The situation: Latin American countries are witnessing a new wave of resource nationalism and increased government intervention that has negative implications for foreign investors.
The result: This resource nationalism goes hand in hand with newer and more subtle forms of government intervention, such as over-regulation and increased taxation, which pose significant challenges for investors.
Look forward: To mitigate the adverse effects of this resource nationalism, foreign investors should systematically monitor government interventions and develop international and local strategies, including liaising with their own governments, developing ties with local communities in the countries of home and using investment treaties to protect their investments.
Latin America is experiencing a new wave of resource nationalism and government intervention, as more populists come to power, spurred by ideological shifts and indigenous movements. This nationalism is further reinforced by the negative economic impact of the COVID-19 pandemic, as governments attempt to recoup their financial losses, especially in resource-rich countries with major mining and energy industries. This new resource nationalism is reflected in the rise of a yardstick used to measure government activism in the resource sector known as the Resource Nationalism Index (“RNI”). In 2021, 34 countries saw a significant increase in RNI, with many Latin American countries topping the chart. For example, Mexico ranked 101st in the world for RNI in 2018, but fell to 14th in 2021; Argentina also fell from 81st to 20th place.
In its most extreme form, the new wave of government interventions could potentially lead to vast expropriations of foreign investment. So, for example, a so-called reform initiative proposed last September in Mexico would transfer control of the electricity sector to the state, reversing parts of the 2013 energy reform that opened up the sector to private investment (see our Jones Day Comments“Mexican Constitutional Reform Bill of 2021: Proposed Changes for Foreign Investors in the Electricity Sector” and “Mexico’s electricity reform in 2021: what foreign investors in Mexico need to know to protect their rights“, and our Jones Day Alert“Mexican Hydrocarbons Law: What Foreign Investors in Mexico Need to Know to Protect Their RightsSimilarly, on February 1, 2022, a constitution committee in Chile approved in the first instance a proposal that could lead to the nationalization of copper and lithium mines in that country. Although these more radical proposals are yet to be Several steps into their enactment, less drastic but still damaging measures are already becoming more common, and the trendlines suggest that investors should exercise more precaution and planning.
More subtle forms of government intervention
The new wave of government interventions in Latin America looks different from those of the past. Instead of blunt measures such as direct expropriation, most governments employ more subtle means – over-regulation, creeping takeover rules, demands for greater local content (indigenization) and indirect expropriation via taxes higher. Although more subtle, these measures are often no less disruptive and potentially financially devastating for foreign investors.
In Mexico, for example, the López Obrador administration rolled back major energy reforms passed by the previous administration and restricted the autonomy of regulatory agencies, which hurt the energy sector. The intervention of the Mexican government seems likely to extend to the mining sector as well. In Argentina, the intervention of the government of Alberto Fernández took many forms, including the nationalization of assets, the attempt to take over private companies and the introduction of price controls, trade restrictions, higher tariffs , an increase in financial withholdings and limits on the repatriation of investors. In Brazil, President Jair Bolsonaro has repeatedly intervened in the country’s energy and other industrial sectors to the detriment of foreign investors. And in Peru and Chile, Pedro Castillo and newly elected Gabriel Boric, respectively, are calling for greater redistribution of the wealth generated by mining to rural communities, and have expressed their intention to revise taxation and mining contracts to make this redistribution (see our Jones Day Remark“June elections in Peru and Mexico raise specter of new threats to foreign investment“).
Protective measures for foreign investors
To mitigate the adverse effects of such government intervention, foreign investors should consider taking proactive steps to monitor resource nationalism and protect their investments. In particular, foreign investors should:
- Create internal monitoring systems systematically monitor and evaluate political and legislative changes in host countries and, if necessary, facilitate negotiations and/or lobbying with host governments before undesirable changes occur.
- Build and strengthen their relationships with local communities strengthen their positions vis-à-vis host governments. Adverse government actions against foreign investors often stem from community dissatisfaction with the foreign investor and pressure on local and central governments to act. Savvy investors therefore work with community leaders, local governments, and NGOs to contribute to community needs. This can be achieved by building housing and infrastructure, supporting health care, education and recreation, and providing technical support for environmental initiatives. Support from the local community can be an invaluable asset for long-term investors.
- Involve the investor’s government, international organizations or the media manage political risks in host countries. Investors should liaise with their own government about adverse political changes in host countries and solicit their support to influence host countries. This support can range from public statements criticizing the interventionism or diplomatic overtures of the host government to the imposition of trade measures or sanctions against the host country. Depending on the nature of the potential problem, investors could also turn to international organizations or the media, which can also put pressure on host country governments. Investors should also consider using specialist intelligence firms with local knowledge who can advise on strategies to help clients find beneficial solutions.
- Use investment treaties as cost-effective tools when needed (and when available) take advantage of international legal protections against many forms of government interference (Brazil has not ratified any investment treaty that includes investor-state arbitration). An enforceable investment treaty will generally protect investors from a range of government actions, including modification of investment incentive programs, breach of contracts, expropriation of property, revocation of licenses or permits , the initiation of unjustified criminal proceedings, the imposition of unjust taxes or penalties, the discrimination against the investor on the basis of nationality, by imposing arbitrary measures or by invalidating patents or other intellectual property rights.
Investment treaties can also help foreign investors avoid unfamiliar and often hostile local legal systems by giving them the right to initiate international arbitration directly against host countries for breaches of the treaty. Given the high profile and public nature of these investment arbitrations, host governments may choose to settle early. If not, an arbitration award in favor of the investor may require the host country to financially compensate the investor for its losses (including lost profits in appropriate cases).
To avail themselves of investment treaty protections, foreign investors must take certain steps, including:
- Participate in treaty planning through a review (and restructuring, if necessary) of their existing corporate structure to ensure that foreign investments are protected by an investment treaty. Structuring or restructuring an investment to take advantage of an investment treaty often involves simply incorporating an SPV into the company’s investment structure, but it has to happen. before a dispute with the government arises or is reasonably foreseeable.
- Developing an international legal strategy that maximizes the rights of the investor, both in local courts and in international tribunals. Many treaties include “forking out” or waiver clauses that prohibit investors from resorting to international arbitration if they have already initiated local court or administrative proceedings regarding the same claims. Further, the submissions in these local legal proceedings can be expected to become factual evidence in any future arbitration. To avoid adverse outcomes, it is important that local and international lawyers coordinate the handling of these disputes from the outset.
- Submit Notice of Intent to Arbitrate. Known as a trigger letter, this notification is required under most investment treaties and can bring host governments to the negotiating table without the need to initiate formal proceedings.
- Start arbitration if a host government refuses to negotiate and settle after receiving the trigger letter. The initiation of arbitration, especially in a public venue such as the International Center for Settlement of Investment Disputes, can also induce the host government to negotiate and settle. About 40% of investment treaty arbitrations are settled or terminated.
- Foreign investors should put in place monitoring mechanisms to systematically track the subtle forms of government intervention stemming from the new wave of resource nationalism in Latin America.
- Investors should develop and deepen relationships with local communities in host countries and with their own governments, to mitigate the adverse effects of increased government intervention.
- Foreign investors should ensure that they are protected by investment treaties that provide broad international law protections against government interference. They are powerful tools in a foreign investor’s legal arsenal and a cost-effective way to manage political risk.