1 January 2011
The American Lawyer Specail Report publishes commentary by Irina Skidan on new privatization program in Russia

Special Report

RUSSIA

The Russian Government has introduced a radical new privatization program to invigorate the country’s economy. Although foreign investment is clearly an objective, the protection of property interests held by foreigners remains a concern for lawyers in Moscow. Camilla Sutton reports

ACCORDING to the Russian Government, including Vice Prime Ministers Aleksey Kudrin and Igor Shuvalov, there are two main drivers behind the Russian Government's new privatization program - to reduce the state's involvement in the Russian economy in order to increase its efficiency and, to replenish the state treasury.

The new privatization program is generally aimed at funding the federal budget, which is expected to incur deficits in the next several years,' explains Rich Wilkie, the partner in charge of the Moscow office of Akin Gump Strauss Hauer & Feld (Akin Gump). The economic crisis and the drop in oil prices have negatively impacted the federal budget. Liberalization of the economy is generally viewed as a secondary goal.'

The principal reason why the Russian Government is implementing a new privatization program is that the Government is facing a budget deficit as a result of the 2008-2009 financial crisis,' agrees Irina Skidan, a senior lawyer at Egorov, Puginsky, Afanasiev & Partners. 'Consequently, it is in the process of approving a special Privatization Plan that specifies the companies to be privatized and the size of the state interests that are being put up for privatization. The goal of the Privatization Plan is to raise an aggregate of 883bn RUB over a five-year period and attract investments into former state-owned companies. Other significant aspects of the Privatization Plan reflect the Government's aims to reduce excessive state ownership of property, draw in more private investment to increase annual fiscal income, undertake structural reforms of relevant economic sectors, improve management efficiency and optimize competition.'

PRIVATISATION IN RUSSIA

The Government is learning from past experience. The first attempt to sell state-owned companies and create a new type of economy based on private ownership was made by the Government of the 1st Russian President Boris Yeltsin in 1992/ explains Maxim Alekseyev, the senior partner of ALRUD. 'But it was not successful for the Russian economy - during 10 years from 1992 to 2002 conditions of the former state-owned companies worsened, budget revenue decreased and the social stratification deepened. The Government policy on "new nationalization" exercised by Vladimir Putin from 2000 led again to forming large state-owned companies in almost all sectors of the Russian economy. Currently the Russian government has interests in 5500 companies and controls (directly or indirectly) 45-50% of GDP. The modern privatization policy, emerged as a result of the financial crisis and subsequent budget deficit, and it has been announced that it will be more controlled by the state.'

'The stated goal is to sell minority stakes in a wide range of industrial and financial companies, potentially including state railway company RZD, merchant shipping company Sovkomflot, fertilizer producer Apatit, and the state-owned banks VTB and Sberbank,' explains John Sheedy, a global projects partner at Baker Botts based in Moscow. 'The sale of 10% of VTB is likely to be the first deal. It is estimated that proceeds from such sales during 2011-2015 will exceed $50bn.'

The major (budget-forming) privatization candidates in 2010 are equity stakes in the open joint stock companies TGK-5, Rosgosstrakh, Moskovsky Metrostroy, Iskitimtsement, and Tyretsky Solerudnik,' adds Timothy Stubbs, head of the Russian banking and finance group at Salans. 'Furthermore, in the event that the President of the Russian Federation decides to end or reduce the shareholdings of the Russian Federation in joint stock companies on the list of strategic enterprises and strategic joint stock companies, in 2010-2011 shareholdings in sea and river ports, and shipping lines, including shares in the open joint stock companies Murmansk Sea Commercial Port, Moscomflot (not more than 25 % minus 1 share from the federal shareholding), Novorossiysk Sea Port, Koftsovo Airport, Anapa Airport, and Tolmachevo Airport could be privatized on the basis of separate decisions of the Russian Federation Government. In 2010 - 2012 work will also be undertaken to form integrated structures in strategic sectors on the basis of joint stock companies with federally-owned shareholdings. In 2010 a further 56 items of other property of the Russian Federation state treasury are to be privatized, including immovable property, sea and river ports.'

'The program is to affect about 900 state-owned companies over the course of 3 years,' says Nikolay Karagodin, an economist at Gorodissky & Partners. 'Although the state will retain the controlling stake in these strategic companies the private owners will get more power to influence management policy. Apparently the government sees foreigners as the preferred investors as they may bring not only money but expertise as well.'

GOVERNMENT INTERVENTION

The new privatization program is only one measure the Government has taken to boost the economy. 'We have seen a number of positive initiatives taken by President Medvedev in the last year,' says Timothy Stubbs. 'We believe some of these will have a net positive impact on foreign investment in Russia. They have included for example a more practical, results-oriented foreign policy initiative; re-focused attention on Russia's membership in WTO; support for modernization of the economy and lobbying of foreign investment communities, such as California's high-tech industry, to invest, and legislative reforms focused on strengthening the position of secured lenders. We have also witnessed the articulation of the Administration's desire to support the journalism community in Russia, the dismissal of former ... thereto.'

'One of President Medvedev's priorities has been to turn Russia into an "innovation economy",' comments John Sheedy. 'Two highly publicized initiatives in this area are the establishment of Rosnano, the state corporation for investment in nanotechnologies, and plans for the establishment of "Russia's Silicon Valley" – Skolkovo - in the Moscow suburbs. Rosnano benefits from substantial government funding and has been extremely active. We've received a number of RFP's recently for various high-tech projects. Skolkovo is not up and running yet, but has received a substantial commitment of government funds and signed letters of intent.'

'Among the big names that have already announced their intention to participate in the Skolkovo project are Nokia, Siemens, Boeing and Microsoft,' adds Nikolay Karagodin. 'American private investments fund Siguier Guff pledged to invest $250m and Cisco Systems -about $1 bn. Russian high tech companies are enthusiastic as well.'

FOREIGN INVESTMENT

Further foreign investment is anticipated. 'In October 2010 the Russian government approved the list of financial consultants who will be advising the government in connection with privatization of state-owned assets. The list includes such prominent market players as Credit Suisse, Deutsche Bank, JP Morgan, Merrill Lynch, Morgan Stanley and Goldman Sachs. In addition, several prominent Russian financial consultants have been included in the list, such as VTB Capital, Renaissance Broker, Russian Auction House,' says Rich Wilkie. The fact that foreign financial consultants have been included into the approved list, seems to indicate that both Russian and foreign investors will be admitted to participation in the tender process. Up until now there have not been any signs of limitations on foreign investors' participation in the process of privatization. In addition, with respect to some of the assets, privatization may be structured through an IPO of part of the shares currently held by the government, which would, presumably, ensure equal access to the privatization process for Russian and foreign investors.'

'Russia is strongly aimed at the improvement of its attractiveness for investors,' says Maxim Alekseyev. 'Recently the Ministry for economic development of Russia presented its proposals where the main areas for development are tax regulation, administrative procedures, customs administration, investment support, and optimization of infrastructure access procedures.

Notably, the utmost position is allotted for the simplification of Russia's migration regime.'

'Russia hopes to attract foreign investors by creating attractive economic opportunities through the privatization of high-profile state-owned companies and developing a favorable investment climate,' agrees Irina Skidan. 'For example, under the Russian Privatization Law, there are no special limits/procedures applied to foreign investors compared to Russian investors that make it more difficult for foreign investors to participate in Russian privatizations.'

'Both Russian and foreign investors are encouraged to purchase state-owned assets,' continues Maxim Alekseyev, 'but it should be mentioned that most of the targets for privatization operate in the sectors of the economy acknowledged as "strategic". Therefore the participation of foreign companies in such businesses is to some extent limited by the The Federal Law On Procedures for Foreign Investments in Companies having Strategic Importance for the National Security and Defence No. 57-FZ dated April 29, 2008 (the Strategic Investments Law).'

In any event, many foreign clients remain cautious, and for good reason. 'The sentiment in the international investment community is that whilst Russia may be an attractive place to invest based on the numbers, other critical elements, such as a fair and impartial judicial system willing to take a stance to protect investors' property interests, have not yet sufficiently developed says Timothy Stubbs. There are serious challenges to face. 'Corruption in Russia remains the number one obstacle to foreign investment. Russia fell from 154th place to 178th place in Transparency International's corruption perception index,' continues Timothy Stubbs. 'And the courts and justice authorities are perceived to have worsened, not improved, over the last decade. In the Yukos case, we saw the wholesale dismantling and undervalue transfer of a private oil company's assets to state-owned oil companies. The Russian courts have yet to convince investors that they operate independently and free of influence from the executive branch, when the latter has major commercial or political interests at stake. Russian justice authorities themselves have also been accused of massive cases of corruption (or, as it is termed in Russia, "raiding") and abusing their positions for personal gain - witness the Magnitsky case. One almost gets the impression that for every single positive step that Mr. Medvedev tries to take in earnest, in cleaning up corruption, someone else in the government or in the courts takes five steps in the opposite direction. It can be extremely frustrating for those of us who are trying to build a healthy economy here.'

There are continuing efforts to modernize the economy and legal framework, such as removing administrative hurdles, agricultural reform, fighting corruption and (hopefully) the relaxation of some of the rather broad restrictions on investment in strategic sectors of the economy,' says John Sheedy. 'It is clear, though, that Russia needs to act more forcefully and effectively to implement these goals, some of which have been honored more in the breach.'

FUTURE GROWTH

There will be interesting times ahead. 'The Federal Reserve policy of printing the US economy out of recession at any cost is favorable for the commodity markets in general and Russian oil exports in particular,' comments Nikolay Karagodin. 'We expect high enough oil prices and healthy growth in the Russian economy in coming years. For 2011 the most probable scenario is 4% growth in GDP.'

'The inbound investment market is definitely picking up again/ says Rich Wilkie. 'The hotels are once again full of foreigners looking for deals. The decrease in foreign investments and slow-down of business activity in the first six months of 2010 seems to be over. The process of recovery is likely to be boosted by increasing oil and minerals prices, which helps with inbound and outbound activity.'

'Both the investment euphoria of 2004-2007 and the panic of 2008-2009 are behind us,' concludes John Sheedy. 'Foreign and domestic investors are more cautious and realistic, but there is increasing confidence - as reflected by a marked uptick in M&A work in the second half of 2010. Russia still remains a difficult place to do business. However, Russian leaders understand that the country really "dodged a bullet" during the economic crisis and was saved by its stabilization fund. There is now a real sense that the government will no longer choose to simply sit on its natural resources laurels, but is committed to taking the hard steps required to improve the investment climate and develop its long-neglected non-resources industries. That will require colossal sums of money which only foreign investment can provide.'

 

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