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

Last Updated: 22 February 2012
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 for foreign investments in Russian strategic sectors would be simplified in the near future. This 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 heavily criticized by foreign investors and Russian business as it creates excessive administrative barriers, which de facto have no social benefits, to investment in Russian businesses. The Russian government responded to this criticism by introducing amendments to the law, which were adopted by the State Duma, the Federation Council and signed by the President into law in November 2011 (the Amendments). The Amendments came into force on December 18, 2011. This article examines the main changes contained in the Amendments and assesses their possible implications for foreign investors.

New Exemption 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 Subsoil Companies) by a foreign state or an international organization are subject to prior consent by the Russian Federal Government Commission for Control over Foreign Investment (the Governmental Commission).

The Amendments introduce a partial exemption from this rule for international financial institutions (IFIs) in which the Russian Federation participates or with which the Russian Federation has entered into an international agreement. However, this exemption does not exclude all transactions involving IFIs from the scope of the Foreign Strategic Investments Law.

First, under the Amendments, the Russian government approves the list of such IFIs (the List). The Amendments are silent as to the legal status of those IFIs that the Russian government does not include in the List; however, it seems reasonable to assume that the exemption will only apply to IFIs on the List. As a result, any acquisition of qualifying stakes in Russian Strategic Companies by IFIs will still be subject to control by the Russian government, but the control mechanism 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, albeit without any clear and formal criteria for initial inclusion of IFIs on the List.

Second, this exemption does not affect the absolute ban on acquisition of qualified control (i.e., more than 50% of Strategic Companies and more than 10% of Strategic Subsoil Companies) by IFIs set out in the Foreign Strategic Investments Law. As a result, any acquisition of qualified control over Russian Strategic Companies by IFIs will still be restricted. Note (discussed in more detail below) that the 10% threshold will be increased to 25% of Strategic Subsoil Companies.

New Treatment of Transactions Involving Russian Beneficiaries

When the Foreign Strategic Investments Law came into force it was heavily criticized for applying to transactions where the acquirer of a Russian Strategic Company is a foreign entity controlled by a Russian beneficiary. While the Amendments were being prepared, Russian government officials declared that this issue would be addressed, and, according to the Amendments, the Foreign Strategic Investments Law will 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 Amendments do not specify whether only such relationships – but not the transactions themselves – are outside the scope of the Foreign Strategic Investments Law. Neither do the 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."

In any case, it seems clear from the Amendments 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 between Russian beneficiaries alone, as is required by the 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 the Russian joint stock company. This is because the Amendments refer to companies that are controlled by the Russian state or Russian individuals, which would likely not apply in such case.

Size of Stakes in Strategic Subsoil Companies Subject to Clearance Increased

According to the Foreign Strategic Investments Law prior to the Amendments, any transaction entered into by a private foreign investor was subject to prior consent by the Governmental Commission, to the extent that such transaction results, inter alia, in:

  • the exercise, whether directly or indirectly, of the rights attached to 10% or more of the voting shares in a Strategic Subsoil Company by a private foreign investor; or
  • the possession by a private foreign investor of the right to appoint 10% or more of the collegial executive body and/or the unqualified right to elect 10% or more of the board of directors or other collegial managing body of the Strategic Subsoil Company.

The Amendments increase the 10% thresholds mentioned above to 25%, which represents a positive step forward in liberalizing investment in Russian subsoil companies.

Number of Strategic Activities Decreased

The Foreign Strategic Investments Law expressly lists 42 types of strategic activities to which it applies. It is important to note that simply carrying out any of the enumerated activities is sufficient grounds for a Russian company to be considered a Strategic Company, regardless of whether the activity in question is a core activity for the company. Due to such a formalistic approach, many Russian companies are considered Strategic Companies simply because an ancillary activity of theirs is 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. Accordingly, the Amendments exclude from the list of strategic activities, encryption activities carried out by a 100 percent privately-held private bank. The Amendments also exclude from the list of strategic activities, the placement, construction, operation and decommissioning of nuclear plants, radiation sources, and nuclear material and radioactive waste storage sites, provided that these are ancillary activities of a company operating in the private sector.

It is important to note that the initial version of the Amendments introduced by the Russian government to the State Duma also excluded activities related to the use of any agent of infection belonging to the fourth pathogen group (i.e., an agent that is highly unlikely to cause human disease) from the list of strategic activities. However, after the second reading, the exemption was removed from the Amendments.

Additional Issuance of Shares in Strategic Subsoil Companies

According to the Foreign Strategic Investments Law prior to the Amendments being adopted, 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 needed to be cleared by the Governmental Commission. Based on a literal interpretation of this rule, arguably, even if a foreign shareholder already holding more than 10% of the shares in a Strategic Subsoil Company acquired more shares in the company as a result of an additional issuance of shares and the foreign shareholder's percentage shareholding remains unchanged or even decreases but did not fall below 10%, then such an acquisition would still be subject to the clearance requirements of the Foreign Strategic Investments Law.

The Amendments address this issue by providing that clearance requirements do not apply to any acquisition of shares in Strategic Subsoil Companies if the shareholder's percentage shareholding does not increase.

Procedural Changes

The Amendments also slightly change the clearance procedure. For example, it is proposed that in addition to 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 regulations were introduced with respect to entering into an agreement, setting out the acquirer's obligations related to the clearance procedure.

In summary, the Amendments introduce largely technical changes and do not substantially change current rules. Unfortunately, the Amendments sometimes are poorly drafted and raise more questions than provide answers, but the new exemptions for IFIs and the changes with respect to subsoil companies should hopefully result in increased foreign investment in subsoil companies.

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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