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. Last Updated: 07/27/2016

Righting Some Wrongs

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In terms of its poor corporate governance record, the Russian equity market over the past several years has had the unenviable distinction of being a world leader. Minority shareholders in Russian companies have been victims of every form of abuse in the book, from crude alterations of shareholder registries to share dilutions and financial legerdemain that the likes of Enron would be proud of.

The result has been angry investors, punishing terms for Russian companies looking to raise foreign capital, a dreadful image on global capital markets and, most importantly, an uphill struggle toward long-term sustainable growth.

However, a raft of recently passed legislation represents a significant step in the right direction and will support the ongoing re-rating of Russian assets. Legislation to protect minority investors -- and most importantly the enforcement of such laws -- benefits both Russian companies, which will find it easier to raise new funds, and investors in Russia, who should be less concerned about being ripped off by company management and see the value of their present holdings in Russian companies appreciate. Indeed, partly in anticipation of improvement in the investment climate, the Russian equity market has jumped 70 percent since its recent lows in October 2001 (although a range of other factors has also contributed to the rise).

The new legislation, which takes the form of amendments to the law on joint-stock companies, focuses on improving the legal protection of minority shareholder rights. Specifically, the amendments, which came into effect Jan. 1, state that: boards of directors will be able to dismiss the company's CEO at any time; share issues of more than 25 percent of total shares outstanding must be approved by a general shareholders' meeting; existing shareholders have the right of first refusal to buy any new shares in their company; and information about a shareholder who controls more than 20 percent of a company (such as details regarding the ultimate beneficiaries and related entities) must be disclosed to the board of directors or auditor upon request.

Another effort by the government to improve corporate governance is the corporate governance code, which lays out rules and ethical standards for Russian companies in their dealings with shareholders. The document calls for all shareholders in a company to be treated equally; sets forth information disclosure standards; posits that shareholders should have the right to influence major corporate decisions; and lays out the responsibilities of corporate boards of directors.

While adherence to the code -- which was crafted on the basis of input from a wide range of market participants -- is voluntary, the Federal Securities Commission has indicated that it will push for elements of it to be turned into law, and the government has said that that it will grant contracts only to companies that have implemented the code.

Additionally, on Wednesday the State Duma was slated to discuss in first reading fresh amendments to the law on joint-stock companies that would help ensure that the votes of American Depository Receipts shareholdings are not automatically allocated to management but rather to an appointed trustee or agent. This is more than just an academic point, as attested by the uproar over the allocation of the votes of ADRs (predominantly held by foreign investors) at last year's annual general meeting of UES. While hardly earth-shattering, it represents a small but long-overdue improvement to current corporate governance legislation.

These improvements point to the fact that another lingering concern about the Russian investment environment is being addressed by the government.

The efforts of the Putin administration over the past year to chip away at the vestiges of the command economy via land, pension, bureaucratic, judicial, and labour reforms, and to create an environment conducive to sustainable long-term growth have buoyed investors.

Corporate governance reforms should support the continued re-rating of Russia as an investment destination, from a basket case -- as it was just a few years ago -- to a respected member among the ranks of emerging markets.

But while changes to corporate governance regulation will help minority investors, they will not completely eradicate the abuse of investors by managers. It would be a mistake to underestimate the capacity of managers to develop new and creative ways of robbing their minority shareholders of value. Also, the record of the government when it comes to implementation of reform legislation is still unclear, given the short period that has elapsed since many reformist measures were adopted.

In the final analysis, companies have to want to change their behavior. Managers have to believe that in the long term, the rewards of a higher share price and access to international capital markets outstrip the short-term gains of stealing from shareholders. This message seems to be sinking in, although progress has been slow and uneven. That the Putin administration is focused on the issue should accelerate the cultural shift on the part of corporate management, to the benefit of both investors and the companies in which they invest.

Kim Iskyan is a director at Renaissance Capital. He contributed this comment to The Moscow Times.