Firms such as aluminium giant Rusal want to change how business views Russia. But corporate governance and corruption problems dog their progress.

Russian companies are on a charm offensive to improve their image in the west as they seek finance and investment to fuel their growth. Russian directors tour London and New York investment houses to explain how their businesses are becoming more transparent. Former Soviet enterprises today use slick public relations firms to make their case for foreign capital. The message for outsiders could not be clearer: Russia is hungry and open for business.

Like any Russian firm planning for aggressive global expansion, United Company Rusal is keen to impress the west. The privately owned company produces 12% of the world’s aluminium and 15% of its alumina – making it the world’s largest producer of each. It has operations in 19 countries on five continents, with ambitions to expand further, and its products are sold to global carmakers, builders and packaging firms in 70 countries.

To improve its reputation abroad, Rusal knows that it must raise its standards of corporate governance, transparency and business ethics. The company is taking steps to address the concerns of potential financiers and investors, presenting itself as an attractive client and business partner. It is also promoting its green credentials to appeal to potential financial backers that are aware of climate change risk.

“Reputation is an increasingly important issue in modern Russia,” says Rusal director of international and special projects Alexander Livshits. An “excellent reputation” is needed to secure loans from global financial institutions, he says, for all Russian firms. Rusal and its compatriots are “adopting international best practices in corporate governance and management”, he says, to raise international capital and debt.

The European Bank for Reconstruction and Development is one major lender to Russian companies that attaches strong corporate governance conditions to its loans. Moscow-based spokesman Richard Wallis says: “The more Russian companies seek access to international capital markets, the more they realise that transparency and corporate governance are sine qua non conditions demanded by investors.” In 2006, the EBRD lent $150m to Rusal, for the Komi aluminium project in Russia’s Komi Republic, 250km south of the Arctic Circle – and imposed conditions on transparency and the appointment of independent directors.

Livshits says standards of Russian business are much higher than outsiders give them credit for. In 2006, Rusal commissioned researchers at the Economist Intelligence Unit to analyse how Russian big business is perceived abroad. Russian companies were believed to lack transparency, management capacity and understanding of modern environmental, health and safety standards, the research found.

“This view is based on a historic perception of the old Soviet Union and its ineffective state controlled economy, and is not the reality today,” says Livshits. He argues that business people working inside Russia have a far more positive view of its corporate culture than those without direct experience of the country.

But outsiders do not have to look far for signs of poor management and weak corporate governance in Russia. Just ask BP, the oil firm that is being bullied out of the country by the local partners in its Russian joint venture, BP-TNK; or mobile phone firm VimpleCom, which struggles to agree on its budgets because of a rift between the major shareholders. Rusal, too, has been on the receiving end the tough boardroom tactics used by oligarch Vladimir Potanin to seize control of Norilsk Nickel, the nickel miner that Rusal wants to take over to create a $100bn mining and metals giant (see box). Rusal has protested that Potanin’s actions are not in the interests of all shareholders.

Governance reform

Rusal makes an odd champion for the rights of minority shareholders. As a private company owned by four shareholders, who all have seats on the board, it has no experience of protecting minority owners. This will change when it goes public. Rusal wants to make an initial public offering by the end of 2009, says Livshits, although the company is yet to decide on the specific timetable, amount of share capital available or the location of the listing. Rusal, which analysts predict would be worth $30-50bn on the market, attempted to list in London at the end of 2006, but the IPO fell through. The company has since continued to update its corporate governance practices to bring them into line with London-listing requirements.

In the past two years, Rusal has appointed three independent directors to its board, who also all sit on a newly formed audit committee – steps taken as part of the Komi loan deal signed in January 2006 with the EBRD and the International Finance Corporation. Under the conditions of the loan to Rusal and its then partner Sual – with which Rusal merged in September 2007 to created the current United Company Rusal – Rusal pledged to be more open about its ownership structure, publish more financial information, and appoint three independent directors by mid-2007. The terms also applied to the Basic Element holding of Rusal owner Oleg Deripaska.

Livshits says: “All of these efforts have not been an overnight process but there is a strong drive on the part of the company’s management to achieve the highest standards in this area.”

But Rusal, registered in Jersey, remains secretive. It still does not publish full financial results, although it does publish selected financial information. Asked why the company does not make this information public, Livshits says: “In terms of wider stakeholders, I think that the strong support from banks and debt markets demonstrates confidence in the company’s financial performance and commitment to best practice.”

Climate change

Aside from improving corporate governance, the environment is an area where Rusal believes it can win a competitive advantage when seeking foreign funds. Livshits explains: “If a company has a strong environmental strategy and a system of environmental management in place, this will have a positive effect on the way potential investors assess the company’s risk factors, and will therefore increase its market value.” He believes that investors will reward Russia’s energy-hungry industry for addressing the legacy of the Soviet Union, “where environmental responsibility and sustainable development took a back seat to production levels and immediate targets”.

Rusal already gets 80% of its energy from its own hydropower facilities, more than the industry average of about 60%. Electrical power accounts for between 25% and 40% of aluminium production costs, and increasing energy costs are proving an obstacle to the growth of global majors, Livshits says. Renewable hydropower has created for the company “a buffer of energy self-sufficiency”, he says, giving it an edge over rivals that must buy from volatile energy markets. He explains: “Our dependence on renewable energy sources is beyond an environmental strategy – it is core to our growth and stability.”

Aluminium production is one of the world’s most energy-intensive industries, as the smelting process – when alumina is turned into aluminium by passing an electric current through it – requires huge amounts of power. Rusal aims to cut greenhouse gas emissions in existing smelters by 50% by 2015. It has committed to invest $1.4bn between 2007 and 2013 in modernising its facilities to make them cleaner, and it is working with the United Nations Development Programme to achieve its climate change goals.

Corruption

Proud of its environmental record, Rusal is more vague when asked how it is addressing corruption. Livshits says it is “never constructive” to generalise about Russia, but says he believes that Russian business is taking steps to combat bribery. “With the emergence of a highly skilled management class, Russian society and businesses now understand the importance of sustainable business models over ‘easy money’,” he explains.

Russia’s new president, Dmitry Medvedev, admitted on taking office in June that bribery had become a “way of life” in the country. One Russian prosecutor has said government officials receive $34bn in bribes a year – or one-third of the national budget. Newspapers have reported that corruption is so widespread in Russia that it is fuelling inflation. No wonder Medvedev has made fighting corruption the top priority for his presidency. “That he has put such emphasis on fighting corruption indicates that he believes the problem is serious,” says the EBRD’s Wallis.

Corruption watchdog Transparency International’s head of Europe and central Asia, Miklos Marschall, says bribery in Russia is “rampant” and if anything is getting worse. “The bad news is that corruption in Russia is as bad as we perceive it from outside. Every indicator confirms that fact,” he says.

Russian companies cannot be entirely blamed for the high levels of corruption in their country, according to TI. “Corruption in Russia is not by choice, it’s by default,” says Marschall. Much of the bribery that takes place in Russia and other transition economies in the former Soviet Union occurs because state institutions are dysfunctional, he says. “There’s a kind of involuntary corruption where you don’t have a choice [about whether to pay a bribe]. This is corruption by default.”

Where the rule of law is weak, companies resort to extra-judicial ways to enforce contracts that may include violence or “mafioso-type enforcement mechanisms”, says Marschall. When the state cannot enforce the rule of law, “that creates a huge market for extra-legal enforcement of contracts that is very conducive to corruption”, he notes.

Observers agree that reforming Russia’s bureaucracy and enforcing the rule of law are the obvious steps to make it easier for companies to do business in the country. Outside investors can help lobby for change, but they will have to be patient. Livshits says: “International business must gain a better understanding of Russian business and banish their prejudices, while Russian business must continue its efforts to be internationally accepted as credible, transparent and worthy business partners.”

As Rusal prepares to go public and expand further, it must hope that foreign banks and investors see the company in this light.

Rusal’s record

· United Company Rusal is the world’s largest producer of aluminium and alumina, operating on five continents and 19 countries.

· It produces 4.2m tonnes of aluminium a year (12% of global production) and 11.3m tonnes of alumina a year (15% of global production).

· The company was formed through the merger of Rusal, Sual and the alumina assets of Glencore in March 2007.

· Shareholders of the pre-merger Rusal own 56.8% of the united company, Sual’s shareholders hold 18.9%, Glencore owns 10.3% and the remaining 14% is owned by Onexim, the investment fund owned by the metals oligarch Mikhail Prokhorov.

· The company operates 15 aluminium smelters, 12 alumina refineries, seven bauxite mines, three foil mills and two cathode plants, and employs 100,000 people.

Source: www.rusal.com

Power struggle at Norilsk Nickel

Rusal owns 25% plus two shares in Norilsk Nickel, the Russian nickel miner. Rusal bought its stake in April, seeming to confirm its publicly stated desire to merge the two companies into a $100bn mining and metals giant. But the move has been opposed by Vladimir Potanin, who owns 30% of Norilsk through his stake in Interros, and who has succeeded in marginalising Rusal’s influence over the company.

At a board meeting on June 30, Potanin successfully restricted Rusal to just two seats on the Norilsk board. On August 8, he won approval for his candidate, Vladimir Strzhalkovsky, to become the company’s new chief executive – despite protests from Rusal that the move was not in the interests of minority shareholders.

Rusal has questioned the impartiality of the board’s three independent directors, and argues that Potanin cannot be an independent chairman of the Norilsk board.

Aneta McCoy, an international corporate governance analyst specialising in Russia at RiskMetrics, says of Potanin’s actions: “It’s strange when one shareholder can completely get rid of management and put in their own people everywhere.” But she questions whether Rusal – or any Russian company for that matter – would have acted differently to Potanin if it was faced with a similar takeover challenge.

McCoy says: “We have talked a lot to Norilsk in the past months. The shareholder they were most scared of was Rusal.” Norilsk was a model of good corporate governance in Russia until Rusal bought its stake, she says. “They were outstanding. They had great transparency. They were very focused on [director] independence.”

Cosmetic governance reforms

Standards of corporate governance in Russia have improved dramatically in the past five years, says RiskMetrics analyst Aneta McCoy. Big listed companies disclose more information, and are far more responsive to investor requests than they used to be, she says.

But Russia remains a difficult place for investors. McCoy says: “It’s very difficult to know what’s really going on. Investors need confidence going in there. What we see on the surface is not actually happening at a given company.”

Russian companies are still largely owned by handfuls of major shareholders, who often own 80%-90%. The Russian corporate governance code, introduced in 2002, requires at least one-quarter of directors on listed company boards to be independent. But, as the code is not mandatory, many companies say they comply when in fact they are less than strict in their definitions of independence, says McCoy. She does not expect the code to be reformed any time soon, saying: “The oligarchs are very close to the government. It’s in everybody’s interests for the state of affairs to stay as it is.”

Director independence is the issue that troubles foreign investors in Russia. Asset manager F&C Investments, for example, voted against management on the election of nominated directors in 296 cases in 2007. The investor says it was concerned that nominated directors were not independent from controlling shareholders, and were put forward with little supporting information about their background or value that they would bring to the board. Companies where F&C registered protest votes included Gazprom, Lukoil, Sberbank and Uralsvyasinform.

Corruption hotspot

· Russia ranks worse than China and the Ukraine as a place where foreign companies will be asked to pay bribes, according to Transparency International’s 2007 Corruption Perceptions Index, which measures perceived levels of corruption in countries around the world.

· Abroad, Russian companies are considered more willing to pay bribes than any other major exporter except for China and India. Russia ranked 28 out of 30 countries in TI’s 2006 bribe payers index, which measures the propensity of companies from 30 leading exporters to bribe abroad.

· As a place to do business, Russia ranks 106th out of 178 countries in the World Bank’s Doing Business report, because of its corrupt bureaucracy and weak rule of law.

· Russia is yet to become a party to the OECD anti-bribery convention that outlaws the bribery of foreign public officials.

· Russia has done little to support the G8 commitments of financial and technical support for the Extractive Industries Transparency Initiative, which aims to improve revenue transparency in the oil, gas and mining sectors, according to TI.

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Business ethics and compliance in Russia: Practical information to develop local compliance strategies and overcome corruption challenges



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