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. Last Updated: 07/27/2016

Cash Privatization Begins Despite Lack of Law

The long-awaited second stage of Russian privatization has quietly taken off, with companies from St. Petersburg to Vladivostok selling large shares for cash despite the lack of any laws to govern the process, according to state officials and private investors.

"Literally hundreds of cash auctions are taking place throughout Russia's 89 regions," said Arkady Yevstafyev, press secretary of the State Property Committee, which oversees the privatization process.

President Boris Yeltsin signed a decree in July to launch the radical program, under which large stakes in enterprises would be sold off for cash instead of privatization vouchers. But no legislation to implement the decree has since been passed or even considered.

In this atmosphere of legal uncertainty, cash auctions went through a slow summer, with only small stakes being sold to cover the costs of voucher privatization.

Recently, however, the tide has changed, with Russian enterprises selling increasingly large stakes at both cash auctions and investment tenders.

"The second stage of privatization has gone ahead without a legal basis," said Boris Jordan, director at CS First Boston, the leading foreign investor in shares of Russian companies. "Auctions are taking place under the old legislation."

Under the rules of voucher privatization, enterprises were allowed to sell up to 3 percent of their shares for cash to cover the costs of privatization. During voucher privatization, the small auctions attracted little interest.

But local officials and company directors soon realized that they were sitting on a gold mine. According to Yevstafyev, 51 percent of the proceeds from cash auctions go directly to the enterprises, while most of the rest goes to the local and regional budgets.

Even small shares can mean big revenues. A 0.076 percent stake in LUKoil Holding, one of 10 divisions of the privatized oil giant that will auction off shares in November, has a current market value of more than $2 million.

In Yekaterinburg, the local budget has gained more than 10 billion rubles ($3,300,000) from cash sales in the past six months, according to Vadim Shirogorov, deputy head of the Urals Stock Center brokerage firm.

"The market started thriving as soon as sales of enterprises for cash began," he said.

The Yekaterinburg Property Committee plans to sell about 40 companies by the end of the year, including the Rezhsky Nickel Factory, turbine producer Turbomotorny Zavod and the Koltsovo airport.

The situation is similar across the country, with auctions held this month ranging from 0.37 percent of giant Norilsk Nickel, to 13 percent of the Vostok textile factory in the far eastern Maritime Region, to 16.4 percent of the Tyumen construction firm Tyumenstroi.

The sell-offs are still a far cry from the controlling stakes that privatization chief Anatoly Chubais had planned to offer foreign strategic investors under the second stage of privatization. Nonetheless, foreign companies say that they have found some good buys.

"We are very active now," said Jordan of CS First Boston. "At a recent auction we were able to purchase a 15 percent block of Volsk Cement," an attractive company in the Saratov region.

New rules for cash auctions are expected to be approved later this week by the Justice Ministry, according to Alexander Pershin, deputy press secretary at the State Property Committee.

Not everyone is happy about the developments, however. Before its summer break, the State Duma repeatedly voted down a diluted version of the second-stage program. Chubais responded with a more aggressive plan, implemented by presidential decree July 22.

Parliamentary opposition to cash sell-offs is still strong and adds significant risk to investments being made now.

"The program is illegal -- it doesn't even fulfill what Chubais himself promised the Duma," said Alexander Shabanov, deputy chairman of the Communist Party of Russia. "We will annul all acts of privatization."

One especially thorny legislative issue crucial to privatization is land ownership. Several presidential decrees have been issued, but no working law exists. In Moscow, Mayor Yury Luzhkov has outlawed private land ownership.

According to Roger Gale, mission head in Moscow for the International Finance Corporation, which has over $750 million invested in Russia, land law is essential to an increase in foreign investment.

"Many foreign investors face home-country restrictions," said Gale. "In order for them to be able to place funds here, it is essential these legal questions be resolved."

Until the parliament can resolve this and other legislative problems investors say that Russia will be working at a disadvantage to other emerging markets.