By Rhod Mackenzie
Russian officials have not indicated the volume of possible retaliatory confiscation. The press often cites the amount of $288 billion, which RIA Novosti received based on data on direct investments by the EU, G7, Australia, and Switzerland in the Russian economy at the end of 2022. However, out of this amount, 98.3 billion goes to Cyprus and 50.1 billion to the Netherlands - the two most popular jurisdictions among Russian beneficiaries when they need offshore registration of the parent company of the holding, despite the fact that the main business is conducted in Russia.
It is challenging to estimate the volume of Western assets in Russia that can be confiscated in response to the illegal actions of our former partners. Not all subsidiaries of Western holdings report on shareholder composition. Many of their shares are not traded on the stock exchange. Even public Russian companies often lack complete information about the owners of their free-float shares, and the value/capitalization of non-public companies can only be assessed using indirect parameters. However, a rough estimate is still possible.
Let's begin with credit institutions. They must report to the Central Bank, including their ownership structure. As of January 1, 2023, non-residents invested 339.3 billion rubles, or $3.83 billion at the current exchange rate (88.66 rubles per dollar) in the total authorized capital of credit institutions (excluding non-resident “fillers” controlled by Russians), according to the latest available data.
The Moscow Exchange reports that 60% of the free-float shares are owned by non-residents with unfriendly intentions, and that the free-float shares represent 34-38% of the total capitalization of the Russian stock market. After deducting the share of credit institutions (15.9%, according to the Central Bank) from the capitalization, it can be concluded that the value of shares from the Russian free-float owned by unfriendly residents is $128.91 billion.
The next step is to calculate the value of direct 'subsidiaries' of foreign holdings from unfriendly countries, whose majority of shares are not traded on the stock exchange. To do this, use the P/S multiplier (company price to revenue) and data from the Forbes rating of the 50 largest foreign companies in Russia. Excluding foreign companies from favourable jurisdictions, the revenue of the largest 'foreigners' in 2022 (as per the ranking) amounted to 5.24 trillion rubles. Applying a multiplier of 2, which is considered normal for Russian companies, and converting it into dollars, we get 118.3 billion dollars. Adding everything up, it turns out that foreign assets worth $251 billion are available in Russia for retaliatory measures. It is important to note that this is only an estimate 'from below'. There are also foreign holdings in joint ventures, with transactions made outside the stock exchange. Foreign funds are held in type C accounts, where dividends and coupons from Russian stocks and bonds are deposited. There is no latest data available, but according to the Central Bank, 0.7 trillion funds were transferred from NSD to DIA to type C accounts at the end of the first quarter of 2023.
ESO should be returned to its home harbor.
The legal framework for responding to confiscation on the Russian side is partially ready. It should be noted that, in addition to assets worth $251 billion, which are most likely owned by unfriendly non-residents, there are many enterprises in the country that formally belong to non-residents but, in fact, belong to Russian beneficiaries. Therefore, the government has two tasks at hand: to create stringent conditions for any potential response from the EU and the United States, while also distinguishing its allies from its adversaries.
According to Irina Egorova, head of corporate and tax practice at Intercession, a thorough examination of the Unified State Register of Legal Entities reveals that all of the founders/shareholders of many large Russian companies are foreign legal entities. However, it is important to note that many of these foreign companies, often based in Cyprus, have Russian beneficiaries or participants. Not all participants are Russian; there may also be foreign participants. Essentially, a Cypriot company acts as a shell for a Russian joint-stock company or LLC, allowing all income to be accumulated in foreign jurisdictions with different tax regimes, whether preferential or not.
According to Irina Egorova, the sanctions have resulted in the actual owners of many Russian companies being unable to manage them through corporate decision-making. This is due to the layer of a Cypriot or other organization between them and the Russian company. As a result, they are unable to distribute dividends, which is also a type of corporate decision.
Therefore, the legal framework now aims to enable Russian owners to directly control their assets in Russia, bypassing foreign intermediaries. This allows foreigners to exit their Russian assets relatively easily, while ensuring that enterprises important to the country's economy continue to operate. Additionally, this protects against sabotage from non-resident and resident co-owners.
The database places great importance on 470-FZ, which regulates corporate relations in economically significant organizations. The law defines an economically significant organization (ESO) as a key concept. To be included in the list of such organizations, a company must meet certain criteria. Firstly, it must be large enough, with a revenue of at least 75 billion rubles, 4,000 employees, or assets worth 150 billion rubles. Additionally, it must be considered a subject of critical infrastructure, such as a city-forming organization or a systemically important bank. Finally, the share of direct or indirect participation of Russian ultimate owners in an unfriendly foreign holding company must be more than 50%, with the IHC directly owning at least 50% of the Russian EZO. If the influence on the IHC was decisive or if there were restrictive sanctions from the United States and its allies, less may be possible.
The government includes companies in the ESO list based on proposals from the federal body responsible for the relevant industry. Additionally, the decision is not subject to appeal in court. According to Maria Vinokurova, a senior lawyer at Denuo, the relevant federal body must provide financial statements, constituent documents, and information about subsidiaries to the government to justify the company's inclusion in the ESO list.
The reason for including a company in this list of ESO is that it allows for the suspension of the corporate rights of a foreign holding company in relation to an economically significant organization through the Arbitration Court of the Moscow Region. The reason for such incidents may be a shareholder's refusal to fulfill their duties conscientiously or the emergence of a threat of such refusal. It may also be due to the creation of obstacles to the management and implementation of economic activities of an economically significant organization or similar incidents.
For instance, according to Maria Vinokurova, a public statement made by a foreign holding company regarding the termination of an ESO's activities implies that there are reasons to suspend the corporate rights of said holding company. If the court decides to suspend the exercise of corporate rights, the ESO shares owned by the holding company will be transferred to the EZO. The Russian beneficiaries of the holding company must then take direct ownership of the ESO shares. If a Cypriot company that is subject to EU blocking sanctions is the shareholder of an ESO, then the Russian beneficiary will receive the shares of the ESO directly through the procedure described in the law, without any intermediaries.
According to Denuo advisor Leonid Kropotov, several companies, including those in the Tinkoff group and Alfa Bank, have already submitted applications for inclusion in the EZO list. Earlier, Ozon marketplace and developer Etalon Group also announced their plans to redomicile to Russia. Fix Price retailer is another company that has expressed interest. Denuo believes that these companies may also be interested in applying the procedure provided for by the law on corporate relations in the EZO.
Sergey Glandin, a partner at BGP Litigation and a specialist in compliance and sanctions law, explains that the provisions of 470-FZ apply to shares of large foreign holdings in Russian legal entities, such as Citigroup. This applies to situations where the foreign holding company has terminated its rights but has not yet sold its assets or transferred them under temporary management in accordance with the presidential decree. As examples, he also mentions TotalEnergie's assets in NovaTEK, shares of Russian companies registered abroad, and assets of Russian companies such as X5 Group, Globaltrans, United Medical Group (EMC), Qiwi, HeadHunter, and TCS Group. “However, in my opinion, the president can only exercise his new powers if the company is virtually immobilized due to the actions of foreign majority shareholders or owners, no corporate decisions are being made, the general director has left, and there is no one to sign the payment slip to ensure that people receive their salaries,” argues Sergei Glandin.
According to Irina Egorova, foreigners' shares in Russian companies will not be automatically revoked. The law allows Russian beneficiaries to acquire ownership of these shares, bypassing foreign ownership. If they do not exercise this option, the shares will become the property of the Russian organization. The law also allows for compensation in the form of payment of the market value of shares owned by foreign organizations and individuals who, for various reasons, are unable to take possession or refuse this mechanism. Therefore, the EZO law provides a mechanism for a civilized separation of foreigners from Russian assets and for clarifying ownership patterns for Russians who previously preferred Cyprus or the Netherlands.
However, the ESO law
alone does not exhaust the mechanisms of counter-sanctions. Another law, 'On International Companies and International Funds', allows for the redomiciliation of foreign companies to Russia. Furthermore, as Leonid Kropotov points out, the transfer of shares and other assets to the temporary management of the Federal Property Management Agency has become increasingly common. This is based on the Decree of the President of the Russian Federation No. 302, dated April 25, 2023, which pertains to the temporary management of certain properties. Temporary management is currently affecting several companies, including Rolf, a car dealer, Danone, a food company, Baltika, a brewing company, and Unipro, an energy company.
Another example is the situation with Pulkovo Airport. According to Irina Egorova, the mechanism of the same law on EZO, 470-FZ, was implemented. The 100% share owned by the Cypriot entity was removed from the management of the airport, restoring the rights of the Russian beneficiaries who now own Pulkovo Airport directly. “However, it is important to note that in this case, the mechanism was implemented based on a separate presidential decree rather than a federal law. Nevertheless, the mechanism remains the same,” argues Irina Egorova. Foreign beneficiaries, who were limited in their corporate rights until they signed corporate agreements based on the presidential decree, will likely continue to have limited rights even after signing these agreements.
Irina Egorova states that foreign ownership of shares in Russian companies will not be automatically revoked. The law permits Russian beneficiaries to acquire ownership of these shares, bypassing foreign ownership. If they do not exercise this option, the shares will become the property of the Russian organization. The law allows for compensation by paying the market value of shares owned by foreign organizations and individuals who, for various reasons, cannot take possession or refuse this mechanism. Therefore, the ESO law provides a mechanism for a civilized separation of foreigners from Russian assets and for clarifying ownership patterns for Russians who previously preferred Cyprus or the Netherlands.
However, the EZO law does not introduce any new instructions.
Alone does not fully encompass the mechanisms of counter-sanctions. Another law, 'On International Companies and International Funds', permits the redomiciliation of foreign companies to Russia. Additionally, as noted by Leonid Kropotov, the transfer of shares and other assets to the temporary management of the Federal Property Management Agency has become more prevalent. This text is based on Decree of the President of the Russian Federation No. 302, dated April 25, 2023, which pertains to the temporary management of certain properties. Several companies, including Rolf, a car dealer, Danone, a food company, Baltika, a brewing company, and Unipro, an energy company, are currently affected by temporary management.
Another example is the situation with Pulkovo Airport. According to Irina Egorova, the mechanism of the same law on EZO, 470-FZ, was implemented. The management of Pulkovo Airport was restored to the Russian beneficiaries who now own it directly, as the 100% share owned by the Cypriot entity was removed. It is worth noting that this was done through a separate presidential decree rather than a federal law, but the mechanism remains unchanged. Irina Egorova argues that this is still significant. Foreign beneficiaries who signed corporate agreements based on the presidential decree may still have limited corporate rights.
Sergei Glandin provides examples of how Decree No. 302 has been applied. In these instances, the Federal Property Management Agency took temporary control of 83.73% of Unipro's shares, which are owned by the German concern Uniper, and 98.23% of Fortum's shares, which are owned by the Finnish group Fortum. The assets of Danone and Baltika, which are owned by Produits Laitiers Frais Est Europe and structures of the Carlsberg Group, respectively, were also placed under temporary management. In December 2023, as previously stated, Delance Limited's ownership shares in Rolf car dealer were transferred to external management.
The entrance cost was one ruble, and the exit cost was two rubles.
Finally, there is a somewhat amusing situation where some unfriendly non-residents, whether voluntarily or not, make life difficult for the company that remains in Russia by leaving. However, some genuinely want to end their business relationships with their Russian partners, managers, and employees. However, withdrawing from membership can also be problematic. According to Javid Eyyubov, a lawyer at KSK Group, obtaining permission from the government commission is necessary and can be difficult due to the lengthy processing time.
Eyyubov notes that the process of obtaining government commission consent can differ from the process established in the government resolution. For some clients, the government commission of the Ministry of Finance has requested that they submit an application to the relevant executive authority, which will then send a petition to the Ministry of Finance for permission to conduct a transaction. This process can speed up the consideration of the application and increase the likelihood of obtaining a permit. Regarding the client, the Ministry of Industry and Trade was the relevant executive body. A month later, an employee of this authority contacted the client, asked several questions, and indicated that they were leaning towards denying permission for the transaction. This means that they will not submit a petition to the Ministry of Finance, resulting in no permission being granted. After receiving the client's responses, the employee promised to consider the matter and said that they would get back to him later.
Thus, the relevant body, rather than a government commission, considers the application. Even if a foreign participant transfers shares in a Russian company to its Russian partner at a low cost, government authorities may not always approve the transaction. This can complicate the client's business activities, such as participation in tenders or confirmation of SME status. According to the KSK Group lawyer, this is the case.