The financing of projects on a limited recourse basis in the emerging markets is a subject which has received much attention over the course of the last several years. This has been particularly the case with respect to mining projects where declining commodity prices worldwide have lead to the need for mining companies to access minerals in countries where the costs of extraction are lower than in the developed markets.

The recent decline in the popularity of hedging as a means to enhance the attained price with respect to any metal produced at a project has only accelerated this trend. This has led to a concentration on the development of projects in sub-Saharan Africa, the former Soviet Union, South East Asia and, although now less of an emerging market, South America.

These trends have become particularly apparent in Africa, especially sub-Saharan Africa. While South Africa has consistently been one of the principal mining producers in the world, minerals have always been known to exist in rich belts throughout the African continent.

However, the absence of stable legal and, in particular, political systems has meant that the development of projects to extract these minerals in the various countries has been significantly restricted. While this has continued to act as a brake on project activity in countries such as Angola and the Democratic Republic of the Congo, stabilising developments elsewhere have enabled a wide variety of projects to be financed in the continent.

Starting with projects in Ghana, and in the first place principally those sponsored by Ashanti Goldfields, traditional limited recourse financing has been utilised since the beginning of the 1990's. Following on from this, other developers have seen projects financed in Ghana, and activity has expanded elsewhere in West Africa and in diverse locations throughout Africa such as Zambia, Zimbabwe, Namibia and Tanzania. Indeed, such has become the commonplace nature of projects of this type in Africa that some financings, particularly those in Ghana, have now been implemented without the benefit of political risk insurance. Ten years ago this would have been unthinkable.

The problems inherent in financing mining projects on a limited recourse basis in the emerging markets are well rehearsed. Which of these problems in particular arise in connection with mining projects in Africa and how have they been addressed? Some of these issues are described and analysed below:

Legal system risk

The basis of the legal systems used in the various African markets are diverse. In many of the countries of the former English Commonwealth located in sub-Saharan Africa an English based common law system prevails. Thus, for example, transactions involving projects in Ghana and Zambia might be structured on the basis of traditional English law concepts of taking fixed and floating security and attendant filings, etc.

In Francophone countries in the same region such as Mali and Mauritania local legal systems based on French civil law are common, frequently based substantially on the French Civil Code. In each of these jurisdictions where the legal system is based on an established Western European model there is some certainty as to the theoretical operation of the legal system. However, it would be truly unwise to rely solely on, say, an analysis of English law in connection with projects in Ghana or an analysis of French law in connection with projects in Mali. For example, the laws in the local African country may be based on old common law or Francophone statutes which have not changed in the same manner as those in Europe.

In addition, constitutional issues can add a layer of complexity. Many, if not most, countries in Africa will have written constitutions which provide a background against which all local legislation must be interpreted and comply with.

In addition, many of the countries in the West African region have recently entered into an arrangement in an attempt to harmonise their laws. As a result, it is essential for both lenders and sponsors to perform extensive legal due diligence in any country before deciding whether to lend or invest.

This might take the form of a detailed legal due diligence questionnaire to be completed by local counsel. It is difficult to ask enough questions in these circumstances. For example, in the case of a lender, is it possible to take security over all of the assets of a project company?

To the lawyer versed in English common law tradition an affirmative answer to this question is axiomatic. In those African countries which follow that tradition the answer will invariably be yes. In other countries the answer is less clear. For example, in countries with a Francophone based legal system there may be issues relating to the taking of security over fixtures where the land on which such fixtures are attached is owned by a different entity to the entity which owns the underlying land.

Notwithstanding the answer to these threshold theoretical legal issues, the real issues frequently lie in the practical operation of the legal system and the remedies available to finance providers upon the occurrence of an event of default, etc.

In addition, one of the biggest problems encountered, particularly in those jurisdictions which do not have an English common-law heritage, is with the mechanics of filing to protect and perfect security. Many countries offer a highly formalistic approach to this process, involving notaries, stamping and the like. Not the least of the problems encountered might be the necessity to negotiate a fee with the notary in question.

Traditionally, notarial fees have been based on a percentage of the debt obligation involved. While this might be all well and good for a local transaction it is potentially problematic in the case of a substantial project financing involving multiples of tens (if not hundreds) of millions of dollars. Practically, of course, a lender must take the legal system as it finds it. There is no way of contracting around statutory requirements. The only real method of ameliorating any difficulties presented by legal systemic risk are by retaining sponsor support past completion for any perceived legal risk (which is frequently unacceptable from a credit perspective) and/or by taking the benefit of political risk insurance to guard against the precipitous act of any local government or related body.

Title risk

Part and parcel of legal risk is the nature of the right of the mining company in question to develop the deposit which forms the basis of the mining project. In some countries the mining company might have full legal right to both surface and sub-surface rights together with the unrestricted right to exploit the deposit in question. However, this is unusual in the context of the emerging markets. Frequently, the ownership right in minerals is vested in the central government and all that can be obtained is a license to mine the minerals. In some jurisdictions, for example some Francophone jurisdictions in West Africa, the situation is exaggerated by virtue of the fact that the operator may be unable to obtain even surface rights.

The project company will merely be granted whatever attendant rights are necessary in order to effectively mine the deposit pursuant to the mining license granted by the government. In many countries, particularly in sub-Saharan Africa, the central government will have the right to retain a carried interest in the project, maybe in a proportion of up to 20% of the equity. In other jurisdictions, this interest may take the form of a royalty payment to the government in respect of minerals extracted from the ground. Whatever the format, virtually all emerging markets in Africa will require that some economic interest in the project be granted to the central government. This is clearly understandable as mineral resources may represent the most significant, if not the sole, source of wealth for those countries.

What is clear is that the development and financing of mining projects in Africa (with the exception of South Africa) involves a greater partnership with the government than might be the case in other areas of the world. Exploration and exploitation licenses granted by governments in the continent frequently mean that governmental departments will need to be involved in the financing arrangements. For example, lenders will require that security over all project assets be granted to them in a manner which would enable them to foreclose over the project and transfer the same to a new owner in the event of a default affecting the current owner. Any exploitation license granted by a government would generally circumscribe the ability of anybody to transfer the benefit of that license to a third party. Accordingly, lenders will need to engage in negotiations with the relevant government officials to obtain flexibility to be able to exercise their expected remedies in the event of a problem in the future. Fortunately, the increasing sophistication of the majority of governmental mining officials means that lenders are usually able to achieve their legitimate expectations.

Tax risk

Potential taxes assessable on a mining project are numerous. The local project company may be subject to a profits tax, importation tax, VAT on services or other forms of local taxation. In addition, there may be withholding taxes on interest and dividend payments made offshore. Fortunately, most emerging markets within the African continent recognise the economic advantages in attracting offshore mining companies to develop deposits and therefore offer tax packages for individual projects which are available to be negotiated on a project by project basis. These will frequently result in tax holidays in connection with profit and related taxes in addition to exemptions from VAT and withholding tax on both interest payments and dividends. One area frequently overlooked in connection with the negotiation of tax packages by sponsors is in connection with stamp taxes and the like assessable on the execution of security documentation in relation to the provision of project finance.

Political risk

This, again, is something which may not be contracted out of and therefore must be covered by the sponsors or by insurance. The former will be resisted for balance sheet and precedential reasons. The latter may be available through one of the multilateral agencies (for example, MIGA), through a national export credit agency from the home jurisdiction of a participant in the project or in the commercial markets. Political risk coverage is available for the majority of the emerging markets. Of course, some emerging markets have now ?emerged?. Deals in certain sub-Saharan Africa countries such as Ghana have been completed without any perceived need for political risk insurance. The insurance is frequently expensive and can add significantly to the cost of any individual project financing.

Political risk insurance for projects in the majority of African countries (with the possible exception of countries such as the DRC and Sudan) is available in the commercial markets, in particular the Lloyds market in London, and elsewhere. There is little which attaches particularly to policies relating to projects in Africa that is not of concern with respect to policies relating to projects elsewhere. Nonetheless, policies need meticulous attention from either sponsors or lenders, depending on the nature of the policy involved. For example, in the case of political risk insurance covering the lenders' interest, the extent of the ability of the underwriters to consent to changes to the underlying loan documentation will be an area of negotiation. One area of sensitivity which can go unnoticed is the usual requirement of the providers of PRI, for obvious reasons, that the issue of the policy not be notified to the host government. Frequently loan documentation will contain specific reference to PRI and so care must be taken where that documentation needs to be shown to governmental officials.

Insurance risk

Comprehensive insurance for any particular project is an essential part of the package which will be required by any provider of limited recourse finance. Prima facie this should not create any difficulty as commercial insurance for a project (third party liability, construction risk, delay in start-up, etc.) should be available irrespective of location. However, a complication arises by virtue of the fact that many of the emerging markets (particularly in sub-Saharan Africa) require that the primary insurance be provided by a local insurance company.

This raises both performance and credit risk issues. While such local insurance will be reinsured by coverage in more traditional insurance markets, such as the London market, that is not the end of the problem. For example, reinsurance is just that, it is a secondary cover with respect to the primary insurance policy. Accordingly, if the primary insurance policy is not valid then the reinsurance will not cure this problem. In those jurisdictions where the primary insurance with the local insurance provider must be governed by local law then comfort must be obtained with respect to the validity and efficacy of that insurance. Note that these issues will not be circumvented by the so called ?cut through? provision present in many reinsurance arrangements which provides for the reinsurers to pay beneficiaries of the primary insurance policy directly rather than being put through the necessity to pay through the primary insurer as a conduit. Such a provision is purely procedural and does not affect the legal analysis that the validity of reinsurance is derived from the validity of the underlying insurance. In addition, the primary insurance/reinsurance structure severely complicates the mechanics of the lenders taking security over insurance since it leads to the need to take security over both the underlying insurance and the reinsurance.

One alternative explored in several financings in African countries where this problem occurs has been that of parallel insurance. In this structure, rather than the off-shore policy being a policy of reinsurance, it is a parallel policy of primary insurance which covers the same risks as that covered by the local policy in addition to off-shore risks. This structure can usually be implemented with minimal incremental cost.

Foreclosure risk

The analysis of the risk inherent in any project in the emerging or other markets frequently ends, at least from a legal perspective, with the documentation. However, this is shortsighted. Enforceable documentation is obviously critical to any project lender but this does not give the whole picture. The rights available in connection with any enforcement of that documentation are paramount. The traditional common law analysis, for example, assumes that any secured party will have a self help remedy which will enable it to sell the secured asset on its own motion without the need to involve any third party. In civil law countries, and in most emerging markets other than those sub-Saharan countries with an English common law tradition, this is not possible. In those jurisdictions no self help remedy is available and foreclosure will usually need to be performed with the assistance of the court system. This usually implies an auction following some defined period and can involve lengthy delay. During a period when a project is in trouble and unable to meet the needs of its trade creditors this can be a significant issue. In addition, some auction procedures may not permit the lenders to bid in debt, rather than bidding in cash, thus potentially materially increasing the exposure of the lenders to the project as a whole if they wish to avoid defeating some wholly inadequate bid made at auction by a third party.

The solution to many of these problems is to present a financing structure which, in the case of problems, can avoid the need to foreclose over assets at the local level. This would involve the creation of a holding company structure whereby, in addition to taking security over the project assets, the lenders also take security over the project company and over a holding company of the project company. That holding company would be located in a jurisdiction where the legal system recognises self-help remedies in the context of foreclosing over security such that the lenders do not need to resort to a court procedure in order to take control of the project.

Foreign currency and export risk

Governments in most African countries will issue licenses with respect to mining projects involving foreign investment which will permit the unfettered sale of metal offshore and deposit of proceeds in an offshore account. This is obviously because those commitments from the government in question (which are usually granted ad hoc on a project by project basis) are a basic requisite for any sponsor or lender. In most of the African countries where those benefits are available they are generally granted on an unrestricted basis. Paradoxically, one of the countries in the continent where exchange control remains an issue is South Africa.

This is only a summary of some of the issues which can arise in connection with the financing of mining projects in Africa. Nevertheless, governments in most countries in the African continent are anxious to encourage investment in the extraction of minerals and so such projects continue to form a significant part of any mining lender's portfolio. This is a trend which can only be expected to continue.