After a lengthy period of suspense, two keenly anticipated implementing regulations under Indonesian law No. 4 of 2009 (the "Mining Law") were issued on 1 February 2010: Government Regulation No. 23/2010 ("GR23") on Mining Business Activities and Government Regulation No. 22/2010 ("GR22") on Mining Areas. We are following these developments closely, and will provide updates focused on their effect on foreign investment activities as new implementing regulations are published — see our previous alert on the Domestic Market Obligation regulations, linked here.

1. Divestment Obligation

One of the key concerns of foreign investors regarding the Mining Law was the scope of the divestment obligation set out in Article 112. This article generally requires foreign shareholders to divest a proportion of their ownership in Indonesian mining concessions to local parties within five years of commencement of production. GR23 clarifies that only 20% of the 'foreign capital' is required to be divested within this timeframe. Surprisingly, the definition of 'foreign capital' in the regulation is fairly weak — it does not employ a beneficial owner test and may suggest that an entity that is even minority local owned is exempted from the definition. However, we believe the intent is to ensure 80% local ownership after five years, and this would be our recommendation for foreign investors in the sector.

GR23 also sets out certain requirements for the divestment process itself. The stake to be divested should be offered to various parties in the following order: the central government, the provincial or regional government, regency, state-owned companies, regional-owned companies, or lastly, to private national legal entities through a tender process. While easy to write, such a tender process may be extremely complex to implement in practice! Additional clarification is intended to come through a further ministerial regulation.

GR23 also specifically requires that the 20% domestic ownership be maintained on an ongoing basis, including in the event of a capital raise. This means that the choice of local partner will be significant, particularly if future capital requirements are a possibility. One interesting point to note is that 'private national legal entity' is defined as a 100% domestic ownership company — on the face of it, a purchase by an Indonesian public company would not qualify as a divestment under GR23.

While many foreign investors will no doubt wish to keep legacy investment structures in place, our first impression of the new divestment requirements is that the new Mining Law regime provides a reasonably certain framework for direct foreign ownership in the Indonesian mining sector. Accordingly, we think direct foreign ownership is now an option that merits serious consideration by investors into Indonesia's mining sector, and we would even (tentatively) suggest that investors through legacy structures consider reorganizing their investments and embracing direct ownership under the new regime.

2. Transitional Provisions

GR23 confirms that existing contracts of work ("CoW") and coal contracts of work ("CCoW") will continue to be valid until their expiry dates. The regulation also makes provision for existing CoWs and CCoWs to be extended as Mining Business Licenses (Ijin Usaha Pertambangan or "IUP") without having to go through a tender process, provided such extension complies with the provisions of GR23. Although the scope and criteria for extensions are not entirely clear, the regulation seems consistent with our understanding that the Indonesian mining authorities do not intend to significantly change the terms applicable to existing CoWs and CCoWs through the Mining Law and implementing regulations.

Existing Mining Authorisations (Kuasa Pertambangan or "KPs") are required to be converted to IUPs by 1 May 2010. The practicality of this will be subject to local governments making available relevant procedures — however, holders of any unconverted KP concessions should make enquiries as soon as possible if they have not already done so. As with CoWs and CCoWs, we do not believe that KPs converted into IUPs would contain materially different terms, except where clearly outside the scope of the new mining law.

3. Determination of Mining Business Area

GR22 provides highly detailed provisions on how mining business areas are determined between various organs of central and local government. Essentially the process is three-fold, whereby the Central Government needs to delineate the Mining Area (Wilayah Pertambangan or"WP") in Indonesia, and then further divide this into a Mining Business Area (Wilayah Usaha Pertambangan or "WUP"), State Reserve Areas (Wilayah Pencadangan Nasional or WPN) and People's Mining Area (Wilayah Pertambangan Rakyat or WPR). This process is heavily reliant on consultation, so we would not anticipate that it will be completed soon!

Sadly, the regulations do not contemplate a coordinated process for obtaining forestry business license/concession from the Department of Forestry, which is one of the key barriers to commencing production in many mining concessions. We recommend careful due diligence into the licensing requirements in any proposed Indonesian mining investment.

4. Transportation, Marketing, Processing and Refinery License

The regulations make provision for a new category of license for companies without a mining license but which are involved in the transportation and marketing or processing and refinery of mining products. We assume that companies involved in these activities will need to make preparations to obtain these licenses. Additional provisions on the application and granting of this license will be set out in a further ministerial regulation.

5. Limitation and Relinquishment of Exploration Area

GR23 provides for progressive relinquishment of exploration areas, a requirement no doubt intended to ensure sufficient application and focus on mining concessions, but one which may cause practical difficulties depending on the circumstances. Holders of exploration IUPs are required to give up part of their mining areas, so that by the fourth year under exploration IUP, the proposed mining area is not more than 50,000 hectares (for metals) and 25,000 hectares (for coal). By the eighth year of the exploration IUP, the proposed mining area cannot exceed 25,000 hectare (for metals) and 15,000 hectares (for coal).

6. Pricing and Production Control

Under the new framework proposed by the Mining Law, GR23 contemplates pricing and production controls (as well as the DMO regulation — see earlier note here) for environmental protection, conservation of resources and pricing control. The regulation does not give details, other than the general statement that benchmark prices will be determined by the Minister, based on market pricing and/or international indices. Additional provisions with regards to pricing and production controls will be determined in a further ministerial decree.

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Our general impression is that these regulations are further evidence of a consistent approach to policy and implementation of the Mining Law by the Indonesian authorities. While a number of details still need to be clarified, the general message is very positive for foreign investors in the sector. In particular, we are encouraged that pre-existing rights under CoW and CCoWs seem to have been respected and that local divestment requirements appear to be reasonable and defined in scope. We are optimistic that further regulations in the sector will continue in this spirit.

O'Melveny & Myers LLP routinely provides advice to clients on complex transactions in which these issues may arise, including finance, mergers and acquisitions, and licensing arrangements. If you have any questions about the operation of the applicable statutory provisions or the case law interpreting these provisions, please contact any of the attorneys listed on this alert.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.