Troika Dalog in Moscow -

At the June 24 government meeting, Russian Prime Minister Vladimir Putin and industry participants discussed the new version of the retail law, which is to be finalized and approved within 10 days. From the proposed amendments so far, we do not expect a significant impact on retailer's operating performance, although some modifications could be positive. Despite the contradictory nature of the implied regulation, which, in our view, will be challenging to enforce, the proposed change to the penalties for non-adherence from 15% of revenues to a maximum of RUB1m should significantly reduce the financial implications for public retailers.

Contrary to previous expectations, there will be no threshold characterizing market dominance. This, however, will be subject to an FAS decision in each region, which we view as negative, as it could delay store openings due to the lack of clarity regarding the law and its means of enforcement.

Importantly, the new regulation is aimed for retailers to shorten their accounts payable period to 30 days, which is less than half of the current average of 70 days for the four public retail chains. Considering the trade-off between pay period and prices, we believe that large-scale retail chains will be able to mitigate the impact on working capital though improved purchasing prices. Ultimately, size will matter. This may benefit smaller players, as supplier terms with national companies already leave little room to manoeuvre.

The mark-up limits were not discussed in the draft law, but Putin, who recently visited a Perekriostok store owned by X5 Retail Group, indicated concern about the mark-up on some product categories, namely pork. Therefore, we do not rule out potential amendments to the final version of the law. On the bright side, the maximum penalties for violation were reduced from 15% of a retailer's turnover to as much as RUB1m.

The law aims to establish mechanisms for market share regulation and profit allocation between different players (through mark-up limits), which inherently contradicts free market ideology.

In practice, these rules will be difficult to enforce. Once the regulatory principles are approved, they will then require a number of supporting rules to enhance efficacy and adherence to the law. These rules are likely to contradict already existing laws, and it will be nearly impossible to apply them to entities with complicated legal structures. For example, X5 Retail Group is incorporated in the Netherlands and operates in Russia through some ten subsidiaries. Russian law cannot be applied to a Dutch company, while standalone local subsidiaries do not violate the criteria of the law.

Background to the legislation

The current version of the retail law was established in 1992 and objectively needs to be updated, especially with regard to the tax regime and the segregation of responsibilities between federal and local authorities in sector regulation. The idea of updating the law first appeared in 2007, when the global spike in agricultural prices resulted in food price inflation of more than 20%, thus attracting the government's attention to the value chain in food products.

The first amendments to the law were proposed by the Federal Antimonopoly Service (FAS) in 2007, which introduced a "biased to producers" version containing a proposal that would establish a "dominance threshold" criterion of 5% in St Petersburg and Moscow and 15% in the regions. The proposal stated that retailers that exceeded the threshold would be subject to a number of restrictions on regional expansion and pricing policy. Also, according to this version, retailers were to first receive approval rather than simply inform the authorities of planned store openings.

In a move that was designed in part to underscore its disagreement with the suggested amendments, X5 Retail Group sent a claim to the Moscow Arbitration Court on July 23, 2008, contesting the legitimacy of the burdensome rules handed down by the FAS during the company's acquisition of Karusel. The claim stated that the company had followed the orders, but had realized that the FAS had no legal grounds for imposing the limitations, which contradicted relevant Russian legislation. The FAS order limits X5 Retail Group's business activities in St Petersburg by restricting the number of services that the retailer may offer, which constrains its choice with regard to counterparties and could potentially put the company at a disadvantage in the St Petersburg food retail market.

On July 25, 2008, shortly after the court claim was filed, the government re-initiated discussion of the proposed amendments and promptly rejected them. The new version of the law was not supposed to contain pricing restrictions, but would have additional criteria for determining the "dominance threshold." Importantly, the law was moved from the responsibility of the FAS to that of the Ministry of Commerce and Industry, which is more open to dialogue with retailers and presented a "more balanced" version for discussion.

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