Russian investments at risk from Ukraine sanctions

Russian investments at risk from Ukraine sanctions

Ukraine has passed a new law “On sanctions,” which poses a wide range of risks for Russian investors and companies. While investors from Europe and the US are highly unlikely to be targeted by this law, they also should consider indirect effects on their portfolios.

In August, just a week before its dissolution, Ukraine’s parliament adopted a draft law “On sanctions” with 244 votes in favor. On September 10, 2014 Ukraine’s President Petro Poroshenko signed this piece of legislation, law № 1644-VІІ, introducing a legal framework for future sanctions against Russia.

Provisions of the law

According to the law, it has been adopted as an effective response to “existing and potential threats to national interests and the national security of Ukraine, including armed attacks of other states or non-state entities.” Although Russia is not specifically mentioned in the law, the wording leaves no room for doubt: “In order to protect national interests, national security, sovereignty and territorial integrity…Ukraine may use special economic and other restrictive measures” (emphasis added).

The right to impose sanctions is granted to Ukraine’s National Security and Defence Council (NSDC) with final approval by the president. NSDC may freeze assets and prevent capital transfers, restrict trading and terminate trade agreements, stop recourse transit and transportation through Ukraine’s territory, suspend the execution of economic and financial liabilities, prohibit participation in the privatization of state property, deny visas, etc.

Russian business in Ukraine

The law provides a fast and flexible framework for adopting restrictive measures against Russian businesses, which have a sizable presence in Ukraine. According to Ukraine’s National Statistics, accumulated Russian FDI in Ukraine constituted USD 4.3 billion or 7.4% of total foreign investments. The actual figures are much higher due to a considerable offshore investment flow through Cyprus.

Russian-owned companies operate in many sectors of Ukraine’s economy: oil and gas, steel, construction, telecommunications, finance, the hotel and restaurant business, wholesale trade, etc. Russian companies are not only present but, in many spheres, dominant. For example, Russian telecom giants MTS and VimpelCom  together account for 80% of Ukraine’s wireless market.

Table 1. Key Russian businesses in Ukraine

Russian parent company Industry Subsidiary/project in Ukraine
MTS Telecom MTS Ukraine
VimpelCom Telecom Kyievstar
Sberbank Finance Sberbank Ukraine
VEB Finance Prominvestbank
VTB Finance VTB Ukraine
Alfabank Finance Alfabank Ukraine
Bank of Moscow Finance BM bank
LUKoil Oil, Fuel Karpatneftekhim
Rosneft Oil TNK-BP Commerce, Lisichansk oil refinery
Gazprom Natural gas distribution Gazprom sbyt Ukraine
Mechel Steel Donetsk electrometallurgical plant
Evraz Steel, Mining DMZ Petrovskogo, Uzhniy GOK
UC Rusal Non-ferrous metals Nikolaev Alumina Refinery, Zaporozhskiy aluminium plant
Transmashholding Transport engineering LuganskTeplovoz
Rosatom Energy engineering Energomashspecstal
Renaissance Capital Agriculture Ukrainian Agrarian Investments
BEZRK Belgrankorm Agriculture Belgrankorm-Poltavschina
Rosinter Food Il Patio, Planeta Sushi
Megapolis Tobacco West-Tobacco Group, Podillia Tiutiun
Finstar Lottery Operator of state lottery “Patriot”

Source: companies’ data, author’s data, Forbes, Vedomosti

And of course Ukraine is a major transit country for Russian resources heading to Europe. Gazprom supplies 162 billion cubic meters of natural gas to Europe, about 50% of which is delivered through Ukraine. The Russian metals and mining sector is also heavily dependent on transit.

Political risks and damages

The law has already locked in on its targets. In his speech before the final parliamentary vote on the bill, Ukrainian Prime Minister Arseniy Yatsenyuk noted that the government is considering sanctions against 172 individuals, mainly Russian citizens, and 65 companies, accused of “sponsoring terrorism, supporting the annexation of the Crimea, and violating the territorial integrity of Ukraine.” However, Ukraine still has not revealed any names.

During the Maidan clashes, Russian business experienced minor disruptions and damages from social unrest. Such was the case largely for the service industry institutions located near the protest sites (banks, restaurants, retail). Yet, as the situation progressed, several companies faced a sharp drop in sales due to increasingly negative attitudes among Ukrainians.

For instance, Russian oil giant Lukoil had to sell its Ukrainian network of 240 gas stations and six oil depots at a discount to an Austrian company AMIC Energy Management, which focuses on investment in undervalued or distressed energy assets. Prior to this, Lukoil was the fifth largest player in the fuel market in Ukraine.

Main damages to heavy industry – from cease of operations to the destruction of production facilities – were caused by military conflict in the Eastern Ukraine. Russian oil giant Rosneft estimated that damages to its Lisichansk oil refinery in Lugansk reached USD 140 million due to artillery fire. The company intends to start negotiations with the Ukrainian government over compensation.

Many other companies in the steel, mining and engineering industries had to stop operations of their Ukrainian subsidiaries. The Ukrainian government also wants to prevent Russian companies from getting 3G licenses in Ukraine at an upcoming auction.

Foreign investors also may be indirectly hit by Ukrainian sanctions since many institutional investors have stakes in Russian companies. For instance, according to MTS officials, the company is nearly half-owned by institutional investors around the world, with over 65% of free float owned by investors in the US and UK.

Political uncertainty has already caused capital flight: during seven months this year total FDI fell by 14%. Russian FDI dropped more aggressively – by 29% to USD 3 billion (not taking into account offshore investments via Cyprus). The difference of 15 percentage points in FDI decrease (Russian vs. total) can largely be attributable to possible Ukrainian sanctions on Russian businesses.

Categories: Europe, Finance

About Author

Alexey Kobylyanskiy

Alexey Kobylyanskiy currently works for a leading Russian mining company. He previously worked for the political risk insurance arm of the World Bank. He also has experience working for Russian regional government bodies and as an international election observer during the 2010 presidential elections in Ukraine. Alexey holds an MA in International Political Economy from Fordham University and an MA in International Relations from St. Petersburg State University, Russia.