Investors Tell State To Seize The Day

APPresident Dmitry Medvedev visiting the opening Friday of General Motors' first Russian plant, in St. Petersburg.
Editor's note: This is the fifth in a series of reports about the effect of the global financial crisis on Russia.

James Beadle keeps an eagle eye on the activities of publicly traded companies from his office at Pilgrim Russia Investment Fund.

So the portfolio manager saw red when Sibir Energy, a London-listed oil company with assets in West Siberia and Moscow, announced in mid-October that it would purchase a hotel and another property from its main shareholder for $115 million.

"If I wanted to buy a hotel, I'd buy a hotel — with my own money," Beadle said.

He said Sibir's decision exemplifies a "sliding away" of corporate governance in Russia.

While corporate governance is largely an internal company issue, its quality is determined by legislation and other external forces — putting it on a wish list of reforms that foreign investors said the government should tackle as Russia is buffeted by the global financial crisis. Other priorities include court and tax reform, equal application of the law and support for small and midsized businesses. Progress in these areas, investors said, will allow Russia to emerge from the storm with a stronger economy.

"When you have a financial crisis, it is trendy to focus on the short term to overcome it," said Klaus Rohland, the World Bank's country director for Russia. "I encourage the government to pursue its long-term agenda side by side with the crisis."

Corporate governance has long been a hot-button issue, and minority shareholders have complained of unfair treatment since the 1990s. The complaints might be fewer these days, but the issue has not been laid to rest.

Businessman Shalva Chigirinsky
Sibir Energy CEO Henry Cameron acknowledged that the decision to buy the three-star Sovetskaya Hotel and a development project at 34 Leningradsky Prospekt from shareholder Shalva Chigirinsky marked a significant departure from the company's core business.

But he said the decision was made in the best interests of all shareholders.

"We took the steps that we took because we felt that margin calls on Mr. Chigirinsky's property could result in his shares being sold on the market," Cameron said by telephone. "And this threatened what we consider to be the fundamental key to Sibir's success — that Sibir is controlled by Russians."

Beadle, who said his fund has not invested in Sibir, is skeptical of the company's methods. "You own some property you want to get rid of. How do you do it? To the detriment of the minority shareholders," Beadle said.

What Russia needs is to develop a culture of accountability — from the courts right on down to the police force — to encourage companies to embrace good corporate governance practices, investors said.

Judicial Reforms

Chris Finlayson of Shell
A key step toward creating that culture of accountability could be to establish an administrative court system that resolves disputes between companies and government agencies or officials, said Andrew Somers, head of the American Chamber of Commerce in Russia.

Such a system, in place in the United States and countries in Western Europe and South America, "takes a lot of complicated issues and drives them into the public domain. It creates transparency, the transparency of judges and is good for clearing up corruption," Somers said.

Unlike judges in common-law court systems, administrative law judges are sector specialists who preside over administrative disputes only in their particular fields of specialization, such as tax policy, zoning legislation, technology or building permits. "If Russia had an administrative law system with experts in the oil sector, there would be a ready-made system to resolve issues," Somers said, naming as an example worries by foreign oil firms about the state's application of a strategic sectors law adopted on May 7. The law requires foreign investors to receive state approval to participate in projects in sectors deemed to be important to national security.

Chris Finlayson, head of Shell in Russia, expressed grave concern at a recent investment conference over the lack of a "clear definition of what constitutes national security."

Many business leaders interviewed for this article agreed that judicial reform should be a priority, but they said they would be happy if steps were just taken to increase the efficiency and independence of the current system. Judges are hindered by underdeveloped infrastructure and case-management systems, and they could be freed up to concentrate on the substantive part of their jobs if qualified law clerks were trained to run the courts like an office, said Rohland of the World Bank. "Any legal system is only as good as its courts," he said.

Level Playing Field

Yevgeny Plaksenkov, general director of MIEL, a real estate company, said he wanted to see the law applied equally for all business players, be they large, medium, small or government-controlled. Concerns about a level playing field have run high since the 2003 arrest of former Yukos CEO Mikhail Khodorkovsky on tax and fraud charges that could just have been filed against any business leader but weren't. "If Russia is interested in playing a respectable role in the global economy, the rules of the game need to be observed by all," Plaksenkov said. "Small, medium and large businesses, you can't treat them differently. Only then will the most effective business happen — and economics without business isn't anything."

The fair application of the law will play a big role in Russia's economic future and its reattraction of foreign investors, said Jeff Costello, CEO of JPMorgan Bank Russia. "The ability of the government to insure that state-owned companies play by the rules is key," Costello said at the recent investment forum. "Investors are fleeing to quality."

Investors also are seeking predictability and transparency in trade and tax regulations — the very measures that help determine a level playing field.

Alexander Lioutyi, head of corporate and regulatory affairs at British American Tobacco in Russia, said he would like to see Russia's web of technical trade regulations consolidated into a more business-friendly format. Lioutyi said he was waiting for the State Duma to pass bills to stimulate such reform, including a technical regulation bill on tobacco products that is up for a second reading in the Duma. "Its early adoption would be a big step forward in streamlining tobacco regulation," he said.

Yevgeny Nadorshin, an economist at Trust Bank, said nebulous, inefficient tax laws make it difficult for firms to operate effectively. "Everything should be designed to make businesses' lives easier, and I don't mean taxes themselves, because most of the things we need to deal with are the burdens related to taxes in excess of the tax system," he said.

Investor Wish List

  • Improved corporate governance, fostered by a culture of accountability with government structures.
  • Streamlined, independent court system. Possible introduction of an administrative court system that resolves disputes between companies and government agencies.
  • Equal and transparent application of the law to all companies, particularly in light of the new strategic sectors law.
  • Predictability and transparency in trade and tax regulations, including technical regulations and VAT.
  • Support for small and midsized businesses.
— MT
A prime example is the payment of value-added tax on exports, he said. The 18 percent VAT applies to the sale of goods and services within Russia's borders, including imports. Exporters, however, must also pay the tax before their goods are shipped abroad and only later are eligible for reimbursement.

"They like to get the money first to make sure you are a proper exporter, and only after that you can get your money back," Nadorshin said. But for some exporters, the time and costs involved in the application process for the VAT refund may not be worth the hassle.

Tax experts have their own wish list, starting with the desire to see the tax service take standard international business operating procedures such as cost sharing between parent companies and their foreign subsidiaries taken into account in their calculations. "The lack of development of a legal framework for cost sharing is the key problem. … It is not known to Russian law," said Dmitry Alimov, tax manager for GE Russia.

Support Small Business

At the same time, the government needs to support the creation of small and midsized businesses, allowing them to flourish and compete with one another, said Heidi McCormack, executive director for General Motors Russia, which opened its first plant in Russia on Friday and is looking for Russian companies to integrate into its business model. McCormack said the choice is limited in some regions when it comes to companies able to provide necessary services that feed into and out of manufacturing operations, including logistics providers, parts suppliers, dealers and wholesale shops for parts.

"Instead of having one company that can serve from the Urals east, there may be more to chose from," McCormack said. "The creation of more businesses and increased competition would give us a broader array and allow us to get the best price and best performance."

This issue is on the government's radar screen. At an Oct. 22 meeting in Novosibirsk, Prime Minister Vladimir Putin said the state would significantly increase its spending for direct support for small and midsized businesses from its current level of 3.4 billion rubles.

Boris Titov, chairman of Delovaya Rossia, the lobby group for small and midsized businesses, said it was imperative for the government to give clear-cut incentives such as VAT cuts for small business development to ensure the creation of a competitive economic environment. "The principle problem of the Russian economy is the lack of competition on the market," Titov told a group of investors late last month.

Only 37 percent of Russian companies face both domestic and foreign competition, and 20 percent of Russian companies face no competition at all, he said.