A warm welcome or a cold shower for investors in Russia?

22.07.2010 — Analysis

During the Russian-German summit held in Ekaterinburg in mid-July, 2010, German businessmen raised the question of easing the visa requirements between Russia and the countries of the European Union.  This issue came as a surprise to Dmitry Medvedev and Angela Merkel. It was the Germans who asked, not the Russians, proving once again that Western businessmen are interested in Russia and this interest is growing steadily.  Investors are beginning to think about where to put their post-crisis cash. Are the current Russian laws ready to give this foreign capital a warm greeting? The director of RusBusinessNews, Vadim Dynin, discusses this with Olga Lashkul, a leading lawyer in the Ekaterinburg office of the law firm Hedman Partners Attorneys-at-Law. 

- It’s no secret that Russia today is not terribly attractive to investors.  That’s a fair assessment. On the World Bank’s list of the 183 most business-friendly countries, Russia is ranked 120th.  Why is that, in your opinion?

- Of course, the primary factors that affect the investment climate in Russia are traditionally economic and political.  Unfortunately, corruption is still a big barrier – that’s well-known to anyone thinking about investing in Russia. But we can’t forget about legal shortcomings as well, despite a number of very real steps that have been taken to liberalize the laws. 

Major investors are primarily interested in the so-called strategic industries, which are still the most highly-regulated. Acquiring more than a 5% equity stake in a company from one of these industries requires the approval of a government commission. Mentioning that kind of a commission would scare off any private investor, but especially a foreign one... So, on one hand, there’s not a favorable investment climate, and on the other, the government’s cautious attitude toward foreign investors has resulted in Russia being nowhere near the top hundred rankings on the World Bank list…

- All right, and how do Russian laws see the foreign investor?

- The federal law called On Foreign Investment considers a foreign investor to be any foreign legal entity, foreign citizen, international organization, or foreign government who is investing foreign capital in businesses that are located within the Russian Federation.

As a rule, there is a distinction between "direct" and "portfolio" investing. And if the foreign investors’ only goal is to make a profit off of businesses operating within the Russian Federation, then there are different ways of doing that. Portfolio investments are capital investments in shares of foreign businesses, but made without acquiring any control over the business itself.  However, if the investor chooses to make a direct investment, then he has the right to participate in the business’s activities. Since portfolio investing is not widespread in Russia, let’s talk about direct investing. 

There are three different ways to participate in the operation of a Russian business through direct investment:

1)         investing capital in a newly-established or already existing Russian legal entity. In this case, a company might be established with a participating stake of foreign capital (known as a joint venture), or a company might be set up using 100% foreign capital

2)         investing capital in a branch of a foreign legal entity, established within the Russian Federation

3)         the foreign investor can lease equipment within the Russian Federation under a capital lease.

In addition, investments may take the form of granting the right to use certain technology, know-how, granting loans and credits, obtaining the right to use land and other resources...In other words, there are many different ways, the main thing is the desire to invest.

- Olga, what type of business organization do you think is the safest and most convenient for an investor?

- It’s hard to give a simple answer - it all depends on the particular situation. For example, if a foreign investor wants to take over the management of a business in Russia, then definitely the best way to do that is to establish a branch of a foreign organization or to invest money in a Russian legal entity, under the condition that his stake in the charter capital gives him the right to make strategic decisions - because minority investors are frequently mistreated in Russia. If the goal is to invest money to see a return, then there are other ways to do it, for example, by making recurring investments (in the form of credits, loans, etc.).

As far as safety is concerned, I can say the following: investing, like any other business activity, comes with certain risks, including economic ones. Any businessman should understand that.  Whether the project is legally secure and whether the investor’s interests will receive the maximum protection depends on the documentation on the basis of which the capital is being invested.  Those documents need to be well-written. It’s very important to get in touch right at the beginning with a professional who has been trained in these matters.

- Here’s an important question: Is there a policy in Russia that protects foreign investment and ensures that it is treated favorably?

- Yes, of course. Russian laws are formulated on the principle of ensuring that foreign investment is treated favorably.  This is the very principle that guides the laws. Foreign investors can operate and use the profit they earn under terms just as favorable as those enjoyed by Russian investors. In addition, Russian laws guarantee full protection of a foreign investor’s rights within the Russian Federation, guarantee the reimbursement of any damages resulting from the illegal actions of a government agency, and so on.  The Russian Federation is also bound by a number of international treaties and ratified conventions on the protection of foreign investments.

- Are there any specific restrictions in the Russian Federation on how foreign individuals and legal entities can conduct business?

- Of course there are, just as in any other country. In the first place, I should mention the restrictions on banking.  There is a legal limit on the amount of foreign capital in the banking system, which was established at the suggestion of the government and in consultation with the Bank of Russia. In addition, a significant law was passed in 2008 on foreign investment in strategic industries, which I have already mentioned. A partial list of these industries would include: aviation safety and the development of aviation technology, television broadcasting, telecommunications, mass media, mining, the exploitation of aquatic biological resources, etc.  It’s a pretty extensive list. Any foreign capital invested in these industries must be regulated by the Russian government.

In addition, there are other restrictions one should bear in mind. For example, organizations may not own agricultural land, if the share of foreign capital in these organizations is above 50%.

- What are some of the unexpected problems in Russian laws that ensnare foreign investors?

- I would have to say that first and foremost the investor needs to pay attention to his Russian partner, whether he is the co-founder of a joint venture or a hired manager. Secondly, it’s important from the very beginning to weigh and evaluate the risks of the industry that the investor is interested in. There are occasionally also unexpected legal problems. One difficulty is that, in addition to the laws in Russia, there is also an extensive system of bylaws and regulations, which can be confusing. The requirements of Russian currency laws are very often a surprise to investors.  These laws can seem quite barbaric in comparison to liberal laws in the West. But these problems can all be solved, as long as one gives them some thought in advance.

- Do you think that Russian laws will move further toward liberalizing the regulation of foreign investments?

- Well, Russia, like any other country, will always regulate the process of attracting foreign investment, especially in some key industries for the government. There probably won’t be any fundamental changes in this position. However, the authorities understand the importance and need for external capital inflow in order to develop the country’s economy. That’s why assistance to investors is essential at both the federal and regional levels. There is also a need for transparency in the regulatory framework and the removal of administrative barriers, which will improve the quality of both federal and municipal governance.

At a meeting in early 2010 about the problems in the investment climate, Russian President Dmitry Medvedev identified investment activity as the deciding factor for the  modernization of the country’s economy and announced a set of measures that should be implemented in order to "warm up" investment activity. Some of these are already in effect, including the suspension of quotas on highly-qualified foreign professionals.