Lexology GTDT Market Intelligence provides a unique perspective on evolving legal and regulatory landscapes. This interview is taken from the Private Equity volume featuring discussion and analysis of emerging trends and hot topics within key jurisdictions worldwide.


1 What trends are you seeing in overall activity levels for private equity buyouts and investments in your jurisdiction during the past year or so?

Market conditions in Russia have been challenging over the past 18 months. In line with other major economies, the Russian economy contracted in 2020 (by approximately 3 per cent according to a World Bank Report published in May 2021), driven largely by the impact of the covid-19 pandemic. This led to a decline in private equity activity, with a particular drop in inbound investment activity from foreign investors. At the same time, several factors helped the Russian economy perform relatively better in 2020 than the world economy (which contracted by approximately 3.8 per cent according to a recent World Bank Report on Russia) and developed countries (which contracted by approximately 5.4 per cent) – including macro-fiscal stabilisation efforts, relatively soft covid-19 restrictions for industrial and construction sectors, closer ties to a relatively fast-growing China, and a large public sector that buffered against unemployment.

In addition to the impact of the covid-19 pandemic, the Russian economy was also challenged over the past 18 months by volatile commodity prices (although commodity prices have rebounded recently, which is particularly important for Russia’s energy exports) and a relatively volatile Russian rouble, which has depreciated against other major currencies. Furthermore, the risk of US and EU sanctions (while not noticeably escalating recently) remains.

In early 2020, the President announced the renegotiation of double tax treaties with what Russia considers to be transit jurisdictions to dramatically increase withholding tax on dividends and interest sourced from Russia. As a result, Russia has revised its DTTs with Cyprus, Luxembourg and Malta. Russia is even denouncing (terminating) the DTT with the Netherlands following a failure to reach an agreement on revision. According to the Russian Ministry of Finance, the DDTs with Singapore, Switzerland and Hong Kong are likely to be revised.

These negative trends, and the associated uncertainty for the Russian economy, have depressed private equity activity in Russia over the past 18 months and some investors have adopted a cautious approach to major transactions in the jurisdiction. At the same time, the current situation has also presented new opportunities in stressed and distressed private equity transactions, and certain sellers have accelerated disposals of non-core or underperforming businesses and assets to raise cash. In addition, certain sectors (such as the technology and innovation, healthcare, and e-commerce sectors) have seen relatively strong levels of deal activity over the past 18 months. We have also seen certain private equity players (particularly state-backed players and some of the largest Russian private equity funds) opportunistically deploy capital.

Looking ahead, according to a World Bank Report published in May 2021, the Russian economy is expected to achieve a moderate recovery in 2021 and 2022 – although this ultimately depends on how the covid-19 pandemic and vaccination campaigns play out. A recovery of the Russian economy should lead to stronger levels of private equity activity. Further, if other major economies recover from the covid-19 pandemic and with global M&A activity hitting record highs in the first half of 2021, we would also expect to see an uptick in private equity transactions driven by foreign investors, including by major sovereign investment funds. Such sovereign funds have been a key driver of private equity activity in Russia in the past few years and we expect this trend to continue. Finally, there have been a growing number of successful initial public offerings (IPOs) of Russian companies over the past 18 months (eg, Fix Price, Ozon, Sovcomflot and EMC (see question 6, below)) and several market commentators are forecasting a strong pipeline of initial public offering (IPO) activity in the next 12 months. It would be a significant development for the Russian private equity market if this pipeline of IPOs comes to fruition, as Russia has traditionally been a challenging market to successfully exit from a private equity investment.

2 Looking at types of investments and transactions, are private equity firms primarily pursuing straight buyouts, or are other opportunities, such as minority-stake investments, partnerships or add-on acquisitions, also being explored?

Buyouts (whether by management or otherwise) and public-to-private transactions tend to be relatively uncommon in Russia. It is more common for investors to take minority stake investments. Where control is acquired, these investments tend to be carried out by way of a consortium deal. One of the main drivers for this is financing. As with any jurisdiction, investors can access larger deals by clubbing together, but this increased financial resource is particularly relevant in Russia where deals have historically tended either to involve limited debt financing or none at all (although there are some early signs that debt financing is being used more often in Russia, which remains a trend to watch).

Finance is just one reason why foreign investors often seek out local investors with whom to partner. Russia has a reputation as a jurisdiction in which it is desirable to have a strong local partner to achieve a successful business operation. A domestic partner brings local knowledge and connections that can be indispensable for foreign investors who are unfamiliar with the Russian regulatory system or who lack relations with the Russian authorities. Partnering with a local private equity house may make obtaining investment committee consent easier, as comfort is taken from the experience, expertise and influence of the local partner.

For the Russian investor, involving an international partner may provide access to funding from banks based in the same overseas jurisdiction as the foreign investor and carries with it a certain cachet that can be of particular leverage when marketing a business for sale or further investment, or trying to negotiate an exit. In addition to funding, international investors can bring a greater depth of deal experience and sector knowledge to what is still a developing private equity market.

3 What were the recent keynote deals? And what made them stand out?

The key deals in the past 18 months have centred around three broad themes:

  • the relatively high levels of deal activity in the technology and innovation, healthcare, and e-commerce sectors driven by the covid-19 pandemic and broader digitisation trends;
  • the large volume of private equity investment by major Russian state-backed players (such as Sberbank, VTB and the Russian Direct Investment Fund (RDIF), Russia’s sovereign wealth fund) as compared to non-state-backed private equity funds; and
  • the ‘pivot east’, evidenced by the continuing participation of Asian and Middle Eastern sovereign funds in Russian private equity deals, in the context of an overall decline in foreign investment activity throughout the period.

The first key trend of the past 18 months was the standout performance of the technology and innovation, healthcare, and e-commerce sectors. The relatively high level of deal activity in these sectors was accelerated by the covid-19 pandemic (which has driven consumers towards e-commerce particularly in the retail, food delivery, education, healthcare and entertainment spaces). This is supported by the long-term trends of digitisation of the economy and the building of ‘ecosystems’ of digital brands under the auspices of established Russian businesses. Notable deals by leading private equity funds in the past 18 months included:

  • the acquisition by a consortium of leading private equity funds (Goldman Sachs, Baring Vostok and Winter Capital) of a stake in GetCourse (a Russia-based SaaS online learning platform);
  • the acquisition by Baring Vostok of a minority stake in 12 Storeez (an online Russian women’s fashion brand retailer);
  • the acquisition by a consortium of Winter Capital and Russia-China Technology Investment Fund of a minority stake in Algorithmics (a Russia-based online school of mathematics and programming); and
  • the acquisition by a consortium of Winter Capital and Baring Vostok of a minority stake in SkyEng (a leading online provider of English-language education).

Major Russian companies, such as Sberbank (a major Russian state-backed bank, which frequently carries out private equity-style investments), Yandex, MTS, Rostelecom and Mail.ru Group have been actively building their e-commerce ecosystems throughout the period, including through early-stage investments, joint ventures and acquiring major stakes in established businesses.

For example, Sberbank, which was mandated by the Russian government to build a world-class digital ecosystem, has been especially active in the innovation and technology and e-commerce sectors over the past couple of years, and this trend has continued. In 2020 and the first half of 2021, Sberbank acquired stakes in Rambler Group (media holding), 2GIS (leading developer of digital maps and city directories), Samokat (food delivery), Local Kitchen (ready-to-eat food delivery), Goods.ru (online shopping portal) and Eapteka (online pharmacy), among numerous other deals. According to media reports, Sberbank is expected to continue its acquisition spree.

While there were many other deals in the innovation and technology and e-commerce sectors in the period, other notable deals include the acquisition by USM Telecom of IKS Holding (a major information technology holding company) for US$2 billion and the series of investments by Mail.ru Group in edtech platforms (including Skillfactory, Tetrika and Uchi.ru).

The second key trend of the past 18 months was the relatively high levels of private equity investments by major Russian state-backed players (such as Sberbank, VTB and RDIF).

RDIF, often in conjunction with Asian and Middle Eastern sovereign fund co-investors, executed a significant number of investments in the period. For example, RDIF and partners acquired a stake in ZetTek (a Russian personal care goods producer), Binnopharm Group (a major Russian pharmaceuticals holding), Tau (e-mobility solutions and advanced materials), AliExpress Russia JV (a leading e-commerce company in Russia and the Commonwealth of Independent States), Travelata (a travel aggregator), Elementaree (a grocery delivery service start-up), and Carprice (an online car sales service), among others. Similarly, VTB, a major Russian state-backed bank, made several large investments in the period – for example, Ivi.ru (a Russian online video streaming service) (other investors included RDIF, Millhouse Capital and AG Invest), Binnopharm Group (major Russian pharmaceuticals holding) and Delimobil (a Russian car sharing company).

One of the largest deals in the first half of 2021 was the acquisition of a 75 per cent stake in JSC Prosveshcheniye, a major educational literature publishing house, by Sberbank, VEB.RF and RDIF for US$1.1 billion.

This trend looks set to continue as Russian state-backed players continue to grow in confidence and experience, and have capital available to deploy on private equity investments.

The final major trend in the period was the ‘pivot east’, evidenced by the continuing participation of Asian and Middle Eastern sovereign funds in Russian private equity deals, in the context of an overall significant decline in foreign investment activity throughout the period. For example, Mubadala (an Abu Dhabi sovereign fund) made significant investments in EN+ (a Russian energy major), Telegram (a Russian version of WhatsApp) and AliExpress Russia, while the Russia–China Investment Fund made investments in Eruditor Group (an online marketplace for freelancers) and Binnopharm Group, among other examples.

We expect the trend of significant inbound investment by Asian and Middle Eastern sovereign funds to continue as these investors become increasingly comfortable with the Russian market and, as highlighted in question 6, RDIF continues to stimulate interest among them.

Finally, many ‘classic’ private equity deals continue in the market. For example:

  • the acquisition by Winter Capital Partners and co-investors of a stake in BestDoctor (online medical insurance platform);
  • the acquisition by Winter Capital and Elbrus Capital of a stake in Banki.ru (online platform for selection and comparison of banking products); and
  • the acquisition by Elbrus Capital of a stake in Aviasales (travel metasearch platform).

4 Does private equity M&A tend to be cross-border? What are some of the typical challenges legal advisers in your jurisdiction face in a multi-jurisdictional deal? How are those challenges evolving?

Most private equity deals relate to Russian targets and, despite some investment activity by international funds (particularly based in Asia and the Middle East), foreign investors are still in the minority. As mentioned above, foreign investment levels have been supressed over the past 18 months in light of the covid-19 pandemic (among other factors), although market commentators expect this to return to more normal levels once the effects of the pandemic subside.

Outbound investment by Russian private equity sponsors in overseas investment opportunities is rare, although LetterOne has proved comparatively active in this respect, acquiring Holland & Barrett, Europe’s largest health and wellness retail chain, for £1.7 billion in 2017, and completing a business merger with BASF in 2019 to create Wintershall Dea, the largest independent oil and gas exploration and production company in Europe. A single major outbound investment (announced in the first quarter of 2021) is ongoing, when Nexters Global, a mobile gaming company, agreed on a merger with special purpose acquisition company (SPAC) Kismet Acquisition One Corp (founded by Russian businessman Ivan Tavrin) in a deal that values the company at US$1.9 billion. The company is expected to go public in the third quarter of 2021 on the NASDAQ.

On the other hand, VTB Capital completed a major overseas divestment in 2019, selling its entire stake in Bulgaria’s leading telecoms operator, Vivacom, to United Group, in a deal reportedly worth up to US$1.3 billion. In 2021, Vista Equity Partners and founder Andrey Filev sold Wrike, a collaboration service with Russian roots, to Citrix for US$2.25 billion.

The bulk of private equity transactions nevertheless involve the acquisition of Russian assets by Russian bidders. However, these deals have traditionally had a strong cross-border element since, as a result of various tax, regulatory and legal considerations, the deals tend to be structured using offshore acquisition vehicles. Although these structures may face increasing challenges in the future, they continue to dominate market practice.

Typical challenges to be dealt with by legal advisers working on cross-border transactions in Russia include:

  • the complex regulatory landscape and marrying the applicable requirements of the Russian legal system with those of the chosen governing law of the transaction;
  • the complexity of sanctions issues;
  • the protective approach of Russian courts, establishing jurisdiction over disputes in contradiction to dispute resolution provisions of contracts;
  • the rapidly evolving taxation regime;
  • the lack of established market practice and relatively few precedent deals against which to benchmark transactions;
  • the related lack of experience of private equity dealmaking among the business community; and
  • managing relations with the Russian regulators and government, particularly where the transaction involves entities operating in strategic sectors such as significant mass media, subsoil industries and aviation.

Russia is a market that is continuing to develop and, as its own laws are revised to include concepts that are commonly used in other markets, we see increasing interaction between differing legal frameworks. It is critical to ensure that advisers have a full understanding both of what international investors expect from their transactions in Russia and how the unique features of the Russian market might impact on them.

5 What are some of the current issues and trends in financing for private equity transactions? Have there been any notable developments in the availability or the terms of debt financing for buyers over the past year or so?

The use of acquisition finance to leverage private equity acquisitions is not a prevalent feature of private equity investment in Russia. The significant majority of deals are equity-only and the restraints on access to international financial markets, resulting from international sanctions, make the ability to self-fund more important than ever. That said, there are examples of state banks providing debt financing for acquisitions – for example, in 2020, Sberbank reportedly provided up to US$1.8 billion to finance a share buy-back of En+ shares from VTB. Also, in 2020, VTB reportedly financed the acquisition of Highland Gold (a Russian gold producer) by Fortiana from Roman Abramovich in a deal valuing the company at US$1.4 billion. In 2019, VTB reportedly provided debt financing to Marathon Group for the acquisition of an 11.82 per cent stake in Magnit for approximately US$1 billion. Domestic financial institutions and funds such as VTB Capital, Sberbank CIB and RDIF can, at times, offer the ability to refinance post-investment, which gives them a competitive advantage over other private equity sponsors.

6 How has the legal, regulatory and policy landscape changed during the past few years in your jurisdiction?

Recent years have been marked by the desire on the part of the government to make Russia more attractive to foreign investors and to support the growth of a local private equity market, although efforts have been made more challenging by the imposition of EU and US sanctions. That said, the recent conviction and issuance of suspended sentences to certain executives of Baring Vostok following a prolonged corporate dispute over control of Vostochny Bank (described in question 7) has negatively impacted foreign investor confidence and is being closely followed by foreign investors.

The emergence of government-backed sponsors and financial institutions over the past several years has transformed the Russian private equity market. In particular, Rusnano, a US$10 billion private equity fund established in 2007 to invest in the nanotechnology sector, and RDIF, a US$10 billion fund established in 2011 to make equity co-investments with major Russian and international players, have significantly impacted the market. Today, RDIF is one of the most active players in the Russian private equity market. RDIF has established investment funds with international partners from a range of countries, although with a focus on Asia (including China, Korea, Japan, Vietnam and India) and the Middle East (including Abu Dhabi, Saudi Arabia, Bahrain, Kuwait, Turkey and Qatar), and to date has attracted US$40 billion into joint funds. These funds have generally committed to investing a substantial percentage of their capital into Russia, and RDIF and various other sovereign wealth funds have made significant investments across various sectors of the Russian economy.

As mentioned, private equity transactions (even with only Russian participants) have in a significant number of cases been structured through non-Russian acquisition and joint venture vehicles. Russian policymakers have implemented a range of measures to try and stem the high level of capital flight from Russia.

The government has sought to stimulate private equity houses to move their assets onshore through the de-offshorisation initiative. The de-offshorisation campaign included the introduction of controlled foreign companies (CFC) legislation (discussed further in question 13), a tax and capital amnesty between 2015 and 2020, a new redomiciliation mechanism available since 2019 and, most recently, changes to the withholding tax rate on dividends and interest paid from Russia to offshore entities (discussed further in question 13).

Court practice regarding the application of double tax treaty relief is rapidly developing and has, so far, been largely detrimental to taxpayers. The Common Reporting Standard, launched in Russia at the end of 2017 (the first exchange of information occurred in 2018), is expected to significantly contribute to the ability of Russian tax authorities to trace evasion schemes. We expect a further hardening of tax and regulatory requirements in the coming years. The government’s impetus for greater transparency around the involvement of offshore structures in Russia-focused transactions is also seen in the foreign investment laws that were introduced on 30 July 2017, which apply greater scrutiny to transactions where a foreign partner acquires an asset in Russia or a Russian investor acquires an asset in Russia through a foreign vehicle, especially if the asset is regarded as strategic in Russia.

In parallel, the government has continued its efforts in creating a more favourable legal and business climate onshore, as evidenced by Russia’s ascent in the World Bank Ease of Doing Business Index from rank 124 in 2010 to 28 at present (with substantial improvements in the ease of starting a business, registering property and enforcing contracts, among others). Russian civil and corporate law has been subject to numerous amendments in recent years with the aim of adapting the legal instruments commonly used in Western jurisdictions for use in Russia (such as representations and warranties, indemnities, and option agreements) and enabling investors to implement typical Western-style corporate governance and shareholder agreement arrangements at the onshore Russian company level. While market participants have generally remained cautious in implementing the new legislative instruments, we have seen an increasing number of clients (both domestic and foreign) get comfortable executing private equity deals onshore under Russian law. Overall, there are positive signs that momentum is building for Russian law to play a bigger role in private equity transactions going forward.

Additionally, there is some possibility that the government will seek to create more domestic investment opportunities through a privatisation programme. In January 2020, the government published a draft privatisation programme for 2020 to 2022, which indicated plans to sell stakes in major enterprises such as Makhachkala Commercial Sea Port, Novorossiysk Commercial Sea Port, Almazyuvelireksport, VTB Bank, Rosspirtprom, Modern Commercial Fleet and Kizlyar cognac factory. Further, in July 2020, the Russian Ministry of Finance published plans to reduce by half the number of companies with state participation in the period from 2020 to 2025. However, it remains to be seen whether these plans will be implemented in the context of the weak global economic climate and relatively strong Russian government finances. There were two major successful privatisations in 2020: the sale of the Adler trout-breeding factory and US$550 million IPO of Sovcomflot, Russia’s largest shipping company and one of the global leaders in hydrocarbons transportation (as a result of which state ownership of Sovcomflot decreased from 100 per cent to 82.8 per cent). Other than the privatisation programme, there have been limited direct efforts from the Russian state to stimulate M&A activity. However, certain sectors have seen an increase in M&A deals through indirect stimulation of the sector by the Russian government (for example, construction M&A grew in 2021, which could be partly attributed to state-subsidised mortgages).

Another area the government has addressed in recent years is investor concern about the legal robustness of dispute resolution forums relating to Russian investments. Over the years, for a number of reasons, participants in Russia’s private equity market have shied away from investment structures that lead to significant corporate disputes being adjudicated in the Russian courts. At the same time, there has been significant uncertainty as to whether such disputes could instead be referred to arbitration. In an effort to address this issue, Russian law now expressly allows corporate disputes concerning Russian entities to be handled by arbitration institutions, provided that they have registered with Russian regulators and, in most cases, provided that the place of arbitration is in Russia. At the time of writing, four foreign arbitral institutions (namely the International Chamber of Commerce International Court of Arbitration, the Singapore International Arbitration Centre, the Hong Kong International Arbitration Centre and the Vienna International Arbitral Centre) have each obtained a licence to administer Russian corporate disputes.

On the other hand, in June 2020, the Russian government enacted a new law granting Russian state courts exclusive jurisdiction over certain disputes involving Russian sanctioned individuals and entities, as well as foreign entities controlled by them. Generally, the new law does not prevent parties from referring disputes to international arbitration or to foreign state courts. However, if the jurisdiction of a foreign court or arbitral tribunal is agreed, sanctioned persons will be able to disregard the dispute resolution provisions if they cannot be enforced due to sanctions that impede access to justice. While it remains to be seen how Russian courts will determine whether dispute resolution clauses involving sanctioned persons are unenforceable and, equally, how widely the courts will interpret the provision on impediments to access to justice, this law may further complicate the already complex arbitration regime and lead to a deterioration of the investment climate in Russia. Accordingly, this is an area for private equity investors to monitor closely.

7 What are the current attitudes towards private equity among policymakers and the public? Does shareholder activism play a significant role in your jurisdiction?

Historically, the private equity industry has been widely supported and championed by Russian policymakers, and there have been no signs of the political or public scrutiny of the private equity industry experienced in other major jurisdictions. This may have been, in part, because of the novelty and relatively low prominence of the private equity industry in Russia, as well as the political and economic headwinds it is facing in the present environment, which have discouraged some foreign players without prior experience of dealmaking in Russia and, conversely, created opportunities for local private equity investors.

While these conditions generally remain true, there has been a spike in political and public scrutiny of the private equity industry in Russia recently because of the widely publicised battle between Baring Vostok Capital Partners (BVCP) (a leading Russian private equity firm) and Russian businessman Artyom Avetisyan over control of Vostochny Bank (one of the 30 largest Russian banks by asset value). The battle has involved litigation in the Russian courts, the London Court of International Arbitration and various offshore jurisdictions over the past few years, and was reportedly settled between the parties in 2021.

The corporate dispute attracted widespread international news coverage when Michael Calvey (CEO of BVCP) and other senior employees of BVCP were first charged, and then found guilty by a Moscow criminal court of criminal embezzlement and given lengthy suspended jail sentences. Despite the conviction, commentators have contended that these criminal charges were unlawfully instigated by Mr Avetisyan to pressure BVCP into handing over control of Vostochny Bank. These events have caused serious concern within the investment community and certain foreign investors.

Another notable incident was the arrest in June 2020 of Alexander Povalko, the chief executive officer of Russian Venture Company (RVC). RVC is a state fund and a development institution in the Russian venture capital market. Mr Povalko is suspected of misusing RVC’s funds. The investigation reportedly concluded in August 2021 with the case going to criminal court and the hearings ongoing. Several prominent investors have already publicly expressed their concerns about the arrest and the impact it may have on the Russian venture capital sector.

Finally, in June 2020, it was announced that Yandex has agreed to terminate its joint venture with Sberbank, bringing an end to a decade-long partnership that had recently soured over Sberbank’s plans to expand further into the technology sector. Under the deal, Yandex will buy out Sberbank’s stake in Yandex.Market (a leading e-commerce platform) and sell its stake in Yandex.Money (a leading payments platform) to Sberbank. It will be interesting to see what impact this split will have on private equity activity as both Sberbank and Yandex have proactively pursued M&A opportunities in the technology sector in recent years.

The prevalence of low free floats and controlling shareholders means that it is unlikely that the levels of activist and turnaround investment experienced in the United States and the United Kingdom will become a regular feature in Russia.

8 What levels of exit activity have you been seeing? Which exit route is the most common? Which exits have caught your eye recently, and why?

Following the listing of HeadHunter (a leading Russian online job search portal) on the NASDAQ in 2019 (the first listing of a Russian company on the NASDAQ since 2013), there were a number of IPOs in 2020 and 2021. Notably, this included Fix Price (a low-priced retailer), raising US$2 billion on the London Stock Exchange in the biggest share offering of a Russian company since 2014; Ozon (an internet retailer), raising US$1.2 billion on the NASDAQ; and the US$550 million IPO of Sovcomflot (transport and logistics); US$500 million IPO of European Medical Centre (healthcare); US$410 million IPO of Segezha Group (forestry holding); and US$40 million IPO of Samolet (construction) on MOEX. These exits are significant given that IPOs have traditionally been rare in the Russian market.

An increasing number of companies are publically touting potential IPOs in 2021 or 2022, such as Rolf Group (a leading car dealership), Krasnoe & Beloe (a leading alcohol stores network), Ivi.ru (a Russian online video streaming service), and Cian (a major Russian real estate marketplace). Accordingly, certain market commentators are anticipating a major uptick in IPO activity.

There have also been a number of negotiated exits by private equity funds reported in the period, such as the sale by Baring Vostok of a stake in ER-Telecom (a Russia-based telecommunication company) to Perm Financial and Industrial Group. In addition, VTB sold its 50 per cent stake in its consolidated grain business to Agronova and Marathon Group for an undisclosed sum in 2020 (estimated to be in the region of US$1 billion).

The secondary market for private equity exits in Russia remains relatively small and there are a limited number of sponsors willing to take on IPO mandates. Given that the strategic market predominantly relies on foreign investors who offer the most attractive terms and that the current geopolitical climate is not conducive to foreign investors entering the market at present, it remains a challenging environment for exits by private equity sponsors in what remains an investment market.

9 Looking at funds and fundraising, does the market currently favour investors or sponsors? What are fundraising levels like now relative to the past few years?

The Russian private equity funds market is in its relative infancy. As such, there is not sufficient volume to determine which side of the investment relationship the market favours. The general sentiment is one of trying to support and grow the industry as a whole, rather than favour one constituency over another.

Russian-focused private equity fundraising levels are low at present. Geopolitical risk, sanctions and low levels of economic growth in Russia, among other factors, have challenged fund closings in recent years. Further, given the impact of the covid-19 pandemic on the global economy and financial markets, we are unlikely to see a major uptick in Russian-focused fund closings in the next 12 months.

At the same time, there have been a limited number of fundraisings bucking this trend. Notably, Elbrus Capital, a leading Russian private equity fund, has (according to which public sources) raised US$260 million to launch its third fund and aims to raise another US$600 million by the end of 2022. Baring Vostok (along with RDIF, RTP Global and Elbrus Capital) also announced the creation of a joint investment platform of up to US$200 million to invest in retail, consumer goods, and product and technology companies affected by the covid-19 pandemic.

On the other hand, state-backed players – which, as explained above, are very active in the Russian private equity market at present – have arguably been more successful in fund formation than private investors. For example, in 2018, RVC and investment fund Da Vinci Capital formed the Da Vinci Pre-IPO Tech Fund (with up to 6 billion roubles under management) to invest in established start-ups that are seeking stock exchange listings and RVC partnered with private investors to establish the Terra Fund II to invest in advanced technology businesses (with up to 6 billion roubles under management). In 2019, VEB.RF reformed its investment division into VEB Ventures, a US$480 million venture fund. In 2021, RVC and Sberbank also announced their intention to create a joint fund totalling US$100 million to invest in technology and science-intensive startups. RDIF has also been active in the past few years in establishing new investment funds in partnership with international state-backed funds (see question 6 for further details).

10 Talk us through a typical fundraising. What are the timelines, structures and the key contractual points? What are the most significant legal issues specific to your jurisdiction?

Russian fundraising has tended to follow the patterns and structures used in other markets, with fund vehicles established in onshore markets such as Luxembourg, Cyprus, Ireland or typical offshore centres such as the Cayman Islands or the Channel Islands.

Luxembourg and Cyprus have been key jurisdictions for investments into Russia given the favourable terms of their DTTs. After the amendments to the Cypriot and Luxembourg DTTs, the benefits in relation to dividend and interest withholding tax will only be available for public companies listed on recognised stock exchanges of one of the contacting states. Following recent statements by the Russian Ministry of Finance, there are some questions as to the interpretation of which stock exchanges should be recognised under the DTTs. Market participants are hoping that the Ministry of Finance will clarify the position in the coming months.

The revision of DTTs should encourage Russian businesses to simplify their ownership structures, change their tax residency or even decide to redomicile to Russia. In 2021, Russia expanded the list of countries from which it accepts redomiciliation to include some offshore countries that are members of the Caribbean Financial Action Task Force (eg, Bermuda and Cayman Islands).

Where investors are taking on greater portfolio risks than in more mature markets, they want to minimise risks from using non-traditional fund vehicles. Due diligence remains key with investors that spend a great deal of time on understanding the team, its governance structures and its approach to investments. This will lengthen the fundraising periods. Fund documentation will also reflect the enhanced portfolio risks in terms of the fund governance arrangements and, of course, the target returns and performance fee triggers.

11 How closely are private equity sponsors supervised in your jurisdiction? Does this supervision impact the day-to-day business?

Private equity sponsors operating in Russia are not subject to additional regulation over and above what applies to other businesses operating in the jurisdiction. In particular, there is no body, whether self-regulated or otherwise, charged with overseeing the private equity industry. However, there are still key regulatory issues of which any entity operating in Russia needs to be aware. For example, in relation to anti-monopoly regulation that falls within the remit of the Federal Antimonopoly Service or regulatory approvals in relation to strategic companies.

12 What effect has the AIFMD had on fundraising in your jurisdiction?

As Russia is outside the European Economic Area (EEA), the AIFMD does not apply to Russian managers raising and marketing funds within Russia or anywhere else outside the EEA. To the extent that Russian managers are marketing or managing EU Alternative Investment Funds (AIFs) or marketing a non-EU AIF to EU investors, the AIFMD will be relevant because of the directive’s extraterritorial effect. As mentioned in question 10, many onshore funds are based in Luxembourg, which offers some flexible solutions to the AIFMD, including its securitisation vehicles.

13 What are the major tax issues that private equity faces in your jurisdiction? How is carried interest taxed? Do you see the current treatment potentially changing in the near future?

Russian legislation dealing with CFC, which came into force in 2015, continues to develop. Russian CFC rules are broadly consistent with the approach of the Organisation for Economic Co-operation and Development and the European Union. While court consideration has so far been limited, tax authorities have started gaining experience in applying these rules. Nevertheless, Russian CFC rules have already started heavily influencing the choice of traditional private equity investment structures.

The Russian CFC legislation sets out rules in four areas of tax structuring. First, it addresses the taxation of profits received by the controlled foreign companies of Russian residents but not yet received by the residents themselves. Second, it requires Russian residents holding shares in, or controlling, foreign companies or non-corporate entities to notify the Russian tax authorities of such shareholding or control. Third, it lays down the test for determining the tax residency of legal entities. Fourth, it introduces the concept of beneficial ownership of income for the purposes of double tax treaties.

It is clear that the government’s aim is to restrict the availability of double tax treaty benefits for recipients of Russian-sourced passive income where offshore structures are deliberately established to obtain tax treaty benefits for the ultimate beneficial owners of such income. This focus of the government’s recent reforms is of key importance to the private equity sector.

In May 2020, the President announced that a withholding tax rate of 15 per cent (being the Russian domestic tax rate in respect of dividends paid out of Russia) should apply to dividends and interest payments flowing out of Russia (compared with the 5 to 10 per cent rates for dividends and zero per cent for interest often obtainable under DTTs). The President acknowledged that this will require amendments to be made to DDTs and instructed the government to make such amendments, or if the countries with which DTTs are in place do not agree to such amendments, to unilaterally terminate such DTTs. Russia has already revised several DTTs with traditional investment jurisdictions (Cyprus, Luxembourg and Malta) and is denouncing (terminating) the DTT with the Netherlands with effect from 2022 since the negotiations failed. Reportedly, reconsideration of the DDTs with Singapore, Switzerland and Hong Kong are underway. The increase in the taxes applicable to dividends and interest is likely to have a greatly negative impact on foreign investment in Russia and may impact the investment structures traditionally used by private equity investors. Furthermore, the volatility of the withholding tax position and the potential for reconsideration (or even denunciation (termination)) of the DTTs could have a significant negative effect for private equity investors.

Starting from 2021, the application of a look-through approach to dividends paid to offshore jurisdictions (ie, where dividends are paid from Russia to abroad, but a Russian person certifies that it is the beneficial owner of these dividends and enjoys a lower withholding tax rate or even participation exemption compared to the withholding tax rates applicable to dividends paid abroad) has been restricted. However, from 2024, the look-through approach in respect of dividends will cease to be available for companies at all. The look-through approach remains available to international holding companies (which are, basically, companies created as a result of redomiciliation of foreign entities to Russia and are resident in special administrative regions). These amendments aim to further incentivise the redomiciliation of foreign companies to Russia. In combination with the amendments to the DTTs, this may further discourage the use of offshore joint ventures, which is often a corporate-driven requirement of foreign investors.

As part of the same trend, interest taxation rules have been heavily amended, with specific transfer pricing regulation introduced for interest in 2016 and thin capitalisation rules revised with effect from 2017. Amendments to the thin capitalisation rules effectively codify the recent court practice and restrict deductibility of interest under loans extended by foreign sister companies. However, according to the most recent amendments to these rules, interest under a loan relating to an investment project should not be subject to these restrictions if the borrowed funds are used solely to finance investment projects in Russia, the repayment of the loan is deferred for at least five years, the lender’s direct or indirect ownership of the Russian borrower does not exceed 35 per cent and the lender’s place of registration (tax residence) is a state with which Russia has a double tax treaty.

In addition, changes to certain obligations have been imposed on members of international corporate groups. They are obliged to notify tax authorities that they belong to such groups. If the consolidated revenue of a group exceeds certain limits, its members are obliged to disclose certain information, such as the structure of ownership and control of the group, main indicators of activity, profits gained and losses incurred, and taxes paid. A breach of these obligations will be punished with fines.

The Russian government has continued to increase the tax burden on businesses. The value added tax rate was increased by 2 per cent to 20 per cent starting from 1 January 2019 and amendments to the profit tax regime (which are mostly disadvantageous for taxpayers) were introduced in 2017 and 2018. The ability of Russian regions to introduce profit tax incentives is gradually being limited. Loss carry-forward was amended such that only half of carried losses can be deducted in a given year (although the carry-forward itself is now unlimited by time). In addition, from 2021, the general resident flat personal income tax rate has, for the first time in decades, been changed to a progressive rate: a general tax rate of 13 per cent remains for annual income below 5 million roubles and a general tax rate of 15 per cent was introduced for annual income received by individuals in excess of 5 million roubles.

These developments illustrate the continuing trend of Russian tax legislation becoming significantly more complex and nuanced. Alongside this, Russian tax authorities are adopting an increasingly sophisticated and rigorous approach in their assessment of applications for double tax treaty relief. Since 2018, we have seen a greater examination of the substance of ownership structures and the nature of the relationship between, and functions of, the entities in these structures. The risk is that, where foreign companies or non-corporate entities are acting as mere conduits or agents for the true beneficial owners of income, they may be disregarded for tax treaty purposes. Court practice on the matter is evolving rapidly and most resolved cases are not favourable to the taxpayers. Private equity investors need to be alive to this issue in the context of their investment structures and seek detailed legal advice accordingly.

For private equity managers themselves, there are no special rules in relation to carried interest in Russia and so many of the more complex structures seen in other jurisdictions are not present.

14 Looking ahead, what can we expect? What might be the main themes in the next 12 months for private equity deal activity and fundraising?

Market conditions are challenging and Russian private equity activity is relatively subdued at present. Major Russian state-backed players and the largest Russian private equity funds have been comparatively active over the past year and we anticipate that they will continue to make their presence felt. Opportunistic and experienced local players have also continued to deploy capital through ‘classic’ private equity deals and there may be opportunities for stressed and distressed M&A in the short term.

The low relative value of the Russian rouble means that production costs in Russia offer significant competitive advantages to investors localising production in Russia for export. This factor, combined with the government’s localisation programme, suggests that the trend of diversification of investment activity across a broader variety of sectors is likely to continue. We expect that the technology and innovation, healthcare, and e-commerce sectors will continue to be active areas of the Russian economy and provide opportunities for private equity investors over the next 12 months.

The continuing development of the government’s de-offshorisation programme and changes to the withholding tax rate are having an impact on overall investment activity. This, in hand with changes to the Civil Code aimed at creating a more flexible onshore legal environment, has put further pressure on Russian private equity investors to return capital to Russia and to invest directly in Russian companies. That said, the traditional approach of structuring deals using overseas intermediaries has not fundamentally changed as a result of this push towards de-offshorisation. This remains a key trend for private equity investors to watch.

Major players in the private equity market will continue to watch global economic, political and regulatory changes closely, including sanctions and the development of the covid-19 pandemic, as these will play a key role in determining whether Russia can continue to develop into an investment-worthy market with substantial scale, depth and liquidity in 2022 and beyond.


The Inside Track

What factors make private equity practice in your jurisdiction unique?

The current international sanctions regime and constraints on international liquidity have enhanced the challenges posed by the heavy influence of government-backed sponsors and financial institutions, alongside the generally unpredictable political environment. When this is combined with the often novel legal issues that arise when dealing with the intersection of the Russian legal regime and international business practices, clients rely heavily on their lawyers to help deliver legally robust and commercial outcomes.

What should a client consider when choosing counsel for a complex private equity transaction in your jurisdiction?

  • Can counsel provide seamless advice on Russian legal, regulatory and tax issues and the legal, regulatory and tax issues across the range of other jurisdictions and governing laws involved?
  • What experience does counsel have in dealing with local counterparties and regulatory authorities?
  • Does counsel have experience of negotiating and bringing to fruition complex transactions based on practical experience across Russian and other markets?

What interesting or unusual issues have you come across in recent matters?

Corporate governance and shareholder arrangements for Russian private equity investments always raise important issues. This is true now more than ever, as de-offshorisation and other legislative reforms have encouraged several international and local investors seeking to explore, under Russian law, Western-style arrangements in respect of Russian companies. In a number of recent transactions, we have worked with our clients to resolve the structuring challenges that arise as a result of both the Russian legal framework, being new and evolving, and certain standard Western protections (such as put-and-call options, certain anti-dilution protections and shareholder information rights) being beyond the scope of Russian law.