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MOSCOW (Mineweb.com) – From one banker’s point of view, lending Russian aluminium oligarch Oleg Deripaska $22.5 million is peanuts – too little to warrant much concern about the creditworthiness or asset risk of Deripaska’s principal production company, Russian Aluminium (Rusal), the world’s no.3 producer and largest exporter of primary aluminium. To be sure, if Rusal turns out to be a walnut shell, and Deripaska’s asset value is elsewhere, then wagering peanuts in a shell-game could be more than embarrassing for the bankers. It could expose them to liability lawsuits far costlier than $22.5 million.

This is the concern that was quietly acknowledged inside the European Bank for Reconstruction and Development (EBRD) and the International Finance Corporation (IFC, the World Bank’s commercial lending window) in the middle of 2004. For several months that year, EBRD and IFC had been negotiating a $150 million loan to Komi Aluminium. In August, the deal appeared to have been done, and was formally announced.

What had been a long, uphill battle by SUAL, Russia’s second aluminium producer, owned by Victor Vekselberg, to get financing for his low-grade but sizeable new bauxite mine., appeared to have succeeded. According to the joint EBRD and IFC announcement, the two banks “have each signed a $75 million loan agreement that will in total provide Russia’s privately-owned SUAL group a total of $150 million to boost Russian production of bauxite, the raw material for the aluminium industry.” The deal was described as a nine-year loan of $45 million from each bank, with “the remaining $30 million portion of each organisation’s $75 million facility, syndicated to international banks under an A/B loan structure. The term of the syndicated portion will be seven years.” The EBRD announced that the syndicate banks included BNP Paribas, the leader, and Barclays, ING, Societe Generate, and Standard Bank.The plan, according to the announcement, is “to increase annual bauxite output at SUAL’s Middle-Timan mine, situated 250 km south of the Arctic Circle, to 6 million tonnes from the current 1 million tonnes over the next four years. This will help overcome a major shortage in domestic supplies of bauxite and improve the competitiveness of the Russian aluminium industry as a whole.” The loan money was to be spent as follows: “$100 million for the expansion of the Middle-Timan bauxite mine and $50 million to fund feasibility studies and preparatory works for an alumina refinery at Sosnogorsk, 245 km southeast of the Middle-Timan mine, and feasibility studies for an aluminium smelter at Pechora, 250 km northeast of Sosnogorsk.”

EBRD and IFC knew that SUAL had been seeking foreign aluminium giants, like Pechiney and Alcan, for a joint venture in the project, but they had refused. As a global aluminium producer, Russia is traditionally long on cheap electricity, but short on alumina. Aluminium is the electrolyzed product of their combination; but to produce the metal, let alone expand production, Rusal is heavily dependent on alumina imported from the Ukraine, Australia, and Guinea, where its control over the supplying refineries, and the bauxite feedstock, is weak, or subject to reversal. Rusal has a local alumina refinery at Achinsk; but it cannot produce enough feedstock for the smelters. SUAL produces more bauxite and alumina than its smelters require.

Logically, their combination made sense. But the opening of negotiations between SUAL and its arch domestic rival, Rusal, came as quite a surprise, Vekselberg and Deripaska had been fighting each other over smelter assets in the Russian northwest – Vekselberg won – and neither seemed inclined to trust the other in a partnership. Each suspected the other – then as now – of plotting to monopolize the assets. Rusal executives publicly aired their pessimism about the possibility of a joint venture.

Nonetheless, on April 24, 2005, Rusal announced it had agreed on the joint venture. Burying the hatchet, Rusal’s CEO Alexander Bulygin is quoted in the announcement as claiming: “The partnership of our two companies in implementing such a large-scale project demonstrates that the Russian aluminium industry is maturing. At the same time, this agreement helps each of our companies address important challenges in their respective strategies”.

They had agreed to jointly, and equally, develop the Komi Aluminium project, starting with an alumina refinery near the city of Sosnogorsk to consume the added output of SUAL’s bauxite. The cost of this stage was estimated at $1.2 billion, and “under the Agreement between RUSAL and SUAL Group,” Rusal said, “the financing will be made on a parity basis by means of debt and shareholders’ capital. The Refinery is scheduled to launch in 2008.” The Komi project, according to both companies, is to “double the share of domestic raw materials consumed by Russian [aluminium] producers from 40% to 70-80%.”

To the EBRD and IFC, this was a significant change in the project they had agreed to lend to. Accordingly, they immediately stopped their plan to disburse the funds committed to the mine expansion and the refinery study. The commercial banks also halted their loan disbursement. SUAL and Rusal were asked to clarify the proposed partnership. While the public and commercial banks had already done the due diligence on SUAL, the prospect of their money finding its way into Rusal management, albeit in a joint venture, led to the disbursement freeze, and to the start of a new process of studying Rusal.

The commercial banks had done this before. To deal with what the bankers at BNP Paribas acknowledged to be the perceived risks of Deripaska as an oligarch, and of the Rusal structure, unusual and unpublicized loan and metal securitization had been introduced. The EBRD and IFC had to start their due diligence from scratch.

This week, on January 17, they announced the process had been completed, and that subject to a set of legal covenants and an 18-month timetable of management promises, which Deripaska had submitted, and Rusal had signed, the EBRD and IFC were lifting the freeze on the old loan, and would start disbursing the cash. According to EBRD, the commercial banks in the syndicate must individually complete their own approval process, before contributing their funds.

The EBRD’s total exposure to the project is $45 million, with the same for IFC. Each of the commercial banks is exposed for $12 million each. Theoretically, the EBRD’s and IFC’s exposure to Rusal in the joint venture is just $22.5 million, while each of the bank syndicate members is exposed to Rusal for just $6 million. These are the peanuts. Together, they add up to just one dollar in eight of the capital expenditure required for the project.

According to a statement issued by Rusal, the unfreezing of the 2004 loan is “a strong endorsement of Rusal’s plans. The [EBRD and IFC] decision to disburse the loans is based on the disclosure of ownership by Rusal and provides for commitments to greater transparency, good corporate governance and high business standards on the part of the company. Compliance with these commitments is stipulated in legal documentation with the IFC and EBRD.”

The dossier EBRD’s lawyers gathered from Rusal remains secret, and EBRD officials refuse to discuss the details. They are sensitive to the fact that Russian prosecutors and auditors of the Accounting Chamber, the Russian state auditor, have long been interested to secure evidence that the offshore companies through which Rusal metal is traded, and through which tax exemption is claimed according to tolling contracts, may belong to Deripaska. If they don’t, then Deripaska doesn’t benefit from more than half of Rusal’s trading activities. If they do, he has violated Russia’s tax laws.

According to a publication by Neil Buckley of the Financial Times, it is the “first [EBRD loan] to Mr. Deripaska.lt suggests an increasing willingness by the EBRD to lend to oligarchs embracing higher governance standards.” To illustrate his own due diligence on this point, Buckley noted that Deripaska had been “named in a $3 bn US lawsuit filed by rivals alleging fraud and racketeering. The case was thrown out by the US courts, and Mr. Deripaska denied all charges.” Buckley and his newspaper omitted to report that the US courts rejected their jurisdiction over the claim, but never tried the charges. He also omitted to mention that Deripaska and Bulygin secretly settled, and paid the claim last year.

New court litigation alleging a similar pattern of business tactics by Rusal has started in the High Court of the UK, in Nigeria, and in the US afresh. The Financial Times has ignored them all.

Remarks and rulings in recent weeks by an English judge in a case where Deripaska, Bulygin and their offshore companies face charges of illegally and fraudulently taking control of the Tajikistan Aluminium Plant (TadAZ) have publicly targeted Rusal in the court record. In the Nigerian case, currently pending in the federal Nigerian appeals court, Rusal is accused of violating Nigerian privatization rules, and corrupting senior Nigerian government officials, using a British Virgin Islands company as a conduit, in order to take control of the Aluminium Smelter Company of Nigeria.

According to its press release on January 17, the EBRD and IFC “confirmed that they plan to disburse loans totalling $150 million for the Komi Aluminium project after determining that the recent entry of Russian Aluminium (RUSAL) as an equal partner is acceptable. The decision is an important step towards final agreement to disburse. It is based on full disclosure of ownership by RUSAL’s and Basic Element’s owner Oleg Deripaska, and additionally provides for detailed commitments to greater transparency, good corporate governance and high business standards, covering RUSAL and Basic Element. Compliance with these commitments is covenanted in legal documentation with the EBRD and IFC. In particular, the EBRD and IFC welcome the adoption by RUSAL of an action plan over an 18-month timetable covering significant corporate ownership disclosure, the publication of financial information and specific steps aimed at improving corporate governance – notably the election of three independent

Did the EBRD come to these conclusions by glossing over the court record, because the loan was peanuts, or because the courts are peanuts?

Mineweb asked, and EBRD answered: “The EBRD conducted extensive checks on the information provided by Mr. Oleg Deripaska on the companies he owned. As stated in its press release, the Bank decided the information provided was sufficient for the Bank to proceed with the project — with Rusal as a new partner in the borrowing entity. The loan agreement includes a large number of detailed legal covenants covering all aspects of the project, including the information disclosed to the Bank by Mr. Deripaska on the ownership and structure of the group as well as the commitments made by Mr. Derispaka on future action.”

Lawyers are trained to write this sort of thing, and expensively compensated to produce it. Mineweb readers can analyze what is meant, free of charge.

There is no secret about the ownership of Rusal. Deripaska controls about 96% of the company, which in turn has yet to complete the consolidation and financial reporting of the principal smelter, refinery and related assets in the aluminium production chain on the territory of Russia. Less than 5% of the shares is held by or for CEO Bulygin, and Gulzhan Moldazhanova; she used to run the commercial operations of Rusal, before moving to Basic Element, the Deripaska holding company supervising all the Russian assets.

Court records in cases filed against Rusal; court and arbitration rulings in Switzerland; and a new UK High Court case involving another Russian oligarch in breach-of-trust proceedings, indicate how the EBRD may have achieved something less than it seems to claim, and to have produced something less than the “endorsement” Rusal claims.

There are four ways in which Deripaska’s Rusal could be the empty part of an elaborate shell-game: if Deripaska’s claim to controlling ownership turns out to be based on hidden trust and other arrangements with others, who claim ownership rights, but have not been bought out or compensated; if Rusal’s assets turn out to be no more than the smelters, and related raw material supply and affiliated production plants, on Russian territory, but do not incorporate the offshore-registered companies through which assets outside Russia are held; if most of Rusal’s tradeable aluminium does not belong to it, or to the smelters, but is governed by tolling arrangements which vest title, tax exemption, pricing, and profit in tollor companies, also registered by the dozens across the globe; and, finally, if the Kremlin has decided that rather than litigate against Deripaska for tax recovery, it may buy him out through a takeover bid from Unified Energy Systems (UES), the state utility company.

On the ownership issue, the EBRD concedes that the principal claimant to dispute Deripaska’s submissions is Mikhail Chernoy, who currently lives in Israel. He has publicly averred, many times, that he provided Deripaska with an unspecified form of trust arrangement to administer the metal production assets in Russia, and that he still owns a sizeable stake, for which, he claims, Deripaska has yet to pay. As often as Chernoy has made these claims, Deripaska has denied them.

Deripaska has certainly told the EBRD the same thing, assuring the bank that long ago he severed his past relations with Chernoy. Chernoy’s influence over Deripaska from his early days at the Sayansk smelter has been so powerful, the EBRD’s due diligence ought to have questioned Chernoy directly. If the “extensive checks”, to which the EBRD refers, omitted him, then the Mineweb reader might judge that the information gathered may be insufficient. If the EBRD’s lawyers decided not to interview Chernoy, but put Deripaska’s severance of relations, and claim to have bought him out, into the form of a legal covenant, then what Chernoy says in future should bear on compliance with that covenant, and hence on the loan disbursement and project agreement.

Giving Deripaska the benefit of the doubt on this point, with the protection of a covenant against future discoveries, is reasonable. Time should tell, one way or the other, and the risk may be peanuts.

The EBRD told Mineweb that it has sufficiently investigated the “structure” of the Rusal group. Investigation appears to be past tense. Legal covenants relate to future actions and promises by Deripaska and Rusal. The lawyers have not obliged Deripaska and Bulygin, or their assigns, to accept the covenants, if they intend to look the other way when they are broken. But the EBRD is not prepared to disclose what the covenants say, and hence what the EBRD is afraid of in terms of borrower risk.

According to its own statements and press releases, legally, the Rusal group is a Russian territorial holding. According to Bulygin, “we operate on five continents, deliver products to major corporations in 40 countries across the globe and cooperate with leading financial institutions.” According to former Rusal spokesman, Yevgenia Harrison, in a statement she was authorized to issue to Mineweb, “the Russian government is well aware that Rusal is the only Russian metals company whose revenues do not primarily come from the mining of Russian ore. To a very large extent, we are processors of imported raw materials. Thus a relatively large portion of Rusal’s value added is created outside of the Russian Federaton.”

At the time she said this in late 2004, Harrison was responding to a federal Tax Ministry report, commissioned by the Prime Ministry, and delivered on September 6, 2004. In the report, tax payment rates of several major Russian metals companies were disclosed and analyzed. Rusal was reported to have paid tax amounting to just 2% of revenues. This was well below comparable rates reported by the Tax Ministry for the other metal exporting companies examined, and even further behind the rates disclosed by Russian oil exporters.

According to the Tax Ministry report, Rusal was able to lower its tax rate by the use of tolling contracts with offshore companies it claimed not to own or control; and by a regional tax relief scheme for corporate affiliates registered in the fareastern region of Chukotka, where Rusal had no other business and negligible investment. Regarding the Tax Ministry report, Harrison said that Rusal was not under official investigation. “To dramatise what is a routine governmental report into an article that insinuates that Rusal has acted somehow improperly is misleading and damaging to the company’s corporate reputation; a reputation that we are working hard to develop as the company, and indeed Russia, moves forward.”

If Rusal’s value is mostly that of a foreign group, did the EBRD receive a comprehensive list of all the foreign-registered companies through which its trading and asset holding operations are conducted? Did the EBRD oblige Bulygin to sign a covenant that the consolidation of assets and financial reports promised in the next 18 months will bring these entities into the group?

The point is a fundamental one for the future of both Rusal and Deripaska. Governments, including at least one government that is a shareholder of the EBRD, have issued opinions on the point. For example, almost a year ago, when Rusal claimed to be bidding for the privatization of the Podgorica Aluminium Plant (KAP), the most important industrial asset of Montenegro, the Montenegrin government refused to accept the bid at first, when Rusal used a Cyprus-registered company called Salomon as the bidder. In Nigeria, when bidding to take Nigeria’s smelter was conducted, Rusal operated behind Dayson Holdings, a BVI registration with no known holdings and no business activities. In the takeover of TadAZ, leading to a privatization expected after the Tajikistan presidential election this year, the cutout for Rusal, identified in London court proceedings, is a BVI company called CDH Investments.

These are asset holders; CDH is also a participant in tolling. But the full list of trading companies engaged in supplying alumina to the Russian smelters and taking out aluminium, according to tolling contracts, runs into the dozens, if not hundreds. Many of them have been identified in litigation or arbitration proceedings related to Rusal’s trading contracts. Last year, for example, in a BVI case initiated by London traders Simon and David Reuben, and reported by Adrian Gatton in The Independent and Metal Bulletin, a $300 million claim accused Deripaska of breaking an alleged joint venture agreement made in 1995, and creating a tolling chain through companies including the Irish-registered Tradalco.

The claim also alleged that Deripaska siphoned off assets without the knowledge of the Reubens to shadow BVI companies, with identical names but different registrations and bank accounts, to pass them off as the jointly owned companies into which profits were to be directed.

That case was never decided by trial in court, but the Reubens were paid off.

If the process of tolling is legal, according to Russian law, then the companies identified in these proceedings, if they are still active, cannot be considered by the EBRD to be part of the Rusal group. And if Rusal has promised to consolidate its trading into Rusal’s accounts, then either it admits it has controlled the tollors – which would expose the group to huge back-tax claims and penalties – or else it is abandoning the tolling practice altogether. The EBRD holds no promise, or covenant, of either kind.

In 2004, Mineweb did the following calculation of the profitability of Rusal’s aluminium exports for the offshore tolling contractor. This was gauged from the margin of difference between the price Rusal declared at Russian Customs for aluminium, as it left the country, and the price at which the same metal was declared at US Customs, when imported to the United States. The average price in the first half of 2004 for Russian alumium imported to the US was $1,685 per metric ton. The average price of Russian aluminium exported from Russia in the same period was $1,262, a gap of $423 per ton.

According to the US trade data, the US imported 524,455 tons in the period to July 31 of this year, mostly from Rusal. The price gap was thus roughly equal to $222 million. Double that for the full year, and count the parallel, but larger volume trading of Rusal metal into countries other than the US, and the price gap in 2004 may have been larger than $1 billion. According to industry estimates, almost two-thirds of Rusal’s metal is traded through tolling schemes. Rusal has confirmed the legality of its tolling agreements; it has not challenged this calculation of the size of the value gap.

The Kremlin has carried through just one experiment in prosecuting large-scale corporate tax avoidance, and that was the Yukos oil company case. Since the dismantling of that company in 2004 and 2005, and its takeover by state oil company Rosneft, a different procedure has been used to achieve the same end, at least operationally and financially. That is, a leveraged buyout of oligarch assets by state companies, in which loan financing is provided by international banks, secured for their repayment by trade receipts or shares.

In this way, Roman Abramovich’s Sibneft oil company has been bought by Gazprom, Kakha Bendukidze’s OMZ (heavy engineering) by Gazprom; Vladimir Potanin’s Power Machines by the electrical utility, UES; and Norilsk Nickel, property of Portanin and Mikhail Prokhorov, is being considered for purchase by Alrosa, while Rosoboronexport, the state arms agency, is planning to take over VSMPO-Avisma, the titanium producer.

Why should Deripaska’s Rusal be exempt from this process? EBRD’s due diligence assumes that it is, and the 18-month programme it has drafted confirms that Deripaska will still own Rusal when the promise to appoint three independent directors comes due. There are, however, international aluminium makers, as well as senior Russian government officials, who suspect otherwise. And they detect in recent news of Norsk Hydro’s negotiations with UES, the opening of a Kremlin campaign to buy out Rusal, and transfer the aluminium assets to the electricity company, without whose supplies at beneficial tariffs, the metal couldn’t be produced and traded so profitably – UES. This is not the only contender. Vekselberg has also sought Kremlin support for a takeover plan of a different kind.

While EBRD is countiDeripaska may still be the controlling owner of the Rusal group in two years’ time; or he may not. EBRD has decided that whether he does, or he doesn’t, there isn’t much at risk for its $45 million outlay to the Komi project, or to the $22.5 million stake that is Rusal risk. But the one thing the EBRD hasn’t done is the very thing it inspired the reporter of the Financial Times to say it had – to endorse the multi-billion dollar flotation of Deripaska’s shares in Rusal on the London Stock Exchange to non-Russian share buyers. The EBRD’s bet on Deripaska may be peanuts; an IPO would be a much bigger nut to crack, and the EBRD wouldn’t dare.ng its covenants and promises of good corporate governance, the Kremlin will have a choice of a rather more strategic kind. And Deripaska will be under pressure to sell out locally, and concentrate what remains of his metal business abroad, disconnected by tolling.

Let’s give Deripaska the additional credit for knowing how to fight a takeover of this type, and to mobilize the resources required to defeat it, and win the Kremlin to his side. In his sale of two rolling mills to Alcoa of the US in 2004, he demonstrated considerable skill in overcoming high governmental objections to what he was doing. In Kremlin thinking, by comparison with Yukos’s and Sibneft’s oilfields, or Potanin’s nickel mines and engineering works, those aluminium plants were peanuts. Subject to some tight domestic supply commitments from Alcoa, letting them go was conceded. Selling a large stake of Rusal to foreign owners is a different story.

Deripaska may still be the controlling owner of the Rusal group in two years’ time; or he may not. EBRD has decided that whether he does, or he doesn’t, there isn’t much at risk for its $45 million outlay to the Komi project, or to the $22.5 million stake that is Rusal risk. But the one thing the EBRD hasn’t done is the very thing it inspired the reporter of the Financial Times to say it had – to endorse the multi-billion dollar flotation of Deripaska’s shares in Rusal on the London Stock Exchange to non-Russian share buyers. The EBRD’s bet on Deripaska may be peanuts; an IPO would be a much bigger nut to crack, and ; the EBRD wouldn’t dare.

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