You can't pick up the newspapers these days without reading about the difficulty that Russian companies are facing in raising capital. Commercial loans are hard to get and extremely expensive; some lenders charge 20% or more. Similarly, raising capital both within Russia and internationally has become much more difficult and expensive. Now the Federal Service for the Financial Markets ("FSFM") seems intent to make it virtually impossible for Russian companies to raise capital in international markets, despite the great need for finance, and the small size and immaturity of the Russian financial markets.
The London Stock Exchange has been and remains the primary market for trading Russian shares internationally. In 2006 - 2007, 48 Russian companies placed their shares on foreign and domestic exchanges, raising an aggregate of $41.3 billion; 31 Russian companies placed shares on foreign exchanges, 28 of which preferred the LSE, and a total of $24 billion was raised.
As an example, in 2007 Sberbank raised $3.304 billion and VTB raised $8.02 billion on the LSE, while in 2006 Rosneft raised $10.44 billion (constituting 3.82%, 22.6%, and 11.34% of the market capitalization of these companies). Russian shares are also listed on the Deutsche Borse, NASDAQ, First North, OMX, NYSE, and other exchanges.
The amendments proposed by FSFM would significantly limit Russian companies' access to foreign stock exchanges, and make it unlikely that Russian companies will be able to launch IPOs outside of Russia .
Current rules of the game
At present, FSFM's procedure for granting permission to place shares internationally, and the limitations thereon, are set forth in the Regulation on the Procedure for the FSFM to grant Permission to place and circulate Shares of Russian Companies outside the Territory of the Russian Federation (approved by FSFM Decree No. 06-5/pz-n of January 12, 2006) (the "Regulation").
The Regulation permits sale (i.e., placement or circulation)1 of up to 30% of the total shares of Russian companies on international exchanges. For example, in 2007 AFI Development placed 19% of its shares overseas for $1.4 billion, BK Evrazia placed 20% ($719 million), Black Earth Farming placed 28% ($259 million), and Integra placed 30% ($668 million).
However, there are two further restrictions.
The first restriction is that a company of strategic importance, pursuant to the Federal Law "On the Procedure for making Foreign Investment in Companies of Strategic Importance for National Defense and State Security" of April 29, 2008, No. 57-FZ, may place no more than 25% of its shares. Furthermore, if the company is engaged in either geological exploration or mining of mineral resources in deposits of "federal significance", the company may place only a maximum of 5% of its shares abroad.
The second restriction provides that no more than 70% of the shares of (a) a particular issue, or (b) the shares intended for sale by an existing shareholder, may be placed abroad.
For example, if a Russian company issues 1,000 shares, it may only place 700 of those for sale abroad. A shareholder who intends to sell 1,000 shares of a Russian company may only sell 700 abroad.
The Regulation provides that a Russian issuer or shareholder intending to sell shares abroad must also offer those same shares for sale in the RF.
The authors of the Regulation have established the threshold of 70% to ensure that the remaining 30% of the shares are sold (or at least offered for sale) in Russia.
It should also be noted that the Regulation and the restrictions it establishes are applicable not only to direct placement/circulation of Russian shares abroad, but also in cases in which such shares are sold indirectly in foreign jurisdictions by "placement under foreign law of foreign securities representing issued securities of a Russian company".
The term "foreign securities" refers, first and foremost, to foreign depositary receipts, such as ADRs (American Depositary Receipts) and GDRs (Global Depositary Receipts)2.
In a Depositary Receipts program, depositary receipts confirming title to shares of a Russian company are issued abroad. The depositary receipts represent an interest in Russian shares deposited with a depositary in Russia. The purchaser of the depositary receipt acquires the rights pertaining to the shares of the foreign issuer (such as dividend and voting rights). The depositary, in turn, must provide the owner of the depositary receipt with the services necessary to exercising those rights. Since depositary receipts are issued by a non-Russian financial institution, depositary receipts are generally considered less risky and more understandable than the direct purchase of the underlying shares.
Since depositary receipts significantly simplify the process of investing in foreign securities, they are widely used, including in Russia. Thus, the authors of the Regulation decided to have the restrictions on shares apply also to depositary receipts issued outside of Russia, but representing shares of Russian companies.
For instance, if 1000 shares are deposited by a Russian company and GDRs are issued representing an interest in those shares – only GDRs representing 700 of these shares may be sold on a foreign exchange.
On June 3, 2009, FSFM published on its website a Draft Regulation (the "Draft"), which would impose more severe limitations on the amount of shares of Russian companies that can be sold abroad3. The Draft is expected to take effect as early as September 2009. Pursuant to the Draft, the limitation on foreign sale of Russian companies' shares largely depends on the quotation list of the shares. For shares on quotation list A, no more than 25% of the issuer's total stock may be sold abroad; for shares in quotation list B the threshold is set at 15%, while the figure is 5% for shares on quotation lists V and I.
The 5% limit also applies to companies of strategic importance engaged in geological exploration or mining of mineral resources in deposits of federal significance.
In this connection, it is important to note that FSFM Decree No. 07-102/pz-n of October 9, 2007 provides that shares offered to the public for placement or circulation for the first time are listed on quotation lists V and I. Thus, according to the Draft, the amount of a Russian company's shares offered in an overseas IPO may not exceed 5% of the company's stock. This amount is generally considered inadequate for an IPO and, consequently, this amendment could spell the end of Russian IPOs on international securities markets.
In addition, the Draft has not only lowered the limits on the percentage of shares that can be sold abroad, but has decreased the percentage of shares per issue that a Russian company is permitted to offer on foreign exchanges – from 70% to 50%. In other words, the Draft provides that no more than 50% of the shares of a single issue or no more than 50% of the shares being offered for sale by an existing shareholder can be placed abroad. Accordingly, the remaining 50% must be offered for sale in the RF.
A new provision of the Draft is the requirement that a report on the results of the sale of the Russian issuer's stock, both in Russia and abroad, be submitted to FSFM. This report must be submitted either by the Russian issuer whose shares are being offered for sale or by the shareholder selling all or a portion of his shares. The Draft also establishes an alternative – if an issuer or shareholder so requests, the report can be submitted to FSFM by the stock exchange on which the shares were sold, or by the broker who provided services in connection with the sale. The report must be submitted no later than 30 days after the end of the periodduring which the Russian issuer's shares were offered in Russia and abroad. For example, if the shares were offered over a period of two months, the report must be submitted within 30 days of the last day of the second month.
Possible implications of the new regulation
Kommersant daily newspaper reported on June 3, 2009 that head of FSFM Vladimir Milovidov is sending the signal that the domestic market is to become the primary market for placement of shares by Russian issuers, and that the Draft is intended to increase liquidity of the domestic securities market.
Thus, it appears that the Draft is intended to strengthen the Russian financial markets by forcing investors to purchase shares of Russian companies in Russia. Perhaps it is also part of the overall trend of protecting the Russian market by limiting competition. Another factor may be the general trend of limiting foreign investment in Russia. Finally, the Draft is also intended to ensure that only large companies experienced in placing their shares abroad can do so. Whatever the motivation, the Draft, with its negative impact on the ability of cash-strapped Russian companies to raise capital abroad, is short-sighted at best.
If adopted, the Draft will make it harder and more expensive for Russian companies to raise capital just at the time when they are unable to get bank loans or any other source of financing. This may lead to greater declines in industrial production and greater unemployment.
The Draft is also likely to lead to an even further decline in foreign investment in Russia. Is this really what Russia needs in the midst of the financial crisis?
Finally, one can assume that adoption of the Draft may compel Russian companies to find ways to circumvent the restrictions in order to attract foreign capital. For example, certain Russian issuers have been known to transfer their assets to foreign holding companies. These holding companies then issue securities and freely trade them on international stock exchanges. In this manner, Russian issuers are able to attract foreign capital and avoid the restrictions set by Russian law. If these new restrictions contained in the Draft come into effect as expected, the use of foreign holding company structures will become even more widespread among Russian companies, particularly those Russian companies that have already started the process of preparation for IPOs outside of Russia.
1 Share placement means that the issuer (a joint-stock company) is selling shares to the first owners (i.e., the shares are being sold for the first time). Share circulation, on the other hand, implies the secondary sales of shares by the issuer's shareholders.
2 FSFM letter _ 05-VG-03/13719 of August 29, 2005, explains the official position that ADRs and GDRs are considered issued securities of foreign companies.
3 We note that the restrictions set forth in the Draft also apply to foreign depositary receipts representing shares of Russian 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.