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As regards the major objectives of all these regulations, five main thrusts can be singled out, first of all as regards the protection of shareholders rights:

- to fill in the legal gaps characteristic of the Russian corporate legislation (such as insiders transactions, affiliated persons and relationships, corporate reorganizations etc.);

- procedural issues of the corporate relationships (authority and procedure of shareholders meetings, boards of directors, new securities issues, etc.);

- requirements concerning the issuers transparency (although at present the quantitative approach to the disclosure of information prevails the qualitative aspects requiring the reliability of the information are no less important);

- strengthening of the system of sanctions for the violation of the corporate law provisions;

- enhancing the authority of the governmental regulatory bodies.

Moreover, at the present stage a new, systemic, approach to the development and updating legislation is needed as well as harmonization between the provisions belonging to the different branches of law (administrative, civil, civil procedural, criminal and criminal procedural) regulating the activity of corporations. Another crucial factor now is the general legal environment in which the companies function as well as systematization of the related regulatory documents: on the securities market, bankruptcy, rules of mergers and takeovers, protection of investors, investment institutions, banks, etc.

In general we can maintain that improvement of the Russian corporate law is proceeding along the global trends in this field:

- more rigid requirements concerning the transparency (disclosure of information) of companies;

- the parallel process of strengthening the companies’ governing bodies authority and control over the governing bodies on the part of shareholders;

- widening the scope of the judicial control over the companies ‘activity;

- development of the legislation for the protection of the small shareholders rights in respect of the whole range of problems (preferential right for the purchase of the new stock issues, qualified (or even higher) majority, rules of mergers and takeovers, cumulative voting etc.);

- development of the legislation for the protection of the rights of the companies’ creditors;

- introducing more rigid regulations in respect of the stock issues, changes in capital, new requirements concerning impermissibility of increasing the profits at the expense of the equity capital;

- bringing closer the legal status of shares and bonds;

- paying special attention to the issues of companies reorganization, transformation of joint-stock companies into other types of entities and vice versa;

- more rigid regulation of relations between legally independent but economically connected companies (take for example the definition of a group according to the French law).

It’s important to point out that the process of developing regulations for this range of problems usually is stepped up when and where (in those transition countries) the reforms have reached a certain qualitative level. All the above-mentioned allows us to draw conclusion that at present time there is no real need for any radical changes in the corporate law. Under normal conditions the policy of gradual improvement and filling in the legal vacuum is probably the optimal solution.

The key problem today is that the efficient regulation of corporate relationships demands not only active (or even leading) legal regulation of the developments in this sphere but also creation of a system of regular control on the part of the state and enforcement which provides for the compliance with the existing legislation. Self-sufficient model of the internal protective mechanisms can’t be strengthened indefinitely or simply doesn’t work under the conditions of the continuing struggle for control in corporations. If such external mechanisms of protection and control as the liquid securities market and well-functioning mechanism of bankruptcy so far are weak the internal mechanisms of control as well as the law enforcement became much more important.

It’s obvious that any single law on the companies simply can’t cover the whole spectrum of corporate problems. Correspondingly the sole governmental regulatory body which will have the possibility to efficiently and legally intervene in case of disputes arising in connection with the relationships between the subjects of the corporate governance and control should become the most important element of the law enforcement system. Of course the role of such a factor as political will is also quite obvious.

3.2. The corporate securities market in Russia and it’s main participants

The importance of the securities market for shaping the model of corporate governance doesn’t require comments. As it was already pointed out in the introduction under the conditions when the developing market is non-liquid, when the major objects of trading are the securities by 10-15 issuers, the mechanism of exit (sale of stocks) as an element of the corporate governance in the absolute majority of cases simply doesn’t work. The market of shares of a specific issuer may be liquid only for a short period of time and it works one way only: small shareholders may only exit and only during the periods of the consolidation of controlling interest or deepening of corporate conflicts between large shareholders and managers. In many cases this simply doesn’t occur at all (if the absolute control is established an/or this enterprise simply can’t be of interest for anybody).

Correspondingly, there is practically no alternative to the corporate governance model which is being formed: if the mechanisms of exit do not work (you can’t sell your shares) than the natural tendency of development would be to strengthen the mechanism of vote. If there are any problems in this connection as well (resulting) from the ideology of a principle still supported by the managers) than the only thing left would be the intervention of the state executive and judiciary authorities.

But the opposite type of relationship also exists. According to many existing estimates violations of the corporate governance rules in the Russian corporations became one of the major factors leading to the withdrawal of investors and collapse of the securities market in 1998.1

187 The prime example in this respect is the adoption of federal law No 74-FZ of May 7, 1998 On the specific aspects of disposal of the shares of the Russian joint-stock company in the field of energy and electrification Unified Energy System of Russia and the shares of the other joint-stock companies in the power sector under the federal ownership

In accordance with Article 3 it was established that foreign states, international organizations, foreign legal persons as well as their affiliated Russian legal persons and foreign individuals may own up to 25% of all types of the RAO’s shares. At the time when the law was adopted 30% of RAO’s shares were already owned by foreigners.1

198 The adoption of this quota which hypothetically meant a demand for nationalization of a certain shareholding became one of the key factors in the Russian stock market crash of 1998.

The Russian market of corporate securities was developing especially intensively during 1996-1997.1

209 The global financial crisis which began in 1997 dealt an especially severe blow to the emerging markets including Russia (the overall decrease of capitalization was 90% between October of 1997 and September of 1998). Nevertheless, even taking into account the sharp drop in the stock indices in 1997 Russia at that time still remained the absolute global leader in the growth of its stock index (which by the end of 1997 increased by 88% as compared with 1996). To a considerable degree it was explained by the significant legislative progress, development of the securities market infrastructure, growth of investment attractiveness of the Russian corporate securities against the background of decreasing yield of other financial instruments in 1995-1997.

Nevertheless, the Asian crisis and the lower world prices of raw commodities were just the external reasons of the financial crisis in Russia which has its own specific features. The catastrophic crash of the Russian stock market in 1998 is impossible to explain just by the unfavorable global financial situation. The latter only aggravated the accumulated internal negative trends in the Russian economy. It was exactly these internal trends which became fatal for the development of the situation in 1998. Unquestionably such a significant drop of the stock prices and liquidity between the autumn of 1997 and autumn of 1998 (see Chart 1 of the Addendum) was linked to a whole range of different factors:2



- in connection with the financial crisis the threat of the overall economic recession became much more acute which would result in the sharp decrease of the profits of the Russian companies and deterioration of their financial situation;

- default on the government debt paper regarded by both domestic and foreign investors as legal nihilism seriously undermined trust to the securities of Russian issuers;

- the leftist government’s coming to power strengthened, from the investors standpoint, the hypothetical possibility of nationalization of many large Russian companies and partial revision of the results of privatization sales to the detriment of the shareholders;

- the threat of enforced bankruptcy of some large Russian issuers because of their tax arrears to the federal budget sharply increased;

- the drop in liquidity of stock of the first echelon issuers and full non-liquidity of the stocks of the second and third echelons of the Russian stock market have frozen the investors’ funds which led to the drop in market demand;

- the banking crisis connected not only with the losses at financial markets but with the very fact of liquidation of the main source of incomes – GKO-OFZ market resulted in the aggravation of the arrears crisis which had direct bearing on the participants of the securities market;

- difficult financial situation of practically all Russian brokers’ companies and the crisis of commercial banks brought fourth the paralysis of the system of settlements under the stock transactions and the respective growth of the system risk;

- many nominee shareholders through which the foreign investments were effected were controlled by the brokers’ companies and commercial banks which got into difficult financial position. Investors were extremely worried over the possible manipulations with these nominee shareholders;

- the capitals which were taken out of Russia and began to come back through the offshore entities were re-oriented towards other investment opportunities.

As a result, the drop of prices of the Russian companies’ shares and decrease of their liquidity caused by the crisis had a direct impact on the investment prospects:

- the Russian companies cannot attract funds through the new stock issues in Russia and abroad;

- the state cannot sell its stakes in the large Russian companies to foreign investors;

- the market value of the Russian companies dropped which had a negative impact on the possibility for the owners of the Russian companies to sell their strategic interest to foreign investors;

- the direct investment funds which, according to the estimates, even in August of 1998 intended to invest into the Russian stocks about 1 bln dollars temporarily lost their interest towards investing their money into the Russian projects since obtaining profits from such investments through floating stocks on the market or sale of shares to the strategic investors in future becomes unrealistic with the low prices.

At the same time the extremely low level of the market prices creates certain preconditions for the long-term investment. Some companies (primarily in telecommunications and oil) in January-April of 1998 managed to issue ADR but the deepening of the crisis in May put an end to this. Moreover, the experience of 1998 showed that, notwithstanding the critical situation at the market, some companies managed to obtain loans for the purpose of enhancing their production and restructuring (open joint-stock company Baltika, open joint-stock company Vympelkom). Primarily this applied to the start-up companies which from the outset had modern technologies, organized process of management, cadre of highly skilled managers, high degree of transparency and loyal to their investors (shareholders).

The financial crisis of 1998 became a serious test for the professional participants of the securities market. The market players who invested their funds into the government securities suffered severe losses which affected their professional activity.

If until July 1, 1998 there was a growth of the number of professional market players (brokers and dealing operations, trust management of securities) and increase of their capital, after August the situation drastically changed. Thus as of January 1, 1998 there were 1.561 licensed market participants, on July 1, 1998 – 1.947 of them, on December 31, 1998 – 1.698.2

221 Significantly, the largest decrease was in the purely broker’s services. The tendency towards the decrease of the number of professional market participants (to 50%, according to the estimates) is also going to continue in 1999. It’s probable that these types of professional activity are going to completely disappear in a number of regions (least probably in Moscow, St.Petersburg and Yekaterinburg) due to the conclusion of a certain stage in the market development when it functioned like a vacuum cleaner i.e., the small regional brokers were buying up shares for their Moscow counterparts who resold them to non-residents.

At the same time in 1998 the dealer’s market for foreign investors suffered an especially severe crisis (within the framework of the Russian Trading System) while the classic exchanges, first of all the Moscow Stock Exchange and The Moscow Interbank Currency Exchange proved to be more viable under the crisis conditions.

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