The Russia Monitor

There have been a few developments with the strategic industries law since I last had the chance to write about this issue.

Archangel Diamond Corporation (ADC)

ADC's troubles never seem to end. It took them 10 years to fight Lukoil's Alekperov, in multiple jurisdictions and fronts, just to assert their ownership over the Verkhotina Grib pipe diamond mine. Finally in October of last year, the Commission on Foreign Investment approved their application to purchase a 49.9% stake in the disputed company - Akhangelskoye Geologodobychnoe Predpriyatie (AGP). Shortly thereafter, however, the Commission conditioned its approval on ADC's agreement to process a predetermined amount of diamonds from the mine in Russia. The agreement, however, never came through and late last year ADC filed notice of a 'termination event' under its share purchase agreement with Lukoil, and then terminated the transaction this January. Almost immediately after the termination, ADC reinitiated its legal attack on Lukoil, the suspension of which had been a part of the deal, including the reopening of a civil suit in Colorado courts.

The Second Commission Session - February 4, 2009

On February 4, the Commission held its second session and approved several transactions. First, Barrick Gold acquired an additional 29% stake from Norwegian state investors, for a total of 79%, in the mining concern Fyodorova Tundra (Федорова Тундра), which has rights to around 100,000 tons of platinum, palladium, and gold ores. Second, Universal Cargo Logistics Holding BV (UCLH) purchased the Taganrog Shipyard (Таганрогский Судоремонтный Завод) from Valars Group (via Yugtranzitservis); the plant includes a port terminal price estimates ranged from $15 to 50 million. The purchasers, though Russian, were forced to comply with the strategic industries law because they made the purchase through offshore entitites. Third, the Commission approved OAO "Khartron's" (Хартрон) acquisition of additional shares in ZAO "International Space Company Kosmostras" (Космострас), to yield a 49.74% stake; Khartron is controlled by the Ukrainian government.

The Commission was supposed to review TNK-BP's proposed acquisition of 5.48% of Verkhnechonskneftegaz (Вернечонскнефтегаз) from OAO "East-Siberian Gas Company" (Восточно-Сибирской Газовой Компании), but the Commission postponed a conclusion. The reason for the delay was a dispute between TNK-BP and its 'junior' partner on the Verkhnechonsk project, state-owned Rosneft. Indeed, media outlets reported that the Commission conditioned any future approval on an agreement between TNK-BP and Rosneft regarding the purchase. Since then, it has been reported that Rosneft, not TNK-BP, will purchase a 5.48% stake in Verkhnechonskneftegaz.

The Upcoming Session - May 26, 2009

Later this month, the Commission will meet again and, in addition to revisiting the TNK-BP application, will rule on several more proposals. First, the Commission will supposedly consider Basic Element and Glencore's application regarding the purchase of RussNeft. Deripaska has been waiting since 2007 to complete this deal, and it seems he might have run out of money at the finish line. Indeed, he is reportedly in talks with Gazprom - one of RussNeft's main creditors - to try and sell the company. Some have suggested in the past that the fight over RussNeft was really a fight between Deripaska and Igor Sechin, who is a member of the Commission. Second, Nafta-Moskva (Suleiman Kerimov) has applied to acquire 15% of Polyus Gold (Полюс Золота) from Interros (Vladimir Potanin) for approximately $1.3 billion; this is another situation where the use of offshore structures trigger the law. Lastly, Polymetal (Полиметалл) has asked for permission to buy OOO Gold Company "Mayskoye" (Золоторудная компания "Майское) from Highland Gold Mining (HGM) for $105 million.

Strategic Industries Law - Nightmare or Silver Bullet?

After a year of being in force, I think we can conclude that the strategic industries law is neither the death knell nor panacea for foreign investment in Russia that both sides were predicting (to be fair, the critics were quite a bit more vocal about how disasterous the law would be). The law has been widely implemented without much scandal, though my coverage might give the opposite impression. Overall, in 2008 (i.e., from May - Dec 2008), the Federal Anti-Monopoly Service (FAS) processed 234 filings under the new law - 224 pursuant to Article 16, Section 3; and 10 pursuant to Article 14. For its May 26 session, the Commission has a docket of 20 applications from foreign companies for the purchase of shares (i.e., under Art. 14). So it appears that the law has functioned in a normal, reasonable way for the majority of applicants whose cases were not interesting enough to generate media coverage (though I admit this is not a fool-proof assumption).

What can we conclude based on the cases with which we are familiar? I think there are several lessons:

• Russia is still Russia - just because ADC got the Commission to approve its purchase does not mean that its partner (Lukoil) will start changing its behavior. The problem here is that it is not clear where the request for local processing came from, which eventually undermined the deal. It's not difficult to imagine Lukoil first working with Akhangelsk officials to ensure that the Commission includes this condition, and then dragging its feet while the clock runs out.
• Beware of the State Interest - one thing is clear - where a state corporation and a private entity are competing for the same asset, the Commission serves as a sort of super-shareholders body with veto power, as the TNK-BP case suggests.
• Bilateral Economic Relations Still Key - the cases that have been most successful are those that supplement a bilateral relationship between Russia and the foreign investor's home country. For example, the Alenia acquisition of Sukhoi Civil Aircraft was never challenged and concluded without any delays or surprises. The purchase of Imperial Energy PLC by Indian state-owned Oil & Natural Gas Company (ONGC) never even had to go to the Commission because the FAS and Subsoil Agency 'determined' that Imperial's oil fields were not of federal significance. This, despite the fact that Imperial's recoverable reserves amounted to 73 million tons of oil, and the law defines federally significant oil fields as those with 70 million or more tons of oil (See Art. 1 of Federal Law No. 58-FZ). Finally, Khartron's (Ukrainian state-controlled) acquisition of more shares in Kosmostras (Russian state-controlled) reeks of a high-level diplomatic agreement, perhaps to take some of the sting out of the last gas war.
  
• Not a Supreme Commission...Yet - when you consider the ADC and TNK-BP outcomes together, and then compare them to the successful deals mentioned above, it suggests that the Commission is still not fulfilling its intended role as final arbiter of hotly contested disputes. In fact, the few examples we have show that, the greater the dispute, the less likely the Commission will be effective. The whole problem in the past was that disputes were resolved according to opaque and either extralegal or illegal methods. Everyone knows that an Alenia acquisition of Sukhoi will happen - for the benefit of the Superjet project, after closed-door head of state discussions, and in the context of a great relationship between Putin and Berlusconi. But this law and the commission were not created to paint a professional veneer on certain outcomes. Rather, their only purpose is to resolve the ADC/Lukoil and TNK-BP/Rosneft disputes in a fair and transparent way. It is still early to expect perfect results, and maybe the Commission has played the role of the neutral arbiter in some non-public cases. Nonetheless, from what we do know now, the Commission still has a long way to go.