Libya: FDI In Libya: The Way

Libya: FDI In Libya: The Way. We note that the Libyan government is planning to introduce many new laws over the coming few months. One of the most important of which will be the new Companies Law (the Draft Law). We have seen an early draft of this and our overall assessment is that it is good in some aspects, but in others, it is a backwards step for the country. We set out in this note an overview of the processes typically involved when developing a new law, an overview as to how other countries within the MENA region address foreign ownership and our preliminary comments on the Draft Law as it affects Foreign Direct Investment.

Proper consultation process

Whilst most of the issues under consideration by Congress are subject to a wide variety of opinions from individuals and groups across the country, it is fairly clear that almost all representatives of the Libyan people acknowledge the vital need to develop the Libyan private sector. One of the key tools for doing this is the legislative framework, and the Companies Law is the cornerstone of this. It is therefore important that a good law is drafted that strikes the right balance for the future development of the country, helping to facilitate a move away from its current economic reliance on

• the hydrocarbon sector for income; and
• the public sector for jobs.

In our view, this law is so critical for Libya’s future that it needs to be properly debated and researched.

It is inappropriate for a committee of unelected court notaries and lawyers to be undertaking the task of drafting this new law, as most of them have limited experience of the international business world, and they are not entrepreneurs or businessmen themselves.

A good Companies Law needs to be user friendly and must take into account the needs and requirements of both Libyan businessmen and the international investor-it should not be drafted in isolation by career civil servants and government officials who often tend to consider issues purely from an academic (rather than practical) perspective. In the UK, the process involved in developing its most recent Companies Law in 2006 took 8 years and was a collaborative process. Similarly, in places like the UAE, the new UAE Companies law has been debated for 10 years. Whilst we are not suggesting that Libya should take anything like this length of time to prepare a new Companies Law, we do think Libya should take some time to get it right, rather than trying to rush through an ill-thought-out piece of legislation that will provide a poor foundation for Libya’s future growth and development.

Protectionism vs free market

The main challenge in drafting a new Companies Law is to set the right balance about FDI. Most mainstream economists agree that protectionism is harmful in that its costs outweigh the benefits and that it impedes economic growth-consequently, protectionism harms the very people that it is supposed to be helping.

Notwithstanding what economists might say, there must clearly be some sensible limitations on FDI at this point as Libya opens its doors to the world for the first time in nearly half a century. This is needed to protect the fledgeling Libyan private sector from powerful international companies with the economic muscle, global reach and know-how to dominate a completely open market. The opinion will be divided as to where the protectionism vs free-market line should be drawn. Most commentators would agree that sensible, pragmatic rules to ensure that infant Libyan businesses will not die before they reach maturity and size to compete in the global marketplace should be considered. However, in assessing what barriers to trade Libya should introduce, legislators should not lose sight of the bigger prize of attracting foreign capital and expertise. It is of paramount importance that any new FDI rules must also encourage the international business community to work alongside Libyan businesspeople, pay Libyan taxes, invest in training and development and most importantly, hire many Libyan nationals who need to find private-sector jobs. In our view, allowing foreigners only to take a minority equity share position in a company is a major disincentive. It will result in many of these investors looking elsewhere for new markets and opportunities.

Striking the right balance between protectionism and an open market is not a unique challenge for Libya, and many other countries have had to face the same challenge in the past. Organisations such as the IMF, World Bank, United Nations and the European Union have vast experience advising on this issue. They should be encouraged to assist Libya as it emerges from so many years of isolation. We suggest that the government refers to the FDI Index prepared by the OECD to assess how various countries rate in these rankings. The OECD FDI Index gauges the restrictiveness of a country’s FDI rules.

Foreign equity limitations

These typically include:

• screening or approval mechanisms;
• restrictions on the employment of foreigners as key personnel; and
• operational restrictions, e.g. restrictions on branching and on capital repatriation or on land ownership.

The OECD FDI Index is not a full measure of a country’s investment climate. A range of other factors come into play, including how FDI rules are implemented. Entry barriers can also arise for other reasons, including state ownership in key sectors. A country’s ability to attract FDI will be affected by factors such as the size of its market, the extent of its integration with neighbours and even geography. Nonetheless, FDI rules are a critical determinant of a country’s attractiveness to foreign investors. Furthermore, unlike geography, FDI rules are something over which governments have control.

What is wrong with the 51/49 rule?

The new law reverses the 65/35 rule passed just over twelve months ago in May 2012. The previous Decree No. 103 of May 2012 was a logical development of the joint venture investment law, which has been in force for several years. In our view, the changes in permitted FDI percentages are outlined first in Decree No. 207. They then carried through to the new Companies Law to curtail FDI and investment generally into the private sector.

Under the new Companies Law, it is proposed that Libyan shareholders can only issue up to 49% of a joint venture to a foreign partner (rather than 65% provided for in Decree No. 103 of 2012). In other words, foreign companies cannot ever own more than half of any company set up in Libya. A foreign investor often provides most capital required in a new enterprise. With the reduction to 49%, many Libyan start-up ventures, which foreign investors might have previously funded, will no longer be capitalised by such partners.

What are the benefits of this decision to move to a 51/49 rule?

On the face of it, new companies will be majority-owned by Libyans. In theory, this is positive for Libyan businessmen, but only if they can find a foreign shareholder that is prepared to take a minority share in what many foreign investors still consider to be a country that is subject to “political risk” and that also has a chequered history for protecting foreign investments. Clearly, granting a majority shareholding right to Libyans is no longer an advantage if the Libyan businessman can’t find an international partner to invest, or if there is significantly less capital for these majority Libyan owned companies to use to grow their business. Also, less investment and less capital mean less international expertise and experience brought into the Libyan economy.

One must not also forget that the foreign partner actually contributes capital disproportionate to their shareholding in the vast majority of joint ventures. In other words, they often fund the Libyan partner. If a foreign investor can only own 49%, then they are unlikely to invest. International companies often have internal policies about whether they can or cannot hold minority interests. Additionally, if they put most of the money into an enterprise, they will inevitably want control over how it is spent and invested. If they can’t get this comfort, then they probably won’t invest. International investors have plenty of global opportunities. They don’t have to come to Libya.

Foreign partners also often bring with them expertise, governance, controls, frameworks, strategies, new products, and services needed in Libya.

A 51/49 rule will also be detrimental to the smaller, newer, entrepreneurial and ambitious Libyan business, not the established Libyan business. Larger Libyan businesses can already afford to invest in enterprises themselves and have less need for a technical foreign partner that can also bring in capital. Young Libyan start-up businesses cannot do this and will be at a disadvantage to the current “economic elite” that already controls much of Libya’s private sector.

If the government wants to retain the 51/49 rule, perhaps it could consider what Dubai has done. In Dubai, the 51/49 rule still prevails (although there is intense speculation that this may change in the future). Given the fact that Dubai is very keen to attract FDI, a rule has been implemented that says that although the shareholding percentages must be 51/49, the JV partners can register a disproportionate dividend entitlement, effectively allowing the foreign partner, in practice, to secure an economic interest of 80%.

International trade considerations

Libya applied to join the World Trade Organisation (WTO) in 2004. The process for Libya’s accession to WTO is expected to resume shortly. Libya’s accession to the WTO will be a significant step to make Libya’s integration in the global free trade system irreversible. It is likely to transform the country’s economy and its legal system and its institutions.

Therefore, in our view, as Libya prepares to become a major player in regional and international trade, it will have to come to grips with the demanding task of adapting to WTO standards, i.e. the fair trade rules of genuine partnership on an equal footing. However, the chances that Libya’s accession to the WTO will result in an immediate gain will be quite slim as long as investor confidence remains low and barriers to entry for foreign firms are high. In addition, there will be several changes that Libya will be requested to commit to by other WTO Members upon the accession to WTO. If Libya, after acceding to WTO, continues to impose restrictions that are inconsistent with its market-access commitments, then it may be subject to WTO’s disciplinary process and may be required to adjust its laws retrospectively.

In this context, the Libyan government may consider a gradual liberalisation of restrictions on its FDI rules as part of the preparation for joining the WTO (or, generally, any bilateral or multilateral trade regime). For instance, full liberalisation (i.e. permitting 100% foreign ownership) may be allowed in certain key sectors where foreign investment and expertise is urgently needed, such as telecommunication, certain technologies, and healthcare. This is the approach that has been taken by many countries that acceded to the WTO in recent years, such as Russia, China, Central Asian countries and Saudi Arabia (see below).

Saudi Arabia model

In the MENA region, Saudi Arabia can provide an excellent example for Libya. The Kingdom started negotiating its membership in 1993. In 2000, the new Foreign Investment Act was introduced. The Saudi Arabian General Investment Authority (SAGIA) was the body in charge of administering the Act under the guidance of the Supreme Economic Council. Several significant changes were made under the Act, which is as follows:

Certain restrictions were made against FDI under the old investment law, including the prohibition of foreigners from investing in sectors that were reserved for the government and domestic investors, such as printing and publishing services, telecommunications services, the transmission and distribution of electrical power, pipeline transmission services, education services, hospital and health services, insurance and the electric power generation. These sectors were no longer closed, and foreign investors were able to invest freely. However, there was an important caveat in that certain sectors were put on a “Negative List“. This Negative List is compiled by SAGIA and approved by the Supreme Economic Council. The Negative List is updated and revised from time to time. In 2012, that is 7 years after Saudi Arabia’s accession, there were only three industrial sectors and 13 service sectors still appearing on the Negative List. In all other sectors, 100% foreign ownership is now permitted.

To various extents, Oman, Egypt, Bahrain, and Qatar have adopted a similar approach to foreign ownership and FDI rules. In the case of the UAE, which has been a WTO member since 1996, the WTO Members have, on various occasions, urged the UAE to relax further its foreign ownership rules outside the free trade zones. So far, the UAE has resisted those calls but has promised to uphold its free-market strategy and will proceed with reviewing all existing policies to make them resilient, adaptable, and responsive to future challenges. The new draft UAE Companies Law still contains 51% local ownership and 49% foreign ownership split. Still, provision is made for Cabinet Resolutions to give exemptions for certain forms of companies, activities or classes. This may either be a full exemption or an increase of 49% foreign ownership.

In this regard, it should be noted that KSA is ranked 28^th in the World Bank’s “2013 Doing Business” under the “protecting investors” criterion, whereas the UAE is ranked 128^th. This indicates a higher level of investor confidence in doing business in Saudi Arabia than in the UAE. In the last few years, Saudi has moved from near the bottom to somewhere near the top. Saudi used to suffer from high levels of bureaucracy, high registration fees, protectionism and slow processes. Now they have moved right up the rankings and are trying to get into the world’s top 10 in terms of the easiest place for doing business along with the likes of Singapore. As a result of this, huge investments have been made by foreign investors worldwide, resulting in an increase in private sector activities generally and an increase in job opportunities for Saudi nationals.

We, therefore, consider that Libya should look at the progress of Saudi Arabia, not just about FDI but about the whole ease of doing business scenario. See attached document at the end of this analysis.

Saudi Arabia has moved away from its old model of limiting the percentage of foreign ownership because this was killing investment. Instead, they decided that the most important issue for the country is to get Saudis working. Saudi can no longer absorb more people into the public sector, so they have to encourage new businesses (local and foreign) to set up. Rather than focusing on shareholding percentages, they have looked at the workforce. They have introduced a rule that foreign companies can hold up to 100% of equity provided that at least 75% of staff must be Saudis and at least 51% of payroll costs must be payable to Saudi nationals. For us, this is the way that Libya should be going. It is much better for the man on the street and does not block the market for the benefit of the local oligarchs.

Additionally, even though foreigners can get up to 100% foreign ownership in Saudi Arabia, the reality is that virtually all foreign companies still go in on a joint venture basis with a Saudi partner because their business is far more likely to succeed if they do so. Moreover, foreign investment in joint ventures with Saudi partners has advantages. While foreign partners in a joint venture entity may hold 100% of the equity, there are major commercial advantages in having a local Saudi partner own 50% of the equity or more. For example, if a Saudi national holds 50% of the equity in a joint venture company, it enables the company to obtain an interest-free loan for up to 50% of the project cost, which is repayable over a period of ten years. In addition, most Saudi-owned joint ventures are entitled to preference after wholly Saudi-owned companies in the allotment of government contracts.

So, in summary, Saudi Arabia has rejected the 51/49 rule in favour of:

• 100% foreign ownership;
• a fairly limited negative list (in years gone by, the negative list was very extensive, but now it is much shorter);
• The requirement for the workforce to be 75% Saudi nationals;
• The requirement for payroll costs to be at least 51% payable to Saudis;
• soft loans for JV companies where Saudi shareholding is 51% or more; and
• pricing preference for bidding on government contracts where the company is at least 51% Saudi owned.

Specific comments on the Draft Law

We have limited our comments on the Draft Law to the Articles which will have the most adverse impact on FDI, namely: Article 66 (Capital, Article 256 (Foreigners Contribution to Libyan Companies), Article 257 (Foreigners Contribution to Libyan Companies), Article 258 (Foreigners Contribution to Libyan Companies), Article 259 (Foreign Companies Representation Offices and Branches) and Article 327 (Rules of Foreign Companies, Branches and Representation Offices of Foreign Companies).

Article 66 provides that the capital of a joint-stock company must not be less than LYD 1 million, provided that no less than three-tenths of the capital is deposited in a bank in Libya.

Due to Article 257 of the Draft Law, the minimum capital requirement in Article 66 applies to every foreign company wishing to enter the Libyan market through a company. The minimum capital requirement of LYD 1 million is a significant outlay for most companies (tiny and medium-sized enterprises). This will deter foreign companies establishing in Libya and, accordingly, deter foreign companies from transferring their know-how and expertise to Libya and the Libyan workforce. The combined effect is that fewer joint-stock companies operated to an international standard will be established. The Libyan workforce will not have access to international expertise and know-how.

The capital requirement could be linked to, for example, the types of activities that the joint-stock company wishes to carry out. A flexible approach of this nature would be more amenable to the international business community whilst, at the same time, allowing the competent authorities in Libya to set the right level of creditor protection and financial commitment by non-Libyan companies in respect of FDI.

Article 256 provides that foreigners may not contribute to the establishment of companies in Libya unless the following requirements are satisfied:

• the foreign partner is a company established in accordance with the law of the country of origin;
• the foreign partner’s experience is not less than ten years after its date of incorporation;
• the foreign partner’s contribution is not more than 49% of the capital of the company; and
• the activity of the company to be established with the assistance of the foreign company must focus on the execution of production or services projects as specified by the Executive Regulations.

This Article is the most important provision of the Draft Law, which affects FDI. We have set out our views on the 51/49 rule in detail above.

This article also provides that a foreign partner needs to have 10 years of experience before taking shares in a Libyan company. This can be counter-productive. Multinational companies often form special purpose companies to carry out investments in a particular country or region. We advocate a more flexible approach that takes account of how multinational companies conduct business.

Article 257 provides that foreign companies may exclusively contribute to the establishment of joint-stock companies.

There may be skills, know-how and expertise from which the Libyan workforce can benefit, but at the same time, the suppliers of such skills, know-how and expertise do not have access to the market due to the very high barriers of entry. Accordingly, a more flexible approach could be taken to strike the right balance between the protection of creditors and transparency and create a more investor-friendly environment.

Article 259 states that foreign companies may establish branches or representative offices in the State; the Executive Regulation of this Law shall specify the authority having the competence to grant the permission as well as the term and conditions for renewal thereof and the scope wherein the opening of representation offices or branches shall be permissible.

Based on the Draft Law, the only real alternative to forming a joint-stock company is the establishment of a branch. It is imperative that the Executive Regulations of the Draft Law set out a wide scope of activities that branches can carry out so that a branch set up is an investor-friendly route. In particular, the right level of prior experience and financial commitment should be set to facilitate FDI by small and medium-sized enterprises and global organisations.

Conclusion

An overview of foreign ownership rules in the MENA region

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.   17 July 2013 by Albudery Shariah and Leopold Zentner Clyde & Co