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The Russian Legal System as a Factor in Attracting Investment

The state of the legal environment is a core factor determining inflow of foreign capital into a country. Russia will need to continue improving its judicial system and foreign currency regulation, streamlining federal and regional laws, ensuring effective legal protection of trade secrets, eliminating excessive regulatory pressure on business, etc.

Foreign direct investment in the Russian economy grew by 62% in 2016 to USD 19 billion, even though globally it fell by 13% to USD 1.52 trillion (UNCAD).

  • The bulk of the growth came from the Government’s sale of a 19.5% stake in Rosneft, however.
  • A significant part of financial flows recorded as foreign investments was in fact money returning to the country from offshore jurisdictions. This process is likely to gather pace following the adoption of de-offshorisation laws.

At the same time, Russia saw a decline of foreign investment in new projects: from USD 14.1 billion in 2015 to USD 12.9 billion in 2016. The biggest investors of 2016 came from Germany (EUR 2.05 billion in 9M 2016) and China (mostly state-owned companies). Only five new projects were announced in January 2017, their aggregate amount at an unprecedented monthly low of USD 34 million.

Obstacles to investment are created by the general economic uncertainty, lack of definite prospects of achieving a steady economic growth rate, a complicated geopolitical situation, and an imperfect legal environment in the country. Participants of the 2016 St. Petersburg International Economic Forum named the weakness of property rights institutes in Russia as the second biggest barrier for investment after fears of economic stagnation.

At present, investors name the following legal obstacles:

  • frequent changes in the legal framework;
  • lack of efficiency in the judicial system;
  • discrepancies between the federal and regional regulations;
  • insufficient protection of minority shareholders’ rights;
  • imperfections in the foreign currency legislation related to transfer of income abroad, VAT refund for exports of goods made in Russia;
  • excessive regulatory interference in business operations;
  • leakage of (commercial, tax and personal) information via government authorities;
  • imperfect insurance mechanisms for investment activities;
  • a high level of corruption in administration of law.

However, the Russian jurisdiction also has certain benefits that make it appealing for investors.

  • Taxes imposed on businesses are lower in Russia than in many developed countries. In 2015, the Government introduced a three-year restriction on tax increases.
  • There are territories with a special legal status that offer economic and tax preferences: special economic zones, technology and industrial parks, and advanced development territories.
  • The legal system already allows for such advanced tools of international law as warranties, representations, escrow accounts, etc.
  • To encourage industrial development, a tool of special investment contracts has been devised. It guarantees stability of tax and regulatory conditions for businesses and offers special federal and regional preferences provided certain commitments with regard to the setup and/or upgrade of industrial production are fulfilled.

Still, many investors prefer to protect their property rights and assets in a foreign jurisdiction (usually in England), which, for them, is more transparent and predictable, and ensures access to foreign courts, if necessary. This is true not only about setting up a business in Russia, but also about stock market trading.

  • Despite their interest in rouble-denominated bonds, which today demonstrate a higher yield than US or European securities, foreign investors usually decide against buying them, one of the reasons being the legal factor of the rouble market. Unlike Eurobonds, Russian securities documents do not include covenants triggering unfavorable consequences for an issuer.