Strategic Sectors Law Update – First Commission Meeting of 2014

On June 26, 2014, PM Medvedev chaired the first 2014 meeting of the Commission on Foreign Investment. At the meeting, several deals were discussed/approved and amendments to the Strategic Sectors Law were discussed.41d4eb09b1f883a168e5

According to public sources, the following deals were addressed:

  • Fresenius Kabi (Germany) -> Binnopharm/Alium - the German-based Fresenius Kabi purchased stakes in Binnopharm and Alium from Sistema JSFC and other shareholders. The acquired companies manufacture pharmaceuticals in Russia such as Combivir (HIV treatment), Salbutamol (asthma), and Erythopoietin (anemia).  Fresenius Kabi will own 51 percent of a joint venture that will hold 100 percent of the companies’ shares (Sistema will retain 37 percent and Zenitko 12 percent).
  • Palfinger (Austria) -> Velmash - Palfinger of Austria together with Steindl Forsttechnik GmbH purchased respectively 60 percent and 20 percent interests in Velmash, a Russian manufacturer of hydraulic loading and unloading equipment. The remaining 20 percent will be held by PMHJ Holding Global Ltd., about which there is literally no information on the internet. I suspect it is either
  • EuroChem (Russia*) -> Astrakhan Oil & Gas Company - EuroChem (ЕвроХим) is purchasing the Astrakhan O&G Company (ANGK). The deal was subject to the Strategic Sectors Law despite the beneficial owner of EuroChem (Andrey Melnichenko) being Russian because, as usual, the transaction was done through various offshore trusts/companies. FAS had previously delayed the deal over competition law concerns. In February of this year, EuroChem acquired 20.1 percent of ANGK for RUR 1.34 billion (USD 38.09 million). The previous owners of ANGK were Gazprombank and the Federal Agency for State Property Management.
  • Abbott Laboratories (U.S.) -> Veropharm - the meeting touched on an application by Abbott to purchase an ownership stake in Veropharm (Верофарм) for USD 495 million from OOO “GardenHills” (ООО ГарденХиллс”), a holding company owned by Roman Andreev with 80 percent of the shares Veropharm. GardenHills recently purchased most of the outstanding shares, which previously traded freely on the RTS. FAS head Igor Artemev stated that Abbott submitted an ‘incomplete application’ and had inquired about the missing documents, which prevented the commission from approving the deal that day. Artemev alluded to a deal from 2013 that the commission denied – Abbott’s proposed acquisition of Petrovaks – but added that he thinks the Veropharm transaction will be a success.

Proposed Amendments to Strategic Sectors Law

Artemev also summarized developments with proposed amendments to the Strategic Sectors Law, which have been dragging out for quite some time. The draft law has already been approved in the first reading, and the second/third readings – which will contain a number of amendments – are scheduled to be done later this year. Here is a copy of the latest version of the amendments, which you can track here.

 

Posted in Business, Business and Economy, Dmitry Medvedev, economics, FAS, Foreign direct investment, foreign investment, Gazprombank, legal update, legislation, oil, pharma, russia, strategic industries | Leave a comment

The Matrix Strikes Back – the Sanctions and Russia’s Post-US Economic Model

Everyone agreed that the first round of Russia sanctions were laughably ineffective, aimed at a motley assortment of Kremlin B-teamers, whom Putin demoted to limit the damage they can cause and about whom Putin couldn’t care less. The second round of sanctions hit closer to the mark, including squarely at members of Putin’s ‘inner circle,’ including his long-time friends – Gennady Timchenko and Brothers Rotenberg. This Monday, the US built on and deepened this strategy with another round of sanctions. In short, the sanctions add the listed individuals/entities to the ‘Specially Designated Nationals’ (SDN) List, which prohibits US persons and companies from doing business with them (e.g., no contracts, no bank deposits, nothing), and with any entities owned or controlled by them.

Targeting the Cancer

Although the major ‘shock’ factor from Monday’s sanctions was the inclusion of Igor Sechin and Sergey Chemezov – but not Rosneft and Rostec, respectively – this seems more like optics. What is more interesting is the addition of entities owned/controlled by Timchenko/Rotenberg. Of course, such entities would already be covered by the sanctions via the individual, but the ownership schemes they prefer are not always models of transparency. Supposedly, the targeting of all business holdings linked to Timchenko and Rotenberg is a strategy of making them ‘radioactive‘ – to essentially freeze them out of the US-led economic system.

This poses some interesting issues, particularly for US/Western companies still trying to go about their day in the hopes that the tensions blow over:

  • Unlisted Entities – what about unlisted entities wholly-owned/controlled by Timchenko or Rotenberg? The rule is they are covered by the individual’s inclusion. Thus, OOO “Gazprom Burenie” (Burgaz) would be covered by the sanctions, as it is 100 percent owned by Rotenberg (who bought it from Gazprom for far below-market value, of course). But Burgaz is the primary drilling contractor for Gazprom. Foreign companies do millions of dollars in business with Burgaz every year.
  • Unclear Ownership – it is not uncommon for rumors about Timchenko’s ownership of a company to swirl for years, he denies it, and then one day it is an established fact. Thus, it’s difficult to know how to treat companies such as Novatek, in which Timchenko holds 23.4 percent, but the rest of the shares are held by close associates (Leonid Mikhelson) or Gazprom. This is the whole system in Russia now – a harmonious marriage between the state and Putin-selected oligarchs with the goal of extracting as much wealth from the country as possible.

To accomplish this goal, they need schemes where money can be transferred from public to private hands – sometimes it’s the government selling a public company at below-market prices; sometimes its the state-owned joint venture partner overpaying for shares held privately; and other times it involves the use of a sham company during a procurement to artificially mark up the price (something both Timchenko and Rotenberg have caught doing, btw).

But they also need access to international capital markets, foreign bank accounts in secrecy jurisdictions, and Western companies trying to sell products to state-owned companies. By targeting Timchenko/Rotenberg, who really do frequently surface in Russia transactions, the US may very well deny them access to these essential tools, and probably will not do much damage to the Russian economy in the process.

In a way, we unplugged Russia from the Matrix, but there’s no alternate reality waiting for Russia where it is a self-sufficient great power. They’re just outside.

Some observers have argued that the sanctions are intentionally ineffective – more of a face-saving measure vis a vis Ukraine. I do agree that there is not necessarily a logic of effectiveness driving the development of these sanctions. What I have heard – second-hand – from sources directly involved in the process is that the whole thing is a circus, with a lack of imagination for how to tailor them to Russia, lack of familiarity with the players in Russia, etc. (that’s the sort of policy acumen you develop after ignoring a country for 20 years). But it seems unlikely that the strategy is brilliantly intended to look tough but fail. I think it’s just random flailing like the US government does in response to every crisis.

What makes the sanctions even more significant, however, is the reaction they are getting out of Russia.

If You Build It, [T]he[y] Will Come

Russia is no North Korea – Putin no Kim. Wild animal photo ops notwithstanding, the systematic extraction of wealth from Russia cannot be built on a Putin personality cult. There has to be an idea, and the current leadership’s indelible Cold War experience provides a convenient fall-back position. The general population’s nationalism, combined with the long-running Russian tendency to turn inwards, provides fertile ground to cultivate this idea. In fact, some reporting indicates that the Cold War mindset shaped the thinking of Putin’s conservative advisers on Crimea before the purported crisis that necessitated Russian intervention.

As for Sechin, we do know that he frequently reviews the minutes of Communist Party congresses from the Soviet era; as one colleague put it: “He was drinking from this fountain of sacred knowledge so that Russia could restore its superpower status and take its rightful place in the world.” Thus, the fall-out with the West over Ukraine presented not only a challenge, but an opportunity to build that alternate reality.

PM Medvedev trotted out the most comprehensive version of this ideology last week, in a report to the Duma on the government’s work. Really, the speech is a reheated version of Medvedev’s standard State of the Union from when he was president – i.e., non-diversification of economy, low investment, poor institutions – minus the laser focus on pervasive corruption and with an added dash of nationalism. Medvedev explained, “Furthermore, the current situation should be viewed not only as a challenge, but also as a great opportunity for improving government efficiency and creating a new foundation for the national economy based on domestic production.” 

The problem is that Russia has long pursued efforts to encourage a more multipolar global system – e.g., establishing the Eurasian Customs Union, promotion of Moscow as financial center, economic partnerships with ‘independent’ states like Venezuela – and modernize its economy. Most of these projects have not gotten off the ground – except the customs union – and none have reduced Russia’s reliance on foreign goods, foreign technology, and foreign financial infrastructure to keep its economy alive. Based on the numbers, Russians simply despise (i) buying domestic goods and (ii) keeping their money in Russia. At a macro level, the economy desperately needs investment to fuel productive enterprises, mostly from Russian enterprises and individuals that stash their cash offshore. In other words, Russians make economic decisions based on the same criteria that guides everyone else, and they don’t like what they see in Russia. Will doubling down on its strategy of playing global gadfly help?

De-Dollarization – Glazyev’s Dream

Reducing or eliminating its reliance on US dollars is reportedly a key elemglazyevent of Russia’s plan to create a ‘new foundation for the national economy based on domestic production’. The de-dollarization plan is the baby of Sergey Glazyev, advisor to Pres. Putin on regional economic integration (pictured right). According to a copy obtained by Vedomosti, Glazyev’s plan includes the following steps:

  1. Transition all state assets in USD/EUR to ‘neutral’ currency
  2. Return all state-owned assets (e.g., precious metals) to Russia
  3. Sell bonds of NATO countries involved in sanctions
  4. Suspend exports of gold, precious metals, and rare earth metals
  5. Monetary swap with China to finance critical imports and transition to settlements in national currencies
  6. Creation of a SWIFT-like local system of interbank information exchange for payments in the Customs Union, the CIS, and ‘partner countries’
  7. Creation of card payment system in Customs Union similar to Visa/Mastercard
  8. Limit foreign exchange position of banks and require declarations of major non-trading transactions; future introduction of tax on capital outflows and speculation
  9. Transition to settlements in national currencies in the trade of the Customs Union and other countries; conclusion of new contracts for export of hydrocarbons in RUR
  10. Monetary swaps with countries to finance trade
  11. Rapid reduction of dollar-denominated instruments from reserves and debt obligations to countries involved with sanctions
  12. Substitution of loans by state banks and corporations in USD/EUR with loans in RUR on the same terms
  13. Advocacy work with the population regarding the need to convert from USD/EUR deposits to RUR; freezing of Central Bank liabilities denominated in USD/EUR
  14. In response to trade embargo, initiate ‘critically important operations’ through Belarusian and Kazakh enterprises
  15. Conversion of strategic enterprises with offshore ownership in hydrocarbons and real estate sectors to national ownership

I agree with Vedomosti’s assessment: Glazyev’s plan has mostly nutty/impossible parts, but some very sensible and likely helpful parts. My personal favorite is the last – Russia’s expressed concern that foreign ownership of ‘strategic’ enterprises may jeopardize national or economic security is belied by the reality that most of these assets are owned via offshore holding companies incorporated in secrecy jurisdictions.

The proposal to reduce reliance on the US dollar and USD-denominated instruments (namely, Treasuries) has generated excitement before. For example, right before the first round of sanctions last month, the Fed reported a record drop in US government securities held in custody at the Federal Reserve. The USD 2.86 trillion held by foreign central banks fell by USD 104 billion during the week ending March 12 (Russia holds approx. USD 123 billion of the total foreign holdings).

There is No Red Pill

Monetary issues are not an area of interest or expertise. Still, based on available research and commentaries, it seems like predicting the end of the US dollar as reserve currency is a perennial pastime of skeptics on the left and right. The interest in the subject appears to have remained constant over the past decade, and you can find roughly equal numbers of articles arguing opposite sides of the issue. Sure, it will definitely happen some day. But for now, it seems clear that the Yuan – probably the only rising challenger to the dollar – is far off from being a reserve currency. And the broader question is – who else will fill that role? Nobody but the US for the moment.

Russia’s folly in its response to the Ukraine conflict is that it assumes the existence of some national autonomy on how to engage with the rest of the world. Russia seems to believe it can reject the terms of the US-led system and go out on its own – the state equivalent of me marking up the iTunes Terms and Conditions and sending revisions to Apple for consideration. The power differential is irrelevant – Apple could not deal with me on an arms-length basis even if it wanted to; it wouldn’t work..

Russia cannot expect to be successful at ‘opting out’ of the US system and creating an alternative. The existence of foreign investment, global trade, commodities markets, and financial centers is inseparable from the US system. Russia’s leaders have already acknowledged ad infinitum that Russia needs these things to modernize. Thus, it’s disappointing to see that Russia’s grand strategy for the post-US world is hoarding gold and precious metals.

If Russia pursues these strategies in response to the sanctions, it will be accurate to say that the sanctions ruined Russia. Not because the sanctions directly damaged the Russian economy, but rather Russia’s reaction to them did.

Posted in Business, Business and Economy, Chemezov, clans, corruption, Dmitry Medvedev, Economic development, economics, Foreign direct investment, foreign investment, foreign policy, goskorporatsii, Government of Russia, Medvedev, offshore, power vertical, Putin, Putin's Plan, Rotenberg, rule of law, russia, Russian economy, siloviki, state corporations, strategic industries, Timchenko, u.s.-russia relations, Vladimir Putin | 4 Comments

Strategic Sectors Law Update – Second (and Last) Commission Meeting of 2013

On November 13, 2013, PM Medvedev held the second and final meeting of the Commission on Foreign Investment for 2013. According to public sources, the following deals were addressed:

  • China National Oil and Gas Exploration and Development Corp. –> Yamal LNG - the Commission approved CNODC’s acquisition of a 20 percent voting stake in Yamal LNG, which is working to develop LNG production capacity on the Yamal peninsula. CNODC will acquire its shares from the current owner of 80 percent of Yamal LNG, Russian company NOVATEK (НОВАТЭК). Total SA owns the other 20 percent of shares.
  • Jilin Horoc Chinese State Company –> Geotekhnologiya - the Commission approved a request by Jilin Horoc to acquire a controlling stake – 25 percent – in ZAO “Geotekhnologiya“, which owns major nickel deposits – 43K tons – in the Kamchatka region.
  • Liebherr –> Liebherr-Aerospace Nizhny Novgorod -  Swiss equipment manufacturer Liebherr won approval to increase its ownership in OOO “Liebherr-Aerospace Nizhny Novgorod” to 75 percent. Currently, Liebherr owns 49.9 percent and the other 50.1 percent was held by Vladimir Luzyanin, President of OAO “Gidromash“. Liebherr’s investment will be focused on the production and repair of equipment for dual-use aircraft.
  • Hetero FZCO –> Makiz-Farma - the Commission approved Indian Hetero’s purchase of Makiz-Farma from unknown owners of multiple offshore companies (pretty good history here).

Global Ports –> National Container Company (Национальная Контейнерная Компания)

The last transaction is quite interesting and merits more detail. The Commission approved Danish port terminal owner/operator Global Ports’ acquisition of 100 percent of National Container Company (NKK) at a purchase price of USD 291 million. The deal will make Global Ports the undisputed king of Russian container terminals, particularly in St. Petersburg, where it will now control two of the biggest ports (PLP and PKT). But behind the Western corporate PR of Global Ports there is a truly Russian story.

Although Global Ports is nominally ‘Danish’, the primary individuals behind it – Nikita Mishin, Konstantin Nikolaev, and Andrey Filatov – are Russian. The three own Transportation Investments Holding Limited (TIHL), which controls 30.75 percent of Global Ports shares. TIHL is a Cyprus company, whose main shareholder (94 percent) is Leverret Holding Ltd Limassol Cyprus. Leverret is in turn 100 percent owned by Mirbay International Inc, a company incorporated in the Bahamas. TIHL owns its shares in Global Ports through its 100 percent ownership of N-Trans. Here is a picture of the whole structure: TIHL Shareholding   (source: http://bankwatch.org/documents/Vinci_oligarchs_taxhavens_Khimki.pdf) 

Many Russian media outlets have argued that N-Trans’ secretive ownership structure is aimed at concealing a fourth individual: Igor Levitin, who was Minister of Transportation from 2004 until his resignation in 2012 (he now serves as an adviser to Putin). It is undisputed that Levitin worked as a manager at N-Trans’ predecessor from 1996-2004, and that there are links between companies owned by his family members and the three official TIHL shareholders.

NKK also has an interesting ownership structure and history. Apparently, the owners are Andrey Kobsar and the management of First Quantum (FQ), a UK company. Duma Deputy Vitaliy Yuzhilin owned FQ since the late-1990s, and apparently continued to own part of FQ at least up until last year, but reportedly sold off his stake.

In 2002, FQ entered into a joint venture with a company called Severstaltrans to form NKK. But in 2006, Severstaltrans withdrew from the investment after a falling out with FQ. Later in 2008, Severstaltrans changed its name to N-Trans, when Aleksey Mordashov, oligarch CEO of Severstal, agreed to exit the company. Shortly after, N-Trans combined its global port holdings under a single brand: Global Ports.

Thus, Global Ports is essentially reacquiring its share – and more – of the company it started in 2002 – NKK – from its former JV partner – FQ, after each company has ‘officially’ shed its ties to any hidden officials with beneficial ownership.

Posted in Foreign direct investment, foreign investment, Law, legal update, offshore, oligarchs, strategic industries

Growth of Russian Bureaucracy – Parkinson’s Law

Parkinson’s Law is a principle governing the natural expansion of bureaucracies, famously articulated in a 1955 essay in the Economist. Under Parkinson’s Law, a government bureaucracy – and, arguably, the administrative staff of some large modern corporations – will naturally grow, irrespective of any change in actual work to be done by said bureaucracy. The reason is boils down to human nature: an official with an excessive – either real or perceived – workload can either (i) split his work with another official of equal rank, (ii) retire early, or (iii) hire subordinates. As the Economist essay explains, variant (i) is unlikely because it elevates a rival for promotion, and variant (ii) is unlikely because it means foregoing retirement benefits, which means variant (iii) is the most rational and common choice for the official. The process replicates itself on down the ranks. But the solution proves to be worse than the problem. The shuffling of a task through multiple layers requires communication and oversight, not to mention the social network element of adding more individuals to a process (e.g., personality conflicts, personal drama). Thus, the official ends up with just as much – likely more – work than he had in the first place. Hence, bureaucracy.

The Economist essay – using data from the British Civil Service – gives some examples, and finds that the “all the researches so far completed point to an average increase of about 5¾ per cent per year.” I was curious whether the Russian bureaucracy has followed Parkinson’s Law, and indeed it has. From 1999-2011, the total number of Russian bureaucrats has grown from 485,566 to 827,503, an increase of 70 percent, or an average increase of 5.8 percent per year.

rost russkoi burokratii

 

The numbers have fallen a bit from their peak in 2009, which is to be expected given the global financial crisis. Commentary at the time the 2009 numbers were released noted that during the Soviet era, the bureaucracy amounted to 0.1 of the total population, whereas now it is closer to 2 percent (note that these numbers include a broader category of people).

The bureaucracy in the United States has also grown, but not in accordance with Parkinson’s Law. Over the same time period – 1999-2011 – the total number of federal employees grew from 4,135,000 to 4,403,000, an increase of 6.5 percent, or an average increase of 0.54 percent per year.

 

Posted in bureaucracy

How the ‘Experts Case’ Explains Everything that’s Happening in Russia Right Now

As covered in the previous post, in June a prominent Russian economist – Sergey Guriev – fled Russia after investigators began targeting him in the case of a 2011 report on the human rights implications of Mikhail Khodorkovsky’s ongoing incarceration. This case – popularly referred to as the ‘experts case’ (дело экспертов) – has gathered momentum since Guriev’s departure. At first, the experts case was officially focused narrowly on the 2011 report. Fast forward two months and the case has officially expanded scope to the general ‘humanization’ (гуманизация) of Russian criminal law, which allegedly took place during the Medvedev administration.

For example, one unnamed official told Vedomosti that investigators asked him whether Mikhail Paleev, a legal aide to Medvedev, was influenced by the Khodorkovsky report authors while he led a working group on the modernization of criminal law.

Михаил Палеев. Фото: pravo.ru

Who is Paleev? There are two notable points: (1) he is such an obscure and insubstantial public figure that finding a picture of him was a challenge until today; and (2) he has been in his position since the Putin administration. In other words, he’s a faceless lifelong bureaucrat. With some imagination, you can see how Paleev is an ideal mark – no siloviki connections, no liberal star power. If he fled Russia, I would wager that it would not make the front page of the NYT.

The Vedomosti report also noted that the investigators have also started asking questions about high-ranking officials and Duma deputies that worked on humanizing Russian criminal law.

The Humanization Project History

The idea of ‘humanizing’ the Russian criminal code was indeed a major priority of then-Pres. Medvedev, who in 2009 spoke of the need to ensure that criminal penalties are “commensurate with the seriousness of the crime” and to “make greater use of so-called administrative preclusion, that is, prosecute only in the case of repeated administrative offenses.” The result was a series of reforms that reportedly led to the freeing of 80,000 inmates out of a total prison population of 864,000. Medvedev also attacked harsh sentences for white collar crimes, including tax evasion. News coverage of the reforms at the time seem to confirm that Paleev played a minor role in pushing the president’s agenda and did draft the text of the working group he led. But, news reports reacting to recent events have stated that “not one of Paleev’s proposals was included in the package of reforms.”

Release the Chaika

The experts case took on its new aggressive approach and received official backing last month when Prosecutor General Yury Chaika gave a speech before the Federation Council. The day before his speech, Chaika attended a ‘working meeting’ with Pres. Putin at the Kremlin (coincidentally, I noticed that it was the first ‘working meeting’ the pair had since Putin resumed the presidency).
The purpose of the meeting was to discuss “work in the sphere of protecting entrepreneurs, and separately reported on the audit results of NGOs as well as issues related to corruption in the education sector” (my emphasis).

In fact, if you do a word search of the meeting transcript, ‘entrepreneur’ in Russian appears four times (incl. the title), and ‘NGO’ in Russian appears 15 times; ‘foreign’: 6 times.

That said, in his remarks on entrepreneurs, Chaika did approvingly cite the “humanization of the legislation” with respect to business crimes. But, Chaika continued, “These recent amendments to humanize the legislation, where the punishment of incarceration has been replaced by penalties, unfortunately, we have hear a big slip-up.” This exchange followed (with Putin interrupting Chaika to prevent him from moving to the next topic):

Putin: one moment, in your opinion, should this judicial practice be tougher?

Chaika: yes, tougher. I believe that the Supreme Court should evaluate this practice in light of our conclusion. We need to analyze this practice and give you suggestions.

Chaika then went on to report about corruption in educational institutions and, finally, the audit of NGOs. To summarize, Chaika reported that many NGOs are acting as ‘foreign agents’ and some were still not in compliance with the law.

The following day, Chaika gave a speech in front of the Federation Council. The speech focused on the NGO audit, but Chaika managed to synthesize the previously separate issues of humanizing legislation and foreign agent NGOs into a single narrative by stating that an NGO receiving money from abroad was “preparing legislation aimed at liberalizing punishment for economic crimes.” Chaika elaborated:

The activities were agreed upon with the official representative of the United States, accredited by the U.S. Embassy in Russia, who also participated in some of the events, and the former Attorney General participated in a round table at the State Duma.

We are not against the humanization of legislation. Just the opposite. And you [the Federation Council] make laws. But that is why we believe that similar processes should be open and transparent. And if an NGO receiving funds from abroad participates in these processes, the state has the right to know who is funding it and in whose interests it is preparing a bill. And we do not understand why realizing the idea of humanization requires assistance from representatives of the United States, which is known for economic crimes often carrying sentences of 150 years and more.

Breaking it All Down

There are several relevant observations that can be made concerning the chain of events described above and in previous posts on Guriev and the NGO law:

  • The as-yet unsubstantiated claim that the 2011 Khodorkovsky report was ‘purchased’ by Khodorkovsky and Lebedev has turned into an official fact, warranting a broader investigation even though the initial investigation has not yielded any results.
  • Russian NGOs that receive any funding from abroad are facing strict scrutiny, regardless of the nature of their relationship/interaction with foreign donors.
  • The benign – and often boring – rule of law activities conducted by U.S. Embassies all over the world will now be viewed retroactively as evidence of some underlying conspiracy. This posture is particularly strange given the regularity with which members of Chaika’s own team – including his own Deputy, Aleksandr Buksman – travel to the United States to meet with their DOJ counterparts. For an example of these activities, see this list I pulled from reports by the DOJ OPDAT section. Indeed, these activities certainly seem less harmful than leaking secrets to a private American intelligence company.
  • The purported Khodorkovsky-foreign agent-NGO-U.S. government nexus is now an official basis for unraveling the Medvedev-era criminal law reforms and launching investigations against any person or organization who can be tied to that effort. Note that this approach relies on a blend of both foreign and domestic enemies who are both known (e.g., Obama, Khodorkovsky) and unknown (e.g., financiers in U.S. or European capitals funding groups to make Russia less Russian).
  • All of these observations are even more significant in light of the targeted politicized attacks on Navalny, Udaltsov, Ponomarev and others.

The Search for Meaning

All of the observations listed above tend to suggest a general outline of the shape of events to come in Russia. Hyperbolic comparisons to the 1930s are not helpful, but it seems possible that a modern, less bloody, variant of the Stalinist purges could take place. Specifically, the facts suggest that Putin has unleashed all law enforcement resources on investigating first a report and now an entire category of activity that is protected under the Russian Constitution.

Moreover, the vague threats to investigate unnamed Duma deputies who ‘participated’ in the criminal law reforms are highly disturbing. Read that again: they are threatening to investigate members of their rubber-stamp legislative body for doing what they were told to do, as expected, by the previous administration.

Thus, the siloviki desire to displace the Medvedev team, roll back curbs to law enforcement powers (e.g., pretrial detention), and inflate the risks of participating in any sort of ‘opposition’ activity. In their heads, this will have the effect of turning back the clock to 2005.

The problem is that the people, ideas, and institutions with which they disagree actually exist in their country. To some extent, their mere existence poses a threat to the very identity of the average siloviki, hence the need to concoct conspiracies that transform them into instrumentalities of an external threat (i.e., U.S. and lesser degree EU). Putin is perhaps the greatest representation of the average silovik, whose personal self-image is based on a country and level of influence that no longer exist. If you add the fact that a reasonable number of your own people disagree with you, it must be maddening. But conflating the ‘opposition’ with the external threat both lifts the obligation to reconsider the course, and reaffirms the old identity (why would the external threat be interested unless Russia still had some of its Soviet-era clout). Russia’s leaders are stuck in the action movie that is their life, and will react negatively to anyone who refuses to play their supporting part.

Short- to medium-term, it is difficult to see a positive dynamic emerging from the approached preferred by the current Russian leadership. The worst case is that unrestrained siloviki will bring back some of the repressive apparatus from the Soviet era, but will ultimately turn on one another in the fight for spoils. In the words of the great Tony Soprano, “It’s called a bust out.”

Posted in Bastrykin, Chaika, criminal law, Dmitry Medvedev, Economic development, economics, Government of Russia, Guriev, investigative committee, legislation, Medvedev, mvd, officials, prosecutor general, Putin, rule of law, russia, Russian economy, siloviki, u.s.-russia relations, Vladimir Putin | 2 Comments

The Guriev Affair – Signal or Noise?

Last month, well-known Russian economist Sergei Guriev fled Russia in an apparent attempt to avoid what he described as a politically motivated investigation of his involvement in co-authoring a 2011 report critical of Russia’s prosecution of Mikhail Khodorkovsky. In an interesting twist, Guriev was reelected to Sberbank’s board on Friday.

Who is Guriev?

Guriev was serving as head of the New Economic School in Moscow and has a professional background in economics. Guriev was a member of the Presidential Council on Science, Technology, and Education, as well as the Presidential Commission for the Implementation of Priority National Projects and Demographic Policy. Importantly, Guriev was also one of the authors of the idea for the Skolkovo Innovation Center and was a member and driving force behind Dmitry Medvedev’s “Open Government” (Открытое Правительство) initiative.

Guriev also serves on the boards of directors at various companies, including OAO “Sberbank”, OAO “AlfaStrakhovanie”, and OAO “Rossiiskaya Venturnaya Kompaniya”. Guriev publishes a regular column at the Russian business daily Vedomosti, and has also published articles in The New York TimesMoscow Times, Project SyndicateEkspert, and other outlets. Since fleeing Russia, Guriev has taken up residence in Paris at the Instituts d’études politiques.

What was the proximate cause of Guriev’s departure?

News of Guriev’s departure first broke on Tuesday, May 28, when it was first reported that he would leave his position at the New Economic School. Guriev was quoted as stating that he was merely abroad on vacation, and not as part of a permanent move. By Friday, May 31, Guriev acknowledged to the NYT via email that he does not plan on returning to Russia.

Guriev explained that his decision stemmed from a conflict-of-interest investigation into the authors of the 2011 report on the Khodorkovsky case prepared by the Council on Human Rights. Essentially, investigators allege that experts involved in the preparation of the 2011 report were paid by Khodorkovsky’s NGO “Open Society” (Открытое общество). Still, there seems to be some doubt among experts as to whether the facts presented by investigators – even if true – would amount to criminal conduct. Others have noted that the report was prepared by the Council on Human Rights – not the individual experts targeted in the investigation – and thus the investigators are “confusing an expert study with free advice for government agencies.”

Guriev stated that the investigators had grown more aggressive over the past few months, “culminating in a sudden … demand that he surrender five years’ worth of professional and personal e-mails and submit to searches of his office and home.” The growing intensity of the investigation led Guriev to conclude that he would be named as a suspect, and not simply a witness, in the Khodorkovsky report case. According to Guriev, in late-April he learned from “well-placed friends” that he no longer had sufficient political protection to avoid being targeted.

The reason for Guriev’s loss of political protection was summed up well by an unnamed silovik source in Nezavisimaya Gazeta (emphasis added):

  • “If you support the other side, then why did you take from us? And he lived well. That is, if you want to play the [part of] opponents, then go live on your own.”
  • “He openly and publicly announced his support of Navalny … that there were falsifications at the elections, and that Khodorkovsky is in jail illegally.”
  • “We don’t know what he discusses while in New York or France or elsewhere with other individuals.”

The same source suggested that there is actually/also an investigation into “some nuances of the New Economic School.” Under this scenario, the Khodorkovsky report investigation was actually used as a ruse to obtain access to Guriev’s emails, home, and office.

Anti-liberal trend?

As other analysts have argued, it is possible that Guriev overreacted to the perceived threat of criminal prosecution, or wanted to promote his own career, or wanted a plausible reason to leave Russia and obtain asylum in a Western country (not that there is any evidence he is petitioning or plans to petition for asylum in France or anywhere else). But that line of thinking misses the point.

The point is that it could be true that Guriev fled Russia to avoid political persecution, and is just as, if not more, likely than any of the alternatives. Such a scenario is difficult to imagine in any of the countries whose economic performance and social development Russia seeks to emulate.

The Guriev affair is the latest in a number of ‘anti-liberal’ developments. These range from major criminal investigations – at Skolkovo in particular – to minor course corrections in policy, such as Putin’s decision to delay Russia’s joining of the  Open Government Partnership. Even Vladislav Surkov – the architect of Putin’s power vertical – got into a public shouting contest with the Investigative Committee over the Skolkovo investigations and got himself fired in the process. And Surkov’s not even a ‘liberal’, except in the post-ironic sense of a shape-shifting political operative.

The moves against the ‘system liberals’ who populate[d] Medvedev’s team are important in light of similar and harsher measures taken against the ‘anti-system’ opposition such as Navalny, Udaltsov, etc., as well as the dawn raids at NGOs to check compliance with the new NGO law.

Guriev foreshadows a worsening and unavoidable dynamic

The statements of the silovik quoted in Nezavisimaya Gazeta and reactions of other regime celebrants such as Sergei Markov do not bode well for Russia’s political – not to mention economic – development. Despite his involvement with the protest movement, Guriev was not a driving force behind any threat to the regime. The post-Soviet Russian elite has tended to tolerate intellectual diversity, even within its own ranks. The idea is to preempt the formation of organized discontent by maintaining a facade of intellectual diversity.

Someone like Guriev can think and say whatever he pleases, so long as his ideas are unpopular and ineffectual. The regime gets two for the price of one: it appears enlightened because of the faux ‘competition of ideas’ in the country, and undermines the rise of an opposition because just enough freedom and opportunity is available.

Guriev’s case suggests that the siloviki hivemind has made a conscious decision to abandon the ‘diet’ authoritarianism approach. Why? The most likely explanation would be that the protest movement that arose after the 2011 Duma elections scared the regime and led some to the dubious conclusion that the liberals in Medvedev’s team caused it to happen. The ‘enemy’ (or CIA/State Department/George Soros/etc.) planned and financed it.

 

Thus, the purge of system liberals like Guriev is likely to pick up steam, even if this dynamic serves to weaken the regime further.

Posted in bureaucracy, Guriev, russia, siloviki

Strategic Sectors Law Update – First Commission Meeting of 2013 and Amendments to Law

On April 19, PM Medvedev held the first Foreign Investment Commission meeting of 2013. At the outset, Medvedev noted that Russia received over $50 bln in FDI inflows over the course of 2012. This statement is drawn from Central Bank of Russia (“CBR”) data, whose measurements often differ from other sources. For example, the OECD measured 2012 FDI inflows into Russia at $31.3 bln, while UNCTAD put the figure at $44.1 bln. By any measure, however, Russia experienced a decrease – ranging from 8 to 17 percent depending on the source – of FDI inflows in 2012. This is somewhat important because Kazakhstan and Ukraine received substantial increases of FDI inflows in 2012. And although those two countries receive much less FDI than Russia, they both have higher FDI as a % of GDP than Russia (i.e., a more ‘saturated’ FDI market). The downward trend is worrisome to Russia because it has yet to fulfill its potential as a recipient of FDI and has made foreign investment (particularly FDI) a linchpin of its economic modernization program.  Interestingly, Medvedev reported that the Commission has thus far issued decisions for $3 bln worth of deals, which amounts to anywhere from 6 to 10 percent of all FDI.

Deals Reviewed at the Commission Meeting

To date, the following deals were publicly reported as having been considered by the Commission at the meeting:

  • Polymetal Acquisition of Ural-MPG - the Commission approved the acquisition by Polymetal International plc of Ural-Metally Platinovoy Gruppy (Урал-металлы платиновой группы).
  • Asseco Poland Purchase of R-Style Softlab - the Commission approved Asseco Poland S.A.’s purchase of R-Style Softlab, a Russian developer of automated banking systems. The Softlab deal was covered by the SSL because Softlab works with encryption products.
  • Republic of Kazakhstan Gains Share of Urals Electrochemical Plant - the Republic of Kazakhstan received approval to acquire a 25 percent stake in the Urals Electrochemical Plant, which works with nuclear energy.
  • Abbott Proposed Purchase of Petrovaks Pharm - perhaps the most interesting story was the deal that was not approved. Specifically, American pharma giant Abbott was prohibited from acquiring Petrovaks Pharm (Петровакс Фарм), a manufacturer of vaccines. The deal between Abbott and Petrovaks was concluded in mid-2012. Abbott planned to use the acquisition as a way to localize production in Russia, where it currently does not have any factories. Coincidentally, the denial of Abbott’s application opens the door to a Russian pharma company – Farmstandart (Фармстандарт) – which is reportedly also seeking to acquire Petrovaks. Most importantly, this the first time that a the acquisition of a pharmaceutical company was denied on the basis of strategic, national security concerns. Petrovaks manufactures three medicines: Longidaze (treatment for connective tissue problems), Polyoxidonium (an antiflu treatment), and Grippol (a flu vaccine). Presumably, the denial of Abbott’s application was based on Petrovaks’ role in manufacturing Grippol.

Proposed Amendments to the Strategic Sectors Law (“SSL”) The Commission also addressed proposed amendments to the SSL, which have already been submitted to the Duma. I have created a copy of the SSL, which shows the amendments in redline format. Here is a summary of the main changes:

  • Tax Resident Exemption Clarification - in a previous post, I evaluated an earlier change to the SSL, which was intended to exclude from the law’s application transactions involving companies under the control of the Russian Federation and citizens/tax residents of the Russian Federation. The goal of the change was to exclude the many deals involving offshore entities ultimately owned/controlled by Russian businessmen and the government. Unfortunately, a wording error by then-President Medvedev’s team resulted in an ambiguous/incomplete remedy. The Medvedev team’s error consisted of one word – between (между) – immediately preceding the list of organizations to whom the law was intended not to apply. My understanding is that this word had the legal effect of limiting the exemption to transactions literally between the various entities indicated, rather than all transactions involving any of these entities. Thus, for example, if Rosneft would have purchased BP’s stake in TNK-BP via an offshore entity, it would have had to apply for approval by the Commission. My sources in Moscow tell me that the между problem was raised with Russian officials responsible for the previous amendments, who acknowledged the error but added that it would be unacceptable to point out the mistake because it came from the President. The pending amendments address the issue by deleting the между from the relevant section.
  • Definition of Control Broadened - the amendments broaden the understanding of ‘control’ over a strategic company to include situations where a written or oral agreement has been made to vote a certain way at meetings of shareholders, board of directors, etc. (bloc voting agreements).
  • Food Sector Excluded from Law - the law excludes the food/drink sector from the law. That sector had previously fallen under the law’s coverage via the ‘infectious agents’ category, as many food companies work with bacterial cultures related to dairy products, which are considered ‘infectious agents’.

TRM Comments on Meeting and Amendments

The Commission meeting and proposed amendments are remarkable in a few ways. At the outset, there is a continued recognition from the FDI numbers that Russia is (a) not returning to its pre-crisis FDI inflow levels and (b) not fulfilling its potential and stated goals in attracting foreign investment. Indeed, Medvedev implicitly conceded as much in his opening statements about how 2012 “was, of course, not very easy” in terms of foreign investment. So, the natural follow-up question: what is Russia doing to reverse these trends?

The Abbott decision does not bode well for several reasons:

  1. National Security Concept: in my opinion the vaccines industry is not unequivocally and inherently related to “national defense and state security.” Yes, people need vaccines to be healthy, and a country is incapable of self-defense if all of its citizens are dying or in the hospital because they lack access to vaccines. But there is no direct military application, such as the production of weapons or defense measures against biological weapons. That said, there is a way to look at having unquestioned and unlimited access to flu vaccine as a ‘state security’ issue – imagine a scenario where there isn’t enough Grippol at state pharmacies for Russian citizens in the midst of a deadly flu pandemic. In such a case, the Russian government would want to have as many pressure points as possible to apply to the manufacturer of Grippol, and Russian ownership = more pressure points. Still, this is a much broader concept of ‘national defense and state security’ than was promoted during the drafting of the SSL, and can be grouped with similar moves, such as the last-minute inclusion of media, internet, and fisheries.  
  2. Warning Shot to Western Pharma Companies: the decision also seems to me like a shot across the bow of western pharmaceutical manufacturers, who have experienced increasing pressure from the Russian authorities over the past several years. The pressure has included highly questionable interpretations of Russian antitrust law by the Federal Anti-monopoly Service (“FAS”) with respect to whether a given pharma company occupies a ‘dominant’ market position. In past cases, FAS has defined the ‘market’ to consist of one pharma company’s patented drug – even if competing treatments exist – which by definition means the pharma company the occupies a dominant position. Market dominance allows the FAS to deploy much more comprehensive and severe controls on a pharma company – e.g., interfering with the company’s right to choose its own business partners. More recently, the Russian government has proposed a requirement that government agencies and companies procuring a product may select a foreign source only if there is no equivalent product made in Russia (i.e., similar to ‘Buy American’ provisions of U.S. spending bills). Russian lawyers that I have spoken to indicated that this measure – although applicable to multiple categories of goods – is aimed primarily at western pharmaceutical companies. Now, the Abbott decision seems like another hostile message, even those ready to localize production.
  3. Written Law/Public Statements vs. Practical Realities: the Abbott case also underscores one of the central risks to doing business in Russia: the gap between written laws/regulations and public pronouncements welcoming investment, and the reality of coming up against local competitors with powerful connections and a paranoid government that has embraced the timeless Russian tradition of turning within in the face of threats, real or imagined.

Finally, the draft amendments reiterate the issues illustrated by Abbott. Namely, it took a nearly two years to eliminate one erroneously-placed word from the 2011 amendments, simply because flagging the issue with the president’s office was a nonstarter. Moreover, the only other substantive limitation of the SSL’s coverage found in the amendments relates to yogurt makers, who probably should not have been included in the first place. Indeed, one gets the sense that the Russians are experts at generating a never-ending stream of new laws, amendments, clarifications, etc. But even where changes to the written  law are significant – and they are not in this case – the underlying reality of everyday practice remains the same or grows worse. The unmistakable impassivity of Russian decision makers when facing one of their main economic/modernization challenges is discouraging.

As always, we end with a video of Medvedev from the meeting:

Posted in Business, Business and Economy, Economic development, economics, Foreign direct investment, foreign investment, Government of Russia, Law, legal update, legislation, pharma, russia, strategic industries