Political risk mounts in Russia's changing business environment

Russia’s business environment has changed dramatically since 24 February. Two weeks after the start of the Ukraine-Russia conflict, Russian President Vladimir Putin on 10 March told his government to “act decisively” to protect Russia from the unprecedented sanctions imposed on the country and businesses within. The government has implemented a growing number of restrictions in response to Western, Canadian, Australian, and Japanese sanctions.

A widespread and voluntary exit from or suspension of foreign company operations from Russia is also under way. More than 330 foreign companies have announced their withdrawal from Russia during this time. The unprecedented exodus of foreign companies from the Russian market is likely to continue in the coming weeks, driven by sanctions, disruption to foreign trade and banking, and general uncertainty, as well as reputational risks associated with doing business in Russia during the conflict in Ukraine.  

Putin’s speech on 10 March signalled his government’s resolve to ride out the current storm with protective measures and import substitution programmes. He asserted that the Russian economy “will, without doubt, adapt to the new situation” and that the crisis “will lead to the strengthening of our independence, self-sufficiency and sovereignty”.

Russian response

Putin essentially endorsed a legislative proposal by which the government would be able to take over and sell the assets of companies that have left the country and that are more than 25% owned by an individual or entity from an “unfriendly country”. At least 48 “unfriendly countries” had been identified as of 11 March, including Australia, the UK, the US, Canada, Japan, Ukraine, South Korea, New Zealand, Taiwan and Switzerland, as well as the countries that are part of the EU and the EEA.

Putin’s governing United Russia party in late February had proposed the nationalisation of the assets of exiting foreign companies, and Russia’s Economic Development Ministry prepared the supporting legislation on 10 March, which will likely soon be put to a vote in the State Duma (the lower house of the parliament).

This is one of the numerous measures the Russian government is taking to mitigate the negative economic impact of the ongoing crisis. Other measures have included limiting withdrawals from foreign currency accounts and foreign currency purchases for Russian residents and non-residents alike, legalising the infringement of patents from “unfriendly countries,” as well as allowing Russian individuals and entities to settle debts with entities in “unfriendly countries” in roubles.

Potential implications: companies that have exited Russia or suspended Russian operations

Given the proposed legislative changes, a key risk to foreign companies that have left Russia will be the prospect of the nationalisation of their assets. The government in the coming weeks, if not days, will almost certainly approve a bill that will create a legal basis for the state to take over the assets of the companies that have exited or suspended operations in Russia. The government is clearly keen to retaliate against both sanctions and voluntary company withdrawals – as well as to save jobs resulting from the economic and financial crisis – so the state takeover of such assets is highly likely once the necessary legislation is passed. 

Once in force, the law would allow the government to use court orders to impose external management by state entities of such companies’ assets for three months, following which the business would be put up for auction. Companies would be able to stop the nationalisation process if they restart their business operations within five days of the court order, or sell their assets while ensuring the preservation of jobs and business activity. The nationalisation is highly unlikely to be subject to due process and companies cannot expect fair treatment should they choose to initiate legal claims against the Russian government in Russian courts. Affected companies are likely to contest nationalisation or seek compensation in international courts.

According to credible Russian media reports from 10 March, the authorities have singled out at least 60 companies as candidates for nationalisation, including US, Swedish, German and Japanese household names. Companies that have left Russia, suspended their operations until further notice or frozen future investments in Russia should be taking steps to minimise risks to their personnel, assets and intellectual property in Russia. Russia’s relations with countries that have sanctioned Russia – Western states in particular – will continue to deteriorate.

Potential implications: companies that remain in Russia

In the coming months, foreign companies that remain in Russia will continue to face operational disruption and elevated reputational risks, as well as an increased regulatory, compliance and due diligence burdens. As sanctions regimes are likely to continue to be expanded or tightened while the Ukraine-Russia conflict continues, so will such companies’ exposure to direct and secondary sanctions. Close links between sanctioned individuals and entities and large swathes of the Russian economy will exacerbate companies’ sanctions exposure.

Reputational risks linked to doing business in Russia will remain elevated and are likely to increase amid reports of significant civilian casualties in Ukraine and the resulting public backlash by employees and the general public in other countries. 

Outlook

The country’s risk environment is now fundamentally different to what it was over two weeks ago. The impact of the ongoing developments on Russia’s business environment will remain profound. The environment for companies will remain fluid and subject to rapid change in the coming weeks.

The likely nationalisation of foreign assets would lead to a sharp deterioration in the rule of law, and would likely accelerate the country’s economic decoupling from the G7 economies.