TREASURE HUNT. How Good Financial Governance can support resource-endowed countries in achieving the SDGs $$$

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1 TREASURE HUNT How Good Financial Governance can support resource-endowed countries in achieving the SDGs $$$

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3 Table of contents Foreword About This Book 1 3 List of Abbreviations 7 Rationale Agenda 2030 Good Financial Governance in Resource-Endowed Countries Framework Conditions in Resource-Endowed Countries Resilience in Sector Dynamics Expectation Management Inter-agency Cooperation

4 Challenges for Good Financial Governance in Resource-Endowed Countries Overview: How to Ensure GFG in Resource-Endowed Countries Legal and Fiscal Framework Revenue Collection Revenue Allocation and Budgeting Contracts State Ownership Artisanal and Small Scale Mining Data Availability Transparency, Oversight and Accountability

5 Foreword About This Book

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7 About This Book The Deutsche Gesellschaft für In ter na tionale Zusam me nar beit (GIZ) has been work ing on the top ics Good Fi nan cial Gov er nance and Re source Gov er nance for sev eral years. Rev enues from the ex trac tive sec tor can if well man aged ac cord ing to Good Gov er nance cri te ria con tribute sig nif i cantly to the de vel op ment of re source-en dowed coun tries. How ever, in many part ner coun tries of the Ger man De vel op ment Co op er a tion (GDC), re source abun dance has not trans lated into sus tain able de vel op ment in a mean ing ful way. This pub li ca tion aims at fur ther con cep tu al is ing the Good Fi nan cial Gov er nance ap proach in its rel e vance for re source-en dowed de vel op ing coun tries. Dur ing five pro duc tive days, the team fo cused on the tech ni cal, po lit i cal and nor ma tive chal lenges re source-en dowed de vel op ing coun tries face re gard ing Pub lic Fi nance Man age ment sys tems and the man age ment of re source rev enues. The dis cus sions moved from tech ni cal fis cal is sues to ex pec ta tion man age ment, cli mate change and eq uity con sid er a tions. The out come is the fol low ing book, which cov ers how Good Fi nan cial Gov er nance can con tribute to bet ter man age ment of the Ex trac tive Sec tor. The book is called Trea sure Hunt, a term re fer ring to both the gold dig ger at mos phere that sur rounds the ex plo ration of nat ural re sources and the often Don-Qui jot ian quest of pub lic of fi cials for rev enues. All this has been con densed into a book dur ing five days, using the Book Sprints tech nique. A team of GIZ ad vi sors work ing in the De mo c ra tic Re pub lic of Congo, Sierra Leone, Ghana and Ger many came to gether in Bad Hon nef, where they were joined by two ex ter nal ex perts from Aus tralia and the USA. The Book Sprint is a fa cil i tated col lab o ra tive writ ing tech nique in which par tic i pants con stantly brain storm, write, edit and copy-edit each other in a work flow that some how man ages to com bine high flu id ity with struc ture. This is a "fast and fu ri ous" process, so the reader may for give some in ac cu ra cies and gaps. 3

8 FOREWORD The book is a work of col lec tive au thor ship pub lished under the Cre ative Com mons li cence, but that does not mean that every one of us, or the af fil i a tions we rep re sent, sub scribes to every state ment made. Bad Hon nef, June 3rd, 2016 Con trib u tors (in al pha bet i cal order): Anna Kravt senko Chris Shee han Henri Pierre Gebauer Jo hanna Jag now Kathrin Russ ner Kris t ian Lempa Ma g ali Man der Nico las Maennling Stephanie Schrade Su sanne Thiel Book Sprints Team: Il lus tra tions and Cover De sign: Hen rik Van Leeuwen Fig ure 1 is adapted from Map ping Min ing to the Sus tain able De vel op ment Goals: A Pre lim i nary Atlas (2016) with per mis sion from CCSI HTML Book Pro duc tion: Julien Taquet Text Clean-Up: Raewyn Whyte Tech Sup port: Juan Gutier rez Book Sprint Fa cil i ta tion: Bar bara Rühling 4

9 ABOUT THIS BOOK This work is licensed under a Creative Commons Attribution-ShareAlike 4.0 International Licence. 5

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11 List of Abbreviations AAAA Addis Ababa Ac tion Agenda ABFA An nual Bud get Fund ing Amount ASM Ar ti sanal and Small-scale Min ing BEPS Base Ero sion and Profit Shift ing BMZ Fed eral Min istry for Eco nomic Co op er a tion and De vel op ment CSR Cor po rate So cial Re spon si bil ity EI Ex trac tive In dus tries EITI Ex trac tive In dus tries Trans parency Ini tia tive EIRT Ex trac tive In dus tries Rev enue Task Force FPIC Free Prior and In formed Con sent GDC Ger man De vel op ment Cor po ra tion GDP Gross Do mes tic Prod uct GFG Good Fi nan cial Gov er nance GIZ Deutsche Gesellschaft für In ter na tionale Zusam me nar beit (GIZ) GmbH IMF In ter na tional Mon e tary Fund IN TO SAI In ter na tional Or gan i sa tion of Supreme Audit In sti tu tions MSG Multi-Stake holder-group MoF Min istry of Fi nance MoM (MoMOG) Min istry of Mines, (Oil and Gas) 7

12 FOREWORD NRA Na tional Rev enue Au thor ity NRTS Non-Tax Rev enue Sys tem ODA Of fi cial De vel op ment Aid OECD Or gan i sa tion for Eco nomic Co-op er a tion and De vel op ment PIAC Pub lic In ter est and Ac count abil ity Com mit tee PFM Pub lic Fi nan cial Man age ment PRMA Pe tro leum Rev enue Man age ment Act SAI Supreme Audit In sti tu tion SDG Sus tain able De vel op ment Goals SOE State-Owned En ter prise VAT Value Added Tax WTO World Trade Or gan i sa tion 8

13 Rationale Agenda 2030 Good Financial Governance in Resource- Endowed Countries

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15 Agenda 2030 The Sustainable Development Goals (SDGs) provide the new global framework for development. The Financing for Development (FfD) Process states that domestic resources must be the most important funding source for achieving SDGs. Building effective institutions, reducing illicit financial flows and corruption, improving domestic resource mobilisation, and tackling climate change are particularly relevant concerns for Good Financial Governance (GFG) in the extractive sector. Certain SDGs may conflict with the objective of resource-endowed developing countries to maximise revenue generation from the sector. Background In Sep tem ber 2015, the world agreed on new tar gets for sus tain able de vel op ment. The 17 SDGs out line the Agenda 2030 with 169 tar gets. Un like the Mil len nium De vel op ment Goals, the SDGs are uni ver sal and not only tar geted at de vel op ing coun tries. Fur ther more, the SDGs place greater im por tance on gov er nance and cli mate change. The Fi nanc ing for De vel op ment Process and the Addis Ababa Ac tion Agenda (AAAA) pro vide the means for im ple men ta tion of Agenda The AAAA states that do mes tic re sources must be the most im por tant fund ing source for de vel op ment. Of fi cial De vel op ment Aid (ODA) can only serve as a tem po rary so lu tion to cover the fi nan cial deficits of de vel op ing coun tries. Ac cord ing to the AAAA, Il licit Fi nan cial Flows rep re sent an im por tant area of in ter ven tion for the in ter na tional com mu nity. The AAAA also ad dresses the spe cial chal lenges of re source-rich coun tries. Para graph 26 of the AAAA states: 11

16 RATIONALE "... We en cour age in vest ment in value ad di tion and pro cess ing of nat ural re sources and pro duc tive di ver si fi ca tion and com mit to ad dress ing ex ces sive tax in cen tives re lated to these in vest ments, par tic u larly in ex trac tive in dus tries. We reaf firm that every State has and shall freely ex er cise full per ma nent sov er eignty over all its wealth, nat ural re sources, and eco nomic ac tiv ity. We un der line the im por tance of cor po rate trans parency and ac count abil ity of all com pa nies, no tably in the ex trac tive in dus tries. We en cour age coun tries to im ple ment mea sures to en sure trans parency and take note of vol un tary ini tia tives such as the Ex trac tive In dus tries Trans parency Ini tia tive. We will con tinue to share best prac tices and pro mote peer learn ing and ca pac ity build ing for con tract ne go ti a tions for fair and trans par ent con ces sion, rev enue, and roy alty agree ments, and for mon i tor ing the im ple men ta tion of con tracts." Relevance of SDGs to Good Financial Governance in extractive industries Even though it is not specif i cally men tioned in the Agenda 2030, the ex trac tive in dus try sec tor bears great po ten tial to help to wards achiev ing the SDGs through sev eral chan nels such as do mes tic rev enue gen er a tion, em ploy ment, and in fra struc ture de vel op ment. At the same time, the sec tor may neg a tively im pact on the achieve ment of the SDGs due to con tribut ing to en vi ron men tal pol lu tion, cli mate change, human rights vi o la tions, in equal ity and cor rup tion. As high lighted in the "Map ping Min ing to Sus tain able De vel op ment Goals: A Pre lim i nary Atlas," the min ing sec tor, and sim i larly the oil and gas sec tors, can have di rect or in di rect im pacts on all SDGs. The most rel e vant SDGs for Good Fi nan cial Gov er nance in the ex trac tive sec tor are re lated to fi nan cial flows from the sec tor (which in turn can af fect all SDGs). These in clude SDG13, SDG16, and SDG17. 12

17 AGENDA 2030 Figure 1: SDGs relevant to Good Financial Governance in extractive industries SDG13: Take ur gent ac tion to com bat cli mate change and its im pacts. While there are no tar gets that are di rectly rel e vant to GFG in the ex trac tive sec tor, the sub se quent Paris Agree ment of De cem ber 2015 may sig nif i cantly in flu ence rev enues com ing from coal, oil and gas. Coun tries agreed to: "Hold ing the in crease in the global av er age tem per a ture to well below 2 C above pre-in dus trial lev els and to pur sue ef forts to limit the tem per a ture in crease 13

18 RATIONALE to 1.5 C above pre-in dus trial lev els, recog nis ing that this would sig nif i cantly re duce the risks and im pacts of cli mate change." It has been es ti mated that in order to achieve this tar get, around a third of global oil re serves, half of global gas re serves and over 80% of cur rent global coal re serves need to be stranded (re main un de vel oped un der ground) in order to meet the 2 C tar get (McGlade and Ekins, 2015, The ge o graph i cal dis tri b u tion of fos sil fuels un used when lim it ing global warm ing to 2 C, Na ture). This does not in clude any ad di tional re serves that might be dis cov ered in the fu ture. Areas for further thinking Can gas be used as a "transitional" energy source to decarbonise the world economy (due to being less carbon intensive than coal and oil)? Or would the timeline for developing gas-related infrastructure be too long to meet the targets agreed to? SDG16: Pro mote peace ful and in clu sive so ci eties for sus tain able de vel op ment, pro vide ac cess to jus tice for all, and build ef fec tive, ac count able in sti tu tions at all lev els. Tar get 16.4: By 2030, sig nif i cantly re duce il licit fi nan cial and arms flows, strengthen the re cov ery and re turn of stolen as sets, and com bat all forms of or gan ised crime. Tar get 16.5: Sub stan tially re duce cor rup tion and bribery in all their forms. As high lighted in the sub se quent chap ters of this book, rev enues from the ex trac tive in dus try sec tor can en cour age cor rup tion and lead to the re source curse if not man aged ap pro pri ately. Avoid ing these is a pri mary ob jec tive of Good Fi nan cial Gov er nance in the ex trac tive sec tor. 14

19 AGENDA 2030 SDG17: Strengthen the means of im ple men ta tion and re vi talise the Global Part ner ship for Sus tain able de vel op ment. Tar get 17.1 Strengthen do mes tic re source mo bil i sa tion, in clud ing through in ter na tional sup port to de vel op ing coun tries, to im prove do mes tic ca pac ity for tax and other rev enue col lec tion. Re source-de pen dent coun tries often rely heav ily on ex trac tive in dus tries for their do mes tic rev enue gen er a tion. The ero sion of do mes tic rev enues re sult ing from tax eva sion and avoid ance, such as abu sive trans fer pric ing prac tices, needs to be ad dressed at the na tional level through im proved au dit ing prac tices and at the in ter na tional level through im proved in for ma tion ex change. Trans fer pric ing will be dealt with in more de tail in sub se quent chap ters. Impact on countries with fossil fuel reserves Coun tries with im por tant fos sil fuel re serves rely on their re sources for en ergy and rev enue gen er a tion. The lat ter is of par tic u lar im por tance for Good Fi nan cial Gov er nance in the ex trac tive sec tor. 43 coun tries were con sid ered fos sil re source-de pen dent in 2014 (using the IMF's de f i n i tion of 25% of ex port value being made up of fos sil fuels). The ne ces sity to man age fos sil re sources will have a par tic u larly heavy im pact on the bud gets of these coun tries. The most eco nomic way to tackle this prob lem on a global level is to ex tract the re sources with the low est pro duc tion costs and strand those as sets with rel a tively high pro duc tion costs. One way to achieve this would be through a global car bon tax which would ren der un con ven tional and Arc tic gas and oil de vel op ments as un eco nomic. Fuel from low-cost pro jects such as those in the Mid dle East would con tinue to be ex tracted. How ever, there are eq uity ques tions that need to be ad dressed: Should the level of de vel op ment of the coun try be con sid ered? Should the cur rent re liance of a coun try on fos sil fuels be con sid 15

20 RATIONALE ered? Should coun tries that his tor i cally have not con tributed to cli mate change (pri mar ily low-in come coun tries) be treated the same as coun tries that have in dus tri alised on the back of fos sil fuel ex trac tion and use? Should coun tries that are par tic u larly vul ner a ble to cli mate change be com pen sated by those that ben e fit from fos sil fuel ex trac tion and use? If the an swer to these ques tions is yes, then al ter na tive fi nanc ing and com pen sa tion schemes would have to be de vel oped. Areas for further thinking Little work has been done to date to provide a framework for discussion of which fossil resources need to be "stranded" in order to achieve the objectives. Another question related to this, but highlighting the revenue side of this aspect is: how to mitigate risks of sinking capacity for domestic resource mobilisation due to the stranding of fossil resources? While a global agree ment is re quired to tackle these com plex ques tions, at the coun try level, gov ern ments need to start as sess ing the im pacts such agree ments may have on their econ omy. Es pe cially for fos sil fuel-de pen dent coun tries, it be comes even more im por tant to di ver sify their economies away from coal, oil and gas, and broaden their tax base. Area for further thinking Little support is being provided to resource-endowed developing countries in understanding the impact the climate change agreement may have on their economies. 16

21 AGENDA 2030 Positioning GIZ to help achieve the Agenda 2030 GIZ is al ready work ing in a lot of the areas that ad dress the SDGs. The fol low ing chap ters of this book will out line, ac cord ing to the Good Fi nan cial Gov er nance ap proach, how in ter ven tions can be im proved to help ad dress SDGs 16 and 17 di rectly, and po ten tially the re main ing SDGs in di rectly, through ef fi cient rev enue col lec tion and bud getary spend ing in rel e vant sec tors. The Ger man De vel op ment Cor po ra tion is also work ing with part ner coun tries to achieve the cli mate ac tion goal. GIZ pro vides mul ti ple sup port pro grammes to part ner coun tries through its cli mate change work stream. Fur ther more, KfW pro vides fi nanc ing to re new able en ergy pro jects and has stopped fi nanc ing coal-fired power pro jects. How ever, there is cur rently lit tle work being done on link ing cli mate change and SDG 13 with Good Fi nan cial Gov er nance in EI, which, as out lined above, will be come in creas ingly im por tant. This is not sur pris ing and no other bi lat eral or mul ti lat eral de vel op ment or gan i sa tion is work ing in this area. This can partly be traced back to the re cent na ture of the Paris Agree ment, which is the first time that coun tries agreed on a tem per a ture rise cap, which pro vides a frame work re gard ing how much fos sil fuels can be safely ex tracted. Areas of intervention > Review development project objectives to align them with Agenda > Coordinate between climate change and GFG in extractive industries workstreams to see whether there are areas of intervention which can address SDG

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23 Good Financial Governance in Resource-Endowed Countries GFG is the key tool for resource-endowed countries in achieving the SDGs. Certain characteristics of the extractive sector potentially have an adverse effect on the quality of Public Financial Management (PFM) systems and hence states with significant resource reserves will need specific GFG tools to safeguard the overall quality of PFM. The German Development Cooperation promotes change processes to achieve GFG in resource-endowed states, considering a technical, a normative, as well as a political economy dimension. Introduction GFG and trans parency of ex trac tive rev enues are rel e vant to the en tire rev enue man age ment process (in clud ing col lec tion, bud get ing and ex pen di ture) and are key to tap ping the po ten tial of nat ural re sources to help to achieve cen tral SDGs in re source-en dowed states, as dis cussed in Chap ter 3.1. The fol low ing chap ter will dis cuss spe cific chal lenges re gard ing GFG that such coun tries face. GFG as a key element of German Development Cooperation The Fed eral Gov ern ment of Ger many is ac tively con tribut ing to the shap ing of in ter na tional dis cus sions in the area of pub lic fi nance. Sup port of part ner coun 19

24 RATIONALE tries in pub lic fi nance re forms plays a key role in the con cep tual ori en ta tion of the Ger man De vel op ment Co op er a tion (GDC). There fore, the Fed eral Min istry for Eco nomic Co op er a tion and De vel op ment (BMZ) has de vel oped its GFG ap proach. GFG is an im por tant con tri bu tion to com pli ance with in ter na tional com mit ments to which Ger many ad heres. It es pe cially com prises the use and strength en ing of part ner sys tems, for ex am ple, in the con text of pro gramme-based ap proaches. Ger many em pha sises that an ef fi cient and trans par ent pub lic fi nance sys tem is an in dis pens able pre-con di tion for sus tain able de vel op ment and poverty re duc tion as de scribed in the Agenda As a cen tral pol icy tool, pub lic fi nance sys tems mo bilise, chan nel and con trol pub lic funds. A func tion ing pub lic fi nance sys tem ful fils im por tant gov er nance func tions: it cre ates le git i macy for state ac tion, stim u lates cit i zens iden ti fi ca tion with the state, and sets the gen eral frame work for pri vate sec tor en gage ment and eco nomic growth. The GFG ap proach refers to PFM not solely as a tech ni cal issue but as one which ad heres to the val ues of GDC, namely human rights, pro mo tion of so cial re spon si bil ity and a sus tain able free-mar ket econ omy, as well as open de mo c ra tic so ci eties and in di vid u als ini tia tive. GFG is a holis tic, sys temic and value-based ap proach which is aligned to the un der stand ing of Good Gov er nance in GDC. By im ple ment ing GFG, Ger many helps to re duce poverty and fos ter eco nomic, so cial and eco log i cal sus tain able de vel op ment. The ap proach is based on the con sid er a tion of as pects from three di men sions and their in ter-link ages. 20

25 GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Figure 2: Three dimensions of Good Financial Governance Resource Governance in German Development Cooperation The GDC ap proach to re source gov er nance is based on the po ten tials and risks the ex trac tive sec tor en tails for sus tain able de vel op ment. Today, a large pro por tion of the world s poor live in coun tries whose economies are dom i nated by 21

26 RATIONALE ex trac tive re sources, as high lighted in the fig ure below. These re sources could po ten tially drive a coun try s de vel op ment, re duce its fi nan cial de pen dency on donors, and in crease the pop u la tion s pros per ity. In many coun tries, how ever, the op po site ef fect may have re sulted: state struc tures are weak ened, the en vi ron ment de stroyed, and so cial con flicts cre ated or ex ac er bated. Al though the ex trac tive sec tor makes a major con tri bu tion to gross do mes tic prod uct and holds huge po ten tial for in creas ing pub lic rev enues, sus tain able de vel op ment ef fects for the poor pop u la tion often fail to ma te ri alise. This is due mainly to weak gov er nance struc tures and cor rup tion. Fur ther more, re source-de pen dent states are at high risk to show an over all worse gov er nance qual ity than coun tries with out a sig nif i cant ex trac tive sec tor. The mech a nism be hind this link still being con tested, yet the in di ca tion is quite clear (e.g. Ox ford Pol icy Man age ment 2011: Bless ing or curse? The rise of min eral de pen dence among low- and mid dle in come coun tries, see the PDF Doc u ment here [ / submissions / OPMBlessingorcursereport2011.pdf] ). Area for further thinking More research is needed to better understand the link (correlation or coincidence) between resource dependency and bad governance. 22

27 GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Figure 3: Map of resource dependence The re source gov er nance ap proach of GDC aims at sup port ing part ner coun tries in find ing the right bal ance be tween max imis ing the po ten tial and man ag ing the risks from the ex trac tive sec tor. Nor ma tively, this man age ment needs to be as in clu sive as pos si ble and to fol low a human rights-based ap proach. Based on this, GDC works in the fol low ing areas: 1. Strengthening the institutional framework in the resource sector 2. Development of sector strategies/policies, laws and regulations (including contract negotiation processes) 3. Public Financial Management of extractive sector revenues 4. Minimising corruption and illicit financial flows 5. Supporting regional cooperation, for example, on shared infrastructure 6. Decentralisation of mining sector administration 7. Promoting human rights in the extractive sector 23

28 RATIONALE Our work in these areas is based on a com pre hen sive un der stand ing of ca pac ity de vel op ment. In this con text, ca pac ity means the abil ity of peo ple, or gan i sa tions, and so ci eties to man age their own sus tain able de vel op ment processes and adapt to chang ing cir cum stances. This in cludes recog nis ing ob sta cles to de vel op ment, de sign ing strate gies to tackle them, and then suc cess fully im ple ment ing these strate gies. This proac tive man age ment ca pac ity en com passes the po lit i cal will, in ter ests, knowl edge, val ues, and fi nan cial re sources that the agents con cerned need in order to achieve their own de vel op ment goals. The un der stand ing of GDC Ca pac ity De vel op ment needs to hap pen con sis tently at four lev els: At the level of individuals: Competence building Purpose: promote personal, social, technical, managerial, methodological and leadership competencies in order to develop comprehensive, proactive capacities in individuals and networking through joint learning processes. Good examples for resource governance are training on the EITI and on contract negotiations. At the level of organisations: Organisational development Purpose: promote organisational learning and raise the performance and flexibility of an organisation. A good example of resource governance is the establishment of an IT-based mining licence system to empower the mining administration to efficiently manage the life cycle of the mining licences. At the level of society: Cooperation / Development of cooperation partnerships Purpose: establish and develop cooperation between organisations to improve coordination and performance; establish and develop networks for knowledge sharing and co-creation. A good example for resource governance is the 24

29 GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES establishment of coordination mechanisms between the mining and financial administration in order to monitor revenue management in the mining sector. Political framework / Development of enabling frameworks Purpose: develop enabling legal, political and socioeconomic frameworks so individuals, organisations, and societies can develop and raise their performance capability. A good example for resource governance is GIZ's cooperation with the African Minerals Development Centre to roll-out the Africa Mining Vision in African Union member countries. GFG in resource-endowed countries The IMF Guide on Re source Rev enue Trans parency (IMF 2007 [ / external / np /fad/trans/guide.htm] ) cat e gorises min eral and/or hy dro car bon-rich coun tries (pp ) by the fol low ing de f i n i tion: A coun try is con sid ered rich in hy dro car bons and/or min eral re sources if it meets ei ther of the fol low ing cri te ria: (i) an av er age share of hy dro car bon and/or min eral fis cal rev enues in total fis cal rev enue of at least 25 per cent dur ing the pe riod or (ii) an av er age share of hy dro car bon and/or min eral ex port pro ceeds in total ex port pro ceeds of at least 25 per cent... (see IMF 2007 [ / external / np / fad / trans / guide.htm], p. 2). One of the prob lems with this de f i n i tion is that it can lead to false ex pec ta tions and may send the wrong sig nal re gard ing the im por tance of the sec tor for poverty re duc tion. For ex am ple DR Congo, cat e gorised as a re source-de pen dent state under the IMF de f i n i tion, gives a dif fer ent im pres sion if one takes into ac count that the DR Congo an nu ally earns roughly USD 405 mil lion from the ex trac tive sec tor and then sets this into re la tion to the pop u la tion fig ure. Given 74 mil lion Con golese, this means USD an in signif i cant one or two cents per capita per day or less than USD 5.50 per capita per year. 25

30 RATIONALE For the pur pose of this paper, we will not thor oughly re strict the dis cus sion to this de f i n i tion. The pre ferred term, 're source-en dowed', refers merely to coun tries with nat ural re source re serves. De spite tem po rary de clines in prices, pro jects being in the early stage of de vel op ment, or the pres ence of other strong eco nomic sec tors which re sult in coun tries (tem porar ily) not being clas si fied as re source-rich or re source-de pen dent ac cord ing to the IMF's de f i n i tion, var i ous char ac ter is tics of the sec tor and cor re spond ing ex pec ta tions may still sig nif i cantly in flu ence the po lit i cal econ omy in a given coun try. With the de f i n i tion cited above in mind, and when ap pro pri ate, we also use the terms 're sourcerich' and 're source-de pen dent'. How ever, we use 're source-rich' if our em pha sis lies on the po ten tial as so ci ated with the ex trac tive sec tor (e.g. eco nomic growth, in creased rev enue), whereas 're source-de pen dent' puts em pha sis on the the risks (e.g. cycli cal na ture of the rev enues or eco nomic de pen dency). Cer tain char ac ter is tics of the ex trac tive sec tor po ten tially have an ad verse ef fect on the qual ity of the PFM sys tem and hence re source-de pen dent states will need spe cific GFG tools to safe guard the over all qual ity of PFM. Ap plied to the ex trac tive sec tor, the three di men sions can be de scribed as fol lows. Technical Dimension The tech ni cal di men sion en com passes mea sures to strengthen PFM processes, tools and ca pac i ties. For re source-de pen dent coun tries, some spe cific tech ni cal in stru ments are nec es sary due to the char ac ter is tics of the ex trac tive sec tor that have a neg a tive im pact on the over all qual ity of GFG. For ex am ple, the cycli cal na ture of the sec tor de mands fis cal tools to sta bilise pub lic rev enue and im prove bud getary plan ning. The key ques tion we ask here is: what tech ni cal so lu tions are avail able to safe guard GFG in re source-de pen dent states? 26

31 GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Political Economy Dimension The po lit i cal econ omy di men sion takes into ac count that re form ing pub lic fi nance is a po lit i cally highly-sen si tive process as it in ter feres with es tab lished power struc tures and al lo ca tion of scarce re sources in a so ci ety. In order to suc cess fully apply the tech ni cal in stru ments de scribed in Chap ter 5, we will con sider the dif fer ent stake hold ers, their in ter ests and their in ter ac tions, in for mal and often in for mal struc tures. Due to the fact that rel a tively few com pa nies gen er ate a con cen trated amount of rev enue, stakes are high and the po lit i cal com pe ti tion for ac cess to these rev enues is strong. This makes the po lit i cal econ omy dif fer ent to other sec tors as in ter ests in keep ing the sta tus quo are much stronger on the side of po lit i cal elites who al ready have ac cess. Hence, the par tic u larly high rel e vance of the po lit i cal econ omy of change processes of GFG in re source-en dowed states. The key ques tion we ask here is: with re gards to the im ple men ta tion a spe cific tech ni cal so lu tion and the in tended change, which stake hold ers are in volved and what are their in ter ests? Normative Dimension The nor ma tive di men sion puts a spe cial em pha sis on the re source gov er nance sit u a tion in a coun try. Re source gov er nance for us is the way gov ern ments man age the sec tor and the ways in which the ben e fits and costs yielded by the sec tor are (re-)dis trib uted in so ci ety. From a nor ma tive per spec tive of good re source gov er nance, we look at the qual ity of these dis tri b u tion processes, such as the level of in clu sive ness with re gards to all stake hold ers, the 27

32 RATIONALE rule of law, trans parency and state ef fi ciency in man ag ing them. The GFG ap proach will focus on fis cal (re-) dis tri b u tion processes, with rel e vance to the ex trac tive sec tor. The key ques tions we ask here are: does the tech ni cal in stru ment have (re-)dis tri b u tional ef fects, and are the af fected stake hold ers in volved in de ci sion-mak ing? are these dis tri b u tional processes man aged ef fi ciently by gov ern ment ac cord ing to the rule of law and in a trans par ent way? Area for further thinking A coherent approach to analysing the political economy of specific change processes towards GFG in resource-endowed countries is currently missing. We recommend undertaking expost analysis of already implemented change processes in order to work towards a standardised approach. 28

33 Framework Conditions in Resource-Endowed Countries Resilience to Sector Dynamics Expectation Management Inter-agency Cooperation

34

35 Resilience in Sector Dynamics The volatility of prices linked to the cyclical nature of commodity markets and EI project cycles is a major challenge for PFM systems. This is especially pertinent for domestic revenue mobilisation and national budgets of resource-dependent developing countries where the ability to fund the SDGs can be severely limited. Countries heavily dependent on revenues from the extractive sector should have a comprehensive strategy for proactive management of the impact of commodity and project cycles. Stabilisation and diversification are avenues for resource-endowed states ensuring a sustainable development path. Introduction Man age ment of ex trac tive re sources, es pe cially when it comes to the man age ment of rev enues and other as pects of pub lic fi nance man age ment, is chal lenged by sev eral fea tures of ex trac tive re sources both at mi cro- and macro-eco nomic lev els: At the micro-economic level, revenues from extractive resources do not flow evenly but follow project cycles. Few revenues are received during exploration and the early stages of production. Only once the project becomes profitable, larger revenues flow. At the macro-economic level, volatility of commodity prices challenges PFM, whith revenue projections being inaccurate or economic activities slowing down. Volatility of commodity prices requires policy instruments that ensure short-term revenue fluctuations do not translate into erratic government 31

36 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES spending. Furthermore, with large investments into a specific sector, a country's currency may appreciate, harming the competitiveness of other sectors and leading to deterioration of businesses that produce goods for export, a phenomenon called Dutch Disease". The term was first coined when describing the adverse effect on manufacturing in the Netherlands attributed to the discovery of natural gas. The micro and macro-eco nomic lev els in flu ence each other. Com pa nies might choose to delay pro duc tion due to low prices, fur ther in creas ing the neg a tive im pact on rev enues. Al ter na tively, a com pany al ready pro duc ing might choose to in crease pro duc tion dur ing a pe riod of low prices, in order to bal ance that de cline and push com peti tors out of the mar ket. Coun tries heav ily de pen dent on rev enues from the EI sec tor should there fore have a com pre hen sive strat egy for proac tive man age ment of the im pacts of com mod ity and pro ject cy cles, and apply this not only in times of down turn or cri sis. Project life cycles In PFM, gov ern ments and pub lic ad min is tra tion have to take into ac count that re lated rev enues flow ac cord ing to the ex trac tion pro ject life cycle. An ex trac tion pro ject will pri mar ily gen er ate rev enues for the gov ern ment dur ing the pro duc tion phase, but would typ i cally gen er ate much less rev enues dur ing the ex plo ration and de vel op ment phases. Ob vi ously, the leg isla tive frame work is de ci sive when it comes to rev enue flows as it de ter mines tax rates, tax ex emp tions and other specifics. The below fig ure out lines the taxes col lected at the var i ous stages dur ing the life cycle of an EI pro ject. 32

37 RESILIENCE IN SECTOR DYNAMICS Figure 4: Project life cycle including payments Coun tries which do not have an 'or gan i cally' grown ex trac tive sec tor, but which have opened up the sec tor for in vest ment and is sued li cences around the same time, may suf fer from more ex treme eco nomic im pacts when com mod ity prices rise or fall, given that most pro jects are at the same stage in the life cycle (this is the case in many African coun tries which at tracted sig nif i cant amounts of for eign di rect in vest ment in the sec tor after the Wash ing ton Con sen sus in the 1980s and 1990s). If a coun try de cided to ex ploit its ex trac tive re sources and ex trac tive pro jects started around the same time, it would typ i cally go through a phase of high in vest ment (and, con se quently, low tax pay ments) fol lowed by a boom of ini tial rapid eco nomic growth (re flected in growth in GDP) di rectly and in di rectly re lated to the ac tiv i ties in the ex trac tive sec tor. Em ploy ment and thus pur chas ing power may also in crease. When com pa nies enter into the pro duc tion phase and cap i tal in vest ments are amor tised, state rev enue should in crease. Stag nat ing eco nomic growth, in creas ing un em ploy ment and shrink ing rev enues will typ i cally 33

38 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES fol low when the re sources are ex hausted and rev enues have not been in vested in pro duc tive sec tors. Commodity boom-bust cycles A major fac tor in flu enc ing the im pact of the ex trac tive sec tor on eco nomic de vel op ment of a coun try are in ter na tional boom-bust cy cles re lated to a fluc tu a tion of com mod ity prices (price volatil ity re sult ing from changes in sup ply and de mand). Ini tial pro jec tions often do not hold true, and eco nomic op er a tors as well as the gov ern ment must pre pare and react to the in ter na tional dy namic. While eco nomic op er a tors may use the cur rent slow-down in order to pre pare for the next boom (e.g. mod ernise), the gov ern ment will most likely be busy man ag ing a 'cri sis'. The nar ra tives may be dif fer ent but tend to be used strate gi cally when tax ex emp tions or tax re duc tions are ne go ti ated. The re cent down turn of com mod ity prices her alded the end of al most a decade of an im pres sive com mod ity boom. A slow-down of the world econ omy, dri ven pri mar ily due to struc tural changes in China com bined with an over sup ply of com modi ties, caused prices to crash. The volatil ity of prices linked to the cycli cal na ture of the com mod ity mar kets is a major chal lenge for PFM sys tems in re source-en dowed coun tries. The fall in prices has led to a fund ing short age for these coun tries to achieve the SDGs. In some coun tries, there are al le ga tions that the past com mod ity boom has not lived up to the ex pec ta tions, with coun tries not being able to cap ture an ad e quate share of the rent and the EI sec tor not hav ing con tributed to eco nomic de vel op ment. In many coun tries, reg u la tions were changed dur ing peak prices in order to cap ture the rent, but these laws were only im ple mented to wards the end of the boom. This counter-cycli cal pol icy re sponse can ex ac er bate the prob lem with higher taxes in low-price sce nar ios dri ving com pa nies out of busi ness. 34

39 RESILIENCE IN SECTOR DYNAMICS Areas for further thinking While fiscal regimes in the oil and gas sector tend to have more progressive mechanisms, these are less prevelant in mining legislations. Many mining-producing country governments were contemplating the introduction of resource rent taxes (or windfall taxes) in order to capture the rent from the mining sector during the boom years. However, such regulations were deeply opposed by the mining industry. Now, during the low-price commodity environment where such tax would not kick in, it might be easier to introduce such progressive taxation systems that would ensure that resourcerich countries do not miss out on the rents created during the next commodity boom. Economic stabilisation and diversification Given the ex hausta bil ity of com modi ties and the volatil ity of rev enue flows, ex trac tive rev enues pose par tic u lar pol icy chal lenges when it comes to en sur ing eco nomic sta bil i sa tion and di ver si fi ca tion in the short, medium and long term. The ef fec tive sta bil i sa tion of the local econ omy, cur rency and ex trac tive rev enue spend ing, as well as in vest ments in di ver si fi ca tion poli cies, help coun tries achieve the SDGs. Coun tries can use var i ous mech a nisms to ad dress sta bil i sa tion and these are ex panded upon in Chap ter 5.4. on Rev enue Al lo ca tion. To di ver sify, coun tries can rely on do mes tic rev enues (in clud ing those col lected from the EI sec tor) to tar get de vel op ment in other sec tors in the econ omy. These sec tors should be set out in a in dus trial or di ver si fi ca tion strat egy. Given that in re source-rich coun tries the ex trac tive in dus try sec tor plays a major role, rev enues should also be al lo cated to cre ate link ages to the EI sec tor that could help in the di ver si fi ca tion process. The fig ure below out lines the var i ous link ages to the EI sec tor and shows to what ex tend they may con tribute to eco nomic di ver si fi ca tion. 35

40 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES The im pact fis cal link ages (rev enues) have on eco nomic di ver si fi ca tion de pends on the ob jec tives and ef fi ciency of gov ern ment spend ing. In vest ments in in fra struc ture and human cap i tal that fos ter pri vate sec tor de vel op ment in other areas of the econ omy will con tribute to di ver si fi ca tion. Spend ing the rev enues on salaries of pub lic ser vants is less likely to con tribute to eco nomic di ver si fi ca tion. Within the pro duc tion value chain, link ages to the up stream sec tors (SMEs pro vid ing goods and ser vices to the EI pro ject) and down stream sec tors (for ex am ple steel plants that process iron-ore) will have a mod er ate im pact on di ver si fi ca tion. These sec tors are still closely linked to the EI sec tor. This is also the case for con sump tion link ages, whereby peo ple em ployed in the EI value chain spend their earn ings in the do mes tic econ omy. Spa tial or in fra struc ture link ages, whereby the in fra struc ture built for the EI sec tor is shared with other users, can con tribute to other eco nomic ac tivies being un locked. Even if the com mod ity prices fall, the in fra struc ture is still avail able to other users. Sim i larly knowl edge and hor i zon tal link ages are highly rel e vant for eco nomic di ver si fi ca tion as skills and knowl edge ac quired in the EI sec tor are used to de velop new in dus tries. 36

41 RESILIENCE IN SECTOR DYNAMICS Figure 5: Linkages to the extractive industry sector & potential for diversification To sum marise, in order for a coun try to di ver sify its econ omy, it needs to sta bilise spend ing, given that with out macro eco nomic sta bil ity new in dus tries will not de velop. Once this is achieved, rev enues earned from the EI sec tor can be used to tar get in dus tries that will help di ver sify its econ omy. Given that the EI sec tor is al ready a major 'an chor' in dus try, it makes sense to tar get link ages to the sec tor through local con tent strate gies. In par tic u lar, in fra struc ture, tech nol ogy and hor i zon tal link ages are highly rel e vant for di ver si fi ca tion. GFG plays an im por tant role in both en sur ing that the sta bil i sa tion mech a nisms have clear rules and are trans par ent, as well as the bud get al lo ca tions to tar geted sec tors in the in dus trial/di ver si fi ca tion strat egy, to en sure that these rev enue flows are not used for pa tron age pur poses. 37

42 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES Areas for further thinking To support resource-endowed developing countries in their efforts to foster a stable and diversified economy, development organisations should broaden their advisory portfolio and be in a position to support governments and other development partners in their efforts to design and implement adequate strategies. These strategies include mitigation strategies to counter the destabilising effect of extractive revenues on the economy and to direct such revenues into policies aimed at economic diversification and transformation. Areas of intervention > Put emphasis on a resource rent tax (or a less complex proxy) based on profitability of projects (e.g. rate of return) in the overall tax take in order to benefit from boom cycles and automatically decrease fiscal pressure on companies during bust times. > Develop transformative policies (e.g. state investment vs. government incentive; industrial development corporations, investment promotion agencies, and special economic zones) as well as complementary policy domains such as trade, labour, infrastructure, and education. For Africa, the Africa Mining Vision represents a very good example of such a policy framework. > Methods for earmarking extractive revenues for such policies and harmonising public and private investments at a local level also play a role. 38

43 RESILIENCE IN SECTOR DYNAMICS > Particular benefits to disadvantaged groups of society through economic diversification should be taken into account. While the fostering of economic linkages of the resource sector plays an important role in diversifying an economy, there are also potential trade-offs between economic linkages and the aims of stabilisation and diversification due to Dutch Disease effects. 39

44

45 Expectation Management High EI revenues often generate expectations demanding quick returns, creating risk of conflict and unsettling governance. Managing expectations of government officials, affected communities and the general public is thus crucial. An open and transparent revenue management and distribution process can facilitate expectation management. Introduction The op por tu ni ties and risks as so ci ated with the ex trac tion of min eral and pe tro leum re sources are of enor mous im por tance for de vel op ing coun tries, and can have a last ing and strong im pact on a coun try s de vel op ment. The ex trac tive sec tor also af fects many other sec tors such as in fra struc ture, en ergy pro duc tion and con sump tion, the en vi ron ment, land use, and other in dus trial processes. The pres ence of min eral and/or pe tro leum re sources cre ates high ex pec ta tions within the pop u la tion, es pe cially in com mu ni ties close to min ing sites, re gard ing an im mi nent boost for de vel op ment through ad di tional pub lic spend ing and em ploy ment op por tu ni ties. At times, there might also be in flated ex pec ta tions of gov ern ments due to a lack of knowl edge about the sec tor and its 'rules of the game'. Pri vate stake hold ers should also know what is ex pected of them and what they can ex pect from the host gov ern ments. From a de vel op ment pol icy per spec tive, it is there fore im por tant for all stake hold ers in a coun try to un der stand how and to what end the state in tends (and will be able) to use its re sources. What does it aim to achieve in terms of so cial and eco nomic de vel op ment? Where should the coun try be in 10, 20 or 30 years, 41

46 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES and what con tri bu tion is the ex trac tive sec tor able to make? Plan ning processes of this kind must in clude not only a large num ber of min istries and pub lic au thor i ties on var i ous lev els, but also civil so ci ety and the pri vate sec tor. It is only through de tailed analy sis and such com mu ni ca tion that re al is tic and com monly shared goals can be set and the risk of re sent ment and civil un rest re duced. Figure 6: Stakeholders in extractive resources While high rev enue pro jec tions for the fu ture may cre ate high ex pec ta tions for im me di ate so cial and in fra struc tural in vest ments by the state, ques tions may also arise re gard ing ben e fits across gen er a tions and across the na tion (re sourcerich re gions vs. re gions with out or with low-value ex trac tive re sources). 42

47 EXPECTATION MANAGEMENT Figure 7: High revenue projections creating high expectations among population The local pop u la tion di rectly sur round ing the ex trac tion areas will likely be most af fected - both pos i tively and neg a tively. While EI pro duc tion can cre ate em ploy ment op por tu ni ties, it might also cre ate fears about en vi ron men tal ef fects or land grab bing. Local com pa nies might, on the one hand, ex pect ad di tional eco nomic op por tu ni ties, but also fear mount ing com pe ti tion or even being dri ven out of busi ness. Ad di tional chal lenges apply in times of low com mod ity prices, where ex pec ta tions need to be ad justed. It is thus cru cial to en sure good po lit i cal com mu ni ca tion of op por tu ni ties and risks as so ci ated with the ex trac tive sec tor. Expectation management, conflict and accountability Against this back drop, po lit i cal di a logue, na tional vi sions and poli cies, and po lit i cal com mu ni ca tion in the ex trac tive sec tor have a cru cial role in man ag ing ex pec ta tions and pre vent ing con flict be tween stake hold ers. 43

48 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES The de vel op ment of ad e quate com mu ni ca tion strate gies needs to be tack led as early as pos si ble and should be ad justed along the EI process (EI value chain, pro duc tion life cycle). Once it is fore see able that the EI sec tor will play a larger eco nomic role, a com pre hen sive and re al is tic strat egy for the sec tor should be de vel oped. The de vel op ment should en com pass a par tic i pa tory process in volv ing all rel e vant stake hold ers. Fur ther, if deemed nec es sary, the de vel op ment of spe cific strate gies can ensue, such as strate gies to pro mote local con tent and strengthen local SMEs (Small and Medium Scale En ter prises) in the min ing in dus try, to for malise ar ti sanal min ing, or to har monise na tional pol icy frame works with re gional or in ter na tional stan dards. From a Good Fi nan cial Gov er nance per spec tive, it is es pe cially im por tant to com mu ni cate about EI rev enue and its dis tri b u tion. Fur ther, in for ma tion about ex pected ad di tional costs needs to be shared. Jointly agreed-upon strate gies, vi sions and ob jec tives allow for greater trans parency and ac count abil ity. It is not only that civil so ci ety, gov ern ment over sight in sti tu tions (es pe cially the supreme audit in sti tu tion, SAI) and par lia ment can de mand rel e vant in for ma tion re gard ing im ple men ta tion ef forts and achieve ments, but they then also need to use that in for ma tion for ad vo cacy pur poses and as the basis of a de mand for ac tion. Areas of intervention > The instruments mentioned below can help improve the planning and management of the extractive sector along the entire value chain and, above all, reduce conflict. Facilitating a high-quality, participatory and transparent policy formulation process can help define an enabling framework for responsible resource governance in the specific context. > Detailed, regular and independent analysis about the economic and revenue potential of the sector 44

49 EXPECTATION MANAGEMENT > Communication strategies specifically aimed at different stakeholder groups (i.e. local economy/ private sector, general public, affected communities) > Policy dialogues with effective stakeholder involvement > Strategic and proactive involvement of media as key agents and partners with an adequate use of media outlets (TV, radio, social media) > Country mining visions - inclusive and participative process of vision development as well as comprehensive dissemination of vision > Multi-sector and multi-stakeholder planning of the extractive sector > Analysis of existing policies and strategies, and harmonisation of these with international and regional approaches > EITI process and Open Contracting - make effective use of transparency initiatives > Monitoring and evaluation systems for sector strategies > Benchmarking of the extractive sector's contribution to (national) development as a basis for policy advice 45

50

51 Inter-agency Cooperation Economic rent potential in extractives, particularly in the petroleum industry, may discourage information sharing and cooperative behaviour within government. Regular exchange of information, coordination and cooperation between different government institutions is vital for efficient EI revenue management. Introduction More than in other eco nomic sec tors, ef fec tive gov er nance of ex trac tive in dus tries and its rev enue con tri bu tions in volves a high num ber of stake hold ers. Eco nomic Plan ning Min istries set a com pre hen sive de vel op ment frame work tak ing into ac count char ac ter is tics of the ex trac tive sec tor. Fi nan cial in sti tu tions such as the Min istry of Fi nance or Rev enue Au thor ity are usu ally re spon si ble for col lect ing the ma jor ity of EI rev enue streams. The Min istry of Mines should de sign and im ple ment a sec tor strat egy which should be rec on ciled with strate gies in re lated sec tors such as trans porta tion, water and en vi ron ment. The gov ern ment unit man ag ing the min ing cadas tral reg is ter or pe tro leum pro duc tion needs to ex change in for ma tion with the rev enue au thor ity to en sure tax com pli ance of ex trac tive com pa nies. To achieve bet ter trans parency and ac count abil ity on the al lo ca tion and use of rev enues from EI, supreme audit in sti tu tions and the par lia ment need to per form ef fec tive over sight and be aware of EI char ac ter is tics. All these in sti tu tions have spe cific man dates and ex per tise re lated to the ex trac tive sec tor, which makes it im per a tive to reg u larly share in for ma tion and data (see Chap ter 5.8. on Data Avail abil ity), rely on each other's ex per tise, and closely co or di nate ac tion. 47

52 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES How ever, in de vel op ing coun tries, in tra-gov ern men tal co or di na tion and co op er a tion often poses a par tic u lar chal lenge due to strong in di vid ual in ter ests in weak in sti tu tions, eth nic ri val ries, clien telism, and pa tron age. As min ing and pe tro leum pro jects in volve vast amounts of money (hun dreds of mil lions of dol lars), their pres ence may even de te ri o rate in ter-in sti tu tional co op er a tion, en cour age com part men tal i sa tion, and pro mote in di vid ual rent seek ing. So in ter ven tions often have to work against such ten den cies. Coordination mechanisms Even if the leg isla tive frame work is clearly de fined, ac tual roles and im ple men ta tion prac tices may de vi ate from it. While there are a num ber of good prac tices, it is im pos si ble to iden tify an ideal in tra-gov ern men tal co op er a tion mech a nism, as in sti tu tional set-ups dif fer from coun try to coun try. Es pe cially in the oil and gas sec tor, the gov ern ment body man dated with the man age ment of the sec tor is or gan ised under a par tic u lar in sti tu tional arrange ment in a num ber of coun tries. Due to the out stand ing rev enue po ten tials, the pe tro leum unit is often di rectly re port ing to and su per vised by the high est level of gov ern ment, i.e. State House or Of fice of the Pres i dent. Ide ally, there would be a close link be tween fis cal in sti tu tions and pe tro leum units or min istries, how ever, this is rarely the case in re al ity. Inter-ministerial platforms and bodies There are pos i tive ex pe ri ences with in ter-min is te r ial bod ies (e.g. task forces, com mis sions) en sur ing reg u lar ex change be tween dif fer ent in sti tu tions. They help to fa cil i tate co op er a tion and can take co or di na tion a step fur ther by con tribut ing to a mu tual un der stand ing of roles, re spon si bil i ties, pro ce dures, chal lenges and link ages. Such bod ies should iden tify clear ob jec tives for their meet ings and be guided by a jointly de vel oped work plan. Chair ing in ter-min is te r ial groups may be as signed to the Of fice of the Pres i dent, State House, Prime Min 48

53 INTER-AGENCY COOPERATION is ter, Min istry of Eco nomic Plan ning or an other cen tral agency. There are fur ther op por tu ni ties to cre ate mu tual un der stand ing, trust and a good work ing re la tion ship be tween in sti tu tions, which could also be com bined with reg u lar ex change for mats, for ex am ple joint ca pac ity build ing ac tiv i ties, work shops on EI re lated top ics or joint au dits. Also, these ex change plat forms pro vide an op por tu nity to im prove donor co or di na tion and chan nel donor sup port to joint in termin is te r ial pro jects. In terms of man ag ing risks this po ten tially can in crease donor sup port. Example from Sierra Leone: Extractive Industries Revenue Task Force Figure 8: Information flows 49

54 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES Exchange of information, coordination, and cooperation between relevant government institutions in Sierra Leone has significantly improved with the introduction of the Extractive Industries Revenue Task force (EIRT). The task force was initially introduced in 2011 to facilitate exchange of data about extractive industries between fiscal and sector institutions. Over the years, this intra-governmental body has broadened its scope and now works on several joint activities aiming to improve extractive companies' compliance and revenue transparency. For example, the task force steered the introduction of the Non-Tax Revenue System (NRTS) used by the National Revenue Authority (NRA) to manage mining royalties. The NRTS is integrated with the Mining Cadastre Administrative System at the National Minerals Agency (NMA) and guarantees both agencies easy access to data at any time. Moreover, the task force facilitated the planning of joint audit exercises and provides consolidated information to politicians and government agents for contract negotiations with mining companies. The efficient exchange of data established a clear initial objective to orient the work of the task force. The work of the task force gradually expanded to further joint activities. A lot of effort has been invested in continuously clarifying roles and mandates, finally explicitly detailed in an Memorandum of Understanding (MoU). The MoU was a significant milestone as it created trust and ensured that institutions didn't feel "threatened" that other agencies would encroach on their areas of responsibility. The members of the EIRT work at the technical rather than the political level within their respective institutions, which may bear less potential for conflict but also means that neither individual members nor the task force itself have any decision-making power. Training and workshops offered specifically for the task force members have proven to increase commitment and sustain a positive dynamic. Notwithstanding all the positive aspects of a common government platform for EI, some important stakeholders such as the Ministry of Mines and Mineral Resources or the Petroleum Directorate have 50

55 INTER-AGENCY COOPERATION decided not to actively participate in the task force, limiting its overall impact on the management of the sector. Despite the positive experiences so far, in a fragile country like Sierra Leone, the EIRT is at risk of losing driving power if key agents change, e.g. the current Chair held by a representative from the Ministry of Finance and Economic Development. Broader information network If com mer cial banks and the Cen tral Bank are in volved in EI rev enue col lec tion, as it is the case in some coun tries, they would need to be part of the in for ma tion ex change. A per ma nent ex change for mat might not be nec es sary for these stake hold ers but it should be ev i dent at which stage of the pro ce dures their in for ma tion and ac tion be comes im por tant and how and to whom within gov ern ment they have to pro vide in for ma tion. Fur ther links be tween min istries and gov ern ment agen cies be come cru cial when it comes to the man age ment of so cial and en vi ron men tal im pacts of re source ex trac tion such as waste-wa ter treat ment, solid waste man age ment, prox im ity to or even over laps with pro tected areas. In the man age ment of local de vel op ment funds, co or di na tion and co op er a tion are nec es sary, not only with sec toral agen cies but also across dif fer ent lev els of gov ern ment (na tional, provin cial and local). Co or di na tion be tween gov ern ment agen cies in terms of ob tain ing in for ma tion from the pri vate sec tor and/or other eco nomic agents such as state-owned en ter prises, should also not be ne glected. Min ing and oil/gas com pa nies are often the main providers of basic in for ma tion in the sec tor as well as about in di vid ual pro jects. In order to avoid myr iad re port ing re quire ments, in for ma tion re quests from gov ern ment ad dressed to the pri vate sec tor shall be co or di nated and fol low a pre dictable sched ule. 51

56 FRAMEWORK CONDITIONS IN RESOURCE-ENDOWED COUNTRIES Data exchange and mutual trust A very prac ti cal issue is the for mats and tech ni cal fa cil i ta tion of data ex change be tween gov ern ment in sti tu tions; ide ally ex change would be au to mated and man aged in an in te grated in for ma tion sys tem with ac cess for dif fer ent stake hold ers. Ex am ples for basic data for ex change are in for ma tion about li cences and con tracts is sued, fig ures for pro duc tion, ex port, com mod ity prices, eco nomic per for mance of sin gle pro jects and the sec tor as a whole, taxes and fees due and pay ments made. How ever, a suf fi cient level of trust be tween in sti tu tions is in dis pens able for such ex change of in for ma tion to work, which is often a chal lenge. Writ ten agree ments to de ter mine which in for ma tion is ex changed, by whom, and how often, have proven to fa cil i tate in for ma tion shar ing and pre vent un cer tainty about col lu sion with tax se crecy rules. Dig i tal sys tems are, how ever, only as good as the peo ple and data be hind them, and ef forts should be made to col lect qual i ta tively sat is fy ing data and en sure gov ern ment of fi cials know how to use the sys tem in place. Areas for further thinking Can more work be done by GIZ on producing a model MoU for co-operation and information exchange? What IT-solutions can be provided for an efficient exchange (e.g. joint data management system)? One-stop-shops For the sake of sim plic ity, in order to im prove the in vest ment cli mate, some coun tries set up one con tact point (a one-stop-shop) for ex trac tive com pa nies where in for ma tion re quests are pooled and later chan nelled back to the re spec tive gov ern ment en tity. One-stop-shops are ob vi ously also help ful when it comes to the pro vi sion of in for ma tion to pri vate sec tor stake hold ers, for ex am ple when rules change or new pro ce dures are put in place. This can not, how 52

57 INTER-AGENCY COOPERATION ever, re place in ter-min is te r ial or in ter-agency col lab o ra tive for mats for spe cific top ics such as rev enue gen er a tion, au dits and con trol. Areas of intervention > Regular exchange platforms for institutions involved in natural resource revenue collection and management offer an opportunity to encourage exchange of information, get institutions familiar with each other, and clarify roles and responsibilities. These are basic conditions for effective coordination and cooperation. > The introduction of integrated digital systems with access for various institutions can facilitate data exchange but there must be sufficient training on how to use the system. > Use the exchange platforms also as donor coordination mechanisms in order to streamline donor support to the sector. > A mapping of information and money flows regarding EI revenues might help to choose a focus for interventions aiming at improving trust, data exchange and coordination. 53

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59 Challenges for Good Financial Governance in Resource-Endowed Countries Overview: How to Ensure Good Financial Governance Legal and Fiscal Framework Revenue Collection Revenue Allocation and Budgeting Contracts State Ownership Artisanal and Small Scale Mining Data Availability Transparency, Oversight and Accountability

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61 Overview: How to Ensure GFG in Resource-Endowed Countries The below table sum marises the three di men sions of Good Fi nan cial Gov er nance in the ex trac tive sec tor for the fol low ing eight chap ters and pro vides ex am ples where GIZ is al ready sup port ing part ner coun tries or where GIZ could play a role going for ward. Challenges Legal and Fiscal framework Contracts Technical dimension: safeguard GFG Ensure alignment and consistency among the various national legislations that are relevant for the EI sector. Ensure that the national legislation does not contradict the international legal framework. Minimise the role of contracts. Ensure consistency between fiscal legislation and concessions in contracts. Avoid a parallel fiscal system for single projects. Political economy dimension: assessing interests of the various stakeholders Ensure that all agencies involved in managing the sector own the legislative reform process jointly. Provide a forum to address potential conflicts of interest early on. Promote contract transparency to empower stakeholders to hold negotiators accountable for the negation results. Give clear mandate to an inter-agency government negotiation team. Normative dimension: (re-) distributional and inclusive process managed efficiently and transparently by Government according to the rule of law Provide opportunities also for nongovernmental stakeholders to participate in the legislative reform process. In case (re-) distribution is part of the contracts (e.g. social investments) ensure affected stakeholders have a voice in the negotiations. Envision trade-offs between possible elements of a contract, e.g. between revenue maximization and local content promotion. 57

62 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Revenue Collection Revenue allocation State Ownership Artisanal and Small Scale Mining Data Availability Develop detailed transfer pricing rules to avoid tax erosion. Support budget planning through accurate forecasting modeling. Put special emphasis on the capacity of the decentralised administration to manage revenues. Ensure that governments are well-informed about the risks associated with state participation in projects. Design ASM systems that encourage formalisation. Ensure qualification of local mining inspectors. Ensure availability and usability of data to increase transparency and monitoring - which are essential for the effective management of revenues. Streamline the revenue collection and avoid multiplication of collecting agencies. Avoid all forms of extra-budgetary management of extractive sector revenues, including the funding of the sector administration. Clear definition and limitation of the tasks and role of SOE within the sector; limitation of political interference by a clear separation of roles within SOEs. Map out the importance of ASM for revenue generation for the central government (given that enforcement is more likely to be effective at the sub-national level). Understand the interests of all stakeholders within the ASM value chain, particularly of the licence holders. Understand the interests behind making data available; this is particularly relevant for contract, beneficial ownership and payment transparency. Ensure transparency of revenue data to empower non-state actors to hold Government accountable. Ensure an inclusive and transparent process to decide how revenues are to be redistributed. Ensure well-designed Sovereign Wealth Funds. Foster accountability, transparency. Ensure that revenues are made available to support ASM operations (such as rehabilitation). Make open fiscal models available and strengthen data literacy in order to increase the ability of civil society, media and parliaments to understand and analyse provided information. 58

63 OVERVIEW: HOW TO ENSURE GFG IN RESOURCE-ENDOWED COUNTRIES Transparency, Oversight and Accountability Secure the independence of supreme audit institutions (SAI) and their access to all necessary information to provide fiscal and budgetary oversight. Provide sectoral knowledge for the audit of extractive resources. Ensure EI sector knowledge for parliamentarians. Strengthening the role of the parliament as an oversight body, ensuring balance of interest. Strengthen mandates, roles and responsibilities of Supreme Audit Institutions. Foster the involvement of all stakeholders in budgetary oversight: government, parliament, civil society, media. 59

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65 Legal and Fiscal Framework Given the special characteristics of the extractive industry sector, the fiscal and legal framework is often complex with various agencies and payments involved. Without clarity, alignment, and coordination, the complexity of the fiscal framework can lead to misinterpretation, loopholes, and increased costs for the government and for companies. With the extractive sector often being one of the main contributors to the Gross Domestic Product (GDP), employment, and domestic revenues, coherence between the fiscal framework and other legislative areas (such as local content) is an imperative for good financial governance. Introduction The rules, rights and oblig a tions of com pa nies, gov ern ments, and cit i zens are set forth in a sys tem of legal doc u ments called the legal frame work. Part of this is the fis cal frame work that spec i fies fis cal rights and oblig a tions vis à vis the state. A co her ent fis cal frame work is key for the ex trac tive sec tor to un fold its po ten tial for sus tain able and in clu sive eco nomic de vel op ment. Strength en ing ju di cial and reg u la tory sys tems for im ple ment ing the fis cal frame work is a long-term process. As com plex ity in creases, the need for har mon i sa tion and trans parency in evitably grows. This in volves up dat ing stan dards, laws and reg u la tions. 61

66 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Hierarchy of law Legal frame works com prise dif fer ent sources of law that in clude the con sti tu tion, leg is la tion, reg u la tions, and con tracts. These doc u ments re late to one an other. The legal hi er ar chy de ter mines which sources of law have more force than the other. Ide ally, the con sti tu tion lays the basis of the legal frame work, fol lowed by leg is la tion. The next level is reg u la tions and rules, and the most spe cific sources are con tracts. This fis cal frame work can be de fined in dif fer ent doc u ments across this hi er ar chy. For ex am ple, some coun tries have spe cial fis cal pro vi sions in the min ing law and give con ces sions for that in con tracts. In other cases one rev enue code en com passes all sec tors and is also valid for the ex trac tive sec tor. Figure 9: The hierarchy of law Most re source-rich coun tries have laws that focus on fis cal el e ments of the oil and/or min ing sec tor (for ex am ple, the min ing code, pe tro leum ex plo ration and pro duc tion act, among oth ers). In ad di tion, more gen eral laws often rep re sent a 62

67 LEGAL AND FISCAL FRAMEWORK major com po nent of the rules for the in dus try, in clud ing en vi ron men tal laws, labour laws, tax laws, and land man age ment laws. The in ter na tional legal sys tem also plays an im por tant role. Most coun tries have signed up to the World Trade Or gan i sa tion (WTO) which pro motes trade lib er al i sa tion. Fur ther more, there has been a pro lif er a tion of bi lat eral in vest ment treaties that coun tries have signed up to which are often more lib er al is ing than those set out by the WTO. As set out in the Chap ter 4.1. on Re silience in Sec tor Dy nam ics one of the tools re source-rich coun tries can use to di ver sify the econ omy is to rely on local con tent leg is la tion. These may be in di rect con flict with the in ter na tional legal frame work as they might be con sid ered as non-tar iff trade bar ri ers. Area for further thinking To what extent should countries follow local content policies and how does this policy trend align with the international legal framework? Complexity of the legal and fiscal framework The com plex ity of legal lay ers also ap plies to tax rules. Mul ti ple lay ers of tax rules cre ate com plex ity for ad min is tra tors and tax pay ers alike. For in stance, the tax law will have rules of gen eral ap pli ca tion which apply to ex trac tive en ti ties as well as to tax pay ers in other in dus tries (e.g. cap i tal al lowances). The tax law may also have rules spe cific to the ex trac tives sec tor (e.g. more gen er ous cap i tal al lowances for as sets used in ex plo ration or de vel op ment). Some ju ris dic tions may also have in cor po rated tax rules into the min ing law (e.g. arm s-length rules). On top of this, there may be spe cial con tracts with in di vid ual com pa nies which seek to mod ify the tax rules still fur ther. This com plex ity of lay ers can 63

68 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES be ad dressed to a lim ited ex tent by con vinc ing gov ern ments that all rules re lat ing to tax a tion should be con tained in the tax law rather than in the min ing laws. Lack of con sis tency in fis cal pro vi sions in in di vid ual con tracts cre ates com plex ity for ad min is tra tion and un cer tainty for in vestors. Dif fer ent con tracts can apply dif fer ent rates of tax and du ties to the same prod ucts and allow tax con ces sions to be given over vastly dif fer ent pe ri ods. In vestors utilise these in con sis ten cies in con tract ne go ti a tions to at tempt to drive a bet ter bar gain. A lack of con sis tency not only cre ates un cer tainty for ad min is tra tion and in vestors but also makes sys tems less trans par ent and more dif fi cult to hold ac count able. This lack of con sis tency can be ad dressed by rules in the tax law which spec ify which of the tax laws can be sta bilised and for how long. This means that in vestors would not ne go ti ate the whole con tract but only cer tain parts of the con tract, and within de fined lim its. For ex am ple, the law could state that only the in come tax rate and min eral roy alty rate can be sta bilised but not the VAT rate, and the sta bil i sa tion can only be for a max i mum pe riod of a de fined num ber of years. Incentives The reg u la tory frame work may allow per for mance bonuses and in cen tives for tax au di tors. The ques tion here is how salaries and in cen tive schemes in flu ence the col lec tion / re cov ery - it de scribes the con flict be tween tax au thor i ties' rev enue tar gets and per sonal tar gets of tax au di tors. Pub lic of fi cials in de vel op ing coun tries can be un der paid and con se quently are likely to re sort to cor rupt prac tices to aug ment their in come. Such in cen tive schemes risk cor rup tion and en cour age the mis ap pli ca tion of the law: tax of fi cials may for ex am ple not be in ter ested in timely and/or full re cov ery of pay ments but en cour age mis ap pli ca tion in order to ben e fit from bonuses for the 64

69 LEGAL AND FISCAL FRAMEWORK 'dis cov ery' of the fault. The gov ern ment would con se quently lose out on rev enues while the in di vid ual tax of fi cial gains. To re duce the scope for cor rup tion, spe cific reg u la tions should be pro vided in the leg is la tion and reg u la tions that de fine the civil ser vice and these reg u la tions should apply to pub lic ser vants. Ad di tion ally, a cor re spond ing sanc tion regime for pub lic ser vants in case of mis be hav iour, has to be in place, and also en forced. Involvement of multiple government agencies Dif fer ent gov ern ment agen cies may have con flict ing legal in ter pre ta tions of laws which are re lated. The laws are ad min is tered by dif fer ent agen cies (the rev enue au thor ity for in come tax and the min ing au thor ity for min eral roy al ties) and can be in ter preted dif fer ently. Often min ing leg is la tion and tax leg is la tion will have pro vi sions re lat ing to de ter min ing an arm s-length price for min er als but which are ad min is tered by dif fer ent gov ern ment agen cies and again are prone to dif fer ing in ter pre ta tion. The in con sis ten cies can po ten tially be used as lever age by in vestors to ob tain a bet ter deal. Ide ally, rev enue pro vi sions should be con tained in tax law and be ad min is tered by tax of fi cials. Where that is not pos si ble (usu ally for po lit i cal rea sons), every ef fort should be made to in ter pret such pro vi sions in a con sis tent man ner. This re quires close co-op er a tion be tween agen cies. Some coun tries may have many (small) pay ments re quired by law to be made by min ing com pa nies to dif fer ent agen cies and au thor i ties (see for ex am ple Doing Busi ness "Pay ing Taxes" by The World Bank). This can re sult in a sig nif i cant com pli ance bur den for com pa nies and act as a dis in cen tive to in vest ment in that coun try. Over sight and data col lec tion be comes a prob lem re sult ing in low ac count abil ity and high cor rup tion risks. 65

70 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Lack of commitment to the rule of law The rule of law is the legal prin ci ple that law should gov ern a na tion, as op posed to being gov erned by ar bi trary de ci sions of in di vid ual gov ern ment of fi cials. Ad her ence to the rule of law cre ates cer tainty in ad min is tra tion and a sta ble in vest ment cli mate. This is be cause po ten tial in vestors are con fi dent in the way the law will be ap plied and that they will not be sub ject to the whim of a tax of fi cial. The rule of law means that dis cre tion in tax law should be lim ited. How ever the per son who has ul ti mate lead er ship of the tax au thor ity (e.g the Com mis sioner Gen eral) has gen eral ad min is tra tion of the tax law and has the abil ity to not apply the law in lim ited cir cum stances for the pur poses of sound ad min is tra tion (e.g. he/she has au thor ity to set tle cases, or to give a tax amnesty to a class of tax pay ers). Areas of intervention > Advise governments with the drafting of the regulatory framework coherently and ensure transfer of knowledge. Ensure that the local administrators participate in the writing of the law and understand the intent and consequences of their laws. This process of ensuring that there is knowledge of policy intent in the administration may reduce discretionary applicationn of laws. This can only enhance the rule of law in the country. > Align policy advice across units; this is particularly relevant between trade and local content advisory work. For example, the investment regime often grants international extractive industry companies import tax exemptions. However, if these are not extended to local suppliers, they are in direct conflict with local content policies. 66

71 Revenue Collection Opportunities to collect revenues are bound to the project lifecycle and vary considerably over time. Sectorial knowledge in the Ministry of Finance and knowledge about taxation within the sectorial ministry can contribute to better coordination between actors. Rent capture from the EI sector is often limited despite this being a highly profitable industry. Therefore, a coherent extractive industry taxation regime established by the government is crucial for citizens to benefit from their country's resource wealth whilst ensuring responsible investment in the sector. The control/verification/audit procedure performed by the tax administration is a complex task, given that resources of the tax administration are limited and have to be used efficiently. A risk differentiation framework can help in determining appropriate compliance activity. While requests and agreements regarding tax exemptions between government and companies may be legitimate, information inequalities pose a severe problem for preventive measures. Much energy has been put into awareness and training of the transfer pricing/profit shifting problem with little apparent audit activity resulting. Introduction Re source en dow ment and the re spec tive state rev enues pro vide coun tries with ex cel lent op por tu ni ties for de vel op ment. How ever, an ef fec tive fis cal regime 67

72 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES and a func tional tax ad min is tra tion are cru cial re quire ments for trans form ing re source wealth into human and eco nomic de vel op ment. While a gov ern ment is sup posed to col lect rev enues from all eco nomic ac tiv ity in a coun try, rev enue col lec tion from ex trac tive in dus tries de serves in creased at ten tion and spe cific ap proaches. The sec tor is marked by high cap i tal in ten sity, lim ited em ploy ment op por tu ni ties, high en tre pre neur ial risk and price volatil ity. More im por tantly, the life span of min ing, oil or gas pro jects is char ac terised by long pro ject cy cles. Often decades elapse from ex plo ration to pro duc tion. Due to up-front in vest ment, rev enues ac crue only after a long time span has elapsed, de pend ing on the min eral, tax a tion regime, and in vest ment needs. Op por tu ni ties to col lect rev enues are bound to the pro ject life cy cle and vary con sid er ably over time. In ad di tion, a large share of min er als, oil, and gas pro duced in de vel op ing coun tries is ex ported with out sig nif i cant value ad di tion in coun try. This often re sults in lim ited rent cap ture from the EI sec tor, de spite it being a highly prof itable in dus try. There fore, a co her ent ex trac tive in dus try tax a tion regime is cru cial for cit i zens to ben e fit from their coun try's re source wealth whilst en sur ing re spon si ble in vest ment in the sec tor. The Gov ern ment plays a crit i cal role to set an ad e quate fis cal frame work for the EI in dus try while en forc ing its tax regime to en sure com pli ance. How ever, un der ly ing po lit i cal econ omy dri vers, re sult ing from a large range of ac tors in volved and an often high ad min is tra tive frag men ta tion, make re form in this area ever more dif fi cult. Fiscal regimes Fis cal regimes in most coun tries have grown to rather com plex sets of rules and reg u la tions with myr iad as so ci ated taxes, fees and other pay ments to be col lected by gov ern ment agen cies. Ad di tion ally, the un cer tainty of the EI sec tor about mar ket prices and the high po lit i cal pres sure make fis cal regimes more un sta ble and prone to fre quent change. The fol low ing po lit i cal eco nomic fac tors 68

73 REVENUE COLLECTION in flu ence the set up and de vel op ment of a fis cal regime: char ac ter is tics of re source en dow ment, the mech a nisms and in sti tu tions avail able for en forc ing com mit ments, rev enue ad min is tra tion ca pac ity and gov er nance, dis tri b u tion of power, pol icy rigidi ties, and the ex tent of tax com pe ti tion. (Barma 2012: Rents to Riches? The Po lit i cal Econ omy of Nat ural Re source-led De vel op ment) [ hdl.handle.net/10986/2381] The most com mon types of EI rev enues are li cence fees, min eral roy al ties, cor po rate in come tax, sur face rent, with hold ing tax and VAT. Some coun tries also apply a wind fall or ex cess-profit/rent tax in times of high prices and prof its, or re ceive div i dends from (par tial) state own er ship of min ing op er a tions. There is ex ten sive lit er a ture cov er ing these dif fer ent rev enue types and their pros and cons. Sup port for the de vel op ment of EI tax sys tems dif fers in coun tries with a long stand ing ex trac tive in dus try to those in coun tries with a newly de vel op ing ex trac tive sec tor. Coun tries with an EI sec tor in its in fancy can not draw on long stand ing tech ni cal ex per tise, a well-de vel oped tax a tion regime, nor an adapted in sti tu tional set-up. On the other hand, in coun tries with a well-de vel oped gov ern ment sec tor con cerned with tax ing the ex trac tive sec tor, myr iad often com pet ing in sti tu tions exist. Different kinds of revenue, different kinds of agencies involved In the ex trac tive sec tor, more than in any other eco nomic sec tor, myr iad ac tors are in volved. Cur rently avail able lit er a ture fo cuses less on the dif fer ent stake hold ers in volved in EI rev enue col lec tion and their in ter ac tions, but rather on dif fer ent tax types. Not only the tax au thor ity is re spon si ble for the col lec tion of taxes and fees but also the re spec tive line min istry or agency. Some times subna tional units as well col lect cer tain pay ments. 69

74 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Each coun try has a dif fer ent in sti tu tional struc ture sup port ing the col lec tion of rev enues from EI. This is typ i cally the tax au thor ity, which can be a semi-in de pen dent in sti tu tion or a de part ment within the min istry of fi nance. Fur ther rel e vant stake hold ers might be cus toms or dif fer ent units within the min ing/oil agency or min istry. Po ten tially, re gard ing tax pay ment, also com mer cial banks or the cen tral bank can play a role in the tax col lec tion process at the na tional level. A num ber of re source-rich coun tries have es tab lished a spe cialised unit for ex trac tive in dus tries within the tax au thor ity. Spe cific chal lenges arise when an ex change of in for ma tion be tween EI sec tor in sti tu tions and the fis cal au thor i ties is weak e.g. when the ad min is tra tion re spon si ble for col lect ing EI rev enues does not have suf fi cient in for ma tion on min eral val u a tion or the pro duc tion or ex por ta tion vol umes. There fore, in ter-in sti tu tional co or di na tion dur ing the tax col lec tion process usu ally re mains highly nec es sary. In de vel op ing coun tries, it re mains com plex and dif fi cult to achieve. Re form ef forts need to take into ac count the po lit i cal econ omy of ad min is tra tion of re source rich coun tries. The process of revenue collection Stan dard steps within tax ad min is tra tion (or within other agen cies that col lect ex trac tive in dus tries-re lated rev enues) in clude: reg is ter ing of tax pay ers, fil ing of re turns (self-as sess ment vs. as sess ment through tax au thor ity), con trol/ver i fi ca tion/audit by tax au thor i ties to de tect in ac cu rate in for ma tion in tax pay ers re turns, tax dis pute (ad min is tra tive/ ju di cial), and pay ment of oblig a tions. These key steps are sup ported by means to im prove vol un tary com pli ance of tax pay ers such as pro vid ing nec es sary in for ma tion on tax regimes and tax payer oblig a tions, prefer ably ac cord ing to tax payer size (small, medium, large) and if pos si ble ac cord ing to eco nomic sec tors e.g. min ing and oil (see Calder 2014: Ad min is ter ing Fis cal Regimes for Ex trac tive Re sources - A Hand book). 70

75 REVENUE COLLECTION Ex cept for ASM, the first step of reg is ter ing EI com pa nies as tax pay ers should be quite easy to do as their num ber is lim ited and it might be done im me di ately when com pa nies reg is ter for op er a tions in a given coun try. In dus trial EI com pa nies will be often found grouped as large tax pay ers by the tax ad min is tra tion. Fil ing of re turns and re ceiv ing these re turns (es pe cially VAT, cor po rate in come tax) is de fined by the gen eral tax code. VAT re turns are usu ally filed each month, in come tax once a year, how ever, pay ments of es ti mated an nual li a bil ity can some times be re quired in ad vance on a quar terly basis. The con trol/ver i fi ca tion/audit pro ce dure per formed by the tax ad min is tra tion is a com plex task given that re sources of the tax ad min is tra tion are lim ited and have to be used ef fi ciently. It is gen er ally con sid ered best prac tice that com pa nies rep re sent ing the high est risk of non-com pli ance with tax oblig a tions should be sub ject to con tin u ous audit. In re source-rich de vel op ing coun tries this would in clude most large oil and min ing com pa nies or pro jects. How ever, if the tax ad min is tra tion lacks the nec es sary re sources to con tin u ously audit large com pa nies, it should stick to an audit strat egy, in clud ing dif fer ent com pli ance prod ucts, based on a set of risk fac tors, and dis trib ute its re sources ac cord ingly. Some tax ad min is tra tions pub lish their audit strat egy to the pub lic, oth ers do not. De ci sions re gard ing pub lish ing should be taken ac cord ing to the re spec tive coun try con text. A tech nique of de ter min ing com pli ance ap proaches which is at tract ing at ten tion in tax ad min is tra tions around the world is the risk dif fer en ti a tion frame work. The frame work rates all tax pay ers in the tar get group in terms of their like li hood of non-com pli ance (based on an analy sis of their track record of co op er a tion with the rev enue au thor ity) and the con se quences of non-com pli ance. The ul ti mate po si tion of the tax payer in the frame work de ter mines the com pli ance ap proach used by the rev enue au thor ity in re spect of that tax payer. For in stance, in a de vel op ing coun try which is re liant on rev enues from the ex trac tives sec tor and which has only a hand ful of very large min ing en ti ties, all of those en ti ties would be high con se quence tax pay ers be cause, re gard less of the 71

76 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES risk of them being non-com pli ant, the rev enue con se quences of any non-com pli ance is great. Of that group, those who lodge in for ma tion and re turns on time and make few mis takes are fully com pli ant, and they would be con sid ered Key Tax pay ers and would re ceive more of a ser vice focus (such as hav ing Key Client Man agers, and mon i tor ing rather than con tin u ous audit). Those who are less com pli ant would re ceive a more fo cussed com pli ance ap proach, such as con tin u ous audit. For a more de tailed ex pla na tion see the Fact sheet on the risk dif fer en ti a tion frame work [ Differentiation-Framework/Risk-differentiation-framework-fact-sheet/] (Aus tralian Tax a tion Of fice). Figure 10: Risk differentiation framework 72

77 REVENUE COLLECTION Once the audit case has been started via no tice to the tax payer, dif fer ent skills are needed to as sess whether the EI com pany has pro vided ac cu rate in for ma tion in their tax re turn. The au di tor ide ally should have knowl edge about the min eral re source and com pany struc tures typ i cal in this sec tor. Ad di tion ally, the au di tor may rely on ex ter nal in for ma tion such as EITI re ports, price in for ma tion for in ter na tional mar kets if traded there, ex port and pro duc tions sta tis tics. Ide ally, au di tors have easy ac cess to in for ma tion from 1) de part ments within tax ad min is tra tion and cus toms, 2) sec toral gov ern ment agen cies (com pany reg is ter, min ing cadas tre) at any stage of the con trol/ver i fi ca tion/audit pro ce dure. When the con trol process has been con cluded, the tax payer has time to ob ject the tax as sess ment. If so, the ob jec tion should be care fully re viewed and an other unit within the tax ad min is tra tion should dou ble check in order to limit dis cre tion of tax au di tors. For var i ous rea sons, there might be dif fer ent mis be hav iours such as col lu sion be tween com pa nies being au dited and tax au di tors. Code of ethics, pay ment and bonus schemes, and rev enue goals set by the tax ad min is tra tion should be as sessed in order to mit i gate po ten tial bad in cen tives. If tax ad min is tra tion and tax payer can not agree on the tax as sess ment, a tax dis pute so lu tion will be started, be gin ning at the ad min is tra tive stage and taken to the ju di cial stage, i.e. to court if nec es sary. If con sen sus is found, taxes have to be paid. Areas for further thinking How can the problem of outstanding payments can be tackled, especially in cases where companies have left the country and are out of reach of tax authorities? What measures could be taken on the international level to "punish" companies with outstanding payments? Would an international agreement tackling this trans-boundary problem be thinkable? 73

78 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Tax evasion and avoidance in EI There is a high rev enue po ten tial from the ex trac tive sec tor in re source-rich coun tries. How ever, the higher the share of wealth a gov ern ment tries to re tain from ex trac tive in dus tries, the higher the in cen tives for com pa nies to try to lower the tax bur den. Gov ern ments have to care fully cal i brate two ob jec tives: max imis ing pub lic rev enue po ten tials, and of fer ing an en abling in vest ment cli mate. Solid knowl edge about the na tional re serves and eco nomic ac tiv ity in the re source sec tor is cru cial to strike the right bal ance. As com pa nies de fend their eco nomic in ter ests, there are fre quent at tempts dur ing con tract ne go ti a tions but also later dur ing the pro ject cycle to con vince the gov ern ment to lower taxes or grant duty waivers. In the past, in ter na tional or gan i sa tions also ex erted pres sure on de vel op ing coun tries to offer tax in cen tives, sup pos edly to com pen sate for other fac tors (such as bad in fra struc ture, low-skilled labour force) im pair ing the ease of doing busi ness. Gov ern ments need to rely on sec tor and fi nan cial ex perts to thor oughly analyse such re quests by the pri vate sec tor: due to long pro ject cy cles in ex trac tive in dus tries, such de ci sions can be far-reach ing. While re quests and agree ments re gard ing tax ex emp tions be tween gov ern ment and com pa nies are le git i mate and of no legal con cern (if cor rup tion does not play a role), big multi na tional en ter prises have many other in stru ments at hand, of which not all might be legal, to lower the taxes they pay. The OECD/G20 pro ject on Base Ero sion and Profit Shift ing (BEPS) ad dresses a num ber of these in stru ments but makes no spe cific ref er ence to EI. De vel op ing coun tries are well ad vised to analyse their coun try con text and the per ti nent is sues for their econ omy, and more specif i cally for the min ing or oil/gas sec tor, be fore get ting in volved in the BEPS Process and im ple ment ing pro posed ac tions. BEPS Ac tion 8-10 ad dress gen eral trans fer pric ing is sues but tax in cen tives and the lack of trans fer pric ing com pa ra ble data for cer tain com modi ties are com mon chal lenges for re source-en dowed coun tries and are not cov ered by the BEPS frame work. 74

79 REVENUE COLLECTION Area for further thinking Does the extractive sector require special instruments fitted to its specific challenges in order to prevent Base Erosion and Profit Shifting (BEPS)? Transfer pricing/profit shifting Con cep tu ally, trans fer pric ing is the set ting of the price for goods and ser vices sold be tween con trolled (or re lated) legal en ti ties within an en ter prise. For ex am ple, if a sub sidiary com pany sells goods to a par ent com pany, the cost of those goods paid by the par ent to the sub sidiary is the trans fer price. Rev enue au thor i ties are only con cerned if the trans fer price that has been set is other than a price that par ties would agree to in an arm s-length trans ac tion. In such trans ac tions the buyer and seller of goods act in de pen dently, have no re la tion ship to each other, are act ing in their own self-in ter est, and are not sub ject to any pres sure or duress from the other party. Where re lated par ties trans act with each other at other than on an arm s-length basis and the re sult is less tax paid in the ju ris dic tion than would be the case if the trans ac tion was at arm s-length, the re sult is some times re ferred to as preda tory trans fer pric ing, trans fer "mis pric ing", or profit shift ing. It is more com mon to hear use of the oth er wise be nign term trans fer pric ing to de scribe this non-arm s-length be hav iour. In the ex trac tives sec tor in de vel op ing coun tries, preda tory trans fer pric ing is a sig nif i cant risk be cause of the large prof its which are made rel a tive to other in dus tries. Donor agen cies have done much to train and oth er wise make rev enue au thor i ties in these coun tries aware of the risks of trans fer pric ing and the method olo gies to de ter mine arm s length prices. How ever, for a va ri ety of rea sons this aware ness and in crease in knowl edge has not trans lated into many trans fer pric 75

80 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES ing au dits or ad just ments. Some of those rea sons in clude short term rev enue de mands made by the gov ern ment which pre clude the lengthy in ves ti ga tions and re search nec es sary to de ter mine an arm s-length price, and frus tra tion at stonewalling tac tics to in for ma tion re quests or the fact that after lengthy in ves ti ga tions and an ad just ment to tax able in come, an even more lengthy ju di cial re view has to be en dured. Areas for further thinking The fact that such energy has been put into awareness and training of the transfer pricing/profit shifting problem with little audit activity resulting should raise questions about whether there is a better way to address the problem of transfer "mispricing" in resource-rich developing countries. Could a judicious use of external experts to assist institutions in resource-rich countries in doing audits be explored? That is, targeted interventions over the life cycle (audit preparation, information collection and assessment, adjustment and settlement negotiation and/or dispute through tribunals and courts) rather than just at the initial stages. Given the complexity of transfer pricing law, and reluctance to use it, are there simpler alternatives to transfer pricing law? Could the recently UK enacted diverted profits tax (available as PDF [ / government / uploads / system / uploads / attachment_data / file / / Diverted_Profits_Tax.pdf] ) be explored? 76

81 REVENUE COLLECTION Areas of intervention > Training for risk-based planning/differentiation frameworks > Support for extractives tax policy and administration inclusive of tax auditors (e.g. on transfer pricing mechanisms) > Digitisation and data exchange between tax authorities > Interconnection between sectorial cadastres and linking cadastres with tax authorities > Inter-agency dialogues (common understanding and better communication) 77

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83 Revenue Allocation and Budgeting To achieve sustainable development, EI revenues need to be managed and allocated according to good governance principles. Open and transparent budget planning is key to minimising the risks of revenue mismanagement. Well-designed models help governments to appropriately react to commodity price volatility and form the basis of long-term planning; modeling and forecasting skills are essential. Local authority capacities for budget planning and accounting need to be strengthened; local civil society organisations should be enabled to ensure social oversight over the expenditures. Introduction As high lighted in Chap ter 4.1. on Re silience in Sec tor Dy nam ics, EI rev enues are volatile in na ture. In re source-de pen dent coun tries where the EI rev enues make up a large pro por tion of do mes tic rev enue gen er a tion, this trans lates into spend ing volatil ity (un less the coun try re lies on debt fi nanc ing to smooth ex pen di tures, al though this may not be sus tain able). Spend ing volatil ity is prob lem atic, be cause it is in ef fi cient. Start ing and stop ping con struc tion work or hir ing and fir ing gov ern ment em ploy ees, for ex am ple, is often not vi able and will also re duce the pos i tive im pact of such spend ing (and can con tribute to Dutch Dis ease as out lined in Chap ter 4.1). Fur ther more, be cause ex trac tive re sources are fi nite, there is a strong ar gu ment that fu ture gen er a tions should also ben e fit from the ex trac tion of these re sources, which in most ju ris dic tions be long to all cit i zens (with the US being the ex cep tion where the in di vid ual own ing the land also owns the as sets un der ground). An other par tic u lar ity of EI rev enues is that 79

84 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES large amounts often orig i nate from a small num ber of pro jects and are not di rectly paid for by the pop u la tion, mak ing them prone to mis man age ment. These char ac ter is tics mean that EI rev enues re quire spe cial at ten tion and care ful man age ment in order to con tribute to sus tain able de vel op ment. En sur ing GFG in the al lo ca tion and bud get ing of EI rev enues is thus of great im por tance. Planning on how to allocate resources De cid ing on what a coun try should do with its re sources is a sov er eign de ci sion. Some coun tries may place greater im por tance on com pen sat ing com mu ni ties liv ing nearby to the ex trac tion pro ject more than those liv ing fur ther away. Other coun tries may place greater im por tance on sav ing for fu ture gen er a tions the rev enues gen er ated today. While pri or i ties and in ter ests may vary, the im por tant as pect when plan ning how to al lo cate the rev enues from ex trac tive in dus tries is that it should be an in clu sive process. Two im por tant fac tors that need to be con sid ered when mak ing this de ci sion are: 1. the relative size of the revenues expected from extractive industries: if it is only a relatively small proportion compared to total domestic revenue, it may not make sense to set up mechanisms to try and smooth consumption (given that overall spending volatility will also not be that large and the capacity of the economy to absorb additional expenditures is likely going to be higher); and 2. the level of development of the country: if the country is less developed with low infrastructure and human capital standards, investments in these areas are likely to have a higher return than in developed countries. (Some jurisdictions such as Alaska have chosen to directly pay out revenues to citizens rather than channelling them through the budget, which is likely going to result in higher personal spending rather than public investments). Once the coun try has de cided on how it wants to al lo cate the rev enues, there are sev eral mech a nisms through which it can chan nel the rev enues. These in 80

85 REVENUE ALLOCATION AND BUDGETING clude spend ing the rev enues through the bud get cycle (in clud ing sub-na tional dis tri b u tion), the cre ation of funds to ad dress volatil ity and in ter-gen er a tional as pects, di rect dis tri b u tion of funds to cit i zens, and spend ing through the stateowned ex trac tive in dus try com pany. More de tail about the first two is found below. Budget planning and execution In order to plan bud gets, gov ern ments re quire the ca pac ity to fore cast rev enues. A lack of or gan i sa tional and in di vid ual ca pac i ties for fore cast ing EI rev enues lim its the abil ity of gov ern ments to de cide on how to use the rev enues and ad e quatly deal with rev enue volatil ity. This is also the case for re al is tic and cred i ble bud get plan ning, par tic u larly in the medium term. Ide ally, rev enue es ti mates from the ex trac tive sec tor feed into medium term bud get pro jec tions. There fore rel e vant ca pac i ties to be de vel oped in clude com modi ties pric ing ex per tise. How ever, even with ac cu rate mod el ing ca pac i ties, price set ting is mostly a po lit i cal de ci sion, there fore up to the dis cre tion of pol icy mak ers and part of the pre vail ing po lit i cal econ omy. This im plies a cer tain risk of set ting prices for mod els too low or too high ac cord ing to po lit i cal op por tu nity. Well-de signed mod els can help gov ern ments to react quickly and ap pro pri ately to dras tic price changes in com mod ity mar kets. Ide ally, EI rev enues should be part of the reg u lar bud get process, fol low fis cal rules, and be openly re ported on. How ever, in some re source-en dowed de vel op ing coun tries, state rev enues gen er ated from EI are han dled off-bud get and man aged by a va ri ety of in sti tu tions. This has neg a tive im pli ca tions for ac count abil ity and trans parency since over sight by Par lia ment and fi nan cial con trol is lim ited and scat tered. It also makes the as sess ment of the over all con tri bu tion of the EI sec tor to the tax base, na tional bud get, and thus to de vel op ment in gen eral, a dif fi cult task. The ef fec tive man age ment of EI rev enues might also be weak ened by sup ple men tary bud gets. 81

86 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES To limit the risk of po lit i cal op por tunism, it is cru cial to en sure that bud get ing pro ce dures are trans par ent and open. There fore, not only the par lia ment needs to be in volved but also sec tor min istries and rel e vant gov ern ment bod ies need to ac tively par tic i pate in bud get plan ning. In re source-en dowed coun tries, all these stake hold ers need to be aware of the chal lenges of re source abun dance (such as high price volatil ity, long pro ject life cy cles). State-owned en ter prises (SOEs) op er ate or take part in ex trac tive pro jects in some coun tries, and may ad di tion ally to ex trac tion as sume broader rev enue col lec tion tasks. Even though SOE prof its should be part of the bud get, many coun tries apply dif fer ent arrange ments, which makes their con tri bu tion to state rev enue opaque. Thus, trans parency and dis tri b u tion re gard ing rev enues gen er ated by SOEs re mains a huge chal lenge. Natural Resource Funds Nat ural re source funds can be setup for sev eral pur poses. These in clude: (1) smooth ing ex pen di tures from volatile rev enue sources, whereby rev enues are saved in sta bil i sa tion funds in years when rev enues from the EI are high, and rev enues from the fund are used in years when the rev enues from the sec tor are low; (2) sav ing rev enues for fu ture gen er a tions; (3) mit i gat ing the neg a tive im pacts from Dutch Dis ease by in vest ing rev enues abroad; (4) ear mark ing pub lic in vest ments from ex trac tive in dus tries to par tic u lar sec tors such as in fra struc ture and human cap i tal (with the ar gu ment that EI rev enues should be used for in vest ment rather than spend ing); (5) ring-fenc ing rev enues to in crease trans parency and ac count abil ity (as re lated to other rev enues); and (6) in creas ing au ton omy to avoid coun tries hav ing to rely on bor row ing. As shown in the Ghana ian ex am ple below, coun tries can chose a com bi na tion of funds. Dis re gard ing of the ob jec tive, nat ural re source funds add to the com plex ity of EI fis cal regimes and rep re sents a chal lenge for trans parency and ac count abil ity: such funds must be well de signed and man aged ac cord ing to good 82

87 REVENUE ALLOCATION AND BUDGETING gov er nance stan dards. Clear ob jec tives and cri te ria are re quired to be suc cess ful. Fis cal rules need to be put in place that de fine when money should be paid into the fund and when money can be taken out of the fund. In vest ment rules that de fine how and where the money in the fund is in vested also need to be put in place. To en sure ac count abil ity and over sight, there should be a clear and in de pen dent struc ture gov ern ing the fund. The Ghanaian Case In order to ensure sustainable management of the petroleum revenues, the Government of Ghana enacted the Petroleum Revenue Management Act (PRMA). The PRMA has instituted a set of mechanisms through which petroleum revenues are allocated and accounted for. These include transfers to the state owned Ghana National Petroleum Cooperation, allocations to the Annual Budget Funding Amount (ABFA) that serve as a source of the annual budget, and transfers to the Ghana Petroleum Funds which is made up of two Sovereign Wealth Funds which are held separately from Ghana s consolidated fund. The Ghana Stabilisation Fund can be used to cushion the effect of oil price volatility on the budget, and the Ghana Heritage Fund provides an endowment to support development for future generations when petroleum reserves have been depleted. Borrowing using petroleum reserves as collateral has been prevented by an amendment of the PRMA in The ABFA is allocated to the Government's annual budget for the execution of government programmes. Funds are earmarked for priority areas selected by the Minister of Finance. Over the last four years ( ), road and other infrastructure made up the largest amount of ABFA, followed by the expenditure and amortisation of loans for oil and gas infrastructure, agriculture modernisation, and capacity building. 83

88 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Parliament is required to approve certain issues pertaining to the management of the Ghana Petroleum Funds. As part of the transparency requirements of the PRMA, the Minister of Finance submits an annual report on the Petroleum Funds as part of the annual presentation of the Budget Statement and Economic Policy to Parliament. To assess compliance with the provisions of the PRMA, Government instituted the Public Interest and Accountability Committee (PIAC), a multi-stakeholder body which issues biannual reports, which are published and submitted to Parliament. The Auditor General is equally entitled to audit the financial statements of the Ghana Petroleum Funds. Figure 11: Allocation of Petroleum Revenues in Ghana (2014) Since 2010, Ghana has produced commercial quantities of crude oil. Although the production and reserves of oil are modest as compared to the global share, the revenues generated through taxes and 84

89 REVENUE ALLOCATION AND BUDGETING payments (mainly income tax, oil entitlements, profits of the Ghana National Petroleum Company, and royalties) contribute significantly to Ghana s domestic revenue base. In 2014, oil and gas contributed 7.2% of total GDP and 13.5% of total government domestic revenue (Ghana Ministry of Finance 2014: Final GHEITI report on the oil/gas sector). As a result of the price drop, in 2015 Ghana only collected around one third of the projected petroleum revenues, putting pressure on the national budget and public spending. Ghana has adopted a unique model for the management of petroleum revenues, drawing together government agencies, the private sector, civil society, and parliament. The importance of transparency has steadily increased and as the country continues to make more oil and gas finds, it is becoming even more compelling to create robust structures for accelerated economic and social development. Sub-national revenue allocation and expenditure management Re source ex trac tion takes place at the com mu nity level. There fore, the local pop u la tion is most af fected (neg a tively and/or pos i tively) by min ing and ex trac tion ac tiv i ties. Pos i tive ef fects can re sult from em ploy ment cre ation, in fra struc ture pro vi sion and con sump tion link ages, while land grab bing, pol lu tion and en vi ron men tal degra da tion can neg a tively im pact local com mu ni ties (in many de vel op ing coun tries, the skills needed to work and/or ser vice the EI sec tor are not de vel oped, which can re duce the pos i tive im pacts). The lat ter calls for com pen sa tion, such as fi nan cial ben e fits al lo cated to or even col lected at the local level. EI poli cies may en com pass schemes whereby rev enues are re dis trib uted ac cord ing to where they orig i nate with a cer tain for mula for re dis tri b u tion. How ever, such in cen tives need to be care fully de signed and re viewed, and a scheme should avoid in creas ing re gional dis par i ties by over com pen sat ing com mu ni ties near oil, gas and min ing pro jects. 85

90 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES On the spend ing side at the sub-na tional level, one needs to take into ac count low ca pac i ties re gard ing bud get plan ning and ac count ing and often de funct ac count abil ity mech a nisms. The prob lems out lined above for the na tional level are often ex ac er bated at re gional or com mu nity level. Rev enue volatil ity, for ex am ple may lead to high in fla tion lev els at the re gional level. Sub-na tional sta bil i sa tion funds can be put in place to man age such volatil ity if it makes up a large pro por tion of total rev enues. While local au thor i ties are closer to the cit i zens and there fore could be, in the ory, bet ter held ac count able for spend ing of pub lic funds ef fi ciently, tra di tions or cus toms may pre vent their de ci sions and ac tions from being ques tioned. Local civil so ci ety or gan i sa tions can play a vital role in con trol ling sub-na tional ex pen di ture. How ever, such or gan i sa tions are often weak and/or ab sent in rural areas. Apart from funds col lected and re dis trib uted by state au thor i ties, gov ern ments should take com pa nies' spend ing on Cor po rate So cial Re spon si bil ity (CSR) into ac count in order to pro vide co her ent and de mand-dri ven pub lic ser vices. CSR spend ing usu ally takes place at the sub-na tional level and is di rected to wards com mu ni ties close to the ex trac tion site. Often this is set be tween local com mu ni ties and the com pa nies in Com mu nity De vel op ment Plans. A com pany might im ple ment cer tain ac tiv i ties (such as build ing a school, health cen ters, roads) it self or fund them through local civil so ci ety or gan i sa tions or au thor i ties. In some cases, nei ther of these chan nels in form na tional or re gional bud get in sti tu tions nor sys tem at i cally con sult sub-na tional au thor i ties about CSR spend ing. This lim its the gov ern ment's abil ity for co her ent bud get ing and pro vi sion of pub lic ser vices, and also cir cum vents es tab lished de ci sion and ac count abil ity mech a nisms. 86

91 REVENUE ALLOCATION AND BUDGETING Area for further thinking Given the importance of good sub-national financial governance in resource-endowed countries, GIZ needs to strengthen its portfolio in that area. A beneficial leverage point can be the large GIZ portfolio in supporting decentralisation and sub-national governance. Areas of Intervention > Support to strengthening PFM reform processes and systems with a focus on EI revenue management > Advise on fiscal transfer mechanism of EI revenue on the sub-national level > Advise on inclusive processes for revenue allocation and design of instruments (e.g. SWFs) > Establish systematic consultation mechanisms for mining communities and reporting standards for CSR spending > Train local civil society on basics of the extractive sector and the fiscal system 87

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93 Contracts Contracts for individual companies or projects are commonly used in EI to clarify government and company fiscal and non-fiscal obligations. Many developing country governments lack appropriate expertise, skills and information to analyse a project and maximise the negotiation outcome for their country. Contractual schemes can cause major difficulties, additional work and expenses for tax authorities, especially if deviating from existing legislation. Contract transparency is vital to hold negotiators accountable. Introduction Its is very com mon for in dus trial pro duc tion in the ex trac tive sec tor to re quire ne go ti a tion and sign ing of con tracts be tween the na tional gov ern ment and min ing and oil/gas com pa nies. These con tracts com ple ment the leg isla tive frame work and pro vide more de tailed reg u la tion for the ex trac tive pro ject in ques tion. Ne go ti a tion of such con tracts in de vel op ing coun tries is often a major chal lenge for the gov ern ment. In many cases, there is a low ne go ti a tion ca pac ity in gov ern ment and im bal ance in the level of in for ma tion held by gov ern ment and EI com pa nies. While the EI com pa nies usu ally have a bet ter-qual i fied team of ex perts to pre pare for ne go ti a tions, in clud ing ge ol o gists, min ing en gi neers, tax and law ex perts, on the other hand, the gov ern ments often lack: 89

94 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES a. all necessary relevant people at the negotiation table (for example tax officials or experts) b. all relevant information c. all the relevant skills. The main skill missing is the ability to create and analyse financial models. Content of extractive industry contracts EI con tracts are sec tor-spe cific (oil, gas or min ing). In min ing, li cences for ex plo ration, ex ploita tion, and op er at ing per mits can be found. In the oil sec tor, con ces sion agree ments, pro duc tion-shar ing agree ments, and risk-ser vice agree ments are used. The issue of tax ex emp tions is vig or ously dis cussed. Gov ern ments should ques tion why a tax con ces sion is nec es sary and how the tax con ces sion being re quested will af fect the pro ject model so they un der stand the ef fect of tax con ces sions on pro ject prof itabil ity. This ques tion ing will en sure that the gov ern ment un der stands the im pact of each con ces sion given and that they can make in formed de ci sions about the type and length of the tax con ces sion given away. For in stance, imag ine a pro ject which has a life time of 25 years and which will be come prof itable after 10 years of op er a tion if the nor mal tax law is ap plied, for which the in vestor is ask ing for more tax con ces sions to be put in place for 25 years. If the in vestor is re quest ing a num ber of tax con ces sions which make the pro ject prof itable in 3 years, the gov ern ment should ask why the 25 year tax con ces sion pe riod is nec es sary, and whether a shorter pe riod is more ap pro pri ate to mit i gate the per ceived in vest ment risk. An other area of con tention is sta bil i sa tion clauses. Due to high sunk costs and the long-term na ture of ex trac tive in dus try in vest ments, sta bil i sa tion clauses have long been in cluded in con tracts to as sure in vestors that the state will not change the con tract re quire ments, in par tic u lar the fis cal terms, over the life of the pro ject. Es pe cially in coun tries that are per ceived as po lit i cally risky, in 90

95 CONTRACTS vestors de mand long-term, some times in def i nite, sta bil i sa tion clauses. While these clauses act as a risk-man age ment tool for in vestors, they cur tail the sov er eignty of the state to adapt the terms if and when there is a change in cir cum stances, and the need to act in favour of the pub lic in ter est. Area for further thinking The length of the stability clause should reflect the riskiness of the country and project context. Could a tool be developed that helps governments negotiate the length of the stability clauses, based on a comparative assessment regarding how long stabilisation clauses are in different jurisdictions? Model con tracts can help to stan dard ise pro vi sions of con tracts and can serve as a start ing point of ne go ti a tion. How ever, model con tracts al ways have to be adapted to coun try-spe cific needs, and ne go ti a tion par ties are well ad vised to start ne go ti a tions on basis of the same model. Breach of contract An other point is that the gov ern ment some times can not de liver on the agreed terms of the con tract, for ex am ple pro vid ing elec tric ity for the pro duc tion. In such cases the EI com pa nies often try to claim fur ther tax con ces sions as com pen sa tion for the gov ern ment's fail ing to pro vide the agreed in fra struc ture. If gov ern ments are prop erly ad vised on the po ten tial and lim its of their re sources be fore mak ing such claims, the is sues of non-com pli ance might be avoided and the risk of los ing tax rev enues as com pen sa tion mea sures may de crease. At the out set of con tract ne go ti a tions, the gov ern ment should con sider the need to in clude pro vi sions in the con tracts re quir ing a shared use of in fra struc ture, as 91

96 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES it is much more dif fi cult to rene go ti ate the con tracts when the shared in fra struc ture be comes nec es sary. Areas for further thinking Governments in some developing countries have recently tried to enforce compliance of EI companies with tax law and contractual obligations entailing long judicial processes. What are government's options when companies do not comply to law or contractual arrangements? What are good practices? How could government avoid reaching this stage of escalation? Support for contract negotiation One way to achieve bet ter con tract ne go ti a tion out comes is di rect sup port for ne go ti a tions through a pool of ex perts with rel e vant in dus try, tech ni cal and coun try/re gional knowl edge. These ex perts must be able to ad vise the gov ern ments not only on legal and min ing tech ni cal is sues, but also de liver ex per tise on fis cal is sues and pro ject mod el ling. Nonethe less to avoid a long-term de pen dency on ex ter nal ex perts, there is a ne ces sity to strengthen ne go ti a tion ca pac i ties di rectly in the gov ern ment struc tures of re source-rich coun tries. It is ad vis able to have a co her ent strat egy for ca pac ity build ing and en sure en abling con di tions for na tional ex perts to con tribute and feed in their knowl edge. An issue re mains that high level politi cians in volved in con tract ne go ti a tions may re frain from seek ing ad vice and rec om men da tions from lower rank ing tech ni cal ex perts. So apart from re ly ing on in ter na tional ex perts, gov ern ments should en sure that they make use of the ex per tise avail able within their own struc tures and sys tem at i cally build up this ex per tise. GIZ of fers a long-term so lu tion for strength en ing of ne go ti a tion ca pac i ties by of fer ing train ing on con tract ne go ti a tions within the frame work of the CON 92

97 CONTRACTS NEX ini tia tive. The ini tia tive was launched by G7 in 2014 and aims at sup port ing de vel op ing coun tries in ne go ti a tions of com plex com mer cial in vest ment and in fra struc ture es pe cially in the ex trac tive sec tor. The train ing in cludes mod ules for ne go ti a tions prepa ra tion and strat egy as well as for mon i tor ing and im ple men ta tion of the con tracts. More in for ma tion can be found at the Ne go ti a tions Sup port Por tal [ http//negotiationsupport.org]. Contract transparency Con tract ne go ti a tions are held in a closed door en vi ron ment. Given the large stakes being ne go ti ated, the risk of cor rup tion is high. To hold the ne go ti at ing team ac count able, the con tracts should be made pub lic. resourcecontracts. org to date has col lected and pub lished 1116 con tracts from 73 coun tries. How ever, there are still many ju ris dic tions where con tracts are not pub lic. Even in coun tries where the trend is mov ing to wards con tract trans parency, the more con tro ver sial ones that have been ne go ti ated in the past are kept se cret. Only by mov ing to wards con tract trans parency can the ne go ti a tion team be held ac count able. This will also help to man age ex pec ta tions (see Chap ter 4.2. on Ex pec ta tion Man age ment). Areas of intervention > Capacity building for areas relevant to contract negotiation (project modelling, taxation, geological, engineering) > Organisational development to ensure technical experts can influence negotiations e.g. clarifying areas of expertise, roles and mandates; possibly introduce standard processes and formats for experts' recommendations 93

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99 State Ownership Governments can take ownership interests in resource projects either directly (via government ministries) or through State Owned Enterprises (SOEs). Equity participation in extractive projects can take many forms, ranging from minority to full state ownership. The form of ownership defines the level of risk and of influence over project activities and profits. So-called free equities rarely come at no cost for the government, usually they go hand-in-hand with tax reductions and other tradeoffs. The funding of SOEs tends to be off-budget and fiscally nontransparent. Staff appointments are often politically motivated. Introduction There are dif fer ent forms of state own er ship in the ex trac tive sec tor ei ther di rectly (usu ally the Trea sury, Min istry of Fi nance, Min istry of Mines) or through 100% state owned en ter prises (SOEs). The own er ship form can be: % ownership which means the government is completely at risk to the investment 2. Majority ownership (greater than 50%) which provides a strong level of influence and mitigation of risk 3. Minority ownership (for example 10% of shares) which provides minimal influence and minimal risk exposure 95

100 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Significance of SOEs While in vest ment can take place di rectly or through SOEs it is the lat ter which has sig nif i cant ac com pa ny ing is sues. There can be dif fer ent ra tio nales for re source-en dowed coun tries to set up SOEs. Often it is as sumed that through SOEs gov ern ments can in crease their po ten tial earn ings and con trol. Be sides ex plo ration and pro duc tion, SOEs often have re spon si bil i ties in man ag ing the de vel op ment of the ex trac tive sec tor by pro mot ing ef fi cient ex plo ration and pro duc tion, chan nelling a fair share of rev enues to the state, man ag ing the sta bil ity of agree ments, and mon i tor ing op er a tions and rev enue col lec tion. Given their unique in sti tu tional sta tus and fre quently high lev els of au thor ity, SOEs often op er ate with lim ited over sight and ac count abil ity (see for ex am ple: NRGI 2015: State Par tic i pa tion and State- Owned En ter prises [ / sites / default / files / documents / nrgi_primer_state-participation-and-soes.pdf] ). Issues with state ownership of extractive projects State owned en ter prises (SOEs) can take many forms. An SOE can be the mo nop oly ex trac tive com pany, a ve hi cle for joint ven tures with for eign com pa nies, or just one of many com pa nies en gaged in ex trac tion. An SOE can also be a reg u la tor for par tic u lar in vest ments. A state-owned pe tro leum com pany, for ex am ple, could be all of the above men tioned and also be the en tity that reg u lates ac tiv i ties in that sec tor. Gov ern ments can take eq uity stakes in many forms (e.g. via paid eq uity, some form of car ried eq uity or free eq uity car ried in ter est, where the gov ern ment pays for its eq uity share out of pro duc tion pro ceeds; eq uity in ex change for a 96

101 STATE OWNERSHIP non-cash con tri bu tion, for ex am ple by the gov ern ment pro vid ing in fra struc ture fa cil i ties; and so-called free eq uity). This dis cus sion will only com ment on paid and carry arrange ments. With paid eq uity, the state pays a mar ket rate for its shares and may have to meet cash calls for pro ject de vel op ment ex penses, as any pri vate part ner would. With car ried eq uity, the pri vate-sec tor min ing part ner fi nances the op er a tion up front and the gov ern ment pays for its eq uity via fore gone div i dends. With freecar ried eq uity, the gov ern ment pays noth ing for the eq uity. How ever, none of these free-car ried arrange ments comes with out costs to the state and, where in sti tuted, typ i cally ob lig ates states to make trade-offs else where in the rev enue sys tem in order to at tract the in vestor (e.g. via lower in come taxes or min eral roy al ties). Carry arrange ments, de pend ing on the form in which eq uity is held and the con se quent div i dend stream, mean that the gov ern ment shares some of the pro ject risk. If the eq uity is in the form of or di nary shares, the board of the com pany de ter mines how much of the prof its (if any) should be dis trib uted by way of a div i dend, and how much should go into debt re duc tion or into re tained earn ings and be used to sup port fu ture op er a tions. The prob lem that often oc curs with mi nor ity own er ship (e.g. a 10% share in a com pany) is that mi nor ity share does not give the coun try a de ci sive in flu ence about what to do with prof its, for in stance, whether to in vest or de clare a div i dend. If the com pany de cides not to de clare a div i dend and, in stead, rein vests that profit, the gov ern ment gets no re turn on the in vest ment. The com pany can still get the ben e fit of those prof its how ever. For in stance, by pay ing in ter est on com pany loans to an off shore re lated en tity. De spite not pay ing the div i dend, the min ing com pany can still take some profit out of the coun try through in ter-com pany loans where the in ter est rate is above the arm'slength rate. Using debt rather than eq uity as a method of in vest ment in a coun 97

102 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES try is often re ferred to as thin cap i tal iza tion and coun tries often have spe cial rules to limit the amount of debt a com pany can have. An ad di tional prob lem for the coun try is that the amount of rev enue gen er ated by div i dends is un pre dictable and may change from year to year mak ing it dif fi cult to rely upon such rev enue for bud getary pur poses. Other free-carry arrange ments may po ten tially in clude the state tak ing a share of the net cash flow from a pro ject in lieu of div i dends. While this still re quires the pro ject to gen er ate pos i tive net cash flows be fore the gov ern ment re ceives any rev enue from this arrange ment, the ad van tage is that pay ments are cal cu lated ac cord ing to an agreed-to for mula, and the amount and tim ing of pay ments are not up to the dis cre tion of the com pany board. In deed such arrange ments would also foil at tempts to re duce div i dends to gov ern ment by fi nan cial ma nip u la tions such as debt load ing. Ad min is tra tion of any eq uity rights and rev enue is typ i cally (but not al ways) con trolled by a gov ern ment de part ment within the ju ris dic tion s fi nance min istry. Also, tax leg is la tion in a coun try typ i cally pro vides its tax rev enue au thor ity with the right to di rectly audit a com pany s ac counts, so gov ern ment can be rea son ably as sured that a proper state ment of profit is de clared. Good Financial Governance challenges of SOEs The fund ing of the SOEs tends to be off-bud get and fis cally non-trans par ent. Some SOEs take on roles that would typ i cally be car ried out by Min istries re spon si ble for gov ern ment ex pen di tures, such as the Min istry of Fi nance or Trans port. In stead of trans fer ring the rev enues to the Trea sury, the SOE di rectly pays for pro jects in in fra struc ture or for so cial is sues. This avoids the usual re view of the na tional bud get process and there fore in fringes ac count abil ity and trans parency stan dards (see NRGI 2015 [ 98

103 STATE OWNERSHIP / sites / default / files / documents / nrgi_primer_stateparticipation-and-soes.pdf] ). In de vel op ing coun tries where in sti tu tions are weak and roles often not well de fined, SOEs can face but also cre ate chal lenges. A sig nif i cant gov er nance issue within SOEs is often a lack of ac count abil ity, some times re sult ing in cor rupt ac tiv i ties. In states in clined to crony ism and nepo tism, heads of SOEs are often po lit i cally ap pointed by the gov ern ment. Badly man aged and not ef fec tively su per vised, SOEs can be come ve hi cles for pub lic of fi cials to steer valu able con tracts to ward their own in ter ests, or to cre ate bloated bu reau cra cies that do lit tle to ad vance broader de vel op ment (NRGI 2015 [ / sites / default / files / documents / nrgi_primer_stateparticipation-and-soes.pdf] ). This can re sult in a slow down in pro ject de vel op ment and sig nif i cantly re duce state rev enues. Remedies Where SOEs ex ists, cer tain mea sures may pre vent neg a tive ef fects. Clear de f i n i tion and lim i ta tion of the tasks and role of SOE within the sec tor may in crease trans parency and un con trolled po lit i cal in flu ence over the sec tor. Po lit i cal in ter fer ence may also be lim ited by a clear sep a ra tion of roles within SOEs them selves. As the case for pri vate en ter prise, stan dards of trans parency and ac count abil ity should be set and en forced in order to pre vent the above-men tioned prob lems. Areas of further thinking How effective is it to train government representatives on company boards to strategically influence company decisions based on government priorities? 99

104 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Areas of intervention > Support Supreme Audit Institution (SAI) to audit SOE in the extractive sector, including profit-making oil trading. 100

105 Artisanal and Small Scale Mining ASM operations often operate in an informal setting, resulting in governments being unable to collect fees, taxes and royalties from these activities. In many countries the potential of ASM value chains for revenue generation have not been tapped into. Decentralising revenue collection to the local level is one avenue to address formalisation and enforcement. Background The over all share of Ar ti sanal and Small Scale Min ing (ASM) pro duc tion of high-value min er als (such as gold, tin, tan ta lum, tung sten, and gem stones) com pared to global pro duc tion is sig nif i cant. ASM also oc curs in ju ris dic tions with low-value com modi ties (such as sand, stones, clay and salt). The sec tor em ploys sig nif i cantly more peo ple than the large scale min ing sec tor and plays an im por tant role in many de vel op ing coun tries re gard ing the liveli hoods of rural pop u la tions and the local economies. Con sid er ing fees, taxes and roy al ties ap plic a ble to the sec tor in most de vel op ing coun tries, the over all rev enue po ten tial of ASM and its re lated value chains is sig nif i cant. Given that ASM op er a tions often op er ate in an in for mal and opaque set ting, gov ern ments are often un able to col lect fees, taxes and roy al ties from these ac tiv i ties. At the same time, gov ern ment agents and se cu rity forces (po lice, mil i tary) may ben e fit from the opac ity of the sec tor and de mand in for mal pay ments from ar ti sanal min ers. This re sults in a com plex set of in ter ests that pre vent the ASM sec tor from for mal i sa tion. Ad di tion ally, the sec tor is often plagued by en vi ron men tal, safety and health prob lems, human rights vi o la tions, so cial ten sion, and cor rup tion. In many 101

106 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES cases there are also ten sions be tween large-scale min ing op er a tions and ASM, which have re sulted in mine stop pages and vi o lent con flicts (also hav ing an im pact on rev enue gen er a tion from large scale mines). Challenges of collecting revenues from ASM The dif fi culty of col lect ing rev enues from the ASM sec tor can be traced back to (a) in for mal op er a tions and (b) un der-re port ing. In the case where the ASM oc curs in an in for mal set ting, the gov ern ment loses out on rev enues in the form of li cence fees, sur face rental fees, roy al ties and other taxes re lated to pro duc tion. Even when of fi cially reg is tered, ASM op er a tions have an in cen tive to un der-re port pro duc tion and em ploy ees in volved in order to avoid em ployee with hold ing taxes, Pay-As-You-Earn, roy alty pay ments and/or any other taxes re lated to pro duc tion. Given that ASM op er a tions pri mar ily occur in rural areas in re mote re gions, the li cens ing and rev enue col lec tion au thor i ties often do not have the ca pac ity to en force and mon i tor reg u la tions. Here it is worth dis tin guish ing be tween ar ti sanal min ers that may not be bound to a par tic u lar area, and small-scale min ing op er a tions with a li censed con ces sion. The for mer can move around eas ily and thereby avoid gov ern ment agen cies look ing to en force the rule of law. Goldpro duc ing coun tries, for ex am ple, ex pe ri ence 'gold rushes' whereby word-tomouth news about a gold find lead to nu mer ous ar ti sanal min ers rush ing to the area. By the time the reg u la tor hears and acts upon such news, the ar ti sanal min ers have al ready moved on. The lat ter group (small scale min ing op er a tions with a li censed con ces sion) is eas ier to iden tify by the reg u la tor. How ever, tax pay ments are based on self-re port ing. Given that it is very dif fi cult to audit these re ports with out con stantly being pre sent at the mine site, there is a strong in cen tive for these op er a tions to un der-re port rev enues. As a re sult, only suf fi cient pro duc tion fig ures are re ported that will guar an tee the con tin u a tion of the li cence. 102

107 ARTISANAL AND SMALL SCALE MINING Given the lim ited re sources of the gov ern ment, the dif fi culty of reg u lat ing and au dit ing the ASM sec tor, as well as the rel a tively small rev enue con tri bu tion by each in di vid ual mine (as op posed to a large scale mine) poses the ques tion as to whether it is worth while for the gov ern ment to chan nel more re sources into over sight and mon i tor ing of this sec tor. If the costs re lated to hir ing more in spec tors to audit in di vid ual min ing pits are more costly than the ben e fits being gen er ated from this ac tiv ity, it might not be worth it (ben e fits should not only in clude rev enues, but also other ex ter nal i ties such as re duced pol lu tion). While the re cov ery of taxes and other legal fees in the sec tor is a major chal lenge, an other chal lenge is elim i nat ing the prac tice of gov ern ment agents re quest ing pay ments with out any legal basis. Min ers, es pe cially those in re mote areas, may not know which taxes and fees they are obliged to pay ac cord ing to cur rent law and reg u la tions and which of the many gov ern men tal agen cies is al lowed to col lect those pay ments. Gov ern ment agents might take ad van tage of this ig no rance and un cer tainty about fis cal oblig a tions and charge il le gal fees and pay ments for min ing ac tiv i ties. While these il le gally raised pay ments may drive min ers into poverty, they may also in cen tivise min ers to op er ate in the in for mal sec tor, hop ing to pass "un seen". Opportunities for collecting revenues from ASM Cases where small-scale min ing and re lated rev enue col lec tion are well man aged by gov ern ment, such as in Rwanda, where the gov ern ment col lected a total of USD 228 mil lion of com bined ex port rev enues for tin, tan ta lum and tung sten in 2013, in di cate the po ten tial of the sec tor. How ever, it has to be ac knowl edged that ASM man age ment is highly con text-spe cific and sucess ful ap proaches are not nec es sar ily replic a ble. 103

108 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES For mal i sa tion is one of the main av enues for tax ing ASM and is a means to en hance trans parency of the sec tor and re lated min eral sup ply chains. This can be in cen tivised by sup port ing li censed ASM op er a tions with ac cess to fi nan cial ser vices (such as loans and grants), ma chin ery leas ing schemes, and tech ni cal sup port (such as pro vid ing ge o log i cal in for ma tion and ed u ca tional pro grammes about how to re duce the health risks of using mer cury). Some coun tries cre ate ad di tional in cen tives for ASM to ob tain a li cence by in creas ing peer pres sure and tying ben e fits for the com mu nity to the num ber of li cences and of fi cial pro duc tion in it. Cer ti fi ca tion schemes have been rolled out in order to dis tin guish which goods are pro duced by li censed op er a tions re spond ing to pre de fined cri te ria as op posed to hav ing been smug gled. For cer ti fi ca tion ini tia tives to be suc cess ful, neigh bour ing and im port ing coun tries need to recog nise these cer tifi cates. Area for further thinking Which practices for ASM incentivisation and enhanced revenue generation have proven successful? Given that the cen tral gov ern ment is often too far re moved from ASM op er a tions, some coun tries have del e gated the li cence fee and tax col lec tion of ASM to the sub-na tional level or es tab lished spe cific sub-na tional struc tures for doing so. In coun tries where ASM rev enue col lec tion makes up a sig nif i cant pro por tion of total gov ern ment rev enues, there may be re luc tance to give up con trol over this rev enue stream. There are also con cerns that the ca pac ity at the subna tional level is often not suf fi cient to be able to man age these re sources ef fi ciently. Due to the dif fi culty of col lect ing rev enues at the mine-site level, many gov ern ments tar get deal ers and ex porters (see fig ure below for a typ i cal ASM value chain). These buy the prod uct of sev eral ASM op er a tions be fore sell ing it onto 104

109 ARTISANAL AND SMALL SCALE MINING larger deal ers within the coun try or ex port ing it abroad. The idea be hind tar get ing deal ers and ex porters is that these need to pay the roy alty and will then pass on this cost to the min ers (by dis count ing the roy alty in the price they pay). In order to be come an of fi cial dealer or ex porter, these op er a tors need to ob tain li cences, which are only re newed if the ap pro pri ate rev enues are paid. How ever, there is still an in cen tive by li censed deal ers and ex porters to un der-re port the quan ti ties of prod uct bought and smug gle out the dif fer ence. Fur ther more, there are un li censed deal ers that smug gle the prod uct out of the coun try. This is more com mon with com modi ties that have high-value-to-weight ra tios such as gold and di a monds. A re lated issue with pre cious min er als is that deal ers re port and get taxed on the com par a tively low prices they pay to in di vid ual min ers but re ceive much higher prices on their sales, with out their profit mar gin being taxed. There fore, a few coun tries have es tab lished de cen tralised points of sales or pub lic cen tres for ASM pro duc ers where prices for e.g. gold and di a monds are es ti mated by gov ern ment agents. Figure 12: Generic ASM value chain 105

110 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Areas of intervention > Advice on integrating the ASM sector into EITI reporting, support to the pooling and publication of data from other initiatives such as mineral certification mechanisms > Support to governments to simplify the ASM licensing and taxation regime > Support to sub-national government entities to collect and manage ASM revenues > Support for increased government inspection and monitoring of ASM activities > Support to ASM operators for better book-keeping and record tracking > Conduct trust-building exercises with ASM stakeholders and government institutions and the licence holders > Organise information campaigns for ASM producers about commodity prices for export products and on international markets 106

111 Data Availability Data availability is a precondition and contribution to good governance in the extractive sector and enables full participation of key actors. A lack in common standards for data creation undermines their usefulness for the management of extractive resources and bears the risk of increasing the costs of production. A main challenge for the pooling and sharing of data is trust building between different agents. Introduction As in all sec tors of the econ omy, more and more data is being gen er ated by the ex trac tive in dus tries sec tor. Large-scale min ing, oil and gas com pa nies pro duce in creas ing amounts of data to op ti mise pro duc tion processes. Rio Tinto s mine of the fu ture in the Pil bara, Aus tralia, with the au toma tion of min ing trucks, rails and ship load ers is lead ing the drive in au toma tion. Ul ti mately the idea is to con trol min ing op er a tions from a con trol room in order to in crease ef fi ciency and re duce the health and safety haz ards for in-pit min ing staff. On the other hand, in creas ing pres sure by civil so ci ety and gov ern ments to mon i tor the sec tor s ac tiv i ties has led to an in crease of re port ing re quire ments for ex trac tive in dus tries. Gen er ally speak ing, data avail abil ity can ful fil two func tions: increasing transparency and thereby contributing to greater oversight and accountability, rule of law and citizens' participation in the management of extractive resources 107

112 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES increasing efficiency and effectivity of management of extractive resources Sev eral global and re gional ini tia tives have cre ated and en cour aged de bate and ac tion around data avail abil ity: the vol un tary re port ing ini tia tive EITI (which be comes oblig a tory for com pa nies op er at ing in a coun try that takes part in EITI) has been adopted by 51 coun tries. The new EITI stan dard will re quire more so phis ti cated data re port ing. At the same time, EITI should be main streamed, mean ing that data would be cre ated and pooled by other na tional in sti tu tions and only shared through EITI re ports. Areas for further thinking Need to establish a shared understanding of what "mainstreaming EITI" means and how this would influence the implementing of individual country technical secretariat roles. What other criteria and conditions, apart from data availability, need to be met in order to ensure effective oversight, accountability and rule of law? How much and which type of civilian participation (information, consultation, decision-making) is useful and desirable in EI management? Home-coun try reg u la tions, which re quire listed com pa nies to pub lish data on pay ments to dif fer ent gov ern ments on a pro ject-by-pro ject basis in all coun tries of op er a tions, have been im ple mented or are in the process of being im ple mented in the EU, UK, Nor way, USA, Canada and Aus tralia (which rep re sent a large pro por tion of where ex trac tive in dus try com pa nies are listed). Cer ti fi ca tion schemes such as the Kim ber ley process for con flict min er als re quire com pa nies to re port where ex actly min ing prod ucts are ex tracted. 108

113 DATA AVAILABILITY Data gen er a tion and data avail abil ity are an im por tant pre con di tion to the im ple men ta tion of tech ni cal in stru ments for sus tain able rev enue man age ment. Data avail abil ity con tributes to broad and in formed par tic i pa tion of all in volved stake hold ers, which is es sen tial in often highly politi cised re source-re lated de ci sion mak ing and ad min is tra tive processes. Key aspects of data provision The trend to in creased data re quire ment re sults in the fun da men tal ques tions of what in for ma tion should be col lected, in what form, who should cre ate and col lect the data, how this data should be shared, and who are the ul ti mate users. Of course, these ques tions are in ter-re lated. The para graphs below ad dress each ques tion in more depth. Agreeing on what to collect and why Data col lec tion comes at a cost. If the ex pected cost of col lect ing data is larger than the wel fare ben e fits of mak ing this data avail able, it does not make sense to col lect it in the first place. Below is a non-ex clu sive list of data points that have be come avail able and the rea sons for why we might want to have ac cess to the data. Cadastre: Many resource rich countries have made information from the mining cadastre public. This helps governments and civil society to monitor which concessions belong to whom and whether there are overlapping concessions. Cross-checking information with other sector-specific cadastres such as environment, property can enhance the use of these data and help to detect irregularities. Beneficial ownership: The new EITI standard requires the publication of beneficial ownership, so governments and civil society can better assess who the 109

114 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES ultimate owners of licences are. This will reduce the scope for entities that are trying to hide their assets. Contracts: An increasing number of countries are making their resource contracts public. The website resourcecontracts.org hosts an ever increasing number of contracts. Contracts allow citizens to see what agreements have been made between the government and the extractive industry sector. It can also help governments to better understand industry best practice. Financial payments: Financial payment transparency was first driven by the EITI process at the country level, with the idea that total payments from extractive industries should be publicly known so citizens can hold their government accountable. Today the trend is moving towards project-by-project level reporting. This allows oversight of individual projects. Given that EI companies do not only pay royalties and taxes, additional data related to payments in kind is also collected. This can include physical data such as ore, oil and gas, infrastructure payments or production sharing with stateowned companies. Employment: With the increasing push towards local content, companies have started to report employment and procurement figures. CSR investments: This is particularly relevant for communities around the EI project. A clear definition of CSR investments and their publication allow for better coordination and control of voluntary and non-voluntary contributions. Environmental impacts: Given that the EI sector usually implies a bad environmental record, there is increasing pressure by civil society to monitor emissions, water consumption and water discharge. 110

115 DATA AVAILABILITY Agreeing on a data collection standard After agree ing what data should be col lected, it is im por tant to agree on a stan dard ac cord ing to which the data will be col lected. If each com pany is left to re port the data as they please, they will not be com pa ra ble. For ex am ple, if it is de cided that local pro cure ment data should be col lected, it needs to be agreed upon what local pro cure ment means. Does it mean a sup plier based in the coun try, or that a cer tain per cent age of local value ad di tion is set to qual ify as "lo cally pro cured"? These ques tions have to be dealt with at the coun try level by gov ern ments but also at the in ter na tional level, for ex am ple, by the Sta tis ti cal Com mis sion of the United Na tions or the OECD Sta tis tic De part ments. Using their ex per tise and call ing on in ter na tional best prac tice may help reach agree ment on a data stan dard suit able and ac cept able to EI com pa nies and coun tries. Data creation Even if a lot of data is gen er ated by dif fer ent stake hold ers at dif fer ent lev els around the ex trac tive sec tor, in most coun tries there is no clear di vi sion of roles and re spon si bil i ties re gard ing data, and stake hold ers in volved rarely have a com pre hen sive strat egy for data gen er a tion that takes into ac count fur ther sources and ini tia tives. 111

116 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Areas for further thinking Who is responsible for data creation? Are companies, the government or civil society responsible for collecting and creating the data? How should it be captured? Does data capture require going into the field and/or monitoring? Can technologies be used for automated data exchange? Streamlining data collection processes (efficiency): there should be a clear timeline as to what data should be collected and when. It is costly to have multiple data collection initiatives. How can one ensure coherence? Cost/benefit of data collection: if the costs related to making the data available are larger than the social benefits, it may not make sense to pursue this endeavour. How can costs and benefits be easily assessed? Compilation of data Very often, data is col lected but not com piled, mak ing it dif fi cult for ac tors to base their de ci sions on ex ist ing and com monly known data. In order to en sure the use ful ness of com piled data, it needs to be struc tured and cat e gorised in a stan dard ised way. Very often, stan dard cat e gories do not exist and this makes the com pi la tion dif fi cult and costly. In many re source-rich coun tries, EITI is the only process by which data from ex trac tive in dus tries is sys tem at i cally com piled and shared. Data sharing Data shar ing de scribes mech a nisms and processes of mak ing data avail able to other stake hold ers or ac tors. Data shar ing al lows for other ac tors to base their work on the same data. 112

117 DATA AVAILABILITY Data shar ing strength ens trans parency and ac count abil ity across the sec tor. When it comes to good fi nan cial gov er nance in ex trac tives, a major prob lem lies in the un will ing ness of ac tors to share ex ist ing data. As data col lec tion is costly and com pli cated, ac tors tend to base work on in com plete in for ma tion. To im prove data shar ing, data needs to be pre sented in agreed-upon and open for mats which allow for the in te gra tion of data into other data bases. Excel spread sheets, for ex am ple, are a more use ful for mat for data than PDF. The fol low ing ques tions need to be ad dressed when de cid ing how to share data: Public vs. private Data made available to the public can be used by civil society and advocacy groups and thus strengthen transparency and accountability, while some data can only be shared between state authorities and would be subject to confidentiality clauses. Governments need to decide on the level of transparency prescribed to actors of extractive industries. 113

118 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Format (user friendly) The formats through which data is shared needs to allow for easy use and integration into different actor systems. Access Very often, data is available but difficult to access as it must be collected from different places and in different formats. An example would be contracts with operators in the extractives sector, which would have to be collected from different websites, sometimes only available in one language (e.g. Chinese) and incomplete. Pooling of data strengthens accessibility: the same can be said for the provision in different formats, languages, electronic versions and hard copies as well as short versions or versions in plain language". Areas for further thinking Considering that the extractive sector, legal and other framework conditions of each country differ, how can a common (international) nomenclature (classification) for reporting and standardisation of units be developed? Which actors should drive this process? Who should be responsible for the compilation and sharing of data? What kind of minimum standards could ensure the accessibility of data in terms of language and format? Data use In order to make data mean ing ful, it needs to be analysed and pre sented ac cord ing to the real needs of po ten tial users. The ques tion of how much ef fort should 114

119 DATA AVAILABILITY be put into data col lec tion, pool ing and shar ing, de pends on which ac tors can make use of re spec tive data. The fol low ing ac tors may use the data for dif fer ent ob jec tives: Parliament Parliaments can use information on all issues related to the value chain and revenue management in their parliamentary session, in order to question authorities or to prepare parliamentary commissions and audits. Civil society Civil society can use data in order to interrogate, hold different actors accountable or to prepare advocacy campaigns around the management of extractive resources. Government Different actors within the Government will use data from the extractive industry sector. Currently, a major concern is the lack of data sharing between line ministries such as the Ministries of Minerals (MoM) and the Ministries of Finance (MoF) and revenue authorities. For example, the cadastre needs to share information about licences with other sections within the MoM, and if customs agencies or the cadastre does not share information with tax authorities, it may become difficult to detect fraud. Another example would be countries where production figures are not systematically shared, resulting in incomplete information for tax auditors. Data can also be used by other actors such as the supreme audit institutions (e.g. for risk based audit planning) and the reform commissions (especially public finance reform commissions). Academia Academia can use data for in-depth studies about the sector and its impact on economic development. As such, these actors are likely to require highly granular and disaggregated data. Resulting reports can then be used by civil society and governments. 115

120 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES International institutions If more data was available, international institutions could base their reports (often a source for policy decisions in partner countries) on the data collected by resource-rich countries for their own use. Data literacy The use of ac ces si ble data is often lim ited by lack ing ca pac i ties of ac tors to read, in ter pret and analyse data. Re source-rich coun tries suf fer from asym met ric in for ma tion be tween gov ern ments and civil so ci ety and EI com pa nies, gen er ally re sult ing in un in formed de ci sion mak ing by gov ern ment agen cies. Data tools fa cil i tate the use of data and allow for stan dard ised and com pa ra ble analy sis of de vel op ments in the sec tor. Open fis cal mod els, for ex am ple, are in creas ingly being made avail able (such as those by the In ter na tional Mon e tary Fund (FARI), the Co lum bia Cen ter on Sus tain able In vest ment, the Nat ural Re source Gov er nance In sti tute, and Open Oil). These can be used and adapted to in ter pret data. How ever, these tools do not di rectly ad dress data lit er acy of the re spec tive user be cause they focus on the pro vi sion of data but not on their in ter pre ta tion. Spe cial train ing for rel e vant data users in dif fer ent stake holder groups can help to over come the lack of ca pac ity to read and in ter pret such data with a so phis ti cated un der stand ing. 116

121 DATA AVAILABILITY Areas for further thinking What are the skills stakeholders need in order to read and interpret data? Are these country- or commodity-specific? Can "data literacy" be taught independently of sectors and focus more on target groups (civil servants, civil society)? Could an open data standard be developed for extractive resources (see Global Open Data Initiative [ globalopendatainitiative.org/] ) which would allow for PFM institutions and Ministries of Mines, Oil and Gas to exchange data more easily? How could data availability be measured? Areas of intervention > Support for creation and implementation of (publicly available) information management systems, digitisation and data sharing > > Use of data training Peer learning to accelerate the spread of innovation > Trust-building measures between stakeholders preparing data for sharing > Support to the application of metadata standards > Data creation, pooling and sharing via EITI, certification mechanisms and indices 117

122

123 Transparency, Oversight and Accountability Strong and independent oversight in public financial management of EI revenues and the overall management of the sector ensures that governments comply with a country's own rules and obligations, follow its development objectives, and channel funds in line with its own planning. Parliaments, Supreme Audit Institutions (SAIs), courts, the media, transparency initiatives and civil society play a key role in holding governments to account and in ensuring Good Financial Governance in the EI sector. Introduction Pub lic Fi nan cial Man age ment of EI rev enues is often as so ci ated with a lack of ac count abil ity and trans parency re gard ing con tracts and pay ments be tween pri vate com pa nies and gov ern ments and the tax rev enues that gov ern ments are re ceiv ing from those com pa nies. It is im por tant that trans parency and ac count abil ity apply to the area of nat ural re sources to sup port good gov er nance. Trans parency is an es sen tial part of this equa tion. It al lows par lia men tar i ans to de ter mine whether the coun try has se cured a fair share of the re source rev enues, and em pow ers cit i zens and their rep re sen ta tives to ask ques tions about how the gov ern ment is using the rev enues. Dur ing the last few years the trans parency move ment has made big strides in push ing for the dis clo sure of data about rev enues gen er ated by oil, gas and min eral ex trac tion. An other pow er ful stake holder can be the Supreme Audit In sti tu tions. If they are well man aged and ful fil their role and man dates, they can fur ther in crease ac count abil ity for the ex trac tive sec tor. 119

124 CHALLENGES FOR GOOD FINANCIAL GOVERNANCE IN RESOURCE-ENDOWED COUNTRIES Extractive Industries Transparency Initiative An ini tia tive which tack les the strik ing non-trans parency of many coun tries' re sources sec tors and which has gained a lot of at ten tion in re cent years is the EITI. It was founded in 2002 by a num ber of gov ern ments of re source-en dowed coun tries, ex trac tive com pa nies and civil so ci ety - the con stituen cies of which now form EITI's 'multi-stake holder group'. The ini tia tive's goal is to shed more light on pub lic and pri vate re source man age ment and to in volve civil so ci ety in mak ing nat ural re source gov er nance a sub ject of pub lic de bate. While EITI can act as a di ag nos tic tool point ing fin gers to tech ni cal skills and so lu tions needed in a coun try's spe cific con text, it also pro vides room for the par tic i pa tion of key stake hold ers in the de bate about the man age ment of often highly politi cised sec tors in which high ex pec ta tions amongst the pop u la tion are often dis ap pointed. Gov ern ments, com pa nies and civil so ci ety have agreed that EITI will focus on the third of five links in the re sources value chain, namely the dis clo sure and audit of pay ment flows be tween the gov ern ment and ex trac tive in dus tries. Figure 13: EITI value chain While EITI makes a valu able con tri bu tion to fi nan cial trans parency in the ex trac tive in dus try sec tor, the con cen tra tion on this link means that it does not con tribute to com pre hen sive re source gov er nance along the en tire value chain. For ex am ple, with rev enue trans parency, the ac count abil ity and de vel op mentori ented use of EI rev enues is not yet as sured. 120

125 TRANSPARENCY, OVERSIGHT AND ACCOUNTABILITY Oversight of EI by Supreme Audit Institutions The high est, and in the best case, most in de pen dent over sight func tion of a state is ex er cised by a coun try's SAI (equiv a lent to the Au di tor Gen eral, and re spon si ble for ex ter nal audit). Over sight by SAIs is an im por tant tool in safe guard ing the ef fec tive ness and ef fi ciency of gov ern ment ac tion, and also its com pli ance with pre vi ously set agen das. Figure 14: Role of SAI One of the core man dates of SAIs is to pro vide bud get over sight in clud ing EI rev enues in the bud get. Fur ther more, SAI man dates typ i cally in clude au dits of the cri te ria used by gov ern ment bod ies to grant pro duc tion and ex plo ration li cences to pri vate and State Owned En ter prises (SOEs) as well as clauses es tab lished in those agree ments. The audit can also look at com pli ance by pri vate and pub lic sec tor com pa nies with a coun try's legal basis and/or agree ments as well as how the gov ern ment mon i tors and reg u lates com pli ance. Thus, in the ory, SAIs have the man date to ex er cise over sight over the en tire EI value chain in con trast with ini tia tives, such as the EITI, which focus on trans parency of spe cific as pects only. 121