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United Company (UC) Rusal global review

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On March 2007, United Company (UC) Rusal was incorporated out of a merger between Rusal, its domestic competitor SUAL and trading group Glencore. It rose to the world’s largest aluminum production company, with assets in 17 countries across five continents before being overtaken by Aluminum Corporation of China Limited as the world’s largest aluminum producer in 2017. UC Rusal is a public limited company with its financial centre incorporated in Jersey and its headquarters situated in Moscow, Russian Federation. Its shares are traded on the Moscow Stock Exchange, Hong Kong Stock Exchange and European Stock Exchange.

On January 2010, UC Rusal was listed on the Hong Kong Stock Exchange with its Initial Public Offering price of HK$10.8 per share and capital raising of US$2.2 billion. The IPO attracted a list of big-name investors including Nathaniel Rothschild and Robert Kuok. As of the year 2017, Rusal’s financial performance has been prosperous, with net profits and total assets improving from 2016 values.

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Rusal’s aluminum production facilities are situated in a diverse portfolio of nations around the globe. By the end of 2017, it owned a total of 11 plants in Sweden, Ireland, Jamaica, Italy and Guinea, Guyana, and Armenia aside from 25 domestic production facilities. Presently, Rusal seeks to hedge itself from potential risks during periods of unpredictability and vulnerability. Rusal’s overarching goal is to maintain a long-term, sustainable position in the challenging and competitive market.

Other than domestically, Rusal aims to accelerate its’ international position as an aluminum supplier and producer in key markets of Europe, Asia, and the United States (US). According to BizVibe, Rusal is the world’s second-largest aluminum producer in 2018, exporting and shipping approximately 5.8% of the world’s aluminum. (Nick, 2018)

Major International customers of Rusal include Toyota (Japan) and Mechem SA. Major suppliers of Rusal’s production include Rio Tinto Inc., FSC and Joint Stock Company ’Russian Railways’ for railway and transport services within the nation.

Country Risk

On 6th April 2018, the majority owner of UC Rusal, Oleg Deripeksa was struck by sanctions imposed by the US. This prevented all US-based suppliers and clients from dealing with Rusal. The sanctions were part of the Trump administration’s way of punishing Deripaksa for his ‘malicious deeds’. Such deeds included interfering with the US 2016 election and supporting certain regimen undertaken by the Assad in Syria.

As such, the unforeseeable imposition of sanctions by the US poses a country risk to Rusal. Following the sanctions list, many existing US-based companies were forced to revoke existing contracts with Rusal. Maersk and Mediterranean Shipping Company (MSC) have decided to halt the transport of all Rusal’s products. As such, Rusal is struggling to transport their aluminium to their buyers and maintain trade.

End users, such as manufacturers have started looking for alternative aluminum producers. The sanctions not only barred trade with US-based companies, but spurred companies in Asia to sever ties with Rusal. Major clients in Asia have halted their contracts with Rusal in fear of being trapped by sudden secondary sanctions imposed by the US. Rusal’s long-term client, Toyota, have already ceased relations with Rusal and have begun looking for alternative aluminum suppliers.

With revoked contracts and a shrinking consumer base, Rusal’s outbound shipments have declined and international trade have been stunted. If Rusal remains unable to replace its primary consumer base, it’s global supply chain would effectively be broken. With a shrinking consumer base, aluminium supply exceeds its demand and Rusal is struggling to keep its aluminium sold. In Rusal’s Siberia plant, stockpiling is occurring to store surplus stock, incurring additional costs.

Currency-Related Risks

The US sanctions also resulted in damaging repercussions on Russia’s foreign exchange market. The value of the ruble dropped to its’ all time lowest in 3 years on Wednesday (April 11, 2018) at the mid-market rate of 0.01589 RUB/ USD. This followed the Friday (April 6, 2018) in which the sanctions list was released. The uncertainty in the strength of the ruble and the risk of the ruble losing out against other currencies poses a foreign-exchange risk for Rusal. (Extracted from Reuters (Onstad, 2018))

The weakening ruble can lead to an inflation of overseas operational costs. Currently, Rusal is dependant on its international operations to supply about two-thirds of its output. As such, Rusal’s profitability is likely to be drastically eroded by the weakening Ruble. Moreover, the weakening Ruble would mean that valuation of their foreign assets would be reduced when translated to domestic currency for consolidation or reporting purposes. Lastly, Rusal’s debtors may have committed a time period before they credit payments. The ruble may have dropped significantly during this time period. By the time Rusal’s debtors have fulfilled their payment obligations, the value of the committed receipt may have already deteriorated due to the weakened Ruble, reducing Rusal’s cash inflow.

Secondly, the sanctions meant that Rusal was entirely barred from transacting in US dollars, posing an Exchange Control Risk. US dollars are the de facto and most universally accepted currency of global trade markets. Hence, Rusal’s inability to transact in US dollars meant that they could not transact with many of their foreign clients who only dealt with US dollars. Moreover, Rusal was not able to finance its’ US dollar-denominated debts to its suppliers as they could no longer credit payments in US dollars. Consequently, this led existing buyers to cease their contracts and prospective buyers to be unwilling to deal with Rusal, further shrinking Rusal’s consumer base.

Cash Flow Risk

Financial reports indicated that there was already a 46% dip in net cash flows generated from operating activities from the quarter ended 31 March 2017 to the Quarter ended 31 March 2018. This occurred just before the sanctions list was announced. With the introduction of the US sanctions, Rusal’s international trade activities have since shrunk dramatically. Sales and shipments have declined, and the company is forking out from their reserves to re-assemble their supply chain. With its operations performing less lucratively than before, it is highly likely that Rusal would experience a deeper plunge in cash flow.

In fact, Rusal is already hit by financial difficulties in terms of paying out its’ salaries payable. It’s local Bauxite company, Windalco has been experiencing cash constraints and fulfilling only partial payment of workers’ salaries in Jamaica. This is a result of the US sanctions causing the company to be banned from accessing financial pools in the banking system, leaving Rusal strapped for cash. Moreover, with a cash-crunch, Rusal would not be able to continue financing their debts and liabilities, causing suppliers to lose confidence in Rusal in meeting credit terms. Ultimately, suppliers may refuse trade with Rusal, stunting international trade.

Mitigating Country Risk

To be fully aware of changes in international trade regulations, Rusal should monitor government regulations and read up on import or export licenses of the country which they are trading with. This ensures that Rusal is not ignorant of unanticipated changes and can react quickly to sudden imposition of sanctions.

As the sanctions were not initially targeted at Rusal, but at the majority owner, Deripaksa, the US Government have stated their willingness to lift the sanctions if the former divests his controlling stake or steps down from his position. (Moehr, n.d.) Hence, Rusal can restructure their management and establish an agreement with the US. In this case, Deripaksa might have to relinquish his control over the company. As such, the interests of the majority owner would have to be sacrificed for the survival of the aluminum company.

The benefit of this strategy is that it targets the root of the problem, the sanctions. Since the U.S Government has offered a solution for Rusal by stating their conditions for lifting the sanctions, the matter can instantly be resolved once Rusal adheres. Moreover, with resolved conflicts, Rusal may be able to eliminate the hostile tensions between the two parties and trade more effectively with the US in future, boosting business prospects.

However, a restructuring of management can be costly for Rusal as hefty legal and administrative fees would be incurred. Moreover, investors may oppose the restructuring as they may speculate a lost in money when there is a radical change in the top-level management. Lastly, it cannot be guaranteed that the US Government would keep to their word and lift the sanctions if Rusal’s majority owner divests his stakes.

Mitigating Currency-Related Risks

To mitigate Exchange Control Risk, Force majeure clauses can be introduced on Rusal’s future contracts with their suppliers. The clause grants the right for a party to suspend or terminate the performance of its obligations when certain unforeseeable circumstances emerge (Force Majeure, n.d.). In this case, this allow Rusal to be cleared of their financial obligations when they are not able to finance their US dollar-denominated debts due to unanticipated government actions (Editors, n.d.). One advantage of Force Majeure clauses is that it allows complete termination of the holder’s obligations regardless of the scale of their obligation.

However, companies would not be willing to incorporate the Force Majeure if they perceive an Exchange Control Risk to affect them less likely than it would for Rusal, hence not needing to rely on a Force Majeure as heavily. As such, they may try to restrict the coverage of the Force Majeure in the contract.

Using Global and Local Currencies

To bypass Exchange Control Risk, the company can also negotiate with their current suppliers and buyers to transact in an alternative currency that is convenient and familiar to both parties involved. Besides US Dollars, the EURO is a global currency. This means it is a widely-accepted currency in global trade activities. Rusal can consider negotiating with their buyers and suppliers to transact in EURO instead of US dollars.

The advantage of negotiation of contract terms is that it results in a win-win solution by allowing both parties to transact in their secondary currency agreed. Through this, Rusal can still continue trade, however, in another currency aside from USD. Moreover, Rusal can consider maintaining a EURO bank account to make payments and receive receipts. This eliminates Currency Risk as Rusal does not have to convert foreign currency to local currency and can simply use EURO as their main transaction currency. Rusal can also negotiate with their customers to fulfill invoices in ruble. As such, this also makes it unnecessary for Rusal to convert foreign currency to local currency, mitigating Currency Risk.

Mitigating Cash Flow Risk

Rusal can adopt Supply-Chain Financing, a working capital management strategy to enhance liquidity. This program encompasses a two-prong approach whereby Rusal can negotiate for extended payment terms while suppliers can still obtain immediate payment by selling their receivables off to funders at a minimal fee. As a buyer, Rusal can also extend payment terms with their own suppliers, slowing cash outflow. The program is that it results in a win-win scenario by increasing the cash flow of both Rusal and its buyers. Disagreements between both parties are unlikely to arise as the program is a desirable option. Ultimately, this strengthens the relationship between Rusal and their suppliers (PJ Bain, 2016). However, the approval process for Supply-chain Financing is known to be a complex one. There may onerous laws set by regulatory systems in Russia or their importer’s countries which may prevent Rusal from successfully applying for supply-chain financing (Schap, 2015).

In Rusal’s context, Sberbank offers appropriate supply-chain financing for finance of Russian export and international trade. Rusal can outsource such services to obtain immediate payment from their buyers or extend supplier payments, enjoy better financing terms at a beneficial rate. This quickens cash inflow and slows cash outflow, optimizing Rusal’s cash flow levels. (Sberbank of Russia – Supply Chain Finance (SCF, n.d.)

On April 2018, Rusal encountered various trade challenges with sudden sanctions imposed by the US Government. Such risks include Country Risk, Cash Flow Risk and Currency-related Risks comprising of Foreign-exchange and Exchange-Control Risk. This led to repercussions such as stunted international trade, increased operational costs, inability to finance salaries payables and debts and a shrinking consumer base. To mitigate or reduce these risks, the team has recommended adopting working capital management strategies such as supply-chain financing, incorporating Force Majeure clauses, using global and local currencies, monitoring international trade regulations and appeasing the US Government.

Country Risk Can Trigger Other Risks

Based on Rusal’s example, the government sanctions not only posed Country Risk for Rusal but triggered other risks such as Cash Flow Risk and Currency-Related Risks. The government sanctions not only barred trade with the US, but also caused Rusal to lose their rights to transact in the widely-accepted US Dollar. Moreover, the sanctions also weakened the foreign-exchange market and reduced Rusal’s cash flows due to stunted international trade and reduced shipments. Hence, we believe that mitigating Country Risk should be of any trading company’s primary focus, as Country Risk may likely lead to a domino effect of other risks if it is not appropriately countered.

Strong Business Relationships is Essential for Trade

The team believes that establishing a positive rapport with the associating nation is one fundamental step to evading trading risks. Based on Rusal’s situation, countries would usually impose sanctions on others when relationships are already sour or when conflicts brew between the two nations. In this case, country risk could be avoided if Rusal’s majority owner, Deripaksa, had exercised better foresight and avoided engaging in activities which may aggravate the US. Hence, it is important to maintain good relationships business partners and governments in the countries involved.

There is No Perfect Solution for a Trading Risk

The team has realized that preventative measures cannot be completely effective as they all have their disadvantages as well as their advantages. In Rusal’s context, appeasing the US Government and undergoing management restructuring is not a faultless measure to mitigate Country Risk as it requires strong financial backing to cover the hefty legal and administrative fees. Moreover, the application for supply-chain financing may be an onerous and complex one. Lastly, companies may restrict the definition of Force Majeure in contracts to protect their own interests. Hence, there is no absolute, perfect solution for a trading risk. The effectiveness of a mitigation strategy would vary depending on the countries involved as well as the needs and wants of the companies involved.

In this case, the team believes that trading companies should not be totally dependent on one mitigation strategy in resolving their trading issues. Instead, they should consider the consequences of all possible options and select the most practical one to mitigate the risk. Moreover, they should also ready back-up plans in the case that a certain preventive measure fails.

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