Since 2017, some destination countries of China's outbound foreign investment have strengthened regulation of foreign investment to varied degrees in terms of national security review. In 2017, US President Trump vetoed two Chinese acquisitions of high-tech enterprises submitted by CFIUS. The US government and public are ceaselessly calling for control over foreign investment review authority. In June 2017, with respect to the European trade policy, the Committee on International Trade of the European Parliament issued a proposal on screening of foreign direct investment in strategic sectors. Subsequently, the European Council and some major EU economies voiced their support or prepared the follow-up measures. In October 2017, the UK Department for Business, Energy and Industrial Strategy published a proposal entitled “National Security and Infrastructure Investment Review” to seek consultation on the reform of the government’s review of the national security implications of short- and medium-and long-term foreign investment. The Statistical Bulletin of China's Outward Foreign Direct Investment shows that Russia has ranked in the 9th place among China's outward FDI countries for four consecutive years and is one of the main destinations of FDI made by Chinese enterprises. As one of the main legal bases for the national security review of foreign investment in Russia, the Federal Law on "Procedures for Foreign Investments in the Business Entities of Strategic Importance for Russian National Defence and State Security" (the “Law”)1 had been amended for eight times since its promulgation in 2008. In 2017, additional material amendments were made to the Law, reflecting to a certain extent the Russian government’s increasingly stringent regulation of foreign investment in strategic industries from the perspective of national security.
I. Overview of the law
The Law provides for 47 restricted industries for foreign investment due to their strategic importance to national security, covering all aspects of the national economy, including national defense, communication & media, nuclear energy, transportation and environmental resources.2 Companies in the 47 strategic industries are also known as "Strategic Companies". Foreign investors and their affiliates in and outside Russia (collectively, the “Foreign Investors”) shall abide by the prohibitions and restrictions of the Law with respect to investment ratios, investors, investment targets and investment procedures etc. when investing in the strategic industries.
In general, in accordance with the Law, Foreign Investors shall not implement without prior approval:
• acquisitions of major operating assets of 25% or more of the total assets value of a Strategic Company in the previous fiscal year; or
• any transaction that leads Foreign Investors to have a certain percentage of shareholdings in any Strategic Company or otherwise control the operation and management of the Strategic Company.
Based on the above-mentioned provisions, for foreign countries, international organizations, offshore companies, Russian citizens with dual nationality, and Russian domestic and foreign entities under the control of any of the above (collectively the “Special Foreign Investors”), or strategic companies those engaged in development and utilization of federal-level mineral reserve3 (the "Special Strategic Companies"), the Law provides for lower preapproval conditions and even directly prohibits their foreign investments of a certain amount in strategic industries. Foreign Investors may freely make other foreign investments not restricted or prohibited by the Law or other Russian laws.4
For asset acquisition transactions, without prior approval, general Foreign Investors are not allowed to acquire main operating assets of Strategic Company of 25% or more of the total assets value in the previous fiscal year. However, for special Foreign Investors, the Law explicitly prohibits their acquisition of main operating assets of any Strategic Company of 25% or more of the total assets value in the previous fiscal year.
For green field investment, equity transactions and management services and other non-asset acquisition transactions which may cause foreign investors to hold shares in or control over Strategic Companies, the Law provides for general prohibitions or restrictions:
“√”: Transaction that may be freely implemented and is not subject to restrictions under the Law
“○”: Transaction that shall not be implemented without prior approval
“×”: Transaction prohibited by the Law
With respect to the “control” in the above table, the Law elaborates on various circumstances in which a Foreign Investor is deemed to “control” a Strategic Company from the perspectives of equity ratio and corporate governance etc.:
II. Major new amendments made in 2017 and their implications
1. Expanded scope of strategic industries and more regulations of foreign investment in Russia .
When the Law was first implemented in 2008, it specified 42 restricted industries for foreign investment due to their strategical importance to national security. After amendments and additions for times, the current Law provides for 47 strategic industries. The 2017 amendments were made in respect of four strategic industries involving nuclear energy, communication & media and defense. At the same time, nuclear materials for military purposes, utilization activities of radioactive materials and procurement electronic platforms of Russian governments at all levels were added into the list of strategic industries.
2. Further expanded scope of special foreign investors and new challenges for transaction structure design.
The 2017 amended Law includes offshore companies and Russian citizens with dual nationality as special foreign investors for the first time. For the purpose of the Law, “offshore companies” refers to the companies registered in the countries and regions set forth in the List of Offshore Regions5 issued by the Ministry of Finance of Russia, including the locations often selected by Foreign Investors for platform companies before investing in Russia, such as the British Virgin Islands, the Cayman Islands, Jersey, Bermuda and the United Arab Emirates. The Hong Kong Special Administrative Region of China had been on the List since its publication, and was just delisted on January 1, 2018.
In general, in the consideration of the factors such as risk isolation, tax planning, fund raising, and investment dispute resolution, intermediate platform companies are often set up in third countries for cross-border investment projects, while the above-mentioned offshore regions are common options. In addition, for joint venture projects, resolution of corporate governance disputes in connection with joint venture companies in Russia is usually to be considered. Russian laws have recently relaxed restrictions on resolution of the disputes over corporate governance in Russia to a certain extent, allowing most corporate governance disputes to be submitted for arbitration to a permanent arbitration institution approved by the Ministry of Justice of Russia. At present, however, the Ministry of Justice of Russia has not yet approved any foreign arbitration institution to accept such corporate governance disputes. As a result, many Foreign Investors and their Russian joint venture partners used to choose the above-mentioned off shore regions as the destinations of establishing intermediate platform companies through which wholly foreign-owned companies were then set up to actually run in Russia. Therefore, for many Foreign Investors, the inclusion of “off shore companies” in the scope of special Foreign Investors may have significant implications on the transaction structure design of foreign investment to be made in Russian strategic industries.
It can be seen from the above-mentioned amendments that foreign investment in strategic industries originating from off shore regions will face more stringent regulatory conditions. It is consistent with the policy orientation of economic deoffshorization that Russia has been pursuing in recent years. Such policy orientation is also reflected in the field of government guarantees. Russia's Budget Code provides that Russian SPVs with 50% or more of shares held by off shore companies may not be the guaranteed parties and creditors of sovereign guarantees or sub-sovereign guarantees, which will directly affect the financing of large infrastructure projects.
3. Expanded regulatory powers of competent authorities and greater uncertainties of transactions.
Before the 2017 amendments to the Law, the Federal Antimonopoly Service of Russia (the first approver, “FAS”) and the Russian Commission on Monitoring Foreign Investment (the final approver, the “Commission”) is expressly empowered by the Law to approve and monitor the transactions subject to pre-approval of foreign investment in the strategic industries. According to statistics, from the promulgation and implementation of the Law in 2008 to July 2017, FAS received a total of 465 applications for pre-approval of foreign investment in the strategic industries, of which 13 were finally not approved. Over the years, the competent authorities, investors, law firms and other intermediaries have basically developed certain experience and practices on pre-approval of foreign investment in strategic industries.
The 2017 amended Law expands the regulatory powers of the competent authorities, resulting in a number of issues to be further clarified through detailed rules and regulations and practices. For example, the newly amended Law empowers the chairman of the Commission (served by the prime minister) to initiate the review process for any foreign investment (even to be made in a non-strategic company) on the ground of protection for national security. Once the Commission decides to initiate a review of any transaction, the investor is obliged to wait until the review results are issued before further implementation of the transaction; otherwise the transaction is void. However, the Law does not expressly provide the specific types of foreign investments of which the competent authorities may initiate a review. According to industry experience, the pre-approval process usually takes 3 to 6 months. Such additional regulatory power granted by the Law is likely to bring considerable uncertainties to large transactions.
For another example, the old Law before the 2017 amendments provided that the competent authorities may condition the approval for foreign investments in the strategic industries with nine explicit obligations, such as confidentiality, product supply guarantees, product price guarantees, personnel employment and mobilization in the wartime and emergencies. However, the 2017 amended Law grants the Commission greater powers of approval. The Commission is empowered to impose any other collateral obligations on Foreign Investors in addition to the above nine obligations when making preapproval decisions. As a result, Foreign Investors are likely to face greater uncertainties when conducting preliminary research or feasibility analysis on projects.
At present, these issues have not yet been clarified by the Law or any industry practices.
III. Conclusion
It can been seen from the latest amendments to the Law that Russia is placing increasingly stringent regulation on foreign investments in strategic industries. Although most of the pre-approval applications were successfully approved in the past, the practice field and the competent authorities still need to reach a consensus on the uncertainties left by the newly amended Law through specific project operations. We will pay close attention to the follow-up developments and progress and share with you. In any case, an experienced lawyer who fully understands the business needs of a company and accordingly designs different plans in consideration of different project conditions plays an indispensable and important role in complex cross-border investment transactions.
The full name of the Foreign Investment Law of Strategic Industries in Russian is Федеральный закон от 29 апреля 2008 г. N 57-ФЗ «О порядке осуществления иностранных инвестиций в хозяйственные общества, имеющие стратегическое значение для обеспечения обороны страны и безопасности государства» редакция от 18.07.2017, namely the Procedure Law for Foreign Investment in Strategic Importance to Safeguard National Defense and National Security of Russia, the latest amendments of which came into effect on July 18, 2017.
The 47 strategic industries consist of 11 national defense industries, 10 communication & media industries, 8 nuclear energy industries, 8 transportation industries, 4 environmental resources industries, 1 health industry, 1 e-commerce industry, 1 aerospace industry and 3 other industries.
The List of Federal-level Minerals Reserve was published and renewed from time to time by the Ministry of Natural Resources and Environment and the Federal Agency for Mineral Resources of Russia.
In addition to the Law, other restrictions or prohibitions on foreign investment may also be provided in other Russian laws. For example, the Russian Foreign Investment Law provides that even if a foreign state-owned enterprise intends to acquire 25% or more of the equities of a non-strategic company, it must be subject to pre-approval before acquisition.
The full name of the List Off shore Regions in Russian is Приказ Минфина РФ от 13 ноября 2007 г. N 108н «Об утверждении Переченя государств и территорий предоставляющих льготный налоговый режим налогообложения и (или) не предусматривающих раскрытия и предоставления информации при проведении финансовых операций (оффшорные зоны)», the latest amendments of which was made and implemented on January 1, 2018, including the inclusion of Macao Special Administrative Region of China.
