LEGAL AND INSTITUTIONAL FRAMEWORK FOR SEZS JEANPAUL GAUTHIER

LEGAL AND INSTITUTIONAL FRAMEWORK FOR SEZS JEAN-PAUL GAUTHIER

“The 7 Habits of Highly Effective SEZs”: Key Questions to Answer in Designing an SEZ Program 1. Is an SEZ the correct policy to address the country’s goals? 2. What is the most appropriate type of zone to address the country’s goals? 3. What will be ‘special’ about the zone? 4. How should the legal framework be built? 5. What exactly should the legal framework contain? 6. What is the best institutional regime to regulate, promote, and administer the SEZ program? 7. What is the best transactional framework for the SEZ program? 1

1. Is an SEZ the correct policy to address the country’s goals? Source: Farole, Baissac & Gauthier (unpublished) 2

1. Is an SEZ the correct policy to address the country’s goals? First steps to answering this question are to identify nation’s development objectives and main constraints to achieving them: Source: OECD (Unpublished) 3

1. Is an SEZ the correct policy to address the country’s goals? Many, if not most, constraints can be addressed by other policies than SEZs: Stand-alone constraints not suited for an SEZ solution: • • 4 Structural constraints, such as geography or scale; Skills and productivity constraints; Social or environmental problems; and Macroeconomic imbalances Constraints to investment addressed more easily through other means: If the problem is only… Simple access to land quality infrastructure An alternative solution is… Industrial park Benefits of the alternative Drawbacks of the alternative No need to establish entirely new legal & regulatory regime Available to domestic and foreign investors Quick to set up and no major infrastructure or (in some cases) new laws required Well-established models Easily made available to FDI and domestic exporters Access to inputs for processing Duty drawback regime; bonded warehouse; manufacturing-inbond Business regulatory environment (set up and operations) Business environment reforms (countrywide) Fiscal incentives Incentives offered through existing investment policy regime Improves situation for all firms in the country Avoids establishment of multiple parallel regimes (avoids confusing investors) No need for new laws More difficult when there is not already strong demand for investment (may need to offer more) Many countries have duty drawback or bonded warehousing schemes, but they are poorly implemented and ineffective Can be difficult to manage when not spatially defined Lack of capacity, funding, and/or political will may make it infeasible within a reasonable time period May be considered insufficient in context of competitive locations Must be open to all investors

1. Is an SEZ the correct policy to address the country’s goals? A number of questions should also be asked during the policy interrogation phase: • Is the SEZ program a national priority (i. e. , is there real government commitment to the SEZ program from a financial/public investment perspective; government commitment to take action on SEZ legal and institutional needs)? • What will be the ‘Unique Selling Proposition’ of the SEZ regime relative to others in the region? • What is the political appetite to do what is necessary, in terms of changes to the investment policy environment, to make the SEZ regime a truly ‘special’ one? • Even if one makes these changes, will the SEZ have a truly credible business regulatory environment from an international business perspective? Does the proposed regime truly protect investors from the counterproductive constraints in the national investment environment? • How competitive are neighboring countries’ investment regimes relative to the proposed SEZ regime? • Even if the answers to the previous questions support the establishment of an SEZ regime, is it realistic to assume that government institutions (whether new or existing) will be able to administer it effectively? 5

2. What is the most appropriate type of zone to address the country’s goals? Broad types of zones Type Commercial free zone Export processing zone (EPZ) Main constraints they can help overcome Trade and investment policy regime Business environment Land infrastructure Appropriate for strategies focusing on: Developing commercial and logistical sectors What is required from the start Trade and investment policy regime Business environment Land infrastructure Low income countries focusing on labor absorption; diversifying into basic manufacturing Significant labor force; relatively favorable location (for input / export shipping); decent national infrastructure; trade preferences to key markets Trade and investment policy environment (Limited) business environment Middle income countries focusing on upgrading; countries focusing on exploiting natural resources for value addition Good national infrastructure; broadly competitive existing national environment; trade preferences to key markets Trade and investment policy regime Business environment Land infrastructure Low and middle income countries focusing on undertaking radical reforms to support broad competitiveness, structural transformation, and regional development Substantial investment resources; large land area; potential for significant agglomeration; willingness for substantial autonomy of governance and radical testing of reforms Free enterprise zones (‘single factory’ zones) Wide-area SEZs and freeports 6 Existing trade-related comparative advantage – location and trade infrastructure (e. g. port)

3. What will be ‘Special’ about the Zones? “I don’t want a sorta special economic zone, I don’t want a kinda special economic zone, I want a SPECIAL economic zone!” – Muntasser Okla, Former Head of the Jordan Investment Promotion Corporation (now JIB), Regarding plans for Aqaba SEZ circa 1999 7

3. What will be ‘Special’ about the Zones? Potential ‘soft’ offerings: • Liberalized Business regulatory environment • End-to-End, including: Land –Environment –Start-up –Labor & Entry –PPPs –Capital –IPR - Product Certs & CSR –Dispute Resolution • Reengineered administrative barriers, in terms of steps, cost, and time to: • obtain licenses and regulatory approvals • deal with ongoing government compliance • Single authority (“single window”) in which a single body has the power to reduce licensing requirements • “Sector levers” –not just “transversal” regulatory improvements • Liberalized trade & customs policies: Should be WCO and WTO compliant, facilitate trade and market access, ideally have an internal market • Investment and fiscal incentives: Should be ‘competitive but not excessive, ’ tied to outcomes, and avoid “race to the bottom” and transfer of revenue to private sector, OECD ‘red flags’ and WTO prohibitions on subsidies 8

4. How should the legal framework be built? Drivers of Effective SEZ Legal & Regulatory Change: Following questions should be asked: • • What are the key structural legal elements necessary to attract private sector investment? • Will a new SEZ Law be needed, or can an effective SEZ program be implemented through regulations, legislative amendments, contracts & concessions, MOUs and ERP? • • What are the political, transactional, and commercial drivers of effective legislative • change? • . 9 Broad based, early, and ongoing consultation & support from many different government agencies and private-sector stakeholders Transparent legislative and procurement procedures Technocratic “power-broker” champions pushing the project forward SEZ Implementation Task Force / Steering Committee responsible for initial policy determinations and implementation on a timeline Capacity building of SEZ Stakeholders, and Regulator and other Government staff MOUs solidifying legal authority over SEZs

4. How should the legal framework be built? The legal and regulatory framework of an SEZ program should also provide a consistent and transparent mandate for the SEZ and SEZ institutions. Generally, an effective SEZ regime consists of three levels of legal instruments: • An SEZ Law (or laws) issued by the highest legislative body that, in certain areas, takes precedence over existing legislation • SEZ Regulations issued by the cabinet or relevant minister • SEZ Operating Procedures issued by the regulator, often in coordination with the developer Characteristics of Good SEZ Legal Instrumentation These instruments are clearly separated to ensure that the framework is: • • sufficiently permanent to ensure consistent, transparent and predictable implementation practical, flexible and responsive to the needs of investors and the public good

5. What should the legal framework contain? Top mistakes in developing SEZ legal frameworks include: • • Assuming that all SEZ frameworks are more or less the same and can thus be more or less copied from ‘off-the-shelf’ “Generically” failing to link the SEZ policy to the country’s real investment policy challenges or to make the SEZ regime “credible”, either due to: • a lack of understanding of the importance of what legal changes can actually deliver • a lack of political will • a desire to take short cuts to get to an adopted SEZ law more quickly • Failing to link the SEZ policy to the targeted sectors and thus failing to address specific sectoral concerns (or worse yet, designing an SEZ policy with no sector/cluster targets and/or absolutely no idea which investors are likely to set up in the zones) • Assuming that fiscal incentives are the only real competitive differentiator that matters. 11

5. What should the legal framework contain? The SEZ Legal Framework should consider incorporating such global best practice elements as: • • Broad Investment Principles & Policies: Statement of objectives: • Investor protections • Competition • NT • Simplified regulatory procedures; etc. An Independent SEZ Regulator • SEZ Designation Criteria: • Public notification requirements • Title check • Ability to use and feasibility of developing off-site infrastructure • Business activity in area; etc. • Developer/Operator Rights & Obligations: • Rights to lease and build on land; PPPs; build infrastructure and utilities; and provide ancillary services. • Obligations to provide public agencies with facilities; report on SEZ performance; Ensure appropriate management, etc. • Subject to Developer Agreements in addition to the SEZ Law 12

5. What should the legal framework contain? • Land Use and Environmental Management: • • Localized, integrated, flexible and streamlined planning and controls Clear environmental guidelines Clear property rights and guarantees Design guidelines and building standards Regulator has power to monitor compliance Fast-Track Environmental Permitting for Small Development Projects Permitting Desk Officers Deregulated Utilities • Licensing Business Activities: • • 13 Allowing the broadest possible range of activities Only denying those activities explicitly listed in a Negative List formed based on sustainability or the public good No restriction on competition / Unimpeded right to operate, employ workers, etc. as long as in compliance with law One-stop shop under effective SEZ Regulator control Declarative system Minimal licensing requirements Elimination of foreign investment restrictions / Equal treatment

5. What should the legal framework contain? • Fiscal Policy and Tax Administration: 14 • Efficient administration and processing of income tax and VAT • If fiscal incentives are present, enterprises must keep separate books • Avoidance of duplication of national tax administration • Low reliance on tax holidays and other fiscal incentives • IASC reporting norms • Simplicity --Max 3 -4 taxes • Automatic incentives • Unified tax and social security filings, inspection and collection • Competitive with region and country • Elimination of indirect taxes • Low, flat tax on SEZ and offshore income; regular taxes on income from transactions in DCT

5. What should the legal framework contain? • Flexible and efficient labor rules, including: 15 • Respect of ILO norms • Hiring and firing without “prior administrative authorization” to promote job creation • Flexible employment and compensation arrangements • Credible system for resolving employment disputes • Liberalized termination & layoff • Freely-negotiated productivity packages • Transparent foreign worker regime • Unified multiple-entry Visa / Work Permit / Residency / ID / Social Security Card • Visa-free temporary entry • Permanent residence visas

5. What should the legal framework contain? • Trade Facilitation and Customs: • • • Close cooperation with national authorities Fast-track, on-site clearance at SEZ rather than point of entry All non-prohibited imports enter duty-and-tax-free Un-capped duty-paid domestic sales Treatment of domestic sales to zones as “constructive exports” eligible for export incentives Freedom of enterprises to sell internally No bonds Defined duty-free consumption Streamlined Kyoto-Compliant Customs procedures • • Streamlined submission and approval of transactions Single, Simplified, and Anticipatory declarations Customs clearance credit lines Annual pre-clearance level agreements 24/7 Customs Clearance 24 hour clearance ceiling Automated, Interactive « EDI » Clearance system Post-entry, selective, inter-agency inspections, audits and enterprise inventory controls • Efficient dispute settlement mechanisms for SEZ investor, including: • • 16 Recourse to binding international investment arbitration Dedicated internal SEZ mechanisms for administrative reviews and other matters

5. What should the legal framework contain? Typical mistakes in SEZ legal frameworks: Mistakes Failing to address the fundamental investment constraints Overlapping zone regimes Failing to consider the content of Developer Agreements Failure to conduct proper developer due diligence Failing to address conflicts of interest between public and private operators 17 Example One of the largest developing country economies recently went through a process to shift from their existing zone legislation to adopt a new ‘SEZ Law’. Despite significant effort and resources, however, political compromises meant that the final product was little more than the old regime with a new name, as failure to tackle the fundamental constraints to investment (which was responsible for the lack of success of the initial zone regime) remained. In Tanzania, the EPZ regime was launched in 2002; in 2006 an SEZ Law was also passed. For the latter, however, no enabling regulations were ever put in place and so the EPZ authority ended up being responsible for the administration and licensing of firms wanting to invest in the SEZ program. In Nigeria, the EPZ Authority was established in 1992; just four years later (and before the first zone was established) the government created the Oil & Gas Free Zone Authority (OGFZA). The two organizations were in conflict for many years over which had authority over a number of important activities, causing significant confusion and uncertainty on the part of investors. In several countries (including Ghana and Kuwait), lack of rigorous focus on the details of Developer Agreements resulted in situations where conflicts between the government and developers resulted in a stalemate, with government unable to step in and take over a failing zone. In a number of countries, failure to undertake appropriate due diligence of developers resulted in government’s getting locked into deals with developers who had insufficient experience or more commonly insufficient financial resources to deliver on their investment obligations. In Lesotho, where the public developer of industrial parks also acts as the promoter, regulator and administrator of the licensing regime, provision of land factory shells and below-market rates has undermined private sector provision of industrial facilities, resulting in an acute shortage of space and acting as a major barrier to entry of new FDI. In Bangladesh, the same authority is responsible for zone development, management, and regulation. Despite, passing a law allowing for the provision of private zones, the first privately zone project languished for 8 years awaiting approval for its operating license.

6. What is the best institutional regime for the SEZ program? The three principal SEZ institutional roles: Regulator Developer Operator & Service Providers Government body that ensures the regulatory environment is more streamlined and efficient than the national one Either a private-sector firm or a public-private partnership (PPP) Private-sector firm(s) that manage(s) day-to-day service provision to investors, tenants, and residents • • 18 Designates land as zones Licensing and permitting of developer, operators, and enterprises Coordinates all public agency inputs Monitors and enforces compliance • • Owns, finances designs, plans, and manages development of infrastructure and facilities Subcontracts for discrete construction and other tasks • • Markets and leases or subleases land and/or buildings Provides or contracts for solid waste removal and treatment, maintenance, security, etc.

6. What is the best institutional regime for the SEZ program? • Clear distinction between Regulator and Developer/Operator: • Conflicts of interest, confusion of goals & responsibilities, and skill gaps result when entities act as both regulators and developers/operators • Public Regulator and Private Developer/Operator: • Private SEZs have performed best for development and operation • Development and/or operation functions can also be assigned to PPPs coowned by private firms and a government-owned ‘Development Corporation’ • Dedicated, single, autonomous Regulator with authority over most other government entities within the SEZs: • Ensures “regime integrity” and delivery • Promotes streamlining of investor-government interface 19

6. What is the best institutional regime for the SEZ program? To ensure its effectiveness, the SEZ Regulator should be characterized by: • Sufficiently broad powers and appropriate authority • Controlling Site Development and Investment • Not overloaded • Leaving ‘public purpose’ / security alone • Coordinated services • Service standards (where existing public agencies have a reputation for poor service, SEZ regulator can work with them to improve performance standards, through regulations and MOUs unless poor or corrupt practices have become entrenched) • One-Stop-Shops / Single Windows • Autonomy and Flexibility • Reporting to the highest levels of government • Budgetary autonomy • Exemption from civil service rules in terms of salaries and procurement • Private sector representation on its Board 20

6. What is the best institutional regime for the SEZ program? Sample Organizational Structure of an Autonomous SEZ Regulator: Board of Directors General Manager General Counsel Registration and Licensing Department Finance Department Marketing & Strategic Planning Labor and Immigration Department Land Environmenta l Protection Infrastructure and Public Works Registry Division Revenue Division Visa and Permit Division Land Registration & Assessment Developer & Operator Oversight Licensing Division Fees & Penalties Division Labor Division Public Lands Management & Marketing Transportatio n and Public Works Zoning and Construction Environmenta l Protection 21

7. What is the best transactional framework for the SEZ program? PPP Structure Government Other Private Shareholders Articles, Bylaws, and Legislation Private Integrated Service Provider (ISP) Private Lenders / Banks Loan Agreements SPV (Master Developer) Ops & Maintenance (O&M) Agreements Facilities Management Provider (Operator) Construction Contracts Subcontractors (e. g. , Airport Developer) Subcontracts Construction Company (Developer) Leases Tenants 22 Parastatal Zone Development Corporation PPP SEZ Developer Agreement Individual Service Providers

DR AF T 7. What is the best transactional framework for the SEZ program? Dividends PPP Financial Flows Government Private Integrated Development Service Partner Corporation (PPP Partner) Dividends Other (Private) Investors Equity/ Contribution (land) Equity Construction Costs for Major Infrastructure and Facilities (if gov’t subsidized) Dividends/ Fees Dividends (Developer) Construction Costs Equity (if applicable) Debt Service SPV Company Payments Operation Costs/Fees Equity (if applicable) Premium Facilities Management Provider Rent / Fees Dividends (if applicable) Insurers NB: May be ISP Dividends (if applicable) Loan Banks Construction Company Tenants/ (Operator) NB: May be ISP Service Users 23