foreign owned, JV Cos in Mongolia)− Chinese State and privately owned companies− Western majors, specialists, mid caps− Western Juniors− Japanese trading companies− Russian mining companies− Korean majors− Other: sovereign wealth funds, resources, investment funds, suppliers

• Also numerous private Mongolian mining companies• Approx 3,600 exploration and 1,100 mining licences issued, covering

approx 32% of the country, many to foreign investors

• Mostly mining investors are engaged in exploration and some earlydevelopment stage projects. As yet, relatively few operating mines

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A. Foreign Mining Investmentin Mongolia

B. Mongolia’s National Circumstances, Development Goals

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● landlocked, positioned between Russia and China ● very small population (approx. 2.8m), 1/3 “poor”● nomadic lifestyle traditions (still >40% engaged in herding)● limited transport, other infrastructure, industrial plant● limited domestic sources of finance and investment ● still in transition to market economy under rule of law ● Soviet era legacies in law, admin. but open to other models, ideas● vibrant democracy, changing government

● strong nationalist social and political forces ● most open of the FSU/satellite countries to DFI in mining● endeavouring to balance foreign investment, geopolitical, national

development goals

Mongolia’s National Circumstances

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Mongolia’s Development GoalsEconomic and social development based on mining and improved standards of living but not beholden to foreigners● education● employment and training● regional economic development ● industrial diversification, value adding● devt. of essential infrastructure: power, transport, water● environmental protection

General recognition that Mongolia can’t develop its resources on its own, hence needs legal, regulatory and fiscal systems balancing relevant interests:– attractive to foreign mining investors– facilitating modern commercial, financing transactions– satisfying nationalistic sentiments in politics, electorate

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A. Foreign Mining Investmentin Mongolia

C. Competing Policy Pressures on Government

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Competing Policy Pressures on Government● Pressures for Liberalisation of Mining and Investment Laws

– domestic economic pressures - need for finance and investment– foreign investors, Governments of investing countries– int’l financial institutions (World Bank, IMF, WTO, EBRD, ADB)– sections of business, government - State should stay out of business

●Countervailing Pressures– domestic political concerns – highly nationalistic electorate – national security concerns – geopolitical balancing of interests – civil movements – too many concessions, insufficient national

revenue/benefits− old guard, academics – State should own 50-100% of mines

●Government wishing to both attract further foreign investment and retain control of natural resources, ensure national equity interests, social benefits

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Other Social Pressures● Corruption

– Transparency International 2009 ranking Mongolia 120/188 (cfKazakhstan120/188, Russia146/188, Kyrgyzstan 162/188)

– reported examples in issue of licences and permits, official monitoring of compliance with licence terms, environmental requirements, etc.

– May’10 Democratic MPs’ open letter to PM referred to unchecked growth of corruption, bribery and bureaucracy in government organizations – urging a comprehensive government response

● Public Expectations of Benefits from Mining– Great public expectations of benefits for Mongolia from mining, in part

created by politicians’ promises of direct individual benefits – cash, shares for individual citizens

– Herders moving into Ulaanbaatar after severe 2009 winter and loss of livestock (accentuating demands on government for money handoutsfrom mining revenue)

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Ambivalence Towards Giant Neighbours●Russian political, commercial relationship still strong

– transit route, important market, source of supply– post Soviet affiliations

●China's Growing Economic Importance– now the key market and transport route, source of supply– also China/HK key source of finance and investment for

local companies– Western juniors also finding Chinese investors

●National security concerns (fears of economic domination leading to loss of sovereignty, independence) - “third neighbour” policy

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D. Mongolia’s Approach to Mining Law and Regulation

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Mongolia’s Legal System● Mongolia: an independent sovereign republic under a national

constitution (1992); a unitary State

● Civil Law Legal System: Romano – Germanic origins, Soviet and other influences (including via input of multilateral agencies)

● Legislative power: State Grand Khural (Parliament) the only body with legislative power– elected every 4 years– convenes twice each year in autumn and spring sessions– 7 standing committees, including National Security and Foreign Policy.

● Executive Powers: The government is the highest executive body. Comprises the prime minister and cabinet. Directly responsible to the SGK

● Other:– President - Head of State elected for 4 years term– Constitutional Court – appointed by the SG Khural– Courts - independent judiciary appointed by the President

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Mongolia’s Mining Laws and Administration● Primary laws on mining:

– Minerals Law 2006– Nuclear Energy Law 2009 (regulating uranium exploration, mining)

● Other important laws/legal acts:– Constitution, Civil Law– Company Law, Foreign Investment Law, Tax Law– Subsoil Law, Land Law, Mining Prohibited in Specified Areas Law,

Environment Protection Law, Labour Law, Labour Safety and Sanitary Law– Various Parliamentary resolutions, Presidential orders– Bilateral, Multilateral Treaties

● Mining administered by several government agencies, including:– Mineral Resources Authority of Mongolia (MRAM) a subordinate agency

of Ministry of Mineral Resources and Energy (MMRE,) esp Department of Geological and Mining Cadastre (“DGMC”) – grants exploration licences(MELs) and mining licences

– Provincial (Aimag) Governors

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1997 Minerals Law●Widely considered at the time as establishing a sound basis for

conduct of mining in Mongolia– drew on western mining law models– created a licensing system; open to foreign investment – provided for transparent, secure and transferable property rights

in exploration, mining and processing – incorporated the fundamental policy principles regarded as

essential by industry– considered to be progressive, internally consistent and effective

●However merely a framework – 65 Articles (32 pages English translation)– requiring further legislative, regulatory detail, specifying how

principles to be applied in practice

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2006 Minerals Law● Preserves much of the basic structure and substance of the 1997 Law

– licensing system; open to foreign investment– exploration on first come, first served basis– relative security of title, transfer freedom – “investment agreement” (cf “stability agreement”, 1997)

● However new provisions reflecting growing resource nationalism– State entitlements, powers (deposits of strategic importance)– provisions increasing role of administrative discretion in licencing, regulation– overall, weakening the rights and security of holders of mineral titles

● Lack of detail, clarity remains a feature of 2006 Law– 66 Articles (38 pages English translation)

– uncertainty still exists as to how a number of important provisions will be interpreted and applied (e.g. several provisions relating to Deposits of Strategic Importance)

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Grant of Exploration Rights ● All areas open to exploration other than reserves, special

purpose territories, existing licence areas, etc.

● Only Mongolian legal person may hold EL

● EL has initial term of 3 years renewable for 2x3 year periods ● Exploration rights ordinarily granted on a first come, first served

basis, except- land explored with State funds or - land where the holder has forfeited exploration rightswhich will be made available by tender.

● In tenders, cash bids neither required nor allowed. Technical merits of exploration proposals determinative. (MRAM still has the authority and responsibility to assess merits of proposals)

● Note: 2006 Minerals Law removed “exclusive” from wording re rights of exploration licensee – significance uncertain – allows MRAM to allocate exploration rights per mineral?

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Freeze on Exploration Licences● Mongolia’s president, Tsakhia Elbegdorj on 20 April 2010

– ordered a halt to the issue and transfer of mineral exploration licenses until the government can enact a stricter law on mininginvestment

– called on the government to hold discussions on the matter in June– remarked that most of the permits currently held by companies and

individuals operating in Mongolia are being held in contravention of existing laws and almost half of the exploration license holders neglect their obligation to provide annual exploration reports, while many are only using the permits as money making tools and not investing in any active exploration

● In early May 2010, the National Security Council NSC partly amended the presidents’ order to allow transfer of licenses from one owner to another

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Continuity from Exploration to Mining

● Exploration Licence holder has the right to progress from exploration to mining

– an exploration licence holder shall be entitled to obtain a mining licence according to its exclusive right (ML Art. 21)

– only the exploration licence holder is entitled to apply for a mining licence (ML Art. 24.1)

● However, mining rights must be approved by Governor of the aimag in which licence area located (Licensing Law)

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Mining Licences● Only Mongolian legal entities entitled to hold ML.

● ML granted for initial term of 30 years, renewable for 2x20 yr periods.

● Only the EL holder entitled to apply for ML in the exploration licence area (ML A 24.1).

● Requested mining area can’t overlap with an area under existing valid licence (ML A 24.4). (i.e. no rights to explore for or export other metals or minerals can be superimposed on ML area).

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Deposits of Strategic Importance

● Defined as: deposit with a size that may have a potential impact on national security, economic and social development of the country or that is or has potential of, producing more than 5% of total GDP in a given year (ML Art 4).

● In 2007 Parliament (Resolution No. 27) – deemed 15 deposits as strategic– also 39 deposits identified as Tier 2 – to be

assessed for Strategic Deposit designation

● Parliament may also designate other deposits as strategic

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Deposits of Strategic Importance - II State Participation● State may participate in the exploitation of mineral deposits of

“strategic importance” (ML Art.5)

– up to 50% jointly…”in exploitation” if the State contributed to exploration of the deposit

– for all others “State may own up to 34% of the shares of the investment”

● Parliament may determine State share based on a proposal by the Government (executive branch) or on its own initiative.

● State share is effected through an exploitation agreement.

● Erdenes MGL LLC, State owned company established 2007, represents State’s interests in deposits of strategic importance (except uranium).

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Deposits of Strategic Importance - III Legal uncertainties, including…●Delineation of boundaries

●Procedure for/extent of government’s exercise rights Commercial basis for obtaining stake? Compensation for expropriation? Deadlock in negotiations? New licences -negotiations on grant?

●Listing obligation – Any company which holds a mineral deposit of Strategic

Importance is required to list at least 10% of its shares on the Mongolian Stock Exchange (ML Art. 5.6)

– Provision not yet enforced re any of those companies with deposits on the Strategic Deposits List. Not clear how will work in practice

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Surface Land Rights● Land Use Rights – Business Entity w/Foreign Inv.

– to engage in mining activity, the licence holder, if a BEFI, must acquire land use rights to the relevant land area

– under the Land Law land use rights may be granted for up to 60 yrs (although typically granted for shorter terms);

– Foreign Investment Law provides that BEFIs may not renew more than once

● Land Use for Special Needs– Land Law provides that land can be taken by the relevant local

government body for the purpose of among others:– specially protected areas;– lands allocated for ensuring national defence and security;– range lands and hayfields

– DGMC may revoke a licence if the exploration or mining area designated as special needs land and licence holder fully compensated

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Mining Prohibition in Specified Areas● 16 July 2009 - “Mining Prohibition in Specified Areas Law”,

prohibiting minerals exploration and mining in– headwaters of rivers and lakes;– forest areas as defined in the Forest Law;– land areas adjacent to rivers and lakes as defined in Water

Law ● Will be no grant of new exploration and mining licences

overlapping the defined prohibited areas ● Under the law, GOM to undertake a survey to determine the

boundaries of prohibited areas - reports that GOM will soon issue a list

● Also however reports of government concerns re compensation obligations provided in the law

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Investment Agreement ● A mining licence holder which undertakes to invest more than

$50m over the first 3 years of a mining project may apply to the State to enter an Investment Agreement (ML Art.29), providing for:

– stability and tax rates (income tax, customs duty, VAT, royalties)– right to export and sell products at international product price– guarantee that the licence holder may receive and dispose of income– the amount and term of the holder’s investment– environment protection, public health– regional development and employment

● The term of the Investment Agreement will depend on the monetaryamount of the five years commitment: $50m - 10 years; $100m - 15 years; $300m - 30 years

● No model form. Initially envisaged that IA for Oyu Tolgoi project (below) would practically provide a template. Now OT IA not being described this way

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Regulation of Operations I – Minerals Law● ML (Art.35.5) requires complete extraction - “the licence holder

shall exhaust all the mineral reserves. It is prohibited to mine selecting the high grade areas”. However unclear what this exactly means or implications of breach

● Obligations re Reserves Reporting

– EL holder must provide report on reserves

– Govt Agency, based on expert opinion shall include in national registry of reserves

– ML holder must submit production estimating annually, action plan annual report; basic indicators of the mining work approved by surveyors of mines, information on changing reserves, quantity of ore mined (ML Art. 48)

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Regulation of Operations II – Investment Agreement● Note: Possibility of clarifying extraction obligations in

IA e.g. the Oyu Tolgoi Investment Agreement provides:– feasibility study contains a schedule of estimated

annual production figures. The Investor will provide an annual updated table.

– investor will use reasonable efforts to extract and process mineral ore that is not less than the estimated quantities.

– actual quantity of products produced in any year remains within the competence and discretion of the Investor.

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Local Content Requirements ● No obligations on Mining Licence holder to purchase, use

locally manufactured goods (cf. e.g. Kazakhstan) ● However ML (Art.43) provides at least 90% of licence holder’s

employees must be local ● Also GOM increasingly encouraging mining cos to carry out

value added production in Mongolia● ML (Art 29) provides Investment Agreement shall contain

clauses re regional development and job creatione.g. The OT IA provides that in accordance with Art. 43.1 not less than 90% of the Investor’s employees will be citizens of Mongolia andInvestor will use best efforts to ensure that

– for construction work in construction period not less than 60% of the employees will be Mongolia citizens

– for mining and mineral work, not less than 75%

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Transfers ● Under ML Art 49 the holder of exploration or mining licence may not sell

the licence per se. However :– exploration licence holder may sell the underlying materials and

reports; and– mining licence holder may sell the mine, machinery etc.

● Upon completion of the sale and payment of applicable taxes the holder may transfer the licence (for no consideration)

● Licence holder may transfer part of the licensed area (A 50)

● Note however – ML prohibits transfers to persons “ineligible” to hold a licence− Uranium interest transfer, share issue, subject to approval by nuclear

energy committee (NEL Art. 7)− Registration of transfer with DGMC required before effective− GOM as a matter of foreign policy sometimes negotiates restrictions

re with whom foreign investors might partner, to whom may sell equity stakes or what financing foreigners may obtain (i.e where national impact /security concerns)

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Pledges – Licences as Loan Security● Licence holder may, with govt approval pledge its licence to a bank

or non banking financial institution with the related documents,information etc. permitted to be pledged by law (ML Art. 51.1).

● However licence alone shall not be a pledge item

● The pledgee shall not assume any obligations under the licence

● In the event of default the pledgee may transfer the pledged licenceto an eligible person, subject to government approval

● Registration of pledge with DGMC required for effectiveness

● Note: –pledges recorded on endorsement sheets separate from but

considered integral part of EL certificate –DGMC does not maintain records of other liens, encumbrances

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Renewals

● Exploration licence (3 year term) holder has right to obtain two, 3 year extensions on fulfilling requirements

● Mining licence (30 year term) holder has right to obtain two, 20 year extensions, depending on reserves (A 21, 22)

● ML provides “if no violations” extension shall be granted (A 27, 28)

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Dispute Resolution ● Exploration and Mining Licences

Where any actions or failures to act by civil servants/or Government Agencies has prevented the exercise by licenceholders of the rights conferred on them by this law the citizens or legal persons may file a complaint with the relevant senior officials, State agencies, or the courts (ML Art. 64.1)

● Investment Agreement– ML Art. 65 provides that any disputes arising out of an IA

according to As 29-30 shall be resolved as per the laws and international treaties of Mongolia

– The OT IA provides that disputes shall be settled by negotiationor failing that by binding arbitration in accordance with the UNCITRAL Rules, in London, administered by the LCIA. The Arbitration shall apply laws of Mongolia

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“Ninja” Miners● No law yet deals with artisanal mining ● so called “ninja” miners illegally mining, mostly gold,

silver, causing significant environmental damage (reportedly approx 35,000 ninjas at 100 different sites in 57 soums)

● reports that Parliament recently approved proposal to amend Minerals Law to provide that artisanal mining be regulated by Government order– intent to press artisanal miners into cooperatives consisting

of at least 5 members, allocating a certain area per soumfor artisanal mining

– mining licence for cooperatives to be issued by local soumor district authorities

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Suspensions, Termination of Rights

● The government agency shall revoke a licence if:– failure to comply with requirements re licence fees– transfer to non Mongolian company– exploration expenditure lower than minimum– failure to fulfill environmental reclamation duties

(ML Art 56.1)

● Within 5 days of determination that grounds exist, government agency shall notify holder

●Holder may object, with evidence, apply to courtE. Mining Taxation

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Mining Taxation – 2006 - 2010● The 2006 Windfall Profits Tax imposed a 68% tax on the portion

of metal sales price of copper ore and concentrate (defined by reference to the London Metal Exchange) in excess of US $2,600 per tonne and sales price of gold (defined by Bank of Mongolia) above US$500 per ounce (raised to US $850 per ounce in 2008)

●August 2009, Govt resolved to abandon the WPT as from 2011● 2009 revocation of VAT (10%) exemption on import of

equipment to be used to bring a mine into production● The Mongolia’s tax regime (top corporate income tax rate of 25%)

otherwise seems generally considered to be broadly competitive with other major foreign mining jurisdictions (although lacking in clarity and detail)

●Mongolia has entered double tax treaties with numerous countriesincluding China, Russia, Canada, Korea and Britain (not Australia)

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Proposed Taxation (Royalty) ChangesMay’10 press reports of GOM plans to introduce a new form of tax called “increased royalty” from 1/1/11 (replacing the 68% windfall profit tax) - to be charged according to commodity price in global markets (cf. profits) on sliding scale.

up to $2109%

up to $21010%

up to $1607%

up to $1908%

up to $1306%

up to $1005%

Processed Coal

up to $659%

up to $6510%

up to $457%

up to $558%

up to $US 356%

up to $255%

Unprocessed Coal

above $3,500 8%

$3,000 - $3,5007%

$2,500 - $3,1006%

up to $2,0005%

Nickel

$1,200 above10%

$1,000 - $1,2007%

Up to $12008%

$1,000 - $1,1006%

up to $9005%

Gold

above $9000 per t10%

$6 - $9000 per t9%

$5 - $5000 per t6%

up to $5000 per t 5%

Copper

Note: Press reports only: Subject to Parliament approval implementation.Also will necessitate change to Article 47 of the Minerals Law (re royalties)

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Contract and Tax Stabilization● No general stability provision in Minerals Law

preserving holder of mining licence or parties to Investment Agreement from legislative change

● However Minerals Law provides Investment Agreement “must contain stable tax environment clause”

e.g. Oyu Tolgoi Agreement provides that various specified forms of taxation (corporate income tax, customs duty, VAT, royalty, payment for exploration and mining licences, other) “are stabilized” (Ch.2)

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Suspensions, Termination of Rights

● The government agency shall revoke a licence if:– failure to comply with requirements re licence fees– transfer to non Mongolian company– exploration expenditure lower than minimum– failure to fulfill environmental reclamation duties

(ML Art 56.1)

● Within 5 days of determination that grounds exist, government agency shall notify holder

●Holder may object, with evidence, apply to courtF. Oyu Tolgoi

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Oyu Tolgoi Investment Agreement● On 6 October 2009, (after a 6 year period of negotiation) GOM,

Ivanhoe Mines and Rio Tinto signed an investment agreement providing for development of the Oyu Tolgoi copper/gold deposit

● Key Elements� 34% GOM ownership� commitments re local employment and procurement� various guarantees, assurances for licence holder

● Scope – All Investor’s Project Activities– exploration and mining– construction of infrastructure– mine closure and environmental rehabilitation

● Term– initial term 30 years– extendable for additional 20 years

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Oyu Tolgoi Investment Agreement (cont’d)● The OT IA almost universally regarded by observers as very

positive sign, demonstrating that� Mongolia can say yes to foreign control of big mining projects� GOM can commit to compensating private holder of rights to deposits

of strategic importance� GOM and Parliament willing to amend laws and regulations to enable,

enhance commercial viability of mining projects

● “The signing of the OT IA will signal Mongolia’s transformation…and will be remembered as heralding Mongolia/rise to become a world mining power” (Canada’s Ambassador Biolik11/09)

● March’10 Ivanhoe Mines announced that CPs for effectiveness satisfied.

● Attention now turning to financing. May’10 mandate to EBRD, IFC to develop funding package

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G.Uranium Sector Policy, Regulatory Developments

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Nuclear Energy Law 2009 ●New Nuclear Energy Law (NEL) - effective August 16, 2009

– to regulate relations connected to exploitation of radioactive minerals and nuclear energy

– ensuring nuclear and radioactive safety, to safeguard the population, society and environment

ie creates a uranium specific regime for licensing, regulating exploration, development, mining and sale of uranium (independent of Minerals Law)

●NEL classifies all radioactive mineral deposits, regardless of size, as strategically important (Art. 6)

●Monatom LLC a State owned company, established Feb. 2009 to undertake uranium exploration and mining and hold State equity in uranium projects

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State Participation in Uranium Mining ● Radioactive minerals existing in the subsoil are the property of the State

(NEL A 5.1)● In case of a reserve determined through exploration conducted

through expenditure from the State budget which is to be exploited with another party the State shall own directly not less than 51% of the shares the joint company and without payment (A 5.2)

● In case of a reserve determined through exploration conducted without expenditure by the State budget the State shall hold not less than 34% of the shares of the company holding the mining licence without payment (A 5.3)

● If the State should possess more shares than those specified – the State Great Khural shall determine the State’s shares according to a proposal submitted by the Government considering the past and future amount of the State’s investment (A 5.4)

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Corporate Decision Making - Government ApprovalsA decision on the following made by the licenceexploration or mining holder’s shareholders meeting, board of directors, or executive body shall become valid after it is approved by the Nuclear Energy Committee (NEL Art.7)● the sale, gift, pledge and transfer of more than 5% of the

shares●newly issue a share subscription or share convertible

security of more than 5% of the total issued shares●A restructuring of the company by merger, consolidation,

division and separation

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Western Investor (esp Juniors) Concerns● GOM’s entitlement to take, without compensation, at least

51% or 34% of the company (cf the deposit) that will develop the mine i.e. Govt. requiring a very substantial, free carried, non compensated interest in any uranium mining operation

● GOM has stated will insist a compliance with Art.7 re prior NEC approvals

●Also, uncertainties – e.g. reportedly, GOM officials have expressed the view that the separate licensing regime under NEL, enables the State to issue a distinct licence for uranium exploration for an area otherwise licensed for other mineral exploration

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Mining Agreement - Uranium ● The State authority shall conclude a mining agreement with a

mining licence holder undertaking uranium mining within 60 days after issuing the licence. (NEL Art 29.1)

● The following must be reflected in the mining agreement:

– reasons for mining of radioactive material

– the term of mining the deposit and details of radioactive materials

– technology, production capacity and quantity of products to be mined as reflected in the feasibility study

– conditions of product sales

– plans for environmental protection and reclamation

– rights obligations and responsibilities of the parties

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Investment Agreement - Uranium● The licence holder may request entity into an investment

agreement with the purpose of providing a stable environment to undertake the activities for up to 10 years (NEL, Art. 30.1)

● The investor shall send together with the request, a draft agreement attaching information on the size of the investment to be made in the 1st 5 years, plant capacity, name and type of product, method and technology of mining the deposit and a feasibility study

● The matters stipulated in Articles 29.1.1 – 29.1.9 of the Minerals Law shall reflected in the Investment Agreement

● The Investment Agreement may be extended for up to 10 years

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Uranium Sector - State to State Relationships● Several recent instances in which agreements with State owned

companies evidently favoured over investment agreements with private companies

● Speculation re possible reasons – Geopolitical concerns balancing interests re giant neighbours– Also, govt. to govt. interaction with “3rd neighbours” towards

broadening diplomatic relationships – GOM wish to maintain control of strategic resource– GOM strategy also to develop value adding activity– History of State to State deals between Mongolian govt.and

foreign Governments– GOM’s awareness that State owned companies consider

uranium to be a strategic resource may be willing to invest even at a loss and less concerned by lack of infrastructure

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Mongolia’s Mining Laws Compared – I Developed Western Mining Jurisdictions ● State ownership entitlements and powers ● lack of detail, clarity● process - important new provisions being adopted

without much consultation, careful consideration● uncertainty - no settled approach to big projects● administrative discretions and practicalities of

mining administration ● general legal, country circumstances, issues

Overall, more of a work in progress – policy direction not settled (esp role of the State)

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Mongolia’s Mining Laws Compared - II CIS Neighbours● open exploration regime, licensing system (cf contracts)● mining specific (cf “subsoil” laws, also covering oil & gas)● transfer freedom (no State preemptive rights)● ready availability of geological information (cf “secrets”)● commercial freedom/absence of state acquisition rights● greater operational freedom● relatively limited local content requirements● laws user friendly (easy to navigate, simple style English

translation on internet)Overall, despite concerns, Minerals Law and mining investment regime less “Soviet” and in many ways more open and attractive to DFI than in neighboring countries

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H. Risk Factors and Risk Mitigation

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Changing Perceptions of Country Risk● Hopes high after 1997 Mineral Law - influx of DFI in coal, copper, gold,

uranium exploration

● Mongolia’s position deteriorating 2006 – 2009.

45/72

51/7267/7242/722010

23/25

18/258/2511/252010

Fraser InstituteBehre DolbereCountry

58/6558/6423/2519/25Russia

59/6546/6419/2518/25Kazakhstan62/6533/6413/259/25Mongolia54/6542/6410/2510/25China2009200620092006

● 2009/2010 – positives: signing of OT - IA, abolition WPT– negatives: provisions in Nuclear Energy Law, Mining Prohibited in

Specified Areas Law; TT uncertainty, ongoing policy debate

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Non Commercial Risks in Central Asia● Security of Mining Tenure

– terminability– convertibility of exploration rights to mining rights– ability to renew contracts, licenses– consent to transfers

● State Priority / Acquisition Rights– compensation, means of determining FMV

● Aggressive Tax Policy and Administration● Creeping Expropriation – changing legislation; reducing investors’

contract and tax stability● Environmental Regulation and Liability● Acts of Provincial, Regional Administrators – e.g. in grants of ancillary

permits, consents to land use, water entitlements● Corruption, Administrative Interference

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Legal Uncertainty - MongoliaFrequently citied uncertainties in legal system limiting available legal protection:● rapid legislative change● uncertain laws, ambiguous and conflicting interpretations by

officials● passing of new laws with limited consultation● inconsistency between laws● limited judicial and administrative guidance on interpretation● substantial gaps in the regulatory structure due to delay or

absence of implementing regulations● debt collection, bankruptcy procedures not well developed

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Judicial Uncertainty● Mongolian judicial system still has relatively little

experience in enforcing existing laws and regulations, leading to:� uncertainty regarding the outcome of any litigation, including ability

to obtain quick, effective enforcement or enforcement of a judgment or arbitral award in another jurisdiction;

– transaction or business structure that would be acceptable in adeveloped legal system may be regarded as outside the scope of existing Mongolian laws, regulation or legal precedent and henceinvalid.

● Lack of established, accepted, interpretations of new principles of Mongolian legislation, esp those relating to business, corporate and securities laws

● Lack of judicial independence from political social and commercial forces

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Acts of Provincial Administrators● Grant of exploration and mining licence subject to approval of

governor of relevant aimag but no clear guidance on what legal grounds will warrant refusal

● ML (Art 42) also provides licence holder shall “conclude agreements” with local admin bodies on environmental protection, mine exploitation, infrastructure development in relation to mine site development and job creation etc.

● No clear regulatory provisions on use of powers, creating potential for differences of interpretation at provincial, central levels

● Reported industry claims –some provincial administrations abusing powers to designate land as

special use zones (by classifying land as for agricultural use)–misuse of local offices’ power to give advisory comments on grants and

permits for water use and grant of mining licences

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Risk Mitigation Strategies

● Thorough Due Diligence (project and regulatory)

● Joint Venture with State/selected local company

● Involve internationally prominent entity

● Balanced, effective Investment/Mining agreement

● Government to Government/Diplomatic Support

● International Arbitration (Agreement and Investment Structuring through BIT Country)

● Other Practical Measures (e.g. PR Insurance, Probity)

● Remember Country Risk doesn’t equal Project Risk

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Risk Mitigation - Other Practical Measures●Understand the “soft side” of Political Risk●Limit capital investment commitment (e.g. consortium)●Confirm project economics can withstand a major change●Constructive relations with both Central Govt, local

officials●Active social involvement/obtain local support/open

communication with local communities●Preferential use of local employees, facilities●Maintain good relationship with local workforce (terms,

OHS)●Strict environmental standards and compliance●Conduct business in transparent and ethical manner

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What Should Legal Due Diligence Cover?

Title to shares, interests, etc.; authority to sellVendor

Due Diligence Review

Target entity: assets, liabilities, decision makingTarget Co

Title - exploration, mining (contract / licence / tender agreements). Other projects specific risks, issues

Project, Contract/Licence

Areas of country and legal risk, incl. security of tenure, legal & fiscal stability, investment protection

Development and environmental approval process

Parties’ legal rights to undertake/operate the project

Procedural requirements, government consents

Parties’ rights to implement sale and purchase

Legal Investment Framework

DescriptionItem

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61

Mining Agreements with Government: Key Legal Considerations for Investors● Ensure Comprehensive Coverage – all necessary rights

– implementation regulations, discretions minimal

● Ensure State is bound by the contract– suitably empowered signing authority and contract validly overrides all

inconsistent laws, either:• appropriately empowered admin authority (competent authority) binds the

State; or• Parliament’s ratification in order to validly override inconsistent laws

(object to create special project agreement containing special law for the project i.e. general law applies except as provided)

● Carefully consider Stability Issues– State always free to change the law; but– should ensure that it agrees won’t do that and that agreement is subject to

foreign law enabling the investor to take steps to international and arbitration breach of contract

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Differing Priorities, Risk Perceptions●Juniors – Stock Market Orientation

– Availability of prospective new ground / secure tenure– Stock exchange/other exploration funding availability, attractiveness

●Major Western Mining Companies – Supplier Orientation– Preference for full or majority ownership/control– High visibility, responsiveness to markets, media, analysts, NGOs– Development funding operational, logistical interests

●Raw Materials Users, Trading Cos – Procurement Orientation– Metals, Power, State owned companies– Strategic national industries, home govt. support– Often content with minority JV interest/offshore equity and offtake

●Differing National Perceptions of Strategic significance, opportunity: China, Korea, Japan

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63

Investment/ Resource Procurement Strategies ● Offtake/Long Term Minerals Supply Contract only● Offtake/LTSC plus equity funding support for holding entity (e.g. public

company share or convertible placement)● Offtake LTSC plus debt funding support for local operating company mine

development● Offtake plus acquisition of minority interest in JV controlled by local private

company/national company/SOE● One of the above plus funding for essential infrastructure● Other earn-in to advanced exploration prospect, substantial JV interest● 100% owned, greenfields project● 100% or majority acquisition of a defined resource or operating

mine/processing facility● 100% private mining/metals company acquisition● Public mining/metals company takeover

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I. Future Directions?

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65

Tavan Tolgoi● South Gobi Aimag, Tsogt Tsetsii Soum● 250km from Chinese border● 6.4bt coking and thermal coal● suitable for open pit mining● discovered in 1950’s, during Soviet era● major portion held by State (part Energy Resources LLC)● Government plans to attract a strategic investor has drawn

substantial international interest and competition (China, US, Australia, Brazil, Japan, Korea, Russia, India)

● also diplomatic pressure from goverments

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Tavan Tolgoi Development Model● GOM initially proposed sale of 49% interest (51% to be

held by Erdenes MGL)● Feb’10 auction cancelled – new tender bids being called● GOM determined to hold TT 100% and derive greater

value for Mongolia than obtained under Oyu Tolgoiarrangements

● Development model proposed PSA/CCOW (cf ML)● Government also stated (May’10) will look for benefit to

national interest– greater role for Mongolian companies and individuals– greater advance payment– commitments to infrastructure value adding and

technology

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67

Contrast Tavan Tolgoi with Oyu Tolgoi

IM

EM OTLLC OT

GOM

RT

IMSub

100%

ML

IA

34%

66%

Oyu Tolgoi(Mining Licence)

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Contrast Tavan Tolgoi with Oyu Tolgoi

Inv.1

EM

Contractor

TTGOM

Inv.2

Holdco

100%ML IA

PSA

TavanTolgoi(PSA/Contract)

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69

Also Contrast Private Investment Structures

Shareholders Agreement

Mining Licence

Foreign Inv

SPV I (foreign)

Holding Co

SPV II (Mongolian)

Holding Co

Operating Co

GOM

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Recent Developments re Tavan TolgoiReports that GOM submitted to Parliament on 27th May a report of the working group on TT which included● draft Investment Agreement

– Mongolia to remain 100% owner;– equal treatment of domestic & foreign bidders in selecting a contractor– Parties- Erdenes MGL (requesting I.A. as licence holder), GOM (Minister of

Finance, MRE, Environment)– Details - 19 Chapters, 144 Articles, 2 Appendixes: stable tax environment,

authority to license holder to sell its product & manage revenue, environment, CSR concepts.

● draft Coal Mining Agreement– Concept - Production sharing arrangement (drawing on Australian, Indonesian

coal mining agreements, Mongolian oil PSA)– Details - 21 Articles, 1 Appendix; Price calculation formula; Product sale; Pre

payment and bonus; Reporting procedure● draft Tender Bid Documents● draft Parliamentary Resolution authorizing TT exploitation

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Other Big Projects – Which Approach?PM Batbold (7 Feb.2010) – ownership and investment in big projects to be decided on a case by case basis. Possibilities:● Joint Ventures

– will State require carried interests to enable it to meet cost?– interest charges?

● Production Sharing Arrangements – mining company bears the cost of developing the project– mining company shares production/revenue with State

● Contract Mining – Government bears the cost of developing the project but hire a

contractor to carry out the extraction work– challenge given development costs and government finances

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Ongoing State Participation in Projects?● Idea of ownership has symbolic importance (people mindful

of historic exploitation; wary of greedy foreign investors)

● Also people’s expectations of direct benefits created by successive governments’, political parties’ election promises

● Western analysts however, argue:– Mongolia would be better served by taxing, royalties– Govt has conflict of interest (shareholder in company vs people)– Govt as owner more vulnerable to dips in production– Mongolia doesn’t have the capital or resources to fund devt, mines,

infrastructure

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73

State Participation (cont’d) Western Commentators also arguing

●Attempts to avoid cost by compulsory (free) acquisitions or by compelling licensees to fund government share, will damage international investors’ confidence

● If Government insistent on equity– should limit State equity to max 34%; paying full mkt value of

time and acquisition– mkt value to be determined by independent valuation process

and agreed by govt and licence– actual level of equity to be determined in concluding an IA– govt must finance the acquisitions without recourse to licence or

its shareholders

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Funding Project, Infrastructure, Development● Mongolia has massive funding needs to meet its aspirations for

development of resources, infrastructure, industrial projects. To be met by …

● Joint Ventures– shareholder equity/loan funding– convertible debt

● Project Finance– an important potential means of mine development funding, risk minimization,

but lending limits and increased risk aversion by lenders– “pure” project financing yet to emerge in Mongolia - Western lenders

generally remain very wary. Bankability concerns include issues re country risk, loan security, enforceability and available means of risk allocation/mitigation

– important role for Multilateral Lenders/Investors (e.g. IFC, EBRD, ADB)

● International Capital Markets (HK, London, other)– GOM policy favouring international capital markets as main tool of privatization– Govt bond issues– public issue of shares in Nat. Champions?– reports of plans for listing TT, OT holdings

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75

Mongolia’s “National Champions”● In December 2009, WSJ report of PM Batbold’s announcement that

GOM intends to– establish 3 major state owned holding companies and – raise capital by offering shares on intn’l and domestic stock markets

(to help finance major mining, energy, and infrastructure projects)

● The companies:– Mongol Erdes (Minerals) – to consolidate mining assets– Mongol Erchim (Power) – to combine power assets– Mongol Ded Butets (Infrastructure) – to include various infrastructure

projects

● Mongol Erdes? Possibly to be established under Erdenes MGL And possibly will hold shares in strategic deposits

● In Feb 2010 PM Batbold stated not yet decided whether to group different classes of assets into 3 companies or to create and list smaller cos around specific commodities

● Ongoing discussions, planning

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Listing of Holdings in Major Projects● Reports on 15 June 2010 MP D Zorigt (Minister for Mineral Resources

and Energy) announced:– a State owned company will be established on a 3.5 bt section of

TT with 100% ownership– its shares will be distributed to citizens of Mongolia evenly, under

the Law on human Development Fund– not less than 10% of the Company will be sold on the Mongolian

Stock Exchange in accordance with the Minerals Law– the remaining 3bt reserves will be offered to foreign investors

● Also reported plan for Erdenes MDL to be become a powerful and competitive company able to raise funds on world capital markets

● Recent reports that GOM planning to list at least part of its shareholding in Oyu Tolgoi and Erdenet Mining Corp. on both Mongolian and an international stock exchange, possibly Hong Kong

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77

Future Mining Policy Directions? ●Natural resources policy remains very emotive issue

– lengthy, vigorous debates, polarized views in getting to OT IA; now TT issues, uncertainty re other big projects

– many stakeholders with high expectations

●Likelihood of further debates, further legislative changes, differences in future IAs

●Experience in other countries (e.g. Indonesia’s Contract of Work “generations”) also suggests indicate contract terms may become less investor friendly as sector matures

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Possible Future Directions? (If e.g. Mongolia follows the Kazakhstan example)● limits on stabililization, tax and general law●more specific obligations regarding local procurement● provisions regarding change of control of companies (further

up the chain) holding mineral licenses/investment agreements● treatment of convertible debt as equivalent to share acquisition● greater operational regulation – extraction, work program

approval and monitoring● required public disclosure by mineral licence holder (as if a

public listed company)● changing taxes and royalties

No suggestions yet but…

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Future Law Reform, Liberalization?● Improving the Legal, Regulatory Framework for Foreign

Investment – reducing bureaucratic controls– separating mining from oil & gas– improving judicial certainty

●Reducing Political/Legal Risk– enhance legal, contract and tax stability– move away from State capitalism, strategic assets and “national champions”

● Infrastructure – Facilitating investment in, enabling access to, private development of transport, power, water– PPP– tariff deregulation

● Facilitating Financing of Major Project Development– loan security, registers and enforcement

●Query future directions. National, political considerations first

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Mongolia’s Agreements with China● Agreement on Encouragement and Protection of

Investments (26/08/91)

● Agreement on Avoidance of Double Taxation (26/08/91)

● Agreement on Mongolian Access to the Sea and Transit Transportation through Chinese Territory (26/08/91)

● Other Arrangements Under Consideration include:– China-Mongolia Free Trade Agreement– press reports of proposal to permit Chinese workers to

work on Oyu Tolgoi being debated closed doors ● Possibly in future another intergovernmental agreement on

rail transport may be considered necessary

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J. Summary and Conclusions

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Mongolia’s Mining Law and Policy 2006 - 2010● Significant change over past 4 years in Mongolia’s policy towards and legal

regulation of foreign mining investment

● Policy rapidly evolving with mixed signals being sent to foreign investors –both openness, encouragement of DFI and resource nationalism/‘Statism’with uncertainties, risks for DFI

● Signing of the OTIA and repeal of the WPT regarded as very positive

● However elements in 2006 Minerals Law, NEL and Mining Prohibition in Specified Areas and current policy uncertainty worrying for foreign miners

● Mongolia’s basic regulatory framework remains overall, relatively open and attractive to foreign mining investors compared with neighboring CIS countries

● Yet much work remains to be done. Industry wants to:

– a settled, workable investment framework– more clarity, predictability and efficiency in granting securing tenure and

in related laws

– reassurance that the goal posts won’t change once foreign investors have committed substantial investment funding into large projects

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World Bank Mining Policy Division 2008 Comments still apt:● Mongolia’s mining sector undoubtedly has significant potential but

development dependent on govt’s ability to establish and maintain– a clear mining policy– a stable and transparent legal framework for mining,

environmental pollution, corporate governance– policies and procedures to attract world class mining investors

with resources, management and technology– efficient mining sector institutions and strong administrative

capability for oversight– appropriate policy, transparent management of mineral revenues

● Need to improve tax regime and adopt a Model Investment Agreement for all new mining investments.

almdms #2033587-v1

Mongolian Mining Investment

- Selected Legal Considerations

John ConnorsManaging Partner, Central [email protected] June 2010

Mongolia Mining investment 2010

21 -22 June 2010 Amora Hotel Jamison, Sydney