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| INVESTMENT IN RUSSIA- THE FINNISH EXPERIENCE |
The Russian Federation, since its
renaissance as a market economy in
the early 90s, has presented itself
to the west both as a most tempting and
as a most intimidating object for trade
and investment. Since 1991, Russia has
attracted a multitude of investors, having
been a market of lucrative profits and, in
some unfortunate cases, of losses, activities
within the region to a good extent
constituting a trade-off between risk and
reward.
Finland can claim a competitive edge
over its European rivals, having always
enjoyed a special relationship with Russia,
by virtue of the long common history of
the two countries and, of course, Finland’s
presence in the immediate vicinity of
Russia (St Petersburg lying only approx.
330km away from the Finnish capital).
The Soviet Union and, for the last decade,
the Russian Federation have always been
significant trade partners to Finland and,
indeed, Finnish companies in several
fields can claim to be forerunners to other western companies.
Recent successes among Finnish
companies include Fazer Bakeries Ltd
which currently controls approximately
one third of St Petersburg bread markets
and Nokian Tyres Plc, a car tyre
manufacturer which is a market leader in
volume in winter tyres within the Russian
markets, while being a brand leader as
well. Other lines of business that have
gained a strong foothold in Russia include
fields such as logistics, ICT, forest industry
and building and construction. |
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| Investment in real estate |
Due to the recent significant changes in
the Russian investment environment in
relation to real estate, causing this line
of business to currently be of particular
interest to investors, the development in
this field deserves a closer examination.
Among Finnish companies in the
real estate field, YIT Plc, specialising
in apartment buildings, is aiming for
a market share of 10 percent within
St Petersburg this year. Other major
developers, such as SRV Group Plc,
Lemcon Ltd and Peab Seicon Ltd have also
become well established in the market.
Requirements for new retail outlets,
related logistics centres, hotels and offices,
needed for the growing businesses, provide
continuing attraction to investors.
Manoeuvring in the field of real estate
is, however, a major challenge to a western
investor, due to factors such as nontransparency
of the markets, issues related
to title, ambiguities in the legislation,
the complex and stiff bureaucratic system
and the all-pervading cultural differences.
These are, as such, typical features in all
emerging economies, and teaming up with
good and experienced partners and advisors
is imperative in order to minimise the
risks involved.
Obtaining of real estate by foreign
natural or legal persons has, as such,
been made a great deal easier by the
recent land reform - the new Land Code
of 2001 harmonises legal rules relating
to acquisition and use of land which
earlier were segmented and difficult to
apply, opening up many opportunities for
investment in the future. Foreign persons
and legal entities may now own land
practically within the whole territory of
the Russian Federation, subject to certain
restrictions in specific cases. Leasing,
however, still remains the most common
form of exercising rights to land.
The Land Code, however, contains
areas that leave room for interpretation.
For example, owners of real estate,
including foreign ones, now have a
prerogative right to purchase land plots
under buildings owned by them, at a
price mandated by the Land Code, but
it seems that due to lack of clarity in
the Code, the state or the municipality
in question may, in most cases, have a
discretion to determine that the land
should be leased instead. The Code also
contains a number of discrepancies with
existing laws and places reliance upon
administrative implementation which may
be problematic, since there is an element
of unpredictability in the activities of
Russian authorities. Due to the complex
bureaucratic system which substantially
precludes the foreign investor from
obtaining insight into the operations of
the real estate sector, it is still advisable
for a western investor to act in close
collaboration with Russian partners who
understand the procedure and are well
connected to the authorities.
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| Importance of proper due diligence |
Purchase of real estate or of a company in
Russia calls for a thorough due diligence
which should include, inter alia, a careful
search of the ownership history of the real
estate or the company in question, its
current ownership structure, and, in case
of real estate, the status of the land (due
diligence is required, in relation to land,
to determine factors such as possible third
party interests resulting from prior land use
and privatisation or other agreements). The
requirement for title insurance, which is
available in Russia, should also be considered
in relation to real estate acquisitions. In
Russia, establishing these facts in a reliable
manner may be a far more complex operation
than in most western countries.
The complexity of the situation
regarding land rights also has to be
taken into consideration in planning the
ownership structure of the real estate to be
purchased: a foreign company wishing to
buy a building or a plot of land, in order
to avoid the complexities of acquiring
rights to land, in practice has to arrange
its ownership through a Russian company
already possessing valid land rights. A
Russian company is in a better position
to apply for the necessary infrastructure
(gas, electricity, water, sewage etc) as well
as for a change of status of the land from
agricultural to industrial, residential or
other use. Correspondingly, in selling the
building or the plot of land forward, a sale
of shares will be a considerably simpler
transaction than a separate sale of the
building and a transfer of the land rights
(or a mere transfer of the land rights).
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| Cultural differences affecting due diligence |
The necessities and requirements for a
thorough due diligence are confronted
by cultural differences and affected by
the unfamiliarity with well-established
western commercial practices on the
part of the actors in the young Russian
market economy, as a result of which the
expectations of both parties in relation
to the process of due diligence as well
as in relation to its outcome may vary
considerably. Indeed, the concept of (legal)
due diligence was only introduced to the
Russian business world with the start of
the economic reforms.
There may, by way of an example, be
differences as to expectations in relation
to speed of closure, as a result of which
sellers may be reluctant to allow prospective
buyers exclusivity for a long enough period
to enable comprehensive due diligence. On the other hand, the requirement of due
diligence is further emphasised by the fact
that in many cases, there is reluctance on
the part of sellers to incorporate warranties,
potential lease guarantees, assignments
of contractors’ warranties etc, into sales
agreements. Further, purchase price
expectations may remain at the level of
the initial offer, despite findings made in
due diligence (due diligence is sometimes
seen by sellers as a mere formality, without
substantial consequence). Determining
the purchase price may be difficult to start
with, due to the novelty of the land market
and market economy in general and the
factual absence of a genuine mergers and
acquisitions and land market as such. Many
sellers are valuing their properties on the
basis of other recent transactions, rather
than their true value. |
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| Minimising the risks |
The rules of the game in the Russian
mergers and acquisitions and real estate
markets are in the process of being
formed. While it is to be expected that
with passage of time, the Russian and
western practices will meet halfway
and commercial customs and traditions
satisfactory to both parties will evolve,
a present day western investor will have
to use the currently available tools to
minimise its risks in Russia.
More security in acting in Russian
markets may currently be obtained
through large-scale projects with major
strategic partners. Aligning the projects
in question with the priorities of local
government and community can pave the
way considerably, and contacts at least
at local government level throughout
the project are highly recommendable.
Directing the activities through a publicly
traded company will naturally afford the investment a far stronger position than
a choice of a private company (although,
in connection with purchase of real estate
through a special purpose vehicle company,
as described above, the use of a private
limited liability company will be more
expedient in view of the time taken by
the share transfer). In addition, having
the right investment and legal advisors is
imperative in any investment activity in
the present day Russia.
For Finnish companies, their strong
technical know-how, combined with a
profound understanding of the market,
together with a realistic appreciation
of the risks involved and willingness
to take adequate steps to control them,
constitute a winning combination. Finnish
companies of a wide variety of fields are
entering the Russian markets and those
already established in the market have the
confidence to continue further expanding
their Russian activities.
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