November 29, 2017 / 9:28 AM / in a year

Fitch: Russian Yarovaya Law Highlights Telco Regulatory Risks

(The following statement was released by the rating agency) MOSCOW, November 29 (Fitch) The continuing uncertainty over the implementation of Yarovaya law increases the risk that many Russian telecoms may face significant one-off investments leading to a leverage spike in 2018. In our view it is unlikely that the law-related costs will be fully passed on to customers, thus spelling negative implications for the industry's profitability and cash flow generation. The Yarovaya law was adopted in mid-2016 and comes into effect on 1 July 2018. The law requires that potentially all customer traffic (including video, audio and graphical information) is stored for up to six months, with a caveat that the government may decide on the exact rules for the timing length and volume of storage. The regulator was reported to have submitted its proposals to the government in November 2017, with the most likely scenario asking for one month of storage initially, gradually increasing to six months over a number of years. Technical requirements may be demanding. Huge traffic volumes would require new storage capacity on an unprecedented scale. In the worst case scenario of storing most of customer traffic, operators would also need to nearly double their port capacity as any data stream to an individual customer would also have to be simultaneously sent to a storage facility. The potential financial impact of the new legislature may be significant. In October 2017 the regulator estimated the likely initial one-off investment at tens of billions of roubles per operator, with the overall investment not to exceed RUB100 billion per operator over a three-year period. Operators with high traffic volumes such as fixed-line broadband providers (e.g. Rostelecom (BBB-/Stable)) would face higher investment requirements than mobile-only providers (e.g. LLC T2 RTK Holding (B+/Negative)). The rating implications will depend on the amount and timing of incremental investments, leverage level and expected deleveraging capacity. We expect that Rostelecom's ratings should be able to withstand a spike in leverage, based on our scenario analysis. With the company's EBITDA at slightly less than RUB100 billion, the Yarovaya law-related one-off costs of also below RUB100 billion are equivalent to 1x additional leverage. With Rostelecom's funds from operations adjusted net leverage forecast by Fitch to end-2017 at 2.3x, an additional 1x would still keep leverage below our 3.5x downgrade threshold. The rating impact may be more negative for operators with lower leverage headroom such as VEON (BB+/Stable) and T2 RTK. Generally, we expect the impact to be more significant for smaller operators such as PJSC Tattelecom (BB/Stable) and Transtelecom (B+/Stable), as they may find it more challenging to comply with the technical requirements at a reasonable cost. We believe operators will not be able to fully pass on incremental costs to subscribers. The Russian telecoms market is mature and competition is intense. Abrupt price increases are unlikely to be well received by customers and could lead to substantial market share changes. We continue to treat the potential impact of Yarovaya law as an event risk as the legislation requirements may change and/or its implementation delayed. Historically, the industry has been able to reach amicable compromises with the authorities. However, with less than eight months to the date when the law comes into effect and no clear implementation parameters set by the regulator, we see the cliff risk as significant and potentially onerous. 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