The Kremlin’s attempts to control the internet threaten Russia’s most vibrant sector

The Kremlin’s attempts to control the internet threaten Russia’s most vibrant sector
The Kremlin’s attempts to control the internet starting with Irina Yarovaya's infamous law threaten Russia’s most vibrant sector.
By Ben Aris in Berlin August 13, 2019

With social unrest on the rise in Russia, the Kremlin is trying to increase its control over internet content. TV is losing its power as a source of information; young people in particular get the majority of their news online and do not watch the leading state controlled TV stations. The explosion of social media sites and encrypted messaging applications also means that large numbers of people can organise themselves amorphously outside the control of the government.

At the same time the government is worried that the leading companies that are foreign listed will see their shares bought by foreign investors and so make them less malleable to manipulation by the Kremlin.

And finally the Kremlin doesn't want to see sensitive data on the population that these companies generate – information that potentially can be used by the Federal Security Service (FSB) – held in remote offshore servers where it can’t get at it.

Less than half a year ago, Russia passed its so-called “sovereign internet” law, which expands government control over the web. This follows on the back of the Yarovaya law, which forces all companies working with Russian internet users – foreign as well as domestic – to hold their data on users on Russian territory and allows the authorities access to that data. Experts say the cost of storing this data in Russia will run to over $1bn and has lead to an explosion of investments into cloud data storage services in Russia.

“Russian President Vladimir Putin’s current term will go down in history as a time of increased repression, but it will also likely be remembered for its growing offensive against the Russian internet. Today, the Kremlin and security agencies want to control both the communications infrastructure and the companies working in it, their owners, and even the content they produce," Alexandra Prokopenko of the Carnegie Endowment for International Peace wrote in a paper recently.

All this is bad news for Russia’s virtual economy, currently the most vibrant and internationally competitive part of the economy. E-commerce is growing at ten times the pace of the traditional economy and Russian businesses are not only internationally competitive but holding their own in the innovation race.

E-commerce booming

E-commerce in Russia already accounts for 4.5% of total retail turnover and is on course to double that share by 2024. The value of e-commerce in Russia hit $18.2bn in 2018 and is forecast to top $42.8bn by the time Putin steps down in 2024.

To highlight the speed of the changes, only last week it was reported that Russia’s pre-eminent online store Wildberries overtook the long time market leader Sportsmaster to become the biggest seller of clothes and apparel in Russia – the first time an online outlet has become the biggest purveyor of any major consumer product group.

“[The Kremlin is] taking aim at a particularly fertile segment of the economy. Russian internet companies have achieved relative success competing with their Western counterparts in several segments of the market: email clients, search engines, taxi apps, food delivery apps, and anti-virus software,” says Prokopenko.

Russia’s leading internet business and Europe’s most valuable tech company, search engine Yandex, is in the firing line. Speculation has been swirling that the state is planning to take the company over, or at least insert itself more deeply in the management for national security reasons. Russia’s state-owned banking giant Sberbank already owns a “golden share” in Yandex that gives it the power to veto any decision – like selling itself to a foreign company – it doesn't like.

The government’s intrusive tactics run contrary to its own stated digitisation of the Russian economy policy. Part of the RUB25.7 trillion ($390bn) investments planned for the 12 national projects includes heavy spending on putting Russia’s economy into the cloud. As bne IntelliNews reported Russia’s leading software developer IBS has been helping Russia’s regions put their accounts into the cloud in a move that has vastly improved their financial management as part of Russia’s tax revolution.

“But the state’s desire for total control is destroying this competitive environment. Despite official plans to develop the digital economy, the authorities are now limiting its growth with their own actions. The first victim of this tech repression will most likely be internet company Yandex, which has found itself under growing pressure in the past year. Other IT companies will follow,” Prokopenko argues.

Kremlin taking control

In July, lawmaker Anton Gorelkin introduced a bill into the State Duma that would prohibit foreign legal entities from owning more than 20% of internet information resources deemed significant for Russian infrastructure. This law follows on from a similar law that banned foreigners from owning 20% of press outlets in 2015 that caused a major shake up in the industry.

The cabinet initially labelled the internet version of the same bill harmful, but the parliament’s upper chamber, the Federation Council, still supported it. 

“Around the same time, Senator Andrei Klishas essentially proposed monitoring what Russians write in their emails. A new draft law he initiated could require email clients to identify their users by phone number and restrict their access to email should they spread forbidden content. If passed, this law would only apply to domestic “information dissemination organisers”: Yandex, Mail.ru, Rambler and other email clients. Klishas presented his bill as an anti-terrorism measure, Prokopenko reports.

Gorelkin has admitted that his bill is specifically aimed at Yandex and Mail.ru. According to him, Yandex is exactly the type of company it seeks to regulate: it’s registered in the Netherlands, 85% of its charter capital is listed on the NASDAQ stock exchange, and 49.2% of its voting rights belong to founder Arkady Volozh, who is a citizen of Malta as well as Russia.

“In reality, however, the presidential administration — specifically deputy chief of staff Sergey Kiriyenko, who oversees domestic policy — is behind both laws, according to several sources in internet companies and the federal bureaucracy. And, in this campaign, the bureaucracy and security agencies have found common cause with businessmen tied to the Russian state,” Prokopenko says.

There has been a long running tension between the security services and the liberal economic elite in the government over what to do about the internet. The FSB sees the internet as a threat and insists on greater powers over companies for the sake of national security, whereas the liberal elite understand that government interference will undo their ability to digitise the economy, which is a key part of Russia’s modernisation strategy. Needless to say Russia’s tech entrepreneurs have vigorously resisted all efforts by the state to inject itself into their business.

Russia's top tech companies in the firing line

This conflict came to a very public head when Russia’s telecom watchdog Roskomnadzor attempted to block messaging app Telegram in April 2018, when its owner, Pavel Durov, refused to hand over the digital keys that would allow the FSB to read the encrypted messages.

The attempt quickly turned into a farce as the tech savvy Telegram nimbly jumped from server to server, running its service without interruption, while Roskomnadzor clumsily chased it around the internet, knocking out dozens of other sites in the process. At one point the watchdog even managed to take out its own website by mistake without touching Telegram’s site at all. Since then all that has happened is the number of Russians using Telegram has increased.

The potential takeover attempt on Yandex is a serious problem for both the economy and Russia’s investment image. Yandex floated its shares in 2011 with a valuation of $11.2bn and has been an investors' darling.

Not only is the company an exciting innovator it is also a profitable concern. Yandex reported yet again strong net US GAAP income growth of 16% year-on-year in 2Q19 last month, with revenues up by 40% y/y, and adjusted Ebitda jumping by 50% y/y. While most Russian shares are still trading below their 2014 prices, following a heavy sell-off in the wake of Russia’s annexartion of the Crimea, Yandex is one of a handful of names that has not only surpassed its 2014 valuation but is trading at record highs.

According to media reports, one of the reasons for Goreklin’s bill is a conflict between Yandex founder Volozh and German Gref, president of state-owned Sberbank, which has its own ambitions to become a leader in tech. Gref has launched a number of big online projects that will transform the bank into a lifestyle company and has even proposed dropping the “bank” part from the bank’s “Sberbank” name.

“In autumn 2018, the state bank aggressively attempted to obtain a 30% share in Yandex — supposedly to defend the company from potential problems with competitors and the state. That news story alone cost the company $1.8bn of its market capitalisation,” Prokopenko reports.

The Kremlin has made it clear that it wants a bigger share in the company, but is constrained by the fact that the company is already listed and any attempt to force the issue would cost Yandex – and Russian stocks in general – billions in lost valuation if the government attempted to nationalise such a prominent and successful company.

So far Volozh has successfully fended off the state’s approaches via Gref, but the new sovereignty bill on the table now represents a blunter instrument for forcing the issue. In a compromise in the talks with Gref, the government has proposed transferring 60% of voting rights into a fund controlled by Volozh and 10 to 12 top managers with Russian citizenship.

Relations between the two have continued to decay. Sberbank entered into a big joint project with Yandex to create an entire e-commerce online ecosystem based on Sberbank’s financial services and Yandex’s Yandex.Market e-commerce platform. The Beru.ru (Ill take it) part of this venture has already been launched.

However, as bne IntelliNews reported the tie up looks like ending in divorce after only one year in due to disagreements between the two, according to reports in July. Within a week Sberbank announced it will create a 50/50 joint venture with internet major Mail.ru Group, Yandex's rival, in the field of transportation and food delivery on the basis of Citimobil and Mail.ru’s Delivery Club, the companies announced on July 25. The JV is valued at RUB100bn ($7.9bn)

Sberbank’s switch of partner and public row with Yandex makes it look less like the government is interested in national security and more like powerful state-owned enterprises simply want to expand their market presence by taking over the most attractive private players in the market.

Sberbank announced its new deal with Mail.ru just days before Gorelkin initiated his draft law.

The whole saga is a classic example of state capitalists pursuing business goals by utilising the government’s own agenda for their own aims. The Kremlin has made it clear that it supports Gorelkin’s law and influential security officials supported by the administration back Klishas’ initiative, claims Prokopenko. “And controlling online content is one of deputy chief of staff Kirienko’s top priorities, especially as Russian society grows more politicised and protests erupt across the country,” Prokopenko says.

“The Russian authorities can control the media through loyal owners, injections of budgetary money, and restrictions on foreign ownership. But to battle user-generated content, bloggers, and information spread by small independent media, the government needs the internet sovereignty law. However, the authorities are not entirely sure how to implement it from a technical standpoint,” Prokopenko says.

Yandex is certainly in danger. This summer, the FSB demanded Yandex provide it with encryption keys for its email and cloud storage services, but like Durov so far Volozh has refused to comply. In order to avoid yet another embarrassing showdown the government stepped in and has promised to intermediate with the FSB.

Prokopenko says all these games the government and its agents are playing are deeply damaging. Russia has made extraordinary progress in the virtual economy and counts world class technicians and companies in its vanguard; the Kremlin’s increasingly heavy hand jeopardises what should be other wise a bright future.

“In these conditions, competitive development and innovation simply cannot occur. And the cost of the bureaucrats and security agents’ joint efforts can be easily measured: major losses due to technological and innovation lag in the medium term as the country tries to digitalise the economy,” says Prokopenko.

 

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