Does Mongolia need a state-owned mineral exchange?

2021-07-06


G.Iderkhangai /May.2021 MMJ/

The Mongolian government is once again looking into creating a national mineral exchange in the hope of stabilizing prices and attracting foreign investment.  it is believed that an exchange would stimulate producers to improve quality through standardization and testing, making Mongolian products more attractive to foreign buyers and expanding export potential.  MMHI, with the support of the Ministry of Finance and the Ministry of Justice, aim to establish a state-owned Mineral Exchange to oversee the trade of mineral products from state-owned companies.   According to R. Ochbadrakh, Head of the working group and advisor to the MMHI Minister, state ownership is required to set realistic market prices, provide transparency, and ensure that prices for state-owned commodities match global market prices. As a result, trade growth and price stability would be a windfall for the government as the increased transparency would lead to more royalty payments and tax revenue.  But a cautious approach has been advised by experts, who recommend testing the concept with one mining product on the Mongolian Stock Exchange, possibly using blockchain technology, prior to investing in the establishment of an independent exchange entity.

Mongolia’s extensive unexplored mineral reserves combined to its proximity to two of the world’s largest mineral consumers present economies of scale that provide a strong incentive for investment that could be facilitated through an Exchange.  With a strong potential pull demand from its neighbors, the development of a brokage-based Exchange, would be improvement over the current practice.  Currently, 50% of mineral exchanges are in the US, with the remained based in Europe and Asia.  

Most exchanges (46%) are agricultural, with mineral exchanges accounting for 27% and energy exchanges making the remainder.  The Tianjin Mining Product Exchange in China trades an estimated one trillion USD per year, while the London Metal Exchange sees up to four trillion USD per year of activity.  The potential for investment and revenue generation from the establishment of a Mongolian Mineral Exchange has not been lost on the government. 

In 2014, the State Policy on the Mineral Sector was passed “for the purpose of regulating export under an integrated policy, an Exchange will be established.” The following year Minister R. Jigjid “returned” the proposed draft law on the Mineral Exchange accompanied with several pages of criticism and a conclusion that the proposal did not provide enough regulation over the Exchange and that it focused excessively on products for the derivatives market, clashing with regulations under the Law on Securities Market. The original draft also proposed having foreign investors jointly participate in establishing the Exchange, sparking concern that Mongolia’s small economy and overwhelming trade dependence on one country would result in foreign dominance of the Exchange. Interestingly the draft had been developed by MMHI and the Financial Regulatory Commission based on international best practices and included sections from the approved Mongolian Law on Agricultural Exchange. According to international practice, a new mineral body or product should be publicly traded for three to five years in order to create a pricing pattern that can be used in the development of derivative instruments such as futures and options, rather than policy.

Until recently, there had been little discussion regarding the establishment of a mineral exchange.  In 2019, under the government’s Single Window Policy, Erdenes Mongol, a state owned company, in partnership with MCX Clearing LLC created their own exchange - Mongolian Mining Exchange LLC - for the purpose of trading coal to “build up a market that meets international standards on trading raw materials to be exported through an organized and regulated market in a transparent manner.”  Since its foundation management has been appointed and during the first meeting of the board of directors, plans for the development of the Exchange was launched.  There is little information on its director and board members or their involvement with the current working group developing the new draft Mineral Exchange law under MMHI. 

Mongolia faces many challenges related to the trade and export of mineral products, particularly issues on pricing information, conditions of export trade agreements, transportation costs and fines related to the management of toxic elements are not available to government organizations or the public.  It is commonly known that government officials and their intermediaries are involved in the trade of coal, copper, fluorspar, and other mining products, influencing the selection of buyers, volume allocation, and contractual conditions often resulting in reduced commodity prices. Despite their efforts, directors of state-owned companies have little influence or control over these trade agreements, resulting in significant potential income loss for which they are held accountable. This lack of transparency and compliance with international trade standards has created an urgent issue requiring an independent body empowered to oversee the involvement of ministries, government agencies and third parties, ensuring that trade is regulated in a fair and equitable manner.  Based on international best practices, a realistic feasibility study on the development of an Exchange needs to be conducted, followed by the development of rules and procedures regulating it’s activities.  This would require extensive study, time, resources, and investment to ensure success. Currently, exchanges are classified according to sectors such as mining (gold, copper, rare and precious metals), energy (oil, oil products, natural gas), and agricultural exchanges.  These are further divided into national, regional, and international exchanges as well as by the type of trade they facilitate: commodities or derivatives such are forwards, futures and option agreements.   It was recommended that a Mongolian Exchange should not directly copy the format and structure of other foreign exchanges but adapt them to internal constraints.  

There are several potential advantages to be derived from the establishment of a mineral commodity exchange.   For products to be traded, quality standards would have to be developed, something currently lacking in the Mongolian market. in order to participate in the Exchange, companies would have to validate reserves and provide a consistent supply of standardized products of verified quality standards.  This would require producers to improve operational consistency, plant output, as well as to develop storage and logistical capacity. Bringing consistency to the mining sector would improve the quality of Mongolian mineral exports and increase product pricing, creating opportunities for small and medium enterprises and entrepreneurs to invest.    

The key is in clearly defining the purpose of the mineral exchange, whether it is to control state-owned companies or to be a financial instrument to develop the mining sector.  Developing the conditions for an investment focused exchange would be challenging and time consuming as there are no product quality or trade standards for private mining operations, requiring an agreement for the private sector on standardization for the Exchange.  Currently state-owned mining operations have quality standards but lack consistent export volume controls.  This is, in part, a logistical issue due to limited rail transport within Mongolia making the movement of product out of the country challenging and expensive.  Significant investment in transportation infrastructure would be needed to ensure that Exchange contractual agreements could be met.  Launching an exchange for state-owned companies could improve their performance and profitability in the long run, but runs the risk of encouraging the development of more state developments to the detriment of the private sector.

In either case, experts have recommended testing the mining commodity trade concept through the Mongolian Stock Exchange as a proof of concept.  Although the majority of mineral exchanges are operated as independent entities, there are a few examples of commodities being traded through stock exchanges, mostly for agricultural products. The exchange would be of greatest benefit to coal and iron ore producers required to deliver large volumes of locally set prices with complex logistical challenges compared to higher value products such as gold, copper or zinc that are strongly influenced by the commodity prices of international exchanges.

Concerns have been expressed over the proposal to have the MSE host the exchange as it is facing its own challenges related to operational efficiency and competitiveness.  Despite several years of discussions to privatize the exchange, it remains a state-owned entity that has not met expectations, and there is doubt on its ability to adapt to the new requirements. Involving the MSE does present the option of incorporating blockchain technology into the trade of mineral commodities, currently under development. This presents Mongolia with opportunity to make a technological lead ahead of existing exchanges and the involvement of cryptocurrencies.  This would expand the investment opportunities to a wider client base.  

Also, of concern are the technical and logistical challenges that the commodity exchange agreements would create for Mongolia.  Currently there are no mineral product quality standards or definitions, with each producer creating their own.  The exchange would require some standardization and quality testing to ensure compliance, capacities that currently do not exist in Mongolia.  These standards would also require investment from mining companies to improve their operational capacity to meet the new standards, costs which may not be recoverable with current reserves. Export of products presents a significant challenge due to Mongolia’s extremely limited logistical infrastructure and the costs associated with its expansion to meet future needs.  The other export challenge are issues with border control and customs requirements on both sides of the border.  Being unable to affect the timely delivery of contractual volumes creates significant risk to the Exchange and could eventually lead to its demise and financial liability to the owners. 

Although the concept of a mineral exchange has the potential for great economic benefit for Mongolia, it also bears a significant amount of risk.  Maintaining control of the Exchange, getting agreement and compliance on standards from the mining sector, investing in infrastructure and logistical capacity to ensure timely delivery of product would require significant short-term effort and investment from the Mongolian government to improve the odds of success.  But in the end, no new venture is guaranteed to succeed.  Careful analysis and discussion is required prior to committing to such a bold venture. 

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