Learning to Fly: Russian Corporate Governance Origins

[Editor's note: The Editor is grateful to Mr. Filatov, whom Dr. Leblanc met in Moscow in 2003, for offering a candid and historical perspective of the challenges and opportunities in developing corporate governance in Russia.]

Dmitry Zimin, founder and first chairman of Vympelcom (Beeline) telecom, which made first Russian IPO at NYSE in 1996, once said to me: “Corporate governance is all about conflict-of-interest resolution.” In a country where the wife of a Moscow Major became the richest businesswoman in the nation during the time when her husband was in office, conflict of interests are not seen as a problem. Moreover, in many cases legal judgments and court procedures are subordinated to orders from federal or regional authorities, rather than to independent courts' decisions. Some Russian scholars and practitioners would speak about different models of corporate governance existing in Russia, which is not similar to the models in the West. It looks similar to the model of sovereign democracy, which differs from democracy in the West. It does in the way that it demonstrates imitation of democratic institutions. So implementing imitation of corporate governance which in practice violates basic principles of it is simply bad corporate governance, as if distorted monopolized market is a stagnating market not attractive to major classes of investors.

Russian corporate governance originally came from the West driven by private businesses selling shares to institutional investors on Russian and Foreign stock markets. Beeline (1996), MTS (2000) telecoms, and Wimm-bill-dunn (2000) IPOs on NYSE raised capital to cover rapid expansion of their services throughout the country. They were followed by Yukos in 2000, when consultants started to speak about “yukosization” of Russia, meaning that big companies started going for Western capital and introducing transparency for investors in financial reporting, inviting Western independent directors to their boards, using Big 4 auditors, and introducing information disclosure, internal audit, and internal control procedures. In 2000, Yukos established an international, independent board of directors, including representatives of the global business community. Yukos also developed a corporate governance code, published financial statements in accordance with GAAP, got audited by outside accountants, and was open to financial analysis. Indeed, Yukos was widely seen as the most visible initiator of westernization in the Russian oil sector. It was the first Russian oil giant to actively hire foreign specialists for crucial positions, including American oil experts Bruce Misamore, who joined in 2001 as CFO, and Steven Theede, who joined in 2003 as chief operating officer. These international appointments helped reinforce the spirit of professionalism and fiduciary duties that kept senior management accountable to shareholders.

Large international organizations like World Bank, IFC, OECD, and EBRD started to include Russia in their programs for support of sustainable and transparent business development. I remember the first OECD Russia corporate governance roundtables discussing issues of investor protection that started in 1999 at the request of the Federal Commission for Securities Market with active participation of the National Association of Securities Market Participants (NAUFOR). Further, in 1999 shareholder activists from foreign and Russian portfolio investors' funds organized the Investor Protection Association at NAUFOR to nominate and elect shareholders' representatives to boards of directors of publicly traded Russian companies. It was based on procedures of cumulative voting for directors' election at board meetings stipulated in the Russian Federal Law on Joint-Stock Companies (Corporations). Actually, Russian Securities Market Law, corporate legislation, and the Corporate Governance Code were derived from best international legislation, conducted by international law firms and localized to Russian realities, making norms more strict and less ambiguous (for instance, the one share/one vote rule, cumulative voting procedure in election of board members at AGM, 2 percent shares quota for the right to nominate candidates to the board of directors for investors). Shareholders agreements and special shares voting rights were introduced into legislation much later.

In 2001, my colleague from NAUFOR and the Investor Protection Association, Alexander Ikonnikov, and I initiated a program supported by Ernst & Young for independent directors that led to establishing the Independent Directors Association (IDA), which I led as executive director for 10 years. Along with the Russian Institute of Directors, we were major players in directors' education programs in conjunction with the National Association of Corporate Directors (NACD), the UK Institute of Directors, and other international directors and corporate governance networks. Compared to the Investor Protection Association, which was an association of institutional investors, IDA was and still is a personal membership organization of directors. In 2004 when the IFC Russian Corporate Governance Project that provided free consultation to Russian private companies in four regions of the country was completed; it made a spinoff and established a joint venture with ID—a corporate governance advisory unit—Center for Corporate Development. It provided fee-based corporate governance consultations to many companies in Russia and Kazakhstan, including large state-owned players such as Gazprom (drafting Corporate Ethics Code), Rosneft (internal communications policies), National Company KazMunaiGaz, KazMunaiGaz Exploration & Production, and many privately owned businesses like LSR Group, OMK, Euroset, and so on.

Big 4 auditors were also quite active in providing corporate governance structuring and sustainable development projects for bigger companies. Standard & Poor's introduced the service of corporate governance ratings to the developing markets, which was a benchmark for companies and provided demand for consultants who were helping to polish corporate governance procedures in the companies that intended to apply for the S&P corporate governance rating.

As for Yukos, unfortunately, President Putin and his inner circle saw its success and increasing independence as opposition to certain political interests. As a result, the Russian authorities decided to reassert control over what they decided was a strategic asset, and began a campaign not of nationalization (which would imply compensation from the State), but simple expropriation. Ultimately, because of the spurious tax reassessments, the selective and inappropriate application of freezing assets and accounts orders, and the sham auction and sale of YuganskNefteGaz, Yukos went bankrupt under Russian law. Its remaining Russian assets were sold in further auctions in which the state-controlled Rosneft was the principal purchaser. Yukos was ultimately dissolved in October 2007.

Other Russian oligarchs and their Union of Industrialists and Entrepreneurs did not confront these actions; each of them chose to stay silent, considering this to be an incident of political issue, as Mikhail Khodorkovsky, principal owner of Yukos, seemed an active independent player both in the national economy and in politics, of whom Putin was afraid. They all stayed away from politics hoping this would prevent their property from expropriation. Later, in the case of reprivatization of Bashneft, which belonged to loyal-to-Putin Vladimir Yevtushenkov, it turned out that the economic interests of Rosneft, led by Igor Sechin, a close associate of President Putin, prevailed in both cases.

In 2008, when Dmitry Medvedev was president, he announced that state-owned companies needed better corporate governance and an especially emphasized role of independent directors on their boards. The State Property Commission, as a major shareholder of those companies, except for so-called strategic companies, whose shareholder was the state government, started to nominate independent professionals suggested for consideration by the pool of directors and corporate governance NGOs on a competitive basis. The problem was that the notion of independent director was quite vague, so it made it possible to nominate recently retired state officials to boards of state-owned companies as “independent directors” while the competitive basis became fake. After President Medvedev left office, the State Property Commission started giving priority to industrial sectors ministries to select candidates for corresponding companies, and the role of NGOs diminished.

Set the Controls for the Heart of the Wealth: Regulators, Shareholders' Activists, Directors' NGOs

Shareholders' activism in Russia started being visible in 1999 with the establishment of the Investor Protection Association (IPA), which united efforts of institutional investors—portfolio investors in stocks of Russian publicly traded companies mostly in the energy sector (YUKOS subsidiaries, RAO UES and its subsidiaries) and landline telecom operators (daughter companies of Sviyazinvest holding). IPA started to collect powers of attorney from funds and coordinated nomination and election of their representatives to supervisory boards of publicly traded companies via a procedure of cumulative voting while electing candidates on boards. Cumulative voting suggests multiplying the number of votes that the shareholder has by the number of seats on the board and ranking of cumulative numbers received by each candidate. All candidates at the top of the list limited by seat numbers are considered elected to the board. Usually if the board has 9 to 11 seats, collecting 10 percent of voting shares enables the shareholder to elect its representative on the board. Nomination to the board of unlimited numbers of candidates requires a request from the shareholder having 2 percent, so funds usually nominated several candidates in different companies by January 31, in compliance with corporate legislation, and afterwards started a coordinated process of collecting powers of attorney from different investors to select target companies with the best chances for election.

Investor representatives on boards were independent of management of the company and of the controlling shareholder, usually the government in state-owned companies, so IPA used to call them “independent directors.” Actually, they were affiliated with the investors' community and were receiving shareholders' instructions for voting on board meetings. In fact, their focus was on boosting dividend payments, OPEX, and CAPEX reduction. In many cases, those funds were long-term investors, not speculators, and this made common ground for management and government representatives to communicate sensibly on issues of strategy and investment programs with investor representatives on the board. Portfolio investors had minority representation on the board, in some cases having a blocking pack of 25 percent, which did not give them the opportunity to become decision makers. Nevertheless, professional advice from those directors on boards was well accepted and threats to publicize the conflict issues in media were a quite effective instrument to protect investors' rights.

In 2001, we realized that in the classical corporate governance model those investor representatives are not seen as independent. They had specific interests that could conflict with long-term interests of growing businesses. Excessive dividend payouts could limit the investment capacity of the company.

Securities Market Regulator, led after Anatoly Chubais by his close fellow Dmitry Vasiliev in 2000, proposed to separate the notion of investor representatives on boards and independent directors. After he left chair of the head of the securities regulator at the end of 2000, he established the Institute for Corporate Law and Governance, calculating corporate governance ratings for Russian publicly traded companies, advising investors on corporate governance issues, and providing management consulting for Russian enterprises. The Institute received support from EBRD, the International Finance Corporation, the World Bank, and a number of market participants. Vasiliev also took the position of chairman of the Investor Protection Association. His successor as head of the Securities Market Commission, Igor Kostikov, made a focus of his activities on developing and promoting a formal Russia Corporate Governance Code, which was drafted by international law firms for the money provided to the Federal Commission by international development organizations. This Code assigned quite detailed regulations and norms based on international best corporate governance practice and was a useful formal guideline for publicly traded companies until it was updated in 2014, by adding the “comply-or-explain” principle borrowed from UK regulators.

Exploring in 2000 best corporate governance practices, we found that in many countries companies were looking for independent directors via search agencies or registers of directors' associations. So we decided to establish the Independent Directors Association (IDA) to promote best international corporate governance practice. Started as a project sponsored by Ernst & Young in 2001, in 2002 we registered an independent entity that later received sponsorship from other companies as well. Compared to the Investor Protection Association, IDA had individual director membership and used different mechanisms to promote its members to boards of directors. We had “pull” versus “push” strategies, in marketing terms: providing education to shareholders of the companies and to directors in order to help them understand and use the benefits good governance gives to them.

After completing the Schulich Russia Corporate Governance Summer Program in Toronto, Canada, in July 2003, where Professor James Gilles and Dr. Richard Leblanc taught us corporate governance basics, I made an appointment and flew to Washington, DC, to establish contacts with the U.S. National Association of Corporate Directors (NACD). After signing a cooperative agreement, we brought NACD's expertise to the Russian market, providing the Director Professionalism Course with highly experienced practitioners as instructors. It was a period when bigger Russian companies were preparing for IPOs at NYSE and Nasdaq and firsthand expertise was in demand. Later when the IPO market went to London, we managed to establish partnership relations with the UK Institute of Directors (IoD).

I remember the first enrollment for the program. Out of 18 persons who took the first Certificate course, almost all successfully passed the exam and were admitted to apply for the second one—diploma-level training in London. The first group consisted of six top managers of the Basic Element holding company who managed Oleg Deripaska assets, led by Basic Element CEO Guljan Moldazhanova. HR of Basic Element convinced shareholders to assign completion of the IoD Director Course by top managers as an integral part of their individual KPIs. At the strategy module I remember harsh discussions between the group and the instructor of the course on whether Russia had its own way of growing businesses. Some of the group members advocated the approach that their strategy was easy. If you have money, you buy assets, pledge them in the banks and buy more assets for the loan monies. A year later, in 2009, we saw who turned out to be right when Oleg Deripaska's businesses started receiving margin calls and asked for government support. The IoD Chartered Director certification program run with IDA support in Russia and in Kazakhstan is still quite in demand among professionals.

The IDA in the early 2000s received grants from U.S. AID to support its development. After conducting joint programs with the International Finance Corporation Russia Corporate Governance Project, in 2004 IFC Moscow manager Seb Mollineus selected IDA to become a recipient of funding as an IFC project spinoff joint venture that would continue providing corporate governance advice to Russian companies after the IFC project ended. IFC provided to us the methodology, and transferred funds and teams of its consultants in four regions of Russia, so IDA would establish a sustainable corporate governance advisory business, which we managed to do. I sourced the head of IDA Center for Corporate Advisory from the IFC Samara branch. We provided our advisory service on a paid basis, compared to free advice from the former IFC project consultants, so many of them left after the IFC money was spent. Having a solid methodology, we managed to grow a substantial pool of clients that included both publicly traded companies such as Gazprom (we drafted the Gazprom Ethics Code), Rosneft, and companies which were restructuring their governance model in preparation for the IPO. The list included Rosinter restaurants, LSR from Russia, and KazmunaiGaz Exploration and Production from Kazakhstan listed on London stock exchange, and many privately owned companies seeking private equity investment. In addition to providing advisory services, we also helped privately held companies to find independent directors on their boards. Later, demand for independent directors emerged in state-owned companies after President Medvedev in 2008 appealed to the government to raise the level of corporate governance in companies with a government stake in capital. With growing demand, several other directors' organizations appeared to meet the hype. The Government Agency for State Property started to select directors from recommendation lists of directors' organizations. Unfortunately, later this practice was transformed into election of former government officials to the boards under recommendation of line ministers of respective industries.

The Dark Side of the Boom: Attempting to Refine Governance in SOEs

In 2005, I presented a research paper on boards of directors of state-owned companies at the OECD roundtable. This meeting took place on 2–3 June 2005 in Moscow. The objective of this plenary meeting was to discuss the policy framework and practices for two priority areas identified by the roundtable at its previous meeting:

• Enforcement of corporate governance rules
• Corporate governance of state-owned enterprises

Both institutional and regulatory issues were identified as weaknesses in the enforcement framework. This included poor monitoring by the securities regulator, insufficient authority of the securities regulator, and heavy caseload at the courts, as well as lack of clarity in the law, particularly on liability of company officers and boards of directors. The key challenges for improving corporate governance of SOEs in Russia included weak SOE boards, poor transparency both of individual SOEs and of the state's ownership policies, as well as inequitable treatment of shareholders.

OECD corporate governance roundtables and educational activities of the IFC Russia corporate governance project plus NGOs lobbying for improvement of corporate governance led to experiments in state-owned companies supported by the government. The problem was in loose control of the government at all levels over performance of hundreds and hundreds of companies, where financial streams were nontransparent and state property was fully in the hands of management, which was stealing from their companies. Therefore, the intent was to regain control over management at the board level.

In February 2008, at the Krasnoyarsk economic forum, Mr. Dmitry Medvedev, then first vice prime minister, in his speech addressed the issue of corporate governance in state-owned companies: “It is necessary to radically improve the quality of governance of companies that are controlled by the state. I believe that most government officials have nothing to do on the boards of directors of these companies. They should be replaced by truly independent directors hired by the State to control its interests.”

This was the turning point for nominating professionals on boards of companies controlled by federal government and regional administrations, replacing some of the government officials previously sitting on these boards. The reason was that those clerks overloaded by their direct work were passive in their board activities. Those officials were not allowed to receive remuneration for participation in board sessions according to the law, so it is no surprise that they viewed their board positions as an unpleasant burden. Therefore, in many cases, in fact management controlled companies, not state officials.

Yet though the intentions were good, practical implementation was quite hectic. In bigger strategic 50+ companies like Gazprom, Sberbank, and VneshEconomBank, where directors on boards were nominated by the office of prime minister, many former government officials were appointed, since no cooling-off period from the time of their being affiliated with the government was imposed. In addition, some well-known academicians fully loyal to authorities were nominated to demonstrate compliance with the initiative. In mid-sized and smaller companies subordinated to the State Property Agency (Rosimuschestvo), progress was more apparent. Rosimuschestvo attracted governance NGOs, directors' institutes, and associations to the decision-making process of board nomination and appointment. Among those organizations, there were Investor Protection Association, Independent Directors' Association, Russian Institute of Directors, and Register of Independent Directors of Russian Union of Industrialists and Entrepreneurs. In the first few years many representatives from those NGOs were elected to boards as independent directors and so-called “shareholder representatives” in hundreds of smaller companies. While the number of companies that required replacement of officials on their boards was about 1,200, there were a lack of professional candidates, and one director was appointed to 5–7 regional companies, which did not make their performance very efficient. In many cases board remuneration was very low and paid only when companies made a profit in the particular year when the director served on the board. Moreover, there was no compensation of travel and accommodation costs for directors to participate in board meetings held far away in the regions. So the situation started to look like an imitation of the work that was not much different from the situation when officials were sitting on boards. For one independent director two members representing shareholders would be appointed. The role of these representatives was to vote according to instructions generated and approved by Rosimuschestvo. These shareholder representatives were supposed to help Rosimuschestvo work out practical voting instructions, but due to inefficiency of the governmental officials in charge of these procedures, in most cases the voice of independent directors and professionals from the board did not reach the decision makers.

Starting from 2011–12, the pace of corporate governance reform in state-owned companies started deteriorating. The work of Rosimuschestvo was considered unsatisfactory and in June 2012 Olga Dergunova, former general director of Microsoft Russia and VTB top manager, was appointed as new head of Rosimuschestvo. Olga started by collecting experts around her and the formation of the Expert Council of Rosimuschestvo, whose aim was to work out a proper methodology to improve the situation with corporate governance in state-owned companies, and a methodology of the privatization process of national champions and of mass privatization of smaller companies.

Based on my book Board of Directors: User's Manual, published in 2009, my colleague, Mikhail Kuznetsov, and I at the Independent Directors Association developed a manual on organizing the work of the board of directors, which was adopted and recommended by Rosimuschestvo as a guideline for directors working on boards of state-owned companies. Nevertheless, despite of all the efforts of Olga Dergunova and the Expert Council Committees, which developed and published many practical guidelines on different aspects of the boardroom activities, the situation with governance was not changing. It ended up with conflict between Mr. Medvedev and Dergunova over the speed of privatization and regarding sharing liability for signing privatization documents on behalf of the state. Dergunova resigned in 2016 after a reprimand from the prime minister's office.

At that time I was serving on the board of the Russian Freddie Mac—State Agency for Home Mortgage Lending (AHML). The board and its committee's composition was quite professional and diverse in competencies. The CEO of AHML at that time, Alexander Semenyaka, was the person who previously launched the market of Gazprom securities on Russian and international stock exchanges. Before Gazprom, he was in charge of organizing the first privatization auctions, where shares of companies were sold for money, not for vouchers as before. So in AHML Semenyaka and his team launched the market of mortgages, network of accredited nonbank outlets, and process of securitization of these mortgages sold in tranches on the open market. The board was active in strategic guidelines and in interaction with the government. AHML specifically was in its status of national development institution in the form of a joint-stock company, so on the one hand it was established to create a home mortgages market, on initial funding provided by government plus its accumulated retained earnings, and on the other hand it had to pay dividends to the government, which was its only shareholder.

By 2015 when major banks became active home mortgage lending market players, banks started to be anxious about the quality of their mortgage portfolios. The government decided to switch AHML from market development to the support of state-owned banks suffering losses. Another guideline received from above was to focus AHML on financing house construction companies so they could continue their activities to prevent high-scale social protests from people who paid for their apartments and did not get them. The construction of their houses froze because construction companies went bankrupt. The board supported the CEO talking to the government about other instruments for resolving this critical situation and the risks involved in proposed government new activities dealing with construction where AHML did not have any expertise. As result, the government dismissed the CEO and the board that supported him, replacing it by government officials who obeyed any instruction from above without any discussion. The newly appointed CEO was First Vice Prime Minister Shuvalov's secretary, 32-year-old Alexander Plutnik. Under Shuvalov's umbrella, who had vast lobbying powers in the government, AHML was transferred into an instrument for pumping out unlimited amounts of state budget money explained as a need for solving social problems caused by the housing construction industry failure. Actually, in my opinion, all state-owned companies, such as Rostech, Rosneft, Vnesheconombank, Rosselkhozbank, or VTB, are instruments for pumping out money from the state budget in the interest of their management and related persons from government. The practice of aggressive M&A deals to hide bad financial results of the operations of state-owned companies under the leadership of their “effective managers” is very apparent in the Rosneft and VTB examples.

Rosneft was the beneficiary of putting Khodorkovsky in jail, destroying Yukos and purchasing its assets at a discount price. While Vladimir Putin was in power in Russia, Rosneft spent more than $100 billion on acquiring assets, Bloomberg calculated. Rosneft used loans to buy Yukos's assets from the state. In 2013, it bought TNK-BP for $55 million. In mid-October 2016, Rosneft insisted on nationalization of Bashneft from AFK Sistema, blaming it for unfair privatization, and then bought Bashneft for $5.3 billion and bought out the company's shares from minority shareholders. In the summer of 2017, Rosneft invested a total of more than $6 billion in 49 percent of Indian Essar Oil Limited, in Egypt's gas field and oil projects in Iraqi Kurdistan, and spent as much on advances to Venezuela. These transactions increased the debt of Rosneft. Net debt and prepayments for oil delivery contract obligations for 2017 increased by 10 percent to 4.7 trillion rubles (over $80 billion) while its capitalization in the beginning of 2019 was about $67 billion.

In 2006, my colleagues and I completed a consulting project for Rosneft's then–financial director Peter O'Brien in improvement of the internal communications system. In December 2008, I was invited to speak for Rosneft's minority shareholders at a special educational event about the role of independent directors. In 2009, Rosneft was interested in building better communications with its small shareholders, who bought shares at a so-called “peoples' IPO” in 2006 and followed the example of Sberbank and VTB in establishing a committee of minority shareholders composed from selected representatives of those minority shareholders. It was at those preparatory meetings with management when I first got acquainted with Alexey Navalny, now the leader of political protests, at that time a shareholders' activist. We have put up a concept and worked out a plan for the committee's activities. The corporate secretary told me it was well received by management. The problem was that Alexey still wanted Rosneft to disclose minutes of board meetings and information on Rosneft payments into charity funds that was unavailable to shareholders. So after management refused to disclose information, Alexey filed a lawsuit against Rosneft. It was the end of our initiative. Igor Sechin, board chairman, was furious and dumped all communications with our group. Actually, Alexey's request was completely legal, so Rosneft violated corporate law by concealing this information from shareholders. After that, Rosneft and other state-owned companies which received similar requests forced amendments in corporate legislation, making it impossible to disclose such information to shareholders possessing under 25 percent of shares.

In April 2016, the Ministry of Economic Development allowed state-owned companies to decide for themselves which information to disclose in the annual reports and which information they consider a commercial secret and keep in secret. New rules were introduced in response to a request from Rosneft. The annual reports of state-owned companies had more requirements than privately held joint-stock companies in 2010, when Prime Minister Vladimir Putin approved the approximate structure of the annual report for companies with state participation by a government decree. For example, the government recommended disclosing key performance indicators of management, and information on the implementation of the investment program and the sale of noncore assets. It was the additional demands of the government that displeased Rosneft. In its appeal, the company said that Rosneft did not want to disclose the objectives of its long-term development program and data on the alienation of noncore assets, indicating deviations of the actual value of the assets sold from the balance sheet. The company also did not want to disclose the costs of investment projects and data on investments with a yield of more than 10 percent per year.

Because of sanctions, problems regularly arise for contractors, including Russian ones, who fear to get under sanction as well for their cooperation. State-owned companies were worried about transparency of information about what was happening within their groups and on financial transactions while all companies under sanction wanted to protect information about contractors and not to disclose schemes that allowed them to bypass the sanctions. In November 2017, Prime Minister Dmitry Medvedev freed state-owned companies from the obligation to disclose suppliers and contractors. A resolution signed allowed state-owned companies to limit their publication in the procurement register to disclose information about the results, the method, and the price of the purchase—without information about the winner. Contracts with subcontractors went even further into the shadows—the search for information about them was concealed from the public.

Sberbank's Bold Analysts' Riot: Comfortably Numb?

In mid-October 2017, Sberbank CIB issued a report on the state-owned company Rosneft: Analyst Alexander Fack explained that its shares should be sold, because after 2019 Rosneft's organic growth would be almost zero. The correctness of the calculation of net debt, debt load, and Rosneft's free cash flow raised questions from Sberbank analysts: After buying TNK-BP for $51.3 billion, Rosneft did not reduce the debt but spent another $14.8 billion on assets around the world.

The report was revoked due to direct criticism from the head of Rosneft. A revised version came out later. Criticism of Sechin's management policies was removed from it, but there were still complaints about strategy and calculations, as well as a recommendation to sell Rosneft shares. According to the calculations of the company itself, net debt was $37.5 billion, but with prepayments for Chinese contracts and adjusted for the dollar rate, the report said it was $73 billion. Analysts who prepared the initial version of the report kept their positions and continued working.

On May 21, 2018, the media circulated the report of the Sberbank analytical service (Sberbank CIB). The authors concluded that the main benefits of the gas pipeline projects of Gazprom—Turkish Stream, Nord Stream 2, and Forces of Siberia—were received by construction contractors, and not by the shareholders of the company.

“Gazprom's decisions are absolutely understandable if we assume that the company is managed in the interests of its contractors, and not for commercial gain,” the report said. Construction contractors include Arkady Rotenberg's Stroygazmontazh and Stroytransneftegaz, 50 percent of which, according to media reports, belong to Gennady Timchenko and his family, although Timchenko himself denies this. Both Timchenko and Rotenberg are known as longtime friends of Vladimir Putin.

On May 22, 2018, analyst Alexander Fack, who prepared this report, was fired. Following him, Alexander Kudrin, director of the analytical department of the company, also left. Sberbank President German Gref called the reason for dismissal a “violation of the company's internal regulations” and “gross violations of ethical standards.” Timchenko told reporters that German Gref personally called him and apologized for the report.

The reports of Sberbank CIB analysts are written in English and are intended for clients of the Sberbank investment division, including foreign portfolio investors working with Russian securities and shares of Russian companies. In my opinion, Sberbank analysts in both cases fulfilled their professional duty and gave an objective view of the situation.

On the other hand, there is no doubt that management of Sberbank fired analysts under pressure from political circles and had no other choice how to react. The situation demonstrated that state-owned companies are governed in the interests dictated by political reasons and not by the interest of growing the market value of the company. This is an evident conflict of interest and violation of shareholders' rights. Dismissal of analysts who did their job professionally also puts further market reports by Russian investment banks under big question.

The Final Cut: Conclusions and Recommendations

The specifics of corporate governance in Russia are associated with the lack of dispersed, widely held shareholding. All companies, both state owned and private, have a controlling shareholder who makes all decisions. The board of directors as a governance body functions formally, approving the decisions of the owner. At the same time, the Russian Corporate Governance Code formally meets the best international practices for protecting the interests of minority investors and providing information disclosure. The issue is with law enforcement and the work of the judicial system, the decisions of which in many cases are influenced by telephone law from the political leadership and by corruption. Recently, a Russian court used the detention of foreign nationals' managers of well-known investment fund Baring Vostok in their dispute with Russian shareholders that recruited representatives of the Russian special services to influence the court.

Since 2008, the improvement of the corporate governance system in companies with state participation has been carried out by replacing public servants on the boards of directors with external experts. The Federal Property Management Agency introduced a mechanism for nominating and selecting candidates for the board of directors through a special electronic portal, taking into account the views of the professional community, which was actively developing. A new version of the Corporate Governance Code was adopted, which formally reflects the high demands placed on companies whose shares are traded on exchanges. The Supreme Arbitration Court adopted a resolution on directors' liability and compensation for losses by persons included in the governing bodies of the companies for shareholders' protection. However, cardinal breakthroughs in institutional development did not occur. The quality of government and the judiciary has not changed. For many Russian businesspersons and officials, corporate governance and boards of directors appear as a kind of façade that they must build in order to attract investors and get their money. In most companies, board members act, at best, as experts advising the controlling shareholder in making strategic decisions.

After 2014, a lot has changed in Russia due to the reaction of the international community and investment institutions to the annexation of Crimea, which reflected in the degradation of public institutions, including the corporate governance system. Fear of Western sanctions caused the restrictions on information disclosure by public joint stock companies included in the sanctions lists, and hiding information on their procurement. It resulted in the return of officials and former civil servants to the boards of directors of strategic companies with state participation and the expulsion of independent directors from the boards. Along with growing criminal prosecution of business owners often initiated by security forces on far-fetched pretexts in order to seize their property, it made the investment climate and demand for corporate governance drop down substantially.

Interest in corporate governance is still observed among business owners who plan to transfer their business to their heirs in the form of capital by creating professional boards of directors, where the heirs become passive shareholders or members of the board of directors and do not participate in the day-to-day management, so the board becomes a decision maker. This gives a chance for investors in those businesses to feel more comfortable and better protected despite the generally unfavorable entrepreneurship climate and economic situation in the country.

The Central Bank of Russia as regulator was always a proponent of good corporate governance. The problem is that it imposed governance rules on the corporate and banking sectors formally, as window dressing. In the near future, the Central Bank intends to pay more attention to improving the quality of corporate governance in nonbanking financial institutions that use or manage clients' funds. In particular, it plans to prepare amendments to the legislation giving the Bank of Russia the authority to assess the compliance of the remuneration system in financial institutions with the risks assumed. The Central Bank already has such powers in relation to banks.

In addition, the Central Bank of the Russian Federation wants to get the authority to establish requirements for the formation of the board of directors in a financial company. The presence of the board of directors is mandatory for banks, private pension funds, and insurance companies, and for brokers and management companies that deal with clients' funds, there are no such requirements. Moreover, the Central Bank plans to systematize approaches to the requirements of the risk management system, internal control, and internal audit in nonbanking financial companies.

However, there are serious claims to the effectiveness of the existing banking sector regulatory system built by Central Bank to apply it further to nonbanking financial institutions. With the current capitalization of the banking sector at $160 billion, the Central Bank of Russia spent at least $80 billion over the past 6 years to rehabilitate and recapitalize collapsed banks, which shows the inefficiency of banking supervision and the regulatory system. The $80 billion figure was announced by Alexander Danilov, senior director of Fitch Ratings banking analytic group, on the sidelines of the International Finance and Banking Forum in March 2019.

According to analysts, growing nationalization of the banking system, squeezing private and foreign banks out of many operations, and increasing customer distrust are not so much a product of real problems as a consequence of the regulator's policy. With the current capitalization of the entire Russian stock market accounting for 80 percent of Apple's capitalization, further tightening of regulation instead of creating conditions for market development will only deepen its stagnation. The solution is rather in demonopolization of the economy, development of competition, and creation of an independent judiciary, which is a much broader task than corporate governance reform.

About the Author

Alexander A. Filatov is an experienced international expert for UNDP projects and IFC short-term consultancy assignments. His proficiency is with a focus on corporate governance/strategic management, internal audit, and finance based on his Ernst & Young background, 15 years of governance consulting, and boardroom experience in banking and in the financial sector, as well as in energy companies and telecommunications in Russia and in Kazakhstan.

Mr. Filatov is currently a partner at Genezis Tech Capital VC fund and an advisor to EdTech start-ups. For three years, he served on the board of the Russia Agency for Home Mortgages Lending Corporation, which is similar to Fannie May in the United States. In Kazakhstan, he served for five years on the board of KazMunai Teniz, a marine exploration and production company, as an independent director and chair of the audit committee of the board of directors.

For six years, he served on the advisory board of the Moscow (MICEX) Stock Exchange, and actively participated in establishing its Market for Investment and Innovation (RII) segment.

As cofounder and CEO of the Independent Directors Association in Russia (IDA), Mr. Filatov closely worked with the IFC Russian Corporate Governance Project in 2003–2006, heading its spinoff—corporate governance team of IFC consultants based in four Russian regions—and merging this spinoff with the IDA team.

Mr. Filatov is a member of the UK Institute of Directors (IoD) since 2008 and currently holds the UK's highest director qualification degree, IoD Chartered Director.