14Section 4. Institutional and Macroeconomic Challenges
4.1.Policies in the sphere of property relations
4.1.1. Privatization and federal property administration: some results of the year of2004
Initiated in 2003, the gradual implementation of the key elements in the new "Concept of the Federal Property Administration"1 began to steadily acquire ever more and more fragmentary character in the year of 2004. One of the most obvious and objective reasons for such a development was the reorganization of the executive power structure which included liquidation of the RF Ministry of Federal Property (RF MFP) replacing it with setting up the Federal Agency for Federal Property Administration (FAFPA or "Rosimush-estvo") with its further subordination to the RF Ministry of Economic Development endowing it with norm setting functions in the sphere of privatization2. The necessity in a rather lengthy adaptive period during and after the said reorganization, the attendant changes in the personnel structure and composition (primarily so departure of a significant part of the former RF Ministry of Federal Property employees), further sophistication of the administration structure followed with the inevitable attending problems of coordination (along with preservation of the RF MFP) although but only functions of the seller were left to the latter, possibility for a new FAFPA re-subordination (for instance, directly under the RF Chairman of the Government) - all these logically led to the indisputable fact that in the year of 2004, respective activities of the state in the sphere of its own property administration were mostly of a rather inertial and spontaneous character.
In fact, the only component of the new "Concept of the Federal Property Administration" which was in such or other way being practically implemented in the year of 2004, was the 3-year long program of privatization. Such a document ("Prognostic plan of privatizing the federal property for the year of 2004 and the main directions of privatizing the federal property up to the year of 2006" was approved by the Instructions of the RF Government, dated August 15, 2003, No. 1165-p. In particular, the following sequence of actions was intended:
• 2003 - privatization of the state owned packages of shares in the amount of up to 2% of the authorized capital;
• 2004 - the state terminates its participation in all joint stock societies where the share of the state comprises less than 25%;
• 2005 - the state terminates its participation in all joint stock societies where the share of the state comprises from 25% to 50% (in particular, it terminates its participation in the capital belonging to companies engaged in the energy supply complex, fishery, foreign economic activities, machine-building and cinematography);
• 2006 - the state terminates its participation in all the companies where itowns more than 50% of the share packages but which are not listed among the strategic ones (in particular, those of the civil aviation whose business activities are directly connected with ensuring security of both the respective flights and the state, the chemical and the
1 Although the "Concept" was approved at the meeting of the RF Government on February 6, 2003, in the period from 2003 to 2004, however, it did not yet receive the status of an official document (as different from the respective "Concept" of 1999). For more details see: Radygin A., Malginov G., Privatization and Federal Policy Administration. Russian economy in 2003. Trends and perspectives. M.: IET, 2004. Pp. 327 - 339.
2 Decree of the RF President, dated March 9, 2004, No. 314 "On the System and Structure of the Federal Executive Power bodies".
petrochemical industries, geology and a number of branches of agriculture), including sale of shares of such joint stock societies which were set up during the transformation process of the FPUEs (Federal Public Unitary Enterprises);
• by the year of 2008 - completion of privatizing the federal property which is not practically used for performing the state functions of the Russian Federation, final formation of the management system over the property in the state sector, doubling of incomes from the practical use of the federal property.
According to the estimations made by the RF Ministry of Federal Property in 2003, practical implementation of this program required annual sales of shares belonging to 4000 joint stock societies (including the reorganized FPUEs). To practically reorganize something about six thousand (6000) FPUEs by the year of 2006 (as was evidently implied in the said plan), it was necessary to simultaneously make changes in the respective normative and legal acts lifting off the current limitations on privatization for over three thousand (3000) existing FPUEs. Accordingly, no more than two thousand (2000) FPUEs and five hundred (500) different packages of shares are expected to remain in the state ownership by the end of 2008. Thus, we can talk about quite a radical scenario of completing the property reform in Russia.
Nevertheless, unreality of the set up time terms stated was quite obvious already when the said program was being adopted and the practical steps undertaken during the year of 2004, became but only an additional confirmation of that fact (Table 1). The basic limitations to practical implementation of such a large - scale program within the time terms stated, still remain valid as well:
• demand for the overwhelming majority of the objects to be privatized remain extremely low; moreover, the rest of the unsold objects which successfully "transit" from one year into the other, only keep on increasing;
• risks of bringing about certain instability factors into the stock market and of selling the state property cheaper than such could take place under a smooth, time extended process of privatization;
• rather high probability of permanent corrections introduced in the lists of the respective packages of shares and enterprises due to various objective and subjective reasons;
• organizational facilities of the respective management bodies for fast enough reforming the state sector are in strong contradiction with the existing quantitative limitation -its scope;
• although the quantity of the state owned minority packages was such or otherwise getting reduced during the recent ten years, the rate of such reductions, however, does not substantiate any reasonable forecast of full solution of the problem within the three year span of time3;
• demand for new implementation mechanisms of not quite attractive minority packages (in particular, rejection of estimating the minority packages put up for sale and determining the starting price at the face - value of the shares to be sold) unless such has been practically confirmed4;
3 The de facto sales of the packages of shares in the recent years comprised but only from 10 to 30 per cent of those planned for a year. For example, 1 965 packages of shares were planned to be sold but nevertheless no respective auctions were officially declared for 571 of them, nor there was any decision on excluding the given enterprise from the said strategic list for 103 of them, and 158 enterprises faced the standard bankruptcy procedures initiated against them (although the latter could easily be viewed as a sort of a spontaneous privatization).
4 As a sufficiently radical instrument, it probably seems sensible to suggest reducing the authorized capital in the amounts equal to the state share in such JSS where several attempts to sell the state package definitely and unequivocally failed and their management does not have reasonable financial, managerial or strategic perspectives. However, this practical step will
• resistance of the branch ministries and primarily so with regard to reforming the PUEs [Public Unitary Enterprises] (mostly due to various financial and administrative reasons);
• drastic reductions in the quantity of unitary enterprises at all levels with their possible transforming into open joint stock societies (OJSS) which, while evidently increasing the loads on the public governance bodies, is hardly demonstrating any better efficiency in the capacity of public representatives during this particular time period as well;
• using the property of the respective unitary enterprises in order to set up an appreciable sector of public enterprises legally functioning as operative managerial units which simultaneously implies increase of financial risks of the state as connected with the subsidiary responsibility with regard to obligations of such enterprises;
• sufficiently significant remains to be the problem of executing full - fledged property rights of the respective enterprises on land plots (overcharged prices of redemption and rent, different methods of cadastral estimations and determining the real market price, administrative barriers, regional policies and so on and so forth).5
• general and not at all simple problems of ensuring the required level of quantitative normative and legislative support.
A significant factor, as noted above, was the 2004 administrative reform the influence of which on the processes of managing the state property simply can not be considered as unambiguous. On the one hand, for example, although revision and redistribution of functions between the respective ministries and departments evidently do stimulate more favourable conditions for radical reductions in the FPUE sector, there, nevertheless, also takes place certain general weakening of control over the said FPUEs as caused by the absence of sufficiently clear and distinct division of functions and authority functions between the FAFPA and the respective agencies under the branch ministries. On the other hand, however, reorganization of the system of managing the federal property often creates quite serious problems for the current representation of the state in governance bodies of the JSS with the state package including the said list consisting of 27 largest strategic JSS. According to the available data, the Charter stipulated meetings of the shareholders in most of these companies were conducted in the year of 2004 without the compulsory instructions and directives, as approved by the RF Government, or the position as formulated by the Rosimushestvo. Another problem to be dealt with is prolonged legal proceedings as connected with the state property management where of particular significance is the succession of the state position6.
indeed require solid legislative support. A positive incentive for potential buyers could become, for instance, consolidation of the residual state and municipal packages of shares for simultaneous sale.
5 In December 2003, the President of the Russian Federation signed the law (amendments to the Law "On the Practical Implementation of the RF Land Code") extending the time term for compulsory re-registration of the right of using the respective land plots by privatized enterprises into the right of ownership or rent in the period from January 1, 2004 to January 1, 2006. As to payments for such land plots, no more than just consideration of the respective projects was taking place during the whole year of 2004.
6 Russian Focus, 2004. July 5 - 11. p. 8.
Table 1
Basic Objects of the Federal Property and the Privatization Program for the 2000s
1999* 2000 2001 2002 2003 2004 2005
Total quantity of FPUEs** 13 786 11 200 9394 9846 9275 8820 -
Privatized FPUEs during
a year:
- forecasted - - - 1652 970 1063 1325
- de facto - 2 5 78 571 455 -
whose packages of
shares are in the owner- 3611 3524 4407 4 222 4 035 3905 -
ship of the RF**
Including, inter alia, the
respective share in the
authorized capital:
- 100% 382 61 90 99 124 273 -
- 50-100% 470 506 646 589 552 499 -
- 25-50% 1601 1211 1401 1 382 1308 1183 -
- less than 25% 863 1746 2270 2152 2051 1950 -
- the "golden" share 580 - 750 958 640 - -
Federal packages of
shares sold during a
year:
- forecasted - - - 1126 1965 719 566
- de facto*** - 87 216 185 638 150 -
*For the end of each year. The year of 1999 is used here as the respective basis with due account taken of the adoption of the "Concept of Administrating the State Property and privatization in the Russian Federation" (officially approved by the Resolution of the RF Government, dated September 9, 1999, No 1024).
** The total quantity of unitary enterprises in the early 2000s comprised about 80 000, including about 20 000 of the state enterprises and about 65 000 of the municipal ones. In 1995, the state owned not less than 15 00017 000 different size packages of shares but in 1999 - about 3 100 of "fixed" packages and from 7 000 to 8 000 of unsold ones (remaining on the balance of the respective regional property funds). In the year of 1995, 1004 joint stock societies already had the said "golden" share.
***Data on the packages of shares annual privatization yield to no correct interpretation for a whole number of reasons: (1) absence of sufficiently regular information from the RF Ministry of Property and the RF MFP; (2) transference of packages of shares from the RF Minimushestvo to the RF MFP and its divisions for further sales which actually never takes place (as a rule, only 10 to 20 per cent of the deals are considered as completed); (3) a "counter" FPUE corporatization process and other methods to increase the quantity of packages in the ownership of the state. As to the FPUEs, the respective data on privatization appear to be rather relative since the official values probably include a number of FPUEs which were subjected only to the primary corporatization. In January 2005, the RF Ministry of Economic Development suggested to include 42 FPUEs and 63 JSS in the privatization plan for the year of 2005 additionally. Source: Data of the RF Ministry of Economic Development, FAFPA.
The necessity of correcting the respective time - terms to complete the privatization process of the federal property, as provided for in the "Forecast plan (Program) for privatizing the federal property for the year of 2004 and the main directions of the federal property privatization up to the year of 2006 ", was determined by the problems mentioned above. According to the "Forecast plan (Program) for privatizing the federal property for the year of 2005 and for the period of up to the year of 2007"7, the following corrections are
7 The project for the years of 2005 - 2007 was considered at the meeting of the RF Government on July 29, 2004, "The forecast plan for the year of 2005" to be then officially approved by the Decision of the RF Government, dated August 26, 2004, No. 1124-p.
provided for in the main directions of the respective privatization process of the federal property for the medium - term period (2005 - 2007):
• prolonging the perspectives of the federal property privatization through the year of 2007;
• completing the privatization process for the federally owned packages of the respective JSS shares comprising less than 25 % of the authorized capital, in the year of 2005;
• changing the structure of the federal property branch-wise privatized;
• introducing such notion as a "perspective financial plan" in the planning concept of the federal property privatization.
The working assumption here also is that decision - taking in accordance with the directions of the state policies in the sphere of privatization currently under consideration, will make it quite possible, already in 2007, to set fully in motion the plan providing for the maximum liberalization of the economy from the state through privatizing the whole federal property which actually is not quite necessary for ensuring the respective functions of the state.
De facto failure of the plan to sell the remaining minority packages of shares en masse in the 2000s actually determined the need in searching for additional (to the current law on privatization, 2002) solutions - these possibly include modernization of the privatization infrastructure, lifting off a number of limitations imposed on the privatization process of strategic enterprises, modification of procedures for conducting special auctions and the system of sales on the whole, empowering the FAFPA with the rights of control over the deals and the right to fire the managerial personnel of the respective enterprises, etc. A separate task consists in reducing the list of strategic enterprises (see below) as well as in revising of any other legislative limitations on privatization.8
Failures with the sales of the remaining packages of shares resulted also in certain reconsidering of the respective accents - e.g., growing attention to the FPUE reform. In terms of quantity (data as of October 2004), the number of the FPUEs retained, should comprise in the perspective about 1000, the number of the respective federal bodies -about 10 000, that is Sof the currently existing ones (about 5500 of them are to be privatized or liquidated, about 4000 of them are to be passed over to the respective regions). In terms of quality, reanimated again are the ideas as to introducing the institute of private management for the state unitary enterprises which proved to be inefficient in the period from the 90s to the 2000s. Obviously much greater interest of the RF Ministry of Economic Development to such an institution can probably be connected with the failure (in 2004) to drastically cut down the number of the PUEs still remaining in the respective strategic lists. Yet, this decision does seem quite disputable. Firstly, there is certain substitution of notions (the PUE problem consists not so much in the efficiency level but rather in the fallaciousness of the very legal structure for the right to carry out economic activities. Secondly, certain difficulties arise when trying to solve problems connected with payments for the private management and for the attendant control over such. To practically organize the latter is not at all any easier than to control activities of the state functionaries.
A real novelty (as compared against the 2003 "Concept") was the suggestion to start transforming the respective unitary enterprises in three main directions: open joint stock societies, public enterprises (provided they do perform state functions) and noncommercial organizations. Rejection of the compulsory transforming of the said PUEs into JSSs with 100 per cent participation of the state (which takes, on average, from nine [9] months to two [2] years) and selling the PUEs unchanged, that is prior to any transforma-
8 Materials to the meeting of the RF Government on July 29, 2004.
336
tions (just as a property complex calculated per one buyer) can become one of the possible methods aimed at speeding up the privatization process. The RF Ministry of Economic Development is now planning to prepare and then to practically introduce the Law "On Non Commercial State Organizations" (i.e. establishing new legislative frame-works for the respective state bodies), further modification of the respective legislation on the estimating activities (to specify procedures for transferring the intellectual property rights), liquidation of such odious institution as the right for economic management of the federal PUEs. The newly raised question of establishing a qualitatively better Federal Property Register (including the relevant information on the balances and efficiency indicators) graphically illustrates the true state of affairs in this particular sphere of activity.
The plan for incomes in the year of 2004, in spite of all the current problems and limitations, was nevertheless significantly overfulfilled. However, there is not any contradiction here as to the cited above thesis on the inertia and spontaneity character of the state activities in the sphere of privatization during the year of 2004. Firstly, similar to the preceding years, a triumphant report about "the fact exceeding the plan" was ensured by the so called one-time large deals. Secondly, the amount of monies planned for the year of 2000 (about 35 to 40 bln roubles), was traditionally and intentionally understated in view of possible breakdown of the expected sales and/or creation of favorable conditions for the next "overfulfilment" of the plan for incomes.
If proceeded from the viewpoint of the budget incomes, then the positive trends of 2000 - 2003 as connected with greater share of incomes obtainable from using the state property (that is renewable returns), retained their positive values in 2004 as well. According to the respective data of FAFPA, the total returns to the federal budget from privatization and practical use of the respective state property for the year of 2004 comprised 118 bln roubles (preliminary estimations with no account taken of the profits from selling the shares of the Magnitogorsk Metallurgy Plant which are to be directed to the budget of 2005).
Winner of the auction in selling the last state package of the "LookOil" oil company (7.59%, the starting price was 1. 928 bln USD) had in all probability secured the a priory approval of the respective state authorities and, accordingly, was known well beforehand. One of such, on September 29, 2004, became the "ConocoPhillips" company (USA) which paid the said 1. 988 bln US dollars necessary for bringing its share up to 10% of the authorized capital. The latter, fully in accordance with the terms and conditions of the respective agreement, enables ConocoPhillips to obtain the rights of the "blocking shareholder" as well as one vote in the Board of Directors. Certain limitations were also set up - 4 year ban on selling shares and a limited (20%) participation in the company's shareholding capital.
Another large deal in the year of 2004, traditionally put off for the end of the year, was the auction in one lot selling of 17.82% shares of the largest steel mill of Russia - the Magnitogorsk Metallurgy Plant (MMP) which was, in fact, the last large asset of the state in this particular industry. As different from the deal with the shares of "LookOil", there were several competing groups there - contenders for the package, and the end result of this competitive race remained quite unclear up to the very closing time of the said auction. Privatization of this particular package was in such or other way under discussion since the year of 1997. During several more recent years, the said package was simultaneously present both in the "strategic" and the "privatization" lists while the most acute struggle between several large metallurgy groups eventually came down to the question of blocking such sales. Accordingly, in August of 2004, the said enterprise was excluded from the said strategic list and the struggle logically turned into another phase with the situation becoming
further complicated due to a very amorphous structure of the respective property and relevant control.
According to some estimations, such acuteness of the competition was to a considerable extent caused by the very fact that selling the package of the MMP shares was the first absolutely open tender in the history of the Russian privatization which had ever been carried out in the raw materials industry.9 Some "methods" should nevertheless be mentioned here which were used in the process of such contending struggle. In November 2004, the RF Ministry of Federal Property (RF MFP) demanded that the MMP pay the intermediary dividends for the nine (9) months for the package under privatization. This decision is primarily to the advantage of the MMP management which can use these monies to finance the deal itself (either directly or for purposes of repaying the respective credit). After the auction which the management did, no doubt, win, a decision was taken not to pay the said intermediary dividends (the formal grounds being absence of such clause in the Charter). Accordingly, two versions of the investment strategy for the year of 2005 were prepared by the management but the choice between them was to be made already after the auction. The optimistic version (in case the management wins) assumed investments of about 800 mln US dollars in development of the raw materials and certain coal projects. The pessimistic version (victory of "Mechel") assumed directing of up to 70% of free monies to paying the dividends and, probably, other ways of taking MMP's profits out.10(10) In December, a search was conducted in the offices of "Mechel" even though no official charges against the Group were brought. Almost simultaneously, the MMP management initiated a massive PR campaign, including also organization of visits of the RF President (the formal grounds being the World Championship in Judo) and of R. Juliani, ex-mayor of New York (the formal grounds being the Road Show in connection with the issue of the ADR). The necessary psychological pressure instruments can include unofficial information on readiness of the MMP management to pay the sum of up to 2.5 bln US dollars for the said package. Obviously, the administrative and financial positions of the MMP management turned out to be really the strongest therefore participation of the "Mechel" Group in the auction was interpreted, inter alia, not so much as a desire to acquire the said package but rather as a wish to try to maximally undermine the MMP's financial resources in other competing projects. According to the available data, the "Mechel" Group finally gave up and at the junction of the years of 2004 - 2005, sold its package to the structures which were affiliated with the MMP management.
The expected returns from the sale of the said package was to comprise something about 0.5 - 0.6 bln US dollars and the final scheme provided for selling the whole package as a single lot at an open auction on December 22, 2004, at the starting price of 790.15 mln US dollars (the net profit normative price of the package for the three years was set in the amount of 320 mln US dollars). Although the deal was completed already in the year of
2004, the incomes from it will be entered in the budget no later than the year of 2005 which, like in the case with a number of big deals of the past years, makes it possible to use "double" accounting for the privatization results for the current year.
But it was not only the triumphant victory of the said management with the MMP Director General in the head, that became the qualitative result of this auction. In February
2005, respective information appeared that V. Rashnikov, the virtual owner of the MMP as well as its beneficiary, even though having brought the control over almost 100% of the shares, is nevertheless planning to resign his post while reserving for himself a vote in the
9 Aggravation of the pre-auctionary competition // Expert. 2004. No 47. p. 8.
10 Molina M. Magnitka Will Leave No Money to the Competitors// Commersant, 2004, December 22
Board of Directors and thus concentrating his efforts on the raw materials projects which still remain a weak link in the MMP chain.
This situation is indicative from the viewpoint of real prerequisites for respective division of property and management with regard to the Russian experience in corporate management.
The expected returns to the federal budget from privatization must comprise in the year of 2005 not less than 42.7 bln roubles. Not relying on any financial illusions with regard to sales of the overwhelming majority of the packages of shares, the government nevertheless expects to get the said amount primarily from selling shares of the "Sviazin-vest" holding.
Selling the package of shares of the "Sviazinvest" telecommunications holding was in the respective plans during practically all the recent years so inclusion of this particular object in the privatization lists for the year of 2005 does not at all imply taking any final decisions. Firstly, further privatization is directly connected with completing of the reorganization processes in the said holding, the tariff reform, solving the social loads problems of regional business companies and providing communications for the respective power bodies. Secondly, in view of the growing attractiveness of the telecommunication shares, any urgent sale of the holding's securities does not seem to have much sense at all. However, there is an opposite (counter) trend here as well. According to the respective estimations of the RF Ministry of Economic Development, in spite of the fact that this holding owns both the controlling and the blocking packages of shares belonging to the regional wire - communication operators, the necessary operative control over the latter has already been lost. Thirdly, serious work over is required by the concrete variant of the planned sale. In 2001 - 2003, the privatization model standardly assumed 25% minus two (2) shares. In 2004, under intensive discussion, inter alia, was the variant of selling the packages of shares of the holding's regional companies (at least four [4] inter - regional daughter companies were included in the list for the year of 2004). In the middle of 2004, the Federal Agency for Federal Property Administration (FAFPA) considered three (3) main variants of the sale: 25%, 50% or 75% minus one (1) share. Yet, no one - time sale of the respective packages of shares of the daughter companies (with all the attendant consequences similar to the "double" privatization of the oil industry in the 90s, mentioned above) can be excluded. In particular, quite possible is selling 28% of the MGTS shares to the current majority owner of the AFK "System" which practically means that this holding is leaving the Moscow market and that it will inevitably tell on the terms of its capitalization. The terms of selling the holding will also depend on the quantity of prospective contenders, their relationships with the respective authorities and the intensity of competition between them.
In August 2004, 1325 FPUEs and 556 JSS packages of shares (see Table 1) were included in the basic list of objects to be privatized in the year of 2005. The largest privatization projects of the next year, apart from "Sviazinvest", may be transforming the "Rosspirt-prom" FPUE into a joint stock society with the following sale of its shares (200 enterprises, 80% of the Russian market), the "Domodedovo avialines" (25% of the shares), the Novo-rossyisk and the Tuapse sea freight ports (about 20% of the shares), "Rosgosstrakh" (25% plus 1 share) and others. Further privatization of the "Aeroflot - Russian Avialines" OJSS (51.2% of the controlling package of shares) is steadily put off from year to year. In 2004, in particular, arguments of the RF Ministry of Transport on the necessity of preliminary regulation of the so called "fly over money" (that is collection of payments for flying of the foreign air companies' planes over the territory of the Russian Federation) were accepted which automatically requires reconsideration of about 100 current agreements in force.
Another problem is financial and leasing contracts in the amount of about 1.5 bln US dollars which can be cancelled in case of their consequent privatization.
Considerable activation of the privatization process in the recent years was often connected with perspective privatization of the wholesale generating companies (WGC) created during the reorganization process of the "UES of Russia" RJSS. According to the statement of V. Khrystenko, Head of the Minpromenergo, made officially known in November 2004, the nearest hypothetical date to start privatizing the WGCs seems to be the year of 2006 by which time the interested parties (the state, the management of the "UES of Russia" RJSS, the "Gasprom" OJSS, the aluminum as well as other groups) are expected to work out certain compromise variants including not only auction sales but possible passing the state WGCs over for private management or privatization through distributing the respective WGC shares among the already existing shareholders of the "UES of Russia" RJSS as well. Reforming of the nuclear energy systems is intended rather for the long -term perspective. The Federal Atomic Energy Agency (the "Rosatom") does accept the impossibility of attracting adequate investments under the existing legislatively consolidated ownership model. Accordingly, almost inevitable appears to be first consequent transforming the "Rosenergoatom" FPUE into a corporation with 100% state participation followed then with attraction of private minority shareholders and company managers.
4.1.2. Changes in the normative - legal basis and federal property management
The past year of 2004 was marked with adoption of the new normative - legal acts as regulating the respective activities of the said economic societies with the state participation in their capital as well as the state unitary enterprises.
Participation in the shareholding and other societies. It is first of all necessary to mention here the Decree of the RF President "On approving the list of the strategic enterprises and strategic joint stock societies", dated August 4, 2004, No 1009. As such, 514 FPUEs and 549 open joint stock societies (OJSS) were determined in it with different shares of the state in their respective authorized capital11.
It is not to be forgotten, however, that formal approval of such a list requires the respective norm of the Law "On privatization of the state and municipal property", dated December 21, 2001, No 178 - FZ. As stipulated in Article 6 of the said Law, in order to practically and efficiently implement a single and universal system of the state policies in the sphere of privatization, the RF Government shall present to the RF President for respective approval, proposals on forming the said list of strategic enterprises and including federal state unitary enterprises (FPUEs) whose end products (work, services, etc) are of strategic significance for assuring the defense ability and respective security of the state, protection of the nation's morality, health, rights and legitimate interests of the citizens of the Russian Federation (hereinafter called as "strategic enterprises"), open joint stock societies (OJSS) whose shares are in the federal ownership and participation of the Russian Federation in their management duly ensures the strategic interests of the state, its defense ability and security, protection of the nation's morality, health, rights and legitimate interests of the citizens of the Russian Federation (hereinafter called as "strategic joint stock societies")12.
11 According to the available data of the RF Ministry of Economic Development for July 2004, the original list of the strategic enterprises was first cut down from 3000 to 200 but then it again grew up to 1200 (672 JSS and 528 FPUEs).
12 Earlier, in the capacity of such enterprises considered were usually those already included in one of the lists approved by the respective Decisions of the RF Government "On the list of the defense complex enterprises and organizations privatization of which is prohibited", dated July 12, 1996, No 802, and "On the list of whose products (commodities, services, etc) are of strategic significance for ensuring the national security of the state as fixed in the federal ownership whose shares are not
Similarly, proposals are presented to the RF President as connected with introducing into the respective list of the strategic enterprises and that of the strategic joint stock societies of certain changes concerning composition of the FPUEs in the lists of respective strategic enterprises, including their consequent privatization (turning into open joint stock societies), as well as the need and the participation degree of the Russian Federation in the said OJSS (the strategic joint stock societies) and, inter alia, for further privatization of the shares owned by the said joined stock societies.
After decisions on cutting down the participation degree of the state in the management of the said strategic or on excluding of the respective enterprises from the strategic enterprises list have been formally taken by the RF President, these category objects may then be included in the so called privatization of federal property "forecast" plan (or program).
The Decree of the RF President, No 1514, issued at practically the same time as the said law, established that until the respective lists of the strategic enterprises and of the strategic joint stock societies were approved by the RF President fully in accordance with Article 6 of the Federal Law "On privatization of the State and Municipal Property", any changes in or amendments to the list of those whose end products (commodities, services, etc) are of strategic significance for ensuring the national security of the state and fixed in the federal ownership whose shares are not subject to any pre - term sale, as approved by the RF Government on July 17, 1998, No 784, shall be implemented through the respective RF Government Regulations based on the RF President's Decrees. However, although the RF Government was duly instructed to present for the approval of the RF President the said lists of the respective strategic enterprises and the strategic joint stock societies before March 1, 2002, this question, like many others, was not solved on the date fixed.
Removal of this sufficiently important gap in the RF legislation took more than two years from the moment the said law came into force. This Decree also permits the RF Government to include the listed enterprises and the respective OJSS's packages of shares in the privatization program after the RF President has taken decision on their exclusion from the corresponding lists.13 This document de facto determines the only way to privatize the strategic FPUEs - their transformation into OJSSs 100% shares of which are in the federal ownership. The Decree also contained instruction to the RF Government to provide for including the said enterprises and in the list of the strategic enterprises and organizations which was approved in January 2004for the purposes of efficient legal use of the respective bankruptcy law.
Quite noteworthy in this context is also another list of the strategic enterprises and organizations approved by the RF Government's Instructions No 22-p, dated January 9, 2004. Formal adoption of this document logically follows from Article 190 of the Federal Law "On insolvency (bankruptcy)". It's not at all unnecessary to remind in this connection that practically the whole paragraph 5 (Art. 190 - 196) of the third law on bankruptcy is devoted to regulating bankruptcies of the strategic enterprises and organisations.14 Accord-
subject for any pre-term sale", dated July 17, 1998, No 784, (in multiple subsequent versions). At that, neither the criteria nor the principles for including (or excluding) respective enterprises in such or other list were present.
13 Literal interpretation of the RF President's Decree leads to the logical conclusion on the appearance of a legal collision here because according to the new 2001 law on privatization, shares of companies and enterprises functioning in the natural monopolies sector, can be included in the said privatization program only on the basis of a special law, as was the case, for example, with adopting the package of laws on restructuring the electrical energy and railway transport industries.
14 These articles contain legal norms taking the said enterprises outside the confines of the standard procedures applied in case of insolvency of the said economic subjects, raising the requirements level to the bankruptcy participants thus allowing for the repeated interference of the state in its undergoing process.
ing to the said law, such list of the strategic enterprises and organisations is subject to its formal approval by the RF Government only provided it has been duly and officially published.
The said Instructions of the RF Government prescribed that all concerned bodies of the federal executive power shall present, each year in February, sufficiently grounded proposals on introducing such or other changes in and amendments to the said list of the respective strategic enterprises and organizations to the RF Ministry of Economic Development and the latter, in its turn, shall present, each year in March, proposals, duly coordinated with the federal executive power bodies concerned, on introducing changes in or amendments to the said list of the respective strategic enterprises and organizations to the RF Government. At present, this said list consists of 591 FPUEs, 494 open joint stock societies and 46 other enterprises (including 37 state enterprises and business associations,15 8 closed and 1 Ltd. society). However, the document does not yet make quite clear the degree of the state participation in the capital of the strategic enterprises and organizations making this said list, except for the federal property unitary enterprises.
Adoption of the two above mentioned lists logically resulted in certain renewal of the respective normative and legal bases of the state property policies with regard to the economic societies where it (the state) participates in their respective capitals which step should have been made long ago as required by the legal norms of the said laws on privatization and insolvency (bankruptcy). This was accompanied with further increases in the quantity of various lists of the economic societies with state participation in their respective capitals and whose activities are governed by different legal norms and different regulating instrumentation.
It is quite noteworthy in this connection that, apart from general provisions and schemes applied with regard to the cases where all the voting shares belong to the Russian Federation, "The Regulations on Implementing the Rights of the Russian Federation as a Shareholder", approved by the Order of the RF Ministry for Property Relations No 260, dated November 26, 2001, have five (5) supplements each of them including various lists of the respective joint stock societies (see Table 2).
Table 2
Structure and content of the supplements to the "Regulations on implementing
the rights of the Russian Federation as a shareholder", the year of 2001
Direction of regulation
No of Splnt
Regulating norms
Order of introducing by the Russian Federation of questions to the agendas of shareholders yearly meetings and proposing candidates to the governance and
1 .Candidatures for General Director and Auditing Committee members require approvals of the RF Government only. 2. The schedules of sending to the said business societies letters with questions for the agenda and candidatures to be approved by the respective Deputy Ministers, apart from the dispatch data, also contain data of sending the said proposals to the RF Ministry of Property Relations* (hereinafter called as "Ministry") and to the RF Government.
1
15 It is not quite clear why all these enterprises and business associations were not included in the said list of the respective FPUEs although 21 such enterprises were confirmed to be PUEs. Probably, the state or unitary enterprises of the Federal property subjects are also meant here but no direct indication of that can yet be found in the said document.
public control bodies (Art. 2)
1-3
Order of initiating by the Russian Federation of the extraordinary meetings of shareholders and moving forward, be such a case, of candidatures from the Russian Federation for the bodies of governance and public control (Art. 4).
Order of ensuring participation of the Russian Federation representatives in the 2 respective shareholders' meetings (Art. 5).
1. Candidatures for the Board of Directors require approvals of the RF Government only.
2. The schedules of sending to the said joint stock societies letters with questions for the agenda and candidatures to be approved by the respective Deputy Ministers, apart from the dispatch data, also contain data of sending the said proposals to the Ministry and to the RF Government.
1 .Candidatures for the Board of Directors members require approvals of both the RF Government and the Administration of the RF President.
2. The schedules of sending to the said joint stock societies letters with questions for the agenda and candidatures to be approved by the respective Deputy Ministers, apart from the dispatch data, also contain data of sending the said proposals to both the Administration of the RF President and the RF Government.
3. The said letter to the RF Government must contain a copy of the official approval of the candidatures for the Board of Directors members by the Administration of the RF President.
Moving forward candidatures for the Council of Directors membership, the Auditing Committees and General Directors requires the respective approvals by the RF Government and (or) the Administration of the RF President (apart from Moving forward candidatures for the Council of bodies which are responsible for coordinating and regulating in the corresponding industries [hereinafter called as "Federal bodies"] as well as executive power bodies of the subjects of the Federation on whose territory such joint stock societies are situated).
Letter of attorney from the Ministry to vote at the shareholders' meetings is issued only on the basis of the RF Government's individual decisions on appointing these representatives. Draft projects of such decisions are sent by the Ministry to the RF Government, as a rule, within five (5) days since the appointed day of the said shareholders' meeting but not later than ten (10) days since the date it has been conducted. The proxy of the Ministry for voting at such shareholders' meeting is issued on the day of the RF Government's respective decision but provided it was taken less than five (5) days prior to the date of such shareholders' meeting.
2
3
1. Should the agenda of such shareholders' meeting contain the question of electing the General Director, then, simultaneously with the draft project of the RF Government's directives, a respective letter of the Ministry shall be sent to the Administration of the RF President with proposals as to the order of voting for this particular matter as well as with official mention that the said directives shall in this case be approved by the RF Government.
2. Subject to respective approvals of the RF Government and the Administration of the RF President are also directives of the Ministry to the representatives of the Russian Federation concerning the question of electing the General Directors of the respective economic societies. The corresponding draft projects of the said directives shall be sent to the RF Government and to the Administration of the RF President fifteen (15) days prior to the appointed date of such meeting. Attached to the said draft projects of the directives must be the filled in questionnaire form of the prospective candidate, and should it be his/her re-nomination, then data on his/her activities as the General Director during the previous period, brief reasoning for his/her election, the appointed date for conducting such meeting as well as information on the quantity of the voting shares of such joint stock society duly belonging to the Russian Federation.
In cases, when the necessary approvals of the RF Government and/or the Administration of the RF President were not yet received one (1) week prior to the appointed date of the respective shareholders' meeting, then the said directives of the Ministry on the matter of electing the General Director shall be issued on the day when the required approvals of the RF Government and the Administration of the RF President are received in the Ministry - separately from directives of the Ministry for any other matters.
The order of voting is approved as determined in the RF Government's respective directives_
The order of ensuring participation of the Russian Federation in the respective shareholders' meetings in the format of voting in absentia (Art. 6).
Order of sequences in the annual forecast activity results of such business society's activities in the year come (Art. 8).
No in absentia voting of the Ministry is permitted at any extraordinary meetings of shareholders convoked either as requested by the Ministry or directly by the Ministry itself provided that their elected format permits to vote both direct and in absentia.
1. The economic efficiency indicators, as presented by the respective federal bodies, shall be within three (3) days directed for consideration by the Ministry's branch structures to the respective structure of the Ministry which is responsible for the financial monitoring of the respective enterprises and JSS, to be accordingly considered with due account taken of a number of respective materials.**
2. Should any differences arise with the respective federal bodied as to whether these be removed (or not) by the respective Deputy Minister provided they have been preliminarily approved by the First Deputy Minister, then such final decisions shall be taken on the basis of which they approve the respective indicators of the business society's economic efficiency.
3. Structural units of the Ministry shall ensure (not later than April 1) daily direct to the respective joint stock societies letters requesting them to send a number of the necessary documents*** to both the respective federal bodies and the Ministry itself (not later than June 1).
3
4
3
5
1 .Based on the proposals of the federal bodies which were sent prior to March 1, the forecast of dividend returns for the year to come is annually compiled prior to April 15. Dividends thus forecasted, are cited by the federal bodies separately for each of the joint stock societies included in Supplement 5.
2. In case of any censorious remarks as to the amount of the dividends with regard to some joint stock societies (included in the said Supplement 5), the respective branch structures of the Ministry shall specify the position of the said federal body. Should any principle differences are found, then the respective Deputy Ministers shall be informed about such within a one-day period and further on the said branch structures shall be guided by their respective directives. The final decision in such cases shall be taken by the respective Deputy Ministers provided it has been approved by the First Deputy Minister.
1.Based on the proposals from the respective federal bodies (made prior to November 1), the forecast of the expected dividend returns for the year to come shall be specified annually prior to December 1. Such forecast dividends are shown separately for each of the respective joint stock societies which are included in the said Supplement 5.
2. According to the results of the respective considering the proposals offered by the federal bodies, the branch structures of the Ministry compile more specified forecasts of dividend returns for the year to come and then direct them (prior to November 20) to the respective structural unit of the Ministry which is responsible for financial monitoring of the respective enterprises and joint stock societies. The said forecast dividends are shown separately for each of the joint stock sosieties duly included in Supplement 5. 1 .Based on the federal bodies proposals which came prior to February 1, the respective Deputy Ministers annually approve (prior to March 1) plans - schedules of dividend returns for each respective industry in the current year to be then sent to the respective federal bodies.
2. In case of any censorious remarks as to amounts of the dividend returns with regard to some joint stock societies. (included in Supplement 5), clauses are applied as typically used in such situations concerning dividend amounts for some joint stock societies at the stage of preparing respective forecasts of annual dividend returns. *In the course of a large - scale reorganization of the RF Government during the spring of 2004, functions of the Ministry of State Property were transferred to the Federal Agency for Federal Property Administration (FAFPA).
**(1). Blank-forms 1 - 5, approved by the Order of the RF Ministry of Finance "On Forms of the Book-Keeping Accounting of Organizations", dated January 13, 2000, No 4h (for the recent three years), with explanations of certain accounts and lines (accounts No No 26, 58, 73, 84, 99; line 480) and in case there are subsidiaries as well as annual consolidated balances of such a group (for the recent three years). (2). The planned indicators of financial activities for the current year including the amount of the net profits. (3). Forecasts of the respective financial and economic development for the year to come (forecasts by profits from the main activities, forecasts by expenditures including the currently planned investments projects with respective calculations of their respective ROI and the time - terms of repayment, description of the financing sources, the expected annual net profits) with the respective substantiating materials attached. (4). Middle - term targets of managing packages of shares owned by the respective joint stock societies (worked out by the respective federal bodies and are to be approved by the Ministry). (5) Forecasting the social and economic development of the Russian economy both as a whole and with regard to its corresponding industries for the middle - term perspective.
Order of sequences in preparing annual proposals for dividend returns to the Draft project of the Russian Federation budget for the year to come (Art. 9).
Order of sequences in preparing to practically implement the expected dividend returns as planned by the budget of the Russian Federation (Art. 10).
Order of sequences for practical implementing the planned annual dividend returns as planned by the budget of the Russian Federation for the current year (Art. 11).
5
5
5
***(1). Blank-forms 1 - 5, approved by the Order of the RF Ministry of Finance "On forms of the book-keeping accounting of organizations", dated January 13, 2000, No 4h (for the recent three years), with explanations of certain accounts and lines (accounts No No 26, 58, 73, 84, 99; line 480) and in case there are subsidiaries as well as annual consolidated balances of such a group (for the recent three years). (2). The planned indicators of financial activities for the current year including the amount of the net profits. (3). Forecasts of the financial and economic development for the year to come (forecasts by profits from the main activities, forecasts by expenditures including the currently planned investments projects with respective calculations of their respective ROI and the time - terms of repayment, description of the financing sources, the expected annual net profits) with the respective substantiating materials attached.
Since the above - mentioned Supplements to the said regulations have never been openly published, quite an interesting and so far totally unanswered remains the question of how intersect are the lists of the respective open joint stock societies they contain.
After legal adoption of the new Law on Privatization which came into force on April 26, 2002, certain additional novelties were introduced into the administration process of the state - owned packages of shares as well.
Resolution of the RF Government No 44, dated January 23, 2003, approved the Regulation on the order of managing the federally - owned shares of open joint stock societies as well as using a special right of the Russian Federation to participate in the management of open joint stock societies (the "golden share"). It replaced the RF Government Resolution "On the Order of Appointing and Functioning of the Russian Federation Representatives in the Management Bodies and the Auditing Committees of Open Joint Stock Societies Set up in the Process of Privatization Whose Shares are in Federal Ownership and with Regard to Which a Decision Was Taken on Using a Special Right for Participation of the Russian Federation in Controlling them (the "golden share")". The text of this document also contains mention of two more lists of the respective joint stock societies.
In the first place, this is a special list of separate joint stock societies, duly approved by the RF Government, with regard to which the respective position of the state as a shareholder is determined by the decision of the RF Government itself, its Chairman or by the Deputy Chairman of the RF Government, acting on his instructions, for the following matters:
• submission of questions into the agenda of the general meeting of the shareholders and nominating prospective candidates to be elected to the respective management bodies, the auditing or to the accounting commissions of such joint stock society;
• demanding convening of an extraordinary general meeting of the shareholders and actual convocation of such extraordinary general meeting of the shareholders;
• voting on the agenda items of such general meeting of the shareholders and appointment of the representative for voting at the general meeting of the shareholders.
It is not quite clear from the document whether this list is sufficiently identical to that of the open joint stock societies in accordance with which nomination of prospective candidates to the Board of Directors, to the Auditing Committee as well as to the OJSS executive bodies, should the solution of such questions be referred by its Charter to the competence of the shareholders general meetings, appointment of respective representatives of the Russian Federation for voting at the said general meetings with shares being in the ownership of the Russian Federation, replacement of those Board of Directors (the Observation Council) members who represent the interests of the Russian Federation - these all were performed by the RF Government in accordance with its Resolution No 195, dated March 7, 2000, which adoption of the said Resolution under consideration automatically made invalid.
Apart from this particular list, the document also contains mention of a special list (to be approved by the RF Government) of the joint stock societies taking into account the re-
spective estimations of such basic finance and economic indicators, including the volume of earnings, the cost of the fixed assets, the balance profits for the respective period of accounting, their share in the market of commodities (services) having a strategic significance for ensuring the defense ability and security of the state, and other relevant economic indicators. It was logically assumed that, having got the necessary approvals from both the federal bodies of executive power and the RF Ministry of Federal Property (MFP), the RF Ministry of State Property (Minimushestvo) shall direct to the RF Government the respective proposals on making changes in and introducing amendments to such. Although it remains not quite clear yet how exactly this list, once again mentioned in the said Resolution of the RF Government, dated January 23, 2003, should correlate with that of the strategic joint stock societies which, in accordance with the 2001 Law on Privatization, must be duly approved by the RF President which was the case not later than in the August of 2004. No information on approving by the RF Government of any lists of the respective joint stock societies in accordance with the said Resolution of 2003, was then available.
According to the information of the Minimushestvo Press - Service on February 3, 200416, the state moved forward as candidates to the Boards of Directors (the Observation Councils) and the Auditing Committees, 43 Russian companies with the respective state participation: the "ALROSA" CJSS, the "Iliushin Finance Co" OJSS, the "KamazAZ" OJSS, the "Finance leasing company" OJSS, the "N.I. Sazykin Progress Arseniev aviation company" OJSS, the "Molot Viatka - Poliansk Machine-building Plant" OJSS, the "Kovrov Electro-mechanical plant" OJSS, the "S.A. Zverev Krasnogorsk plant" OJSS, the "Vympel Interstate Shareholding Corporation" OJSS, the "Elara Cheboksar Research and Production Instrumental Plant" OJSS, the "Amber Baltic Ship - Building Plant" OJSS, the "Amur Ship -Building Plant" OJSS, the "Irkutskenergo" OJSS, the "Nefteotdacha Russian Inter - Industry Complex" OJSS, the Iliushin Inter - State Avia-construction company" OJSS, the "Aerocosmic Equipment Corporation" OJSS, the "M.L. Mill Moscow Helicopter Plant" OJSS, the "Tupolev" OJSS, the "Aviadvigatel" OJSS, the "Ulan - Ude Aviation Plant" OJSS, the "Academician V.P Glushko NPO Energomash" OJSS, the "Saturn Scientific and Production Trust" OJSS, the "Avtodizel" OJSS (the Yaroslavl motor plant), the "Moskvich" OJSS, the "Tver Carriage - Building Plant " OJSS, the "Motorostroitel" (Samara) OJSS, the "Khimprom" (Volgograd) OJSS, the "S. Ordjonikidze Kolchugin Non Ferrous Metals Procession" OJSS, the "Novorossyisk Bakery Combine" OJSS, the "Novoship Novorossyisk Sea Steamship Lines" OJSS, the "Murmansk Sea Steamship Lines" OJSS, the "Enisei River Steamship Lines" OJSS, the "Volga - Fleet Shipping Company" OJSS, the "Novorossyisk Sea Commercial Port" OJSS, the "Murmansk Sea Commercial Port" OJSS, the "Tuapse Sea Commercial Port" OJSS, the "Krasnoyarsk Avialines (KrasAir)" OJSS, the "Domodedovo Avialines Company" OJSS, the "Koltsovo Airport" OJSS, the "Rosagroleas-ing" OJSS, the "Rosgosstrakh" OJSS, the "Rosselkhozbank" OJSS, the "Russian Bank of Development" OJSS.
After the reorganization of the RF Government in the spring of 2004, the RF Ministry of Property Relations in the system of the state administration bodies was replaced with the Federal Agency for Federal Property Administration (FAFPA). But on the whole, a transition to the three - level system of the power bodies took place within the administrative framework at the federal level: ministries - agencies - services. As to the FAFPA, it went under the jurisdiction of the RF Ministry of Economic Development and Trade (MEDT). This all indeed stimulated a new spiral of the legislative norm setting in the sphere of the state property administration.
16 www.rosim.ru
The Resolution of the RF Government No 738, dated December 3, 2004, approved the new Regulations on managing the federally owned shares of open joint stock societies (OJSS) and using a special right for participation of the Russian Federation in such management of the open joint stock societies (the "golden share"). But although this document replaced a similar one approved by the former Cabinet of Ministers (Resolution of the RF Government No 44, dated January 23, 2003) it did not any significantly differ from its predecessor, its main provisions being as follows.
Rights of the OJSS shareholders, whose shares are in the federal ownership of the Russian Federation, shall be exercised in the name of Russia by the Federal Agency for Federal Property Administration (FAFPA). It is this governance body which implements with regard to the respective OJSS (with the exception of those all voting shares of which are in the federal ownership)17 submission of questions to the agenda of the shareholders meetings, nomination of candidates to the respective governance bodies, moving forward demands to convoke and to actually conduct an extraordinary general meeting of shareholders, appointment of the respective representative (duly issuing the letter of attorney) for voting at the said general meeting of shareholders, determining the position of the state as a legitimate shareholder with regard to matters contained in the agenda for the said general meeting of shareholders.
The official position of the Russian Federation as a legitimate shareholder with regard to matters contained in the agenda of the said general meetings of shareholders, shall be reflected in the respective written directives issued by the FAFPA to the officially appointed representative for voting at the said general meetings of shareholders, which acts on the basis of the written directives and the letter of attorney issued by the said Federal Agency for Federal Property Administration.
The legitimate rights of the state, as a legal shareholder, shall be exercised by the FAFPA proceeding from the following three-category classification of all the OJSS with a federal share in the respective capital:
• in the joint stock societies included in the said special list, as approved either by the respective federal ministry or by the respective federal body of executive power duly authorised to manage state property, whose activities are controlled either by the RF President or by the RF Government (hereinafter called as the "Federal Body")18;
• in the joint stock societies included in the said list of the strategic joint stock societies as approved by the RF President (hereinafter called as the "Strategic List")19, except for those joint stock societies which are included in the said special list on the basis of proposals made by the respective federal agency under the federal ministry (hereinafter called as the "Federal Agency") or under the respective Federal Body;
• in other joint stock societies - independently but should the said Federal Agency or the said Federal Body make duly executed proposals with regard to determining the shareholder position, then - with due account taken of such proposals.
17 Be such a case, the authority of the general meetings of shareholders is then exercised by the FAFPA and decisions of the general meetings shall be duly executed by its respective Instructions. At that, inapplicable become the legal norms concerning the procedure, time-terms, convocation and actual conducting of the said general meetings of shareholders. Should such an OJSS be included in the special list, as officially approved by the RF Government, then the position of the state as a legal shareholder, shall be determined by the corresponding Decision of the RF Government, the Chairman of the RF Government or by the respective Deputy Chairman of the RF Government acting on the instructions of the latter.
18 With regard to the joint stock societies included in the said special list: should the respective federal ministry have the said Federal Agencies under it, then such proposals as presented to the FAFPA for each particular matter, shall reflect a consolidated position of both such federal ministry and the respective Federal Agency under it.
19 Approved by the RF President on August 4, 2004, No 1009.
Should the federal ministries, agencies or other respective federal bodies have any proposals on convening and/or conducting such extraordinary general meetings of shareholders then they shall direct such proposals to the FAFPA not later than twenty (20) days prior the assumed date. In case the agenda of such extraordinary general meeting of shareholders includes questions connected with re-election of members of the Board of Directors or of the OJSS Observation Committee, then such time - terms will comprise thirty (30) and forty (40) days, respectively.
The above proposals are to contain sufficiently precise formulations of the questions which are subject for entering in the agenda of the extraordinary general meeting of shareholders, those for consequent decisions on such as well as proposals concerning the format of conducting such extraordinary general meeting of shareholders. The said proposals shall be submitted along with some explanatory note containing a reasonable justification for entering such proposal in the agenda and the materials necessary for the respective decision making. When proposing to include into the agenda of the said extraordinary general meeting of shareholders the question on changing the composition of the respective governance bodies, the auditing and the accounting committees, presented also must be respective information on the prospective candidates to be elected to the said governance bodies, the auditing and the accounting committees of the said joint stock society (official references from the personnel departments of the candidates' previous jobs).
The preparation procedure for the annual general meting of the shareholders clearly implies that the respective federal ministry (body or agency) shall direct to the FAFPA its proposals with regard to questions to be entered in the agenda of the meeting and the candidates to be elected at the said general meeting to the respective governance bodies, the auditing and the accounting committees prior to December 1 of the year preceding the one when the said annual general meeting of shareholders is to be conducted.
The said proposals shall contain the position as regards voting for or against the matters suggested, formulations of decisions to be taken; attached should also be the explanatory note, the necessary materials and the respective information on the candidates to be elected to the said governance bodies, the auditing and the accounting committees of this particular joint stock society (official references from the personnel departments of the candidates' previous jobs).
Upon receiving information on conducting the general meeting of shareholders, the respective federal ministry (body or agency) shall direct to the FAFPA its proposals with regard to voting on the matters of the agenda of the said general meeting of shareholders and appointment of the representative for voting at the general meetings of shareholders (with regard to the joint stock societies included in the said special list) within three (3) days but not later than fifteen (15) days prior to the date of the said general meeting of shareholders and should the agenda of the said general meeting of shareholders contain the question on prospective reorganization of such joint stock society then - not later than twenty (20) days prior the said date.
Should no information on conducting the said general meeting of shareholders has been received in due time, the proposals may be formulated on the basis of the agenda of such general meeting of shareholders as approved by the respective Board of Directors.
The proposals shall be presented with the accompanying explanatory note containing reasonable justifications of the decisions proposed as well as with all the necessary materials attached.
These proposals can be prepared on the basis of the protocol of the respective Board of Directors' meeting where the agenda for the said general meeting of sharehold-
ers was determined, and then directed to the FAFPA well in advance of the time officially set up.
The quantity of candidates to be included in the list for being elected to the Board of Directors membership, directed then by the FAFPA to the respective OJSS, must exceed the number of candidates by three (3) which corresponds to the share of the state in the authorised capital of the said joint stock society. The quantity of candidates to be included in the list for being elected to members of the Board of Directors, the Auditing and the Accounting committees of this OJSS, should not exceed the quantitative composition of such bodies as determined by the general meeting of shareholders.
As to the joint stock societies included neither in the said special nor the strategic lists, the respective federal agency or body have a right to direct to the FAFPA their own proposals (including those with regard to prospective candidates to be included in the voting list for electing to the Board of Directors membership).
Respective directives to the representatives of the state for voting at the said general meetings of shareholders shall be duly executed by the FAFPA.
According to the procedure for determining position of the state as a legitimate shareholder of the joint stock society which is included in the special list (Art. 12 - 15 of the Regulations), proposals on nominating candidates to be elected to the governance bodies, the Auditing and the Accounting committees of the said joint stock society as well as on entering some other matters in the agenda of the annual general shareholders meeting, except for the questions as specified in Par. 1 Art. 47 of the Federal Law "On Joint Stock Societies"20, shall be proposed by the RF
Ministry of Economic Development and Trade not later than December 1 of the year preceding the date of conducting the annual general meeting of shareholders (in case of conducting an extraordinary general meeting of shareholders - not later than 10 days prior to the end date of their submission to the respective joint stock society) with all the necessary materials attached. These include:
• proposals from the respective federal ministry (body);
• information on candidates to be elected to the respective OJSS governance bodies, the Auditing and the Accounting committees (official references from the personnel departments of the candidates' previous jobs);
• relevant information on the OJSS (share of the state in the authorized capital, composition of the respective governance bodies, the Auditing and the Accounting committees, the main financial and economic indicators and other necessary data);
• copies of the constituent documents and the accounting materials for the last year duly certified by the notary or by the MEDT.
Proposals with regard to demanding the conduct of an extraordinary general meeting of shareholders shall be presented by the MEDT to the RF Government not later than ten (10) days prior to the intended date of producing such demand with all the necessary materials attached.
Proposals with regard to voting on the agenda questions of the general meeting of shareholders shall be presented by the MEDT to the RF Government not later than ten (10) days prior to the intended date of holding such general meeting of shareholders with all the necessary materials presented by the said joint stock society when preparing for holding such general meeting of shareholders as well as any other relevant materials attached.
20 Implied here are matters obligatory for the annual general meetings of shareholders such as electing the Board of Directors (the Observation Council) of the Society, the Auditing and the Accounting committees, official approval of the annual and the annual accounting reports.
Proposals with regard to the agenda matters of the general meeting of shareholders included in the said special list, all voting shares of which are in the federal ownership shall be presented by the MEDT to the RF Government not later than thirty (30) days prior to the intended date of holding such annual general meeting of shareholders and in case of holding an extraordinary general meeting of shareholders - not later than ten (10) days prior to the intended date of taking the respective decision.
Table 3
Some procedures used by the state with regard to joint stock societies included in the respective special and strategic lists in accordance with the Provisions approved by the Resolution of the RF Government No 738, dated December 3, 2004
Direction of With regard to OJSS included in the regulation_special list_
With regard to OJSS included in the strategic list
In order to prepare the respective shareholder position of the Russian Federation, the Federal Agency for Federal Property Administration (FAFPA) directs the respective notification on holding the general meeting of shareholders with the agenda and all other materials, obtained from the said joint stock society attached, within the three (3) days term from the date of its receipt but not later than twenty (20) days prior to the intended date of holding such general meeting of shareholders and in case the said agenda includes the questions of this society's reorganization - not later than twenty five (25) days prior to the said date:
Procedure for expressing the shareholder will of the Russian Federation
to the federal ministry (body)
the federal ministry (body, agency) directs to the FAFPA its proposals on the agenda and nomination of candidates to be elected at the given general meeting of shareholders to the respective governance bodies, the Auditing and the Accounting committees prior to November 15 of the year preceding the year when the respective annual general meeting of shareholders was held.
Upon receiving such notification on holding the general meeting of shareholders, the federal ministry (body, agency) shall direct to the FAFPA its proposals with regard to voting on the respective agenda and appointment of the representative for voting at the said general meeting of shareholders within three (3) days but not later than twenty (20) days since the day such general meeting of shareholders was held, and in case the said agenda contains questions of reorganizing the society, then not later than twentyfive (25) days prior to the said date.
The advance presenting of the said proposals to the FAFPA based on the minutes of the Board of Directors meeting where the agenda of the said general meeting of shareholders was determined, is obligatory when respectively directing them not later than twenty five (25) days prior to holding
such general meting of shareholders._
to the federal agency (body)
Order of activities of the said representatives of the Russian Federation in the Board of Directors
In case certain differences arise between the federal ministry (body) and the Federal Agency for Federal Property Administration (FAFPA) with regard to the OJSS included in the respective special list, or between the federal agency (body) and the FAFPA with regard to the OJSS included in the respective strategic list, then it is the responsibility of the FAFPA Head (the respective Deputy Head) to provide for holding a conciliatory meeting regarding:
a). making demands for holding an extraordinary general meeting of shareholders -not later than fifteen (15) days prior to the date of its actual presenting (in case the agenda of such extraordinary meeting of shareholders includes the question of electing the Board of Directors members, then the said time - term shall comprise twenty five (25) days);
b). inclusion into the respective agenda of the annual general meeting of shareholders of proposals regarding nomination of candidates to be elected to the governance bodies, the Auditing and the Accounting committees of the said joint stock society, and other matters - not later than prior to December 10 of the year preceding the year of holding the annual general meeting of shareholders, with regard to the joint stock societies included in the said special list - prior to November 25 of the year preceding the year of holding the annual general meeting of shareholders (in case of an extraordinary general meeting of shareholders - no- later than fifteen [15] days prior to final day of presenting such notification to the said joint stock society);
c). voting on the respective agenda matters of the general meeting of shareholders -not later than fifteen (15) days prior to the day of its holding.
Should the said conciliatory meeting fail to reach a mutually agreed position then the Head of the FAFPA (not later than the day following the day of holding the said conciliatory meeting) shall present to the RF Ministry of Economic Development and Trade (RF MEDT) all the necessary materials, including the list of differences with reasonably substantiated justification of the positions of the respective parties and proposals of the federal ministry (body, agency) duly attached.
Be such a case, the position of the Russian Federation as a legitimate shareholder of the joint stock societies included in the said strategic list, or the respective proposals with regard to such position of the said shareholder (the Russian Federation) included in the said special list, presented to the RF Government in accordance with the pp. 12 - 15 of these present Provisions, shall be formed by the RF MEDT as mutually agreed with the respective federal; ministry (body).
The FAFPA directs the notification on the agenda for the meeting of the Board of Directors of the said joint stock society with all the necessary materials attached, to the respective federal ministry (body) not later than 15 days prior to the date of Its actual holding. In case this information on holding the said meeting of the Board of Directors reached the FAFPA later than the stipulated date, then the said notification shall be directed on the day of its actual receipt.
Beforehand direction to the FAFPA by the said federal ministry (body) of respective proposals as based on the data obtained from the representatives of the state in the Board of Directors, is obligatory._
The FAFPA directs the notification on the agenda for the meeting of the Board of Directors of the said joint stock society with all the necessary materials attached, to the respective on federal agency (body) and the RF MEDT not later than 15 days prior to the date of its actual holding. In case this information on holding the said meeting of the Board of Directors reached the FAFPA later than the stipulated date, then the said notification shall be directed on the dayof its actual receipt.
In case of differences with regard to the said directives to the representatives of the Russian Federation in the Board of Directors of the OJSS included in either the special or the strategic lists, then the Head (or the respective Deputy Head) of the FAFPA shall provide for holding a conciliatory meeting not later than twelve (12) days prior to the date of holding the said meeting of the Board of Directors. Should the said conciliatory meeting fail to reach a mutually agreed position then the Head of the FAFPA shall present to the RF Ministry of Economic Development and Trade (RF MEDT) all the necessary materials, including the list of differences with reasonably substantiated justification of the positions of the respective parties and proposals of the federal ministry (body, agency) duly attached.
Be such a case, the directives to the legitimate representative of the Russian Federation in the respective Board of Directors shall be duly formed by the RF MEDT in accords_
Interests of the Russian Federation in the Board of Directors of the respective OJSS shall be represented by persons duly elected to the said Board of Directors of the number of candidates duly nominated by the state.
It is therefore stipulated that the said representatives of the state in the Board of Directors of the respective OJSS shall vote on the agenda matters on the basis of the written directives of the FAFPA whose expressed duty it is to issue these directives with regard to matters as stated in sub-paragraph 1 (determining the priority directions in the activities of the respective OJSS) , sub-paragraph 2 (convening the annual and extraordinary general meetings of shareholders except for the cases when the target dates of convening such extraordinary general meeting of shareholders have not been duly observed or when holding of such extraordinary general meeting of shareholders has for such or other reasons not been allowed), sub-paragraph 3 (approval of the agenda of the general meeting of shareholders), sub-paragraph 5 (increasing the authorized capital of the respective joint stock society through placing by the society of additional shares within the quantitative and category confines of thus declared shares provided the respective Charter of this society, strictly in compliance with the law, refers this to the competence of the Board of Directors), sub-paragraph 6 (placement by the society of bonds and other emissive securities in cases as stipulated by the respective legislation), sub-paragraph 7 (determining the price [monetary estimation] of the property, the price of the placement and repurchase of the said emissive securities in cases as stipulated by the respective legislation), subparagraph 9 (forming of the executive body of the joint stock society and its pre-scheduled termination if such prerogative is referred to the competence of the Board of Directors by the Charter of this society), sub-paragraph 11 (recommendation with regard to the sizes and payment order for the respective dividends of the shares) and sub-paragraph 15 (approval of large deals) of paragraph 1 art. 65 of the Federal Law "On Joint Stock Societies" as well as on the matter of electing (re-electing) the Chairman of the Board of Directors.21 The Federal Agency for Federal Property Administration is entitled to issue to the respective representatives of the state in the respective Boards of Directors directives on other matters as well.
The said directives to the representatives of the state in the respective Boards of Directors shall be formed with due account taken of the said classification of all the OJSS with the respective federal share in their capital:
21 For the representatives of the state in the Boards of Directors of those joint stock societies which are included in the said special list, the question as mentioned in sub-paragraph 2 of paragraph 1, art. 65 of the Federal Law "On Joint Stock Societies", is not contained in the list of questions for which the respective directives are to be issued.
• joint stock societies included in the said special list - in accordance with the respective federal ministry (body);
• joint stock societies included in the said strategic list - based on proposals of the respective federal agency (body);
• other joint stock societies - independently but in case the respective federal agency (body) presents duly executed proposals, then with due account taken of such proposals.
As to the joint stock societies which are included in the said special list, should the respective federal ministry have the respective federal agencies under it, then such proposals, presented to the FAFPA, shall reflect a consolidated position of both the federal ministry itself and the respective federal agency subordinated to it for each particular question.
The federal ministry (body, agency) shall direct their proposals to the FAFPA within three (3) days since the date of receiving all the necessary materials but not later than twelve (12) days prior to the intended meeting of the Board of Directors. The said proposals may be duly prepared and directed to the FAFPA well in advance as based on the data obtained from the respective representatives of the state in the respective Boards of Directors. The federal agency (body) is entitled to direct to the FAFPA proposals for the agenda of Board of Directors' meetings of other joint stock societies as well.
Directives for the representatives of the state in the Boards of Directors of those joint stock societies which are included in the said special list, with regard to questions as mentioned in sub-paragraphs 1, 3, 5, 6, 7, 9, 11 and 15 of paragraph 1 art. 65 of the Law "On joint stock societies", shall be approved either by the Chairman of the RF Government or by the respective Deputy Chairman of the RF Government acting on the expressed instructions of the latter.
Draft projects of the directives for the representatives of the Russian Federation in the respective Boards of Directors prepared fully in accordance with the said Provisions, shall be presented by the MEDT to the RF Government not later than seven (7) days prior to the date of meeting of such Board of Directors.
It is assumed from the order of appointments and consequent activities of the respective representatives of the state in the Boards of Directors and the Auditing committee of the Open Joint Stock Society in whose regard a decision has been taken on using the special right for participation of the Russian Federation in the respective management (the "golden share"), that such persons shall be appointed by the RF Government, as recommended by the RF MEDT and prepared by the FAFPA fully in accordance with the respective federal agency (body). The opinion of the respective federal agency, at that, must be coordinated with the respective federal ministry under which it functions. Representatives of the state in the respective Boards of Directors and the Auditing committees of such joint stock societies exercise their authority on the basis of the FAFPA's written directives. Like in the case with the OJSS which are included in the said special list for the matters as pointed out in sub-paragraphs 1, 3, 5, 6, 7, 9, 11 and 15 of paragraph 1, art. 65 of the Law "On Joint Stock Societies", such representatives shall be approved by the Chairman of the RF Government or by the respective Deputy Chairman of the RF Government acting on the expressed instructions of the latter.
Besides, in accordance with the said Provisions, the federally owned OJSS shares handed over to the RF Ministry of Federal Property (RF MFP) for further selling, are subject to be transferred to the Federal Agency for Federal Property Administration within one (1) month from the date of introducing the respective changes in the RF MFP Charter with the exception of those shares which are subject to be handed over to the respective buyers 354
fully in accordance with the purchase and sale contracts concluded. The RF MFP is obliged then to present to the RF Government (annually, prior to March 31) a report on the management of the federally owned OJSS shares as well as on practical using the said special right for the Russian Federation to participate in the management of the respective OJSS (the "golden share").
The unitary enterprises. As to the unitary enterprises, in the spring of 2004, the new management of the Federal Agency for Federal Property Administration came out with an initiative to strive for transferring half of their net profits to the state budget motivating it with the fact that a number of such enterprises no more than just imitate modernization of production accordingly using the said profits for purposes off the main stream of their respective production activities.22 This initiative quite fits the previous proposals of the Accounting Chamber, made known in 2001 - 2002, on the necessity of transferring by the unitary enterprises of no less than 95% of their net profits to the state budget.
An alternative viewpoint, as expressed in this respect by top functionaries of the branch management bodies as well as by the representatives of the so called "directors corps", comes down in the long run to the proposal that the deduction of the profits normatives should be differentiated either by industries or by enterprises on an individual basis. Under the present conditions of a rather stable proficit, the budget does not seem to experience any acute need in such source of incomes and comparatively high normatives of the said deductions in the context of non-existent centralized investments may turn modernization of production quite a questionable matter, create incentives for artificial underestimation of profits, fake bankruptcy and so on and so forth. It makes sense to remind in this connection that it was relatively recently that getting the amount of the monies transferred to the state budget, to each federal public unitary enterprise (FPUE) followed with further approval of its program of activities by the respective federal property management body (prior to the spring of 2003 - by the RF Ministry of Property) in coordination with the respective curatorial ministry or department started to be practically implemented. The corresponding provisions were adopted by the RF Government Regulations No 228, dated April 10, 2002.
It was also confirmed by the new management of the FAFPA that such organizational and legal form as the FPUE should be retained but only in single cases (for example, when such an enterprise works in the interests of the state security or defense).
In practical terms, the major novelty in the property policies of the state in respect of unitary enterprises was the Decision of the RF Government No 739, dated December 3, 2004, "On the Authority of the Federal Executive Power Bodies to Exercise the Ownership Rights on Property of the Federal State Unitary Enterprises".
It was established that as regards the federal state unitary enterprises which are subject to be retained in the federal ownership or have been included in the forecast plan (program) of the federal property privatization, if the respective OJSS shares created through their respective transformation are planned to be contributed in the authorized capital of other joint stock societies or to be retained in the federal ownership, the respective federal executive power bodies then implement the following functions23: • approving the Charter of the enterprise (except for the respective federal public enterprises);
22
www.rosim.ru
23 As to other enterprises, the said authority is exercised by the Federal Agency for Federal Property Administration with due account taken of proposals from the respective federal executive power bodies.
• appointing Head of the enterprise, concluding, making changes in and termination of the respective labor agreement with such;
• measures necessary for ensuring due attestation of Head of such enterprise; - approvals necessary for giving employment to the Chief Accountant of the enterprise, conclusion of, making changes in and/or termination of such labor agreement with him/her;
• approving the program of the enterprise's business activities, determining the part of the enterprise's profits subject to transference to the federal budget;
• coordinating of large deals as well as those connected with granting loans, guarantees, banking guarantees, other burdens, concession to demands, transference of debts, making borrowings;
• coordinating business deals in which the Head of such enterprise is obviously interested;
• coordinating business deals connected with decision - making with regard to the respective contribution in the authorized capital of such economic societies or partnerships or with shares belonging to the said enterprise;
• coordinating of the respective affiliations and representations set ups;
• approving the reports of the respective financial accounting and of the enterprise Head;
• coordinating the decisions on participation of the said enterprise in both commercial and non-commercial organizations as well as on concluding of simple partnership agreements.
Decisions on coordinating business deals which are connected with handling contributions (shares) in the authorized capital of economic societies or partnerships as well as such shares which belong to the said enterprise, decisions on participation of such enterprise in both commercial and/or non-commercial organizations as well as on concluding simple partnership agreements shall be taken by the respective federal executive power bodies as mutually and duly agreed upon with the Federal Agency for Federal Property Administration. The latter must also be kept fully informed on decisions taken with regard to matters of coordinating large deals as well as those connected with granting respective loans, guarantees, banking guarantees, other burdens, concessions to demands, transference of debts, making borrowings within twenty four (24) hours from taking such decisions.
The business activities of such federal public unitary enterprise as well as the report of its Head shall be directed, within three (3) days since their respective approval, to the FAFPA which performs with regard to them:
• formal approval of the respective auditor and determination of remuneration for his/her professional services;
• coordination with due account taken of proposals from the respective federal executive power body which is responsible for this given enterprise and business deals connected with the real estate property;
• forming of the enterprises' authorized capital;
• formal approval of the transfer act or the separating balance when reorganizing such enterprise or the liquidation balance when liquidating such enterprise;
• concluding of, changes in and termination in the established order of the labor agreement with Head of the given enterprise beginning from the date of including of such enterprise in the forecast privatization plan (program) of the federal property except for the cases when the shares created through its transformation of the joint stock society, are planned to be contributed to the authorized capital of other joint stock societies or to be retained in the federal ownership.
Any decisions on establishing, reorganization in the form of dividing, singling out of FPUEs based on the right of economic operation, and transforming them into federal state enterprises as well as on changing the type of such enterprises into federal public ones, shall be taken by the RF Government. The respective draft project on its establishment and/or reorganization must envisage the aims, subject and main types of its business activities. Also, it is presented to the RF Government by the respective federal ministry, federal agency or federal service whose professional activities are under control of either the RF President or the RF Government, fully in accordance with the RF Ministry of Economic Development and Trade.
Reorganization of the FPUEs based on the said right of economic operation, in the form of merger and/or association as well as their respective liquidation shall be implemented by the decision of the FAFPA on the basis of the respective proposal from the federal executive power body under whose responsibility such respective enterprise is operating.
Liquidation and reorganization of such FPUEs which have been included in the list of the strategic enterprises or the strategic joint stock societies and approved by the Decree of the RF President No 1009, dated August 4, 2004, shall be implemented by the RF Government on the basis of the respective decision of the RF President.
When attesting Heads of such FPUEs functioning under the jurisdiction of the respective federal executive power bodies whose activities, in their turn, are under direct control of either the RF President or the RF Government, formation of the said attestation commissions shall be practically executed by the said bodies. As to the FPUEs which are under the jurisdiction of the respective federal executive power bodies which are subordinate to the federal ministries, the said attestation commissions shall be formed by the respective federal ministries.
The RF MEDT was duly instructed to approve (within a three month period since the date of the official publication of the said Regulations) a sample labor agreement with Head of such FPUE and a sample Charter of such FPUE established on the said right of economic operation24 as well as to present to the RF Government (within a two months period and in the established order) proposals on bringing the existing normative legal acts of the RF Government to conformity with this present Resolution.
Further changes. As to the practical aspect in the respective policies of the state with regard to its own property, rather noteworthy seems to be the fact that it was not too much later after the said list of the strategic enterprises and the joint stock societies was officially approved in August of 2004, that it became the subject of certain changes.
Most notable of them was exclusion from this list (by the Decree of the RF President No 1502, dated December 7, 2004) of the "Rosneft Oil Company" OJSS as connected with adoption of the GR Government's proposal to include 100% of this federally owned joint stock society's shares as a contribution of the Russian Federation into the authorized capital of the "Rosneftegas" open joint stock society which only added to the strategic OJSS list. It is also to be reminded here that the state's initial intention was to exchange the "Rosneft" for 10.7% of the "Gasprom" OJSS necessary for consolidating the control package of the gas holding in its property which, in its turn, permitted to liberalize the respective market of the "Gasprom" shares without any damages brought to the majority control over the company. As to "Rosneftegas", its creation was intended to serve as a temporary eco-
24 It is quite noteworthy that the present Sample Labor Agreement with Head of FPUE and the Sample Charter of such FPUE were officially approved rather recently - by the orders of the RF Minimushestvo NoNo 6946-p and 6945-p, dated December 11, 2003, respectively.
nomic entity whose framework would enable functional exchange of the respective assets. A new element appeared in the position of "Gasprom" while preparing for such a maneuver, which came down to a simple fact that 100% of the "Rosneft" shares will not be enough for the state to acquire the "Gasprom" package of shares of the desired size and that some other assets should be added to this, for example, the "Zarubezhneft" RFTS FPUE whose turning into a OJSS was started as far back as the spring of 2004. Further perspectives of the said "Rosneftegas" OJSS (after the 'Yuganskneftegas" OJSS has been purchased by the "Rosneft") indeed seem to be rather uncertain.
In addition to the "Rosneft" OJSS, fully in accordance with the Decrees of the RF President No 1483, dated November 29, 2004, and No 41, dated January 19, 2005, respectively, twelve (12) unitary enterprises and eight (8) joint stock societies of the machine-building and defense industries were also excluded from the said lists of strategic enterprises. Instead, the "RIA - Novosti" Russian International Information Agency was included into such list of strategic enterprises by the Decree of the RF President No 1470, dated November 22, 2004.
Apart from a possible merger of "Gasprom" and "Rosneft" (through skilful maneuvering with the state owned assets of these two corporations which, because of their substantial scale and size, were of a general national significance), quite noteworthy are the plans of the RF Government, made publicly known in February 2004, to amalgamate by the end of this year the "Pulkovo" FPUAC (the third largest air carrier in the country) and the "Russia" State Transporting Company (GTC) into one unitary enterprise dealing in air shipping. However, because of the ongoing administrative reform, the said amalgamation project was stopped and another confirmation that such amalgamation would indeed be completed appeared only in the autumn months. The current plan is that practically all of the respective GTC stock (except for the property necessary to ensure carriage of the country's first persons) shall be passed over to the new company. As well as the assets of the "Pulkovo" FPUAC not connected with the airport business. This may very well lead to the appearance of the second large air-carrier after the "Aeroflot - Russian Avialines" OJSS. True, early in the year of 2004, there were rumors about possible including in the said structure of the "Kavminvodyavia", the "Dalavia" and a number of other public unitary air carriage enterprises.
Thus, analysis of the property policies of the state in the area of the federal property administration in the year of 2004 permits to make the following conclusions.
The respective normative - legislative basis has been significantly renewed; the legislative gaps at the junction with the respective privatization and insolvency legislation have been successfully liquidated; presence of at least three lists (the special, which has not yet been published, the strategic and the specific insolvency regimes) of companies with different degrees of the property control (e.g., economic societies and unitary enterprises) with regard to which the state applies a special regulation, in fact, means nothing but early stages in forming a particular legal field for the enterprises of the state (public) economic sector. Hence, it remains rather unclear where the said lists of the joint stock societies, contained in the respective supplements to the "Regulations on the Rights of the Russian Federation as a Shareholder" (2001), really fit the system.
An additional functional quality in the capacity of a new subject of the property policies with regard to the state economic sector enterprises was acquired by the RF Ministry of Economic Development and Trade which is now called upon to act as a sort of an arbiter between the Federal Agency for Federal Property Administration (FAFPA) and the branch management bodies in many managerial aspects of the economic societies with such or other degree of state participation in the capital and the respective unitary enterprises. In 358
practical terms, there are certain indications that the trend towards enlargement of the state sector enterprises through their integration, which appeared in the year of 2000, is still going on. Although concrete implementation of such projects, as but too often demonstrated in real life (for instance, certain enlargement plans for the military and industrial complex, absorption of "Rosneft" by "Gasprom", etc) in the long run seems to be quite problematic.
4.2. Ownership Rights Protection and Collapse of YUKOS
In the period between 2000 and 2004, the RF Government expanded its influence on ownership rights, attempted to establish (expand) control over major cash flows in the Russian economy and, more generally, made efforts to make the Russian business community dependant on public institutions in spite of decisions on economic deregulation and further privatization25. Such policy is most likely to result in creating a "state capitalism" model (keeping in mind conditionality of this term) which is distinguished by a combination of the following elements :
• strengthening (widening the scope of application) firmly standard elements of public entrepreneurship, which seems to be viewed as a component providing the national interests of Russia (which is quite arguable) ;
• creating favorable (or at least neutral) conditions for a small group of loyal companies, including private ones, which have gained a reputation of "government supporters" and based themselves upon a highly centralized state machine which is subordinate to the RF President (including law making structures and judicial authorities) ;
• applying (selectively) demonstratively punitive actions (represented by administrative and criminal cases) against powerful economic subjects which fail to suit the model under construction ;
• asymmetry of goals and approaches. The goals which have been assigned, most of them quite reasonably, with a view to regaining assets, making property structures transparent, returning profit centers to Russia, abolishing ineffective tax schemes, etc., are being implemented by using approaches which have nothing to do with such issues, rather than making reforms in the relevant sectors ;
• making distinctions between the national interests of Russia and the principle of private property integrity.
Though the foregoing trends developed as the new order strengthened itself throughout the entire period of 2000 thru 2004, the YUKOS case of 2003 - 2005 became a point of reference for understanding a full picture of ongoing processes. Obviously, the case should be interpreted in terms of creation of public "centers of power" in the strategic industries (GAZPROM - ROSNEFT - YUGANSKNEFTEGAZ - power supply industry), public control over resources of the Eastern Siberia where YUKOS used to be quite powerful26, geopolitical aspects (selection of pipeline options between China and Japan), etc., rather than the collapse of disgraced tycoon's empire (YUKOS). Such interpretation provides a better picture of the real criteria to be relied upon in developing a concept of "partnership between the state and the business" which is currently so popular among senior public servants.
25 For more details please refer to Radygina A. Russia in 2000 - 2004 : The Way to State Capitalism? // Voprosy Ekonomiki. 2004. No. 4. p. 42 - 65.
26 It is only in 2005 - upon the sale of YUGANSKNEFTEGAZ to a state-owned company - when the government has brought up the issue of multifold increase of budget allocations on geologic exploration and eastward reorientation of the industry from the Western regions of Russia. A series of license auctions on natural resource development in this region are expected to be held in the long term. However, it is public companies that are to be granted preferences at these auctions.
The model under construction can be better pictured from the point of view of a series of "small" effects that emerged in the YUKOS case to become a general alarm signal for major businesses in Russia. In 2003 the experts were mostly interested in real motives of the government in the YUKOS case, while in 2004 they focused on other aspects. It is almost obvious that YUKOS will not exist in the way it did until late in 2004, and the company will continue to break up in 2005. In regard to M. Khodorkovsky and other shareholders and staff members being under arrest in Russia, there is probably no way to achieve compromise like "property in exchange of freedom"27. In spite of all procedural costs involved, major criminal cases will be brought to their final judgment which is unpredictable as it will depend not only on the provisions of the RF Criminal Code. In general, it is the unbiased assessment of strategic effects of the YUKOS case for the Russian economic and legal systems that will matter, rather than destiny of the company itself and its owner28. More importantly, potential impacts of the YUKOS case have recently been emerging.
4.2.1. Selling YUGANSKNEFTEGAZ
It is our opinion that the sale of YUGANSKNEFTEGAZ, basic YUKOS's oil producing asset, in December 2004 (refer to Annex) is one of the most alarming signs for the Russian business .
According to the history of YUGANSKNEFTEGAZ, the provisions of RF Law "On Execution of Legal Process" were sufficient to take control over the company29. In particular, RF Federal Law "On Execution of Legal Process" provides no prohibition of preferential forfeiture and sales of shares of a company integrated into a holding company. The order of forfeiting debtor's property is supposed be determined unilaterally by an officer of justice who is entitled to discretionary conceive debtor's specification of the property to be forfeited first. Altogether, this creates conditions for abuse of power by law enforcement officers in executing legal processes, as well as provides for a case when a single person is empowered at his own or any other government entity's discretion (including the government itself) seal fate of a major company. The sale of YUGANSKNEFTEGAZ also demonstrated that the applicable law enforcement process is not only far from being perfect but also selective thus violating the principle of equality before the law and justice, i.e. one of the fundamental principles of the RF Constitution.
The sale of YUGANSKNEFTEGAZ had an ambiguous effect. Referring to the chronicle of events specified in Annex, the stock market responded by some growth. Furthermore, as seen in Section 4, empirical data provide no support for the prevailing opinion that the Russian stock market was driven to London by the risks caused by the YUKOS case and political and economic uncertainty in Russia . Indeed, the conflict concerning YUKOS oil company created concerns of non-residents about protection of their participation in Russian companies. This factor, however, caused no capital outflow from the MICEX to London because a share of non-residents trading in Russian shares at the MICEX is insignificant. More likely the YUKOS case had an adverse impact on volatility of trade volumes of depositary receipts at the London Stock Exchange which fluctuated substantially on a monthly basis.
However, almost all stock market analytics point out that foreign investors and business community at large have a more negative perception of Russia. In addition, the following aspects should be taken into account in this respect: (1) the current situation in the
27 The staff members have a chance to achieve the freedom-in-exchange-of-information compromise.
28 However, the YUKOS case should be broken down into two components from the very beginning: claims on the company and legal prosecution of its owners as physical bodies.
29 YUKOS still remains in business, as was promised at the top governmental level in fall of 2004.
Russian "domestic" stock market is commonly assessed as fairly speculative and poorly relying on the fundamental parameters of the Russian economy; (2) the fact that basic risks related to YUKOS case were created by investors as early as 2003. The latter is fully supported by the data on comparative movement of stock indices. For example, the RTS index and the MICEX index grew by only 7% at the background of a general growth by 18% in the consolidated stock index of emerging markets in 2004 , while in 2003 the consolidated stock index of emerging markets and the RTS index and the MICEX index showed nearly similar growth, correspondingly by 52, 58 and 61% (Table 4).
Table 4
Changes in Priorities of Foreign Portfolio Investors
1997 1998 1999 2000 2001 2002 2003 2004
Emerging markets consolidated -13 -28 +64 -32 -5 -4 +52 +18
stock index, %
RTS stock index, % +98 -85 + 197 -20 +98 +34 +58 +7
MICEX stock index, % - - +77,6 -4,7 +65,5 +34 +61,6 +7,3
Note. In 2004, incremental growth in the stock market in Russia came to be close to zero, while other countries - raw materials exporters - demonstrated different results: Venezuela +52%, Indonesia +47% , Mexico +36%, Republic of South Africa +35% . According to the IIF (21 countries in January 2005), private investment inflow to the emerging markets grew by 32% to reach its maximum in 2004 since 1997 ($279 billion). Source: according to the data of Vedi analytical laboratory (seminar on "Changes in the Russian Economy", Higher School of Economics, January 26, 2005); Institute of International Finance (IIF); authors' estimates .
Moreover, assessments of the "input" of the transaction with YUGANSKNEFTEGAZ's equity and the YUKOS case in overall investment process in 2004 are quite ambiguous. This is due to different approaches employed at various socio-economic institutions. On the one hand, almost all liberals, including senior government executives, expressed their negative attitude towards the transaction in terms of violation of ownership rights, creating unfavorable investment environment, collapse of confidence in the government, moving towards an autocratic regime, etc. The arrest and sales of YUGANSKNEFTEGAZ were directly associated with (drastic) deterioration of the investment climate in Russia and increased capital outflow (export)30 in 2004. A regular polling by Expert analytical center of 50 top managers of the western investment banks, companies and funds operating in Russia, revealed less importance of such factors as investment attractiveness as law enforcement, protection of ownership rights in general and those of minority shareholders in particular, enhanced administrative pressure upon the business community and corruption31. A monthly polling conducted by the Association of Managers of Russia (in January 2005)32 revealed the following distribution of answers to the question of the reasons for capital outflow from Russia in 2004 : 47% - poor protection of ownership rights, 38.6% - the YUKOS case, 14.5% - search for new investment objects, 1.2% - USD fall, 1.2% - the summer (2004) banking crisis.
On the other hand, there were some positive assessments as early as 2005. For example, in February 2005, according to Standard & Poor's, one of the most conservative rating agencies, ranked "B-" for Russia with "stable" forecast (with the proviso, however, that political decisions and actions of regulatory agencies are unpredictable), which provides for investments from long-term conservative investors. In spite of deteriorated in-
30 According to A. Illarionov, adviser to the RF President, specified $27 billion of "capital export" in 2004 against $10 billion in 2001 . The Deputy Minister of Economic Development and Trade A. Sharonov specified four-time growth in "capital outflow" in 2004, but his total amount is more moderate, $8 billion.
31 Shokhina E. Investors Feel Uncomfortable in Russia // Expert. 2005. No. 4. p. 43.
32 According to the data of the Association of Managers of Russia (www.amr.ru).
vestment environment for a certain part of business community, the RF Ministry of Economic Development and Trade has forecasted investment demand in 2005, which may potentially be created in high-tech industries and aircraft industry. Nevertheless, credit balance deficit of net foreign capital inflow is expected in 2005 as it was in 200433. The Expert's analytics also provided a fairly optimistic forecast of a new wave of economic growth as based on interpreting the data of the Russian Agency for Statistics on investments in fixed assets in 2004. They believe that there were two basic factors that worked for animation of investments in 2004: the government made its intentions more clear and transparent in regard to YUKOS and the economy at large (the government intends to gain control over the sector of raw materials exports as well as get "compensation" from the "first wave" tycoons who got hold of their assets on the tide of uncivilized privatization, which made a clear picture of most risky political areas as well as those economic areas under minimum risk: small and medium-size businesses, high-tech industries, consumer sector), and substantial amount of idle funds in the economy34.
There is another unique material aspect which is worth mentioning. The transaction with YUGANSKNEFTEGAZ's equity demonstrated clearly that there was a, putting it mildly, foreign economic issue (or the most important task) about the entire YUKOS case. This was evidenced by a fairly contradictive and poorly designed process of establishing a public oil company on the basis of GAZPROM OJSC.
The idea of setting up a public oil company (conditionally GOSNEFT) was discussed as early as at the beginning of the 2000'. This company (if established) was supposed to become a foothold for more active participation of the government in the industry along with consolidation of all remained state-owned assets in this industry. As early as 2003, the hypothetic GOSNEFT (on a par with ROSNEFT and SURGUTNEFTEGAZ) was considered by analytics as a candidate manager of the nationalized package of YUKOS's equity in the name of the government.
In 2004 this idea was implemented in practice. In spite of a relatively wide range of options of increasing public share in GAZPROM OJSC's equity, the final choice was made in favor of combining assets of a series of companies with government participation. In September 2004, a future acquisition of JSC NK ROSNEFT was announced - exchange of 100% OJSC ROSNEFT's shares for 10.47% "treasury" stocks of GAZPROM OJSC available on the balances of its subsidiaries (presumably 4.83% of GAZPROM's shares are on the balance of Gazprominvestholding, 3.64% - Gazprombank, 1.5% - gas producing enterprises, as well as 1.74% out of 4.58% shares owned by Gazprom Finance BV). On November 1, 2004, the Chairman of the Board of GAZPROM OJSC signed an initiator's decision on establishing LLC GAZPROMNEFT with a 100% participation of GAZPROM. Director of ROSNEFT35 S. Bogdanchikov was appointed as the Director General of the company. Oil and gas condensate production, transportation and storage were supposed to be core business of the company.
As far as we know, the following scheme was officially approved by mid- December 2004 :
• the Russian Federation establishes JSC ROSNEFTEGAZ in the name of an authorized body and invests 100% shares of JSC NK ROSNEFT owned by the federal government in its authorized capital ;
33 Press conference of A. Klepach, Head of Macroeconomic Forecast Department under the RF Ministry of Economic Development and Trade February 1, 2005 . (www.economy.gov.ru).
34 The worse is behind. Editorial // Expert . 2005. No. 4. P. 11.
35 Data from official website OJSC GAZPROM www.gazprom.ru. The issues of corporate risks and assessment of combined assets are not considered.
• OJSC GAZPROM'S subsidiaries transfer 10.74% of GAZPROM OJSC shares owned by them to LLC GAZPROMNEFT's balance ;
• JSC ROSNEFTEGAZ transfer to LLC GAZPROMNEFT 100% shares of JSC NK ROSNEFT in exchange for 10.74% of OJSC GAZPROM's shares.
Implementation of the scheme was started late in 2004. The Russian Federation established JSC ROSNEFTEGAZ. On December 7, 2004, the RF President issued a Regulation in which he excluded JSC NK ROSNEFT36 from and included JSC ROSNEFTEGAZ into the list of strategic enterprises and joint stock companies, as well as ordered to accept the proposal of the RF Government to invest 100% shares of JSC NK ROSNEFT owned by the federal government in the authorized capital of JSC ROSNEFTEGAZ.
The scheme of establishing a public energy giant was supposed to be finalized by purchasing a block of stocks of YUGANSKNEFTEGAZ by GAZPROMNEFT (and consequently making the former a subsidiary to GAZPROM OJSC) at an auction to be held on December 19, 2004. However, it encountered a strong opposition of YUKOS shareholders (refer to Annex) and failed: in order to avoid potential legal risks abroad, OJSC GAZPROM had to sell 100% of its participation in LLC GAZPROMNEFT to unknown persons which are not affiliated to JSC GAZPROM. ROSNEFT OJSC won through an intermediary which assumed all risks at the auction, thus increasing its capitalization by several times.
Further prospects of merging oil assets of GAZPROM and ROSNEFT or making the government a majority shareholder of GAZPROM OJSC still remain uncertain. In spite of large financial liabilities arisen from transactional payments (existing debts plus debts related transactional financing and debts due to YUGANSKNEFTEGAZ), ROSNEFT OJSC may become a leading player in the petroleum industry (such position is enhanced by major contracts on oil supply to China till 2010). However, various options are possible: a 100% integration of ROSNEFT into GAZPROM OJSC without a block of shares of YUGANSKNEFTEGAZ; exchange of shares between GAZPROM OJSC and ROSNEFT considering the value of the latter (GAZPROM OJSC may come to have a minority share); establishing direct control over GAZPROM - ROSNEFT - Baikal Finance Group -YUGANSKNEFTEGAZ; and unconditional refusal of merger.
For example, according to the option of the RF Ministry of Industrial Energy, it would be expedient to transfer YUGANSKNEFTEGAZ's assets from a corresponding joint stock company to an independent company owned (100%) by the government (it could be previously established ROSNEFTEGAZ). Twenty percent of shares of the new company may be sold to CNPC (China). GAZPROM should acquire ROSNEFT without participation of assets of YUGANSKNEFTEGAZ. It is obvious that this scheme is intended to prevent legal risks abroad: the new public company may become an oil supplier to the domestic market, ROSNEFT will become the key public oil exporter after integration into GAZPROM37. On January 19, 2005, А. Miller, Chairman of the Board of GAZPROM OJSC, announced that development of the merger scheme of GAZPROM and ROSNEFT, which reportedly makes no provision for including YUGANSKNEFTEGAZ's assets, had been completed and packages of stocks would be exchanged at the end of January 2005. However, early in Febru-
36 JSC NK ROSNEFT was included into the list of strategic enterprises and joint stock companies by a Decree of the RF President "On Approval of the List of Strategic Enterprises and Strategic Joint Stock Companies" of August 4, 2004 No. 1009. Strategic enterprises and joint stock companies must not be privatized unless they are excluded from this list as provide for by Federal Law "On Privatization of Public and Municipal property" of 21 December 2001 , No. 178 - FL.
37 This option was presented by D. Medvedev, Head of RF President's Administration on December 30, 2005 (see : YUGANSKNEFTEGAZ Is Designated a Great Public Future // Kommersant. January 11, 2005). The option of the RF Ministry of Economic Development and Trade presented in January 2005 by G. Gref (privatization of ROSNEFT and YUGANSKNEFTEGAZ), as well as the option of A. Illarionov, Advisory to the RF President, (YUGANSKNEFTEGAZ remains with YUKOS) are very unlikely to be applied in practice.
ary 2005, the idea of ROSNEFT independency and its transformation into a major public oil exporter was reanimated again (in this case, YUGANSKNEFTEGAZ would remain integrated into ROSNEFT). According to this option, GAZPROM would not acquire 100% of ROSNEFT. Instead, "treasury" shares of GAZPROM would be assigned to the government in exchange for the minority share in independent ROSNEFT 38.
Ultimately, three basic criteria should be relied on in selecting other options: the government should obtain a controlling stake in GAZPROM OJSC; key participants in the events associated with YUGANSKNEFTEGAZ should be protected from legal risks (on the part of the purchaser) ; the balance of influences and interests in the RF President's Office and its projection on GAZPROM and ROSNEFT should be maintained. Such balance is most likely to determine a critical decision regardless of whether ROSNEFT is going to become an independent oil player. It is our opinion that this is the main challenge which governs, first, prevalence of foreign economic criteria in planning acquisition in prejudice of corporate interests (both for GAZPROM OJSC and ROSNEFT); second, incompetence in take-over represented by using illegal techniques, especially in estimating purely economic effects and risks; third , it is necessary to make responsible decisions (which are worth billions of dollars and reputation) in the "fire-squad" mode. Responsible strategic decisions, for which parties have to get prepared over years in common world practice, are made and revoked within several hours subject to the current political situation and quite a flexible balance of administrative influences.
4.2.2. Economic Rent, Licensing and Fiscal Policy
The issues of economic rent and fiscal policy are fundamental. The YUKOS case of 2003 - 2004 is most likely to have impact on this field. There are two interconnected trends that are worth mentioning.
On the one hand, the large Russian businesses demonstrated their almost unanimous tolerance (absolutely demonstrative though) to various government's innovations and "goodwill" in relation to tax load (in 2003, a series of oil companies declared that they would employ no tax minimization schemes, in 2004 LUKOIL announced a "voluntary" decrease of gasoline prices by 5%, etc.). The subject of "corporate social responsibility" became a popular topic for discussions. However, the idea of such subject seems to be quite cloudy for any business organization which pays all taxes in good faith.
At the same time, in the period between 2003 and 2004, the business community found itself to be able to protect its interests with the government. In fact, the existing business associations (RSPP, OPORA Rossii, Delovaya Rossiya, etc.) accepted the rules of the game and acted as applicants rather than independent political force.
In the 90', the mechanism of relationship between large businesses and the government was distinguished by the possibility for major financial and industrial groups to directly participate in developing and imposing upon the government vital political decisions which surely served for the benefit of these groups. The 2000' saw quite an opposite situation, when the government began to deliberately disregard the interests of private business in general and enforced new rules of the game to be observed by the business community through a wide range of enforcement techniques. The YUKOS case draw a line under the era of "tycoons". However, one cannot but take into consideration that pursuing the policy of "state capitalism for insiders" may logically create the situation of the 90', because the model under construction means that new potential "tycoons" may emerge.
38 Press conference of S. Oganesyan, Head of the Federal Agency for Power Engineering (member of the Board of Directors of ROSNEFT, former vice-president) on February 1, 2005 . (www.lin.ru).
"At present, there are two interdependent forces existing in the country, each climbing to power. One is represented by advocates of capitalism, i.e. a party of governmental bourgeoisie. It is currently being in power, alone. Obviously, there should be another party of independent bourgeoisie, business "39. Establishing a political party to represent the interests of the Russian independent bourgeoisie (not only large business) would be a civilized option, but such party is very unlikely to emerge at the present time. In addition, one should understand whether there is any business in this country which is totally independent from the government, and what are the chances to establish a true political party rather than a dummy one. The existing business associations are unlikely to fit this role.
On the other hand, the government continued its policy aimed at tightening " the rules of the game " for large businesses in 2004 and early in 2005. Late in 2004 and early in 2005, practical testing of the "tax arrears compensation "40 extra-bankruptcy schemes was accompanied by introducing a series of tax innovations in regard to business. Though some of the rules seem to be quite positive, that is not the point. It is our opinion that the measures discussed at the beginning of 2005 (rationalizing tax audit mechanisms, regulating transfer costs in the RF Tax Code, making confiscation amendments to the RF Criminal Code, imposing restrictions for offshore companies at natural resources auctions, etc.) were too alien in terms of expected effects to be conceived as a reasonable and comprehensive system of measures.
In substance, the only proposal that was found favorable for the private business was an initiative of the RF Ministry of Finance presented on February 8, 2005 at a meeting on rationalizing tax audit mechanisms chaired by the President of the Russian Federation. It was proposed to approve a full list of documents requested for the purposes of tax audit; to establish a fixed number of tax audits for a certain period; to approve large amounts in arrears by superior bodies; to perform additional tax audits only in exceptional circumstances41 ; and to set up a special body to consider conflicts arising during tax audits.
The issues of tax amnesty (especially establishing a limited period to make additional tax payments) are not considered by the government. Instead, the RF President made an amendment to the RF Tax Code (in January 2005) allowing the RF Federal Tax Service to collect tax penalties (from legal entities and physical bodies) without any judgment.
In January 2005, (upon five years of discussion of this issue at different levels) the RF Ministry of Finance submitted a package of draft amendments to Article 20 and 40 of the RF Tax Code on regulating market prices (transfer pricing) for taxation purposes . In particular , they determine specific features of interdependent entities and principles of pricing of goods, works and services for taxation purposes, as well as circumstances when additional tax payments should be made in case of transfer prices overshooting the market ones, etc.
There is a point of view that the idea of such regulation is insignificant for the time being due to introduction of fixed tax rates in RUR for oil companies, the use of export duties and other methods of skimming of excess profits, and liquidation of internal offshore companies. The idea, however, is not rejected, since it is widely employed in the world practice, and transfer prices are used in a variety of other industries. The fact that transfer prices are employed not only for tax evasion but also simply for optimizing the management system
39 Rodionov I., Need for a Swing // Expert . 2004. No. 35. P. 42.
40 We believe, however, that other well-known (by mid- February 2005) major claims by the Federal Tax Service on large companies (Sibneft, Vympelkom, Dalsvyaz) should not yet be bracketed with the YUKOS case. These cases along with a variety of other ones may be based on quite different motives: from execution of duties in good faith to settlement of accounts between senior government officials and a company, trivial incompetence or intention to prove political loyalty.
41 It were additional (second) tax audits that caused basic additional tax payments with regard to the YUKOS case.
within a group of companies, creates a serious problem which can not be settled legislatively. This is accompanied by another objective problem which lies in the fact that, on the one hand, it is impossible to determine legislatively all types of interdependence and hence is subject to judicial decision. On the other hand, according to the practice, courts are not qualified to provide judgment to such specific issues, while it is not only availability of precedents but also effective and non-commercialized judicial system at large that is critical for identifying specific features of interdependence "according to other grounds". The foregoing problem will also be encountered by tax agencies in making decisions on additional tax payments, because it is extremely difficult to determine price "deviations". Therefore, a new material risk of subjectivity is arising in the context of relationship between the government and the business in relation to the latter. Another material risk is represented by emergence of a new tool of exerting pressure upon competitors by using administrative mechanisms.
Amendments to the RF Criminal Code (Article 104.1) proposed by the RF President at the beginning of 2005 may be become another serious innovation . Virtually, the question at issue concerns restoration of "forfeiture" regulations which were excluded from the RF Criminal Code on the initiative of the RF President as early as 2003. Forfeiture is expected to be applied to all types of criminal offences, and provision is made for forfeiture of property for the benefit of the government. It may also include:
• earnings and revenues generated from criminally made property (in order to confiscate all assets of a company, it is sufficient to prove a criminal origin of the initial "million" of a capital or unlawfulness of privatization transactions) ;
• property intended to finance organized criminal groups or criminal activity (it is well known that YUKOS's principal shareholders were also accused of creating such a group) ;
• property assigned by a convicted person to other person, provided that the latter has evidence to suggest that it has been obtained by criminal activity (in January 2005, M. Khodorkovsky announced that he transferred 59.9% shares of MENATEP Group to other shareholder, L. Nevzlin42. According to the estimates, such innovation allows even wages of employees of a company to be seized assuming that they suspect the management of criminal actions)43.
Adoption of a revised RF Law "On Mineral Resources" is an essential factor of government's attitude towards economic rent and the related issues of strengthening public control44. The following key issues were considered in 2004: participation of local governments in distributing rights to mineral resources (this is specified in the Constitution of the Russian Federation), searching an alternative to licenses (for example, "exclusive right to utilize the area of mineral resources" purchased at an auction), terms and conditions of granting rights to mineral resources, and geologic exploration issues. Most likely a concessionary mechanism of mineral resources utilization is going to be introduced to impose restrictions on private sector operations in this field. In 2004, however, licensing was used
42 50% of shares of Gibraltar MENATEP Group are allocated in a special trust. M. Khodorkovsky was its manager and beneficiary prior to the legal against YUKOS. L. Nevzlin became a beneficiary of the trust (under the terms and conditions of the trust) upon M. Khodorkovsky was put under arrest in October 2003. L. Nevzlin was granted the right to dispose 50% of shares in trust according to the terms and conditions of the trust upon the loss of the principal asset - YUGANSKN EFTEGAZ - on December 19, 2004 . Certain rights to 9.5% of shares held by M. Khodorkovsky were transferred directly L. Nevzlin in addition to the shares in trust.
43 Refer to : Tightening // Trade secret. February 7 thru 13, 2005. P. 8 - 9.
44 RF Law "Mineral Resources" of February 21, 1992. No. 2395-1 is currently effective. Latest updates of June 29, 2004, No. 58- FL and August 22, 2004 , No. 122- FL were related to the changes caused by adoption of a series of other laws and made no changes in the previously accepted approaches.
quite extensively as a mechanism of public regulation in oil and gas sector (both for the purposes of direct redistribution of control and trivial competitive pressure). In doing so, however, no transparency of procedures and claims was provided. According to the RF Ministry of Natural Resources, 50 out of 110 examined license agreements were revoked in 2004 .
A proposal of the RF Ministry of Natural Resources 45 to tighten the procedure allowing extractive companies to participate in field development auctions became an innovation at the beginning of 2005. This means that offshore companies will be excluded from the list of participants in future auctions as a soft option, or licenses of these companies will be revoked46 as a hard option. Unconditional registration of at least subsidiaries of foreign (foreign de jure and Russian de facto) offshore and other holding companies in the Russian Federation is proposed as the only alternative, while transparency of ownership structure and tax and judicial jurisdictions of the Russian Federation are presented as a positive effect. Such initiative also provides an ambiguous character.
Historically, (the end of the 80' with abolished foreign trade monopoly thru the first half of the 90') offshore companies were registered in the name of real owners, relatives, front parties, etc. The most commonly used scheme didn't seem sophisticated: Russian company is offshore holding. However, the fact of holding these shares (of foreign companies) was a violation of the Russian Law. In a sense, the modern Russian law on affiliated entities (groups of entities) evolved mechanically from the simple schemes that used to be employed in the 90', which are practically outdated. The shares of many offshore companies were then transferred to "non-name" trusts (the simplicity of this scheme was assessed relatively later). The scheme is currently typical of a the overwhelming majority of large enterprises (groups). Such "innovation" in creating non-transparent ownership structures and deriving tax-free revenues from property is linked to a gradual recognition (by many Russian majority shareholders) of multiple advantages: tax benefits, political risk protection, inheritance security, manipulation (switch) with assets/blocks of shares for construction (reorganization) of their corporate groups, etc. According to the assessments available, it is "non-transparency" of an offshore for law enforcement agencies of a nonresident (i.e. "insecure" rating according to Financial Stability Forum) that is most important criterion in selecting a jurisdiction.
Offshore companies (established both by Russian physical bodies and legal entities) were booming in the period between 1992 and 1995. Late in the 90', the number of Russian offshore companies in foreign countries accounted for tens of thousands (there is no exact data available). Nearly 2000 companies were established annually. Geography of foreign offshore companies used by Russian physical bodies and companies is quite ample. There are countries that were preferred most. For example, as of 2002, 8% of GDP of Cyprus fell at offshore companies, including 60% ones of Russian origin. A total of over 52 thousand offshore companies were incorporated in Cyprus at that period. From 18 to 25 thousand companies (i.e. up to 40%) belonged to Russian residents, according to various assessments. Cyprus-based offshore companies were widely used by stock market participants, insurance and trade companies as well as for assets protection on the basis of sophisticated schemes. Many large Russian companies utilized offshore companies incorporated in Gibraltar, British Virgin Isles, holding companies at Denmark, Luxemburg, Netherlands, etc. There were several scandals associated with offshore companies estab-
45 A report of the RF Minister of Natural Resources Yu. Trutnev at the State Duma on February 11, 2005 .
46 In this case , foreign (offshore) companies, groups, groups of entities (according to the terminology of the RF Ministry of Natural Resources) mean companies in which participation of Russian residents accounts for not less than 51%.
lished for money laundry. The offshore mechanism is typical of the banking sector of Russia .
It is not for the first time that the issue of tightening the treatment of offshore companies has been brought up47. Attempts to interpret the "real owner" concept as applied to banks and amendments made to RF Law "On Banks and Banking Business" in terms of restricting a share of offshore companies in authorized capital of Russian banks up to 10% (in 2003 thru 2004) are worth mentioning. At the beginning of 2005, the RF Ministry of Finance put forward an initiative (corresponding amendments were made to the RF Tax Code) on additional tax payments due by companies with offshore management (i.e. in cases when a group have a management company in offshore zones located in foreign countries). The latest innovations of the RF Ministry of Natural Resources will be indisputably positive from the point of view of making transparent the information on ownership structure and beneficiaries. However, both world and Russian practice shows that legal requirements alone will bring no positive general economic effect unless supported by "confidential relations" (this classic term of a new institutional theory is appropriate here as never before) and effective international cooperation.
4.2.3. International Expansion Boundaries
There was another essential trend that emerged in regard to the YUKOS case: boundaries of international expansion of Russian corporate groups were determined quite explicitly, especially those based on extracting industries of the economy. The divide line is most likely to be represented by trans- or multinational nature of possible strategic international business alliances.
Drastically enhanced ownership-driven expansion of the largest Russian groups in foreign countries, which is typical of the period of 2004 - 2005 , has been faced no restrictive counter measures yet. As an example we refer to attempts made by a series of major oil companies in keeping industrial vertical "fixed" on the consumer (by purchasing oil refineries and gas station chains in foreign countries, etc.): NORILSKY NICKEL in gold mining, SEVERSTAL with Canadian Stelco and Italian Lucchini and other ferrous metallurgy companies, BAZOVY ELEMENT with aluminous production enterprises, SUAL with a variety of projects in non-ferrous metallurgy, telecommunications and diamond production business, etc.
In doing so, however, any options of including foreign companies into the list of principal shareholders of the largest Russian extractive-industry groups are subject to approval by the government. Recently, all major transactions related to purchase of Russian assets by foreign companies are subject to be submitted to the RF President for preliminary consideration (TNK-BP in 2003 , Silovye Mashiny and Siemens, LUKOIL and Conoco-Phillips in 2004). Most likely such approval was also needed by ROSNEFT to obtain a loan from a syndicate of Chinese banks to the amount of $6 billion, which will be repaid by oil supplies to CNPC, Chinese oil company (48,4 million tons till 2010). According to the estimates, this loan was obtained to effect settlements on YUGANSKNEFTEGAZ48, though ROSNEFT doesn't consider this transaction a loan and specifies that the funds are in-
47 Refer to, for example, : Apel A., Gunko V., Sokolov I. Cashing and Offshore Business in Schemes. St.Petersburg : PITER , 2002 ; Kabir L.S. Organizing Offshore Business. M.: Finances and Statistics, 2002; Ushakov D.L. Offshre Zones in Practice of Russian Taxpayaers. M.: Yurist, 1999; Radygin A. Disclosing Information on Beneficiary Ownership // Records of an OECD "round table" on corporate management. Moscow .
October 2 thru 3, 2003 .; Behind the Corporate Veil. Using corporate entities for illicit purposes. Paris: OECD, 2001.
48 Kommersant Publishing House (www.kommersant.ru). July 22, 2004 .; Finansy. 2005. No. 5. P. 52.
tended to "make investments in industrial and economic activity and implementation of capital-intensive projects".
4.2.4. Revising Privatization Results
The issue of revision of privatization results is the most important tool intended to exert psychological pressure upon large businesses. Though almost all senior government officials expressed, at least once, their non-acceptance of such methods on a large-scale basis, the true intentions of the government are represented by uncertainty in this field. None of the relatively efficient solutions (public political decision on moratorium in revising privatization results; reduction in limitation periods; differentiation of possible approaches in revising transactions subject to a criminal component; adoption of clearly-defined rules of nationalization, etc.) that were put forward in the period between 1999 and 2004, has been adopted.
A report made by the RF Accounting Chamber, "Analysis of Public Property Privatization in the Russian Federation Over the Period Between 1993 and 2003", which was drafted in 2004 and scheduled for discussion (after several delays) at the State Duma during its spring session in 2005, received a wide discussion. It is our opinion that the report itself provides no innovations in regard to Russian privatization, which in neither event would have been analyzed by Russian and foreign experts in the 90' - 2000' (the literature contains thousands of articles and monographs on the subject). Tens, if not thousands, of evidences of nontransparent or questionable privatization transactions were reported by all-Russian and regional mass media (in this case, it is not important whether these materials are invited or not). It is generally recognized that almost every privatization transaction performed within the 90' - 2000' might be impeached on the ground of at least formal (procedural) evidences. Furthermore, since its inception in 1995, the RF Accounting Chamber itself performed several audits on privatization both at separate enterprises and objects and particular industries and regions. As far as we know, its audit reports received no serious response (though quite unreasonably in several cases) until the mid-2000'.
The authors of the report reasonably identified some adverse affects in the analysis of the three visible stages of Russian privatization: large-scale privatization in the period between 1993 and 1994, monetary privatization in the period between 1994 and 1999, and current privatization, which started from the adoption of the "Concept" 1999 :
• losses sustained from investment tenders ;
• biased evaluation (including undervaluation) of privatized objects and blocks of shares;
• assets are not classified into tangible and financial ones ;
• intangible assets are not included into evaluation of enterprises ;
• abuse of power by executive authorities in the process of privatization ;
• illicit sales of objects which are not subject to privatization ;
• dilution of public blocks of shares ;
• lack of a procedure of termination and damage recovery in case of violation of investment terms and conditions by a purchaser , etc.
There are three issues to be underlined as disputable: first, "negative" impact of privatization on structural reconstruction and efficiency, investment attraction, competitive advantages and, in a general sense, real earnings growth (the latter is most questionable in the context of privatization alone); second , suspension of the State Duma from decision-making on privatization (a well-known problem related to the privatization forecast plan) at the monetary stage; third , share-for-loans auctions.
It is impossible to make unambiguous conclusions in the fist case (which is also evidenced by a series of empirical studies of interaction between privatization and efficiency that were conducted in the 2000'). It is our opinion that in the second case the government reasonably avoided cooperation with the State Duma for the benefit of further privatization, however, this problem was eliminated by a new law on privatization adopted in 2002. The case of share-for-loans auctions is more complicated. In spite of the fact that formal judicial structure of share-for-loans auctions managed to withstand numerous court proceedings, their odium and non-transparency are generally recognized. Therefore, public (not legal ones) claims can be laid to the actual creators of the regulatory and legal framework rather than its practical users.
The authors of the report emphasized that it is the legal problems that are responsible for most of the deficiencies related to Russian privatization. It is our opinion that both political context and system-based corruption and employment of the notorious "administrative mechanism" in the process of privatization were poorly covered in the report49. Nevertheless, the key conclusions of the RF Accounting Chamber are undisputable: "Privatization assisted in fulfilling the task aimed at changing the patterns of ownership: almost 60% of enterprises became private, new market institutions were established, namely joint stock companies, stock market, institutional investors system, commercial banks, insurance companies, whereas privatization itself was accompanied by a minimum of social conflicts", "many enterprises are currently efficient", " the results of privatization of 1993 -2003 must neither be abolished nor revised on the ground of imperfection and incompleteness of the legislative base ", it is useful to analyze the deficiencies of the previous stages of privatization in order to avoid mistakes in privatizing mineral resources, land, electric-power industry and railroads in the future50.
Obviously, the RF Accounting Chamber is supposed to focus on the issues related to the looses sustained by the government during privatization, as it is mainly responsible for monitoring utilization of public funds and public property (however, it is supposed to do the same in analyzing utilization of budgetary funds, export of weapons, operation of public banks, etc., -- privatization is not the case here). In spite of that the RF Accounting Chamber's aggregate estimates of potential losses from privatization (nearly $45 billion over ten years) are quite conditional and adequately unjustifiable, there were identified the fields where regulation still remains the weakest. These are as follows:
• law-based settlement of issues related to restitution of government's rights as a public property owner (the relevant recommendation is not a novelty - a Federal Law "On the Procedure of Nationalization and Municipalization " should be adopted)51 (foot-note);
• law-based identification of the criteria of strategic enterprises involved in providing national security, as well as lack of mechanisms prohibiting or restricting foreign capital participation in privatization of strategic objects ;
• in spite of adoption (with nearly 10-year delay) of Federal Law "On Public and Municipal Unitary Enterprises", the existing institution of unitary enterprises remains inefficient ;
• inefficient management of the blocks of shares held by the government ;
• lack of both legal base for privatization of foreign property of the Russian Federation and control mechanisms over its current utilization by public agencies and other organizations.
49 This is most readily illustrated by the following data of the RF Accounting Chamber : 89% (of those disclosed by the RF Accounting Chamber) of violations during privatization were caused by government authorities, whereas private businesses were responsible for only 11%.
50 An interview with S. Stepashin, Chairman of the RF Accounting Chamber // Rossyiskaya Gazeta . December 20, 2004.
In fact, these "problem issues" also represent comprehensive recommendations of the RF Accounting Chamber for the future, which are undisputable with few exceptions. For example, the thesis on further "thorough examination of privatization practice " and "restoration of violated ownership rights of the government at law on the basis of obtained and proved evidence" can not be rejected. It is quite another matter that such facts as illicit privatization, undervaluation of property during privatization, inobservance of investment terms and conditions, etc. can be "detected", as the need arises, in any privatization transaction for any Russian enterprise. Most likely Article 301 of the RF Civil Code (legitimate owner's right to reclaim its property from illicit possession by other entity) is referred to here to resolve the problem of limitation period related to privatization transactions.
Eventually, the need for open political moratorium in revision of the results of privatization has been manifesting itself. Such moratorium must be applied to all privatization transactions, except for those involving flat violation of the laws applicable at that moment (also as an element of corruption) as well as material elements of criminal offence. The list of the latter should be well-defined in a special regulation. Such a decision could seriously restrict any attempts to of pseudo-legitimate redistribution of assets on a large-scale basis subject to objective law enforcement practice.
In addition, effectiveness of practical recommendation on redressing the situation which is most advocated by the RF Accounting Chamber, is questionable. It suggests to utilize an "independent, i.e. external public financial control" body. It is not so much as "strengthened independent control" as the range of possible interpretations of such strengthening that arises concern. The most revealing example of it as follows. At a meeting with British top-managers of TNK-BP in 2004, the Chairman of the RF Accounting Chamber S. Stepashin unambiguously classified large businesses into those investing in the Russian economy and observing tax liabilities and others. As applied to TNK-BP, this could mean discontent with both the merging transaction of 2003 and profit centers available outside Russia (the merging resulted in establishing TNK-BP Ltd. which was incorporated in British Virgin Isles, well-known offshore zone). At the same meeting, the Chairman of the RF Accounting Chamber provided assessment of the results of privatization over a decade52. A statement of "corporate structure optimization" - merger of THK, SIDANKO and ONAKO - was first response of TNK-BP. However, restructuring plan was announced in 2005 (two-stage consolidation of 17 principal Russian assets of JSC TNK-BP HOLDING located in Tyumen).
Eventually, the assessment of the results of privatization in Russia produces no negative response and is objective within certain context and typical not only of Russia but also a variety of other countries with economies under transition53. As noted above, the report provides no discoveries whatsoever with regard to Russian privatization .
The question at issue is complex: who is the formal author of the report? (private or public entity), who is the informal customer? (unless the report was a politically correct initiative by the RF Accounting Chamber itself), which socio-political environment is it replicated in? and, consequently, who is going to need such conclusions for practical application?. According to practice of the mid-2000', there is demand for negative assessment of the results of privatization. It is our opinion, however, that the companies mentioned in the report of the RF Accounting Chamber will not necessarily be selected as most likely candidates for deprivatization.
52 Refer to : Russkiy Fokus. 2004. No. 3. , P. 9.
53 An illustrative example is notorious scandals related to funneling assets from Czech privatized enterprises (the scheme is called the "tunneling effect"), though Czechia used to be considered a benchmark in terms of large-scale privatization.
From all appearances, the primary political task of the report (perhaps, the authors of the report had no such desire whatsoever) is to a priori increase uncertainty for all subjects, whereas certain sanctions will be imposed on selected ones by authorities other than auditors of the RF Accounting Chamber . It is obvious that under the circumstances large businesses will be treated strictly on the basis of the three criteria as follows: whether a company is a government supporter or cosmopolitan, whether it is politically loyal and whether it can be selected to become a "new tycoon". At the same time, the transaction with the shares of YUGANSKNEFTEGAZ revealed quite effective and legal options of seizing property at any level by using non-judicial methods and bypassing regulations on companies, bankruptcy and nationalization.
* * *
Hence one can assume that the issue of protection of ownership rights has evolved to a qualitatively new level, which is a long-lasting problem for modern Russia. Referring to the analysis provided in Annex to the present section, the issue of illicit sale of shares during the YUGANSKNEFTEGAZ transaction is not so much a case as the antithetic situation when the shares were most probably sold on a formally legitimate basis. And, paradoxically as it is, this is the key ground for basic risks in terms of protection of business-related ownership rights in Russia .
First, the YUKOS case, in particular the sale of its primary oil production asset YUGANSKNEFTEGAZ, has demonstrated that the applicable Russian regulations provide a formally legitimate basis for taking over the control of any company. Second, taking a legitimate control over YUGANSKNEFTEGAZ by a public company is a revealing example of assets reassignment by bypassing bankruptcy procedure and avoiding corporate wars. All the aforesaid means that the present Russian legislation and the law enforcement system provide for no protection of private ownership by the government to the full extent. Finally, the sale of YUGANSKNEFTEGAZ and, as a consequence, collapse of a major Russian company YUKOS may become a threshold of a new stage of reassignment of assets in Russia.
Third, the aforementioned latest innovations of the Russian law proposed in 2005 are quite illustrative in this context. Positive effect from restrictions imposed on tax audits of the RF Federal Tax Service (the only innovation that is favorable for the business) will be compensated multiply by new measures tightening business operations and enabling the government to subjectively interfere in private sector's affairs. The liberal government officials seem to be well aware of that as well. Tax regulations (above all tax amnesty) would not be eased and privatization transactions would be subject to revision, acknowledged G. Gref, Head of the RF Ministry of Economic Development and Trade, at a meeting of the Soviet of the Federation in February 2005. "Rights of the business community and the government are distributed in prejudice of the former, whereas liberal rhetoric of several government officials is accompanied by a rigorous administration which is incompatible with the principle of free-market economy. In doing so, intervention by the government has an adverse effect rather than positive one. The government intends to keep asset holders in fear instead of fostering enlargement of output "54, said V. Reznik, Chairman of the Committee for Credit Organizations and Financial Markets of the RF State Duma .
The period between the beginning of the 90' and the 2000' was distinguished by a relatively developed economy legislation, while the law enforcement system was in critical state. The situation seemed to be changed in the mid-2000': though the diseases of the
54 Reznik V. A Threat of Administrative Assaults Impending Over All Business Entities // Kommersant . February 2, 2005 .
372
Russian law enforcement system remained uncured55, there was a certain advance in the economy legislation (and its interpretation) which, on the one hand, enhanced substantially uncertainty of the effects of economic decisions related to the business community in terms of retaliatory measures by the government, and, on the other hand, made more rigorous relationships between the government and private businesses. The problems related to the law enforcement system in Russia, as being reinforced by the move towards reestablishment of rigorous legislative regulations, are notably enlarging the range of risks in terms of ownership rights. Consequently, the only way to avoid a dead-end and provide a distinct picture of the government's intentions is to revise the legislation of the Russian Federation in order to remove ambiguous interpretations in terms of rights of private ownership, refrain from reestablishing the punitive regulations removed as early as the post-communist period, and refrain from replacing civilized law enforcement actions with forcing tactics.
Annex
Selling JSC YUGANSKNEFTEGAZ: legislative aspects
As is well known, in May 2004, the RF Federal Tax Service won a legal action against NK YUKOS for recovery of RUR99,4 billion ($3,4 billion), which according to the RF Federal Tax Service were illegally received by using tax evasion schemes in 2000. In July, the RF Federal Tax Service made tax claims against YUKOS for the period of 2001 to the amount of RUR98 billion (of which tax arrears accounted for RUR50,8 billion, penalties - RUR20,3 billion, fines - RUR27,2 billion). By the end of December 2004, tax claims against YUKOS and its subsidiaries exceeded $23 billion, of which $8,6 billion was due by YUGANSKNEFTEGAZ. Later on, the legal office service levied a distrainment upon 76.79% of YUGANSKNEFTEGAZ's shares held by YUKOS with a view to sell them as discharge of tax arrears. The transaction was prepared according to the timing follows56 :
On October 12, 2004, the RF Ministry of Justice made a decision on sale of NK YUKOS in order to discharge debts of its primary subsidiary YUGANSKNEFTEGAZ. The initial price was $10,4 billion which figured as minimum on the basis of the assessment performed by Dresdner Kleinwort Wasserstein bank.
On October 17, the RF Ministry of Justice forwarded to the Russian Federal Property Fund an order of sale of YUGANSKNEFTEGAZ's shares and a draft agreement specifying terms and conditions of the sale.
On November 19, the Russian Federal Property Fund announced an auction of sale of the arrested YUGANSKNEFTEGAZ's shares accounting for 76.79% of the authorized capital, as based on the decision of legal officers. The auction was set on December 19.
On November 30, S. Bogdanchikov, Director of GAZPROMNEFT, announced that his company would take part at the auction.
On December 5, the International Energy Agency (IEA) announced that purchase of YUGANSKNEFTEGAZ by GAZPROM would cause jeopardize the energy security of Europe.
55 Typical assessments of the judicial system (except for the opinions of official government representatives of the judicial power in Russia) are basically varying from "inefficient and corrupted" (in regard to the entire system) to "judicial service market" and "close to catastrophe". The same was stated by senior public officials representing various government agencies in Russia. In particular, the system-related corruption was mentioned by V. Zorkin, Chairman of the RF Constitutional Court (2004), while catastrophic and threatening situation in the judicial system was announced D. Kozak, a representative of RF President in the South Federal District (2005), who used to supervise the judicial system in the pervious periods.
56 These materials were obtained from Kommersant Publishing House (www.kommersant.ru , December 2004 - February 2005) and Russian information agencies in the period between 2004 and 2005 .
On December 7, Reuters announced that a group of six western banks headed by Deutsche Bank had prepared a syndicated loan of up to $10 billion to JSC GAZPROM to take part in the auction.
On December 7, the RF President issued an order excluding JSC NK ROSNEFT from the list of strategic enterprises and joint stock companies and including JSC ROS-NEFTEGAZ into the list , as well as decreed to adopt the proposal of the RF Government on making a contribution of 100% shares of JSC NK ROSNEFT held by the government to the authorized capital of JSC ROSNEFTEGAZ.
On December 8, the Board of Directors GAZPROM approved participation of GAZ-PROMNEFT at the auction.
On December 10, the Federal Antimonopoly Service reported receipt of three applications for taking control over YUGANSKNEFTEGAZ: from GAZPROMNEFT , LLC Pervaya Venchurnaya Kompaniya and CJSC INTERCOM.
On December 13, MENATEP Group announced that it would initiate legal proceedings not only against purchasers of YUGANSKNEFTEGAZ's shares but also those who would extend a loan to the winner at the auction.
On December 15, YUKOS filed an application to the Houston Court for Bankruptcies (USA) with the request to suspend all transactions with assets of the company and cancel the auction.
On December 16, the group of banks rejected to sigh a loan agreement with GAZPROMNEFT until the decision of the Houston Court for Bankruptcies was made .
On December 16, LLC BAIKALFINACEGROUP submitted its application for participation at the auction.
On December 17, GAZPROMNEFT submitted its application for participation at the auction . At the same day the Houston Court for Bankruptcies made a legal decision to prohibit all transactions with YUKOS's assets, including the UGANSKNEFTEGAZ auction.
On December 18, the group of banks made a final decision to refuse to extend the syndicated loan to GAZPROM. 100% participation of LLC GAZPROMNEFT was sold to unknown entities not affiliated with GAZPROM OJSC.
On December 19, GAZPROMNEFT and BAIKALFINACEGROUP were qualified to participate in the auction on sale of 76.79% of the authorized capital of YUGANSKNEFTEGAZ or 100% voting shares held by YUKOS. LLC Pervaya Venchurnaya Kompaniya failed to apply for participation at the auction, CJSC INTERCOM failed to provide the required $1,7 billion deposit. The initial price of the foregoing block of shares was RUR246,75 billion. The auction's step was RUR2,8 billion. LLC BAIKALFINACEGROUP made its initial bid of RUR260,7 billion for YUGANSKNEFTEGAZ's shares to become the winner . The remainder (upon granting a deposit) of $7,65 billion due was to be transferred before January 18, 2005. GAZPROMNEFT made no bid.
On the night of December 22 to 23, 2004, NK ROSNEFT announced that it had repurchased a 100% equity of BAIKALFINACEGROUP thus taking possession of 76.6% of YUGANSKNEFTEGAZ (and getting entitled to purchase YUGANSKNEFTEGAZ together with the winner). '"YUGANSKNEFTEGAZ's shares were purchased as part of ROSNEFT development plans providing for its transition into a national energy corporation through the development of production facilities ". Neither terms and conditions nor the value of the transaction were disclosed.
On December 23, 2004, RF President V. Putin announced at a press conference: "In fact, ROSNEFT, a 100% public company, has purchased a well-known asset, YUGANSKNEFTEGAZ In my opinion, it has been done by using purely market mechanisms You all are well aware of how privatization was performed in this country in the beginning of 374
the 90', and how many market participants took possession of public assets which are worth a billions of dollars by utilizing various tricks, including those violating the law applicable even at that time. Today, the government is securing its interests through absolutely legal market mechanisms Referring to this very transaction, I believe that it has been performed in severe conformity to the Russian law and all standards of international law and international commitments assumed by the Russian Federation as part of the documents which we sign with our counterparts at the international level".
On December 23, 2004, the RTS index grew by more than 2% and got close to 600 points by the middle of the day. Shares of ROSNEFT's subsidiaries grew by nearly 10%, GAZPROM's shares by 3% (with the value of ROSNEFT ranging within $6 - 8,5 billion, while the value of acquired YUGANSKNEFTEGAZ is estimated not less than $9,35 billion with nearly $8 billion of debt, the settlements required for the transaction on YUGANSKNEFTEGAZ's shares are raising ROSNEFT's debt).
At the end of December 2004, ROSNEFT obtained a $6 billion loan from a syndicate of Chinese banks. According to the official data, the loan was obtained to "invest in production and economic activity and implementation of capital-intensive strategic projects " which were not disclosed.
On December 30, 2004, D. Medvediev, Head of the RF President Office and Chairman of the Board of Directors of GAZPROM OJSC announced that GAZPROM and ROSNEFT would merge without YUGANSKNEFTEGAZ's assets .
On January 6, 2005, Italian Ministry of Industry А. Marzani announced to Reuters that it kept interested in YUKOS's assets.
On January 7, 2005, Chinese mass media released information that Chinese public oil company CNPC assessed it possible to purchase 20% shares of YUGANSKNEFTEGAZ .
On January 10, 2005, Indian oil company ONGC announced its intention to purchase a block of shares of YUGANSKNEFTEGAZ by means of the Indian government.
On February 8, 2005, MENATEP Group laid a legal action for $28 billion against the Russian Federation to the International Committee for Settlement of Trade Disputes in relation to expropriation of the group, YUGANSKNEFTEGAZ. Financial claims were laid against Energy Charter according to an Agreement. Membership of the Charter includes mostly European countries (Russia signed it in 1994 but not ratified).
On February 9, 2005, Deputy Minister of Finance Т. Golikova announced that proceeds from the sale of YUGANSKNEFTEGAZ (RUR213 billion) were allocated to the consolidated budget (RUR138 billion to the federal budget, the remainder to the budgets of constituent entities of the Russian Federation).
On February 9, 2005, Arbitration Court of Appeal No. 9 (Moscow) confirmed that the decision of the Major Taxpayers Interregional Inspection No. 1 (under the RF Federal Tax Service) obliging YUKOS to pay additional RUR115,4 billion of tax arrears for the period of 2001 was legitimate.
Negative legal evaluation of the transaction relied upon determination of a fact of illicit sale of shares, because YUGANSKNEFTEGAZ is the principal oil production asset of YUKOS holding company. The similar line of arguments was presented in the previous periods: the arrest of YUGANSKNEFTEGAZ's shares was baseless, since NK YUKOS should be considered as a holding company, and it is specified in the law that securities of subsidiaries held by a holding company shall not be first to forfeit. Law enforcement officers shall first to forfeit the property that is not utilized in production 57.
57 Egorova Т., Tutushkin А. Yukos Subsidiaries Remain Under Arrest // Vedomosti . August 10, 2004
It is our opinion that the key problem of the transaction with YUGANSKNEFTEGAZ's shares is not so much an illicit sale as a directly opposite case: the sale was performed on absolutely formal legitimate grounds. And, paradoxical as it may appear, it is the very case that creates principal risks in terms of protection of ownership rights of the business in Russia. We will try to analyze in details the sale of YUGANSKNEFTEGAZ's shares in terms of its legitimacy58.
1. Debtor's Assets Arrest Procedure
Federal Law "On Law Enforcement Proceedings" of July 21, 1997 FL -119 specifies a procedure of forfeiture of debtor's (organization's) assets . In particular, Article 59 of the Law specifies that debtor's assets must be seized and sold in order of priorities as follows: first priority: assets which are not directly utilized in production (securities, deposit funds and funds on other accounts of a debtor, foreign exchange assets, passenger cars, office design items and other assets); second priority: final products (goods) as well as other tangible assets which are neither directly utilized in production nor intended to be directly utilized in production; third priority: immovable property as well as raw materials, plant and equipment, other fixed assets designed for direct utilization in production.
Hence, pursuant to Federal Law "On Law Enforcement Proceedings", the securities (YUGANSKNEFTEGAZ's shares in this case) held by NK YUKOS are neither considered the assets which are directly utilized in production nor subject to first-priority seizure and sale. Nevertheless, pursuant to Clause 3 of a Regulation issued by a Plenary Meeting of the RF Superior Arbitral Court on March 3, 1999 No. 4 "On Various Issues Related to Imposing a Recovery on Shares", " the following should be taken into account in making a decision on order of priorities of imposing recovery actions on assets of a debtor acting as a holding company or other type of company established during privatization of public assets pursuant to a Decree of the President of the Russian Federation or a regulation of the Government of the Russian Federation, whose authorized capital is built up by contributing a controlling block of shares of subsidiaries held by the government.
The foregoing companies are established by the government as single economic bodies for the purpose of coordination and cooperation of operational and commercial activity of integrated subsidiaries, and operation of such company may come to be impaired or discontinued if one or several such subsidiaries would be withdrawn from the company as a result of recovery imposed upon the relevant blocks of shares. Article 59 of Federal Law "On Law Enforcement Proceedings" specifies the order of priorities of levying an execution upon debtor's (organization) assets so that it may not be unreasonably forced to discontinue its core activity (production or any other activity the organization is established for) upon liquidation of debt due to seizure and sales of its assets (including shares). In this connection, the blocks of shares of subsidiaries contributed to the authorized capital of the foregoing companies can not be subject to first-priority recovery. Pursuant to SubParagraph 3, Article 59 of Federal Law "On Law Enforcement Proceedings», such blocks of shares should be considered as assets which are critical for maintaining production activity of the company and subject to third-priority recovery".
58 It should be noted, however, that the key issue related to the sale of YUGANSKNEFTEGAZ's shares is justification of tax claims laid against YUGANSKNEFTEGAZ and its parent company YUKOS. For some obvious reasons we cannot make a comprehensive analysis of tax claims against these and other companies integrated into YUKOS. It is also worth noticing that, in judging the YUKOS case, the courts relied upon the materials provided by the Federal Tax Service and refused the defense to file reports of independent expertise of the tax claims made by request of the defendant with other documents of the case. Apparently, the right to unconditional filing of at least the independent expertise (appraisal) reports with the tax arrears documents must be undisputable.
Hence, a Plenary Meeting of the RF Superior Arbitral Court specified the following conditions under which blocks of shares of subsidiaries are not subject to first-priority recovery:
• authorized capital of a corresponding holding company or other type of company was built up during privatization of public assets by contributing a controlling block of shares of subsidiaries held by the government ;
• a parent company was established by the government as a single economic body for the purpose of coordination and cooperation of operational and commercial activity of its integrated subsidiaries, and operation of such company may come to be impaired or discontinued if one or several such subsidiaries would be withdrawn from the company as a result of recovery imposed upon the relevant blocks of shares.
To which extent the foregoing provisos of Federal Law "On Law Enforcement Proceedings" can be applied to YUKOS and YUGANSKNEFTEGAZ ? In 1993, pursuant to a Decree of the RF President of November 17, 199259, the authorized capital of YUKOS oil company 38% was supplemented by shares of YUGANSKNEFTEGAZ joint stock company established during reorganization of PO YUGANSKNEFTEGAZ. Later, the share of YUKOS in the authorized capital of YUGANSKNEFTEGAZ was increased up to 100%. On the one hand , YUGANSKNEFTEGAZ was actually integrated into YUKOS during privatization. YUGANSKNEFTEGAZ is owned by YUKOS, hence operation of the entire holding company may come to be impaired or discontinued due its withdrawal from YUKOS60. On the other hand, as was noted above, the shares of subsidiaries held by the parent company are not subject to first-priority recovery provided that the authorized capital of the parent company is built up by including controlling blocks of shares of its subsidiaries. The foregoing statement, which is included into the ruling issued at a Plenary Meeting of the RF Superior Arbitral Court, can be interpreted both as restrictive and expansive. In case of restrictive interpretation, one may suppose that the authorized capital of a corresponding company must be built up exclusively by including controlling blocks of shares of its subsidiaries. However, in case of expanding interpretation, one may conclude that the authorized capital of a corresponding holding company may be built up both of majority and minority blocks of shares of its subsidiaries. In addition, as was noted above, the authorized capital of YUKOS was initially supplemented by only 38% shares of YUGANSKNEFTEGAZ (i.e., a share of YUKOS in the authorized capital of YUGANSKNEFTEGAZ was initially less than the value of controlling block of shares of YUGANSKNEFTEGAZ).
From the aforesaid, it might me assumed that the foregoing provision as part of a the regulation of the Plenary Meeting of the RF Superior Arbitral Court on exclusion of recovery on holding companies from the order of priorities is applicable to the sale of YUGANSKNEFTEGAZ's block of shares held by YUKOS. In addition, it should be noted that the provision of the Plenary Meeting of the RF Superior Arbitral Court actually provides for exclusion of Clause 59, Article 1 of Federal Law "On Law Enforcement Proceedings". However, according to the applicable law, the Plenary Meeting of the RF Superior Arbitral Court is not vested with legislative functions. In particular, pursuant to Clause 1, Article 13 of Federal Law "On Arbitration Courts of the Russian Federation"61, the competence of the
59 RF President's Decree No. 1403 "On Specifics of Privatization and Reorganization of Public Enterprises, Production and Research Associations of Petroleum and Petroleum Refinery Industries and Oil-Product Supply".
60 In 2003, YUGANSKNEFTEGAZ's output accounted for 49,7 million tons of crude oil, or 62% of total oil production by YUKOS. Production totaled 25,6 million tons of crude oil within the first half of 2004 . The company has 26 oil and gas production licenses at the fields located in Nefteyugansk, Surgut and Khanty-Mansyisk regions with the reserves totaling (according to the SPE methodology) 16,2 billion tons of crude oil, or 73% of reserves proved by YUKOS (refer to: "Rock Bottom Price" by Reznik I., Bushuyeva Yu.,. YUGANSKNEFTEGAZ can be sold at $3 billion // Vedomosti . October 15, 2004).
61 Federal Law of April 28, 1995 . No. 1- FL.
Plenary Meeting of the RF Superior Arbitral Court includes reviewing materials of study and generalization of enforcement of laws and other regulations of courts of arbitration and providing consultancy on judicial practice. The Plenary Meeting of the RF Superior Arbitral Court issued regulations on its proceedings being mandatory for all courts of arbitration in the Russian Federation pursuant to Clause 2, Article 13 of Federal Law "On Arbitration Courts of the Russian Federation". In addition, regulations specified in the federal law are superior to the provisions issued at the Plenary Meeting of the RF Superior Arbitral Court.
From the aforesaid, it might be assumed that according to the language of law applied to the sale of YUGANSKNEFTEGAZ's shares held by YUKOS, the law enforcement officers service lawfully qualified debtor's shares as assets subject to first-priority seizure and sale under RF Law "On Law Enforcement Proceedings".
2. First Priority Sale of YUGANSKNEFTEGAZ's Shares
Ambiguous assessments were also caused by the fact that the law enforcement officers made a decision on first-priority sale of YUGANSKNEFTEGAZ, principal oil production subsidiary of YUKOS. In particular, according to some opinions, the very selection of YUGANSKNEFTEGAZ's shares suggests that the RF government intends to ultimately destroy YUKOS62.
Pursuant to Article 46 of Federal Law "On Law Enforcement Proceedings", in case the debtor has no funds sufficient to settle recoverer's claims, debtor's assets are subject to recovery, except for the assets which are not subject to recovery under the federal law. In addition, the debtor is entitled to specify those types of assets or items which are subject to first-priority recovery.
JSC YUKOS was entitled to do the same, as evidenced from available public materials. In particular, the company made a list of enterprises which could be sold (YUGANSKNEFTEGAZ's shares were not included into the list). Nevertheless, since Article 46 of Federal Law "On Law Enforcement Proceedings" specifies that it the law enforcement officer who is to determine the order of priority for recovering debtor's assets, the law enforcement officers acted within their competence in the YUKOS case in qualifying YUGANSKNEFTEGAZ's shares held by YUKOS as first-priority assets to sell. From the above said it appears that the law enforcement officers had the right to impose first-priority recovery upon YUGANSKNEFTEGAZ's shares held by YUKOS on a pro forma basis.
3. Front Bidder de facto at the Auction
An unknown company, LLC BAIKALFINANCEGROUP, won at the auction on sale of YUGANSKNEFTEGAZ's shares held by YUKOS. Neither official data bases nor registers nor the Federal Tax Service website made any reference to this company. According to the documents submitted to the Russian Federal Property Fund, the LLC BAIKALFINANCEGROUP appeared to be incorporated in Tver (Russia). In this connection, many experts asked a question as to how an unknown company was admitted to the auction and hence whether the results of the auction were legitimate.
Pursuant to RF Law "On Law Enforcement Proceedings", the bidding procedure during law enforcement shall be specified in the RF Civil Code . Pursuant to Article 447 of the RF Civil Code , the entity offered the highest bid shall be deemed the winner at an auction. Any entity may participate at an open auction. In addition, the regulation issued by Russian Federal Property Fund on November 29, 2001, No. 418 "On Approval of the Procedure of
62 Reznik I. They Started from Key Issues // Vedomosti . July 21, 2004 .
Organization and Conducting of Bidding on Arrested and Seized Assets As Well As Confiscated, Unprocessed and Other Assets Appropriated by the Russian Federation" provides no special requirements to participants at auctions on a block of shares.
Pursuant to RF Law "On Mineral Resources", both changes in the authorized capital structure and replacement of a majority shareholder shall not be deemed a reasonable justification for license redistribution, early termination of the right of utilization of mineral resources on the basis of a license issued to a corresponding company. Hence the law provides no special requirements to entities participating at an auction on sale of shares. From the above said it follows that the unknown LLC BAIKALFINANCEGROUP participated at the auction on a legitimate basis and in conformity with the Russian law and met all formal conditions and requirements.
4. Legal Action in the United States
It is known that YUKOS filed a bankruptcy claim with the United States Court of Bankruptcy in connection to the recovery of tax arrears. YUKOS moved for prohibition of the auction on sale of YUGANSKNEFTEGAZ as a security for the claim. On December 16, 2004, the United States Court of Bankruptcy, South District, Houston, Texas, issued a provisional prohibitory injunction on YUKOS's claim on suspension of the auction on sale of YUGANSKNEFTEGAZ's shares . The court ordered to perform no further transactions for the time being related to YUGANSKNEFTEGAZ's shares, including but not limited to the auction on sale of the shares in question63.
Later, on December 30, 2004, YUKOS published an notice through mass media: "pursuant to § 541, Section 11 of the Code of the Laws of the United States, the shares shall be deemed assets included into the bankruptcy assets of NK YUKOS pursuant to Chapter 11. The United States Court of Bankruptcy has an exclusive jurisdiction pursuant § 1334 (e), Section 28 of the Code of the Laws of the United States in relation to the bankruptcy assets of NK YUKOS "wherever they are located " (pursuant to Chapter 11). YUKOS notified the parties concerned that "should the shares have been sold, NK YUKOS would sustain losses to the amount beyond $20 billion ". In addition, the company specified that it "would apply all available legal mechanisms in order to claim compensation for the losses against any legal entities or physical bodies which would: 1) take part at the auction on sale or purchase of the shares, encourage or finance such sale or purchase; 2) interfere with the relationship between NK YUKOS and its staff members; 3) dispute NK YUKOS's assets representing the bankruptcy assets pursuant to Chapter 11; 4) intend to recover on claims against NK YUKOS which raised prior to petition in bankruptcy64.
Of course, the question now arises on whether the jurisdiction of the aforementioned American court may be applied to a bankruptcy case of the Russian company. One of the documents filed with the American court in regard to the YUKOS case provides the following justification of the American court's jurisdiction for this particular case. YUKOS is an open joint stock company established in compliance with the legislation of the Russian Federation . According to B.Mizamor, Financial Director of the company, Debtor's subsidiary deposited nearly $2 million to funds on the accounts with the Texas South-Western Bank located at the South District of Texas. The Debtor also deposited nearly $6 million on the trust account of lawyers from Fubright & Jaworsky L.L.P as an advance fee for the provision of legal services and administrative costs which would be incurred in regard to the case in question. The foregoing funds are Debtor's fixed assets in the United States. In ad-
63 Notice concerning the automatic stay. Case No. 04-47742-H3-11, Chapter 11. 20.12.2004 (www.yukosbankruptcy.com).
64 In particular, the "Notification of NK YUKOS" was published by Izvestiya newspaper on December 30, 2004 .
dition, B. Mizamor specified that American institutional investors held nearly 15% of Debtor's shares. Eventually, the American court issued the tentative prohibitory injunction at YUKOS's request to suspend the auction on sale of YUGANSKNEFTEGAZ's shares65.
Pursuant to Article 27 of the RF Arbitration Practice Code, the jurisdiction of courts of arbitration of the Russian Federation also includes cases related to Russian business organizations, except as otherwise provided for by an international agreement with the Russian Federation . According to the regulations of the RF Arbitration Practice Code, the YUKOS bankruptcy case is subject to the exclusive jurisdiction of Russian courts of arbitration . Furthermore, for the time being there is no international agreement with the Russian Federation that would provide for otherwise.
In fact, there is a formal conflict of jurisdictions. On the one hand , pursuant to the Russian law, the YUKOS bankruptcy case is subject to the jurisdiction of Russian courts of arbitration. On the other hand, pursuant to the American law, the company may move the corresponding American court, since it certain assets of the company are allocated on the territory of the United States of America. Nevertheless, the ruling in question may be executed on the territory of the Russian Federation, provided that the corresponding ruling is issued by a Russian court of arbitration pursuant to the procedure specified in Chapter 31 of the RF Arbitration Practice Code . Pursuant to Article 244 the RF Arbitration Practice Code, arbitration court shall deny in full or in part the ruling on a case issued by a court of a foreign country, provided that such case is subject to the exclusive jurisdiction of the Russian court pursuant to an international agreement of the Russian Federation or the federal law. However, as was noted above, pursuant to the Russian law, bankruptcy cases of Russian legal entities are subject to the exclusive jurisdiction of Russian courts of arbitration, and there is no agreement concluded between Russia and the United States that would provide for otherwise. In addition, there is no public information on whether YUKOS applied to a Russian court of arbitration for adoption and execution of the aforementioned ruling issued by the American court. Consequently, the aforesaid ruling imposing a temporal injunction on sale of YUGANSKNEFTEGAZ' shares, is currently effective only on the territory of the United States of America.
4.3. The third law on insolvency: the first results and prospects of improvement
By present, in Russia there have formed all key elements of the institution of insolvency. However, the institution of bankruptcy in Russia can not be seen yet as a stable and efficient mechanism aimed at the rehabilitation of management and finances of companies. The existing institution of insolvency, in spite of a growth in the number of bankruptcy cases, is only of a "point" scale as concerns its application, and fails to settle the problem of withdrawal of inefficient enterprises from the market and repayment of debts to creditors at the macro-level. On the whole, the institution of bankruptcy fails to ensure the predictable distribution of risks faced by creditors. Moreover, in the 1990s and early 2000s, the institution of bankruptcy in Russia was used either as a method of redistribution (takeover, retention, and privatization) of property, or a highly selective way to put political and economic pressure on enterprises on the part of the state. At the same time, there is observed a significant underdevelopment of the infrastructure related to the implementation
65 Pursuant to 28 & U.S.C. &1334 (a), district courts have primary and exclusive jurisdiction in regard the case pursuant to Title 11. A foreign company may be deemed a debtor pursuant to 11 U.S.C. & 109 (a), provided that a part of its assets is located on the territory of the United States of America. Refer to "Memorandum opinion" of the United States Courts Southern District of Texas. 16.12.2004.
of the bankruptcy legislation. However, in spite of all costs of implementation of the institution of insolvency, the "catastrophic" tone of statements implying that exactly bankruptcy is the root of all evil should not be shared. For instance, in absolute terms there are much more offences and abuses in the framework of corporate law. There is little doubt that in the sphere of small and medium sized businesses a positive influence of the institution of bankruptcy has already been felt by now. In Russia, the bulk of criticism is related to the practices of bankruptcy of large enterprises.
4.3.1. Legislation on bankruptcy in 1990s through 2000s: specifics of formation
In foreign countries, regulation of insolvency is a most dynamically developing sphere of law, since the economies of states require constant modernization of the respective provisions. In theory, the legal norms governing the regulation of bankruptcy of enterprises may be aimed at the settlement of the following problems:
• at the macro-level it is reduction of the level of economic risks in the economy by the way of liquidation of inefficient enterprises and redistribution of industrial assets in favor of efficiently operating economic agents, as well as development of a competitive environment;
• at the micro-level it is protection of the rights of creditors, instilment of financial discipline, enhancement of reliability of the credit circulation, carrying out of reorganization of enterprises and their financial restructuring, improvement of the quality of corporate governance, redistribution of property in favor of "efficient" owners, replacement of inefficient managers, introduction of a rational management system at enterprises66.
The experience of developed foreign countries does not unambiguously indicate that the regulation of insolvency should be formed exclusively proceeding from the priority of creditors. There are examples, where the respective regulations are primarily aimed at protection of the interests of debtors or the state. All specifics of legislation are determined by the concrete economic policies pursued by the states and are closely associated with the sizes of public sectors in the respective economies and the attitudes as concerns the necessity of these sectors. A characteristic feature of the majority of modern developed systems aimed at regulation of insolvency is that they include and develop rehabilitation procedures aimed at the preservation of businesses in addition to such a classical mechanism of bankruptcy as the closing down sale of debtors' assets in the course of bankruptcy proceedings.
The role of bankruptcy as a means to put pressure on managers of corporations in market economies is well known, and all aspects of the problem are described in a large number of studies. The threat of bankruptcy of a corporation due to managerial errors on markets (or, as the extreme variant, the cases where creditors intercept control) is traditionally seen as the most important external tool of corporate governance. Apparently, it is expected that the application of such a mechanism (notwithstanding the pluses and minuses of the models (pro-creditor or pro-debtor) used in different countries) should result in rehabilitation of finances and enhancement of efficiency of operations carried out by the corporation being the object of the respective procedures.
66 For details see: Radygin A., Swain H., Simachev Yu., Entov R. et al. Institut bankrotstva: stanovleniye, problemy, naprav-leniya reformirovaniya (The institution of bankruptcy: it's rise, challenges, and reform avenues). M., IET - CEPRA, 2005.
In principle, all systems of insolvency and bankruptcy may be classified in two extreme groups: those oriented towards the debtor (USA, France), and those oriented towards the creditor (Great Britain, Germany)67.
Thus, the model formed in Germany is oriented towards an increase in the efficiency of satisfaction of creditors' claims, at the same time, the rehabilitation procedures are aimed at the maximization of debtors' assets for further distribution among creditors. A typical UK model is aimed at the protection of credit circulation, creation of efficient and rapid mechanisms of distribution of debtors' assets among creditors. Over the time, when the bankruptcy procedures are applied, the control over the enterprise is transferred to a third party acting on behalf of the creditors. An apparent flaw of this model is the fact that it is aimed at the liquidation of enterprises rather than their rehabilitation, since creditors are primarily interested in the sale of the assets of companies experiencing differences and not their rescue.
The models adopted in the USA and especially in France are based on a combination of the solution of macroeconomic problems as concerns the ensuring of stability an sustained growth of the economy, and the objectives of creation of efficient mechanisms of distribution of debtors' assets. For instance, in France the institution of insolvency is to a considerable extent aimed at the protection of the debtor's interests and restructuring of debtors' enterprises. The US legislation permits debtors to keep control of insolvent legal entities and grants the debtor the exclusive right to propose own plans with respect to the reorganization of the company for a certain period of time. The distribution of rights biased in favor of the debtor is to a considerable extent a policy choice, since the preservation of companies subject to bankruptcy proceedings as functioning enterprises, and not the cessation of their activities via liquidation, is seen as the priority. A significant flaw of this model is that the debtor has the possibility to abuse its rights.
All intermediate models primarily differ primarily as concerns the ratio (balance) between the infringement on the rights of creditors and preservation of operating enterprises.
According to the estimates presented by EBRD, the bankruptcy legislation of countries with transitional economies is underdeveloped in comparison with other spheres of commercial law68. It is especially true with respect to the efficiency of enforcement of this legislation. Short duration of the bankruptcy procedures permits to avoid delays, which could negatively affect both the debtor, and creditors, as well as overload the judiciary system. Nevertheless, bankruptcy proceedings often are protracted and bring no results. There are doubts as concerns the competence of the assigned external managers, as well as their powers. In spite of the fact that in the recent years the countries of Central and Eastern Europe, the Baltic States and member countries of the CIS have been taking serious steps towards the improvement of both the respective legislation, and practices in the sphere of bankruptcy of companies, there are no apparent changes to the better.
At the same time, the specific objective constraints, which render difficult the efficient and large scale application of this mechanism in Russia and a number of other transitional economies, are well known. These constraints include: • unfavorable financial standing of a significant part of newly created corporations;
67 See, for instance, Telyukina M. Osnovy konkursnogo prava (Principles of bankruptcy law). M.: Wolters Kluwer, 2004; Ste-panov V. Nesostoyatlnost (bankrotstvo) v Rossii, Frantsii, Anglii, Germanii (Insolvency (bankruptcy) in Russia, France, England, Germany). M.: Statut, 1999.
68 See: EBRD Transition Reports. 1999-2003. EBRD. See also: Radygin A. D., Gontmaher A. E., Mezheraups I. V., Turunt-seva M. Yu. Ekonomiko-pravovye factory i ogranicheniya v stanovlenii modelei korporativnogo upravleniya (Economico-legal factors and restrictions in formation of corporate governance models). M.: IET, 2004.
• the traditions of soft budgetary constraints;
• persistence of a considerable number of corporations with state participation;
• the lack of an adequate and competent executive and judicial infrastructure;
• social and political barriers preventing implementation of real bankruptcy proceedings of with respect to loss making corporations, especially as concerns the largest enterprises, or enterprises in single company towns;
• technical difficulties associated with the objective assessment of the financial standing of potential bankrupts;
• corruption and other criminal aspects of this problem, including those associated with the property redistribution processes.
Bankruptcy legislation biased towards debtors is typical with respect to Uzbekistan, Moldova, Lithuania, and Ukraine (although in the latter case the general pro-debtor bias is combined with certain serious pro-creditor provisions). The legal frameworks of bankruptcy in Azerbaijan, Kazakhstan, and Georgia may be defined as systems biased towards creditors. Significant pro-creditor elements are present in the legislation of Latvia, Estonia, and Ukraine. Initially, the countries of Central and Eastern Europe and the CIS member states faced the choice between these two models. However, since the majority of developed countries applies mixed models, which include elements of both the American and British models, these countries attempt to find a balance between the rights of creditors and debtors (thus, for instance, the management of the enterprises subject to bankruptcy proceedings is usually transferred to a neutral manager biased neither towards the debtor, nor creditors), therefore many countries with transitional economies also chose this way. The modern (since 2002) system of the Russian bankruptcy law may be defined as a neutral system with a significant pro-debtor bias69.
In all fairness, it should be noted that the legal basis of insolvency in Russia had been set forth yet before the beginning of the first stage of its development indicated below70. Nevertheless, at present there may be singled out 3 major stages as concerns the development of the institution of bankruptcy in Russia:
• from the end of 1992 to the beginning of 1998, the period, when law of the Russian Federation No. 3929-1 of November 19, 1992, "On insolvency (bankruptcy) of enterprises", hereinafter referred to as the first law on bankruptcy, was in force;
• from the beginning of 1998 to the end of 2002, the period, when federal law No. 6 FZ "On insolvency (bankruptcy)", hereinafter referred to as the second law on bankruptcy, was in force;
• from the end of 2002 till present time, the period, when federal law No. 127 FZ "On insolvency (bankruptcy)", hereinafter referred to as the third law on bankruptcy, is in force.
The first law on bankruptcy was adopted in Russia at about the same time as in other countries with transitional economies. Although in 1995 through 1997 the number of bankruptcy related claims submitted to arbitration courts significantly increased, bankruptcy proceedings did not become as widespread as in other countries with transitional economies. This law was based on the "inability to pay" principle, which in turn based on the analysis of the ratio between the values of assets and liabilities and in the case the amount
69 See: Telyukina M. Osnovy konkursnogo prava (Principles of bankruptcy law). M.: Wolters Kluwer, 2004, pp. 77 - 79.
70 Decree of the RF President No. 623 of June 14, 1992, "On measures aimed at the support and rehabilitation of insolvent state owned enterprises (bankrupts) and implementation of special measures with respect to such enterprises"; Resolution of the RF State Committee for Management of State Property No. 717 r of November 5, 1992, "On the approval of the model rules governing the bankruptcy procedures with respect to the sale of bankrupt enterprises and property thereof."
of creditor indebtedness exceeded the value of property owned by the enterprise, it was considered to be insolvent on the basis of its balance sheet indicators.
At this stage, the most significant external factors determining the interests of the parties in the sphere of insolvency were as follows:
• the excess of the amount of debt over the value of the debtor's property was set as the criterion permitting to declare the enterprise bankrupt, what caused significant difficulties with respect to the initiation of bankruptcy proceedings;
• a significant number of large attractive enterprises remained in the state or mixed ownership;
• the economy was characterized by a high level of barter payments and there existed an acute problem of non-payments, which also concerned tax and other mandatory payments due to the state.
The first law on bankruptcy is as a rule characterized as a rather imperfect document. The overwhelming majority of authors agree that this law was too biased towards debtors. The law defined insolvency (bankruptcy) as the inability of the debtor to meet creditors' claims to pay goods (works, services), including the inability to make mandatory payments due to the budget and extra-budgetary funds due to the fact that the debtor's liabilities exceeded the value of its property, or in relation to the unsatisfactory structure of the debtor's balance sheet. The practical enforcement of the law revealed that the rights of creditors were significantly limited due to the difficulties associated with the appraisal of the real value of property by arbitration courts and respective delays of decisions ruling the debtor bankrupt. The legal terms and indications of bankruptcy, which were in force at that time, protected mala fide debtors, thus destroying the principles of property circulation71.
Among the reasons of insufficiently active enforcement of the first law on bankruptcy there were also indicated the lack of systematic implementation of bankruptcy proceedings on the part of the state in capacity of the tax creditor and its orientation towards such tools as the imposition of penalties for delays of payments. Ordinary creditors had no incentives to initiate bankruptcy proceedings, since all liquid assets were used in order to repay the debts to the state as a privileged creditor.
The serious flaws of the first law on bankruptcy accounted for the fact that this law had failed to produce any significant impact on the Russian economy72. As a result, in this period bankruptcy was neither a serious threat to inefficient managers of the majority of Russian enterprises, nor a means to ensure the rights of external creditors.
The lack of efficiency of the first law on bankruptcy resulting from its excessive bias towards debtors is most often named as the key factor behind the adoption of the second law on bankruptcy. It is believed that the key innovation in the second law was the radical change in the approach to the determination of criteria of insolvency (bankruptcy) as concerns the debtors in the form of legal entities, which had significantly strengthened the positions of creditors. The second law on bankruptcy was based on the insolvency principle: the inability of an enterprise to meet its liabilities was determined at the time the respective payments were due, therefore enterprises were deemed insolvent on the cash basis. This innovation had significantly reduced the barriers preventing initiation of bankruptcy proceedings.
71 See: Vitryanski V. Novoye zakonodatelstvo o nesostoyatelnosti (bankrotstve) (New legislation on insolvency (bankruptcy) // Khozyaistvo i pravo. 1998. No. 3.
72 See: Sonin K., Zhuravskaya E. Bankrotstvo v Rossii: ni zashchity kreditorov, ni restrukturizatsii (Bankruptcy in Russia: Away From Creditor Protection and Restructuring), Special report. Russian Economic Trends. 2000. Transl. from English. M.: RECEP, 2000, Volume 9: Issue 1, 2000.
As a result, the scale of the application of insolvency proceedings in the economy started to increase intensively (see Fig. 1). The growth in the number of bankruptcy cases was viewed in particular as a result of toughening of budgetary constraints with respect to Russian enterprises related to the enactment of the second law on bankruptcy. In other words, a sharp increase in the number of bankruptcies was associated with the fact that due to the absence of an efficient legal framework of bankruptcies until 1998 the majority of Russian firms had accumulated significant debts to the federal and regional budgets and private creditors.
At the same time, the practice of enforcement of the second law on bankruptcy had demonstrated that bankruptcy proceedings could be easily initiated with respect to large enterprises, where the levels of indebtedness were insignificant in comparison with the scales of their businesses. In accordance with the second law on bankruptcy, the creditor could submit to the arbitration court the claim to declare the debtor bankrupt in the case the latter failed to meet its obligations within 3 months and the amount of indebtedness was above 500 minimal wages. As it had turned out, the principle of insolvency was significantly more efficient as concerned the instilment of payment discipline; it ensured equal opportunities as concerns the initiation of bankruptcy on the part of creditors; in principle, it did not required that judges had special highly professional training in order to take decisions concerning the substance of claims. However, this principle failed to take into account the scale of businesses and possible cash gaps, which were not indicative of the inefficiency of enterprises.
Fig. 1. The dynamics of claims resulted in initiation of bankruptcy proceedings (the first and second laws on bankruptcy)
The second stage of development of the institution of bankruptcy, especially after the financial crisis of 1998, was characterized by significant changes in the complex of key factors affecting the implementation of bankruptcy proceedings:
• the threshold permitting to start bankruptcy proceedings was sharply lowered;
• the processes of industrial integration intensified alongside with the law-making activities aimed at protection of minority shareholders;
• the stock market crisis of the late 1990s resulted in a search for alternative low cost tools of interception of corporate control;
• at a significant number of enterprises there was observed a growth in production; however, the high level of indebtedness of enterprises associated with tax payments per-sisted73;
• the state was deprived of voting rights with respect to the most important decisions at the meetings of creditors;
• the problems related to the training of bankruptcy commissioners and their affiliation to certain creditors became more urgent.
While in the period in which the first law on insolvency was in force (1992 through 1998), the institution of bankruptcy was rather of the imitation nature, the second law (1998 through 2002) had even more distorted the situation turning the institution of bankruptcy from a method to instill financial discipline into a tool of redistribution of property and withdrawal of assets 74. There was observed a paradoxical situation: the enterprises of rather safe financial standing were involved in bankruptcy procedures (since there existed the favorable chance to seize control over such enterprises on the part of competitors), while hopelessly loss making enterprises avoided these proceedings (since there was no one wishing to seize these enterprises and there were low chances to collect debts in the course of bankruptcy proceedings).
In fact, in 1998 through 2002 initiation of bankruptcy proceedings was a low cost (in the case of a potential collusion of the bankruptcy commissioner and creditors, arbiters, and FSFR officials) alternative to hostile takeovers carried out via the buy up of shares on the secondary market. In this relation it is interesting to suggest that there was a direct connection between the enactment of the law "On insolvency (bankruptcy) in 1998 and the low level of the resistance demonstrated by the Russian stock market in 1998 through 200075. It is significant that the law "On joint stock companies" provides numerous legal opportunities to efficiently repulse corporate aggressors in the framework of corporate law, while the bankruptcy proceedings existing in 1998 through 2002 practically ensured the success of the aggressors.
The analysis of 100 bankruptcy cases carried out by FSFR revealed that with respect to about one third of enterprises creditors were interested to change owners rather than collect the debts. In 2000, FSFR and its territorial agencies carried out 388 expert appraisals aimed at the detection of fraudulent and fictitious bankruptcies, and in 156 cases there were revealed the respective indications76. Such offences were also directly related to the tax payment situation. According to FSFR77 evaluations, each fifth bankruptcy case had the indications of premeditated criminal actions (in particular bankruptcies aimed at write down of debts). At the same time, in accordance with the data collected in 2002, only 5 out of 2000 initiated bankruptcy cases resulted in convictions78.
73 A systemic toughening of budget constraints started only in the second half of 2001 in relation to the launch of a campaign for restructuring of the debts of enterprises related to mandatory payments.
74 See: Radygin A., Simachev Yu. Bankrotstva (Bankruptcies). - In: Ekonomika perekhodnogo perioda. Ocherki eko-nomicheskoi politiki postkommunisticheskoi Rossii 1998 - 2002. M., Delo, 2003, pp. 498 - 512.
75 See: Volkov A., Privalov A. A nu-ka otnimu! (Why Don't I Try To Take It Away!) - In: Ekspert, 2001, No. 1 - 2, pp. 28 - 29.
76 See: FSFR final report for year 2000.
77 Since September of 1993, in Russia there had been operating the Federal Administration for Insolvency (Bankruptcy) (FAIB) under the RF State Committee for Management of State Property, in March of 1997 there was set up the Russian Federal Service for Insolvencies and Financial Rehabilitation (FSIFR), which in June of 1999 was reorganized as the Russian Federal Service for Financial Rehabilitation and Bankruptcies (FSFR). Since March of 2004 the FSFR functions were distributed across several state bodies.
78 See: Sliyaniya i pogloshcheniya (Mergers and takeovers) // Zhurnal dlya aktsionerov. 2002. No. 6. P. 15.
It should be noted that sometimes the state also used the threat of bankruptcy as a tool to exert pressure on enterprises in order to make them repay the tax related debts or for other non-economic purposes. On the whole, the state actively used the institution of bankruptcy in the 2000s. The state, as represented by the tax authorities, attempted to "clear the field" of abandoned enterprises, and, as represented by FSFR, to intimidate the debtors defaulting on payments to budgets and other mandatory payments. In 2002, the state authorities submitted 90 per cent of bankruptcy claims against debtors. It seems that the tax authorities made haste to take advantage of the opportunities, yet available in 2002, to use bankruptcy proceedings for the liquidation of "empty" enterprises.
FSFR still played a considerable role as concerns the initiation of bankruptcy proceedings. According to our estimates, in 2002 in the case the bankruptcy claims submitted by the tax authorities were excluded, the share of FSFR in the total number of claims against "substantive" debtors made about 30 per cent.
However, private structures rather used the institution of insolvency as a tool of redistribution of property, reorganization of enterprises, and interception of control. The first two ways of the use of the institution of insolvency were determined by dynamically progressing integration processes, the necessity to carry out organizational restructuring of enterprises, and lower (as compared to other methods) costs associated with the application of bankruptcy procedures. The third method could be used due to a large number of opportunities for falsifications and machinations in the framework of management procedures. The significant shifts occurring in the sphere of protection of the rights of minority shareholders generated additional demand for bankruptcies as an efficient tool suitable for the settlement of various corporate problems: from ensuring the protection of managers from owners to carrying out hostile takeovers.
However, in spite of the fact that on the whole the Russian law "On insolvency (bankruptcy)," which was in force in 1998 through 2002, was a rather progressive document from the viewpoint of international practices and maintained a certain balance of interests of debtors and creditors, the practical implementation of its provisions became one of the most odious manifestations of discrimination of the rights of certain participants of the process (depending on the concrete situation it could be owners of enterprises or various creditors, including the state). Over the last few years, the major substantive criticism of the Russian institution of insolvency was aimed at the practices of bankruptcy of large economically and socially important enterprises, the large scale use of bankruptcy procedures for mala fide purposes, and infringements on the interests of the state as a creditor and owner.
Evidently, it was necessary, on one hand, to ensure protection of creditors' rights in the process of bankruptcy of enterprises, but also, on the other hand, to prevent the use of simplified schemes of mala fide interception of control over debtor enterprises (or parts of their assets) via bankruptcy procedures. During the whole period, when the second law on insolvency was in force, there were being taken attempts to improve its provisions79. A considerable part of proposals concerning the reform of the legislation resulted from the insufficiently developed enforcement infrastructure (dependence of arbitration courts of local governments, the professional level of judges, etc) rather than the imperfection of the regulations being in force at that time.
79 See, for instance: Radygin A. Soprotivleniye korporativnomu agressoru (Resisting a corporate aggressor) // Dlya aktsion-erov. 2002. No. 4. P. 26 - 28.
In the second half of 2001, there were formed the prerequisites for a radical reform of the institution (legislation on) insolvency. At the governmental level, there were registered the following most urgent problems in the sphere of bankruptcy (insolvency):
• infringement on the rights of debtors and founders of debtor enterprise (initiation of bankruptcy proceeding on the basis of false documents or an insignificant amount of debt without giving debtors a chance to repay these indebtednesses, the fact that founders of debtor enterprises were deprived of the opportunity to carry out creditor-controlled rehabilitation after the initiation of bankruptcy proceedings;
• infringement on the rights of the state as the creditor with respect to tax payments;
• withdrawal of debtors' assets in the interests of certain groups of creditors in the framework of external management and bankruptcy proceedings;
• insufficient protection of the rights of creditors;
• widespread practices involving the use of premeditated bankruptcies as a tool of uncivilized seizure of property;
• non-transparency and insufficient regulation of bankruptcy proceeding permitting bankruptcy commissioners and other participants of bankruptcy proceedings to abuse the respective flaws;
• absence of efficient mechanisms bringing to responsibility mala fide and inefficient bankruptcy commissioners;
• insufficiently clearly defined status of self-regulating organizations of bankruptcy commissioners, terms of membership, guarantee funds;
• possibility of emergence of conflicts of interests as concerns authorized state agencies, the lawfulness and consequences of proposed broader powers;
• settlement of such an issue as the complete elimination of the powers of arbitration courts (which should bear no responsibility) powers to take any decisions concerning the selection and professional level of bankruptcy commissioners and decisions (approval of decisions) with respect to the assets of enterprises;
• settlement of the issue of the principal exclusion of such procedures as "external management" and "financial rehabilitation";
• existence of unfair specifics of bankruptcy as concerns all enterprises of the fuel and energy complex in the absence of legislatively fixed specifics of bankruptcy;
• absence of reasonable mechanisms of bankruptcy as concerns the enterprises of the defense industrial complex and natural monopolies;
At the same time, in many cases the ideas about possible ways to settle the problems indicated above turned out to be antipodal. The state authorities had no common concept with respect to the transformation of insolvency regulations.
The heated discussion concerning the new - already third - law on bankruptcy was primarily related to the flaws of this law (as of any other law) in the general institutional context of problems of corruption, redistribution of property, arbitrary administration, and incompetence of various state structures. As a result, the new - third - federal law No. 127 FZ approved on October 26, 2002, "On insolvency (bankruptcy)" contains the following principal innovations.
1. Reduction of risks of misuse of the rights on the part of creditors. Initiation of bankruptcy proceedings on the basis of creditors' claims is possible only in the case the creditor presents the writ of execution indicating that the creditor has taken an attempt to collect the debt in the framework of executive proceedings and that all attempts taken by the bailiffs within 30 days after the court ruling about the recovery of the debt have failed, so the bankruptcy proceedings with respect to the debtor is the means of last resort for the creditor to collect the debt. 388
2. Granting of equal rights to the state and other creditors in the course of bankruptcy proceedings, consolidation of state claims. The law equalized the rights of the state and the rights of other creditors in the course of bankruptcy proceedings. The state had obtained the rights to vote at all meetings of shareholders via its authorized agency and participate in the meetings of the creditors' committees, at the same time, the priority of the claims of the state was made equal to that of other creditors in the course of bankruptcy proceedings.
3. Enhancement of the mechanisms aimed at the protection of bona fide owners. Owners of debtor enterprises were accepted as participants of bankruptcy proceedings. The law stipulates the right of representatives of owners of debtor enterprises to appeal against the claims of creditors, as well as the right of the debtors, owners of debtor enterprises, and any third parties on the condition of approval on the part of bankruptcy commissioners, to stop bankruptcy proceedings at any stage by repaying the debts of debtor enterprises.
4. Introduction of a new procedure - financial rehabilitation. In certain situations, this procedure should permit the founders (partners) of the debtor to keep control over the fate of the enterprises even in the case there are initiated bankruptcy proceedings. There were enhanced mechanisms of support of the debtor's business, in particular, there was envisaged the option to revert bankruptcy proceedings to external management in the case there is a real opportunity of restoration of solvency and additional issue of stocks during external management on condition of approval of such an issue by the debtor's owner.
5. Protection of bona fide participants of bankruptcy proceedings from mala fide actions taken by third parties. There are envisaged the following innovations: it is prohibited to initiate new bankruptcy proceedings against the debtor within 3 months since the date of conclusion of the amicable settlement; there is introduced the possibility to appeal against determinations issued in the course of bankruptcy proceedings basing on the results of disputes between the parties participating in the case; there is improved the procedure governing the sale of debtors' properties; there is stipulated that in the cases where the balance sheet value of property confirmed by an independent appraiser exceeds a certain level, the tender for the sale of the debtor's property should be public on the mandatory basis.
6. Enhancement of efficiency of control over the actions of bankruptcy commissioners. One of the most important objectives is the introduction of efficient supervision over the actions of bankruptcy commissioners due to the abolition of licensing of such activities. The whole system of responsibility and supervision of bankruptcy commissioners' activities is radically changed. The supervisory functions with respect to bankruptcy commissioners were transferred from the state as represented by FSFR to non-for-profit self-regulating organizations (SRO). The law vests with SRO the right to take disciplinary measures with respect to their members, including the expulsion from the number of members of SRO, and to submit to arbitration courts applications to suspend their members from participation in bankruptcy proceedings in the capacity of arbitration commissioners. The law introduces property qualification with respect to bankruptcy commissioners - the amount of the lump sum fee each bankruptcy commissioner should pay to the compensatory fund of the SRO the commissioner joins. The law stipulates that the civil liability of bankruptcy commissioners should be on mandatory basis insured by the insurance companies accredited by SRO.
7. Setting of specifics of bankruptcy of certain debtors' categories in one law. The law envisages certain specifics of bankruptcy for organizations related to defense industry and subjects of natural monopolies. The law has abolished the "inability to pay" criterion
applicable to subjects of natural monopolies; however, it does not set forth any special insolvency criteria with respect to organizations of the military industrial complex, subjects of natural monopolies, and other organizations of serious social, economic, and strategic importance. Therefore, the latter will be subject of the same criteria of insolvency based on the "inability to pay" principle as other categories of debtors. The specific feature here is the external indications of insolvency: bankruptcy proceedings with respect to such organizations should be initiated if their indebtedness makes Rub. 500 thousand delayed by 6 months. Besides, as concerns strategic enterprises, the law grants the state the right to suspend the sales of property for a certain period in order to elaborate proposals aimed at the restoration of such organizations' solvency, including the switching to the procedures of financial rehabilitation.
8. Constrains on too broad use of bankruptcy proceedings as concerns liquidation of absent debtors. The law stipulates that bankruptcy procedures with respect to absent debtors should be applied only in the case the budget has available the respective funds.
In 2004, the alignment of forces of the respective authorities engaged in the regulation and practical enforcement of bankruptcy procedures principally changed80. Accordingly, the problem of further division (coordination) of the functions performed by different authorities in the sphere of insolvency became more urgent. The distribution of key functions and powers concerning the regulation an practical implementation of the institution of bankruptcy among executive authorities is presented in Table 581. In 2004 and 2005, there were observed two most pronounced trends: first, the trend towards a reduction in the number of "poles" of regulation in this sphere after their "atomization" in the course of the liquidation of the Federal Service of Financial Rehabilitation (FSFR) 82, and, second, towards an enhancement of Federal Tax Service (FTS) powers.
Table 5
Modification of functions and powers of executive authorities in the sphere of insolvency in 2004 and 2005
Functions
01.01.2004
01.01.2005
Regulation in the sphere of insolvency of enterprises
Decisions about submission of bankruptcy claims against debtors
FSFR of Russia
As concerns debtors of Category A -the RF Government, the Chairman of the RF Government, or the Deputy Chairman of the RF Government acting on instructions of the Chairman of the RF Government.
RF Ministry of Economic Development and Trade FTS of Russia
The procedures governing the process of taking of decisions with respect to bankruptcy claims referring to the debtor included in the list of strategic enterprises and organizations is set forth by the RF Ministry of Economic
80 Decree of the RF President No. 314 of March 9, 2004, "On the system and structure of federal executive authorities" in particular envisaged the liquidation of FSFR and the RF State Property Ministry, creation of the Federal Agency for Management of Federal Property (FAMFP) and transfer of certain FSRF functions to FAMFP, transfer of the functions related to the approval of regulatory legal acts on the issues being in the FSFR competence to the RF Ministry of Economic Development and Trade, reorganization of the RF Tax Ministry in the Federal Tax Service, transfer of the FSFR functions relating to the representation of the interests of the Russian Federation with respect to creditors in bankruptcy proceedings to the Federal Tax Service.
81 Prepared by M. G. Kuzyk.
82 In a certain sense, this situation may be interpreted in terms of the theorem on the minimal production of entropy advanced by I. Prigozhin (1945), according to which any system always tend to a "stationary state corresponding to the minimal production of entropy compensating the impact of external relationships producing negative entropy." (For details see, for instance, Alekseyev N. S. Teoriya upravleniya "Epokhi bez zakonomernostei" (Theory of management in the "Age without regularities") // Menedzhment v Rossii i za rubezhom. 2000. No. 3). In other words, each system (in this case the system of regulation of the institution of bankruptcy) in accordance with the principle of internal resource conservation tends to the state of equilibrium with the maximal level of disorganization permitted by external destructive impacts, to which the system has to withstand.
As concerns debtors of Category B - Development and Trade FSFR of Russia on the basis of decisions taken by the interdepartmental commission
Choice of SRO in the case
of submission of bankruptcy claims against debtors
Voting at meetings of creditors
Execution of the powers of the owner of the debtor's property (as concerns federal state unitary enterprises (FSUE) in the course of bankruptcy proceedings
Supervision of SRO activities
FSFR of Russia
FSFR of Russia
As concerns the choice of bankruptcy proceedings - taking into account the opinion the respective executive authority of the RF subject and the local government
RF State Property Ministry
RF Ministry of Justice *
FTS of Russia
In accordance with the procedures set forth by the RF Ministry of Economic Development and Trade
FTS of Russia
In accordance with the procedures set forth by the RF Ministry of Economic Development and Trade As concerns the choice of bankruptcy proceedings - taking into account the opinion the respective executive authority of the RF subject and the local government
Federal Agency for Management of Federal Property (FAMFP)
Federal Registration Service (Rosregis-tratsiya)
* By 2005, the RF Ministry of Justice retained only rather modest powers as concerns the formation of commissions for organization and carrying out of theoretical examinations in accordance with the unified training program for bankruptcy commissioners.
The approval of a new law on bankruptcy, which has significantly modified the institution of insolvency, determined the necessity to revise the regulatory bylaws in this sphere. In 2002 through 2005, different state authorities issued more than 20 bylaws pertaining to the sphere of bankruptcy, however, the "tuning" of the new legislative mechanisms continues. At the same time, after the enactment of the new bankruptcy law there is required a period for formation of the respective infrastructure and its adaptation to new legislative regulations. It is also apparent that such "tuning" requires to take into account the specifics of real demand for institutional innovations, which would be adequate to the existing economic realities83. However, the practices of 2003 and 2004 indicate significant changes in the dynamics of respective cases, appearance of new important trends in the sphere of bankruptcy, revision of the significance of certain problems observed in the preceding period.
4.3.2. Practical implementation of the third law on bankruptcy (2003 and 2004)
Basing on the results of implementation of bankruptcy proceedings in 2003, there may be made certain preliminary remarks with respect to the problems related to the enforcement of the new law on insolvency. Naturally, due to the lack of formed court practices of enforcement of the provisions of the third law on insolvency, it may be considered that its potential is far from being exhausted; however, even now it is possible to form a judgment on the most noticeable miscalculations relating to the evaluation of the situation
83 See: Golikova V., Dolgopyatova T., Kuznetsov B., Simachev Yu. Spros na pravo v oblasti korporativnogo upravleniya: em-piricheskiye svidetelstva (Demand for corporate law: empirical evidence). Working papers series: independent economic analysis. No. 148. M.: MONF, 2003; Simachev Yu. Institut nesostoyatelnosti v Rossii: spros, osnovnye tendetsii i problemy razvitiyza (Institution of insolvency in Russia: demand, trends, and major problems) // Voprosy ekonomiki. 2003. No. 4.
in the sphere of enforcement of insolvency procedures and certain flaws in the provisions of the new law. Certain general trends are presented in Table 684.
Table 6
The dynamics of bankruptcy cases in Russia in 1998 through 2003
(second and third laws)
1998 1 999 2000 2001 2002 2003
Total number of bankruptcy claims against debtors 12 781 15 583 24 874 55 934 106647 14 277
Total number of bankruptcy claims against
debtors with the exception of claims against 11 604 12 367 15 523 21 170 25 396 12 148
absent debtors
Total number of initiated bankruptcy cases 10 000 11 000 19 000 48 000 94 531 9 695
Including monitored bankruptcy cases 4 893 5 940 7 959 8 548 10 739 5 351
Source: data presented by RF SAC, FSFR.
In 2003, the scale of application of bankruptcy proceedings sharply declined: the number of bankruptcy claims against debtors declined 7.5 times from 106647 cases in 2002 to 14277 cases in 2003 (see Fig. 2). Even a more dramatic decline was observed with respect to the claims resulted in initiation of bankruptcy proceedings - the number of such claims decreased 9.8 times from 94531 in 2002 to 9695 in 2003 (see Fig. 3).
120000 t
100000 --
80000 --
60000 --
40000 --
20000
106647
12781
1998 1999 2000 2001 2002 2003
Total number of claims
Number of claims without those against absent debtors
0
Fig. 2. The dynamics of bankruptcy claims against debtors
84 At the moment the work with this material was completed, the official statistics for year 2004 (RF Supreme Arbitration Court, etc) was not available.
The fact that tax authorities have practically stopped to accept bankruptcy claims against absent debtors accounts for about 85 per cent of this radical reduction in the number of bankruptcy claims. In 2003, there were registered only 2129 claims against absent debtors as compared with 81251 claims registered in 2002. It is an illustrative demonstration of the enforcement of the provisions of the third law on insolvency, which stipulates that bankruptcy procedures with respect to absent debtors should be applied only in the case budgets have available the respective funds; however, as it should be expected, no such funds were provided in the budget for year 2003.
On the whole, this result may be positively appraised, since it reduced the irrational burden on the system of arbitration courts. However, the problem of absent debtors has not been resolved by a legislation envisaging methods other than bankruptcy procedures. However, the problem of absent debtors per se has not been settled yet in the framework of legislation other than that concerning bankruptcies. Accordingly, the top officials of the RF Supreme Arbitration Court evaluate the nearest perspectives as rather pessimistic presupposing that in the near future there may be resumed actions aimed at the liquidation of about 1.5 million of actually absent enterprises and organizations by the application of simplified bankruptcy proceedings85.
100000 -r
90000 -80000 -70000 -60000 -50000 -40000 -30000 -20000 -10000 -0
I Initiated bankruptcy cases
Including monitored bankruptcy cases
1998 1999 2000 2001 2002 2003
Fig. 3. The dynamics of initiated bankruptcy cases
At the background of such a massive reduction of claims against absent debtors, the decline in the number of claims against "substantive" debtors does not look very significant; however, in reality the number of such claims decreased about two times. The number of initiated bankruptcy cases involving monitoring made 5351 in 2003 as compared
85 Yakovlev V. F. Itogi raboty arbitrazhnykh sudov v 2003 g. Osnovnye zadachi na 2004 g. (Arbitration courts: the results of work in 2003. Major objectives in 2004.) Verbatim record of the conference of heads of arbitration courts of the Russian Federation (February 11, 2004).
with 10739 cases registered in 2002. It seems that these developments resulted from more strict conditions of the registration of claims concerning insolvency. However, it is expected that this would be a rather short term effect as it is probable that many creditors have not yet subjected their debtors to executive proceedings.
On the face of it, a more sharp reduction of the number of initiated bankruptcy cases in comparison with the decline in the number of bankruptcy claims against debtors may be interpreted as a more strict approach of courts to the submitted claims (see Fig. 4). However, the growth in the number of initiated bankruptcy proceedings observed in 1999 through 2002 was related to the increase in the specific weight of the number of claims against absent debtors; therefore, in 2003 the activity related to the initiation of cases governed by simplified procedures sharply declined, while the share of dismissed claims increased.
120000
100000
80000
60000
40000
20000
100 90 80 70 60 50 40 30 20 10 0
1998 1999 2000 2001
2002 2003
i i Number of bankruptcy
claims against debtors (left scale)
i i Number of initiated bankruptcy cases (left scale)
The rate of initiation of claims in % of the total number of submitted claims
The specific weight of claims against absent debtors in % of the total number of claims (right scale)
Fig. 4. The rate of initiation of bankruptcy proceedings against debtors
On the whole, the "exclusiveness" of the application of bankruptcy procedures has significantly increased. On the face of it (judging by the number of submitted claims and the share of claims against absent debtors in this number), the scale of application of bankruptcy procedures in 2003 reminds of the situation existing in 1998 and 1999.
0
The law on insolvency continues to rather successfully "compete" with the Law on privatization as concerns the liquidation of unitary enterprises86. Although in 2003 the number of bankruptcy claims initiated against "substantive" debtors declined two times in comparison with the figures registered in 2002, the number of SUEs, with respect to which there were taken decisions to initiate bankruptcy proceedings, did not decreased so significantly - from 643 in 2002 to 511 in 2003 (see Fig. 5). According to the top officials of the Federal Agency for Management of Federal Property87, as soon as there appear plans to privatize a SUE, its assets are diluted, and its managers themselves initiate its bankruptcy.
2940
2045
891 H
764 ■
428 496 i— I
-281
3500 3000 2500 2000 1500 1000 500
0
1998 1999 2000 2001 2002 2003 year year year year year year
Fig. 5. The dynamics of bankruptcy proceedings with respect to unitary enterprises
The practices of enforcement of the third law on insolvency in 2003 do not permit to indicate any positive shifts in the solution of reorganization and rehabilitation problems in the course of implementation of bankruptcy procedures (see Fig. 6 - 7). In about 70 per cent of cases, the monitoring procedures resulted in the initiation of bankruptcy proceedings. The trend towards a decline in the both the number, and the share of rulings initiating external administration persisted (547 cases in 2003 as compared with 931 cases in 2002). There was observed a significant decline in the number of approved amicable settlements: from 145 in 2002 to 54 in 2003.
At the same time, there was observed a significant increase in the share of rulings dismissing bankruptcy claims against debtors and the share of rulings terminating proceedings related to bankruptcy cases, what is an evidence of a growing role played by arbitration courts as concerns the protection of interests of potentially solvent enterprises.
5 In 2000 through 2003, there were privatized about 500 FSUEs.
' Interview of V. Nazarov, the Head of the Federal Agency for Management of Federal Property // Vedomosti. 2004. May 18.
Only due to these factors the bankruptcy bias of monitoring procedures has somewhat diminished.
The procedures of external administration proved to be even less suitable both for the achievement of amicable settlements, and for recovery of enterprises' paying capacities. In 2003, more than 90 per cent of external administration procedures resulted in rulings initiating bankruptcy proceedings. The trend towards a decline in the number of amicable settlements persisted (53 cases in 2003 as compared with 121 cases in 2002), while financial rehabilitation of enterprises was achieved only in few cases (only 28 cases).
□ On termination of proceedings concerning bankruptcy cases
□ On dismissal of bankruptcy claims against debtors
□ On introduction of external management
□ On bankruptcy of the debtor and start of bankruptcy proceedings
Fig. 6. Monitoring: the structure of decisions taken On the whole, taking into account all "stages" of bankruptcy proceedings, in 2003 there were registered about 230 cases where businesses were "rehabilitated": 170 proceedings were terminated after the conclusion of amicable settlements and 56 bankruptcy proceedings resulted in the rehabilitation of debtors and satisfaction of debtors' claims.
Therefore, in spite of enhancement of the mechanisms aimed at the preservation of the debtors' businesses (the third law on bankruptcy in particular envisages the option to revert bankruptcy proceedings to external management in the case there is a real opportunity of restoration of solvency and additional issue of stocks during external management on condition of approval of such an issue by the debtor's owner) there are hardly observed positive shifts. The practice of enforcement of insolvency procedures in 2003 indicates that the bankruptcy bias persists and even increases.
It is apparent that in the course of elaboration of the provisions of the third law on bankruptcy the wish of owners to rehabilitate and develop debtors' businesses was overestimated. It has been assumed that the major part of bankruptcies does not result in amicable settlements only due to the fact that owners have no possibility to repay the indebtedness of enterprises and carry out their rehabilitation. Provisions of the third law on insolvency introduced owners of debtor enterprises as participants of the process. Besides, the law stipulates the right of the debtors, owners of debtor enterprises, and any third parties on the condition of approval on the part of bankruptcy commissioners, to stop bankruptcy proceedings at any stage by repaying the debts of debtor enterprises. The law
introduced a new procedure - financial rehabilitation, which in certain situations should permit the founders (partners) of the debtor to keep control over the fate of the enterprises even in the case there are initiated bankruptcy proceedings. However, it seems that all these innovations are in low demand. The procedures of financial rehabilitation have been introduced only in 10 cases. The procedures of external management have resulted in satisfaction of the claims filed by creditors only in 28 cases. Only in 19 cases the bankruptcy proceedings have been reverted to external management.
□ Proceedings terminated because of restoration of solvency
□ Proceedings terminated after the conclusion of amicable settlements
□ There were taken decisions on bankruptcy of the debtor and start of bankruptcy proceedings
Fig. 7. External management: the structure of decisions taken
From the authors' point of view, the practical implementation of the third law on insolvency in 2003 indicates the fallibility of the actively discussed in 2001 and 2002 assumption that in the framework of bankruptcy proceedings there occur mass infringements on the rights of debtors and their owners, who are "prevented" to rehabilitate enterprises and repay the debts.
i i Specific weight of disputes in % of the total number of reviewed cases (left axis)
Specific weight of disputes in % of the total number of reviewed cases with the exception of proceedings carried out in accordance with simplified procedures (left axis)
~ "Number of applications, complaints, and claims submitted during the year (right axis)
Fig. 8. Evaluation of the disputableness of bankruptcy proceedings
In 2003, there was registered a sharp increase in the number applications and complaints in the framework of bankruptcy cases, there was also observed an increase in the level of "disputableness" of insolvency cases; however, it was the result of not only the "innovation nature" of the law on insolvency (see Fig. 8). The provisions of the third law on bankruptcy have significantly enhanced the possibility to appeal in the course of conduct of bankruptcy cases, for instance, there has been introduced the right of representative of owners of debtor enterprises to appeal against the claims of creditors and stipulated the possibility to appeal against the determinations issued in the course of bankruptcy proceedings basing on the results of disputes between the parties participating in the case.
At the same time, it should be noted that out of the total number of appellations and complaints submitted in the course of the conduct of bankruptcy cases 60 per cent of such appellations and complaints concerned the determination of the amounts of creditors' claims. Therefore, in spite of the declared purposes, the third law on insolvency retained a rather wide field for different interpretations of principles set forth with respect to the determination of creditors' claims.
The trends noted above were also characteristic in 2004. According to the data presented by the RF Ministry of Economic Development and Trade, as on September 1, 2004, the number of bankruptcy cases examined by Russian arbitration courts declined two times (to 48833) as compared with the respective figure registered in 2002. As it has been
noted above, a sharp decline (including the data for year 2004) of the number of bankruptcy claims against debtors was to a significant extent related to the "freezing" of the state activity as concerns the initiation of bankruptcy procedures since March of 2004 because of the administrative reform and the necessity to provide budgetary funds for the payment of bankruptcy procedures related costs. At the same time, about 50 per cent to 60 per cent of the consolidated debts of enterprises undergoing the bankruptcy procedures are due to the state. The changes in this situation (including the solution of administrative, legal, and financial issues) will result in a sharp increase in the number of bankruptcies.
In particular, this also means that in the near future the state will become the major "contractor" of bankruptcies and the issues relating to the criteria of initiation of such cases become extremely urgent at present. For instance, in the autumn of 2004 there started a heightened discussion concerning the plans of FTS to initiate bankruptcy of 170 "strategic" enterprises related to the defense and military complex and double purpose technologies. At the same time, in the process of transfer of powers in the sphere of bankruptcy from FSFR to FTS the latter refused to accept the elaboration of expert reports about the presence or absence of indications of deliberate bankruptcy. The extreme statements in this discussion implied that FTS wished to initiate artificial bankruptcies for the purposes of redistribution of property88.
The problem of fraudulent and deliberate bankruptcies remained urgent in 2003 and 2004. According to the data presented by FSFR, in 2002 there were revealed 457 cases of deliberate and fraudulent bankruptcies and 417 such cases in 2003. It should be noted that in 2002 through 2004 there were initiated about 300 respective criminal cases, however, only 20 were examined in courts, and only 12 of them resulted in convictions. Due to the introduction of more complicated procedures governing the initiation of bankruptcy proceedings and restriction of the discretion of bankruptcy commissioners, since 2003 the number of "contracted" bankruptcies (according to the FSFR estimates) has significantly declined in 2003 and 200489; however, there were implemented corporate procedures (withdrawal of assets is carried out prior to bankruptcy). This problem is rather urgent as concerns state unitary enterprises, especially those included in yearly privatization plans. According to certain estimates, up to 10 per cent of such state unitary enterprises (included in privatization plans) go bankrupt within a year, while 70 per cent to 80 per cent of assets of such enterprises are withdrawn prior to bankruptcies90.
As a result, as it is demonstrated by the practices of 2003 and 2004, since the enactment of the provisions of the new law on bankruptcy the role of this institution in the sphere of seizure of assets has significantly declined. However, it means only that the respective "burden" was transferred to the traditional market of corporate control (hostile takeovers via purchase of shares or other actions related to the company's shares) and the sphere of executive proceedings. According to the provisions of the new law, the creditor has the right to submit the bankruptcy claim against the debtor only in the case the law enforcement officers failed to exact the
88 Bankrotstva i skandaly (Bankruptcies and scandals) // Sliyaniya i pogloshcheniya. 2004. No. 12. P. 15.
89 According to the FSFR data for year 2001, after the "sifting out" of the cases of absent debtors there remained about 21 000 "substantive" cases, one third of which (i.e. 7 000) were of "contracted" nature. (An interview with T. Trefilova - Kom-mersant, 2004, February 13).
90 Pervyi god deistviya novogo zakona o bankrotstve: resultaty i perspektivy. (The first year of enforcement of the new law on bankruptcy: results and perspectives). The materials of the conference of the RF Commerce Chamber, the RF SAC, and the RF State Duma, February 24, 2004.
debt. There is formed a situation, where all assets of a company may be purchased via bailiffs without initiation of the bankruptcy proceedings 91.
Below, there are presented certain general evaluations of the impact of the insolvency institution on the demography of organizations (see Table 7) 92. On the whole, about 145 thousand of organizations ceased their operations in the period from July 1, 2002 till July 1, 2004; at the same period there were created almost 600 thousand of organizations. In 77 per cent of these cases, the cessation of operations of legal entities related to their liquidation and only in 20 per cent of cases - to reorganization. In the majority of cases, the liquidation of organizations (72 per cent of the total number of such organizations) was related to bankruptcy procedures. On the whole, in 2 years 4.7per cent of the total number of organizations as on July 1, 2002, was liquidated via bankruptcy procedures.
Table 7
Liquidations involving bankruptcy procedures
The share of organizations liqui-Number of legal entities liquidated dated via bankruptcy procedures via bankruptcy procedures in the in % of the number of organiza-period: tions at the beginning of the pe-
riod:
July 1, 2002 -September 30, 2003 October 1, 2003 -July 1, 2004 July 1, 2002 -September 30, 2003 October 1, 2003 -July 1, 2004
All legal entities 47 531 32 729 2,8 1,6
Limited liability companies 14 035 9 575 1,6 0,8
Joint stock companies (open, closed) 3 760 3 223 2,5 1,9
Production cooperatives 1 346 1 302 5,5 5,1
Unitary enterprises 241 228 1,7 1,4
As concerns the sectoral structure (basing on the data for the first ten months of 2004), the largest number of bankruptcies was registered in the sector of trade, public catering, and consumer services (what is not surprising taking into account the fact of the absolute quantitative domination of these enterprises). These enterprises were followed by agricultural and industrial enterprises. The significance of bankruptcy procedures in the course of liquidation of organizations depend on their organizational and legal forms: the bankruptcy processes were more intensive among production cooperatives and joint stock companies. The observed decline in the significance of bankruptcy procedures and liquidation of enterprises in the period from October 1, 2003 till July 1, 2004, is related to both a lesser duration of the observation period, and the fact that over all this period (in contradistinction to the first period) there was in force the third law on bankruptcy. Accordingly, in this period there was most clearly indicated the sharp reduction of practices of submission of bankruptcy claims against absent debtors. It should be noted that this decline of the role played by bankruptcy procedures and liquidation of enterprises were not proportional across the groups of legal entities depending on their organizational and legal forms. The less intensive use of bankruptcy procedures became the most significant for limited liability companies (in this group there were observed much more "abandoned" firms and eph-
91 See: Vyshegorodtsev I. Chto budet s bankrotstvami (What will happen to bankruptcies) // Sliyaniya I Pogloshcheniya, 2005, No. 1, p. 59.
92 For evaluations, there were used the data on the state registration of legal entities in the Single State Registry of Legal Entities carried out in 2002 through 2004 presented by the Russian Tax Ministry.
emerid companies) and least significant for production cooperatives and unitary enterprises.
4.3.3. Perspectives of modification of the institution of bankruptcy
The problem of protection of the rights of both debtors and creditors in the course of bankruptcy proceedings is of the principal importance as concerns the creation of incentives for investment activities of Russian enterprises. This problem should be settled in an integrated way in the framework of contractual law, bankruptcy proceedings, tax regulation, and executive proceedings.
However, it should be noted that there are no ideal laws, which could settle the problem in a moment, instantly. Experts in the field of law note that in foreign countries regulation of insolvency is a most dynamically developing sphere of law, since the economies of states require constant modernization of the respective provisions. Moreover, a similar approach is the objective necessity for the transitional economy of Russia.
In about one year after the enactment of the new law on bankruptcy there was started a work on its improvement and, what is equally important, the harmonization of other legal acts with this law. For instance, in 2003 and 2004, the RF Government approved on the whole the following areas of modification of the bankruptcy law presented by the RF Ministry of Economic Development and Trade and the RF Justice Ministry:
• improvement of the criminal and administrative legislation and bankruptcy legislation as concerns the responsibility for offences and crimes related to bankruptcy;
• determination of the procedures and terms of participation of the authorized agencies in the procedures of financial rehabilitation and amicable settlement of bankruptcy cases;
• modification of the law on bankruptcy as concerns the more clear definition of current payments, requirements pertaining to the bankruptcy commissioner, consequences of the dismissal of the bankruptcy commissioner, the status of compensatory funds and mutual insurance societies, the procedures governing the sale of property in the framework of financial rehabilitation or external administration, development of self-regulation;
• creation of the legal framework of the procedures of bankruptcy, financial rehabilitation, and amicable settlements;
• introduction of the option of the amicable settlement in bankruptcy cases, where the Russian Federation is the major creditor;
• expansion of the circle of legal entities subject to bankruptcy procedures;
• harmonization of the issues of priority of satisfaction of creditors' claims with the bankruptcy legislation currently in force;
• protection of property from criminal offences, prevention of crimes and offences via the improvement of provisions of the RF Criminal Code and RF Code of Administrative Offences setting forth the responsibility for offences related to bankruptcy procedures and pre-bankruptcy operations.
The same guidelines were indicated in the Program of social and economic development of the RF in a medium term outlook (2005 through 2008) worked out by the RF Ministry of Economic Development and Trade and being elaborated in November of 2004 through January of 2005. In January of 2005, the RF Government approved a package of draft laws aimed at the improvement of the legislation on bankruptcy and introducing amendments to the law "On insolvency (bankruptcy)," the RF Criminal Code, the RF Code
of Administrative Offences, the RF Tax and Budget Codes. Among the approved innovations, there should be noted the following:
• more precise definition of provisions of the RF Criminal Code concerning premeditated (deliberate creation of insolvency by the manager or owner of an enterprise for personal gain) and fictitious bankruptcies, as well as and mala fide actions taken in the course of bankruptcies (for instance, concealment of information about property liabilities of the debtor);
• toughening of criminal responsibility of managers (the term of imprisonment for premeditated bankruptcy was increased from 3 to 6 years);
• introduction of responsibility for obstruction of actions taken by bankruptcy commissioners;
• introduction of provisions permitting FTS to grant debtors deferrals or respites with respect to tax arrears for periods up to 1 year in the case of amicable settlements in the RF Tax Code (at present the sate has no rights to grant such deferrals, what brings to naught the possibility to start the procedures of financial rehabilitation);
• introduction of responsibility of self-regulating organizations (SRO) of bankruptcy commissioners, including material responsibility, as concerns the conscientious of commissioners and correctness of bankruptcy proceedings.
In perspective (in 2005 and 2006), it is envisaged to introduce such innovations as subsidiary property liabilities of debtors' managers and imposition of the burden of proof of innocence on managers (for instance, in the cases where withdrawal of assets from bankrupt enterprises was ordered by owners). At present, creditors should prove in courts the unlawfulness of transactions provoking bankruptcies. Among other problems, which should be settled, there are the following: dispute of transactions in the framework of bankruptcy cases, detection of interdependent persons in bankruptcy proceedings, bankruptcies of agricultural organizations, broker companies, insurance firms, private pension funds, etc93.
A separate problem is the bankruptcy of so called strategic enterprises. Although official lists of strategic enterprises intensively change every year, the total number of such enterprises traditionally remains at a high level, and it is hardly adequate to real requirements as concerns such restrictions. According to evaluations presented by the RF Ministry of Economic Development and Trade, some of these enterprises are "phantoms" absent even in the register of legal persons, while the share of the state in such enterprises makes 4 per cent. In this connection, the primary objective is to shorten this list. However, the more precise definition of the lists of strategic enterprises and more detailed determination of respective bankruptcy proceedings are traditionally delayed, although the lack of clear procedures apparently will not permit to apply measures envisaged in the legislation on bankruptcy to this group.
A special problem is so called subjects of natural monopolies in the fuel and energy complex. According to the law "On bankruptcy" being in force since January 1, 2005, the law "On the specifics of insolvency (bankruptcy) of subjects of natural monopolies in the fuel and energy complex" should be abolished and the provisions of item 6, article IX, of the law "On bankruptcy," which stipulate respective procedures applicable to the subjects of natural monopolies, enacted. In December of 2004, the State Duma Property Committee recommended that the law "On the specifics of insolvency (bankruptcy) of subjects of natural monopolies in the fuel and energy complex" should be in force until July 1, 2009.
93 There were used the materials presented at the official web site of the RF Ministry of Foreign Development and Trade (www.economy.gov.ru), PD Kommersant of January 20, 2005 (www.kommersant.ru), and the LIN.RU project (www.lin.ru).
According to the Committee, this time horizon is needed because of the estimated terms of reorganization in electrical power engineering and natural gas industry.
The planned changes seem to embrace a rather wide range of flaws and gaps of the law on bankruptcy and in the case these amendments are approved, they may significantly improve the quality of the new law. However, there remain significant possibilities for further modification of the law.
First, in the framework of the third law on bankruptcy there remains the risk of rise in corruption due to the "trade" with the state votes as concerns the decisions taken at the meetings of creditors, as well as the risk of higher activity of local governments as concerns hidden nationalization and redistribution of enterprises' property in favor of third parties. From the authors' point of view, in the cases of state participation in bankruptcy proceedings concerning large economically and socially important enterprises it would be feasible to envisage the creation of Boards of authorized representatives of the state in order to ensure the balanced representation of different state interests.
Second, direct participation of the state in amicable settlements may significantly increase the risk of bias in favor of certain enterprises. In this connection, it is necessary to create a transparent and exhaustive legal framework (the Tax and Budget Codes) of the terms, on which the state may participate in amicable settlements.
Third, as concerns the initiation of bankruptcy proceedings, at present the state (the executive authorities) is guided by the principles, which are non-transparent not only for market operators, but for the executive authorities as well, what sharply increases investment risks due to the unpredictable results of application of bankruptcy proceedings with respect to concrete enterprises. It is necessary that the state works out its own criteria of initiation of bankruptcy proceedings with respect to debtor enterprises, which would concern only a limited number of industrial enterprises and could be consistently implemented in practice.
Fourth, the problem of state debts to enterprises, for instance, as concerns the payments related to state procurement, remains partially unsettled. In a number of cases, this resulted in enterprises' indebtedness to budgets. It seems feasible to supplement the law on bankruptcy with provisions stipulating that authorized agencies or local government should have no right to submit to arbitration courts creditor claims on behalf of the Russian Federation, RF subjects, or municipal entities in the case the debtor has debtor indebtedness to the budget of the respective level. However, this way is possible only on condition that interbudgetary liabilities are fully met, otherwise there are inevitable conflicts, where local governments might claim that they could not make respective payments to enterprises due to delayed and (or) not full transfers from the federal budget.
Fifth, the new law on insolvency, similarly to the previous one, contains provisions on pretrial rehabilitation, which have not been implemented in practice yet (article 31). Although the new law on bankruptcy does not contain provisions envisaging that the state should include the respective expenditures in the federal budget does not mean that such expenditures should not be preliminary estimated in the budget. Therefore, there arises the problem of evaluation of the minimal amount of expenditures to be included in the budgets for the purposes of pretrial rehabilitation. Besides, there should be determined the limited group of enterprises, with respect to which the state is ready to carry out the pretrial rehabilitation in a certain unfavorable situation and, what is very important, there should be preliminary determined the amount of liabilities of the debtors to the state in the course of pretrial rehabilitation.
Sixth, the new law on insolvency introduces the new bankruptcy procedure - financial rehabilitation (Section 5, articles 76 - 92). This procedure may become an important
tool of rehabilitation and reform of enterprises under control of their owners (including the state as a shareholder). At the same time, it should be taken into account that this procedure may be introduced by arbitration courts without consent of creditors (items 2, 3 of article 75, item 1 of article 80). However, at the same time the plans of financial rehabilitation and the schedule of debt repayment prepared by owners should be approved by the meeting of creditors. It is necessary to correct the following principle flaw of the law: it fails to stipulate, what possible decisions may be taken in the case the meeting of creditors refuses to approve the plan of financial rehabilitation (what is highly probable in the case the meeting of creditors is against the introduction of this procedure).
Seventh, in the course of bankruptcy proceedings the exchange of enterprises' debts for the shares transferred to creditors could became a rather efficient mechanism aimed at the preservation of businesses of large economically and socially important enterprises. The previous law on insolvency did not determine the questions of additional issues of shares. However, this mechanism was applied in practice: in certain cases creditors received shares in newly created enterprises (to which there were transferred assets of debtor enterprises cleared of debts), and in other cases additionally issued shares of debtor enterprises. As concerns the regulation of additional issues in the framework of external management, in accordance with the new law on insolvency shareholders should have the preferential right to purchase the placed shares, the placement should be carried out exclusively on conditions of closed subscription, while the payment for additional shares should be made only in money. However, the law failed to paid attention to the situations, where the state is a shareholder.
Eight, as concerns the sales of strategic enterprises in the course of bankruptcy proceedings, it is important to note the following provision of the new law on bankruptcy: in accordance with item 8 of article 195, bankrupt's creditors and the respective affiliated persons. Although the concept of this norm is rational, in the present Russian situation it may create a number of serious problems as concerns bankruptcies of large companies. In particular, as it is demonstrated by the practices of activities of antimonopoly agencies, the detection if person is affiliated or not is a labor intensive, disputable, and long process.
Ninth, there has not been yet settled the problems of integrated financial rehabilitation of several enterprises making technological chains of an industry or a region. In a number of cases, the successful rehabilitation of one enterprise may produce only a short time effect, since the inefficiency of operations of concrete enterprises may be primarily determined not by their internal problems, but the situations at their partner enterprises.
Tenth, one of the efficient forms of preservation of business may be the sale of the enterprises (the single property complexes) of organizations in the single company towns. The respective terms of sale the previous law set forth with respect to the buyer (article 137) were too burdensome; therefore this form was not widespread. More soft requirements to the buyer set forth in article 175 of the new law on insolvency (the requirement to keep not 70 per cent but 50 per cent of jobs, introduction of the time limit on this requirement (3 years), enhancement of the options to change the core activities of such enterprises) will permit to render the enterprises in single company towns more attractive for purchase as single property complexes.
At the same time, there persists the formality (non-economic character) of requirements to buyers. Indeed, mala fide buyers may insignificantly reduce the number of jobs and sharply reduce the average wages and salaries at the enterprise. In fact it may result in persistence or even an increase in the scale of "hidden unemployment." It seems to be also necessary to set forth the framework regulating the changes in the wage bills at enterprises, while enhancing possibilities to reduce personnel. 404
At last, it is necessary to more precisely define the specifics of bankruptcy of enterprises in single company towns (articles 168 - 176). The "modification" of the criteria according to which enterprises may be included in this category is rather arguable. Although these criteria of definition of enterprises were toughened, the formal approach here persisted. It would be feasible to use such criteria as the share of tax payments made by the enterprise in the total amount of taxes collected in the respective town, the fact of dominating position of the enterprise on the commodity market, etc. Besides, the new law on insolvency sharply reduces the possibilities to rehabilitate enterprises in single company towns because financial rehabilitation or external management may be prolonged for only one year (article 172), and the terms of even so insignificant prolongation have been toughened. At the same time, it should be noted that enterprises in single company towns are probably the most difficult object of financial rehabilitation.
Special regulation is required with respect to the problem of protection of minority shareholders in the process of bankruptcy proceedings. This problem is even more urgent in the cases, where the state is the largest creditor of the enterprise.
From the authors' point of view, as concerns bankruptcy there is necessary the whole range of innovations in the sphere of enforcement and technical procedures of conduct of bankruptcy cases. The same is true with respect to the procedures governing initiation of bankruptcy proceedings; the order of appointment and activities of bankruptcy commissioners; the procedures governing financial rehabilitation, external management, and bankruptcy proceedings; regulation of amicable settlements; the procedures governing bankruptcies of absent and liquidated debtors. It would be feasible to amend article 224 of the law "On bankruptcy" by adding a provision, in accordance with which creditors should also have the right to submit bankruptcy petitions with respect to liquidated debtors. At the same time, as it has been demonstrated by the practice of bringing of culprits to civil, administrative, and criminal responsibility for offences of the bankruptcy legislation, the respective provisions of article 10 of the law "On bankruptcy," as well as articles 14.12, 14.13 of the RF Code of Administrative Violations and articles 195 - 197 of the RF Criminal Code practically have not been enforced; in this connection all these provisions should be radically and conceptually revised in stead of being subjected to fragmented changes94.
It is also necessary to note that in spite of a number of apparent achievements, the new law on insolvency has principally failed to settle a number of principal problems being outside the framework of technical procedures.
First, since the state is granted the same rights as other creditors, it will require the creation of a respective infrastructure necessary for representation of its interests. It is unlikely that the necessary resources will be available. Therefore, while at several hundreds of enterprises the progress and control of bankruptcy proceedings may be really improved, at the majority of other enterprises these actions will result in an increase in corruption and interest to the buying up of "administrative resources." The latter is very probable also because the state has the better possibility to initiate bankruptcy proceedings: it is not required to confirm its claims in courts.
Second, more tough terms, on which there can be initiated bankruptcy proceedings will not result in a significant restriction of the processes of redistribution of property. It is an objective process and even if it was not reflected in the law on joint stock companies it will continue, but now in the framework of executive proceedings.
94 For details see: Radygin A., Swain H., Simachev Yu., Entov R. et al. Institut bankrotstva: stanovleniye, problemy, naprav-leniya reformirovaniya (The institution of bankruptcy: it's rise, challenges, and reform avenues). M., IET - CEPRA, 2005.
Third, in the case there are set specific features of insolvency in certain sectors, there originate prerequisites for dumping of debts to such sectors. At the same time, if it is not done, there increase social costs. Besides, the issue of classification of enterprises as natural monopolies, enterprises in single company towns, or strategic enterprises is rather complicated.
Fourth, A considerable part of proposals concerning the reform of the legislation resulted from the insufficiently developed enforcement infrastructure (dependence of arbitration courts of local governments, the professional level of judges, etc) rather than the imperfection of the regulations being in force at that time. One of the most important problems in this sphere is the dependence of arbitration courts on local authorities and insufficient level of professional skills of the judges required to examine complex economic disputes.
Fifth, a significant part of changes in the legislation on insolvency resulted from over-estimation of certain problems; therefore, some provisions of the new law on insolvency have not been in demand yet.
Important, although rather distant prospects are related with the improvement of judicial practices at large. For instance, in the interests of protection of enterprises from mala fide interception of control over them (or a part of their assets) via bankruptcy proceedings it is necessary to develop the practice of enforcement of article 10 of the RF Civil Code (misuse of a right) and envisage both the transparency of judicial procedures, and responsibility of the judges. It is necessary to make additional efforts in order to develop self-regulating organizations of bankruptcy commissioners and nongovernmental enforcement institutions, including those applicable to the sphere of bankruptcies.
Accordingly, time is needed in order to form an adequate infrastructure and its adaptation to new legislative regulations. As it turned out, the institution of bankruptcy has been in demand as a tool of redistribution of property. In this connection, speaking about large enterprises, it is more often applied with respect to potentially attractive businesses. Recently, there have been observed significant shifts as concerns the protection of the rights of minority shareholders. Therefore, for a long time yet bankruptcy will remain a tool of settlement of different corporate problems: from protection of the rights of managers from owners to carrying out hostile takeovers. Therefore, there can not be excluded the possibility of further expansion of the practices of bankruptcy of large potentially attractive enterprises. Most probably, in the nearest future the ambiguous impact of bankruptcies on economic development will be even more apparent.
4.4. Problems of competitiveness of the Russian stock market
An indispensable condition of competitive economy is competitiveness of its market institutions. In this case, competitiveness of institutions is regarded here as "correspondence of formal and informal institutions of the country - legislation, behavioral norms and traditions, exercising power, range of discretion, degree of confidence to requirements of
95
production of competitive goods and services" . The stock market may be considered as one of institutions of the market economy, which competitiveness has an overall impact on the country's national economy.
The stock market may be regarded as an aggregate of specific segments, to dominate which different structures are engaged in competition. By a market niche is meant a demand for securities on the part of different groups of investors or offering securities on
95 Yasin E.G. Report at the 5th International Conference of the the State University -tiveness and Modernization of the Economy". April 6, 2004. Internet www.hse.ru.
Higher School of Economics "Competi-
the part of a certain group of issuers. An analysis had been made by the example of exchanges, which play the leading role among the infrastructure organizations, - a group of companies of the Moscow Interbank Currency Exchange (MICEX), Russian Trading System (RTS), and foreign organizers of trade with the stock of Russian joint-stock companies in the form of depositary receipts - these are London Stock Exchange (LSE), German stock exchanges, and the New York Stock Exchange.
Note that, in itself, the presence of competition of trade organizers' services on both international capital market and domestic stock market is an important instrument contributing to raising the quality of those services and reducing the operational costs of market participants .
4.4.1. Russian issuers' stock market
The stock market of Russian issuers encompasses the two main segments: circulation of stocks issued directly by Russian companies, and the market of depositary receipts for the above stock issued by depositaries abroad. To analyze internal mechanisms of the stock market development of Russian issuers, we may single out three phases of its evolution, during which considerable changes took place concerning the competitors' standing on the market (Fig. 9)96.
100,0 90,0 80,0 70,0 60,0 50,0 40,0 30,0 20,0 10,0 0,0
T
The MICEX boom period I Equilibrium period |
SPE' s capture of the new
niche
London Stock Exchange
□ St. Petersburg Exchange
□ Russian Trading System
1,2
■ MICEX
1998 1999 2000 2001 2002 2003 2004
Source: Stock exchange data.
Fig.9. The proportional weights of exchanges in the volumes of trading with
the stocks of Russian JSC
The first period spans 1998-2001. This period is characterized by growth of the share of MICEX (Moscow Interbank Currency Exchange) as organizer of trade with the
96 Here and in what follows the volume of exchange trading is calculated by totaling the stock turnovers on Russian exchanges and depositary receipts turnovers on foreign exchanges (in USD million).
stock of Russian JSC=s from 5,4% in 1998 to 52,0% in 2001. Such growth occurred against cutting of RTS market share from 30,4% in 1998 to 9,3% in 2001, and also the share of London Stock Exchange from 64,2% in 1998 to 37,3% in 2001.
The second period refers to 2002-2003. It may be characterized as a period of temporary balance of forces of the competitors. In those years, the share of MICEX, as organizer of trade with the stock of Russian issuers, decreased, but negligibly - from 52,0 to 45,8%, while the share of LSE (London Stock Exchange) increased from 37,3% in 2002 to 46,9% in 2003. At the same time, RTS competitiveness at the stock market noticeably weakened, the exchange share in the market decreased from 9,3% in 2002 to 3,2% in 2003.
The third period of evolution of the stock market of Russian JSC began in late 2003 and was characterized by qualitative changes in the balance of forces on the market of services of organizers of trade with the stock of Russian issuers. In 2004, the share of LSE on the stock market of Russian JSC=s reached 75,4%, the share of MICEX decreased to 21,4%. The RTS share, as organizer of trade, reached the critical level 1,2% of the volume of exchange trade.
Reasons for such profound alterations in the balance of forces on the stock market of Russian issuers can be found in new priorities of issuers and investors in the capital markets, which caused changes in the balance of supply and demand for the stock of Russian JSC=s.
The priority rates of volumes of exchange trade with the stock of Russian companies on MICEX during the first period is explained by emergence of an interest of new owners of the Russian largest companies, which received control over them during the privatization, in establishing a liquid stock exchange market of those companies, as an instrument of building up their capitalization to the market level, appearance on the Russian stock market of a number of domestic speculative investors, after the crisis of 1998, and introducing modern technologies of the exchange trade and settlements on MICEX.
Based on the data of "Russian economic barometer", since the mid-1990s, 3 stable trends could be observed in the structure of privatized companies' property: passing of a title from workers to managers, from insider (of the same management) to outsiders (financial groups and non-resident), and from the state to private persons. In 1995-2003, the share of insiders decreased from 54,8 to 46,6%, and outsiders - increased from 35,2 to 44,0%97.
The privatization gave rise to active development of extra-exchange trading with stocks, within the frame of which buying the stock of privatized companies had been carried out in regions from their employees and from the citizens, who received stock in exchange for vouchers from the financial intermediaries acting in interests of the outsiders and companies' management. The development of extra-exchange market gave an impulse to growth of volumes of stock exchange trade, where each exchange occupies its own niche. On MICEX, brokers bought small blocks of stock and sold them, after consolidation, via RTS (in currency) to non-residents, including the off-shore companies established by the Russian participants of the market.
In 1999, an inter-depositary interaction ("bridge") had been organized between the settlement depositaries of MICEX and RTS, which allowed to noticeably facilitate the counter flows of shares between the Russian and foreign markets. "High" and "low tides"
97 From the report of R. Kapelyushnikov "The Impact of Property Concentration on the Economic Activity of Industrial Enterprises" at the international conference "Socio-Economic Transformation in CIS Countries: Achievements and Problems", organized by IET on September 13-14, 2004.
of shares on the Russian market occurred in accordance with clearly defined regularities. Rise in prices of shares, including the depositary receipts of Russian issuers on global markets, caused additional demand for the stock of Russian issuers. To satisfy the demand, Russian brokers bought "blue chips" on MICEX, and using a "bridge", withdrew packages from MICEX settlement depositary to RTS settlement depositary. Then, the shares were sold in RTS or the extra-exchange market, and moved abroad. On the other hand, in falling of prices on global markets, the shares of Russian issuers returned, in the same way, to the MICEX settlement depositary and were sold on exchange in small packages.
Changes in the behavior of big business, which followed the privatization, also contributed to the development of domestic capital market. During the 2000, as far as the economic efficiency had grown, an interest of the largest privatized companies increased in formation of long-term development strategy and entering the strategic alliance with transnational corporations98. For Russian business, the condition of forming such alliances on competitive terms was - bringing the market capitalization of the companies in its possession to a level equal to intrinsic value of shares. Oligarchs wished to operate on Russian exchanges. Access to circulation on MICEX and RTS of the companies' blocks of stock, amounted to several percent of the total volume of issuance, made possible to get a quick growth of companies' capitalization. In the following, selling at the market price of big packages to outsider investors would bring holders of controlling stakes a real compensation for the "privatization risks" and possibility of transformation of "ficticious" stock capital to its more real liquid forms. It is to be noted that the usage of similar strategies should not be regarded as negative phenomenon. This is a regular and typical (for transition economies) process of stage by stage building an efficient private business.
As an illustration of strategies of accelerated building up the capitalization, data are given in Fig. 10 on the proportion of capitalization and the share of "blue chips", circulating on exchanges, in the total volume of their issuance, as of 2003.
The rate of effective capitalization of most liquid shares, excluding the shares of the RAO UES Russia was, in 2003, in inverse ratio to proportion of free circulating shares (reserved here for trading in the settlement depositary of MICEX). Most capitalized are issuers (primarily oil companies), who had insignificant participation of free circulating blocks of shares on the exchange: such were, for example, "YUKOS" - 0,7% of shares, "Surgut-neftegas" - 1,2%, "LUKOIL" - 2,2% and mining-and-metallurgical integrated works "Norilsk Nickel" - 1,4% of shares.
98 At present such alliances began to be formed, while at the end of the 1990s - the early 2000s such plans were only conceived. As an example of an alliance between Russian and foreign business may be mentioned "Severstal-Group", which general director, A. Mordashov, told in an interview to "Vedomosti" of an intention to "to establish, on "Severstal" basis a global mining-and-metallurgical company ..." "with Russian control" (Vedomosti. October 21, 2004). Another example is acquisition of a big block of stocks of the JSC LUKOIL by ConocoPhillips. An illustration of Russia's big business intention to stand equal in such alliances is the statement of LUKOIL's vice-president and the compamy's board member L. Fedun that LUKOIL's managers should never sell their shares, not to loose control over the company (Vedomosti. October 25, 2004).
O RAO UES Russia ■ OAO LUKOIL • OAO Surgutneftegas + OAO YUKOS
A OAO Mosenergo X OAO Aeroflot X OAO Dalenergo A OAO AvtoVAZ
ÜGMK Norilsk Nickel ♦ OAO Rostelecom
Fig. 10. Stock capitalization and their proportion in free circulation (according to MICEX data for January-September 2003)
Fig. 11 shows the data of growth of Russian companies' capitalization and the volumes of trade on Russian exchanges.
200
JS
JC
C
^ 100
50
0,048
□ Capitalization
□ Volume of stick tiade at Russian exchanges Volatility (means square oK the yields bias of the RTS indeX)
0,036
230
0,(
44,5
20
176
0,0
92,8
21
0,0
124,4
20
0,045
0,035
0,030 u
co
Source: Calculated according to the data of MICEX, RTS, and St. Petersburg stock exchanges.
Fig. 11. Capitalization, liquidity and volatility of the Russian stock market
0,040
0,025
0,020
0
1998
1999
2000
2001
2002
2003
Enhancing the capitalization of Russian companies and increase in the volumes of trade on the stock exchange market occurred simultaneously. And still the capitalization grew in a faster pace than the volumes of trade, which met the needs of the largest issuers interested in increasing the cost of their business. In 1998-2004, the capitalization of Russian companies increased from USD 17 bn to USD 230 bn or 13,5 times. The volume of trade with shares on Russian exchanges (MICEX, RTS, St. Petersburg stock exchange) increased from USD 10 bn in 1998 to USD 101.2 bn 2004, i.e. 10 times. To a large extent, lessening of risks, changed by index of standard deviation of relative price changes of assets contributed to growth of the Russian stock market, especially in the early 2000s.
Striving of big business to increase the capitalization meant arising on Russian exchanges, primarily on MICEX, an additional demand for "blue chips" on the part of privatized companies and their related financial intermediaries. Such transactions led to raising the share of MICEX on the stock market of Russian companies.
The third factor of growth of demand on the domestic stock market in 1998-2001 was emergence on the market of domestic small investors, inclined to short-term and speculative equity in conditions of increased risks. The above became possible because of quick growth of earning power of the Russian issuers' equity investment, happened in 2000 after two years of negative effective yield of shares as a result of crisis of 1998. Though, in 1998, proceeding from its annual average the value the RTS index resulted in negative yield amounting to -54,0% annualized, and in 1999 to -46,2% annualized, in 2000, the earning power of investment in this index made up +99,9%.
An important growth factor, in 1998-2001, of the share of MICEX in the market, as compared to RTS and LSE, became implementing of new technologies of exchange trade and settlements. A project had been implemented on the exchange increasing the number of those involved in exchange trade by means of using the Internet technologies. Using Internet, small investors, being the clients of brokers, got a chance to participate in the exchange trade on a real-time basis, to receive information about the course of trading and on their own to make requests for purchase and sale of papers, which, via interface with broker, were promptly entered in the trading system. According to MICEX, 70% of the exchange transactions are performed via Internet. At present, the Internet trading systems have been developed on RTS and MICEX in equal proportion, but the structure, which succeeded to occupy the niche earlier found itself in a more valued position.
MICEX became a leader on development of the electronic document management between participants of the stock exchange market. After the crisis, considerable demand arose (on the part of investors) on the stock market, concerned with granted by MICEX guarantees of settlements on "delivery against payment" (DAP) terms with preliminary depositing securities and funds reservation by the participants of trade. All this helped MICEX occupy a new niche on the stock market, where investors dominate with ruble demand for shares, interested in settlements on DAP deals.
Thus, during the first period of the development of the stock exchange market MICEX success had been achieved due to more prompt response to arising an additional demand for the stock of Russian JSC=s on the part of the companies' management, the financial groups interested in growth of their companies' capitalization, and small domestic investors inclined to short-term speculative transactions99.
99 According to the head of FSFM O. Vyugin in 2005, "on the structure of investors the market ... has not considerably changed for the last five years"; "according to different estimates, about half of the market participants - are foreign investors, next are Russian investors, who earn money by short-term operations", "the proportion of conservative institutional investors is not too large - 10%" (see: Vyugin O. Uncertainty hampers to take decisions // Vedomosti. 2005. January 31).
However, by its nature, the new sources of demand for the stocks of Russian companies were short-term. The purchase of stock by management could not be everlasting, the volumes of such transactions decreased with concentration in the hand of those persons controlling stakes. Financial groups and other holders, interested in original increasing the capitalization, sooner or later will sell their packages to strategic investors. Meanwhile, the joint stock companies that became transnational corporations will inevitably go to global capital markets to maintain their competitive ability. As a rule, the resources of domestic speculative investors are limited, and on their own cannot maintain the high demand for the stock of Russian companies.
At the second stage of stock market development - from the beginning of 2002 to October 2003 - a period of temporary balance became on the domestic stock market. It was characterized by absence of noticeable coming to the stock market of new categories of domestic investors, primarily physical persons and collective investors. The number of exchange trade participants practically did not increase over that period, basically, on the stock market they were represented by domestic investors inclined to short-term speculative strategies.
The RTS exchange continues to compete with MICEX for organized stock market with settlements on DAP terms, but, up until now there are no clear results of such competition. At the same time, RTS could find more effective solutions on the futures market and the stock market of the JSC Gazprom, succeeded to be the first in occupying new market niches. The lesson to be learned from the experience - most efficient strategies on the market are those directed to forming new market niches, rather than fighting for already occupied market segments.
At that time, the stock market of Russian companies and that of depositary receipts for those shares developed in parallel, complementing each other. It should be said that the Russian stock market fulfilled the functions of a liquidity and price formation center, while the external market allowed the foreign portfolio investors, who are not ready to bear "ruble" risks and legal risks of the country of issuers registration to invest, by means of depositary receipts, in shares. The arbitrage beetween the domestic and external stock markets raised attractiveness of both market segments in the eyes of financial intermediaries and investors.
The third stage of stock market development started from October 2003. Granting to Russia by Moody's agency of the investment rating led to forming a new niche on the stock market of Russian companies, concerned with additional demand for the stock of Russian issuers on the part of non-residents. This opened possibilities for investing in the stock of Russian companies large volume of means by conservative foreign investors, who are allowed, in accordance with the law, to form portfolios using only papers with the investment rating. But the investors were not ready to acquire shares with settlements in rubles, as ruble is not a recognized investment currency.
At this stage the Russian stock market needed taking the agreed decisions by market participants and regulatory bodies, which made possible to form the competitive strategy of Russian exchanges regarding additional demand for the stock of Russian JSC=s on the part of foreign conservative investors. Many years heretofore, the problems of forming an international financial center based on Moscow exchanges raised by the experts of the stock market and scientific community representatives100. The idea of establishing such a
100 See, for example: Mirkin Ya.M. The Securities Market of Russia: the impact of fundamental factors, forecast and development policy. M.: Alpina Publisher, 2002.
center suggested formation in Russia of a securities exchange market with settlements in foreign currency between its participants.
Unfortunately, the Russian stock exchange market could not make an adequate decision. Instead, a new federal law had been adopted in Russia on currency control and currency regulation, which retained for all non-residents, without restriction, a possibility to acquire the stock of Russian JSC=s in rubles and repatriation of profits from their sale, and also restrictions for residents in purchasing securities with settlements in foreign currency. The Russian infrastructure, that by the amount of risks and operational costs was substantially behind its competitors was not ready to serve the conservative foreign investors.
As a result, the new niche, concerned with additional demand for the stock of Russian issuers in currency, had been developed by London Stock Exchange. Fig. 12 shows, how changed changed, since October 2003, the balance of forces between the competitive
60 000
50 000
40 000
30 000
20 000
10 000
0
■
2003 2004
■ MICEX □ RTS, the classical market □ St. Petersburg Exchange ■ London Stock Exchange
□ German exchangesNYSE □ NYSE □ RTS Stock Exchange
Source: According to the stock exchange data .
Fig. 12. Volumes of secondary exchange trade with the stock of Russian JSC=s
(USD million)
The data of Fig. 12 contradict the prevailing opinion that under the influence of risks caused by Yukos case and the political and economical uncertainties in Russia, the Russian stock market moved to London. According to the volume of exchange trade with shares, the MICEX market retained positive dynamics. According to MICEX, in 2004, the volume of trade with ishares on MICEX increased by 35% in comparison with previous year. At the same time, the volume of trade with receipts for the stock of Russian companies in London over the same period increased 4,7 times, which is explained by emergence on the market of new investors-non-residents, as a result of improvement of the investment climate in Russia.
tock markets of Russian JSC=s.
October 8, 2003Khodorkovsky's detentionFITCH rating
IV V VI VII VIII IX X XI XII
The conflict around YUKOS oil company caused fears of non-residents in protectabil-ity of their property rights to the stock of Russian companies, but this factor did not cause capital outflow from the MICEX market to London, as proportion of non-residents, trading with the stock of Russian JSC=s on MICEX is negligible. The YUKOS case rather told on volatility of volumes of trade with depositary receipts on LSE, which, as is seen in Fig. 12, were changing significantly from month to month.
The more detailed proportional weights of exchanges on the stock market of Russian companies and depositary receipts on them are shown in Fig. 13.
100 -, 90 --80 --70 --60 --RTS 50 --40 --30 --20 --10
•KT-^tiT?
Jun. Jul. | Aug. Sep. | Oct. Nov. Dec. Jan. Feb. Mar. Apr. May Jun. Jul. Aug.
2003 2004
□ MICEX
□ London Stock Exchange
□ RTS, the classical market □ St. Petersburg Exchange
□ German exchanges □ NYSE
Source: According to the data of MICEX, RTS, St. Petersburg, London, New-York, German and Berlin stock exchanges.
Fig. 13. The proportional weights of exchanges in the volumes of secondary trading with the stock of Russian JSC=s (%)
In 2004, the share of MICEX in thevolumes of trade with the stock of Russian JSC=s varied from 14 to 26%, the share of LSE - from 58 to 80%. In December 2004, by volume of trade, the New-York stock exchange, where depositary receipts were circulated for the stock of only 6 Russian JSC=s, came close to MiCEX; the share of NYSE in the volumes of trade with financial instruments for the stock of Russian issuers reached 12% of the market, while MICEX share for the same month was 18,2%. On NYSE the main participants of transactions with ADR are institutional portfolio investors, NYSE advancement, in comparison with MICEX, is explained by their greater interest in receipts for the stock of Russian companies.
The successful marketing policy of the London stock exchange, which offered the market participants a new electronic system, to conclude transactions on anonymous basis, played the important part in forming a liquid market of depositary receipts for the stock 414
0
of Russian companies. However, influence of this factor should not be overestimated, as it cannot explain the following: of all the developing economies there were just the stock of Russian issuers that caused rapid increase of the volumes of trade with depositary receipts on LSE, the volumes of trade with which reach now about 70% of volumes of all transactions with depositary receipts for the shares of issuers from the developing countries on that exchange.
Depositary receipts for the shares of Russian companies proved to be the more practical financial instrument than shares themselves, which issuance and circulation is regulated by legislation of the Russian Federation. Acquisition of depositary receipts reduces the risks of private investors determined by possession of basic shares of Russian companies in conditions, where the Russian law and enforcement cannot ensure reliable protection of property rights. In the scheme of depositary receipts violator of rights of stockholders will have to do not with an isolated small investor, who often simply does not know Russian legislation, but with one of one of the largest world custodians, which represent the collective interests of owners of depositary receipts. The rights of owners of depositary receipts are protected not by Russian but the American legislation, which, among other things, provides for criminal responsibility of the officials of Russian joint stock companies before the USA for the crimes committed against owners of depositary receipts. In addition, participants of the market of depositary receipts make transactions with them according to the legislation and exchange rules of a foreign state, not to be subjected to restrictions laid in accord with the Russian legislation on exchange control and currency regulation for participants of the domestic securities market.
The problems of deterioration of competitive positions of the Russian exchanges on the stock market are clearly realized by the regulatory body - FSFM (Federal Service on Financial Markets). According to the head of this department, reorganization of infrastructure of the stock market, in particular, establishing a central depositary institution will contribute to overcoming those negative trends on the market, which will help raise the economic efficiency of operations and reduce the investors' operational risks101. FSFM promises to simplify IPO shares procedures on the Russian exchanges, including substantial reduction of the period of time between the state registration of stock issues and conducting auctions for their placement102.
However, such measures will hardly be able to radically change those trends. Going of Russian largest companies to global markets is an objective process, and changing the procedures of share issuance in the Russian legislation is not of vital importance here. Global exchanges are more suitable for non-residents, as allow to make deals with the securities of issuers from different countries, not assuming the risks of settlements in national currencies. It is known by experience that it is by far more difficult to win competitors in the niche that had already been occupied. Progressive advance of the domestic stock exchange market and its infrastructure is possible only if it will be supported by the long-term investment resources of domestic investors - investment and pension funds, insurance organizations, households and non-financial companies. For this, it is required to solve problems of Russian portfolio investors entering into international capital markets and establishing efficient systems for distribution of their products within Russia. In this area, no significant regulating activities have been observed as yet.
Therefore, since October 2003, a qualitative decrease in the share of local exchanges happened as organizer of trade with Russian "blue chips", which raise a question
101 Vyugin O. Uncertainty hampers to take decisions // Vedomosti. 2005. January 31.
102 Kozitsyn S. Priglasheniye regulyatora FSFR khochet oblegchit provedeniye IPO v Rossii // Vedomosti. 2005. January 28.
about moving the centers of price formation of the stock of Russian issuers to global capital markets. The main problem of Russian exchanges on the stock market is absence of sufficient number of domestic investors oriented to long-range investments. In conditions where main investors on the market of Russian "blue chips" are non-residents, it is difficult for Russian exchanges to hold positions in competition with global markets. Movement for attraction of no-residents to the domestic stock exchange market is complicated by the fact that this niche has already been occupied by global exchanges. In order to convince non-residents to go from the global markets of the stock of Russian issuers, weighty arguments are needed, which are so far absent.
4.4.2. Problems of development of ruble bond market
In contrast to the Russian stock market, on which the Russian exchanges could not form in 2002 new significant niches, since 2001 the ruble bond market experiences a period of rapid growth. Development of the market of regional and corporate bonds is recognized as one of major successes of MICEX for the past years. Using the market of corporate bonds, the Russian exchanges for the first time realized their potential for funding real sector of economy. In 2000-2004, by placing corporate bonds, Russian companies drew from the market over USD 10 bn of investment resources.
The scales of a new segment of the Russian market reached, and for some parameters exceeded, the indices of GKO-OFZ market in the period of its prosperity, which is seen in Fig. 14, 15.
450 400 350 300 250
cz
.Q
£ 200 150 100 50
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 ■ GKO-OVZ «Regional bonds □ Corporate bonds
Source: According to MICEX data.
Fig. 14. Volume of bond placement
According to the volume of placement in 2004, the market of ruble bonds made up Rb 387.5 bn and almost reached "historical" maximum of bonds placed for a year, which had been fixed in 1996 on GKO-OFZ in the amount of Rb 415.1 bn (with account of denominations). But, in contrast to GKO-OFZ market, which collapsed, the market of ruble bonds is now growing not only because of placement of federal securities, but, primarily, due to issuance of corporate and regional bonds. In 2004, on MICEX there were placed
OFZ for a total of Rb 192 bn; the volumes of issuance of corporate and regional bonds made up Rb 140.4 bn and Rb 55.1 bn correspondingly, i.e., totally, a little more than the issuance of federal securities.
In 2004, the volume of secondary exchange trade with bonds on MICEX exceeded maximum indicators of liquidity of the GKO-OFZ market in 1995-1997, which is seen from Fig. 15.
■ GKO-OVZ ■ Regional bonds □ Corporate bonds
Source: According to MICEX data.
Fig. 15. Volumes of secondary trade with bonds on MICEX
The maximum volume of secondary trade with GKO-OFZ on MICEX had been fixed in 1997 and reached Rb 876.1 bn denominated rubles. In 2004, the total volume of secondary trade with ruble bonds amounted to Rb 1169.8 bn, of which Rb 408.6 bn is accounted for OFZ market, Rb 338.0 bn - for regional bonds, and Rb 423.2 bn -the corporate bond market.
Despite rapid growth of volumes of the market of ruble bonds, the situation on this segment of the market still differs from that taking palce on GKO-OFZ market the day before default. The main differences are in that the present issuers are making borrowings at reasonable rates, which are often lower than the level of inflation. Increase in the volumes of corporate and regional bond redemption is so far behind the volumes of bond placements. Moreover, supervising the market of ruble bonds is carried out by FSFM (Federal Service on Financial Markets), i.e. the body that is independent of issuers and market participants.
Though, such a rapid growth of ruble borrowings causes a number of problems. The main problem is in that demand is formed at the bond market from the short-term resources, basically excessive bank liquidity, as balances of correspondent bank accounts and on their deposits in the Bank of Russia. Extra amount of such resources allows to finance the public debt, corporate and regional issuers at a negative real interest rate. This, in turn, repels from the ruble bond market non-governmental pension funds, unit investment funds and citizens who, in contrast to banks, do not possess excess money supplies and cannot afford investments at interest rates lower than the level of inflation.
The structure of investors on the market of corporate and regional bonds is shown in Fig. 16 and 17.
Mutual funds
oo :
Others 4%
National Pension Fun 12%
Commercial banks
76%
Source: Calculations according to the data of the Bank of Russia, FSFM and.
Fig. 16. Structure of regional bond investors in Russia in the mid-2004 (estimate)
On the regional bond market 76% of securities belong to commercial banks, the share of banks on the corporate bond market accounts for about 50%. Considering that part of the banks make bond investments through subsidiary non-bank agencies, the actual share of banking groups on the market of corporate and regional bonds still higher.
In conditions of low-liquidity market of the government securities and absence of bank refinancing system on the part of the Bank of Russia, the corporate and regional bonds began to act an unusual (for them) part of regulating the volume of money in circulation and servicing the interbank crediting market. However, involvement in the market of companies' long-term debts and banks' excessive liquidity substantially raised the risks of this market segment in the eyes of investors103. Falls of bank liquidity because of changes in the economic situation, bank crisis or emergence of a new financial instrument, which is better adapted to regulation of banks' excessive liquidity (for example, the Bank of Russia bonds or liquid GKO), may restrict new bond placements and considerably decrease liquidity of the secondary market. Impossibility of refinancing the domestic debts will make problems of creditworthiness of individual issuers, and in unfavorable scenario will provoke a wave of defaults on the bonds of companies and regions.
Therefore, despite differences in the structure of investors on domestic bond and stock markets, both markets incur a deficit in domestic investors ready to invest in the long-term bonds of Russian issuers. Major obstacle for the emergence of such investors on the domestic debt market is negative effective yield of the greater part of ruble issuers.
103 In the opinion of MDM-bank analysts, "just the use of short cheap liabilities for purchase of long... bonds u generates the investors' profits on the market"; however, this is an extremely risky model, which is not for the first time in Russia, in 2004 again "punished" many of investors (bank crisis), as in conditions of "credibility crisis" on the interbank market many investors could not finance their positions in ruble bonds and had to sell them at the bottom of the market. (See: MDM-bank Investment Banking. Debt market. Results of 2004. Strategy of 2005. January 2005. p. 31. www.invest.mdmbank.ru.)
Others 37%
Commercial banks 50%
National Pension Fund
7%
6%
Fig. 17. Structure of the investors on the corporate bond market in Russia
in the mid-2004 (estimate)
The domestic bond market begins suffering considerable competitive pressure on the part of global markets, where not only more reputable creditors are available, but, in conditions of falling the real dollar rate credits also become much less expensive than ruble borrowings. Even now the volumes of external borrowings, made by Russian companies, substantially exceed the volume of means attracted by them on the ruble bond market.
In conditions of acute competition with global capital markets the Russian stock market needs finding new niches that will allow it to survive and exercise its practicality for various groups of investors.
4.4.3. New niches for the Russian stock market
For the Russian stock market the most actual problem is attraction of mass domestic investor to the market. Despite curtailing the central social programs and failure of pension reform, the most part of Russian population does not take interest, so far, in saving up for the future. According to our calculations, it's many years already that the population's savings in financial assets are decreasing - from 16,1% in 1997 to 8,7% in 2004.
The reasons why population does not invest their means in financial assets in Russia are - low profitability and increased risks. The main body of bank deposits and ruble bonds may gain negative effective yield. Even if investments in the stock of Russian companies gain positive effective yield, they are often unacceptable for conservative investors because of increased risks of considerable volatility of their prices. The services of Russian financial intermediaries are often inaccessible for population because of remoteness of people's place of residence and high cost of such services.
A serious problem for the growth of schemes of collective investment in Russia is excessive cash resources concentrated in the banks, foreign exchange reserves of the Bank of Russia, and in the Stabilization Fund. Investing such resources in financial instruments of the Russian issuers is impossible without increased risks and negative effective yield. In such an environment cannot successfully develop the schemes of collective investments that accumulate the resources of private investors.
Shortage of qualitative financial instruments on the domestic stock exchange market is necessary for the formation of diversified portfolios, it may be added by an access of Russian investment funds and other portfolio investors to acquisition of securities of foreign issuers. Calculations show that an increase of the proportion of securities of issuers from the developed financial markets in portfolios of Russian investment funds to 80%, allows to considerably reduce the risks with minor lessening of investment yield. Such approach requires taking competitive decisions in the sphere of currency regulation, in particular, authorization for the Russian portfolio investors unhampered purchase and sale and keeping foreign assets under the supervision of banks as currency control agents. Such deals must be out of requirements on the resource reservation in making transactions in foreign currency.
The advantage of such an approach is in that it provides conditions for competitive ability of Russian financial intermediaries through enhancement of their capability to invest in assets on global markets. The financial intermediaries in Europe or USA are not confined in possibility of purchasing reliable financial assets abroad, so, to restrict the rights of Russian investment or pension funds in acquisition of foreign assets is unwise.
Another field in development of investment funds and other forms of collective investing, where a breakthrough may be achieved, is creation of modern centralized systems of financial product distribution, for example, the investment shares of unit investment funds. The above can be achieved by orientation of clearing infrastructure of the Russian stock market (depositaries, registrars, clearing organizations and clearing houses) to receiving requests for purchase and repayment of investment shares of the unit investment funds and settlements on deals with shares on DAP terms.
The perspective direction of growth of the exchange market in Russia may become the secondary market of investment shares of the exchange index funds, closed end and interval unit investment funds. On the MidAmerica Stock Exchange in the USA the volume of transactions with securities of investment funds reaches 85% of the total volume of trade. On the Tokyo and Osaka exchanges in Japan, Hong Kong exchange, All-European Trading System Euronext, German stock exchanges, and on other largest foreign trading floors, deals with the papers of investment funds are a significant segment of the markets served by them. The growth rates of the securities market of the exchange index funds and the stock of closed end investment funds on the New-York Stock Exchange and in NASDAQ multiply surpass the growth rates of turnovers on deals with other securities.
In Russia, on MICEX the volume of deals with shares of unit investment funds make up only 0,003% of the total volume of trade with securities. At the same time, revival of domestic investor with the use of efficient collective investments, oriented to the potential of exchange infrastructure, would lead to forming additional demand of the domestic investors for securities circulated on exchanges.
Therefore, the future of the Russian stock exchange is concerned with its integration into global capital markets. To retain the domestic securities market as an independent competitive institution, it should be reoriented to needs of the country's population and other Russian investors. It is possible to attract such categories of investors to the market, only if every possible effort is made by Russian financial intermediaries in usage of the advantage of international diversification of portfolio investments and forming the organized market of papers of investment funds. 420
4.5. Functioning of the pension system's saving component
In March 2004, the Pension Fund of the Russian Federation for the first time delivered the monies of the pension savings to the managing companies for the purpose of their respective asset management. These were the insurance payments for the saving part of the labor pensions according to the results of the year of 2004 as well as returns from their investing. In 2002, according to the data of the RF Pension Fund, about 38 bln roubles were paid to the saving system as insurance premiums for the saving part of the labor pensions, in the year of 2003 - 50 bln roubles104. In the end of the first quarter of 2004, the Pension Fund of the Russian Federation transferred to the said managing companies 47.2 bln roubles105 consisting of the premiums made in the year of 2002, and 13.5 bln roubles of the investment returns from the respective investing.
If we proceed from the data on the returns received from the temporary placement of insurance premiums in the saving part of the labor pension in 2002 which comprised 1.5 bln roubles, as stated in the Federal law "On Performing the Budget of the Pension Fund of the Russian Federation for the Year of 2002", then most of the returns from investing the said premiums collected in 2002, come on the year of 2003 and the beginning of the year of 2004. However, it does not seem possible to make definite conclusions about it with a sufficiently high degree of assurance because of the absence of respective information on the methods of accounting used by the RF Pension Fund. In particular, it is not quite clear whether due account was taken of the unrealized exchange rate growth of securities in the year of 2002 or if all these returns were shown only by the results of the securities sales but the account was being performed at prices of the acquisition while the respective incomes from the said temporary placement in the year of 2002 were not reflected in full.
Returns from investing the premiums collected in 2003 by the results of the year, were estimated by the Pension Fund of the Russian Federation to comprise 2.015 bln roubles106 although, like in the case with the insurance premiums for the year of 2002, it can be asserted that the resulting profitability from their investing will be significantly different from the respective intermediate data.
A rather significant part of the premiums collected which the Pension Fund of the Russian Federation received in 2002 but was unable to duly distribute to the respective bank accounts of insured persons and, accordingly, referred them to the category of "unidentified" (of the total sum of 37.85 bln roubles, 33.68 bln roubles107 were distributed to respective personal bank accounts of the insured persons).
Profitability of investing insurance premiums for the saving part of the labor pension, collected by the Pension Fund of the Russian Federation in the year of 2002, comprised 40%. This high indicator is easily explainable taking into consideration the dynamics of prices on the euro bonds of the Russian Federation in which a significant part of the collected premiums was invested. During the year of 2003 alone, prices on the issues which are in the portfolio of the RF Pension Fund, grew:
• for the RF 10 issue - 5.7%;
• for the RF 28 issue - 20.3%;
• for the RF 30 issue - 21.2.
104 Data for the year of 2003 are preliminary.
105 1.66 bln US dollars as recounted at the rate for the end of March 2004.
106 "Commersant", 16. 04. 2004.
107 "Rossiyskaya Gazeta", 31. 03. 2004.
The period both for the acquisition and for selling the euro bonds turned out to be very successful. The Pension Fund of the Russian Federation became able to start investing its monies in the summer - autumn of 2002 when prices on the most liquid RF30 issue were at the level of the face-value, and it sold them at a price close to the face-value, that is the profitability, due to the growth rate for the RF30 issue during this period alone, comprised about 43% in the US dollars.
Information on investing pension savings by the said management companies after they have received the respective monies from the Pension Fund of the Russian Federation is also of a rather episodic character. In 2003, such managing companies selected 704 thousand people. Accordingly, they received 1.6 bln roubles from more than 47 bln roubles of the total sum of the respective payments. The rest went to Vnesheconombank legally appointed as the State Managing Company (SMC).
If distribution of funds is considered among private managing companies alone, then it is to be noted that 37% of the monies given for the asset management of the pension savings, account for only two managing companies - "Capital" and the "Rosbank" managing company.
Choice of instruments for investing monies of pension savings
In April 2004, the managing companies, which had successfully passed the competitive testing for the right to conclude agreements on the asset management of the pension savings, started investing the monies transferred to them by the Pension Fund of the Russian Federation, according to respective applications of duly insured persons.
The aggregated structure of the investment portfolios of the non-governmental managing companies, as of the end of May, same year, is represented in Fig. 18.
According to the data on the 25th of May, the said managing companies invested in the state securities 78.3% of all the savings of those who entrusted to them for duly asset management. 0.53% of the monies were invested in the shares of the Russian companies, 0.5% - in the bonds of the RF subjects, 0.57% - in the corporate bonds. The respective monies and deposits account for 12.9% of the pension savings volume including 9.67% invested in roubles and 3.01% in foreign currency. Another 7.14% went to other assets.
□ state securities
□ shares
□ sub-federal bonds
□ corporate bonds
□ deposits in roubles
0,57-
□ deposits in foreign
currency
□ other assets
0,53'
0,5
Fig. 78.Investing monies of the pension savings by the respective managing companies as of May 25, 2004
Thus, the part of shares and corporate bonds turns out to be much less than the maximal permitted values.
1 - RusIndex 10 [USD] (left axis)
2 - RTS index [USD] (right axis) Sources: www.rts.ru,www.djindexes.com
Fig. 19. Dynamics of the RTS and Ruslndex Titan 10 index values (in the US dollars)
110 t
100
0 0 0 0 0 0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0 0 0 0 0 0
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O O O O O O O O O O O o o
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0 1 0 1 0 1 <N <N 1 <N 0 <N
Source: www.micex.ru
Fig. 20. Dynamics of the MICS (Moscow International Currency Stock Exchange)
index of corporate bonds
The decisive influence on carefulness of the managing companies with regard to such instruments was indeed exerted by the negative situation on the stock -exchange market (see Fig. 19 and 20). In April, the said market seemed to be a sort of "overheated" but then recession began which continued in May as well. The greatest decrease fell on the "blue chips" and the most liquid issues of the corporate and sub-federal bonds. Negative impacts on the price dynamics on the stock -exchange market were exerted by both the lower level of the rouble liquidity in the banking system caused by the reduction of residuals on the corresponding accounts of respective banks, and high rates of the interbank credits.
In countries with long traditions of collective investing, both the pension and investment funds play a stabilizing role in such situations since their investment horizons are typically oriented towards the long-term perspective. In the USA of the 80s - early 90s, for example, when private persons were intensively selling shares while net purchases of households were of negative value, net purchases of the pension funds were, on the contrary, of positive value during the whole period thus exerting smoothing influence on the general dynamics of the stock exchange market (see Fig. 21).
Bln dollars 80 •
60 40 20 0 -20 -40 -60 -80 -100 -120 -140
ü
iff
□ Households
] Pension funds
□ Total
1980 1982 1984 1986 1988 1990 1991 1992
Source: Federal Reserve Bulletin, November 1993.
Fig. 21. Net purchase of shares in the USA in 1980-1992
The Russian asset managers are so far more disposed to behave more in line with the situation which is, to a certain extent, provoked by the very model of the saving pensions system where a person, insured once a year, enjoys the right to transfer his/her savings to any other managing company or a non government pension fund as well as the uncertainly in the future fate of these very monies in the light of the Government declared measures aimed at financing the forecasted deficit of the Pension Fund of Russia' budget. Besides, the total volume of the monies transferred to various private managing companies, obviously could not exert any significant influence on the dynamics of the respective market indicators. The aggregate volume of trading in shares on the RTS and MICS stock exchanges in April comprised 353.4 bln roubles, in May it comprised but 211.5 bln roubles (in accordance with the official data published by the RTS and MICS). Thus, even if the sum of the pension savings in the amount of 1.6 bln roubles transferred to the respective
managing companies, were fully and completely invested in the respective shares in April, would have comprised no more than 0.4% of the turnover. In May, this indicator would have comprised 0.7% of the total volume of sales. Since it was established by the Decision of the RF Government No. 379, dated 30.06.2003108, that no more than 40% of the pension savings can be invested in shares then the respective indicators undergo more than a double reduction, accordingly. A similar situation was developing with bonds as well. In April 2004, the summary volume of trading in the bonds segment at the MICS and RTS cites comprised 15.4 bln roubles of which 6.2 bln roubles were directed to corporate bonds, 9.1 bln roubles - to the sub-federal and 0.1 bln roubles to the municipal ones. In May, the summary volume of trading in bonds at the MICS and RTS cites comprised 8.2 bln roubles of which 2.3 bln roubles were directed to corporate bonds, 5.8 bln roubles to the sub-federal and 01. bln roubles to the municipal ones. Thus, if we proceed from an assumption that the respective private managing companies could invest in bonds maximally permitted volumes of the pension savings (50%) then these would comprise 5.2% in April 2004 and 9.8% in May 2004. Since the probability of investing monies of the pension savings in the maximal permitted volumes is rather miserable, then the respective shares of pension savings in the trading volumes of bonds and shares should indeed be less and they are not very likely to exert any significant influence on the respective markets of shares and corporate bonds.
At the same time, as clearly shown by analysis of the publications devoted to the initial investing stage of pension savings carried out by respective non Government managing companies, not all them proved to be ready for work in this new segment of the market. Thus, a certain part of the managing companies faced a problem of selecting the investing instruments on their own, not transgressing at that certain limitations set up by the Federal Law "On Investing Monies for Financing the Saving Part of the Labor Pension in the Russian Federation", the Investment Declaration and other complementary quantitative limitations for issuers of securities as established by the said Decision of the RF Government, No. 379. This, first of all concerns questions of the necessary informational support for investing in securities of various non Government issuers.
The form in which some of the requirements to securities for investing pension savings were formulated in the said Decision of the RF Government No. 379, really turned out to be far from being the best. As noted by the managing companies, the selection process of securities is extremely labor intensive and, accordingly, is very time taking.
In accordance with the said Decision of the RF Government No. 379, investing the monies of the pension savings which the respective management companies have in their asset management, in shares is limited by such issuers whose shares are included in the stock exchange quotation lists. The market cost of such shares must comprise no less than 300 mln roubles, the cost of net assets of the securities issuer must comprise for shares no less than 500 mln roubles, the average monthly sum of market deals with the shares of Open Joint Stock Societies (OJSS), as calculated according to the results of the last six (6) months, must comprise no less than 2 mln roubles. Besides, such issuer must have no less than 1000 shareholders and work without any losses the last two years as minimum.
Nevertheless, some questions inevitably arise to which the said Decision of the RF Government No. 379 does not give any sufficiently clear answer. For example: with what
108 Besides, the RF Ministry of Finance issued Order No. 27H, dated March 5, 2004, "On establishing the criteria of placing monies of the pension savings in the assets as stated in sub-points 2 -4 and 6, point 1, p. 26 of the Federal Law No.111 - F3, dated July 24, 2002 "On Investing monies to finance the saving part of the labor pension in the Russian Federation", but it does not contain any amendments to the demands as stated in the said Decision of the RF Government No.379.
periodicity must the managing companies check the correspondence degree of those issuers whose shares they bought for their portfolios, to the established requirements? Besides, information with regard to the cost of net assets is not freely available so its estimation is quite hard for managers to make. Also, it is extremely difficult to collect such necessary information on issuers in whose securities private managing companies invest pension savings, as quantity of the share holders, periodicity of the publications and the composition of accounting.
On the whole, the requirements, as officially stated in the said Decision of the RF Government No. 379, are quite close to those established for including securities in the respective quotation list "A" of the first level109. Thus, according to Decision of the Federal Commission for Securities (FCS), dated January 4, 2002, "On Approving the Regulations on the Requirements to Organizers of Trading on the Securities Market"110, the market cost of shares must comprise no less than 300 mln roubles, the cost of net assets of the securities issuer must comprise for shares no less than 500 mln roubles, the average amount of monthly deals with securities calculated on the basis of the results for the last six (6) months, must be for shares no less than 2 mln roubles. The list of shares which the respective pension monies are allowed to be invested in, can indeed be made wider than the quotation list "A" of the first level since the issuer, on the one hand, can fully correspond to the requirements established for the quotation list "A" of the first level but on the other
hand, for such or other reasons, has not yet became its part. Among the shares entered in this category, judging by the lists which were compiled by the respective managing companies on the basis of their own analytical investigations, are shares of such largest companies as "Aeroflot", "Norilsk Nickel", "Severstal", "Sibirtelecom" and "Surgut-neftegas". Their total capitalization amount on the date of March 31 comprised approximately 53 bln US dollars. On the other hand, however, the common shares of the Stoylensk OMPE (Ore mining and processing enterprise) are included in the MICS quotation list "A" of the first category but the volume of trading in them is less than the average monthly amount of market deals with shares of JSS as established by the known Decision of the RF Government No. 379. Yet, they remain to be in the listing.
According to our estimations, capitalization of issuers in whose shares the pension savings were permitted to be invested, comprised, as of March 31, 2004, 208 bln US dollars or something about 83% of the summary capitalization volume (according to the data of the Red - Stars/Financial Informational Agency, capitalization amount of the Russian issuers comprised, as of March 30, 250.2 bln US dollars). The summary volume of trading in respective shares which are included in the "A" list of the first level, comprised, for the five years of 2004, 85% of the total volume of the MICS trading in shares for the same period.
As established in the said Decision of the RF Government No. 379, requirements to bonds quite coincide with such for requirements to include bonds in the quotation list "A" of the first level in accordance with the FCS Decision No. 1- pc. Thus, the market cost of bonds in which the respective pension savings are permitted to be invested, must comprise no less than 30 mln roubles. The average monthly amount of market deals with the state securities of a RF subject, municipal bonds as well as with bonds of the Russian economic societies as calculated according to the results of the last six (6) months, must comprise no less than 400 thousand roubles.
109 Later, certain changes were introduced in the said Decision which directly pointed at the necessity to include securities in the quotation lists "A" of the first level so that they could be acquired with the monies of the pension savings.
110 The Decision of the FCS, dated December 26, 2003, entered into force beginning from July 1, 2004.
As of early April, the MICS quotation list "A" of the first level included bonds of nine (9) issuers. Yet, the volume of trading in the "MMK" JSS bonds which are included in the top listing category, does not fully comply with the limitations as established by the Decision of the RF Government No. 379 for the average amount of deals with bonds of the Russian economic societies. The summary volume in the circulation of the corporate bonds issues in which the non state managing companies may invest part of the respective pension savings, comprised, according to the estimations as of the end of the first quarter
2004, comprised approximately 14% of the total volume in the corporate bonds circulation at face value. According to the data on issues at the MICS, the volume of the respective trading in January - May comprised about 30% of the aggregate secondary trading volume in the MICS corporate bonds segment111.
The sub-federal and municipal bonds are basically traded in two respective stock exchanges - the MICS and the SPCS (St Petersburg Currency Stock Exchange). The said MICS quotation list "A" of the first level includes bonds from all RF subjects whose total issue volume comprises 88.7 bln roubles, and the respective municipal bonds of one issuer (the issue volume comprises 0.7 bln roubles). The dominant position here belongs to bonds issued by the Government of Moscow. The respective SPCS quotation list of the first level includes only those bonds issued by the Finance Committee under the Saint -Petersburg's Administration (a number of issues in circulation the total volume of which comprised, as of March 1, 2004, 10.6 bln roubles) but the managing companies which took an active part in the discussion of the investment matters in the press, simply ignored them.
Among the sub-federal bonds which were taken by the respective managing companies as fully corresponding to the criteria set up in the said Decision of the RF Government No. 397, but which are not included in the quotation list "A" of the first level, presented are bonds of the Irkutsk, Kostroma, Tomsk, Yaroslavl regions and the Chuvash Republic. The respective managing companies also paid attention to the municipal bonds of the city of Novosibirsk as permitted for respective investing. The total issue volume of these bonds comprises 41.1 bln roubles and they satisfy the necessary requirements both to the issue volume and to the turnover of the respective trading for investing pension savings in them but they are nevertheless included in the MICS quotation list "B".
On the whole, even if the additional requirements have been taken into due consideration, the list of permitted instruments for investing provides the managing companies with quite a sufficient choice of instruments necessary for investing such amounts of the pension savings which they were able to obtain for the respective asset management. Besides, the prospect of significantly increasing this amount in the feasible future seems to be rather vague, particularly so if we proceed from the amendments to the Federal Law "On Compulsory Pension Insurance in the Russian Federation", approved by the State Duma, in accordance with which, citizens who had been born before the year of 1967, are excluded from the saving pension system which is inevitably leading to the reduction of the respective premiums to the saving pension system approximately by 23% in the year of
2005.
* * *
In the autumn of 2004, 376 thous. people more of the 42 mln insured persons decided to transfer their pension savings to the respective private managing companies and
111 The list of corporate bonds issuers which are not included in the top level quotation list but the acquisition of which does not exclude non state managing companies, includes "Bashkirenergo", "Bashinformsviaz" "Mechel" and "Centrtelecom". The total volume of bonds issue by these issuers comprises 2.25 bln roubles.
non state pension funds. Most of the applications - 256 thous. - were made by the citizens in favour of the non state pension funds (NPF). The leading position in the quantity of clients - more than 60 thous. - belongs to the "Lookoil - Guarant", 38 funds were unable to conclude at least one respective agreement, 22 funds - less than 1 thous.112 clients (81 funds enjoy the right to draw pension savings according to the official data of the Pension Fund of the Russian Federation). The real quantity of citizens who made their choice in favour of the non state form of managing their pension savings, for the period of two years, is less than the amount of applications which came to the Pension Fund of the Russian Federation. According to the information which appeared in the mass media means, part of the clients who last year elected private managing companies, this year changed their minds and turned to the said Non State Pension Fund.
4.6. Realty market in the Moscow Region: some results and forecast
Results of the year of 2004; the turning point in the trend
In the year of 2004, quite significant impacts on the Russian realty market were exerted by the processes undergoing in the Russian economy as a whole113.
Actually, the early part of the year of 2004 was not fraught with any threatening changes on the Moscow realty market: quite preserved remained the record price growth rates on realty which fully corresponded to the earlier obtained regression dependence of these rates on the level of the world oil prices114. It should probably be reminded in this respect that in the period of 2002 - 2003, with the oil prices comprising 18 to 20 USD per barrel, the growth rates of realty prices were rather insignificant, with the oil prices comprising 25 -26 USD per barrel, they grew up to 2% a month, with such prices comprising 29 to 30 USD per barrel, these already reached 3.5 - 4.0%. Averagely, 1 USD per barrel growth of oil prices accounted for 0.35 % growth of the monthly price rates on realty. During the year of 2003, this corresponded to half the total increment in the respective prices which comprised then 45 %. Similar regularities were also observed on the realty market of Moscow, the Moscow Region (Fig. 22) and St. Petersburg. By the Autumn of 2003, such growth of prices went outside the confines of the Russia's European part having thus acquired a somewhat universal character.
In connection with this, growth of realty prices in Moscow for the year of 2004 was forecasted115 at the 2003 level, i.e. 35 to 40 % (from 1594 to 2100 - 2300 USD per sq. m). Two possible scenarios were considered then. According to the first and most probable of these, expected was a rather gradual asymptotic transition to the price stabilization at the level of 2100 - 2200 USD per barrel accompanied with the further 5 to 10 per cent "inflationary" increase during the next two - three years. In accordance with the second scenario, the price level could comprise then 2100 to 2200 USD per barrel in the year of 2004 followed then by a 20 to 25 per cent "rollback" of the realty prices and a fluctuating stabilization (the "price bubble" scenario).
112 Finance. 08. 11. 2004.
113 This section contains the monitoring data on the Moscow realty market carried out by the MIEL-Realty company (Sternik, G.M., Lutzkov, V.M. Certified Analyst of the Realty Market [CARM]), RMLC (Sapozhnikov, A.Yu. CARM), "IK «DM Fund»" (Kolokolnikov, D.A. CARM), independent analyst Beketov, A.G. (CARM).
114 Sternik, G.M., Forecast of the Moscow Realty Market Development till the Year of 2005. The AEKSIP Report. April 2003. www.realtymarket.org.
115 Sternik, G.M. Realty Market in Moscow: results of the year. - www.realtymarket.org. January 2004; Russian Economy in 2003. Trends and Perspectives. Issue 25. M.: IET. February 2004, pp. 383 - 393.
2000 1800 1600 1400 1200 1000 800 600 400
—■—Moscow —♦—Moscow Region
■4-
®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®o®
HI § ilitiii mi § ii.i=in sI i-i
^«-j
1-K >
Fig. 22. Dynamics of the average specific prices for supply of living apartments in Moscow and the Moscow Region in the years of 2002 - 2004
Practically, the de facto dynamics of prices in Moscow on the whole did correspond to the second forecast scenario during the first five (5) months of the year of 2004 but already in June - July there followed a sudden change in the said trend, that is transition from growth of the respective turnovers and prices (which lasted during more than three years) to stabilization. At that, the realty market during the first half year was characterized with lower sales of the living apartments and continued price growth (the average specific price of realty supply at the secondary market in Moscow grew from 1594 to 1950 USD per sq. m or by 22.3 % in the period from December 2003 to June 2004) while the second half was characterized with slow restoring rates of the sales volumes and the stable supply prices which were fluctuating within the 1944 - 1953 USD per sq. m range. As to the Moscow Region, the average specific realty prices there grew from 748 to 908 USD per sq. m (by 21.3 %) during the first seven months and then stayed rather stable at the level of 903 -915 USD per sq. m (see: Table 8, Fig. 22).
Table 8
Dynamics of the growth and price index rates on realty in Moscow in 2002 - 2004 (December 2001 is the datum period)
Moscow Moscow Region
Month, year Average specific price of realty USD/sq. Index of growth by datum period (nomi- Growth rates (to preceding period), % Average specific price of realty USD/sq. Index of growth by datum period (nomi- Growth rates (to preceding period), %
m nal) m nal)
12.01 940 1,00 - 471 1,00 -
12.02 1096 1,166 16,6 559 1,187 18,7
12.03 1594 1,696 45,4 748 1,588 33,8
06.04 1950 2,074 22,3 898 1,906 20,1
12.04 1953 2,078 0,15 908 1,928 1,1
12.04* 1953 2,078 22,5* 908 1,928 21,4*
* Values characterizing respective growth in December 2004 as compared against December 2003.
On the whole, the nominal USD prices grew during the year of 2004, as compared against such during the December of 2003, by 22.5% (by 17% in 2002, by 45% in 2003), in the Moscow Region - by 21.4% (by 18.7% in 2002, by 33.8% in 2003). As compared against December 2001, such growth comprised 2.07 times in Moscow and 1.93 times in the Moscow Region.
Influences exerted by the macroeconomic parameters on the realty market as well as prerequisites for respective changes in the price trend in-between the two halves of the year
The dynamics of the respective macroeconomic parameters in the year of 2004 can be characterized by the following indicators. The January "burst" of inflation (1.8 %) which took place on the eve of the presidential elections, was suppressed down to 1 % a month accompanied with simultaneous bringing to a stop of the rouble strengthening with regard to the US dollar which had earlier caused devaluation of the population's savings. However, already by November, this support of the dollar resulted in a new speed up of inflation (1.3 %) so the financial authorities let its rate float free. Nevertheless, the annual growth of inflation comprised 11.57 % (having exceeded the predicted value of the RF Government more than by 1.5 %).
The average nominal dollar rate comprised 27.92 roubles in December 2004 whereas it was 29.44 roubles only a year before. Hence, the inflation rate index of the rouble to the dollar comprised 0.948 roubles in 2004. Thus, the dollar in Russia kept its creeping devaluation in the course of the past year, like that in the year of 2003, and its purchasing power during one year went down by 15.1 %.
For purposes of evaluating the index of the real (both the rouble and the dollar inflation rectified) realty prices (the IGS index)116, below are the macroeconomic dynamics indicators in Russia for the recent three years (2002 - 2004) relative to the December of 2001 as well as for certain periods (Table 9).
Table 9
Dynamics of the macroeconomic parameters in 2002 - 2004: (December 2001 - the datum period)
Month, Year Index of consumer prices (relative to the datum period) Rate of inflation (relative to preceding period) % Average monthly exchange rate rouble/dollar Index of devaluation (rouble to dollar) Index of inflation of dollar in Russia Index of dollar purchasing power relative to the consumer basket
12.2001 1,0 18,6 30,09 1,000 1,000 1,0
2002 1,151 15,1 1,058 1,088 0,919
12.2002 1,151 15,1 31,84 1,058 1,088 0,919
2003* 1,120 12,0 0,925 1,211 0,826
12.2003 1,289 12,0 29,44 0,978 1,318 0,759
1st half year 2004* 1,061 6,1 0,986 1,076 0,929
06.2004 1,368 6,1 29,03 0,965 1 ,41 8 0,705
2004* 1,117 11,7 0,948 1,178 0,849
12.2004 1,44 11,7 27,92 0,928 1,552 0,644
* Indicators for the period (year, half year).
116 The IGS index was calculated according to the following formula: IGS = HPIR/CPI = HPID/IID,
where HIPR - housing price index, as Rb.; CPI - Consumer Price Index, I HPID - housing price index, as USD.; IID = CPI/ DIIR - index of USD inflation in Russia (vs. the dynamics of consumer price); DIIR - index of Rb. depreciation vis-avis USD.
Calculations with regard to the data given in Tables 8 and 9, clearly show that growth of the IGS index in Moscow, which went 14 points up during the first half year, comprised in 2004 on the whole no more than 4.0 % (due to the respective lowering during the following months). However, as compared against the said datum period (December of the year of 2001), the growth in question comprised 34 %. In the Moscow Region, the index of real prices during the year of 2004 went 3 % up while that for the three years (2002 - 2004) -24 % (Table 10).
Table 10
Dynamics of the average level of realty supply in the Moscow Region in 2002 - 2004
Indexes of realty nominal values_Indexes of realty real value (IGS)
Period — Moscow Moscow Region Moscow Moscow Region
12.2001 1,0 1,0 1,0 1,0
12.2002/2001 1,166 1,187 1,07 1,09
12.2003/2002 1,454 1,338 1,20 1,10
12.2003/2001 1,696 1,588 1,29 1,20
1 2 3 4 5
06.2004/ 12.2003 1,223 1,201 1,14 1,12
06.2004/ 12.2001 2,074 1,906 1,46 1,34
12.2004/2003 1,225 1,214 1,04 1,03
12.2004/2001 2,078 1,928 1,34 1,24
It obviously follows from the above said that the true realty value was growing faster in the capital of Russia than in the Moscow Region. However, such an impressive result was achieved much due to the previous 2003 results when the annual IGS index in Moscow was twice the similar indicator for the Moscow Region. Nevertheless, in the years of 2001 and 2003 the growth rates of the true realty value in both subjects of the Russian Federation were approximately the same.
On the whole, volatility of the said macroeconomic parameters did not exert any significant influence on the dollar realty market in the Moscow Region although should this trend continue there is always a possibility for the "running of the population away from the dollar to realty" scenario to come to life again.
The sequence of events which led to the change of trends on the realty market in Moscow was as follows.
The first alarming signs appeared already in February - March of 2004 during the preparation period for the presidential elections as well as right after such. In March, for instance, many Heads of the respective sales departments in a number of developer and broker companies noted lessening of their customer flows while in April even large companies recorded some 20 to 40 % lower sales in newly-erected living constructions and 10 to 20 % more in May and June. Moreover, under conditions of high and steadily growing oil prices on the world markets, possible causes of such events on the realty market in Moscow (similarly - in the Moscow Region and St. Petersburg as well) remained rather unclear. The banking crisis which started in June - July, 2004, seemed to the respective analysts both quite unexpected and rather hard to explain.
Early in July, the RF Central Bank made an official statement about the outflow of foreign currency from the RF to other countries (5.5 bln US dollars during the half year), starting from February, as caused by the worsening investment climate which was traditionally attributed to the well-known events developing around the "Yukos" oil company as well as
to the efforts of the state to cut the inflation rates down. A direct consequence of this was the attendant liquidity crisis both in the banking system and as regards individual enterprises. It was from this particular moment that it was quite clear that nothing else but this very fact became the fundamental cause for the said negative processes in the banking sector and on the real estate markets117.
Both these processes were chain-like strengthening each other. The lower inflow of investments from private buyers of realty in newly-erected buildings obstacled financing of the housing construction, servicing the bank credits and redemption of the earlier issued promissory notes. This, along with the general liquidity crisis in the country, made it much more difficult for the banks to issue new credits to developers thus only further aggravating their respective (already existing) problems. There followed lesser profitability levels of the housing construction (according to the available official data, the net profits in the housing construction industry went 20 % down during the said half year), the construction rates slowed (in some cases even up to "freezing" of certain objects), some larger developers became unable to fulfill their obligations to their contractors, creditors and, what's more important, to their respective private investors. Hence, lower attractiveness of living apartments in the buildings still under construction and even the money withdrawn from the problematic banks (about 2 bln US dollars overall), did not at all "hurry" to start overflowing into the realty market. Plus - careless (or, may be, quite purposefully targeted) statements made by certain functionaries (who obviously were in a rush to report to the RF President on fulfilling the task set up by him) about 10 - 15 % decreases of realty prices in Moscow as well as about availability of lists containing the so called "unfair developers, problematic banks, etc".
Thus, the above chain of negative events started not at all with the falling prices on energy - carriers, as had been assumed in the 2004 forecast, but rather with pure foreign currency outflow from the country due to reasons within the Russian economy itself. Further on, lower activity of the realty market accompanied with the crisis in the banking sector started both to strengthen and to support each other in a sort of mutual way.
Accordingly, growth of realty prices in Moscow in June was sort of minimum and quite indicative of the turning point in the three year long price trend. It became finally clear in July that the said turning point in the realty market trend had been caused by respective events in the macroeconomic sphere. It took place simultaneously in different industries of economy and was supported by efforts of the authorities in sterilizing the money mass (in order to decrease the ensuing inflation).
At first, the full of confidence declaration by Sergei Ignatiev, Chairman of the RF Central Bank (made on July 3), that the foreign currency outflow and the liquidity crisis had already been overcome, gave certain hopes for quick enough restoring growth of demand and prices on the realty market in Moscow. However, later on, as clearly shown by concrete results in July, such foreign currency outflow reached the record mark (up to 1.1 bln US dollars), nor did it any slow down in August. Taking capitals out of the country became the business of not only our own countrymen but that of foreign investors as well - finding themselves under conditions of pressing political instability, they, after all, were not yet quite ready to invest money in the Russian economy.
However, there are, indeed, some other factors to hinder the price growth process. Primarily so with regard to lowering the accessibility factor for the average income group buyers. In 2002 - 2003, significant price growth was ensured mainly by exceeding the
117 Sternik, G.M. Influence of the banking crisis on the realty market (report at the conference). -www.realtymarket.org.
purchasing capacity over the supply price level which resulted in a record growth of the respective sales. The sales volume sharply fell down in early 2004 and such cut down in the demand involved not only high-income population groups (as a direct/indirect result of the foreign currency outflow) but much less well-to-do citizens as well. Which, in its turn, demonstrated that the realty price growth started to outstrip real possibilities of the population on the whole. Quite a large number of buyers just couldn't keep up on the par with the price race and...and simply had to leave the market. Developing of the respective mortgage crediting system is normally happening somewhat late with regard to these very processes. The realty renting rates, at that, were growing much slower than those of the sales with the resulting lower investment attractiveness of such living apartments buying.
Because of these reasons, prices on the realty market just stopped growing. Even though during five months running, the said events were developing rather according to the "prick-the-bubble" scenario, this June saw the practical implementation of the gradual stabilization scenario. Moreover, this stabilization had started about half a year before and at the level of something like 90 % of the earlier forecasted level. As of the present day, the realty market is being so far kept from a serious "avalanche" mainly due to high world oil prices accompanied at that with the record volumes of exports.
Fully in connection with this, the earlier growth of prices forecast in the second half of the year of 2004, was then duly corrected (see Fig. 25). Which can be described as moderately optimistic: slowly increasing business volumes under stabilized prices... On the whole, some fluctuating stability was expected to be preserved for the year of 2005 (average price level fluctuations within the 1900 to 2000 US dollars per sq. m range). In certain realty segments (elite dwelling, cottages, land) however, a possibility still remained for continuing the price growth accompanied with the respective transition to stabilization just within a half-year period. While, at the same time, as regards other objects (low quality housing facilities, newly-constructed housing buildings in certain areas of Moscow, cottages in some so called "unfavourable" cottage settlements), lower prices were forecasted but not of the "landslide" nature at all. Because the de facto price dynamics in the 2-nd half year quite corresponded to the above forecast.
Trends of the second half-year
As was shown above (see Table 8), the realty prices in both Moscow and the Moscow Region were rather stable during the second half of the year with only certain segments of the primary and secondary markets demonstrating some insignificant increase or decrease of such prices. As to their respective turnovers and activities, then, according to the data on the profile units of the "MIEL-Realty" company, the quantity dynamics of the deals registered by them, was as follows (see Fig. 23).
According to the management data of this company, the sales volume in this segment of the Moscow realty market (which reached its minimum in June) kept increasing till the end of the year and finally returned to the level of April - 2.92, relative to the December 2002. The sales volume of the living apartments on the secondary market of Moscow (according to the data of the respective department of the "MIEL-Realty" company) were first slightly decreasing after April but then they got sort of stabilized at the 1.25 level and, already by the end of the year, grew up to 2.0, relative to the same datum period. According to the same source, the sales volumes of cottages were steadily going down from April till August (from 1.43 to 0.45 by the December 2002) but during the last months they grew up to the June 1.10 level. As to the rent segment, its activity was much higher than such in the preceding year; the maximum turnover level (as compared against the December 2002)
was achieved in November 2004 - 3.10, but then it went down to 2.3 in December, although comprising only 1.5 in December 2003.
newly-erected buildings rent
cottages_
secondary housing mortgage deals
Fig. 23. Dynamics of the number of deals on the Moscow realty market and on the cottages market in the Moscow Region (according to the data of the "MIEL-Realty" company)
According to the data, as provided by the respective mortgage department, volumes of the mortgage deals on the primary and secondary realty markets of Moscow grew up drastically in the first half year (2.5 times relative to the December 2002), kept slightly increasing in the second half year and in December this index of the respective turnover already reached 2.9. The total share of such mortgage deals (for both the primary and the secondary markets of the living apartments) grew from 2 % in 2003 up to 8 % in the end of 2004 (Fig. 24).
CI CI Cl Cl Cl Cl Tt Tt Tt Tt
o o o o o o o o o o o
(J .Q h s M .M u .Q s- s M
& & s s (J & s s
Q fa < o Q fa <
Fig. 24. Dynamics of the mortgage deals on the realty market of Moscow
in 2003 - 2004 (%)
Thus, both positive and negative trends were present on the realty market of Moscow in the second six months of the year.
Certain impacts were indeed exerted by the consequences of the negative developments in the finance sphere which took place during the respective spring - and - summer periods. As a consequence of the recent liquidity crisis (possibly, almost overcome already) we now have slower growth rates of the industrial production. Not all banks have yet fully recovered their ability (particularly so taking into account higher norms for reserving the respective funds in the RF Central Bank) and wish to give crediting to developers (especially those having problems with servicing the credits received earlier). Quite a number of them, particularly bigger ones, who have entered the market of borrowing (obviously for purposes of preparing their further expansion into certain RF regions), turn out to be unable to settle accounts with their respective creditors and/or contractors even though they are doing their best to hide their insolvency under a thick smokescreen of noisy and aggressive advertising. While the middle-size developers, as well as some big ones, have sufficient working capital even under conditions of slower rates in attracting private investors which quite significantly helps them to successfully develop their respective business projects. Although, on the whole, the building industry has not yet fully overcome the falling profitability factor certain improvements are already visibly - the share of unprofitable enterprises still remains rather high but is nevertheless somewhat going down.
All the external factors which exerted certain impacts on the realty market in the second half year also had both positive and negative variables. The respective trends were (as before) determined mainly by unstable balances of foreign currency flows, i.e. the correlation between the level of the world oil prices and that of the foreign currency outflow from the country. Oil prices on the world markets remained sufficiently high. The outflow of capital abroad (net export of capital from the private sector in accordance with the data on the RF payment balance as estimated by the RF Central Bank) caused by the worsening investment climate in Russia as well as by the notorious capital - power confrontation, increased in the year of 2004 about four times over as compared against 2003, having thus actually returned to the 2002 level even though there was some net inflow in the last quarter.
Forecasting the trends on the realty market
The following factors capable of exerting stimulating influences on the realty market were primarily taken into consideration when forecasting the level of realty prices in Moscow for the new year of 2005 (Fig. 25): confidence of analysts in maintaining sufficiently high oil prices and amounts of energy carriers exported from Russia, potential attractiveness of the country for returning the national capital and inflow of foreign investments, development of the market legislation in the housing sphere which creates conditions necessary for further development of the mortgage crediting.
2400 2200 2000 1800 J= 1600
1400 1200 1000 800
Fact December 2003 forecast
-July 2004 forecast cast for the year of 2005
Fore
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Fig. 25. Forecasting the dynamics of realty prices in Moscow
However, the macroeconomic situation in the country gives little grounds for making undoubtedly positive forecasts. In 2005, the realty market may have to face serious upheavals. Conditions for normal business activities are becoming neither better nor any more definite. The package of laws (adopted at the end of 2004) which is expected (at least from the respective official point of view) to stimulate more efficient development of the accessible housing markets, will be practically capable of exerting any positive influences after three to four years at best. Accordingly, the nearest feasible time promises but only quite painful consequences for all players of the realty sphere because of uncompleted transition of financing the housing and communal services (HCS) to the non-subsidy system and quite unclear perspectives for full monetization of privileges with regard to the HCS, the precocity and unjustified toughness of a number of norms in the new Housing and Town Planning codes from the viewpoints of expected social consequences, hardness of struggling against monopolistic structures and practices in the housing business (as demonstrated by the process of restructuring the natural monopolies and the present situation on the Russian fuel market, achievement of the real competition is not evident even several years after the respective normative and legislative basis has been enacted). Rather improper beginning of the practical implementation of the law on monetization of privileges has caused social tension in the country while measures being undertaken to overcome it will undoubtedly lead to unforeseen growth of inflation.
Under such conditions, disposition of the population to spending money, to crediting (mortgage included) will indeed be decreasing while that for saving will most definitely be on the rise. However, under conditions of stable and somewhat going down prices on realty the latter ceased being an attractive means for saving monies and investing. Having become convinced in insufficiency of the purchasing capacity for realty, developers will simply have to begin to cut down prices in order to improve the value of the liquidity factor. Nevertheless, we are still of the opinion that they are already somewhat late: the attendant combination of both macroeconomic and microeconomic factors is expected to lead not to greater market turnover and adequate support of the price levels but rather to comparatively prolonged falling of prices in the spring and summer periods - by 15 to 20 % before
the end of the year. Then the said realty market will return to the trajectory of the second scenario forecast which was calculated in December of 2003. By the end of the year, the average price level of realty supply in Moscow will comprise 1700 - 1750 US dollars/sq. m.
4.7. Issues of Practical Implementation of the Local Self-Governance Reform
4.7.1. Normative and Legal Regulation of Reforms
In October 2003 a new version of the Law "On General Principles of Organization of Local Self-Governance in the Russian Federation" (Law No. 131-FZ) was adopted. It is envisaged that the Law will fully enter into force on 01 January 2006.118 Chapter 12 "Transitional Provisions" of the Law describes peculiar properties of local self-governance in the period of transition and the actions of government agencies of various levels aimed at preparing full-scale implementation of the municipal reform. In particular, the following actions aimed at implementing the provisions of the new version of the Law were to be carried out.
It was intended to establish the boundaries of municipal formations before 01 January 2005 and to endow these entities with the status of an urban or rural settlement, a city region or municipal district. As it will be shown below, this process has been developing with many complications and not without contradictions (experts warned it would); this necessitated additional legislative control. In December 2004 Law No. 186-FZ "On Introducing Changes into the Federal Law "On General Principles of Organization of Local Self-governance in the Russian Federation" was adopted, in which the deadline for establishing the boundaries and endowing municipal formations with a status was shifted to 01 March 2005.
The necessity to solve a number of issues of redistributing powers, property etc. between the regional and municipal levels in 2004 was related to the provisions of Law No. 95-FZ "On Introducing Changes In and Additions To the Federal Law "On General Principles of Organization of Legislative (Representative) and Executive Government Agencies of Constituent Entities of the Russian Federation" that came into force on 01 January 2005 (one year earlier than the legislation on local self-governance). It had been planned at the level of the Russian Federation government:
• Before 01 June 2004, to approve the list of territories with low and high population density;
• Before 01 June 2005, to approve the order of property redistribution between the Russian Federation, entities of the Russian Federation and municipal formations as well as the order of delimitation of property in municipal ownership between various types of municipal entities;
• Before 01 January 2005, to introduce in the State Duma draft federal laws on making changes in and additions to federal laws that regulate the order of lodging local self-governance agencies with individual government powers, the authorities of local self-governance agencies to solve local issues and the rights local self-governance agencies for legal defense.
• Before 01 January 2005, to approve the order and dates of preparation of the act of transfer (delimitation) determining the local self-governance agencies' obligations that appear as a result of legal succession.
118 In two entities of the Federation, Stavropol Krai and the Novosibirsk Oblast, the Law comes into force on 01 January 2005.
437
In its decree of 03 March 2004 the RF Government approved the plan of preparing legal acts necessary to implement the Federal Law "On General Principles of Self-Governance in the Russian Federation". This plan envisaged implementing nine items including development of two federal level draft legal acts (one, on making changes in federal laws due to the coming into force of new legislation on Federation entities and on local self-governance, and, two, on state registration of municipal entities' charters) and a number of RF Government's regulations on qualification requirements to the heads of municipalities' financial agencies, to the relationship between tax inspectorates and municipalities etc. It had been intended to prepare the regulation on delimitation of territories with high and low population density in April 2004, and the regulation on segregation of property and regulation of legal succession issues, in November 2004. It had been recommended on the level of constituent entities of the Federation to approve similar plans, and most of the regions followed this recommendation.
Although, by the end of 2004 most of the envisaged normative legal acts had been either adopted or prepared to a high degree, not all of the plan items had been implemented.
E.g., in August 2004 Federal Law "On Making Changes in Legal Acts of the Russian Federation and Acknowledging Some Legal Acts of the Russian Federation as Inoperative due to Adoption of Federal Laws "On Making Changes in and Additions to the Federal Law "On General Principles of Organization of Law-making (Representative) and Executive Bodies of State Power of Constituent Entities of the Russian Federation" and "On General Principles of Organization of Local Self-governance in the Russian Federation" No. 122-FZ was adopted that provided for introducing changes to more than 150 legal acts of the Russian Federation. At the same time, the procedure for regulation of a number of issues that is contained in this Law does not correspond to the provisions contained in laws No. 95-FZ and No. 131-FZ. E.g., this law stipulates for making changes in the Law "On Education", in accordance with which it is the competence of entities of the Russian Federation to provide state guarantees for citizens' rights to free-for-all and publicly accessible pre-school and general education as well as additional education by means of allocating to local authorities subventions in an amount necessary for the implementation of basic programs of general education. At the same time Law No. 131-FZ stipulates that organizing the process of granting additional education and free-for-all and publicly accessible pre-school education is a local level issue; moreover, as opposed to the case of primary, basic and secondary general education, in this case no reservation is made that the authority to fund education are excluded from local issues.
In addition, the RF Government issued four regulations in the course of the year: "On the Order of Interaction of Agencies of State Authority of a Constituent Entity of the Russian Federation and Local Self-Governance Agencies with Territorial Agencies of a Federal Agency of Executive Power Authorized in the Area of Taxes and Duties" (August 2004); "On Qualification Requirements to the Head of the Financial Agency of a Constituent Entity of the Russian Federation and the Head of the Financial Agency of a Local Administration" (November 2004); "On the Authorized Federal Agency for the Approval of Boundaries of Municipal Formations" (December 2004) and "On Approving the Rules for Delineation of Municipal Formations' Obligations and for Preparation of the Act of Transfer (Delineation)" (December 2004). The RF Government regulated the issues of determining territories with low and high population density in its decree of 25 May 2004, which approved the list of constituent entities of the Russian Federation and separate districts of entities (within the existing borders) belonging to the territories with low population density and the list of constituent entities of the Russian Federation and separate districts of entities (within the 438
existing borders) belonging to the territories with high population density. The draft law on state registration of municipal formations was prepared in 2004; however, it has not been introduced for approval in the State Duma.
Owing to the fact that property redistribution between the regional and municipal levels was quite actively carried out in 2004 in connection with preparation for the implementation of Law No. 95-FZ, lack of a normative legal act regulating the order of such redistribution affected the course of reforms especially negatively.
Adoption of amendments to the Tax Code and Budget Code has become a most important novation that has a considerable effect on preparation of a full-scale introduction of Law No. 131-FZ. These documents regulate such issues as assigning sources of income to various type municipal formations (including a list of local taxes), possible mechanisms of establishment of interbudgetary relations, introducing provisional financial administration etc. The notion of local budget undergoes a fundamental change: it is now defined as a form of amassing and spending funds for financial year, which are allocated for the execution of specific expenditure liabilities of the relevant municipal formation, and not for implementing tasks and functions reckoned among issues of local self-governance in general. Expenditure liabilities arise out of normative legal acts and agreements adopted at the municipal level. It is made obligatory for agencies of local self-government to keep a register of their expenditure liabilities.
At the same time, not all of financial issues provided for in Law No. 131-FZ were described in the new version of the Budget Code. E.g., the Budget Code has failed to provide for adequate forms of including the citizens' self-taxation in the local budget's income.
4.7.2. Determining the Boundaries and Status of Municipal Formations: Practice and Problems
In the course of determining the boundaries and status of municipal formations the regions encountered a number of problems arising both out of flawed regulation of these norms in Law No. 131-FZ and out of objective contradiction between various municipal formation types that started to appear as early as at the stage of organization of municipalities. Municipal districts were affected by such reforms least of all; the district structure has remained unchanged practically everywhere. Problems have been mainly connected with the establishment of two municipal formation types, namely rural settlements and urban districts. By the time the municipal reform began there were no full-fledged municipalities at the village level in an overwhelming majority of Russian regions. In most of Federation entities with a developed municipal formation structure there were submunicipal entities at that level, namely settlements, village soviets, rural areas, volosts, etc. While the head of such an entity was appointed by the district management and its funding was carried out according to a cost estimate, the real status of these structures varied greatly from one region to another. In some Federation entities they took an intermediary position between the district administration's subdivisions and independent municipal formations because the heads of sub-municipal structures were appointed in consultation with the local population, their fairly broad authorities were confirmed in the charters of municipal formations, and they had a certain degree of freedom in disposing of the formation's finances, both in respect of a part of the cost estimate, when it included the reserve fund in one way or another, and the self-taxation funds, where these played a considerable role. In some of Federation entities municipal structures formally existed at the village level, but in most cases they had no independent budget and were funded according to a cost estimate.
In reorganizing the territorial structure of local self-governance, in particular in creating a system of rural settlements, the regions had to take account of the following conditions and restrictions that resulted from Law No. 131- FZ :
• The entire territory of the Federation entity, with the exception of the territories with low population density, must be delimited between settlements;
• The settlement's administrative center must be close enough to reach it on foot within one working day from any inhabited locality included in its structure;
• As a rule, the population of a settlement must be over 1000 inhabitants, and for territories with high population density, over 3000 inhabitants; however, this condition does not apply to independent municipal formations that existed as of the date the law was adopted;
• The list of local matters must be codified in the law.
As early as at initial stages of territorial structure reforms it turned out that the legally codified benchmarks were quite vague and did not match. E.g., it remained unclear how one should determine the proximity on foot and what population categories were taken into account in the process of such determination. This criterion per se was criticized as being archaic and not in line with the present posture of affairs. Moreover, the requirement of on-foot accessibility in many cases did not match the necessity to take into account criteria related to the number of inhabitants in rural settlements. The proposal made by a number of region to substitute transportation accessibility for on-foot accessibility was not adopted; however, in the amendments to Law No. 131-FZ that were made in December 2004 this requirement was somewhat softened.
Problems encountered in the course of establishing settlements also occurred because the right to determine the list of underpopulated territories, in which the principle of territory delimitation between settlements would not apply, had been legally overcentral-ized at the level of the RF Government. Moreover, such a list could include only either constituent entities of the Federation as a whole or districts within such Federation entities, while population density may differ considerably not only from one district to another but also within one district. In some districts there are territories with inhabited localities, in which there remain only few inhabitants. Further still, even in densely populated areas there are practically unpopulated spots (reserves, forestlands etc.). Under these conditions it is fairly difficult to ensure delimitation of the entire territory between settlements' municipalities; at the same time, such delimitation stops to make sense because the most part of the territory of some settlements turns out to be unpopulated. However, no steps had been made in 2004 to expand the regions' authority to determine underpopulated territories.
Along with the contradictions related to legal benchmarks for the formation of the territorial structure, this process also brought to light deeper problems. Assigning certain issues to settlements implied that municipal formations of that level were capable of implementing the functions assigned. However, the number of inhabitants or on-foot accessibility does not generate such capabilities. It is necessary to take into account other factors, namely availability of an adequate infrastructure, economic base etc., although the law does not say that these are necessary. The importance of such factors is further underscored by the fact that the experience and traditions of establishing co-operation between municipalities are lacking in Russia, and so municipal formations are quite wary of such an approach to local matters. All the attempts at establishing intermunicipal cooperation that the authors have considered in the course of researching this problem were either short-lived and ineffective or resulted in such tensions that the parties concerned made efforts to find other ways of providing the population with municipal services. 440
Under these conditions, the regions usually followed one of the three below-mentioned strategies in forming rural localities' territorial structure
Strategy No. 1 was to keep the district structure of municipal formations unchanged despite the novations introduced in the new law. The solution selected was to form urban regions that included the entire territory of a district even if the district in question was to a great extent rural. Without breaking the letter of the law, such an approach clearly contradicted the municipal reform concept. Therefore, the definition of the territory of an urban region was detailed in the amendments to Law No. 131-FZ so as to prevent broad interpretation. Under these amendments, the territory of an urban settlement (including an urban region) can incorporate territories, including rural territories, that, in accordance with the general layout, are designed for the development of its social, transportation and other infrastructures. In the event that the town (settlement) that is to receive the status of an urban settlement has no general layout or its existing territory exceeds the urban boundary and in the event that there are territorial disputes between the town (settlement) and other municipal formations that have not been determined in a judicial proceeding, the composition and boundaries of the urban settlement in question shall be fixed:
• On the basis of the town's (settlement's) historical territory and in accordance with the boundaries of plots of land allotted for urban development and of the territories designed for the development of the town's (settlement's) social, transportation and other infrastructures;
• In accordance with the boundaries of the territories and plots of land specified in the legal acts, which determine that the disputed territories and plots of land are part of the town's (settlement's) territory.
As of now, it is still unclear what will be the steps of the regions adhering to this strategy after the amendments to Law No. 131-FZ have been passed; they will have to change their approach to the formation of the territorial structure in a very short period of time, namely before 01 March 2005.
Strategy No. 2 was to form rural settlements on the basis of existing sub-municipal structures, namely village soviets. Under this strategy, there usually occurred no problems with on-foot accessibility, but the criteria relating to the number of inhabitants were sometimes not observed. Such an approach formally conforms to the legally fixed requirements and takes into account historical relations. However, in the event of a full-scale implementation of the law it can cause serious difficulties because it ignores both real capability of the created structures to solve local issues assigned to them and availability of the necessary personnel, infrastructure and economic potential. Furthermore, this approach ceteris paribus will cause the greatest increase in administrative expenses and expansion of the managerial staff machinery.
Strategy No. 3 proceeded from the necessity to take into account a bunch of factors that would ensure the most favorable starting conditions for the operation of rural settlements. It considered both formal criteria provided for in the law and transportation accessibility, available infrastructure and economic base. As a result, in the regions adhering to this strategy the number of rural settlements is appreciably, up to several times, lower than the number of sub-municipal structures existing in that territory. Under these conditions, a settlement's ability to solve local issues increases and administrative expenses grow to a lesser extent; however, this is achieved at the expense of on-foot accessibility. In this event the distance from some inhabited localities to the administrative center can exceed 30 km. Thus, as a result of applying this approach the administration may become estranged from the population instead of moving nearer to it as this was proclaimed when Law No. 131-FZ was adopted.
Under these conditions it becomes especially important to provide municipal services to the population of the territories where administrative structures (village soviets) had existed previously and were liquidated in the course of the reforms.
It is thus clear that each of the strategies used to form territorial structures in the rural area has internal contradictions that are bound to come to the fore in the course of a full-scale implementation of the municipal reform thus complicating management in new conditions.
The urban region issue was just as critical for many regions in the course of forming their territorial structure. Initially, the status of the towns that were not regional capitals or large science towns developed in different and fairly chaotic ways in different regions. In some constituent entities of the Russian Federation practically all of them were independent towns of the so-called oblast subordination, in other regions an overwhelming majority of them were part of districts. There were regions, in which towns with practically equal numbers of inhabitants and economic potential (including towns with population of 80 to 100 thousand) were independent municipal formations in some cases and were included in the district in other cases. At the same time, relatively small urban settlements with up 20 thousand inhabitants could be made independent municipalities. In the event that a town was part of a district, usually no special sub-municipal structures were established in its territory; the district administration carried out the urban management functions directly.
Provisions regulating the formation of urban regions were one of the most actively disputed parts of the legislation on local self-governance and in the course of the legislation's development they were changed many times. As a result, any references to quantitative criteria of urban region formation that related to the number of inhabitants were eliminated from the wording of the law. At the same time, it was proclaimed that an urban settlement that is a full-fledged municipal formation must become an urban region unless the law of the constituent entity of the Federation stipulated otherwise before 01 February 2005 (according to the amendments, before 01 March 2005). In doing so, the entity in question was to be governed by two provisions: firstly, both the urban settlement and the territory of the adjacent district were to have a social, transportation and other infrastructure necessary for them to independently solve local matters and to carry out certain governmental authorities. Secondly, it is necessary to obtain the consent of the local population to assign or to withdraw the status of an urban settlement. The situation became even more complicated because the article prescribing to find out the population's opinion is to enter into force only from 01 January 2006.
At the same time, assigning the urban region status to urban settlements that were not a full-fledged municipal formation required that the above-mentioned infrastructure criteria must be taken into account and that the opinion of the population both of the urban settlement and the municipal district that has incorporated this settlement be found out.
As a result, the case of assigning the urban settlement status to urban regions has developed as follows. At this point in time the authors do not know of any case in which the urban settlement status has been assigned to an urban settlement that previously was not an independent municipal formation even if a developed infrastructure allowed both the town and surrounding district to solve local issues independently. The procedure related to such assigning turned out to be overly complicated and costly to apply in practice. The situation with independent municipal formations developed in different ways. In some regions they were assigned the urban settlement status automatically; in others they were incorporated in districts even in the event of fairly large towns with long-time traditions of self-regulation. In doing so, no attempts were made at finding out or taking into account the population's opinion about the status of such municipal entities. 442
It is clear, like in the first case, that both decisions are pregnant with future conflicts. Creating an urban region on the basis of an urban settlement that is a district center will in most cases strip the district of any considerable sources of income and is bound to create problems linked to joint use of objects of social infrastructure located in the town's territory. On the other hand, incorporating a town in a district as an urban settlement is not a problem-free solution either. E.g., in this event one can predict that there will be inevitable conflicts between the head of the district and the head of the district center, which may negatively affect the process of making and implementing decisions that require cooperation from both sides.
Different options of solution for the urban settlement problem can lead to controversial results for municipal formations' investment attraction. E.g., the necessity to get an approval at one more level, namely that of a district, can affect investor interest to urban objects negatively. At the same time, as a result of the lack of a tradition of intermunicipal cooperation, in some instances the town needs a territory for establishing new production and the district needs the infrastructure, but the two entities of municipal power cannot reach an agreement.
The idea that an urban center cannot be the center of the surrounding district, which does not follow from the wording of Law No. 131-FZ directly, has posed a special problem in assigning urban settlements with the urban region status. As a result, in some regions reorganization of the territorial structure of local self-governance provided for assigning the urban region status to all urban type independent municipal formations except for district centers, i.e. the largest formations that solid grounds to qualify for this status. A special clarification to this effect has been included in amendments to Law No. 131-FZ, which stated "a town (settlement), which has the status of an urban region and is located within the boundaries of a municipal district can be considered the municipal district's administrative center".
The mechanism used in forming the territorial structure of local self-governance is of considerable importance from the point of view of the consequences that the introduction of Law No. 131-FZ will have. In most regions district level municipalities that developed drafts of new territorial structures played the main role in this process. As a rule, the heads of sub-municipal structures were involved. Population was mainly gathered in the event of a conflict, however, in some districts gatherings were convoked everywhere. Then the prepared draft was presented to the oblast administration, where a special committee would consider and usually adopt it, although occasionally the draft was returned for rework. However, we have seen cases of a different approach to this issue, in which the draft of a new territorial structure was worked out at the oblast level together with district heads; sub-municipal structures were not involved and practically no gatherings were convoked.
Clearly, in the first case the process of territorial structure formation included cooperation and co-ordination of interests of various "players". In this event the heads of sub-municipal structures played the role they do play in most cases, namely that of an organizer of the local community, and not just a formal role of an employee of the district administration. Although the process of creating the structure of a municipal formation could include more difficulties and conflicts, social adaptation of this structure should ceteris paribus be less painful. Approach No. 2 wholly rests on the formal structure of power and in many respects transfers the procedure for the formation of a territorial structure to the area of administrative solutions. It is clearly not as time-consuming as the above-mentioned option. However, the advantage that this approach can offer at the stage of territorial structure formation can lead to additional difficulties and problems by the time it is necessary to solve local issues using such a structure. A new territorial structure that has
not undergone social adaptation with the local population and has been created without account for information available at the sub-municipal structure level can turn out to be socially and politically vulnerable.
4.7.3. Other Aspects of Municipal Reform Preparation.
It is obvious that preparing the municipal reform at the regional level included two main components, namely establishing the boundaries and determining the status of municipal formations. Other aspects of the reform played a far lesser role. Still, we should not pass over at least three groups of issues that are bound to exert fundamental influence on the creation of municipal formations after 01 January 2006. These groups are: redistribution of authorities and property between various levels of power, both between the regional and municipal levels and between districts and settlements, as well as creation of financial mechanisms that conform to the new versions of the Tax Code and Budget Code.
Redistribution of Power and Property
In 2004, due to the preparation for enactment of Law No. 95-FZ, authorities were quite actively redistributed between the regional and municipal levels. The most significant change in this respect is the centralization at the regional level of the functions relating to social protection of the population. Some regions transfer such functions to municipal formations in the form of official authorities; others fully centralize them at the regional level, creating subdivisions of regional structures in municipalities.
The management of many municipal structures is quite wary about transferring social functions to the region. It is believed that the real state of affairs and real needs of the people are better known at the local level, while granting social aid from the regional level would only result in bureaucratization of the process. At the same time, they are considering options aimed at keeping at the local level certain authorities in the field of social policy under the new legislation. E.g., a number of municipal programs in the field of social assistance may be changed into programs in the field of education or health care without any essential change in their content.
The transfer of social authorities to the regional level is accompanied by transfer of items of property necessary to implement such authorities. Conflicts arising in the process of property transfer are caused by two main reasons. Firstly, municipal formations have invested considerable amounts of money from local budgets (and, in some instances, money of the population) in a number of social facilities, and transferring them without any compensation is considered unfair. Secondly, difficulties arise when premises and a number of other items of property necessary for administrating the social sphere are divided.
As far as distribution of power between districts and settlements is concerned, it should be borne in mind that, despite strict delineation of local issues between the district and the settlement levels, the law provides for a possibility to transfer power from settlements to the district and from the district to settlements. Such a transfer may be carried out on the basis of agreements concluded for a certain period of time. The authorities transferred must be funded out of subventions granted either from the budgets of settlements to the budgets of municipal districts or from the budgets of municipal districts to the budgets of settlements.
So far, in most regions this issue has not reached the practical stage. At this point in time only approaches to the delineation of powers between the two levels of municipal formations are being discussed. And since both the necessary human resources and organizational potential are lacking at the settlement level, it is now widely believed that the
functions must everywhere be transferred from settlements to districts together with the corresponding financial resources. This in fact means reproducing the previous, pre-reform model of organization of municipal formations.
But, even if we forget that such a system contradicts the spirit of the law, it should be taken into account that it is fraught with deep conflicts. The law stipulates for elected bodies at the settlement level, and such bodies will see their task in protecting the interests of the people that have elected them. If settlement level authorities are deprived of powers and means of solving their inhabitants' daily issues, new authorities will concentrate their main efforts on protecting the interests of their inhabitants at the district level, which will inevitably result in problems and conflicts. In a situation like this the proneness to conflict that is inherent in the two-level model (and that has been on many an occasion pointed out by foreign and Russian experts on municipal issues) can grow significantly.
In our opinion, the option providing a greater degree of selectivity in respect of distribution of powers between the district and settlement levels is more promising. From this point of view, four various settlement groups may be separated:
1. Settlements, to which additional powers are transferred, primarily in the field of education and health care. Such a transfer allows to ensure coordinated growth of the communal and social infrastructure in the settlement's territory and to optimize use of municipal immovable property. In respect of stations of first medical and obstetrical aid, such a transfer appears advisable practically everywhere. As far as other authorities in the sphere of health care and education are concerned, this is important for urban settlements in the first place.
2. Settlements that can solve local issues legally assigned to them without external assistance.
3. Settlements that transfer to the district level issues that are related to the organization of communal services to the population. It is this set of local issues, which causes the greatest problems, because, in many cases, economies of scale play an important role here. Given the lack of tradition of intermunicipal cooperation (which we have already mentioned above), losses at the level of a separate settlement connected with an insufficient scale of operations are highly possible; this can result in a higher price and lower quality of the services provided. It is advisable to pose the questions of maintaining the municipal housing stock at the settlement level. This will allow settlements to become gradually involved in the organization of granting housing and utility services, starting from the easiest (housing) services; at the same time this will help to delineate the granting of housing (potentially competitive) and utility (naturally monopolistic) services that, at present, in most cases is combined within multidisciplinary housing and utility companies operating at the district level. This results in insufficient transparency of financial flows in the housing and utility sector, lower manageability in the sector of services granted by natural monopolies and to artificial monopolization of potentially competitive services markets.
4. Settlements that transfer most of authorities relating to local issues to the district level. Clearly, in this case it is the smallest settlements that are really unable to implement even the easiest functions assigned to them.
In spite of the fact that, under the law, each settlement must have a local administration of its own, it could be more expedient to join the efforts of several settlements to implement some specialized functions. This could to a certain extent mitigate the problem of insufficient human and organizational resources as well as lower administrative expenses on municipal management without transferring the main settlement authorities to the dis-
trict level. Moreover, it is not necessary (and, probably, simply inexpedient) to organize such co-operation at the district level.
Formation of New Financial Mechanisms
The main elements of organization of municipal level funding have been provided for in the new version of the Tax Code and the Budget Code. It is stipulated that both local taxes (the land tax and the tax on property of individuals) and deductions from federal taxes or taxes introduced as part of a special tax regime (the tax on income of individuals, tax on imputed earnings and unified agricultural tax) shall be assigned to municipal formations.
A list of sources of income assigned by the federal law to each municipal formation type is presented in Table 11.
Table 11
Tax Incomes Assigned to Local Budgets (%)
Tax Incomes
Deductions to Budgets of
Urban Regions
Municipal Districts
Settlements
Local Taxes and Duties
Land tax collected on the territories of settlements and urban regions
Land tax collected on territories between settlements Tax on property of individuals collected on the territories of settlements and urban regions
Tax on property of individuals collected on territories between settlements (??)
Federal Taxes and Duties, Including Those Stipulated by Special Tax Regimes
Income tax 30 Unified tax on imputed earnings 90 Single agricultural tax 60 State duty payable at the place of registration_100_
100 0 100
0
0 100 0
100
20 0
30 100
100 0 100
0
10 0
30 0
Source: RF Budget Code, dated 31 July 1998. No. 145-FZ (version of 20August 2004).
It is possible at the regional level to assign to the budgets of municipal districts or settlements single norms of deductions, established on a permanent basis, from regional taxes or federal taxes assigned to constituent entities of the Federation. In addition, the Federation entity should decide what instruments of interbudgetary relations from the 'menu' provided in the Budget Code will be used in the region.
In 2004, most regions began to work out approaches to the formation of a system of intergbudgetary relations under new conditions and made preliminary calculations (in some of the regions these calculations included the level of the proposed settlements). Approaches to solving individual issues of a new mechanism to be applied for the funding of municipal formations are being discussed, in particular the following issues:
• On the possibility to assign single deduction norms at the regional level (some regions do not intend to assign additional norms, others contemplate, e.g., assigning part of the tax on corporate property to municipal districts);
• On organizing financial leveling of settlements (some regions propose to do it starting from the regional level, others intend to establish district funds of financial assistance to the population);
• On the necessity of applying negative transfer119.
However, in 2004 only few regions that set the target to speed up the implementation of the municipal reform or its individual elements did develop full-fledged methods of financial leveling on the basis of the new principles. It became clear in the process of this development that distributing financial means under the old and new financial assistance mechanisms differs significantly. Cities (in particular, regional capitals) gained most. In order to make the process of transition to the new financial leveling mechanism smoother, practically all of these regions decided to establish a fund that would in ever smaller portions partially compensate municipal formations' losses from the introduction of the new financial mechanism throughout the transition period. It is envisaged to compensate 90 percent of losses in 2005.
This measure could become even more efficient if it were accompanied by creation and implementation of special municipal formation level programs. Such programs should stipulate the directions of growth of budgetary income and provide for greater efficiency of budgetary spending. This would allow, by the end of the period of transition, to co-ordinate budgetary spending with sources of income under the conditions of leveling the fiscal capacity and to guarantee that local issues are solved at the level that corresponds the requirements of the local community.
4.8. Reform of the accounting system in Russia
The harmonization of national accounting standards in Russia with those accepted in the international practice has a long history behind it. The transition to the International Accounting Standards (IAS) - now International Financial Reporting Standards (IFRS)120 -was set forth as the major avenue of the reforms in this sphere by Resolution of the RF Government No. 283 of March 6, 1998, "On the Approval of the Program for Reforming Accountancy in Accordance with the International Accounting Standards (IAS)."
The action plan aimed at the implementation of this program included the improvement the normative legal regulation; formation of a regulatory framework, formation of a methodological and personnel base; as well as measures of international cooperation in the sphere of development of accounting standards and regulation of accounting. It was planned to implement the whole package of these measures within two years121. Thus, the publication of the International Accounting Standards and the related glossary of terms in Russian translation was scheduled for March of 1998. The measures aimed at the final elaboration of the new standards, in particular, the development of instructions and methodological recommendations across individual rules (standards) of the accounting, as well as those relating to the training of respective experts and their attestation were delayed until year 2000.
According to the Program, the key element of the reform of the accounting and financial reporting in Russia should be the development of new and elaboration of the previ-
119 The law of a constituent entity of the RF can introduce the negative transfer (subvention transferred from municipal formations' budgets to the budgets, whose funds are used for the financial leveling of the corresponding type of municipalities) for settlements, whose estimated fiscal capacity level is at least the double of the average level for the settlements in such a region. The amount of a negative transfer cannot exceed 50-percent difference between the estimated fiscal capacity of this settlement and the double average fiscal capacity of the region's settlements in the past reporting year. At present discussions are under way whether it is expedient to introduce amendments to the Budget Code that would allow wider application of the negative transfer practice and increase the related revenues.
120 On April, 1st, 2001 International Accounting Standards Board (IASB) has come in stead of former Board of the International Accounting Standards Committee (IASC). Eventually the International accounting standards will be improved by IASB and to be added to new International financial reporting standards (IFRS). IFRS includes earlier accepted standards (IAS).
121 See the Supplement to Resolution of the RF Government No. 283 of March 6, 1998, "On the Approval of the Program for Reforming Accountancy in Accordance with the International Accounting Standards (IAS)."
ously approved rules (standards) of accounting and introduction of these rules and standards to practice. It should be noted that such an approach to the harmonization of the national accounting standards to IFRS has not in fact required the Russian accountants' community to familiarize itself with the system of International Standards per se. It only required the implementation of the new Accounting Rules (AR) developed and approved by the RF Finance Ministry. This became one of the reasons, which generated the grave legislative and personnel problems relating to the switching of Russian enterprises to the presentation of their financial statements in accordance with IFRS they face at present122.
At the same time, the new Accounting Rules only in part correspond to IFRS. The fundamental principles of the International Financial Reporting Standards - the under-standability, relevance, and reliability of the information contained in the reports have not been clearly set forth in the AR. The principles underlying the formation of reports - the completeness, prudence, and priority of economic substance over the legal form are set forth in item 7 of the AR 1/98 "Accounting policy of the organization."123 However, the accounting policies of organizations reflect the specifics of accounting at individual enterprises, what creates an ambiguous situation with respect to these fundamental principles.
A certain exception is the principle of neutrality of information in the financial statements. This principle is set forth in item 7 of AR 4/99 "Financial reporting of the organization."124 According to this Rule, information is not neutral in the case it influences the decisions and estimates of users due to the selection or forms of presentation of such information aimed at the achievement of predetermined results or consequences. In spite of clear formulation, at present this principle is not completely complied with, since it does not contain the prohibition to use the financial statements of enterprises for the purposes of tax administration and control.
The reform of the Russian accounting carried out in accordance with the Program of 1998 did not bring the expected results. The system of accounting and reporting formed at present has failed to provide the users of financial statements with reliable and useful information necessary to take economic decisions. An evidence of this is the fact that the majority of large Russian enterprises having counterparts abroad draw up their reports not only in accordance with the national standards, but in accordance with the standards accepted in the international practice, like IFRS or US GAAP, as well. Therefore, the reform of the accounting system in Russia is still far from being completed.
In 2004, there was made a significant step towards the creation of a system of accounting disciplines in Russia meeting the modern requirements to the quality of financial information. As compared with the Program of 1998, there was taken another approach to the reform in this sphere - the harmonization of national accounting standards with international practice began to transform into the transition to the International Financial Reporting Standards. For instance, there was taken an attempt to grant IFRS a legal status in Russia.
The following documents indicate the origination of this new trend:
1. The "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook";
2. Draft federal law "On Consolidated Financial Statements."
122 For details, see: Russian economy in 2003. Trends and outlooks. M.: IET, 2004. Chapter 4.5 "Reform of the accounting system in Russia."
123 Approved by Order of the RF Finance Ministry No. 60 n of December 9, 1998.
124 Approved by Order of the RF Finance Ministry No. 43 n of July 6, 1999.
At the same time, these documents contain a number of provisions, which may have a significant negative impact on the progress of the reform of the Russian system of accounting.
4.8.1. The Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook
The "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" (2004-2010) was approved by Resolution of the RF Government No. 180 of July 1, 2004. The Concept stated that it was aimed at the improvement of the quality of information formed in accounting and reporting and at ensuring of guaranteed access to such information for interested users.
In order to achieve this aim, it was decided to develop accounting and reporting in Russia along the following key avenues:
• Improvement of the quality of information formed in accounting and reporting;
• Creation of the infrastructure of the use of IFRS;
• Changes in the system of regulation of accounting and reporting;
• Increase in control of the quality of financial statements;
• Training and improvement of skills of the personnel.
The Concept envisages that accounting and formation of non-consolidated financial statements of enterprises should correspond to the Russian accounting standards, consolidated financial statements of groups of enterprises should be formed in accordance with the International Financial Reporting Standards (IFRS), while tax reporting should be based on the information formed in accounting by the way of adjustment in accordance with the rules set forth by the tax legislation.
In 2004 through 2007, it is planned to mandatory switch consolidated financial statements presented by socially important economic entities, with the exception of enterprises having securities traded on stock markets of other countries and drawing up their reports in accordance with other standards accepted in the international practice, to IFRS. Economic entities are defined as socially important in the case their commercial activities involve the funds of unlimited circles of persons: open joint stock companies and other organizations issuing publicly placed and/ or publicly circulated securities; financial organizations working with the funds of individuals and legal entities; other organizations.
Besides, it is stated in the Concept that the major package of the Russian standards of accounting based on IFRS should be approved at the same time.
In 2008 through 2010, the enterprises, which in the previous years used other standards accepted in the international practice for the drawing up of their consolidated financial statements, should also switch to the mandatory presentation of their reports in accordance with IFRS.
The evaluation of the option permitting a certain circle of economic entities to carry out their accounting in accordance with IFRS in stead of the Russian standards was postponed until 2008.
It should be noted that the version of the "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" approved by the RF Finance Ministry in July of 2004 is significantly different from the variant presented to the RF Finance Ministry by the Ministry of Economic Development and Trade of the Russian Federation in March of 2004125. The draft presented by the RF Ministry of Economic Devel-
125 "Minekonomrazvitiya RF napravilo v Minfin RF predlozheniya po kontseptsii ucheta i otchetnosti v Rossii na srednes-rochnuyu perspektivu" (The RF Ministry of Economic Development and Trade forwarded to the RF Finance Ministry the pro-
opment and Trade was elaborated in cooperation with the National Organization for the Standards of Financial Accounting and Reporting (NSFO).
These proposals envisaged several stages of implementation of the development strategy with respect to the accounting and reporting, at each stage the circle of Russian organizations using International Financial Reporting Standards should gradually expand and the state regulation in the sphere of accounting should be consistently liberalized126.
In 2004 through 2006, the enterprises, whose securities are admitted to the circula-
127
tion via organizers of trade on the stock market, banks , as well as professional operators of the stock market, should switch to the mandatory presentation of their financial statements in accordance with IFRS. At the same time, these enterprises should be exempted from the accounting and reporting based on the Russian standards. Since 2006, the option not to draw up financial statements should be introduced for all enterprises not included in the list of socially important entities. These enterprises would have to present only tax and statistical reporting.
The regulatory and methodological functions performed by the state in the sphere of accounting and reporting should be gradually transferred to a non-state regulatory authority.
2007. Insurance companies and state unitary enterprises128 should present their financial statements in accordance with IFRS. These entities should be also exempted from the accounting and reporting based on the Russian standards.
2010. All joint stock companies and enterprises, which in the previous years presented their financial statements based on other standards accepted in the international practice, should switch to the International Financial Reporting Standards. The Government will have the possibility to influence the formation of the standards of financial reporting only via its representation in the supervisory board of a non-state regulatory authority.
Therefore, it is clear that the version of the "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" has significantly tightened the procedures governing the reform in this sphere, which would hardly be favorable for the Russian system of accounting.
There may be indicated the following negative changes:
• The requirement that the enterprises drawing up their financial statements in accordance with IFRS should continue to carry out the mandatory accounting and reporting based on the Russian standards;
• The requirement that the enterprises, which in fact have no interested outside users of their financial statements, continue to carry out mandatory accounting and financial reporting;
• Sharing of rule making and regulatory functions in the sphere of accounting biased in favor of state bodies.
The requirement to present non-consolidated financial statements based on the Russian standards presupposes the necessity to either carry out two types of financial ac-
posals concerning the concept of accounting and reporting in Russia for a medium term outlook) - published at http://www.gaap.ru on March 25, 2004.
126 See, for instance, the publication "Ot redaktsii gazety Vedomosti: MSFO ne strashny" (From the Vedomosti editorial board: IFRS are not frightful) at http://www.gaap.ru on March 25, 2004.
127 According to Instruction of the Central Bank of the Russian Federation No. 1363 - U of December 25, 2003, Russian banks should prepare IFRS based financial statements for the period ending on September 30, 2004.
128 As concerns the budgetary sphere, the respective guidelines of the development of accounting and reporting are set forth in the "Concept of the reform of the budgetary process in the Russian Federation in 2004 through 2006," which was approved by Resolution of the RF Government No. 249 of May 22, 2004). According to this document, the key tool of the reform of accounting and reporting in the budgetary sphere should be the International Public Sector Accounting Standards (IPSAS).
counting, or transform the accounts, among other things, for the purposes of consolidation. Therefore, enterprises lack the incentive to apply the best practices with respect to the organization of the system of their accounting. It should be recognized that the introduction of accounting based on the International Financial Reporting Standards will result in information of a better quality (i.e. that correspond to IFRS) than the transformation of accounts.
As concerns the enterprises without a large circle of interested external users of financial information (small and medium sized businesses), the requirement of mandatory accounting and financial reporting results in an increase in the expenditures borne by such enterprises and slow down their development. Besides, the fact that these enterprises have to carry out accounting prevents the final division of functions of financial and tax accounting.
At the same time, it should be noted that at present the financial statements is also used for statistical purposes. The option not to draw up financial reports granted to a certain circle of enterprises should be accompanied by the elaboration of forms and procedures of statistical reports in the cases, where the necessary data can not be obtained basing on tax reporting. Such a step requires a balanced approach.
The approved text of the Concept states that "Changes in accounting and reporting, in particular, the transition to IFRS, should occur gradually and take into account the capability, requirements, and preparedness of the professional community and other interested public, as well as the state authorities." At present, the majority of Russian enterprises, which may be deemed to be socially important, already draw up their financial statements in accordance with the standards accepted in the international practice (IFRS or US GAAP). The users feel that the reports prepared in accordance with the Russian standards are unreliable. The professional community is involved in the respective decision making process. Therefore, as it has turned out, only the state authorities turn were not ready for a full scale reform and for incomprehensible reasons linger to take the urgent measures aimed at the liberalization of accounting.
However, the current version of the "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" is a significant step forward as compared with the Program for Reforming Accountancy of 1998, primarily due to the fact that the Concept recognized the necessity to grant IFRS a legal status in Russia. Among other positive shifts there are the following:
• The recognition of serious problems encountered in the course of the reform of accounting and reporting in Russia on the part of the state authorities responsible for these activities;
• The division of regulatory functions in the sphere of accounting and reporting between the state authorities and the professional community.
The text of the Concept indicates the following problems:
1. The absence of a legal status of the financial statements drawn up in accordance with IFRS;
2. The formal attitude of the regulating authorities and enterprises to many categories, principles, and requirements of accounting and reporting answering the market economy environment;
3. Unjustifiably high expenditures borne by enterprises with respect to the preparation of consolidated financial statements in accordance with IFRS by the way of transformation of the reports drawn up on the basis of the Russian standards;
4. Enterprises have to present excessive reporting to the state authorities, while the simultaneously carried out financial and tax accounting result in excessive expenditures;
5. The faulty system of quality control with respect to financial reporting and low quality of the respective audit;
6. Insufficient participation of the professional community and users of financial statements in the regulation of this sphere;
7. Low level of professional skills of the majority of accountants and auditors and the lack of practice as concerns the use of information prepared in accordance with IFRS.
The measures aimed at the solving of these problems are apparent and are as follows:
1. Legislative recognition of IFRS in Russia;
2. 3, 5, 6, 7. Implementation of educational and professional certification pro-
grams based on the standards accepted by the international community (the International Federation of Accountants, the International Accounting Standards Committee Foundation);
3. 4. The option to present financial statements, included non-
consolidated financial statements in the IFRS format in stead of Russian financial reporting;
4. Exemption of enterprises without a large circle of interested external users of financial information from the mandatory financial reporting;
5. Reasonable convergence of the rules of financial and tax accounting;
6. Gradual transfer of regulatory functions in the sphere of accounting and reporting to the level of independent nongovernmental organizations.
However, the version of the Concept approved by the RF Finance Ministry reflects only some of these measures. At the same time, it should be noted that the Concept contains a number of provisions indicating the same formal attitude of the regulatory authorities to the fundamental principles of the modern system of accounting and reporting, which is named among the serious problems preventing its further development. Among such provisions there are the following:
1. The Concept (item 2.1) states: "The key objective in the sphere of non-consolidated financial reporting is to ensure that the interested users had guaranteed access to high-quality, reliable, and comparable personified information about economic entities. In order to achieve this objective, non-consolidated financial statements should be drawn up in accordance with the Russian standards developed on the basis of IFRS." At the same time, it is noted that non-consolidated financial reporting performs two functions -informational and control functions. According to the authors of the Concept, the latter statement means that "non-consolidated financial statements should be used for: <...> presentation to the supervisory authorities; detection of the indications of bankruptcy of economic entities; formation of the common state database of statistical observation and macroeconomic indicators, as well as for management of the economic entity, legal proceedings, and for taxation purposes."
The following questions arise:
In the case financial statements should be used for all these purposes, what for is the managirial accounting, statistical, and tax reporting required then?
What IFRS based standards may be discussed, if the fundamental principles of division of accounting disciplines are not complied with?
The attempt to develop Russian standards of accounting and reporting "on the basis of IFRS" is the most striking example of formal attitude to the reform of the system of accounting. The essence of the Russian standards contradicts IFRS, since they are based 452
not on the substance of financial events and operations, but their forms, as well as control on the part of the state. In the international practice, the controlling functions concerning financial reporting are performed by the users of information via respective economic decisions and auditors via audit reports. For the purposes of tax control there is formed tax reporting, which exists separately from financial reporting.
2. Item 2.1 of the Concept states: "In certain cases, Russian standards may envisage several alternative approaches to the formation and presentation of financial statements. However, for the purposes of better comparability of financial statements presented by different economic entities the number of such cases should be limited and consistently reduced." Item 2.2 of the Concept also states: "The mechanism of generalization and dissimilation of the practices related to the application of IFRS is important for the consistent and uniform use of the standards by economic entities and, as a result, the comparability of financial information about such economic entities."
These provisions also indicate the lack of understanding of the essence of the International Financial Reporting Standards. The uniformity of the use of IFRS by Russian enterprises should not be an objective, IFRS are based on the economic substance of financial events and operations, on the evaluation of such operations. At the same time, the requirement of comparability of information is achieved not via the use of a chart of accounts and mandatory reporting forms, but via the presentation of information in comparable form broken down across periods supplemented by respective explanations in the explanatory notes attached to the financial statements. Indeed, the comparison of indicators across enterprises may be inconvenient, however, it would not present serious difficulties in the case the user of financial statements has adequate professional skills and has notion about the economic substance of the respective indicators.
3. Item 2.4 of the Concept states: "As the domestic and international practices demonstrate, the most important element as concerns the ensuring of quality of financial statements is an efficient quality control." Further, the Concept states: "The system of control of quality of financial statements should also include a package of measures of financial, administrative, and criminal responsibility of economic entities and their managers."
In this, the Concept fails to discern the concepts of the audit of financial statements and state control. At present, users consider the reporting drawn up in accordance with the Russian standards as unreliable even in the case there is an audit report. The quality of audit of IFRS based reporting also is not high. At the same time, this problem should not be approached by the way of toughening responsibility for the presentation of unreliable information in financial statements. This approach is inefficient and will result in misrepresentation of information in financial statements, since the principle of neutrality will be violated. The interested users of information or professional nongovernmental organizations can evaluate and indirectly control the work of auditors.
The role played by the state in the implementation of the reform of the accounting system in Russia is excessive. As concerns the sphere of accounting and reporting, item 2.3 of the Concept stipulates the division of the respective regulating functions between the state authorities and the professional community. However, the Concept suggests that professional organizations should play only an advisory role, besides, this division of functions seems to be artificial.
For instance, the Concept vests with the professional community the development of the draft national standards, while stipulating that exactly the state authorities should organize the development. Therefore, the work of the existing professional associations,
where representatives of the government are among the members129, will be organized by the state. Moreover, the initiative of such organizations is limited by administrative barriers. In this situation, insufficient participation of professional nongovernmental organizations in the regulation of accounting and reporting will for a long time remain a serious problem on the way to the creation of a modern and efficient system of accounting disciplines in Russia.
Yet another point should be stressed. In item 2.2 of the Concept it is stated: "In Russian Federation, there should be used the official text of IFRS in Russian. In this connection, it is necessary to create a standing nongovernmental body, which should: prepare the official Russian text of IFRS; monitor changes in the English text and in good time introduce such changes in the official Russian text; maintain a glossary of IFRS terms in Russian." These measures are indeed necessary and useful; however, the fact that the Concept fails even once mention the cooperation with the International Accounting Standards Committee Foundation (IASCF), including the work related to the preparation of the authorized translation is perplexing. If the Russian authorities wish to influence the substance of the standards of accounting and reporting to be applied in the territory of the Russian Federation after the transition to IFRS, it is necessary to actively involve representatives of our country in the development of the standards in accordance with the procedure set forth by IASCF. The procedure proposed by the Concept for the approval of the International Financial Reporting Standards in our country is in this case not sufficiently efficient and may result in the legal vacuum in stead of granting the legal status to IFRS.
4.8.2. Draft federal law "On Consolidated Financial Statements"
The draft federal law "On Consolidated Financial Statements"130 passed the second reading in the State Duma in December of 2004.
In the case this law is approved, it will set forth the general requirements with respect to the preparation, presentation, and publication of consolidated financial statements on the part of organizations - legal entities. Consolidated financial statements is drawn up by a group of enterprises, which are defined as a single economic entity in accordance with the International Financial Reporting Standards.
It is proposed to extend this law to crediting organizations, as well as the enterprises, whose securities are admitted to the circulation via trade at stock exchanges and other organizers of trade on the stock market.
Consolidated financial statements should be drawn up in accordance with IFRS similarly to the non-consolidated financial statements of the organization drawn up in accordance with federal law "On accounting" No. 129 FZ of November 21, 1996.
The annual consolidated financial statements should be presented to the members of the organization, including the shareholders, as well as to the authorized federal executive body by all organizations with the exception of crediting organizations, while crediting organizations should present the respective documents to the Central Bank of the Russian Federation.
Annual consolidated financial statements are subject to the mandatory annual audit. The audit reports should be published alongside the respective financial statements.
129 For instance, representatives of the RF Ministry of Economic Development and Trade and the Federal Tax Service are members of the Board of Trustees of the National Organization for the Standards of Financial Accounting and Reporting (NSFO).
130 Bill No. 55792-4.
Organizations should publish their consolidated financial statements not later than 30 days after the presentation of such statements to the users eligible according to the aforesaid law.
It is set forth that all organizations subject to the law "On Consolidated Financial Statements" should present and publish the respective statements starting with reports for year 2005.
The organizations, whose securities (including bonds) are admitted to the circulation on the stock market and which draw up their financial statements in accordance with other standards accepted in the international practice, should present their consolidated financial statements drawn up in accordance with IFRS starting with reports for year 2008.
Since the terms of formation of the reports depend, according to the aforesaid law, on the time IFRS are granted the legal status in the territory of the Russian Federation, which has not been set yet, the draft law includes the clause that in the case the International Financial Reporting Standards are granted such a status after September 1, 2005, organizations should begin to present and publish their consolidated financial statements starting with reports for year 2006.
On the whole, the draft federal law "On Consolidated Financial Statements" is in compliance with the "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook"; however, it represents its most elaborated part.
The International Financial Reporting Standards, and not the national rules developed on the basis of IFRS, should become the basis for the preparation of the consolidated financial statements of the groups of enterprises in Russia. The subject of the drawing up of the consolidated reporting should be also determined in accordance with IFRS (item 2 of article 1 of the draft law).
Consolidated financial statements is indeed designated for the members of the organization - subject of reporting (including the shareholders), potential investors, and other interested users, to whom the external general purpose financial statements is usually addressed in the international practice. In item 3 or article 2 of the draft law it is stipulated that the information contained in the consolidated financial statements can not be used for the purposes of tax administration and tax control131.
The draft federal law "On Consolidated Financial Statements" also stipulates that it is necessary that IFRS would be granted the legal status in Russia. Item 3 of article 3 of the draft law states: "In the territory of the Russian Federation, there should be applied IFRS and IFRS Interpretations approved by the International Accounting Standards Board and recognized under the due procedure established by the RF Government as adjusted to the requirements set forth by the legislation of the Russian Federation. The recognized IFRS and IFRS Interpretations should be officially published in Russian language."
Therefore, in the case this draft law is approved, the RF Government should establish the procedures governing the legal recognition of IFRS in Russia and official publication of the standards thus settling one of the key problems encountered in the course of the reform of the domestic system of accounting caused by the fact that financial statements of enterprises prepared in accordance with IFRS has no legal status. It should be noted that officially published should be the Russian translation of IFRS authorized by the International Accounting Standards Board.
131 This provision of the law does not prevent a group of enterprises to pay taxes proceeding from the consolidated data in the case this option (consolidated tax reporting) is envisaged in the tax legislation. It is the matter of prohibition of the use of the information contained in financial statements for the purposes of tax control, i.e. of the division of the objectives of financial and tax accounting.
At the same time, the draft federal law "On Consolidated Financial Statements" as a part of the Concept contains some insufficiently clear provisions. Below, there will be discussed some of such provisions.
1. The "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" does not envisage that enterprises would have the option to present their consolidated financial statements based on IFRS in stead of financial statements prepared in accordance with the Russian standards in the nearest future, what is reflected in item 2 of article 3 of the draft law "On Consolidated Financial Statements." According to item 1 of article 3 of the draft law, consolidated financial statements of enterprises should be drawn up in accordance with IFRS. Therefore, enterprises would have to either carry out two types of financial accounting simultaneously, or transform the financial statements presented by all enterprises being the members of the group. Somehow or other, this stipulation makes enterprises to bear additional costs, which the Concept recognizes as a serious problem in the Russian system of accounting.
The larger will be the group of enterprises, the lower will be the quality of information (the less will be its correspondence to IFRS) in consolidated statements, since in the course of transformation of larger volumes of data there exists a higher probability of omissions and errors. Besides, the draft law does not mention the procedures governing the formation of consolidated financial statements in a situation, where the majority of Russian enterprises just see no benefit in carrying out accounting in accordance with the international standards.
2. The draft law vests the control over the quality of information contained in consolidated financial statements with auditors. At the same time, the supervision over the presentation and publication of such statements (with the exception of the reporting carried out by crediting organizations) should be vested with an authorized federal executive body determined by the RF Government (item 1, article 6 of the draft law).
These provisions have been somewhat altered in comparison with the text of the draft law "On Consolidated Financial Statements" prepared for the first reading. Initially, it was envisaged to include in the law the provision setting forth the necessity of annual mandatory audits of consolidated financial statements in accordance with the International Standards on Auditing. As concerns the provisions for the supervising agency, this body was more clearly defined in the original version of the draft law as the authorized federal executive body in the sphere of financial markets. This definition capacitated such control with respect to the reporting prepared in accordance with IFRS.
4.8.3. Banking sector
The survey describing the reform of the accounting system in Russia in 2004 should necessarily dwell on the reform of accounting in the banking sector.
In accordance with the requirements set forth by the RF Central Bank (CB RF Instruction No. 1363 - U of December 25, 2003), crediting organizations should be bound to prepare financial statements based on IFRS for the period ending on September 30, 2004, and annual financial statements for the period ending on December 31, 2004.
Both consolidated and non-consolidated annual financial statements of crediting organizations should be confirmed by audit certificates and be submitted to the territorial agencies of the Bank of Russia vested with supervision of the activities of such organizations prior to October 1, 2005.
In spite of the fact that the IFRS based statements for the period starting on January 1, 2004, and ending on September 30, 2004, should be presented by the crediting organi-
zations to the Bank of Russia by November 30, 2004, it is impossible to evaluate the real results of the switching of the banking sector to the formation of IFRS based statements, in particular, because the financial statements not certified by auditors can not be reviewed as reliable information suitable for analysis on the part of external users.
Unfortunately, in the situation presently existing in Russia financial statements prepared in accordance with international standards is presented relatively late, since the respective audit, as a rule, takes a rather long time132. Taking into account the deadlines set forth in the documents elaborated by the Central Bank, more or less suitable data pertaining to financial statements of crediting organizations based on IFRS certified by audit reports will be available only by the end of 2005.
At present, there may be discussed only the results of the transition of the Russian banking sector to the presentation of IFRS based statements recognized by the Central Bank.
On November 22, 2004, there was held the conference "Transition of the banking sector of the Russian Federation to the preparation of financial statements in accordance with IFRS - the way towards the rising of competitiveness of Russian banks." The participants discussed the problems existing in this sphere, the results of transition, as well as perspectives of improvement of accounting of crediting organizations and banking supervision. Judging by the practical materials of the conference published by the mass media133, at present the Central Bank and other participants see the International Financial Reporting Standards in the Russian banking sector primarily as a tool of banking supervision.
For instance, the report on the TACIS project, where the RF Central Bank is a participant, "Banking supervision and reporting, Russian Federation" presented by a Pricewater-houseCoopers's consultant notes that the key principles of efficient banking supervision set forth that financial statements of banks should be formed on the basis of internationally accepted accounting principles. According to the presenter, from the viewpoint of the banking supervision requirements the standards of financial reporting should answer three general criteria: facilitate reliable practice of bank management and risks control; tighten market discipline via the transparency of financial reporting; facilitate efficient banking supervision. The statements prepared in accordance with IFRS answer the aforesaid criteria.
In her report "International Financial Reporting Standards - the most important tool of development of the banking sector," T. Paramonova, the first deputy Chairperson of the RF Central Bank, presented a complex approach to IFRS as a means of ensuring security, consistency, and integrity of the procedures governing the evaluation, control, and preparation of financial statements. At the same time, the report notes that the RF Central Bank views the financial reporting drawn up in accordance with IFRS as the basis for implementation of the "Basel II" agreement used for the purposes of regulation and supervision. The toolkit set forth in this agreement is used for the evaluation of future expected and unexpected losses and, therefore, is useful not only for supervising authorities, but also for banks.
Only time can tell if the financial reporting of crediting organizations drawn up in accordance with IFRS may become a tool facilitating a better transparency of the banking sector in the interests of consumers of banking services in spite of the fact that it should
132 A considerable part of audit certificates pertaining to the reporting for year 2002 was signed only in the 3rd quarter of 2003. (see: Matovnikov M. Rossiyskiye banki prisposobili Mezhdunarodnye standarty finotchetnosti k otechestvennym realiyam (Russian banks have adapted International Financial Reporting Standards to the domestic realities) // Kompaniya. 2004. No. 3 (64)).
133 http://www.gaap.ru
play a controlling role, which is uncharacteristic for it in the international practice. In the process of evaluation of the future results it is necessary to bear in mind that the largest Russian banks carrying out up to 90 per cent of all banking operations in the country had prepared their financial statements in accordance with international standards even before the Central Bank made public its instruction. Besides, crediting organizations prepared their financial statements for year 2004 in the situation, where IFRS had no legal status and the official Russian translation of the IFRS text did not exist, proceeding from Methodological Recommendations of the Bank of Russia No. 181 - T of December 25, 2003, "On the procedure of formation and presentation of financial statements by crediting organizations." The RF Central Bank failed to outline the perspectives of the use of the official text of IFRS by banks in the case it is available in Russia.
At present, it may be reasonably presumed that financial statements of crediting organizations presented to the RF Central Bank drawn up in accordance with international standards will significantly differ from the reports they prepare for foreign investors. Here, the mandatory audit of financial statements would hardly be an obstacle. In the present situation, where there is felt a significant lack of personnel able to carry out accounting and prepare reporting in accordance with international standards with quality and responsibility, Russian enterprises, including banks, hire experts of international auditing companies for drawing up such reporting (or for consultations concerning the issue of formation of such reporting), who later certify the respective statements. At the same time, it should be taken into account that financial statements formed for presentation to supervising agencies is more prone to offences related to the neutrality of information.
According to the "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" until year 2010, the reforms in this sphere will be of transitional nature, i.e. the rule making and regulatory functions will be gradually transferred to the level of professional and public associations. It will depend on the further measures of the Government in the sphere of reform of accounting and reporting, what financial statements is in the end available to the Russian users - in the format accepted in
the international practice, or in the format adapted for supervision authorities.
* * *
So, in 2004 there was taken a serious step forward in the sphere of the reform of the Russian accounting system: there was recognized the necessity and indicated the intent to grant the legal status to the International Financial Reporting Standards in Russia. Therefore, there appeared a prerequisite for the principal change in the approaches taken with respect to the reform in this sphere. At present, although only with caution, it may be stated that there takes place not the harmonization of domestic accounting practices with the international standards, but the proper switching to IFRS, i.e. the adoption of these standards as an integral system of accounting disciplines.
In order to achieve the objective of creation of the system of accounting and reporting answering the modern requirements to the quality of information in Russia it is necessary to consistently implement the new approach to the respective reforms. It is important that the "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" recognizes serious problems preventing the success of the reform. Among these problems there are the formal approach to and misunderstanding of the fundamental principles of the system of accounting and reporting answering the requirements set by the market economy on the part of the regulatory authorities. Unfortunately, the substance of the Concept does not permit to state that this problem will be solved in the nearest future. 458
The consistent implementation of the new approach implies a complex of measures aimed at the realization of fundamental principles of accounting and reporting answering international standards, including rationality, in Russia. These measures should include:
• Division of financial and tax accounting, legislative fixation of the prohibition to use financial statements for the purposes of tax administration and tax control;
• Enterprises should be granted the right to choose the format of presentation of their non-consolidated financial statements (either in accordance with the Russian standards, or IFRS in stead of the Russian standards);
• Enterprises without large circles of interested external users of financial information should be granted the right not to draw up financial statements; such enterprises should carry out only tax and statistical reporting.
The division of financial and tax accounting is necessary primarily because these disciplines are oriented towards different target users and perform different functions. The method of adjustment of accounting records in the course of drawing up tax reporting does not imply that enterprises are completely relieved of tax accounting. This may be avoided by the way of harmonization of accounting and tax legislation. However, such measures, first, will negatively affect the accounting per se, since they imply the rejection of the use of accounting methods and ways of reflection of events and operations, which are based on the system approach and the requirement of completeness of the reflection of events and operations, what in turn challenges the reliability of information presented in financial statements.
Second, the artificial convergence of the tax and financial accounting creates a prerequisite for the inclusion of the controlling function in the sphere of accounting information, what is inadmissible from the viewpoint of adherence to the neutrality principle. Therefore, the result of the convergence of the tax and financial accounting may be positive only as concerns the degree, to which the calculation of the profit tax is simplified, while the confusion of terms is inadmissible.
The problem of personnel still remains acute. The insufficient level of professional training of Russian accountants, auditors, users of financial statements, as well as the lack of experience with respect to the use of information prepared in accordance with IFRS creates many serious obstacles to the reform of the domestic system of accounting. In particular, these problems are as follows:
• Disproportions on the market of consultative and auditing services in the sphere of IFRS;
• High costs borne by enterprises in relation to the drawing up and audit of the reporting prepared in accordance with international standards;
• Insufficient participation of professional organizations and interested public in the regulation of the system of accounting and reporting;
• Slack system of control of the quality of financial statements on the part of auditing organizations and external users of general purpose financial reporting;
• Slowing down of the rates of development of the Russian accounting system, the formal attitude to the reform in this sphere.
The Government and the professional community should set the support of the educational programs and improvement of professional skills of experts in the sphere of the International Financial Reporting Standards as the priority of their activities. It is necessary to design a program of continuous education for accountants and auditors with respect to IFRS answering the requirements set forth by the International Federation of Accountants, as well as the system of attestation of accountants and auditors approved by the International Accounting Standards Committee Foundation.
The "Concept of Development of Accounting and Reporting in the Russian Federation in a Medium Term Outlook" failed to indicate the cooperation with the International Accounting Standards Committee Foundation as a priority measure; however, it is necessary to develop such cooperation in order to play an active role in the elaboration and implementation of best practices in the sphere of accounting and reporting accepted by the international professional community.
