Russian Federation: Russian Foreign Strategic Investments Law: A Step Forward On The Way To Liberalization Or A Decorative Dash?

Last Updated: 19 October 2011
Article by Alexander Egorushkin

At the Berlin forum of German business leaders held in November 2010, Russian Prime Minister Vladimir Putin declared that the clearance procedure of foreign investments in Russian strategic sectors would be simplified in the near future. Such procedure is governed by Russian Federal Law No. 57-FZ 'On the Procedure for Foreign Investments in Business Entities Having Strategic Significance for State Defense and National Security' (the 'Foreign Strategic Investments Law'). The Foreign Strategic Investments Law has been strongly criticized by foreign investors and Russian business as it creates excessive administrative barriers for investments in Russian businesses which de facto have no social benefits. The Russian Government responded to the criticism by introducing amendments to the law which were adopted by the State Duma in the first reading at the end of March 2011 (the 'Draft Amendments'). In order to come into force, the law would need to pass two more readings to be approved by the Federative Council, being signed into law by the President. This article examines the main changes of the Amendments and assesses their possible effect on foreign investors.

The Draft Amendments in their current version provide for the following main changes.

Exception for International Financial Institutions

According to the Foreign Strategic Investments Law, acquisitions of more than 25% of Russian companies qualifying as 'strategic' ('Strategic Companies') and more than 5% in Russian Strategic Companies carrying out activities associated with subsoil research and/or the exploration and extraction of certain minerals from federal-level subsoil property ('Strategic Mining Companies') by a foreign state or an international organization are subject to prior consent of the Governmental Commission.

The Draft Amendments introduce an exception to this rule with respect to international financial institutions ("IFIs") in which the Russian Federation participates or with which the Russian Federation has entered into an international agreement. However, this exception does not exclude all IFIs from the scope of the Foreign Strategic Investments Law.

First, under the Draft Amendments, the Russian Government approves the list of such IFIs (the 'List'). The Draft Amendments are silent as to the legal status of those IFIs that the Russian Government does not include in the List. Most likely the exception will only apply to IFIs on the List. Thus, the acquisition of minor stakes of Russian Strategic Companies by IFIs will still be subject to oversight of the Russian government, but the form of such control will change from a formal one-shot clearance as currently envisaged in the Foreign Strategic Investments Law to 'permanent exemption' for IFIs on the List without any clear and formal criteria for initial inclusion therein.

Second, the exception does not affect the general rules of the Foreign Strategic Investments Law which requires approval of the acquisition by a foreign investor of control over a Russian Strategic Company (i.e., more than 50% in Strategic Companies and more than 10% in Strategic Subsoil Companies). Thus, the acquisition of control over Russian Strategic Companies by IFIs must also be cleared by the Governmental Commission under the Foreign Strategic Investments Law.

Transactions Involving Russian Beneficiaries

When the Foreign Strategic Investments Law came into force it was heavily criticized for covering transactions where the acquirer of a Russian Strategic Company is a foreign entity controlled by a Russian beneficiary. While the Draft Amendments were being prepared, Russian government officials declared that the above issue would be addressed. As a result, under the Draft Amendments, the Foreign Strategic Investments Law does not apply to 'relationships related to transactions' between companies 'controlled by the Russian state or Russian individuals who are Russian tax residents.'

Unfortunately, the term 'relationships related to transactions' is not defined and the Draft Amendments do not specify whether only such relationships – but not the transactions themselves – are outside the scope of the Foreign Strategic Investments Law and, if so, what such relationships mean. Neither do the Draft Amendments specify whether simple oral pre-transaction negotiations between parties or written non-binding documents signed by the parties and reflecting their intentions (such as a Memorandum of Understanding qualify as relationships related to transactions).

It also seems clear from the above provision that transactions between a seller having a foreign beneficiary and an acquirer having a Russian beneficiary would still be subject to clearance requirements since these relationships are not only between Russian beneficiaries, as required by the Draft Amendments in order for the exemption to apply.

Finally, it is also not clear whether and how this exemption would apply to transactions between parties controlled by a Russian joint stock company whose shares are dispersed among many shareholders and where no shareholders unilaterally or jointly control such Russian joint stock company. This is because the Draft Amendments refer to companies that are controlled by the Russian state or Russian individuals; which would not apply in such case.

Decreasing the Number of Strategic Activities

The Foreign Strategic Investments Law lists 42 types of strategic activities covered by the law. It is important to note that simply carrying out any such activities is sufficient for a Russian company to be considered as a Strategic Company, regardless of whether or not these are core activities for the company. Due to such a formal approach, many Russian companies are considered Strategic Companies simply because their ancillary activities are on the list of strategic activities set out in the Foreign Strategic Investments Law. For example, many banks involved in encryption activities are regarded as Strategic Companies under the Foreign Strategic Investments Law. However, these encryption activities are carried out by banks for the purpose of ensuring the safety and security of their clients' personal data, not as a core profit-generating activity.

The Draft Amendments propose to exclude from the list of strategic activities the following activities, which can hardly be regarded as having strategic importance for state defense and national security:

  1. encryption activities carried out by a private bank (does not apply to banks in which the Russian state holds any stake);
  2. activities related to the use of agents of infection belonging to the fourth pathogen group (i.e., an organism that is highly unlikely to cause human disease); and
  3. the placement, construction, operation and decommissioning of nuclear plants, radiation sources, and nuclear material and radioactive substance storage facilities, or radioactive waste storage sites that belong to the fourth radiation hazard category (i.e., in the event of an accident any radioactive effect wuld be limited to the room where it occured).

Additional Issuance of Shares in Strategic Subsoil Companies

According to the current version of the Foreign Strategic Investments Law, any acquisition by a foreign investor of shares in a Strategic Subsoil Company resulting in 10% of the shares in such a company being held by a foreign party must be cleared by the Governmental Commission. Based on the literal interpretation of this rule, arguably, even if a foreign shareholder which already holds more than 10% of the shares in a Strategic Subsoil Company acquires more shares in such company as a result of an additional issuance of shares while its shareholding percentage remains unchanged or even decreases but does not fall below 10%, then such an acquisition is still subject to the clearance requirements under the Foreign Strategic Investments Law.

The Draft Amendments address this issue by providing that clearance requirements do not apply to the acquisition of shares in Strategic Subsoil Companies if the percentage share does not increase.

Procedural changes

The Draft Amendments also slightly change the clearance procedure. For example, it is proposed that apart from the Russian Federal Security Service (FSB) the Ministry of Defense of the Russian Federation will also be involved in the review process. In addition, detailed regulation will be introduced with respect to entering into an agreement setting out the acquirer's obligations related to the clearance.

In summary, the Draft Amendments introduce largely technical changes. Unfortunately, the Draft Amendments are rather poorly drafted and raise more questions than provide answers. Hopefully, the language will be improved in the second and the third readings. The Draft Amendments are anticipated to be adopted sometime during the late fall of 2011 and to come into force in the beginning of 2012.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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