THE MINING INDUSTRY AND VENTURE CAPITAL MARKETS IN LATIN AMERICA: THE CHILEAN CASE (ENGLISH VERSION)

• Jurisdiction: Derecho Internacional

MINING LAW & INVESTMENT IN LATIN AMERICA
(April 2003)
CHAPTER 15A
THE MINING INDUSTRY AND VENTURE CAPITAL MARKETS IN LATIN AMERICA: THE CHILEAN CASE (ENGLISH VERSION)
Rafael Vergara G.
Carey y Cía, Abogados
Santiago, Chile

I. INTRODUCTION

The mining industry has significantly grown in Latin America in the last 15 years. Three classic phases or stages of the mining industry--the exploration of minerals, the exploitation of mines and the construction of processing plants-have undergone notable growth.

The financial resources that have enabled such growth have come principally from abroad and have entered via capital contributions and/or loans by parent companies to their Latin American subsidiaries.

In light of Chilean experience, this presentation intends to explain the reasons for the lack of a stock market in Latin America aimed at financing all stages of the mining industry, as well as present the issues involved, specially the requirements for the development of a mining venture capital market.

II. FINANCING MINING

Like in any other type of investment project, one of the principal aspects that must be considered by mining companies when analyzing eventual initiatives is determining the most appropriate source of financing. Normally, there are several sources, so the advantages and disadvantages must be reviewed as well as the best way to combine them (if several sources must be used), all in consideration of the specific project.

In the last 15 years, many mining companies have had the pppppossibility of resorting to several sources of financing to develop their activities. Several of those sources did not used to be available and some are still to this day limited to certain jurisdictions and certain mining projects that meet a strict profile. ¹

The phase of mining that is to be developed will be one of the essential elements in determining the source of financing available. Mining exploration has been financed, in the case of the Latin American subsidiaries of foreign companies, principally through capital contributions to those subsidiaries or inter-company loans. Exploration by local companies has been financed with internal cash generation, principally from the profits of some mining exploitation that is already under way by that local company or by loans between companies and one same controlling group of the exploration company.

Large-scale mining and the construction of mineral processing plants has been financed in Latin America, basically to this date, in the form of "project finance." ² This method implies, in addition

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to the capital that must be contributed by the project owner and/or inter-company loans, ³ the assumption of debt through one or several or a combination of the following forms of finance. ⁴ This will depend on the particular characteristics of the project, the country where it is located, the actual availability of the source of financing at the moment, its cost, advantages and disadvantages and the mining company sponsoring the project:

a) The bank market, principally international banks, followed by national banks; ^{5 6}

b) International agencies such as the International Finance Corporation (IFC), the World Bank (IDB), and the Andean Development Corporation (CAF);

c) Other types of financial entities such as Export-Import Bank of the United States of America (ExImBank), the Export-Import Bank of Japan (J-Exim) or the Export Development Corporation of Canada (EDC);

d) Credits associated to the sale of equipment and machinery;

e) Credits associated to the purchase of part of the production;

f) Domestic financing by local commercial banks and/or government agencies.

The proliferation of this type of project finance for mineral exploitation and processing has been due, among other reasons, but very principally, to the capacity that international banks and agencies have developed in appropriately evaluating the feasibility and accepting the risks ⁷ that are involved in the development of a mining project, both during its construction and start-up ⁸ as well as subsequent operation.

III. STOCK MARKETS AND THE MINING INDUSTRY

Consistent with the foregoing, one of the greatest absences in the mining finance process in this part of America have been the stock markets. For example, in Chile, save some isolated cases that are

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often due to other reasons, ⁹ neither mining exploration nor exploitation have been financed via the primary securities markets.

Among the reasons why this form of financing has not been extended and generalized to Latin America are:

a) The depth or magnitude of the market. It does not suffice for there to be a stock market but rather it must have a proportion that justifies including mining companies in the many-colored range of options, which normally require significant sums of money for their activity.

b) Third parties are not allowed to take ownership interests in the companies.

c) There is exposure to a greater volatility in the appraisal of the company because mining is essentially a contingent activity.

d) The lack of a true capacity of local securities markets to appropriately analyze and evaluate the risks inherent to the development of a mining project, specially in its exploratory phase, where there must be an adequate and sophisticated technical and economic preparation and structure to provide sufficient guarantees to investors, both to those who administrate third-party funds (institutional investors) as well as those who venture their own capital.

e) No clear rules on mining resources and reserves, who classifies them and how and when they are reported.

f) Lack of general rules applicable to the mining industry, which prevent forecasting high performances, specially in the exploration phase.

g) Legal impediments against investing in companies other than corporations and that are very particular to mining, such as the special contractual mining company.

h) No tax incentives to offset the associated risks.

Moreover, financing via share placement has several advantages, including: ¹⁰ it is the only way to secure continuing financing, meaning without the obligation to reimburse the capital invested (this is in line with the long term of mining projects); there is an ongoing valuation of the investment since the progress in the mining project should generally increase the company's value; it improves the creditworthiness of the company because the debt-equity ratio is not used up; there should be no problem with the involvement of other stakeholders-usually institutional or private investors-in the company because they are generally not interested in being actively involved in management but rather in seeing a good management performance and a reasonable return; it improves the

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corporate image because financial information must be presented on a continuing basis; and they are more profitable but riskier.

With this outlook, it seems clear that in order to consider establishing a local venture capital market that would cover at least part of the financial needs of the mining industry, there must be certain vehicles that gather, with the adaptations required by our culture, the experience of countries such as Canada and Australia, where considerable capital markets of this type have been developed. ¹¹ Moreover, as part of the process-that could be called the globalization of the mining industry- there is now a clear world trend to establish international standards in all areas of mining that will obviously include the aspects relevant to the implementation and development of a possible venture capital market for mining, specially exploration. And Canada and Australia have also contributed notably to that international standardization.

Moreover, these countries suffered the consequences of not having sufficient regulations that forced them to make serious structural changes to their regulations.

In fact, after the Bre-X financial scandal in 1996 in Canada, Canada had to reformulate its securities legislation entirely in relation to the mining industry. For that purpose, in 1997, the Toronto Stock Exchange and the Ontario Securities Commission agreed to set up a joint expert committee to examine and evaluate the standards used in the mining industry and analyze the efficiency with which exploration programs and methods of operation should be implemented and the results had to be publicly disclosed in order to restore and increment the trust of investors. One of the most immediate results was the implementation of new rules contained in National Instrument 43-101. ¹²

Australia also raised its standards considerably in connection with the implementation of mining exploration programs and the public disclosure of information on the results of exploration campaigns. The rules resulting from the revision process conducted during the 1980's culminated in the enactment of the Australian Code for Reporting of Identified Mineral Resources and Ore Reserves (the JORC Code).

IV. THE CHILEAN MINING INDUSTRY: NOW AND PROJECTED

In the last 15 years, Chile has more than quadrupled its annual copper production from one million tons, produced virtually solely by government companies in the early 80s, to nearly 4.7 tons, of which 3.2 million come from private enterprise. The annual production of gold has increased 17- fold in a bit more than 20 years while that of silver also quadrupled, to nearly one thousand tons. The production of nitrates, iodine, bentonite, diatomite and lithium, to name the most relevant (but not the only ones) in non-metal mining, also rose considerably. ¹³ And in all the above cases, it was also caused by the intervention of private enterprise in mining exploitation, largely foreign investment, which accounted for nearly 40% of the total made in Chile, ¹⁴ or approximately 16 billion dollars (including the expenses incurred in mining exploration).

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