Strategic Sectors Law Update – Draft Amendments and First Meeting of 2011

Strategic Sectors Law Amendments

On February 17, the Russian government submitted amendments to the Strategic Sectors law.  The only substantive change the amendments address is the ownership issue I covered herei.e., that the law currently applies to any group of companies that includes a foreign entity.  In fact, the bill does nothing else of any significance – some of the changes are already the existing practice/interpretation by FAS.  Banks are exempted, but this has been the policy since the crisis began.  So really, this is a housekeeping bill to (i) eliminate the laughable ‘catch-all’ definition of groups of foreign investors and (ii) codify what is by now habitual practice.  FAS has tantalized foreign investors with the prospect of much more substantive reforms in the near future that may *gasp* reduce the number of industries designated strategic.  Last week, the Duma passed the amendments in the first reading.  There is a small hope that this set of amendments can be ‘tweaked’ to reflect the opinions of foreign investors, though it is a very small hope.

First Commission Meeting of 2011

Last week also saw the first 2011 meeting of the Government Commission on Monitoring Foreign Investment (I may have not covered the last 2010 meeting – FYI).  Twelve applications were reportedly reviewed during the session.  As of now, the Russian press has reported that the following deals were addressed during last week’s meeting:

  • Alstom-Transmashholding – France’s Alstom and Russia’s Transmashholding‘s (TMH) plans to develop and reequip the Tver Carriage Building Plant (Тверской Вагонстроительный Завод or TVZ) and Bryansk Engineering Plant (Брянский Машиностроительный Завод or BMZ) were approved.  These plans apparently resulted in Alstom acquiring a 25%+1 stake in TMH.  Note that under the law, control is numerically defined as over 50% control.  Control may also be found if other tests are met, including sufficiently high board representation, right to control corporate decisions, etc.  The deal likely triggered the law based on one of these non-numerical factors (possibly the appointment of an Alstom Transport representative as TMH’s deputy managing director).  Another interesting legal aspect is that state-owned rail company Russian Railways will retain a blocking interest in TMH, which seems to undermine any claim that Alstom will obtain control over TMH as a result of this deal.  The plants are involved in railcar production.  The deal is the product of a two-year-old strategic partnership agreement between Alstom and TMH.  Interestingly, TVZ used to be majority-owned by some strange company named OOO Sapfir (ООО “Сапфир”), until bought them out earlier this year.  I cannot find any information on Sapfir (meaning, ‘sapphire’ in Russian).  TMH has always owned a 100% stake in BMZ.  TMH is the largest manufacturer of locomotives and rail equipment in Russia, and is wholly-owned by Dutch Breakers Investments (vehicle for oligarchs Iskander Makhmudov and Andrey Bokarev).  Makhmudov, by the way, allegedly used to belong to an organized crime outfit based in the Urals, though I do not know of any proof substantiating these claims.  Less is known about Bokarev, though he seems to belong to the group of oligarchs that rose to prominence in the post-Yukos era (e.g., Vagit Alekperov). 
  • Kupol Ventures Ltd. (Kinross)-Chukotka Mining and Geological Co. – subsidiary of Canadian gold mining giant Kinross – Kupol Ventures Ltd. – received permission to purchase the remaining shares in the Chukotka Mining and Geological Company from the State Unitary Enterprise of the Chukotka Autonomous Okrug.  Kinross currently owns 75% of Chukotka Mining and Geological Co., with the other 25% held by the State Unitary Enterprise.  This is another interesting deal from a legal perspective.  Normally, the law would not apply to such a deal because the foreign investor already owns more than 50% of the ‘strategic’ company in question (Article 4.4).  But Article 4.4 includes a parenthetical exception for companies working with subsoil deposits of ‘federal significance‘.  The definition includes gold mines with 50 tons or more of reserves, and the Kupol deposit appears to have at least 100 tons, if not more.
  • Omirico Ltd.-Novoport Ltd. – this is a typical deal involving typically opaque offshore entities that are a national pastime in Russia.  Omirico, a Cyprus company, received approval to obtain 51% of the shares in Novoport, which owns 50.1% of OAO Novorossiysk Commercial Sea Port or NCSP (ОАО “Новороссийский Морской Торговый Порт“). NCSP is actually traded on the London Stock Exchange (symbol: NCSP).  The company’s primary activity consists of operating the Port of Novorossiysk, a deep-water port on the Black Sea and number one in Russia and number four in Europe measured in terms of cargo turnover.  So who is Omirico?  The offshore entity that ‘represents the interests’ of state-owned pipeline company Transneft and oligarch Ziyavudin Magomedov of Summa Capital.  It is not at all clear why a state-owned, Russian company like Transneft is using an offshore Cypriot entity to purchase another Russian company.  Indeed, if Transeft had structured the deal with itself as purchaser, it would have been able to avoid the Strategic Sectors Law altogether, as the law does not apply to Russian Government-owned entities.  After doing research, this deal turned out to be much too interesting to confine to a bullet point.  Thus, I will devote a post to it soon.

Putin Does Reforms, Still Sucks at Math

At the Commission meeting, Putin also did his typical routine of emphasizing the need to improve Russia’s investment climate and exhorted his minions to make it so.  He once again misstated the level of FDI inflows during 2010, putting the number at $40bln (it was $14bln according to Rosstat).  Other Commission members – including Finance Minister Kudrin – clearly know the real number and are quoted providing the correct number.  So it seems to be an ’emperor wears no clothes’ scenario, which by itself can give readers an idea of how this regime works.

This time, however, Putin threw investors a bone by proposing a concrete change to the Strategic Sectors Law: raising the threshold for when the law applies to investments in the subsoil sector.  Currently, any transaction resulting in a foreign investor controlling 10% or more of a subsoil company with strategic significance is covered by the law and requires approval.  Putin proposed raising this number to 25%.  Remember though, the numeric basis for finding ‘control’ is only one of several options available to the Russian authorities. So, FAS and the Commission could always conclude that a foreign investor is obtaining ‘control’ over a strategic subsoil company even if the percentage ownership were to fall below the threshold (see the Alstom case above).  In this light, the proposed reform is certainly not the type of amendment that would result in greater transparency/predictability, and is unlikely to attract investment.

What Changes Should Russia Make to the Strategic Sectors Law?

What investors really want are changes like: less sectors covered by the law (e.g., fishing, telecom are low-hanging fruit here); firmer deadlines for the review of applications and incentives put on the government to finish by a date certain (e.g., presumptive approval beyond a given time period); including the necessary bases for the right of judicial review currently found in the law (e.g., clearer definitions of legal concepts like control and security, guidance to judges on how to approach this unique area); and a formal opinion request procedure to FAS, under which FAS would provide non-binding answers/interpretations to real-world questions about the law and publish the answers on its website (minus the requestor’s identity).

As always, we end with Vladimir Vladimirovich:

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