2012 Investment Climate Statement
Bureau of Economic and Business Affairs
June 2012
Report

Openness to, and Restrictions Upon, Foreign Investment

The Russian market presents many promising investment opportunities. Capitalizing on those opportunities, however, requires that firms navigate a complicated and fluid set of challenges ranging from corruption to a weak judiciary to excessive red tape. Russia recognizes foreign investment's critical role in the country's economic development and has encouraged foreign investment by removing administrative barriers and establishing special economic zones, high-technology parks, and investment promotion funds. At the same time, despite the Russian government's stated goals of combating corruption and improving the investment climate, independent organizations continue to rank Russia as one of the most difficult major economies in which to do business.

Russia was one of the countries most adversely affected by the 2008-2009 financial crisis, with 2009 GDP dropping by 7.9%. Russia's economy grew 4.0% in 2010 and further picked up in 2011, with annual growth predicted to reach 4.2-4.5%. From 2004-2008, foreign direct investment (FDI) inflows picked up substantially, rising to $75 billion in 2008. In 2009, however, FDI inflows fell by almost half and have remained well below 2008 levels. According to Prime Minister Putin, FDI inflows for the first ten months of 2011 equaled $36 billion, an 11.8% increase from the same period of 2010. The last few years have also seen large amounts of capital leaving the country. Russia experienced a net capital outflow of $133.9 billion in 2008 and $56.9 billion in 2009. In 2010, capital outflow slowed to $33.6 billion, but has accelerated again in 2011, and is expected to reach about $85 billion for the year. These outflows can be attributed to external as well as Russia-specific factors.

President Medvedev and Prime Minister Putin have repeatedly emphasized the importance of improving Russia's business climate and attracting foreign capital, particularly in the high technology sector. The country's solid base of expertise in the scientific and mathematics fields, combined with a sizable market and an economy growing faster than most others in the region, have helped entice a series of U.S. firms to make headline acquisitions and investments in Russia. Roughly a dozen U.S. companies and organizations already have announced their intention to invest in the Skolkovo Innovation Center, Russia's initiative to create a high-tech cluster, modeled on the example of Silicon Valley, in Moscow's outskirts. Nevertheless, the investment climate has been undermined by the slow pace of structural reform and the government's leading role in certain sectors of the economy, notably energy. Additionally, past government actions have contributed to a sense of wariness among some foreign investors about the risks of the Russian market, such as the apparently politically-motivated investigations into businesses. Rule of law, corporate governance, transparency, and respect for property rights are gradually improving but remain key concerns for foreign investors. While Russia took significant steps in 2010 and 2011 to improve the legal framework for intellectual property protection, effective enforcement remains a challenge. Possible liabilities associated with existing operations (especially environmental cleanup) and still-developing bankruptcy procedures are additional factors affecting the investment climate. In short, while there is strong interest in the opportunities Russia presents, many U.S. companies, particularly small and medium-sized enterprises, remain cautious about investing.

While a legal structure exists to support foreign investors, the laws are not always enforced in practice. The 1991 Investment Code and 1999 Law on Foreign Investment guarantee that foreign investors enjoy rights equal to those of Russian investors, although some industries have limits on foreign ownership (discussed below). Unfortunately, corruption plays a sizeable role in the judicial system (see the Dispute Settlement section). Russia has sought to enhance consultation mechanisms with international businesses, including through the Foreign Investment Advisory Council, regarding the impact of the country's legislation and regulations on the business and investment climate. Still, the country's investment dispute resolution mechanisms remain a work in progress, and at present can result in a non-transparent, unpredictable process.

Russian government officials have repeatedly stressed that foreign investment and technology transfer are critical to Russia's economic modernization. At the same time, the government adopted new policies to more effectively control foreign investments in key sectors of the Russian economy. In May 2008, Russia enacted the Strategic Sectors Law – specifying 42 activities that have strategic significance for national defense and state security – and established an approval process for foreign investment in these areas. According to the law, investors wishing to increase or gain ownership above certain thresholds need to seek prior approval from a government commission headed by Russia's Prime Minister. Partly in response to investor criticism, in 2011 Russia amended the law to simplify the approval process and narrow the range of potential investments requiring formal review by the commission. With respect to the extractive industries, previously, government approval was required for foreign ownership above 10% of companies operating subsoil plots of "federal significance." The November reforms raised the threshold to 25%, a move that experts predict will greatly reduce the number of cases considered by the commission. Some foreign investors have raised concerns that the Strategic Sectors Law could be used to restrict foreign investors' access to certain sectors. Since 2008, however, the commission has approved 128 of 136 applications for foreign investment.

Between 2004 and 2010, the share of Russia's private sector in GDP decreased from 70% to 65%, according to the European Bank for Reconstruction and Development. The government also continues to hold significant blocks of shares in many privatized enterprises. In an effort to increase market forces in the economy and raise revenue for the federal budget, in 2009 the government began considering more ambitious privatization of strategic enterprises. In October 2010, the Russian Cabinet approved a major Privatization Plan, which Russia is now in the process of expanding, that paves the way for selling an estimated $60 billion of government stakes in about 1000 companies (out of a total of 6,467 companies with some government ownership). The government will retain controlling stakes, however, in major Russian companies such as Rosneft, Russian Railways, and banking giants Sberbank and VTB. The pace of privatization has been slow, however, and Russian officials have signaled that it is unlikely to accelerate in the near-term.

To date, treatment of foreign investment in new privatizations has been inconsistent. As with the 2011-2013 Privatization Plan, foreign investors participating in Russian privatization sales are often confined to limited positions. As a result, many have faced problems with minority shareholder rights and corporate governance. Potential foreign investors are advised to work directly and closely with appropriate local, regional, and federal ministries and agencies that exercise ownership and other authority over companies whose shares they may want to acquire.

The following table includes the most recent data from indices measuring the investment and business climate in Russia:


If a scroll bar appears below the following table, swipe the table to move left/right of the dashed line.

Measure

Year

Index/Ranking

TI Corruption Index

2011

2.4 – 143 of 183 countries

Heritage Economic Freedom

2011

50.5 – 143 of 183 countries

World Bank Doing Business

2012

120 of 183 economies

Gov't Effectiveness
(Worldwide Governance Indicators)

2010

-0.39 – Percentile rank: 41.6

Rule of Law
(Worldwide Governance Indicators)

2010

-0.78 – Percentile rank: 26.1

Control of Corruption
(Worldwide Governance Indicators)

2010

-1.07 – Percentile rank: 12.9

Fiscal Policy
(IMF World Economic Outlook)

2011 (est.)

Government net annual borrowing: 1.11% of GDP

Trade Policy
(Heritage Economic Freedom)

2011

68.2 (moderately free)

Regulatory Quality
(Worldwide Governance Indicators)

2010

-0.39 – Percentile rank: 38.3

Business Start Up
(World Bank Doing Business)

2012

111 of 183 economies

Land Rights Access
(World Bank Doing Business)

2012

Construction Permits: 178 of 183 economies
Registering Property: 45 of 183 economies

Natural Resource Mgmt
(Natural Resource Management Index)

2011

90.3 on a 0 – 100 scale (100 is best)

Conversion and Transfer Policies

While the ruble is the only legal tender in Russia, companies and individuals generally face no significant difficulty in obtaining foreign exchange. Finding a bank licensed to conduct foreign currency transactions is not difficult. Russia has no capital controls and there are no barriers to remitting investment returns abroad, including dividends, interest, and returns of capital. Nonetheless, investors should seek expert advice at the time of an investment.

Currency controls exist on all transactions that require customs clearance, which in Russia applies to both import and export transactions and certain loans. A business must open a "deal passport" with the Russian authorized bank through which it will receive and service the transaction or loan. A deal passport is a set of documents that importers and exporters provide to authorized banks. Such documents enable banks, the agents of Russian currency control, to monitor payments in respect of the transaction or loan and to report the corporation's compliance with currency control regulations to the Central Bank. Russia's regulations regarding deal passports are described under Instructions of the Central Bank of Russia number 117-I of June 15, 2004. In early 2011, the Central Bank of Russia expanded the list of grounds under which a deal passport does not have to be submitted.

Only authorized banks may carry out foreign currency transactions. According to currency control laws, the Central Bank retains the right to impose restrictions on the purchase of foreign currency, including the requirement that the transaction be completed through a special account. The Central Bank does not require security deposits on foreign exchange purchases.

Expropriation and Compensation

The 1991 Investment Code prohibits the nationalization of foreign investments, except following legislative action and where deemed to be in the national interest. Such nationalizations may be appealed to the courts of the Russian Federation, and the investor must be adequately and promptly compensated. At the sub-federal level, expropriation has occasionally been a problem, as has local government interference and a lack of enforcement of court rulings protecting investors.

Dispute Settlement

Russia has a body of conflicting, overlapping, and frequently changing laws, decrees and regulations, which complicates the environment for dispute resolution. In an attempt to address these challenges, First Deputy Prime Minister Shuvalov in 2010 was tasked with coordinating and overseeing efforts to improve the business and investment climate, including the protection of foreign and domestic investors. In 2011, President Medvedev appointed Investment Ombudsmen in each Federal District to perform similar roles at the regional level. The government has also encouraged international business leaders to participate in the discussion of dispute resolution mechanisms, as well as individual commercial disputes, as part of their work in the Foreign Investment Advisory Council. While these steps offer some promise, overall, the country's investment dispute mechanisms remain underdeveloped and largely non-transparent.

Independent dispute resolution in Russia can be difficult to obtain since the judicial system is still developing. Courts are sometimes subject to political pressure. According to numerous reports, corruption in the judicial system is widespread and takes many forms, ranging from bribes of judges and prosecutors to fabrication of evidence. Corruption likely does not play a role in the vast majority of cases, most of which involve relatively low stakes. A law enacted in late 2008 as part of President Medvedev's anti-corruption initiative requires that judges disclose their incomes and real estate assets, including those owned by their spouses and minor children. While this represents a step in the right direction, it is too early to assess the law's impact.

Another component of President Medvedev's anti-corruption initiative has been a series of amendments to the Code of Criminal Procedure – in 2008, 2009, and 2010 – to limit pre-trial detention of individuals accused of economic crimes. Implementation of these reforms has yielded mixed results. Prosecutors have sometimes avoided them by charging defendants under articles technically not covered by the amendments and judges have sometimes refused to apply them. Nevertheless, available statistics reveal a substantial decrease in the number of pre-trial detentions in cases involving economic crimes since the legislation was passed.

Commercial courts are required by law to decide business disputes relatively quickly, and many cases are decided on the basis of written evidence and little or no live testimony of witnesses. The commercial court workload is dominated by relatively simple non-contentious cases involving the collection of debts between firms and disputes with the taxation and customs authorities, pension fund, and other state organs. Taxpayer firms often prevail in their disputes with the government in court. The number of routine cases limits the time available to decide more complex cases. Many observers believe that over the twenty year period that the commercial court system has existed, its judges have grown more competent and better at writing decisions. Many lawyers nonetheless report that due to insufficient training, especially in complex business disputes, many judges often make poorly reasoned or simply incorrect decisions. Execution of court decisions is often problematic. Few firms pay judgments against them voluntarily and rumors of corruption concerning bailiffs, who are charged with enforcing decisions, are frequent, although hard evidence is more scarce.

Federal Law 262, in effect since mid-2010, requires the courts to publish their decisions online and otherwise make information about their activities publicly available. All Russian courts now have websites, which generally include a schedule of cases to be heard, the name of the judge, the location of the court, form documents that can be used by prospective litigants, and copies of decisions. Personal information is expunged before case decisions are posted online. The better websites allow citizens to calculate filing fees and search for analogous decisions. The commercial courts have played a leadership role in providing information online and using information technology. Electronic filing allows citizens to sign up to receive e-mail notifications of developments in cases of interest to them. NGOs have rated the compliance of courts with their obligations under the law and found that the information provided varies greatly in quality from one region to another, but have noted a willingness by some courts to respond to queries and criticisms by improving their sites. Although there are gaps and failures to provide information, overall judicial transparency has increased since the law took effect in 2010.

Many attorneys refer Western clients who have investment or trade disputes in Russia to international arbitration in Stockholm or to courts abroad. A 1997 Russian law allows foreign arbitration awards to be enforced in Russia, even if there is no reciprocal treaty between Russia and the country where the order was issued. Russia is a member of the International Center for the Settlement of Investment Disputes and accepts binding international arbitration. Russia is also a signatory to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. However, enforcement of international arbitral awards still requires action from Russian courts and follow-up by bailiffs, which have yet to become consistently effective enforcers of court judgments.

As noted above, commercial disputes between business entities are heard in the commercial court system. That court system has special procedures for the seizure of property before trial, such that it cannot be disposed of before the court has heard the claim, as well as for the enforcement of financial awards through the banks. Additionally, the International Commercial Arbitration Court at the Russian Chamber of Commerce and Industry will hear claims if both parties agree to refer disputes there. A similar arbitration court has been established in St. Petersburg. As with international arbitral procedures, the weakness in the Russian arbitration system lies in the enforcement of decisions.

President Medvedev has encouraged the more widespread adoption of alternative dispute resolution (ADR) to help courts handle their caseloads and to provide citizens with speedier and cheaper methods of resolving legal disputes. In January 2011, a new law took effect that authorizes the use of mediation in various kinds of disputes, including commercial ones, and provides for the confidentiality of mediation proceedings and for their enforceability in court. Although there are still issues concerning how the law will be applied, it represents an important step towards further development of ADR in Russia.

Performance Requirements and Incentives

Performance requirements are not generally imposed by Russian law and are not widely included as part of private contracts in Russia. However, they have appeared in the agreements of large multinational companies investing in natural resources and in production-sharing legislation. There are no formal requirements for offsets in foreign investments. Since approval for investments in Russia frequently depends on relationships with government officials and on a firm's demonstration of its commitment to the Russian market, this may result in offsets in practice.

The Russian government has strenuous requirements and an extremely cumbersome process of approval and renewal for visas and residence permits for foreign businessmen and investors. Additionally, requirements in some sectors that a certain percentage of staff be Russian citizens may have a negative impact on foreign investors. The situation is improving, however. As part of Russia's efforts to encourage investment in innovation sectors, the GOR has eased the regulations on visas and residence permits for "highly-skilled" workers, and eliminated yearly quotas for foreign workers who fall into this category (defined by salary, position and education level). In addition, the United States and Russia are currently finalizing a bilateral visa agreement that will extend visa validities to 36 months for both Russian and American travelers, as well as extend terms of stay and reduce documentary requirements for Russian visas. This agreement is expected to take effect in the first half of 2012. Potential investors are advised to consult the State Department's Country-Specific Information on travel to Russia, which includes the latest information on Russian visas.

Right to Private Ownership and Establishment

Both foreign and domestic legal entities may establish, purchase, and dispose of businesses in Russia. As noted above, foreign investment in sectors that are regarded as affecting national security may be limited.

Protection of Property Rights

The Constitution and a 1993 presidential decree give Russian citizens general rights to own, inherit, lease, mortgage, and sell real property. Foreigners enjoy similar rights with certain restrictions, notably the ownership of farmland and areas located near federal borders. Mortgage legislation enacted in 2004 facilitates the process for lenders to evict homeowners who do not stay current in their mortgage payments. Thus far this law has been successfully implemented and generally effective. Mortgage lending is in its initial stages, and after a sharp contraction in 2008-09, the total value of mortgages in Russia is around 3% of GDP. New mortgage issuances in 2010, both by number and volume, were more than double that in 2009, totaling more than $11 billion. In 2011, mortgage lending continued its strong growth, with new issuances amounting to $13.6 billion in the first eight months of the year.

In Russia, the protection of intellectual property rights (IPR) is enforced on the basis of civil, administrative, criminal or customs legislation. The Civil Code sets up the level of compensation for IPR infringement and/or incurred damages for copyright, trademarks and geographical indications. The Code of Administrative Offenses concerns IPR infractions that violate public or private interest or rights, but do not meet the criteria of the Criminal Code. An administrative investigation may be initiated at the request of an IPR owner or by law enforcement authorities (police or customs) suspecting possible IPR infringement. Administrative cases are dealt with by general jurisdiction courts or state commercial courts that have jurisdiction over economic disputes. The IPR provisions of the Criminal Code apply to large-scale infringements of copyright, patent and trademark rights that cause gross damages, as defined by the Criminal Code.

In 2010, Russia made significant progress in improving the legislative environment and legal framework for IPR protection. Russia passed amendments to Part IV of the Civil Code for compliance with the Trade-Related Aspects of Intellectual Property (TRIPs) agreement, amended its Customs Code to include ex-officio authority for Russian Customs officials, and amended the Law on Circulation of Medicines to provide for 6 years of regulatory data protection upon WTO accession. Additionally, a law adopted in December 2011 laid the foundation for the establishment of a Russian IPR Court within Russia's system of commercial courts by February 2013.

Under a presidential initiative to liberalize Russian criminal legislation and decriminalize some "white-collar" crimes, Russia adopted a law in 2011 that sets a 100,000 ruble (approx. $3,400) threshold for what constitutes a "large scale crime" of copyright infringement. While twice the previous amount, many in the copyright industries consider the new threshold reasonable. Concerns remain, however, over the efficacy of deterring piracy and counterfeiting through criminal penalties and the lack of Internet-related IPR enforcement (including ISP liability and regulations for takedown notices).

Copyright violations (films, videos, sound recordings, computer software) remain a serious problem. Legitimate DVD sales are on the rise, however, thanks in part to cheaper legitimate products, a growing consumer preference for high quality goods, and increased law enforcement action against pirates. Local representatives of the entertainment and software industries have also reported declining levels of piracy. Russian police continue to carry out end-user raids against businesses using pirated products. At times, police have used IPR enforcement as a tactic to elicit bribes or harass NGOs.

Russia has had a law providing for bankruptcy of enterprises since the early 1990s. Law enforcement officials, however, tend to view bankruptcy with suspicion and reported 500 cases of financial crime involving bankruptcy in 2011. Russia lacks legislation on individual (personal) bankruptcy or insolvency.

Transparency of the Regulatory System

Russia's legal system remains in a state of flux, with various parts of the government continuing to implement new regulations and decrees on a broad array of topics, including the tax code and requirements related to regulatory and inspection bodies. Negotiations and contracts for commercial transactions, as well as due diligence processes, are complex and protracted. Investors must do careful research to ensure that each contract fully conforms to Russian law. Contracts must likewise seek to protect the foreign partner against contingencies that often arise. Keeping up with legislative changes, presidential decrees, and government resolutions is a challenging task. Uneven implementation of laws creates further complications; various officials, branches of government, and jurisdictions interpret and apply regulations inconsistently and the decisions of one may be overruled or contested by another. As a result, reaching final agreement with local political and economic authorities can be a long and burdensome process. Companies should be prepared to allocate sufficient funds to engage local legal counsel to set up their commercial operations in Russia.

Surveys have shown that many entrepreneurs complain about the complexity of the tax code and requirements of other regulatory and inspection bodies. Well-intentioned small and medium-sized enterprises (SMEs) often go out of their way to follow the law but are then penalized for making mistakes in documentation. They complain that the tax police make no distinction between overt tax-evaders and inexperienced SMEs who do not fully understand the bookkeeping requirements. Companies often have little recourse other than the courts to resolve tax disputes. While firms have successfully appealed to the courts, tax authorities are often slow to implement judicial decisions. Penalties for non-compliance include confiscation of property and freezing a company's bank accounts. A 2010 law greatly increased the criminal threshold of tax underpayment, forbade pre-trial detention for tax offences, and allowed first-time offenders to escape criminal liability for a tax offence by paying their arrears during the pre-trial investigation.

In consultation with foreign firms, Russia developed and adopted in 2011 a new Law on Transfer Pricing. While certain provisions of the new law, having been drafted in accordance with OECD principles, show promise, some experts warn that other provisions may lead to additional disputes with tax authorities. Ultimately, the new law's impact will depend on its implementation.

All draft laws that go through the Russian Duma are published on the Duma's website. Sometimes, but not consistently, ministries and other Russian government bodies also publish proposed legislation (including draft laws, government decrees and regulations) on their websites. While there is opportunity for public comment, the general perception is that this opportunity is limited and has minimal impact. Russian Ministries have become more active in seeking input from industry experts and business groups, including the Foreign Investment Advisory Council, when developing business-related laws and regulations. Nevertheless, observers complain that last-minute regulatory changes are often rushed through without consultation or explanation.

Efficient Capital Markets and Portfolio Investment

The Russian banking system remains relatively small, with RUB 4.9 trillion ($164.7 billion) in aggregate capital as of November 1, 2011. Though Russia has roughly 1000 banks, the sector is dominated by state-owned banks, particularly Sberbank and VTB. The six largest banks in Russia are state-controlled, and the top five held 49.1% of all bank assets in Russia as of November 1, 2011. The successful implementation of the Deposit Insurance System in 2004 has proved a critical psychological boon to the banking sector, evidenced by growth in overall deposits. Despite measured progress, the Russian banking system is not yet efficiently performing its basic role of financial intermediary (i.e., taking deposits and lending to business and individuals). At the beginning of 2011, aggregate assets of the banking sector amounted to just 75% of GDP and aggregate capital was just 10% of GDP. Russia's banking sector is recovering from the economic crisis, with loan growth reaching 15% in 2010 and accelerating to 20% in the 12 months running to November 1, 2011. The share within Russia's banking sector of non-performing and troubled loans, which during the 2008-2009 financial crisis increased substantially, stabilized in 2010 at around 20% and began to slowly decline in the second half of 2011. Russia's two main stock exchanges – the Russian Trading System (RTS) and the Moscow Interbank Currency Exchange (MICEX) – merged on December 19, 2011. The integration of their trading platforms, clearing systems, data centers and other operations should be completed by the end of 2012 and the MICEX-RTS bourse is eyeing an initial public offering (IPO) soon. Russian authorities and shareholders of MICEX and RTS believe the merged entity, MICEX-RTS, will become a global player. However, most large Russian companies choose to list their stock in London and elsewhere abroad in order to obtain higher valuations.

The Law on the Securities Market includes definitions of corporate bonds, mutual funds, options, futures, and forwards. Companies offering public shares are required to disclose specific information during the placement process, as well as on a quarterly basis. In addition, the law defines the responsibilities of financial consultants who assist companies with stock offerings and holds them liable for the accuracy of the data presented to shareholders.

Russian financial authorities are trying to deepen the ruble-denominated domestic debt market to make it more attractive to foreign investors. In December, the Central Bank issued a resolution allowing, effective January 1, 2012, government bonds (aka OFZs) to be traded outside Russian exchanges (over the counter). Currently, foreign investors wanting to trade domestic bonds have to set up local brokerage and custody accounts, a lengthy process that discourages many investors from buying OFZs. Additionally, MICEX intends to sign an agreement with Euroclear Bank, the world's largest settlement system for securities, which will allow foreigners to settle their Russian government bond transactions without the need for a local trading account.

Hostile takeovers are common in Russia among both foreign and local firms. Private companies' defenses to prevent hostile takeovers relate to all potential hostile takeovers, not just foreign ones.

Russia's financial market suffers from a shortage of private domestic institutional investors. For example, the life insurance market is miniscule, comprising only 3% of insurance premium payments. Private pension funds, held back by a public distrust of financial instruments and a lack of tax incentives, make up just 2% of financial assets in Russia, equal to 2% of GDP.

Competition from State-Owned Enterprises

Despite large-scale privatizations, the seven existing state corporations still play a large role in the Russian economy. (Note: State corporations are 100% owned by the Russian government and operate under special legislation. The Russian economy also features thousands of other companies owned in part or whole by the Russian government that operate under different legal arrangements, such as unitary enterprises and joint stock companies.) While private enterprises are technically allowed to compete with state corporations on the same terms and conditions, in practice, the playing field is tilted. State corporation holding structures and management arrangements (e.g., state representatives as board members) make it difficult for private enterprises to compete. Furthermore, specific legal constructions can result in preferential treatment of state corporations. For example, state corporations have no unified legal framework, being set up under different legislation than that which applies to other corporations. Such a case-by-case approach leaves much scope for discretion and lobbying by company insiders.

Corporate governance of state corporations is characterized by the "dual management" model. The Federal Agency for State Property Management (Rosimushchestvo) is authorized by the Russian government to exercise shareholder rights for federally-owned shares in companies and is responsible for the preparation and nomination of candidates at the annual meetings of shareholders. As a general rule, Rosimushchestvo nominates to a company's board of directors representatives of the most relevant government body, based on the sectoral characteristics of the business. The sectoral state body thus participates in managing the company through its representatives. In important companies that straddle the sectoral priorities of the government and its political interests, top government officials were traditionally nominated to the boards of directors. An April 2011 Presidential decree, however, ordered high-level government officials to step down from the boards of directors of state companies. Issues that hamper the efficient operations of state corporations include a lack of transparency, unclear responsibilities of boards of directors, misalignment of managers' incentives and company performance, inadequate control mechanisms on managers' total remuneration or their use of assets transferred by the state to the state corporation, and reduced disclosure requirements.

As discussed above, the Russian government Privatization Plan aims to sell an estimated $60 billion of government stakes in about 1000 companies, and an expansion of the Plan is currently being developed. In February 2011, the government successfully privatized a 10% minority share in VTB Bank. Overall, however, implementation of the Privatization Plan has slowed, in part due to poor market conditions and uncertain government enthusiasm to carry out the plan.

There are two sovereign wealth funds in Russia: the Reserve Fund ($25 billion as of December 2011) and the National Wealth Fund ($88 billion as of December 2011). Management of both funds' assets is executed by the Ministry of Finance in accordance with procedures and terms established by Government of the Russian Federation. The Central Bank of Russia acts as operational manager.

Reserve Fund assets can be used to purchase: foreign currencies (dollars, euro, pounds) that are then kept in the Federal Treasury's accounts with the Central Bank of Russia, which in turn pays interest on those deposits; and financial assets denominated in foreign currencies. The list of eligible financial asset classes is determined by Russian legislation. Ministry of Finance guidelines for Reserve Fund asset allocation are foreign (12 OECD countries) government debt instruments – 95%, international financial institutions' (a closed list of 9) debt instruments – 5%. The National Wealth Fund can be held in foreign currencies (dollars, euro, pounds) in the Federal Treasury's accounts with the Central Bank of Russia, which pays interest according to the bank account agreement. The National Wealth Fund can also be used to purchase financial assets denominated in Russian rubles and eligible foreign currencies. The Reserve Fund and National Wealth Fund are audited by Russia's Chamber of Accounts and the results are reported to the Federal Assembly. In 2009 and 2010, the Russian government tapped into both funds heavily to finance bail-out programs for major banks and industries during the global economic crisis. In 2011, the funds remained untouched, and in early 2012 the GOR plans to use a trillion rubles from the expected 2011 federal budget surplus to replenish the Reserve Fund to RUB1.8 trillion ($58 billion).

Corporate Social Responsibility (CSR)

While there is still little pressure from Russian consumers and shareholders, contact with peers, investors, and customers overseas has led Russian companies to focus more on their CSR reputations, and those of their brands. When seeking to acquire companies in Western countries or raise capital on international financial markets, Russian companies face international competition and scrutiny, including on CSR standards. Consequently, most large Russian companies currently have a CSR policy in place or are developing one. Russian firms' CSR policies often are now published on corporate Web sites and detailed in annual reports. These CSR policies and strategies, however, are still in an early stage relative to those of Western counterparts. The Russian government remains the most powerful stakeholder in the development of certain companies' CSR agendas, resulting in the expectation that these companies support local health, educational and social welfare systems as specified by the government.

The Federal Service for Financial Markets established a corporate governance code in 2002 and has endorsed an OECD White Paper on ways to improve practices in Russia. International business associations such as the American Chamber of Commerce in Russia, the U.S.-Russia Business Council, the Association of European Businesses in Russia, and the International Business Leaders Forum, as well as Russian business associations, stress corporate governance as an important priority for their members and for Russian businesses overall. One association, the Russian Union of Industrialists and Entrepreneurs, developed a Social Charter of Russian Business in 2004 that over 200 Russian companies and organizations have since joined.

Political Violence

Although the use of strong-arm tactics is not unknown in Russian commercial disputes, the Embassy is not aware of cases where foreign investments have been attacked or damaged for purely political reasons. Many have argued that the Russian Government's dismantlement of Yukos, in which American and other foreign investors held significant stakes, was undertaken in retaliation for the independent political activity of the company's head, Mikhail Khodorkovsky. While this case has raised questions about corruption, selective prosecution, and rule of law in Russia, the European Court of Human Rights ruled in September 2011 that the applicants had not offered sufficient evidence to prove that the Russian Government's actions against Yukos were politically motivated. Russia continues to struggle with an ongoing insurgency in Chechnya, Ingushetiya and Dagestan. These republics and neighboring regions in the northern Caucasus have a high risk of violence and kidnapping.

Recent large-scale public protests suggest that the country has become more politically engaged and that civic action may become more commonplace. Following wide-spread allegations of fraud during December 2011 parliamentary elections, tens of thousands of people turned out on the streets of Moscow and across Russia to demand free elections and the resignation of Central Election Committee chairman Vladimir Churov. Such public protests will likely continue in the run-up to March 2012 Presidential elections.

Corruption

Corruption remains a major problem for businesses and investors in Russia. According to Transparency International's 2011 Corruption Perceptions Index, Russia ranked 143rd out of 183 nations surveyed. This represented an improvement from its 154th place showing in 2010, but was still far below its 2004 ranking (90th place).

Corruption, including bribery, raises the costs and risks of doing business. Corruption has a corrosive impact on both market opportunities overseas for U.S. companies and the broader business climate. It deters international investment, stifles economic growth and development, distorts prices, and undermines the rule of law. Moreover, the NGO Information Science for Democracy (INDEM) estimated in a 2009 report that bribes and corruption annually cost Russia the equivalent of one-third of its GDP. In November 2010, President Medvedev announced that Russia is losing up to a trillion rubles (approximately $33 billion) annually due to corruption in its state procurement system.

The Government of Russia has repeatedly designated the fight against corruption and the enforcement of law as priorities. Russia is a signatory to the UN Convention against Corruption, the Council of Europe's Criminal Law Convention on Corruption, and the OECD Anti-Bribery Convention (which is pending ratification in the Duma). In May 2011, Russia adopted new legislation that, among other steps, criminalizes transnational bribery and substantially increases penalties for domestic bribery. In December 2011, Russia passed additional anti-corruption legislation strengthening penalties for state servants who fail to avoid conflicts of interest. Even so, Transparency International-Russia, a Russian affiliate of the international network, has reported that the enforcement of most anti-corruption legislation to date is weak or non-existent. In recent years, there appears to be a greater number of prosecutions and convictions of mid-level bureaucrats for corruption, but real numbers are difficult to obtain and high-ranking officials are rarely prosecuted. And while anti-corruption measures have been repeatedly strengthened, most monitoring organizations register an increase rather than a decrease in corruption. It is important for U.S. companies, irrespective of size, to assess the business climate in the relevant market in which they will be operating or investing, and to have an effective compliance program or measures to prevent and detect corruption, including foreign bribery. U.S. individuals and firms operating or investing in Russia should take the time to become familiar with the relevant anticorruption laws of both Russia and the United States in order to properly comply with them, and where appropriate, they should seek the advice of legal counsel.

The U.S. Government seeks to level the global playing field for U.S. businesses by encouraging other countries to take steps to criminalize their own companies' acts of corruption, including bribery of foreign public officials, by requiring them to uphold their obligations under relevant international conventions. A U.S. firm that believes a competitor is seeking to use bribery of a foreign public official to secure a contract should bring this to the attention of appropriate U.S. agencies, as noted below.

U.S. Foreign Corrupt Practices Act (FCPA): In 1977, the United States enacted the FCPA, which makes it unlawful for a U.S. person, and certain foreign issuers of securities, to make a corrupt payment to foreign public officials for the purpose of obtaining or retaining business for or with, or directing business to, any person. The FCPA also applies to foreign firms and persons who take any act in furtherance of such a corrupt payment while in the United States. For more detailed information on the FCPA, see the FCPA Lay-Person's Guide at: www.justice.gov/criminal/fraud/fcpa/docs/lay-persons-guide.pdf. In 2011, the Federal Anti-Monopoly Service (FAS) fined a Danish pharmaceutical importer for terminating a local distributor. The importer claimed that FCPA due diligence had yielded evidence of corruption on the part of the local distributor while the distributor claimed that the importer was using the FCPA as a shield to engage in anti-competitive practices. FAS largely accepted the position of the local distributor and this case has caused concern on the part of some foreign companies that legitimate attempts to do FCPA due diligence will be misinterpreted by Russian authorities as illegal attempts to limit competition. As of late 2011, FAS indicated that it was considering revising its policy to address this problem and to give companies more discretion to terminate local distributors suspected of corruption. However, as of the time of writing, the new policy had not yet been adopted.

Guidance on the U.S. FCPA: The Department of Justice's (DOJ) FCPA Opinion Procedure enables U.S. firms and individuals to request a statement of the Justice Department's present enforcement intentions under the anti-bribery provisions of the FCPA regarding any proposed business conduct. The details of the opinion procedure are available on DOJ's Fraud Section Website at www.justice.gov/criminal/fraud/fcpa. Although the Department of Commerce has no enforcement role with respect to the FCPA, it supplies general guidance to U.S. exporters who have questions about the FCPA and about international developments concerning the FCPA. For further information, see the Office of the Chief Counsel for International Counsel's website, at http://www.ogc.doc.gov/trans_anti_bribery.html. More general information on the FCPA is available at the Websites listed below.

Other Instruments: It is U.S. Government policy to promote good governance, including host country implementation and enforcement of anti-corruption laws and policies pursuant to their obligations under international agreements. Since enactment of the FCPA, the United States has been instrumental to the expansion of the international framework to fight corruption. Several significant components of this framework are the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (OECD Anti-Bribery Convention), the United Nations Convention against Corruption (UN Convention), the Inter-American Convention against Corruption (OAS Convention), the Council of Europe Criminal and Civil Law Conventions, and a growing list of U.S. free trade agreements.

OECD Anti-Bribery Convention: The OECD Anti-Bribery Convention entered into force in February 1999. There are 38 parties to the Convention including the United States (see http://www.oecd.org/dataoecd/59/13/40272933.pdf). The Convention obligates the Parties to criminalize bribery of foreign public officials in the conduct of international business. The United States meets its international obligations under the OECD Anti-Bribery Convention through the FCPA. In 2011, Russia passed anti-corruption legislation that clearly criminalized foreign bribery and is expected to formally accede to the Anti-Bribery Convention in early 2012.

Local Laws: U.S. firms should familiarize themselves with local anticorruption laws, and, where appropriate, seek legal counsel. While the U.S. Department of Commerce cannot provide legal advice on local laws, the Department's U.S. Commercial Service can provide assistance with navigating the host country's legal system and obtaining a list of local legal counsel.

Assistance for U.S. Businesses: The U.S. Department of Commerce offers several services to aid U.S. businesses seeking to address business-related corruption issues. For example, the U.S. Commercial Service can provide services that may assist U.S. companies in conducting their due diligence as part of a company's overarching compliance program when choosing business partners or agents overseas. The U.S. Commercial Service can be reached directly through its offices in major U.S. and foreign cities, or through its Website at www.trade.gov/cs.

The Departments of Commerce and State provide worldwide support for qualified U.S. companies bidding on foreign government contracts through the Commerce Department's Advocacy Center and State's Office of Commercial and Business Affairs. Problems, including alleged corruption by foreign governments or competitors, encountered by U.S. companies in seeking such foreign business opportunities can be brought to the attention of appropriate U.S. government officials, including local embassy personnel and through the Department of Commerce Trade Compliance Center "Report A Trade Barrier" Website at tcc.export.gov/Report_a_Barrier/index.asp.

Anti-Corruption Resources

Some useful resources regarding combating corruption in global markets include the following:

· Information about the U.S. Foreign Corrupt Practices Act (FCPA), including a "Lay-Person's Guide to the FCPA" is available at the U.S. Department of Justice's Website at: http://www.justice.gov/criminal/fraud/fcpa.

· Information about the OECD Anti-Bribery Convention including links to national implementing legislation and country monitoring reports is available at: http://www.oecd.org/department/0,3355,en_2649_34859_1_1_1_1_1,00.html.

· General information about anticorruption initiatives, such as the OECD Convention and the FCPA, including translations of the statute into several languages, is available at the Department of Commerce Office of the Chief Counsel for International Commerce Website: http://www.ogc.doc.gov/trans_anti_bribery.html.

· Transparency International (TI) publishes an annual Corruption Perceptions Index (CPI). The CPI measures the perceived level of public-sector corruption in 183 countries and territories around the world. The CPI is available at: http://cpi.transparency.org/cpi2011/. TI also publishes an annual Global Corruption Report which provides a systematic evaluation of the state of corruption around the world. It includes an in-depth analysis of a focal theme, a series of country reports that document major corruption related events and developments from all continents and an overview of the latest research findings on anti-corruption diagnostics and tools. See http://www.transparency.org/publications/gcr. Transparency International-Russia also posts corruption-related research materials and findings on the following sites, all specific to Russia: www.transparency.org.ru/INTER/index.asp and www.askjournal.ru.

· The World Bank Institute publishes Worldwide Governance Indicators (WGI). These indicators assess six dimensions of governance in 213 economies, including Voice and Accountability, Political Stability and Absence of Violence, Government Effectiveness, Regulatory Quality, Rule of Law and Control of Corruption. See http://info.worldbank.org/governance/wgi/sc_country.asp. World Bank Business Environment and Enterprise Performance Surveys may also be of interest.

· The World Economic Forum publishes the Global Enabling Trade Report, which presents the rankings of the Enabling Trade Index, and includes an assessment of the transparency of border administration (focused on bribe payments and corruption) and a separate segment on corruption and the regulatory environment. See http://www3.weforum.org/docs/WEF_GlobalEnablingTrade_Report_2010.pdf.

· Additional country information related to corruption can be found in the U.S. State Department's annual Human Rights Report available at http://www.state.gov/g/drl/rls/hrrpt/.

· Global Integrity, a nonprofit organization, publishes its annual Global Integrity Report, which provides indicators with respect to governance and anti-corruption. The report highlights the strengths and weaknesses of national level anti-corruption systems. The report is available at: http://www.globalintegrity.org/report.

Bilateral Investment Agreements

Russia has concluded bilateral investment treaties (BITs) with 70 countries, and 54 of them are in force. The United States and Russia have not concluded a BIT, although both sides have expressed interest in discussing such an agreement. The United States and Russia do not have a bilateral taxation treaty, and there has been no discussion of negotiating one. There is some concern that taxation requirements have sometimes been used in Russia as a way to "raid" or illegally take possession of foreign companies, particularly small and medium enterprises.

OPIC and Other Investment Insurance Programs

In an agreement ratified in 1992, the U.S. Overseas Private Investment Corporation (OPIC) was authorized to provide loans, loan guarantees ("financing"), and investment insurance against political risks to U.S. companies investing in Russia. OPIC's political risk insurance and financing help U.S. companies of all sizes invest in Russia. OPIC insures against three political risks: expropriation; political violence; and currency inconvertibility. OPIC recently announced that political risk insurance now covers private equity fund investments. To meet the demands of larger projects in Russia and worldwide, OPIC can insure up to $250 million per project and up to $300 million for projects in the oil and gas sector with offshore, hard currency revenues. Projects in the oil and gas sector with offshore, hard currency revenues may be approved for an exposure limit up to $400 million if the project receives a credit evaluation ("shadow rating") of investment grade or higher. The individual per project exposure limit for financing is $250 million. The maximum combined (insurance and financing) exposure limit to OPIC on a single project is $400 million. OPIC has no minimum investment size requirements. OPIC also makes equity capital available for investments in Russia by guaranteeing long-term loans to private equity investment funds. Detailed information about OPIC's programs can be accessed at www.opic.gov. Russia is a member of the Multilateral Investment Guarantee Agency.

Labor

The Russian labor market remains fragmented, characterized by limited labor mobility across regions and consequent wage and employment differentials. Earnings inequalities are substantial, enforcement of labor standards is relatively weak, and collective bargaining is underdeveloped.

The rate of actual unemployment (calculated according to ILO methodology) in 2011 declined from 7.8% in January to 6.4% in October. Average unemployment in urban districts (5.5%) is much lower than in rural districts (9%). Two regions in the North Caucasus have the highest unemployment rates in the country: Ingushetia (48.6%) and Chechnya (35.8%). In stark contrast, the unemployment rate is only 1.1% in Moscow and 1.6% in St. Petersburg.

Employers complain about the low quality of applicants' skills and labor shortages outside of urban centers. This is due in part to weak linkages between the education system and the labor market. In addition, the economy suffers from a general shortage of highly skilled labor. Employers in regions outside Moscow and St. Petersburg contend with a dearth of available workers. Businesses in these areas face increasing labor costs as competition over a limited pool of workers intensifies. On the other hand, a large number of inefficient enterprises with high vacancy levels offer workers unattractive, uncompetitive salaries and benefits.

The government registered only two strikes in 2011. Independent commentators, however, noted 194 protests during the first nine months of 2011, including 67 that involved the complete or partial cessation of work. The majority of labor disputes occurred in the manufacturing sector. The primary causes of labor disputes were wage arrears, company reorganization or closure, low pay, and layoffs. Approximately 45% of Russia's workforce is unionized. The government generally adheres to ILO conventions protecting worker rights but often fails to enforce them.

The 2002 Labor Code governs labor standards in Russia. When adopted, it was meant to diminish the role of the government in setting and enforcing labor standards, with trade unions playing a role in representing workers' interests. Revisions to the Labor Code since 2002 have included new procedures for investigating industrial accidents and the requirement that businesses employing more than 50 workers establish a work safety division and create a position for a "work safety specialist." The enforcement of worker safety rules continues to be a major issue, as enterprises are often unable or unwilling to invest in safer equipment or to enforce safety standards.

Foreign Trade Zones/Free Ports

Russia has 24 Special Economic Zones (SEZs), which fall in one of four categories: industrial and production zones; technology and innovation zones; tourist and recreation zones; and port zones. Enterprises operating within SEZs enjoy a range of benefits that the Ministry of Economic Development (MED) – which manages the SEZ program – estimates can save investors up to 30% of the cost of doing business. Specifically, investors enjoy streamlined administrative requirements and procedures, a more favorable customs regime (including the waiver of import duties and refunds of the value-added-tax), and reduced tax rates on income, property, land, and transport. SEZ investors also receive cut rates on infrastructure expenses, including facilities and utilities costs. Such benefits are extended for an agreed introductory period, often lasting five years.

The SEZs are developing gradually, with the majority of investments still listed as "planned." Detailed information about the benefits and results of Russia's SEZs can be found at the MED's SEZ website: http://www.economy.gov.ru/minec/activity/sections/sez/main/.

Independent of the SEZs, in 2010 President Medvedev launched an initiative to establish the Skolkovo Innovation Center in the Moscow suburbs to promote investment in high-technology startup businesses, research, and commercialization of technological innovation. Inspired by the model of Silicon Valley, Skolkovo "resident companies" can receive a broad range of benefits, including complete exemption from profit tax, value-added tax, property taxes, and import duties, and partial exemption from social fund payments. Applicants for residency are evaluated and selected by an international admission board. According to the Skolkovo Foundation, over 200 companies have been selected as residents thus far.

Foreign Direct Investment Statistics

Table 1 shows flows of foreign investment by country for the first nine months of 2011, compared to the same period in 2010. Total foreign investment increased sharply in 2011, rising by 182% year-on-year. According to Russian statistical practice, total foreign investment numbers include direct investment (FDI), portfolio investment, and other investment (largely trade credits). FDI flows into Russia also increased in 2011, albeit less dramatically than total investment. This year, the largest share of foreign investment came from Switzerland. FDI from the Netherlands and Cyprus is consistently high because most FDI coming from these countries is either returning or reinvested Russian capital through subsidiaries or off-shore vehicles. The United States was the thirteenth largest investor in Russia during this period, with $1.3 billion in total investment, $88.2 million of which was FDI. (Note: The data in the tables below are from the Russian State Statistical Service (RosStat) and differ from data maintained by the Central Bank of Russia and the U.S. Department of Commerce.)

Table 1: Top Investors - By Year (in USD million)


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Country

Jan-Sep 2011

Jan-Sep 2010

Total

FDI

Total

FDI

Switzerland

69,115

70.1

3,398

64.5

Netherlands

13,218

3,023

7,507

943

Cyprus

12,972

2,758

5,635

1,912

Germany

8,169

1,480

7,520

1,095

UK

6,336

176

4,240

430

All Others

23,976

4,228

19,189

3,751

Total

133,784

11,736

47,488

8,196

The numbers in Table 2 represent the accumulated stock of total foreign investment by country, including FDI, portfolio, and "other" investment as of September 30, 2011, compared to the amount accumulated a year prior. As of September 30, 2011, the United States had the eleventh largest stock of investment in Russia at $6.95 billion, $3.27 billion of which was FDI. Source: RosStat.

Table 2: Top Investors - Accumulated Basis (in USD million)


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Country

As of Sep 30, 2011

As of Sep 30, 2010

Total

FDI

Total

FDI

Cyprus

69,057

47,290

57,600

40,377

Netherlands

46,295

23,328

44,184

22,790

Luxembourg

35,051

643

32,228

652

Germany

29,779

11,386

22,656

8,332

China

27,356

1,238

10,543

931

All Others

115,650

42,529

98,743

37,074

Total

323,178

126,415

265,954

110,156

Table 3 shows total foreign investment by region over the first nine months of 2011, compared to the same period in 2010. Moscow continues to attract the largest volume of investments (63.4% of total foreign investment), mainly due to the concentration of companies' headquarters and consumers with high purchasing power. Source: RosStat. (Note: includes direct, portfolio and "other" investment.)

Table 3 – Foreign Investment – Top Regions (in USD million)


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Jan-Sep 2011

Jan-Sep 2010

Amount

%

Rank

Amount

%

Rank

Moscow (city)

84,878

63.4%

1

15,816

33.3%

1

Tyumen Region

9,821

7.3%

2

701

1.5%

11

Sakhalin Region

6,570

4.9%

3

3,611

7.6%

4

St. Petersburg

3,972

3.0%

4

3,723

7.8%

3

Belgorod Region

3,171

2.4%

5

24.7

0.1%

58

Others

25,371

19.0%

23,612

49.7%

Total

133,784

100%

47,488

100.0%

Table 4 shows investment by sector over the first nine months of 2011, compared to the same period in 2010. Total investment rose in each of the top ten sectors, with the largest jump occurring in the financial sector. Foreign investment into the financial sector rose from 3.7% to nearly half of all foreign investment in Russia. The vast majority of that investment, however, was made up of a number of large short-term loans rather than FDI. Source: RosStat.

Table 4: Foreign Investment: Top Sectors (in USD million)

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Jan-Sep 2011

Jan-Sep 2010

%

Amount

%

Amount

Finance

49.1%

65,711

3.7%

1,764

Extraction of Fuel

9.6%

12,850

17.1%

8,115

Wholesale and Retail Trade

9.2%

12,363

18.3%

8,688

Production of coke and oil products

7.5%

9,997

10.5%

4,980

Metallurgy

4.4%

5,902

10.4%

4,950

Transport and Communications

4.1%

5,494

8.3%

3,952

Real Estate and Related Services

3.6%

4,782

8.1%

3,843

Chemical Industry

2.7%

3,636

3.5%

1,679

Food Industry

1.5%

1,964

3.9%

1,866

Production of vehicles

1.4%

1,845

3.3%

1,569

All Others

6.9%

9,240

12.8%

6,082

Total

100.0%

133,784

100.0%

47,488


Table 5 shows stocks of Russian FDI abroad as of September 30, 2011 and September 30, 2010, as well as flows of Russian FDI abroad for the first nine months of 2011, compared to the same period in 2010. Russian FDI stocks abroad increased by 29.9% in the year ending on September 30, 2011. Flows of Russian FDI abroad were also higher in 2011, nearly double in the first nine months of 2011 what they were in the same period in 2010. Source: RosStat.

Table 5: Top Destinations of Russian FDI - By Year (in USD million)

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Country

as of Sep 30, 2011

Jan-Sep 2011

as of Sep 30, 2010

Jan-Sep 2010

Stock

Flow

Stock

Flow

Netherlands

25,067

8,427

16,862

4,017

Cyprus

14,280

842

13,250

820

United States

6,663

439

5,656

158

Switzerland

2,814

328

2,001

N/A

Belarus

2,685

629

2,642

0.3

All Others

12,724

2,035

9,038

385

Total

64,231

12,072

49,448

6,009

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