Russian sanctions and their effect on doing business with Russia
July 2014 | SPOTLIGHT | INTERNATIONAL TRADE
Financier Worldwide Magazine
The imposition of economic sanctions on Russian individuals and companies has had a profound effect on the way legal and financial risks of doing business with Russia and the CIS are perceived. This article aims to summarise the key developments and put into perspective the practical implications for Russian companies and banks.
The beginning of June has marked the third month of the economic sanctions and similar measures imposed on Russia by the G7 countries and a number of international organisations, including the OECD and the EU. This period has also seen a landslide in how Russia is perceived in the main financial centres of the world. In the meantime, Russia has reinforced its big turn to the East by signing a US$400bn gas deal with China. Russian President Vladimir Putin, speaking at the St. Petersburg Economic Forum in May, has tried to play down the negative effect of the sanctions on Russia.
Our analysis of the unfolding sanctions reveals two different approaches taken by the US and Europe to dealing with Russia. The US approach has been marked by targeting individuals with substantial economic powers that are in the top of the Russian political and economic establishment. A good example is Gennadiy Timchenko, former part-owner of Gunvor, a large oil trader based in Switzerland. The US inclusion of Mr Timchenko onto its sanctions list led to the sale of his stake in Gunvor to the Western partners. The US has so far stopped short of imposing industry-wide sanctions on the Russian economy, such as on natural resources or financial services. Russia’s response to the US-led sanctions has remained relatively mild (e.g., by including US nationals in a symmetrical sanctions list).
We believe that the US approach, although more broad, will have most of its negative impact on Russian businesses not in the present but in the future, as the unspoken steps aimed at banning cooperation with Russian companies take their toll. This may have a more serious cumulative effect on the Russian economy over a much longer period, just at the time when the economic growth in the country has for the first time in more than a decade slowed down significantly.
By contrast, the European approach to the sanctions against Russia has been more reactive, as opposed to the US proactive approach. The EU has struggled to produce its own meaningful policy towards the sanctions and is more or less drifting after the US in imposing measures against Russian corporations. This is largely explained by the fact that imports of goods by Russia from the European Union in 2012 reached €123.26bn, which puts Russia in second place in this category among EU trade partners ahead of the US. It should also be remembered in assessing the reticence of the EU to go further down the sanctions route that a number of its members are heavily dependent on Russian gas supplies (Germany by more than 30 percent, Greece by 60 percent, Poland by 80 percent, Bulgaria and Finland by almost 100 percent). While the US is trying to address this by encouraging its European partners to switch to non-Russian supplies of energy commodities (such as LNG and shale gas), this plan looks unrealistic within the foreseeable future. It is therefore most likely that the practical effect on Russian businesses of any further measures by the US will be somewhat mitigated by the European approach.
How does this affect Russian companies doing business with their Western counterparts? An interesting trend has been identified in the IT industry that is heavily orientated towards the main developed markets, including the US. For example, a successful Russian online gaming company, Game Insight, has recently announced that it will move its headquarters from Moscow to Lithuania. In the absence of having hard assets, such as manufacturing facilities, situated in Russia, companies such as Game Insight and another large IT developer LUXOFT are taking advantage of the European regime while detaching themselves from the negative Russian baggage by moving their business away from Russia. Another example is the world’s largest free-download gaming company World of Tanks, which has its origins in Russian neighbour Belarus, recently listing on the Cyprus stock exchange. While the benefits of listing on the Cyprus exchange are questionable, this will allow the company to change its domicile from Belarus to an EU country such as Cyprus.
Between 2005 and 2014 the London Stock Exchange has seen close to 70 IPOs of companies with Russian assets, representing the lion’s share (more than 55 percent) of all such public offerings compared to other bourses (Moscow Exchange is the runner-up with 33 percent, followed by NASDAQ with 5 percent and Deutsche Börse with 3 percent). London had been selected by at least four Russian companies for their public offerings in the first half of 2014.
We believe that AIM listings will in fact be less affected by the current (and potential future) sanctions against Russia given AIM is the focus of smaller-cap businesses with shareholders unlikely to be named by the EU or US in the future. However, even if no industry-wide sanctions are adopted against Russia, the admission document for new issuers will need to be reviewed with a particular focus on significant shareholders, directors and senior management, market and customers. The ‘risk factors’ section of the admission document is most likely to be revised by all issuers in light of the current and potential sanctions. Investors should be aware of the language describing new ‘Russian risks’ for all Russian offerings from now on. There is no indication, however, that any specific measures will be adopted to bar Russian companies from the LSE.
The ‘risk factors’ section of the admission document is most likely to be revised by all issuers in light of the current or potential sanctions. Investors should be aware of the language describing new ‘Russian risks’ for all Russian offerings from now on. There is no indication, however, that any specific measures will be adopted to bar Russian companies from the LSE.
While it is much easier for IT companies to change their domicile, the effect on Russian banks and its financial system is harder to predict. VTB Capital, a UK indirect subsidiary of JSC VTB Bank, a Russian government majority owned bank, has recently received, according to its president Andrei Kostin, a disproportionate amount of attention from the FCA. Unlike VTB Capital, banks that have connections or are controlled by the individuals who are listed in the sanctions list have had much more serious issues. For example, Visa International and Mastercard stopped processing cards issued by Bank Rossija which is owned by the Rotenberg brothers, who appear on the US sanctions list alongside Mr Timchenko and other members of President Putin’s inner circle. In the broader context the US may target the Russian financial system by barring Russian banks from joining the international tax evasion procedures (such as FATCA) that may result in Russian banks being unable to process international payments. US or European lenders have already started to impose harder measures on Russian banks, tightening up the contractual safeguards for their Russian counterparties, including the introduction of more severe covenants and warranties.
Although there is clearly not much optimism in Moscow, Washington or Brussels at the moment, the economic ties between Russia and the West have reached a critical mass that is likely to sustain continued high levels of trade and business developed over the previous two decades.
Una Deretic is a partner and Innokenty Alekseev is a legal consultant at Kerman & Co. LLP. Ms Deretic can be contacted on +44 (0)20 7539 7090 or by email: firstname.lastname@example.org. Mr Alekseev can be contacted on +44 (0)20 7539 7310 or by email: email@example.com.
© Financier Worldwide
Una Deretic and Innokenty Alekseev
Kerman & Co. LLP