PREPARING AN INVESTMENT CODE: OBJECTIVE, SCOPE, STRUCTURE, AND CHARACTERISTICS

CHAPTER 3: PREPARING AN INVESTMENT CODE: OBJECTIVE, SCOPE, STRUCTURE, AND CHARACTERISTICS

Although a country must tailor its investment As such, it is normally granted different code to its own objectives, circumstances, and

rights and is subject to different restrictions legal framework, being aware of what other

and regulatory authorities. If the scope of countries, particularly those whose investment

legislation is limited to direct investment, the policy and code were instrumental in attracting

law will deal with the creation or acquisition significant private investment and FDI, have

of enterprises and the foreign investor exer- included in their code can be extremely valuable.

cising control or having a predominant influence over the management of the business. If the concept of “investment” is broader, the law will cover minority

Objective and Scope

shareholdings, transfers of technology, and concession contracts. Our experience

The key objective of the investment code is to suggests the investment law should apply promote private investment and protect the

only to direct investment, and that concept rights and property of investors.

needs to be defined at the outset of the law. Policymakers must define the scope of the invest-

Private or public sector: Interest in ment code, that is, the types of investment the

developing an investment code assumes that code should cover. (See Chapter 1 for

a country seeks private investment. But it explanations of each type.) Following is a

must decide from whom or what it will summary of the key options.

accept investment: Individuals? Corpora- tions? Noncorporate entities such as

Direct or portfolio investment: As foundations, associations, or nongovernmen- discussed in Chapter 1, portfolio investment

tal organizations? What about public entities differs substantially from direct investment.

such as sovereign wealth funds?

Foreign or domestic investment: Policy-

Structure and Characteristics

makers must decide whether the investment code should focus on foreign investment or

There is no international consensus on the cover both domestic and foreign investment.

recommended content for an investment code. However, some provisions in the World Bank

New or existing investment: It must be guidelines are increasingly considered standard, decided whether the legislation will apply to

almost universal. 5 A review of recently adopted all investment − existing as well as new

investment codes confirms this. investment − or only to one category.

To fulfill its objectives of promoting investment

Form of investment to be governed: This and protecting investors, an investment code refers to the types of assets that can be

should have the structure and characteristics as invested (equipment, know-how, funds, and

discussed in Box 15.

so forth). This will also affect the scope of the law and should be examined early in the process.

5 See Shihata, (1993) and one of the papers that led to the guidelines: Parra (1991).

Box 15. Structure and Characteristics

Structure

1. A preamble or a “purpose and scope” section should appear at the beginning of the investment

Definitions:

code, followed by a definitions section. The definitions set forth the key terms and concepts used in the law by reference to international standards. Here are the terms typically useful to investors:

n The law should specify the investments covered. It is preferable to retain a broad definition of the investment concept. Ordinary trade transactions and (short-term) monetary operations should be excluded. It should also be made clear that the legislation covers the investments made in conformity with the laws and regulations of the host country. n One of the most important definitions is that of a “foreign investor.” The government will have to decide whether to base the definition on the investor’s nationality or residence. One factor to consider is whether the government wishes to seek investment from its own nationals residing abroad. Some countries have large numbers of nationals living as expatriates in other countries. Treating them as ”foreign investors” under the investment law can be an incentive for them to invest some of their earnings in a productive way in their homeland. n It is common for an investment law to distinguish between a “resident” and a “nonresident,” mainly to address the issue of whether the investor is entitled to repatriate profits and capital. Investment codes frequently use the definitions of these terms that are found in the country’s foreign exchange law. Good practice: It is international good practice to define “nonresident” in a broad, all-encompassing way, not subject to any significant limitations. n Another important definition is the distinction between direct investment and portfolio investment. n The investment law should define investment-related institutions and authorities mentioned in the law, as well as the entities that will implement the law. This will help the investor understand the steps of the investment process.

Box 15. Structure and Characteristics (continued)

Structure

2. An important issue for the preparation of the investment policy and then the investment code is

Entry:

how the country will regulate investors’ entry and in particular foreign investors’ entry. The trend today is toward an open-admission approach. Examples of entry barriers used in investment codes that do not have an open admission are the following:

n sectors restrictions through positive or negative lists. If the government insists on restricting investment in certain sectors, it is advisable to have such sectors listed in the investment code in a short, clear, and concise negative list. n Limitations on foreign ownership n Screening v. registration/notification n Minimum investment requirements n Performance requirements

3. The “heart” of an investment law lies in a small number of guarantees and principles that are

Guarantees:

increasingly considered good practice and almost prerequisites for attracting serious investors. These fundamental guarantees (discussed in Chapter 5) include the following:

n Fair and equitable treatment n National treatment n MFN treatment n Guarantees against expropriation n Convertibility and repatriation of capital and “fruits of enterprise“ n Settlement of disputes n Other provisions

4. An investment law may address investment promotion and incentives. Often, a government uses

Promotional

the investment code to:

devices:

n Establish the institutional framework in charge of promoting investment (either as a separate entity or as a unit within the ministry in charge of investment or private sector development). n Define investment incentives offered to investors and how they are granted.

Although investment codes of many countries include provisions on these two issues, it is advisable to organize both incentives and promotion through other pieces of legislation. We will review those two issues in Chapters 6 and 7, respectively.

5. An explicit transitional section at the end is useful for understanding how the law complements,

Transition:

amends, or repeals previous laws and regulations, thus reducing uncertainty and risks of “conflict” with other laws.

Grandfathering clauses are usually included in transitional sections and create a framework by which existing investments are permanently or temporarily excluded from the ambit of new investment laws. Sometimes, albeit rarely, an option may be given to investors to choose to keep their investment package or to switch to the new one as provided under the new law.

Box 15. Structure and Characteristics (continued)

Characteristics

1. If a government’s principal objective in preparing an investment code is to create a tool that will

Length:

help in its investment promotion effort, a principle for the drafting team to follow is “less is more.” There is some tendency to include in the investment law various provisions including tax, environmental protection, and establishment of corporations, which should be covered by the relevant pieces of legislation and not by investment codes. It is important, however, for an investment code to refer to such other legislation when necessary. The law should be as short and clear as possible. There is no ideal length for an investment code, but common sense should prevail. For instance, investors with significant presence in Eastern Europe who may have looked at the Belarus investment code of 2001 were probably not reassured by the fact that it contained 105 clauses. Prospective investors are likely to assume that a lengthy code is indicative of a cumbersome, restrictive, and probably unpredictable policy and regulatory environment. In contrast, the foreign investment statute of Chile (decree law # 600) had 18 articles. A short code, if it includes basic guarantees and entry rights, is more likely to be an effective promotion tool than a lengthy one.

2. Investment legislation should be easily accessible to foreign investors and published in an

Accessibility:

easely comprehensive format. It should be published without undue delay. To the extent possible, the host government should publish in advance any measure that it proposes to adopt, and provide investors an opportunity to be kept informed on such proposed measures.

3. The investment code should be transparent, allowing investors to know not only the basic rules

Transparency: but also the procedures investors should follow. Transparency requires ready access to reliable,

comprehensive, timely, and understandable information.*

* http://www.transparency.org/news_room/faq/corruption_faq#faqcorr2 and http://www.estandardsforum.org/about_standards/ code-of-good-practices-on-transparency-in-fiscal-policy

Preparing an Investment Code in

autonomy. This is important to determine

Subnational and Conflict-affected

whether the new or reformed subnational

Areas investment law will be implementable. Even

where the

subnational government is semi-autonomous (has direct authority within its

Investment Codes in a Subnational Context

borders subject to existing national laws, regula- tions, and procedures), it may encounter

When considering subnational investment law problems if it tries to make significant changes reform, it is important to start by reviewing the such as streamlining and simplifying the devolution of powers to the subnational

regulatory regime:

government, to (i) check whether the devolution is clear and (ii) determine to what extent the

It might be deemed contravening national subnational government has authority and

law.

Other parts of the country may refuse to legislative act) and such ratified investment recognize the investment licenses and

agreement may in certain jurisdictions supersede permits it issues, meaning its investors risk

national provisions such as labor, environmental increased difficulties in doing business in the

etc.

rest of country. Consultations on the design and enactment of new or revised investment laws can take longer and be more complicated in post-conflict

Investment Codes in Conflict-affected Areas

settings. The law must anticipate post-war political sensitivities without restricting the

In post-conflict areas, investment law reforms principles of commercial practice. For example, have a good chance of being adopted because

the law might have to restrict investments in often the government will be willing to adopt

certain subnational locations. It might also have liberal investment policies and donors are more

to (i) contain different provisions, some that likely to assist with reform. However, a post-

would apply before the peace process is com- conflict government might have to make

pleted and some afterwards, or (ii) be amended tradeoffs when developing its investment law

after the peace process. Where multiple political reform:

parties have conflicting interests, the law might have to provide for an investment committee that

The government’s need to attract investment would comprise members of each party and in the short term may conflict with a law

require investment decisions to be made by written for the longer term, once the

consensus instead of by majority. economy is healthy. The following chapters discuss the various issues

The country’s need for immediate, expensive that may discourage or encourage investors to infrastructure (re)construction might limit

invest in a country. Although the recommenda- the government’s bargaining power with

tions below will most immediately benefit indi- investors.

vidual investors, more importantly, the resulting investments are likely to benefit countries over

Investors entering into investment agreements in

through increased

a post-conflict country might try to take employment, transfer of technology, revenue advantage of the situation. Such agreements

others. Eliminating likely will need to be revised and renegotiated,

generation,

among

unnecessary approvals is not only good for with better terms for the government, or even

investors but also for the government − cancelled. For example, Liberia’s 2005 iron ore

streamlining the approval process can lower costs, concession to Mitta Steel had to be renegotiated

avoid opportunity costs, diminish the risk of in 2007 with better terms for Liberia. In

losing projects, reduce opportunities for addition, when the investment agreement is

corruption, and improve the image of the confirmed by a legislative act, a similar act may

country both domestically and externally.

be required to amend the agreement (i.e. a

An important issue for the formulation of the investment policy and investment code is how the country will regulate “investor entry” (or “admission”) and in particular “foreign investor entry.” Entry is a special requirement imposed on investment projects. It is usually not an issue for domestic investors, who, by definition, are resi- dent in the country and can invest under the normal procedure generally defined in the law. We have elected therefore, to dedicate this chapter to entry of foreign investors. However, it is important to note that in many countries, entry can also apply to domestic investors such as when certain strategic sectors (such as infrastructure) are restricted or subject to special conditions.

Some countries, especially developing countries, have a screening process that subjects foreign investment projects to host-country review and formal authorization before project imple- mentation can begin.

Since the early 1990s however, the trend in admission of foreign investments is toward a more open or liberal policy. Today, the open-admission approach prevails in countries of the Organization for Economic Co-operation and Development (OECD) and in an increasing number of developing and transition countries as well.

In an open-admission system, the host country admits foreign investment without a formal screening and approval process. In some cases, a filing or notification requirement is required from the foreign investor purely for statistical or investor after-care purposes.

Even with an open-admission system, a country may impose restrictions on foreign investment, usually for host-country national security concerns or economic development objectives. The World Bank guidelines on foreign investment (WBG 1992) recognized this possibility (Guideline II, Section 4):