Evaluation of corporate governance - API...

АНАЛИТИЧЕСКИЙ ОТВЕТ ПО ПАО ВТБ / 1

Evaluation of corporate governance

at state-owned Russian public joint-stock companies traded on the organized securities market

2017

Association of Institutional Investors (API)

RESEARCH LABORATORY FOR BUSINESS COMMUNICATIONS,

NATIONAL RESEARCH UNIVERSITY

HIGHER SCHOOL OF ECONOMICS

EVALUATION OF CORPORATE GOVERNANCE / 2


RESEARCH LABORATORY FOR BUSINESS

COMMUNICATIONS, NATIONAL RESEARCH

UNIVERSITY HIGHER SCHOOL OF

ECONOMICS

Contents

Preamble 3

Research goals and objectives 5

Main principles and criteria for the selection of companies 6

Selection criteria for PJSCs 6

Sources of information 7

Benchmarking (comparative review of peers) 9

Main corporate governance aspects 10

1. Ownership structure and review of shareholders’ activity 10

2. Information support of general shareholders meetings 14

3. Boards of Directors (Supervisory Boards) 15

4. Effective dividend policy and the role of the Board of Directors 17

5. External and internal audit, internal control, risk management 20

6. Information disclosure 23

7. Remuneration of members of the Board of Directors and the management team 25

8. Assessment of investors’ corporate governance quality impressions 28

Recommendations resulting from the research 30

Conclusion 31

Glossary 32

EVALUATION OF CORPORATE GOVERNANCE / 3





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Preamble Prime Minister Dmitry Medvedev: “Given the structure of our economy, predominantly state-owned enter-prises where the Government holds a controlling interest play an outstanding, sometimes systemically im-portant role in quite a number of sectors. The activity of our single regulatory authority for financial activities and the financial market has resulted, among other things, in the development of a Corporate Governance Code. This document comprises basic principles and recommendations for improving governance at companies relying on best international practices – in particular, it provides certain measures for protecting shareholders’ rights, measures related to information disclosure standards and the audit procedure. The main provisions of this Code should be consistently put into practice at state-owned companies.”

“The Corporate Governance Code is a code of basic rules and principles aimed at improving various aspects of corporate relationships: ensuring equality of shareholders, protecting investors’ interests, organizing the Board of Directors activity, disclosure rules and virtually everything related to the comprehensive activities of corpo-rate governance bodies.”

The Government constantly focuses on management effi-ciency at state-owned public companies as one of the top priority matters. Corporate governance is the key instrument for ensuring sustainability and long-term successful development of companies. Given shrinking opportunities in the rent-based economy, the management standards at companies and the quality of corporate governance come to the fore. Efficiency becomes the core of capitalization and competitive edge for companies and, accordingly, for the entire national economy.

The special focus on efficiency and quality of corporate gov-ernance at Russian public joint-stock companies is attribut-able to a number of emerging external and internal factors.

The external factors include the continuing effects of the economic crisis, volatility in the global economy and the ge-

opolitical landscape which put certain external restrictions on Russia in 2014.

Most of the Russian companies have exhausted the benefits (opportunities) of Russia’s catch-up economic growth and need to search for other sources and drivers of long-term development.

These trends are bringing issues of responsible development at Russian public companies, business process optimization and transition to determining strategic and long-term de-velopment programs on top of the agenda.

This is essential for relations with investors who want to clearly understand the strategic goals and prospects of the companies they invest in and to be certain that their rights will not be prejudiced, which is impossible without improving corporate governance practices.

EVALUATION OF CORPORATE GOVERNANCE / 4 Association of Institutional Investors (API)




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To a notable extent, the general state of the Russian econo-my, its “state of health”, depends on infrastructure compa-nies holding a monopoly, or leading positions, in the indus-try or at least being among the key players in their respec-tive market segments.

These companies, inter alia, are of high social significance serving as a source of revenues for the federal budget (through an increase in the dividend flow and income from possible privatization activities) and contributing to the do-mestic market development through opportunities for inves-tors, including non-state pension funds, to buy into their shares.

In addition, given their notable relative weight in the Rus-sian economy, state-owned PJSCs are, in a way, headliners for the Russian financial market setting trends for other market participants.

Therefore, corporate governance improvements at major state-owned enterprises could have a positive effect on the development of corporate governance standards and prac-tices at both private and public Russian companies, increase the investment appeal of the Russian market as a whole.

In this connection, issues such as protection of investors’ rights during major corporate actions, a well-balanced and realistic development strategy, monitoring its implementa-tion, improving the performance of Board of Directors’ com-mittees, creation of effective systems for managing risks and preventing conflicts of interest, development of remu-neration policies for senior managers grow in relevance.

On February 13, 2014, the Government of the Russian Federa-tion approved the Corporate Governance Code (CGC) recom-mended for application at joint-stock companies listed on the organized securities market, followed by the approval from the Bank of Russia Board of Directors on March 21. Lat-er, the Government of Russia made a decision on the priority implementation of the Corporate Governance Code (CGC) at 13 state-owned enterprises included in the list approved by the Government’s order no. 91-r.

This study can be considered as an independent appraisal of the progress in implementing the main recommendations of the CGC at Russia’s major state-owned enterprises.





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Research goals and objectives This study primarily aims at getting an insight into the practical aspects of today’s corporate governance (hereinafter abbreviat-ed as CG and also referred to as corporate practice) at major Russian state-owned public joint-stock companies (hereinafter ab-breviated as PJSCs) as viewed by independent directors of PSJCs, CG experts, and taking into account the opinion of institutional investors holding stakes in PJSCs on their priority CG aspects.

The main research objective is a comprehensive evaluation of parameters of corporate governance systems at PJSCs based on a review of publicly disclosed information and results of meetings with members of their Boards of Directors/Supervisory Boards (hereinafter referred to as BoD) serving as chairs of audit committees and/or HR and remuneration committees, independent di-rectors.

The following companies were selected for the research:

PJSC ALROSA PJSC Aeroflot

PJSOC BASHNEFT VTB Bank (PJSC)

PJSC Gazprom PJSC UAC

Rosneft Oil Company PJSC ROSSETI

PJSC Rostelecom PJSC RusHydro

Sberbank PJSC Transneft

FGC UES, PJSC





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Main principles and criteria for the selection of companies

Every PJSC selected for the research meets at least several of the criteria provided below. The criteria reflect the rela-tionship between the level of corporate governance (through its influence on the company’s activities and their perception by investors), on the one hand, and the economic develop-ment factors, determinants of the Russian financial market’s

competitive edge and investment appeal, as well as the prin-cipal shareholder’s positions on CG improvement aspects, on the other hand.

Selection criteria for PJSCs:

controlling interest of the Russian Federation and/or enti-ties controlled by it in the company (involvement in the extended public sector of the economy): this factor is es-sential for understanding the Government’s resources to implement a CG-related policy;

inclusion of the company’s shares in level 1 or 2 quotation lists of Moscow Exchange (a mandatory requirement ap-plying to all the reviewed companies, given the need for them to have minority shareholders) and the level of in-fluence on the sectoral stock indices;

infrastructure-focused business activity, the nature of its impact on the economy and social development (through taxes, procurement, employment, provision of basic re-sources or infrastructure services);

inclusion of the company in the list of entities approved by the Government of the Russian Federation for the pri-ority implementation of the basic principles and recom-mendations of the Corporate Governance Code: this shows the level of attention to the quality of corporate govern-ance both from the minority shareholders and from the principal shareholder of the PJSC.

In 2015, the PJSCs covered by the research earned a total of RUB 15,162 billion in revenues, RUB 4,351 billion in EBITDA, paid approximately RUB 3,750 billion* in taxes and earned RUB 1,763 billion in consolidated net profit (based on IFRS).

The activities of these companies (in relation to the GDP in current prices, net of indirect economic effects) account for about one quarter of the whole economic activity in the Rus-sian Federation and more than half of the operations in the financial sector (excluding the Central Bank of Russia’s oper-ations). The combined net profit earned by these companies accounts for 2.3% and taxes paid by them for 4.7% of Russia’s GDP. As of September 30, 2016, their aggregate capitalization amounted to RUB 13,610 billion or about 40% of the total Russian stock market capitalization.

Therefore, the PJSCs selected for this research are both actu-ally positioned and perceived by the investment community (including international institutional and strategic investors) * based on the report on the profits tax and other taxes according to IFRS





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as market leaders and, in a way, indicators for evaluating the investment appeal of the Russian market in general and the structural quality of corporate governance at Russian com-panies.

Sources of information

In this research, we deliberately chose only two main sources of information on the companies: the publicly available sources, the most important of which is the mandatory in-formation disclosure system (the objective statutory regula-tion-related component) and interviews with independent directors that are open and ready for such contacts (expert appraisals of the real performance of the key CG system el-ements). This approach is specifically intended to demon-strate the feasibility of a comprehensive CG system monitor-ing using publicly available instruments in a situation where the researcher has no power to request and obtain infor-mation from the shareholders, the management team, regu-latory authorities, etc.

When preparing to interview independent directors of each company and drawing up a list of individually tailored ques-tions (taking into account the specifics of the corporate gov-ernance system), we analyzed material facts concerning Boards of Directors and general shareholders meetings (here-inafter referred to as GSMs), quarterly reports and other in-formation disclosed by the company in the period from Janu-ary 1, 2015 to September 30, 2016. The companies’ key CG as-pects were evaluated as at the end of the 3rd quarter of 2016. For companies witnessing changes essentially influenc-

ing the conclusions and recommendations which occurred after the reference reporting date, we deemed it necessary to provide appropriate disclosure and comments.

The meetings with independent directors took place in Octo-ber-November 2016. We managed to meet with directors of more than half of the target PJSCs, including ALROSA, Aero-flot, VTB Bank, Bashneft (before the acquisition by Rosneft Oil Company), UAC, Rostelecom, RusHydro, Transneft, ROSSETI. Where existing independent directors showed no interest in such meetings, we approached former BoD members serving in the 2015-2016 corporate season. Virtually all meetings with the current directors were arranged through the mediation of corporate secretaries as official letters highlighting the research objectives and inviting to a meeting were circulated.

The lack of opportunities to meet with other companies’ in-dependent directors (INEDs) has resulted in a more formal approach to them where the evaluation is entirely based on information disclosure. Quite a number of substantive practi-cal corporate governance aspects (including the BoD involve-ment in the formation and monitoring of the corporate strategy, the process of top-level business planning and benchmarking activity goals and results against peers, the level and activity of discussions at BoD meetings, the balance of power and opinions on the Board, the effectiveness of in-dependent directors, interaction with the management team, internal audit, external auditors, the remuneration system, the BoD members’ access to information and other signifi-cant aspects) cannot be properly evaluated at these PJSCs. Besides, the non-response to the invitation is also a research





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result indicating independent directors’ availability for com-munication, including contacts with shareholders.

The research also built on the results of a survey of institu-tional and portfolio investors aimed at determining priority CG elements for research purposes and obtaining expert opinions and appraisals on the pivotal aspects of corporate governance at the PJSCs covered by the research.

In particular, we surveyed 27 employees (heads of divisions, portfolio managers, senior analysts) responsible for invest-ments at investment companies, investment subsidiaries of banks, asset managers of Russian or foreign-owned invest-ment funds engaged in professional activities in the Russian Federation or being professional participants of the Russian securities market, managing a total of approximately USD 21 billion and RUB 38.0 billion (the aggregate result is based on the disclosure of related figures in the survey by about 50% of the respondents).

We also deemed it necessary to analyze the shareholders of the reviewed companies using the Bloomberg data on their respective shareholding structure as of 09/30/2016 and ap-proaches to formulating a voting position and a voting policy, as well as reports on voting on GSM agenda items disclosed on websites by the shareholders (usually portfolio and insti-tutional investors) and foreign regulatory authorities. We understand that these data may not fully reflect the current ownership structure and that not all shareholders may be included in Bloomberg’s (conditional) shareholder registers; however, the publicly available voting reports of some share-holders provide indirect evidence that these

funds/companies, at least, were shareholders of respective companies on the GSM dates. We detected only two compa-nies (PJSC Gazprom and Rosneft Oil Co.) whose shareholders did not provide such information in their reports; for all the other companies, the shareholders’ reports provided exactly the same ownership data as Bloomberg.





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Benchmarking (comparative review of peers)

One of the mandatory issues covered by meetings with INEDs was benchmarking (comparison with peers) in the activity of the Board of Directors, for example, when discussing the company’s development strategy (including the long-term development program*) or, which is less common in the do-mestic practice, when determining the set of key perfor-mance indicators and their target levels, discussing the man-agement remuneration system, etc. Viewing benchmarking as one of the key CG improvement instruments, we tried to use it as often as possible when analyzing all CG aspects at PJSCs, although not particularly focusing on the peer selec-tion procedure, seeing as this should stay entirely within the competence of the BoD and the management team (should they aim at a good understanding of the competitive envi-ronment).

For benchmarking CG-related properties (remuneration of the BoD and the management team, performance of the BoD and the committees, charity and social responsibility, general comparison of specific CG aspects), we selected foreign peers, i.e. similar companies (at least 3 peers for each of the re-viewed PJSCs, 4 for banks). The same groups of peers were taken for several PJSCs engaged in similar activities. The main selection criteria included economic sector similarity,

comparable scope and nature of business, including interna-tional business operations or activities in a strong and ma-ture markets, admission of shares to trading on one or sev-eral exchanges in the EU, USA, Canada or other OECD coun-tries, inclusion of shares in top-tier quotation lists, the gov-ernment’s equity participation (where other criteria were met).

Given the expediency of comparing and highlighting absolute (e.g. scope and quality of disclosure, number of INEDs, num-ber of BoD meetings) or relative values (e.g. the net profit-based dividend payout ratio or charity and sponsorship spending in relation to financial results) for different re-search aspects, ensuring the maximum similarity between the companies under review and their respective peers in terms of business conditions and the regulatory environ-ment, the scale and operational specifics of each company was not a deciding factor. In our view, this brief analysis is enough for making the shareholders, the Board of Directors and the management aware of essential CG aspects. Besides, some of the peers referred to in the research (based on our understanding and comments from some INEDs) are actually used by PJSCs for different purposes, including the develop-ment and/or adjustment of development strategies.

* a long-term business plan (usually covering a period of until 2020-2025)

based on the company’s development strategy and pursuant to resolu-tions of the Government of the Russian Federation.





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Main corporate governance aspects

1. Ownership structure and review of shareholders’ activity

Minority shareholders

According to Bloomberg data, most of the foreign institu-tional and portfolio investors holding stakes in the PJSCs normally declare the possibility of, and even the need for, voting at general shareholder meetings; some of them dis-close a detailed voting policy covering, in particular, ap-proaches to formulating a position, the investor’s stance to-wards possible agenda items and draft resolutions of meet-ings. The largest shareholders make their reports on voting at meetings publicly available. Western investors (including investors from both Europe and North America) generally take the lead in terms of voting process regulation, engage-ment with companies and information disclosure, which re-sults, among other things, from the active development and implementation of the responsible investment policy, for which corporate governance is one of the key investment process factors to be necessarily taken into consideration. Some of the shareholders separately disclose their engage-ment with companies on a regular basis, such as disclosure of engagement (for example, with Gazprom and Transneft) con-

cerning environmental protection, reporting and transparen-cy. Some of the shareholders publish lists of companies in which no investment can be made due to restrictions or pro-hibitions arising, among other things, from their (potentially) negative environmental impact. Therefore, while encouraging an active approach to protecting interests of clients (institu-tional investors, pensioners, insurance companies, etc.), the responsible investment policy also contributes to bringing requirements for compliance with basic standards of envi-ronmental and human rights protection, etc. into the invest-ment process.

In practice, the overall activity of minority shareholders of the reviewed companies as regards voting at annual general shareholders meetings is relatively low (no more than 15-30% of the free float on average). As follows from a review of in-ternational investors’ voting activity, many of them (such as the funds managed by Blackrock) did not vote at any GSMs except for the one held by Sberbank in 2016. The low activity of “responsible” investors is partially attributable to the overall political environment and the general attitude to the Russian market. In these circumstances, internal compliance managers of funds and corporate governance experts opt out of voting or for limited voting. In some cases (Aeroflot, Ros-telecom), foreign nominal holders would block voting by their clients at general shareholder meetings, even though the companies are not on any sanction lists.

It should however be noted that some PJSCs held extraordi-nary shareholders meetings in the period under review ad-dressing an increase in the number of authorized shares,





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amendments of by-laws (including amendments to charters in connection with the authorized capital increase), approval of related party transactions, restructuring procedures, etc. Interestingly, the international investors which abstained from voting at annual general meetings in 2015-2016 showed high voting activity at extraordinary meetings. Therefore, no major problems with minority shareholders’ voting could be detected in relation to the quorum on key issues in the peri-od under review, except for an extraordinary meeting of RusHydro shareholders addressing the approval of related party transactions involving RusHydro and VTB Bank in rela-tion to a share capital increase (in December 2015) where the quorum could not be formed, even though minority share-holders participated in that meeting.

Conspicuously, there are almost no Russian institutional and portfolio investors qualifying as large shareholders (i.e. hold-ing more than 0.2% of the voting shares) in the Bloomberg register. This could be explained by a related specific feature of investors’ reporting process and data collection for this register. At the same time, a separate study of publicly avail-able information on major Russian asset managers has shown the absence of any voting policies at companies who may hold significant stakes in Russian companies. The expe-rience of engagement with Russian investors as regards par-ticipation in shareholders meetings shows that their voting activity is not consistent and individually determined in each case.

In 30% of the reviewed PJSCs (ALROSA, Aeroflot, Rostelecom and Sberbank), minority shareholders take an active ap-

proach to the formation of Boards of Directors proposing in-dependent directors for election. In 2016, the candidates nominated by them were successfully elected at only 3 com-panies (Rostelecom prevented such an election by voting quasi-treasury shares). It should be noted that only two companies follow the practice of supporting the nomination of independent directors by the management and/or repre-sentatives of the controlling shareholder interested in the election of independent directors backed by institutional and portfolio investors (a case of best practice).

No other proposals to GSM agendas from minority share-holders at the PJSCs under review were detected.

At the same time, the availability of active minority share-holders ready to consistently exercise their rights, including the nomination of candidates and the proposal of agenda items (particularly concerning amendments to corporate doc-uments), with subsequent voting at general shareholders meetings, was recognized as one of the priority CG aspects in a survey of both Russian and international institutional and portfolio investors.

The Government as a majority shareholder

At all the other companies, independent directors are nomi-nated and elected by the Government (through controlled entities or subject to shareholder agreements, among other means), with a mixed approach to making lists of candidates to Boards of Directors.

In 2016, independent directors fully meeting the independ-ence criteria and the requirements for the number of INEDs





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on the Board provided for by the Moscow Exchange Listing Rules and the 2014 Corporate Governance Code were nomi-nated by the Government only at 4 of the 13 companies un-der review (VTB Bank, Rostelecom, RusHydro, Transneft). Without the 2014 CGC compliance requirement, the number of such companies increases to 9 (Aeroflot, UAC, Sberbank and Rosneft fail to comply with the Listing Rules).

Furthermore, only ALROSA (owing to the support of signifi-cant minority shareholders) and Rostelecom formally meet the CG Code recommendation for the minimum proportion of independent directors (at least 1/3 of the Board of Directors). Bashneft, ROSSETI and FGC UES meet the milder requirements of the MOEX Listing Rules (at least 3 independent directors). As for Rosneft where a large strategic minority shareholder elects solely its representatives to the Board of Directors, the Government has so far failed to ensure the election of 3 independent directors to the Board of Directors preferring, quite expectedly, to maintain 100% control over the BoD res-olutions.

At the other companies (Gazprom, UAC, RusHydro and Trans-neft), only a few BoD members meet the independence crite-ria, while most of them are actually affiliated with the Gov-ernment or a major counterparty in some or other way. As a result, the Boards of Directors have to recognize their mem-bers as independent directors to comply with the Listing Rules, despite the formal evidence of affiliation.

Therefore, the controlling shareholder is primarily liable for a Board of Directors which fails to meet best corporate gov-ernance practices, but some of the responsibility lies with

the minority shareholders if their holdings of local shares (at least 0.3-0.4% in practice) enable them to consolidate 2% of the voting shares together with other shareholders and to nominate a truly independent director. The liability for non-compliance is also indirectly shared by the Board of Direc-tors, namely, its HR and Remuneration Committee composed of independent directors and responsible for evaluating the BoD efficiency.

The Government represented by Russia’s Federal Agency for State Property Management (Rosimushchestvo) starts select-ing candidates to the Boards of Directors of the reviewed companies for the next corporate year several months after their annual meetings. Rosimushchestvo’s Commission for the selection of independent directors which includes representa-tives of the Government, relevant federal executive authori-ties, public unions and associations, as well as representa-tives of companies draws up proposals to the Government concerning candidates to the Boards of Directors. According to a survey of independent directors, the Boards of Directors (their HR and Remuneration committees) mostly treat the process of drawing up proposals for lists of BoD candidates and submitting them to the controlling shareholder as a pure formality or even stay completely out of finalizing such lists. In such cases, the task of drawing up proposals falls to the management, which obviously poses risks of a potential con-flict of interest manifesting itself, in particular, when an ef-fective BoD member bringing up pertinent issues which, in a way, embarrass the management is replaced by a less active candidate the management feels more comfortable with when drawing up proposals for BoD candidates. The compa-





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ny’s position is usually presented and extensively substanti-ated at Commission meetings by management representa-tives whose opinions, at best, are technically approved by the HR & Remuneration (Nominations) Committee through absen-tee voting, instead of heads of such committees. Given the currently discussed legislative initiative to allow Boards of Directors to nominate BoD candidates on equal terms with shareholders, we believe that the Government and Boards of Directors should pay higher attention to ensuring a proper discussion of candidates based on an objective appraisal of their personal qualities and performance results provided by either independent directors in a self-assessment procedure or, if necessary, external consultants. In this case, the Board of Directors should act as the customer considering the eval-uation results and recommendations to shareholders con-cerning candidates for the following corporate season pro-vided by relevant committees. Opinions/appraisals arising from regular meetings between representatives of the Gov-ernment, other minority shareholders and independent direc-tors addressing their performance should also play an im-portant role.





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2. Information support of general shareholders meetings In our view, the recent years have brought substantial im-provements to the disclosure of materials for general share-holders meetings. Almost all of the PJSCs disclose such mate-rials in the Russian and English languages at least 30 days prior to the meeting date (the minimum period provided for by the law being 20 days). Materials concerning amendments to corporate by-laws enable the shareholders to understand the expediency and substance of such amendments (compari-son tables, documents with highlighted amendments, etc.). At the same time, we could not identify an undisputed infor-mation disclosure leader among the reviewed PJSCs that could compare with Moscow Exchange in that respect, for example.

The following most frequent problems should be highlighted:

1. absence of complete information on the shareholders nominating candidates to the Board of Directors or pro-posing issues to the agenda of a general shareholders meeting;

2. non-disclosure of information on auditor selection proce-dures, including the bidders, the terms and conditions of-fered by them, in GSM-related materials;

3. presentation of amendments to the company’s by-laws in a way that complicates understanding the expediency and substance of such amendments (absence of existing ver-

sions for reference, comparison tables of changes, etc.). The worst approach is providing only a restated version without highlighting the amendments;

4. absence of a proper rationale for the profit distribution proposed by the Board of Directors, including the way it is linked to the company’s dividend policy and investment initiatives, with disclosure of key efficiency parameters. As a rule, the company only provides the Board of Direc-tors’ recommendation identical in wording to the draft resolution on the issue;

5. poor information disclosure on separate aspects of the company’s activities in the annual report;

6. absence of a full-fledged rationale for the conclusion of related party transactions submitted for approval by shareholders and their material terms. This flaw becomes blatantly obvious if the number of such transactions is high. For example, in the period under review (2015-2016), 291 related party transactions for a total amount of more than RUB 51 trillion, USD 25.7 billion and EUR 1 billion were approved at the AGMs of only three major compa-nies (VTB, Gazprom, Rosneft).

The above weaknesses substantially complicate, even though to various extents, the formation of the shareholder’s well-reasoned position on the agenda, given the inability to promptly obtain proper explanations as necessary.





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3. Boards of Directors (Supervisory Boards)

Importance of meetings between Board of Directors members and shareholders

The Board of Directors performance appraisal resulting from an exchange of views with independent directors and heads of committees apparently indicates the need to implement or develop the practice of independent directors and/or mem-bers of the Board of Directors (depending on the format) holding 1-2 meetings with the shareholders during each year. At such meetings, investors and/or representatives of the Government can obtain directors’ opinions on essential as-pects of the Board’s activity and the company’s corporate governance system, get a clear insight into activities of the Board members, which would ultimately help shareholders form a well-reasoned position when voting on the election of a new Board.

Besides, such meetings would enable the Government, the majority shareholder in such companies, to make Board members aware of its views on certain activity aspects that are of relevance to the shareholder. We believe that the ar-rangement in the corporate season of 1-2 meetings with gov-ernment officials (members of the Russian Government) su-pervising the companies and making decisions on instruc-tions would result in a more effective corporate governance system, with reasonable influence of the BoD on strategic decisions in relation to the PJSCs.

The substantive appraisal of each Board of Directors’ activi-ties for the purpose of this research is based on the official disclosure of all available information and the Board mem-bers’ personal experiences. Of special interest is the compari-son between opinions on certain activity issues or aspects obtained at separate meetings and the preliminary under-standing of such aspects based on information disclosure. The result is a holistic concept based on evidence from multi-ple sources. Unfortunately, the plans to meet with several directors of one company and with each of them separately did not work out at all companies because of the directors’ tight schedule.

A survey of investors clearly demonstrated that the availa-bility of a responsible and effective Board of Directors ac-countable to shareholders is of importance to Russian asset managers and of top priority to international investors. The absolute majority of investors consider the above-mentioned meetings between investors and independent directors with-out the management in attendance to be useful, one-third of the respondents referred to this practice as extremely useful.

Chair of the Board of Directors

The surveyed Board of Directors members confirm the rele-vance of the personal factor in approaching Boards of Direc-tors’ activities. The personality and attitude of the Chair may have purely formal influence on the Board activity (“enough for nominal voting”, as one of the Board members put it) or ensure the required level of motivated and meaningful dis-





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cussion involving all representatives of shareholders and in-dependent directors.

The latter may be exemplified by the RusHydro case where the number of physical Board of Directors meetings in-creased several times following the election in June 2015 of a new Chairman whose actions energized the whole Board.

In fact, the link to the Board Chair is the key opportunity for independent directors to have their opinions heard and taken into account as far as possible when preparing or making decisions on agenda items. The Board Chair’s duty is not just to allow all Board members to prepare and speak up, but sometimes even to “force” independent opinions out of them so that the final decision is well-balanced taking into account different positions.

The appointment of a Minister, i.e. a member of the Russian Government (in the ALROSA case), or a deputy Prime Minister of Russia (in the RusHydro case) as Chair of the Board of Di-rectors does not seem to cause any problems to the Boards of Directors’ activities, at least from what we heard at the meetings with independent directors. On the contrary, all the INEDs unanimously welcomed such appointments laying em-phasis on the positive approach of each Board Chair and their availability for contacts with independent directors as neces-sary.

Board of Directors operation patterns

As a result of monitoring the Boards of Directors’ perfor-mance at the companies under review, two Board operation patterns can be conditionally distinguished:

predominant consideration of the management team’s proposals, while additionally covering issues proposed by Board members (the most frequent case);

formation of an independent position on issues within the Board’s scope of authority and responsibility (taking into account the management team’s proposals), including consideration of joint proposals and different decision-making scenarios.

Some of the companies switch to the second mode when ad-dressing only certain activity aspects, while others (such as the Supervisory Board of ALROSA) have made it a standard practice, which is commendable. Seeing as the second ap-proach is followed much rarer than the first one, the organi-zation and dynamics of the Board activities is of much more substantive interest in view of the strategic nature of the Board’s activities. However, a final comparison of the opera-tion patterns and their impacts on companies can only be carried out in several years.

Issues subject to instructions

The surveyed members of Boards of Directors showed a gen-erally mixed attitude to instructions, but all of them agree that their abundance (seeing as their number has notably increased in recent years) substantially impairs responsibility of the Board of Directors (this refers to fiduciary responsibil-ity, given that voting as instructed is no excuse when it comes to liability for losses caused to the company).





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In our view, the problem primarily arises from the Board of Directors’ non-involvement in the consideration of issues subject to instructions, preparation and generation of in-structions. In practice, either the management team prepares and submits them for approval while the Board of Directors is notified post factum at the moment of voting, or the con-trolling shareholder’s representatives develop draft instruc-tions by themselves. The result is that a highly qualified Board is unable to propose reasonable additions or objec-tions to an already finalized instruction and its members are forced to vote as instructed despite any objections to it they may have. In many cases – including sales and acquisitions of large assets or determination of key performance indicators – it seems strange, to say the least, that the key shareholder does not employ an easily available, highly effective resource which in addition is responsible for decisions approved within its competence. We recommend that the Government should elaborate and approve a procedure for participation of Board members in the preparation and approval of instructions as-suming the possibility of direct contacts between Board members and representatives of the shareholders finalizing instructions. It should be noted that not all members of Boards of Directors confirmed readiness for such cooperation, but most of the professional attorneys and even several (most active) independent directors offered their services in preparing professional opinions on draft instructions in rela-tion to their companies, apparently being aware of the is-sue’s relevance and of today’s bottlenecks.

Board of Directors liability insurance

The companies targeted by our research proactively insure the liability of directors, members of management boards / committees and other officers as regards compensation of damage caused to other persons arising from filing claims against the insured person in relation to errors and failures in management activities. All companies disclose information on concluded or endorsed liability insurance contracts in some or other way (the insurance limits ranging from RUB 3 billion to $250 million).

Investors’ opinions on liability insurance were divided: some of the surveyed regard insurance as a useful option (given the possibility of damages that are otherwise difficult to re-cover from a physical person, e.g. an independent director), the others, on the contrary, tend to believe that being in-sured could stimulate unreasonable risk taking by the man-agement and/or the Board of Directors when making deci-sions. The surveyed investors consider this issue to be some-what important (useful) rather than essential or of top prior-ity.

4. Effective dividend policy and the role of the Board of Directors

A clear dividend policy (including disclosure of payout ratio benchmarks and the base for determining dividend pay-ments) is one of the top priority corporate governance as-pects for all the surveyed investors.





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As opposed to international practice, the reviewed PJSCs have a separate by-law governing their dividend policies.

At the same time, our research has shown that in practice, dividend payments are primarily based on shareholder return on preferred and ordinary shares versus peers at foreign companies. We were unable to identify a similar approach at Russian state-owned enterprises.

In Russia, the best dividend policies aim at paying at least 35% of the consolidated IFRS profit in dividends (as exempli-fied by ALROSA, with Rosneft Oil Company announcing the same target after the reporting date of this study) or, a more common approach, 25% of the consolidated IFRS net profit, subject to various adjustments and restrictions (Bashneft, Aeroflot, VTB). Some of the PJSCs (such as Gazprom, RusHydro, FSK UES) have not yet updated their dividend poli-cies with regard, among other things, to the Russian Govern-ment’s effective executive order no. 774-r dated 05/29/2006 and to the Guidelines for the development of dividend poli-cies at state-owned joint-stock companies approved by Rosimushchestvo’s order no. 524 dated 12/29/2014 and/or set minimal dividend payout ratios (5-10%, such as RusHydro, UAC). Only a few companies disclose the exact dividend base calculation procedure factoring in investment expenses and other restrictions (as is the case with Aeroflot, Gazprom, ROSSETI). None of the companies disclose their approaches to spending earnings on investments, despite the reference to it in executive order 774-r. This actually indicates that divi-dends are paid out of leftovers at state-owned enterprises, despite contrary international experience. In our view, even

the new dividend policies (such as the first ever dividend pol-icy of Transneft approved in December 2016) need a revision due to their non-compliance with the key requirements and recommendations of the principal owner, minority sharehold-ers’ expectations and the relevant benchmark.

Only one company (namely, Rostelecom) calculates dividends based on the free cash flow / FCF (a performance indicator widely used internationally) while also setting a dividend to FCF ratio close to international practice (75%).

As a result, despite the payment by the PJSCs of substantial-ly higher 2015 dividends subject to the Government’s re-quirements, the average payout ratio (the ratio of dividends for a year to consolidated net profit) at foreign peers re-mains higher than at Russian PJSCs.

The gap between the dividend payout ratios at some of the Russian PJSCs and their respective foreign peers was very large (2-3 times for Gazprom, 7 times for UAC, 1.8-2 times for Rosneft, 10 times for Transneft). The percentage of net profit earmarked for dividends exceeds the foreign peers’ dividend payout ratios only at Rostelecom (1.5-3 times) and the banks covered by this research. For example, Sberbank’s dividend payout ratio is 1.5-2.6 times higher than at two peer banks and 2-3 times lower than at two other peers taken for com-parison.

The increase in dividend payments at Russian PJSCs is mainly attributable to the Government’s consistent policy of setting minimum requirements for the percentage of net profit to be earmarked for dividends driven, among other things, by pri-





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orities external to companies (particularly, the need to in-crease fiscal revenues) rather than the Boards of Directors’ commitment to a well-balanced profit distribution policy with the aim of increasing shareholder return in the first place and ensuring long-term return on investments in corporate development. We believe that Boards of Directors (including their strategy committees) should play a more active role in shaping and implementing dividend policies, preparing rec-ommendations and proposals for the profit distribution, par-ticularly for spending on investment projects. Today’s rec-ommendations from Boards of Directors to shareholders meetings in this respect appear to be a pure formality*.

At the same time, given the current instruction-based meth-od of managing major state-owned enterprises, it is advisa-ble that the Government (the principal shareholder) improve transparency and update its own approaches to achieving the required dividend yield at companies controlled by it. Order no. 774-r actually implies the requirement for appro-priate additions and amendments taking into account, among other things, recommendations of Rosimushchestvo and best profit distribution practices assuming that the principle of paying dividends out of net profit leftovers should be aban-doned.

Therefore, the dividend policies and practices at PJSCs need further harmonization with the principal shareholder’s (the Government) position and with international practices, in-cluding the following potential improvements:

* Pursuant, inter area, to the Government of Russia’s executive orders no. 774-r dated 05/29/2006, no. 705-r dated 04/18/2016

update of dividend policy-related corporate by-laws; active involvement of the BoD (its strategy committee) in

preparing preliminary proposals and recommendations to the main shareholder as regards profit distribution (as part of preparing AGM voting recommendations) and amendments to the charter where necessary;

more active benchmarking and focus on the dividend yield;

update of the Government’s own vision of the dividend yield at controlled companies, encouraging the Boards of Directors’ higher contribution to profit distribution-related proposals (including their involvement in prepar-ing instructions).

According to a survey of investors concerning the dividend policy, investors mostly consider it necessary to use consoli-dated IFRS profit only for dividend calculation purposes; about half of them believe that the payout ratio should be at least 50%, the others would make it subject to consideration in each individual case. The dividend policy-related issues are referred to as essential matters.

The investors consider the FCF and, to a lesser degree, the net profit adjusted for one-off (extraordinary) effects to be reasonable possible components of the dividend calculation base, without giving obvious preference to any of them.





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5. External and internal audit, internal control, risk management

External audit

Our research has shed light on two problems in relations be-tween the Board of Directors and external auditors:

a rather low level of communication between members of the Audit Committee/Board of Directors (except for Aero-flot, Bashneft) and external auditors concerning ongoing or completed audits, related weaknesses (including those identified without the management in attendance), selec-tion of auditors and arrangement of open bidding proce-dures. Participation of the BoD or the Audit Committee in the arrangement or holding of an auditor selection proce-dure is crucial for the CG system, particularly, for the cor-rect positioning of the Board of Directors as the key cus-tomer (by virtue of its power to represent shareholders’ interests);

some of the companies predominantly focus on the mini-mum price of services when implementing the auditor se-lection procedure, with the result that international audi-tors cannot compete against regional players.

Most of the surveyed investors are upset seeing the Big Four companies discontinue the audit of major Russian PJSCs. In-vestors generally estimate the ability of Russian audit firms to provide a completely independent opinion lower than that of international firms relying on the simple indicator of each

client’s significance for the whole business of the auditor, including the international business. It should be noted that most of the surveyed investors are also skeptical about Rus-sian divisions of international audit firms suggesting possible influence of clients on their activities; however, they have much more confidence in well reputed international brands, given the possible reputational risks, than in a solely Russian auditor.

We also note relatively low quality of information disclosure on completed auditor selection procedures (including infor-mation on bidders, essential terms and conditions proposed by them), the current auditor (including the cost of audit and non-audit services provided) and the proposed auditor (audit timeframe, scope and cost of services) for general sharehold-ers meetings at most of the reviewed PJSCs.

Internal audit

All the companies distinguish between the internal audit function and internal control and have established separate internal audit divisions in 2014 or (mostly) in 2015.

The following aspects of the corporate internal auditing practice should be viewed as negative, insufficiently effective or not fully complying with the CG Code recommendations (for 2015 and January-September 2016):

the Board of Directors has no power to approve the budg-et and/or size of remuneration payable to head of the in-ternal audit service; in some cases (UAC, Transneft), the Articles of Association do not expressly vest the Board of





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Director with any powers at all in relation to head of the internal audit division (while other documents are not dis-closed);

confusion of internal audit and internal control functions as they are not formalized by separate updated docu-ments (for example, the internal control regulation of UAC has not been updated since 2011, although the company’s internal audit policy was approved in 2015);

the internal audit division’s powers to carry out audits are not sufficiently particularized, despite detailed descrip-tions of its other powers;

in certain cases, the Board of Directors did not consider the report on implementing the internal audit function (the basic internal audit document) and did not consider or adopt a remedial action plan;

the “hotline” (a system for reporting violations, cases of corruption, involvement of the management/members of the Board of Directors in conflicts of interests, non-observance of codes of ethics and codes of corporate con-duct, etc.) is locked solely to the internal control service without simultaneously notifying the internal audit ser-vice and the audit committee of major violations;

the Board of Directors (the Audit Committee) does not separately consider organizational and operating efficien-cy of the hotline and the conflict of interest prevention and management system (even if these issues are covered by the internal audit report, no information is disclosed in this respect);

no disclosure of internal audit organization-related docu-ments (policies, regulations), e.g. at Transneft and UAC (the internal audit policy adopted in 2015);

the head of the internal audit service is a member of the collective executive bodies (as in the Rosneft case);

the basic internal audit document has not been updated in the past few years;

poor quality of information disclosure on the internal au-dit division (it is impossible to assess the adequacy of available resources, only Rostelecom discloses the number of employees and the detailed structure of the division).

The positive internal audit practice includes:

availability of a powerful internal audit unit comprising several bodies (at banks, PJSC Bashneft and PJSC Ros-telecom as of the reporting date of the study);

broad powers of the internal audit division specified in detail in corporate documents and fully consistent with Corporate Governance Code recommendations, including auditing activities (Sberbank);

approval of heads of structural divisions of the internal audit unit by the Board of Directors (the Audit Committee) (ROSSETI, FGC UES);

simultaneous and independent delivery of information on possible violations submitted via the hotline to the Audit Committee (Aeroflot), or the obligation undertaken by the internal control unit to keep the internal audit unit in-formed about the results of checking up on messages;





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regular meetings between the Audit Committee and the internal audit division;

consideration by the Audit Committee of a large number of issues predominantly at physical meetings (the Audit Committee of Sberbank only held physical meetings in 2015).

Internal control and risk management

Most of the PJSCs have mature internal control and risk management systems, including specialized divisions at their HQ, as well as units and their heads arranging and imple-menting internal control and risk management-related busi-ness processes at the companies’ divisions, branches and subsidiaries.

Just as expected, the most comprehensive and mature inter-nal control and risk management system is created at banks (Sberbank, VTB Bank).

The corporate governance shortcomings related to internal control and risk management revealed in the course of the research include:

potential flaws and imperfections of the internal audit system which pose risks to internal control efficiency;

no disclosure of internal control efficiency evaluation re-sults by the company (the Audit Committee) in annual statements;

excessive generalization, formality and lack of detail in regulations for the prevention and management of con-

flicts of interest and for anti-corruption policies; no dis-closure of approved documents (especially conflict of in-terest management regulations) on the company’s web-site;

no or irregular consideration of risk management reports by the Boards of Directors of some companies (according to information disclosure on BoD meetings).

The positive internal control and risk management practice includes:

automated verification of declarations submitted by sen-ior managers and executive employees, broad coverage of verification procedures (e.g. at RusHydro);

requirements for counterparties in the procurement sys-tem to disclose ownership chains, requirement to ensure non-involvement of dubious entities in fulfilling obliga-tions;

availability of detailed regulations for the prevention and management of conflicts of interest and for anti-corruption policies, disclosure of documents on corporate websites (we note the exemplary quality of documents and completeness of their disclosure at Sberbank);

participation of the Board of Directors and committees in determining and monitoring key risks;

participation of the HR (Remuneration) Committee and the Board of Directors in the process of determining bonuses to heads of risk management divisions (e.g. at Ros-telecom).





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6. Information disclosure

All the PJSCs under review follow the basic requirements for the mandatory information disclosure system disclosing, in particular, resolutions taken by their Boards of Directors (ex-cept for those not subject to disclosure), resolutions taken by general shareholders meetings, quarterly reports, lists of affiliates and other documents and information stipulated by the information disclosure regulations.

Most of the surveyed investors consider the quality and timeliness of information disclosure, particularly in the form of quarterly reports and quarterly financial statements, to be of high priority.

Differences in the PJSCs’ approaches to disclosure arise where the statutory regulation does not provide enough de-tails on disclosure specifics leaving them to the discretion of the issuers (companies). The polar opposite approaches can be exemplified by disclosure of voting on separate resolu-tions taken by the Board of Directors (Supervisory Board).

The best disclosure practice (ALROSA, FGC UES) is providing information on individual voting, which ensures the most comprehensive evaluation of positions taken by Board mem-bers (particularly independent directors) in case of voting “against” or “abstained” on certain issues. All the surveyed investors consider it necessary to disclose such information and to provide dissenting opinions of Board members voting “against” or “abstained”. ROSSETI and FGC UES disclose

minutes of all Board of Directors meetings on their websites (the best practice).

The worst disclosure of reports on resolutions made by the Board of Directors was detected at Rosneft which omitted nearly all information except that the quorum is available and resolutions on agenda items are passed, which prevents understanding of detailed voting results.

Most of the companies will not disclose individual voting re-sults, which hampers the analysis of voting activity.

There are also different approaches to disclosing information on related party transactions and major transactions. The disclosure regulations do not provide for the scope of infor-mation on such transactions subject to disclosure in reports on resolutions taken by the Board of Directors. Taking ad-vantage of this vagueness, some of the PJSCs omit all mate-rial terms of such transactions (primarily, the counterparties and prices / limits), only specifying that the resolution to approve the transaction was passed. Most of the companies, however (including RusHydro, FGC UES, Aeroflot, Gazprom, ALROSA), follow a good practice of disclosing all material terms, including the subject, price (limits), counterparties, period, etc.

It should be noted that for large companies (with value of assets exceeding 100 billion rubles), the mandatory disclosure threshold (1% of the asset value) is too high, which allows such companies to lawfully omit material terms when draw-ing up reports on such transactions.





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According to the surveyed investors, it is also appropriate to include information on the total spending on charity, includ-ing approaches to determining limits for charity spending, and the availability of a charity and social investment policy in the scope of disclosure. Importantly, expenses for lobbying and payments effected for political purposes should not be included in the charity section.

It should be noted that almost all of the PJSCs covered by this research have established, to a greater or lesser extent, a legal framework for charity in their corporate documents. A comparison between spending (e.g., in relation to net profit) at PJSCs and their peers shows that most of the Russian PJSCs bear higher relative charity expenses, and some of them spend extremely heavily on charity both in relative and absolute terms (as exemplified by VTB Bank and Transneft).

Besides, investors would welcome more transparent disclo-sure of capital expenses (CAPEX) with exhaustive information on the structure and schedule of such investments provided in annual statements, including deviations, if any, from initial projections.

The range of problems related to disclosure of the Board of Directors and management team remuneration system are considered in a separate section below.





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7. Remuneration of members of the Board of Directors and the manage-ment team

Board of Directors

Most of the PJSCs employ single approaches generally meet-ing Rosimushchestvo’s recommendations (base remuneration plus bonuses for membership in and chairmanship of the Board and its committees). The remuneration policies provide for proportional deductions for missing BoD meetings and non-participation thresholds (mostly 50%) for complete non-payment of remuneration. Besides, additional responsibilities at committees are sometimes not taken into account for re-muneration purposes (e.g. at ALROSA).

The remuneration of Boards of Directors at the PJSCs under review is mostly substantially lower than at international peers – with the exception of Rosneft (paying commensurate or somewhat higher remuneration) and a few PJSCs (Gazprom, Transneft, Bashneft, Sberbank) catching up with European peers while being notably behind U.S. and Canadian compa-nies in terms of remuneration. Meanwhile, at some PJSCs (RusHydro, ROSSETI, FGC UES), the level of remuneration tends to zero, the ratio of remuneration paid to Board of Di-rectors members to average remuneration of Management Board members being inadequately low, which is inconsistent with Corporate Governance Code recommendations and com-mon practice. The Code recommends that the remuneration

payable to members of the Board of Directors should not be overstated but should be adequate to the skills and respon-sibilities of directors, as well as their time expenditure, also taking into account the remuneration paid to other employ-ees. According to independent directors of some PJSCs, the inappropriate remuneration prevents the engagement of di-rectors who could primarily focus on professional activities on the Board without feeling dependent on income from their primary employment or being ready to entirely devote them-selves to service on the Board of Directors.

The problem of discouraging remuneration at power compa-nies arises, inter alia, from the application of outdated guide-lines for determining the remuneration of BoD members at state-owned enterprises issued by the Ministry of Economic Development in 2009*. We view this as an extremely negative practice and propose revising the Board of Directors remu-neration system at these companies to bring it in accordance with the common practice and current market approaches.

The practice of making components of annual bonuses con-tingent on capitalization and/or profit followed by some of the PJSCs (Aeroflot, Bashneft, Gazprom (in relation to KPIs) is not entirely consistent with the Code recommendations to avoid short-term incentives for BoD members, including in-centives depending on capitalization or earnings. At the same time, these programs are not equivalent to equity participa-tion plans typical for U.S. companies where BoD members are partly remunerated with conditional shares (awarded at no * see letter no. D08-3156 of the Ministry of Economic Development dated 09/28/2009





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cost, the number being calculated based on a notional fixed price) transferred to them only at the end of their tenure as BoD members.

In some cases, the by-law on remuneration of BoD members is not available on the company’s website (for example, Gaz-prom discloses only general information on the related regu-lation without disclosing its content, including the procedure for determining the size of remuneration).

As regards the size of remuneration payable to members of the Boards of Directors at major state-owned PJSCs (assum-ing the need to engage the most competent independent di-rectors), most of the surveyed investors believe that the most comfortable option is a fixed amount of up to RUB 10 million per year or partial fixed remuneration with an addi-tional payment of up to 100% of the fixed part in shares. In general, this issue is of certain importance, but not of top priority to investors.

Management remuneration system

An essential deviation (noted, inter alia, by the surveyed in-vestors) from the generally accepted international practice of remuneration is the non-disclosure by companies of the ex-act top management remuneration system, the KPI perfor-mance calculation and the procedure for structuring remu-neration for the reporting period, as well as individual remu-neration components (at least for the sole executive body and the CFO).

For investors, this is a litmus test for the quality of corpo-rate governance at the company, and investors are extremely

interested in disclosure of at least top managers’ long-term and short-term remuneration components and the remunera-tion structuring system taking into account KPIs (both target and actual levels). Disclosure in absolute terms (either for 5 highest-paid managers in aggregate or individually, at least for the SEB) also appears to be quite useful. In general, all the surveyed investors support the international practice in this respect.

PJSCs currently only disclose the aggregate remuneration paid to Management Board members subject to regulatory requirements. Only Bashneft and Rostelecom comply with the Corporate Governance Code as regards disclosure of the re-muneration of the highest paid key executives and only Ros-neft discloses the basic document governing the SEB remu-neration.

Advisory voting of shareholders is also a widespread interna-tional practice. Foreign peers used this scheme most fre-quently when considering the approval of the management remuneration system. The point and aim of such voting is to let the Board of Directors understand the shareholders’ atti-tude towards the management motivation system (whether effective or proposed by the Board of Directors). The voting is purely advisory in nature and actually enables the Board of Directors to “compare notes” with the shareholders as re-gards the most important issues. Where the Board disagrees with the shareholders’ decision, the position and arguments of the Board are generally disclosed as appropriate.

Most of the PJSCs pay remuneration largely composed of short-term incentives, while lacking a system of long-term





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remuneration meeting the international practice to the ex-tent required* (even if a related document designed for 2-3 years and therefore being technically regarded as a long-term remuneration program is available). This applies both to cash bonus programs and option plans, although separate programs disclosed by companies come close to international practice (Bashneft) and resemble, to a varying degree, ordi-nary cumulative stock ownership plans (ESOP, as exemplified by Rostelecom’s option plan).

Besides, most companies pay quarterly bonuses, which is to-tally unacceptable in international practice.

* This assumes availability of KPIs calculated for a time horizon exceeding one year, determination of key KPI targets and/or KPI achievement eval-uation at peers, a waiting period from the moment of conditional award of remuneration to the moment of actual payment in shares or cash (normally, 3-4 years, or until termination of powers, for stock accumula-tion plans), retroactive disqualification for bonus (including a reduction in total remuneration or recovery of the previously paid portion) in case of a failure to meet the KPIs in the calculation period, non-achievement of a target stock ownership percentage, infringements, early employment termination, etc. (the clawback / malus provisions).

To increase the management team’s commitment to long-term development of the company – which would also serve shareholders’ interests – it is advisable to gradually imple-ment long-term incentive programs largely based on the in-ternational corporate practice (while quasi-treasury shares of the company, if any, could also be partially used as an in-centive).

The absolute majority of the surveyed investors believe that the long-term portion of senior management remuneration should account for at least 50% of their total remuneration. This issue is being regarded as rather important.

As for a recommended long-term remuneration scheme, the survey of investors did not reveal any clear preference; re-stricted phantom shares, options and stock ownership plans were recognized as the basic remuneration schemes.





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8. Assessment of investors’ corporate governance quality impressions

To evaluate investors’ perception of the quality of corporate governance at the PJSC under review, we asked the institutional and portfolio investors participating in our survey to generally assess the quality of corporate governance at each company on a scale of 1 to 5 (from 1 meaning “very poor” to 5 standing for “very good”), based on a comparison of the companies, taking into account the international experience of engagement with other companies, including conditional peers.

Company Very poor Poor Average Good Very good Undecided Mean value

Sberbank of Russia 0 1 5 12 9 0 4.07

PJSOC Bashneft 0 2 6 11 6 2 3.84

PJSC ALROSA 0 0 11 9 5 2 3.76

PJSC Aeroflot 0 0 12 12 0 3 3.5

PJSC Rostelecom 0 6 8 8 0 5 3.09

PJSC RusHydro 1 5 11 6 0 4 2.96

FGC UES, PJSC 0 6 6 5 0 10 2.94

Rosneft Oil Company 2 3 18 3 0 1 2.85

PJSC UAC 0 5 8 2 0 12 2.8

PJSC ROSSETI 1 6 6 3 0 11 2.69

VTB Bank (PJSC) 6 12 5 3 0 1 2.19

PJSC Gazprom 13 6 5 2 0 1 1.85

PJSC Transneft 17 3 3 2 0 2 1.6

The survey results generally confirm the basic findings of this study about corporate governance parameters at the PJSCs.





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Importantly, the above results reflect the surveyed investors’ general perception of the quality of corporate governance. Their opinions can be influenced by a number of factors, in-cluding corporate actions, information disclosure, efficiency of the company’s engagement with investors and historical relations with shareholders (the so-called track record which investors referred to as one of the priority activity aspects during the survey), financial performance and overall man-agement efficiency, as well as the actual dividend policy. The most essential factors include the company’s financial per-formance, dividend policy, general treatment of minority shareholders (including minority shareholders of other com-panies during takeovers, for example), as well as the corpo-rate authorized capital increase policy which investors rely on as the company’s integral performance index.

The relevance of this structure of priorities manifests itself in the case of Bank VTB which, according to its disclosure, has a sufficiently mature corporate governance system, complies with many recommendations of the Corporate Governance Code yet is perceived by many respondents, including repre-sentatives of international investors, as inferior to compa-

nies with a comparable or even formally lower level of corpo-rate governance.

Besides, there are companies whose level of corporate gov-ernance the majority of respondents found difficult to assess (UAC, ROSSETI, FGC UES), despite an objectively decent level of disclosure, for example (ROSSETI and FGC UES) – most likely, for individual reasons in each case. In the case of UAC, the liquidity of shares and the current capital structure are among significant factors at play. At ROSSETI and FGC, the majority shareholder’s high stake adds to many investors’ accumulated frustration with the electricity transmission sector as a whole.

In our opinion, the companies ranked by investors at the bot-tom of the list (Gazprom and Transneft) have indeed huge room for improvement of the corporate governance system which goes far beyond adopting formal regulations and re-quires long and meticulous work at all key levels (sharehold-ers, Board of Directors, management team), an approach in-strumental in building reputation and ensuring a fair valua-tion of their assets.





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Recommendations resulting from the research

As a result of the research, we offer below a number of basic recommendations to be followed:

transition to the profit distribution based on IFRS statements while avoiding the leftover-based dividend distribution prac-tice (active involvement of the BoD in preparing recommendations and instructions, taking into account benchmarks and the dividend yield);

legislative abolition of the linkage between dividend payments and the company’s RAS (Russian GAAP) profit; non-involvement of quasi-treasury shares in voting; higher voting activity of professional investors at general shareholders meetings; higher role, responsibility and accountability of Boards of Directors (including disclosure of information); remuneration of BoD members based on market principles; selection of BoD candidates supported by shareholders based on a reasonable assessment of their contribution and the

company’s development program for the upcoming corporate year/period; election of independent directors to the extent of at least 1/3 of the total BoD, ensuring their independence, increasing their

role in decision-making according to Corporate Governance Code recommendations; improve disclosure of materials for shareholders meetings and material facts in accordance with the CG Code recommenda-

tions; long-term remuneration of the management team should be linked to long-term KPIs accounting for at least 40-50% of the

total remuneration; disclosure of information on the management remuneration system; application of a KPI system assuming the relative weight of each KPI in the aggregate remuneration of at least 20%, the pri-

ority of financial KPIs (free cash flow, EBITDA, ROIC, ROE, etc.) in terms of relative weight and the calculation method disclo-sure for each KPI.





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Conclusion In 2014, the Corporate Governance Code was brought to the Russian corporate sector as a key guidance document superseding the Code of Corporate Conduct which had been in effect since 2002 and played an enormous role in the formation of the Russian cor-porate legislation and a civilized system of corporate relations. The 2002 Code defined the basic rules of conduct and set a good trend for corporate relations in terms of key development objectives. It became, in a way, a “soft law” mechanism assuming that the company undertakes to comply with recommendations and tries to follow them. The 2002 Code certainly had a positive impact on the level of corporate governance.

The 2014 Code is a step forward, with advanced recommendations to corporate governance which hardly all companies are ready to follow immediately, for example, in respect of significant corporate actions.

The results of this study show that there is still much to be done in the way of development and improvement of corporate gov-ernance practices, as proved by opinions of investors and independent directors, the expert monitoring of information disclosure.

The level of corporate governance at state-owned enterprises holding significant market shares influences, among other things, the level of corporate governance in Russia as a whole. The achievements of some of the companies under review can already be used for benchmarking the level and quality of corporate governance at other companies.

Given the lack of rapid economic growth, it is corporate governance – which is becoming a key market positioning driver for com-panies both domestically and internationally - that investors currently focus on as one of their main priorities. State-owned en-terprises can and should play a pivotal role in this process.

The independent expert evaluation and the monitoring of key corporate governance practices during their implementation could add momentum to these processes at companies, which will ultimately have a positive effect on the capitalization of the Russian corporate sector and serve as an additional source of information on the level of corporate governance at the companies for their shareholders and decision makers, including those who take policy decisions.

Considering the results of this study, it seems important to extend this research experience to other companies and to develop professional educational programs aimed at enhancing the skills and competencies of corporate governance experts.





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Glossary AC Audit Committee of the Board of Directors / Supervisory Board

ADR American Depositary Receipt

BoD Board of Directors of the Company

BoDC Board of Directors committee / Supervisory Board committee

CEB Collective executive body (Management Board) of the company

CEO Chief Executive Officer, the sole executive body of the company, General Director (chairman of the Management Board)

CFO Chief Financial Officer, financial director

CG Corporate governance, a concept encompassing the system of relations between the joint stock company’s ex-ecutive bodies, Board of Directors, shareholders and other stakeholders. Corporate governance is an instrument for setting objectives, determining means to achieve them and ensuring effective control by shareholders and other stakeholders over the company’s activities (the 2014 Corporate Governance Code)

CGC, CG Code Corporate Governance Code, a document approved in 2014 by the Bank of Russia and the Government of the Russian Federation and recommended for application by joint-stock companies listed on the organized securi-ties market

COO, CRO Chief Operation Officer, Chief Risk Officer

CTS Quasi-treasury shares, shares issued by the company and belonging to its subsidiaries and controlled entities

DP Dividend policy, a by-law of the company formalizing its policy in relation to the amount and payment of divi-dends

DSU (DSP) Deferred stock / share units (deferred stock / share plan), similar to RSU, but with different terms of accrual (using part of annual bonuses instead of separate motivation programs)





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EACC Earnings after cost of capital

EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization

EBITDAR Earnings Before Interest, Taxes, Depreciation, Amortization and Rent/Restructuring Costs, a financial analytic indicator reflecting the company’s financial performance result unadjusted for the capital structure (interest paid on borrowed capital), tax rates, amortization and rental payments/restructuring costs/operating lease ex-penses

EEI Index Edison Electric Institute Index measuring TSR at 56 privately held power companies in the U.S.

EPS Earnings per share, the ratio of net profit available for distribution to average annual number of ordinary shares

ESG Environmental Social and Governance, the policy and approaches ensuring the observance of standards related to environment, social responsibility and corporate governance

ESOP Employee stock ownership plan

FCF Free Cash Flow, the cash flow from current operations net of the fixed asset investment cash flow

FNH Foreign nominal holder

Free float A ratio showing the proportion of all securities of the company in free circulation among private shareholders on the stock market

GSM (AGM, EGM)

General shareholders meeting, annual / extraordinary general meeting

HRRC, HRC, RC, NC, NRC

Human Resources and Remuneration Committee (HR Committee, Remuneration Committee, Nomination Commit-tee, Nomination and Remuneration Committee) of the Board of Directors / Supervisory Board

IA

internal audit, provision of objective and independent guarantees and advice to corporate management bodies aimed at improving the company’s activities based on a systematized and consistent approach to evaluating and increasing efficiency of risk management, internal control and corporate governance systems. Also, it means the relevant activity of the company’s structural division (divisions, auditors) performing this function.





ECONOMICS

IAC Internal Audit Commission of the company

IAD (IAS) Internal Audit Division (Department, Service), a structural division exercising the internal audit function

IAS Internal audit service of the company

IC (ICS) Internal control (internal control system), a set of organizational measures, methods and procedures used for keeping records of the company’s financial and economic activities, detecting, correcting and preventing errors and any distortion of information, preparing management and financial (accounting) statements, preventing of wrongdoing, abuse and violations committed by employees and contractors and causing damage to the compa-ny. Also, it means the relevant activity of the company’s structural division performing this function.

IFRS International financial reporting standards

INED Independent executive director, a member of the Board of Directors/Supervisory Board (BoD) meeting the appli-cable independence criteria stipulated by the MICEX Stock Exchange Listing Rules (for PJSCs) or other relevant independence criteria (for foreign companies), or a BoD member not meeting such requirements but recognized by a Board of Directors resolution as an independent director deemed to be capable of independent judgment despite the failure to meet the independence criteria

KPI, KPIs key performance indicators (for the purpose of this study), a system of corporate and individual target perfor-mance indicators of the company used in the system of business planning and/or in the corporate senior man-agement motivation system

LTDP Long-term development program, an in-house policy document of a company in which the Russian Federation holds a controlling interest adopted pursuant to the Government of Russia’s resolutions on the development and audit of long-term development programs; this document provides for sets of resources and measures to ensure achievement of the company’s strategic development objectives and includes current and expected per-formance results of the company, its subsidiaries and controlled entities.

LTIP (STIP) Long-term (short-term) incentive plan for the company’s management

NP Net profit

Payout ratio The ratio of dividend payments to net profit (earnings) of the company





ECONOMICS

PJSC Public joint-stock company; a company under review, for the purpose of this study

PJSC Group The PJSC and the companies directly or indirectly controlled by it, belonging to its group identified in accord-ance with the competition law and the law on joint-stock companies

PRI A United Nations-supported organization whose mission is to put principles for responsible investment into practice

Proxy advi-sory firms

Companies providing investors with recommendations for voting at shareholders meetings (for example, ISS / Institutional Shareholder Services, Inc.)

RAS (Russian GAAP)

Russian Accounting Standards / Russian Generally Accepted Accounting Procedures

RM (RMS) Risk management (risk management system), a set of organizational measures, methods and procedures used for managing the principal risks arising from the company’s business activities (detecting and preventing risks, mitigating effects of their materialization)

ROACE Return on Average Capital Employed, the ratio of net profit net of dividends per preferred shares to average shareholder equity

ROCE Return on Capital Employed, the return on equity and long-term borrowings (long-term credits and loans) in-volved in commercial operations equal to the ratio of profit before taxes and interest to average annual value of equity capital and long-term loan liabilities

ROIC Return on Invested Capital, the ratio of net operating profit (earnings from current operations net of operating expenses and profits tax, according to fiscal accounting data) to average annual value of aggregate invested capital (equal to net working and fixed assets involved in core activities or equity plus long-term debt)

RSU Restricted stock (share) units, phantom shares, conditional units corresponding to a certain number of shares (and dividends for a certain period of time) used for management motivation purposes. RSUs are accrued at a certain moment or upon expiration of a certain period of time (including the moment of resignation/dismissal), subject to the manager’s compliance with certain conditions (clawback/malus provisions) not related to KPIs. The accrual of RSUs usually depends on the manager’s annual salary and the stock market price at the time of accrual. Sometimes RSUs are used as equivalent to PSUs / DSUs





ECONOMICS

SB Supervisory Board of the company

SEB Sole Executive Body of the company (General Director / Chief Executive Officer, Chairman of the Management Board, management company)

SM Senior manager

TSR Total Shareholder Return, equal to the stock market price change plus dividends for the period

UK Stewardship Code

A document defining the role of shareholders and their relationship with the Board of Directors aimed at ensur-ing good corporate governance, creating value and achieving the company’s long-term development objectives. The UK Corporate Governance Code defines the corporate governance principles related to activities of the Board of Directors and the company’s management team.

© Federal State-Funded Institution of Higher Education ‘National Research University Higher School of Economic’ (NRU HSE) 2017; NRU HSE has the exclusive right to this report

http://universal_en_ru.academic.ru/2455953/total_shareholder_return


Research report on PJSC ALROSA

as of 09/30/2016


RESEARCH LABORATORY FOR BUSINESS COM-

MUNICATIONS, NATIONAL RESEARCH UNIVERSITY


RESEARCH REPORT ON PJSC ALROSA / 2 Association of Institutional Investors (API)




ECONOMICS

33.03%

25.00%

8.00%

33.97%

Breakdown of voting shares

Russian Federation (Rosimushchestvo)

Ministry of Property Relations of Sakha (Yakutia)

Local government authorities of the Yakutia's districts (uluses)

Free-float

Brief capital structure overview

The Company has the most interesting share capital structure in terms of corporate governance (CG), with real opportunities to balance the interests of all major groups of shareholders. All 3 groups (institu-tional investors, Russia’s Federal Agency for State Property Manage-ment / Rosimushchestvo and Yakutia) are actively involved in the company management: for example, each group nominates and elects Supervisory Board members, implementing their CG approaches. The Company takes a progressive approach to the Supervisory Board (SB) formation: each group elected independent directors (INEDs) (three INEDs were elected by the Government, one by the Sakha Republic (Yakutia), and one by investors).

After the sale of the Government’s 10.9% stake in July 2016, the free float exceeds the Government’s interest. 5.7% shareholding is required to elect 1 INED, at least 6.3% per INED for 2 INEDs (prior to the SPO). After the SPO, at least 11.4% is required to elect 2 INEDs.

At the 2017 AGM, the shareholders are expected to reform the Supervi-sory Board based on the post-SPO share capital structure. To preserve the current balance of power (the relationship between INEDs and directors representing shareholders), minority shareholders (institu-tional and portfolio investors) need to consolidate their votes to elect at least 2 INEDs (currently one is elected).

Corporate governance self-assessment According to the company, ALROSA complied with 65, partially com-plied with 11, failed to comply with 3 out of 79 principles and recom-mendations of the Corporate Governance Code in 2015.





ECONOMICS

Summary of CG practice +

5 of the 15 Supervisory Board members are independent (INEDs), 3 of them are extremely active and complement each other, the senior INED properly coordinates the work of all INEDs with the management and the Government’s representatives; INEDs often express their own meaningful opinions and do not always vote as proposed by the management; the Government’s representatives respect their opinions; regional and federal officials sometimes disagree – INEDs’ votes decide on the outcome of the voting then;

corporate by-laws reflecting most of the CG Code recommendations were approved or re-approved at the AGMs in 2015-2016;

according to the dividend policy, the Company normally earmarks at least 35% of the consolidated IFRS net profit for dividends;

the SB has developed and approved a special procedure for preparing materials concerning related-party transactions proposed for approval at Supervisory Board meetings (an exceptional case!);

advanced information disclosure, including disclosure of material terms of most of approved related party transactions and individual voting for each Supervisory Board member;

the list of reasons for recognizing Supervisory Board members’ related-party interest in transactions is expanded: a Supervisory Board member qualifies as a party in interest if the member or his/her affiliate has managerial authority at the company’s counterparty, even if being tech-nically outside its executive bodies;

major related-party transactions of controlling entities are subject to prior consideration by INEDs whose positions are included in SB materials;

the company has created all conditions for the development of an independent internal audit system accountable to the Committee for Audit mostly composed of INEDs;

(conditionally positive) the Articles of Association provide for the Supervisory Board’s authority to manage quasi-treasury shares (pro-posals to agendas of GSMs and SB meetings, voting quasi-treasury shares at GSMs). The Company currently has no quasi-treasury shares, the SB must refrain from voting them should they appear.

- the Company does not disclose the top management remuneration

system and the relation of payments to specific KPIs (disclosure of target and actual KPIs);

according to INEDs, development of the long-term motivation system is taking too much time to complete; a system making a substantial part of the total management compensation contingent on the mar-ket cap is required;

according to INEDs, there is a lack of attention from the SB to the Company’s development strategy; meaningful annual strategic ses-sions involving the management and SB members are necessary (in our opinion, the acknowledgment by SB members of their insufficient involvement in strategy-related matters is rather a positive factor: the first case of SB members’ self-criticism in our experience);

due to the principal shareholder’s (the Government of Russia) failure to nominate candidates to the Company’s control and management bodies in due time (as was the case in 2015), the Company misses deadlines for the consideration of matters by the SB and is unable to timely disclose relevant information;

information on the persons proposing agenda items for GSMs is not disclosed;

the CGC recommendations for to set forth the need for a qualified majority of SB members or the majority of elected SB members’ votes in the Articles of Association are only partially followed (4 of 10 key issues in terms of the Code were addressed).





ECONOMICS

81,7

91,2 87,5 89,8 88,5

18,3

8,8 12,5 10,2 11,5

74,7

32,3

47,7

37,8 43,3

2013 2013 EGM 2014 2015 2016

%, government/local authorities (proportion of quorum)

%, private shareholders (proportion of quorum)

Proportion of private shareholders taking part in the general meeting

General shareholders meeting: activity and shareholder voting policies

In 2015-2016, over 85% of shareholders took part in GSMs, the participation ratio for portfolio and institutional investors was 40% of the free float. For 2 years, institutional investors have nominated and elected independent director Maria Gordon as a Supervisory Board member. The Govern-ment’s representatives and the management welcome this practice. The key problem for institutional investors is nomination: not all investors are willing to undergo internal compliance procedures for candidate nomination purposes, many come across problems exercising their shareholder rights through foreign nominal holders where their shares are taken account of on a joint account with other clients. In this respect, shareholders highly appreciate the majority shareholder’s (the Government) assistance in nominating independent directors. Voting at a GSM is much easier for shareholders than nomination of any candidate.





ECONOMICS

Information on ALROSA shareholders according to Bloomberg data and disclosures by shareholders

Shareholder Name Voting stake

Comment on voting

RUSSIAN FEDERATION 33.03 No voting policy, Rosimushchestvo votes as instructed by the Government of Russia. SAKHA REPUBLIC 25 Voting policy is not available (not disclosed)

ADMINISTR. DISTRICTS OF SAKHA REPUBLIC

8 Voting policy is not available (not disclosed)

MASSACHUSETTS MUTUAL LIFE INS

2.72 Voting policy is not available (not disclosed)

LAZARD LTD 1.19

Commitment to ESG factors is disclosed and related approaches to voting specified, among others. The share-holder follows recommendations from proxy advisory firms. The standard approach assumes that the share-holder takes part in voting and votes, in particular, for independent directors. Voting is not publicly disclosed, the company publishes an aggregate report for the corporate season (year/quarter). No participation in nomi-nation of candidates to the Board of Directors (BoD) / SB.

VANGUARD GROUP 1

At the 2016 AGM, the shareholder voted for the INED nominated by minority shareholders. The shareholder discloses its approaches to voting at GSMs as well as the way it voted in the last corporate season. The share-holder does not nominate BoD/SB candidates, but supports, according to the generally disclosed approaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years, for example. The shareholder follows recommendations from proxy advisory firms.

JPMORGAN AM/IM 0.95 The shareholder annually discloses the voting policy in various regions (North America, Europe, Middle East, Africa, Central America, South America, Asia). The voting takes into account recommendations of regional CG Codes. The actual voting data may be provided at the client’s request within 7 years.

GENESIS ASSET MANAGERS LLP

0.86 The shareholder joined other shareholders in nominating and electing independent directors at the AGM in 2016. The shareholder publicly discloses the voting policy, its commitment to the UK Stewardship Code and ac-tual voting results at the AGM in the last 5 years. Recommendations of proxy advisory firms are followed.

CAPITAL GROUP COMPA-NIES INC

0.81 The shareholder discloses the general voting policy and sometimes mentions the voting. Actual voting results are only disclosed as requested by the client.

BLACKROCK 0.76 The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies. Information on voting in the last corporate season is disclosed. The shareholder did not vote at the AGM in 2016. Recommendations of proxy advisory firms are followed.

NORGES BANK 0.63

At the 2016 AGM, the shareholder voted for an independent director nominated by minority shareholders. The shareholder discloses the voting policy and the way it actually voted in the last 4 years. The shareholder has so far not nominated BoD/SB candidates in Russia, unlike other countries. Recommendations of proxy advisory firms are followed.

EAST CAPITAL ASSET MANAGEMENT AB

0.47 ESG factors are taken account of in the investment policy; the shareholder actively nominates and votes on candidates, including active participation in ALROSA’s general shareholders meetings. The shareholder is a signatory of PRI.





ECONOMICS

General shareholders meeting: disclosure of information

+ the materials related to GSMs are disclosed in the English and Russian

languages 30 days prior to such a meeting, according to the rules of corporate by-laws;

the materials indicate the persons proposing candidates to the Supervisory Board and the Auditing Committee (AC);

a list of amendments, including the rationale for changes, is attached to the Company’s restated by-laws;

the timeframe for proposing agenda items and candidates to the SB/AC is increased to 75 days, one of the longest deadlines among Russian companies;

the annual report provides data on related party transactions approved by the Supervisory Board and the GSM in the reporting year, including information on the transaction counterparty, parties in interest and the corporate body approving the transaction.

-

the materials related to GSMs: - do not provide information on the proposed remuneration

payable to auditors for audit and non-audit services and other material terms of the contracts with auditors, as well as details of the tenders for audit services, including tender participants and their bids, as required by clause 5.4.5 of the General Meeting of Shareholders Regulation, in the section of auditor-related information and in the explanatory note);

- do not disclose information on the persons proposing GSM agenda items, except for candidates to the SB/AC;

- do not provide meaningful explanations and the economic feasibility of allocating some of the net profit for corporate needs. The profit distribution is actually based on the Gov-ernment’s instructions and laws, as well as the requirement of the dividend policy (approved in 2013) to earmark at least 35% of the net profit according to IFRS standards for divi-dends.

Notes on the results of voting at GSMs

A review of the 2015 general shareholders meeting (GSM) voting results revealed a substantial percentage of ballot papers recognized as invalid: 2.44% in the process of election of SB members (the cost of this package being RUB 16.6 billion as of 09/30/2016), 1.18% (RUB 7.5 billion) in the process of approving the restated Articles of Association and profit distribution. Given the cost of the packages, the errors were most likely committed either by portfolio investors when instructing the custodians or by the custodians when converting the client’s instructions into the marks in the ballot paper. Such cases, anyway, pose risks of an adverse voting outcome for shareholders, for example, when SB members are elected (2.44% is almost one-half of the SB passing score).





ECONOMICS

Supervisory Board

SB Chairman Anton Siluanov (representing the Russian Federation), the Ministry of Finance of Russia; no shareholding in the Company;

Chair of the Committee for Audit Maria Gordon* (INED) no shareholding in the Company;

Senior independent director Oleg Grinko* (INED) Adviser to CEO on investments and external relations, PERESVET-Invest Group, no shareholding in the Company;

______________________________________

Oleg Fedorov* (INED) Adviser to Head of Rosimushchestvo (on a voluntary basis) no shareholding in the Company;

Chair of the Committee for HR and Remuneration Valentina Lemesheva (INED) no shareholding in the Company;

Pavel Ulyanov (INED) Head of the Energy Business, RUSAL Global Management B.V., no shareholding in the Company.

* The API was able to meet with 3 of the 5 INEDs. Please find below the summary of SB members’ comments including the API’s expert opinion based on the results of these meetings. We appreciate the members’ participation in the interview and believe that such annual meetings with investors, shareholders are extremely useful for assessing the SB performance and making decisions on the voting for SB candidates at GSMs, among other things.





ECONOMICS

Supervisory Board (SB): domestic and international practice

*The basic component of remuneration of members of PJSC ALROSA’s Supervisory Board is below that of peers referred to above.

SB activity aspect Anglo American plc Rio Tinto plc Dominion Diamond Corpo-

ration PJSC ALROSA

INEDs/total number of SB members

9 of 12 (no more than 13 under the charter)

9 of 12 6 of 9 5 of 15

Participation in meetings of SB and committees in 2015 (attendances/no. of meet-

ings)

BoD: 6 meetings, two BoD members missing 1 meeting each. Audit and Remunera-tion Committees: 4/4, 3/3

(100% attendance)

BoD: 100% (9 meetings); Au-dit and Remuneration Com-mittees: 100% attendance.

BoD: 100% participation in 31 meetings, except for 3 BoD members missing 1, 2 and 3

meetings, respectively. Committees: 100% participa-

tion

SB: 6 of 15 meetings were held in presentia. (Note: the attendance report contains contradictory figures). Audit and Remuneration Commit-

tees: 100%, with cases of participation in physical

meetings through expres-sions in writing.

Remuneration of SB mem-bers, actual payments based

on 2015 performance

Subject to revision every 5 years, 5% adjustment for

inflation possible. Actual remuneration: £724 thousand to Chair of the

BoD, £110-140 thousand to chairs of committees, £80 thousand to SB members.

Basic component: £750K to Chair of the BoD, £90K to BoD member, additional

payment of £40K to INED, £35K to Chair of Audit Com-mittee, £20K to Audit Com-

mittee member, £30K to Chair of Remuneration Com-mittee, £15K to Remunera-tion Committee member. Actual: $1,116K to Chair,

$218K-340K to members* data disclosed in US dollars

Basic component (2017): C$80K to BoD member +

C$1,500 per meeting, C$15K to Audit Committee member,

C$10K to Remuneration Committee member +

C$1,500 per committee meet-ing, additional payment of

C$20K to senior INED, initial grant in phantom deferred stock C$50K (in case of BoD membership termination). Actual payments (2016):

C$116K-182K, (smaller pay-ment to new SB members)

Basic component: RUB 4 mil-lion, bonus payments to SB

Chair (+50%) and in the Committee (+20%). Deduc-

tions for non-attendance of meetings. Actual payments: RUB 3.4-6 million to each SB member entitled to remu-

neration.

RESEARCH REPORT ON PJSC ALROSA / 9 RESEARCH LABORATORY FOR BUSINESS



ECONOMICS

Association of Institutional investors (API)

Supervisory Board: practical activity aspects

In the period under review (2015, 9 months of 2016), the SB held 23 meetings, 8 of them (35%) in the form of joint attendance. 32% of all the agenda items addressed were related-party transactions for a total amount of more than RUB 6.4 billion and $711 million, including a loan agreement with Vilui Hydroelectric Station-3 in the amount of RUB 5.5 billion at a rate of 0.5% p.a. to be repaid by installments from 2016 to 2021, 2 BoD members voted “Against” (one of them being ac-tive re-elected INED) and 1 “Abstained”.

In this period, the Supervisory Board addressed the following signifi-cant issues:

reports and changes to the long-term management program to 2023 (2 issues);

approval and adjustment of KPIs and the Company’s consoli-dated budget (3 for each);

remuneration of the management team (5); internal audit-related issues (7); charity (4 issues, including 1 of systemic relevance, namely,

the efficiency of these expenses). Independent directors (INEDs) confirm the need for the SB to pay closer attention to strategy development, including scenario fore-casts. The current Supervisory Board members have initiated an up-date of the company’s strategy, to be completed in 2017. Among other things, mandatory full-fledged “strategic sessions” for the manage-ment and SB members and more intensive marketing and research activities are being considered. In fact, the Supervisory Board ad-dressed the long-term development program twice, one of the issues in absentia. Of particular note is also the absence of disclosed information on the consideration of matters pertaining to the risk management system in the period under review, including related reports. The only thing mentioned is the approval of a risk management regulation.

The senior independent director has taken a more principled approach insisting that it is the Supervisory Board that should lay down the corporate strategy, rather than the management team and/or hired consultants. “Shaping a strategy is the prerogative and responsibility of the Supervisory Board - the consultants cannot draw up a strategy without the company, and the management team without the in-volvement of executors at the upper or lower level.” One of the INEDs adds that the Company should have own proper information sources in addition to consultants. In our opinion, this is one of the most active Supervisory Boards, as evidenced, among other things, by feedback from the INEDs appreci-ating the high activity and good preparation of SB members repre-senting the Government, the Sakha Republic (Yakutia) and of INEDs themselves for SB meetings and their willingness to collaborate with the management team on a full scale at Committees and directly. Due to a major replacement of SB members nominated by the Government in 2015, the SB needed a period of adaptation which ended in the 2015/2016 corporate year (the SB approved an inauguration program for newly elected SB members). The SB Chair is committed to pragmatism in managing the Board, hearing both representatives of the Sakha Republic and INEDs. Agen-da items can be adjusted during consideration, the Chairman consist-ently takes appropriate action to resolve conflicts of interest, in case of imbalance in the interests and opinions of SB members. The num-ber of convened physical SB meetings is sufficient, INEDs welcome the chairmanship of the Government’s representative as their opinions are taken account of, even though many decisions are approved by a simple majority vote. There is no communication between the Chair-man and the INEDs outside SB meetings, but INEDs confirm that the Chairman responds almost immediately to their requests or pro-posals.





ECONOMICS


The senior INED competently monitors and coordinates INEDs’ activi-ties, constantly interacts with the management so as to increase the overall performance.

The Chair of the Committee for Audit (INED) especially noted the ex-tremely high activity and proficiency of the senior INED Oleg Grinko and INED Oleg Fyodorov. We also appreciate the extremely positive impression from the contacts with all three INEDs. In 2015-2016, the INEDs visited the Company’s main production facilities and major cus-tomers (site holders) in Europe and Asia. While yielding better under-standing of process flows and business processes, this also contribut-ed essentially to the development by the SB of a sales, marketing and motivation system for the Company. We recommend that these INEDs engage in the Company’s investor relations so as to demonstrate, among others, an effective SB and to present an independent opinion on the CG system efficiency. According to the INEDs, no such practice currently exists at the Company.

The SB motivation, according to INEDs, is drastically lower. SB mem-bers are not motivated to serve on the committees, decisions on payments are made at the AGM at the end of the year, not at the beginning.

The SB and the management team are considering a long-term motivation system for the management linked to the Company’s stock price, but the preparation and approval process is clearly longer than expected (several years). In the meantime, the Company has a short-term remuneration system (up to 1 year) linked, among other things, to a list of financial performance results. INEDs highly appre-ciate the short-term motivation system, but understand the need for a long-term remuneration component.

We note the Company’s controversial practice of adjusting the KPIs and annual budget parameters relating to the reporting period 1 month before the reporting period ends.

For instance, as part of the disclosure procedure, the SB considered adjusted KPIs and 2015 budget parameters on November 19, 2015! Ac-cording to disclosed materials, the budget was adjusted to reflect changes in the diamond market environment and macroeconomic fac-tors, including the inflation rate and exchange rates. ALROSA’s dia-mond production guidance was confirmed at 38 million carats. Sales plans were revised based on the global diamond market activity. Ac-cording to INEDs, some of the SB members opposed this practice. Re-sponding to our inquiry, the INEDs commented that the SB subse-quently adopted the top management’s proposal to motivate the Company’s middle managers, but a decision was also made to reduce the bonuses payable to top managers (members of the Management Board), assuming their joint partial responsibility for the Company’s performance result. The need for such adjustments one month before the end of the reporting period remains an open question; in our opinion, the Company should better abandon this practice.

According to INEDs, no benchmark is used consistently for business planning, KPI determination and motivation purposes.

Committee for Audit

The Committee for Audit is mostly composed of INEDs (3 of 5). Its Chair is also an independent director (INED).

Despite the CGC recommendation to have a Committee for Audit composed entirely of INEDs, the Chair is comfortable with some of the members representing the major shareholders. All members of the Committee for Audit show adequate commitment.





ECONOMICS

Committee for Audit (continued)

According to the Chairman of the Committee for Audit, the approved work schedule of the internal audit department is extremely tight, with risks of underperformance given the current workforce and amount of financing. The committee suggests an independent audit of the internal audit system efficiency and separation of internal con-trol.

Our recommendation is to consider the Committee for Audit’s participation in the hotline handling possible abuse issues.

Committee for HR and Remu-neration

The Committee for HR & Remuneration entirely consists of independ-ent directors (INEDs). The HR & Remuneration Committee has the standard scope of author-ity, the range of issues it considers is consistent with the general practice.

Among other things, the HR & Remuneration Committee addressed performance assessment of SB members; according to INED infor-mation, an independent consultant was engaged for that purpose in 2014. The proposal of SB candidates for the following corporate year to the shareholders was not considered or formalized.

Supervisory Board’s best practices concerning related-party transactions The SB has approved the requirements for the preparation of materi-als concerning related-party transactions submitted to the SB and the GSM for approval:

the draft resolution should contain information on the parties to the transaction, the type of the contract, the subject and all material terms of the transaction, including the deadline for the performance of obligations under the transaction, the total amount (limit) and the price of the subject matter;

rationale for the counterparty as the sole supplier; comparison of its prices for ALROSA with those offered to other consumers and/or cal-culation of the supplier’s estimate profit rate. The materials for a SB meeting should include the following: a) information justifying the price of the transaction (a valuation re-port or results of a market price research, including information on the procurement procedure (bidders, final bids, description of the pro-curement procedure, main selection and assessment criteria, pro-curement identification data), or reasons for the omission of pro-

curement procedures or for non-competitive transactions (if any) and alternative transaction options, with documentary evidence attached); b) information on the compliance of the transaction submitted to the SB for approval with the Company’s consolidated budget; c) economic effect of the transaction (profit, cost reduction, etc.), with relevant justification; d) counterparty details (capital structure, share of transactions with ALROSA in the counterparty’s total earnings, ROE); e) information on the parties in interest in relation to the transaction; f) minutes of the meetings held by SB committees which included preliminary consideration of the transaction. Of special note is an expanded list of reasons for recognizing SB mem-bers’ related-party interest in transactions: a SB member or his/her affil-iate vested with managerial authority at the company’s counterparty while being technically outside its executive bodies qualifies as a party in interest.

RESEARCH REPORT ON PJSC ALROSA / 12





ECONOMICS

Essential CG aspects

Regulation on the SB activity The Company’s Articles of Association determine the structure of the SB authority, depending on the quorum required for decision-making. Corporate by-laws (internal documents) do not require that the key issues be only considered at physical meetings, but formulate a num-ber of issues where resolutions can only be passed by a qualified ma-jority or a majority of all elected SB members. Most of such issues, however, are subject to “stricter” quorum requirements under the law. Dissenting opinions of SB members are attached to the related minutes of the SB meetings as integral parts. SB members have the right to propose alternative draft resolutions on issues considered. The Company has approved an inauguration program for newly elect-ed SB members (although the results of its implementation, if any, remain undisclosed).

Engagement with external auditor ALROSA selects external auditors through bidding. The SB and the Committee for Audit set the initial (maximum) price the Company is ready to pay for audit services. In 2016, JSC PricewaterhouseCoopers Audit won the bidding for the right to audit ALROSA’s statements based on RAS (Russian GAAP) accounting standards in 2016-2018 (the cost of services is RUB 22.5 million, 64.4% of the initial bid price) and the consolidated financial statements of ALROSA Group based on In-

ternational Financial Reporting Standards (IFRS) in 2016-2018 (RUB 81 million, 75.2% of the initial price). In 2015, FBK audited ALROSA’s RAS statements (the cost of services was RUB 8 million, plus RUB 2.9 mil-lion paid for the additional long-term strategy audit, RUB 3.4 million for the actuarial valuation), while JSC PricewaterhouseCoopers Audit audited the Company’s IFRS statements (the cost of services was RUB 24.75 million).

ALROSA will not disclose the specifics of interaction between mem-bers of the SB Committee for Audit and auditors (holding Committee meetings or meetings with auditors without the management’s repre-sentatives in attendance, principles of interaction during competitive auditor selection procedures, proportion of the cost of non-audit ser-vices in the total contractual obligations).

Dividend policy

The Company has approved and officially disclosed (on the website) its dividend policy. The SB passes recommendations on the amount of dividends by a three-quarter majority vote. The basic principle the SB follows is that the Company should earmark at least 35% of the net profit under consolidated IFRS financial statements. In 2015, the divi-dend practice was based on the Government’s instructions and met the target level of 50% of the consolidated profit, which brings the Company close to its foreign peers in terms of dividend payout.

The Company, just like most of PJSCs in Russia does not pay interim dividends, as opposed to foreign peers.

million USD / million £ / million USD / million rubles

Anglo American plc Rio Tinto plc Dominion Diamond Cor-

poration PJSC ALROSA

2015 profit (incl. 2014 for Rio Tinto plc) -5,624 5,661 67.09 30,674

2015 dividends (including interim dividends) 1,078 5,892 34.05 15,393 Payout ratio (the ratio of dividends to earnings) - 104% 51% 50%





ECONOMICS

Essential CG aspects (continued)

Charity & social responsibility The Company operates in 9 regions of the Russian Federation, its headcount exceeds 30,000 employees. According to the survey, the SB pays due attention to these issues formulating its recommendations to the management on the charity process regulation. The SB supports the management team in the de-velopment of social obligations to ensure stability among employees and in the region of operation. In 2015, ALROSA provided financial, pat-ronage, sponsor and targeted support in the amount of RUB 2,573.9 million; RUB 81.7 million were spent under the program of regional development of the Sakha Republic’s (Yakutia) uluses (districts) in 2015, RUB 208.5 million under the “Culture and Sports” program, RUB 245.4 million under the “Health” program, RUB 876.1 million under the

“Health Resort Treatment and Recreation” program (including RUB 717.1 million out of the Company’s profit) and RUB 1,121.9 million under the “Housing” program. In 2014-2015, ALROSA’s expenses for anniversary celebrations (the 50th anniversary of the Mirninsky district, the 60th anniversary of Mirny town and the diamond mining industry, the 70th anniversary of Rus-sia’s Great Victory) exceeded RUB 1 billion. Expenses incurred by conditional peers

- Anglo American plc: $124.15 million under the “Corporate social investment” program in 2015. - Rio Tinto plc: $184 million under the “Communities and Social Performance” program in 2015.

Disclosure of information on the management remuneration system at ALROSA’s international peers

Disclosure: in 2015, members of the Company’s Management Board received the following payments: RUB 229.1 million in salaries, RUB 396.3 million in premiums, RUB 103.7 million in compensations and other benefits. The annual report discloses the Company’s key performance indicators; how they are pegged to the payments remains undisclosed. The motivation system is not described.

Approximate ratio of the CEO remuneration at

ALROSA to peers in 2015 Anglo American plc Rio Tinto plc

Dominion Diamond Cor-poration

PJSC ALROSA

Fixed component 42% 27% 35% 37%

Bonuses (annual) 32% 45% 16% 63% Long-term 26% 28% 49% 0%

RESEARCH REPORT ON PJSC ALROSA / 14 Association of Institutional investors (API)




ECONOMICS

Disclosure

The company does not disclose the top management remuneration system, including the dependence of actual payments on the achievement of key performance indicators. In our opinion, taking into account international practices, the Supervisory Board should at least consider disclosing the top management remuneration system, includ-ing the fixed and variable parts, long-term and short-term motivation components and the dependence between payments in the reporting period and the KPI achievement. The Company’s independent directors also highlight the need to implement a long term-term motivation system.

Mandatory information disclosure by the company is in accordance with the law. Disclosure of the individual voting by SB members in reports on the resolutions passed by SB should be viewed as good practice. Besides, in most cases where related-party transactions are approved by the SB, the Company discloses essential parameters of such transactions (including the parties to it, amount/limits, party in interest), which should also be regarded in a positive way.

Anglo American plc Rio Tinto plc

Dominion Diamond Corpo-ration PJSC ALROSA

Disclosure, all payment, incl. in the form of stock, estimates of future pay-ments

CEO, CFO, CTO CEO+CFO (including calcula-tions) + 8 key managers, with-

out calculations

6 top managers Members of collective executive body in aggregate, including sole

executive body (CEO)

KPIs influencing the short-term (annual) vari-able remuneration com-ponent (incl. the KPI rela-tive weight, if any)

50% and higher: EPS; under 50%: individual

KPIs linked to the strate-gy, less reduction if safe-ty targets are not met.

Safety 20%, base profit 12.5%, adj. base profit 12.5%, FCF

12.5%, adj. FCF 12.5%, individual component: 30% (Business

transformation, Development functions, Cost and capital

reductions, performance deliv-ery, Leadership and engage-

ment)

Safety 24%, turnover ra-tio reduction 10%, EBITDA 33%, actual production /

target 16.5%, cost per tonne produced 16.5%, individual component:

25%

N/a Based on annual report: TSR, in-

crease in dividends, adjusted EBITDA margin, ROE, net profit, production,

revenue, cost of sales/revenue, acci-dent, net debt/EBITDA

KPIs influencing the long-term variable remunera-tion component

50%: ROCE, 50%: TSR of leading peers in industry

and UK

TSR in relation to Euromoney Global Mining Index, TSR in relation to Morgan Stanley Capital World Index (MSCI),

EBIT margin vs. peers (33.3% each)

Strategic performance indicators + TSR + EBITDA

Depends on the policy adopted, n/a

Long-term bonuses money +shares + phan-tom stock (3+2 years)

Money + deferred stock (3 years)

Money + shares + option Money


Research report on PJSC AEROFLOT

as of 09/30/2016


RESEARCH LABORATORY FOR BUSINESS COMMU-

NICATIONS, NATIONAL RESEARCH UNIVERSITY


RESEARCH REPORT ON PJSC AEROFLOT / 2 Association of Institutional Investors (API)




ECONOMICS

51.17%

3.30%

4.84%

34.49%

6.10%



Rostec Group

Quasi-treasury shares

Institutional & portfolio investors

Individuals

Capital structure

The controlling stake belongs to the Government, the majority share-holder’s effective voting stake in the Company (including the share-holding of a substantial shareholder controlled by it) is 54.47%. The Company has a package of quasi-treasury shares (4.84%) voting for the management team’s representative on the Board of Directors (BoD).

The BoD includes 2 representatives of the management, 6 representa-tives of the Russian Federation and 3 independent directors (INEDs), including 1 INED nominated and elected by institutional and portfolio investors. The free-float and the activity of minority shareholders makes it possible to elect at least 2 candidates to the current BoD. This requires consolidation of 12.5% to 13.5% of the shareholders, de-pending on the quorum.

Corporate governance self-assessment

According to the Company, Aeroflot complied with 64, partially com-plied with 11, failed to comply with 4 out of 79 principles and recom-mendations of the Corporate Governance Code in 2015.





ECONOMICS


The BoD and the management team effectively shape, monitor and implement the Company’s strategy;

3 of the 11 BoD members are independent (INED), 2 of 3 INEDs are well-known to the market as INEDs and open for contact;

at the AGMs in 2015-2016, the shareholders approved new or restated corporate by-laws legally recognizing most of the CG Code recommenda-tions;

high standards of information disclosure for shareholders’ meetings and in the mandatory disclosure system;

the Company has partially implemented the CG Code recommendations as regards the need for a majority vote of the elected BoD members for decision-making on key issues of the Company’s activity (7 of 10 issues) and for considering essential issues at BoD meetings (6 of 19 issues);

the owners of 2% of shares have the right to propose an agenda item for the BoD meeting (the owners of at least 10% have the right to convene a BoD meeting);

the Company uses a “Hotline” system of confidential information delivery to the BoD / Audit Committee (the best practice among the companies covered by the research);

the BoD pays special attention to relations with shareholders and the investment community revisiting this issue regularly (at least once every 6 months);

the Company implements a long-term motivation program (3 years) for executive top managers and other key employees involving finan-cial instruments based on the Company’s shares; payments are con-tingent on the achievement of KPIs and the stock price growth vs. the Company’s key competitors;

a procedure for returning wrongfully / unreasonably received bonus payments exists at the Company (no disclosure).

- despite the recognition of the BoD control over the exercise of rights

related to quasi-treasury shares in the Regulations on the procedure for exercising the rights related to quasi-treasury shares (January 2016, the document is not disclosed, but conditionally positive prac-tice), the actual implementation is purely negative: the voting of qua-si-treasury shares at the AGM has a decisive impact on the election of the management’s representative to the Board of Directors;

the dividend policy (conditionally negative) can be improved; individual voting by the BoD members is not disclosed in notices on

resolutions made by the BoD; the procedure for preparing and submitting recommendations on BoD

candidates to the controlling shareholder is not formalized; ‘Any Other Business’ items are put on agendas of some BoD meetings

without providing specifics: the non-disclosure of their substance implies the possibility of such items covering significant issues with-out prior distribution of related materials;

The Company does not disclose the top management remuneration system parameters, including the correlation between the remunera-tion and the actual achievement of KPIs;

the BoD has no powers in relation to significant aspects of subsidiary companies’ activity (formation of management bodies, approval of corporate by-laws, etc.). As for the BoD members’ access to infor-mation on controlled companies, INEDs do not tend to believe that additional regulation of the process of obtaining information on con-trolled companies is expedient;

The BoD has increased the number of BoD members required for converting the agenda of a meeting in absentia to the agenda of a physical meeting from one to two. Our recommendation is to restore the right of every single BoD member (the best practice among the companies covered by the research!) to request consideration of sig-nificant issues, primarily related party transactions and major trans-actions, at a physical meeting.





ECONOMICS

77,0 76,0 76,0 83,0

23,0 24,0 24,0 17,0

38,0 41,0 41,0

29

2013 2014 2015 2016

%, proportion (in relation to quorum) of Rosimushchestvo

%, proportion (in relation to quorum) of the minority shareholders takingpart in the meeting%, proportion of all the minority shareholders participating in the meeting

General shareholders meeting: activity of shareholders, related party transactions The GSM quorum has been in the range of 71.27%-73.97% in the past 4 years, the lower threshold was reached in 2016. Private shareholders taking part in the meeting (about 27.5% of all minority shareholders) accounted for 17% of the quorum in 2016, which is lower than in 2014-2015. In 2015, the GSM approved 5 related party transactions for a total amount of RUB 92.9 billion and 7 deals worth $1.2 billion. In 2016, the GSM approved 4 deals, including transactions which the Company may effect in the normal course of business in future, in the amount of RUB 92.8 billion/$100K and 1 transaction for the financing of the purchase of aircraft in the amount of $417 million.





ECONOMICS

Information on the shareholders of PJSC AEROFLOT, according to Bloomberg data and information disclosure by the shareholders


Comment on voting

RUSSIAN FEDERATION 51.17 No voting policy, Rosimushchestvo votes as instructed by the Government of Russia.

AEROFLOT-FINANCE 4.84 Quasi-treasury shares, the voting is subject to approval by the BoD since 2016. The quasi-treasury shares usu-ally vote for a management team representative.

EAST CAPITAL ASSET MANAGEMENT AB

1.6 The shareholder takes into account ESG factors and actively contributes to corporate actions. The shareholder nominated 2 INEDs at the AGM in 2015 and 2 INEDs 2016. 1 of them was elected at the AGMs in 2015 and 2016.

PICTET FUNDS 1.27

According to the UK Stewardship Code compliance report published by the shareholder, PICTET FUNDS declares a passive approach to participation in corporate actions (with exceptions possible under certain conditions). The shareholder also declares taking advice from a proxy advisory firm (ISS) for voting purposes. The voting details are not disclosed, but ISS recommended voting for 2 independent directors nominated by one of the institu-tional investors at the 2016 AGM.

ASHMORE GROUP PLC 0.8 The shareholder publishes a UK Stewardship Code compliance report according to which it always votes in the best interests of its clients at shareholder meetings. The shareholder denies using the services of proxy adviso-ry firms. Voting details are disclosed at the client’s request.

HSBC INVESTMENT FUNDS 0.75

The shareholder publicly discloses the history of voting at the AGM since 2013 for most of its funds. At the 2016 AGM, the shareholder voted for 4 independent candidates (3 of them were elected to the BoD), 2 representa-tives of the management (CEO of Aeroflot, CEO of Rossiya airlines) and Chairman of the Aeroflot BoD. The shareholder discloses the global principles of voting at GSMs noting its reliance on best practices when making voting decisions.

PROSPERITY CAPITAL MANAGEMENT UK

0.62 The shareholder is actively involved in corporate actions and implements the responsible investment principles in practice. At the 2016 AGM, the shareholder voted for the candidate nominated by minority shareholders.





ECONOMICS


Comment on voting

ALLIANZ SE 0.53 The shareholder discloses the details of its voting policy and its approaches to voting. The shareholders only discloses voting details for its funds in relation to investments in the US market.

HANDELSBANKEN FONDER AB

0.48

The shareholder discloses the CG policy particularly declaring participation in GSMs of the companies they in-vest in. Voting details is not disclosed. The shareholder discloses a list of companies it does not invest in, along with a list of companies it keeps in touch with over infringements of international standards and principles (to the extent of the ESG philosophy), for instance, this list, among others, includes two Russian companies, Gaz-prom and LUKOIL, with a negative environmental impact referred to as the reason.

BLACKROCK 0.44 The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies. Information on voting in the last corporate season is disclosed. The shareholder did not vote at the AGM in 2016. Recommendations of proxy advisory firms are followed.

NORGES BANK 0.4

At the 2016 AGM, the shareholder voted for two independent directors nominated by a minority shareholder. The shareholder discloses the voting policy and its voting history (the way it actually voted) in the last 4 years. The shareholder has so far not nominated BoD/Supervisory Board (SB) candidates in Russia, unlike other coun-tries. Recommendations of proxy advisory firms are followed.





ECONOMICS

General shareholders meeting: disclosure of information, essential aspects

+ The GSM-related materials are disclosed in the English and Russian

languages 30 days prior to a GSM, according to the standards of cor-porate by-laws;

the GSM-related materials specify the persons proposing agenda items and candidates to the BoD and the Audit Commission;

draft documents are submitted for approval at GSMs with comparison tables attached to them reflecting the changes proposed to separate provisions of such documents and the rationale for such changes;

the timeframe for proposing agenda items and candidates to the BoD and the Audit Commission is increased to 70 days, one of the longest deadlines among Russian companies;

the Company’s annual report includes details on related party transactions approved by the BoD and the GSM in the reporting year, specifying, among others, the counterparty, subject, amount, parties in interest and the management body which approved the transac-tion;

the BoD has a meaningful position on GSM agenda items, unlike most of the similar documents at other PJSCs (whether the Company is ready to disclose to shareholders the dissenting opinions of BoD members on GSM agenda items, should they be expressed, is an open question);

materials related to the approval of related party transactions are informative, disclose the key parameters of the transactions proposed for approval.

- the BoD’ proposal for approving the auditor at the AGM does not

contain any details on the Company’s auditors (except for names), including a description of the selection procedures ensuring inde-pendence and fairness of the auditors, information on the proposed auditors’ fees for all audit and non-audit services (including the cost of their services in the preceding year) and other material terms of the agreements with the auditors. Comment on the results of voting at GSMs

The Company’s shareholders have come across an unreasonable treatment by some of the nominal holders of the sanctions regime imposed by Western countries on certain listed individuals and legal entities. Aeroflot is NOT included in the list of Specially Designated Nationals (the SDN or sanction list), but a member of its Board of Di-rectors is personally included in this list. Some of the custodians pre-vented the shareholders from exercising their rights refusing to exe-cute their clients’ instructions for this reason. In this connection, many of the shareholders wishing, for example, to vote for an inde-pendent director supported by other institutional investors in 2016 were unable to do that. As a result, 3 independent directors were eventually elected, although the election of 4 INEDs (including 2 INEDs supported by minority shareholders) was possible.





ECONOMICS

Board of Directors: international and domestic practice

The remuneration payable to the BoD of Aeroflot includes a long-term motivation component with variable benefits linked to the target level of capi-talization. The practice is quite interesting but controversial as not all CG experts support the BoD members’ participation in such motivation schemes. Of special note is the low amount of base remuneration at Aeroflot versus (conditional) peers. The independent directors also noted the relatively low remuneration of the BoD members.

BoD activity aspect Deutsche Lufthansa AG Delta Airlines Corp American Airlines Group, Inc. PJSC Aeroflot

INEDs/total number of BoD members

20/20 (if all staff repre-sentatives are INEDs), otherwise 16/20

11/14 12/13 3/11

Participation in meetings of BoD and committees in 2015

95%, no further details are disclosed

12 BoD members, attend-ance ratio at least 75%

No data available for committees

6 BoD meetings, attendance ratio at least 75% for BoD and commit-tees (no details disclosed)

BoD held 20 meetings (incl. 9 physical meetings), attendance ratio 100% (including expressions in writing); Audit Committee held 10 meetings (100% attendance), Personnel and Remuneration Committee held 8 meetings (1 non-attendance - 99%)

Remuneration of BoD members / actual pay-ments based on 2015 per-formance* *according to the 2015 annual report

€240K to BoD Chair, €80K to BoD member, €120K to Deputy BoD Chair, €60K to Audit Committee Chair , €30K to Audit Committee members, €40K to head of another committee, €20K to member of another committee Actual: €80-280K

BoD member $90K + $160K in the form of restricted phantom shares (payable at following meeting) $30K to Senior Director $20K to Committee Chair, $10K to Committee mem-ber Actual: $215-518K

$90K to BoD member, $20K to Audit Committee Chair-man, $15K to Audit Committee member, $12.5K to member of another committee, $15K to head of another committee, $30K to senior INED + $140K in the form of restricted stock to each BoD member

Base remuneration: RUB 1.8 mil-lion. Multiples: 4.5 for BoD Chair-man, 2 for Chair of committee, 1.5/2.75/3.75 for member of 1/2/3 committees + bonus for capitali-zation under long-term 2016-2019 program (up to 150% of the base remuneration in total). Actual: RUB 3.1-4.7 million in base remuneration + 2013–2015 stock options plan (RUB 1.1-3.4 million) for the 12-month period.

RESEARCH REPORT ON PJSC AEROFLOT / 9





ECONOMICS

Board of Directors: practical activity aspects

Chairman of the Board of Directors Kirill Androsov (representing the Russian Federation), Managing Director, Altera Investment Fund, no shareholding in the Company. Chairman of the Audit Committee Vasily Sidorov (INED)* General Director, LLC Agency for Recapitalization of Infrastructure and Long-term Assets / ARIDA, no shareholding in the Company.

Chairman of Personnel and Remuneration Committee Igor Kamenskoy (INED) Managing Director, Renaissance Broker LLC, no shareholding in the Company.

Alexey Germanovich (INED)* Member of the Executive Board, Saint Petersburg State University Development Fund, no shareholding in the Company.

____________________________________

The API met with 2 of the 3 INEDs and had an opportunity to communicate with an ex-BoD member (INED until the 2016 AGM). The independent directors who met with us are open to contact with the shareholders.

Please find below the summary of BoD members’ comments, including the API’s expert opinion based on the results of these meetings. We appreciate the BoD mem-bers’ participation in the interview and believe that such annual meetings with the Company’s investors and shareholders are extremely useful for assessing the BoD performance and making decisions on the voting for candidates to the BoD at general shareholders meetings, among other things.






ECONOMICS

Board of Directors: practical activity aspects In the period under review (2015 and 9 months of 2016), the BoD held 31 meetings, including 20 meetings in 2015 (9 physical meetings and 11 meetings in absentia, according to the 2015 annual report). The 2015 disclosure system specifies a different number of meetings (19 against 20 meetings) and does not expressly indicate the form of BoD meetings; from the press releases one could infer that the wording “Chaired by” (Kirill Androsov) implies a meeting held in the form of joint attendance. In the above-said period, the BoD considered 242 issues, including:

approval of related party transactions (102 issues or 42.1%, the BoD considered 151 transactions in the amount of RUB 117,887.9 million and $1,267.9 million, including transactions which the Company could effect in future in the normal course of business, for a total amount of RUB 109 billion, submitted for approval at the AGM in 2015);

implementation of Aeroflot Group’s strategy (5 issues) + several issues considered separately (IT, marketing strategy, development of the Group’s services (4 issues);

consideration of reports on performance results (8 issues); financial plan (6 issues); remuneration of the management team (6 issues); long-term development program (LTDP, 2 issues); KPI (CEO + LTDP) (2 issues); risk management (1 issue).

The Company pays special attention to strategy; according to INEDs, any BoD member can formulate the current priorities of the strategy and identify the present state of the Company. The BoD separately addresses LTDP-related issues (taking into account the Government’s instruction and the Group’s strategy) and focuses on specific aspects (IT, marketing, service) demonstrating a customer-oriented approach which the Company pursued even before the Government’s initiative to make the LTDP a mandatory requirement.

The managers actively collaborate with all BoD members; the sole ex-ecutive body (CEO), according to INEDs, is open to contact, “the dia-logue is at an advanced level typical for a market-minded privately held Company.”

We note that the disclosure system does not contain information on the consideration by the BoD of risk management system-related mat-ters, including related reports, in the period under review. The only case mentioned in the disclosure system is the approval of the risk management regulations. That said, most of the risk management-related issues, including approaches to hedging against forex risks, were addressed at the Audit Committee meetings.

The BoD has approved the long term management motivation program effective from 2016 to June 30, 2019.

The approaches, KPIs and main principles are not disclosed, but, ac-cording to INEDs, the Company is committed to market-oriented poli-cies and practices.

The BoD Chairman is highly committed to the BoD activity: while en-suring a formally sufficient number of physical meetings (virtually every month, except for the generally accepted vacation periods), he also advocates a meaningful approach to work, taking into account the requests and requirements of the BoD members and the Company.

For instance, the Company’s budget for the following financial year is considered by the BoD reasonably in advance and in two stages (ac-cording to the disclosure of corporate actions in 2015-2016), namely, in October and November, based on a preliminary forecast of the Group’s operating performance.

The Company and the BoD make extensive use of benchmarks both in terms of strategy and for setting budget and motivation targets.





ECONOMICS


The presence of the undefined ‘Any Other Business’ item on the agen-da should be regarded as a negative element in the BoD activity. In practice, this item may imply consideration of significant issues with-out providing materials required for decision-making to BoD members in advance. Proceeding from the disclosure materials, the Company’s equity participation in OJSC TRANSAERO was actually included in the ‘Any Other Business’ section. We recommend that the Company aban-don this practice as the required level of secrecy can be ensured through restrictions on the disclosure of information on the most sensitive issues.

The BoD has an experience of voting “against” (in particular, 1 BoD member voted “against” on 5 related party transactions, 2 of the 3 INEDs voted in the negative1 on the Company’s equity participation in OJSC TRANSAERO) and “abstained” (2 BoD members on 2 transactions and one BoD member on 31 agenda items).

The multitude of cases where one of the BoD members voted ‘ab-stained’ on related party transactions and some corporate by-laws proposed for approval (31 times in total), in our view, calls for addi-tional disclosure on the part of Company, certainly including an ap-propriate statement/comment from the abstaining BoD member. We understand that this issue primarily concerns the “dissident” BoD member. The Company represented by the BoD or the management team may provide for the possibility of such disclosure, which would raise shareholders’ awareness of the position of BoD members, while BoD members will have to substantiate their repeated “protest” vot-ing on certain types of issues for all the shareholders.

1 as regards the equity participation in OJSC TRANSAERO, we deliberately requested from the INEDs information on the BoD members voting “against” (Vasily Sidorov and Marlen Manasov, both INEDs), as we regard this very case of voting as a key evidence of the CG system’s efficiency, with truly, not just technically, independent directors in practice.

On a separate note, based on the Company’s comment,2 the BoD made a decision formalized in a corporate by-law which allows any BoD member to request consideration of any issue at a physical meeting, even if the issue is scheduled for consideration at a meeting in ab-sentia. While we certainly commend this practice in terms of the INED efficiency, especially as regards related party transactions, the num-ber and amount of which is essential for the BoD activity, this docu-ment is not publicly disclosed and can be modified by a simple majori-ty vote of the BoD members at any time without appropriate disclo-sure. According to INEDs, such a scenario already occurred - now an issue can be shifted from consideration in absentia to the agenda of a physical meeting only if 2 BoD members require that. Our recom-mendation is that the Company abandon this practice and restore the original approach which we consider to be one of the best practices in the BoD activity.

The charter only provides for the BoD’s powers in relation to the Company’s subsidiaries to the extent of their economic activities (making or approving transactions) and does not vest the BoD with powers concerning other significant issues (e.g., formation of man-agement bodies: the BoD and CEO).

As regards provision of information to BoD members, including infor-mation on controlled companies, INEDs note they have had no prob-lems with access to any requested information

2 see the Company’s comment in the report of the Government Expert Council and the Moscow International Financial Centre Taskforce on implementing the Corporate Governance Code as of August 22, 2016.






ECONOMICS


(some of the information may be provided at the Company’s office, given the confidential treatment).

As regards the regulation of sponsorship and charity issue, the BoD has approved the regulations on the generation and application of the sponsorship and charity funds. The BoD annually considers the sponsorship of Russian sports clubs. The BoD’s approaches to setting limits on the charity and sponsorship spending are not publicly dis-closed. According to INEDs, the Company has established a fairly negative practice of holding joint meetings of BoD committees one day prior to the BoD meeting to address the BoD meeting agenda items. While this approach to meetings of the BoD committees ensures maximum at-tendance by members of the committees, it leaves insufficient time for the development of a dissenting position for the BoD meeting, if

any. Besides, long meetings (more than 4-5 hours) impair the concen-tration required to consider the most complicated issues.

In January 2016, the BoD approved the Regulations on the procedure for exercising the rights related to quasi-treasury shares of PJSC Aer-oflot according to which the management team’s proposals for the procedure of exercising the rights related to voting these shares are subject to approval by the BoD. The document is not disclosed, and neither is information on the consideration and approving by the BoD of the management’s proposals for voting this package (there is no such BoD agenda item in the information disclosure system). At the 2015 and 2016 AGMs, the voting of quasi-treasury shares paved the way for Dmitry Saprykin, a representative of the management team, to the BoD. Since 2015, he has been CEO of the Company’s largest sub-sidiary Rossiya airlines, which notably increases the risk of a conflict of interest in the BoD when certain issues are considered.





ECONOMICS

Audit Committee

The Audit Committee consists of 3 members, 2 INEDs, including the Chairman.

In 2015, the committee held 10 meetings, including 9 physical meet-ings!

Unlike the situation at most of the other PJSCs, the Company’s Audit Committee directly considers the budget and certain financial issues (financial hedging, provision of loans, transactions related to the air-craft fleet development, reports on reviews of other entities’ debts to the Company), as well as the procurement policy. The Audit Committee also attends to its traditional responsibilities (internal audit depart-ment’s reports, internal audit control system improvements, risk management system regulation). Of special note is the Chairman’s highly professional approach to organizing the committee’s activity.

Personnel and Remuneration Committee 3 of the 5 committee members are INEDs, the other two members being non-executive directors.

The Personnel and Remuneration Committee (PRC) formulates the policy, principles and criteria for determining the amount of remuner-ation for BoD members, the CEO and members of the Management Board (including the development of short-term and long-term man-agement motivation programs), supervises the adoption and imple-mentation of this policy. The PRC oversees the process of induction training given to newly elected BoD members. In 2015, the PRC held 8 meetings, including 5 meetings in the form of joint attendance. The Committee addressed the standard range of issues (remuneration, KPIs, corporate by-laws / internal documents). The Committee also considered candidates to BoD members repre-senting interests of the Russian Federation in 2016. Why the Commit-tee only considered potential representatives of interests of the Rus-sian Federation remains an open question. The related proposal prep-aration procedure is not formalized. No assessment of the BoD was conducted in the period under review. The BoD members take an ironic attitude towards self-assessment suggesting that this should be exclusively reserved to the sharehold-er.





ECONOMICS


External auditor

Law firm JSC BDO Unicon is approved as the auditor of the Company’s Russian GAAP (RAS) statements for the year 2016 (the price of the audit contract effective in 2016-2018 is RUB 10,578,000, 34.5% of the initial bid price), while JSC PricewaterhouseCoopers Audit is approved as the auditor of Aeroflot Group’s consolidated financial statements according to IFRS standards for the year 2016 (the price of the con-tract effective 2016-2018 is RUB 66,375,000, 85.7% of the initial bid price). Neither the scope of non-audit services provided by the exter-nal auditor nor information on the auditor selection competition and the role of the Audit Committee in the tendering procedures is dis-closed. This information should be disclosed in materials prepared for GSMs.

Internal audit, internal control, risk management

In 2015, the Company took the following measures to improve internal audit and internal control efficiency: structural optimization of the internal audit department; development of an internal audit method-ology according to international practices (including special internal audit techniques, drawing-up of a risk-based plan and development of procedures for assessing internal audit efficiency based on KPIs); teaching global professional internal audit standards to employees of the internal audit department, launch of a system of confidential information delivery to the BoD, the Audit Committee and the internal audit department using, among other things, the “hotline” mechanism (email).

Judging by INEDs’ comments, the “hotline” solution assumes a direct independent access to Audit Committee members, among others; it is suggested that this mechanism undergo testing, followed by consid-eration of the possibility to engage an independent operator to pro-

cess messages, according to best practices. We welcome the absolute-ly progressive attitude of the Company and the Audit Committee and hope to see it adopted by others.

The internal audit department’s reports on the progress in imple-menting the annual activity plan, on audits performed and on imple-menting the internal audit department’s recommendations are regu-larly submitted to the Audit Committee.

The Company has adopted and disclosed by-laws concerning the anti-corruption policy, violation reporting to the BoD (the Audit Commit-tee) and the management of conflicts of interest. This should be re-garded as a case of best corporate practices.

On a practical side of risk management efforts, we note the total loss of RUB 25.47 billion from hedging operations in 2014-2015 which es-sentially affects the Company’s financial result. As part of the CG sys-tem, the Company discloses the consideration by the Audit Committee of the hedging issue in 2015, an evidence of the system’s proper oper-ation. The BoD’s position and the consideration of this issue, if any, by the BoD remain undisclosed. It should be noted that, according to INEDs, despite the existing regulatory framework, the Company did not have an executive personally responsible for the risk manage-ment system as of the reporting date.

Dividend policy

The Company has a dividend policy approved in 2014. The basic divi-dend payout ratio is 25% of Aeroflot Group’s consolidated IFRS net profit; depending on the values of specific metrics taking into account results of the reporting year, cash flows, debt leverage, the base level can be 20% or 15%. The Company did not pay dividends in 2016 (on account of a RUB 18.9 billion loss posted in 2015) and in 2015 (due to





ECONOMICS

an IFRS loss of RUB 17.1 billion, adjusted for extraordinary expenses, in 2014 – although the Company’s RAS profit amounted to RUB 14 billion in the same year). It should be noted that the BoD did not explain to the shareholders its recommendation to pass dividends.

In our view, the Company’s current business development cycle and the recent changes in the Government’s philosophy of earning divi-dends as a shareholder call for the consideration by the Board of Di-rectors of amendments to the current dividend policy so as to enable the Company to spend 50% of its consolidated IFRS net profit on divi-dends subject to the achievement of the required metrics, which would be the best practice among peers.

History of dividend payments by PJSC Aeroflot 2010 2011 2012 2013 2014 2015

Proportion of net profit, % 10.0 19.2 26.0 25.0 - - Accounting standard applying to net profit calculation RAS RAS RAS RAS IFRS IFRS

Payout ratios at (conditional) peers Deutsche

Lufthansa AG Delta Airlines Corp

American Airlines Group Inc.

Turkish Airlines

Payout ratio 13.6% 7.9% 3.7% 0% (coverage of

prior years’ losses)

Management remuneration system disclosure practice at international peers of PJSC Aeroflot The Company does not disclose information on the proportion of long term remuneration which, according to partial information disclosure, does exist. We welcome the availability of long-term motivation, Aer-oflot being one of the most forward-looking state-owned company in this respect (as confirmed by INEDs, among others), but the level of disclosure, unfortunately, is in line with the current Russian practice, which prevents assessment of the management remuneration sys-

tem’s compliance/non-compliance with international peers/practices. Of particular note is that investors prioritize the possibility of dis-closing information primarily on the remuneration system: disclosure of individual remuneration of the sole executive body (CEO) or other employees is subject to debate, but not a top priority in terms of the system performance. Disclosure of 5 highest-paid employees’ remu-neration is possible. Please see the best practices below.

RESEARCH REPORT ON PJSC AEROFLOT / 16 RESEARCH LABORATORY FOR BUSINESS



ECONOMICS


Disclosure of information on shareholdings of Management Board members as of September 30, 2016 Management Board member Rounded-off value of share package

Vitaly Saveliev RUB 157 million Vladimir Antonov RUB 0.56 million

Igor Chalik RUB 0.15 million Igor Parakhin RUB 0.009 million

Approximate proportions of CEO remuneration components (based on payment forecast, incl. shares) in 2015

Deutsche Lufthansa AG

Delta Airlines Corp American Airlines

Group Inc. PJSC Aeroflot

Fixed annual remuneration 47% 5% 6% 55%

Annual bonuses 23% 21% 59% 45%

Long-term component 30% 74% 35% n/a

2015 Deutsche Lufthansa AG Delta Airlines Corp American Airlines Group Inc. PJSC Aeroflot

Disclosure, all payments, incl. in the form of stock, estimates of future pay-ments

CEO+CFO+3 top managers. Actual: CEO €1,207K in salary, €593K in bonus, €133K in long-term bonus-es, €626K in options (in-dicative)

CEO+CFO+3 top managers. Actual: CEO $800K in salary, $3,200K in bonus, $7,667K in shares (restricted stock units), $3.8 million in op-tions.

CEO+CFO+2 top managers. Actual: CEO $231.5K in salary, $387.4K in bonus, $10, 330K in shares (restricted stock units)

Management Board (11 members) in total: Salaries and compensa-tions RUB 198.6 million, annual bonuses: RUB 163.97 mil-lion





ECONOMICS

2015 Deutsche Lufthansa AG Delta Airlines Corp American Airlines Group Inc. PJSC Aeroflot

KPIs influencing the short-term (annual) vari-able remuneration com-ponent (incl. the fixed relative weight of the KPI, if any)

Multiple of 0.8-1.2 x base level depending on indi-vidual KPIs of manager Base level depends on operating margin of Lufthansa Group

Income before tax 50% Monthly operational KPIs 25% Income per seat-mile vs. peers 25%

Adjusted income before tax TSR 10%; ROIC 20%; long-term debt /EBITDAR 5%; integral KPI of innovation activities 5 %; investment program efficiency 5%; reduction of expenses for available seat-kilometer / ASK 5%; share of state support in financing 5%; time accuracy of flights 5%; flight safety 15%; seat load factor 10%; labor productivity 15%

KPIs influencing the long-term variable remunera-tion

Marg. EBIT and EACC (earnings after cost of capital ) for 3 years 70%, environmental protection, customer satisfaction, personnel efficiency 30%. For options: stock price growth above target level

Average annual operating margin vs. peers 50%, quality of customer services 15% for domestic customers, 10% for international, ROIC 25%

Average annual operating margin before tax, adjusted for extraordinary expenses vs. peers

Not disclosed

Long-term bonuses 25% of base annual remu-neration. Multiple of 1 to 2 (but not to exceed 150% of 2-year salary); payment period: 2 years, calculation period: 3 years. Options: a 4-year period

Restricted shares, options (5-year calculation period) and phantom shares (1/3 each, CEO)

Restricted stock units (cal-culation and payment period of 3 years)

The stock options plan was com-pleted in 2015. The long-term motivation program is approved for a period until June 30, 2019. Based on the annual report, motivation principles are similar to those underlying the motiva-tion program for BoD members.





ECONOMICS

Corporate social responsibility

In 2015, PJSC Aeroflot allocated RUB 1.9 billion for sponsorship. The funds were spent on football (67.5%) and other sports projects (23%), cultural projects (9.5%) and promotion of the Company’s brand abroad through international cooperation. In 2015, Aeroflot contributed RUB 50 million to the target capital fund of the Far Eastern Federal University. Aeroflot Group carries passengers by air to the Far East of Russia, Kaliningrad and Simferopol under the government’s program of subsi-dizing socially important air flights. In 2015, the Company transported 325 thousand passengers under this program. The amount of reim-bursement is not disclosed.

The Company has also developed and implemented its own program of flights to these regions at flat rates. The Company has launched two seasonal flat rates to Kaliningrad and Simferopol: a ‘reduced win-ter’ fare and a ‘summer’ fare. In the reporting year, the Company pro-vided services to 1,465 thousand passengers under the flat rate pro-gram. The Company’s net related expenditure is not disclosed. The Aeroflot group undertook and successfully honored the obligation to transport approximately 2 million passengers of Transaero (a dis-tressed air company which ceased operations), including 1.8 million passengers transported by Transaero flights under the operational control and at the expense of Aeroflot Group.

Delta Airlines Corp American Airlines Group Inc.

Direct charity expenses ($ thousand) 23,600 22,500

% of consolidated net profit 0.52% 0.30%

Information disclosure

The mandatory disclosure of information is generally consistent with the law. Most of the notices of related party transactions approved by the BoD disclose essential parameters of such transactions, which should be regarded as a good practice. In some cases, the price pa-rameters of related party transactions are not disclosed, but the an-nual report discloses ALL essential parameters of the transactions effected in the reporting period, including the subject matter, timeframe, parties, price (limits), rationale for recognizing related-party interest, the body approving the transaction. It should be noted that the Company failed to meet the statutory disclosure deadlines 12 times in the period under review. The Company does not disclose individual voting of the BoD members in the mandatory disclosure system, which prevents adequate as-sessment of the BoD members’ position(s) on certain significant agenda items (this especially concerns independent directors). Our

recommendation is that the Company should disclose individual vot-ing and discuss the possibility of providing the voting BoD members’ comments on their positions in case of repeated voting ‘abstained’ or ‘against’ on certain types of agenda items. The form of BoD meetings mostly remains undisclosed in the Compa-ny’s material facts. Besides, the number of BoD meetings in 2015 ac-cording to the disclosure system is 19, i.e. one less than the number of meetings specified in the 2015 annual report. There is a discrepancy between different sources as regards the num-ber of quasi-treasury shares: according to the list of affiliates as of September 30, 2016, Aeroflot–Finance LLC, a company controlled by Aeroflot, has 4.83661% of shares, while clause 6.1. of the Company’s report for the 3rd quarter specifies that the number of Aeroflot shares held by its controlled entities is 49,918,611 or 4.49468%.


Research report on PJSOC Bashneft

as of 09/30/2016





RESEARCH REPORT ON PJSOC BASHNEFT / 2 Association of Institutional Investors (API)




ECONOMICS

60.16%

9.31%

25.79% 2.32% 2.42%


Rosneft Oil Company

Free float (INEDs, legal entities)

Republic of Bashkortostan


Physical persons

Brief capital structure overview As follows from the breakdown of capital (voting shares), the com-bined interest of private minority shareholders is low (11.5% including individuals). Following the Company’s privatization (which took place after the reporting date of this research), Rosneft Oil Company owns the majority block of voting shares. Quasi-treasury shares account for 2.32% of the share capital. Given the size of the Board of Directors / BoD (10 members), this capital structure theoretically enables minority shareholders to elect 1 independent director (INED) by their votes without involving the principal shareholders (the indicative passing score is approximately 8.5%, i.e. votes of more than 70% of the minori-ty shareholders are required). As regards ordinary shares, the Company has received a mandatory offer for the acquisition of shares by Rosneft at a price of RUB 3,706.41 per share, effective if the shareholder applies for the sale until January 31, 2017. Upon completion of this process, the structure of voting shareholders will most likely prevent any opportunities for minority shareholders to exert real influence on corporate governance within the scope of their rights. At the same time, the Company’s authorized capital consists of type A preferred shares (16.77%) and ordinary shares (83.23%). The annual dividend per preferred share is 10% of the nominal share value; the parity of dividend payments is guaranteed by the Articles of Associa-tion in case dividends on ordinary shares exceed dividends on pre-ferred shares.

Corporate governance self-assessment According to self-assessment, the Company complied with 61, partially complied with 13, failed to comply with 4 out of 79 principles and rec-ommendations of the Corporate Governance (CG) Code in 2015; one recommendation is not applicable to the Company (stock bonuses to BoD members).





ECONOMICS

Summary of CG practice

+ 3 out of 10 BoD members are independent directors (all of them being

non-residents as of 09/30/2016); their contribution to the Board’s activity was highly appreciated by the BoD and the management;

The Audit Committee and the Nomination & Remuneration Committee wholly consist of INEDs and predominantly hold physical meetings (as of September 30, 2016);

The Company has a full-fledged internal audit (IA) division consisting of 3 thematic departments;

In addition to standard internal audit-related issues, the BoD has the power to approve the budget of the internal audit division;

to a large extent, the Company follows the CG Code recommendations as regards passing resolutions on key issues by a qualified majority or by a majority vote of the elected BoD members;

the Company follows the CG Code recommendations to consider key issues at physical BoD meetings (although the BoD Chair may decide to consider them in absentia by way of exception);

the BoD is authorized by the Articles of Association to determine the procedure for the Company’s engagement with entities and organiza-tions in which the Company has equity interests and to make deci-sions on such companies according to this procedure. Resolutions on such matters shall be passed by a majority of the elected BoD mem-bers;

the “hotline” details (phone numbers, email, postal address) for reporting violations, faults and cases of corruption to the compliance control department are easily available on the website, privacy is guaranteed; on behalf of the parent company, cash rewards are prom-ised for providing information that enables the Company to repair damage, including damage caused to reputation;

many by-laws are disclosed, including internal audit and internal control-related documents; information on persons proposing agenda items for general shareholders meetings (GSMs) and candidates to the BoD and the Internal Audit Commission (IAC), as well as brief ra-tionales for transactions and the profit distribution are included in GSM-related materials.

- there were no INEDs among BoD members at the EGM on December 16,

2016 – the Company faces the prospect of having its shares excluded from the quotation list;

the reports on BoD resolutions provided in the disclosure system have been omitting information on specific voting results (except that the quorum is available and resolutions are passed) since Rosneft gained control over the Company, which is a negative practice;

the Company’s shareholders have no right to call for a BoD meeting; the practice of awarding short-term bonuses to BoD members for the

growth of capitalization is not consistent with the CG Code recom-mendations (conditionally negative, given different international practices);

the reports on BOD resolutions do not disclose the individual voting by BoD members on the issues discussed at meetings and the terms and conditions of related party transactions;

(conditionally negative) the top management remuneration system description is one of the best among the companies covered by the research, highlighting, among others, the availability of a long-term remuneration program and providing details of the top 5 highest-paid BoD members’ remuneration. However, no specific provisions of the motivation system are disclosed.





ECONOMICS

95.7 98.9 98.2 98.1 99.8 96.9

4.3 1.1 1.8 1.9 0.2 3.1

24.2

6.0 12.0 12.4

1.4

24.3

2014 AGM EGM 03/11/15 EGM 12/03/15 (redemption) 2015 AGM EGM 12/01/15 2016 AGM

Proportion of Russia, Rep. of Bashkortostan and quasi-treasury shares in the quorum

Proportion of private shareholders in the quorum

Private shareholders' participation ratio, %

General shareholders meeting: activity of shareholders, related party transactions

The activity of minority shareholders at GSMs is steadily low. At least 70% of all minority shareholders’ votes need to be consolidated to elect at least one INED, which is hardly possible in practice. At the AGMs in 2015-2016, only the Russian Federation nominated candidates to the BoD and the Internal Audit Commission. In the period from the start of 2015 to September 2016, 8 related party transactions for a total amount of RUB 269 million and $1.05 million were con-sidered at two AGMs and three 3 EGMs.





ECONOMICS

Information on the shareholders, according to Bloomberg data and information disclosure by the shareholders

Shareholder name Voting stake, %

Comment on voting

Russian Federation 60.16 No voting policy, Rosimushchestvo votes as instructed by the Government of Russia. Republic of Bashkortostan 25.79 Voting policy is not available (not disclosed)

NORGES BANK 2.11

At the 2016 AGM, the shareholder voted for all the independent directors. At the EGM on 12/16/2016, it vot-ed against all the candidates to the BoD (following the majority stake acquisition by Rosneft). The share-holder discloses the voting policy and the way it actually voted in the last 4 years. The bank has so far not nominated BoD/Supervisory Board candidates in Russia, unlike other countries. The shareholder receives recommendations from proxy advisory firms.

VANGUARD GROUP 0.44

The shareholder discloses Vanguard’s proxy voting guidelines in relation to GSMs, as well as the way it voted in the last corporate season. For funds focused on investments in Russia, the shareholder disclosed voting for all the independent directors at the 2016 AGM. The shareholder does not nominate BoD/SB can-didates, but supports, according to the generally disclosed approaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preced-ing 3 years. The shareholder receives recommendations from proxy advisory firms.

GRANTHAM MAYO VAN OTTERLOO & CO

0.21 GMO’s Proxy Voting Policy discloses voting in accordance with ISS recommendations. No disclosure of the voting results. In 2016, the ISS recommendation to the shareholders was to vote for independent directors.

PROSPERITY CAPITAL MA-NAGEMENT UK 0.16

PCM usually takes an active approach to participating in GSMs, including the nomination of independent directors. No disclosure of the voting results.

SEB 0.12 The shareholder has disclosed the basic document of the asset management division (Ownership policy for SEB Investment Management AB), The voting results are not disclosed.

SWEDBANK AB 0.11 The shareholder has disclosed the basic document of the asset management division (Swedbank Robur Fonder AB ownership policy); concise disclosure of the 2015 results through the PRI portal (Swedbank Ro-bur Fonder AB is generally a rare voter at Russian companies’ meetings).

PICTET FUNDS 0.10

The shareholder discloses its Proxy Voting Policy for funds, participates in GSMs on behalf of clients, re-ceives recommendations from ISS. According to the 2016 disclosure, the shareholder did not participate in the 2016 GSM, but took part in the EGM in December 2016 voting in the affirmative (“FOR”) on all issues, except for the BoD election where it voted against all candidates.





ECONOMICS


+ the GSM-related materials, including their translation into English,

are disclosed 30 days prior to the GSM date, according to the stand-ards of corporate by-laws;

the GSM materials specify the persons proposing agenda items and candidates to the BoD and the Internal Audit Commission (IAC);

the materials include draft amendments to the Company’s by-laws, with comparative tables and rationales for changes attached to them, which should be regarded as the best practice;

rationales are also available for the approval of interested party transactions and the profit distribution (conditionally positive, be-cause the rationales are generally based on formal grounds);

the materials contain information on candidates for auditors, the selection procedure employed by the Company (without specifying the bidders and their bids), and the cost of the winning bidder’s ser-vices;

the Company discloses the list of parties in interest to related-party transactions and a rationale for recognizing related-party interest;

the period for proposing candidates to the BoD and the IAC, as well as agenda items is increased to 60 days.

- the GSM-related materials do not include details on the participants

in the open competitive auditor selection procedure and their respec-tive bids (the terms proposed by them).





ECONOMICS


BoD activity aspect Royal Dutch Shell BP Exxon Mobil PJSOC Bashneft

INEDs/total number of BoD members 9/11 13/15 11/13 3/10

Participation in meet-ings of BoD and com-mittees in 2015: num-ber of meetings (at-tendance ratio)

BoD: 12 meetings (3 BoD members missed 1 meeting), Audit Committee: 6 meetings (1 non-attendance), Nomina-tion Committee: 7 meetings (100% attendance), Remu-

neration Committee: 5 meet-ings (1 BoD member missed 2

meetings)

BoD: 13 meetings (2 via teleconference), 1 BoD

member missed 2 meet-ings, 3 BoD members

missed 1 meeting each. Audit Committee: 11 meet-ings (3 members missed 1

meeting each)

BoD held 11 meetings, Au-dit Committee 11 meetings, Compensation Committee 7 meetings, Board Affairs Committee 7 meetings.

Average attendance ratio: 92%, attendance ratio at

BoD and all committees is at least 75% (no individual

disclosure).

BoD: 21 meetings (incl. 7 physical meetings) – (2 BoD members

missed all meetings (2) held dur-ing their tenure). Average at-

tendance ratio: 95%. AC: 100% (1 expression in writing at 9 meet-ings), Nomination and Remunera-

tion Committee: 100%

Remuneration of BoD members / actual payments for 2015

(2016) €850K to BoD Chair, €130K to BoD member, €55K to senior INED, €55 (25)K to AC Chair / member, €35K (17.25K) to Remuneration

Committee Chair/member, €25K (12K) to Nomination Committee Chair. Actual (2015): €147-315K (616K to

BoD Chair)

£785K to BoD Chair, £120K to Senior INED, £90K to

BoD member, £30/20K to Committee Chair/member. Actual: £141-178K for cor-

porate year

$110K to BoD member, $10K to Committee Chair +

2,500 shares annually (+ 8,000 shares upon taking office) and dividends on them (not applicable if

resigned before age of 72). Actual: $110-120K+ $231K in

shares

Base remuneration: RUB 5 million (RUB 6.5 million to INED). Addi-tional payments: RUB 0.125 mil-lion for committee membership (RUB 0.25 million to INED), RUB

0.25 million for committee chair-manship (RUB 0.5 million to INED). Uplift factor: 25-55% of base re-

muneration for capitalization growth (as compared with 5

peers). Actual: RUB 4.49 - 18 million.

Deductions for non-attendance: 25% for missing 20%, 100% for

missing 40%.





ECONOMICS

Board of Directors: practical activity aspects (as of 09/30/2016)

Chairman of the Board of Directors Alexey Teksler non-executive director (until the EGM on 12/16.20126), no shareholding in the Company; Chairman of the Nomination and Remuneration Committee Maurice Dijols (INED), no shareholding in the Company; A BoD member* referred to the BoD as “one of the best Boards of Directors in terms of activity and contribution of independent direc-tors.” All the INEDs are extremely effective at work and entirely fo-cused (together with experts) on BoD affairs during their stay in Mos-cow. Besides, the management team highly appreciated the performance of the Government’s representatives on the BoD (after the ownership of these shares was transferred to the Russian Federation). Decisions are worked out at committees, physical BoD meetings are held at least once in a quarter, meetings of committees once every 1-2 months. The BoD takes full account of recommendations provided by the committees, relies on independent directors in relation to audit and remuneration issues and does not actually consider materials for BoD meetings until receiving the committees’ recommendations on these issues.

Chairman of the Audit Committee Anthony Considine (INED), no shareholding in the Company.

Cases of non-unanimous voting are extremely rare; where BoD mem-bers disagree on specific aspects, issues are most often left for fur-ther consideration with the aim of achieving a consensus, including the approval by independent BoD members.

______________________________________________

*The API met with a member of the previous Board of Directors.

http://www.bashneft.ru/company/directors/detail/?id=7845





ECONOMICS


For the period under review (2015 and 9 months of 2016), the BoD held 37 meetings, including 11 physical meetings (30%). 220 issues were considered. The number of transactions is relatively small compared to other PJSCs (12 transactions addressed in 8 agenda items).

The BoD also considered the following significant issues:

performance results, reports (9 issues);

key performance indicators (5 issues);

long-term corporate development program (2 issues);

internal audit and internal audit service’s activity (6 issues);

risk management and risk reports (2 issues);

budget and business plan (5 issues).

The Company implements a noteworthy practice of business dinners (normally on the eve of BoD meetings) in which independent directors, non-executive directors, key senior managers and the Corporate Sec-retary participate. INEDs also have an opportunity to discuss share-holders’ opinion on the Company’s activities with non-executive direc-tors representing the principal shareholder. 7 such meetings took place in 2015, which ensured more effective discussions at the suc-ceeding BoD meetings. In 2015, the BoD Chairman had a number of meetings with INEDs (without other BoD members or the management in attendance) addressing matters which, in INEDs’ view, required spe-cial attention. We regard this as the best practice among the compa-nies covered by the research.

Strategy, business plan and KPIs

Minor tweaks were made to the KPI system following the change of ownership in late 2014 (as follows from the disclosure system, TSR and ROIC were added to the list of KPIs), the practice of revising tar-gets shortly before the reporting date is generally not followed, the only case of approving 2015 KPIs in June 2015(!) occurred because of the change of ownership and the shareholders meetings this change entailed.

KPIs can be adjusted under the influence of changes in macroeconom-ic indicators as recent years’ volatility, to a large extent, lays the groundwork for their changes. Such adjustments are considered and substantiated by the Nomination & Remuneration Committee. In gen-eral, the Company always has several scenarios as regards KPIs.

Benchmarks are used as a mandatory requirement when setting tar-gets and evaluating progress. To ensure comparability of values, the Company primarily focuses on major Russian players in the seg-ments/components of the industry (upstream & downstream).

When handling systemic issues, (KPI list, types of incentives, devel-opment strategy etc.), the Company extensively uses an international benchmark, as proved by related disclosure materials.

The 2015 business plan was approved at the end of March 2016 due to a change of ownership and a BoD reshuffle. At the same time, we were unable to detect the issue “Key parameters of the 2016 business plan of PJSOC Bashneft” in the disclosure of information on BoD reso-lutions. In late December, the Board only considered the issue “Key performance indicators (KPIs) of senior executives of PJSOC Bashneft for 2016.”





ECONOMICS

Audit Committee (AC) All members of the Committee, including the Chairman, are INEDs, which is in line with the best practices.

The powers and rights of the Committee members generally meet the best CG practice and the CG Code recommendations.

In 2015, the AC held 10 meetings, including 7 physical meetings, and considered 46 issues. The agendas mainly covered the standard range of issues relevant for the Committee, including consideration of the candidate for external auditor, dismissal and approval of the head of the internal audit division, review of financial statements, approval of by-laws within the competence of the Committee, etc.

In addition to these standard issues, the AC considered the risk man-agement report and the risk management development plan for 2015, a plan of corrective measures in the internal control system, devel-opment of the compliance function at the Company, safeguarding of shareholders’ investments and the Company’s assets.

Unfortunately, it was clear at the time of the research that the BoD was in for a major change, which prevented us from arranging a meeting with the AC Chairman due to the lack of time.

Nomination and Remuneration Committee (NRC) All members of the Committee, including the Chairman, are independ-ent directors, the powers of its members meet the best CG practices and the Code of Corporate Governance recommendations.

In 2015, the committee held 11 meetings, including 6 physical meetings, considered 52 issues.

The NRC, inter alia, considered the Company’s documents defining the terms of remuneration, bonuses to the Company’s senior managers (including long-term and short-term incentive programs) based on the achievement of KPIs, approval of KPIs, conducted a comparative re-view of the remuneration of different groups of employees at petro-leum companies.

The NRC was involved in the process of agreeing upon the proposal of BoD candidates for the corporate year 2016 to the principal share-holder (Rosimushchestvo), which we regard as a good practice.

Information on the consideration by the NRC of the BoD performance appraisal is not disclosed.

The Committee is authorized to consider all the terms of the employ-ment contracts with the President, Management Board members and even the sole executive bodies (CEOs) of controlled companies, as well as the motivation system.





ECONOMICS

Essential CG aspects External auditor The Company chose CJSC Deloitte & Touche CIS for the audit of consol-idated financial statements of the Company, its subsidiaries and structural divisions (the Group) according to IFRS standards as of, and for the years ending on, December 31, 2015, 2016 and 2017; reviews of condensed interim consolidated IFRS financial statements of the Group as of, and for the 3-month periods ending on, March 31, 2015, 2016 and 2017, as of, and for the 6-month periods ending on, June 30, 2015, 2016 and 2017, as of, and for the 9-month periods ending on, September 30, 2015, 2016 and 2017; review of the financial information included in the Company’s annual report; review of the financial in-formation contained in the prospectus for bonds registered for the issue on exchanges in the Russian Federation. The amount of remu-neration is not supposed to exceed RUB 47.2 million. Besides, the Company chose RSM RUS LLC as the auditor of Bashneft Group’s financial statements prepared according to RAS (Russian GAAP) standards as of, and for the years ending on, December 31, 2015, 2016 and 2017. The amount of remuneration is not supposed to exceed RUB 8.084 million.

Internal audit, internal control, risk management The IA division consists of 3 departments, an evidence of the Compa-ny’s attention to the IA function. The BoD has the following powers in relation to the IA system: - approval of the appointment, dismissal and the amount of remuner-ation and other payments to the head of the internal audit division (Senior Auditor);

- approval of the Company’s Internal Audit Regulation, the activity plan and budget of the internal audit division. The organization procedure for the internal control system and the proposals for structuring an internal control division were approved by the Audit Committee in the 1st quarter of 2016. The Company has a hotline service for countering corporate fraud, corruption, theft of corporate property, unfair competition, conflicts of interests, as well as a hotline for customers. The hotline phone number, email and postal addresses are easily available on the Com-pany’s website. The internal control division regularly monitors the Company’s activi-ties (analysis of performance results, follow-up checks on selected business operations, regularly appraisals and updates of by-laws and executive documents). The Company has established a dedicated compliance control division. No involvement of BoD members and Management Board members in any conflicts of interest was detected in 2015.

Dividend policy The Company has approved a dividend policy which recommends ear-marking at least 25% of its IFRS net profit for dividends and notes the Company’s commitment to increasing dividends every year while en-suring financial stability, meeting covenants in relation to liabilities and keeping leverage moderate (the net debt to EBITDA ratio does not exceed 2). The 4-year dividend history shows that the Company com-plies with the dividend policy recommendations.

RESEARCH REPORT ON PJSOC BASHNEFT / 12





ECONOMICS

2015 dividend payout ratios at Bashneft vs. (conditional) peers

Royal Dutch Shell BP plc* Exxon Mobil PJSOC Bashneft

Payout ratio* 63% 176% 75% 56% of RAS profit (51% of IFRS profit)

*information on 2014 dividends is provided for companies posting losses in 2015

Information disclosure The Company’s mandatory disclosure system provides the results of voting at BoD meetings but no individual voting data, so that the results of

voting by BoD members on separate significant agenda items cannot be properly analyzed; material terms of related party transactions (parties, price/limits, validity period) are not disclosed for all such transactions considered by the BoD.

Many transactions are not covered at all; in addition to the generally accepted practice of disclosing the discipline of BoD members’ participation in meetings of the BoD and its committees,

the Company discloses the number of contributions (speeches, reports etc.) made at meetings, which is a superior practice, a good way of demon-strating the activity of directors.





ECONOMICS

Disclosure of the management remuneration system at international peers Approximate proportions of CEO remuneration components at Bashneft vs. peers in 2015

Royal Dutch Shell BP Exxon Mobil PJSOC Bashneft

(5 coll. exec. body members)

Disclosure: all pay-ments, incl. in the form of stock, esti-mate of future pay-ments

CEO+CFO. Actual (CEO): €1,430K in salaries,

€3,500K in bonuses (in-cluding 50% deferred for 3

years. €163K in long-term remu-neration, unadjusted for deferred annual bonus

payments

CEO+CFO. Actual (CEO): $1,854K in salaries, $1,391K in bonuses, $2,603K in deferred stock bo-

nuses (2/3 of the annual bonus) + shares

Long-term remuneration in the form of shares for KPI achievement: $7,116K

CEO + CFO + 3 top managers

Actual (CEO): $3,047K in sala-ries, $2,386K in bonuses

$18,288K in the long-term remuneration in the form of

shares

Collective executive body (CEB) and separately to 5 highest-paid CEB

members Actual 2015 (5 CEB members):

RUB 237 million in salaries RUB 41.5 million in annual bonuses, RUB 36 million in other bonuses in the course of the year (no long-

term premiums were paid in 2015) KPIs influencing the short-term (annual) variable remunera-tion component (incl. fixed relative weights of KPIs, if any)

Operating cash flow, pro-ject delivery in time and budget, production, sales, capacity utilization, secu-

rity, energy and water efficiency

Reduction in the number of primary environmental pollu-tion cases, accident rate, num-ber of industrial accidents (10% each); operating cash flow, re-

placement cost profit (20% each); net investment 15%, cor-porate and functional expenses

10%, priority projects 5%

Safety and operational per-formance, ROCE, TSR vs. peers, FCF, payments to sharehold-ers, strategic results, imple-mentation of projects. Addi-tionally, 50% of the bonus is

deferred until target EPS achievement

TSR, ROIC, EBITDA NetDebt/EBITDA

Reduction in operating expenses, operating availability, labor produc-tivity, oil production, increment of reserves, yield of light products,

integral KPI of innovation activities

Royal Dutch Shell BP Exxon Mobil

PJSOC Bashneft (5 coll. exec. body members)



Long-term remuneration 38% 75% 77% 0%*





ECONOMICS

Royal Dutch Shell BP Exxon Mobil

PJSOC Bashneft (5 coll. exec. body members)

KPIs influencing the long-term variable remuneration (target KPIs set for 3-year periods)

TSR (30%); EPS growth in relation to cost of supplies (30%); increase in operat-

ing cash flow balance (20%); ROACE (20%) for

peers divided into 5 groups with 20% incre-

ments

TSR vs. peers 1/3, operating cash flow 1/3, stock replenish-ment rate, safety and industrial risks, implementation of priori-

ty projects 1/3 in total

See annual remuneration component

TSR vs. peers, EBITDA per tonne of oil produced (vs. peers). Reserve

replacement ratio, evaluation of the business plan execution, sustaina-ble development (qualitative evalu-

ation)

Long-term bonuses Base salary x 3.4 (CEO) x KPI achievement ratio (0-2) x TSR underachievement

ratio (1/2)

Part of annual remuneration (3-year period) is converted into

shares and long-term remuner-ation in shares for KPI

achievement (3-year accumula-tion period)

Payment of long-dated shares: 50% in 5 years, 50% in 10 years or in case of resigna-

tion

The Company approved a long-term incentive program* for 2015-2019.

Payments have been effected since 2016. No program details are dis-

closed

* The incentive program is approved by the Regulation on the 2015-2019 long-term incentive program. Participation of top managers in the program is subject to BoD decisions to include certain positions in lists of program plan participants. Plan 1 is intended for 2015-2017, plan 2 for 2016-2018, plan 3 for 2017-2019. Payments under plan 1 are made annually, while plans 2 and 3 provide for payments upon completion of the program plan.

The Company has a long-term incentive system with relevant KPIs providing for the distribution of treasury preferred shares. In case of ownership change employees are entitled to these shares without conditions suspensive, but to the extent of their actual tenure. Disclosure of information, including long-term remuneration details, is not sufficient compared with peers, despite the Company’s progressive atti-tude towards the management remuneration system.

Disclosure of information on shareholdings of the Company’s Management Board (5 largest shareholdings) Management Board member Rounded-off value of share package as of 09/30/2016

Alexander Korsik RUB 16 million Kirill Andreychenko RUB 6 million Mikhail Stavsky RUB 7 million Denis Stankevich RUB 6 million Vladislav Pozdyshev RUB 4 million





ECONOMICS


In 2015, the Company’s charity activities were as follows: Republic of Bashkortostan: approximately RUB 1.5 billion in the following segments:

• support of infrastructure projects: - educational projects (including construction, reconstruction and repairs): RUB 426.6 million; - road building (rehabilitation of roads/bridges): RUB 196 million.; - water supply improvements, environmental protection: RUB 179.4 million; - healthcare (construction, reconstruction and repairs of healthcare institutions): RUB 159.1 million; - culture: RUB 70.7 million;

• development of physical training and sports: RUB 325.6 million; • assistance to the poor and disadvantaged, other social projects: RUB 75.8 million; • supply of high-quality drinking water to districts of the Republic: more than 164 million.

Nenets Autnomous Okrug: RUB 40 million; Orenburg region: RUB 20 million. Spending on charity at Bashneft vs. conditional peers Royal Dutch

Shell BP plc* Exxon Mobil PJSOC Bashneft

Direct expenses for social investment and charity in relation to IFRS profit 0.82% 1.77% 1.66% 2.58%

*information on 2014 spending is provided for companies posting losses in 2015


Research report on VTB Bank (PJSC)

as of 09/30/2016


RESEARCH LABORATORY FOR BUSINESS COMMUNICA-

TIONS, NATIONAL RESEARCH UNIVERSITY HIGHER

SCHOOL OF ECONOMICS

RESEARCH REPORT ON VTB BANK (PJSC) / 2 Association of Institutional Investors (API)




ECONOMICS

60.93%

29.77%

2.95% 2.73% 2.36%

1.26%



Other minority shareholders and INEDs

State Oil Fund of the Repulbic of Azerbaijan (SOFAZ)

Joint stock company Russian Agricultural Bank (JSC Rosselkhozbank / RusAg)

Credit Suisse AG

BANK ROSSIYA

Capital structure

The controlling parcel of shares belongs to the Government whose effective voting stake (including the shareholding of a substantial shareholder controlled by it) is 63.66%. A mere 65.69% to 68.37% of the voting shareholders have participated in general shareholders meetings (GSMs) since 2015, the involvement of portfolio and institu-tional investors (taking into account the other substantial sharehold-ers disclosed by VTB) in GSMs is extremely low. The passivity of mi-nority shareholders negatively affects the Bank’s corporate govern-ance (CG). According to Bloomberg (2014 and 2016 data), 5 shareholders with an ownership interest of more than 0.2% (Norges Bank, CREDIT SUISSE GROUP AG, ONEXIM HOLDINGS LTD, OLYBRIUS LIMITED, OTKRITIE HOLD-INGS JSC) held 14.28% of the voting shares. Judging by the quorum at the recent GSMs. most of these shareholders stayed out of GSMs, even though the shareholding required for additional INED election is 6.1-6.3% for one, 13.8% for two INEDs.

According to the quarterly report, the package of quasi-treasury secu-rities (0.11%) does not affect decision-making.

According to the Bank’s Corporate Governance Code (CGC), the voting of such shares is inadmissible, but the charter does not authorize the SC to manage this package, including the possible prohibition to vote.





ECONOMICS


The Bank’s multi-level risk management system is highly appreciated by independent directors (INEDs);

INEDs and other members of the Supervisory Council (SC) have a real capacity to influence decision-making (in 2015, 14 SC meetings (33%) were held in the form of joint attendance, the Committees have relatively broad powers);

• 4 of 11 SC members are independent directors (INEDs), according to the listing rules;1

The Supervisory Council: – regularly considers the long-term development program (6 of

the 8 related issues considered since 2015 are meaningful), but forecasts under current conditions are actually made for a peri-od of up to 3 years;

– applies benchmarks in determining strategic priorities (the re-view covers local players, among others);

The Remuneration and HR Committee has access to all top manage-ment motivation-related documents and the terms and conditions of the labor contracts, the SC relies on the Committee);

Since 2015, the Bank has held 3 shareholder meetings, including 1 extraordinary meeting), which formalized most of the Russian 2014 Corporate Governance Code recommendations in the Bank’s by-laws;

Publication of monthly non-audited financial report under IFRS standards, including a breakdown by segments;

The internal audit and the risk management are left to the purview of the Audit Committee (which implies higher potential influence of the Committee). 1 according to materials disclosed by the Bank, there is a potential risk of the senior INED ceasing to be independent (the question of monitoring by the Remuneration and HR Committee and its competence)

- Formal approach to information disclosure:

– The terms of related party transactions approved by the SC are not disclosed (see the “Main conclusions” section),

– No disclosure of the top management remuneration system (the proportions of fixed and variable parts, the long-term and short-term motivation components, the correlation between payments for the reporting period and the KPI achievement);

– no information on individual voting by SC members; – the reports do not provide information on the performance (or its

assessment by the Audit Committee) of the system warning of po-tential unfair actions of the Bank’s employees and third parties and of other disturbances in the Bank’s activities, including the practical role of the Audit Committee in obtaining information and monitoring the reaction to such warnings (except for compliance procedures);

Insufficient activity of the SC committees. The Remuneration and HR Committee (RHRC) only conducted meetings in absentia in 2015 be-cause of the Chairman’s tight schedule; the Audit Committee is still unable, despite related discussions, to operate independently from the management in relations with the auditor (including participation in holding tenders, meetings with auditors without the management in attendance) and the internal audit department. Of special note is also the Chairman’s perfect awareness and experience in best foreign practices;

Insufficient involvement of INEDs and the HRRC in the process of preparing the list of candidates for election to the SC in the following corporate year;

Negative investor perception of corporate governance quality on account of decisions made at the GSMs, by the SC and the manage-ment team in certain cases in the past, among other things.





ECONOMICS

75,5 75,5

60,93 60,93 60,93 60,93 60,93

4,54 5,7

16,21

4,5 6,47 4,75 7,44

18,54 23,27

41,49

11,6 16,56

12,17

19,04

2012 2013 2014 EGM 2014 2015 EGM 2016 2016

Equity stake of Rosimushchestvo

Equity stake of minority shareholders participating in the meeting

Proportion of minority shareholders participating in the meeting

General shareholders meeting: information disclosure, activity and rights of shareholders

Our review of the shareholders’ participation in general shareholders meetings (GSMs) in the last 6 years shows that the shareholders’ activity is extremely low, although this does not hamper decision-making on agenda items. 39 related-party transactions with a total limit of RUB 917.5 billion and USD 471 billion were considered at the AGMs in 2015 and 2016.





ECONOMICS

Information on VTB Bank’s shareholders, according to Bloomberg data and information disclosure by the shareholders


Comment on voting

Russian Federation 60.93 No voting policy, Rosimushchestvo votes as instructed by the Government of Russia.

NORGES BANK 4.28

The shareholder did not vote at the AGMs in 2016 and 2015, according to information disclosure. The sharehold-er voted at the EGM on March 14, 2016. The shareholder discloses the voting policy and the way it actually votes. The bank has so far not nominated BoD/SC candidates in Russia, unlike other countries. Recommenda-tions of proxy advisory firms are followed.

CREDIT SUISSE GROUP AG1 2.95 QIA generally votes on substantial assets only (in absolute and relative terms). Information on the sharehold-er’s voting policy, if any, is not available.

REPUBLIC OF AZERBAIJAN 2.95 Voting policy is not available (not disclosed) ONEXIM HOLDINGS LTD 2.43 Voting policy is not available (not disclosed)

OLYBRIUS LTD 2.36 Voting policy is not available (not disclosed) OTKRITIE HOLDINGS JSC 1.77 Voting policy is not available (not disclosed)

BLACKROCK 0.49

The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies. Information on voting in the last corporate season is disclosed. The shareholder only disclosed non-voting at the VTB AGM on March 14, 2016. Recommendations of proxy advisory firms are followed. The shareholder does not nominate BoD/SC candidates but can support other shareholders’ proposals if there is certainty about meeting shareholders’ interests in the best way possible.

VANGUARD GROUP 0.2

The shareholder discloses its approaches to voting at GSMs as well as the way it voted in the last corporate season. For funds focused on investments in Russia, the shareholder only disclosed non-voting at the VTB AGM on March 14, 2016. The shareholder does not nominate BoD/SC candidates, but supports, according to the gen-erally disclosed approaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder follows recommenda-tions from proxy advisory firms.

BUSINESS FINANCE OOO 0.11 Voting policy is not available (not disclosed)

CAISSE DE DEPOT ET PLACEMENT

DU QUEBEC 0.1

Probably, a nominal holder. The shareholder discloses the policy of exercising voting rights at public compa-nies, as well as information on voting in the past 6 months. No information on participating in the VTB AGM in 2016 is available. The shareholder does not nominate candidates but is ready to support other shareholders’ proposals as necessary.

1 According to the Vedomosti (as of June 5, 2013), the ultimate beneficial owner is the QATAR Investment Authority (QIA)





ECONOMICS

Preparation for shareholders meetings

+ materials related to GSMs are disclosed in the English and Russian

languages 30 days prior to such a meeting, despite the absence of related requirements in the Bank’s statutory documents (only in the Bank’s CGC recommendations);

GSM materials specify the persons proposing agenda items, candi-dates to the Supervisory Council and the Statutory Audit Commission, contain comparative tables of changes to draft documents regulating the activities of the Bank’s bodies;

According to The Bank’s CGC, items may be put on the agenda and candidates included in the general list of nominees for the GSM, with minor flaws, at the shareholder’s clearly expressed will;

In 2015, the SC actually nominated an independent director (INED) proposing that the shareholders nominate him for a vacant position. Even though this practice is unprecedented and the management has played the key role in it, this case can lay a foundation for increasing the role of the SC in its formation.

- According to the survey of SC members, the SC Remuneration and HR

Committee, unlike the management, sticks to a formal and rather passive approach to the assessment and preparation of the list of candidates for election to the SC for the following corporate season;

The materials related to general shareholders meetings have the following drawbacks: – no information on the competitive external auditor selection

process (terms and conditions, bidders, bids) and the role of the Audit Committee in the auditor assessment and selection pro-cess; information on the target and actual cost of audit ser-vices, as well as the cost of non-audit services provided by the auditor;

– no rationale for the proposed profit distribution (for example, the benchmark used and/or consequences for the Bank’s activi-ty, taking into account regulatory restrictions and require-ments, as well as the economic efficiency of investing profit in development). The only statement is that the retained earnings will be used “to ensure the bank’s business”;

– the comparative tables of changes to draft documents proposed to the GSM for approval are only provided for the charter and the documents regulating the activities of the Bank’s bodies; no table of changes is provided for the Regulation on remuneration and compensations paid to the SC members;

– the SC position on separate agenda items is only disclosed to the extent of whether or not SC members expressed dissenting opinions.

The charter and statutory documents do not provide for the regula-tion of voting quasi-treasury voting shares of the Bank.





ECONOMICS

Issue of preferred shares

In 2014-2015, the Bank privately placed preferred shares and type A preferred shares. the placement of preferred shares of different types creates uncertainty in respect of dividend rights carried by them, which is not recommended by the CG Code (p. 34). That said, the shares were placed privately in favor of the Russian Federation and state corporation Deposit insurance Agency as in-structed by the Government of Russia and pursuant to federal laws; the placement improved the Bank’s financial condition, while the vot-ing power attributable to the transferred stock is below the related property contribution to the Bank’s authorized capital; therefore, these decisions as such cannot be viewed as an example of bad corporate practice.

Our recommendation is to specify the exact value of dividend rights carried by such shares in the charter, according to the CG Code recom-mendations.

Main conclusions

The Bank has made substantial changes to its by-laws according to the plan of implementing the Russian 2014 Corporate Governance Code. The SC and the relevant committees have broad powers that have yet to be put into practice. Preparation for GSMs is adequate, although it is recommended that certain aspects be improved, includ-ing the following:

1. Ensure the involvement of independent directors in the preparation of proposals to shareholders concerning the drawing-up of the list of candidates to the SC for the follow-ing corporate season;

2. Formalize the power of the SC to determine the fee payable to the head of the internal audit department and to approve the internal audit department’s budget and the list (deter-mination criteria) of significant corporate actions;

3. Disclose material terms of related party transactions in the disclosure system and attachments to the annual reports. Where bank secrecy restrictions are applicable, only the fact of making (approving) the transaction is provided, with ref-erence to the legal provision prohibiting the disclosure of the terms of transaction;

4. Disclose the detailed information on the terms of the con-tract with the external auditor, the candidate assessment and selection procedure and its results in GSM-related mate-rials.





ECONOMICS

Supervisory Council: practical activity aspects

SC Chairman Alexey Ulyukaev** (representing the Government of Russia), ex-Minister of Economic Development of the Russian Federation, no shareholding in the Bank;

Senior INED Sergey Galitsky Chairman of the Management Board, PJSC Magnit, no shareholding in the Bank;

Chairman of the Remuneration and HR Committee Sergey Dubinin* (representing the Government of Russia) owns 0.00164% of the ordi-nary shares of the Bank (worth RUB 15.3 million**)

Chairman of the Audit Committee Yves Thibault de Silguy* (INED), Vice President, VINCI, SAS (France), no shareholding in VTB;

Valery Petrov* (INED), Deputy Director General, Institute for Development of Financial Markets (IRFR), owns 0.00000008% of the Bank’s shares (746 rubles**)

Shahmar Movsumov (INED), Executive Director of the State Oil Fund of Azerbaijan, no shareholding in the Bank

______________________________________________ * The API met with 1 INED and 2 current chairmen of committees (the Remuneration and HR Committee and the Audit Committee). Please find below the summary of SC members’ comments including the API’s expert opinion based on the results of these meetings. We appreciate the SC members’ participation in the interview and believe that such annual meetings with the Bank’s investors and shareholders are extremely use-ful for assessing the SC performance and making decisions on the voting for SC candidates at general meetings, among other things.

** as of September 30, 2016





ECONOMICS

Supervisory Council: practical activity aspects In the period under review (2015, 9 months of 2016), the SC held 42 meetings (2 meetings per month on average), 33% of them in the form of joint attendance.

39% of all the agenda items addressed were related-party transac-tions, with no amounts and counterparties to the related-party transactions disclosed. In the period under review, the SC prioritized the following issues:

long-term development program and related matters (8 issues considered);

internal audit: activity plans/reports (6 issues); risk management: reports/regulations (5 issues); charity: reports/efficiency (5 issues);

95% of the matters were considered at physical meetings. For strategic planning purposes, the SC and the management team con-sider the 3-year forecasting horizon with annual adjustments to subse-quent forecasts. VTB group’s strategy was shaped by the SC before the Government of Russia’s instruction to adopt a long-term development program. The SC uses both international and Russian companies as key benchmarks when considering strategy-related matters, which enables it to factor in regional specifics. It seems necessary to increase the SC’s involvement in handling moti-vation issues, seeing as the relevant Committee did not hold a single physical meeting in 2015 (in 2016, a new Chairman of the Committee was elected). The SC addressed systemic motivation issues and KPIs only 2 times (once at a physical meeting and once in absentia). The SC members and the Committee members have full access to the current top man-agement motivation system-related documents and the terms and conditions of the labor contracts with the top managers. However, the meetings did not make clear how the Committee assesses the motiva-tion system taking into account international experience and actual payments at peers, among other things.

We regard the monthly management statements submitted in the agreed form to the SC on the instructions of the SC Chairman as good practice. Physical SC meetings are productive, the Chairman allows any partici-pant to speak – although the main discussions take place at SC Com-mittees. Recommendations of Committees are followed, no cases of decision making contrary to the SC recommendations were mentioned. The SC has found a reasonable balance between handling issues a physical meetings and in absentia; there is no shortage of physical meetings. Voting “against” may be regarded as an exceptional case. In case of disagreement, the matter may be revisited by the relevant Committee or at the next SC meeting. Resolutions on related party transactions are usually passed unanimously. SC members (including INEDs) proposed alternative draft resolutions several times, most likely as an exception. The Company has devel-oped a standard practice of their prior discussion with the Company’s executive bodies. The senior INED is viewed by SC members as a novelty. The senior INED has additional responsibilities in the form of meetings with the Company’s shareholders, but in this case, only with individuals. No practice of the senior INED or INEDs participating in road shows and other meetings with institutional investors exists at the company. In our view, the exceptionally heavy workload of the senior INED pre-vents him from effectively performing the senior INED functions, as indirectly proven by his refusal to meet with the API for this reason. The practice of approving adjustments to KPIs one month before the reporting date / one quarter before the end of the reporting period etc. is not applicable.





ECONOMICS

Supervisory Council (SC): international and domestic practice, activity of VTB Bank’s Supervisory Council

______________________________________________

* 10.3% (the biggest share package) belongs to Belgium + 1% package belonging to Luxembourg. ** The current disclosure does not make clear how many meetings held in the form of joint attendance (8 meetings in 2015) the SC members missing the meetings in 2015 attended (one of them is an INED who chairs the Audit Committee) ***some of the EU residents that are SC members missed the meetings addressing, among others, sanction-related issues (according to the Bank’s management)

SC activity as-pect

HSBC Holdings plc

Citigroup Inc. Raiffeisen Bank International AG

BNP Paribas S.A.* VTB Bank (PJSC)

INEDs/total number of SC

members 18 of 21 14 of 16 16 of 16

7 + 2 (according to Superviso-ry Board’s decision, employ-ees of a controlled entity) of

14

4 of 11**

Participation in meetings of SC and committees

in 2015

7 Supervisory Board (SB) meetings

7 meetings of Audit Committee

100% participation All meetings held in the form of joint at-

tendance

20 SB meetings, 18 committee

meetings >75% participation All meetings held

in the form of joint attendance

6 SB meetings, participation

>50% (general disclosure only)

2 Audit Committee meetings, 100%

participation All meetings held

in the form of joint attendance

11 SB meetings: 3 members missing 1 meet-

ing, 1 member missing 2 meetings, 1 member missing

3 meetings. 12 meetings of committees: 1

non-attendance All meetings held in the form of joint attendance

28 meetings, no disclosure of par-ticipation broken down by meet-ings in the form of joint attend-ance /in absentia; 2 current SC

members (including 1 INED) missed 8 and 10

meetings, respectively***, 16 Audit Committee meetings, in-

cluding 4 physical meetings, 100% participation

Remuneration of SC members /

actual payments based on 2015 performance

$95K + $45K to senior INED + $50K/30K,

$40K/25K, $25K/15K to Chair / member of SC

Committee (depending on the

committee). Actual: $99K to $524K, ca. $200K per person

on average

$75K in cash, $150K in deferred stock, $500K to SB Chair, $50K Audit Com-

mittee, $35K other com-

mittees, $25K for any extra committee.

Actual: $137K–500K

€70K to SB Chair, €60K to Deputy

SB Chair, €50K to SB mem-

bers. Actual: €50K–70K

€21 fixed component, €3K per meeting,

€4.4K per out-of-schedule meeting, €4.2/4K

to directors outside France, €5.7K to Chair of Committee, €2.7K to member of Commit-tee for each meeting attend-

ed. Upper limit of €1.3 million for

all SB members. Actual: €43K–90K

Basic component RUB 4,600K. (€64K based on the exchange rate

of €1 = RUB 71.875), bonus pay-ment of 30% for SC chairmanship, 20% for SC Committee chairman-ship, 10% for SC committee mem-

bership. Actual: RUB 4.6 million –5.98 mil-lion (up to €83.2K). Commensu-rate with payments at Raif-

feisen Bank, BNP Paribas





ECONOMICS

Audit Committee (AC)

The AC is chaired by an INED.

AC members: 2 independent directors and 1 professional attorney (representing the Russian Federation).

The AC powers cover the whole scope of authority typical for an audit committee, including compliance; the AC competence description is even broader and in more detail than generally accepted, meeting the best international practice. Where necessary, the AC has the right to propose engaging external consultants, but has no power to decide on that at its own discretion. That said, the AC Chairman has not referred to that as a problem in fact. According to the AC Chairman, the existing practices at the Committee are being enhanced towards the generally accepted European stand-ards, but it will take time to ensure independent and more substantial engagement with external and internal auditors, including the as-sessment of their performance, selection of candidates and negotia-tion of financial terms and conditions. It also makes sense for the AC to consider providing AC members with independent access to the system warning of potential unfair actions of the Bank’s employees and third parties and of other disturbances in the Bank’s activities, including the possibility of outsourcing the reception, processing and rapid transmission of signals to the management team and the AC.

Remuneration and HR Committee (RHRC)

Most of the RHRC members are INEDs, but the Chairman represents the Russian Federation. This should be rather viewed as the least-evil solution, given the former Chairman’s tight schedule and the absence of physical meetings in 2015. The authority of the committee covers, among others, significant is-sues that should be addressed in detail:

long-term management motivation linked to KPIs, applica-tion of a benchmark;

performance assessment of the SC and committees, prepara-tion of proposals for the SC composition, including involve-ment in negotiating it with major shareholders;

monitoring the SC members’ status of independence*.

______________________________________________

*Case: Sergey Galitsky who serves as an INED at VTB Bank is simultaneously a sole executive body (CEO) and a beneficial owner of >5% of shares in Rus-sia’s retailer PJSC Magnit. Magnit is one of the Bank’s borrowers, with cur-rent drawdown limits of RUB 46 billion. If the amount of current loan obliga-tions exceeds 2% of the carrying value of consolidated assets as of the re-porting date (RUB 8.08 billion on December 31, 2015), the INED is considered to be related to the Bank’s major counterparty. In such cases of potential forfei-ture of the INED status, the Committee should monitor compliance with the independence criteria and disclosure of information on such compliance.





ECONOMICS


External auditor On March 18, 2015, VTB Bank made a competitive selection of auditors to conduct the mandatory annual audit of VTB Bank’s statements in 2015 - 2019. Ernst & Young LLC (the Bank’s auditor since 2003) won the bidding offering the best audit terms and conditions in terms of the contract price and the bidder qualification). The price of the contract amounted to RUB 1.06 million (3.4% of the initial price). The reason behind the low price of the audit services is another open invitation to tender for the right to conclude a contract for quarterly review audits of interim condensed consolidated financial statements of the Bank under the IFRS standards as of 03/31/2015, 06/30/2015, 09/30/2015, with Ernst & Young LLC as the sole bidder and the price of services reaching RUB 75.664 million. Being aware of the problems associated with the evaluation of bids based on the price only, we believe that the Audit Committee (AC) should play the pivotal role in the auditor selection process so as to prevent a potential conflict of interest between the management team and the auditor, seeing as the management actually pays for the auditor’s services. The AC is to ensure adequate rotation (replacement) of auditors and the required quality of audits by the counterparties.

We highlight the institutional investors’ concern about the Big Four auditors discontinuing cooperation with quite a few major state-owned companies because of tendering procedures involving Russian bidders/auditors who can offer low prices while potentially compro-mising the quality of audits. Furthermore, while international auditors put their international brand and reputation on the line, Russian au-ditors do not feel such a barrier.

Dividend policy In 2016, the SC approved and disclosed the Bank’s a new dividend poli-cy. The recommended amount of dividend payments is based on the Bank’s consolidated 12-month financial result and is normally at least 25% of its consolidated IFRS net profit. It should be noted that the practice of dividend payments at foreign banks also assumes the mandatory aiming at the average industrial dividend payout and the use of a benchmark (this approach is not disclosed in the Bank’s cur-rent dividend policy – our recommendation is to amend it).

Charity and social responsibility The SC pays considerable attention to charity and social responsibil-ity. In 2015, it addressed 5 related issues, including the optimization and improvement of the efficiency of charity and sponsorship-related expenses. In general, the SC members surveyed did not express any concern or suggest additional consideration of charity and social re-sponsibility issues separately from the forecast of VTB Bank’s finan-cial results. The Bank discloses its corporate social responsibility poli-cy and detailed annual social reports presenting the key sustainabil-ity performance results of VTB group. The reports, among others, con-tain tables of compliance with GRI (Global Reporting Initiative) Guide-lines, information on the key projects implemented in the reporting year, including the financing of activities in various segments. In 2015, the Group’s charity expenses amounted to RUB 3.6 billion, including RUB 2.26 billion spent by the Bank. The Bank does not dis-close its sponsorship expenses, despite the participation in numerous sponsorship programs.





ECONOMICS

Practice of dividend payments and charity expenses

HSBC Holdings plc Citigroup Inc. Raiffeisen Bank International AG

BNP Paribas S.A. VTB Bank (IFRS) VTB Bank (RAS)

Payout ratio (the ratio of dividends to earnings), IFRS

75.23%

7.27%

13.33%

42.95%

309.28%

67.34%

Ratio of charity expenses and social investments to

net profit, % 1.36% 0.45% 0.79% 0.58% 33.64% 7.33%

We recommend that the Bank consider disclosing its approaches to setting limits on charity and sponsorship spending.

Information disclosureIn relation to material facts and other investor-relevant information, the Bank follows the policy of complying with the minimum statutory disclosure standards. We believe that the SC should consider and implement best information disclosure practices increasing transparency of significant issues:

description of the top management motivation system linked to the KPI achievement;

material terms of the approved related-party transactions (except for mandatory disclosure cases). However, the exist-ing “non-disclosure threshold” (1% of the assets or approxi-mately RUB 94 billion) allows the Bank to avoid disclosing the terms of almost any related party transactions;

the number of “for”, “against” or “abstained” votes and indi-vidual voting in relation to disclosure of information on cer-

tain decisions made by the issuer’s Board of Directors (Su-pervisory Council) in the form of a corporate action notice;

additional materials for GSMs including comments and ra-tionales (see above);

information on related party transactions in the annual re-port or reference to such information in disclosure materials, stipulated by the information disclosure regulation.





ECONOMICS

Information disclosure practice

Information disclosure by VTB Bank: in 2015, the Management Board received RUB 399 million in remuneration (salaries, bonuses) against RUB 1,597.6 million in 2014. No information is available on the proportion between the fixed part and bonuses and on the type of remuneration (quarter-ly/annual/long-term). VTB’s annual report discloses the KPIs related to implementation of the long-term development program, the specifics of this relation are not provided.

Investors make a point of having information on the motivation system (including the proportion between the fixed and variable components, the types of remuneration in terms of duration, the total payments and the estimate of future payment obligations, as well as the relation between the payments and the achievement of specific KPIs) disclosed by the Bank. In the Russian practice, this essential aspect of disclosure is underdeveloped, which ultimately prevents the monitoring of fundamental corporate governance system components. Approaches to the disclosure of information to shareholders are an absolute prerogative of the SC.

No on the long-term remuneration is not available either. The Bank discloses the shareholdings of the Management Board members.

Management Board member Rounded-off value of share package as of September 30, 2016 (5 largest share-

holdings Yuri Soloviev RUB 170 million Herbert Moos RUB 97 million

Andrey Kostin (CEO) RUB 17 million Vasily Titov RUB 10 million

Viktoria Vanurina RUB 10 million

International management motivation disclosure practice, Bank vs. peers

Approximate ratio of the CEO remuneration (based on forecast, incl. shares) at VTB to

peers in 2015* HSBC Holdings plc Citigroup Inc.

Raiffeisen Bank International AG

BNP Paribas S.A.

Fixed annual remuneration 48% 10% 75% 35% Annual bonuses 26% 41% 25% 55%

Long-term component 26% 49% 0% 10%

* The peers also disclose total pension obligations in their statements in each case.





ECONOMICS

HSBC Holdings plc Citigroup Inc.

Raiffeisen Bank International AG

BNP Paribas S.A.

Disclosure, all pay-ment, incl. in the

form of stock, esti-mates of future

payments

CEO/CFO/COO/CRO CEO: £1,250K in salaries;

£1,700K in fixed supplement in the form of immediately distrib-uted shares (obligation to hold shares for 5 years). £1,072K in bonuses, £1,969K in long-term remuneration in the form of

shares

CEO/CFO, three heads of business segments

CEO: $1,500K in salaries, $6,000K in bonuses.

Long-term remuneration: $4,500K in deferred shares, $4,500K in Perfor-

mance Share Units

All Managing Board mem-bers

CEO: €1,108K in salaries, €364K in bonuses

CEO, CFO

CEO: €1,250K in salaries, €1,950K in bonuses.

Long-term remuneration in the form of shares: €340K

KPIs influencing the short-term (annual) variable remunera-

tion component (incl. the fixed relative

weight of the KPI, if any)

Pre-tax profit 15%, ROE 15%, marginal operating

profit 15%, increase in dividend payments 15%, successful im-plementation of strategy 15%,

meeting standards, including risk management and compliance 25%; observance of the HSBC

Values policy: yes/no

Cost efficiency, net earnings at-tributable to shareholders, ROA, RCE (Return on Common Equity), 12-month TSR, 3-year cumulative TSR vs. 8 peers + Balanced Scorecard (case for CEO): earnings from current operations, cost efficiency across the Group, RTCE (Return on Tangible Common Equity), Core Return on Assets, excess in Risk Appetite Ratio

No disclosure Changes in EPS 37.5%, gross operating profit 37.5%, qualitative estimates 25%: decision-making; quality of governance; a case of ob-

servance of ethical and so-cial responsibility standards; others subject to a decision

by HR & Remuneration Committee.

KPIs influencing the long-term variable remuneration com-

ponent

Panel of long-term financial KPIs: 60% Financial KPIs:

Relative TSR 33.3%, ROE 33.3%, cost efficiency 33.3%. KPIs asso-ciated with the achievement of risk and strategy implementa-

tion targets: 40%

See above + TSR-based adjustment for shares; target value is com-

pared with median value at peers for 3 years

(Program terminated be-cause of regulation, 60% of the shares are distrib-

uted) ROE, higher TSR compared with that of peers includ-ed in the DJ EURO STOXX Banks index over a period

of 5 years

Annual stock price growth for 5 years compared with initial price, discount for

stock price growth rate vs. the EURO STOXX Banks index

Long-term bonuses Shares (in case of partial pay-ment in cash subject to a deci-sion by the HR & Remuneration

Committee, shares account for at least 50% of the total long-term

remuneration) Payment period: 3 years

Deferred shares kept for distribution (50%) + phantom shares (50%) (a

total of 60% of annual bonus) + op-tion (expired), payment period: 4 and

3 years

Not available Money Payment period: 5 years


Research report on PJSC GAZPROM

as of 09/30/2016





RESEARCH REPORT ON PJSC GAZPROM / 2 Association of Institutional Investors (API)




ECONOMICS

38.37%

10.97% 0.89%

2.93%

27.75%

19.09%


Russian Federation

Rosneftegaz

OAO Rosgazifikatsiya

Gazprom Gerosgaz Holdings B.V. (E.On, PJSC Gazprom)

ADR holders

Nominal holders, individuals

Brief capital structure overview Proceeding from the equity capital structure, the Russian Federation (the Federal Agency for State Property Management / Rosimush-chestvo and the JSCs controlled by Russia) effectively owns 50.23% of the Company’s shares. Quasi-treasury shares (including the stake of Gazprom Gerosgaz Holdings B.V., a company jointly controlled by Gaz-prom and E.On, and controlled companies) reach about 3%. Proceeding from the AGM quorum and the results of voting by shareholders, qua-si-treasury shares are presumably voted at shareholders meetings.

About 28% of the Company’s share capital is represented by deposi-tary receipts (ADRs) mainly owned by institutional investors, while the heavily dispersed local shares in free float account for ca. 19.09% of the total capital. ADR holders are not entitled to propose issues to the AGM agenda, including candidates for election to the Board of Direc-tors (BoD), which considerably narrows shareholders’ opportunities to contribute to the development of corporate governance (CG) at the company. For example, independent directors (INEDs) were only nomi-nated to the BoD by the majority shareholder (the Russian Federation) in 2016 (while 2 of the 3 candidates are affiliated with the Govern-ment).

Taking into account the quorum history, the election of one INED by minority shareholders’ votes requires consolidation of 5.4-5.9% of shareholders’ votes and the candidate’s nomination by shareholders jointly holding at least 2% of the local shares.

Corporate governance self-assessment The results of self-assessment (the full list of the principles and rec-ommendations the Company complies with is not disclosed in the an-nual report) shows that PJSC Gazprom complied with 72 out of 79 prin-ciples and recommendations of the CG Code in 2015, excluding 7 items disclosed as being partially complied or not complied with.





ECONOMICS


+ the Company’s Articles of Association vest the BoD with the power to

determine at its discretion the procedure for engagement with enti-ties in which the Company has equity interests, including the scope of its authority in relation to such entities (a relatively rare practice);

the Company discloses an external evaluation in 2015 of its internal audit activities for compliance with the internal audit definition, the Code of Ethics and the International Standards for the Professional Practice of Internal Auditing, preparation of measures in follow-up of the evaluation;

the description of related party transactions in the annual report includes a detailed rationale for recognizing related-party interest;

reports on BoD resolutions disclose information on material terms of related party transactions and on the BoD members’ voting results (except for individual voting);

the Company has a hotline for countering illegal actions and corrup-tion, as well as a Commission for Corporate Ethics.

- According to our estimates, quasi-treasury shares are voted at

shareholders meetings, while the Company’s voting policy is not dis-closed and the BoD is not involved in shaping the policy of voting quasi-treasury shares;

2 out of 3 INEDs do not meet the CG Code independence criteria (both are formally affiliated with the Government as the major shareholder, one of them, in our opinion, is affiliated with a significant counterpar-ty) and recognized as INEDs by a special decision of the BoD;

no disclosure of the top management remuneration system (the long-term/short-term components, the variable/fixed parts, etc.) and the correlation between actual payments and the achievement of KPIs;

the regulation on the procedure for determining the amount of BoD members’ remuneration is not disclosed. The Company follows the practice of short-term incentives for the achievement of KPIs;

no disclosure of BoD members’ individual voting and their participa-

tion in meetings, including the breakdown by the meeting format (personal attendance, including expressions in writing, or meetings in absentia);

the period for submitting AGM agenda items and nominating candi-dates to the management and supervision bodies is only 30 days;

the BoD has no powers to appoint and dismiss the head of the internal audit division / IAD (although in practice, the BoD approves the decision to appoint the IAD head) and to consider the IAD budget and activity plan;

the Company’s dividend policy has not been updated since its adop-tion in 2010; the dividends are linked to the Company’s RAS (Russian GAAP) profit, adjusted for the financing of investments out of profits in the amount of 40% to 75% of the Company’s RAS profit;

the Company does not follow the CG Code recommendations to pass resolutions on key issues of the Company’s activities by a qualified majority or a majority vote of the elected BoD members (only 1 out of 10 issues stipulated by the CG Code are taken account of in the Arti-cles of Association) and to consider such issues at physical meetings (1 out of 19 issues);

the Company’s shareholders have no right to call for a BoD meeting; materials prepared for general shareholders meetings (GSMs) do not

disclose details on candidates to the BoD and the Audit Commission, except for positions, as well as on persons proposing candidates and agenda items;

the Company does not comply with the legal requirement to make public offers to shareholders of controlled companies, despite related court rulings and instructions from the Bank of Russia;

the Company has a Coordinating committee for relations with shareholders and investors chaired by the Deputy Chairman of the Management Committee, but no specifics on the work of this Commit-tee are disclosed; the minority shareholders surveyed by the API are not aware of this Committee’s activities.





ECONOMICS

77,0 76,0 76,0

83,0

23,0 24,0 24,0

17,0

38,0 41,0 41,0

29

2013 2014 2015 2016

Proportion of Rosimushchestvo in the GSM quorum, %

Proportion of minority shareholders in the GSM quorum, %

Proportion of minority shareholders participating in the GSM, %

General shareholders meeting: activity of shareholders, related party transactionsThe percentage of private minority shareholders participating in GSMs decreased considerably in the last three years to 13% of the total free float and 10% of the quorum in 2016). The low participation of minority shareholders in shareholders meetings produces a quite adverse impact on the Is-suer’s corporate governance. According to the Russian legislation, shareholders possessing 2% of the Company’s shares in aggregate are entitled to propose amendments implementing the CG Code recommendations and best CG practices to the Articles of Association and by-laws, including the nomination of independent directors meeting all independence criteria and well known to investors.

94 related party transactions for a total amount of RUB 3,334 billion, $12,664 million and €604 million which may be effected in the normal course of business in the future were approved at the 2015 AGM, 96 transactions for a total amount of RUB 5,779 billion, $12,633 million and €438 million at the 2016 AGM (the wording of issues concerning the approval of 22 transactions contains the clause “for each transaction” without specifying the total number of transactions). Seeing as the majority shareholder is not recognized as a party in interest, minority shareholders do not influence the policy of effecting such transactions.





ECONOMICS

Information on the shareholders of PJSC Gazprom, according to Bloomberg data and information disclosure by the shareholders

Shareholder Name Voting stake,

% Comment on voting


Rosneftegaz 10.97 The shareholder votes according to decisions based on instructions from the Government of Russia, no voting policy.

GAZPROM GEROSGAZ HOLDINGS BV

2.93 The company is controlled by Gazprom, according to the Issuer’s website. The voting of quasi-treasury shares cannot be properly detected due to imperfect disclosure of GSM-related materials. According to our estimates, quasi-treasury shares are voted at GSMs.

OAO Rosgazifikatsiya 0.89 The company is controlled by the Russian Federation. No voting policy.

BNY MELLON (INEDs, mainly ADRs)

27.83

The shareholder owns depositary receipts (the total limit of the program reaches 35% of the share capital). The custodian bank discloses the 15 biggest ADR holders. A separate review of voting by these investors was not conducted, but many of them are direct shareholders of the Russian companies covered by this research and their voting policies are disclosed accordingly. According to the Russian legislation, holders of depositary receipts are entitled to dividends, allowed to vote at GSMs, but de-void of all the other rights related to corporate actions. Judging by the 2016 AGM quorum, participa-tion of ADR holders in the meeting was extremely low.

VANGUARD GROUP INC 0.91

The shareholder discloses the GSM voting policy (Vanguard’s proxy voting guidelines), as well as the way it voted in the last corporate season (including filings submitted to the U.S. Securities and Ex-change Commission). For funds focused on investments in Russia, no participation data in relation to the Company’s 2016 AGM is available for disclosure. The shareholder does not nominate BoD/Supervisory Board (SB) candidates, but supports, according to the general approaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder receives recommendations from proxy advisory firms.

BLACKROCK Group 0.64

The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies (Proxy voting guidelines for European, Middle Eastern and African securities). Information on voting in the last corporate season is disclosed. The shareholder disclosed non-voting at the 2016 AGM. The shareholder receives recommendations from proxy advisory firms. The shareholder does not nominate BoD/SB candidates but can support other shareholders’ proposals if there is certainty about meeting shareholders’ interests in the best way possible.

NORGES BANK 0.46

According to the disclosure, no data on voting at the 2016 AGM are available, The shareholder disclos-es the voting policy (Norges Bank Investment Management’s voting guidelines) and the way it actually voted in the last 4 years. The bank has so far not nominated BoD/SB candidates in Russia, unlike oth-er countries. The shareholder receives recommendations from proxy advisory firms.





ECONOMICS


+ draft versions of new by-laws submitted for approval by the GSM

highlight amendments proposed to them. However, no rationale for such amendments is provided. Our recommendation is to make com-parison tables reflecting proposed changes, including the reason(s) for each of the proposed amendments.

-

profiles of candidates to the BoD and the Audit Commission do not contain sufficient information for understanding of their personal and professional qualities and do not disclose details on their concurrent service in other positions;

GSM-related materials do not disclose persons proposing agenda items and candidates to the BoD and the Audit Commission;

GSM-related materials do not include a rationale for the proposed profit distribution, including the payment of dividends and other spending; besides, no calculation according to the Company’s dividend policy is provided;

GSM-related materials do not contain a rationale for proposed amendments to the Articles of Association and their existing version (for comparison);

GSM-related materials include detailed, though not quite essential information on the proposed auditor, including the list of Russian cli-ents, but do not disclose its fee and the auditor selection procedure (the tender number in the public procurement system, the bidders), as well as information on anticipated non-audit services and their price;

the coverage of related party transactions submitted for approval by a GSM which PJSC Gazprom may effect in the normal course of busi-ness in the future is limited to brief rationales and comments. The non-disclosure of their economic feasibility (whether calculated or otherwise clarified) and the key risks arising from effecting or not effecting them (at least for the largest and most significant transac-tions for which such clarification is advisable) hampers informed deci-sion-making by the shareholders.





ECONOMICS


The Company does not disclose information on the attendance of BoD meetings. The total actual remuneration of BoD members is commensurate with peers or somewhat higher.

BoD activity aspect Total S.A. BP plc ExxonMobil PJSC Gazprom

Number of INEDs / total BoD size

7/12 (the number of INEDs does not include representa-

tives of employees and shareholders related to

them)

13/15 11/13 3 (2 of them recognized as INEDs

by a special BoD decision)/11

Participation in meetings of BoD and committees in 2015 (number of meetings / at-

tendance ratio, %)

BoD: 9 meetings (4 BoD members have attendance

ratio of 80%, 1 BoD member 89%). Audit Committee: 7

meetings (2 members missed 1 meeting each), Compensa-tion Committee: 3 meetings

(attendance ratio 100%)

BoD: 13 meetings (2 via teleconference), 1 BoD

member missed 2 meet-ings, 3 BoD members

missed 1 meeting each. Audit Committee: 11 meet-ings (3 members missed 1

meeting each)

BoD held 11 meetings, Audit Committee 11 meetings,

Compensation Committee 7 meetings, Board Affairs

Committee 7 meetings. Av-erage attendance ratio: 92%, attendance ratio at

BoD and all committees is at least 75% (no individual

disclosure).

A total of 66 BoD meetings, in-cluding 11 physical meetings; no attendance data are provided in the annual report and in GSM-

related materials

Remuneration of BoD mem-bers / actual payments for

2015

€20K to BoD member, 30K to Audit Committee Chair, 25K to Audit Committee member + 5K per BoD meeting, 7K per

Audit Committee meeting, 3.5K per meeting of other

committees. Actual: € 61-130K

£785K to BoD Chair, £120K to Senior INED, £90K to

BoD member, £30/20K to Committee Chair/member. Actual: £141-178K for the

corporate year

$110K to BoD member, $10K to Committee Chair + 2,500 shares annually (+ 8,000

shares upon taking office) and dividends on them (not distributed if resigned be-

fore age of 72). Actual: $110-120K+ $231K in shares

Regulation on remuneration of BoD members is not disclosed.

Actual (2016 GSM): RUB 26 million to BoD Chairman, RUB 25.2 million to Deputy BoD Chairman, RUB 22.2 million to AC

Chair, RUB 21.4 million to AC member; RUB 20.9 million to

other BoD members (not holding a public office and not being

civil servants)





ECONOMICS


Chairman of the Board of Directors Viktor Zubkov (representing the Russian Federation) Russia’s Special Presidential Representative for Cooperation with the Gas Exporting Countries Forum, no shareholding in the Company Chairman of the Audit Committee Viktor Martynov (INED*) Rector, Gubkin Russian State University of Oil and Gas, no shareholding in the Company;

Vladimir Mau (INED*) Rector, Russian Presidential Academy of National Economy and Public Administration (RANEPA) Member of the Audit Committee, member of the Nomination and Re-muneration Committee; no shareholding in the Company; Timur Kulibaev (INED) Chairman, KAZENERGY Kazakhstan Association of Oil, Gas and Energy Sector Organizations, no shareholding in the Company.

_______________________________________________ The API failed to arrange for a meeting with independent BoD members as the Company did not respond to a request. We therefore cannot include comments on key corporate governance issues in this report and present a review of the BoD activity in practice. Besides, the Company does not disclose information on individual voting by BoD members, which also prevents a proper analysis of certain aspects of the BoD activity.

*BoD members Viktor Martynov and Vladimir Mau elected at the 2016 AGM were recognized as independent directors by a BoD resolution as of 08/23/2016, despite their formal affiliation with the Government: both are rectors of state-financed educational institutions appointed by order of the Ministry of Education and Science, i.e. a federal executive authority (Viktor Martynov) or the Government of Russia (Vladimir Mau).

It should be noted that the Board of Directors did not take into consideration the possible affiliation of Viktor Martynov, the rector of the Gubkin Russian State University of Oil and Gas, with this higher education institution as the Company’s major counterparty when acknowledging his inde-pendence. Financing from the Company, including donations, makes a large portion of the Gubkin University’s revenues. In the period under review (2015 and 9 months of 2016), Gazprom’s governing bodies approved 43 transactions involving the Gubkin University as a party, for a total amount of more than RUB 2,773 million (21 transactions for a total amount of RUB 336.5 million were approved by the BoD, 22 transactions worth RUB 2,437 mil-lion by the general shareholders meetings in 2015-2016). The aggregate ceiling amount of the transactions approved for execution in 2015-2017 ex-ceeds 30% of the University’s aggregate budget revenues in 2015 and 2016.For reference: for the same period, the Company’s governing bodies ap-proved a mere 4 transactions for a total amount of RUB 979 thousand with RANEPA whose rector (Vladimir Mau) is also a member of the Board of Directors. No donation contracts were approved.





ECONOMICS

Board of Directors: practical activity aspects For the period under review (2015 and 9 months of 2016), according to the disclosure system, the BoD held 110 meetings (one of the highest results among the companies covered by the research). The BoD con-sidered 336 issues, including 118 related party transactions (35% of all the issues) for a total amount of more than RUB 368 billion, $3.2 bil-lion and €119 million. The Company does not always disclose the meet-ing format (physical/in absentia) in material facts. In 2015, the BoD held 11 physical meetings; two of the meetings held in January-September 2016 were clearly identified as physical meetings.

Key issues considered by the BoD:

charity (11 issues considered); only one of them, “Optimization and efficiency increase of charity and sponsorship expenses”, qualified as a systemic issue, all the other issues concerned specific transactions, basically the financing of educational institutions;

approval, adjustment and reporting on the achievement of KPIs and the Company’s effective regulations on the KPI system (8 issues);

long-term development program (LTDP), amendments and implemen-tation reports, as well as LTDP audit-related issues (6 issues);

approval of actual KPIs and the management remuneration calcula-tion procedure (5 issues);

risk management (approval of the policy and regulation), road map, assessment and updating of key risks (5 issues);

review of performance results, including the annual report and financial statements (4);

consideration of the budget and investment program, including related adjustments (3);

organization of the internal audit function at the Company (3).

Based on the information from disclosure system, the Board of Direc-tors considered the issue “On adjusting the target (planned), thresh-old and maximum values of the Company’s 2015 key performance indi-cators for the purpose of the annual senior management bonus sys-tem of PJSC Gazprom” on December 25, 2015. Consideration of such adjustments virtually at the expiration of the reporting period calls for an explanation and is not advisable in goal-setting. As for risk management, the Board of Directors separately considered the issue “On assessing and updating the key risks”, although as late as in August 2015. In June 2016, the BoD considered a plan of measures addressing risk management and internal control processes aimed at preventing and countering corruption. According to the in-formation disclosure, regular risk management reports are not con-sidered at BoD meetings as a separate issue. The Company’s Articles of Association do not provide for the share-holders’ right to request the convening of a BoD meeting. According to CG Code recommendations, this right should be given to sharehold-ers who own at least 2% of the Company’s voting shares. As regards regulation of the Board of Directors activities, the proce-dure for considering BoD members’ expressions in writing is too fo-cused on formalities. In particular, expressions in writing containing amendments and reservations on proposed draft resolutions, as well as statements of opinion on issues for which the draft resolutions were amended at the BoD meeting are disregarded. At the same time, the establishment of a procedure for negotiating amendments with BoD members who are not in attendance ensures that BoD members’ positions are taken into account to the fullest extent possible, espe-cially where views on draft resolutions differ, and should therefore be regarded as the best practice.





ECONOMICS


2 of the 3 AC members (including the Chairman) are recognized by the BoD as independent BoD members. 1 AC member is a representative of the management (a negative practice existing only at PJSC Gazprom among the companies covered by the research). The AC members are only specified in a press release – no disclosure on the website.

In 2015, the BoD held 7 meetings, including 5 meetings in the form of joint attendance, and considered a total of 13 issues.

The practical activity of the committee and the power of the BoD in this respect are not consistent with the CG Code recommendations, given the lack of power to appoint and dismiss the IAD head, the lack of power to exercise control over the system for reporting potential unfair actions of employees and third parties and to approve the IAD budget.

In 2015, the AC approved the internal audit system development con-cept, the Internal Audit Regulation, the annual and long-range plans of internal audits, the risk management policy and the Regulation on the Risk Management System of Gazprom Group. According to the disclosure system, the AC considered information on the internal au-dit division’s activity.

The AC and the IAD have no direct top-level control over the preven-tion and settlement of conflicts of interests or violations – this power is vested in the Commission for Corporate Ethics of PJSC Gazprom, a collective executive body established by order of the Chairman of the Management Committee based on the Company’s Code of Corporate Ethics.

Nomination and Remuneration Committee (NRC)

The NRC consisting of three BoD members has the same composition as the Audit Committee, the only difference being that the manage-ment representative chairs the committee (a negative practice exist-ing only at PJSC Gazprom among the companies covered by the re-search).

The committee was established by a resolution of the BoD as late as in October 2016 (most likely with the aim of meeting the listing rules of the exchange).

Evaluating the NRC members’ access to all contracts with the senior managers and the remuneration system is problematic due to the lack of opportunity to meet with the committee members.





ECONOMICS

Essential CG aspects Relations with the external auditor

According to clause 2.1.6 of the Regulation on the Audit Committee, the committee is authorized to approve tender documents, to review the results of evaluation and comparison of tender bids by the bid-ding commission and to prepare recommendations on the auditor for the BoD, which is good practice. However, the AC does not formulate the key requirements to the procurement of audit services. FBK LLC was approved as the auditor by a resolution passed at the GMS on June 30, 2016. The cost of audit services in relation to the accounting (financial) statements of PJSC Gazprom, the consolidated accounting statements and consolidated financial statements of Gaz-prom Group according to IFRS standards for the year 2016 amounted to RUB 228 million (64% of the initial tender price). The price of services is the key evaluation component taken into ac-count for auditor selection purposes (60%), the other factors being the qualitative parameters of the procurement item (the standard terms of audit services, 30%) and the auditor qualification (10%). See-ing as Russian auditors generally bid lower prices (in this case, 12% below the price offered by the second best bidder) while offering comparable terms and conditions of services (let alone the advantage of being licensed to deal with state secret), the Big Four companies’ superiority in terms of qualification cannot offset the lag in the other criteria. This is showcased by the 2016 auditor selection when the aggregate score of the second best bidder (JSC PwC Audit, a Russian subsidiary of PWC possessing extensive experience in auditing PJSC Gazprom and its subsidiaries) was 0.81 points (on a 100-point scale) or 0.9% below the score of the winner, Russia’s audit firm FBK LLC (which also has a track record of cooperation with Gazprom), while the second best bidder surpassed the winner in professional qualification by 8.54 points. Therefore, the lower price and the license to deal with state secret actually decided in favor of the Russian firm. We recommend that AC members pay attention to the investors’ opinion on the engagement by the Company of a Russian specialist to

audit IFRS financial statements. Investors feel more comfortable with an international auditor for whom the quality of audit services is primarily a matter of reputation. The Company discloses information on the provision (scope) / non-provision by the current auditor of non-audit services. In 2015, the cost of audit services was RUB 204 million (net of VAT), the cost of non-audit services reached RUB 24.7 million (VAT included).


The Company has approved the Internal Audit Regulation, the Regula-tion on the Risk Management System of Gazprom Group and the Risk Management Policy of PJSC Gazprom. The Internal Audit Regulation is not disclosed, although most of the PJSCs covered by this research do disclose internal audit policies. Besides, the disclosure system does not indicate whether the BoD considered the internal audit depart-ment’s report in 2015 (as follows from the annual report, information on the internal audit department’s activities was presented to the AC, without further specifics). The Company has a rather mature internal control and risk manage-ment system. The internal audit, internal control and risk manage-ment functions are differentiated. The essential flaws of the internal audit function are as follows: - the head of the internal audit department is appointed and dis-missed by the Chairman of the Management Committee as advised by the Deputy Chairman and approved by the AC, while the CG Code as-sumes that it is the BoD that has decisive influence on decisions to appoint the IAD head and to determine the IAD head’s remuneration, as well as on the approval of the IAD activity plan (after preliminary consideration by the AC), according to a practice already pursued at most of the PJSCs covered by this research. In 2015, the Company and the entities controlled by it concluded over 17,000 contracts for a total amount of more than RUB 1 trillion, but saved a mere RUB 33 billion, i.e. no more than 3.3% on average, which means that attention should be paid to further improvement of pro-





ECONOMICS

curement management and control efficiency on the part of the BoD and the IAD. The Company has a hotline for countering illegal activities and cor-ruption (the hotline is under control of the corporate protection ser-vice and the Commission for Corporate Ethics). The internal audit de-partment’s participation in checking up on appeals is duly regulated, but the AC is not supposed to exercise control and to receive copies of related opinions, although the responsibility to control the ob-servance of corporate ethics is assigned exactly to the Committee.

The Commission for Corporate Ethics was established by a BoD reso-lution as an additional supervisory body for tracking conflicts of in-terests and monitoring compliance with by-laws on corporate ethics (the composition and operation procedure of the Commission were approved by an order, not by a BoD resolution, it is not a BoD body).

Negative practice of non-performing mandatory cor-porate actions

The Company does not meet the obligations to make a mandatory public offer for the buy-back (repurchase) of securities to minority shareholders 72 regional gas distribution companies which Gazprom acquired from OJSC Rosneftegaz in 2013 with the permission of the Russian Government given in 2010. According to certain estimates, the cost of all stakes in regional gas distribution companies to be repur-chased if all the shareholders accepted the offer would reach almost RUB 8 billion. Courts repeatedly dismissed the Company’s actions to challenge the minority shareholders’ claims. The Bank of Russia sent related orders to the Company and imposed non-compliance penal-ties, but the Company still fails to make the offers. In the middle of 2016, a draft law proposing the transfer of shares between state-owned companies without making an offer if pursuant to decrees issued by the President or the Government of the Russian Federation was submitted to the State Duma. The draft law gives full legal recognition to the Company’s currently illegal refusal to make offers to regional gas distribution companies’ shareholders, as it pro-poses, among other things, extending the exemption from mandatory offers to previously effected transactions and therefore, makes PJSC

Gazprom one of the main beneficiaries of its adoption. We believe that there is, and should be, no difference between decrees of the Government / President acting as the majority shareholder of state-owned companies and decisions of a private controlling shareholder. The enactment of this draft law will compromise the basic guarantees of investors and ultimately discredit both the Company and the Rus-sian Federation as a country with an attractive economy for portfolio and institutional investors.

Dividend policy

The Company’s dividend policy has not been updated since its adop-tion in 2010, the amount of dividends is linked to the RAS (Russian GAAP) profits and further limited to ensure the financing of invest-ments out of profits in the amount of 40% to 75% of the Company’s RAS profit; The 2015 dividends amounted to 23.7% of the IFRS profit attributable to the shareholders of PJSC Gazprom (25% of the total IFRS profit), 46.29% of the RAS (Russian GAAP) net profit. It should be noted that the dividend payout ratio was below the tar-get level set by the Government of Russia for 2015 (50% of the IFRS or RAS net profit, whichever is the greater). Just like most of the PJSCs covered by the research, the Company does not pay interim (quarterly or 6-month) dividends, a practice typical with foreign peers. The dividend policy needs to be updated, particularly given the need to abandon the practice of paying dividends out of leftovers, to use a benchmark in relation to profit distribution and to set target values for the return on capital investment, the cost and volume of borrow-ings, etc.





ECONOMICS

Dividend payments at Gazprom vs. (conditional) peers, in relation to IFRS net profit (2015), %


The total amount spent by Gazprom Group on charity and social projects in 2015 was not disclosed in the annual report, which is not consistent with the generally accepted international practice for major companies. However, according to the 2015 Russian GAAP statement, the Company’s expenses for charity amounted to RUB 17,634 million or 2.19% of the consolidated IFRS profit earned in 2015, slightly higher than at peers. Spending on charity and social development of regions compared with peers, in relation to net profit, %


The Company does not disclose the individual voting of BoD members in the mandatory disclosure system; most of the reports on related party transactions approved by the BoD disclose essential parameters of such transactions, which we regard as

good practice; the Company provides reasons for non-disclosure of information (including reference to confidentiality), which is commendable; the Company does not disclose the senior management remuneration system and the correlation between payments and specific KPIs (including

the disclosure of target and actual KPIs, particularly versus peers); the Company does not disclose the results of activity of the Coordinating committee for relations with shareholders and investors; no disclosure of members of the BoD committees on the website.

IFRS/US GAAP Total S.A. BP plc Exxon Mobil PJSC Gazprom

Payout ratio (the ratio of dividends to net income) 124%

No profit earned in 2015 (176% in relation to 2014

net profit) 75% 24%

Total S.A. BP plc Exxon Mobil PJSC Gazprom

0.36% 1.77% (in relation to the

previous year’s net profit) 1.66% 4.37% of RAS profit (2.24%

of IFRS profit)





ECONOMICS

Disclosure of the management motivation system at international peers

Approximate proportions of CEO re-muneration components in 2015



Long-term remuneration 36% 75% 77% 0%

Employee stock option plan (ESOP) highlights The Company has adopted a Regulation on the system of annual bonuses for senior employees of PJSC Gazprom, a Regulation on key performance indicators and a Regulation on the equity participation program for senior employees. The system of annual bonuses (applying, among others, to senior employees of controlled companies) is based on unified remuneration principles and approaches assuming that the remuneration is linked to the achievement of KPIs. The total bonus fund is determined on the basis of company-wide KPIs divided into two groups: no more than 7 financial and economic KPIs with a total relative weight of up to 70% and no more than 4 industry-specific KPIs factoring in special features of the business activity, with a total relative weight of no more than 50% of the combined weight of all KPIs). The target (planned) and actual KPI values are subject to annual approval by the BoD. In 2015, 65 executive employees qualified for the equity participation program (the share acquisition program). Under the terms of the program, such employees can acquire shares at their own expense or using borrowed funds provided by Bank GPB (JSC) under the program. The acquisition of shares using borrowed funds is not a generally accepted international practice.

Disclosure of information on shareholdings of the Company’s Management Committee (5 largest shareholdings) Management Committee member Rounded-off value of share package as of 09/30/2016

Alexey Miller RUB 31 million Andrey Kruglov RUB 23 million Vitaly Markelov RUB 198 million Oleg Aksyutin RUB 70 million Nikolai Dubik RUB 31 million





ECONOMICS



CEO Actual:

€1,200K in salary €1,814.4K in bonus pay-

ments €1,723K in bonuses for KPIs

CEO+CFO Actual (CEO): $1,854K in salary,

$1,391K in bonus payment, $2,603K in deferred bonus pay-

ment in shares (2/3 of annual bo-nus payment) + shares;

$7,116K in long-term remuneration in the form of shares for KPI

achievement

CEO+CFO+3 top managers; actual (CEO): $3,047K in salary, $2,386K in

bonus payment, $18,288K in the long-term remuner-

ation in the form of shares

Collective executive body (in aggregate)

Actual: RUB 1,429 million in sala-ries, RUB 1,155 million in

bonuses

KPIs influencing the short-term (annual) variable remunera-tion component (incl. fixed relative weights of the KPIs, if any)

Security, ROE, net income/equity capital, adjusted net income, oper-ating cost reduction, per-

sonal KPIs

Reduction in the number of prima-ry environmental pollution cases,

accident rate, number of industrial accidents (10% each); operating

cash flow, replacement cost profit (20% each); net investment 15%,

corporate and functional expenses 10%, priority projects 5%

Safety and operating efficiency, ROCE, TSR vs. peers, FCF, payments to shareholders, strategic results, implementation of projects. Addi-tionally, 50% of the bonus is de-ferred until target EPS achieve-

ment

Specific costs in the “Pro-duction” business seg-

ment (15%) and “Transpor-tation” business segment (15%), ROE 20%, return on shareholder investment 10%, labor efficiency 5%, operating expenditure

(cost) reduction 5%, gas sales in physical terms 15%, commissioning of

priority industrial projects 15%

KPIs influencing the long-term variable remuneration

ROE, ROACE, adjusted net income

TSR vs. peers 1/3, operating cash flow 1/3, stock replenishment rate, safety and industrial risks, imple-mentation of priority projects 1/3

in total

See annual remuneration compo-nent

N/a

Long-term bonuses Shares for KPIs, options Portion of annual remuneration (3-year period) converted into

shares and long-term remunera-tion in shares for KPI achievement

(3-year accumulation period)

Payment of long-dated shares: 50% in 5 years, 50% in 10 years or in

case of resignation

N/a


Research report on PJSC UAC

as of 09/30/2016





RESEARCH REPORT ON PJSC UAC / 2 Association of Institutional Investors (API)




ECONOMICS

90.48%

3.86% 5.53%


Russian Federation

Minority shareholders

VEB Group


The Company’s capital structure resulted from the contribution to its authorized capital of stakes in publicly and privately-owned aircraft manufacturers. The number of quasi-treasury shares, according to reports for the second and third quarters of 2016, exceeds the total number of shares. For capital structure calculation purposes, the num-ber of quasi-treasury shares was reduced by 3 digit positions (the last three digits were discarded). The Company’s free float does not allow minority shareholders to in-fluence the formation of the Board of Directors, while the nomination of a Board of Directors (BoD) member is possible and was implemented in practice.

Corporate governance self-assessment According to the Company, UAC complies with 39, partially complies with 29, fails to comply with 11 out of 79 recommendations of the 2014 Corporate Governance Code.





ECONOMICS


The BoD is vested with rather broad powers as regards subsidiaries, including essential aspects of their activities (formation of executive bodies, changes in the authorized capital, etc.);

only issues where resolutions should be passed by a simple majority of votes may be considered at BoD meetings in absentia. Issues that require a qualified majority or unanimity of votes are only considered at physical meetings (conditionally positive, given that such issues cover the smaller part of the Corporate Governance (CG) Code recom-mendations at the Company).

- Only 2 of the 11 BoD members are independent. Both are recognized as

independent directors (INEDs) by a BoD resolution with the wording “due to an exceptional need to ensure compliance of PJSC UAC with the mandatory listing requirements,” despite the affiliation of both candidates with the Company at the moment of this resolution;

the Company does not disclose information on the BoD committees (including their current members) and the documents governing their activities on its website;

no disclosure of specific approaches to structuring the top manage-ment’s remuneration, including the correlation between the remuner-ation and the achievement of KPIs;

the system of remuneration of BoD members is not consistent with the shareholders’ interests and does not meet the CG Code recom-mendations;

the basic documents (Articles of Association, regulations on manage-ment and control bodies) were approved in 2010. While 6 amendments were made to the Articles in 2015-2016, the legislative innovations and CG Code recommendations (concerning the procedure for exercising rights carried by securities, the procedure for notifying shareholders of resolutions made at general shareholders meetings / GSMs, etc.) were almost completely disregarded;

the Company’s website only provides information on the 2016 GSM; the CG Code recommendation concerning the need for a qualified

majority of votes for passing BoD resolutions on the key aspects of the Company’s activities is not followed completely;

information on persons proposing GSM agenda items is not disclosed; the notices on resolutions made by the BoD do not disclose details on

related party transactions (except for the names of counterparties) and related voting results, including the votes cast for different vot-ing options (except for the total number of votes and the statement of passing a resolution);

the shareholders have no right to convene a BoD meeting.





ECONOMICS

99.82 99.84 97.84

0.18 0.16 2.16 2.70 2.50

54.99

2014 2015 2016

Russia, VEB, quasi-treasury shares

Free float

Proportion of free float shareholders participating in the GSM in total free float

General shareholders meeting: activity of shareholders, related party transactions

The rather low free float percentage (about 4% on the 2016 AGM date) prevents minority shareholders from electing at least one independent direc-tor (no chart of changes in the minority shareholders’ participation in GSMs is provided for lack of information value). The activity of the minority shareholders at the 2016 AGM was relatively high, even though their votes can only influence the approval of certain interested party transactions (55% of the free float, which most likely indicates the concentration of share packages in the hands of a single investor). 5 transactions for a total amount of RUB 181 billion, 1 related party transaction (a surety in the amount of RUB 32.5 billion) and 29 related party trans-actions which may be effected in the normal course of business in future for a total amount of RUB 67 billion were approved at the GSM in 2015. Next year, 44 related party transactions which may be effected in the normal course of business in future for a total amount of RUB 879.4 billion were approved at the GSM.





ECONOMICS

Information on the shareholders of PJSC UAC, according to Bloomberg data and information disclosure by the shareholders

Shareholder Name Voting

stake, % Comment on voting


VNESHECONOMBANK 5.53 No voting policy, voting most likely according to the Government’s interests and instructions.

LGT CAPITAL PARTNERS LTD

0.01 The shareholder is a signatory of PRI, According to its 2016 reporting documents, the shareholder voted in 93% of all the ballot papers received from companies as their shareholder. The shareholder receives recommenda-tions from a proxy advisory firm. The voting information is not publicly disclosed.

POLUNIN CAPITAL PART-NERS LTD

0.01 According to the shareholder’s report on following the UK Stewardship Code recommendations (2015), the shareholder votes in the interests of its clients at the GSM. Voting details are disclosed at the client’s request.

FLEXSHARES TRUST 0.01 The voting right is exercised by investment consultant Northern Trust Investments which discloses its voting policy, including approaches to determining its position on particular issues.





ECONOMICS

General shareholders meeting: disclosure of information and es-sential aspects

+ the Company’s Articles of Association provide for the disclosure of

GSM-related materials no later than 30 days prior to the GSM date; the GSM-related materials specify the persons proposing candidates

for election to the Board of Directors and the Internal Audit Commis-sion (IAC);

the period for proposing agenda items and candidates to the BoD and the IAC is increased to 60 days;

the Company’s annual report includes details on related party trans-actions approved by the BoD and the GSM in the reporting year, speci-fying, among others, the counterparty, amount, parties in interest and the management body which approved the transaction.

- no information is disclosed on the auditor’s remuneration for audit

and non-audit services and other material terms of the agreements with the auditor.

no information is disclosed on the persons proposing GSM agenda items;

the Company only discloses materials related to the last two 2016 GSMs, which prevents appropriate evaluation of the quality of infor-mation disclosure to shareholders as regards amending the Articles of Association and the corporate by-laws, as well as other specifics of the GSM information support (conditionally negative).





ECONOMICS


BoD activity aspect Lockheed Martin Corporation The Boeing Company Airbus Group SE PJSC UAC

INEDs/total number of BoD members 11/12 12/13 11/12 2*/11

Participation in meetings of BoD and committees in 2015 Number of meetings / Attendance

BoD: 10 meetings (over 75%) Committees: attendance >75% (details remain undisclosed)

BoD: 31 meetings (attend-ance ratio >90%) Committees: attendance ratio exceeds 97% (no further details disclosed)

BoD: 9 meetings (attend-ance ratio exceeds 91%) Audit Committee (AC): 5 meetings (attendance ratio 93%) Remuneration, Nomination and Governance Commit-tee: 6 meetings (attend-ance ratio 96%)

BoD: 32 meetings, attendance ratio 95% (1 member missed 50%), Audit Committee: 33 meetings (100% attendance, but the format of meetings is un-disclosed), HR and Remuneration Committee: 10 meetings (100%)

Remuneration of BoD mem-bers / actual payments for 2015

$145K to BoD member Up to $145K in deferred shares per BoD member: $25K to Senior INED $25K to Chair of AC $20K to Chair of Management Development & Compensation $15K to other Chairs of Board committees. Actual: $272 - $309K (for full year), incl. shares

$130 -175K in monetary form + $165K in shares. Actual: $303-371K (for full year), incl. shares

€180K to BoD Chair, €80K to BoD member; €30K to committee chairs; €20K to committee mem-bers; €10K per BoD meeting to BoD Chair, €5K per BoD meeting to BoD member. Actual: €105-250K (for full year)

Base remuneration: RUB 0.2-1 million per year, depending on revenues adjusted for weighted average KPI achievement ratio and BoD meeting attendance ratio. 30% for BoD chairmanship, 20% for committee chairmanship, 10% for committee membership, uplifts are added together. Actual: RUB 0.53 – 1.3 million (public servants not entitled to remuneration)

* fail to meet CG Code recommendation criteria, recognized as independent directors by a BoD resolution.

The BoD remuneration system at UAC is not consistent with the generally established CG practices; in absolute terms, the remuneration is not com-mensurate with the amounts payable by conditional peers and most of the Russian companies covered by the research, the remuneration system needs to be revised.





ECONOMICS


Chairman of the Board of Directors Denis Manturov (representing the Russian Federation) Minister of Industry and Trade of Russia, no shareholding in the company;

Chairman of the Audit Committee Evgeny Yurchenko (INED)* President, Popov Investment Cooperation Fund, no shareholding in the company;

Chairman of the Strategy Committee Boris Alyoshin (INED) Adviser to UAC President on Science and Technology, no shareholding in the company. * Due to a tight schedule, we had no time to meet with the Chairman of the Audit Committee during the research, despite his readiness for a meeting. The second BoD member recognized by the BoD as an independent director and the Company itself did not respond to the API’s request for a meeting. There-fore, given the poor information disclosure, the Board of Directors’ perfor-mance cannot be evaluated at a minimum possible level.

In the period under review (2015 and 9 months of 2016), the BoD held 57 meetings (201 issues considered). 37 issues (18%) concerned approv-ing related party transactions, with a total of 591 deals considered.

Other aspects considered at BoD meetings: key performance indicators (4 issues); financial and economic plan / budget (4 issues); long-term development program (6 issues); decision-making on significant issues of subsidiaries and affiliates,

including the formation of their management bodies (10 out of 11 is-sues).

It should be noted that the BoD considered approving the Group’s budget, KPIs, the internal audit department’s activity plan and other documents for the financial year at the end of the 1st quarter of the planning period, which is quite late.

Recommendations of the 2014 CG Code in respect of issues requiring a qualified majority of BoD members in attendance are partially fol-lowed. The Articles of Association provide for a qualified majority of 11/14 BoD members; however, the number of BoD members was re-duced from 14 to 11 in 2012, while the related provisions in the Articles of Association were not amended as appropriate. The requirement to pass resolutions by a qualified majority, a majority of elected BoD members or unanimously applies to 14 issues within the competence of the BoD, but only 4 of them fully or partially comply with the CG Code recommendations.

The Board of Directors Regulation provides for the possibility of al-ternative wordings of BoD resolutions, but there is no mechanism for negotiating them with BoD members who are not in attendance.

No self-evaluation or external evaluation of the BoD performance was conducted in 2015, no external organization was engaged to conduct an independent evaluation in the last three years.





ECONOMICS


The AC consists of two conditionally independent directors. The Chairman of the Committee is one of these INEDs. The Audit Committee Regulation is not disclosed. According to the Regulation on the system of internal control over the Company’s financial and economic activities, the Audit Commit-tee is vested with the following powers: preparation of exter-nal auditor-related proposals for GSMs, consideration of the auditor’s opinion, assessment of efficiency of internal control procedures, control over the budget discipline, financial stabil-ity and liquidity, expert review of internal and external finan-cial statements of the Company and its subsidiaries, control over transactions involving affiliates, initiation of audits and inspections of the Company’s financial and economic activities. In 2015, the AC held 33(!) meetings, more than any other com-pany covered by the research (the format of the meetings was not disclosed). The range of issues considered by the Commit-tee included preliminary approval of transactions (10), recom-mendations of the BoD on their approval (17), audit of compa-nies and subsidiaries (7), endorsement of the plan of measures aimed at implementing the 2014 CG Code recommendations, the plan of efficiency improvement measures.

HR and Remuneration Committee (HRRC) The HRRC consists of three members: one of them is recognized by the BoD as an independent BoD member, the other two, including the Chairman, represent the Russian Federation. The HRRC Regulation is not disclosed. According to the Board of Direc-tors Regulation, the HRRC is vested with the following powers: devel-opment of principles (criteria) for the remuneration of BoD members, Management Board members and the President, development of pro-posals concerning material terms of the contracts with them; regular performance evaluation of the President and the Management Board, preparation of proposals for their possible reappointment; develop-ment of policies and standards for executive recruitment, develop-ment of the senior staff motivation and stimulation system and methods. At its 10 meetings held in 2015, the HRRC considered the following issues: recommendations to the BoD concerning subsidiaries (6); cor-porate structure (4); concurrent service of the Company’s top manag-ers in other positions (4), termination of powers and election of the sole executive body (SEB), drawing up of the contract with it, recom-mendations on the remuneration of BoD and IAC members, the list of candidates to the BoD and the IAC for the corporate year 2016-2017. The degree of formality in the HRRC activities cannot be assessed without conducting meetings with HRRC members as appropriate.





ECONOMICS

Essential CG aspects External auditor

In April 2015, the procurement commission approved Audit and Con-sulting Firm Top-Audit LLC licensed to deal with state secret as the Company’s auditor for 2015 and 2016 following an open competition. Information on the terms and conditions of bidding, the participants, the scope and cost of audit services, as well as the role of the Audit Committee is not disclosed, except for noting the consideration by the Committee of the candidate for external auditor in the annual report.


The internal audit system at the Company failed to meet the CG Code recommendations and the applicable international internal audit standards in 2015. In particular, the Audit Committee did not consider a number of issues within its scope and authority, including candi-dates for the position of head of the internal audit (IA) division, the budget, activity plan and reports of the IA division. At the same time, the AC considered the approval of transactions, the external audit of statements and the comprehensive audit of subsidiaries. The internal audit and internal control functions are not completely differentiated in the internal audit and control department.

The BoD approved the Company’s internal audit policy and risk man-agement policy as late as in 2015. Besides, no business process and risk management department existed until December 2015. Before that, the Company did not go beyond approving the Regulation on the system of internal control over the Company’s financial and economic activities (2011). The disclosure system provides no information on the regular consideration by the BoD of risk management-related issues. Therefore, the current condition and efficiency of the risk manage-ment and internal audit system can only be evaluated based on the 2016 results, subject to adequate information disclosure. In our view, the BoD does not pay enough attention to these issues (or proper information disclosure).

Dividend policy

The dividend policy has not been updated since it was adopted in 2013. According to the document, the Company aims at setting the amount of dividends equal to 25% of the consolidated IFRS net profit earned by it, a payout ratio meeting the good practice criteria. The Company paid 25.5% of its RAS (Russian GAAP) net profit based on its business activities in 2013, 25% of the RAS net profit (unadjusted for earnings from the positive balance of exchange rate differences re-lated to currency resources on the Company’s accounts) based on the 2014 performance. No 2015 dividends were paid due to the absence of net profit.

2014 dividend payout ratios at UAC vs. (conditional) peers

Lockheed Corp. The Boeing Company Airbus Group SE PJSC UAC*

PJSC UAC* (net profit un-adjusted for exchange rate

differences)

Payout ratio* 48.8% 40.6% 40.3% 5.5% 25.0%

* 2014 data are provided, both adjusted and unadjusted for exchange rate differences (the Company generated a loss according to IFRS); no 2015 dividends were paid by the Company due to the absence of net profit.





ECONOMICS

Disclosure of the management motivation system at peers Approximate proportions of CEO remuneration components at UAC vs. peers in 2015

Lockheed Corp. The Boeing Company Airbus Group PJSC UAC


CEO+CFO+3 top managers Actual (CEO): $1,603K in salaries, $5,477K in annual bonus, $3,618K according to LTIP, $8,900K in deferred shares

CEO+CFO+3 top managers. Actual (CEO): $1,350K in salaries, $1,962K in annual bonus, $2,600K in long-term remuneration, deferred component of annual bonus, $5,100K in long-term remunera-tion in deferred shares

CEO: €1,400K in salaries, €1,930K in bonus, €3,148K in long-term remuneration, €1,400K in deferred shares

Collective executive body (10-13 members) Actual: RUB 2.9 mil-lion for participation in the collective executive body’s ac-tivity, RUB 39.5 million in sala-ries, RUB 18.96 million in bonus-es

KPIs influencing the short-term (annual) variable remuneration component (incl. the fixed relative weight of the KPI, if any)

Finance: orders 20%, sales 20%, operating profit 30%, operating revenue 30% (60% in total) + strategic and operating objec-tives (40% in total) + targets in segments + individual KPIs

The Group’s economic profit (net operating profit after tax, net assets multiplied by the cost of capital), other KPIs (descriptive disclosure)

50% in aggregate: EBIT (45%), FCF (45%), ROCE (10%); 50% for individual KPIs (achievements and behavior).

15 KPIs. Key KPIs: TSR (15%), ROE (15%), revenue, net margin, debt/revenue, cost reduction (50% for fin./econ. indicators in total), labor efficiency, R&D volume, share of exports


Relative TSR (50%), ROIC (25%), revenue (25%)

Relative TSR, economic profit (see above)

Positive EBIT, EPS (75%), FCF (25%)

No

Long-term bonuses LTIP in cash (20%), and deferred restricted stock units (30%), payment period 3 years + shares for KPIs (50% of total remunera-tion) calculation period 3 years

Cash bonuses for KPI achieve-ment (50%), bonuses for KPI achievement in restricted stock units (25%), accrued restricted stock units (25%). Calculation period 1 or 3 years (depending on type of remuneration), payment period 3 years

Cash remuneration (up to 75%), deferred shares (25% or more). Shares: calculation period 3 years, payment period 3 years (5 years for certain tranches).

No

Lockheed Corporation The Boeing Company Airbus Group SE PJSC UAC Fixed annual remuneration 8% 12% 18% 69% Annual bonuses 28% 18% 25% 31% Long-term component 64% 70% 58% 0%





ECONOMICS


The notices on resolutions made by the BoD do not disclose essential parameters of related party transactions (except for the names of counterpar-ties) and related voting results (including individual voting), which prevents understanding of the positions of BoD members (especially those recog-nized by the BoD as independent directors). The Company does not disclose the current members of the BoD committees and the effective Regulation on Committees on its website. The disclo-sure system only provides information on the heads of the committees. The only source of information on members of the committees is the Compa-ny’s press center (the News section of the website). According to the information disclosure system, the collective executive body’s incentives include salaries, bonuses for the service on the Manage-ment Board, bonuses for the achievement of KPIs and one-time bonuses for special achievements; it is not clear what payments are covered by the disclosure, the reported amounts are not commensurate with those paid by conditional peers or other companies covered by this research. The correlation between the remuneration of executive bodies and the achievement of target KPIs is governed by the Regulation on the remunera-tion of the President and the Regulation on the remuneration of Management Board members of PJSC UAC. The document is not disclosed. In our opinion and in accordance with international practice, the Board of Directors should at least consider disclosing the remuneration system, including the ratios between the fixed and variable components, the long-term and short-term incentives and the correlation between the payments for the reporting period and the KPI achievement. The Company discloses that the President’s and BoD members’ employment contracts stipulate their per-sonal responsibility for achieving the KPIs set by the BoD.

Charity and social responsibility

In 2015, the total sponsorship expenses of the Company and its subsidiaries amounted to RUB 103 million, and sports accounted for 95% of that amount (RUB 98.9 million), support of educational projects (universities and specialized secondary educational institutions) cost the Company RUB4.2 million (4%), the remaining spending (assistance to children, patriotic projects, contributions to social organizations) being less than 1% of the total amount. The Company’s charity expenses amounting to RUB 265.3 million have a similar structure. The Company accounted for a mere 8.5% of UAC Group’s total charity expenses, 32% of its sponsorship spending, while the share of PJSC Company Sukhoi was 77% and 42%, respectively. The charity to profit ratios of the Company and its peers were not compared due to heavy losses incurred by the Company and the Group in 2015.

RESEARCH REPORT ON ROSNEFT OIL COMPANY / 1 Association of institutional investors (API)


COMMUNICATIONS, NATIONAL RE-

SEARCH UNIVERSITY HIGHER SCHOOL

OF ECONOMICS

Research report on ROSNEFT OIL COMPANY

as of 09/30/2016




UNIVERSITY HIGHER SCHOOL OF ECONOMICS

RESEARCH REPORT ON ROSNEFT OIL COMPANY / 2 Association of Institutional Investors (API)




ECONOMICS

69.50%

19.75% 10.36%

0.39%


ROSNEFTEGAZ

BP Russian Investments Limited

National Settlement Depository (free-float)

Other


Russia’s direct stake in the Company is only 1 share (0.000000009%). The Government actually maintains control over Rosneft through the sole ownership of Rosneft’s controlling shareholder Rosneftegaz. The Company has no quasi-treasury shares. The largest minority share-holder elects 2 representatives to the Board of Directors (BoD), while the Government elects 2 independent directors (INEDs) and 5 repre-sentatives of the Russian Federation* through Rosneftegaz. In December 2016, a 19.5% stake in Rosneft was reportedly sold to a consortium of investors including Glencore and Qatar Investment Au-thority. In 2017, the shareholders will have to negotiate approaches to the BoD formation so as to ensure availability of at least three INEDs on the BoD (there were only 2 INEDs meeting the CG Code independ-ence criteria on the Board of Directors + 1 BoD member recognized as independent* at the time this report was being prepared). This is possible under two scenarios, one of which assumes that the number of directors increases to 11: 1) with a BoD consisting of 11 members, the Russian Federation techni-cally loses control over the BoD resolutions in case the largest minori-ty shareholders elect two representatives each, ultimately resulting in the following structure: 4 representatives of Russia, 4 representatives of minorities, 3 INEDs proposed by Russia; 2) with a BoD retaining its current size of 9 members, minority share-holders have to “sacrifice” 1 seat on the BoD each for INEDs; in this case, the Russian Federation technically loses control as well, but a resolution needs only support from one INED to be passed. The free float is 10.36%, with 7.4% of the shares represented by Global Depository Receipts. Theoretically, the remaining minority sharehold-ers’ influence on the BoD formation is insignificant, although pro-posals for INED candidates are technically possible, for example. *On December 23, 2016, the BoD recognized one its members represent-ing the Russian Federation as an independent director based, among others, on the Government’s order assuming exemption of 1 BoD mem-ber from the obligation to vote as instructed.





ECONOMICS

General summary of CG practice +

the Company discloses many corporate by-laws, including internal audit and risk management documents, as well as the standard apply-ing to the remuneration of top managers (CEO, Vice Presidents and executives in the rank of Vice President), which is a case of best prac-tice;

the attitude to minority shareholders of controlled entities is gener-ally fair, although there were cases of intra-corporate loans before the buy-back of shares during the TNK-BP takeover deal (according to the acquired company’s shareholders), which does not meet the good practice standards;

the Company has approved the plan of actions for implementing the Corporate Governance (CG) Code recommendations in the Company’s activities by 2018;

the Audit Committee considers activity reports of the Internal Audit Service, appoints and dismisses the head of the Internal Audit Service;

the notices of decisions taken by the Company’s BoD disclose essen-tial terms of related party transactions;

the Company discloses the persons proposing GSM agenda items and candidates to the control and management bodies;

(conditionally positive) information on the hotline handling, among others, security issues, is provided on the first page, but no infor-mation is available on the working principles, the role of the Internal Audit Service and the Audit Committee;

after the research was completed, the Company announced changes to the dividend policy assuming that the payout ratio reaches at least 35% in terms of IFRS net profit and that dividends will be paid twice a year in the foreseeable future. The changes to the current dividend policy have not been disclosed so far.

- we were not able to assess the key activities of the BoD and its

Committees in practice, as we had no opportunities to meet with IN-EDs and to rely on the disclosure of material facts;

only 2 of the 9 BoD members are fully independent (INEDs) meeting the applicable independence criteria of the CG Code;

the notices of BoD decisions in the mandatory disclosure system do not identify the voting BoD members and do not indicate individual voting results;

the CG Code recommendations regarding the need to ensure a qualified majority or the majority vote of the elected BoD members for significant issues are not followed completely (2 of 10);

the BoD has no powers to form management bodies at substantial controlled entities;

no disclosure of the top management remuneration system and the correlation between the payments and the achievement of specific KPIs (including information on the target and actual KPIs);

(conditionally negative) the Company does not completely follow the CG Code recommendation to consider the most significant issues at physical BoD meetings (for 2 of 19 issues), but the Company’s CG Code provides for a list of issues which BoD intends to address at physical meetings (the practice of consideration cannot be assessed, given the quality of information disclosure and the lack of BoD members’ opin-ions);

there are risks of influence on the Internal Audit Service’s independ-ence and objectivity;

the shareholders have no power to convene a BoD meeting;

the disclosure system contains no information on the involvement of the BoD and/or the relevant Committee in preparing proposals con-cerning BoD candidates for the next corporate year for the principal shareholder, including Rosimushchestvo.





ECONOMICS

96,03 99,75 99,1

3,97 0,9

35,64

2,18 7,78

2014 2015 2016

Proportion of Rosneftegaz+BP in quorum of GSM participants

Proportion of free float in quorum of GSM participants

Percentage of minority shareholders taking part in GSM, in relation to total free float

General shareholders meeting: activity of shareholders

The activity of minority shareholders is extremely low due to the sanctions which hamper voting at general shareholder meetings and reduce the free float level. In practice, the consolidation of portfolio and institutional investors has no effect on decision-making, even without the sanction-related problems. For instance, consolidation of about 10% of the votes is required to elect an independent director (100% of the free float).





ECONOMICS

Information on the shareholders of ROSNEFT OIL COMPANY, according to Bloomberg data and information disclo-sure by the shareholders


Comment on voting

ROSNEFTEGAZ (wholly owned by the Russian Federation)

69.5 No voting policy, voting according to the Government of Russia’s instructions

BP PLC 19.75 Strategic investor, no voting policy VANGUARD GROUP 0.18 The shareholder discloses its approaches to voting at shareholder meetings, as well as the way it voted in the

last corporate season. For funds focused on investments in Russia, information on Rosneft is not provided in reports (obsolete ownership data or no information disclosure at all as the sanctions remain in effect). The shareholder does not nominate BoD/SB (Supervisory Board) candidates, but supports, according to the general-ly disclosed approaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder receives recommenda-tions from proxy advisory firms.

FIDELITY MANAGEMENT & RESEARCH

0.13 The shareholder discloses the details of its voting policy on key issues (election of the Board of Directors, ap-proval of the remuneration system, anti-takeover position, etc.). The shareholder also discloses its voting in the corporate season (from July 2015 to June 30, 2016). No information on voting at Rosneft’s AGM is available in the disclosure system.

SECHIN IGOR IVANOVICH 0.13 As of September 30, 2016, the Company’s Chief Executive Officer owned shares for a total amount of RUB 4,624 million. Investors welcome the CEO’s significant shareholding in the Company. The number of securities used to calculate the money equivalent is disclosed on the Company’s website, along with information on all BoD mem-bers and members of the Management Board.

BLACKROCK 0.13 The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies. Information on voting in the last corporate season is disclosed. The shareholder disclosed non-voting at the EGM in 2015 and the AGM in 2016. The shareholder receives recommendations from proxy advisory firms. The shareholder does not nominate BoD/SB candidates but can support other sharehold-ers’ proposals if there is certainty about meeting shareholders’ interests in the best way possible.

SWEDBANK ROBUR FONDER AB

0.04 The shareholder is a signatory of PRI. The Board of Directors approves a responsible investment policy for sev-eral following years, including approaches to avoiding investments in some sectors and companies. In Russia, the shareholder votes at GSMs on a selective basis, the voting results are not disclosed. The shareholder may participate in the nomination of independent directors or propose an agenda item for a general shareholders meeting. Besides, the shareholder regularly discloses the list of companies where it communicated with the management teams in the reporting period (2016). Among the Russian companies, the list refers to Transneft in relation to environmental, human rights, reporting and transparency issues.





ECONOMICS


+ The GSM-related materials are disclosed in the English and Russian


the GSM materials specify the persons proposing agenda items and candidates to the BoD and the Audit Commission;

the materials contain information on the proposed auditor, the auditor selection procedure, as well as the price of audit services in relation to the Company’s accounting (financial) statements according to Russian GAAP (RAS) standards and the consolidated statements according to IFRS standards. The materials related to AGMs (including the AGMs held in 2014-2016) contain a list of all services which the auditor provided to the Company, including their cost, which we re-gard as a good practice.

- the Company’s annual report does not include details of related party

transactions approved by the BoD and the GSM in the reporting year; the materials do not contain a rationale for the distribution of profit,

including the portion earmarked for dividends and the earnings re-tained by the Company;

the materials include draft amendments to corporate by-laws, if any, but without a rationale for the proposed changes. Besides, there are no current versions of the to-be-amended documents attached to the draft amendments for comparison to give the shareholders clear un-derstanding of the content and value of such changes. The best prac-tice would be to provide comparison tables reflecting the proposed changes, as is the case at other PJSCs, with a rationale for each change;

for the recent AGM, the Company only reviewed compliance with 49 of the 79 principles and recommendations set forth in the CG Code (full compliance with 27 recommendations, partial compliance with 17, fail-ure to comply with 5). In addition, the Company believes that 6% of these recommendations are not applicable to it, without exact refer-ence to such recommendations.





ECONOMICS


BoD activity aspect

Royal Dutch Shell

BP

Exxon Mobil

Rosneft Oil Company


9/11 13/15 11/13 2/9

Participation in meet-ings of BoD and commit-tees in 2015

BoD: 12 (3 BoD members missed 1 meeting each, 1 BoD member 3 meetings); Audit Committee: 6 meetings (1 non-attendance), Nomination Committee: 7 meetings (100% attendance), Remuneration Committee: 5 meetings (1 BoD member missed 2 meetings)

BoD: 13 meetings (2 via tele-conference), 1 BoD member missed 2 meetings, 3 BoD members missed 1 meeting each. Audit Committee: 11 meetings (3 members missed 1 meeting each)

BoD held 11 meetings, Audit Committee 11 meet-ings, Compensation Com-mittee 7 meetings, Board Affairs Committee 7 meetings. Average at-tendance ratio: 92%, the BoD and all Committees have attendance ratio of at least 75% (no individual disclosure).

BoD: 30 meetings, 100% attend-ance (adjusted for cases of non-attendance due to a conflict of interest or a related-party inter-est), Audit Committee: 18 meetings (100% attendance), HR and Remu-neration Committee: 15 meetings (100% attendance).

Remuneration of BoD members / actual pay-ments based on 2015 performance

(2016) €850K to BoD Chair, €130K to BoD member, €55K to Senior INED, €55 (25)K to Audit Committee Chair/member, €35 (17,25)K to Remuneration Committee Chair/member, €25 (12)K to Nomination Committee Chair. Actual (2015): €147-315K (616K BoD Chair)

£785K to BoD Chair, £120K to Senior INED, £90K to BoD member, £30/20K to Com-mittee Chair/member. Actu-al: £141-178K for corporate year

$110K to BoD member, $10K to Committee Chair + 2,500 shares annually (+ 8,000 shares upon taking office) and dividends on them (not applicable if resigned before age of 72). Actual: $110-120K+ $231K in shares

$500K to BoD member, $600K to BoD Chair, $30K to Committee member, $50K to Committee Chair.





ECONOMICS


Chairman of the Board of Directors Andrey Belousov (representing the Russian Federation), Assistant to the President of the Russian Federation, no shareholding in the Company;

Chairman of the Audit Committee Donald Humphreys (INED), equity position: 0.0021% of the ordinary shares (worth RUB 76.3 million);

Chairman of the HR and Remuneration Committee Matthias Warnig (INED since December 23, 2016)*, Executive Director, Nord Stream 2 AG (Swityerland) representing the Russian Federation until 12/23/2016, equity position: 0.0009% of the ordinary shares (worth RUB 28.2 mil-lion);

Chairman of the Strategic Planning Committee Oleg Viyugin (INED) Professor, NRU Higher School of Economics, no shareholding in the Company.

______________________________________________

The API failed to arrange for a meeting with independent BoD members as the Company did not respond to the request. Therefore, we are not able to provide the BoD members’ comments on key CG issues and a case study of the BoD’s activity in the report. The results of BoD members’ voting (in-cluding individual voting for each BoD member) also remain undisclosed, which prevents a proper analysis of certain BoD activity aspects.

* After the reporting date, the Company’s Board of Directors recognized Matthias Warnig (representing the Russian Federation) as an independent member, despite his affiliation with significant counterparties (membership in the BoDs of VTB and Transneft) and the Government (through Nord Stream 2 AG in which state-controlled PJSC Gazprom owns a 51% stake), given the Government’s order to exclude the BoD member from the list of persons obliged to vote as instructed. We did not invite this BoD member to a meeting as he did not qualify as an INED at the time the research was conducted. It should be noted that the Board of Directors did not take into account Matthias Warnig’s possible affiliation with the Company’s possible competi-tor PJSC Gazprom (arising, among other things, through his service as CEO of Nord Stream 2 AG controlled by Gazprom) when recognizing his inde-pendence. We believes that Rosneft’s own gas business and the inclusion of Gazprom Neft PJSC (also controlled by PJSC Gazprom) in the competitive environment review section of the annual report serve as a ground for recognizing PJSC Gazprom as the Company’s competitor and for consideration of this issue by the Rosneft Board of Directors.





ECONOMICS


In the period under review (2015 and 9 months of 2016), the BoD held 46 meetings. Seeing as not all notices of BoD resolutions specify the form of the meeting, determining the exact ratio between physical meetings and meetings in absentia is problematic. The Company does not disclose the meeting participants and the voting results either. In 2015, according to the 2015 annual report, the BoD held 30 meetings, including 5 physical meetings. We could only identify 6 physical meet-ings in the period under review (based on the disclosure system), with 165 issues considered.

Key issues addressed by the BoD:

approval of related party transactions (39 issues, almost 24% of the total number; 2,244 transactions for a total amount of RUB 33.6 tril-lion, $24.7 billion and €4.1 million were considered);

determining the Company’s position in respect of transactions effected by the Company and Rosneft Group, activities of controlled entities and other issues (22 issues);

approval of documents (regulations, policies, standards) and amend-ments to them (21 issues);

approval of performance indicators (9 issues);

activity of the Internal Audit Service (7 issues);

long-term development program (6 issues);

business plan (plan of financial and economic activities, 4 issues).

It should be noted that, according to the disclosure system, the BoD considered the issue “On adjusting the top managers’ 2015 target per-formance indicators for annual remuneration purposes” on December 31, 2015. Consideration of such adjustments at the close of the report-ing period requires proper explanation and is not advisable in goal-setting. It should also be noted that the issue “On approving the top

managers’ 2015 target performance indicators” was actually consid-ered after the first quarter of 2015, which is quite late.

In 2015, the BoD approved the “Regulation on the Procedure for KPI Normalization when Analyzing and Assessing Operations of the Com-pany Management for the Reporting Period for Annual Bonus Pay-ment” (the procedure and approaches are not disclosed).

The Board of Directors did not give separate consideration to risk management (in 2015, the Company approved a policy on the risk management and internal control system which obliges the BoD to consider the organization, operation and efficiency of the risk man-agement and internal control system at least once a year).

The Company’s Charter does not give shareholders the power to re-quest the convening of a BoD meeting. The CG Code recommends that the shareholders possessing at least 2% of the Company’s voting shares should be given this right.

The Company does not disclose the breakdown of BoD members’ par-ticipation in meetings by the type of the meeting (physical meet-ing/meeting in absentia). The Boards of Directors of peers hold meet-ings in the form of joint attendance or via teleconference.





ECONOMICS


Most of the Committee members (2 of 3)*, including the Chairman, are INEDs.

*all members of the Committee have been independent since Decem-ber 23, 2016 subject to the BoD decision to recognize the independence of one Committee member.

In 2015, the AC held 18 meetings (12 or 6 meetings for some members, given their different terms of office). The attendance ratio is 100%. The Company does not disclose the form of the meetings.

The powers and rights of the Committee generally meet best practic-es and the CG Code recommendations. In particular, the Audit Commit-tee’s scope of authority includes monitoring of the Company’s CG sys-tem, assessment of the CG practice, maintenance of regular interac-tion between the BoD and the Company’s executive bodies, financial and economic divisions, internal audit and control, and risk manage-ment system.

In 2015, the Committee addressed the standard range of AC - relevant issues, including nomination of the auditor, approval of candidates for the position of Head of the Internal Audit Service (IAS), financial statements, approval of corporate by-laws within the competence of the Committee, etc. Additionally, the AC considered the candidates for the positions of heads of IAS divisions, which should be regarded as a good practice. The AC held 18 meetings as well as conference calls with the Head of IAS, external auditor’s representatives and members of the Audit Commission.

The AC did not give special consideration to the operation of the “hot-line” for reporting violations, although this issue was probably ad-dressed as part of the internal audit activity report.

HR and Remuneration Committee (HRC) The HR and Remuneration Committee is chaired by Matthias Warnig recognized by the BoD as an independent director on December 23, 2016. The Committee also includes 1 representative of a substantial minority shareholder and 1 independent director. In 2015, the HRC held 15 meetings (8 or 7 meetings for some members, given their different terms of office). The attendance ratio is 100%. The Company does not disclose the form of the meetings. The powers of the Committee generally meet best practices and the CG Code recommendations. In particular, the HRC is authorized to de-velop and regularly revise the policy of remuneration of BoD members and members of executive bodies (including the terms of the con-tracts concluded with them) and to monitor its adoption and imple-mentation. According to the disclosure system, the HRC also contributes to the development of criteria for assessing the performance of the Compa-ny’s top managers and members of its executive bodies, annually as-sesses the performance of the BoD and its members. The results of assessment remain undisclosed. In 2015, the HRC addressed the standard range of issues, including remuneration of the Management Board members based on the KPI achievement, approval of the KPI system for the Management Board members, self-assessment of the BoD and the Company’s sustainable development report. The HRC responsibilities include self-assessment of the BoD perfor-mance, an independent consultant is expected to be engaged in 2017.

Assessing the access of HRC members to all contracts with top man-agers and the remuneration system is problematic, given the lack of opportunity to meet with the Committee members.





ECONOMICS


External auditor

As a result of a competitive selection procedure, the BoD proposed approving Ernst & Young LLC as the Company’s auditor and determin-ing the auditor’s fees at the 2016 AGM. The proposed auditor’s fees are no more than RUB 3,246,000 for the audit of RAS (Russian GAAP) statements, no more than RUB 95,059,290 for the audit of consolidat-ed IFRS financial statements. Ernst & Young LLC has been cooperating with the Company since 2002. In addition to the statutory audit, the auditor currently provides the following services: reviews of interim consolidated financial statements, additional one-time audit services in relation to new assets acquired by Rosneft Group for consolidated IFRS financial reporting purposes. Ernst & Young also provides audit services to a number of the Company’s largest Russian and foreign subsidiaries.

The level of interaction between the auditor and the Audit Committee / BoD members does not seem possible to assess.

Internal auditor, internal control, risk management

The Company has approved the Policy on Internal Audit, the Policy on Risk Management and Internal Control System and the Internal Audit Quality Assurance Program (the documents, except for the latter one, are disclosed on the website). To improve the quality of internal con-trol and risk management, the Company has developed risk and check-up matrices for business processes at the Company and 16 enti-ties of Rosneft Group (a total of more than 100 matrices) reflecting flaws in the design of the check-up procedures. The Company is cur-rently taking remedial actions, training its top managers and employ-ees in the administration of risk management and internal control, as well as fraud and corruption management.

The Company has adopted an anti-corruption policy and arranged a security hotline (email, phone) ensuring confidentiality and (if re-quested by the informant) anonymity as the hotline is under control of the Company’s security service). To what extent the Internal Audit Service and members of the Audit Committee have access to infor-mation obtained via the hotline is not disclosed.

The Internal Audit Service (IAS) consists of 3 departments and 2 ad-ministrations (the total number of IAS employees is not disclosed). The power vested in the Head of IAS in the rank of Vice President, in our view, is adequate to responsibilities.

However, the membership of the Head of IAS in the Management Board presents risks to independence and impartiality of the internal audit. In terms of international professional internal audit standards, it is not advisable that internal auditors take responsibility for the audited activities and even experience a potential conflict of interest. It should also be noted that the Head of IAS technically holds the office of CEO of Rosneft’s main shareholder ROSNEFTEGAZ, while Ros-neft CEO is the Chairman of the BoD at ROSNEFTEGAZ whose responsi-bilities include the signing of a contract with CEO of ROSNEFTEGAZ, unless another person is authorized by a BoD decision. Besides, the Company’s Board of Directors and AC members are not directly au-thorized to consider the terms of the labor agreement with the Head of IAS and the budget of this division (according to the Policy on In-ternal Audit, information on resource limitations, the staff schedule and the resource plan of the IAS can be provided to the Board of Di-rectors when considering the internal audit plan (for the next period).





ECONOMICS

Dividend policy

The dividend policy which Rosneft approved in 2015 recommends that the Company earmark at least 25% of its IFRS net profit for dividends and declares commitment to increasing dividends every year. The 4-year dividend history shows that the dividend policy recommenda-tions are followed, but the percentage of net profit earmarked for dividends is substantially below the dividend payout ratio of interna-

tional peers. Seeing as the Company has not disclosed the content of changes made to the dividend policy subject to a BoD resolution as of December 7, 2016 (according to the Company’s press release, dividends will amount to at least 35% of the IFRS net profit in the foreseeable future and be paid to shareholders twice a year), we confirm our rec-ommendation to amend the dividend policy so as to provide for the profit distribution taking into account the return on retained earnings (RORE), the free cash flow and the target debt load.

Dividend per share,

rubles Total dividends declared, mil-

lion rubles Total dividends paid, million

rubles Dividend payout ratio*,

RAS Dividend payout ratio*,

IFRS/US GAAP 2012 8.05 85,315 85,250 28.2 % 25.0 % 2013 12.85 136,187 136,076 99.9 % 25.0 % 2014 8.21 87,011 86,931 17.4 % 25.0 % 2015 11.75 124,529 ** 52.0% 35.0 % * the ratio of dividends declared to net profit for the reporting period; ** n/a Dividend payout ratio at Rosneft vs. peers

Royal Dutch Shell BP plc Exxon Mobil Rosneft Oil Company

63% loss (176% of previous year’s net profit) 75% 35%

Information disclosureThe Company does not disclose individual voting of the BoD members in the mandatory disclosure system, which prevents adequate assessment of the BoD members’ position(s) on certain significant agenda items (this especially concerns independent directors). Most of the notices of related par-ty transactions approved by the BoD disclose essential parameters of such transactions, which should be regarded as a good practice. However, the prices of transaction are not disclosed in some cases (without providing reasons for non-disclosure).

The Company does not disclose the top management remuneration system and the correlation between payments and specific KPIs (including the disclosure of target and actual KPIs); the current approaches to disclosure need to be amended as appropriate based, among others, on the disclo-sure practices at (conditional) peers.





ECONOMICS

Management remuneration system disclosure practice at international peers

Approximate proportions of remuneration components for CEO in 2015

Royal Dutch Shell BP Exxon Mobil Rosneft Oil Co. (collective executive body)



Royal Dutch Shell BP Exxon Mobil Rosneft Oil Company


CEO+CFO. Actual (CEO): €1,430K in salary,

€3,500K in bonus pay-ment (including 50% deferred for 3 years) €163K in long-term

remuneration unad-justed for deferred

annual bonus payment

CEO+CFO. Actual (CEO): $1,854K in salary, $1,391K in bonus

payment, $2,603K in deferred bonus payment in shares (2/3 of annual bonus payment) +

shares; $7,116K in long-term remuner-ation in the form of shares for

KPI achievement

CEO+CFO+3 top manag-ers; actual (CEO): $3,047K

in salary, $2,386K in bonus payment,

$18,288K in the long-term remuneration in

the form of shares

Management Board remuneration in total (reduced from 13 to 11 members in 2015),

including sole executive body (CEO) Actual in 2015 (collective executive body):

RUB 2,884 million*. RUB 764 million in salary and service on

the Management Board, RUB 2,008 million in bonus payments

Standard: RUB 180-240 million in base sala-ry, base bonus for meeting KPI up to 150%

of salary, additional bonuses unlimited. Stock option plan possible in the future.

* this does not include the one-time bonuses paid in 2015 for implementing major projects in 2014, the bonuses paid by the President of Russia’s decision on national awards for achievements in 2014 and part of the 2014 remuneration, this information is not disclosed separately.





ECONOMICS

Royal Dutch Shell BP Exxon Mobil Rosneft Oil Company

KPIs influencing the short-term (annual) variable remunera-tion component, (incl. the KPI relative weight, if any)

Operating cash flow, project delivery in

time and budget, pro-duction, sales, capacity

utilization, security, energy and water effi-

ciency

Reduction in the number of primary environmental pollu-

tion cases, accident rate, number of industrial accidents

(10% each); operating cash flow, replacement cost profit (20% each); net investment

15%, corporate and functional expenses 10%, priority pro-

jects 5%

Safety and operational per-formance (set of metrics), ROCE, TSR vs. peers, FCF,

payments to shareholders, strategic results, implemen-

tation of projects. Additional-ly, 50% of the bonus is de-

ferred until target EPS achievement

ROACE, extraction and production of hydrocarbons, EBITDA, net debt /

EBITDA, TSR vs. average level across Russian companies, cost reduction

under comparable conditions, innova-tive development program implemen-tation (for CEO); additional KPIs from different blocks apply to other top

managers


TSR (30%); EPS growth in relation to cost of supplies (30%); in-crease in operating cash flow balance

(20%); ROACE (20%) for peers divided into 5 groups with 20% in-

crements

TSR vs. peers 1/3, operating cash flow 1/3, stock replen-ishment rate, safety and in-

dustrial risks, implementation of priority projects 1/3 in total

See annual remuneration component

N/a

Long-term bonuses Base salary x 3.4 (CEO) x KPI achievement

ratio (0-2) x TSR un-derachievement ratio

(1/2)

Part of annual remuneration (3-year period) is converted into shares and long-term

remuneration in shares for KPI achievement (3-year accumu-

lation period)

Payment of long-dated shares: 50% in 5 years, 50% in 10 years or in case of res-

ignation

N/a





ECONOMICS

Management remuneration The BoD has approved the Standard on payments and compensations to top managers which is disclosed on the official website. The standard de-fines the basic principles for remuneration of labor, bonuses, compensations and social payments to the President (currently the Chief Executive Of-ficer), Vice Presidents and officers in the rank of Vice President. The annual bonus for the achievement of KPIs cannot exceed 150% of the annual salary (the President’s maximum annual salary is RUB 240 million), members of the collective executive body are entitled to an additional bonus equal to 5% of the President’s salary, bonuses are paid for implementing particularly important projects (unlimited but subject to decision of the HR and Remuneration Committee if exceeding the annual salary 6 times and more). No long-term remuneration is paid, but a stock option plan is provid-ed for (pending approval).

The best disclosure of the top management remuneration principles among the PJSCs covered by the research; however, actual payments are not disclosed, as opposed to (conditional) peers.

Disclosure of information on shareholdings of the Company’s Management Board (the largest shareholdings) as of 09/30/2016 Management Board member Rounded-off value of share package as of 09/30/2016 (5 largest shareholdings)

Igor Sechin RUB 4,624 million Eric Maurice Liron RUB 185 million

Didier Casimiro RUB 156 million Peter Lazarev RUB 153 million Zeljko Runje RUB 131 million

Andrey Shishkin RUB 131 million

Corporate social responsibility In 2015, the Company directly spent RUB 6.3 billion (1.78% of its 2015 net profit) on charity and social development of regions (under related agree-ments).

Spending on charity and social development of regions vs. peers, % of net profit Royal Dutch Shell BP plc Exxon Mobil Rosneft Oil Co.

0.82% 1.77% (of previous year’s net profit) 1.66% 1.78%

The Company’s charity expenses as a proportion of its net profit are commensurate with those of peers.


Research report on PJSC ROSSETI

as of 09/30/2016





RESEARCH REPORT ON PJSC ROSSETI / 2 RESEARCH LABORATORY FOR BUSINESS


SEARCH UNIVERSITY HIGHER SCHOOL OF

ECONOMICS


88.75%

7.64%

2.55%

1.06%


Russian Federation

National Settlement Depository (NSD) (nominal holder)

Limited liability company "Depositary and corporate technologies" /DCT Ltd (nominal holder)Other shareholders

Capital structure overview Preferred shares account for 1.04% of the Company’s share capital. The relative weight of quasi-treasury shares divided among 6 compa-nies, including 3 interregional distribution grid companies, is 0.0043% (0.0017% according to the quarterly report).

The Company has 4 global depositary receipt (GDR) programs (the combined possible limit of the program is 5.4062767% of the author-ized capital), the GDR to share ratio being 1:200.

In 2010-2016, the Company floated 5 additional issues of ordinary shares, with the result that their number increased from 41,041,753,984 to 195,995,579,707. The placing price ranged from 1 to 4.14 rubles per share. The overall dilution ratio was 0.26 (i.e. minority shareholdings decreased by 74%). As a result, the Russian Federation increased its holding of ordinary shares from 56.58% (2012) to 88.75% (2016).

The biggest issues were placed in 2013 (the number of ordinary shares increased by more than 2.8%) and 2015 (about 1.2 times).

The Company’s current free float leaves no opportunity for minority shareholders to contribute to the development of corporate govern-ance in practice. Theoretically, the consolidation of 60% of all minority shareholders would enable them to elect one independent director by their votes.

Corporate governance self-assessment According to the Company’s estimate, PJSC ROSSETI complied with 50, partially complied with 24, failed to comply with 5 out of 79 principles and recommendations of the Corporate Governance (CG) Code in 2015.

RESEARCH REPORT ON PJSC ROSSETI / 3 RESEARCH LABORATORY FOR BUSINESS



ECONOMICS


Summary of GC practice +

4 out of 15 BoD members are independent directors, which meets the listing rules (but not the CG Code recommendations for the proportion of independent directors / INEDs in the BoD);

The Audit Committee and the Nomination & Remuneration Committee consist entirely of independent directors;

the corporate website discloses internal audit and internal control-related documents, as well as the anti-corruption policy;

material terms of related party transactions are disclosed in reports on BoD resolutions;

the Company discloses detailed procurement guidelines; the anti-corruption policy includes a detailed regulation on prevent-

ing and managing conflicts of interests; the Audit Committee has broad powers; the BoD’s mandate in relation to internal audit is in line with CG Code

recommendations, including the power to approve the internal audit division’s budget;

the BoD has fairly broad powers to formulate positions of the Company’s representatives in management bodies of subsidiaries, although being unable to nominate candidates to BoDs of controlled companies);

the BoD’s mandate has been extended in relation to major transac-tions (disposal of property with a balance sheet value of 10-25% of the core assets, etc.);

the BoD has the power to approve candidates for deputy CEOs and chief accountant;

the Company has established an evaluation committee responsible for considering the value of major transactions.

- flaws in the BoD activity management (including repeated non-

compliance with deadlines for providing materials to BoD members, consideration of essential issues at meetings in absentia, overcon-centration of essential issues on meeting agendas);

some of the documents (programs, KPI-related procedures for the relevant year) are approved or adjusted in the middle or even at the end of the achievement period (in fact, retrospectively);

the Company’s shareholders have no right to call for a BoD meeting; BoD members are paid mean remuneration (even by the Russian

standards) linked to the Company’s financial performance indicators (revenue and net profit), which is not consistent with the CG Code recommendations;

absence of an effective long-term motivation system for the management and controlled companies, imbalance towards quarterly and annual remuneration;

the management strategy prioritizes the technical and investment policy over the shareholder return at controlled companies (taking into account the balanced opportunities and conditions of the regu-lated business activity);

CG flaws at controlled companies (including non-observance of deadlines for providing materials for BoD/committee meetings, sub-mitting significant issues for consideration at meetings in absentia, non-disclosure of details of the motivation system, etc);

the Central Commission for compliance with corporate ethics standards and settlement of conflicts of interest, a collective execu-tive body, is the supreme authority for preventing and managing conflicts of interest.

the CG Code recommendations to pass resolutions on key issues of the Company’s activities by a qualified majority or a majority vote of the elected BoD members are virtually not followed (2 out of 10 issues stipulated by the CG Code are taken account of in the Articles of Association); no issues subject to consideration only at physical meetings are provided for by the Articles of Association.

due to the principal shareholder’s (the Government of Russia) failure to nominate candidates to the Company’s control and management bodies in due time (as was the case in 2016), the Company missed deadlines for the consideration of these matters by the BoD and was unable to timely disclose related information.

RESEARCH REPORT ON PJSC ROSSETI / 4





OF ECONOMICS

General shareholders meeting: activity and shareholder voting policies

The percentage of private minority shareholders participating in general shareholders meetings (GSMs) remained consistently average in 2014-2016 (42.2% of the total number of private minority shareholders in 2016), but higher than at many other PJSCs. However, their combined shareholding is rather small, which prevents them from influencing the BoD election process and decision-making on key issues of the Company’s activity. Today, even the 100% consolidation of minority shareholders’ votes is not enough to elect 2 INEDs; despite a relatively low successful election threshold (6.67% of the quorum) the votes of the minority shareholders participating in the meeting (5.1%) are not enough to elect at least one INED.

Candidates to the BoD were only nominated by Russia’s Federal Agency for State Property Management (Rosimushchestvo) and the Company’s mi-nority shareholder operating as part of Gazprom Group (Gazprom energoholding LLC and Gazprom Finance B.V.).

93.0 95.0 94.9

7.0 5.0 5.1

47.3

33.3

42.2

2014 2015 2016

% кворума ОСА -РФ и квазиказначейские акции % кворума ОСА -freefloat и физлица

freefloat и физлица - доля принявших участие в ОСА, %

Proportion of the Russian Federation and quasi-treasury shares in the quorum, %

Proportion of free float and individuals in the quorum, %

Percentage of the free float and individuals participating in the GSM, %

RESEARCH REPORT ON PJSC ROSSETI / 5 Association of Institutional Investors (API)




ECONOMICS

Information on the shareholders of PJSC ROSSETI, according to Bloomberg data and information disclosure by the shareholders




VANGUARD GROUP 0.39

The shareholder discloses its voting policy at shareholder meetings, as well as the way it voted in the last corporate season. According to the disclosure based on forms N-PX, the funds voted in the affirmative (“FOR”) on all issues, including related party transactions, at the 2016 AGM (except for the Internal Audit Commission election), and voted for Vasiliy Belov as BoD candidate. The shareholder does not nominate BoD/Supervisory Board candidates, but sup-ports, according to the generally disclosed approaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder re-ceives recommendations from proxy advisory firms.

NORGES BANK 0.14

The shareholder discloses its voting policy and voting results. According to the disclosure for 2016, the shareholder voted in the affirmative (“FOR”) on all issues, including the Internal Audit Commission election, at the 2016 AGM and voted for Vasiliy Belov as BoD candidate. The bank has so far not nominated BoD/Supervisory Board candidates in Russia, unlike other countries. The shareholder receives recommendations from proxy advisory firms.

ALPINEX ASSET MANAGE-MENT

0.13 Closed end fund asset manager, no voting policy, no voting activity disclosure

EATON VANCE CORP 0.12 Asset manager for funds, no voting data based on form SEC N-PX available in relation to the 2016 AGM at ROSSETI.

VAN ECK ASSOCIATES CORPORATION

0.11 The stake is divided among several funds, no aggregated voting.





ECONOMICS


+ explanatory notes and records of preliminary approval resolu-

tions made by the BoD and/or the Management Board are pro-vided on all major agenda items;

the shareholders have a long period for submitting proposals in relation to the AGM agenda (90 days);

the Company’s materials disclose persons proposing candidates to the BoD and the Internal Audit Commission, but not separate-ly for each candidate;

detailed disclosure of the auditor selection procedure, including the final competition report specifying the bidders and their re-spective places (a case of good practice!);

comparison tables of changes and additions, including the ra-tionale for such amendments, are attached to new versions of the Company’s by-laws;

the annual report provides information on related party trans-actions approved in the reporting year, including the counter-party, subject and value of each transaction, as well as the par-ties in interest;

the annual report contains information on meetings of BoD committees, details of the long-term development program and proposed changes to it, comments on the CG Code aspects the Company fails to comply with;

GSM-related materials are also disclosed in English.

- according to the Articles of Association and the Regulations for the

General Meeting of Shareholders, the Company aims at disclosing GSM-related materials 30 days prior to the GSM date; in 2016, how-ever, the late approval of the GSM agenda reduced this period to 20 days, which is not consistent with the CG Code recommendations;

GSM-related materials do not disclose CVs of candidates to the BoD and the Internal Audit Commission, except for their positions and information on their consent for election;

explanatory notes on agenda items are merely a formality (except for comments to the data provided in the annual report);

the minutes of the BoD meeting approving the list of candidates are not disclosed in GSM-related materials.

RESEARCH REPORT ON PJSC ROSSETI / 7




ECONOMICS



* The base remuneration of BoD members at PJSC ROSSETI stipulated by corporate by-laws is significantly below the level of remuneration at peers and cannot even compare to the practice followed by Russian issuers; the gap between the average remuneration paid to BoD members and members of the Management Board (top managers) was almost 6 times wider at ROSSETI than at peers (87.8 times at ROSSETI, approximately 15.2 times at peers). The amount of remuneration depends on the Company’s revenues and is paid out of net profit. In 2015, no remuneration was paid due to the absence of net profit on account of paper losses in the amount of RUB 18.2 billion (revaluation of financial investments in shares of subsidiaries). The policy of remuneration of BoD members needs to be revised.

BoD activity aspect EDF S.A. Eversource Energy National Grid plc PJSC ROSSETI

Number of INEDs / total BoD size

5/12 11/12 7/11 4/15

Participation in meetings of BoD and committees

in 2015 (attendance ratio / number of meetings)

BoD (11 meetings, all of them physical): attend-

ance ratio 96.3%; Audit Committee (8 meet-ings, all of them physical): average attendance ratio

87.5% Nominations and Compen-

sation Committee (2 meetings, all of them physical): attendance

ratio 87.5%

Board of Trustees (7 meet-ings, all of them physical); average attendance ratio

93% (1 non-attendance for a good reason).

Audit Committee, Compen-sation Committee, Corpo-

rate Governance Committee: attendance ratio 100%

BoD (10 meetings, all of them physical): 2 BoD members missed one meeting each;

Audit Committee: (5 meetings, all of them physical): attend-ance ratio 100%; Nominations Committee (7 meetings, all of

them physical): 1 non-attendance; Remuneration

Committee (6 meetings, all of them physical): 1 non-

attendance.

43 meetings in the corporate year: attend-ance ratio 100% for 1 BoD member, 28-98% for other BoD members, 81% on average for INEDs, 25-95% for BoD members whose peri-od of service in the corporate year covered

20 (or 23) meetings; Audit Committee (11 meetings held in the

corporate year): attendance ratio is 65% for 1 member, 100% for the other members;

Nomination and Remuneration Committee (5 meetings): attendance ratio 0% for 1 mem-

ber, 67% for 2 members

Remuneration of BoD members / actual pay-

ments for 2015

€510K (2016) for all BoD members

Actual: €14.2-17.3K for an incomplete corporate year, €39.4-48.2K for a

complete corporate year.

$100K in fixed remunera-tion, $100K in shares (accu-mulated until termination of powers; $25K to Chief

Trustee, $15K to AC Chair, $10K to

chairs of other committees. Actual: $202.6-237.6K (adj. for market value of de-

ferred shares)

£500K to BoD Chairman, £22K to Senior INED, £66K to BoD member (UK), £78K to BoD

member (US), £9K to Commit-tee member, £19K to Chairs of the Audit Committee and the

Remuneration Committee, £12.5K to Chairs of other

Committees

Fixed remuneration: RUB 0.7 million, with uplift factors of 30% for BoD Chair, 20% for

heads of committees, 10% for committee members. Remuneration is dependent on net profit (clause 4.4 of the Regulations for Re-muneration and Compensation for Members

of the Board of Directors). Actual: 0*





ECONOMICS

Board of Directors

Chairman of the Board of Directors Alexander Novak (representing the Russian Federation), Minister of Energy of the Rus-sian Federation, no shareholding in the Company; Chairman of the Audit Committee Vasiliy Belov (INED) Senior Vice-President for Innovations, non-profit organization Fund for Development of the Center for Elaboration and Commercialization of New Technologies, no shareholding in the Company

Chairman of the Nomination and Remuneration Committee Alexander Kalinin (INED) President, OPORA RUSSIA All-Russian Public Organization of Small and Medium Business (INED), no shareholding in the Company

Oleg Dubnov (INED) Adviser to CEO, Institute of Professional Directors (INED), no share-holding in the Company

Oleg Barkin (INED) Deputy Chairman of the Board, nonprofit partnership Council for Or-ganizing Efficient System of Trading at Wholesale and Retail Electrici-ty and Capacity Market (INED), no shareholding in the Company

___________________________________

The API was unable to arrange for meetings with the current BoD members, including INEDs. We therefore cannot include their independent opinions on key corpo-rate governance issues in this report. The API was only able to obtain the opinion of a member of the previous Board of Directors.





ECONOMICS

Board of Directors: practical activity aspects In the period under review (2015 and 9 months of 2016), the BoD held 64 meetings, including at least 11 meetings in the form of joint at-tendance. 308 issues were considered.

20 issues concerned related-party transactions for a total amount of more than RUB 2.6 billion (some of the deals provided for additional terms and conditions of previously effected transactions).

The BoD considered the following significant issues: KPIs, KPI achievement reports, KPI calculation procedures (15); reports on performance results (13); investment program for 2014 and for the 2015-2019 forecast period,

budget, financial plan (12); long-term development program (9); internal audit (7) and risk management (3); charity (3); management remuneration principles and motivation system; CG Code implementation plan.

According to a former Board member, the BoD activity in the period under review failed to meet good practice standards and the CG Code recommendations in the following aspects:

Deadlines for providing materials for BoD meetings are missed repeatedly. In some cases, materials for important and complicated issues which required thorough consideration were provided 4-5 days prior to the meeting, instead of the stipulated period of 10 days – sometimes even 1-2 days before the meeting, or on Friday, with the meeting scheduled for the following Monday);

In some cases, committee meetings are held just a few (even 1-2) days prior to related BoD meetings, with the result that directors who are not members of committees are unable to consider related materials as long as they are supposed to;

the approval of essential by-laws and key reports (e.g. the internal audit report) is considered at BoD meetings in absentia;

submission of expressions in writing instead of personal attendance at BoD meetings is common practice; the personal attendance ratio at BoD meetings is lower than at peers;

some of the documents related to business planning (innovative development programs, consolidated investment programs, KPI cal-culation procedures for the corresponding year) were approved after partial expiration of their implementation period (sometimes in the middle or at the end of the year), which reduces efficiency of busi-ness planning and motivation (this is partially attributable to the special nature of the Company’s regulated business activity). For example, the KPI calculation procedure for 2015 was adopted and put into effect starting from the 4th quarter of 2015, the KPIs for 2016 were approved in December 2016, the 2016 innovative development program on 12/30/2016, the 2016 investment program was taken note of on 06/09/2016;

insufficient involvement of the BoD and its committees in preparing draft resolutions on issues subject to instructions, with the result that decision making on such issues becomes, to a large extent, a formality. Just as other PJSCs, the Company lacks established proce-dures for the preliminary consideration by the SD/committees of proposals to the Government as regards issues where resolutions are made subject to instructions. A number of significant issues (in-cluding the approval of key by-laws) is considered at meetings in absentia; in some cases, delays in providing materials to BoD mem-bers impair the Board efficiency.

The Company carried out the individual performance evaluation of BoD members in the corporate year 2014-2015 (with questionnaires filled in on Rosimushchestvo’s interdepartmental portal). The evalua-tion results were not disclosed – meanwhile, the procedure does not assume interviewing BoD members and summarizing the main as-pects of the BoD activity;

The Board of Directors has formed a sufficiently active Strategy Committee and engaged external experts, but problems in providing information and organizing the committee’s activity persist.





ECONOMICS

Audit Committee (AC) The AC consists of INEDs (3 out of 4 AC members were INEDs in 2015).

In 2015, the AC held 11 meetings, including 6 physical meetings (28 issues were considered). The meeting attendance is relatively low (0-67%, only 1 AC member participated in all meetings).

The Committee considered new versions of corporate by-laws: the internal audit policy, the risk management policy, the internal con-trol policy. Besides, the Committee considered the internal audit directorate’s budget, the candidate for head of the internal audit directorate and essential terms of the contract with him, the report on completing the implementation roadmap for the Strategy of de-velopment and improvement of the internal control system at PJSC ROSSETI and its subsidiaries, as well as the internal audit division’s reports on internal audit and risk management efficiency.

Besides, the AC considered a number of standard matters, such as accounting (financial) statements (25% of the issues), the candidate for external auditor.

Our inability to meet with the Chairman and members of the Audit Committee prevented a proper practical assessment of the Commit-tee’s performance covering relations with external and internal audi-tors (performance evaluation and selection, adequacy of resources), particularities of the internal control and risk management system, etc. The underwhelming meeting attendance, in our view, indicates a formal approach of at least some of the BoD members to the Com-mittee’s activity.

Nomination and Remuneration Committee (NRC) The NRC which consists of INEDs held 5 meetings in 2015, including only one physical meeting. The Committee considered 12 issues. 2 NRC members did not attend the physical meeting in person.

The Committee considered the principles of remuneration and the motivation system for the management of PJSC ROSSETI, as well as standard matters (approval of the KPI calculation procedure, as-sessment of the KPI achievement, executive office structure).

The NRC did not consider the BoD performance evaluation and pro-posals to shareholders on BoD candidates (before their nomination) for the next corporate year (for further consideration by Rosimush-chestvo).

The Committee’s activity, in our view, is based on a formal approach and needs to be revised.





ECONOMICS

Essential CG aspects Relations with the external auditor Documents related to the auditor selection procedure are subject to approval at a BoD meeting. In 2015, ROSSETI conducted an open bid-ding for the right to audit the Company’s statements for 2015-2017, with 3 bidders. RSM Rus LLC was declared the winner. The auditor was approved at the Company’s AGM. The cost of audit services is RUB 15 million (the initial bid price being RUB 36.2 million). The auditor does not provide non-audit services to the Company.

Information disclosure The Company performs mandatory information disclosure in accord-ance with the current legislation. The Company discloses material terms of related party transactions, including parties, amount (limits), party in interest). Details on BoD members’ participation in physical BoD meetings are not disclosed in the annual report. However, the Company publishes minutes of BoD meetings (excluding confidential issues) on its website; the minutes contain names of BoD members in attendance, note the availability of expressions in writing, if any (for physical meetings) and provide in-formation on individual voting activity (a case of best practice), de-spite non-disclosure of BoD members’ dissenting opinions.

Internal control and risk management The Company’s internal control system is based on the internal con-trol policy (2015), the internal control development and improvement strategy (2014). The executive internal control bodies include local divisions and employees (parties to controlled business processes), the control activities department of PJSC ROSSETI, the corporate treasury, etc. The internal control activities in relation to subsidiaries aim to ensure uniform approaches to internal control at subsidiaries, centralization of some of the procurement activities and control of subsidiaries’ expenses by the corporate treasury. Assessing the effi-ciency of anti-corruption measures (including the hotline operation),

verifying employees’ declarations, checking conflicts of interest and counterparties, etc. is problematic without interviews, but the system can be regarded as well-developed in terms of organization. The Company manages existing risks according to its risk manage-ment policy. It should be noted that the policy of managing risks at the Company and its subsidiaries has an element of formality, given that many risks (especially economic risks) are only partially manage-able and that risk management makes part of general activities. Basi-cally, the Company’s risk management efforts are limited to identify-ing threshold values for risk factors and related reports. The treat-ment of certain risks is derivative of other management goals and objectives of economic, legal, organizational and technical relevance rather than being a standalone activity. Therefore, there is no dedi-cated “risk-specific” management (a practice followed by banks). At the same time, risk owners’ periodic consolidated quarterly reports on risks for the BoD offer a really useful instrument for pinpointing the main problem points and predicting performance results. Besides, certain KPIs are linked to some of the risks via risk determinants.

Dividend policy According to the Company’s Dividend Policy Regulations, dividends on preferred shares are equal to 10% of the Company’s net earnings per share (EPS); the parity of dividend payments is provided for in case dividends on ordinary shares exceed dividends on preferred shares. The Company pays at least 25% of a base equal to RAS (Russian GAAP) net profit less extraordinary financial income (revaluation of financial investments, recovery of allowance, etc.), deductions to the reserve funds and other funds, investments and repayment of previous years’ losses (no more than 50% of the net profit less deductions to funds and investments financed out of profits). The dividend policy needs to be amended to reflect the need for a transition to IFRS standards and for higher transparency of the profit distribution policy, including the need to ensure a minimum return on investment payable out of profits.





ECONOMICS

Dividend payments at ROSSETI vs. peers The Company paid interim dividends for the first quarter of 2016 as its 3-month profit amounted to ca. RUB 37 billion, mainly due to the positive re-valuation of shares in subsidiaries), which partially offset the non-payment of 2015 dividends. This practice lacks consistency being dependent on the principal shareholder’s position. Dividends on preferred shares account for a mere 8.67% of the total dividend payments (although in absolute terms, the dividend per preferred share exceeds the dividend per ordinary shares almost 9 times).

Charity and social responsibility In 2015, the charity projects of PJSC ROSSETI, its subsidiaries and affiliates cost it RUB 1,449.69 million, with the following breakdown:

Expenditure Mio rubles

Culture 92.86 Healthcare 5.75 Science & education 835.39 Physical culture and mass sports 155.53 financially disadvantaged, physically handicapped and other persons 38.47 Environment and animal protection 5.52 Restoration of facilities and territories 254.17 Other socially significant expenditures 62.00

In 2015, ROSSETI Group provided sponsor support in the amount of RUB 2.95 million to the social and economic development of regions. The Company does not disclose the amount of sponsorship in the sports sector, which we regard as a negative practice (the initial price of the adver-tising services contract concluded with PFC CSKA Moscow for 2013-2018 was RUB 4.185 billion; later, according to media reports, the contract price was reduced and partially distributed among subsidiaries).

Spending on charity social investment by comparable companies, % of net profit (estimate): EDF S.A.** Eversource Energy National Grid plc PJSC ROSSETI (2015 IFRS profit)*

1.85% 0.57% 0.61% 1.74%*

* approximately 2.54%, taking into account media estimates*, no exact value can be provided due to non-disclosure. ** also a government-controlled company.

Mio € / Mio £ /Mio USD/Mio rubles EDF S.A. Eversource Energy National Grid plc PJSC ROSSETI

2015 profit 1,187 878.5 2,386 Loss amounting to RUB 18.2 billion (Q1

2016: RUB 36.9 billion in net profit)

2015 dividends (including interim dividends) 2,043 529.8 1,337 Passed (RUB 1,785 million for Q1 2016)

Payout ratio (the ratio of dividends to net profit)

172% 61% 56% 4.84% (Q1 2016)





ECONOMICS

Management team remuneration

In 2015, the Management Board members were paid RUB 6.38 million for the performance of their duties as members of the Management Board, RUB 119.24 million in salaries, RUB 181.67 million in bonuses, RUB 5.13 million in compensations and other forms of remuneration. The Company’s annual report discloses its KPIs, but not their correlation with the payments.

The Company does not disclose the senior management remuneration system, including the correlation between actual payments and the achieve-ment of KPIs, although the KPIs, their target levels and the fact of their achievement (without exact figures) are disclosed in the annual report. In our opinion and in accordance with international practice, the BoD should consider disclosing the remuneration system, including the ratios between the quarterly, annual and long-term components and the correlation between the payments for the reporting period and the KPI achievement.

The Company does not have a proper system of long-term remuneration linked to its business value; a new program should be launched as long as ROSSETI intends to remain a public company, given the current shareholder capital structure and a painful history of diluting minority shareholdings.

It should be noted that the existing Management Board members of PJSC ROSSETI do not own shares in the Company.

Approximate proportions of CEO remunera-tion components at PJSC ROSSETI vs. peers

in 2015 EDF S.A. Eversource Energy National Grid plc

PJSC ROSSETI (Management Board)

Fixed annual remuneration 100% 13% 24% 41% Annual bonuses (also, quarterly bonuses at

PJSC ROSSETI) 0% 25% 28% 59%






ECONOMICS

Disclosure of the management remuneration system at international peers

EDF S.A. Eversource Energy National Grid plc PJSC ROSSETI


CEO Actual (CEO): €450K in salaries

(subject to regulatory re-strictions), zero bonuses; long-

term remuneration remains unknown until resignation sub-

ject to BoD decision

CEO + CFO + 3 top managers Actual (CEO):

$1,232K in salaries, $2,400K in bonuses, $5,800K in long-

term incentives

CEO + CFO + 2 top managers Actual (CEO):

£1,033K in salaries, £1,222K in bonuses, £2,125K in long-term

remuneration

All collective executive body members, incl. sole executive

body (SEB): RUB 6.38 million for performance of duties as Man-agement Board members, RUB 119.24 million in salaries, RUB 181.67 million in annual and

quarterly bonuses

KPIs influencing the short-term (annual) variable remuneration component (incl. fixed relative weights of the KPIs, if any)

None EPS, dividend growth, credit rating (70% in aggregate) Reliability, security, staff

diversity, operating efficien-cy, application of new tech-nologies, consumer percep-

tion (30% in total)

EPS 35%, ROE (Group) 35%, indi-vidual KPIs 30% (security and

compliance; strategy; business growth; individual

management indicators; con-sumer perception; staff in-volvement; development of opportunities and relations

with stakeholders)

TSR, ROIC, specific operating cost reduction, energy loss,

achievement of target reliabil-ity of services, reduction in

specific investment expendi-tures, compliance with facility commissioning deadlines, com-pliance with power connection

deadlines, labor efficiency KPIs influencing the long-term variable remuneration (incl. relative weights, if any)

Actual EBITDA >80% of target level in 2 out of 3 last years

before early resignation

Average EPS adjusted for irregular profit components,

TSR vs. companies included in EEI Index.

TSR vs. FTSE 100 companies 25%, adj. ROE of group vs. retail

price index 50%, ROE in UK 12.5%, ROE in US 12.5% (vs. aver-age ROE approved by regulato-

ry authorities)

No data available

Long-term bonuses €200K after 1 year (once) + €60K quarterly, but not to ex-ceed total annual salary. Pay-ment only at early resignation subject to BoD resolution, ex-cept for dismissal because of

violations

Deferred stock units (without KPIs, incl. limit, 1/3 of total

amount payable annually for 3 years in shares). Shares for KPI achievement (calculation

period 3 years)

Long Term Performance Plan (LTPP) in the form of shares (3

years)

No data available


Research report on PJSC ROSTELECOM

as of 09/30/2016





ECONOMICS

RESEARCH REPORT ON PJSC ROSTELECOM / 2 Association of Institutional Investors (API)




ECONOMICS

48.71%

28.94%

15.04% 4.29% 3.00%


The Russian Federation

Freefloat (INEDs) & individuals

Mobitel LLC (quasi-treasury shares)

Vnesheconombank

RTK-Razvitie, closed-end unit investment hedge fund

Brief capital structure overview The Government of Russia’s effective voting stake in the Company (including the stake of VEB, a substantial shareholder controlled by the Government) is 53%. Preferred shares account for 7.5% of the company’s authorized capital, among them 2.32% of the authorized capital are quasi-treasury shares, with one of the largest packages of voting quasi-treasury shares in the Russian market (15%); the policy of voting the quasi-treasury share package is not formalized*, although the package has a substantial impact on decision-making, with ensuing risks for shareholders. Due to the use of this package for voting at the 2016 AGM, the minority shareholders failed to elect the independent director they nominated, with a top manager of the Company elected instead. The President of Rostelecom announced the intention to prevent the election of an independent director to the Board of Directors**.

* The media actively discussed the possible signing of an agreement between Rostelecom and Russia’s Federal Agency for State Property Management / Rosimushchestvo on the management of this share package; the agreement has so far not been signed, the quasi-treasury shares are technically voted by the management of Rostelecom Group.

**“The independent candidate is affiliated to shareholders with a certain track record, which could bring people sometimes pursuing non-corporate interests inside the company. We are against that” (RBC, June 21, 2016).

Corporate governance self-assessment In 2015, the Company complied with 73, partially complied with 5 out of the 79 principles and recommendations of the CG Code; amendments to the corporate documents reflecting the CG Code recommendations were approved at the AGMs in 2015 and 2016.





ECONOMICS

General Summary of CG +

4 of the 11 members of the Board of Directors (BoD) are independent Directors (INEDs);

The Audit Committee (AC) and the Nominations and Remuneration Committee (NRC) are entirely composed of INEDs;

The Board of Directors meeting may be convened by shareholders possessing at least 2% of the voting shares;

the company takes the most progressive attitude towards shaping the dividend policy: dividends are based on the free cash flow (FCF) for each financial year, with minimal dividends fixed in absolute terms;

the actions to be taken by the BoD and its members in case of a conflict of interest are covered in detail by the corporate documents;

broad powers of the BoD Audit Committee (AC) in relation to internal and external audit, internal control and risk management;

the Company has created an effective internal audit division regularly and truly accountable to the AC, BoD and CEO;

the BoD has adequate instruments for monitoring the risk management system, including the payment of bonuses to the chief risk officer;

all material facts concerning related party transactions are disclosed;

the charter contains the requirement to consider the most essential aspects of the Company’s activities at physical BoD meetings;

the BoD is authorized to formulate the Company’s position when the subsidiaries consider transactions involving the Company’s shares;

all CG Code recommendations as regards the need for a qualified majority or the majority vote of the elected BoD members when voting on most essential issues are given legal recognition in the Company’s charter.

- a major drawback in the Company’s CG, with negative implications in

practice, is the voting of quasi-treasury shares at general shareholders meetings (GSMs). The BoD found it appropriate that Mobitel LLC should conclude a shareholders’ agreement with Rosimushchestvo concerning the management of this package (the essential terms and conditions of this advisable agreement were not disclosed). The agreement has so far not been concluded. In our view, the agreement is only expedient if it provides for a prohibition on the voting; such a prohibition needs proper formalization.

the results of BoD members’ voting on the issues addressed at the meeting, including the individual voting (how exactly each of the BoD members voted), are not disclosed;

a low number of physical BoD meetings (4 meetings in the period under review, i.e. in January 2015 – September 2016), the key committees virtually existed on paper (no physical meetings of the AC and the NRC);

due to the principal shareholder’s (the Government of Russia) failure to nominate candidates to the Company’s control and management bodies in due time (as was the case in 2015), the Company misses deadlines for the consideration of matters by the BoD under the corporate legislation (according to the generally established CG practice, the shareholder is to meet the statutory deadlines for AGM-related proposals);

(conditionally negative) the company partially discloses the top management remuneration system. While its description is one of the best among the companies covered by the research, the disclosure approaches need to be refined to make the system a benchmark of disclosure for Russian companies;

the agenda of BoD meetings sometimes includes the “Any Other Business” item. Without details, there is a risk of considering essential issues without properly notifying the BoD members.

RESEARCH REPORT ON PJSC ROSTELECOM / 4





ECONOMICS

70

94 89 91

30

6 11 9

59

17

30 25

2013 2014 2015 2016

%, proportion (in relation to quorum) of the Russian Federation, controlledshareholders, quasi-treasury shares

%, proportion (in relation to quorum) of minority shareholders taking partin the meeting

%, proportion of free-float taking part in GSMs in relation to total numberof shareholders

General shareholders meeting: quorum, related party transactions, shareholder specifics

The proportion of minority shareholders participating in meetings decreased in 2016 (25% of the free float minority shareholders, a mere 7% of all shareholders). The quorum was 78.4% in 2016. In 2015 and 2016, the AGMs approved 1 and 4 related party transactions in the amount of RUB 90 billion and RUB 510 billion, respectively, which the Company may effect in future in the normal course of business, as well as 1 related party liability insurance transaction in the amount of €368,500 in 2015 and a similar one worth €654,000 in 2016. It should be noted that one of the reasons for voting quasi-treasury shares, as stated by the management, was to ensure positive decisions on related party transactions.





ECONOMICS

Information on ROSTELECOM shareholders, according to Bloomberg data and disclosures by shareholders


Comment on voting


MOBITEL LLC 15.06 The company holds quasi-treasury shares used for voting at the 2016 AGM, with the result that a candidate nominated by the management team was elected to the BoD.

VNESHECONOMBANK 4.29 No voting policy, no disclosure of voting.

VANGUARD GROUP 1.27

The shareholder discloses its approaches to voting at GSMs as well as the way it voted in the last corporate season. For funds focused on investments in Russia, the shareholder disclosed non-voting at the AGM in 2016. The shareholder does not nominate BoD/SB (Supervisory Board) candidates, but supports, according to the generally disclosed approaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder follows recommendations from proxy advisory firms.

BLACKROCK 0.89

The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies. Information on voting in the last corporate season is disclosed. The shareholder did not vote at the AGM in 2016. Recommendations of proxy advisory firms are followed. The shareholder does not nominate BoD/SB candidates but can support other shareholders’ proposals if there is certainty about meeting shareholders’ interests in the best way possible.


0.25 The shareholder discloses information on its voting at the shareholders’ meeting following ISS recommendations. No specific voting disclosure. In 2016, the ISS recommended voting for 4 independent directors, one of whom was nominated and supported by the minority shareholders.

Sergey B Kalugin 0.23 As of 09/30/2016, the President of Rostelecom owned a package of ordinary shares in the amount of RUB 458 million. Investors welcome the President’s significant shareholding in the Company. The data are confirmed by the quarterly report disclosed by the issuer.

HSBC 0.22

The shareholder publicly discloses the voting at GSMs since 2013 for most of its funds. At the 2016 AGM, the shareholder voted for 5 candidates to independent directors (4 of them were elected to the Board of Directors with the Government’s support), 4 representatives of the management (CEO + vice presidents). The shareholder discloses the global principles of voting at GSMs noting its reliance on best practices when making voting decisions.

DEUTSCHE BANK AG 0.17 The shareholder publishes the voting policy on behalf of the asset management division; in this case, the shareholder is likely a nominal holder.

RAM (LUX) SYSTEMATIC FUNDS

0.13 The shareholder does not disclose the voting policy but specifies its status of PRI signatory. In this connection, the shareholder declares its commitment to voting at GSMs, but does not disclose actual voting cases and approaches.





ECONOMICS


Comment on voting

NORDEA BANK AB 0.10 Approaches to voting are disclosed by the asset management division as part of the responsible investment policy; in this case, the shareholder is likely a nominal holder.

General shareholders meeting: disclosure of information and essential aspects

+ materials related to GSMs specify the persons proposing agenda

items and candidates to the Board of Directors and the Audit Commission;

draft documents are submitted for approval with comparison tables attached to them reflecting the changes proposed to such documents and the rationale for such changes (in the form of reference to the laws);

the annual report section concerning the BoD members’ participation discipline as regards meetings of the BoD and committees includes information on the format of meetings;

the Company considers minority shareholder’ proposals for AGM agendas on merits, even if the shareholders cannot attach any formally required documents.

- the Company’s documents (the charter and the Regulations on the

General Shareholders’ Meeting) do not contain any reference to the timeframe of disclosure of GSM-related materials; in practice, however, such materials are disclosed in good time.

Comment on the results of voting at GSMs

The Company’s shareholders have come across an unreasonable treatment of the sanctions regime imposed by Western countries on a number of individuals and entities. PJSC Rostelecom is NOT included in the list of Specially Designated Nationals (the SDN or sanction list), but the Chairman of its Board of Directors is personally included in this list. Some of the custodians prevented the shareholders from exercising their rights refusing to execute their clients’ instructions for this reason. In this connection, the shareholders concerned wishing, for example, to vote for an independent director supported by other institutional investors in 2016 were unable to do that. As a result, according to our estimates, while the election of 5 INEDs was possible and, if successful, could have set a record among all state-owned companies in terms of the proportion of INEDs in the Board of Directors, only 4 independent directors supported by the Government were eventually elected.





ECONOMICS


BoD activity aspect AT&T BT Group Vodafone Rostelecom


11 of 12 7 of 10 9 of 12 4 of 11

Participation in meetings of BoD and committees in 2015 (all meetings at peers are held in the form of joint

attendance)

At least 75% to each BoD member (no further details disclosed)

BoD: 10 meetings, 100% attendance;

Audit Committee: 8 meetings, 100%

attendance HR & Remuneration

Committee: 6 meetings, 100% attendance

BoD: 7 meetings, 2 directors missed 1

meeting each, 1 director 2 meetings; Audit

Committee: 5 meetings, 1 non-attendance, HR &

Remuneration Committee: 5 meetings,

100% attendance

BoD: 40 meetings (3 physical), 2 BoD members missed 1 meeting in absentia each, 2 BoD members

missed 1 physical meeting each, 1 BoD member (foreign resident): 0%

attendance. Audit Committee: 4 meetings, all in

absentia. Nominations and Remuneration Committee: 5

meetings, all in absentia. Remuneration of BoD

members / actual payments based on 2015

performance

$95K to BoD member + $2K for BoD/AC/HR&RC

meeting, $1.7K for meeting of other

committees, $25K (Chair of AC/HR&RC), $15K (other

committees) + $170K in deferred phantom shares

accrued up to 15 times per year, but payments

upon expiration of tenure only (net of discount)

Actual: $292K-395K

£675K to Chair of BoD, £70K to BoD members;

Audit & Risk Committee: £30K to Chair, £20 K to

members; Remuneration

Committee: £25 K to Chair, £15K to members.

£5K-15K to others Actual: £91-168K for

corporate year (£686K to Chair of BoD)

No breakdown specified, actual: £625K to BoD

Chair; £ 128K to senior INED;

£115-140K to BoD members

Basic component: RUB 4 million*., RUB 6 million to BoD Chairman.

RUB 0.4 million for membership in AC, RUB 0.32 for membership in other committees (1.25 multiple

applies to Chair of the committee) Proportional subtractions for

missing meetings Actual payments: 4 received RUB 6.72 million, zero paid to foreign

BoD member because of 100% non-attendance.

*The amount of basic remuneration payable to members of the Board of Directors of PJSC Rostelecom is below that of the (conditional) peers.





ECONOMICS


Board of Directors Chairman Sergei Ivanov (representing the Government of Russia), a special representative of the Russian President, no shareholding in the Company

Senior Independent Director, Alexander Auzan* (INED) Dean, Department of Economics, Lomonosov Moscow State University, no shareholding in the Company

Nominations and Remuneration Committee Chairman

Ruben Aganbegyan* (INED) General Director, Otkritie Holding JSC, no shareholding in the Company

Strategy Committee Chairman, Anatoly Milyukov* (INED) Chairman of the Board of Directors, JSC April Capital Management Co., no shareholding in the Company

Audit Committee Chairman Vadim Semenov* (INED) Chairman of the Supervisory Board, Avtodor Group, no shareholding in the Company

______________________________________________

* The API met with all independent directors, all of them are open to contact with the shareholders. Please find below the summary of BoD members’ comments including the API’s expert opinion based on the results of these meetings. We appreciate the BoD members’ participation in the interview and believe that such annual meetings with the Company’s investors and shareholders are extremely useful for assessing the BoD performance and making decisions on the voting for candidates to the BoD at general meetings, among other things.





ECONOMICS


For the period under review (2015, 9 months of 2016), the Board of Directors held 61 meetings, including 4 meetings in the form of joint attendance. 578 issues were considered.

Most of the issues (63.4%) concerned one of the following activities:

determining the Company’s position on issues within the purview of the supreme management bodies of entities wholly owned by the Company (199 issues, 34.4%);

approval of related party transactions in the amount of RUB 117 billion and $3.3 million (141 issues, 24.4%);

approval of a transaction involving property accounting for 0.5% to 25% of the Company’s carrying asset value (27 issues, 4.7%).

The BoD also considered issues related to:

the risk management system and remuneration of the chief risk officer (22 issues);

internal audit and remuneration of the chief audit executive (17 issues); budget performance results (6 issues); long-term management program and KPIs (6 issues); sponsorship and charity (3 issues).

The company’s strategy is discussed in detail by the BoD, primarily based on the management’s standpoints; BoD usually prefer listening and asking questions to bringing up their proposals for discussion. The management team possesses broad and undisputable strategic visioning skills compared with the BoD members. We had the impression that some INEDs see the need for the BoD members’ deeper involvement in the development, monitoring and implementation of the corporate strategy. A benchmark is actively used in all business planning, KPI setting and motivation aspects. Both external (international) and internal (Russian) benchmarks are applicable.

Independent directors wish to increase the number of physical BoD meetings: in the period under review (2015 and 9 months of 2016), the BoD held 4 physical meetings, which falls short of the BoD activity level at any international (conditional) peers and does not meet the normal practice at other Russian companies. At the 4 physical meetings, the BoD addressed the approval and implementation of the long-term development program, the company’s budget, the strategy in new segments and the establishment of a corporate real estate fund. All the other essential issues, including the management’s motivation, activity of the internal audit system, risk management system, preparation for the shareholders meeting, etc. were discussed in absentia. According to INEDs, physical BoD meetings are effective and productive, proposals of BoD members and discussions are welcome, any BoD member can express their opinions and make amendments, if necessary, to the draft resolution proposed by the management. The BoD members surveyed commend the role of the BoD in the CG system, however, it is the quality and performance of the management team that is the determining factor for CG, they say. The independent directors surveyed highly appreciate the effectiveness of the current team and personally of the sole executive body (CEO). INED note a large number of issues subject to instructions, which can dilute, in a way, responsibility of the BoD. That said, directors have not noted any considerable problems with such issues in the BoD activity. As for submitting proposals to Rosimushchestvo for candidates to the BoD for the next corporate year, INED take a passive attitude assuming that this should primarily concern the shareholder.

The senior independent director position is technically established at the Company, but the focus of activity and objectives are under discussion, for example, in the way of some involvement in relations with shareholders and investors.





ECONOMICS

In our view, the practice of putting the undefined ‘Any Other Business’ item on the agenda is a negative element in the BoD activity. In one case (the BoD meeting as of October 8, 2015), the company discloses the resolution made when handling an AOB issue: “On invalidating the Regulations on Remuneration of Management Board members,” in another case (December 14, 2015), the results of the BoD meeting were not disclosed, the agenda item in question was presumably not considered. We recommend that the Company abandon this approach to shaping the agenda of BoD meetings.

At the same time, we appreciate the good practice of legal recognition of the following in the corporate documents:

procedure for providing requested information on the company and its controlled entities to BoD members (INED commend the absence of any problems with access to any information they need);

the right of BoD members to require that the dissenting opinion on agenda items and resolutions, if any, be included in the minutes of the meeting (the practice of disclosing the dissenting opinion of a BoD member, e.g. concerning the preparation for a GSM). We should also note the broad expertise of the BoD as regards participation in the management of subsidiary entities (as evidenced by the biggest proportion of agenda items considered at the meetings). At the same time, it is useful to give BoD members the right to nominate candidates to the management bodies of substantial controlled and subsidiary entities, including the companies where Rostelecom does not have 50% +1 share (the mobile business). At the moment, proceeding from the current wording of the charter, the BoD, in our view, only has the power to coordinate the Company’s position.

The Board of Directors has established 5 specialized committees, namely, the Strategy Committee, the Investment Committee, the Nominations and Remuneration Committee, the Audit Committee and the Corporate Governance Committee. Of special note is the extremely formal approach to activity at no less than 2 key committees in 2015: all meetings of the Audit Committee and the Nominations and Remuneration Committee were held in absentia. Only the Strategy Committee held all its 3 meetings in the form of joint attendance. Information on meetings held by the other committees was not disclosed. Independent directors assured us that the committees held meetings in the form of joint attendance in 2016 (the related statistics will be disclosed in the Company’s 2016 annual report). The BoD committees have the right to engage external experts (on a paid basis, among other things, to the extent of the budgeted expenses for such services).





ECONOMICS


The Audit Committee consists of 3 INEDs. 4 meetings were held in 2015. The role and activities of the committee meet the CG Code recommendations. The Committee has broad powers in the field of internal and external audit, internal control and risk management, which is one of the best cases among the companies targeted by the research. The Company discloses the full list of issues considered by the Audit Committee in an annex to the annual report. The AC regularly approved reports on the internal audit department’s activity, on the award of bonuses to the risk manager and the head of the internal audit department, on the risk management program and the internal audit department regulations, on the recommendations for selecting the auditor and determining the auditor’s fee, on implementing the risk management program. The efficiency assessment of the system for preventing conflicts of interest, illegal actions and violations, an independent system for warning members of the Audit Committee and BoD members (the hotline) was not considered separately, but the chief audit executive informs members of the committee on all feedback received via the hotline and the progress in follow-up checks when reporting on the internal audit division’s activity.

Nominations and Remuneration Committee (NRC) The NRC consists of three INEDs, 5 meetings were held in 2015. The Committee considered approving the terms of additional agreements to labor contracts with the management as regards the stock option plan and the management’s remuneration, the terms and conditions of additional agreements to the labor contract with head of the internal audit department, the President’s appointment and his term of office, as well as the bonuses payable to BoD members and the Company’s President. The Committee has not assessed the Board of Directors’ activity. The procedure for preparing proposals to the majority shareholder as regards candidates to the BoD for the next corporate year is not formalized. According to comments from the Chairman, the Committee considered a new long-term motivation program for Rostelecom employees in 2016. At the moment of the meeting with INEDs, the committee discussed the launch of a new motivation program covering up to 6% of Rostelecom shares. A portion of the quasi-treasury share package was considered as the source of the program.





ECONOMICS

Essential CG aspects External auditor

The remuneration payable to Ernst & Young LLC engaged as the auditor for auditing the Company’s statements in 2016 and H1 2017 is RUB 102.6 million (76.6% of the initial purchase price). As regards the auditor selection criteria, it should be noted that the bidder with the second best result offered a much lower price but could not primarily compete in the experience of auditing major companies and state-owned enterprises (SOEs). We appreciate the positive practice of assessing the quality of audit services without focusing on the contract price as the only determining factor. Based on the disclosed materials, the auditor does not provide non-audit services to the Company. The 2015 annual report contains a declaration of checking the auditor’s independence. The Audit Committee prepares recommendations to the BoD as regards selection of the auditor and determination of the auditor’s fee based on a review of the auditors’ services and the terms and conditions of their provision, as well as an opinion of the Company’s top executives. The terms of the contract with the auditor are subject to approval by the BoD. The Audit Committee is satisfied with the quality of external audit.


In 2015, the Company updated the Internal Audit Regulations and the Internal Audit Department Regulations. The internal audit division headed by the chief audit executive consists of the internal audit department of the corporate center and the internal audit departments of each of Rostelecom’s macroregional branches. At the end of 2015, Rostelecom had 142 employees engaged in the internal audit activities (the disclosure by the Company of this figure is extremely important for assessing the adequacy of resources for the internal audit function). In 2015, the internal audit department checked the Company’s business processes and conducted

comprehensive inspections at macroregional branches, according to the 2015 activity plan approved by the BoD, performed preventive control of documents and control of remedy measures, checked the measures aimed at improving efficiency of the internal control service and business processes, and made a selective assessment of the risk management system efficiency. According to the BoD members surveyed, the internal audit system is effective, accountability to the BoD is high and adequate. The powers of the BoD and of the Audit Committee in relation to internal audit are consistent with the CG Code recommendations (except for approving a separate budget of the internal audit division). The Board of Directors effectively monitors the risk management system. In the period under review, risk-related matters were considered 22 (!) times, including quarterly reviews of substantial risk management results, bonuses to the chief risk officer, the annual risk management program and related adjustments, the risk management policy.

Dividend policy

Under the Dividend Policy Regulations, the Company earmarks at least 75% of the FCF for the financial years 2015, 2016 and 2017 (but no less than RUB 45 billion in total for all types of shares) for the payment of dividends. According to the old version of the Dividend Policy Regulations, the Company was to earmark at least 20% of its IFRS net profit for dividends on ordinary shares. The minimum required dividend per preferred share did not change: 10% of the Russian GAAP (RAS) net profit divided by the number of preferred shares, while maintaining parity in dividend payments if the estimated dividend per ordinary share exceeds the dividend per preferred share. We welcome the use of the FCF as the benchmark, which increases the Company’s dividend yield and ensures effective distribution of profits taking into account the current situation and the stage of development.





ECONOMICS

Proportion of profit earmarked for dividends before and after the new dividend policy

Dividend payout ratio Dividends on ordinary shares in relation to RAS

net profit

Dividends on ordinary shares in relation to IFRS

net profit

Dividends on prefs in relation to RAS net profit

Dividends on prefs in relation to IFRS net profit

2014 29.2% 22.8% 2.9% 2.2 %

2015 70.63% 105.84% 5.75% 8.61%

Dividend payout ratios at (conditional) peers vs. Rostelecom in 2015

Rostelecom AT&T (2014 dividends**) BT Group Vodafone (2014 dividends**)

Payout ratio* 118.1% (76% of the RAS net

profit) 80% 39% 35%

*factoring in the profit attributable to the parent company’s shareholders **information on 2014 dividends is provided for companies posting losses in 2015


for 95% of all related party transactions, the Company discloses their material terms, including the subject of the transaction, the parties, the price (or its limits), the party in interest to the transaction (the best transaction disclosure practice!);

the notices on resolutions made by the BoD do not disclose information on the results of voting on the agenda items, including the individual voting, i.e. how exactly each of the BoD members voted (we recommend that the Company disclose this information);

the link to the hotline mentioned in the Company’s Code of Ethics and intended for reporting violations of the Code is quite difficult to find without using the search form and without knowing of the existence of the Company’s Code of Ethics; it is recommended that the link be located where people wishing to share information about violations can easily find it.





ECONOMICS

Management remuneration system disclosure practice at international peers of PJSC Rostelecom The company has one of the most advanced management motivation disclosure systems among the companies covered by the research (for example, it discloses payments to the 5 highest-paid employees). Our recommendation is to consider still broader disclosure based on international practices and focusing on the ratio between the long-term and short-term components, information on the target and actual (achieved) KPIs, estimates of future payments, etc.

Approximate proportions of CEO remuneration components in 2015

AT&T Inc. BT Group plc Vodafone Rostelecom

Disclosure, all payment, incl. in the form of stock, estimates of future payments

CEO + CFO + 3 top managers.

Actual, CEO: Salary $1,741,667, bonus:

$5,500K, long-term remuneration: $14,600K.

CEO + CFO. Actual, CEO: Salary £ 946K, bonus:

£1,322K (including deferred stock), long-term

remuneration: £1,812K.

CEO + CFO + Chief Engineer. Actual, CEO: Salary £1,150K, bonus:

£1,342K (including deferred stock), long-term

remuneration: £2,429K

Total for Management Board + separately to 5 highest-paid Management Board members in total. Management Board reduced from 15 to 6 since September 2015. Remuneration for membership in Management Board: RUB 46 million, salary: RUB 208 million, annual bonus: RUB 314 million, including an option worth RUB 180.7 million. Payments to 5 highest-paid Management Board members: RUB 16 million for membership in 5 Management Board, RUB 145 million in salaries, RUB 174 million bonuses

AT&T BT Group Vodafone Rostelecom

Fixed component 8% 23% 23% 45%

12-month bonuses 25% 32% 27% 55%

Long-term 67% 44% 49% 0%*





ECONOMICS

AT&T Inc. BT Group plc Vodafone Rostelecom

KPIs influencing the short-term (annual) variable remuneration component (incl. the KPI relative weight, if any)

Consolidated profit, EPS, Free cash flow. No

proportions provided.

Executive achievements 10%,

revenue growth – 10%, personal contribution to

strategic achievements 15%, normalized FCF 20%,

customer satisfaction 25%, adj. EPS 20%

EBITDA, revenue, adjusted FCF 20% each, strategic

KPIs (eg. consumer recommendation index,

market share) 40%

TSR, ROIC, Revenue, OIBDA, labor productivity, quality of the innovative development program, subscriber growth, number of

households connected to fiber optical cables, net debt/OIBDA ratio

KPIs influencing the long-term variable remuneration component (3-year targets for some of the KPIs)

Shares for achievement of KPIS: ROIC 75%, TSR vs. S&P 100: 25%, restricted stock units: same KPIs

(the number of restricted stock units in money terms equal to the number of phantom

shares for achievement of KPIs

Relative TSR across peers 40%, normalized FCF 40%, increase in base revenue without excludin transit

revenues 20% (for a period of 3 years)

TSR across peers (info contains peers + total

growth index in emerging markets)

see remuneration of the management section: long-term motivation*

Long-term bonuses

(Phantom) shares for the achievement of KPIs (settlement/payout

period: 3 years); restricted stock units (accumulation period: 4 years, payment

in shares)

Shares with deferred distribution (base April 1, 2014). Base calculation

period: 3 years + 3-year deferred shares (1/3 of

annual bonus

Shares with 3-year deferral of receipt and

obligations to co-invest in company’s shares

+dividends on them (up to 594% of CEO’s salary and 525% of other salaries)

see remuneration of the management section: long-term motivation*

Shareholdings of Management Board members

Management Board member Rounded-off value of share package as of September 30, 2016 Sergey Kalugin (CEO) RUB 978 million (including preferred shares) Maria Florentieva RUB 121 million (including preferred shares) Larisa Tkachuk RUB 26 million Kai-Uwe Mehlhorn RUB 24 million Galina Rysakova RUB 24 million Alexander Tseitlin RUB 24 million





ECONOMICS

*Management remuneration: long-term motivation

The Company has a long-term 2014-2015 management motivation program. Its participants purchase ordinary shares at a fixed price out of the annual bonus paid subject to the achievement of KPIs based on FCF, net profit and ROIC. The shares are sold annually, a certain percentage of the total target package, with an adjustment, depending on the KPI achieved (30% for 2014, 30% for 2015, 40% for 2016; or 40%-60%, respectively, for those who joined the program in 2015). The final package is subject to periodic adjustment based on the KPI achieved in each year and factors in expected changes in the KPIs for the remaining years of the program. Structurally, the program differs from long-term top manager motivation programs used in the international practice in the following way: the Company does not provide for an accumulation period during which the shares or corresponding conditional units are accrued subject to annual KPIs but do not pass into the manager’s ownership until expiration of the tranche settlement period. According to international practices, such an accumulation period ranging from 2 to 5 years is intended for backdated bonus reduction in case of a failure to meet a target KPI (e.g. the TSR for a certain period and/or multiple targets in succession during the period) or in case of non-compliance with the conditions related to early employment termination, absence of violations over the period, etc.).

Besides, the Company does not provide for a base KPI calculation period until the bonus award in more than 1 year. Shares are transferred to the ownership of managers under Rostelecom’s program at a fixed price. According to international practices, the price at which payments are effected at the end of the calculation period differs from the accrual price in each year applying to the calculation of the number of shares each year during the accumulation period.

The approaches to determining the size of the bonus payable for the successful KPI achievement used in the program are not disclosed. In the international practice, the bonus determination is mainly based on a combined multiplicative KPI achievement assessment formula. Therefore, the program is similar to employee stock ownership plans (ESOP) used in the international practice, subject to an adjustment for motivation purposes (setting the total number of shares for bonuses based on the achievement of KPIs monitored in each year over a period of 2 or 3 years). The information on exercising options disclosed in the annual report does not contain a clear indication of the physical contingent income (loss) attributable to the managers in each reporting year (no specific financial calculation). The reports on remuneration of Management Board members do not specify whether the bonus component includes the stock option plan.





ECONOMICS


In 2015, the Company approved restated Regulations on the donations and charity procedure. The Company does not disclose the document or its approaches to charity & sponsorship budgeting and to setting limits on these expenses. The annual 2015 report contains the following information:

Charity and sponsorship expenditure of the Company and its subsidiaries in 2015 (million rubles)

PJSC Rostelecom 294.2 PJSC Bashinformsvyaz 51 OJSC MMTS-9 0.95 JSC MC NTT 0.48 OJSC Orbita Health Resort 0.03 Rostelecom Retail Systems Ltd 0.003

TOTAL 346.7 The corporate social responsibility issues and related matters are also disclosed in the annual social reports published on the Company’s website since 2011 and consisting of the following sections: company profile, corporate culture, social policy, socially oriented services and security. The document contains separate data on charity expenses, for example, the transfer of about RUB 7 million to regional orphanages and boarding schools in 2015.

Charity expenses at Rostelecom vs. conditional peers Rostelecom AT&T BT Group Vodafone (2014)

Ratio of direct social investment and charity expenses to IFRS profit 2.49% 1.14% 1.31% 0.68%


Research report on PJSC RUSHYDRO

as of 09/30/2016




SCHOOL OF ECONOMICS

RESEARCH REPORT ON PJSC RUSHYDRO / 2 Association of Institutional Investors (API)




ECONOMICS

66.84%

5.61%

27.55%


Russian Federation


free-float (incl. individuals)


The controlling interest in the Company belongs to the Government of Russia, the majority shareholder’s possible effective voting stake is 72.4%. Quasi-treasury shares account for about 5.6% of the share cap-ital; a shareholder agreement was concluded on June 23, 2016 between Russia’s Federal Agency for State Property Management / Rosimush-chestvo and three entities controlled by the Company in respect of 5.53% of the shares which, among other things, governs the voting of these shares. Some of the quasi-treasury shares, according to media reports, can be acquired by VTB Bank (PJSC) in a deal aimed at increas-ing the Company’s capital, as was announced on November 16, 2016, with the result that the Bank’s shareholding in RusHydro may reach about 14%. After four consecutive issues in 2010-2013, the number of the Compa-ny’s shares increased by 97.5 billion (33.8%). The Government acquired 93% of the additionally issued shares and eventually increased its stake by 8.87 percentage points. The dilution ratio for minority stakes was 0.79.


According to the Company, RusHydro complied with only 30, partially complied with 39 (more than half), failed to comply with 10 out of 79 principles and recommendations of the Corporate Governance Code in 2015.





ECONOMICS

General summary of CG practice

+ Professional approach of the current BoD Chairman to organizing the BoD

activity: encouraging the BoD to attend to its direct responsibilities, high commitment to physical meetings (9 meetings in presentia in the period from the BoD Chairman’s election in June 2015 to September 30, 2016);

high information disclosure standards: materials for GSMs, disclosure of material facts, the Company publishes minutes of BoD meetings and meetings of committees on the website, discloses material terms of re-lated party transactions, persons proposing BoD candidates etc., infor-mation on the auditor selection procedure;

according to the Articles of Association, the BoD is vested with powers in relation to significant agenda items of corporate bodies’ meetings at subsidiaries;

the current independent director contributes to the Company’s communi-cations with the investment community;

the Audit Committee takes an active approach to work (this conclusion is drawn from the minutes and comments by one of the committee mem-bers, while a meeting with the Chairman failed);

the regulatory and procedural framework of the risk management system meets the best standards.

- no disclosure of the top management remuneration system (the

proportions of quarterly and annual remuneration components) and the correlation between payments for the reporting period and the KPI achievement, including the integral long-term development pro-gram execution index (the correlation is proclaimed in the Company’s statements, but the target and actual KPIs are not disclosed);

(conditionally negative*) no long-term motivation system at the

Company (*the Chairman of the Nominations and Compensations Committee and representatives of the management confirmed that the issue is being jointly addressed by the BoD and the management, the program is expected to be launched in 2017. We highlight the need for proper disclosure of the program in case it is approved);

judging by the results of voting at the 2016 AGM, quasi-treasury shares are used for voting at GSMs (the voting policy is not dis-closed). The shareholder agreement concluded with Rosimushchestvo is at variance with the proper corporate governance practice and the CG Code if it does not impose a prohibition on the voting of such shares;

changes made to the corporate by-laws at the GSMs in the last 3 years do not fundamentally improve the observance of CG Code rec-ommendations;

the existing dividend policy assuming that the Company intends to earmark at least 5% of its IFRS net profit for dividends needs to be updated. The current policy does not take into account the Company’s actual (financial) standing, including the need to set debt covenants, free cash flow-related potential, etc.;

absence of a proper remuneration system for BoD members;

low proportion of physical meetings held by BoD committees in 2015;

independent directors (INEDs) and the Nominations and Compensa-tions Committee do not contribute to the drawing-up of a list of BoD candidates for the next corporate year for Rosimushchestvo (the management team has to submit such a list despite a potential con-flict of interest).





ECONOMICS

82,1 86,5 84,7

17,4 13,5 15,3

48,53

37,88

47,43

2014 2015 2016

%, proportion (in relation to quorum) of Russia + quasi-treasury shares

%, proportion (in relation to quorum) of the free-float and individuals

%, minority shareholders taking part in the meeting, in relation to total free-float+individuals

General shareholders meeting: activity of shareholders, related party transactions The proportion of minority shareholders participating in the 2015-2016 AGMs was a mere 14-15% of the quorum or 40-47% of the free-float and pri-vate shareholders, the GSM quorum being 86% in 2016 and 77% in 2015. Given the high share capital dispersion among low-active portfolio investors, it is not clear from the voting results disclosed by the Company which of the minority shareholders (accounting for 4.5% in 2015 to 13% in 2016) voted in support of candidates nominated by the Russian Federation and quasi-treasury shares at the GSM. Based on the Company’s quarterly report, Gaz-prombank owned 6.367% of the voting power as of December 30, 2015. Besides, 5.8% of the Company’s outstanding shares are represented by deposi-tary receipts in circulation. At each of the AGMs in 2015 and 2016, the Company’s investors approved one related party transaction (a liability insur-ance transaction worth $68,700 in 2015, a related party transaction which the Company may effect in the normal course of business in future, name-ly, the purchase of foreign currency, in the amount of RUB 100 billion, in 2016).





ECONOMICS

Information on the shareholders of PJSC RUSHYDRO, according to Bloomberg data and information disclosure by the shareholders


Comment on voting


HYDROINVEST OJSC 4.31 Quasi-treasury shares, the company is controlled by RusHydro. OAO ZZOP 0.81 Quasi-treasury shares, the company is controlled by RusHydro.

VANGUARD GROUP 0.8

The shareholder discloses its approaches to voting at shareholder meetings, as well as the way it voted in the last corporate season. For funds focused on investments in Russia, the shareholder disclosed voting in the af-firmative (FOR) on all agenda items at the EGM of RusHydro held on December 25, 2015 and non-voting at the 2016 AGM. The shareholder does not nominate BoD/SB (Supervisory Board) candidates, but supports, according to the generally disclosed approaches to voting, the idea of nominating at least 20% of INEDs by a group of share-holders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder follows recom-mendations from proxy advisory firms.

BLACKROCK 0.73

The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies. Information on voting in the last corporate season is disclosed. The shareholder disclosed non-voting at the EGM in 2015 and the AGM in 2016. Recommendations of proxy advisory firms are fol-lowed. The shareholder does not nominate BoD/SB candidates but can support other shareholders ’ proposals if there is certainty about meeting shareholders’ interests in the best way possible.

OAO INDEX ENERGETIKI 0.41 Quasi-treasury shares, the company is controlled by RusHydro.

NORGES BANK 0.29

The shareholder discloses its voting in the last 3 years. At the EGM in 2015, voting in the affirmative (FOR) on all agenda items; at the 2016 AGM, the shareholder voted FOR 4 independent BoD candidates (3 of them were elect-ed to the Board of Directors, the independent candidate nominated by the quasi-treasury package was not elect-ed). The shareholder discloses its voting policy and the results of its voting, does not nominate BoD/SB candi-dates in Russia, unlike other countries. Recommendations of proxy advisory firms are followed.

PICTET FUNDS 0.18

According to the UK Stewardship Code compliance report published by the shareholder, PICTET FUNDS declares a passive approach to participation in corporate actions (with exceptions possible under certain conditions). The shareholder acknowledges taking advice from a proxy advisory firm (ISS) for voting purposes. The voting details are not disclosed.

RAIFFEISEN BANK INTER-NATIONAL AG

0.17 The shareholder is likely a nominal holder.


0.15 The shareholder discloses information on its voting at the shareholders’ meeting following ISS recommendations. No specific voting disclosure.

EATON VANCE CORP 0.14 According to the shareholder’s latest voting policy available for review dating back to 2009, the shareholder employs the services of a proxy advisory firm (ISS).

DOD EVGENY V 0.12 Ex-CEO, the shareholding is valued at RUB 354.5 million as of September 30, 2016.





ECONOMICS

General shareholders meeting: disclosure of information, preparation process

+ the deadline for putting issues on the GSM agenda and nominat-

ing candidates to the Company’s control and management bod-ies is 90 days;

materials for GSMs are disclosed in the English and Russian lan-guages 30 days prior to the GSM date;

the materials contain information on the external auditor, its qualification and experience, information on the competitive procedures used in the auditor selection process (including the bidders’ names, comparative data on the cost of services, ac-cording to the tender bids, and results of the bid evaluation pro-cess);

the minutes of the BoD committees’ meetings included in the GSM materials disclose individual voting by the committees’ members on their respective agenda items, which provides an opportunity for assessing their personal positions;

the Company’s annual report contains details of major transac-tions and related party transactions: their key parameters (sub-ject matters, parties, price/limits, validity period), parties in in-terest, the corporate body approving the transaction (including the minutes details to obtain information on the voting and other aspects of approving the transaction from the disclosure system or other sources).

- the persons proposing issues to the GSM agenda for consideration

are not disclosed in the GSM materials; comparison tables reflecting changes made to corporate docu-

ments are only attached to restated versions of the Articles of Association. The tables do not contain the reasons for proposed changes;

the materials do not contain the rationale for the profit distribu-tion, including the profit earmarked for dividends and for corpo-rate development purposes (the Company should provide the re-lated recommendation of the BoD members with a detailed ra-tionale for the proposal;

the minutes of BoD meetings summarizing the agenda should disclose dissenting opinions of the BoD members if they concern the GSM agenda.

Comment on the opportunities for minority shareholders’ participation in the meeting

The serious share capital dispersion, including a substantial propor-tion of depositary receipts, prevents minority shareholders from con-solidating 2% of the Company’s shares for nominating another inde-pendent director to the Board of Directors, even though the current BoD structure enables shareholders to elect at least one INED by their own forces if their candidate gains votes from at least 6% of the shareholders. Overall, in our view, the Company’s BoD would only ben-efit from the shareholders’ ability to additionally elect 2 independent directors.





ECONOMICS


BoD activity aspect TransAlta Corporation ENEL E.On PJSC RusHydro


8 of 9 8of 9 10 of 12 (6 staff repre-sentatives are consid-ered to be INEDs)

3 of 13 (2 of them were recognized as INEDs by a special decision of the BoD, seeing as the BoD members fail to meet the applica-ble independence criteria).


BoD: attendance ratio is 96% (for 13 BoD members) Audit Committee: 100% attend-ance HR Committee: 94%

BoD: 1 member missed 1 meeting (BoD held a total of 15 meetings). All committees: 100% attendance.

BoD: 1 member missed 2 meetings (a total of 6 meetings were held). All committees: 100% attendance.

Attendance ratio 58% for 1 BoD member, ~80% for 4 BoD members, 90% for 2 BoD members, 95% for 3 BoD members, 100% for 3 members. Audit Committee: 95%, Nominations and Compensations Committee: 100% attend-ance.

Remuneration of BoD members / actual payments based on 2015 performance*

$330K to BoD Chair, $160K to BoD member, including 50% in shares (deferred restricted stock units/ DRSU) or money at payee’s choice, 50% in shares or DRSU + $25K to Chairs of Audit Committee and HR Committee, $15K to Chair of Governance Committee +$1,500 for meeting, Actual: $192-417K (excluding BoD members who do not serve for a whole corporate year):

€80K + up to €70K for membership in com-mittees (€30K for chairpersons, €20K for members + €1K for each meeting). €238K payable sepa-rately to BoD Chair-man, as decided by the GSM following the committees’ recom-mendation). Actual: €80K for BoD membership + €57-66K for committees

Actual: €140-440K €440K to BoD Chair-man, €320K to Deputy BoD Chairman, €140K to BoD member, €180K to AC Chair; €110K to AC members; €140K to Chairs of other com-mittees, €70K to mem-bers of other commit-tees. €1K additionally paya-ble for each meeting of the BoD or its com-mittee

RUB 0.9 million, but no more than RUB 1 million. Uplift factors: 30% for BoD Chair, 20% for Chair of a committee, 15% for sen-ior INED, 10% for member of a committee. Actual: RUB 7.8 million for all BoD members BoD members earn precious little in the way of in remuneration, a destructive approach to the BoD motivation, no oth-er cases of such an approach among peers. The gap between the annual re-muneration of a BoD member and that of a Management Board member is more than 120 times (no more than 15-20 times at peers)!

We recommend that the shareholder and the Board of Directors, including the Nominations and Compensations Committee, revise the existing ap-proach to remuneration of BoD members by increasing the base remuneration at least 5 times, given the Company’s scale. Surprising is the position of the BoD members (only 1 ‘abstained’ vote) and members of the Nominations and Compensations Committee who voted in favor of the recommendation to approve the 2016 regulations on the remuneration of BoD members (essentially similar to the existing regulations, with a base remuneration of RUB 900,000 or $14.2 thousand) at the general shareholders meeting. Seeing as the company does not disclose who put this issue on the GSM agenda, we cannot be sure whether this initiative came from the shareholder or the BoD, but the practice is negative in any case.





ECONOMICS


Chairman of the Board of Directors Yuri Trutnev (representing the Russian Federation), no shareholding in the Compa-ny;

Chairman of the Audit Committee Sergey Ivanov (INED)** CEO, RT Capital LLC, no shareholding in the Company

Chairman of the Nominations and Compensations Commit-tee (NCC) Viatcheslav Pivovarov (INED)* President, Altera Capital LLC, no shareholding in the Company;

Maxim Bystrov (INED)** member of the Audit Committee and the Nominations & Compensa-tions Committee, no shareholding in the Company.

______________________________________________

* The API only met with 1 INED, Chairman of the Nominations and Compensations Committee. ** the directors are recognized by the Board of Directors as INEDs even with their affiliation with the Government and the Company’s major counter-party. It should be noted that the Government’s instruction nominated 6 candidates with an independent director status, all 6 were elected but only 1 meets the applicable independence criteria, while 3 of them are referred to as non-executive directors. Please find below the summary of the BoD member’s comments combined with the API’s expert opinion based on the results of the meeting with the BoD member and a review of information disclosure. We appreciate the BoD member’s participation in the interview and believe that such annual meetings with the Company’s investors and shareholders are extremely useful for assessing the BoD performance and making decisions on the vot-ing for BoD candidates at general shareholders meetings, among other things.





ECONOMICS


For the period under review (2015 and 9 months of 2016), the BoD held 31 meetings, including 10 physical meetings (32% of all meetings for the period). 9 of the 10 physical meetings were held after the new BoD Chairman was elected in June 2015.

Following the new BoD Chairman’s arrival, meetings are held almost monthly and the BoD members are actively involved in discussions. According to the INED, the current BoD cannot be called a “dummy body” as the Chairman ensures high efficiency, performance and re-sponsibility. In addition, the Chairman’s resources are comparable to those of the management, which also plays an important role. 164 issues were considered at the meetings. Related party transac-tions were discussed at 13 meetings (51 transactions for a total amount of RUB 609 billion). The main priorities for the Board of Directors were as follow:

business plan execution (quarterly): 9 issues;

approval of and adjustments to business plan: 3 issues;

charity: 9 issues;

key performance indicators: 7 issues;

long-term development program: 2 issues;

report on the strategic plan implementation, approval of the development strategy to 2020, with an outlook to 2025: 2 issues.

The BoD pays close attention to business planning and the corporate development strategy. At the same time, the current performance indicators persistently fall short of targets, as exemplified by the need to seriously improve the return on equity. As for the business plan consideration, we note a delay in approving the 2015-2019 plan (the 2015 business plan was approved at the end of April 2015) and untimely adjustments to the investment program, an integral part of the business plan (in December 2015). However, the 2016-2020 business plan was approved as early as in December 2015.

As for setting KPIs for the financial year, it should be noted that the CEO was instructed by a BoD decision as of June 6, 2016 to submit a proposal concerning the procedure for the calculation and assessment of key performance indicators of PJSC RusHydro for the next planning period on or before November 30, 2016 (1 BoD member representing the Russian Federation voted ‘against’ the proposal, with no dissent-ing opinion provided). It is recommended that the Company abandon the practice of establishing the KPI calculation procedure or introduc-ing new KPIs almost retrospectively (or closer to the end of the re-porting period). The reason for the delay is usually the absence of the relevant federal executive authority’s position or the shareholder’s (the Government’s) instruction to urgently amend the KPIs. Charity and sponsorship issues are addressed, among other things, in the context of the Company’s performance results. Voting at BoD meetings is often not unanimous, with the following breakdown of ‘abstained’ votes by the number of voters: 1 director: 97 cases (hereinafter including sub-items); Maxim Bystrov, a reputable INED, took the lead in voting ‘abstained’ (77 cases, the dissenting opinion is presented in 1 case); 2 directors simultaneously: 39 cases; 3 directors simultaneously: 14 cases; 4 directors simultane-ously: 10 cases (mainly in relation to EGM recommendations in De-cember 2015, no dissenting opinions were presented); 5 directors sim-ultaneously: two cases (both relating to a guarantee to Sberbank of Russia, the terms of which remained undisclosed). Besides, 36 cases of 1 BoD member voting ‘against’ and one case of 4 directors voting ‘against’ simultaneously were registered. In the period under review, INEDs Viatcheslav Pivovarov and Sergey Ivanov only voted in the affirmative; (after the reporting date, Viatch-eslav Pivovarov voted ‘abstained’ on the long-term development pro-gram (LTDP), with no dissenting opinion provided).





ECONOMICS

The minutes usually contain reference to dissenting opinions of BoD members normally in relation to voting in the negative (‘against’), but the dissenting opinion as such is not disclosed. The most reasons for voting were provided by Vyacheslav Kravchenko (Deputy Minister of Energy, a representative of the Russian Federation). The opinion of only one BoD member we were able to meet with is not enough for a comprehensive assessment of the BoD activity. In any

case, we recommend that the BoD discuss the results of voting in the corporate season in order to either optimize the process of preparing materials for BoD meetings (or drawing up draft resolutions) or dis-cuss with the BoD members who most frequently vote ‘against’ or ‘abstained’ how approaches to the BoD activity need to be adjusted so as to reduce the number of “protest” votes.

Audit Committee (AC) The Audit Committee consists of current independent directors. The powers and the range of issues considered by the AC meet the CG Code recommendations and the best practices. In 2015, the AC held 11 meetings, including 3 meetings in the form of joint attendance. In 2016, 12 meetings were held, including 4 meetings in the form of joint attendance. Among others, the AC addressed risk management, internal control, measures against unfair actions, engagement with the external audi-tor, the Company internal audit and LTDP. Almost all the minutes of the AC meetings are disclosed on the Com-pany’s website. Judging by the minutes and comments from the INED (who is also an AC member), the work of the Committee is active and regular. The Committee gives proper consideration to any results of inspections and audits, including those conducted by the Ministry of Energy or Russia’s Accounts Chamber. We were not able to meet with the AC Chairman, which prevents a meaningful review of the Committee’s activity.

Nominations and Compensations Committee (NCC) The Committee consists of independent directors. The powers and the range of issues addressed by the NCC generally meet the CG Code recommendations. In particular, the NCC prepares recommendations to the BoD for the approval of the sole executive body (CEO) and mem-bers of the Management Board. It should be noted that the NCC con-sidered all these significant issues in absentia in 2015. The Company also discloses the minutes of the NCC’s meetings in 2016 (through June 2016), all meetings were also held in absentia in 2016.

However, according to the NCC Chairman, the Committee worked sub-stantively on the generation of proposals/recommendations concern-ing the remuneration of the Company’s management. The Committee is in a position to consult experts on some issues requiring additional expertise. We regard this as a positive practice. The Committee did not consider the BoD performance assessment and did not contribute to the preparation of proposals for the shareholder concerning BoD candidates for the next corporate year. We believe that the NNC and the Board of Directors should show more activity in this regard lest a conflict of interest should occur.





ECONOMICS

Essential CG aspects External auditor In 2013-2014, the Company’s statements were audited by JSC Pricewa-terhouseCoopers Audit (PWC). As a result of a procurement procedure, PWC was also selected as the auditor for 2015-2017. The price of audit (review) services in relation to the Company’s financial statements prepared under Russian GAAP (RAS) standards and the consolidated financial statements of RusHydro Group prepared under IFRS stand-ards in 2015-2017 is RUB 394.4 million (79.7% of the initial bid price). In 2015, the Audit Committee gave a positive opinion on the audit of the Company’s 2014 RAS and IFRS statements for 2014. The amount of remuneration payable to PWC for 2014 was RUB 121.6 million. The AC considered the following issues: establishing the procedure for the selection of an auditor for 2015-2017; recommendations to the Board of Directors concerning the proposed auditor for 2015-2016 and de-termination of the auditor’s fee. In 2016, the AC committee held a physical meeting as part of preparation for the GSM (the minutes are disclosed in the GSM materials).


In 2015, the Company established an internal audit service accounta-ble to the BoD (the Audit Committee). Based on the reporting, the Company discloses information on more than 25 monitoring activities carried out by the service in 2015, including audits at branches and subsidiaries, focused audits and selective risk management assess-ment. That said, no information on the structure, headcount and budget of the service is disclosed. Being unable to meet with the Chairman of the Audit Committee, we have no information about the assessment of performance and resource adequacy in the internal audit activity. The internal audit policy approved by the BoD does not provide for the need to negotiate the budget of the division with the Audit Committee/BoD, which directly affects the possible effective-ness of the division and reduces independence from the Company’s management. In all other aspects, the regulations meet the best prac

tices. At the same time, the Audit Committee regulations vest the Committee with the power to consider the budget of the division in the context of limitations of the service’s authority. This issue is omitted in the disclosure of information on matters considered by the Committee in 2015. In the period under review, the BoD approved the Company’s anti-corruption policy, conflict of interest management policy, internal audit policy, as well as the internal control and risk management policy. All the documents are disclosed on the Compa-ny’s website: an outstanding corporate practice.

Internal control: a system of detecting and preventing conflicts of interest has been developed: the top executives of RusHydro Group annually submit declarations of income, assets and liabilities for themselves and their close relatives; contractors disclose chains of beneficiaries; a personnel commission operates at the Company. More than 3,000 declarations were verified in 2015, the process is automat-ed. Based on the results of verification, a number of employees were subject to disciplinary actions. Suppliers and contractors are obliged to provide information and documentary evidence on the entire chain of ownership, including ultimate beneficiaries, and to sign a letter of guarantee on avoiding dealing with shell companies. The chains of beneficiaries for 669 counterparties were verified during procurement and contracting procedures, no cases and signs of conflicts of interest were revealed.

Risk management: the internal control and risk management policy, the register of strategic risks of PJSC RusHydro for 2015-2016, the internal control and risk management policy of RAO ES East, PJSC are updated; internal control and risk management policies of 17 key sub-sidiaries are approved subject to the parent company’s requirements, risk management plans for 2015-2016 are developed, procedures for regular risk management reports at year-end are given effect. At the same time, we note the absence of issues related to the consideration of reports on assessing the internal control and risk management





ECONOMICS

system performance on the agendas of BoD meetings in the period under review (2015 and 9 months of 2016), even though this is defi-nitely within the purview and power of the BoD, according to the ex-isting Articles of Association. Besides, information on the headcount

of the risk management division is not provided in the reports, which prevents the assessment of resource adequacy.


Mandatory information disclosure is in line with the current legisla-tion:

Most of the notices of related party transactions approved by the BoD disclose essential parameters of such transactions, which should be regarded as a good practice. The price parameters of related party transactions are not always disclosed in material facts, as opposed to annual reports;

The individual voting of BoD members is not disclosed in the notices of decisions taken by the BoD, only the number of votes cast for the voting options is provided; that said, the Company publishes the minutes of BoD meetings on its website.

Dividend policy

The dividend policy has not been updated since 2014. The Company intends to earmark at least 5% of its consolidated IFRS profit for div-idends. Expenses for the investment program approved by the gov-ernment authorities financed by profits and other spending are in-cluded in restrictions. On paper, the dividend policy is not consistent with the current state policy of having state-owned companies ear-mark at least 25% (50% in 2016) of their respective consolidated IFRS net profits for dividends. Nevertheless, the Company’s dividend pay-ment practice complies with the current policy: 47.6% of the consoli-dated IFRS profit attributable to the Company’s shareholders was paid in 2015 dividends. Compared with international peers, the Com-pany has a lower 2015 dividend payout ratio.

Dividend payout ratios at (conditional) peers vs. RusHydro in 2015*

TransAlta (proportion of FCF, loss for year)

ENEL E.On RusHydro

65% 70% 59% 50% The Company’s dividend policy does not take into consideration the current debt and free cash flow being limited to setting a technical minimum IFRS payout ratio; the investment program is taken into account but the required return ratios are not specified for reasonable profit distribution purposes. In our view, the Board of Directors should update the dividend policy taking into account the Company’s development strategy, investment yield targets, including return on invested capital, current and projected debt.

*data based on the company’s profits unadjusted for non-controlling equity interests.





ECONOMICS

Management motivation system disclosure practice at international peers of PJSC RusHydro The payment of remuneration and compensations to members of the BoD are governed by employment contracts and an undisclosed regulation on the procedure for the payment of remuneration and compensations to BoD members dated 2010. At all conditional peers, the proportion of long-term remuneration is at least 40% of the total level.

Approximate proportions of CEO remuneration components in 2015

Information on top management shareholdings

Management Board member Rounded-off value of share package as of 09/30/2016

George Rizhinashvili RUB 42 million Boris Bogush RUB 13 million

* for RusHydro, this includes the quarterly and annual remuneration, other companies have no practice of paying quarterly remuneration; ** actual proportion for the recently appointed CEO previously serving at subsidiary (proportion of at least 35% is projected in 2016)

Remuneration components (based on payment forecast, incl. shares)

TransAlta Corpora-tion ENEL E.On PJSC RusHydro

Fixed annual remuneration* 25% 43% 28% 14% Annual bonuses 20% 52% 27% 86% Long-term component 55% 5% (for 2014*) 45% 0%





ECONOMICS

TransAlta Corporation ENEL E.On PJSC RusHydro

Disclosure: all pay-ments, incl. in the form of stock (esti-mates of future payments)

CEO+CFO+3 top managers Actual (CEO): $950K in salary, $763K in cash bonus, $2,090K in long-dated stock.

CEO + managers with strategic responsibilities, in total. Actual (CEO): €1,155K in salary, €1,386K in cash bonus, €147K in long-dated stock (received at sub-sidiaries)

CEO+CFO+5 top managers Actual (CEO): €1,240K in salary, €1,197.5K in cash bonus, €1,965K in long-dated phantom stock

Management Board in total, incl. sole executive body (CEO) Actual: RUB 97 million + RUB 625 million in bonuses (for 5 Management Board members in total, incl. carryover bonus-es from 2014)

KPIs influencing the short-term (annual) remuneration com-ponent

FFO (cash flow from opera-tions) 50%, FCF (free cash flow) 25%. Equipment availability 25% + individual KPIs (multiple). Performance multiple for all KPIs: 2 x base level (90% of salary for CEO, 55% for others)

FFO/ consolidated net debt (up to 40%), consolidated EBITDA (30%), Consolidated spending out of own sources (20%) Reduction in accident rate (10%)

EBITDA, individual KPIs + adjustments for cost of capital, ROACE, compari-son with previous year’s EBITDA and market indi-cators

TSR 10%, ROE 20%, proportion of procurement from SME 10%, reliability (accident rate, equipment availability) 25%, commissioning of facilities and plan of financing and imple-menting investment develop-ment program 25%, financial leverage 10% + integral KPI of LTDP execution (12 KPIs) for additional remuneration

KPIs influencing the long-term remuner-ation

growth of FFO per share, growth of FCF per share, rela-tive TSR to S&P/TSX Composite Index*0.8 (Company’s beta) (1/3 each)

For managers with strategic responsibilities Consolidated EBITDA, EPS, RO-ACE. 2016 plan: Enel vs. average TSR EUROSTOXX Utilities Index (60%), ROACE (40%)

Comparison of average ROACE across a 4-year period with target ROACE set by BoD

N/a

Long-term bonuses Accumulation and calculation period: 3 years. Stock units (2/3 annual +1/3 deferred). Payment at the end of period in shares / money + part of annual salary and bonuses may be converted into de-ferred shares (with a manda-tory accumulation level)

Calculation procedure based on LTI (long-term incentive program) 2016 – calculation period: 4 years starting from 2016, ceiling 144% of salary subject to KPI targets

Calculation procedure based on LTI (phantom stock payment period: 4 years). Remuneration ceiling for all components: no more than 200% of the total target remuneration per year

N/a





ECONOMICS


The Company has approved a concept and regulations on charity and sponsorship. The documents remain undisclosed. No information is available on the Board of Directors’ approaches to generating the budget of expenditure, including the limits of spending.

In 2015, the Company reduced expenses for charity and social programs almost 3 times versus the 2014 level from RUB 1,171 million to RUB 436 million. The difference in expenses is attributable to the one-time financial support of HC Dynamo Moscow (RUB 500 million) and FC Alania (RUB 440 million). No financial support details are disclosed, despite the heavy spending financed by the Company’s profit, among other things. RusHydro Group develops corporate volunteering and supports individual involvement of employees in social projects. The Company carries out char-ity campaigns to raise funds for low-income people, fairs featuring charity foundations, donor days. In 2015, donations by employees of the Compa-ny’s executive office amounted to approximately RUB 0.93 million.

Spending on social programs and charity at RusHydro vs. peers in 2015 (% of consolidated profit) TransAlta (proportion of FCF, loss for

year) ENEL E.On RusHydro

1.11% 1.46% 0.85% 1.45%


Research report on SBERBANK OF RUSSIA

as of 09/30/2016





RESEARCH REPORT ON SBERBANK / 2 RESEARCH LABORATORY FOR BUSINESS



ECONOMICS


52.32%

47.68%


Bank of Russia

Minority shareholders (NSD, shareholdersaccording to register)


The Russian Federation owns the controlling block of shares in Sber-bank Russia through the Bank of Russia (CBR), the effective voting stake (including the stakes of federal subjects and municipal entities) being 52.32%. The Bank has issued 1 billion preferred shares accounting for 4.427% of the authorized capital.

There are no major private shareholders with stakes exceeding 5% or quasi-treasury shares; most of the minority shareholders (45.6% of the authorized capital) are foreign legal entities. Shareholders ac-counting for 67-69.8% of the voting power, including 31-37% of the total number of minority shareholders, participated in the general shareholders meetings (GSMs) in 2015-2016.

The results of voting on the election of Supervisory Board (SB) mem-bers show that the Bank’s minority shareholders elect independent directors by their votes, i.e. by own resources. This opportunity arises from the position of the principal shareholder nominating a limited number of representatives to the SB and distributing its votes among 8 candidates, although, given the current quorum, it could ensure elec-tion of 10 to 11 out of 14 SB members with guaranteed certainty, as-suming minority shareholders’ concerted voting.

The Bank does not disclose details on the shareholders owning 2% of the voting shares in aggregate and nominating candidates to the SB (including independent directors), proposing the CEO and the current Deputy SB Chair.

Corporate governance self-assessment According to the bank’s estimates, Sberbank fully complies with 68, partially with 11 out of 79 recommendations of the 2014 CG Code, one of the best results among the reviewed PJSCs (first-second place).




ECONOMICS


Summary of GC practice +

6 out of the 14 SB members are independent directors (INEDs), only 1 of the 6 INEDs being technically affiliated with the Government and major counterparties. In any case, the Bank has more independent directors than any other company targeted by this research;

new versions of the Charter and by-laws (including regulations governing the management bodies’ activities) incorporating the CGC recommenda-tions were approved at the AGMs in 2015 and 2016;

the Company has complied with the CG Code recommendations to provide for issues subject to consideration only at physical meetings and issues subject to resolution by a qualified majority or a majority vote of the elected SB members in the Charter in relation to most of such issues;

the Bank has a multilevel risk management system; information on the structure and cost of services provided by the Bank’s

external auditor is disclosed; the Bank has established conditions for the development of an independ-

ent internal audit system accountable to the audit committee mostly consisting of independent directors (INEDs);

the Bank discloses its anti-corruption policy and accepts reports on violations, conflicts of interest, etc. via the hotline on the website;

the anti-corruption policy (dated 2014) covers, among other things, actions to be taken when a conflict of interest was detected;

according to the annual report, the HR and Remuneration Committee actively contributes to making the list of candidates to the Supervisory Board (although the related minutes of the meetings are not disclosed).

- no disclosure of specifics of the senior management remuneration

system (proportions of the fixed and variable components, long-term and short-term incentives) and the correlation between the payments for the reporting period and the KPI achievement;

the Supervisory Board’s scope of authority does not cover the appointment and early termination of powers of the President, Chair of the Bank’s Executive Board;

(conditionally negative) the reports on resolutions taken by the SB do not disclose voting results (except for reference to unanimously passed resolutions and 4 cases of voting “abstained” at two SB meet-ings in September 2015) and individual voting by SB members in case of non-unanimous voting;

the shareholders have no powers to call for an SB meeting; no disclosure of details on persons proposing issues to GSM agendas; most of the Audit Commission members are employed by the Bank, no

independent experts; according to statements in the disclosure system, the absentee

voting dates almost always coincide with the dates on which the SB Chair decides to hold such a vote (in separate cases, the voting takes place the following day), the SB meeting procedure remains undis-closed;

the agenda of SB meetings sometimes includes the “Any Other Business” item. The non-disclosure of related details poses a risk of considering essential issues without properly notifying the SB mem-bers.




ECONOMICS


67

77.9 75

33

22.1 25

54.14

31.11 36.63

2014 2015 2016

Proportion of the state in the quorum, %

Proportion of the minority shareholders in the quorum, %

Percentage of the minority shareholders participating in the GSM, %

General shareholders meeting: activity of shareholders, related party transactions According to our review of the shareholders’ participation in the Bank’s GSMs in the last 3 years, the activity of minority shareholders has recently been at a medium level (25% of the quorum, 37% of the total number of minority shareholders in 2016). At the same time, minority shareholders nominate candidates to the Supervisory Board (in 2015 and 2016), most of whom are independent. The ma-jority shareholder, judging by its voting activity (the nomination of and voting for a limited number of representatives) actually welcomes the elec-tion of independent directors. This encouraging treatment enabled minority shareholders to elect 2 independent directors to the Supervisory Board in 2015, even though their candidates were supported by a mere 0.6% of the shareholders entitled to vote. The shareholders approved 1 related party transaction at the AGM in 2015 and one at the AGM in 2016. Both related to directors and officers liability insurance, with a total limit of RUB 37.6 and RUB 50.4 million, respectively. The President, Chair of the Executive Board, is elected for a period of 4 years by the general shareholders meeting which can terminate the Chair’s powers at any time. The current President was elected at the 2015 AGM.




ECONOMICS


Information on the shareholders of Sberbank of Russia, according to Bloomberg data and information disclosure by the shareholders



CENTRAL BANK OF RF 50 Voting policy is not available (not disclosed)

VANGUARD GROUP 1.38

The shareholder discloses its voting policy at shareholder meetings, as well as the actual voting activity in the last corporate season. For the principal funds focused on investments in Russia, the shareholder disclosed non-voting at the Bank’s 2016 AGM. The shareholder does not nominate candidates to Boards of Directors (BoD) / Supervisory Boards, but supports, according to the generally disclosed approaches to voting, the idea of nomi-nating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder receives recommendations from proxy advisory firms.

LAZARD LTD 1.03

The ESG policy disclosed by the shareholder includes, without limitation, approaches to voting. The shareholder receives recommendations from proxy advisory firms. The standard approach assumes that the shareholder takes part in voting and votes for independent directors. At the 2016 GSM, the shareholder voted in the affirm-ative (“FOR”) on all issues, including the election of the Audit Commission, and supported the independent di-rectors: Gennady Melikyan, Alessandro Profumo, Sergei Sinelnikov-Murylev (not elected in 2016) and Nadia Wells. As a rule, the shareholder does not nominate BoD/SB candidates.

JPMORGAN CHASE & CO 0.69

While disclosure by Bloomberg covers the investment business, i.e. asset management or investment manage-ment (the funds under management), the shareholder discloses the voting policy in various regions (including Europe). The voting takes into account recommendations of regional CG Codes. The actual voting data are not disclosed in the interests of clients, but can be provided at the client’s request in the following 7 years. The shareholder usually does not nominate candidates.

NORGES BANK 0.69

The shareholder voted at all AGMs in the last 3 years. In 2016, the shareholder voted in the affirmative (“FOR”) on all issues with a positive recommendation from the management or the SB. In the SB election, the share-holder voted on all the elected INEDs, except for Vladimir Mau, as well as for Sergei Sinelnikov-Murylev who was not elected in 2016. The shareholder discloses its voting policy and voting results. The bank has so far not nominated BoD/SB candidates in Russia, unlike other countries. The shareholder receives recommendations from proxy advisory firms.

BLACKROCK 0.58

The shareholder discloses both global corporate governance principles and regional approaches to voting and engagement with companies. Information on voting in the last corporate season is disclosed. According to the 2016 AGM disclosure, several funds voted, while others stayed passive. Where the funds voted, the voting was in the affirmative (“FOR”) on all issues with a positive recommendation from the management / SB. In the SB election, the shareholder voted on all the elected INEDs, except for Vladimir Mau, as well as for Sergei Sinelni-kov-Murylev who was not elected in 2016. The shareholder does not nominate BoD/SB candidates but can sup-port other shareholders’ proposals if there is certainty about meeting shareholders’ interests in the best way possible.




ECONOMICS



+ materials prepared for GSMs are disclosed in the English and Russian


the materials include a detailed rationale for the Bank’s profit distribution, including the profit earmarked for dividends in accord-ance with the Bank’s approved dividend policy, as well as earnings retained for financing activities under the Bank’s Development Strat-egy until 2018;

the materials include the list of amendments, if any, proposed to the Bank’s Charter, as well as a comparison table with a rationale for such amendments;

the timeframe for proposing agenda items and candidates to the SB and the Audit Commission is increased to 75 days;

the Bank discloses the cost of services provided by the auditor, as well as the auditor selection procedure form. The annual report discloses the structure and cost of services provided by the Bank’s auditor in 2015 (RUB 613.3 million), including the cost of services not related to the audit of annual statements (RUB 367.9 million, or 60%).

- The materials prepared for GSMs:

(conditionally negative) do not include details on the participants in the open competitive auditor selection procedure and the terms pro-posed by them. The search for auditor selection-related documents on the Bank’s website (www.sberbank.ru) requires much effort. In this and other similar cases, our recommendation is that the Bank should provide the exact page location (URL) when referring to the website or make the page easily available without much browsing;

do not disclose details on persons proposing GSM agenda items.

Comment on results of the voting activity at GSMs

Our review of the results of voting at the 2015 AGM has shown that a considerable number of votes cast on the election of SB members (2.839% of the total votes cast) were not included in the vote tally, whether being recognized as invalid or for other reasons. In 2016, the number of such votes decreased substantially to 0.172%. We believe that the errors may have been committed by the minority shareholders instructing their custodians or by the custodians converting the clients’ instructions into ballots. Such cases primarily pose risks for electing independent SB members.




ECONOMICS


Supervisory Board: international and domestic practice

SB activity aspect

HSBC Holdings plc Citigroup Inc. Raiffeisen Bank In-ternational AG

BNP Paribas S.A. Sberbank of Russia

INEDs/total number of SB

members 18/21 14/16 16/16

7 + 2 (according to the Board of Directors’ decision, employ-ees of a controlled entity) of

14

6/14 (Vladimir Mau is recog-nized as an independent

director by a SB resolution)

Participation in meetings of SB and commit-tees in 2015

7 BoD meetings 7 Audit Committee

(AC) meetings Attendance ratio:

100% All meetings held in

the form of joint attendance

20 BoD meetings, 18 AC meetings

attendance ratio >75% All meetings held in the form of joint attendance

6 SB meetings, at-tendance ratio >50% (general disclosure

only); 2 AC meetings, attendance ratio

100% All meetings held in

the form of joint attendance

11 BoD meetings: 3 members missing 1 meeting, 1 member missing 2 meetings, 1 member missing 3 meetings. 12 meetings of committees: 1

non-attendance All meetings held in the form

of joint attendance

50 SB meetings in absentia, 7 physical meetings, 1 SB

member missed 2 meetings (out of 5 meetings held dur-ing the member’s tenure), 1 SB member missed 1 meet-ing, attendance ratio at all

committees: 100%

Remuneration of SB members / actual pay-

ments for 2015

$95K + $45K to senior INED +

$50K/30K, $40K/25K,

$25K/15K to Chair / member of BoD

committee (depending on the

committee). Actual: $99K to

$524K, ca. $200K per per-

son on average

$500K to BoD Chair, $75K to BoD mem-

ber, $50K Audit Committee,

$35K other commit-tees, $25K

for any extra com-mittee.

+ $150K in deferred stock to each BoD

member, Actual: $137-500K

€70K to SB Chair, €60K to Deputy SB

Chair, €50K to SB member.

Actual: €50K–70K

€21 in fixed remuneration + bonuses for meetings:

€3K per BoD member per meeting, €4.4K per out-of-

schedule meeting, €5.7K/2.7K to Chair/member of commit-

tee + €4.2/4K to directors outside France.

Upper limit of €1.3 million for all BoD members. Actual: €43K–90K

Base remuneration (2016): RUB 5.9 million. Uplift fac-

tors: 20% for membership in a committee, 30% to Com-mittee Chair / senior INED,

50% to SB Chair Actual: RUB 59.9 million to

all SB members. Average remuneration paid to 13 SB members: RUB 4.6

million




ECONOMICS



Chairman of the Supervisory Board Sergey Ignatiev (non-executive director) Advisor to the Governor of the Central Bank of Russia, no shareholding in the Bank;

Chairman of the Audit Committee Vladimir Mau (INED); Rector of the Russian Presidential Academy of National Economy and Public Administration (RANEPA), no shareholding in the Bank;

Chairman of the Risk Management Committee Gennady Melikyan (INED) Senior Independent Director, equity position: 0.0001% of the Bank’s ordinary shares (worth RUB 3.1 million as of the research reporting date);

Nadia Wells (INED) Member of the Audit Committee, independent consultant, no share-holding in the Bank;

Alessandro Profumo (INED) Chairman of the Board of Directors, Equita SIM Spa; no shareholding in the Bank;

Esko Tapani Aho (INED) Chairman of the Board of Directors, East Office of the Finnish Indus-tries; no shareholding in the Bank;

Martin Grant Gilman (INED) Advisor to the Rector, NRU HSE, equity position: 0.00019% of the Bank’s ordinary shares. (worth RUB 5.96 million as of the research reporting date)

______________________________________________

The API was unable to agree on a meeting or a conference call with the Bank’s independent directors; we therefore cannot include comments on key corporate gov-ernance issues in this report and present a case study of the SB activity, the internal audit and internal control system, the risk management system and other essential activity aspects as viewed by investors and independent directors.




ECONOMICS


Supervisory Board (SB) For the period under review (2015 and 9 months of 2016), the SB held 111 meetings (5 meetings per month an average), including 14 physical meetings. The SB considered 213 issues, more than half of them (131) concerned related party transactions for a total amount of over RUB 7.8 trillion, $1,825 million and €486 million. Resolutions to approve related party transactions are generally accepted at meetings held in absentia.

In the period under review, the SB considered the following essential issues: quarterly, annual and other periodic performance reports (8 is-

sues); Internal Audit Service-related matters (activity plan, results of

inspections, regulation of activities, 5 issues in total); risk management-related issues, including the methodology,

strategy and reports on compliance with risk appetite standards (5 issues);

staff remuneration policies (3 issues); governance model development priorities at Sberbank (3 issues); current implementation progress and update of the objectives

set out in the Development Strategy of Sberbank (1 issue).

The Supervisory Board regularly evaluates its activities, considers related performance results, the plan of implementing recommenda-tions.

The lack of opportunity to meet with independent directors prevents the coverage of the following Supervisory Board activity aspects:

- SB working principles for considering related party transactions (taking into account their volume and cost); - procedure for consideration by the SB of key performance indicators and their correlation with the remuneration paid to the Bank’s senior management;

- the SB’s approaches to shaping the Bank’s development strategy, the use of benchmarks in planning and evaluating the management team’s performance, etc.; - voting at SB meetings (working principles in case of non-unanimous voting of SB members); - access to information, working principles of SB committees, etc.

Audit Committee (AC) Three of the five AC members, including the Chairman, are independ-ent directors. The powers vested in the Committee are typical of simi-lar bodies, as provided for by CG Code recommendations and the in-ternational practice, including control over procedures ensuring com-pliance with legal requirements, ethical rules, regulations and proce-dures of the Bank, requirements of stock exchanges and requirements for combating fraud committed by the Company’s employees and third parties, ensuring the independence and impartiality of external and internal audits.

In 2015, the AC held 4 meetings, all of them in the form of joint at-tendance (a case of good practice), considered 11 issues.

HR and Remuneration Committee (HRRC) Two of the three HRRC members (not including the Chairman) are in-dependent. The Committee has the standard scope of authority meet-ing the international practice and the CG Code recommendations.

In 2015, the HRRC held 6 meetings, including only 1 meeting in absen-tia (a good practice), considered 12 issues, including the shareholders’ proposals for candidates to the SB and for the sole executive body (SEB) position, drawing up of the list of candidates for the GSM, the results of self-assessment by the SB and its committees (no disclo-sure) and an independent evaluation of the SB performance in 2015.

RESEARCH REPORT ON SBERBANK / 10 Association of Institutional Investors (API)




ECONOMICS

Essential CG aspects External auditor At the 2016 AGM, the shareholders approved JSC Pricewaterhouse-Coopers Audit as the auditor for 2016 and Q1 2017 (the cost of services is RUB 52.5 million; the cost of non-audit services, if any, are not dis-closed; in 2015, non-audit consulting services accounted for 26% of the total fee paid to the auditor, Ernst & Young LLC). The role of the AC in the auditor selection is consistent with the CG Code recommendations, the generally accepted practice and the Company’s documents.

Internal audit, internal control, risk management The Company discloses the code of corporate ethics, the internal audit regulations, the regulation on the internal control system, the risk and capital strategy, the anti-corruption policy, the conflict of inter-est management policy, the regulation on major transactions and related-party transactions – a progressive approach to disclosure in terms of completeness. The Company has an effective multi-level in-ternal audit, internal control and risk management system (including compliance control), as well as a dedicated Risk Management Commit-tee of the Supervisory Board. The powers and accountability of the AC and the Internal Audit Ser-vice comply with the CG Code recommendations (except for the SB’s power to approve the Internal Audit Service’s budget).

No information is available in the Bank’s reports on the consideration by the SB / AC in 2015 of the performance evaluation of the system for reporting compliance with ethical standards, infringements and illegal actions (information of anti-corruption relevance is delivered to the Bank’s Compliance Department and Compliance Committee). These issues were probably covered in the general report of the In-ternal Audit Service and the list of risk management system devel-opment issues.

The Executive Board’s Compliance Committee is authorized to take current decisions aimed at the settlement of conflicts of interest. In 2015, the Bank conducted a mass staff training on the management of conflicts of interest and anti-corruption practices. The Company’s website contains the phone numbers and postal address of the Bank’s internal security department for reporting corruption offences com-mitted by employees, the use of insider information, and conflicts of interest, as well as a form for sending a message to the Compliance Department. Dividend policy The Bank’s Regulation on Dividend Policy dated 2015 does not provide for an obligation to aim at paying a certain proportion of Sberbank Group’s IFRS or RAS (Russian GAAP) profit taking into account statuto-ry capital requirements. At the same time, the Policy directly refers to the Bank’s Development Strategy until 2018, which provides for the Bank’s intent to earmark 20% of the group’s IFRS net profit for divi-dends. The Bank has also declared commitment to paying equal divi-dends on ordinary and preferred shares subject to a number of condi-tions, including the availability of net profit according to consolidated IFRS statements, the capital needs for implementing the Development Strategy, the macroeconomic environment, the balance between the Bank’s interests (including its investment appeal) and the interests and rights of its shareholders, etc. The application by the SB of benchmarks for profit distribution purposes is not disclosed. In 2016, the dividend payout ratio at the Bank was higher than at some of the peers but lower than at others (see below):

RESEARCH REPORT ON SBERBANK / 11 Association of Institutional Investors (API)




ECONOMICS

HSBC Holdings plc Citigroup Inc. Raiffeisen Bank Interna-tional AG

BNP Paribas S.A. Sberbank of Russia (IFRS)

Sberbank of Russia (RAS)

75.2% 7.3% 13.3% 42.9% 19.9% 20.4%

Charity and social responsibility In 2015, the Bank’s expenses for charity and sponsorship amounted to RUB 3,280 million, a 80% increase against the 2014 level). Assistance to chil-dren’s institutions, sports, culture, education, veterans and physically challenged people accounted for 70% of the total expenses. The relative spend-ing on charity and social projects versus peer banks is provided below:

HSBC Holdings plc Citigroup Inc. Raiffeisen Bank Interna-tional AG

BNP Paribas S.A. Sberbank of Russia (IFRS)

Sberbank of Russia (RAS)

1.36% 0.45% 0.79% 0.58% 1.47% 1.50%

Long-term management motivation The long-term incentive program for top executives (dated 2015) meets the Bank of Russia’s requirements for the remuneration pay-ment systems at Russian credit institutions; furthermore, its parame-ters are close to the international practice, which is not common with the PJSCs under review: 40% of the variable annual compensation is paid in annual install-ments over a period of 3 years. If the Bank’s posts a loss for any of the 3 years following the year of entitlement to payments, the partic-

ipant loses the right to remuneration for each such year. The partici-pant can also be partially or completely disqualified from payments if unable to perform official duties, or dismissed for that reason, or per-sonally making a negative contribution to the Bank’s performance. In 2015, the amount of remuneration under the Program was RUB 600 million. The compensation is subject to revaluation as of each report-ing date based on the average price of the Bank’s ordinary shares for the preceding 6 months.

Disclosure of information on shareholdings of the Bank’s Executive Board (5 largest shareholdings) as of 09/30/2016

Executive Board member Rounded-off value of shareholding Herman Gref RUB 94 million

Alexander Bazarov RUB 72 million Alexander Morozov RUB 45 million

Lev Khasis RUB 41 million Bella Zlatkis RUB 16 million




ECONOMICS


Disclosure of the management motivation system at international peers Approximate proportions of CEO remuneration components in 2015 (including shares)

In 2015, the 12 members of the Bank’s Executive Board received RUB 640 million in salaries and RUB 1,850 million in annual and quarterly bonuses.

HSBC Holdings plc Citigroup Inc. Raiffeisen Bank Inter-national AG

BNP Paribas S.A. Sberbank of Russia

Fixed remuneration (salaries) 48% 10% 75% 35% 26%

Annual bonuses (also, quarterly bo-nuses at Sberbank)

26% 41% 25% 55% 74%*

Long-term remuneration 26% 49% 0% 10% n/a


BNP Paribas S.A. Sberbank of Russia *

Disclosure of payments

CEO/CFO/COO/CRO CEO: £1,250K in salaries;

£1,700K in fixed supplement in the form of immediately dis-tributed shares (obligation to

hold shares for 5 years). £1,072K in bonuses, £1,969K in

long-term remuneration in the form of shares

CEO/CFO + 3 heads of busi-ness segments

CEO: $1,500K in salaries, $6,000K in bonuses. Long-

term remuneration: $4,500K in deferred shares,

$4,500K in Performance Share Units

All Managing Board members CEO: €1,108K in

salaries, €364K in bonuses

CEO, CFO CEO: €1,250K in sala-

ries, €1,950K in bonus-es.

Long-term remunera-tion in the form of

shares: €340K

Collective executive body in aggregate (12 members in total), in-

cluding the sole execu-tive body.

Actual: RUB 643.3 million in salaries, RUB 1,675 million in annual and quarterly bonuses.

KPIs influenc-ing the short-term (annual) variable remu-neration com-ponent (incl. the fixed rela-tive weight of the KPI, if any)

Pre-tax profit 15%, ROE 15%, marginal operating profit 15%, increase in dividend payments 15%, successful implementa-tion of strategy 15%, meeting standards, including risk man-agement and compliance 25%; observance of the HSBC Val-

ues policy: yes/no

Cost efficiency, net earn-ings attributable to share-

holders, ROA, RCE, 12-month TSR, 3-year cumula-tive TSR vs. 8 peers + Bal-anced Scorecard (case for CEO): earnings from cur-

rent operations, cost effi-ciency across the Group, RTCE (Return on Tangible Common Equity), Core Re-turn on Assets, excess in

Risk Appetite Ratio

No disclosure Changes in EPS 37.5%, gross operating profit

37.5%, qualitative estimates 25%: deci-sion-making; quality of governance; a case of observance of ethi-cal and social respon-

sibility standards; other KPIs subject to a decision by HR & Re-muneration Commit-

tee.

A system of balanced KPIs: financial, non-financial, individual

and collective (team-specific) KPIs, no dis-

closure




ECONOMICS


* this probably includes the participation of Executive Board members in the long-term remuneration program (no disclosure in the Bank’s reports)


BNP Paribas S.A. Sberbank of Russia *

KPIs influenc-ing the long-term variable remuneration

Financial KPIs: 60% (relative TSR 33.3%, ROE 33.3%, cost

efficiency 33.3%), KPIs associated with the

achievement of risk and strat-egy implementation targets:

40%

See above + TSR-based adjustment for shares;

target value is compared with median value at peers

for 3 years

(Program termi-nated because of regulation, 60%

of the shares are distributed)

ROE, higher TSR compared with that of peers

included in the DJ EURO STOXX

Banks index over a period of 5

years

Annual stock price growth for 5 years

compared with initial price, discount for stock price growth rate vs. the EURO

STOXX Banks index

Positive profit earned by the Bank in each year of the Program. Payment based on stock price for the past 6 months. In addi-tion to the KPIs men-tioned in this report, the Bank applies a risk materialization ac-counting system. Long-term remunera-tion is only paid if none of the material-ized risks (if any) ex-ceeds the established materiality threshold. Long-term remunera-tion system principles are described in the Staffing Policy dis-closed by the Bank.

Long-term bonuses

Shares: at least 50% of the total long-term remuneration)

Payment period: 3 years

Deferred shares (50%) + phantom shares (50%) (a total of 60% of annual

bonus) + option (expired). Payment period: 4 and 3

years

Not available Money Payment period: 5

years

Since 2015, 40% of the variable remuneration has been deferred for 3 years, paid in annual

installments

RESEARCH REPORT ON PJSC TRANSNEFT / 1 RESEARCH LABORATORY FOR BUSINESS



OF ECONOMICS

Association of institutional investors (API)

Research report on PJSC TRANSNEFT

as of 09/30/2016





RESEARCH REPORT ON PJSC TRANSNEFT / 2 Association of Institutional Investors (API)




ECONOMICS

78.11%

21.89%


Government of Russia (100% of ordinary shares)

Russian and international investors (100% of preferredshares)


The capital structure assumes that the Company’s is under full control of the state: decisions are taken by the sole shareholder, require-ments for the preparation and holding of shareholders’ meetings are not applicable except for the AGM timing requirement.

The Company has always paid dividends on preferred shares; accord-ingly, minority shareholders have never received voting rights.

The Company’s management does not regard the holders of preferred shares as minority shareholders, which is a fundamental problem det-rimental to the Company’s investment appeal1.


In 2015, according to self-assessment, the Company complied with a mere 32 (40%), partially complied with 33 (41.7%), failed to comply with 14 (17.7%) of the 79 principles and recommendations set forth in the Russian Corporate Governance Code (CG Code). This is one of the worst proportions among the PJSCs under review. A significant part of the requirements the Company fails to meet are related to the holding of GSMs, although there are also substantive issues.

1 The following quotation is taken from the President’s speech (2015): “We have one shareholder, the state. No minority shareholders. There are preferred sharehold-ers indeed, but they are called this conventionally, you know. They are no shareholders as a matter of fact.”





ECONOMICS


+ Proceeding from the disclosure of issues under consideration, the BoD

exercises its powers to the full extent. The involvement of BoD members is not disclosed. According to one of the BoD members, the current BoD composition is sustainable and does not require additional expert ap-praisal;

the BoD pays considerable attention to the long-term development program (LTDP): at least 7 of the 11 LTDP-related issues considered in the period under review were matters of substance;

The Audit Committee (AC): - is historically directly involved in the open competitive selection of ex-ternal auditors (the related information remains undisclosed, but a BoD member mentioned this practice in the survey); - has the right to engage independent consultants/experts and to re-quest (even if through the management team) documents and infor-mation from the Company’s divisions and subsidiaries;

Essential terms of related party transactions considered by the BoD are disclosed, information on such transactions is included in the Company’s annual reports (a good practice);

according to the Company’s Articles of Association, decision-making on most of the significant issues of the Company’s activity recommended by the CG Code requires a majority vote of the elected BoD members;

the Articles of Association vest the BoD with powers as regards large shareholdings, i.e. companies in which Transneft’s interest exceeds 20%, including approval of the sole executive body, formulation of a position on the restructuring/liquidation, approval of transactions, divestiture of shares;

the principal shareholder approved amendments to the Articles (after the reporting date of this study), providing for a fair approach to the pay-ment of dividends on preferred shares which cannot be below the amount of dividends paid on ordinary shares. This should certainly be regarded as an improvement.

- the dividend policy approved by the BoD for the first time in Decem-

ber 2016 (after the reporting date of this study), in our view, does not fully meet the interests of shareholders and the principal sharehold-er’s requirements/recommendations, contains a number of internal contradictions;

there are only two INEDs on the BoD (1 of them is recognized by the BoD as an independent director);

the Articles of Association do not vest the BoD with the power to determine the remuneration payable to the head of the internal audit division and to approve the budget of this division;

the CG Code recommendations concerning the issues to be only addressed at physical meetings are followed in relation to 4 out of 19 issues, with a remark about predominantly physical meetings;

the independent internal audit (IA) system is at an early stage of development (after the reporting date, the BoD approved the general guidelines (the plan) and the head of the IA division;

the following information is not disclosed: – BoD members’ participation in meetings of the BoD and its com-

mittees; – remuneration payable to each of the BoD members; – top management remuneration system (the proportions between

the of fixed and variable components, the long-term and short-term incentives), the correlation between the payments for the reporting period and the KPI achievement;

the Company does not disclose the anti-corruption policy-related documents, the abuse prevention practices (in annual reports), includ-ing the “hot line” performance and the role of the AC;

no rules or standards for preventing or handling a conflict of interest; the charity expenses are commensurate with dividends (in 2015, the

ratio of charity expenses to dividends was 63%); the BoD remuneration system is not in line with the CG Code recom-

mendations.




OF ECONOMICS

Association of institutional investors (API)


Chairman of the Board of Directors Alexander Novak (representing the Russian Federation), Minister of Energy of the Rus-sian Federation, no equity stake in the Company;

Chairman of the Strategy, Investment and Innovation Committee Mikhail Grishankov (independent director*), Deputy Chairman for relations with the Gov-ernment of Russia, JSC KTK-R, no equity stake in the Company

Chairman of the Audit Committee Ilya Klebanov (INED) Chairman of the Board of Directors, PAO Sovcomflot, no equity stake in the Company

Chairman of the Personnel and Remuneration Committee Ilya Klebanov (INED) Chairman of the Board of Directors, PAO Sovcomflot, no equity stake in the Company

_______________________________________________________________ * The API met with the Chairman of the Strategy, Investment and Innovation Committee who qualified as an independent director until 2016 when he joined the Company’s competitor JSC KTK-R (as disclosed by the Company). Subject to a decision of the Board of Directors, he was recognized as an independent director (after the reporting date). We were not able to meet with the other INEDs. We appreciate the BoD member’s participation in the interview and believe that such annual meetings with the Company’s investors and shareholders are extremely useful for assessing the BoD performance, among other things. It should be noted that Mr. Grishankov confirmed his readiness to hold such meetings annually.





ECONOMICS

Board of Directors: international and domestic practice BoD activity as-

pect Enbridge Inc. TransCanada Corporation

Sunoco Logistics Part-ners LP

PJSC Transneft

INEDs/total num-ber of members

10/11 11/12 4/8 Among the 8 BoD members, 3 INEDs were elected at 2016 AGM, currently 2/7*

Number of BoD meetings and committee meet-ings, attendance in 2015

BoD: 9 meetings, Audit Committee 4

meetings, HR & Com-pensation Committee

6 meetings 100% attendance in

all cases

BoD 10 meetings, 1 BoD member missed 3 meetings, 3 BoD members

missed 1 meeting each; Audit Committee: 5 meetings, 1 non-attendance; HR Committee: 3 meet-

ings, 2 cases of non-attendance, Conflicts Committee: 5 meetings, 1 non-attendance, otherwise 100%.

BoD 5 meetings, Audit Committee 4 meetings, Compensation Commit-

tee 3 meetings, Con-flicts Committee 4

meetings No attendance data

are disclosed

BoD: 32 meetings (6 physical meetings), Audit Committee: 8 meetings (4 in pre-sentia), Personnel and Remuneration

Committee 5 meetings (1 in presentia) ; no attendance data are disclosed

Remuneration of BoD members / actual payments based on 2015 performance

$235K in base remu-neration + bonus

payment of $260K to BoD Chair, $10-25K to

Chairs of commit-tees. At least 50% in

deferred stock. Actual: $230-340K to BoD members, $507K

to BoD Chair

C$70K in base remuneration + C$110K in deferred phantom stock

units. C$201K + C$291K to BoD Chair, C$5.5K additionally payable to committee members, C$12-20K to committee

chairs + C$1.5K per BoD member per meeting.

Median payments at peers taken account of for calculation purposes. Actual: C$227K-238K to BoD mem-

bers, C$535K to Chair

Base remuneration of INEDs (others are not

entitled to any) $50K + $15K/7.5K for

chairmanship of AC/CC + $10K/5K to AC/CC members + $1.2K per

AC/CC meeting + $100K in deferred units under

a long-term motiva-tion program.

Actual: $128K-212K

Base remuneration: RUB 1 million + 0.025% of consolidated net profit, ad-justed for KPI achievement (ROE, divi-dends, cost reduction, amount of R&D financing, share of procurement from

SME) + additional payments (50% to BoD Chair, 20% to chairs of Committees, 10%

for membership in each committee. Actual payments in 2015 based on 2014 performance: RUB 39.6 million to BoD members (8 directors, including public servants not entitled to remuneration, individual payments are not disclosed),

which is equal to $608K proceeding from the exchange rate of 1 USD = RUB 65.12.

* In our view, after independent BoD member Chilingarov suspended his activity as a BoD member (even though he officially maintains the BoD member status as individual termination of BoD membership is contrary to the Russian legislation), the Company has only one independent director meeting the independence criteria of the Moscow Exchange Listing Rules and one director not fully complying with these criteria but recognized as an independent director by a resolution of the Board of Directors.

The fixed part of the remuneration payable to BoD members of Transneft is several times below the fixed remuneration paid by conditional peers. The variable remuneration is subject to operational KPIs and performance targets. For example, the dividend KPI achievement is assessed in terms of equivalence between the dividends recommended for payment to the shareholders and the target level approved by the BoD. In international prac-tice, such approaches are not applicable. The Company does not disclose the KPI calculation method or the comparison between the target and actual KPIs. The procedure for adjusting the variable remuneration components is subject to approval by the Management Board, which is unacceptable in terms of good corporate governance.





ECONOMICS

Board of Directors: practical activity aspects In the period under review (2015 and 9 months of 2016), the BoD held 48 meetings addressing 135 issues. The material facts disclosed by the Company do not contain information on the format of the meetings and the individual voting by BoD members. According to the 2015 an-nual report, only 6 out of 32 meetings were held in the form of joint attendance, but, according to a BoD member, all important issues were addressed at physical meetings. Related party transactions accounted for 10% of the issues consid-ered by the BoD. Their total amount reached RUB 973 million (the spe-cific amounts of transactions are not always disclosed, but the mate-rial terms of most of such transactions are disclosed even if not in-cluded in the main body of the contracts). In the said period, the BoD addressed the following essential groups of issues:

long-term development program and related matters: 11 issues (the BoD pays considerable attention to this aspect; according to the BoD member, Transneft has the best long-term development program among state-owned corporations);

key performance indicators: 6 issues (the BoD does not follow the practice of approving adjustments to KPIs one month before the re-porting date / one quarter before the end of the reporting period, although the issue “On the KPIs of the business activities of PJSC Transneft” was addressed on December 23, 2015, according to the dis-closure system, without indication of the period the issue refers to);

budget for the financial year/adjustment: 3 issues; charity: 4 issues, one of them being “Optimization and cost efficiency

improvement”; risk management: 3 issues, one of them, “Currency and interest risk

management policy”, was considered in June 2016 based, among other things, on a discussion of losses from hedging;

internal audit: 1 issue (approval of the Internal Audit Regulations in November 2015).

System-relevant issues of senior management and staff remuneration were considered as two agenda items at a meeting in January 2016, the changes, if any, to the system of remuneration are not disclosed. The Company has no long-term motivation system and, according to a BoD member, the related issue was not raised at BoD meetings. The corporate documents allow BoD members to express a dissenting opinion on the issues considered, and if expressed, such an opinion should be included in and attached to the minutes; the BoD members did not exercise this right in the period under review (2015 and 9 months of 2016). There is no practice of BoD members voting “against” or “abstained”: the only negative vote was cast in the period under review on the Company’s participation in nonprofit partnership Russian International Affairs Council; who precisely voted in the negative was not disclosed. Our recommendation is to adopt the practice of disclos-ing the voting by BoD members and their meeting attendance (whether indicating their presence or providing expressions in writing) which increases transparency of BoD members’ activities. The system of BoD members’ remuneration contradicts the CG Code recommendations and the best practices, creates a potential conflict of interests by making payments to BoD members dependent on annual operating performance indicators, most of which are primarily under the management’s control. However, the BoD, according to its member, is comfortable with the current state of affairs and has not called for changes. We recommend that the Company’s policy be brought into line with the general practice. According to a BoD member, the Company applies benchmarks when discussing both KPIs and the corporate strategy; moreover, the BoD and the Audit Committee actually commissioned a review of compara-tive parameters (the list of which is not precisely defined and not dis-closed, no information disclosure in reporting documents either); the review was carried out by a Big Four audit firm. No benchmark was applied to the remuneration system, as far as we understand.





ECONOMICS

Audit Committee

The Audit Committee consists of 2 independent directors. The in-ternal audit division is not accountable to the BoD; the approval of the appointment / dismissal and remuneration of the head of division, its budget and activity plan are not properly regulated. In 2015, the Audit Committee held 4 physical meetings and 4 meetings in absentia, mainly addressing external audit issues.

Personnel and Remuneration Committee The Committee consists of 2 members, its Chairman is an inde-pendent director. In 2015, 5 meetings were held in absentia and only 1 in the form of joint attendance. In October 2015, the Committee considered an objective assessment of the BoD members and formulated proposals to the shareholder for candidates to the Board of Directors (the consideration procedure is not disclosed).

Essential CG aspects Dividend policy

The Company disclosed the dividend policy for the first time in December 2016. Transneft is the last among the state-owned companies covered by this research to approve such a document by the Board of Directors (after the reporting date of the research). The dividend policy analysis shows that the approved document needs to be refined:

the normalized consolidated IFRS profit indicator used by the Company is not adjusted for the share in profits of affiliated and jointly controlled companies, the income from financial investment revaluation, the positive balance of exchange rate differences and other non-recurring cash compo-nents of net profit. Under this approach, it is fair that the Company also disregards the paper losses from revaluation, the negative balance of ex-change rate differences and other non-recurring cash components reducing the profit for distribution;

the amount of dividends is limited to 25% of the proposed normalized profit (i.e. less than 25% of the IFRS net profit). In our opinion, subject to the benchmark and the Government of Russia’s decision on 2015 dividends, the Board of Directors should opt for a more ambitious dividend payout ratio of at least 50% of the IFRS profit, with real values of respective adjustment factors used in the dividend policy;

the proposed adjustment factors (for payment limitation purposes) almost similar to the dividend policy of Aeroflot – Russian Airlines are considera-bly over- or underestimated (depending on the factor) resulting in an understated ratio of dividends to net IFRS profit (payout ratio). The BoD is rec-ommended to consider adjusting the factors using the benchmark, among other things.

The Company’s current dividend distribution policy is actually based on the leftover principle without taking into account the total ROIC ratio and the rate of return on investment projects (the policy does not contain a description of the approach to financing investment projects out of profits proceeding from the rate of return);

the dividend policy does not provide for the payment of interim dividends. In our view, the BoD has all powers and full capacity to make appropriate proposals / recommendations to the shareholders as regards amending the Articles of Association and to stay committed to eliminating the above-stated weaknesses in the dividend policy.





ECONOMICS

Dividend payout ratio at Transneft vs. conditional peers

million US dollars ($), million C$, million rubles

Enbridge Inc.

(USGAAP, adjusted) TransCanada Corporation

(USGAAP) SUNOCO LOGISTICS PART-

NERS L.P. (USGAAP) Transneft (IFRS)

Net profit 1,866 -1,140 395 143,378

Dividends for 2015 1,596 1,538 689 12,801

Dividend payout ratio (share of profit)

86% not applicable 174% 9%

Risk management, internal audit

The Company’s risk management activities as regards currency and interest risk management can be regarded as ineffective. In 2015, PJSC Transneft created provisions in the amount of RUB 19.8 billion against the loss of the Group’s cash funds deposited with banking institutions which forfeited their general banking licenses (Vneshprombank and Bank Intercommerz). In 2014-2015, this policy resulted in substantial losses from currency hedging operations (more than RUB 80 billion) in relation to transactions effected in 2013-2014. As far as we under-stand, the Company probably did not envisage any limits on losses under strong volatility scenarios. According to the 2015 annual report, the related policy was not considered by the AC in 2015.

However, on June 29, 2016, the BoD approved the currency and inter-est risk management policy of PJSC Transneft: according to the BoD member, the changes were made factoring in the Company’s losses, among other things. As regards the internal audit system, the BoD approved an internal audit regulation which remains undisclosed. After the reporting date (09/30/2016), the BoD approved the general guidelines (the plan) and the head of the IA division. The interview of the BoD member also confirms that BoD has started following the generally accepted inter-nal audit practice assuming, among others, related reports. How the IA division actually interacts with the Audit Committee will be clear after the first year of activity in the new format. The activity report-ing procedure is not formalized.

External auditor

Just as in previous years, PJSC Transneft chose JSC KPMG as the audi-tor for 2016. The cost of services amounted to RUB 34.5 million for the audit in 2015 and Q1 2016, RUB 27.5 million (77.5% of the initial bid price) for the audit in 2016 and a review of the interim consolidated IFRS financial statements for Q1 2017. KPMG was engaged to audit the implementation of the long-term development program in 2014.

According to the BoD member, the auditor selection procedure is properly formalized and involves the Audit Committee on a mandato-ry basis. The annual report provides information on the consideration by the Committee of competition-specific issues. We support and wel-come this practice.




ECONOMICS


Charity and social responsibility

In 2015, the charity projects cost the Company and the Group a total of RUB 8.1 billion (63% of the RAS net profit or the 2015 dividends, 5.6% of the IFRS net profit; for reference, the peers’ charity spending is as follows: C$7.54 million at TransCanada (0.4% of the 2014 net earnings), C$19 million at Enbridge (1% of the adjusted net profit). In 2015, the Company and the Group’s entities spent a total of RUB 97.4 million for the sponsorship of social-ly important events.

Seeing as the charity spending is commensurate with the dividends distributed by the Company (for example, the charity expenses in 2015 in relation to the 2015 dividends), it is advisable that the Company disclose approaches to setting limits on such expenses taking into account the financial and operating results.


The mandatory disclosure by the Company generally meets the applicable requirements and, in certain aspects, even complies with the best practic-es (particularly concerning related party transactions, except for a few of them). However, the Company does not disclose information on a number of CG-relevant issues:

1. individual voting by BoD members and their participation in meetings of the BoD and its committees;

2. the format of each meeting (only the total number of meetings in each format is specified in annual reports);

3. approaches to the distribution of charity expenses, including a system of applicable limits and exact amounts in absolute terms for each item;

4. system of remuneration of BoD directors and senior managers (the proportions between the monthly/quarterly, fixed and variable compo-nents), the correlation between the remuneration and the KPI achievement (including the actual and target payments).

The Company’s Board of Directors certainly can and should consider approaches to disclosing this information as part of their responsibility for the CG system transparency.

Disclosure of information on the management remuneration system compared with international (conditional) peers of PJSC Transneft

Transneft: the total amount of remuneration paid to the Management Board (10 members) based on the 2015 performance is RUB 779.5 million. No information is disclosed for 2014. The Company does not provide long-term incentives which account for more than 50% at foreign peers.

Approximate proportions of CEO remuneration components (based on forecast, incl. shares) at Transneft vs. peers in 2015

Enbridge Inc. TransCanada Cor-poration

Sunoco Pipeline Partners LP

Transneft (estimated)



Long-term component 58% 66% 74% 0%





ECONOMICS

The following target KPIs are disclosed in Transneft’s the 2015 annual report: accident rate, emissions, reduction in expenses/energy consumption, labor productivity; implementation of plans: financing of investment programs, capex reduction, delivery time for investment projects, pipe replace-ment plans, construction and renovation; financing of innovations/R&D, intellectual property (results of intellectual activity) for the 3-year period; commercialization of innovations; quality of the investment development program; debt/EBITDA ratio; ROIC; dividends; percentage of procurement from SMEs. The correlation between these KPIs and the remuneration is not disclosed.

Some of the above-stated KPIs (including dividends) are beyond the management’s control. The peers prefer a fairer KPI of earnings per share (EPS). Priority is given to non-financial KPIs (the assumption is based on the number of disclosed KPIs absent disclosure of their relative weights)

Enbridge Inc. TransCanada Corp. Sunoco Pipeline LP

Disclosure: all payments, incl. in the form of stock, estimate of future pay-ments

CEO+CFO+3 top managers Actual: $7.15 million to CEO, including $1.24 million in salaries, $1.75 million in bonuses, $4.15 million in phantom stock and options. Other senior managers: $2.1-2.7 million.

CEO+CFO+3 top managers Actual: C$ 1.3 million to CEO, C$1.56 million in bonus, C$2.8 million in restricted stock units, C$2.8 million in options. Other managers: C$2-4.7 million.

CEO+CFO+4 top managers. Base salary is somewhat below market median value. Actual: $5.7 million to CEO, $1.2-1.4 million to others

KPIs influencing the short-term (annual) variable remuneration component, (incl. the fixed relative weight of the KPI)

60%: EPS adjusted for industry peers and TSX Com-posite index factoring in the growth of DPS, TSR and risk-adjusted TSR for 1,3,5 and 10 years; 20%: KPI of business units (security, adjusted earn-ings, FCF, expenses, relations with consumers and shareholders, implementation of individual plans and staff development); 20%: individual KPIs (undis-closed).

General corporate factor (application is not dis-closed): EPS and income from operations 20%, industrial safety and economic security 10%, business value maximization 20%, implementation of projects 20%, portfolio of new projects 15% investment program implementation 15%

Comparison with target EBITDA value (75% for the Group, 25% for the busi-ness unit / division)

KPIs influencing the long-term variable remu-neration

Deferred units (phantom units linked to stock price, calculation period 3 years): KPI adjusted EPS growth in relation to reference value (relative weight 50%), P/E versus peers (50%); KPI for options: achievement of 3 stock price targets in succession over a period of 6.5 years. No data on incentive options available.

Program of deferred units (phantom stock, calcula-tion period 3 years). KPIs (rel. weight): 50% EPS, 25% TSR vs. S&P/TSX 60, 25% TSR vs. Peers + adjustment for ratio of accumulated 3-year dividends to accu-mulated 3-year EPS from operations (target per-centage: 50%).

Undisclosed

Long-term bo-nuses

Options awarded for achieving targets (accumulation period 5 years + exercise period 3 years) and incen-tive options (accumulation period 4 years + exercise period 6 years)

Program of deferred units (payment period 3 years), with share options (accumulation period 3 years, 1/3 per year, exercise period 7 years)

Program of deferred re-stricted units (in replace-ment of shares) 60% in 3rd year + 40% in 5th year


Research report on FGC UES, PJSC

as of 09/30/2016




SCHOOL OF ECONOMICS

RESEARCH REPORT ON FGC UES, PJSC / 2 Association of Institutional Investors (API)




ECONOMICS

80.13%

0.59% 1.08% 18.21%


PJSC ROSSETI

Russia's Federal Agency for State Property Management(Rosimushchestvo)Quasi-treasury shares

Private minority shareholders (free float)

Brief capital structure overview In 2008-2014, the Company floated 5 additional issues of ordinary shares with the same nominal value but different placement prices, with the result that the total number of shares increased by 10.5% in relation to the number of shares at the moment of incorporation.

Quasi-treasury shares owned by FGC – Asset Management LLC account for 1.0769% of the share capital. The direct stake of Rosimushchestvo is 0.59%. PJSC ROSSETI and Rosimushchestvo have agreed on the pro-cedure for managing and voting the shares owned by ROSSETI. Under the agreement, ROSSETI votes at AGMs as instructed by the Govern-ment and elects both representatives of Russia and independent di-rectors to the BoD. 8 of the 11 current BoD members are obliged to follow the Government of Russia’s voting instructions.

The Company has 2 global depositary receipt (GDR) programs (the combined possible limit of the program is 22.54% of the authorized capital, the actual GDR program volume as of 09/30/2016 was ca. 0.0644% of the authorized capital), the GDR/share ratio being 1:500.

The combined share of minority shareholders in the share capital (in-cluding physical persons) is 18.2%. The annual quorum reaching 90%, minority shareholders, with due consolidation, can theoretically elect at least 1 candidate to the Board of Directors with their votes.

Corporate governance self-assessment According to the results of corporate governance (CG) quality self-assessment in 2015 (disclosure is based on Rosimushchestvo’s proce-dure dated 2014), the average compliance with the principles and rec-ommendations is 82% (from 74% and 79% for the BoD and executive bodies to 94% for risk management, internal control and audit). The Company complied with 51, partially complied with 21, failed to comply with 6 out of the 78 CG principles provided in the 2015 annual report.





ECONOMICS


the Company partially discloses relative KPI weights, the information on target and achieved KPIs and, separately, the sole executive body’s (CEO) remuneration broken down into salaries and bonuses (the best practice among the companies covered by the research; adding relative weights of all KPIs, including disclosure of the procedure for calculating the remu-neration and components of the quarterly/annual and long-term remu-neration, would enable the Company to meet the best international prac-tices);

the Audit Committee and the HR & Remuneration Committee are entirely composed of independent directors; the independent directors formally meet the CG Code independence criteria;

documents on the internal audit system, internal control organization, anti-corruption policy, as well as detailed procurement guidelines are disclosed on the Company’s website;

the Company discloses minutes of BoD meetings, including individual voting by BoD members; its reports on BoD resolutions included in the disclosure system provide individual voting data (a case of best practice), but do not disclose BoD members’ dissenting opinions, if any, including issues related to GSMs. The Company discloses material terms of related party transactions (parties, amount/limits, party in interest, etc.);

the Audit Committee is vested with broad powers; extensive authority of the BoD in relation to internal audit matters,

including the approval of the internal audit division’s budget; the BoD is vested with powers to determine positions of the Company’s

representatives in the management bodies of subsidiaries; extended authority of the BoD in relation to a number of transactions

qualifying as major transactions (material items) for the Company; an independent evaluation of the BoD’s and committees’ performance in

2015 was carried out (the general results are disclosed); The Strategy Committee includes external experts and provides a broad

range of opinions to the BoD.

- the Company’s management efforts are focused on the investment

policy and reliability (a low proportion of KPIs focused on return rati-os and a positive cash flow) rather than on profit earning (given the special nature of the Company’s regulated business activity);

no long-term management remuneration system; the dividend policy is not up-to-date: the minimum dividend payout

ratio is set equal to 10% of the Company’s RAS (Russian GAAP) profit, there are no benchmarks for the minimum return on investment made out of net profits, dividends are paid out of profit leftovers;

the low remuneration of BoD members is not consistent with the Company’s asset value and does not meet the Russian and foreign practice (risks of having a poorly motivated BoD);

the CGC Code recommendations to pass resolutions on key activity issues by a qualified majority or a majority vote of the elected BoD members are not followed (2 out of 10 issues stipulated by the CG Code are taken account of in the Articles of Association);

the BoD cannot nominate candidates to BoDs of subsidiaries; the shareholders cannot request the convening of a BoD meeting; the appointment and early termination of powers of the Management

Board Chair is not within the BoD competence; the BoD has no power to approve the terms of contracts with Man-

agement Board members; the BoD and the HRC do not participate in the drawing up of the list

of BoD candidates for the next corporate year; certain BoD resolutions (e.g. as regards KPI setting) are approved or

adjusted in the middle or even at the end of the period in which they should be achieved (in fact, retrospectively);

the collective executive body is the supreme authority for preventing and managing conflicts of interest;

in 2016, the BoD failed to timely consider BoD and Audit Commission candidates and ensure related information disclosure as the principal shareholder (the Russian Federation) missed nomination deadlines.





ECONOMICS

88.6 90.8 91.2

11.4 9.2 8.8

45.5 43.6

2014 2015 2016

PJSC ROSSETI, Russian Federation, quasi-treasury shares

Private minority shareholders

Percentage of minority shareholders in attendance atGSMs

General shareholders meeting: activity of shareholders, related party transactions In 2014-2016, the percentage of private minority shareholders participating in general shareholders meetings (GSMs) remained consistently average, with a small decline (43.6% of the total number of private minority shareholders attending GSMs in 2016). The quorum reaches about 90%. In 2016, the under-involvement of minority shareholders in GSMs resulted in non-approval of related party transactions (for lack of a quorum). The manage-ment team declares voting quasi-treasury shares to ensure decision-making, including resolutions on related party transactions. Seeing as the re-cent changes in legislation solve the quorum problem as regards related party transactions starting from 2017, voting the package of quasi-treasury shares should be prohibited.

The minority investors’ combined shareholding does not allow them to influence decision-making on key issues of the Company’s activity at GMSs (except for related party transactions where PJSC ROSSETI is recognized as a party in interest). With due consolidation of votes, shareholders can elect one independent director. In 2016, only one of the minority shareholders controlled by Gazprom Group (Centerenergoholding) nominated 3 non-executive directors (the candidates were not elected).





ECONOMICS

Information on the shareholders of FGC UES, PJSC, according to Bloomberg data and information disclosure by the shareholders



PJSC ROSSETI 80.13

PJSC ROSSETI and Rosimushchestvo have agreed on the procedure for managing and voting the shares owned by ROSSETI. The said agreement is disclosed in materials prepared for one of the shareholders meetings, ROSSETI exercises the rights arising from its shareholding in FGC only as instructed by the President of the Russian Federation, Rosimushchestvo, or certain authorized offi-cials of the Russian Government.

KOPERNIK GLOBAL INVESTORS LLC

0.77

The shareholder discloses the voting policy applying to its funds (Statement of additional information dated June 29, 2015). According to the disclosure based on form N-PX, the funds (KOPERNIK GLOBAL ALL-CAP FUND) voted in the affirmative (“FOR”) on all issues, including related party transactions, at the 2016 AGM (except for the Audit Commission election), and voted for INEDs Igor Kamenskoy and Ernesto Fer-lenghi as BoD candidates.

VANGUARD GROUP INC 0.61

The shareholder discloses the GSM voting policy (Vanguard’s proxy voting guidelines), as well as the way it voted in the last corporate season. According to N-PX disclosure forms, the funds voted in the affirma-tive (“FOR”) on all issues, including related party transactions, at the 2016 AGM (except for the Audit Commission election) and voted for Igor Kamenskoy and Ernesto Ferlenghi as BoD candidates. The share-holder does not nominate BoD/SB candidates, but supports, according to the generally disclosed ap-proaches to voting, the idea of nominating at least 20% of INEDs by a group of shareholders holding at least 3% of the company’s shares in the preceding 3 years. The shareholder receives recommendations from proxy advisory firms.

TIFF ADVISORY SERVICES 0.38 The voting policy is disclosed in the general corporate profile. According to the available information disclosure, the shareholder did not vote in 2016.

PROSPERITY CAPITAL MANAGE-MENT UK

0.29 The shareholder is actively involved in corporate actions and implements the responsible investment principles in practice. No disclosure of the voting results.

HEPTAGON CAPITAL LLP 0.25 A summary of the voting policy is provided in leaflets. No data available on voting results.

LONDON STOCK EXCHANGE GROUP PLC

0.2 No data available

RUSSELL INVESTMENTS IRELAND LTD

0.15 The voting policy is disclosed (Russell Investments Proxy Voting Policies and Procedures, May 2015). Ac-cording to N-PX disclosure forms, the shareholder participated in the AGM 2016, voted in the affirmative (“FOR”) on all issues, including related party transactions, abstained on candidates to the BoD.





ECONOMICS


+ GSM-related materials (including their translation into English) are

disclosed 30 days prior to the meeting; shareholders can submit proposals to the AGM agenda over a long period

of time (90 days); explanatory notes and records of preliminary approval resolutions

made by the BoD are provided on all major agenda items; a comparison table of changes and additions, including the rationale

for making such amendments, is attached to new versions of by-laws; the annual report contains detailed information on related transac-

tions and major transactions approved in the reporting year, specify-ing the related counterparty, the essence and amount of transaction, as well as the parties in interest. Information on major transactions also includes the disclosure of entities controlled by the Company;

the annual report includes general information on meetings of committees, detailed information on the Company’s long-term devel-opment program and proposed changes to it, rather detailed com-ments on the CG Code recommendations the Company fails to meet and a description of the top management remuneration system, in-cluding a list of applied KPIs.

- dissenting opinions of BoD members on issues related to the holding

of GSMs are not disclosed; explanatory notes on agenda items are merely a formality (except for

comments in the annual report); materials related to the auditor selection by the GSM do not disclose

the non-audit services offered by the auditor (if any) and the pro-posed price of audit services.





ECONOMICS


* The base remuneration of BoD members at FGC UES, PJSC is substantially below the payments at the above peers and other Russian companies. Furthermore, the remuneration of BoD members is linked to the Company’s net profit and is only paid if the Company earns one (which contradicts the CG Code recommendations). The remuneration of BoD members at FGC UES in more than 37 times below the remuneration of Management Board members, while payments to BoD members at conditional peers are 15 times (on average) below the remuneration of senior managers (including the CEO). The BoD remuneration approach needs revision.

BoD activity aspect EDF S.A. Eversource Energy National Grid plc FGC UES, PJSC


5/12 11/12 7/11 3/11


(attendance / number of meetings)

BoD (11 meetings, all of them physical): attend-

ance ratio 96.3%; Audit Committee (8

meetings, all of them physical): attendance

ratio 87.5%; Nominations and Com-pensation Committee (2 meetings, all of them physical): attendance

ratio 87.5%

Board of Trustees (7 meetings, all of them physical); attendance

ratio 93% (1 non-attendance for good rea-

sons). Audit Committee, Com-pensation Committee, Corporate Governance Committee: attendance

ratio 100%

BoD (10 meetings, all of them physical): 2 BoD members missed one meeting each;

Audit Committee: (5 meetings, all of them physical): attend-ance ratio 100%; Nominations Committee (7 meetings, all of

them physical): 1 non-attendance; Remuneration

Committee (6 meetings, all of them physical): 1 non-

attendance.

BoD (59 meetings in total, 31 and 28 meet-ings before and after the BoD election, re-spectively. For 3 BoD members, attendance

ratio 73-86% (excluding BoD members quali-fying as parties in interest to many related party transactions); other BoD members: 94-100%. Participation by submitting expres-

sions in writing is not disclosed. Audit Com-mittee: 10 meetings, incl. 2 physical meet-ings; attendance ratio 80% for 1 member, 100% for others. HR and Remuneration

Committee (3 meetings, incl. 1 physical meet-ing): attendance ratio 100%.

Remuneration of BoD mem-bers / actual payments for

2015

€510K (2016) for all BoD members

Actual: €14.2 – 17.3K for an incomplete corporate year, €39.4 – 48.2K for a

complete corporate year.

$100K in fixed remunera-tion, $100K in shares (ac-cumulated until termina-tion of powers; $25K to

Chief Trustee, $15K to AC Chair, $10K to chairs of other commit-

tees. Actual: $202.6-237.6K (adj. for market value of

deferred shares)

£500K to BoD Chairman, £22K to Senior INED, £66K to

BoD member (UK), £78K to BoD member (US), £9K to Committee member, £19K to Chairs of the Audit Com-

mittee and the Remuneration Committee, £12.5K to Chairs of

other Committees

Maximum base remuneration: RUB 0.9 mil-lion per BoD member, divided by a factor of 1.3. Reduced base remuneration uplift fac-

tors: 30% for BoD Chair, 20% for Committee Chair, 10% for Committee member.

Actual: RUB 0.62 – 0.83 million.





ECONOMICS

Board of Directors

Chairman of the Board of Directors Oleg Budargin Chairman of the Management Board, PJSC ROSSETI, owns shares ac-counting for 0.0006403563% of the Company’s authorized capital;

Chairman of the Audit Committee Igor Kamenskoy (INED) Managing Director, Renaissance Broker LLC, no shareholding in the Company

Chairman of the HR and Remuneration Committee Ernesto Ferlenghi (INED) President of Confindustria Russia, Italian Industrialists Association, no shareholding in the company Independent director Pavel Grachev (INED) CEO, Polyus Management Company Ltd, no shareholding in the com-pany.

______________________________________________

The API was unable to arrange for a meeting with independent BoD members as the Company did not respond to a request. We therefore cannot in-clude comments on key corporate governance issues in this report and present a review of the BoD activity in practice.





ECONOMICS


In the period under review (2015 and 9 months of 2016), according to the information disclosure system, the BoD held 96 meetings, includ-ing 18 physical meetings. 1,110 issues were considered, including 742 issues concerning the approval of related party transactions amount-ing to more than RUB 135 billion in total (the highest number of relat-ed party transactions, over 66% of the total number of issues). Given the considerable number and volume of transactions, the non-disclosure by the BoD of approaches to considering such issues as regards both standardization of the information provided and the involvement of independent directors in their discussion is a negative point. In addition to related party transactions, the Board of Directors con-sidered the following significant issues:

reports on performance results (15 issues); issues related to internal audit (8 ) and risk management (6 issues); approval of KPIs/KPI achievement reports (6 issues); financial plan for the current and following years (8 issues); remuneration of the management (1 issue): a formal issue of canceling

the stock options plan regulation; approval of by-laws (regulations, policies, etc.).

The attendance ratio at the BoD is generally satisfactory, but lower at physical meetings. We note the following negative factors in the BoD activity:

consideration of essential issues at BoD meetings held in absentia; practice of replacing the personal attendance at BoD meetings by

expressions in writing; untimely submission of issues for consideration by the BoD; consideration by the BoD and committees (e.g., the Audit Committee,

the HR & Remuneration Committee), including independent directors, of issues put on meeting agendas (by-laws, preparation of transac-tions, consideration of the terms of contracts with BoD members, re-muneration of the management, etc.), especially issues recommended by the principal shareholder, is insufficient or completely lacking (a typical problem for the whole ROSSETI Group);

approval or taking note of separate planning documents several months after the commencement of the execution period, sometimes nearly at the deadline.

This underperformance is partially attributable to the special nature of the Company’s regulated business activity, such as delays in mak-ing tariff decisions or approvals from the Ministry of Energy: for in-stance, the 2016 KPIs were approved at the end of the relevant period (the decision was made on December 30, 2016!).

It should be noted that the BoD did not pay attention to updating the dividend policy on its own initiative.

As follows from the information disclosure, the BoD also stays away from considering the terms and conditions of contracts with Manage-ment Board members authorizing a certain person to define the terms of contracts and to sign employment contracts with senior managers. The same was the case beyond the period under review, as exemplified by the consideration of the contract with the Management Board Chairman in 2013.

We note the frequency of non-unanimous voting, i.e. negative (“against”) and neutral (“abstained”) votes cast, inter alia, by the BoD Chairman (in 2015-2016), which is a unique case among the companies covered by this research. No comments from the BoD are available as the INEDs declined to meet with the research experts.

In early 2016, JSC VTB Registrar engaged through competitive bidding as an external adviser evaluated the BoD performance in 2015. The evaluation covered the general performance of the BoD, the perfor-mance of each committee and the individual performance of each BoD member. VTB Registrar’s research involved questionnaire surveys of members of the BoD, committees and the Management Board, interviews with several members of the BoD, committees and the Corporate Secretary. The performance evaluation results are disclosed in most general terms (total score 4.7 out of 5 on average for the BoD, 5 out of 5 for the BoD Chairman).





ECONOMICS

Audit Committee (AC) The AC consists of INEDs (2 INEDs / 3 AC members in 2015, all members being independent in 2016).

In 2015, the AC held 10 meetings, including only 2 physical meetings (a total of 28 issues were considered). The meeting attendance ratio is close to 100% (80% for one AC member)

The AC considered the following key issues in 2015: reports of the internal control and risk management department (a

case of good practice), reports of the internal audit department; performance evaluation of the external auditor; recommendations for the payment of the external auditor’s services; report on organizing a monitoring and control system; financial viability of the Company’s counterparties; internal audit quality evaluation and improvement program; regulation on the risk management system; efficiency assessment standard for the internal control and risk

management system; internal audit regulation; internal audit organization guidelines; other standard matters: accounting (financial) statements (including

their discussion with the external auditor), external auditor selection, activity plan and budget of the internal audit department, report on key risks. Our inability to meet with the Chairman and members of the Audit Committee prevented a proper practical assessment of the Commit-tee’s performance covering relations with external and internal audi-tors (performance evaluation and selection, adequacy of resources), particularities of the internal control and risk management system, etc. The number of physical meetings, in our view, indicates a formal approach to the Committee’s activity.

HR and Remuneration Committee (HRC) The Committee consists of INEDs (2 INEDs / 3 HRC members in 2015). Only 3 meetings were held in 2015, including 1 physical meeting. The attendance ratio is 100%.

The HRC considered the following issues:

executive office structure; quarterly KPI achievement reports; top management KPI calculation and achievement evaluation

method; inclusion of operating cost (expenditure) reduction targets in the

KPI system.

The HRC did not consider the BoD performance evaluation (except for a survey of HRC members for independent appraisal purposes). There is also no information on the consideration by the HRC of proposing a list of BoD candidates for the next corporate year to the shareholders (at least proposing a list of independent directors to Rosimush-chestvo). The HRC did not consider the terms of contracts with BoD members; when the election of a Management Board member was considered in 2015, the BoD delegated the power of defining the terms of the contract with the new member to the Management Board Chairman instead of handling this essential issue at its own discretion (a negative practice).

We were not able to meet with the Chairman and members of the HRC to discuss, among other things, long-term incentives of the manage-ment team, access and participation of BoD members in the discussion of effective essential terms of contracts with Management Board members, the KPI system and other essential aspects of the Commit-tee’s activity. The number of physical meetings, in our view, indicates a formal approach to the Committee’s activity.





ECONOMICS

Essential CG aspects Relations with the external auditor

The final price of the auditor’s services is subject to approval by the BoD, the terms of the auditor competitive selection procedure are approved based on the AC recommendations (with no AC minutes dis-closed, it is not clear whether the maximum bid price and other terms of the procurement specifications were subject to prior consideration before the procurement was approved by the Company’s bidding commission).

In April 2015, PJSC ROSSETI conducted the comprehensive procurement of audit services to audit the RAS (Russian GAAP) and IFRS financial statements of ROSSETI’s subsidiaries and affiliates for 2015-2017 (3 bidders, including 2 bidders from the Big Four group). RSM Rus LLC was declared the winner (the cost of audit services in relation to FGC UES amounted to RUB 74.049 million). The procurement was pursuant to an order of PJSC ROSSETI, the bidding terms and conditions were ap-proved by the bidding organizer subject to the Company’s (the cus-tomer) procurement regulation (the approval of the terms of procure-ment by the bidding commission is not disclosed).

In August 2015, the Company announced an open invitation to tender for the audit of FGC UES Group’s consolidated financial statements for 2015-2017 and a review of FGC UES Group’s consolidated IFRS financial statements for the 6-month periods in 2015-2017. Among 3 bidders, JSC KPMG was declared the winner, the price was RUB 44.816 million, while the parties agreed to negotiate its reduction).

The reasons behind the additional bidding for the audit of IFRS finan-cial statements and the role of the AC in approving the bidding terms and conditions are not disclosed.

It should be noted that investors are discomforted by the Big Four companies discontinuing the audit of major Russian public state-owned companies, believing in their higher independence and fairness guaranteed by their international reputation, compared with Russian peers.

At the 2016 AGM, the BoD proposed (minutes no. 322 as of 05/27/16) and approved RSM Rus LLC selected during ROSSETI’s comprehensive procurement of audit services as the single auditor.


The Company discloses minutes of BoD meetings (except for BoD meetings addressing sensitive / confidential issues), including individ-uals voting by BoD members; reports on BoD resolutions included in the disclosure system also contain individual voting data, which is a case of best practice. At the same time, the Company does not disclose dissenting opinions of BoD members, which is of particular relevance for shaping the GSM agenda.

The Company discloses essential parameters of related party transac-tions, including the parties, values/limits and respective parties in interest.

Dividend policy

The dividend policy regulation has not been updated since its adoption in 2010, dividends are paid out of the Company’s RAS net profit.

The Company earmarks at least 10% of its RAS net profit (less ex-traordinary financial income (revaluation etc.) and reserve fund deduc-tions) for dividends. In addition to the compulsory portion, there is a voluntary portion of the base equal to the RAS net profit less extraor-dinary financial income, less reserve fund deductions, less 10% of the said amount (minimum dividends), less investment (at least equal to the amount of investment financed out of net profits as approved by the regulatory authority). No minimum return ratios are set for such investments.

The actual 2015 dividends were equal to the whole RAS net profit (38% of the consolidated IFRS net profit) net of reserve fund deductions. This approach has not yet become a standard practice being depend-ent on the principal shareholder’s position (the Government of Rus-sia’s executive order no. 705-r dated April 18, 2016).

Conditional peers earmark more than 50% of net profits for dividends.





ECONOMICS

Dividend payments at FGC UES, PJSC vs. peers

Charity & social responsibility

In 2015, FGC UES, PJSC, its subsidiaries and affiliates spent RUB 50.9 million on charity. The Company has not disclosed its sponsorship spending in 2015 (including sponsorship and advertising in sports), so that its real expenses for these purposes cannot be properly assessed.

Spending by comparable companies on charity social investment, % of net profit (estimate)

* the exact estimate is problematic, given that the Company does not disclose additional advertising expenses under contracts with sports organizations, etc

Disclosure of the management motivation system at international peers The Company’s 2015 annual report discloses its KPIs, sometimes with relative weights (their combined relative weight for annual remuneration pur-poses reaching 45%), but the correlation between the KPIs and specific payments is not disclosed. Taking into account international practices, the BoD should consider disclosing the remuneration system, including the long-term and short-term incentives and the correlation between payments for the reporting period and the KPI achievement. In our view, the list of KPIs for remuneration purposes needs revision (fewer KPIs, higher relative weight of each KPI, more KPIs related to EPS and shareholder return).

The Company separately discloses the size and structure of the Management Board Chairman’s remuneration, which is an example of best practice and the only case of such disclosure among the PJSCs covered by the research.

No long-term management incentives based, among others, on the Company’s shareholder value are awarded; that said, FGC is the only company among the conditional peers paying quarterly bonuses to senior managers.

Management Board members actually do not own shareholdings in the Company: only 2 of them possess insignificant stakes (worth RUB 0.05 million and RUB 0.21 million, respectively).

Mio €/ Mio £/Mio USD/Mio rubles EDF S.A. Eversource Energy National Grid plc FGC UES, PJSC (IFRS)

2015 profit 1,187 878.5 2,386 44,768

2015 dividends (including interim dividends) 2,043 529.8 1,337 16,976.63

Payout ratio (the ratio of dividends to net profit) 172% 61% 56% 38%

. EDF S.A. Eversource Energy National Grid plc FGC UES, PJSC (IFRS)

1.85% 0.57% 0.61% 0.11%*





ECONOMICS

Approximate proportions of CEO remu-neration components at FGC UES vs.

peers in 2015 EDF S.A. Eversource Energy National Grid plc

FGC UES, PJSC (Management Board)

Fixed annual remuneration 100% 13% 24% 36% Annual bonuses (also, quarterly bonuses

at FGC UES, PJSC) 0% 25% 28%

64%

Long-term remuneration 0% 62% 49%

EDF S.A. Eversource Energy National Grid plc FGC UES, PJSC

Disclosure: all payments, incl. in the form of stock, estimate of fu-ture payments

CEO Actual: €450K in salaries,

zero bonuses and zero long-term incentives (not awarded until

resignation)

CEO + CFO + 3 top manag-ers

Actual (CEO): $1,232K in salaries, $2,400K in bo-nuses, $5,805K in long-

term incentives

CEO + CFO + 2 top managers Actual (CEO): £1,033K in salaries,

£1,222K in bonuses, £2,125K in long-term remuneration

All collective executive body members, incl. sole executive body (SEB) + sepa-rate payments to SEB. Actual (Man-agement Board): RUB 110 million in

salaries, RUB 194 million in annual and quarterly bonuses

KPIs influencing the short-term (annual) variable remuneration component (incl. fixed relative weights of the KPIs, if any)

None

EPS, dividend growth, credit rating (70% in ag-

gregate) Reliability, security, staff diversity, operating effi-ciency, application of new technologies, consumer

perception (30% in total)

EPS 35%, ROE (Group) 35%, individ-ual KPIs 30% (security and compli-

ance; strategy; business growth; individual man-

agement indicators; consumer per-ception; staff involvement; devel-opment of opportunities and rela-

tions with stakeholders)

TSR, ROIC, specific operating cost re-duction, safety (accident rate, injuries), energy losses, achievement of target

reliability of services, reduction in spe-cific investment expenditures, compli-ance with facility commissioning dead-lines, compliance with power connec-

tion deadlines, labor efficiency KPIs influencing the long-term variable re-muneration

>80% EBITDA in 2 out of 3 last years before

resignation

Average diluted EPS adj. for irregular components, TSR vs. companies includ-ed in Edison Electric In-

stitute Index

TSR 25% (vs. FTSE 100), adj. ROE (for the group) (vs. retail price index) 50%, ROE UK 12.5%, ROE US 12.5%

(vs. average ROE approved by regu-latory authorities)

None

Long-term bonuses €200K and €60K quar-terly, but not to ex-ceed total annual

salary, final payment at resignation

Deferred stock units (without KPIs, incl. limit,

1/3 of total amount paya-ble annually for 3 years in shares). Shares for KPI achievement (calculation

period 3 years)

Long Term Performance Plan (LTPP) in the form of shares (3 years)

None





ECONOMICS





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