When Russia invaded Ukraine on 22 February last year, New Zealand fund managers, companies and other entities scrambled to announce that they would divest their Russian assets. Many did. But for others, Russia has proven to be a case study in just how difficult it can be to divest.

Nineteen months into the war, significant numbers of New Zealand companies are still struggling with their moral and legal obligations. That includes large corporates, fund managers and smaller companies that fly under the radar.

To say that MinterEllisonRuddWatts partner Sarah Salmond’s sanctions-related practice has been busy since Russian tanks crossed the border in February 2022 would be an understatement. When war broke out, New Zealand businesses were becoming increasingly aware of the regulatory, contractual and reputational risks associated with doing business in countries involved in armed conflicts, Salmond says.

Within two weeks of the invasion, a significant proportion of publicly listed entities and those with public profiles such as KiwiSaver funds announced an intention to sell their Russian investments. “Those announcements were being picked up by the media, and that creates more pressure,” says Salmond, who took part in a panel discussion at the Responsible Investment Association Australasia (RIAA) conference in Auckland last month.

For some, that announcement to the market proved awkward because they couldn’t follow through.

Rock and a hard place

There are no statistics on the degree to which New Zealand companies have divested, Salmond says. She’d expect it would be similar to other Western countries, where those with Russian subsidiaries or other operations have divested around 10%. But businesses and fund managers have divested between 70% and 90% of their Russian government bonds, along with securities in companies with ties to the Kremlin.

For companies that have stayed in Russia, the reasons vary. Some cite humanitarian issues or fiduciary obligations. Others, which may have dormant or expropriated assets, have found themselves unable to exit.

Many of those still invested find themselves between a rock and a hard place, trying to balance conflicting multi-jurisdictional regulatory, legal, risk management, fiduciary and reputational considerations, Salmond says. The sensitive nature of remaining invested means that after these businesses receive advice, the outcome is not made public.

No-win situation

Whatever investors chose to do after the invasion, it was largely a no-win situation, except for Ukraine. Those able to divest in the immediate fire-sale made significant losses because Russian share and bond prices collapsed, the rouble went into free-fall and buyers were hard to come by.

Those who failed to divest immediately found themselves hamstrung when, just weeks later on 17 March 2022, New Zealand introduced the Russia Sanctions Act 2022. The Act was based on a general autonomous sanctions bill from 2017, which had been voted down.

The first draft of the sanctions legislation effectively made it illegal for a New Zealand person to do anything that benefited a sanctioned person. “If you, as a New Zealand person or business, had securities in a Russian company that became designated, you couldn’t sell them,” Salmond says.

“This sparked a wave of urgent sanctions advice, and lobbying of MFAT (the Ministry of Foreign Affairs and Trade) to lift the prohibitions. The regulations were changed rapidly, with new provisions added to enable businesses to divest securities.” For many, however, the delay brought new issues. “We had this permission [from MFAT] to sell, but the Russian government started to introduce counter-sanctions. New Zealand quite quickly ended up on the list of unfriendly nations.”

Presidential decrees in August and October last year made it especially difficult to get foreign currency out of Russia without Vladimir Putin’s personal approval, which was generally provided only when businesses were being sold at less than half-price to his friends. Banks, in particular, struggled.

“You had to find a bunch of intermediaries to facilitate the sale, none of whom were restricted, and you had to find someone who wanted to buy. Quite often you had to find a Russian buyer or a Chinese buyer [and] that became quite difficult,” Salmond says. “Then you had to balance your fiduciary obligations because you’re meant to be trying to get a good return for your investors. Selling at a bargain-basement price wasn’t necessarily seen as doing right by your investors.”

Reputation risk

Just days after the invasion, responsible investment charity and comparison site Mindful Money analysed fund portfolio data and found that KiwiSaver, ACC and the NZ Super Fund had more than $100 million invested in Russian government bonds and companies.

Barry Coates, chief executive of Mindful Money, notes that few funds took action in the months before the invasion, despite clear warning signs, and then had to sell at a loss. “Very few funds seem to have exited during that time. Those that didn’t lost an estimated 80% to 100% of the value of their investments.”

Once their names hit the headlines, the KiwiSaver and other investment funds took rapid action to get out of Russia. Coates told LawNews his analysts went back to fund managers afterwards and checked that they actually had divested. “We found that all had, apart from a few residual holdings that had no value but were unable to be exited because of restrictions from the Russian government.”

Physical presence

While most funds and many corporates could sell securities, it was more difficult for New Zealand companies with a physical presence in Russia. “For them, trying to sell any of their holdings on the ground became [almost] impossible,” Salmond says.

Buyers tended to be Russian-sanctioned people, thanks to the decrees of August and October. “Not exactly great terms of business. You were really only going to get his personal approval if you were selling for at max half-price and selling to either an oligarch or someone that Putin approved. If the only way you can sell is to sell to a sanctioned person, you [might be] better off holding what you have.”

Under New Zealand’s sanctions legislation, companies were allowed to continue to hold securities in a sanctioned company and do nothing with them. “They’re not legally doing anything wrong. But someone might make the argument that morally, they’re doing something wrong,” she says.

Humanitarian good

New Zealand companies that continue to do business in Russia tend to fly under the radar. Generally, they are not corporates or investment funds. There are plenty of New Zealand businesses that provide a weightless export to Russia and get payment for that. They might provide software services [and] the public are not aware of them. They feel they’re providing a completely benign service and being paid for it via lawful channels, so they’re still in the market.”

Some companies have decided they provide humanitarian good, and on balance it is the right thing to do to stay in the market, Salmond says. “[There are] others who believe that what they’re doing leaves no footprint and therefore, for whatever reason, they’re not really changing the model either.”

Big ‘buts’

There are several big “buts” for companies still caught up in Russia. Banks, both in New Zealand and internationally, have no appetite for the risk involved in doing business in Russia which can make it difficult for companies still operating in Russia.

The second “but” is that Russian transactions are predominantly in US dollars with US banks involved, adding another layer of complexity. “It has become really difficult for all those who continue to have some kind of interest in Russia to facilitate transactions,”

Salmond says. “It takes a lot of time, effort and money [for the banks] to work out what the boundaries are between what is and isn’t possible from a legal perspective. It’s just a lot easier to just go ‘you know what, from a risk management perspective we just don’t want to be involved in a transaction with material nexus to Russia’.

“Then that becomes difficult because you’ve got a New Zealand company saying,’ well, actually, my transaction is lawful for the following reasons. Please reconsider’. So you have now a tension between banks and companies arguing about what is and isn’t possible and whether you’re allowed to restrict transactions from a risk management point of view.”

An iron rod

That aligns with the other “but” – companies still involved in Russia don’t have only New Zealand law and the MFAT regulator to worry about. The bigger concern for many is the US Office of Foreign Assets Control [OFAC], which administers and enforces economic and trade sanctions with an iron rod. “Probably 60% of New Zealand’s trade and general foreign exchange transactions are in US dollars. If you can’t do those, you’re out of it,” Salmond says.

“OFAC is a very, very well-resourced, well-run organisation. It has a lot of people dedicated to compliance with its sanctions and it does take enforcement action, [including] against foreign corporates. New Zealand banks and New Zealand’s big corporates are all terrified of breaching US sanctions [and] getting a big fine from OFAC.

“Even if you don’t get a big fine but you’re found to have breached sanctions by OFAC, that’s terrible public relations. US businesses will not want to deal with you. And if you’re a bank that has been found to be repeatedly breaching US sanctions, you can actually find one of the repercussions is that you get effectively locked out of the US banking system. If you’re a New Zealand bank that can’t transact in US dollars, or with US persons, game over.”

It’s complicated

Adding to the pain, US legal fees are very high. “You have to get all these different lawyers involved.”

Corporates with continuing connections to Russia have found ways to operate for now, but could face further issues. “[From] the private practice perspective, most corporates with some kind of involvement with Russia have gotten their heads around the basics of the regime and what is and isn’t possible,” Salmond says.

But we’re seeing the more gnarly stuff. It’s fascinating, but all very difficult. The really tricky transactions or relationships that are very difficult to exit from.” She adds that more disputes are moving into the litigation phase. “There are a lot of cases involving the banks, [and] a lot of cases involving insurers because people who’ve had their assets frozen or seized by the Russian state are now turning to insurers [which] are trying to avoid cover. This is likely only to continue.”

Much of the litigation is happening overseas, albeit not in Russia itself because Western corporates don’t want to bring a case there. “Even if a contract is between a Western party and a Russian party governed by the law of Russia, ordinarily you’d expect a dispute to be resolved in the Russian courts. Western parties are making arguments that actually another seat is appropriate, whether that’s London or Hong Kong, because you can’t get a fair trial or an expeditious trial in Russia at the moment.”

New Zealand entities with insurance claims will be battling with London-based reinsurers, she says. Sanctioned Russian oligarchs are also proving litigious. “You’re seeing cases all around the world where Russian persons who’ve been sanctioned, whether they are corporates or individuals, are suing the governments that sanction them, saying that their designation was unlawful.”

Russian billionaire Alexander Abramov, who has ties to New Zealand, went to court in Australia arguing he was not an oligarch. Another case, which came out of the High Court in London in August, involved an associate of Abramov who challenged his designation but was unsuccessful.

Salmond herself has written about a New Zealand case involving people connected to Abramov. ■