Globally over the last twelve months, we have experienced an economic paradigm shift akin, on a commercial basis to the Fall in Christian theology - that is not to say, that previously we were living in idyllic perfection, rather that, like the Fall, there are some ways of being that are no longer possible, that require our assumptions and responses to be fundamentally retooled. Collectively, we are searching to understand the extent of the damage to our traditional assumptions and the corresponding scope of the required retooling.
This paper seeks to delineate a response to the foregoing inquiry from the perspective of Canada in relation to the mining sector and specifically with respect to the financing of that sector. Accordingly, this discussion has been organized around three questions:
- What has been the effect on the global financial crisis on the Canadian mining sector to date?
- What has been the response from the sector?
- Is it possible to identify trends based on the foregoing for the Canadian mining sector in the future?
What has been the effect on the global financial crisis on the Canadian mining sector to date?
Generally speaking, Canada has been relatively less impacted in the global financial crisis as compared to many other nations. This, in turn has been extremely important for the health and welfare of its capital markets, the “sandbox” of the Canadian mining sector. That is not to say that, particularly historically, there has not been a significant degree of international participation in the financing of Canadian companies, but, unlike many other resource-rich nations, Canadian companies in the mining sector have always benefited from a healthy, developed and relatively effective domestic capital markets system. The importance of the same cannot be underestimated and has always been a key driving factor supporting the growth and development of the mining sector in Canada. The combined effect of a strong capital market system, accustomed to financing mining projects, and the less significant impact of the global financial crisis on Canadian institutions can be seen in continued investor confidence, resulting in ongoing financings for Canadian mining companies as will be more fulsomely discussed in subsequent paragraphs.
(a) General background and “distinguishing marks” of the Canadian mining industry
In order for the reader to situate the Canadian mining industry within the sector in a global context, it is helpful to understand that The Toronto Stock Exchange (the “TSX”) hosts 55% of the listed mining companies in the world.1 There were 1,427 listed mining companies on the TSX at the end of 2008, compared with 684 companies and 216 companies on each of the Australian and London Stock Exchanges, respectively.2 Between 2004 and 2008, there were 8,253 financings completed for mining companies on the TSX, representing 81% of the world total and 31% of the world value.3 As will be seen below, this reflects the diverse nature of the sector in Canada, which boasts a healthy number of junior exploration companies as well as intermediate and senior companies.
To be clear, when discussing “Canadian mining companies”, it must be recognized that many Canadian mining companies are exploring and, therefore, financing projects held by them around the world. The term “Canadian mining companies” as used in this paper does not discriminate among the various stages of exploration and development, and, for this purpose, includes exploration, advanced exploration, pre-development, development and producing companies with assets around the world, but with a Canadian listing and a Canadian corporate presence. Accordingly, to the extent that the proceeds of financings for Canadian companies are used to fund projects held by Canadian mining companies in other jurisdictions, there is a positive international effect from ongoing success of Canadian mining companies to finance themselves. In fact, Natural Resources Canada estimates that in 2008 there were approximately 800 Canadian companies exploring in more than 100 countries other than Canada and accounting for about 40% of global exploration spending.4
A second, related point to the foregoing, is that, due to more than a century of commitment by the Canadian capital markets to support, particularly, the exploration by Canadian mining companies, the Canadian mining sector has developed on a vertically integrated basis. The sector is represented in Canada by a few Canadian major mining companies, several intermediate mining companies and over 1,000 junior companies.
In addition, there is an entire spectrum of Canadian companies providing services in support of the foregoing, such as drilling companies, food service and logistics, etc. Of the 1,427 mining companies listed on the TSX, 356 are senior companies with an aggregate market capitalization at the end of 2008 of CDN$207 billion as compared with CDN$338 billion on 2007.5 This represents a decline in value attributable in large . part to the financial crisis of 39% as compared with a 75% decline of the 1,071 mining issuers listed on the more junior TSX Venture Exchange in Canada.
What this means, is that the smaller capitalization companies are losing more value relative to their more senior counterparts as might be expected. The significance of this is that the aggregate market share of the TSX in respect of the global landscape of the mining sector is likely to show a decrease over the next year, as compared to other exchanges who have fewer overall participants, but less of a junior market. This will have the effect of understating the importance of the Canadian portion of the sector, which continues to fuel a significant percentage of global exploration, which is generally done through the more junior companies.
The structure of the mining sector within the Canadian economy gives it credibility at the more junior levels and provides for an influx of financing, both debt and equity at the levels of the major and intermediate companies and primarily equity at the junior level. This is important, because traditionally, the major and intermediate mining companies in Canada have been, themselves, a source of financing for the junior companies by way of direct financing or indirect, such as joint venture etc. In addition, the presence of the more significant Canadian mining companies within the sector, provide added confidence from the investment community for the Canadian mining industry as a whole.
(b) Effect of the Crisis - Canadian Exploration Financing Performance compared with Global Performance
The following two charts show mining and exploration financings comparing announced financings to confirmed financings from January 2007 through to June 2009. Figure 1 shows this information on a global basis, while Figure 2 carves this information out for Canadian exploration companies only. A comparison of these charts allows us to examine both the trend of the financing markets by comparing announced to confirmed financings, and evaluate the relative performance of Canadian exploration companies to the larger universe.
To view diagrams click here.
From the foregoing, we can observe several things:
(i) on a global basis, announced financings were significantly mismatched with confirmed financings at significantly high levels from February 2008 through June 2008, indicating that confidence in mining companies’ ability to finance were already out of step with economic realities even before the most significant events contributing to the global financial crisis had emerged;
(ii) this confirmed mismatch and the degree of the same were not replicated at the Canadian exploration company level for the same period;
(iii) while globally, the lack of conformity between announced and confirmed financings continues, albeit on a much reduced level, this is not replicated to any great degree at the Canadian exploration company level for the same period;
(iv) the evidence is that both on a global and a Canadian exploration basis, the true peak of financing (both announced and confirmed) for the mining sector was in 2007, with the Canadian exploration data showing this trend much more strongly and consistently throughout 2007 and the global data demonstrating this more intermittently.
We can conclude from the foregoing, that while the total value of exploration financings has decreased significantly as compared with 2007 and 2008, Canadian exploration financings have decreased relatively less than their global counterparts, and the gap between announced and confirmed financings is much less in the Canadian than the global context. From this we see that Canadian exploration financings are still tracking from announcement to completion quite effectively albeit on a reduced scale compared with prior years. Given, the Canadian contribution to world mining exploration as discussed above, this is good news for global exploration.
What has been the Response to the Crisis from the Canadian Mining Sector?
The answer to this question has been broken out into two parts: the first is a comparative financial analysis of financings, focussing on exploration as well as an analysis shifts in financing type over the past three years, while the second is more qualitative. One must bear in mind, as discussed above, that the financial crisis has had less of an impact on Canada than other regions around the world, and therefore there is a certain sense of “business as usual”. Accordingly, there are a number of initiatives that have been developing over the past few years, that are likely to have an impact on continued investment and the ongoing success of the Canadian mining industry. In particular, the second part of this section, will examine: (i) the recent changes to the Mining Act (Ontario), which governs mining activity in one of Canada’s principal mining provinces, (ii) the effect of the recently expanded role of the Export Development Corporation of Canada in the mining sector, and (iii) the impact of discussions concerning a national securities regulator in Canada on the sector.
(a) Analysis of Response Expressed in Terms of Financing Activity and Type
(i) Financing Activity
The easy response to the primary question posed in this section from a financial point of view, is of course, that fewer financings are occurring for Canadian mining companies, at less overall value. As indicated by Table 1 below, year to date announced exploration financings are down by almost 68% and confirmed financings have decreased by almost 52% over the same period:
Note that this data is the most recent available at time of writing, but only captures transactions to June 2009. It will be interesting to analyze the information for the third and fourth quarters of the year as they become available to observe whether these numbers demonstrate significant improvement, as this author suspects they will, based on anecdotal evidence for the third quarter. Recall that mining and exploration financings in Canada were generally the strongest during the 2008 year (cf. Table 2 supra), so the comparison above is with the strongest two quarters of 2008 at this time.
(ii) Financing Type
An analysis of announced financings by type, yields some interesting observations. As can be seen from Figure 3 below, there has been a shift away from debt, to convertible debt, reflective of tougher traditional debt project financing conditions around the world. In addition, although prospectus offerings are down from their high in 2007, they are currently exceeding the levels of both 2008 and, more significantly, 2006, indicating that there is still equity financing available for the traditionally larger junior companies, as well as the intermediate and senior players. Finally, there has been a clear shift from private placement financings to rights offerings.
Both the shift from traditional debt to equity and from private placements to rights offerings make sense.
Convertible debt has always been considered effectively an equity-type instrument. At a time when project lending terms contain conditions and hurdles that are much more difficult for companies to achieve, it is logical that there would be a move away from traditional project lenders and bank financing towards other types of instruments. In addition, with respect to rights offerings, considering the great decline in value of Canadian mining companies, particularly in the junior portion of the sector as discussed above, it is understandable that companies are seeking to give their existing shareholders an opportunity to participate in the diminished company values through rights offering financings.
(iii) Flow-through Financing
The other type of financing which shows some surprising results is that of flowthrough financing. Flow-through financing is a unique instrument of Canadian origin, which has helped to sustain the Canadian mining industry historically through periods during which traditional equity financing has been difficult for companies to secure due to general market conditions or low commodity prices. Flow-through financing is a Canadian federal government incentive program, supplemented at various provincial government levels. It is designed to stimulate investment in the Canadian exploration area. It is aimed at high net worth investors, who receive a tax credit against income (rather than capital gains) equal to the dollar value of their investment. The simple mechanics of the expenditure program are as follows:
- the investor must invest in a company who is seeking to raise flow-through financing by issuing shares designated on a flow-through basis. That is to say, that the investee company agrees that it will spend the proceeds of the investor’s investment on qualifying expenditures defined as “Canadian exploration expenditures” (“CEE”) in the Income Tax Act (Canada);
- note that CEE is only able to be incurred on exploration properties located in Canada;
- the investee company has a designated period of time to make the required expenditures
- the investee company renounces the value of the CEE expenditures to the original investor in an amount generally equal to the investor’s initial investment; and
- the investor deducts the renounced expenditures from his or her income for the fiscal year.
In this way, the expenditure program unlocks amounts that would otherwise be losses for the Canadian company, which would be generally unusable for any foreseeable time period in the case of pure exploration companies, who are the major beneficiaries of this program, and passes those losses on to high net worth investors in order to enhance their preference for investing in the Canadian exploration area.
What is interesting about the foregoing data is that flow-through expenditures for 2008 closely mirrored those of 2006. As has been discussed previously, 2007 was generally the peak year for investment and again we can observe that despite the fact that the brunt of the financial crisis had not yet been felt in the market-place in the first quarter of 2008, there was no significant change in flow-through investment from 2006. The other interesting observation that can be made from the data, is that the levels of flow-through financing through to June 2009 are uncharacteristically low, compared with previous years. This may be a function of reduced income at the level of high net worth investors in Canada, resulting in a reduced appetite for flow-through investment, but this low level of flow-through investment could have significant implications for the ongoing health of the battered junior mining sector in Canada if this trend does not reverse.
(b) Qualitative Developments in the Canadian Mining Industry
As discussed above, the following three areas are not specific responses to the effect of the financial crisis on Canadian mining companies by the Canadian government, Canadian regulatory authorities and Crown corporations, however, they are important initiatives and developments which will have an impact on the timing and extent of the recovery by Canadian mining companies.
(i) Amendments to the Mining Act (Ontario)
There has been a great deal of work towards amending and modernizing the mining act of one of the most prolific mining areas in Canada, the Province of Ontario. Bill 173, which proposes amendments to the Mining Act (Ontario) has as its purpose, the encouragement of prospecting, staking and exploration for the development of mineral resources, in a manner consistent with the recognition and affirmation of existing Aboriginal treaty rights as provided in the Constitution Act, 1982 (Canada).6 It can be argued, as will be seen from the below, that the sweeping amendments to the Mining Act (Ontario) are likely to have the opposite from stated effect. This paper does not seek to analyze the amendments in great detail, nor to argue their respective public and commercial policy merits, but merely to familiarize the reader generally with the types of amendments proposed, and their potential effect on the mining industry in Canada.
One of the most significant areas of the proposed legislative amendments, is in the area of Aboriginal consultation7. Historically, the duty to consult has principally been a responsibility of the Crown. The proposed amendments appear to shift at least a portion of this duty generally to private actors, namely, resource development companies.8 In addition, consultation is specifically required for exploration permits, advanced exploration, mine production approvals and mine rehabilitation.9 Some of the issues with these proposals, include, the lack of detail concerning the scope of the duty to consult faced by private actors and any remaining governmental responsibility for the duty as well. One of the long-standing criticisms of the jurisprudence surrounding the duty to consult, is the ability of Aboriginal groups to effectively delay or stop a project from continuing despite the exploring or developing company having reached even advanced impact benefit agreements with the affected Aboriginal groups, for failure by the Government to consult. This issue appears more vague with the proposed amendments, rather than more clear.
The other key area of amendment is the reduction of lands in Canada available for mineral exploration and development. This reduction is proposed in four major areas:
- excluding private lands in Southern Ontario where surface rights are privately owned;
- an ability to restrict the availability of lands defined as sites of “Aboriginal cultural significance”;
- excluding 50% of the boreal forests located in the far north of Ontario from development; and
- restricting uses that are inconsistent with mining, if there is no community based land use plan consistent with mining.
Although part of the stated objective of the amendments is to encourage exploration, it is difficult to see how these elements of the proposed amendments will achieve this aspect of the stated objective for the amendments. The impact of these amendments, if passed, may be to discourage mining investment in Canada in favour of increased exploration and development by Canadian companies abroad.
A. Proposed Amendments to Canadian Securities Legislation
Currently each of the ten Provinces and three Territories in Canada have separate securities regulatory authorities. There has been discussion for over ten years concerning the desirability of a singe national securities regulator. This concept has met with constitutional obstacles as well as regional political obstacles, but appears to be gaining momentum. If this concept were to become a reality, it would greatly facilitate investment in Canadian capital markets, both across Canadian regions and from abroad. Given the importance to Canadian mining companies of access to capital and the capital market systems in Canada this would represent a significant positive change for the industry.
B. Contribution of the Export Development Corporation (“EDC”) to the Canadian Mining Industry10
The EDC is a Crown corporation, which has, over the last seven years or so, greatly expanded its investment and product line in relation to the Canadian mining industry. It will often act as an adjunctive participant, lending confidence enabling other private actor syndicate members to participate as well. The principal services offered by the EDC of relevance to the Canadian mining industry (and certain non- Canadian beneficiaries as described below) are in the areas of accounts receivable insurance, financing, political risk insurance, contract insurance and bonding. To give the reader an idea of the order of magnitude of these services, see Table 2 below:
In addition, the EDC contributed approximately CDN$300 million in support for the Canadian mining industry in light of the global financial crisis. Of this, CDN$60 million was provided to Agnico Eagle Mines Limited and CDN$40 million was provided to Lundin Mining.
The mandate of the EDC comprises support for Canadian exporters and Canadian companies doing business overseas, provided that overseas assets benefit Canada. The EDC also assists foreign purchasers of Canadian products with portfolio of financing solutions.
Given the magnitude of the EDC participation in the mining industry over recent years, the EDC is uniquely poised to provide assistance to the industry as it works through the impact of the global economic crisis. It will be interesting to see whether the EDC mandate in this area becomes more oriented to assisting infrastructure projects, particularly outside Canada, to the extent that they utilize Canadian companies. This would be of great assistance to developing projects abroad for the Canadian mining industry.
Conclusion: what are the trends that can be identified for the Canadian mining sector in the future?
From the foregoing discussion, a number of trends emerge, that will direct the future of the Canadian mining sector. First, from a financing perspective, the Canadian capital markets continue to be supportive of Canadian mining companies. Given the dominant role of Canadian companies in foreign resource exploration, this is good news for countries that have been the target of Canadian exploration. Notwithstanding the foregoing, in light of the decrease in available funds for the sector from Canadian public markets since the global financial crisis, it is logical to assume that Canadian mining companies will be more selective concerning the destination countries for their exploration dollars. Therefore, countries with who have responded to the global crisis or otherwise have migrated to a less miningfriendly regime, those that have or have implemented foreign currency controls or other barriers to the entry or exit of capital or which are experiencing greater political or economic instability, will all be less likely choices for the deployment of Canadian exploration human and economic resources.
Second, it remains to be seen, but the likelihood is that the decrease in available flowthrough financing coupled with the proposed amendments to the Mining Act (Ontario) will reduce the appetite of Canadian companies to explore within Canada and may result in additional exploration funds being available for foreign projects. This trend is still in early stages, and will need to be confirmed once third and fourth quarter flow-through financing information becomes available (which are traditionally the high water marks of this type of financing), and once the detailed implementation of the proposed legislative amendments are known.
Third, positive impact on the industry will be felt if there is further movement towards a national securities regulator, which should encourage the level of capital markets financing in Canada, and reduce financing barriers for foreigners and Canadian investors resident in the various Provinces and Territories alike. In addition, the EDC has demonstrated growth in its commitment and resources available to the Canadian mining industry, which will continue to have a positive effect on both Canadian mining companies and foreign projects involving Canadian companies. It is hoped that this growth trend by the EDC will continue, such that the level of commitment and breadth of services available to the Canadian mining industry will increase in the future.
By way of conclusion and despite the global economic crisis, it is the view of this author, that the current environment for the Canadian mining industry and particularly its relative capacity for financing, presents a unique opportunity for it to play a leadership role in the global mining industry to an extent that has not been possible historically.