World business is cutting ties with Russia's FSB "investment fund"

European Bank for Reconstruction and Development has issued official statement in which on behalf of itself and its partners announced the end of co-operation with Russian investment fund Fanansgroup, whose CEO Oleg Shvartsman, in an interview several days ago in his capacity of one of the business leaders receiving orders from Kremlin, revealed existence of far-reaching plan to redistribute property in Russia, from the current private owners to Kremlin and its security services.

In the interview given to business daily Kommersant, 3,5 billion dollar fund's manager claimed to work within the framework of former security service association numbering 600 thousand personnel with the goal of "re-privatization" of large part of private assets in Russia.

According to the interviewee the so called re-privatization constituted takeover of businesses from their current owners using administrative pressure to draw the market value of the undertakings down and then, after their the price of the acquisition drops, purchase them for select people in FSB and presidential administration.

Today Russian media reported (see this piece in Russian language) that foreign partners, including EBRD, which previously had plans to invest in the fund, which in addition to the financial sources in the West also received money form Russia's state, withdrew their participation amid scandal which erupted after the publication.

Obviously, there were voices denying involvement, in particular some of the high ranking officials mentioned by Mr Shvartsman as being behind the operation denied everything, though they obviously could not deny knowing Shvartsman as he is clearly not the last man in Russia. But in the end, after several days, even Mr Shvartsman himself changed his mind and started to deny his own revelations as "misinterpreted". The interview, however, was both signed by Mr Shvartsman with own hand on every page of the script as well as audio-recorded by the newspaper (all those materials in Russian language are accessible at the following address on the Kommersant website). It is understandable that before publishing something like this the newspaper took measures to fortify its position in order to avoid the fate of less thorough Russian news channels, such as NTV television station in 2000. Despite these efforts there are reasons to believe that by publishing such stories Kommersant puts its relative editorial independence in danger.

Not without significance is also the fact that before Mr Shvartsman started to deny his own words Mr Shvartsman's wife Mrs Olga Heifits (Ольгa Хейфиц), answering to a phone call from Russian newspaper New Times claimed her husband unavailable because "he is currently in the administration of the president" (see following piece in Russian language). Not surprisingly, Mr Shartsman also denied this meeting taken place, too (told to deny everything?). But if this topic is so inconvenient why then did Mr Shvartsman say what he said in the first place? It seems to me that he is just the kind of person, one of the so called noveaux russes, the other example being famous oligarch, billionaire Mr Berezovski, who just can't resist the temptation. Unlike Berezovski, however, Shvartsman is the real deal and (although this could change quickly) he is connected to Kremlin. More importantly, the business says he is right.

Despite the efforts to cover up the leak, the business elite confirmed everything Shvartsman said. Russian media outlets asked several key business leaders, including powerful CEO of Russian energy monopoly RAO EES Anatoly Chubais about Shvartsman's claims and he too confirmed the information. Other interviewees include Russian bankers and non-exiled oligarchs. They all said Shvartsman is telling the truth (see this piece in Russian language).

The statement of the European Development bank reads:

EBRD, RVK and Tamir Fishman decide not to proceed with Russian venture capital investment

The Russian Venture Company, the Tamir Fishman Group and the European Bank for Reconstruction and Development have decided not to proceed with the creation of the proposed Tamir Fishman Russian Venture Capital Fund, following statements by a minority shareholder in the Fund’s management company. All three were investors in what was to be a fund to invest in high-technology in Russia, remain actively committed to supporting the Russian market and the goal of developing advanced technologies. The Russian state investor in the Fund, the Russian Venture Company (RVK), the Tamir Fishman group, an Israeli merchant bank and venture capital specialist, which is the majority owner of the Fund’s management company were to be partners in the Fund, along with the EBRD as an important investor. The EBRD looks forward to the opportunity of working with high quality fund managers such as Tamir Fishman in future investment vehicles to promote Russia’s fledgling venture capital industry and provide support for the country’s high-technology sector. The Russian Ministry of Economic Development & Trade organised a public tender which was won in May 2007 by the Finance Trust, a Russian company originally designated to manage the Tamir Fishman Russian Venture Capital Fund.
Press contact: Richard Wallis, Moscow - Tel: +7495 787 1111; E-mail: wallisr@ebrd.com

The move of EBRD shows that Kremlin's operatives have nearly exhausted even seemingly bottomless European tolerance. After the hit at foreign investors in 2003 when Yukos shares value plummeted due to criminal charges (bankruptcy and suspicious acquisition of assets followed) the revelations by Shvartsman ought to become the next big hit at Western trust in doing business in Russia. Because Western interpreters probably have involvement as partners in many of the undertakings, connected to the privatizations of the state assets, which in this capacity can become target.

The picture is obscure, but in my view Western investments inside Russia have slim legal protection. I believe there are some, most likely sufficiently vague clauses in PCA agreement between EU in Russia, which can theoretically be relied upon by the Europeans doing business in Russia to protect their business from "re-privatizers", but even the fate of that agreement remains unclear as it is expected to expire in 2008 without clear perspective of extension due to recent worsening of relations, induced by Russia.

Russia is not a party in WTO and unlikely to have investment protection agreements with many countries, apart from those which remain from the USSR times (about dozen). For example, such agreement has been concluded with the US in 1990 and most likely it remains in force today. However, the agreements in question normally stipulate an obligation of "equal treatment", which in practice means that if Moscow harms an entity with both Russian and foreign shareholders, it does not infringe the equal treatment condition. Kremlin never had any problem harming Russian investors, unless they were from Kremlin itself. Of course, this is just an opinion and provides no proper legal analysis of the situation. On the other hand even the proper legal analysis would be a mere indicator of the environment, as legal system in Russia is managed from above according to current priorities. But the events of recent years continue to serve as a warning to everyone doing business in Russia about the risks of dealing with criminals.

Additional Background. Financial Times on the scandal (read the full text on the FT.com page):

"Bank drops Russia venture fund plan" (By Catherine Belton in Moscow)

The European Bank for Reconstruction and Development dropped plans to create a Russian venture capital fund after a shareholder in the fund's management company claimed he was leading a "velvet reprivatisation" drive for the state.
The EBRD and the Israeli Tamir Fishman group, which was also to be a major shareholder in the fund, made the announcement just three days after Russian daily Kommersant published an interview with fund manager Oleg Shvartsman in which he claimed he was managing industrial assets on behalf of members of the Kremlin administration.
The interview, published two days before parliamentary elections last weekend, provoked controversy in Moscow.

Mr Shvartsman told the newspaper he was setting up a company called Social Investments that would "hoover" up strategic assets in the regions through "voluntary-coercive" methods. He said he co-owned a company, Finans-Group, that managed $3.2bn (£1.6bn) in assets and was "closely connected to several political figures". "We manage their assets. We have ties with the presidential administration, and with its power bloc," he told Kommersant. Finans-Group, he said, had formed an alliance with law enforcement structures incl-uding the interior ministry and the Federal Security Service to gather oil assets and other mineral wealth. Adding that he reported indirectly to Igor Sechin, the deputy chief of the Kremlin administration and chairman of state-controlled oil major Rosneft, he said the aim was to take over assets that were not following the "correct" tax regimes. Finans-Group is registered at the same Red Square address as the Kremlin's property department.