Getting the mining sector to work for Africa: the role of DFIs

Since 2002, a number of base metal and precious metal commodity prices – particularly for gold and copper – have risen sharply. This has prompted an increase in investments in the mining industry, both in exploration and in commercial operations. Africa has not been left out – even though one could have imagined it would have been able to benefit more from this keen interest. Copper exploitation has resumed in Zambia, and now also in the Democratic Republic of Congo (DRC). The gold mining potential of Tanzania and West Africa – with Ghana the leader – has been confirmed. It is expected that Madagascar will very soon be producing nickel. In view of this situation, Development Finance Institutions (DFIs) should also logically have scaled up their investments in Africa's mining sector. The reality is, however, more contrasted. There have been relatively few opportunities for debt financing that meet the criteria for DFI investments. Although institutions, such as the European Investment Bank, have invested sizeable amounts in projects to exploit copper in Zambia or nickel in Madagascar, most mining projects in Africa produce gold and manage to obtain financing from the markets. Proparco, for its part, has focused its efforts on mining exploration, mainly by making a total investment of USD 13 million in three African Lion investment funds, alongside partners such as EIB, Investec or Rand Merchant Bank. To date, thanks to these investments, six gold or nickel mines have been opened in five countries by junior companies, such as Red Back in Ghana, Gallery Gold in Botswana, Albidon in Zambia. Even though these companies have experienced mixed fortunes and have sometimes been subject to consolidation processes, this type of investment does appear to be particularly justified from a DFI's perspective. The exploration phase may require less investment than the launch of the operating Getting the mining sector to work for Africa: the role of DFIs phase, yet it is crucial to the development cycle of a mining site. Junior companies are not always viewed favorably, but at least some do employ experienced professionals. Moreover, these companies often do not have the capacity to put as much pressure on local authorities as the major players. This allows public authorities to negotiate more profitable contracts. However, these companies lack resources, which can mean they do not apply the best environmental and social practices. African Lion has consequently decided – under the impetus of its investors – to strengthen its environmental and social requirements by monitoring the companies in its portfolio more closely. The investments made by DFIs such as Proparco have consequently been lower than could have been expected. This situation can be explained by the obligation to only finance projects with strong impacts on economic development, by the respect for the principle of financial subsidiarity, and also by the scale of the environmental and social impacts of the projects.

Only finance projects that contribute to economic development

The first condition for a DFI operation to finance a mining project is the contribution this project will actually make to the economic development of the country and to poverty reduction. The developmental impacts of mining investments are gauged by the direct and indirect employment created and the scale of fiscal revenues levied by the State. In terms of job creation, mining projects generally employ several hundred people that are either unskilled or have a low level of skills. They are generally recruited locally during the construction phase (the most intensive phase in terms of labor). DFIs play close attention to the impacts projects have on local employment. Some countries have legislation that requires a certain percentage of local employees to be recruited. For example, the agreement signed between the Senegalese State and the Australian company Mineral Deposits concerning the operating of the Sabodala gold mine stipulated that the operator had to train and employ local labor. At the end of the day, 45% of employees were Senegalese and came from regions immediately neighboring the mining site (Mineral Deposits, 2010). The tax system is also a tool that can help the mining sector make a greater contribution to the economic development of a country – provided, however, that the revenues States receive are equitably redistributed to the population. DFIs must ensure that fiscal regimes for mining projects guarantee a fair level of remuneration for States. This vigilance is even more important in Africa, where the mining sector often accounts for a large share of a country's exports and GDP. Donors must consequently be careful not to finance projects using “fiscal optimization” techniques, which deprive States of the revenues they are entitled to. Proparco has come across this type of arrangement in West Africa. As the borrower was registered in a tax haven, it was logical to wonder whether such an arrangement amounted to reducing the taxable base of the project, something which is unacceptable for DFIs. If the taxation of mining revenues is too low, it can lead to governments renegotiating contracts and a legal instability which can deter foreign investors. A few years ago, the governments of DRC and Zambia, having observed that the conditions they had granted to mining projects were too favorable, engaged in an extensive process to renegotiate contracts in order to gain a greater share of mining revenues, which were on an upward trend at the time.

A principle of financial subsidiarity jeopardized by highly liquid markets

DFIs only finance projects or businesses when there is a lack of investors or private lenders, thus respecting the principle of financial subsidiarity. There is consequently less need for DFI investments in mining projects – even in Africa – due to the strong presence of private funders in this industry. This phenomenon is exacerbated by the predominance of gold mining projects on the continent, which are generally financed by loans with maturities of five years or shorter that specialized banks are perfectly willing to offer. The financial subsidiarity of DFIs is even less relevant during periods of upward price trends. Indeed, mining investments were bolstered by the boom in the global raw materials market which rose 39% between 2004 and 2009 (Raw Materials Group, 2010). Mining companies generally had no difficulty in obtaining vast amounts of financing from commercial banks and specialized equity markets, the first being the Toronto, Sydney and London stock exchanges, which were highly liquid at the time. The financial crisis, which coincided with a slump on raw materials markets, spared gold – a safe investment in times of crisis – the prices of which soared to record levels. A gold mine project in West Africa demonstrates the fact that investors have not lost their appetite for the yellow metal. It was entirely financed by the promoter on its own equity, despite the financial turmoil in 2009.

Projects with strong social and environmental externalities

Most mineral extraction projects have an impact – which is sometimes extremely strong – on natural capital and local populations. DFIs must systematically ensure that the projects they finance comply with the environmental and social legislation of the relevant country. Beyond this, the reference international standards for mining projects must be respected – particularly the “Performance Standards on Social and Environmental Sustainability” defined by the International Finance Corporation (IFC). For example, Proparco has studied the feasibility of a gold mining project in West Africa, which required the displacement of over 2,000 households, i.e. a total of roughly 11,000 people. The initial impact assessment and resettlement plan did not provide for measures to compensate people affected by the project who earned their l ivelihood from  gold panning on the site of the future mine. The application of IFC Performance Standards makes financial compensation for the tangible or intangible assets that are lost by displaced persons mandatory. It also requires for them to be rehoused in a new home and for their incomes to be restored in a sustainable manner. A mission to the project site was able to ensure that the negative impacts of the project had effectively been mitigated by its sponsors. Despite these constraints, DFI investments in Africa's mining sector do offer a real added value. Indeed, these investments are essential in countries and metals which are seen as carrying risks; they are also imperative for promoting the best environmental, social and fiscal practices.

Higher level of risk taken

Although commercial banks continue to show a high level of interest in short-term mining projects, in the most common metals (such as gold, nickel and copper) and in the most stable countries on the continent, they are, however, more cautious when it comes to long-term financing and countries and metals which present a higher risk profile. DFIs have a mission to respond to market discontinuities, for example, by allocating long-term loans (10 years or longer) that allow mining projects, which have sizeable upfront investments, to be profitable thanks to more extended repayment schedules. DFIs can also support projects involving rarer and more risky metals, for which there are no forward hedging instruments to secure volumes and sale prices. Finally, one of the missions of DFIs is to take more risks than private funders by investing in countries that are geologically rich, but more unstable or less developed.

Promoting exemplary projects

If DFI investments are to guarantee the exemplary nature of the mitigation of the social and environmental impacts of projects, it is essential for the IFC Performance Standards to be systematically applied. These standards were reviewed in 2006 and have de facto become the key reference standards for the responsible development and financing of extractive projects in emerging countries. They also widely inspired the Equator Principles that have to date been adopted by some sixty private financial institutions. The eight IFC Performance Standards cover extremely varied areas, which include human resources, working conditions, pollution prevention and mitigation, biodiversity conservation and sustainable natural resources management. These standards require a high level of involvement of local populations in the project.

A fair distribution of revenues and greater transparency

The overhaul of the mining sector tax system must both ensure that States and mining companies receive a fair remuneration, and guarantee the stability of the legal and fiscal framework in order to attract investors. It is necessary to ensure that Africa's mining States do not enter into a form of fiscal dumping, whereby they constantly lower tax rates in order to attract investors. Minimum  rates – which could become international standards – could be defined under the impetus of donors and in consultation with the different players in the sector. Tax exemptions must be less systematic and should be approved by national parliaments. Greater transparency in transactions between States and mining groups, in line with the recommendations of the Extractive Industries Transparency Initiative (IEITI), will strengthen their legitimacy. This will also make it possible to measure the developmental impacts of projects more accurately. DFIs have a key role to play in all these reforms in terms of both their application and widespread implementation. DFIs should be neither excessively proud nor ashamed of the results achieved by their investments in Africa's mining sector in recent years. They tend to be left on the sidelines due to the dynamism of private investors and the specific constraints of extraction projects. Yet this must not lead them to stay away from the sector. They must remain true to their mission and invest in areas where the private sector is absent. In addition, they can play a key role in the widespread implementation of good environmental, social and fiscal practices – prerequisites for the sustainable and equitable development of Africa's mining sector.

RÉFÉRENCES :

Mineral Deposits, 2010. Presentation paper.

Raw Materials Group, 2010. Raw Materials Data, database.