China Business Law Journal, October 2012, Volume 3, Issue 9

Vladislav Zabrodin, Managing Partner of Capital Legal Services

Derek Bloom, Partner of Capital Legal Services

The Russian economy is expected to grow by 3.5% to 4% in 2013 according to investment research published in October by Sberbank, Russia’s largest bank. Every sector of the Russian economy requires significant investment and presents valuable opportunities for Chinese manufacturers to export their products to Russia.

There is a strong appetite for Chinese financial investment in Russia, yet despite the opportunities, reports indicate that so far there has been relatively little mutual investment activity. Russia is exporting raw materials to China. What investment there is in China by Russians has been done by the largest Chinese natural resources companies. The China Investment Corporation (CIC), the largest investment fund in China, and the China International Trust and Investment Corporation Securities (CITIC Securities), the largest investment company in China, have reportedly been in discussions in Moscow with Russia’s leading companies including Rosneft, Gasprom, Vimpelcom, the Russian Railways, Rusnano, Lukoil and VTB Bank.

In the future, the likeliest areas for Chinese investment into Russia appear to be:

• transportation, warehousing and logistical centres for the sale in Russia of machines and equipment, electronics, agricultural products and construction materials;

• railroad, roads and other large transportation infrastructure projects to create modern lines of communication with China through Kazakhstan via Russia to Europe, and also investment in Russia’s industries in Siberia and the Russian far east, and to create new pipelines and rail connections to deliver Russian products to China;

• office centres and other commercial real estate in Russia's major cities;

• high-speed trains in Russia.

Chinese investment in Russia will be divided between those that the Russian government considers to be investments into strategic sectors of Russian industry, and generic private sector industrial investments. Russia has a strategic investment law that governs and sets out a procedure for approval of investment into strategic entities, which are a small portion of the Russian economy. Prior approval is required for a foreign investor to acquire a controlling stake in a “strategic entity”, which includes certain natural resources, defence, media and natural monopoly companies. Where the Russian law on strategic investments applies, an application must be submitted to the Russian Federal Antimonopoly Service (FAS) for prior approval. FAS approval may also be required prior to the acquisition of control of a foreign company that owns a subsidiary in Russia, regardless of whether it is engaged in a strategic industry (depending on the size of the acquiring company and the company to be acquired).

The great majority of potential investments in Russia by Chinese companies would not involve a strategic industry in Russia, as defined, but would call for conventional corporate planning in Russia. Conventional corporate transactions in Russia involve either acquiring a stake in existing Russian legal entities,
or setting up a new investment structure.

Depending on the industry, a Russian partner may or may not be advisable. In certain industries that require extensive licences and permits, it is common for a joint venture to be formed with a Russian partner. There have been many well publicised, prolonged disputes between Russian partners and their foreign counterparts for corporate control over joint ventures in Russia. These issues may be avoided if an existing business is acquired completely, or a new business is established.

In the case of an acquisition of an existing business in Russia, it is necessary to conduct a detailed legal and financial due diligence investigation to identify potential risks and liabilities. Most due diligence investigations will reveal the existence of multiple regulatory risks concerning licences and permits, and clouds surrounding the title of real estate. Most such legal risks, once identified, may be managed.

In the case of a Chinese company that is intending to export products to Russia, or to set up a new trading activity in Russia, it will typically not be necessary to acquire an existing Russian legal entity. Instead, a clean, new legal structure may be created that has no unknown legal risks associated with it. As for the form of legal entity to be used in Russia, the most common choice is between a representative office or branch, a closed joint stock company (JSC) or a limited liability company (LLC). LLCs are far more common and recommendable than JSCs, due to cost and reporting efficiency, and they provide much more flexibility for their owners.

One unique aspect of investments in Russia is the prevailing practice that investments in Russia are made through offshore
holding companies located outside of Russia.

The forms for investing and doing business in Russia can be different, and the choice depends on the goals the investor has. One of the reasons Chinese investments in Russia have been slow is that Chinese potential investors do not have a clear understanding of either Russia’s laws and regulations, or of local practices. We have to admit that sometimes they do not look too easy from the outside, however, as soon as you are on the market there is nothing that cannot be legally tackled. Keep in mind that Russia, being a very high-profit country from the business point of view, is still an emerging market and still has work to do to improve its business infrastructure. That is why one of the major tasks facing the Russian government is to significantly improve its position in the World Bank’s rankings for “Doing Business” from 112 now to 50 in 2015, and then to 20 in 2018. We are sure that Chinese investments can start benefiting from this already, and place themselves far ahead of competition.