Direct and portfolio foreign investment in Russia Dr. Ivan Darushin St-Petersburg State University

1. Direct and portfolio foreign investment in Russia Dr. Ivan DarushinSt-Petersburg State University

2. Forms of international market participation • Export of production • Investments to the present or new-formed foreign enterprises (real investments) • Buying of foreign companies securities (financial investments) • Buying of foreign patents, licenses and another intangible assets Last three types – foreign investments

3. Forms of foreign investments • Direct investments: buying of shares or parts that give the ability to take part in management (to control). In Russia – if you get 10% of company capital. • Portfolio investments: buying of securities to sell it on the secondary market

4. Methods of direct investments • Foundation of a new company abroad (in property of foreign firm) • Buying of present company • Buying of control share holding • Participation in joint enterprises • Foundation of franchise company

5. Methods of portfolio investments • Buying of securities on the foreign markets • Buying of foreign securities on the local market • Part in international investment fund

6. Risk of foreign investments

7. Features of direct investments • Long-term period • Considerable (big) amounts • Dependence of financial and political situation (currency risks, interest rates risk, authorities decisions)

8. Usual methods of foreign investments regulation • Preliminary permission for direct investments • Restrictions for direct investments in some branches and spheres • Restrictions for the part of foreign entities in national entities • Counter requirements for foreign countries

9. Foreign investments in Russia • No restrictions for portfolio investments (just to carry Law on Currency Regulation and Currency Control) • Special Law on Foreign Investments (1999): • Insurance arrangements for foreign investors (their profits and capitals) • Not affect on banks, insurance firms and non-profit organizations • Subject of regulation: Foreign investor and residents entity in which foreign investor hold more than 10% of shares (own capital)

10. The low on foreign investments in the Russian Federation • Articles 3 and 4: foreign investors have the right to invest capital in the territory of Russia by means of purchasing shares, bonds and other securities. • Article 7: foreign investments cannot be subject to nationalisation, requisition or confiscation, other than in exceptional cases introduced by legislative acts. In the case of nationalisation or requisition, the investors must receive compensation. • Articles 10 and 11: guarantees of profit repatriation made in connection with foreign investment. Foreign investors, after payment of all appropriate taxes, are guaranteed free transfer abroad of payments received in any foreign currency. • Foreign investors can use roubles received in connection with investments to purchase foreign currency in the domestic currency market. For currency bought in this way (and by roubles), free transfer abroad is guaranteed after the payment of applicable taxes.

11. High level of demand for direct foreign investments • Deficit of internal investments (deficit of free funds) • Demand for foreign materials and component parts • Access to foreign new technologies • Increase of production competitiveness

12. Factors of foreign investments supply • Breadth of markets • High level of professional skills • Low level of salaries • High demand for foreign investments (ability to earn excess profit) • High level of risks • Distrust for authorities

13. Some characteristics of foreign investments • Usual form: joint companies and foreign companies (not a lot of branches) • Concentration in 3 regions: • Moscow (40%) • Extraction regions (Tumen, Tatarstan) • Industrial regions (St-Petersburg, Leningrad region, Moscow region) (irregularly distributed by infrastructure, resources, demand) • Some regions (about 50) have own regulation and laws

14. Competitors of Russia • East-European countries (Poland, Czech Republic, Hungary) • Developing countries (Brazil, Mexico, Argentina) • China (countries with similar environment)

15. Foreign investments in 2007

16. Foreign investments by branches (accumulated to 2007, mill. USD)

17. Foreign investments Main investors: Grate Britain, Netherlands, Cyprus, Luxemburg, Switzerland, France, German, Ireland, USA (86,3% of accumulated investments; 85,1% of accumulated direct investments). Foreign investments of Russia: accumulated to 2007 – 36,8 bill. of dollars; in 2007 – 10,9 bill. of dollars.

18. Two methods to operate on the Russian market direct • With established and registered permanent dependents office (like local entity) • Without registered local entity (through unaffiliated specialised intermediary organisations – brokerage firm) To carry out investment activities in last case, it is necessary to operate with a brokerage agreement through a licensed Russian brokerage firm or through a Russian bank. Investment operations without a permanent representative office or branch in Russia are more preferable for tax purposes.

19. Requirements for brokerage firm Intermediary organisations must fulfill the following requirements: • be independent (unaffiliated) organisations; • perform duties for foreign entities on commission terms; • perform only those operations that constitute its usual activities

20. Relationships with brokers • According to Russian legislation, Russian brokers must ask for written agreements and written instructions for each transaction. • A broad range of brokerage agreements currently exist. • Larger brokers have special standard agreements, in most cases these firms are willing to modify these according to client needs. • Agreements are valid for one transaction only; however, long-term agreements with special orders for particular transactions are also possible to arrange.

21. The broker's bank Bank which services broker is an essential element in the execution of the transactions Requirements to banks: • the general foreign currency license; • membership at a currency exchange; • membership on SWIFT; • correspondent relationships with the major foreign banks; • participation in the Russian direct interbank settlement systems.

22. Buy/Sell agreements • Each securities transaction in Russia must be executed in written form. Such agreements must be registered by licensed market professionals (if the broker executes a transaction for a client, it typically registers the transaction itself). • Usually three copies of the agreement are signed (additional copies of the agreement are usually required by the issuer's registrar to be left on his file).

23. Buy/Sell agreements • If a buy/sell agreement is executed directly between the client and the broker, one copy is left with the client. If the broker executes an agreement with the third party on behalf of a client, the client has the right to demand one copy of the agreement. • Currently there are two ways for foreign investors to enter in an agreement: a purchase agreement can be signed by an investor directly with the seller; or the investor can sign an agreement with a broker who in turn signs an agreement with the seller.

24. Brokerage fees • Brokerage fees are agreed upon between brokers and clients on a case-by-case basis. • Fees can vary greatly depending on the type of investment instrument and on the status of the market. • For the most liquid issues, commissions usually range from 0.05% to 0.2%.

25. Communication • in Russia almost all agreements are executed in the written form, signed by the authorised parties and sealed with corporate seals. • According to the requirements of the Civil Code, brokerage agreements must be executed in written form. • Client orders can be given to a broker in any agreed-to form, though, including fax or phone communication. The usual practice for the broker is to make a deal by phone, then to prepare and sign a written report on the deal.

26. Order types 1) Accept a current price quoted by the broker (if he acts as a market maker in any particular security). In this case, a transaction is executed with the broker as a counterparty at the broker's bid or ask. Usually no commission is charged for this type of transaction. 2) Specify the exact counterparty and price: An investment manager or advisor can directly determine a buyer or a seller and negotiate contract terms. In this case, the broker would sign the agreement with the specified counterparty only for legal reasons. The broker can also supervise settlement.

27. Order types 3) Place a limit order: The foreign investor instructs its broker to find a buyer or seller at a price equal to or better than specified. A time limit is usually set and guarantees of payment or delivery are given. The broker is responsible for finding a counterparty and signing the purchase/sale agreement. Commissions are highest for this type of order, as brokers often risk their own capital in the accumulation of the block of shares requested (purchase order). Such orders are seldom executed at a price better than the limit price if no "success premium" is established. 4) Place a market or limit order for a specific market: As there are almost no organised markets in Russia, this type of order currently makes sense only for financial futures contracts

28. Representation of interests • The broker represents the interests of foreign investors in all relations with the Russian state tax authorities. • Relations with the Russian state tax authorities are necessary only with regard to claiming an exemption from withholding tax or with regard to claiming a tax refund.

29. Share ownership registration • All equities in Russia are issued in book-entry (or registered) form. • For the majority of enterprises certificates are unavailable and shareholder rights are certified only by receipts (extracts) from the issuer's registrar. • Under the existing obscure legislation, all issuers with more then 1,000 shareholders are required to give their registers to the third-party registrar

30. Share ownership registration • Payment for the transfer of registration is established arbitrarily by the registrar. • Various pricing practices can be encountered, ranging from a fixed payment per transfer, to a percentage of the transaction (up to four percent of the deal). • any person registered in the shareholders' register other than a beneficiary owner is considered to be a nominee.

31. Share ownership registration • The registrar is obliged to register transfer from the beneficiary to the nominee on the written instruction from the former, delivered in the usual way. • The nominee owner is obliged to disclose the beneficiary owners to the registrar at least once a year, before the shareholders meeting.

32. Securities delivery 1)Settlement directly through the shareholder's register: • The register is kept by the issuer or by its appointed registrar • Long trips across Russia to register share transfers at the issuer are common and add to investor expenses. • Rules followed by registrars and their prices are different from issuer to issuer. • Usually brokers provide registration directly in the client's name as one of the settlement options. Registration of the securities can be effected by the broker based on the presentation of appropriate documents giving power of attorney and other required documents from an investor.

33. Securities delivery 2)Registration in the broker's name as a nominee owner: • The broker can register securities purchased for the client in its own name as a nominee owner and perform safekeeping services for clients. In this case, the broker opens an account for a client and gives the client receipts confirming the status of this account. The client has the right to demand direct registration in its own name at any time.

34. Securities delivery 3)Registration in the name of a third-party depository as a nominee: • Several types of Russian and foreign financial institutions can act as depositories under the current Russian legislation. Nominee registration through a depository is effected in the same way as registration through a broker. The basic obligations of a depository are the same as for brokers.

35. Making the delivery If an investor is selling securities, he has several options to give in order to transfer shares out of his account: • to send his own employee to the registrar (with power of attorney); • to give power of attorney to a third party (custodian or lawyer); • to give power of attorney to his broker; • to give power of attorney to the buyer.