Sanctions Developments Resulting From the Conflict in Ukraine - Russia
May 24, 2023
Table of Contents:
While sanctions imposed by the U.S., UK, EU and other countries in response to the ongoing military conflict in Ukraine generally encourage foreign capital withdrawal from Russia, new Russian foreign direct investment (“FDI”) mechanisms make such withdrawal extremely complicated. Over 2022, Russia gradually tightened different exit screening processes. Exit transactions, involving persons from “unfriendly” jurisdictions, and other transactions resulting in capital outflow are now subject to additional governmental clearances and limitations.
Note that pre-existing regulatory clearances, such as merger control clearances, are still required.
1.1. Persons from “Unfriendly” Jurisdictions
Persons from “unfriendly” jurisdictions generally include:[1]
- persons associated with foreign states that commit unfriendly acts towards the Russian Federation, Russian legal entities and natural persons (including foreign citizens, persons registered in foreign states, persons having predominant business activities in such states or persons deriving principal profits in such states); and
- persons under control of the aforementioned foreign persons,[2] irrespective of the place of registration of such controlled persons or where they have predominant business activities or where they derive principal profits.
The current list of “unfriendly” jurisdictions comprises, generally, the countries that have introduced sanctions against Russian persons: (i) the Republic of Albania; (ii) the Principality of Andorra; (iii) the Commonwealth of Australia; (iv) the Commonwealth of The Bahamas; (v) Canada; (vi) the European Union (all Member States); (vii) Iceland; (viii) Japan; (ix) the Republic of Korea; (x) the Principality of Liechtenstein; (xi) the Federal States of Micronesia; (xii) the Principality of Monaco; (xiii) Montenegro; (xiv) New Zealand; (xv) the Republic of North Macedonia; (xvi) Norway; (xvii) the Republic of San Marino; (xviii) the Republic of Singapore; (xix) the Swiss Confederation; (xx) the Republic of China (Taiwan); (xxi) Ukraine; (xxii) the United Kingdom of Great Britain and Northern Ireland (including the United Kingdom’s Crown Dependencies and British Overseas Territories); and (xxiii) the United States of America.[3]
Jurisdictions that are not included in the list are considered “friendly” by the Russian authorities.
1.2. Additional Clearances Required for Transactions with Shares and Participation Interests in Russian Companies
Over 2022, countersanctions regulations introduced the requirement for pre-clearance of a broad range of transactions involving persons from “unfriendly” jurisdictions, irrespective of the residency of the counterparty and whether the person from the “unfriendly” jurisdiction is on the buy- or the sell-side, including:[4]
- direct sales of shares in Russian joint-stock companies (“JSCs”) and participation interests in limited liability companies (“LLCs”);
- indirect sales through foreign holding companies; and
- any other transactions that lead, directly or indirectly, to the establishment, change or termination of the rights to possess, use and dispose of Russian shares and participations interests, or any other rights allowing to give management directions to Russian JSCs and LLCs or to determine the terms of their business activities, such as shareholders agreements, joint venture agreements, pledges over participation interests, convertible loan agreements, agreements with management companies and buybacks by LLCs.[5]
Certain exceptions apply. At the same time, in practice local Russian counterparties and their advisors tend to interpret the catch-all category of “any other transactions” expansively and sometimes include into it even indirect transfers of minority stakes in the holding companies of a Russian entity that do not amount to the change of control over the Russian entity.
In general, clearance applications are considered by the Governmental Commission for Control over Foreign Investments (the “Governmental Commission”) and respective industry ministries.[6] There is no statutorily prescribed timeline for getting a clearance, and, in practice, it may take months, especially in case of a significant back log of pending applications.
At the end of 2022, the requirements to the applications became more burdensome and the approval process generally became more coercive. Applicants are now required to provide appraisal reports from independent appraisers, approved by the Government, establishing the market value of targets, and to suggest business KPIs that the target shall meet in the future.[7] Furthermore, the Government now requires that at least 50% discount is applied to the market value of targets, as determined in the appraisal reports. In addition to at least 50% discount, the Government also requires a ’voluntary’ payment into the Russian federal budget. In accordance with the clarifications adopted in March 2023, if the price discount is up to 90% of the market value as determined by the approved appraiser, the budget payment shall be at least 5% of the market value. If the discount is more than 90% (which would include deals at nominal value), the budget payment is supposed to be at least 10% of the market value.[8] The Governmental Commission has broad discretion to impose additional conditions (such as payment of consideration in installments over a period of 1-2 years), or provide certain exceptions from these requirements.
There are certain instances, where clearances are issued by the Central Bank of Russia (the “CBR”) and the Ministry of Finance of the Russian Federation (the “Ministry of Finance”), such as the purchase of shares trading on exchange,[9] charter capital reductions, liquidation and bankruptcy proceedings.[10] See also, 1.4.2 below.
Special pre-clearances from the President of the Russian Federation are required for transactions involving certain industries or companies.[11] They are required for transactions in shares of:
- certain foreign-controlled financial institutions,[12] such as the Russian subsidiaries of American Express, Bank BNP Paribas, Citibank, Credit Agricole, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, ING Bank, Intesa Banca, J.P. Morgan, Mizuho Bank, Natixis, Raiffeisen Bank, Sumitomo Mitsui Banking Corporation, UBS, Western Union and certain others;
- certain companies, operating in the energy sector,[13] such as the Russian subsidiaries of ABB, Aggreko, Atos, Baker Hughes, BASF, DHL, Enel, ESAB, FMC Corporation, Hitachi, Honeywell, Liebherr, PNG Drilling Company, Schlumberger, Schneider Electric, SGS, Siemens, Weatherford and certain others;
- certain subsoil users; and
- strategic enterprises.[14]
1.3. Depositary Receipts
In 2022, the Russian Government issued a prohibition on trading in the shares of Russian companies, including in the form of depositary receipts (the “DRs”), outside of Russia. The issuers whose shares were trading abroad were required to take delisting measures unless such companies apply for, and receive, derogation from the Governmental Commission, allowing them to keep depositary receipt programs, or unless such derogation is granted by the Governmental Commission at its own discretion (i.e., in the absence of any application).[15] Very few companies received such derogations, [16] and even the ultimate Russian blue chips, such as Gazprom, did not succeed.[17]
Russia also introduced two statutory procedures for the conversion of DRs into local shares creating the regulatory framework for dismantling the DR programs. Namely, the two procedures are (i) automatic conversion and (ii) forced conversion, that allow Russian investors and investors from “friendly” jurisdictions to take Russian shares directly into their accounts in Russia, and avoid any dealing with the DRs stuck in the foreign securities market infrastructure where their accounts have been frozen:[18]
- in case of automatic conversion—DRs, accounted for in Russian depositories, were automatically converted into underlying Russian shares without recourse to foreign infrastructure, such as the frozen Euroclear accounts; and
- in case of forced conversion—the holders of DRs, accounted for in foreign depositories, could apply to Russian custodians of respective DR programs and receive the underlying shares into their Russian accounts without any need to transfer any DRs from the frozen foreign accounts.
In practice, the aforementioned statutory conversion procedures led to transfer of the underlying shares without cancelling the DRs, i.e., not in the way prescribed by the depositary program documentation. As a result, DR depositaries had to temporarily halt the conventional conversion processes because they were struggling to reconcile DRs on their books with the remaining underlying shares in Russian custodians[19]. Furthermore, throughout the process, many investors faced delays and rejections from the brokers processing transfer requests (in particular, where the issuer or the Russian custodian were subject to sanctions imposed by the U.S., UK, EU or other jurisdictions).
1.4. Other Capital Outflow Restrictions
Certain other restrictions, preventing capital outflow, are briefly described below.
1.4.1 Requirement to Pre-Clear Certain Regulated Transactions with the Governmental Commission or the CBR[20]
Regulated transactions include: (i) the provision of hard currency loans by Russian residents to persons from “unfriendly” jurisdiction, excluding loan restructurings; (ii) the provision of ruble-denominated credits and loans to persons from “unfriendly” jurisdictions; and (iii) certain real estate transactions involving persons from “unfriendly” jurisdictions.
1.4.2 Special Procedure for Debt Repayment and Other Payments to Persons from “Unfriendly” Jurisdictions[21]
Other payments include coupon payments on Eurobonds, payments under independent guarantees, dividend distributions and payments, arising out of charter capital reduction, liquidation or bankruptcy proceedings. Such payments in excess of 10 million rubles per calendar month (in aggregate, for all obligations of a payor to all creditors, irrespective of amounts owed to particular creditors) shall only be made into Russian restricted S-type accounts, opened in the name of the payees from “unfriendly” jurisdictions.
The funds on S-type accounts could be applied towards a limited number of purposes within Russia, such as tax payments and payments relating to transactions with Russian local sovereign bonds (OFZs). There is a theory that the Russian Government may want to exchange the unfreezing of the funds in the S-type accounts for, for example, unfreezing of the funds of Russian investors and companies in foreign clearing houses.
Interested parties may seek derogation from the requirement to use S-type accounts from the CBR or the Ministry of Finance, as applicable. Although authorities have broad discretion, dividend distributions are subject to additional restrictions, which are taken into account by the CBR or the Ministry of Finance, as applicable, when making derogation decisions:[22] the total amount of dividends should not exceed 50% of the company’s net profits for the previous year, the recipient should be committed to maintaining business in Russia, and quarterly business KPIs should be set for the company. Dividend distribution history and other authorities’ views for certain industries shall also be considered. The Government is clearly focused on keeping the money in the country and making sure the businesses invest it into R&D to replace withdrawn foreign technologies, rather than pay dividends to foreign shareholders, even those that are not exiting the country.
Debtors that perform their obligations in accordance with the statutory procedure and send money to S-type accounts should not be deemed in default of their contractual obligations as a matter of Russian law (which means that the contractual provisions would be disregarded by Russian courts should they consider a dispute from such contract or be asked to enforce a foreign court decision or arbitration award).
1.4.3 Requirement to Pre-Clear Transactions in Securities Acquired from Persons from “Unfriendly” Jurisdictions within the Foreign Financial Infrastructure[23]
To prevent speculative operations in the Russian securities by various intermediaries that were purchasing such securities held by investors from “unfriendly” jurisdictions with significant discounts, and to have visibility and control over the transactions in securities acquired from persons from “unfriendly” jurisdictions within the foreign financial infrastructure, the President of the Russian Federation has established the requirement to pre-clear such transactions with the Governmental Commission or, in case of financial organizations, with the CBR.
Such clearance is required for any transactions in Russian securities or DRs issued on Russian shares, if such securities have been acquired from persons from “unfriendly” jurisdictions after March 1, 2022 and are held in Russian accounts. The requirement applies to transactions executed after March 1, 2022 cut-off date, even if the transaction documents had been signed before this cut off. A number of exemptions from the clearance requirement include transactions in Russian shares underlying the DRs, if the DRs were acquired from “unfriendly” investors before March 1, 2022; buybacks, redemptions and conversions of securities by the issuer; repo arrangements entered into before March 1, 2022 and transactions by Russian sanctioned banks in securities that such banks hold as collateral for the bank loans.
1.4.4. Special Procedure for Performance under Eurobonds[24]
Since many Russian borrowers could not pay through the accounts in foreign clearing houses, such as Euroclear, as prescribed under their Eurobond documents, the Russian Government introduced another regulation that allows to settle the Eurobond debt in Russia. Again, as a matter of Russian law, such regulation effectively supersedes the contractual requirements of the Eurobond documentation. The ways to repay or novate Eurobond debt under the regulation are:
- To issue and place substitute local bonds, the key terms of which are identical to the terms of Eurobonds, which is now an obligation of Russian borrowers and guarantors under Eurobonds;[25] or
- To buy back the Eurobonds using the proceeds received from the placement of local bonds.
Furthermore, Russian borrowers and guarantors of the Eurobonds are entitled to open restricted ruble D-type accounts in the name of a holder, or several holders, of Eurobonds whose rights to the Eurobonds are accounted for in foreign infrastructure and perform the payment obligations by transferring funds to such restricted accounts. The opening of the restricted accounts is subject to the receipt of an approval from the Governmental Commission or the CBR, as applicable. Once funds are deposited in D-type accounts, the holders of Eurobonds shall apply to credit institutions, where D-type accounts are opened, to get the funds.
1.4.5 Special Procedure for Performance under Russian Sovereign External Bonds (Sovereign Eurobonds)[26]
In 2022, instead of using foreign infrastructure, Russia started making coupon payments on sovereign Eurobonds in rubles to its payment agent, the National Settlement Depositary (the “NSD”), and divided the holders thereof into three groups:
- investors holding through Russian infrastructure (Group I);
- investors holding through Russian depositaries but with the involvement of foreign infrastructure (Group II); and
- investors, to whom it is not possible to transfer funds due to the freeze of the Russian accounts in foreign infrastructure (Group III).
Payments to Group I proceed in the same way as before. Payments to Group II are made bypassing foreign infrastructure. Once payments to Groups I and II are made, the residual funds are transferred to a special ruble I-type account. In order to get paid, Group III investors shall apply to the NSD, disclose their holding structure up to the ultimate holder and prove their title to sovereign Eurobonds. Such investors shall also waive any potential claims to the Ministry of Finance in the future, after which they are entitled to get paid to their personal accounts with Russian banks.
1.4.6. Special Procedure for Performance of Contracts, Governing the Use of Intellectual Property (“IP”)[27]
If a foreign IP holder restricted the use of its IP in Russia after February 23, 2022, Russian counterparties may continue to use respective IP regardless of the contractual termination or suspension and shall pay for such use in rubles into Russian restricted O-type accounts, opened in the name of persons from “unfriendly” jurisdictions. Any withdrawals from O-type accounts to other accounts of the IP holders are subject to clearance by the Governmental Commission.
In addition to new FDI regimes and other countersanctions described above, Russia introduced a number of new trade regulations which include:
- Parallel import[28]—it is now permitted to import certain goods into the Russian Federation without the consent of trademark holders if the trademark holders terminated or suspended their supplies into Russia. The list of goods authorized for parallel import currently includes alcoholic beverages, clothes and shoes, copper, cosmetics and perfumes, ferrous metals, fuels, furs, machinery, nuclear reactors, paper, planes, ships, tires and many other goods;
- Export restrictions[29]—it is prohibited to export from Russia certain pharmaceutical products, agricultural machinery and industrial equipment. Certain goods are subject to special licensing requirements. Furthermore, gas supply settlements with “unfriendly” jurisdictions shall be conducted in rubles via special K-type accounts, opened with Gazprombank;
- Oil price cap ban[30]—it is prohibited to supply Russian oil and petroleum products to any foreign entities and individuals where supply contracts, directly or indirectly, establish price cap or similar mechanism. Special derogation approval could be sought from the President of the Russian Federation. The ban on capping the supply of Russian oil came into force on February 1, 2022, while the ban on capping the supply of Russian petroleum products will enter into force on a date to be announced by the Government of the Russian Federation.
Other measures introduced by Russia include blocking sanctions,[31] a possibility to restrict the access of shareholders from “unfriendly” jurisdictions to information with respect to certain companies,[32] and internal stock market restrictions.
Furthermore, Russia ordered to hand over full control over a major oil and natural gas project (Sakhalin-2), partly owned by Shell, Mitsui and Mitsubishi, from an off-shore Sakhalin Investment Company Ltd. to a newly created Russian company, allowing foreign partners to apply for shares in the newly established Russian company.[33] Similar approach was taken with respect to another major project (Sakhalin-1), partly owned by Exxon Mobil Corp., ONGC and SODECO.[34]
[1] See, e.g., Decree of the President of the Russian Federation dated March 1, 2022, No. 81, as amended (“Decree No. 81”).
[2] Control shall be determined in accordance with Article 5 of Federal Law dated April 29, 2008, No. 57-FZ, as amended. See, e.g., Letter of the Ministry of Finance dated October 13, 2022, No. 05-06-14RM/99138 (“Letter No. 05-06-14RM/99138”).
[3] See, Order of the Government of the Russian Federation of March 5, 2022, No. 430-r, as amended.
[4] See, Decree No.81, Decree of the President of the Russian Federation dated September 8, 2022, No. 618, as amended (“Decree No. 618”), Decree of the President of the Russian Federation dated October 15, 2022, No. 737 (“Decree No. 737”).
[5] See, Letter No. 05-06-14RM/99138.
[6] See, Decrees Nos. 81, 618, 737 and Resolution of the Government of the Russian Federation dated March 6, 2022, No. 295, as amended (“Resolution No. 295”).
[7] See, the Extract from Minutes of the Governmental Commission dated December 22, 2022, No. 118/1 (the “Extract”), the Extract from Minutes of the Governmental Commission dated January 19, 2023, No. 127/3.
[8] See, the Extract, the Extract from Minutes of the Governmental Commission dated March 2, 2023, No. 143/4.
[9] See, Decree No. 81.
[10] See, Decree No. 737.
[11] See, Decree of the President of the Russian Federation dated August 5, 2022, No. 520, as amended (“Decree No. 520”).
[12] See, Order of the President of the Russian Federation dated October 26, 2022, No. 357-rp.
[13] See, Order of the President of the Russian Federation dated November 9, 2022, No. 372-rp.
[14] See, Decree of the President of the Russian Federation dated August 4, 2004, No. 1009, as amended.
[15] See, Federal Law dated April 16, 2022, No. 114-FZ, as amended (“Federal Law No. 114-FZ”).
[16] See, e.g., an announcement, available at: https://www.londonstockexchange.com/news-article/LNTA/lenta-ipjsc-lenta-received-permission-to-retain-its-depositary-receipts-program/15460751.
[17] See, a press release, available at: https://www.gazprom.com/press/news/2022/april/article551809/.
[18] See, Federal Law No. 114-FZ.
[19] See, e.g., a press release, available at: https://www.adrbnymellon.com/files/al1014592.pdf.
[20] See, Decree of the President of the Russian Federation dated February 28, 2022, No. 79, as amended (“Decree No. 79”), Decree No. 81, Resolution No. 295, the Extract from Minutes of the Governmental Commission dated December 27, 2022, No. 120/1 and Official Guidance by the CBR dated March 18, 2022, No. 2-OR (“CBR Guidance No. 2”).
[21] See, Decree of the President of the Russian Federation dated March 5, 2023 No. 95, as amended (“Decree No. 95”), Decree of the President of the Russian Federation dated May 4, 2022, No. 254 (“Decree No. 254”), the Decision of the Board of Directors of the CBR dated November 21, 2022, as amended, the Decision of the Board of Directors of the CBR dated March 17, 2023, CBR Guidance No. 2, Official Guidance by the CBR dated April 4, 2022, No. 3-OR, Official Guidance by the CBR dated May 20, 2022, No. 6-OR and Official Guidance by the Dated November 23, 2022, No. 11-OR (“Official Guidance No. 11-OR”).
[22] See, the Extract.
[23] See, Decree of the President of the Russian Federation dated March 3, 2023, No. 138.
[24] See, Federal Law dated July 14, 2022, No. 319-FZ, as amended, Decree of the President of the Russian Federation dated July 5, 2022, No. 430, Decree of the President of the Russian Federation dated August 8, 2022, No. 529, Official Guidance No. 11-OR.
[25] See, Letter of the CBR dated December 30, 2022, No. IN-018-34/154 and Decree of the President of the Russian Federation dated May 22, 2023 No. 364.
[26] See, Decree of the President of the Russian Federation dated June 22, 2022, No. 394 and Order of the Ministry of Finance dated June 22, 2022, No. 240, as amended.
[27] See, Decree of the President of the Russian Federation dated May 27, 2022, No. 322, Resolution of the Government of the Russian Federation dated June 6, 2022, No. 1031, Letter of the Ministry of Economic Development of the Russian Federation dated July 19, 2022, No. 26614-KM/D01i, Decision of the CBR dated June 10, 2022.
[28] See, Federal Law dated March 8, 2022, No. 46-FZ, as amended, Resolution of the Government of the Russian Federation dated March 29, 2022, No. 506, Decree of the Ministry of Industry and Trade of the Russian Federation dated April 19, 2022, No. 1532, as amended, Decree of the Ministry of Industry and Trade of the Russian Federation dated March 2, 2023, No. 684.
[29] See, Decree of the President of the Russian Federation dated March 8, 2022, No. 100, as amended, Decree of the President of the Russian Federation dated march 31, 2022, No. 172, as amended, Resolution of the Government of the Russian Federation dated March 9, 2022, No. 311, as amended, Resolution of the Government of the Russian Federation dated March 9, 2022, No. 313, as amended.
[30] See, Decree of the President of the Russian Federation dated December 27, 2022, No. 961.
[31] See, Decree of the President of May 3, 2022, No. 252, as amended, Resolution of the Government of the Russian Federation dated May 11, 2022, No. 851, as amended.
[32] See, Decree No. 681.
[33] See, Decree of the President of the Russian Federation dated June 30, 2022, No. 416, as amended, Resolution of the Government of the Russian Federation dated August 2, 2022, No. 1369, as amended, Resolution of the Government of the Russian Federation dated September 6, 2022, No. 1566.
[34] See, Decree of the President of the Russian Federation dated October 7, 2022 No. 723, Resolution of the Government of the Russian Federation dated October 12, 2022 No. 1808.