Article for Russian magazine LOGINFOPresentation at Krasnodar Political Risk

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					   Presentation at Krasnodar Transportation Infrastructure Conference, Anapa, Russia
                                  November 30, 2001

          PREREQUISITES FOR SUCCESSFUL BUSINESS DEVELOPMENT

                                   By: William T. Robinson

Bill Robinson, with the Seattle, Washington law firm of William T. Robinson PLLC, has provided
legal services to domestic and international clients for 28 years. He has lived in Japan and
Russia, and since 1990 has worked with over 130 clients and projects in eight republics of the
former Soviet Union. The firm advises clients on how to structure Russian business operations,
and how to manage legal issues relating to trade and investment in Russia. Robinson recently
completed the legal and tax analysis for a proposed Russian regional development bank to
finance infrastructure projects. The firm’s practice is equally divided between representing
Russian-owned companies, and Western or Asian companies doing business in Russia. Much of
his work has involved transportation and logistics. In addition to his legal experience, Robinson
holds a U.S. Coast Guard Captain’s Certificate, and is an active aviator with a commercial
pilot’s license.

Introduction

I thank the organizers of this conference for the opportunity to be here and meet with you. I have
worked in Russia for twelve years and am very pleased to be here at a time of such
encouragement and renewed interest in economic development and improving bilateral
relationships between our countries.

By way of background, my first connection with the Russian transportation sector was through
my wife, Katia Romanoff. Katia, whose grandparents immigrated to Seattle after the
Revolution, was the Pacific Northwest traffic manager for Morflot Freightliners and FESCO
(Dalnevostochnoye Morskoye Parohodstvo / Дальнeвосточное Морское Пaроходство) from
1972 to 1981. At that time, up to twelve ships a month visited Seattle, carrying cargo between
the US and other countries. I never dreamed that a short ten to fifteen years later I would be
representing Japanese, Korean, Russian and US shipping companies in Russia, or that I would
have the experience of working on development in a half dozen Russian ports and airports.

While my work has involved many sectors of the Russian economy, most of the lessons learned
over the years are particularly relevant to project development in transportation, energy and
infrastructure.

Despite the business potential of vast human and material resources, many Russian projects have
not developed as expected or hoped for ten years ago. At their last summit meeting, President
Putin said that he and President Bush were united in saying that the economic ties between our
two countries do not correspond to their potential, and there is a lot they can do to support
effectiveness of those ties. But there is also a lot that participants in projects can do. Projects
that had merit and economic potential have often not been developed because the participants
failed to build a foundation for success. Aside from transitional political and legal issues,
business development could be much more successful if proper attention is paid to four key
issues during the predevelopment phase of a project. These include: how to integrate Western
due diligence requirements with current Russian conditions, public/private sector issues, project
financing and creation of capital, and risk management. Understanding and addressing these
issues at the beginning of a project is essential to encourage foreign business participation and
project success.

Global Choices – Why Not Russia?

Western companies make global choices as to where to invest or do business. Comparing
investment in China and Russia in recent years, there has been ten times the foreign investment
in China as in Russia - $36 billion versus $3.6 billion in one year. If asked, “Which country will
reach a successful market economy first – China or Russia?” most people in the West would
probably answer China. Why is that so, when it seems clear that Russia has far greater economic
long-term potential? In natural resources, Russia is unequaled – 1,000 barrels of oil per capita
versus 25 for China – energy, fish, gold, timber, minerals, and other resources. Consider
Russia‟s human resources, with a 99% literacy rate, and half the world‟s engineers. Most
important, Russia has made a commitment to democracy and a market economy that China has
not yet made. With these advantages for Russia, why the disparity in investment results? We
may identify many causes, but the difference between Western perception and reality is surely
one of the most significant.

Whether those misperceptions exist because different standards are applied to Russia than to
other countries, or are leftover biases from the Cold War, or simply from the failure to keep up
with the pace of change in Russia, is not the issue. The issue is to recognize that Western
investor skepticism and ignorance must be overcome in order for business development to
proceed. It is necessary to deal with the perception problem as an element of business planning.
Russians cannot assume that others appreciate or understand the historically unprecedented
challenges that Russia is facing. It is in Russia‟s interest, that they make the effort to help the
West understand these challenges, and understand Russia‟s success in dealing with them.

The first challenge is transition to democracy with no recent history of democratic institutions.
The second is transition to a market economy. There have been other command economies, but
none that attempted to repeal the law of supply and demand for three generations, making it
difficult to know what things are worth in absolute or relative terms when putting a deal together.
The third challenge is to cope with the first two while creating relations with new neighboring
countries – with different currencies, customs regimes, and taxes. In addition, there are
jurisdictional issues to deal with between Moscow and the regions, among the regions, and
among regulatory agencies competing to assert their authority.

While progress over the past ten years may seem slow, it is quite remarkable in view of these
challenges. The Western media has failed to communicate the successful political transition,
marked by development of a strong pro-democratic coalition, and legislative support in the
Duma for reform leadership. On the economic front, real growth in GDP began before the 1998
financial crisis, and was 8.3% in 2000, and 5.4% in the first half of 2001 – facts that need to be
recognized.




 2001 William T. Robinson PLLC                                                                   2
Russia‟s legal infrastructure is rapidly developing, yet largely unknown in the West. Businesses
and investors want two things from the law that are absolutely inconsistent: they want to know
what it is, and they want it to change. This tension should not be unexpected, nor is it
unmanageable. Most new legislation is quite workable, but it simply takes time to gain
transactional experience, and learn how laws should be implemented to operate in a transitional
market economy.

On a personal note, I want to comment on how attitudes have changed over these years. In 1990,
there was almost a euphoria over the possibilities of our newfound relationship. After 45 years
of Cold War, I was surprised at the deep affection toward Americans and had to ask myself
„Why?‟ The answer is obvious: we are more like each other, even in our diversity, than any
other people in the world; our countries are more the same – wide open spaces, sea to sea, North
to the pole. President Putin, in his speech to U.S. political leaders at the Russian Embassy in
Washington D.C. two weeks ago, reminded us that our countries shared the era of emancipation
reforms in the middle of the 19th century, which coincided with the U.S. Civil War. He noted
that it is symbolic that two great statesmen – Emperor Alexander II and President Abraham
Lincoln, abolished slavery in their countries at about the same time, and both fell at the hands of
terrorists. Later, we were on the same side in two World Wars. And now we are on the same
side in the war against terrorism. It is perhaps easier for us to relate on a personal level than other
two peoples in the world.

However, the path has not been smooth, and relations deteriorated over the past ten years. The
euphoria shifted to skepticism about our intentions. Now the world has changed again; we each
have a new team in our capitols, and our presidents are developing an understanding that gives
us a great hope for future cooperation.

 Within hours of the attacks on the World Trade Center and Pentagon, I began receiving
messages of condolence from friends all over Russia. There were so many I prepared a set
response to thank them for their concern. In it, I said “I wonder how the world might be
different if we had spent the past ten years in constructive engagement with Russia to resolve
global issues and deal with international terrorism, rather than the counterproductive expansion
of NATO, and failure to appreciate Russia‟s security concerns along its southern borders.”

These recent events have created a new awareness in our country, and a new understanding of
the need to work with Russia with less arrogance and more respect.

With an informed perspective, we can deal with the real issues. And with proper consideration
and focus on the following four areas during early stages of business development planning,
many projects can move ahead without waiting for a generation of further reforms.

Integration

Because the history of project development in the former Soviet Union is different from
established market economies, it is necessary to integrate Western due diligence and feasibility
requirements with current conditions for using Russian experience and resources. Russia is a
relational economy, and relations among people are essential for any project to work.



 2001 William T. Robinson PLLC                                                                      3
Russians and Americans read Kipling, and they all know the verse, “East is East and West is
West and never the twain shall meet.” But few seem to recall the last line: “But there is no
border, breed, nor birth, when two strong men stand face to face though they come from the ends
of the earth.”

Kipling‟s observation on developing a solid personal relationship based on confidence and
mutual respect is critical to business success. Without diminishing the role of law in business
development, unless the right personal relationships and understanding exist, no number of
lawyers or contract provisions can save a project. In a time of transition, business partners must
rely on trusting relationships to add assurances and certainty that the law does not yet provide.

A key to project success is to develop a common understanding of each partner‟s competency,
experience, and ability to get things done. The euphoria of ten years ago over potential business
development shifted to skepticism of intentions, and disappointment over lost opportunities.
Failure to understand the need to build relationships and focus on details in business
development was a major factor in missed opportunities.

Partners from different backgrounds need to develop a common understanding and foundation
for a project. The lack of market experience often tends to create an oversimplified view of what
is necessary to make a project work. It is important in working together to manage expectations
from the outset; sometimes that means resisting pressure to move ahead until the proper
foundation is laid for a project. It is in working out the details that a relationship is built, and the
participants come to understand the terms, conditions and resources that will be made available
for the project.

I agree with what President Putin said in Washington, that the world still has a long way to go
before international relations – or international business – are built solely on trust. We will
continue to rely on contracts and treaties, but trust is the essential first element.

Public/Private Sector Issues

The government‟s role in Russia is shifting from one of administering the economy, to one of
regulating the economy. Instead of acting as owner of an enterprise, in most cases the state is
becoming the regulator and the tax collector. However, in a number of sectors of the economy,
the state continues to own assets and enterprises, or at least exerts substantial control over
economic activities and decisions. This is particularly true with respect to transportation, energy
and infrastructure, and is an issue that must be precisely addressed early on for a project to be
developed in these areas.

A market economy is not an unregulated economy. There have been problems where
privatization has occurred, and when assets have been transferred from state ownership before an
adequate regulatory regime has been put in place to protect essential public interests. The lack of
experience and interaction between public agencies and private entities provides little practical
guidance, and makes it more difficult to conceive or structure a project so that it will attract
foreign investment or participation. Foreign investors are looking for stability and predictability
as to who has ultimate authority over elements of a project.



 2001 William T. Robinson PLLC                                                                       4
This issue extends to any form of foreign participation, whether as a lender, investor, equity
owner, or merely a contractor to the project. Unless the foreign party has a clear understanding
of the nature and ownership of the organizations with which it will be dealing, it will turn its
attention elsewhere in considering global choices.

Many sectors of the economy that were vertically integrated in the former Soviet Union are now
a mix of public and private enterprises. Even where the state has retained ownership or control
of major assets, there are increasing opportunities for private sector participation in those
industries and related activities.

For example, the electric power industry includes generation, transmission, and industrial and
retail distribution. The state role in each of these components will likely vary in timing and
substance. Power generation may be initially dominated by large state-owned facilities, but the
system must accommodate development of private plants and co-generation, including sale and
distribution of surplus power from those facilities. Retail distribution, even if privatized, would
likely remain highly regulated as a local monopoly. These issues are not unique to Russia, and
have been managed with varying degrees of success in other countries. Even the United States,
with a long history of public and private utility districts, and public and private generation and
transmission facilities, continues to restructure the power industry as market conditions and
technology change.

Similar issues face development of transportation and other energy resources. Until there is
agreement as to public and private sector roles in construction, operation, ownership, and
infrastructure cost sharing, we cannot expect pipelines, transportation and other major projects to
be developed.

Resolution of these matters up front is critical to the development of ports and airports. In most
cases, the port or airport is likely to be owned or controlled by a government agency or a special
purpose entity established to run the port in the public interest. In either event, it is likely that
many of the functions, such as warehousing, repairs, fuel sales, freight forwarding, support
services and other activities will be privatized. It is essential that port legislation and operations
clearly define the relationship and accountability for public and private activities within the port
organization.

With regard to participation in any of these projects, it is not the role of the foreign side to decide
who owns the resources or facilities, or whether they are developed by public or private
organizations. That is clearly a Russian decision. However, when a decision has been made that
allows for participation by the private sector, it is necessary to be clear about government‟s
influence or participation in the structure and authority of juridical entities related to the project.

The perception of widespread corruption has had a chilling effect on Western business
development in Russia. It is an issue that should be anticipated and dealt with if a project is to
succeed. Most firms planning for the long-term will not accept corruption as unavoidable, nor
should they discount the importance of dealing with it. Recent reform efforts to simplify
regulation are welcome, and in time should reduce transaction costs for Russian businesses. In
the interim, attention to precisely identifying the role of the state in project development, and



 2001 William T. Robinson PLLC                                                                      5
providing a fair, efficient and transparent method of obtaining necessary governmental
permissions, will do much to encourage participation by Russian and other investors.

Project Financing and Creation of Capital

The third area that does not get enough attention is how to finance projects with Russian capital.
There has been a shift of thinking in the last five years. Instead of financial aid to the
government, Western capital should flow to the private sector. I agree with Boris Federov, who
said that only this (private sector investment) will help change the country, create jobs and
increase efficiency. However, despite the good news that foreign investment in Russia will
increase by 40% this year, it will still be a tiny fraction of what is needed for sustainable
economic development. Even if a project expects to include foreign investment, that investment
will usually be in a project that includes commitment of Russian resources. With all the
attention that has been given to foreign investment, and providing legal protection for foreign
investors, it is of no use unless the right conditions for Russian investment exist.

Measured in terms of human and material resources, many view Russia as the richest country in
the world. However, much of those resources are “soft capital”, lacking the finite characteristics
and transferability that are necessary for them to be used or have value in project financing. The
question is how to convert assets and resources to “hard capital” to make them bankable. Only
then do assets have value as contributions of capital to a project, or as security to lenders or
investors. The answer is having a combination of laws and practices in place that provide
certainty as to possession, ownership or control of assets, and a means to characterize and
demonstrate those rights to potential investors or business partners.

For example, in a port or an airport project, the first questions are who has the right to control or
allocate use of port land, under what terms and conditions, for what length of time, and what
parties need to be involved to obtain necessary functional and legal objectives. I have had
several cases where bankruptcy of an enterprise operating at a port has delayed or seriously
complicated getting secure use of property for a new project. Further improvements to Russia‟s
bankruptcy laws are needed to provide the finality that investors expect if property is put back
into productive use as a capital asset for a project.


One of Russia‟s greatest assets is land – potentially five trillion dollars in value, but only if four
conditions are met. There must be a right to ownership, a system to identify the parcels of land
and who might have rights in it, the right to mortgage property, and rights in land must be freely
transferable. Recent passage of the Land Code established the fourth and final condition with
respect to urban land and dacha plots, permitting sale of about two percent of Russia‟s land.
Agricultural land was excluded from the Land Code, and will be subject of future legislation
before its value can be realized as an asset in business development. (Editor note: the
Agricultural Land Code was passed in 2002). Complex issues of land ownership and land use
are beyond the scope of this presentation. However, it should be noted that agricultural land
markets may be allowed to develop and create value in land, yet be regulated to address public
concerns over what may happen if land is privatized. For example, the Land Code, or a land
market law, could place limitations on ownership of agricultural land by foreigners, establish
maximum size limits to agricultural land holdings, restrict use for non-agricultural purposes, and


 2001 William T. Robinson PLLC                                                                     6
provide other mechanisms to permit reasonable access to land ownership for future generations.
Such legislation would encourage investment to put land to more productive use, while limiting
incentives for speculation.

Other land legislation is equally important to complete what is necessary for land to be used to
finance transportation projects. For example, the 1998 Federal Law on Land Registration must
be fully implemented in the regions so that there is an efficient uniform system for the lender to
know who has rights against property. The new Mortgage Law is helpful, but further changes are
needed to make it easier and less expensive to foreclose on property in event of default. This
would allow the lender to take over property and find someone qualified to complete the project,
or otherwise put the property to productive use to avoid losses.

There are other examples of using laws to create value to finance a project. In financing a
mining project, it is not only a question of ownership of the mining resources, but having
licenses to export, and knowing the terms and conditions under which resources may be sold.
Other than physical assets and resources, there is the same need to quantify and legalize the basis
for other rights, such as intellectual property. Russia‟s rapidly growing IT (information
technology) industry gains value as products and services receive the same recognition and
protection as in other countries.

All of these resources, human and material, form the basis for business development. They can
contribute to project financing if the right laws and documentation are in place. Much legislation
affecting property rights, including laws on leasing, land, mortgages, security interests, and
bankruptcy, is new. Transaction costs may be higher, but a diligent effort to implement and use
these laws will greatly increase the value of Russian assets in project development. Legal,
engineering, and financing expertise is required to realize potential value of assets as
contributions to a project. Financing and investment, whether from Russia or other sources, will
become increasingly available, and viable projects will be defined by attention to these issues.

Risk Management

The fourth issue that does not get enough attention is risk management. When businesses
consider whether to invest or do business in Russia, many simply say it is too risky and look
among their global choices for something else. This is another case of misperception versus
reality. The concept of risk in the abstract, is absolutely meaningless. An abstract fear of risk,
often caused by fear of the unknown, has caused many Western investors to shy away from
transitional markets despite current opportunities. Risk assessment and risk management are
impossible without identifying specific risks. If the investor or lender is concerned with true
political risk, in the sense of nationalization or expropriation of assets, most observers would
discount those risks in the Russian market, and note that political risk insurance is available for
those with continuing concerns.

Of more practical importance are routine risks that are faced by projects anywhere in the world,
which in most instances can be quantified, contained, allocated or otherwise dealt with through a
variety of strategies. These discreet risks include changes in taxation, labor conditions,
environment, control of property, inflation, and regulatory issues, including what may be
required to obtain permits and licenses. These are specific risks each of which may be allocated


 2001 William T. Robinson PLLC                                                                   7
by contract to the party which is best able to deal with it, insured against, or priced and accepted
as a project cost. These are examples; there are many other strategies and techniques available to
manage and contain risk.

Risk management includes avoiding common causes of failure of joint ventures. These include a
poor contractual framework, failure to sufficiently define the rights and responsibilities of the
parties, unrealistic schedules, poor documentation of project components, over-inflated
expectations, poor communication, and lack of flexibility. These and other issues can be dealt
with by frequent and close communication, and by working together to have common, clear
understanding of what is necessary to solve problems.

Aside from assessment of specific risks, the best security for any project is to provide local
benefit, and for the participants to understand that success is not measured by what they get from
each other, but by what they do together to provide goods and services to their customers.

After doing a risk analysis, a business may not want to do the project. But, it is an analysis that
should be done, rather than simply concluding it is risky without considering the facts and
options. Local knowledge, trust and experience are critical to these assessments. It is here that
personal relationships are paramount if risks are to be accurately characterized, and the investor
is to have enough information to know whether those risks may be managed in order to make a
decision.

Final Note

Russia today is a rapidly changing country that has made an irreversible historical choice. The
challenges I mentioned are transitional, and have to do with forming a mature democratic state
and a modern and effective market economy.

With an understanding and commitment to address these four issues at the beginning of a project,
it is possible to limit risk and greatly increase chances of success. For example, if tenders are put
out for a project, responses will be more serious and competitive if these points are considered in
preparing the tender. Failure to deal with these four issues in advance will doom projects that
otherwise have merit. Attention to these points will help develop the solid foundation and
common understanding that is necessary to succeed and do business in Russia, and further
Russia‟s full integration into the global economy.


William T. Robinson PLLC
14432 SE Eastgate Way, Suite 400
Bellevue, WA 98007 USA
Tel: (425) 285-2318
Fax: (206) 770-6530
Email: wtr@wtrobinson.com
Website: www.wtrobinson.com




 2001 William T. Robinson PLLC                                                                    8

				
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Description: Article for Russian magazine LOGINFOPresentation at Krasnodar Political Risk