Executive Summary

La’o Hamutuk comments

This purpose of this Act is to establish a Petroleum Fund for Timor-Leste. The provisions in the Act reflect the discussion paper on the key policy issues that was released on 18 October 2004, as well as submissions received during the ensuing period of broad public consultations.

The objective of the public consultation is to get comments from civil society and the public at large on this draft Act by 1 March 2005. After considering the submissions the Government will submit the Act establishing the Petroleum Fund to Parliament. Subject to the approval by Parliament and promulgation by the President, the Petroleum Fund can be operational from 1 July 2005 (the start of the 2005-2006 fiscal year).

This draft Act should be revised, and the revisions released to the public, before it is submitted to the Council of Ministers and the Parliament.

Also, regulations must be written and positions filled before the Fund is operational. It’s hard to see that happening in two months.

The design of the Petroleum Fund is based on the following key principles:

• The Petroleum Fund shall be a tool that can contribute to the wise management of Timor-Leste’s petroleum resources, for the benefit of both current and future generations.

The phrase “for the benefit of both current and future generations” occurs often in this Act, but it is vague, especially as to how far into the future it applies. The Act should have a goal of providing sustainable income for Timor-Leste for the indefinite future, including after our petroleum reserves have been exhausted.

• The Petroleum Fund builds on international best practice and reflects the circumstances of Timor-Leste. It is based on the petroleum fund used in Norway, one of the few models internationally that are generally seen to function well and contributing to a wise management of the petroleum wealth. The proposed model for Timor-Leste is currently referred to as the ”Norway Plus” model, reflecting additional accountability, transparency and information features that are judged appropriate for Timor-Leste’s circumstances.

As we discussed earlier, São Tomé e Príncipe is a more appropriate and relevant model for Timor-Leste. Furthermore, several of the best elements of Norway’s Fund are omitted from the proposal for Timor-Leste, making this “Norway Minus.”

• The Petroleum Fund builds on the Constitution. The Petroleum Fund Act lays down the key parameters for the operation and management of the Fund in accordance with article 139 in the Constitution, which states that the petroleum resources shall be owned by the State, shall be used in a fair and equitable manner in accordance with national interests, and that the petroleum extraction should lead to the establishment of mandatory financial reserves. The proposed Petroleum Fund builds on the constitutional framework, giving to the Parliament and the Government the powers that correspond to their competencies.

• The Petroleum Fund allows for a strengthening of the responsibilities, powers and capacity of key public sector institutions, such as Parliament, the Government, the Ministry of Planning and Finance and the Central Bank. There will be an Investment Advisory Board advising the Minister of Planning and Finance to enhance the quality of advice preceding decision-making. There will also be an independent Consultative Council to advise Parliament on the operations of the Fund, acting as a “watchdog” and contributing to an informed public debate and a sound management of the petroleum wealth.

The independence of the Investment Advisory Board and Consultative Council needs to be strengthened, and they need to be able to invoke investigatory and prosecutorial authorities when appropriate, on their own initiative, and to freely share their findings and opinions with the public.

• The Petroleum Fund is to be a tool that contributes to sound fiscal policy, and thereby help deliver on a sustainable basis strong economic growth and improved public services. The design of the Petroleum Fund acknowledges that good planning and execution of public sector budgets are key to avoiding the resource curse found in so many petroleum producing countries. The Petroleum Fund is to be coherently integrated into the budget process, supporting a fiscal policy framework that strikes the right balance between current consumption, investing in physical assets (infrastructure and human development) and investing in financial assets.

This Act and the Fund should encourage planning for our nation’s post-petroleum era. This would include long-term planning, development of non-petroleum sectors, and investing in human and physical infrastructure.

• The Petroleum Fund is to be prudently managed, invested securely in low-risk financial assets abroad.

• The management of the Petroleum Fund shall be carried out with the highest standard of transparency and accountability. This is a key element in building public confidence and support for a wise strategy of managing the petroleum resources. This can allow Timor-Leste to avoid the negative experiences found in so many petroleum producing countries, where petroleum has proved to be a curse instead of a blessing.

“Highest” is not a relative term. There are many ways transparency in this Act could be improved and made more effective.

The draft Petroleum Fund Act has the following key features:

• The Petroleum Fund’s income: all revenues emanating directly or indirectly from Timor-Leste’s petroleum resources will flow into the Fund, as well as the return on the Fund’s investments (net of management expenses). All the income of the Fund shall flow into an ‘earmarked receipts account’. The Fund’s opening balance on 1 July 2005 will be the accumulated First Tranche Petroleum payments, plus an amount to be determined by the Government to take into account the large petroleum revenues during the current fiscal year. [Articles 5 and 6]

• The Petroleum Fund’s expenditure: transfers from the Fund can only be made to a designated State Budget account, and the sum of all transfers in a fiscal year can not exceed a ceiling set by Parliament when approving the State Budget. This ceiling will as a general rule correspond to the amount necessary to finance the deficit on the State Budget excluding petroleum revenues. The Budget approved by Parliament decides the level of domestic tax revenues and spending – be it on current public consumption or on investment in infrastructure and human capital. Since it is the Budget’s financing need that determines the outflow from the Petroleum Fund, the Budget also decides the net allocation to the Petroleum Fund that gets invested in financial assets. This creates a direct link between the Budget approved by Parliament and the development of the Fund, and the Petroleum Fund will give a good representation of the Government’s rate of savings and net financial asset position. [Article 7]

The Parliament should pass a separate annual resolution authorizing a set amount, not a ceiling, for transfers from the Fund.

• The Government has separately adopted a savings/expenditure policy of maintaining the real value of the petroleum wealth, which will serve as a reference to determine the amount of money that should flow out of the Fund. This policy translates to spending the estimated sustainable income from petroleum, which is the amount that can be spent each year forever and therefore can be said to strike a good balance between the interests of current and future generations. On current calculations, this policy allows for a significant increase in Government spending in the medium term.

We have been unable to obtain a written document describing this policy. Is it a public document? How has it been adopted, and who has approved it? How will it be reviewed and revised?

• The Act has specific reporting requirements imposed on the Government and the Consultative Council if the State Budget proposes to withdraw from the Petroleum Fund more than the estimated sustainable income from petroleum. While there at times may be good reasons to spend more than the estimated sustainable income, the provisions in the Act should contribute to making sure that such decisions are transparent and well informed. [Articles 7 and 17]

• The management of the Petroleum Fund: The Government has responsibility for the overall management of the Fund, and the Minister of Planning and Finance will exercise key functions and competences. The operational management will be delegated to the Central Bank in accordance with a management agreement, and it is envisaged that other investment managers will be appointed. [Article 8]

• The Investment Advisory Board is an expert body that shall advise the Minister on any matter relating to the management of the Petroleum Fund. Members of the Board will include the Director of the Treasury, the Head of the Central Bank, two persons with significant experience in investment management and one other person. [Article 10]

This Board needs to be expanded to insure independence from the Government, the Finance Ministry and the Central Bank.

• The investment of the Petroleum Fund: The Fund’s savings will from the beginning be invested securely in low risk financial assets abroad. The Act stipulates that investments must be USD denominated debt instruments with a low credit risk (a minimum credit rating of Aa3 by Moody’s or AA- by S&P). This will in practice mean investments mostly in government bonds, which means that the financial risk is seen to be limited and the expected investment return moderate. The investment strategy shall be reviewed within five years, when a larger Fund and improved institutional capacity may suggest a different asset allocation. [Article 9]

• There will be independent, external audits carried out by an internationally recognized accounting firm to bolster confidence that money going to, from or remaining in the Petroleum Fund are not misappropriated. The external auditor will also certify the calculation of the estimated sustainable income, and prepare a report on payments made by companies as Petroleum Fund receipts. [Articles 1, 7, 14, 20 and 23]

The audit report should also validate and explain the assumptions on which the sustainable income calculation is based. It should look at investments, not just income and expenditures. Audit reports should be made public in full.

• There will be an independent Consultative Council. The Council is to advise Parliament on the operations of the Fund, acting as a “watchdog” and contributing to an informed public debate and a sound management of the petroleum wealth. Members of the Council will be appointed by the President, Parliament, Government and civil society, and there will in addition be seats for former Presidents, Speakers of Parliament, Prime Ministers, Ministers of finance and Heads of the Central Bank. [Articles 15, 16 and 17]

The Consultative Council should include representatives from a broader range of civil society. These appointments should not be made by the Minister, but by the sectors of society they represent, to ensure that they are accountable to the people whom they represent.

• There are accountability, transparency and information features to contribute to a wise management of the petroleum wealth. There will be a high degree of transparency of operations, including comprehensive and accessible reporting requirements – both on the management of the Fund and on whether the spending of petroleum revenues is consistent with long-term considerations. There are also information requirements on payments made by companies as Petroleum Fund receipts, which is a core element of the Extractive Industries Transparency Initiative. [Articles 7, 10, 14, 17, 18 and 20]

There is room for a great deal of improvement in these areas, as discussed elsewhere in this submission.

This Act establishes a Petroleum Fund which seeks to meet with the constitutional requirement laid down in Article 139 in the Constitution of the Republic. This provision states that the petroleum resources shall be owned by the State, shall be used in a fair and equitable manner in accordance with national interests, and that the petroleum extraction should lead to the establishment of mandatory financial reserves.

The Petroleum Fund shall contribute to a wise management of the petroleum resources for the benefit of both current and future generations. The Petroleum Fund shall be a tool that contributes to sound fiscal policy, where appropriate consideration and weight is given to the long-term interests of Timor-Leste’s citizens.

The Act and its implementers need to go beyond the vague “for the benefit of both current and future generations.” The Fund Act should specify goals involving transition to the post-petroleum era, human rights, building human and physical assets and capacity, moving towards renewable energy. It should also discourage use of Fund money for military expenditures, weapons, one-time projects, etc. Since the preamble of the Act will be the standard by which the Investment Advisory Board, Consultative Council and others judge whether the Fund is being properly managed, it needs to be explicit, detailed and carefully thought out.

Efficient planning and proper execution of public sector budgets are key components of a sound management of the petroleum wealth. The Petroleum Fund is to be coherently integrated into the State Budget, and shall give a good representation of the development of public finances. The Petroleum Fund shall be prudently managed and shall operate in an open and transparent fashion, within the constitutional framework.

As discussed below and in our narrative and earlier submissions, the Act should include binding rules to improve the ability of Timor-Leste officials to properly plan and execute their budgets. In the absence of such rules, windfalls of petroleum revenue, magnified by short-term pressures, almost invariably lead to bad policy.

This Act lays down the key parameters for the operation and management of the Petroleum Fund. The Act governs the collection of and management of receipts associated with the petroleum wealth, regulates transfers to the State Budget, and provides for Government accountability and oversight of these activities.

Therefore, pursuant to Article 139 of the Constitution and for the purpose of establishing a fund of income from the exploitation of non-renewable petroleum resources for the needs of both current and future generations, The Government presents to the National Parliament, pursuant to paragraph c), item 1, Article 97, and paragraph a), item 2, Article 115, of the Constitution of the Republic, the following draft law:

Chapter I – General Provisions

Article 1: Citation

This Act may be cited as the Petroleum Fund Act.

Article 2: Definitions

1.1 In this Act, unless the context requires otherwise:

“Central Bank” means the authority to be established under Section 143 of the Constitution of the Republic or, until such authority is established, the Banking and Payments Authority;

“Code” means the Petroleum Mining Code agreed and adopted by Timor-Leste and Australia under Article 7 of the Treaty, as amended, varied, modified or replaced from time to time, and regulations made and directions given under it;

This is referenced only once, in the definition for petroleum authorization.

“estimated sustainable income” for a fiscal year means the amount determined in accordance with the formula set out in Schedule 1;

“Exchange of Notes” means:

This is referenced only once, and this Act would be clearer if it were spelled out in Article 6.2, rather than here.

(a) Exchange of Notes Constituting an Agreement between the Government of Australia and the United Nations Transitional Administration in East Timor, of 10 February 2000; or

(b) Exchange of Notes Constituting an Agreement between the Government of Timor-Leste and the Government of Australia, of 20 May 2002.

“fiscal year” means the period of twelve (12) months from 1st July to 30th June;

“independent auditor” means the auditor appointed, from time to time, for the purpose of auditing the Government accounts as set out in the Timor-Leste law, or an internationally recognised accounting firm appointed pursuant to Article 23;

“investment manager” means the Central Bank and any person appointed as investment manager under Article 8;

“Minister” means the Minister in charge of finances;

“Parliament” means the National Parliament of Timor-Leste;

 “petroleum” has the same meaning given to it in the Petroleum Act;

“Petroleum Act” means the Petroleum Act, 2005, as amended, varied, modified or replaced from time to time, and regulations made and directions given under it;

This is only referenced in the previous and next definitions. Given that the Petroleum Act has not yet been enacted or released to the public, we do not know what it says.

“petroleum authorisation” means:

(a) an access authorisation, a petroleum contract, a prospecting authorisation or a seepage use authorisation, or any agreement made in respect of such an authorisation or contract, granted or entered into under the Petroleum Act; or

(b) an authorisation or production sharing contract, or any agreement made in respect of such an authorisation or contract, granted or entered into under the Code;

“Petroleum Fund” means the Petroleum Fund for Timor-Leste established under Article 5;

“Petroleum Fund receipts” has the meaning given to it in Article 6;

“petroleum operations” means authorised activities under a petroleum authorisation;

“State Budget” means the State Budget referred to under Section 145 of the Constitution of the Republic;

“tax revenue” means any tax or duty imposed under Timor-Leste law;

“Timor-Leste” means the Democratic Republic of Timor-Leste; and

“Treaty” means the Timor Sea Treaty between the Government of Timor-Leste and the Government of Australia signed on 20th May 2002, as amended, varied, modified or replaced from time to time.

2.2 All terms in the present Act that are defined in the Timor-Leste law on budget and financial management have the same meaning given to it in that law.

Can the law be referenced specifically?

Article 3: Scope of the Act

This Act shall provide for the establishment and management of the Petroleum Fund, and the procedural rules relating thereto.

Article 4: Inconsistencies

For the purposes of this present Act, in the event of any inconsistency between the provisions of the Act and the provisions in the law of Timor-Leste on budget and financial management, the provisions of the present Act shall prevail.

Chapter II – The Petroleum Fund for Timor-Leste

Article 5: Petroleum Fund for Timor-Leste

5.1 There is hereby established a Fund known as the Petroleum Fund for Timor-Leste.

5.2 The Petroleum Fund shall have an earmarked receipts account into which the Petroleum Fund receipts set out in Article 6 are credited. Transfers from the Petroleum Fund shall be made only in accordance with Article 7.

Article 6: Petroleum Fund Receipts

6.1 The following amounts are Petroleum Fund receipts:

The Act should specify that oil companies (including a Timor-Leste National Oil Company) and all other entities make payments directly into the Fund.

The Act should forbid any petroleum-related payments, by any party, to places other than the Fund. There should be penalties for companies not complying with the Act, including for making payments outside of the Fund.

(a) the gross revenue, including tax revenue, of Timor-Leste from any petroleum operations, including prospecting or exploration for, and development, exploitation, transportation, sale or export of petroleum, and other activities relating thereto;

This should include all revenue from the sale of seismic or other data.

(b) any amount received by Timor-Leste from the Designated Authority pursuant to the Treaty;

(c) any amount received by Timor-Leste from the investment of Petroleum Fund receipts, net of management expenses including that paid to the Central Bank pursuant to the management agreement referred to in Article 8.3;

Management expenses should be shown as Fund withdrawals, not pre-deducted from receipts. This is essential for auditing and oversight, and to ensure that excessive management fees are not charged.

(d) any amount received from direct or indirect participation of Timor-Leste in petroleum operations; and

Does this section refer to profits and/or income received by the future National Oil Company?

(e) any amount received by Timor-Leste relating, directly or indirectly, to petroleum resources not covered in subparagraphs (a) to (d).

This should explicitly include money paid by Australia according to the March 2003 “Memorandum of Understanding Between the Government of the Democratic Republic of Timor-Leste and the Government Of Australia Relating to the Exploitation of the Sunrise and Troubadour Petroleum Fields in the Timor Sea” if the IUA comes into effect.

It should also include money to be paid by Australia in compensation for Timor-Leste forgoing downstream development rights or boundaries, as is envisioned in the proposed “Hong Kong solution” to the boundary dispute.

Also revenues and compensation to be recovered from Australia for revenue they already collected from illegal exploitation of Laminaria-Corallina and other fields, or from escrow accounts relating to such revenue. Also fines or interest collected on this – plus any damages awarded by a court in connection with these activities.

6.2 The opening balance of the Petroleum Fund is the total amount of the payments received by Timor-Leste, up to the commencement of the present Act, as First Tranche Petroleum, from the Joint Authority pursuant to the terms of the Exchange of Notes, or from the Designated Authority pursuant to the terms of the Treaty, increased by such amount, if any, as determined by the Government.

Plus any amounts listed in 6.1(a and e) additions above which have been received by the time the Fund becomes operational.

There should be an audited, public report on the opening balance of the Fund and its components.

Article 7: Transfers

Rules should set binding limits on the amount which can be withdrawn from the Fund in a given year. Otherwise, Parliament could decide to spend the entire Fund in a single year.

7.1 The only debits permitted to the Petroleum Fund are electronic transfers made in accordance with this article to the credit of a single State Budget account.

This article is contradicted by the tax refund in Article 7.5 below, as well as the exception for management expenses implicit in article 6.1(c).

If debits not permitted by this article are made, is that a criminal offense? Who is responsible? What are the penalties?

7.2 The total amount transferred from the Petroleum Fund for a fiscal year shall not exceed the appropriation amount approved by Parliament for the fiscal year. Subject to Article 7.3, transfers from the Petroleum Fund by the Central Bank in the fiscal year, shall only take place after publication of the budget law, or any subsequent changes thereto, in the Jornal da República, confirming the appropriation amount approved by Parliament for that fiscal year.

This should not be a ceiling, but a fixed amount like the rest of the budget. Unspent money can be carried over to the following year’s budget, reducing the amount needed from the Fund for that year.

This Act should require a specific resolution by the Council of Ministers and the Parliament for each transfer from the Fund to the budget, as in Norway. The resolution should specify the amount of money, what it will be used for, its relation to current Fund income and its impact on future dividends.

All authorizations of transfers, actual transfers, budget resolutions and related reports should be promptly recorded in the Public Register. See proposed new article 18½ below.

7.3 Subject to Article 7.4, no transfer shall be made from the Petroleum Fund in the fiscal year unless the Government has first provided Parliament with reports:

All of these reports, unedited, should be made public before or when they are given to Parliament.

(a) specifying the estimated sustainable income for the fiscal year for which the transfer is made;

The report needs to explain how these figures are calculated, not just the amount, and what assumptions were made. See our comments on Schedule 1 below.

(b) specifying the estimated sustainable income for the preceding fiscal year; and

The report should also specify the estimated sustainable income (ESI) for future years, based on the proposed amount of the transfer (if it is less than the sustainable income, future ESI will increase). A more sophisticated ESI calculation, as suggested in our comments on Schedule 1 (projecting the Fund’s earnings year-by-year, instead of assuming they will be constant) could yield variations in ESI from year to year.

(c) from the independent auditor certifying the amount of the estimated sustainable income in paragraphs (a) and (b).

The auditor certifies the assumptions and models which the ESI is derived from, not only the amount (See Schedule 1 comments).

7.4 No transfer shall be made from the Petroleum Fund in a fiscal year in excess of the estimated sustainable income for the fiscal year unless the Government has first provided Parliament with:

All of these reports, unedited, should be made public before or when they are given to Parliament.

(a) the reports described in Article 7.3(a) and (b);

(b) a report estimating the amount by which the estimated sustainable income for fiscal years commencing after the fiscal year for which the transfer is made will be reduced as a result of the transfer from the Petroleum Fund of an amount in excess of the estimated sustainable income of the fiscal year for which the transfer is made;

This report should also indicate the impact of exceeding the ESI on the total amount which can be withdrawn from the Fund, not only on the reduction of the ESI. If Parliamentarians realize that an excess transfer of $10 this year will cost Timor-Leste $44 over the next 50 years (assuming 3% annual Fund revenues), they might be more reluctant to do it.

(c) a report from the independent auditor certifying the estimates of the reduction in estimated sustainable income in paragraph (b); and

(d) a detailed explanation of why it is in the long-term interests of Timor-Leste to transfer from the Petroleum Fund an amount in excess of the estimated sustainable income.

This explanation should include whether or not withdrawals larger than the ESI are anticipated for each of the next few years, and why.

There should be a prohibition on exceeding the ESI level for more than two consecutive years.

7.5 Transfers from the Petroleum Fund are exceptionally permitted for purposes of refund of tax, in the event of overpayment of tax under Article 6.1(a). This amount represents a reduction of the Petroleum Fund receipts, and shall not be considered as part of the appropriation approved under Article 7.2.

Does this only apply to Supplemental Petroleum Tax? From our reading of the earlier draft of the Petroleum Tax Act and Model PSC, other tax overpayments are credited to the following year rather than refunded. This article should reference relevant articles of other acts.

Each tax refund should be timely and publicly reported as a negative receipt, including the date, amount, payee and reason for the transfer.

Chapter III – Investment and Protection Rules

Article 8: Management of the Petroleum Fund

8.1 The Government is responsible for the overall management of the Petroleum Fund. In the exercise of any management functions and competences entrusted thereto, the Minister shall be accountable before the Prime Minister, and they both shall be accountable before the Council of Ministers and before Parliament.

Every person listed in this article is responsible to obey all laws of RDTL (including this one), and subject to penalties if they do not.

Does this mean that each member of the Council of Ministers or Parliament could be sanctioned if the Minister or Prime Minister fails to manage the Petroleum Fund according to law?

8.2 The Minister shall not make any decisions in relation to the investment strategy or management of the Petroleum Fund without first seeking the advice of the Investment Advisory Board in accordance with Article 10.

See comments on Article 10.2, which propose deletion of the limitations in articles 10.2 and 10.3.

8.3 The Minister shall enter into an agreement with the Central Bank for the operational management of the Petroleum Fund and the Central Bank shall be responsible for the operational management of the Petroleum Fund.

Since this Act specifies that the Central Bank operates the petroleum Fund, why is such an agreement needed? What does it say that is not in this Act? In any event, the agreement should be public and subject to approval by the Council of Ministers and the Board of Governors of the Central Bank.

8.4 The Central Bank may propose to the Minister, either of its own motion or at the request of the Minister, the appointment of one or more investment managers to be responsible for managing the investment of amounts in the Petroleum Fund.

The appointment of investment managers should be public.

If they are to be paid from the assets or revenues of the Petroleum Fund, that must be included in the public announcement, auditor’s reports, and estimates of sustainable income.

8.5. The Central Bank may appoint an investment manager proposed under Article 8.4 only if the Minister is satisfied that:

(a) the investment manager is a legal person with sufficient equity capital and adequate guarantees and insurances against operational risks;

In addition to the characteristics listed in (a-c), investment managers should have familiarity and experience with ethical investing, as well as long-term asset management.

(b) the investment manager has a sound record of operational and financial performance; and

(c) the references and reputation of the investment manager in the field of fund management are of the highest standard.

They should have an excellent record of integrity and be committed to following Timor-Leste’s principle of the highest level of transparency, willing to forego any predilection they might have to keep information confidential.

8.6 The Government tendering procedures shall be followed for any appointment made pursuant to Article 8.5.

Is UNTAET Regulation 2000-10 the current law on public tender processes? This should be referenced specifically, as well as which articles of that law apply.

Will this require the appointment of the manager who proposes the lowest management fees? That is one factor, but the factors listed in 8.5, including additional ones we suggest, may be more important.

8.7 The Petroleum Fund shall be managed prudently in accordance with the principle of good governance for the benefit of current and future generations. The duty of the investment manager is to maximise the return on the Petroleum Fund investments having regard to appropriate risk as indicated by the investments permitted under Article 9, any subsidiary legislation under this Act, any instructions by the Minister and the management agreement referred to in Article 8.3.

The investment and management of the Petroleum Fund should include ethical guidelines, as in Norway. Maximizing the rate of return is important, but it should not be done at the costs of violating human rights, financing unsustainable development, or profiting from war or occupation.

The Fund should be invested according to socially responsible principles that should be included in this Act, and the investment managers should act according to those principles as well.

All instructions by the Minister referred to in this article should be public.

As discussed above, “for the benefit of current and future generations” is an inadequate standard.

8.8 The Central Bank shall present to the Minister quarterly reports on the performance and activities of the Petroleum Fund no later than twenty (20) days after the end of each quarter. The Central Bank shall provide for the publication of its reports in such form and manner as may be adapted for public information no later than forty (40) days after the end of the quarter. The Central Bank shall ensure that in releasing, or allowing access to, such reports measures are taken to prevent the disclosure of confidential information.

There should be specific requirements for the contents of such reports, including all income, expenditures, and investments made to, from and by the Fund during the reporting period, as well as other information. All management fees and commissions paid should also be reported.

Complete report must be published, in addition to any “adapted” versions.

No censorship of “confidential information.”

Article 9: Investment Rules

9.1 Amounts in the Petroleum Fund shall be invested only in qualifying instruments described in Article 9.2.

The Fund is strongly protected against risky investment, but not against unsafe spending. This seems incomplete; it is like locking a window while leaving the door wide open.

9.2 Subject to Article 9.3, a qualifying instrument is:

(a) a debt instrument denominated in United States Dollars that bears interest or a fixed amount equivalent to interest, that is:

This should not be restricted to U.S. currency, particularly since most of the goods purchased by the government of Timor-Leste come from countries which use other currencies. This may also be bad policy financially, as the dollar continues to fall.

(i)  rated Aa3 or higher by the Moody's rating agency or rated AA– or higher by Standard & Poor’s rating agency; and

(ii) issued by or guaranteed by the World Bank or by a sovereign State, other than Timor-Leste, provided the issuer or guarantor is rated Aa3 or higher by the Moody's rating agency or rated AA– or higher by Standard & Poor’s rating agency; or

(b) a United States Dollars deposit with, or a debt instrument denominated in United States Dollars that bears interest or a fixed amount equivalent to interest issued by:

(i)  the Bank for International Settlements;

(ii) the Federal Reserve Bank of the United States; or

This clause should be removed. It is redundant with 9.2(b)(iii), except that it makes the United States exempt from the credit rating requirement.

(iii) the Central Bank of a sovereign State, other than Timor-Leste, with a long-term foreign currency rating of Aa3 or higher by the Moody’s rating agency or AA– or higher by the Standard & Poor’s rating agency.

9.3 The investment manager shall dispose of an instrument if it ceases to be a qualifying instrument because of a change in the rating of the instrument or the issuer of the instrument within one month of the instrument ceasing to be a qualifying instrument.

Any such disposal should be publicly announced and included in the Public Register.

9.4 The average interest rate duration of Petroleum Fund qualifying instruments under Article 9.2 shall be less than six (6) years.

Longer-term, less liquid investments should comprise the majority of the Fund’s holdings. Not only does this encourage savings and planning for future generations, but it helps reduce brokers’ and currency exchange fees, making it more profitable to invest in a wider range of securities, including those not in U.S. dollars.

9.5 A derivative instrument that satisfies Article 9.2 is a qualifying instrument only if the financial exposure does not exceed the exposure that would have resulted from investing directly in the underlying instrument.

9.6 The range of instruments included as qualifying instruments in Article 9.2 shall be reviewed by the Minister at the end of the first five (5) years of the Petroleum Fund existence, having regard to the size of the Petroleum Fund.

This review and consequent recommendations should be made public. If it results in changing the qualifying instruments listed in 9.2, an act of Parliament would be required to amend this Act.

Proposed new Article 9½: Ethical Investment

Similar to Norway’s Ethical Guidelines, Timor-Leste’s Petroleum Fund should incorporate rules governing investment which incorporate ethical guidelines and avoid Timor-Leste supporting activities against our national interest or beliefs.

Since our Fund is to be invested outside Timor-Leste, it is part of our nation’s international relations. Section 8 of the RDTL Constitution says, inter alia, that international relations shall be governed “by the principles of national independence, the right of the Peoples to self-determination and independence, the permanent sovereignty of the peoples over their wealth and natural resources, the protection of human rights, … the peaceful settlement of conflicts, the general, simultaneous and controlled disarmament, … and establishment of a new international economic order capable of ensuring peace and justice in the relations among peoples.”

These principles are the basis for ethical rules for investment of the Fund. The Fund should explicitly seek to prevent negative outcomes associated with petroleum producing countries. It should therefore include rules regarding environmental protection, sustainable development and energy independence.

The investment managers should be instructed to comply with these rules, and the “watchdog” mechanisms of the Consultative Council and others could verify compliance.

Article 10: Investment Advisory Board

10.1 There is hereby established an Investment Advisory Board that is responsible for:

All the benchmarks, instructions, advice and recommendations from the Investment Advisory Board (IAB) (articles 10.1 and 10.2) should be made available to the Parliament, the Consultative Council and the public in a timely manner, preferably before the related decisions have been made. The documents should be released by the IAB directly, the Minister should not be responsible for publication (10.10) or able to interfere with this process.

If the IAB does not have unanimous agreement, majority and minority reports should both be published. All advice from the IAB to the Minister should be public, preferably before the Minister makes his decision.

(a) developing for the Minister performance benchmarks of desired returns from, and appropriate risks of, the investments of the Petroleum Fund;

(b) advising the Minister on the investment instructions that the Minister shall provide to the investment managers of the Petroleum Fund appointed pursuant to Article 8;

(c) advising the Minister on the performance of the investment manager or managers and making recommendations to the Minister on the appointment or removal of investment managers; and

(d) advising the Minister on the need for changes in the overall investment strategy or management of the Petroleum Fund, including the making of recommendations as to such changes.

This advice should also include compliance with sustainability rules, intergenerational equity and ethical investment guidelines.

Additionally, the Investment Advisory Board (IAB) should be authorized to, at its own initiative or in response to requests from the Parliament or the Consultative Council, prepare reports, advice and/or recommendations on any issue related to the investment of or withdrawals from the Fund.

10.2 Subject to Article 10.3, the Minister shall seek the advice of the Investment Advisory Board before making a decision on any matter relating to the investment strategy or management of the Petroleum Fund. If the Investment Advisory Board does not provide the advice requested in a timely manner, having regard to the nature of the advice sought, the Minister shall make the decision.

Petroleum Fund assets are so important to the future of the people of Timor-Leste that they should never be invested or managed hastily. The exceptions from following or seeking IAB advice described in articles 10.2 and 10.3 should be deleted, restoring the spirit of 8.2 which involves the IAB in all investment strategy and management decisions.

If our recommendation in the previous paragraph is rejected, at minimum there need to be definitions of “timely” and a requirement that the Minister act in a timely manner to request the IAB’s advice.

10.3 If, having regard to the nature of the decision, there is insufficient time to seek the advice of the Investment Advisory Board in relation to a particular decision, the Minister shall make a decision without first seeking the advice of the Investment Advisory Board.

Delete this paragraph.

10.4 If the Minister makes a decision under Article 10.2 or 10.3, the Minister shall immediately report the making of the decision to the Investment Advisory Board. The Minister shall reexamine the decision having regard to any subsequent advice provided by the Investment Advisory Board.

If the Minister makes a decision without IAB advice or at variance with the advice from the IAB, the Minister must report to the IAB, Parliament and the public explaining the reasons for his action.

10.5 Any advice given by the Investment Advisory Board on investment strategy or management of the Petroleum Fund shall take into account:

(a) the overall objective that the Petroleum Fund be a fund of income from the exploitation of non-renewable petroleum resources for the benefit of current and future generations;

As discussed above, “for the benefit of current and future generations” is an inadequate standard.

(b) the current conditions, opportunities and constraints in investment markets, and the constraints under which the Central Bank and other key institutions in Timor-Leste operate; and

(c) the need to ensure that sufficient amounts are available when needed for transfers referred to in Article 7.

10.6 The members of the Investment Advisory Board shall be:

The first two members of the Board have an inherent conflict of interest between providing objective advice and justifying their own actions as officials responsible for managing the Fund.

The appointments in (c) and (d) need to be people with no personal interests related to investment or other activities of the Fund. This Article should contain language or a reference to another statute prohibiting appointment of people with actual, apparent or potential conflicts of interest.

(a) the Director of Treasury;

(b) the Head of the Central Bank;

(c) two persons appointed by the Minister with significant experience in investment management; and

Experienced people like these can make mistakes. The IAB needs people with a broader perspective, including ethical investment, inter-generational equity and management of publicly owned assets.

(d) one other person appointed by the Minister.

The IAB should include at least two people appointed by someone other than the Minister, given that the Minister also directly or indirectly appoints all other members. This is essential to ensure independent, objective advice.

10.7 The Central Bank shall provide the secretariat for the Investment Advisory Board and any support required by the board to carry out its functions.

10.8 The Minister shall provide, in accordance with Timor-Leste law:

Everything the Minister does must be in accordance with Timor-Leste law. Which law is specifically intended to apply here?

(a) a person to sit on the secretariat of the Investment Advisory Board; and

(b) appropriate remuneration for the members of the Investment Advisory Board appointed under Article 10.6(c) and 10.6(d).

10.9 The Investment Advisory Board shall determine the rules of procedure under which it operates.

Transparency and accountability, and avoidance of conflicts of interest, are mandatory.

10.10 When required by Parliament, the Government shall provide Parliament with all advices given thereto by the Investment Advisory Board. The Minister shall ensure that in releasing, or allowing access to, advices given thereto, measures are taken to prevent the disclosure of confidential information.

All advice given by the IAB to the Government should be automatically given to Parliament, without waiting for a requirement. It should also be released to the public. There is no “confidential information” to censor, so the last sentence should be removed.

Article 11: No Encumbrances on the Assets of the Petroleum Fund

Borrowing by petroleum-producing countries is one of the most common paths to financial ruin, and we support the intent of this article.

11.1 Any amount that is invested pursuant to Article 9 shall, at all times, remain the property of Timor-Leste.

11.2 Any contract, agreement or arrangement, to the extent that it purports to encumber the assets of the Petroleum Fund, whether by way of guarantee, security, mortgage or any other form of encumbrance, is null and void.

To make this article more effective, Fund assets must also be prohibited from be used for payments for debt service. The automatic use of the Petroleum Fund to fill annual budget deficits ensures that any level of government expenditure will be covered by the Fund, so the Fund becomes de facto collateral: if money is borrowed, debt payments are guaranteed by the Fund.

Perhaps there’s a way to adjust the ESI to take debt into account, such that the amount which could be withdrawn sustainably from the Fund each year is reduced to account for payments which must be made on debt. Article 14.2(h) helps make this more visible, but there also need to be mechanisms to discourage borrowing.

Chapter IV – Supervision of the Petroleum Fund

Article 12: Maintenance of Petroleum Fund Accounts and Records

12.1 The Director of Treasury is responsible for maintaining the Petroleum Fund accounts and records in accordance with the International Accounting Standards in force, to reflect the operations and financial condition of the Petroleum Fund.

Define “International Accounting Standards.” These are evolving (see http://www.iasplus.com/standard/standard.htm ) and some have been replaced by IFRS. Should refer to a specific document or standards agency.

12.2 The Director of Treasury shall submit to the Minister quarterly management information reports and analyses on the performance and activities of the Petroleum Fund no later than twenty (20) days after the end of each quarter.

These reports should go promptly to Parliament and the public by inclusion in the Public Register (see Article 18 below).

12.3 The Director of Treasury is responsible for reporting on the performance and activities of the Petroleum Fund for the purpose of the annual financial statements of Timor-Leste.

These reports should go promptly to Parliament and the public by inclusion in the Public Register (see Article 18 below).

Article 13: Internal Audit

The accounts, records, and financial statements of the Petroleum Fund shall be audited every six months by the Government bodies responsible for the internal audit of the concerned Government departments.

The audit reports should go promptly to Parliament and the public by inclusion in the Public Register (see Article 18 below).

Article 14: Annual Report

14.1 The Minister/Government shall submit an Annual Report for the Petroleum Fund for a fiscal year to Parliament, at the same time as the annual financial statements of that year are submitted to Parliament.

14.2. The Annual Report for the Petroleum Fund shall be prepared in a manner that makes it readily adaptable for public information, and shall contain the following information for the fiscal year for which the Report is prepared:

The unedited, complete Annual Report and subsidiary documents should be public, in addition to any version adapted for public information, included in the Public Register. This is the primary report of Fund activities, so special efforts should be taken to make it easily accessible to the public.

The information spelled out in this article is a minimum standard; the Annual Report should contain additional information which the Ministry, Central Bank, IAB or CC believes is helpful in increasing the public’s awareness, participation and sense of ownership of the Fund.

In article 18½, we have listed reports and documents which should be included in a Public Register. Many of these, or at least summaries of them, should also be in the Annual Report. However, the Public Register will be more timely, enabling public participation in decisions before they are made, not just the ability to lock the barn door after the horse has escaped.

(a) audited financial statements conducted by the independent auditor, comprising:

If the independent auditor is unwilling to sign off the audit, or includes any qualifications, then the Annual Report should disclose the auditor’s objections and what is being done to resolve them.

(i)   an income and expenditure statement;

(ii)  a balance sheet, including a note listing the qualifying instruments of the Petroleum Fund;

This should include each of the Fund’s holdings, in a form similar to the Annual Report of the Norwegian Petroleum Fund.

(iii) details of all appropriations and transfers from the Petroleum Fund; and

Also details of all deposits into the Fund (see Article 6)

(iv) notes to the financial statements, as appropriate;

(b) a report signed by the Minister describing the activities of the Petroleum Fund in the year, including all advice provided by the Investment Advisory Board, any reports prepared by the independent auditor under Article 20 and drawing attention to particular issues or matters that may be of concern or interest to Parliament;

(c) a statement by the Treasurer drawing attention to any accounting issues or practices arising from the Report that may materially affect the interpretation of amounts or activities shown within it;

(d) the income derived from the investment of Petroleum Fund assets during the fiscal year compared with the income of the previous three fiscal years;

(e) a comparison of the nominal income realized on the investment of Petroleum Fund assets with the real return after adjusting for inflation;

(f) a comparison of the income derived from the investment of Petroleum Fund assets with the benchmark performance indices provided to the Minister pursuant to Article 10.1;

(g) a comparison of the estimated sustainable income for the fiscal year with the sum of transfers from the Petroleum Fund for the year;

Include projections of ESI for future years, as well as details of the underlying assumptions and data for its calculation (see comment on Schedule I).

(h) in the event of Government borrowings, the liabilities shall be reflected in the presentation of Petroleum Fund accounts so as to give a true representation of the past and expected future development of the Government’s net financial assets and rate of savings; and

(i) a list of persons holding positions relevant for the operation and performance of the Petroleum Fund, including:

(i)   the Minister;

(ii)  the Director of Treasury;

(iii) the members of the Investment Advisory Board;

(iv) the investment manager or managers;

(v)  the Head of the Central Bank; and

(vi) the members of the Petroleum Fund Consultative Council.

Also the auditor

Chapter V – Petroleum Fund Consultative Council

Article 15: Petroleum Fund Consultative Council

15.1 There is hereby established a Petroleum Fund Consultative Council.

The Petroleum Fund Consultative Council (CC) is described as a “watchdog,” buts its powers are severely limited.

The CC should be mandated to publish its own reports and its advice to Parliament in a timely manner and to communicate directly with the public, the media or any other person or organization.

A watchdog is not a guard dog. A watchdog serves only to sound an alarm – there needs to be a higher power which will respond to the alarm.

The CC should be able to seek the advice of the Provedor or other agencies concerned with oversight of public finances, and to share its findings with these agencies.

If the CC finds a discrepancy or believes the law is not being followed, it must, on its own initiative without the intervention of the Minister or Parliament, refer the matter and all relevant information in its possession to the Provedor or General Prosecutor.

15.2 The Petroleum Fund Consultative Council shall:

All such advice should be promptly public.

(a) advise Parliament on matters relating to the performance and operation of the Petroleum Fund;

(b) advise Parliament on appropriations from the Petroleum Fund as set out in Article 17.2; and

(c) in the context of the budgetary process, advise Parliament on whether the appropriations of the Petroleum Fund are being used effectively to the benefit of current and future generations.

As discussed above, “the benefit of current and future generations” is an inadequate standard.

Article 16: Composition

16.1 The Petroleum Fund Consultative Council shall comprise the following members, who are to be appointed in accordance with procedures laid down by Parliament:

(a) former Presidents of the Republic who were not removed from office;

(b) former Speakers of the Parliament who have effectively been in office for at least three (3) years;

(c) former Prime Ministers who have effectively been in office for at least three (3) years;

(d) former Ministers in charge of finances who have effectively been in office for at least three (3) years;

(e) former Heads of the Central Bank who have effectively been in office for at least three (3) years;

(f) a member appointed by the President of the Republic;

(g) a member appointed by Parliament;

(h) a member appointed by the Government;

(i) a member appointed to represent civil society non-profit organisations;

The representatives of civil society, business sector and religious organizations should be chosen by the society, business and religious organizations, not by Government or Parliament. Although this may be more complicated, it is essential if the CC is to be a credible, independent “watchdog” on the Ministry and the Central Bank.

(j) a member appointed to represent the private business sector; and

(k) a member appointed to represent religious organisations.

We suggest augmenting the representatives of civil society to include one or more NGO representatives, representatives of popular organization, youth representatives (since the purpose of the Fund is to provide for future generations, and the inclusion of many former holders of high office will heavily weight this council toward older people), people living in the districts outside Dili, and members of opposition political parties.

16.2 The members of the Petroleum Fund Consultative Council referred to in paragraphs (a), (b) and (c) of Article 16.1 are appointed from the end of their term in office for a period of ten (10) years. These members are not eligible for reappointment.

The first several seats will be vacant at least until after the 2007 election. If the government is stable, the CC could be very small.

16.3 The members of the Petroleum Fund Consultative Council referred to in paragraphs (d) and (e) of Article 16.1 are appointed from the end of their term in office for a period of five (5) years. These members are not eligible for reappointment.

16.4 The members of the Petroleum Fund Consultative Council referred to in paragraphs (f), (g), (h), (i), (j) and (k) of Article 16.1 are appointed for a period of three (3) years. These members are eligible for reappointment for a second term.

16.5 The members of the Petroleum Fund Consultative Council referred to in paragraphs (i), (j) and (k) of Article 16.1 shall be appointed according to procedures laid down by Parliament.

This is redundant with Article 16.1, which says that all CC members are appointed according to procedures laid down by Parliament. In the spirit of transparency, these procedures should be public and specified in this Act.

16.6 Subject to approval by Parliament, the Petroleum Fund Consultative Council may select and appoint as its international adviser for economic and financial matters, for a period of two (2) years, an academic or professional of the highest reputation and competence.

The CC should be able to have more than one international advisor, providing access to expertise and experience related to helping petroleum-dependent countries manage revenues to avoid negative long-term consequences. The CC should also be free to seek or accept advice from anyone it chooses. Any such advisors should be publicly disclosed.

16.7 A person shall not be appointed as a member of the Petroleum Fund Consultative Council if the person:

(a) has been declared bankrupt or insolvent; or

(b) has been convicted of a criminal offence.

Or has a conflict of interest, with reference to specific definition in other legislation.

16.8 Members of the Petroleum Fund Consultative Council have security of tenure and, unless otherwise provided for by law, may not be suspended, retired or removed from office.

16.9 The appointment of a member of the Petroleum Fund Consultative Council ceases if the member:

(a) is declared bankrupt or insolvent;

(b) is convicted of a criminal offence; or

(c) is unfit for office.

Define “unfit for office.”

A CC member should be permitted to refuse appointment or to resign for personal reasons.

A conflict of interest should also be grounds for removing someone.

[16.10 Until such time as specific procedures for the removal of a member under paragraph (c) of Article 16.9 are established by law, the procedures applicable for the removal of judges shall apply.]

Article 17: Working Principles and Powers of the Petroleum Fund Consultative Council

17.1 In conducting its activities, the Petroleum Fund Consultative Council shall take into account:

1. the overall objective that the Petroleum Fund be a fund of income from the exploitation of non-renewable petroleum resources for the benefit of current and future generations; and

As discussed above, “the benefit of current and future generations” is an inadequate standard.

2. the principles for the operation of the Petroleum Fund as outlined in this present Act.

17.2 When:

(a) the Government introduces legislation to Parliament to appropriate an amount from the Petroleum Fund, and

Is this separate legislation (as we suggest) or part of the budget (as the Act appears to say)?

(b) the amount the legislation would appropriate in the fiscal year is greater than the estimated sustainable income of the Petroleum Fund for the fiscal year,

The CC should submit an opinion even if the proposed transfer is at or below the ESI. It is for the benefit of Timor-Leste to keep withdrawals from the Fund as low as possible, even below the ESI, if the money is not needed in a given year. The CC can evaluate whether it believes the entire ESI amount can be spend effectively in a given year.

the Petroleum Fund Consultative Council shall submit, in a timely manner, an opinion to the Parliament on the Government’s proposed appropriation. If the Petroleum Fund Consultative Council does not provide its opinion in a timely manner, Parliament shall make the decision.

What is “timely”? When will the CC be notified of proposed withdrawal amount?

17.3 Parliament shall provide for the publication of the advices of the Petroleum Fund Consultative Council, including minority opinions, in such form and manner as may be adapted for public information. Parliament shall ensure that in releasing, or allowing access to, advices of the Petroleum Fund Consultative Council measures are taken to prevent the disclosure of confidential information.

The Council’s advice should automatically be published in full (in addition to any adapted version), when it is given to Parliament, to avoid possible political interference.

Parliament should make public if it followed the CC’s advice, and if not, there should be a clear explanation of why.

No censorship of “confidential information.”

17.4 For purposes of advising Parliament, the Petroleum Fund Consultative Council shall consult widely in the community and, to this end, shall hold an annual forum on issues relating to the Petroleum Fund.

This specifies a minimum level of public consultation for the CC. The CC should be able to, on its own or at the request of a member of Parliament, hold additional fora or provide information to the public. The CC’s purpose in this is not only to advise Parliament, but to help ensure continuing public buy-in of the Fund, and to seek public views on how the Fund should be invested, managed and spent, as well as information about any possible mismanagement or corruption.

17.5 The Petroleum Fund Consultative Council shall determine the rules of procedure under which it will operate.

Within principles of transparency, accountability, etc.

17.6 Parliament shall provide adequate funding for the operations of the Petroleum Fund Consultative Council, including appropriate remuneration for members of the Petroleum Fund Consultative Council, through the budgetary appropriation for the operation of Parliament.

Is there staff or a secretariat for the CC? How is it established?

17.7 The Minister and/or the Head of the Central Bank shall furnish the Petroleum Fund Consultative Council with information it requests on any aspect of the operation or performance of the Petroleum Fund for the purpose of its monitoring of the Petroleum Fund. The Petroleum Fund Consultative Council shall ensure that measures are taken to prevent the disclosure of confidential information.

The Council should have access to all information it deems necessary for its work from the Ministry of Finance, the Central Bank, investment manager, IAB, Petroleum Ministry, TSDA, National Oil Company and international petroleum companies.

The Council should review not only the legality of Fund operations, but also the wisdom of operational decisions. If Fund managers fail in their duty of transparency, the Council should give information to the media and the public about Fund balances, inflows, expenditures, and interest.

No censorship of “confidential information.”

Chapter VI – Transparency

Article 18: Transparency as a Fundamental Principle

18.1 The management of the Petroleum Fund shall always be carried out, and the related duties of all relevant parties shall be discharged, with the highest standard of transparency. Unless it is demonstrated that certain information should be treated as confidential, it shall be deemed susceptible of public release.

A “highest standard” doesn’t allow any discretion – everything is transparent. We hope this will be implemented fully, with no censorship of “confidential information.”

18.2 In the exercise of its functions and competences, and as provided for in this present Act, Parliament, the Government, the Minister, Central Bank, Investment Advisory Board and the Petroleum Fund Consultative Council shall take all necessary measures to ensure transparency mechanisms and free access to public information.

Add investment managers to this list.

18.3 The Minister shall ensure that this present Act, any subsidiary legislation made thereunder, any instructions relating to the Petroleum Fund, the management agreement referred to in Article 8.3 and the reports referred to in Article 7.3 and 7.4 are readily available to the public.

Add “in a timely manner.”

Many of these documents should be made public directly by their authors, without intervention by the Minister.

Proposed new Article 18½: Public Register

Because of the large number of public documents and information associated with the Petroleum Fund and the multiplicity of institutions which produce these materials, we suggest that a Public Register be established for information relating to the Petroleum Fund.

Since the principal purpose of this Register is transparency, those managing it should be protected from political or personal pressure. The Public Register should not reside in the Finance Ministry or the Central Bank.

At a minimum, the Public Register should include the following in a timely manner, uncensored:

• Information on the opening balance (Article 6.2) of the Fund, and how that revenue was received, from whom, and for what.

• The proposed State Budget (Article 7.3) as soon as it is approved by the Council of Ministers.

• Reports from the Government and auditor to Parliament regarding transfers (Articles 7.3 and 7.4), published at the same time they are given to Parliament. These reports should explain the underlying assumptions and calculations of the estimated sustainable income.

• Information on any refunds of tax (Article 7.5).

• The Agreement between the Minister and the Central Bank about Fund management (Article 8.3).

• Appointments of and contracts with investment managers (8.4)

• Instructions from the Minister to the Manager (8.7)

• Quarterly reports from the Central Bank to the Minister (8.8)

• A list of all investments made, sold, or disposed (9.2, 9.3)

• The Minister’s review of the qualifications of investment instruments (9.6)

• Performance benchmarks from the IAB (10.1(a))

• Advice from the IAB to the Minister on various topics (10.1(b,c,d), 10.2, 10.3, 10.10)

• Decisions by the Minister, plus an explanation if IAB advice was not followed (10.2, 10.3, 10.4)

• Quarterly management reports by the Director of the Treasury (12.2)

• Annual financial reports by the Director of the Treasury (12.3)

•  Results of internal audits (13)

• Annual Reports and Annual Financial Statements (14), including all the items enumerated in 14.2

• Advice from the CC to the Parliament (15.2(a), (b), (c))

• Procedures for appointing some CC members (16.5)

• Qualifications and appointment of CC advisors (16.6)

• CC analysis and opinion on Fund appropriations (17.2), including minority opinions (17.3)

• Notices, submissions and reports from the CC annual public form and consultations (17.4)

• CC rules of procedure (17.5)

• Auditor’s report listing each payment made into the Fund (20.1 as amended)

• Auditor’s referral of discrepancies (20.4) and report (20.5)

• Regulations to carry out the provisions of this act (24)

• Details and assumptions underlying the calculation of estimated sustainable income (Schedule 1)

Article 19: Payments into the Petroleum Fund Account

For all purposes of Timor-Leste law, a payment made as a Petroleum Fund receipt shall not be treated as paid unless it has been deposited, fully and effectively, in the Petroleum Fund earmarked receipts account.

Article 20: Payments made as Petroleum Fund Receipts

20.1 The independent auditor shall prepare a report for the Minister of all payments made as Petroleum Fund receipts for each fiscal year.

The Auditor’s report should be made public in full in a timely manner.

In addition to each receipt, the auditor’s report should include all transfers and debits from the Fund, including transfers to the State Budget, management and brokers expenses and commissions (6.1(c)), tax refunds (7.5), legal fees, settlements, payments, etc. A separate section of the report should detail costs related to the Petroleum Fund -- the auditor, IAB, CC, Central Bank management costs, etc.

In addition to the information the auditor receives from the Central Bank and the Ministry, the Auditor must have access to information from the oil companies about all payments they have make to Timor-Leste. Without this, it will be impossible for the auditor to verify that the reported receipts are correct. (See narrative part of this submission.)

20.2 The independent auditor’s report shall state the aggregate amounts of payments made as Petroleum Fund receipts for each payer for the fiscal year.

The report should not be an aggregate, but each individual receipt. Should also explain what the payment was for (FTP, tax, etc.), for what project, how much oil was produced, what costs were recovered, etc. All of this is required by the PSC, but should be reported by the auditor.

In addition, the companies should be required to make public reports of ALL payments.

There must be no “commercial in confidence” exceptions.

20.3 If there are reasonable grounds for the independent auditor to believe that there is a discrepancy between the Petroleum Fund receipts and the payments made as Petroleum Fund receipts, the independent auditor may require any payer to provide any information and to make proof of facts necessary for the clarification of such discrepancy.

The CC, General Prosecutor and Provedor should also be able to demand this information. It should not only be triggered by a discrepancy between receipts and payments, but by any apparent irregularity, including management of investments and calculation of the estimated sustainable income from the Fund.

The Petroleum Act and Production Sharing Contracts also need to specify that every payer must cooperate with the auditor, CC, General Prosecutor and Provedor’s requests for information.

20.4 If the independent auditor concludes that there is a discrepancy that cannot be accounted for, the independent auditor shall refer the matter to the Minister. In referring the matter to the Minister, the independent auditor shall provide all information that the independent auditor possesses regarding the discrepancy in question.

If the auditor has any suspicion that the Minister or his subordinates or superiors are involved in an irregularity or discrepancy, he should inform the Minister and Consultative Council, while referring the matter to the Provedor or the General Prosecutor. The Auditor should consult with the IAB, CC or any other relevant official in attempting to ascertain the causes of a discrepancy.

If such a referral is made, it must be announced publicly.

20.5 The Minister shall provide for the publication of the independent auditor’s report in such form and manner as may be adapted for public information. The independent auditor shall ensure that in preparing the report measures are taken to prevent the disclosure of confidential information.

No censorship of “confidential information.”

The auditor’s report should be published in full, within a specified time, regardless of actions by the Minister, and in addition to any “adapted” versions.

Chapter VII – Penalties

Article 21-A: Scope

The provisions included in this Chapter are without prejudice of criminal and civil liability under general law.

The IAB, Independent Auditor, CC, and/or Parliament should be able to refer any evidence or suspicion of violation of the law, including of this Act, to the Provedor and/or General Prosecutor for further investigation and possible judicial sanction.

Article 21-B to “n”:

[To be drafted at a later stage, taking into account the developments in the general penal regime which are expected to take place in the near future.]

If this Act is to be in effect by July 2005, penalties need to be specified here. Other laws already passed contain specific penalties; they could be included here on a transitional basis.

Chapter VIII – Transitional and Final Provisions

Article 22: Appointment of Investment Managers

The requirement of Article 8.6 enters into force six (6) months after the date of entry into force of this present Act, and shall apply to all appointments of investment managers made thereafter. Any appointment of investment managers made during the six (6) months after the date of entry into force of this present Act shall lapse after the five (5) year period referred to in Article 9.6.

According to slide 17 of the presentation by José Teixeira at the public consultation on this Act on 14 February 2005, “investment management will from start be outsourced (to the US central bank).” If this is true, the appointment was made before the six-month period specified in this article. If it is reaffirmed after this Act enters into force, it should not last for five more years.

Since an extralegal transitional appointment has apparently already been made, we propose that this article be amended to reflect actual practice, and that the transitional appointment expire one year after this Act enters into force, at which time new or the same investment managers would be appointed according to the procedures in Article 8.

Article 23: Independent Auditor

Once the hierarchy of the administrative, tax and audit courts is established, and without prejudice of the powers and competences of such courts, there shall be appointed an independent auditor, which will be an internationally recognized accounting firm selected by the Government.

The CC should be responsible for recommending the auditor. If the auditor is selected by the Government alone, it will not be independent. The appointment should also be approved by Parliament.

This article appears to say that no auditor can be appointed until the tax and audit courts have been established. There needs to be a transitional provision so that the auditor is functional in time to certify the estimated sustainable income (article 7.3(c)) prior to the first budget which includes a transfer out of the Petroleum Fund, or in time to prepare the first Annual Report (article 14), whichever comes first.

Article 24: Subsidiary Laws and Regulations

The Government and the Minister may make regulations for the effective carrying out of the provisions of this present Act including regulations of a transitional nature consequent upon the making of this present Act.

Need a public rule-making process, with a chance for Parliament to be informed. All regulations should be included in the Annual Report and the Public Register.

Article 25: Entry into force and application

25.1 This present Act enters into force on the day following its publication in the Jornal da República.

25.2 This present Act applies to fiscal years commencing on or after 1 July 2005.

This is a very short time in which to make transitional and other regulations, appoint various people, and develop an investment strategy.

Schedule 1: Calculating estimated sustainable income for a fiscal year

I. Estimated sustainable income for a fiscal year is the maximum amount that can be appropriated from the Petroleum Fund in that fiscal year and leave sufficient resources in the Petroleum Fund for an amount of the equal real value to be appropriated in all later fiscal years as determined in accordance with the formula in paragraph II below. The amount determined in accordance with the formula in paragraph II below shall be certified by the independent auditor.

The validity and accuracy of the estimated sustainable income (ESI) projection is crucial to protecting the long-term interests of Timor-Leste. Yet this estimate is derived from incomplete data, and attempts to anticipate financial and petroleum market developments for the indefinite future.

Recent projections (see narrative submission) show that Timor-Leste’s population will grow rapidly over the next two generations. Even if the ESI is accurate and obeyed, the income from the Petroleum Fund for each Timor-Leste citizen each year will drop 71% by 2050.

Although the auditor certifies this estimate (and his certification should include Paragraph III as well as II below), it is unclear who calculates the estimate and determines the underlying assumptions which will define the input data.

II. Estimated sustainable income for a fiscal year is calculated according to the following formula:

r × petroleum wealth

where:

r   is the estimated average real rate of return, or real interest rate, on Petroleum Fund investments in the future and, at the commencement of this present Act, is 3.0%.

It’s misleading to give a complex formula which implies certainty, but which is based on very uncertain raw data.

How and when is r to be re-estimated in the future? Is it always the rate of return on the Petroleum Fund for the previous year, or does it involve averages and/or projections? Does it consider exchange rate variations between the U.S. dollar and other currencies?

III. In this Schedule, “petroleum wealth” is calculated according to the following formula:

where:

V  is the estimated value of the Petroleum Fund at the end of the prior fiscal year

R1,R2, etc. are the published budget projections for expected annual Petroleum Fund receipts for that fiscal year (R1) and future fiscal years (R2,etc.)

i    is the estimated nominal yield on a U.S. government security, averaged over the years in which Petroleum Fund receipts are expected

n   is the number of years until no further Petroleum Fund receipts are projected to be received.

Timor-Leste has experienced large swings in anticipated and actual government oil revenue while preparing our budget over the last three years. Those projections go only five years into the future, for a single field whose ownership, production and taxation are already defined. The Government relied on projections by ConocoPhillips which turned out to be wrong in both timetable and amounts, leading to swelling and shrinking of projections of Timor-Leste’s “financial gap.”

Estimating for many fields over decades will be far less exact. Will the Government rely on petroleum companies for this information, in which case there will be no data for fields not yet under Production Sharing Contracts, or will an agency of the Timor-Leste government make this estimate, considering the nation’s entire potential petroleum wealth?

The interest rate (i) should not be averaged over all years, but projected for each individual year.

To be certifiable by the independent auditor, this estimate must include:

1.    Which petroleum fields and reserves are included, estimated extractable petroleum from each reserve, and at what Proved/Probable/Possible levels.

2.    Statements of projected selling prices for oil and gas for each year.

3.    Statement of when extraction from each field is to commence, and what the amount of production and expenditure for cost recovery will be for each year the field is in production.

4.    Projections of when and if each field will recoup its investment, with consequent increase in “profit oil” tax receipts.

5.    For fields whose revenue is shared with Australia, including the JPDA and potentially unified Greater Sunrise, statements of what portion of revenues Timor-Leste will receive.

6.    Anticipated settlement of maritime boundaries with Australia, including any payments from Australia to Timor-Leste as part of this settlement.

7.    Projections for downstream revenues and incomes from a Timor-Leste National Oil Company.

8.    Anticipated rates of return from Petroleum Fund investments.

9.    Anticipated withdrawals above or below the ESI in the near future.

10. Anticipated rates of inflation.

Each of these assumptions must be enumerated and explained in a public document, certified by the independent auditor, which is revised at least annually.

Approved in Council of Ministers, on …… ………  2005

The Prime Minister

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Mari Alkatiri

The Minister of Planning and Finance

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Madalena Boavida