What to Make of Putin’s Anti-Offshore Crusade

Posted on January 22, 2012 by

Last month, PM Putin addressed the Government Commission on Electricity Generation. At the meeting, Putin launched into a searing critique of Russian companies using offshore “front companies.” Indeed, Putin noted, “Taking the Russian economy and its strategic sectors out of shady offshore zones is our high-priority task for the upcoming period.” Putin then went on to report on the findings of an audit conducted by the Ministry of Energy, which he ordered during a meeting with Deputy PM Igor Sechin in November. Specifically, the audit found “almost 50% [of senior officials of the power and energy sector] are affiliated with 385 commercial companies, except for those currently employing them.” Putin even named certain officials identified in the Ministry of Energy report.  Vedomosti later reported that all of the energy officials identified in the audit either resigned or were fired within one week. [Update: Vedomosti has published a useful follow-up to the report here; cross-posted here]

Putin concluded by saying, “We must be absolutely clear about the ownership structure, beneficial shareholders, and beneficiaries[of these companies]. This is a key sign of a civilized business climate and mature economy.” Putin then ordered the Ministry of Energy, Ministry of Economic Development, industrial agencies, and state corporations such as Gazprom, Transneft, Russian Railways, Sovcomflot, Vnesheconombank, VTB,  Rosatom, and Sberbank to “[take] and report on [similar] measures taken within the next two months.”

The Missing Order

On December 28, Putin issued an order (поручение) formalizing the request made during the meeting. The order – No. ВП-П13-9308 от 28 Декабря 2011 г. – is mysteriously difficult to locate online, prompting panicked, lengthy forum discussions among Russian lawyers looking for the elusive document. Fortunately, TRM was able to locate a copy, and made it publicly available here.

The order is five pages long, with three attachments, and requires certain state-owned companies to submit two types of information:

  1. Financial Info on Managers – information on the income, property, and property debts of all members of the management team and Board of Directors, in accordance with Attachment 1
  2. Info on Business Partners – all information – including identities of ultimate beneficiaries – on contracting parties (контрагенты), in accordance with Attachment 3

The order is addressed to the following companies:

  1. Rosatom
  2. INTER RAO UES
  3. RusHydro
  4. East Energy System
  5. Far East Energy Management Company
  6. System Operator UES
  7. Federal Grid Company UES
  8. MRSK Holding
  9. Gazprom
  10. Transneft
  11. Irkutskenergo
  12. Russian Railways
  13. Sovkomflot
  14. NGO Market Council
  15. Aeroflot
  16. Rostelecom
  17. Avtodor
  18. Vnesheconombank
  19. VTB (exempt from item 2)
  20. Sberbank (exempt from item 2)
  21. Rosselkhozbank (exempt from item 2)

As Vedomosti reported, Deputy PM Sechin personally prepared the list and notably excluded Rosneft, where he until recently served as Chairman of the Board. Rosneft replied to Vedomosti‘s article, saying it was untrue, and added that it is complying with the instructions in the order. Also left off were Sergey Chemezov’s Rostekhnologii and United Shipbuilding Corporation, as well as Rosnano.

State-Owned Companies – “Let’s Not and Say We Did”

The immediate response to Putin’s order by officials at the affected companies included various stages of shock, denial, and outrage. One legitimate complaint is that it is factually impossible to comply with the order, as currently formulated, because of the number of partners with whom these companies do business (even if the reportable contracts are limited to a certain $$ threshold). And if the contracting parties refuse to provide the information, the Russian companies would have to break their contracts with them. There are plenty of private American companies that would simply refuse to provide information on ultimate ownership, if only out of principle. The government gave some ground this month when it excluded clients from the reporting requirement, and limited ‘ultimate ownership’ information to business partner shareholders owning more than 5 percent of the company’s stock. President Medvedev also proposed delaying the deadlines for providing the information until after the March presidential elections.

Putin’s Born-Again Support for Corporate Governance

Putin’s new campaign against the evils of offshore entities is a bit puzzling, to say the least, because they have always been a problem in post-Soviet Russia and Putin has never expressed much concern about them. One tempting conclusion is that this is a reaction to the public outrage over corruption, but Putin’s instructions to Sechin came before the December Duma elections and subsequent protests.

Interestingly, Vedomosti reported that virtually all candidates for posts on the affected companies’ Boards of Directors will be drawn from Medvedev’s personnel reserve. Indeed, this furthers a trend over the past few years of Medvedev acolytes filling state-owned company positions. Could the new disclosure requirements be meant as a “gift” to Medvedev upstarts possibly looking to cash in on their new posts? This also seems doubtful, as Medvedev and his people have come out strongly in favor of the new rules, even suggesting that they could soon be passed into law.

The most interesting outcome will be the volume and level of detail of the material disclosed. If it is high-volume/detail, anticorruption campaigners will undoubtedly mine the disclosures for evidence of wrongdoing. The campaigners themselves have cautiously praised the new campaign, while noting that it is arising out of the current political climate and does not address Russia’s systemic corruption in a systematic way. Moreover, the disclosure requirement has all the hallmarks of a typical Russian response to complex problems – more paperwork. Note that these disclosures will shed no light on situations where business partners are pressured by officials to sign side contracts with service providers linked to said officials (e.g., as allegedly happened in the Valery Morozov case).

Finally, even if this is a good idea, why limit its application to state-owned companies, which should presumably be given more autonomy than government ministries/agencies? For example, when the Ministry of Health procures medical equipment for government hospitals, it is not required to identify and disclose the ‘ultimate beneficiaries’ of the suppliers. At least Gazprom in theory has an incentive to not overpay for goods and services because it is expected to be profitable, while government ministries can waste their entire budget without anyone noticing.

Posted in Business, Business and Economy, corruption, Dmitry Medvedev, Gazprom, goskorporatsii, legal update, offshore, PM Putin, President Medvedev, Rostekhnologii, russia, state corporations, utilities companies, Vedomosti, Vladimir Putin, war on corruption | 2 Comments

Tipping Points – Handicapping the Chances of an ‘Arab Spring’ in Russia

Posted on January 6, 2012 by

Who are the Protesters?

VTSIOM recently published a survey of the protesters, conducted at the rally at Sakharov Prospekt on Dec. 24. The survey results confirmed other reports that the protesters are mainly drawn from educated, urbanized elites, prompting the name, “revolution of the satisfied.” The survey found that the typical protest-goer is a Russian man under 45 with a high level of education, and middle class income, who heard about the protest on the internet. Interestingly, although 27 percent of those surveyed reporting voting for Yabloko, 33 percent voted for ‘systemic opposition’ parties LDPR or the Communist Party.  A strong plurality of protesters went to Sakharov Prospekt mainly because of the Duma election results. And even though being against Putin was not one of the leading reasons for people attending, the slogan “down with Putin” (долой Путина) was the second most popular, after “For free/fair elections” (За честные выборы).

Tipping Point? Even Feodor I Ruled Russia for 14 Years

As I argued in this previous post, increasing disappointment among the Russian populace is an inherent feature of the system Putin created. That said, these initial protests share more in common with the 2009-10 Iran protests than they do with the 2011 Egyptian revolution, both in terms of the makeup of the protesters and the nature of the complaints. Unlike Egypt, Russia’s protesters are not drawn from all ranks of society and all regions of the country. While intelligentsia are great for speeches and pamphlets, you need the sans-culottes to actually get the work done. Also unlike Egypt, Russia does not have a deeply-rooted opposition ready to form a cohesive party that could arguably represent a plurality of the country (see Muslim Brotherhood). Even the Iranian protesters had Mousavi as the victim of Ahmedinejad/clerical perfidy. Russians only have Just Russia, the Liberal-Democrats, and the Communists (nobody is arguing Yabloko would get into the Duma in a free election). Thus, Russian protesters are mad generally at dirty elections, but have no organizational lever for channeling that energy or claiming victimhood. For lack of a better term, Russian protesters lack agency. This is why, much to the State Department’s chagrin, we cannot expect a “Color Revolution” in Russia – seriously, who would take over? And this is before considering the fact that a slim majority of Russians do not support the protesters (although notably an emerging majority of Russians do not approve of Putin).

Most important (in my humble opinion) is that the Russian authorities are displaying the wisdom of having been in power for quite a long time, but not the arrogance of being in power for way too long. Remember that the turning point in all of the Arab Spring countries was the overreaction of the authorities against the protesters – and the utter befuddlement amongst Arab dictators that ordinary people do not like them. While Mubarak’s “tipping point” may have been unleashing goons mounted on camels into central Cairo, the Russian authorities have been noticeably restrained in their treatment of protesters since the first protest immediately after the election results were announced. Even now, most of the ‘crackdown’ forecasts are intramural affairs, with talk of a possible consolidation of core Putinists and expelling of all others. Without a violent overreaction by Russian authorities, the opposition is not provided a ‘flash in the pan’ moment that totally delegitimizes the regime’s right to continued existence, which can then be posted and shared ad infinitum on the interwebs.

“Russia is the only country where no matter what you say about it, it is probably true”

That all said, there is a sense that Russia has changed, and is changing, for good right before our very eyes. Of course, a lot of this is blown out of proportion by journalists living in the moment – Jack Reed types who can be forgiven. But there is some truth to it. Another relevant point is that the last two previous Russian upheavals – 1917 and 1989 – were largely driven by upper-class intellectuals, much like the current protests. Still, the Bolsheviks were to revolution what Henry Ford was to mass production. And Alexei Navalny seems like a highly intelligent guy, but he’s no Vladimir Lenin. That leaves 1989, which these protests are beginning to look more and more like, and will fan the flames of opposition hopes. In 1989, however, the authorities basically stood down – largely because all the constituent republics declared independence anyway. So we do not see that ‘death of an empire’ dynamic. The question then is whether Putin is the type to just step down from power when faced with nothing more than a large number of angry professionals calling him names? Something tells me he’s not the type.

That leaves one possible scenario, assuming that a bunch of accountants, engineers, and lawyers will not resort to unprovoked acts of violence: a run-off election where Putin loses. For the opposition, obviously the ideal approach would be to force the authorities to allow  their candidates to run, particularly those who missed the filing deadline (i.e., Navalny). But this does not seem likely to happen – the Russian authorities care about the law too much – and the opposition would fracture between ten candidates anyway. Therefore, it seems like the only likely run-off election will be between Putin and Zyuganov. It will be interesting to see: (i) whether Putin’s people will spin a yarn about nationalization the way Yeltsin’s people did in ’96 and (ii) whether these middle/upper class Russians could hold their nose and vote for someone so anachronistic and uncool as Zyuganov and the KPRF. I actually think they could, given how poorly they view Putin and his coterie at the moment. So will Communism come back to Russia via a democratic coalition of nostalgic pensioners and highly-educated professionals? As crazy as it sounds, it seems like a possible outcome. Stay tuned.

Posted in duma, Government of Russia, protests, russia | 2 Comments

The Ghost of Medvedev’s Presidency Lives on … in Putin

Posted on November 12, 2011 by

Yesterday, PM Putin did his annual sit-down with the Valdai discussion club. Since its inception, the Valdai meeting has come to be seen as a forum where Putin relaxes the message discipline and says what he thinks without much of a filter. Whether this is true or just another stage-managed PR gimmick, one can only guess (likely, Putin himself hardly knows anymore). In its previous sessions, Putin’s theme has been resolute – criticisms are unfounded and perhaps motivated by a desire to weaken Russia, and the Putin era has been a unequivocal success. Putin’s argument has consistently relied on two main premises: (1) that the Russian people overwhelmingly and unconditionally support Putin and the political system he created; and (2) that there was no end to economic growth in sight, with general economic well-being improving at a rapid rate. Ironically, to the extent that premise 2 has been correct, it has made the sustainability of premise 1 increasingly less viable.

Russian Magic Show

Russia’s economic “miracle” over the Putin years was largely based on the incredible contraction of GDP following the collapse of the Soviet Union and the subsequent devaluing of the ruble and deleveraging of state finances. Thus, Russia not only enjoyed a devaluation-fueled export boom, but it had existing un- or underutilized capacity available to fuel that boom. The spike in oil prices was icing on the cake, which allowed the Russian government to accumulate funds for social projects and to avert crises. Due to the low starting point and additional stimuli, the lives of ordinary Russians improved dramatically during this time period. Rather than having to encourage the growth of new industries, the Russian government could create jobs “out of thin air” with spare capacity. And instead of structuring state expenditures and obligations around tax revenues, Russia financed social stability with its oil revenues windfall. The rapid rise in disposable income jump-started the growth of the retail and real estate industries. Consequently, Russia’s economic growth from 2000-08 was concentrated in legacy industries from the Soviet Union (extractive industries, some manufacturing) and new “fluff” industries dependent on consumer spending.

Recent Economic Forecasts Look Grim

Recent economic forecasts do not bode well for the Russian economy either. For example, the Ministry of Economy’s 2010-14 forecast assumes a GDP growth rate largely driven by investment in fixed capital assets. But others have designated this “wishful thinking” because investment growth has been extremely volatile. So far investment has only grown 4.1 percent this year, and Russia will be lucky if quarter IV growth pushes the annual number to the predicted 6 percent. Moreover, MinEcon is assuming investment growth of 7.8 percent in 2012, 7.1 in 2013, and 7.2 in 2014, which all seem unlikely in light of the current dynamics. Most important, even if MinEcon’s investment growth projections are correct, these numbers will be “insufficient for large-scale modernization of the economy,” and thus the estimates are predicated on the continuing import of capital assets.

With respect to foreign investment, the picture is also bleak. Although foreign investment increased so far in 2011, the proportion of foreign direct investment (FDI) fell dramatically, by over 50 percent. The biggest growth was in “other foreign investment,” which mostly included loans and other financial credits to Russian firms, the majority of which had a term of 180 days or less. Such short-term financial credits are the type of foreign investment least likely to spur modernization. In fact, many of the financial credits are probably inter-company loans within a group of companies where cash is held offshore.

Unhappy Dialectic of Putin Power

The logic is simple: as Russians’ economic well-being rose at a rapid rate, their support of Putin and the Power Vertical softened because it was based on expectations that would be inherently unsustainable in even the healthiest, most innovative economy (i.e., unchecked, rapid economic growth over an indefinite period of 10+ years). Russians have not only grown to expect that their incomes will rise every year, they have grown accustomed to a high rate of income growth as well. So, the campaign slogan is not – “are you better off now than you were four years ago,” but rather “are you 3x better off now than you were four years ago.” This is in addition to the political science theory that a growing middle class will demand more representative forms of government, which is not clearly applicable to present day Russia.

In the case of pensioners, Putin backed down from a fight over pension reform in 2005, instead opting to retain mandatory military service for young students. This approach has set the tone for all benefits debates, again with any reduction posing a serious risk to the Power Vertical. Similarly, Putin grew the size of the bureaucracy to pursue his centralization project in the regions, which also served as a de facto jobs program. If modernization requires that the bureaucracy be slimmed down, it undermines the stability of the Power Vertical.

In sum, Putinism was so successful, that it ensured its own demise. Most countries have adopted “safety valves” for situations like this – some use elections, others purges, and still others coups. But there is a sense that this time is different, as evidenced by unrest in both developing and developed countries. And Russia is in the unenviable position of having no safety valve (in fact, several were dismantled during Putin’s post-Beslan reforms).

Putin on Ice

Putin’s comments at Valdai seem to reflect Putin’s lack of understanding of the predicament he is in, as he is poised to return to the presidency for another 12 years. Putin did the familiar victory lap about this political era, albeit with less vigor than in previous years. But he did admit that the “world is changing” and that “we are thinking about it too,” referring to Medvedev’s modernization program. According to Putin, Medvedev took the modernization issue “out of the paper and office sphere” and into the “public consciousness.” Putin also acknowledged that Russia’s political system is “not perfect” but hastened to note that he “does not know of any perfect systems.”

According to journalists at the meeting, Putin proposed introducing something called “direct democracy” to help rebuild trust and connections between the authorities and Russian populace. An unfortunate turn of phrase perhaps: “direct democracy” was the name of the political model elaborated in the late-Muammar Gaddafi’s Green Book.

Medvedev’s Modernization Ghost

In some ways, Putin’s comments on Medvedev and the public consciousness are prescient. Although Medvedev did very little of substance during his term, he did not fail to use the “bully pulpit” to harp on the ills of corruption and the need for a modernized, innovative economy. It does not take much thought to see that the targets of Medvedev’s critique are byproducts of or encouraged by the Putin political system. Thus, Medvedev legitimized attacks on the Power Vertical by adopting a chief national priority – modernization – that is inconsistent with the Putin model. By assuming the mantle of modernization at Valdai, Putin indicated that the ghost of Medvedev’s presidency will continue to haunt him.

Video of Valdai Meeting

Posted in russia | 1 Comment

Strategic Sectors Law Update – Draft Amendments and Commission on Foreign Investment Meeting

Posted on November 10, 2011 by

Last week, PM Putin chaired the latest meeting of the Commission on Foreign Investment and the following day the draft amendments to the Strategic Sectors Law (SSL) entered their third reading, after languishing in 2nd reading purgatory since the summer.

Final Draft Amendments 

The second reading of the SSL amendments were finally passed by the Duma on October 19, and the third reading was adopted on October 25. The Federation Council rubber stamped the law on November 8, and the only remaining step is Pres. Medvedev’s signature. This may be the last piece of significant legislation Medvedev signs as president due to the Duma elections in December and presidential elections in March. Ironically, the original SSL legislation was the last significant law signed by then-Pres. Putin on May 5, 2008, two days before Pres. Medvedev assumed office.

Although all of the changes were within the second reading, for ease of reference, I will refer to changes between the second and third reading. I have highlighted the changes in this document, which shows deletions (strikethrough red), additions (blue), and relocations (green). A “clean” version of the third reading is here.  Aside from some stylistic/technical tinkering, the only significant changes were provisions that were added or enhanced between the second and third readings. These include:

  • Liberalized Threshold for Extractive Industries - previously, companies investing in oil, gas, or mining companies had to apply to the Commission if a transaction involved the acquisition of 10 percent or more of a Russian company’s shares. The amendments raise this requirement to 25 percent.  Note that this follows up on last months lowering of the export duty on crude oil. Viewed in conjunction, the two policy changes suggest the Russian government is concerned about the health of its oil export industry – the cash cow that has largely fueled its ‘economic miracle’ since the early 2000s. It also indicates a realization that foreign investment is essential to maintaining Russia’s place among the leading oil producers/exporters. In some cases, the 10% vs. 25% difference may be important, but I doubt it is very many. If the Russian government was really serious about encouraging foreign investment in this sector, it would have hiked the approval requirement to the same level as every other sector covered by the SSL law – i.e., a controlling stake of 50+ percent. Furthermore, it is interesting that investors have yet to hear what relationship the extractive industries have to national security, such that they require higher scrutiny than, for example, weapons manufacturers.
  • Exemptions for Radiology Activities - the amendments also exempt activities involving the use of radioactive materials from coverage by the SSL law. This is likely aimed at promoting FDI in the country’s nascent medical device industry, primarily in the area of diagnostic imaging (e.g., the radiocontrast elements used with CT scanners would qualify as ‘radioactive’ material). Russia has thus far failed to encourage FDI in anything but ‘screwdriver’ assembly facilities where all of the high-skill, high-tech manufacturing is done offshore, and the final components are assembled by semi-skilled Russian workers. Clearly, the Russian government would like to see a more substantial FDI than this.
  • Notable Non-Changes - though the more liberal extractive industry threshold and radiology exemption are tangible victories for foreign investors, the SSL law amendments lack provisions addressing many foreign investors’ most significant concerns. In particular, there was no reduction in the number (42) of so-called ‘strategic’ sectors. Yes, fisheries are still strategic. Yes, television – most of it state-owned and unprofitable – is still strategic. The latter category is particularly tragic. U.S. networks are churning out more quality television than most people have time to watch, while Russian shows remain absolutely dreadful. Another non-change worth noting is that the concept of ‘control’ was not given a more precise definition. This is significant because a transaction requires Commission approval based on certain percentage ownership thresholds, OR if the transaction would result in a foreign investor gaining control over an enterprise. Although the law provides a list of examples, it is not exclusive.
So there you have it – the first amendments to the SSL law, after 3+ years since the law’s passage, and 22 months since the amendments were announced.
Commission Meeting
On October 24, PM Putin presided over a meeting of the Commission on Foreign Investment.  In his preliminary remarks, one interesting statement Putin made related to Russia’s improvement in the World Bank’s Doing Business rankings, which were released recently. The benefit of the Doing Business rankings is that they are based on hard facts – e.g., number of procedures to register property, days to clear customs – and not ‘perceptions’ like many other metrics. So it is intriguing to know that these rankings are on the Russian government’s radar, even if they have been cited opportunistically in this particular case.
So far, the following deals addressed during the Commission meeting have been reported publicly in the Russian press:
  • Pirelli Acquisition of Kirov Tire Factory from SIBUR Group - Pirelli purchased the Kirov Tire Factory from SIBUR, based on an agreement between SIBUR, Pirelli, and Rostekhnologii. The total price paid for the tire manufacturing assets was EUR 222 mln.
  • Polyus Zoloto FTSE Listing Delayed - perhaps the most newsworthy event from the Commission meeting did not involve an approval – Mikhail Prokhorov’s mining company Polyus Zoloto had applied to list on the FTSE. The Commission delayed an official decision on this request. According to Dmitry Peskov, the decision was not politically motivated but instead the “matter required additional work because certain documents were lacking” (“недоставало нескольких документов“). Let’s be clear – in Russia, documents can always be missing – you cannot clear a shipment through customs without a stack of paper (bumagi) as thick as War and Peace. Indeed, discretion comes into play in these situations and a decision by the Prime Minister of Russia is never prevented because a few documents were missing.
  • Norilsk-Nickel? - news outlets reported that the Commission would consider Norilsk-Nickel’s stock buy-back plan, although there have not been any post-meeting reports on whether this was actually considered.
  • Électricité de France S.A - during the introduction to the Commission meeting, Putin “singled out” a “very interesting and promising project” in the energy generation sector. Specifically, he noted, Électricité de France S.A (“EDF”)”plans to establish a special company in Russia that will introduce innovation and state-of-the-art technology in management and organizing the work of power-generating facilities.” The only problem is that there is literally no information on this supposed company on the web. While EDF has been active in the Russian power generation sector in the past – e.g., in a JV with Inter RAO – there simply is no reference to this new company in EDF’s press releases or on the web generally.
Really? Is that it? This is the smallest number of approved deals – specifically, one – that has been publicly reported from the Commission meetings since the passage of the SSL law. What is the explanation? One plausible candidate is that the upcoming Duma and Presidential elections have foreign investors spooked and putting FDI in Russia on hold until the picture is more clear in early 2012. Of course, most of the foreign investors that have submitted applications to the Commission in the past are from the Eurozone, and the ongoing turmoil may be contributing to a dearth of new projects. Finally, the soon-to-be-law amendments, which will relieve Russian firms from applying for approvals even if transactions are achieved via offshore entities, may be putting many of the domestic/”foreign” transactions on hold until the amendments pass. Perhaps reflecting this lack of “action,” for the first time ever the Prime Minister’s website did not publish a video of the Commission meeting. Thus, we will have to commemorate this meeting with a picture of PM Putin’s [possibly final] Commission meeting studying documents.

Posted in Foreign direct investment, foreign investment, legal update, legislation, PM Putin, President Medvedev, prokhorov, Rostekhnologii, russia, strategic industries

Putin to Return to Presidency, Medvedev to be PM

Posted on September 24, 2011 by

So Russia’s elite has succumbed to ‘Titanic Syndrome’ – hoping to steal a bit more under the existing arrangement rather than squarely confront the serious problems that face their economy/society. It really is an unfortunate choice for Russia and do not believe for a second that this was decided ‘years ago’ as Putin and Medvedev suggested at the EdRos party conference. I am sure a lot of ink will be spilled arguing that it makes no difference, that Medvedev/Putin as President or PM still sits on top of the same underlying reality. I completely disagree – today marked a turning-point in post-Soviet Russian history, and Russia’s leaders could not have messed up more than they did.

Posted in russia | 6 Comments