New rules for investing in a Russian strategic company.

08.07.2010

Although the global economic crisis hit the Russian economy hard, foreign direct investment in Russia remained at a high level throughout 2009 and it is expected to stay that way in 2010.

According to BNE 2010 Outlook FDI has fallen from a high of $27bn in 2008 to around $17bn in 2009, which is still well above the 2007 level. However, a combination of complex market conditions and strict corporate governance issues means that the level of foreign direct investment in Russia does not reflect the tremendous opportunities there are and remains very low

As time goes on, there certainly is a clear effort from the Russian authorities to maintain the current level of interest and also attract more investors. Russia’s large consumer market still seems to be attractive enough, but it is the costs that foreign businesses have to bear and the complex bureaucracy procedures and legal uncertainty they face that discourage them as they often won’t make enough of a short-term profit to get involved in the first place.  According to estimations from Renaissance Capital, it costs around 34% more to build a distribution centre in Moscow than it does in London and it takes six times longer to obtain a construction permit in Russia than it does in Sweden.

The Russian government has always considered foreign investment into the country as a top priority. In the early nineties, Russia determined that the legal regime of foreign investors’ activities and profits allocation could not be less favorable than the regime applied to local investors except for some specific exceptions determined by federal laws. The exceptions were not extensive and concerned the banking and insurance sectors as well as the aviation industry. Yet, there was never any question of restraining foreign investment into the country.

In order to strengthen the independence of the Russian economy and establish the sovereignty of the country, systematic steps have been taken to develop special regulatory norms for foreign investment. Eventually, a law on foreign investments into strategically important companies in the fields of national defense and security, was passed in April 2008.

Foreign companies, both those already present in Russia, and those ready to invest into the country, have expressed caution towards the new order. In addition to maintaining restrictions in the banking and insurance sectors, the law has introduced a special procedure to follow for foreign investments in another 42 sectors of activity. These include: radioactive substances and nuclear facilities, aerospace activities, oil & gas pipeline transportation, rail transportation, transportation terminals services, exploration and mining in the subsurface areas of federal significance, television and radio broadcasting, editing and publishing of periodicals of large circulation. These sectors are considered strategic to the Russian government. Foreign investors must follow the terms of the company charters on capital subscription above certain levels and the completion of deals to obtain the control of the company. This law also applies to transactions concluded outside of Russia, if they can lead to extensive control over Russia’s strategic companies. A foreign investor intending to exceed the established limits for capital subscription or to gain control over a strategic company must obtain the approval of a special government commission.

People ask how justified the suspicion surrounding this new law is. Looking at its application over the last two years, it doesn’t seem to create unnecessary obstacles to foreign participants in Russian strategic companies. The Government Commission has reviewed around 50 applications, most of which have been granted. However, the practice has identified a number of defects in this law and the government recognizes the need to revise parts of it. 

It is possible to diminish the control of the government on some foreign investors’ activities, especially if you take into consideration the difficulty identifying whether a company is included within a strategic industry or not due to different interpretations of certain types of activities. The provisions made in the case of  non-strategic companies taking on strategic activities (such as banks who codify their information) are far from satisfactory. As an example, investors seldom accept the rules indicating that when a company discovers a deposit of federal significance, the government can deny the right to exploration and mining in this field. The law does not regulate issues related to the participation in Russian strategic companies in case this company has depositary receipts representing shares.  (the lines two sentences are not very clear and I am not sure they are directly relevant to the rest of the article. I would consider taking them out)

The Federal Antimonopoly Service and the Ministry of Natural Resources are working on the amendments to this law. The most pressing issues are, in my opinion, reducing the list of strategic activities, facilitating foreign investors’ access to the Russian mineral resources, and reducing the number of documents and other information that investors are obliged to submit for deals approval.

In the end, Russian government is aimed to keep interest of foreign investors in the Russian markets by all means. Thus it will do its best to try and stabilize the economy, working in a range of different directions. We already see positive trends in its efforts both from a legal and economic perspective. And latest Eurobond issue is a benchmarking example - Russia's launch of its first bonds on international markets since the 1998 crisis was a success, and it will definitely stimulate further foreign investments.

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