eSelection 81873 Armenian Dairy Development Impact Bond Terms of Reference

1. Background The European Bank for Reconstruction and Development (“EBRD” or the “Bank”) and the United Nations Development Programme (“UNDP”) are partnering to structure a pilot development impact bond in Armenia (the “Project”). A development or social impact bond is an innovative financing tool that applies a private sector’s mind-set to the commissioning of certain services. Investors typically fund the delivery of such services and get repaid together with a financial return by an outcome funder (typically a government or a donor) upon successfully delivering the services and achieving pre-defined outcomes. The services are typically implemented by social sector organisations which investors support with working capital and management resource to achieve the best outcomes. The Project aims to tackle one of the key social challenges facing Armenia especially in its remoter regions namely the low productivity in the agriculture sector, and particularly in the dairy sector. This challenge has a particularly negative impact on the populations which are subsisting on small dairy farms and contributes to their poverty. The Project was initiated based on a feasibility study conducted by UNDP which explains why an impact bond structure is appropriate to tackle such challenge and outlines a possible intervention model. In this context, EBRD is seeking to engage a consultant (the “Consultant”) to get the Project to an ‘investment ready’ stage. This is expected to be achieved through two main steps: (i) reviewing UNDP’s feasibility study to validate the “impact bond case” and identify any potential gaps that need further work prior to structuring the Project; and (ii) preparing an investment proposal which will require amongst others to finalise the Project’s intervention model and identify the parties which will implement the Project (e.g. the service providers, the impact bond manager team, etc.) (all together, “the Assignment”). Please refer to Annex 1 for UNDP’s feasibility study. During the Assignment, UNDP will be responsible for coordination of works related to securing the outcome funds from donors. Such outcome funds will repay investors alongside a financial return upon the successful delivery of the Project and achieving pre-agreed results. It is expected that once completed, the Project would be replicated and scaled up to cover others regions of Armenia with outcome funds being provided amongst others by the Government of Armenia.

About European Bank for Reconstruction and Development  Background - EBRD is an international financial institution established in 1991 with the purpose to facilitate transition towards well-functioning and sustainable market systems in more than 30 countries. EBRD invests in projects (through debt and equity) where it expects to earn a market- based return (sound banking), where it does not crowd out private sources of financing (additionality) and where it expects to have a measurable impact (transition).  EBRD and impact bonds - Development and social impact bonds are a new financing instrument for EBRD. In 2018, the Bank’s Board of Directors approved for the first time a pilot investment of up to USD 500,000 in favour of a development impact bond designed to address the issue of youth unemployment in the West Bank & Gaza. With the support of the Slovak Republic through the EBRD-Slovak Republic Cooperation Agreement, the Bank is planning to support the structuring of a development impact bond in Armenia on the back of the UNDP’s feasibility study prepared by UNDP. About United Nations Development Programme (“UNDP”)  Background - UNDP works in around 170 countries. Its mains purpose is to help achieve the eradication of poverty, and the reduction of inequalities. UNDP helps countries to develop policies, leadership skills, partnering abilities, institutional capabilities and build resilience in order to sustain development results.  UNDP and impact bonds - UNDP has recently partnered with the Finnish Innovation Fund Sitra to support the development of impact bonds and results-based financing mechanisms in Europe and CIS. These efforts have led to the design of six potential impact bonds, including the Project.

2. Objectives of the Assignment The main objective of the Assignment is to lead the Project by leveraging UNDP’s feasibility study and ensuring that it is (i) based on sound fundamentals (e.g. validate the impact bond thesis and establish a baseline); (ii) well designed (e,g, clear cohort, viable intervention model, strong service providers identified, clearly defined and measurable target results, etc.); and (iii) ready to be marketed to private investors and subsequently launched (e.g. project structure, investment report, etc.).

3. Scope of work The Consultant’s tasks and responsibilities shall encompass, but will not be limited to, the following:

1. Review and analysis of UNDP’s feasibility study • Reviewing the proposal and assessing how it fits in the Armenian agribusiness contexts • Commenting on the rationale of the proposal including amongst others the theory of change underlying the Project, the impact thesis and the investment thesis • Commenting on the substance of UNDP’s feasibility study including amongst others the overall Project structure, the proposed intervention model, the proposed target volumes and success rates • Completing a cost/benefit or benchmarking analysis (vs. other projects implemented to tackle the same challenge) to assess a baseline against which the Project’s targets can be compared • Providing conclusive feedback on UNDP’s feasibility study and outlining any potential gaps that may need further work prior to Phase 2 below.

2. Preparing the investment proposal • Finalising the Project’s intervention model • Identifying a pipeline of potential service providers in charge of implementing the Project • Proposing the structure of the team that will act as the Project’s manager during its implementation phase (the “Project’s Management Team”) • Identifying potential candidates for the key members of the Project’s Management Team • Proposing the corporate governance for the Project • Finalising the outcome metrics and proposing outcome payment model (e.g. based on rate card or other methods as appropriate) • Preparing the Project’s financial model and proposed scenario analysis • Proposing a verification methodology to ensure that the Project’s results are effectively achieved and in compliance with the criteria associated with such results • Preparing an investment report • Propose a list of potential investors

The Consultant shall collaborate with UNDP throughout the Assignment as follows: • UNDP will provide relevant documents and information to support the Assignment • The Consultant will be able to leverage UNDP’s local network of contacts and sectorial expertise • The Consultant will share relevant analysis with UNDP as required • The Consultant will ensure the proposed interventions comply with UNDP and EBRD Environmental and Social policies, particularly with regard to animal welfare, use of antibiotics and biosafety

4. Implementation Arrangements

The Consultant shall report to the SME Finance and Development team (the “EBRD Team”). The EBRD Team is responsible for setting the deliverables for the Consultant, as well as ensuring the implementation of the deliverables by the Consultant. The Consultant will maintain an ongoing communication with the EBRD Team throughout the Assignment. Deliverables will be considered as final only once approved by EBRD as being of an adequate quality. If certain conditions change beyond the control of the Consultant which impact preparation of the deliverables, deadlines may be reconsidered by EBRD. The Consultant is expected to remain in regular contact with the Project Team and provide a monthly update on activities related to the Assignment. Such updates will take place as conference calls or in person, depending on required arrangements. UNDP will be invited to attend such update meetings as observer.

Annex 1

Armenia Dairy Impact Bond Feasibility Report Table of Contents

Executive Summary ------1 1. CONTEXT ------2 1.1. Situational Analysis ------2 1.2. The Social Challenge ------2 1.3. Evidence and Types of Intervention – Theory of Change ------3 1.4. Linking the SIB to the SDGs ------4 2. SELECTION CRITERIA------6 2.1. Identifying the geographical area ------6 2.2. Identifying the cohort------7 2.3. Identifying Service Provider(s) ------8 3. OUTCOME METRICS, MEASUREMENT AND DATA SOURCES------9 3.1. Metrics ------9 3.2. Financial model ------13 3.3. Risk Scenarios ------145 Annex 1: The Legal Roadmap ------18 Annex 2: Examples of dairy factories in Shirak Marz------29

Acronyms

EEU Eurasian Economic Union EU European Union GoA Government of Armenia IFI International Finance Institutions NSS National Statistical Service SCC Somatic cells count SDGs Sustainable Development Goals SIB Social Impact Bond ToC Theory of Change UNDP United Nations Development Programme WTO World Trade Organisation

Executive Summary

It is forecasted that 3 trillion USD is needed on an annual basis to achieve the Sustainable Development Goals (SDGs) by 2030. However, only 1.4 trillion is currently identified, leaving a 2.6 trillion financing gap annually. Therefore, new sources of funds need to be identified, and since many private and institutional funds have surplus of capital, there is a good momentum to better integrate social component into development projects. Innovative financing solutions are being developed and implemented in emerging economies to engage private capital to meet the SDGs. One family of pay-for-success financing mechanisms that has gained popularity is known as development or social impact bonds (“Impact Bonds”). These mechanisms use investor money to pay the up-front costs of certain social programmes that are delivered by service providers. Ultimately, governments or donors make repayment for the services alongside a financial return for investors if pre-agreed targets are met. These mechanisms have been proven to drive performance management, incentivize collaboration, reduce risk for governments and donors, and ensure a focus on results – particularly outcomes1. For this reason, the European Union, in the framework of its ENPARD Technical Assistance – Support to Producer Group and Value Chain Development project, provided funding for UNDP to mobilise a team of local and international experts to undertake a feasibility study and understand whether one of these mechanisms could be structured to address some of the more complex development challenges in Armenia. Following extensive desk-based and field research, the feasibility team has identified an appropriate set of variables that are conducive to the development of an Impact Bond to address one of the most intractable and complicated social challenges faced by Armenia. Focussed on the impoverished north-west of the country, the Shirak region, the most vulnerable population are those subsisting on small-holder dairy farms. Using evidence from market-systems development approaches in the region, a detailed assessment indicated that the prerequisite conditions existed to develop an Impact Bond to reduce endemic poverty in the region through increasing the income of women-headed households; bolstering food security and reducing undernourishment in a highly vulnerable region; fostering the dairy export trade; and improving the quality of dairy products domestically. Initially a EUR 1.2 million pilot impact bond lasting for 5 years is recommended, with results after two measured to validate the project’s viability. All recommendations outlined in this document will be reviewed and confirmed by the advisor to be contracted to structure the Armenia Dairy SIB. The outcome funds are expected to be secured from donors. Armenian high-net worth individuals, diaspora, foundations and institutional investors, are considered as potential investors. Ultimately, this initiative, applying a commercial approach to the development of the smallholder dairy industry and focusing on both productivity and quality, should result in the extension of the approach to cover all farms in Shirak and other regions of Armenia.

1 Impact Bonds in Developing Countries: Early Learnings from the Field. Brookings Institution September 2017.

1. CONTEXT

1.1. Situational Analysis

Agriculture sector: The agriculture sector is one of the most important contributors to economic growth in Armenia. According to World Bank data, the sector is the primary livelihood for approximately 65% of the rural population and employs 31% of the total workforce in Armenia. The share of primary agricultural production 2 constituted 14.9% of GDP in 2017. The sector is important for the country’s food security (food availability, accessibly and affordability). While self-sufficiency levels were maintained at approximately 64% in 2016, this is projected to decline due to the diminishing pro duction of wheat. The situation is exacerbated by the fact that the agricultural sector in Armenia has low productivity. One of the most significant issues, impacting the development and hampering the competitiveness of the sector, is the small size of farm parcels due to fragmentation of agricultural holdings - on average 1.48 hectare per holding; slightly smaller in Ararat valley and Armavir and slightly larger in pre-mountainous and mountainous areas. 22.6% of land (78,447 farms) is less than 0.1 hectare, and only 50 farms are relatively large at 50-200 hectares. Only 66% of arable land is utilized and many regions and communities are struggling to access irrigation. Another challenge is the slow uptake of new technologies, as well as poor quality of education and advisory services. There is also little dialogue between farmers and processing organizations, particularly in the dairy sector. Positive developments in the sector are largely associated with growth in horticulture; however, livestock performance is poor and during the first two quarters of 2018 a 3.7% decrease was registered in the agriculture sector. Importation of meat and dairy products is increasing, and the cost of local production is growing. In general, there are few investments in this sector. The most critical challenges relate to the state of animal health and disease control, low dairy productivity, bad pasture management practices, absence of animal traceability system, poor hygiene and sanitary conditions and high price for animal feed. Dairy sector: Milk yield per dairy farm is low and constitutes on average 2,192 litres per cow. In the Shirak Region, the average yield per small dairy farm is only 1,600 litres per cow, and for an average farm with 50 cows, it is 2,800 litres. A s a comparison, in Hungary the average annual dairy farm productivity per cow is 6,500 litres, while it is 10,000 litres per dairy cow in both the US and Israel. This demonstrates the poor competitiveness of the dairy sector in Armenia, and accounts for th e poverty of dairy farmers. However, due to a paucity of high quality data on the number of animals per dairy farm, dairy farm productivity and milk qualitative factors, additional data collection is a critical necessity. According to the expert analysis undertaken, combining face-to-face consultations with cheese factory owners and international, regional and national literature research, vast majority (more than 90%) of the highland rural population owns dairy cows and one of the most efficacious solutions to the poverty afflicting remote rural populations is to ensure that dairy farmers increase productivity per cow per farm and to improve the quality of milk produced. By boosting productivity, farmers will significantly increase household income, while improving the quality of milk will have an impact on the nutrition of poorer families and on the sales potential of the milk produced. With a view to the longer-term development of the dairy industry in Armenia, improving the quality of milk production in terms of not merely fat content but also nutritional content will allow Armenia to export milk and dairy products to markets in the European Union (EU) and Eurasian Economic Union (EEU). As part of the proposed intervention design, formal cooperation between all major stakeholders in dairy value chain, especially farmers, milk collecting units and processors will be formalised. This will ensure stable longer-term partnerships and increase the bargaining power, particularly of small dairy producers.

1.2. The Social Challenge

After the collapse of the Soviet Union, Armenia was a pioneer in implementing comprehensive transitional reforms from a state-planned to a market economy. It included privatization of land and property, institutional reforms and trade liberalization. Armenia also underwent complex socio-economic dynamics due to difficulties in providing population with

2 Agriculture includes forestry, hunting, and fishing, as well as the cultivation of crops and livestock production. basic products and services; majority of population had no access to a secure supply of water, electricity and natural gas. Both the conflict and the scarcity of basic necessities caused a massive outflow of youth and professionals abroad. Economic disparities between regions, as well as between rural and urban communities in Armenia, are widening. According to National Statistical Service (NSS) data, 29.4% of the population lived below the poverty line in 2016 and 16% of families were classified as food insecure. Due to limited economic opportunities, many rural youth and working -age men migrate to Yerevan or abroad to earn their living. This is particularly evident in the Shirak Region. It is the poorest region in Armenia, with 45.5% of the total population livin g under poverty line. In particular, Amasia and Ashotsk urban and surrounding rural communities are struggling with extreme high poverty and malnutrition rates. The Shirak Region is also the country’s most concerning region when it comes to important indices relating to the potential for the growth of violent extremism, with an 18.8% general unemployment rate and high levels of criminality. The situation in the Shirak region was exacerbated by the devastating earthquake in 1988 which devastated Gyumri, the capital of Shirak and the second largest city in Armenia. As a result, most of the residential and non -residential buildings were completely demolished, as well as other public infrastructures. After thirty years, many families still do not have decent housing conditions and live in poor settings. As the majority of the rural population earns their income through agriculture, investments in improving capacities and educating farmers can translate into more economic growth, which will in turn spur social improvement in these communities through reduction of poverty, better education and healthcare system, improved infrastructure and better nutrition. The agriculture sector is particularly vulnerable due to weather, size of farms, fragmentation of land parcels, low productiv ity and traditional but ineffective methods of production. Owing to the severe climate conditions, the major agricultural activities in the Shirak region focus on wheat and grains, potato, livestock and dairy.

1.3. Evidence and Types of Intervention – Theory of Change

The assessment of livestock sector productivity intervention in the developing and transition countries reveal that milk productivity can be improved through both production and market linkage improvements. In Tanzania, dairy value chain interventions delivered by the Irish Aid-funded More Milk project helped increase average household daily revenue by 20% 3. In Bangladesh, milk yield per cow per month increased by more than 20% over a period of two years by applying a Making Markets Work for the Poor (M4P) approach. This resulted in a production of 1.57 litres of milk per cattle per day and an increase in mean profit per cow with more than 25% per month compared to the baseline 4. In Armenia, milk production increased by 37%, between 2011 and 2016 in selected mountain communities through interventions that focused on improving livestock productivity and the sustainability of pasture management systems. Mentioned interventions were funded by CARMAC I and CARMAC II projects of the World Bank5. CGIAR, which is the largest global partnership addressing agricultural research for development, with research centres working on the ground with farmers in developing countries, has incorporated impact measurement in its research. Back in 2013, within its Results Strategy Framework and Intermediate Development Outcomes for the Livestock and Fish Research Program, CGIAR presented its framework of the Theory of Change (ToC). This ToC links outputs such as production and market linkage improvements with the intermediate development outcomes and the system level outcomes 6. The ToC envisaged for the Armenia Dairy SIB is as follows: Table 1 Theory of Change – Armenia Dairy SIB

3 ILRI. 2016. Dairy income results from baseline and monitoring surveys in the More Milk in Tanzania project. ILRI Project Update. Nairobi, Kenya: ILRI. (https://cgspace.cgiar.org/handle/10568/71124) 4 Milk Sector Outcome Report from the Chars Livelihoods Program in the Riverine Iselands and North-West Bangladesh. (http://clp-bangladesh.org/wp- content/uploads/2015/02/Milk-sector-outcome-report_December-2014_FINAL.pdf) 5 No: ICR00003849RT. IMPLEMENTATION COMPLETION AND RESULTS REPORT, World Bank 2017. (http://documents.worldbank.org/curated/en/195781494340252189/pdf/ICR00003849 -05052017.pdf) 6 CGIAR Research Program on Livestock and Fish. 2013. Results Strategy Framework and Intermediate Development Outcomes (IDOs) for the Livestock and Fish Research Program. Nairobi: ILRI (https://cgspace.cgiar.org/bitstream/handle/10568/27666/results_strategy_framework_ido_mar2013.pdf?sequence=1&isAllowed=y)

The theory of change was built by using the example from the Armenian brandy sector, which we nt through similar intervention programme with successful outcomes. The intervention strategy is building strong linkages between the milk producers and processors and increasing not only their knowledge and capabilities but also enabling a better market a ccess through increased quality of the milk and higher-value products. This will have positive outcome in health and income levels of the farmers and the processors and reduce the poverty of the target population in the long run. Other expected long -term outcomes will be increased income for government through taxation and development of the dairy market in Armenia. It has been studied that Armenia has a good potential to increase exports of European -type quality cheese to Russia. Export potential is increasing because of the sanctions between EU and Russia which prevent EU producers to export to Russia. At the same time, demand for quality food is high; a study of Russian and UK consumers found that 70% of dairy or bakery purchases are influenced by ingredients used7. Production of European-type quality cheese, compared to traditional cheeses, requires high quality milk in large volumes. The supply of this type of milk is thus a bottleneck that is significantly preventing local cheese factories from expanding t heir production. According to interviews with local processors, European quality cheese has considerable higher profitability compared to other cheeses. Consequently, factory owners have expressed a willingness to pay a premium price for high quality milk. Dairy farmers in Armenia are highly impacted by the market price of milk powder as this is a commonly used substitute for fresh milk. However, milk used for the production of European-type cheeses cannot be replaced with milk powder. This improves the farmers’ position since their income is less dependent on milk powder price fluctuations. The SIB is set out to support economically and socially vulnerable groups in Armenia. If the intervention proves to be successful, i.e. improvements in the agriculture ecosystem and value chain improves the income and outlook for participating farmers, it is assumed that the interventions will have a long-term impact. This will in turn reduce the need for additional finance considerably and indicate long-term sustainability.

1.4. Linking the SIB to the SDGs

To better understand the links between the proposed intervention model of the Armenia Dairy SIB, the envisaged ToC and the implementation of the 2030 Agenda for Sustainable Development, five development goals and associated key drivers have been identified for the Armenia Dairy SIB and mapped against the 17 SDGs.

7 Dairy Reporter, Feb 2016.

The Armenia Dairy SIB’s development goals are defined as expected outcomes that will trigger positive multiplier effects across the SDGs. The key drivers of such development goals are defined as factors that affect progress of such development goals. It is expected that the intervention model of the Armenia Dairy SIB will be designed and implemented with these key drivers in mind, to enable the desired development goals. As demonstrated in table 2 and table 3 below, it is expected that the Armenia Dairy SIB will contribute to the achievement of 10 out of the 17 SDGs, namely SDG1. No poverty; SDG2. No hunger; SDG3. Good health and well-being; SDG 8. Decent work and economic growth; SDG 9. Industry, innovation and infrastructure; SDG 10. Reduced Inequalities; SDG 11. Sustainable cities and communities; SDG 12. Responsible consumption and production; SDG 15. Life on land; and SDG 17. Partnerships for the goals. Achievements related to SDG 1, 2, 3, 8 and 12 will directly impact the lives of the most economically and socially vulnerable groups in Shirak and Armenia and help the government to honour its commitment to “leaving no one behind”. SDG 11, 12, 15 and 17 will take longer to realise, but will over time contribute to economic and social and environmental enhancements in the region as a whole.

Table 2 Development goals/SDG coverage matrix

Table 3 Key driver matrix and development goals 1. Increased 2. Improved food 3. Increased 4. Improved 5. Improved trade income for dairy security, nutrition income for the animal welfare in and investment farmers and health government the region opportunities Develop skills and Develop skills and Reduce the number Promoting improved Increase production capacities to capacity to increase of people animal welfare capacity in the Key improve the milk the milk production emigrating from the practises, including region by improving Driver 1 quality and quality in the region through promoting improved the supply of quality region improved income feeding and milking milk opportunities practices. Introduce new Introduce monitoring Increase cheese Introduce Promote investor technologies and systems for milk production volumes monitoring systems confidence through innovative methods quality, thereby and diversify for animal welfare the successful to increase the dairy improving the quality production varieties and hygiene implementation of Key productivity. of dairy products in the region and the SIB Driver 2 consume thereby the total tax paid by the cheese factories, consumers, exporter etc. Promote price Promoting improved transparency animal welfare through the practises, including introduction of promoting improved routine tests/quality feeding and milking Key control protocols in practices. Driver 3 the milk procurement process

Increase the Introduce monitoring willingness for systems for animal cheese factories to welfare and hygiene pay a premium price Key for quality milk Driver 4 through the introduction of monitoring systems of milk quality Generate new employment opportunities at the Key cheese factory by Driver 5 increasing the supply of high- quality milk

2. SELECTION CRITERIA

2.1. Identifying the geographical area

The Armenia Dairy SIB’s proposed intervention is designed to benefit marginalised farmers in Armenia but also to demonstrate financial viability of Impact Bonds. The following criteria were considered when selecting the geographical area for the Armenia Dairy SIB: i. High levels of poverty: the region shall inhabit a higher number of people living under the poverty level than the national average; ii. High dependency on diary: the region must be considered a key dairy producing area, assessed in terms of (i) volumes (litres of milk) produced; and (ii) number of households holding dairy cattle;

iii. Underdeveloped agricultural ecosystem: the current agricultural ecosystem, i.e. the linkages between the land use, animal stock, feeding practices, hygiene etc, is underdeveloped and/or fragmented; iv. Access to processing facilities: at least four processing facilities must be located in the region; and v. Access to domestic and international markets: the region’s processors must have established relationships with domestic and international off-takers. Recommendation: It is proposed that the pilot phase of the Armenia Dairy SIB focuses on Shirak marz. The region is in the north-western part of the country, and borders with Turkey and Georgia. Shirak comprises of 116 rural and three urban communities of Gyumri (marz centre), Artik, and Maralik. There are number of factors that led to the selection of the proposed regions for the pilot phase. (i) The poverty level in Shirak (45.5%) is significantly higher than other regions (national average of 29.4% in 20168). (ii) Shirak is among the most important regions in the country in terms of total milk production and total number of households holding dairy cattle. According to the Agricultural Census 2014,9 44% of 31,695 agricultural households in Shirak owned cows. In 2016 registered dairy farms produced 116,400 litters or 15,4% of total milk in Armenia10. (iii) There is a number of technical and professional challenges that hampers competitiveness and hinders development of the dairy sector in Shirak, such as animal welfare, feed production and feeding practices, livestock housing, and milking infrastructure which are not satisfactory. These lead to both low productivity and low quality of dairy output. (iv) There are several dairy processing facilities located in the region (please see Annex 2 for a detail description of the four key milk processors in the region). (v) Most of these processors have successfully targeted both local and international (mostly Russian) markets. The Shirak region is linked to the main railway and automobile highways connecting Armenia with Georgia.

2.2. Identifying the cohort

It is expected that a pre-determined number of processors and farms in Shirak will be invited to participate to the Armenia Dairy SIB. These direct and indirect beneficiaries will be identified by the service provider/s. To ensure a fair and nonbiased selection, the following eligibility criteria are expected to be applied:

Processors (indirect beneficiaries): i. Each processing facility must be located in the Shirak region; ii. Each processor shall regularly procure milk from farms in the Shirak region; iii. Each processor is not using milk powder in any of its cheese production activities; iv. Each processor shall express a commitment to share data; and v. Each processor shall agree to sign contracts with the farmers, specifying the terms of the milk purchase, including information on the volume, quality, and price of the milk. Farms (direct beneficiaries):

8 https://www.armstat.am/file/article/poverty_2017_a_2.pdf 9 https://www.armstat.am/en/?nid=82&id=1854 10 https://www.armstat.am/am/?nid=729

i. Each farm shall supply milk to the selected processor/s; ii. Each farm will commit to providing required data in a timely manner; iii. Each farm shall have no more than 50 cows to begin with; and iv. Each farm shall agree to sign a contract with the selected processor/s, specifying the terms of the milk purchase, including information on volume, quality, and price. Recommendation: It is recommended to work with several dairy processors in Shirak to create positive competition for the market and not to create potential monopolies. There are four main dairy processing units in Shirak: Ashotsk Cheese Factory, Amasia Cheese Factory, Iqit, and Ban divan Kat. Furthermore, several processors work with a large group of dairy farms in the region.

2.3. Identifying Service Provider(s)

The success of the Armenia Dairy SIB will largely depend on the activities carried out by the service provider(s). To be eligible for this role, it is expected that each service provider meets the following criteria: i. Have proven experience in development of the dairy sector in Armenia; ii. Have a strong track record in capacity building and training of farmers working in the dairy sector in Armenia; iii. Have a good understanding of the main issues in the dairy sector in Armenia and Shirak region; iv. Have experience in implementation of dairy sector development projects, including but not limited to productivity and milk quality improvements; and v. Meet legal requirements for operations in Armenia11. The agricultural education and extension/advisory service system in Armenia today comprise a mix of public, private and non-governmental actors. The public sector is the main provider of agricultural education through vocational schools/agriculture advisory centres and the Armenian National Agrarian University. Extension services aimed at promoting sales of agricultural inputs are widely practiced by local agribusinesses and private agriculture input suppliers. Most of these companies do not charge farmers for these extension services. Examples include pesticides shops and veterinary pharmacies. NGOs are primarily engaged in providing agriculture extension service such as specialised trainings, and oth er types of capacity development programs. These activities are often funded by bilateral and multilateral donors and diaspora organizations.

Some of the key actors in the sector in Armenia today include: . Strategic Development Agency (SDA). SDA is an Armenian NGO founded in 2002. The main target of the SDA is the implementation of innovative community based/participatory operational projects, research and analysis, trainings, seminars, business and legal advice, exchange/cooperation etc. The organization has been implementing agricultural and community development and livestock development programs since 2003 in more than 120 communities of Tavush, Shirak, Lori, Syunik and Vayots Dzor. . The Centre for Agribusiness and Rural Development (CARD): CARD is a local foundation established in 2005 as a successor of USDA’s Marketing Assistance Program (USDA-MAP). CARD’s mission is to assist farmers and agribusinesses in the production and marketing of food and related products to increase incomes and create jobs leading to sustainable livelihoods for rural populations. They do this through a) promoting the application of advanced agricultural technologies; b) supporting the agricultural processing and the development of competitive food products for domestic and export markets; c) improving food safety and food security at the production, processing and service level; d)

11 It is a legal requirement to be incorporated as a legal entity so as to be able to provide those services e.g., LLC or CJSC. However, the service provider can also be as a non-profit e.g., a foundation. For more details see, the Legal Road-Map.

promoting animal genetics, improvement of animal health and husbandry practices; and e) supporting the establishment of new policies and regulation at government level. . Farm and Veterinary Service Centres (FVSC). Supported by the Armenian government and international development organizations, CARD has initiated one-stop shop farm service centres in 20 communities in Armenia. Most of the centres have financial self-sufficiency. There are three centres in Shirak province. These centres sell agricultural inputs, tools and farm equipment but also providing basic financial services such as leasing and credits. . The International Centre for Agribusiness Research and Education (ICARE) Foundation: ICARE is a non-governmental and non-commercial organization established in 2005. ICARE is an umbrella institution for the Agribusiness Teaching Centre (ATC), the Agribusiness Research Centre (ARC), and the EVN Wine Academy. ATC provides agribusiness education to achieve sustainable entrepreneurial activities in the food and agriculture sector in Armenia and Georgia. ICARE conducts studies on behalf of other entities, including economic and marketing - based research that assess the region’s agribusiness climate as well as identifies new opportunities for investment and development. Recommendation: The selection of service providers should be based on a competitive process to ensure the best quality proposals with the most affordable cost. To ensure a smooth transition from the traditional output-based contracts to an outcome-based contract, it is suggested that the selected service providers are compensated based on a mix of both output and outcome indicators, e.g. costs could be reimbursed based on outputs achieved, and any premium could be based on the realisation of the outcomes.

3. OUTCOME METRICS, MEASUREMENT AND DATA SOURCES

3.1. Metrics

The overall goal of the intervention is to increase income and health of small and mid-size dairy farmers in Shirak marz. This will be achieved by improving the productivity and milk quality amongst the beneficiaries. All proposed metrics are subject to review and confirmation by the advisor to be hired to structure the Armenia dairy SIB. A. Output metrics: Milk quantity and quality: 1. Total volume of good quality milk (kg) sold to factories, by all beneficiaries. Assumption: Farmers use parts of the production themselves (not measurable) but it is assumed that increased production is sold to processors. Requirements: Milk must meet following quality requirements: i. Fat -content: % fat in milk (fat-% affects cheese yield directly and cheese factories pay more for higher fat-%)

3 3 ii. Density: kg/m (milk has a weight density of 1028–1035 kg/m ) iii. Acidity: Degrees Turner (fresh milk has an acidity of 16°–18°T degrees Turner) Targets: In collected samples, the milk’s density was 1,028.3 and acidity 19.8. The proposed target is that no more than 0.5% of the milk supplied to the processor is below the required quality standard of 1028 for density and 16°–18° for acidity). Regarding fat levels, the collected samples showed an average of 3.2% whilst the proposed target is 3.8-4.2%. 2. Annual average milk production per cow (kg/cow)

Assumption: According to FAO12, the fat level of Caucasian brown-breed is 3.8-3.9% and the annual milk yield 4,000 kg (type dairy) and 3,300 kg (type dairy-beef). However, based on the collected data during interviews with randomly chosen farmers the average Caucasian brown-breed milk cow produces 1,850 kg per year if no additional feed, care and good quality pasture is provided. Following the implementation of improved sanitation, animal welfare practices and enhanced feed rations, the potential increase in production could be around 15-20%. To achieve higher levels of production, also herd quality should be looked into. Targets: From a baseline of 1,700 kg per year, productivity increase is targeted at 5% in year 1 and 15% from year 2 onwards.

Proposed verification model: a. Quality Indicators: 1. Cheese processor  Routine measurement embedded in the procurement process for all beneficiaries. 2. Service providers  Milk collection point monitoring at least one time per month during high season (May- October)  Milk collection point monitoring once per two months during low season (November- April)  Risk based households monitoring, need based 3. Independent verification agency  It is proposed that an independent verification agency develops baselines and monitor the project’s progress against such baseline  Baseline measurements at the inception stage of the project- estimated [•]  Measurements – estimated [•], samples to be taken at the milk collection point Both the cheese processors and the service providers must take measurements in line with the “four eye principle” to avoid potential problems arising from corruption and data falsification. Measurements are to be taken with portable devices supplied by the SIB. In addition, the levels of somatic cells count (SCC) could be added as one of the quality indicators. The measurement of farm or cow level SCC levels could be done at least twice per month (using portable cell counter). There is currently no SCC baseline data available, so the database could be collected by the independent verification agency during the first year of the implementation to set up thresholds/baselines or to collect it during the structuring period. According to S. Skeie13, “good quality milk, giving an optimal cheese yield and cheese quality, originates from healthy animals, has good flavour, has been cold stored for a limited amount of time and has a high protein content with the BB genotypes of ß-lactoglobulin and κ-casein (bovine milk). The milk should be low in somatic cell count, as proteases from somatic cells attacks αS2- and ß-caseins and reduce the cheese yield. The content of free fatty acids should be low, as free fatty acids bind Ca2+ and thereby reduce the coagulation properties of the milk. In addition free fatty acids contribute to the development of rancid flavour in cheese. Milk used for cheese making must be of good microbiological quality and absent from pathogenic bacteria. Psychotropic bacteria have heat resistant lipases and proteases, which may reduce yield and may also cause undesirable flavours in the ripened cheese. Clostridia spores cause late blowing in cheeses with eyes, and these bacteria also induces inedible flavours to cheeses with closed texture. Antimicrobial agents

12 http://www.fao.org/3/ah759e/AH759E08.htm 13 Characteristics in milk influencing the cheese yield and cheese quality. Journal of Animal and Feed Sciences, 16, 2007, pp. 130-142.

as antibiotics, detergents etc. must be absent, as the acidification by lactic acid bacteria will be strongly influenced.” The majority of somatic cells are leukocytes (white blood cells) - which become present in increasing numbers in milk usually as an immune response to a mastitis -causing pathogen - and a small number of epithelial cells, which are milk-producing cells shed from inside of the udder when an infection occurs (animal welfare). As such, the level of SCC provides an indication on potential infections. Specifically: - SCC below 100 000 = uninfected, - SCC >100 000 and <200 000 = at risk, - SCC over 200 000 infected, - SCC over 300 000 infected with significant pathogens (animal health and welfare) SCC levels also influence milk’s shelf life, its taste and how well it can be transformed into other dairy products such as yoghurt or cheese. The Armenian regulation for raw milk suitable for cheese production is not very strict. For example, the regulation states that raw milk should have no more than 1x106 somatic cells in 1 cm3, an acidity level of no more than 19°T, and protein level of no less than 2.8%. High levels of SCCs lead to unusable milk. According to Philpot and Nickerson 14 report, milk loss per SCC level is as follows: Somatic Cells Milk loss (%) 100000 3 300000 7 600000 10 1000000 12

In addition to losses in milk production, infections such as mastitis cause additional medical costs and death loss, which affect further farmers’ income. In smaller herds, the total effect of one or more cows with very high somatic cell counts can be enormous. In the larger herd, milk from a sick cow is diluted and averages down the total quality of milk. b. Productivity Indicators: 1. Cheese processor  Routine measurement embedded in the procurement process for all beneficiaries. 2. Service provider  Household and collection point monitoring at least one time per month during high season (May-October)  Household and collection point monitoring once per two months during low season (November-April) 3. Independent Verification agency  It is proposed that an independent verification agency develops baselines and monitor the project’s progress against such baseline  Household level Baseline Census and collection point measurement at the inception stage of the project- estimated March 2019  Household level census and collection point measurements – estimated [•] B. Outcome Metrics

Household income:

14 Mastitis: Counter Attack: A Strategy to Combat Mastitis. Bradson Brothers Co., Illinois (1991)

 At the farmer’s level the household income is expected to increase in line with the increasing productivity and quality of milk (since the processors are willing to pay higher price for higher milk quality)  At the factory level, employment is expected to increase due to the increasing volume of cheese production (which is expected to be correlated to the increasing productivity and quality of milk) Taxes  Total sum of taxes paid by the cheese processor

C. Other Metrics to be considered

Animal welfare It is recommended that the SIB will include animal welfare interventions since only healthy cows are productive. No baseline data is currently available so the monitoring should focus on output -based metrics or the baseline could be built during the structuring period.

1. Household monitoring of animal welfare, feeding and milking practices at least 1 time per month during the high milk season (mid-April – mid-October). 2. Household monitoring of animal welfare, feeding and milking practices at least 1 time per two months during the low milk season. If desired and possible, region(s) with similar characteristics to Shirak can be used as a control group. This way, outcome, output and other metrics can be compared in the two regions, allowing for a data -based assessment of the success of the SIB-intervention.

3.2. Financial model

3.2.1. Pricing and costing data – sensitivities, cashflow analysis, risk scenarios

The below tables summarise the proposed financial model for the SIB implementation period over five years. This model is based on field interviews of farmers and milk process ors, as well as on service providers’ budget and their success rates.

Table 4a Financial model assumptions

ASSUMPTIONS Baseline Year 1 Year 2 and beyond Productivity increase compared to baseline 1700 kg 5 % 15 % Hay price per bale in AMD 1 100,00 ֏ 1 100,00 ֏ 1 100,00 ֏ Hay price per bale in EUR € 1,96 € 1,96 € 1,96 Share of high quality milk 30 % 52,4% 86,0% Share of low quality milk 70 % 48 % 14 % Success-rate quality improvement 80 % 80 % Success-rate productivity improvement 70 % 70 % Operating rate (share covered) 40 % 100 %

Table 4b Inputs for SIB implementation period

Inputs Baseline EUR to AMD 562.00 ֏

Number of beneficiaries 700 Number of cows per farm 11.8

European cheese price 2,800 €/kg

Armenian cheese price 2,100 $/kg Number of processors 2

Based on a EUR 1.2 million investment15, focused on 700 small- and medium-sized farmers which will supply approximately 1,700 kg high quality milk per year to two processors, the beneficiaries’ overall income is expected to increase by EUR 900.000 through the improvement of the quality of the milk and EUR 1.7 million through productivity gains during next five years. The overall profit increase after 5 years is estimated as EUR 3.840 per farm or EUR 2.6 million in total.

Table 5 Farmers’ overall income increase Improvement of Improvement of Average increase per Year Total milk quality productivity farm, annual Year 1 € 83 952 € 55 220 € 139 172 € 199 Year 2 € 209 880 € 427 369 € 637 249 € 910 Year 3 € 209 880 € 427 369 € 637 249 € 910 Year 4 € 209 880 € 427 369 € 637 249 € 910 Year 5 € 209 880 € 427 369 € 637 249 € 910

15 The impact bond structurer is recommended to consider whether a EUR 200k component can be sourced from the farmers.

Total € 923 474 € 1 764 696 € 2 688 169 € 3 840

The table 5 illustrates the estimated increase in farmer’s income levels during the five-year period. As demonstrated in the table, both milk quality and productivity gains will contribute to the farmers’ income considerably, and equal weights in outcome payments are thus recommended. Improvements in milk quality will mainly be achieved through the removal of adulteration. Improvement in productivity will require significant investments and will thus take longer to realise. The increase in herd size is not included in these calculations but it can be considered to be added during the structuring period. It could be assumed that farmers will invest a part of their income in new cows after increased income levels or for the SIB to invest in new cows as well. A cow reaches milk production age at two years of age and the further increase in profits through an estimated 10% increase in herd size could be added from year 3. Increased cheese production in plants creates new employment opportunities for local people. Based on interviews with local factory managements, increased production is expected to create five new FTEs in a single factory. Increased sales of high-quality products will furthermore expand the governments tax base as demonstrated below with EUR 1.1m VAT income as part of the EUR 3.8m overall income increase. Table 6 SIB implementation period impact Quality improvement € Productivity improvement € Total Year 1 2 3 4 5 1 2 3 4 5 impact € Beneficiaries 83,952 209,880 209,880 209,880 209,880 55,220 427,369 427,369 427,369 427,369 € 2 688169 Processors: 51,059 127,647 127,647 127,647 127,647 17,137 136,570 136,570 136,570 136,570 € 1,125,060 VAT increase

Total 135,011 337,527 337,527 337,527 337,527 72,357 563,939 563,939 563,939 563,939 € 3,813,230 3.3. Risk Scenarios

3.3.1. Main risk

The following risk scenarios are divided into operational risks and measurement risks. Operational risks refer to risks that affect milking results because of reasons which are out of the SIB’s control. Measurement risks refer to a situation where the indicators show contrary to expected results. Three main risk factors are considered: 1. Hay price fluctuations Operational risk: droughts may have a negative effect on hay price, which in some cases force farmers to slaughter their cows to survive. This provides a short-term solution to the problem but decreases milking profits in the long run. Because of a lack of historical data, we cannot estimate a model for the relation between hay price and precipitation. Hay price may also be affected by the number of cows in Armenia.

In the financial model, it is simply assumed that the hay price doubles. This decreases farmer’s profit margin from 57% to 14% in case of low-quality milk and from 61% to 22% in case of good quality milk. Identified mitigants: a) the farmer can grow other products that are negatively correlated with hay, for example feed corn (when hay is suffering, the corn grows well and vice versa); and b) farmers can co -operate

if damages are unevenly distributed. These activities will stabilize the income levels of the farmers and enable them to keep the level of cows stable.

2. Cheese price fluctuations

Operational risk: demand for Armenian cheese may decrease for example if Russia closes the border. A 15% reduction in milk prices is assumed to account for such a scenario.

Table 7 Price fluctuations – price decrease of 15% Improvement of Productivity, Average Improvement of Improvement of quality and herd increase per Year milk quality Productivity size farm, annual Year 1 € 71,359 € 46,937 € 118,296 € 169 Year 2 € 178,398 € 363,264 € 541,662 € 774 Year 3 € 178,398 € 363,264 € 541,662 € 774 Year 4 € 178,398 € 363,264 € 541,662 € 774 Year 5 € 178,398 € 363,264 € 541,662 € 774 Income increase € 784,953 € 1,499,991 € 2,284,944 € 3,264

3. Temperature High temperatures have a considerable negative effect on milk yield (critical point approximately 20-22 degrees Celsius as well as humidity). Because of a lack of local historical data, it is difficult to put in place a model connecting temperature and average milk yield. Operational risk: High temperatures may lead to the cows being stressed, and their milking decreasing as a result. Identified mitigants: Night feedings, showers, special feed during heat wave, more water, shed ventilation.

Measurement risk: Abnormal heat wave can dilute the impact of the activities provided as part of the SIB. Current data does not allow estimating the relation between monthly or yearly temperature and milk yield. Identified mitigants: a. Use control groups to compare the “SIB outcome” with a “no SIB scenario”; and/or b. Change the measurement period in the case of an abnormal heat wave (definition to be determined). I.e. if the SIB operates during two milking seasons and an abnormal heat wave occurs in one season, outcomes are used only from the normal season. Important to note that this would not work if abnormal heat wave occurs in both seasons.

3.3.2. Other risks

The project can be confronted with certain non-financial risks, but the magnitude, nature and direction of these non-financial risks are difficult to predict. However, these should be taken into account when entering into the structuring phase and discussed with the government and other main stakeholders to mitigate the potential risks.

1. Political risks:

Political risks may include government instability as well as societal instability. The main political risks are as follows: 1. Stability of local economy, and absence of high inflation. 2. Fair and equal treatment of investors from the host government. 3. Freedom from arbitrary and changing government regulation. 4. Free transfer of profit from the host country. 5. Ability to sell or liquidate investment and subsequently, to withdraw funds from the country. 6. The political willingness and ability to make structural reforms.

Manifestations of political risk include:

• outright ban in selected industries (e.g., exclusion of FDI in a number of important sectors specified in a 1 Systems for controlling inflows of investments negative list) • high taxes and weak incentives • equity limits • blocks to capital and profit repatriation • long repatriation delays 2 Limits on foreign exchange transfers • limits on repatriation by net worth • limits on repatriation by foreign exchange earnings The role of the state in the economy: government • price controls 3 intervention • uncertain legislative instruments

• fragile political structures 4 Societal instability • weak organizational level in the society

2. Other risks:

Risk Risk mitigation approach

Farmers unwilling to participate in the trainings and Using the farmers’ experience through involving them in workshops the project co-design and development processes. Processor not paying premium price for quality milk Develop a contract between the individual farmers and reduces farmers willingness to improve their dairy the processor that would specify the price, volume, and farming practices quality of the milk procured by the processor.

Drought reduces the milk yield per cow Install additional watering stations around the communities. Encourage nightshift grazing by supporting the farmers with diesel generators to power milking machines. Encourage fodder cultivation. Lack of trust between the farmers and the processor Establish on-the-spot testing capability for milk in all does not allow for an honest dialogue on milk quality participating communities.

Instability in the Russian market reduces the demand Support the processor to diversify its market. or the price of cheese

Management of the processing company does not Work with several processors to reduce the buying keep its commitment to pay higher price for higher power of the processors. quality milk Decrease in the international milk prices increases Focus on the production of high-quality milk for high the volume of the imported milk powder quality cheeses (which are impossible to produce using milk powder). Poor quality of statistics which may be improper or All data including production and major social indicators mislead and/or cannot be disaggregated. is to be collected during baseline study through surveys Furthermore, social and nutrition related data is not and other methods. available Interest rate for deposits in Armenian drams for Final proposal should consider alternative investments midterms allocations exceed 10% annually. This and provide competitive terms for investors. considered to be a good annual return on investment and may not attract many investors into the project with lower profitability and higher risks. In particular, Armenian dram in general terms is stable currency and banking system proved to be stable as well Limited number of organizations capable to Project need to prepare specific requirement for bidding implement project when funding is available implementing agency, paying attention on specific and measurable indicators and considering not only the cost but also quality of implementation.

Annex 1: The Legal Roadmap

This Legal Roadmap is the result of an in-depth study concerning the legal and regulatory challenges that policy makers may face in implementing social impact bonds in Armenia. It provides the players with an understanding of how to structure the legal relationship among the participating entities and to manage the risks and consequences. The Legal Roadmap provides an overview of all legal challenges known to date regarding the implementation of SIBs in Armenia and propose a theoretical framework for addressing such challenges from the perspective of each SIB participant. Furthermore, it presents the recommendations how to apply a set of the legislative instruments in practice. The study was based on A Legal Road Map for Social Impact Bonds in Developing Countries 16

PART 1: INVESTORS Funding and Procurement 1. Financial instrument Question 1: Does the Armenian legal system allow donors and private sector investors to fund Impact Bonds by directly delivering funds to an intermediary (either as equity or loans)? Does the law prohibit or limit funding of social service programs? Would the law limit the structure in which the funding is made or the amounts to be funded? What legal formalities would apply to the delivery of funds to an in termediary (e.g., notarial proceedings)? Armenian law overall allows funding of Impact Bonds either through loans or equity contributions into a legal entity. However, there isn’t a defined notion of social impact bond under the laws of Armenia. According to Article 3 of the Foreign Investments Act of 1994, the definition of investment is broad and open-ended, with a list of specific types of covered investments that is indicative rather than definitive i.e., investment as “every kind of asset”. The main financial instrument components under the Act are equity and debt instruments. Equity includes common and preferred shares (exclusive of non-participating preference shares which should be included under debt), reserves, capital contributions and reinvestment of earnings. Dividends, distributed branch earnings, reinvested earnings and undistributed branch earnings are components of the investment income on equity. Debt instruments include marketable securities such as bonds, debentures, commercial paper, promissory notes, non-participating preference shares and other tradable non-equity securities as well as loans, deposits, trade credit and other accounts payable/ receivable. Finally, from a financial services’ regulatory perspective, there is nothing that prohibits investors from funding Impact Bonds by delivering funds to an intermediary. No legal formalities (such as notarial proceedings, administrative verifications, etc.) would apply to the delivery of funds to and intermediary. Question 2: Are “hybrid investments” legal or subject to special regulation? Hybrid investments into Armenian companies are permitted. An Impact Bond, could be funded by a combination of debt and equity, in which case, each portion of the funding will be subject to the particular rules applicable to it. 2. Capital controls Question 1: What legal framework applies to debt and equity investments? What limitations or procedures apply to bringing in funds to Armenia? Debt and equity investments may be freely made in Armenia. The precise investment regime may vary depending on the legal status of the entity in which investment is made. Thus, a foreign investor is permitted to subscribe directly to or directly acquire equity shares, fully and mandatorily convertible preference shares (converting into equity within a fixed period of time, with formula

16 https://www.instiglio.org/wp-content/uploads/2015/02/Legal-Road-Map-for-SIBs-in-Developing-Countries.pdf

for such conversion being set out upfront) and fully and mandatorily convertible debentures (converting into equity within a fixed period of time, with formula for such conversion being set out upfront) of an Armenian company as foreign direct investment, subject to certain conditions e.g., certain filings are required to be made under the Competition Act of 2000 and the Legal Entities Act of 2001. For equity investments, are there quantitative/qualitative legal limitations on the repatriation of profits (e.g., foreign exchange regulations)? Foreign capital in Armenia is generally permitted to be repatriated along with capital appreciation, if any, after the payment of taxes due on them (Articles 9 and 10 of the Foreign Investments Act of 1994 and Article 5(1) of the Currency Control Act of 2005 provides that there are no limitation on repatriation of profits). Generally, remittance or credit of net sale/maturity proceeds (after payment of taxes) from sale of securities (such as shares, debentures, dated government securities, etc.) is permitted to be made to or by the foreign investors. Remittance is usually also permitted to be made with respect to dividend, interest payable, or approved income to the share/debenture/government securities holder at the applicable rate, subject to deduction of tax at source. Depending on the route or mode of investment into Armenia, remittance of various kinds of funds is permitted into Armenia, including winding-up proceeds of companies, reimbursements for pre-operating expenses, royalty, lump sum fees for technical services, consultancy fees and dividends. 3. Procurement and contract with government Question 1: Given the legal framework under which the government is allowed to enter into agreements, what options, if any, would an investor have when contracting with the government directly? Public works, services, purchases and sales must be performed by means of a public bidding procedure in Armenia. This legislative principle is enshrined in the Procurement Act of 2016 which establishes the conditions for both public bidding procedures and governmental agreements (usually of pre-agreed and standardised form and there is little scope for possible re-negotiations) entered into by public administration. The obligation of contracting through tenders aims to provide equal opportunities to those who are interested in negotiating with the Government and respected the standards previously established by the procuring legal entity. It presupposes the idea of competition, to be held between those who meet all the condition s and qualities required for the satisfactory performance of the contract. In 2017 the public procurement regulations underwent a fundamental reform. Currently, the legislation provides four different kinds of procurement procedures to award government contracts. They are electronic auctions, tenders, requests for quotations and single-source procurement. The list of goods, works and services are purchased by electronic auction prescribed by the Government. They are standardized, simple, and generally available goods, services or construction, such as off-the-shelf products or commodities. Request for quotations is applicable when purchasing goods/works/ services are not included in Electronic auction purchasing list and their total value is 1,000,000 to 70,000,000 AMD. There are several types of tendering methods. Open tendering is the preferred competitive public procurement method used for acquiring goods, services and infrastructure works. Open tendering is also known as open competitive bidding, open competition or open solicitation, and the procurement notices used to call for bids for these requirements are identified as invitation for Bids or Invitation to Tender. This method is applicable when purchasing goods/works/ services are not included in Electronic auction purchasing list and their total value is above 70,000,000 AMD. Closed tendering method is used when the project concerns national security or contains confidential information. A process should be in place for arriving at the number and specific firms that will be invited by the procurement entity. Another method prescribed by the Law is single-source procurement. This is a non-competitive procurement method, and it should be used only under exceptional circumstances, namely: ● purchasing goods/works/services is possible to be realized only from one source, due to patent or exclusive rights; ● for emergency situations; ● there is a need for purchasing additional quantity of goods,

● the total value of procurement item is up to 1,000,000 AMD; and ● purchasing of needed goods, works and services is taking place not in the territory of Republic of Armenia However, it is to be noted that the Procurement Act of 2016 has a preference to open tendering which states that public procurement shall be through the use of open tender proceedings if the purchasing subject is not state secret or if it is not included in Electronic auction purchasing list. Finally, it is to be noted that currently, the draft Public Private Partnerships Act is being discussed within the Government which would enable the investor to enter into agreements with the Government. It is important to keep in mind that this type of agreement is usually tied to the development of infrastructure, which could be, in this case, social infrastructure, e.g., schools, hospitals, jails, sports, etc. Finally, it is to be stated that once a contract has been entered into with Government through the appropriate process, it becomes enforceable, like any other private agreement. The Government is bound to the co ntract in so far as the contract is not null and void as well as unlawful. Question 2: Would the independent evaluator’s report be binding to the Government (i.e., assuming that the Government is committed to accept the outcome of the report, could the Government challenge such a report)? What are the contract enforcement concerns and mechanisms to ensure that the Government follow its commitment to pay according to an independent evaluator’s report? Could the Government easily challenge the report? What are the risks? According Article 46(2) of the Procurement Act of 2016 public procurement is subject to the regulations of the Civil Code of 1999, without prejudice to the particular regulations of the Procurement Act. Where the Government has entered into a contract, it is obliged by the terms of that contract. To the extent that the contract provides for the independent evaluator’s report being binding, the Government must uphold its obligations in terms of the contract. Once it has entered into the contract, the Government becomes functus officio and as such, the government does not have the power to revoke its own decision and abandon the contract and its obligations thereunder, unless there is statutory authority to do so. The functus officio doctrine applies to a decision that is final, in that it has been published, announced or otherwise communicated to affected persons. If the Government wishes to have the contract set aside, it must approach a competent court that can then review the decision to enter into the contract or into that particular term of the contract and set it aside. There must, however, be a basis upon which the contract can be set aside. Such grounds include when the government body did not have the requisite authority to enter into the contract or term (it therefore acted ultra vires), where the contract is otherwise unlawful or there has been a fettering of discretion.

Tax Aspects Question 1: What tax rules apply to the funding provided by investors (either donations, loans or eq uity)? Would withholdings apply to the repayment of capital/interest, or dividends/repatriation of equity? Generally, Armenian tax legislation allows three structures through which non-residents can carry out their activities in Armenia:  separate subdivision  recognized place of business of a non-resident  directly – without subdivision or recognized place of business of a non-resident Subdivision: It represents part of a non-resident legal entity and can take the form of a registered affiliated branch or representation office. As such, subdivision is the equivalent of a PE.17 It is to be noted that the subdivision does not represent a separate legal entity and acts on the basis of a charter approved by the legal entity. A subdivision pays regular corporate income tax on its profit, with a few restrictions on deductible expenses. Taxable profit is defined as the positive difference between the gross income of the subdivision and all deductions allowed by the law. The current rate of regular corporate income tax is 20%. Gross income

17 Under the model double tax treaty (DTT), which is generally used by Armenia while concluding DTTs, the term “permanent establishment (PE)” is defined as a fixed place of business through which the business of an enterprise is wholly or partly carried out.

comprises all revenues of the subdivision received in the reporting year from Armenian sources. Deductions include the amount of all necessary expenses (which must be supported by documentary evidence unless expressly described otherwise in the context) incurred by a non-resident in Armenia for its subdivision’s purposes, the amount of losses incurred in connection with activities implemented in Armenia and the amount of other deductions. Recognized place of business of a non-resident: it is also considered an equivalent of a PE, is the place of actual implementation of business activity of a non-resident that doesn’t have a separate subdivision (branch or representation) in Armenia. Specifically, the place of business can include offices, agencies, plants, factories, workshops, places of construction works implemented under a contract, places of installation, assembly, arrangement and research, places of supervision works and consulting. When a non-resident’s activity is carried out through a business agent, the place where the business agent is located is considered to be the place of business of a non-resident. A resident legal entity, an enterprise without the status of a legal entity or an individual can act as a business agent if their activities are controlled by the non-resident through an assignment contract, trust administration contract, power of attorney or in any other way. A non- resident with a recognized place of business is also considered to be a regular corporate income taxpayer in Armenia. The taxation of the recognized place of business is similar to that applied to a separate subdivision. Directly – without subdivision or recognized place of business of a non-resident: if a non-resident does not carry out periodic business activities in the territory of Armenia and does not apply for registration of a subdivision or a place of business, it can carry out its activities without any legal status in Armenia. As a general rule, in such cases, income received by the non-resident is taxed by a tax agent at the source of payment through the withholding mechanism. The following rates are applied by tax agents, in this case, depending on the type of income received by the non-resident from Armenian sources:18

Dividends, interest, royalties, income from the 10% lease of property, capital gains and other passive incomes

Income from other services 20% provided by non- 20% residents, as well as income from services provided outside Armenia to Armenian residents, and separate subdivisions of non-residents in Armenia

It is important to note that a non-resident’s income received from intermediary activities such as assignment, commission and agency services, should be considered derived from Armenian sources if such services are provided by a non-resident in the territory of Armenia. However, when it is impossible to classify clearly whether the non-resident’s income is derived from Armenian or other sources, such income is ascribed to Armenian sources if it results from the activity of a subdivision or a place of business of a non-resident, and there are insufficient evidence proving the provision of intermediary services outside Armenia. It should be noted that, in this case, it is necessary that the income from intermediary activity was received from a resident or another non-resident’s subdivision or place of business in Armenia, or from a citizen of Armenia.

18 It is to be noted that the agricultural sector has a different tax regime. According Article 59(2) of the Tax Code the agricultural activities are subject to VAT in case of being carried by legal entities and private entrepreneur if sales’ turnover exceeds 58,35 million AMD. However, the said regulation is applicable when the undertaking is engaged only in agricultural sector. The said applies also to non-profit organizations. As regards the profit tax payers, they are exempted from the obligation to pay profit tax till 31 December 2024 for the profit generated by the realization of agricultural goods and from the sale of other actives and other profit as long as the portion of the latter two income items do not exceed 10% of the gross income of that tax year. In case of exceeding the threshold of 10% the exemption is active only for the agricultural goods. The definition of agricultural goods is provided by Article 126(1)(1).

Furthermore, income derived from management, financial and insurance services rendered by a non- resident to its subdivision or place of business in the territory of Armenia shall be subject to taxation, providing that the cost of such services is treated as an expense by the subdivision or place of business. Finally, it is to be stated that income received by a non-resident through the investment or provision of its property or other assets, exclusively from the activity of third parties in the territory of Armenia, is considered to be passive income. Passive income specifically includes the following incomes: a. Dividends Dividends are income derived from participation (stocks and shares) in the share capital of a legal entity or unincorporated enterprise. Dividends received by a non-resident are considered to be derived from Armenian sources if received from participation in the share capital of a resident legal entity, resident unincorporated enterprise or resident investment fund. b. Interest Interest is defined as income received from all kinds of debt claims, such as borrowings, loans, commodity credits, commercial loans, deposits, bonds and bills. A non-resident’s interest is considered to be derived from Armenian sources if such interest is received specifically from:  the provision of borrowings, loans, commodity credits and commercial loans to a resident or another non-resident’s subdivision or place of business in Armenia, or a citizen of Armenia in relation to which the obligation to pay interest has arisen  a deposit in a resident bank or credit organization in relation to which the obligation to pay interest has arisen  bonds issued by the issuer (or authorized body of the latter) according to the procedures established by the legislation of Armenia  the balance of any account (deposit, operating, current, correspondent accounts, etc.) of a non- resident opened in the resident bank. Question 2: Does Armenia have international investment agreements, preferential trade or double taxation treaties in force? Are there any on the way of becoming effective (e.g., being negotiated, pending ratification, etc.)? As of May 2018, Armenia has entered into double tax treaties with 48 countries. There are different withholding tax rates under these treaties.19 In general, if the withholding tax rate provided in a treaty exceeds the rate provided by the Law of Armenia on corporate income tax, the domestic rate applies. Tax residents are allowed to credit foreign taxes paid on income received abroad against their Armenian tax liabilities. The amount of foreign tax credit is limited to the amount of Armenian tax that would arise from the equivalent income in Armenia. As of May 2018, Armenia has signed 42 bilateral investment treaties, most of which are in force. The BIT regime provides the most fundamental substantive protection including national treatment, MFN treatment, as well as fair and equitable treatment. Armenia is also a party to the Convention on the Protection of the Rights of the Investor signed in the City of Moscow on March 28 1997. The Convention provides certain guarantees for the protection of rights of the investors and has a number of features e.g., it applies to investors both of the state signatories to the Convention and to the investor of non-member states as well. As mentioned above, Armenian BITs usually contain a very broad definition of “investment”, recognising that current investments take a wide variety of forms. The examples cover investments that are owned or controlled by nationals or companies of one of the BIT partners made in the territory of the other. Investments can be made either directly or indirectly through one or more subsidiaries, including those of third countries. Control is not specifically defined in BITs. Ownership of over 50 percent of the voting stock of a company would normally convey control but in many cases the requirement could be satisfied by less than that

19 In several treaties, a 0% rate applies to interest paid to governmental entities, political or administrative-territorial subdivisions, local authorities, central banks or financial institutions owned or controlled by the Government.

proportion. The samples also provide a non-exclusive list of assets, claims and rights that constitute investment. These include both tangible and intangible property, interests in a company or its assets, a claim to money or performance having economic value, and associated with an investment, intellectual property rights, and any right conferred by law or contract (such as government-issued licenses and permits). Armenia agrees in many BITs not to engage in conduct that restricts by arbitrary or discriminatory measures the operation, maintenance, expansion, or disposition of investments, and to provide effective means of asserting claims and enforcing rights so as to resolve any disputes arising out of the investments. Importantly, very few BITs also require Armenia to observe all obligations undertaken toward investor. Armenian BITs also typically define the conditions under which property may be expropriated. For example, one BIT formulation provides that property may only be expropriated for a public purpose, in a non- discriminatory manner, according to due process of law, and upon payment of prompt, adequate and effective compensation. Compensation is usually defined as equivalent to the fair market value of the expropriated investment immediately before the action was taken or became known. All BITs provide dispute settlement procedures. Some BITs require that a case be submitted in the first instance to the local courts, but if the case has not been resolved within a certain period of time, then, the investor may pursue an international arbitration. Other BITs allow the investor to file an international arbitration after a specified consultation period has elapsed, generally, three and six months. The investor is afforded a wide choice of submitting the dispute to international arbitration  the International Centre for Settlement of Investment Disputes (ICSID)  an ad hoc tribunal established under the Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL)  an arbitral proceeding under the Arbitration Institute of the Stockholm Chamber of Commerce Finally, it is to be noted that the Land Code also prohibits foreign investors to acquire real estate in Armenia. However, the investor can establish a subsidiary company to purchase real estate. Non-resident individuals are taxed only on their Armenian-source income. Non-resident entities are subject to Armenian tax only on income that has a source in Armenia. Non-resident entities are those whose existence is established under foreign law. Question 3: Are there tax incentives/breaks for socially oriented investing? How cumbersome is the process for obtaining/collecting these incentives?

There are no specific tax incentives for socially oriented investment in Armenia. However, projects involving development, humanitarian, and other assistance provided by international organisations often enjoy tax exemptions in Armenia. Exemptions may apply to imports and procurement of goods and services and may extend to both direct and indirect taxes (including customs duties). Most of the not-for-profit organisations with public aims in Armenia are entitled to enjoy tax benefits which are provided for associations or foundations e.g., VAT or corporate tax. Question 4: Is it possible to write off losses or to reframe a failed investment in SIBs as a grant/donation? If so, would the grant/donation be subject to taxes? At the outset, it must be stressed that a non-resident conducting business activity in Armenia through a subdivision or place of business is required to independently complete and submit a return on annual incomes to the Tax Inspectorate prior to 15 April of the year following the tax year (the latter coincides with the calendar year). However, in the case of cessation of the activity prior to the end of the tax year, the non- resident should submit the return within a month after cessation of the activity. The return includes all incomes derived from Armenian sources. As mentioned above, according to the Tax Code, deductions include the amount of all necessary expenses supported by documentary evidence incurred by a non-resident in Armenia for its subdivision’s purposes, the amount of losses incurred in connection with activities implemented in Armenia and the amount of other deductions. Losses include the amount of natural or other actual losses and incidental losses of property. Natural or other actual losses are losses supported by documentary evidence occurring from shortage or damages to property.

Such losses are subtracted from non-resident’s gross income in an amount not exceeding the norms defined by the Government within the year of occurrence or identification. In case of the absence of norms or if the norms are exceeded (extra losses), the non-resident’s gross income is reduced by the whole amount of losses if:  the person who caused the damage voluntarily compensates for the loss  a decree is adopted by the body of preliminary inquiry on the suspension or cessation of the criminal action as a consequence of not revealing the person who caused the losses  the person is convicted Incidental losses are the actual losses supported by documentary evidence occurring in consequence of any natural disaster or other extreme event, as well as due to changes in legislation (e.g., prohibition of some types of activities by law). The amount of incidental losses of property are subtracted from the non- resident’s taxable income within the year of occurrence or identification. As mentioned above, the gross income can also be reduced in the amount of other deductions, except in the following cases:  expenses and losses relating to assets received free of charge  tax losses incurred by a non-resident during the previous years  the amount of received dividends Finally, the other deductions can include;  the amount of funds reimbursed to the other party of the transaction as a consequence of invalid transactions  the amount of bad debt allowances allocated to the reserve fund and the amount of repaid payables written off and recognized as income earlier, according to the procedures established by the Government  the amount of assets (goods and cash) transferred and the value of services rendered to non- commercial organizations, museums, public schools, orphanages and hospitals, but not exceeding 0.25% of gross income  the amount of 150% of salaries and wages, and other payments deemed equal thereto, in respect of every disabled person employed by the taxpayer

PART 2: GOVERNMENT Question1: What is the general structure of the state in Armenia? What degree of autonomy do government entities have for contracting? The constitutional amendments adopted through the December 2015 referendum marked a change from a semi-presidential to a parliamentary system of government. The Council of Europe’s Venice Commission published two opinions welcoming improvements on the respect of human rights and on checks and balances. The constitutional amendments adopted through the December 2015 referendum marked a change from a semi-presidential to a parliamentary system of government. The Council of Europe’s Venice Commission published two opinions welcoming improvements on the respect of human rights and on checks and balances. The Government is the supreme body of the executive power. It, based on its programme, develops and implements the domestic and foreign policies of the State, exercise general management of the bodies of the state administration system. The power of the Government is prescribed by the Constitution and other legislative instruments. All the matters pertaining to the executive power and not reserved to state administration bodies or other local self-government bodies shall fall under the competence of the Government. The Government is composed of the Prime Minister, Deputy Prime Ministers and ministers.

The candidate elected by the parliamentary majority shall be appointed by the President of the Republic as a Prime Minister. Deputy Prime Ministers and ministers shall be appointed by the President of the Republic, upon recommendation of the Prime Minister. The Prime Minister shall, within the framework of the Programme of the Government, determine the main directions of policy of the Government, manage the activities of the Government and co-ordinate the work of the members of the Government. Question 2: Do applicable public procurement rules authorize the implementation of an SIB scheme, i.e., funding social programs by means of an agreement between a government agency and an intermediary, in which payment from the government would be entirely contingent on the organization achieving measurable and positive social outcomes? There is nothing in the Procurement Act which prohibits the implementation of social projects including SIBs. Whether a particular government instrumentality may enter into a SIB scheme will depend on its authorities as described by the Articles of Association or other relevant legislative tools. Furthermore, the SIB scheme shall be scrutinised and included in the annual budget process which is integrated in a Medium- Term Expenditure Framework serving as the strategic phase in the budget allocation process. There are no further limitations for contracting schemes other than those in the regime of incapacities, conflict of interests and incompatibilities, and the principles of public functions and fiscal management. Question 3: How does the government of Armenia contract social services? Is public procurement subject to special rules or would it be subject to general and commercial law rules? Is there flexibility in the performance and supervision of contracts by government? There is no specific way for the Government to contract social services i.e., the general rules of the public procurement must apply. Public tenders consist of a series of activities that are regulated by mandatory norms of the Procurement Act, except where the law permits technical and administrative choices by the Government in the interests of expediency. As mentioned above, there are various ways in which government actors can enter into contracts for goods and services: through a public procurement process, a direct contract; or a PPP (the draft bill is being scrutinised by the Government).20 When the contract is signed by the parties they are bound to the rules of the Civil Code and there is limited opportunity for parties to revisit the contractual terms and conditions during the subsistence of the contract. The fact that the Government cannot escape the contract without approaching a court to set it aside however, provide a legal safeguard for the contracting party, as once the government entity is functus officio. Finally, the Civil Code provides the freedom of contract principle based on which the party can negotiate with the Government various conditions of the contract i.e., the dispute settlement clause (commercial arbitration), the waiver of state immunity, the applicable law (English law) etc. Question 4: May an intermediary tender for both design and implementation stages or would there be impediments because of conflict of interests? Would it be possible to combine direct contracting or PPPs with public procurement and, thus, avoid the conflict of interest issue (i.e., intermediary would either design or implement under a PPP or direct contract and, thus, be able to tender for the remaining stage.)? There are no restrictions in Armenia to tender for the design and implementation of a particular project. However, the Government may provide specific restrictions in the tender documents saying that an

20 It is acknowledged by the Government that the availability of efficient and transparent policy, legal/regulatory and institutional frameworks encouraging private sector participation are vital for effective implementation of infrastructure projects. When properly designed and implemented, PPPs may provide an invaluable source of additional private sector funding, capacity and resources to the country’s infrastructure needs. Although a number of transport, water and energy projects structured as PPPs are under implementation in Armenia, the absence of a PPP policy and clear legal and regulatory framework remains an obstacle to structuring and funding a greater number of PPP projects in the country.

intermediary is not entitled to tender for different stages of a project by doing so it will aim to avoid conflicts of interest in order to prevent collusion and cartelization.21 Question 5: Does annual budgeting apply? If so, are there legal mechanisms to ensure future payments? Can these mechanisms commit future administrations? Where the law does not readily allow for future payments, could trust structures or special vehicles be set up to make up for any shortfalls in the law? All governmental actions are ruled by budgetary laws, including those related to the payment of compensation as to long-term programmes. The basic legal framework regulating the budget process has been in place for more than a decade. The Constitution defines the separation of powers and enshrines the right of National Assembly to approve the Annual Budget Act while the Rules and Procedures Act of the National Assembly specifies the framework for the legislative deliberation of the annual budget law and its adoption. The Budget System Act, which was first enacted in 1997, serves as the organic budget law and broadly describes the budget preparation process and responsibilities of the various players involved. There have been numerous amendments to the budget system law since in its enactment to reflect ongoing reforms to budget process. The most important was the inclusion in 2003 of provisions to make the Medium-Term Expenditure Framework22 a mandatory component of the annual budget process. In addition, the Debt Management Act which was adopted in 2008 contains elements of a fiscal responsibility law and as such affects fiscal policy and budgetary management. Armenia has a well-structured budget process. The budget process is divided into two stages:  preparation of the Medium-Term Expenditure Framework, containing the macro-fiscal framework, aggregate resource envelops and key fiscal policy priorities and  the detailed budget preparation process. While the Budget System Act itself does not provide for a detailed budget calendar it requires annual issuance of a Prime Minister Decree on the Commencement of the budget preparation process which contains a detailed timetable. The budget process typically begins about 9 months before the new fiscal year begins and includes repeated interactions between the Ministry of Finance, line ministries, and the parliament culminating in the adoption of the annual budget law in December of the presiding year. It is to be noted that Armenia has two key pieces of legislation for managing the government financial system, the Budget Systems Act and the Treasury Systems Act. The Budget Systems Act is an organic budget law enacted in 1997 which covers both budget preparation and budget execution. The Treasury Systems Act was enacted in 2001 and covers budget execution in greater detail than the Budget Systems Act. In accordance with the Treasury Systems Act, the Treasury is responsible for organizing the execution of the State and Community budgets and managing their cash flows. It also has the responsibility to record extra budgetary transactions of state agencies and government Institutions. On the financing side the Treasury manages internal debt and records grants and credits. Chief financial officers of departments of state and community agencies are responsible for managing the financial and accounting services of the department under the supervision of the head of the Agency. The Treasury Systems Act also provides for the appointment of a chief accountant by the head of the government agency with the approval of the chief finance officer of the supervising department. State agencies are required inter alia, to record and report on commitments, assets, liabilities, payments, and cash flows. The Treasury Systems Act makes it mandatory for all government cash balances to be managed through a Treasury Single Account. Finally, once the Government contract has been executed, both parties would be equally bound by the contractual terms. However, if the Government fails to fulfil its contractual obligation, the party can bring a legal action as provided in the dispute settlement clause of the contract. The doctrine of promissory estoppel

21 Armenia legislation also permits the formation of “consortiums,” where two or more bidders cooperate and consolidate their individual strengths such that their bid or proposal gets pre-qualified by the government agency, provided adequate disclosure has been made with respect to the same. The consortium thus formed often forms a special company or a “special purpose vehicle” (SPV) and the SPV then signs a contract with the government and with the subcontractors to build the facility and maintain it. 22 The Medium-Term Expenditure Framework can be divided into two main parts: (i) Macro-Fiscal Framework which is aimed at maintaining fiscal discipline. The Macro-Fiscal Framework provides clarity about the overall resource envelop consistent with fiscal policy objectives, e.g., economic growth, debt sustainability, countercyclical fiscal policy, intergenerational equity that is available for budgetary allocations ; and (ii) Medium-Term Expenditure Framework which aims to support strategic expenditure allocation. The Medium-Term Expenditure Framework is prepared on a functional basis outlining sector strategies, objectives and indicative funding requirements.

would apply to both parties, and if the private party has commenced performance under the contract due to reliance on the promise of the Government, then it would be estopped from terminating the contract or withdrawing from it. Question 6: What happens if a government entity does not execute the whole of its annual budget? Would there be any negative consequences for the entity? If so, would there be legal mechanisms to enable the “freezing” of budget funds?

As mentioned above, the execution of the budget by the Government is supervised by the National Assembly under Article 114 of the Rules and Procedures Act of the National Assembly. Generally, there are no certain negative consequences for the entity. No mechanisms to enable the “freezing” of funds exist. PART 3: INTERMEDIARY

Question 1: If the intermediary carries out activities as simply an advisor, would the law require the intermediary to set up a permanent presence in Armenia? If the intermediary is receiving and administering investors’ money, would the law require the intermediary to set up a specific type of entity in Armenia? The intermediary is not required to establish a permanent presence in Armenia so as to provide advisory services. However, it is important to understand the scope and term of the activities performed by the intermediary. It means if the intermediary is regularly transacting with Armenian customers and binding contracts are being executed in Armenia, an inference could be made that the intermediary is carrying out business in Armenia, and consequently, it will need to register as s legal entity or branch to operate (see above – “Tax Aspects”). Typically, the authorities have never made such a determination on any foreign investor doing business in Armenia without setting up a permanent establishment in the territory, but it seems realistic that they would come to a determination that the foreign entity is conducting business in Armenia if the campaign pursued takes a considerable dimension. It is a matter of degree and of nature of the activity. Question 2: What types of entities are available in Armenia? There are various legal entities available in Armenia. The Civil Code recognizes two categories, namely “profit company” and the “non-profit company”. The following types of companies are defined by legislation:  limited liability companies,  joint-stock companies (open and closed)  business partnership (full partnership, limited partnership) A limited liability company (LLC) is founded by one or more persons with capital divided into ownership shares, with nominal value determined by the Articles of Association. The participants in a limited liability company are not liable for the company’s obligations, but they bear the risk of losses connected with the activity of the company within the limits of the value of their initial investment. The founders share profit according to the investment share ratio. The LLC and its founders are taxed separately. A joint-stock company is a business entity whose equity is split into a specified number of shares defining the rights and obligations of its shareholder towards the company. Only joint-stock companies have the right to issue shares of stock. The stockholders in a joint-stock company are not liable for its obligations but bear the risk of losses within the limits of the value of their shares of stock. A joint-stock company may be created by a single individual, and its ownership may consist of one person in the case of acquisition by that person of all the shares of stock of the company. The charter of the company should be registered and published. Armenian legislation defines two types of joint-stock companies – open and closed. The open joint-stock company has an open subscription for shares. The stocks are sold to the public without the consent of other stockholders, and the number of shareholders in these types of companies is not limited. In closed joint-stock companies the stocks are distributed only among its founders or a pre-determined group of persons or entities. A closed company may not hold an open subscription for its shares or otherwise offer them to an unlimited number of purchasers. A closed joint-stock company should have no more than

49 shareholders. A closed joint-stock company may create separated subdivisions, branches and representative offices, in accordance with applicable laws and regulations. A business partnership is an association of two or more people or organizations who manage a profit-making business as owners. The partners personally participate in the management of the partnership. An individual is not permitted to be a partner in more than one partnership. Business partnerships may be created as a full or limited partnership. A full partnership is a legal entity that may be established by at least two persons (general partners) who represent the business entity and act as the owners of the company. The partners jointly bear full liability for the company's debts and obligations. An individual may be a general partner in only one partnership. A limited (trust) partnership is also formed by two or more persons who are the owners or contributors to the partnership. The main difference between this and a full partnership is the liability status of the partners. A limited partnership has two types of partners – general and limited. The general partner has the right to manage the company, and also bears full liability for the partnerships' debts and obligations with all their property. Limited partners bear limited liability up to the limit of their contribution to the partnership's capital. The law allows for the establishment of supplementary liability companies and cooperatives as legal entities, but such vehicles are not widely used. Representative offices and branches. Foreign companies may operate in Armenia without establishing a new legal entity by registering as a representative office or a branch of a foreign legal entity. Representative offices and branches do not have the status of an independent legal entity, and they are governed by the rules and regulations of the foreign legal entity. The approved activities of a representative office are to represent and protect the interests of the home office, but they may not conduct independent business activities. Nonetheless the permitted scope of activities of a branch is wide, in that it is allowed to perform all necessary business functions and activities on behalf of the home office. Finally, the Civil Code provides for the establishment of a non-profit legal entity. Non-profit companies are incorporated for a “public benefit purpose” e.g., a foundation. Non-profit organisation must have a public benefit object or an object relating to one or more cultural or social activities, or communal or group interests and must apply all of its assets and income to advance its stated objects. Thus, income and property is not distributable to its members or office-bearers except as reasonable compensation for services rendered. Question 3: Assuming that the intermediary will receive funding (either through equity or loans) and will use them for the advancement of social projects, could the law of Armenia consider that the intermediary is carrying out financial intermediation activities or any other sort of regulated activity? What thresholds apply (if any) for being considered a regulated entity (i.e., under financial regulations)? The Investment Funds Act of 2010 provides that investment fund means a legal entity or a group of assets that are pooled on the basis of fund management contracts, which is founded and/or operates having the purpose of or one of its main purposes being the return of investments by investors through collective investments in securities and (or) other assets under a unified investment policy in the form of increase of capital, dividends and (or) other financial income in line with the investments done. However, it is to be noted that if the intermediary uses the funds it received for the implementation of the SIBs (i.e., that the intermediary does not simply keep the funds and commits to simply managing the funds in return for a profit), it is not required to get a license provided by the Central Bank of Armenia. Question 4: Does the law of Armenia set forth foreign exchange constraints or mechanisms for remitting money into Armenia and converting it into local currency? According to Article 5(1) of the Current Control Act there are no limitations on the remission of money into Armenia. Article 7(1) of the same Act states that the right to convert the money into local currency is not limited. It is to be emphasized that foreign investors may freely invest in Armenia, provided that suitable documentary evidence is scrutinised by the bank concerned, in order to ensure that such transactions are concluded e.g., at arm’s-length, financed in an approved manner, etc. Again, any income earned on the investment may be transferred abroad. Question 5: If the intermediary requires bringing foreign personnel into Armenia, what types of visas/permits may be required?

Article 95(3)(6) of the Labor Code states that the right to sign a contract with foreign citizen depends on the duration of validity of the work permit or residence permit. It is important to note that the work permit obtaining procedure is suspended until 01.01.2019 under the decree of the Government N: 827-N. It is to be noted that the citizens of 45 countries with all types of passports are exempt from the requirement to obtain a visa to enter Armenia. They can stay in the territory of Armenia up to 180 days per year. Foreigners investing in the Armenian economy may qualify for one of the following residence permits:  special residence permit, issued in the form of a passport and valid for 10 years  permanent residence permit, issued in the form of a card and valid for 5 years  temporary residence permit, issued in the form of a card and valid for 1 year In practice, the immigration authorities (Police and National Security Service) will consider the nature of the investment, its size, location, creation of jobs, your nationality and other factors in deciding whether you qualify for a residence permit. Question 6: Is there any requirement for intermediary’s directors/officers in Armenia to be national or residents of Armenia? Armenian law does not require that the directors or senior executives of a company be Armenians or have residency in Armenia. PART 4: SERVICE PROVIDERS

Question 1: Assuming that the intermediary signs a contract with the government, would the law allow the intermediary to freely choose and contract with the service provider? Would the contract with the government restrict the choice of services provider made by the intermediary? The notion of service provider is not determined under Armenian legislation. It will depend on the negotiation of the respective contract. Question 2: Is there a substantial risk that services providers’ personnel could be re-characterized as employees of the intermediary? What mechanisms are available for reducing/managing this risk? It is unlikely that the employees of the Service Provider would be treated as employees of the intermediary. Article 6(1) of the Labor Code clearly stipulates that an employment relationship between an employer and employee is regulated by a labour contract. The parties should ensure that elements required for an employment relationship are not present in dealing with personnel of the Service Provider, for instance, entitlement to basic salary and elements of control and subordination. Furthermore, in the contract between the intermediary and the Service Provider, a clause could be inserted to the effect that the personnel of the Service Provider shall, at no time, be considered as employees/agents of the intermediary.

Annex 2: Examples of dairy factories in Shirak Marz

Ashotsk Cheese Factory, LLC Address: Musaelyan Village Director: Jora Baghdasaryan Mobile: +37477 727278 Orientation: Cheese Products: Local and European types of cheese Lori-classic, Chechil, Suluguni, Emmental. Milk source: About 400 local dairy farms

Amasia Cheese Factory, LLC

Address: Amasia Village, Shirak Marz Director: Shaboyan Norik Mobile: +37493 325410 Orientation: Cheese Products: Lori-classic, Amasia, Elianor, Chanakh, Chechil, Suluguni, Sheep cheese Pikorino, Smoked cheeses, etc. Milk source: About 300-400 local dairy farms Iqit, LLC Address: Azatan Village, Shirak Marz Production of food and milk products Director Igityan Andranik Mobile: +37491 215535 Orientation: Cheese and dairy products Products: Chees -- Lori, Shirak, Edamer, Sulguni, Gyumri, Tilziter, Graf Arlov Dairy – milk, plain yogurt, sour cream, tan etc. Milk source: Milk collected from farmers and imported milk powder. The factory claims to have 5,000 suppliers, but this number is highly elevated. Bandivan Kat, LLC Address: Bandivan Village, Shirak Marz Manager: Hovakimyan Arman Mobile: +37491 412579 Orientation: Cheese and dairy products Products: Cheese -- Lori, Chanakh, Sulguni Dairy – milk, plain yogurt, sour cream, tan, etc Milk source: Mostly own milk production.