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Re-Thinking Foreign Investment in Russia

Grayling Think Piece Moscow, June 2011

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Executive Summary

Over the last twelve months, new and formally institutionalized methods of interaction and

dialogue with the federal government have brought tangible gains for foreign investors in

Russia. A revitalized Foreign Investment Advisory Council (FIAC), the appointment (at Deputy

Prime Minister level) of an investment ombudsman, and President Medvedev’s modernization

manifesto are laying a path to a more stable, predictable, sensible and appropriate investment

and regulatory climate.

While some may worry about Duma elections at the end of 2011 and Presidential elections in

March 2012, we argue that the politics is less important than the intent, that reported differences

between President Medvedev and Prime Minister Putin are more imagined or fanciful than real,

that reform is set whatever the results of elections.

For too long, it has been a difficult challenge for many of our international clients to get clear

federal endorsement for their investments in Russia. The vortex of power is made for Russians

to be controlled by Russians in what outsiders often see as an opulent, Byzantine, chaotic and

cynical way. A clear agreement from the Russian government to treat our clients as they would

major domestic investors has usually been achieved with the help of an intensive bilateral

political dialogue at the highest level and a round of shaking hands with numerous Russian

heavyweights. Political leverage from selected regional governors in exchange for localizing

production in their regions has also proved to be extremely helpful in getting continuous federal

support for a multinational company’s development in Russia1.

Diplomacy, direct federal contacts and regional leverage continue to be effective and necessary

instruments for foreign investors to strengthen their foothold in Russia. On top of that a reformed

FIAC, which now plays a more meaningful role, and some interventions by the newly appointed

Investment Ombudsman provide more opportunities for international players with sizable

investments in Russia to structure their relations with the federal centre.

The greatest challenge for Russia, post the Presidential election in March 2012, will be to cope

with growing ―manual‖ control by Russia’s leadership over the state’s economic and social

development and the degradation of economic and political competition. This will not make life

of Russian businesses easier, let alone that of foreign investors. There will be more regulation,

the effects of the new Customs Union, and inevitable mistakes. Regulation will be an increasing

fact of life, in terms of both quantity and complexity.

1 http://www.graylingcontent.com/wp-content/uploads/2010/09/Think-Piece-Pharma-2020.pdf

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At the same time the pipeline of changes to get state officials to engage in dialogue with

investors, including foreign investors, is promising. A white paper has been prepared for

businesses’ complaints about corruption-intensive areas of state control at different levels, to be

reviewed by the federal centre. The Russian President has issued a decree outlining an ideal

process of public consultations of the state authorities with businesses before a new regulation

is enacted. Investment ombudsmen offices will be set up in every Russian federal district.

Overall, there are good preconditions to re-set the regulatory environment for foreign investors

in Russia. For the benefit of both the Russian economy and foreign investors. It is time to give

Russia another try, to get involved in changing the game.

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Contents

Declaration of Interest & Special Note 5

Political Background 6

Economic Background 7

Reforming the Foreign Investment Advisory Council (FIAC) 8

Foreign Investment Ombudsman 10

Grayling Recommendations 12

Attachment 1: A Sample of a Draft Application to Join FIAC 13

Attachment 2: FIAC Application Process 14

Attachment 3: FIAC Members 2010 15

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Declaration of Interest

Grayling provides public, government and investor relations services to clients, including major

foreign investors, active in Russia. In the twelve months prior to the publication of this think

piece Grayling (our Russian unit) worked for the following companies: 20th Century Fox;

Allergan; Altium; AstraZeneca; APCOR; Blackberry; BSA; British Airways; Comité

interprofessionnel du vin de Champagne; Chartis; Clariant Produkte; Computershare; Credit

Suisse; Facebook; Flydubai.com; Fujitsu; Goltsblat BLP; GE Corporate; GE Energy; Dow;

GOST; Hitachi; Hotels.com; IKEA; Irdeto; John Deere; Kapsch; Kellogg; Mars; Medtronic; MOL;

NBCUniversal; New Yorker; Papa John's Worldwide; Paramount Farms; Riverbed; Rixos;

Sandisk; Saatchi & Satchi; Saxo Bank; SES Astra; Skype; Tarkett; Tenneco; TPG; Ulysse

Nardin; UPS; Wizz Air; Velux; and Yota.

In other markets in which Grayling operates, through 70 offices around the world, Grayling may

have, or currently does, work with these or other firms in other countries.

Special Note

This report and its contents are issued only on behalf of Grayling and statements herein should

not, in any way, be imputed to be statements from, endorsed by, or otherwise supported by,

individual client firms, unless so stated in the text. Grayling accepts no liability for any errors or

omissions in this publication or for any losses or damages incurred by anyone who acts solely

on reliance of the information contained herein, outside of any duty of care Grayling owes to its

contracted clients. This report may be freely quoted subject to crediting its source.

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Political Background

In Russia, 2011 is the year of parliamentary elections (to be held on 4 December 2011) and the

year-previous to Presidential elections (to be held on 11 March 2012).

In 2008 alterations to the Constitution were made under which the new President will remain in

his post for six years instead of four. This means that the coming elections will be strategically

important for the country’s development in the following decade.

As for the Parliamentary elections, a victory of the Edinaya Rossiya (ED) political party / All-

Russia People’s Front coalition around ED can be safely assumed despite the significant fall of

public support for the government’s policy over the past twelve months. The Parliamentary

terms have also been altered in 2008, allowing the deputies to remain in their posts for five

consecutive years.

Investment in the national economy remains on

top of the government’s agenda despite all the

pre-election fuss. While Prime Minister Putin

mostly overlooks domestic business, President

Medvedev has taken up the topic of foreign

investment. During a recent Presidential

Committee on Modernization meeting in

Magnitogorsk (March 30, 2011) Dmitry

Medvedev announced a major initiative to

reform the country’s business climate, listing a

dozen measures to be implemented.

The March Liberal Manifesto made by

Medvedev, and subsequent calls for a cautious

approach towards national economic policy

(―improving the quality of the economy by

overhauling infrastructure, lessening

dependence on energy and spurring

innovation‖) made by PM Putin during his

speech before the State Duma, essentially

highlight the balance between the rhetoric of

both tandem members. If Medvedev’s moves

are supposed to attract liberal democratic

voters, Putin is more on the conservative side.

One way or another, foreign investors can

hope for a substantial improvement of the

overall investment climate within the next

presidential term.

In the shorter-term, recent weeks saw closer attention to the investment climate in Russia from

both Putin and Medvedev. Medvedev’s aide, Arkady Dvorkovich, and Putin’s deputy, Igor

Shuvalov, have been tasked to ―oversee‖ foreign investors and innovation projects in Russia. As

Medvedev’s modernization manifesto:

1. The Ministry of Economic Development will get new powers for the Justice Ministry to take action to repeal state agency regulations that unjustifiably obstruct business and investment activity. The Justice Ministry will then have the duty to demand that the agencies immediately repeal the anti-business regulations in question.

2. Privatization program to be implemented.

3. Improving transparency for minority shareholders through amendments in legislation.

4. Removing government officials from the boards of directors of selected state companies.

5. Reducing procurement expenditure of large state-owned companies by 10% within three years.

6. Introducing a special Investment Ombudsman for each federal district, whose job will be to assist companies in carrying out private investment projects, above all, helping them in their dealings with the executive authorities.

7. Reducing social taxes for employers.

8. Establishment of Presidential mobile reception offices, comprising of Presidential Executive Office staff, which will be responsible for receiving information from individuals and company representatives, complaints from people about the actions or inaction by authorities, and reacting to this information accordingly.

9. Publishing of anti-corruption reports in the media.

10. Improvement of higher education.

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for the latter one cannot but notice two parallel projects running: Medvedev’s Skolkovo and

Putin’s Agency of Strategic Initiatives.

Interestingly, in our day-to-day work we have noticed a new trend: if before, it was safe for

foreign investors to engage both Shuvalov and Dvorkovich in discussion of the same issue /

idea, it is now becoming increasingly evident that foreign investors are strongly recommended

to use either the President’s or the Prime Minister’s networks to handle their specific issues. It

may well be that an international company discusses one issue with Shuvalov and another with

Dvorkovich, but at any rate the foreign investor is supposed to know what issues are to be

discussed in either Presidential or Prime Minister’s camps to avoid duplication of efforts. Failure

to do so may slow down the process of endorsement of one’s investment idea / handling

specific issues relating to Russian operations.

Economic Background

Unsatisfactory results, achieved by the Russian economy in 2010, are a sign that the

dependency on a raw exports economy is inefficient and struggling. Overall economic growth in

2010 amounted to only 4%. This fact is acknowledged by the authorities, including the Minister

of Finance Alexei Kudrin, who admitted that the country should achieve at least 6-7% annual

growth, otherwise the struggle will continue. The recent forecast of the Ministry of Economic

Development shows that Russia is far from this goal – the real economic growth in the coming

years will not exceed 4.5%.

This adds to the poor investment climate, which resulted in a drastic decline of foreign direct

investment (FDI) in Russia in 2010. Preliminary figures show that last year the volume of FDI

amounted to only 12-14 billion dollars, which is just half of what was invested in the best pre-

crisis years. In the same period money outflow exceeded 33 billion dollars. Russia has attracted

less private equity money than other emerging markets—$1.4 billion over the past three years,

compared with $28.6 billion for China, $15 billion for India, and $5 billion for Brazil, according to

the Emerging Markets Private Equity Association.

Government efforts (focused on a handful of industry-specific target development programs and

investment projects) aimed at reducing the budget deficit seem to have lost momentum. This

adds to the aforementioned pre-election race issue, when significant budget funding is diverted

to economically inefficient, if politically popular, steps such as the lowering of prices on products

and spending on federal political promotion campaigns. Russia’s national economy survived the

crisis years and is still growing mainly because of high prices on oil. As long as oil prices remain

high the Government will be able to fulfill its obligations and balance the budget deficit. Even an

average price of 75-80 dollars per barrel would allow Russia to slightly increase its fiscal

spending and even allocate some of the funds to the national reserve fund. In case the price for

crude oil falls below this range the Government will be obliged to review the budget for 2012-

2013.

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Nonetheless, the Russian Government is conscious of the glaring need to stop scaring foreign

investors away, not just because it is a question of prestige in the current situation but because

even high oil prices do not guarantee stable economic growth. The optimistic goals set by the

Government can be achieved only through well-executed modernization and a constant flow of

foreign investment. ―Achieving modernization, which is the purpose of this Commission’s

meeting, requires a major increase in investment. We need technology and we need money in

amounts corresponding to Russia’s huge potential. We need the confidence and interest of

Russian and foreign investors‖, – said Dmitry Medvedev during the March 30, 2011 meeting in

Magnitogorsk.

Surprisingly, despite all the criticism and skepticism, some of the actions proposed by President

Medvedev are already being implemented. In particular, Deputy PM Igor Sechin left the post of

Chairman of the Board of Rosneft and Energy, Finance and Transport Ministers are to follow his

lead before July, 1 2011. In late May, Rostelecom state holding approved a new business

development strategy by 2015, under which the telecom giant plans to cut operational costs by

EUR 0,6 billion. It is also highly likely that social taxes for employers will be reduced from 34%

to as low as 26%, at least for small and medium-sized enterprises.

Reforming the Foreign Investment Advisory Council (FIAC)

The Foreign Investment Advisory Council was established in June 1994 in a combined effort of

the Russian Government and foreign companies to improve the overall investment climate in

Russia, as it was declared then. Today it would be fair to say that the council was formed by

foreign oil majors, who aspired to lobby their interests and persuade the Government to pass

the bill on ―Production Sharing Agreements‖. After that goal had been achieved, FIAC for

almost 10 years became a get-together club for foreign companies but without a clear purpose

and strategy.

FIAC is the only officially established and regulated platform for communication and dialogue between foreign investors and the Russian Government

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Years 2007-2008 became a turning point for FIAC when the Government showed that it no

longer needed any advice from its members (it is even rumoured that at some point Vladimir

Putin wanted to move away from FIAC as a ―pretty useless get-together of unhappy foreign

investors―). However the Government decided to give FIAC a second chance and proposed a

reorganization of the council with a head-on effort from the Ministry of Economic Development

expressed in a Government decree, under which relevant state Ministries and authorities were

obliged to participate in FIAC executive meetings or its working group’s discussions, which

instantaneously raised the status of FIAC to the level of an intergovernmental discussion forum.

In turn FIAC members were asked to guarantee the presence of their global CEOs once a year

during the plenary sessions of FIAC, which are traditionally chaired by Prime Minister Putin.

FIAC’s organizational structure was reformed as well. An Executive Committee was formed

along with the introduction of several ―think tanks‖ tasked with lifing administrative barriers and

improving investment image plus customs and energy efficiency. As a result FIAC became a

strategic playground for public-private dialogue making possible a number of developments in

state regulation, which resulted in a certain improvement of the overall investment climate in

Russia. FIAC is directly or indirectly responsible for the realization of such measures as:

- reduction of customs duties on agricultural raw materials, which do not grow in Russia;

- reduction of customs duties on equipment for food production;

- free circulation of automobile components, imported under the ―promsborka‖

agreements;

- introduction of electronic customs declarations;

- establishment of a public council within the Russian Federation State Committee for

Construction, Architectural and Housing Policy.

- FIAC has also provided expert counsel during the elaboration of the bill ―On foreign

investments in strategic enterprises‖, of the federal bills ―On patent agents‖ and ―On

technology transfer‖ and amendments to the migration regulation and the bill ―On the

status of foreign workers‖.

All these wins have been achieved in the last two years, increasing the council’s influence and

making it the real government relations instrument in the hands of foreign investors. Our clients

who either have become members of FIAC or have been inside the Council for a number of

years admit FIAC has become more operationally effective, helping them change the game in

the Russian market.

Nevertheless the Government would like to see an even more active FIAC. The Ministry of

Economic Development authorities maintain that the Russian Government would like to see

more members, including from such sectors as IT, pharma and retail. The Ministry is also ready

to consider introducing new ―think tanks‖ within the framework of FIAC for the sake of attracting

new members and improving the public-private dialogue should there be a strong base for such

a move.

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Foreign Investment Ombudsman

During a meeting on the investment climate in 2010, President Medvedev instructed the

Government to elaborate an appropriate mechanism for processing complaints and suggestions

from companies that come across various problems in the Russian Federation. As a result the

―investment ombudsman‖ position was established in August 2010, which was taken up by First

Deputy PM Igor Shuvalov. The creation of this position is a logical step as the government

continues to promote economic transparency and improve Russia's investment climate.

Simultaneously, a Department for Investment Policy and Development of Private/Public

Partnership was established within the Ministry of Economic Development, which processes

claims from foreign companies.

The Government has received a total of 67 complaints against federal and regional officials.

The complaints relate to various issues, from protection of property rights to connection to

power grids. At the moment, 21 cases are being reviewed from a variety of companies.

In April, President Medvedev gave public instructions to the following members of the Cabinet to

pro-actively review issues which investors may be having when interacting with state authorities

(by 1 October 2011):

Sergey Ivanov Border-crossing related, post and courier service and services at airports

and railway stations

Igor Sechin Technical control and safety in the natural resources sector, geological

research and rational use and protection of natural resources

Igor Shuvalov Fire safety, visas, work permits and registration

Dmitry Kozak Capital construction related

Alexandr Zhukov Sate sanitary and epidemiological control

Alexey Kudrin Financial markets and taxes

This refers to a proactive strategic review of state services. However, current issues and ideas

by foreign investors can be addressed to Igor Shuvalov as an investment ombudsman.

Common procedure for filing a complaint by the foreign investor can be visualized as follows:

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Company

Federal/local authority

I. The company has an

issue with the authority.

II. A letter outlining the issue is sent to the Ministry of Economic Dvlpm.

Deputy Minister of Economic Development

Stanislav Voskresensky

Head of the Economic Ministry’s Department for Investment Policy and Development of Private/Public Partnership

Sergei Belyakov

III. The Ministry decides internally whether the case requires consideration the letter. is being readdressed within the Ministry

IV. The case is studied by the Department and corresponding authorities are being asked to provide a formal reply to the complaint within 30 days.

Aide to First Deputy Prime

Minister Igor Shuvalov

Alexei Abramov

V. The letter along with the reply from the corresponding authority and the description of the case is sent to the Office of the First Deputy Prime Minister Igor Shuvalov.

First Deputy Prime Minister

Igor Shuvalov

VI. After final approval by Alexei Abramov the case is presented to First Deputy PM Igor Shuvalov for final decision.

VII. First Deputy PM Igor Shuvalov may prepare a governmental decision, which would oblige the authority to resolve the issue in question.

Minister of Economic

Development

Elvira Nabiullina

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Grayling Recommendations

What to do What NOT to do

- If your company qualifies, consider

joining FIAC

- If your company is a FIAC member re-

think engagement in this re-born

institution

- Navigate more carefully between the

Government and the Presidential

Administration

- Engage more proactively at the expert

level with Russian state authorities (there

are quite a few expert councils in state

authorities which are meaningful and

impactful). This will allow you to be

plugged in the game and subsequently

help you change it to your own and

Russian consumers/patients/clients’

benefit.

- This year can be the right period for

announcing an intention to invest in

Russia or even a general commitment to

keep Russia among the world’s priority

markets for your company. A foreign

investor can get a more ―mutually

beneficial‖ framework from the ruling

elite who are bound to stay in power

post the elections.

- Assume the Russian Government is

desperate to have new big names in the

FIAC, and that writing an application will

automatically get you on board (only one

company per year, on average, became a

member of FIAC in the past). Or that as an

existing member of FIAC you can leave

your membership dormant until a really big

issue arises.

- Engage both the Presidential

Administration and the Government for

discussion of the same topic at the same

time. The executive branch is the

Government: do not see the Presidential

Administration as duplicating the structure

of the Prime Minister’s Office. However, if

you are at the initial stage of negotiations

and contemplating an innovation project it

may be a good idea to start with Skolkovo

(vs. the Strategic Investment Agency).

- Think that you can continue to ignore

government relations if your investment in

Russia exceeds 5m EUR. Or be extra

proactive this pre-election year: you may

end up with imposed commitment unless

you navigate more carefully.

We hope the news from / meetings at the upcoming International Economic Forum in St.

Petersburg will demonstrate to your global HQ that Russia should be kept/get a priority status in

the list of the world’s hot investment destinations.

Give Russia another chance: engaging Russian authorities now with careful and thought

through navigation can change the game to your benefit in this market.

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Attachment 1: A Sample of a Draft Application to Join FIAC

―__‖ June 2011

Mr. Vladimir Putin

Prime Minister of the Russian Federation

Chairman of the Foreign Investment Advisory Council in Russia

2 Krasnopresnenskaya Emb.

103274 Moscow, Russia

Dear Mr. Putin,

…

(Company name) is a leading multinational ___ company. We have about ___ employees

worldwide and operate in more than ___ countries.

We are the world’s largest producer of ___. We are among the major players in ___.

In 2010, the Company recorded net income of ___ EUR. The Company’s is traded at ___.

Together with its subsidiaries and affiliates, our company stands as the ___ largest international

___ corporation and is one of major foreign investors working in the ___ Region of Russia.

At the moment key investment projects for our company in Russia are ___.

The Corporation has already invested about ___ EUR in the development of the Russian

economy for the past ___ years.

We plan to continue our policy of business development both in Russia and other CIS countries.

Company expects to invest over ___ EUR in the development of Russian deposits.

In view of our development plans for Russia, we would like to become an active member of the

Foreign Investment Advisory Council.

Accordingly, we apply to you with the request to approve our application for FIAC membership.

We believe that our extensive knowledge and experience will be a valuable contribution to the

efforts of FIAC aimed at improving the investment climate and creating a favorable environment

for foreign investors in Russia.

Sincerely,

CEO [global]

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Attachment 2: FIAC Application Process

There is an annual rotation (admission/expulsion) of FIAC members and the procedure usually

takes place during the plenary meeting of FIAC in November. The companies are rarely

expulsed, and admissions take place even more rarely. As a rule, each year only one

application is considered.

The procedure is quite simple but takes time.

Technically, any foreign investor can qualify for admission if he complies with certain

requirements but in reality it is not enough. The company should present recommendations from

present members of FIAC and authorized consultants and should pass a certain procedure with

a special body which is responsible for the decision-making – the FIAC Executive Committee.

The final admission decision is taken by the Head of Government (Prime Minister) on

submission by the Executive Director of FIAC (Minister of Economic Development), who in his

turn relies on findings of the FIAC Secretary (Deputy Minister of Economic Development) and

appraisal of the Executive Committee, which is comprised of Heads of the FIAC working groups

and FIAC consultants.

Stage I:

- Applicant presentation and meeting with FIAC Secretary

- Working group on admission on the basis of the Ministry of Economic Development

Investment Policy Department

- Preliminary approval of the filing of an application and its elaboration

- An address to the Head of Government (see Attachment 1)

- Control in the Government Administration

- Control in the Ministry of Economic Development Administration

Stage II:

- Appraisal and expert evaluation of the application, consultations and additions

Stage III:

- Examination of the application by the Preparation Working Group of the FIAC Executive

Committee

- Approval by the FIAC Executive Committee

Stage IV:

- Approval in the First Deputy Prime Minister Office

- Elaboration of a decision and answer of the Head of Government

Stage V:

- Examination during a plenary session and decision

- Admission

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Attachment 3: FIAC Members 2010

Company Country Name Position

1 3M USA George W. Buckley

Chairman of the Board, President and CEO

2 ABB Sweden Joseph Hogan CEO

3 Alcoa USA Klaus Kleinfeld President and CEO

4 BASF Germany Dr. Juergen Hambrecht

Chairman of the Board

5 BAT UK Richard Burrows Chairman, British American Tobacco

6 BHP Billiton UK/Australia Andrew Mackenzie

Group President and Chief Executive Non Ferrous

7 BP UK/USA Tony Hayward Group Chief Executive BP

8 Cargill USA Greg Page Chairman and CEO

9 Deutsche Bank Germany Dr. Josef Ackermann

Chairman of the Management Board and the Group Executive Committee

10 EBRD Thomas Mirow President

11 ENEL s.p.a Italy Fulvio Conti CEO

12 ENI s.p.a. Italy Paolo Scaroni CEO

13 Ernst&Young USA James Turley Chairman & CEO Global

14 ExxonMobil USA Neil W. Duffin President of ExxonMobil Development Company

15 Finmeccanica Italy Pier Francesco Guarguarglini

CEO

16 Ford Motor Company

USA John Fleming Ford Executive Vice President, Chairman and CEO, Ford of Europe

17 Intel USA Jane Shaw Chairman of the Bord

18 Itochu Corp. Japan Eizo Kobayashi President and CEO

19 Kinross Gold Corp.

Canada Tye W. Burt President and CEO

20 Kraft Foods USA Irene Rosenfeld CEO and Chairman

21 Lafarge France Bruno Lafont Chairman & CEO of Lafarge Group

22 Mars USA Olivier Goudet Chief Operating Offiecer

23 METRO Group Germany Dr. Eckhard Cordes

CEO METRO AG

24 Mitsubishi Corp. Japan Yorihiko KOJIMA

Chairman of the Board

25 Mitsui & Co. Japan Masami Iijima President and CEO

26 Nestle Switzerland Paul Bulcke CEO

27 Novartis Switzerland Dr. Daniel Vasella

Chairman & CEO Novartis International AG

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28 PepsiCo USA Indra K. Nooyi Chairman and CEO

29 Procter& Gamble USA Robert McDonald

CEO

30 Renault France Carlos GHOSN President and CEO

31 Royal Dutch Shell UK/Netherlands Peter Voser Chief Executive Royal Dutch Shell plc

32 Siemens Germany Peter Loescher President & CEO Siemens AG

33 SUN Group India Nand Khemka Chairman

34 Sсhlumberger France Andrew Gould Chairman and CEO, Schlumberger Limited

35 Telenor Norway Jon Fredrik Baksaas

President and CEO

36 Tetra Pak Sweden Dennis Jonsson President & CEO Tetra Pak Group

37 The Coca-Cola Company

USA Muhtar A. Kent Chairman of the Board and CEO

38 Total France Christophe de Margerie

CEO

39 Unicredit Italiano Italy Alessandro Profumo

CEO

40 Unilever UK/Netherlands Paul Polman CEO

41 United Technologies

USA Louis R. Chenevert

Chairman and CEO, United Technologies Corporation

42 World Bank Robert B. Zoellick

World Bank Group President